Skip to main content
No. of Recommendations: 57
Solid quarter - Zscaler is firing on all cylinders. They had a sales hiccough in Q4 of 2019, and a lot of us (including myself) wrote them off. I think this sales problem caused us to perceive their tech as being inferior, which does not appear to be the case at all. Zscaler is innovating. Their latest major cloud upgrade added over 100 new product enhancements, they can deploy their ZDX solution in minutes, and "every day, we are processing more than 150 billion transactions, while preventing up to seven billion security incidents and policy violations". This is by no means a technically inferior company.

Regarding Zscaler's business model: Previously my understanding about Zscaler (as well as Cloudflare) is that they both charge on a per person basis for pretty much all their products. This is true for most of Zscaler's products, but Zscaler's newest big product, ZCP (Zscaler Cloud Protection) protects workloads. In other words, it's protecting servers, containers, applications and services! They talk about this a bit in one of their customer wins. This, in my opinion, is a big deal for the future of Zscaler. Their TAM is no longer limited to the number of employees their customers have - it now encompasses the number of employees plus the number of workloads their customers require. Additionally, the number of workloads in the world will for sure grow much faster than the number of people in the world. That said, it will take some time before this becomes Zscaler's marquee product.

Third, the sunburst data breach is causing an increase in inbound conversations that potential customers and existing customers want to have with Zscaler. It also underscores the need for a zero trust approach, which Zscaler specializes in.

Lastly, DBNER rose from 122% in Q3 2020 to 127% in Q4 2020. This is the fourth quarter in a row that DBNER has risen. It was 119% in the comparable Q4 2019. A few things could be causing this - a) covid b) sunburst c) strength of Zscaler's products or d) all the above. It was mentioned during the call that Zscaler estimates they have a 6x upsell opportunity within their customer base, which makes me think that DBNER can continue to stay at elevated levels for the long term.

CEO/Founder Jay Chaudry Opening Remarks
...Strong performance in Q2, which showed accelerating growth at scale and rapid innovation of our Zero Trust platform. We drove 55% growth in revenue and 71% growth in billings, while also generating growth in operating profits and free cash flow.

During the quarter, we achieved a milestone of over 5,000 customers, including over 500 of the Global 2000.


We drove increased wins in our enterprise segment, as we begin to pursue smaller enterprises with 2,000 to 6,000 employees.

We are helping our customers to securely accelerate their digital transformation journey, which remains their top priority. With our Zero Trust Exchange, Zscaler provides secure, any-to-any connectivity for users, applications, workloads and IoT and OT systems, regardless of their location.
OT= operational technology.
Workload = A cloud workload is a specific application, service, capability or a specific amount of work that can be run on a cloud resource. Virtual machines, databases, containers, Hadoop nodes and applications are all considered cloud workloads.


The recent SolarWinds security incident has further elevated the need for a true zero trust platform like Zscaler. During such sophisticated attacks, our proxy-based architecture would prevent loss of sensitive data and our application-level segmentation eliminates lateral threat movement.
We provide users access to applications, not the network, which is fundamentally different from firewalls and legacy network security architecture. The CIO level awareness, engagements and inbound requests for our purpose-built zero trust platform have significantly increased, and we are viewed as a foundation of application, network and security transformation.


I’m proud of our speed of innovation, which is accelerating and further expanding our substantial technology lead. There are four pillars of our Zero Trust Exchange: ZIA (Zscaler Internet Access), ZPA (Zscaler Private Access) and ZDX (Zscaler Digital Exchange)for user protection and experience, and ZCP for workload protection.
Last quarter, we launched our fourth pillar called Zscaler Cloud Protection or ZCP, which extends our Zero Trust Exchange from users to workloads, and has an expanding portfolio of products including: CSPM to ensure proper configuration and compliance; Workload Communication to secure app-to-app and cloud-to-cloud secure communication; and Workload Segmentation to achieve app segmentation without legacy network segmentation.

