Zscaler, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2020, three months ended October 31, 2019. The interim financial statements are unaudited. Zscaler provides cloud-based security subscriptions and related support, primarily through channel partners.
Key financial results
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Revenue | $93.6 million | $63.3 million | +48% |
| Gross profit / margin | $74.0 million / 79% | $51.2 million / 81% | Margin down 2 percentage points |
| Operating expenses | $92.3 million | $59.9 million | +54% |
| Loss from operations | $(18.3) million | $(8.7) million | Loss widened |
| Net loss | $(17.1) million | $(7.6) million | Loss widened |
| Operating cash flow | $21.4 million | $11.0 million | +$10.4 million |
| Free cash flow (non-GAAP) | $9.4 million | $5.2 million | +$4.2 million |
Cash, cash equivalents and short-term investments totaled $377.6 million at October 31, 2019. The company reported no debt in the presented balance sheet. Current liabilities included $218.2 million of deferred revenue; total deferred revenue was $245.9 million. Total liabilities were $322.2 million and stockholders’ equity was $314.1 million. Operating lease liabilities totaled $34.2 million after adoption of the new lease standard.
Changes and operating trends
- Revenue growth reflected expansion among existing customers and new customer additions. Dollar-based net retention was 120%, versus 118% a year earlier; management attributed $11.7 million of quarterly revenue to new customers.
- Subscription and support revenue represented approximately 99% of revenue. Channel partners generated 96% of revenue, and the top five partners and affiliates accounted for 40%.
- Cost of revenue grew 62%, faster than revenue, and gross margin fell from 81% to 79%. Management cited higher hosting and equipment costs, employee-related costs, stock compensation and acquired-intangible amortization.
- Sales and marketing expense rose 63%, research and development rose 54%, and general and administrative expense rose 25%. Stock-based compensation increased to $18.4 million from $7.6 million.
- Calculated billings, a non-GAAP measure, were $88.3 million, up 37% from $64.6 million. Management cautioned that billings growth is affected by seasonality and invoicing mix.
- Investing cash outflow was $33.6 million, including purchases of short-term investments and $12.0 million of capital expenditures and capitalized software. Cash decreased $9.1 million during the quarter.
Outlook, risks and unusual items
Management expects continued net losses for the foreseeable future while investing in sales and marketing, research and development, infrastructure and public-company requirements. It expects operating expenses to rise in absolute dollars; over the long term, it expects gross margin to remain relatively unchanged and expense ratios to decline, though results may fluctuate. The company stated that available cash, cash equivalents and short-term investments should fund operating and capital needs for at least 12 months. No specific quarterly or annual revenue or earnings guidance is provided in the filing.
- Litigation: Zscaler is vigorously defending two Symantec patent cases; certain asserted patent claims were dismissed, and rights in the patents were assigned to Broadcom subsidiary CA, Inc. Zscaler recorded no liability because it determined a loss was not probable, but says an adverse outcome could materially affect the business. The Finjan patent dispute was settled in April 2019 for $7.3 million, accrued across prior periods.
- Lease accounting: Topic 842 adoption on August 1, 2019 added lease right-of-use assets and liabilities; prior-period balance sheets are not comparable. The company also disclosed $20.2 million of future minimum payments for leases not yet commenced.
- Principal business risks: competition and customer adoption; service availability and cybersecurity; reliance on channel partners; customer renewal and expansion; international, privacy and regulatory requirements; and litigation. Management highlighted the seasonality of customer bookings, typically stronger in fiscal Q2 and Q4.
- Management concluded disclosure controls were effective at a reasonable assurance level as of October 31, 2019. The company implemented lease-accounting software and related controls during the quarter.
Investor verification points
- Track whether revenue growth and 120% net retention persist, and monitor customer additions and renewal trends.
- Assess whether gross margin stabilizes as hosting, infrastructure and compensation costs rise.
- Reconcile cash generation with deferred revenue movements, billing seasonality and capital investment; review the non-GAAP billings and free cash flow definitions.
- Monitor channel-partner dependence and concentration, particularly the share of revenue from the largest partners.
- Follow the Symantec litigation and any resulting change in the company’s loss assessment, legal costs or operating outlook.