Why Shares of Zendesk Dropped Today

By Markets Fool.com

Image Source: Zendesk.

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What happened

Shares of software-as-a-service provider Zendesk (NYSE: ZEN) slumped on Wednesday following the company's third-quarter report, despite revenue and earnings coming in ahead of analyst expectations. Guidance could be the culprit, with Zendesk predicting that revenue will rise by just 38% year over year during the fourth quarter. At 11:30 a.m. EDT, the stock was down about 10.5%.

So what

Zendesk reported third-quarter revenue of $80.7 million, up 45% year over year and $1.25 million higher than the average analyst estimate. This represents a slowdown compared to the 54% growth Zendesk reported during the second quarter. The company blamed a sales and marketing realignment for disrupting its ability to close deals during the third quarter, which contributed to its decelerating revenue growth.

Non-GAAP EPS came in at a loss of $0.04, an improvement compared to a loss of $0.05 during the prior-year period, and $0.02 better than analysts were expecting. GAAP earnings tumbled, with Zendesk posting a $25.8 million loss, worse than the $18.9 million loss the company reported during the third quarter of 2015.

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Zendesk expects to generate between $86 million and $88 million of revenue during the fourth quarter, representing year-over-year growth of just 38% at the midpoint. Growth rates are bound to slow as Zendesk grows larger, but investors clearly expected more.

Now what

Zendesk has a goal of reaching $1 billion of annual revenue by 2020. Assuming the company hits its full-year guidance of $309 million to $311 million, it will need to grow revenue at an annualized rate of 34% through 2020 in order to hit the $1 billion mark. With guidance for the fourth quarter perilously close to this required rate, Zendesk's long-term revenue goal is beginning to look optimistic.

While Zendesk performed better than analysts expected during the third quarter, investors seemed to focus more on the company's guidance. With GAAP losses rising, any slowdown in revenue growth is a big problem for the company and for the stock.

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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.