Zendesk Announces Second Quarter 2018 Results

07/31/2018

Highlights

  • Second quarter revenue increased 39% year over year to $141.9 million
  • Second quarter GAAP operating income (loss) of $(33.6) million and non-GAAP operating income (loss) of $(2.0) million

SAN FRANCISCO--(BUSINESS WIRE)-- Zendesk, Inc. (NYSE: ZEN) today reported financial results for the fiscal quarter ended June 30, 2018, and released a Shareholder Letter on its investor relations website at https://investor.zendesk.com. All results and guidance are based on the revenue recognition standard ASC 606.

Results for the Second Quarter 2018

Revenue was $141.9 million for the quarter ended June 30, 2018, an increase of 39% over the prior year period. GAAP net income (loss) for the quarter ended June 30, 2018 was $(34.4) million, and GAAP net income (loss) per share was $(0.33). Non-GAAP net income (loss) was $3.1 million, and non-GAAP net income (loss) per share was $0.03. Non-GAAP net income (loss) excludes approximately $30.2 million in share-based compensation and related expenses (including $1.7 million of employer tax related to employee stock transactions and $0.4 million of amortization of share-based compensation capitalized in internal-use software), $5.9 million of amortization of debt discount and issuance costs, $0.7 million of amortization of purchased intangibles, and $0.7 million of acquisition-related expenses. GAAP net income (loss) per share for the quarter ended June 30, 2018 was based on 105.0 million weighted average shares outstanding (basic and diluted), and non-GAAP net income (loss) per share for the quarter ended June 30, 2018 was based on 105.0 million weighted averages shares outstanding (basic) and 111.7 million weighted average shares outstanding (diluted).

Outlook

As of July 31, 2018, Zendesk provided guidance for the quarter ending September 30, 2018 and updated its guidance for the year ending December 31, 2018.

For the quarter ending September 30, 2018, Zendesk expects to report:

  • Revenue in the range of $150.0 - 152.0 million
  • GAAP operating income (loss) in the range of $(31.0) - (33.0) million, which includes share-based compensation and related expenses of approximately $33.7 million, amortization of purchased intangibles of approximately $0.7 million, and acquisition-related expenses of approximately $0.6 million
  • Non-GAAP operating income (loss) in the range of $2.0 - 4.0 million, which excludes share-based compensation and related expenses of approximately $33.7 million, amortization of purchased intangibles of approximately $0.7 million, and acquisition-related expenses of approximately $0.6 million
  • Approximately 106.4 million weighted average shares outstanding (basic)
  • Approximately 113.2 million weighted average shares outstanding (diluted)

For the full year 2018, Zendesk expects to report:

  • Revenue in the range of $582.0 - 586.0 million
  • GAAP operating income (loss) in the range of $(130.0) - (135.0) million, which includes share-based compensation and related expenses of approximately $129.7 million, amortization of purchased intangibles of approximately $2.7 million, and acquisition-related expenses of approximately $2.6 million
  • Non-GAAP operating income (loss) in the range of $0.0 - 5.0 million, which excludes share-based compensation and related expenses of approximately $129.7 million, amortization of purchased intangibles of approximately $2.7 million, and acquisition-related expenses of approximately $2.6 million
  • Approximately 105.8 million weighted average shares outstanding (basic)
  • Approximately 113.3 million weighted average shares outstanding (diluted)
  • Free cash flow in the range of $28.0 - 30.0 million

We have not reconciled free cash flow guidance to net cash from operating activities for the full year 2018 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 2018 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 31, 2018, 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 3378309. 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 3378309. The dial-in replay will be available until the end of day August 2, 2018. The webcast replay will be available for 12 months.

About Zendesk

The best customer experiences are built with Zendesk. Zendesk’s powerful and flexible customer service and engagement platform scales to meet the needs of any business, from startups and small businesses to growth companies and enterprises. Zendesk serves businesses across a multitude of industries, with more than 125,000 paid customer accounts offering service and support in more than 30 languages. Headquartered in San Francisco, Zendesk operates worldwide with 15 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 towards its long-term financial objectives. The 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 market in which Zendesk operates is intensely competitive, and Zendesk may not compete effectively; (vii) the development of the market for software as a service business software applications; (viii) Zendesk’s ability to introduce and market new products and to support its products on a shared services platform; (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; (xi) breaches in Zendesk’s security measures or unauthorized access to its customers’ data; (xii) service interruptions or performance problems associated with Zendesk’s technology and infrastructure; (xiii) real or perceived errors, failures, or bugs in its products; and (xiv) Zendesk’s substantial reliance on its customers renewing their subscriptions and purchasing additional subscriptions.

