(EDGAR Online via COMTEX) -- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited condensed consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the year ended December 31, 2019 included in our Annual Report on Form 10-K, filed with the Securities and Exchange Commission, or SEC, on February 14, 2020. This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of
LogMeIn simplifies how people connect with each other and the world around them to drive meaningful interactions, deepen relationships, and create better outcomes for individuals and businesses. A market leader in unified communications and collaboration, identity and access management, and customer engagement and support solutions, LogMeIn has millions of customers spanning virtually every country across the globe. LogMeIn is headquartered in Boston, Massachusetts with additional locations in North America, South America, Europe, Asia and Australia.
We offer both free and fee-based, or premium, subscription software services. Sales of our premium services are generated through online search, word-of-mouth referrals, web-based advertising, off-line advertising, broadcast advertising, public relations, the conversion of free users and expiring free trials to paid subscriptions and direct marketing to new and existing customers. We derive our revenue principally from subscription fees from our customers, who range from individual consumers to small and medium businesses, or SMBs, to multi-national enterprises. Our revenue is driven primarily by the number and type of our premium services to which our paying customers subscribe.
We are closely monitoring the impact of the 2019 novel coronavirus, or COVID-19, pandemic on all aspects of our business.
In the first quarter of 2020, we took a number of precautionary measures designed to help minimize the risk of the spread of the virus to our employees, including suspending all non-essential travel worldwide for our employees, temporarily closing our worldwide offices and requiring all employees to work remotely.
In March 2020, we experienced an increase in demand for our services as more people around the world practiced social distancing and more employees were forced to work remotely. As a result of increased sales, the deferred revenue contribution to cash flows from operations was $24 million and $49 million for the three months ended March 31, 2019 and 2020, respectively, an increase of $25 million, and we ended the quarter with a deferred revenue balance of $451 million. However, going forward we expect there to be significant volatility in customer demand and buying habits as the pandemic continues and the resulting economic impacts are felt.
In early March, the Company also introduced free Emergency Remote Work Kits to help communities and those on the frontline who are directly combatting the virus and/or struggling to adapt to working remotely. We have offered these complimentary kits to schools (both K-12 and higher education), health care organizations, public municipalities, and non-profits. To date, over 5,000 Emergency Remote Work Kits have been deployed, which has also contributed to the increased usage of our services during the quarter.
We are also incurring additional costs and making additional investments in order to meet the demands of increased customer usage of our services and to expand the capacity of our global infrastructure. If this increased customer demand and usage of our services continues, we expect our cost of revenue to increase and our gross margins to be negatively impacted.
This situation is changing rapidly, and additional impacts may arise that we are not aware of currently. We recommend that you review Item 1A. "Risk Factors" in this Quarterly Report on Form 10-Q for a complete description of the material risks we currently face.
In December 2019, we entered into an Agreement and Plan of Merger, or the Merger Agreement, with Logan Parent, LLC, or Parent, and Logan Merger Sub, Inc., a wholly owned subsidiary of Parent, or Merger Sub. Pursuant to the terms of the Merger Agreement, Merger Sub would merge with and into LogMeIn, which we refer to herein as the Merger. Parent and Merger Sub are controlled by Francisco Partners, a technology-focused global private equity firm, and Evergreen Coast Capital Corp., the technology-focused global private equity affiliate of Elliott Management Corporation, an investment management firm. Assuming the satisfaction of the conditions set forth in the Merger Agreement, we currently expect the Merger to close in mid-2020. In the first quarter of 2020, our stockholders adopted the Merger Agreement at a special meeting of stockholders and we recorded $2.3 million of Merger-related costs.
In the three months ended March 31, 2020, we recognized revenues of $322.4 million and generated cash flows from operating activities of $88.0 million, and we ended the quarter with $189.6 million of cash and cash equivalents and $200.0 million of outstanding borrowings under our credit facility. We recorded a net loss of $11.3 million in the three months ended March 31, 2020, including amortization of acquired intangible assets of $52.7 million, a restructuring charge of $18.5 million, acquisition-related costs of $2.5 million for retention-based bonuses primarily related to our acquisition of Jive Communications, Inc., or Jive, and our 2019 acquisitions, and Merger-related costs of $2.3 million.
On February 7, 2020, our Board of Directors approved a global restructuring plan, including a reduction in force which will result in the termination of approximately 7% of our workforce and the consolidation of certain leased facilities. By restructuring, we intend to streamline our organization and reallocate resources to better align with our current strategic goals. We expect to incur pre-tax restructuring charges of approximately $22 million and to substantially complete the restructuring by the end of fiscal year 2020. The pre-tax restructuring charges are comprised of approximately $20 million in one-time employee termination benefits and $2 million for facilities-related and other costs. In the first quarter of 2020, we recorded a restructuring charge of $18.5 million for termination benefits and related costs associated with approximately 265 employees.
