Zscaler, Inc. (ZS) Earnings Call Transcript & Summary

Okay. Great. Well, hey, good afternoon or good morning, depending on what coast you're on, and welcome to day 2 of the Barclays TMT Conference. Very honored to have with us the team from Zscaler. We've got Jay Chaudhry, Co-Founder and Chief Executive Officer. We've got Remo Canessa, Chief Financial Officer. We've also gotten Bill Choi, SVP and Head of Investor Relations on the call as well. We've got about 25 minutes together. Let's maybe take the first 15 or 20 minutes to go through some fireside chat with the team, which I know is going to be fun and action packed. And then let's make this interactive. So anybody on the call that's got any questions, just feel free to shoot me an e-mail at [email protected]. I'll do my best to weave in your questions at the end of the session. So maybe with that as a framework, Jay, Remo, Bill, thanks so much for being with us here today.

Thank you.

Jay, especially on the heels of your earnings call last week and a very busy stretch for Zscaler as well here in the last couple of days, you obviously had Zenith live. Greatly appreciate the time.

I'd love to maybe tag team a question with you and Remo. Maybe a question for you, Jay, is what were some of the highlights for you coming out of your Q1 report last week from a business perspective? And Remo, I'd love if you could add a little bit of color from the financial perspective as well. Does that make sense?

Of course. So Saket, regarding Q1, I'm sure all the investors have seen the numbers and results that we're very proud of our billings growth, our revenue growth, our cash flow in all areas. I think to me, more exciting is how some of the larger customers are doing bigger and bigger deals, ACV deals and the like. And also, I always like to look forward more than looking backwards and let Remo figure out the numbers and analysis of everything or what happened in Q1 because I'm focused on Q2. The pipeline here is getting stronger and stronger, which is very exciting to me because there are many leading indicators of our business that we look at, but pipeline is #1 indicator. Then they go little more deeper. You could have a good pipeline. You need to look at the quality of the pipeline besides the quantity and quality itself could have many things you look at, and we are looking at all those things pretty well. So I think COVID has helped accelerate the transformation. It has shown the CIOs that this legacy you thought is hard to change is not that hard to change. You thought that network was such an important piece of your business, and you're spending $30 million, $50 million $100 million on this network. And you're using -- you're not using any of it, right, now sitting at home and conducting all the work. So now they are saying, wow, I could move faster. And that some of them are saying, I don't need to do network transformation. I need to do network elimination. That's music to my ears. Remo?

Yes. I mean, from my perspective, Saket, you take a look at the numbers, it's hard to poke a hole at any number. It's -- in my career, I made a comment to a few folks that the numbers we put up, I haven't been able to put up ever in my career, like we did, just across the board. I mean, everything you look at is just positive and strong. Some things to call out, ZPA comparable contribution for new and upsell in Q1 versus Q4, which is great. New customers that are buying both the ZIA and ZPA, which is a good barometer for us related to customers, really looking to do digital transformation was up in Q1. It was in the high 30% range. Hiring is accelerating. Net hires over 260 in the quarter versus 200 the quarter before, 150 the quarter before that. Acceleration in our business that we're seeing and momentum. And for us, investing more into the company. We're investing for the growth, and we feel we have that momentum. So those are the things that I'd like to call out.

Yes, absolutely. That's a helpful framework from both you, gentlemen. So thank you. Jay, maybe one question that I get, and maybe there are some slides that you've got here that can help frame this question. But one of the questions that I get that's interesting is what is Zscaler doing that's different now versus what it's done in the past? And also, what's different versus its competition? Anything that you could share there? I know that's a loaded question, but any kind of view points that you would highlight there that you think are really important?