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, 2018. 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, 2018.

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,


2018  

2017
* As adjusted


2018  

2017
* As adjusted

Revenue
$ 141,882

$ 102,096

$ 271,673

$ 195,984
Cost of revenue
44,160  
30,663  
83,216  
58,770  
Gross profit
97,722

71,433

188,457

137,214
Operating expenses:







Research and development
37,624

28,698

74,708

55,154
Sales and marketing
69,450

50,412

134,508

96,681
General and administrative
24,245  
19,788  
46,452  
38,105  
Total operating expenses
131,319  
98,898  
255,668  
189,940  
Operating loss
(33,597 )
(27,465 )
(67,211 )
(52,726 )
Other income (expense), net







Interest income
3,826

827

5,344

1,540
Interest expense
(6,289 )


(7,053 )

Other income (expense), net
27  
(319 )
272  
(814 )

Total other income (expense), net


(2,436 )
508  
(1,437 )
726  
Loss before benefit from income taxes
(36,033 )
(26,957 )
(68,648 )
(52,000 )
Benefit from income taxes
(1,667 )
(690 )
(4,957 )
(652 )
Net loss
$ (34,366 )
$ (26,267 )
$ (63,691 )
$ (51,348 )
Net loss per share, basic and diluted
$ (0.33 )
$ (0.26 )
$ (0.61 )
$ (0.52 )
Weighted-average shares used to compute net loss per share, basic and diluted
105,000  
99,506  
104,350  
98,545  

*Adjusted to reflect the adoption of ASC 606.













 
Condensed Consolidated Balance Sheets
 

(In thousands, except par value; unaudited)

 

  June 30,   December 31,


2018
2017


 
*As adjusted
Assets



Current assets:



Cash and cash equivalents
$ 492,752

$ 109,370
Marketable securities
191,503

137,576
Accounts receivable, net of allowance for doubtful accounts of $2,478 and $1,252 as of June 30, 2018 and December 31, 2017, respectively
69,419

57,096
Deferred costs
19,335

15,771
Prepaid expenses and other current assets
31,170  
24,165  
Total current assets
804,179

343,978
Marketable securities, noncurrent
188,770

97,447
Property and equipment, net
69,426

59,157
Deferred costs, noncurrent
20,250

15,395
Goodwill and intangible assets, net
65,647

67,034
Other assets
10,813  
8,359  
Total assets
$ 1,159,085  
$ 591,370  
Liabilities and stockholders’ equity



Current liabilities:



Accounts payable
$ 14,229

$ 5,307
Accrued liabilities
39,481

21,876
Accrued compensation and related benefits
33,612

29,017
Deferred revenue
206,456  
173,147  
Total current liabilities
293,778

229,347
Convertible senior notes, net
446,060


Deferred revenue, noncurrent
1,504

1,213
Other liabilities
12,877  
6,626  
Total liabilities
754,219  
237,186  




 
Stockholders’ equity:



Preferred stock, par value $0.01 per share



Common stock, par value $0.01 per share
1,056

1,031
Additional paid-in capital
871,343

753,568
Accumulated other comprehensive loss
(5,799 )
(2,372 )
Accumulated deficit
(461,734 )
(398,043 )
Total stockholders’ equity
404,866  
354,184  
Total liabilities and stockholders’ equity
$ 1,159,085  
$ 591,370  

*Adjusted to reflect the adoption of ASC 606.









 

Condensed Consolidated Statements of Cash Flows

 

(In thousands; unaudited)

 

  Three Months Ended June 30,


2018  

2017
*As adjusted

Cash flows from operating activities



Net loss
$ (34,366 )
$ (26,267 )
Adjustments to reconcile net loss to net cash provided by operating activities:



Depreciation and amortization
8,798

8,209
Share-based compensation
28,148

20,945
Amortization of deferred costs
5,020

3,419
Amortization of debt discount and issuance costs
5,930


Other
2,048

(338 )
Changes in operating assets and liabilities:



Accounts receivable
(17,587 )
(2,303 )
Prepaid expenses and other current assets
(4,061 )
(2,473 )
Deferred costs
(10,536 )
(5,507 )
Other assets and liabilities
2,716

(3,072 )
Accounts payable
9,214

1,851
Accrued liabilities
590

1,664
Accrued compensation and related benefits
5,091

3,990
Deferred revenue
22,691  
10,177  
Net cash provided by operating activities
23,696

