Zscaler, Inc. (ZS) Q1 2021 Earnings Report, Transcript and Summary

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 a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions]. Please be advised that today's conference is being recorded. [Operator Instructions]. 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 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. Starting in fiscal 2021, we are excluding stock-based based compensation related payroll taxes in our non-GAAP presentation. The GAAP to the non-GAAP reconciliations for historical periods can be found in the supplemental financial information. I would 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 7, Barclays Global TMT Conference on December 10, 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 9. The presentations for these events will be webcast and the links will be available on our Investor Relations website. Now, I will 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 am proud of our strong results and an exceptionally strong start to fiscal 2021 in our first quarter. We delivered 52% growth in revenue 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 remains 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 am also pleased and 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. I believe in the current challenging environment and in the post-COVID economy, Zscaler will be the go-to-platform for vendor consolidation, cost saving, 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, any place legacy perimeter-based security with zero trust security. As the CIO of a Zscaler customer told us, we ended up with the 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 secured digital transformation. 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. 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 installed 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 am 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 their security appliances when they deployed Office 365. Firewall-based technologies were ruled out due to strict security requirements or 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 the 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. Their IT team had to cope with over 4,000 trouble tickets per month from users having issues with their connectivity. This customer purchased 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, that 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 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. Building a cloud native architecture with full security and minimal latency is very hard and running a massive in-line global cloud with five 9s 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 an 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 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. 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. In addition to our ongoing partnership with Microsoft and CrowdStrike, we have now extended our strategic partnership with VMware to integrate with their SD-WAN solution and to partner for joint go-to-market engagements. I believe we have built a go-to-market engine that will generate long term sustainable growth. Now, I would 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 have 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-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. 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 ZPA 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 include ZDX, 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 building our teams and go-to-market initiatives offset by lower T&E with our employees working from home. We have been very successful in hiring and onboarding remotely and we are 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 $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. 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 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. We continue to see the market coming to us and 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 will balance growth and profitability, growth will continue to take priority considering our significant market momentum. Now, I would like to turn the call back over to Jay.

Thank you, Remo. Coming off a record Q1, we are 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 are seeing this reflected in our business momentum over the last three quarters. We have 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.

[Operator Instructions]. I show our first question comes from the line of Sterling Auty from JPMorgan. Please go ahead.

Yes. Thanks guys. So Jay, you mentioned financial services a number of times in terms of the traction that you are seeing. 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 some continued momentum as maybe it catches up to other industries?

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. Remo, you want to add anything to it?

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

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

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.

Great. Thanks a lot. Well done, guys.

One follow-on with Jay is that, if we take a look at our pipeline, our pipeline is accelerating. So, we are seeing an acceleration in our pipeline and that's across the board, both in ZIA and ZPA.

Thank you. I show our next question comes from the line of Saket Kalia from Barclays. Please go ahead.

Okay. Great. Hi guys. Thanks for taking my question here. 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?

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.

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

Thank you very much. Kind of hard to decide what's more to like in your numbers, the margin expansion or the accelerated topline. Good job. I wanted to look forward a little bit, if I could with you, when you talk about machine-to-machine environments, domain-to-domain and what you are 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 are doing to secure it?

Yes. 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. 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 or switching technology, we needed identity technology. Identity for various apps would be built using the acquisition we did a few months ago through a company called, Edgewise Networks. So with that, we can do within the datacenter 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 a position there, that's a big area of investment for us.

Super. Thank you very much.

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

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

Yes. Thank you. Good question, Walter. Cloud protection is not one piece, it's multiple pieces and they are 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 firewall and whatnot, which doesn't work or you can simply send it through Zscaler Internet Access by simply pointing traffic. We are 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 start-ups 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. It hasn't worked. I had tried this. And the buyer is somewhat different, as you said. There are two types of buyer for cloud protection. One is actually the IT organization that's actually building application, the DevOps team. Because they are actually driven by application and they often ignore security. Then CSO 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, CSOs that 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. I show our next question comes from the line of Tal Liani from Bank of America. Please go ahead.

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.

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 know 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?

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. In addition to that, proof points that we have pipeline, interest, productivity. Just you feel the momentum. You feel 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 are feeling very good about it.

Agreed.

Got it. Thank you.

