A to Z Software and SaaS Operational Benchmarking Series: Zscaler

In this series, I will go through a list of currently public (or to be public and formerly public) software and SaaS companies, and run through a set of operational benchmarks based on publicly available data. Using public information such as SEC filings, press releases, earnings transcripts and investor presentations, I have pieced together a variety of items that are noteworthy to monitor and understand for these companies of varying scale, growth rates and profitability. Given the sheer amount of publicly available data and information circulated over the time horizon considered in this article, I may have missed item(s) worthy of consideration (so please leave me your thoughts!) and will not be adjusting all the historical financials on a pro forma basis for M&A. I have conducted this analysis myself and it expresses my own opinions and work product, as I have no business relationship with the company mentioned in this article, nor should anyone use this article to make an investment decision. Please do your own due diligence and do not rely on this information herein.

Introduction

The next company covered in the A to Z Software and SaaS Operational Benchmarking Series is Zscaler.

Zscaler has been a public company since March 2018, and has a wealth of filings available for us to scour and review.

Here is an excerpt describing the business from the company’s filings: Zscaler is a cloud security company that developed a platform incorporating core security functionalities needed to enable fast and secure access to cloud resources based on identity, context and organization’s policies. Our solution is a purpose-built, multi-tenant, distributed cloud platform that incorporates the security functionality needed to enable users, applications, and devices to safely and efficiently utilize authorized applications and services based on an organization’s business policies. We deliver our solutions using a software-as-a-service (“SaaS”) business model and sell subscriptions to customers to access our cloud platform, together with related support services.

Here are some high-level overviews of the company’s platform from its most recent quarterly filing and presentation slides.

The company has generated nearly $2.3 billion in total revenue over the last twelve months ended October 31, 2024 and has approximately 8,650 customers as of their latest fiscal year ended July 31, 2024. The average revenue per customer as of July 31, 2024 was $250.6K.

Zscaler provides a solid breakout of additional metrics on its financial and operational profile, which we will breakdown in later sections of this article.

I will walk through Zscaler’s key operational metrics across the company’s financial statements and key trends, and have compiled scorecards to compare the company to a variety of software / SaaS company benchmarks. This article serves as another example on how to evaluate a company’s financial and operational profile through a detailed assessment of available data and metrics. This can help business owners and investors apply similar approaches and analyses for other companies of interest.

For those who are not interested in going through the entire article and want a brief snapshot of the company’s key metrics as of its latest publicly available quarter (three months ended October 31, 2024), here is a compilation of summary charts:

Revenue Profile

Zscaler has a diverse sales model and GTM approach to drive towards its nearly 9K customers and $2.3 billion revenue. The company utilizes a very mature channel sales model with a direct sales approach that jointly drives new and existing revenue adoption.

The company had 8,650 total customers over its most recent fiscal year, which grew 12% year-over-year over the 7,700 total customers figure as of July 31, 2023.

Zscaler has a largely recurring / subscription-based revenue model, generating at / above 97% of its total revenue from recurring subscription and related support revenue. The company typically sells agreements that range from 1 year to 3 years with annual upfront invoicing across its contract base.

The company also provides additional disclosures on billings, which represent total revenue plus the change in deferred revenue over the disclosed period. As of the latest disclosure in October 31, 2024, the company disclosed billings of nearly $2.7 billion over LTM ended October 31, 2024, which grew 25% over LTM ended October 31, 2023 billings of ~$2.2 billion.

Beyond its subscription revenue, the company derives a nominal amount of revenue from professional services, which represent fees from mapping, implementation, network design, and training of its SaaS platform.

The company does not breakout its revenue by subscription vs. professional services within any of its filings, but does provide additional segmentation detail on its revenue generated through its channel vs. direct sales model, as well as revenue by geography.

Zscaler generates most of its revenue from channel partners, which made up 90% of its total revenue as of LTM ended October 31, 2024 revenue. The remaining 10% of revenue was generated from its direct sales model.

From a geographic perspective, the company has solid diversification across its four disclosed categories. As of LTM ended October 31, 2024, Zscaler generated 51% of its revenue from the United States, 31% from EMEA, 15% from APAC, and 4% from Other.

Here is the view of the Zscaler’s quarterly revenue details and quarterly YoY revenue growth rates in its revenue profile, as well as its revenue segmentation and mix by channel/direct and geography:

From an annual standpoint, here is a view of Zscaler’s revenue by type and growth rates, along with its overall revenue mix by channel/direct and geography again:

According to the disclosed data I was able to retrieve and review, the company has made 10 acquisitions. The company discloses data on some of these transactions within its public filings, but I have not made explicit adjustments for any pro-forma details across the financial information I have provided in this article.

