Edgar Filing: Zendesk, Inc.

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2019

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 001-36456

ZENDESK, INC.

(Exact Name of Registrant as Specified in its Charter)



Delaware		26-4411091
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1019 Market Street San Francisco, CA		94103
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number, including area code: (415) 418-7506

Securities registered pursuant to Section 12(b) of the Act



Title of each class	Trading symbol(s)	Name of each exchange on which registered
Common Stock, par value $0.01 per share	ZEN	New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.



Large accelerated filer	x	Accelerated filer	☐
Non-accelerated filer	☐	Smaller reporting company	☐
		Emerging growth company	☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No x

As of April 30, 2019, there were 109,564,955 shares of the registrant’s common stock outstanding.

ZENDESK, INC.

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PART I — FINANCIAL INFORMATION



Item 1	Financial Statements (unaudited):	5
	Condensed Consolidated Balance Sheets as of March 31, 2019 and December 31, 2018	5
	Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2019 and 2018	6
	Condensed Consolidated Statements of Comprehensive Loss for the Three Months Ended March 31, 2019 and 2018	7
	Condensed Consolidated Statements of Stockholders' Equity for the Three Months Ended March 31, 2019 and 2018	8
	Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2019 and 2018	9
	Notes to Condensed Consolidated Financial Statements	10
Item 2	Management’s Discussion and Analysis of Financial Condition and Results of Operations	25
Item 3	Quantitative and Qualitative Disclosures About Market Risk	34
Item 4	Controls and Procedures	35

PART II — OTHER INFORMATION

Item 1	Legal Proceedings	36
Item 1A	Risk Factors	36
Item 6	Exhibits	60
SIGNATURES		61

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of federal securities laws, which statements involve substantial risks and uncertainties. Forward-looking statements generally relate to future events or our future financial or operating performance. In some cases, you can identify forward-looking statements because they contain words such as “may,” “will,” “should,” “might,” “expects,” “plans,” “anticipates,” “could,” “intends,” “target,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” or the negative of these words or other similar terms or expressions that concern our expectations, strategy, plans, or intentions. Forward-looking statements contained in this Quarterly Report on Form 10-Q include, but are not limited to, statements about:


•	our future financial performance, including our revenue, cost of revenue, gross profit, operating expenses, ability to generate positive cash flow, and ability to achieve and maintain profitability;


•	the sufficiency of our cash and cash equivalents and marketable securities to meet our liquidity needs;


•	our ability to attract and retain customers to use our products, and our ability to optimize the pricing for such products;


•	the evolution of technology affecting our products, services, and markets;


•	our ability to innovate and provide a superior customer experience;


•	our ability to successfully expand in our existing markets and into new markets;


•	the attraction and retention of qualified employees and key personnel;


•	worldwide economic conditions and their impact on information technology spending;


•	our ability to effectively manage our growth and future expenses;


•	our ability to introduce and market new products and to integrate such products into our infrastructure;


•	our ability to maintain, protect, and enhance our intellectual property;


•	our ability to comply with modified or new laws and regulations applying to our business, including privacy and data security regulations;


•	our ability to securely maintain customer data;


•	our ability to service the interest on our convertible notes and repay such notes, if required;


•	our ability to successfully integrate people, products, technology and services following completion of acquisitions;


•	our ability to maintain and enhance our brand; and


•	the increased expenses and administrative workload associated with being a public company.

We caution you that the foregoing list does not contain all of the forward-looking statements made in this Quarterly Report on Form 10-Q.

You should not rely upon forward-looking statements as predictions of future events. We have based the forward-looking statements contained in this Quarterly Report on Form 10-Q primarily on our current expectations and projections about future events and trends that we believe may affect our business, financial condition, operating results, and prospects. The outcome of the events described in these forward-looking statements is subject to risks, uncertainties, and other factors described in the section titled “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Moreover, we operate in a very competitive and rapidly changing environment. New risks and uncertainties emerge from time to time, and it is not possible for us to predict all risks and uncertainties that could have an impact on the forward-looking statements contained in this Quarterly Report on Form 10-Q. We cannot assure you that the results, events, and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results, events, or circumstances could differ materially from those described in the forward-looking statements.

The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. We undertake no obligation to update any forward-looking statements made in this Quarterly Report on Form 10-Q to reflect events or circumstances after the date of this Quarterly Report on Form 10-Q or to reflect new information or the occurrence of unanticipated events, except as required by law. We may not actually achieve the plans, intentions, or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures, or investments we may make.

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PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

ZENDESK, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except par value and shares)



	March 31, 2019			December 31, 2018
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	142,418		$	126,518
Marketable securities	301,941			300,213
Accounts receivable, net of allowance for doubtful accounts of $3,060 and $2,571 as of March 31, 2019 and December 31, 2018, respectively	90,465			85,280
Deferred costs	26,882			24,712
Prepaid expenses and other current assets	38,629			35,873
Total current assets	600,335			572,596
Marketable securities, noncurrent	401,079			393,671
Property and equipment, net	75,619			75,654
Deferred costs, noncurrent	28,312			26,914
Lease right-of-use assets	99,435			—
Goodwill and intangible assets, net	144,069			146,327
Other assets	23,829			22,717
Total assets	$	1,372,678		$	1,237,879
Liabilities and stockholders’ equity
Current liabilities:
Accounts payable	$	29,458		$	16,820
Accrued liabilities	32,722			34,097
Accrued compensation and related benefits	50,389			46,603
Deferred revenue	257,731			245,243
Lease liabilities	19,402			—
Total current liabilities	389,702			342,763
Convertible senior notes, net	464,364			458,176
Deferred revenue, noncurrent	1,865			2,719
Lease liabilities, noncurrent	94,943			—
Other liabilities	2,859			17,300
Total liabilities	953,733			820,958
Commitments and contingencies (Note 9)
Stockholders’ equity:
Preferred stock	—			—
Common stock	1,092			1,080
Additional paid-in capital	994,031			950,693
Accumulated other comprehensive loss	(2,330		)	(5,724		)
Accumulated deficit	(573,848		)	(529,128		)
Total stockholders’ equity	418,945			416,921
Total liabilities and stockholders’ equity	$	1,372,678		$	1,237,879

See Notes to Condensed Consolidated Financial Statements.

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ZENDESK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(Unaudited)



	Three Months Ended March 31,
	2019			2018
Revenue	$	181,484		$	129,791
Cost of revenue (1)	55,654			39,056
Gross profit	125,830			90,735
Operating expenses (1):
Research and development	46,791			37,085
Sales and marketing	91,700			65,058
General and administrative	31,253			22,207
Total operating expenses	169,744			124,350
Operating loss	(43,914		)	(33,615		)
Other income (expense), net:
Interest income	5,472			1,519
Interest expense	(6,544		)	(764		)
Other income, net	700			245
Total other income (expense), net	(372		)	1,000
Loss before provision for (benefit from) income taxes	(44,286		)	(32,615		)
Provision for (benefit from) income taxes	434			(3,290		)
Net loss	$	(44,720	)	$	(29,325	)
Net loss per share, basic and diluted	$	(0.41	)	$	(0.28	)
Weighted-average shares used to compute net loss per share, basic and diluted	108,630			103,692

(1) Includes share-based compensation expense as follows:



	Three Months Ended March 31,
	2019		2018
Cost of revenue	$	4,937	$	3,098
Research and development	11,636		10,231
Sales and marketing	12,399		8,007
General and administrative	7,685		5,652

See Notes to Condensed Consolidated Financial Statements.

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ZENDESK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS

(In thousands)

(Unaudited)



	Three Months Ended March 31,
	2019			2018
Net loss	$	(44,720	)	$	(29,325	)
Other comprehensive gain (loss), before tax:
Net unrealized gain (loss) on available-for-sale investments	3,342			(636		)
Foreign currency translation loss	—			(12		)
Net unrealized gain (loss) on derivative instruments	1,124			(742		)
Other comprehensive gain (loss), before tax	4,466			(1,390		)
Tax effect	(1,072		)	—
Other comprehensive gain (loss), net of tax	3,394			(1,390		)
Comprehensive loss	$	(41,326	)	$	(30,715	)

See Notes to Condensed Consolidated Financial Statements.

