Since ZS revenues have accelerated heavily the past few quarters, I added it back to my portfolio and thought it would be helpful for me to summarize the earnings that came out on 12/3/2020.
One thing at the front of my mind was, is this another company that covid enabled to “take all the low hanging fruit”? Based on the transcript, it sounds like they didn’t take all the low hanging fruit, but covid certainly helped the business. I suspect covid helped ZS about as much as it helped Crowdstrike or Cloudflare, and less so than say, ZM or Teladoc.
Anyway, here are my highlighted quotes:
excited to welcome, Chris Kozup to the Zscaler team as our new Chief Marketing Officer.
Let me highlight three factors that drove our strong performance in the quarter. One, building on our growing traction with large enterprises. We closed a record number of seven-figure ACV deals. The majority of these wins are three-year commitments to provide the foundation for application, network, and security transformation. In particular, I am pleased with our increasing wins in the financial services vertical, which is now embracing the cloud and the Office 365 deployments have become an important catalyst for us.
Two, our optimized go-to-market engine is driving significant velocity, including a strong pace of new logo acquisitions. I am very pleased with our performance across all geos. Last year, we doubled down on our investment in our sales organization. We scaled our sales enablement team and built a repeatable and metrics-driven process, which is giving us better visibility into our business and ultimately resulting in a strong and growing pipeline. These efforts are also bearing fruit in two big ways. One, our newly hired sales reps are contributing at a faster pace. And two, our sales productivity is higher than a year ago, despite a high percentage of ramping sales reps.
Three, the power of our Zero Trust Exchange platform is resonating with CxOs. Our platform is comprised of four key pillars with each enabling a critical element of the transformation. ZIA to secure direct access to Internet and SaaS, ZPA for zero trust access to private applications, Zscaler Digital Experience or ZDX to deliver user experience for work from anywhere, cloud workload segmentation to protect applications.
An increasing share of our sales is coming from initial platform purchases by new customers and also growing upsell to existing customers, which is driving a record 122% net retention rate.
Many CxOs shared with me that their current work from home environment, while temporary, has helped them realize that zero trust architecture is the future, and it can be implemented easily and rapidly. COVID was a catalyst in changing the mindset and shaking off inertia, resulting in a reduced need for educating customers about the value of the Zscaler architecture over legacy approaches.
Inbound customer requests have greatly increased, and we are becoming an integral part of a growing number of larger transformation projects. We continue to see more customers buying ZIA and ZPA together, which enables a true transformation with direct and seamless access to SaaS applications or applications in your datacenter or the public cloud.
For example, a global manufacturing company purchased our Transformation Bundle plus DLP and CASB for 45,000 users and ZPA for 25,000 users. Drivers for this deal were network and security transformation. They had a traditional hub and spoke network for 300 manufacturing facilities, which were slowing their adoption of cloud applications such as WebEx, Office 365 and Workday. A next-gen firewall vendor tried to sell its hybrid offering but failed to meet their security and performance requirements, including SSL inspection.
In one new customer win, a Fortune 50 retail customer replaced a legacy web gateway with ZIA for cybersecurity and data protection. This customer purchased ZIA Professional Bundle plus CASB, Sandbox, and DLP for 45,000 users. Security was a major requirement and only a proxy architecture with SSL inspection was considered. This deal was a good example of Zscaler leveraging our tech partners, where CrowdStrike became the endpoint security provider and Microsoft, the identity provider.
The most common themes in our customer wins are to increase user productivity, reduce business risk, simplify IT and reduce cost. The Zscaler platform enables this by consolidating and eliminating point products.
ZPA - zscaler private access
Moving on to ZPA. Our customers view ZPA as the foundation for their architectural shift to zero trust access for private applications. Our platform eliminates the Internet attack surface of customers’ applications, resulting in reduced business risk. ZPA is the clear market leader with proven maturity and scalability. We are supporting hundreds of large enterprises in the complex multi-cloud environment.
