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TMCNet:  LOGMEIN, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

[February 22, 2013]

LOGMEIN, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and the related notes and other financial information included elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business and related financing, includes forward-looking statements that involve risks and uncertainties. You should review the "Risk Factors" section of this Annual Report on Form 10-K for a discussion of important factors that could cause actual results to differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis.



Overview LogMeIn provides essential cloud-based collaboration, IT management, and customer service offerings aimed at addressing the evolving multi-device, security, management, and accessibility requirements of the new mobile workplace. Our solutions are used by tens of millions of professionals to work from virtually anywhere on virtually any Internet-enabled device. Hundreds of thousands of small and medium businesses use our solutions to manage distributed work environments, embrace employee-owned technology in the workplace and facilitate collaboration across distributed teams. Thousands of service providers, including more than 50 of the world's largest telecommunications providers, use our solutions to service and support businesses and individual professionals across mobile, social and online channels. Our services range from free downloadable apps to state-of-the-art SaaS-based professional helpdesk solutions and are accessible from anywhere with an Internet connection. With tens of millions of users and hundreds of millions of sessions, we believe our cloud-services are used to connect more Internet-enabled devices worldwide - smartphones, tablets, PCs, Macs and sensor-enabled devices - than any other connectivity platform on the market.

We offer seven free services and ten premium services. Sales of our premium services are generated through word-of-mouth referrals, web-based advertising, expiring free trials that we convert to paid subscriptions and direct marketing to new and existing customers.

We derive our revenue principally from subscription fees from SMBs, IT service providers, mobile carriers, customer service centers, OEMs, and consumers. The majority of our customers subscribe to our services on an annual basis. Our revenue is driven primarily by the number and type of our premium services for which our paying customers subscribe. For the year ended December 31, 2012, we generated revenues of $138.8 million, compared to $119.5 million for the year ended December 31, 2011, an increase of approximately 16%.

In addition to selling our services to end users, we entered into a service and marketing agreement with Intel Corporation in December 2007 pursuant to which we adapted our service delivery platform, Gravity, to work with specific technology delivered with Intel hardware and software products. The agreement provided that Intel market and sell the services to its customers. Intel paid us a minimum license and service fee on a quarterly basis during the term of the agreement, and we shared with Intel revenue generated by the use of the services by third parties to the extent it exceeded certain minimum payments. We began recognizing revenue associated with the Intel service and marketing agreement in the quarter ended September 30, 2008 upon receipt of customer acceptance. In September 2010, Intel notified us 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 us a one-time termination fee of $2.5 million and did not owe us any of the $5.0 million in fees associated with 2011, the final year of the agreement. During the year ended December 31, 2010, we recognized $9.6 million in revenue from this agreement, which includes the $2.5 million termination fee which was paid in December 2010.

Through December 31, 2012, we have primarily funded our operations through the sale of common stock in connection with our initial and secondary offerings which resulted in proceeds of $85.7 million, the sale of redeemable convertible preferred stock which resulted in proceeds of approximately $27.8 million and cash flows from operations. We earned net income of $21.1 million for 2010, $5.8 million for 2011, and $3.6 million for 2012. We expect to continue making significant future expenditures to develop and expand our business.

33-------------------------------------------------------------------------------- Table of Contents 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 Annual Report on Form 10-K.

• We continue to closely monitor current adverse economic conditions, particularly as they impact SMBs, IT service providers and consumers. We are unable to predict the likely duration and severity of the current adverse economic conditions in the United States and other countries, but the longer the duration the greater risks we face in operating our business.

• 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 that as we continue to grow revenue at expected rates, 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 we anticipate in various expense categories, see "Cost of Revenue and Operating Expenses" below.

• 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.

Sources of Revenue We derive our revenue principally from subscription fees from SMBs, IT service providers, mobile carriers, customer service centers, OEMs and consumers. Our revenue is driven primarily by the number and type of our premium services for which our paying customers subscribe and is not concentrated within one customer or group of customers. The majority of our customers subscribe to our services on an annual basis and pay in advance, typically with a credit card, for their subscription. A smaller percentage of our customers subscribe to our services on a monthly basis through either month-to-month commitments or annual commitments that are then paid monthly with a credit card. 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.

In addition to our subscription fees, to a lesser extent, we generate revenue from license and annual maintenance fees from the licensing of our RemotelyAnywhere product. We license RemotelyAnywhere to our customers on a perpetual basis. Because we do not have vendor specific objective evidence of fair value, or VSOE, for our maintenance arrangements, we record the initial license and maintenance fee as deferred revenue and recognize the fees as revenue ratably, on a daily basis, over the initial maintenance period. We also initially record maintenance fees for subsequent maintenance periods as deferred revenue and recognize revenue ratably, on a daily basis, over the maintenance period. We also generate revenue from the license of our Ignition for iPhone, iPad and Android product, which is sold as a perpetual license and is recognized as delivered. In the fourth quarter of 2011, we introduced LogMeIn for iOS, a free app for iPhones and iPads, to the Apple App Store and changed our Ignition for iPhone and iPad business model from a perpetually-based licensing model to a subscription-based business model. We believe this change will have a positive impact on our business, but short-term the business model change has impacted the revenue recognized from our Ignition product.