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ZENDESK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(In thousands)

(unaudited)



	Three Months Ended March 31, 2019															Three Months Ended March 31, 2018
	Common Stock			Additional Paid-In Capital			Accumulated Other Comprehensive Loss			Accumulated Deficit			Total Stockholders’ Equity			Common Stock			Additional Paid-In Capital			Accumulated Other Comprehensive Loss			Accumulated Deficit			Total Stockholders’ Equity
	Shares	Amount														Shares	Amount


Balances at beginning of period	108,037	$	1,080	$	950,693		$	(5,724	)	$	(529,128	)	$	416,921		103,121	$	1,031	$	753,568		$	(2,372	)	$	(398,043	)	$	354,184
Issuance of common stock upon exercise of stock options	376	4		8,434			—			—			8,438			454	4		6,189			—			—			6,193
Issuance of common stock for settlement of RSUs	847	8		(2,425		)	—			—			(2,417		)	688	7		(741		)	—			—			(734		)
Share-based compensation	—	—		37,329			—			—			37,329			—	—		27,487			—			—			27,487
Equity component of convertible senior notes	—	—		—			—			—			—			—	—		44,255			—			—			44,255
Other comprehensive gain (loss), net of tax	—	—		—			3,394			—			3,394			—	—		—			(1,390		)	—			(1,390		)
Net loss	—	—		—			—			(44,720		)	(44,720		)	—	—		—			—			(29,325		)	(29,325		)
Other	—	—		—			—			—			—			—	—		(17		)	—			—			(17		)
Balances at end of period	109,260	$	1,092	$	994,031		$	(2,330	)	$	(573,848	)	$	418,945		104,263	$	1,042	$	830,741		$	(3,762	)	$	(427,368	)	$	400,653

See Notes to Consolidated Financial Statements.

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ZENDESK, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)



	Three Months Ended March 31,
	2019			2018
Cash flows from operating activities
Net loss	$	(44,720	)	$	(29,325	)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization	8,732			9,865
Share-based compensation	36,657			26,988
Amortization of deferred costs	6,918			4,510
Amortization of debt discount and issuance costs	6,188			720
Other	394			250
Changes in operating assets and liabilities:
Accounts receivable	(6,966		)	3,691
Prepaid expenses and other current assets	(3,774		)	(3,364		)
Deferred costs	(10,190		)	(7,043		)
Lease right-of-use assets	4,373			—
Other assets and liabilities	(498		)	(12,027		)
Accounts payable	15,655			1,052
Accrued liabilities	2,512			10,986
Accrued compensation and related benefits	(4,629		)	(971		)
Deferred revenue	12,149			10,910
Lease liabilities	(3,832		)	—
Net cash provided by operating activities	18,969			16,242
Cash flows from investing activities
Purchases of property and equipment	(9,258		)	(6,808		)
Internal-use software development costs	(1,213		)	(2,344		)
Purchases of marketable securities	(145,142		)	(78,321		)
Proceeds from maturities of marketable securities	47,265			55,263
Proceeds from sales of marketable securities	91,562			6,982
Purchase of strategic investment	(500		)	—
Net cash used in investing activities	(17,286		)	(25,228		)
Cash flows from financing activities
Proceeds from issuance of convertible senior notes, net of issuance costs paid of $12,937	—			562,063
Purchase of capped call related to convertible senior notes	—			(63,940		)
Proceeds from exercises of employee stock options	8,437			6,193
Proceeds from employee stock purchase plan	8,415			5,096
Taxes paid related to net share settlement of share-based awards	(2,416		)	(734		)
Net cash provided by financing activities	14,436			508,678
Effect of exchange rate changes on cash, cash equivalents and restricted cash	33			(35		)
Net increase in cash, cash equivalents and restricted cash	16,152			499,657
Cash, cash equivalents and restricted cash at beginning of period	128,876			110,888
Cash, cash equivalents and restricted cash at end of period	$	145,028		$	610,545

Reconciliation of cash, cash equivalents and restricted cash to condensed consolidated balance sheets
Cash and cash equivalents	$	142,418		$	609,229
Restricted cash included in prepaid expenses and other current assets	1,891			682
Restricted cash included in other assets	719			634
Total cash, cash equivalents and restricted cash	$	145,028		$	610,545

Supplemental cash flow data
Cash paid for interest	$	719		$	—
Cash paid for taxes	$	700		$	918
Non-cash investing and financing activities
Balance of property and equipment in accounts payable and accrued expenses	$	2,411		$	3,504
Property and equipment acquired through tenant improvement allowances	$	349		$	1,370
Share-based compensation capitalized in internal-use software development costs	$	375		$	850
Estimated convertible senior notes offering costs incurred but not yet paid	$	—		$	850
Share-based compensation capitalized in deferred costs	$	297		$	163

See Notes to Condensed Consolidated Financial Statements.

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ZENDESK, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note 1. Overview and Basis of Presentation

Company and Background

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, products that are intended to help organizations and their customers build better experiences. Our product family is 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 a family of products and platform 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.

Basis of Presentation

These unaudited condensed consolidated financial statements have been prepared in accordance with United States generally accepted accounting principles, or GAAP, and applicable rules and regulations of the Securities and Exchange Commission, or SEC, regarding interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. Therefore, these condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes included in our Annual Report on Form 10-K, for the year ended December 31, 2018, filed with the SEC on February 14, 2019. There have been no changes to our significant accounting policies described in the Annual Report on Form 10-K that have had a material impact on our condensed consolidated financial statements and related notes, except as described below.

The consolidated balance sheet as of December 31, 2018 included herein was derived from the audited financial statements as of that date. The unaudited condensed consolidated financial statements reflect all normal recurring adjustments necessary to present fairly our financial position, results of operations, comprehensive loss, stockholders' equity, and cash flows for the interim periods, but are not necessarily indicative of the results of operations to be anticipated for the full year ending December 31, 2019.

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 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 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;

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•the fair value and expense recognition for certain share-based awards;

•the preparation of financial forecasts used in currency hedging; and

•the recognition of tax benefits.

These estimates are based on information available as of the date of the financial statements; therefore, actual results could differ from those estimates.

Concentrations of Risk

As of March 31, 2019 and December 31, 2018, no customers represented 10% or greater of our total accounts receivable balance. There were no customers that individually exceeded 10% of our revenue during the three months ended March 31, 2019 or 2018.

Recently Issued Accounting Pronouncements

In June 2016, the Financial Accounting Standards Board, or FASB, issued ASU 2016-13, 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. Additionally, any expected credit losses are to be reflected as allowances rather than reductions in the amortized cost of available-for-sale debt securities. This guidance is effective for annual reporting periods beginning after December 15, 2019, 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.

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. The standard is effective for fiscal years beginning after December 15, 2019, however early adoption is permitted. We do not expect the adoption of this standard to have a material 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. The guidance is effective for annual reporting periods beginning after December 15, 2019, including interim periods within that reporting period. Early adoption is permitted. We do not expect the adoption of this standard to have a material effect 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 on January 1, 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 effect of adopting ASC 842 resulted in the recognition of lease right-of-use assets and corresponding lease liabilities on our condensed consolidated balance sheets. As of March 31, 2019, 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 statement of operations or cash flows.

In August 2017, the FASB issued ASU 2017-12, regarding ASC Topic 815 “Derivatives and Hedging.” This guidance simplifies various aspects of hedge accounting, including the measurement and presentation of hedge ineffectiveness and certain documentation and assessment requirements. The guidance also makes more hedging strategies eligible for hedge accounting. We adopted this standard in the first quarter of 2019. Upon adoption, we no longer recognize hedge ineffectiveness

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immediately in our consolidated statements of operations, but we instead recognize the entire change in the fair value of the hedge contract in other comprehensive income. The cumulative-effect adjustment to eliminate ineffectiveness was not material. The presentation and disclosures have been modified on a prospective basis, as required by the guidance.

In February 2018, the FASB issued ASU 2018-02, “Income Statement - Reporting Comprehensive Income,” which provides for the reclassification of the effect of remeasuring deferred tax balances related to items within accumulated other comprehensive income to retained earnings resulting from the Tax Cuts and Jobs Act, or Tax Act. The guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period. We adopted this standard in the first quarter of 2019. We have elected not to reclassify the income tax effects of the Tax Act from accumulated other comprehensive income to retained earnings, therefore the adoption did not have an effect on our consolidated financial statements.

In June 2018, the FASB issued ASU 2018-07, regarding ASC Topic 718 “Compensation - Stock Compensation,” which largely aligns the accounting for share-based compensation for non-employees with employees. The guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period. We adopted this standard in the first quarter of 2019. The adoption did not have an effect on our consolidated financial statements.

In June 2018, the FASB issued ASU 2018-08, regarding ASC Topic 958 “Not-for-Profit Entities,” which clarified the guidance on how entities determine whether to account for a transfer of assets as an exchange transaction or a contribution. The guidance is effective for annual reporting periods beginning after December 15, 2018, including interim periods within that reporting period. We adopted the standard in the first quarter of 2019. The adoption did not have an effect on our consolidated financial statements.

In August 2018, the FASB issued ASU 2018-15, regarding ASC Topic 350-40 “Intangibles - Internal-Use Software,” which aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The guidance is effective for annual reporting periods beginning after December 15, 2019, including interim periods within that reporting period. We early adopted the standard in the first quarter of 2019. The adoption did not have an effect on our consolidated financial statements.

Note 2. Business Combinations

FutureSimple Inc.

On September 10, 2018, we completed the acquisition of FutureSimple Inc., or FutureSimple, the developer of Base, a sales force automation software product. We acquired FutureSimple for purchase consideration of $81 million in cash. We incurred transaction costs of $2 million in connection with the acquisition, which were included within general and administrative expenses.

