In our view the market made a big mistake last night on Zscaler but dissecting the lapses in logic is instructive whether you've soured on the stock or not. After all, as Apple shows, a warning can turn into a win in the blink of an eye.
So Zscaler (ZS: $49 in after hours, down from $61) wrapped our 2Q19 earnings cycle with horrified talk about how management's outlook for the coming year won't match "consensus" forecasts. Last quarters numbers numbers were great. We wanted $83 million on the top line to turn into at best $0.01 per share of earnings. We got $86 million and $0.07. But earnings guidance wasn't enough for some people.
Strangely enough, none of the analysts on the conference call considered that to be a big enough concern to comment on it. As far as they're concerned, profit growth is a non-issue at this stage. We agree.
The call lasted an hour and every question hit the top line from every imaginable direction. That's what really matters here, and on that respect we're satisfied. Management is comfortable with our sense that revenue will come in around $400 million in the coming year, reflecting healthy 35% growth on that side while leaving the door open to faster progress. As they put it on the call, "We like to be prudent with our guidance."
However, that revenue is unlikely to turn into much more than $18 million in profit or $0.15 per share next year, which is a comedown from what our math indicated could be as much as a $40 million profit. That's the real "disappointment" here. Management didn't talk much about the cost factors, but reading between the lines it's a matter of a more mature sales organization being more expensive to run.
Zscaler just hired a Chief Revenue Officer after an 18-month search. That's going to be a drag on the bottom line until he settles in and starts convincing enterprise customers they need this particular Data Security solution on their desktops. But unlike the people who rushed to sell the news last night, we don't see any sign of the bottom blowing out from here. For one thing, anyone who tells you a few cents less profit next year is a sell signal don't understand the dynamics. Remember, nobody's revenue target budged. That number is as secure as it gets.
Even if Zscaler is all about the profit outlook, surely this decline is exaggerated. And it wasn't really about massive earnings expansion, either. Most of the people on the conference call were only looking for the bottom line to move $0.01 next year, which is not what justifies any of these multiples.
Zscaler was always about the revenue trend. Profit can come and go at this stage in its evolution, but nobody seriously expected real cash flow here before 2021. As long as there's enough money on the balance sheet to reach that point, everything else is really just a mirage of the accounting. After all, this is a company that's still technically burning $28 million a year but with $365 million in the bank, liquidity will not be an issue.
And here's one last data point. That $18 million that management expects to book as profit next year is barely a fraction of the $45 million Zscaler raked in last year from employees buying the stock and exercising options grants. Their level of skin in the game definitely motivates them to work harder to make this company a long-term success. While we understand if you thought that profit number was a do-or-die trigger, we're willing to give the management team a little more time to work. Our $68 Sell Price on Zscaler remains suspended. As far as we're concerned, this is a long-term accumulation opportunity.
After all, if we'd sold Apple (AAPL: $217, up 2% this week) on our first warning that the 2018 iPhone models weren't attracting huge sales, we would have missed out on what's now a 39% YTD run . . . double the performance of the the S&P 500. And now that the market is applauding the 2019 phones, we're looking for richer rewards for our patience in the coming year. One of the biggest companies on the planet has once again turned the corner. We're excited.
Management was paying attention to all the complaining about last year's phones being priced too high for the global market. The new entry level iPhone has rolled back the sticker shock to $699 with the usual improvements in processing power, durability, camera resolution and design. It's going to keep a lot of people in Apple's ecosystem for the next few years and introduce new ones to the company. That's what it's all about now. The bigger the audience, the more Services the company can sell.
But that doesn't mean Apple is leaving free money on the table. The highest-end phones still start at $1,100, so fans who want the elite experience and can afford it still have a way to shift cash into shareholder pockets. Forget about China and trade. This gigantic stock is back within 8% of last year's all-time peak . . . and it only takes half that lost ground to break the $1 trillion barrier one more time. Look out bears. Apple is back.