LIVONGO HEALTH, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and with our Management's Discussion and Analysis of Financial Condition and Results of Operations and audited consolidated financial statements in our Annual Report on Form 10-K for the year endedDecember 31, 2019 , or our Annual Report. As discussed in the section titled "Note Regarding Forward-Looking Statements," the following discussion and analysis contains forward-looking statements that involve risks and uncertainties. Our actual results could differ materially from those discussed below. Factors that could cause or contribute to such differences include, but are not limited to, those identified below and those discussed in the sections titled "Risk Factors" under Part II, Item 1A in this Quarterly Report on Form 10-Q and Part I, Item 1A in our Annual Report. Recent Developments OnAugust 5, 2020 , we entered into an Agreement and Plan of Merger, or the Merger Agreement, with Teladoc Health, Inc, aDelaware corporation, or Teladoc, andTempranillo Merger Sub, Inc. , aDelaware corporation and a direct, wholly-owned subsidiary of Teladoc, or Merger Sub. The Merger Agreement provides that, subject to the satisfaction of customary closing conditions, Merger Sub will be merged with and into Livongo, or the Merger, with Livongo continuing as the surviving corporation and a direct, wholly-owned subsidiary of Teladoc. Pursuant to the terms of the Merger Agreement, at the effective time of the Merger, each share of our common stock, par value$0.001 per share, issued and outstanding immediately prior to the effective time of the Merger (other than shares held by any shareholderwho properly demands and perfects his, her or its appraisal rights with respect to such shares and treasury shares held by us) will be converted into the right to receive (i) 0.5920 of a share of common stock, par value$0.001 per share, of Teladoc and (ii)$4.24 in cash, without any interest thereon. In addition, prior to the effective time of the Merger, we will declare a special cash dividend, or the Special Dividend, equal to$7.09 per share of common stock to shareholders of Livongo as of a record date immediately prior to the effective time of the Merger. The Merger, which is currently expected to close in the fourth quarter of 2020, is subject to the satisfaction or waiver of certain customary closing conditions, including, among others, (i) adoption of the Merger Agreement by the affirmative vote of holders of a majority of outstanding shares of our common stock, (ii) approval of an amendment to Teladoc's certificate of incorporation by the affirmative vote of the holders of a majority of outstanding shares of Teladoc's common stock and approval of the issuance of shares pursuant to the Merger Agreement by the affirmative vote of holders of a majority of all votes cast by holders of outstanding shares of Teladoc's common stock, and (iii) the termination or expiration of the waiting period under the Hart-Scott Rodino Antitrust Improvements Act of 1976. The Merger Agreement contains certain termination rights for both us and Teladoc. If the Merger Agreement is terminated under certain specified circumstances, we will be required to pay Teladoc a termination fee of$562,810,000 (including in connection with our entry into an agreement with respect to a superior proposal, as defined in the Merger Agreement, if certain conditions are met). Additional information about the Merger Agreement is set forth in our Current Report on Form 8-K filed with theSEC onAugust 6, 2020 . Overview Our mission is to empower people with chronic conditions to live better and healthier lives. The advancement of technology and data science has transformed nearly every industry except healthcare to create new, consumer-first experiences that are both personalized and empowering. Livongo is pioneering a new category in healthcare, called Applied Health Signals, which is transforming the management of chronic conditions. We believe the future of health is about keeping people healthy at-home and being able to do so at scale. Meeting individuals where they are in their health journey in order to understand how they are doing, determining their care needs, and recommending a next-best action is the future of health. At Livongo, we call this Consumer Directed Virtual Care, which is enabled by connected devices and data science. And we believe remote monitoring, when combined with traditional virtual health and advanced data science offers advantages that align well with this move towards Consumer Directed Virtual Care. 37
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Index to Financial Statements Our platform, which leverages data science and technology, creates a new kind of personalized experience for people with chronic conditions (our members). This empowers our members to make sustainable behavior changes that lead to better outcomes and lower costs. The Livongo experience makes it easier for our members to stay healthy. We fit into the way our members live, put them in control of managing their condition, and give them an experience that they don't just like, but love (evidenced by our average Livongo for Diabetes member Net Promoter Score, or NPS, of +64 as ofDecember 31, 2019 ). We currently offer Livongo for Diabetes, which has historically accounted for a substantial portion of our revenue, and we expect that to continue for the next several years, as well as Livongo for Hypertension, Livongo for Prediabetes and Weight Management, and Livongo forBehavioral Health by myStrength. Our solutions include a smart, cellular-connected device and related testing materials, if applicable, that are sent directly to the member, and member access to a suite of personalized feedback and remote monitoring and coaching services on our platform. We invoice our clients monthly on a per-member or per-solution