Zscaler (ZS) Q4 2019 Earnings Report

Added 70 Shares at $49.6 after the report

Image From: ZS

BLUFF (bottom line up front):

Zscaler reported earnings after the market closed. The stock is currently down 20% to $49.29 in after hours trading. I have a couple guesses as to why. First, there’s some type of sentiment shift or rotation away from many high-growth companies that have outperform so long and second, ZS didn’t report as strong of a quarter as they usually do. They also guided for First Half 2020 billings growth to be 42%-43% instead of 43%-44%.

What I did: I took this opportunity to add 70 shares at $49.6. We now own 619 shares at and average price of $54.91 for a total cost basis of $34,000. The position makes up 7.42% of our portfolio and is down roughly 10%.

Why I did that: ZS is a medium sized position for us and we’re comfortable with it being around 7%-10% of our portfolio. The company grew revenue 53% year over year which is not a sign of a suffering business. The company just hired a Chief Revenue Officer, refuted some claims from a competitor that they “displaced” ZS with a couple customers, improved net-loss metrics, and mentioned some new innovations which I believe will drive future growth.

Press Release Notes:

Fourth Quarter 2019 positives:

  • Revenue: Grew 53% YoY to $86.1 million

  • Deferred Revenue: Grew 53% YoY to $251.2 million

  • GAAP net loss of $5.3 million, improved from $7.0 million last year

  • Non-GAAP net income of $9.1 million, improved from net loss of $1.4 million last year

  • Cash, cash equivalents and short-term investments: $364.6 million, an increase of $66.1 million from last year.

  • Net Dollar Retention Rate: 118%, up from 117% in Q4 FY 18. Equal to 118% in Q3 & Q2 FY19.

Fourth Quarter 2019 negatives:

  • Calculated Billings: Grew 32% YoY to $125.8 million. *This was because of a very large deal in Q4 2019 which made this a very, very hard comparison*

    • Excluding upfront greater than one year billings in both periods. Billings would have grown over 50%

  • Cash Flow: Cash provided by operations was $17.8 million, or 21% of revenue compared to $14.7 million, or 26% of revenue last year. Positive free cash flow was $7.6 million or 9% of revenue, compared to $11.9 million or 21% of revenue last year.

Full-Year 2019 financial highlights:

  • Revenue: 302.8 million, up 59% YoY.

  • Cash flow: Cash provided by operations was $58 million or 19% of revenue compared to $17.3 million, or 9% of revenue in 2018. Positive free cash flow was $29.3 million, or 10% of revenue, compared to $2.1 million, or 1% of revenue in 2018.

Financial Outlook

For the first quarter of fiscal 2020:

  • Total revenue of $89 million to $90 million (41% YoY growth)

    • They normally provide very conservative guidance and beat it handily.

  • Non-GAAP loss from operations of $1 million to breakeven 

  • Non-GAAP earnings per share of $0.00 to $0.01, assuming approximately 139 million common shares outstanding

For the full year fiscal 2020, we expect:

  • Total revenue of $395 million to $405 million (32% growth)

    • In Q4 2018, guidance was for FY 2019 revenue of $255 million (mid-point), up from $190.2 in FY 2018. 34% YoY growth.

    • In FY 19, the company brought in revenue of $302.8 million. 59% YoY growth

  • Calculated billings of $490 million to $500 million

  • Non-GAAP income from operations of $13 million to $18 million

  • Non-GAAP earnings per share of $0.12 to $0.15, assuming approximately 140 million common shares outstanding

Conference Call Highlights:

Jay Chauldry - Co-Founder & CEO:

In Q4, we are pleased to announce that we delivered strong revenue and operating profit growth in the fourth quarter with positive free cash flow. For the quarter, our revenue grew 53% and billings grew 32% year-over-year against a very difficult comparison.

We are seeing a mega shift take place, where organizations are choosing multi-tenant cloud architecture to empower them to scale quickly as they move their applications and data to the cloud. Digital transformation and adoption of mobile and cloud fundamentally change network traffic patterns and break that traditional perimeter protection model, where organizations build a hub-and-spoke network and a mode of security appliances to secure the network.

Jay then referenced a new study from Gartner which introduces a concept of Secure Access Service Edge (SASE). I have no idea what this means, but Chauldry believes it’s a good thing for ZS. If that’s true, we will see it in the business performance moving forward.

In our large ZIA deals, we continue to see Office 365 deployments and securing local Internet breakouts as the primary driver. A Global 500 industrial company with headquarters in Europe purchased our business bundle and Cloud Sandbox for 120,000 users as they required a scalable solution that can keep pace with over 50% growth in Internet traffic for a year.

