Bear's ZS OctQ Review

I keep an excel file that I manually update each quarter for all the companies I follow. It’s a lot of work, but since companies are prone to highlight whatever makes them look good in the current quarter, it’s tough to get a consistent picture over time without doing it yourself.

Not so with Zscaler. They lay out the last several quarters, and it seems like they’re going to update it each new quarter. Brilliant. https://ir.zscaler.com/static-files/c622d089-247b-45ea-a4c4-… My favorite feature? They have both a GAAP and non-GAAP Income Statement by quarter. You can also see Calculated Billings and a whole slew of other things to easily track their progress. Saves me a lot of trouble, but it also gives me a lot of confidence that management is being completely on the up and up. Totally avoids the “who moved my cheese” problem we’ve had with other companies. Here’s some trends we’ve seen since they went public:

  1. Accelerating Revenue Growth each quarter (49%, 54%, 59%)
  2. FCF positive each quarter (3.7m, 11.9m, 5.2m)
  3. Shrinking costs as a percentage of revenue

I love all of that, but what I love most is that they seem to be utterly dominating their space. On the call today, Jay talked about the tailwinds they’re seeing from the increasingly SaaS/Cloud world. Zscaler is in demand more and more because of all the things we already know are driving innovation today.

With now 1 more quarter of evidence, I still like everything that drew me to ZS in the first place: https://discussion.fool.com/zscaler-wading-in-34015154.aspx

I added more after hours today.

Bear

50 Likes

Bear,

Not mentioned in the call, but what happens when 5G becomes mainstream? The world becomes more and more mobile, with more and more cloud apps on the edge. Appliances and virtual machiens are not going to provide enterprise security on such an internet is your architecture. So the world is moving more and more towards Zscaler.

One very revealing anecdote from Jay Chaudry was that a network management project was bid on by 5 telecoms in Europe for a European enterprise. Each telecom company, independent of each other, used Zscaler in their bid to RFP (request for proposal) to try and win the contract. There was no one else these companies could use that would be competitive is the inference.

A little more than 50% of Zscaler’s business, if I read it correctly (and I read too fast sometimes) are coming from such sources - network integrators, consultants, that sort of thing.

Nice.

Tinker

18 Likes

In looking at ZS’ financial information in the last 10k, I found that Zscaler is defending 2 patent litigation lawsuits. One was filed by Symantec (described somewhere as a “partner” of Zscaler) and one by Finjan. Some of Symantec’s claims were dismissed by the court. Finjan’s claims may have some merit since it appears that Zscaler has engaged in settlement discussions with it (or maybe ZS feels it is cheaper to settle than to fight). This may be similar to the Arista-Cisco disputes but I did not find anything where Zscaler stated it could do workarounds.

Here is the information taken from ZS’ SEC filing:

