Earnings Call Transcript - ZS Q1 2020

Operator, Operator

Good afternoon, and welcome to the Zscaler first quarter 2020 earnings conference call. On the call with me today are Jay Chaudhry, Chairman and CEO; and Remo Canessa, CFO. By now, everyone should have access to our earnings announcement, which can be found on our website in the Investor Relations section. In addition, a supplemental financial schedule is available for download at ir.zscaler.com. Please note, unless otherwise noted, all numbers we talk about today, other than revenue 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. For historical periods, the GAAP to the non-GAAP reconciliations can be found in the supplemental financial information referenced a moment ago. Let me remind you that we'll be making forward-looking statements during today's discussions, 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, 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. Our actual results may differ significantly from those projected or suggested in any forward-looking statements. 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 that could impact our future operating results and financial condition, please see our filings with the Securities and Exchange Commission, as well as in today's earnings release. I would like to inform you that we will be participating in several upcoming investor conferences. Next week, management will be at the UBS Global TMT Conference and Cowen's Networking and Cyber Security Summit in New York City. And also the Barclays' TMT Conference in San Francisco. On January 14, we will be at Needham's Growth Conference in New York. Now I will turn the call over to Jay.

Jay Chaudhry, CEO

Thank you, Bill, and thank you, everyone for joining us. We reported solid Q1 results delivering strong revenue and operating profit growth in the first quarter with positive free cash flow, while making strategic investments to scale our go-to-market machine to the next level. Our revenue grew 48% and billings grew 37% year-over-year in Q1, and we are increasing our outlook for revenue and billings for the full fiscal year 2020. Adoption of the ZIA Transformation Bundle continues to grow and ZPA remains our fastest-growing product. I'm thrilled that more customers are using ZIA and ZPA together, which provides a single platform for secured cloud transformation that we believe no other vendor can match. As you know, Dali Rajic joined this September as our President Go-To-Market and Chief Revenue Officer. I'm excited about the key initiatives our sales leadership is putting in place to position us well for the long term. At our recent Zenith Live Cloud Summit, I was pleased to hear CIOs, CTOs, and CSOs of Global 2000 Enterprises sharing with pride their cloud transformation journeys enabled by Zscaler that delivered lower costs, improved security, and provided fast and reliable user experience. I'm very proud that Gartner recently recognized Zscaler as a leader in the Secure Web Gateway Magic Quadrant for the ninth year in a row. More importantly, Zscaler is positioned the highest for both execution and vision, significantly separating us from the competition. We pioneered the cloud-native, integrated security platform, and our cloud service is trusted by over 3,900 customers, including over 400 of the Forbes Global 2000 to access applications no matter where they live. The Zscaler cloud processes over 80 billion transactions per day, which is over ten times the number of Google searches per day. This provides an unprecedented network effect, which allows us to deliver superior security to our customers. We are aggressively investing in our business to pursue a massive opportunity to disrupt traditional network security, which mostly relies on legacy security appliances. Let me now highlight a few wins in Q1 that showcase what we believe are our sustainable competitive advantages. I will start with an upsell that highlights the scalability and elasticity of our cloud. This Fortune 100 customer purchased our professional Bundle for all 40,000 employees three years ago. In Q1, they tripled that annual business with us by upgrading to the Business Bundle, adding additional users, and purchasing protection for server traffic going from the data center to the public cloud. They deployed local Internet breakouts at over 1,000 locations during their cloud journey, including rolling out Office 365. Their Internet traffic increased exponentially, reaching 1.2 petabytes per month, which is equal to 10 billion photos on Facebook, and their IT leaders praised the elasticity of the Zscaler cloud when a companywide video conference call by the CEO went flawlessly even though the network traffic doubled during the event. How would a single-tenant security cloud possibly handle this? Now, I will share a new logo win of a Fortune 100 customer that needed to up-level their security. Unlike most large enterprises, they had no proxy gateways and instead relied upon next-gen firewalls for the user traffic to the Internet. No wonder they had a high-risk posture. They purchased the ZIA Transformation bundle for all 14,000 employees. With Zscaler, they can detect and prevent advanced threats and zero-day attacks which are increasingly found in encrypted traffic. This results in better security. Next, I will highlight the win that illustrates benefits of our Edge cloud capabilities and enabled faster M&A integration. A top global healthcare company that bought our Business Bundle and cloud firewall for 30,000 employees 18 months ago purchased an additional 30,000 seats to integrate a recent acquisition. The two companies have a combined global presence with hundreds of locations across 70 countries. Each company had embarked on a network transformation journey for local Internet breakouts but with two very different approaches to security. The acquired company was a next-gen firewall shop which scored offline walls deployed in branch offices giving a false sense of security, as 95% of the web traffic is encrypted and was not being inspected. To integrate the two companies, they standardized on Zscaler, implemented SSL inspection, and are ripping out all the branch firewalls. The result is significant savings and a big improvement in their security posture. Next, I'd like to share considerable momentum we are building in the U.S. Federal market. Last year, ZIA and ZPA received FedRAMP certification at the moderate level, and last month ZPA reached FedRAMP readiness at the high-impact level which puts Zscaler in an elite group of technology companies. ZIA is the only FedRAMP certified secure cloud Internet gateway today. ZPA is the first and only cloud security service that has received FedRAMP certification for zero trust remote access. This positions us very well in this large market. In Q1, we won two deals with civilian