Yes. So what we are doing different now versus what we have done in the past. I'll start with what we're doing the same, we believed and always worked for the last several years. Being able to help CIOs drive secured digital acceleration rather than trying to do traditional network security. So we have not wavered that we are the true enablers. We are the true foundation of transformation in story, starting with CIOs going down to CXOs to CISOs and the like is very important. Probably good for me to share one slide to show where our view hasn't changed a bit. Here, since digital transformation has become a buzzword, and people have lost meaning to it. To me, it's pretty straightforward. It's a 3-step journey. Everything is driven by application modernization, application transformation that every CIO is driving as the highest priority, applications moving to either SaaS or to a public cloud. And that's what breaks the hub-and-spoke network. Because that network is designed for the traffic to go to the data center. But now applications are no longer in the data center. The cast of the data center is getting empty. So you want to go direct just like you don't want to fly from San Fran to Chicago via Houston. But you can't do it unless you transform security. Hence, where we come in with our exchange. So our story has been transformation enablement by Zscaler. So that's the same. What's different is, we have been beefing up our go-to-market model. As I said, soon after our IPO, I knew that I needed to bring a different kind of leadership and sales to really build the infrastructure, the process and whatnot to scale our company from X $100 million to $1 billion or $2 billion. We hired a new CRO. In the past 4 quarters, we really put a lot of things in place, better recruiting, better enablement, better visibility with dashboards that tell you our leading indicators on a weekly basis. Proper training for leaders on the front line, having more leaders. So all that stuff has shown us consistent results in the past 4 quarters, as we expected. So that's what we are doing differently from a go-to-market execution point of view. From a competitive point of view, haven't really seen a whole lot of change other than about a year -- 15 months ago, some of the legacy firewall vendors were trying to make a lot of noise, spread lots of disinformation. That has calmed down a lot. So -- but customers are realizing, they understand the difference, they realize that a cloud native, multi-tenant proxy architectures needed for ZIA, for traffic inspection and true zero trust is needed for access to internal applications like ZPA. You can take your VPN box and spin it as a VM in a cloud, it's still VPN. So architectural difference is helping us. And I see our business accelerating all around.

Absolutely. Maybe if we dig into the products a little bit deeper, Jay. Maybe starting with Zscaler Internet Access, or ZIA, of course. I guess, so much of that business really started as a displacement for the legacy secure web gateway with appliance vendors like Blue Coat. And so the question is, how much of that business sort of starts with that secure web gateway displacement? And how big of an installed base can you go after there?

Right. Very good question. So I think we -- our business really didn't start with let me replace your Blue Coat box. It started with, I need to do local Internet breakouts. To be able to go to the Internet to cloud and Office 365 and the like fast. And to do that, you needed a secure -- a local brake out story, and that's what we enabled. And then the customer said, oh, I am doing Blue Coat in 3 locations today. I really need to do it in 100 locations. So yes, we replaced the web proxy in 3 locations, but we added 97 more locations to it. So it is a combination of replace and greenfield opportunity. And for ZIA, that's the starting point. But what has happened since then is the definition of secure web gateway has expanded much, much more. In fact, Gartner even though they call it secure web gateway today, the Magic Quadrant that gets released now includes everything that should be needed at the gateway level of a proxy with web filtering, with antivirus, with advanced web protection, with sandboxing, with add-on firewall, the DLP, all criteria is in there. In fact, I am so excited that Gartner just released its latest Magic Quadrant. It actually will be all over out there starting tomorrow as we launch it. But maybe I can just give you a glimpse of something you haven't seen before. This is being shown to the audience for the first time since we just got this thing last night. Let me share. Can you see it?

I can.

Okay. Well, do you find us?

Up into the right.

Yes. I don't recall having seen a Magic Quadrant with only one vendor in leader's quadrant. They used to be our -- go back and look at -- they used to be about 8 or 9 vendors 10 years ago. Then it came down to 6, 5, 4, 3. It was 2 last year. Last year it was Blue Coat or Broadcom, Symantec and us and they had a pretty big fall, as all of us know. So this is where it sits. And it's kind of interesting. Gartner basically said, if you read the documents, firewall vendors are disqualified and not included because they don't have the right content inspection architecture. If you can terminate connection inspected, you can do security. Firewalls are pass-through devices. You can do it no matter how much firewall vendors will try to claim that I can do user traffic, a secure web gateway. We just don't. Now can they fool smaller enterprises or enterprises who don't have security savviness and bundle it in as free or whatever they can. But if you look at the enterprise space, savvy guys will never buy a firewall for doing user protection.

Got it. Got it. That's very helpful. And thanks for sharing that. I think that's really valuable. We look forward to seeing that more tomorrow as well. Remo, maybe a question for you, sort of staying on the topic of ZIA. You've talked about some interesting statistics just on the different bundles, right, that customers are opting for. Can you just remind us of some of those statistics and what you sort of glean from them?

