Zendesk' (ZEN) CEO Mikkel Svane on Q4 2015 Results - Earnings Call Transcript

| About: Zendesk, Inc. (ZEN)

Zendesk, Inc. (NYSE:ZEN)

Q4 2015 Earnings Conference Call

February 16, 2015 05:00 pm ET

Executives

Marc Cabi - VP, Investor Relations

Mikkel Svane - Founder, CEO and Chair of the Board of Directors

Alan Black - SVP, CFO

Analysts

Philip Winslow - Credit Suisse

Jesse Hulsing - Goldman Sachs

Kash Rangan - Bank of America Merrill Lynch

Stan Zlotsky - Morgan Stanley

Brendan Barnicle - Pacific Crest Securities

Ross MacMillan - RBC Capital Markets

Richard Davis - Canaccord Genuity

Bhavan Suri - William Blair & Company

Alex Zukin - Stephens Inc

Natasha Asar - JMP Securities

Patrick Walravens - JMP Securities

Shebly Seyrafi - FBN Securities

Jeff Van Rhee - Craig-Hallum Capital Group

Operator

Welcome to the Fourth Quarter 2015 Zendesk's Earnings Conference Call. During the call, all participants will be in a listen-only mode. After the presentation, we will conduct a question-and-answer session. [Operator Instructions]. As a reminder, this conference is being recorded, and will be available for replay from the Investor Relations section of Zendesk's website following this call.

I will now turn the call over to Marc Cabi, Vice President of Investor Relations. Thank you, Mr. Cabi, you may now begin.

Marc Cabi

Thanks, Victoria. This is Marc Cabi. I'm pleased to welcome you to Zendesk's fourth quarter and full year 2015 earnings conference call and webcast to discuss our financial results. Joining me today are Mikkel Svane, Founder, CEO and Chair of the Board of Directors and Alan Black, our Chief Financial Officer.

After the market closed today, Zendesk announced financial results for its fourth quarter and full fiscal 2015. The earnings press release and a live webcast of this session are available by visiting investor.zendesk.com, which is our investor's website. A replay of this webcast will also be available for one year on our website.

During the course of today's call, we may make forward-looking statements such as statements regarding our future financial performance, product development, growth prospects, our ability to attract and retain customers and our ability to complete [ph] effectively. These forward-looking statements are based on assumptions that we believe to be reasonable as of today and are subject to risks, uncertainties and assumptions that could cause actual results to materially differ from such statements. Additional information on the factors that could affect actual results is contained in our earnings press release and the risk factors in our prior and subsequent filings with the Securities and Exchange Commission including our most recent Form 10-Q and our upcoming annual report.

We undertake no obligation to update these statements after today's presentation or to conform these statements to actual results or to changes in our expectations except as required by law. During this call, we will present both and GAAP and non-GAAP financial measures. The non-GAAP measures should be considered in addition to and not as a substitute for, or in isolation from our GAAP financial information. You could find additional disclosures regarding these non-GAAP financial measures, including reconciliations with the comparable GAAP financial measures in today's earnings press release regarding our fourth quarter and full year 2015 results.

And for certain non-GAAP financial measures for prior periods in the earnings press releases for such prior periods, both of which are available on our investor website.

With that, let me turn the call over to Mikkel.

Mikkel Svane

Perfect, thanks Marc. And thank you everybody, again for joining us here today. I am excited to share our accomplishments in 2015 and our results from the fourth quarter. I like to begin by focusing on several key milestones that I'm particularly excited about because they illustrate how much we've grown in the past year and the significant momentum, that we have heading into 2016.

Diving into the numbers, total number of paid customer accounts exceeded 69,000 as of the end of fourth quarter. Our global growth remained strong in Q4 with 44% off revenues coming from outside to United States. Of all our fourth quarter numbers are most excited to share that we, ended the year with an annual revenue run rate of a $250 million that's a great milestone and represents 63% increase year-over-year.

We reached another very significant milestone, when for Q4 we achieved an annual run rate of almost a 1 billion tickets. That illustrates our ability of our infrastructure to scale, to meet the demands of our larger customers with a very high volume of customer attractions.

On the personal front, the majority of our hiring last year was for positions outside of our San Francisco headquarters. At the end of 2015, our total worldwide employee count was more than 1,200 employees that includes the addition of the BIME Analytics team. Last year's acquisitions of that team brought us a new office in Montpellier in Southern France, which joins five others Zendesk development centers around the world, where engineers are building the next-generation of Zendesk features and products.

Well, all of this growth in 2015, we build the momentum, we need to have an even bigger 2016 and importantly to propel us to a new goal. As we've told you before, driving high growth is one of the fundamental management principles at Zendesk. Our new long-term growth target is to be a $1 billion revenue company in 2020. Why we do that? We are committed to continually improving our annual free cash flow including our goal to be free cash flow positive for the full year of 2017.

I'll talk a little bit more about those aspirations in a few minutes, but let's talk initially more about the 2015 momentum that helping us getting there. On the enterprise side of the business, 2015 was a breakout year. A big factor in our revenue growth was the increasing size of new deals. We signed three times more contracts with an annualized value of more than $50,000 during the last quarter of 2015 than we did in Q4 of 2014.

