Zscaler, Inc.

Ladies and gentlemen, thank you for standing by and welcome to the Zscaler first quarter 2021 earnings conference call. At this time, all participants are in the listen-only mode. After the speaker presentation, there will be a question and answer session. To ask a question during the session, you would need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your first speaker today, to Mr. Bill Choi, Senior Vice President, Investor Relations and Strategic Finance. Thank you. Please go ahead.

Good afternoon, everyone, and welcome to the Zscaler Fiscal First Quarter 2021 Earnings Conference Call. On the call with me today are Jay Chowdhury, Chairman and CEO, and Remo Canessa, CFO. Hello. 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. Starting in fiscal 2021, we are excluding stock-based compensation-related payroll taxes in our non-GAAP presentation. The gap to the non-gap reconciliations for historical periods can be found in the supplemental financial information. 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, and earnings per share. These statements and other comments are not guarantees of future performance, but rather are subject to risk and uncertainty, some of which are beyond our control, including but not limited to the duration and impact of COVID-19 on our business, the global economy, and the respective businesses of our customers, vendors, and partners. These forward-looking statements apply as of today, and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. For a more complete discussion of the risks and uncertainties, please see our filings with the SEC as well as in today's earnings release. I would also like to inform you that management will be presenting at the following upcoming events. Credit Suisse Technology Conference tomorrow, UBS Global TMT Conference on December 7th, Barclays Global TMT Conference on December 10th. Our annual Zenith Live Cloud Summit for the Americas and EMEA will be held virtually next week and for APJ the following week. We encourage everyone to register and view our summit. We also invite you to attend a one-hour product Q&A session specifically for investors and financial analysts on Wednesday, December 9th. The presentations for these events will be webcast, and the links will be available on our investor relations website. Now I'll turn the call over to Jay.

