Item 1. Business.
Overview
Modern organizations need technology that adapts to their individual needs and empowers them with the ability to guide and enhance their customers’ experiences. To position themselves for success, organizations must integrate service into every customer interaction and use customer insights and service data to enrich the overall experience. With the right technology, organizations can empathize with their customers and identify points of friction in their customers’ experiences with their businesses and address them.
Zendesk believes that every customer relationship is built upon one ongoing conversation between a customer and the organization. As champions of customer service, we are a service-first customer relationship management (“CRM”) company, with support, sales, and other customer engagement solutions designed to improve customer relationships.
Founded to democratize customer service software by making it easy to try, buy, and use, our solutions are built on an open and flexible platform that is both quick to set up and customizable. With roots in service and a deep understanding of the customer mindset, Zendesk gives companies the solutions they need to create easy, cohesive, and frictionless experiences. Through our solutions, organizations of all sizes and across many industries can set their teams up for success and keep their businesses in sync, while making it easy for customers to do business with them. The result: better, more conversational experiences for everyone.
We are a software development company founded in Copenhagen, Denmark in 2007, and reincorporated in Delaware in 2009. Our principal executive offices are located at 989 Market Street, San Francisco, California 94103, and our telephone number is (415) 418-7506. Our website address is www.zendesk.com. Information contained on or that can be accessed through our website does not constitute part of this Annual Report on Form 10-K, and inclusions of our website address in this Annual Report on Form 10-K are inactive textual references only. Unless expressly indicated or the context requires otherwise, the terms “Zendesk,” “company,” “we,” “us,” and “our” in this Annual Report on Form 10-K refer to Zendesk, Inc., a Delaware corporation, and its consolidated subsidiaries.
The Zendesk Approach
We build software that helps organizations build better customer relationships through conversational experiences, and we believe in the design and delivery of products and solutions that are unique and innovative, while also being fast to implement and easy to use, yet robust and sophisticated for all types and sizes of organizations and across all industries. Our focus on these core principles has led us to design customer experience solutions that share the following characteristics:
•A more conversational experience: Through our product and platform solutions, we enable organizations to have seamless conversations with their customers, allowing organizations of all sizes and industries to transform how they engage with customers regardless of how and when those customers want to communicate. As we expand the reach of our technology, we recognize the critical importance of having our solutions work cohesively together and we are continuing to invest in supporting our product solutions on a shared services platform.
•Easy to use and implement: We build our solutions first and foremost for the people that use them every day. We focus on making the user experience intuitive and product implementation fast while managing complex processes and interactions on the backend of our software. Because of our attention to ease of use, we believe organizations who use our solutions are more effective and efficient, and are able to engage with and deliver better experiences to their customers as a result.
•Open and flexible platform: We believe that the establishment of open and public cloud computing has fundamentally changed how organizations can and will build their customer experiences. Our flexible CRM platform leverages public cloud technologies and open standards. Organizations are able to connect and integrate customer data to build customer-focused experiences, by providing relevant customer data in one modern, flexible, and developer-friendly environment. Our platform enables many audiences - from customer support agents, to developers, to sales
representatives - to get a more complete picture of the customer so they can deliver personalized experiences and adapt to evolving customer expectations.
•Expanding access to analytics and data science: We are committed to enabling and empowering organizations of all sizes to better understand their customers through analytics that unify data across our product and platform solutions and connect easily to outside data sources. We believe our investments in building machine learning and artificial intelligence into our solutions gives more organizations and users access to data science so they can be more efficient, informed, and proactive with their customers.
We have witnessed business software undergo a sweeping shift toward consumerization over the past decade. Zendesk has embraced this shift with an approach to delivering customer experience solutions that is different from earlier generations of business software. Our goal is to remove barriers that make business software difficult to buy, deploy, and use. Our approach to software delivery focuses on the following key elements:
•Elastic and agile: Our product and platform solutions can easily grow and scale with our customers and be used in new departments and use cases without the expensive deployment projects required in the past. Zendesk product solutions are flexible by design and easy to configure and use. In addition to our product solutions, we enable our customers through our platform solution, which gives customers the freedom to build customer applications and experiences using open tools and cloud architecture, instead of proprietary tools and technology.
•Try before you buy: We believe customers should be able to try our solutions and see how they work before they commit to a purchase. Free trials are core to the marketing of our solutions and we can deliver fast prototypes and proof of concepts for our most sophisticated prospective customers. We offer a wide range of trial experiences for our solutions, ranging from introductory offerings to experiences geared towards larger organizations, each with an ability to begin an implementation during the evaluation period.
•Price transparency: We provide our customers a well-defined total cost of ownership across our solutions by providing transparent and predictable pricing. Our pricing is designed to make our software accessible to customers of all sizes by offering a variety of subscription packages that include features based on customer need. We offer subscriptions that may be purchased online and deployed without the need to engage a sales or enablement professional.
Growth Strategy
Zendesk was founded with a mission to help organizations build better relationships with their customers. We have continued to pursue that mission by building and delivering our customer experience solutions, which include product solutions and a CRM platform, that help organizations be the company their customers want them to be. We believe our future growth will be a natural extension of our mission, and we are focused on the following key growth drivers:
•Making experiences simple for organizations and their customers: At our core, we believe that customer experiences should be simple and effortless. This belief has enabled us to build a compelling brand among both small to midsized organizations and larger organizations for which our ease of use, quick return on investment, and agility and flexibility are important differentiators. Our customer experience solutions provide simple and contextual interfaces across the customer journey and multiple communication channels for organizations interacting with their customers. Additionally, our product and platform solutions have been built on the premise that our solutions should be easy to discover, deploy, and purchase so that any organization, from startup to large organizations, can realize their value.
•Expanding our market by maturing and investing in our customer experience solutions: From our roots in customer service software, we have evolved to helping organizations design, build, and manage their entire customer experience infrastructure and transform how they interact and proactively engage with their customers. Our product solutions have expanded to serve the entire customer journey. Our focus is to engage in customer-facing conversations for our customers and to expand our footprint in support, sales, and beyond. We will continue to mature our product and platform features and usability across communication channels, while also integrating and expanding our solutions across CRM functions.
Our objective is to enhance the customer experience by extending our solution and accelerating development through our unified CRM platform. With our platform solution, we provide organizations the ability to unify and use customer data to build a more complete picture of that customer and deliver them unique experiences. Developers gain the ability to build and deploy custom applications and services faster because of the flexibility, scale, and capabilities of
the public cloud. With the addition of our messaging platform to our CRM platform, organizations can build more unified conversational experiences by integrating social, web, and mobile messaging channels into their own apps and services. We will continue to expand the capabilities of our platform solution and its integration with our product solutions.
Additionally, we will continue our investments in building automation, machine learning and artificial intelligence into our product and platform solutions, empowering organizations to harness the power of data science and be more efficient, informed, and proactive with their customers.
•Being strategic partners with our customers who are larger organizations: With our customer experience solutions, we are increasingly evolving from a software vendor to a trusted partner that is strategically engaging with our customers around their visions and digital transformations. We are helping organizations build or transform their organizations around their customer experience. We are scaling these capabilities by continuing to build and mature our expertise in sales, success, relationships, systems architecture, and integrations. Additionally, we are continuing to develop a partner ecosystem strategy to help us reach and serve more of our customers who are larger organizations and build a community of developer evangelists for our CRM platform.
•Intentionally differentiate for our customers: With more than 170,000 paid customer accounts as of December 31, 2020, our customers range from startups to traditional small and midsized organizations to large organizations. These customers have very different dynamics and needs. To better engage with our customers, we are differentiating our offerings and services. For large organizations, we want to be the strategic provider of modern customer experiences, built on and extended with our platform solution. To accomplish this, we aim to continue to develop and focus a coordinated team to collaborate product development, go-to-market initiatives, and customer success and support for our customers that are larger organizations. For our customers who are small and midsized organizations, we want to continue to be the easiest solution to implement, use, and scale. We will continue to enhance our self-service capabilities for our customers' standard needs and requests, while engaging with our customers on higher-value strategic initiatives.
Our principle of democratizing software has developed into an efficient business model represented by expansion within customer accounts and organic growth through promotion by our customers. We will continue our focus on providing customer experience solutions that create simple and straightforward experiences for both our customers and the organizations they support.
With our customer experience solutions, Zendesk has served a global market and, for the year ended December 31, 2020, we generated 48% of our revenue outside of the United States. We have customers in more than 160 countries and territories, and solutions available in more than 30 languages. We will continue to invest in expanding our global footprint, particularly in those markets where we have demonstrated significant customer traction with our democratized approach or which represent particularly strategic opportunities. We are also taking a more coordinated approach to our business outside the U.S. to further invest in our international business. We plan to continue to develop our leadership in sales and operations, standardize processes and metrics, share best practices across regions, and mature our partner ecosystem.
Zendesk Solutions
Zendesk’s customer service and sales solutions are built to help organizations address the rise in customer expectations and to craft their customer experiences into a competitive differentiator. Zendesk solutions are developed to support a shared services infrastructure and common customer data platform. Zendesk’s solutions are developed using agile software techniques, and are designed to quickly incorporate and innovate on feedback from our customers. This approach allows us to share our newest technology with customers, and quickly adapt our solutions to address customer needs.
Zendesk offers product solutions that are used throughout the customer lifecycle by key customer facing teams, including support, sales, customer success, and more.
•Zendesk Support, our flagship product solution, is an easy-to-use system for tracking, prioritizing, and solving customer support tickets across multiple channels, bringing customer information and interactions into one place.
•Zendesk Chat is live chat and messaging software that provides a fast and responsive way to connect with customers on websites, on mobile devices, and through social messaging applications.
•Zendesk Talk is cloud-based call center software for more personal and productive phone and short message service support conversations and enables organizations to provide phone support from the same platform they use to manage all other support channels.
•Zendesk Guide is a knowledge base that powers both customer self-service and support agent productivity through content that is created and organized by our customers. Guide content is available via self-service website, accessible through APIs on websites, in apps and mobile devices, and surfaced to agents within Support and Chat. Additionally, Answer Bot is a feature available within Guide that uses machine learning to automatically answer customers’ questions by suggesting content from the Guide knowledge base.
•Zendesk Gather is community forum software that allows customer end-users to connect and collaborate.
•Zendesk Explore provides analytics for organizations to measure and improve the entire customer experience, with instant access to the customer analytics that matter and the deeper understanding of customers and business that comes with it.
•Zendesk Sell is a sales CRM product solution to enhance productivity, processes, and pipeline visibility across our customers’ organizations. Sell is easy to use and designed to keep sales representatives selling. Zendesk Sell eliminates the friction from deal updates so representatives and management are always able to access, analyze, and collaborate on relevant deal data.
Zendesk’s platform solutions and developer tools allow organizations to extend the functionality of our customer experience solutions, integrate into internal and third-party systems, and customize the experience for their employees and customers. These include:
•Zendesk Sunshine, our open and flexible platform solution that allows organizations to address an increasingly broader set of customer experiences. Sunshine provides organizations with the ability to develop a more complete picture of their customer with flexible databases and the ability to model, store and manage customer profiles, events, objects and relationships. Organizations can connect and integrate this data across our product solutions with other business applications to build highly specialized workflow and unique customer experiences.
Zendesk Sunshine includes the following key components: Unified Profiles facilitate building customer profiles with attributes from third-party applications to obtain a more complete picture of customers; Custom Events capture customer interactions, such as shopping cart, web, or mobile activity, which in turn provides a dynamic view of the customer journey; and Custom Objects store and connect new data sources, such as products and order history, for greater context about customers.
•Sunshine Conversations is the platform solution our messaging capabilities are built on that allows businesses to extend Zendesk’s messaging capabilities for more sophisticated use cases and empowers organizations to proactively engage customers, introduce third-party bots for automation, and design bespoke messaging experiences that help customers transact directly within the conversation, such as browsing products, making reservations, and making payments.
•Zendesk Embeddables, a combination of our application programming interfaces, or APIs, web widget, and mobile software development kits allow developers to embed Zendesk experiences natively on the web and within mobile applications.
•Zendesk APIs are extensible and built on open standards, allowing users to build custom integrations and interact with Zendesk data using over 1,000 different API endpoints.
•Zendesk Apps enable organizations to customize Zendesk product and platform solution interfaces and optimize workflow through powerful plug-ins. Our customers can build custom apps or select from over a thousand pre-built apps and integrations on the Zendesk Marketplace.
Zendesk Suite
In the first quarter of 2021, we released a new version of our omnichannel offering, which combines many of our existing solutions (Support, Chat, Talk, Guide, Gather, Explore, and Sunshine) into a complete customer experience offering -
Zendesk Suite. Zendesk Suite combines our customer experience solutions into easy to purchase plans, which grow as our customers’ needs grow.
With Zendesk Suite, our customers get the three components they need to deliver exceptional customer experiences. First, we help our customers provide support where and how it is convenient for their customers, and we allow our customers to customize the experience to fit their businesses. Second, we help agents, administrators, and internal teams do their best work by giving them powerful tools to manage conversations, collaborate effectively, and create content for customers all within a unified workspace. Finally, we keep our customers’ businesses in sync during the customer experience process through a unified view of their customer, enhanced integration and extension capabilities, world-class customer experience analytics, and workflows that make it easy to automate and optimize the experience.
Zendesk Suite also features our new unified messaging capabilities. Zendesk messaging delivers rich conversational experiences for businesses that are connected and engaging with customers across websites, mobile devices or social messaging applications. Zendesk messaging is easy to automate and can be customized within our open and flexible platform.
Technology
We employ a modern technology architecture in which our solutions are built upon a set of core APIs that enable rapid innovation and deep integration. The technology infrastructure used for the Zendesk customer experience solutions are designed to provide a highly available and scalable cloud-based platform with industry-standard security measures.
Zendesk’s strategy is to leverage the open and public cloud both in hosting our applications and providing platform tools and services for developers, for both extensions of Zendesk as well as to power their own applications and experiences. We believe this provides Zendesk and our customers with greater reliability, performance, and flexibility than operating through proprietary platforms and self-managed data centers.
The architecture and deployment of our software are described and guided by the following key characteristics:
•Reliability. Our customers are highly dependent on our solutions, which are designed to be available 24 hours a day, 365 days a year. We provide transparency to customers on availability and technical operations matters that impact them through our website and other channels.
•Scalability. Our data infrastructure is highly scalable and regularly processes a high volume of data driven requests that require the processing of specific data.
•Security. Each of our solutions is designed to host a large quantity of customer data. We maintain a comprehensive security program designed to help safeguard the security and integrity of our customers’ data. We regularly review our security program. In addition, we regularly obtain third-party security audits and examinations of our technical operations and practices covering data security.
Customers
As of December 31, 2020, we had an aggregate of approximately 173,600 paid customer accounts using our solutions. This includes approximately 88,100 customer accounts for paid subscription plans for Zendesk Support (other than our legacy Starter plan) and approximately 39,000 customer accounts for paid subscription plans of Zendesk Chat. In addition, we had approximately 46,600 paid customer accounts on our other solutions, collectively, as of December 31, 2020. Prior to purchase, we generally provide our prospective customers with the opportunity to try fully-functioning versions of our solutions for a free trial period. This is a central part of our business model as we believe customers should have the right to try solutions before being locked into a subscription. Providing our customers with a free trial period exposes customers to our brand and establishes a relationship that can facilitate further adoption of our solutions as organizations grow in size and their needs become more complex. For further details as to how we calculate our number of paid customer accounts, please see the discussion in the “Key Business Metrics” section of this Annual Report on Form 10-K.
Our customers are located in over 160 countries and territories and represent organizations across a broad array of sizes, industries, and geographies.
Research and Development
Our research and development organization is responsible for the development, design, and testing of all aspects of our product and platform solutions. We invest heavily in these efforts to continuously improve and innovate. In addition to our product and platform solutions, we have developed multi-functional APIs that we utilize to build our solutions as well as facilitate integrations of our solutions with third-party applications.
Our global research and development team is primarily based in San Francisco, California; Melbourne, Australia; Dublin, Ireland; Krakow, Poland; Copenhagen, Denmark; Singapore; Madison, Wisconsin; Montreal, Canada; and Montpellier, France. To foster rapid innovation, our research and development team is further apportioned into smaller, agile development teams.
We deploy new features, functionality, and technologies across our solutions through software releases or updates in order to minimize disruption and provide for constant improvement.
To create a product roadmap that meets our customers’ needs, we emphasize collaboration during the development process. Customers provide input through feedback forums, dialogue with our product support and research and development teams, and feature utilization. As a result of using our solutions internally to support our customers, we also develop new or improved features based on our own employees’ feedback.
As of December 31, 2020, we had approximately 1,090 employees in our research and development organization. Our research and development expenses were $255 million, $208 million, and $160 million for the years ended December 31, 2020, 2019, and 2018, respectively.
Sales and Marketing
Subscriptions to our product and platform solutions are designed to be easy to purchase. A substantial number of our customers subscribe to our solutions with limited or no direct interaction with our sales team.
We also deploy a direct sales approach, which includes a sales team based in four regional hubs: North America, LATAM (Latin America), EMEA (Europe, Middle East, and Africa), and APAC (Asia-Pacific). This team manages prospective and current customers, aiming to initiate, retain, and expand their use of our solutions over time, and is responsible for driving expansions and renewals of existing contracts. Our sales team also partners with sales and product engineers to provide pre-sales technical support to prospective customers.
We expect to continue increasing penetration into larger organizations through a land and expand strategy whereby we attempt to capitalize on the use of our solutions by a functional or geographic department to expand the use of our solutions throughout the organization. Through our sales team, we also seek to discover and work with a growing number of forward-thinking organizations on larger initiatives to transform their approach to customer experience.
We also utilize indirect sales channels, including referral partners, resellers, business process outsourcers and implementation partners. These channel partners provide additional sales coverage, particularly in geographic markets where we may have limited presence, as well as implementation services to our customers. We plan to continue investing in these relationships to help us in certain markets and to complement our direct sales efforts.
Our marketing efforts are focused on generating awareness of our solutions, creating sales leads, nurturing prospective customers through the process of product discovery and evaluation, establishing and promoting our brand, and cultivating a community of successful and vocal customers. Based on our belief that the best method to sell subscriptions to our solutions is to provide customers with the opportunity to actively use and explore our solutions’ capabilities, one focus of our marketing team is to drive and encourage free trials and the successful conversion of free trials to paid subscriptions. We utilize both online and offline marketing initiatives, including digital advertising such as search engine, paid social, e-mail and product marketing, content marketing, user events, conferences, corporate communications, web marketing and optimization, and outbound list and contact generation.
As of December 31, 2020, we had approximately 1,640 employees in our sales and marketing organizations. Our sales and marketing expenses were $512 million, $397 million, and $292 million for the years ended December 31, 2020, 2019, and 2018, respectively.
Product Support, Customer Success, and Professional Services
We strive to exemplify the great customer experiences that organizations of all sizes can provide with our product and platform solutions by offering multi-channel service from our product support team, a rich self-help knowledge base with detailed product guides, and active community forums for agents, managers, and developers.
We offer different levels of product support based upon the subscription plans purchased by our customers. Regardless of the plan purchased, our solutions provide a unified intuitive interface, connectivity to our self-help knowledge base and community forums, and step-by-step tutorials to help users learn, use, and deploy our solutions effectively.
We additionally offer a variety of customer success initiatives aimed to address customer needs with varying levels of complexity, from our small business customers to even our largest customers. These initiatives are designed to ensure that our customers are best equipped to meet their business goals and to realize the full value of the implementation of our solutions.
Along with our global partners, our professional services team assists our customers in implementing more complex deployments of our solutions. These services include implementing our products for new and existing business processes, advising our customers on customer experience best practices and optimizing their infrastructure as a trusted partner. Service engagements are typically scoped on a time and materials or fixed fee basis and billed separately from the subscription to our solutions.
Through our training platform, we offer free on-demand training, paid courses and certifications to help our customers quickly learn how to effectively use our solutions as well as implement best practices. Courses are available online. Our training sessions are typically targeted at specific levels of employee seniority and product experience, such as agent essentials or administrator expert, to more effectively tailor training to intended audiences.
Seasonality
Historically, we have experienced the highest demand for our solutions and services in our fourth quarter, which we believe is a result of industry buying patterns. For a more detailed discussion of the seasonality impacting our business, see the “Seasonality” discussion in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this Annual Report on Form 10-K.
Competition
There are a number of established and emerging competitors in the broad market of customer engagement software. This market is fragmented, rapidly evolving, and highly competitive, with relatively low barriers to entry in some segments. We consider the principal competitive differentiators in our market to include:
•Enablement of customer communications across channels;
•Solutions that are open and flexible;
•Time to value realization through ease-of-deployment and use;
•Availability of self-service options;
•Data-rich analytics and performance recommendations;
•Mobile and multi-device capabilities;
•Proactive outreach tools;
•Product and platform solutions grounded in customer experience;
•Customization and integration with third-party applications;
•Brand recognition and thought leadership; and
•Total cost of ownership for the customer (including software updates, ongoing maintenance, and consulting and system integration fees).
While we believe that we successfully compete with respect to these dynamics, given the large number, disparate sizes, and varying areas of focus of other organizations with which we compete in the provision of customer experience solutions, we may not always compare favorably with respect to some or all of the foregoing factors.
For small to midsized organizations, we often compete with general use computer applications and other tools that organizations have adapted for managing relationships with their customers, including shared accounts for email communication, phone banks for voice communication and text messaging, shared accounts for social messaging, and pen and paper, text editors, and spreadsheets for tracking and management. In addition, we compete with a number of other software as a service, or SaaS, providers with focused applications competitive to one or more of our product and platform solutions that our potential customers may elect to use in lieu of our solutions, and such providers may be able to offer their products at a lower price due to the focused nature of their applications. For larger organizations, we compete with custom software systems and software vendors geared towards larger organizations, including salesforce.com, Inc. and ServiceNow, Inc., each of which may have greater operational flexibility to bundle competing products and services with other software offerings, or offer them at a lower price than our current Zendesk Suite offering, which will negatively affect our competitiveness for that offering. Other established SaaS providers not currently focused on the functionality that our solutions provide may expand their services to compete with us as well. Further, large enterprise software vendors have a greater ability to aggressively price their product at a level below their typical selling price in order to gain market share, decreasing our ability to compete successfully with such vendors in certain regions. Additionally, some existing and potential customers, particularly large organizations, have elected, and may in the future elect, to develop their own internal customer support software system. Pricing pressures and increased competition generally could result in reduced sales, reduced margins, losses, or the failure of our solutions to achieve or maintain more widespread market acceptance, any of which could harm our business.
In order to maintain and improve our competitive position in the market, we remain focused in our development, operations, and sales and marketing efforts on the evolving customer service needs of all organizations.
Intellectual Property
We rely on a combination of patent, trade secret, copyright, and trademark laws, a variety of contractual arrangements, such as license agreements, assignment agreements, confidentiality and non-disclosure agreements, and confidentiality procedures and technical measures to gain rights to and protect the intellectual property used in our business.
We have developed a patent program, and a strategy to identify, apply for, and secure patents for innovative aspects of our platform and technology. We have ten issued U.S. patents and 18 U.S. patent applications pending. We intend to pursue additional patent protection to the extent we believe it would be beneficial and cost-effective.
We actively pursue registration of our trademarks, logos, service marks, and domain names in the United States and in other key jurisdictions. We are the registered holder of a variety of United States and international domain names that include the term Zendesk or certain variations. Our solutions and services utilize our “Zendesk” trademark as well as our logo and images.
We also rely on certain intellectual property rights that we license from third parties, including under certain open source licenses. Though such third-party technologies may not continue to be available to us on commercially reasonable terms, we believe that alternative technologies would be available to us.
Our policy is to require employees and independent contractors to sign agreements assigning to us any inventions, trade secrets, works of authorship, developments, and other processes generated by them on our behalf and agreeing to protect our confidential information, and all of our key employees and contractors have done so. In addition, we generally enter into confidentiality agreements with our vendors and customers. We also control and monitor access to, and distribution of, our software, documentation, and other proprietary information.
Although we rely on intellectual property rights, including patents, trade secrets, copyrights, trademarks, a variety of contractual arrangements, and confidentiality procedures, we believe that factors such as the technical and creative skills of our personnel, development of new features and functionality, and frequent enhancements to our solutions are more fundamental to establishing and maintaining our technology leadership position.
Human Capital Management
As a service-first customer relationship management company, we design customer experience solutions that drive improvements in the relationships between organizations and their customers. We believe that to achieve that purpose, it is essential to invest in building an engaged, diverse, supported, and incentivized workforce who can empathize and empower our customers to build those relationships.
The Company employed approximately 4,130 people as of December 31, 2020, including the following employees in each region as provided below:
Although we have statutory employee representation obligations in certain countries, our U.S. employees are not represented by a labor union. We have not experienced any work stoppages.
Our primary initiatives in attracting, retaining, and developing our employees include:
Diversity, Equity, and Inclusion
Armed with the slogan, “Put in the work,” our commitment to diversity, equity, and inclusion is about taking concrete and sustained action in building belonging-rich environments where the mosaic of our employees can find success. For us, that means hiring diversely, building equitable processes and leading inclusively every step of the way.
•Hiring Diversely: In the year ended December 31, 2020, our workforce grew by over 500 employees. As of December 31, 2020, over 37% of our global workforce identify as female and 60% identify as male, with approximately 2% of employees who did not disclose an identification. Within the United States, our employees self-identified their race and ethnicity as provided below (as of December 31, 2020):
We will continue to drive progress through targeted recruiting partnerships (which have included relationships with The Mom Project, Breakline, National Sales Network, and BYP Network), debiasing our job descriptions using artificial intelligence software, and implementing initiatives that focus on ensuring greater representation from underrepresented communities in our sourcing processes.
•Building Equitably: In 2020, we released a Global Equity Policy, which encourages our employees to seek opportunities to promote equity through our work, model respectful and inclusive behavior, and prevent and report policy violations. Additionally, we spent 2020 evolving our employee resource group global framework into an Employee Communities structure to reflect their function as the foundation of culture and inclusion at Zendesk. Led by three primary areas of investment - our people, our products and customers, and corporate social justice - Employee Communities work to educate others and raise awareness about issues that affect our workforce in and beyond company walls, advocate for product and service accessibility, and build relationships with external partners and organizations. Employee Communities are supported by executive sponsors representing many of our regions and offer development opportunities through coaching, mentorship programs, and discussion forums. We currently offer eight communities that represent persons of color, LGBTQIA+ employees, women, veterans, parents and caregivers, persons of advanced experience, and persons who are neurodivergent.
•Leading Inclusively: In 2020, we made two critical investments in talent management: First, to develop anti-racism consciousness and behaviors within our management group through training; and second, to support the development
of leadership from underrepresented communities by releasing an allyship toolkit globally to enable people managers to be allies in their communities and workplace. In 2021, we are continuing our commitment to develop the next generation of leaders through Ignite, a program for rising underrepresented leaders.
Culture and Talent Acquisition
As a company, we are investing in the future of our employee experience with a similar philosophy to our view on the future of customer experience. Despite significant global headcount growth over the past few years, we continue to embrace our core values: we value simplicity, agility, sincerity, as well as a sense of humor and humility often absent from large organizations. Just as we build our solutions first and foremost for the people that use them every day, we also build an organization and culture that trusts, values, and empowers our employees.
We are a global, inclusive team who actively embraces diverse sets of perspectives. We continue to primarily operate in a remote capacity during the pandemic. Post-pandemic, we intend for a significant proportion of our workforce to continue to be designated as remote employees. By hiring and maintaining more remote teams, we are able to more easily enter new geographical regions to support our customers, and expand our talent footprint while keeping diversity top-of-mind.
Talent Development
We believe that building a high performing and agile workforce requires enabling our employees to learn, adapt, and model strong leadership capabilities as we grow.
Over 1,100 employees across levels actively participated in learning programs in 2020. All employees had access to always-on learning opportunities via our online learning platform, which included programs for building leadership capabilities, fostering equity and inclusion, and working in a digital-first environment. We additionally have partnerships in place with external learning partners, including BetterUp for coaching. Over 400 people managers engaged in a University of California, Berkeley Executive Education leadership series focused on leading in a virtual and volatile, uncertain, complex, and ambiguous world. Finally, over 700 people managers participated in sessions on racism, equity and privilege to support us in leading inclusively and with empathy.
Based on results from our internal employee survey platform, our employee engagement in 2020 was above our industry benchmark. We also began to measure inclusion more comprehensively, and our first survey yielded outcomes that were also favorable compared to our industry benchmark.
Total Rewards
Our total rewards programs are designed to attract, reward and retain our talented employees in a transparent and equitable way. Zendesk offers market competitive compensation and a comprehensive healthcare benefits package to all employees worldwide. We review our programs annually to ensure we maintain competitiveness and employee intrinsic value. In response to the COVID-19 pandemic, our top priority has been to ensure our employees have the resources they need to care for themselves and their families. We introduced and promoted new and existing resources related to mental health and mindfulness, time away and caregiving leave, as well as financial support and reimbursements to encourage healthy living and establishing remote workspaces.
•Comprehensive Benefits: We strive to offer options that are competitive, locally relevant and provide the resources needed to live fully, healthy and balanced in work and life. Our benefits include comprehensive healthcare, income protection insurance, time off and leave programs, retirement programs and additional resources to support employees' overall well-being.
•Mental Health & Well-being: We prioritize well-being and offer resources focused on mental health. These resources include online therapy programs from licensed clinicians, relationship counseling and critical incident support, and an online application that promotes mindfulness and guided meditation.
•Family Resources: Employees have access to an online platform that finds general care services to support employees in balancing work and life. We also offer family-forming benefits with access to employer-sponsored funds to pay for fertility treatments and family-forming services, including adoption and surrogacy. We have a global parental leave program with an equal length of time for maternity and paternity leave.
•Pay Equity: We are committed to pay equity and perform pay equity analysis on an annual basis.
Social Impact
Social impact has long been a foundational element of Zendesk’s culture and brand. Promoting empathy to solve complex social issues is a core value; we believe it is an important way for employees to engage with work, our customers, and our communities around the globe. Our goals for social impact fall into four core areas:
•Giving Money: We funded over $3 million to Zendesk Neighbor Foundation to grant to nonprofits, including those who have engaged on issues of racial inequity in our communities.
•Giving Time: Zendesk has transitioned to focusing on virtual volunteering as a way to give back to our communities, even during the pandemic. In 2020, our employees volunteered over 5,000 hours virtually around the world.
•Giving Technology and Expertise: Zendesk responded quickly in the wake of the COVID-19 pandemic, with a free software offer to nonprofits and community organizations who provide community aid, including the equivalent of over $1 million worth of software to various organizations including Wir Gegen Corona and Hospitality Helps.
•Improve our Environmental Stewardship: We set goals for operating 100% of our offices on renewable energy by the end of 2021 and ensuring our data center hosting operations are carbon neutral by the end of 2022.
Regulatory Considerations
The legal environment of Internet-based businesses is evolving rapidly in the United States and elsewhere. The manner in which existing laws and regulations are applied in this environment, and how they will relate to our business in particular, both in the United States and internationally, is often unclear. For example, we sometimes cannot be certain which laws will be deemed applicable to us given the global nature of our business, including with respect to such topics as data privacy and security, pricing, credit card fraud, advertising, taxation, content regulation, and intellectual property ownership and infringement.
Our customers, and those with whom they communicate using our product and platform solutions, upload and store customer service and other data into our solutions and provide access to such data, generally without any restrictions imposed by us. This presents legal challenges to our business and operations, such as rights of privacy related to the content loaded into our solutions. Both in the United States and internationally, we must monitor and comply with a host of legal concerns regarding the data stored and processed in our solutions by customers. We must also monitor and comply with these issues directly in the operation of our business in these jurisdictions.