And we saw an increase of more than 45% in the average annualized values of those larger contracts as compared to Q4 last year. Many of these larger deals are with existing customers, highlighting the success of our land and expand strategy. In another sign of growth, the percentage of our MRR, our monthly recurring revenue from accounts with 100 or more agents is up year-over-year, 32% as of the end of Q4 compared to 24% as of the end of fourth quarter of 2014.

This growth comes from both in increase in the size of new deals and expansion deals with our existing customers. You also see, this growth reflected in our dollar base and expansion rate, which was 123% at the end of the fourth quarter. Several great brands joined us as new customers during 2015 including the California Pizza Kitchen, which now uses Zendesk to power customer service for its almost 200 US restaurants in more than 30 states.

GrubHub an online and mobile food ordering company operating in more than 1,000 US cities and ESPN which shows our LiveChat product for support in its website, which is one of the top 50 most traffic websites in the US.

We also had strong traction in the education, government and health sectors including new businesses from the Tennessee Department of Labor, which serves the states employers and its 6 million citizens. There's University of South Australia, which is the largest university in the states of South Australia with an enrollment of 33,000 students.

Denmark's [indiscernible] for the non-Danish speakers, the Danish National Environmental Portal and the Emory clinic, the largest healthcare system in the state of Georgia. Part of our focus in the second half of 2015 wasn't building the go-to-market organization to capitalize on enterprise opportunities such as these.

As we begin 2016, I feel very confident in the strength of the global sales leadership team and our reputed [ph] field marketing organization. On the development side, we made significant investments in enhancing our products to meet the requirements of these larger and more complex organizations, while maintaining the ease and deployment and the ease of use that we are so famous for.

Security, compliance, data center, locality and scale were a big focus of those updates in 2015. We broadened our support channel offerings as well, making update to our LiveChat product and most recently on dealing our advanced voice product in December. This major update brought much needed advance features to our offering making phone calls via Zendesk and attractive option for a much larger segment of our customer base.

Our product development work caught the attention of industry analyst, who are influential in the buying decisions of larger companies. We were favorably positioned in the Gartner's Magic Quadrant for our industry last year. More recently in the Forrester Wave, in which we were appraised for our completeness of our product and innovative approach.

Even as we make significant inroads in the enterprise market, we continue to foster the roots of our business, the large community of self-service buyers. These are mostly small businesses within and some smaller deployments within enterprise companies mixed in. We call it our velocity business and this low or not touch customer acquisition model fueled our early success and it remains a critical part of our growth story moving forward.

Some of the new entrepreneurial or emerging companies that joined us as customer in Q4 include Three Jerks Jerky renowned for its Filet Mignon Jerky and whose founders recently won over the investors on the TV Show, the Shark Tank. Prosper Marketplace another great customer peer-to-peer lending service with few million members and Ingresso, which is Brazil's largest mobile movie ticketing service.

So we're proud of our momentum last year and now looking ahead, we believe it lays a strong foundation for us, as we seek to become a $1 billion revenue company by 2020. Reaching a $1 billion growth requires us to build on our success in customer support. It's a move to broader opportunities and markets around the entire customer relationship.

We believe the time is right to broaden our appeal because of major trends changing customer relationships. First, we see the rise of new subscription and convenient space business models, that require organizations to build loyalty with customers rather than focus on individual transactions.

Next we see the promoter economy that has turned customers into the most important asset, into the most important ventures [ph] for businesses and an extension off the marketing and sales operations. And finally, the today's conscious consumer, that are making buying decision based on an organization community involvement and values, really requiring a high degree of trust and transparency in the customer relationship.

As these trends reshape customer relationship, they're also forcing a rapid blurring of the lines between traditional customer support between marketing and sales within organization. We're well positioned to move beyond support in order to address the overall customer relationship and we've taken the necessary steps to become a multi-product company that can serve a wider market.

To start, we are aggressively pursuing new products to build out our capabilities across the lifecycle of customer relationships. We're building new features for our call customer service platform to better track and understand relationships. While also incubating individual product categories in pursuit of rapid growth on new markets.

LiveChat, BIME Analytics and voice are three examples of those categories. Each of these teams with incentives have freedom to experiment and to innovate in product development and go-to-market approaches, while the call centers platform benefits from the new functionality.

One of Zendesk's strongest asset has always been our brand. We are building unique and recognizable brand in the world of customer service. This year, we plan to elevate that brand to better represent the wider world of customer relationships and increase awareness amongst a broader set of business leaders and buyers.

Already, we launched a new live event series, an online site called Relate, to reach that wider audience and next we plan to appeal to them with new brand awareness campaigns.

Similarly to our brand, we believe our philosophy around corporate responsibility and community involvement are an important differentiator for us. Corporate responsibility is deeply rooted in our culture, but it's not only an internal initiative. We believe our products and sales are helping to foster greater corporate responsibility for our customers. The responsiveness, the transparency enabled by Zendesk are helping organizations build closer ties to their communities, as we help organizations address the conscious consumer of today.

Today, along with our earnings update, we have also announced a new addition to our board. Carl Bass, President and CEO of our Autodesk. Carl brings so much relevant experience to the table including building and managing a company with more than a $1 billion in revenues and developing multiple products that served a wide range of customers from consumer to small businesses to enterprises.