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

Hi 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 am wondering, where are these newer hires coming from? Are they coming from some of your competitors within the security space? Or they are coming from cyber security space? Can you give us any sort of color on that?

Yes. 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. 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 RSMs. Typically sales reps are not coming from box-selling background. Majority of our sales rep come from solution selling, SaaS type of background, because our sales is very different from than a typical box security selling. 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 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. On a net hiring basis, one of the things that I would call out, we had a record quarter for net hires. In the quarter, we hired over 260 people. A quarter before, it was 200. A 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. We are accelerating the hiring even more than what we had anticipated on our last call, given what we are 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 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?

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.

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 on a great result in the quarter. Jay, I was wondering if you could maybe give a little bit of color on the sales force and the maturity of deals that you are seeing. I think in your 10-K, it looks like customer growth was just over 15%. But it sounds like deals are getting larger, as you noted record number of seven-figure ACV deals. Can you maybe help me understand what factor is the maturity of the sales force playing into the type of deals that you are seeing? How much is new customer versus expansion into your installed base or better penetration into your installed 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 better growth in the back half of this year. Is that accelerating? Just to 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 sales force maturity.

Yes. That's quite a few questions. So let me give a piece at a time. Sales force maturity, right. Since Dali joined us, we spent about 3.5 to 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 would say, 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 of holistically, that out of whatever 4,500 or 4,800 whatever those customers are, those percentages will be misleading. Because there is 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 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. And as I finish, I will let Remo talk about some of those numbers. And then we also are expanding more into the lower enterprises, so to speak. I think over time, we will 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 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. Also, the comment about sales productivity, the thing to keep in mind, which is really encouraging is that, significant majority of the RSM 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. But things are looking strong for the company, as well as what we put in place the structure, the organization. I have been around for a long time and I have seen a lot. I have never seen anything like we have got here at Zscaler with our go-to-market, quite frankly.

Super helpful multi-part answer. I appreciate it.

Thank you. I show our next question comes from the line of Andrew Nowinski from D.A. Davidson. Please go ahead.

Hi. Great. Thank you, gentlemen. Congrats on a great quarter. I just wanted to ask about the partnerships. So you announced a new partnership with VMware and you have always had a very strong partnership with Microsoft. So I am just wondering, if Microsoft contributed to the record number of seven-figure deals you had in the quarter? And how you are 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-WAN, if you look at SD-WANs, we have always said that SD-WAN is a good complementary area for us and we have been actually securing some very, very large SD-WAN deployments out there. And it was natural for us to team up with VMware. So what did we do? We had done integrations. So those SD-WANs can be deployed 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 sales people are kind of doing joint account planning and we have a number of market initiatives. So we think that would be a good partnership for incremental revenue for both the companies. That's on the VMware side of it. 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. I am not sure if any of the specific deals this quarter was impacted by Microsoft. But in large companies, there will be large deals where we will be working together with Microsoft to close those deals. Remo, did I miss something?

No. You got it.

Yes. That's great. Thanks guys.

Thank you. I show our next question comes from the line of Fatima Boolani 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 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?

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. Remo?

Yes. For new customer business, you take a look at what percentage of our new customers are buying both ZIA and ZPA, right. 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 that gets, again, the things that we are seeing internally related to what's occurring in the market indicates that digital transformation is top of mind for many IT professionals. And Zscaler has got a great solution or the best solution for them. And so that's giving us confidence.

Yes. 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.

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

Thank you. I show our last question comes from the line of Catharine Trebnick from Colliers. Please go ahead.

Congratulations on a phenomenal quarter. You have said in your prepared remarks that you had done well in the three verticals, finance, healthcare and manufacturing. But it seems like the federal government is a pretty big greenfield for you in 2021. And can you describe or give us some background on what you are doing to prepare to do well in that, because they are also moving to Office 365, similar to the financial folks? Thanks.

Yes. Catharine, thank you. Federal is a big opportunity for us and our business is making good progress there. Our market, we have a sizable team in place now. We have some very good FedRAMP certifications and we have got a growing pipeline in 2021 and beyond. We expect federal to be a bigger part of our business. Remo, do you want to give a color of where it is now?

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

Okay. Thank you.

All right. So I think we are done with the questions. And I will like to say thank you for your interest in Zscaler. We hope to see you at Zenith Live and upcoming several investor conferences that we are participating in. Goodbye.

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