Thank you, Bill. First of all, I hope all of you and your families are healthy and safe. I'm proud of our strong results and an exceptionally strong start to fiscal 21 in our first quarter. We delivered 52% growth in revenues. and 64% growth in billings, while also generating record operating profits and free cash flow. I believe our financial results demonstrate Zscaler's pivotal role in enabling our customers' digital transformation journeys, which are accelerating at a pace never seen before. Our visibility and business momentum remain strong, and we are pleased to increase our fiscal year guidance. I believe the market is coming to us and we are investing across our organization to capture a significant share of our large and growing opportunity. I would like to thank the Zscaler team and our partners for their tireless efforts and commitment to our customer success. I'm also pleased and excited to welcome Chris Koza 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'm very pleased with the 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. I believe in the current challenging environment and in the post-COVID economy, Zscaler will be the go-to platform for vendor consolidation, cost savings, increased user productivity, and better cyber protection. We are excited about our mission to make the cloud safe for business and enjoyable for users. We enable our customers to increasingly use the Internet as their corporate network and replace legacy, premier base security with zero trust security. As the CIO of a ZSkiller customer told us, we ended up with a security posture that's better than when we had a complex network and network security. and have a user experience that's materially better. As we look forward to the next few years, we are focused on driving broader adoption of our four major cloud solutions, which together maximize the value for our customers' digital transformation. From pre-sales to deployment and customer success, we have built a sophisticated sales machine to sell value and deliver measurable outcome at the CXO level. We continue to scale our organization as the market increasingly moves our way. We will continue to build our ecosystem of technology and channel partners, which are contributing to overall sales velocity and expanding our reach across our total addressable market. Additionally, we are demonstrating our value to customers through an increased focus on thought leadership and demand generation programs. At our recent virtual CXO Summit Series, we hosted six events that drew over 400 CXOs and IT leaders to discuss secure digital transformation. Many CXOs shared with me that the 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 ZSkiller 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 ZI and ZPA together, which enables a true transformation with direct and seamless access to SaaS applications, or applications in your data center or the public cloud. For example, a global manufacturing company purchased our transformation bundle plus DLP and CASB for 45,000 users and DPA for 25,000 users. Drivers for this deal were network and security transformations. they had a traditional hub-and-spoke network for 300 manufacturing facilities, which was slowing their adoption of cloud applications such as WebEx, Office 365, and Workday. A NextGen firewall vendor tried to sell its hybrid offering but failed to meet the security and performance requirements, including SSL inspection. Interestingly, This initiative was part of a five-year managed services RFP where all six system integrators and service providers bid Zscaler. We are seeing customers increasingly migrate away from their large install base of legacy on-prem gateway and security appliances to pursue direct-to-cloud architecture. 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. I'm very pleased with our growing success with the financial industry where adoption of cloud is accelerating. A Fortune 100 financial services company purchased our transformation bundle with advanced DLP and CASB for 18,000 employees to overcome capacity issues with the security appliances when they deployed Office 365. Firewall-based technologies were ruled out due to strict security requirements for SSL inspection and DLP with exact data match. As these three deals show, our comprehensive data protection offering within ZIA has been gaining traction as customers are concerned about data leakage with employees working from anywhere. Our new out-of-band CASB is helping us displace CASB point products and increase our deal size. 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. 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 a clear market leader with proven maturity and scalability. We are supporting hundreds of large enterprises in the complex multi-cloud environment. Let me highlight two ZPA deals in the quarter. First, A global bank with headquarters in Europe needed to scale its remote access after the legacy VPN and VDI became a performance bottleneck and a security concern. The IT team had to cope with over 4,000 trouble tickets per month from users having issues with their connectivity. This customer purchase, ZPA, for over 100,000 employees, to deliver a seamless, always-on experience. While the immediate objective for this deal was to replace legacy VPN, ZPA was selected to implement Zero Trust architecture by establishing an application-level policy where users connect to specific applications, not to a network. In another deal, a Fortune 500 tech company purchased ZPA to accelerate M&A integration. After one year, 6,000 employees at the acquired division were still using two laptops with separate VPNs to two separate networks. Integrating two complex corporate networks can take 12 months or more. ZPA is the elegant solution to this problem. Without having to connect to corporate networks, ZPA provides secure application access across both companies in weeks. Purchasing our high-end ZPA offering, the customer is leveraging ZPA's multiple identity support to accelerate deployment. The customer plans to use ZPA as a standard solution for future M&A, a core strategy for growth at this customer. In addition to ZPA, the customer purchased ZDX for 6,000 users to quickly troubleshoot issues and increase employee productivity. 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. We also had wins for our CSPM offering, giving us additional opportunities for growth. Our emerging products are increasing our overall competitive differentiation. For large enterprises who want network and security modernization, we believe we are the only cloud-native multi-tenant platform that meets their needs. Zscaler is the largest inline 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. Building a cloud native architecture with full security and minimal latency is very hard. And running a massive inline global cloud with five nines of availability is an order of magnitude harder. 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 and ERP. How many cloud-native ERP systems are you aware of since NetSuite started two decades ago? While single-dimensional SaaS applications are easy to develop, multi-dimensional platforms like an ERP and Zscaler are much harder to design, build, and operate. With our business momentum, We are also demonstrating that our strategic sales process and world-class execution are important competitive advantages. First, our concerted 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. We are now a destination for top talent around the globe. Second, we are deepening our ecosystem of technology partners, which are contributing to deal wins and adding leverage to our sales model. to our ongoing partnership with Microsoft and CrowdStrike. We have now extended our strategic partnership with VMware to integrate with the SD-WAN solution and to partner for joint go-to-market engagements. I believe we've built a go-to-market engine that will generate long-term sustainable growth. I'd like to turn over the call to Remo for our financial results.

