LOGMEIN, INC., 10-Q filed on 7/28/2011
Quarterly Report
Document and Entity Information (USD $)
6 Months Ended
Jun. 30, 2011
Jul. 20, 2011
Jun. 30, 2010
Document and Entity Information [Abstract]
 
 
 
Entity Registrant Name
LogMeIn, Inc. 
 
 
Entity Central Index Key
0001420302 
 
 
Document Type
10-Q 
 
 
Document Period End Date
Jun. 30, 2011 
 
 
Amendment Flag
FALSE 
 
 
Document Fiscal Year Focus
2011 
 
 
Document Fiscal Period Focus
Q2 
 
 
Current Fiscal Year End Date
--12-31 
 
 
Entity Well-known Seasoned Issuer
No 
 
 
Entity Voluntary Filers
No 
 
 
Entity Current Reporting Status
Yes 
 
 
Entity Filer Category
Accelerated Filer 
 
 
Entity Public Float
 
 
$ 451,060,864 
Entity Common Stock, Shares Outstanding
 
24,197,883 
 
Condensed Consolidated Balance Sheets (USD $)
Jun. 30, 2011
Dec. 31, 2010
Current assets:
 
 
Cash and cash equivalents
$ 94,003,584 
$ 77,279,987 
Marketable securities
90,116,871 
90,144,484 
Accounts receivable (net of allowance for doubtful accounts of $111,000 and $104,000 as of December 31, 2010 and June 30, 2011, respectively)
7,354,808 
4,744,392 
Prepaid expenses and other current assets (including $9,000 and $0 of non-trade receivable due from related party at December 31, 2010 and June 30, 2011, respectively)
2,411,148 
2,905,618 
Deferred income tax assets
1,318,162 
1,315,529 
Total current assets
195,204,573 
176,390,010 
Property and equipment, net
6,292,713 
6,198,487 
Restricted cash
397,797 
350,481 
Intangibles, net
495,311 
577,815 
Goodwill
615,299 
615,299 
Other assets
190,172 
27,019 
Deferred income tax assets
3,208,004 
2,518,158 
Total assets
206,403,869 
186,677,269 
Current liabilities:
 
 
Accounts payable
2,673,061 
2,176,390 
Accrued liabilities
9,948,472 
10,829,310 
Deferred revenue, current portion
48,850,024 
41,763,138 
Total current liabilities
61,471,557 
54,768,838 
Deferred revenue, net of current portion
2,282,604 
1,030,017 
Other long-term liabilities
407,110 
500,156 
Total liabilities
64,161,271 
56,299,011 
Commitments and contingencies (Note 8)
 
 
Stockholders' equity:
 
 
Preferred stock, $0.01 par value - 5,000,000 shares authorized, 0 shares outstanding as of December 31, 2010 and June 30, 2011
Common stock, $0.01 par value - 75,000,000 shares authorized as of December 31, 2010 and June 30, 2011; 23,858,514 and 24,179,086 shares outstanding as of December 31, 2010 and June 30, 2011, respectively
241,791 
238,585 
Additional paid-in capital
141,882,081 
133,425,098 
Accumulated deficit
(467,239)
(3,084,316)
Accumulated other comprehensive income (loss)
585,965 
(201,109)
Total stockholders' equity
142,242,598 
130,378,258 
Total liabilities and stockholders' equity
$ 206,403,869 
$ 186,677,269 
Condensed Consolidated Balance Sheets (Parenthetical) (USD $)
Jun. 30, 2011
Dec. 31, 2010
Current assets:
 
 
Accounts receivable, net of allowance for doubtful accounts
$ 104,000 
$ 111,000 
Non-trade receivable due from related party
$ 0 
$ 9,000 
Stockholders' equity:
 
 
Preferred stock, par value
$ 0.01 
$ 0.01 
Preferred stock, shares authorized
5,000,000 
5,000,000 
Preferred stock, shares outstanding
Common stock, par value
$ 0.01 
$ 0.01 
Common stock, shares authorized
75,000,000 
75,000,000 
Common stock, shares outstanding
24,179,086 
23,858,514 
Condensed Consolidated Statements of Income (USD $)
3 Months Ended
Jun. 30,
6 Months Ended
Jun. 30,
2011
2010
2011
2010
Condensed Consolidated Statements of Income [Abstract]
 
 
 
 
Revenue (including $1,487,000, $2,973,000, $0 and $0 from a related party during the three and six months ended June 30, 2010 and 2011, respectively)
$ 29,097,956 
$ 23,492,454 
$ 56,136,735 
$ 44,817,254 
Cost of revenue
2,445,765 
2,264,772 
4,981,901 
4,484,935 
Gross profit
26,652,191 
21,227,682 
51,154,834 
40,332,319 
Operating expenses
 
 
 
 
Research and development
4,661,979 
3,760,170 
8,979,758 
7,313,967 
Sales and marketing
14,056,128 
10,806,416 
27,042,237 
20,646,897 
General and administrative
3,836,955 
2,677,142 
9,895,645 
5,480,499 
Legal settlements
 