agencies, each with an annual contract value greater than $0.5 million. The first win is with a large strategic agency with an initial order for ZIA and ZPA for 15,000 mobile users to deliver secure access to applications with zero trust network access. The second agency purchased the complete ZIA and ZPA platform for all 6,800 employees to enable cloud transformation to secure SD-WAN deployment for local breakouts and to provide direct access to any application from anywhere. Turning to Japan, we entered this large market only two years ago, but have been gaining great traction. In Q1, one of Japan's largest transportation companies purchased our ZIA Business Bundle and cloud sandbox for all 30,000 employees to secure local breakouts and increased security for all users. Non-proxy technologies, such as next-gen firewalls, were not considered since comprehensive security was important. A common theme among all these wins is that a cloud-first world requires a cloud-native architecture. In a recent groundbreaking research note, Gartner defined a new product category named Secure Access Service Edge or SASE, pronounced SASE. Gartner predicts that the future of network security is in the cloud, and most organizations will move their network security to a SASE model. Importantly, Gartner recommends reducing the complexity of network security by moving to one vendor for Secure Web Gateway, CASB, DNS, zero trust network access, and remote browser isolation capabilities. This is Zscaler. We strongly believe this validates our vision when we founded Zscaler over 10 years ago. Here are the core architectural principles Gartner has outlined for SASE. Number one, SASE demands that the security providers offer security at the cloud EDGE close to the user for good user experience. Zscaler provides in-line security at the cloud EDGE in more than 150 data centers around the world. In contrast, legacy security vendors claiming to offer a SASE service are spinning up virtual machines on public clouds, and the traffic is backhauled to centralized compute that is not security at the edge. That is not SASE. Number two, SASE recommends that a branch office should have a light footprint which simply includes an SD-WAN router and all security services in the cloud. While the Zscaler cloud is a light branch architecture, the legacy firewall vendors are selling heavy branch appliances; again, that is not SASE. Number three, Gartner specifically stated that many of these SASE capabilities will use a proxy model, as our proxy is required to inspect encrypted traffic. Zscaler meets this requirement while next-gen firewalls do not; hence, next-gen firewalls are not SASE. Number four lastly; SASE advocates a cloud-native multi-tenant architecture which is the foundation of the Zscaler cloud platform. You can take legacy single-tenant security appliances and stick them in the cloud as virtual machines and call it cloud security; that would be like placing thousands of DVD players in a public cloud and calling it a Netflix streaming service. In summary, Zscaler was designed for the SASE world that Gartner has spelled out. Some of you have asked questions about competition from next-gen firewall vendors. Over the last 10 years, we have faced various competitors starting with large legacy secured web gateway vendors who claim to offer a cloud security service. Where they are today, as security must move to the cloud, legacy firewall vendors are now making similar claims. Next-gen firewalls are designed to build a moat around the castle, to secure the network and the data center. They are the wrong architecture for security for users. The next question is why they can't build a platform like Zscaler. The answer lies in the architecture. Architecture is like the foundation of a building; you can't change the foundation unless you start all over, which is hard and takes a long time. We know that startups like Salesforce and Workday competed and won against much larger on-premise incumbent vendors because of their cloud-native architecture. We believe we are doing the same in the network security space. Let me talk about our product. I will highlight a few innovations expanding our platform: Zscaler B2B and Zscaler Digital Experience or DDX. The two major product lines we announced at Zenith Live are getting great initial feedback from our customers. The out-of-band CASB that we announced at Zenith Live is receiving very good early reception combined with our existing in-line CASB capabilities. We will now offer a complete CASB solution. The integration of browser isolation technology, which we acquired through Appsulate, is ahead of plan and is already being tested by customers. Building upon the TrustPath acquisition we did last year, we have significantly enhanced our threat detection capabilities with machine learning and AI. Moving on to tech partnerships to complement our comprehensive platform, we believe in partnering with tech leaders. This provides an integrated solution for customers and creates go-to-market leverage for Zscaler. For example, we have a deep and wide partnership with Microsoft Office 365 and Azure public cloud. Microsoft named Zscaler the first and only cloud security provider to be a certified partner in the Microsoft Networking Partner Program or NPP for Office 365, which has stringent requirements for user performance. Microsoft only recommends NPP partners for Office 365 connectivity. We are working closely with both VMware and Silver Peak, the only two leaders in Gartner's recently published SD-WAN Magic Quadrant. Let's now turn to our go-to-market. Zscaler is the enabler of cloud transformation. As a result, we have a different top-down sales process and go-to-market strategy than legacy vendors. As I stated during the last earnings call, we are focused on improving our sales execution to take Zscaler beyond $1 billion in revenue. That is why I'm excited to have Dali on board as he is keen on building a highly scalable go-to-market machine. He has already driven rapid and tangible progress building a multi-dimensional go-to-market model, putting us into a great position to scale. Let me give you a few examples; we implemented a more refined metrics-based model of accountability and transparency giving us better visibility into how our business is run. We are ahead of our plan to build a new sales process and enablement program that will deliver consistent and high-level execution in the field; it is already having a meaningful impact on our day-to-day execution, and we continue to mature our sales leadership structure. With all that we have implemented in a very short time, I'm very pleased with our progress and confident that we are building a solid foundation for a highly scalable sales machine for our long-term growth. Now I'd like to turn over the call to Remo for our financial results.