The fair value of assets acquired and liabilities assumed was based on a preliminary valuation, and our estimates and assumptions are subject to change within the measurement period. The primary areas that remain preliminary relate to the evaluation of certain tax-related items. The total purchase consideration was allocated to the assets acquired and liabilities assumed as set forth below (in thousands). During the three months ended March 31, 2019, we made certain immaterial adjustments to the preliminary purchase price allocation, which are reflected in the table below.

The excess of the purchase price over the net assets acquired was recorded as goodwill. Goodwill generated from the acquisition is primarily attributable to assembled workforce and expected growth from the expansion of the scope of and market opportunity for our products. Goodwill is not deductible for income tax purposes. Goodwill will not be amortized but instead will be tested for impairment at least annually and more frequently if certain indicators of impairment are present.

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Net tangible liabilities acquired	$	(2,966	)
Identifiable intangible assets:
Developed technology	19,000
Customer relationships	10,400
Backlog	2,200
Goodwill	52,389
Total purchase consideration	$	81,023

The developed technology, customer relationships, and backlog intangible assets were assigned useful lives of 6.5, 5.0, and 2.0 years, respectively.

In connection with the acquisition, we granted cash and share-based retention awards to certain employees of FutureSimple. The cash awards vest over a required service period and the share-based awards vest upon fulfillment of certain service and performance conditions. Each retention award will be recorded as expense based on the fulfillment of such service and performance conditions, as applicable, and is not included in the total purchase consideration.

From the date of the acquisition, the results of operations of FutureSimple have been included in and are immaterial to our consolidated financial statements. Pro forma revenue and results of operations have not been presented because the historical results of FutureSimple are not material to our consolidated financial statements in any period presented.

Note 3. Financial Instruments

Investments

The following tables present information about our financial assets measured at fair value on a recurring basis based on the three-tier fair value hierarchy (in thousands):



	Fair Value Measurement at March 31, 2019
	Level 1		Level 2		Total
Description
Corporate bonds	$	—	$	474,511	$	474,511
Asset-backed securities	—		140,271		140,271
U.S. treasury securities	—		64,070		64,070
Money market funds	58,650		—		58,650
Commercial paper	—		13,977		13,977
Agency securities	—		11,339		11,339
Certificates of deposit	—		1,150		1,150
Total	$	58,650	$	705,318	$	763,968
Included in cash and cash equivalents					$	60,948
Included in marketable securities					$	703,020

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	Fair Value Measurement at December 31, 2018
	Level 1		Level 2		Total
Description
Corporate bonds	$	—	$	460,210	$	460,210
Asset-backed securities	—		127,078		127,078
U.S. treasury securities	—		58,039		58,039
Money market funds	57,758		—		57,758
Commercial paper	—		38,900		38,900
Agency securities	—		11,256		11,256
Certificates of deposit and time deposits	—		3,200		3,200
Total	$	57,758	$	698,683	$	756,441
Included in cash and cash equivalents					$	62,557
Included in marketable securities					$	693,884

As of March 31, 2019 and December 31, 2018, there were no securities within Level 3 of the fair value hierarchy. There were no transfers between fair value measurement levels during the three months ended March 31, 2019. Gross unrealized gains and losses for cash equivalents and marketable securities as of March 31, 2019 and December 31, 2018 were not material. Unrealized losses for securities that have been in an unrealized loss position for more than 12 months as of March 31, 2019 and December 31, 2018 were not material.

The following table classifies our marketable securities by contractual maturity (in thousands):



	March 31, 2019		December 31, 2018
Due in one year or less	$	301,941	$	300,213
Due after one year and within five years	401,079		393,671
Total	$	703,020	$	693,884

As of March 31, 2019 and December 31, 2018, the balance of strategic investments without readily determinable fair values was $11 million and $10 million, respectively. There have been no adjustments to the carrying value of strategic investments resulting from impairments or observable price changes.

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

Our foreign currency exposures typically arise from expenditures associated with foreign operations and sales in foreign currencies of our products. To mitigate the effect of foreign currency fluctuations on our future cash flows and earnings, we enter into foreign currency forward contracts with certain financial institutions and designate those contracts as cash flow hedges. Our foreign currency forward contracts generally have maturities of 15 months or less.

Upon the adoption of ASU 2017-12 in the first quarter of 2019, 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 accumulated other comprehensive income (loss), or AOCI. Prior to adoption, we excluded time value for effectiveness testing purposes and we recognized changes in time value immediately in other income (expense), net.

As of March 31, 2019, the balance of AOCI included an unrecognized net loss of $1 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 loss of $1 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 (in thousands):

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	March 31, 2019
	Asset Derivatives			Liability Derivatives
Derivative Instrument	Balance Sheet Location	Fair Value (Level 2)		Balance Sheet Location	Fair Value (Level 2)
Foreign currency forward contracts	Other current assets	$	1,842	Accrued liabilities	$	3,726
Total		$	1,842		$	3,726



	December 31, 2018
	Asset Derivatives			Liability Derivatives
Derivative Instrument	Balance Sheet Location	Fair Value (Level 2)		Balance Sheet Location	Fair Value (Level 2)
Foreign currency forward contracts	Other current assets	$	2,047	Accrued liabilities	$	4,862
Total		$	2,047		$	4,862

Our foreign currency forward contracts had a total notional value of $232 million and $200 million as of March 31, 2019 and December 31, 2018, respectively. We have a master netting arrangement with each of our counterparties, which permit net settlement of multiple, separate derivative contracts with a single payment. We may also be required to exchange cash collateral with certain of our counterparties on a regular basis. 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. As of March 31, 2019 and December 31, 2018, there was no cash collateral posted with counterparties. All derivatives have been designated as hedging instruments.

The following table presents information about our foreign currency forward contracts on our condensed consolidated statements of operations for the three months ended March 31, 2019 (in thousands):



Classification	Gain (Loss) Reclassified from AOCI into Earnings
Revenue	$	443
Cost of revenue	(474		)
Research and development	(434		)
Sales and marketing	(790		)
General and administrative	(276		)
Total	$	(1,531	)

The loss recognized in AOCI related to foreign currency forward contracts was not material for the three months ended March 31, 2019.

The gain recognized in AOCI related to foreign currency forward contracts was not material for the three months ended March 31, 2018. The gain reclassified from AOCI into earnings related to foreign currency forward contracts was $1 million for the three months ended March 31, 2018, which was included within revenue, cost of revenue and operating expenses on our consolidated statements of operations.

The cash flow effects related to foreign currency forward contracts are included within operating activities on our consolidated statements of cash flows.

Convertible Senior Notes

As of March 31, 2019, the fair value of our convertible senior notes was $838 million. The fair value was determined based on the quoted price of the convertible senior notes in an inactive market on the last trading day of the reporting period and has been classified as Level 2 in the fair value hierarchy. Based on the closing price of our common stock of $85.00 on March 31, 2019, the if-converted value of our convertible senior notes exceeded the principal amount of $575 million.

Note 4. Costs to Obtain Customer Contracts

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The balances of deferred costs to obtain customer contracts were $55 million and $52 million as of March 31, 2019 and December 31, 2018, respectively. Amortization expense for these deferred costs was $7 million and $5 million for the three months ended March 31, 2019 and 2018, respectively. There were no impairment losses related to these deferred costs for the periods presented.

Note 5. Property and Equipment

Property and equipment, net consists of the following (in thousands):



	March 31, 2019			December 31, 2018
Leasehold improvements	$	58,119		$	51,832
Capitalized internal-use software	37,489			36,444
Computer equipment and licensed software and patents	22,768			21,100
Furniture and fixtures	12,046			11,550
Construction in progress	4,564			10,538
Hosting equipment	—			34,105
Total	134,986			165,569
Less: accumulated depreciation and amortization	(59,367		)	(89,915		)
Property and equipment, net	$	75,619		$	75,654

Depreciation expense was $5 million and $6 million for the three months ended March 31, 2019 and 2018, respectively.

Amortization expense of capitalized internal-use software was $2 million for each of the three months ended March 31, 2019 and 2018. The carrying value of capitalized internal-use software at March 31, 2019 and December 31, 2018 was $19 million, including $3 million in construction in progress, for both periods.

During the first quarter of 2019, we completed the transition from our self-managed colocation data centers to third-party managed hosting services, at which time, management concluded that these assets met the criteria to be classified as held for sale. Accordingly, these assets were written down to their estimated salvage value and reclassified from property and equipment to other current assets, with $34 million and $33 million being reclassified from hosting equipment and accumulated depreciation respectively, for a net amount of $1 million.

Note 6. 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 use our incremental borrowing rate based on the information available at 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 sheet; we recognize lease expense for these leases on a straight-line basis over the lease term.

The following tables present information about leases on our consolidated balance sheet (in thousands):

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	March 31, 2019
Assets
Lease right-of-use assets	$	99,435
Liabilities
Lease liabilities	19,402
Lease liabilities, noncurrent	94,943

As of March 31, 2019, the weighted average remaining lease term was 6.2 years and the weighted average discount rate was 5.3%.