 
1,250,000 
 
Amortization of acquired intangibles
92,048 
81,929 
184,082 
163,858 
Total operating expenses
22,647,110 
17,325,657 
47,351,722 
33,605,221 
Income from operations
4,005,081 
3,902,025 
3,803,112 
6,727,098 
Interest income, net
239,958 
139,808 
450,670 
253,950 
Other expense
(151,872)
28,602 
(260,683)
(35,435)
Income before income taxes
4,093,167 
4,070,435 
3,993,099 
6,945,613 
Benefit (provision) for income taxes
(1,410,843)
4,910,771 
(1,376,022)
4,771,612 
Net income
$ 2,682,324 
$ 8,981,206 
$ 2,617,077 
$ 11,717,225 
Net income per share:
 
 
 
 
Basic
$ 0.11 
$ 0.39 
$ 0.11 
$ 0.51 
Diluted
$ 0.11 
$ 0.37 
$ 0.10 
$ 0.48 
Weighted average shares outstanding:
 
 
 
 
Basic
24,116,686 
23,132,807 
24,023,018 
22,889,735 
Diluted
25,169,689 
24,551,399 
25,118,423 
24,464,395 
Condensed Consolidated Statements of Income (Parenthetical) (USD $)
3 Months Ended
Jun. 30,
6 Months Ended
Jun. 30,
2011
2010
2011
2010
Condensed Consolidated Statements of Income [Abstract]
 
 
 
 
Revenue from related party
$ 2,973,000 
$ 1,487,000 
$ 0 
$ 0 
Condensed Consolidated Statements of Cash flows (USD $)
6 Months Ended
Jun. 30,
2011
2010
Cash flows from operating activities
 
 
Net income
$ 2,617,077 
$ 11,717,225 
Adjustments to reconcile net income to net cash provided by operating activities
 
 
Depreciation and amortization
2,074,756 
1,860,292 
Amortization of premium on investments
95,291 
99,614 
Provision for bad debts
30,000 
42,500 
(Benefit from) provision for deferred income taxes
1,335,520 
(4,881,225)
Income tax benefit from the exercise of stock options
(2,028,000)
(1,185,567)
Stock-based compensation
3,996,617 
2,239,856 
Gain on disposal of equipment
(396)
(1,606)
Changes in assets and liabilities:
 
 
Accounts receivable
(2,640,416)
228,826 
Prepaid expenses and other current assets
494,470 
127,363 
Other assets
(163,153)
10,455 
Accounts payable
645,428 
(136,535)
Accrued liabilities
(881,303)
954,050 
Deferred revenue
8,339,473 
4,280,520 
Other long-term liabilities
(93,046)
(196,049)
Net cash provided by operating activities
13,822,318 
15,159,719 
Cash flows from investing activities
 
 
Purchases of marketable securities
(85,073,350)
(105,347,800)
Proceeds from sale or disposal of marketable securities
85,000,000 
60,000,000 
Purchases of property and equipment
(2,094,569)
(1,337,671)
Intangible asset additions
(137,519)
(194,202)
Increase in restricted cash and deposits
(25,569)
 
Net cash used in investing activities
(2,331,007)
(46,879,673)
Cash flows from financing activities
 
 
Payments of issuance costs related to secondary offering of common stock
 
(210,394)
Proceeds from issuance of common stock upon option exercises
2,432,090 
2,365,560 
Income tax benefit from the exercise of stock options
2,028,000 
1,185,567 
Net cash provided by financing activities
4,460,090 
3,340,733 
Effect of exchange rate changes on cash and cash equivalents and restricted cash
772,196 
(711,830)
Net increase (decrease) in cash and cash equivalents
16,723,597 
(29,091,051)
Cash and cash equivalents, beginning of period
77,279,987 
100,290,001 
Cash and cash equivalents, end of period
94,003,584 
71,198,950 
Supplemental disclosure of cash flow information
 
 
Cash paid for interest
950 
429 
Cash paid for income taxes
175,014 
69,312 
Noncash investing and financing activities
 
 
Purchases of property and equipment included in accounts payable and accrued liabilities
242,494 
251,579 
Deferred stock offering costs included in accounts payable and accrued liabilities
 
