Zscaler, Inc. — Q2 FY2024 Form 10-Q
Reporting period: Three and six months ended January 31, 2024; fiscal year ends July 31. The filing is unaudited. Zscaler sells cloud security subscriptions and related support, primarily through channel partners, and reports one operating segment.
Financial performance and position
| Metric | Q2 FY2024 | Q2 FY2023 | Six months FY2024 | Six months FY2023 |
|---|---|---|---|---|
| Revenue | $525.0 million | $387.6 million | $1,021.7 million | $743.1 million |
| GAAP gross margin | 78% | 77% | 78% | 78% |
| Operating loss | $45.5 million | $65.2 million | $91.5 million | $134.3 million |
| Net loss | $28.5 million | $57.5 million | $62.0 million | $125.6 million |
| Operating cash flow | $142.1 million | $89.5 million | $402.9 million | $217.9 million |
| Free cash flow, non-GAAP | $100.8 million | $62.8 million | $325.5 million | $158.4 million |
- Q2 revenue grew 35% year over year; six-month revenue grew 37%. Six-month GAAP gross margin was unchanged. Q2 operating margin was approximately (9)% versus (17)%; six-month operating margin was approximately (9)% versus (18)%. Six-month net loss per share was $0.42 versus $0.87.
- Non-GAAP operating income was $103.2 million for Q2 and $192.9 million for the six months, compared with $48.8 million and $90.9 million, respectively. These measures exclude stock-based compensation and related payroll taxes, and acquired-intangible amortization.
- Cash, cash equivalents and short-term investments totaled $2.460 billion at January 31, 2024, versus $2.100 billion at July 31, 2023. Current assets were $3.143 billion and current liabilities $1.584 billion. Deferred revenue totaled $1.502 billion.
- Convertible notes had $1.150 billion principal and a $1.141 billion net carrying amount. Accumulated deficit was $1.152 billion. Stock-based compensation expense was $269.6 million for the six months.
Changes and operating drivers
- Revenue gains primarily reflected expansion in existing customers, including more users and subscriptions ($89.3 million of Q2 growth; $195.6 million for the six months), along with new customers. Management reported a 14% increase in customer base year over year.
- Dollar-based net retention was 117% for the trailing 12 months, down from above 125% a year earlier. Remaining performance obligations were $3.613 billion; the company expects to recognize 51% within 12 months and 96% within three years.
- Q2 cost of revenue rose 34%, mainly from higher hosting/data-center costs and employee costs; operating expenses rose 24%. Research and development expense increased 42% in Q2 and 47% for the six months, primarily reflecting headcount and stock-based compensation.
- Operating cash flow improved year over year, aided by noncash adjustments, collections and higher deferred revenue. Six-month investing cash flow was an outflow of $248.8 million, including investment purchases and $77.4 million in capital expenditures; financing cash flow was $22.3 million.
Outlook, risks and unusual items
- The filing provides no specific quarterly or annual revenue or earnings guidance. Management expects continued operating losses for the foreseeable future while investing in sales and marketing, research and development, infrastructure and growth. It expects gross margin to increase slightly over the long term and operating expenses to rise in absolute dollars near term.
- Management says customer scrutiny and longer approval processes, particularly for large deals, may continue amid macroeconomic uncertainty. It also cites competition, customer renewal and expansion, channel-partner reliance, service availability and cybersecurity, regulatory compliance, and execution of growth and acquisitions as important risks.
- Management believes existing cash, cash equivalents and investments are sufficient for at least 12 months from issuance of the financial statements, but notes this is forward-looking and that future financing may be needed.
- The notes became conditionally convertible during Q2 and were convertible at holders’ option from February 1 through April 30, 2024. Conversion could require cash settlement and affect liquidity; accounting reclassification could reduce reported working capital. Capped calls are intended to partially offset dilution, subject to a cap.
- Effective in fiscal 2024, the estimated useful life of servers and networking equipment was extended from four to five years. This reduced depreciation expense by $3.2 million in Q2 and $6.3 million for the six months.
- The company acquired Securelyshare for stated consideration of $5.3 million, including a $0.8 million holdback, and recorded $2.8 million of developed technology and $3.2 million of goodwill. It also entered a cloud-platform services agreement with a $100 million minimum commitment over five years.
- The company reported no pending or threatened legal proceeding it believed likely to have a material adverse effect, while noting litigation outcomes are uncertain. Management concluded disclosure controls were effective as of January 31, 2024.
Important facts for investors to verify
- Whether retention and customer expansion stabilize, given net retention’s decline to 117%, and whether large-deal sales cycles affect growth.
- Whether operating cash flow and free cash flow remain strong after considering deferred-revenue timing, capital spending and stock-based compensation.
- How convertible-note holders act during conversion windows, and any resulting cash requirements, share dilution or working-capital presentation changes.
- Whether the useful-life estimate change, which lowered depreciation, affects comparability of reported costs and margins.
- Progress integrating Securelyshare and the economics and obligations of the five-year, $100 million cloud-services commitment.
- Whether ongoing investment, macroeconomic conditions, cybersecurity and service-availability risks affect profitability, renewals or liquidity.