Zscaler Sales Will Lead To UPOD

I have been going through the the ZS quarterly results and am focusing on the reformulation of its sales force. It appears to me that management 
is setting up for an under promise over deliver (UPOD) scenario with regard to its guidance which could lead to significant upside in the share
price.

Below is the company's historical spend for the category of "sales and marketing" including stock based compensation. 

Fiscal Quarter      Sales & marketing        Change from prior quarter
                      ($ thousands)                   ($ thousands)
Q2, FY18:               27,110                           n/a
Q3, FY18:               29,892                          2,782
Q4, FY18:               32,479                          2,587
Q1, FY19:               36,545                          4,066
Q2, FY19:               38,756                          2,211
Q3, FY19:               45,295                          6,539
Q4, FY19:               49,317                          4,022
Q1, FY20:               59,411                         10,094

The source of the information is the 2020 Q1 Supplemental information page 2:

[https://ir.zscaler.com/static-files/63234705-7130-4c6d-9092-...](https://ir.zscaler.com/static-files/63234705-7130-4c6d-9092-3c9036f1906e)

You can see that the sales & marketing spend in the past quarter is far greater than the spend in any of the prior quarters. Since the spend is
 primarily related to compensation the sequential difference of the numbers is far more valuable than the year-over-year comparison as headcount
 spend is additive with each successive quarter.

The main point that I want to make is that sales spending should be a "leading indicator" to revenue growth over time as it takes about eighteen
 months before the sales additions become 100% efficient within the new organization. The increase in sequential spend indicates a transformational
 process is going on within the company's sales organization as opposed to an incremental process. (This matches what we heard the CEO say on the
 conference call.)

<i>...So for execution at scale. I'll give you three examples, one you know when you have scores of salespeople it's one thing, when you hundreds
 of salespeople you need far a better sales enablement, far better training for us. We used to have a small sales enablement team Dali has come in
 and built a pretty sizable team and the team is already rolling out some of the training programs.

Number two, do really scale your business. You need a very consistent and repeatable sales process that may be more refined and Dali has come in
 and taken our processed and further refined it and it's being rolled out to the whole field. Number three, while we had tools and systems in
 place to scale to the next level and to have better accountability, better visibility to give us better leading indicator in the sales activities
 he and the leadership team has started work on many areas. So a lot of these things are already making a difference and we are seeing it. And I
 think as each quarter goes by, we will see more and more impact of the work being done by Dali and his team.</i>

[https://www.fool.com/earnings/call-transcripts/2019/12/03/zs...](https://www.fool.com/earnings/call-transcripts/2019/12/03/zscaler-inc-zs-q1-2020-earnings-call-transcript.aspx)

You can also take a look at the Zscaler company website open jobs under sales to see there are 103 openings. 

[https://www.zscaler.com/careers/sales-business-development?p...](https://www.zscaler.com/careers/sales-business-development?p=search%3Fc%3DSales%26c%3DSales-%257C-Business%2BDevelopment%26p%3D0#positions)

Frank - long ZS, see profile for all holdings
42 Likes

Frank,

Thanks for your excellent post. I found it too difficult to read and reformatted it but did not want to post it since it would appear under my name. Unfortunately, the TMF email system does not allow me to enclose my reformatted doxc for you.

It reads much better and you would get more recommendations if only use the monospaced font for your actual table, see https://discussion.fool.com/btw-could-you-point-me-to-a-how-to-u…. Using “Table Data” makes for a messy looking post.

The point you made about sales moved me to not touch my position but wait and see.

Best,

im

6 Likes

Great post Frank,

Historically it looks like they had been spending 60-63% of revenue on Marketing and Sales but last year at this time (Aug-Oct) let this drift to 56%. One wonders if this was to show less bottom line loss / pander to the analysts? Until now - the Dali period - S&M’s back to 63% of revenue.

So my take is a sarcastic one:
Do these people understand running a business or are they just techno-nerds, that realize late in the game that building a sales & marketing org is required. Why did they take one year to act? I know the product sells itself, for a while, but good management says these people are late. (I’m thinking of Arista, Nutanix, as well).

Are there commissioned reps in this business of enterprise IT selling? Maybe the rep route takes less time as relationships at IT and Purchasing departments are already made…though I realize you sacrifice some common goals. By the job openings it sounds like they’re hiring direct employees.

Part of this is just venting. Is there something to the “natural” personality differences between “salesperson” and “engineers” that get in the way of making these decisions?

From the call (Chaudry):

…we are focused on improving our sales execution to take Zscaler beyond $1 billion in revenue.
Why not a year ago?