As is standard when assessing software companies, it is important to understand the impact of seasonality across its revenue and financial profile.

In typical scenarios for numerous software / SaaS companies, we see a revenue skew towards the back-half of the year, especially the fourth quarter. This can be a result of numerous factors, most notably customers releasing budgeted spend (planned or excess amounts) to invest in new software purchases.

The company has a fiscal year that ends in July 31, but for the purposes of the seasonality, we are showing the revenue breakdown on as close to a calendar year basis. The calendar year figures shown throughout this article are ended as of January 31.

There is back-half seasonality in the company’s disclosed figures, as are shown below:

For the data I have analyzed, Zscaler has consistently generated very strong growth rates that used to exceed the 50% range. However, the company is classified as a mid-growth business given it is between 20% and 40% growth, but is very close to 40%, so it is on the upper end of the mid-growth classification.

Given its scale and growth rates, I have classified the company as a scaled, mid-growth company. If you have followed along in this series and read about the other companies I have covered to-date, this categorization I have provided means that Zscaler has revenue above $100M a year, and has grown its revenue at rates between 20% and 40%.

The below graphs and the scorecard chart summarize the company’s revenue metrics and performance history over a variety of benchmarks for typical software / SaaS companies:

Expense Profile

Before we dig into Zscaler’s costs and expense profile, here is a typical composition of expense categories for most software and SaaS companies:

• Cost of Sales / Cost of Goods Sold: costs to deliver, maintain, service and host product / services and support existing customers on platform
• Sales & Marketing: costs to directly / indirectly sell and market product / services
• Research & Development: costs to develop new products / services (incremental of the maintenance of existing product / services, which typically falls under COS / COGS)
• General & Administrative: costs that do not fall under other buckets; typically include: legal, finance, admin, executive, rent and other general corporate costs

In addition to these typical expense categorizations, companies may choose to break out cost of revenues by each individual revenue stream.

Given that the company does not segment its revenue into multiple categories, the cost of revenue line item is similarly disclosed as one line item.

At the end of this section, I have included benchmarks to compare against as well, serving as useful rules of thumb.

Here are quarterly summaries of Zscaler’s expenses as a % of revenue over time:

Zscaler has a solid cost of revenue profile that benefits from operating scale and economies to scale, as is noted by its slight improvement and steady state % of revenue over time as the business has continued to grow. This is largely due to the fact that the cost of revenue is largely tied to operating its data center costs, as well as employee costs in the customer success/support and cloud operations functional areas.

The company does have a relatively high sales and marketing % of revenue, which has consistently trended in the high 40s/low 50% range as of late, and was historically above 60% of revenue. The company notes that its sales and marketing expenses are its largest operating expense, and that the company expects it to continue to be its largest category into the future. Despite being higher historically, Zscaler management notes that they will continue to attempt to drive sales and marketing expenses as a % of revenue downwards, like they have in recent periods.

Beyond that, the research and development and general and administrative expenses round out the rest of the operating expense profile, both of which have been steady / slightly improved over time. The only exception to that is the recent uptick in research and development costs as a % of revenue, which recently ticked above 24% of total revenue.

The below shows the company’s expense profile scorecard:

The benchmarks shown above are representative of what similarly sized software and SaaS companies should attempt to attain based on my experience in the industry and working with clients. A note of caution / disclosure — these benchmarks are not applicable to every single software and SaaS company, but illustrative ranges that business owners and investors can use as rules of thumb.

Profitability Profile

Generally speaking, the three selected profit metrics that I focus on in this section are: gross profit, EBITDA and operating cash. Primary reasons on why each of these profitability metrics are important to consider for all software and SaaS businesses are detailed here:

• Gross Profit: conveys a company’s profitability considering departments and business areas such as hosting, IT operations and customer support
• EBITDA: conveys how profitable a business is across all major functions and departments, including the impact of operating expenses (S&M, R&D and G&A)
• Operating Cash: conveys how profitable a company is on an operating cash basis (i.e. how effective a company is converting EBITDA into cash)

Zscaler does not explicitly disclose EBITDA, but provide all of the components for us to calculate it. The company also does a good job of keeping its operating income relatively clean from its face of the P&L, as it does not separate add-backs or items explicitly in the face of its income statement, but within its footnotes accordingly.

Let’s dig into Zscaler’s gross profit and gross profit margins on a quarterly and annual basis:

The company boasts a gross margin of close to 80%, a number that is has been consistently been between 77% and 78% on a blended basis. Because Zscaler generates 97% of its revenue from recurring, subscription revenue, it is not surprising to see a strong and stable gross profit and margin profile.