basis, depending on the solution, and may also charge an upfront fee for the devices. We do not sell member support services separately. As a result, member enrollment and continued usage drives our revenue and we primarily generate revenue not through the upfront fee for our devices, but from the ongoing subscription revenue for our members to access to our integrated solution. Our agreements have fixed and variable pricing components based on the number of members. This results in a highly predictable revenue stream, which helps us plan for growth and scale. Furthermore, over time, many of our clients make our solutions available to a greater percentage of their employee population, allowing us to both increase enrollment within our existing clients, which we refer to as product intensity, and for the sale of additional solutions to existing clients, which we refer to as product density. Beginning in 2020, we introduced pricing options that provide members with access to multiple solutions in order to enable us to more fully address the health of the whole person. We typically enter into a higher percentage of agreements with new clients, as well as renewal agreements with existing clients, in our third and fourth quarters, which results in higher enrollment launch rates in the first quarter. We believe that this results in part from the timing of open enrollment periods of many of our clients. We sell to companies of all sizes, including employers, from small businesses to Fortune 500 enterprises, hospital payors, government entities, and labor unions. We currently derive a high concentration of our revenue from sales to clients that are self-insured employers, with hospital payors, government entities, and labor unions accounting for a smaller portion of our revenue. As ofJune 30, 2020 andDecember 31, 2019 , we served 1,328 and 872 clients, respectively. For a discussion of the methodology used to determine the number of clients, see the section titled "Key Metrics" below. As ofJune 30, 2020 andDecember 31, 2019 , we had approximately 410,300 and 222,700 members, respectively, enrolled in our Livongo for Diabetes solution. In addition, we have a growing number of members enrolled in our hypertension, prediabetes and weight management, and behavioral health solutions. Our client and member base is located inthe United States . We have experienced significant growth since our inception. Our revenue increased$51.0 million , or 125%, to$91.9 million for the three months endedJune 30, 2020 , compared to$40.9 million for the three months endedJune 30, 2019 . Our revenue increased$87.8 million , or 120%, to$160.7 million for the six months endedJune 30, 2020 , compared to$73.0 million for the six months endedJune 30, 2019 . We have also made significant investments to grow our business, particularly in research and development and sales and marketing. As a result, we have incurred net losses of$1.6 million and$13.0 million for the three months and$7.1 million and$27.3 million for the six months endedJune 30, 2020 and 2019, respectively. As ofJune 30, 2020 , we had an accumulated deficit of$171.3 million . COVID-19 Update InMarch 2020 , theWorld Health Organization declared the 2019 novel coronavirus, or COVID-19, a global pandemic. We are closely monitoring the impact of the COVID-19 pandemic on all aspects of our business. We have taken measures in response to the COVID-19 pandemic, including temporarily closing our offices and implementing a work from home policy for our worldwide workforce; limiting capacity at our offices that have reopened; implementing additional safety policies and procedures for employees working in our offices that have reopened; suspending employee travel and in person meetings; and adjusting our supply chain and inventory levels. We may take further actions that alter our business operations as may be required by federal, state or local authorities or that we determine are in the best interests of our employees, clients, members and stockholders. The effects of these operational modifications are unknown and may not be realized until further reporting periods. 38
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Index to Financial Statements While the COVID-19 pandemic has not had a material adverse impact on our financial condition and results of operations to date, the future impact of the COVID-19 pandemic on our operational and financial performance will depend on certain developments, including the duration and spread of the pandemic, impact on our clients and members, impact on our sales cycles, impact on our marketing efforts, and effect on our suppliers, all of which are uncertain and cannot be predicted. Public and private sector policies and initiatives to reduce the transmission of COVID-19 and disruptions to our operations and the operations of our third-party suppliers, along with the related global slowdown in economic activity, may result in decreased revenues, decreased collections, and increased costs, and we expect such impacts on our revenue, collections, and costs to continue through the duration of this crisis. Further, the economic effects of the COVID-19 pandemic have financially constrained some of our prospective and existing clients' healthcare spending, which we expect will negatively impact our ability to acquire new clients and our ability to renew subscriptions with or sell additional solutions to our existing clients. We also expect to experience increased member attrition to the extent our existing clients' reduce their respective workforces in response to the current economic conditions. As of the date of this report, the extent to which the COVID-19 pandemic may materially impact our financial condition, liquidity or results of operations is uncertain. In addition, due to our subscription-based business model, the effect of the COVID-19 pandemic