Alarm.com
Alarm.com Holdings, Inc. (Form: 10-Q, Received: 11/09/2017 06:07:18)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2017
OR
¨  TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-37461
 
ADCLOGOHORIZONTALA03.JPG
ALARM.COM HOLDINGS, INC.

(Exact name of registrant as specified in its charter)
 
 
Delaware
 
26-4247032
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
8281 Greensboro Drive, Suite 100, Tysons, Virginia
 
22102
(Address of principal executive offices)
 
(zip code)

Tel: (877) 389-4033
(Registrant's telephone number, including area code)
 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes ¨ No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes ¨ No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
¨
 
Accelerated filer
þ
Non-accelerated filer
¨ (Do not check if a smaller reporting company)
Smaller reporting company
¨
 
Emerging growth company
þ

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.     þ

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    ¨ Yes þ  No  

As of November 1, 2017 , there were 47,140,413 outstanding shares of the registrant's common stock, par value $0.01 per share.
 




ALARM.COM HOLDINGS, INC.

Table of Contents
 
Page


1


PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS (unaudited)

ALARM.COM HOLDINGS, INC.
Condensed Consolidated Statements of Operations
(in thousands, except share and per share data)
(unaudited)
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2017
 
2016
 
2017
 
2016
Revenue:
 
 
 
 
 
 
 
SaaS and license revenue
$
61,924

 
$
44,630

 
$
171,078

 
$
126,652

Hardware and other revenue
28,038

 
23,216

 
79,066

 
64,660

Total revenue
89,962

 
67,846

 
250,144

 
191,312

Cost of revenue (1) :
 
 
 
 
 
 
 
Cost of SaaS and license revenue
9,545

 
7,787

 
26,137

 
21,779

Cost of hardware and other revenue
22,288

 
18,579

 
62,166

 
50,886

Total cost of revenue
31,833

 
26,366

 
88,303

 
72,665

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
10,426

 
10,705

 
32,639

 
29,532

General and administrative
12,974

 
14,804

 
41,799

 
42,124

Research and development
19,257

 
11,477

 
53,840

 
32,224

Amortization and depreciation
5,071

 
1,659

 
12,781

 
4,863

Total operating expenses
47,728

 
38,645

 
141,059

 
108,743

Operating income
10,401

 
2,835

 
20,782

 
9,904

Interest expense
(658
)
 
(49
)
 
(1,548
)
 
(137
)
Other income, net
342

 
139

 
716

 
338

Income before income taxes
10,085

 
2,925

 
19,950

 
10,105

(Benefit from) / provision f or income taxes
(5,018
)
 
358

 
(8,981
)
 
2,927

Net income
15,103

 
2,567

 
28,931

 
7,178

Income allocated to participating securities
(6
)
 
(3
)
 
(14
)
 
(10
)
Net income attributable to common stockholders
$
15,097

 
$
2,564

 
$
28,917

 
$
7,168

 
 
 
 
 
 
 
 
Per share information attributable to common stockholders:
 
 
 
 
 
 
 
Net income per share:
 
 
 
 
 
 
 
Basic
$
0.32

 
$
0.06

 
$
0.62

 
$
0.16

Diluted
$
0.31

 
$
0.05

 
$
0.59

 
$
0.15

Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
46,886,345

 
45,716,961

 
46,520,469

 
45,615,399

Diluted
49,259,701

 
48,319,952

 
49,074,279

 
47,741,365

_______________
(1)
Exclusive of amortization and depreciation shown in operating expenses below.


See accompanying notes to the condensed consolidated financial statements.

2


ALARM.COM HOLDINGS, INC.
Condensed Consolidated Balance Sheets
(in thousands, except share and per share data)
(unaudited)
 
September 30,
2017
 
December 31, 2016
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
84,640

 
$
140,634

Accounts receivable, net
41,201

 
29,810

Inventory
13,617

 
10,543

Other current assets
15,777

 
9,197

Total current assets
155,235

 
190,184

Property and equipment, net
23,399

 
20,180

Intangible assets, net
97,863

 
4,568

Goodwill
63,591

 
24,723

Deferred tax assets
27,273

 
16,752

Other assets
7,297

 
4,838

Total Assets
$
374,658

 
$
261,245

Liabilities and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable, accrued expenses and other current liabilities
$
35,157

 
$
28,300

Accrued compensation
10,857

 
8,814

Deferred revenue
3,115

 
2,585

Total current liabilities
49,129

 
39,699

Deferred revenue
9,587

 
10,040

Long-term debt
72,000

 
6,700

Other liabilities
14,028

 
13,557

Total Liabilities
144,744

 
69,996

Commitments and contingencies (Note 11)

 

Stockholders’ equity
 
 
 
Preferred stock, $0.001 par value, 10,000,000 shares authorized; 0 shares issued and outstanding as of September 30, 2017 and December 31, 2 016.

 

Common stock, $0.01 par value, 300,000,000 shares authorized; 47,147,364 and 46,172,318 shares issued; and 47,130,456 and 46,142,483 shares outstanding as of September 30, 2017 and December 31, 2 016.
471

 
461

Additional paid-in capital
318,440

 
308,697

Accumulated deficit
(88,997
)
 
(117,909
)
Total Stockholders’ Equity
229,914

 
191,249

Total Liabilities and Stockholders’ Equity
$
374,658

 
$
261,245



See accompanying notes to the condensed consolidated financial statements.

3


ALARM.COM HOLDINGS, INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)
 
Nine Months Ended 
 September 30,
Cash flows from operating activities:
2017
 
2016
Net income
$
28,931

 
$
7,178

Adjustments to reconcile net income to net cash from operating activities:
 
 
 
Provision for doubtful accounts
(360
)
 
415

Reserve for product returns
1,732

 
1,537

Amortization for patents and tooling
817

 
550

Amortization and depreciation
12,781

 
4,863

Amortization of debt issuance costs
70

 
79

Deferred income taxes
(6,360
)
 
385

Change in fair value of contingent liability

 
(226
)
Undistributed losses from equity investee
120

 
60

Stock-based compensation
5,134

 
2,880

Changes in operating assets and liabilities (net of business acquisitions):
 
 
 
Accounts receivable
(1,342
)
 
(9,337
)
Inventory
(2,775
)
 
(5,030
)
Other assets
(8,122
)
 
(3,056
)
Accounts payable, accrued expenses and other current liabilities
7,975

 
9,302

Deferred revenue
(493
)
 
130

Other liabilities
437

 
1,801

Cash flows from operating activities
38,545

 
11,531

Cash flows used in investing activities:
 
 
 
Business acquisitions, net of cash acquired
(154,289
)
 

Additions to property and equipment
(7,652
)
 
(6,110
)
Investment in cost method investee
(42
)
 
(139
)
Issuances of notes receivable
(5,000
)
 
(73
)
Receipt of payment on notes receivable
4,000

 
2,441

Purchases of licenses to patents

 
(1,600
)
Cash flows used in investing activities
(162,983
)
 
(5,481
)
Cash flows from financing activities:
 
 
 
Proceeds from credit facility
67,000

 

Repayments of credit facility
(1,700
)
 

Payments of debt issuance costs

 
(131
)
Payments of long-term consideration for business acquisitions

 
(417
)
Repurchases of common stock
(9
)
 
(12
)
Issuances of common stock from equity-based plans
3,153

 
1,202

Cash flows from financing activities
68,444

 
642

Net (decrease) / increase in cash and cash equivalents
(55,994
)
 
6,692

Cash and cash equivalents at beginning of the period
140,634

 
128,358

Cash and cash equivalents at end of the period
$
84,640

 
$
135,050


4


ALARM.COM HOLDINGS, INC.
Condensed Consolidated Statements of Cash Flows - Continued
(in thousands)
(unaudited)
 
Nine Months Ended 
 September 30,
Supplemental disclosure of noncash investing and financing activities:
2017
 
2016
 Assumed options from business acquisition
$
1,375

 
$

Contingent liability from business acquisition
$

 
$
5

Cash not yet paid for capital expenditures
$
909

 
$
359


See accompanying notes to the condensed consolidated financial statements.

5


ALARM.COM HOLDINGS, INC.
Condensed Consolidated Statement of Equity
(in thousands)
(unaudited)
 
Preferred Stock
 
Common Stock
 
Additional
Paid-In
Capital
 
Accumulated
Deficit
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
Shares
 
Amount
 
Balance as of January 1, 2017

 
$

 
46,142

 
$
461

 
$
308,697

 
$
(117,909
)
 
$
191,249

Adoption of accounting standard on employee share-based payments

 

 

 

 
31

 
(19
)
 
12

Common stock issued in connection with equity-based plans

 

 
976

 
10

 
3,143

 

 
3,153

Vesting of common stock subject to repurchase

 

 
12

 

 
60

 

 
60

Stock-based compensation

 

 

 

 
5,134

 

 
5,134

Stock options assumed from acquisition

 

 

 

 
1,375

 

 
1,375

Net income

 

 

 

 

 
28,931

 
28,931

Balance as of September 30, 2017

 
$

 
47,130

 
$
471

 
$
318,440

 
$
(88,997
)
 
$
229,914



See accompanying notes to the condensed consolidated financial statements.


























6


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements
September 30, 2017 and 2016
(unaudited)

Note 1. Organization

Organization

Alarm.com Holdings, Inc. (referred to herein as Alarm.com, the Company, or we) is the leading platform for the intelligently connected property. We offer a comprehensive suite of cloud-based solutions for the smart home and business, including interactive security, video monitoring, intelligent automation and energy management. Millions of property owners rely on our technology to intelligently secure, monitor and manage their homes and businesses. Our solutions are delivered through an established network of over 6,000 trusted service provider partners, who are experts at selling, installing and supporting our solutions. We derive revenue from the sale of our cloud-based Software-as-a-Service, or SaaS, services, license fees, software, hardware, activation fees and other revenue. Our fiscal year ends on December 31 st .

Note 2 . Basis of Presentation

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements include our accounts and those of our majority-owned and controlled subsidiaries after elimination of intercompany accounts and transactions.

These unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP, for interim financial information and the applicable rules and regulations of the Securities and Exchange Commission, or SEC. Accordingly, they do not include all the information and footnotes required by GAAP for annual financial statements. They should be read together with our audited consolidated financial statements and related notes thereto for the year ended December 31, 2016 appearing in our Annual Report on Form 10-K filed with the SEC on March 16, 2017 , or the 2016 Annual Report. The condensed consolidated balance sheet as of December 31, 2016 was derived from our audited financial statements, but does not include all disclosures required by GAAP for annual financial statements.

In the opinion of management, these condensed consolidated financial statements include all normal recurring adjustments necessary for a fair statement of the results of operations, financial position and cash flows. The results of operations for the three and nine months ended September 30, 2017 are not necessarily indicative of the results that can be expected for our entire fiscal year ending December 31, 2017 .

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of our assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Our estimates, judgments and assumptions are continually evaluated based on available information and experience. Because the use of estimates is inherent in the financial reporting process, actual results could differ from those estimates. Estimates are used when accounting for revenue recognition, allowances for doubtful accounts, allowance for hardware returns, estimates of obsolete inventory, long-term incentive compensation, stock-based compensation, income taxes, legal reserves, contingent consideration and goodwill and intangible assets.

Significant Accounting Policies

We updated the following significant accounting policies as a result of acquiring the Connect line of business from Icontrol Networks, Inc., or Icontrol, during the first quarter of 2017: (i) internal-use software, (ii) external software, (iii) revenue recognition and deferred revenue and (iv) cost of revenue. We generate SaaS and license revenue from monthly fees charged to service providers on a per subscriber basis for access to our newly-acquired Connect software platform. The Connect software for interactive security, automation and related solutions is typically deployed and operated by the service provider in its own network operations center. Except for as disclosed herein, there have been no other material changes to our significant accounting policies during the quarter ended September 30, 2017 from those disclosed in our 2016 Annual Report on Form 10-K for the year ended December 31, 2016, filed on March 16, 2017 with the SEC.

Internal-Use Software

We capitalize the costs directly related to the design of internal-use software for development of our Alarm.com and other SaaS platforms during the application development stage of the projects. The costs are primarily comprised of salaries, benefits

7


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

and stock-based compensation expense of the project engineers and product development teams. Our internally developed software is reported at cost less accumulated depreciation. Depreciation begins once the project is ready for its intended use, which is usually when the code goes into production in weekly software builds on our platform. We depreciate the asset on a straight-line basis over a period of three years, which is the estimated useful life. We utilize continuous agile development methods to update our software for our SaaS multi-tenant platform on a weekly basis, which primarily consists of bug-fixes and user interface changes. We evaluate whether a project should be capitalized and do so if it adds significant functionality to our platform. Maintenance activities or minor upgrades are expensed in the period performed.