Remo Canessa, CFO

Thank you, Jay. Revenue for the quarter was $93.6 million, up 9% sequentially and 48% year-over-year. From a geographic perspective, for the quarter, the Americas represented 51% of revenue, EMEA was 41%, and APJ was 8%. 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 37% year-over-year to $88.3 million. 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-cancelable future revenue, was $555 million on October 31st, up 35% from $411 million one year ago. Our strong customer retention and ability to upsell have resulted in a consistently high dollar-based net retention rate, which is 120% for the quarter ended October 31st. This compares to 118% a year ago and last quarter. Our increased success selling bigger deals starting immediately with our Transformation bundle and faster upsell within a year while good for our business can reduce our dollar-based net retention rate which is calculated on a year-over-year ARR basis. Considering these factors, we feel 120% is outstanding and it will vary quarter-to-quarter. We are pleased with the continued adoption of our comprehensive cloud platform by our customers as they increasingly rely on us for their transformation journey; in fact, two-thirds of our top 25 customers were also customers two years ago, and the cumulative ARR has more than doubled over this period. Total gross margin was 81%, flat sequentially and down 1% year-over-year. We feel that 80% continues to be a good target range in the near term as it is important to continue to invest in our platform to drive top line revenue growth. Turning to operating expenses, our total operating expenses increased 17% sequentially and increased 44% year-over-year to $72.7 million; it decreased as a percentage of revenue, 78% compared to 80% last year. Sales and marketing increased 20% sequentially and 46% year-over-year to $49.4 million. The year-over-year increase is due to higher compensation expenses and the cost of three major marketing events: Zenith Live Americas, Zenith Live Europe, and our sales kickoff. R&D was up 12% sequentially and 44% year-over-year to $14.8 million as we continue to invest to enhance our product functionality and innovate new products. G&A increased 6% sequentially and increased 32% year-over-year to $8.5 million. The year-over-year growth in G&A includes investments in building our team; these expenses exclude $2 million in litigation-related expenses. Our first-quarter operating margin was 3%, which compares to 2% in the same quarter last year. Net income in the quarter was $4.1 million or non-GAAP earnings per share of $0.03. We ended the quarter with $378 million in cash, cash equivalents, and short-term investments. Free cash flow was positive at $9.4 million in the quarter compared to positive $5.2 million for the same quarter a year ago. Our ESPP program increased our free cash flow by approximately $3 million in the quarter, the same as a year ago. The ESPP program does not impact the overall cash balance. Now moving on to guidance, as a reminder, these numbers are all non-GAAP, which exclude stock-based compensation expenses, amortization of intangible assets, certain litigation-related expenses, and any associated tax effects. For the second quarter, we expect revenue in the range of $97 million to $100 million, reflecting a year-over-year growth of 31% to 35% for the year-ago comparison; recall the Q2, 2019 revenue was aided by $2.3 million in nonrecurring revenue from a large public sector customer deploying our platform as a private cloud. Excluding this revenue from last year, guidance reflects 35% to 39% growth. Operating profit in the range of $3 million to $4 million; income taxes of $900,000 and earnings per share of approximately $0.03, assuming 138 million common shares outstanding. For the full year fiscal 2020, we expect revenue in the range of $405 million to $413 million or year-over-year growth of 34% to 36%. Calculated billings in the range of $500 million to $510 million or year-over-year growth of 28% to 31%. Operating profit in the range of $15 million to $18 million. In Q4, we expect to host our annual Zenith Live Events in both EMEA and Americas. We expect the cost of these two events to be in the range of $5 million to $6 million, income taxes of $3.6 million and earnings per share in the range of $0.13 to $0.15, assuming approximately 139 million common shares outstanding. Our guidance reflects our plans to invest aggressively in our business to pursue our significant market opportunity. We are pleased with the progress our CRO is making and we are confident he is the right person to drive our sales and go-to-market execution. We are stepping up sales and marketing investments in order to build the foundation for long-term growth. In addition, we'll increase investments in our technology platform and cloud infrastructure. As you model billings, I want to remind you that historically, Q2 and Q4 have been our strongest billing quarters with sequential declines in Q1 and Q3 quarters respectively. With our outperformance in Q1 billings, we now expect the first half billings to be approximately 43% of full year billings compared to our prior expectations of 42% to 43%. Also, please keep in mind that we had a large upfront billing of $1 million in Q2 of 2019 from a large public sector customer deploying our platform as a private cloud, which will pose a tough year-over-year comparison in Q2. Excluding this deal, our billings guidance for the full year implies 32% to 35% growth. In terms of free cash flow, please note that we'll have additional spend for tenant improvements related to our headquarters' move in January as well as ongoing cash outlays for lease payments on our existing San Jose buildings and litigation expenses related to our ongoing Symantec lawsuit. These extraordinary items are expected to be approximately $15 million to $20 million in cash payments for the full year. As a result of these payments, we expect our free cash flow margins in fiscal 2020 to be zero to two points lower compared to our operating profit margins. Longer term, we expect our free cash flow margins to be higher than our non-GAAP operating margins.