$ 18,493 
Nature of the Business
Nature of the Business
1. Nature of the Business
     LogMeIn, Inc. (the “Company”) develops and markets a suite of remote access, remote support, and collaboration solutions that provide instant, secure connections between Internet enabled devices. The Company’s product line includes GravityTM , LogMeIn Free® , LogMeIn Pro®, LogMeIn® CentralTM , LogMeIn Rescue®, LogMeIn® Rescue+MobileTM, LogMeIn Backup®, LogMeIn® Ignition SMTM , LogMeIn Hamachi®, join.meTM and RemotelyAnywhere®. The Company is based in Woburn, Massachusetts with wholly-owned subsidiaries in Hungary, The Netherlands, Australia, England, Brazil and Japan.
Summary of Significant Accounting Policies
Summary of Significant Accounting Policies
2. Summary of Significant Accounting Policies
     Principles of Consolidation — The accompanying condensed consolidated financial statements include the results of operations of the Company and its wholly-owned subsidiaries. All intercompany transactions and balances have been eliminated in consolidation. The Company has prepared the accompanying consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”).
     Unaudited Interim Condensed Consolidated Financial Statements — The accompanying condensed consolidated financial statements and the related interim information contained within the notes to the condensed consolidated financial statements are unaudited and have been prepared in accordance with GAAP and applicable rules and regulations of the Securities and Exchange Commission for interim financial information. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. The accompanying unaudited condensed consolidated financial statements should be read along with the Company’s audited financial statements included in the Company’s Annual Report on Form 10-K, filed with the Securities and Exchange Commission on February 28, 2011. The unaudited interim condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements and in the opinion of management, reflect all adjustments, consisting of normal and recurring adjustments, necessary for the fair presentation of the Company’s financial position, results of operations and cash flows for the interim periods presented. The results for the interim periods presented are not necessarily indicative of future results. The Company considers events or transactions that occur after the balance sheet date but before the financial statements are issued to provide additional evidence relative to certain estimates or to identify matters that require additional disclosure.
     Use of Estimates — The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates 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 and the reported amounts of revenue and expenses during the reporting period. By their nature, estimates are subject to an inherent degree of uncertainty. Actual results could differ from those estimates.
     Marketable Securities — The Company’s marketable securities are classified as available-for-sale and are carried at fair value with the unrealized gains and losses, net of tax, reported as a component of accumulated other comprehensive income in stockholders’ equity. Realized gains and losses and declines in value judged to be other than temporary are included as a component of earnings based on the specific identification method. Fair value is determined based on quoted market prices. At December 31, 2010 and June 30, 2011, marketable securities consisted of U.S. government agency securities that have remaining maturities within two years and have an aggregate amortized cost of $90,119,605 and $90,097,664 and an aggregate fair value of $90,144,484 and $90,116,871, including $65,136 and $87,752 of unrealized gains and $40,257 and $68,545 of unrealized losses, respectively.
     Revenue Recognition — The Company derives revenue primarily from subscription fees related to its LogMeIn premium services and from the licensing of its Ignition for iPhone, iPad and Android software products and RemotelyAnywhere software and related maintenance.
     Revenue from the Company’s LogMeIn premium services is recognized on a daily basis over the subscription term as the services are delivered, provided that there is persuasive evidence of an arrangement, the fee is fixed or determinable and collectability is deemed reasonably assured. Subscription periods range from monthly to four years, but are generally one year in duration. The Company’s software cannot be run on another entity’s hardware nor do customers have the right to take possession of the software and use it on their own or another entity’s hardware.
     The Company recognizes revenue from the sale of its Ignition for iPhone, iPad and Android software product which is sold as a perpetual license and is recognized when there is persuasive evidence of an arrangement, the product has been provided to the customer, the collection of the fee is probable, and the amount of fees to be paid by the customer is fixed or determinable.
     The Company’s multi-element arrangements typically include subscription and professional services, generally consisting of development services. The Company has determined that the delivered items within its multi-element arrangements do not have value to the customer on a stand-alone basis as the services are not sold by any other vendor and the customer would not be able to resell such services. As a result, the deliverables within these arrangements do not qualify for treatment as separate units in accounting. Accordingly, the Company accounts for fees received under these multi-element arrangements as a single unit of accounting and recognizes the entire arrangement consideration ratably over the term of the related agreement as a single unit of accounting and recognizes the entire arrangement consideration ratably over the term of the related agreement, commencing when all significant performance obligations have been delivered and when all revenue recognition criteria have been met.
     Concentrations of Credit Risk and Significant Customers — The Company’s principal credit risk relates to its cash, cash equivalents, marketable securities, restricted cash, and accounts receivable. Cash, cash equivalents, and restricted cash are deposited primarily with financial institutions that management believes to be of high-credit quality and custody of its marketable securities is with an accredited financial institution. To manage accounts receivable credit risk, the Company regularly evaluates the creditworthiness of its customers and maintains allowances for potential credit losses. To date, losses resulting from uncollected receivables have not exceeded management’s expectations.
     As of December 31, 2010 and June 30, 2011, one customer accounted for 14% and 16% of accounts receivable, respectively. No customers accounted for more than 10% of revenue for the three and six months ended June 30, 2010 or 2011.
     Foreign Currency Translation —The functional currency of operations outside the United States of America is deemed to be the currency of the local country. Accordingly, the assets and liabilities of the Company’s foreign subsidiaries are translated into United States dollars using the period-end exchange rate, and income and expense items are translated using the average exchange rate during the period. Cumulative translation adjustments are reflected as a separate component of stockholders’ equity. Foreign currency transaction gains and losses are charged to operations. The Company had a foreign currency gain of approximately $29,000 for the three months ended June 30, 2010 and a foreign currency loss of approximately $152,000 for the three months ended June 30, 2011 and foreign currency losses of approximately $35,000 and $261,000 for the six months ended June 30, 2010 and 2011, respectively.
     Stock-Based Compensation — Stock-based compensation is measured based upon the grant date fair value and recognized as an expense on a straight-line basis in the financial statements over the vesting period of the award for those awards expected to vest. The Company uses the Black-Scholes option pricing model to estimate the grant date fair value of stock awards. The Company uses the with-or-without method to determine when it will realize excess tax benefits from stock based compensation. Under this method, the Company will realize these excess tax benefits only after it realizes the tax benefits of net operating losses from operations.
     Income Taxes — Deferred income taxes are provided for the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and operating loss carry-forwards and credits using enacted tax rates expected to be in effect in the years in which the differences are expected to reverse. At each balance sheet date, the Company assesses the likelihood that deferred tax assets will be realized, and recognizes a valuation allowance if it is more likely than not that some portion of the deferred tax assets will not be realized. This assessment requires judgment as to the likelihood and amounts of future taxable income by tax jurisdiction. As of December 31, 2010 and June 30, 2011, the Company maintained a full valuation allowance related to the deferred tax assets of its Hungarian subsidiary due to its historical net losses.
     The Company evaluates its uncertain tax positions based on a determination of whether and how much of a tax benefit taken by the Company in its tax filings or positions is more likely than not to be realized. Potential interest and penalties associated with any uncertain tax positions are recorded as a component of income tax expense. Through June 30, 2011, the Company has not identified any material uncertain tax positions for which liabilities would be required.
     Comprehensive Income — Comprehensive income is the change in stockholders’ equity during a period relating to transactions and other events and circumstances from non-owner sources and currently consists of net income, foreign currency translation adjustments and unrealized gains and losses on available-for-sale securities.
Comprehensive income was calculated as follows:
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2010     2011     2010     2011  
Net income
  $ 8,981,206     $ 2,682,324     $ 11,717,225     $ 2,617,077  
Cumulative translation adjustments
    (603,489 )     218,037       (747,083 )     790,497  
Unrealized gain (loss) on available-for-sale securities
    157,471       13,720       143,052       (3,423 )
 
