Zendesk Announces Second Quarter 2019 Results

Jul 30, 2019

Highlights

  • Second quarter revenue increased 37% year over year to $194.6 million
  • Second quarter GAAP operating loss of $51.4 million and non-GAAP operating income of $3.8 million

SAN FRANCISCO--(BUSINESS WIRE)-- Zendesk, Inc. (NYSE: ZEN) today reported financial results for the second quarter ended June 30, 2019, and released a Shareholder Letter on its investor relations website at https://investor.zendesk.com.

Results for the Second Quarter 2019

Revenue was $194.6 million for the quarter ended June 30, 2019, an increase of 37% over the prior year period. GAAP net loss for the quarter ended June 30, 2019 was $54.5 million, and GAAP net loss per share (basic and diluted) was $0.50. Non-GAAP net income was $5.9 million, and non-GAAP net income per share (basic and diluted) was $0.05. Non-GAAP net income excludes approximately $46.8 million in share-based compensation and related expenses (including $2.7 million of employer tax related to employee stock transactions and $0.4 million of amortization of share-based compensation capitalized in internal-use software), $6.3 million of amortization of debt discount and issuance costs, $5.8 million of acquisition-related expenses, $2.6 million of amortization of purchased intangibles, and non-GAAP income tax effects of $1.0 million. GAAP net loss per share for the quarter ended June 30, 2019 was based on 110.0 million weighted average shares outstanding (basic and diluted), and non-GAAP net income per share for the quarter ended June 30, 2019 was based on 110.0 million weighted average shares outstanding (basic) and 119.7 million weighted average shares outstanding (diluted).

Outlook

As of July 30, 2019, Zendesk provided guidance for the quarter ending September 30, 2019 and updated its guidance for the year ending December 31, 2019.

For the quarter ending September 30, 2019, Zendesk expects to report:

  • Revenue in the range of $206 - 208 million
  • GAAP operating income (loss) in the range of $(46) - (44) million, which includes share-based compensation and related expenses of approximately $43 million, amortization of purchased intangibles of approximately $3 million, and acquisition-related expenses of approximately $2 million
  • Non-GAAP operating income (loss) in the range of $2 - 4 million, which excludes share-based compensation and related expenses of approximately $43 million, amortization of purchased intangibles of approximately $3 million, and acquisition-related expenses of approximately $2 million
  • Approximately 111 million weighted average shares outstanding (basic)
  • Approximately 121 million weighted average shares outstanding (diluted)

For the full year ending December 31, 2019, Zendesk expects to report:

  • Revenue in the range of $807 - 811 million
  • GAAP operating income (loss) in the range of $(178) - (175) million, which includes share-based compensation and related expenses of approximately $173 million, amortization of purchased intangibles of approximately $10 million, and acquisition-related expenses of approximately $11 million
  • Non-GAAP operating income (loss) in the range of $16 - 19 million, which excludes share-based compensation and related expenses of approximately $173 million, amortization of purchased intangibles of approximately $10 million, and acquisition-related expenses of approximately $11 million
  • Approximately 111 million weighted average shares outstanding (basic)
  • Approximately 122 million weighted average shares outstanding (diluted)
  • Free cash flow in the range of $35 - 45 million

Our guidance for free cash flow for the full year ending December 31, 2019, has been adjusted from the guidance for free cash flow provided in our shareholder letter dated April 30, 2019. This guidance was adjusted due to, among other factors, refinements in our cash flow forecasting methodology, increased acquisition activity and the associated acquisition-related expenses, the prepayment of certain vendor expenses in order to achieve more favorable pricing, additional capital expenditures intended to increase our real estate utilization, and revisions to the timing of and changes in the form of certain contingent payments from share-based to cash-based payments.

We have not reconciled free cash flow guidance to net cash from operating activities for the full year 2019 because we do not provide guidance on the reconciling items between net cash from operating activities and free cash flow, as a result of the uncertainty regarding, and the potential variability of, these items. The actual amount of such reconciling items will have a significant impact on our free cash flow and, accordingly, a reconciliation of net cash from operating activities to free cash flow for the full year 2019 is not available without unreasonable effort.

Zendesk’s estimates of share-based compensation and related expenses, amortization of purchased intangibles, acquisition-related expenses, weighted average shares outstanding, and free cash flow in future periods assume, among other things, the occurrence of no additional acquisitions, investments or restructurings, and no further revisions to share-based compensation and related expenses.

