Zscaler, Inc. — Q3 Fiscal 2021 Form 10-Q
Reporting period: Quarter and nine months ended April 30, 2021. The interim financial statements are unaudited. Zscaler provides cloud-delivered security subscriptions and related support services; subscriptions generally run one to three years and revenue is recognized over the contract term.
Financial performance
| Metric | Q3 FY2021 | Q3 FY2020 | Nine months FY2021 | Nine months FY2020 |
|---|---|---|---|---|
| Revenue | $176.4 million | $110.5 million | $476.0 million | $305.4 million |
| GAAP gross margin | 78% | 78% | 78% | 79% |
| Loss from operations | $(43.9) million | $(20.5) million | $(140.4) million | $(69.1) million |
| Net loss | $(58.5) million | $(19.3) million | $(181.0) million | $(65.6) million |
| Net loss per share, diluted | $(0.43) | $(0.15) | $(1.34) | $(0.51) |
Q3 revenue grew 60% year over year; nine-month revenue grew 56%. Management attributed growth to customer additions and expansion, with the customer base up 21% year over year and dollar-based net retention at 126%, versus 119% a year earlier. Subscription and support revenue represented approximately 97% of revenue. Channel partners generated 94% of Q3 revenue.
Q3 GAAP operating expenses were $181.3 million, up 70% year over year. Sales and marketing rose 71%, research and development 70%, and general and administrative 68%. Stock-based compensation expense was $60.0 million for the quarter and $178.5 million for the nine months. Non-GAAP operating income was $22.9 million for Q3 and $57.3 million for the nine months; these non-GAAP measures exclude specified items, including stock-based compensation.
Cash, liquidity and debt
- Cash, cash equivalents and short-term investments totaled $1.468 billion at April 30, 2021, compared with $1.371 billion at July 31, 2020. Cash and cash equivalents alone were $106.6 million.
- Nine-month operating cash flow was $157.3 million, versus $47.7 million a year earlier. Free cash flow, a non-GAAP measure, was $116.0 million, versus $16.6 million.
- Investing cash flow was $(212.8) million, including $29.4 million paid net of acquired cash for Trustdome and substantial purchases of short-term investments. Cash, cash equivalents and restricted cash declined $35.3 million during the nine months.
- Deferred revenue was $495.4 million. Remaining performance obligations were $1.208 billion; the company expected to recognize 51% within 12 months and 98% within three years.
- The company had $1.150 billion principal amount of unsecured 0.125% convertible senior notes due 2025. Their net carrying amount was $900.3 million and disclosed fair value was $1.587 billion. Management stated its current intent to settle principal in cash. The notes have no financial covenants.
- Management said available cash, cash equivalents and short-term investments were sufficient for expected operating and capital needs for at least the next 12 months.
Material changes and unusual items
- Revenue growth was accompanied by higher operating losses. Nine-month GAAP gross margin declined one percentage point, to 78%; management cited increased use of more expensive public-cloud infrastructure to handle ZPA traffic, as well as stock compensation and acquired-intangible amortization.
- Interest expense was $39.7 million for the nine months, primarily non-cash amortization of the notes’ debt discount and issuance costs. This expense was not present in the prior-year period.
- In April, Zscaler acquired Trustdome for approximately $31.1 million in cash, recording $23.2 million of goodwill and $7.2 million of developed technology. In June 2021, after quarter-end, it acquired Smokescreen for approximately $11.5 million in cash.
- Foreign-currency forward hedging began during the fiscal year. Management reported the hedges effective and their period impact not material.
- The prior-year nine-month period included a $15.0 million Broadcom patent-litigation settlement expense. No pending or threatened proceeding was identified as likely to materially adversely affect future results, though litigation outcomes remain uncertain.
Outlook, commentary and risks
The filing provides no specific numerical revenue or earnings guidance. Management expects operating expenses to increase in absolute dollars as it invests in sales and marketing, research and development, infrastructure and public-company compliance. It expects continued net losses for the foreseeable future, while anticipating gross margin to increase slightly over the long term. Management noted calculated billings growth may trend down over time and may fluctuate with seasonality and invoice timing.
COVID-19 had not caused significant business disruption to date, but its future effects remained uncertain. Principal risks include sustained losses and the ability to achieve profitability; competition and customer adoption, renewal and expansion; service availability and cybersecurity; reliance on channel partners; execution of rapid growth and acquisitions; regulatory, privacy and litigation exposure; and servicing or settling the convertible notes. The filing also warns that note conversions, if triggered, could require cash settlement and affect liquidity. A hypothetical 100-basis-point interest-rate change would have changed the fair value of short-term investments by $8.2 million.
Important facts for investors to verify
- Whether revenue growth, retention and billings trends persist, and whether customer expansion offsets acquisition and renewal risks.
- How much of operating cash flow and free cash flow depends on advance customer billings, and how deferred revenue converts to recognized revenue.
- The scale and potential dilution implications of stock-based compensation, outstanding equity awards and convertible notes; confirm the company’s expected cash settlement approach.
- Whether public-cloud infrastructure costs, hiring and other growth investments improve margins over time, and whether the Trustdome and Smokescreen acquisitions deliver expected benefits.
- Monitor channel-partner dependence, cybersecurity and service-continuity risks, and any material developments in litigation or regulatory matters.