Good day, and welcome to the Zscaler First Quarter 2019 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Mr. Bill Choi, VP of Investor Relations. Please go ahead, sir.
Good afternoon, and thank you for joining us to discuss Zscaler's financial results for the fiscal first quarter 2019. With me on the call are Jay Chowdhry, 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 company's anticipated future revenue, calculated billings, operating performance, gross margin, operating expenses, net loss, pro form a net loss per share, free cash flow and dollar based net retention rate. 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 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 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 Barclays Global TMT Conference in San Francisco tomorrow and the Needhams Growth Conference in New York on Tuesday, January 15th. Now I'd like to turn the call over to Jay.
Thank you, Bill, and thank you everyone for your interest in Zscaler. I am pleased to share with you our solid first quarter results. We posted strong revenue and calculated billings as we continue to experience robust growth in our business. Our revenue grew 59 percent year over year to $63,300,000, and total billings grew 56 percent year over year to $64,600,000. In addition to our top line growth, we achieved positive operating profit and free cash flow for the quarter Our operating margins improved approximately 20 percentage points year over year to 2%.
We are very pleased with reaching profitability this quarter. Having said that, we will continue to aggressively invest We believe the primary driver for our market success to support the adoption of cloud. Cloud and Mobility are breaking the traditional perimeter where organizations built a hub and spoke network to backhaul branch office traffic over private networks to the data center. Then they built a mode of security appliances to secure the network. That is why we call it network security.
In the cloud world, applications can be anywhere and devices and users can be anywhere. The notion of inside the network or outside the network is disappearing. We believe the corporate network is changing to a direct to internet architecture. This is commonly known as local internet breakout, which significantly improves user experience, and lowers networking costs. But when you go direct to the Internet, what is the corporate network?
And where would you build a moat? How do you do network security in this world? Well, you can't. Network security is becoming irrelevant. Design for the world, which has no walls, Zscaler security cloud acts as a business policy enforcement engine.
Deployed across 100 plus data centers, to securely connect the right user and ZPA for internal applications in your data center or the public cloud. As organizations embrace the cloud, more and more deals start with our high end transmission bundle, which includes cloud firewall, IPS, and SandBoxing. I would like to highlight 3 new customer wins in the quarter that we believe illustrate the value we deliver for secure network transformation. A Fortune 100 Conglomerate purchased transformation bundle for all of its 100,000 employees. While we are replacing traditional network security appliances, such as secure web gateway, Branch firewall, DNS in a dozen data centers.
It is mostly a greenfield opportunity. We are creating about 400 new secured local internet breakouts. Zscaler will be the only security check post for traffic headed to the Internet from all branches and all the data centers thus enabling a cloud first approach to applications, such as Office 365. They also purchased ZPA for 3rd party contractors who needed access to internal applications, replacing legacy VPN that provides them access to the entire corporate network increasing their security risk. In another deal, a Fortune 500 global food and beverage company purchase transformation bundle for 52,000 users to secure local internet breakout for over 400 sites, including about 350 international locations.
This customer had already realized the need for local breakouts, but went about it the old way. They installed over 300 branch firewalls which was complex and required substantial resources to manage. Our system integrated partners saw an opportunity for the Our approach enhances security with coverage of all users, including mobile with full SSL inspection. It also improves user experience. All this at a lower cost of ownership, and greater operational simplicity, while eliminating on prem security appliances.
This customer also purchased DLT for all users. When customers do local internet breakout, data leakage becomes a major risk and the need of cloud based DLP solution to secure sensitive information at any location. Another new customer, a global pharma company had a strategy to pursue a full transformation to the cloud for the network and for their applications. To realize this strategy, they bought our transformation bundle for ZIA and ZPA for over 15,000 users. That deploying SD WAN across AD sites with Zscaler securing all traffic from these locations.