34-------------------------------------------------------------------------------- Table of Contents Employees We have increased our number of full-time employees to 575 at December 31, 2012 as compared to 482 at December 31, 2011.

Cost of Revenue and Operating Expenses We allocate certain overhead expenses, such as rent and utilities, to expense categories based on the headcount in or office space occupied by personnel in that expense category as a percentage of our total headcount or office space. As a result, an overhead allocation associated with these costs is reflected in the 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, including wages and benefits for personnel, telecommunication and hosting fees for our services, equipment maintenance, software license and maintenance fees and depreciation.

Additionally, amortization expense associated with the acquired software and technology as well as internally developed software is included in cost of revenue. The expenses related to hosting our services and supporting our free and premium customers is related to the number of customers who subscribe to our services and the complexity and redundancy of our services and hosting infrastructure. We expect cost of revenue expenses to increase in absolute dollars but remain relatively constant as a percentage of revenue as we continue to increase our number of customers over time.

Research and Development. Research and development expenses consist primarily of wages and benefits for development personnel, professional fees associated with outsourced development projects, facilities rent and depreciation associated with assets used in development. We have focused our research and development efforts on both improving ease of use and functionality of our existing services, as well as developing new offerings. The majority of our research and development employees are located in our development centers in Europe. Therefore, a majority of research and development expense is subject to fluctuations in foreign exchange rates. The majority of research and development costs have been expensed as incurred. However, we capitalized approximately $0.7 million and $0.3 million for the years ended December 31, 2012 and 2011, respectively, of costs related to internally developed computer software to be sold as a service, which was incurred during the application development stage.

We expect that research and development expenses will increase in absolute dollars but remain relatively constant as a percentage of revenue primarily as a result of an increase in stock-based compensation offset by lower contingent payment costs associated with acquisitions and as we continue to enhance and expand our services and invest in research and development.

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, professional fees and credit card processing fees. 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 commit resources to our sales and marketing efforts. We expect that sales and marketing expenses will increase in both absolute dollars and as a percentage of revenue.

General and Administrative. General and administrative expenses consist primarily of wages and benefits for management, human resources, internal IT support, finance and accounting personnel, professional fees, insurance and other corporate expenses. We expect general and administrative expenses to increase primarily due to the significant legal costs associated with our continued defense against the patent infringement claims made by 01 Communique and the declaratory judgment action we filed against Pragmatus. Additionally, general and administrative expenses will increase as we continue to add personnel, enhance our internal information systems, incur additional expenses related to audit, accounting and insurance costs. We expect that our general and administrative expenses will significantly increase in both absolute dollars and as a percentage of revenue primarily related to defending the patent infringement claims made by 01.

35-------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. 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 summarized below. See Note 2 to our financial statements included elsewhere in this Annual Report on Form 10-K for additional information about these critical accounting policies, as well as a description of our other significant accounting policies.

Revenue Recognition. We derive our revenue primarily from subscription fees related to our premium services, the licensing of our Ignition for iPhone, iPad and Android software products, and the licensing of our RemotelyAnywhere software and its related maintenance.

Revenue from our premium subscription 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 five years, but are generally one year in duration. Our 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.

Revenue from the sales of our Ignition for iPhone, iPad and Android software product, which is sold as a perpetual license, 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 the fees to be paid by the customer is fixed and determinable.

Our multi-element arrangements typically include subscription and professional services, which may include development services. We evaluate each element within the arrangement to determine if they can be accounted for as separate units of accounting. If the delivered item or items have value to the customer on a standalone basis, either because they are sold separately by any vendor or the customer could resell the delivered item or items on a standalone basis, we have determined that the deliverables within these arrangements qualify for treatment as separate units of accounting. Accordingly, we recognize revenue for each delivered item or items as a separate earnings process commencing when all of the significant performance obligations have been performed and when all the revenue recognition criteria have been met. In cases where we have determined that the delivered items within our multi-element arrangements do not have value to the customer on a stand-alone basis, the arrangement is accounted for as a single unit of accounting and the total consideration is recognized ratably over the term of the related agreement, or the estimated customer life, commencing when all of the significant performance obligations have been delivered and when all the revenue recognition criteria have been met.

Income Taxes. We are subject to federal, state, and foreign income taxes for jurisdictions in which we operate, and we use estimates in determining our provision for these income taxes and deferred tax assets. Deferred tax assets, related valuation allowances, current tax liabilities and deferred tax liabilities are determined separately by tax jurisdiction. In making these determinations, we estimate deferred tax assets, related valuation allowances, current tax liabilities and deferred tax liabilities, and we assess temporary differences resulting from differing treatment of items for tax and accounting purposes. At December 31, 2012 and 2011, our deferred tax assets consisted primarily of net operating losses, research and development credit carryforwards, and stock option compensation expense. We assess the likelihood that deferred tax assets will be realized, and we recognize 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. During 2010, we reassessed the need for a valuation allowance against our deferred tax assets and concluded that it was more likely than not that we would be able to realize certain of our deferred tax assets primarily as a result of continued profitability, achieving three years of cumulative profitability and forecasted future earnings. Accordingly, we reversed the valuation allowance related to our U.S. and certain foreign deferred tax assets of $8.6 million during the year ended December 31, 2010. As of December 31, 2012 and 2011, we maintained a full valuation allowance against the deferred tax assets of our Hungarian subsidiary.

