Zscaler Inc
NASDAQ:ZS

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Earnings Call Transcript

Earnings Call Transcript
2019-Q2

from 0
Operator

Abrupt start

B
Bill Choi
VP, IR

financial results for the second quarter of fiscal 2019. With me on the call are Jay Chaudhry, Chairman and CEO; and Remo Canessa, CFO.

By now, everyone should have access to our earnings announcement. This announcement may also be found on our website in the Investor Relations section. In addition, a supplemental financial schedule was posted to our website earlier today.

Let me remind you that we’ll be making forward-looking statements during today’s discussion, including, but not limited to, the company’s anticipated future revenue, calculated billing, 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. Unless otherwise noted, all numbers we talk about today will be on an adjusted non-GAAP basis.

Please refer to our earnings release on the Investor Relations portion of our website for a reconciliation of GAAP to the non-GAAP financial measures. For historical periods, the GAAP to the non-GAAP reconciliations can be found in the supplemental financial information referenced a few moments ago.

I would also like to inform you that we will be participating in the Piper Jaffray’s Security Symposium in Chicago on March 14th.

Now, I’ll turn the call over to Jay.

J
Jay Chaudhry
CEO, Chairman and Founder

Thank you, Bill and thank you everyone for joining us on our call today. I am pleased to share with you our record second quarter results.

Our revenue grew 65% and calculated billings grew 74% year-over-year. In addition to our top line growth, we achieved another quarter of positive operating profit and free cash flow.

Our operating margins improved 19 percentage points year-over-year to 13%. Our Q2 results demonstrate the leverage in our business model and our ability to drive growth and profitability.

Having said that, we will continue to aggressively invest in our business to pursue our significant market opportunity. We are well positioned to capitalize on the megashifts in the data center and network architectures to support the secured adoption of cloud.

In the cloud worlds, applications can be anywhere and devices and users can be anywhere. The notion of inside the network or outside the network is disappearing. It is no longer a simple matter of defending a network parameter which has effectively disappeared.

Design for the wall which has no walls, the Zscaler clouds acts as a business policy engine deployed across more than 100 data centers to securely connect the right user to the right application; ZIA for Internet and SaaS applications and ZPA for internal applications in your data center, the public cloud or a hybrid cloud with the Zscaler security cloud there is no policy or trust assigned to the network level and therefore there is no need to maintain a complex expensive private network and stacks of appliances that is network security.

Our comprehensive cloud security platform has been leveraged by our customers as they progress through various stages of their cloud adoption journey. Let me highlight several days in the quarter that illustrate the diverse used cases.

A top global bank in Asia puts the Zscaler business bundle for over 100,000 employees to scale capacity and uplevel security. This customer experience driven issues with an on-prem web proxy as their piloted Office 365. Their existing appliances would not keep up with the surge in internet bound traffic from 400 [ph] offices worldwide. The incumbent appliance vendor offered hybrid cloud security.

As we often see in the market, the hybrid solution failed to meet the customer’s requirements. They are also up leveling security by deploying accessory inspection, advanced head protection and sandboxing. In addition, they purchase our DLP Solution to help meet regulatory requirements.

We talked to you about our entry into Japan last year. And I am pleased to share with you that our business is growing well in this new market. For example, a global 500 IT products and services company, which last year purchased Zscaler entry level professional bundle and SLL inspection functionality for 135,000 users to replace on-premise web proxies is now consolidating additional layers of the security stack with us.

This quarter they upgraded to our business bundle and cloud sand box for all 135,000 users replacing their incumbence sandboxing vendor. The drivers, protection against highly targeted zero day attacks that are almost always hidden in SLL traffic. SLL traffic has increased to more than 80% of the web traffic, and this traffic is not visible to traditional security appliances.

Imagine 80% of the luggage passing through airport security unchecked. You can’t, because that would be unacceptable, but this is exactly what happens when organizations attempt to use next-gen firewalls to protect users. Zscaler [Indiscernible] natively designed has a full SLL proxy, which means our customers can inspect encrypted traffic without impacting user experience, leading to better security and reduce businesses.