Jay Chaudhry, CEO

Thank you, Remo. In closing, let me state four key points that make me excited. Number one, architecture matters, especially for a cloud security platform that must set in line to inspect all traffic for policy enforcement. We believe we have the best architecture with 10 years of operational experience to run a massive cloud and an enormous barrier to entry. Number two, with multiple tailwinds such as Office 365 SaaS adoption, SD-WAN, and app migration to public clouds, we believe the market is coming to us. Number three, we are in the early innings of the cloud journey we are disrupting a $20 billion TAM with ZIA and ZPA. In addition, we recently announced Zscaler B2B and ZDX, which we believe will expand our TAM significantly. Number four, with new go-to-market leadership on board, we are building a sales machine that can deliver world-class execution and sustainable long-term growth. We thank you for your interest in Zscaler and look forward to reporting on our progress in the future. Operator, you may now open the call for questions.

Operator, Operator

Our first question will come from Alex Henderson with Needham.

Alex Henderson, Analyst

Thank you very much. I would like to ask a question regarding the new Chief Revenue Officer. To what extent has he become effective since joining, and how long do you believe it will take for his programs to be fully implemented and achieve maximum benefit? Is that a three to four quarter process for reacceleration? Additionally, I have been receiving many inquiries from clients about competition from the next-gen firewall players. It appears this hasn't been a factor, but could you discuss whether this has impacted pricing pressure or any other significant metrics, apart from lost deals? Thank you.

Jay Chaudhry, CEO

Yes, Alex. Thank you. This is Jay. Regarding your question about our go-to-market, our CRO. As you know, we have done very well so far billing to business to hundreds of millions of dollars. Now, our goal is to take it to $1 billion and plus, which means scaling our sales execution. Dali actually is the right guy who is driving a number of these things. Let me give you a perspective of what all he's driving. So, for execution at scale, I will give you three examples. One, when you have scores of salespeople, it's one thing; when you have hundreds of salespeople, you need far better sales enablement, far better training. For us, we used to have a small sales enablement team. Dali has come in and built a pretty sizable team, and the team has already rolled out some of the training programs. Number two; to really scale your business, you need a very consistent and repeatable sales process that may be more refined. And Dali has come in and taken our process and further refined it, and it's being rolled out to the whole field. Number three, while we had tools and systems in place to scale to the next level and to have better accountability, better visibility to give us better leading indicators of sales activities, he and the leadership team have started work in many areas. So, a lot of these things are already making a difference, and we're seeing it. And I think as each quarter goes by, we will see more and more impact of the work being done by Dali and his team. Remo, do you want to add anything?

Remo Canessa, CFO

Yes, a couple of add-ons to that also. I mean, our plan is still to be at a 20% plus operating margin once we hit $800 million to $1 billion in revenue. Related to pricing pressure, our discounts are lower this quarter. Our average prices per user are higher. When I take a look at our ARR for customers with greater than 3,000 users, it is higher this quarter. It's in the high 300,000 range, and our churn is down.

Jay Chaudhry, CEO

Alex, regarding your second question about competition from firewall vendors, you know, somehow discussion keeps on coming, I tried to address it during my statements, but fundamentally if you look at the large enterprises; to protect users, they almost always look for a proxy architecture. You guys deal with large banks. If you talk to the top 20 banks and ask anyone whether you would just depend upon next-gen firewall for user protection, I haven't found a yes answer from a single bank so far. Now, it's probably true. There used to be some of that is happening on the lower end where the customer is less security savvy, and they are able to go with some of that solution happening. So, probably on the SD-WAN side, some of that is happening in the lower end. But where our primary focus is, we don't really think any of the impact from the firewall vendors making noise has happened and impacted us. So far, I think it's the architecture that we got, much better, that's giving us an edge, and I think it's a long-term edge.

Operator, Operator

Our next question comes from Daniel Bartus with Bank of America.

Daniel Bartus, Analyst

Great. Thanks for taking the questions, guys. First for Jay maybe, no mention of the longer sales cycle order. So, can you just walk us through the changes you're seeing versus last quarter when you called that out, and then I've got a quick follow-up. Thanks.

Jay Chaudhry, CEO

Yes. Changes in terms of the sales cycle and all haven't really changed a whole lot for us. I think what we are doing is tightening our sales process and tightening our execution. We aren't really seeing much market impact in terms of a slowdown of any of the stuff. With better leadership and some of the things I outlined, I think focused execution is what we are doing, and we are beginning to see it's making a difference for us. And I think it'll help us in the long run because we're building a stronger infrastructure to scale our sales.

Daniel Bartus, Analyst

Great, makes sense. And then, Remo, quick, good to hear the new products are getting good reception. I'm curious if you have any ZDX or Z B2B in your fiscal 2020 expectations, and what's the potential for these new products to ramp and maybe drive some upside this year? Thanks.

