Zscaler Inc  (NASDAQ: ZS) Q3 2020 Earnings Call Transcript

Zscaler Inc  (ZS) Q3 2020 earnings call dated May 28, 2020

Corporate Participants:

Bill Choi — Senior Vice President and Investor Relations

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Remo E. Canessa — Chief Financial Officer

Analysts:

Alex Henderson — Needham — Analyst

Andrew Nowinski — DA Davidson — Analyst

Brad Zelnick — Credit Suisse — Analyst

Daniel Bartus — Bank of America — Analyst

Saket Kalia — Barclays — Analyst

Catharine Trebnick — Dougherty — Analyst

Gray Powell — BTIG — Analyst

Srini Nandury — Summit Insights — Analyst

Fatima Boolani — UBS — Analyst

Shebly Seyrafi — FBN Securities — Analyst

Presentation:

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Zscaler Third Quarter 2020 Earnings Conference Call. [Operator Instructions] After the speaker presentation, there will be a question-and-answer session. [Operator Instructions]

I would now like to hand the conference over to your speaker today to Bill Choi. Please go ahead.

Bill Choi — Senior Vice President and Investor Relations

Good afternoon, everyone and welcome to the Zscaler fiscal third quarter 2020 earnings conference call. On the call with me today are Jay Chaudhry, Chairman and CEO; and Remo Canessa, CFO. Please note that we have posted our earnings release and a supplemental financial schedule to our Investor Relations website. Unless otherwise noted, all numbers we talk about today will be on an adjusted non-GAAP basis. You will find a 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.

I’d like to remind you that today’s discussion will contain forward-looking statements, including but not limited to the company’s anticipated future revenue, calculated billings, operating performance, gross margin, operating expenses, operating income, net income, free cash flow, dollar-based net retention rate, remaining performance obligations, income taxes and earnings per share. These statements and other comments are not guarantees of future performance, but rather are subject to risk and uncertainty, some of which are beyond our control, including but not limited to the duration and impact of COVID-19 on our business, the global economy and the respective businesses of our customers, vendors and partners.

These forward-looking statements apply as of today and you should not rely on them as representing our views in the future. We undertake no obligation to update these statements after this call. For a more complete discussion of the risks and uncertainties, please see our filings with the SEC, as well as in today’s earnings release.

I would also like to inform you that management will be attending the following upcoming virtual investor conferences, Cowen’s TMT Conference tomorrow, Bank of America’s Global Technology Conference on June 3rd, Baird’s Consumer Technology and Services Conference on June 4th and the Morgan Stanley Thematic Conference on Zero Trust Architectures on June 25th. Presentations for these events will be webcast and the links will be available on our Investor Relations website.

Now, I will turn the call over to Jay.

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Thank you, Bill and thank you for joining us. I hope everyone is staying healthy and safe during these unprecedented times. Our thoughts and prayers are with those who have been impacted. As you saw in the earnings release, we delivered very strong results for the third quarter and we are increasing our guidance for fiscal 2020. We’ve built the right cloud-native security platform for the cloud world and the digital transformation market driving our business as further accelerate combined with our improved sales execution, we are capitalizing on the market opportunities to take Zscaler beyond a $1 billion in annual revenue.

Zscaler was founded on the belief that in a cloud and mobile world, a user must be able to securely access any application from anywhere on any device. In the new work from anywhere economy, fulfilling this vision is even more critical, because almost all users are now outside the corporate network, where traditional perimeter-based security becomes irrelevant. To protect their employees working from home, our customers are using Zscaler Internet Access or ZIA to provide secure access to the Internet and SaaS applications, and Zscaler Private Access or ZPA for zero trust access to internal applications.

Combined, ZIA and ZPA enabled our customers to work securely from home literally overnight as quarantine orders went into effect around the globe. We saw exceptional strength in our ZPA service with over 10 times growth in usage during the quarter. Many new and existing customers deployed hundreds of thousands of new ZPA users. Our employees worked around the clock to support these deployments in a matter of weeks or even days. Even with this unprecedented traffic growth, our net promoter score or NPS reached a world-class level, more than twice the average NPS of SaaS companies. I personally received many emails from customers about the positive impact Zscaler made on their business by enabling them to continue their operations.

Let me quote a couple of them. Cecil, a large insurance company in US said, “Zscaler deployment was executed to a near perfection. We quickly secured 10,000 users, kudos to Zscaler for such great tech and people”. CIO of a high-tech company in UK said, “without doubt, I now consider Zscaler acquisition to be one of the most timely and beneficial services I have purchased in 25 years of working in IT”. I spoke to over hundred CxOs this past quarter and most of them believe COVID-19 is accelerating the digital transformation and resistance to change is dissipating.

Zscaler was born in the cloud, for the cloud. And as a result, we’ve seamlessly transitioned work from anywhere. We are focused on ensuring the health and safety of our employees around the globe, while we are successfully engaging and supporting our customers virtually. For example, we are leveraging modern tools like virtual whiteboarding to conduct interactive architectural workshops.