Let me give another example, where Zscaler was purchased to secure the transformation of a customer’s network and security infrastructure. A Fortune 500 retail and manufacturing company purchase Zscaler transformation bundle which includes Cloud firewall, IPS and cloud sandbox, for all 25,000 users to secure hundreds of locations.

In addition to helping Office 365 deployment, the customer will secure and upcoming SD-WAN initiative for local internet breakouts. Zscaler will further enhance secure [ph] with coverage for all users, including mobile and improve user experience, as their own premise DLP sitting in a few data centers become ineffective the local breakouts. The customer purchase DLP for all users to protect sensitive information from leaking, no matter where the user is, at the headquarter, or a branch office or on the road, on a laptop or on a mobile device.

Another deal highlights our capability used in M&A and business the organization used cases. A global pharma is spinning off one of its division, driving the need to separate out its applications, network and security from its parent company.

In the pre-cloud world, they would be moving the applications to new data centers, building a separate wide area, hub and spoke network, and a mode with security appliances, which can often take a year or two.

Instead, they pursued a full transformation to the cloud with internet as its wide area network and Zscaler as the policy engine. They purchase Zscaler transformation bundle for ZIA and ZPA for 24000 users across 155 locations without building a new network and new security gateways. The customer is leveraging Zscaler to provide secure, fast, and reliable access for any user from any location and device at a lower cost of ownership, and with greater operational simplicity. And this will take months rather than years.

Next, I will highlight a deal for Fortune 500 Auto Company that started the ZPA and quickly expanded to ZIA. In August, this customer purchase ZPA for 10,000 users, including 2000 contractors for VPN replacement and M&A integration.

With ZPA, our customer was able to provide access for specific users to specific applications without putting them on the corporate network, and have full visibility into user’s, applications and traffic. This success led the customer to purchase ZIA business bundle, plus cloud firewall functionality for all 46,000 users across 350 locations less than six months after the initial purchase.

This completes the full network and security transformation. This latest purchase resulted in quadrupling of the total customer spend with Zscaler. Lastly, on our Q4 call, we discussed the largest deal in Zscaler’s history, which contributed $16.5 million to billings in the quarter. This quarter, this public sector customer began the second stage of this security transformation project, resulting in an additional $11 million in billings. Over a five year period, we expect this deal to generate $50 million in revenue.

Remo will discuss this deal further. This customer required a highly scalable policy engine, that can handle 120 gigabits per second throughput, while inspecting SSL traffic for secure [ph] to give you a reference point, a majority of Fortune 500 enterprise customers need a few gigabits per second of sustained throughput.

These current cloud architecture allowed us to extend our cloud to the data center and deliver a hybrid solution. These deals demonstrate the unmatched benefits that Zscaler delivers. While traditional firewall and VPN vendors are making more noise about the hybrid security cloud, the technology is fundamentally designed to protect the corporate network by building a moat [ph] around the corporate castle.

In the cloud world, where will you build a moat? Yet legacy network security vendors are trying to do what their technology can, extend your corporate network to various public clouds where they will spend their virtual machines. This increases our tax office, hence increasing business risk. Legacy network security vendors, hybrid cloud security is a defensive strategy, which in my view serves the self-preservation of the vendor not the needs of the customer. It’s a single tenant architecture, that’s not designed for the cloud.

Their message is, keep on [Indiscernible] my boxes, but use my cloud service when your users are on the road or in a branch office. In this hybrid cloud approach, who manages the on-prem boxes, and who manages the cloud version? Where are logs, and how do you keep data private?