Shareholder Letter and Conference Call Information

The detailed Shareholder Letter is available at https://investor.zendesk.com and Zendesk will host a conference call to answer questions today, July 30, 2019, at 2:00 p.m. Pacific Time, 5:00 p.m. Eastern Time. A live webcast of the conference call will be available at https://investor.zendesk.com. The conference call can also be accessed by dialing 833-287-0801, or +1 647-689-4460 (outside the U.S. and Canada). The conference ID is 7164839. A replay of the call via webcast will be available at https://investor.zendesk.com or by dialing 800-585-8367 or +1 416-621-4642 (outside the U.S. and Canada) and entering passcode 7164839. The dial-in replay will be available until the end of day August 2, 2019. The webcast replay will be available for 12 months.

About Zendesk

The best customer experiences are built with Zendesk. Our customer service and engagement products are powerful and flexible, and scale to meet the needs of any business. Zendesk serves businesses across a multitude of industries, with more than 145,000 paid customer accounts offering service and support in over 30 languages. Zendesk is headquartered in San Francisco, and operates worldwide with 17 offices in North America, Europe, Asia, Australia, and South America. Learn more at www.zendesk.com.

Forward-Looking Statements

This press release contains forward-looking statements, including, among other things, statements regarding Zendesk’s future financial performance, its continued investment to grow its business, and progress toward its long-term financial objectives. Words such as “may,” “should,” “will,” “believe,” “expect,” “anticipate,” “target,” “project,” and similar phrases that denote future expectation or intent regarding Zendesk’s financial results, operations, and other matters are intended to identify forward-looking statements. You should not rely upon forward-looking statements as predictions of future events.

The outcome of the events described in these forward-looking statements is subject to known and unknown risks, uncertainties, and other factors that may cause Zendesk’s actual results, performance, or achievements to differ materially, including (i) adverse changes in general economic or market conditions; (ii) Zendesk’s ability to adapt its products to changing market dynamics and customer preferences or achieve increased market acceptance of its products; (iii) Zendesk’s ability to effectively expand its sales capabilities; (iv) Zendesk’s ability to effectively market and sell its products to larger enterprises; (v) Zendesk’s expectation that the future growth rate of its revenues will decline, and that, as its costs increase, Zendesk may not be able to generate sufficient revenues to achieve or sustain profitability; (vi) the intensely competitive market in which Zendesk operates and the difficulty that Zendesk may have in competing effectively; (vii) Zendesk’s ability to introduce and market new products and to support its products on a shared services platform; (viii) Zendesk's ability to maintain and develop its strategic relationships with third parties; (ix) Zendesk’s ability to integrate acquired businesses and technologies successfully or achieve the expected benefits of such acquisitions; (x) Zendesk’s ability to effectively manage its growth and organizational change, including its international expansion strategy; (xi) potential breaches in Zendesk’s security measures or unauthorized access to its customers’ data; (xii) Zendesk's ability to comply with privacy and data security regulations; (xiii) the development of the market for software as a service business software applications; (xiv) potential service interruptions or performance problems associated with Zendesk’s technology and infrastructure; (xv) real or perceived errors, failures, or bugs in its products; (xvi) Zendesk’s substantial reliance on its customers renewing their subscriptions and purchasing additional subscriptions; and (xvii) Zendesk’s ability to accurately forecast expenditures on third-party managed hosting services.

The forward-looking statements contained in this press release are also subject to additional risks, uncertainties, and factors, including those more fully described in Zendesk’s filings with the Securities and Exchange Commission, including its Quarterly Report on Form 10-Q for the quarter ended March 31, 2019. Further information on potential risks that could affect actual results will be included in the subsequent periodic and current reports and other filings that Zendesk makes with the Securities and Exchange Commission from time to time, including its Quarterly Report on Form 10-Q for the quarter ended June 30, 2019.

Forward-looking statements represent Zendesk’s management’s beliefs and assumptions only as of the date such statements are made. Zendesk undertakes no obligation to update any forward-looking statements made in this press release to reflect events or circumstances after the date of this press release or to reflect new information or the occurrence of unanticipated events, except as required by law.

Condensed Consolidated Statements of Operations

 

(In thousands, except per share data; unaudited)

 

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

 

2019

 

2018

 

2019

 

2018

Revenue

 

$

194,583

 

 

$

141,882

 

 

$

376,068

 

 

$

271,673

 

Cost of revenue

 

57,670

 

 

44,160

 

 

113,324

 

 

83,216

 

Gross profit

 

136,913

 

 

97,722

 

 

262,744

 

 

188,457

 

Operating expenses:

 

 

 

 

 

 

 

 

Research and development

 

50,510

 

 

37,624

 

 

97,301

 

 

74,708

 

Sales and marketing

 

94,746

 

 

69,450

 

 

186,447

 

 

134,508

 

General and administrative

 

43,019

 

 

24,245

 

 

74,271

 

 

46,452

 

Total operating expenses

 

188,275

 

 

131,319

 

 

358,019

 

 

255,668

 

Operating loss

 

(51,362

)

 

(33,597

)

 

(95,275

)

 

(67,211

)