Certain Trends and Uncertainties
The following represents a summary of certain trends and uncertainties, which could have a significant impact on our financial condition and results of operations. This summary is not intended to be a complete list of potential trends and uncertainties that could impact our business in the long or short term. The summary, however, should be considered along with the factors identified in the section titled "Risk Factors" of this Quarterly Report on Form 10-Q and elsewhere in this report.
Failure to complete the previously announced Merger could adversely impact the market price of our common stock as well as our business and operating results. This risk, as well as risks associated with the Merger, are identified further in "Risk Factors - Risks Related to the Merger" of this Quarterly Report on Form 10-Q and elsewhere in this report.
While the COVID-19 pandemic has not had an adverse impact on our operations to date, the future impacts of the pandemic and any resulting economic impact are largely unknown and rapidly evolving. It is possible that the COVID-19 pandemic, the measures taken by the governments of countries affected and the resulting economic impact may materially and adversely affect our results of operations, cash flows and financial position.
There is frequent litigation in the software and technology industries based on allegations of infringement or other violations of intellectual property rights. We have been, and may in the future be, subject to third party patent infringement or other intellectual property-related lawsuits as we face increasing competition and become increasingly visible. Any adverse determination related to intellectual property claims or litigation could adversely affect our business, financial condition and operating results.
The risk of a data security breach or service disruption caused by computer hackers and cyber criminals has increased as the frequency, intensity and sophistication of attempted attacks and intrusions from around the world have increased. Our services and systems have been, and may in the future be, the target of various forms of cyberattacks. While we make significant efforts to maintain the security and integrity of our services and computer systems, our cybersecurity measures and the cybersecurity measures taken by our third-party data center facilities may be unable to anticipate, detect or prevent all attempts to compromise our systems. Any security breach, whether successful or not, could harm our reputation, subject us to lawsuits and other potential liabilities and ultimately could result in the loss of customers.
We believe that competition will continue to increase. Increased competition could result from existing competitors or new competitors that enter the market because of the potential opportunity. We will continue to closely monitor competitive activity and respond accordingly. Increased competition could have an adverse effect on our financial condition and results of operations.
We believe if customer demand and usage of our services continues at levels similar to those exhibited at the end of March 2020 or continues to increase, our cost of revenue and operating expenses, including sales and marketing, research and development and general and administrative expenses will increase in absolute dollar amounts. For a description of the general trends in various expense categories, see "Cost of Revenue and Operating Expenses" below.
Sources of Revenue
We derive our revenue primarily from subscription fees for our premium services from enterprise customers, SMBs, IT service providers, mobile carriers, customer service centers, OEMs and consumers, usage fees from our audio services, and, to a lesser extent, the sale or lease of telecommunications equipment. Our customers who subscribe to our services generally pay in advance and typically pay with a credit card for their subscription. We initially record a subscription fee as deferred revenue and then recognize it ratably, on a daily basis, over the life of the subscription period. Typically, a subscription automatically renews at the end of a subscription period unless the customer specifically terminates it prior to the end of the period.
We calculate our gross renewal rate on an annualized dollar basis across all product lines as of the end of each period. For the three months ended March 31, 2020, our gross renewal rate was approximately 80%. We will continue to monitor and assess our renewal rate calculation and methodology to ensure that it is appropriate. While the COVID-19 pandemic has not had an adverse impact on our revenue to date, the future impacts of the pandemic and any resulting economic impact are largely unknown and rapidly evolving and could negatively impact our future renewal rates.
Revenue by product grouping is as follows:
Three Months Ended March 31, 2019 2020 (In thousands) Revenues: Unified communications and collaboration $ 169,957 $ 173,687 Identity and access management 94,179 105,581 Customer engagement and support 43,564 43,115 Total revenue $ 307,700 $ 322,383
Our number of full-time employees was 3,936 at March 31, 2020, compared to 3,974 at December 31, 2019 and 3,554 at March 31, 2019.
Cost of Revenue and Operating Expenses
We allocate certain overhead expenses, such as rent, utilities and information technology, to expense categories primarily based on headcount allocation. As a result, an overhead allocation associated with these costs is reflected in cost of revenue and each operating expense category.
Cost of Revenue. Cost of revenue consists primarily of costs associated with our data center operations and customer support centers. Included in these costs are wages and benefits for personnel, telecommunications, hosting fees, hardware and software maintenance costs, outsourced customer support staffing costs, telecommunications product costs, and depreciation associated with our data centers. Additionally, amortization expense associated with the acquired software, technology, and internally developed software to be sold as a service is included in cost of revenue. The expenses related to hosting our services and supporting our free and premium customers are dependent on the number of customers who subscribe to our services and the complexity and redundancy of our services, the level of usage of our services by our customers, and hosting infrastructure.
