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Zendesk Gets a Growth Boost From Large Customer Wins

Customer service software provider Zendesk (NYSE: ZEN) reported its third-quarter results after the market closed on Nov. 1. Revenue growth accelerated compared to the previous quarter, driven by success in signing large customers. The company still isn't profitable, but it reiterated its expectation to produce a positive free cash flow this year. Here's what investors need to know about Zendesk's third-quarter results.

Zendesk results: The raw numbers

Metric

Q3 2017

Q3 2016

Year-Over-Year Change

Revenue

$112.8 million

$80.7 million

39.8%

Net income

($27.7 million)

($25.8 million)

N/A

Non-GAAP EPS

($0.02)

($0.04)

N/A

Data source: Zendesk.

Image source: Zendesk.

What happened with Zendesk this quarter?

  • Paid customer accounts reached 113,900, up from 107,400 at the end of the second quarter and 89,100 at the end of the third quarter of 2016.
  • Zendesk Support reached 61,200 paid customer accounts, Zendesk Chat reached 46,600 paid customer accounts, and other Zendesk products reached 6,100 paid customer accounts.
  • 37% of monthly recurring revenue was derived from customer accounts with 100 or more support agents, up from 35% during the second quarter.
  • The number of contracts signed with an annual value of $50,000 or more jumped 50% year over year, and the average size of those contracts rose 40%.
  • Zendesk's dollar-based expansion rate was 118% at the end of the third quarter, up from 116% at the end of the second quarter. The company expects this metric to remain between 110% and 120% for the next several quarters.

Zendesk provided the following guidance:

  • For the fourth quarter, Zendesk expects revenue between $118 million and $120 million, GAAP operating loss between $29 million and $31 million, and non-GAAP operating loss between $3 million and $5 million.
  • For the full year, Zendesk expects revenue between $425 million and $427 million, GAAP operating loss between $116 million and $118 million, and non-GAAP operating loss between $18 million and $20 million.
  • Zendesk expects cash from operating activities and free cash flow to be positive in 2017.

What management had to say

In Zendesk's letter to shareholders, management discussed its progress in going after larger customers:

Our third quarter results highlight the inroads we are making with larger organizations. We closed a significantly larger number of enterprise-class deals this quarter -- both new business and expansions. In addition, we are building optimism around our 2018 growth potential, given greater visibility into our pipeline of expansion opportunities with existing customers and new business opportunities with prospective customers across a variety of industries.

Management also discussed Answer Bot, the company's first product that uses machine learning in conjunction with a customer's data:

Also in the third quarter, Answer Bot graduated from its early access program to become a paid add-on to our Guide self-service product. It is our first machine learning product to directly monetize our data assets. Answer Bot is designed to respond quickly to common inquiries, while routing more complex questions that require more personalized and contextual responses to support agents. While still new, Answer Bot has gained traction within our customer base.

Looking forward

Zendesk managed nearly 40% year-over-year revenue growth during the third quarter, an acceleration compared to the 36.5% growth it reported for the second quarter. A big surge in large contract signings and in the size of those contracts contributed to that result, providing some evidence that the company's efforts to go after bigger customers are working.

Zendesk is still unprofitable, although it's on the cusp of turning a non-GAAP profit. Free cash flow turning positive this year will be a milestone in its journey to profitability, but it may still be quite a while before the company manages to produce a GAAP profit. As long as revenue growth remains robust, investors likely won't mind.

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Timothy Green has no position in any of the stocks mentioned. The Motley Fool recommends Zendesk. The Motley Fool has a disclosure policy.