Summary of Business and Significant Accounting Policies (Policies) 10Q

6 Months Ended

Dec. 31, 2018

Summary of Business and Significant Accounting Policies

eGain Corporation (“eGain”, the “Company”, “our”, “we” or “us”) is a leading provider of cloud-based customer engagement software with operations in the United States, United Kingdom and India. We help B2C brands operationalize digital customer engagement strategy. Our suite includes rich applications for digital interaction, knowledge management, and AI-based process guidance. We also provide advanced, integrated analytics for contact centers and digital properties to holistically measure, manage, and optimize resources. We believe the benefits of our products include reduced customer effort, customer satisfaction, connected service processes, converted upsell opportunities, and improved compliance—across mobile, social, web, and phone. Hundreds of global enterprises rely on eGain to transform fragmented customer service systems into unified Customer Engagement Hubs.

Fiscal Year

Our fiscal year ends on June 30. References to fiscal year 2019 refer to fiscal year ending June 30, 2019.

Basis of Presentation

The accompanying condensed consolidated balance sheets as of December 31, 2018 and June 30, 2018 and the condensed consolidated statements of operations, comprehensive income (loss) and cash flows for the three and six months ended December 31, 2018 and 2017, respectively, were unaudited.

We prepared the condensed consolidated financial statements pursuant to the rules and regulations of the Securities and Exchange Commission (SEC) and included the accounts of our wholly-owned subsidiaries. All significant intercompany balances and transactions have been eliminated. Certain information and footnote disclosures, normally included in consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America (GAAP), have been condensed or omitted pursuant to such rules and regulations although we believe that the disclosures made are adequate to make the information not misleading. In our opinion, the unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of our financial position, results of operations and cash flows for the periods presented.

These condensed consolidated financial statements and notes should be read in conjunction with our audited consolidated financial statements and accompanying notes for the fiscal year ended June 30, 2018, included in our Annual Report on Form 10-K. The condensed consolidated balance sheet as of June 30, 2018 was derived from audited consolidated financial statements as of that date but does not include all the information and footnotes required by GAAP for complete financial statements. The results of our operations for the interim periods presented are not necessarily indicative of results that may be expected for any other interim period or for the full fiscal year ending June 30, 2019.

We adopted Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606), as of July 1, 2018. In addition, we adjusted the presentation of our condensed consolidated statements of operations in connection with our business model. Through June 30, 2018, our revenue was classified as recurring, legacy license and professional services revenue. In connection with our adoption of Topic 606 as of July 1, 2018, we classify our revenue as subscription and professional services revenue. Our legacy license revenue, which has been declining related to our focus on cloud offerings, is included with subscription revenue. Fiscal periods prior to adoption were adjusted to conform to current period presentation.

Use of Estimates

The preparation of financial statements requires us to make estimates and assumptions in the condensed consolidated financial statements and accompanying notes. Actual results could differ significantly from estimates. We make estimates that we believe to be reasonable based on historical experience and other assumptions. Significant estimates and assumptions made by management include the following:

Standalone selling price (SSP) of performance obligations for contracts with multiple performance obligations;

Estimate of variable consideration for performance obligations in connection with the adoption of Topic 606;

Period of benefit associated with capitalized costs to obtain revenue contracts;

Valuation, measurement and recognition of current and deferred income taxes;

Fair value of stock-based awards; and

Useful lives of intangible assets.

Recent Accounting Pronouncements

Pronouncements Not Yet Adopted

In August 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2018-15, Intangibles—Goodwill and Other—Internal-Use Software (Subtopic 350-40). This update requires a customer in a cloud computing service arrangement to follow the internal-use software guidance to determine which implementation costs to recognize and defer as an asset. This update is effective for fiscal years beginning after December 15, 2019 (our fiscal 2020). We are currently evaluating the impact of this update on our consolidated financial statements and related disclosures.

In June 2018, the FASB issued ASU 2018-07, Compensation —Stock Compensation (Topic 718) —Improvements to Nonemployee Share-Based Payment Accounting. This update expands the scope of Topic 718, Compensation—Stock Compensation, to include share-based awards granted to non-employees in exchange for goods or services. The accounting for employees and non-employees will be substantially aligned. This update is effective for fiscal years beginning after December 15, 2018 (our fiscal 2020) and interim periods within those fiscal years. We are currently evaluating the impact of this update on our consolidated financial statements and related disclosures.

