Strictly Business: Zscaler Earnings Recap
Thoughts on ZS's recent report.
ZS 0.00%↑ – Zscaler posted what I thought was a solid quarter. I’d estimated ~$381M in revenue with a $397.5M Q3 guide. We received $387.6M and $398M. So, right on track.
How about secondary metrics?
At least a slight bump to the current $1.53B (+40.3% YoY) FY23 revenue guide. This now stands at $1.563B (+43.3% YoY). Check.
More importantly, a noticeable raise of the $1.94B (+31.0% YoY) FY23 billings guide. Keeping that guide flat after Q1 caused a muted market response especially given management’s emphasis on billings as a key metric for underlying health. Competitor Palo Alto Networks has delivered pleasant billings surprises three of the last four quarters including this one. Meanwhile, ZS has issued billings disappointments two of the last three. It’s put up or shut up time for ZScaler to prove it isn’t losing new business to competitors. I guess a $5M raise is technically noticeable, but I was honestly expecting more. One thing noted on the call is management has extended the ramp payments for some customers so less hits the first year of a contract and more falls into the second. This timing change will create billing pressure now but hopefully lead to a small buffer later assuming these customers meet their payment schedule.
Both $100K+ and $1M+ customer adds were lighter than anticipated in Q1. I’ll be looking for stability here, especially since ZS’s billings totals are traditionally weighted toward the second half of the year. It will be hard to maintain that trend if large customer growth deteriorates. ZS added 120 new $100K+ customers versus 128 last quarter and 135 last year. So, just OK. However, it added 30 new $1M+ customers vs 21 in Q1 and 27 last year. I’d give this one a push overall.
A ninth consecutive quarter meeting management’s 125%+ net retention baseline. Check, and nice to see given the NRR declines of other firms like Cloudflare and Snowflake.
Simply meeting ZS’s $43M operating income guide would set a new dollar record. I’m curious if we can get a large enough beat to challenge the record 13.8% operating margin from 1Q21. The $48.8M was a new raw record. The 13.5% margin is 2nd all-time, so plenty good. Expenses came in at just 68% of revenue versus 70% last quarter an 72% last year, which helped the bottom line. This is a seasoned management team which knows which levers to pull.
Call comments suggesting billings softness will not be an ongoing issue. Ideally, we’ll also get hints all those FedRAMP approvals management touts are on the verge of winning new business. CEO Jay Chaudhry addressed billings right away by stating, “Billings were impacted by new customers being more deliberate about their large purchasing decisions at the start of the calendar year. These deals have not gone away, and we have closed a few already in February…In select instances, where timing of budgets was a hurdle for new customers, we enabled them to ramp into larger subscription commitments. These strategic deals lowered our first year billings but will go into of higher annual run rate level in the second year.” Along those same lines, the CFO said to expect a 9% decline in sequential billings for Q3 “with a little more conservatism related to our billings guidance than the past.” Working off the updated guide, that means billings growth would be ~27% YoY in Q4 with room to stabilize or even creep up a tick next year. That’s not the end of the world, but we’re not quite out of the woods yet either. I find I’m ultimately OK with it given the ramp arrangement. It’s tough to close deals for everyone right now, so I can’t penalize ZS for taking advantage of its cash flows and profits to give customers a temporary break while still landing the deal.
This is one of those quarters where I wish Jay Chaudhry could simply have Matthew Prince of Cloudflare or Jeff Green of The Trade Desk run the call for him. I see plenty of wins, no outright losses, and enough breadcrumbs to feel optimistic about the future. While others might use the result as a springboard to sell the vision and potential, Chaudhry immediately reverted to his technobabble comfort zone of ZIA’s, ZPA’s, ZDX’s and CISO’s. Compared to other reports this quarter, I’d grade this one a solid B. It’s too bad the market reacted more like it was a C-. Oh well. I’m comfortable holding tight to the shares we own.