His wealth of knowledge will be invaluable, as we pursue our path to being a multi-product, multi-segment company. Carl also shares our passion for building beautiful product experience and cultivating a strong developer community. I can't think of a better addition to the Zendesk Board of Directors and I'm very excited to welcome, Carl.

As we now close the books on 2015, we feel very energized by the success of the past year and well prepared for 2016 and beyond. And speaking of being well prepared, Alan - in 2016, we are preparing to see if not goodbye then so long to you Alan, as we announced in December. Alan Black will be moving on from Zendesk once we complete our search for our next CFO.

I really enjoyed working with you Alan and I appreciate, you sticking around while we look for someone to fill your giant shoes. And with that, Alan I'm going to turn it over to you for more in depth look at the numbers for 2015 and for Q4. Take it away.

Alan Black

Well, Mikkel. Thank you for your kind words and good afternoon, everybody. As Mikkel said, we're extremely proud of the progress we made in 2015. We delivered strong year-over-year revenue growth and improved cash flows and gross margin and operating margins also improved, as we execute in our go-to-market strategy.

Our fourth quarter results were particularly solid and without further delay, let me take you to the numbers. Fourth quarter revenue was $62.2 million up 63% year-over-year from $38.5 million of revenue reported in the fourth quarter of 2014 and up 12% sequentially from $55.7 million of revenue reported in the third quarter.

Our revenue growth this quarter was driven by both new and expansion sales. For the full year 2015, revenue grew by 64% to $208.8 million up from $127 million in 2014. Non-GAAP gross margin increased slightly to 72.7% in Q4 compared to 72.6% in the third quarter despite additional expenses incurred from the addition of our new German data center launched in the third quarter.

Our fourth quarter non-GAAP net loss was $6.7 million or $0.07 per share and our non-GAAP operating loss was $6.6 million in line with our outlook for the quarter. Non-GAAP operating margin was negative 10.5% in Q4 compared to negative 7.4% in the third quarter, due primarily to additional depreciation expense from the new data center.

And additional research and development and sales and marketing expenses stemming from the We Are Cloud acquisition. For the full year, our non-GAAP operating margin improved from negative 24.3% in 2014 to negative 11.8% in 2015. We continue to manage the business with a goal of delivering year-over-year improvement in our operating margin.

On a GAAP basis, fourth quarter gross margin was 68.6% compared to 69.4% in the third quarter. And operating margin was negative 38.9% versus negative 33.8% in the third quarter. GAAP gross margin was impacted quarter-over-quarter primarily due to two factors. Amortization of acquired internally developed software arising from the BIME acquisition and increased data center depreciation expenses, I just discussed.

GAAP net loss was $24.5 million or $0.27 a share versus $18.9 million or $0.22 per share in the third quarter. Our loss increased primarily as a result of increased operating expenses following the BIME acquisition and increased share-based compensation expense. Our GAAP net loss included $15.8 million of share-based compensation and related corporate payroll taxes. $300,000 of share-based compensation expense capitalized in internal use software and amortized the cost of revenue. $900,000 of amortization of purchased intangibles and $700,000 of acquisition-related expenses.

Along with expanding our margin profile. We made improvements in our operating and free cash flows. In fact, 2015 represents the third consecutive year we have achieved positive cash flow from operating activities. We ended the year with $216.2 million of cash and equivalents and we had an additional $29.4 million of short-term marketable securities at our disposal.

At the end of the quarter, our dollar-based net expansion rate, as Mikkel indicated was 123%. We calculate expansion net of churn. Annual dollar-based churn is consistently been less than 10%, which to us is a sign that we're doing the right things to forge and maintain great relationships with our customers.

Currently [ph] from everything, we believe maintaining great relationships with our customers is what matters most for us to continue our long-term growth. Of course, notwithstanding the strength of this metric, we continue to expect our report net expansion rate to decline overtime as our customer rates grows.

And lastly concerning, the We Are Cloud acquisition with the application of purchase price accounting completed. We incurred in our GAAP results in the fourth quarter $0.5 million in amortization of purchased intangibles relating to the acquisition. And looking ahead, as Mikkel highlighted, we enter 2016 on a solid foundation for growth. Before, I provide guidance for 2016, let me elaborate on our vision to reach $1 billion of revenue in 2020.

As we plan to grow the company while maintaining our committeemen to improving operating margin. We believe the economics of our business will allow us to continue to scale more efficiently as we go as demonstrated in 2014 and 2015 results.

With our recent progress improving gross margin and after reviewing future opportunities to scale more efficiently. We are today raising our long-term gross margin target to 76% to 78% from our earlier target of 74% to 76%. Finally, we have set our sights on achieving positive free cash flow. In the fourth quarter, you'll note that we in fact reached breakeven free cash flow for the period driven by $10.3 million in net cash from operating activities for the quarter.

Our current for 2016 recognizes that we have seasonal patterns for cash flow, that suggest we are net users of cash early in a calendar year, while generating cash in the second half of the year. We're committed to continue our improvement in annual free cash flow and expect to be free cash flow positive for the year in 2017, as Mikkel indicated earlier. Embedded in our cash assumptions is our need to invest in faculties and other technologies.