To close my business review, I will touch on some early success with our new emerging products. There is an accelerated market shift towards work from anywhere, which aligns with our platform and emerging products like ZDX. We had a number of ZDX wins in the quarter, including an upsell with a European Bank for 40,000 employees. This customer had ZIA for all employees. And it was frictionless to turn on ZDX to get end-to-end visibility and resolve performance issues.
Zscaler is the largest in-line cloud security platform in the world. We are processing more than 140 billion transactions daily, while preventing seven billion security incidents and policy violations. Deployed across more than 150 data centers, our Zero Trust Exchange platform was built from the ground up for the Secure Access Service Edge or SASE framework.
As the world moves to SASE framework and zero trust architecture, some of you have asked about competition and why others can’t build a cloud native platform like Zscaler.
Well, the answer lies in the architecture, which is like the foundation of a building that supports everything. Our foundation is a multi-tenant architecture built from the ground up for in-line traffic inspection. It delivers over 20 key security solutions including antivirus, cloud sandbox, cloud firewall, DLP, advanced threat prevention and SSL inspection at scale. That’s extremely hard to build and complex to operate as a cloud service without compromising user experience. It is like the difference between building a simple SaaS application versus a highly complex SaaS platform like an ERP.
With our business momentum, we are also demonstrating that our strategic sales process and world-class execution are important competitive advantages. First, our consultative sales model identifies the value we can drive for the customers and enables them to fully realize the benefits of digital transformation. This strategic sales process requires top sales talent. I believe we are the best sales team top to bottom and we are hiring at a rapid pace.
ExponentialDave If I recall, it was just 3 or 4 quarters ago where the sales team got the blame for slowing sales. Now just a few quarters later, they are “the best sales team”. I think it’s normal for CEO’s to boast on these calls - just seems hyperbolic to me at this point in the call.
Second, we are deepening our ecosystem of technology partners, which are contributing to deal wins and adding leverage to our sales model. In addition to our ongoing partnership with Microsoft and CrowdStrike, we have now extended our strategic partnership with VMware
FINANCIALS
Revenue for the quarter was $142.6 million, up 13% sequentially and 52% year-over-year.
ZPA revenue was 13% of total revenue.
ExponentialDave: Would love to see a breakdown of revenue by product. Seems they only broke out zpa revenue for some reason…
From their slide show:
Zscaler has 450 companies of the Forbes Global 2000
Revenue model is on a per user basis
ExponentialDave: I threw this in there from the slideshow because it has become a flashpoint for us to focus more on investing in companies that charge per data usage such as FSLY and SNOW as opposed to companies that can only sell per seat such as ZM, AYX and apparently ZS too.
From a geographic perspective, we have broad strength across our three major regions. Americas represented 51% of revenue, EMEA was 39% and APJ was 10%.
ExponentialDave: Relative to our other SAAS companies, ZS has a lot of business abroad.
Revenue exceeded our guidance due to stronger than expected deal activity as the value proposition of ZIA and ZPA is increasingly becoming clear to customers.
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 64% year-over-year to $144.7 million. As a reminder, our contract terms are typically one to three years.
Remaining performance obligations or RPO, which represents our total committed non-cancelable future revenue, was $864 million on October 31, up 56% from a year ago. The current RPO is 54% of the total RPO. We had a healthy mix between new and existing customers with new customers contributing over 50% of new and upsell ACV.
Our strong customer retention ability to upsell have resulted in a consistently high dollar-based net retention rate, which is 122% compared to 120% last quarter a year ago. As we have highlighted, this metric will vary quarter-to-quarter. While good for our business, our increased success selling bigger transformation bundles, selling both ZIA and ZPA from the start and faster upsells within a year can reduce our dollar-based net retention rate in the future.
ExponentialDaveThis is intuitive when phrased eloquently, but it sounds like they are basically implying this might be as good as NER gets. Selling more stuff now, in this case, means there is less stuff to upsell customers to later.
Total gross margin of 81% increased two percentage points sequentially and was comparable on a year-over-year basis. Sequential improvement was driven by migrating most of the ZPA infrastructure to our data centers during the quarter, as well as timing of expenses.