Research and Development. Research and development expenses consist primarily of wages and benefits for development personnel, retention-based bonus expense related to our acquisitions, facility expense, cloud computing services, consulting fees associated with outsourced development projects, travel-related costs for development personnel, and depreciation of assets used in development. Our research and development efforts are focused on both improving ease of use and functionality of our existing services, as well as developing new offerings. More than half of our research and development employees are located internationally in our development centers in Hungary, Germany, Canada, Israel and India. Therefore, a large portion of research and development expense is subject to fluctuations in foreign exchange rates. We capitalized costs of $8.9 million and $10.3 million for the three months ended March 31, 2019 and 2020, respectively, related to internally developed software to be sold as a service, which were incurred during the application development stage. The majority of research and development costs have been expensed as incurred. We expect that research and development expenses will remain relatively constant as a percentage of revenue.
Sales and Marketing. Sales and marketing expenses consist primarily of online search and advertising costs, wages, commissions and benefits for sales and marketing personnel, offline marketing costs such as media advertising and trade shows, consulting fees, credit card processing fees, facility expense and hardware and software maintenance costs. Online search and advertising costs consist primarily of pay-per-click payments to search engines and other online advertising media such as banner ads. Offline marketing costs include radio and print advertisements, as well as the costs to create and produce these advertisements, and tradeshows, including the costs of space at tradeshows and costs to design and construct tradeshow booths. Advertising costs are expensed as incurred. In order to continue to grow our business and awareness of our services, we expect that we will continue to invest in our sales and marketing efforts.
General and Administrative. General and administrative expenses consist primarily of wages and benefits for management, human resources, internal IT support, legal, finance and accounting personnel, professional fees, insurance and other corporate expenses, including acquisition-related expenses. We expect that general and administrative expenses related to personnel, recruiting, internal information systems, audit, accounting and insurance costs will remain relatively constant as a percentage of revenue as we continue to support the growth of our business. Further, we expect to continue to incur acquisition-related and Merger-related costs, and general and administrative expenses could increase if we incur litigation-related expenses associated with our defense against legal claims.
Critical Accounting Policies
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. The preparation of our financial statements and related disclosures requires us to make estimates, assumptions and judgments that affect the reported amount of assets, liabilities, revenue, costs and expenses, and related disclosures. We base our estimates and assumptions on historical experience and other factors that we believe to be reasonable under the circumstances. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions and conditions. Our most critical accounting policies are listed below:
Goodwill and acquired intangible assets; and
Revenue Recognition. We derive our revenue primarily from subscription fees for our premium services, usage fees from our audio services, and, to a lesser extent, the sale or lease of telecommunications equipment. Revenue is reported net of applicable sales and use tax, value-added tax and other transaction taxes imposed on the related transaction including mandatory government charges that are billed to our customers. Revenue is recognized when control of these services or products are transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in exchange for the contract's performance obligations.
We determine revenue recognition through the following five steps:
Identification of the contract, or contracts, with a customer
Identification of the performance obligations in the contract
Determination of the transaction price
Allocation of the transaction price to the performance obligations in the contract
Recognition of revenue when, or as, performance obligations are satisfied
We account for a contract when it has approval and commitment from both parties, the rights of the parties are identified, payment terms are identified, the contract has commercial substance and collectability of consideration is probable.
Revenue from our premium subscription services represents a single promise to provide continuous access (i.e., a stand-ready obligation) to our software solutions and their processing capabilities in the form of a service through one of our data centers. Our software cannot be run on another entity's hardware and customers do not have the right to take possession of the software and use it on their own or another entity's hardware. As each day of providing access to the software is substantially the same and the customer simultaneously receives and consumes the benefits as access is provided, we determined that our premium subscription services arrangements include a single performance obligation comprised of a series of distinct services. Revenue from our premium subscription services is recognized over time on a ratable basis over the contract term beginning on the date that our service is made available to the customer. Subscription periods range from monthly to multi-year, are typically billed in advance, and are non-cancelable.
Revenue from our audio services represent a single promise to stand-ready to provide access to our audio platform. As each day of providing audio services is substantially the same and the customer simultaneously receives and consumes the benefits as access is provided, we have determined that our audio services arrangements include a single performance obligation comprised of a series of distinct services. Our audio services may include fixed consideration, variable consideration or a combination of the two. Variable consideration in these arrangements is typically a function of the corresponding rate per minute. We allocate the variable amount to each distinct service period within the series and recognize revenue as each distinct service period is performed (i.e., recognized as incurred).
Apr 24, 2020
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