Zscaler, Inc. — Q3 Fiscal 2024 Form 10-Q
Reporting period: Three and nine months ended April 30, 2024. Fiscal year ends July 31. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless noted.
Business context
Zscaler sells cloud-security subscriptions and related support through a SaaS model, primarily via channel partners. Subscription and support revenue represented approximately 98% of Q3 revenue and 97% for the nine-month period. The company operates as one reportable segment.
Financial highlights
| Metric | Q3 FY2024 | Q3 FY2023 | Nine months FY2024 | Nine months FY2023 |
|---|---|---|---|---|
| Revenue | $553.2; +32% | $418.8 | $1,574.9; +36% | $1,161.9 |
| Gross profit / margin | $434.9 / 79% | $323.0 / 77% | $1,228.0 / 78% | $901.8 / 78% |
| Operating loss | $(3.0) | $(55.7) | $(94.5) | $(190.1) |
| Net income (loss) | $19.1 | $(46.0) | $(42.8) | $(171.7) |
| Operating cash flow | $173.4 | $108.5 | $576.3 | $326.4 |
| Free cash flow, non-GAAP | $123.1 | $73.9 | $448.6 | $232.3 |
- Q3 diluted EPS was $0.12, versus a loss of $0.32 a year earlier. Nine-month diluted loss per share was $0.29, versus $1.19.
- Q3 interest income was $27.6, helping produce positive net income despite the operating loss. Nine-month interest income was $81.9; interest expense was $9.5.
- At April 30, cash and cash equivalents were $1,259.2 and short-term investments were $980.8, totaling $2,240.0. Current assets were $2,970.0 and current liabilities $1,701.3.
- Convertible notes had $1,150.0 principal and a $1,137.7 carrying amount, net; they bear 0.125% interest and mature July 1, 2025. Cash and investments exceeded note principal by approximately $1.09 billion.
- Deferred revenue was $1,577.0, up from $1,439.7 at July 31, 2023. Remaining performance obligations were $3,824.1; Zscaler expects to recognize 51% within 12 months and 95% within three years.
Changes versus comparable periods
- Revenue growth reflected expanded usage and additional subscriptions from existing customers, plus new customer additions. Management attributed $91.4 of Q3 revenue growth and $318.5 of nine-month growth to existing customers; customer count increased 14% year over year.
- Q3 gross margin improved two percentage points, while nine-month margin was unchanged. Management attributed the Q3 improvement partly to extending estimated server and networking equipment useful lives from four to five years. The estimate change reduced depreciation expense by $3.4 in Q3 and $9.7 over nine months.
- Operating losses narrowed as revenue growth outpaced expense growth. Nine-month sales and marketing expense rose 15%, R&D rose 42%, and G&A rose 19%. Stock-based compensation expense was $382.8 over nine months, compared with $322.7 a year earlier.
- Nine-month operating cash flow increased to $576.3, supported in part by a $132.4 increase in deferred revenue and noncash expenses. Investing cash outflow rose to $609.0, including $361.8 of acquisition payments, net of cash acquired. Cash and cash equivalents were nearly unchanged from July 31, 2023.
- Dollar-based net retention was 116% for the trailing 12 months, down from above 125% a year earlier. Calculated billings grew 30% in both Q3 and the nine-month period; management expects the growth rate to trend down over time.
Outlook, risks and unusual items
- The filing provides no quantified quarterly or full-year revenue or earnings guidance. Management expects operating expenses to rise in absolute dollars in the foreseeable future, anticipates continued investment in sales and marketing and R&D, and expects net losses for the foreseeable future. It expects gross margin to increase slightly over the long term, but notes that margins may fluctuate.
- Management stated that existing cash, cash equivalents and short-term investments should fund operating and capital needs for at least 12 months from issuance of the financial statements. It cautioned that growth investments, acquisitions, macroeconomic conditions and other factors could change capital needs and that future financing may not be available on acceptable terms.
- Management reported customer scrutiny and longer approval processes, particularly for large transactions, amid inflation, high interest rates and geopolitical uncertainty. Other key risks include competition, customer renewal and expansion, channel-partner reliance, platform availability and cybersecurity, AI-related legal and development risks, and international regulatory and operating exposure.
- Zscaler completed the Avalor and Airgap acquisitions in March and April 2024, respectively. Their preliminary purchase-price allocations added $327.8 of goodwill; integration and valuation adjustments remain relevant. Deferred employee merger consideration is payable in restricted shares and subject to vesting.
- The COO responsible for sales resigned in February 2024; cancellation of unvested awards produced an $11.7 stock-based compensation reversal in Q3 sales and marketing expense. The useful-life estimate change also benefited reported depreciation and gross margin.
- A new cloud-platform services agreement carries a $100.0 minimum purchase commitment over five years. Zscaler disclosed ordinary-course litigation but no pending or threatened proceeding it believed likely to materially adversely affect future results or operations.
- Disclosure controls and procedures were deemed effective as of April 30, 2024; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- Whether growth in revenue, calculated billings and deferred revenue can continue as customer approval cycles lengthen and billings growth is expected to moderate.
- Whether the decline in dollar-based net retention to 116% persists, and how much future growth depends on existing-customer expansion versus new customers.
- How sustainable cash generation is after considering stock-based compensation, deferred-revenue timing, contract-acquisition costs and infrastructure investment.
- Whether the Avalor and Airgap integrations deliver expected benefits, and whether preliminary goodwill and intangible-asset valuations change during the measurement period.
- Plans and liquidity needs around the $1.15 billion notes due July 2025, including potential conversion, cash settlement and dilution implications.
- The impact of the server-life estimate change and unusually high stock-based compensation on comparisons of reported and non-GAAP performance.