Now, let me discuss our performance for the third quarter. Our revenue grew 40% and billings grew 55% year-over-year. We also delivered very strong growth in operating profits and free cash flow. We saw broad strength across verticals, with notable strength in financial services. From a product perspective, we had strong growth in both ZIA and ZPA, but a stand-out performance in ZPA, which contributed 43% of new and add-on business compared to approximately 20% in the first half of fiscal 2020.

ZPA is a natural purchase for existing ZIA customers, which had a positive impact on our net retention rate of 119%. Gross margins were slightly lower, as we temporarily increased our use of public cloud to handle the significant growth in ZPA traffic. We are moving this increased traffic to our data centers in coming quarters and expect gross margins to improve. Remo will speak more about our gross margins in his section.

As I mentioned earlier, many new and existing customers deployed hundreds of thousands of new ZPA users in the quarter. A Europe based global conglomerate added more than 200,000 users in three weeks across 185 countries. A US based insurance company deployed 30,000 users in one week. An oil and gas company enabled over 27,000 users in 10 days. And an India based financial services company enabled 11,000 users in only two days. We are seeing the attach rate of ZPA increase in our deals, but we still have a very large opportunity for upsell in the future, as only 32% of our global 2,000 customers have purchased ZPA.

Ultimately, we believe all employees need ZPA, as internal applications migrate to the public cloud and COVID-19 is accelerating this adoption. ZPA is much more than a VPN replacement. Customers are buying ZPA to implement a zero trust network approach, or what Gartner calls ZPNA, which advocates that network security can no longer be done in a perimeter less world. Hence, users should not be connected to the network, but only to specific applications. While many enterprises purchased VPN appliances from the legacy VPN vendors in the past couple of months, I believe those were tactical purchases.

In the world of zero trust, there is no place for firewalls and VPNs since they are network security devices and traditional networks are disappearing. Our new customers are increasingly purchasing ZIA and ZPA together, as both are needed to enable employees to work from anywhere securely with great user experience. For example, a FinTech customer purchased our Transformation Bundle, plus DLP, inline and out-of-band CASB and Browser Isolation for 40,000 users and ZPA for 25,000 users. This Fortune 500 company was increasingly using cloud applications like Office 365, but the multi-vendor appliance based security stack was a bottleneck that was hurting user performance and business agility.

The deal started as a legacy web gateway replacement, but our sales team successfully demonstrated a value in transforming the network and security to deliver great user experience, superior security and a very attractive return on investment. With Zscaler, they’re consolidating four different vendors and eliminating more than 8 point products, including secure web gateway, next-gen firewall, Sandbox, DNS, DLP, CASB and SSL inspection. Moreover, our cloud native architecture scales to meet any searches in their traffic that had overwhelmed their security appliances. In addition, their new zero trust approach will enable their company to quickly integrate mergers and acquisitions, which is a core growth strategy for them.

Next, let me talk about ZIA, which we believe is also accelerating due to COVID-19. ZIA protects employees working from home as they access SaaS applications and the Internet. Without ZIA, enterprises must use legacy VPN to route traffic to the corporate data center fast, then out to the Internet, back to the data center and finally back to the user. No wonder, this results in poor user experience. And we all know that VPN, even a cloud-based VPN puts users on the corporate network and represents a major cyber risk. Last quarter, a threat labs security research team uncovered well over 0.5 million COVID-19 specific threats and protected our customers from them.

Let me highlight a few of the ZIA deals. A major US bank was experiencing performance issues with an incumbent web gateway that could not meet the traffic requirements of Office 365 and was due for a refresh. And this partner-led deal, customer purchased Transformation Bundle, CASB and Browser Isolation for 23,000 users and will retire the legacy proxy solution along with a few other security [Indecipherable] products. The customer expects this project to yield ROI an exceeding 100% and a payback period less than 12 months, while adding critical capabilities like SSL inspection at scale, cloud firewall and [Indecipherable] DLP, as DLP is becoming important in the world of cloud and work from anywhere.

While SD-WAN was an important consideration for this deal, with COVID-19, the focus shifted to deploying Zscaler right away to protect users working from home and visit SD-WAN in the future. With similar goals, a Fortune 500 financial services company, an existing customer, upgraded their 50,000 user subscription from business to Transformation Bundle. This is another example of a sizable deal that has driven by [Indecipherable] new products, out-of-band CASB and Browser Isolation. These examples illustrate that many of our customers are buying our high-end ZIA bundles and additional product modules.

Lastly, a European public sector customer purchased our Transformation Bundle and DLP for 100,000 users. They needed to replace recently purchased so-called cloud security service, a legacy next-gen firewall vendor after taking 10 months to onboard 14,000 users, they had to stop their deployment. Since security was important for this customer, they needed to inspect SSL traffic. While this virtual firewall could ostensibly inspect SSL, it could not do so at any meaningful scale. When their single-tenant cloud service failed, the vendor offered to replace it with on-prem firewall of bonuses reconnaissance. Since Zscaler was natively designed as a pro-SSL proxy, our customers can inspect encrypted traffic at scale without impacting user experience, leading to better security and reduced business risk. This customer also purchased ZPA for 30,000 users with plans to expand in the near future.