                       
Comprehensive income
  $ 8,535,188     $ 2,914,081     $ 11,113,194     $ 3,404,151  
 
                       
     Net Income Per Share — Basic net income per share is computed by dividing net income by the weighted average number of common shares outstanding for the period. Diluted net income per share is computed by dividing net income by the sum of the weighted average number of common shares outstanding during the period and the options to purchase common shares from the assumed exercise of stock options.
     The Company excluded 976,475 of options to purchase common shares from the computation of diluted net income per share for both the three and six months ended June 30, 2010, respectively, and 795,175 for both the three and six months ended June 30, 2011, respectively, because they had an anti-dilutive impact.
Basic and diluted net income per share was calculated as follows:
                 
    Three Months Ended     Six Months Ended  
    June 30, 2010     June 30, 2010  
Basic:
               
Net income
  $ 8,981,206     $ 11,717,225  
 
           
Weighted average common shares outstanding, basic
    23,132,807       22,889,735  
 
           
Net income, basic
  $ 0.39     $ 0.51  
 
           
 
               
Diluted:
               
Net income
  $ 8,981,206     $ 11,717,225  
 
           
Weighted average common shares outstanding
    23,132,807       22,889,735  
Add: Options to purchase common shares
    1,418,592       1,574,660  
 
           
Weighted average common shares outstanding, diluted
    24,551,399       24,464,395  
 
           
Net income, diluted
  $ 0.37     $ 0.48  
 
           
                 
    Three Months Ended     Six Months Ended  
    June 30, 2011     June 30, 2011  
Basic:
               
Net income
  $ 2,682,324     $ 2,617,077  
 
           
Weighted average common shares outstanding, basic
    24,116,686       24,023,018  
 
           
Net income, basic
  $ 0.11     $ 0.11  
 
           
 
               
Diluted:
               
Net income
  $ 2,682,324     $ 2,617,077  
 
           
Weighted average common shares outstanding
    24,116,686       24,023,018  
Add: Options to purchase common shares
    1,053,003       1,095,405  
 
           
Weighted average common shares outstanding, diluted
    25,169,689       25,118,423  
 