The following table presents information about leases on our consolidated statement of operations (in thousands):



	Three Months Ended March 31, 2019
Operating lease expense	$	5,045
Short-term lease expense	874
Variable lease expense	885
Sublease income	401

The following table presents supplemental cash flow information about our leases (in thousands):



	Three Months Ended March 31, 2019
Cash paid for amounts included in the measurement of lease liabilities	$	4,176
Operating lease assets obtained in exchange for new lease liabilities	19,550

As of March 31, 2019, remaining maturities of lease liabilities are as follows:



Remainder of 2019	$	17,599
2020	25,880
2021	23,598
2022	22,102
2023	15,464
Thereafter	29,315
Total lease payments	133,958
Less imputed interest	19,613
Total	$	114,345

The table above excludes future payments of $9 million related to signed leases that have not yet commenced.

Note 7. Goodwill and Acquired Intangible Assets

The changes in the carrying amount of goodwill for the three months ended March 31, 2019 are as follows (in thousands):



Balance as of December 31, 2018	$	111,584
Goodwill adjustments	(64		)
Balance as of March 31, 2019	$	111,520

Acquired intangible assets subject to amortization consist of the following (in thousands):

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	As of March 31, 2019
	Cost		Accumulated Amortization			Net		Weighted Average Remaining Useful Life
								(In years)
Developed technology	$	31,000	$	(9,492	)	$	21,508	5.3
Customer relationships	11,310		(1,827		)	9,483		4.3
Backlog	2,200		$	(642	)	1,558		1.4
	$	44,510	$	(11,961	)	$	32,549



	As of December 31, 2018
	Cost		Accumulated Amortization			Net		Weighted Average Remaining Useful Life
								(In years)
Developed technology	$	31,000	$	(8,151	)	$	22,849	5.5
Customer relationships	11,310		(1,249		)	10,061		4.6
Backlog	2,200		(367		)	1,833		1.7
	$	44,510	$	(9,767	)	$	34,743

Amortization expense of acquired intangible assets was $2 million and $1 million for the three months ended March 31, 2019 and 2018, respectively.

Estimated future amortization expense as of March 31, 2019 is as follows (in thousands):



Remainder of 2019	$	6,605
2020	6,832
2021	5,490
2022	5,490
2023	4,719
Thereafter	3,413
	$	32,549

Note 8. 0.25% Convertible Senior Notes and Capped Call

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 “Notes"). The 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.

Each $1,000 principal amount of the 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 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 Notes at any time, regardless

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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 Notes) prior to the maturity date, holders of the 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 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 Notes. During the three months ended March 31, 2019, the conditions allowing holders of the Notes to convert have not been met. The Notes are therefore not convertible during the three months ended March 31, 2019 and are classified as long-term debt.

In accounting for the transaction, the 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 representing the Conversion Option was $125 million and was determined by deducting the fair value of the liability component from the par value of the 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, the “Debt Discount,” is amortized to interest expense over the contractual term of the Notes at an effective interest rate of 5.26%.

In accounting for the debt issuance costs of $14 million related to the Notes, we allocated the total amount incurred to the liability and equity components of the Notes based on their relative values. Issuance costs attributable to the liability component were $11 million and are amortized to interest expense using the effective interest method over the contractual term of the 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 Notes is as follows (in thousands):



	March 31, 2019			December 31, 2018
Principal	$	575,000		$	575,000
Unamortized Debt Discount	(101,743		)	(107,494		)
Unamortized issuance costs	(8,893		)	(9,330		)
Net carrying amount	$	464,364		$	458,176

The net carrying amount of the equity component of the Notes is as follows (in thousands):



	March 31, 2019			December 31, 2018
Debt Discount for Conversion Option	$	124,976		$	124,976
Issuance costs	(2,948		)	(2,948		)
Net carrying amount	$	122,028		$	122,028

Interest expense related to the Notes is as follows (in thousands):



	Three Months Ended March 31,
	2019		2018
Contractual interest expense	$	356	$	44
Amortization of Debt Discount	5,751		671
Amortization of issuance costs	437		49
Total interest expense	$	6,544	$	764

In connection with the pricing of the Notes, we entered into privately negotiated capped call transactions with certain counterparties, the “Capped Calls.” The 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 Notes. The Capped Calls have initial cap prices of $95.20 per share, subject to certain adjustments. The Capped Calls cover, subject to anti-dilution adjustments,

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approximately 9.1 million shares of our common stock. Conditions that cause adjustments to the initial strike price of the Capped Calls mirror conditions that result in corresponding adjustments for the Notes. The Capped Calls are generally intended to reduce or offset the potential dilution to our common stock upon any conversion of the Notes with such reduction or offset, as the case may be, subject to a cap based on the cap price. For accounting purposes, the Capped Calls are separate transactions, and not part of the terms of the Notes. As these transactions meet certain accounting criteria, the Capped Calls are recorded in stockholders' equity and are not accounted for as derivatives. The cost of $64 million incurred in connection with the Capped Calls was recorded as a reduction to additional paid-in capital.

The net impact to our stockholders' equity, included in additional paid-in capital, of the above components of the Notes is as follows (in thousands):



Conversion Option	$	124,976
Purchase of Capped Calls	(63,940		)
Issuance costs	(2,948		)
Net deferred tax liability	(13,784		)
Total	$	44,304

Note 9. Commitments and Contingencies

Commitments

As of March 31, 2019, there were no material changes in our commitments under contractual obligations, as disclosed in our audited consolidated financial statements for the year ended December 31, 2018.

Litigation and Loss Contingencies

We accrue estimates for resolution of legal and other contingencies when losses are probable and estimable. From time to time, we may become a party to litigation and subject to claims that arise in the ordinary course of business, including intellectual property claims, labor and employment claims, threatened claims, breach of contract claims, tax, and other matters. We currently have no material pending litigation.

We are not currently aware of any litigation matters or loss contingencies that would be expected to have a material adverse effect on our 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 10. Common Stock and Stockholders’ Equity

Common Stock

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As of March 31, 2019 and December 31, 2018, there were 400 million shares of common stock authorized for issuance with a par value of $0.01 per share and 109.3 million and 108.0 million shares were issued and outstanding, respectively.

Preferred Stock

As of each of March 31, 2019 and December 31, 2018, 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 our Employee Stock Purchase Plan, or 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 an offering period or the fair market value of our common stock at the end of the purchase period. No shares of common stock were purchased under the ESPP during the three months ended March 31, 2019. Pursuant to the terms of the ESPP, the number of shares reserved under the ESPP increased by 1.1 million shares on January 1, 2019. As of March 31, 2019, 5.0 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 5.4 million shares on January 1, 2019. As of March 31, 2019, we had 12.1 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 three months ended March 31, 2019 is as follows (in thousands, except per share information):

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			Options Outstanding							RSUs Outstanding
	Shares Available for Grant		Number of Shares		Weighted Average Exercise Price		Weighted Average Remaining Contractual Term	Aggregate Intrinsic Value		Outstanding RSUs		Weighted Average Grant Date Fair Value		Aggregate Intrinsic Value
							(In years)
Outstanding — January 1, 2019	8,232		5,938		$	20.85	6.58	$	222,959	6,611		$	37.77	$	385,891
Increase in authorized shares	5,402
Stock options granted	(336	)	336		73.27
RSUs granted	(1,522	)								1,522		64.88
Stock options exercised			(376	)	22.43
RSUs vested										(847	)	33.95
Stock options forfeited or canceled	26		(26	)	28.98
RSUs forfeited or canceled	251									(251	)	37.73
RSUs forfeited or canceled and unavailable for grant										(7	)	23.44
Outstanding — March 31, 2019	12,053		5,872		$	23.71	6.53	$	360,015	7,028		$	44.11	$	597,191

The restricted stock units, or 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 three months ended March 31, 2019 and 2018 was $21 million and $13 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 three months ended March 31, 2019 and 2018 was $28.65 and $16.38, respectively.

The total fair value of RSUs vested during the three months ended March 31, 2019 and 2018 was $63 million and $30 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 three months ended March 31, 2019 and 2018 was $64.88, and $36.90, respectively.

As of March 31, 2019, we had a total of $330 million in future expense related to our stock options and RSUs to be recognized over a weighted average period of 2.9 years.

Performance Restricted Stock Units

During the three months ended September 30, 2018, the compensation committee of our board of directors granted performance-based restricted stock units, or PRSUs, representing 0.2 million shares of common stock, the substantial majority of which were granted in connection with the acquisition of FutureSimple. 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. During the three months ended March 31, 2019, we recorded $1 million of share-based compensation expense related to the PRSUs and no PRSUs were vested. The total future expense related to the PRSUs will be based on the fair value of the underlying shares on the grant date for each performance tranche.

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Note 11. Deferred Revenue and Performance Obligations

During the three months ended March 31, 2019 and 2018, $118 million and $86 million of revenue was recognized that was included in the deferred revenue balances at the beginning of each period, respectively.

The aggregate balance of remaining performance obligations as of March 31, 2019 was $441 million. We expect to recognize $346 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 and does not include contract amounts which are cancelable by the customer and amounts associated with optional renewal periods.