As this last example shows, architecture matters for a cloud security platform that must sit in line to inspect traffic and enforce policy. Single tenant architecture, whether deployed as appliances or as virtual machines in a public cloud, will only work if enterprises settle for poor security, but not inspecting SSL traffic. As I have said before, you can’t create a Netflix service by stacking thousands of DVD players in the cloud. We believe Gartner strongly validated our platform and vision when they published a new approach for security named Secure Access Service Edge or SASE.

While many imitators claim to be SASE, they conveniently forget to mention that Gartner identifies SSL inspection as a key requirement of SASE architecture. We believe our 10-year track record of running a massive inline cloud that has to be highly reliable and available makes Zscaler the safe and the best choice when enterprises need to securely access mission-critical applications. We recently crossed a milestone of processing over 100 billion transactions per day, which we believe allows us to provide an unmatched network effect for better security for our customers.

Let me now discuss a tremendous progress we have made in our go-to-market initiatives to implement a repeatable and scalable process for world-class sales execution. I believe our consultative sales approach played a major role in our success this quarter. It enabled us to maintain a high level of engagement with our customers and prospects in the current virtual environment. Last quarter, I said that we were making good progress based on key leading sales indicators.

Let me give you a few examples of our progress in Q3. We hired a record number of field sales reps and we are continuing to attract high level talent. We built out strong sales leadership at the regional director, regional VP and area VP levels. We increased sales productivity, we generated strong pipeline and we recruited cloud focused channel partners to drive further sales leverage. I could not be happier with our progress and we believe this quarter’s strong results are a proof of our ability to execute our sales strategy.

Moving on to products. As we discussed previously, we have four new product offerings that are generally available this quarter, CASB, Browser Isolation, Zscaler B2B and Zscaler Digital Experience or ZDX. As I mentioned in my deal highlights, our CASB and Browser Isolation products are beginning to generate revenue. As we have indicated before, we anticipate these new products will add to our growth in fiscal 2021 and beyond. Our cloud security platform protects users access to any application from anywhere. Our next opportunity is to expand into protecting applications and data in the cloud.

We are pursuing this opportunity in three areas. One, with out-of-band CASB, we are providing comprehensive data protection for SaaS applications. Two, with the acquisition of Cloudneeti and its cloud security posture management for CSBM functionality. We now provide data protection to public cloud workloads, which is an emerging security market segment. Three, with today’s announcement of the acquisition of Edgewise Networks, we are extending zero trust protection to east-west traffic within a public cloud or a data center.

With Edgewise, we can provide a zero trust approach for machine-to-machine and process-to-process communications. Edgewise discovers individual micro services and the legitimate communication patterns and using AI and machine learning algorithms automatically creates and enforces authorized process to process communication to provide application segmentation. This is a far superior approach than legacy network segmentation for security. With our existing and new products, we believe Zscaler is the most comprehensive cloud security platform and these additional products will expand our already large market opportunity.

Now, I’d like to turn over the call to Remo for our financial results.

Remo E. Canessa — Chief Financial Officer

Thank you, Jay. As mentioned, we had a very strong third quarter. Revenue for the quarter was $110.5 million, up 9% sequentially and 40% year-over-year. From a geographic perspective for the quarter, Americas represented 51% of revenue, EMEA was 40% and APJ was 9%.

Turning to calculated billings, which we define as the changed deferred revenue for the quarter, plus total revenue recognized in that quarter. Billings grew 55% year-over-year to $131.3 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 $654 million on April 30, up 31% from a year ago. The current RPO is 56% of the total RPO and grew 36% year-over-year.

I’d like to call out two dynamics that impacted our billing and contract duration. We are offering shorter commitments and invoicing periods for customers needing help with their business continuity requirements for COVID-19, and in China and Japan, free access to ZPA for three months. The overall impact of these initiatives to our billings and RPO was relatively modest, with billing duration approximately flat year-over-year and with contract duration down slightly. We also had a higher mix of upsell business, which typically is shorter contract and billing duration as it often co-terminates with existing contract.

Our strong customer retention and ability to upsell have resulted in a consistently high dollar based net retention rate, which is 119% for the quarter and benefited from increased adoption of ZPA with existing customers. This compares to 118% a year ago and 116% last quarter. As we’ve highlighted, this metric will vary quarter-to-quarter. While good for our business, our increased success selling bigger Transformation Bundles, selling both the ZIA and ZPA from the start and faster upsells within a year can reduce our dollar based net retention rate in the future. Considering these factors, we feel that 119% is outstanding.

Total gross margin was 80%, down 2 percentage points sequentially and year-over-year. This decline is primarily due to ZPA traffic, growing over 10 times during the quarter. We supported the surge in demand by augmenting the use of AWS and Azure, which run at significantly higher cost compared to our data centers. We decided to prioritize helping our customers gain ramp quickly rather than managing our cloud infrastructure to optimize our gross margins.

We are working to reduce the use of public cloud and increase the capacity in our data centers over the next three quarters, but we expect some pressure on gross margin in the near-term. We expect overall gross margins to be 76% to 77% in Q4, 78% in the first half of fiscal 2021 and we expect to return to our 80% target in the second half of fiscal 2021. We feel it is important to continue to invest in our cloud infrastructure to drive top line revenue growth.