Turning to operating expenses. Our total operating expenses increased 11% sequentially and 33% year-over-year to $96 million. Operating expenses as a percentage of revenue improved by 10 percentage points from 77% a year ago to 67% in the quarter. Sales and marketing increased 12% sequentially and 31% year-over-year to $64.2 million. The year-over-year increase was due to higher compensation expenses and investments in building our teams and go-to-market initiatives offset by lower T&E with our employees working from home.
ExponentialDave: So they are spending more money on marketing which is paying off in the form of higher revenues from the looks of it. On the one hand, it’s a good thing when we see their investment in sales/marketing paying off. On the other hand, it can become a bad thing if the sales/marketing ROI is not high enough. Nice that we are seeing operating expenses as a percent of revenue go down significantly.
R&D increased 8% sequentially and 42% year-over-year to $20.9 million. The increase was primarily due to continued investments in our team. G&A increased 9% sequentially and 29% year-over-year to $10.9 million. The growth in G&A includes investments in building our teams, compensation-related expenses and professional fees
Our first quarter operating margin was 14%, which compares to 4% in the same quarter last year.
Net income in the quarter was $20 million or non-GAAP earnings per share of $0.14.
We ended the quarter with over $1.4 billion in cash, cash equivalents and short-term investments.
Free cash flow was positive $42 million in the quarter, which is a meaningful improvement from $11 million in the prior quarter and $9 million in the year ago quarter.
For the second quarter of fiscal 2021, we expect revenue in the range of $146 million to $148 million, reflecting a year-over-year growth of 44% to 46%. Operating profit of $11 million to $12 million, other income of $800,000, net of interest payments on the senior convertible notes, income taxes of $1,250,000 and earnings per share of approximately $0.07 to $0.08, assuming $144 million common shares outstanding.
Due to better than expected first quarter performance and our strong pipeline, we are increasing our full-year fiscal 2021 guidance for revenue, billings and profit. For fiscal 2021, we now expect revenue in the range of $608 million to $612 million or year-over-year growth of 41% to 42%. Calculated billings in the range of $755 million to $765 million or year-over-year growth of 37% to 39%. Operating profit in the range of $55 million to $57 million. Other income of $2.7 million, income taxes of $4.5 million and earnings per share in the range of $0.37 to $0.38, assuming approximately $145 million common shares outstanding.
Q & A
JAY Chaudhry: Sterling, thank you. Financial services have been slow in embracing the cloud, but now they are all opening up. They are embracing cloud and Office 365 is becoming the catalyst. To make Office 365 work, there had to be some transformation in the network and security, and we have done so much work with Microsoft to make sure Office 365 can be enabled securely delivering a fast user experience. So that’s becoming our number one application to get into that space, and then it’s expanding from there.
Jay on covid induced growth:
Yes. Lots of questions are being asked pre-COVID, post-COVID, and whatnot. If you look at our record pre-COVID, we had very good growth, our business is accelerating. It’s driven by acceleration in digital transformation. Now, COVID was a catalyst in shaking off inertia. The change in mindset has accelerated demand for zero trust. When I talk to CIOs, they tell me, we did not realize how important it was to do transformation being able to embrace cloud for collaboration, for security, and the like. So, they are really moving faster than they did before. And so, momentum to our business clearly has picked up because it has highlighted the limitation of the old legacy and old network, and need to transform and this transformation works. So, we are pretty bullish. We think even after a vaccine, our business will keep on accelerating.
ExponentialDave: This was a good answer from Jay in the sense that, he is sort of telling us what we as investors want to hear. How much truth is behind it, I think only time will tell.
Jay, maybe for you, the question is do you have any statistics or just general thoughts on how many of your engagements are competitive? Meaning, a competitive breakup process versus perhaps being brought in by a service provider where there really isn’t a competitive process. Does that makes sense?
Jay Chaudhry
Yes. Saket, thank you. Your question reminds me of my days at AirDefense and CipherTrust when I used to sell security appliances and we used to have lots of bake-offs, which box is faster, which big box is cheaper. At Zscaler, we are all driven by transformation. Transformation is not a box you sell. It actually starts with CIO level discussion to help them enable their applications to network, to security, all of them together. So, most of our deals at the higher end, at the large enterprise level aren’t really competitive much at all.