Remo Canessa, CFO

Yes. So, no, there's nothing we're planning for, and you shouldn't plan for anything either. We're planning to get these products out in the second calendar quarter of 2020. There's potential for the products as Jay mentioned with the CASB out-of-band browser isolation user experience in the B2B. We feel that there's pretty significant upside for us with these types of products but nothing for this fiscal 2020 should be accounted for.

Jay Chaudhry, CEO

Yes. If I may add, we are engaged with customers as you would expect in beta stages during evaluation and testing. Our interest is real. I mean just to clarify what we announced was two big product lines, Zscaler B2B and Zscaler Digital Experience. And then we also announced two, what I would call features, out-of-band CASB, CASB as a feature and browser isolation is another feature that's relevant for both ZI and ZPA. Early indications are very positive. These products become generally available in calendar Q2.

Operator, Operator

Our next question will come from Patrick Colville with Arete Research.

Patrick Colville, Analyst

Thank you for taking my question. Can we discuss the CASB product? There seems to be significant interest in CASB from your customers, and some have mentioned that this could be a natural point of entry in the CASB discussion, in addition to your existing partnerships with Microsoft and McAfee. I would like to gain a better understanding of that product, if possible.

Jay Chaudhry, CEO

Yes. So for a long time we have had what we call in-line CASB; if all traffic goes through us, we have to do CASB which includes threat detection and protection DLP and alike. And for out-of-band, we depended upon two partnerships. You mentioned McAfee and Microsoft. Our customers kept on telling us that it's a small add-on we should be doing it. So we took them seriously; we built it. So we become a single provider. So it's a natural feature for us to add-on and we're seeing lots of traction. We will continue our partnership with Microsoft and Sky High McAfee in this area. If customers want something like that they have it, but we believe a large number of our customers will take Zscaler, and if there is another CASB solution, I think we will end up displacing it.

Patrick Colville, Analyst

Great. And can I just ask a quick follow-up on the dollar-based net retention rate? So the 120% is extremely impressive, no doubt, and especially given it's a sequential and annual increase, but it does imply that revenue from new customers would have tailed off, both sequentially and annually. So do you mind just helping me understand if that's correct? The revenue contribution became increasingly skewed to existing customers? Or if there are any metrics you can share to help me better understand new customer revenue and customer count. Great.

Remo Canessa, CFO

Yes. That's a good question. So typically, we range with 2 versus upsell 60% to 40% new versus upsell and also 50 to 50. In Q1, the mix was closer to 50% to 60%. What's important to recognize is we don't really distinguish internally the difference between new and upsell when we track it. But we incentivize our sales organization both for new and upsell. When you take a look at the installed base that we have and the penetration with our installed base, there's a significant opportunity for us to upsell into that installed base. We don't want to disincentivize our sales organization from selling into that installed base. With Dali onboard, I'm sure he'll be driving all aspects of the business including new customer acquisition.

Jay Chaudhry, CEO

Remo, if I may add. If a company is a single-product company with a narrow offering, they have to keep on worrying about new customers in order to drive growth. We have such a wide platform and more products being added to it. So we're less worried about making sure we just do new customers. So our number one goal is to maximize new ACV. Hence, we don't have a difference between new versus upsell. As Remo said, the range of new has varied from 50% to 60%. And I think that's a good range. But as you see more new products coming, some of them can be sold on their own without the install base. We expect over time to go up. But we don't look at our net retention revenue as the most reliable indicator. It varies quite a bit. Remo, you have commented on this in the past about why it varies.

Remo Canessa, CFO

Yes. So, I mean, a 120% that's clearly outstanding. We've ranged on 118% for several quarters. We called out several quarters ago that there could be pressure on that and our net retention rate. As more companies are buying transformation upfront, which is what we're seeing? In addition, if customers are buying things quicker within the year because our net retention rate is based on ARR at the beginning of the year versus what it is currently. If customers buy products within that period, that's going to put pressure also on the net retention rate. Now those are the negative effects to it. The positive effects are that 43% of our ARR in ZIA was transformation. 14% of our new and upsell business last year was the ZPA. So there are upsell capabilities with those products. In addition, as Jay mentioned with our new products, there's a potential for it also going up. The point to make is it's going to fluctuate. It's a hard metric to really put your finger on. 120% is outstanding, but it could fluctuate.

Operator, Operator

Our next question will come from Andrew Nowinski with DA Davidson.

Andrew Nowinski, Analyst

Thank you, and congratulations on a strong quarter. I'd like to start with a question regarding the Federal side. You mentioned a few modest deals with civilian agencies. Can you share your thoughts on how Microsoft's award of the Jedi contract might affect Zscaler, considering your strong partnership with Microsoft and the fact that both ZIA and ZPA are now FedRAMP certified?

Jay Chaudhry, CEO

Actually, I'm very excited about the opportunity. We started investing in FedRAMP certifications over two years ago. It's a very hard certification, but we made the investment, and as you've seen in recent press releases and the like, we got certification for both ZPA and ZIA. And as I said, we're the only vendor that's FedRAMP-certified with a cloud security gateway. And on the ZPA side, we are the only vendor certified for zero trust remote access. That puts us in a very, very good position. Now, the way Zscaler works is it's independent of the cloud. We can access Microsoft, AWS, Azure; all these clouds worked with us, but having a good partnership already in place with Microsoft will help us work closely with them in the field from a go-to-market point-of-view. So while we have begun to get some early deals, we are pretty optimistic about the opportunity. Though we do realize that federal deals can take a little bit of a longer time. But I'm very pleased with the team we have put in place. The team has grown quite a bit and it's delivering.