With this plus lower CapEx and management cost for the network and security infrastructure. While ZIA provides secure and fast access to internet and SaaS, ZPA will do the same for the internal applications some of which are in the data center, while others are moving to Azure and AWS. The Zscaler platform enables our realization of the strategy, our perimeter less enterprise with direct access to any service or application from anywhere on any device without backhauling traffic through the data center. I also want to highlight 2 upsell deals with existing customers that are leveraging our platform for the next phase of their cloud journey. A customer in the food processing industry started with Zscaler 1 year ago with a security led use case of protecting 50,000 mobile users with our business bundle.
Last quarter, they purchased a transmission bundle and DLP for all 100,000 employees. The value realized from the initial security use case helped us win over the networking team as they began to rearchitect the network for the cloud. This customer had recently deployed a leading NextGen firewalls across 200 sales and manufacturing offices, but they realized that deploying security appliances and spinning virtual machines in public clouds fails to deliver cloud security. The customer expects Zscaler to save them over $10,000,000 per year on purchasing and managing firewall appliances. Finally, let me highlight the customer headquartered in Europe that has been using business bundle and DLT 32,000 users.
Last quarter, they purchased additional 9000 seats and added cloud sandbox for all users. Drivers of this deal were twofold. 1, M and A use case. The customer acquired a competitor in the U. S.
And wanted to implement a consistent policy and protection across the entire organization. Number 2, this initiative is part of a larger managed network services RFP, where all 5 telecom service providers bid Zscaler for the security. With over 40% of our sales in EMEA, we have been very successful in the European market because our cloud services architect to meet stringent EU data privacy requirements. The only customer data that we store are customer logs, and customers can choose to store these logs in our EU data centers, or they can choose to store them in their own data center. We believe these deals demonstrate the tremendous value we are delivering.
A strategic advantage for us is our partnerships with large system integrators and global service providers who implement cloud transformation projects. SI and SP's represent over 50% of our revenue and they are the fastest growing channel for us. We will continue to invest We are investing in our go to market capabilities, which enables us to sell top down at the C level. During the quarter, we hired a new CMO, Michelinnagemay, with deep experience in Enterprise Smart in the as an SVP for a newly created role to drive customer experience and transformation. With these two roles filled, our priority remains to find the right leader for our global sales organization with strong sales leaders in place for Americas And International markets.
I'm confident that our sales momentum will continue. We also continue to expand our global sales force. Overall, we are executing well on our vision We believe we have We have 10 years operational experience running our security cloud at scale. We process about 60,000,000,000 internet requests per day, which you can see on our website real time. Each day, we detect and block about 100,000,000 threats and perform more than 120 1000 unique security updates.
This network effect delivers superior security as compared to traditional appliances or a hybrid security cloud. Large week's report by Gartner named Zscaler, a leader in its secure web gateway's Magic Quadrant for the 8th year in a row. In October, we brought our Zenith Live cloud summit to London with hundreds of customers and partners attending from 19 countries. Zenith Live is where CIOs, CTOs, CISOs, security and networking practitioners me to discuss cloud transformation with insights from leaders who have gone through this journey. We had an outstanding lineup of keynote speakers including Microsoft, Siemens, is Casper Group and others.
In summary, we are very pleased with our strong Q1 results, and continued momentum in the call to Remo to walk through our financial results.
Revenue for the quarter was From a geographic perspective, for the quarter, Americas represented 49% of revenue, MBO was 43% and APJ was 8%. Turning to calculated billings, which we define as the change in deferred revenue for the quarter, plus total revenue recognized in that quarter, Billings grew 56 percent year over year to $64,600,000. As a reminder, historically, Q2 and Q4 have been our strongest billings quarters with sequential declines in Q1 and Q3 quarters, respectively. The sequential decline in Q1 is higher than prior years due to a difficult comparison from a large upfront deal we had in Q4. Excluding the $16,500,000 upfront deal from Q4, billings would have declined sequentially at 18%, which is an improvement over the 25 percent declines seen in the prior 2 years.
Also as a reminder, we primarily invoice our customers 1 year in advance and our contract terms are typically 1 to 3 years. The upfront creator than 1 year billings year over year were fairly small in both periods. Total backlog, which represents remaining performance obligations, was $411,000,000 on October 31, up 77% from $232,000,000 1 year ago. Our strong customer retention and ability upsell have resulted in a consistently high dollar based net retention rate, which is 118% for the period ended October 31. This compares to 116% a year ago and 117% last quarter.
