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Zscaler (NASDAQ:ZS) Beats Expectations in Strong Q3, Provides Optimistic Full Year Guidance


Full Report / June 23, 2022
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Cloud security platform Zscaler (NASDAQ:ZS) reported Q3 FY2022 results beating Wall St's expectations, with revenue up 62.5% year on year to $286.8 million. On top of that, guidance for next quarter's revenue was surprisingly good, being $305 million at the midpoint, 4.7% above what analysts were expecting. Zscaler made a GAAP loss of $101.4 million, down on its loss of $58.4 million, in the same quarter last year.

Zscaler (ZS) Q3 FY2022 Highlights:

  • Revenue: $286.8 million (5.64% beat)
  • EPS (non-GAAP): $0.17 vs analyst estimates of $0.11 ($0.06 beat)
  • Revenue guidance for Q4 2022 is $305 million at the midpoint, above analyst estimates of $291.3 million
  • Free cash flow of $43.7 million, up 48.5% from previous quarter
  • Gross Margin (GAAP): 77.6%, 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)

Sales Growth

As you can see below, Zscaler's revenue growth has been incredible over the last year, growing from quarterly revenue of $176.4 million, to $286.8 million.

Zscaler Total Revenue

This was another standout quarter with the revenue up a splendid 62.5% year on year. On top of that, revenue increased $31.2 million quarter on quarter, a very strong improvement on the $25 million increase in Q2 2022, and a sign of acceleration of growth, which is very nice to see indeed.

Guidance for the next quarter indicates Zscaler is expecting revenue to grow 54.7% year on year to $305 million, in line with the 56.5% 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 37.2% 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 77.6% in Q3.

Zscaler Gross Margin (GAAP)

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 follow 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 $43.7 million in Q3, down 21.5% year on year.

Zscaler Free Cash Flow

Zscaler has generated $184.2 million in free cash flow over the last twelve months, an impressive 18.9% 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 $18.7 billion, more than $1.65 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. Zooming out, we think this was a fantastic quarter that should have shareholders cheering. The company currently trades at $149 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. There are a number of reasons why we think Zscaler is a great business. While we would expect growth rates to moderate from here, 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 strong gross margins suggest it can operate profitably and sustainably.

The market is certainly expecting long term growth from Zscaler given its price to sales ratio based on the next twelve months is 15.2x. But looking at the tech landscape today, Zscaler's qualities stand out and we still like it at this price.

The Wall St analysts covering the company had a one year price target of $322.5 per share right before these results, implying that they saw upside in buying Zscaler even in the short term.

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