Other income (expense), net

 

 

 

 

 

 

 

 

Interest income

 

5,294

 

 

3,826

 

 

10,766

 

 

5,344

 

Interest expense

 

(6,614

)

 

(6,289

)

 

(13,158

)

 

(7,053

)

Other income (expense), net

 

(1,268

)

 

27

 

 

(570

)

 

272

 

Total other income (expense), net

 

(2,588

)

 

(2,436

)

 

(2,962

)

 

(1,437

)

Loss before provision for (benefit from) income taxes

 

(53,950

)

 

(36,033

)

 

(98,237

)

 

(68,648

)

Provision for (benefit from) income taxes

 

591

 

 

(1,667

)

 

1,024

 

 

(4,957

)

Net loss

 

$

(54,541

)

 

$

(34,366

)

 

$

(99,261

)

 

$

(63,691

)

Net loss per share, basic and diluted

 

$

(0.50

)

 

$

(0.33

)

 

$

(0.91

)

 

$

(0.61

)

Weighted-average shares used to compute net loss per share, basic and diluted

 

109,986

 

 

105,000

 

 

109,312

 

 

104,350

 

Condensed Consolidated Balance Sheets

 

(In thousands, except par value; unaudited)

 

June 30,
2019

 

December 31,
2018

Assets

 

 

 

Current assets:

 

 

 

Cash and cash equivalents

$

171,218

 

 

$

126,518

 

Marketable securities

255,930

 

 

300,213

 

Accounts receivable, net of allowance for doubtful accounts of $3,252 and $2,571 as of June 30, 2019 and December 31, 2018, respectively

105,806

 

 

85,280

 

Deferred costs

30,259

 

 

24,712

 

Prepaid expenses and other current assets

45,697

 

 

35,873

 

Total current assets

608,910

 

 

572,596

 

Marketable securities, noncurrent

371,245

 

 

393,671

 

Property and equipment, net

87,520

 

 

75,654

 

Deferred costs, noncurrent

31,805

 

 

26,914

 

Lease right-of-use assets

102,702

 

 

 

Goodwill and intangible assets, net

212,436

 

 

146,327

 

Other assets

24,379

 

 

22,717

 

Total assets

$

1,438,997

 

 

$

1,237,879

 

Liabilities and stockholders’ equity

 

 

 

Current liabilities:

 

 

 

Accounts payable

$

38,887

 

 

$

16,820

 

Accrued liabilities

36,598

 

 

34,097

 

Accrued compensation and related benefits

51,955

 

 

46,603

 

Deferred revenue

286,552

 

 

245,243

 

Lease liabilities

22,784

 

 

 

Convertible senior notes, net

470,641

 

 

 

Total current liabilities

907,417

 

 

342,763

 

Convertible senior notes, net

 

 

458,176

 

Deferred revenue, noncurrent

797

 

 

2,719

 

Lease liabilities, noncurrent

97,860

 

 

 

Other liabilities

5,946

 

 

17,300

 

Total liabilities

1,012,020

 

 

820,958

 

 

 

 

 

Stockholders’ equity:

 

 

 

Preferred stock, par value $0.01 per share

 

 

 

Common stock, par value $0.01 per share

1,106

 

 

1,080

 

Additional paid-in capital

1,053,488

 

 

950,693

 

Accumulated other comprehensive loss

772

 

 

(5,724

)

Accumulated deficit

(628,389

)

 

(529,128

)

Total stockholders’ equity

426,977

 

 

416,921

 

Total liabilities and stockholders’ equity

$

1,438,997

 

 

$

1,237,879

 

Condensed Consolidated Statements of Cash Flows

 

(In thousands; unaudited)

 

 

Three Months Ended June 30,

 

 

2019

 

2018

Cash flows from operating activities

 

 

 

 

Net loss

 

$

(54,541

)

 

$

(34,366

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

Depreciation and amortization

 

8,969

 

 

8,798

 

Share-based compensation

 

43,751

 

 

28,148

 

Amortization of deferred costs

 

7,622

 

 

5,020

 

Amortization of debt discount and issuance costs

 

6,277

 

 

5,930

 

Other

 

452

 

 

2,048

 

Changes in operating assets and liabilities:

 

 

 

 

Accounts receivable

 

(15,901

)

 

(17,587

)

Prepaid expenses and other current assets

 

(5,380

)

 

(4,061

)

Deferred costs

 

(14,123

)

 

(10,536

)

Lease right-of-use assets

 

4,734

 

 

 

Other assets and liabilities

 

(1,242

)

 

2,716

 

Accounts payable

 

5,678

 

 

9,214

 

Accrued liabilities

 

(2,057

)

 

590

 

Accrued compensation and related benefits

 

8,887

 

 

5,091

 

Deferred revenue

 

27,294

 