In our latest major cloud upgrade, we added over 100 new product enhancements. Over the past 12 months, we have significantly increased the number of solutions delivered through our platform, including Zscaler Browser Isolation, Out-of-band CASB, Zscaler B2B and Zscaler Digital Experience or ZDX. All this innovation is making our cloud platform wider and deeper. For enterprises who want network and security modernization, we believe we are the only zero-trust, multitenant platform that meets their needs.

Many vendors have tried and failed to build a high performance, highly reliable proxy required for proper cybersecurity protection and data loss prevention. As a true SASE (secure access service edge) framework, we are deployed across 150 data centers, enforcing policy at the edge instead of a limited number of public cloud locations. Every day, we are processing more than 150 billion transactions, while preventing up to seven billion security incidents and policy violations.

Now, on to the customer wins. There is an accelerated market shift towards work from anywhere, which is the world Zscaler was built for. In an upsell win, a Fortune 500 chemical company that was using ZIA for a subset of its workforce, accelerated their zero-trust initiative by purchasing ZIA transformation, ZPA and ZDX for all 45,000 employees. In addition, they bought two of our recently announced ZCP solutions. They purchased Workload Communications to secure server traffic out to the Internet from 200 plants, and Workload Segmentation for 7,000 servers to secure east/west traffic in the public cloud and data center. I am excited to see wins like this where the customer is buying all four pillars of the Zscaler platform.

Moving on to ZPA. Our customers view ZPA as the foundation for their architectural shift to zero-trust access for private applications. ZPA is the clear market leader, with proven maturity and scalability, supporting millions of daily active users and nearly 40% of our global 2000 customers. Today, ZPA is delivering over million unique application segments without operational overhead of traditional network segmentation.

In an upsell deal, a Global 2000 bank with headquarters in EMEA started with ZIA and ZPA for 10,000 employees in July to expand their work-from-home capacity as a result of the pandemic. Within six months of the initial purchase, the customer bought ZIA and ZPA for the remaining 30,000 employees and CASB for all 40,000 employees.

Lastly, I would like to share another new customer win that highlights our continued ZIA success with large enterprises that are embracing direct to cloud architecture and migrating away from their complex, legacy onpremise appliances. A Fortune 100 professional services customer purchased our ZIA Transformation bundle plus CASB, advanced DLP and CSPM for Office 365 to protect 125,000 employees across 150 countries as they embraced work from anywhere. Zscaler eliminated the need for 30 different gateways and consolidated six different legacy point products, while meeting the customer’s environmental goals for their ESG program. With sensitive customer data at risk, security was a major requirement and the customer only considered solutions with a proxy architecture.

... This customer concluded that if a user connects to the network with a VPN, that is not zero trust. Based on this criteria, the legacy firewall and VPN providers were disqualified. An important consideration for our selection was ZPA’s position as the first and only cloud security service with FedRAMP certification for Zero Trust Remote Access. With the highest levels of FedRAMP certifications for both ZIA and ZPA, we are very well positioned to serve the Federal government.

At our Analyst Day in January, we laid out our audacious goal of serving 200 million users and 100 million workloads on our Zero Trust Exchange.

I believe we are on the right track to capture a material share of the $72 billion serviceable market that we outlined on our Analyst Day.
We are also seeing opportunities in bringing zero trust to IoT and OT systems, and are excited about 5G, which pushes computing further to the edge and opens up additional opportunities for Zscaler. We are excited about our future.

FINANCIALS
Revenue for the quarter was a $157.0 million, up 10% sequentially and 55% year-over-year. ZPA product revenue was 14% of total revenue. From a geographic perspective, we had broad strength across our three major regions: Americas represented 51% of revenue, EMEA was 38% and APJ was 11%.


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 71% year-over-year to $232.0 million, with billing duration around the mid-point of our 10-14 month range. As a reminder our contract terms are typically one to three years, and we primarily invoice our customers one year in advance.