In 2015, we invested approximately $28 million in capital expenditures and for 2016, we anticipate our capital expenditure budget will be approximately $32 million. Before, we take your questions, let me now review our guidance. For the first quarter, we expect revenue to be in the range of approximately $65 million to $67 million and we expect our non-GAAP operating loss to range between $8 million and $9 million.

We expect our GAAP operating loss to range between $28 million and $29 million, which includes in the estimate to include share-based compensation and related expense of approximately $19 million and approximately $1 million in amortization of purchased intangibles. For the full year 2016, we expect revenue to grow between 40% and 45% year-over-year or between $290 million and $300 million.

We expect our annual non-GAAP operating loss to range between $20 million and $30 million and we expect our annual GAAP operating loss to range between $120 million and $122 million. Our GAAP operating loss for 2016 is estimated to include share-based compensation of related expenses of approximately $88 million and amortization of purchased intangibles of approximately $4 million.

Finally we estimated, that we will have approximately $90 million weighted average shares outstanding for the first quarter and $92 million weighted average shares outstanding for all of 2016.

With that, I want to thank you again for your attention and now I'll turn the call back to our operator. Victoria, so we can take your questions. Victoria?

Question-and-Answer Session

Operator

[Operator Instructions] your first question comes from the line of Philip Winslow with Credit Suisse

Philip Winslow

Just a couple questions from me. First, obviously the seat count or the percentage of MRR that's coming from your largest seat count deals. I'm wondering, if you comment more on that. Obviously, it's a 32% this quarter up and last quarter like you said from 24% last year. Just what you're seeing in that portion of the business. And then second one, for Alan and Mikkel. The operating loss guidance for this coming year is definitely kind of higher than were consensus.

I'm wondering, if you give can give us a sense as for sort of where the dollars are going, is it in R&D as you talked about coming becoming more than sort of single product company in customer service whereas in go-to-market, just more color there, will be great.

Alan Black

I think your first question related to, how much of our business comes from customers with over 100 seats. They grew to 32% of our revenue in the fourth quarter. I think we've seen steady growth some quarters more, some less. And I think that, you should expect that will continue. Regarding the operating loss outlook for 2016. I think we clearly thought very long and hard about this. We introduced at the end of 2015. I think as everyone knows, new products I think that there's tremendous opportunity for us to see them contribute significantly over the years to the growth of the business.

The investments that we're making this year, allow us to successfully launch those into the market place. And at the same time, there's as Mikkel just spoke about in his prepared remarks, tremendous amount of innovation left in the core customer service platform area as well as new products that we're developing. So I think that, when you're focused year-to-year, you think differently that when you're focused on a five-year horizon. The investments that we're making and have made last year and continuing into this year towards successfully growing the business that where we ended up in terms of the guidance for the year.

And we think that, the opportunity in front of us warrants the investments towards making sure that we launch this in particular the new product successful.

Philip Winslow

Got it, thanks guys.

Operator

Your next question comes from the line of Jesse Hulsing with Goldman Sachs

Jesse Hulsing

I've a couple of questions on products. First, probably for Mikkel. As you add more products to your portfolio is that helping your enterprise selling motion and message as far as having that roadmap and having more optionality for the customer? And two, this is probably for Alan, what are your expectations for Advanced Voice and for BIME when you look at your 2016 forecast on the top line? Thanks.

Mikkel Svane

Well I want to say, first and foremost that. We're always been considered like a traditional customer service company, but there is no doubt that our most forward-looking customers are really using Zendesk to overall kind of maintaining and managing the customer relationship. Anything, what we're doing now is really doubling down on that trend and product pricing these different capabilities and also our own innovation and aspirations for the market.

And it definitely helps our enterprise efforts tremendously because we want to have more strategic, we want to have more long-term, customer relationship oriented conversations with our customers and doing that with a platform in a broader product portfolio is incredibly helpful and provides much more credibility to our business.

Marc Cabi

Just before I turn it over to Alan for your question on Advanced Voice and also our data analytics products. We really don't breakout those products. And as you know Advanced Voice launched in middle December, but it's seen some really good uptake in its early release, but Alan if you want to add some more color to that?

Alan Black

Yes, thanks Marc, not a lot. I think what I would say is, it's early days. We expect that they're going to contribute modestly to our growth this year. I think, the key is that we lay the foundation for long-term success for those products. Going back to Phil's question, some many investments that we're making this year are towards making sure that those do get a strong foothold in the marketplace.

Operator

Your next question comes from line of Kash Rangan with Bank of America Merrill Lynch

Kash Rangan

I was just curious given all the macroeconomic weakness everybody is speculating on. How was the close process for you guys in terms of sales productivity and also I notice, that Mikkel talked about $1 billion goal which is nice to see certainly. How do you envision becoming this multi-product company and how broad of a products that are we talking about, do you think you could get there with the occurrence of the products or do you think, the company is going to look a little, is going to have to look a little different the next two to three years in terms of its products in order to hit your $1 billion goal. Thank you.

Mikkel Svane

Thanks, Kash. If I can start here. First and foremost, I want to say about Q4 that we probably have the best orchestrated quarter in a very long time and we actually closed, I don't know if I can say this, but I'm. We closed the books on the 23rd which was amazing and gave everybody, our sales people, [indiscernible] our legal team an opportunity to enjoy Christmas. So I'm very proud about that.