 

22,691

 

Lease liabilities

 

(2,562

)

 

 

Net cash provided by operating activities

 

17,858

 

 

23,696

 

Cash flows from investing activities

 

 

 

 

Purchases of property and equipment

 

(4,896

)

 

(13,228

)

Internal-use software development costs

 

(1,753

)

 

(1,817

)

Purchases of marketable securities

 

(125,681

)

 

(170,690

)

Proceeds from maturities of marketable securities

 

53,031

 

 

39,317

 

Proceeds from sales of marketable securities

 

151,550

 

 

1,866

 

Cash paid for the acquisition of Smooch, net of cash acquired

 

(70,794

)

 

 

Net cash provided by (used in) investing activities

 

1,457

 

 

(144,552

)

Cash flows from financing activities

 

 

 

 

Issuance costs related to convertible senior notes

 

 

 

(570

)

Proceeds from exercises of employee stock options

 

4,773

 

 

3,554

 

Proceeds from employee stock purchase plan

 

6,895

 

 

4,853

 

Taxes paid related to net share settlement of share-based awards

 

(2,663

)

 

(1,412

)

Other

 

 

 

(1,716

)

Net cash provided by financing activities

 

9,005

 

 

4,709

 

Effect of exchange rate changes on cash, cash equivalents and restricted cash

 

33

 

 

(1

)

Net increase (decrease) in cash, cash equivalents and restricted cash

 

28,353

 

 

(116,148

)

Cash, cash equivalents and restricted cash at beginning of period

 

145,028

 

 

610,545

 

Cash, cash equivalents and restricted cash at end of period

 

$

173,381

 

 

$

494,397

 

Non-GAAP Results

(In thousands, except per share data)

The following table shows Zendesk’s GAAP results reconciled to non-GAAP results included in this release.

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

2019

 

2018

 

2019

 

2018

Reconciliation of gross profit and gross margin

 

 

 

 

 

 

 

GAAP gross profit

$

136,913

 

 

$

97,722

 

 

$

262,744

 

 

$

188,457

 

Plus: Share-based compensation

5,246

 

 

3,474

 

 

10,183

 

 

6,572

 

Plus: Employer tax related to employee stock transactions

391

 

 

296

 

 

840

 

 

556

 

Plus: Amortization of purchased intangibles

1,943

 

 

612

 

 

3,561

 

 

1,224

 

Plus: Amortization of share-based compensation capitalized in internal-use software

413

 

 

356

 

 

833

 

 

718

 

Plus: Acquisition-related expenses

160

 

 

 

 

$

274

 

 

$

 

Non-GAAP gross profit

$

145,066

 

 

$

102,460

 

 

$

278,435

 

 

$

197,527

 

GAAP gross margin

70

%

 

69

%

 

70

%

 

69

%

Non-GAAP adjustments

5

%

 

3

%

 

4

%

 

4

%

Non-GAAP gross margin

75

%

 

72

%

 

74

%

 

73

%

 

 

 

 

 

 

 

 

Reconciliation of operating expenses

 

 

 

 

 

 

 

GAAP research and development

$

50,510

 

 

$

37,624

 

 

$

97,301

 

 

$

74,708

 

Less: Share-based compensation

(11,911

)

 

(9,529

)

 

(23,548

)

 

(19,758

)

Less: Employer tax related to employee stock transactions

(931

)

 

(642

)

 

(2,223

)

 

(1,385

)

Less: Acquisition-related expenses

(864

)

 

(404

)

 

(1,431

)

 

(787

)

Non-GAAP research and development

$

36,804

 

 

$

27,049

 

 

$

70,099

 

 

$

52,778

 

GAAP research and development as percentage of revenue

26

%

 

27

%

 

26

%

 

27

%

Non-GAAP research and development as percentage of revenue

19

%

 

19

%

 

19

%

 

19

%

 

 

 

 

 

 

 

 

GAAP sales and marketing

$

94,746

 

 

$

69,450

 

 

$

186,447

 

 

$

134,508

 

Less: Share-based compensation

(13,575

)

 

(9,178

)

 

(25,973

)

 

(17,186

)

Less: Employer tax related to employee stock transactions

(763

)

 

(500

)

 

(1,791

)

 

(1,074

)

Less: Amortization of purchased intangibles

(658

)

 

(57

)

 

(1,235

)

 

(167

)

Less: Acquisition-related expenses

(379

)

 

(281

)

 

(771

)

 

(563

)

Non-GAAP sales and marketing

$

79,371

 

 

$

59,434

 

 

$

156,677

 

 

$

115,518

 

GAAP sales and marketing as percentage of revenue

49

%

 

49

%

 

50

%

 

50

%

Non-GAAP sales and marketing as percentage of revenue

41

%

 

42

%

 

42

%

 

