Overall, it has been a very
successful earnings season for cyber security stocks, as a host of companies in
the space posted strong, better-than-expected results. For instance, Palo Alto
Networks (PANW 245.26, -1.01, -0.41%), Fortinet (FTNT 86.63, -0.16, -0.18%), CyberArk (CYBR 109.10, -0.67, -0.61%), and Tenable (TENB 31.83, +0.65, +2.09%) each
delivered upside quarterly results and have seen their stocks fly higher as a
result. From a broader perspective, there are a number of trends that are
creating a strong tailwind for cyber security companies.
One of the most significant factors is the ever-increasingly reliance on mobile devices and applications to conduct work outside of an office setting. The number of potential threat points has expanded exponentially. It is no longer sufficient to simply secure on-premise servers and networks.
Emerging technologies like IoT, artificial intelligence, and biometrics are also adding to enterprises' vulnerability. On top of this, personal data breaches at various financial services companies are leading to increased governmental regulation, forcing companies to ramp up their cyber security technology.
These are just a few of the trends that continue to create robust demand for cyber security products, which in turn has led to a multitude of providers in the space. Indeed, it is a very crowded space with companies trying to differentiate themselves in the way their products approach IT security. Of course, their products often over-lap each other. One company that does seem to have a more unique solution is Zscaler (ZS 59.26, +9.58, +19.28%), which reported impressive 2Q19 results after the close last night.
ZS is a pioneer and leader in an emerging concept in cyber security called "zero trust". Simply put, zero trust is an approach to IT security that eliminates the premise that people inside an organization are safe and immune to instigating a threat. With its ZScaler Security Cloud offering, there is no policy or trust assigned to the network level. Therefore, there is no need to maintain an expensive and complex private network and appliances that typically accompany network security systems.
Instead of securing traditional, on-premise equipment, its security cloud resides between an organization's users and devices, regardless of what kind of device and where a user might be.
The company has two primary offerings: ZIA (Zscaler Internet Access) and ZPA (ZScaler Private Access). ZIA securely connects people to externally managed apps and internet destinations. It protects each device from malware and ensures that threats don't reach corporate data. ZIA provides authorized users with secure access to internally managed applications hosted in data centers or the cloud.
Quarterly Results & Outlook
Now with a better understanding of ZS, let's take a look at its results. It generated EPS of $0.09, easily beating the $($0.01) consensus. Just the fact that ZS is profitable is noteworthy because most younger cloud software companies in the early stages of their growth curves are not.
- On a yr/yr basis, operating margin improved by 19% to 13%. In addition to the impressive 65% revenue growth, the vast improvement here was also due to a 1% sequential decrease in its Sales & Marketing expense. That said, the drop is mainly due to the timing of some sales and marketing events and ZS says that it intends to keep building its sales and marketing team going forward.
- In addition to the profitability and jump in margin, what really stands out about ZS is that its billings growth rate actually accelerated. Again, that is quite rare for a high-growth, tech IPO. Most of the time when a company goes public, it has already achieved peak growth. That doesn't seem to be the case for ZS, though.
- In 3Q18, billings were up 73%; 4Q18 billings increased 72%; in 1Q19 billings were up 56%, and then this quarter billings surged by 74%. Its best performance since going public. That said, there is one caveat. During the earnings call, management commented that this quarter benefited from a higher mix of upfront greater than 1 year billings, including approximately $11 mln from the public sector customer.
- Another key metric for ZS, net dollar retention rate, also continues to be very healthy at 118% for the quarter, matching last quarter's performance. ZS' strong customer retention and ability to successfully up-sell has resulted in a consistently high dollar-based net retention rate.
- ZS issued upside guidance for both Q3 and FY19, as well. For Q3, it is forecasting EPS of $0.01 vs. the ($0.02) consensus on revenue of $74-$75 mln vs. the $68 mln expectations. And for FY19, it is expecting EPS of $0.11-$0.13 compared to the ($0.02) consensus with revenue of $289-$291 mln vs. the $272 mln consensus.