Yes. Yes. So we sell in 3 bundles, both for ZIA and ZPA and starts with the professional bundle, goes to business of then transformation. The pricing basically is 1x for the professional, 1.5x for the business and 3x for the transformation. The pricing for CPA and CIA is comparable, same type of pricing. The -- what's interesting is that transformation being our biggest bundle. And again, companies looking to go digital transformation are going to go to the transformation stage, has been increasing every year. And last year, of our ARR business for ZIA, it was 49%, and it continues to increase. And one of the comments I made earlier is that what we're seeing, we're seeing bigger deals, a record quarter, bigger deals in Q1, for any quarter, not just in Q1, but any quarter. And also the percentage of new ACV that they're buying both ZIA and ZPA is in the high 30% range. That's what we're seeing. We're seeing the digital transformation that the shift to companies rethinking their architecture. We're seeing the inertia. COVID was basically -- brought the spotlight to the difficulties the current architectures have in this new world, in this new environment. And Zscaler is well positioned, very well positioned to take advantage of it.

Got it. Got it. That's really helpful, Remo. I think that's a good segue maybe into a question for you, Jay, on ZPA, right? And so I mean, I think we've all seen the success for this product. I think we understand kind of high level what it does and the accelerating interest. But I'm curious, right? As we start to go back to the office, right, knock on wood, that's not too far in the future. But I guess the question is, do you think that future prospects will change their attention, right, on modernizing the remote access? Or could it be opposite, right, because there will perhaps be structurally more folks working remotely? There's a lot there. Does that make sense?

Yes. So first of all, I think no one believes that we'll go back the day we used to work in the office all the time. Now everyone may not be working at home, you'll be somewhere in between. People will have far more freedom to work from wherever they need to work for them. But that's only one part of it. ZPA success is not driven by that it is looked at as a remote access tool to replace VPN. ZPA is the architecture or platform to implement zero trust. Zero trust says the user should never be on the same network that applications are. Don't connect users to the network, connect user to a particular application or service. When they're in the office or at home, it doesn't matter. They should go through zero trust switchboard of Zscaler. So all the deals that we have been closing with ZPA have largely been 3-year deals for 3-year commitment. Now VP ends up being the first step to replace VPN. The second step typically ends up being, let's go to my public cloud applications sitting in Azure or AWS, those numbers are growing in the old world of VPN. You don't do VPN to public cloud. You do VPN to data centers. And then you do a site-to-site VP and again to go to a public cloud. Very inefficient low metric. And three, they didn't want to do zero trust in their data center, where even if you're sitting at the headquarters, you actually go through ZPA to your data center, even though data center may be 3 milliseconds wave. So for that, we have actually extended the private access over to your data center with something called private service edge. So you've got the same experience, same consistent trial. You don't turn anything on and turn anything off when you're at the office, at home or coffee shop or wherever you go to. That's the true vision of zero trust, and that's what we're driving. That's why we don't see any slowdown in ZPS sales even after people started working from home.

Got it. Got it. I want to maybe shift topics a little bit to maybe what I would call a little bit of an underappreciated point. But I actually got the point is one of the things that you, Jay, or the team, I would say, is most proud of, and that is building a go-to-market engine for growth at scale, right? I think that came through a lot on the last call. And I think the hiring of Dali Rajic, I think, was very key there. And then also sort of the scaling of the organization that he's done in the rank and file. And so maybe the question -- maybe a 2-part question for Jay and Remo. Jay, maybe you could just talk about that sales force building? And Remo, you talked about just qualitatively maybe the pace of that hiring kind of as '21 kind of has started. Any comments there just to remind us about?

Sure. Yes. So I think we have a very good plan to figure out what needs to be done. We have thought about it methodically, a step at a time. In fact, before Dali started for about 6 months, we talked through exactly what needs to be done and all. He and I are fully aligned, not at a 20,000 foot level, about 1,000 foot level, okay, to really sketch to the plan. We executed properly. We saw the results and kept on putting more and more fuel on the fire to drive it as we saw good and good results. So I would say on the sales team side of it, whether it's leadership, it's hiring, our enablement, we've done well. We are seeing good results. In fact, one of the very exciting thing for me is I am seeing more and more deals being closed by the new hire during the first quarter and the second quarter, which is much different than it used to be. Now sales doesn't succeed just because of doing sales. Channel plays a big role in to it, marketing plays a big role into it. While I think most of the changes that our CRO had started are essentially done, the channel thing push got started about 6 months ago to really drive some more leverage from the channel. So we've got a number of initiatives underway. Early results are looking very good, but the better leverage channel generates, the better opportunity it is for us. So that's kind of the -- maybe call it the second leg of the stool of go-to market. There's a third leg of the stool that we are working on now. In the past year, we have taken sales from here to here, several notches up. Now I need to bring marketing several notches up too because sales and marketing must be aligned to stay in sync. That's why you saw the announcement of Chris Kozup, our new CMO, who joined us a couple of weeks ago. And we got some serious plans to make sure we start driving a lot more marketing initiatives. And I think those additional things between channel and marketing will give us a lot more momentum we need to keep on scaling our go-to-market machine.