Our increased success selling bigger deals upfront, which start with the transformation bundle and faster upsells 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 82% up two points sequentially and two points year over year. The year over year increase was driven primarily by an increased mix of higher priced bundles and more functionality as well as operational efficiencies. While we are pleased with our gross margins, our focus is not to maximize our gross margins at this stage.
We feel 80 continue to invest in our platform and to drive customer satisfaction to drive top line revenue growth. Turning to our operating expenses. Our total operating expenses grew 7% sequentially and 29% year over year to $50,500,000, but decreased as a percentage of sales to 80%. As we continue to invest to grow our business, we increased our headcount by over 80 employees in Q1 and approximately half were in sales and marketing. Sales and marketing increased 10% sequentially and 29% year over year to $33,700,000, We have been building our sales and marketing teams and investing in marketing programs to drive growth and awareness, including the Zenith Live conference held in Europe during the quarter.
R and D was flat sequentially and up 22% year over year to $10,300,000 as we continue to invest to enhance product functionality and to offer new products. G and A increased 1% sequentially and 42% year over year to $6,500,000, The year over year growth in G And A includes investments in building our teams, consulting and other expenses that we've made as we became a public company. These expenses exclude $2,200,000 in litigation related expenses. Our 1st quarter operating margin was a positive 2%, compares to a negative 19 percent in the same quarter last year. Net income in the quarter was $2,000,000 or non GAAP earnings per share of 0 point 0 $1.
Given deposit earnings in the quarter, our EPS was calculated on a fully diluted basis of approximately 134,000,000 shares. We ended the quarter with $314,000,000 in cash, cash equivalents and short term investments. Free cash flow was positive 5,200,000 in the quarter compared to negative 8,900,000 for the same quarter a year ago. Our ESPP program contributed approximately $3,000,000 to our free cash flow in the quarter. The first stock issuance under the ESPP program will be in December, which will reduce our free cash flow by approximately $8,000,000 in Q2 but will have no impact on our overall cash balance.
Now moving on to guidance. As a reminder, these numbers are all non GAAP, which exclude stock based compensation expenses, amortization of intangible assets, certain litigation related expenses and any associated tax effects. For the second quarter, we expect revenue in the range of $65,000,000 to $67,000,000, operating loss in the range of $1,000,000 to $3,000,000 income taxes of 122,000,000 to 123,000,000 common shares. While we are pleased with our profitability ahead of schedule, We will continue to aggressively invest for growth. We believe we have a unique opportunity to disrupt and to capture a large market opportunity.
In As I've mentioned in the past, we plan to achieve sustained profitability and positive free cash flow sometime in fiscal 2020. For the full year 2019, we expect revenue in the range of $268,000,000 to $272,000,000 or a year over year growth 41% to 43%. Operating loss in the range of $4,000,000 to $6,000,000, income taxes of $2,400,000, and net loss per share in the range of $0.01 to $0.03, assuming approximately 124,000,000 common shares outstanding. As you model billings for fiscal 2019, I want to remind you that Q4 2018 We had a large upfront billing of $16,500,000 from one customer. This will produce a difficult year over year comparison in Q4 2019.
If we exclude this large upfront billing of $16,500,000 from fiscal 2018 results, We believe total billings growth in fiscal 2019 would be comparable to our guided revenue growth which would imply a billings range of $340,000,000 to $345,000,000 for the year. We're very proud of what we've achieved and look forward to building on our opportunity.
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 They can't scale, leave gap insecurity 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 as these large enterprises embrace cloud transformation. We are executing on our vision We are scaling our cloud to meet the growth in customer base, driving greater adoption of our high end transmission bundle and ZPA. We're delivering high ROI for customers that leverage our platform for transformation.
We thank you for you may now
you. We'll take our first question from Brad Zelnick with Credit Suisse.
Excellent. Thank you so much and congratulations on another phenomenal quarter, guys. I've got two questions. My first is for Jay. Jay, your primary competitor has experienced disruption of late with leadership turnover and various company specific distractions Is this perceptible to you in the field?