may not be fully reflected in our revenue until future periods. It is possible that the COVID-19 pandemic, the measures taken by the governments and businesses affected and the resulting economic impact may materially and adversely affect our business, results of operations, cash flows and financial positions as well as our customers. Factors Affecting Our Performance New Client Acquisition. We believe there are significant opportunities for growth as enterprises and individuals seek better ways to manage chronic conditions. We believe our ability to add new clients is a key indicator of our increasing market adoption and future revenue potential. Our client count grew from 872 as ofDecember 31, 2019 to 1,328 clients as ofJune 30, 2020 , representing an increase of 52%. For a discussion of the methodology used to determine the number of clients, see the section titled "Key Metrics" below. Our channel partners, pharmacy benefit managers, or PBMs, and resellers play an important role in marketing to and contracting with our clients. They often speed up the process of contracting and increase our access to clients. Under our agreements with our channel partners, PBMs and resellers, we are obligated to pay such third parties an administrative or a marketing fee. While these relationships carry up-front costs, they significantly expand the distribution channels through which we may capture new clients and enroll new members. Our growth and financial results will depend in part on our ability to acquire new clients, particularly as we pursue Medicare Advantage, Managed Medicare, Fee for Service Medicare, Medicaid, and other fully-insured employers. We expect our ability to add new clients may be negatively impacted by current economic uncertainty in light of the COVID-19 pandemic. Our ability to increase our total number of clients also increases our future opportunities for product intensity through expansion of members within an existing client using a solution, renewals, and product density through sales of additional solutions for other chronic conditions. Product Intensity and Enrollment. An important component of our revenue growth strategy is to retain our existing clients and members, as well as increase product intensity through growing member enrollment within our client base. We believe we are well-positioned to continue our relationships with existing clients due to the quality of our solutions and member satisfaction with our solutions. However, we expect our ability to retain existing clients and members and increase product intensity may be negatively impacted by certain of our clients' financial constraints in light of the COVID-19 pandemic. Members see real value in our solutions and are satisfied with our offering, which is demonstrated by our average Livongo for Diabetes member NPS of +64 as ofDecember 31, 2019 . We work to continually improve our enrollment rate through the use of our AI+AI engine, which provides feedback on successful outreach and engagement strategies. The ability to enroll additional members with chronic conditions represents a significant opportunity for us within our existing clients. Once a client is onboarded, we leverage our AI+AI engine to target and engage with potential new members in an informed manner that drives rapid enrollment and increases our product intensity in these new clients. Product Density. While Livongo for Diabetes was our first solution, there is significant overlap in the target members for each of our solutions and we see significant cross-selling opportunities. We currently offer solutions focused on diabetes, hypertension, prediabetes and weight management, and behavioral health. We are continuing to invest in expanding our solutions, as well as developing solutions that address other chronic conditions. As we continue to add solutions that address additional chronic conditions to our platform and deepen our product density, we see increased sales opportunities as members often experience multiple chronic conditions simultaneously and could benefit from access to multiple Livongo solutions. Additionally, we see significant opportunities to add new clients and members to our platform as we offer an increasing number 39
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of solutions. Beginning in 2020, we introduced pricing options that provide
members with access to multiple solutions in order to enable us to more fully
address the health of the whole person.
Enhancing and Extending Our Platform. We offer web and mobile resources,
empowering members to be active participants in their journey to becoming and
staying physically and mentally healthy. Our AI+AI engine constantly assesses
which approaches are most effective in helping our members, and we will continue
to add to our repertoire as we receive further data and feedback. We expect to
continue to invest in research and development to enhance our platform by
improving our existing solutions and furthering product density by expanding
into solutions for other chronic conditions. Our platform is highly scalable and
is built to treat the whole person. We believe our platform can be expanded to
address a range of chronic conditions, and we are constantly reviewing areas of
improvement and potential density expansion. We are continuing to evaluate other
chronic conditions, as well as solutions that are compatible with other payors
such as government programs, including Medicare Advantage, Managed Medicaid, Fee
for Service Medicare, and Medicaid. In addition to our ongoing investment in
research and development, we may also pursue acquisitions of businesses,
technologies and assets that complement and expand the functionality of our
solutions to other chronic conditions, add to our technology or security
expertise, or bolster our leadership position by gaining access to new clients
or markets.