Beyond gross profit, we can dig into the company’s EBITDA and EBITDA margin profile to get a sense of its operating profitability over time.

Please note that I have not made any other adjustments (e.g. no add-backs for any one-time, non-recurring items like litigation, M&A expenses, etc.) to these figures beyond adding back depreciation and amortization to the company’s disclosed operating income figures, along with stock-based compensation given that many software and SaaS companies do so in their non-GAAP disclosures.

Here is a view of Zscaler’s EBITDA, again on a quarterly and annual basis:

While this EBITDA removes the cost impact of stock-based compensation through the add-back of these figures, the company has done a good job recently of driving improvement in its EBITDA profile. This is driven through a combination of sustaining a very strong growth rate that remains close to 40%, despite recent deceleration, as well as the company’s improving cost profile across nearly all of the functional categories.

Finally, here is a view of operating cash. This takes EBITDA and includes the impact of capital expenditures and capitalized software, as well as the impact of change in net working capital.

As I have done in previous articles in this series, I am calculating operating cash as follows:

EBITDA less capital expenditures and capitalized software less the period-over-period change in net working capital (net working capital is defined as current assets (excluding cash) minus current liabilities)

Here are Zscaler’s operating cash metrics over time:

As expected, the company has some variability / swings from period-to-period due to its working capital, but generally speaking, the operating cash profile mirrors the EBITDA profile. It has improved and remained solid. Again, the caveat with this figures is that this removes the impact of stock-based compensation (aka — stock-based compensation is added back to EBITDA). While I do not necessarily agree with this approach, it helps us get comparability and as close to parity between software / SaaS companies in the public market.

In sum, here is the company’s profitability scorecard across a variety of benchmarks:

Balance Sheet and Capex

Detailed views and analyses into a company’s balance sheet and capital spending trends can provide insight into a company’s working capital trends (e.g. is there any seasonality or nuances within accounts?) and cash flow generation (e.g. how a company bills and collects on customer contracts; what the company spends on capital outlays).

In this section, I will go into Zscaler’s cash and cash equivalents balance, working capital accounts (excluding cash), and capital spending trends.

The below shows the company’s cash and cash equivalents balance trending over time:

Given that the company has been efficient with its profitability and operating cash generation, it’s no surprise that it has over $2.7B of cash and cash equivalents available on its balance sheet.

Beyond cash, it is also essential to assess a company’s working capital to understand how operating cash flow is generated over time. I have calculated working capital for Zscaler based largely on the following current asset and current liability accounts:

• Current Assets: Accounts Receivable, Deferred Contract Acquisition Costs, and Prepaid Expenses & Other Current Assets
• Current Liabilities: Accounts Payable, Accrued Expenses and Other Current Liabilities, Accrued Compensation, and Deferred Revenue (current)

For a typical software and SaaS business, we would expect a relatively simple balance sheet with a few notable trends: 1) potential seasonality with accounts receivable, accounts payable, and deferred revenue in line with a company’s collection and payable cycles; and 2) negative working capital that continues to become increasingly negative over time as the company grows, sells more subscriptions, and has an increase in deferred revenue.

The below charts highlight the working capital and net working capital trends of Zscaler:

Here is a view of the company’s Accounts Receivable, Accrued Expenses and Other Current Liabilities, and total Deferred Revenue balances, broken out by current and non-current:

Beyond its balance sheet, things to analyze and look for are within capital expenditures and capitalized software expenses.

As is the norm for many software businesses, Zscaler does capitalize software development costs.

In its LTM ended October 2024 financials, the company had capital expenditures of ~6% of revenue and capital expenditures + capitalized software of ~9% of revenue.

For software / SaaS businesses, capital expenditures are typically limited to investment in office space, equipment such as office items and computers and other tech-related items such as data centers, IT systems and infrastructure used for hosting.

A good benchmark / rule of thumb for the capital expenditures as a % revenue ratio is between 5% to 15% of revenue. Zscaler is below the range for capital spending.

Here are the views of Zscaler’s capital spending ratios:

Company-Specific KPIs and Other KPIs

Zscaler produces a handful of operational and supplemental metrics, such as its non-GAAP free cash flow, billings, net revenue retention, total customers, total customers that spend at least or more than $100K ARR, and total customers that spend at least or more than $1M ARR with the company.

Here is the company’s disclosed non-GAAP free cash flow (quarterly and annual), billings (quarterly and annual), total customers, average LTM revenue per customer, and customers that spend at least $100K ARR and at least $1M ARR over time.