Note 12. 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):



	Three Months Ended March 31,
	2019			2018
Net loss	$	(44,720	)	$	(29,325	)
Weighted-average shares used to compute basic and diluted net loss per share	108,630			103,692
Net loss per share, basic and diluted	$	(0.41	)	$	(0.28	)

The anti-dilutive securities excluded from the shares used to calculate diluted net loss per share are as follows (in thousands):



	As of March 31,
	2019	2018
Shares subject to outstanding common stock options and employee stock purchase plan	6,167	6,646
Restricted stock units	7,028	7,768
Shares related to convertible senior notes	1,283	—
	14,478	14,414

The shares related to convertible senior notes calculated in the table above are calculated based on the average market price of our common stock for the three months ended March 31, 2019.

We expect to settle the principal amount of the convertible senior 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 price of $63.07 per share for the convertible senior notes. Based on the initial conversion price, potential dilution related to the convertible senior notes is approximately 9.1 million shares. The convertible senior notes are not convertible as of March 31, 2019.

Note 13. Income Taxes

We reported immaterial income tax expense in the three months ended March 31, 2019. We reported a benefit from income taxes of $3 million in the three months ended March 31, 2018, primarily due to the recognition of an income tax benefit of $4 million related to taxable temporary differences of the convertible senior notes and the capped call. 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.

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Note 14. 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):



	Three Months Ended March 31,
	2019		2018
United States	$	94,901	$	68,354
EMEA	52,075		37,872
APAC	19,476		13,996
Other	15,032		9,569
Total	$	181,484	$	129,791

Long-Lived Assets

The following table presents our long-lived assets by geographic area (in thousands):



	As of March 31, 2019		As of December 31, 2018
United States	$	77,242	$	32,351
EMEA:
Republic of Ireland	46,293		14,698
Other EMEA	3,544		2,450
Total EMEA	49,837		17,148
APAC:
Singapore	20,486		1,117
Other APAC	8,151		5,772
APAC	28,637		6,889
Total	$	155,716	$	56,388

The carrying values of capitalized internal-use software and intangible assets are excluded from the balance of long-lived assets presented in the table above.

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Item 2. 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 our condensed consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on February 14, 2019. 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, those identified below, and those discussed in the section titled “Risk Factors” included under Part II, Item 1A below.

Overview

We are a software development company that provides SaaS products that are intended to help organizations and their customers build better experiences. Our product family is 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 a family of products and a platform 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 products that serve organizations of all sizes and across all industries. The flagship product in our family, 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 products integrate with Support and include Zendesk Chat, Zendesk Talk, Zendesk Guide, and Zendesk Connect. 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. Connect enables customer service teams to send automated and timely messages based on a customer’s past actions and preferences. Additionally, we offer Zendesk Suite, an omnichannel offering which provides Support, Chat, Talk, and Guide together for a single price, Zendesk Sell, sales force automation software that complements our mission in delivering products that provide a better customer experience, and Zendesk Sunshine, a customer relationship management platform which enables organizations to connect and integrate customer data generated through the Zendesk product family.

We offer a range of subscription account plans for our products 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 three months ended March 31, 2019 and 2018, our revenue was $181 million and $130 million, respectively, representing a 40% growth rate. For the three months ended March 31, 2019 and 2018, we derived $87 million, or 48%, and $61 million, or 47%, respectively, of our revenue from customers located outside of the United States. 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 three months ended March 31, 2019 and 2018, we generated net losses of $45 million and $29 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 unified omnichannel offering geared towards the entire customer experience, build brand recognition and a scalable product for larger enterprises, maintain our leadership in the small and medium-sized 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. We anticipate that we will continue to expand our operations and headcount in the near term. 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.

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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 products, to further integrate these products and services, and to introduce new products. We plan to continue to expand our sales and marketing organizations, particularly in connection with our efforts to expand our customer base. 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.

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 products 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 products through a single paid customer account, Zendesk Suite. The number of Suite paid customer accounts are included in the number of accounts on products other than Support and Chat, and are not included in the number of paid customer accounts using Support or 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. Each of these accounts is also treated as a separate paid customer account. Other than paid accounts for Zendesk Connect, 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 145,600 paid customer accounts as of March 31, 2019, including approximately 75,600 paid customer accounts on Support, approximately 45,300 paid customer accounts on Chat, and approximately 24,700 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 products. 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 paid customer accounts, upgrades in subscription plans, and the purchase of additional products as offset by churn, contraction in authorized agents associated with paid customer accounts, and downgrades in subscription plans. We do not currently incorporate operating metrics associated with our legacy analytics product, our legacy Outbound product, our Sell product, our legacy Starter plan, 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

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subscription base, if any, that may be applicable to such subscription. Monthly recurring revenue is not determined by reference to historical revenue, deferred revenue, or any other 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 results in our dollar-based net expansion rate being calculated across approximately 102,200 customers, as compared to the approximately 145,600 total paid customer accounts as of March 31, 2019. 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. While not material, we believe the failure to account for these activities would otherwise skew our dollar-based net expansion metrics associated with customers that maintain multiple paid customer accounts across their products, and paid customer accounts associated with reseller and other similar channel arrangements.

Our dollar-based net expansion rate was 118% as of March 31, 2019. 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.

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, Explore, Sell, and Connect. 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 products that vary in price based on functionality, type, and, for Support and Chat, the amount of product 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. 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. Additionally, because of the mix of contract lengths, customer purchasing patterns, and renewal patterns for our products, we similarly do not believe that the amount of unsatisfied performance obligations, or any backlog calculated therefrom, measured as of any particular determination date, or period-over-period changes in such amounts, provides sufficient context to accurately predict our future revenue for any future period, and we caution you not to rely on such amounts for that purpose.

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

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Cost of Revenue. Cost of revenue consists primarily of personnel costs (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 capitalized internal-use software, amortization expense associated with acquired intangible assets, 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 transitioning support of our customers from our self-managed colocation data centers to third-party managed hosting services.

We intend to continue to invest additional resources in our infrastructure, product support, and professional service organizations, 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 products 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 products or for certain subscription plans or integrations, we expect third-party license fees for technology that is incorporated in such products 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 (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 products, including the development and deployment of new features and functionality and enhancements to our software architecture and integration across our products. 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 (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 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 generation. Sales commissions are considered incremental costs of obtaining customer contracts and are capitalized and amortized on a straight-line basis over the anticipated period of benefit, which we have determined to be three years.

We focus our sales and marketing efforts on generating awareness of our products, 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, building brand awareness, and sponsoring additional marketing events, 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.

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General and Administrative. General and administrative expenses consist primarily of personnel costs (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. However, we expect our general and administrative 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 extent of our general and administrative expenses.

Other Income (Expense), Net

Other income (expense), net consists primarily of interest income from marketable securities, foreign currency gains and losses, and interest expense from our convertible senior notes. 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

The following tables set forth our results of operations for the periods presented in dollars and as a percentage of our revenue:



	Three Months Ended March 31,
	2019			2018
Revenue	$	181,484		$	129,791
Cost of revenue (1)	55,654			39,056
Gross profit	125,830			90,735
Operating expenses (1):
Research and development	46,791			37,085
Sales and marketing	91,700			65,058
General and administrative	31,253			22,207
Total operating expenses	169,744			124,350
Operating loss	(43,914		)	(33,615		)
Other income (expense), net:
Interest income	5,472			1,519
Interest expense	(6,544		)	(764		)
Other income, net	700			245
Total other income (expense), net	(372		)	1,000
Loss before provision for (benefit from) income taxes	(44,286		)	(32,615		)
Provision for (benefit from) income taxes	434			(3,290		)
Net loss	$	(44,720	)	$	(29,325	)

______________

(1) Includes share-based compensation expense as follows:

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	Three Months Ended March 31,
	2019		2018
Cost of revenue	$	4,937	$	3,098
Research and development	11,636		10,231
Sales and marketing	12,399		8,007
General and administrative	7,685		5,652



	Three Months Ended March 31,
	2019		2018
Revenue	100.0	%	100.0	%
Cost of revenue (2)	30.7		30.1
Gross profit	69.3		69.9
Operating expenses (2):
Research and development	25.8		28.6
Sales and marketing	50.5		50.1
General and administrative	17.2		17.1
Total operating expenses	93.5		95.8
Operating loss	(24.2	)	(25.9	)
Other income (expense), net:
Interest income	3.0		1.2
Interest expense	(3.6	)	(0.6	)
Other income, net	0.4		0.2
Total other income (expense), net	(0.2	)	0.8
Loss before provision for (benefit from) income taxes	(24.4	)	(25.1	)
Benefit from income taxes	0.2		(2.5	)
Net loss	(24.6	)%	(22.6	)%

______________

(2) Includes share-based compensation expense as follows:



	Three Months Ended March 31,
	2019		2018
Cost of revenue	2.7	%	2.4	%
Research and development	6.4		7.9
Sales and marketing	6.8		6.2
General and administrative	4.2		4.4

Revenue



	Three Months Ended March 31,
	2019		2018		% Change
	(In thousands, except percentages)
Revenue	$	181,484	$	129,791	40	%

Revenue increased $52 million, or 40%, in the three months ended March 31, 2019 compared to the same period in 2018. The increase in revenue was primarily due to the increase of subscription services revenue from new customer contracts, as well as expansions from existing customers.

