Zendesk's (ZEN) CEO Mikkel Svane on Q2 2016 Results - Earnings Call Transcript

| About: Zendesk, Inc. (ZEN)

Zendesk Inc. (NYSE:ZEN)

Q2 2016 Earnings Conference Call

August 2, 2016 17:00 ET

Executives

Marc Cabi - VP, Finance & IR

Mikkel Svane - Founder & CEO

Elena Gomez - CFO

Analysts

Kash Rangan - Bank of America Merrill Lynch

Brendan Barnicle - Pacific Crest Securities

Bhavan Suri - William Blair

Stan Zlotsky - Morgan Stanley

Jesse Hulsing - Goldman Sachs

Richard Davis - Canaccord

Jeff Van Rhee - Craig-Hallum

Jonathan Kees - Summit Redstone

Ross MacMillan - RBC Capital Markets

Patrick Walravens - JMP Securities

Operator

Welcome to the Second Quarter 2016 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 you, Mike and thank you all for joining us today. Welcome you to our second quarter 2016 earnings call. We're pleased to report another solid quarter. Joining me on the call today are Mikkel Svane, Founder, CEO and Chair of the Board; and our new CFO Elena Gomez. You met her last quarter. Before we get into the results, let me just pass along a few reminders. Our shareholder letter is available at investor.zendesk.com which details our full results and commentary.

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, ability to attract and retain customers and our ability to compete effectively. The assumptions, risks and factors that could affect our 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 Annual Report and our upcoming Form 10-Q.

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. Please refer to today's earnings release for more information regarding forward-looking statements. During this call, we will present both GAAP and non-GAAP financial measures. The non-GAAP measures should be used and considered in addition to, 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 and for certain non-GAAP financial measures for prior periods in the earnings press releases of those period, both of which are available on our investor website. With this introduction, I would like to turn the call over to Mikkel.

Mikkel Svane

Yes, thank you so much, Marc. Of course very proud to report our strong financial results and accomplishments from the second quarter of 2016. We've shared the shareholder letter, but I want to highlight a few key results reported in the letter.

So first and foremost, revenue for Q2 grew 54% year-over-year to $74.2 million, we crossed 81,000 paid customer accounts worldwide, and we now have 1,500 employees worldwide too. Accounts with more than 100 seats remained very strong. And 33% of our monthly recurring revenue in Q2 up from 27% in Q2 last year. We also saw margin improvement with our Q2 2016 GAAP operating margin loss narrowing to minus 35.4% from 43.4% in Q2 of last year. While the non-GAAP operating margin loss narrowed to minus 7.6% from minus 13.4% over the same period last year.

During our second quarter 2016, we continued strong performance and progress in three key strategic areas that we have laid out before. First, elevating our brand. Second, becoming the most brand company. And last, expanding our opportunity in the mid-market enterprise. We saw key accomplishments across all these in Q2 and over the recent months. So we've held three large relayed live events between May and July in San Francisco, in London and Sydney. And together, all these relayed live events we've held in 2016 have attracted more than 3,000 attendees.

We also announced our second Machine Learning Base Feature called Automatic Answers. We also introduced SMS as a native channel now for supporting customers' engagement. And we launched a series of sales service advancements including a new responsive [ph] named Copenhagen which is also on the front page of our shareholder letter this quarter.

Finally, we were positioned in the Leaders Quadrant in Gartner's May 2016 Magic Quadrant for the CRM Customer Engagement Center. And we continue to build partnerships with leading software and internet platforms. One of these is a great new integration that we launched with Google in May for the Google Play Store. And it basically allows Zendesk customers to automatically convert Google Play Store reviews, meaning apps, app reviews, into tickets so that customer service agent can respond to and engage with their customers around these reviews using the Zendesk Support Tool.

You can reach much more, a lot more, about all these accomplishments from the last quarter, in our shareholder letter which as Marc mentioned is also available on our investor website at investor.zendesk.com.

Before I turn it back now to Marc and to our Q&A, I want to hand it over to our rookie, Elena. Congratulations on kind of hitting the ground running here in Q2 for a lot of work unknown then.

Elena Gomez

I'm thrilled to be on board, officially, for 90 days and it went fast. I don't know how long I'll be a rookie. Anyhow, wanted to share with all of you how I spent my time in the first 90 days which is really spending time with my peers, understanding our customer base and really discussing our future strategy, and through those discussions I've gained confidence in our future plans. I would like to share that I'm continuing the commitment to growth and equally prepared to demonstrate operating leverage along the way.

Our path to $1 billion is going to require discipline around trade-off positions, we all know that, and focus, but I'm really confident in this leadership team and more confident than probably it was 90 days when I was, they wanted me. But anyway I just wanted to share those comments before we turn it over back to Marc.