Turning to operating expenses. Our total operating expenses increased 11% sequentially and 35% year-over-year to $79.6 million and decreased as a percentage of revenue to 72% compared to 74% last year. Sales and marketing increased 6% sequentially and 35% year-over-year to $52.6 million. We had two mid-year regional sales kick-offs in February for training and team building that represented $2.3 million in expenses. The year-over-year increase is due to higher compensation expenses and investments in building our teams and go-to-market initiatives offset by lower T&E.

R&D was up 20% sequentially and up 39% year-over-year to $17.1 million. The increase is primarily due to continued investments in our team to enhance our product functionality and to innovate new products. G&A increased 22% sequentially and 26% year-over-year to $9.9 million. The growth in G&A includes investments within our teams, compensation-related expenses and professional fees including acquisition-related expenses. Our third quarter operating margin was 8%, which compares to 8% in the same quarter last year. Net income in the quarter was $9 million or non-GAAP earnings per share of $0.07. We ended the quarter with $391 million in cash, cash equivalents and short-term investments and no debt. Free cash flow was positive $9 million in the quarter.

Before moving on to guidance, I’d like to share a few additional thoughts related to COVID-19 that may be informative. Though we are not yet able to accurately predict the long-term impact of the pandemic, we did not experience a negative impact to our top line results from COVID-19 this quarter. We attribute this to our focus on large enterprises, our recurring revenue model and our market position as customers move increasingly to the cloud. We had good linearity in the quarter with a strong March and April, and May to-date continues to be strong.

We have not seen any meaningful pressure on renewals, receivable collections to-date due to COVID-19, though the long-term impact on our customers and partners is not fully known. Renewals due in the next 12 months to 18 months may face downward pressure, depending on how the economy recovers. Our overall exposure to industries particularly impacted by COVID-19 like transportation, hospitality, retail and leisure, where workforce reductions have been announced publicly is less than 10%.

Now moving on to guidance, which incorporates these observations. A reminder, these numbers are all non-GAAP, which excludes stock-based compensation expenses, amortization of intangible assets, facility exit costs and any associated tax effects. For the fourth quarter, we expect revenue in the range of $117 million to $119 million, reflecting year-over-year growth of 36% to 38%. Operating profit in the range of $2 million to $4 million. Other income of $1 million. Income taxes of $1 million. And earnings per share of approximately $0.02 to $0.03, assuming 140 million common shares outstanding.

For the full year fiscal 2020, we expect revenue in the range of $422 million to $424 million or year-over-year growth of 39% to 40%. Calculated billings in the range of $529 million to $531 million or year-over-year growth of 36%. Excluding the $11 million of upfront billings in Q2 of 2019, our updated billings guidance for the fiscal year implies growth of 40%. Operating profit in the range of $24 million to $26 million. Other income of $6.4 million. Income taxes of $3.5 million. And earnings per share in the range of $0.20 to $0.21, assuming approximately 138 million common shares outstanding.

The acquisitions of Cloudneeti and Edgewise Networks are expected to have an immaterial impact on revenue in Q4 and fiscal 2021, as they are early-stage companies. The cash purchase price of Cloudneeti, which closed in mid-April was $9 million and the cash purchase price of Edgewise, which closed last week, was $31 million. Our plan is to further develop these products and incorporate their technologies into our platform. We expect to incur approximately $2 million in additional operating expenses related to the acquisitions in Q4 and $12 million to $14 million in fiscal 2021. This is incorporated into our Q4 guidance.

Our guidance reflects our plans to invest aggressively in our business to pursue our significant market opportunity. We’ve been very successful in hiring and onboarding remotely, and remain on track to increase our field sales rep headcount by 60% for the full year. We are very pleased with the progress in our go-to-market initiatives and confident that these investments will build the foundation for long-term growth. In addition, we’ll increase investments in our technology platform and cloud infrastructure.

Now, I’d like to hand the call back over to Jay.

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Thank you, Remo. In closing, let me state five key points that make me excited. One, secure digital transformation, which is the market we are purpose-built to address, is accelerating. Two, as we have seen with SaaS leaders, like Salesforce and Workday, architecture matters. Only a cloud-native, multi-tenant architecture can enable true transformation. Three, our customers are consolidating and simplifying legacy network and security infrastructure, resulting in significant cost savings. Hence, our value proposition is highly attractive to CFOs and CIOs, especially in today’s challenging economic environment.

Four, in addition to our ongoing success for delivering comprehensive user protection, our next big opportunity is to expand into protecting applications and data, which we are pursuing through our own internal innovation and targeted acquisitions. Five, we are delivering world-class sales execution, which we believe will drive sustainable long-term growth. We are mindful of the terrible toll that COVID-19 is inflicting on the lives of so many people in so many ways and we hope that we are helping and making a difference to our customers and their employees in these challenging times. We wish everyone good health and safety.

Operator, you may now open the call for questions.

Questions and Answers:

Operator

Thank you, sir. [Operator Instructions] I show our first question comes from the line of Alex Henderson from Needham. Please go ahead.

