Zscaler, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended April 30, 2023. Amounts are in U.S. dollars; financial statement figures below are in millions unless stated otherwise.
Business context
Zscaler sells subscriptions to its cloud security platform, primarily through channel partners. Subscription and support revenue, recognized over contract terms generally lasting one to three years, accounted for approximately 97% of revenue. Channel partners generated 92% of quarterly and year-to-date revenue.
Key financial metrics
| Metric | Three months ended April 30, 2023 | Nine months ended April 30, 2023 |
|---|---|---|
| Revenue | $418.8; up 46% year over year | $1,161.9; up 50% |
| Gross profit / gross margin | $323.0 / 77% | $901.8 / 78% |
| Operating loss / operating margin | $55.7 / (13)% | $190.1 / (16)% |
| Net loss / diluted loss per share | $46.0 / $0.32 | $171.7 / $1.19 |
| Operating cash flow | $108.5 | $326.4 |
| Free cash flow (non-GAAP) | $73.9; 18% margin | $232.3; 20% margin |
At April 30, cash and cash equivalents were $1,275.3 and short-term investments were $693.1, totaling $1,968.4. Current assets were $2,527.3 and current liabilities $1,289.1. Deferred revenue totaled $1,175.4. The company reported $1,149.993 million principal amount of 0.125% convertible notes due July 2025, with a balance-sheet carrying amount of $1,140.8 million. Accumulated deficit was $1,059.7.
Remaining performance obligations were $3,023.0; management expected to recognize 50% within 12 months and 94% within three years. Dollar-based net retention was above 125%. Calculated billings increased 40% in the quarter and 37% year to date, as defined by the company.
Material changes versus prior comparable periods
- Quarterly revenue rose $132.0 million, driven by $89.2 million in additional revenue from existing customers and users, with the remainder primarily from new customers. The reported customer base was 15% larger than a year earlier.
- Quarterly gross margin declined to 77% from 78%, primarily due to greater use of public cloud infrastructure to handle traffic. Year-to-date gross margin increased to 78% from 77%.
- Quarterly operating loss narrowed to $55.7 million from $86.6 million; year-to-date operating loss narrowed to $190.1 million from $244.9 million. Net losses also narrowed in both periods.
- Interest income increased substantially, while interest expense fell following adoption of ASU 2020-06, which eliminated amortization of the notes’ debt discount. The reported reduction in interest expense is an accounting change, not evidence of debt repayment.
- Year-to-date operating cash flow increased to $326.4 million from $218.8 million, supported in part by higher deferred revenue and substantial non-cash expenses, including stock-based compensation.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no specific numerical revenue or earnings guidance. Management expects operating losses to continue for the foreseeable future and operating expenses to rise in absolute dollars as it invests in sales and marketing, research and development, infrastructure and operations. It expects gross margin to increase slightly over the long term, while noting it may fluctuate.
- Demand conditions: Management reported increased customer scrutiny and longer approval cycles, especially for large transactions, amid inflation and economic uncertainty. It expects customer caution and elongated sales cycles to persist in the near term.
- Restructuring: A plan announced March 1 reduced worldwide headcount by approximately 3%. The company recorded $6.3 million of charges and expected approximately $0.7 million more in fiscal Q4, for estimated total charges of about $7.0 million.
- Acquisition: Zscaler acquired Canonic Security Technologies in February for approximately $16.5 million in cash. Certain acquired employees may receive stock-based deferred consideration subject to continued employment.
- Convertible debt accounting: Adoption of ASU 2020-06 increased the notes’ carrying amount by $169.9 million and reduced additional paid-in capital by $273.7 million, with a $103.8 million cumulative adjustment to accumulated deficit. The notes’ conversion conditions were not met during the reported periods.
- Liquidity and risks: Management stated existing cash, cash equivalents and short-term investments should fund operations and capital needs for at least 12 months. Key risks include ongoing losses, competition, customer adoption and renewals, longer sales cycles, cloud-platform availability and cybersecurity, reliance on channel partners, macroeconomic conditions, and servicing or settling the 2025 notes. The company reported no pending or threatened legal proceeding it believed likely to have a material adverse effect, while noting litigation outcomes are inherently unpredictable.
Investor verification priorities
- Track revenue growth, calculated billings, remaining performance obligations and their conversion into recognized revenue; these measures can be affected by advance billing and seasonality.
- Assess whether customer expansion and retention remain strong as purchasing approvals lengthen; verify the basis and trend of the reported net retention rate above 125%.
- Monitor cloud infrastructure costs and gross margin, particularly public-cloud usage and data-center investment.
- Evaluate cash generation alongside stock-based compensation, capitalized contract acquisition costs and capital expenditures; free cash flow is a non-GAAP measure.
- Review the $1.15 billion notes’ maturity, conversion and settlement terms, potential dilution and the impact of the accounting-standard adoption.
- Check whether restructuring costs stay near the estimated $7.0 million and whether the Canonic acquisition delivers the expected technology integration and benefits.