43

%

 

 

 

 

 

 

 

 

GAAP general and administrative

$

43,019

 

 

$

24,245

 

 

$

74,271

 

 

$

46,452

 

Less: Share-based compensation

(13,019

)

 

(5,967

)

 

(20,704

)

 

(11,619

)

Less: Employer tax related to employee stock transactions

(567

)

 

(282

)

 

(1,318

)

 

(589

)

Less: Acquisition-related expenses

(4,358

)

 

 

 

(4,989

)

 

 

Non-GAAP general and administrative

$

25,075

 

 

$

17,996

 

 

$

47,260

 

 

$

34,244

 

GAAP general and administrative as percentage of revenue

22

%

 

17

%

 

20

%

 

17

%

Non-GAAP general and administrative as percentage of revenue

13

%

 

13

%

 

13

%

 

13

%

 

 

 

 

 

 

 

 

Reconciliation of operating income (loss) and operating margin

 

 

 

 

 

 

 

GAAP operating loss

$

(51,362

)

 

$

(33,597

)

 

$

(95,275

)

 

$

(67,211

)

Plus: Share-based compensation

43,751

 

 

28,148

 

 

80,408

 

 

55,135

 

Plus: Employer tax related to employee stock transactions

2,652

 

 

1,720

 

 

6,172

 

 

3,604

 

Plus: Amortization of purchased intangibles

2,601

 

 

669

 

 

4,796

 

 

1,391

 

Plus: Acquisition-related expenses

5,761

 

 

685

 

 

7,465

 

 

1,350

 

Plus: Amortization of share-based compensation capitalized in internal-use software

413

 

 

356

 

 

833

 

 

718

 

Non-GAAP operating income (loss)

$

3,816

 

 

$

(2,019

)

 

$

4,399

 

 

$

(5,013

)

GAAP operating margin

(26

)%

 

(24

)%

 

(25

)%

 

(25

)%

Non-GAAP adjustments

28

 %

 

23

 %

 

26

 %

 

23

 %

Non-GAAP operating margin

2

 %

 

(1

)%

 

1

 %

 

(2

)%

 

Three Months Ended June 30,

 

Six Months Ended June 30,

 

2019

 

2018

 

2019

 

2018

Reconciliation of net income (loss)

 

 

 

 

 

 

 

GAAP net loss

$

(54,541

)

 

$

(34,366

)

 

$

(99,261

)

 

$

(63,691

)

Plus: Share-based compensation

43,751

 

 

28,148

 

 

80,408

 

 

55,135

 

Plus: Employer tax related to employee stock transactions

2,652

 

 

1,720

 

 

6,172

 

 

3,604

 

Plus: Amortization of purchased intangibles

2,601

 

 

669

 

 

4,796

 

 

1,391

 

Plus: Acquisition-related expenses

5,761

 

 

685

 

 

7,465

 

 

1,350

 

Plus: Amortization of share-based compensation capitalized in internal-use software

413

 

 

356

 

 

833

 

 

718

 

Plus: Amortization of debt discount and issuance costs

6,277

 

 

5,930

 

 

12,465

 

 

6,650

 

Less: Income tax effects and adjustments

(985

)

 

(1,977

)

 

(1,896

)

 

(1,977

)

Non-GAAP net income

$

5,929

 

 

$

1,165

 

 

$

10,982

 

 

$

3,180

 

 

 

 

 

 

 

 

 

Reconciliation of net income (loss) per share, basic

 

 

 

 

 

 

 

GAAP net loss per share, basic

$

(0.50

)

 

$

(0.33

)

 

$

(0.91

)

 

$

(0.61

)

Non-GAAP adjustments to net loss

0.55

 

 

0.34

 

 

1.01

 

 

0.64

 

Non-GAAP net income per share, basic

$

0.05

 

 

$

0.01

 

 

$

0.10

 

 

$

0.03

 

 

 

 

 

 

 

 

 

Reconciliation of net income (loss) per share, diluted

 

 

 

 

 

 

 

GAAP net loss per share, diluted

$

(0.50

)

 

$

(0.33

)

 

$

(0.91

)

 

$

(0.61

)

Non-GAAP adjustments to net loss

0.55

 

 

0.34

 

 

1.00

 

 

0.64

 

Non-GAAP net income per share, diluted

$

0.05

 

 

$

0.01

 

 

$

0.09

 

 

$

0.03

 

 

 

 

 

 

 

 

 

Weighted-average shares used in GAAP per share calculation, basic and diluted

109,986

 

 

105,000

 

 

109,312

 

 

104,350

 

 

 

 

 

 

 

 

 

Weighted-average shares used in non-GAAP per share calculation

 

 

 

 

 

 

 

Basic

109,986

 

 

105,000

 

 

109,312

 

 

104,350

 

