Cloud security company Zscaler (NASDAQ:ZS) reported its fiscal first-quarter results after the market closed on Nov. 4. Revenue grew by nearly 60%, and the company managed to turn an adjusted profit and produce positive free cash flow. It may be another year or two before those profits become sustainable as ZScaler invests in growth, but the company is on the right track.

Zscaler results: The raw numbers

Metric

Q1 2019

Q1 2018

Year-Over-Year Change

Revenue

$63.3 million

$39.9 million

58.7%

Net income

($7.6 million)

($11.4 million)

N/A

Non-GAAP earnings per share

$0.01

($0.07)

N/A

Data source: Zscaler.

What happened with Zscaler this quarter?

  • Calculated billings were up 56% year over year to $64.6 million, while deferred revenue grew 68% to $165.3 million.
  • Operating cash flow was $11.0 million in the quarter, which drove $5.2 million of free cash flow. Both metrics were negative in the prior-year period.
  • Cash, cash equivalents, and short-term investments reached $314 million.
  • 49% of revenue came from the Americas, with 43% coming from Europe, the Middle East, and Africa, and the remaining 8% coming from the Asia-Pacific region.
  • Zscaler's dollar-based net retention rate was 118%, up from 116% in the prior-year period.
  • Gross margin rose 2 percentage points year over year to 82%, driven by a mix shift toward higher-priced bundles and operational efficiencies.

Zscaler provided the following guidance:

  • For the second quarter, the company expects revenue between $65 million and $67 million, and a non-GAAP showing per share between $0.00 and a $0.02 loss. 
  • For the full year, the company expects revenue between $268 million and $272 million, and a non-GAAP net loss per share between $0.01 and $0.03.
  • Zscaler expects to achieve sustained profitability and positive free cash flow sometime in fiscal 2020.
An animation of a cloud, with computer circuits in the background and trails of light extending from the edges of the image to points on the cloud.

Image source: Getty Images.

What management had to say

On the earnings call, Zscaler CEO Jay Chaudhry talked about a major customer win: "A Fortune 100 conglomerate purchased Transformation Bundle [a suite of Zscaler services] for all of its 100,000 employees. While we are replacing traditional networking appliances, such as secure Web gateway, branch firewall, DNS, and a dozen data centers, it is mostly a greenfield opportunity."

Chaudhry also discussed a key advantage driving the company's growth: "A strategic advantage for us is the partnerships with large system integrators and global service providers, who implement cloud transformation projects. SI and SPs represent over 50% of our revenue, and they are the fastest-growing channel for us."

Chaudhry described the company's process for bundling products:

Bundling is an interesting exercise with no simple answers. If you bundle too much, you can increase the price too much. If you don't bundle enough, you're not selling additional modules. It's one of those art and science things. I think when a module becomes widely accepted and more and more customers start buying it a la [carte], it tells us it's really time to bundle it.

Looking forward

ZScaler was profitable on an adjusted basis during the first quarter, but that may not last as the company invests in growth. Chaudhry made it clear that taking advantage of growth opportunities is more important than short-term profits: "So when you think about contribution margin, yes, if we stopped everything and just went with renewals, it goes incredibly high. With this large market opportunity, we're going to keep investing in business to maximize what we feel is the biggest shareholder value."

With revenue expected to be less than $300 million this year, Zscaler has plenty of room to grow as demand for cloud security ramps up in the coming years.

Timothy Green has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.