And for -- yes. My comments are, I think people are aware that we took a bet last year that were going to increase our field quota sales headcount by 60%. That was a pretty lofty target. That's net, not gross. And we're able to do that. As a matter of fact, in Q4, we had a record quarter of hiring. Q1 was comparable. So when we came into this year, we saw the market momentum. We know we saw things and just pipeline and other factors. So we are increasing our field quota sales headcount net more. We didn't give the percentage, but more. And the comment we made on the last call is that since our year-end call, we've increased it even more. And so we see the momentum, and we're going to hire into it. And our objective is growth. Profitability is really not an issue for a SaaS company that's got 80% gross margin. It really isn't with the type of growth we got. It only takes a couple of quarters to get to really high operating profitability, free cash flow. When you have the momentum and you have the ability to really exploit a market as we do, we're going to invest in it. Now there's 2 parts to that -- there's more than 2 parts, but 2 key parts: sales and marketing and R&D. We also increased R&D hiring from what we thought we would do at the end of the year. So -- and what are the advantages that Zscaler has or a major, major advantage because it was founded 10-plus years ago, and it was founded both in India, R&D excellence as well as U.S. excellence. And the capacity that we have in R&D in India, in 3 locations in Bangalore, Shadnagar, in Pune is really significant. And the quality of the people we have in India is high. So you look at our R&D as a percentage of revenue, it's in the mid-teens, 15%, 16% range. But a big majority of -- a big piece of that is in India, and we get a significant amount of leverage, which gives us a competitive advantage, I feel.

Absolutely, absolutely. A few minutes left. One topic I want to hit on is, I mean, the great thing -- success is great. The tough part about success is that, that just creates a tough compare for next year, right, as the old adage goes. And so I think there are some folks that maybe wonder if when we start to lap some of the quarters where COVID was arguably benefiting the business, growth in some metrics like billings, for example, might start to normalize, let's say, if nothing else from tough compares, it certainly doesn't sound like from a lack of momentum. And so open-ended question, really for both of you. How do you think about that?

Remo, you want to start?

Yes. We gave our guidance. We had a strong beat and a strong raise. And we'll continue to grow the business and put the focus on top line growth. We think we're in the early stages of this market. We feel that we are the leader. And we feel we have significant opportunity. I don't want to directly answer your question exactly. That's where I'm at. We feel good about where we're at. We feel good about where we're at.

Yes. If I were to add, the way I look at these kind of opportunity, first, I look at, say, is there -- how big is the market? And is -- how big is TAM? You see our TAM is big. It's growing. And in fact, we added ZDX, this digital experience, a new kind of product in a new kind of market. This market did not really exist when people were working in the office. So it's ZDX is a new market, new opportunity. And cloud protection then further expands them quite a bit. A big market opportunity. It's coming to us. We've got customers who rave about us. We just wrapped up Zenith Live in Europe today, our annual user conference. Hope somewhere, you had a chance to watch it. Our customers, the biggest or the big customers are raving about upgrade the product set, the solutions and everything. We've got customers, we are happy. We've got innovation happening at a fast pace. The launch of Zscaler Cloud Protection is a combination of bringing a bunch of internal innovations and some of the acquisitions brought together. So if you got all the stuff and your cloud scales and works, no matter how good of a technology you have, learning how to run a massive cloud where all traffic goes through you. If you are down, our enterprise is dead and down, they can't do any business at all, requiring [ 5 nines ] of availability. And I can tell you that only comes through experience and learning, and we have 10-plus years of that. So I believe it gives us much, much differentiation from others. So we are focused on one thing: execution, making sure that my team doesn't get complacent. We became paranoid, like Andy Grove has said, and keep on driving our execution and delighting our customers.

I can't think of a better way to end on that note, Jay and Remo and Bill. Thank you so much for the time here. I have so many more questions to ask. There's so much more to dig into, but unfortunately, limited time. I certainly found this useful. I know the folks on the webcast did as well. So again, Jay, Remo, Bill, thank you so much for taking the time and look forward to when we could do this in person again out in San Francisco, like we usually do.

Look forward to it.

Thank you so much.

Thank you. Have a good one. Bye now.

You too.

Goodbye.

Bye.