Zscaler, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter ended April 30, 2019; comparisons are with the same periods in 2018 unless noted. Amounts are in U.S. dollars.
Business context
Zscaler provides cloud-based security through a subscription software-as-a-service platform. Subscription and support services generated approximately 99% of revenue. The company generally recognizes subscription revenue over contracts lasting one to three years and sells primarily through channel partners.
Financial results and liquidity
| Metric | Three months ended April 30, 2019 | Nine months ended April 30, 2019 |
|---|---|---|
| Revenue | $79.1 million; up 61% | $216.7 million; up 62% |
| Gross profit / margin | $64.2 million / 81% | $174.4 million / 80% |
| Operating loss | $13.5 million | $27.4 million |
| Net loss | $12.2 million | $23.4 million |
| Operating cash flow | $13.5 million | $40.2 million |
| Free cash flow | $4.6 million | $21.8 million |
Quarterly net loss increased from $8.8 million a year earlier, while the nine-month net loss narrowed from $26.7 million. Nine-month free cash flow improved from negative $9.8 million in 2018. Results include significant stock-based compensation: $13.3 million for the quarter and $34.1 million year to date. Management’s non-GAAP operating measure was income of $6.1 million for the quarter and $17.2 million year to date; this excludes stock compensation, certain litigation expenses and acquired-intangible amortization.
At April 30, cash and cash equivalents were $55.0 million and short-term investments were $297.8 million, totaling $352.7 million. Current assets were $456.0 million versus current liabilities of $221.6 million. Deferred revenue totaled $211.5 million. The balance sheet reports no debt line item. Accumulated deficit was $219.2 million. The company said available cash, cash equivalents and investments should fund operations and capital needs for at least 12 months.
Other operating indicators: calculated billings were $84.7 million for the quarter, up 55%, and $264.2 million for nine months, up 63%. Dollar-based net retention was 118%, compared with 120% for the trailing year ended April 30, 2018. Remaining performance obligations were $497.1 million; management expected to recognize 54% within 12 months and 97% within three years.
Material changes and unusual items
- Revenue growth reflected new customers as well as expansion among existing customers. For the quarter, new customers contributed $13.2 million of the increase; for nine months, they contributed $27.4 million.
- Operating expenses continued to rise with hiring and investment. For the quarter, sales and marketing increased 52%, research and development 67%, and general and administrative 77% year over year.
- The quarter included a $7.3 million payment to settle Finjan patent litigation and obtain a portfolio license. The company recorded $4.1 million of incremental general and administrative expense, concluding the license provided no material future economic benefit.
- In April, Zscaler entered a San Jose headquarters sublease covering approximately 172,000 square feet, with stated base rent of approximately $39.1 million over the initial term through September 2026. Occupancy is phased; a $2.8 million letter of credit was required.
- After quarter-end, in May 2019, the company acquired browser-isolation company Appsulate for approximately $13.0 million; initial purchase accounting was still in progress.
- Investing cash outflow of $153.7 million for nine months primarily reflected purchases of short-term investments, net of maturities, and capital expenditures. This largely represents investment reallocation rather than operating cash consumption.
Outlook, commentary and risks
No specific numerical revenue or earnings guidance is provided in the supplied filing text. Management expects continued net losses for the foreseeable future while investing in sales and marketing, research and development, infrastructure, and public-company compliance. It expects gross margin to remain relatively unchanged over the long term, while noting period-to-period variability. Management also expects calculated-billings growth rates to trend down over time and notes that billings are affected by seasonality and invoice timing.
Key risks include intense competition, uncertain adoption of cloud security, dependence on channel partners, retention and expansion of customers, service availability and cybersecurity, and the ability to manage rapid growth. Symantec patent litigation remained unresolved; the company said it was vigorously defending the cases, had recorded no liability because loss was not considered probable, and could not predict the outcome. The filing also describes regulatory and privacy risks, international exposure, and contractual commitments for leases and data-center capacity.
Most important facts for investors to verify
- Whether revenue growth, calculated billings and customer expansion remain durable, particularly given retention of 118% versus 120% a year earlier.
- How operating expenses, stock-based compensation and litigation costs affect the path to GAAP profitability and cash generation.
- Whether operating cash flow remains supported by advance customer billings and how deferred revenue converts to recognized revenue.
- The outcome and potential financial exposure from Symantec litigation, and the effects of the Finjan settlement and Appsulate acquisition.
- The costs and occupancy schedule for the new headquarters, data-center commitments, and continued adequacy of liquidity under management’s 12-month assessment.