Andrew Nowinski, Analyst

Okay, thanks Jay. And then the Telcos have also been a fairly large driver of demand over the course of the last few years. So can you just give us any color on what if anything has changed with regard to the revenue contributed by the Telco providers? Thanks.

Jay Chaudhry, CEO

Yes. Telco, they have been an important partner for us. I won't see any partner has been driving a lot of demand for us. As you know, as we drove transformation, we have done a lot of evangelism. So we have been driving a lot of demand. It has been high-touch sales. But as customers are asking for more and more transformations, we do see more leads coming from telco partners to say my customers are asking for it. We're beginning to see RFPs coming out and saying I need to do transformation. The deal I referred to in my earnings calls from Japan actually was an RFP that was issued to three telcos. All three telcos were Zscaler because we met the requirements. So good business happening. We are trying to go further down market with telcos. That's a new project that Dali is trying to drive. So far a lot of business we've done with telcos in the very high end with the large enterprises. So excited about the opportunity. They are natural partners for us even though there is, yes, some contention about network costs and what not. But we really don't impact that; it is the market that's looking for it and we're taking advantage of the market.

Remo Canessa, CFO

Yes. Telcos typically represent around 50% of our revenue, and that's about where it was in Q1.

Operator, Operator

Our next question will come from Saket Kalia with Barclays.

Saket Kalia, Analyst

Hi, guys. Thanks for taking my questions here. Jay maybe to start with you. A lot of talk on competition particularly from the firewall side. I'd actually like to shift a little bit and maybe talk about competition from the traditional Secure Web Gateway players here that are transitioning. Most notably with Blue Coat. I guess the question is what are you seeing in terms of sales engagement with those types of opportunities since the deal is closed and really their willingness to explore a solution from legacy Zscaler?

Jay Chaudhry, CEO

Yes. When it comes to competition, our real competition from an incumbency point-of-view is Secure Web Gateway because they have the right architecture as a proxy architecture. Where we have been winning against them is because they have been good on-premise single-tenant proxy architecture, but they couldn't pivot to the cloud; they couldn't build a viable multi-tenant architecture right. Remember my DVD versus Netflix example. Now among these traditional vendors for Secure Web Gateway, Blue Coat had a big presence in large enterprises as an appliance and with sales to a new owner. There's somewhat uncertainty out there. So we are seeing a lot of additional interest from large enterprises who are looking for alternatives and also some of these customers are moving to the cloud, so it is actually helping us. So we're getting inbound inquiries that we're not getting before. So we think it's a big opportunity for us. We got some focus to take advantage of it.

Saket Kalia, Analyst

Makes sense. Remo, maybe for my follow-up for you somewhat related but now that Symantec is part of a larger entity. You talked about $15 million to $20 million in one-time cash costs including litigation. Can you talk about the litigation portion of it? And how does that sort of progress now that ownership on Symantec has sort of changed hands?

Remo Canessa, CFO

Yes. The litigation portion is $8 million to $10 million. And the transaction with Broadcom and Symantec just was completed. So there's not much update. I mean, the only thing I can say is that we do not feel we infringe; we're going to defend ourselves vigorously, and the lawsuit that is currently out there is not having any impact on our business at all.

Jay Chaudhry, CEO

Yes. We are carrying on, as you pointed out, change of hands can present an opportunity. And if it did, we will be open to it.

Operator, Operator

Our next question will come from Brian Essex with Goldman Sachs.

Brian Essex, Analyst

Hi, good afternoon. And thank you for taking the question. Jay, maybe if I could point to a couple of the sustainable competitive advantage examples that you gave. One, the first one pointed to the scalability and elasticity of your platform and the third one pointed to your Edge cloud capabilities. But both were really interesting instances of pursuing Internet breakouts. Maybe if you could help us understand a little bit how these deals transpired? And who the partners on the SD-WAN side were and was this driven by maybe an SI that was putting the deal together and working with the company on a consultative basis? Or was this something that you led and held their hands through this process and pulled maybe the SD-WAN vendors in and put the deal together on your side?

Jay Chaudhry, CEO

Yes. The way these things are happening, it's still not a process where the market is mature, and RFPs get sent out all the time. As we have mentioned, we are still in a high-tech sales model. There is a good amount of evangelism needed though it's getting easier and easier what it used to be. A typical process, our sales team goes or they engage with customers shows them the value of transformation that can deliver user experience at a lower cost. And that basically leads to a natural discussion in sale. Let's get an SP or SA together because it's generally involved in transformation; SD vendor awareness is out there. We start collaborating with SD vendors out there. As I mentioned to you, VMware and Silver Peak are good partners for us; they're the leaders out there. And we come together and offer our proposal and solution. So what I see is, I would say a majority of the large deals that are driven and closed are still led by us, and we bring the partners along. But in a good number of them, they do come from partners, and many times our SD-WAN vendors introduced us to the deal, and sometimes we introduced them to deals. So that's why we liked these technology partnerships. Microsoft and VMware are too big technology partners that are helping us on the SP front. The large SP, the top four or five SP are globally very good partners.

