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Zendesk Announces Second Quarter 2018 Results

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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

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.

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