External Software

Costs incurred in researching and developing a computer software product that will be marketed and sold are charged to expense when incurred until technological feasibility is established. Technological feasibility is established upon completion of a detailed program design or, in its absence, completion of a working model (a beta version). After technological feasibility is established, the salaries, benefits and stock-based compensation expense of the project engineers and product development teams performing coding and testing are capitalized. Cost capitalization ceases when the product is available for general release. The Connect software is typically developed in an agile environment with frequent revisions to product release features and functions. Agile development results in a short duration between completion of the detailed program design and beta release. Accordingly, as of September 30, 2017 , we do not have any capitalized external software due to the shorter development cycle associated with agile development.

Revenue Recognition and Deferred Revenue

We derive our revenue from three primary sources: the sale of cloud-based SaaS services on our integrated Alarm.com platform, the sale of licenses and services on the newly-acquired Connect software platform and the sale of hardware products. We sell our platform and hardware solutions to service provider partners that resell our solutions and hardware to home and business owners, who are the service provider partners’ customers, and whom we refer to as our subscribers. We also sell our hardware to distributors who resell the hardware to service provider partners. We enter into contracts with our service provider partners that establish pricing for access to our platform solutions and for the sale of hardware. These contracts typically have an initial term of one year, with subsequent renewal terms of one year. Our service provider partners typically enter into contracts with our subscribers, which our service provider partners have indicated range from three to five years in length.

Our hardware includes cellular radio modules that enable access to our cloud-based platform, as well as video cameras, image sensors and other peripherals. Our service provider partners may purchase our hardware in anticipation of installing the hardware in a home or business when they create a new subscriber account, or for use in an existing subscriber’s property. The purchase of hardware occurs in a transaction that is separate and typically in advance of the purchase of our platform services. Service provider partners transact with us to purchase our platform solutions and resell our solutions to a new subscriber, or to upgrade or downgrade the solutions of an existing subscriber, at which time the subscriber’s access to our platform solutions is enabled and the delivery of the services commences. The purchase of platform solutions and the purchase of hardware are separate transactions because at the time of sale of the hardware, the service provider partner is not obligated to and may not purchase a platform solution for the hardware sold, and the level and duration of platform solutions, if any, to be provided through the hardware sold cannot be determined.

We recognize revenue with respect to our solutions when all of the following conditions are met:

Persuasive evidence of an arrangement exists;

Delivery to the customer, which may be either a service provider partner, distributor or a subscriber, has occurred or service has been rendered;

Fees are fixed or determinable; and

Collection of the fees is reasonably assured.

We consider a signed contract with a service provider partner to be persuasive evidence that an agreement exists, and the fees to be fixed or determinable if the fees are contractually agreed to with our service provider partners. Collectibility is evaluated based on a number of factors, including a credit review of new service provider partners, and the payment history of existing service provider partners. If collectibility is not reasonably assured, revenue is deferred until collection becomes reasonably assured, which is generally upon the receipt of payment.


8


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

SaaS and License Revenue

We generate the majority of our SaaS and license revenue primarily from monthly fees charged to our service provider partners sold on a per subscriber basis for access to our cloud-based intelligently connected property platform and related solutions. Our fees per subscriber vary based upon the service plan and features utilized.

Under terms in our contractual arrangements with our service provider partners, we are entitled to payment and recognize revenue based on a monthly fee that is billed in advance of the month of service. We have demonstrated that we can sell our SaaS offering on a stand-alone basis, as it can be sold separately from hardware and activation services. As there is neither a minimum required initial service term nor a stated renewal term in our contractual arrangements, we recognize revenue over the period of service, which is monthly. Our service provider partners typically incur and pay the same monthly fee per subscriber account for the entire period a subscriber account is active.

We also generate SaaS and license revenue from monthly fees charged to service providers sold on a per subscriber basis for access to our newly-acquired Connect software platform. The Connect software for interactive security, automation and related solutions is typically deployed and operated by the service provider in its own network operations center. Our agreements for the Connect platform solution typically include software and services, such as post-contract customer support, or PCS. Software sales that include multiple elements are typically allocated to the various elements based on vendor-specific objective evidence of fair value, or VSOE. There have been no separate sales of PCS, as PCS is always bundled with the software license for the Connect platform solution. Therefore, the VSOE of fair value for PCS cannot be established. The entire Connect arrangement fee is recognized ratably over the period during which the services are expected to be performed or the PCS period, whichever is longer, once the software is delivered and services have commenced, if all the other basic revenue recognition criteria have been met. Under terms in our contractual arrangements with our service provider partners, we are entitled to payment of a monthly fee for Connect that is billed per subscriber for the month of service. We recognize revenue over the period of service, which is monthly. Our service provider partners typically incur and pay the same monthly fee per subscriber account for the entire period a subscriber account is active.

We offer multiple service level packages for our platform solutions including a range of solutions and a range of a la carte add-ons for additional features. The fee paid by our service provider partners each month for the delivery of our solutions is based on the combination of packages and add-ons enabled for each subscriber. We utilize tiered pricing plans where our service provider partners may receive prospective pricing discounts driven by volume.

We also generate SaaS and license revenue from the fees paid to us when we license our intellectual property to service provider partners on a per customer basis for use of our patents. In addition, in certain markets our EnergyHub subsidiary sells its demand response software with an annual service fee, with pricing based on the number of subscribers or amount of aggregate electricity demand made available for a utility’s or market’s control.

Hardware and Other Revenue

We generate hardware and other revenue from the sale of cellular radio modules that provide access to our cloud-based platform, from the sale of video cameras and from the sale of other devices, including image sensors and peripherals. We recognize hardware and other revenue when the hardware is received by our service provider partner or distributor, net of a reserve for estimated returns. Amounts due from the sale of hardware are payable in accordance with the terms of our agreements with our service provider partners or distributors, and are not contingent on resale to end-users, or to service provider partners in the case of sales of hardware to distributors. Our terms for hardware sales sold directly to either service provider partners or distributors typically allow for the return of hardware up to one year past the date of sale. Our distributors sell directly to our service provider partners under terms between the two parties. We record a reserve against revenue for hardware returns based on historical returns, which was 2.2% and 2.3% of hardware and other revenue for the three and nine months ended September 30, 2017 , respectively. We evaluate our hardware reserve on a quarterly basis or if there is an indication of significant changes in return experience. Historically, our returns of hardware have not significantly differed from our estimated reserve.

Hardware and other revenue also includes activation fees charged to service provider partners for activation of a new subscriber account on our platform, as well as fees paid by service provider partners for our marketing services. Our service provider partners use services on our platform, such as support tools and applications, to assist in the installation of our solutions in a subscriber’s property. This installation marks the beginning of the service period on our platform and on occasion, we earn activation revenue for fees charged for this service. The activation fee is non-refundable, separately negotiated and specified in our contractual arrangements with our service provider partners and is charged to the service provider partner for each subscriber activated on our platform. Activation fees are not offered on a stand-alone basis separate from our SaaS offering and are billed and received at the beginning of the arrangement. We record activation fees initially as deferred revenue and we recognize these fees ratably over the expected term of the subscribers’ account which we estimate is ten years based on our annual attrition rate. The portion of these activation fees included in current and long-term deferred revenue as of our balance sheet date represents the amounts that will be recognized ratably as revenue over the following twelve months, or longer as

9


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

appropriate, until the ten -year expected term is complete. The balance of deferred revenue for activation fees was $10.7 million and $11.2 million as of September 30, 2017 and December 31, 2016 , respectively, which combines current and long-term balances.

Cost of Revenue

Our cost of SaaS and license revenue primarily includes the amounts paid to wireless network providers and, to a lesser extent, the costs of running our network operation centers. We record the salaries and benefits of the department dedicated to providing service exclusively to a specific service provider for the Connect platform to cost of SaaS and license revenue.

Our cost of hardware and other revenue primarily includes cost of raw materials and amounts paid to our third-party manufacturer for production and fulfillment of our cellular radio modules and image sensors, and procurement costs for our video cameras, which we purchase from an original equipment manufacturer, and other devices. Our cost of revenue excludes amortization and depreciation.

Recent Accounting Pronouncements

Adopted

On March 30, 2016, the Financial Accounting Standards Board, or FASB, issued ASU 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting,” which simplifies several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The update is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, and we adopted ASU 2016-09 during the first quarter of 2017.

The adoption of this standard had the following impact on our financial statements:

Tax windfall benefits or deficiencies from stock-based awards are now recorded in provision for income taxes in the period incurred, whereas previous guidance required the tax windfall benefits to be recorded in additional paid-in-capital. This change has been applied prospectively.

Tax windfall benefits from stock-based awards after adoption will be reported in cash flows from operating activities in the statement of cash flows. For comparability, we elected to retrospectively apply this guidance which resulted in a reclassification of $2.7 million from tax windfall benefit from stock options (a financing activity) to deferred income taxes (an operating activity) for the nine months ended September 30, 2016 .

We elected to record forfeitures as they occur in our calculation of stock-based compensation expense. In prior periods, we estimated forfeitures for the calculation of stock-based compensation expense. We adopted this change using the modified retrospective method, which resulted in an increase of less than $0.1 million to accumulated deficit, additional paid-in capital and deferred tax assets as of January 1, 2017.

Cash flows from tax windfall benefits from stock-based awards will no longer factor into the calculation of the number of shares for diluted earnings per share. This change was applied prospectively and did not have a material impact on diluted earnings per share for the three and nine months ended September 30, 2017 .

On July 22, 2015, the FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory , which requires entities to measure most inventory "at the lower of cost and net realizable value," thereby simplifying the current guidance under which an entity must measure inventory at the lower of cost or market (market in this context is defined as one of three different measures). The guidance does not apply to inventories that are measured by using either the last-in, first-out method or the retail inventory method. Under current guidance, an entity subsequently measures inventory at the lower of cost or market, with market defined as replacement cost provided that it is not above the ceiling (net realizable value) or below the floor (net realizable value less an approximately normal profit margin) which is unnecessarily complex. The amendment does not change other guidance on measuring inventory. The amendment is effective for annual periods, including periods within those annual periods beginning after December 15, 2016 with early adoption permitted. We adopted this pronouncement prospectively in the first quarter of 2017, and the adoption of this pronouncement did no t have a material effect on our financial statements.

On January 26, 2017, the FASB issued ASU 2017-04, "Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment , " which removes step two of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment amount will now be the amount by which a reporting unit's carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. The amendment is effective for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019 with early adoption permitted for goodwill impairment tests performed after

10


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

January 1, 2017. We adopted this guidance prospectively in the first quarter of 2017. Our goodwill impairment test is performed annually as of October 1st, therefore the adoption had no impact to our financial statements.

Not Yet Adopted

Revenue from Contracts with Customers (Topic 606):

In May 2014, the FASB and International Accounting Standards Board jointly issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606) , " a new revenue recognition standard that provides a framework for addressing revenue issues, improves the comparability of revenue recognition practices across industries, provides useful information to users of financial statements through improved disclosure requirements and simplifies the presentation of financial statements. From March to December 2016, amendments to Topic 606 were issued to clarify numerous accounting topics, including, but not limited to: (i) the implementation guidance on principal versus agent considerations, (ii) the identification of performance obligations, (iii) the licensing implementation guidance, (iv) the objective of the collectability criterion, (v) the application of the variable consideration guidance and modified retrospective transition method, (vi) the way in which impairment testing is performed and (vii) the disclosure requirements for revenue recognized from performance obligations. This guidance permits the use of either a full retrospective method or a modified retrospective method. This guidance will be effective for annual reporting periods beginning after December 15, 2017.

We have developed a project plan for the adoption of Topic 606 focused first on our standard service provider partner agreements. Based on our assessment to date, we do not believe Topic 606 will have a material impact on our revenue recognition policies associated with our standard service provider partner agreements. In addition, we continue to evaluate our 17 largest non-standard service provider partner agreements, including distributors of our hardware and licensees of our intellectual property. These service provider partners accounted for 61% of our revenue for the nine months ended September 30, 2017 . While we have not finalized our review of these 17 non-standard service provider partners, based on our assessment to date, we have not identified any changes to date that we believe would result in a material impact on our revenue recognition policies associated with our largest non-standard service provider partners. Additionally, in the third quarter of 2017 , we began assessing the impact of the adoption of Topic 606 on our subsidiaries’ service provider partner agreements.