Diluted

119,678

 

 

111,725

 

 

118,339

 

 

110,300

 

 

 

 

 

 

 

 

 

Computation of free cash flow

 

 

 

 

 

 

 

Net cash provided by operating activities

$

17,858

 

 

$

23,696

 

 

$

36,827

 

 

$

39,938

 

Less: purchases of property and equipment

(4,896

)

 

(13,228

)

 

(14,154

)

 

(20,036

)

Less: internal-use software development costs

(1,753

)

 

(1,817

)

 

(2,966

)

 

(4,161

)

Free cash flow

$

11,209

 

 

$

8,651

 

 

$

19,707

 

 

$

15,741

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities margin

9

 %

 

17

 %

 

10

 %

 

15

 %

Non-GAAP adjustments

(3

)%

 

(11

)%

 

(5

)%

 

(9

)%

Free cash flow margin

6

 %

 

6

 %

 

5

 %

 

6

 %

About Non-GAAP Financial Measures

To provide investors and others with additional information regarding Zendesk’s results, the following non-GAAP financial measures were disclosed: non-GAAP gross profit and gross margin, non-GAAP operating expenses, non-GAAP operating income (loss) and operating margin, non-GAAP net income (loss), non-GAAP net income (loss) per share, basic and diluted, free cash flow, and free cash flow margin.

Specifically, Zendesk excludes the following from its historical and prospective non-GAAP financial measures, as applicable:

Share-Based Compensation and Amortization of Share-based Compensation Capitalized in Internal-use Software: Zendesk utilizes share-based compensation to attract and retain employees. It is principally aimed at aligning their interests with those of its stockholders and at long-term retention, rather than to address operational performance for any particular period. As a result, share-based compensation expenses vary for reasons that are generally unrelated to financial and operational performance in any particular period.

Employer Tax Related to Employee Stock Transactions: Zendesk views the amount of employer taxes related to its employee stock transactions as an expense that is dependent on its stock price, employee exercise and other award disposition activity, and other factors that are beyond Zendesk’s control. As a result, employer taxes related to its employee stock transactions vary for reasons that are generally unrelated to financial and operational performance in any particular period.

Amortization of Purchased Intangibles: Zendesk views amortization of purchased intangible assets, including the amortization of the cost associated with an acquired entity’s developed technology, as items arising from pre-acquisition activities determined at the time of an acquisition. While these intangible assets are evaluated for impairment regularly, amortization of the cost of purchased intangibles is an expense that is not typically affected by operations during any particular period.

Acquisition-Related Expenses: Zendesk views acquisition-related expenses, such as transaction costs, integration costs, restructuring costs, and acquisition-related retention payments, including amortization of acquisition-related retention payments capitalized in internal-use software, as events that are not necessarily reflective of operational performance during a period. In particular, Zendesk believes the consideration of measures that exclude such expenses can assist in the comparison of operational performance in different periods which may or may not include such expenses.

Amortization of Debt Discount and Issuance Costs: In March 2018, Zendesk issued $575 million of convertible senior notes due in 2023, which bear interest at an annual fixed rate of 0.25%. The imputed interest rate of the convertible senior notes was approximately 5.26%. This is a result of the debt discount recorded for the conversion feature that is required to be separately accounted for as equity, and debt issuance costs, which reduce the carrying value of the convertible debt instrument. The debt discount is amortized as interest expense together with the issuance costs of the debt. The expense for the amortization of debt discount and debt issuance costs is a non-cash item, and we believe the exclusion of this interest expense will provide for a more useful comparison of our operational performance in different periods.

Income Tax Effects: Zendesk utilizes a fixed long-term projected tax rate in its computation of non-GAAP income tax effects to provide better consistency across interim reporting periods. In projecting this long-term non-GAAP tax rate, Zendesk utilizes a financial projection that excludes the direct impact of other non-GAAP adjustments. The projected rate considers other factors such as Zendesk's current operating structure, existing tax positions in various jurisdictions, and key legislation in major jurisdictions where Zendesk operates. For the year ending December 31, 2019, Zendesk has determined the projected non-GAAP tax rate to be 21%. Zendesk will periodically re-evaluate this tax rate, as necessary, for significant events, based on relevant tax law changes, material changes in the forecasted geographic earnings mix, and any significant acquisitions.

Zendesk provides disclosures regarding its free cash flow, which is defined as net cash from operating activities, less purchases of property and equipment and internal-use software development costs. Free cash flow margin is calculated as free cash flow as a percentage of total revenue. Zendesk uses free cash flow, free cash flow margin, and other measures, to evaluate the ability of its operations to generate cash that is available for purposes other than capital expenditures and capitalized software development costs. Zendesk believes that information regarding free cash flow and free cash flow margin provides investors with an important perspective on the cash available to fund ongoing operations.