Marc Cabi

That's great. And I will turn the call back over to Mike to begin pulling for our Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question is from Kash Rangan from Bank of America Merrill Lynch.

Kash Rangan

Hey, guys, thanks for taking my question. Congrats on the strong top line. A couple of things; one is did we make any kind of field changes, organization changes, given that you had significant changes of sales leadership happening in the mid-way point of the quarter? And -- because although the top line results look good, I think the deferred revenues were not as high as what we we're expecting. So curious to see is there any organizational impact from the addition of new management talent? And secondly, with the new pricing, I'm curious to see how you're seeing this playing out in the market. Are you starting to see folks upgrade from older skews to the newer skews that gives them a lot more flexibility, and how is that playing out with the new customers as well? Thank you so much.

Marc Cabi

I'm going to start with the pricing and then let Mikkel address kind of the principles that are new management team members are bringing to the table. So from a pricing perspective, we're continuing to monitor the price changes we made in November, as you know we grandfather, all of our existing price plan. So at this point the impact of new pricing is only really relevant with our new customers that we add or customers that have elected to abandon an old price book and move on to a new price book. So from that perspective, we're continuing to monitor early indicators were and remain that the pricing exercise was good for us and that at the very low end we are creating better entry points with a very valuable product that people can adopt very frictionless, within a frictionless manner, and then at the high-end we can put together a portfolio of features to address what type of needs those larger customers may have. So we're continuing to monitor it. We are happy with kind of the characteristics we see there, but the pricing is something that we'll continually adjust as we move forward.

Mikkel Svane

And as for the former part of the question, so when we hired Elena, we also hired a new Chief Revenue Officer, Bryan Cox, and like first and foremost Bryan and Elena has been working excellently together, that's great. And also Elena and Bryan has been really well-integrated into the exec team here. So we hired Bryan because like not only what he's like a great revenue, sales executive but he has incredibly operational discipline. And I think that a lot of, some of the things we are thinking about and some of the things we already have implemented is kind of improvements to how we run our go-to market organization and be much smarter about some things and also be much more efficient and basically making things simpler and easier. Not only for our customers but also for our sales people. And I think that he's been working very hard and we've been working very hard across the organization to implement some of these changes and I think it's been incredibly well-received and I think it's, we've been so busy building a company, so you implement a lot of things all the time and it's been really good as almost as a catalyst to get Bryan into this. Okay, let's take a step back and review how we can do a lot of things simpler, easier, better and we feel incredibly good about that. Thanks for asking, Kash.

Kash Rangan

You bet. I think, was there any impact from the new organization changes that could explain why the deferred revenues were maybe not as high as [indiscernible] was pretty strong quarter. We're just trying to get behind what could have impacted the quarter, if anything.

Marc Cabi

Kash, I'm just going to see that from the perspective of kind of our calculated billings that you see from deferred revenue with the change in deferred revenue plus revenues. It includes also some of the seasonality we do see in the business as we're getting much more of a mid-market and enterprise group of customers in our pipe and you'll see that we're looking into the second half with a favorable look on the opportunities that we have ahead of us. So from that perspective we feel pretty good about the opportunities in the second half.

Kash Rangan

Got it. Thanks, Marc, useful.

Operator

The next question is from Brendan Barnicle from Pacific Crest Securities.

Brendan Barnicle

Thanks so much. Marc, I wanted to try and reconcile two things that looked a little different to me. It's a nice acceleration year-over-year in customer accounts but then a little bit of deceleration in dollar-based and expansion. How do we reconcile those two things?

Marc Cabi

So customer accounts include all of our customers from very low to very high, and so part of that is being generated by the new pricing environment where at the low-end we've created a very frictionless entry point for Zendesk that are SMB self-service customers find very useful. From a dollar-based and expansion rate, there are two components to dollar-based and expansion. One is our expansion and the second is turning contraction.

So turning contraction, since our IPO has not seen any significant changes, we continue to monitor that and work to improve that but that has been a significant change. Where you have seen a change is last year. We ended up booking some very large, both expansion and new business throughout the year. And so we're going against a larger denominator in terms of lands than our traditional lands were the prior year. And we try to signal that in the first quarter earnings to kind of indicate that we were heading into these comparisons that are very different from our typical business from the prior year. But that's exactly what we were forecasting this and this is kind of where we expect to continue to trend for this anniversary of this new deals that we brought in last year.

Brendan Barnicle

Okay, Marc. Thanks for that clarification. And Mikkel, as you look at some of the newer products, Zendesk Voice or the Automatic Answers of service, which of those are contributing materially to revenue at this point?