We are subject to data privacy and security regulation by data protection authorities in countries throughout the world, by the U.S. federal government, and by the states in which we conduct our business. In recent years, there have been a number of well-publicized data breaches involving the improper use and disclosure of personal information of individuals. Many governing authorities have responded to these incidents by enacting laws requiring holders of personal information to maintain safeguards and to take certain actions in response to a data breach, such as providing prompt notification of the breach to affected individuals and public officials, or amending existing laws to expand compliance obligations. In the European Union (the “EU”), U.S. companies must meet specified privacy and security standards, such as the European General Data Protection Regulation, or the GDPR, which governs the protection of individuals with regard to the processing of personal data, and on the free movement of such data established in the European Union to certain non-EU countries, such as the United States. Additionally, the data protection laws of each of the European member countries require comprehensive data privacy and security protections for consumers with respect to personal data collected about them. In February 2016, the European Union and U.S. officials announced an agreement, which established the EU-U.S. Privacy Shield, or the Privacy Shield, as a means for legitimating the transfer of personal data by U.S. companies doing business in Europe from the European Economic Area to the U.S. However, on July 16, 2020, the European Court of Justice (the “CJEU”) invalidated the Privacy Shield. As a result, we are no longer using the Privacy Shield as a legal mechanism for the transfer of data between the EU and the U.S. However, the CJEU upheld the validity of Standard Contractual Clauses, which we will continue to use as a legal mechanism for the transfer of data between the EU and the U.S. As previously disclosed, in June 2017, we announced that we completed the EU approval process for our global Binding Corporate Rules, or BCRs, as a data processor and data controller. This significant regulatory approval validated our implementation of the highest possible standards for protecting personal data globally, covering both the personal data of our customers and employees. We will extend our BCRs to cover the transfer of data from the EU to the UK in late 2021. We have and will continue to engage in efforts to ensure that data transfers from the European Economic Area comply with the GDPR, our BCRs, and the data protection legislation of individual member states.
In the United States, many federal, state, and foreign government bodies and agencies have adopted, or are considering adopting, laws and regulations regarding the collection, use, and disclosure of personal information. California recently enacted the California Consumer Privacy Act, or CCPA, that among other things, requires covered entities to provide new disclosures to California consumers, affords such consumers new abilities to opt-out of certain sales of personal information, and gives such consumers a private right of action to enforce data breaches resulting from the covered entity's violation of its duty to implement and maintain reasonable security measures.
Geographic Information
For a description of our revenue and long-lived assets by geographic location, see Note 15 of the Notes to our Consolidated Financial Statements included in this Annual Report on Form 10-K.
Additional Information
Our website is located at http://www.zendesk.com, and our investor relations website is located at http://investor.zendesk.com. Copies of our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, are available, free of charge, on our investor relations website as soon as reasonably practicable after we file such material electronically with or furnish it to the Securities and Exchange Commission, or the SEC. The SEC also maintains a website that contains our SEC filings. The address of the site is http://www.sec.gov.
We webcast our earnings calls and certain events we participate in or host with members of the investment community on our investor relations website. Additionally, we provide notifications of news or announcements regarding our financial performance, including SEC filings, investor events, press and earnings releases, and blogs as part of our investor relations website. We have used, and intend to continue to use, our investor relations website, our Twitter account (@Zendesk), and our Chief Executive Officer's Twitter account (@mikkelsvane), as means of disclosing material non-public information and for complying with our disclosure obligations under Regulation FD. Further corporate governance information, including our certificate of incorporation, bylaws, governance guidelines, board committee charters, and code of business conduct and ethics, is also available on our investor relations website under the heading “Corporate Governance.” The contents of our websites are not intended to be incorporated by reference into this Annual Report on Form 10-K or in any other report or document we file with the SEC, and any references to our websites are intended to be inactive textual references only.
Item 1A.
Item 1A. Risk Factors.
A description of the risks and uncertainties associated with our business is set forth below. You should carefully consider such risks and uncertainties, together with the other information contained in this report, and in our other public filings. If any of such risks and uncertainties actually occurs, our business, financial condition, or operating results could differ materially from the plans, projections, and other forward-looking statements included in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere in this report and in our other public filings. In addition, if any of the following risks and uncertainties, or if any other risks and uncertainties, actually occurs, our business, financial condition, or operating results could be harmed substantially, which could cause the market price of our stock to decline, perhaps significantly.
Risk Factors Summary
Our business is subject to a number of risks that may adversely affect our business, financial condition, results of operations, and cash flows. These risks are discussed more fully below and include, but are not limited to, risks related to:
Risks Related to Our Product and Platform Solutions
•our substantial reliance on the continued market acceptance of our Support solution;
•developing our current solutions as well as new solutions that keep pace with the customer experience market;
•our ability to integrate new enhancements and solutions into our infrastructure;
•our reliance on application platform interfaces to integrate with third-party applications;
Risks Related to Our Industry
•the intensely competitive nature of the customer experience industry among organizations of all sizes;
•our dependency on the growth of the SaaS market overall;
•the delayed reflection of new sales in our results due to recognizing revenue over the term of our customer contracts;
•the unpredictability of our results due to seasonality in industry buying patterns;
Risks Related to Customer Retention and Acquisition
•our substantial reliance on our customers renewing their subscriptions and purchasing additional subscriptions;
•selling to and developing our solutions to both large organizations and small to midsized organizations;
•our ability to optimize the pricing model for our solutions to maximize attraction of new customers;
•our reliance on conversion of free trials, other inbound lead generation strategies, and third-party technology partners;
•the difficulty of continuing to offer high-quality product support and customer success initiatives;
•our ability to develop and maintain successful relationships with channel partners;
•our ability to maintain our brand;
Risks Related to Operating and Growing a Global Business
•our history of losses and our expectation that our revenue growth rate will decline over time;
•quarterly fluctuations in our financial results due to various factors and increasing variability in our sales cycles;
•scaling our sales capabilities and managing our organization to achieve acceptance of our solutions internationally;
•the ability to effectively acquire or invest in companies and to successfully integrate acquired businesses;
•retaining our key employees and attracting qualified personnel, particularly in the primary regions we operate;
•maintaining compliance with export and import controls given our global business;
•ability to secure additional financing on favorable terms to meet our future capital needs;
Risks Related to Cybersecurity, Reliability, and Data Privacy
•our ability to securely maintain customer data and to prevent and respond to historical and future data breaches;
•service interruptions, errors, failures, or bugs in our solutions, and improper implementation of our solutions;
•increased costs from complying with privacy and security regulation;
Risks Related to Intellectual Property Matters
•our exposure to contractual indemnification for intellectual property infringement and third-party claims;
•our use of open source software;
•a failure to protect our intellectual property rights;
Risks Related to Tax and Accounting Matters
•taxing authorities which may assert we owe sales, value added or similar taxes, either in the future or for past amounts;
•international operations which subject us to potential tax consequences and foreign exchange rate fluctuations;
•the potential for our goodwill or intangible assets to be impaired;
•limitations on our ability to use our net operating losses to offset future taxable income;
•our reliance on third-party SaaS technologies to operate our business;
Risks related to Macroeconomic Conditions
•the effect of COVID-19 on global markets, the demand for our solutions, and the demand for our customers' solutions;
•unfavorable conditions in the business software applications industry;
•the occurrence of future catastrophic events;
Risks Related to Ownership of our Common Stock and our Outstanding Convertible Notes
•volatility in our stock price separate from our operating performance and the absence of a dividend on our stock;
•high concentration of ownership among relatively few principal stockholders;
•changing laws and regulations and potential legal proceedings related to governance and public disclosure;
•anti-takeover provisions in our charter and limitation of forum to the Delaware Court of Chancery;
•dependency on favorable securities and industry analyst reports;
•pressures on cash flows resulting from servicing our outstanding debt;
•conversion features on our debt which may affect our operating results and value of our common stock;
•counterparty risk with respect to capped call transactions entered into in connection with our debt offerings; and
•accounting considerations related to interest, settlement, and expense recognition related to our outstanding debt.
Risks Related to Our Product and Platform Solutions
We derive, and expect to continue to derive, substantially all of our revenue and cash flows from Support. If we fail to adapt this product to changing market dynamics and customer preferences or to maintain or achieve increased market acceptance of Support, our business, results of operations, financial condition, and growth prospects would be harmed.
We derive, and expect to continue to derive, substantially all of our revenue and cash flows from sales of subscriptions to Support or from sales of subscriptions to our product solutions primarily resulting from an interest in Support. As such, the market acceptance of this product solution is critical to our success. Demand for our solutions is affected by a number of
factors, many of which are beyond our control, such as continued market acceptance of our solutions by customers for existing and new use cases, the timing of development and release of new product and platform solutions, features, and functionality introduced by our competitors, technological change, and growth or contraction in our addressable market. We expect that an increasing focus on the customer experience and the growth of various communications channels will continue to impact the market for our software and blur distinctions between traditionally separate systems for customer support, customer engagement and retention software, messaging, sales force automation, and other customer relationship management product and platform solutions, enabling new competitors to emerge. If we are unable to meet customer demands to improve relationships between organizations and their customers through flexible solutions designed to address all these needs or otherwise achieve more widespread market acceptance of our solutions, our business, results of operations, financial condition, and growth prospects will be adversely affected.
If we are not able to develop enhancements to our product and platform solutions or introduce new solutions and services that achieve market acceptance and that keep pace with technological developments, our business would be harmed.
Our ability to attract new customers and increase revenue from existing customers depends in large part on our ability to enhance and improve our existing solutions and to introduce new solutions. In order to grow our business, we must research and develop solutions and services that reflect the changing nature of the customer experience, and expand beyond customer service to other areas of improving relationships between organizations and their customers or potential customers. In order to retain our business, we must ensure that our existing solutions and services maintain the high level of reliability, security, and sophistication our customers will continue to expect. Those expectations will continue to evolve and the resources required to continue to maintain reliable and secure solutions and services will increase over time.
We have limited history in offering multiple product and platform solutions as part of a comprehensive customer experience solution to our customers. As we increase focus on the customer experience and increasingly seek to offer our solutions as part of a broader offering, we may discover challenges in creating a seamless, unified offering across our solutions that achieves market acceptance and grows our business. In each of the fiscal years ending 2020 and 2019, our research and development expenses were 25% of our revenue. If we do not spend our research and development budget efficiently or effectively on compelling innovation and technologies, our operating results may be harmed and we may not realize the expected benefits of our strategy.
The success of any enhancement to our solutions depends on several factors, including timely completion, adequate quality testing, service reliability, and market acceptance. Any new solution or service that we develop may not be introduced in a timely or cost-effective manner, may contain defects, or may not achieve the market acceptance necessary to generate sufficient revenue. If we are unable to successfully develop new solutions or services, enhance our existing solutions to meet customer requirements, or otherwise gain market acceptance, our business and operating results will be harmed. In particular, as we continue to manage operational costs and decrease our hiring levels relative to historical periods, our long-term plans for the development of our products and services may be negatively impacted.
We may not be able to integrate new product and platform solutions into our infrastructure, which could negatively impact our future sales and results of operations.
Our business depends in part on our ability to build or acquire product and platform solutions that both complement our existing solutions and respond to our customers’ needs. Our customers also expect that new solutions will integrate with existing solutions that we currently offer. This expectation will increase especially with the launch of the Zendesk Suite, which packages multiple solutions into one offering. Our ability to successfully integrate newly developed or acquired solutions into a shared services infrastructure is unproven. Because we have a limited history in integrating newly developed or acquired solutions and the market for such solutions is rapidly evolving, it is difficult for us to predict our operating results following the integration of such solutions. If we are not able to fully integrate new solutions into our infrastructure, our business could be harmed.
If we fail to integrate our product and platform solutions with a variety of operating systems, software applications, and hardware that are developed by others, our solutions may become less marketable, less competitive, or obsolete, and our operating results would be harmed.
Our solutions must integrate with a variety of network, hardware, e-mail, messaging, and software platforms, and we need to continuously modify and enhance our product and platform solutions to adapt to changes in cloud-enabled hardware, software, networking, browser, and database technologies. For example, we have developed our solutions to be able to easily integrate with third-party SaaS applications, including the applications of software providers that compete with us, through the interaction of application platform interfaces, or APIs. To date, we have not typically relied on a long-term written contract to govern our relationship with these providers. Instead, we are typically subject to the standard terms and conditions for
application developers of such providers, which govern the distribution, operation, and fees of such software systems, and which are subject to change by such providers from time to time. To the extent that we do not have long-term written contracts to govern our relationship with these providers, we rely on the fact that the providers of such software systems continue to allow us access to their APIs to enable these customer integrations. Our business may be harmed if any provider of such software systems:
•discontinues or limits our access to its APIs;
•modifies its terms of service or other policies, including fees charged to, or other restrictions on, us or other application developers;
•changes how customer information is accessed by us or our customers;
•establishes more favorable relationships with one or more of our competitors; or
•otherwise favors its own competitive offerings over ours.
We believe a significant component of our value proposition to customers is the ability to optimize and configure our solutions to communicate with these third-party SaaS applications through our respective APIs. If we are not permitted or able to integrate with these and other third-party SaaS applications in the future, demand for our solutions could be adversely impacted and business and operating results would be harmed. In addition, an increasing number of individuals within organizations are utilizing mobile devices to access the Internet and corporate resources and to conduct business. We have designed mobile applications to provide access to our solutions through these devices. If we cannot provide effective functionality through these mobile applications as required by organizations and individuals that widely use mobile devices, we may experience difficulty attracting and retaining customers. Failure of our solutions to operate effectively with future infrastructure platforms and technologies could also reduce the demand for our solutions, resulting in customer dissatisfaction and harm to our business. If we are unable to respond to changes in a cost-effective manner, our solutions may become less marketable, less competitive, or obsolete, and our operating results may be negatively impacted.
Risks Related to Our Industry
The market in which we participate is intensely competitive, and if we do not compete effectively, our operating results could be harmed.
Pricing pressures and increased competition generally could result in reduced sales, reduced margins, losses, or the failure of our solutions to achieve or maintain more widespread market acceptance, any of which could harm our business. The market for customer experience solutions is fragmented, rapidly evolving, and highly competitive, with relatively low barriers to entry. Our competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards, or customer requirements, and we expect competition to continue to intensify in the future. Among the small to midsized organizations that make up a large proportion of our customers, we often compete with general use computer applications and other tools, which these organizations use to provide support and which can be deployed for little or no cost. These include shared accounts for email communication, phone banks for voice communication and text messaging, shared accounts for social messaging, text editors, and spreadsheets for tracking and management. In addition, we compete with a number of other SaaS providers with focused applications competitive to one or more of our product and platform solutions that our potential customers may elect to use in lieu of our solutions, and such providers may be able to offer their products at a lower price due to the focused nature of their applications, such as Freshworks Inc. and Kustomer, Inc. As a result, small to midsized organizations are able to switch to one of our competitors relatively easily. Additionally, as the barriers to entry are low into this market, new entrants or current competitors may be able to change branding, marketing, or sales strategy more quickly and effectively than us, and/or develop products that mimic our new product releases and sell those products at a low price, resulting in a decreased ability for us to increase our marketing pipeline or sales. With respect to larger organizations seeking to deploy a customer service software system, we have many competitors that are larger than us and which have greater name recognition, much longer operating histories, more established customer relationships, larger marketing budgets, and significantly greater resources than we do. For larger organizations, we compete with customer software systems and large enterprise software vendors such as salesforce.com, Inc. and ServiceNow, Inc., each of which may have greater operational flexibility to bundle competing products and services with other software offerings, or offer them at a lower price than our current solutions, which will negatively affect our competitiveness for our solutions. Further, other established SaaS providers not currently focused on the functionality that our solutions provide may expand their services to compete with us as well. Large enterprise software vendors additionally have a greater ability to aggressively price their product at a level below their typical selling price in order to retain their existing customers and gain market share, both within the United States and in regions across the world, decreasing our ability to compete successfully with such vendors.
We face competition from in-house software systems, large integrated systems vendors, and smaller companies offering alternative SaaS applications. Many of our current and potential competitors have established marketing relationships, access to larger customer bases, pre-existing customer relationships, and major distribution agreements with consultants, system integrators, and resellers. Some existing and potential customers, particularly large organizations, have elected, and may in the future elect, to develop their own internal customer support software systems. Certain of our competitors have partnered with, or have acquired, and may in the future partner with or acquire, other competitors to offer services, leveraging their collective competitive positions, which makes, or would make, it more difficult for us to compete with them. In particular, as the platform offerings increase in prevalence, our competitors who focus on such offerings may, through organic growth or acquisition, be able to increasingly provide customizable platform solutions which would impact our ability to compete with them. As our offerings have additionally expanded to adjacent markets, such as integration of messaging into the customer experience platform, sales force automation and platform-based features and functionality, in which we may not have the operational history or familiarity, we may find it difficult to compete with established vendors in those markets. For all of these reasons, we may not be able to compete successfully against our current and future competitors or retain existing customers, which would harm our business.
If the market for SaaS business software applications develops more slowly than we expect or declines, our business would be adversely affected.
The market for SaaS business software applications is less mature than the market for on-premise business software applications, and the adoption rate of SaaS business software applications may be slower among subscribers in industries with heightened data security interests or business practices requiring highly customizable application software. Our success will depend to a substantial extent on the widespread adoption of SaaS business applications in general, and of SaaS customer service applications in particular. Many organizations have invested substantial personnel and financial resources to integrate traditional on-premise business software applications into their businesses, and therefore may be reluctant or unwilling to migrate to SaaS applications. The expansion of the SaaS business applications market depends on a number of factors, including the cost, performance, and perceived value associated with SaaS, as well as the ability of SaaS providers to address data security and privacy concerns. If SaaS business applications do not continue to achieve market acceptance, if there is a reduction in demand for SaaS business applications caused by a lack of customer acceptance, or if there are technological challenges, weakening economic conditions, data residency, data security or privacy concerns, governmental regulation, competing technologies and products, or decreases in information technology spending, it would result in decreased revenue and our business would be adversely affected.
We recognize revenue over the term of our customer contracts. Consequently, downturns or upturns in new sales may not be immediately reflected in our operating results and may be difficult to discern.
We generally recognize subscription revenue from customers ratably over the terms of their contracts and a majority of our revenue is derived from subscriptions that have terms longer than one month. As a result, a portion of the revenue we report in each quarter is derived from the recognition of deferred revenue relating to subscriptions entered into during previous quarters. Consequently, a decline in new or renewed subscriptions with terms that are longer than one month in any single quarter may have a small impact on our revenue results for that quarter. However, such a decline will negatively affect our revenue in future quarters. Accordingly, the effect of significant downturns in sales and market acceptance of our solutions, and potential changes in our pricing policies or rate of expansion or retention, may not be fully reflected in our results of operations until future periods. We may also be unable to reduce our cost structure in line with a significant deterioration in sales. In addition, because we believe a substantial percentage of subscriptions to our solutions are shorter than many comparable SaaS companies and because we have many variations of billing cycles, our deferred revenue may be a less meaningful indicator of our future financial results as compared to other SaaS companies. A significant majority of our costs are expensed as incurred, while revenue is recognized over the life of the agreement with the applicable customer. As a result, increased growth in the number of our customers could continue to result in our recognition of more costs than revenue in the earlier periods of the terms of our agreements. Our subscription model also makes it difficult for us to rapidly increase our revenue through additional sales in any period, as revenue from new customers must be recognized over the applicable subscription term.
Certain of our operating results and financial metrics may be difficult to predict as a result of seasonality.
We have experienced, and expect to continue to experience in the future, seasonality in our business, and our operating results and financial condition may be affected by such trends in the future. We generally experience seasonal fluctuations in demand for our solutions and services, and believe that our quarterly sales are affected by industry buying patterns. For example, we typically have customers who add flexible agents when they need more capacity during busy periods, especially in the fourth quarter, and then subsequently scale back in the first quarter of the following year. We believe that the seasonal trends that we have experienced in the past may continue for the foreseeable future, particularly as we expand our sales to larger
organizations. Additionally, since a large percentage of our subscriptions are monthly, customers are able to increase and decrease the number of authorized agents for whom they require a subscription quickly and easily, thereby potentially increasing the impact of seasonality on our revenue. Seasonality within our business may be reflected to a much lesser extent, and sometimes may not be immediately apparent, in our revenue, due to the fact that we recognize subscription revenue over the term of our agreement. To the extent we experience this seasonality, it may cause fluctuations in our operating results and financial metrics, and make forecasting our future operating results and financial metrics difficult. Additionally, we do not have sufficient experience in selling certain of our solutions to determine if demand for these services are or will be subject to material seasonality.
Risks Related to Customer Retention and Acquisition
Our business depends substantially on our customers renewing their subscriptions, expanding the use of their subscriptions, and purchasing subscriptions for additional product and platform solutions from us. Any decline in our customer retention or expansion, or any failure by us to sell subscriptions to additional solutions to existing customers, would harm our future operating results.
In order for us to maintain or improve our operating results, it is important that our customers renew their subscriptions when the initial contract term expires and add additional authorized agents or additional product and platform solutions to their customer accounts. Even though the majority of our revenue is derived from subscriptions to our solutions that have terms longer than one month, a significant portion of the subscriptions to our solutions have monthly terms. Our customers have no obligation to renew their subscriptions, and our customers may not renew subscriptions with a similar contract period or with the same or a greater number of agents. Some of our customers elect not to renew their agreements with us and it is difficult to accurately predict long-term customer retention. Because the revenue derived from our customers on contracts with monthly terms are often small and midsized organizations, and because small and midsized organizations can have liquidity and expense limitations more restrictive than large organizations, such revenue is particularly susceptible to changes in global demand arising from economic downturns. Additionally, as we expand our offerings to increasingly appeal to larger enterprises and such customers agree to longer contractual terms with subscriptions to additional solutions, if and when such larger enterprise customers decide not to renew their contractual arrangement, the negative impact on our results and operations will accordingly be increasingly larger. Further, a substantial proportion of our revenue derives from and our future success is substantially dependent on our ability to expand our existing customers’ use of our solutions by expanding the number of solutions to which such customers subscribe. This has required and will continue to require increasingly sophisticated and costly sales efforts, may not result in additional sales, and it may be difficult to predict the success of such efforts.
Further, we have seen the impact of COVID-19 vary significantly across different industries. Certain industries have seen increased demand for their products and services as the needs of the economy shift, while other industries have struggled to maintain demand for their products and services consistent with historical levels. Our ability to retain current customers or sell additional solutions to those customers has and will depend on our ability to understand the varying impacts of COVID-19 on each industry. Because we have a limited history in understanding these impacts, our ability to adapt our sales and marketing initiatives to such changes may be uncertain and our ability to forecast rates of customer retention and expansion will be negatively impacted.
Our customer retention, our ability to sell additional product and platform solutions to existing customers, and the rate at which our existing customers purchase subscriptions to additional solutions may be impacted by a number of factors, including our customers’ satisfaction with our solutions, our product support, our prices, the prices of competing software systems, the effects of global economic conditions, or reductions in our customers’ spending levels. In addition, the rate at which our existing customers purchase subscriptions to additional solutions depends on a number of factors, including the perceived need for additional solutions to build better relationships between organizations and their customers. If our customers do not renew their subscriptions, renew on less favorable terms, fail to add more agents, or fail to purchase subscriptions to additional solutions, our revenue may decline, and we may not realize improved operating results from our customer base.
We face a number of risks in targeting larger organizations for sales of our solutions and, if we do not manage these efforts effectively, our business and results of operations could be adversely affected.
As we target a portion of our sales efforts to larger organizations, we expect to incur high costs and long sales cycles, and we may be less effective at predicting when we will complete these sales. In this market segment, the decision to subscribe to one or more of our product and platform solutions may require the approval of a greater number of technical personnel and management levels within a potential customer’s organization than we have historically encountered, and if so, these types of sales would require us to invest more time educating these potential customers on the benefits of our solutions.
The success of the broader market acceptance of our product and platform solutions depends on offering solutions designed to give organizations of all sizes the ability to deliver powerful customer experiences with a focus on solutions that have the broadest market appeal across those organizations. Larger organizations may demand more features and integration services than small to midsized organizations. We may not be able to devote sufficient resources to developing those features and functionality in our solutions that are exclusively in demand by large organizations, which may negatively affect our potential sales to those organizations. Further, as we continue to focus on self-serve capabilities and simplicity in buying our solutions, many of those efforts may not be effective in selling and marketing to larger organizations as those organizations may require greater customer-specific investment, which may additionally impact our potential sales to those organizations. To the extent we do invest in customer-specific investment, such investment is and will continue to be a disproportionately large focus of internal resources on a small number of customers, negatively impacting our efficient use of those resources.
We have limited experience in developing and managing sales channels and distribution arrangements for larger organizations. We may experience difficulty hiring employees with qualifications appropriate for selling to larger organizations, which could adversely affect our ability to meet expected sales targets. Further, given their generally broader international presence, selling to larger organizations also may require us to divert resources to international regions in which we may not have sufficient personnel, affecting our results of operations. Sales opportunities to larger organizations may require us to devote greater research and development, sales, marketing events, product support, and professional services resources to individual customers, resulting in increased costs and reduced profitability, and would likely lengthen our typical sales cycle, which could strain our resources. Moreover, these transactions may require us to delay recognizing portions of the associated revenue we derive from these customers until any technical or implementation requirements have been met, and larger customers may demand discounts to the subscription prices they pay for our solutions. Furthermore, because we have limited experience selling to larger organizations, our investment in marketing our solutions to these potential customers may not be successful, which could harm our results of operations and our overall ability to grow our customer base. Following sales to larger organizations, we may not fully understand the opportunities to expand usage of our solutions or to sell additional functionality within such organizations, and we may not be able to effectively predict subscription terminations, any of which could harm our results of operations.
We employ a pricing model that subjects us to various challenges that could make it difficult for us to derive sufficient value from our customers particularly because we do not have the history with our subscription or pricing models that we need to accurately predict optimal pricing necessary to attract and retain customers.
We generally charge our customers for their use of our product and platform solutions based on the number of users they enable as 'agents' under their customer account, as well as the features and functionality enabled. The features and functionality we provide within our solutions enable our customers to promote customer self-service and otherwise efficiently and cost-effectively address product support requests without the need for substantial human interaction. As a result of these features, customer agent staffing requirements may be minimized and our revenue may be adversely impacted. Conversely, customers may overestimate their agent needs when they initially use our solutions, negatively affecting our ability to accurately forecast the number of agents our customers need in a period. Other than subscriptions related to the Zendesk Suite, the Sell Suite and Duet, we generally require a separate subscription to enable the functionality of each of our solutions. We are continuing to analyze and improve our pricing and packaging models as we adapt to a changing market, but we do not know whether our current or potential customers or the market in general will accept changes to those models and, if it fails to gain acceptance, our business and results of operations could be harmed. In particular, in February 2021, we released a new version of our omnichannel offering, the Zendesk Suite, which offers access to Support, Chat, Talk, Guide, Explore, Sunshine, and Messaging at new, unified purchase plans with various levels of pricing for different types of organizations. While we believe that simple purchase plans will enable greater adoption of the Zendesk Suite, certain organizations may not want to purchase all the included solutions in the Zendesk Suite, and other organizations may want more features offered in one solution without paying for the next purchase plan level, affecting our new business, retention, and sales for additional solutions. Those purchasing decisions will be difficult to predict due to our limited experience offering the new Zendesk Suite, and we may not fully understand the impact of our pricing changes in the market. If we fail to find an optimal pricing strategy for our latest offering, our business and results of operations may be harmed. If customers do not accept our new purchase plans, we may increasingly have difficulty in attract new customers as well as our ability to retain existing customers to the extent we apply new pricing models to existing customer agreements. Our current pricing model may be either too complex or too simple for organizations of different sizes. Pricing decisions may also impact the mix of adoption among our subscription plans and negatively impact our overall revenue. Moreover, larger organizations may demand substantial price concessions. As a result, in the future we may be required to reduce our prices or develop new pricing models, which could adversely affect our revenue, gross margin, profitability, financial position, and cash flow.
Finally, as the market for our solutions matures, or as new competitors introduce new solutions or services that compete with ours, we may be unable to attract new customers at the same price or based on the same pricing models as we have used historically.
Additionally, our terms of service generally prohibit the sharing of user logins and passwords. These restrictions may be improperly circumvented or otherwise bypassed by certain users and, if they are, we may not be able to capture the full value of the use of our solutions. We provide access and use of our solutions exclusively for our customers’ internal use. If customers improperly resell or otherwise make our solutions available to their customers, it may cannibalize our sales or commoditize our solutions in the market. Additionally, if a customer that has received a volume discount from us offers our solutions to its customers in violation of our terms of service, we may experience price erosion and be unable to capture sufficient value from the use of our solutions by those customers.
While our terms of service provide us the ability to enforce our terms, our customers may resist or refuse to allow us to audit their usage, in which case we may have to pursue legal recourse to enforce our rights. Any such enforcement action would require us to spend money, distract management, and potentially adversely affect our relationship with our customers.
We are highly dependent upon free trials of our solutions and other inbound lead generation strategies to drive our sales and revenue. If these strategies fail to continue to generate sales opportunities or do not convert into paying customers, our business and results of operations would be harmed.
We are highly dependent upon our marketing strategy of offering free trials of our solutions and other inbound lead generation strategies to generate sales opportunities. As we increasingly focus on our core strengths of simplicity, agility, and offering solutions that are easy to adopt, it will be additionally increasingly critical to maintain a simple trial experience that markets and leads to an easy adoption of our solutions. These strategies may not be successful in continuing to generate sufficient sales opportunities necessary to increase our revenue. Many early users never convert from the trial version of a solution to a paid version of such solution. We often depend on individuals within an organization who initiate the trial versions of our solutions being able to convince decision makers within their organization to convert to a paid version. Many of these organizations increasingly have complex and multi-layered purchasing requirements, especially the larger organization that we continue to target. Furthermore, in the case of our sales force automation software and features and functionality related to our platform offering, we ate increasingly pursuing decision makers that are not in the customer support organizations that we have traditionally targeted. Additionally, as we offer new, broader, pricing and packaging offerings for our solutions, we may not be able to understand how our prospective customers trial and use each individual solution, negatively affecting our ability to sell additional solutions effectively to those organizations. To the extent that these users do not become, or are unable to convince others to become, paying customers, we will not realize the intended benefits of this marketing strategy and our ability to grow our revenue will be adversely affected.
Our business and growth depend substantially on the success of our strategic relationships with third parties, including technology partners, channel partners, and professional services partners.
We depend on, and anticipate that we will continue to depend on, various third-party relationships in order to sustain and grow our business. We are highly dependent upon third-party technology partners for certain critical features and functionality of our platform. For example, the features available on Zendesk Talk are highly dependent on our technology integration with products offered by Twilio Inc., the features available on Zendesk Support are highly dependent on our technology integration with products offered by Alphabet Inc. Failure of this or any other technology provider to maintain, support, or secure its technology platforms in general, and our integrations in particular, or errors or defects in its technology, could materially and adversely impact our relationship with our customers, damage our reputation and brand, and harm our business and operating results. Any loss of the right to use any of this hardware or software could result in delays or difficulties in our ability to provide our solutions until equivalent technology is either developed by us or, if available, identified, obtained, and integrated.
For deployments of our solutions into complex technology environments and workflows, we are highly dependent on third-party implementation consultants to provide professional services to our customers. The failure of these third-party consultants to perform their services adequately may disrupt or damage the relationship between us and our customers, damage our brand, and harm our business.
Identifying, negotiating, and documenting relationships with strategic third parties such as technology partners and implementation providers requires significant time and resources. In addition, integrating third-party technology is complex, costly, and time-consuming. Our agreements with technology partners and implementation providers are typically limited in duration, non-exclusive, and do not prohibit them from working with our competitors or from offering competing services. Our competitors may be effective in providing incentives to third parties to favor their solutions or services or to prevent or reduce subscriptions to our solutions.
If we are unsuccessful in establishing or maintaining our relationships with these strategic third parties, our ability to compete in the marketplace or to grow our revenue could be impaired and our operating results would suffer. Even if we are successful, we cannot assure you that these relationships will result in improved operating results.
Any failure to offer high-quality product support or customer success initiatives may adversely affect our relationships with our customers and our financial results.