Zendesk has not reconciled free cash flow guidance to net cash from operating activities for the year ending December 31, 2019 because Zendesk does not provide guidance on the reconciling items between net cash from operating activities and free cash flow, as a result of the uncertainty regarding, and the potential variability of, these items. The actual amount of such reconciling items will have a significant impact on Zendesk’s free cash flow and, accordingly, a reconciliation of net cash from operating activities to free cash flow for the year ending December 31, 2019 is not available without unreasonable effort.

Zendesk does not provide a reconciliation of its non-GAAP operating margin guidance to GAAP operating margin for future periods beyond the current fiscal year because Zendesk does not provide guidance on the reconciling items between GAAP operating margin and non-GAAP operating margin for such periods, as a result of the uncertainty regarding, and the potential variability of, these items. The actual amount of such reconciling items will have a significant impact on Zendesk’s non-GAAP operating margin and, accordingly, a reconciliation of GAAP operating margin to non-GAAP operating margin guidance for such periods is not available without unreasonable effort.

Zendesk’s disclosures regarding its expectations for its non-GAAP gross margin include adjustments to its expectations for its GAAP gross margin that exclude share-based compensation and related expenses in Zendesk’s cost of revenue, amortization of purchased intangibles primarily related to developed technology, and acquisition-related expenses. The share-based compensation and related expenses excluded due to such adjustments are primarily comprised of the share-based compensation and related expenses for employees associated with Zendesk’s infrastructure and customer experience organization.

Zendesk does not provide a reconciliation of its non-GAAP gross margin guidance to GAAP gross margin for future periods because Zendesk does not provide guidance on the reconciling items between GAAP gross margin and non-GAAP gross margin, as a result of the uncertainty regarding, and the potential variability of, these items. The actual amount of such reconciling items will have a significant impact on Zendesk’s non-GAAP gross margin and, accordingly, a reconciliation of GAAP gross margin to non-GAAP gross margin guidance for the period is not available without unreasonable effort.

Zendesk uses non-GAAP financial information to evaluate its ongoing operations and for internal planning and forecasting purposes. Zendesk’s management does not itself, nor does it suggest that investors should, consider such non-GAAP financial measures in isolation from, or as a substitute for, financial information prepared in accordance with GAAP. Zendesk presents such non-GAAP financial measures in reporting its financial results to provide investors with an additional tool to evaluate Zendesk’s operating results. Zendesk believes these non-GAAP financial measures are useful because they allow for greater transparency with respect to key metrics used by management in its financial and operational decision-making. This allows investors and others to better understand and evaluate Zendesk’s operating results and future prospects in the same manner as management.

Zendesk’s management believes it is useful for itself and investors to review, as applicable, both GAAP information that may include items such as share-based compensation and related expenses, amortization of debt discount and issuance costs, amortization of purchased intangibles, and acquisition-related expenses, and the non-GAAP measures that exclude such information in order to assess the performance of Zendesk’s business and for planning and forecasting in subsequent periods. When Zendesk uses such a non-GAAP financial measure with respect to historical periods, it provides a reconciliation of the non-GAAP financial measure to the most closely comparable GAAP financial measure. When Zendesk uses such a non-GAAP financial measure in a forward-looking manner for future periods, and a reconciliation is not determinable without unreasonable effort, Zendesk provides the reconciling information that is determinable without unreasonable effort and identifies the information that would need to be added or subtracted from the non-GAAP measure to arrive at the most directly comparable GAAP measure. Investors are encouraged to review the related GAAP financial measures and the reconciliation of these non-GAAP financial measures to their most directly comparable GAAP financial measure as detailed above.

About Operating Metrics

Zendesk reviews a number of operating metrics to evaluate its business, measure performance, identify trends, formulate business plans, and make strategic decisions. These include the number of paid customer accounts on Zendesk Support, Zendesk Chat, and its other products, dollar-based net expansion rate, annual recurring revenue represented by its churned customers, and the percentage of its annual recurring revenue from Support originating from customers with 100 or more agents on Support.

Zendesk defines the number of paid customer accounts at the end of any particular period as the sum of (i) the number of accounts on Support, exclusive of its legacy Starter plan, free trials, or other free services, (ii) the number of accounts using Chat, exclusive of free trials or other free services, and (iii) the number of accounts on all of its other products, exclusive of free trials and other free services, each as of the end of the period and as identified by a unique account identifier. In the quarter ended June 30, 2018, Zendesk began to offer an omnichannel subscription which provides access to multiple products through a single paid customer account, Zendesk Suite and in the quarter ended June 30, 2019, Zendesk began to offer a subscription which provides access to Sell and Support through a single paid customer account, Zendesk Duet. All of the Suite paid customer accounts are included in the number of accounts on all of Zendesk’s other products and are not included in the number of paid customer accounts using Support or Chat. All of the Duet paid customer accounts are included in the number of paid customer accounts using Support. Existing customers may also expand their utilization of Zendesk’s products by adding new accounts and a single consolidated organization or customer may have multiple accounts across each of Zendesk’s products to service separate subsidiaries, divisions, or work processes. Other than usage of Zendesk’s products through its omnichannel subscription offering, each of these accounts is also treated as a separate paid customer account.