Mikkel Svane

We still make [ph] business somehow from our call center support progress. Voice is still very early on but likely are very, very enthusiastic. We're very excited about the results. We're very excited about the customer feedback especially, and as I think Marc put in the shareholder letter, we've seen some really, really good deals in the recent quarter with Zendesk Voice. So lots of opportunities there and we'll continue to execute on that. You mentioned some of these capabilities, and just wanted to say that we don't see, and I think that is really our mission is like we think about Machine Learning almost as a resource, almost as a utility in our product. And so it's not going to be something that we will monetize individually, but it's going to be part of how we think about how our product works. That is not just, you're not just buying workflow software anymore, you're actually buying access to data and capabilities that makes you smarter through using the collective of data.

And this is really our mission around Machine Learning and we really visited the northern office recently and I'm really, really excited about the team that is working with a lot of these things there and like some of the things they have, some of the things they are working on. And it is of course something that we initially going to make available for all the higher end skews because there is an investment in it. But this is also where we see that we'll need this with a lot of these high volume, very sophisticated customers that can scale their customer service operations much, much better using these technologies.

Brendan Barnicle

Great, thanks so much, Mikkel. I appreciate it.

Mikkel Svane

Thank you.

Operator

The next question is from Bhavan Suri from William Blair.

Bhavan Suri

Thanks for taking my question and congrats there. Two quick questions. Just first, obviously Facebook has had a bunch of success with Messenger, and I was just wondering if you'd seen any impact from that at all. You had given sort of your early integration there. And then my second question just to Mikkel really is with your on focus on product and strategy, Mikkel, and you look at some of the blurring of the lines, service, CRM, sales, are there pieces that you guys feel you need to add, either organically or inorganically, in let's say 12 to 18 months to sort of broaden the product portfolio? Thanks.

Mikkel Svane

Starting with the letter. There's no doubt that preparing ourselves from really becoming a multi-product company has a lot of, requires a lot of investments and how we think about our infrastructure, how we think about the scalability elasticity of different parts of our infrastructure, how we think about a much more services-based infrastructure making it a lot easier for us to do these things. So there's no doubt that becoming true to becoming a multi-product company requires investments. And as always; considering like how we can build versus kind of leap frog some of our own development. But if not, it is very much in our DNA to focus on building great technology ourselves and in this instances where we see great opportunities to integrate foreign DNA, foreign technology into our product. We try to execute on those when we have that opportunity.

Marc Cabi

And let me take the Facebook question. If I may I mean just kind of take us back a year. So in April of 2015 at Facebook Cafe that year, we were selected to participate in Facebook's First Close Beta, Invitation Beta, to create the messaging infrastructure for their new messaging platform for business. And we learned a lot through that first year and as we move in to the summer and early fall we have a set of customers that are beginning to use our early access program for Facebook Messenger, and that is moving along as we expected. We still look for general availability of that product in early 2017. We're getting very good feedback from customers. And the three things that we're kind of learning, one, that messaging requires a slightly different approach from architecture, from the way you communicate with customers to you need to kind of allow for some automated responses and being able to keep those messages and contacts with everything that's required as very important.

A customer should not know whether they're really interacting with a bot or a human, and the handoff from an automated response to a human response need to be really done well. And then the third thing is as with all of our other products, understanding that customer, understanding the value of the customer and lifetime value opportunity from that customer is very important. So everything we're doing at messaging is bringing the data richness that we have in our other products into our messaging product.

Bhavan Suri

Got it, got it. May I squeeze just one more quick one in. You guys have realigned a little bit of the Salesforce in the territory and you sort of said let's go after customers where it's repeatable, where customer acquisition and customer attention matters, and I know it's early, but have you seen any impact to win rates there at all, or is it still too early to tell? Thank you.

Mikkel Svane

I think it's too early to tell. I mean, I think it's really important that, so the one thing that I can tell you as working well is we've taken the burden of administrative duties off of our sales teams and created a much more efficient way for them to get orders processed and those kind of items taken cared of which allows them to spend time with more customers. So from that perspective that's an immediate response that our sales team is very excited about. But I think we need to let this play out. It is a simpler sales structure than we have before and we're pretty excited about it.

Bhavan Suri

That's great. Thank you, guys. Thanks for taking my questions and congrats.

Mikkel Svane

Thank you.

Operator

The next question is from Stan Zlotsky from Morgan Stanley.

Stan Zlotsky

Hi, guys, good afternoon, and thank you for taking my questions. So I wanted to focus on your traction and then move up market into, and venture to larger engagements. 33% of MRR came from business with greater than 100 seats, and I think in the letter you also mentioned 11% more deals in value greater than 50,000. So I was just wondering if you can give us some color on your move up market and how that's going, and then a quick follow up on FX and if that have any impact in the quarter? Thank you.