In February 2018, the FASB issued ASU 2018-02, Income Statement-Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. This update provides the option to reclassify tax effects to retained earnings relating to items in accumulated other comprehensive income that the FASB refers to as having been stranded in accumulated other comprehensive income as a result of the U.S. Tax Act. This update is effective for fiscal years beginning after December 15, 2018 (our fiscal 2020), and interim periods within those fiscal years. Early adoption is permitted. We are currently evaluating the impact of this new standard on our consolidated financial statements and related disclosures.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which requires that we recognize lease assets and liabilities on the balance sheet. This standard is effective for annual periods beginning after December 15, 2018 (our fiscal 2020), and interim periods within those annual periods. Early adoption is permitted provided ASC 606, Revenue Recognition, has been adopted. We are currently evaluating the impact of this update on our consolidated financial statements and related disclosures.

In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which provides an alternative transition method by allowing companies to initially apply the new leases guidance at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. We are currently evaluating the impact of this update on our consolidated financial statements and related disclosures.

Pronouncements Recently Adopted

In May 2017, the FASB issued ASU 2017-09, Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting, which provides guidance about which changes to the terms or conditions of a shared-based payment award require an entity to apply modification accounting in Topic 718. ASU 2017-09 is effective for annual reporting periods beginning after December 15, 2017 (our fiscal 2019), including interim reporting periods within those annual reporting periods. We adopted this guidance in connection with the adoption of ASC 606 as of our first quarter of fiscal year 2019 with no impact on our financial statements.

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, which provides specific guidance on how to classify restricted cash. ASU 2016-18 is effective for annual reporting periods beginning after December 15, 2017 (our fiscal 2019), including interim reporting periods within those annual reporting periods. We adopted this guidance as of our first quarter of fiscal year 2019 with no impact on our financial statements.

In October 2016, the FASB issued ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory, which provides that an entity should recognize the income tax consequences of an intra-entity transfer of an asset other than inventory when the transfer occurs. ASU 2016-16 is effective for annual reporting periods beginning after December 15, 2017 (our fiscal 2019), including interim reporting periods within those annual reporting periods. We adopted this guidance as of our first quarter of fiscal year 2019 with no significant impact to our financial results.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments, to address diversity in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments should be applied using a retrospective transition method to each period presented. If it is impracticable to apply the amendments retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date practicable. ASU 2016-15 is effective for fiscal years beginning after December 15, 2017 (our fiscal 2019), and interim periods within those fiscal years. We adopted this guidance as of our first quarter of fiscal year 2019 with no significant impact to our financial results.

Revenue from Contracts with Customers

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements under Revenue Recognition (Topic 605). The standard requires increased disclosures including the nature, amount, timing, and any uncertainty of revenues and cash flows related to customer contracts. Topic 606 includes Subtopic 340-40, Other Assets and Deferred Costs - Contracts with Customers, which requires the deferral of incremental costs of obtaining a contract with a customer. We refer to Topic 606 and Subtopic 340-40 as Topic 606, collectively, for purposes of disclosure and discussion in this filing.

We adopted Topic 606 using the modified retrospective method with a cumulative decrease of $3.8 million to our opening balance of our accumulated deficit as of July 1, 2018 in our first quarter of fiscal year 2019.

Under Topic 606, or ASC 606, revenue is recognized when a customer under a contract obtains control of promised goods and services at an amount that reflects consideration that is expected to be received in exchange for those goods and services. The new revenue recognition standard requires that we apply a five-step approach for recognizing revenue which includes (i) identifying the contract with a customer; (ii) identifying the performance obligations in the contract; (iii) determining the transaction price; (iv) allocating the transaction price to the performance obligations in the contract on a relative SSP; and (v) recognizing revenue when, or as, we satisfy each performance obligation in the contract typically through delivery or when control is transferred to the customer.

The adoption of Topic 606 did not significantly impact the revenue recognition of our cloud delivery arrangements, our maintenance and support arrangements, and our time and materials-based professional services. Additionally, our estimate of SSP remains consistent with our estimate of best estimated selling price (BESP) under Topic 605. When we determine the transaction price in an arrangement, we include estimates of variable consideration such as usage-based surcharges and potential refunds or credits for service level credits, volume rebates, and tenure discounts.

