ZS • 10-Q • Q4 2022 • Positive

Zscaler's Cloud Security Growth Accelerates Despite Macro Headwinds as Margins Expand

December 07, 2022 • 1 min read

TL;DR

Zscaler delivered strong Q1 FY23 results with revenue growing 54% YoY to $355.5M, demonstrating resilient demand for zero trust security. Billings grew 37% YoY to $340.1M while operating margin improved 300bps YoY to -3%. The company is seeing increased deal sizes and platform adoption as enterprises accelerate cloud transformation. Management raised FY23 guidance despite macro uncertainty, suggesting continued momentum in enterprise security spending.

Financial Performance Overview: Revenue growth accelerated to 54% YoY while maintaining 80%+ gross margins at 80.6%. Calculated billings of $340.1M grew 37% YoY, with increasing contribution from large enterprise deals >$1M. Operating margin improved 300bps YoY to -3% as sales efficiency gains offset growth investments. Deferred revenue grew 55% YoY to $1B, providing strong visibility into future growth. Free cash flow margin expanded to 16% from 12% in the year-ago period.
Strategic Initiatives and Operational Changes: Management is doubling down on platform expansion with new Zero Trust Exchange capabilities and federal market penetration. Key initiatives include enhanced data protection, IoT security, and digital experience monitoring. The company increased sales capacity 40% YoY while improving productivity metrics. Strategic partnerships with Microsoft and AWS are driving larger transformation deals. Federal business momentum accelerated with FedRAMP High authorization.
Market Position and Competitive Dynamics: Zscaler maintained leadership in cloud security with >6,700 enterprise customers and 40%+ of Global 2000. Net retention rate remained strong above 125% despite macro concerns. The company is winning larger platform deals against legacy security vendors, with 20% YoY growth in customers spending >$1M annually. Competitive positioning strengthened in key segments including SSE and ZTNA where Zscaler leads Gartner evaluations.
Operational Efficiency and Profitability: Gross margin expanded 50bps YoY to 80.6% driven by platform scale and improved cloud infrastructure efficiency. Sales productivity gains led to lower customer acquisition costs despite 40% sales headcount growth. R&D spend increased 65% YoY but declined as a percentage of revenue. The company remains on track for Rule of 40 with combined growth and FCF margin of 70%+. Operating leverage improved across all key metrics.
Growth Catalysts and Material Risks: Key growth drivers include federal/government expansion, upsell of new platform capabilities, and international markets. Macro headwinds creating longer sales cycles but deal values increasing. Primary risks include intensifying competition, execution on sales hiring/productivity, and potential IT budget constraints. Management cited strong pipeline and raised FY23 guidance indicating confidence in growth sustainability.

Revenue

$355.5M ( YoY, QoQ) with strength across segments

↑ +54%

Rd Spend

$78.3M ( YoY) representing of revenue

↑ +65%

Net Income

-$68.2M (improved from -$90.8M YoY) with margin expansion

Gross Margin

(+50bps YoY) driven by platform efficiency

↑ 80.6%

Free Cash Flow

$57M ( YoY) with margin

↑ +95%

Operating Margin

-3% (+300bps YoY) showing operating leverage

Growth Indicators

$340.1M ( YoY) showing strong bookings

↑ +37%

Customer Count ↑6,700+ enterprises with 40%+ of Global 2000

Retention Metrics ↑>125% net retention rate maintained

Key Risks

Macro uncertainty impacting IT budgets and sales cycles
Execution risk from rapid sales force expansion
Intensifying competition in cloud security market
Cybersecurity talent shortage constraining growth

Key Opportunities

Federal market expansion with FedRAMP High certification ($40B+ TAM)
International growth acceleration from low base (51% of revenue)
Platform expansion into adjacent security markets
Zero trust architecture becoming mainstream standard

Bottom Line

Zscaler delivered a strong quarter that demonstrated the strategic priority enterprises are placing on zero trust security transformation despite macro uncertainty. The combination of accelerating revenue growth, improving margins, and strong leading indicators like billings and deferred revenue suggest sustainable momentum. While sales cycles are elongating, deal sizes are increasing and the company's competitive position appears to be strengthening. Key metrics to watch include federal business traction, international expansion, and sales productivity as the company aggressively adds capacity. The contrarian insight is that macro headwinds may actually accelerate cloud security adoption as companies seek cost efficiencies through platform consolidation.