It's a disjointed solution. This equates to splitting a single application between the data center and the cloud. How many customers have deployed Siebel or PeopleSoft in the data center and a virtual version of it in the cloud? We know what happened to it. When was the last time you heard of them. With our born in the cloud architecture, based on the use case, we extend Zscaler’s cloud to the customer's premise, doing hybrid cloud the right way, where we have full responsibility for managing, scaling and running the service. We believe, we have a significant competitive advantage as a result of the technology, architecture and maturity of our platform. As the world's largest security cloud, we are inspecting 65 billion transactions each day. As part of ongoing expansion, our latest fourth generation data centers provide multiple hundred gigabytes per second links for a total appearing capacity of over one terabyte per second per site.

The requirement for a security cloud that handles all of your internet and cloud traffic is very high. Hence, Zscaler delivers five nines of availability SLA. We have over 10 years of operational experience, running our security cloud at scale. As some have said, there really is no compression algorithm or experience. As seen with some of our highlighter deals, ZPA is building momentum. Customers are exploring zero trust network techniques to offer access to apps without granting access to the corporate network. As an early pioneer in software defined perimeter, we have a mature, rich ZPA offering that's running in production at hundreds of enterprises.

While many imitators are coming out with access to web apps, ZPA was designed for secure and fast access to internal applications using all protocols and running on multi cloud and hybrid cloud environment. This allows us to address a wide range of use cases that others can't. I'm pleased to report that we are executing on our vision and making solid progress in the Global 2000 accounts. We remain focused on execution, and investing in our go-to-market capabilities and we expanded our workforce by approximately 100 employees this quarter, with half in sales and marketing. We are taking our Zenith Live Cloud Summit on the road, with a series of regional events called Zscaler Academy World Tours.

At these events, we are providing hands on labs, best practices and customer case studies on how to enable IT Cloud Transformation securely. We are also strengthening our channel partnerships, the large system integrators and global service providers, which contribute over 50% of our revenue.

In summary, we are very pleased with our strong Q2 results and continued growth in our business. We believe, we are in the early innings of a significant market opportunity to disrupt traditional networks security. I like to now turn the call over to Remo to walk through our financial results.

R
Remo Canessa
CFO

Thank you, Jay. As Jay mentioned, we had a very strong Q2. Revenue for the quarter was $74.3 million up 17% sequentially and 65% year-over-year. Q2 revenue was aided by $2.3 million and non-recurring revenue from the large public sector customer deploying our solution as a private cloud. This amount was mostly comprised of private cloud infrastructure as well as recognition of deferred subscription revenue from Q1 as we achieve a project milestone.

From a geographic perspective for the quarter, Americas represented 53% of revenue, EMEA was 40% in APJ was 7%. 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 74% year-over-year to $115 million.

This quarter we benefited from a higher mix of upfront greater than one year billings including approximately $11 million from the public sector customer. As a reminder, our contract terms are typically one to three years when we primarily invoice our customers one year in advance.

Excluding upfront greater than one year billings in both periods, billings would have grown over 50%. Total backlog, which represents remaining performance obligations was $461 million on January 31st, up 69% from $273 million one year ago.

Our strong customer retention and ability to up sell have resulted in a consistently high dollar base net retention rate, which is 118% for the period ended January 31st. This compares to 122% a year ago, and 118% last quarter.

Our increased success selling bigger deals upfront, which start with the transformation bundle and faster up sales within a year, while good for our business, can reduce our net dollar retention rate, which is calculated on a year-over-year ARR basis. Considering these factors, we feel 118% is outstanding and it will vary quarter-to-quarter.

Total gross margin was 80%, down 2% sequentially and 1% year-over-year. We feel that 80% continues to be a good target range in the near to medium term. And it is important to continue to invest in our platform to drive topline revenue growth.

Turning to operating expenses, total operating expenses decreased 1% sequentially and increased 27% year-over-year to $49.8 million, but decreased as a percentage of sales to 67%. The sequential decline in operating expenses is primarily due to the timing of our worldwide sales kick-off and Zenith Live European User Conference in Q1. We increased our headcount in Q2 by approximately 100 employees.