Additionally, here is the view of the company’s net revenue retention. Over time, the company has changed its disclosures on what it provides to the public on net revenue retention. In its annual filings, it has typically disclosed a specific number, whereas in other filings and historically, it has disclosed ranges of net retention or even disclosing that net retention is “below,”, “in-line,” or “above” its expectations or benchmark range.

On dollar-based net retention, the company defines it as follows:

We calculate our dollar-based net retention rate as follows: Denominator: To calculate our dollar-based net retention rate as of the end of a reporting period, we first establish the ARR from all active subscriptions as of the last day of the same reporting period in the prior fiscal year. This effectively represents recurring dollars that we expect in the next 12-month period from the cohort of customers that existed on the last day of the same reporting period in the prior fiscal year. Numerator: We measure the ARR for that same cohort of customers representing all subscriptions based on confirmed customer orders booked by us as of the end of the reporting period. Dollar-based net retention rate is obtained by dividing the numerator by the denominator. Our dollar-based net retention rate may fluctuate due to a number of factors, including the performance of our cloud platform, our success in selling bigger deals, including deals for all employees with our higher-end bundles, selling multiple-pillars from the start of our contract with new customers, faster upsells within a year, the timing and the rate of ARR expansion of our existing customers, potential changes in our rate of renewals and other risk factors described elsewhere in this Annual Report on Form 10-K.

These calculations can sometimes be opaque and vary, so it is good to not put too much emphasis on these ratios alone without additional context and details about the company’s profile. Nevertheless, we have to take what management and companies provide us.

Based on my experience with prior clients, software and SaaS companies that disclose net dollar retention rates above the 105%-110% range are impressive.

For the information disclosed throughout its tenure as a public company, Zscaler has consistently produced very strong net dollar retention rates, as is evident by the chart below:

With respect to other operational KPIs we typically like to assess and understand in software and SaaS companies, Zscaler provides its periodic stock-based compensation, full-time employee counts, average revenue per employee, and CEO compensation figures.

These additional operational KPIs and trends are shown in the graphs below:

Another key metric we like to assess is customer acquisition cost (CAC) ratio. For Zscaler, I have calculated its CAC ratio over time using the company’s total GAAP sales & marketing spend, its total revenue, and LTM total gross profit margin.

For reference, here are the detailed breakdowns of the calculations I have used for CAC ratio:

Without gross margin: (LTM ended Current Quarter Sales & Marketing Expense) / ((Sum of the company’s Total Revenue in Current Quarter x 4) — (Sum of the company’s Total Revenue in Last Year’s Comparable Quarter x 4))

With gross margin: (LTM ended Current Quarter Sales & Marketing Expense) / ((Sum of the company’s Total Revenue in Current Quarter x 4) — (Sum of the company’s Total Revenue in Last Year’s Comparable Quarter x 4) x LTM Total Revenue GM %)

Here is what Zscaler’s CAC ratio looks like over time with and without the impact of gross margin:

For reference, a useful benchmark for software and SaaS CAC ratios is between $1 to $3. We can see that Zscaler has consistently been below or within the benchmark reference range for both versions of the calculation. The company has held generally steady, but has had a slight degradation in the ratio in recent periods as growth has slowed down a bit versus historical periods.

Finally, one final metric we assess for software and SaaS companies is the Rule of 40. The Rule of 40 represents the sum of a company’s revenue growth rate and its EBITDA margin in each period.

This metric has become commonplace (and more important in recent years) as an effective measurement of a company’s health and value, as it blends growth and profitability into one metric for business owners and investors to monitor.

Although this metric is certainly not a panacea for all financial reporting concerns, it is indeed a useful tool to convey how balanced a company is in its growth and profitability.

Here are the quarterly and annual views of Zscaler’s Rule of 40 metric over time:

And here is a scorecard of Zscaler’s CAC ratio, Rule of 40, and net revenue retention metrics:

Concluding Thoughts and Summary

This detailed assessment provides useful operational benchmarks for Zscaler that can be used as a basis to analyze other software and SaaS companies, both public and private.

Please do your own due diligence and do not rely on the charts, figures, and details shown here to make a decision, as these are illustrations based on the company’s filing and are not my responsibility for accuracy and are not a recommendation to buy or sell the stock.

With further compilation of these metrics and averages from other companies covered in this series I have created, there will be an increase in the availability and precision of the operational benchmarks used as reference points. This will provide business owners and investors with incremental detail to be used in their financial planning, reporting, and analysis of companies.

And of course, these can be used as a baseline to have me help you all out in your own private businesses, so give me a shout if you are interested.

To learn more about this article and gain other valuable insight into your business, please visit www.rtdinsights.com or contact me directly at rzacharia@rtdinsights.com.