We expect that the adoption of the new standard will change our current treatment of commissions paid to employees, which we currently expense as incurred. Under the new standard, we expect to capitalize a portion of our commission costs as an incremental cost of obtaining a contract. We currently plan to amortize our commission costs over a period of three years, which is consistent with the period over which the products and services related to the commission are transferred to the customer. The three-year period was determined based on our review of historical enhancements and upgrades to our products and services. We are currently evaluating the overall impact of adopting Topic 606 on our commission costs.

We currently plan to adopt Topic 606 on January 1, 2018, using the modified retrospective transition method. The modified retrospective transition method would be applied only to the most current period presented along with a cumulative-effect adjustment at the date of adoption. The next stages of our adoption plan will focus on (i) finalizing our review of the largest revenue service provider partners, (ii) finalizing our review of our subsidiaries’ service provider partners, (iii) assessing the quantitative impact of adopting Topic 606 and (iv) assessing the quantitative impact of capitalizing a portion of our commission costs. We plan to continue to put processes in place and to design internal controls over these processes to collect the data required for the additional disclosures required under Topic 606.

Other Accounting Standards :

On May 10, 2017, the FASB issued ASU 2017-09, "Compensation - Stock Compensation (Topic 718) - Scope of Modification Accounting , " which amends the scope of modification accounting for share-based payment arrangements. The update provides guidance on the types of changes to the terms or conditions of share-based payment awards to which an entity would be required to apply modification accounting under ASC 718. Specifically, an entity would not apply modification accounting if the fair value, vesting conditions and classification of the awards are the same immediately before and after the modification. The amendment is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. We are required to adopt ASU 2017-09 no later than the first quarter of 2018 and we do not anticipate the adoption will have a material impact on our financial statements.

On January 5, 2017, the FASB issued ASU 2017-01, "Business Combinations (Topic 805) - Clarifying the Definition of a Business , " which provides guidance to assist entities in evaluating when a set of transferred assets and activities is a business. To be considered a business, an acquisition would have to include an input and a substantive process that together significantly contribute to the ability to create outputs. The amendment is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. We are required to adopt ASU 2017-01 no later than the first quarter of 2018.


11


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

On February 25, 2016, the FASB issued ASU 2016-02, “Leases (Topic 842) , which requires lessees to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet. The update also requires improved disclosures to help users of financial statements better understand the amount, timing and uncertainty of cash flows arising from leases. The update is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. We are required to adopt ASU 2016-02 no later than the first quarter of 2019, and we are currently assessing the impact of this pronouncement on our financial statements. We have begun to evaluate our existing leases which all have been classified as operating leases under Topic 840. We anticipate using some of the available practical expedients upon adoption. We have not yet determined the amount of operating and financing lease liabilities and corresponding right-of-use assets we will record on our balance sheet, however, we anticipate that our assets and liabilities will increase materially when our leases are recorded under the new standard.

Note 3. Accounts Receivable, Net

The components of accounts receivable, net are as follows (in thousands):
    
 
September 30,
2017
 
December 31, 2016
Accounts receivable
$
45,041

 
$
33,406

Allowance for doubtful accounts
(1,448
)
 
(1,282
)
Allowance for product returns
(2,392
)
 
(2,314
)
Accounts receivable, net
$
41,201

 
$
29,810


For each of the three and nine months ended September 30, 2017 , we recorded a reduction to the provision for doubtful accounts of $0.4 million . For the three and nine months ended September 30, 2016 , we recorded a provision for doubtful accounts of $0.2 million and $0.4 million , respectively.

For the three and nine months ended September 30, 2017 , we recorded a reserve for product returns in our hardware and other revenue of $0.6 million and $1.7 million , respectively, as compared to $0.5 million and $1.5 million for the same periods in the prior year. Historically, we have not experienced write-offs for uncollectible accounts or sales returns that have differed significantly from our estimates.

Note 4. Inventory

The components of inventory are as follows (in thousands):
    
 
September 30,
2017
 
December 31,
2016
Raw materials
$
6,673

 
$
4,313

Finished goods
6,944

 
6,230

Total inventory
$
13,617

 
$
10,543


Note 5 . Acquisitions

Connect and Piper Business Units from Icontrol Networks

On March 8, 2017 , in accordance with the asset purchase agreement we entered into with Icontrol, on June 23, 2016, we acquired certain assets and assumed certain liabilities of the Connect line of business and all of the outstanding equity interests of the two subsidiaries through which Icontrol conducted its Piper line of business, or the Acquisition. Connect provides an interactive security and home automation platform for service providers. Piper, designs, produces and sells an all-in-one video and home automation hub. We expect the addition of new technology infrastructure, talent, key relationships and hardware devices to help accelerate our development of intelligent, data-driven smart home and business services.

The cash consideration was $148.5 million , after the estimated working capital adjustment, of which $14.5 million was deposited in escrow in accordance with the asset purchase agreement for indemnifications obligations of Icontrol stockholders and the final determination of closing working capital. We used $81.5 million of cash on hand and drew $67.0 million under our senior line of credit with Silicon Valley Bank, or SVB, and a syndicate of lenders to fund the Acquisition.

The Acquisition also included non-cash consideration. In accordance with the terms of the asset purchase agreement, we were obligated to assume the Icontrol Networks, Inc. 2013 Equity Incentive Plan and Icontrol Networks, Inc. 2003 Stock Plan, or collectively, the Icontrol Plans, and converted the 2,001,387 unvested employee stock options into 70,406 Alarm.com stock

12


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

options using a conversion ratio stated in the agreement to convert the original exercise price and number of options. The fair value of the unvested stock options on the date of the Acquisition was $1.7 million calculated using a Black-Scholes model with a volatility and risk-free interest rate over the expected term of the options and the closing price of the Alarm.com common stock on the date of acquisition. We applied our graded vesting accounting policy to the fair value of these assumed options and determined $1.4 million of the fair value was attributable to pre-combination services and was included as a component of total purchase consideration. The remaining $0.3 million of the fair value was determined to be attributable to post-combination services and will be recognized over the remaining service periods of the stock options.

The following table summarizes the assumptions used for estimating the fair value of stock options assumed from the Connect business unit of Icontrol:
    
 
Nine Months Ended September 30, 2017
Volatility
42.7 - 44.4%

Expected term
2.5 - 5.0 years

Risk-free interest rate
1.4 - 2.0%

Dividend rate
%

The table below sets forth the purchase consideration and the fair value allocation of the tangible and intangible net assets acquired (in thousands):
    
 
March 8, 2017
Calculation of Purchase Consideration:
 
Cash paid, net of working capital adjustment
$
148,500

Assumed stock options
1,375

Total consideration
$
149,875

Estimated Tangible and Intangible Net Assets:
 
Cash
$
211

Accounts receivable
11,421

Current assets
883

Long-term assets
4,446

Customer relationships
93,260

Developed technology
4,770

Trade name
170

Current liabilities
(1,608
)
Long-term liabilities
(288
)
Goodwill
36,610

Total estimated tangible and intangible net assets
$
149,875


Goodwill of $36.6 million reflects the value of acquired workforce and synergies we expect to achieve from integrating support for Connect's security service providers and for the Connect platform. The goodwill will be deductible for tax purposes. We allocated goodwill to reporting units based on expected benefit from our synergies, and have allocated the goodwill to the Alarm.com segment.

The purchase price allocation for the Acquisition was finalized during the third quarter of 2017 . The final fair value of the assets and liabilities related to the Acquisition reflects an increase of $0.1 million in tangible assets, net and a decrease of $0.1 million  in goodwill based on working capital adjustments identified by the Company.



13


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

Fair Value of Net Assets Acquired and Intangibles

In accordance with ASC 805, the business units acquired in the Acquisition constituted a business and the assets and liabilities were recorded at their respective fair values as of March 8, 2017 . We developed our estimate of the fair value of intangible net assets using a multi-period excess earnings method for customer relationships, the relief from royalty method for the developed technology and the relief from royalty method for the trade name.

Customer Relationships

We recorded the customer relationships intangible separately from goodwill based on determination of the length, strength and contractual nature of the relationship that Connect shared with its customers. We valued two groups of customer relationships using the multi-period excess earnings method, an income approach. We used several assumptions in the income approach, including attrition and renewal rate, margin and discount rate. We are amortizing the first customer relationship, valued at $92.5 million , on an attribution basis derived from the discounted cash flows of the model over an estimated useful life of twelve years and the second group of customer relationships, valued at $0.8 million , on the same basis, over an estimated useful life of four years.

Developed Technology

Developed technology primarily consists of intellectual property of proprietary software that is marketed for sale. The Connect platform is software for interactive security, automation and related solutions that was typically deployed and operated by the service provider in its own network operations center. We valued the developed technology by applying the relief from royalty method, an income approach. We used several assumptions in the relief from royalty method, which included royalty rate and discount rate. We are amortizing the Connect developed technology, valued at $4.4 million , on an attribution method based on the discounted cash flows of the model over an estimated useful life of three years. Other developed technologies, valued at $0.3 million , were also acquired.

Trade Name

We determined that there was no fair value for the Connect trade name as the largest customer for Connect had re-branded the interactive security and automation platform and marketed it under the customer's own name. We valued the other trade names acquired using a relief from royalty method. We used several assumptions in the income approach, including royalty and discount rates. We are amortizing the other trade names, valued at $0.2 million , on an attribution basis derived from the discounted cash flows of the model over an estimated useful life of three years.

Deferred Tax Asset

The equity interests in the subsidiaries we acquired provided for a carryover tax basis in goodwill and intangible assets that arose from a previous acquisition. We have recorded a deferred tax asset of $4.1 million that represents the excess of the carryover tax basis in those previously acquired goodwill and intangible assets over the fair value of goodwill and intangible assets we recorded on the date of the Acquisition.

ObjectVideo

On January 1, 2017 , in accordance with an asset purchase agreement, we acquired certain assets of ObjectVideo, Inc., or ObjectVideo, that constituted a business now called ObjectVideo Labs, LLC, or ObjectVideo Labs, including products, technology portfolio and engineering team. ObjectVideo is a pioneer in the fields of video analytics and computer vision with technology that extracts meaning and intelligence from video streams in real-time to enable object tracking, pattern recognition and activity identification. We anticipate that the ObjectVideo Labs engineering team's capabilities and expertise will accelerate our research and development of video services and video analytic applications. In addition, ObjectVideo Labs will continue to perform advanced research and engineering services for the federal government. The consideration included $6.0 million of cash paid at closing.


14


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

The table below sets forth the purchase consideration and the fair value allocation of the tangible and intangible net assets acquired (in thousands):
    
 
January 1, 2017
Calculation of Purchase Consideration:
 
Cash paid, net of working capital adjustment
$
6,000

 
 
Estimated Tangible and Intangible Net Assets:
 
Developed technology
$
3,800

Current liabilities
(58
)
Goodwill
2,258

Total estimated tangible and intangible net assets
$
6,000


Goodwill of $2.3 million reflects the value of acquired workforce and expected synergies from pairing ObjectVideo Labs' video analytics capabilities with our offerings. The goodwill will be deductible for tax purposes.

The purchase price allocation for the ObjectVideo Labs acquisition was finalized during the third quarter of 2017 . The final fair value of the assets and liabilities related to the ObjectVideo Labs acquisition reflects an increase of  $0.4 million  in developed technology and a decrease of $0.4 million  in goodwill as well as a corresponding change to amortization of the developed technology based on our use of the replacement cost method to value the developed technology.

Fair Value of Net Assets Acquired and Intangibles

In accordance with ASC 805, the assets and liabilities of ObjectVideo Labs we acquired were recorded at their respective fair values as of January 1, 2017, the date of the acquisition. We developed our estimate of the fair value of intangible assets using the replacement cost method for the developed technology.

Developed Technology

Developed technology recorded separately from goodwill consists of intellectual property such as proprietary software used internally for revenue producing activities. ObjectVideo Labs proprietary software consists of source code and video analytics testing programs used internally to provide video analytics consulting services and research and development to customers and for the SaaS Alarm.com platform. We valued the developed technology by applying the replacement cost method. We used several assumptions in this cost approach, which included analyzing costs that a company would expect to incur to recreate an asset of equivalent utility. We are amortizing the developed technology, valued at $3.8 million , on a straight-line basis over an estimated useful life of two  years which coincides with the rapidly developing technology of video analytics.

