ZS • 10-K • FY 2022 • Positive

Zscaler's Zero Trust Growth Accelerates as Enterprise Security Shifts to Cloud

September 15, 2022 • 1 min read

TL;DR

Zscaler delivered exceptional FY22 growth with revenue surging 62% YoY to $1.09B, driven by accelerating enterprise adoption of zero trust architecture. Billings growth of 59% to $1.46B reflects strong platform expansion and increased customer spending. The company maintained 125%+ net retention while expanding gross margins to 80.9%, demonstrating powerful operating leverage. However, operating losses widened to $327.4M as Zscaler heavily invests in sales capacity and R&D to capture market shar

Financial Performance Overview: Revenue growth accelerated to 62% YoY reaching $1.09B, up from 56% growth in FY21. Calculated billings grew 59% to $1.46B, indicating strong future revenue visibility. Gross margins expanded 150bps to 80.9% while operating margins compressed 300bps to -30% as the company invested aggressively in sales and R&D. Free cash flow margin improved to 15% from 13% in FY21, generating $164.8M in FCF. Customer cohorts from FY19-20 have expanded spending by over 6x on average.
Strategic Initiatives and Operational Changes: Zscaler significantly expanded its zero trust platform capabilities through both organic development and strategic acquisitions including Smokescreen and TrustDome. The company doubled its sales capacity and expanded strategic partnerships with Microsoft, AWS and Google Cloud. Management is focused on landing larger enterprise deals, with customers spending >$1M growing 77% to 287 accounts. Product innovation is centered on expanding Zero Trust Exchange platform to cover broader security use cases.
Market Position and Competitive Dynamics: Zscaler maintained its leadership position in cloud security with Gartner positioning the company furthest in vision and execution. Total customer count grew 24% to over 6,700 enterprises with particularly strong growth in Global 2000 accounts. While facing competition from legacy vendors and cloud providers, Zscaler's purpose-built architecture and platform approach continues to resonate with large enterprises. The company cited 75% win rates in competitive deals with a growing displacement of legacy vendors.
Operational Efficiency and Profitability: Despite heavy growth investments, Zscaler demonstrated strong unit economics with gross margins expanding to 80.9%. Sales efficiency metrics remained healthy with CAC payback period of ~15 months. R&D spend increased 77% to $289M (26.5% of revenue) as the company accelerated platform innovation. Operating losses widened but free cash flow generation improved, highlighting the underlying profitability of the core business. Employee count grew 57% to 4,975 with significant additions in sales and R&D.
Growth Catalysts and Material Risks: Key growth drivers include accelerating zero trust adoption, expansion into adjacent markets like IoT security, and increased platform adoption by existing customers. Major risks include intense competition, potential cybersecurity incidents, and execution challenges in scaling sales capacity. Management guided to 47-48% revenue growth for FY23 with improving operating leverage. The $72B TAM and only 6,700 current customers suggests significant runway for growth despite macro uncertainties.

Revenue

$1.09B ( YoY) with subscription revenue at of total

↑ +62%

Gross Margin

(+150bps YoY) driven by platform efficiency

↑ 80.9%

Free Cash Flow

$164.8M ( YoY) with margin

↑ +86%

Operating Margin

(-300bps YoY) due to growth investments

↓ -30%

Growth Indicators

$2.61B ( YoY)

↑ +73%

Net Retention ↑>125% for 6th consecutive quarter

Customer Count ↑6,700+ (+24% YoY)

Calculated Billings ↑$1.46B (+59% YoY)

Key Risks

Intense competition from legacy vendors and cloud providers
Cybersecurity incident risk could damage reputation
Execution challenges in scaling sales and R&D
Macro headwinds impacting enterprise IT spending

Key Opportunities

Zero trust adoption acceleration ($72B TAM)
Platform expansion into IoT and cloud workload security
Deeper penetration of Global 2000 accounts
Strategic partnership expansion driving adoption

Bottom Line

Zscaler delivered exceptional execution in FY22 with accelerating growth and expanding market opportunity as zero trust security reaches mainstream adoption. The company's strategic investments in sales capacity and product innovation position it well to capture share in the $72B TAM despite intense competition. While operating losses widened, improving free cash flow generation demonstrates the underlying profitability of the model at scale. Key metrics to watch include new customer additions, platform expansion rates, and sales productivity as the company doubles its go-to-market capacity. The contrarian insight is that Zscaler's high growth investments may actually be too conservative given the massive market opportunity and accelerating displacement of legacy security vendors.