Brian Essex, Analyst

Got it. Maybe just a follow-up to, thank you for that. That's very helpful. Remo, when we spoke with Dali in September, he had a goal of maybe taking 30 to 60 days to evaluate data on a platform, build models, evaluate tie-up, talent and hire and so forth. Is he through with that? And do you know definitively kind of the framework of what the incremental spend on the sales and marketing side will be for this year or might that kind of bleed into next year? I'm just trying to get a sense of when we might anticipate some meaningful leverage on our sales and marketing side of the model.

Remo Canessa, CFO

Yes. Good question. I would start seeing basically improvement next year related to, and again the guidance that we gave contemplates the investments we're making in sales and marketing. Dali's 30 to 60-day plan. I mean I've worked with a few CROs, and watching what Dali is doing here in the first couple of months as he's moving very quickly and doing an outstanding job. I mean he is building the sales leadership in the organization. He's building, as Jay mentioned, our sales enablement and training. He is better defining sales responsibility and putting in place the framework for us to be a much bigger company and placing in, putting in place that accountability. In summary, what I see with Dali is doing, he's putting structured, disciplined leadership and has a passion that he has. Quite frankly, I don't know when he sleeps. It's going very quickly, but it is going to take time. So that was the reason for our guidance initially at 42% to 43% billings in the first half, and we increased that to 43% and increased our billings guidance to $500 and $510. I'm excited working with Dali and what he's doing and look forward to it.

Operator, Operator

Our next question comes from Matthew Wells with Citi.

Unidentified Analyst, Analyst

Hi, thanks for taking my question. Can you provide an update on customer feedback and learnings around the ZB2B and ZDX? I understand both are still in beta and plan to go live I believe next quarter actually.

Jay Chaudhry, CEO

Yes. I think we will be able to give you more tangible and meaningful customer feedback probably next quarter. Right now, I would say the degree of interest and opportunity is higher than anticipated three or six months ago. It seems bigger than that. So high customer interest but again it's limited engagement so far. So the limited engagement we have is very high degree of interest. But we'll give you more as we have more tangible feedback.

Unidentified Analyst, Analyst

Got it. And just a follow-up on that. Is the salesforce incentivized around the products while they're still in beta or is this just when they go live next quarter?

Jay Chaudhry, CEO

We have no incentive. In fact, product management is actually working closely with a selected number of customers. So we're not really pushing. We would rather not push till the products are properly cooked and all the kinks are out to fit. Once they become GA, only then will the salesforce start selling.

Unidentified Analyst, Analyst

I just wanted to clarify that these new products are going to be generally available in calendar Q2, so it is not next quarter. Thanks.

Operator, Operator

Next we have Melissa Dan with Morgan Stanley.

Melissa Dan, Analyst

Hi, this is Melissa Dan on for Melissa Franchi. I was hoping you could provide some color around activity in EMEA. Revenue growth in that area was slightly slower than the rest of the region. So wondering if there was any macro softness in your view or maybe execution considerations. Thank you.

Remo Canessa, CFO

Yes, thank you. From a macro perspective, we really don't see it. EMEA grew 40%, which is slower than the Americas and APJ. We did have a leadership change in EMEA which we're very excited about. But at 41% of total revenue in the EMEA, APJ at 8%, Americas at 51% is pretty consistent with what it's been in the past. But from a macro perspective, not really seeing any changes.

Jay Chaudhry, CEO

Yes. We're bullish on EMEA. I think we got a good incumbent installed base and we will keep on growing it. We're making the right amount of investments for EMEA.

Melissa Dan, Analyst

And just a quick follow-up. To what extent is ZPA driving initial conversations with new customers versus ZIA? And there have been a lot of other vendors that are seemingly trying to address this opportunity. So has there been any change in what you've seen in competitive deals?

Jay Chaudhry, CEO

So in the past few quarters, we have been seeing about half the new customers coming for ZPA; sorry, half the ZPA deals are coming from new customers and half coming from upsell. So that's kind of the number of customers. But having said that, the ZPA deals are smaller than ZIA deals. As we said before, when ZIA is bought, it's bought for everyone in the company for all employees, and ZPA is based on the number of applications. So it's one. GPA is opening more doors for new logos than we had initially thought of. So pleased with that. Your second question is competition for ZPA; the ZPA market in what gotten called zero-trust network access or others call, SDP, it is still a young market. We kind of really run into each other because it's a relatively small market. So it's not a very competitive space. It's more of a matter of evangelizing and showing people that doing traditional network security with things like VPN is a dangerous thing they don't need to do. Once they get it, you win the deal.

Operator, Operator

Our next question will come from Fatima Boolani with UBS.

Fatima Boolani, Analyst

Good afternoon and thank you for taking the questions. Jay, I have a question for you and a follow-up for Remo. Jay, you talked a lot about the internal improvements and pipeline rigor and sales enablement initiatives that Dali has sort of put in place and put into motion. So internally you're really elevating the rigor in the sales organization and go-to-market. I'm wondering if you can speak to the external and external distribution avenues and sort of what you're doing there from maybe a channel perspective or service provider or SI distribution perspective. Because as we understand your model doesn't traditionally lend itself well to the box pressures. So I wanted to get your sense of what sort of investments are in play from an external distribution perspective?