Thank you, Jay. As Jay mentioned, we are pleased with the results for the first quarter of 2021. Revenue for the quarter was $142.6 million, up 13% sequentially and 52% year-over-year. ZPA revenue was 13% of total revenue. From a geographic perspective, we had broad strength across our three major regions. Americas represented 51% of revenue, EMEA was 39%, and APJ was 10%. 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. We primarily invoice our customers one year in advance. Remaining performance obligations, or RPO, which represents our total committed non-cancellable future revenue, was $864 million on October 31st, 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 and ability to upsell have resulted in a consistently high dollar-based net retention rate, which is 122% compared to 120% last quarter and 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 ZTA from the start and faster upsells within a year can reduce our dollar-based debt retention rate in the future. Considering these factors, we feel that 122% is outstanding. 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 ZTA infrastructure to our data centers during the quarter, as well as timing of expenses. While we are pleased with the gross margin performance, I would like to remind investors that a number of our new emerging products, which includes CDX, workload segmentation, and CSPM, will be running in the public cloud until we scale them into our own data centers in the future. While in the public cloud, these products will have lower gross margins than our core products. As a result, we expect gross margins to be approximately 79% for the full year in fiscal 2021. 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 billionaire teams and go-to-market initiatives offset by lower T&E with our employees working from home. We've been very successful in hiring and onboarding remotely, and we're accelerating our sales and marketing hiring throughout this fiscal year. 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 14 cents. 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. The strength of free cash flow was driven by strong receivable collections and better underlying profitability in the quarter. Now, moving on to guidance. As a reminder, these numbers are all non-GAAP, which excludes stock-based compensation expenses and related payroll taxes, amortization of debt discount, amortization of intangible assets, facility exit costs, and any associated tax effects. 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, $11 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 7 to 8 cents, assuming 144 million common shares outstanding. Due to better-than-expected first quarter performance and our strong pipeline, we're 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. We continue to see the market coming to us, but we remain committed to investing aggressively in our company behind the growth in our business. We have a highly efficient business model and are making investments across the organization today in order to capitalize on the large opportunity ahead of us. While we'll balance growth and profitability, growth will continue to take priority considering our significant market momentum. Now I'd like to turn the call back over to Jay.

Thank you, Rimal. Coming off a record Q1, we're seeing the market coming to us and validating our vision for Zero Trust cloud native platform. We believe we are in the early innings of a significant market opportunity to enable secure digital transformation. The value proposition of our Zero Trust platform is resonating with customers, and we're seeing this reflected in our business momentum over the last three quarters. We scaled our go-to market engine and are delivering world-class sales execution, which we believe will drive sustainable long-term growth. Thank you for your interest in Zscaler. We hope to see you at Zenith Live next week. Operator, you may now open the call for questions.

Thank you, sir. As a reminder, to ask a question, you would need to press star one on your telephone. To withdraw your question, please press the pound key. Due to the essence of time, we ask that you please limit yourselves to one question. Please stand by while we compile the Q&A roster. I show our first question comes from the line of Sterling Audie from JP Morgan. Please go ahead.

Yeah, thanks, guys. So, Jay, you mentioned financial services a number of times in terms of the traction that you're seeing. You know, where would you say or where would you characterize the penetration in that industry? How big is it as a percentage of revenue? And perhaps are we seeing, you know, some continued momentum as maybe it catches up to other industries?

Thank you. Financial services have been slow in embracing cloud, but now they're all opening up. They're embracing cloud, and Office 365 is becoming the catalyst. To make Office 365 work, There have to be some transformations in the network and security. And we've done so much work with Microsoft to make sure Office 365 can be enabled securely delivering fast user experience. So that's becoming our number one application to get into that space. Then it's expanding from there. Remo, you want to add anything to it?

Yeah. So, I mean, the three top verticals that we have are financial, manufacturing, and health. But we're broad across all verticals. So there's really no vertical that's dominant. So, you know, we haven't given out the percentages of each of those verticals, but we're very broad.

Got it. Thank you.

Thank you. I show our next question comes from the line of Matt Hedberg from RBC Capital Markets. Please go ahead.

Hey, guys. Thanks for taking my question. Congrats on really strong results here. You know, Jay, I'm curious, you know, the conversations with CIOs obviously are showing up in numbers, you know, really the importance of Zscaler. Yeah, I'm curious, though, you know, how are those conversations, you know, in the tone of a vaccine? I mean, to me, it would feel like, you know, a lot of the momentum has sort of cemented the change. But I'm sort of curious on sort of, you know, post-vaccine, what do you think the tone of buying behavior is in your target customer?

Yeah, 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 and digital transformation, not COVID. COVID was a catalyst and shaking of 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 really 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 the vaccine, our business will keep on accelerating.

Great. Thanks a lot. Well done, guys.

Yeah, one follow-on with Jay is that we take a look at our pipelines. Our pipeline is accelerating. So we're seeing, you know, an acceleration in our pipeline, and that's across the board, both in CIA and CPA.

Thank you. I share our next question. It comes from the line of Saket Khalia from Barclays. Please go ahead.

Okay, great. Hey, guys, thanks for taking my question here. Jay, maybe for you, you know, the question is, do you have any statistics or just general thoughts on how many of your engagements are competitive, meaning a competitive bake-off process, versus perhaps being brought in by a service provider where there really isn't a competitive process? Does that make sense?

