ZS • 10-K • FY 2023 • Positive

Zscaler's Zero Trust Growth Engine Accelerates Despite Enterprise IT Headwinds

September 14, 2023 • 1 min read

TL;DR

Zscaler delivered exceptional growth with revenue surging 48% YoY to $1.62B, demonstrating strong enterprise demand for zero trust security despite macro headwinds. Billings growth of 37% signals continued momentum, though slightly decelerating from 2022's 59% as deals face increased scrutiny. Notable customer wins include 419 new customers spending >$100K annually, bringing the total to 2,609. The company's platform expansion and federal traction position it for sustained 30%+ growth, though op

Financial Performance Overview: Revenue grew 48% YoY to $1.62B, with calculated billings up 37% to $1.95B. Gross margins improved 100bps to 81.1% on platform efficiencies, though operating margins compressed 200bps to -13.5% due to continued sales investments. Dollar-based net retention rate remained strong at 125%, while deferred revenue grew 41% to $1.25B. The revenue mix shifted further toward larger enterprise deals, with customers spending >$100K now representing 58% of revenue versus 52% last year.
Strategic Initiatives and Operational Changes: Zscaler significantly expanded its platform capabilities through the launch of Zscaler Data Protection and Business Analytics. The company increased R&D investment by 52% to $358M to accelerate AI/ML capabilities and cloud-native security features. Management restructured the sales organization to focus on enterprise digital transformation deals, resulting in 120% growth in deals over $1M. Federal sector momentum accelerated with FedRAMP High certification and 135% YoY growth in federal bookings.
Market Position and Competitive Dynamics: Zscaler maintained its leadership position in cloud security with Gartner positioning them furthest in vision and execution. Customer concentration improved with no customer exceeding 10% of revenue. Win rates against legacy vendors increased to 85%+ in competitive deals. The company expanded its addressable market to $72B through new product launches. Key competitive advantages in cloud-native architecture and zero trust capabilities helped secure 90% of Fortune 100 companies as customers.
Operational Efficiency and Profitability: Operating leverage improved in H2 with sales efficiency metrics showing positive trends - magic number increased to 0.8 from 0.7 last year. Gross margin expansion of 100bps came from platform optimization and increased scale. Operating expenses grew faster than revenue at 51% YoY as the company invested heavily in sales capacity and R&D. Cash flow from operations reached $343.7M (21% margin) demonstrating strong underlying unit economics despite GAAP losses.
Growth Catalysts and Material Risks: Key growth drivers include federal sector expansion, upsell of new products like data protection, and international expansion particularly in APAC. Macro headwinds are extending sales cycles and increasing deal scrutiny, though security remains a top priority. Primary risks include intensifying competition from cloud hyperscalers, potential pricing pressure, and cybersecurity threats. Management is focused on sales productivity improvements and platform expansion to maintain 30%+ growth trajectory.

Revenue

$1.62B ( YoY) with from subscriptions

↑ +48%

Rd Spend

$358M ( YoY) representing of revenue

↑ +52%

Net Income

-$218.1M ( margin) vs -$167.7M prior year

↓ -13.5%

Gross Margin

(+100bps YoY) driven by platform efficiencies

↑ 81.1%

Free Cash Flow

$251.8M ( margin, YoY)

↑ 15.5%

Operating Margin

(-200bps YoY) due to sales investments

↓ -13.5%

Growth Indicators

2,609 >$100K customers ( YoY)

↑ +19%

Arr Or Bookings ↑$1.95B calculated billings (+37% YoY)

Retention Metrics ↑125% dollar-based net retention (-1000bps YoY)

Key Risks

Cloud hyperscaler competition expanding security capabilities threatens market share
Extended sales cycles and deal scrutiny impacting growth trajectory
Cybersecurity threats to Zscaler's infrastructure pose operational risks
International expansion brings increased regulatory compliance challenges

Key Opportunities

Federal sector expansion with FedRAMP High certification ($40B TAM)
Data protection and analytics platform expansion driving upsell
AI/ML capabilities providing competitive differentiation
International markets particularly APAC present significant growth potential

Bottom Line

Zscaler delivered strong FY2023 results that demonstrate the compelling value proposition of its zero trust platform despite macro challenges. While growth is moderating from peak levels, the company's strategic investments in product innovation and sales capacity position it well for sustained 30%+ growth. Key focus areas include improving sales productivity, expanding platform capabilities particularly in AI/ML, and maintaining technological differentiation against increasing competition. The shift to cloud-native security and zero trust architectures provides strong secular tailwinds, though near-term profitability will remain pressured by growth investments. Monitoring metrics include billings growth trajectory, sales efficiency improvements, and competitive win rates.