Alex Henderson — Needham — Analyst

Well, thank you very much and thanks for the great quarter. I was hoping you could talk a little bit about the transaction that you won from a next-gen firewall player, as cloud architecture. Are you seeing an increased flow of traffic coming at you in your pipeline from people who are having those same type of issues? To what extent have you been able to demonstrate that the architecture really does matter to some of those customers? Is that becoming a funnel of opportunity for you?

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Alex, thank you for the question. If there were good amount of installed base, we will be seeing a lot of flow coming in. There aren’t that many customers who are using firewall based cloud security services. The one that are deployed we are seeing and who are trying to do security, the proper SSL inspection are foundry. So in a nutshell, are there lots of customers out there who had firewall installed base in the cloud? Not really.

Alex Henderson — Needham — Analyst

Okay. Then let me shift to the second follow-up question, if I could. Clearly, you’re driving a cloud direct model. As that happens, you’re connecting the user direct to the cloud and then applications are increasingly being driven by Cooper Netties in a variety of locations, whether that be AWS, Azure or a private cloud and those start to become points in the cloud and connectivity to them becomes critical. Are you planning on doing the connectivity into those locations, those points in the cloud or are you also planning on going beyond that to the CICD processing and the like, where the image is secured before it goes into production or in run time?

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

So, the way we look at processes is applications whether it’s sitting in a data center or in a public cloud or a private cloud are simply destinations. So with ZPA, any user can access any of those applications. We are independent of how those applications are deployed and where they are deployed. So we are doing that today, but the most — more important step we are doing in future, as we announced the acquisition of Edgework — Edgewise Network is application-to-application communication securely, process-to-process communication, which we think is the next big opportunity for us.

Alex Henderson — Needham — Analyst

I see. Thank you very much for helping us out. Thanks.

Operator

Thank you. Our next question comes from Andrew Nowinski from DA Davidson. Please go ahead.

Andrew Nowinski — DA Davidson — Analyst

Great. Thank you and congrats on a fantastic quarter. I would like to start with a question on ZPA. So I was wondering if you could give us any color relative to the pricing of ZPA versus ZIA, and what I’m trying to get at is, whether you’re indifferent in terms of whether customers start with ZPA and then move to ZIA or vice versa?

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

I will start and Remo can add on. ZIA and ZPA are two independent product lines. ZIA to provide secured access to an external applications, like SaaS and Internet and ZPA to provide access to internal applications. Customers can start from either side, it doesn’t really matter. But since ZIA started very early on with us, so we have a large installed base of customers who started with ZIA and those happy customers are adding ZPA, but we do see a number of customers starting with ZPA. Pricing similar, we sell in three bundles for each, pro, business and transformation. So the pricing is similar and the bundles are similar for both the products.

Andrew Nowinski — DA Davidson — Analyst

Got it. That makes sense. And then just a quick follow-up on your hiring target. I don’t know if you mentioned it, but I know you were targeting a 60% growth in headcount by the end of the July quarter. Are you still on track to achieve that?

Remo E. Canessa — Chief Financial Officer

Yes. Yeah. We had a record quarter in Q3 hiring. And we also feel the quality of people they’re bringing onboard is outstanding. The leadership that we’re putting in place throughout the sales organization, for the most part, it’s completely in place right now. So, now we’re filling up the ranks with the field sales reps, but we are planning and expecting to get the 60% field sales rep growth.

Andrew Nowinski — DA Davidson — Analyst

Great, thanks guys.

Operator

Thank you. Our next question comes from Brad Zelnick from Credit Suisse. Please go ahead.

Brad Zelnick — Credit Suisse — Analyst

Great. Thank you very much. Guys, I just first want to say congratulations on the success, very impressive to see the acceleration in the business and frankly the execution during these crazy times. And that really leads to my first question for Jay. Jay, can you just talk us through the balance of headwinds and tailwinds from COVID-19 that impacted the business? And if you look out on the horizon longer term, how does this experience change the shape of adoption for Zscaler going forward?

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Yeah. If you look at what COVID has done, it has forced everyone to work from home. It is accelerating digital transformation and that’s a market we were designed to address. So, we are getting benefit from COVID-19, as every customer had to work from home and you saw a number of examples where we enabled so many customers literally overnight or over a week or two weeks. So, it’s helping us. Now, the next question ends up being, what happens after two or three months? We think the changes that CIOs, CTOs are seeing with transformation, with being able to work from home, they are actually accelerating their transformation.

One of the new thing they learned during this transition was, I’m working from home, all of my employees are working from home without using my corporate network, why do I need the corporate network? Why do I need to do this local Internet breakout and why do I need to do this SD-WAN transformation? So, a lot of customers are buying into going to the final step of transformation, where a user can directly go to any application from anywhere. So net-net, we are seeing some good tailwinds.

Now, the headwind could potentially be the reduction in spend because every company is becoming cost conscious. And that’s where I — actually our story is getting more compelling. Since we do such a great ROI, so CFOs and CIOs are now looking for consolidation of vendors and this consolidation is around best-of-breed platforms rather then best-of-breed point products. So they like our position that we are not trying to play in four different market segments that are totally different, but in a very meaningful segment, where we are the zero trust exchange to connect anything to anything. So net-net, we think this accelerated digital transformation is going to help our business.

