ZS • 10-Q • Q4 2020 • Positive

Zscaler Accelerates Growth Amid Remote Work Surge, But Operating Losses Widen

December 08, 2020 • 1 min read

TL;DR

Zscaler delivered strong Q1 FY2021 results with revenue growing 52% YoY to $142.6M, driven by accelerated enterprise digital transformation. Billings increased 64% YoY to $144.7M reflecting strong platform adoption. However, operating losses expanded to -$42.7M as the company heavily invested in sales expansion and R&D. The shift to remote work has created tailwinds for Zscaler's Zero Trust security platform, though rising competition and high customer acquisition costs remain key challenges. Ma

Financial Performance Overview: Revenue growth accelerated to 52% YoY, up from 46% in the previous quarter, reaching $142.6M. Calculated billings grew 64% YoY to $144.7M, indicating strong forward momentum. Gross margin improved 100bps YoY to 77%, while operating margin declined 500bps to -30% due to aggressive investments in sales and R&D. Deferred revenue increased 51% YoY to $371.9M, suggesting robust pipeline conversion. Customer acquisition costs remain elevated but management expects efficiency improvements in FY2021.
Strategic Initiatives and Operational Changes: Zscaler expanded its Zero Trust Exchange platform capabilities through the acquisition of Edgewise Networks and Cloud Security Posture Management (CSPM) launch. The company increased sales capacity by 60% YoY and implemented a new channel partner program. Management highlighted success in upselling existing customers to broader platform adoption, with multi-product deals now representing over 50% of new ACV. The go-to-market strategy focuses on large enterprises, with average deal sizes increasing 25% YoY.
Market Position and Competitive Dynamics: Zscaler maintained its leadership position in cloud security with 4,500 enterprise customers and 150M+ licensed seats. Net retention rate remained above 120% for the seventh consecutive quarter. The company faces increasing competition from legacy security vendors pivoting to cloud-native solutions and emerging SASE providers. However, Zscaler's platform breadth and early-mover advantage in Zero Trust architecture provide meaningful competitive moats. Enterprise adoption of SASE frameworks is accelerating, expanding TAM to $72B by 2025.
Operational Efficiency and Profitability: Sales efficiency metrics declined with magic number dropping to 0.8 from 1.1 last year as the company invested heavily in expanding enterprise coverage. R&D spend increased 65% YoY to $35.8M or 25% of revenue. Gross margins improved through platform scaling but operating losses expanded due to front-loaded investments. Management expects operating leverage to improve in H2 as recent sales hires ramp productivity. Cash flow from operations was -$8.4M compared to -$5.4M in Q1 FY2020.
Growth Catalysts and Material Risks: Key growth drivers include accelerated cloud transformation, remote work security needs, and 5G enabling edge computing security demand. Rising competition from Palo Alto Networks, Cisco, and startups could pressure win rates and pricing. Customer concentration risk persists with top 10 customers representing 30% of revenue. Execution risks around sales force expansion and new product launches could impact growth trajectory. Management highlighted strong pipeline visibility but macro uncertainty remains a wild card.

Revenue

$142.6M ( YoY, QoQ) with acceleration from YoY growth in Q4

↑ +52%

Rd Spend

$35.8M ( YoY) representing of revenue

↑ +65%

Net Income

-$55.0M ( margin vs YoY) due to growth investments

↓ -38.6%

Gross Margin

(+100bps YoY) driven by platform efficiency

↑ 77%

Free Cash Flow

-$8.4M vs -$5.4M YoY with FCF margin

↓ -5.9%

Operating Margin

(-500bps YoY) reflecting aggressive investments

↓ -30%

Growth Indicators

4,500 enterprise customers ( YoY)

↑ +25%

Arr Or Bookings ↑Calculated billings $144.7M (+64% YoY)

Retention Metrics ↑>120% net retention rate for 7th consecutive quarter

Key Risks

Intensifying competition from legacy vendors and SASE startups threatening market share
Customer concentration with top 10 representing 30% of revenue
Execution risk around sales force expansion and productivity ramp
Potential IT budget constraints impacting large enterprise deals

Key Opportunities

SASE market expansion to $72B by 2025 driven by remote work and cloud adoption
International expansion in EMEA and APAC regions with <50% current penetration
New product adoption (ZDX, workload protection) expanding wallet share
5G enabling edge computing security opportunities

Bottom Line

Zscaler delivered strong Q1 results that demonstrate accelerating momentum in cloud security adoption, though profitability remains pressured by growth investments. The company's early leadership in Zero Trust architecture and expanding platform capabilities position it well to capture growing SASE opportunities. While competitive intensity is rising, Zscaler's technology advantages and land-and-expand motion provide sustainable differentiation. Key metrics to watch include net retention rates, new product adoption, and sales efficiency improvements. The contrarian insight is that current elevated investments in sales and R&D may actually widen Zscaler's competitive moat despite near-term margin pressure.