Unaudited Pro Forma Information

The following unaudited pro forma data is presented as if the Acquisition and ObjectVideo Labs were included in our historical consolidated statements of operations beginning January 1, 2016. These pro forma results do not necessarily represent what would have occurred if all the business combinations had taken place on January 1, 2016, nor do they represent the results that may occur in the future.

This pro forma financial information includes our historical financial statements and those of our business combinations with the following adjustments: (i) we adjusted the pro form amounts for income taxes, (ii) we applied interest expense as if the additional borrowing for the acquisitions were as of January 1, 2016, (iii) we adjusted for amortization expense assuming the fair value adjustments to intangible assets had been applied beginning January 1, 2016 and (iv) we adjusted for transaction fees incurred and reclassified them to January 1, 2016.


15


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

The pro forma adjustments were based on available information and upon assumptions that we believe are reasonable to reflect the impact of these acquisitions on our historical financial information on a supplemental pro forma basis, as follows (in thousands):
 
Pro Forma Nine Months Ended September 30,
 
2017
 
2016
 
(unaudited)
Revenue
$
261,214

 
$
234,011

Net income / (loss)
35,380

 
(2,864
)
Net income / (loss) per diluted share
$
0.72

 
$
(0.06
)

Business Combinations in Operations

The operations of each of the business combinations discussed above were included in the consolidated financial statements as of each of their respective acquisition dates. The following table presents the revenue and earnings of the business combinations in the year of acquisition as reported within the consolidated financial statements for the nine months ended September 30, 2017 (in thousands):
 
Nine Months Ended 
 September 30, 2017
Revenue
$
22,996

Net loss
(3,021
)

For the Acquisition, we included the results of Connect's operations since its acquisition date in the Alarm.com segment and the results of Piper's operations since its acquisition date in the Other segment. We included the results of ObjectVideo Labs operations since its acquisition date in the Alarm.com segment.

Note 6. Goodwill and Intangible Assets, Net

The changes in goodwill by reportable segment are outlined below (in thousands):
    
 
Alarm.com
 
Other
 
Total
Balance as of January 1, 2017
$
24,723

 
$

 
$
24,723

Goodwill acquired
38,868

 

 
38,868

Balance as of September 30, 2017
$
63,591

 
$

 
$
63,591


On January 1, 2017 , we acquired ObjectVideo Labs and recorded $2.3 million of goodwill in the Alarm.com segment. On March 8, 2017 , in connection with the Acquisition, we recorded $36.6 million of goodwill in the Alarm.com segment. There were no impairments of goodwill during the three and nine months ended September 30, 2017 and 2016 .

The following table reflects changes in the net carrying amount of the components of intangible assets (in thousands):
    
 
Customer
Relationships
 
Developed
Technology
 
Trade
Name
 
Total
Balance as of January 1, 2017
$
3,363

 
$
1,048

 
$
157

 
$
4,568

Intangible assets acquired
93,260

 
8,570

 
170

 
102,000

Amortization
(5,674
)
 
(2,960
)
 
(71
)
 
(8,705
)
Balance as of September 30, 2017
$
90,949

 
$
6,658

 
$
256

 
$
97,863


We recorded $3.7 million and $8.7 million of amortization related to our intangible assets for the three and nine months ended September 30, 2017 , respectively, as compared to $0.4 million and $1.4 million for the same periods in the prior year. There were no impairments of long-lived intangible assets during the three and nine months ended September 30, 2017 and 2016 .


16


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

The following tables reflect the weighted average remaining life and carrying value of finite-lived intangible assets (in thousands):
    
 
September 30, 2017
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Carrying
Value
 
Weighted-
Average
Remaining Life
Customer relationships
$
103,926

 
$
(12,977
)
 
$
90,949

 
11.0
Developed technology
13,959

 
(7,301
)
 
6,658

 
2.2
Trade name
1,084

 
(828
)
 
256

 
3.5
Other
234

 
(234
)
 

 
0.0
Total intangible assets
$
119,203

 
$
(21,340
)
 
$
97,863

 
 
    
 
December 31, 2016
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Weighted-
Average
Remaining Life
Customer relationships
$
10,666

 
$
(7,303
)
 
$
3,363

 
3.8
Developed technology
5,390

 
(4,342
)
 
1,048

 
4.1
Trade name
914

 
(757
)
 
157

 
4.3
Other
234

 
(234
)
 

 
0.0
Total intangible assets
$
17,204

 
$
(12,636
)
 
$
4,568

 
 

The following table reflects the future estimated amortization expense for intangible assets (in thousands):
    
Year Ending December 31,
 
Amortization
Remainder of 2017
 
$
3,577

2018
 
15,219

2019
 
13,644

2020
 
12,217

2021 and thereafter
 
53,206

Total future amortization expense
 
$
97,863


Note 7 . Investments in Other Entities

Investments in and Loans to a Platform Partner

We have invested in the form of loans and equity investment in a platform partner which produces connected devices to provide it with the capital required to bring its devices to market and integrate them onto our connected home platform.

Based upon the level of equity investment at risk, the platform partner is a Variable Interest Entity, or VIE. We have concluded that we are not the primary beneficiary of the platform partner VIE. We do not control the product design, software development, manufacturing, marketing, or sales functions of the platform partner and therefore, we do not direct the activities of the platform partner that most significantly impact its economic performance. We account for this investment under the cost method. As of September 30, 2017 and December 31, 2016 , the fair value of this cost method investment was not estimated as there were no events or changes in circumstances that may have had a significant adverse effect on the fair value of the investment. As of September 30, 2017 and December 31, 2016 , our $1.0 million cost method investment in the platform partner was recorded in other assets in our condensed consolidated balance sheets.

Note 8. Other Assets

Patent Licenses

From time to time, we enter into agreements to license patents. The carrying value, net of amortization, was $2.6 million and $3.2 million as of September 30, 2017 and December 31, 2016 and was included in other assets. We have $4.9 million of

17


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

historical cost in patent licenses related to such agreements. We are amortizing the patent licenses over the estimated useful lives of the patents, which range from three to eleven years. Amortization expense on patent licenses was $0.2 million and $0.6 million for the three and nine months ended September 30, 2017 , respectively, as compared to $0.1 million and $0.4 million for the same periods in the prior year and was included in cost of SaaS and license revenue in our condensed consolidated statements of operations.

Loan to a Distribution Partner

In September 2016, we entered into dealer and loan agreements with a distribution partner. The dealer agreement enables the distribution partner to resell our SaaS services and hardware to their subscribers. Under the loan agreements, we agreed to loan the distribution partner up to $4.0 million , collateralized by all assets owned by the distribution partner. The advance period for the loan was amended in August 2017 and now begins each year on September 1 and ends each year on December 31. Interest on the outstanding principal accrues at a rate per annum equal to the greater of 6.0% or the Eurodollar Base Rate, or LIBOR, plus 4.0% , as determined on the first date of each annual advance period. The repayment of principal and accrued interest is due in three installments beginning in July and ending in August following the advance period. The term date of the loan is August 31, 2019, however, the borrower has the option to extend the term of the loan for two successive terms of one year each.

During the third quarter of 2017 , the distribution partner repaid the entire $4.2 million balance of principal and interest due for this loan receivable under the first advance period, in accordance with the provisions of the loan. In September 2017, our distribution partner drew $1.0 million under the second advance period, which is available from September 2017 to December 2017. Subsequent to September 30, 2017 and prior to the filing of this Quarterly Report on Form 10-Q, our distribution partner drew an additional $2.0 million under the second advance period.

The loan receivable balance, which is recorded in other current assets, was $1.0 million and $3.0 million as of as of September 30, 2017 and December 31, 2016 , respectively. Interest accrues on the loan receivable at 6.0% per annum as calculated at the beginning of the applicable advance period.

In April 2017, we entered into a subordinated credit agreement with an affiliated entity of the distribution partner and loaned the affiliated entity $3.0 million , with a maturity date of November 21, 2022 . Interest on the outstanding principal balance accrues at a rate of 8.5% per annum and requires monthly interest payments. The $3.0 million loan receivable balance was included in other assets as of September 30, 2017 .

Note 9 . Fair Value Measurements

The following table presents our assets and liabilities measured at fair value on a recurring basis (in thousands):
    
 
Fair Value Measurements on a Recurring Basis as of
September 30, 2017
Fair Value Measurements in:
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Money market account
$
62,454

 
$

 
$

 
$
62,454

Total
$
62,454

 
$

 
$

 
$
62,454

Liabilities:
 
 
 
 
 
 
 
Subsidiary unit awards
$

 
$

 
$
3,051

 
$
3,051

Contingent consideration liability from acquisition

 

 

 

Total
$

 
$

 
$
3,051

 
$
3,051


18


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

    
 
Fair Value Measurements on a Recurring Basis as of
December 31, 2016
Fair value measurements in:
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Money market account
$
135,204

 
$

 
$

 
$
135,204

Total
$
135,204

 
$

 
$

 
$
135,204

Liabilities:
 
 
 
 
 
 
 
Subsidiary unit awards
$

 
$

 
$
2,768

 
$
2,768

Contingent consideration liability from acquisition

 

 

 

Total
$

 
$

 
$
2,768

 
$
2,768


The following table summarizes the change in fair value of the Level 3 liabilities for subsidiary unit awards and contingent consideration liability from acquisition (in thousands):
    
 
Fair Value Measurements Using Significant Unobservable Inputs
 
Three Months Ended 
 September 30, 2017
 
Three Months Ended 
 September 30, 2016
 
Subsidiary unit awards
 
Contingent consideration liability from acquisition
 
Subsidiary unit awards
 
Contingent consideration liability from acquisition
Beginning of period balance
$
2,912

 
$

 
$
834

 
$
40

Total (gains) losses included in earnings
139

 

 
1,330

 
(35
)
Ending of period balance
$
3,051

 
$

 
$
2,164

 
$
5

    
 
Fair Value Measurements Using Significant Unobservable Inputs
 
Nine Months Ended 
 September 30, 2017
 
Nine Months Ended 
 September 30, 2016
 
Subsidiary unit awards
 
Contingent consideration liability from acquisition
 
Subsidiary unit awards
 
Contingent consideration liability from acquisition
Beginning of period balance
$
2,768

 
$

 
$
532

 
$
230

Total (gains) losses included in earnings
283

 

 
1,632

 
(225
)
Ending of period balance
$
3,051

 
$

 
$
2,164

 
$
5


The money market account is included in our cash and cash equivalents in our condensed consolidated balance sheets. Our money market assets are valued using quoted prices in active markets.

The liability for the subsidiary unit awards relates to agreements established with two employees of our subsidiaries for cash awards contingent upon the subsidiary companies meeting certain financial milestones such as revenue, working capital, EBITDA and EBITDA margin. We account for these subsidiary awards using fair value and establish liabilities for the future payment for the repurchase of subsidiary units under the terms of the agreements based on estimating revenue, working capital, EBITDA and EBITDA margin of the subsidiary units over the periods of the two awards through the anticipated repurchase dates. We estimated the fair value of each liability by using a Monte Carlo simulation model for determining each of the projected measures by using an expected distribution of potential outcomes. The fair value of each liability is calculated with thousands of projected outcomes, the results of which are averaged and then discounted to estimate the present value. At each reporting date until the respective payment dates, we will remeasure these liabilities, using the same valuation approach based on the applicable subsidiary's revenue, an unobservable input, and we will record any changes in the employee's compensation expense. One of the awards is subject to the employee's continued employment and therefore recorded on a straight-line basis over the remaining service period. The liability balances are included in either accounts payable, accrued expenses and other current liabilities or other liabilities in our condensed consolidated balance sheets (see Note 11 ).

The amount of contingent consideration liability to be paid, up to a maximum of $2.0 million , from our acquisition of SecurityTrax in the first quarter of 2015, will be determined based on revenue and adjusted EBITDA for the year ended

19


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

December 31, 2017. We estimated the fair value of the contingent consideration liability by using a Monte Carlo simulation model for determining projected revenue by using an expected distribution of potential outcomes. The fair value of contingent consideration liability is calculated with thousands of projected revenue outcomes, the results of which are averaged and then discounted to estimate the present value. At each reporting date until payment in first quarter of 2018, we will remeasure the contingent consideration liability, using the same valuation approach based on our subsidiary’s revenue, an unobservable input, and we will record any changes in general and administrative expense. We did no t record a liability related to this contingent consideration in our condensed consolidated balance sheets as of September 30, 2017 and December 31, 2016 , as the fair value of the contingent consideration liability was zero .