Brad Zelnick — Credit Suisse — Analyst

It makes perfect sense and it would seem to me, Zscaler was built for a situation just like this. Maybe my follow up just for Remo. The net expansion is a metric that you’ve been de-emphasizing over the last several quarters and maybe somewhat unsurprisingly, at least to us, it’s nice to see it tick up significantly in the April quarter. How should we think about it as we look forward? And what are you assuming, I know you’ve only given us one quarter of guidance, but even as you are formulating your own plan into next year, how are you thinking about expansion of the base?

Remo E. Canessa — Chief Financial Officer

Yeah. We’ve talked about it and we have de-emphasized the net retention rate. However, it stayed pretty consistent for the last three years. From my perspective, I don’t want to give forward guidance on the net retention rate, but I don’t see the composition of our business significantly changing in the near future.

Brad Zelnick — Credit Suisse — Analyst

Great. Thank you guys so much and congrats again.

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Great. Thank you.

Remo E. Canessa — Chief Financial Officer

Thank you.

Operator

Thank you. Our next question comes from the line of Daniel Bartus from Bank of America. Please go ahead.

Daniel Bartus — Bank of America — Analyst

Great. Hey, guys. Thanks a lot for taking the questions. Jay, I just wanted to drill down on your SD-WAN driven sales and what you’re hearing from customers. And I’m thinking, does it make sense that this 3Q maybe the trough for your ZIA business that’s typically tied to SD-WAN? And then as we look into 4Q and beyond, do SD-WAN headwinds potentially persist or do you hear that it’s going to be a priority as to save money as people kind of trickle back into the offices?

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Right. That’s a question we have been asking a lot of CIOs as we talk to them. As work from home order happened, all network changes got put on hold. We had only one priority, I need my employees to work from home securely, which really needed a ZIA kind of product to go to external applications, ZPA to go to internal applications. So we actually benefited from not even having to deal with SD-WAN because sometimes network transformation can take longer. We expect that as customers go back to the office, they will be revisiting those SD-WAN projects, but it has shown the CIOs that they don’t have to depend upon the network and they can move forward faster with it. I was talking to a CIO at this very large company, about 100,000 users who was actually looking at doing the SD-WAN breakout. And now having seen this, you say, I’ll think about it if I need to, but I’m finding that I can run my business without worrying about the network. In IT, things don’t change overnight, but the emphasis is changing. We think now the shift is happening with less focus on network, more focus on access from anywhere.

Daniel Bartus — Bank of America — Analyst

Great, great. And then — that’s really helpful. And just quickly Remo. I’m wondering, if you can help us break out the strength for ZPA between existing ZPA customers adding more seats and actually adding new ZPA customers?

Remo E. Canessa — Chief Financial Officer

Yeah. So, the strength in the quarter was ZPA and it was with the existing customers. So, the growth both in ZIA and ZPA were very good. So the growth in the — with the work from home initiative, the existing customers quickly purchased ZPA and ZPA represented close to 40% of our new customers. So the new customer business historically 56% mix of the new ACV, but we expect it to return back to historical norms.

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Yeah. If I may add, ZPA came from three sources. One was our existing customers who have bought some number of seats of ZPA, which is generally — have been in that 20%, 30%, 40%, 50% range. So that’s one. Second bucket was Zscaler customers who had bought ZIA were still looking at ZPA hadn’t bought it, that decision moved on, that became number two. And third was customers who bought ZIA and ZPA together because they were new logos to us. All three contributed to the success of ZPA, while ZIA did very well as well.

Remo E. Canessa — Chief Financial Officer

Yeah. For the follow-on, also typically in the past, we’ve seen a 50-50 mix of new and existing. Over the last several quarters, that mix has been more in the 30% to 50% range. In Q3, it was closer to that lower end of the range.

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

And that’s number of customers.

Remo E. Canessa — Chief Financial Officer

And the number of customers.

Daniel Bartus — Bank of America — Analyst

Perfect. Thanks, guys.

Operator

Thank you. Our next question comes from Saket Kalia from Barclays. Please go ahead.

Saket Kalia — Barclays — Analyst

Hey, guys. Thanks for taking my questions here and I’ll echo my congrats on the quarter.

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Thank you.

Saket Kalia — Barclays — Analyst

Jay, maybe for you, just to change subjects here just for a second. Can you talk about some of the acquisitions here with Cloudneeti and Edgewise? Those are a little different than ZIA and ZPA in terms of displacing sort of an existing vendor, a per user kind of per year pricing model, how do you sort of envision those two new acquisitions sort of fitting into the go-to-market for the future?

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Yeah. So first of all, if you look at overall positioning, Zscaler has been focused on protecting users, no matter what they need to access. That’s our ZIA, ZPA, Zscaler B2B story. Our next natural step was to protect applications and data in the cloud. So, for that, Cloudneeti helps us to protect workloads because misconfigurations and all can cause leakage of data. So that’s an important piece for data protection. And then Edgewise basically extends our story of saying, why should we just stop at connecting users to applications, why not applications to applications, why not process to process using the same zero trust approach that disrupts typical network-based security. So that’s how they fit. Now, from pricing point of view, yes, our pricing has been based on number of users. Now, the price will be based on what, workloads. Right? There are millions and millions of workloads going out in the cloud. It will be subscription service just like everything else, but the unit of pricing becomes workloads.

