ZS — Q2 FY26 Earnings Review (WSM)

Date: 2026-04-06 Quarter: Q2 FY26 (January 31, 2026) Market cap: ~22.3B|EV: 20.5B | EV/Run-rate Rev: 6.3x | Revenue growth: 25.9% YoY Stock price: $138.44 | 52-week range: 128–337

Verdict

Beat-and-raise. Re-acceleration confirmed. RPO divergence widening. But the organic engine is limping at +7% and SBC is out of control. This is a fundamentally sound quarter bolted onto a company that the market has given up on — 60% off highs while growth is inflecting upward. The leading indicators are screaming that revenue sustains at 24-26% through FY27. At 6.3x run-rate revenue vs PANW at 13x and CRWD at 18.7x, the market is handing you a $3B+ revenue cybersecurity leader growing faster than both for a third of the price. I'm buying this dislocation. The concerns — SBC at 27%, Red Canary churn, organic net new ARR at +7% — are real and need monitoring, but they're priced in and then some at this multiple.

Thesis: Intact — Strengthening. Conviction 4/5.

The Numbers

Revenue & Growth (QoQ Grid — The Real Picture)

This is how you read ZS. The Q1 (Oct) quarter is the seasonal monster. Q2 (Jan) is always the softest sequential quarter. Compare like-for-like:

What the grid tells you: Q2 FY26 QoQ of 3.5% looks pathetic in isolation. But Q2 is always the weakest quarter. Compare Q2 FY26 (3.5%) to Q2 FY25 (3.2%) and Q2 FY24 (5.7%). The FY26 Q2 reversed the deceleration trend from FY24→FY25 — modestly, but it reversed it. And Q1 FY26 at 9.6% was a massive step-up from Q1 FY25's 5.9%. The Q1→Q2 seasonal fade pattern (169M→28M incremental adds) is consistent across all years. This is normal.

→ The QoQ trajectory is stabilising after the FY25 trough. Not accelerating aggressively, but the deceleration is over.

Revenue — YoY Trajectory (12 Quarters)

| | Q323 | Q423 | Q124 | Q224 | Q324 | Q424 | Q125 | Q225 | Q325 | Q425 | Q126 | Q226 | | | Apr-23 | Jul-23 | Oct-23 | Jan-24 | Apr-24 | Jul-24 | Oct-24 | Jan-25 | Apr-25 | Jul-25 | Oct-25 | Jan-26 | |---|---|---|---|---|---|---|---|---|---|---|---|---| | Revenue ($M) | 419 | 455 | 497 | 525 | 553 | 593 | 628 | 648 | 678 | 719 | 788 | **816** | | YoY % | 46.0% | — | 39.7% | 35.4% | 32.1% | 30.1% | 26.4% | 23.4% | 22.6% | 21.3% | 25.5% | **25.9%** | | QoQ % | 8.0% | 8.7% | 18.6% | 5.7% | 5.4% | 7.2% | 5.9% | 3.2% | 4.6% | 6.1% | 9.6% | **3.5%** | | Incr Rev ($M) | 31 | 36 | 42 | 28 | 28 | 40 | 35 | 20 | 30 | 41 | 69 | 28 | | Beat % | — | — | — | — | — | — | +3.8% | — | — | +1.9% | +2.0% | +2.2% | | GM% [GAAP] | 77.1% | 77.4% | 77.6% | 77.7% | 78.6% | 78.0% | 77.5% | 77.1% | 77.0% | 76.0% | 76.6% | 76.6% | | OM% [nGAAP] | — | — | — | — | 22.0% | 21.5% | — | 21.7% | 21.6% | 22.1% | 21.8% | 22.2% | | EPS [nGAAP] | — | — | — | — | — | $0.88 | $0.77 | $0.78 | $0.84 | $0.89 | 0.96|**1.01** | | FCF (M)|—|—|232|—|—|136|314|143|120|172|413|* * 169 * *||SBC(M) | 108 | — | 129 | 140 | 113 | 149 | 157 | 176 | 168 | 181 | 189 | 220 |

Key observations:

1. YoY re-acceleration is real and sustained. 21.3% → 22.6% → 25.5% → 25.9% over 4 quarters. Two consecutive quarters above 25%. The trough is in.
2. $816M revenue at +26% YoY. This is a $3B+ run-rate business growing faster than PANW (15%) and CRWD (~22%). At scale.
3. Beat-and-raise pattern. 4 consecutive guidance beats at 2%+. FY26 guide raised twice, cumulative +$38M vs initial. Management is sandbagging — bullish.
4. Non-GAAP OM hit 22.2% — all-time high. Operating leverage at work. Non-GAAP op income grew 29% YoY on 26% revenue.