Yeah, thank you. Your question reminds me of my days at Air Defense and Cypher Trust when I used to sell security appliances and we used to have lots of wake-ups. Which box is faster? Which box is cheaper? You know, at Zscaler, we're 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 wake-ups are rare. In fact, I highlighted a win in my prepared remarks where even though there was RFP that we won with managed services partners, all six SINSPs bid Z-scaler, okay, I'm very proud of it. That's because the customers and the SISP channel understands that you can't 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 to really purpose-build something, have a good architecture, we'll maintain this lead.

Thank you. Thank you. I'm sure our next question comes from the line of Alex Henderson from Needham. Please go ahead.

Thank you very much. It's kind of hard to decide what's more to like in your numbers, the margin expansion or the accelerated top line. Good job. I wanted to look forward a little bit, if I could, with you, talk about machine-to-machine environments, domain-to-domain and what you're doing on that front, It seems pretty clear to me that as we see more and more modern applications coming out, that it's not just the cloud direct architecture that's important, but actually the cross-domain traffic. Can you talk a little bit about how you participate in that and what you're doing to secure it?

Yeah. There are two aspects to your question. One is machine-to-machine or app-to-app communication within a public cloud. And the second part is across clouds. Maybe Azure East and Azure West type of stuff. You know, while companies are trying to do this, doing traditional network security way, doing virtual firewalls and whatnot, we have taken zero trust approach to the public cloud where we can have app-to-app communication and where we have the zero trust of switching technology, we needed identity technology, identity for various apps would be built using the acquisition we did a few months ago for a company called Edgewise Networks. So with that, we can do within the data center machine-to-machine communication without doing network segmentation and achieve app segmentation. And we can also go across clouds. But having said that, that's a young market. That's a nascent market. It needs some education. So it will take some time for the market to grow But if we are well positioned to go in early and get positioned there, that's a big area of investments for us.

Super. Thank you very much.

Thank you. Our next question comes from the line of Walter Pritchett from Citi. Please go ahead.

Hi. I'm wondering, Jay, on the cloud workload protection market, you're in that market, fairly new product for you. A number of players are in that market. Could you help us understand what you're seeing in the early deals and sales cycles there? Who's the competition? Is the buyer the same as the buyer that you've generally been selling to? And the differentiation you have there when you're competing in that market kind of as maybe a starting point or when it's a pretty competitive situation. Thanks.

Yeah. Thank you. Good question, Walter. You know, cloud protection is not one piece of multiple pieces. and they're in different stages of the market. CSPM is one area where we are actually competing well. That's a fairly well understood and fairly simple market. Your cloud traffic from Azure AWS workload going to internet, which most of these workloads do. You can try to do some virtual firewalling and whatnot, which doesn't work, or you can simply send it through Zscaler internet access by simply pointing traffic. We're very well positioned in that part of the segment. Then the third segment is what Alex asked about, machine-to-machine communication and whatnot, app-to-app. That's a younger area, and that's where we see some young players, some startups in the game. But generally, the market being so young, there's not a whole lot of competition in that space, and only selected customers are kind of trying to pursue that. I see many customers who said, I tried to do network segmentation doing this, and this hasn't worked. I tried this. And the buyer is somewhat different, as you said. There are two types of buyers for cloud protection. One is actually the IT organization that's actually building applications, the DevOps team, because they are actually driven by application, and they often ignore security. Then CISO comes and says, wait a second. You can do things fast, but you must put security in place. So we end up dealing with two parties, CISOs we already deal with and DevOps party that's a little bit new for us to get to know and learn.

Thank you. Thank you.

Thank you. Thank you. I show our next question comes from the line of Tal Liani from Bank of America. Please go ahead. Hey, guys.

Great quarter. My question is more higher level. I'm trying to understand the expectations for next year. So if I look at your guidance and I add a little bit more for beat and raise, which you've done in the last few years, you're going to be staying in the same growth rate we've seen this year. And I'm trying to get the qualitative part of, you know, you have older solutions and you have newer markets. How do you view the growth rate in older solutions like ZPA and How do you view your level of competition there, ability to gain new customers versus grow with existing customers? And then same question about your newer areas. What are the driving factors? I'm trying to understand how to build a spreadsheet for next year when it comes to the various solutions that you're offering.