Investing in Growth. We expect to continue to focus on long-term revenue growth
through investments in sales and marketing and research and development. While
we offer our own devices that are compatible with our solutions, we are also
working to enhance our offering to integrate existing health monitoring devices
and incorporate new technology. We also believe our solutions are well suited
for people living with chronic conditions around the globe, and we view
international expansion as a longer-term opportunity. In addition, we expect our
general and administrative expenses to increase in absolute dollars for the
foreseeable future to support our growth. We plan to balance these investments
in future growth with a continued focus on managing our expenditures and
investing judiciously. Accordingly, in the short term we expect these activities
to increase our net losses, but in the long term we anticipate that these
investments will positively impact our business and results of operations.
Timing of Sales. While we sell to and implement our solutions to clients
year-round, we experience some seasonality in terms of when we enter into
agreements with our clients and when we launch our solutions to members. We
typically enter into a higher percentage of agreements with new clients, as well
as renewal agreements with existing clients, in our third and fourth quarters,
which coincide with typical employee benefit enrollment periods, with higher
implementation rates in the first quarter. Regardless of when the agreement is
entered into, we can typically complete client implementation in an average of
approximately three months. Any downturn in sales, however, may negatively
affect our revenue in future periods. Further, the COVID-19 pandemic may
negatively impact the timing of our sales cycle. Accordingly, the effect of
downturns in sales and potential changes in our rate of renewals may not be
fully reflected in our results of operations until future periods.
Key Metrics
We monitor the following key metrics to help us evaluate our business, identify
trends affecting our business, formulate business plans and make strategic
decisions. We believe the following metrics are useful in evaluating our
business:
Six Months Ended June
Three Months Ended June 30, 30,
2020 2019 2020 2019
(dollars in thousands)
Clients(1) 1,328 758 1,328 758
Enrolled Diabetes Members 410,270 192,934 410,270 192,934
Estimated Value of Agreements(2) $ 108,705 $
74,234
(1)First quarter and first half of 2019 have been updated to conform to current methodology as described further below. (2)Previously referred to as total contract value. Clients. We define our clients as business entities that have at least one active paid contract with us at the end of a particular period. Entities that access our platform through our channel partners, such as PBMs and resellers, are counted as individual clients. Historically, we have treated our partnerships with health plans as a single client, though multiple employers may contract for our services through a single health plan, because of the relatively small number of employerswho enrolled under those plans. Because of the increase in the number of employerswho are enrolling through health plans instead of other channels, beginning with the first quarter of 2020 we believe that it is more appropriate to treat health plans in the same manner as we treat our channel partners, such as PBMs and resellers, and include entitieswho enroll in our platform through a health 40
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Index to Financial Statements plan as separate clients. The historical information presented has been revised to include such entities as individual clients. We do not count our channel partners, such as PBMs, health plans, or resellers as clients, unless they also separately have active paid contracts for our solutions. If business units or subsidiaries of the same entity enter into separate agreements with us, they are counted as separate clients. However, entities that have purchased multiple solutions through different contracts are treated as a single client. Enrolled Diabetes Members. We believe our ability to grow the number of enrolled diabetes members is an indicator of penetration of our flagship solution, Livongo for Diabetes. We define our enrolled diabetes members as all individuals that are enrolled in Livongo for Diabetes at the end of a given period. This number excludes: (i) employees or dependents of a client that has ceased using our solution, (ii) employeeswho no longer have an employment relationship with an active client, and their dependents, and (iii) employees and dependentswho have not been active on or used our solution for a period of time as specified in the applicable client's agreement, which is typically between four and six months. Estimated Value of Agreements. This represents the estimated value of agreements, signed in the relevant period and was previously referred to as the Total Contract Value, or TCV, in certain of Livongo's previous filings with theSecurities and Exchange Commission . Estimated Value of Agreements includes agreements entered into with new clients or expansions entered into with existing clients. Estimated Value of Agreements is helpful in evaluating our business because it provides some visibility into future revenue. Our new client subscriptions typically have a term of one to three years, and we generally invoice our clients in monthly installments at the end of each month in the subscription period based on the number of members in such monthwho were active on or used our solution within a certain period of time, as specified in the applicable client's agreement. We define Estimated Value of Agreements as contractually committed orders to be invoiced under agreements initially entered into during the relevant period. Agreements are only counted in Estimated Value of Agreements in the period in which they are entered into, and for purposes of this