Remaining performance obligations or RPO, which represents our total committed non-cancellable future revenue, exceeded $1 billion during the quarter and ended at $1.025 billion as of January 31.
RPO grew 68% from one year ago. The current RPO is 53% of the total RPO.

Our strong customer retention and ability to upsell have resulted in a consistently high dollar-based net retention rate, which was 127% compared to 122% last quarter and 116% a year ago.

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 127% is outstanding.

Total gross margin of 81% was flat quarter-over-quarter and declined one percentage point year-over-year, but exceeded our expectations. The year-over-year decline was primarily driven by a higher mix of newly introduced products.

Turning to operating expenses. Our total operating expenses increased 18% sequentially and 60% year-over-year to $112.9 million. Operating expenses as a percentage of revenue increased by two percentage points from 70% a year ago to 72% in the quarter.
Sales and marketing expense increased 19% sequentially and 57% year-over-year to $76.5 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 hom

R&D expenses increased 15% sequentially and 71% year-over-year to $24.0 million. The increase is primarily due to continued investments in our engineering teams.
G&A expenses increased 14% sequentially and 57% year-over-year to $12.5 million. The growth in G&A includes investments in building our teams, compensation-related expenses and professional fees.

Our second quarter operating margin was 9% compared to 12% in the same quarter last year. Net income in the quarter was $14 million or a non-GAAP earnings per share of $0.10. We ended the quarter with over $1.4 billion in cash, cash equivalents, and short-term investments. Free cash flow was positive $18 million in the quarter, which compares to negative $2 million during the same quarter last year. The strength in free cash flow was driven by strong receivable collections.

For the third quarter of fiscal 2021, we expect revenue in the range of $162 million to $164 million reflecting a year-over-year growth of 47% to 48%.
Operating profit of $11 million to $12 million, Other Income of $300,000, net of interest payments on our senior convertible notes. Income taxes of $1.5 million and earnings per share of approximately $0.07 assuming approximately 146 million common shares outstanding.

Due to better than expected first half performance and our strong pipeline, we are increasing our full year fiscal 2021 guidance for revenue, calculated billings and operating profit. For fiscal 2021 we now expect revenue in the range of $634 million to $638 million or year-over-year growth of 47% to 48%.
Calculated billings in the range of $820 million to $825 million or year-over-year growth of 49% to 50%. Operating profit in the range of $59 million to $61 million. Other income of $2.4 million, income taxes of $5.3 million, and earnings per share in the range of $0.39 to $0.40 assuming approximately 145 million to 146 million common shares outstanding.

For your modeling, we would like to remind investors that Q2 and Q4 have historically been our strongest billing quarters with declines in Q1 and Q3 quarters, respectively. The average sequential decline in billings during fiscal third quarters over the last five years was approximately 20%. We continue to see the market coming to us and 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 will balance growth and profitability, growth will continue to take priority considering our strong business momentum.

Analyst Q&A

Jay, I wanted to ask you a high level question around the impact that the Sunburst Breach is having on the industry. At your Analyst Day in January, you'd mentioned that the impact is likely to be larger than the Target breach was in 2013. And if you can maybe parse out for us how the event has impacted your pipeline across your strategic accounts, maybe all the way down to smaller commercial accounts and how, if at all, you've changed the way you approach initial conversations with new prospects?

Jay Chaudhry
As we discussed during our Analyst Day, we are having increased conversations with our customers as well as prospects. So what is that causing? It is increasing engagements. I'm not sure I can quantify the impact on the pipeline, but we're seeing that the customers who are already educated on Zero Trust quite a bit are making implementation of Zero Trust a bigger priority.
The number one question ends up being if people get compromised, how do make sure that the lateral movement doesn't happen? The answer is simple. Don't connect people to your network. Don't build a moat with firewalls and VPNs, do Zero Trust implementation where you connect users to applications not to the network.

Unidentified Analyst
Hi guys. Good evening. This is Daniel on from Mike. Thanks for taking my question. So I know over the past quarters, you've been working on really improving your sales motion in the SMB and smaller enterprise area. Can you just provide some color on some of the investments you are making. And I guess, where you expect to be moving forward?