This entity has historical losses and we concluded it was not more likely than not that these deferred tax assets are realizable.

36-------------------------------------------------------------------------------- Table of Contents During 2012, we reassessed the need for a valuation allowance against our deferred tax assets related to our Cosm subsidiary and concluded that we would be able to realize the deferred tax assets as a result of projected future profitability. Accordingly, we reversed the valuation allowance related to our Cosm subsidiary of approximately $677,000 during the year ended December 31, 2012.

We evaluate our uncertain tax positions based on a determination of whether and how much of a tax benefit we have taken in our 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.

As of December 31, 2012, we provided a liability of approximately $251,000 for uncertain tax positions. Although we believe that our tax estimates are reasonable, the ultimate tax determination involves significant judgment that is subject to audit by tax authorities in the ordinary course of business.

On January 2, 2013, President Barack Obama signed into law the American Taxpayer Relief Act of 2012. This law extended the federal research and development tax credit for the year ended December 31, 2012. Since the law was signed after December 31, 2012, we will record a federal income tax benefit of approximately $140,000 related to the R&D tax credit in the 2013 financial statements.

Goodwill and acquired intangible assets. We record goodwill as the excess of the acquisition price over the fair value of the net tangible and identifiable intangible assets acquired. We do not amortize goodwill, but perform an annual impairment test of goodwill on the last day of our fiscal year and whenever events and circumstances indicate that the carrying amount of goodwill may exceed its fair value. We operate as a single operating segment with one reporting unit and consequently evaluate goodwill for impairment based on an evaluation of the fair value of the Company as a whole. As of December 31, 2012, our fair value as a whole significantly exceeds our carrying value. No impairments have been recorded through December 31, 2012.

We record intangible assets at their respective estimated fair values at the date of acquisition. Intangible assets are amortized based upon the pattern in which their economic benefit will be realized, or if this pattern cannot be reliably determined, using the straight-line method over their estimated useful lives, which range from one to seven years.

Stock-Based Compensation. Share-based awards are accounted for at fair value, which requires us to recognize compensation expense for all share-based awards granted, modified, repurchased or cancelled on or after January 1, 2006. These costs are recognized on a straight-line basis over the requisite service period for all time-based vested awards.

The assumptions used in determining the fair value of share-based awards represent management's best estimates, but these estimates involve inherent uncertainties and the application of management's judgment. As a result, if factors change, and we use different assumptions, our share-based compensation could be materially different in the future. The risk-free interest rate used for each grant is based on a U.S. Treasury instrument with a term similar to the expected term of the share-based award. The expected term of options has been estimated utilizing the vesting period of the option, the contractual life of the option and our option exercise history. We estimate the expected volatility of our 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 our own stock price volatility since our IPO. We recognize compensation expense for only the portion of options that are expected to vest. Accordingly, we have estimated expected forfeitures of stock options based on our historical forfeiture rate and we use these rates to develop future forfeiture rates. If our actual forfeiture rate varies from our historical rates and estimates, additional adjustments to compensation expense may be required in future periods. Past fair value of option grants may not be a reliable indicator of future fair values as assumptions such as volatility may change over time.

Loss Contingencies. We are currently involved in various legal claims and legal proceedings and may be subject to additional legal claims and proceedings in the future that arise in the ordinary course of business. We consider the likelihood of a loss or the incurrence of a liability, as well as our ability to reasonably estimate the amount of loss, in determining loss contingencies. An estimated loss contingency is accrued when we believe that it is both probable that a liability has been incurred and the amount of loss can be reasonably estimated.

Significant judgment is required to determine both probability and the estimated amount. We regularly evaluate current information available and reflect the impact of negotiations, settlements, rulings, advice of legal counsel, and updated information to determine whether such accruals should be adjusted and whether new accruals are required and update our disclosures accordingly.

Litigation is inherently unpredictable and is subject to sig- 37-------------------------------------------------------------------------------- Table of Contents nificant uncertainties, some of which are beyond our control. Should any of these estimates and assumptions change or prove to have been incorrect, it could have a material adverse effect on our results of operations, financial position and cash flows. See Note 12 to the Consolidated Financial Statements in Part II, Item 8 for a further discussion of litigation and contingencies as well as "Legal Proceedings" in Part I, Item 3.

Results of Consolidated Operations The following table sets forth selected consolidated statements of operations data for each of the periods indicated as a percentage of total revenue.

Years Ended December 31, 2010 2011 2012 Operations Data: Revenue 100 % 100 % 100 % Cost of revenue 9 9 10 Gross profit 91 91 90 Operating expenses: Research and development 15 17 19 Sales and marketing 46 48 51 General and administrative 12 17 15 Legal settlements - 1 - Amortization of acquired intangibles - - - Total operating expenses 73 83 85 Income from operations 18 8 5 Interest and other income (expense), net - - - Income before income taxes 18 8 5 Benefit from (provision for) income taxes 3 (3 ) (2 ) Net income 21 % 5 % 3 % Years Ended December 31, 2012 and 2011 Revenue. Revenue for the year ended December 31, 2012 was $138.8 million, an increase of $19.4 million, or 16%, over revenue of $119.5 million for the year ended December 31, 2011. Of the 16% increase in revenue, the majority of the increase was due to an increase in revenue from new customers, as our total number of premium subscribers increased to approximately 462,000 at December 31, 2012 from approximately 360,000 premium subscribers at December 31, 2011, and incremental add-on revenues from our existing customer base.