calculation, we assume an average member enrollment rate. Our estimates include assumptions regarding the total recruitable individuals at a client, commencement of enrollment period, enrollment method, starting enrollment rates, monthly increases to enrollment rates over time, contract length, and client size and industry. Estimates also assume the agreement will not be terminated early and will be serviced for the full term, there are no changes to the total recruitable individuals at a client during the relevant period, and no changes to the per participant per month fee during the relevant period. Until such time as these amounts are invoiced, which occurs at the end of each month of service, they are not recorded in revenue, deferred revenue, or elsewhere in our condensed consolidated financial statements. Non-GAAP Financial Measures We believe that, in addition to our financial results determined in accordance with GAAP, adjusted gross profit, adjusted gross margin, and adjusted EBITDA, all of which are non-GAAP financial measures, are useful in evaluating our business, results of operations, and financial condition. Adjusted Gross Profit and Adjusted Gross Margin Adjusted gross profit and adjusted gross margin are key performance measures that our management uses to assess our overall performance. We define adjusted gross profit as GAAP gross profit, excluding (i) stock-based compensation expense, (ii) amortization of intangible assets, and (iii) employer payroll taxes on stock-based compensation. Prior to the second quarter of 2020, the employer portion of payroll taxes on stock-based compensation was insignificant and therefore we have not historically excluded such amounts from adjusted gross profit and adjusted gross margin. However, because the amount of stock-based compensation expense has increased in the ordinary course of business, the employer payroll taxes on our stock-based compensation has also increased and become more meaningful. We believe that, similar to stock-based compensation expense, such payroll taxes are unrelated to overall operating performance and therefore we have determined to exclude such amounts from adjusted gross profit and adjusted gross margin beginning with the second quarter of 2020. We are making this update to our presentation prospectively for the second quarter of 2020 and have not updated any prior periods because such amounts were insignificant. We define adjusted gross margin as our adjusted gross profit divided by our revenue. We believe adjusted gross profit and adjusted gross margin provide our management and investors consistency and comparability with our past financial performance and facilitate period-to-period comparisons of operations, as these metrics eliminate the effects of the above-referenced items as factors unrelated to overall operating performance. The following table presents a reconciliation of adjusted gross profit from the most comparable GAAP measure, gross profit, for the periods presented: 41
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Six Months Ended June
Three Months Ended June 30, 30,
2020 2019 2020 2019
(dollars in thousands)
Gross profit $ 70,457 $ 28,951 $ 121,173 $ 51,155
Add:
Stock-based compensation expense 118 6 210 12
Amortization of intangible assets 420 353 840 680
Employer payroll tax on stock-based
compensation(1) 27 - 27 -
Adjusted gross profit $ 71,022 $ 29,310 $ 122,250 $ 51,847
Adjusted gross margin (as a percentage of
revenue) 77.3 % 71.6 % 76.1 % 71.0 %
(1)As noted above, beginning in the second quarter of 2020, we made a
prospective update to our presentation of adjusted gross profit and adjusted
gross margin to exclude (i.e., add back) the employer portion of payroll taxes
on stock-based compensation. As such, the adjusted gross profit and adjusted
gross margin presented above for the three and six months ended June 30, 2020
excludes our portion of payroll taxes on stock-based compensation from the
second quarter of 2020 recorded as a component of cost of revenue. We have not
updated any prior periods. The employer portion of payroll taxes on stock-based
compensation was $23 for the three months ended March 31, 2020 ; as such,
adjusted gross profit would have been $122,273 , and adjusted gross margin (as a
percentage of revenue) would have been unchanged for the six months ended June
30, 2020 had this update been made on a retroactive basis back to the first
quarter of 2020.
Adjusted EBITDA
Adjusted EBITDA is a key performance measure that our management uses to assess
our operating performance. Because adjusted EBITDA facilitates internal
comparisons of our historical operating performance on a more consistent basis,
we use this measure for business planning purposes and in evaluating acquisition
opportunities.
We calculate adjusted EBITDA as net loss adjusted to exclude (i) depreciation
and amortization, (ii) amortization of intangible assets, (iii) stock-based
compensation expense, (iv) employer payroll taxes on stock-based compensation,
(v) acquisition-related expenses, (vi) change in fair value of contingent
consideration, (vii) other income, net, and (viii) provision for (benefit from)
income taxes. Prior to the second quarter of 2020, the employer portion of
payroll taxes on stock-based compensation was insignificant and therefore we
have not historically excluded such amounts from adjusted EBITDA. However,
because the amount of stock-based compensation expense has increased in the
ordinary course of business, the employer payroll taxes on our stock-based
compensation has also increased and become more meaningful. We believe that,
similar to stock-based compensation expense, such payroll taxes are unrelated to
overall operating performance and therefore we have determined to exclude such
amounts from adjusted EBITDA beginning with the second quarter of 2020. We are
making this update to our presentation prospectively for the second quarter of
2020 and have not updated any prior periods because such amounts were
insignificant.