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Cost of Revenue and Gross Margin



	Three Months Ended March 31,
	2019			2018			% Change
	(In thousands, except percentages)
Cost of revenue	$	55,654		$	39,056		42	%
Gross margin	69.3		%	69.9		%

Cost of revenue increased $17 million, or 42%, in the three months ended March 31, 2019, compared to the same period in 2018. The overall increase was primarily due to increased employee compensation-related costs of $7 million, driven by headcount growth, increased hosting costs of $4 million, and increased third-party license fees of $2 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 of certain product features. Further contributing to the overall increase was an increase in allocated shared facilities and information technology costs of $1 million.

Our gross margin decreased by 0.6 percentage points in the three months ended March 31, 2019, compared to the same period in 2018, driven primarily by lower capitalization of employee compensation for internal-use software due to timing of projects and increased amortization expense of acquired intangible assets from our acquisition of FutureSimple Inc. The overall decrease was partially offset by a lower depreciation from our self-managed colocation data centers in connection with our transition to third-party managed hosting services.

Operating Expenses

Research and Development Expenses



	Three Months Ended March 31,
	2019		2018		% Change
	(In thousands, except percentages)
Research and development	$	46,791	$	37,085	26	%

Research and development expenses increased $10 million, or 26%, in the three months ended March 31, 2019, compared to the same period in 2018. The overall increase was primarily due to increased employee compensation-related costs of $7 million, driven by headcount growth. Further contributing to the overall increase was an increase in allocated shared costs of $1 million.

Sales and Marketing Expenses



	Three Months Ended March 31,
	2019		2018		% Change
	(In thousands, except percentages)
Sales and marketing	$	91,700	$	65,058	41	%

Sales and marketing expenses increased $27 million, or 41%, in the three months ended March 31, 2019, compared to the same period in 2018. The overall increase was primarily due to increased employee compensation-related costs, including amortization of deferred commissions, of $17 million, driven by headcount growth, and an increase in marketing program costs of $3 million. The increase in marketing program costs was primarily driven by increased volume of marketing and advertising activities. Further contributing to the overall increase was an increase in allocated shared costs of $3 million.

General and Administrative Expenses

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	Three Months Ended March 31,
	2019		2018		% Change
	(In thousands, except percentages)
General and administrative	$	31,253	$	22,207	41	%

General and administrative expenses increased $9 million, or 41%, in the three months ended March 31, 2019, compared to the same period in 2018. The overall increase was primarily due to increased employee compensation-related costs of $6 million, driven by headcount growth. Further contributing to the overall increase was an increase in allocated shared costs of $1 million.

Other Income (Expense), Net



	Three Months Ended March 31,
	2019			2018			% Change
	(In thousands, except percentages)
Interest income	$	5,472		$	1,519		260	%
Interest expense	(6,544		)	(764		)	*
Other income (expense), net	700			245			*

* not meaningful

Interest income increased $4 million in the three months ended March 31, 2019, compared to the same period in 2018, primarily due to the increase in the amount of marketable securities from the proceeds received from our convertible senior notes. Interest expense increased $6 million in the three months ended March 31, 2019, due to the issuance of our convertible senior notes.

Liquidity and Capital Resources

As of March 31, 2019, our principal sources of liquidity were cash, cash equivalents, and marketable securities totaling $845 million, which were held for working capital and general corporate purposes. Our cash equivalents and marketable securities are comprised of corporate bonds, asset-backed securities, U.S. Treasury securities, money market funds, commercial paper, agency securities, and certificates of deposit.

The following table summarizes our cash flows for the periods indicated (in thousands):



	Three Months Ended March 31,
	2019			2018
Net cash provided by operating activities	$	18,969		$	16,242
Net cash used in investing activities	(17,286		)	(25,228		)
Net cash provided by financing activities	14,436			508,678

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. 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.

Our future capital requirements will depend on many factors, including 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 products, 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.

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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 the three months ended March 31, 2019 was $19 million, reflecting our net loss of $45 million, adjusted by non-cash charges including share-based compensation expense of $37 million, depreciation and amortization of $9 million, amortization of deferred costs of $7 million, amortization of debt discount and issuance costs of $6 million, and net changes in operating assets and liabilities of $5 million. The net changes in operating assets and liabilities were primarily attributable to an increase in accounts payable of $16 million due to timing of payments and an increase in deferred revenue of $12 million due to sales growth and the timing of customer billings. These sources of cash flow were primarily offset by an increase in deferred costs of $10 million, primarily including sales commissions, and an increase in accounts receivable of $7 million due to the timing of customer billings and collections.

Net cash provided by operating activities in the three months ended March 31, 2018 was $16 million, reflecting our net loss of $29 million, adjusted by non-cash charges including share-based compensation expense of $27 million, depreciation and amortization of $10 million, amortization of deferred costs of $5 million, and net changes in operating assets and liabilities of $3 million. The net changes in operating assets and liabilities were primarily attributable to an increase in deferred revenue of $11 million and a decrease in accounts receivable of $4 million due to the timing of customer billings and collections and sales growth. These sources of cash flow were offset by an increase in deferred costs of $7 million, primarily including sales commissions, and an increase in prepaid expenses and other current assets of $3 million driven by overall growth in our business.

Investing Activities

Net cash used in investing activities in the three months ended March 31, 2019 of $17 million was primarily attributable to purchases of marketable securities of $6 million, net of sales and maturities, purchases of property and equipment of $9 million, primarily associated with leasehold improvements for newly leased office facilities, and capitalized internal-use software costs of $1 million related to the development of additional features and functionality for our platform.

Net cash used in investing activities in the three months ended March 31, 2018 of $25 million was primarily attributable to purchases of marketable securities of $16 million, net of sales and maturities, purchases of property and equipment of $7 million, primarily associated with newly leased office facilities, and capitalized internal-use software costs of $2 million related to the development of additional features and functionality for our platform.

Financing Activities

Net cash provided by financing activities in the three months ended March 31, 2019 of $14 million was primarily attributable to proceeds from our employee stock purchase plan of $8 million, and proceeds from exercises of employee stock options of $8 million, partially offset by payments for withholding taxes related to net share settlement of RSUs of $2 million.

Net cash provided by financing activities in the three months ended March 31, 2018 of $509 million was primarily attributable to proceeds from the issuance of our convertible senior notes of $562 million, proceeds from the exercise of employee stock options of $6 million, and proceeds from our employee stock purchase plan of $5 million, partially offset by the purchase of the capped call in connection with the issuance of our convertible senior notes of $64 million.

Critical Accounting Polices and Estimates

We prepare our condensed consolidated financial statements in accordance with GAAP. In the preparation of these condensed 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.

There were no changes to our critical accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2018, filed with the SEC on February 14, 2019, that had a material impact on our condensed consolidated financial statements and related notes.

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Recently Issued and Adopted Accounting Pronouncements

Refer to Note 1 of the notes to our condensed consolidated financial statements for a summary of recently issued and adopted accounting pronouncements.

Contractual Obligations and Other Commitments

Our principal commitments consist of our convertible senior notes, obligations under our operating leases for office space, and contractual commitments for third-party managed hosting and other support services. There were no material changes to our commitments under contractual obligations from those disclosed in our audited consolidated financial statements for the year ended December 31, 2018.

Off-Balance Sheet Arrangements

Through March 31, 2019, 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.

Item 3. 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, Polish Zloty 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. 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 for the three months ended March 31, 2019.

We operate a hedging program to mitigate the impact of foreign currency fluctuations on our cash flows and earnings. For additional information, see Note 3 of the notes to our condensed consolidated financial statements.

Interest Rate Sensitivity

We had cash, cash equivalents, and marketable securities totaling $845 million as of March 31, 2019, of which $764 million was invested in corporate bonds, asset-backed securities, U.S. Treasury securities, money market funds, commercial paper, agency securities, and certificates of deposit. 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 our portfolio of 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. However, because we classify our debt securities as “available for sale,” no gains or losses are recognized due to changes in interest rates unless such securities are sold prior to maturity or declines in fair value are determined to be other-than-temporary.

As of March 31, 2019, 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 $7 million. This estimate is based on a sensitivity model that measures market value changes when changes in interest rates occur. Fluctuations in the value of our cash equivalents and portfolio of marketable securities caused by a change in interest rates (gains or losses on the carrying value) are recorded in other comprehensive income, and are realized only if we sell the underlying securities prior to maturity or declines in fair value are determined to be other than temporary.

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In March 2018, we issued $575 million aggregate principal amount of 0.25% convertible senior notes due 2023. The fair value of our convertible senior notes is subject to interest rate risk, market risk and other factors due to the conversion feature. The fair value 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 value 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 obligation. 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.