10,295
Cash flows from investing activities



Purchases of property and equipment
(13,228 )
(4,485 )
Internal-use software development costs
(1,817 )
(1,463 )
Purchases of marketable securities
(170,690 )
(41,567 )
Proceeds from maturities of marketable securities
39,317

30,032
Proceeds from sales of marketable securities
1,866

12,141
Cash paid for the acquisition of Outbound, net of cash acquired
 
(16,470 )
Net cash used in investing activities
(144,552 )
(21,812 )
Cash flows from financing activities



Issuance costs related to convertible senior notes
(570 )

Proceeds from exercises of employee stock options
3,554

3,486
Proceeds from employee stock purchase plan
4,853

3,295
Other
(3,128 )
(1,609 )
Net cash provided by financing activities
4,709  
5,172  
Effect of exchange rate changes on cash, cash equivalents and restricted cash
(1 )
81  
Net decrease in cash, cash equivalents and restricted cash
(116,148 )
(6,264 )
Cash, cash equivalents and restricted cash at beginning of period
610,545  
110,776  
Cash, cash equivalents and restricted cash at end of period
$ 494,397  
$ 104,512  

*Adjusted to reflect the adoption of ASC 606 and ASU 2016-18.









 

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,


2018

 

2017
*As adjusted


2018

 

2017
*As adjusted

Reconciliation of gross profit and gross margin







GAAP gross profit
$ 97,722

$ 71,433

$ 188,457

$ 137,214
Plus: Share-based compensation
3,474

2,156

6,572

4,260
Plus: Employer tax related to employee stock transactions
296

133

556

302
Plus: Amortization of purchased intangibles
612

919

1,224

1,749
Plus: Amortization of share-based compensation capitalized in internal-use software
356  
448  
718  
878  
Non-GAAP gross profit
$ 102,460  
$ 75,089  
$ 197,527  
$ 144,403  
GAAP gross margin
69 %
70 %
69 %
70 %
Non-GAAP adjustments
3 %
4 %
4 %
4 %
Non-GAAP gross margin
72 %
74 %
73 %
74 %








 
Reconciliation of operating expenses







GAAP research and development
$ 37,624

$ 28,698

$ 74,708

$ 55,154
Less: Share-based compensation
(9,529 )
(7,584 )
(19,758 )
(14,498 )
Less: Employer tax related to employee stock transactions
(642 )
(356 )
(1,385 )
(904 )
Less: Acquisition-related expenses
(404 )
(175 )
(787 )
(175 )
Non-GAAP research and development
$ 27,049  
$ 20,583  
$ 52,778  
$ 39,577  
GAAP research and development as percentage of revenue
27 %
28 %
27 %
28 %
Non-GAAP research and development as percentage of revenue
19 %
20 %
19 %
20 %








 
GAAP sales and marketing
$ 69,450

$ 50,412

$ 134,508

$ 96,681
Less: Share-based compensation
(9,178 )
(5,884 )
(17,186 )
(11,408 )
Less: Employer tax related to employee stock transactions
(500 )
(247 )
(1,074 )
(614 )
Less: Amortization of purchased intangibles
(57 )
(123 )
(167 )
(225 )
Less: Acquisition-related expenses
(281 )
(187 )
(563 )
(187 )
Non-GAAP sales and marketing
$ 59,434  
$ 43,971  
$ 115,518  
$ 84,247  
GAAP sales and marketing as percentage of revenue
49 %
49 %
50 %
49 %
Non-GAAP sales and marketing as percentage of revenue
42 %
43 %
43 %
43 %








 
GAAP general and administrative
$ 24,245

$ 19,788

$ 46,452

$ 38,105
Less: Share-based compensation
(5,967 )
(5,321 )
(11,619 )
(9,883 )
Less: Employer tax related to employee stock transactions
(282 )
(133 )
(589 )
(403 )
Less: Acquisition-related expenses
 
(522 )
 
(522 )
Non-GAAP general and administrative
$ 17,996  
$ 13,812  
$ 34,244  
$ 27,297  
GAAP general and administrative as percentage of revenue
17 %
19 %
17 %
19 %
Non-GAAP general and administrative as percentage of revenue
13 %
14 %
13 %
14 %








 
Reconciliation of operating loss and operating margin







GAAP operating loss
$ (33,597 )
$ (27,465 )
$ (67,211 )
$ (52,726 )
Plus: Share-based compensation
28,148