Revenue recognition under Topic 606 impacted our on-premise offerings that do not incorporate substantial cloud functionality. Under Topic 605, licenses that were sold with undelivered elements but without vendor-specific objective evidence (VSOE) were recognized ratably over the term of the undelivered elements. Under Topic 606, the requirement to establish VSOE for undelivered elements was eliminated. Therefore, we recognize a portion of the sales price upon delivery of the software. To the extent that amounts recognized as revenue have not been billed, the corresponding amounts are recorded as unbilled receivables and are classified in accounts receivable.

Under Topic 606, the transaction price is allocated to various performance obligations based on their stand-alone selling prices. Revenue allocated to each performance obligation is recognized as work is performed. Our consulting and implementation service contracts are bid either on a time-and-materials basis or on a fixed-fee basis. Fixed fees are generally paid upon acceptance at pre-determined points in the contract. Under Topic 605, we had recognized revenue when we met acceptance clauses.

With respect to professional services revenue, when professional service arrangements include acceptance clauses, we factor this in the estimated transaction price if they are probable of being achieved. Additionally, we recognize the transaction price allocated to professional services over time as the services are provided as compared to the time that the milestone was achieve under prior guidance.

We used the following transitional practical expedients and exemptions in the adoption of Topic 606:

The option to recognize revenue upon invoicing amounts that correspond directly with the value to the customer of performance completed to date which primarily includes professional service arrangements entered on a time and materials basis;

At adoption, the election to reflect the aggregate effect of all modifications occurring before adoption when (i) identifying the satisfied and unsatisfied performance obligations; (ii) determining the transaction price; and (iii) allocating the transaction price of the arrangement to the satisfied and unsatisfied performance obligations;

The optional exemption to not disclose the remaining transaction price for short-term contracts less than one year and contracts where the right to invoice method is used. Contracts that fall under these exemptions relate to short-term professional services and would be expected to be completed, on average, within the next three to six months;

At adoption, the election to use the practical expedient to disregard the effect of the time value of money in a significant financing component when its payment terms are less than one year. These contract advances are liquidated when revenue is recognized; and

The option to expense the cost of obtaining a contract when the amortization period is less than one year.

Costs Capitalized to Obtain Revenue Contracts

Under Topic 606, we capitalize incremental costs to obtain non-cancelable subscription and maintenance and support revenue contracts with amortization periods that may extend longer than the non-cancelable subscription and maintenance and support revenue contract terms.

We capitalize incremental costs of obtaining a non-cancelable subscription and maintenance and support revenue contract with amortization periods of one year or more. The capitalized amounts consist primarily of sales commissions paid to our direct sales force. Capitalized amounts also include (i) amounts paid to employees other than the direct sales force who earn incentive payouts under annual compensation plans that are tied to the value of contracts acquired; (ii) commissions paid to employees upon renewals of subscription and support; and (iii) the associated payroll taxes and fringe benefit costs associated with the payments to our employees.

Costs capitalized related to new revenue contracts are generally deferred and amortized on a straight-line basis over a period of benefit that we estimate to be five years. We determine the period of benefit by taking into consideration the historical and expected durations of our customer contracts and the expected useful lives of our technology among other factors. Amortization of costs capitalized related to new revenue contracts is included as a component of sales and marketing expense in our operating results. Under Topic 605, we capitalized only commissions earned on initial software and support sales which were amortized ratably over the initial contract period averaging two years.

Deferred Revenue

Deferred revenue primarily consists of payments received or invoiced in advance of revenue recognition from cloud delivery arrangements, term licenses and embedded OEM royalties and associated support. Deferred revenue is recognized as revenue once revenue recognition criteria is met. We generally invoice our customers in annual installments. The deferred revenue balance does not represent the total transaction price of our non-cancelable cloud delivery and support arrangements.

Prior to adopting Topic 606, we netted down our accounts receivable and deferred revenue for amounts that were invoiced but not collected. We no longer net down our accounts receivable and deferred revenue with the adoption of Topic 606 related to contractual amounts in our arrangements. Deferred revenue that is expected to be recognized within one year and beyond one year is classified as current and noncurrent deferred revenue, respectively.