           
Net income, diluted
  $ 0.11     $ 0.10  
 
           
Fair Value of Financial Instruments
Fair Value of Financial Instruments
3. Fair Value of Financial Instruments
     The carrying value of the Company’s financial instruments, including cash equivalents, restricted cash, accounts receivable, and accounts payable, approximate their fair values due to their short maturities. The Company’s financial assets and liabilities are measured using inputs from the three levels of the fair value hierarchy. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement. The three levels are as follows:
     Level 1: Unadjusted quoted prices for identical assets or liabilities in active markets accessible by the Company at the measurement date.
     Level 2: Inputs include quoted prices for similar assets and liabilities in active markets, quoted prices for identical or similar assets and liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability, and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
     Level 3: Unobservable inputs that reflect the Company’s assumptions about the assumptions that market participants would use in pricing the asset or liability.
The following table summarizes the basis used to measure certain of the Company’s financial assets that are carried at fair value:
                                 
    Basis of Fair Value Measurements
            Quoted Prices        
            in Active   Significant    
            Markets for   Other   Significant
            Identical   Observable   Unobservable
            Items   Inputs   Inputs
    Balance   (Level 1)   (Level 2)   (Level 3)
Balance at December 31, 2010
                               
Cash equivalents — money market funds
  $ 48,074,441     $ 48,074,441     $     $  
Cash equivalents — bank deposits
    5,022,089             5,022,089        
Short-term marketable securities — U.S. government agency securities
    90,144,484       90,144,484              
Balance at June 30, 2011
                               
Cash equivalents — money market funds
  $ 48,457,000     $ 48,457,000     $     $  
Cash equivalents — bank deposits
    5,028,132             5,028,132        
Short-term marketable securities — U.S. government agency securities
    90,116,871       90,116,871              
     Bank deposits are classified within the second level of the fair value hierarchy and the fair value of those assets are determined based upon quoted prices for similar assets in active markets.
Intangible Assets
Intangible Assets
4. Intangible Assets
Acquired intangible assets consist of the following:
                                                         
            December 31, 2010     June 30, 2011  
    Estimated     Gross             Net     Gross           Net  
    Useful     Carrying     Accumulated     Carrying     Carrying     Accumulated     Carrying  
    Life     Amount     Amortization     Amount     Amount     Amortization     Amount  
Identifiable intangible assets:
                                                       
Trademark
  5 years   $ 635,506     $ 563,105     $ 72,401     $ 635,506     $ 626,656     $ 8,850  
Customer base
  5 years     1,003,068       888,791       114,277       1,003,068       989,099       13,969  
Domain names
  5 years     202,120       10,038       192,082       202,313       30,261       172,052  
Software
  4 years     298,977       298,977             298,977       298,977        
Technology
  4 years     1,361,900       1,361,900             1,361,900       1,361,900        
Internally developed software
  3 years     213,942       14,887       199,055       351,268       50,828       300,440  
 
                                         
 
          $ 3,715,513     $ 3,137,698     $ 577,815     $ 3,853,032     $ 3,357,721     $ 495,311  
 
                                         
     The Company capitalized $75,575 and $137,326 of costs related to internally developed computer software to be sold as a service incurred during the application development stage during the three and six months ended June 30, 2011, respectively, and is amortizing these costs over the expected lives of the related services. No amounts were capitalized during the three and six months ended June 30, 2010 as the costs incurred during the period were immaterial.
     The Company is amortizing its intangible assets on a straight-line basis over the estimated useful lives noted above. Amortization expense for intangible assets was $185,733 and $112,658 for the three months ended June 30, 2010 and 2011, respectively, and $371,467 and $220,023 for the six months ended June 30, 2010 and 2011, respectively. Amortization relating to software, technology and internally developed software is recorded within cost of revenues and the amortization of trademark, customer base, and domain names is recorded within operating expenses. Future estimated amortization expense for intangible assets is as follows at June 30, 2011:
Amortization Expense (Years Ending December 31)
         
    Amount
2011 (six months ending December 31)
  $ 93,615  
2012
    156,867  
2013
    142,684  
2014
    71,077  
2015
    31,068  
Accrued Expenses
Accrued Expenses
5. Accrued Expenses
Accrued expenses consisted of the following:
                 
    December 31,     June 30,  
    2010     2011  
Marketing programs
  $ 3,265,692     $ 3,362,969  
Payroll and payroll related
    4,535,322       3,506,869  
Professional fees
    745,834       745,816  
Other accrued liabilities
    2,282,462       2,332,818  
 
           
 