At $1B revenue I would expect the S&M spend would be a more reasonable 20-30%? In industrial markets this is usually around 15-20%. At $240MM annual rate, they’re already about there. 107 more employees will add $10-15MM I suppose.

Lots of questions, some rhetorical, I know.

From forbes.com profile, that doesn’t say Chaudry is an engineer, only that he has a UC MBA…Before ZScaler, Chaudhry founded four other tech companies that were all acquired: SecureIT, CoreHarbor, CipherTrust and AirDefense. Let’s see, do tigers change their stripes?

https://www.forbes.com/profile/jay-chaudhry/#3ad3094661a1

Joe
Long ZS
$47 short Dec Puts

5 Likes

Just to be clear, last time I checked, around 80% of ZS’ revenue came from VARs. To some degree, these companies should be promoting/selling ZS product. That’s one of the reasons ZS uses them. As for commission, yes, ZS made it clear that their sales reps are paid on commission. Just 2 quarters ago, everything looked fine. Remember 2 quarters ago ZS hit a record 65% growth. And the CRO job was something that took a year to fill, so it’s not like ZS let everything fall apart before continuing to scale.

My problem is not that there is a slowdown. There is not a clear, valid explanation for the slowdown. We are hearing everything is fine, customers are coming to us, huge demand, less discounts, higher selling prices, now we are being told that even the elongated sales cycle has been abated, the CRO is here to save the day and gets mentioned more than anything during the sales call… yet, every metric is pointing down. RPO, what we are told is the most useful metric for future sales (not by ZS but by most every company out there), grew 35% YOY. This does not add up! Even if billings are not an accurate forecaster (it seems to me they are but OK, we’ll throw that one out), the supposedly most reliable “backlog” indicator, RPO, is also pointing down. Give me something that things are turning around or tell me this is a 35% grower going forward! I have nothing factual to go off of other than how great everything is.

ZS did get expense light, in regard to S&M… a year ago that was a plus. 6 months ago it was a plus, when they had 65% revenue growth and 3 quarters back to back accelerating growth. They didn’t have to spend on marketing because the customer came to them… just like that is a plus for DDOG now. Nobody was questioning if they weren’t spending enough on marketing. It was a reason to be invested in the stock because they didn’t have to go around promoting it because we were told “the customers are coming to us”. Nobody is asking “is DDOG spending enough on S&M?” No, they’re bidding the share price up because the light expenses make it more profitable.

11 Likes

Thanks im for the info around table insertion into a post. I spent over an hour in the MF editor yesterday getting the text to line break properly after checking the box at the bottom of the page for “table data” - everything looked fine in the “preview” view & then I posted it and cringed.

So thanks now I know the secret


.

Joe - it is very common for small companies in Silicon Valley run by techies to run behind in getting sales launched - it has something to do with the cost and a lot more to do with loss of control. When you simply run with an in house or HQ sales force based internally the technologists have a lot more control. I was involved in the move that Avantek made to go from an HQ sales team all located in Santa Clara running teams of third party reps all over the world to its own employee field sales force. Most of the concern during the transition was related to sales getting a lot more power and loss of control by the product lines. (Avantek was subsequently acquired by HP)

Regarding the numbers looking light, you place your money & make your bets. There are no numbers that I can point to other than my experience around building a sales force. I have watched interviews of the new CRO and I am fairly certain based on what he said that he knows what he is doing.

My guess is that management is underestimating the effect the new hires + training + new processes are going to have on the business.

Also I am a very patient investor - I am not looking to hop from one growth stock to the next - I am willing to let things play out. (I still hold my Arista Networks shares & may add to it before too long, one of my favorite companies going into 2020.)

Fundamentally the thing I like most about Zscaler is what I have read about its product architecture which would seem to give it a substantial competitive advantage.

The addition of a well run sales organization will help with its revenue growth.

…and I could be all wrong - you bet your money & you take your chances.

Frank - long ZS, see profile for all holdings

20 Likes

Yes, Jay Chaudhry was trained as an engineer. See his LinkedIn profile here –

https://www.linkedin.com/in/jaychaudhry/

B. Tech Electronics Engineering, Indian Institute of Technology, BHU, India
MS Science, Electrical & Computer Engineering, University of Cincinnati
MS Industrial Engineering & Management, University of Cincinnati
MBA, Marketing, University of Cincinnati
Executive Management Program, Marketing/Marketing Mgmt, Harvard Business School

I don’t have any insight into University of Cincinnati’s engineering program having never met anyone who graduated from there. The Indian Institute of Technology are respected programs.

Vicki
long ZS

1 Like