Sales and marketing decreased 1% sequentially and increased 27% year-over-year to $33.2 million. As mentioned the decline is primarily due to the timing of sales and marketing events. Even though we have a sequential decline in sales and marketing expenses, we are building our sales and marketing teams and investing in marketing programs.

In Q2, we increased our sales and marketing teams by approximately 50 employees. R&D was up 4% sequentially and up 23% year-over-year to $10.7 million. As we continue to invest to enhance product functionality and to offer new products.

G&A decreased 8% sequentially and increased 37% year-over-year to $5.9 million. The year-over-year growth in G&A includes investments in building our teams, consulting and other expenses that we've made as we became a public company. The sequential decline in G&A is primarily due to lower professional fees.

These expenses exclude $1.8 million in litigation related expenses. Our second quarter operating margin was a positive 13% which compares to a negative 6% in the same quarter last year.

Net income in the quarter was $11.6 million or non-GAAP earnings per share of $0.09. Given the positive earnings in the quarter, our EPS was calculated on a fully diluted basis of approximately 134 million shares. We ended the quarter with $340 million in cash, cash equivalents and short term investments.

Free cash flow was positive $12 million in the quarter compared to negative $4.6 million for the same quarter a year ago. Our SVP program reduced our free cash flow by approximately $5.6 million as we initiated our first stock issuance in December. The SVP program does not impact our overall cash balance.

So now moving on to guidance. As a reminder, these numbers are all non-GAAP, which excludes stock based compensation expenses, amortization of intangible assets, certain litigation related expenses, and any associated tax effects. For the third quarter, we expect revenue in the range of $74 million to $75 million reflecting a year-over-year growth of 51% to 53%.

Operating profit in the range of zero to $1 billion. Income taxes of $600,000, earnings per share of approximately $0.01 assuming 135 million common shares outstanding. For the full year 2019, we expect revenue in the range of $289 million to $291 million or a year-over-year growth of 52% to 53%.

Billing in the range of $365 million to $370 million or a year-over-year growth of 42% to 44%. Operating profit in the range of $11 million to $13 million. Income taxes of $2.1 million and earnings per share in the range of $0.11 to $0.13 assuming approximately 135 million common shares outstanding.

Looking forward, our plans are not to maximize profitability or to generate additional operating leverage, but to invest aggressively in our business to pursue our significant market opportunity, with our CMO and senior VP of customer experience and transformation of our board we'll be stepping up our marketing investments in the coming quarters.

In addition, we'll increase investments in our technology platform and cloud infrastructure. And, 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. This sequential decline will be accentuated by the multiple greater than one year billings we had in Q2, including $11 million from the public sector customer.

Also keep in mind, that we had a large upfront billing of $16.5 million in Q4 of 2018 that will pose a tough year-over-year comparison in Q4. We're very proud of what we have achieved and look forward to building on our opportunity.

Now I would like to turn the call back over to Jay.

J
Jay Chaudhry
CEO, Chairman and Founder

Thank you, Remo. We believe we’re the best choice for securing the cloud and the mobile-first world. The right architecture matters. On-prem, single tenant architecture whether deployed as appliances or as virtual machines spun up in a public cloud will not allow enterprises to fully realize the benefits of cloud

These imitators can scale, leave gap in security, are expensive and deliver a poor user experience. With multiple tailwinds such as SaaS adoption, SD-WAN and app migration to public clouds, we believe the market is coming to us.

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

Thank you. [Operator Instructions]. Our first question comes from Melissa Franchi with Morgan Stanley.

M
Melissa Franchi
Morgan Stanley

Great. Thank you so much for taking my question, and congrats on the quarter. So it sounds like obviously Zscaler is enabling a transformational scale particularly with ZIA, but also ZPA. Just given your result, it does seem like perhaps that transformational sale is becoming a little bit more mainstream. If that's correct, and it is becoming more mainstream What are you seeing in terms of the sales cycle or are you seeing a shortening of sales cycles as enterprises are getting more comfortable with this approach?

