LOGMEIN, INC., 10-Q filed on 10/27/2011
Quarterly Report
Document and Entity Information (USD $)
9 Months Ended
Sep. 30, 2011
Oct. 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
Sep. 30, 2011 
 
 
Amendment Flag
FALSE 
 
 
Document Fiscal Year Focus
2011 
 
 
Document Fiscal Period Focus
Q3 
 
 
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
 
24,310,895 
 
Condensed Consolidated Balance Sheets (USD $)
Sep. 30, 2011
Dec. 31, 2010
Current assets:
 
 
Cash and cash equivalents
$ 95,394,977 
$ 77,279,987 
Marketable securities
90,113,600 
90,144,484 
Accounts receivable (net of allowance for doubtful accounts of $111,000 and $102,000 as of December 31, 2010 and September 30, 2011, respectively)
6,338,855 
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 September 30, 2011, respectively)
2,613,382 
2,905,618 
Deferred income tax assets
1,315,200 
1,315,529 
Total current assets
195,776,014 
176,390,010 
Property and equipment, net
5,448,779 
6,198,487 
Restricted cash
380,689 
350,481 
Intangibles, net
3,465,906 
577,815 
Goodwill
7,332,674 
615,299 
Other assets
255,271 
27,019 
Deferred income tax assets
4,105,592 
2,518,158 
Total assets
216,764,925 
186,677,269 
Current liabilities:
 
 
Accounts payable
3,467,337 
2,176,390 
Accrued liabilities
11,516,831 
10,829,310 
Deferred revenue, current portion
51,743,961 
41,763,138 
Total current liabilities
66,728,129 
54,768,838 
Deferred revenue, net of current portion
2,251,500 
1,030,017 
Other long-term liabilities
753,673 
500,156 
Total liabilities
69,733,302 
56,299,011 
Commitments and contingencies (Note 9)
 
 
Stockholders' equity:
 
 
Preferred stock, $0.01 par value - 5,000,000 shares authorized, 0 shares outstanding as of December 31, 2010 and September 30, 2011
 
 
Common stock, $0.01 par value - 75,000,000 shares authorized as of December 31, 2010 and September 30, 2011; 23,858,514 and 24,285,395 shares outstanding as of December 31, 2010 and September 30, 2011, respectively
242,854 
238,585 
Additional paid-in capital
146,857,936 
133,425,098 
(Accumulated deficit) retained earnings
660,458 
(3,084,316)
Accumulated other comprehensive loss
(729,625)
(201,109)
Total stockholders' equity
147,031,623 
130,378,258 
Total liabilities and stockholders' equity
$ 216,764,925 
$ 186,677,269 
Condensed Consolidated Balance Sheets (Parenthetical) (USD $)
Sep. 30, 2011
Dec. 31, 2010
Current assets:
 
 
Accounts receivable, net of allowance for doubtful accounts
$ 102,000 
$ 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
24,285,395 
23,858,514 
Condensed Consolidated Statements of Income (USD $)
3 Months Ended
Sep. 30,
9 Months Ended
Sep. 30,
2011
2010
2011
2010
Condensed Consolidated Statements of Income [Abstract]
 
 
 
 
Revenue (including $1,738,000, $4,711,000, $0 and $0 from a related party during the three and nine months ended September 30, 2010 and 2011, respectively)
$ 31,001,833 
$ 25,349,529 
$ 87,138,568 
$ 70,166,783 
Cost of revenue
2,597,780 
2,243,288 
7,579,681 
6,728,223 
Gross profit
28,404,053 
23,106,241 
79,558,887 
63,438,560 
Operating expenses
 
 
 
 
Research and development
6,105,253 
3,560,484 
15,085,011 
10,874,451 
Sales and marketing
14,612,072 
11,506,645 
41,654,309 
32,153,542 
General and administrative
5,681,539 
2,909,644 
15,577,184 
8,390,143 
Legal settlements
 