So we felt like, so that's what I keep coming back. So incredible momentum from Q4 that takes us, so strongly into 2016. And yes, like we're developing tremendously as a company. All these new products, all these new capabilities, all these new type of conversations we have with customers about like not only just supporting your customers and servicing your customers, but how do you think about your customer relationship in context of growing your business, retaining of revenue and really become a new trusted company in the marketplace.

I think these are incredibly interesting conversations and we have to level up and our customers are asking us to move quickly and aggressive with them and we're super, super excited about that and yes it is changing ourselves as a company. But change is something that we have been embracing for the last five, six years from US and we're going to continue to embrace that going forward.

Alan Black

Maybe just, me double click on it, Kash. I think if anything, I'll pick about the productivity of the sales organization. Fourth quarter, you measure it based upon the amount of business new and existing customers. It was a record quarter for the company. So I think shout out to them and shout out to the development team that makes it possible with the products that they deliver.

So for us, we looked at the environment. Yes, there is a lot going on across the economy and the markets that we serve. We are very diverse in terms of our business geographically across industry lines and market segments. As we've spoken at length for years now, we serve customers in the full range from larger businesses to smaller ones.

So, we're watching our business closely and I think you should know that we will remain vigilant, as the year progresses and steer the company accordingly as we see things unfold in the economy. But fourth quarter, great job as far as the team's executing. We're pleased with what they've delivered.

Kash Rangan

Really, appreciate the down, but I was just curious given all the commentary about the unicorns, the evaluations coming down. I think the speculation that some of the emerging growth companies are cutting back and I'm just curious to get your perspective. Do you see that all? And also your sales productivity is actually getting better from my calculation? So curious what you're embedding in your 2016 operating loss forecast, that's it from me. Thank you for sure.

Mikkel Svane

Okay, Kash I'm going to touch on the unicorn conversation. So obviously some of those customers that new companies from new economies. They really allow us to move fast in terms of some of the developments and innovations that we're creating to serve those types of customers. So they've been extremely helpful in terms of the way we manage our business, that said. We're a very diversified company both regionally and across industry lines.

The so-called unicorns that the Wall Street Journal labels, we have 40% of those as our customers, but they only represent approximately 7% of our revenues. So again you can see that from across the board, our business has been strong both with them and outside of the unicorn population.

Second part of your question, will let Alan touch on.

Alan Black

Yes, I think your question, if I understood it Kash, related to given that we see improved sales productivity, which I think factually is true. What's behind our outlook in terms of the operating loss for the coming year? And I think, clearly if you launch new products, my book is no greater failure than to not make sure that they succeed in the marketplace. And so, we've got plans in terms of making sure that we get traction with those products. And as Mikkel spoke, we also I think are shifting some of our spend in the sales and marketing area towards increasing focus on building our brand, towards being that $1 billion dollar company that we aspire to be.

So I think that, we are taking five year view of this and believing that over that time, the company is going to scale towards being a $1 billion dollar company and as it does, we're going to turn free cash flow positive and ultimately be free cash flow positive for the year next year, which we think is perhaps the best way in which to measure how responsible we are in the management of the business. So I hope, that helps you in terms of the questions you posed.

Operator

Your next question comes from the line of Stan Zlotsky with Morgan Stanley

Stan Zlotsky

Two very quick ones. One, so the $1 billion target is certainly very impressive. And maybe just to draw a final point on Kash's question, previously. Would you need to enter new product areas such as maybe marketing or sales force automation or is it just, razor sharp focus on the customer service software and really improving and adding to what you already have?

And then second question, when you do get there the target for 2020 over $1 billion, what would the company look like from a profitability profile? Thank you.

Mikkel Svane

So yes, let me start with the former question. There is no doubt that our product evolves and the portfolio of our products evolve overtime and don't think about it as a traditional, we're moving from the world of service automation into the world of sales automation or marketing automation. We really believe that, this whole industry is changing dramatically and the world of and the lines between these disciplines are increasingly blurring. We see that with new generation companies especially like in the world of retail, ecommerce, gaming and so on, where it becomes less about these different disciplines and more become about like, how do you nurture and manage the lifetime value of a customer.

And that really breaks down these traditional disciplines and we see that as a huge opportunity for the planning what is the future of this industry and that is what we are executing, is incredibly customer driven, rather than trying to put a stakehold in some other kind of defined products definition, if you will.

Alan Black

As far as the long-term. As you know, we raised the long-term gross margin target to 76% to 78% and what the company will look like in 2020 is really dependant a little bit on what we grow beyond that. Obviously this indicates that we're managing the company for some high growth between now and then. But we'll be able to share full concise long-term growth profile with you in our May meeting. But clearly, we're looking for ways to continue to scale the business for improving margins year-over-year.

Stan Zlotsky

Okay, great. Thank you guys.

Operator

Your next question comes from the line of Brendan Barnicle with Pacific Crest Securities

Brendan Barnicle

Thank you for the additional color in some of the new products. One that I wanted to follow-up on was Facebook Messenger. I know you guys have been working with Facebook on looking to incorporate that a little more flame to the product. Any update you can give us on that?

