Zscaler, Inc. — Q3 FY2020 Form 10-Q
Reporting period: Three and nine months ended April 30, 2020. Financial statements are unaudited. Zscaler provides cloud security subscriptions and related support on a SaaS basis; subscription and support represented about 98% of revenue. Amounts below are in U.S. dollars.
Financial results
| Metric | Three months ended Apr. 30, 2020 | Year-over-year change | Nine months ended Apr. 30, 2020 | Year-over-year change |
|---|---|---|---|---|
| Revenue | $110.5 million | +40% | $305.4 million | +41% |
| Gross profit / margin | $85.9 million / 78% | Margin down from 81% | $241.0 million / 79% | Margin down from 80% |
| Operating expenses | $106.5 million | +37% | $310.1 million | +54% |
| Operating loss | $20.5 million | Prior-year loss: $13.5 million | $69.1 million | Prior-year loss: $27.4 million |
| Net loss | $19.3 million; $0.15 per share | Prior-year loss: $12.2 million; $0.10 per share | $65.6 million; $0.51 per share | Prior-year loss: $23.4 million; $0.19 per share |
| Operating cash flow | $20.8 million | Prior-year: $13.5 million | $47.7 million | Prior-year: $40.2 million |
| Free cash flow, non-GAAP | $9.1 million | Prior-year: $4.6 million | $16.6 million | Prior-year: $21.8 million |
Balance sheet and liquidity: At April 30, 2020, cash and cash equivalents were $124.6 million and short-term investments were $266.7 million, totaling $391.3 million of liquidity. Current assets were $552.1 million and current liabilities $345.6 million. Deferred revenue was $300.8 million, including $274.7 million current. The filing reports no borrowings or financial debt on the balance sheet; operating lease liabilities totaled $40.8 million. Accumulated deficit was $290.0 million.
Changes and operating indicators
- Revenue growth reflected expansion among existing customers and new customer additions. Dollar-based net retention was 119%, compared with 118% in the prior-year trailing period; the customer base grew 16% year over year.
- Gross margin fell as increased work-from-home use drove higher ZPA traffic and greater reliance on public cloud infrastructure, which management said costs more than its own data centers.
- Sales and marketing expense rose 50% in the quarter and 57% year to date, largely with headcount and related compensation growth. Research and development expense rose 46% and 45%, respectively. Stock-based compensation was $27.8 million for the quarter and $70.0 million year to date.
- Year-to-date operating cash flow increased, supported in part by a $49.6 million rise in deferred revenue and noncash expenses, including stock compensation. Free cash flow declined, reflecting higher capital expenditures and capitalized software spending.
- Calculated billings, a non-GAAP measure, were $131.3 million for the quarter, up 55%, and $355.0 million year to date, up 34%. Remaining performance obligations were $653.5 million; the company expected to recognize 56% within 12 months and 98% within three years.
Outlook, risks, and unusual items
- No specific numerical revenue or earnings guidance is provided in the supplied filing text. Management expects operating expenses to increase in absolute dollars and continued net losses for the foreseeable future, while investing in sales and marketing, research and development, infrastructure, and growth. It expects gross margin to remain relatively unchanged over the long term, subject to period-to-period fluctuations.
- Management said it had not experienced significant business disruption from COVID-19 by the filing date, but could not predict the pandemic’s full impact. Remote work and increased ZPA traffic had already raised public-cloud costs. Risks cited include weaker customer spending, longer sales cycles, renewals or collections, and disruption to customers, partners, vendors, and operations.
- The company paid $15.0 million in January 2020 to settle the Symantec patent litigation and obtain patent licenses; it recorded the amount as general and administrative expense. The cases were dismissed with prejudice. The filing also describes other ordinary-course litigation and claims, whose outcomes are inherently uncertain.
- Cloudneeti was acquired in April for approximately $8.9 million in cash, with up to $6.0 million of employee RSUs subject to vesting conditions. In May, after quarter-end, Zscaler acquired Edgewise Networks for approximately $31.0 million in cash; initial purchase accounting was still in progress.
- Management stated existing cash, cash equivalents, and short-term investments should fund operating and capital needs for at least 12 months from issuance of the financial statements, while noting that actual needs depend on growth, investment plans, acquisitions, and COVID-19 effects. Contractual obligations were $100.6 million, including lease commitments; an additional $17.5 million of undiscounted payments for leases not yet commenced was excluded from the lease maturity table.
Important facts for investors to verify
- Whether revenue growth, customer expansion, and the 119% retention rate persist, and how much growth depends on channel partners (97% of quarterly revenue came through channel partners).
- Whether work-from-home-related public-cloud costs continue to pressure gross margin, and whether infrastructure investment produces expected efficiency gains.
- The composition and sustainability of operating cash flow and billings growth, particularly the contribution from advance invoicing and deferred revenue; assess free cash flow alongside capital spending and contract acquisition costs.
- The earnings and dilution effects of stock-based compensation, which totaled $70.0 million year to date, and the $278.1 million of unrecognized compensation cost disclosed at quarter-end.
- The integration, cash use, and eventual purchase accounting for Cloudneeti and Edgewise, as well as any material developments in litigation or other contingencies.