We monitor the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another. In such instances, the transfer is reported at the beginning of the reporting period. There were no transfers between Levels 1, 2 or 3 during the three and nine months ended September 30, 2017 and 2016 . We also monitor the value of the investments for other than temporary impairment on a quarterly basis. No other-than-temporary impairments occurred during the three and nine months ended September 30, 2017 and 2016 .

Note 10. Liabilities

The components of accounts payable, accrued expenses and other current liabilities are as follows (in thousands):
    
 
September 30,
2017
 
December 31,
2016
Accounts payable
$
23,124

 
$
18,289

Accrued expenses
4,427

 
5,298

Subsidiary unit awards
2,671

 
2,506

Other current liabilities
4,935

 
2,207

Accounts payable, accrued expenses and other current liabilities
$
35,157

 
$
28,300


The components of other liabilities are as follows (in thousands):
    
 
September 30,
2017
 
December 31,
2016
Deferred rent
$
12,478

 
$
11,056

Other liabilities
1,550

 
2,501

Other liabilities
$
14,028

 
$
13,557


Note 11 . Debt, Commitments and Contingencies

The debt, commitments and contingencies described below would require us, or our subsidiaries, to make payments to third parties under certain circumstances.

Debt

We have a $75.0 million revolving credit facility with SVB, as administrative agent, and a syndicate of lenders that matures in November 2018, or the 2014 Facility. We have the option to increase the borrowing capacity of the 2014 Facility to $125.0 million with the consent of the lenders. The 2014 Facility is secured by substantially all of our assets, including our intellectual property.

The outstanding principal balance on the 2014 Facility accrues interest at a rate equal to either (1) LIBOR plus an applicable margin based on our consolidated leverage ratio, or (2) the higher of (a) the Wall Street Journal prime rate, and (b) the Federal Funds rate plus 0.50% plus an applicable margin based on our consolidated leverage ratio, at our option. For the nine months ended September 30, 2017 and 2016 , we elected for the outstanding principal balance to accrue interest at LIBOR plus 2.00% , LIBOR plus 2.25% , and LIBOR plus 2.50% when our consolidated leverage ratio was less than 1.00 : 1.00 , greater than or equal to 1.00 : 1.00 but less than 2.00 : 1.00 , and greater than or equal to 2.00 : 1.00 , respectively. For the nine months ended September 30, 2017 and 2016 , the effective interest rate on the 2014 Facility was 3.46% and 2.73% , respectively.

On March 7, 2017, we drew $67.0 million under the 2014 Facility to partially fund the Acquisition. During the three and nine months ended September 30, 2017 , we repaid $0.7 million and $1.7 million , respectively, of the outstanding balance of the 2014

20


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

Facility. The carrying value of the 2014 Facility was $72.0 million and $6.7 million as of September 30, 2017 and December 31, 2016 . Our outstanding amounts under the 2014 Facility are due at maturity in November 2018.

The 2014 Facility included a variable interest rate that approximated market rates and, as such, we determined that the carrying amount of the 2014 Facility approximated its fair value as of September 30, 2017 . The 2014 Facility carried an unused line commitment fee of 0.20% to 0.25% depending on our consolidated leverage ratio. The 2014 Facility contained various financial and other covenants that required us to maintain a maximum consolidated leverage ratio not to exceed 3.00 : 1.00 and a consolidated fixed charge coverage ratio of at least 1.25 : 1.00 . As of September 30, 2017 , we were in compliance with all financial and non-financial covenants and there were no events of default.

Subsequent to September 30, 2017 and prior to the filing of this Quarterly Report on Form 10-Q, we refinanced the $72.0 million outstanding under the 2014 Facility, by entering into a new $125.0 million senior secured revolving credit facility, or the 2017 Facility, with SVB, as administrative agent, PNC Bank, National Association, as documentation agent, and a syndicate of lenders. Upon entry into the 2017 Facility, we borrowed $72.0 million , which was used to repay the previously outstanding balance under the 2014 Facility. As of the date of the filing of this Quarterly Report on Form 10-Q, no additional amounts have been drawn under the 2017 Facility. The 2017 Facility matures in October 2022 and includes an option to further increase the borrowing capacity to $175.0 million with the consent of the lenders. The outstanding principal balance of the 2017 Facility accrues interest at a rate equal to, at our option, either (1) LIBOR, plus an applicable margin based on our consolidated leverage ratio, or (2) the highest of (a) the Wall Street Journal prime rate, (b) the Federal Funds rate plus 0.50% , or (c) LIBOR plus 1.0% , plus an applicable margin based on our leverage ratio. The 2017 Facility also carries an annual unused line commitment fee of 0.20% , payable quarterly, and includes a maximum consolidated leverage ratio of 3.50 :1.00.

Commitments and Contingencies

Repurchase of Subsidiary Units

In 2012, we formed a subsidiary to develop and market home and commercial energy management devices and services. We granted an award of subsidiary stock to the founder and president. The terms of the award for the founder, who is also our employee, require a payment in cash on either the third or the fourth anniversary from the date the subsidiary first makes its products and services commercially available, which was determined to be April 1, 2014. The vesting of the award is based on the subsidiary meeting certain minimum financial targets. We did no t record a liability in our condensed consolidated balance sheets as of September 30, 2017 and December 31, 2016 , as the fair value of this commitment was zero .

In 2011, we formed a subsidiary that offers to professional residential property management and vacation rental management companies technology solutions for remote monitoring and control of properties, including access control and energy management. Since its formation, we granted an award of subsidiary stock to the founder and president. The vesting of the award is based upon the subsidiary meeting certain minimum financial targets from the date of commercial availability, which was determined to be June 1, 2013, until the fourth anniversary. In 2016, we amended the term of the award, extending the valuation date for the payment in cash to December 31, 2017, amending the financial targets and allowing for payments in cash from 2018 through 2020 based on collection of financed customer receivables that existed as of the valuation date. We recorded a liability of $2.7 million in accounts payable, accrued expenses and other current liabilities and $0.4 million in other liabilities related to this commitment in our condensed consolidated balance sheet as of September 30, 2017 . We recorded a liability of $2.5 million in accounts payable, accrued expenses and other current liabilities and a liability of $0.3 million in other liabilities related to this commitment in our condensed consolidated balance sheet as of December 31, 2016 .

At each reporting date until the respective payment dates, we will remeasure these liabilities, and we will record any changes in fair value in general and administrative expense (see Note 9 ).

Leases

We lease office space and office equipment under non-cancelable operating leases with various expiration dates through 2026. In August 2014, we signed a lease for new office space in Tysons, Virginia, where we relocated our headquarters in February 2016. This lease term ends in 2026 and includes a five -year renewal option, an $8.0 million tenant improvement allowance and scheduled rent increases. During 2016, we entered into amendments to this lease, which provided for 30,662 square feet of additional office space and an additional $1.7 million tenant improvement allowance. We took possession of the additional space in February 2017 and we were allowed to utilize the tenant improvement allowance for design prior to moving into the space.

As of September 30, 2017 , we have utilized the entire $9.7 million of tenant improvement allowances. Rent expense was $1.6 million and $4.5 million for the three and nine months ended September 30, 2017 , respectively, as compared to $1.2 million and $3.8 million for the same periods in the prior year.


21


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

Indemnification Agreements

We have various agreements that may obligate us to indemnify the other party to the agreement with respect to certain matters. Generally, these indemnification provisions are included in contracts arising in the normal course of business. Although we cannot predict the maximum potential amount of future payments that may become due under these indemnification agreements, we do not believe any potential liability that might arise from such indemnity provisions is probable or material.

Letters of Credit

As of September 30, 2017 and December 31, 2016 , we had no outstanding letters of credit under our 2014 Facility.

Legal Proceedings

On August 14, 2017, Alarm.com filed a lawsuit against ABS Capital Partners, Inc., ABS Partners V, LLC, ABS Partners VII, LLC, and Ralph Terkowitz in the Delaware Court of Chancery, or the Chancery Court. The complaint sought declaratory and injunctive relief preventing the defendants from using Alarm.com’s confidential information and trade secrets to compete with Alarm.com, and preventing the defendants from executing their planned transaction to invest in two companies (ipDatatel, LLC, or ipDatatel, and Resolution Products, Inc., or Resolution Products). The complaint alleged claims of breach of fiduciary duty, aiding and abetting a breach of fiduciary duty, misappropriation of trade secrets, and misappropriation of confidential information, in connection with the defendants’ planned investment. At a hearing on August 21, 2017, the Chancery Court denied Alarm.com’s motion for expedited proceedings and a temporary restraining order enjoining ABS Capital Partner Inc.’s planned transaction with ipDatatel and Resolution Products. On September 22, 2017, Alarm.com filed an amended complaint against ABS Capital Partners, Inc., ABS Partners V, LLC, and ABS Partners VII, LLC, alleging claims for misappropriation of trade secrets and misappropriation of confidential information. The amended complaint seeks damages, declaratory relief, and injunctive relief enjoining ABS Capital Partners, Inc., ABS Partners V, LLC, and ABS Partners VII, LLC from using Alarm.com’s trade secrets and confidential information to compete with Alarm.com. On October 6, 2017, the defendants filed a motion to dismiss the lawsuit. The matter remains pending.

On April 25, 2017, Alarm.com Incorporated and its wholly owned subsidiary, ICN Acquisition, LLC, filed a patent infringement complaint against Protect America, Inc., or Protect America, and SecureNet Technologies, LLC, or SecureNet, in the United States District Court for the Eastern District of Virginia. The complaint seeks injunctive relief to stop the further sale of the infringing Protect America and SecureNet products and systems, and damages for the infringement of Alarm.com’s patents. The complaint asserts that the technology in the Protect America and SecureNet Alarm Systems products infringe one or more claims of Alarm.com’s patents: United States Patent Numbers 7,113,090; 7,633,385; 8,395,494; 8,493,202; 8,612,591; 8,860,804; and 9,141,276. If the litigation is successful, Alarm.com will be entitled to receive monetary damages, injunctive relief, and any other relief, including attorney’s fees, from Protect America and SecureNet. In June 2017, Alarm.com filed an amended complaint against Protect America only and voluntarily dismissed SecureNet from the suit, reserving the right to refile. In September 2017, Alarm.com voluntarily dismissed the amended complaint in the United States District Court for the Eastern District of Virginia and refiled a complaint against Protect America, with substantially the same allegations, in the United States District Court for the Eastern District of Texas. The Court has not yet issued a scheduling order. Protect America has not yet answered the complaint or asserted counterclaims and defenses.

On August 24, 2017, Alarm.com Incorporated and its wholly owned subsidiary, ICN Acquisition, LLC, filed a patent infringement complaint against ipDatatel, in the United States District Court for the Eastern District of Texas. The complaint seeks injunctive relief to stop the further sale of the infringing ipDatatel’s products and systems, and damages for the infringement of Alarm.com’s patents. The complaint asserts that the technology in the ipDatatel products infringe one or more claims of Alarm.com’s patents: United States Patent Numbers 7,113,090; 7,633,385; 7,956,736; 8,478,871; and 9,141,276. If the litigation is successful, Alarm.com will be entitled to receive monetary damages, injunctive relief, and any other relief, including attorney’s fees, from ipDatatel.  The Court has not yet issued a scheduling order. ipDatatel has not yet answered the complaint or asserted counterclaims and defenses.

22


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016


On June 2, 2015, Vivint, Inc., or Vivint, filed a lawsuit against us in U.S. District Court, District of Utah, alleging that our technology directly and indirectly infringes six patents that Vivint purchased. Vivint is seeking permanent injunctions, enhanced damages and attorney’s fees. We answered the complaint on July 23, 2015. Among other things, we asserted defenses based on non-infringement and invalidity of the patents in question. On August 19, 2016, the U.S. District Court, District of Utah stayed the litigation pending inter partes review, or IPR, by the U.S. Patent Trial and Appeal Board, or PTAB, of five of the patents in suit.  In March of 2017, the PTAB issued final written decisions relating to two patents finding all challenged claims unpatentable. In May of 2017, the PTAB issued final written decisions relating to the remaining patents that found certain claims unpatentable, while certain other claims were not found to be unpatentable. Vivint has appealed the decisions to the U.S. Court of Appeals for the Federal Circuit, and we have cross-appealed. The U.S. District Court, District of Utah lifted the stay on the litigation on June 26, 2017, and Vivint is proceeding with its case on four of the six patents in its complaint. A trial date has not yet been scheduled. In September 2017, the U.S. Patent and Trademark Office ordered ex parte reexaminations of certain claims of two of the remaining patents in suit, at our request.