Marc Cabi

We continue to move, the part of our business that is in the mid-market and enterprise continues to expand, and I'm going to let Elena kind of talk a little bit about because she comes from the experience from her previous association and have you know how mid-market and enterprise is also second half oriented. But from our position we're starting to see some very nice deals with larger companies that we want to be doing business with in the mid-market and enterprise. Basically defining a sweet spot which is companies with 500 employees up to just below the global 2000 where we can really win well especially in B2C and B2B companies that use B2C tactics from market for customer acquisition.

Elena Gomez

So just to comment expand on what Marc said, in terms of as we move up market from mid-market and enterprise, we'll start seeing this dynamic which is backend loading our business in particular. As we move up, that business will become lumpy but the good news is we bounce back really well here with, for the repeatable business that comes very predictable for us, so very easy for us to kind of forecast that for the top line. And in terms of FX, I think you had a question about that. That didn't really have the material impact on our financials this quarter.

Stan Zlotsky

Great, thank you.

Mikkel Svane

Thanks, Stan.

Operator

The next question is from Brent Still [ph] from UBS.

Unidentified Analyst

Good afternoon. I want to go back to Dr. Kash's initial question on deferred. The billings at 47% were below any growth rate you've seen, ranging from mid-50s to low about 60% for some time. It sounds like, if I'm reading this correctly that a lot of these enterprise deals you feel comfortable on the back half of the year that maybe some of those slipped or run the pipe and you didn't necessarily closed on those in the quarter and that may have had some discrepancy or was there some change in duration that resulted in that. I think I was just trying to reconcile. You haven't seen this before. Obviously understand the cons are getting harder, but anything or even there.

Mikkel Svane

Well, so Brent, I think that's a great question. We do have, last year in this same period we had a lot of productivity showing up from the new Salesforce that was higher the year prior. So you did see some really good numbers a year ago. As far as our current outlook, we continue to feel very good about the opportunities we have ahead of us. Duration is not changed, but recall that most of our SMB customers may bill monthly, and then we have a set of customers in the mid-market and enterprise that may bill monthly, quarterly or annually. So we do not yet have a plan to require annual invoicing for all our customers, so we do have those mixed issues. As we go into the second half of the year and you see a larger percentage of wins from larger customers, you may see that dynamic show up then.

Unidentified Analyst

Great, thank you.

Operator

The next question is from Alec Zukin [ph] from Piper Jaffray.

Unidentified Analyst

Yes, thanks guys for taking the question. So I guess another way of asking Brent's question, if you look at the enterprise business in the quarter, was it at or below or above your kind of expectations? And then is there anything competitively that's changed either at the top end or the bottom end? And then separately on the dollar-based and expansion, did you see any incremental increase or decrease in retention rates on either the volume or the enterprise business.

Mikkel Svane

So, Alex, net dollar-based expansion rate again. So we have not seen any significant changes in turn and contractions since our IPO. It's been, it's in a bend for several quarters, back to back. In terms of the dollar-based and expansion rate, it really is an artifact of if you were to look at our typical land in 2014 versus 2015, we had a big step up in LANs as we move into larger opportunities as mid-market and enterprise companies. We anniversary that this year. So the expansion on that larger denominator on a percentage basis is translated into the one teens, and we try to be very upfront about that. Earlier this year we were able to predict that that was happening. And I forgot the second part of your question, I'm sorry.

Unidentified Analyst

I was just asking if the kind of enterprise business performed in line with your expectations.

Mikkel Svane

When we look at our business mix in the first to second quarter we always see a lot more activity in the SMB space, so that's been our traditional pattern. So I think we feel very good about what we produce so far.

Unidentified Analyst

Got it, and then just if I can squeeze one in on the competition. Any changes in competitive environment, either at the bottom-end or the top-end.

Mikkel Svane

From my perspective, I talked to the sales people and we're continuing to have areas where we do extremely well and they're trying to spend more resources in those areas where we win better and win more often. Generally when we're looking at these larger opportunities it's between Salesforce and Zendesk, usually those are the two names that come up. And Elena, you want to give your take on this.

Elena Gomez

I think you coined it exactly. I think the market's still fragments and I don't know that it's changed much this year from 90 days ago, but I still think it's really two key players in the market right now and it's Salesforce and Zendesk.

Unidentified Analyst

Got it, thank you guys.

Mikkel Svane

Thank you.

Operator

The next question is from Jesse Hulsing from Goldman Sachs.

Jesse Hulsing

Yes, thanks for taking my question guys. Question on Europe, I don't think it's been asked yet. Any signs of the slowdown in your U.K. business from Brexit related, push outs or anything like that in the quarter, and I guess to start Q3, and then I will follow up as well.