 
1,250,000 
 
Amortization of acquired intangibles
32,912 
81,929 
216,994 
245,787 
Total operating expenses
26,431,776 
18,058,702 
73,783,498 
51,663,923 
Income from operations
1,972,277 
5,047,539 
5,775,389 
11,774,637 
Interest income, net
210,209 
202,369 
660,879 
456,319 
Other expense
(146,039)
(66,902)
(406,722)
(102,337)
Income before income taxes
2,036,447 
5,183,006 
6,029,546 
12,128,619 
Benefit (provision) for income taxes
(908,750)
(1,188,475)
(2,284,772)
3,583,137 
Net income
$ 1,127,697 
$ 3,994,531 
$ 3,744,774 
$ 15,711,756 
Net income per share:
 
 
 
 
Basic
$ 0.05 
$ 0.17 
$ 0.16 
$ 0.68 
Diluted
$ 0.04 
$ 0.16 
$ 0.15 
$ 0.64 
Weighted average shares outstanding:
 
 
 
 
Basic
24,233,996 
23,435,172 
24,094,117 
23,072,983 
Diluted
25,108,470 
24,882,767 
25,108,398 
24,734,943 
Condensed Consolidated Statements of Income (Parenthetical) (USD $)
3 Months Ended
Sep. 30,
9 Months Ended
Sep. 30,
2011
2010
2011
2010
Condensed Consolidated Statements of Income [Abstract]
 
 
 
 
Revenue from related party
$ 4,711,000 
$ 1,738,000 
$ 0 
$ 0 
Condensed Consolidated Statements of Cash Flows (USD $)
9 Months Ended
Sep. 30,
2011
2010
Cash flows from operating activities
 
 
Net income
$ 3,744,774 
$ 15,711,756 
Adjustments to reconcile net income to net cash provided by operating activities
 
 
Depreciation and amortization
3,276,737 
2,737,594 
Amortization of premium on investments
119,014 
159,756 
Provision for bad debts
45,000 
65,000 
(Benefit from) provision for deferred income taxes
2,087,268 
(3,755,556)
Income tax benefit from the exercise of stock options
(3,666,000)
(2,898,577)
Stock-based compensation
6,535,693 
3,536,185 
Gain on disposal of equipment
(396)
(1,882)
Changes in assets and liabilities:
 
 
Accounts receivable
(1,639,463)
(1,741,950)
Prepaid expenses and other current assets
292,236 
(325,505)
Other assets
(228,252)
5,641 
Accounts payable
1,556,042 
849,586 
Accrued liabilities
463,111 
1,613,851 
Deferred revenue
11,202,306 
6,358,711 
Other long-term liabilities
253,517 
(124,248)
Net cash provided by operating activities
24,041,587 
22,190,362 
Cash flows from investing activities
 
 
Purchases of marketable securities
(135,066,500)
(155,388,550)
Proceeds from sale or disposal of marketable securities
135,000,000 
105,000,000 
Purchases of property and equipment
(2,252,724)
(2,434,040)
Intangible asset additions
(245,399)
(376,638)
Cash paid for acquisition
(10,000,000)
 
(Increase) decrease in restricted cash and deposits
(25,569)
5,118 
Net cash used in investing activities
(12,590,192)
(53,194,110)
Cash flows from financing activities
 
 
Payments of issuance costs related to secondary offering of common stock
 
(195,840)
Proceeds from issuance of common stock upon option exercises
3,231,933 
3,776,705 
Income tax benefit from the exercise of stock options
3,666,000 
2,898,577 
Net cash provided by financing activities
6,897,933 
6,479,442 
Effect of exchange rate changes on cash and cash equivalents and restricted cash
(234,338)
(125,314)
Net increase (decrease) in cash and cash equivalents
18,114,990 
(24,649,620)
Cash and cash equivalents, beginning of period
77,279,987 
100,290,001 
Cash and cash equivalents, end of period
95,394,977 
75,640,381 
Supplemental disclosure of cash flow information
 
 
Cash paid for interest
1,090 
860 
Cash paid for income taxes
312,929 
110,478 
Noncash investing and financing activities
 