In deploying and using our product and platform solutions, our customers depend on our product support team, customer success organization, and our professional services organization to resolve complex technical and operational issues. We may be unable to respond quickly enough to accommodate short-term increases in customer demand for product support. We also may be unable to modify the nature, scope, and delivery of our product support to compete with changes in product support services provided by our competitors. Increased customer demand for product support, without corresponding revenue, could increase costs and adversely affect our operating results. Adoption of the Zendesk Suite and increasing usage by customers of multiple solutions may additionally increase demand on our product support team and customer success organizations. We may allocate resources to support such increased demand and, as a consequence, our support of any individual solution may suffer. Additionally, we may be unable to develop our customer success organization to continue to support the increasing level of complexity that our customers that are large organizations require while maintaining the same level of engagement across all customers. For example, adoption of features and functionality related to our platform offering may increase demand on our professional services organization as customers may increasingly demand platform-related features that may not currently exist.
Our sales are highly dependent on our business reputation and on positive recommendations from our existing customers. Any failure to maintain high-quality product support, or a market perception that we do not maintain high-quality product support, maintain a high complexity customer success organization, or maintain an adaptive and responsive professional services organization, could adversely affect our reputation, our ability to sell our solutions to existing and prospective customers, and our business, operating results, and financial position.
If we are unable to develop and maintain successful relationships with channel partners, our business, operating results, and financial condition could be adversely affected.
To date, we have been primarily dependent on our direct sales force to sell subscriptions to our product and platform solutions. Although we have developed certain channel partners, such as referral partners, resellers, and integration partners, these channels have resulted in limited revenue to date. We believe identifying, developing, and maintaining strategic relationships with additional channel partners are important to driving revenue growth for our company, and we will continue to dedicate resources to those efforts. Our agreements with our existing channel partners are non-exclusive, meaning our channel partners may offer customers the solutions of several different companies, including solutions that compete with ours. They may also cease marketing our solutions with limited or no notice and with little or no penalty. We expect that any additional channel partners we identify and develop will be similarly non-exclusive and not bound by any requirement to continue to market our solutions. If we fail to identify additional channel partners, in a timely and cost-effective manner, or at all, or are unable to assist our current and future channel partners in independently selling and deploying our solutions, our business, results of operations, and financial condition could be adversely affected. Additionally, customer retention and expansion attributable to customers acquired through our channel partners may differ significantly from customers acquired through our direct sales efforts. If our channel partners do not effectively market and sell our solutions, or fail to meet the needs of our customers, our reputation and ability to grow our business may also be adversely affected.
Sales by channel partners are more likely than direct sales to involve collectibility concerns. In particular, sales by our channel partners into developing markets, and accordingly, variations in the mix between revenue attributable to sales by channel partners and revenue attributable to direct sales, may result in fluctuations in our operating results.
If we are not able to maintain and enhance our brand, our business, operating results, and financial condition may be adversely affected.
We believe that maintaining and enhancing our reputation as a differentiated and category-defining company in customer experience solutions is critical to our relationships with our existing customers and to our ability to attract new customers. The successful promotion of our brand attributes will depend on a number of factors, including our marketing efforts, our ability to continue to develop high-quality software, and our ability to successfully differentiate our product and platform solutions from competitive solutions and services. Our ability to maintain our brand will depend on ensuring we communicate our core strengths in simplicity, agility of our solutions, and easy adoption of sophisticated solutions to our prospective customers, particularly as compared to our competitors offering products to small and midsized organizations and other competitors offering products to larger organizations. We are and have been highly dependent upon “consumer” tactics to build our brand and develop brand loyalty, but may need to increasingly spend significant energy to develop branding to retain and increase brand recognition with our customers who are larger organizations. In addition, independent industry analysts often provide reviews of our solutions, as well as products and services offered by our competitors, and perception of our solutions in the marketplace may be significantly influenced by these reviews. If these reviews are negative, or less positive as compared to those of our competitors’ products and services, our brand may be adversely affected. It may also be difficult to maintain and
enhance our brand, specifically following the launch of our updated corporate brand, in connection with sales through channel or strategic partners.
The promotion of our brand requires us to make substantial expenditures, and we anticipate that these expenditures will continue to increase, as our market becomes more competitive, as we expand into new markets, and as more sales are generated through our channel partners. To the extent that these activities yield increased revenue, this revenue may not offset the increased expenses we incur. If we do not successfully maintain and enhance our brand, our business may not grow, we may have reduced pricing power relative to competitors, and we could lose customers or fail to attract potential customers, all of which would adversely affect our business, results of operations, and financial condition.
Risks Related to Operating and Growing a Global Business
We have a history of losses and we expect our revenue growth rate to decline. As our costs increase, we may not be able to generate sufficient revenue to achieve and sustain our profitability.
We have incurred net losses in each year since our inception, including net losses of $70 million and $36 million for the three months ended December 31, 2020 and 2019, respectively, and net losses of $218 million and $170 million for the fiscal years ended December 31, 2020 and 2019, respectively. We had an accumulated deficit of $917 million as of December 31, 2020. For the three months ended December 31, 2020 and 2019, our revenue was $283 million and $230 million, respectively, representing a 23% growth rate. For the fiscal years ended December 31, 2020 and 2019, our revenue was $1,030 million and $816 million, respectively, representing a 26% growth rate. Our historical revenue growth has been inconsistent, and should not be considered indicative of our future performance. We expect that our revenue growth rate will decline over time. We may not be able to generate sufficient revenue to achieve and sustain profitability as we also expect our costs to increase in future periods. We expect to continue to expend substantial financial and other resources on:
•development of our existing product and platform solutions or acquisition of new product and platform solutions to appeal to as many types and sizes of organizations as possible, including investments in our research and development team and improvements to the scalability, availability, and security of our solutions;
•continued international investment in an effort to increase our customer base and sales;
•investments in programs to ensure retention of current customers and expansion of use cases for our products with those customers;
•enhancements to our network operations and infrastructure;
•sales and marketing;
•general administration, including legal, accounting, and other expenses related to being a public company.
These investments may not result in increased revenue or growth of our business. If we fail to continue to grow our revenue, our operating results and business would be harmed.
Our quarterly results may fluctuate significantly from period to period, and if we fail to meet the expectations of analysts or investors, our stock price and the value of an investment in our common stock could decline substantially.
Our quarterly financial results may fluctuate as a result of a variety of factors, many of which are outside of our control. If our quarterly financial results fall below the expectations of investors or any securities analysts who follow our stock, the price of our common stock could decline substantially. Some of the important factors that may cause our revenue, operating results, and cash flows to fluctuate from quarter to quarter include:
•the impact of the market volatility and economic downturn caused by COVID-19 or any other worldwide pandemic on our business, including but not limited to a decreased demand for our solutions and services, negative impacts on our revenue results, an increasing unpredictability in expenses and negative impacts to cash flow;
•our ability to attract new customers, retain and increase sales to existing customers, and satisfy our customers’ requirements;
•the amount and timing of operating costs and capital expenditures related to the operations and expansion of our business;
•the rate of expansion and productivity of our sales force;
•general economic conditions that may adversely affect either our customers’ ability or willingness to purchase additional subscriptions, delay a prospective customer’s purchasing decision, reduce the value of new subscription contracts, or affect customer retention;
•changes in our or our competitors’ pricing policies;
•security breaches, technical difficulties, or service interruptions to our solutions;
•our ability to meet the increasing expectations on product functionality of larger organizations while continuing to maintain an easily accessible solution for organizations of all sizes;
•changes in our billing and invoicing policies and customer reception of those changes;
•our investments in and our ability to successfully sell newly developed or acquired products, features, or functionality;
•increasing efforts by our customers to develop native applications as a substitute for our own;
•the timing of customer payments and payment defaults by customers;
•the timing of the grant, price of our common stock, or vesting of equity awards to employees;
•changes in the relative and absolute levels of professional services we provide;
•expenses such as litigation or other dispute-related settlement payments;
•changes in foreign currency exchange rates and our customers' willingness to accept the risk of those changes; and
•the impact of new accounting pronouncements.
Many of these factors are outside of our control, and the occurrence of one or more of them might cause our revenue, operating results, cash flows, gross margin, operating margin, profitability, unearned revenue, and remaining revenue performance obligations, to vary widely. As such, we believe that quarter-to-quarter comparisons of our revenue, operating results, and cash flows may not be meaningful and should not be relied upon as an indication of future performance.
Failure to effectively maintain and scale our sales capabilities could harm our ability to increase our customer base and achieve broader market acceptance of our product and platform solutions.
Increasing our customer base and achieving broader market acceptance of our product and platform solutions will depend, to a significant extent, on our ability to effectively maintain and scale our sales and marketing operations and activities. We are substantially dependent on our direct sales force to obtain certain of our new customers, including larger organizations. We plan to continue to invest in our direct sales force both domestically and internationally to increase the effectiveness of our sales motions and increase our sales capacity. During the year ended December 31, 2020, our sales and marketing organization increased by approximately 360 employees to approximately 1,640 employees. There is significant competition for experienced sales and marketing professionals with the skills and technical knowledge that we require, both domestically and internationally. Our ability to achieve significant revenue growth in the future will depend, in part, on our success in recruiting, training, and retaining a sufficient number of experienced sales and marketing professionals. New hires require significant training and time before they achieve full productivity, particularly in new sales segments and territories. In territories outside the United States, attraction, recruiting and retention of our sales personnel may become increasingly difficult and costly, affecting our ability to compete in such jurisdictions. Further, as organizations worldwide adjust to continuing precautions and safety measures related to decreasing the health risks of COVID-19, our ability to connect in person with our customers and potential customers may be and has been negatively impacted, resulting in delayed sales cycles.
We cannot predict whether, or to what extent, our sales will increase as we continue to invest in our sales and marketing functions or how long it will take for new personnel to become productive, continue to focus on our core strengths, and achieve broader market acceptance. Our business will be harmed if our sales and marketing efforts do not generate a significant increase in revenue.
If we fail to effectively manage our growth and organizational change in a manner that preserves the key aspects of our culture, our business and operating results could be harmed.
We have experienced and may continue to experience rapid growth and organizational change, which has placed, and may continue to place, significant demands on our management, operational, and financial resources. For example, our headcount has grown from approximately 3,570 employees as of December 31, 2019 to approximately 4,130 employees as of December 31, 2020. In addition, we have established subsidiaries in Denmark, the United Kingdom, Australia, Ireland, Japan, the Philippines, Brazil, Germany, India, Mexico, and South Korea since our inception in 2007, and, as a result of acquisitions, we also have subsidiaries in Singapore, France, Poland, and Canada. We may continue to invest in our international operations into other countries in the future. We have also experienced significant growth in the number of customers, end users, transactions, and data that our solutions support. Our organizational structure is becoming more complex and we may need to scale and adapt our operational, financial, and management controls, as well as our reporting systems and procedures, to manage this complexity. Further, as our employees work from geographic areas across the globe, we will require investment of resources and close monitoring of local regulations and requirements that continually change due to events that may have a global impact, such as the shift to remote work arising from the COVID-19 pandemic, and we may experience unpredictability in our expenses and employee work culture. We will require significant capital expenditures and the allocation of valuable management resources to grow and change in these areas without undermining our corporate culture of rapid innovation, simplicity in design, and attention to customer experience that has been critical to our growth so far. If we fail to manage our anticipated growth and change in a manner that preserves the key aspects of our culture, the retention and productivity of our
employees may be impacted, and the quality of our solutions and services may suffer, which could negatively affect our brand and reputation and harm our ability to retain and attract customers.
We may acquire or invest in companies, which may divert our management’s attention and result in additional dilution to our stockholders. We may be unable to integrate acquired businesses and technologies successfully or achieve the expected benefits of such acquisitions.
We may evaluate and consider potential strategic transactions, including acquisitions of, or investments in, businesses, technologies, services, product and platform solutions, and other assets in the future. We also may enter into relationships with other businesses to expand our solutions and services, which could involve preferred or exclusive licenses, additional channels of distribution, discount pricing, or investments in other companies.
Any acquisition, investment, or business relationship may result in unforeseen operating difficulties and expenditures. In particular, we may encounter difficulties assimilating or integrating the business strategy, sales plans, technologies, products, personnel, or operations of the acquired companies, particularly if the key personnel of the acquired company choose not to work for us, their software is not easily adapted to work with our solutions, or we have difficulty retaining the customers of any acquired business due to changes in ownership, management, customers' experience with the acquired company prior to acquisition, or otherwise. Acquisitions may also disrupt our business, divert our resources, and require significant management attention that would otherwise be available for development of our existing business. Moreover, the anticipated benefits of any acquisition, investment, or business relationship may not be realized or we may be exposed to unknown risks or liabilities.
Negotiating these transactions can be time-consuming, difficult, and expensive, and our ability to complete these transactions may often be subject to approvals that are beyond our control. Consequently, these transactions, even if announced, may not be completed. For one or more of these transactions, we may:
•issue additional equity securities that would dilute our existing stockholders;
•use cash that we may need in the future to operate our business;
•encounter difficulties retaining key employees of the acquired company or integrating diverse software codes or business cultures;
•incur large charges or substantial liabilities;
•incur debt on terms unfavorable to us or that we are unable to repay;
•divert our resources to understand and comply with new jurisdictions if such acquired company is in a new country; and/or
•become subject to adverse tax consequences, substantial depreciation, or deferred compensation charges.
Our financial results may fluctuate due to increasing variability in our sales cycles.
We plan our expenses based on certain assumptions about the length and variability of our sales cycle. These assumptions are based upon historical trends for sales cycles and conversion rates associated with our existing customers, many of whom to date have been small to midsized organizations that make purchasing decisions with limited interaction with our sales or other personnel. As we continue to sell to larger organizations, we expect our sales cycles to those organizations to lengthen and become less predictable. This may adversely affect our financial results. Factors that may influence the length and variability of our sales cycle include the competitive nature of evaluation and purchasing processes, the need to educate prospective customers about the uses and benefits of our product and platform solutions, the discretionary nature of purchasing and budget cycles and decisions, announcements or planned introductions of new solutions, features, or functionality by us or our competitors, and lengthy purchasing approval processes.
If we are unable to close one or more expected significant transactions with these customers in a particular period, or if an expected transaction is delayed until a subsequent period, our operating results for that period, and for any future periods in which revenue from such transaction would otherwise have been recognized, may be adversely affected.
Additionally, the COVID-19 pandemic has, and may continue to, put pressure on global economic conditions and overall spending for customer experience solutions, and may cause our customers or their customers to modify spending priorities or delay or abandon purchasing decisions, thereby lengthening sales cycles, and may make it difficult for us to forecast our sales and operating results. Further, as the pandemic continues, organizations that previously delayed their purchasing decision may later purchase our solutions on a timeline not consistent with historical patterns, negatively impacting our ability to accurately forecast such decisions and sales results.
Our international sales and operations subject us to additional risks that can adversely affect our business, operating results, and financial condition.
In each of the fiscal years ended December 31, 2020 and 2019, we derived 48% of our revenue from customers located outside of the United States. We are continuing to invest in our international operations as part of our growth strategy. We currently have sales personnel and sales and product support operations in certain countries across North America, Europe, Australia, Asia, and South America. To date a very limited portion of our sales has been driven by resellers or other channel partners. We believe our ability to convince new customers to subscribe to our solutions or to convince existing customers to renew or expand their use of our solutions is directly correlated to the level of engagement we obtain with the customer. To the extent we are unable to effectively engage with non-U.S. customers due to our limited sales force capacity and limited channel partners, we may be unable to effectively grow in international markets.
Our international operations subject us to a variety of additional risks and challenges, including:
•economic conditions in each country or region and general economic uncertainty around the world;
•the need for sales representatives to be recruited, hired, and retained locally in increasing numbers of countries abroad;
•communication and integration problems related to entering new markets with different languages, cultures, and political systems, particularly in regions with a high level of such differences between each country;
•increased management, travel, visa compliance, infrastructure, and legal compliance costs associated with having multiple international operations;
•longer payment cycles and difficulties in enforcing contracts, collecting accounts receivable, or satisfying revenue recognition criteria, especially in emerging markets;
•increased financial accounting and reporting burdens and complexities;
•differing technical standards, existing or future regulatory and certification requirements and required features and functionality;
•compliance with foreign privacy and security laws and regulations and the risks and costs of non-compliance;
•burdens of complying with a variety of foreign laws, including laws related to content removal, data localization, and regulatory oversight;
•compliance with laws and regulations for foreign operations, including anti-bribery laws (such as the U.S. Foreign Corrupt Practices Act of 1977, as amended, the U.S. Travel Act, and the U.K. Bribery Act 2010), import and export controls laws, tariffs, trade barriers, economic sanctions, and other regulatory or contractual limitations on our ability to sell our solutions in certain foreign markets, and the risks and costs of non-compliance;
•heightened risks of unfair or corrupt business practices in certain geographies and of improper or fraudulent sales arrangements that may impact our financial results and result in restatements of our consolidated financial statements;
•fluctuations in foreign currency exchange rates and the related effect on our operating results, particularly as our customers increasingly demand less exposure to such fluctuations;
•difficulties in repatriating or transferring funds from or converting currencies in certain countries;
•difficulties in adapting to global supply chain changes and delivery of equipment to employees in different jurisdictions;
•requirements or preferences for domestic products;
•differing labor standards, including restrictions related to, and the increased cost of, terminating employees in some countries;
•the need for localized software and licensing programs, including the need for localized language support;
•reduced protection for intellectual property rights in some countries and practical difficulties of enforcing rights abroad;
•compliance with the laws of numerous foreign tax jurisdictions, including withholding obligations, and overlapping of different tax regimes; and
•the impact of natural disasters, diseases and pandemics, such as COVID-19, and travel restrictions and other measures undertaken by governments in response to such issues.
Any of these risks could adversely affect our international operations, reduce our international revenue, or increase our operating costs, adversely affecting our business, operating results, financial condition, and growth prospects.
Compliance with laws and regulations applicable to our international operations substantially increases our cost of doing business in foreign jurisdictions. We may be unable to keep current with new or revised government requirements as they change from time to time. Failure to comply with these regulations could have adverse effects on our business. Additionally, in many foreign countries it is common for others to engage in business practices that are prohibited by our internal policies and procedures or U.S. or other regulations applicable to us. Although we have implemented certain policies and procedures designed to ensure compliance with these laws and policies, there can be no assurance that all of our employees, contractors, partners, and agents will comply with these laws and policies. Violations of laws or key control policies by our employees, contractors, partners, or agents could result in delays in revenue recognition, financial reporting misstatements, enforcement actions, disgorgement of profits, fines, civil and criminal penalties, damages, injunctions, other collateral consequences, or the prohibition of the importation or exportation of our solutions and services, and could adversely affect our business and results of operations.
We depend on our executive officers and other key employees and the loss of one or more of these employees or an inability to attract and retain highly skilled employees could adversely affect our business.
Our success depends largely upon the continued services of our executive officers and other key employees. We rely on our leadership team and on individual contributors in the areas of research and development, operations, security, sales, marketing, support, and general and administrative functions. From time to time, there may be changes in our executive management team resulting from the hiring or departure of executives, which could disrupt our business.
We do not have employment agreements with our executive officers or other key personnel that require them to continue to work for us for any specified period of time and, therefore, they could terminate their employment with us at any time. The loss of one or more of our executive officers, especially our Chief Executive Officer, or other key employees globally could have an adverse effect on our business.
In addition, to execute on our growth plan, we must attract and retain highly qualified personnel. Competition for these personnel in the San Francisco Bay Area, where our headquarters is located, and in other locations where we maintain offices, especially in Dublin, Ireland and Singapore is intense, especially for engineers experienced in designing and developing software and SaaS applications and experienced sales professionals. We have, from time to time, experienced, and we expect to continue to experience, difficulty in hiring and retaining employees with appropriate qualifications. For example, certain domestic immigration laws restrict or limit our ability to recruit internationally. Any changes to U.S. immigration policies that restrain the flow of technical and professional talent may inhibit our ability to recruit and retain highly qualified employees. Additionally, many of the companies with which we compete for experienced personnel have greater resources than we have. If we hire employees from competitors or other companies, their former employers may attempt to assert that these employees or we have breached their legal obligations, resulting in a diversion of our time and resources. In addition, job candidates and existing employees often consider the value of the equity awards they receive in connection with their employment. If the perceived or actual value of our equity awards declines, it may adversely affect our ability to recruit and retain highly skilled employees. If we fail to attract new personnel or fail to retain and motivate our current personnel, our business and future growth prospects could be adversely affected.
We are subject to governmental sanctions restrictions and export and import controls that could impair our ability to compete in international markets or subject us to liability if we violate the controls.
We incorporate encryption technology into our solutions that is enabled through mobile applications and other software we may be deemed to export, and therefore we may be subject to U.S. export controls and economic sanctions regulations. These encryption solutions and the underlying technology may be exported outside of the U.S. only with the required export authorizations, including by license, a license exception, or other appropriate government authorizations. We previously deployed mobile applications prior to obtaining the required export authorizations. Accordingly, we have not fully complied with applicable encryption controls in U.S. export administration regulations.
Furthermore, U.S. export controls laws and economic sanctions prohibit the shipment or provision of certain products and services to countries, governments, territories, and persons targeted by U.S. sanctions. While we are currently taking precautions to prevent our solutions from being enabled by persons targeted by U.S. sanctions, including IP blocking and periodic customer screening against U.S. government lists of prohibited persons, such measures may be circumvented. Given the technical limitations in developing measures that will prevent access to internet-based services from particular geographies or by particular individuals, we have previously identified and expect we will continue to identify customer accounts for our solutions that we suspect originate from countries or parties which are subject to U.S. sanctions restrictions.
We are aware that trials of and subscriptions to our solutions have been initiated by persons and organizations in countries that are the subject of U.S. embargoes, or to persons and organizations supporting customers in countries that are subject of U.S. embargoes, or to parties which are subject to targeted export and sanctions restrictions. Our provision of
services in these instances was likely in violation of U.S. export controls and sanctions laws. We have terminated the accounts of such organizations as we have become aware of them, implemented certain measures designed to prevent future unauthorized access by such persons and organizations, and filed voluntary self-disclosures with the U.S. Department of Commerce’s Bureau of Industry and Security, or BIS, and the U.S. Department of Treasury’s Office of Foreign Assets Control, or OFAC, concerning prior potential violations. With respect to these resolved matters, each of BIS and OFAC completed its investigations, and no monetary penalties or other sanctions were imposed. With respect to future matters, there is the potential for the government to impose fines or sanctions.
If we are found to be in violation of U.S. sanctions or export controls laws, it could result in fines or penalties for us and for individuals, including civil penalties of approximately $300,000 or twice the value of the transaction, whichever is greater, per violation, and in the event of conviction for a criminal violation, fines of up to $1 million and possible incarceration for responsible employees and managers for willful and knowing violations.
If our channel partners fail to obtain appropriate import, export, or re-export licenses or permits, we may also be adversely affected, through reputational harm as well as other negative consequences, including government investigations and penalties. We presently incorporate sanctions compliance requirements in our channel partner agreements for our solutions. Complying with export controls and sanctions regulations for a particular sale may be time-consuming and may result in the delay or loss of sales opportunities. Failure to comply with export controls and sanctions regulations for a particular sale may expose us to government investigations and penalties, which could have an adverse effect on our business, operating results, and financial condition.
In addition, various countries regulate the import of certain encryption technology, including import permitting and licensing requirements, and have enacted laws that could limit our ability to offer or distribute our solutions or could limit our customers’ ability to implement our solutions in those countries. Changes in our solutions or future changes in export and import regulations may create delays in the introduction of our solutions in international markets or prevent our customers with international operations from deploying our solutions globally. Any change in export or import regulations, economic sanctions, or related legislation, or change in the countries, governments, persons, or technologies targeted by such regulations, could result in decreased use of our solutions by, or in our decreased ability to export or sell our solutions to, existing or potential customers with international operations. Any decreased use of our solutions or limitation on our ability to export or sell our solutions would likely adversely affect our business operations and financial results.
We may not be able to secure additional financing on favorable terms, or at all, to meet our future capital needs.
We have funded our operations since inception primarily through customer payments for subscription services, the issuance of our convertible senior notes, and public and private equity financings. In the future, we may require additional capital to respond to business opportunities, challenges, acquisitions, a decline in the level of subscriptions for our solutions, or unforeseen circumstances. We may not be able to timely secure additional debt or equity financing on favorable terms, or at all. Any additional debt financing obtained by us could involve restrictive covenants relating to financial and operational matters, which may make it more difficult for us to obtain additional capital and to pursue business opportunities, including potential acquisitions. Additionally, we may not be able to generate sufficient cash to service any debt financing obtained by us, which may force us to reduce or delay capital expenditures or sell assets or operations. If we raise additional funds through further issuances of equity, convertible debt securities, or other securities convertible into equity, our existing stockholders could suffer significant dilution in their percentage ownership of our company, and any new equity securities we issue could have rights, preferences, and privileges senior to those of holders of our common stock. If we are unable to obtain adequate financing or financing on terms satisfactory to us, when we require it, our ability to continue to grow or support our business and to respond to business challenges could be significantly limited.
Risks Related to Cybersecurity, Reliability, and Data Privacy
Our network and computer systems have been breached in the past, and in one case that we publicly disclosed, a malicious actor appears to have had unauthorized access to customer data. In light of this incident, and in the event that we are subject to any future breaches or we learn that the extent of this breach is more significant than is currently known, our solutions may be perceived as insecure, we may lose existing customers or fail to attract new customers, and we may incur significant liabilities.
Growth in sales of our services and solutions and customer retention are increasingly dependent on the trust of existing customers in and the perception by potential customers of the secure and reliable use of our solutions. As we develop our product and platform solutions to reflect our core strengths of simplicity, agility, and transparency in the customer experience for organizations of all sizes, we will continue to focus on developing a product and information security program that minimizes vulnerabilities and protects our customers’ data. If we fail to meet our customers’ expectations in maintaining that trust, our customer retention will decrease, our perception in the market will be harmed, and our results of operations will be negatively affected.
Use of our product and platform solutions involves the storage, transmission, and processing of our customers’ proprietary data, including personal information regarding their customers or employees. Unauthorized access to such information or security breaches of our solutions could result in the loss of data, loss of intellectual property or trade secrets, loss of business, severe reputational damage adversely affecting customer or investor confidence, regulatory investigations and orders, litigation, or indemnity obligations. Furthermore, if our network or computer systems are breached or unauthorized access to customer data is otherwise obtained, we may be held responsible for damages for contract breach, penalties for violation of applicable laws, regulations, or contractual obligations, and could incur significant costs for remediation that may include liability for stolen assets or information and repair of system damage that may have been caused, incentives offered to customers or other business partners in an effort to maintain business relationships after a breach, and other liabilities. Notifications related to a security breach regarding or pertaining to any of such service providers have and could impact our reputation, harm customer confidence, hurt our sales and expansion into new markets, or cause us to lose existing customers. We have incurred, and expect to continue to incur, significant expenses to prevent, investigate, and remediate security breaches and vulnerabilities, including deploying additional personnel and protection technologies, hiring and training employees, and engaging third-party experts and consultants. Our errors and omissions insurance coverage covering certain security and privacy damages and claim expenses may not be sufficient to compensate for all liability related to or arising out of any security incidents.
We have previously experienced significant data breaches and security incidents. We have also previously identified major vulnerabilities of our security measures and the security measures deployed by third-party vendors upon which we rely, and our solutions are at risk for future breaches as a result of third-party action, employee, vendor, or contractor error, malfeasance, or other factors. In the quarter ended September 30, 2019, we discovered a security matter that may have affected the Zendesk Support and Chat product solutions and customer accounts of those solutions activated prior to November of 2016. On September 24, 2019, we determined that information belonging to a small percentage of customers was accessed prior to November of 2016. The information accessed appears to have included some personal information and other service data, including customer credentials. We may learn additional information in the future regarding this incident. In light of this incident, and in the event that we are subject to any future breaches or we learn that the extent of this prior incident is more significant than is currently known, our solutions may be perceived as insecure, we may lose existing customers or fail to attract new customers, and we may incur significant liabilities.
In addition, new solutions and services, including newly acquired solutions and services, may rely on systems, networks, personnel, equipment, and vendors that may initially be different from those utilized in connection with our existing solutions and may not have been subject to the same security reviews and assessments as those used to provide our existing solutions. Any failure to complete these security reviews and assessments and to implement improvements to the security measures deployed to protect our new solutions in a timely manner could increase our risk of a security breach with respect to these solutions, which would harm our reputation and our business as a whole.
Because the techniques used and vulnerabilities exploited to obtain unauthorized access to or to sabotage systems change frequently and generally are not identified until they are launched against a target, we may be unable to anticipate these techniques or vulnerabilities or to implement adequate preventative measures. The number and complexity of security incidents continue to increase over time, and may include phishing attacks, ransomware, dissemination of computer viruses, worms and other destructive or disruptive software, denial of service attacks, attacks by foreign state actors, and other malicious activity, which may be heretofore unknown. We may also experience security breaches that may remain undetected for an extended period.
Because data security is a critical competitive factor in our industry, we make numerous statements in our privacy policies, terms of service, and data processing agreements, through our certifications to privacy standards, and in our marketing materials, providing assurances about the security of our solutions, including detailed descriptions of security measures we employ. Should any of these statements be untrue or become untrue, even due to circumstances beyond our reasonable control, we may face claims of misrepresentation or deceptiveness by the U.S. Federal Trade Commission, state and foreign regulators, and private litigants.
Interruptions or performance problems associated with our technology and infrastructure may adversely affect our business and operating results.
Our continued growth depends in part on the ability of our existing and potential customers to access our solutions at any time and within an acceptable amount of time. Our solutions are proprietary, and we rely on the expertise of members of our engineering, operations, and software development teams for their continued performance. We have experienced, and may in the future experience, disruptions, outages, and other performance problems due to a variety of factors, including infrastructure changes, introductions of new functionality, human or software errors, capacity constraints due to an overwhelming number of users simultaneously accessing our solutions, distributed denial of service attacks, or other security related incidents, which may affect and have affected our perception of reliability with customers. In some instances, we may not be able to identify the cause or causes of these performance problems within an acceptable period of time. It may become increasingly difficult to maintain and improve our performance, especially during peak usage times and as our solutions become more complex and our user traffic increases. If any of our solutions are unavailable or if our users are unable to access our solutions within a reasonable amount of time or at all, our business would be negatively affected. In addition, a significant portion of our infrastructure does not implement multi-region data replication. Therefore, in the event of any of the factors described above, or certain other failures of our infrastructure, customer data may and have been permanently lost. Moreover, some of our customer agreements and certain subscription plans include performance guarantees and service level standards that obligate us to provide credits or termination rights in the event of a significant disruption in our services. To the extent that we do not effectively address capacity constraints, upgrade our systems as needed, and continually develop our technology and network architecture to accommodate actual and anticipated changes in technology, our business and operating results may be adversely affected.
We rely substantially on third-party managed hosting services to support our operations and disruption or interference in such service may negatively impact our business.
Given that we are significantly reliant on third-party managed hosting services, any significant disruption of or interference in our use of such services will negatively impact our operations and customer satisfaction. Third-party managed hosting services may additionally take actions beyond our control that could seriously harm our business, including discontinuing or limiting our access to the service, increasing price terms, including establishing more favorable relationships or pricing terms with one or more of our competitors, maintaining control over the pricing models of those hosting services for when customers experience unique spikes in demand and usage, terminating or seeking to terminate the contractual relationship altogether, or modifying or interpreting its terms of service or other policies in a manner that impacts our ability to run our businesses and operations.
We have made and will continue to make substantial expenditures for third-party managed hosting services to support our growth and provide enhanced levels of service to our customers. If costs associated with third-party managed hosting services utilized to support our growth are greater than expected, the negative impact on our operating results would likely exceed our initial expectations.
Real or perceived errors, failures, or bugs in our solutions could adversely affect our operating results and growth prospects.
Because our solutions are complex, undetected errors, failures, vulnerabilities, or bugs may occur, especially when updates are deployed. Our solutions are often used in connection with large-scale computing environments with different operating systems, system management software, equipment, and networking configurations, which may cause errors or failures of our solutions or other aspects of the computing environment into which they are deployed. In addition, deployment of our solutions into complicated, large-scale computing environments may expose undetected errors, failures, vulnerabilities, or bugs in our solutions. We have discovered, and expect to continue to discover, software errors, failures, vulnerabilities, and bugs in our solutions, some of which have or may only be discovered and remediated after deployment to customers. Real or perceived errors, failures, vulnerabilities, or bugs in our solutions could result in negative publicity, loss of or delay in market acceptance of our solutions, loss of competitive position, or claims by customers for losses sustained by them. In such an event, we may be required, or may choose, for customer relations or other reasons, to expend additional resources in order to help correct the problem.
