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Zscaler (NASDAQ:ZS) Reports Strong Q1 But Stock Drops 11.8%


Full Report / December 01, 2022
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Cloud security platform Zscaler (NASDAQ:ZS) reported Q1 FY2023 results topping analyst expectations, with revenue up 54.2% year on year to $355.5 million. Guidance for next quarter's revenue was $365 million at the midpoint, 2.7% above the average of analyst estimates. Zscaler made a GAAP loss of $68.1 million, improving on its loss of $90.8 million, in the same quarter last year.

Zscaler (ZS) Q1 FY2023 Highlights:

  • Revenue: $355.5 million vs analyst estimates of $340.7 million (4.33% beat)
  • EPS (non-GAAP): $0.29 vs analyst estimates of $0.26 (11.4% beat)
  • Revenue guidance for Q2 2023 is $365 million at the midpoint, above analyst estimates of $355.3 million
  • The company lifted revenue guidance for the full year, from $1.49 billion to $1.52 billion at the midpoint, a 2.17% increase
  • Free cash flow of $95.6 million, up 27.8% from previous quarter
  • Gross Margin (GAAP): 78.4%, up from 77.5% 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)

Sales Growth

As you can see below, Zscaler's revenue growth has been exceptional over the last two years, growing from quarterly revenue of $142.5 million in Q1 FY2021, to $355.5 million.

Zscaler Total Revenue

This was another standout quarter with the revenue up a splendid 54.2% year on year. On top of that, revenue increased $37.4 million quarter on quarter, a solid improvement on the $31.2 million increase in Q4 2022, and happily, a slight re-acceleration of growth.

Guidance for the next quarter indicates Zscaler is expecting revenue to grow 42.8% year on year to $365 million, slowing down from the 62.7% 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 32.3% over the next twelve months.

Profitability

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 78.4% in Q1.

Zscaler Gross Margin (GAAP)

That means that for every $1 in revenue the company had $0.78 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 $95.6 million in Q1, up 14.6% year on year.

Zscaler Free Cash Flow

Zscaler has generated $243.5 million in free cash flow over the last twelve months, an impressive 20% 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 Q1 Results

Sporting a market capitalization of $19.2 billion, more than $1.82 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.

We were impressed by the exceptional revenue growth Zscaler delivered this quarter. And we were also glad that the revenue guidance for the next quarter exceeded analysts' expectations. Overall, we think this was a really good quarter, that should leave shareholders feeling positive. But investors might have been expecting more and the company is down 11.8% on the results and currently trades at $127.5 per share.

Is Now The Time?

Zscaler may have had a good quarter, but investors should also consider its valuation and business qualities, when assessing the investment opportunity. 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 12.9x 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 $199.1 per share right before these results, implying that they saw upside in buying Zscaler even in the short term.

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