Financial Impact from Initial Adoption

The following table shows cumulative adjustments included in our condensed consolidated opening balance sheet as of July 1, 2018 related to the adoption of Topic 606 (in thousands):


	Balance as of June 30, 2018 ($)		Impact as of July 1, 2018 ($)		Balance as of July 1, 2018 ($)
Balance sheet captions:
Accounts receivable, net		7,389		14,824		22,213
Costs capitalized to obtain revenue contracts, net		986		(395)		591
Costs capitalized to obtain revenue contracts, net of current portion		891		933		1,824
Accrued liabilities		2,285		60		2,345
Deferred revenue		18,364		11,700		30,064
Deferred revenue, net of current portion		7,833		(422)		7,411
Accumulated deficit		(353,260)		3,816		(349,444)

Financial Impact after Initial Adoption

The following table shows cumulative adjustments included in our condensed consolidated balance sheet as of December 31, 2018 related to the adoption of Topic 606 (in thousands):


	December 31, 2018
	Reported under Topic 606 ($)		Topic 606 Impact ($)		Excluding Topic 606 Impact ($)
Balance sheet captions:
Accounts receivable, net		16,178		(9,036)		7,142
Costs capitalized to obtain revenue contracts, net		682		315		997
Costs capitalized to obtain revenue contracts, net of current portion		1,904		(1,137)		767
Deferred revenue		28,836		(61)		28,775
Deferred revenue, net of current portion		6,136		(4,628)		1,508
Accumulated deficit		(346,840)		3,816		(343,024)

The following table presents the financial impact between guidance under Topic 605 and newly adopted guidance under Topic 606 during the three months ended December 31, 2018 (in thousands):


	Three Months Ended December 31, 2018
	Reported under Topic 606 ($)		Topic 606 Impact ($)		Excluding Topic 606 Impact ($)
Income statement captions:
Subscription revenue		15,823		(422)		15,401
Professional services revenue		1,881		(603)		1,278
Total revenue		17,704		(1,025)		16,679
Gross profit		12,162		(1,025)		11,137
Total operating expenses		10,033		171		10,204
Net income (loss)		2,000		(1,196)		804

The following table presents the financial impact between guidance under Topic 605 and newly adopted guidance under Topic 606 during the six months ended December 31, 2018 (in thousands):


	Six Months Ended December 31, 2018
	Reported under Topic 606 ($)		Topic 606 Impact ($)		Excluding Topic 606 Impact ($)
Income statement captions:
Subscription revenue		29,550		(29)		29,521
Professional services revenue		3,855		(806)		3,049
Total revenue		33,405		(835)		32,570
Gross profit		22,628		(835)		21,793
Total operating expenses		19,746		292		20,038
Net income (loss)		2,604		(1,127)		1,477

Revenue Recognition

Revenue Recognition Policy

Our revenue is comprised of two categories including subscription and professional services. Subscription includes SaaS revenue and legacy support revenue. SaaS includes revenue from cloud delivery arrangements, term licenses and embedded OEM royalties and associated support. Legacy support is revenue associated with support contracts on perpetual license arrangements that we no longer sell. Professional services includes consulting, implementation and training.

Significant Judgment Applied in the Determination of Revenue Recognition

We enter into contractual arrangements with customers that may include promises to transfer multiple services, such as subscription, support and professional services. With respect to our business, a performance obligation is a promise to transfer a service to a customer that is distinct. Significant judgment is required to determine whether services are distinct performance obligations that should be accounted for separately or combined as one unit of accounting. Additionally, significant judgment is required to determine the timing of revenue recognition.

We allocate the transaction price to each performance obligation on a relative standalone selling price. The SSP is the price that we would sell a promised service separately to one of our customers. Judgment is required to determine the SSP for each distinct performance obligation.

We determine the SSP by considering our pricing objectives in relation to market demand. Consideration is placed based on our history of discounting prices, size and volume of transactions involved, customer demographics and geographic locations, price lists, contract prices and our market strategy.

Determination of Revenue Recognition

Under Topic 606, we recognize revenue upon the transfer of control of promised services to our customers in the amount that is commensurate with the consideration that we expect to receive in exchange for those services. If consideration includes a variable amount in the arrangement, such as service level credits or contingent fees, then we include an estimate of the amount that we expect to receive for the total transaction price.