It's a very good question, Tal. Think about the four key solutions we talked about. ZIA has been a workhorse, 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. The majority of the market is sitting open out there. In fact, there's still a sizable market of legacy web proxies like Bluecoat, and that's to be removed. And we are taking more and more part of that. So that's kind of one piece. And ZI is not one product. As you know, ZI is a portfolio of several offerings, and more and more customers are buying either bigger bundles, like transformation to start with, or they're moving up from business bundles or professional bundles. So that's a pretty sizable thing on ZI. We're nowhere close to leveling off at all. ZPA, relatively younger, only about four years old, has gone from zero to about 30% of the new business in that range. And if you look at our customer base, just about in the mid-30s, somewhere 30% or so of the global 2,000 ZIA customers have ZPA. So even in our install base of ZIA, there's a big market out there. So we think these two big proven product portfolios are called them two big pillars. They have plenty of room for opportunities. And then the ZI and 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 ZI, ZPA, and ZDX. 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 Zimu has said, we are not really putting 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're part of ZIA portfolio. They automatically attach to our ZIA bundle. In the same way, we're 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. Karima, did I cover anything?

Yeah, I mean, you know, it's a great question. I mean, you take a look at the percentage of customers that have transformation. We indicated it was 49%. you know, in our last call in July. And it's gone up. You know, this quarter has continually gone up. So EPA, 13% of revenues. So big opportunity with our installed base for that and our emerging products. We had an acceleration, you know, in growth of new customers in Q1, you know, versus the growth in Q4. So we're seeing, you know, momentum. We're seeing deal sizes getting bigger. We're seeing, you know, the need for transformation on a broader scale. And as Jay mentioned, driven by, you know, COVID. But COVID started the visibility. What we're seeing right now is the realization on the part of, you know, CIOs and others and companies at high levels who understand that the legacy architectures they've got, you know, are really not the right architectures. That's what's driving the business for us. It is that. In addition to that, you know, proof points that we have pipeline, you know, interest, you know, productivity, you know, just... You feel the momentum. You feel the momentum that's coming our way. What it comes down to at the end, it comes down to the people. It comes down to the execution. The market is there. The product is there. The vision is there.

And I believe the people are there also. And I think in the past three quarters, we had done an amazing job in scaling our go-to market, which was the last piece we needed to scale. And we're very... feeling very good about it. Agreed.

Got it.

Thank you.

Thank you. Thank you. Our next question comes from the line of Hamza Fuduluola from Morgan Stanley. Please go ahead.

Hey, guys. Thank you for taking my question. Jay, a question for you. You mentioned earlier that COVID has been a catalyst for Zscaler more longer term in terms of the market coming to you, in terms of customers coming to you for cloud transformation deals, as well as talent coming to you as well. And you mentioned a really strong hiring environment for you guys. I'm wondering, where are these newer hires coming from? Are they coming from some of your competitors within the security space, or are they coming from outside the security space? Can you give us any sort of color on that? Yeah.

First of all, I think a 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. Anyone recall that? All that has passed. I think probably a brand is helping, well-known out there also. Sales leadership has put a deep and wide leadership in place. And then getting more specific to answer your question, if you look at two broad areas of sales hiring, even though there are multiple areas beyond that, are our strengths. Typically, sales reps are not coming from box selling background. Majority of our sales reps come from solution selling, SaaS type of background, because our sales is very different from Dan, a typical box security selling background. So they come from generally software and SaaS type of companies by and large. That's number one. On the technical side, the SC side, we generally hire from someone that comes with a little bit networking and security background because they need domain expertise, which takes a little bit longer. But we are getting tons and tons of interest. And we are trying to stay selective when we hire. But we are pretty much tracking our progress on hiring very well.

Yeah, on a net hiring basis, one of the things I'd like to call out, we had a record quarter for net hires in the quarter. We hired over 260 people. The quarter before it was 200, the quarter before it was 150, and the quarter before that it was 100. Of that 260, about 60% were in the sales and marketing area. We had a record quarter for quota-carrying sales rep hires in Q4. We had a comparable number in Q1. Mm-hmm. we are accelerating the hiring even more than what we had anticipated on our last call, given what we're seeing.

