ZSpace (ZSPC) Q3 2025: Software Mix Jumps 11 Points, Driving 640bps Margin Expansion
Margin expansion outpaced revenue declines as ZSpace’s software and services mix surged, offsetting persistent U.S. education funding headwinds. International momentum and product innovation provided critical offsets to a challenging domestic market. Management remains cautious on near-term volume but points to structural improvements in profitability and customer engagement that could set the stage for recovery once funding clarity returns.
Summary
- Software-Driven Margin Gains: Mix shift to software and services sharply improved profitability despite top-line contraction.
- International and CTE Expansion: Global deployments and workforce education traction provided diversification beyond U.S. K-12.
- Funding Uncertainty Remains Central: Tariffs and U.S. education funding volatility continue to cloud near-term outlook.
Performance Analysis
ZSpace’s third quarter underscored a strategic pivot toward higher-margin software and services, which accounted for 57% of total revenue, up 11 percentage points year-over-year. This shift fueled a gross margin increase of 6.4 percentage points to 51.2%, even as overall revenue declined 38% from last year’s unusually large Q3 order. Sequentially, revenue rebounded 18% from Q2, signaling some stabilization after prior softness.
Bookings remained pressured, down 37% year-over-year, as K-12 U.S. education customers delayed decisions amid federal funding uncertainty and the government shutdown. However, the Career Explorer application, developed post-acquisition of Second Avenue Learning, contributed to CTE (Career and Technical Education) bookings, which rose to 49% of total bookings from 41% last year. International deployments in Europe and the Middle East began to offset domestic headwinds.
- Margin Expansion Outpaces Revenue Decline: Software and services mix shift and improved hardware drove sustained profitability gains.
- Bookings Weakness Reflects Macro Pressure: U.S. K-12 delays and funding unpredictability weighed on new orders.
- CTE and International Provide Offsets: Workforce education and global wins are mitigating some domestic risk.
Adjusted EBITDA losses narrowed below $2 million, reflecting ongoing cost discipline and margin improvement. Management highlighted that tariff impacts now represent a modest gross margin drag, largely treated as pass-through, while new hardware and software introductions are expected to further structurally enhance margins.
Executive Commentary
"During the quarter, our software and services revenue comprised over 50% of total revenue, contributing to gross margin expansion of over 640 basis points. This performance was driven by strong customer renewals and the continued adoption of our software offerings, which is a key part of our strategy."
Paul Kallenberger, Chief Executive Officer
"Our path to profitability continues to run through revenue growth via operating leverage, through our ongoing expansion of gross margins and tight stewardship of operating expenses. While overall revenues are challenged by the headwinds in the U.S. K-12 market, our success in deriving more of the revenue portfolio from software is bearing fruit."
Eric de Oliveira, Chief Financial Officer
Strategic Positioning
1. Software and Services Mix Shift
The strategic emphasis on software and services is reshaping the business model. These offerings now represent a majority of total revenue, up significantly from last year, and are the primary engine behind margin expansion. This move is reducing dependence on hardware and making the revenue base more resilient to supply chain and tariff volatility.
2. International Expansion and Diversification
Global deployments are gaining momentum, with new wins in Europe and the Middle East, including a flagship lab at GEMS Education in Dubai. These international markets are less exposed to U.S. policy risk and provide a growth vector as domestic funding remains uncertain. Management noted a deliberate increase in focus and pipeline building internationally.
3. CTE and Workforce Education Traction
Career and Technical Education (CTE), workforce-focused solutions, such as the AI-powered Career Explorer application, are resonating with both K-12 and post-secondary customers. CTE bookings now represent nearly half of total bookings, supported by stable federal Perkins funding and bipartisan policy support. The rapid go-to-market of Career Explorer, enabled by the Second Avenue Learning acquisition, highlights execution agility.
4. Hardware Innovation and Cost Structure
Product innovation continues with the upcoming launch of a new “game-changing” stylus, expected to simplify user experience and reduce hardware-related logistics and shipping costs. Management also referenced ongoing efforts to shift manufacturing out of China, further reducing cost and tariff exposure. Each new hardware iteration delivers step-change, rather than linear, margin improvement.
5. Funding and Policy Headwinds
Persistent U.S. education funding volatility—exacerbated by the government shutdown and evolving federal-to-state funding flows—remains the largest constraint on near-term visibility. While software renewals and customer engagement are holding up, new order timing is highly unpredictable, limiting management’s ability to provide credible guidance.
Key Considerations
ZSpace’s Q3 highlighted a business in transition, leveraging software mix and international expansion to weather a turbulent domestic environment. Investors should weigh the following:
Key Considerations:
- Resilient Margin Structure: Gross margin expansion is now a five-quarter trend, underpinned by software mix and hardware improvements.
- CTE and International as Growth Levers: Workforce education and global markets are emerging as critical sources of diversification.
- Funding and Tariff Uncertainty: U.S. K-12 funding remains volatile; tariff drag is now modest but still a factor for gross margins.
- Execution on Innovation: Rapid product launches, AI integration, and hardware upgrades are supporting customer engagement and margin profile.
Risks
U.S. education funding volatility, especially in K-12, remains the primary risk, with the government shutdown and evolving federal-to-state flows creating order timing unpredictability. Large customer renewal downgrades highlight exposure to district-level budget cycles and leadership changes. While international and CTE provide offsets, the lack of formal guidance underscores limited near-term visibility and the potential for further revenue variability if macro or policy headwinds persist.
Forward Outlook
For Q4, ZSpace guided to:
- No formal quantitative guidance due to U.S. education market unpredictability
- Continued focus on margin expansion and cost discipline
For full-year 2025, management refrained from issuing guidance:
- Emphasis on profitability path via software mix and hardware cost structure
Management highlighted several factors that will shape the next quarter:
- Potential for typical seasonal Q4 revenue uplift is clouded by funding delays
- New product launches and international wins could drive incremental upside
Takeaways
Investors should focus on the durability of ZSpace’s margin gains and the company’s ability to diversify beyond the U.S. K-12 market.
- Software Outperformance: The mix shift to software and services is structurally improving profitability, even as revenue remains pressured.
- Strategic Diversification: CTE and international growth are mitigating domestic risk, but depend on continued execution and product-market fit.
- Visibility Challenge: Watch for signs of stabilization in U.S. education funding and the impact of new product launches on both adoption and margin trajectory.
Conclusion
ZSpace delivered a quarter defined by margin resilience and strategic diversification, even as top-line pressures persisted. The company’s execution on software, CTE, and global expansion positions it for recovery once U.S. education funding volatility abates, but near-term visibility remains limited.
Industry Read-Through
ZSpace’s results signal a broader industry pivot toward software-centric, higher-margin models in the EdTech sector, as hardware commoditization and policy-driven funding volatility pressure legacy business lines. The company’s success in rapidly integrating acquisitions and launching AI-powered applications highlights the importance of innovation speed and product mix agility. For peers, U.S. K-12 exposure remains a structural risk, while CTE and international diversification are increasingly critical levers for resilience and growth. Hardware cost structure and tariff management will remain key themes for all education technology providers navigating global supply and policy uncertainty.