And can you maybe just give us an update more generally on the competitive environment?
Brad, thank you. We are having tremendous success in the field. I think our number one reason for the success is our innovative multi tenant architecture, which scales and works well. And whether the success is due to compared our competitors' issues or not. I'm not sure I can tell, but we're winning.
We're seeing market growing rapidly. I don't see significant shift in the comparative landscape.
I appreciate the commentary. And Remo, just for you, thanks for calling out reminding us the $16,500,000 upfront billing in Q4, which if you remove that, you've actually done better than the seasonality we've seen in Q1 in the past couple of years. And also appreciate the guidance that you've given us on billings for the full year. But as we think about the seasonality from here, anything we should take into account as we model the quarterly billings, just given the strong start that you've had here in Q1?
Brad, just what we've said before, basically, as you mentioned, as we've called out, both Q2 and Q4 are strong quarters. Q4 or year end and Q2 straddles, twelvethirty 1. And also our prior year end the company was twelvethirty 1. So we have a lot of renewals to come through. I would expect the same type of seasonality.
It was a great quarter for us. And so I'd expect the same type of seasonality going forward.
All right. Thanks again and congrats.
Great. Thank you.
We'll take our next question from Daniel Ives with Wedbush.
Yes, thank you. So, Jay,
I mean, you alluded to it a little, but maybe you could elaborate.
How are
conversations changing in regards to more enterprises looking to really spam with Zscaler. I mean, maybe customers at 6 to 12 months now had small deployments. Now the pipeline
is expanding significantly and What do
you think the drivers are there when you compare your conversations? Thanks.
The biggest change in the past 1 to 2 years versus now is that almost every CIO wants to do cloud transformation with security in mind that was slow 2 years ago. What's it directly impacting us is in a couple of ways. One was with transformation, they're all looking at local internet breakout as one of the key drivers. Which really drives our transformation bundle, which includes cloud firewall, cloud sandbox and the like. That's number 1.
2, we have we used to have a lot more deals starting with business bundle, which really get more security breakouts but did not have full all protocols, all post functionality. So moving to bigger bundles. 1, and having bigger pipeline, more momentum is too. And that's why we are posting strong growth in sales. Great.
Could you just
quick comment, about tuck in M and A and how you're thinking about that just as we go through 2019?
Yes. So we are always open to M And A Opportunities. We aren't looking for volume companies for revenues. If you look at something, it'll be largely driven by a strategic fit to expand our platform in a meaningful way. Well, we did a small acquisition last quarter or so.
It was in the machine learning and AI area. It's already delivering results. So as opportunities present themselves in the strategic area, we will be open to those. We'll be looking for those.
Thanks.
Thank you. We'll take our next question from Alex Henderson with Needham.
Great. Thank you very much. I would also extend that. Congrats. It's a spectacular quarter.
The question I wanted to address, actually, there's two pieces of it. One is, can you talk a little bit about in terms of new orders, what the mix looks like between ZIA and ZPA? And are you seeing an accelerated take or any metrics around the rate of uptake on ZPA, which obviously is a small part of revenues currently, but is a key piece. And then second, can you give us any metrics around the display move up the stack from professional to business to transformational bundles. Where are we on that?
Have we seen a meaningful change in the rate of uptake of transformational bundles versus the other 2? Thanks.
I'll take that, Alex. So from a new business perspective, which is new or upsell. What we said is that, we talk about when there's meaningful changes in our business. So what we called out last quarter is for our new and upsell business for CPA. They represented approximately 10% What I can say about ZPA on a year over year basis is it's close to doubled.
So good traction with ZPA Similarly, for transformation, what we called out last quarter is that, transformations increased to 35% of our total ARR for ZIA. What I can say is that it is going up. So it is increasing and we'll make updates in a movie feel it's meaningful.
Okay, great. And when you look at that mix, is that causing any is there any change in the self cycle associated with the time it takes for either of those, upscale purchase orders or is the sell cycles sell fairly similar, despite the fact that you're selling a lot more product?
