Despite Challenges, Zendesk Posts Strong Growth

Image source: Zendesk.

Software-as-a-service company Zendesk (NYSE: ZEN) reported its third-quarter results after the market closed on Nov. 1. Zendesk produced strong revenue growth, but management was quick to point out that the company failed to reach its full potential during the quarter because of disruptions caused by a recent sales and marketing realignment. GAAP losses expanded during the quarter, but Zendesk still expects to produce positive free cash flow next year. Here's what investors need to know about Zendesk's third-quarter results.

Zendesk results: The raw numbers

Data source: Zendesk Q3 earnings report.

What happened with Zendesk this quarter?

Zendesk continued adding customers, although a realignment of its sales and marketing activities in July caused some disruptions.

Paid customer accounts now exceed 87,000, up from 81,000 at the end of the second quarter. The realignment in July negatively affected the company's ability to close new business, particularly late in the quarter.
33% of Zendesk's monthly recurring revenue came from paid customers with 100 or more agents. This percentage has now remained unchanged for three consecutive quarters.
The number of contracts signed with an annual value of $50,000 or greater increased by 44% year over year, while the average size of these contracts decreased.
Zendesk added or expanded its relationship with a few notable customers during the third quarter, including Instacart, MailChimp, and Neato Robotics.

Zendesk provided guidance for the fourth quarter and the full year, as well as some longer-term targets.

For the fourth quarter, Zendesk sees revenue in the range of $86 million to $88 million, GAAP operating loss between $29 million and $30 million, and non-GAAP operating loss between $5 million and $6 million.
For the full year, the company sees revenue between $309 million and $311 million, GAAP operating loss between $108.5 million and $109.5 million, and non-GAAP operating loss between $22 million and $23 million.
Zendesk remains confident that it will reach $1 billion of annual revenue in 2020.
Zendesk expects to produce positive free cash flow in 2017.

What management had to say

While the realignment in July caused some problems during the third quarter, management pointed out in the company's letter to shareholders that a lot is going right: "Despite those challenges, there was much to be excited about in our business performance during the quarter. Our core low-touch business continued to thrive, with the result being that a very substantial portion of our business is being closed with short and highly efficient sales cycles."

With the realignment complete, management expects to enter 2017 on a strong footing: "With the rearchitecting of our go-to-market organization largely complete and the rollout of our new brand messaging and family of products, we believe we are well positioned to close out 2016 and turn to 2017. We will maintain our focus on sustaining high growth while demonstrating scale through improved operating margins over time as we pursue our ultimate goal of helping organizations build better relationships with their customers."

Looking forward

One thing to watch going forward is the company's ability to win bigger customers. The percentage of monthly recurring revenue coming from larger clients has been mostly stagnant for over a year, despite big increases in the number of large contracts being signed.

Strong revenue growth and growing GAAP losses have been the theme of Zendesk's quarterly reports, and the third-quarter report was no different. Zendesk will need to keep growing at a breakneck pace to reach its goal of $1 billion of revenue in 2020, but so far the company has had little trouble in that area. Even with disruptions during the quarter, the company still managed 45% year-over-year revenue growth, an impressive rate given its size.

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Timothy Green has no position in any stocks mentioned. The Motley Fool recommends Zendesk. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.