How Zscaler Trounced Estimates in Its Q3 Report

Zscaler (ZS 1.04%) shares fell after the company's earnings report earlier this month, but the cloud security specialist delivered blowout numbers.

In this segment of "Beat and Raise" recorded on Dec. 1, Fool contributors Trevor Jennewine and Brian Withers discuss Zscaler's third-quarter report and how the business is firing on all cylinders.

Trevor Jennewine: Borrowing from Zane, Brian, do you know what Zscaler stands for?

Brian Withers: No.

Trevor Jennewine: The company's named for Zenith of Scalability, and that references the scalability of their cloud security platform, rather than enforcing security policies through a corporate data center, which is not only costly, but it tends to create bottlenecks and performance issues. Zscaler has this massive network of 150 data centers around the world, where it can enforce those policies. That means better performance, better security, as well as reduced costs because clients aren't relying on that on-site hardware.

Brian Withers: Well, I think it's better that they call themselves Zscaler because when I think of Zenith, I think of these TVs. There is a TV brand that is no longer producing TVs.

Trevor Jennewine: So let's jump in. The company reported their first-quarter earnings for fiscal 2022 yesterday after the market closed, and everything looked good. If you looked at the stock today, it got hammered. I don't think that has anything to do with the earnings. Revenue came in at $230.5 million. That was up 71%, a beat on the top line. Non-GAAP [adjusted] earnings were $0.14 per diluted share. That was flat, but a beat on the bottom line there. Cash from operations was $93.3 million, up 74%. So a little bit more color on that non-GAAP earnings figure. All of that looks solid to me.

The company also reported a retention rate of 125%, so its clients are spending more. As additional context for the revenue, so revenue's up 71%, but the remaining performance obligation actually grew 97%. Remaining performance obligation, or RPO, is a combination of deferred revenue, which should be sales that the company has made, but that revenue doesn't apply yet. Or contracted revenue that hasn't been received, or billing that hasn't been billed yet. That fast growth in RPO tells me that the company should see strong sales growth in the coming quarters.

A few highlights: Zscaler has four different products. One of them is called Zscaler digital experience. This essentially helps IT teams monitor the experience that users have across applications, networks, and devices. That way, when a problem arises, they can identify it, troubleshoot the problem, and then resolve it pretty quickly. Zscaler announced that it's integrating its digital-experience platform with unified communications as a service application. Specifically, it's going to be working with Microsoft Teams and Zoom, and I think that's pretty relevant given all the trend toward remote work and the collaboration software.

Also noteworthy, they expanded their partnership with CrowdStrike; we'll talk about CrowdStrike shortly. But basically, Zscaler is focused on networking and the network security side of things. CrowdStrike is focused on the endpoint security and identity protection. CrowdStrike's platform gives essentially like a security score to a device. Zscaler's integration allows that security score to be one of the variables that it considers when it's enforcing security policies. The companies have already partnered before, but they're expanding that partnership. I think as two leaders in the space, that's great to see.

Zscaler also was granted impact-level-five accreditation by the Department of Defense. They are the first and only zero-trust network-access solution to achieve that level. Basically what that means is that agencies under the Department of Defense can use Zscaler for more workloads than any other network-access solution out there. Moving into the government sector, as far as concerns, I didn't really have any concerns with the quarter. I think the company has a big market opportunity, I think they're executing on it. Everything seems to be going well. The outlook for the second quarter looks great. Revenue of $242 million, that was a raise. Non-GAAP earnings per share at $0.11 also a raise on the bottom line there. I think last time I checked, the stock was down 5, 6, 7 percentage points today, but tech was just getting hammered today, so I don't think that has anything to do.

Brian Withers: My whole portfolio was [laughs] red today to a couple of percent; 3 or 4% for sure. Zscaler seems to be firing on all cylinders, and I know it's priced that way as well. But when you look at high-growth companies, I think Zscaler is one of those that has got a track record of execution, great stock appreciation. Even though it's expensive today, there's a massive, massive market as people move out of their own data centers into the cloud. Zscaler was born in the cloud and cloud security.

Trevor Jennewine: Yeah, I completely agree with this. If we see this sell-off keep gaining momentum, its probably a good opportunity to buy some shares on the way down.