The following table presents a reconciliation of adjusted EBITDA from the most
comparable GAAP measure, net loss, for the periods presented:
Six Months Ended June
Three Months Ended June 30, 30,
2020 2019 2020 2019
(in thousands)
Net (loss) $ (1,554) $ (12,977) $ (7,127) $ (27,348)
Add:
Depreciation and amortization(1) 1,439 754 2,619 1,450
Amortization of intangible assets 692 629 1,388 1,193
Stock-based compensation expense 9,875 4,453 17,938 9,963
Employer payroll tax on stock-based
compensation(2) 1,597 - 2,197 -
Acquisition-related expenses(3) - 18 - 225
Change in fair value of contingent
consideration 2 282 86 956
Other income (expense), net(4) 1,220 (185) (94) (647)
Provision for (benefit from) income taxes 72 5 93 (1,383)
Adjusted EBITDA $ 13,343 $ (7,021) $ 17,100 $ (15,591)
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Index to Financial Statements (1)Depreciation and amortization includes depreciation of property and equipment, amortization of debt discount, and amortization of capitalized internal-use software costs. (2)As noted above, beginning in the second quarter of 2020, we made a prospective update to our presentation of adjusted EBITDA to exclude (i.e., add back) the employer portion of payroll taxes on stock-based compensation. As such, the adjusted EBITDA presented above for the three and six months endedJune 30, 2020 excludes our portion of payroll taxes on stock-based compensation from the second quarter of 2020. We have not updated any prior periods. The adjusted EBITDA presented above for the six months endedJune 30, 2020 also excludes the employer portion of payroll taxes paid in connection with the stock releases upon the expiration of the lock-up agreement related to our IPO because such payroll taxes were a one-time occurrence in the three months endedMarch 31, 2020 . The employer portion of payroll taxes on stock-based compensation was$1,555 for the three months endedMarch 31, 2020 ; as such, adjusted EBITDA would have been$18,655 for the six months endedJune 30, 2020 had this update been made on a retroactive basis back to the first quarter of 2020. (3)Acquisition-related expenses consist primarily of transaction and transition related fees and expenses, including legal, accounting, and other professional fees. (4)Other income (expense), net includes interest income, interest expense, and other (expense) income, net. Some of the limitations of adjusted EBITDA include (i) adjusted EBITDA does not properly reflect capital commitments to be paid in the future, and (ii) although depreciation and amortization are non-cash charges, the underlying assets may need to be replaced and adjusted EBITDA does not reflect these capital expenditures. Our adjusted EBITDA may not be comparable to similarly titled measures of other companies because they may not calculate adjusted EBITDA in the same manner as we calculate the measure, limiting its usefulness as a comparative measure. In evaluating adjusted EBITDA, you should be aware that in the future we will incur expenses similar to the adjustments in this presentation. Our presentation of adjusted EBITDA should not be construed as an inference that our future results will be unaffected by these expenses or any unusual or non-recurring items. When evaluating our performance, you should consider adjusted EBITDA alongside other financial performance measures, including our net loss and other GAAP results. Components of Statements of Operations The financial results of operations for the three and six months endedJune 30, 2019 in this Management's Discussion and Analysis of Financial Condition and Results of Operations reflect the effects of the revisions to reflect the adoption of ASC 606 onJanuary 1, 2019 and to correct prior period errors and the immaterial prior period misclassification as discussed in Note 2 of Part I, Item 1 of this Quarterly Report on Form 10-Q. Revenue The substantial majority of our revenue is derived from monthly subscription fees that are charged based on a per participant per month basis, which is determined based on number of active enrolled members each month. Our Livongo for Diabetes, Livongo for Prediabetes and Weight Management, and Livongo forBehavioral Health solutions incorporate the integration of devices used to monitor members' chronic conditions, supplies and services, including access to our platform. The contract term is generally one to three years, with one year auto-renewal terms. There is usually a six-month minimum enrollment period within our contracts. Many of our customers can stop their monthly recurring subscription but will be required to pay an early termination fee if the termination occurs during the minimum enrollment period. Additionally, certain of our contracts are subject to pricing adjustments based on various performance metrics including member satisfaction scores, cost savings guarantees and health outcome guarantees. In most agreements associated with our Livongo for Diabetes, Livongo for Hypertension, and Livongo for Prediabetes and Weight Management solutions, clients primarily pay monthly subscription fees based on a per participant per month model, based on the number of active enrolled members each month. In addition, clients can choose to pay an upfront amount with a lower per participant per month fee. We have determined that access to our solution is a single continuous service comprised of a series of distinct services that are substantially the same and have the same pattern of transfer (i.e. distinct days of service). These services are consumed as they are received and we recognize revenue each month using the variable consideration allocation exception. We apply this exception because we concluded that the nature of our obligations and the variability of the payment being based on the number of active members are aligned. In most agreements associated with our Livongo forBehavioral Health by myStrength solution, clients either pay a fixed upfront fee or a monthly fee based on the number of members to whom the solution is available. The contract term is generally one to three years, with one year auto-renewal terms. We have determined that access to our solution is a single continuous service comprised of a series of distinct services that are substantially the same and have the same pattern of transfer (i.e. distinct days of service). These services are consumed as they are received and we recognize revenue each month using the 43
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variable consideration allocation exception. We apply this exception because we
concluded that the nature of our obligations and the variability of the payment
terms based on the number of available members are aligned and uncertainty
related to the consideration is resolved on a monthly basis as we satisfy our
obligations. For certain arrangements where the per-member fee varies as the
number of available members changes, we estimate the expected transaction price
based on the number of expected members over the term of the arrangement.
