Zscaler, Inc. — FY2020 Form 10-K
Reporting period: Fiscal year ended July 31, 2020. The filing also reports fourth-quarter results for the three months ended July 31, 2020. Amounts below are in U.S. dollars.
Business context
Zscaler sells subscriptions to its cloud security platform, primarily through channel partners. Its offerings include secure internet and SaaS access, private-application access, digital experience monitoring, and workload segmentation. Subscription and support services represented about 98% of FY2020 revenue, recognized ratably over contract terms typically lasting one to three years. At year-end, the company reported more than 4,500 customers and more than 450 Forbes Global 2000 customers.
Key financial metrics
| Metric | FY2020 | FY2019 |
|---|---|---|
| Revenue | $431.3 million | $302.8 million |
| Revenue growth | 42% | 59% |
| Gross profit / gross margin | $335.5 million / 78% | $243.2 million / 80% |
| Operating loss / operating margin | $114.0 million / (26%) | $35.3 million / (12%) |
| Net loss | $115.1 million | $28.7 million |
| Net loss per share, diluted | $0.89 | $0.23 |
| Cash from operations | $79.3 million | $58.0 million |
| Free cash flow (non-GAAP) | $27.5 million | $29.3 million |
| Calculated billings (non-GAAP) | $549.8 million | $390.0 million |
At July 31, 2020, cash, cash equivalents and short-term investments totaled $1.371 billion; working capital was $1.158 billion. Deferred revenue was $369.8 million, including $337.3 million current. The company reported $1.150 billion principal amount of 0.125% convertible notes due 2025, with a net carrying value of $861.6 million. The notes generated $5.0 million of FY2020 interest expense, mostly non-cash discount and issuance-cost amortization.
Changes versus the prior year
- Revenue grew 42%, down from 59% growth in FY2019. Management attributed the increase mainly to expansion within existing customers and new customer additions; dollar-based net retention was 120%, versus 118%.
- Gross margin fell two percentage points to 78%. The company cited higher costs from using public-cloud infrastructure to handle increased ZPA traffic as customers shifted to remote work, alongside higher data-center and equipment costs.
- Operating expenses rose to $449.5 million from $278.5 million. Sales and marketing increased 64%, R&D 58%, and general and administrative expense 58%.
- Net loss widened to $115.1 million from $28.7 million. Stock-based compensation increased to $121.4 million from $46.4 million and was a substantial expense component.
- Operating cash flow increased, but free cash flow declined, reflecting higher infrastructure investment and capitalized software costs.
- The company issued $1.150 billion of convertible notes and spent $145.2 million on capped calls intended to reduce potential conversion dilution. It acquired Cloudneeti and Edgewise for approximately $39.6 million net cash.
Outlook, commentary and risks
The filing provides no formal numeric revenue or earnings guidance. Management expects continued investment in sales and marketing, R&D, infrastructure and international expansion, and expects operating expenses to rise in absolute dollars. It expects net losses to continue for the foreseeable future, while stating that available liquidity should fund operating and capital needs for at least 12 months from issuance of the financial statements. Management expects gross margin to increase slightly over the long term, but notes that it may fluctuate.
Management reported no significant business disruption from COVID-19 through the filing date, but emphasized substantial uncertainty. Remote-work-driven ZPA traffic increased reliance on more expensive public-cloud capacity; prolonged use could pressure margins. Other principal risks include slower customer spending or renewals, lengthening sales cycles, intense competition, dependence on channel partners, service availability and security incidents, privacy and regulatory requirements, and the ability to manage rapid growth.
Unusual items: A $15.0 million payment to Broadcom in January 2020 settled the Symantec patent litigation and was expensed in general and administrative costs. FY2020 general and administrative expense also included $18.4 million of litigation-related expense and a $0.7 million facility impairment. The auditor issued an unqualified opinion on the financial statements and internal control; revenue recognition was identified as a critical audit matter.
Important facts for investors to verify
- Whether revenue growth, 120% dollar-based net retention and customer expansion persist as growth moderates.
- Whether gross margin recovers as public-cloud capacity costs and remote-work traffic evolve.
- The impact of substantial stock-based compensation on GAAP losses, dilution and future expense.
- Convertible-note conversion, cash-settlement and refinancing exposure, including the capped-call terms and counterparty risk.
- Cash generation after capital spending, deferred contract-acquisition costs and customer collections.
- Developments in COVID-19 effects, channel-partner concentration, cybersecurity and privacy risks, and any new litigation or contingencies.