Saket Kalia — Barclays — Analyst

Got it. That makes sense. Maybe for my follow-up for you, Remo. So helpful commentary in the prepared remarks just around duration. Can you just tell us how you’re thinking about duration here in Q4? Understanding the majority of billings here are annually in advance. You talked a little bit about more co-term business, maybe some shorter commitments as well kind of in a COVID environment. How are you thinking about sort of that duration inside the implied Q4 billings guide?

Remo E. Canessa — Chief Financial Officer

Yeah. I really don’t see much change in the billing duration in Q4. Our billing duration typically is between 10 months and 14 months. And for the last few quarters, several quarters, it’s been the lower half of that range. I’d expect the same in Q4.

Saket Kalia — Barclays — Analyst

Very helpful. Thanks guys.

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Great. Thank you.

Operator

Thank you. Our next question comes from Catharine Trebnick from Dougherty. Please go ahead.

Catharine Trebnick — Dougherty — Analyst

Thank you for taking my question and congratulations on good quarter. So, in your prepared remarks, you discussed that you were doing whiteboarding in some of your activities in the sales motion. Can you describe, every time I talk to investors, I get push back on how complicated the sales process is for you all, takes longer — it’s a long sales cycle, could you explain to us or give us more background on what that new sales process looks like in COVID-19? Thank you.

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Thank you, Catharine. At the core of Zscaler is transformation of the network and applications because you no longer need traditional hub-and-spoke network. So when you try to replace one box of a firewall with a second box of firewall, it’s simpler. This box comes out, that box goes in. In Zscaler, we generally need to show them that you don’t have to have this hub-and-spoke network and castle-and-moat security model. So you end up doing this architectural discussion.

Now, once architect start getting it — understanding it, the life becomes a lot easier because typically we don’t go through this typical POCs, proof-of-concept that compares features and functions. And whiteboarding becomes important to show essentially how the network is sitting today, how could it change in Phase 1, Phase 2, Phase 2 — Phase 3. So we show them their transformation journey. That’s where whiteboarding comes in. Is it complicated? I won’t say it’s complicated. I would say it’s different than doing the box-centric, POC-centric sale.

Here, transformation start from the C level. And those are generally the first parties we work with and generally that C level really depends upon architects to show them how the architecture changes. So we haven’t seen any slowdown in terms of engagement, actually I’ve been surprised to find that getting meetings with C level as well as architects in this confined at home world is actually much easier. Did I answer your question?

Catharine Trebnick — Dougherty — Analyst

Yes, you did. Thank you very much.

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

All right. Thank you, Catharine.

Operator

Thank you. Our next question comes from the line of Gray Powell from BTIG. Please go ahead.

Gray Powell — BTIG — Analyst

Great. Thanks for taking the question and congratulations on the good results.

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Thank you.

Gray Powell — BTIG — Analyst

Yeah. I just want to — I want to go back to one of the comments you made in the prepared remarks, particularly on linearity. So, did you guys see any material benefit from the emergency spending initiatives to support work from home? And then I know you said linearity was strong in March and April and that may continue to be strong. So, I just — I’m just trying to think of the trend line there. Was there any like decel in May or just how did May compare to April?

Remo E. Canessa — Chief Financial Officer

Yeah. I won’t make a specific comment between May and April. What I can say is that linearity in Q3 was better than we’ve had in prior quarters. We picked up strongly in March with the work from home with COVID-19. We continue to have a strong April. And so, we ended the quarter well and that momentum that we had in Q3 is carrying over into May and May continues to be strong.

Gray Powell — BTIG — Analyst

Got it.

Remo E. Canessa — Chief Financial Officer

Yes.

Gray Powell — BTIG — Analyst

That makes perfect sense. And then just one quick one. So I know you guys mentioned, you did some free, I think it was 90-day trials for promotions on ZPA back in March and April. Just what’s your confidence level on converting those into paid customers and how big should we think of that opportunity, Jay? [Phonetic]

Remo E. Canessa — Chief Financial Officer

Yeah. I mean, see, as COVID-19 became basically a global pandemic, most of the customers have started with their original pre-offer for their China-based employees converted to paying customers. Some of the customers converted to business continuity program, which is sort of commitment period, but many also converted to multi-year commitments with annual billings. So, that’s proved out to be pretty good for us.

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

And just to add on Remo, we did not have a global trial free program.

Remo E. Canessa — Chief Financial Officer

That’s correct.

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

We essentially did it in China early on when things started. And after that, our customer started to call us and say, we need help to get turned on. It’s less of an issue of money, it’s more of a matter of my employees need to be productive on Monday morning. And we were crazy busy getting our customers online and making sure they work well.

Gray Powell — BTIG — Analyst

Got it. Okay. Yeah. Thank you very much for clarifying that. All right. I am good. Thanks.

Operator

Thank you. Our next question comes from the line of Srini Nandury from Summit Insights. Please go ahead.