20,945

55,135

40,049
Plus: Employer tax related to employee stock transactions
1,720

869

3,604

2,223
Plus: Amortization of purchased intangibles
669

1,042

1,391

1,974
Plus: Acquisition-related expenses
685

884

1,350

884
Plus: Amortization of share-based compensation capitalized in internal-use software
356  
448  
718  
878  
Non-GAAP operating loss
$ (2,019 )
$ (3,277 )
$ (5,013 )
$ (6,718 )
GAAP operating margin
(24 )%
(27

)%


(25 )%
(27 )%
Non-GAAP adjustments
23 %
24 %
23 %
24 %
Non-GAAP operating margin
(1 )%
(3 )%
(2 )%
(3 )%

 
 


Three Months Ended June 30,
Six Months Ended June 30,


2018  

2017
*As adjusted


2018  

2017
*As adjusted

Reconciliation of net income (loss)







GAAP net loss
$ (34,366 )
$ (26,267 )
$ (63,691 )
$ (51,348 )
Plus: Share-based compensation
28,148

20,945

55,135

40,049
Plus: Employer tax related to employee stock transactions
1,720

869

3,604

2,223
Plus: Amortization of purchased intangibles
669

1,042

1,391

1,974
Plus: Acquisition-related expenses
685

884

1,350

884
Plus: Amortization of share-based compensation capitalized in internal-use software
356

448

718

878
Plus: Amortization of debt discount and issuance costs
5,930  
 
6,650  
 
Non-GAAP net income (loss)
$ 3,142  
$ (2,079 )
$ 5,157  
$ (5,340 )








 
Reconciliation of net income (loss) per share, basic







GAAP net loss per share, basic
$ (0.33 )
$ (0.26 )
$ (0.61 )
$ (0.52 )
Non-GAAP adjustments to net loss
0.36  
0.24  
0.66  
0.47  
Non-GAAP net income (loss) per share, basic
$ 0.03  
$ (0.02 )
$ 0.05  
$ (0.05 )








 
Reconciliation of net income (loss) per share, diluted







GAAP net loss per share, diluted
$ (0.33 )
$ (0.26 )
$ (0.61 )
$ (0.52 )
Non-GAAP adjustments to net loss
0.36  
0.24  
0.66  
0.47  
Non-GAAP net income (loss) per share, diluted
$ 0.03  
$ (0.02 )
$ 0.05  
$ (0.05 )








 
Weighted-average shares used in GAAP per share calculation, basic and diluted
105,000

99,506

104,350

98,545








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







Basic
105,000

99,506

104,350

98,545
Diluted
111,725

99,506

110,300

98,545








 
Computation of free cash flow







Net cash provided by operating activities
$ 23,696

$ 10,295

$ 39,938

$ 17,577
Less: purchases of property and equipment
(13,228 )
(4,485 )
(20,036 )
(9,276 )
Less: internal-use software development costs
(1,817 )
(1,463 )
(4,161 )
(3,315 )
Free cash flow
$ 8,651  
$ 4,347  
$ 15,741  
$ 4,986  

*Adjusted to reflect the adoption of ASC 606.

































 

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, and free cash flow.

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.

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. Zendesk uses free cash flow, among 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 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, 2018 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, 2018 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 and amortization of purchased intangibles related to developed technology. 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, monthly recurring revenue represented by its churned customers, and the percentage of its monthly 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. 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. Other than usage of Zendesk’s products through its omnichannel subscription offering, the use of Support, Chat, and Zendesk’s other products requires separate subscriptions and each of these accounts are treated as a separate paid customer account. 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 monthly recurring revenue for a set of paid customer accounts on its products. 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 one-time discounts or any platform usage above the subscription base, if any, that may be applicable to such subscription. 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 monthly recurring revenue across its products for customers with paid customer accounts on Support or Chat 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 monthly 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 transfer of agents between paid customer accounts, 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 107,800 customers, as compared to the approximately 130,300 total paid customer accounts as of June 30, 2018.

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 analytics product or its Connect product 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 monthly recurring revenue from Support that is generated by customers with 100 or more agents on Support is determined by dividing the monthly recurring revenue from Support for paid customer accounts with 100 or more agents on Support as of the measurement date by the monthly 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.

Zendesk determines the annualized value of a contract by annualizing the monthly recurring revenue for such contract.

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

Source: Zendesk, Inc.

Zendesk, Inc.
Investor Contact:
Marc Cabi, +1 415-852-3877
ir@zendesk.com
or
Media Contact:
Analisa Schelle, +1 510-292-5410
press@zendesk.com

Source: Zendesk, Inc.

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