Jay Chaudhry
I will start and Remo going to add on. Yes, we talked about our expansion towards the enterprise segment that we defined as between 2,000 and 6,000 employees in a company. As you know, we have done extremely well in the higher end in large enterprises for the last several years. So in this segment, the progress we've made is ahead of our expectations. Our growth was faster in this segment. Well, it did come from a smaller base.

Having said that, our large enterprise segment is driving the overall strength of our business. We are doing three specific things to grow our business in this enterprise segment, one, adding more sales reps, more sales teams. And we had done a lot of good progress in the past two quarters and we'll do more in the coming quarters. Secondly, adding and expanding channel partners who covered the segment. And third, we are directing our marketing programs to support the segment as well. So in summary, it's a good opportunity to expand the segment and we are doing well. We're pleased with the performance.

Alex Henderson
Thank you very much. I wamt to talk to one of the architectural issues that I think is fairly interesting differentiator, which is the argument that you guys have built a network based off per user policy implementation versus architectures from some of your – one of your competitors that are unable to differentiate the traffic flows on a per user basis, or have the policy implementations on a per user basis. Can you talk about that delta between what you're doing and how that shows up in alternative competitors networks?

Jay Chaudhry
Yes. The fundamental difference is being a pass through on network security architecture when traffic is flowing over the network and a traditional device, like a firewall is trying to scan what kind of application is, guess it and trying to stop it or not. With our proxy architecture, where we terminate every connection, inspect and decide to connect to a particular user. So we have policies that are per user by design. There's no – in fact, a user coming from company A or company B or company C each looks like an untrusted user. While in the traditional way, they are kind of batch based policies. The end result is – our architecture gives us two big benefits. One with proxy we can do far better inspection at a high scale high performance, including SSL. Two, it allows us to do Zero Trust where you don't connect people to a network. You connect to a specific application. Zero Trust is probably the biggest thing to help you minimize the damage of lateral movement if something gets infected.

Andrew Nowinski
Great, thanks. And congrats on a great quarter. So I just wanted to follow up on Brad's earlier question regarding SolarWinds. It sounds like that's creating more pipeline but not necessarily contributing to revenue yet. But your billings growth is the strongest that we've seen in over two years. So I'm wondering if you could just comment on what the key drivers are that are contributing to that inflection in your billings growth. Now SolarWinds winds, it doesn't look like it's really had much of an impact yet.

Jay Chaudhry
Generally, in all these sessions, analysts like to pinpoint to particular event that may cause something, so COVID was viewed as maybe the catalyst. This is being viewed as a catalyst. As we have said before, the overall catalyst is that everyone is driving towards digital transformation, COVID maybe helping it SolarWinds maybe helping it. But customers are realizing that they believe that they need to accelerate their transformation. And we are the one who enabled the transformation. If you do your transformation without something like Zscaler, your risk goes up significantly. So where is our growth coming from? ZIA, which has been our work horse. Yes. Now we've got over 25% of global 2000 companies, but we have 75% more to go. It is generating pretty good sales, ZPA, which was relatively young product two or three years ago now is actually contributing significantly about 40% of our global 2000 customers already have our ZPA.
So these two are the biggest contributors of our billings growth. And then the new pillars ZDX is picking up quite well. And also is that the new pillar off cloud protection? I think I'm very pleased that our customers are buying more and more bigger bundles together. I talked about ZIA, ZPA and ZDX being bought together by our customers during our in my prepared remarks. So across the board, we're seeing strength from product side of it
ExponentialDave: Great question and answer here. Jay gives us a very honest answer - it's not clear if Covid was the catalyst, or sunburst, or a more general need for digital transformation. And also that Zscaler still has much of the global 2K to penetrate, even with its more established product such as ZIA.