Cost of Revenue. Cost of revenue for the year ended December 31, 2012 was $14.5 million, an increase of $3.9 million, or 37%, over cost of revenue of $10.6 million for the year ended December 31, 2011. As a percentage of revenue, cost of revenue was 10% and 9% for the years ended December 31, 2012 and 2011, respectively. The increase in absolute dollars resulted primarily from an increase in both the number of customers using our premium services and the total number of devices that connected to our services, including devices owned by free users, which resulted in increased hosting and customer support costs.

The increase in cost of revenue was primarily due to a $1.9 million increase in costs associated with managing our data centers and the hosting of our services.

The increase was also due to a $1.0 million increase in amortization of intangible assets primarily due to the Cosm acquisition in July 2011 and the Bold acquisition in January 2012 and a $0.9 million increase in personnel-related costs, as we increased the number of customer support employees to support our overall growth. Included in the increase in personnel-related costs is a $0.1 million increase in stock-based compensation.

38 -------------------------------------------------------------------------------- Table of Contents Research and Development Expenses. Research and development expenses for the year ended December 31, 2012 were $26.3 million, an increase of $5.6 million, or 27%, over research and development expenses of $20.8 million for the year ended December 31, 2011. As a percentage of revenue, research and development expenses were 19% and 17% for the year ended December 31, 2012 and 2011, respectively.

The increase in absolute dollars was primarily due to a $4.9 million increase in personnel-related costs as we hired additional employees to improve the ease of use and functionality of our existing services and develop new service offerings, and retained employees from the Cosm acquisition in July 2011 and the Bold acquisition in January 2012, respectively. Included in the increase in personnel-related costs is a $1.3 million increase in stock-based compensation.

The increase was also due to a $0.3 million increase in travel-related costs, a $0.2 million increase in professional fees, a $0.2 million increase in rent costs, a $0.2 million increase in hardware and software maintenance costs, and a $0.1 million increase in depreciation expense. These were offset by a $0.3 million increase in costs related to internally developed computer software to be sold as a service which was incurred during the application development stage and therefore capitalized rather than expensed.

Sales and Marketing Expenses. Sales and marketing expenses for the year ended December 31, 2012 were $70.1 million, an increase of $12.9 million, or 23%, over sales and marketing expenses of $57.2 million for the year ended December 31, 2011. As a percentage of revenue, sales and marketing expenses were 51% and 48% for the year ended December 31, 2012 and 2011, respectively. The increase in absolute dollars was primarily due to a $6.9 million increase in personnel-related and recruiting costs, as we hired additional employees to support our growth in sales and expand our marketing efforts and $3.8 million increase in marketing program costs. Included in the increase in personnel-related and recruiting costs is a $2.1 million increase in stock-based compensation. The increase was also due to a $0.7 million increase in credit card processing fees, a $0.6 million increase in professional fees, a $0.3 million increase in travel-related costs, a $0.2 million increase in hardware and software maintenance costs, and a $0.2 million increase in depreciation expense.

General and Administrative Expenses. General and administrative expenses for the year ended December 31, 2012 were $21.3 million, an increase of $1.3 million, or 7%, over general and administrative expenses of $20.0 million for the year ended December 31, 2011. As a percentage of revenue, general and administrative expenses were 15% and 17% for the year ended December 31, 2012 and 2011, respectively. The increase in absolute dollars was due to a $3.5 million increase in personnel-related costs, primarily consisting of a $2.1 million increase in stock-based compensation. The increase was also due to a $0.4 million increase in accounting fees, a $0.2 million increase in travel-related costs, a $0.1 million increase in hardware and software maintenance costs, a $0.1 million increase in rent expense, a $0.1 million increase in telecom expense, a $0.1 million increase in depreciation expense, a $0.1 million increase in director fees, and a $0.1 million increase in miscellaneous tax fees. These were offset by a decrease of $1.8 million for legal costs primarily associated with our defense against the patent infringement claims made by 01 Communique and a $1.3 million state sales tax settlement for uncollected taxes recorded in 2011.

Legal Settlement Expenses. Legal settlement expenses for the year ended December 31, 2012 were $0 compared to $1.3 million for the year ended December 31, 2011. Legal settlement expenses for the year ended December 31, 2011 were related to the License Agreement we entered into with Gemini IP LLC on April 25, 2011 (see Note 12 to the Notes to the Consolidated Financial Statements).

Amortization of Acquired Intangibles. Amortization of acquired intangibles for the years ended December 31, 2012 and 2011 were $0.6 million and $0.2 million, respectively. The amortization of intangibles for the year ended December 31, 2012 related primarily to the value of intangible assets acquired in our January 2012 acquisition of Bold. The amortization of intangibles for the year ended December 31, 2011 related primarily to the value of intangible assets acquired in our July 2006 acquisition of Applied Networking, Inc., which is fully amortized as of December 31, 2012.

Interest and Other Income, Net. Interest and other income, net was income of approximately $0.2 million and $0.3 million for the years ended December 31, 2012 and 2011, respectively. The decrease was primarily related to an increase in foreign currency losses.