J
Jay Chaudhry
CEO, Chairman and Founder

So thank you, Melissa. As we have said in the past, our sales cycles for smaller accounts is about three to six months, for larger is about six to 12 months. I would say, the number of deals are growing rapidly; hence our pipeline is going up. That's why we're closing more deals. But some of the transformations do take time. So it's probably moving to the lower end of the range we talked about. But I won't say it's been cut down until a few months. Yeah I would still say probably six or twelve months more on the lower side and upper side.

Operator

Our next question comes from Brad Zelnick with Credit Suisse.

B
Brad Zelnick
Credit Suisse

Thank you so much and congrats once again, Jay, Remo and team on a phenomenal quarter. Jay, so much of a legacy approach and security is tied to infrastructure. Like you said in your prepared remarks, building moats and what we've protected things in the past like networks and endpoints, but now the world is hyper virtualized and dynamic which is really driving your success. But just in the last couple of days you've seen two major legacy security players rattling sabers as it relates to end point. And we're also seeing a battleground emerge around data analytics, and orchestration as the next platform plays.

So, my question is in the past, you've talked about endpoint players being natural partners for Zscaler? Does that ever change, in and as well as for becoming the data orchestration layer, it would seem Zscaler has a natural advantage if you wanted to participate. How do you see the future shaping up in this regard, and what role might Zscaler play? And I've got a follow up for Remo.

J
Jay Chaudhry
CEO, Chairman and Founder

Okay, it’s a good question. It is true that there are lots of security vendors out there and enterprises do want consolidation. But I believe real consolidation is done by building an extensible platform from a clean slate, and that's what we are doing about network security by sitting in the traffic path and consuming subsuming all that functionality.

Now, having said that, I don't believe you see a God security vendor who consolidated all functionality from end point to analytics to identity and the like. So there needs to be a natural ecosystem of partners. Well you know where your strengths are. You talk about end point. Let's look at the end point. We think the core competencies and technology for end points are very different form in line traffic inspections.

You've seen in the past many network security vendors have tried to sell Endpoint Protection for years. How much progress have they made? We believe in being partners with Endpoint pipe vendors. Now security analytics and orchestration, it is an interesting area. We actually partner in this area. You don't just need logs form in line traffic inspection, you need it from endpoints, identity, servers, applications like Office 365.

I personally believe, that large non, network security vendors who have core competency of cloud scaling databases and machine learning will do a better job. So we are partnering with those vendors. I think we have talked to you in the past between ZIA, ZPA together eliminating entire in-line policy enforcement is about $18 billion Tam and it seems to be growing. So a long answer, but do we want to compete in the endpoint or security analytics? Not really. We have good partnerships there.

Operator

Our next question comes from Dan Ives with Wedbush Securities.

D
Daniel Ives

Yes. Hey hope all is well, and but just a phenomenal quarter. So my question is in terms of the transformation going on in terms of sales cycles, I mean are you are you seeing the transformation on a particular vertical or is kind of across the board in terms of this kind of acceleration that we're seeing in terms of the strategic deals.

J
Jay Chaudhry
CEO, Chairman and Founder

Yes, Dan good question. So the transformation lies along the lines of which verticals are embracing cloud sooner than others. Our manufacturing sector actually embraced cloud before many others and they also needed to do local internal breakouts. So that's where we got GE and Siemens of the world out there. The companies that are a bit slow in embracing cloud, financial services were slower, but now they are picking up. Healthcare was slow, but they are picking up, so it's a bit along the vertical line, but it’s hard to meet a CIO who say’s I don’t embrace cloud. Once you embrace cloud you must transform your network and your legacy security.

So we are seeing increased interest, but a little bit on the timing of the question, sorry the sales cycle. See transformation requires the CIOs, CTOs, CXOs, architects to come along together. So it does take some time. It’s not a matter of here is a cool new security box. It has better feeds and speeds and lesser place one with other. It is an architectural transformation that’s why it takes a bit longer time, and a different kind of technology.