Item 4. 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 Quarterly Report on Form 10-Q. In designing and evaluating our disclosure controls and procedures, 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. Based on management’s evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, our principal executive officer and principal financial officer have concluded that as of such date, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC's rules and forms and to provide reasonable assurance that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosures.

Changes in Internal Control over Financial Reporting

There were no changes in our internal control over financial reporting during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II — OTHER INFORMATION

Item 1. Legal Proceedings

From time to time, we may be subject to legal proceedings, claims, investigations, and government inquires 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, 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.

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.

Risks Related to Our Business

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 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. As such, the market acceptance of this product is critical to our success. Demand for our products is affected by a number of factors, many of which are beyond our control, such as continued market acceptance of our products by customers for existing and new use cases, the timing of development and release of new products, 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 profoundly impact the market for our software and blur distinctions between traditionally separate systems for customer support, customer engagement and retention software, sales force automation, marketing automation, and customer relationship management, 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 products, our business, results of operations, financial condition, and growth prospects will be adversely affected.

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 $45 million and $29 million in the three months ended March 31, 2019 and 2018, respectively. We had an accumulated deficit of $574 million as of March 31, 2019. For the three months ended March 31, 2019 and 2018, our revenue was $181 million and $130 million, respectively, representing a 40% 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 family of products, including investments in our research and development team, ,improvements to the scalability, availability, and security of our products, and the integration of acquired products into our platform;


•	the development or acquisition of new products, features, and functionality,

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•	enhancements to our network operations and infrastructure;


•	sales and marketing, including an expansion of our direct sales organization;


•	continued international expansion in an effort to increase our customer base and sales; and


•	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.

We face a number of risks in our strategy to increasingly target larger organizations for sales of our products and, if we do not manage these efforts effectively, our business and results of operations could be adversely affected.

As we target more of our sales efforts to larger organizations, we expect to incur higher costs and longer 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 products 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 products. In addition, larger organizations may demand more features and integration services. We have limited experience in developing and managing sales channels and distribution arrangements for larger organizations. As a result of these factors, these sales opportunities 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 products. Furthermore, because we have limited experience selling to larger organizations, our investment in marketing our products 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 have fewer opportunities to expand usage of our products or to sell additional functionality, and we may experience increased subscription terminations as compared to our experience with smaller organizations, any of which could harm our results of operations.

As we target larger organizations, we may need to divert a greater percentage of personnel and investments away from support of smaller organizations, resulting in an increasing churn in such segment and a negative effect on our results of operations. Additionally, as support and sales to larger organizations generally require different types of personnel and investments than those required to support sales to smaller organizations, we may need to commit greater resources to delivering a consistent approach and our costs may rise. For example, we may become increasingly reliant on our professional services to customize our offerings as we offer more features and functionality that are geared towards larger enterprises, which may disproportionately require greater diversion of internal resources for a result relevant to a smaller number of customers.

The market in which we participate is intensely competitive, and if we do not compete effectively, our operating results could be harmed.

The market for customer experience solutions is fragmented, rapidly evolving, and highly competitive, with relatively low barriers to entry. 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. Among the small to medium-sized 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 pen and paper, text editors, and spreadsheets for tracking and management.

Our competitors may be able to respond more quickly and effectively than we can to new or changing opportunities, technologies, standards, or customer requirements. With the introduction of new technologies, the evolution of our products, and new market entrants, we expect competition to intensify in the future. Pricing pressures and increased competition generally could result in reduced sales, reduced margins, losses, or the failure of our products to achieve or maintain more widespread market acceptance, any of which could harm our business.

We face competition from in-house software systems, large integrated systems vendors, and smaller companies offering alternative SaaS applications. Our competitors vary in size and in the breadth and scope of the products and services they offer. For larger organizations, we compete with customer software systems and large enterprise software vendors such as salesforce.com, Inc., Oracle Corporation, Microsoft Corporation, and ServiceNow, Inc., each of which may have greater

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operational flexibility to bundle competing products and services with other software offerings, or offer them at a lower price than our current Suite offering, which will negatively affect our competitiveness for that offering. In addition, we compete with a number of other SaaS providers with focused applications competitive to one or more of our products that our potential customers may elect to use in lieu of our products, and such providers may be able to offer their products at a lower price due to the focused nature of their applications. Further, other established SaaS providers not currently focused on the functionality that our products provide may expand their services to compete with us. 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. 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. 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. Additionally, as our offerings expand to adjacent markets, such as 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.

Our business depends substantially on our customers renewing their subscriptions, expanding the use of their subscriptions, and purchasing subscriptions for additional products from us. Any decline in our customer retention or expansion, or any failure by us to sell subscriptions to additional products 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 to their customer accounts. Even though the majority of our revenue is derived from subscriptions to our products that have terms longer than one month, a significant portion of the subscriptions to our products 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 have elected not to renew their agreements with us and it is difficult to accurately predict long-term customer retention. Additionally, our future success is also substantially dependent on our ability to expand our existing customers' use of our products by expanding the number of products to which such customers subscribe. This may require increasingly sophisticated and costly sales efforts and may not result in additional sales.

Our customer retention, our ability to sell additional products to existing customers, and the rate at which our existing customers purchase subscriptions to additional products may be impacted by a number of factors, including our customers’ satisfaction with our products, our product support, our prices, the prices of competing software systems, mergers and acquisitions affecting our customer base, 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 products depends on a number of factors, including the perceived need for additional products 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 products, our revenue may decline, and we may not realize improved operating results from our customer base.

Additionally, as we expand our offerings to increasingly appeal to larger enterprises and such customers agree to longer contractual terms with subscriptions to additional products, 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.

Failure to effectively expand and maintain our sales capabilities could harm our ability to increase our customer base and achieve broader market acceptance of our products.

Increasing our customer base and achieving broader market acceptance of our products will depend, to a significant extent, on our ability to effectively expand and maintain 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 expand our direct sales force both domestically and internationally to increase our sales capacity. During the twelve months ended March 31, 2019, our sales and marketing organization increased by approximately 330 employees to approximately 1,040 employees. There is significant competition for experienced sales and marketing professionals with the skills and technical knowledge that we require. 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. Our recent hires and planned hires may not become as productive as we anticipate as quickly as we expect, and we may be unable to hire or retain sufficient numbers of qualified individuals in the future in the markets where we do business. We cannot predict whether, or to what extent, our sales will increase as we expand our sales and marketing functions or how long it will

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take for new personnel to become productive. Our business will be harmed if our sales and marketing efforts do not generate a significant increase in revenue.

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, products, and other assets in the future. We also may enter into relationships with other businesses to expand our products 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 products, 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


•	become subject to adverse tax consequences, substantial depreciation, or deferred compensation charges.

If we are not able to develop enhancements to our products or introduce new products 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 products and to introduce new products and services. In order to grow our business, we must research and develop products and services that reflect the changing nature of customer service, and expand beyond customer service to other areas of improving relationships between organizations and their customers. In the three months ended March 31, 2019 and 2018, our research and development expenses was 26% and 29% of our revenue, respectively. 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 products depends on several factors, including timely completion, adequate quality testing, and market acceptance. Any new product 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 products or services, enhance our existing products to meet customer requirements, or otherwise gain market acceptance, our business and operating results will be harmed.

Because our products are available over the Internet, we need to continuously modify and enhance them to keep pace with changes in Internet-related hardware, software, communications, and database technologies and standards. If we are unable to respond in a timely and cost-effective manner to these rapid technological developments and changes in standards, our products may become less marketable, less competitive, or obsolete, and our operating results will be harmed.

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If our network or computer systems are breached or unauthorized access to customer data is otherwise obtained, our products may be perceived as insecure, we may lose existing customers or fail to attract new customers, and we may incur significant liabilities.

Use of our products involves the storage, transmission, and processing of our customers’ proprietary data, including personal or identifying information regarding their customers or employees. Unauthorized access to or security breaches of our products 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 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 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, 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.

We have previously experienced significant breaches and identified significant vulnerabilities of our security measures and the security measures deployed by third-party vendors upon which we rely, and our products are at risk for future breaches as a result of third-party action, employee, vendor, or contractor error, malfeasance, or other factors.

New products and services, including newly acquired products and services, may rely on systems, networks, personnel, equipment, and vendors that may initially be different from those utilized in connection with our existing products and may not have been subject to the same security reviews and assessments as those used to provide our existing products. Any failure to complete these security reviews and assessments and to implement improvements to the security measures deployed to protect our new products in a timely manner could increase our risk of a security breach with respect to these products, 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. 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 products, 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.

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.

We generally charge our customers for their use of our products 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 products 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 products, negatively affecting our ability to accurately forecast the number of agents our customers need in a period. Additionally, other than subscriptions related to our Suite offering, we generally require a separate subscription to enable the functionality of each of our products. We do not know whether our current or potential customers or the market in general will accept this pricing model going forward and, if it fails to gain acceptance, our business and results of operations could be harmed.