Mikkel Svane

Let me just put the contacts around our European business. So yes, we do have a larger percentage of our business to some of our peers in Europe and outside the U.S. But within those opportunities until first quarter 2015 we've built most of our customers in U.S. Dollars, and it's because we wanted to move off of the U.S. Dollar billing to a local currency, the Pound Sterling or the Euro, they needed to opt out of their current price book onto our existing price books at that time. So we're layering on foreign currency exposure from our revenue basis very slowly from that perspective. So from impact on our financials that's very minimal. And in terms of the U.K. specifically, we have not seen any changes in terms of anything that's been reported back to us at this point.

Jesse Hulsing

And then an oldie, but a goody. I love the tech sector, and in particular I'm curious as your larger customers in the tech sector scale, how is your spending trending with them?

Mikkel Svane

You mean our own spending with them? I think that's a question that I'm going to reserve for Tom Keiser, our new CIO, because he is have to bringing a lot of discipline on how we're spending and who we're spending with. And I would want to kind of have him address that because the reason to create that CIO role was really to look at our opportunities and how we spend on different tech resources. I think that was question, right?

Jesse Hulsing

No, I was -- specifically on your tech sector customer base.

Mikkel Svane

Our tech customers, yes, we have not seen any changes from our tech customers on demand. Sorry about that, Jesse, I misunderstood your question.

Jesse Hulsing

No worries, no worries. Thanks guys. Have a good one.

Operator

The next question is from Richard Davis from Canaccord.

Richard Davis

Hey, thanks. I guess we have to run the tutoring test on your [ph] at some point. In any case, one of the things I saw from a, it was a small vendor but it was kind of slick, they're starting to incorporate the ability to take a feed of a picture or even a video, so like if you have some problem and you're trying to work with a call center rep and they're trying to, hey I'll help you, wiring, this and that and the other, to what extent do you have that and do you see a demand for that feature functionality set in your customer base?

Mikkel Svane

So there's a bunch of different ways of kind of engaging live and sharing kind of rich media through chat or messaging. We also have a bunch of partner integrations where they provide these types of functionalities. It's typically within like very specific segments where these things make sense. So like we're a little undecided whether this is something like there's a general functionality that everybody would be interested in. But we do see this specific segments where there is, where it makes sense and I think so far we've been dealing with those via partners.

Richard Davis

A bunch of questions; do you think customers are buying on the basis of office or they're using their call centers to actually drive their demand or is it still more like luck. We just want the most efficient, easy to use product which is not negative but it's more of a, you shouldn't get people out there looking at this as almost as a branding opportunity and if so kind of, is that a 30 of your customers you think, I mean there's no real answer, but...

Mikkel Svane

I think it was a little bit different today, like these shops where you have dialers sitting out and creating leads if you want a few of those. But I think what our customers agree on is that when you have that opportunity to create real engagement with a customer, that is one of the primary things, like real emotion and really connect with that customer in the moment when there is opportunity to connect. That's one of the best opportunities to create [ph] and I think more and more of our customers are really starting to measure that and understand the direct correlation between [ph] which just drives customer acquisition, and I think our own business is still a very, very good example of that, like it is still the primary driver of leads to Zendesk is that customer say what a great experience, what a great product, this just went so smoothly, why didn't anybody tell me we could do this so easily, why didn't anybody tell me we suddenly we're going to have this level inside into our customers, like they go out and tell that to their colleagues and are willing to share that with the internet. It's incredibly powerful, and that is really what more and more of our customers are realizing.

Richard Davis

That makes sense. Well thank you so much.

Mikkel Svane

Thank you.

Operator

The next question is from Jeff Van Rhee from Craig-Hallum.

Jeff Van Rhee

Great, thanks. Just a couple for me. I guess, as you look to the business evolve here, can you just quantify or give us maybe a little color in terms of the sales cycle influence that you've been seeing from partners and how that's evolved the last three, six, nine months?

Mikkel Svane

The partner program is still early relative. Most of our business is still direct. So from that perspective, the partner business is a business that we've been growing overtime but from a financial point of view, from a percentage of revenue point of view it's still a small percentage. We are seeing changes in terms of how long it takes to close deals between SMB and of the larger deals, where SMB deals close leads in quarter, whereas the other deals may take a little bit longer. But the partner deals really don't have an impact on our revenues today.

Jeff Van Rhee

Yes, I mean I was thinking not so much, the deals and -- closed by the partner, but more partner-influenced on cycles. I mean, we do a ton of work in and around the customer engagement space and we hear very frequently people that are routinely recommending you, so it's certainly my sense that you've won their hearts and mine as well. I'm just wondering if there's a way to start to quantify what they're doing to influence your direct cycles.

Mikkel Svane

I don't have that kind of insights into metrics for that. We're spending time with partners like Google and Microsoft because they are a great source of customers that would need additional workflow for managing customer activities and so forth, so that's why we're spending so much time with Google, with Microsoft, and all those other companies that are one of the first entry points for business at the very early stages.