Should Vivint prevail on its claims that one or more elements of our solution infringe one or more of its patents, we could be required to pay damages of Vivint’s lost profits and/or a reasonable royalty for sales of our solution, enjoined from making, using and selling our solution if a license or other right to continue selling such elements is not made available to us or we are unable to design around such patents, and required to pay ongoing royalties and comply with unfavorable terms if such a license is made available to us. The outcome of the legal claim and proceeding against us cannot be predicted with certainty. We believe we have valid defenses to Vivint’s claims. Based on currently available information, we determined a loss is not probable or reasonably estimable at this time.

On December 30, 2015, a putative class action lawsuit was filed against us in the U.S. District Court for the Northern District of California, alleging violations of the Telephone Consumer Protection Act, or TCPA. The complaint does not allege that Alarm.com itself violated the TCPA, but instead seeks to hold us responsible for the marketing activities of our service provider partners under principles of agency and vicarious liability. The complaint seeks monetary damages under the TCPA, injunctive relief, and other relief, including attorney’s fees. We answered the complaint on February 26, 2016. On May 5, 2017, the court granted plaintiffs' motion for class certification. Discovery is underway, and the matter remains pending in the U.S. District Court for the Northern District of California. Based on the current schedule, we anticipate a trial will take place at the end of 2018. Based on currently available information, we determined a loss is not probable or reasonably estimable at this time.

On February 9, 2016, we were sued along with one of our service provider partners in the Circuit Court for the City of Virginia Beach, Virginia by the estate of a deceased service provider partner customer alleging wrongful death, among other claims. The suit seeks a total of $7 million in compensatory damages and $350,000 in punitive damages. We filed our answer on March 22, 2016. Discovery is underway, and the matter remains pending. The Court has scheduled trial to begin on July 10, 2018.

On March 21, 2017, Taraneh Vessal filed a complaint against us and Monitronics International, Inc. in the United States District Court for the Northern District of Illinois, alleging violation of the TCPA and the Illinois Consumer Fraud and Deceptive Business Practices Act, or ICFDBA. We filed a motion to dismiss the complaint on May 12, 2017. Plaintiff filed her First Amended Complaint on June 2, 2017, alleging similar violations of the TCPA and ICFDBA. We filed a motion to dismiss the First Amended Complaint on June 16, 2017, and Plaintiff filed her response on July 31, 2017. We filed our reply on August 21, 2017. On October 18, 2017, the Court granted our motion to dismiss the claims with respect to violations of the ICFDBA without prejudice, but allowed the claims with respect to the TCPA to proceed. Discovery has commenced, and the matter remains pending. Based on currently available information, we determined a loss is not probable or reasonably estimable at this time.

In September 2014, Icontrol, filed a Complaint in the United States District Court, District of Delaware, asserting that Zonoff Inc., or Zonoff, infringes certain U.S. Patents owned by Icontrol, all of which are now owned by Alarm.com through a subsidiary. In November, 2015, Icontrol filed a second lawsuit, also in the United States District Court, District of Delaware, alleging that Zonoff infringes additional U.S. Patents owned by Icontrol, now owned by Alarm.com through a subsidiary. The Court held a claim construction hearing in the first case on March 14, 2016 and consolidated the cases on August 1, 2016. Zonoff has not filed any proceedings at the United States Patent Office, or asserted any counterclaims. Because Zonoff has ceased business operations, Court has declined to enter a schedule for the remainder of the case.

In September 2014, Icontrol filed a Complaint in the United States District Court, District of Delaware, asserting that SecureNet infringes certain U.S. Patents owned by Icontrol, patents now owned by Alarm.com through a subsidiary. In March, 2015, Icontrol voluntarily agreed to dismiss the case, reserving the right to refile. In September, 2015, Icontrol refiled the case against SecureNet in the same district court alleging infringement of some of the same patents. SecureNet filed petitions for inter partes review of the patents-in-suit before the PTAB. Proceedings as to one of the patents in suit has been instituted. The PTAB has rejected the remaining applications for inter partes review, and SecureNet has appealed the rejection as to one of the patents in suit. The Court has scheduled a claim construction hearing for March 20, 2018 and commencement of trial on February 4, 2019.


23


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016

From time to time, we may be a party to litigation and subject to claims incident to the ordinary course of business. Although the results of litigation and claims cannot be predicted with certainty, we currently believe that the final outcome of these ordinary course matters will not have a material adverse effect on our business.

Other than the preceding matters, we are not a party to any lawsuit or proceeding that, in the opinion of management, is reasonably possible or probable of having a material adverse effect on our financial position, results of operations or cash flows. We reserve for contingent liabilities based on ASC 450, “ Contingencies ,” when it is determined that a liability, inclusive of defense costs, is probable and reasonably estimable. Litigation is subject to many factors that are difficult to predict, so there can be no assurance that, in the event of a material unfavorable result in one or more claims, we will not incur material costs.

Note 12. Stock-Based Compensation

Stock-based compensation expense is included in the following line items in the accompanying condensed consolidated statements of operations (in thousands):
    
 
Three Months Ended 
 September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Sales and marketing
$
181

 
$
130

 
$
359

 
$
422

General and administrative
584

 
444

 
1,908

 
907

Research and development
1,141

 
512

 
2,867

 
1,551

Total stock-based compensation expense
$
1,906

 
$
1,086

 
$
5,134

 
$
2,880


The following table summarizes the components of non-cash stock-based compensation expense (in thousands):
    
 
Three Months Ended 
 September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Stock options and assumed options
$
939

 
$
1,030

 
$
3,005

 
$
2,787

Restricted stock units
936

 
34

 
2,029

 
34

Restricted stock awards

 

 
19

 

Employee stock purchase plan
31

 
22

 
81

 
59

Total stock-based compensation expense
$
1,906

 
$
1,086

 
$
5,134

 
$
2,880

Tax benefit from stock-based awards
$
6,059

 
$
2,221

 
$
11,645

 
$
2,680


We granted 8,050 and 245,600 stock options pursuant to our 2015 Equity Incentive Plan during the three and nine months ended September 30, 2017 , respectively, as compared to 12,600 and 588,900 stock options for the same periods in the prior year. There were 425,376 and 943,797 stock options exercised during the three and nine months ended September 30, 2017 , respectively, as compared to 241,165 and 321,286 for the same periods in the prior year. We granted 40,150 and 367,350 restricted stock units during the three and nine months ended September 30, 2017 , respectively, as compared to 25,640 restricted stock units for each of the same periods in the prior year.

24


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016


Note 13. Earnings Per Share

Basic and Diluted Earnings Per Share

The components of basic and diluted earnings per share, or EPS, are as follows (in thousands, except share and per share amounts):
    
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2017
 
2016
 
2017
 
2016
Net income
$
15,103

 
$
2,567

 
$
28,931

 
$
7,178

Less: income allocated to participating securities
(6
)
 
(3
)
 
(14
)
 
(10
)
Net income attributable to common stockholders (A)
$
15,097

 
$
2,564

 
$
28,917

 
$
7,168

Weighted average common shares outstanding — basic (B)
46,886,345

 
45,716,961

 
46,520,469

 
45,615,399

Dilutive effect of stock options, RSUs and RSAs
2,373,356

 
2,602,991

 
2,553,810

 
2,125,966

Weighted average common shares outstanding — diluted (C)
49,259,701

 
48,319,952

 
49,074,279

 
47,741,365

Net income per share:
 
 
 
 
 
 
 
Basic (A/B)
$
0.32

 
$
0.06

 
$
0.62

 
$
0.16

Diluted (A/C)
$
0.31

 
$
0.05

 
$
0.59

 
$
0.15


The following securities have been excluded from the calculation of diluted weighted average common shares outstanding because the effect is anti-dilutive:
    
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2017
 
2016
 
2017
 
2016
Stock options
189,117

 
112,350

 
318,917

 
132,350

RSAs
192

 

 
192

 

RSUs

 
25,640

 
39,350

 
25,640

Common stock subject to repurchase
16,716

 
34,678

 
16,716

 
34,678


Participating securities are composed of certain stock options granted under the 2015 Equity Incentive Plan, and previously granted under the 2009 Equity Incentive Plan, that may be exercised before the options have vested. Unvested shares have a non-forfeitable right to dividends. Unvested shares issued as a result of early exercise are subject to repurchase by us upon termination of employment or services at the original exercise price. The common stock subject to repurchase is no longer classified as participating securities when shares revert to common stock outstanding as the awards vest and our repurchase right lapses.

Note 14. Significant Service Provider Partners

During the three and nine months ended September 30, 2017 , our 10 largest revenue service provider partners accounted for 60% of our revenue, as compared to 60% and 61% for the same periods in the prior year. One of our service provider partners individually represented greater than 10% but not more than 15% of our revenue for the three months ended September 30, 2017 . One of our service provider partners individually represented greater than 15% but not more than 20% of our revenue for the three months ended September 30, 2017 . Two of our service provider partners individually represented greater than 10% but not more than 15% of our revenue for the nine months ended September 30, 2017 . One of our service provider partners individually represented greater than 10% but not more than 15% of our revenue for the three and nine months ended September 30, 2016 .

One individual service provider partner represented more than 10% of accounts receivable as of September 30, 2017 . No individual service provider partner represented more than 10% of accounts receivable as of December 31, 2016 .

25


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016


Note 15. Income Taxes

For purposes of interim reporting, our annual effective income tax rate is estimated in accordance with ASC 740-270, "Interim Reporting." This rate is applied to the pre-tax book income of the entities expected to be benefited during the year. Discrete items that impact the tax provision were recorded in the period incurred.

Our effective income tax rate was (49.8)% and (45.0)% for the three and nine months ended September 30, 2017 , respectively, as compared to 12.2% and 29.0% for the same periods in the prior year. Our effective tax rate was below the statutory rate primarily due to recognizing the tax windfall benefits from employee stock-based payment transactions through the income statement provision for income taxes in the period incurred, as well as the research and development tax credits claimed, partially offset by the impact of state taxes and non-deductible meal and entertainment expenses. We adopted the accounting provision that simplified the tax for employee-stock based exercises in the first quarter of 2017. Prior to adoption of the new accounting provision, tax windfall benefits were required to be recorded in additional paid-in capital.

We recognize a valuation allowance if, based on the weight of available evidence, both positive and negative, it is more likely than not that some portion, or all, of net deferred tax assets will not be realized. Based on our historical and expected future taxable earnings, we believe it is more likely than not that we will realize all of the benefit of the existing deferred tax assets as of September 30, 2017 and December 31, 2016 . Accordingly, we have not recorded a valuation allowance as of September 30, 2017 and December 31, 2016 .

We apply guidance for uncertainty in income taxes that requires the application of a more likely than not threshold to the recognition and de-recognition of uncertain tax positions. If the recognition threshold is met, this guidance permits us to recognize a tax benefit measured at the largest amount of the tax benefit that, in our judgment, is more likely than not to be realized upon settlement. There was no net change recorded to the unrecognized tax benefit related to research and development tax credits for the three months ended September 30, 2017 . We recorded an unrecognized tax benefit of $0.2 million for research and development tax credits claimed during the nine months ended September 30, 2017 . For the three and nine months ended September 30, 2017 , we recorded interest for the period on prior year research and development tax credits we claimed. As of September 30, 2017 and December 31, 2016 , we had accrued less than $0.1 million of total interest expense related to unrecognized tax benefits. We recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense.

We are not aware of any events that make it reasonably possible that there would be a significant change in our unrecognized tax benefits over the next 12 months. Our cumulative liability for uncertain tax positions was $0.9 million and $0.7 million as of September 30, 2017 and December 31, 2016 , respectively, and if recognized, would reduce our income tax expense and the effective tax rate.

Note 16 . Segment Information

We have two reportable segments:

Alarm.com segment

Other segment

Our chief operating decision maker is our chief executive officer. Management determined the operational data used by the chief operating decision maker is that of the two reportable segments. Management bases strategic goals and decisions on these segments and the data presented below is used to measure financial results.

