Zscaler, Inc. — Form 10-Q Summary
Reporting period: Fiscal third quarter and nine months ended April 30, 2018. The filing is unaudited. Zscaler provides cloud-based security services through subscriptions, primarily under one- to three-year contracts. It completed its IPO in March 2018.
Financial performance and liquidity
| Metric | Q3 FY2018 | Q3 FY2017 | Nine months FY2018 | Nine months FY2017 |
|---|---|---|---|---|
| Revenue | $49.2 million | $33.0 million | $134.0 million | $89.2 million |
| Gross margin | 81% | 79% | 80% | 78% |
| Operating loss | $9.0 million | $7.6 million | $26.7 million | $22.0 million |
| Net loss | $8.8 million | $7.6 million | $26.7 million | $22.2 million |
| Operating cash flow | $8.1 million | $0.2 million | $2.6 million | $(2.3) million |
| Free cash flow (non-GAAP) | $3.7 million | $(1.8) million | $(9.8) million | $(8.7) million |
Q3 revenue grew 49% year over year; nine-month revenue grew 50%. Q3 GAAP net loss per share was $0.14, compared with $0.34; for nine months it was $0.73, compared with $1.01. Nine-month calculated billings, a non-GAAP measure, were $162.2 million, up 61%. Dollar-based net retention was 120% for the trailing 12 months, versus 115% a year earlier.
At April 30, 2018, cash and cash equivalents were $287.4 million, including $267.2 million in money market funds. Current assets were $350.4 million and current liabilities $147.2 million; working capital was approximately $203.3 million. Deferred revenue totaled $124.8 million, including $111.0 million current. No borrowings are reported in the presented balance sheet. Nine-month investing cash outflow was $12.4 million, principally for property, equipment and internal-use software. The company said existing cash should fund operating and capital needs for at least 12 months.
Material changes and notable items
- Q3 customer additions contributed $9.0 million of revenue growth; expansion among existing customers contributed the remainder. The company reported its customer base had grown 15% year over year.
- Gross margin improved, which management attributed partly to greater technology, infrastructure and data-center efficiency. Cost of revenue rose 35% in Q3, slower than revenue growth.
- Operating expenses rose 45% in Q3. Sales and marketing increased 44%, R&D 27%, and general and administrative expense 77%; the latter reflected higher legal costs and public-company-related staffing.
- IPO proceeds provided $205.3 million net of underwriting discounts and commissions, before offering costs. Preferred shares converted into common stock; the company reported 119.8 million common shares outstanding at April 30.
- Nine-month operating cash flow benefited from a $28.2 million increase in deferred revenue, partly offset by a $21.2 million increase in deferred contract acquisition costs.
Outlook, risks and contingencies
- No specific revenue or earnings guidance is provided. Management expects continued losses for the foreseeable future and said the fiscal 2018 net loss is expected to increase as it invests in sales and marketing and incurs public-company and legal costs. It expects gross margin to remain relatively unchanged over the long term, while operating expenses are expected to rise in absolute dollars.
- Growth depends on adoption of cloud security, new customer acquisition, renewals and expansion, and effective execution through channel partners. Channel partners generated 93% of Q3 revenue; the top five partners and affiliates represented 42% of nine-month revenue.
- Symantec patent litigation remains unresolved; Zscaler recorded no liability for those cases because it did not consider a loss probable, and said loss likelihood and range could not be estimated. A court dismissed asserted claims involving two Symantec patents as invalid, while other claims remained pending.
- Finjan litigation also remains pending. The company accrued $3.2 million related to past negotiations, including $0.7 million in the nine-month period; it could not reasonably estimate the range of potential loss from the lawsuit.
- Other key risks include service availability and cybersecurity, intense competition, customer and channel-partner concentration, international and regulatory requirements, and execution of rapid growth. The company also identified a potential market overhang when IPO lockups were scheduled to expire on September 11, 2018.
- The company adopted ASC 606 using full retrospective application. Management reported disclosure controls were effective at a reasonable-assurance level and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether revenue growth, customer retention and expansion remain strong, and how calculated billings and deferred revenue develop.
- Whether improving gross margins and operating cash flow can persist as investment, commissions and infrastructure costs rise.
- The timing and financial impact of Symantec and Finjan proceedings, including any new accruals, settlements or court rulings.
- Dependence on channel partners, including the revenue share attributable to the largest partners and the effect of any changes in those relationships.
- Cash use, IPO-proceeds deployment, share-based compensation and dilution, and the impact of the scheduled lockup expiration.