Operator

Our next question comes from Andrew Nowinski with Piper Jaffray.

A
Andrew Nowinski
Piper Jaffray

Great. Thank you, and congrats on a great quarter. So you talked about winning a deal against an on-premise Web proxy vendor and they were trying -- as customers trying to use that to support their Office 365 or a lot. I’d assume, that the scalability issues that you highlighted are likely not specific to that necessarily that customers environment meaning other potential customers deploying Office 365 would likely face similar issues. I was just wondering if you could give us your estimate of how far along we are with regard to the tailwind from the Migration Office 365?

J
Jay Chaudhry
CEO, Chairman and Founder

So, very good question. You are correct, that this issue wasn't specific to this customer and the Web proxy. This is what happens when you move your exchange server to the cloud 80% of e-mail traffic and calendar traffic that used to stay within your company, only a 20% used to go out. Now all traffic, every e-mail, every calendar entry has to go out to the cloud and come back. So the amount of traffic with all the file attachments and everything grows significantly. What we are finding is once you go to

[Technical difficulty]

simply increase your total Internet traffic to double or triple. Now that not only creates problems for web proxies, it creates problems for firewalls and because each outlook client creates 15 to 20 persistent connections. You run out of connections, you have to operate the security equipment out there and then there are bandwidth costs and MPLS.

So Office 365 doesn't just work through simple proxies in a firewall. It has a lot of IP address management issues. There's some bandwidth quantity or service issues. We have worked Microsoft over the past three years, with single click deployment and handling quality of service and the like. So we are well positioned to handle Office 365.

Now, the second part of the question is how much deployment? What's going on with Office 365? Office 365 has actually been bought by probably a majority of the enterprises we deal with, and those who haven't bought, they are probably in the early stage of piloting and the like.

So to give you a perspective, today about 22% of the traffic that goes through these colored cloud is Office 365 traffic. Three years ago, that number was about 2%. Okay, as it goes up, the number will keep on going up. I believe, we have probably about 25% of the Office 365 customers, off our customers on the cloud, but there's plenty of headroom for us where office becomes a catalyst for us to drive transformation.

A
Andrew Nowinski
Piper Jaffray

That's great. Thanks Jay. And then one question with regard to the marquee public sector customer you referenced on the call. Do you think that when established that Zscaler somewhat the vendor of choice in the public sector that you can leverage that win across other agencies perhaps?

J
Jay Chaudhry
CEO, Chairman and Founder

So it definitely does. The interesting point is, when the customer put all the requirements, we were the only vendor who could really meet the requirements. I think, the [Indiscernible] position, but still you have to go and engage in and win the deal, but very well positioned for others.

A
Andrew Nowinski
Piper Jaffray

That’s great. Keep up the good work, guys.

J
Jay Chaudhry
CEO, Chairman and Founder

Thank you.

Operator

The next question comes from Gray Powell with Deutsche Bank.

G
Gray Powell
Deutsche Bank

Great. Thanks for taking the questions and congratulations on the good results. I'm curious, I know that you're selling a much broader platform, but I love to hear what your what your view is on the overall growth of the secure web gateway market?

And then, within that do you think or how fast do you think that cloud form factors are growing versus appliance form factors?

J
Jay Chaudhry
CEO, Chairman and Founder

So we don't track the growth of appliance form factor. I'm not even sure there is a growth in appliance form factor. But having said that, every deal Zscaler wins, actually has some kind of web proxy out there, because it's hard to find an enterprise that doesn't have web proxy for outbound traffic. Web proxy has been the standard for user traffic going to the Internet.

But as you saw in most of our deals something may start with web proxy, but it evolves to the next and the next level. Are Web proxy equal and bundle is actually our professional bundle, which is a very small number of probably 3% about 5% of the business comes from essentially a proxy placement. The remaining from business bundle which has a lot of advance functionality, including bandwidth controls type of stuff needed and transformation bundle, which obviously includes firewall and cloud -- sandbox and the like.