Income Taxes. During the years ended December 31, 2012, we recorded a provision for federal, state and foreign income taxes of approximately $2.7 million compared to a provision of $4.0 million for the year ended 39-------------------------------------------------------------------------------- Table of Contents December 31, 2011. At each balance sheet date, we assess the likelihood that deferred tax assets will be realized, and recognize 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, 2012 and 2011, we maintained a full valuation allowance related to the deferred tax assets of our Hungarian subsidiary as this entity has historical losses. During 2012, we reassessed the need for a valuation allowance against the deferred tax assets of our Cosm subsidiary and concluded that it was more likely than not that we would be able to realize these assets based upon forecasted future earnings. Accordingly, we reversed the valuation allowance related to Cosm's deferred tax assets of approximately $677,000 during the year ended December 31, 2012. Although we believe that our tax estimates are reasonable, tax determinations involve significant judgment making and may be subject to audit by tax authorities in the ordinary course of business.

Net Income. We recognized net income of $3.6 million for the year ended December 31, 2012 compared to net income of $5.8 million for the year ended December 31, 2011. For the year ended December 31, 2012, revenue increased $19.4 million while cost of revenue increased $3.9 million, operating expenses increased $18.9 million, interest and other income decreased $0.1 million, and our tax provision decreased $1.3 million, resulting in a $2.2 million decrease in net income.

The $19.4 million increase in revenue is primarily due to an increase in revenue from new customers and add-on revenues from our existing customer base, partially offset by a decrease in Ignition product revenue, mainly caused by the change in our business model related to our Ignition for iPhone and iPad app from a perpetually based licensing model to a subscription based business model.

The $3.9 million increase in cost of revenue is primarily due to a $1.9 million increase in costs to manage our data centers and the hosting of our services, a $1.0 million increase in acquisition related amortization, and $0.9 million related to an increase in personnel-related costs.

The $18.9 million increase in operating expenses is primarily due to a $13.0 million increase in personnel-related costs, a $5.6 million increase in stock-based compensation, a $3.8 million increase in marketing program costs, and a $2.0 million increase in acquisition related costs and amortization. These are offset by a $3.0 million decrease in patent litigation related costs and a $1.3 million state sales tax settlement for uncollected taxes recorded in 2011.

The $0.1 million decrease in interest and other income is primarily due to an increase in foreign currency losses.

The $1.3 million decrease in our tax provision is primarily due to a provision for federal, state, and foreign income taxes of $2.7 million for the year ended December 31, 2012, compared to a $4.0 million provision for the year ended December 31, 2011. The decrease in the tax provision is primarily due to the release of the valuation allowance relating to Cosm's deferred tax assets as of December 31, 2012.

Years Ended December 31, 2011 and 2010 Revenue. Revenue for the year ended December 31, 2011 was $119.5 million, an increase of $18.4 million, or 18%, over revenue of $101.1 million for the year ended December 31, 2010. Of the 18% increase in revenue, the majority of the increase was due to an increase in revenue from new customers, as our total number of premium accounts increased to approximately 1.0 million at December 31, 2011 from approximately 585,000 premium accounts at December 31, 2010, and incremental add-on revenues from our existing customer base. Revenue for the year ended December 31, 2010 included $9.6 million related to the service and marketing agreement with Intel, compared to $0 for the year ended December 31, 2011.

Cost of Revenue. Cost of revenue for the year ended December 31, 2011 was $10.6 million, an increase of $1.4 million, or 16%, over cost of revenue of $9.1 million for the year ended December 31, 2010. As a percentage of revenue, cost of revenue was 9% for the years ended December 31, 2011 and 2010. The increase in absolute dollars resulted primarily from an increase in both the number of customers using our premium services and the total number of devices that connected to our services, including devices owned by free users, which resulted in increased hosting and customer support costs. The increase in cost of revenue was primarily due to a $0.7 mil- 40-------------------------------------------------------------------------------- Table of Contents lion increase in costs associated with managing our data centers and the hosting of our services. The increase was also due to a $0.3 million increase in amortization of intangible assets primarily due to the Cosm acquisition in July 2011 and a $0.2 million increase in personnel-related costs, including a $0.1 million increase in stock-based compensation, as we increased the number of customer support employees to support our overall growth.

Research and Development Expenses. Research and development expenses for the year ended December 31, 2011 were $20.7 million, an increase of $5.6 million, or 37%, over research and development expenses of $15.2 million for the year ended December 31, 2010. As a percentage of revenue, research and development expenses were 17% and 15% for the year ended December 31, 2011 and 2010, respectively.

The increase in absolute dollars was primarily due to a $4.5 million increase in personnel-related costs as we hired additional employees to improve the ease of use and functionality of our existing services and develop new service offerings, retained employees from the Cosm acquisition in July 2011, recognition of $1.5 million of contingent payment costs also associated with the Cosm acquisition (see note 4 to the consolidated financial statements) and a $0.8 million increase in stock-based compensation primarily resulting from our decision to issue stock options to our Hungarian employees in 2011. The increase was also due to $0.4 million increase in professional fees, a $0.3 million increase in depreciation expense, a $0.1 million increase in travel-related costs, a $0.1 million increase in rent costs, a $0.1 million increase in hardware and software maintenance costs and $0.1 million increase in telecom costs. These were offset by a $0.2 million increase in costs related to internally developed computer software to be sold as a service which was incurred during the application development stage and therefore capitalized rather than expensed.