The amount of revenue that we recognize is based on (i) identifying the contract with a customer; (ii) identifying the performance obligations in the contract; (iii) determining the transaction price; (iv) allocating the transaction price to the performance obligations in the contract on a relative SSP basis; and (v) recognizing revenue when, or as, we satisfy each performance obligation in the contract typically through delivery or when control is transferred to the customer.

Subscription Revenue

The following customer arrangements are recognized ratably over the contract term as the performance obligations are delivered:

Cloud delivery arrangements;

Maintenance and support arrangements; and

Term license subscriptions which incorporate on-premise software licenses and substantial cloud functionality that are not distinct in the context of our arrangements as such are considered highly interrelated and represent a single combined performance obligation.

For contracts involving distinct software licenses, the license performance obligation is satisfied at a point in time when control is transferred to the customer.

We typically invoice our customers in advance upon execution of the contract or subsequent renewals with payment terms between 30 and 45 days. Invoiced amounts are recorded in accounts receivable, deferred revenue or revenue, depending if control transferred to our customers based on each arrangement.

The Company has a royalty revenue agreement with a customer related to the Company’s embedded intellectual property. Under the terms of the agreement, the customer is to remit a percentage of sales to the Company. These embedded OEM royalties are included as subscription revenue. Under Topic 606 revenue guidance, since these arrangements are for sales-based licenses of intellectual property, for which the guidance in paragraph ASC 606-10-55-65 applies, the Company recognizes revenue only as the subsequent sale occurs. However, the Company notes that such sales are reported by the customer with a quarter in arrears, such revenue is recognized at the time it is reported and paid by the customer given that any estimated variable consideration would have to be fully constrained due to the unpredictability of such estimate and the unavoidable risk that it may lead to significant revenue reversals.

Professional Services Revenue

Professional services revenue includes system implementation, consulting and training. The transaction price is allocated to various performance obligations based on their stand-alone selling prices. Revenue allocated to each performance obligation is recognized as work is performed. Our consulting and implementation service contracts are bid either on a time-and-materials basis or on a fixed-fee basis. Fixed fees are generally paid upon milestone billing or acceptance at pre-determined points in the contract. Amounts that have been invoiced are recorded in accounts receivable and in unearned revenue or revenue, depending on whether transfer of control to customers has occurred.

Training revenue that meets the criteria to be accounted for separately is recognized when training is provided.

Segment Information

We operate in one segment: the development, license, implementation and support of our customer interaction software solutions. Operating segments are identified as components of an enterprise for which discrete financial information is available and regularly reviewed by the Company’s chief operating decision-makers in order to make decisions about resources to be allocated to the segment and assess its performance. Our chief operating decision-makers, under Accounting Standards Codification (ASC) 280, Segment Reporting, are our executive management team. Our chief operating decision-makers review financial information presented on a consolidated basis for purposes of making operating decisions and assessing financial performance. The Company operates in one operating segment and all required financial segment information can be found in the condensed consolidated financial statements.

Our sales are derived from North America and EMEA. However, we incur operating expenses in the North America, EMEA and APAC regions. Revenue by geography is generally determined on the region of our contracting entity rather than the region of our customer. Information relating to our geographic areas for the three and six months ended December 31, 2018 and 2017 is as follows (unaudited, in thousands):


	Three Months Ended				Six Months Ended
	December 31,				December 31,
	2018		2017		2018		2017
Revenue:
North America	$	10,065	$	8,683	$	18,540	$	16,122
EMEA		7,639		6,715		14,865		13,851
Total revenue	$	17,704	$	15,398	$	33,405	$	29,973
Income (loss) from operations:
North America	$	964	$	(1,401)	$	949	$	(1,218)
EMEA		2,405		2,355		4,361		3,062
Asia Pacific		(1,240)		(1,350)		(2,428)		(2,494)
Income (loss) from operations	$	2,129	$	(396)	$	2,882	$	(650)

In addition, long-lived assets corresponding to our geographic areas are as follows (unaudited, in thousands):


	December 31,		June 30,
	2018		2018
Long-lived Assets:
North America	$	195	$	210
EMEA		130		245
Asia Pacific		143		104
Long-lived Assets	$	468	$	559

Concentration Risk Credit Risk

Concentration of Credit Risk and Significant Customers

Our financial instruments that are exposed to concentrations of credit risk include cash and cash equivalents and accounts receivable. We maintain an allowance for doubtful accounts which is based on historical losses and the number of days past due for collection. Receivables are written off against the allowance when we have exhausted collection efforts without success. For the three and six months ended December 31, 2018, one customer accounted for 17% and 16% of revenue, respectively. For the three and six months ended December 31, 2017, one customer accounted for 15% of revenue.