In certain legacy arrangements, we derive revenue from the sale of our
cellular-connected weight scale and access to the Livongo for Prediabetes and
Weight Management solution through the Retrofit platform. When an agreement
contains multiple performance obligations, we allocate the transaction price to
each performance obligation based on the relative standalone selling price, or
SSP. The determination of SSP is judgmental and is based on the price an entity
charges for the same good or service, sold separately in a standalone sale, and
sold to similar clients in similar circumstances. We typically price the devices
and services within a narrow range to represent SSP. Amounts allocated to the
connected device are recognized at a point in time upon delivery of the device.
Amounts allocated to the services are recognized as the service is performed.
Although we are in the early stages of selling our newer solutions, we are
experiencing client demand to broaden their relationship with Livongo and are
seeing add-on orders as well as contracts being executed with multiple
solutions.
Our contracts are negotiated directly with the customer or through a partner. We
are the principal that controls the transfer of promised goods and services to
members with respect to the contracts originated through partners, we have
latitude in establishing pricing, and we have inventory risk. In these
situations, revenue is recognized on a gross basis and fees paid to partners are
recorded as commission expenses as a component of sales and marketing expenses.
Cost of Revenue
Cost of revenue consists of expenses that are closely correlated or directly
related to delivery of our solutions and monthly subscription fees, including
product costs, data center costs, client support costs, credit card processing
fees, allocated overhead costs, amortization of developed technology, and
amortization of deferred costs. In light of COVID-19, we continue to evaluate
changes to our supply chain to protect against current market uncertainty. For
our Livongo for Diabetes, Hypertension and Weight Management solutions, which
offer the cellular-connected devices, device costs are deferred and amortized
over the shorter of the expected member enrollment period or the expected device
life. Certain personnel expenses associated with supporting these functions,
such as salaries, bonuses, stock-based compensation expense and benefits,
including allocated overhead expenses for facilities, information technology and
depreciation expense, are included in cost of revenue. We expect cost of revenue
to increase in the foreseeable future in absolute dollars, but decrease as a
percentage of revenue over the long term.
Gross Profit and Gross Margin
Gross profit and gross margin, or gross profit as a percentage of revenue, has
been and will continue to be affected by various factors, including the timing
of our acquisition of new clients, renewals of our existing agreements, sales of
additional solutions to our existing clients, our product life cycle as we
transition into new products, our introduction of new solutions for other
chronic conditions, including the costs associated with bringing such new
solutions to market, the extent to which we expand our coaching and monitoring
features, and the extent to which we can increase the efficiency of our
technology through ongoing improvements, cost reduction, and operational
efficiency. We expect our gross margin to increase over the long term, although
it could fluctuate from period to period depending on the interplay of these and
other factors.
Operating Expenses
Our operating expenses primarily consist of sales and marketing, research and
development and general and administrative expenses. For each of these
categories, personnel costs are the most significant component, which include
salaries, bonuses, stock-based compensation expense and benefits. Operating
expenses also include overhead costs for facilities, information technology, and
depreciation expense.
As a result of stock-based compensation expense related to stock awards, we
expect our research and development, sales and marketing, and general and
administrative expenses to increase significantly in absolute dollars.