Sales and Marketing Expenses. Sales and marketing expenses for the year ended December 31, 2011 were $57.2 million, an increase of $11.3 million, or 25%, over sales and marketing expenses of $45.9 million for the year ended December 31, 2010. As a percentage of revenue, sales and marketing expenses were 48% and 46% for the year ended December 31, 2011 and 2010, respectively. The increase in absolute dollars was primarily due to a $6.0 million increase in personnel-related and recruiting costs, including a $1.1 million increase in stock-based compensation, from additional employees hired to support our growth in sales and expand our marketing efforts and $3.1 million increase in marketing program costs. The increase was also due to a $0.5 million increase in travel-related costs, a $0.5 increase in rent costs primarily related to the expansion of our corporate headquarters, a $0.4 million increase in credit card processing fees, a $0.3 million increase in hardware and software maintenance costs, a $0.2 million increase in telecom costs and a $0.1 million increase in depreciation expense.

General and Administrative Expenses. General and administrative expenses for the year ended December 31, 2011 were $20.0 million, an increase of $7.7 million, or 62%, over general and administrative expenses of $12.3 million for the year ended December 31, 2010. As a percentage of revenue, general and administrative expenses were 17% and 12% for the year ended December 31, 2011 and 2010, respectively. The increase in absolute dollars was primarily due to a $3.2 million increase in legal costs associated with our defense against the patent infringement claims made by 01 Communique. The increase was also due to a $2.6 million increase in personnel-related costs, primarily consisting of a $1.9 million increase in stock-based compensation, a $1.3 million state sales tax settlement for uncollected taxes, a $0.4 million increase in accounting fees, a $0.2 million increase in hardware and software maintenance costs and a $0.1 million increase in travel-related costs. These were offset by a $0.2 million decrease in professional fees.

Legal Settlement Expenses. Legal settlement expenses for the year ended December 31, 2011 were $1.3 million compared to $0 for the year ended December 31, 2010. Legal settlement expenses for the year ended December 31, 2011 were related to the License Agreement we entered into with Gemini IP LLC on April 25, 2011 (see Note 12 to the Notes to the Consolidated Financial Statements).

Amortization of Acquired Intangibles. Amortization of acquired intangibles for the year ended December 31, 2011 and 2010 was $0.2 million and $0.3 million, respectively, and related primarily to the value of intangible assets acquired in our July 2006 acquisition of Applied Networking, Inc.

Interest and Other Income, Net. Interest and other income, net was income of approximately $0.3 million and $0.4 million for the years ended December 31, 2011 and 2010, respectively. The change was mainly due to 41-------------------------------------------------------------------------------- Table of Contents an increase in interest income resulting from an increase in the balance of funds invested in higher yielding marketable securities, offset by an increase in foreign currency losses.

Income Taxes. During the years ended December 31, 2011, we recorded a provision for federal, state and foreign income taxes of approximately $4.0 million compared to a benefit of $2.5 million for the year ended December 31, 2010. Our effective tax rate increased year-over-year as we released our $8.6 million valuation allowance against primarily all of our net domestic deferred tax assets during the year ended December 31, 2010, and also as a result of losses incurred in our UK subsidiaries attributable to our Cosm acquisition for which no corresponding benefit was recognized during the year ended December 31, 2011.

At each balance sheet date, we assess the likelihood that deferred tax assets will be realized, and recognize 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, 2011 and 2010, we maintained a full valuation allowance related to the deferred tax assets of our Hungarian subsidiary. Additionally, as of December 31, 2011, we maintained a full valuation allowance against the deferred tax assets of our Cosm subsidiary.

These entities have historical losses and we concluded it was not more likely than not that these deferred tax assets are realizable.

Net Income . We recognized net income of $5.8 million for the year ended December 31, 2011 compared to net income of $21.1 million for the year ended December 31, 2010. For the year ended December 31, 2011, revenue increased $18.4 million while cost of revenue increased $1.4 million, operating expenses increased $25.6 million and our tax provision increased $6.5 million, resulting in a $15.3 million decrease in net income.

The $18.4 million increase in revenue is primarily due to a $28.0 million increase in revenue from new customers and add-on revenues from our existing customer base partially offset by a $9.6 million decrease in revenue related to our Intel agreement which ended in December 2010.

The $1.4 million increase in cost of revenue is primarily due to a $0.7 million increase in costs to manage our data centers and the hosting of our services, a $0.3 million increase in acquisition related amortization, and $0.2 million related to an increase in personnel-related costs.

The $25.6 million increase in operating expenses is primarily due to a $7.8 million increase in personnel-related costs, a $3.8 million increase in stock-based compensation, a $3.6 million increase in patent litigation related costs, a $3.1 million increase in marketing program costs, a $1.8 million increase in acquisition related costs and amortization, a $1.3 million state sales tax settlement, and a $1.0 million increase in equipment and software related costs.

The $6.5 million increase in our tax provision is primarily due to a provision for federal, state, and foreign income taxes of $4.0 million for the year ended December 31, 2011, compared to a $6.1 million provision for the year ended December 31, 2010, which was offset by an $8.6 million tax benefit associated with the reversal of our valuation allowance against our domestic and certain foreign deferred tax assets.