Accounts Receivable and Allowance for Doubtful Accounts

We extend unsecured credit to our customers on a regular basis. Our accounts receivable are derived from revenue earned from customers and are not interest bearing. We also maintain an allowance for doubtful accounts to reserve for potential uncollectible trade receivables. We review our trade receivables by aging category to identify specific customers with known disputes or collectability issues. We exercise judgment when determining the adequacy of these reserves as we evaluate historical bad debt trends, general economic conditions in the U.S. and internationally, and changes in customer financial conditions. If we made different judgments or utilized different estimates, material differences may result in additional reserves for trade receivables, which would be reflected by charges in general and administrative expenses for any period presented. We write off a receivable after collection efforts have been exhausted and the amount is deemed uncollectible.

Deferred Financing Costs

Costs relating to obtaining the credit agreement with Wells Fargo Bank, National Association (Wells Fargo) are capitalized and amortized over the term of the related debt using the effective interest method. As of December 31, 2018 and June 30, 2018, deferred financing costs were each $981,000, and accumulated amortization was $898,000 and $740,000, respectively. Deferred financing costs are included net of bank borrowings in the accompanying condensed consolidated balance sheets. Amortization of deferred financing costs recorded as interest expense was $158,000 and $108,000 for the six months ended December 31, 2018 and 2017, respectively. When a loan is paid in full, any unamortized financing costs are removed from the related accounts and charged to operations as interest expense.

Stock-Based Compensation

We account for stock-based compensation in accordance with ASC 718, Compensation—Stock Compensation. Under the fair value recognition provisions of ASC 718, stock-based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period. Stock-based compensation expense consists of expenses for stock options and employee stock purchase plan, or ESPP.

The ESPP provides that eligible employees may purchase the Company’s common stock through payroll deductions at a price equal to 85% of the lower of the fair market value at the entry date of the applicable offering period or at the end of each applicable purchasing period. The offering period, meaning a period with respect to which the right to purchase shares of Stock may be granted under the Plan, will not exceed twenty-seven months and consist of a series of six-month purchase periods. Eligible employees may join the ESPP at the beginning of any six-month purchase period. Under the terms of the ESPP, employees can choose to have between 1% and 15% of their base earnings withheld to purchase the Company’s common stock.

Determining the fair value of the stock-based awards at the grant date requires significant judgment and the use of estimates, particularly surrounding Black-Scholes valuation assumptions such as stock price volatility and expected option term.

Below is a summary of stock-based compensation included in the costs and expenses (unaudited, in thousands):


	Three Months Ended				Six Months Ended
	December 31,				December 31,
	2018		2017		2018		2017
Stock-Based Compensation Expense:
Cost of revenue	$	70	$	146	$	144	$	209
Research and development		108		275		224		385
Sales and marketing		54		129		100		192
General and administrative		104		186		230		269
Total stock-based compensation expense	$	336	$	736	$	698	$	1,055

Total stock-based compensation includes expense related to non-employee awards of $27,000 and $48,000 during the three and six months ended December 31, 2018, respectively. Total stock-based compensation includes expense related to non-employee awards of $12,000 and $26,000 during the three and six months ended December 31, 2017, respectively.

Total stock-based compensation includes expense related to the ESPP of $33,000 during the three and six months ended December 31, 2018. There was no expense related to the ESPP during the three or six months ended December 31, 2017.

We utilized the Black-Scholes valuation model for estimating the fair value of the stock-based compensation of options granted. All shares of our common stock issued pursuant to our stock option plans are only issued out of an authorized reserve of shares of common stock which were previously registered with the SEC on a Registration Statement on Form S-8.

On September 19, 2017, our board of directors approved a repricing to $2.50 per share of certain outstanding options under our 2005 Stock Incentive Plan held by employees who are not executive officers or directors of the Company. The repricing applied to options held by such employees with an exercise price greater than $2.50 per share which was the closing stock price as reported on Nasdaq on September 19, 2017.