...In addition when we talked at the Analyst Day that for companies of 5,000 employees on the user side, we'd expect, we're seeing ARPUs in that $145 range. I can say that in the quarter, we've had deals with customers at the 5,000 employee range in that range at $145. So what's happening basically is that there's a huge need in the market. Legacy architecture is not the answer. And so with Zscaler with the breadth of platform – in the increasing platform that we've created and we'll continue to create is really perfectly set to go forward into this market.


Fatima Boolani
Good afternoon, thank you for taking my questions. Remo question for you, Jay, in his prepared remarks alluded to a number of very large sort of wall-to-wall transactions that were also multi-product. So, I'm wondering if you could comment on the large deal activity that you saw in the quarter and if it was maybe outsized in any particular regions? It would be really helpful if you can give us some quantification of that?
Jay Chaudhry
Yes. A good question. So large deal activity was strong in the quarter, it was comparable to Q1. It was significantly higher than last year. From a geographic perspective, all regions did well. I mean, we are investing in all regions, pretty much the same, same level. APJ, probably a little bit faster than the other regions, but all regions have done well and we continue to invest.
Related to the comment I made before, when companies see – with the breadth of the platform that we have and companies see the value of Zscaler. And the ease of implementation, the increased security and also the ROI. The value proposition is resonating with our customers. And so, we're seeing that. And so, by adding ZDX and ZCP and broadening the platform, it actually increases the value of what we are – of Zscaler.
If I may add a couple of points to it, we have truly expanded the platform. We haven't gone on a buying spree and throw them in there and call it a platform because those – these unintegrated products don't add a lot of value, our customers see the value. For example, to turn on ZDX, it's literally a few minutes. It hardly takes anything because the traffic is already flowing through everything is happening.
The second one, I like to make is, yes, we did have what you call wall-to-wall deals. I guess that meant all teller deals. But there are no mega deals in the quarter. Okay. And there's no one time kind of special deal that artificially increased our billings numbers. It was properly distributed various pillars, and across all geos.

Matt Swanson
Yes, thank you. This is Matt Swanson on for Matt. Jay, kind of going back on some of those large deals, it seemed like you had a lot of success upselling the, ZPA [ph]. I know at the Analyst Day, we talked about maybe six times (6x) upsell opportunity within your base. When it comes to kind of realizing that opportunity is it more just a matter of time and as the customer see the value they are coming back, or are there steps you can take to kind of more aggressively pursue that expansion?

Remo Canessa
And going forward, we think a good mix, for Zscaler is fifty-fifty (new vs up sell) . In the reasons, the point that you brought up, I mean the 6x, ability to upsell into existing customers, just for ZIA and ZPA. And so, it is significant.
ExponentialDave: Transcription of the call was a bit poor here, but I think the question stands nicely by itself to point out that Zscaler has a massive upselling opportunity right at their doorstep.

Tal Liani
Hi guys. My question is about the comps for 2021. Do you feel, or do you have any data to think that some of the growth this year was related to COVID an increase in license take rate because of COVID. And if that's the case, we might have an issue second half 2021 with the comps. I know that this is on investors’ mind, and I'm wondering if you have any data to support the view one way or another?
Jay Chaudhry
Yes, let me start with the general comments Remo, you can be more specific. I give you the hard part.
Remo Canessa
I will have to give numbers.
Jay Chaudhry
Look we do believe that work from anywhere has had to stay, I guess, COVID became a catalyst to shake off inertia. It actually changed the mindset and it really not just gave momentum, but also brought to light the limitations of legacy network and security. So, we are seeing our customers saying we are implementing zero trust, which means any ZIA ZPA top on deployments even after everything gets back to normal. If that was not the case, they would be doing short term ZPA deal and saying, I'm going back to the office, I no longer need to renewal of ZPA, beyond seeing that.
So, we think the world is changing. So, going back to the office should not be impacting our momentum of the business.
That's how I look at it overall. Remo?
Remo Canessa
Pipeline is strong and interest is high in Zscaler, and engagement is significant.
Print the post  

Announcements

What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and Glassdoor #1 Company to Work For 2015! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.