Our Alarm.com segment represents our cloud-based platform for the intelligently connected property and related solutions that contributed 94% of our revenue for the three and nine months ended September 30, 2017 and 2016 . Our Other segment is focused on researching, developing and offering home and commercial automation solutions and energy management products and services in adjacent markets. Inter-segment revenue includes sales of hardware between our segments.

26


ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued)
September 30, 2017 and 2016


Management evaluates the performance of its segments and allocates resources to them based on operating income as compared to prior periods and current performance levels. The reportable segment operational data is presented in the table below (in thousands):
 
Three Months Ended September 30, 2017
 
Alarm.com
 
Other
 
Intersegment
Alarm.com
 
Intersegment
Other
 
Total
Revenue
$
85,287

 
$
6,311

 
$
(794
)
 
$
(842
)
 
$
89,962

Operating income
12,500

 
(2,095
)
 
(11
)
 
7

 
10,401

 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2016
 
Alarm.com
 
Other
 
Intersegment
Alarm.com
 
Intersegment
Other
 
Total
Revenue
$
64,420

 
$
5,355

 
$
(700
)
 
$
(1,229
)
 
$
67,846

Operating income
4,930

 
(2,024
)
 
(62
)
 
(9
)
 
2,835

 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2017
 
Alarm.com
 
Other
 
Intersegment
Alarm.com
 
Intersegment
Other
 
Total
Revenue
$
237,137

 
$
16,198

 
$
(1,939
)
 
$
(1,252
)
 
$
250,144

Operating income
27,903

 
(7,302
)
 
(68
)
 
249

 
20,782

 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30, 2016
 
Alarm.com
 
Other
 
Intersegment
Alarm.com
 
Intersegment
Other
 
Total
Revenue
$
182,205

 
$
13,289

 
$
(2,040
)
 
$
(2,142
)
 
$
191,312

Operating income
16,173

 
(6,259
)
 
(188
)
 
178

 
9,904

 
 
 
 
 
 
 
 
 
 
 
Alarm.com
 
Other
 
Intersegment
Alarm.com
 
Intersegment
Other
 
Total
Assets as of September 30, 2017
$
355,516

 
$
19,142

 
$

 
$

 
$
374,658

Assets as of December 31, 2016
246,798

 
14,447

 

 

 
261,245


We derived substantially all revenue from North America for the three and nine months ended September 30, 2017 and 2016 . Substantially all of our long-lived assets were located in North America as of September 30, 2017 and December 31, 2016 .

Note 17. Related Party Transactions

Installation Partner

Our installation partner in which we have a 48.2% ownership interest performs installation services for security dealers and also provides installation services for us and certain of our subsidiaries. On December 11, 2015, we purchased an additional 9,290 common units of the same company for $0.2 million , which did not change our proportional share of ownership interest. We account for this investment using the equity method. We recorded $0.1 million and $0.6 million of cost of hardware and other revenue in connection with this installation partner for the three and nine months ended September 30, 2017 , respectively, as compared to $0.2 million and $0.9 million for the same periods in the prior year. As of September 30, 2017 and December 31, 2016 , the accounts payable balance to our installation partner was less than $0.1 million and $0.1 million . In September 2014, we loaned $0.3 million to our installation partner under a secured promissory note that accrues interest at 8.0% . Interest is payable monthly with the entire principal balance plus accrued but unpaid interest due at maturity in September 2018. We recorded less than $0.1 million of interest income related to this note receivable for the three and nine months ended September 30, 2017 and 2016 .

27


ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations together with (1) our condensed consolidated financial statements and the related notes and other financial information included elsewhere in this Quarterly Report on Form 10-Q and (2) the audited consolidated financial statements and the related notes and management’s discussion and analysis of financial condition and results of operations for the fiscal year ended December 31, 2016 included in our Annual Report on Form 10-K filed on March 16, 2017 with the Securities and Exchange Commission, or the SEC. This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements are often identified by the use of words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “will,” “would” or the negative or plural of these words or similar expressions or variations. Such forward-looking statements are subject to a number of risks, uncertainties, assumptions and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified in this Quarterly Report on Form 10-Q and those discussed in the section titled “Risk Factors” set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our other Securities and Exchange Commission, or SEC, filings. You should not rely upon forward-looking statements as predictions of future events. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.

Overview

Alarm.com is the leading platform for the intelligently connected property. We offer a comprehensive suite of cloud-based solutions for the smart home and business, including interactive security, video monitoring, intelligent automation and energy management. Millions of property owners rely on our technology to intelligently secure, monitor and manage their homes and businesses. In the last year alone, our platform processed more than 30 billion data points generated by over 35 million connected devices. We believe that this scale of subscribers, connected devices and data operations makes us the leader in the connected property market.

Our solutions are delivered through an established network of over 6,000 trusted service providers, who are experts at selling, installing and supporting our solutions. We primarily generate Software-as-a-Service, or SaaS, and license revenue through our service provider partners, who resell these services and pay us monthly fees. Our service provider partners have indicated that they typically have three to five year service contracts with home or business owners, whom we call subscribers. We believe that the length of these contracts, combined with our robust SaaS platform and over a decade of operating experience, contribute to a compelling business model. We also generate hardware and other revenue, primarily from our service provider partners and distributors. Our hardware sales include gateway modules and other connected devices that enable our services, such as video cameras and smart thermostats.

Our technology platform is designed to make connected properties safer, smarter and more efficient. Our solutions are used in both smart homes and businesses, which we refer to as the connected property market and we have designed our technology platform for all market participants. This includes not only the home and business owners who subscribe to our services, but also the hardware partners who manufacture devices that integrate with our platform and the service provider partners who install and maintain our solutions.

Alarm.com service provider partners can deploy our interactive security, video monitoring, intelligent automation and energy management solutions as standalone offerings or as combined solutions to address the needs of a broad range of customers. Our technology enables subscribers to seamlessly connect to their property through our family of mobile apps, websites, and new engagement platforms like voice control through Amazon Echo, wearable devices like the Apple Watch, and TV platforms such as Apple TV and Amazon Fire TV.

Highlights of Third Quarter Results

We primarily generate SaaS and license revenue, our largest source of revenue, through our service providers who resell our services and pay us monthly fees. Our service providers sell, install and support Alarm.com solutions that enable home and business owners to intelligently secure, connect, control and automate their properties. Our service providers have indicated that they typically have three to five year service contracts with home or business owners, whom we call subscribers. We derive a portion of our revenue from licensing our intellectual property to service providers on a per customer basis. We also generate SaaS and license revenue from monthly fees charged to service providers on a per subscriber basis for access to our newly-acquired Connect platform. The Connect software for interactive security, automation and related solutions is typically deployed and operated by the service provider in its own network operations center. SaaS and license revenue represented 69% and 66% of our revenue in the third quarter of 2017 and 2016 and 68% and 66% of our revenue for the first nine months of 2017 and 2016 .

We also generate revenue from the sale of hardware, including cellular radio modules, video cameras, image sensors, thermostats and other peripherals, that enables our solutions. We have a rich history of innovation in cellular technology that

28


enables our robust SaaS offering. Hardware and other revenue represented 31% and 34% of our revenue in the third quarter of 2017 and 2016 and 32% and 34% of our revenue in the first nine months of 2017 and 2016 . We typically expect hardware and other revenue to fluctuate as a percentage of total revenue.

We believe there is significant opportunity to expand our international business, as approximately 1% percent of our total revenue in the first nine months of 2017 originated from customers located outside of North America. Our products are currently localized and available in 32 countries outside of North America.

Highlights of our financial performance for the periods covered in this report include:

SaaS and license revenue increase d 39% to $61.9 million in the third quarter of 2017 , from $44.6 million in the third quarter of 2016 . SaaS and license revenue increase d 35% to $171.1 million in the first nine months of 2017 , from $126.7 million in the first nine months of 2016 .

Revenue increase d 33% to $90.0 million in the third quarter of 2017 , from $67.8 million in the third quarter of 2016 . Revenue increase d 31% to $250.1 million in the first nine months of 2017 , from $191.3 million in the first nine months of 2016 .

Net income increase d to $15.1 million in the third quarter of 2017 , from $2.6 million in the third quarter of 2016 . Net income increase d to $28.9 million in the first nine months of 2017 , from $7.2 million in the first nine months of 2016 .

Adjusted EBITDA, a non-GAAP measurement of operating performance, increase d to $19.5 million in the third quarter of 2017 , from $11.8 million in the third quarter of 2016 . Adjusted EBITDA increase d to $49.5 million in the first nine months of 2017 , from $34.7 million in the first nine months of 2016 .

Please see Non-GAAP Measures below in this section of this Quarterly Report for a discussion of the limitations of Adjusted EBITDA (a non-GAAP measure) and a reconciliation of Adjusted EBITDA to net income, the most comparable measurement in accordance with generally accepted accounting principles in the United States, or GAAP, for the third quarter and the first nine months of 2017 and 2016 .

Other Business Metrics

We regularly monitor a number of financial and operating metrics in order to measure our current performance and estimate our future performance. Our other business metrics may be calculated in a manner different than similar other business metrics used by other companies and include the following (dollars in thousands):
    
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2017
 
2016
 
2017
 
2016
SaaS and license revenue
$
61,924

 
$
44,630

 
$
171,078

 
$
126,652

Adjusted EBITDA
19,478

 
11,821

 
49,462

 
34,723

 
 
 
 
 
 
 
 
 
 
 
 
 
Twelve Months Ended September 30,
 
 
 
 
 
2017
 
2016
SaaS and license revenue renewal rate
 
 
 
 
93
%
 
94
%

SaaS and License Revenue

We believe that SaaS and license revenue is an indicator of the productivity of our existing service provider partners and their ability to activate and maintain subscribers using our intelligently connected property solutions, our ability to add new service provider partners reselling our solutions, the demand for our intelligently connected property solutions, and the pace at which the market for these solutions is growing.

Adjusted EBITDA

Adjusted EBITDA represents our net income before interest expense, other income, net , amortization and depreciation expense, stock-based compensation expense, acquisition-related expense and legal costs incurred in connection with non-ordinary course litigation, particularly costs involved in ongoing intellectual property litigation. We do not consider these items to be indicative of our core operating performance. The non-cash items include amortization and depreciation expense and stock-based compensation expense. We do not adjust for ordinary course legal expenses resulting from maintaining and enforcing our intellectual property portfolio and license agreements.


29


Adjusted EBITDA is a key measure that our management uses to understand and evaluate our core operating performance and trends to generate future operating plans, to make strategic decisions regarding the allocation of capital, and to make investments in initiatives that are focused on cultivating new markets for our solutions. In particular, the exclusion of certain expenses in calculating Adjusted EBITDA facilitates comparisons of our operating performance on a period-to-period basis and, in the case of exclusion of acquisition-related adjustments and certain historical legal expenses, excludes items that we do not consider to be indicative of our core operating performance. Adjusted EBITDA is not a measure calculated in accordance with GAAP and should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with GAAP. Please see Non-GAAP Measures in this section for a discussion of the limitations of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income, the most comparable GAAP measurement, for the third quarter and first nine months of 2017 and 2016 .

SaaS and License Revenue Renewal Rate

We measure our SaaS and license revenue renewal rate on a trailing 12-month basis by dividing (a) the total SaaS and license revenue recognized during the trailing 12-month period from our subscribers on one of our platforms who were subscribers on the first day of the period, by (b) total SaaS and license revenue we would have recognized during the period from those same subscribers assuming no terminations, or service level upgrades or downgrades. The SaaS and license revenue renewal rate represents both residential and commercial properties. Our SaaS and license revenue renewal rate is expressed as an annualized percentage. Our service provider partners, who resell our services to our subscribers, have indicated that they typically have three to five year service contracts with our subscribers. Our SaaS and license revenue renewal rate is calculated across our entire subscriber base, including subscribers whose contract with their service provider reached the end of its contractual term during the measurement period, as well as subscribers whose contract with their service provider has not reached the end of its contractual term during the measurement period, and is not intended to estimate the rate at which our subscribers renew their contracts with our service provider partners. We believe that our SaaS and license revenue renewal rate allows us to measure our ability to retain and grow our SaaS and license revenue and serves as an indicator of the lifetime value of our subscriber base.