 
Purchases of property and equipment included in accounts payable and accrued liabilities
140,330 
677,646 
Fair value of contingent consideration in connection with acquisition included in accrued expenses and other long term liabilities
$ 201,398 
 
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® IgnitionTM, LogMeIn Hamachi®, join.me®, PachubeTM 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 September 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 $90,067,091 and an aggregate fair value of $90,144,484 and $90,113,600, including $65,136 and $92,138 of unrealized gains and $40,257 and $45,629 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, 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, one customer accounted for 14% of accounts receivable. As of September 30, 2011 there were no customers that accounted for 10% of accounts receivable. No customers accounted for more than 10% of revenue for the three and nine months ended September 30, 2010 or 2011.
     Goodwill - Goodwill is the excess of the acquisition price over the fair value of the tangible and identifiable intangible net assets acquired related to the Pachube acquisition in July 2011 (see note 4) and the Applied Networking acquisition in July 2006. The Company does not amortize goodwill, but performs an annual impairment test of goodwill on the last day of its fiscal year and whenever events and circumstances indicate that the carrying amount of goodwill may exceed its fair value. The Company operates as a single operating segment with one reporting unit and consequently evaluates goodwill for impairment based on an evaluation of the fair value of the Company as a whole. Through September 30, 2011, no impairments have occurred.
     Long-Lived Assets and Intangible Assets - The Company records intangible assets at their respective estimated fair values at the date of acquisition. Intangible assets are being amortized using the straight-line method over their estimated useful lives, which range from three to five years.
     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 foreign currency losses of approximately $67,000 and $146,000 for the three months ended September 30, 2010 and 2011, respectively and approximately $102,000 and $407,000 for the nine months ended September 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.
     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 September 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 September 30,     Nine Months Ended September 30,  
    2010     2011     2010     2011  
Net income
  $ 3,994,531     $ 1,127,697     $ 15,711,756     $ 3,744,774  
Cumulative translation adjustments
    611,064       (1,332,067 )     (136,019 )     (541,570 )
Unrealized gain on available-for-sale securities
    46,894       16,477       189,946       13,054  
 
                       
 
                               
Comprehensive income
  $ 4,652,489     $ (187,893 )   $ 15,765,683     $ 3,216,258  
 
                       
     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 324,150 and 1,012,875 of options to purchase common shares from the computation of diluted net income per share for the three months ended September 30, 2010 and 2011, respectively, and 1,029,350 and 935,225 for the nine months ended September 30, 2010 and 2011, respectively, because they had an anti-dilutive impact.
Basic and diluted net income per share was calculated as follows:
                 
    Three Months Ended     Nine Months Ended  
    September 30, 2010     September 30, 2010  
Basic:
               
Net income
  $ 3,994,531     $ 15,711,756  
 
           
Weighted average common shares outstanding, basic
    23,435,172       23,072,983  
 
           
Net income, basic
  $ 0.17     $ 0.68  
 
           
 
               
Diluted:
               
Net income
  $ 3,994,531     $ 15,711,756  
 
           
Weighted average common shares outstanding
    23,435,172       23,072,983  
Add: Options to purchase common shares
    1,447,595       1,661,960  
 
           
Weighted average common shares outstanding, diluted
    24,882,767       24,734,943  
 
           
Net income, diluted
  $ 0.16     $ 0.64  
 
           
                 
    Three Months Ended     Nine Months Ended  
    September 30, 2011     September 30, 2011  
Basic:
               
Net income
  $ 1,127,697     $ 3,744,774  
 
           
Weighted average common shares outstanding, basic
    24,233,996       24,094,117  
 
           
Net income, basic
  $ 0.05     $ 0.16  
 
           
 
               
Diluted:
               
Net income
  $ 1,127,697     $ 3,744,774  
 
           
Weighted average common shares outstanding
    24,233,996       24,094,117  
Add: Options to purchase common shares
    874,474       1,014,281  
 
           
Weighted average common shares outstanding, diluted
    25,108,470       25,108,398  
 
