Shares of Zscaler, a cloud security firm, dropped over 31% on Wednesday after the company issued a disappointing outlook for its fiscal year, despite a modest rise in its earnings for the third quarter.
For the upcoming fourth quarter, Zscaler anticipates revenue between $875 million and $878 million, which is just shy of expectations set at $879 million. Additionally, they project non-GAAP earnings per share to fall between $1.08 and $1.09.
A more significant concern is the company’s initial guidance for fiscal 2027, which suggests a growth rate of 16% to 17% for revenue and annual recurring revenue (ARR). This indicates a notable decline from current growth levels and is below earlier forecasts of about 19% to 20%.
In the third quarter, Zscaler reported adjusted earnings per share of $1.08, surpassing analyst expectations of $1.01. Their revenue stood at $850.5 million, beating the forecast of $835.5 million, while ARR reached $3.53 billion, marginally exceeding consensus predictions of $3.51 billion.
Year-over-year, revenue saw a 25% increase, and ARR also grew by 25% to $3.53 billion. The net new ARR for the quarter amounted to $166 million, benefiting from the Red Canary acquisition. Without this acquisition, organic ARR growth was around 21%, and organic net new ARR growth hovered near 14%.
The profitability trends were somewhat mixed. The GAAP operating loss widened slightly to $29.6 million, whereas non-GAAP operating income grew to $195.8 million, accounting for 23% of sales. Non-GAAP net income rose to $177.9 million, with diluted earnings per share climbing to $1.08, up from $0.84 a year ago. Free cash flow increased to $136 million, but cash from operations fell to $198 million.
Deferred revenue surged 25% year-over-year to reach $2.48 billion.
Analysts from Jefferies indicated that while the quarter met expectations, the outlook represents a substantial reset in growth projections, influenced by recent changes in revenue leadership and an unexpected slowdown in ARR assumptions for fiscal 2027.
They highlighted an organic ARR growth of 20.6% for the fiscal third quarter, with organic net new ARR of $153 million, showcasing a 14% increase year-over-year. However, they noted concerns that fourth-quarter guidance may suggest a slowdown in ARR growth to around 19.6%, even after considering possible upside.
Jefferies stated that the adjustment of FY2027 ARR growth to 16% to 17% marks a significant downward revision, yet described this reset as “very necessary and achievable.” They also pointed out that the growth expectation for the Red Canary business is anticipated to lag behind the main platform, compounded by the departures of sales leaders and a new logo alongside a more cautious growth outlook.
Analysts noted a mix of trends in ARR for the third quarter, such as robust demand in the public sector and significant upsells by the federal government. The Asia-Pacific region also performed well, with large deals increasing by 150% year-over-year.
Additionally, there was a change in sales leadership towards the end of the quarter, with the exit of two senior executives. Management indicated that this development did not affect third-quarter results but has impacted the near-term outlook. Jefferies commented that the company is seeking to stabilize execution by enhancing channel partnerships, expanding coverage for small and medium-sized businesses, and strengthening relationships with clients.