Got it. Super helpful. Thank you.

Thank you. Our next question comes from the line of Patrick Colville from Deutsche Bank. Please go ahead.

Hi, guys. This is Dan Cayello on for Patrick. Congratulations on a great quarter. I just wanted to ask on the pricing environment. You know, obviously it seems Really strong. I'm just curious if you guys could comment on how prices have trended and then obviously really impressive retention rate. So I'm curious how much of that is adding new products on versus expanding more into the organization, if that makes sense.

Yep. So it's a comparable pricing environment. Our price per user did go up quarter to quarter. Related to what drove the net retention rate, As Jay mentioned, the emerging products are not significant impact, so it's more the existing products, the movement to transformation, as well as EPA, which is what drove the increase in that retention rate. Great.

Thank you.

Thank you. Our next question comes from the line of Brian Essex from Goldman Sachs. Please go ahead.

Great. Thank you very much for taking the question, and congrats from me as well, and a great result in a quarter. Jay, I was just wondering if you could maybe give a little bit of color on the sales force and the maturity of deals that you're seeing. I think near 10K, it looked like customer growth was just over 15%, but it sounds like deals are getting larger, as you noted, record number of seven-figure ACB deals increasing. Could you maybe help me understand what factor is the maturity of the sales force playing into the type of deals that you're seeing? How much is new customer versus expansion into your install base or better penetration into your install base? And how do you see that maturing throughout the rest of the year? I know that you noted previously that the elevated hiring in last year should drive you know, better growth in the back half of this year. Is that accelerating? Just maybe get a little bit of color in terms of the level of confidence you have for growth through the back end of the year based on the deal activity and Salesforce maturity.

Yes, Brian. That's quite a few questions, so let me give it a piece at a time. Salesforce maturity. Since Dolly joined us, we spent about three and a half, four quarters to make sure we bring in a systematic and disciplined sales process, sales enablement, and sales metrics to understand the business leading indicators and all that stuff, plus putting a number of leaders in place. So you asked me, what do I think about the maturity of the sales organization? I said extremely happy, very good about it, because having that in place drives the rest of the stuff. So very comfortable, and it's because of that comfort we are accelerating hiring more and more salespeople in the field. Next question is related to deals, customers, new customers, customer growth. I think if you look at one number holistically that out of whatever 4,500 or 4,800, whatever those customers are, those percentages will be misleading because there's some small customers, some large customers. We need to get to a level where we start kind of looking at proper segmentation and growth within segmentations. Our big focus traditionally has been large enterprises, and we've done extremely well. The amount of penetration we're doing in those customers in terms of percentage and in terms of the deal, the ARR we're having in those customers is actually going up very well. We're very pleased with that. And as I finish, I'll let Remo talk about some of those numbers. And then we're also expanding more into the lower enterprises, so to speak. I think over time we'll give you more color so you can start computing the growth better. 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 it's pretty well covered, and we are getting great wins out there. So there's a big market for us to come downstream and expand as well. Anyone you want to add?

Jay is absolutely correct. The ARR per customers is definitely increasing. One of the ways we break it out is customers with greater than 3,000 users, we're over $450,000 ARR per customer, which is up year over year. It just keeps on going up. New customer growth, we've stated it's within the range or historical range of 50%, 60%. As I've mentioned before, we had an acceleration of new customer growth in Q1. Also, you know, the comment about sales productivity, the thing to keep in mind, which is really encouraging, is that a significant majority of the RSN headcount increase occurred in the second half of fiscal 2020. Also, the comment that I made about Q1, that the hiring that we had for RSMs in Q1 was comparable to our record quarter in Q4, and our sales productivity on a year-over-year basis in Q1 was up. Those are all good indicators from my perspective and give me confidence that things are looking strong for the company, as well as what we've put in place, the structure, the organization. I've been around for a long time. You know, and I've seen a lot. I've never seen anything like we've got here at Zscaler with our go-to-market, quite frankly.

Super helpful multi-part answer. I appreciate it.

Thank you. I'm sure our next question comes from the line of Andrew Nowinski from D8 Davidson. Please go ahead.

Hey, great. Thank you, gentlemen. Congrats on a great quarter. I just want to ask about the partnerships. So you announced a new partnership with VMware, and you've always had a very strong partnership with Microsoft. So I'm just wondering if Microsoft contributed to the record number of seven-figure deals you had in the quarter, and how you're thinking about the new partnership with VMware.