Marc Cabi

With just delivered a great new integration with Google Apps. So like if you are using Google Apps in your business today, it's like the onboarding or senders gets almost like, it's seamless. You're up and running and it just works for you. You have all your users, you have all your permissions, all these things add up. It's just very, very slick.

Jeff Van Rhee

And then in the shareholder letter, under infrastructure, you talked about this decision to emphasize cloud infrastructure solutions particularly in the U.S. I guess you're talking in the second half here. Can you just maybe expand on that a bit? What lead to that decision at this point? What's been the experience thus far, but what drove that conclusion?

Mikkel Svane

You have more data on this, Marc, but I just want to say that we early on started investing in kind of the continuation of our infrastructure and that has given us, like the results of that has been amazing and given us so much agility on the infrastructure side. So I think like once we start our first experiment in Asia with AWS pod and that just gave us some advantages and some opportunities that we're looking further into. So I'll be sending out a few more things at the shareholder letters here in the U.S.

Marc Cabi

I mean that's pretty complete answer. I think you know the experience in our first AWS implementation was extremely positive to the point where we feel that we can look much more than a hybrid structure and move forward.

Jeff Van Rhee

Yes, got it, great. And one last one for me if I could, on the Advanced Voice. In terms of agents per Advanced Voice customer, what is the typical engagement? Obviously you're early, I get it, and it's just starting to contribute to revenue. But I'm just curious what the early adapters are coming in at? How many agents on Advanced Voice per Advanced Voice customer, if you will?

Mikkel Svane

So think of the common customer being in the double digit of agents, but we do have some customers that are using us in 100 plus agent deals. We will be moving in that direction continually. We wanted to make sure that the experience early on for any customer choosing Zendesk Voice was good, and we feel like we've kind of passed that hurdle. And we're growing that business now.

Jeff Van Rhee

Okay, great, got it. Thank you.

Operator

The next question is from Jonathan Kees from Summit Redstone.

Jonathan Kees

Hi, thanks for taking my questions, and congrats on the quarter. I wanted to just direct my questions, if I can, towards Elena and the comments that she made. They're kind of a follow up in terms of what she had said, I guess when you talked about spending time with the customers, with your peers, with the team, having confidence to plans and in terms of the objectives. You talked about the trade-offs that need to be made and need to be implemented, I guess if you can elaborate more in terms of what your thoughts there are, are you talking about some more financial discipline in terms of spending, are you talking about prioritizing spending in terms of projects? Yes, just a little more color on that.

Elena Gomez

Thank you, that's a fair question. So it was more of a broad statement, candidly on our path to $1 billion. So I think you can appreciate that we'll have to increase our operating leverage overtime and as we do that we're going to have to make some choices of things that we're going to stop doing, some things that we're going to do more of and think about sort of our big bets along the way and those are, there's going to be some tray of decisions that as the management team we have to align on and those could be everything from how so do we go to market on product X versus Y, et cetera. So just being very intentional about how we gain leverage overtime and that could go across all of our cost categories, candidly.

Jonathan Kees

Okay, all right. Got you there. And then, I guess second follow up question's kind of related. Since you've gotten to know more of the company and the plans and what you've been in charge with. Just curious in terms of, do you see anything you're going to do differently than what was done before, how are you going to approach, what your drive is?

Elena Gomez

That's a good question. So the team has already setup a really good, sort of frame of, kind of making strategic decisions. But if you were to ask me what can we do better or what can we continue to do, I would say my focus would be to continuing that product expansion to grow our TAM, obviously, and really being intentional about which products drive the greatest revenue opportunity for us but at the same time meet the customer needs in the marketplace. We're going to continue to do that and be very focused around that. I think the other opportunity for us as a team is to really leverage the executive team that we've just brought on board.

So if you can think of all of us coming from a larger enterprise customers, part of that sale involves tapping into the C Suite, maybe a bit more than we have and having the confidence with our brand and with our evolving product to go ahead and have those conversations head to head. And then if I were to add one last thing, I would say in terms of our international presence, we've had some success I would say in Northern Europe, maybe we need to think about how we have even more success in other parts of Europe that we haven't tapped as much.

Jonathan Kees

Are you saying that I need to go out filling them?

Elena Gomez

Possibly, I can bring you along.

Jonathan Kees

A new person, different way of doing or slightly different way of doing business. All right, that makes sense. Good luck, and thanks for letting me direct the questions with you, Elena.

Operator

The next question is from Robert Simmon from RBC.

Ross MacMillan

Hi, it's actually Ross MacMillan from RBC. Thanks for taking my question.

Mikkel Svane

Hey, Ross.

Ross MacMillan

Hey, I had two, maybe a clarification. As we go forward on that annualized dollar-based net expansion rate, what's the right way for us to think about it? Because you're obviously going to have incrementally tougher calls over the next couple of quarters. So what's the right way for us to think about where that number will trend?

