Zscaler, Inc. — Fiscal 2020 Second-Quarter Form 10-Q
Reporting period: Three and six months ended January 31, 2020; filed March 4, 2020. Dollar amounts below are in millions unless stated otherwise. Comparisons are with the corresponding 2019 periods.
Business context
Zscaler sells subscriptions to its multi-tenant cloud security platform, primarily through channel partners. Subscription and support revenue is recognized over contract terms, generally one to three years. The company operates as one reportable segment.
Financial performance and liquidity
| Metric | Q2 FY2020 | Q2 FY2019 | Six months FY2020 | Six months FY2019 |
|---|---|---|---|---|
| Revenue | $101.3 | $74.3 | $194.9 | $137.6 |
| Revenue growth | 36% | — | 42% | — |
| Gross margin | 80% | 79% | 80% | 80% |
| Loss from operations | $(30.3) | $(5.2) | $(48.6) | $(13.8) |
| Net loss | $(29.2) | $(3.6) | $(46.2) | $(11.1) |
| Operating cash flow | $5.4 | $15.7 | $26.9 | $26.7 |
| Free cash flow (non-GAAP) | $(1.9) | $12.0 | $7.5 | $17.2 |
- Q2 diluted and basic net loss per share was $0.23, versus $0.03 a year earlier; six-month loss per share was $0.36 versus $0.09.
- At January 31, cash and cash equivalents were $76.5 and short-term investments were $308.4, totaling $384.9. Current assets were $523.1 and current liabilities were $303.7.
- No borrowings are reported on the balance sheet. Operating lease liabilities totaled $34.4, including $11.1 current and $23.3 noncurrent. Deferred revenue totaled $280.0.
- Six-month capital spending was $19.4, including $15.1 for property, equipment and other assets and $4.3 for capitalized internal-use software.
- Stock-based compensation was $42.2 for the six months, compared with $20.8 a year earlier. Accumulated deficit was $270.7.
Changes versus the prior comparable period
- Revenue increased 36% in the quarter and 42% for the half year. Management attributed growth to expansion among existing customers and new customer additions; the customer base increased 17% year over year.
- Dollar-based net retention was 116%, down from 118%. Management said existing-customer user growth and additional subscriptions contributed $14.0 in quarterly revenue growth and $36.2 for the six-month period.
- Gross margin rose one percentage point in the quarter to 80%, partly because of one-time costs in the prior-year quarter; the six-month margin remained 80%.
- Operating expenses grew faster than revenue. Q2 sales and marketing rose 59%, R&D rose 37%, and general and administrative expense rose 179%. The G&A increase included the litigation settlement described below.
- Six-month calculated billings, a company-defined non-GAAP measure, were $223.7, up 25%. Deferred revenue increased to $280.0 from $206.0 at January 31, 2019.
- Operating cash flow was nearly flat for the six-month comparison, while free cash flow declined to $7.5 from $17.2. Q2 free cash flow was negative, partly reflecting investment in property, equipment and internal-use software.
Outlook, commentary, risks and unusual items
- No specific quarterly or full-year financial guidance is provided in the supplied filing text. Management expects continued net losses and rising operating expenses in absolute dollars as it invests in sales and marketing, R&D, infrastructure and public-company operations. It expects long-term gross margin to remain relatively unchanged and believes existing cash, cash equivalents and investments can fund operations and capital needs for at least 12 months.
- Management reported $608.5 of remaining performance obligations, expecting to recognize 56% within 12 months and 98% within three years.
- In January 2020, Zscaler paid Broadcom $15.0 to settle the Symantec patent cases and obtain a patent license, release and covenant not to sue. The cases were dismissed with prejudice. The company expensed the payment in Q2 G&A because it determined the license had no material future economic benefit. Litigation-related expenses totaled $16.3 in Q2 and $18.3 for the six months.
- The company recorded a $0.3 asset impairment charge related to relocating its headquarters. Lease accounting was adopted on August 1, 2019, adding $16.9 of right-of-use assets and $18.0 of lease liabilities at adoption; prior-period balance sheets are not comparable on this basis.
- Management identifies continued operating losses, competition, customer adoption and renewal, dependence on channel partners, platform availability and security, rapid growth, and litigation as important risks. The filing also notes potential effects from COVID-19, including disruption to employees, customers, suppliers, travel and the global economy.
- As of January 31, the company had $20.5 of future minimum payments for operating leases not yet commenced, in addition to reported lease commitments. Total contractual obligations were $99.2, including lease arrangements and purchase obligations.
Important facts for investors to verify
- Whether revenue growth, customer additions and retention remain strong, and how the 116% net retention rate develops.
- Whether expense growth—particularly stock-based compensation and sales and marketing—translates into durable growth and improved operating margins.
- How much of reported operating cash flow depends on advance customer billings and deferred-revenue growth, and the trajectory of free cash flow after investment spending.
- Whether additional patent claims or other litigation create costs beyond the $15.0 Symantec settlement and the disclosed commitments.
- Whether channel-partner concentration, platform security and availability, and COVID-19-related disruption affect renewals, new sales or operating costs.
- Whether liquidity remains adequate as lease obligations, infrastructure investment and other contractual commitments come due.