Zscaler, Inc. — Q2 FY2023 Form 10-Q
Reporting period: Three and six months ended January 31, 2023; fiscal year ends July 31. Unaudited results. Zscaler provides cloud security subscriptions and support on a SaaS basis and reports as one segment. Amounts below are in U.S. dollars; financial figures are in millions unless stated otherwise.
Financial performance and liquidity
| Metric | Q2 FY2023 | Q2 FY2022 | Six months FY2023 | Six months FY2022 |
|---|---|---|---|---|
| Revenue | $387.6 | $255.6 | $743.1 | $486.1 |
| GAAP gross margin | 77% | 77% | 78% | 77% |
| Operating loss | $(65.2) | $(83.9) | $(134.3) | $(158.3) |
| Net loss | $(57.5) | $(100.4) | $(125.6) | $(191.2) |
| Net loss per share, diluted | $(0.40) | $(0.71) | $(0.87) | $(1.37) |
| Operating cash flow | $89.5 | $48.3 | $217.9 | $141.5 |
| Free cash flow (non-GAAP) | $62.8 | $29.4 | $158.4 | $112.8 |
- Q2 revenue grew 52% year over year; six-month revenue grew 53%. Management attributed growth to increased users and additional subscriptions from existing customers, as well as new customers; the customer base increased 16% year over year through January 31.
- Q2 non-GAAP operating income was $48.8 million, with a 13% margin, versus $22.3 million and 9% a year earlier. Six-month non-GAAP operating income was $90.9 million, with a 12% margin, versus $46.3 million and 10%. These measures exclude stock compensation and related payroll taxes, and acquired-intangible amortization.
- Six-month free-cash-flow margin was 21%, compared with 23%; free cash flow is a non-GAAP measure. Operating cash flow benefited from $90.9 million of deferred-revenue growth and collections, and included $214.9 million of stock-based compensation as a noncash adjustment.
- At January 31, cash and cash equivalents were $1,257.0 million and short-term investments were $648.3 million, totaling $1,905.3 million. Current assets were $2,416.1 million and current liabilities $1,204.0 million.
- Convertible notes had $1,150.0 million principal and a $1,140.5 million net carrying value, bear 0.125% interest, and mature July 1, 2025. The notes’ conversion conditions were not met in the quarter. Cash and investments exceeded the notes’ principal, but the company expects continued operating losses.
- Deferred revenue totaled $1,111.9 million, up from $1,021.1 million at July 31, 2022. Remaining performance obligations were $2,809.2 million; management expects to recognize 51% within 12 months and 96% within three years.
Material changes and notable items
- Operating loss narrowed despite higher operating expenses: Q2 sales and marketing rose 35%, R&D 24%, and general and administrative expense 16% year over year. The company continued hiring and investing in sales, platform development, and infrastructure.
- For the six months, calculated billings grew 36% to $833.9 million; Q2 calculated billings grew 34%. Management cautioned that growth rates may trend down and that billings are affected by seasonality and invoicing mix.
- Channel partners represented 92% of Q2 revenue and 93% for the six months. The five largest channel partners and affiliates represented 27% of six-month revenue.
- Adoption of ASU 2020-06 on August 1, 2022 increased the notes’ carrying amount by $169.9 million, reduced additional paid-in capital by $273.7 million, and increased accumulated deficit by $103.8 million. It also substantially reduced reported interest expense versus the prior period; this accounting change is not an operating improvement.
- Notable compensation items included a $9.9 million reversal of stock-based compensation following the President’s October 2022 resignation, $5.6 million of expense from certain equity-award modifications, and $8.3 million of incremental ESPP compensation to be recognized over future periods.
Outlook, commentary, and risks
- No quantified revenue, earnings, or cash-flow guidance for the remainder of FY2023 is provided in the filing text. Management expects continued net losses for the foreseeable future, operating expenses to rise in absolute dollars near term, and gross margin to increase slightly over the long term.
- Management reported longer approval processes and increased scrutiny of large purchases in the challenging macroeconomic environment, and expects customer caution and elongated sales cycles to continue in the near term. It stated that existing cash, cash equivalents, and investments should fund operations and capital needs for at least 12 months from issuance of the financial statements.
- After quarter-end, Zscaler completed its acquisition of Canonic Security for approximately $20.3 million before adjustments; the initial purchase accounting was incomplete. It also committed on March 1 to reduce worldwide headcount by about 3%, with expected non-recurring charges of $8–$10 million, mostly in Q3 FY2023.
- Principal disclosed risks include continued losses and uncertain path to profitability; competition and customer adoption, renewal, and expansion; macroeconomic-driven spending delays; dependence on channel partners; service availability and cybersecurity incidents; hiring and retention; regulatory and litigation exposure; and the ability to service or settle the convertible notes. The company reported no pending or threatened legal proceeding it believed likely to materially adversely affect future results or operations, while noting litigation remains unpredictable.
Important facts for investors to verify
- Track revenue, calculated-billings growth, deferred revenue, RPO conversion, and renewal/expansion trends as customer purchasing decisions slow.
- Assess the sustainability of cash generation, including the effects of advance customer billings, deferred commissions, capital spending, and substantial stock-based compensation.
- Review the notes’ conversion and settlement terms, potential dilution, and July 2025 maturity; the capped calls have a stated cap price of $246.76 per share.
- Confirm the final Canonic purchase accounting and the actual timing, headcount impact, and costs of the announced restructuring.
- Monitor progress toward profitability and margin improvement against ongoing investment needs and the company’s stated expectation of continued losses.