Mikkel Svane

So I think you need to look at the fact whereas before we started really intentionally going after mid-market and enterprise. It was a pure land and expand kind of activity. And last year and going forward we intend to land bigger deals with these companies upfront, so that does have that tension in terms of the denominator. That doesn't mean we're not going to expand with those companies that we get into, but the rate of expansion is going to be different. We're also very careful, and Elena's brought in some really good discipline around making sure that even though we're pleased with our turn and contraction that we can always do better. And so we'll always be looking at ways to improve on that. And again, like we said, it hasn't change significantly since our IPO, but that's another area where you can impact that number.

Ross MacMillan

So just to be clear, it could trend down from this level of 118% as we come up again, tougher incremental comp or is that not absolutely right?

Mikkel Svane

I think last quarter when I haven't -- if we were to look at and we said that we would expect it to be in the one-teens, that's kind of what I'd like to leave it at and just repeat what we said last quarter at this point.

Ross MacMillan

Okay. And then just wanted to follow-up on sales org; as I understand that you got three go-to-market groups if you will. You've got the enterprise enlargement market, the volume business and you've got a new products business. Have you actually formally made any restructuring to the shape of those three teens or the actual structure of the go-to-market functions?

Mikkel Svane

I think we've become a little bit smarter about like -- some of the things we achieved with kind of having -- like our velocity business versus an enterprise business, kind of we achieved all these things but like -- maybe some of the organizational processes, some of the organizational processes were little bit over engineered. So I think we've accomplished making a simpler model where we still kind of understand the distinction but made it a little bit less complicated for ourselves, post navigated internally and also of course to make it easier for our customers.

Ross MacMillan

And last one, any -- without simplification have there been any formal change to sales compensation plans or is that something that's yet or has not happened?

Mikkel Svane

Yes, the sales compensation plans are based on the objectives that are put up by the leadership. So we still get rewarded on the business they bring in. So that's been -- I mean, they're really pushed on to two funds. They are making sure we're always bringing in new customers. Secondly, and very importantly is, really pushing on expansion. What I think we've done is though made it simpler forthright sales people and for the organization to kind of understand where we bring value and how we reward for that value.

Ross MacMillan

Thanks so much.

Operator

The next question is from Patrick Walravens from JMP Securities.

Patrick Walravens

Great, thank you. So Mikkel and maybe Elena, I would love to hear your perspective on the Microsoft acquisition of LinkedIn. I mean if you read the background of the mergers -- well, you've got to let me finish my question. If you read the background of the merger, they went back and forth like five times bidding on that asset. And so we were all surprised by that I think, so this was a fair question I think. Here we go, so how many guys think Microsoft going LinkedIn might change the CRM market?

Mikkel Svane

I think that would purely speculative for now. I think they see that very much from the kind of their office position and but again, this is purely speculation, how they think they are adding value to that whole and does that involve CRM tool, yes, basically around -- especially around sales organization. Sales already -- sales people, they live in LinkedIn. But again, like this is purely speculation for my part.

Elena Gomez

I won't speak out further. I assume I have to say that I'm actually more curious to see how they will leverage the network of records they have if you will without sort of compromising the good standalone brand of LinkedIn and what people use it for. So more TVD but it appears speculation at this time.

Mikkel Svane

I've stopped using LinkedIn like a year ago.

Patrick Walravens

Okay, thank you. And Mikkel, can I ask you a follow-up, a different stage, which is now that you have a straight team around you -- what is your primary focus? What are you spending your time on?

Mikkel Svane

Well, I think I've put an executive from our place in the organization, really investing and getting enough time together in this quarter, why we -- to have day jobs has been incredibly important and I'm just very proud of the team and how they've hit the ground running and how it's just fun to work. We're doing some of our 2017 and beyond planning this month and going away together. We really look forward to that; we really worked together as a team. And I think my mission is really to be about getting -- making the team successful and that's what very much my job is and to make sure that we always keep our eyes from the long transition or what we want to be when we grow up. And I think that's -- I'm going to -- that's what I spend my time on and making sure that we build the right kind of company for the right kind of future and continue to be aggressive with our growth. And -- because like growth is gross but it's also just because we have an opportunity to build a better product for better world and be a better company, that's what we want to execute on.

Patrick Walravens

Great, thank you.

Operator

[Operator Instructions] And the next question is from Kash Rangan from BofA Merrill Lynch.

