Zscaler (ZS) FY2025 — Grade F: 4 Years GAAP Losses, But $727M FCF

Grade: F — Major Red Flags

Framework: Schilit *Financial Shenanigans* + Beneish M-Score + forensic accounting principles

Data: SEC EDGAR 10-K (Filed 2025-09-11) + Yahoo Finance

Auditor: PricewaterhouseCoopers LLP (PCAOB ID 238) — Clean opinion

One-line verdict: Zscaler is a leading zero trust security platform with $2.67B in revenue (+23% YoY) and 77% gross margins, but the company has never been profitable and carries $1.8B in convertible debt against chronic GAAP losses. The screening engine flags two critical failures: CFFO has been less than net income for three consecutive years (because net income is negative while CFFO is positive — a mathematical artifact), and leverage stands at 16.6x Debt/EBITDA with -24.3x interest coverage. Stock-based compensation of $685.5M consumes 33% of gross profit and exceeds revenue growth. The Beneish M-Score of -3.00 and the Z-Score of 2.31 (grey zone) offer some reassurance, while $3.6B in cash covering debt 2x provides liquidity comfort. But Zscaler remains structurally unprofitable at the GAAP level, and the path to profitability runs through a massive reduction in SBC that would risk talent retention.

The Zero Trust Security Platform

The 10-K states: "For fiscal 2025, fiscal 2024 and fiscal 2023, our revenue was $2,673.1 million, $2,167.8 million and $1,617.0 million, respectively." Approximately 98% of revenue comes from subscription and support.

Revenue growth from the filing: "Revenue increased by $505.3 million, or 23%, in fiscal 2025, compared to fiscal 2024. The change in revenue was driven primarily by an increase in users and sales of additional subscriptions to existing customers, which contributed $434.0 million in additional revenue."

The company defines ARR (annual recurring revenue) as "the next 12 months of revenue from subscription contracts as of the measurement date."

Profitability: Chronic Losses

The 10-K explicitly warns: "We have incurred net losses in all annual periods since our inception. For fiscal 2025, fiscal 2024 and fiscal 2023, our net loss was $41.5 million, $57.7 million and $202.3 million, respectively. We expect we will continue to incur net losses for the foreseeable future."

The SBC breakdown from the filing: "Cost of revenue $70,998; Sales and marketing $259,562; Research and development $257,663; General and administrative $97,311; Total $685,534" (in thousands) for fiscal 2025, up from $549,100 in fiscal 2024. SBC of $685.5M on -$41.5M net loss means without SBC, Zscaler would be solidly profitable ($644M+ non-GAAP operating income). But GAAP is GAAP.

Cash Flow: Strong Cash Generation Despite Losses

The 10-K states: operating cash flow for fiscal 2025 "was $972.5 million, which resulted from a net loss of $41.5 million, adjusted for non-cash charges of $987.2 million and net cash inflows of $26.7 million from changes in operating assets and liabilities. Non-cash charges primarily consisted of $661.4 million for stock-based compensation expense, $166.3 million for amortization of deferred contract acquisition costs."

The C1 check fails because CFFO is less than net income for 3 consecutive years — this is a mathematical quirk since net income is negative (a loss of -$41.5M is "greater than" CFFO of $972.5M in the ratio calculation, which produces a negative ratio). In reality, Zscaler generates strong cash flow despite GAAP losses. This flag is structurally driven rather than indicative of cash flow problems.

Leverage: Convertible Debt Overhang

The filing discloses: the company has "$1.15 billion in aggregate principal amount of our 0.0% Convertible Senior Notes due 2028, which mature on July 15, 2028." Total debt stands at $1.8B.

With an operating loss of -$128.5M, EBITDA is minimal, producing an extreme Debt/EBITDA ratio. Interest coverage is deeply negative. However, the convertible notes carry a 0.0% coupon — no cash interest is owed. The "interest expense" is primarily amortization of debt issuance costs ($4.3M per the filing).

Mitigating context: Cash of $3.6B ($2.4B cash + $1.2B short-term investments) covers the $1.8B debt 2.0x. The Z-Score of 2.31 (grey zone) reflects negative retained earnings, not operational weakness.

Deferred Revenue and RPO: Strong Forward Visibility

From the filing: "As of July 31, 2025, we had deferred revenue of $2,468.0 million, of which $2,054.4 million was recorded as a current liability and is expected to be recorded as revenue in the next 12 months."

Remaining performance obligations: "the aggregate amount of the transaction price allocated to remaining performance obligations was $5,780.1 million. We expect to recognize 46% of the transaction price over the next 12 months and 90% of the transaction price over the next three years."

$5.78B in RPO represents 2.2x trailing revenue — strong forward visibility for a subscription business.

The 18-Point Screening

Beneish M-Score Component Breakdown:

The M-Score of -3.00 is well below the -2.22 threshold. The strongly negative TATA (-0.158) confirms that cash generation substantially exceeds reported earnings — consistent with the deferred revenue and SBC dynamics.

Key Risks from the 10-K

1. Chronic GAAP Losses and SBC Dependency

The company "expects to continue to incur net losses for the foreseeable future." SBC of $685.5M represents 26% of revenue and 33% of gross profit. Non-GAAP income from operations was $580.1M — but this relies entirely on adding back SBC. The real economic cost of compensating employees in stock is shareholder dilution.

2. SG&A Intensity

SG&A consumed 73.4% of gross profit, exceeding the 70% watch threshold. The filing attributes rising costs to "an increase in headcount" and "increased expenses of $18.6 million in marketing and advertising expenses, $10.6 million in travel expenses."

3. Customer Concentration

The filing notes: "Channel partner A" accounted for 12% of accounts receivable. While no single customer exceeds 10% of revenue, channel concentration creates risk.

4. Convertible Note Conversion Risk

The 0.0% Convertible Senior Notes due 2028 carry no cash interest cost but upon conversion could substantially dilute existing shareholders. The company purchased capped calls to partially offset this dilution, but the net effect remains meaningful.

5. Soft Asset Growth

Other assets grew 69.9% vs. revenue growth of 23.3% — a watch item suggesting the balance sheet is becoming more asset-heavy relative to the revenue it generates.

Key Financial Trends (4-Year)

Summary

Grade: F. Two red flags — both structurally driven by chronic losses and convertible debt rather than traditional financial distress.

Zscaler is operationally improving: revenue grew 23% to $2.67B, net losses narrowed to -$42M (from -$202M two years prior), and free cash flow surged to $727M. The Beneish M-Score of -3.00 clears the company of manipulation. RPO of $5.78B provides over two years of revenue visibility.

Both FAIL flags are structural rather than acute. The C1 flag triggers because the CFFO/NI ratio is negative for 3 years — but that is because net income is negative while cash flow is strongly positive. The D2 leverage flag triggers because $1.8B in convertible notes against thin EBITDA produces extreme ratios — but the notes carry 0.0% coupon and cash of $3.6B covers the debt 2x.

The real concern is not the flags themselves but the underlying economics. Zscaler spends $686M on SBC — 26% of revenue — to attract and retain talent. Without this expense, the company would be profitable. With it, the company has "incurred net losses in all annual periods since our inception." The question is whether a cloud security company approaching $3B in revenue should still be asking shareholders to subsidize employee compensation through dilution — or whether GAAP profitability should be within reach.

**Disclaimer**: This report is based on Zscaler's fiscal year 2025 10-K filed with the SEC on September 11, 2025. This is NOT investment advice.

**About EarningsGrade**: We screen earnings reports for financial red flags using an 18-point forensic framework. Grade F means major red flags were detected that warrant thorough investigation.