               
Total accrued expenses
  $ 10,829,310     $ 9,948,472  
 
           
Income Taxes
Income Taxes
6. Income Taxes
     The Company recorded a provision for federal, state and foreign income taxes of approximately $1.4 million for the three and six months ended June 30, 2011. The Company’s tax provision for the three and six months ended June 30, 2010 includes a tax benefit of approximately $5.6 million related to the reversal of its valuation allowance against U.S. and certain foreign deferred tax assets offset by a provision for federal, state and foreign income taxes of approximately $0.7 million and $0.8 million, respectively. The Company’s tax provision and effective tax rate has increased for the three and six months ending June 30, 2011 compared to the three and six months ending June 30, 2010 as a result of reversing the valuation allowance against primarily all of its net deferred tax assets at June 30, 2010.
     Deferred income taxes are provided for the tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, and operating loss carry-forwards and credits using enacted tax rates expected to be in effect in the years in which the differences are expected to reverse. At each balance sheet date, the Company assesses the likelihood that deferred tax assets will be realized, and recognizes a valuation allowance if it is more likely than not that some portion of the deferred tax assets will not be realized. This assessment requires judgment as to the likelihood and amounts of future taxable income by tax jurisdiction. As of December 31, 2010 and June 30, 2011, the Company maintained a full valuation allowance related to the deferred tax assets of its Hungarian subsidiary.
     The Company files income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. The Company’s income tax returns since inception are open to examination by federal, state, and foreign tax authorities. The Company has no amount recorded for any unrecognized tax benefits as of December 31, 2010 or June 30, 2011. The Company’s policy is to record estimated interest and penalty related to the underpayment of income taxes or unrecognized tax benefits as a component of its income tax provision. During the three and six months ended June 30, 2010 and 2011, the Company did not recognize any interest or penalties in its statements of operations, and there are no accruals for interest or penalties at December 31, 2010 or June 30, 2011.
     The Company has performed an analysis of its ownership changes as defined by Section 382 of the Internal Revenue Code and has determined that an ownership change as defined by Section 382 occurred in October 2004 and March 2010 resulting in approximately $219,000 and $12,800,000, respectively, of net operating losses (“NOLs”) being subject to limitation. As of December 31, 2010 and June 30, 2011, the Company believes all NOLs generated by the Company, including those subject to limitation, are available for utilization given the Company’s large annual limitation amount. Subsequent ownership changes as defined by Section 382 could potentially limit the amount of net operating loss carry-forwards that can be utilized annually to offset future taxable income.
Stock Option Plans
Stock Option Plans
7. Stock Option Plans
     The Company’s 2009 Stock Incentive Plan (“2009 Plan”) Plan is administered by the Board of Directors and Compensation Committee, which have the authority to designate participants and determine the number and type of awards to be granted and any other terms or conditions of the awards. Options generally vest over a four-year period and expire ten years from the date of grant. Certain options provide for accelerated vesting if there is a change in control. There were 1,685,979 shares available for grant under the 2009 Plan as of June 30, 2011.
     The Company uses the Black-Scholes option-pricing model to estimate the grant date fair value of stock option grants. The Company estimates the expected volatility of its common stock at the date of grant based on the historical volatility of comparable public companies over the option’s expected term as well as its own stock price volatility since the Company’s IPO. The Company estimates expected term based on historical exercise activity and giving consideration to the contractual term of the options, vesting schedules, employee turnover, and expectation of employee exercise behavior. The assumed dividend yield is based upon the Company’s expectation of not paying dividends in the foreseeable future. The risk-free rate for periods within the estimated life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. Historical employee turnover data is used to estimate pre-vesting option forfeiture rates. The compensation expense is amortized on a straight-line basis over the requisite service period of the options, which is generally four years.
The Company used the following assumptions to apply the Black-Scholes option-pricing model:
                                 
    Three Months Ended   Six Months Ended
    June 30,   June 30,
    2010   2011   2010   2011
Expected dividend yield
  0.00%   0.00%   0.00%   0.00%
Risk-free interest rate
  2.18%   1.73%   2.18% - 2.46%   1.73% - 2.28%
Expected term (in years)
  5.56 - 6.25   5.56 - 6.25   5.56 - 6.25   5.56 - 6.25
Volatility
  70%   60%   70% - 75%   60%
The following table summarizes stock option activity, including performance-based options:
                                 
                    Weighted        
                    Average        
            Weighted     Remaining        
            Average     Contractual     Aggregate  
    Number     Exercise     Term     Intrinsic  
    of Shares     Price     (Years)     Value  
Outstanding, January 1, 2011
    2,564,315     $ 12.76       7.3     $ 80,983,495  
 
                             
 
                               
Granted
    757,695       40.43                  
Exercised
    (320,572 )     7.74             $ 10,412,108  
 
                             
 
                               
Forfeited
    (144,996 )     28.04                  
 
                           
 
                               
Outstanding, June 30, 2011
    2,856,442     $ 19.89       7.6     $ 54,800,739  
 
                       
 
                               
Exercisable at December 31, 2010
    1,246,838     $ 5.36       5.7     $ 48,600,697  
 
                       
 
                               
Exercisable at June 30, 2011
    1,237,895     $ 7.81       5.8     $ 38,088,467  
 
                       
     The aggregate intrinsic value was calculated based on the positive differences between the estimated fair value of the Company’s common stock on December 31, 2010, of $44.34, and $38.57 per share on June 30, 2011, or at time of exercise, and the exercise price of the options.
     The weighted average grant date fair value of stock options issued or modified was $14.63 per share for the year ended December 31, 2010, and $23.17 for the six months ended June 30, 2011.
     The Company recognized stock based compensation expense within the accompanying condensed consolidated statements of operations as summarized in the following table:
                                 
