Large Customers Drive Growth for Zendesk

Software-as-a-service provider Zendesk (ZEN) reported its second-quarter results after the market closed on Aug. 3. Customer gains drove revenue growth, with the addition of larger customers accelerating, and the company's guidance calls for similar growth during the third quarter. Zendesk still expects to be free-cash-flow positive this year, although the bottom line will likely remain negative for quite some time.

Here's what investors need to know about Zendesk's second-quarter report.

Zendesk results: The raw numbers

Data source: Zendesk. GAAP = generally accepted accounting principles.

Image source: Zendesk.

What happened with Zendesk this quarter?

• Paid customer accounts reached 107,400, up from 101,800 at the end of the first quarter and 82,800 at the end of the second quarter of 2016.
• Zendesk Support reached 57,800 paid customer accounts, Zendesk Chat reached 45,300 paid customer accounts, and other Zendesk products reached 4,300 paid customer accounts.
• Up from 34% at the end of the first quarter, 35% of monthly recurring revenue came from customer accounts with 100 or more support agents.
• The number of contracts signed with an annual value of $50,000 or greater rose 45% year over year, with the average contract size remaining roughly flat.
• Zendesk's dollar-based expansion rate was 116% at the end of the second quarter, up from 115% at the end of the first quarter. The company expects a range of 110% to 120% over the next several quarters.
• Tom Keiser, previously the chief information officer and VP of technology operations, has been appointed chief operating officer.

Zendesk provided the following guidance:

• For the third quarter, Zendesk expects revenue between $108 million and $110 million, GAAP operating loss between $31 million and $32 million, and non-GAAP operating loss between $6 million and $7 million.
• For the full year, Zendesk expects revenue between $420 million and $425 million, GAAP operating loss between $115 million and $119 million, and non-GAAP operating loss between $16 million and $20 million.
• Zendesk continues to expect to produce positive free cash flow in 2017.

What management had to say

In Zendesk's shareholder letter, the company detailed the progress made winning larger customers and cross-selling products:

In our efforts to further expand our markets, we made additional inroads with larger organizations by both closing a greater number of bigger deals during the quarter and growing our pipeline. We recently expanded our investments internationally with major events in Brazil, Japan, and Australia and the announcement of plans for an additional Amazon Web Services (AWS) data center in Australia. Meanwhile, we made advancements toward selling solutions, reflecting our evolution to a multi-product company.

The company also reiterated that it would be investing in infrastructure throughout the rest of the year:

As we previously stated, we anticipate our step-up investment in infrastructure will continue throughout 2017 as we continue our transition from co-located data centers into cloud infrastructure hosted from multiple providers. As a result of these investments, our GAAP gross margin declined quarter over quarter to 69.7% in the second quarter of 2017, from 69.8% in the first quarter of 2017.

Looking forward

Zendesk continues to grow revenue quickly, with a surge in large customer wins helping the cause during the second quarter. On a GAAP basis, the bottom line continues to sink deeper into the red, although adjusted earnings are slowly grinding their way closer to breakeven. Free cash flow should turn positive this year, but earnings will still be squarely negative.

Zendesk again failed to mention its previously stated goal of reaching $1 billion in revenue by 2020. The company's growth rate would need to remain roughly constant for the next few years to hit that goal, which may be overly optimistic.