Zscaler, Inc. quarterly report, Q1 FY2019

Zscaler, Inc. — Form 10-Q Summary

Reporting period: Fiscal first quarter ended October 31, 2018. Comparative figures are for the three months ended October 31, 2017, unless otherwise noted. Financial statements are unaudited. Zscaler provides cloud-based security subscriptions and related support services, primarily through channel partners.

Key financial results

Revenue growth reflected $12.6 million from new customers, with the remainder attributed to expansion in existing accounts. Dollar-based net retention was 118%, compared with 116% for the trailing 12 months ended October 31, 2017. Calculated billings increased 56% to $64.6 million. Subscription and support revenue represented approximately 99% of revenue. Channel partners generated 95% of quarterly revenue.

Financial position and liquidity

At October 31, 2018, cash and cash equivalents were $42.8 million and short-term investments were $271.3 million, totaling approximately $314.0 million in cash, cash equivalents and short-term investments. Total current assets were $391.6 million; current liabilities were $183.9 million. Deferred revenue totaled $165.3 million, including $144.5 million current. Remaining performance obligations were $411.2 million; the company expected to recognize 54% over the following 12 months and 97% over the following three years.

The filing reports no debt balance. Operating cash flow was positive, while investing activities used $115.3 million, primarily reflecting purchases of short-term investments. Cash, cash equivalents and restricted cash declined $92.9 million during the quarter, but cash and short-term investments together increased from approximately $298.5 million at July 31 to $314.0 million. Capital expenditures and capitalized internal-use software totaled $5.8 million; reported free cash flow is a non-GAAP measure.

Material changes and notable items

• Revenue grew 59% year over year; gross margin rose from 79% to 81% as revenue growth and technology and infrastructure efficiencies outpaced higher platform costs.
• Operating expenses increased to $59.9 million from $42.9 million, including higher sales and marketing, research and development, and general and administrative costs. Stock-based compensation rose to $7.6 million from $1.7 million.
• The company recorded $2.2 million of litigation-related expenses in the quarter. It accrued $3.2 million in total related to past Finjan negotiations; the possible loss range in the Finjan lawsuit was not reasonably estimable. Zscaler recorded no liability for the Symantec cases because management concluded a loss was not probable.
• The company acquired developed technology, recording $1.5 million of cash payments for acquired intangible assets and $0.1 million of amortization expense.
• In August 2018, Zscaler adopted accounting guidance for nonemployee share-based payments, recording a $0.3 million cumulative-effect adjustment within equity. The filing also reports early adoption of guidance on cloud-computing implementation costs, with no material impact.

Outlook, commentary and risks

The filing provides no specific numerical revenue or earnings guidance. Management expects operating losses to continue for the foreseeable future while investing in sales and marketing, research and development, platform capacity, and public-company infrastructure. It expects gross profit to increase in absolute dollars and gross margin to remain relatively unchanged over the long term, while operating expenses are expected to rise in absolute dollars. Management stated that 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.

Key risks include the company’s continuing losses and uncertain path to profitability; competition and adoption of cloud security; dependence on channel partners; customer renewals and expansion; service availability and cybersecurity; and intellectual-property litigation. The filing also highlights seasonality in bookings, exposure to international regulation and currency movements, and the risk that growth-related hiring and spending may not produce expected returns. Management reported effective disclosure controls as of October 31, 2018 and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

• Whether revenue growth, 118% net retention and billings growth persist, and how much growth comes from new customers versus existing-account expansion.
• Whether positive operating cash flow and free cash flow are sustainable, given deferred revenue, working-capital movements and capital needs.
• The company’s continued reliance on channel partners, which generated 95% of quarterly revenue; the top five channel partners and affiliates represented 45%.
• Developments and potential financial exposure in the Symantec and Finjan litigation, including the existing $3.2 million Finjan-related accrual.
• The impact of stock-based compensation and equity awards on future expenses and shareholder dilution; unrecognized stock-based compensation cost was $148.6 million at quarter-end.
• Whether the company can execute its growth investments while managing ongoing losses, and whether its stated liquidity runway remains adequate.