Zscaler, Inc. — Q3 FY2022 Form 10-Q
Reporting period: Three and nine months ended April 30, 2022. The quarter was the third quarter of Zscaler’s fiscal year, which ends July 31. Financial statements are unaudited.
Business context
Zscaler sells subscriptions to its cloud security platform and related support, primarily through channel partners. Subscription and support revenue represented approximately 97% of revenue; contracts generally run one to three years, with revenue recognized over the contract term.
Financial and operating results
| Metric | Q3 FY2022 | Q3 FY2021 | Nine months FY2022 | Nine months FY2021 |
|---|---|---|---|---|
| Revenue | $286.8 million | $176.4 million | $772.9 million | $476.0 million |
| Revenue growth | 63% | — | 62% | — |
| Gross margin, GAAP | 78% | 78% | 77% | 78% |
| Operating loss | $86.6 million | $43.9 million | $244.9 million | $140.4 million |
| Net loss | $101.4 million | $58.5 million | $292.6 million | $181.0 million |
| Operating cash flow | $77.2 million | $73.4 million | $218.8 million | $157.3 million |
| Free cash flow, non-GAAP | $43.7 million | $55.8 million | $156.6 million | $116.0 million |
Quarterly GAAP operating margin was negative 30%, versus negative 25% a year earlier. Q3 non-GAAP operating income was $27.2 million, compared with $22.9 million; non-GAAP operating margin declined to 9% from 13%. Q3 calculated billings, a non-GAAP measure, were $345.6 million, up 54% year over year. Dollar-based net retention was above 125% for the trailing 12 months ended April 30, 2022.
Liquidity and debt: At April 30, cash, cash equivalents and short-term investments totaled $1.658 billion. Current assets were $2.047 billion and current liabilities were $912.6 million. Convertible notes had $1.150 billion principal outstanding and a $954.6 million net carrying amount; their stated coupon is 0.125% and maturity is July 1, 2025. The notes’ disclosed fair value was $1.747 billion.
For the nine months, deferred revenue increased to $818.7 million from $630.6 million at July 31, 2021. Remaining performance obligations were $2.216 billion; management expected to recognize 49% within 12 months and 96% within three years. Stock-based compensation expense was $105.9 million in Q3 and $294.7 million for the nine-month period.
Material changes and management commentary
- Revenue rose primarily from expanding usage and additional subscriptions with existing customers; existing-customer expansion contributed $64.7 million of the quarterly increase. The customer base was 23% larger than at April 30, 2021.
- Operating expenses grew faster than revenue in several areas: Q3 sales and marketing increased 66%, research and development 87%, and general and administrative 65%. Management cited higher headcount, compensation and stock-based compensation, as well as increased sales commissions and platform development spending.
- Management expects continued operating losses in the foreseeable future while investing in sales and marketing, research and development, infrastructure and growth. It expects gross margin to increase slightly over the long term, but near-term margins and results may fluctuate.
- Management stated existing cash, cash equivalents and investments should fund operating and capital needs for at least 12 months from issuance of the financial statements. It also cautioned that growth, investment, acquisitions, economic conditions and other factors could increase capital needs.
Risks, contingencies and unusual items
- The notes’ conversion condition was triggered. Holders could convert all or part of the notes from May 1 through July 29, 2022; cash settlement could affect liquidity. Conversion notices received through April 30 were not material.
- On June 7, 2022, Zscaler signed an agreement to acquire an early-stage technology company for approximately $44 million: approximately $26 million in cash and $18 million in shares subject to vesting and performance conditions. Initial purchase accounting was incomplete.
- Non-cancelable purchase and co-location/bandwidth commitments totaled $284.1 million, including $162.7 million due within one year. The filing also disclosed $2.8 million in standby letters of credit.
- Management cited risks including intense competition, customer adoption and renewal, channel-partner reliance, cybersecurity and service availability, hiring and retention, inflation and economic uncertainty, COVID-19, and geopolitical developments including the Russia-Ukraine crisis. No pending or threatened legal proceeding was identified as likely, in management’s opinion, to have a material adverse effect, though litigation outcomes are inherently uncertain.
- The company reported an accumulated deficit of $894.2 million and stated it had incurred losses since inception. It maintained valuation allowances on U.S. federal, state and U.K. deferred tax assets.
Most important facts for investors to verify
- Whether revenue growth, calculated billings and retention remain strong, and how much growth comes from existing-customer expansion versus new customers.
- Whether operating expense growth and stock-based compensation moderate relative to revenue, and whether GAAP losses narrow.
- How much free cash flow is supported by advance customer billings and deferred revenue, and whether cash conversion remains durable.
- Whether holders convert the notes and how any conversion or settlement affects cash, share count and liquidity.
- The closing, consideration and integration of the announced $44 million acquisition, plus the company’s continuing purchase and infrastructure commitments.
- Whether platform security, availability, channel relationships and customer renewals withstand the competitive and macroeconomic risks described in the filing.