The point I'll make is, I don't think our business is driven by replacement of a Web proxy or a firewall. Our business is driven by a CIO saying, I am embracing cloud which is driving to do network transformation which essentially requires local Internet breakouts and they must be secured and we are the purposeful solution for securing the local breakouts.

G
Gray Powell
Deutsche Bank

Got it. That's that's really helpful. And then one for Remo, if I may. Just kind of looking at sequential trends, if I back out the onetime item from revenue, you grew revenue by about 14% in the January quarter from the October quarter. Any expect -- and reason we should expect growth to be more like 3% to 4% sequentially in April?

R
Remo Canessa
CFO

Well, I mean, let's you've got our guidance. So you know we're comfortable with our guidance. And again we feel prudent with the guidance that we've given.

G
Gray Powell
Deutsche Bank

Okay. Thank you very much.

R
Remo Canessa
CFO

Great. Thank you.

Operator

Our next question comes from Gabriela Borges with Goldman Sachs.

D
Dan Church
Goldman Sachs

Good evening. This is Dan Church on for Gabriela Borges. Thanks for taking my question. Yes just a start. It certainly sounds like customers are coming onto the platform at higher AOV. Maybe just, if you can walk me through some of the puts and takes of me you know what they're like what AOVs look like relative to a year ago when you IPO and what that puts and takes to upscale opportunity from there and how that's been trending?

J
Jay Chaudhry
CEO, Chairman and Founder

What is an AOV?

D
Dan Church
Goldman Sachs

Average Order Value, sorry or Initial Order Value.

J
Jay Chaudhry
CEO, Chairman and Founder

Got it. So yes, the average sales price. Yes. It's been increasing on a quarter-over-quarter basis. It currently you know for customers of and we look at the larger customers that are greater than 3000 users. It's in the mid-300,000 range. It has gone up year-over-year and it has gone up consistently quarter-over-quarter.

D
Dan Church
Goldman Sachs

Probably at the IPO time it is less than 300 KL, the same type of customer.

J
Jay Chaudhry
CEO, Chairman and Founder

That's correct. At the IPO time was below 300.

D
Dan Church
Goldman Sachs

Right. Thank you. I guess just as a follow up there's a handful of appliance vendors out there talking about SD-WAN maybe, how have your conversations with customers been changing and how our customers thinking about the transformative switch to Zscaler versus going with another appliance vendors and maybe some of the puts and takes? And if you think – given the ROI and lower MPLS costs, customers are willing to invest in these transformations irrespective of a more challenging macro environment.

J
Jay Chaudhry
CEO, Chairman and Founder

Yes. Good question. We actually are the natural choice for the SD-WAN securing the SD-WAN. As I said in some of the earlier comments, that natural transformation is driving local Internet breakouts, and those breakouts need to be secured.

SD-WAN vendors are consolidating that functionality at branch level, switching, routing functionality, but they really don't have security built in and some of them are trying and they will try to do so. But it's very hard to do top notch security. So the way I look at it, as SD-WAN market accelerates, it becomes a stronger and stronger tailwind for us.

Now ZIA sales does not require SD-WAN. Traffic can be sent to Zscaler from any router. But SD-WAN makes deployment and management of the branch network easier, by doing local breakcode, it can save money but it still needs security and that's where we play in.

So we believe the SD-WAN wave will keep on helping us, and also, we were working with all of them. In fact we've done integration where literally with a single click on the console configuration the traffic can be sent to us through APIs and monitoring can be done very excited and comfortable with that opportunity.

Operator

Our next question comes from Tal Liani with Bank of America.

U
Unidentified Analyst

Hey guys. This is Dan Bartlettson [ph] for Tal. Thanks for taking my questions. Kind of follow up to the last one, but I wanted to focus on pricing. And so you guys have obviously discussed a lot of the tactical advantages, but when we look at your competitors that can bundle SD-WAN meaning mainly Cisco umbrella [ph] and Ford and SD-WAN and knowing those architecture differences, do you think Zscaler would still potentially be a lower cost option there?