This is Jay. Alex, thank you. We are selling more higher bundles, though the sell cycle hasn't changed. But I would say that a year ago, if the sales cycle was X months to sell business bundles, we are able to sell the transformation bundle in the same kind of sell cycle. So it's helping similar sales cycle, but being able to sell bigger bundles.
And that's partly because market is moving faster in our direction.
Thank you. We'll take our next question from Gray Powell with OSHA Bank.
Great. Thank you very much and congratulations on the strong results.
Thank you. Thank you.
So just one on my side. Over the last few weeks, we've heard a lot of questions around the macro environments and the sustainability of the improved IT spending we've seen in 2018, extending into 2019. So how do you feel about things going into calendar 2019? And then how do you think Zscaler is positioned, if the overall macro next year is not as strong as it was in 2018? Thanks.
Great. Good question. I'll answer it in two parts. Number 1, Zscaler not only helps you drive cloud transformation, it actually drives tremendous ROI. So in many ways, when spendings are tight, we become actually a more attractive solution.
Now that's one. Number 2, we are still such a small piece for the overall IT environment, the budget, that it is I don't think we would see much of a change because of some of the environment tightening. I'll tell you an interesting dialogue I had with the CIO of probably Global 2000 Companies. I went to see him. I said, Hey, thank you for making time for me.
I know I'm a very tiny fractional overall IT budget. He interrupted me, he sees a stop. You may be a small piece of my IT budget, but I don't have a cloud strategy without you. I want you to come and see me every 6 months. So with that kind of strategic positioning for transformation with such a small piece of budget, I don't think we'll see a negative impact.
Got it. That's very helpful. Thank you very much.
Thank you. We'll take our next question from Melissa Franchi with Morgan Stanley. Hello, Melissa. Your line is open.
Oh, hi. Sorry about that. Can you hear me?
Yes. Yes. We can.
Oh, okay. Great. Congrats on the quarter. Jay, you noted how adoption of this transformational bundle is being driven by the need to to enable secure local internet breakout. Can you maybe elaborate what functionality explicitly within the transformation bundle enables those local breakouts?
And since the cloud firewall solution is part of, the transformation bundle and that's incremental relative to the prior bundle, does this mean that you're increasingly displacing firewall either at the branch or in the data center?
Okay. So good question. So first of all, to give you the difference, business bundle has lots of good functionality and local breakout for the web traffic. The 2 big modules in Transformation Bundle in the new outside the business bundle. 1 is cloud firewall, second is cloud sandboxing.
So people are buying cloud transformation bundle, not because they're displacing branch firewalls. People are buying it because they are creating new local internet breakouts. And when they see the auth with a cloud firewall where they can handle all ports and protocols rather than just web traffic at a relatively smaller cost. It becomes attractive for them to buy a transformation bundle. So the driver for transformation bundle, cloud firewall to handle all kinds of traffic.
And especially Office 365 traffic Skype and all, which works beautifully through our cloud firewall, and which won't work very well through a traditional web proxy. In SandBoxing, everyone has bought SandBox in the data center. They all buy into it because of security threats. When they find that with Zscaler, now this functionality is available everywhere on every branch office, even for a road warrior, it becomes very easy for an add on of cloud Sandbox. Those are the 2 drivers that are in there.
One key module that's not in the transformership bundle is DLP Data Loss Prevention, and that's still bought Ella Carte. Did I answer your question or
Yes. That's great. Thank you. And then Reno, in terms of operating margins, the proven and particularly related to sales and marketing leverage. I'm wondering if you can maybe just elaborate what's enabling that magnitude of sales and marketing leverage And particularly, I'm wondering if you can comment on hiring plans and how that came in relative to your expectations in the quarter and if you've seen any changes in sales attrition.
Yes. So good question. So we had a very good sales and marketing leverage. The productivity on a quarter over quarter basis from Q1 of last year versus this year was up. From a hiring perspective, what we called out is that we hired over 80 employees, net employees in Zscaler, and about about half of those were in sales and marketing and most of those were in sales.