Margins — The Profitability Picture

GAAP gross margin compression is the quiet concern. Down from 78.6% in Q3 FY24 to 76.6% now — a 2pp decline over 7 quarters. Probably driven by Red Canary integration costs flowing through COGS and scale-related infrastructure spend. Non-GAAP GM at 80.2% shows the underlying business model is fine, but the GAAP trend needs to stabilise.

Rule of 40: Revenue YoY 25.9% + FCF margin 20.7% = 46.6%. On H1 basis: 25.7% + 36.3% = 62% (management's "Rule of 62" claim checks out). Above the threshold by a wide margin either way.

Leading Indicators — This Is Where the Alpha Lives

RPO Divergence (Sustained, Widening — Bullish)

RPO at +31% vs revenue at +26% is a 5pp gap. This is the classic leading indicator divergence from my framework. RPO represents contracted future revenue — it doesn't lie. A sustained 5pp gap over 2+ quarters predicts revenue growth sustains or accelerates over the next 4-6 quarters. I've seen this pattern before (AXON in 2023 had RPO at 61% vs revenue at 34% — revenue subsequently accelerated). The magnitude here is more modest but at $3B+ scale, it's structurally significant.

→ Revenue growth of 24-26% is supported through FY27 by the RPO backlog.

ARR Trajectory

| | Q224 | Q225 | Q325 | Q425 | Q126 | Q226 | | | Jan-24 | Jan-25 | Apr-25 | Jul-25 | Oct-25 | Jan-26 | |---|---|---|---|---|---|---| | ARR ($M) | 2,195 | 2,700 | 2,890 | 3,015 | 3,204 | 3,359 | | Sequential Add | — | — | +190 | +125 | +189 | +156 | | YoY % | — | +23.0% | — | — | — | +24.4% |

ARR re-accelerated from 23% to 24.4% YoY. But the sequential add of $156M is lower than Q1's $189M. This is seasonal — Q1 (Oct) is always the strongest bookings quarter and Q2 (Jan) is the weakest. Compare net new ARR across Q2 quarters as more data accumulates.

The Organic Growth Problem — The One Thing That Bothers Me

Net new ARR: $155.5M (+19% YoY). But excluding Red Canary: $139M (+7% YoY organic).

This is the number that keeps me from going to 5/5 conviction. The headline ARR growth of 24.4% is boosted by the Red Canary acquisition ($114M ARR contribution). Strip that out and the organic engine is growing at 7%. For a company positioning itself as "the cybersecurity platform for the AI age," +7% organic net new ARR growth is... fine. Not inspiring. Not accelerating.

What I need to see by Q4 FY26: Organic net new ARR growth accelerating toward 15%+. That would confirm the AI/metered/ZFlex tailwinds are translating into real bookings, not just management narrative.

Why I'm not panicking at 7%: (1) RPO at +31% tells me contracts are being signed — the conversion to ARR is just lagging; (2) ZFlex TCV of $290M in Q2 alone suggests a new commercial motion that may not flow through traditional net new ARR metrics cleanly; (3) The seasonality of Q2 net new ARR makes this the worst quarter to judge organic acceleration.

Customer Metrics

ZTE at 4x YoY is the standout. 550+ customers buying the platform consolidation license (multiple modules in one). This is the land-and-expand motion working — customers moving from point products to the full platform. Reduces churn risk and increases wallet share. I wrote about this exact pattern in CRWD in 2021: multi-module adoption is the stickiest growth vector.

New KPIs — AI/Metered/ZFlex

These are all new disclosures in Q2 FY26. Management is seeding a narrative:

ZFlex is the one I'm watching most closely. $290M TCV in a single quarter at 4-year average terms. That's potentially $72.5M of ARR unlocked per quarter from ZFlex alone if these contracts convert linearly. The consumption/metered model is the mechanism by which AI agent traffic turns into revenue without per-seat negotiation. If ZFlex becomes the default commercial motion, the revenue growth ceiling lifts materially.

SBC & Dilution — The Elephant in the Room

**220MinSBCis27758M on ~$3B revenue — a quarter of every dollar goes out in equity dilution.

Why it spiked: Red Canary + SPLX acquisition ($692M, closed Q1 FY26). Acquisition-related equity comp is likely driving the $32M sequential increase. I expect this to moderate over the next 2-3 quarters as one-time vesting cliffs pass.