So let me start with VMware. VMware has been a good partner for us. the portfolio of SD-VANs. If you look at SD-VANs, we have always said that SD-VAN is a good complementary area for us, and we have been actually securing some very, very large SD-VAN deployments out there. And it was natural for us to team up with VMware, so what did we do? We had done integration, so those SD-VANs can be deployed a lot more easily with a single click. But more exciting than that, we are actually working with them on a number of joint go-to-market initiatives. Our salespeople are kind of doing joint account planning, and we've got a number of market initiatives. So we think that will be a good partnership for incremental revenue for both the companies. That's on the VMware side of it. Microsoft, you know, that partnership goes for several years. It started with us. helping 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 ZSkill is the 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. I'm not sure if any of the specific deals this quarter were impacted by Microsoft, but in large companies, there will be large deals where we'll be working together with Microsoft to close those deals. Remo, did I miss something? No, you got it.

That's great. Thanks, guys.

Thank you. Aisha, our next question comes from the line of Fatima Bulani from UBS. Please go ahead.

Good afternoon, gentlemen. Thank you for taking the questions. Jay or Remo, I wanted to hit back on some of the commentary and the prepared remarks around VPA, VPA deployment. I mean, we've gone from zero to mid-teens percentage of your revenue now derived from from ZPA. So I'm wondering and appreciating some of the bigger picture factors that are driving the demand for ZPA. I'm wondering if you can be more specific about where some of the budget dollars are coming from that are getting reallocated in your favor for ZPA adoption. And to what extent is there more expansion runway here that hasn't necessarily been pulled forward because we've all started working from home overnight over the course of this year? So just getting some more specificity around where the ZPA budgetary dollars are being earmarked away from in your favor.

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 a budget point of view. So VPN ends up being the entry point at the first point. But as we have said many times, ZPA is being bought or 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 networks. 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 a 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 applications sitting in Azure or AWS. And more and more customers want to implement zero trust, even when you are in the office. So we don't think the 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 continuing. So very confident about the ZPA projection, and that's reflected in the pipeline we're seeing for ZPA.

Raymond? Yeah, for new customer business. You take a look at what percentage of our new customers are buying both ZIA and ZPA. It's in the high 30% range. That's up from Q4 and was low 30% range. That's what's resonating. That is the digital transformation occurring that we see. So, you know, it's, again, the things that we're seeing internally related to what's occurring, you know, in the market is, you know, indicates that, you know, digital transformation is top of mind for many IT professionals. And, you know, Zscaler's, you know, got a great solution or the best solution for them. And so that's giving us, you know, confidence.

Yeah, if I may say, the combination of ZI and ZPA ensures that any user can work from anywhere, office, home, wherever. And that's where the leader trust comes in, it's the same user experience, same level of security, same level of policy. That's what CIOs are buying.

That's super helpful. Thank you, gentlemen. Appreciate the call.

Thank you. I share a last question. It comes from the line of Catherine Trevnik from Colleens. Please go ahead.

Oh, congratulations on a phenomenal quarter. You had said in your prepared, Mark, that you had done well in the three verticals, finance, health care, and manufacturing. But it seems like the federal government is a pretty big green field for you in 2021. And can you describe or give us some background on what you're doing to prepare to do well in that? Because they're also moving to Office 365, similar to the financial folks. Thanks.

Yes, Kathleen, thank you. Federal is a big opportunity for us. and our business is making good progress there. You know, our market, we have a sizable team in place now. We have some very good FedRAMP certifications, and we've got a growing pipeline in 21 and beyond. We expect federal to be a bigger part of our business. Raymond, do you want to give a color of where it is now?

Yeah, federal in Q1 was mid-single digit of our new and upsell business. And as Jay mentioned, we're very pleased with the progress of our federal and see that as a substantial opportunity going forward.

Thank you.

All right. Thank you. So I think we're done with the questions. Then I would like to say thank you for your interest in Zscaler. We hope to see you at Zenith Live. upcoming several investor conferences that we are participating in. Goodbye. Great. Thank you.

Ladies and gentlemen, this concludes today's conference call. Thank you for attending. You may disconnect.