Kash Rangan

Yes, the first question was my artificial bot, the real question. Forget what I asked, from what my -- asked upfront but, curious to get your elaborated data on the second half seasonality. Can you talk a little bit more length about what's driving the seasonality? Is it a result of the pipeline building that's happened last year? Secondly, how are you looking at sales headcount? It looks like based on Mark's comments, the investment you've made into 2014 yielded an better landing expand in 2015. So consequently, how are you looking to add sales capacity because a lot of work you're doing this year is going to have an impact on how you look at your next year's growth. So just wanted to get your thoughts on these two. Thank you so much.

Mikkel Svane

Kash, that really is an interesting, when you work with the numbers, remember that in 2014 we made a large step up investment in our sales organization and marketing organization. Those guys took 9 to 12 months to become fully productive which would have anniversaried in 2015. And so we saw very large output of that. And then our investment in the salesforce going forward has been much more in line commensurate with the growth opportunity we see ahead of us. We had said that we were also going to at the same time prove out more productivity and scale that organization so that it represented a small percentage of the revenue expense in prior year. So now you're seeing all of those things kind of come together in 2016 versus 2015.

In terms of enterprise deals in general, I do think that that we are still learning some of the cadence around how are these three to six month lead time deals and the 12 month lead time deals. And so we always wanted to kind of forecast in a more conservative way to make sure that until we understand kind of the regular patterns of enterprise deals. Now Elena brings to us a whole different set of experiences from the larger company but from a forecasted perspective the guys that are doing the forecasting are still learning what it looks like for us quarter-to-quarter.

Elena Gomez

Yes, I would just add that as we look at adding capacity in the second half of the year, we're really mindful of the fact that on the low land we have a very predictable business and so as we think about capacity we're also considering that in our seasonality. But Kash you're right on in terms of the capacity we add in the second half would be in the cater of our revenue next year and we're -- are spending a lot of time together looking at that and understanding that dynamics.

Operator

And the next question is from Brent Still [ph] from UBS.

Unidentified Analyst

Mikkel, can you just share a quick radian on the duration of the deals. What's the average duration and can you just talk about the bill -- is it -- the majority still monthly or are you starting to see this now shift to more annual -- any higher the numbers around those would be really helpful.

Marc Cabi

So as of the end of Q1, I don't have the Q2 update for you, it takes a little while to get to present, they don't change much from quarter to quarter. Less than 50% of our current invoicing is annual which means that it's either monthly or quarterly. And as we -- so that's kind of a backdrop. And that hasn’t really changed significantly, no move a few points up and down from quarter-to-quarter but has now changed significantly in the near term. Most of your deals, even if they are multi-year deal are build and invoiced annually or shorter period. So we don't have a very large long-term deferred component at this point.

Unidentified Analyst

Great, thanks.

Operator

The next question is from Alec Zukin [ph] from Piper Jaffray.

Unidentified Analyst

Marc, I just wanted to come back to your answer to Ross's question, particularly about having changed maybe the cadence of land and expand to potentially much larger than before. I guess what gives you the confidence to execute on that, is it something in a pipeline and the deals that you've got in the pipeline and you're working to close. I mean what that gives you the confidence that -- as a new type of sales talent that you've been able to bring on Board successfully, is it that the expansion of management ranks, just wanted to really stay on that specific point.

Marc Cabi

Thanks, that's a great question. I do want to point out that we still have a very large part of our business self-service driven, that's growing at very nice rates and that part of business is consistent but we now have more than 30% kind of as an indicator coming from these larger deals if you were to just use our MRR of customers with 100 plus seats. So from that perspective they have different timelines and so forth that they close in but couple of indicators that give us confidence. This year in May we were designated as the leader in the magic quadrant by Gardner. There were big influence purchase decisions our potential customers and I do know that they are continuously getting increased about us.

Same with forestry, forestry is written and talked about us in ways that put us into a very good end-market and enterprise opportunity. We have a great set of sales people that have been doing this now for a while and we have confidence in their capabilities to continue to execute. We have simplified some of the things for them so that they can execute better. And we're always looking to become more efficient in terms of our user sales and marketing dollars. But we're generating leads from the activities we're doing around, relay around branding, around some of the improvements we've seen from analysts in terms of our ratings, in terms of our capabilities. So those are all kind of combined to give us a confidence going forward.

Unidentified Analyst

And Marc, maybe just to follow-up; so I guess specifically on Elena or Mikkel, specifically on the pipeline that you're looking at for the back of this year. As you compare that to the pipeline made from this time last year, how do you kind of classify?

Marc Cabi

Elena would have had a harder time comparing it because it is the last year's pipeline but when you look at it from a list of potential customers, it's a good list of customers. Mikkel, do you want to…

Mikkel Svane

Looks good.

Unidentified Analyst

Thank you.

Operator

There are no further questions. I will turn the call back over to the presenters.

Marc Cabi

Thank you, Mike. Again, we appreciate your time and interest in Zendesk, and we look forward to speaking with you next quarter.

Operator

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

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