In accordance with ASC 718, as applicable to the repricing on September 19, 2017, a modification to the price of an option should be treated as an exchange of the original option for a new option. The calculation of the incremental value associated with the new option is based on the excess of the fair value of the modified option based on current assumptions over the fair value of the original option measured immediately before its price is modified based on current assumptions. As of December 31, 2017, we finalized our accounting estimates related to the repricing. Total incremental stock-based compensation expense was $445,000. We recognized $0 and $373,000 in incremental stock-based compensation during the three months ended December 31, 2018 and 2017, respectively. We recognized $3,000 and $414,000 in incremental stock-based compensation expense during the six months ended December 31, 2018 and 2017, respectively. Unrecognized incremental stock-based compensation expense was $8,000 and $31,000 as of December 31, 2018 and 2017, respectively.

During the three months ended December 31, 2018 and 2017, we granted options to purchase 122,400 and 357,400 shares of common stock with a weighted-average fair value of $3.94 and $1.16 per share, respectively.

During the six months ended December 31, 2018 and 2017, we granted options to purchase 213,250 and 1,472,541 shares of common stock with a weighted-average fair value of $5.29 and $1.26 per share, respectively.

In connection with the repricing and finalizing our estimates as of December 31, 2017, we repriced options to purchase 804,172 shares of common stock which were previously granted between May 2011 and September 2016, with a weighted-average fair value of $1.19 per share.

We used the following assumptions:


	Three Months Ended				Six Months Ended
	December 31,				December 31,
	2018		2017		2018		2017
Expected volatility	68	%	59	%	66	%	57	%
Average risk-free interest rate	2.88	%	2.07	%	2.85	%	1.88	%
Expected life (in years)	4.39		4.36		4.34		4.51
Dividend yield	—		—		—		—

The dividend yield of zero is based on the fact that we have never paid cash dividends and have no present intention to pay cash dividends. We determined the appropriate measure of expected volatility by reviewing historic volatility in the share price of our common stock, as adjusted for certain events that management deemed to be non-recurring and non-indicative of future events. The risk-free interest rate is derived from the average U.S. Treasury Strips rate with maturities approximating the expected lives of the awards during the period, which approximate the rate in effect at the time of the grant.

The fair value of the ESPP stock-based expense for the three and six months ended December 31, 2018 were estimated using the following weighted-average assumptions:


	Three and Six Months Ended
	December 31, 2018
Expected term (in years)		0.47
Volatility		90	%
Expected dividend		—
Risk-free interest rate		2.54	%
Estimated forfeiture rate		—
Wieghted average grant date fair value	$	2.82

During the three and six months ended December 31, 2018, ESPP purchase rights of 94,805 were granted and compensation expense related to those purchase rights but not yet recognized was approximately $235,000. During the three and six months ended December 31, 2018, no ESPP shares were issued. As of December 31, 2018, there were 400,000 ESPP shares available for issuance under the Plan.

We base our estimate of expected life of a stock option on the historical exercise behavior and cancellations of all past option grants made by the Company during the time period which its equity shares have been publicly traded, the contractual term of the option, the vesting period and the expected remaining term of the outstanding options.

In accordance with ASU 2016-09, Compensation—Stock Compensation: Improvements to Employee Share-Based Accounting, we elected to continue to estimate forfeitures in the calculation of stock-based compensation expense.

Total compensation cost, net of forfeitures, of all options granted but not yet vested as of December 31, 2018 was $1.7 million, which is expected to be recognized over the weighted-average period of 1.47 years. There were 14,967 and 34,899 options exercised during the three months ended December 31, 2018 and 2017, respectively. There were 216,253 and 138,049 options exercised during the six months ended December 31, 2018 and 2017, respectively.

Leases

The Company categorizes leases at their inception as either capital or operating leases in accordance with ASC 840, Leases. When any one of the four test criteria in ASC 840 is met, the lease then qualifies as a capital lease.

Capital leases are capitalized at the lower of the net present value of the total amount payable under the leasing agreement (excluding finance charges) or the fair market value of the leased asset. Capital lease assets are depreciated on a straight-line basis, over a period consistent with our normal depreciation policy for tangible fixed assets, but not exceeding the lease term. Interest charges are expensed over the period of the lease in relation to the carrying value of the capital lease obligation.

Rent expense for operating leases, which may include free rent or fixed escalation amounts in addition to minimum lease payments, is recognized on a straight-line basis over the duration of each lease term.