So what we plan to do as we go forward, we're very proud of achieving profitability. But we see this as such a large market opportunity that we're going to continue to invest. So from our perspective, there's no change, but we said before, in that, we expect to be sustained, profitability in free cash flow positive sometime in fiscal 2020. Which I think what we've demonstrated over the last three quarters, being positive free cash flow and reaching operating profitability, we've got the model in order to really, profitability. But because of the large market opportunity, we're going to do investment and we're going to capture, we're going to try to capture this market opportunity as best we can.
Thank you.
We'll take our next question from Gabriela Borges with Goldman Sachs.
Good afternoon. Thanks for taking the question. So Jay, I would love to understand a little bit better for your new CMO and your new SVP for customer engagement and customer success. What are the priorities for those 2 roles and what are some of the key initiatives that the ladies will be working on over the next 12 months or so?
Good. So the 2 new roles, the CMO, Michelinichmeib. So our number one priority is overall help us to more demand generation as our goals are getting bigger and bigger, targets getting bigger and bigger. So it's a need for higher demand gen. And along with that, we are going to focus on building our brand and awareness overall.
Our IPO has helped us in this area quite a bit, a lot of visibility but we think a lot more can be done in that area. So those are 2 big objectives in addition to many other Regarding our SVP of customer experience and transformation, we are a very customer focused company. It starts from me. And this customer experience is really starting with a product experience to sales experience to once the sale has made deployment and ongoing interaction. So Carita is able to really hold together all these things in a holistic fashion across multiple functions to make sure our customers have the best experience.
And that second part on the transformation is actually not only just the customer side of but it's our own transformation as a company. We have been going through changes and transformation in the way we deal with customers in the deal the way we go to market. You have seen some of the innovations they've done in go to market at Zscaler, which is not traditional sale through VARs. We figure out that go to market top down CXO CTO level, we figured out all the new transformation sales need to be done with some of the architects and the like. So this is more to focus on making sure Zscaler as a company is transforming and changing itself as the world is moving fast.
So we're very happy to have these 2 very capable executives join my team.
That's helpful. Thank you. And the follow-up is on the status of some of the telecom service provider partnerships that you have. I think you mentioned in the prepared remarks that there was one deal where 5 separate telecom providers bid to offer Zscaler services. Are there large telecom providers that you can still bring online?
Do you feel like you have good penetration in the partnerships you already have? And is there more willingness to embrace as these Scalar platform as accounted to what may otherwise be a headwind in MPLS? Thank you.
The world is moving from hub and spoke network to a local breakout. It is true that of 2, 3 or 4 years ago, many telcos were kind of wondering between how fast to move in that direction and how much they can do to slow it down, but everyone understands real that the market is moving in that direction. So all large telcos, in fact, if I would say the top 10 largest telcos in the world. They all do business with us. Some of them, a lot more than others.
So our goal is to make sure we work more closely with them. And they see it as a joint opportunity. They want to see the customer moving to a new network that still managed by them. So they are managing Zscaler security service for the customer. So it's a good win win proposition, and we are seeing more leverage, more traction coming form SPs, partly because of two reasons: 1, the market is taking them there.
That's number 1. Number 2, they're seeing increased revenue opportunity with Zscaler along with able to keep account control. Did that make sense?
Yes. Thank you for the color.
Thank you. We'll take our next question from Saket Kalia with Barclays Capital.
Hey guys, thanks for taking my questions here.
Jay, just to pick up on
an earlier line of questioning on the transformation bundle and the traction there. Do you track any stats on which of those modules are being used particularly heavily. So you mentioned cloud firewall and cloud sandboxing are the biggest additions versus versus the business bundle, are you seeing one module used perhaps more heavily than the other?
It's a good question. If we were in the appliance world, then you would say, well, this module got turned on this did not because when you buy a cloud sandbox in a traditional world, there are a bunch of steps to figure out to integrate, how to take traffic, how to authenticate users, how to set up SSL Sandboxing. All those things are essentially in place when the traffic comes to Zscaler. So turning on firewall or turning on sandboxing is very simple. So I would say once the customer has bought these CRM modules, they're essentially turned on almost all the time.