           
Net income, diluted
  $ 0.04     $ 0.15  
 
           
     Recently Issued Accounting Pronouncements — In September 2011, the Financial Accounting Standards Board (“FASB”) issued an Accounting Standards Update (“ASU”) which simplifies how companies test goodwill for impairment. The amendment permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test described in goodwill accounting standard. The amendments are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted. The Company does not expect the new ASU to have a material effect on its financial position, results of operations or cash flows.
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 September 30, 2011
                               
Cash equivalents — money market funds
  $ 48,769,543     $ 48,469,543     $     $  
Cash equivalents — bank deposits
    5,030,309             5,030,309        
Short-term marketable securities — U.S. government agency securities
    90,113,600       90,113,600              
Contingent consideration liability
                      201,398  
     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.
     The Level 3 liability consists of contingent consideration related to the July 19, 2011 acquisition of Pachube. The fair value of the contingent consideration was estimated by applying a probability based model, which utilizes significant inputs that are unobservable in the market. Key assumptions include a 13% discount rate and a 76% weighted-probability of earn-out. A reconciliation of the beginning and ending Level 3 liability is as follows:
         
    Three and  
    Nine  
    Months  
    Ended  
    September  
    30, 2011  
Balance beginning of period
  $  
Transfers into Level 3
    192,561  
Payments
     
Change in fair value (included within research and development expense)
    8,837  
 
     
Balance end of period
  $ 201,398  
 
     
Acquisition
Acquisition
4. Acquisition
     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 (collectively “Connected Environments”), primarily including their Pachube service, for an initial cash payment of $10 million plus contingent payments totaling up to $5.2 million. The Pachube service is a cloud-based connectivity and data management platform for the Internet of Things. The Company acquired Pachube to expand its capabilities with embedded devices and reach into the Internet of Things. The operating results of the acquired Pachube service, of which there was no revenue and $1.1 million of expenses during the three and nine month periods ended September 30, 2011, are included in the consolidated financial statements beginning on the acquisition date.
     The Pachube acquisition has been accounted for as a business combination. The assets acquired and the liabilities assumed were recorded at their estimated fair values as of the acquisition date. The Company retained an independent third party valuation firm to calculate the fair value of the intangible assets using the cost method with estimates and assumptions provided by Company management. The excess of the purchase price over the tangible net assets and identifiable intangible assets was recorded as goodwill.
     The purchase price was allocated as follows:
         
    Amount  
Tangible assets
  $ 7,595  
Technology and know-how
    3,250,000  
Goodwill
    6,934,966  
 
     
Total purchase price
    10,192,561  
Liability for contingent consideration
    (192,561 )
 
     
Cash paid
  $ 10,000,000  
 
     
     The asset purchase agreement included a contingent payment provision requiring the Company to make additional payments to the shareholders of Connected Environments, as well as certain employees, on the first and second anniversaries of the acquisition, contingent upon the continued employment of certain employees and the achievement of certain product performance metrics. The range of the contingent payments that the Company could pay is between $0 to $4,898,000. The Company has concluded that the arrangement is a compensation arrangement and is accruing the maximum payout ratably over the performance period, as it believes it is probable that the criteria will be met.
     The asset purchase agreement also includes a contingent payment provision to a non-employee shareholder for an amount between $0 and $267,000, which the Company has concluded is part of the purchase price. This contingent liability was recorded at its fair of $192,561 at the acquisition date. The Company will re-measure the fair value of the consideration at each subsequent reporting period and recognize any adjustment to fair value as part of earnings in the related period.
     The goodwill recorded in connection with this transaction is primarily related to the expected synergies to be achieved related to Gravity, our service delivery platform, and the ability to leverage existing sales and marketing capacity and customer base with respect to the acquired Pachube service. All goodwill acquired is expected to be deductible for income tax purposes.
     The Company incurred approximately $269,000 and $324,000 of acquisition-related costs which are included in general and administrative expense in the three and nine month periods ended September 30, 2011, respectively.
Goodwill and Intangible Assets
Goodwill and Intangible Assets
5. Goodwill and Intangible Assets
     The changes in the carry amounts of goodwill for the nine months ended September 30, 2011 are due to the impact of foreign currency translation adjustments related to asset balances that are recorded in non-U.S. currencies.
     Changes in goodwill for the nine months ended September 30, 2011, are as follows:
         
