Zscaler's Product Expansions Drive Sales: Are Margins at Risk?

Zscaler ZS reported strong results for its third quarter of fiscal 2025. The company’s revenues rose 23% year over year to $678 million. But one area to watch closely is non-GAAP gross margins. The company’s total gross margin slipped slightly to 80.3%, down from 81.4% a year ago, representing a 110-basis point contraction.

Management attributes this dip in the margins to the rollout of its latest products, which are built to gain market share quickly rather than deliver high margins right away. The company plans to focus on improving margins once these products achieve scale.

Over the past few months, Zscaler has introduced several fast-growing new modules under categories like Zero Trust Everywhere, Data Security Everywhere, and Agentic Operations. While these are attracting large deals and expanding annual recurring revenue (ARR), they’re not margin-optimized yet.

The launch of the Z-Flex program, which offers flexible purchasing options across modules, has helped land multi-year platform deals, contributing more than $65 million in total contract value in the third quarter alone. These deals, however, often bundle lower-margin modules, making near-term margin stability more challenging.

Despite these pressures, management emphasised during the third quarter call that it has achieved revenue growth of 24% and a free cash flow margin of 28% for the year-to-date period. This led to Zscaler hitting a combined score of 52%, which it calls Rule of 52, marking 21st straight quarter of exceeding the Rule of 40 benchmark. This highlights the company’s ability to balance growth with profitability.

However, management guides for a gross margin of 80% for the fourth quarter of fiscal 2025.  This indicates a sequential decline of 30 basis points. If Zscaler can execute on its plans to optimize newer offerings, the current margin trade-off may strengthen its long-term position in cloud security.

How Competitors Fare Against ZS

CrowdStrike CRWD and Okta Inc. OKTA are also evolving their platforms to meet enterprise security demands.

CrowdStrike is another established player in the identity security space, providing unified, real-time protection across cloud, identity and endpoint. CrowdStrike is enhancing its identity security platform with the implementation of AI copilots like Charlotte AI and agentic AI solutions like Charlotte AI Agentic Workflows.

Okta focuses on identity and access management, providing cloud-based solutions that help businesses safeguard user data. Enterprises can now implement Identity Threat Protection with Okta AI to leverage AI and machine learning techniques for real-time detection of the entire spectrum of Identity attacks.

ZS’s Price Performance, Valuation and Estimates

Shares of Zscaler have surged 74.4% year to date compared with the Security industry’s growth of 22.1%.

ZS YTD Price Return Performance

From a valuation standpoint, Zscaler trades at a forward price-to-sales ratio of 15.32X, higher than the industry’s average of 14.67X.

ZS Forward 12-Month P/S Ratio

The Zacks Consensus Estimate for Zscaler’s fiscal 2025 earnings implies a year-over-year decline of 0.31%, while for fiscal 2026 earnings implies year-over-year growth of 12.01%. The earnings estimates for fiscal 2025 and fiscal 2026 have been revised upward in the past 60 days and 30 days, respectively. 

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This article originally published on Zacks Investment Research (zacks.com).

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