Incorrect or improper implementation or use of our product and platform solutions could result in customer dissatisfaction and negatively affect our business, results of operations, financial condition, and growth prospects.
Our product and platform solutions are deployed in a wide variety of technology environments and into a broad range of complex workflows. Increasingly, our solutions have been, and will continue to be, integrated into large-scale, complex technology environments and specialized use cases, and we believe our future success will depend on our ability to increase use of our solutions in such deployments. We often assist our customers in implementing our solutions, but many customers attempt to implement deployments, including complex deployments, themselves. If we or our customers are unable to implement our solutions successfully, or are unable to do so in a timely manner, customer perceptions of our solutions and of our company
may be impaired, our reputation and brand may suffer, and customers may choose not to renew or expand the use of our solutions.
Our customers and third-party partners may need training in the proper use of our solutions to maximize their potential. If our solutions are not implemented or used correctly or as intended, inadequate performance may result. Because our customers rely on our solutions to manage a wide range of operations and to drive a number of their internal processes, the incorrect or improper implementation or use of our solutions, our failure to train customers on how to efficiently and effectively use our solutions, or our failure to provide adequate product support to our customers, may result in negative publicity or legal claims against us. Also, as we continue to expand our customer base, any failure by us to properly provide these services will likely result in lost opportunities for additional subscriptions to our solutions.
Because our solutions can be used to collect and store personal information, domestic and international privacy and data security concerns could result in additional costs and liabilities to us or inhibit sales of our solutions.
Personal privacy and data security have become significant issues in the United States, Europe, and in many other jurisdictions where we offer our solutions. The regulatory framework for privacy and security issues worldwide is rapidly evolving and is likely to remain uncertain for the foreseeable future. Many federal, state, and foreign government bodies and agencies have adopted, or are considering adopting, laws and regulations regarding the collection, use, and disclosure of personal information. In the United States, these include rules and regulations promulgated under the authority of federal agencies and state attorneys general and consumer protection agencies. Certain state laws may be more stringent or broader in scope, or offer greater individual rights, with respect to sensitive and personal information than federal or other state laws, and such laws may differ from each other, which may complicate compliance efforts. For example, California enacted the CCPA, which went into effect in January 2020 and became enforceable by the California Attorney General in July 2020, and which, among other things, requires companies covered by the legislation to provide new disclosures to California consumers and afford such consumers new rights with respect to their personal information, including the right to request deletion of their personal information, the right to receive the personal information on record for them, the right to know what categories of personal information generally are maintained about them, as well as the right to opt-out of certain sales of personal information. The CCPA provides for civil penalties for violations, as well as a private right of action for certain data breaches that result in the loss of personal information. This private right of action may increase the likelihood of, and risks associated with, data breach litigation.
Additionally, a new California ballot initiative, the California Privacy Rights Act, or “CPRA,” was passed in November 2020. Effective starting on January 1, 2023, the CPRA imposes additional obligations on companies covered by the legislation and will significantly modify the CCPA, including by expanding consumers’ rights with respect to certain sensitive personal information. The CPRA also creates a new state agency that will be vested with authority to implement and enforce the CCPA and the CPRA. The effects of the CCPA and the CPRA are potentially significant and may require us to modify our data collection or processing practices and policies and to incur substantial costs and expenses in an effort to comply and increase our potential exposure to regulatory enforcement and/or litigation.
Certain other state laws impose similar privacy obligations and we also expect anticipate that more states to may enact legislation similar to the CCPA, which provides consumers with new privacy rights and increases the privacy and security obligations of entities handling certain personal information of such consumers. The CCPA has prompted a number of proposals for new federal and state-level privacy legislation. Such proposed legislation, if enacted, may add additional complexity, variation in requirements, restrictions and potential legal risk, require additional investment of resources in compliance programs, impact strategies and the availability of previously useful data and could result in increased compliance costs and/or changes in business practices and policies.
Internationally, virtually every jurisdiction in which we operate has established its own data security and privacy legal framework with which we or our customers must comply. On May 25, 2018, the European General Data Protection Regulation, or the GDPR, became effective, which imposes additional obligations and risks upon our business. Compliance with GDPR has and will continue to require valuable management and employee time and resources, and failure to comply with GDPR could trigger severe penalties, including steep fines of up to €20 million or 4% of global annual revenue, whichever is higher, and could reduce demand for our solutions. In many European jurisdictions enforcement actions and consequences for non-compliance are also rising.
On July 16, 2020, the Court of Justice of the European Union invalidated the EU-U.S. Privacy Shield on the grounds that the Privacy Shield failed to offer adequate protections to EU personal data transferred to the U.S. While our Binding Corporate Rules and our Standard Contractual Clauses provide an alternative to our Privacy Shield certification for EU-U.S. data flows, the decision (and certain regulatory guidance issued in its wake) casts doubt on the legality of EU-U.S. data flows in general. Any inability to transfer personal data from the EU to the U.S. in compliance with data protection laws may impede our ability to attract and retain customers and adversely affect our business and financial position.
Jurisdictions outside of Europe are also considering and/or enacting comprehensive data protection legislation. For example, as of August 2020, the Brazilian General Data Protection Law imposes requirements similar to GDPR on products and services offered to users in Brazil. The GDPR and other laws or regulations associated with the enhanced protection of certain types of personal data, could greatly increase our cost of providing our products and services, require significant changes to our operations or even prevent us from offering certain services in jurisdictions in which we operate. Failure to comply with data protection regulations may result in data protection authorities and other privacy regimes imposing additional obligations to obtain consent from data subjects by or on behalf of our customers. Additionally, the inability to guarantee compliance or otherwise provide acceptable privacy assurances may inhibit the sale and use of our software in the European Union and certain other markets, which could, were it to occur, harm our business and operating results.
In addition to government regulation, privacy advocates and industry groups may propose new and different self-regulatory standards that either legally or contractually apply to us. Further, our customers may require us to comply with more stringent privacy and data security contractual requirements. Particularly in this regulatory environment, if we or other SaaS providers experience data security incidents, loss of customer data, disruptions in delivery, or other problems, the market for SaaS business applications, including our solutions, may be negatively affected.
We also continue to see jurisdictions, such as Russia, imposing data localization laws, which under Russian laws require personal information of Russian citizens to be, among other data processing operations, initially collected, stored, and modified in Russia. These regulations may deter customers from using services such as ours, and may inhibit our ability to expand into those markets or prohibit us from continuing to offer services in those markets without significant additional costs.
Because the interpretation and application of many privacy and data protection laws (including the GDPR), commercial frameworks, and standards are uncertain, it is possible that these laws, frameworks, and standards may be interpreted and applied in a manner that is inconsistent with our existing data management practices or the features of our solutions. If so, in addition to the possibility of fines, lawsuits, breach of contract claims, and other claims and penalties, we could be required to fundamentally change our business activities and practices or modify our solutions, which could have an adverse effect on our business. Any inability to adequately address privacy and security concerns, even if unfounded, or comply with applicable privacy and security or data security laws, regulations, and policies, could result in additional cost and liability to us, damage our reputation, inhibit sales, and adversely affect our business.
Furthermore, the costs of compliance with, and other burdens imposed by, the laws, regulations, and policies that are applicable to the businesses of our customers may limit the use and adoption of, and reduce the overall demand for, our solutions. Privacy and data security concerns, whether valid or not valid, may inhibit market adoption of our solutions, particularly in certain industries and foreign countries.
Risks Related to Intellectual Property Matters
Indemnity provisions in various agreements potentially expose us to substantial liability for intellectual property infringement and other losses.
Our agreements with customers and other third parties may include indemnification or other provisions under which we agree to indemnify or otherwise be liable to them for losses suffered or incurred as a result of claims of intellectual property infringement, damages caused by us to property or persons, or other liabilities relating to or arising from our solutions or other acts or omissions. The term of these contractual provisions often survives termination or expiration of the applicable agreement. Large indemnity payments or damage claims from contractual breach could harm our business, operating results, and financial condition. From time to time, customers require us to indemnify or otherwise be liable to them for breach of confidentiality or failure to implement adequate security measures with respect to their data stored, transmitted, or processed by our product and platform solutions. Although we normally contractually limit our liability with respect to such obligations, we may still incur substantial liability related to them. Any dispute with a customer with respect to such obligations could have adverse effects on our relationship with that customer and other current and prospective customers, reduce demand for our solutions, and harm our business and operating results.
Our use of “open source” software could negatively affect our ability to sell our solutions and subject us to possible litigation.
We use open source software in our solutions and expect to continue to use open source software in the future. We may face claims from others claiming ownership of, or seeking to enforce the terms of, an open source license, including by demanding release of the open source software, derivative works, or our proprietary source code that was developed using such software. These claims could also result in litigation, require us to purchase a costly license, or require us to devote additional research and development resources to change our solutions, any of which would have a negative effect on our business and operating results. In addition, if the license terms for the open source software we utilize change, we may be forced to reengineer our solutions or incur additional costs. Although we have implemented policies to regulate the use and incorporation of open source software into our solutions, we cannot be certain that we have not incorporated open source software in our solutions in a manner that is inconsistent with such policies.
Any failure to protect our intellectual property rights could impair our ability to protect our proprietary technology and our brand.
Our success and ability to compete depend in part upon our intellectual property. We currently have ten issued patents and have a limited number of pending patent applications, none of which may result in an issued patent. We rely on copyright, trade secret, and trademark laws, patents, and confidentiality or license agreements with our employees, customers, partners, and others to protect our intellectual property rights. However, the steps we take to protect our intellectual property rights may be inadequate.
In order to protect our intellectual property rights, we may be required to spend significant resources to monitor and protect these rights. Litigation brought to protect and enforce our intellectual property rights could be costly, time-consuming, and distracting to management, and could result in the impairment or loss of portions of our intellectual property. Furthermore, our efforts to enforce our intellectual property rights may be met with defenses, counterclaims, and countersuits attacking the validity and enforceability of our intellectual property rights. Our failure to secure, protect, and enforce our intellectual property rights could adversely affect our brand and adversely impact our business.
We have been, and may in the future be, sued by third parties for alleged infringement of their proprietary rights.
There is considerable patent and other intellectual property development activity in our industry. Our future success depends in part on not infringing upon the intellectual property rights of others. From time to time, our competitors or other third parties have claimed, and may in the future claim, that we are infringing upon their intellectual property rights, and we may be found to be infringing upon such rights. We have received, and may in the future receive, claims from third parties, including our competitors, that our solutions and underlying technology infringe or violate a third party’s intellectual property rights, and we may be found to be infringing upon such rights. We may be unaware of the intellectual property rights of others that may cover some or all of our technology. Any claims or litigation could cause us to incur significant expenses and, if successfully asserted against us, could require that we pay substantial damages or ongoing royalty payments, prevent us from offering one or more of our solutions, or require that we comply with other unfavorable terms. We may also be obligated to indemnify our customers or business partners in connection with any such litigation and to obtain licenses, modify our solutions, or refund subscription fees, which could further exhaust our resources. In addition, we may incur substantial costs to resolve claims or litigation, whether or not successfully asserted against us, which could include payment of significant settlement, royalty, or license fees, modification of our solutions, or refunds to customers of subscription fees. Even if we were to prevail in the event of claims or litigation against us, any claim or litigation regarding our intellectual property could be costly and time-consuming and divert the attention of our management and other employees from our business operations. Such disputes could also disrupt our solutions, adversely impacting our customer satisfaction and ability to attract customers.
Risks Related to Tax and Accounting Matters
Taxing authorities may successfully assert that we should have collected or in the future should collect sales and use, value added, or similar taxes, and we could be subject to liability with respect to past or future sales, which could adversely affect our results of operations.
We do not collect sales and use, value added, or similar taxes in all jurisdictions in which we have sales, based on our understanding that such taxes are not applicable. Sales and use, value added, and similar tax laws and rates vary greatly by jurisdiction. Certain jurisdictions in which we do not collect such taxes may assert that such taxes are applicable, which could result in tax assessments, penalties, and interest, and we may be required to collect such taxes in the future. Such tax assessments, penalties, and interest, or future requirements, may adversely affect our results of operations.
Our international operations subject us to potentially adverse tax consequences.
We were founded in Denmark in 2007 and were headquartered in Denmark until we reincorporated in Delaware in 2009. Today, we generally conduct our international operations through subsidiaries and report our taxable income in various jurisdictions worldwide based upon our business operations in those jurisdictions. Our intercompany relationships and transactions are subject to complex regulations, including transfer pricing regulations administered by taxing authorities in various jurisdictions. Our tax returns are generally subject to examination by taxing authorities and the relevant taxing authorities may disagree with our transfer pricing practices and procedures, including our determinations as to the value of assets sold or acquired or income and expenses attributable to specific jurisdictions or transactions. If such a disagreement were to occur, and our position were not sustained, we could be required to pay additional taxes, interest, and penalties, which could result in one-time tax charges, higher effective tax rates, reduced cash flows, and lower overall profitability of our operations.
Additionally, tax laws are dynamic and subject to change as new laws are passed and new interpretations of the law are issued or applied. The United States continuously enacts tax legislation, including regulations related to the significant tax reform legislation enacted in 2017, and certain tax provisions may potentially adversely affect us in the future. For example, the Tax Cuts and Jobs Act’s “base erosion and anti-abuse tax” provision, and the regulations issued thereunder, which we are subject to, could adversely impact our effective tax rate by limiting our ability to deduct certain expenses. In addition, governmental tax authorities are increasingly scrutinizing the tax positions of companies. Many countries in the European Union, as well as a number of other countries and organizations such as the Organization for Economic Cooperation and Development, are actively considering changes to existing tax laws that, if enacted, could increase our tax obligations in countries where we do business. If U.S. or other foreign tax authorities change applicable tax laws, our overall taxes could increase, and our business, financial condition, or results of operations may be adversely impacted.
If our goodwill or intangible assets become impaired, we may be required to record a significant charge to earnings.
We review our intangible assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is required to be tested for impairment at least annually. As of December 31, 2020, we had a net balance of $196 million of goodwill and intangible assets related to business acquisitions. An adverse change in market conditions, particularly a change resulting in a significant decrease in our share price, or if such change has the effect of changing one of our critical assumptions or estimates, could result in a change to the estimation of fair value that could result in an impairment charge to our goodwill or intangible assets. Any such charges may have a material negative impact on our operating results.
Our ability to use our net operating losses to offset future taxable income may be subject to certain limitations.
As of December 31, 2020, we had federal and state net operating loss carryforwards, or NOLs, of $1,230 million and $491 million, respectively, due to prior period losses. In general, under Section 382 of the Internal Revenue Code of 1986, as amended, or the Code, a corporation that undergoes an “ownership change” is subject to limitations on its ability to utilize its NOLs to offset future taxable income. Our existing NOLs may be subject to limitations arising from previous ownership changes, including in connection with our initial public offering or our follow-on public offering. Future changes in our stock ownership, some of which are outside of our control, could result in an ownership change under Section 382 of the Code. Furthermore, our ability to utilize NOLs of companies that we may acquire in the future may be subject to limitations. Our NOLs generated before fiscal year 2018 are subject to a 20-year carryover limitation and may expire if unused within that period. There is also a risk that due to legislative changes, such as suspensions on the use of NOLs, or other unforeseen reasons, our existing NOLs could expire or otherwise be unavailable to offset future income tax liabilities. In addition, under the Tax Cuts and Jobs Act of 2017, as modified by the Coronavirus Aid, Relief, and Economic Security Act, the amount of NOLs that we are permitted to deduct in any taxable year is limited to 80% of our taxable income in such year, where taxable income is determined without regard to the NOL deduction itself. For these reasons, we may not be able to realize a tax benefit from the use of our NOLs, whether or not we attain profitability.
Our reported financial results may be adversely affected by changes in accounting principles generally accepted in the United States.
Generally accepted accounting principles, or GAAP, in the United States are subject to interpretation by the Financial Accounting Standards Board, or FASB, the SEC and various bodies formed to promulgate and interpret appropriate accounting principles. A change in these principles or interpretations could have a significant effect on our reported financial results and could affect the reporting of transactions completed before the announcement of a change. For example, on January 1, 2018, we adopted Accounting Standards Codification, or ASC, 606, “Revenue from Contracts with Customers,” which changed our accounting policies regarding revenue recognition and incremental costs to acquire customer contracts. We also adjusted our consolidated financial statements from amounts previously reported to reflect the adoption. Certain other standards that become
effective in the future may have a material impact on our consolidated financial statements. See Note 2 of the Notes to our Consolidated Financial Statements for information regarding the effect of new accounting pronouncements on our consolidated financial statements. Any difficulties in implementing these standards could cause us to fail to meet our financial reporting obligations, which could result in regulatory discipline and harm investors’ confidence in us.
We depend and rely upon SaaS technologies from third parties to operate our business and interruptions or performance problems with these technologies may adversely affect our business and operating results.
We rely heavily on hosted SaaS applications from third parties in order to operate critical functions of our business, including billing and order management, enterprise resource planning, and financial accounting services. If these services become unavailable due to extended outages or interruptions, or because they are no longer available on commercially reasonable terms, our expenses could increase, our ability to manage finances could be interrupted, and our processes for managing sales of our solutions and supporting our customers could be impaired until equivalent services, if available, are identified, obtained, and implemented, all of which could adversely affect our business.
We face exposure to foreign currency exchange rate fluctuations.
As our international operations expand, our exposure to the effects of fluctuations in currency exchange rates grows. While we have primarily transacted with customers in U.S. dollars historically, we expect to continue to expand the number of transactions with our customers that are denominated in foreign currencies in the future. Fluctuations in the value of the U.S. dollar and foreign currencies may make our subscriptions more expensive for international customers, which could harm our business. Additionally, we incur expenses for employee compensation and other operating expenses at our non-U.S. locations in the local currency for such locations. Fluctuations in the exchange rates between the U.S. dollar and other currencies could result in an increase to the U.S. dollar equivalent of such expenses. These fluctuations could cause our results of operations to differ from our expectations or the expectations of our investors. Additionally, such foreign currency exchange rate fluctuations could make it more difficult to detect underlying trends in our business and results of operations.
Our international subsidiaries maintain net assets that are denominated in currencies other than the functional operating currencies of these entities. Accordingly, changes in the value of foreign currencies relative to the U.S. dollar can affect our operating results due to transactional and translational remeasurements that are reflected in our results of operations. To the extent that fluctuations in foreign currency exchange rates cause our results of operations to differ from our expectations or the expectations of our investors, the trading price of our common stock could be adversely affected.
We currently operate a hedging program to mitigate the impact of foreign currency exchange rate fluctuations on our cash flows and earnings. The use of such hedging activities may not offset any or more than a portion of the adverse financial effects of unfavorable movements in foreign currency exchange rates over the limited time the hedges are in place. Moreover, the use of hedging instruments may introduce additional risks if we are unable to structure effective hedges with such instruments, which could adversely affect our financial condition and operating results.
Risks Related to Macroeconomic Conditions
The recent global COVID-19 outbreak may and has caused harm to our business, results of operations, and financial condition.
In March 2020, the World Health Organization declared the novel coronavirus and resulting COVID-19 disease ("COVID-19") a global pandemic. This contagious disease outbreak, which has continued to spread, and the related adverse public health developments, including orders to shelter-in-place, travel restrictions, and mandated business closures, have adversely affected workforces, organizations, customers, economies, and financial markets globally. In light of the uncertain and rapidly evolving situation relating to the spread of COVID-19, we have taken precautionary measures, including imposing travel restrictions for our employees, mandating a global work from home policy, and shifting customer events to virtual-only experiences. Operationally, we have increased our focus on being prudent in managing operating expenses. Although we continue to monitor the situation and may adjust our current policies as more information and public health guidance become available, precautionary measures that have been adopted could negatively affect our customer success efforts, customer retention, sales and marketing efforts, delay and lengthen our sales cycles, affect our revenue growth rate, or create operational or other challenges, any of which could harm our business and results of operations. Additionally, our customers and potential customers may and have been exposed to similar operational considerations, resulting in significant pressures on their expenditures, and subsequently resulting in a decreased demand for our solutions.
In addition, COVID-19 may and has disrupted the operations of our customers and partners for an indefinite period of time, including as a result of travel restrictions and/or business shutdowns, all of which could negatively impact our business
and results of operations, including cash flows. More generally, the outbreak of COVID-19 has adversely affected economies and financial markets globally, potentially leading to a prolonged economic downturn and disproportionate impacts to certain industries, which could decrease technology spending and adversely affect demand for our offerings and harm our business and results of operations. Further, as companies adapt to the changing economic environment, they may have purchasing behavior which does not match historical trends, negatively impacting our ability to forecast our results.
It is not possible for us to estimate the duration or magnitude of the adverse results of the outbreak and its effects on our business, results of operations, or financial condition at this time as the impact will depend on future developments, which are highly uncertain and cannot be predicted. To the extent the COVID-19 pandemic adversely affects our business and financial results, it may also have the effect of heightening many of the other risks described in this “Risk Factors” section.
Unfavorable conditions in our industry or the global economy or reductions in information technology spending could limit our ability to grow our business and negatively affect our operating results.
Our operating results may vary based on the impact of changes in our industry or the global economy on us or our customers. The revenue growth and potential profitability of our business depend on demand for business software applications and services generally and for customer service systems in particular. In addition, our revenue is dependent on the number of users of our solutions, which in turn is influenced by the employment and hiring patterns of our customers. To the extent that weak economic conditions cause our customers and prospective customers to freeze or reduce their hiring for personnel providing service and support, demand for our solutions may be negatively affected. Historically, during economic downturns there have been reductions in spending on information technology and customer service systems as well as pressure for extended billing terms and other financial concessions. Additionally, our global operations further expose us to risks associated with public health crises, such as pandemics and epidemics, which could harm our business. The recent COVID-19 outbreak has created significant additional uncertainty in the global economy. If the COVID-19 crisis worsens, particularly in the regions in which we have material operations or sales, our business activities originating from affected areas, including sales-related activities, could be and have been adversely affected. If global economic conditions deteriorate, our customers and prospective customers may elect to decrease their information technology and customer service budgets, which would limit our ability to grow our business and negatively affect our operating results.
Catastrophic events may disrupt, and have disrupted, our business.
Our corporate headquarters are located in San Francisco, California, an area that has been significantly affected by the COVID-19 pandemic, and we operate in or utilize hosting resources that are located in North America, Europe, Asia, and Australia. Key features and functionality of our solutions are enabled by third parties that are headquartered in California and operate in or utilize data centers in the United States and Europe. Additionally, we rely on our network and third-party infrastructure and enterprise applications, internal technology systems, and our website for our development, marketing, operational support, hosted services, and sales activities. In the event of a major earthquake, hurricane, or catastrophic event such as fire, pandemic (such as the outbreak of COVID-19), flood, power loss, telecommunications failure, cyber-attack, war, or terrorist attack, we may be unable to continue our operations and may endure system interruptions, reputational harm, delays in our application development, lengthy interruptions in our solutions, breaches of data security, disruption to our customer success efforts, and loss of critical data, all of which could have an adverse effect on our future operating results. For example, the COVID-19 pandemic has caused us to adopt precautionary measures, such as work from home, that could negatively affect our business and results of operations.
Our business and operations in the United Kingdom (“UK”) and EU may be negatively impacted by the UK’s withdrawal from the EU.
On June 23, 2016, the UK held a referendum in which a majority of voters approved an exit from the EU, or Brexit. After nearly three years of negotiation and political and economic uncertainty, the UK’s withdrawal from the EU became effective on January 31, 2020. There was a transitional period, during which EU laws, including pharmaceutical laws, continued to apply in the UK, however this ended on December 31, 2020. The UK and EU have signed a EU-UK Trade and Cooperation Agreement, which became provisionally applicable on January 1, 2021 and will become formally applicable once ratified by both the UK and the EU. This agreement provides details on how some aspects of the UK and EU’s relationship will operate, however there are still many uncertainties. Many of the regulations that now apply in the UK following the transition period (including financial laws and regulations, tax, intellectual property rights, data protection laws, supply chain logistics, environmental, health and safety laws and regulations, immigration laws, and employment laws), will likely be amended in the future as the UK determines its new approach, which may result in significant divergence from EU regulations. This lack of
clarity on future UK laws and regulations and their interaction with the EU laws and regulations increases our regulatory burden of operating in and doing business with both the UK and the EU.
The long-term effects of Brexit will depend in part on how the EU-UK Trade and Cooperation Agreement, and any future agreements signed by the UK and the EU, take effect in practice. Such a withdrawal from the EU is unprecedented, and it is unclear how the restrictions on the UK’s access to the European single market for goods, capital, services and labor within the EU and the wider commercial, legal and regulatory environment, could impact our current and future operations and clinical activities in the UK.
We expect that, now the transition period has expired, Brexit could lead to legal uncertainty and potentially divergent national laws and regulations as the UK determines which EU laws to replicate or replace. Any of these effects of Brexit, and others we cannot anticipate, could negatively impact our business and results of operations in the UK.
The uncertainty concerning the UK’s legal, political and economic relationship with the EU following Brexit may also be a source of instability in the international markets, create significant currency fluctuations, and/or otherwise adversely affect trading agreements or similar cross-border co-operation arrangements (whether economic, tax, fiscal, legal, regulatory or otherwise).
Risks Related to Ownership of Our Common Stock
Our stock price has been, and may continue to be, volatile or may decline regardless of our operating performance, resulting in substantial losses for our stockholders.
The trading price of our common stock has been, and may continue to be, volatile and could fluctuate widely regardless of our operating performance. The market price of our common stock may fluctuate significantly in response to numerous factors, many of which are beyond our control, including:
•actual or anticipated fluctuations in our operating results;
•the financial projections we may provide to the public, any changes in these projections, or our failure to meet these projections;
•failure of securities analysts to initiate or maintain coverage of our company, changes in financial estimates, and publication of other news by any securities analysts who follow our company, or our failure to meet these estimates or the expectations of investors;
•ratings changes by any securities analysts who follow our company;
•announcements by us or our competitors of significant technical innovations, acquisitions, strategic partnerships, joint ventures, or capital commitments;
•changes in operating performance and stock market valuations of other technology companies generally, or those in our industry in particular;
•price and volume fluctuations in the overall stock market from time to time, including as a result of trends in the economy as a whole;
•the short and long-term impact of the COVID-19 outbreak, including on the global economy, our results of operations, software spending and business continuity;
•changes in accounting standards, policies, guidelines, interpretations, or principles;
•actual or anticipated developments in our business or our competitors’ businesses or the competitive landscape generally;
•developments or disputes concerning our intellectual property or our solutions, or third-party proprietary rights;
•announced or completed acquisitions of businesses or technologies by us or our competitors;
•new laws or regulations or new interpretations of existing laws or regulations applicable to our business;
•any major change in our board of directors or management;
•sales of shares of our common stock by us or our stockholders;
•lawsuits threatened or filed against us; and
•other events or factors, including those resulting from war, incidents of terrorism, public health crises or responses to these events.
In addition, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many technology companies. Stock prices of many technology companies have fluctuated in a manner unrelated or disproportionate to the operating performance of those companies. In the past, stockholders have instituted securities class action litigation following periods of market volatility. If we were to become involved in securities litigation in the future or if we are unsuccessful in defending securities litigation currently filed against us, it could subject us to substantial costs, make it more expensive for us to obtain director and officer liability insurance, divert resources
and the attention of management from operating our business, and adversely affect our business, results of operations, financial condition, and cash flows.
Our directors, officers, and principal stockholders beneficially own a significant percentage of our stock and will be able to exert significant influence over matters subject to stockholder approval.
As of December 31, 2020, our directors, officers, five percent or greater stockholders, and their respective affiliates beneficially owned in the aggregate approximately 29% of our outstanding common stock. As a result, these stockholders have the ability to influence us through this ownership position. These stockholders may be able to exert significant influence in matters requiring stockholder approval. For example, these stockholders may be able to exert significant influence in elections of directors, amendments of our organizational documents, and approval of any merger, sale of assets, or other major corporate transaction. This may prevent or discourage unsolicited acquisition proposals or offers for our common stock that you may feel are in your best interest as one of our stockholders.
Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of our company more difficult, limit attempts by our stockholders to replace or remove our current management, and limit the market price of our common stock.
Provisions in our certificate of incorporation and bylaws may have the effect of delaying or preventing a change of control or changes in our management. Our certificate of incorporation and bylaws include provisions that:
•authorize our board of directors to issue, without further action by our stockholders, shares of undesignated preferred stock with terms, rights, and preferences determined by our board of directors that may be senior to our common stock;
•require that any action to be taken by our stockholders be effected at a duly called annual or special meeting and not by written consent;
•specify that special meetings of our stockholders can be called only by our board of directors, the Chair of our board of directors, or our Chief Executive Officer;
•establish an advance notice procedure for stockholder proposals to be brought before an annual meeting, including proposed nominations of persons for election to our board of directors;
•establish that our board of directors is divided into three classes, Class I, Class II, and Class III, with each class serving three-year staggered terms;
•prohibit cumulative voting in the election of directors;
•provide that our directors may be removed only for cause;
•provide that vacancies on our board of directors may be filled only by a majority of directors then in office, even though less than a quorum; and
•require the approval of our board of directors or the holders of at least 75% of our outstanding shares of capital stock to amend our bylaws and certain provisions of our certificate of incorporation.
These provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the General Corporation Law of the State of Delaware, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any “interested” stockholder for a period of three years following the date on which the stockholder became an “interested” stockholder. Any delay or prevention of a change of control transaction or changes in our management could cause the market price of our common stock to decline.
The changing laws and regulations related to being a public company may strain our resources and divert management’s attention.
Changing laws, regulations, and standards relating to corporate governance and public disclosure can create uncertainty for public companies and increase legal and financial compliance costs. These laws, regulations, and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to continue to invest resources to comply with evolving laws, regulations, and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from business operations to compliance activities. If our efforts to comply with new laws, regulations, and standards differ from the activities intended by regulatory or governing bodies due to ambiguities related to their application and practice, regulatory authorities may initiate legal proceedings against us and our business may be adversely affected.
We do not intend to pay dividends on our common stock so any returns will be limited to changes in the value of our common stock.
We have never declared or paid any cash dividends on our common stock. We currently anticipate that we will retain future earnings for the development, operation, and expansion of our business, and do not anticipate declaring or paying any cash dividends for the foreseeable future. In addition, our ability to pay cash dividends on our common stock may be prohibited or limited by the terms of our future debt financing arrangements. Any return to stockholders will therefore be limited to the increase, if any, of our stock price, which may never occur.
If securities or industry analysts do not continue to publish research or publish inaccurate or unfavorable research about our business, our stock price and trading volume could decline.
The trading market for our common stock depends in part on the research and reports that securities or industry analysts publish about us or our business. If one or more of the analysts who cover us downgrade our common stock or publish inaccurate or unfavorable research about our business, our common stock price would likely decline. If one or more of these analysts cease coverage of us or fail to publish reports on us regularly, demand for our common stock could decrease, which might cause our common stock price and trading volume to decline.
Our charter documents designate the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers, or other employees.
Our certificate of incorporation and bylaws provide that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware shall be the sole and exclusive forum for (A) any derivative action or proceeding brought on our behalf, (B) any action asserting a claim of breach of a fiduciary duty owed by any of our directors, officers, or other employees to us or our stockholders, (C) any action asserting a claim arising pursuant to any provision of the General Corporation Law of the State of Delaware, our certificate of incorporation, or our bylaws, or (D) any action asserting a claim against us governed by the internal affairs doctrine. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock shall be deemed to have notice of and consented to the provisions of our certificate of incorporation described above. This choice of forum provision may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, or other employees, which may discourage such lawsuits against us and our directors, officers, and other employees. Alternatively, if a court were to find these provisions of our certificate of incorporation inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect our business, financial condition, or results of operations.
Risks Related to our Outstanding Convertible Notes
Servicing our debt may require a significant amount of cash. We may not have sufficient cash flow from our business to pay our indebtedness, and we may not have the ability to raise the funds necessary to settle cash conversions of the Notes or to repurchase the Notes for cash upon a fundamental change, which could adversely affect our business and results of operations.