Liquidity and Capital Resources The following table sets forth the major sources and uses of cash for each of the periods set forth below: Years Ended December 31, 2010 2011 2012 (In thousands) Net cash provided by operations $ 36,469 $ 32,871 $ 28,257 Net cash used in investing activities (65,003 ) (17,760 ) (29,800 ) Net cash provided by financing activities 5,789 12,094 9,228 Effect of exchange rate changes (265 ) (881 ) 643 Net (decrease) increase in cash $ (23,010 ) $ 26,324 $ 8,328 42 -------------------------------------------------------------------------------- Table of Contents At December 31, 2012, our principal source of liquidity was cash and cash equivalents and short-term marketable securities totaling $212.1 million. As of December 31, 2012, $12.0 million of the $212.1 million of cash and cash equivalents and short-term marketable securities was held by our foreign subsidiaries. If the undistributed earnings of our foreign subsidiaries are needed for our operations in the United States, we would be required to accrue and pay U.S. taxes upon repatriation. Our current plans are not expected to require repatriation of cash and investments to fund our U.S. operations and, as a result, we intend to indefinitely reinvest our foreign earnings to fund our foreign subsidiaries.

Cash Flows From Operating Activities Net cash provided by operating activities was $28.3 million, $32.9 million, and $36.5 million for the years ended December 31, 2012, 2011, and 2010, respectively.

Net cash inflows from operating activities during the year ended December 31, 2012 were mainly attributable to a $11.0 million increase in deferred revenue associated with the increase in subscription sales orders and customer growth.

Net cash inflows from operating activities were also attributable to non-cash operating expenses, including $14.8 million for stock compensation, $6.1 million for depreciation and amortization, offset by a $6.6 million income tax benefit from the exercise of stock options and a $0.8 million benefit from deferred income taxes. The increase in net cash inflows from operating activities were also attributable to a $7.4 million increase in accounts payable and accrued expenses, offset by a $4.5 million increase in accounts receivable, a $1.1 million increase in prepaid expenses and other current assets and a $1.3 million increase in other assets. We expect that our future cash flows from operating activities will be impacted by costs associated with the relocation of our corporate headquarters to Boston, Massachusetts and by the contingent payments associated with the Cosm and Bold acquisitions. Additionally, we expect to incur significant legal costs associated with our continued defense against the patent infringement claims made by 01 Communique and the declaratory judgement action we filed against Pragmatus, which will impact our future cash flows from operating activities.

Net cash inflows from operating activities during the year ended December 31, 2011 were mainly attributable to a $15.5 million increase in deferred revenue associated with the increase in subscription sales orders and customer growth.

Net cash inflows from operating activities were also attributable to non-cash operating expenses, including $8.9 million for stock compensation, $4.4 million for depreciation and amortization, and a $3.8 million provision for deferred income taxes, offset by non-cash benefits, primarily including a $5.9 million income tax benefit from the exercise of stock options. The increase in net cash inflows from operating activities were also attributable to a $3.3 million increase in accounts payable and accrued expenses, a $0.1 million increase in other long-term liabilities and a $0.1 million decrease in prepaid expenses and other current assets, offset by a $4.1 million increase in accounts receivable and a $0.2 increase in other assets.

Cash Flows From Investing Activities Net cash used in investing activities was $29.8 million, $17.8 million, and $65.0 million for the years ended December 31, 2012, 2011, and 2010, respectively.

Net cash used in investing for the year ended December 31, 2012 was primarily related to the acquisition of Bold for $14.8 million, net of cash acquired, and the purchase of $135.1 million of marketable securities offset by proceeds of $130.0 million from redemption and maturity of marketable securities. Net cash used in investing activities also related to the addition of $5.3 million in property and equipment mainly related to the expansion and upgrade of our data center capacity, the expansion and upgrade of our internal IT infrastructure and expansion of our offices. Restricted cash and deposits also increased $3.6 million as a result of the letter of credit associated with the lease of our new corporate headquarters in Boston. We also had $1.0 million in intangible asset additions related to internally developed software and the purchase of domain names and trademarks.

Net cash used in investing for the year ended December 31, 2011 was primarily related to the acquisition of Cosm for $10.0 million and the purchase of $150.1 million of marketable securities offset by proceeds of $145.0 million from maturity of marketable securities. Net cash used in investing activities also related to the addition of $2.3 million in property and equipment mainly related to the expansion and upgrade of our data center capacity as well as the expansion and upgrade of our internal IT infrastructure.

43-------------------------------------------------------------------------------- Table of Contents Our future capital requirements may vary materially from historical levels and will depend on many factors including, but not limited to, the relocation of our corporate headquarters to Boston, Massachusetts and the expansion of our other existing offices, the establishment of additional offices in the United States and worldwide, the expansion of our data center infrastructure, the development of new services and the expansion of our sales, support, development and marketing organizations necessary to support our growth. Since our inception, we have experienced increases in our expenditures consistent with the growth in our operations and personnel, and we anticipate that our expenditures will continue to increase in the future. We also intend to make investments in computer equipment and systems and infrastructure related to existing and new offices as we move and expand our facilities, add additional personnel and continue to grow our business. We are not currently party to any purchase contracts related to future capital expenditures.