Srini Nandury — Summit Insights — Analyst

All right. Thank you for taking my question. Congrats on a great quarter. Jay, you talked about using AWS for some of the processing of the data since you didn’t have enough capacity. How does that affect the latency? And more importantly, how long does it take for you to add more capacity to the infrastructure? Thank you.

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Add capacity to our infrastructure?

Srini Nandury — Summit Insights — Analyst

Yes. That’s the reason I presume you’re using AWS, right?

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Yes. So the difference is the following. You need to have some hardware sitting in the data centers, where you want to add capacity. The turning on and turning them up and running is not a hard thing at all. Literally, that’s a matter of maybe a day or two. So whatever time it takes, it takes time to acquire hardware and ship it to a data center and it gets turned on pretty quickly. Now, as COVID happened literally overnight, I still recall on Thursday, I got a call from very large conglomerate in Europe.

They said my over 300,000 people need to start working from home Monday 14 of March, and we’re already using ZIA, I’m still playing with ZPA, but I need ZPA to be turned on by Monday morning. This is in two days notice. Right? So, for us to get our capacity ready doesn’t take a whole lot, shipments and all does take some time. And so, it’s a good option to be able to use Azure or AWS as we need to increase capacity for a short amount of time. And as we said in our prepared remarks, the gross margin difference can be significant, so we use them as we need them and then we can dial that out.

Srini Nandury — Summit Insights — Analyst

All right. Thank you.

Operator

Thank you. Our next question comes from the line of Fatima Boolani from UBS. Please go ahead.

Fatima Boolani — UBS — Analyst

Good afternoon, and thank you for taking the questions. Hope you’re all safe and sound. Jay, maybe a question for you to start. As I zoom out or as you zoom out rather and consider your pipeline at a time when organizations are perhaps becoming more measured in what they’re spending and whom they’re spending with perhaps flow playing some of the big architectural decisions, particularly around SD-WAN as you had alluded to earlier. I was curious, how a lot of these dynamics are or will be impacting your pipeline composition, if I consider some of your traditional demand drivers across competitive displacement, SD-WAN adoption and Office 365 migrations?

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Yeah. If I may say, our number one driver has been digital transformation, whether Office 365 or SD-WAN, any of those things have been coming from one core thing. It is very true that every CIO and CFO is becoming more cost conscious. And that’s where — so the decision is not driven by, I need to change the architecture. The decision is driven by, I need to consolidate and my multiple vendors reduce my costs and be ready for digital transformation. If you look at from two buckets point of view, consolidations we do because of great platform and architecture readiness gets them there. So we actually see this thing accelerating in many ways, especially the network with generally the slowest moving part is becoming less important factor because CIOs have seen business work without using their corporate network. Did I answer your question?

Fatima Boolani — UBS — Analyst

Yes. That’s super helpful. And Remo, maybe a question for you. Just as it relates to volumes of large deals. In the quarter, you provided some very marquee examples in the prepared remarks of 200,000 seat win. So I’m curious if there was any outsized or unusually large impact from very large deals in the quarter? And that’s it from me. Thank you.

Remo E. Canessa — Chief Financial Officer

No. I mean, there was no real large deal in the quarter. I mean, a lot of deals greater than $500,000…

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

ACV.

Remo E. Canessa — Chief Financial Officer

ACV, which was a great quarter for us, but nothing stands out as a very, very large deal.

Fatima Boolani — UBS — Analyst

Appreciate that. Thank you.

Operator

Thank you. And our last question comes from Shebly Seyrafi from FBN Securities. Please go ahead.

Shebly Seyrafi — FBN Securities — Analyst

Hey, guys. So my question is, you’re going to have four new products ramping in ’21. Do you have an estimate roughly what kind of revenue contribution there will be?

Remo E. Canessa — Chief Financial Officer

Yeah. I mean, it’s small, it’s not going to be material. If you take a look at our ZPA product that we introduced, I’d say it’s going to be along those same type of trajectory. Couple of percentage points of our total perhaps in fiscal ’21 and then accelerating as we go forward. But clearly, immaterial basically impact for the products in fiscal ’21.

Shebly Seyrafi — FBN Securities — Analyst

Okay. And then I know from the number you provided, Americas growth accelerated with my spreadsheet to 39% from 30% growth the prior quarter. And you even had a tougher year-to-year comparison in the Americas. So, is it — this just COVID or are there other factors in the Americas driving this?

Remo E. Canessa — Chief Financial Officer

Yeah. So related to the new products, it also relates to new and upsell, not revenue. So just so you’re aware of that. Related to the growth in the regions, I can say that all regions did very, very well. For new and upsell, there was no region that did not do well. EMEA, APJ and Americas, all did about the same.

Shebly Seyrafi — FBN Securities — Analyst

Okay. Thank you.

Operator

Thank you. This concludes our Q&A session. At this time, I’d like to turn it over to Mr. Chaudhry, CEO for closing remarks.

Jay Chaudhry — Chief Executive Officer, Chairman and Founder

Good. All right. Well, thank you for your interest in Zscaler. We wish everyone good health and safety. Look forward to seeing you at our next quarterly earnings call.

Remo E. Canessa — Chief Financial Officer

Great. Thank you.

Operator

[Operator Closing Remarks]