Zscaler, Inc. — Form 10-Q Summary
Reporting period: Fiscal first quarter ended October 31, 2020; comparisons are to the three months ended October 31, 2019 unless otherwise noted. Financial statements are unaudited. Zscaler provides cloud security subscriptions and related support through a SaaS model.
Financial performance
| Metric | Q1 FY2021 | Q1 FY2020 | Change |
|---|---|---|---|
| Revenue | $142.6 million | $93.6 million | Up 52% |
| Gross profit / gross margin | $110.9 million / 78% | $74.0 million / 79% | Margin down 1 percentage point |
| Operating expenses | $153.5 million | $92.3 million | Up 66% |
| Loss from operations | $(42.7) million | $(18.3) million | Loss widened |
| Net loss | $(55.0) million | $(17.1) million | Loss widened |
| Net loss per share, diluted | $(0.41) | $(0.13) | — |
| Operating cash flow | $53.5 million | $21.4 million | Increased |
| Free cash flow (non-GAAP) | $42.2 million | $9.4 million | Margin: 30% vs. 10% |
Revenue growth reflected increased usage and additional subscriptions from existing customers, contributing $26.8 million, and new-customer growth; the company reported its customer base grew 18% year over year. Dollar-based net retention was 122%, compared with 120% in the prior-year trailing 12-month period. Calculated billings, a non-GAAP measure, were $144.7 million, up 64% year over year.
Stock-based compensation was $57.2 million, compared with $18.4 million. Interest expense was $13.0 million, largely from noncash amortization of the convertible notes’ discount and issuance costs; there was no comparable expense in the prior-year quarter. The company reported non-GAAP operating income of $19.7 million and a 14% non-GAAP operating margin, versus $3.7 million and 4%, respectively; these measures exclude specified expenses and should be considered alongside GAAP results.
Balance sheet, debt and liquidity
- At October 31, 2020, cash and cash equivalents were $102.0 million and short-term investments were $1.314 billion, totaling $1.416 billion in cash, cash equivalents and short-term investments.
- Total current assets were $1.580 billion and current liabilities were $416.5 million. Deferred revenue totaled $371.9 million, including $340.0 million current.
- The company had $1.150 billion principal amount of 0.125% convertible senior notes due 2025. Their net carrying amount was $874.4 million; disclosed fair value was $1.339 billion. Management stated its current intent is to settle principal in cash. Capped calls, purchased for $145.2 million, are intended to reduce potential dilution or cash settlement above principal, subject to a cap.
- Operating cash flow was $53.5 million; investing cash use was $97.9 million, primarily reflecting purchases of short-term investments, partly offset by maturities and sales. Financing cash inflow was $4.5 million, primarily from stock-option exercises. Cash and cash equivalents declined by $39.8 million during the quarter.
- Management believed existing cash, cash equivalents and short-term investments were sufficient for operating and capital needs for at least 12 months from issuance of the financial statements. Accumulated deficit was $394.6 million.
Material changes and management commentary
- Cost of revenue rose 62%, faster than revenue growth, and gross margin declined to 78% from 79%. Management attributed pressure partly to greater use of more expensive public-cloud infrastructure to handle increased ZPA traffic as customers’ employees worked remotely, as well as higher stock compensation and acquired-intangible amortization.
- Sales and marketing expense increased 63%, research and development 76%, and general and administrative expense 65%, reflecting primarily higher employee-related costs and headcount investments. Travel and marketing expenses were lower in part due to COVID-19-related changes.
- Operating cash flow benefited from collections and noncash charges, including stock-based compensation and debt-discount amortization; deferred contract acquisition costs increased as commissions rose with new and expanded subscriptions.
- Subscription and support revenue represented approximately 97% of revenue. Channel partners generated 94% of revenue, compared with 96% a year earlier. No single customer generated at least 10% of revenue.
Outlook, risks and contingencies
The filing provides no numerical financial guidance. Management expects operating expenses to continue increasing in absolute dollars as it invests in sales and marketing, research and development, infrastructure and public-company requirements. It expects ongoing losses for the foreseeable future, while anticipating modest long-term gross-margin improvement; actual results may fluctuate.
Management reported no significant business disruption from COVID-19 to date, but said its effects on sales cycles, customer spending, collections, operations and the broader economy remained uncertain. Increased reliance on public-cloud infrastructure could continue to pressure margins. Other highlighted risks include competition, dependence on channel partners, service availability and cybersecurity, customer renewals and adoption, international and regulatory exposure, and the company’s ability to achieve profitability.
The company reported no pending or threatened legal proceeding that it believed likely to have a material adverse effect, while noting that litigation outcomes and costs are unpredictable. It reported no material change to contractual commitments outside the ordinary course of business. Disclosure controls and procedures were assessed as effective at the reasonable-assurance level as of October 31, 2020.
Important facts for investors to verify
- Whether revenue growth and 122% dollar-based net retention continue, and how much growth comes from existing-customer expansion versus new customers.
- Whether public-cloud infrastructure costs and other delivery expenses stabilize, and whether gross margin recovers.
- How operating-expense growth, especially stock-based compensation, compares with revenue growth and affects the path to profitability.
- Whether operating cash flow and free cash flow remain supported by collections, advance billings and noncash expenses.
- The potential cash, dilution and accounting effects of the 2025 convertible notes, including conversion conditions and capped-call coverage.
- How COVID-19, channel-partner concentration, competition, cybersecurity and customer renewal trends affect demand and execution.