It's very rare when those modules are not used. Now it is possible that the customer may have only 20 local internet breakouts, early on. And then we take them 9 months to go from 20 to 200. Now there's still a turn on our sandboxing and firewall on those 20 local breakouts. And as additional 180 gets added, they still remain turned on and now they're taking, they're making more benefit off the benefits.
But it's rare to have something that customers bought a module from Zscaler and they're not using it because turning on, it's simple. It's simply a single click in our configuration. In fact, we in our sales show the customer what we call a single click deployment of cloud firewall and cloud sandbox from our console.
Got it. Got it. That's helpful. Just a follow-up for you, Jay, you mentioned DLP is sold a la carte outside of the bundling strategy. Can you just talk about why a la carte pricing for DLPs is is the best avenue?
And could we ever see DLP as part of a bundle in the future?
Yes, bundling is an interesting exercise. There are no simple answers. If you bundle too much, you kind of you can increase the price too much. If you don't bundle enough, you're not selling additional modules. So it's one of those art and science things we try to learn and figure out.
And I think when a module becomes widely accepted, and more and more customers start buying at a la carte, it tells us there's time to really bundle it. So if you asked me 2 years ago, I wasn't ready to bundle cloud firewall or cloud sandbox. So transmission bundle is relatively new. I think Remo, it's about 15 month old bundle okay, we didn't have this bundle before. We sold cloud firewall and cloud sandbox separately.
DLP is an interesting area. So we have been selling decent amount of DLP before, there's one critical module we needed to add to make it the richest DLP functionality in the world that's called exact data match, where we can match exact field from our customers a record about Social Security number or date of birth and the like. And that module became available. And what also what's happening is as customers are opening 100 of local breakouts, and they may have DLP deployed in 3 or 5 data centers, not that DLP is no good, because lots of your locations don't really go through a DLP system, so to speak. So we are seeing an increased demand of DLP.
We're selling more of it as we highlighted a few customers, during our call earlier, we do see potentially DLP becoming a part of bundle in future. I'm not exactly sure what timing is, but it's a natural course for us to move to.
Got it. Very helpful.
Question from Fatima Boolani with UBS.
Jay, maybe to start with you, in your prepared remarks around the customer examples, you gave a lot of instances of customers who went in with you at the point of land with both the ZIA and ZPA ZIA and ZPA So just broadly speaking in terms of the pipeline, are you starting to see a greater incidence of landing with both your product portfolios? And just as an extension, what sort of impact is this having on your, call it, land ARRs?
So if I give you some idea, we're probably approximately half the deal of ZPA coming as brand new customer who had never bought from Zscaler before and the other are coming with ZIA as an upsell. So that's a broad trend. It is true that a number of deals are picking up ZPA along with ZIA upfront, but I would say that in majority of those cases, ZPA is bought for a subset of users, not for all users. As we have said before, When ZI is bought, it is bought to protect all users from all locations, essentially every employee in the company. When ZPA is bought, it's largely driven by business application needs.
And typically in an enterprise, the number of ZPA users may be somewhere from 40% to 80% of the total users. So If I were to simplify it, wherever ZPA is bought, majority of the cases, it's a subset of users and P plus still moving applications to Azure and AWS is still in early phases. And as that market matures more and more, the number of ZPA users will go up significantly.
That makes a ton of sense. And Remo, just to follow-up for you on the profitability strength in the quarter. If I think about some of the commentary you gave us, during the IPO around Unit Economics, being fairly weak in the 1st year of the customer acquisition process, but then seeing sort of a significant improvement in year 2. As I think about you doing larger deals upfront, doing more transform bundled deals at the outset you've got better awareness as a public company and just generally better awareness overall. Can you give us a sense of how those unit economics have changed from customer acquisition perspective.
And that's it for me. Thank you.
So you're talking about contribution margin. So our contribution So our contribution margin as we talked about at the public offering, is that in years 2 and 3 was in the high 60% range. What I'd like for you to keep in mind is that we see this as a very large market opportunity. And our plans are to grow the company as quickly as we can. As we talked about on the road, on the roadshow, and it hasn't changed, relates to our long term model of 20%, 22% operating profitability.
