While Okta (OKTA) is trading sharply higher today on earnings, it's another story for fellow cybersecurity company, Zscaler (ZS), which is down 7%. The stock has made a nice run since making its IPO debut in March 2018 but it's making a rare stumble this morning.
Zscaler's cloud platform allows for clients to provision which employee gets access to which application and what data.
The company has been teetering around finally making it to profitability the past few quarters. In fact, it has now posted three consecutive profitable quarters in a row and for two of those quarters a loss was expected. It's always a big milestone for a company to become consistently profitable and it seems ZScaler is doing just that.
Turning to the Q3 (Apr) results, non-GAAP EPS jumped to $0.05 from a $(0.04) loss last year. This was well above prior guidance of approximately $0.01. Revenue rose 60.8% yr/yr to $79.1 mln, which was also well above prior guidance of $71-75 mln. Non-GAAP operating margin improved to 8% from (6)% last year. Looking ahead to Q4 (Jul), ZS expects non-GAAP EPS of $0.01-0.02 and revenue of $81-83 mln. The EPS guidance is roughly in-line while the revenue upside was pretty large.
On the call, CEO Jagtar Chaudhry said "Just as enterprises have adopted multi-tenant SaaS applications like Salesforce and Workday to replace legacy on-premise applications, enterprises are saying goodbye to security appliances and choosing Zscaler's born-in-the-cloud, multi-tenant security platform to securely embrace the cloud. Unlike traditional network security, we've built some moat and owned a castle."
While the opportunity looks attractive, Chaudhry also said the company will "aggressively invest in our business for a significant market opportunity that is ahead of us." ZS believes it's going after a $20.3 bln TAM (total addressable market) in calendar 2019.
The concern here is that this higher level of spending could jeopardize ZS' recent achievement of profitability. While it's good for a company to invest in growth, there is likely to be a near term impact on margins. In fact, ZS' guidance or Q4 (Jul) of $0.01-0.02 is a sequential decline from the $0.05 reported in Q3 (Apr).
On the product front, Chaudhry says the company is seeing "significant interest in ZPA (Zscaler Private Access), which [ZS] introduced only a couple of years ago. It remains the fastest growing product in our history. ZPA delivers, what Gartner calls, zero-trust network access to provide application access to users without granting network access that significantly reduces business risk. While ZPA has been and continues to be purchased as an upsell by existing ZIA (Zscaler Internet Access) customers, we are seeing more upfront sales of both the ZIA and ZPA."
In sum, the stock is clearly taking a breather today as the upside this quarter was not as impressive as last quarter. Also, we think the comment about increasing spending may be causing concern about the near-term financial results and could jeopardize ZS' recent foray into profitability. It seems like it could be having an impact already as EPS is expected to decline on a sequential basis in JulQ.
How long could this impact to margins last? We should get a better sense when ZS reports JulQ results in early September. That's when we'll get our first look at FY20 guidance. Also, the OctQ guidance will be a good indicator as to whether this increase in spending will impact just one quarter or whether it will be a longer term issue.