In March 2018, we issued $575 million in aggregate principal amount of 0.25% convertible senior notes due 2023 (the “2023 Notes”), in a private offering. The interest rate on the 2023 Notes is fixed at 0.25% per annum and is payable semi-annually in arrears on March 15 and September 15 of each year. In June 2020, we issued $1,150 million aggregate principal amount of 0.625% convertible senior notes due 2025 in a private offering (the “2025 Notes,” and together with the 2023 Notes, the “Notes”). The interest rate on the 2025 Notes is fixed at 0.625% per annum and is payable semi-annually in arrears on June 15 and December 15 of each year, commencing on December 15, 2020. In connection with the offering of the 2025 Notes, the Company used $618 million of the net proceeds from the offering of the 2025 Notes to repurchase $426 million aggregate principal amount of the 2023 Notes in cash through individual privately negotiated transactions (the “2023 Notes Partial Repurchase”). As of the repurchase date, the carrying value of the 2023 Notes subject to the 2023 Notes Partial Repurchase, net of unamortized debt discount and issuance costs, was $367 million. The 2023 Notes Partial Repurchase resulted in a $26 million loss on early debt extinguishment. As of December 31, 2020, $149 million of principal remains outstanding on the 2023 Notes. Our ability to make scheduled payments of the principal of, to pay interest on or to refinance our indebtedness, including the Notes, depends on our future performance, which is subject to economic, financial, competitive and other factors beyond our control. Our business may not generate cash flows from operations in the future that are sufficient to service our debt and make necessary capital expenditures. If we are unable to generate such cash flows, we may be required to adopt one or more alternatives, such as selling assets, restructuring debt or obtaining additional debt financing or equity capital on terms that may
be onerous or highly dilutive. Our ability to refinance any future indebtedness will depend on the capital markets and our financial condition at such time. We may not be able to engage in any of these activities or engage in these activities on desirable terms, which could result in a default on our debt obligations.
Holders of the Notes have the right to require us to repurchase their Notes upon the occurrence of a fundamental change (as defined in the indenture governing the Notes) at a repurchase price equal to 100% of the principal amount of the Notes to be repurchased, plus accrued and unpaid interest, if any. Upon conversion, unless we elect to deliver solely shares of our common stock to settle such conversion (other than paying cash in lieu of delivering any fractional share), we will be required to make cash payments in respect of the Notes being converted. We may not have enough available cash or be able to obtain financing at the time we are required to make repurchases in connection with such conversion and our ability to pay may additionally be limited by law, by regulatory authority or by agreements governing our future indebtedness. Our failure to repurchase the Notes at a time when the repurchase is required by the indenture governing the Notes or to pay any cash payable on future conversions as required by such indenture would constitute a default under such indenture. A default under the indenture or the fundamental change itself could also lead to a default under agreements governing our future indebtedness. If the repayment of the related indebtedness were to be accelerated after any applicable notice or grace periods, we may not have sufficient funds to repay the indebtedness and repurchase the Notes or make cash payments upon conversions thereof. Additionally, subject to certain exceptions, if we fail to timely file any document or report required under the Securities and Exchange Act of 1934, in certain circumstances we may be required to pay additional interest of up to 0.50% per annum on our Notes in order to avoid an event of default under the indenture, which may affect our ability to repay the Notes. Furthermore, if we do not remedy such failure within 360 days after receiving notice thereof from the noteholders, there would be an event of default under the indenture.
The conditional conversion feature of the Notes, if triggered, may adversely affect our financial condition and operating results.
In the event the conditional conversion feature of the Notes is triggered, holders of Notes will be entitled to convert the Notes at any time during specified periods at their option. If one or more holders elect to convert their Notes, unless we elect to satisfy our conversion obligation by delivering solely shares of our common stock (other than paying cash in lieu of delivering any fractional share), we would be required to settle a portion or all of our conversion obligation through the payment of cash, which could adversely affect our liquidity. As disclosed in Note 9 of the Notes to our Consolidated Financial Statements, the conditional conversion feature of the 2023 Notes that is based on the closing stock price of our common stock during the last 30 trading days of a calendar quarter was triggered as of December 31, 2020, and the 2023 Notes are convertible at the option of the holders, in whole or in part, between January 1, 2021 and March 31, 2021. Whether the Notes will be convertible following such calendar quarter will depend on the satisfaction of this conditional conversion feature or another conversion condition in the future.
In addition, even if holders do not elect to convert their Notes, we are required to reclassify the outstanding principal of the Notes as a current rather than long-term liability, resulting in a material reduction of our net working capital. We have classified the 2023 Notes as a current liability on the consolidated balance sheet as of December 31, 2020. As of the date of this filing, we have received one request for conversion for an immaterial amount of 2023 Notes.
Transactions relating to our Notes may affect the value of our common stock.
The conversion of some or all of the Notes would dilute the ownership interests of existing stockholders to the extent we satisfy our conversion obligation by delivering shares of our common stock upon any conversion of such Notes. Our Notes may become in the future convertible at the option of their holders under certain circumstances. If holders of our Notes elect to convert their Notes, we may settle our conversion obligation by delivering to them a significant number of shares of our common stock, which would cause dilution to our existing stockholders.
In addition, in connection with the issuance of the Notes, we entered into capped call transactions with certain financial institutions, or the Option Counterparties. The capped call transactions are expected generally to reduce the potential dilution to our common stock upon any conversion or settlement of the Notes and/or offset any cash payments we are required to make in excess of the principal amount of converted Notes, as the case may be, with such reduction and/or offset subject to a cap. From time to time, the Option Counterparties or their respective affiliates may modify their hedge positions by entering into or unwinding various derivative transactions with respect to our common stock and/or purchasing or selling our common stock or other securities of ours in secondary market transactions prior to the maturity of the Notes. This activity could cause a decrease in the market price of our common stock.
We are subject to counterparty risk with respect to the capped call transactions.
The Option Counterparties are financial institutions, and we are subject to the risk that any or all of them may default under the capped call transactions. Our exposure to the credit risk of the Option Counterparties will not be secured by collateral. Global economic conditions have resulted in actual or perceived failure or financial difficulties of many institutions. If an Option Counterparty becomes subject to insolvency proceedings, we will become an unsecured creditor in those proceedings, with a claim equal to our exposure at that time under our transactions with the Option Counterparty. Our exposure will depend on many factors, but generally, an increase in our exposure will be correlated to an increase in the market price and in the volatility of our common stock. In addition, upon default by an Option Counterparty, we may suffer adverse tax consequences and more dilution than we currently anticipate with respect to our common stock. We can provide no assurances as to the financial stability or viability of the Option Counterparties.
The accounting method for convertible debt securities that may be settled in cash, such as the Notes, could have a material effect on our reported financial results.
Under FASB ASC 470-20, Debt with Conversion and Other Options, or ASC 470-20, an entity must separately account for the liability and equity components of convertible debt instruments (such as the Notes) that may be settled entirely or partially in cash upon conversion in a manner that reflects the issuer’s economic interest cost. ASC 470-20 requires the value of the conversion option of the Notes, representing the equity component, to be recorded as additional paid-in capital within stockholders’ equity in our consolidated balance sheet and as a discount to the Notes, which reduces their initial carrying value. The carrying value of the Notes, net of the discount recorded, will be accreted up to the principal amount of the Notes from the issuance date until maturity, which will result in non-cash charges to interest expense in our consolidated statement of operations. Accordingly, we will report lower net income or higher net loss in our financial results because ASC 470-20 requires interest to include both the current period’s accretion of the debt discount and the instrument’s coupon interest, which could adversely affect our reported or future financial results, the trading price of our common stock and the trading price of the Notes.
In addition, under certain circumstances, convertible debt instruments (such as the Notes) that may be settled entirely or partly in cash are currently accounted for utilizing the treasury stock method, the effect of which is that the shares issuable upon conversion of the Notes are not included in the calculation of diluted earnings per share except to the extent that the conversion value of the Notes exceeds their principal amount. Under the treasury stock method, for diluted earnings per share purposes, the transaction is accounted for as if the number of shares of common stock that would be necessary to settle such excess, if we elected to settle such excess in shares, are issued.
In August 2020, the FASB published an Accounting Standard Update that, for most convertible instruments (such as the Notes), requires the entire debt amount to be classified as a liability. This would eliminate the recognition of non-cash charges to interest expense and accordingly would result in higher net income or lower net loss in our financial statements. Additionally, the new guidance eliminates the treasury stock method for most convertible instruments and instead requires application of the “if-converted” method. Under that method, diluted earnings per share would generally be calculated assuming that all the notes were converted solely into shares of common stock at the beginning of the reporting period, unless the result would be antidilutive. Upon adoption of the standard, which we expect to adopt in fiscal year 2022, we expect that we may be unable to use the treasury stock method in accounting for the shares issuable upon conversion of the Notes. Accordingly, our diluted earnings per share is expected to be adversely affected in periods when we report net income after adoption of the standard.
Item 1B.
Item 1B. Unresolved Staff Comments.
None.
Item 2.
Item 2. Properties.
Our corporate headquarters are located in San Francisco, California, where we lease approximately 199,000 square feet of total space under multiple leases.
We also maintain offices in various locations in North America, South America, Europe, Australia, and Asia. All of our properties are currently leased. We believe our existing facilities are adequate to meet our current requirements. See Note 7 in the Notes to our Consolidated Financial Statements included in this Annual Report on Form 10-K for more information about our lease commitments. We may expand our facilities capacity as our employee base grows. We believe we will be able to obtain such space on acceptable and commercially reasonable terms.
Item 3.
Item 3. Legal Proceedings.
On October 24, 2019 and November 7, 2019, purported stockholders of the Company filed two putative class action complaints in the United States District Court for the Northern District of California, entitled Charles Reidinger v. Zendesk, Inc., et al., 3:19-cv-06968-CRB and Ho v. Zendesk, Inc., et al., No. 3:19-cv-07361-WHA, respectively, against the Company and certain of the Company’s executive officers. The complaints are nearly identical and allege violations of Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934, as amended (the “1934 Act”), purportedly on behalf of all persons who purchased Zendesk, Inc. common stock between February 6, 2019 and October 1, 2019, inclusive. The claims are based upon allegations that the defendants misrepresented and/or omitted material information in certain of our prior public filings. To this point, no discovery has occurred in these cases. The court has appointed a lead plaintiff and consolidated the various lawsuits into a single action (Case No. 3:19-cv-06968-CRB), and the lead plaintiff filed its amended complaint on April 14, 2020 asserting the same alleged violations of securities laws as the initial complaints. On June 29, 2020, Zendesk and the executive officer defendants moved to dismiss the amended complaint. On November 9, 2020, the court granted Zendesk's motion to dismiss and granted plaintiff leave to amend its complaint. On January 8, 2021, plaintiff filed its second amended complaint and on January 22, 2021, Zendesk and the executive officer defendants moved to dismiss the second amended complaint which is set for hearing on March 5, 2021.
On June 2, 2020, a purported stockholder of the Company filed a derivative complaint in the United States District Court for the Northern District of California, entitled Anderson v. Svane, et al., 3:20-cv-03671, against certain of the Company's executive officers and directors. The derivative complaint alleges breaches of fiduciary duty against all defendants and an insider trading claim, and violations of Section 10(b) of the Securities Exchange Act of 1934 against the officer defendants, purportedly on behalf of the Company itself. The claims are based on nearly identical allegations as the two putative class action complaints described above, namely that the defendants misrepresented and/or omitted material information in certain of our prior public filings. On June 29, 2020, the court stayed the derivative action until either the class action is dismissed with prejudice or class action defendants answer the complaint. On July 27, 2020, the court ordered the derivative action related to the class action.
The class action and derivative action are still in the preliminary stages, and it is not possible for the Company to quantify the extent of potential liability to the individual defendants, if any. Management believes that the lawsuits lack merit and intends to vigorously defend the actions. We cannot predict the outcome of or estimate the possible loss or range of loss from the above described matter.
From time to time, we may be subject to other legal proceedings, claims, investigations, and government inquiries in the ordinary course of business. We have received, and may in the future continue to receive, claims from third parties asserting, among other things, infringement of their intellectual property rights, defamation, labor and employment rights, privacy, and contractual rights. Legal risk is enhanced in certain jurisdictions outside the United States where our protection from liability for content added to our products by third parties may be unclear and where we may be less protected under local laws than we are in the United States. Future litigation may be necessary to defend ourselves, our partners, and our customers by determining the scope, enforceability, and validity of third-party proprietary rights, or to establish our proprietary rights. The results of any current or future litigation cannot be predicted with certainty, and regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources, and other factors. In general, the resolution of a legal matter could prevent the Company from offering its service to others, could be material to the Company’s financial condition or cash flows, or both, or could otherwise adversely affect the Company’s operating results.
In management’s opinion, resolution of all current matters is not expected to have a material adverse impact on business, consolidated balance sheets, results of operations, comprehensive loss, or cash flows. However, the outcome of these matters is inherently uncertain. Therefore, if one or more of these matters were resolved against us for amounts in excess of management's expectations, our results of operations and financial condition, including in a particular reporting period in which any such outcome becomes probable and estimable, could be materially adversely affected.
Item 4.
Item 4. Mine Safety Disclosures.
Not Applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Market Information for Common Stock
Our common stock has been listed on the New York Stock Exchange under the symbol “ZEN” since May 15, 2014, the date of our initial public offering. Prior to that date, there was no public trading market for our common stock.
Holders
As of December 31, 2020, there were approximately 30 holders of record of our common stock. However, because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to accurately estimate the total number of stockholders represented by these record holders.
Dividends
We have never declared or paid any cash dividend on our capital stock. We currently intend to retain any future earnings and do not expect to pay any dividends in the foreseeable future. Any future determination to declare cash dividends will be made at the discretion of our board of directors, subject to applicable laws, and will depend on a number of factors, including our financial condition, operating results, capital requirements, contractual restrictions, general business conditions, and other factors that our board of directors may deem relevant.
Issuer Purchases of Equity Securities
No shares of our common stock were repurchased during the three months ended December 31, 2020.
Securities Authorized for Issuance Under Equity Compensation Plans
See Item 12, “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” for information regarding securities authorized for issuance.
Stock Performance Graph
The following stock performance graph and related information shall not be deemed “soliciting material” or to be “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent that we specifically incorporate it by reference into such filing.
The following stock performance graph compares total stockholder returns for Zendesk, Inc. from December 31, 2015, through December 31, 2020, against the S&P 500 Index and the S&P 500 Software & Services Index, assuming a $100 investment made on December 31, 2015. The S&P 500 Software & Services Index is the official name of the index referred to in prior Annual Reports on Form 10-K as the S&P 500 Composite/Software Index. This change to refer to such index's official name has no effect on the identity or values of the index. Each of the two comparative measures of cumulative total return assumes reinvestment of dividends. The stock performance shown in the graph below is not necessarily indicative of future price performance.
Item 6.
Item 6. Selected Financial Data.
The consolidated statement of operations data and the consolidated balance sheet data are derived from our audited consolidated financial statements and should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” our consolidated financial statements, and the related notes included in this Annual Report on Form 10-K. Our historical data results are not necessarily indicative of our results in any future period.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the section titled “Selected Financial Data” and consolidated financial statements and related notes appearing in this Annual Report on Form 10-K. As discussed in the section titled "Special Note Regarding Forward-Looking Statements," the following discussion and analysis contains forward-looking statements that involve risks and uncertainties, as well as assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, impacts on our business and general economic conditions due to the current COVID-19 pandemic, those identified below and those discussed in the section titled “Risk Factors” included in this Annual Report on Form 10-K.
Overview
We are a software development company that provides software as a service solutions that are intended to help organizations and their customers build better experiences. Our customer experience solutions are built upon a modern architecture that enables us and our customers to rapidly innovate, adapt our technology in novel ways, and easily integrate with other products and applications. With our origins in customer service, we have evolved our offerings over time to product and platform solutions that work together to help organizations understand the broader customer journey, improve communications across all channels, and engage where and when it’s needed most.
We believe in developing solutions that serve organizations of all sizes and across all industries. Our flagship product solution, Zendesk Support, provides organizations with the ability to track, prioritize, and solve customer support tickets across multiple channels, bringing customer information and interactions into one place. Our other widely available product solutions integrate with Support and include Zendesk Chat, Zendesk Talk, and Zendesk Guide. Chat is live chat software that provides a fast and responsive way for organizations to connect with their customers. Talk is cloud-based call center software that facilitates personal and productive phone support conversations between organizations and their customers. Guide is a self-service destination that organizations can use to provide articles, interactive forums, and a community that help an organization's customers help themselves. For an omnichannel solution which provides Support, Chat, Talk, and Guide together for a single price, we offer the Zendesk Suite.
We additionally offer Zendesk Sell, sales customer relationship management software that complements our mission in delivering solutions that provide a better customer experience, Zendesk Explore, a solution to provide analytics for organizations to measure and improve the entire customer experience, Zendesk Gather, a product solution that enables companies to provide trusted and transparent support to customers through online community forums, Zendesk Sunshine, a customer relationship management platform which enables organizations to connect and integrate customer data generated through our product solutions, and Zendesk Sunshine Conversations, a messaging platform solution that allows businesses to integrate messaging through social channels and directly interact and transact with customers.
We offer a range of subscription account plans for our solutions that vary in price based on functionality, type, and the amount of product support we offer. We also offer a range of additional features that customers can purchase and add to their subscriptions.
For the years ended December 31, 2020, 2019, and 2018, our revenue was $1,030 million, $816 million, and $599 million, respectively, representing a 26% growth rate from 2019 to 2020 and a 36% growth rate from 2018 to 2019. For the years ended December 31, 2020, 2019, and 2018 we derived $493 million, $389 million, and $289 million, respectively, of our revenue from customers located outside of the United States, or 48% each year. We expect that the rate of growth in our revenue will decline as our business scales, even if our revenue continues to grow in absolute terms. For the years ended December 31, 2020, 2019, and 2018, we generated net losses of $218 million, $170 million, and $131 million, respectively.
The growth of our business and our future success depend on many factors, including our ability to continue to innovate, further develop our product and platform solutions geared towards the entire customer experience, build brand recognition and scalable solutions for larger organizations, maintain our leadership in the small and midsized business market, add new customers, generate additional revenue from our existing customer base, and increase our global customer footprint. While these areas represent significant opportunities for us, we also face significant risks and challenges that we must successfully address in order to sustain the growth of our business and improve our operating results, including continuing uncertainties related to the COVID-19 pandemic. We anticipate that we will continue to invest in our operations. The expected expenditures that we anticipate will be necessary to manage our anticipated growth, including personnel costs, expenditures relating to hosting capabilities, leasehold improvements, and related fixed assets, will make it more difficult for us to achieve profitability
in the near term. Many of these investments will occur in advance of us experiencing any direct benefit and will make it difficult to determine if we are allocating our resources efficiently.
We have focused on rapidly growing our business and plan to continue to invest for long-term growth. We expect to continue to develop our hosting capabilities primarily through expenditures for third-party managed hosting services. The amount and timing of these expenditures will vary based on our estimates of projected growth and planned use of hosting resources. Over time, we anticipate that we will continue to gain economies of scale by efficiently utilizing our hosting and personnel resources to support the growth in our number of customers. In addition, we expect to incur amortization expense associated with acquired intangible assets and capitalized internal-use software. As a result, we expect our gross margin to improve in the long-term, although our gross margin may decrease in the near-term and may vary from period to period as our revenue fluctuates and as a result of the timing and amount of such costs.
We expect our operating expenses to continue to increase in absolute dollars in future periods. We have invested, and expect to continue to invest, in our software development efforts to broaden the functionality of our existing solutions, to further integrate these solutions and services, and to introduce new solutions. We plan to continue to invest in our sales and marketing organizations, particularly in connection with our efforts to expand our customer base and expand usage of our solutions. We also expect to continue to incur additional general and administrative costs in order to support the growth of our business and the infrastructure required to comply with our obligations as a public company.
COVID-19 Update
We are continuing to ascertain the long-term impact of the the novel coronavirus and resulting disease ("COVID-19") pandemic on our business. The full effect on our results of operations in future quarters is uncertain, but in the near to intermediate term, we continue to expect our financial performance to be impacted by the economic crisis arising from COVID-19. We continue to focus on supporting our employees, customers, and community. Our business continuity plans have continued to focus on the health and safety of our employees while continuing to drive innovation in customer experience solutions for our customers. Since the advent of the COVID-19 pandemic, we continue to monitor and identify the major impacts of COVID-19, and as of the date of this filing, those impacts can generally be grouped into the following categories:
•Changing customer needs. As commercial, personal, and social spheres continue to increasingly rely on online interactions and experiences worldwide, some of our customers’ businesses have seen increased activity or have begun to use our solutions in novel ways. Conversely, due to cash flow pressures on organizations worldwide, we expect to continue to see the COVID-19 pandemic impact our ability to attract and retain organizations of all sizes. The economic pressures affecting our customers and the resulting effects have and will continue to have an effect on our operating results, including our cash flows. We are continuing to understand the long-term net effect and anticipated future magnitude of the various factors introduced by COVID-19 on our results for future periods.
•Employee health and safety. We have continued to require all of our employees globally to work remotely, in order to minimize the spread of COVID-19 among our employee base and to comply with local regulations within the United States and internationally. We have invested resources in supporting our employees in a shift to remote work, including providing supplemental home office hardware, increasing the cadence of company-wide communications, improving the frequency and effectiveness of employee feedback, and analyzing current and future real estate needs. While we have not observed significant impacts to the productivity of our workforce, we continue to have a limited history of remote working and the long-term impact on, and the resulting types of continuing investments necessary for, our employee base.
•Evolving our organizational focus. In light of the need for organizations worldwide to assess an increasing reliance on online interactions resulting from COVID-19, we believe that our product and platform solutions will continue to play an increasingly essential role in customer experience for both current and potential customers. As some of our customers demonstrate a greater need to deploy customer experience solutions quickly and for new use cases, we believe in continuing our focus on providing solutions that are easy to implement, use, and scale, and have a quick time to value. We will increase our focus on those core strengths by continuing to simplify the experience of buying our solutions and enable our customers to provide a seamless omnichannel experience to their customers.
We may continue to experience curtailed customer demand for our solutions that could materially adversely impact our business, results of operations, and overall financial performance in future periods. Because we primarily have a subscription-based business model which generally results in recognition of revenue in subsequent periods originating from customer contracts executed in prior periods, the effect of the COVID-19 pandemic may not be fully reflected in our results of operations until future periods. See the Risk Factors section for further discussion of the possible impact of the COVID-19 pandemic on our business.
Key Business Metrics
We review a number of operating metrics, including the following key metrics, to evaluate our business, measure our performance, identify trends affecting our business, formulate business plans, and make strategic decisions.
Number of Paid Customer Accounts. We believe that our ability to increase our number of paid accounts using our solutions is an indicator of our market penetration, the growth of our business, and our potential future business opportunities. We define the number of paid customer accounts as the sum of the number of accounts on Zendesk Support, exclusive of our legacy Starter plan, free trials, or other free services, the number of accounts on Chat, exclusive of free trials or other free services, and the number of accounts on all of our other products, exclusive of free trials and other free services, each as of the end of the period and as identified by a unique account identifier.
In the quarter ended June 30, 2018, we began to offer an omnichannel subscription, which provides access to multiple solutions through a single paid customer account, Zendesk Suite, and in the quarter ended June 30, 2019, we began to offer a subscription which provides access to Sell and Support through a single paid customer account, Zendesk Duet. In the quarter ended March 31, 2020, we began to offer two new omnichannel subscriptions, the Zendesk Support Suite and the Zendesk Sell Suite, which provide access to multiple support solutions and sales solutions, respectively, through a single paid customer account. The number of Support Suite paid customer accounts are included in the number of paid customers on Suite, which are included in the number of paid customer accounts on products other than Support and Chat, and are not included in the number of paid customer accounts on Support or Chat. The number of Sell Suite paid customer accounts are included in the number of paid customer accounts on products other than Support and Chat, and are also included in the number of paid customer accounts on Support or Chat. Each Duet paid customer account is included once in the number of paid customer accounts on Support and once in the number of paid customer accounts on products other than Support and Chat.
Existing customers may also expand their utilization of our products by adding new accounts and a single consolidated organization or customer may have multiple accounts across each of our products to service separate subsidiaries, divisions, or work processes. Other than usage of our products through our omnichannel subscription offering, each of these accounts is also treated as a separate paid customer account. An increase in the number of paid customer accounts generally correlates to an increase in the number of authorized agents licensed to use our products, which directly affects our revenue and results of operations. We view growth in this metric as a measure of our success in converting new sales opportunities.
We had approximately 173,600 paid customer accounts as of December 31, 2020, including approximately 88,100 paid customer accounts on Support, approximately 39,000 paid customer accounts on Chat, and approximately 46,600 paid customer accounts on our other products. As the total number of paid customer accounts increases, we expect the rate of growth in the number of paid customer accounts to decline.
Dollar-Based Net Expansion Rate. Our ability to generate revenue is dependent upon our ability to maintain our relationships with our customers and to increase their utilization of our solutions. We believe we can achieve this by focusing on delivering value and functionality that retains our existing customers, expands the number of authorized agents associated with an existing paid customer account, and results in upgrades to higher-priced subscription plans and the purchase of additional products. Maintaining customer relationships allows us to sustain and increase revenue to the extent customers maintain or increase the number of authorized agents licensed to use our products. We assess our performance in this area by measuring our dollar-based net expansion rate. Our dollar-based net expansion rate provides a measurement of our ability to increase revenue across our existing customer base through expansion of authorized agents associated with a paid customer account, upgrades in subscription plans, and the purchase of additional products as offset by churn and contraction in authorized agents associated with a paid customer account, and downgrades in subscription plans. We do not currently incorporate operating metrics associated with our legacy analytics product, our legacy Outbound product, our legacy Starter plan, our Sell product, Sunshine Conversations, our legacy Smooch product, free trials, or other free services into our measurement of dollar-based net expansion rate.
Our dollar-based net expansion rate is based upon our annual recurring revenue for a set of paid customer accounts on our products. Annual recurring revenue is determined by multiplying monthly recurring revenue by 12. Monthly recurring revenue for a paid customer account is a legal and contractual determination made by assessing the contractual terms of each paid customer account, as of the date of determination, as to the revenue we expect to generate in the next monthly period for that paid customer account, assuming no changes to the subscription and without taking into account any usage above the subscription base, if any, that may be applicable to such subscription. Beginning with the quarter ended June 30, 2019, we excluded the impact of revenue that we expect to generate from fixed-term contracts that are each associated with an existing account, are solely for additional temporary agents, and are not contemplated to last for the duration of the primary contract for the existing account from our determination of monthly recurring revenue. Monthly recurring revenue is not determined by reference to historical revenue, deferred revenue, or any other United States generally accepted accounting principles, or GAAP, financial measure over any period. It is forward-looking and contractually derived as of the date of determination.
We calculate our dollar-based net expansion rate by dividing our retained revenue net of contraction and churn by our base revenue. We define our base revenue as the aggregate annual recurring revenue across our products from paid customer accounts as of the date one year prior to the date of calculation. We define our retained revenue net of contraction and churn as the aggregate annual recurring revenue across our products from the same customer base included in our measure of base revenue at the end of the annual period being measured. Our dollar-based net expansion rate is also adjusted to eliminate the effect of certain activities that we identify involving consolidation of customer accounts, or the split of a single paid customer account into multiple paid customer accounts. In addition, our dollar-based net expansion rate is adjusted to include paid customer accounts in the customer base used to determine retained revenue net of contraction and churn that share common corporate information with customers in the customer base that is used to determine our base revenue. Giving effect to this consolidation would result in our dollar-based net expansion rate being calculated across approximately 112,300 customers, as compared to the approximately 173,600 total paid customer accounts as of December 31, 2020. To the extent that we can determine that the underlying customers do not share common corporate information, we do not aggregate paid customer accounts associated with reseller and other similar channel arrangements for the purposes of determining our dollar-based net expansion rate.
Our dollar-based net expansion rate was 112% as of December 31, 2020. We expect that, among other factors, our continued focus on adding larger paid customer accounts at the time of addition and the growth in our revenue will result in an overall decline in our dollar-based net expansion rate over time as our aggregate annual recurring revenue grows. Given the uncertainty of the economic conditions arising from the impact of COVID-19, in the near term, we expect that we may have a dollar-based net expansion rate that continues to fall below historical trends.
Components of Results of Operations
Revenue
We derive substantially all of our revenue from subscription services, which are comprised of subscription fees from customer accounts on Support and, to a lesser extent, Chat, Talk, Guide, Sell, Explore, Gather and Sunshine and includes related support services. We also derive revenue from Zendesk Suite, which provides a subset of these solutions for a single price. Each subscription may have multiple authorized users, and we refer to each user as an “agent.” The number of agents ranges from one to thousands for various customer accounts. Our pricing is generally established on a per agent basis. We offer a range of subscription account plans for our solutions that vary in price based on functionality, type, and the amount of support we offer. We also offer a range of additional features that customers can purchase and add to their subscriptions. Certain arrangements provide for incremental fees above a fixed maximum number of monthly agents during the subscription term. Additionally, certain customers have arrangements that provide for unlimited users during the subscription term for a fixed fee. We sell subscription services under contractual agreements that vary in length, ranging between one month and multiple years, with the majority of subscriptions having a term of either one month or one year.
Subscription fees are generally non-refundable regardless of the actual use of the service. Subscription revenue is typically affected by the number of customer accounts, number of agents, and the type of plan purchased by our customers, and is recognized ratably over the term of the arrangement beginning on the date that our services are made available to our customers. Subscription services purchased online are typically paid for via a credit card on the date of purchase while subscription services purchased through our internal sales organization are generally billed with monthly, quarterly, or annual payment frequencies. Due to our mixed contract lengths and billing frequencies, the annualized value of the arrangements we enter into with our customers may not be fully reflected in deferred revenue at any single point in time. Accordingly, we do not believe that the change in deferred revenue for any period provides sufficient context to accurately predict our future revenue for a given period of time.
We also derive revenue from implementation and training services, for which we recognize revenue based on proportional performance, and Talk usage, for which we recognize revenue based on usage.
Cost of Revenue, Gross Margin, and Operating Expenses
Cost of Revenue. Cost of revenue consists primarily of personnel costs (primarily including salaries, share-based compensation, and benefits) for employees associated with our infrastructure, product support, and professional service organizations, and expenses for hosting capabilities, primarily for third-party managed hosting services and costs associated with our self-managed colocation data centers. Cost of revenue also includes third-party license fees, payment processing fees, amortization expense associated with acquired intangible assets, amortization expense associated with capitalized internal-use software, and allocated shared costs. We allocate shared costs such as facilities, information technology, and security costs to all departments based on headcount. As such, allocated shared costs are reflected in cost of revenue and each operating expense category.
We utilize third-party managed hosting facilities located in North America, Europe, Asia and Australia to host our services, support our infrastructure, and support certain research and development functions. In the first quarter of 2019, we completed the transition of our customers from self-managed colocation data centers to third-party managed hosting services.
We intend to continue to invest additional resources in our infrastructure, professional service organizations, and product support organically and through acquisitions. We expect that recent and future business acquisitions will result in increased amortization expense of intangible assets such as acquired technology. As we continue to invest in technology innovation, we expect to continue to incur capitalized internal-use software costs and related amortization. We expect these investments in technology to not only expand the capabilities of our solutions but also to increase the efficiency of how we deliver these services, enabling us to improve our gross margin over time, although our gross margin may decrease in the near-term and may vary from period to period as our revenue fluctuates and as a result of the timing and amount of these investments. To the extent that we continue to rely on third-party technology to provide certain functionality within our solutions or for certain subscription plans or integrations, we expect third-party license fees for technology that is incorporated in such solutions and subscription plans to remain significant over time.
Gross Margin. Gross margin is gross profit expressed as a percentage of revenue. Our gross margin may fluctuate from period to period as our revenue fluctuates and as a result of the timing and amount of usage of third-party managed hosting resources, investments to expand our product support and professional services teams, investments in additional personnel, increased share-based compensation expense, as well as the amortization of certain acquired intangible assets, costs associated with capitalized internal-use software, and third-party license fees.