Zendesk’s dollar-based net expansion rate provides a measurement of its ability to increase revenue across its existing customer base through expansion of authorized agents associated with a paid customer account, upgrades in subscription plans, and the purchase of additional products as offset by churn, contraction in authorized agents associated with a paid customer account, and downgrades in subscription plans. Zendesk’s dollar-based net expansion rate is based upon annual recurring revenue for a set of paid customer accounts on its products. Zendesk determines the annual recurring revenue value of a contract by multiplying the monthly recurring revenue for such contract by twelve. Monthly recurring revenue for a paid customer account is a legal and contractual determination made by assessing the contractual terms of each paid customer account, as of the date of determination, as to the revenue Zendesk expects to generate in the next monthly period for that paid customer account, assuming no changes to the subscription and without taking into account any platform usage above the subscription base, if any, that may be applicable to such subscription. Beginning with the quarter ended June 30, 2019, we excluded the impact of revenue that we expect to generate from fixed-term contracts that are each associated with an existing account, are solely for additional temporary agents, and are not contemplated to last for the duration of the primary contract for the existing account from our determination of monthly recurring revenue. Monthly recurring revenue is not determined by reference to historical revenue, deferred revenue, or any other GAAP financial measure over any period. It is forward-looking and contractually derived as of the date of determination.

Zendesk calculates its dollar-based net expansion rate by dividing the retained revenue net of contraction and churn by Zendesk’s base revenue. Zendesk defines its base revenue as the aggregate annual recurring revenue across its products for customers with paid customer accounts as of the date one year prior to the date of calculation. Zendesk defines the retained revenue net of contraction and churn as the aggregate annual recurring revenue across its products for the same customer base included in the measure of base revenue at the end of the annual period being measured. The dollar-based net expansion rate is also adjusted to eliminate the effect of certain activities that Zendesk identifies involving the consolidation of customer accounts or the split of a single paid customer account into multiple paid customer accounts. In addition, the dollar-based net expansion rate is adjusted to include paid customer accounts in the customer base used to determine retained revenue net of contraction and churn that share common corporate information with customers in the customer base that are used to determine the base revenue. Giving effect to this consolidation results in Zendesk’s dollar-based net expansion rate being calculated across approximately 103,400 customers, as compared to the approximately 149,000 total paid customer accounts as of June 30, 2019.

To the extent that Zendesk can determine that the underlying customers do not share common corporate information, Zendesk does not aggregate paid customer accounts associated with reseller and other similar channel arrangements for the purposes of determining its dollar-based net expansion rate. While not material, Zendesk believes the failure to account for these activities would otherwise skew the dollar-based net expansion metrics associated with customers that maintain multiple paid customer accounts across its products and paid customer accounts associated with reseller and other similar channel arrangements.

Zendesk does not currently incorporate operating metrics associated with its legacy analytics product, its legacy Outbound product, Sell, its legacy Starter plan, free trials, or other free services into its measurement of dollar-based net expansion rate.

For a more detailed description of how Zendesk calculates its dollar-based net expansion rate, please refer to Zendesk’s periodic reports filed with the Securities and Exchange Commission.

Zendesk’s percentage of annual recurring revenue from Support that is generated by customers with 100 or more agents on Support is determined by dividing the annual recurring revenue from Support for paid customer accounts with 100 or more agents on Support as of the measurement date by the annual recurring revenue from Support for all paid customer accounts on Support as of the measurement date. Zendesk determines the customers with 100 or more agents on Support as of the measurement date based on the number of activated agents on Support at the measurement date and includes adjustments to aggregate paid customer accounts that share common corporate information. For the purpose of determining this metric, Zendesk builds an estimation of the proportion of annual recurring revenue from Suite attributable to Support and includes such portion in the annual recurring revenue from Support.

Zendesk does not currently incorporate operating metrics associated with products other than Support into its measurement of the percentage of annual recurring revenue from Support that is generated by customers with 100 or more agents on Support.

Zendesk determines its annual revenue run rate by multiplying the revenue generated over its most recently completed quarter by four.

Source: Zendesk, Inc.

Zendesk, Inc.
Investor Contact:
Karen Sansot, +1 415-852-3877
ir@zendesk.com

or

Media Contact:
Tian Lee, +1 415-231-0847
press@zendesk.com

Source: Zendesk, Inc.

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