When you come to lower end, we do see some of the competition, but bake-offs are rare. In fact, I highlighted a win in my prepared remarks where even though there was an RFP that we won with a managed services partners, all six SI and SPs bid Zscaler, okay. I am very proud of it. That’s because the customers and the SI/SP channel understands that you can take typical legacy boxes and try to make them do cloud transformation. So when it comes to competition, I think we got some big, big lead. Unless someone tries really purpose-build something, have a good architecture, we will maintain this lead.
Tal Liani
Hi guys. Great quarter. My question is more higher level. I am trying to understand the expectations for next year. So if I look at your guidance and I add a little bit more for beaten raise which you have done in the last few years, you are going to be staying in the same growth rate we have seen this year. And I am trying to get the qualitative part of, you have older solutions and you have newer markets. How do you view the growth rate in older solutions like ZPA? How do you view your level of competition there? The ability to gain new customers versus grow with existing customers? And then, same question about your newer areas. What are the driving factors? I am trying to understand how to build a spreadsheet for next year when it comes to the various solutions that you are offering.
Jay Chaudhry
I mean it’s a very good question, Tal. Think about the four key solutions I talked about. ZIA has been a workhorse. It has been growing rapidly. But in spite of that, if you look at our penetration, in Global 2000 we are just under 25%. And there’s a big market, majority of the market sitting open out there. In fact, there is still a sizable market of legacy where proxies like Blue Coat and that’s to be removed and we are taking more and more part of that. So that’s kind of one-piece.
And ZIA is not one product. As you know, ZIA is a portfolio of several offerings and more and more customers are buying either bigger bundles like Transformation to start with or they are moving up from business bundles or professional bundles. So that’s a pretty sizable thing on ZIA. We’re nowhere close to leveling off at all.
ZPA, relatively younger, only about four years old, have gone from zero to about 30% and offer new business in that range. And if you look at our customer base, just about in the mid-30%, somewhere 30% or so of the Global 2000 ZIA customer have ZPA. So even in our installed base of ZIA, there’s a big market out there. So we think these two big proven product portfolios or call them, too big pillars, they have plenty of room for opportunity.
And then ZDX, digital experience, is becoming an interesting product. It’s a new product in a new area. Because as you go over the Internet, no one has any meaningful offering to let someone know end-to-end response time. We expect pretty good growth from it. One day we expect almost every user will have ZIA, ZPA and ZDX. And that’s the way we are driving towards.
The fourth area is new area, the cloud workload, the data center. I think that market will take some time to mature. As Remo has said, we are now really pulling tons of revenue in some of the new areas. But you shouldn’t think about CASB type of things as new products. I mean, they are new, but they are part of ZIA portfolio. They automatically attach to our ZIA bundle. In the same way, we are seeing browser isolation picking up, which either goes with ZIA or goes with ZPA. But plenty of room in all areas.
And I always said to my sales leaders, we have lots of product to sell. Let’s scale our sales organization and that’s what we are focused on. We are focused on growing go-to-market, which is doing very well. So excited for next year.
Remo, did I cover?
Remo Canessa
Yes. I mean, it’s a great question. I mean you take a look at the percentage of customers that have transformation, we have indicated it was 49%, over the last call in July. And it has gone up this quarter and it has continually gone up. ZPA is 13% of revenue, so big opportunity with their installed base for that in our emerging products. We had an acceleration in growth of new customers in Q1 versus the growth in Q4. So we are seeing momentum. We are seeing deal sizes getting bigger. We are seeing the need for transformation on a broader scale, as Jay mentioned, driven by COVID.
But COVID started the visibility. What we are seeing right now is the realization on the part of CIOs and others and companies at high level who understand the legacy architectures they have got are really not the architectures. That’s what’s driving the business for us. It is that.
…So first of all, I think our hiring is happening at a faster pace than we had even expected. So very good actually. Remember about a year or two years ago, we used to say we are behind in hiring sales reps. Remo, you recall that. All that is past. I think probably our brand is helping that well known out there. Also our sales leadership has put a deep and wide leadership in place.