J
Jay Chaudhry
CEO, Chairman and Founder

Do you think Zscaler will be a lower cost option there? So, first of all, even before SD-WAN in fact I was talking to you one of the Cisco executive a couple of years ago, 70% of the traffic that came to Zscaler came from Cisco devices, 70%. In fact, he smiled and said, oh, that's in line with my market share of 70% that I would present in the market are my routers.

Okay. So what you are really seeing is, we have been all the customers we have out there from these big network vendors. The traffic is still coming to us. And the reason is the following; the Zscaler security is not bought as a part of the network stuff. Zscaler truly transformation sales top down driven. It creates kind of a need for securing the local breakout and when the customer selects SD-WAN and all we become a natural player. So the other point I'll mention is, in all these large enterprises, security becomes functionality, the richness, ability for policy to move around, ability for logs to come back, GDP compliance. The requirements of so high that some of the solution that are not designed for the cloud world, they just they just don't work very well. So do those things concern us? Not really.

U
Unidentified Analyst

Okay, great. Make sense. And then, really quick if we get any metrics on the breakout of percent of sales that are direct or through the channel or manage through service providers? Just trying to get a feel for where the momentum is shifting in the go-to-market strategy as well? Thanks.

J
Jay Chaudhry
CEO, Chairman and Founder

Yes. So, direct is under 5%, [Indiscernible] or legacy deals we’ve got – everything is going to the channel currently for new business, and its pretty close split 50-50 between SPs and SI with 50% and 50% for the VAR channel.

R
Remo Canessa
CFO

If I may add, I mean, having done appliance companies before, typical appliance vendor but 85%, 90%, 95% business go through traditional VARs and SPs and SI is very small percentage because those are -- they don't like to resell boxes. In our case to have over 50% revenue comes from SP and SI is a good differentiation because those drive transformation.

Operator

And our next question comes from Alex Henderson with Needham.

A
Alex Henderson
Needham

Hey, guys. So price for perfection and you delivered it. Nice job.

J
Jay Chaudhry
CEO, Chairman and Founder

Okay.

A
Alex Henderson
Needham

Again, just the housekeeping things I'd love to take care of. Can you give us some sense of what the uptake around the ZPA was in the quarter? What the mix and bundles was? And what was the increase in sales staffing percentage-wise sequentially? I think 15%, am I doing the math right?

J
Jay Chaudhry
CEO, Chairman and Founder

The increase related to transformation and ZPA. What we said is that, we give metrics out on that when we had meaningful changes. All I can say is that ZPA is doing very well and business has been increasing on a quarter over quarter basis. Transformation also as companies are recognizing the need to adopt a transformational strategy, our transformation sales are also increasing. We’ll give you an update certainly at the end of our fiscal year for that.

Related to the sales increase and sales mix and so forth, we increased our headcount overall in the company by approximately 100 employees in Q2, and about half of those were in sales and marketing. So we see the large market opportunity that we have in front of us and we are aggressively hiring.

A
Alex Henderson
Needham

I got this.

R
Remo Canessa
CFO

But let me add on ZPA, Alex. It’s a fastest growing product for us and very bullish on it.

A
Alex Henderson
Needham

I got the 50 higher, just trying to figure out what the base was compared to that 15% to 20% increase sequentially in staffing on account?

R
Remo Canessa
CFO

We haven’t given those metrics out related to what the increase is.

A
Alex Henderson
Needham

Okay, great. Thanks.

Operator

That concludes today's question-and-answer session. CEO, Jay Chaudhry at this time, I will turn the conference over back for your closing remarks.

J
Jay Chaudhry
CEO, Chairman and Founder

Well, thank you all for your interest and time. Hope to see many of you at the Odyssey Conference. Otherwise we’ll talk to you at the next quarter's earnings call. Thank you again. Bye-bye.

Operator

This concludes today's call. Thank you for your participation. You may now disconnect.