Mikkel Svane

Not a lot of public updates. We still see a lot of attention, a lot of demand around it. The program is being expanded, getting more end customers involved. Our relationship is great there but as we told you before, it is up to Facebook's as to when kind of the program evolves and when it comes out of Beta.

Alan Black

Brendan, what they'll add is, that is we look at the Facebook activities messaging in general as an area where we believe new channel of customer relationships begin and are developed. So with spending time understanding and delivering additional capabilities around messaging is part of our portfolio.

Brendan Barnicle

Great and then, Alan. Can you remind us about your foreign currency exposure? I think previously you said like 90% of product was still done in US dollars, but I know you guys were considering maybe doing some local pricing, any changes there?

Alan Black

Yes, let me just take you through that. So we began in 2015 hedging both on the revenue side as well as the cost side of ledger. So on the cost side for those cost that we incurred in foreign currencies, we have entered into hedges now that cover approximately 80% of our cost borne in foreign currency Euro or Pound Sterling or Aussie Dollar or Singapore Dollar. And as it relates to the revenue side less but growing, so as a percentage of the total.

And I think that, the primary reason for us to do so was to be as predictable as we possibly can in terms of our future financial results, be very top line as well as on the cost side. Don't have an intention today to add another local currency in terms of how we price our products. We price those right now in dollars, in Euros and in pound sterling. Might add Aussie Dollars in the future, but no immediate plan.

Brendan Barnicle

And then just currency aside, any changes around pricing or price points that we should be thinking about for this year, anything that you saw sort of change over the fourth quarter?

Alan Black

As you know, Brendan we introduced our new pricing plans. And we'll provide more updates on the results from the new pricing plans, but our early indicators are we've seen very positive feedback both at the low and high end and we'll continue to measure progress around that. It's really set us up to do add on sales in other types of activities we weren't set up to do prior. So from our perspective, we're off to a good start with that pricing activity and will provide more information on that, once we kind of hit the six month mark. If you recall, we announced those in November.

Brendan Barnicle

Great, thanks a lot guys.

Operator

Your next question comes from line of Ross MacMillan with RBC Capital Markets

Ross MacMillan

I've two. First, Alan maybe you can just go back on the operating expense plan. Once thing that would be helpful me to understand, I guess two things. One is, is there any sort of framework either growth or revenue run rate where you could help us understand how we think about incremental margins. And then second, is there a way to think about the income statement when you get to over the free cash flow, is there some rule of thumb around what the non-GAAP operating margin might look like and then one follow-up.

Alan Black

Sure, so I think what do we think of as it relates to the operating expense plan. We've committed going back to the time of our road show and after, that we will deliver year-over-year improvement in operating margin. You saw that in terms of both 1,300 basis point improvement in 2015 relative to 2014.

For the current year, but for the delivered investments that we're making towards getting the new products successfully launched in the marketplace. I think that, we would have greater improvement in the year, but those are important investments. And so, we took a decision to make them. I mean that said we're going to deliver year-over-year improvement again in 2016 relative to 2015.

And then, I think that long-term we remain of the view that there is a path for us to deliver long-term operating profit of 20%. I think Stan you had earlier asked about the profitability profile for the business as you scale towards a $1 billion. We came in the last quarter to a point of single digit, I mean Q3 2015 single-digit operating loss on a non-GAAP basis. So this is a business that we think with the new investments that we're making towards getting the new products launch, can get to a point of being profitable in the 2017 to 2020 window.

We look upon the results that we had from the investments we made in 2014 to penetrate, a new market at that point we had deliberately decided to make investments to be able to go after up the enterprise market segment and I think you've all seen the results of those investment. So we expect to have similar success that relates to the launching of the new products and for those who become very meaningful contributors to our growth in the out years.

Ross MacMillan

Thanks and just one follow-up, other for Mikkel or you, I was just curious on, the pricing. You mentioned that obviously you introduced new pricing plans. But I think you were grandfathering the old pricing plans for deals in Q4. Can you just give us any color on sort of which way customer sell between kind of the old grandfathered and the new plans? Was there anything to talk about there in terms of mix? Thanks.

Alan Black

Parts of our business, we actually cut over to the new pricing and we had really good results in that part of the business, where we did that. If there were relationships that were built on the enterprise side. We had a mix of business come in, but I would say that the legacy pricing was a strong component of last quarter and in the enterprise segment. But going forward, we're seeing that good transition to the new pricing environment.

Ross MacMillan

Thanks, so much.

Operator

Your next question comes from the line of Richard Davis with Canaccord

Richard Davis

Two questions, one on product and then, we'll beat the dead horse on the numbers. But, on the product. Why wouldn't customer experience be on the product roadmap because it seems like that's a logical step, you're actually trying to make your customers happy, so that's the question one. And then more broadly maybe on the $1 billion, if you were growing 25% to 30%, I get 7% to 10% operating margins in 2020. At that level, in that scenario how much higher would free cash flow margins be? Because for 2016 we have like 700 basis points higher as free cash flow, would it be 500 basis points, just the math, when they run the numbers. It feels like 500, is that illogical or logical or what? Thanks.