Hi guys. This is Dan Caiello, on for Patrick. Congratulations on a great quarter. I just wanted to ask on the pricing environment. Obviously, it seems really strong. But I am just curious if you guys could comment on how prices have trended? And then obviously really impressive retention rate. So I am curious how much of that is adding new product on versus expanding more into the organization, if that makes sense?
Remo Canessa
Yes. So it’s a comparable pricing environment. Our price per user did go up quarter-over-quarter. Related to what drove the net retention rate, as Jay mentioned, the emerging products are not significant impact. So it’s more of the existing products, the movement to transformation as well as ZPA, which is what drove the increase in net retention rate.
…Our big focus traditionally has been large enterprises and we have done extremely well among the penetration we are doing in those customers in terms of percentage and in terms of the deal, the ARR we are having in those customers is actually going up very well. We are very pleased with that…
…But if you look at the segment, we are now getting more focused on 2,000 user to 10,000 user segments, because we already got the largest segment over 10,000 and pretty well covered and we are getting great wins out there. So there is a big market for us to come downstream and expand as well.
Remo, you want to add more.
Yes. I mean, Jay is absolutely correct. The ARR per customer is definitely increasing. One of the ways we break it out is, customers with greater than 3,000 users were over $450,000 ARR per customer, which is up year-over-year, just keeps on going up. New customer growth, we have stated, it’s within the range of our historical range of 50%, 60%. As I had mentioned before, we had an acceleration of new customer growth in Q1.
…Microsoft, you know that partner goes for several years. It started with Office 365 deployments with great user experience, single configuration type of deployments. And then expanded beyond to Azure AD to Azure Access to Azure Sentinel and even to endpoint areas. Microsoft is pushing now Office 365 in financial services, because they have been the late adopter of Office 365. And that’s particularly helping us because those large companies want to make sure this deployment goes well and Zscaler is their go-to partner in those deployments.
So Microsoft is helping or we are helping Microsoft and they are helping us in these financial services customers.
Fatima Boolani
Good afternoon, gentlemen. Thank you for taking the questions. Jay or Remo, I wanted to hit back on some of the commentary in the prepared remarks around ZPA deployment. I mean, we have gone from zero to mid-teens percentage of your revenue now derived from ZPA. So I am wondering and appreciating some of the bigger picture factors that are driving the demand for ZPA. I am wondering if you can be more specific about where are some of the budget dollars are coming from that are getting reallocated in your favor for ZPA adoption?And to what extent is there a more expansion runway here that hasn’t necessarily been pulled forward, because we have all started working from home overnight over the course of this year? So just getting some more specificity around where sort of the ZPA budgetary dollars are being earmarked away from in your favor?
Jay Chaudhry
So if you think about it, while a lot of stuff we do are transformation, generally there’s an entry point for each area that’s the easiest one from budget point of view. So VPN ends up being the entry point and the first point. But as we have said many times, ZPA is being bought for zero trust implementation. In the past one year, I have seen interest in zero trust gone big, big time. And it’s a specific architecture, where you don’t put connect users to the network. So any product that’s a VPN related, whether it is an on-prem product or it’s a cloud-based VPN, it’s still VPN and doesn’t really get counted as the zero trust offering.
So it starts with taking out the VPN budget. But more importantly, all the wins we are having are being done to make sure they can also do zero trust access to not only your data center, but also to cloud application sitting in Azure AWS and more and more customers want to implement zero trust even when you are in the office. So we don’t think that ZPA wins are coming because some of the deals are being pulled forward. We think COVID is actually accelerating and showing the need for zero trust being able to access anything from anywhere. And we see this acceleration continue. So very confident about the ZPA projection and that’s reflected in the pipeline we are seeing for ZPA.
If I may say, the combination of ZIA and ZPA ensures that any user can work from anywhere, office, home, wherever. And that’s where the zero trust comes in. It’s a same user experience, same level of security, same level of policy and that’s what CIOs are buying.