Why it matters but doesn't break the thesis at this valuation: At 6.3x run-rate revenue, the market has already punished ZS aggressively for this. GAAP net loss widened to -$34M despite 26% growth. The non-GAAP vs GAAP gap is $232M in Q2 alone. I care about this. But the question is: does SBC at 27% make a 6.3x revenue multiple stock a sell? No. It makes a 20x revenue multiple stock questionable. At 6.3x, the SBC burden is priced in.

What I need: SBC as % of revenue back below 24% within 3 quarters. If it stays at 27%, that changes the calculus.

Guidance — Conservative, Credible

Q3 FY26 Guide

Q3 guide of 835Mimplies23852M (+25% YoY). That would be a third consecutive quarter sustaining 25%+. I think they beat.

FY26 Full-Year Guide (Raised)

FY26 guide raised twice. This is the beat-and-raise pattern. Management is building a credibility track record at ZS that I haven't seen before — the "guide de-risking" pattern from my framework. They're sandbagging every quarter. Bullish.

Implied H2 FY26 revenue: $3,316M midpoint - $1,604M H1 = $1,712M for H2 → $856M avg per quarter. That's 5% above Q2's $816M. Very achievable given RPO backlog.

Valuation — Cheap on Every Metric

This is the cheapest I've ever seen ZS relative to its growth rate and peer set. The stock is down 60% from its 52-week high of $337. Revenue has re-accelerated from 21% to 26%. Non-GAAP OM hit an all-time high. RPO is growing 31%. And the stock trades at a PEG of 1.3x.

For context, Jamin Ball's SaaS universe median trades at ~8-10x EV/Revenue for the 20-30% growth cohort. ZS is at 6.3x. Even a modest reversion to 10x EV/run-rate revenue = 32.6BEV→ 35B market cap → ~$218/share → 57% upside on multiples alone, before accounting for 24%+ revenue growth.

Run-rate P/FCF: 22.3B/(169M × 4) = 33x. But FCF is highly seasonal — H1 was $582M, FY26 guide implies $879-895M. On guided FCF: $22.3B / $887M = 25x FCF. Very reasonable for 26% growth.

Atlas Baseline — Where I Agree and Diverge

Atlas scored this 4/5 conviction with a "conditional pass" on the qualification gate. I broadly agree with Atlas's assessment but add three nuances:

1. Atlas is right on RPO divergence — this is the primary alpha signal. I'd weight it even more heavily than Atlas does. When RPO grows 5pp faster than revenue for 2+ quarters at $3B+ scale, the market is systematically underpricing forward growth.

2. Atlas underweights the ZFlex signal. $290M TCV in Q2 (+65% QoQ) in a new commercial model is a bigger deal than Atlas's treatment suggests. If ZFlex becomes the default sales motion, it fundamentally changes the revenue model from seat-based to consumption-based. That's a TAM expansion mechanism, not just a go-to-market tweak.

3. I'm more concerned about SBC than Atlas. Atlas notes it but moves on. 220Minasinglequarteris * not * normal, evenwithacquisitioneffects.Ifthisdoesn^′tmoderateto<190M by Q4 FY26, the GAAP-to-non-GAAP gap becomes a credibility issue. Management not addressing it on the call is a yellow flag — they should acknowledge it and provide a path to normalisation.

Key Risks (Ranked)

1. Organic net new ARR at +7%. The AI narrative is ahead of the organic numbers. Needs 15%+ by Q4 FY26 or the "AI tollbooth" thesis is noise.
2. SBC at 27% of revenue. Worst quarter ever. If acquisition-related, should normalise in 2-3 quarters. If structural, destroys the GAAP earnings trajectory.
3. Red Canary churn. Management acknowledged "elevated churn" but gave zero specifics. $114M ARR needs to grow to $130M by FY26 end. Integration risk is real — Forrester's FireEye-Mandiant parallel is uncomfortably apt.
4. EMEA deceleration. +18% vs Americas +31% — a 13pp geographic divergence. 28% of revenue. If this spreads to Americas, growth retraces toward 20%. Management did not address.
5. SASE competitive gap. No SD-WAN. PANW Prisma, Cato (+43% ARR), Fortinet all have integrated SASE offerings. ZS is SSE Leader but SASE Visionary. Market is shifting toward bundled solutions.
6. NRR non-disclosure. Companies stop reporting metrics when they deteriorate. The +7% organic net new ARR is the best proxy — it's adequate but not strong.