Legal Matters
Symantec Litigation
We are currently involved in legal proceedings with Symantec. On December 12, 2016, Symantec filed a complaint, which we refer to as Symantec Case 1, in the U.S. District Court for the District of Delaware alleging that “Zscaler’s cloud security platform” infringes U.S. Patent Nos. 6,279,113, 7,203,959 (“’959 patent”), 7,246,227 (“’227 patent”), 7,392,543, 7,735,116, 8,181,036 and 8,661,498. The complaint seeks compensatory damages, an injunction, enhanced damages and attorney fees. On August 2, 2017, the court granted our motion to transfer Symantec Case 1 from the District of Delaware to the Northern District of California. On March 23, 2018, the Northern District of California court granted our motion to dismiss the asserted claims of the ’959 and ’227 patents as invalid based on unpatentable subject matter.
On April 18, 2017, Symantec filed a second complaint, which we refer to as Symantec Case 2, in the U.S. District Court for the District of Delaware alleging that “Zscaler’s cloud security platform” infringes U.S. Patent Nos. 6,285,658, 7,360,249, 7,587,488, 8,316,429, 8,316,446, 8,402,540 and 9,525,696.
The complaint seeks compensatory damages, an injunction, enhanced damages and attorney fees.
On June 22, 2017, Symantec filed a notice of voluntary dismissal of its complaint in Symantec Case 2 along with a new complaint alleging infringement of the same patents and adding Symantec Limited as a plaintiff and alleging willful infringement of the ’429 and ’446 patents. On July 31, 2017, the court granted our motion to transfer Symantec Case 2 from the District of Delaware to the Northern District of California. On May 21, 2018, Symantec filed an amended complaint adding allegations of willful infringement of all of the asserted patents in Symantec Case 2.
We have also received letters from Symantec alleging that our “cloud security platform” infringes U.S. Patent Nos. 7,031,327, 7,496,661, 7,543,036 and 7,624,110.
We believe that our technology does not infringe Symantec’s asserted patents and that these patents are invalid.
Should Symantec prevail with its infringement allegations, we could be required to pay substantial damages for past and future sales and/or licensing of our services, enjoined from making, using, selling or otherwise disposing of our services if a license or other right to continue selling our services is not made available to us, and required to pay substantial ongoing royalties and comply with unfavorable terms if such a license is made available to us. Any of these outcomes could result in a material adverse effect on our business. Even if we were to prevail, this litigation could be costly and time-consuming, divert the attention of our management and key personnel from our business operations, deter distributors from selling or licensing our services, and dissuade potential customers from purchasing our services, which would also materially harm our business. The expense of litigation and the timing of this expense from period to period are difficult to estimate, subject to change and could adversely affect our results of operations. In addition, any public announcements of the results of any proceedings in Symantec Case 1 or Case 2 could be negatively perceived by industry or financial analysts and investors, and could cause our stock price to
experience volatility or decline.
We have not recorded a liability with respect to Symantec Case 1 or Case 2 based on our determination that a loss in either case is not probable under the applicable accounting standards.
We are vigorously defending Symantec Case 1 and Case 2. We are unable to predict the likelihood of success of Symantec’s infringement claims.
Finjan Litigation
We are currently involved in legal proceedings with Finjan. On December 5, 2017, Finjan filed a complaint, in the U.S. District Court for the Northern District of California alleging that Zscaler’s “Internet Access Bundles,” “Private Access Bundle,” “Zscaler Enforcement Node,” “Secure Web Gateway,” “Cloud Firewall,” “Cloud Sandbox” and “Cloud Architecture products and services” infringe U.S. Patent Nos. 6,804,780, 7,647,633, 8,677,494 and 7,975,305. The complaint seeks compensatory damages, an injunction, enhanced damages and attorney fees.
We believe our technology does not infringe Finjan’s asserted patents and that Finjan’s patents are invalid.
Should Finjan prevail with its infringement allegations, we could be required to pay substantial damages for past and future sales and/or licensing of our services, enjoined from making, using, selling or otherwise disposing of our services if a license or other right to continue selling our services is not made available to us, and required to pay substantial ongoing royalties and comply with unfavorable terms if such a license is made available to us. Any of these outcomes could result in a material adverse effect on our business. Even if we were to prevail, this litigation could be costly and time-consuming, divert the attention of our management and key personnel from our business operations, deter distributors from selling or licensing our services, and dissuade potential customers from purchasing our services, which would also materially harm our business. The expense of litigation and the timing of this expense from period to period are difficult to estimate, subject to change and could adversely affect our results of operations. In addition, any public announcements of the results of any proceedings in this matter could be negatively perceived by industry or financial analysts and investors, and could cause our stock price to experience
volatility or decline.
While the range of potential loss resulting from the lawsuit cannot be reasonably estimated, we have accrued a total liability of
$3.2 million as of July 31, 2018 related to past negotiations with Finjan of which we recorded $0.7 million in fiscal 2018 and
$2.5 million in fiscal 2017.
We are vigorously defending this lawsuit. Given the early stage in the litigation, we are unable to predict the likelihood of success of Finjan’s
infringement claims.

10 Likes

j214,

Google Finjan and you will find that they file lots of lawsuits against lots of companies for some patent violation. Almost like a Patent Troll company disguised as an IT Security firm. Few days ago they just filed a patent infringement lawsuit against Qualys. In this article they are described as “Cybersecurity’s Top Patent Litigator” – https://www.bna.com/finjan-cybersecuritys-top-n73014445998/

It seems like it’s just the cost of doing business and maybe even a badge of honor that you actually successful business model.

tj

9 Likes

Also interesting is Finjan’s $2.00 stock price - maybe this company is not doing well litigating and should come up with another business plan.

The more difficult thing to evaluate is the Symantec litigation. ZS was able to get some counts dismissed but not all. ZS is spending over 2 million per quarter on litigation costs and who knows how much time management must spend on this which could otherwise be devoted to enhancing the business.

It would be helpful to me being long if ZS provided ANET type information on the Symantec litigation.

Did they disclose the number of customers they ended the quarter with? Seems like they said 3250. Isn’t that the same number as last quarter. I’m sure I’m missing something.

From the earnings report:

“Zscaler serves more than 3,250 customers across all major industries and currently counts over 300 of the Forbes Global 2000 as customers.”

Hi JKB2016,

I noticed a little ** after the “more than 3,250 customers”, and in very tiny print at the bottom of the slide it says: As of July 31, 2018.

Not sure why they did not highlight new adds over the quarter, and I dont believe any analyst asked on the call. Seems a little strange as all of our companies proudly brag about how many new customers they have added over the quarter and year over year. (I even checked the 10Q and found the same July 31 date for customers).

You can always send an email to Investor Relations and ask if they will disclose that for you, or if it a metric they will only disclose on a yearly or semi annual basis.

Best,
Matt

2 Likes

Given the 118 or 120% repeat purchase figure Zs had to have retained many new customers this quarter. I do not think there is anything trying to be hidden there. The math just does not work out any other way. They would have to have had Pivotal like numbers in that regard otherwise.

But good catch, always good to see what is left out, as that can be as important as what is discussed.

Tinker

3 Likes

Thanks all. Fully agree w Tinker’s comments that the math wouldn’t work any other way. I did ping ZS Investor Relations. Here’s there feedback:

Hi Jay,
Thank you for your interest in Zscaler. Our total customer count is updated annually at the end of the fiscal year. As such, we did not provide a figure for Q1’19.
Thanks, Michelle

4 Likes