    Three Months Ended,     Six Months Ended,  
    June 30,     June 30,  
    2010     2011     2010     2011  
Cost of revenue
  $ 105,264     $ 82,523     $ 137,434     $ 171,575  
Research and development
    137,155       393,511       273,118       673,628  
Selling and marketing
    376,549       619,508       612,069       1,182,043  
General and administrative
    594,089       1,155,581       1,217,235       1,969,371  
 
                       
 
  $ 1,213,057     $ 2,251,123     $ 2,239,856     $ 3,996,617  
 
                       
     As of June 30, 2011, there was approximately $23,379,000 of total unrecognized share-based compensation cost, net of estimated forfeitures, related to unvested stock option grants which are expected to be recognized over a weighted average period of 3.0 years. The total unrecognized share-based compensation cost will be adjusted for future changes in estimated forfeitures.
     Of the total stock options issued subject to the plans, certain stock options have performance-based vesting. These performance-based options granted during 2004 and 2007 were granted at-the-money, contingently vest over a period of two to four years depending upon the nature of the performance goal, and have a contractual life of ten years.
The performance-based stock option activity is summarized below:
                                 
                    Weighted        
                    Average        
            Weighted     Remaining        
            Average     Contractual     Aggregate  
    Number     Exercise     Term     Intrinsic  
    of Shares     Price     (Years)     Value  
Outstanding, January 1, 2011
    532,932     $ 1.25       4.6     $ 22,964,040  
 
                             
 
                               
Granted
                             
Exercised
    (45,000 )     1.25               1,730,050  
 
                             
 
                               
Forfeited
                             
 
                           
 
                               
Outstanding, June 30, 2011
    487,932       1.25       4.1       18,209,622  
 
                       
 
                               
Exercisable at December 31, 2010
    532,932       1.25       4.6       22,964,040  
 
                       
 
                               
Exercisable at June 30, 2011
    487,932       1.25       4.1       18,209,622  
 
                       
     The aggregate intrinsic value was calculated based on the positive differences between the estimated fair value of the Company’s common stock on December 31, 2010, of $44.34 per share, and $38.57 per share on June 30, 2011, or at the time of exercise, and the exercise price of the options.
Commitments and Contingencies
Commitments and Contingencies
8. Commitments and Contingencies
     Operating Leases — The Company has operating lease agreements for offices in Massachusetts, Hungary, The Netherlands, Australia, England and Japan that expire in 2012 through 2016. The lease agreement for the Massachusetts office required a security deposit of $125,000 in the form of a letter of credit which is collateralized by a certificate of deposit in the same amount. The lease agreement for one of the Company’s Hungarian offices required a security deposit, which totaled approximately $247,000 (170,295 Euro) at June 30, 2011. The lease for the Company’s Australian office required a bank guarantee which totaled $26,000 (24,375 AUD) at June 30, 2011, whereby the bank agrees to pay the lessor this amount should the Company default under the terms of the lease. The certificate of deposit, the security deposit and bank guarantee are classified as restricted cash. The Netherlands, England and Budapest, Hungary leases contain termination options which allow the Company to terminate the leases pursuant to certain lease provisions.
     In February 2011, the Company entered into a lease for new office space for its Australian office. The term of the new office space began in February 2011 and extends through January 2014. The approximate annual lease payments for the new office space are $91,000.
     In April 2011, the Company entered into a lease for new office space for its UK office. The term of the new office space began in April 2011 and extends through April 4, 2016. The approximate annual lease payments for the new office space are $231,000. The lease contains a termination option which allows the Company to terminate the lease pursuant to certain lease provisions.
     Rent expense under all leases was approximately $520,000 and $799,000 for the three months ended June 30, 2010 and 2011, respectively, and $1,038,000 and $1,460,000 for the six months ended June 30, 2010 and 2011, respectively. The Company records rent expense on a straight-line basis for leases with scheduled escalation clauses or free rent periods.
     The Company also enters into hosting services agreements with third-party data centers and internet service providers that are subject to annual renewal. Hosting fees incurred under these arrangements aggregated approximately $398,000 and $428,000 for the three months ended June 30, 2010 and 2011, respectively, and $757,000 and $924,000 for the six months ended June 30, 2010 and 2011, respectively.
     Future minimum lease payments under non-cancelable operating leases including one year commitments associated with the Company’s hosting services arrangements are approximately as follows at June 30, 2011:
         
Years Ending December 31        
2011 (six months ending December 31)
  $ 2,417,000  
2012
    3,811,000  
2013
    1,473,000  
2014
    383,000  
2015
    232,000  
Thereafter
    58,000  
 
     
 