Research and Development. Research and development expenses consist primarily of personnel costs (primarily including salaries, share-based compensation, and benefits) for employees associated with our research and development organization and allocated shared costs.
We focus our research and development efforts on the continued development of our solutions, including the development and deployment of new features and functionality and enhancements to our software architecture and integration across our solutions. We expect that, in the future, research and development expenses will increase in absolute dollars. However, we expect our research and development expenses to decrease modestly as a percentage of our revenue in the long-term, although this may fluctuate from period to period depending on fluctuations in revenue and the timing and the extent of our research and development expenses.
Sales and Marketing. Sales and marketing expenses consist of personnel costs (primarily including salaries, share-based compensation, sales commissions, and benefits) for employees associated with our sales and marketing organizations, costs of marketing activities, and allocated shared costs. Marketing activities include online and offline marketing initiatives, including digital advertising, such as search engine, paid social, e-mail and product marketing, content marketing, user events, conferences, corporate communications, web marketing and optimization, and outbound list and contact generation. Sales commissions are considered incremental costs of obtaining customer contracts and are capitalized and amortized on a straight-line basis over their anticipated period of benefit, which we have determined to be three years.
We focus our sales and marketing efforts on generating awareness of our solutions, establishing and promoting our brand, and cultivating a community of successful and vocal customers. We plan to continue investing in sales and marketing by increasing the number of sales employees, developing our marketing teams, improving our demand generation strategies, and building brand awareness, which we believe will enable us to add new customers and increase penetration within our existing customer base. Because we do not have a long history of undertaking or growing many of these activities, we cannot predict whether, or to what extent, our revenue will increase as we invest in these strategies. We expect our sales and marketing expenses to continue to increase in absolute dollars and continue to be our largest operating expense category for the foreseeable future. Our sales and marketing expenses as a percentage of our revenue over time may fluctuate from period to period depending on fluctuations in revenue and the timing and extent of our sales and marketing expenses.
General and Administrative. General and administrative expenses consist primarily of personnel costs (primarily including salaries, share-based compensation, and benefits) for our executive, finance, legal, human resources, and other administrative employees. In addition, general and administrative expenses include fees for third-party professional services, including legal, accounting, and tax related services, other corporate expenses, and allocated shared costs.
We expect to incur incremental costs associated with supporting the growth of our business, both in terms of size and geographic expansion, and the infrastructure required to be a public company. Such costs include increases in our finance, legal, and human resources personnel, additional legal, accounting, tax, and compliance-related services fees, insurance costs, and costs of executing significant transactions, including business acquisitions, and other costs associated with being a public company. As a result, we expect our general and administrative expenses to continue to increase in absolute dollars for the foreseeable future. Our general and administrative expenses as a percentage of our revenue over time may fluctuate from period to period depending on fluctuations in revenue and the timing and extent of our general and administrative expenses.
Other Income (Expense), Net
Other income (expense), net consists primarily of interest income from marketable securities, strategic investment gains and losses, foreign currency gains and losses, interest expense from our convertible senior notes, and loss on early extinguishment of debt. Interest expense includes amortization of the debt discount, amortization of issuance costs, and contractual interest expense.
Provision for (Benefit from) Income Taxes
Provision for (benefit from) income taxes consists of federal and state income taxes in the United States, income taxes in certain foreign jurisdictions, and a non-cash benefit in 2018 related to the issuance of our convertible senior notes.
Results of Operations for Fiscal Years 2020, 2019, and 2018
The following tables set forth our results of operations for the periods presented in dollars and as a percentage of our revenue (in thousands):
(1) Includes share-based compensation expense as follows (in thousands):
(1)Includes share-based compensation expense as follows:
Revenue
Revenue increased $213 million, or 26%, in 2020 compared to 2019. The total increase in revenue was primarily attributable to expansions from existing accounts as of December 31, 2019 and the remainder was attributable to revenue from new accounts acquired thereafter.
Revenue increased $218 million, or 36%, in 2019 compared to 2018. The total increase in revenue was primarily attributable to expansions from existing accounts as of December 31, 2018 and the remainder was attributable to revenue from new accounts acquired thereafter. Revenue for the year ended December 31, 2019 includes revenue from Smooch Technologies Holdings ULC, or Smooch.
Cost of Revenue and Gross Margin
Cost of revenue increased $17 million, or 7%, in 2020 compared to 2019. The overall increase was primarily due to increased expenditures for third-party managed hosting services of $9 million and increased third-party license fees of $4 million, due to increased customer usage. The increase was also driven by increased employee compensation-related costs of $2 million, mainly driven by headcount growth and incentive compensation.
Our gross margin increased by 4.3 percentage points in 2020 compared to 2019, driven primarily by increased optimization of our personnel costs in our product support organization and efficiency from our hosting infrastructure.
Cost of revenue increased $53 million, or 29%, in 2019 compared to 2018. The overall increase was primarily due to increased employee compensation-related costs of $23 million, driven by headcount growth, increased hosting costs of $9 million, and increased third-party license fees of $6 million. The increase in hosting costs was driven by an increase in expenditures for third-party managed hosting services, partially offset by lower depreciation from our self-managed colocation data centers in connection with our transition to third-party managed hosting services. The increase in third-party license fees was driven by increased customer usage. Further contributing to the overall increase was an increase in allocated shared costs of $4 million, primarily related to facilities and information technology.
Our gross margin increased by 1.6 percentage points in 2019 compared to 2018, driven primarily by efficiency from our hosting infrastructure, including our transition to third-party managed hosting services.
Operating Expenses
Research and Development Expenses
Research and development expenses increased $48 million, or 23%, in 2020 compared to 2019. The overall increase was primarily due to increased employee compensation-related costs of $40 million, driven by headcount growth and incentive compensation. Further contributing to the increase was an increase in allocated shared costs of $5 million.
Research and development expenses increased $47 million, or 30%, in 2019 compared to 2018. The overall increase was primarily due to increased employee compensation-related costs of $34 million, driven by headcount growth, and increased allocated shared costs of $8 million.
Sales and Marketing Expenses
Sales and marketing expenses increased $116 million, or 29%, in 2020 compared to 2019. The overall increase was primarily due to increased employee compensation-related costs, including amortization of capitalized commissions, of $103 million, driven by headcount growth, and an increase in allocated shared costs of $16 million. The overall increase was partially offset by decreased travel costs of $9 million, driven by reduced in-person activities due to the COVID-19 pandemic.
Sales and marketing expenses increased $105 million, or 36%, in 2019 compared to 2018. The overall increase was primarily due to increased employee compensation-related costs, including amortization of capitalized commissions, of $72 million, driven by headcount growth, and an increase in marketing program costs of $8 million. The increase in marketing program costs was driven by increased volume of advertising activities. Further contributing to the overall increase was an increase in allocated shared costs of $14 million.
General and Administrative Expenses
General and administrative expenses increased $25 million, or 18%, in 2020 compared to 2019. The overall increase was primarily driven by a real estate impairment charge of $15 million in the fourth quarter of 2020 and increased employee compensation-related costs of $12 million, driven by headcount growth and incentive compensation. Further contributing to the overall increase was an increase in bad debt expense of $5 million, driven by a reduction in customer collectibility caused by the COVID-19 pandemic. The overall increase was partially offset by acquisition related costs of $6 million associated with our acquisition of Smooch and accelerated retention compensation of $3 million, recorded in 2019.
General and administrative expenses increased $38 million, or 36%, in 2019 compared to 2018. The overall increase was primarily due to increased employee compensation-related costs of $15 million, driven by headcount growth. The overall increase was also driven by acquisition related costs of $6 million associated with our acquisition of Smooch and accelerated retention compensation of $3 million. Further contributing to the overall increase was an increase in allocated shared costs of $3 million.
Other Income (Expense), Net
*not meaningful
Interest expense increased $17 million, or 62%, in 2020 compared to 2019 primarily due to the issuance of the 2025 Notes. The loss on early extinguishment of debt of $26 million in 2020 was due to the 2023 Notes Partial Repurchase. Interest and other income (expense), net decreased by $9 million in 2020 compared to 2019, primarily due to a decrease in interest rates, partially offset by a gain on the sale of a strategic investment of $1 million in 2020.
Interest expense increased $7 million, or 34%, in 2019 compared to 2018 due to the issuance of the 2023 Notes in March 2018. Interest and other income (expense), net increased $7 million, or 46%, in 2019 compared to 2018, primarily due to the increase in the amount of marketable securities from the proceeds received from the issuance of the 2023 Notes.
Provision for (Benefit from) Income Taxes
*not meaningful
Provision for income taxes increased $4 million in 2020 compared to 2019 primarily due to income taxes in foreign jurisdictions and the adoption of ASU 2019-12.
Provision for income taxes increased $13 million in 2019 compared to 2018 primarily due to the recognition of a net income tax benefit of $14 million in 2018 related to the issuance of the 2023 Notes.
The effective tax rate for each period differs from the statutory rate primarily as a result of not recognizing a deferred tax asset for U.S. losses due to having a full valuation allowance against U.S. deferred tax assets.
Quarterly Results of Operations
The following unaudited quarterly results of operations data for each of the eight quarters in the two-year period ended December 31, 2020 have been prepared on a basis consistent with our audited consolidated annual financial statements and include, in management’s opinion, all normal recurring adjustments necessary for the fair presentation of the results of operations data for these periods, in accordance with GAAP. The following quarterly financial data should be read in conjunction with our consolidated financial statements and the related notes included in this Annual Report on Form 10-K. The results of historical periods are not necessarily indicative of the results of operations for any future period.
(1)Includes share-based compensation expense as follows:
(1)Includes share-based compensation expense as follows:
Quarterly Trends in Revenue
Our quarterly revenue increased sequentially for each period presented, primarily due to the continued expansion of existing customer accounts and the addition of new customer accounts. We cannot assure you that this pattern of sequential growth in revenue will continue.
Our revenue in the first quarter of any fiscal year is negatively impacted relative to the preceding fourth quarter due to the fewer number of days in the first quarter over which we record subscription revenue as compared to the preceding fourth quarter.
Quarterly Trends in Expenses
Our quarterly expenses increased sequentially for all but two periods presented, primarily due to increased compensation-related costs related to an increase in headcount in connection with the expansion of our business. Total expenses in the second quarter of 2020 reflect decreased levels of certain operating expenses due to the COVID-19 pandemic, and total
expenses in the second quarter of 2019 included certain one-time general and administrative costs. Refer to Results of Operations above for further discussion.
Seasonality
We have experienced, and expect to continue to experience in the future, seasonality in our business, and our operating results and financial condition may be affected by such trends in the future. We generally experience seasonal fluctuations in demand for our solutions and services, and believe that our quarterly sales are affected by industry buying patterns. For example, we typically have customers who add flexible agents when they need more capacity during busy periods, especially in the fourth quarter, and then subsequently scale back in the first quarter of the following year. We believe that the seasonal trends that we have experienced in the past may continue for the foreseeable future.
Liquidity and Capital Resources
As of December 31, 2020, our principal sources of liquidity were cash, cash equivalents and marketable securities totaling $1,400 million, which were held for working capital and general corporate purposes. Our cash equivalents and marketable securities are comprised of U.S. Treasury securities, corporate bonds, money market funds, asset-backed securities, agency securities, commercial paper, certificates of deposit, and time deposits.
The following table summarizes our cash flows for the periods indicated (in thousands):
To date, we have financed our operations primarily through customer payments for subscription services, the issuance of our convertible senior notes, and public and private equity financings. Cash from operations could also be affected by various risks and uncertainties, including, but not limited to, the effects of the COVID-19 pandemic, including timing of cash collections from our customers, and other risks detailed in the Risk Factors section. However, based on our current business plan and revenue prospects, we believe that our existing cash, cash equivalents, and marketable securities balances, together with cash generated from operations, will be sufficient to meet our working capital and capital expenditure requirements for at least the next 12 months.
In March 2018, we issued $575 million aggregate principal amount of 0.25% convertible senior notes due March 15, 2023 (refer to Note 9 of the Notes to our Consolidated Financial Statements for more information). As of the date of this filing, we have received one request for conversion for an immaterial amount. The 2023 Notes are convertible during the three months ending March 31, 2021.
In June 2020, we issued $1,150 million aggregate principal amount of 0.625% convertible senior notes due June 15, 2025 (refer to Note 9 of the Notes to our Consolidated Financial Statements for more information). In connection with the offering of the 2025 Notes, we used $618 million of the proceeds from the offering to repurchase a portion of the 2023 Notes, of which $39 million was related to repayment of the debt discount and was reflected as a cash outflow from operating activities. We also terminated a portion of our existing capped call in amounts corresponding to the principal of the 2023 Notes repurchased. The 2025 Notes are not convertible during the three months ending March 31, 2021.
We are in compliance with all covenants under both the 2023 Notes and the 2025 Notes as of December 31, 2020.
The impact of the 2023 Notes and the 2025 Notes on our liquidity will depend on whether we elect to settle any conversions in shares of our common stock or a combination of cash and shares. We currently intend to settle the principal amount of any converted convertible senior notes in cash.
Our future capital requirements will depend on many factors, including employee-related expenditures from expansion of our headcount, hosting costs to support the growth in our customer accounts and continued customer expansion, the timing and extent of spending to support product development efforts, the expansion of sales and marketing activities, the introduction of new and enhanced solutions, features, and functionality, and costs related to building out our leased office facilities. We may in the future enter into arrangements to acquire or invest in complementary businesses, services, and technologies, and intellectual
property rights. We may be required to seek additional equity or debt financing in order to meet these future capital requirements. In the event that additional financing is required from outside sources, we may not be able to raise it on terms acceptable to us, or at all. If we are unable to raise additional capital when desired, our business, results of operations, and financial condition would be adversely affected.
Operating Activities
Our largest source of operating cash inflows is cash collections from our customers. Our primary uses of cash from operating activities are for employee-related expenditures, hosting costs, office facilities, and marketing programs.
Net cash provided by operating activities in 2020 was $26 million, reflecting our net loss of $218 million, adjusted by non-cash charges including share-based compensation expense of $182 million, amortization of deferred costs of $45 million, depreciation and amortization expense of $42 million, amortization of debt discount and issuance costs of $39 million, loss on early extinguishment of debt of $26 million, a real estate impairment of $15 million, and increase in allowance for credit losses on accounts receivable of $10 million, partially offset by repayment of debt discount of $39 million related to the 2023 Notes Partial Repurchase and net changes in operating assets and liabilities of $82 million. The net outflow from changes in operating assets and liabilities was primarily attributable to an increase in accounts receivable of $81 million due to the timing of customer billings and collections, an increase in deferred costs of $77 million, primarily related to sales commissions, and a decrease in accounts payable of $21 million due to timing of payments, partially offset by an increase in deferred revenue of $59 million due to sales growth and the timing of customer billings and an increase in accrued compensation and related benefits of $38 million.
Net cash provided by operating activities in 2019 was $89 million, reflecting our net loss of $170 million, adjusted by non-cash charges including share-based compensation expense of $157 million, depreciation and amortization expense of $39 million, amortization of deferred costs of $32 million, amortization of debt discount and issuance costs of $25 million, and net changes in operating assets and liabilities of $5 million. The net inflow from changes in operating assets and liabilities was primarily attributable to an increase in deferred revenue of $78 million due to sales growth and the timing of customer billings, and an increase in accounts payable and accrued compensation of $33 million due to overall growth in our business and timing of payments. These sources of cash were offset by an increase in deferred costs of $50 million, primarily related to sales commissions, an increase in accounts receivable of $50 million due to the timing of customer billings and collections, and an increase in prepaid expenses and other current assets of $8 million.
Net cash provided by operating activities in 2018 was $79 million, reflecting our net loss of $131 million, adjusted by non-cash charges including share-based compensation expense of $119 million, depreciation and amortization expense of $37 million, amortization of deferred costs of $21 million, amortization of debt discount and issuance costs of $19 million, partially offset by income tax benefit related to convertible senior notes of $14 million, and net changes in operating assets and liabilities of $25 million. The net inflow from changes in operating assets and liabilities was primarily attributable to an increase in deferred revenue of $73 million due to sales growth and the timing of customer billings, and an increase in accrued compensation of $15 million due to overall growth in our business and timing of payments. These sources of cash were offset by an increase in deferred costs of $41 million, primarily related to sales commissions, an increase in accounts receivable of $30 million due to the timing of customer billings and collections, and an increase in prepaid expenses and other current assets of $11 million.
Investing Activities
Net cash used in investing activities in 2020 of $382 million was primarily attributable to purchases of marketable securities of $344 million, net of sales and maturities, purchases of property and equipment of $23 million primarily associated with leasehold improvements for newly leased office facilities, and capitalized internal-use software costs of $16 million related to the development of additional features and functionality for our platform.
Net cash used in investing activities in 2019 of $67 million was primarily attributable to cash paid for the acquisition of Smooch, net of cash acquired, of $71 million, purchases of property and equipment of $39 million primarily associated with leasehold improvements for newly leased office facilities, and capitalized internal-use software costs of $8 million related to the development of additional features and functionality for our platform, partially offset by proceeds from sales and maturities of marketable securities of $52 million, net of purchases.
Net cash used in investing activities in 2018 of $590 million was primarily attributable to purchases of marketable securities of $458 million, net of sales and maturities, cash paid for the acquisition of FutureSimple, net of cash acquired, of $79 million, purchases of property and equipment of $35 million primarily associated with leasehold improvements for
newly leased office facilities, and capitalized internal-use software costs of $7 million related to the development of additional features and functionality for our platform.
Financing Activities
Net cash provided by financing activities in 2020 of $564 million was primarily attributable to proceeds from issuance of the 2025 Notes of $1,129 million, proceeds from the termination of capped calls related to the 2023 Notes of $83 million, proceeds from our employee stock purchase plan of $40 million, and proceeds from exercises of employee stock options of $29 million, partially offset by payment for the 2023 Notes Partial Repurchase of $579 million, the purchase of the capped calls related to the 2025 Notes of $130 million, and payments for withholding taxes related to net share settlement of RSUs of $9 million.
Net cash provided by financing activities in 2019 of $48 million was primarily attributable to proceeds from our employee stock purchase plan of $31 million and proceeds from exercises of employee stock options of $26 million, partially offset by payments for withholding taxes related to net share settlement of RSUs of $10 million.
Net cash provided by financing activities in 2018 of $529 million was primarily attributable to net proceeds from the issuance of the 2023 Notes of $561 million, proceeds from our employee stock purchase plan of $21 million, and proceeds from exercises of employee stock options of $16 million, partially offset by the purchase of the capped calls related to the 2023 Notes of $64 million.
Contractual Obligations and Other Commitments
Our principal commitments consist of our convertible senior notes, contractual commitments for third-party managed hosting and other support services, and obligations under operating leases for office space. The following table summarizes our contractual obligations as of December 31, 2020 (in thousands):
(1) Includes principal and interest payments. For more information regarding our convertible senior notes, refer to Note 9 of the Notes to our Consolidated Financial Statements included in this Annual Report on Form 10-K.
(2) Primarily relates to third-party managed hosting services.
(3) Represents obligations under non-cancellable lease agreements for our corporate headquarters and worldwide offices.
Off-Balance Sheet Arrangements
Through December 31, 2020, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities that would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
Critical Accounting Policies and Estimates
We prepare our consolidated financial statements in accordance with GAAP. In the preparation of these consolidated financial statements, we are required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations would be affected. We base our estimates on past experience and other assumptions that we believe are reasonable under the circumstances, and we evaluate these estimates on an ongoing basis. We refer to accounting estimates of this type as critical accounting policies and estimates, which we discuss below.
Revenue Recognition
We generate substantially all of our revenue from subscription services, which are comprised of subscription fees from customer accounts on Zendesk Support and, to a lesser extent, Chat, Talk, Guide, Sell, Explore, Gather and Sunshine and includes related support services. We also derive revenue from Suite, which provides a subset of these solutions for a single price.
Additionally, we derive revenue from implementation and training services, for which we recognize revenue based on proportional performance, and Talk usage, for which we recognize revenue based on usage.
Subscription revenue is recognized on a ratable basis over the contractual subscription term of the arrangement, as the underlying service is a stand-ready performance obligation, beginning on the date that our service is made available to the customer. Payments received in advance of services being rendered are recorded as deferred revenue.
Certain customers have arrangements that provide for a maximum number of users over the subscription term, with usage measured monthly, and additional fees are incurred for incremental users above the maximum. In determining the transaction price for these arrangements, we evaluate the expected usage and estimate any additional fees that we are entitled to throughout the subscription term and recognize revenue ratably over the subscription term. Our estimates for expected usage are based on the trend of historical usage as of each reporting period. We constrain our estimates based on the length of the remaining subscription term, seasonality, and other relevant economic or other factors, as applicable. To date, there have been no significant reversals of revenue recognized.
Costs to Obtain Customer Contracts
Sales commissions and related expenses are capitalized and amortized on a straight-line basis over their anticipated period of benefit, which we have estimated to be three years. Significant judgment is required in arriving at this average period of benefit. We determined the period of benefit by taking into consideration the length of our customer contracts, our technology lifecycle, and other factors.
Capitalized Internal-Use Software Costs
We capitalize certain development costs incurred in connection with software development for our platform and software used in operations. Costs incurred in the preliminary stages of development are expensed as incurred. Once software has reached the development stage, internal and external costs, if direct and incremental, are capitalized until the software is substantially complete and ready for its intended use. Capitalization ceases upon completion of all substantial testing. We also capitalize costs related to specific upgrades and enhancements when it is probable the expenditures will result in additional functionality. Capitalized costs are recorded as part of property and equipment. Maintenance and training costs are expensed as incurred.
Capitalized internal-use software is amortized on a straight-line basis over its estimated useful life and recorded in cost of revenue within the accompanying consolidated statements of operations. We evaluate the useful lives of these assets and test for impairment whenever events or changes in circumstances occur that could impact the recoverability of these assets. There were no material impairments to internal-use software during the years ended December 31, 2020, 2019, or 2018 other than those disclosed in Note 6 of the Notes to our Consolidated Financial Statements.
Business Combinations and Valuation of Goodwill and Acquired Intangible Assets
When we acquire a business, we allocate the purchase price to the net tangible and identifiable intangible assets acquired. Any residual purchase price is recorded as goodwill. The allocation of the purchase price requires management to make significant estimates in determining the fair values of assets acquired and liabilities assumed, especially with respect to intangible assets. These estimates can include, but are not limited to, the cash flows that an asset is expected to generate in the future, the appropriate weighted-average cost of capital, and the cost savings expected to be derived from acquiring an asset. These estimates are inherently uncertain and unpredictable.
Goodwill is evaluated for impairment annually in the third quarter, and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. Triggering events that may indicate impairment include, but are not limited to, a significant adverse change in customer demand or business climate or a significant decrease in expected cash flows. Goodwill is evaluated for impairment at the consolidated level, as we operate as a single reporting unit.
Acquired intangible assets consist of identifiable intangible assets, primarily developed technology and customer relationships, resulting from our acquisitions. Acquired intangible assets are recorded at fair value on the date of acquisition and
amortized over their estimated useful lives. The carrying amounts of our acquired intangible assets are periodically reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable or that the useful life is shorter than originally estimated.
Recently Issued and Adopted Accounting Pronouncements
Refer to Note 2 of the Notes to our Consolidated Financial Statements included in this Annual Report on Form 10-K for a summary of recently issued and adopted accounting pronouncements.
Item 7A.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
Foreign Currency Exchange Rate Risk
While we primarily transact with customers in the U.S. dollar, we also transact in foreign currencies, including the Euro, British Pound Sterling, Australian Dollar, Singapore Dollar, Danish Krone, Brazilian Real, Philippine Peso, Japanese Yen, Indian Rupee, Korean Won, Polish Zloty, Canadian Dollar, and Mexican Peso due to foreign operations and customer sales. We expect to continue to grow our foreign operations and customer sales. Our international subsidiaries maintain certain asset and liability balances that are denominated in currencies other than the functional currencies of these subsidiaries, which is the U.S. dollar for all international subsidiaries. Changes in the value of foreign currencies relative to the U.S. dollar can result in fluctuations in our total assets, liabilities, revenue, operating expenses, and cash flows. As of December 31, 2020, the effect of a hypothetical 10% change in foreign currency exchange rates applicable to our business would not have had a material impact on our cash and marketable securities.
We operate a hedging program to mitigate the impact of foreign currency fluctuations on our cash flows and earnings. For additional information, see Note 4 of the Notes to our Consolidated Financial Statements included in this Annual Report on Form 10-K.
Interest Rate and Market Risk
We had cash, cash equivalents and marketable securities totaling $1,400 million at December 31, 2020, of which $1,189 million was invested in U.S. Treasury securities, corporate bonds, money market funds, asset-backed securities, agency securities, commercial paper, certificates of deposit, and time deposits. The cash and cash equivalents are held for working capital and general corporate purposes. Our investments in marketable securities are made for capital preservation purposes. We do not enter into investments for trading or speculative purposes.
Our cash equivalents and marketable securities are subject to market risk due to changes in interest rates. Fixed rate securities may have their market value adversely affected due to a rise in interest rates, while floating rate securities may produce less income than expected if interest rates fall. Due in part to these factors, our future investment income may fluctuate due to changes in interest rates or we may suffer losses in principal if we are forced to sell securities that decline in market value due to changes in interest rates. Our debt securities are classified as “available for sale.” When the fair value of the security declines below its amortized cost basis, any portion of that decline attributable to credit losses, to the extent expected to be nonrecoverable before the sale of the security, is recognized in our consolidated statement of operations. When the fair value of the security declines below its amortized cost basis due to changes in interest rates, such amounts are recorded in other comprehensive income, and are recognized in our consolidated statement of operations only if we sell or intend to sell the security before recovery of its cost basis.
As of December 31, 2020, an immediate increase of 100-basis points in interest rates would have resulted in a decline in the fair value of our cash equivalents and portfolio of marketable securities of approximately $9 million. This estimate is based on a sensitivity model that measures market value changes when changes in interest rates occur.
We had non-controlling equity investments in privately-held companies totaling $11 million as of December 31, 2020. The fair value of these strategic investments may fluctuate depending on the financial condition and near-term prospects of these companies, and we may be required to record an impairment loss if the carrying value of these investments exceed their fair values.
In March 2018, we issued $575 million aggregate principal amount of 0.25% convertible senior notes due 2023. In June 2020, we issued $1,150 million aggregate principal amount of 0.625% convertible senior notes due 2025. In connection with offering of the 2025 Notes, we used part of the proceeds from the offering to repurchase a portion of the 2023 Notes. The fair values of our convertible senior notes are subject to interest rate risk, market risk and other factors due to the conversion feature. The fair values of the convertible senior notes will generally increase as our common stock price increases and will generally decrease as our common stock price declines. The interest and market value changes affect the fair values of our convertible senior notes but do not impact our financial position, cash flows or results of operations due to the fixed nature of the debt obligations. Additionally, we carry the convertible senior notes at face value less unamortized discount on our balance sheet, and we present the fair value for required disclosure purposes only.
The table below provides a sensitivity analysis of hypothetical 10% changes of our stock price as of December 31, 2020 and the estimated impact on the fair value of the convertible senior notes (in thousands). The selected scenarios are not
predictions of future events, but rather are intended to illustrate the effect such events may have on the fair value of the convertible senior notes.
Item 8.
Item 8. Financial Statements and Supplementary Data.
ZENDESK, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Page
Reports of Ernst & Young LLP, Independent Registered Public Accounting Firm
Consolidated Balance Sheets
Consolidated Statements of Operations
Consolidated Statements of Comprehensive Loss
Consolidated Statements of Stockholders' Equity
Consolidated Statements of Cash Flows
Notes to Consolidated Financial Statements
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of Zendesk, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Zendesk, Inc. (the Company) as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive loss, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) and our report dated February 12, 2021 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Revenue Recognition
Description of the MatterAs described in Note 2 of the consolidated financial statements, the Company recognizes revenue when control of promised services is transferred to customers. The Company must assess whether promises made to customers represent distinct performance obligations, the appropriate measure of the transfer of control and when the transfer of control has occurred. These assessments can require significant judgment, particularly when contracts include non-standard terms. In addition, key inputs important to revenue recognition, including those related to the transaction price, and the period over which control of performance obligations is transferred, are input in systems that are different from systems where the calculations are performed, and where revenue is ultimately recorded.
Auditing the Company’s accounting for revenue recognition was challenging because certain determinations, such as whether performance obligations are distinct and the timing of revenue recognition, require judgment. For example, there were nonstandard terms and conditions that required judgment to determine if distinct performance obligations were created, and the impact on the timing of revenue recognition.
How We Addressed the Matter in Our AuditWe obtained an understanding, evaluated the design and tested the operating effectiveness of controls over the Company's process to identify and evaluate performance obligations including identification and consideration of non-standard contractual terms, the transaction price, the measure of progress of the transfer of control, and whether system controls that are important to the initiation, recording and billing of revenue transactions were effective and underlying data was complete and accurate.
Among other audit procedures, we read a sample of contracts and evaluated whether management appropriately identified and considered terms within those documents that would affect revenue recognition. For a sample of contracts, we assessed whether the timing of revenue recognition was appropriate. We also evaluated the accuracy and completeness of the underlying data used in management's determination of relative selling prices, and the reasonableness of management’s judgments. We also incorporated IT professionals with appropriate skills and expertise as members of our team to assess whether revenue systems were properly configured.
Accounting for Issuance and Repurchase of Convertible Notes
Description of the MatterAs described in Note 9 of the consolidated financial statements, in June 2020 the Company issued $1.15 billion of 0.625% convertible senior notes due June 15, 2025 (2025 Notes), which permit the Company to settle conversions in cash, stock, or any combination thereof. In connection with the offering of the 2025 Notes, the Company entered into separate capped call transactions to reduce potential dilution upon conversion of the 2025 Notes. Simultaneous with the issuance of the 2025 Notes, the Company repurchased a portion of the convertible notes issued in March 2018, due March 15, 2023 (2023 Notes) (2023 Notes Partial Repurchase) and accounted for this transaction as a debt extinguishment. These transactions are collectively referred to as the Convertible Notes Transactions.
Auditing the Company’s accounting for the Convertible Notes Transactions was complex due to the significant judgment required in determining the liability component of the related convertible notes as well as the balance sheet classification of the elements of the 2025 Notes. The Company accounted for the Convertible Notes Transactions as separate liability and equity components, determined the fair value of the respective liability components based on an estimate of the fair value of a similar liability without a conversion option and assigned the residual value to the equity component.
The Company estimated the fair value of the liability component of the 2025 Notes and 2023 Notes using a discounted cash flow model incorporating an effective yield reflecting their estimated borrowing rate for nonconvertible debt with similar terms but without an embedded conversion feature. In estimating the effective yield, the Company used both an income and market approach. For the income approach, the Company used a convertible bond pricing model, which included several assumptions including volatility and a risk-free rate. For the market approach, the Company performed an evaluation of issuances of nonconvertible debt securities by other comparable companies with similar maturities. Additionally, a detailed analysis of the terms of the 2025 Notes was required to determine existence of any derivatives that may require separate mark-to-market accounting under applicable accounting guidance.
How We Addressed the Matter in Our AuditWe obtained an understanding, evaluated the design, and tested the operating effectiveness of controls over the accounting for the Company’s Convertible Notes Transactions. For example, we tested the Company’s controls over the initial recognition and measurement of the Convertible Notes Transactions, including the recording of the associated liability and equity components.
Among other procedures, to test the initial accounting for the Convertible Notes we read the underlying agreements and evaluated the Company’s accounting analysis of the initial accounting of the Convertible Notes Transactions, including the determination of the balance sheet classification of each transaction, and evaluated the identification of any derivatives included in the arrangements. To test the accounting for the 2023 Notes Partial Repurchase we assessed whether the requirements of a debt extinguishment were met.
Among other procedures, to evaluate the fair value of the liability components of the 2025 Notes and the 2023 Notes Partial Repurchase, we assessed the Company's selection of the valuation methodology and significant assumptions used by the Company, and the completeness and accuracy of the underlying data supporting the significant assumptions and estimates. We evaluated the Company’s assumptions used to determine the risk adjusted yield as well as its analysis of comparable issuances of debt securities by other companies. In addition, we involved a valuation specialist to assist in our assessment of the significant assumptions and methodology used by the Company.
