Cloud security platform Zscaler (NASDAQ:ZS) beat analyst expectations in Q3 FY2023 quarter, with revenue up 46% year on year to $418.8 million. The company expects that next quarter's revenue would be around $430 million, which is the midpoint of the guidance range. That was roughly in line with analyst expectations. Zscaler made a GAAP loss of $46 million, improving on its loss of $101.4 million, in the same quarter last year.
Zscaler (ZS) Q3 FY2023 Highlights:
- Revenue: $418.8 million vs analyst estimates of $411.7 million (1.71% beat)
- EPS (non-GAAP): $0.48 vs analyst estimates of $0.43 (12.7% beat)
- Revenue guidance for Q4 2023 is $430 million at the midpoint, above analyst estimates of $426.9 million
- Free cash flow of $73.9 million, up 17.6% from previous quarter
- Gross Margin (GAAP): 77.1%, in line with same quarter last year
After successfully selling all four of his previous cybersecurity companies, Jay Chaudhry's fifth venture, Zscaler (NASDAQ:ZS) offers software as a service that helps companies securely connect to applications and networks in the cloud.
The Zscaler Internet Access platform works as a door to the internet through which their customers route all their web traffic and Zscaler ensures malware and viruses doesn’t get in and internal data doesn’t get out. Their Private Access product creates a secure tunnel between a user and an internal application, so the data transferred is never put on the public internet.
Almost every company is slowly finding itself becoming a technology company and facing cybersecurity risks. The migration of businesses to the cloud and employees working remotely in insecure environments is increasing demand modern cloud-based network security software, which offers better performance at lower cost than maintaining the traditional on-premise solutions, such as expensive specialized firewall hardware.
Cybersecurity is a competitive space and Zscaler is competing with companies like Palo Alto Networks (NYSE:PANW) and Cisco (NASDAQ:CSCO)
As you can see below, Zscaler's revenue growth has been exceptional over the last two years, growing from quarterly revenue of $176.4 million in Q3 FY2021, to $418.8 million.
And unsurprisingly, this was another great quarter for Zscaler with revenue up 46% year on year. Quarter on quarter the revenue increased by $31.2 million in Q3, which was in line with Q2 2023. This steady quarter-on-quarter growth shows the company is able to maintain a strong growth trajectory.
Guidance for the next quarter indicates Zscaler is expecting revenue to grow 35.2% year on year to $430 million, slowing down from the 61.4% year-over-year increase in revenue the company had recorded in the same quarter last year. Ahead of the earnings results the analysts covering the company were estimating sales to grow 28.5% over the next twelve months.
What makes the software as a service business so attractive is that once the software is developed, it typically shouldn't cost much to provide it as an ongoing service to customers. Zscaler's gross profit margin, an important metric measuring how much money there is left after paying for servers, licenses, technical support and other necessary running expenses was at 77.1% in Q3.
That means that for every $1 in revenue the company had $0.77 left to spend on developing new products, marketing & sales and the general administrative overhead. This is a good gross margin that allows companies like Zscaler to fund large investments in product and sales during periods of rapid growth and be profitable when they reach maturity. It is good to see that the gross margin is staying stable which indicates that Zscaler is doing a good job controlling costs and is not under pressure from competition to lower prices.
Cash Is King
If you have followed StockStory for a while, you know that we put an emphasis on cash flow. Why, you ask? We believe that in the end cash is king, as you can't use accounting profits to pay the bills. Zscaler's free cash flow came in at $73.9 million in Q3, up 68.9% year on year.
Zscaler has generated $307.1 million in free cash flow over the last twelve months, an impressive 20.7% of revenues. This extremely high FCF margin is a result of Zscaler asset lite business model and strong competitive positioning, and provides it the option to return capital to shareholders while still having plenty of cash to invest in the business.
Key Takeaways from Zscaler's Q3 Results
Sporting a market capitalization of $19.7 billion, more than $1.97 billion in cash and with positive free cash flow over the last twelve months, we're confident that Zscaler has the resources it needs to pursue a high growth business strategy.
Zscaler topped analysts’ revenue expectations this quarter, even if just narrowly. And we were also glad that the revenue guidance for the next quarter exceeded analysts' expectations. Zooming out, we think this was a decent quarter, showing the company is staying on target. But the market was likely expecting more and the company is down 3.37% on the results and currently trades at $130.56 per share.
Is Now The Time?
When considering Zscaler, investors should take into account its valuation and business qualities, as well as what happened in the latest quarter. We think Zscaler is a good business. We would expect growth rates to moderate from here, but its revenue growth has been exceptional, over the last two years. On top of that, its bountiful generation of free cash flow empowers it to invest in growth initiatives, and its impressive gross margins are indicative of excellent business economics.
Zscaler's price to sales ratio based on the next twelve months of 10.3x indicates that the market is certainly optimistic about its growth prospects. There is definitely a lot of things to like about Zscaler and looking at the tech landscape right now, it seems that it doesn't trade at an unreasonable price point.The Wall St analysts covering the company had a one year price target of $152.8 per share right before these results, implying that they saw upside in buying Zscaler even in the short term.
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