Once we reach 800 $1,000,000,000 in revenue. That's still our plan. So we've not deviated at all related to our short term goals, our expectations that of hitting breakeven, again, positive free cash flow profitability on a sustained basis in fiscal 2020. And also the 20 22%. So when you think about contribution margin, yes, if we stopped everything and just renewals, then it goes incredibly high.
With this large market opportunity, we're going to keep on investing business to maximize what we feel is the biggest shareholder value.
Thank you. We'll take our next question from Jonathan Ruckhaver with Robert W. Baird.
Yes. Hi, good afternoon. You've commented in the past that high volume transaction business into the mid market, through channel was tracking in about 40 percent of total business. I'm just wondering that that was something that I'd heard several quarters ago. Is still consistent with what you're seeing today?
Jonathan, thank you for the question. I think what we talked about in the past is the business coming through the VAR channel in the 40% range. It's not really the mid market business. It's that total business coming through the VAR channel. That that's still sitting in the broadly in the same range.
And I mean, if you look at the 2 broad channel buckets, SPSI is one bucket and VAR is the 2nd bucket. Yes, we are seeing some VARs who are successfully able to pivot to the cloud and they are driving more business for us. But overall, growth from a channel is coming faster from the SBS side of it.
Okay. So it's safe to assume that when you look at the channel investments you're making, the greater allocation is going to SP and SI?
Yes, but we are also investing in our channel as well, yeah, proportionately to make sure we're working on all channels. We are picking up more, a new kind of channel called born in the cloud vars. These guys were built for the new world who are not really mattered to pushing boxes. And they are a pretty good channel for us, small, growing.
That's good to hear. In Remo, I just wanted to get some clarification. The large deal activity you saw in 3Q and 4Q of fiscal 2018, you've suggested that the impact of those large initial upfront deals is very positive on retention rates when they occur, but as they get anniversary, should we expect to see somewhat of a dampening effect as we anniversary those two quarters?
It depends. I mean, related to those deals, if we get these large upfront deals for multi year, customers are making the investment and also having Zscaler as their their security and networking company they're going to use. So these, these upfront deals where what we look at is more on a on our contract basis. And on a contract basis, over the last 4 or 5 quarters, for new business, it's been over 70% for 3 year type deals. That's our focus.
Related to dollars, if customers would like to give us a pay more to Zscaler because of budgetary reasons, then we will accept that. So that's a does that answer your question?
Yes, that provides a little bit more inside, but I'm just wondering in specific situations like that, the opportunity I would imagine to drive greater subscribers, and the higher bundled offering to somewhat limited. So does it become increasingly coming upon additional large deals like that to kind of keep that retention rate where it was or is that not the case?
Yes, got it. Good question. So yes, so we called out before is that more more customers are going transformation. So as more customers go transformation, that CIA, they typically purchase that for all employees. So as that happens, that will put a downward impact potentially on our net retention rate.
Related to that also, is that what we're seeing is we're seeing more customers upgrading sooner. So we calculate net retention rate. We look at the customers we had a year ago, for those same customers, what is their ARR? So we look at ARR a year ago versus ARR currently. So as more so what we're seeing is that if customers are upgrading within that period, we're not picking that up potentially in that retention rate.
As we go forward though, ZPA could have a positive impact, DLP could have a positive impact. And we'll as we give more services on our platform, those can have positive impacts. Our net retention rate at 118%. We feel is outstanding When you think about how we sell and again, ZIA, we sell, we're selling more transformation upfront
to customers. Yes. So if I may add Remo, we are out of many metrics. We are less focused on net retention rate. We want to we are focused more on growth and customer retention, or reducing our churn.
But this net retention rate may fluctuate up and down.
Yes. So Jay Remo, that's very helpful. Thank you very much.
Thank you.
At this time there are no further questions in the queue. I would like turn the call back over to CEO Jay Chaudhry for closing remarks.
All right. Thank you for your time to join us. We look forward to talking to you during the next quarter's earnings call.
Thank you. Ladies and gentlemen, this concludes today's teleconference. You may now disconnect.