Zendesk Is Now Free-Cash-Flow Positive

Customer service software provider Zendesk (ZEN) reported its fourth-quarter results after the market closed on Feb. 8. The company produced near-40% revenue growth, its non-GAAP bottom line inched toward positive territory, and free cash flow turned positive for the full year. The company expects to reach $1 billion of revenue by 2020, more than double its revenue in 2017. Here's what investors need to know about Zendesk's fourth-quarter results.

Zendesk results: The raw numbers

Data source: Zendesk.

What happened with Zendesk this quarter?

• Paid customer accounts reached 118,900, up from 113,900 at the end of the third quarter, and up from 94,000 in the prior-year period.
• Zendesk Support reached 64,100 paid customer accounts, Zendesk Chat reached 47,000 paid customer accounts, and other Zendesk products reached 7,800 paid customer accounts.
• Thirty-eight percent of monthly recurring revenue was derived from paid customer accounts with 100 or more support agents, up from 37% in the third quarter.
• The number of contracts signed with an annual value of $50,000 or more increased by 25% year over year, while the average size of these large contracts declined by an unspecified amount.
• Zendesk's dollar-based net expansion rate was 119% during the fourth quarter, up from 118% in the third quarter. The company continues to expect this metric to remain between 110% and 120% for the next several quarters.
• Major customers joining or expanding with Zendesk during the fourth quarter include Ryanair, GoFundMe, and Etsy.
• Free cash flow was $18.2 million for 2017, up from a loss of $2.4 million in 2016.

Zendesk provided the following guidance for the first quarter of 2018 and for the full year:

• For the first quarter, Zendesk expects revenue between $125 million and $127 million, GAAP operating loss between $33 million and $35 million, and non-GAAP operating loss between $3 million and $5 million.
• For the full year, revenue between $555 million and $565 million, GAAP operating loss between $113 million and $118 million, and non-GAAP operating income between $0 and $5 million.
• Zendesk expects to produce between $25 million and $30 million of free cash flow for the full year.
• Zendesk continues to target $1 billion of revenue by 2020.

Image source: Zendesk.

What management had to say

In Zendesk's letter to shareholders, management discussed the new products and features the company launched in 2017:

On the product front, we focused on creating a more unified customer experience and simplifying the buying experience across our product family. As part of that process, we launched Chat Enterprise in August and Talk Enterprise in September, and brought greater consistency in feature set and scalability across all our products. Zendesk Support, Chat, Talk, and Guide can now be used together across a variety of use cases and degrees of complexity to deliver improved customer experiences.

Management also laid out two main goals for 2018: "As we move into 2018, our key priorities will revolve around two major themes: accelerating our upmarket business through larger deals and greater penetration with enterprise customers, and empowering our customers to provide the best omnichannel customer experiences possible."

Looking forward

Free cash flow turned positive in 2017, and Zendesk expects it to grow substantially in 2018. The company is still deeply unprofitable on a GAAP basis, and that is unlikely to change anytime soon as it focuses on growth. More than half of revenue went toward sales and marketing in 2017, pushing total costs well above revenue.

Zendesk's growth continues to impress, putting it on track to reach its goal of $1 billion of revenue by 2020. Assuming Zendesk hits the midpoint of its 2018 revenue guidance, the company will need to grow revenue by 33.6% in both 2019 and 2020 to cross the $1 billion mark. Continuing to win contracts with larger customers will be the key to hitting that target.