Research and Development. Our research and development expenses support our
efforts to add new features to our existing solutions and to ensure the
reliability and scalability of our existing solutions. Research and development
expenses consist of personnel expenses, including salaries, bonuses, stock-based
compensation expense and benefits for employees and
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Index to Financial Statements contractors for our engineering, product, and design teams, and allocated overhead costs. We have expensed our research and development costs as they were incurred, except those costs that have been capitalized as software development costs. We plan to hire employees for our engineering team to support our research and development efforts. We expect that research and development expenses will increase on an absolute dollar basis in the foreseeable future as we continue to increase investments in our technology architecture. However, we expect our research and development expenses to decrease as a percentage of revenue over the long term, although our research and development expenses may fluctuate as a percentage of revenue from period to period due to the timing and amount of these expenses. Sales and Marketing. Sales and marketing expenses consist of personnel expenses, sales commissions for our direct sales force and our channel partners' commission expenses, as well as communication, promotional, client conferences, public relations, other marketing events, and allocated overhead costs. Personnel expenses include salaries, bonuses, stock-based compensation expense and benefits for employees and contractors. Upon our adoption of ASC 606 effectiveJanuary 1, 2019 , incremental sales commissions and stock-based compensation associated with costs to acquire clients are amortized to sales and marketing expense over the estimated period of benefit. We intend to continue to make significant investment in our sales and marketing organization to increase our brand awareness, drive additional revenue and expand into new markets. However, we anticipate sales and marketing expenses may decrease in the near-term due to restrictions on travel, entertainment, and other events in response to the COVID-19 pandemic. Despite the impact of COVID-19, we expect our sales and marketing expenses to continue to increase in absolute dollars in the foreseeable future. However, we expect our sales and marketing expenses to decrease as a percentage of revenue over the long term, although our sales and marketing expenses may fluctuate as a percentage of revenue from period to period due to the timing and amount of these expenses. General and Administrative. General and administrative expenses consist of personnel expenses and related expenses for our executive, finance, human resources and legal organizations. In addition, general and administrative expenses include external legal, accounting and other professional fees, and allocated overhead costs. We expect our general and administrative expenses to increase in absolute dollars in the foreseeable future. However, we anticipate general and administrative expenses to decrease as a percentage of revenue over the long term, although they may fluctuate as a percentage of revenue from period to period due to the timing and amount of these expenses. In addition, we expect to incur additional general and administrative expenses as a result of operating as a public company, including expenses related to compliance with the rules and regulations of theSEC and the listing standards of Nasdaq, additional corporate and director and officer insurance expenses, greater investor relations expenses and increased legal, audit and consulting fees. 45
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Index to Financial Statements
Other Income, Net
Other income, net primarily consists of interest income earned from our cash,
cash equivalents and short-term investments.
Provision for (Benefit from) Income Taxes
The income tax provision and benefit were primarily due to state and foreign
income tax expense, and benefit related to release of the valuation allowance as
a result of our acquisitions.
Deferred tax assets are reduced by a valuation allowance to the extent
management believes it is not more likely than not to be realized. The ultimate
realization of deferred tax assets is dependent upon the generation of future
taxable income. Management makes estimates and judgments about future taxable
income based on assumptions that are consistent with our plans and estimates.
Results of Operations
The following tables set forth consolidated statements of operations for the
periods indicated and such data as a percentage of revenue for the periods
indicated:
Six Months Ended June
Three Months Ended June 30, 30,
2020 2019 2020 2019
(in thousands)
Revenue $ 91,923 $ 40,915 $ 160,745 $ 72,982
Cost of revenue(1)(2) 21,466 11,964 39,572 21,827
Gross profit 70,457 28,951 121,173 51,155
Operating expenses:
Research and development(1) 15,809 10,291 29,806 19,285
Sales and marketing(1)(2) 32,881 17,833 60,535 32,476
General and administrative(1)(3) 22,027 13,702 37,874 27,816
Change in fair value of contingent consideration 2 282 86 956
Total operating expenses 70,719 42,108 128,301 80,533
Loss from operations (262) (13,157) (7,128) (29,378)
Interest income 1,099 183 2,476 641
Interest expense (2,283) - (2,320) -
Other (expense) income, net (36) 2 (62) 6
Loss before provision for income taxes (1,482) (12,972) (7,034) (28,731)
Provision for (benefit from) income taxes 72 5 93 (1,383)
Net loss $ (1,554) $ (12,977) $ (7,127) $ (27,348)
______________(1)Includes stock-based compensation expense as follows:
Six Months Ended June
Three Months Ended June 30, 30,
2020 2019 2020 2019
(in thousands)
Cost of revenue $ 118 $ 6 $ 210 $ 12
Research and development 1,593 491 3,809 852
Sales and marketing 2,364 41 4,416 260
General and administrative 5,800 3,915 9,503 8,839
Total stock-based compensation expense $ 9,875 $
4,453
______________
(2)Includes amortization of intangible assets as follows:
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