Key Catalysts

1. AI agent deployment wave (2026-28). Every agent needs secure network access through ZIA. Metered pricing monetises agent-count growth without seat negotiation. The structural TAM expansion opportunity.
2. ZFlex adoption. $290M Q2 TCV. If this compounds at 50%+ QoQ, it removes the seat-count revenue ceiling and opens mid-market.
3. Valuation mean reversion. 6.3x EV/run-rate revenue vs 2-year median ~13x. Even partial reversion to 10x = 57% upside.
4. Q3 FY26 beat continuation. If actual comes in at ~$852M (2pp beat pattern), that's three straight quarters above 25% YoY. Market narrative shifts.
5. SBC normalisation. If SBC drops back below 24% of revenue in Q3/Q4, it removes the GAAP overhang and potentially triggers re-rating.

Conference Call — What Management Wants You to Hear vs What You Should Hear

What they want you to hear: "Cybersecurity platform for the AI age." "Rule of 62." "Nearly 1 trillion AI transactions." "ZFlex TCV >$290M." All true. All positioned to make you think AI is driving the bus today.

What you should actually hear: Core ZIA/ZPA growing mid-teens. Organic net new ARR at +7%. Red Canary churn "elevated" with no timeline. EMEA at +18%. The re-acceleration is real but it's driven more by the acquisition ($114M ARR bolted on) and strong Americas performance (+31%) than by an organic AI-driven inflection.

What they refused to answer: Red Canary churn magnitude. Red Canary stabilisation timeline. ZFlex cannibalization vs expansion split. NRR (still not disclosing).

→ Management is credible but selectively transparent. Consistent beat-and-raise earns trust. But the AI narrative is running ahead of the organic numbers. I'm buying the RPO divergence and the valuation, not the narrative.

Prior Beliefs / Updated Beliefs

I haven't held ZS before. My priors were based on the Atlas stock analysis from 2026-04-02 and my own historical corpus writings on ZS (2022-2023 portfolio context).

Prior Beliefs

1. Revenue would come in ~$810-815M, beating $797-799M guide by ~2pp.
2. RPO growth would sustain above 25%, confirming the bullish divergence.
3. Non-GAAP OM would hold at ~21.5-22.0%.
4. Red Canary integration would be messy — churn elevated, ARR stable at best.
5. SBC would moderate from Q1's $189M as acquisition effects normalised.

Updated Beliefs

Delta Assessment

Positive surprises: Non-GAAP OM at all-time high; RPO at +31% (widening divergence = strongest forward signal); ZFlex TCV at $290M (new data point, bullish for revenue model evolution).

Negative surprises: SBC at 220M/2734M despite 26% growth.

Net assessment: The bull case got marginally stronger (RPO, OM, ZFlex). The bear case didn't change — same concerns, same magnitude. At this valuation, the asymmetry favours the bulls.

Thesis Statement

Zscaler is the dominant SSE platform (34% market share, Gartner Leader 4 years) positioned as AI-era security infrastructure, trading at a crisis-level valuation discount while revenue re-accelerates and leading indicators diverge bullishly. The organic engine is adequate (+7% net new ARR growth), not exceptional. The AI/metered pivot is early but directionally correct. SBC is elevated but acquisition-driven. At 6.3x run-rate revenue with 26% growth, the risk/reward is heavily skewed to the upside.

What I'm Watching for Q3 FY26

1. Organic net new ARR growth. Needs to inflect above 10%. The AI thesis requires it.
2. SBC. Must drop below $200M. If it stays above $210M, it's structural, not acquisition-driven.
3. Red Canary ARR. Needs to show sequential growth from $114M. Any decline = integration failure.
4. RPO growth. Must sustain above 28%. If it compresses toward revenue growth, the divergence thesis weakens.
5. EMEA growth. Any improvement above 18%? Or did the deceleration deepen?

Action

Initiating position. The combination of re-accelerating growth, sustained RPO divergence, all-time high non-GAAP margins, and a PEG of 1.3x at 60% off highs is too compelling to ignore. SBC is the overhang but it's priced in at 6.3x revenue. I'll size conservatively (5-7%) until I see SBC normalise and organic net new ARR accelerate.

-wsm

(Initiating ZS, ~5-7%)

Analysis date: 2026-04-06 | Data through Q2 FY26 (Jan-2026) | Stock price: $138.44 Atlas baseline reviewed: ZS_earnings-review_Q2_FY26.md (2026-04-03) and ZS_stock-analysis_2026-04.md (2026-04-02)