Mikkel Svane

I'll take the product one. If you want to call it product experience or like, if somebody want to call it product experience. We don't want to, that's not important for us. What really matters is, that we focus on this big change there is in how businesses are thinking about customer relationships and then we support that with innovation with technology, with process and support.

And we believe that it's much more interesting to look at how this industry is overall changing and that's new paradigm for thinking about the customer relationships that what we're focusing on instead of trying to squeeze our product definition into some already established kind of category.

If you want to think about it as product experience, be my guest. But our ambition is really to focus on this changing paradigm. Alan?

Alan Black

Yes, yes so Richard I think one of the challenges obviously I know you have, is in building your long-term model. We're providing a view of what we think, we can accomplish in terms of the top line over the next five years. Certainly, we've given our outlook as far as free cash flow for 2017 that we will be positive for the year as a whole. I think beyond that, we are in a business that's growing obviously very rapidly and believe that there is free cash flow improvement that will scale as revenue scales over time, but I don't want to be in a position where we're giving you guidance for 2020 in terms of what percentage of revenue we're going to throw off in terms of free cash flow in that year. Right?

And know, as we've done in the past, that we reinvest back into the business in a measured way and what that really means is, the rate of growth that we experienced in the business is what drives the reinvestment in terms of additional facilities for our staff, as well as infrastructure to support our customers.

So we calibrate how we much we invest there based upon on what we're seeing coming our way in the way of growth in the business.

Richard Davis

Got it, thanks.

Operator

Your next question comes from the line of Bhavan Suri with William Blair

Unidentified Analyst

This is Sarah [indiscernible] in for Bhavan. Congrats guys on the quarter. I've two quick questions. The first one is, you guys have such a compelling time to market strategy that allows for a quick implementation. But are you seeing anything change as you move up market, as are you experiencing increasing implementation times or issues with catering to larger customers [indiscernible]?

Mikkel Svane

This is Mikkel. We really see our rapid deployments and what we call our first time to take it really as being disruptive elements, as we compete in the enterprise space. And we really challenge - some of our customers in that space really challenge us to do this rapid deployments or help them do these type of deployments and we're very successful with that. it is a huge differentiator for us, that with a product like Zendesk, if you get up and running in days or weeks other than doing like six months, 12 month, 19 months, 20 months long projects to get yourself up and running.

So it's a huge disruption and we really see that's a big part of DNA.

Unidentified Analyst

Okay and then real quickly from, you're seeing a lot of success from your sales rep in terms of productivity. Can you provide any details or color on what's driving this increased productivity?

Alan Black

I think, Sarah if you were to look, part of it is the mix of business come in. So as our sales force becomes productive, they're landing bigger and bigger deals and those deals are also leading to a lot of expansion activity and those expansion activities are actually are very important part of our business. Land and expand is something that we are very focused on, so as we're doing business with these larger companies and larger opportunities, it allow itself to kind of become a very nice opportunity for us to pursue. So I think that is a play here.

Unidentified Analyst

Okay, thank you guys.

Operator

Your next question comes from the line of Alex Zukin from Stephens.

Alex Zukin

When you guys look at the wins that you're getting on the large enterprise side. Can you touch on how many of those are coming for internal support versus external support and importantly, how is the competitive landscape differ for those two?

Mikkel Svane

Well, the vast majority of our business are external customer service solution. So that is also the majority of our wins in the enterprise space. We do think it's very interesting that we this land opportunity with some enterprise to go in and land in, smaller used cases well those will be external or internal which because it really give us an opportunities to work with the customer and grow from smaller used cases into bigger used cases.

So that's also why, we're not focusing on becoming a big internal helpdesk company, but we are really focusing on solving a lot of those internal leads [ph] too, so that we can grow into the external used cases with our customers.

Alan Black

And then the second part of your question. Alex, in terms of the competitive landscape, I think that the larger wins be they for external customer service used cases or internal. They're heavily contested I beg your pardon. So the usual large competitors that we talked about in the past are almost always competing for those win, for those opportunities. I think it's clearly something that we're proud that we've had the success, we had beginning to make in rows of market. Some of that comes back to what Mikkel described in terms of ease of adoption in time for to first ticket.

It's just, it's a very different experience for customers and one of the things that I think is, plays a big part in terms of our success. Don't see the competitive landscape getting different, meaning it's always been competitive and then see it really changing and tenor it all during the fourth quarter.

Alex Zukin

Got it and then Alan, maybe one follow-up. You mention the sustainability of the dollar based net expansion metric little bit on your prepared. So I was wondering, how you see that playing out in 2016 and what you kind of thought about for your guidance?

Alan Black

I think, Marc has some thoughts, but first I would say is, I think if anything pleasantly surprise in terms of how strong it was in 2015. It was our outlook at the beginning of 2015 that it would decline overtime. So the fact that increasing as much as it did was something that we were really pleased to see.

As the customer base grows, it's function of math some level that number is going to decline over time. Indeed you saw it drop two basis points in the fourth quarter. Key thing is, it's still super healthy and we think it's indicative of the degree to which we're succeeding in retaining customers and the degree to which existing customers like the product and want to use it more extensively across the business.