Cash Flows From Financing Activities Net cash provided by financing activities for the year ended December 31, 2012 was primarily related to a $6.6 million income tax benefit from the exercise of stock options as well as $2.7 million in proceeds from the issuance of common stock upon exercise of stock options. These were offset by a $0.1 million payment for contingent consideration.

Net cash provided by financing activities for the year ended December 31, 2011 was primarily related to $6.2 million in proceeds received from the issuance of common stock upon exercise of stock options as well as a $5.9 million income tax benefit from the exercise of stock options.

On July 7, 2009, we closed our IPO raising net proceeds of approximately $82.9 million after deducting underwriting discounts and commissions and offering costs. On December 16, 2009, we closed our secondary public offering raising net proceeds of approximately $1.2 million after deducting underwriting discounts and commissions and offering costs. While we believe that our current cash and cash equivalents will be sufficient to meet our working capital and capital expenditure requirements for at least the next twelve months, we may elect to raise additional capital through the sale of additional equity or debt securities or obtain a credit facility to develop or enhance our services, to fund expansion, to respond to competitive pressures or to acquire complementary products, businesses or technologies. If we elect, additional financing may not be available in amounts or on terms that are favorable to us, if at all. If we raise additional funds through the issuance of equity or convertible debt securities, our existing stockholders could suffer significant dilution, and any new equity securities we issue could have rights, preferences and privileges superior to those of holders of our common stock.

During the last three years, inflation and changing prices have not had a material effect on our business and we do not expect that inflation or changing prices will materially affect our business in the foreseeable future.

Off-Balance Sheet Arrangements We do not engage in any off-balance sheet financing activities, nor do we have any interest in entities referred to as variable interest entities.

Contractual Obligations The following table summarizes our contractual obligations at December 31, 2012 and the effect such obligations are expected to have on our liquidity and cash flow in future periods.

Payments Due by Period Less Than More Than Total 1 Year 1-3 Years 3-5 Years 5 Years Operating lease obligations $ 53,448,000 $ 7,299,000 $ 10,997,000 $ 9,904,000 $ 25,248,000 Hosting service agreements 2,641,000 2,265,000 363,000 13,000 - Total $ 56,089,000 $ 9,564,000 $ 11,360,000 $ 9,917,000 $ 25,248,000 The commitments under our operating leases shown above consist primarily of lease payments for our future corporate headquarters located in Boston, Massachusetts (see Note 12 to the Condensed Consolidated 44-------------------------------------------------------------------------------- Table of Contents Financial Statements), our research and development offices in Hungary, our international sales and marketing offices located in The Netherlands, Australia, the United Kingdom, Ireland, and India, contractual obligations related to our data centers and our current corporate headquarters located in Woburn, Massachusetts.

In April 2012, we entered into a lease for a new corporate headquarters located in Boston, Massachusetts. Pursuant to the lease, the landlord is obligated to rehabilitate the existing building and we expect that the lease term will begin in April 2013 and extend through June 2023. The aggregate amount of minimum lease payments to be made over the term of the lease is approximately $41.3 million. Pursuant to the terms of the lease, the landlord is responsible for making certain improvements to the leased space up to an agreed upon cost to the landlord. Any excess costs for these improvements will be billed by the landlord to us as additional rent. We estimate these excess costs to be approximately $5.2 million, of which $4.1 million will be paid in 2013. The lease required a security deposit of approximately $3.3 million in the form of an irrevocable standby letter of credit which is collateralized by a bank deposit in the amount of approximately $3.5 million or 105 percent of the security deposit. The security deposit is classified as restricted cash. The lease includes an option to extend the original term of the lease for two successive five year periods.

In October 2012, we entered into a lease for new office space in Dublin, Ireland. The term of the new office space began in October 2012 and extends through September 2022. The approximate annual lease payments for the new office space are $161,000 (EUR 122,000). The lease agreement required a security deposit of approximately $247,000 (EUR 187,000) and contains a termination option which allows us to terminate the lease pursuant to certain lease provisions.

Recent 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 ASU 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 the 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. We have adopted this new ASU and it did not have a material effect on our financial position, results of operations or cash flows.

In June 2011, the FASB issued ASU No. 2011-05, Comprehensive Income (Topic 220) - Presentation of Comprehensive Income (ASU 2011-05), to require an entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of equity. In December 2011, the FASB issued ASU No. 2011-12, Comprehensive Income (Topic 220) - Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in ASU 2011-05 (ASU 2011-12), which defers the effective date of only those changes in ASU 2011-05 that relate to the presentation of reclassification adjustments. ASU 2011-05 is effective for us in our first quarter of fiscal 2012 and was applied retrospectively. We have adopted ASU 2011-05 and ASU 2011-12 and it did not have a material impact on our financial position, results of operations or cash flows.

In May 2011, the FASB issued ASU No. 2011-04, Fair Value Measurement (Topic 820) - Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (ASU 2011-04), to provide a consistent definition of fair value and ensure that the fair value measurement and disclosure requirements are similar between GAAP and International Financial Reporting Standards. ASU 2011-04 changes certain fair value measurement principles and enhances the disclosure requirements particularly for Level 3 fair value measurements (as defined in Note 3). ASU 2011-04 was effective for us in our first quarter of fiscal 2012 and was applied prospectively. We have adopted ASU 2011-04 and it did not have a material impact on our financial position, results of operations or cash flows.

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