       
Total minimum lease payments
  $ 8,374,000  
 
     
     Litigation — On September 8, 2010, 01 Communique Laboratory, Inc., or 01, filed a complaint that named the Company as a defendant in a lawsuit in the U.S. District Court for the Eastern District of Virginia (Civil Action No. 1:10cv1007). The Company received service of the complaint on September 10, 2010. The complaint alleged that the Company infringed U.S. Patent No. 6,928,479, which allegedly is owned by 01 and has claims directed to a particular application or system for providing a private communication portal from one computer to a second computer. The complaint sought damages in an unspecified amount and injunctive relief. On April 1, 2011, the U.S. District Court for the Eastern District of Virginia granted the Company’s motion for summary judgment of non-infringement and the trial tentatively scheduled for the second quarter of 2011 was removed from the court’s calendar. The court issued a written order regarding this decision on May 4, 2011. On May 13, 2011, 01 filed a notice of appeal declaring its intention to appeal the court’s ruling granting summary judgment. At this time the Company does not believe that a loss is probable and remains unable to reasonably estimate a possible loss or range of loss associated with this litigation.
     On November 3, 2010, Gemini IP LLC, or Gemini, filed a complaint that named the Company as a defendant in a lawsuit in the U.S. District Court for the Eastern District of Texas (Civil Action No. 4:07-cv-521). The Company received service of the complaint on November 10, 2010. The complaint alleged that the Company infringed U.S. Patent No. 6,117,932, which allegedly is owned by Gemini and has claims related to a system for operating an IT helpdesk. The complaint sought damages in an unspecified amount and injunctive relief. On April 25, 2011, the Company and Gemini entered into a License Agreement which granted the Company a fully-paid license that covers the patent at issue in the action and mutually released each party from all claims. The Company paid Gemini a one-time licensing fee of $1,250,000 in connection with the License Agreement. As a result, the action was dismissed by the court on May 23, 2011.
     The Company is from time to time subject to various other legal proceedings and claims, either asserted or unasserted, which arise in the ordinary course of business. While the outcome of these other claims cannot be predicted with certainty, management does not believe that the outcome of any of these other legal matters will have a material adverse effect on the Company’s consolidated financial statements.
     Other Contingencies — The Company was contacted by a representative from a state tax assessor’s office requesting remittance of uncollected sales taxes. The Company does not believe it was responsible for collecting sales taxes in this state and is investigating this request and intends to vigorously defend this position. If the Company does not prevail in its position, uncollected sales taxes due for the period from 2005 to the present could amount to approximately $1.3 million excluding interest or penalties.
Related Party Transactions
Related Party Transactions
9. Related Party Transactions
     In December 2007, the Company entered into a strategic connectivity service and marketing agreement with Intel Corporation to jointly develop a service that delivers connectivity to computers built with Intel components. Under the terms of the multi-year agreement, the Company adapted its service delivery platform, Gravity, to work with specific technology delivered with Intel hardware and software products. The agreement provided that Intel would market and sell the service to its customers. Intel paid the Company a minimum license and service fee on a quarterly basis during the multi-year term of the agreement. The Company began recognizing revenue associated with the Intel service and marketing agreement upon receipt of acceptance in the quarter ended September 30, 2008. In addition, the Company and Intel shared revenue generated by the use of the service by third parties to the extent it exceeded the minimum payments. In conjunction with this agreement, Intel Capital purchased 2,222,223 shares of the Company’s Series B-1 redeemable convertible preferred stock for $10,000,004, which were converted into 888,889 shares of common stock in connection with the closing of the IPO on July 7, 2009.
     In September 2010, Intel notified the Company that it intended to terminate the connectivity service and marketing agreement effective on December 26, 2010. In accordance with the termination provisions of the agreement, Intel paid the Company a one-time termination fee of $2.5 million in lieu of the $5 million in annual fees associated with 2011. Intel paid the Company the $2.5 million termination fee in December 2010.
     At December 31, 2010 and June 30, 2011, Intel owed the Company approximately $9,000 and $0, respectively, recorded as a non-trade receivable relating to this agreement. The Company recognized approximately $1,487,000 and $0 of net revenue relating to these agreements for the three months ended June 30, 2010 and 2011, respectively, and approximately $2,973,000 and $0 for the six months ended June 30, 2010 and 2011, respectively. As of December 31, 2010 and June 30, 2011, the Company had recorded $0 related to this agreement as deferred revenue.
Subsequent Events
Subsequent Events
10. Subsequent Events
     On July 19, 2011, the Company acquired substantially all of the assets of Connected Environments (BVI) Limited, a British Virgin Island Limited Company and Connected Environments, Limited , a U.K. limited company, including their Pachube service, for a cash purchase price of $10,000,000 plus contingent payments totaling $5,165,000 and the assumption by the Company of certain liabilities. The Pachube service is a cloud-based connectivity and data management platform for the Internet of Things. The Company purchased Pachube to expand its capabilities with embedded devices and its reach into the Internet of Things. The Company is in the process of allocating the purchase price to the assets acquired and liabilities assumed. Any goodwill resulting from this acquisition will be deductible for tax purposes.