Balance, December 31, 2010
  $ 615,299  
Goodwill related to the acquisition of Pachube
    6,934,966  
Foreign currency translation adjustments
    (217,591 )
 
     
Balance, September 30, 2011
  $ 7,332,674  
 
     
Intangible assets consist of the following:
                                                         
            December 31, 2010     September 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     $ 635,506     $  
Customer base
  5 years     1,003,068       888,791       114,277       1,003,068       1,003,068        
Domain names
  5 years     202,120       10,038       192,082       202,055       40,355       161,700  
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        
Technology and know-how
  3 years                       3,148,028       228,432       2,919,596  
Internally developed software
  3 years     213,942       14,887       199,055       459,406       74,796       384,610  
 
                                         
 
                                                       
 
          $ 3,715,513     $ 3,137,698     $ 577,815     $ 7,108,940     $ 3,643,034     $ 3,465,906  
 
                                         
     As a result of the Pachube acquisition, the Company capitalized $3,250,000 of technology and know-how as an intangible asset. Changes in the gross carrying amount of technology and know-how are due to foreign currency translation adjustments. The Company is amortizing this intangible asset on a straight line basis to cost of revenue over an estimated useful life of three years.
     The Company capitalized $142,432 and $108,138 during the three months ended September 30, 2010 and 2011, respectively and $142,432 and $245,464 during the nine months ended September 30, 2010 and 2011, respectively, of costs related to internally developed computer software to be sold as a service incurred during the application development stage and is amortizing these costs over the expected lives of the related services.
     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 $110,842 and $294,462 for the three months ended September 30, 2010 and 2011, respectively, and $557,201 and $514,486 for the nine months ended September 30, 2010 and 2011, respectively. Amortization relating to software, technology and know-how 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 September 30, 2011:
Amortization Expense (Years Ending December 31)
         
    Amount  
2011 (three months ending December 31)
  $ 300,897  
2012
    1,233,812  
2013
    1,221,527  
2014
    676,750  
2015
    32,920  
       
Total
  $ 3,465,906  
       
Accrued Expenses
Accrued Expenses
6. Accrued Expenses
Accrued expenses consisted of the following:
                 
    December 31,     September 30,  
    2010     2011  
Marketing programs
  $ 3,265,692     $ 3,052,594  
Payroll and payroll related
    4,535,322       3,998,897  
Professional fees
    745,834       658,258  
State sales tax accrual (See note 9)
          1,300,000  
Other accrued liabilities
    2,282,462       2,507,082  
 
           
 
               
Total accrued expenses
  $ 10,829,310     $ 11,516,831  
 
           
Income Taxes
Income Taxes
7. Income Taxes
     The Company recorded a provision for federal, state and foreign income taxes of approximately $0.9 million and $2.3 million for the three and nine months ended September 30, 2011, respectively. The Company’s tax provision for the nine months ended September 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, which was recorded in the second quarter of 2010. The tax benefit for the nine months ended September 30, 2010 was offset by a provision for federal, state and foreign income taxes of approximately $2.0 million. The Company’s effective tax rate has increased for the three and nine months ending September 30, 2011 compared to the three and nine months ending September 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 September 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 September 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 nine months ended September 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 September 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 September 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
8. Stock Option Plans
     The Company’s 2009 Stock Incentive Plan (“2009 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 1,585,718 shares available for grant under the 2009 Plan as of September 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   Nine Months Ended
    September 30,   September 30,
    2010   2011   2010   2011
Expected dividend yield
  0.00%   0.00%   0.00%   0.00%
Risk-free interest rate
  1.43%   1.13%   1.43% - 2.46%   1.13% - 2.28%
Expected term (in years)
  5.56 - 6.25     6.25     5.56 - 6.25     5.56 - 6.25  
Volatility
  65%   60%   65% - 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
    920,145       39.20                  
Exercised
  (426,881 )     7.69             $ 13,095,828  
 