Components of Operating Results

Our fiscal year ends on December 31 st . The key elements of our operating results include:

Revenue

We generate revenue primarily through the sale of our SaaS solutions over our cloud-based intelligently connected property platform through our service provider partner channel. We also generate revenue from the sale of hardware products that enable our solutions. We generate revenue from the sale of licenses and services to service providers for access to our newly-acquired Connect software platform.

SaaS and License Revenue. We generate the majority of our SaaS and license revenue primarily from monthly recurring fees charged to our service provider partner s sold on a per subscriber basis for access to our cloud-based intelligently connected property platform and related solutions. Our fees per subscriber vary based upon the service plan and features utilized. We enter into contracts with our service provider partner s that establish our pricing as well as other business terms and conditions. These contracts typically have an initial term of one year, with subsequent annual renewal terms. Our service provider partner s typically enter into contracts with their end-user customers, which we refer to as our subscribers, for their engagement with our solutions. Our service provider partner s have indicated that those contracts generally range from three to five years in length.

We also generate SaaS and license revenue from monthly fees charged to service providers on a per subscriber basis for access to our newly-acquired Connect platform. The Connect software for interactive security, automation and related solutions is typically deployed and operated by the service provider in its own network operations center. Our agreements for the Connect platform solution typically include software and services, such as post-contract customer support, or PCS. Under terms in our contractual arrangements with our service provider partners, we are entitled to payment of a monthly fee that is billed per subscriber for the month of service and we recognize revenue over the period of combined service. Our service provider partners typically incur and pay the same monthly fee per subscriber account for the entire period a subscriber account is active.
We offer multiple service level packages for our solutions, including integrated solutions and a range of a la carte add-ons for additional features. The price paid by our service provider partners each month for the delivery of our solutions is based on the combination of packages and add-ons enabled for each subscriber. We use tiered pricing plans under which our service provider partner s may receive prospective pricing discounts driven by volume. We recognize our SaaS and license revenue on a monthly basis as we deliver our solutions to our subscribers.

We define our subscribers as the number of residential or commercial properties to which we are delivering at least one of our solutions. A subscriber who subscribes to one of our service level packages as well as one or more of our a la carte add-ons is counted as one subscriber. The number of subscribers represents our number of subscribers, rounded to the nearest

30


thousand, on the last day of the applicable year. Our number of subscribers does not include the customers of our service provider partners to whom we license our intellectual property as they do not utilize one of our platforms.

We also generate SaaS and license revenue from the fees paid to us when we license our intellectual property to service provider partner s on a per customer basis for use of our patents. In November 2013, we entered into a license agreement with Vivint Inc., or Vivint, who represented at least 10% but not more than 15% of our revenue in 2014, pursuant to which we granted Vivint a license to use the intellectual property associated with our intelligently connected property solutions. Vivint began generating customers and paying us license revenue in the second quarter of 2014. Pursuant to this arrangement, Vivint has transitioned from selling our SaaS solutions directly to its customers to selling its own home automation product to its new customers, and we receive less revenue from Vivint from license fees as compared to revenue received from its subscribers that continue to utilize our SaaS platform. Additionally, in certain markets, our EnergyHub subsidiary sells its demand response software with an annual service fee, with pricing based on the number of subscribers or amount of aggregate electricity demand made available for a utility’s or market’s control.

Hardware and Other Revenue. We generate hardware and other revenue from the sale of cellular radio modules that provide access to our cloud-based platform, from the sale of video cameras and from the sale of other devices, including image sensors and peripherals. We sell hardware to our service provider partner s as well as distributors. The purchase of hardware occurs in a transaction that is separate and typically in advance of the purchase of our platform services. We recognize hardware and other revenue when the hardware is delivered to our service provider partner s or distributors, net of a reserve for estimated returns. Our terms for hardware sales typically allow service provider partner s to return hardware up to one year past the date of original sale.

Hardware and other revenue also includes activation fees charged to service provider partner s for activation of a subscriber’s account on our platform. We record activation fees initially as deferred revenue and we recognize these fees on a straight-line basis over an estimated life of the subscriber relationship, which is currently ten years. Hardware and other revenue also includes fees paid by service provider partner s for our marketing services.

Cost of Revenue

Our cost of SaaS and license revenue primarily includes the amounts paid to wireless network providers and, to a lesser extent, the costs of running our network operating centers. We record the salaries and benefits of the department dedicated to providing service exclusively to a specific service provider for the Connect platform to cost of SaaS and license revenue. Our cost of hardware and other revenue primarily includes cost of raw materials and amounts paid to our third-party manufacturer for production and fulfillment of our cellular radio modules and image sensors, and procurement costs for our video cameras, which we purchase from an original equipment manufacturer, and other devices.

We record the cost of SaaS and license revenue as expenses are incurred, which corresponds to the delivery period of our services to our subscribers. We record the cost of hardware and other revenue when the hardware and other services are delivered to the service provider partner, which is when title transfers. Our cost of revenue excludes amortization and depreciation. We expect our cost of revenue to increase on an absolute dollar basis primarily from anticipated growth in SaaS and license revenue.

Operating Expenses

Our operating expenses consist of sales and marketing, general and administrative, research and development, and amortization and depreciation expenses. Salaries, bonuses, stock-based compensation, benefits and other personnel related costs are the most significant components of each of these expense categories, excluding amortization and depreciation. We include stock-based compensation expense in connection with the grant of stock options and other forms of equity compensation in the applicable operating expense category based on the respective equity award recipient’s function (sales and marketing, general and administrative or research and development). We grew from 507 employees as of January 1, 2016 to 785 employees as of September 30, 2017 , and we expect to continue to hire new employees to support future growth of our business.

Sales and Marketing Expense.   Sales and marketing expense consists primarily of personnel and related expenses for our sales and marketing teams, including salaries, bonuses, stock-based compensation, benefits, travel, and commissions. Our sales and marketing teams engage in sales, account management, service provider partner support, advertising, promotion of our products and services and marketing.

The number of employees in sales and marketing functions grew from 188 as of January 1, 2016 to 249 as of September 30, 2017 . We expect to continue to invest in our sales and marketing activities to expand our business both domestically and internationally and, as a result, expect our sales and marketing expense to increase on an absolute dollar basis and remain relatively flat as a percentage of our total revenue in the short term. We intend to increase the size of our sales force and our service provider partner support team to provide additional support to our existing service provider partner base to drive their productivity in selling our solutions as well as to enroll new service provider partners in North America and in international

31


markets. We also intend to increase our marketing investments in the form of marketing programs, trade shows and training to support our service provider partners’ efforts to enroll new subscribers and expand the adoption of our solutions.

General and Administrative Expense.   General and administrative expense consists primarily of personnel and related expenses for our administrative, legal, information technology, human resources, finance and accounting personnel, including salaries, bonuses, stock-based compensation, benefits and other personnel costs. Additional expenses included in this category are legal costs, including those that are incurred to defend and license our intellectual property, as well as non-personnel costs, such as travel related expenses, rent, subcontracting and professional fees, audit fees, tax services, and insurance expenses. Also included in general and administrative expenses are acquisition-related expenses, which consist primarily of legal, accounting and professional service fees directly related to acquisitions, valuation gains or losses on acquisition-related contingent liabilities.

The number of employees in general and administrative functions grew from 58 as of January 1, 2016 to 93 as of September 30, 2017 . Excluding intellectual property litigation and acquisition-related costs, we expect general and administrative costs to increase prospectively as our business grows. This includes cost increases related to accounting, finance, and legal personnel, additional external legal, audit fees and other expenses associated with compliance with the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and other regulations governing public companies. Under the JOBS Act, our auditors are not required to report on the effectiveness of our internal control over financial reporting pursuant to Section 404 until the end of the fiscal year ending December 31, 2017, at which time we will no longer qualify as an “emerging growth company” as defined in the JOBS Act because we will qualify as a "large accelerated filer," with at least $700 million of equity securities held by non-affiliates. Compliance with 404 of the Sarbanes-Oxley Act will result in additional external audit fees and consulting fees. While somewhat unpredictable, we also expect to continue to incur costs related to litigation involving intellectual property, as well as acquisition-related costs associated with the acquisition of the Connect and Piper business units from Icontrol, which closed on March 8, 2017, which we refer to as the Acquisition, and the integration of the Connect and Piper business units.

Research and Development Expense . Research and development expense consists primarily of personnel and related expenses for our employees working on our product development and software and device engineering teams, including salaries, bonuses, stock-based compensation, benefits and other personnel costs. Also included are non-personnel costs such as consulting and professional fees paid to third-party development resources.

The number of employees in research and development functions grew from 261 as of January 1, 2016 to 443 as of September 30, 2017 . Our research and development efforts are focused on innovating new features and enhancing the functionality of our platform and the solutions we offer to our service provider partner s and subscribers. We will also continue to invest in efforts to extend our platform to adjacent markets and internationally. We expect research and development expenses to continue to increase on an absolute dollar basis and as a percentage of revenue in the short term to maintain our leadership position in the development of intelligently connected property technology, and continued enhancement of our Enterprise Tools platform for our service provider partners.

Amortization and Depreciation .  Amortization and depreciation consists of amortization of intangible assets originating from our acquisitions as well as our internally-developed capitalized software. Our depreciation expense is related to investments in property and equipment. Acquired intangible assets include developed technology, customer related intangibles, trademarks and trade names. We expect in the near term that amortization and depreciation may fluctuate based on our acquisition activity, development of our platform and capitalized expenditures.

Interest Expense

Interest expense consists of interest expense associated with our revolving credit facility, or the 2014 Facility, with Silicon Valley Bank, or SVB, as administrative agent, and a syndicate of lenders. The 2014 Facility is available to us to refinance existing debt and for general corporate and working capital purposes, including financing the Acquisition and other acquisitions as permitted under the terms of the 2014 Facility. Interest expense is expected to increase in upcoming periods as we have utilized the 2014 Facility for the Acquisition.

Other Income, net

Other income, net consists of our portion of the income or loss from our minority investments in other businesses accounted for under the equity method and interest income earned on our cash and cash equivalents and our notes receivable.










32


Provision for Income Taxes

We are subject to U.S. federal, state and local income taxes as well as foreign income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. As a result, we recognize tax liabilities based on estimates of whether additional taxes will be due. Our effective tax rate was below the statutory rate primarily due to recognizing the tax windfall benefits from employee stock-based payment transactions through the income statement provision for income taxes in the period incurred, as well as the research and development tax credits claimed, partially offset by the impact of state taxes and non-deductible meal and entertainment expenses. We recognize excess tax windfall benefits on a discrete basis in the quarter in which it occurs and we anticipate that our effective tax rate will vary from quarter to quarter depending on our stock price and exercises of stock options under our equity incentive plans each period.

Results of Operations

The following table sets forth our unaudited selected condensed consolidated statements of operations and data as a percentage of revenue for the periods presented (in thousands):     
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2017
 
2016
 
2017
 
2016
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SaaS and license revenue
$
61,924

 
69
 %
 
$
44,630

 
66
 %
 
$
171,078

 
68
 %
 
$
126,652

 
66
 %
Hardware and other revenue
28,038

 
31

 
23,216

 
34

 
79,066

 
32

 
64,660

 
34

Total revenue
89,962

 
100

 
67,846

 
100

 
250,144

 
100

 
191,312

 
100

Cost of revenue (1) :
 
 


 
 
 


 
 
 
 
 
 
 
 
Cost of SaaS and license revenue
9,545

 
11

 
7,787

 
11

 
26,137

 
10

 
21,779

 
11

Cost of hardware and other revenue
22,288

 
25

 
18,579

 
27

 
62,166

 
25

 
50,886

 
27

Total cost of revenue
31,833

 
35

 
26,366

 
39

 
88,303

 
35

 
72,665

 
38

Operating expenses (2) :
 
 


 
 
 


 
 
 
 
 
 
 
 
Sales and marketing
10,426

 
12

 
10,705

 
16

 
32,639

 
13

 
29,532

 
15

General and administrative
12,974

 
14

 
14,804

 
22

 
41,799

 
17

 
42,124

 
22

Research and development
19,257

 
21

 
11,477

 
17

 
53,840

 
22

 
32,224

 
17

Amortization and depreciation
5,071

 
6

 
1,659

 
2

 
12,781

 
5

 
4,863

 
3

Total operating expenses
47,728

 
53

 
38,645

 
57

 
141,059

 
56

 
108,743

 
57

Operating income
10,401

 
12

 
2,835

 
4

 
20,782

 
8

 
9,904

 
5

Interest expense
(658