In addition to Office 365, SSL traffic inspection and cloud sandboxing were needed for better security for all locations across 60 plus countries and all users whether at the headquarters, or branch office or on the road. In another deal, a Fortune 100 consumer goods company that purchased business bundle several years ago upgraded to Transformation Bundle plus data loss prevention for all 100,000 employees.

After deploying Office 365 last year. The customer was overwhelmed with the growth of traffic for One Drive and SharePoint. With Zscaler, they will no longer have to backhaul Office 365 to four data centers. Instead, they are implementing SD-WAN for nearly 300 locations for local Internet breakouts to deliver better user experience.

Office 365 continues to be a huge driver of growth for ZS. This is a bit of a risk, but also a huge benefit. I think ZS would be a great acquisition for Microsoft, but that’s one of the reasons I’m invested in ZS.

Overall, the competitive environment remains favorable. And we have high win rates, coupled with a strong net dollar retention rate of 118%. In fact, our customer churn rate declined quarter-over-quarter and year-over-year. We ended fiscal 2019 with over 3,900 customers. Total [Phonetic] Global 2000 customers increased to over 400 as of July 31, up from over 300 a year ago. And we have over 100 of the Fortune 500 companies as our customers.

We are strengthening our channel partnerships with large system integrators and global service providers, who contribute over 50% of our revenue. We will continue to aggressively invest in our business to pursue our significant market opportunity.

Lower customer churn rates are great. This helps to explain the 1% improvement in net-dollar retention rate. Management remains confident in growth going forward.

Q&A Notes:

There was nothing earth-shattering in the Q&A, but I do want to highlight a couple things management said:

On the competitive environment and potential macro sales concerns

We didn’t really see any comparative real competition from firewall guys or any -- other guys. So our competitive rate remains very, very strong. On the macro level, we haven't seen any significant things to really say that macro is playing a role in it. We do believe that as the large number of reps are being hired, they all need to go through a bit more sophisticated sales methodology, sales framework and the like.

as we compete out there, we almost win every deal, very low situations where we don't win. So very comfortable with our differentiated technology, very comfortable with our sales process [Indecipherable]. We just need to make sure we can keep on scaling it as we set our targets for bigger and bigger numbers.

About claims from Palo Alto Networks that they displaced ZS with 2 customers

I think if you asked any expert out there, what security inspection technology gives you better capability to inspect on law [Phonetic] threats, I think 99% of smart people agree it's a proxy technology. So I think while statements like that made by competition truly making zero sense. In fact, a lot of you work for large banks. All right. You clear about security, if you look at the top 10 large banks in the world and how many of them have next-gen firewall. Lots of them. How of them replaced a proxy technology for outbound traffic. I believe you will find it zero.

In fact, I know of a very large bank that has spent ten of millions of dollars on a next-gen firewall and deployed them all over. And this bank is still depending upon a proxy technology to inspect to clear traffic for threats. That's one piece. Two, if you look at any vendor, who is doing any meaningful thing even sitting in front of servers like Akamais of the world. They all have proxy-based technology because without proxy, you have little or no control. Lastly firewall, which is a pass-through device was a good thing before the SSL world when traffic was not encrypted. Today in most of the cases, 90 plus percent of the cases, it's SSL traffic, TLS traffic . Firewalls were never designed to inspect SSL, proxy technologies needed for SSL, if you really don't inspect the traffic, it is like your luggage passing through an airport inspection check post without inspecting. That's not a good thing. So I think. These statements are meaningless, they mislead customers, they give them false sense of security and do a disservice to the security industry.

Regarding displacement at a Fortune 50 retail customer, they alluded to. I personally know every Zscaler, Fortune 100 Zscaler customer and we did not lose any. So people, I think when they get desperate, they look for leading information. I've analyzed top 50 deals and we rarely see this firewall vendor in there. We do expect to see further misleading claims in the future from legacy firewall vendors, who are trying to tout their cloud security wins. When legacy secure web gateway vendors were trying to compete with Zscaler, we saw the same behavior. They try to upgrade the security appliances, they gave away the cloud, and they were falsely claim it as a cloud security win and displacement of Zscaler.

Conclusion and Links

I don’t see any signs of a failing business in this report. As I said above, I added some shares. I don’t see this as a time to do anything extreme. These companies could continue to fall so I’m going to continue adding to what I believe are great companies as our monthly contributions come into our investment accounts.

Press Release
Earnings Calls Transcript - Motley Fool
Zscaler S-1 Breakdown - Alex Clayton

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