Shares of Zscaler (ZS) are attempting to rebound after tumbling 40% from the 52-week high of $259.61 reached in early February to a low of $155.25 on May 30. Recently trading around $177.30, the stock has rallied 14% from this low, but is still off 20% YTD.
Sentiment in late May going into Zscaler’s fiscal Q3 (April) earnings report was fairly dour. Amid ongoing customer scrutiny of spending on large deals and threats of increasing competition, the cybersecurity solutions vendor earlier this year went through a go-to-market shakeup after its COO departed for competitor Wiz Security and took some sales reps with him.
Despite these headwinds, Zscaler delivered positive results for the April quarter. Total revenue rose 32% to $553.2 million, topping the consensus estimate by 3.2%. The company handily outperformed on the key billings metric. After guiding to $583.7 million (down 7% sequentially), Zscaler reported billings of $628 million, up 30% year over year and flat on a sequential basis.
In FQ3, gross margin of 81.4% rose 120 basis points year over year. Operating margin was a record 22%. Free cash flow margin hit 22%. EPS of 88 cents beat the consensus by 33 cents. Total RPO of $3.824 billion went up against a tough year-over-year comp, but still rose 27%. Dollar-based net retention ticked down slightly to 116% from 117% in FQ2.
Zscaler continues to expand its enterprise customer base. There are 2,922 customers with total annual recurring revenue (ARR) above $100k, up 20% from the year-ago level. There are 523 customers with ARR over $1 million, up 31%. Zscaler now has more than 50 customers with ARR above $5 million.
Despite elevated attrition across the sales force in the April quarter, Zscaler still managed exceptional execution under the new head of sales, Mike Rich, who joined the company last November from ServiceNow (NOW), where he was president of Americas sales. In FQ3, Rich hired important sales leaders and now has a full management team in place. Rich has since shifted the focus to increasing the pace of hires across core quota-carrying reps.
As one of the major players in the security space, Zscaler can easily attract top sales talent. In May, it hired about the same number of reps as in the entire April quarter. Management cautioned that it would take some time for these new reps to ramp to full productivity (normally about nine to 12 months). Without giving formal guidance for FY’25 (July), Zscaler CFO Remo Canessa on the FQ3 call said these new hires would pressure billings growth next year by “a few points.”
In FQ3, Zscaler closed a number of large strategic deals, some of which entailed replacing legacy solutions as part of a broad vendor consolidation plan. It secured a new logo win with a major financial services firm that bought ZIA, ZDX and Data Protection for 25,000 users in a 7-figure annual contract value (ACV) multi-year transaction. The company won this deal thanks to its superior architecture and strong data protection capabilities.
A global 100 financial services customer significantly expanded its Zscaler engagement, signing a 7-figure ACV deal covering more than 64,000 users. Even though it had a long-standing relationship with a legacy firewall vendor, this customer decided to consolidate multiple point solutions with Zscaler. In addition, a large financial services customer based in Asia bought most of Zscaler’s platform services as part of a 7-figure ACV multi-year deal covering 10,000 users.
It’s encouraging that Zscaler in FQ3 saw significant deal wins across its various emerging products—including ZDX (now with its own AI Copilot), Zscaler for Workloads, AI Cloud solutions and Zero Trust for Branch. These newer offerings contributed nearly 25% of all new and upsell business in the quarter. In an 8-figure ACV deal that included multiple emerging products, a Fortune 500 tech customer upped its total ARR by over 5x to more than $10 million.
For FY’24 (July), Zscaler now expects total revenue growth of 32%, up 100 basis points from the previous forecast, with billings growth of 28% versus 25% to 26% previously. The market is already looking ahead to FY’25. There is some trepidation about how the company will guide for next year, especially given the ongoing go-to-market disruption. This appears to be the primary reason why Zscaler stock hasn’t rallied more since the release of FQ3 results.
On Wall Street, there are now a number of bullish price targets clustered in the $200 to $220 range. BMO Capital recently raised its target to $208 from $192, saying it was impressed with Zscaler’s growing revenue diversification, which will help support durable growth through upsell, cross-sell and larger landing deals. Barclays raised its target to $210 from $205, calling out the FQ3 billings outperformance.
Last week, JP Morgan upgraded Zscaler to ‘Overweight’ with a target of $230, saying the company is exposed to the largest security market as a best-of-breed Zero Trust network security vendor founded on next-generation and cloud-centric architecture. The firm believes Zscaler is well-positioned to inflect to better growth in the second half of FY’25, as the company’s scale and architecture position it well to compete with emerging peers in what’s now a $96 billion serviceable addressable market.
