Shares of Zscaler Inc. plunged more than 19% in late trading today after the cloud security company reported beats on earnings and revenue in its third quarter.

It also raised its full-year revenue and earnings outlook but slashed its free cash flow margin guidance on higher planned capital expenditure.

For the quarter ended April 30, Zscaler reported adjusted earnings per share of $1.08, up from 84 cents in the same quarter a year earlier, on revenue of $850.5 million, up 25% year-over-year. Analysts were expecting adjusted earnings of $1.01 per share on revenue of $835.55 million.

Annual recurring revenue rose 25% to $3.525 billion, with $166 million in net new annual recurring revenue added during the quarter. Stripping out the contribution from Zscaler’s August acquisition of managed detection and response firm Red Canary Inc., annual recurring revenue grew 21%, to $3.398 billion and net new annual recurring revenue grew 14%.

Profitability hit a record. Adjusted operating income came in at $195.8 million, or 23% of revenue, up from $146.7 million a year earlier and the highest operating margin in the company’s history. It posted a net loss of $13.9 million, wider than the $4.1 million loss it reported a year ago. Cash flow from operations was $198 million, down from $211.1 million in the same quarter last year, while free cash flow rose 14%, to $136 million.

Business highlights in the quarter included a string of artificial intelligence partnerships and acquisitions. Zscaler announced its intent to acquire Symmetry Systems Inc., whose access graph technology maps how identities, applications and data connect across enterprises and will be used by Zscaler to govern AI agent communication. The company also joined Anthropic PBC’s Project Glasswing initiative and partnered with OpenAI Group PBC through the DayBreak program to embed frontier models into its security development workflows.

“Zscaler is ideally positioned as the cybersecurity platform for the AI era,” Chief Executive Jay Chaudhry said in the company’s earnings release. “Our differentiated Zero Trust SASE architecture, which hides applications from attackers and eliminates lateral movement, has never been more essential in securing against threats exposed by frontier models and compromised AI agents.”

For its fiscal fourth quarter, Zscaler expects revenue of $875 million to $878 million and adjusted earnings per share of $1.08 to $1.09. For its full fiscal year, the company raised its revenue outlook to $3.330 billion to $3.333 billion, up from prior guidance of $3.309 billion to $3.322 billion. Adjusted earnings guidance was lifted to $4.10 to $4.11 per share, up from $3.99 to $4.02.

Though the headline numbers were positive, the reason for the share price drop was buried lower in the release. Zscaler cut its full-year free cash flow margin guidance to 22.8% to 23.3%, well down from prior guidance of 26.5% to 27%. The company attributed the reduction to capital expenditure tracking in the high single digits as a percentage of revenue, a level investors were not prepared for in a business long pitched on its capital-light cloud model.

Photo: Zscaler