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

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our products. We license access and use of our products exclusively for our customers’ internal use. If customers improperly resell or otherwise make our products available to their customers, it may cannibalize our sales or commoditize our products in the market. Additionally, if a customer that has received a volume discount from us offers our products 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 products 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 may not be able to integrate new products 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 products that both complement our existing products and respond to our customers’ needs. Our customers also expect that new products will integrate with existing products that we currently offer. Our ability to successfully integrate newly developed or acquired products into a shared services infrastructure is unproven. Because we have a limited history in integrating newly developed or acquired products and the market for such products is rapidly evolving, it is difficult for us to predict our operating results following the integration of such products. If we are not able to fully integrate new products into our infrastructure, our business could be harmed.

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 2,230 employees as of March 31, 2018 to approximately 2,950 employees as of March 31, 2019. In addition, we have established subsidiaries in Denmark, the United Kingdom, Australia, Ireland, Japan, the Philippines, Brazil, Germany, India, and Mexico since our inception in 2007, and, as a result of acquisitions, we also have subsidiaries in Singapore, France, and Poland. We may continue to expand 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 products support. Finally, 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. 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 quality of our products and services may suffer, which could negatively affect our brand and reputation and harm our ability to retain and attract customers.

We do not have the history with our subscription or pricing models that we need to accurately predict optimal pricing necessary to attract new customers and retain existing customers.

We have limited experience with respect to determining the optimal prices for our products and, as a result, we have in the past and expect in the future that we will need to change our pricing model from time to time. As the market for our products matures, or as new competitors introduce new products 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. 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.

Additionally, we have a very limited history in respect of pricing our Suite offering and our Sell product. We may not fully understand the impact of pricing changes in the market, and if we fail to find an optimal price for our Suite offering or our Sell product our business and results of operations may be harmed.

If the market for SaaS business software applications develops more slowly than we expect or declines, our business would be adversely affected.

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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 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.

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 products at any time and within an acceptable amount of time. Our products 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 products, distributed denial of service attacks, or other security related incidents. 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 products become more complex and our user traffic increases. If any of our products are unavailable or if our users are unable to access our products 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 currently support the mirroring of data. Therefore, in the event of any of the factors described above, or certain other failures of our infrastructure, customer data may be 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.

Real or perceived errors, failures, or bugs in our products could adversely affect our operating results and growth prospects.

Because our products are complex, undetected errors, failures, vulnerabilities, or bugs may occur, especially when updates are deployed. Our products 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 products or other aspects of the computing environment into which they are deployed. In addition, deployment of our products into complicated, large-scale computing environments may expose undetected errors, failures, vulnerabilities, or bugs in our products. We have discovered, and expect to continue to discover, software errors, failures, vulnerabilities, and bugs in our products, 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 products could result in negative publicity, loss of or delay in market acceptance of our products, 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.

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 medium-sized organizations that make purchasing decisions with limited interaction with our sales or other personnel. As we continue to become more dependent on sales to larger organizations, we expect our sales cycles 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:

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•	the need to educate prospective customers about the uses and benefits of our products;


•	the discretionary nature of purchasing and budget cycles and decisions;


•	the competitive nature of evaluation and purchasing processes;


•	announcements or planned introductions of new products, features, or functionality by us or our competitors; and


•	lengthy purchasing approval processes.

An increasing dependence on sales to larger organizations may increase the variability of our financial results. 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.

Our quarterly results may fluctuate for various other reasons, 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 other 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:


•	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;


•	changes in our or our competitors’ pricing policies;


•	the rate of expansion and productivity of our sales force;


•	security breaches, technical difficulties, or service interruptions to our products;


•	the number of new employees added to our company in a given period;


•	new products, features, or functionalities introduced by our competitors;


•	our investments in and our ability to successfully sell newly developed or acquired products, features, or functionality;


•	our ability to meet the increasing expectations on product functionality of larger enterprises;


•	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;


•	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 the relative and absolute levels of professional services we provide;


•	changes in foreign currency exchange rates;


•	expenses such as litigation or other dispute-related settlement payments;


•	the impact of new accounting pronouncements; and


•	the timing of the grant, price of our common stock, or vesting of equity awards to employees.

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.

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Our ongoing and planned expenditures on third-party managed hosting services and remaining expenditures on self-managed colocation data centers are expensive and complex, have resulted, and will result, in a negative impact on our cash flows, and may negatively impact our financial results.

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. We have been continuing to decrease the amount of capital expenditures on hosting equipment for use in our self-managed colocation data centers as we have transitioned to greater dependence on third-party managed hosting services. If costs associated with third-party managed hosting services utilized to support our growth are greater than expected, or if we are required to make larger continuing investments in our self-managed colocation data centers than we anticipated, the negative impact on our operating results would likely exceed our initial expectations. Additionally, due to the difficulty in predicting usage of third-party managed hosting services related to customers recently migrated, we may not be able to accurately forecast our expenditures on such third-party managed hosting services, which may increase the variability of our results of operations. Furthermore, if we determine to no longer utilize our self-managed colocation data centers earlier than we expect, we may be forced to accelerate expense recognition as a result of the shorter estimated life of such assets.

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 have become 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;


•	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.

Our international sales and operations subject us to additional risks that can adversely affect our business, operating results, and financial condition.

In the three months ended March 31, 2019 and 2018, we derived 48% and 47% of our revenue from customers located outside of the United States, respectively. We are continuing to expand 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 products or to convince existing customers to renew or expand their use of our products 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:


•	increased management, travel, 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;


•	requirements or preferences for domestic products;


•	differing technical standards, existing or future regulatory and certification requirements, and required features and functionality;


•	economic conditions in each country or region and general economic uncertainty around the world;


•	compliance with foreign privacy and security laws and regulations and the risks and costs of non-compliance;

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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 products in certain foreign markets, and the risks and costs of non-compliance;

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•	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;


•	difficulties in repatriating or transferring funds from or converting currencies in certain countries;


•	communication and integration problems related to entering new markets with different languages, cultures, and political systems;


•	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;


•	the need for localized language support;


•	reduced protection for intellectual property rights in some countries and practical difficulties of enforcing rights abroad; and


•	compliance with the laws of numerous foreign tax jurisdictions, including withholding obligations, and overlapping of different tax regimes.

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 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 products 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 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.

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Incorrect or improper implementation or use of our products could result in customer dissatisfaction and negatively affect our business, results of operations, financial condition, and growth prospects.

Our products are deployed in a wide variety of technology environments and into a broad range of complex workflows. Increasingly, our products 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 products in such deployments. We often assist our customers in implementing our products, but many customers attempt to implement deployments, including complex deployments, themselves. If we or our customers are unable to implement our products successfully, or are unable to do so in a timely manner, customer perceptions of our products 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 products.

Our customers and third-party partners may need training in the proper use of our products to maximize their potential. If our products are not implemented or used correctly or as intended, inadequate performance may result. Because our customers rely on our products 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 products, our failure to train customers on how to efficiently and effectively use our products 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 products.

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 products, 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 Suite and increasing usage by customers of multiple products 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 product may suffer. Additionally, we may be unable to develop our customer success organization to continue to support the increasing level of complexity that larger enterprise customers require while maintaining the same level of engagement across all customers. For example, adoption of feature 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 products to existing and prospective customers, and our business, operating results, and financial position.

We are highly dependent upon free trials of our products 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 products and other inbound lead generation strategies to generate sales opportunities. 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 product to a paid version of such product. Further, we often depend on individuals within an organization who initiate the trial versions of our products 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 as we continue to target larger organizations and in the case of our sales force automation software and features and functionality related to our platform offering, increasingly target decision makers that are not in the customer support organizations we have traditionally targeted. 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.

If we are unable to develop and maintain successful relationships with channel partners, our business, operating results, and financial condition could be adversely affected.

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To date, we have been primarily dependent on our direct sales force to sell subscriptions to our products. 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 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 products of several different companies, including products that compete with ours. They may also cease marketing our products 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 products. 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 products, 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 products, 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 service 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 products from competitive products and services. 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 enterprises. In addition, independent industry analysts often provide reviews of our products, as well as products and services offered by our competitors, and perception of our products 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.

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Because our products 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 products.

Personal privacy and data security have become significant issues in the United States, Europe, and in many other jurisdictions where we offer our products. 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. For example, California recently enacted the California Consumer Privacy Act, orCCPA that will, among other things, require covered companies to provide new disclosures to California consumers and afford such consumers new abilities to opt-out of certain sales of personal information, when it goes into effect on January 1, 2020. The CCPA recently was amended, and it is possible that it will be amended again before it goes into effect. We cannot yet predict the impact of the CCPA on our business or operations, but it may require us to modify our data processing practices and policies and to incur substantial costs and expenses in an effort to comply. 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 products. In many jurisdictions enforcement actions and consequences for non-compliance are also rising.

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 products, may be negatively affected.

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 products. 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 products, 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 products. Privacy and data security concerns, whether valid or not valid, may inhibit market adoption of our products, particularly in certain industries and foreign countries.

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 products 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 products 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. If economic conditions deteriorate, our customers and prospective

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customers may ele