Marc Cabi

Alex in 2016, one addition there will be, as we do our cross selling activities around chat and voice and other products we're going to announce that. We will have that as additional opportunities to go revisit with our customers and so, there'll be a lot of different factors on that. But we do want everyone to remember that base is growing larger and so that has pressure in terms of large numbers.

Alex Zukin

Got it, thank you guys.

Operator

Your next question comes from line of Patrick Walravens with JMP Securities.

Natasha Asar

Hi, this is Natasha on for Patrick. I was just wondering if you could provide more details on how Advanced Voice is doing. I know you touched on it earlier, but just we were wondering things such as quality of the service so far, how you thought about the pricing and what kind of customers are adopting it?

Marc Cabi

So as you know Advanced Voice was introduced out of Beta in December. So it's very early, but we saw a very good uptake in that first period when it was available. We're getting really good feedback from our customers around both the quality of the service as well as many of the reporting features that are associated with it. It really does provide some very good feedback in terms of management of the voice channel for customers.

We also had indicated that, this is our first price point what maybe a portfolio voice product. So we'll ask you to stay tuned for that.

Natasha Asar

Okay, great. Thank you.

Operator

Your next question comes from line of Shebly Seyrafi with FBN Securities.

Shebly Seyrafi

This $1 billion target in 2020, that actually imply like a four-year CAGR of 36% on revenue than you're actually sort of implying after Q1, this current quarter like high 30s growth for the rest of the year. So my question is, you're not really mauling any kind of deceleration over the next several years. How much of this target is organic versus inorganic? And maybe you could elaborate, why you're not mauling any kind of deceleration?

Alan Black

Yes, I'll take that. So I think, ultimately the question is how much of the $1 billion target do we expect to be generated from the existing products that we have to offer and are we expecting, that we're going to have M&A over the next five years that will contribute. I think, we've acquired two companies in the last two years both I think are ones that I would say are typical of what we probably would be expected to do overtime, although I take there is nothing in the immediate future.

We are predominantly a business that believes in growing revenue through products that we develop organically and inside and we've got, if you look to our operating results. We've got an investment that we've been making and will continue to make in R&D that we think is commensurate with the remaining innovation left to be delivered from us internally.

So I think if you fast forward in the 2020, you should expect to the majority of growth from here will come from organic investment and the fruit of the labor is associated with developing product internally.

Shebly Seyrafi

Okay, also on the expense side, how much We Are Cloud SAS contribute to expenses in Q4 and separately what kind of headcount growth are you estimating, you were at 1,200 so in Q4, what do you think it will end this year at? And that'll be it from me. Thanks.

Marc Cabi

We don't guide headcount growth, but we'll be adding to headcount to support our growth objectives. And with that in mind, we'll also be moving toward better operating margins and margin profile year-over-year as we said before. In terms of We Are Cloud, the disclosures will be in the filings. They were the small acquisition for us relative to its size. We had good retention of their team, which we're very happy about, which is embedded in our guidance that we just gave you for Q1 and beyond.

Shebly Seyrafi

Thanks.

Operator

Your last question comes from the line of Jeff Van Rhee with Craig-Hallum Capital Group.

Jeff Van Rhee

So real nice quarter. Just curious, I guess. To start with the pipeline, have you seen any notable difference in terms of the flow of deals both how they're being sourced and you've accounted in the past about the percent that comes from organic search, but as you're looking to deals that are coming inbound and I'm talking specifically about the new deals. Has there been any change in that flow that's notable over the last six months in terms of where they're coming from, how you're finding them?

Marc Cabi

We have a large component of our business that is online discovery velocity in terms of number of accounts that we add each year. And there's a high organic content to that. in the past, we used to give you a measure of that, but we were dependent on a third party for the attribution model and so, we're not using that party any longer for attribution, but we can say that we're continuing to see similar dynamics as we had in the past.

Alan Black

Jeff over that, six or maybe nine month period and we've spoken extensively about investing in the past towards building outbound sales and marketing organization and so to degree the shift is occurred where we have more and more pipeline build that's coming not only from inbound but also from outbound marketing activities and pipeline build effort on the part of the sales team themselves.

So I think there's been some shift in the business. So although, it's been a gradual one as oppose to a sea change.

Jeff Van Rhee

Okay and would you able to quantify I guess a couple of things. First just that, sales build out, a sense of where you're headcount wise now and then higher level, just as you think about 2016 the capacity expansion or the spend that you planned in the sales organization, if you could just expand a bit on that?

Mikkel Svane

Yes, so we don't really disclose our sales numbers in terms of sales quarter carrying sales people, but we have indicated in the past that we will continue to grow our sales capacity commensurate with the way we view the market. With a notion that overtime will be scaling that team to become more productive. So those are kind of the guiding principles.

We have people located across the globe focused on our different regions, as we have diversified business and we're going to continue to manage the business that way.

Jeff Van Rhee

Okay, fair enough. Thank you.

Marc Cabi

Victoria was that our last question that I hear.

Operator

That was our last question.

Marc Cabi

I'd like to thank everybody for joining us today. We will again have our results on the investor website and a replay will also be available on our investor website and invitations for May 10 should have gone out for our first annual and investor day and we hope to see you here at our headquarters in San Francisco at that time. Thank you.

Operator

This concludes today's conference call. You may now disconnect.

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