/s/ Ernst & Young LLP
We have served as the Company's auditor since 2013.
San Francisco, CA
February 12, 2021
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of Zendesk, Inc.
Opinion on Internal Control Over Financial Reporting
We have audited Zendesk, Inc.’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), (the COSO criteria). In our opinion, Zendesk, Inc. (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2020, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of the Company as of December 31, 2020 and 2019, the related consolidated statements of operations, comprehensive loss, stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2020 and our report dated February 12, 2021 expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management's Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Ernst & Young LLP
San Francisco, CA
February 12, 2021
ZENDESK, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value and shares)
See Notes to Consolidated Financial Statements.
ZENDESK, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
(1) Includes share-based compensation expense as follows:
See Notes to Consolidated Financial Statements.
ZENDESK, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(In thousands)
See Notes to Consolidated Financial Statements.
ZENDESK, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(In thousands)
See Notes to Consolidated Financial Statements.
ZENDESK, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See Notes to Consolidated Financial Statements.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Organization
Zendesk was founded in Denmark in 2007 and reincorporated in Delaware in April 2009.
We are a software development company that provides software as a service, or SaaS, solutions that are intended to help organizations and their customers build better experiences. Our customer experience solutions are built upon a modern architecture that enables us and our customers to rapidly innovate, adapt our technology in novel ways, and easily integrate with other products and applications. With our origins in customer service, we have evolved our offerings over time to product and platform solutions that work together to help organizations understand the broader customer journey, improve communications across all channels, and engage where and when it's needed most.
References to Zendesk, the “Company,” “our,” or “we” in these notes refer to Zendesk, Inc. and its subsidiaries on a consolidated basis.
Note 2. Summary of Significant Accounting Policies
Basis of Presentation
The consolidated financial statements have been prepared in accordance with United States Generally Accepted Accounting Principles, or GAAP. The consolidated financial statements include the accounts of Zendesk, Inc. and its subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Reclassification
Certain prior year amounts have been reclassified for consistency with the current year presentation. These reclassifications had an immaterial effect on our reported results of operations.
Use of Estimates
The preparation of our consolidated financial statements in conformity with GAAP requires management to make certain estimates, judgments, and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenue and expenses during the reported periods.
Significant items subject to such estimates and assumptions include:
•the estimate of variable consideration related to revenue recognition;
•the estimate of credit losses for accounts receivable and marketable securities;
•the fair value and useful lives of acquired intangible assets;
•the capitalization and useful life of capitalized costs to obtain customer contracts;
•the valuation of strategic investments;
•the fair value and useful lives of property and equipment;
•the capitalization and useful lives of internal-use software;
•the lease term and incremental borrowing rate for lease liabilities;
•the fair value of our convertible senior notes;
•the fair value of asset retirement obligations;
•the fair value and expense recognition for certain share-based awards;
•the preparation of financial forecasts used in currency hedging;
•the recognition and measurement of legal contingencies; and
•the recognition of tax benefits and forecasts used to determine our effective tax rate.
In December 2019, the novel coronavirus and resulting disease (“COVID-19”) was reported and in March 2020 the World Health Organization declared it a pandemic. The extent of the impact of COVID-19 on our operational and financial performance will depend on certain developments, including the duration and spread of the outbreak, impact on our customers and our sales cycles, and impact on our employees, as discussed in more detail in the Overview section. During fiscal year 2020, this uncertainty resulted in a higher level of judgment related to our estimates and assumptions concerning variable consideration for revenue recognition, the estimate of credit losses for accounts receivable, and the valuation of strategic investments. For example, the uncertainty around our customers who have faced continued cash flow pressure and decreased demand for their products and services had a variable impact on our revenue from variable consideration and the allowance for credit losses.
As of the date of issuance of the financial statements, we are not aware of any specific events or circumstances that would require us to update our estimates, judgments, or to revise the carrying values of our assets or liabilities. These estimates may change, as new events occur and additional information is obtained, and are recognized in the consolidated financial statements as soon as they become known. Actual results could differ from those estimates and any such differences may be material to our financial statements.
Segment Information
Our chief operating decision maker reviews the financial information presented on a consolidated basis for purposes of allocating resources and evaluating our financial performance. Accordingly, we have determined that we operate in a single operating segment.
Revenue Recognition
We generate substantially all of our revenue from subscription services, which are comprised of subscription fees from customer accounts on Zendesk Support and, to a lesser extent, Chat, Talk, Guide, Sell, Explore, Gather and Sunshine and includes related support services. We also derive revenue from Zendesk Suite, which provides a subset of these product solutions for a single price. In addition, we generate revenue by providing additional features to certain of our subscription plans for a fee that is incremental to the base subscription rate for such plans. Subscription service arrangements are generally non-cancelable and do not provide for refunds to customers in the event of cancellations or any other right of return. We record revenue net of sales or excise taxes.
We also derive revenue from implementation and training services, for which we recognize revenue based on proportional performance, and Talk usage, for which we recognize revenue based on usage.
Revenues are recognized when control of these services is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for those services.
We determine revenue recognition through the following steps:
•Identification of the contract, or contracts, with a customer;
•Identification of the performance obligations in the contract;
•Determination of the transaction price;
•Allocation of the transaction price to the performance obligations in the contract; and
•Recognition of revenue when, or as, the performance obligations are satisfied.
Subscription revenue is recognized on a ratable basis over the contractual subscription term of the arrangement, as the underlying service is a stand-ready performance obligation, beginning on the date that our service is made available to the customer. Payments received in advance of services being rendered are recorded as deferred revenue.
Certain customers have arrangements that provide for a maximum number of users over the subscription term, with usage measured monthly, and additional fees are incurred for incremental users above the maximum. In determining the transaction price for these arrangements, we evaluate the expected usage and estimate any additional fees that we are entitled to throughout the subscription term and recognize revenue ratably over the subscription term. In making these assessments, we constrain our estimates based on factors that could lead to a probable significant reversal of cumulative revenue recognized. Additionally, certain customers have arrangements that provide for unlimited users during the subscription term for a fixed fee. We recognize revenue from these arrangements on a ratable basis over the subscription term.
To a lesser extent, we derive revenue through indirect sales channels, including referral partners and resellers, as well as implementation partners, for which we recognize revenue on a gross basis, as we act as the principal in such arrangements.
Certain of our product solutions include service-level agreements warranting defined levels of uptime reliability and performance and permitting those customers to receive credits for future services in the event that we fail to meet those levels. To date, we have not accrued for any material liabilities in our consolidated financial statements as a result of these service-level agreements.
Deferred Revenue
We invoice customers for subscriptions to our solutions in monthly, quarterly, or annual installments. Deferred revenue consists primarily of customer billings made in advance of performance obligations being satisfied and revenue being recognized, and includes an immaterial amount of billings for subscriptions with customer cancellation rights. The term between invoicing and when payment is due is not significant and we do not provide financing arrangements to customers. Deferred revenue associated with performance obligations that are anticipated to be satisfied, and thus revenue recognized, during the succeeding 12-month period is recorded as current deferred revenue and the remaining portion is recorded as noncurrent deferred revenue.
We invoice customers based on billing schedules established in our contracts. Accounts receivable are recorded when the right to consideration becomes unconditional.
Cost of Revenue
Cost of revenue consists primarily of personnel costs (primarily including salaries, share-based compensation, and benefits) for employees associated with our infrastructure, product support, and professional service organizations, and expenses for hosting capabilities, primarily for third-party managed hosting services and costs associated with our self-managed colocation data centers. Cost of revenue also includes third-party license fees, payment processing fees, amortization expense associated with acquired intangible assets, amortization expense associated with capitalized internal-use software, and allocated shared costs, primarily including facilities, information technology, and security costs.
Cash, Cash Equivalents, and Restricted Cash
We consider all highly liquid investments purchased with a remaining maturity of three months or less to be cash equivalents. Cash and cash equivalents are recorded at fair value and consist primarily of bank deposits and money market funds.
As of December 31, 2020, our restricted cash balance was $2 million, consisting primarily of cash pledged for charitable donation. As of December 31, 2019, our restricted cash balance was $3 million, consisting of $2 million pledged for charitable donation and $1 million related to a deposit for leased office space. Restricted cash is included within prepaid expenses and other current assets and other assets on our consolidated balance sheets.
Marketable Securities
Marketable securities consist of U.S. Treasury securities, corporate bonds, money market funds, asset-backed securities, agency securities, commercial paper, certificates of deposit, and time deposits. We classify marketable securities as available-for-sale at the time of purchase and reevaluate such classification as of each balance sheet date. All marketable securities are recorded at their estimated fair values. When the fair value of a marketable security declines below its amortized cost basis, any portion of that decline attributable to credit losses, to the extent expected to be nonrecoverable before the sale of the security, is recognized in our consolidated statement of operations. When the fair value of the security declines below its amortized cost basis due to changes in interest rates, such amounts are recorded in accumulated other comprehensive income (loss), or AOCI, and are recognized in our consolidated statement of operations only if we sell or intend to sell the security before recovery of its cost basis. Realized gains and losses are determined based on the specific identification method and are reported in interest and other income (expense), net in our consolidated statements of operations.
Accounts Receivable and Allowance for Credit Losses
Accounts receivable are recorded at the invoiced amount, net of allowance for credit losses. The allowance is based upon historical loss patterns, the age of each past due invoice, and an evaluation of the potential risk of loss associated with delinquent accounts, including reasonable and supportable forecasts of future economic conditions. Accounts receivable
deemed uncollectible are charged against the allowance for credit losses when identified. The balance of accounts receivable also includes contract assets, which are recorded when revenue is recognized in advance of invoicing.
Our allowance for credit losses for accounts receivable consists of the following activity (in thousands):
The activity for the year ended December 31, 2019 has been restated from the previously reported amounts to correct an immaterial calculation error.
Costs to Obtain Customer Contracts
Sales commissions and related expenses are considered incremental and recoverable costs of acquiring customer contracts. These costs are capitalized and amortized on a straight-line basis over their anticipated period of benefit, which we have estimated to be three years. We determined the period of benefit by taking into consideration the length of our customer contracts, our technology lifecycle, and other factors. Amortization expense is recorded in sales and marketing expense within our consolidated statement of operations. Sales commissions paid for contract renewals are not material.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets. Maintenance and repair costs are charged to expense as incurred. The estimated useful lives of our property and equipment are as follows:
Leases
We lease office space under noncancelable operating leases with various expiration dates. Additionally, we are the sublessor for certain office space. All of our office leases are classified as operating leases with lease expense recognized on a straight-line basis over the lease term.
Lease right-of-use assets and liabilities are recognized at the commencement date based on the present value of lease payments over the lease term. As our leases do not provide an implicit rate, we estimate our incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The lease right-of-use assets also include any lease payments made and exclude lease incentives such as tenant improvement allowances. Options to extend the lease term are included in the lease term when it is reasonably certain that we will exercise the extension option.
Our operating leases typically include non-lease components such as common-area maintenance costs. We have elected to include non-lease components with lease payments for the purpose of calculating lease right-of-use assets and liabilities, to the extent that they are fixed. Non-lease components that are not fixed are expensed as incurred as variable lease payments.
Leases with a term of one year or less are not recognized on our consolidated balance sheets; we recognize lease expense for these leases on a straight-line basis over the lease term.
Derivative Instruments and Hedging
We enter into foreign currency forward contracts with certain financial institutions to mitigate the impact of foreign currency fluctuations on our future cash flows and earnings. All of our foreign currency forward contracts are designated as cash flow hedges. Our foreign currency forward contracts generally have maturities of 15 months or less.
We recognize all forward contracts on our balance sheet at fair value as either assets or liabilities. The effective portion of the gain or loss on each forward contract is reported as a component of AOCI, and reclassified into earnings, into revenue, cost of revenue or operating expense in the same period, or periods, during which the hedged transaction affects earnings. The ineffective portion of the gains or losses, if any, is recorded immediately in interest and other income (expense), net. We include time value related to our cash flow hedges for effectiveness testing purposes and the entire change in the unrecognized value of our hedge contracts is recorded in AOCI. We evaluate the effectiveness of our cash flow hedges on a quarterly basis.
We have a master netting agreement with each of our counterparties, which permits net settlement of multiple, separate derivative contracts with a single payment. We do not have collateral requirements with any of our counterparties. GAAP permits companies to present the fair value of derivative instruments on a net basis according to master netting arrangements. We have elected to present our derivative instruments on a gross basis in our consolidated financial statements. We do not enter into any derivative contracts for trading or speculative purposes.
Fair Value Measurements
We measure certain financial instruments at fair value using a fair value hierarchy. A financial instrument’s classification within the fair value hierarchy is based upon the lowest level of input that is significant to the fair value measurement. Three levels of inputs may be used to measure fair value:
Level 1-Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.
Level 2-Other inputs that are directly or indirectly observable in the marketplace.
Level 3-Unobservable inputs that are supported by little or no market activity.
Our marketable securities are classified within either Level 1 or Level 2, and our foreign currency forward contracts and convertible senior notes are classified within Level 2. We have no financial assets or liabilities measured using Level 3 inputs. The fair values of our Level 1 marketable securities are based on quoted market prices of identical underlying securities. The fair values of our Level 2 marketable securities are based on indirect or directly observable market data, including readily available pricing sources for identical underlying securities that may not be actively traded. The fair values of our foreign currency forward contracts are based on quoted prices and market observable data of similar instruments in active markets, such as currency spot rates, forward rates, and LIBOR. The fair value of our convertible senior notes is determined based on the quoted price of the convertible senior notes in an inactive market.
For certain other financial instruments, including accounts receivable, accounts payable and other current liabilities, the carrying amounts approximate their fair value due to the relatively short maturity of these instruments.
Capitalized Internal-Use Software Costs
We capitalize certain development costs incurred in connection with software development for our platform and software used in operations. Costs incurred in the preliminary stages of development are expensed as incurred. Once software has reached the development stage, internal and external costs, if direct and incremental, are capitalized until the software is substantially complete and ready for its intended use. Capitalization ceases upon completion of all substantial testing. We also capitalize costs related to specific upgrades and enhancements when it is probable the expenditures will result in additional functionality. Capitalized costs are recorded as part of property and equipment. Maintenance and training costs are expensed as incurred.
Capitalized internal-use software is amortized on a straight-line basis over its estimated useful life and is typically recorded in cost of revenue within the consolidated statements of operations.
Business Combinations
When we acquire businesses, we allocate the purchase price to the net tangible and identifiable intangible assets. Any residual purchase price is recorded as goodwill. The allocation of the purchase price requires management to make significant estimates in determining the fair values of assets acquired and liabilities assumed, especially with respect to intangible assets. These estimates can include, but are not limited to, the cash flows that an asset is expected to generate in the future, the appropriate weighted-average cost of capital, and the cost savings expected to be derived from acquiring an asset. These estimates are inherently uncertain and unpredictable.
Goodwill, Acquired Intangible Assets, and Impairment Assessment of Long-Lived Assets
Goodwill. Goodwill represents the excess purchase consideration of an acquired business over the fair value of the net tangible and identifiable intangible assets. Goodwill is evaluated for impairment annually in the third quarter, and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. Triggering events that may indicate impairment include, but are not limited to, a significant adverse change in customer demand or business climate or a significant decrease in expected cash flows. No impairment charges were recorded for the years ended December 31, 2020, 2019, or 2018.
Acquired Intangible Assets. Acquired intangible assets consist of identifiable intangible assets, primarily developed technology and customer relationships, resulting from our acquisitions. Intangible assets are recorded at fair value on the date of acquisition and amortized over their estimated useful lives.
Impairment of Long-Lived Assets. The carrying amounts of our long-lived assets, including property and equipment, lease right-of-use assets, capitalized internal-use software, costs to obtain customer contracts, and acquired intangible assets, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying value of these assets may not be recoverable or that the useful lives are shorter than originally estimated. Recoverability of assets to be held and used is measured by comparing the carrying amount of an asset to future undiscounted net cash flows the asset is expected to generate over its remaining life. If the asset is considered to be impaired, the amount of any impairment is measured as the difference between the carrying value and the fair value of the impaired asset. If the useful life is shorter than originally estimated, we amortize the remaining carrying value over the new shorter useful life. There were no material impairments for the years ended December 31, 2020, 2019, and 2018, other than those disclosed in Note 6, Note 7, and Note 8.
Strategic Investments
Strategic investments consist of non-controlling equity investments in privately-held companies. We have elected to apply the measurement alternative for these investments as they do not have readily determinable fair values, measuring them at cost, less any impairment, plus or minus adjustments resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. An impairment loss is recorded when events or circumstances indicate a decline in value has occurred. We include strategic investments in other assets in our consolidated balance sheets.
Share-Based Compensation
Share-based compensation expense to employees is measured based on the fair value of the awards on the grant date and recognized in our consolidated statements of operations over the period during which the employee is required to perform services in exchange for the award (generally the vesting period of the award, which is typically four years). The contractual term of our stock options is typically ten years. We estimate the fair value of stock options granted using the Black-Scholes option valuation model. We measure the fair value of Restricted Stock Units, or RSUs, and Performance Restricted Stock Units, or PRSUs, based on the fair value of the underlying shares on the date of grant. Compensation expense for awards with only service conditions is recognized over the vesting period of the applicable award using the straight-line method. We record share-based compensation expense for performance-based equity awards using the accelerated attribution method. Share-based compensation expense for our Employee Stock Purchase Plan, or ESPP, is recognized over each 18-month offering period using the straight-line method.
Advertising Expense
Advertising costs are expensed as incurred. For the years ended December 31, 2020, 2019, and 2018, advertising expense was $52 million, $57 million, and $48 million, respectively.
Government Grants
We have obtained government grants in certain jurisdictions where we operate. We receive the grant funds as we meet certain commitments, including targeted levels of employment and/or spending within the local jurisdictions. If we fail to maintain these commitments, we may be required to repay grant funds received or be ineligible to receive future funding. We recognize grant proceeds to offset costs to which the grants relate on a straight-line basis when it is reasonably assured that the applicable commitments have been met. For the years ended December 31, 2020, 2019, and 2018, we recognized grant proceeds of $4 million, $4 million, and $2 million, respectively, in our consolidated statements of operations.
Income Taxes
We record income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in our consolidated financial statements or tax returns. Deferred tax assets and liabilities are measured using the tax rates that are expected to apply to taxable income
for the years in which those tax assets and liabilities are expected to be realized or settled. Valuation allowances are provided when necessary to reduce deferred tax assets to the amount expected to be realized.
We recognize tax benefits from uncertain tax positions if it is more likely than not that the tax position will be sustained on examination by the taxing authorities based on the technical merits of the position. Although we believe that we have adequately reserved for our uncertain tax positions, we can provide no assurance that the final tax outcome of these matters will not be materially different. We make adjustments to these reserves when facts and circumstances change, such as the closing of a tax audit or the refinement of an estimate. To the extent that the final outcome of these matters is different than the amounts recorded, such differences will affect the provision for income taxes in the period in which such determination is made and could have a material impact on our financial condition and results of operations.
We have elected to record interest accrued and penalties related to unrecognized tax benefits in our consolidated statements of operations within provision for (benefit from) income taxes.
Foreign Currency
The functional currency of our foreign subsidiaries is the U.S. dollar. Accordingly, monetary balance sheet accounts are remeasured using exchange rates in effect at the balance sheet dates and non-monetary items are remeasured at historical exchange rates. Expenses are generally remeasured at the average exchange rates for the period. Foreign currency remeasurement and transaction gains and losses are included in interest and other income (expense), net and were not material for the years ended December 31, 2020, 2019, and 2018, respectively.
Concentrations of Risk
Financial instruments potentially exposing us to concentrations of credit risk consist primarily of cash and cash equivalents, restricted cash, marketable securities, accounts receivable, and derivative instruments, including the capped calls associated with our convertible senior notes. We place our cash and cash equivalents with high-credit-quality financial institutions. However, we maintain balances in excess of the FDIC insurance limits. We do not require our customers to provide collateral to support accounts receivable and maintain an allowance for credit losses for accounts receivable balances. We seek to mitigate counterparty credit risk related to our derivative instruments by transacting with major financial institutions with high credit ratings.
At December 31, 2020 and 2019, no customers represented 10% or greater of our total accounts receivable balance. There were no customers that individually exceeded 10% of our revenue in any of the periods presented.
Recently Issued Accounting Pronouncements
In August 2020, the Financial Accounting Standards Board, or FASB, issued ASU 2020-06, regarding ASC Topic 470 “Debt” and ASC Topic 815 “Derivatives and Hedging,” which reduces the number of accounting models for convertible instruments, including amending the calculation of diluted earnings per share and the balance sheet presentation of those instruments, as well as the resulting recognition of interest expense, among other changes. The guidance is effective for annual reporting periods beginning after December 15, 2021, including interim periods within that reporting period. Early adoption is permitted. We are currently evaluating the impact of the adoption of this standard on our consolidated financial statements.
Recently Adopted Accounting Pronouncements
In February 2016, the FASB issued ASU 2016-02, regarding ASC Topic 842 “Leases,” including subsequent amendments. We refer to the new guidance as “ASC 842.” This new guidance requires lessees to recognize most leases on their balance sheets as lease right-of-use assets with corresponding lease liabilities and eliminates certain real estate-specific provisions. The new guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period.
We adopted ASC 842 in the first quarter of 2019 and applied the following practical expedients:
•comparative periods prior to the adoption date are not adjusted to reflect the new guidance (the modified retrospective method of transition); and
•the historical determination as to the existence and classification of leases is carried forward for existing contracts as of the adoption date.
The adoption of ASC 842 resulted in the recognition of lease right-of-use assets and corresponding lease liabilities on our consolidated balance sheet. As of March 31, 2019, the first quarter of adoption, the aggregate balance of lease right-of-use
assets and lease liabilities was $99 million and $114 million, respectively. The standard did not affect our consolidated statements of operations or cash flows.
In June 2016, the FASB issued ASU 2016-13, including subsequent amendments, regarding ASC Topic 326 “Measurement of Credit Losses on Financial Instruments,” which modifies the accounting methodology for most financial instruments. The guidance establishes a new “expected loss model” that requires entities to estimate current expected credit losses on financial instruments by using all practical and relevant information, including reasonable and supportable forecasts of future economic conditions. Additionally, any expected credit losses are to be reflected as allowances rather than reductions in the amortized cost of available-for-sale debt securities. We adopted this standard in the first quarter of 2020. The adoption did not have a material effect on our consolidated financial statements.
In connection with the adoption, for purposes of identifying and measuring impairment, the policy election was made to exclude accrued interest from both the fair value and amortized cost basis of our available-for-sale debt securities. Such accrued interest is recorded in prepaid expenses and other current assets.
In January 2017, the FASB issued ASU 2017-04, regarding ASC Topic 350 “Simplifying the Test for Goodwill Impairment,” which simplifies the required methodology to calculate an impairment charge for goodwill. We adopted this standard in the first quarter of 2020. The adoption did not have an effect on our consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13, regarding ASC Topic 820 “Fair Value Measurement,” which modifies the disclosure requirements for fair value measurements for certain types of investments. We adopted this standard in the first quarter of 2020. The adoption did not have an effect on our consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12 “Simplifying the Accounting for Income Taxes,” which simplifies certain aspects of accounting for income taxes. ASU 2019-12 removes certain exceptions related to the approach for intraperiod tax allocation and clarifies the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The guidance is effective for interim and annual periods beginning after December 15, 2020, with early adoption permitted. We early adopted ASU 2019-12 in the second quarter of 2020 on a prospective basis. As a result of the adoption, we did not record an income tax benefit from the release of our valuation allowance due to the issuance of our 2025 convertible senior notes.
Note 3. Business Combinations
Smooch Technologies Holdings ULC
On May 14, 2019, we completed the acquisition of Smooch Technologies Holdings ULC, or Smooch, a developer of messaging technology. We acquired Smooch for purchase consideration of $72 million in cash. The total purchase consideration was allocated to the assets acquired and liabilities assumed as set forth below (in thousands):
The developed technology, customer relationships, and backlog intangible assets were assigned useful lives of 5.5, 8.0, and 2.0 years, respectively.
FutureSimple Inc.
On September 10, 2018, we completed the acquisition of FutureSimple Inc., or FutureSimple, the developer of Base, a sales force automation product solution. We acquired FutureSimple for purchase consideration of $81 million in cash. The total purchase consideration was allocated to the assets acquired and liabilities assumed as set forth below (in thousands):
The developed technology, customer relationships, and backlog intangible assets were assigned useful lives of 6.5, 5.0, and 2.0 years, respectively.
Note 4. Financial Instruments
Investments
The following tables present information about our financial assets measured at fair value on a recurring basis as of December 31, 2020 and 2019 based on the three-tier fair value hierarchy (in thousands):
As of December 31, 2020 and 2019, there were no securities within Level 3 of the fair value hierarchy. There were no transfers between fair value measurement levels during the years ended December 31, 2020 or 2019.
Gross unrealized gains and losses for marketable securities as of December 31, 2020 were $6 million and not material, respectively. The aggregate amortized cost basis for cash equivalents and marketable securities as of December 31, 2020 was $1,183 million and excludes accrued interest of $3 million. The aggregate fair value of securities with unrealized losses was $107 million.
Gross unrealized gains and losses for marketable securities as of December 31, 2019 were $4 million and not material, respectively. The aggregate amortized cost basis for cash equivalents and marketable securities as of December 31, 2019 was $719 million and excludes accrued interest of $4 million. The aggregate fair value of securities with unrealized losses was $45 million.
As of December 31, 2020 and 2019, there were no securities that were in an unrealized loss position for more than twelve months. We have not recorded an allowance for credit losses, as we believe any such losses would be immaterial based on the high-grade credit rating for each of our marketable securities as of the end of each period. We intend to hold our marketable securities to maturity and it is unlikely that they would be sold before their cost bases are recovered.
The following table classifies our marketable securities by contractual maturity as of December 31, 2020 and 2019 (in thousands):
As of December 31, 2020 and 2019, the balance of strategic investments without readily determinable fair values was $11 million. There have been no adjustments to the carrying values of strategic investments resulting from impairments or observable price changes. During the year ended December 31, 2020, we received proceeds of approximately $2 million on the sale of a strategic investment and realized a gain of approximately $1 million, which was recorded in interest and other income (expense), net in our consolidated statements of operations.
For our other financial instruments, including accounts receivable, accounts payable, and other current liabilities, the carrying amounts approximate their fair values due to the relatively short maturity of these balances.
Derivative Instruments and Hedging
As of December 31, 2020, the balance of AOCI included an unrecognized net gain of $2 million related to the changes in the fair value of foreign currency forward contracts designated as cash flow hedges. We expect to reclassify a net gain of $3 million into earnings over the next 12 months associated with our cash flow hedges.
The following tables present information about our derivative instruments on our consolidated balance sheets as of December 31, 2020 and 2019 (in thousands):
Our foreign currency forward contracts had a total notional value of $345 million and $260 million as of December 31, 2020 and 2019, respectively.
The following table presents information about our foreign currency forward contracts on our consolidated statements of operations for the years ended December 31, 2020 and 2019 (in thousands):
The loss recognized in AOCI related to foreign currency forward contracts was not material for the year ended December 31, 2020. The loss recognized in AOCI related to foreign currency forward contracts was $1 million for the year ended December 31, 2019.
The cash flow effects related to foreign currency forward contracts are included within operating activities on our consolidated statements of cash flows.
Amounts recognized in earnings related to hedge ineffectiveness for the years ended December 31, 2020 and 2019 were not material.
Convertible Senior Notes
As of December 31, 2020, the fair values of our 0.25% convertible senior notes due 2023 and our 0.625% convertible senior notes due 2025 were $349 million and $1,685 million, respectively. The fair values were determined based on the quoted price of the convertible senior notes in an inactive market on the last traded day of the quarter and have been classified as Level 2 in the fair value hierarchy. Based on the closing price of our common stock of $143.12 on the last trading day of the quarter, the if-converted values of the 2023 and 2025 convertible senior notes exceeded the remaining principal amounts by $189 million and $363 million, respectively, as of December 31, 2020.
Note 5. Costs to Obtain Customer Contracts
The balance of deferred costs to obtain customer contracts was $105 million and $71 million as of December 31, 2020 and 2019, respectively. Amortization expense for these deferred costs was $45 million, $32 million, and $21 million for the years ended December 31, 2020, 2019, and 2018, respectively. There were no impairment losses related to these deferred costs for the periods presented.
Note 6. Property and Equipment
Property and equipment, net consists of the following (in thousands):
Depreciation expense was $26 million, $21 million, and $24 million for the years ended December 31, 2020, 2019, and 2018, respectively.
Amortization expense of capitalized internal-use software was $8 million, $6 million, and $6 million for the years ended December 31, 2020, 2019, and 2018, respectively. We recorded impairment losses for capitalized internal-use software of $3 million and $2 million in the years ended December 31, 2020 and 2018, respectively. The impairments were recorded primarily to construction in progress and were included primarily within research and development expenses on our consolidated statements of operations. The carrying values of capitalized internal-use software at December 31, 2020 and 2019 were $32 million and $23 million, respectively, including $13 million and $8 million in construction in progress, respectively.
Note 7. Leases
The following tables present information about leases on our consolidated balance sheets (in thousands):
As of December 31, 2020 and 2019, the weighted average remaining lease term was 6.0 years and 5.7 years, respectively. As of December 31, 2020 and 2019, the weighted average discount rate was 4.7% and 5.3%, respectively.
The following table presents information about leases on our consolidated statements of operations (in thousands):
The following table presents supplemental cash flow information about our leases (in thousands):
As of December 31, 2020, remaining maturities of lease liabilities are as follows:
In the fourth quarter of 2020, we determined that we would no longer occupy the leased premises located at 1019 Market Street and 988 Market Street, San Francisco, California 94103. As a result, we assessed these lease right-of-use assets and leasehold improvements for impairment and determined that the carrying values were not recoverable. We recorded an aggregate impairment charge of $15 million, which is the amount that the carrying value of the asset groups exceeded their estimated fair values. The estimated fair values were based on the present value of the estimated cash flows that could be generated from subleasing each property for the remaining lease term. The impairment charge was recorded in general and administrative expenses on our consolidated statement of operations.
Note 8. Goodwill and Acquired Intangible Assets
The changes in the carrying amount of goodwill for the two years ended December 31, 2020 are as follows (in thousands):
Acquired intangible assets subject to amortization consist of the following (in thousands):
Amortization expense of acquired intangible assets for the year ended December 31, 2020 was $11 million, which included a $1 million impairment of developed technology recorded within cost of revenue on our consolidated statement of operations. Amortization expense of acquired intangible assets for the years ended December 31, 2019 and 2018 was $10 million and $5 million, respectively.
Estimated future amortization expense as of December 31, 2020 is as follows (in thousands):
Note 9. Convertible Senior Notes
2025 Convertible Senior Notes
In June 2020, we issued $1,150 million aggregate principal amount of 0.625% convertible senior notes due June 15, 2025 in a private offering, the “2025 Notes.” The 2025 Notes are senior unsecured obligations and bear interest at a fixed rate of 0.625% per annum, payable semi-annually in arrears on June 15 and December 15 of each year, commencing on December 15, 2020. The total net proceeds from the offering, after deducting initial purchase discounts and estimated debt issuance costs, were approximately $1,129 million.
Each $1,000 principal amount of the 2025 Notes will initially be convertible into 9.1944 shares of our common stock, which is equivalent to an initial conversion price of approximately $108.76 per share, subject to adjustment upon the occurrence of specified events.
The 2025 Notes will be convertible at the option of the holders at any time prior to the close of business on the business day immediately preceding March 15, 2025, only under the following circumstances: (1) during any calendar quarter commencing after the calendar quarter ending on September 30, 2020 (and only during such calendar quarter), if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (2) during the five business day period after any ten consecutive trading day period in which, for each trading day of that period, the trading price per $1,000 principal amount of 2025 Notes for such trading day was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such trading day; (3) if we call any or all of the 2025 Notes for redemption, at any time prior to the close of business on the second business day immediately prior to the redemption date as discussed further below, but only with respect to the 2025 Notes called (or deemed called) for redemption; or (4) upon the occurrence of specified corporate events (as set forth in the indenture).