Jay Chaudhry, CEO

Absolutely, there are a number of points I could make there. In fact, I heard from someone the other day, they said, it seemed like you're defocusing on channel. I said I'm not sure where that's coming from. Because actually we are putting more focus on channel. Now the point is it's not the same traditional channels. So what are we doing about channel? We know SPs have worked for us. We will keep on making more investments rather looking at going downstream with some of the SPs and not just do the very large enterprise deals. On the channel, or maybe called the VAR channel traditionally, guide. The people who largely on the box selling business that has limited synergy with us but Dali is focused on two types of channel partners. One, we have done cloud-native boutique VARs well but only limited. We are expanding the reach. Dali has successfully done those cloud-native types of vendors in his previous life. So we're focused on getting those things done. Two, finding more vendors who are ready to pivot. Every channel person doesn't want to pivot or they wish they don't have to pivot because boxes will keep on selling forever. So those are the two things we're doing. I talked about sales enablement and training. That's really not just needed for channel, sorry for internal things; that's needed for channel as well. So we are actually putting a lot of focus in that area as well because that's needed for them to become more effective. Does it make sense?

Fatima Boolani, Analyst

I appreciate that. That makes a ton of sense. Remo, a question for you. You've been very explicit on the level of investments especially on the sales and marketing front as reflected in your guide. But as I think about Analyst Day, you were a little bit more explicit on your sales capacity investments. So maybe accelerating that sales capacity footprint is 60% this year. I just wanted to get a sense of an update of how the sales hiring has been tracking as you started the New Year and that's it for me. Thank you.

Remo Canessa, CFO

Yes. Our sales tracking for Q1, it's a little bit behind, but our expectation is still to get to that 60%. We are looking for Q4 to be a good quarter for us, but it's all taken into account in our guidance.

Jay Chaudhry, CEO

Yes. I would add that in the past quarter, we have raised the bar in hiring better quality people. And also acceleration hiring. In fact, under Dali, we have put together a new recruiting playbook where we're educating and training all of our frontline sales leaders to make sure we hire the right kind of people. Again part of scaling when you only have 10 leaders who are hiring, it's a small problem. When you have 50 sales leaders who are hiring, it needs better scaling and better methodology and process. And that's what we're really scaling out.

Operator, Operator

Our next question will come from Dan Ives with Wedbush Securities.

Dan Ives, Analyst

Yes, thanks. So maybe can you talk about the government market? Obviously, a lot of deals moving into cloud, Jedi, just I think one of them. And just given where you are in terms of Azure in terms of that channel, maybe just talk about that as an opportunity over the next 6-12 months in terms of how you're viewing that going into 2020?

Jay Chaudhry, CEO

Yes. I think I'll add upon what I said earlier. Getting FedRAMP certifications is the first thing unless you have been nothing, not much matter. So we have done that. And also in FedRAMP, there's a moderate level certification and a high impact. Having done both of them for ZIA, sorry ZPA, we are at more rates we will get to high impact shortly. The door is wide open for us to leverage. And Azure with Microsoft partnership is a good opportunity, but we also work with a fair amount of AWS out there. Very bullish on it. Remo, can I say that? Good team. I would say, if you asked me a year ago versus today, I feel we are significantly ahead of where I thought it would be.

Operator, Operator

Thank you. Our last question will come from Yun Kim with Rosenblatt Securities.

Yun Kim, Analyst

Thank you and congrats on the solid quarter. On the ZPA front, just wanted to ask about the competitive nature of that market. Are you seeing some of the same competitors for ZIA for your ZPA product and also are you selling to the same department or are they typically two different buyers for VPN and ZIA? Thanks.

Jay Chaudhry, CEO

That's a great question. ZIA is typically influenced by transformation in our ideal scenario, starting with the CIO and moving down to the head of infrastructure, who seeks to transform the network, with security being integrated into the process. ZPA, on the other hand, has several distinct paths. I will outline three different opportunities. First, when we approach customers who are moving their applications to public clouds like Azure and AWS, we suggest they bypass their data center and connect directly through Zscaler. The head of infrastructure usually makes the purchasing decision here, as they previously managed that connectivity. Second, many customers acknowledge their cloud strategy but need to address an immediate issue: their remote access VPN, which they find slow and insecure. In this scenario, the buyer could be from the security or network teams. Lastly, during mergers and acquisitions, companies often aim to integrate their networks. However, within the Zscaler framework, there's no need to merge networks; instead, ZPA offers seamless access to each application. This scenario often involves CIOs, but sometimes an M&A team is involved as well, depending on how the companies are being integrated. There are some common buyers and some that differ significantly.

Operator, Operator

Thank you, gentlemen. That concludes our question-and-answer session. And I would like to turn the call back over to Mr. Jay Chaudhry for any closing remarks.

Jay Chaudhry, CEO

Well, thank you all for your time. And we look forward to seeing you at upcoming conferences this quarter. Thank you again.

Operator, Operator

Thank you, ladies and gentlemen. This concludes today's teleconference, and you may now disconnect. Please enjoy the rest of your day.