                             
 
                               
Forfeited
  (207,185 )     27.66                  
 
                           
 
                               
Outstanding, September 30, 2011
    2,850,394     $ 20.97       7.5     $ 40,467,417  
 
                       
 
                               
Exercisable at December 31, 2010
    1,246,838     $ 5.36       5.7     $ 48,600,697  
 
                       
 
                               
Exercisable at September 30, 2011
    1,208,136     $ 8.83       5.7     $ 29,622,367  
 
                       
     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 $33.21 per share on September 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 $22.40 for the nine months ended September 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,     Nine Months Ended,  
    September 30,     September 30,  
    2010     2011     2010     2011  
Cost of revenue
  $ 58,889     $ 65,167     $ 196,323     $ 236,742  
Research and development
    173,722       421,482       446,840       1,095,110  
Selling and marketing
    431,177       801,678       1,043,246       1,983,721  
General and administrative
    632,541       1,250,749       1,849,776       3,220,120  
 
                       
 
                               
 
  $ 1,296,329     $ 2,539,076     $ 3,536,185     $ 6,535,693  
 
                       
     As of September 30, 2011, there was approximately $22,925,000 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 2.9 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
    (63,800 )     1.25               2,338,404  
 
                             
 
                               
Forfeited
                             
 
                           
 
                               
Outstanding, September 30, 2011
    469,132     $ 1.25       3.9     $ 14,993,459  
 
                       
 
                               
Exercisable at December 31, 2010
    532,932     $ 1.25       4.6     $ 22,964,040  
 
                       
 
                               
Exercisable at September 30, 2011
    469,132     $ 1.25       3.9     $ 14,993,459  
 
                       
     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 $33.21 per share on September 30, 2011, or at the time of exercise, and the exercise price of the options.
Commitments and Contingencies
Commitments and Contingencies
9. 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 2017. 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 $232,000 (170,295 Euro) at September 30, 2011. The lease for the Company’s Australian office required a bank guarantee which totaled $24,000 (24,375 AUD) at September 30, 2011, whereby the bank agrees to pay the lesser 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.
     In September 2011, the Company extended its lease for existing office space for its Budapest office. The term of the new lease begins in April 2012 and extends through March 2017. The approximate annual lease payments for the new office space are $803,000. 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 $725,000 for the three months ended September 30, 2010 and 2011, respectively, and $1,038,000 and $2,185,000 for the nine months ended September 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 $457,000 for the three months ended September 30, 2010 and 2011, respectively, and $757,000 and $1,381,000 for the nine months ended September 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 September 30, 2011:
         
Years Ending December 31        
2011 (three months ending December 31)
  $ 1,227,000  
2012
    3,912,000  
2013
    1,410,000  
2014
    1,039,000  
2015
    1,031,000  
Thereafter
    1,061,000  
 
     
 
       
Total minimum lease payments
  $ 9,680,000  
 
     
     Litigation — On September 8, 2010, 01 Communiqué 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 issued a written order regarding this decision on May 4, 2011. On May 13, 2011, 01 filed a notice of appeal appealing 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 due for the period from 2005 to the present. The Company does not believe it was responsible for collecting sales taxes in this state but, after vigorously defending its position and exhausting its defenses against this claim, in September 2011 the Company agreed to make a payment in the amount of $1.3 million to resolve uncollected sales tax claims with the tax assessor’s office. The Company accrued for this liability at September 30, 2011 and recorded the amount in general and administrative expense for the three and nine months ended September 30, 2011.
Related Party Transactions
Related Party Transactions
10. 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 September 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 $1,738,000 and $0 of net revenue relating to these agreements for the three months ended September 30, 2010 and 2011, respectively, and approximately $4,711,000 and $0 for the nine months ended September 30, 2010 and 2011, respectively. As of December 31, 2010 and September 30, 2011, the Company had recorded $0 related to this agreement as deferred revenue.