On or after March 15, 2025 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert all or any portion of their 2025 Notes, in minimum denominations of $1,000 or an integral multiple in excess thereof, at the option of the holders regardless of the foregoing circumstances. Upon conversion, we will pay or deliver, as the case may be, cash, shares of our common stock or a combination of cash and shares of our common stock, at our election.
If certain specified fundamental changes occur (as set forth in the indenture) prior to the maturity date, holders of the 2025 Notes may require us to repurchase for cash all or any portion of their notes at a repurchase price equal to 100% of the principal amount of the 2025 Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date. In addition, if specific corporate events occur prior to the applicable maturity date or if we deliver a notice of redemption, we will increase the conversion rate for a holder who elects to convert their notes in connection with such a corporate event or converts its notes called (or deemed called) for redemption in connection with such notice of redemption in certain circumstances. It is our current intent and policy to settle conversions through combination settlement with a specified dollar amount of $1,000 per $1,000 principal amount of 2025 Notes.
During the three months ended December 31, 2020, the conditions allowing holders of the 2025 Notes to convert were not met.
We may not redeem the 2025 Notes prior to June 20, 2023. We may redeem for cash all or any portion of the 2025 Notes, at our option, on or after June 20, 2023 and on or prior to the 41st scheduled trading day immediately preceding the maturity date, if the last reported sale price of our common stock has been at least 130% of the conversion price then in effect for at least 20 trading days (whether or not consecutive), including the trading day immediately preceding the date on which we provide notice of redemption, during any 30 consecutive trading day period ending on, and including, the trading day immediately preceding the date on which we provide notice of redemption, at a redemption price equal to 100% of the principal amount of the 2025 Notes to be redeemed, plus accrued and unpaid interest to, but excluding, the redemption date. No sinking fund is provided for the 2025 Notes.
In accounting for the transaction, the 2025 Notes were separated into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar debt instrument that does not have an associated convertible feature. The fair value of the liability component is estimated by calculating the present value of expected cash flows using an interest rate that reflects our incremental borrowing rate, with an estimated adjustment for our credit standing on nonconvertible debt with similar maturity. The carrying amount of the equity component representing the conversion option was $220 million and was determined by deducting the fair value of the liability component from the par value of the 2025 Notes. The equity component was recorded in additional paid-in capital and is not remeasured as long as it continues to meet the conditions for equity classification. The excess of the principal amount of the liability component over its carrying amount is amortized to interest expense over the contractual term of the 2025 Notes at an effective interest rate of 5.00%.
In accounting for the debt issuance costs of $21 million related to the 2025 Notes, we allocated the total amount incurred to the liability and equity components of the 2025 Notes based on their relative values. Issuance costs attributable to the liability component were $17 million and will be amortized to interest expense using the effective interest method over the contractual term of the 2025 Notes. Issuance costs attributable to the equity component were netted with the equity component in additional paid-in capital.
The net carrying amount of the liability component of the 2025 Notes is as follows (in thousands):
The net carrying amount of the equity component of the 2025 Notes is as follows (in thousands):
Interest expense related to the 2025 Notes is as follows (in thousands):
The difference between the book and tax treatment of the debt discount and debt issuance costs of the 2025 Notes resulted in a difference between the carrying amount and tax basis of the 2025 Notes. This taxable temporary difference resulted in the recognition of a $51 million net deferred tax liability which was recorded as an adjustment to additional paid-in capital. The creation of the deferred tax liability represents a source of future taxable income which supports realization of deferred tax assets. As we continue to maintain a full valuation allowance against its deferred tax assets, this additional source of income resulted in the release of a portion of its valuation allowance. Consistent with the adoption of ASU 2019-12, the release of the valuation allowance of $51 million was recorded as an adjustment to additional paid-in capital.
2025 Capped Calls
In connection with the pricing of the 2025 Notes, we entered into privately negotiated capped call transactions with certain counterparties, the “2025 Capped Calls.” The 2025 Capped Calls each have an initial strike price of approximately $108.76 per share, subject to certain adjustments, which correspond to the initial conversion price of the 2025 Notes. The 2025 Capped Calls have initial cap prices of $164.17 per share, subject to certain adjustments. The 2025 Capped Calls cover, subject to anti-dilution adjustments, approximately 10.6 million shares of our common stock. Conditions that cause adjustments to the initial strike price of the 2025 Capped Calls are similar to the conditions that result in corresponding adjustments for the 2025 Notes. The 2025 Capped Calls are generally intended to reduce or offset the potential dilution to our common stock upon any conversion of the 2025 Notes with such reduction or offset, as the case may be, subject to a cap based on the cap price. For accounting purposes, the 2025 Capped Calls are separate transactions, and not part of the terms of the 2025 Notes. As these transactions meet certain accounting criteria, the 2025 Capped Calls are recorded in stockholders’ equity and are not accounted for as derivatives. The cost of $130 million incurred in connection with the 2025 Capped Calls was recorded as a reduction to additional paid-in capital.
2023 Convertible Senior Notes
In March 2018, we issued $575 million aggregate principal amount of 0.25% convertible senior notes due March 15, 2023 in a private offering, the “2023 Notes.” The 2023 Notes are unsecured obligations and bear interest at a fixed rate of 0.25% per annum, payable semi-annually in arrears on March 15 and September 15 of each year, commencing on September 15, 2018. The total net proceeds from the offering, after deducting initial purchase discounts and estimated debt issuance costs, were approximately $561 million.
In connection with the offering of the 2025 Notes, we used $618 million of the net proceeds from the offering of the 2025 Notes to repurchase $426 million aggregate principal amount of the 2023 Notes in cash through individual privately negotiated transactions (the “2023 Notes Partial Repurchase”). Of the $618 million consideration, $393 million and $225 million were allocated to the debt and equity components on our consolidated balance sheets, respectively, utilizing an effective interest rate to determine the fair value of the liability component. The fair value of the liability component is estimated by calculating the present value of expected cash flows using an interest rate that reflects our incremental borrowing rate, with an estimated adjustment for our credit standing on nonconvertible debt with similar maturity. As of the repurchase date, the carrying value of the 2023 Notes subject to the 2023 Notes Partial Repurchase, net of unamortized debt discount and issuance costs, was $367 million. The 2023 Notes Partial Repurchase resulted in a $26 million loss on early debt extinguishment. Additionally, $39 million of the total consideration was related to repayment of the debt discount and reflected as a cash outflow from operating activities. As of December 31, 2020, $149 million of principal remains outstanding on the 2023 Notes.
Each $1,000 principal amount of the 2023 Notes will initially be convertible into 15.8554 shares of our common stock, the “Conversion Option,” which is equivalent to an initial conversion price of approximately $63.07 per share, subject to adjustment upon the occurrence of specified events. The 2023 Notes will be convertible at the option of the holders at any time prior to the close of business on the business day immediately preceding December 15, 2022, only under the following circumstances: (1) during any calendar quarter commencing after the calendar quarter ending on June 30, 2018 (and only during such calendar quarter), if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price on each applicable trading day; (2) during the five business day period after any five consecutive trading day period, the “Measurement Period,” in which the trading price per $1,000 principal amount of notes for each trading day of the Measurement Period was less than 98% of the product of the last reported sale price of our common stock and the conversion rate on each such trading day; or (3) upon the occurrence of specified corporate events (as set forth in the indenture). On or after December 15, 2022 until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their 2023 Notes at any time, regardless of the foregoing circumstances. Upon conversion, we will pay or deliver, as the case may be, cash, shares of our common stock or a combination of cash and shares of our common stock, at our election. If certain specified fundamental
changes occur (as set forth in the indenture governing the 2023 Notes) prior to the maturity date, holders of the 2023 Notes may require us to repurchase for cash all or any portion of their notes at a repurchase price equal to 100% of the principal amount of the 2023 Notes to be repurchased, plus accrued and unpaid interest to, but excluding, the fundamental change repurchase date. In addition, if specific corporate events occur prior to the applicable maturity date, we will increase the conversion rate for a holder who elects to convert their notes in connection with such a corporate event in certain circumstances. It is our current intent and policy to settle conversions through combination settlement with a specified dollar amount of $1,000 per $1,000 principal amount of 2023 Notes.
During the three months ended December 31, 2020, the conditions allowing holders of the 2023 Notes to convert were met. The 2023 Notes are therefore convertible during the three months ending March 31, 2021 and are classified as a current liability as of December 31, 2020. To date, we have received one request for conversion for an immaterial amount of 2023 Notes.
In accounting for the issuance of the 2023 Notes, the 2023 Notes were separated into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar debt instrument that does not have an associated conversion feature. The carrying amount of the equity component was determined by deducting the fair value of the liability component from the par value of the 2023 Notes. The equity component was recorded in additional paid-in capital and is not remeasured as long as it continues to meet the conditions for equity classification. The excess of the principal amount of the liability component over its carrying amount is amortized to interest expense over the contractual term of the 2023 Notes at an effective interest rate of 5.26%.
In accounting for the debt issuance costs related to the 2023 Notes, we allocated the total amount incurred to the liability and equity components of the 2023 Notes based on their relative values. Issuance costs attributable to the liability component are amortized to interest expense using the effective interest method over the contractual term of the 2023 Notes. Issuance costs attributable to the equity component were netted with the equity component in additional paid-in capital.
The net carrying amount of the liability component of the 2023 Notes is as follows (in thousands):
The net carrying amount of the equity component of the 2023 Notes is as follows (in thousands):
Interest expense related to the 2023 Notes is as follows (in thousands):
2023 Capped Calls
In connection with the pricing of the 2023 Notes, we entered into privately negotiated capped call transactions with certain counterparties, the “2023 Capped Calls.” The 2023 Capped Calls each have an initial strike price of approximately $63.07 per share, subject to certain adjustments, which correspond to the initial conversion price of the 2023 Notes. The 2023 Capped Calls have initial cap prices of $95.20 per share, subject to certain adjustments. The 2023 Capped Calls covered, subject to anti-dilution adjustments, approximately 9.1 million shares of our common stock. Conditions that cause adjustments to the initial strike price of the 2023 Capped Calls mirror conditions that result in corresponding adjustments for the 2023 Notes. The 2023 Capped Calls are generally intended to reduce or offset the potential dilution to our common stock upon any conversion of the 2023 Notes with such reduction or offset, as the case may be, subject to a cap based on the cap price. For accounting purposes, the 2023 Capped Calls are separate transactions, and not part of the terms of the 2023 Notes. As these transactions meet certain accounting criteria, the 2023 Capped Calls are recorded in stockholders' equity and are not accounted for as derivatives. The cost of $64 million incurred in connection with the 2023 Capped Calls was recorded as a reduction to additional paid-in capital.
In June 2020, and in connection with the 2023 Notes Partial Repurchase, we terminated the 2023 Capped Calls corresponding to approximately 6.7 million shares for cash proceeds of $83 million. The proceeds were recorded as an increase to additional paid-in capital in the consolidated balance sheets. As of December 31, 2020, there remains outstanding 2023 Capped Calls giving the Company the option to purchase approximately 2.4 million shares (subject to adjustment).
The net impact to our stockholders' equity, included in additional paid-in capital, of the above components of the 2023 Notes is as follows (in thousands):
Note 10. Commitments and Contingencies
Commitments
As of December 31, 2020, our contractual obligations are as follows for the years ending December 31 (in thousands):
(1) Represents obligations under non-cancellable lease agreements for our corporate headquarters and worldwide offices.
(2) Primarily relates to third-party managed hosting services.
(3) Consists of principal and interest payments. Principal of $149 million and $1,150 million is due in March 2023 and June 2025, respectively.
Letters of Credit
As of December 31, 2020 and 2019, we had a total of $5 million and $4 million, respectively, in unsecured letters of credit outstanding, including bank guarantees, primarily related to leased office space. The letters of credit renew annually and mature at various dates through October 31, 2023.
Litigation and Loss Contingencies
We accrue estimates for resolution of legal and other contingencies when losses are probable and estimable. These estimates are reviewed at least quarterly and adjusted to reflect the impacts of negotiations, estimated settlements, legal rulings, advice of legal counsel and other information and events pertaining to a particular matter.
On October 24, 2019 and November 7, 2019, purported stockholders of the Company filed two putative class action complaints in the United States District Court for the Northern District of California, entitled Charles Reidinger v. Zendesk, Inc., et al., 3:19-cv-06968-CRB and Ho v. Zendesk, Inc., et al., No. 3:19-cv-07361-WHA, respectively, against the Company and certain of the Company’s executive officers. The complaints are nearly identical and allege violations of Section 10(b) and Section 20(a) of the Securities Exchange Act of 1934, as amended, purportedly on behalf of all persons who purchased Zendesk, Inc. common stock between February 6, 2019 and October 1, 2019, inclusive. The claims are based upon allegations that the defendants misrepresented and/or omitted material information in certain of our prior public filings. To this point, no discovery has occurred in these cases. The court has appointed a lead plaintiff and consolidated the various lawsuits into a single action (Case No. 3:19-cv-06968-CRB), and the lead plaintiff filed its amended complaint on April 14, 2020 asserting the same alleged violations of securities laws as the initial complaints. On June 29, 2020, Zendesk and the executive officer defendants moved to dismiss the amended complaint. On November 9, 2020, the court granted Zendesk's motion to dismiss and granted plaintiff leave to amend its complaint. On January 8, 2021, plaintiff filed its second amended complaint and on January 22, 2021, Zendesk and the executive officer defendants moved to dismiss the second amended complaint which is set for hearing on March 5, 2021.
On June 2, 2020, a purported stockholder of the Company filed a derivative complaint in the United States District Court for the Northern District of California, entitled Anderson v. Svane, et al., 3:20-cv-03671, against certain of the Company's executive officers and directors. The derivative complaint alleges breaches of fiduciary duty against all defendants, and an insider trading claim and violations of Section 10(b) of the Securities Exchange Act of 1934 against the officer defendants, purportedly on behalf of the Company itself. The claims are based on nearly identical allegations as the two putative class action complaints described above, namely that the defendants misrepresented and/or omitted material information in certain of our prior public filings. On June 29, 2020, the court stayed the derivative action until either the class action is dismissed with prejudice or class action defendants answer the complaint. On July 27, 2020, the court ordered the derivative action related to the class action.
The class action and derivative action are still in the preliminary stages, and it is not possible for the Company to quantify the extent of potential liability to the individual defendants, if any. Management believes that the lawsuits lack merit and intends to vigorously defend the actions. We cannot predict the outcome of or estimate the possible loss or range of loss from the above described matter.
From time to time, we may be subject to other legal proceedings, claims, investigations, and government inquiries in the ordinary course of business. We have received, and may in the future continue to receive, claims from third parties asserting, among other things, infringement of their intellectual property rights, defamation, labor and employment rights, privacy, and contractual rights. In general, the resolution of a legal matter could prevent the Company from offering its service to others, could be material to the Company’s financial condition or cash flows, or both, or could otherwise adversely affect the Company’s operating results.
The outcomes of legal proceedings and other contingencies are inherently unpredictable and subject to significant uncertainties. As a result, the Company is not able to reasonably estimate the amount or range of possible losses in excess of any amounts accrued, including losses that could arise as a result of application of non-monetary remedies, with respect to the contingencies it faces. In management’s opinion, resolution of all current matters is not expected to have a material adverse impact on business, consolidated balance sheets, results of operations, comprehensive loss, or cash flows.
Indemnifications
In the ordinary course of business, we enter into contractual arrangements under which we agree to provide indemnification of varying scope and terms to customers, business partners, and other parties with respect to certain matters, including, but not limited to, losses arising out of the breach of such agreements, intellectual property infringement claims made
by third parties, and other liabilities relating to or arising from our products or our acts or omissions. In these circumstances, payment may be conditional on the other party making a claim pursuant to the procedures specified in the particular contract. Further, our obligations under these agreements may be limited in terms of time and/or amount, and in some instances, we may have recourse against third parties for certain payments. In addition, we have indemnification agreements with our directors and executive officers that require us, among other things, to indemnify them against certain liabilities that may arise by reason of their status or service as directors or officers. The terms of such obligations may vary. To date, we have not incurred any material costs, and we have not accrued any liabilities in our consolidated financial statements, as a result of these obligations.
Certain of our product offerings include service-level agreements warranting defined levels of uptime reliability and performance, which permit those customers to receive credits for future services in the event that we fail to meet those levels. To date, we have not accrued for any significant liabilities in our consolidated financial statements as a result of these service-level agreements.
Note 11. Common Stock and Stockholders’ Equity
Common Stock
As of December 31, 2020 and 2019, there were 400 million shares of common stock authorized for issuance with a par value of $0.01 per share and 117.5 million and 113.1 million shares were issued and outstanding as of December 31, 2020 and 2019, respectively.
Preferred Stock
As of December 31, 2020 and 2019, there were 10 million shares of preferred stock authorized for issuance with a par value of $0.01 per share and no shares of preferred stock were issued or outstanding.
Employee Equity Plans
Employee Stock Purchase Plan
Under the ESPP, eligible employees are granted options to purchase shares of our common stock through payroll deductions. The ESPP provides for 18-month offering periods, which include three six-month purchase periods. At the end of each purchase period, employees are able to purchase shares at 85% of the lower of the fair market value of our common stock at the beginning of the offering period or the fair market value of our common stock at the end of the purchase period. During each of the years ended December 31, 2020 and 2019, 0.6 million shares of common stock were purchased under the ESPP. Pursuant to the terms of the ESPP, the number of shares reserved under the ESPP increased by 1.2 million shares and 1.1 million shares on January 1, 2021 and 2020, respectively. As of December 31, 2020, 4.8 million shares of common stock were available for issuance under the ESPP.
Stock Option and Grant Plans
Our board of directors adopted the 2009 Stock Option and Grant Plan, or the 2009 Plan, in July 2009. The 2009 Plan was terminated in connection with our initial public offering in May 2014, and accordingly, no shares are available for issuance under this plan. The 2009 Plan continues to govern outstanding awards granted thereunder.
Our 2014 Stock Option and Incentive Plan, or the 2014 Plan, serves as the successor to our 2009 Plan. Pursuant to the terms of the 2014 Plan, the number of shares reserved for issuance under the 2014 Plan increased by 5.9 million and 5.7 million shares on January 1, 2021 and 2020, respectively. As of December 31, 2020, we had 14.4 million shares of common stock available for future grants under the 2014 Plan.
On May 6, 2016, the compensation committee of our board of directors granted equity awards representing 1.2 million shares of common stock. These awards were granted outside of the 2014 Plan pursuant to an exemption provided for “employment inducement awards” within the meaning of Section 303A.08 of the New York Stock Exchange Listed Company Manual and accordingly did not require approval from our stockholders.
A summary of our share based award activity for the year ended December 31, 2020 is as follows (in thousands, except per share information):
The RSUs forfeited or canceled and unavailable for grant relate to our employment inducement awards. The aggregate intrinsic value for options outstanding represents the difference between the closing market price of our common stock on the last trading day of the reporting period and the exercise price of outstanding, in-the-money options.
The total intrinsic value of stock options exercised during the years ended December 31, 2020, 2019, and 2018 was $70 million, $76 million, and $37 million, respectively. The intrinsic value for options exercised represents the difference between the exercise price and the market value on the date of exercise. The weighted-average grant date fair value of stock options granted during the years ended December 31, 2020, 2019, and 2018 was $32.03, $28.65, and $17.87, respectively.
The total fair value of RSUs vested during the years ended December 31, 2020, 2019, and 2018 was $241 million, $240 million, and $176 million, respectively. The fair value of RSUs vested represents market value on the vesting date. The weighted-average grant date fair value of RSUs granted during the years ended December 31, 2020, 2019, and 2018 was $89.69, $73.40, and $44.35, respectively.
Share-Based Compensation Expense
All share-based awards to employees and members of our board of directors are measured based on the grant date fair value of the awards and recognized in the consolidated statements of operations over the period during which the employee is required to perform services in exchange for the award (generally the vesting period of the award, which is typically four years). The contractual term of our stock options is typically ten years. We record share-based compensation expense for service-based equity awards using the straight-line attribution method. We record share-based compensation expense for performance-based equity awards using the accelerated attribution method. Forfeitures are recognized as they occur.
We estimate the fair value of stock options granted using the Black-Scholes option valuation model, which requires inputs, including the fair value of our underlying common stock, expected term, expected volatility, risk-free interest rate and dividend yield of our common stock. These inputs involve inherent uncertainties and the application of management’s judgment. If factors change and different assumptions are used, our share-based compensation expense could be materially different in the future.
The inputs are as follows:
•Expected Term. We determine the expected term based on the historical exercise activity of our employees.
•Expected Volatility. We determine expected volatility based on the historical volatility of our own common stock.
•Risk-Free Interest Rate. The risk-free interest rate is based on the yield available on U.S. Treasury zero-coupon issues with an equivalent remaining term of the stock options for each stock option group.
•Dividend Yield. We have not paid and do not anticipate paying any cash dividends in the foreseeable future and, therefore, use an expected dividend yield of zero.
The assumptions used to estimate the fair value of stock options are as follows:
The assumptions used to estimate the fair value of ESPP awards are as follows:
As of December 31, 2020, we had a total of $404 million in future expense related to all equity awards to be recognized over a weighted average period of 2.6 years.
For the year ended December 31, 2020, we recorded $1 million of share-based compensation expense related to accelerated vesting of share-based awards for terminated employees. There were no material share-based award modifications for the years ended December 31, 2019 and 2018.
Performance Restricted Stock Units
In 2018, PRSUs representing 0.2 million shares of common stock were granted in connection with the acquisition of FutureSimple Inc. The PRSUs vest in four semi-annual tranches through March 2021. The PRSUs include a service condition and a performance condition related to the attainment of semi-annual performance targets approved and communicated in advance of each performance period. For the years ended December 31, 2020 and 2019, we recorded $6 million and $7 million of share-based compensation expense related to the PRSUs, respectively, including accelerated amounts upon termination. For the years ended December 31, 2020 and 2019, 60 thousand and 48 thousand PRSUs were vested, respectively. For the year ended December 31, 2018, we recorded an immaterial amount of share-based compensation expense related to the PRSUs and no PRSUs were vested.
Note 12. Deferred Revenue and Performance Obligations
The changes in the balances of deferred revenue are as follows (in thousands):
*Other revenue primarily includes implementation and training services, Talk usage and amounts from contract assets.
For the years ended December 31, 2020, 2019, and 2018, less than half of revenue recognized was from the deferred revenue balances at the beginning of each period.
The aggregate balance of remaining performance obligations as of December 31, 2020 was $925 million. We expect to recognize $627 million of the balance as revenue in the next 12 months and the remainder thereafter. The aggregate balance of remaining performance obligations represents contracted revenue that has not yet been recognized, including contracted revenue from renewals, and does not include contract amounts which are cancellable by the customer and amounts associated with optional renewal periods.
Note 13. Net Loss Per Share
Basic net loss per share is computed by dividing net loss by the weighted-average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by giving effect to all potential shares of common stock, including those related to outstanding share-based awards and our convertible senior notes, to the extent dilutive. Basic and diluted net loss per share were the same for each period presented as the inclusion of all potential common stock outstanding would have been anti-dilutive.
The following table presents the calculation of basic and diluted net loss per share for the periods presented (in thousands, except per share data):
The anti-dilutive securities excluded from the shares used to calculate diluted net loss per share are as follows (in thousands):
The shares related to convertible senior notes in the table above are calculated based on the average market price of our common stock for the three months ended December 31, 2020.
We expect to settle the principal amount of both the 2023 Notes and 2025 Notes in cash and therefore use the treasury stock method for calculating any potential dilutive effect of the conversion spread on diluted net income per share, if applicable. The conversion spread has a dilutive impact on diluted net income per share when the average market price of our common
stock for a given reporting period exceeds the initial conversion prices of $63.07 and $108.76 per share for the 2023 Notes and 2025 Notes, respectively. Based on the initial conversion price, potential dilution related to the 2023 Notes and 2025 Notes is approximately 2.4 million and 10.6 million shares, respectively.
Note 14. Income Taxes
The components of loss before provision for (benefit from) income taxes are as follows (in thousands):
The income tax provision (benefit) is composed of the following (in thousands):
Significant components of deferred tax assets are as follows (in thousands):
Certain amounts for the year ended December 31, 2019 in the table above have been restated from the previously reported amounts for comparability.
The following is a reconciliation of the statutory federal income tax rate and the effective tax rates:
We have not provided income taxes for the possible tax consequences of repatriating undistributed earnings of foreign subsidiaries as of December 31, 2020 because we intend to permanently reinvest such earnings outside of the U.S. If these foreign earnings were to be repatriated in the future, the related U.S. tax liability may be reduced by any foreign income taxes previously paid on these earnings. As of December 31, 2020, the cumulative amount of earnings upon which U.S. income taxes have not been provided is approximately $1 million. Determination of the amount of unrecognized deferred tax liability related to these earnings is not practicable.
As of December 31, 2020, we had net operating loss carryforwards of approximately $1,230 million for federal income taxes and $491 million for state income taxes. Of the federal net operating loss carryforwards, $520 million will begin to expire in 2029 and $710 million will carry forward indefinitely. The state carryforwards will begin to expire in 2031. As of December 31, 2020, we had research and development credit carryforwards of approximately $20 million for each of federal and state income taxes. If not utilized, the federal carryforwards will begin to expire in 2029. The state tax credit can be carried forward indefinitely. Internal Revenue Code Section 382 limits the use of net operating loss and tax credit carryforwards in certain situations where changes occur in the stock ownership of a company. In the event that we had a change of ownership, utilization of the net operating loss and tax credit carryforwards may be restricted. In addition, we have $8 million of net operating loss carryforwards in France, of which approximately $3 million were obtained as part of our acquisition of We Are Cloud SAS. These carryforward losses do not expire, however, utilization of these carryforwards may be subject to annual limitations. In addition, the right to the carryforward losses could be challenged if the French tax authorities determined that a significant change in the company’s actual business has occurred.
We account for income taxes under an asset and liability approach. Deferred income taxes reflect the impact of temporary differences between assets and liabilities recognized for financial reporting purposes and such amounts recognized for income tax reporting purposes, net operating loss carryforwards, and other tax credits measured by applying currently enacted tax laws. Realization of deferred tax assets is dependent on future earnings, if any, the timing and amount of which are uncertain. We regularly assess the need for a valuation allowance against our deferred tax assets by considering both positive and negative evidence to determine whether it is more-likely-than-not that some or all of the deferred tax assets will not be realized. We recorded a valuation allowance to fully offset our U.S. deferred tax assets, as we consider our cumulative loss in recent years to be strong negative evidence for retaining the valuation allowance. The valuation allowance increased by $17 million during the year ended December 31, 2020. We will continue to assess the future realization of our deferred tax assets in each applicable jurisdiction and adjust the valuation allowance accordingly.
A reconciliation of the beginning and ending amount of unrecognized tax benefits (excluding interest and penalties) for the three years ending December 31, 2020 is as follows (in thousands):
As of December 31, 2020, we had no accrued interest and penalties related to the uncertain tax positions. We have elected to record interest and penalties in the financial statements as a component of provision for (benefit from) income taxes. Included in the balance of unrecognized tax benefits at December 31, 2020 and 2019 are no potential benefits, which if recognized, would affect the effective tax rate.
We are currently unaware of any uncertain tax positions that could result in significant additional payments, accruals, or other material deviation in this estimate over the next 12 months.
We are subject to taxation in the United States and foreign jurisdictions. Our tax years 2009 to 2019 remain subject to examination in most jurisdictions.
Note 15. Geographic Information
Our chief operating decision maker reviews the financial information presented on a consolidated basis for purposes of allocating resources and evaluating our financial performance. Accordingly, we have determined that we operate in a single reporting segment.
Revenue
The following table presents our revenue by geographic area, as determined based on the billing address of our customers (in thousands):
Long-Lived Assets
The following table presents our long-lived assets by geographic area (in thousands):
The table above includes property and equipment and lease right-of-use assets and excludes capitalized internal-use software and intangible assets.
Note 16. Retirement Plans
We have a 401(k) retirement and savings plan made available to all United States employees. The 401(k) plan allows each participant to contribute up to an amount not to exceed an annual statutory maximum. For the years ended December 31, 2020, 2019, and 2018, we made matching contributions of $8 million, $4 million, and $1 million, respectively.
Item 9.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A. Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act), as of the end of the period covered by this Annual Report on Form 10-K.
Based on this evaluation, our management concluded that, as of December 31, 2020, our disclosure controls and procedures are effective to provide reasonable assurance that information we are required to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Management’s Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rule 13a-15(f) of the Exchange Act. Our management conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Our internal control over financial reporting includes policies and procedures that provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles. Based on this evaluation, management concluded that our internal control over financial reporting was effective as of
December 31, 2020. Our independent registered public accounting firm, Ernst & Young LLP, has issued an audit report with respect to our internal control over financial reporting, which appears in Part II, Item 8 of this Annual Report on Form 10-K, and is incorporated herein by reference.
Changes in Internal Control over Financial Reporting
There was no change in our internal control over financial reporting identified in connection with the evaluation required by Rules 13a-15(d) and 15d-15(d) of the Exchange Act that occurred during the quarter ended December 31, 2020 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Further, while the majority of our employees are currently working remotely, we have not experienced any material impact in our internal control over financial reporting as a result of the COVID-19 pandemic.
Limitations on Effectiveness of Controls and Procedures
In designing and evaluating the disclosure controls and procedures and internal control over financial reporting, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures and internal control over financial reporting must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating the benefits of possible controls and procedures relative to their costs.
Item 9B.
Item 9B. Other Information.
None.
PART III
Item 10.
Item 10. Directors, Executive Officers and Corporate Governance.
The information required by this item will be set forth in our Proxy Statement for the 2021 Annual Meeting of Stockholders, or the 2021 Proxy Statement, to be filed with the SEC within 120 days of the fiscal year ended December 31, 2020 and is incorporated herein by reference.
We have a code of business ethics and conduct that applies to all of our employees, including our Principal Executive Officer, Principal Financial Officer, Principal Accounting Officer, and our Board of Directors. A copy of this code, “Code of Business Conduct and Ethics,” is available on our website at http://investor.zendesk.com. We intend to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding amendment to, or waiver from, a provision of our Code of Business Conduct and Ethics by posting such information on our investor relations website under the heading “Corporate Governance” at http://investor.zendesk.com.
Item 11.
Item 11. Executive Compensation.
The information required by this item will be included in the 2021 Proxy Statement and is incorporated herein by reference.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The information required by this item will be included in the 2021 Proxy Statement and is incorporated herein by reference.
Item 13.
Item 13. Certain Relationships and Related Transactions, and Director Independence.
The information required by this item will be included in the 2021 Proxy Statement and is incorporated herein by reference.
Item 14.
Item 14. Principal Accounting Fees and Services.
The information required by this item will be included in the 2021 Proxy Statement and is incorporated herein by reference.
PART IV
Item 15.
Item 15. Exhibits, Financial Statement Schedules.
(a)The following documents are filed as part of this report:
(1) Financial Statements.
The financial statements filed as part of this report are listed on the Index to Consolidated Financial Statements in Item 8.
(2) Financial Statement Schedules.
Schedules not listed above have been omitted because the information required to be set forth therein is not applicable or is shown in the financial statements or notes herein.
(3) Exhibits.
The documents listed in the Exhibit Index of this report are incorporated by reference or are filed with this report, in each case as indicated therein.
Item 16. Form 10-K Summary.
Not applicable.
Exhibit Index
# Indicates management contract or compensatory plan, contract, or agreement.
† The certifications attached as Exhibit 32.1 that accompany this Annual Report on Form 10-K, are not deemed filed with the Securities and Exchange Commission and are not to be incorporated by reference into any filing of Zendesk, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, whether made before or after the date of this Annual Report on Form 10-K, irrespective of any general incorporation language contained in such filing.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
POWER OF ATTORNEY
Each person whose signature appears below constitutes and appoints Mikkel Svane and Elena Gomez, and each of them, as his or her true and lawful attorney-in-fact and agent, with full power of substitution and resubstitution, for him or her and in his or her name, place and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents, and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith, as fully to all intents and purposes as he or she might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his or her substitutes, may lawfully do or cause to be done by virtue thereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated: