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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q/A

(Amendment No. 1)

 

 

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2015

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 333-191132-02

 

 

APX Group Holdings, Inc.

(Exact name of Registrant as specified in its charter)

 

 

 

Delaware   46-1304852

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

 

4931 North 300 West

Provo, UT

  84604
(Address of Principal Executive Offices)   (Zip Code)

Registrant’s Telephone Number, Including Area Code: (801) 377-9111

 

 

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.    Yes  ¨    No  x

(Note: From January 1, 2015, the registrant has been a voluntary filer not subject to the filing requirements of Section 13 or 15(d) of the Exchange Act; as a voluntary filer the registrant filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant would have been required to file such reports) as if it were subject to such filing requirements.)

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).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

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

As of May 19, 2015, there were 100 shares of the issuer’s common stock, par value $0.01 per share, issued and outstanding.

 

 

 


Table of Contents

Explanatory Note

APX Group Holdings, Inc. (the “Company”) is filing this Amendment No. 1 (the “Amendment” or “Form 10-Q/A”) to its Quarterly Report on Form 10-Q for the three months ended March 31, 2015 to restate the Company’s unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2015 and 2014 which were included in the Company’s Quarterly Report on Form 10-Q for the three months ended March 31, 2015 (the “Original Form 10-Q”), originally filed with the Securities and Exchange Commission (the “SEC”) on May 19, 2015.

As disclosed in the Company’s Current Report on Form 8-K filed with the SEC on August 4, 2015, the Company determined that its condensed consolidated financial statements as of and for the three month periods ending March 31, 2015 and 2014 contained errors related to the classification of certain subscriber acquisition costs on its Condensed Consolidated Statements of Cash Flows. The Company determined that certain cash payments related to subscriber acquisition costs were improperly classified as investing activities rather than operating activities in its Condensed Consolidated Statements of Cash Flows. These errors do not have any impact on the Company’s previously issued condensed consolidated balance sheets or its statements of operations, or its previously reported total cash flows or Adjusted EBITDA. For further information regarding the restatement and additional changes to previously issued financial statements, See Note 2 – Restatement of Condensed Consolidated Statements of Cash Flows in the accompanying condensed consolidated financial statements.

Accordingly, the following items of the Original Form 10-Q are being amended by this Amendment:

Part I

Item 1. – Unaudited Condensed Consolidated Financial Statements

Item 2. – Management’s Discussion and Analysis of Financial Condition and Results of Operations

Item 4. – Controls and Procedures

This filing does not reflect events occurring after the filing of the Original Form 10-Q except as noted above. Except for the foregoing amended information, this Form 10-Q/A continues to speak as of the date of the Original Form 10-Q and the Company has not otherwise updated disclosures contained therein or herein to reflect events that occurred at a later date.

 

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Table of Contents

APX Group Holdings Inc.

FORM 10-Q

TABLE OF CONTENTS

 

         Page
No.
 

PART I — Financial Information

     5   

Item 1.

  Unaudited Condensed Consolidated Financial Statements      5   
  Unaudited Condensed Consolidated Balance Sheets as of March 31, 2015 and December 31, 2014      5   
  Unaudited Condensed Consolidated Statements of Operations for the three months ended March 31, 2015 and 2014      6   
  Unaudited Condensed Consolidated Statements of Comprehensive Loss for the three months ended March 31, 2015 and 2014      7   
  Unaudited Condensed Consolidated Statements of Cash Flows for the three months ended March 31, 2015 and 2014 (restated)      8   
  Notes to Unaudited Condensed Consolidated Financial Statements      9   

Item 2.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations      33   

Item 3.

  Quantitative and Qualitative Disclosures About Market Risk      47   

Item 4.

  Controls and Procedures      48   

PART II — Other Information

     48   

Item 1.

  Legal Proceedings      48   

Item 1A.

  Risk Factors      49   

Item 2.

  Unregistered Sales of Equity Securities and Use of Proceeds      49   

Item 3.

  Defaults Upon Senior Securities      49   

Item 4.

  Mine Safety Disclosures      49   

Item 5.

  Other Information      50   

Item 6.

  Exhibits      50   

SIGNATURES

     51   

 

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Table of Contents

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

This Amendment No. 1 on Form 10-Q/A to our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2015 includes forward-looking statements regarding, among other things, our plans, strategies and prospects, both business and financial. These statements are based on the beliefs and assumptions of our management. Although we believe that our plans, intentions and expectations reflected in or suggested by these forward-looking statements are reasonable, we cannot assure you that we will achieve or realize these plans, intentions or expectations. Forward-looking statements are inherently subject to risks, uncertainties and assumptions. Generally, statements that are not historical facts, including statements concerning our possible or assumed future actions, business strategies, events or results of operations, are forward-looking statements. These statements may be preceded by, followed by or include the words “believes,” “estimates,” “expects,” “projects,” “forecasts,” “may,” “will,” “should,” “seeks,” “plans,” “scheduled,” “anticipates” or “intends” or similar expressions.

Forward-looking statements are not guarantees of performance. You should not put undue reliance on these statements which speak only as of the date hereof. You should understand that the following important factors, in addition to those discussed in “Risk Factors” and elsewhere in this Form 10-Q/A, could affect our future results and could cause those results or other outcomes to differ materially from those expressed or implied in our forward-looking statements:

 

    risks of the security and home automation industry, including risks of and publicity surrounding the sales, subscriber origination and retention process;

 

    the highly competitive nature of the security and home automation industry and product introductions and promotional activity by our competitors;

 

    litigation, complaints or adverse publicity;

 

    the impact of changes in consumer spending patterns, consumer preferences, local, regional, and national economic conditions, crime, weather, demographic trends and employee availability;

 

    adverse publicity and product liability claims;

 

    increases and/or decreases in utility and other energy costs, increased costs related to utility or governmental requirements; and

 

    cost increases or shortages in security and home automation technology products or components.

In addition, the origination and retention of new subscribers will depend on various factors, including, but not limited to, market availability, subscriber interest, the availability of suitable components, the negotiation of acceptable contract terms with subscribers, local permitting, licensing and regulatory compliance, and our ability to manage anticipated expansion and to hire, train and retain personnel, the financial viability of subscribers and general economic conditions.

These and other factors that could cause actual results to differ from those implied by the forward-looking statements in this Form 10-Q/A are more fully described in the “Risk Factors” section of Amendment No. 1 on Form 1-K/A to our Annual Report on Form 10-K for the fiscal year ended December 31, 2014 and elsewhere in this Amendment No. 1 on Form 10-Q/A to our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2015. The risks described in “Risk Factors” are not exhaustive. Other sections of this Form 10-Q/Adescribe additional factors that could adversely affect our business, financial condition or results of operations. New risk factors emerge from time to time and it is not possible for us to predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor or combination of factors may cause actual results to differ materially from those contained in any forward-looking statements. All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the foregoing cautionary statements. We undertake no obligations to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise

 

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Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1. UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

APX Group Holdings, Inc. and Subsidiaries

Condensed Consolidated Balance Sheets

(In thousands)

 

     March 31,
2015
    December 31,
2014
 
ASSETS    (unaudited)     (audited)  

Current Assets:

    

Cash and cash equivalents

   $ 18,046      $ 10,807   

Restricted cash and cash equivalents

     14,214        14,214   

Accounts receivable, net

     6,901        8,739   

Inventories

     65,852        36,157   

Prepaid expenses and other current assets

     12,842        15,454   
  

 

 

   

 

 

 

Total current assets

     117,855        85,371   

Property and equipment, net

     71,396        62,790   

Subscriber acquisition costs, net

     562,892        548,073   

Deferred financing costs, net

     53,830        52,158   

Intangible assets, net

     665,056        703,226   

Goodwill

     838,968        841,522   

Long-term investments and other assets, net

     10,466        10,533   
  

 

 

   

 

 

 

Total assets

   $ 2,320,463      $ 2,303,673   
  

 

 

   

 

 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Current Liabilities:

    

Accounts payable

   $ 73,790      $ 31,324   

Accrued payroll and commissions

     28,024        37,979   

Accrued expenses and other current liabilities

     59,619        28,862   

Deferred revenue

     32,003        33,226   

Current portion of capital lease obligations

     5,715        5,549   
  

 

 

   

 

 

 

Total current liabilities

     199,151        136,940   

Notes payable, net

     1,862,887        1,863,155   

Revolving line of credit

     32,500        20,000   

Capital lease obligations, net of current portion

     10,236        10,655   

Deferred revenue, net of current portion

     33,079        32,504   

Other long-term obligations

     7,716        6,906   

Deferred income tax liabilities

     8,243        9,027   
  

 

 

   

 

 

 

Total liabilities

     2,153,812        2,079,187   

Commitments and contingencies (See Note 12)

    

Stockholders’ equity:

    

Common stock, $0.01 par value, 100 shares authorized; 100 shares issued and outstanding

     —         —    

Additional paid-in capital

     637,513        636,724   

Accumulated deficit

     (441,321 )     (393,275 )

Accumulated other comprehensive loss

     (29,541 )     (18,963 )
  

 

 

   

 

 

 

Total stockholders’ equity

     166,651        224,486   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 2,320,463      $ 2,303,673   
  

 

 

   

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements

 

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Table of Contents

APX Group Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Operations (unaudited)

(In thousands)

 

     Three Months Ended March 31,  
     2015     2014  

Revenues:

    

Recurring revenue

   $ 145,664      $ 124,554   

Service and other sales revenue

     5,225        4,834   

Activation fees

     1,308        766   
  

 

 

   

 

 

 

Total revenues

     152,197        130,154   

Costs and expenses:

    

Operating expenses (exclusive of depreciation and amortization shown separately below)

     51,330        41,317   

Selling expenses

     25,275        25,579   

General and administrative expenses

     28,234        25,135   

Depreciation and amortization

     57,057        50,352   
  

 

 

   

 

 

 

Total costs and expenses

     161,896        142,383   
  

 

 

   

 

 

 

Loss from operations

     (9,699 )     (12,229 )

Other expenses (income):

    

Interest expense

     38,257        35,640   

Interest income

     —         (552 )

Other (income) expenses, net

     (40 )     (245 )
  

 

 

   

 

 

 

Loss before income taxes

     (47,916 )     (47,072 )

Income tax expense

     130        208   
  

 

 

   

 

 

 

Net loss

   $ (48,046 )   $ (47,280 )
  

 

 

   

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements

 

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APX Group Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Comprehensive Loss (unaudited)

(In thousands)

 

     Three Months Ended March 31,  
     2015     2014  

Net loss

   $ (48,046 )   $ (47,280 )

Other comprehensive loss, net of tax effects:

    

Foreign currency translation adjustment

     (10,578 )     (4,572 )
  

 

 

   

 

 

 

Total other comprehensive loss

     (10,578 )     (4,572 )
  

 

 

   

 

 

 

Comprehensive loss

   $ (58,624 )   $ (51,852 )
  

 

 

   

 

 

 

See accompanying notes to unaudited condensed consolidated financial statements

 

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APX Group Holdings, Inc. and Subsidiaries

Condensed Consolidated Statements of Cash Flows (unaudited)

(In thousands)

 

     Three Months Ended March 31,  
     2015     2014  

Cash flows from operating activities:

    

Net loss

   $ (48,046 )   $ (47,280 )

Adjustments to reconcile net loss to net cash provided by operating activities:

    

Amortization of subscriber acquisition costs

     19,391        10,319   

Amortization of customer relationships

     31,458        35,928   

Depreciation and amortization of other intangible assets

     6,208        4,104   

Amortization of deferred financing costs

     2,292        2,288   

Fire related asset losses

     —         2,853   

Loss on asset impairment

     —         1,351   

Gain on sale or disposal of assets

     (118 )     (151 )

Stock-based compensation

     789        445   

Provision for doubtful accounts

     3,557        2,499   

Non-cash adjustments to deferred revenue

     55        67   

Deferred income taxes

     90        120   

Changes in operating assets and liabilities, net of acquisitions and divestiture:

    

Accounts receivable

     (1,830 )     (2,123 )

Inventories (restated)

     (21,392 )     (14,705 )

Prepaid expenses and other current assets

     (262 )     (6,852 )

Subscriber acquisition costs – deferred contract costs (restated)

     (34,655     (34,390

Accounts payable (restated)

     37,154        16,330   

Accrued expenses and other current liabilities (restated)

     21,844        16,353   

Deferred revenue

     (203 )     1,612   
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities (restated)

     16,332        (11,232

Cash flows from investing activities:

    

Subscriber acquisition costs – company owned equipment (restated)

     (6,846 )     (1,340 )

Capital expenditures (restated)

     (10,002 )     (6,497 )

Proceeds from the sale of capital assets

     188        —    

Acquisition of intangible assets

     (736 )     (2,240 )

Net cash used in Wildfire acquisition

     —         (3,500 )

Change in restricted cash

     —         161   

Proceeds from insurance claims

     2,984        —    

Investment in short-term investments—other

     —         (60,000 )

Investment in convertible note

     —         (3,000 )

Acquisition of other assets

     (67 )     —    
  

 

 

   

 

 

 

Net cash used in investing activities (restated)

     (14,479 )     (76,416 )

Cash flows from financing activities:

    

Borrowings from revolving line of credit

     22,500        —    

Repayments on revolving line of credit

     (10,000 )     —    

Proceeds from contract sales

     —         2,261   

Repayments of capital lease obligations

     (2,280 )     (1,971 )

Deferred financing costs

     (4,233 )     (311 )
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     5,987        (21 )

Effect of exchange rate changes on cash

     (601 )     (174 )
  

 

 

   

 

 

 

Net increase (decrease) in cash

     7,239        (87,843 )

Cash:

    

Beginning of period

     10,807        261,905   
  

 

 

   

 

 

 

End of period

   $ 18,046      $ 174,062   
  

 

 

   

 

 

 

Supplemental non-cash flow disclosure:

    

Capital lease additions

   $ 2,027      $ 3,428   

Capital expenditures included within accounts payable and accrued expenses and other current liabilities (restated)

   $ 2,264      $ 692   

Subscriber acquisition costs – company owned assets included within accounts payable and accrued expenses and other current liabilities (restated)

   $ 6,726      $ 201   

See accompanying notes to unaudited condensed consolidated financial statements

 

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APX Group Holdings, Inc. and Subsidiaries

Notes to Condensed Consolidated Financial Statements (unaudited)

NOTE 1 – BASIS OF PRESENTATION AND SIGNIFICANT ACCOUNTING POLICIES

Unaudited Interim Financial Statements —The accompanying interim unaudited condensed consolidated financial statements included in this Amendment No. 1 on Form 10-Q/A to the Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2015 have been prepared by APX Group Holdings, Inc. and subsidiaries (the “Company”) without audit. Certain information and footnote disclosures normally included in consolidated financial statements prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) have been condensed or omitted pursuant to such rules and regulations. The information as of December 31, 2014 included in the unaudited condensed consolidated balance sheets was derived from the Company’s audited consolidated financial statements. The unaudited condensed consolidated financial statements included in this Amendment No. 1 on Form 10-Q/A to the Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2015 were prepared on the same basis as the audited consolidated financial statements and, in the opinion of management, reflect all adjustments (all of which are considered of normal recurring nature) considered necessary to present fairly the Company’s financial position, results of operations and cash flows for the periods and dates presented. The results of operations for the three months ended March 31, 2015 are not necessarily indicative of the results that may be expected for the year ending December 31, 2015.

These unaudited condensed consolidated financial statements and notes should be read in conjunction with the Company’s audited consolidated financial statements and related notes for the years ended December 31, 2014 and 2013 set forth in Amendment No. 1 on Form 10-K/A to the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, as filed with the Securities and Exchange Commission (“SEC”) on August 10, 2015, which is available on the SEC’s website at sec.gov.

The direct-to-home component of the sales cycle for the Company is seasonal in nature. The Company makes investments in the recruitment of the sales force and inventory for the summer sales period prior to each summer season. The sales season generally runs from late April to the end of August each year. The Company experiences increases in subscriber acquisition costs, as well as costs to support the sales force around North America, during this time period.

Basis of Presentation —The unaudited condensed consolidated financial statements of the Company are presented for APX Group Holdings, Inc. and its wholly-owned subsidiaries.

During the three months ended March 31, 2015, the Company recorded certain out-of-period adjustments totaling $2.0 million, primarily associated with the timing of the recognition of deferred revenue related to 2014 recurring monitoring services. As a result of these adjustments, recurring revenues increased for the three months ended March 31, 2015 and deferred revenue decreased by $2.0 million, respectively. The Company evaluated the impact of the out-of-period adjustments and determined that they are immaterial to the March 31, 2015 unaudited condensed consolidated financial statements.

 

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Changes in Presentation of Comparative Financial Statements —Certain reclassifications have been made to our prior period condensed consolidated financial information in order to conform to the current period presentation. These changes did not have a significant impact on the condensed consolidated financial statements.

Revenue Recognition— The Company recognizes revenue principally on three types of transactions: (i) recurring revenue, which includes revenues for monitoring and other automation services of the Company’s subscriber contracts, certain subscriber contracts that have been sold and recurring monthly revenue associated with the Company’s wireless Internet services, (ii) service and other sales, which includes services provided on contracts, contract fulfillment revenue, sales of products that are not part of the basic equipment package and revenue from 2GIG up through the date of the 2GIG Sale, and (iii) activation fees on the Company’s contracts, which are amortized over the expected life of the customer.

Recurring revenue for the Company’s subscriber contracts are billed in advance, generally monthly, pursuant to the terms of subscriber contracts and recognized ratably over the service period. Costs of providing ongoing recurring services are expensed in the period incurred.

Service and other sales revenue is recognized as services are provided or when title to the products and equipment sold transfers to the customer. Contract fulfillment revenue, included in service and other sales, is recognized when payment is received from customers who cancel their contract in-term. Revenue from sales of products that are not part of the basic equipment package is recognized upon delivery of products.

Activation fees represent upfront one-time charges billed to subscribers at the time of installation and are deferred. These fees are recognized over the estimated customer life of 12 years using a 150% declining balance method, which converts to a straight-line methodology after approximately five years.

Subscriber Acquisition Costs —A portion of the direct costs of acquiring new subscribers, primarily sales commissions, equipment, and installation costs, are deferred and recognized over a pattern that reflects the estimated life of the subscriber relationships. The Company amortizes these costs over 12 years using a 150% declining balance method, which converts to straight-line methodology after approximately five years. The Company evaluates subscriber account attrition on a periodic basis, utilizing observed attrition rates for the Company’s subscriber contracts and industry information and, when necessary, makes adjustments to the estimated subscriber relationship period and amortization method.

On the condensed consolidated statement of cash flows, subscriber acquisition costs that are comprised of equipment and related installation costs purchased for or used in subscriber contracts in which the Company retains ownership to the equipment are classified as investing activities and reported as “Subscriber acquisition costs – company owned equipment”. All other subscriber acquisition costs are classified as operating activities and reported as “Subscriber acquisition costs – deferred contract costs” on the condensed consolidated statements of cash flows as these assets represent deferred costs associated with customer contracts.

Cash and Cash Equivalents— Cash and cash equivalents consists of highly liquid investments with remaining maturities when purchased of three months or less.

Restricted Cash and Cash Equivalents —Restricted cash and cash equivalents is restricted for a specific purpose and cannot be included in the general cash account. At March 31, 2015 and December 31, 2014, the restricted cash and cash equivalents was held by a third-party trustee. Restricted cash and cash equivalents consists of highly liquid investments with remaining maturities when purchased of three months or less.

Accounts Receivable —Accounts receivable consists primarily of amounts due from customers for recurring monthly monitoring services. The accounts receivable are recorded at invoiced amounts and are non-interest bearing. The gross amount of accounts receivable has been reduced by an allowance for doubtful accounts of $2.9 million and $3.4 million at March 31, 2015 and December 31, 2014, respectively. The Company estimates this allowance based on historical collection experience and subscriber attrition rates. When the Company determines that there are accounts receivable that are uncollectible, they are charged off against the allowance for doubtful accounts. As of March 31, 2015 and December 31, 2014, no accounts receivable were classified as held for sale. Provision for doubtful accounts is included in general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations.

 

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The changes in the Company’s allowance for accounts receivable were as follows for the periods ended (in thousands):

 

     Three Months Ended
March 31,
 
     2015      2014  

Beginning balance

   $ 3,373       $ 1,901   

Provision for doubtful accounts

     3,557         2,499   

Write-offs and adjustments

     (4,022 )      (2,763 )
  

 

 

    

 

 

 

Balance at end of period

   $ 2,908       $ 1,637   
  

 

 

    

 

 

 

Inventories —Inventories, which comprise home automation and security system equipment and parts, are stated at the lower of cost or market with cost determined under the first-in, first-out (FIFO) method. The Company records an allowance for excess and obsolete inventory based on anticipated obsolescence, usage and historical write-offs.

Long-lived Assets and Intangibles —Property and equipment are stated at cost and depreciated on the straight-line method over the estimated useful lives of the assets or the lease term for assets under capital leases, whichever is shorter. Intangible assets with definite lives are amortized over the remaining estimated economic life of the underlying technology or relationships, which ranges from 2 to 10 years. Definite-lived intangible assets are amortized on the straight-line method over the estimated useful life of the asset or in a pattern in which the economic benefits of the intangible asset are consumed. Amortization expense associated with leased assets is included with depreciation expense. Routine repairs and maintenance are charged to expense as incurred. The Company periodically assesses potential impairment of its long-lived assets and intangibles and performs an impairment review whenever events or changes in circumstances indicate that the carrying value may not be recoverable. In addition, the Company periodically assesses whether events or changes in circumstance continue to support an indefinite life of certain intangible assets or warrant a revision to the estimated useful life of definite-lived intangible assets.

Long-term Investments —The Company’s long-term investments are comprised of cost based investments in other companies as discussed in Note 4. The Company performs impairment analyses of its cost based investments annually, as of October 1, or more often when events occur or circumstances change that would, more likely than not, reduce the fair value of the investment below its carrying value. When indicators of impairment do not exist and certain accounting criteria are met, the Company evaluates impairment using a qualitative approach. As of March 31, 2015, no indicators of impairment existed associated with these cost based investments.

Deferred Financing Costs —Costs incurred in connection with obtaining debt financing are deferred and amortized utilizing the straight-line method, which approximates the effective-interest method, over the life of the related financing. Deferred financing costs incurred with draw downs on APX Group Inc.’s (“APX”) revolving credit facility will be amortized over the amended maturity dates discussed in Note 3. If such financing is paid off or replaced prior to maturity with debt instruments that have substantially different terms, the unamortized costs are charged to expense. Deferred financing costs included in the accompanying unaudited condensed consolidated balance sheets at March 31, 2015 and December 31, 2014 were $53.8 million and $52.2 million, net of accumulated amortization of $22.6 million and $20.0 million, respectively. Amortization expense on deferred financing costs recognized and included in interest expense in the accompanying unaudited condensed consolidated statements of operations, totaled $2.6 million and $2.5 million for the three months ended March 31, 2015 and 2014, respectively.

Residual Income Plan —The Company has a program that allows third-party sales channel partners to receive additional compensation based on the performance of the underlying contracts they create. The Company calculates the present value of the expected future payments and recognizes this amount in the period the commissions are earned. Subsequent accretion and adjustments to the estimated liability are recorded as interest and operating expense, respectively. The Company monitors actual payments and customer attrition on a periodic basis and, when necessary, makes adjustments to the liability. The amount included in accrued expenses and other current liabilities was $0.4 million at both March 31, 2015 and December 31, 2014, and the amount included in other long-term obligations was $3.2 million and $3.0 million at March 31, 2015 and December 31, 2014, respectively, representing the present value of the estimated amounts owed to third-party sales channel partners.

Stock-Based Compensation —The Company measures compensation cost based on the grant-date fair value of the award and recognizes that cost over the requisite service period of the awards (See Note 11).

 

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Advertising Expense —Advertising costs are expensed as incurred. Advertising costs were approximately $5.3 million and $7.6 million for the three months ended March 31, 2015 and 2014, respectively.

Income Taxes —The Company accounts for income taxes based on the asset and liability method. Under the asset and liability method, deferred tax assets and deferred tax liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Valuation allowances are established when necessary to reduce deferred tax assets when it is determined that it is more likely than not that some portion of the deferred tax asset will not be realized.

The Company recognizes the effect of an uncertain income tax position on the income tax return at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. The Company’s policy for recording interest and penalties is to record such items as a component of the provision for income taxes.

Use of Estimates —The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements. Actual results could differ from those estimates.

Concentrations of Credit Risk —Financial instruments that potentially subject the Company to concentration of credit risk consist principally of receivables and cash. At times during the year, the Company maintains cash balances in excess of insured limits. The Company is not dependent on any single customer or geographic location. The loss of a customer would not adversely impact the Company’s operating results or financial position.

Concentrations of Supply Risk —As of March 31, 2015, approximately 93% of the Company’s installed panels were either 2GIG Go!Control panels or SkyControl panels. On April 1, 2013, the Company completed the sale of 2GIG Technologies, Inc. (“2GIG”) and its subsidiary to Nortek, Inc. (the “2GIG Sale”). In connection with the 2GIG Sale, the Company entered into a five-year supply agreement with 2GIG, pursuant to which they will be the exclusive provider of the Company’s control panel requirements, subject to certain exceptions as provided in the supply agreement. The loss of 2GIG as a supplier could potentially impact the Company’s operating results or financial position.

Fair Value Measurement —Fair value is based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Assets and liabilities subject to on-going fair value measurement are categorized and disclosed into one of three categories depending on observable or unobservable inputs employed in the measurement. These two types of inputs have created the following fair value hierarchy:

Level 1: Quoted prices in active markets that are accessible at the measurement date for assets and liabilities.

Level 2: Observable prices that are based on inputs not quoted in active markets, but corroborated by market data.

Level 3: Unobservable inputs are used when little or no market data is available.

This hierarchy requires the Company to minimize the use of unobservable inputs and to use observable market data, if available, when determining fair value. The Company recognizes transfers between levels of the hierarchy based on the fair values of the respective financial measurements at the end of the reporting period in which the transfer occurred. There were no transfers between levels of the fair value hierarchy during the three months ended March 31, 2015 and 2014.

The carrying amounts of the Company’s accounts receivable, accounts payable and accrued and other liabilities approximate their fair values due to their short maturities.

Goodwill —The Company conducts a goodwill impairment analysis annually in the fourth fiscal quarter, as of October 1, and as necessary if changes in facts and circumstances indicate that the fair value of the Company’s reporting units may be less than its carrying amount. When indicators of impairment do not exist and certain accounting criteria are met, the Company is able to evaluate goodwill impairment using a qualitative approach. When necessary, the Company’s quantitative goodwill impairment test consists of two steps. The first step requires that the Company compare the estimated fair value of its reporting units to the carrying value of the reporting unit’s net assets, including goodwill. If the fair value of the reporting unit is greater than the carrying value of its net assets, goodwill is not considered to be impaired and no further testing is required. If the fair value of the reporting unit is less than the carrying value of its net assets, the Company would be required to complete the second step of the test by analyzing the fair value of its goodwill. If the carrying value of the goodwill exceeds its fair value, an impairment charge is recorded (see Note 7).

 

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Foreign Currency Translation and Other Comprehensive Income —The functional currencies of Vivint Canada, Inc. and Vivint New Zealand, Ltd. are the Canadian and New Zealand dollars, respectively. Accordingly, assets and liabilities are translated from their respective functional currencies into U.S. dollars at period-end rates and revenue and expenses are translated at the weighted-average exchange rates for the period. Adjustments resulting from this translation process are classified as other comprehensive income (loss) and shown as a separate component of equity.

Letters of Credit —As of March 31, 2015 and December 31, 2014, the Company had $3.8 million and $3.0 million, respectively, of letters of credit issued in the ordinary course of business, all of which are undrawn.

New Accounting Pronouncement —In April 2015, the Financial Accounting Standards Board issued authoritative guidance to simplify the presentation of debt issuance costs. This update requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The guidance is effective for fiscal years beginning after December 15, 2015, and for interim periods within fiscal years beginning after December 15, 2016. Early adoption is permitted. The Company is currently evaluating the impact the adoption of this guidance will have on its consolidated financial statements.

In February 2015, the Financial Accounting Standards Board issued authoritative guidance which provides guidance on consolidation of certain legal entities. These updates requires management to change the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. The guidance is effective for fiscal years beginning after December 15, 2016, and for interim periods within fiscal years beginning after December 15, 2017. Early adoption is permitted, and the guidance allows for either a retrospective adoption or a “modified retrospective” approach by recording a cumulative-effect adjustment to equity as of the beginning of the fiscal year of adoption. The Company is currently evaluating the impact the adoption of this guidance will have on its consolidated financial statements.

In August 2014, the Financial Accounting Standards Board issued authoritative guidance which provides guidance on determining when and how to disclose going-concern uncertainties in the financial statements. The new standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. This ASU is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2016, with early adoption permitted. The Company is evaluating the new guidance and plan to provide additional information about its expected impact at a future date.

 

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In May 2014, the FASB issued authoritative guidance which clarifies the principles used to recognize revenue for all entities. The new guidance requires companies to recognize revenue when it transfers goods or services to a customer in an amount that reflects the consideration to which a company expects to be entitled. The guidance is effective for annual and interim periods beginning after December 15, 2016. The guidance allows for either a “full retrospective” adoption or a “modified retrospective” adoption, however early adoption is not permitted. The Company is currently evaluating the impact the adoption of this guidance will have on its consolidated financial statements.

NOTE 2 – RESTATEMENT OF CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

The Company has restated its condensed consolidated statements of cash flows for the three month periods ended March 31, 2015 and 2014 to properly reflect cash paid for subscriber acquisition costs – deferred contract costs as an operating activity as opposed to an investing activity as previously reported. The amounts related to subscriber acquisition costs – deferred contract costs were reclassified as operating activities because those costs represent deferred costs associated with creating customer contracts which is an operating activity. The restated condensed consolidated statements of cash flows for the three month periods ended March 31, 2015 and 2014 also reflects other adjustments to properly exclude non-cash transactions related to subscriber acquisition costs and capital expenditures.

The effect of the revised presentation of net cash flows provided by (used in) operating activities and net cash used in investing activities are presented below (in thousands):

 

     Three Months Ended March 31, 2015      Three Months Ended March 31, 2014  
     Reported      Restated      Reported      Restated  

Inventories

   $ (29,802    $ (21,392    $ (15,305    $ (14,705

Subscriber acquisition costs - deferred contract costs

     —          (34,655      —          (34,390

Accounts payable

     42,503         37,154         16,359         16,330   

Accrued expenses and other current liabilities

     26,928         21,844         17,007         16,353   

Net cash provided by (used in) operating activities

     53,010         16,332         23,241         (11,232

Subscriber acquisition costs - company owned equipment

     (43,154      (6,846      (35,304      (1,340

Capital expenditures

     (10,372      (10,002      (7,006      (6,497

Net cash used in investing activities

     (51,157      (14,479      (110,889      (76,416

Supplemental non-cash investing and financing activities:

           

Capital expenditures included in accrued expenses and other liabilities

   $ —        $ 2,264       $ —        $ 692   

Subscriber acquisition costs - company owned assets included within accounts payable and accrued expenses and other current liabilities

   $ —        $ 6,726       $ —        $ 201   

In addition to the condensed consolidated statements of cash flows, the Company has restated the associated statements of cash flows in the guarantor and non-guarantor supplemental financial information included in the notes to the consolidated financial statements as stated below (in thousands):

 

Three Months Ended March 31,

2015

   Parent      APX
Group, Inc.
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations      Consolidated  

Reported:

              

Net cash (used in) provided by operating activities

   $ —        $ (268 )   $ 44,503      $ 8,775      $ —        $ 53,010   

Subscriber acquisition costs - company owned equipment

     —          —         (41,064 )     (2,090 )     —          (43,154 )

Capital expenditures

     —          —         (10,372 )     —         —          (10,372 )

Net cash used in investing activities

     —          (9,869 )     (49,081 )     (2,076 )     9,869         (51,157 )

 

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Three Months Ended March 31,

2015

   Parent      APX
Group, Inc.
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Consolidated  

Restated:

             

Net cash (used in) provided by operating activities

   $ —        $ (268 )   $ 9,884      $ 6,716      $ —       $ 16,332   

Subscriber acquisition costs - company owned equipment

     —          —         (6,815 )     (31     —         (6,846 )

Capital expenditures

     —          —         (10,002 )     —         —         (10,002 )

Net cash (used in) provided by investing activities

     —          (9,869     (14,462 )     (17     9,869        (14,479 )

Three Months Ended March 31,

2014

   Parent      APX
Group, Inc.
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Consolidated  

Reported:

             

Net cash (used in) provided by operating activities

   $ —        $ (207 )   $ 17,007      $ 6,648      $ (207 )   $ 23,241   

Subscriber acquisition costs - company owned equipment

     —          —         (33,270 )     (2,034 )     —         (35,304 )

Capital expenditures

     —          —         (6,948     (58     —         (7,006

Net cash used in investing activities

     —          (92,984 )     (48,797 )     (2,092 )     32,984        (110,889 )

Restated:

             

Net cash (used in) provided by operating activities

     —          (207 )     (15,432 )     4,614        (207 )     (11,232 )

Subscriber acquisition costs - company owned equipment

     —          —         (1,340 )     —         —         (1,340 )

Capital expenditures

     —          —         (6,439     (58     —         (6,497

Net cash used in investing activities

     —          (92,984 )     (16,358 )     (58 )     32,984        (76,416

NOTE 3 – LONG-TERM DEBT

On November 16, 2012, APX issued $1.3 billion aggregate principal amount of notes, of which $925.0 million aggregate principal amount of 6.375% senior secured notes due 2019 (the “2019 notes”) mature on December 1, 2019 and are secured on a first-priority lien basis by substantially all of the tangible and intangible assets whether now owned or hereafter acquired by the Company, subject to permitted liens and exceptions, and $380.0 million aggregate principal amount of 8.75% senior notes due 2020 (the “2020 notes” and together with the 2019 notes, the “notes”), mature on December 1, 2020.

During 2013, APX completed two offerings of additional 2020 notes under the indenture dated November 16, 2012. On May 31, 2013, the Company issued $200.0 million of 2020 notes at a price of 101.75% and on December 13, 2013, APX issued an additional $250.0 million of 2020 notes at a price of 101.50%.

During 2014, APX issued an additional $100.0 million of 2020 notes at a price of 102.00%.

Interest accrues at the rate of 6.375% per annum for the 2019 notes and 8.75% per annum for the 2020 notes. Interest on the notes is payable semiannually in arrears on each June 1 and December 1. APX may redeem each series of the notes, in whole or part, at any time prior to December 1, 2015 at a redemption price equal to the principal amount of the notes to be redeemed, plus a make-whole premium and any accrued and unpaid interest at the redemption date. In addition, after December 1, 2015, APX may redeem the notes at the prices and on the terms specified in the applicable indenture.

Revolving Credit Facility

On November 16, 2012, APX entered into a $200.0 million senior secured revolving credit facility, with a five year maturity. In addition, APX may request one or more term loan facilities, increased commitments under the revolving credit facility or new revolving credit commitments, in an aggregate amount not to exceed $225.0 million. Availability of such incremental facilities and/or increased or new commitments will be subject to certain customary conditions.

On June 28, 2013, APX amended and restated the credit agreement to provide for a new repriced tranche of revolving credit commitments with a lower interest rate. Nearly all of the existing tranches of revolving credit commitments was terminated and converted into the repriced tranche, with the unterminated portion of the existing tranche continuing to accrue interest at the original rate.

 

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On March 6, 2015, APX amended and restated the credit agreement governing the revolving credit facility to provide for, among other things, (1) an increase in the aggregate commitments previously available to APX thereunder from $200.0 million to $289.4 million and (2) the extension of the maturity date with respect to certain of the previously available commitments.

Borrowings under the amended and restated revolving credit facility bear interest at a rate per annum equal to an applicable margin plus, at APX’s option, either (1) the base rate determined by reference to the highest of (a) the Federal Funds rate plus 0.50%, (b) the prime rate of Bank of America, N.A. and (c) the LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for an interest period of one month, plus 1.00% or (2) the LIBOR rate determined by reference to the London interbank offered rate for dollars for the interest period relevant to such borrowing. The applicable margin for base rate-based borrowings (1)(a) under the Series A Revolving Commitments of approximately $247.5 million and Series C Revolving Commitments of approximately $20.8 million is currently 2.0% per annum and (b) under the Series B Revolving Commitments of approximately $21.2 million is currently 3.0% and (2)(a) the applicable margin for LIBOR rate-based borrowings (a) under the Series A Revolving Commitments and Series C Revolving Commitments is currently 3.0% per annum and (b) under the Series B Revolving Commitments is currently 4.0%. The applicable margin for borrowings under the revolving credit facility is subject to one step-down of 25 basis points based on APX meeting a consolidated first lien net leverage ratio test at the end of each fiscal quarter.

In addition to paying interest on outstanding principal under the revolving credit facility, APX is required to pay a quarterly commitment fee (which will be subject to one interest rate step-down of 12.5 basis points, based on APX meeting a consolidated first lien net leverage ratio test) to the lenders under the revolving credit facility in respect of the unutilized commitments thereunder. APX also pays customary letter of credit and agency fees.

 

 

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APX is not required to make any scheduled amortization payments under the revolving credit facility. The principal amount outstanding under the revolving credit facility will be due and payable in full on (1) with respect to the non-extended commitments under the Series C Revolving Credit Facility, November 16, 2017 and (2) with respect to the extended commitments under the Series A Revolving Credit Facility and Series B Revolving Credit Facility, March 31, 2019.

The Company’s debt at March 31, 2015 consisted of the following (in thousands):

 

     Outstanding
Principal
     Unamortized
Premium
     Net Carrying
Amount
 

Revolving credit facility due 2017

   $ 2,332       $ —        $ 2,332   

Revolving credit facility due 2019

     30,168         —          30,168   

6.375% Senior Secured Notes due 2019

     925,000         —          925,000   

8.75% Senior Notes due 2020

     930,000         7,887         937,887   
  

 

 

    

 

 

    

 

 

 

Total Notes payable

   $ 1,887,500       $ 7,887       $ 1,895,387   
  

 

 

    

 

 

    

 

 

 

 

 

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The Company’s debt at December 31, 2014 consisted of the following (in thousands):

 

     Outstanding
Principal
     Unamortized
Premium
     Net Carrying
Amount
 

Revolving credit facility due 2017

   $ 20,000       $ —        $ 20,000   

6.375% Senior Secured Notes due 2019

     925,000         —          925,000   

8.75% Senior Notes due 2020

     930,000         8,155         938,155   
  

 

 

    

 

 

    

 

 

 

Total Notes payable

   $ 1,875,000       $ 8,155       $ 1,883,155   
  

 

 

    

 

 

    

 

 

 

NOTE 4 – COST BASED INVESTMENTS

During the year ended December 31, 2014, the Company entered into a project agreement with a privately-held company (the “Investee”), whereby the Investee will develop technology for the Company. The Company is not required to make any payments to the Investee for developing the above technology, however, the Company is required to pay the Investee a royalty for any sales of product that include the technology once developed. In connection with the project agreement, the Company also entered into an investment agreement with the Investee, whereby the Company will purchase up to a predetermined number of shares of the Investee. The amount of the investment by the Company in the Investee was $0.2 million as of March 31, 2015. The Company could make up to $2.7 million in additional investments in the Investee, subject to the achievement of certain technology development milestones. These additional investments are expected to occur through July 1, 2016. The Company has determined that the arrangement with the Investee constitutes a variable interest. The Company is not required to consolidate the results of the Investee as the Company is not the primary beneficiary.

On February 19, 2014, the Company invested $3.0 million in a convertible note (“Convertible Note”) of a privately held company not affiliated with the Company. The Convertible Note had a stated maturity date of February 19, 2015 and bore interest equal to the greater of (a) 0.5% or (b) annual interest rates established for federal income tax purposes by the Internal Revenue Service. The outstanding principal and accrued interest balance of the Convertible Note converted to preferred stock (“preferred stock”) of this privately held company on August 29, 2014, under the terms of the agreement.

The Company performs impairment analyses of its cost based investments annually, or more often, when events occur or circumstances change that would, more likely than not, reduce the fair value of the investment below its carrying value. When indicators of impairment do not exist and certain accounting criteria are met, the Company evaluates impairment using a qualitative approach. As of March 31, 2015, no indicators of impairment existed associated with these cost based investments.

NOTE 5 – BALANCE SHEET COMPONENTS

The following table presents balance sheet component balances (in thousands):

 

     March 31,
2015
     December 31,
2014
 

Subscriber acquisition costs

     

Subscriber acquisition costs

   $ 662,347       $ 628,739   

Accumulated amortization

     (99,455 )      (80,666 )
  

 

 

    

 

 

 

Subscriber acquisition costs, net

   $ 562,892       $ 548,073   
  

 

 

    

 

 

 

Long-term investments and other assets

     

Notes receivable from related parties, net of allowance (See Note 13)

   $ 505       $ 600   

Security deposit receivable

     6,580         6,606   

Investments

     3,352         3,306   

Other

     29         21   
  

 

 

    

 

 

 

Total long-term investments and other assets, net

   $ 10,466       $ 10,533   
  

 

 

    

 

 

 

Accrued payroll and commissions

     

Accrued payroll

   $ 12,991       $ 16,432   

Accrued commissions

     15,033         21,547   
  

 

 

    

 

 

 

Total accrued payroll and commissions

   $ 28,024       $ 37,979   
  

 

 

    

 

 

 

 

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     March 31,
2015
     December 31,
2014
 

Accrued expenses and other current liabilities

     

Accrued interest payable

   $ 47,341       $ 11,695   

Loss contingencies

     5,623         9,663   

Other

     6,655         7,504   
  

 

 

    

 

 

 

Total accrued expenses and other current liabilities

   $ 59,619       $ 28,862   
  

 

 

    

 

 

 

NOTE 6 – PROPERTY AND EQUIPMENT

Property and equipment consisted of the following (in thousands):

 

     March 31,
2015
     December 31,
2014
     Estimated Useful
Lives

Vehicles

   $ 20,605       $ 20,728       3 - 5 years

Computer equipment and software

     18,816         18,069       3 - 5 years

Leasehold improvements

     13,644         13,606       2 - 15 years

Office furniture, fixtures and equipment

     10,352         8,979       7 years

Wireless Internet infrastructure

     7,293         3,866       3 - 5 years

Buildings

     702         702       39 years

Warehouse equipment

     110         110       7 years

Construction in process

     18,081         12,601      
  

 

 

    

 

 

    
   $ 89,603       $ 78,661      

Accumulated depreciation and amortization

     (18,207 )      (15,871 )   
  

 

 

    

 

 

    

Net property and equipment

   $ 71,396       $ 62,790      
  

 

 

    

 

 

    

Property and equipment includes approximately $16.9 million of assets under capital lease obligations at March 31, 2015 and $16.8 million at December 31, 2014, net of accumulated amortization of $4.0 million and $4.1 million at March 31, 2015 and December 31, 2014, respectively. Construction in process includes $11.3 million and $9.8 million of infrastructure associated with the Wireless Internet business as of March 31, 2015 and December 31, 2014, respectively. Depreciation and amortization expense on all property and equipment was $3.7 million and $2.5 million for the three months ended March 31, 2015 and 2014, respectively. Amortization expense relates to assets under capital leases and is included in depreciation and amortization expense.

NOTE 7 – GOODWILL AND INTANGIBLE ASSETS

Goodwill

As of March 31, 2015 and December 31, 2014, the Company had a goodwill balance of $839.0 million and $841.5 million, respectively. The change in the carrying amount of goodwill during the three months ended March 31, 2015 was a result in the effect of foreign currency translation.

In accordance with authoritative guidance for accounting for goodwill and other intangible assets, the Company performs an impairment test on its goodwill annually in its fourth fiscal quarter, as of October 1, or more often when events occur or circumstances change that would, more likely than not, reduce the fair value of a reporting unit below its carrying value. When indicators of impairment do not exist and certain accounting criteria are met, the Company is able to evaluate goodwill impairment using a qualitative approach. As of March 31, 2015, no indicators of impairment existed.

 

 

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Intangible assets, net

The following table presents intangible asset balances (in thousands):

 

     March 31,
2015
     December 31,
2014
     Estimated
Useful Lives

Definite-lived intangible assets:

        

Customer contracts

   $ 971,471       $ 978,776       10 years

2GIG 2.0 technology

     17,000         17,000       8 years

CMS and other technology

     7,067         7,067       5 years

Space Monkey technology

     7,100         7,100       6 years

Wireless Internet technologies

     4,690         4,690       2-3 years

Patents

     6,895         6,518       5 years

Non-compete agreements

     2,000         2,000       2-3 years
  

 

 

    

 

 

    
     1,016,223         1,023,151      

Accumulated amortization

     (351,790 )      (320,198 )   
  

 

 

    

 

 

    

Definite-lived intangible assets, net

     664,433         702,953      

Indefinite-lived intangible assets:

        

IP addresses

     564         214      

Domain names

     59         59      
  

 

 

    

 

 

    

Total Indefinite-lived intangible assets

     623         273      
  

 

 

    

 

 

    

Total intangible assets, net

   $ 665,056       $ 703,226      
  

 

 

    

 

 

    

During the three months ended March 31, 2015 and 2014, the Company recognized $0.3 million and $0.3 million, respectively, of amortization expense related to the capitalized software development costs.

During the three months ended March 31, 2015, the Company acquired $0.7 million of intangibles related to patents, domain names and Internet Protocol (“IP”) addresses.

On March 29, 2014, the Company implemented new customer relationship management software (“CRM”). Historically, the Company’s customer management system (“CMS”) technology was used for customer support and inventory tracking. The new CRM software replaced the customer support functionality of the CMS technology. Following the CRM implementation, the CMS technology continued to be used for inventory tracking. Due to the implementation of the new CRM software, as of March 31, 2014, the Company determined there to be a significant change in the extent and manner in which the CMS technology was being used. The Company estimated the fair value of the CMS technology as of March 31, 2014 to be $0.3 million. The associated impairment loss of $1.4 million is included in operating expenses in the accompanying unaudited condensed consolidated statement of operations for the three months ended March 31, 2014. In addition, the estimated remaining useful life of the CMS technology was evaluated and revised to one year from March 31, 2014, based on the intended use of the asset. As such, the CMS technology was fully amortized as of March 31, 2015. The impact on income from continuing operations and net income from the change in the estimated remaining useful life was immaterial.

Amortization expense related to intangible assets was approximately $31.6 million and $37.6 million for the three months ended March 31, 2015 and 2014, respectively.

 

 

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Estimated future amortization expense of intangible assets, excluding approximately $0.4 million in patents currently in process, is as follows as of March 31, 2015 (in thousands):

 

2015 - remaining period

   $ 101,317   

2016

     117,806   

2017

     101,587   

2018

     89,932   

2019

     78,264   

Thereafter

     175,137   
  

 

 

 

Total estimated amortization expense

   $ 664,043   
  

 

 

 

NOTE 8 – FAIR VALUE MEASUREMENTS

Cash equivalents and restricted cash equivalents are classified as Level 1 as they have readily available market prices in an active market. The following summarizes the financial instruments of the Company at fair value based on the valuation approach applied to each class of security as of March 31, 2015 and December 31, 2014 (in thousands):

 

     Fair Value Measurement at Reporting Date Using  
     Balance at
March 31,
2015
     Quoted Prices
in Active Markets
for Identical
Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Assets:

           

Restricted cash equivalents:

           

Money market funds

   $ 14,214       $ 14,214       $ —        $ —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 14,214       $ 14,214       $ —        $ —    
  

 

 

    

 

 

    

 

 

    

 

 

 
     Fair Value Measurement at Reporting Date Using  
     Balance at
December 31,
2014
     Quoted Prices
in Active Markets
for Identical
Assets
(Level 1)
     Significant
Other
Observable
Inputs
(Level 2)
     Significant
Unobservable
Inputs
(Level 3)
 

Assets:

           

Cash equivalents:

           

Money market funds

   $ 1       $ 1       $ —        $ —    

Restricted cash equivalents:

           

Money market funds

     14,214         14,214         —          —    
  

 

 

    

 

 

    

 

 

    

 

 

 

Total assets

   $ 14,215       $ 14,215       $ —        $ —    
  

 

 

    

 

 

    

 

 

    

 

 

 

The carrying amounts of the Company’s accounts receivable, accounts payable and accrued and other liabilities approximate their fair values due to their short maturities.

The fair market value of the 2019 notes was approximately $920.4 million and $881.1 million as of March 31, 2015 and December 31, 2014, respectively. The carrying value of the 2019 notes was $925.0 million as of both March 31, 2015 and December 31, 2014. The 2020 notes had a fair market value of approximately $855.6 million and $792.8 as of March 31, 2015 and December 31, 2014, respectively, and a carrying amount of $930.0 million as of both March 31, 2015 and December 31, 2014. The fair value of the 2019 notes and the 2020 notes was considered a Level 2 measurement as the value was determined using observable market inputs, such as current interest rates as well as prices observable from less active markets.

NOTE 9 – FACILITY FIRE

On March 18, 2014, a fire occurred at a facility leased by the company in Lindon, Utah. This facility contained the Company’s primary inventory warehouse and call center operations. Through March 31, 2015, the Company recognized gross expenses related to the fire of $8.3 million, which were primarily related to impairment of damaged assets and recovery costs to maintain business continuity. As of March 31, 2015, the Company had also received insurance recoveries of $8.8 million, related to the fire damage,

 

 

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$3.0 million of which related to the reconstruction of the facility damaged by the fire, and is included within the Company’s cash flows from investing activities in the condensed consolidated statement of cash flows for the three months ended March 31, 2015. Insurance recoveries of $0.5 million in excess of gross expenses were included in other income as of December 31, 2014. All probable insurance recoveries have been received as of March 31, 2015. Expenses in excess of insurance recoveries during the three months ended March 31, 2015 were immaterial.

NOTE 10 – INCOME TAXES

In order to determine the quarterly provision for income taxes, the Company uses an estimated annual effective tax rate, which is based on expected annual income and statutory tax rates in the various jurisdictions in which the Company operates. Certain significant or unusual items are separately recognized in the quarter during which they occur and can be a source of variability in the effective tax rates from quarter to quarter.

The Company’s effective income tax rate for the three months ended March 31, 2015 was approximately (0.26)%. In computing income tax expense, the Company estimates its annual effective income tax rate jurisdiction by jurisdiction and entity by entity for which tax attributes must be separately considered for the calendar year ending December 31, 2015, excluding discrete items. Each jurisdictional or entity estimated annual tax rate is applied to actual year-to-date pre-tax book income (loss) of each jurisdiction or entity. The Company had no discrete items that affected the calculated income tax benefit or expense for the three months ended March 31, 2015. Both the 2015 and 2014 effective tax rates are less than the statutory rate primarily due to the combination of not recognizing benefit for expected pre-tax losses of the US jurisdiction and recognizing current state income tax expense for minimum state taxes.

For 2015, the Company expects to realize a loss before income taxes and expects to record a full valuation allowance against the net deferred tax assets of the consolidated group within the US, Canadian and New Zealand jurisdictions. The Company has recorded tax expense for state and local taxes. A valuation allowance is required when there is significant uncertainty as to the ability to realize the deferred tax assets. Because the realization of the deferred tax assets related to the Company’s net operating losses (NOLs) is dependent upon future income related to domestic and foreign jurisdictional operations that have historically generated losses, management determined that the Company continues to not meet the “more likely than not” threshold that those NOLs will be realized. Accordingly, a valuation allowance is required. A similar history of losses is present in the Company’s Canadian and New Zealand jurisdictions. However, as of March 31, 2015, the deferred tax assets related to the Company’s Canadian and New Zealand jurisdictions’ NOLs are offset by existing deferred income tax liabilities resulting in a net deferred tax liability position in both jurisdictions.

NOTE 11 – STOCK-BASED COMPENSATION

313 Incentive Units

The Company’s indirect parent, 313 Acquisition LLC (“313”), which is wholly owned by the Investors, has authorized the award of profits interests, representing the right to share a portion of the value appreciation on the initial capital contributions to 313 (“Incentive Units”). In March, 2015, a total of 4,315,106 Incentive Units previously issued to the Company’s Chief Executive Officer and President were voluntarily relinquished. The Company recorded all unrecognized stock-based compensation associated with such Incentive Units at the time the Incentive Units were relinquished. As of March 31, 2015, 70,212,836 Incentive Units had been awarded to current and former members of senior management and a board member, of which 42,169,456 were outstanding to the Company’s Chief Executive Officer and President. The Incentive Units are subject to time-based and performance-based vesting conditions, with one-third subject to ratable time-based vesting over a five year period and two-thirds subject to the achievement of certain investment return thresholds by The Blackstone Group, L.P. and its affiliates (“Blackstone”). The fair value of stock-based awards is measured at the grant date and is recognized as expense over the employee’s requisite service period. The grant date fair value was determined using a Monte Carlo simulation valuation approach with the following assumptions: expected volatility of 55% to 65%; expected exercise term from 4 to 5 years; and risk-free rate of 0.62% to 1.18%.

Vivint Stock Appreciation Rights

The Company’s subsidiary, Vivint, has awarded Stock Appreciation Rights (“SARs”) to various levels of key employees, pursuant to an omnibus incentive plan. The purpose of the SARs is to attract and retain personnel and provide an opportunity to acquire an equity interest of Vivint. The SARs are subject to time-based and performance-based vesting conditions, with one-third subject to ratable time-based vesting over a five year period and two-thirds subject to the achievement of certain investment return thresholds by Blackstone. In connection with this plan, 6,377,500 SARs were outstanding as of March 31, 2015. In addition, 36,065,303 SARs have been set aside for funding incentive compensation pools pursuant to long-term incentive plans established by the Company. Subsequent to March 31, 2015, a new plan was created and all issued and outstanding Vivint SARs were re-granted and all reserved SARs were converted under the new plan (see Note 16—Subsequent Events).

 

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The fair value of the Vivint awards is measured at the grant date and is recognized as expense over the employee’s requisite service period. The fair value is determined using a Black-Scholes option valuation model with the following assumptions: expected volatility varies from 55% to 60%, expected dividends of 0%; expected exercise term between 6.01 and 6.50 years; and risk-free rates between 1.72% and 1.77%. Due to the lack of historical exercise data, the Company used the simplified method in determining the estimated exercise term, for all Vivint awards.

Wireless Stock Appreciation Rights

The Company’s subsidiary, Vivint Wireless, has awarded SARs to various key employees, pursuant to an omnibus incentive plan. The purpose of the SARs is to attract and retain personnel and provide an opportunity to acquire an equity interest of Vivint Wireless. The SARs are subject to a five year time-based ratable vesting period. In connection with this plan, 70,000 SARs were outstanding as of March 31, 2015. The Company anticipates making similar grants from time to time.

The fair value of the Vivint Wireless awards is measured at the grant date and is recognized as expense over the employee’s requisite service period. The fair value is determined using a Black-Scholes option valuation model with the following assumptions: expected volatility of 65%, expected dividends of 0%; expected exercise term of 6.50 years; and risk-free rate of 1.51%. Due to the lack of historical exercise data, the Company used the simplified method in determining the estimated exercise term, for all Vivint Wireless awards.

Stock-based compensation expense in connection with all stock-based awards is presented as follows (in thousands):

 

     Three Months Ended March 31,  
     2015      2014  

Operating expenses

   $ 14       $ 9   

Selling expenses

     33         68   

General and administrative expenses

     742         368   
  

 

 

    

 

 

 

Total stock-based compensation

   $ 789       $ 445   
  

 

 

    

 

 

 

NOTE 12 – COMMITMENTS AND CONTINGENCIES

Indemnification — Subject to certain limitations, the Company is obligated to indemnify its current and former directors, officers and employees with respect to certain litigation matters and investigations that arise in connection with their service to the Company. These obligations arise under the terms of its certificate of incorporation, its bylaws, applicable contracts, and Delaware and California law. The obligation to indemnify generally means that the Company is required to pay or reimburse the individuals’ reasonable legal expenses and possibly damages and other liabilities incurred in connection with these matters.

Legal —The Company is named from time to time as a party to lawsuits arising in the ordinary course of business related to its sales, marketing, the provision of its services and equipment claims. Actions filed against the Company include commercial, intellectual property, customer, and labor and employment related claims, including complaints of alleged wrongful termination and potential class action lawsuits regarding alleged violations of federal and state wage and hour and other laws. In general, litigation can be expensive and disruptive to normal business operations. Moreover, the results of legal proceedings are difficult to predict, and the costs incurred in litigation can be substantial. The Company believes the amounts provided in its financial statements are adequate in light of the probable and estimated liabilities. Factors that the Company considers in the determination of the likelihood of a loss and the estimate of the range of that loss in respect of legal matters include the merits of a particular matter, the nature of the matter, the length of time the matter has been pending, the procedural posture of the matter, how the Company intends to defend the matter, the likelihood of settling the matter and the anticipated range of a possible settlement. Because such matters are subject to many uncertainties, the ultimate outcomes are not predictable and there can be no assurances that the actual amounts required to satisfy alleged liabilities from the matters described above will not exceed the amounts reflected in the Company’s financial statements or that the matters will not have a material adverse effect on the Company’s results of operations, financial condition or cash flows.

The Company regularly reviews outstanding legal claims and actions to determine if reserves for expected negative outcomes of such claims and actions are necessary. The Company had reserves for all such matters of approximately $5.6 million and $9.7 million as of March 31, 2015 and December 31, 2014, respectively. In conjunction with one of the settlements, the Company is obligated to pay certain future royalties, based on sales of future products.

Operating Leases —The Company leases office, warehouse space, certain equipment, software and an aircraft under operating leases with related and unrelated parties expiring in various years through 2028. The leases require the Company to pay additional rent for increases in operating expenses and real estate taxes and contain renewal options. The Company entered into a lease agreement for its corporate headquarters in 2009. In July 2012, the Company entered into a lease for additional office space for an initial lease term of 15 years. In August 2014, the Company entered into a lease for additional office space for an initial lease term of 11 years.

 

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Table of Contents

Total rent expense for operating leases was approximately $2.9 million and $1.6 million for the three months ended March 31, 2015 and 2014, respectively.

Capital Leases —The Company also leases certain equipment under capital leases with expiration dates through August 2016. On an ongoing basis, the Company enters into vehicle lease agreements under a Fleet Lease Agreement. The lease agreements are typically 36 month leases for each vehicle and the average remaining life for the fleet is 27 months as of March 31, 2015. As of March 31, 2015 and December 31, 2014, the capital lease obligation balance was $16.0 million and $16.2 million, respectively.

NOTE 13 – RELATED PARTY TRANSACTIONS

Transactions with Vivint Solar

The Company and Solar have entered into agreements under which the Company subleased corporate office space through October 2014, and provides certain other ongoing administrative services to Solar. During the three months ended March 31, 2015 and 2014, the Company charged $1.8 million and $1.6 million, respectively, of general and administrative expenses to Solar in connection with these agreements. The balance due from Solar in connection with these agreements and other expenses paid on Solar’s behalf was $1.8 million and $2.1 million at March 31, 2015 and December 31, 2014, respectively, and is included in prepaid expenses and other current assets in the accompanying consolidated balance sheets.

On December 27, 2012, the Company executed a Subordinated Note and Loan Agreement with Solar. The terms of the agreement state that Solar may borrow up to $20.0 million, bearing interest on the outstanding balance at an annual rate of 7.5%, which interest was due and payable semi-annually on June 1 and December 1 of each year commencing on June 1, 2013. On October 10, 2014, in connection with the completion of its initial public offering, Solar repaid loans to APX, the Company’s wholly-owned subsidiary, and to the Company’s parent entity. The Company’s parent entity, in turn, returned a portion of such proceeds to APX as a capital contribution. These transactions resulted in the receipt by APX of an aggregate amount of $55.0 million. These variable interests represent the Company’s maximum exposure to loss from direct involvement with Solar.

Also in connection with Solar’s initial public offering, the Company entered into a number of agreements with Solar related to services and other support that it has provided and will provide to Solar including:

 

    A Master Intercompany Framework Agreement which establishes a framework for the ongoing relationship between the Company and Solar and contains master terms regarding the protection of each other’s confidential information, and master procedural terms, such as notice procedures, restrictions on assignment, interpretive provisions, governing law and dispute resolution;

 

    A Non-Competition Agreement in which the Company and Solar each define their current areas of business and their competitors, and agree not to directly or indirectly engage in the other’s business for three years;

 

    A Transition Services Agreement pursuant to which the Company will provide to Solar various enterprise services, including services relating to information technology and infrastructure, human resources and employee benefits, administration services and facilities-related services;

 

    A Product Development and Supply Agreement pursuant to which one of Solar’s wholly owned subsidiaries will, for an initial term of three years, subject to automatic renewal for successive one-year periods unless either party elects otherwise, collaborate with the Company to develop certain monitoring and communications equipment that will be compatible with other equipment used in Solar’s energy systems and will replace equipment Solar currently procures from third parties;

 

    A Marketing and Customer Relations Agreement which governs various cross-marketing initiatives between the Company and Solar, in particularly the provision of sales leads from each company to the other; and

 

    A Trademark License Agreement pursuant to which the licensor, a special purpose subsidiary majority-owned by the Company and minority-owned by Solar, will grant Solar a royalty-free exclusive license to the trademark “VIVINT SOLAR” in the field of selling renewable energy or energy storage products and services.

Other Related-party Transactions

Long-term investments and other assets, includes amounts due for non-interest bearing advances made to employees that are expected to be repaid in excess of one year. Amounts due from employees as of both March 31, 2015 and December 31, 2014, amounted to approximately $0.3 million. As of March 31, 2015 and December 31, 2014, this amount was fully reserved.

 

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Table of Contents

Prepaid expenses and other current assets at March 31, 2015 and December 31, 2014 included a receivable for $0.1 million and $0.3 million, respectively, from certain members of management in regards to their personal use of the corporate jet.

The Company incurred additional expenses during the three months ended March 31, 2015 and 2014, respectively, of $0.4 million and $0.9 million for other related-party transactions including contributions to the charitable organization Vivint Gives Back, legal fees, and services. Accrued expenses and other current liabilities at March 31, 2015 and December 31, 2014, included a payable to Vivint Gives Back for $0.7 million and $1.3 million, respectively.

On November 16, 2012, the Company was acquired by an investor group through certain mergers and related reorganization transactions (collectively, the “Merger”). In addition, the Company engaged Blackstone Management Partners L.L.C. (“BMP”) to provide monitoring, advisory and consulting services on an ongoing basis. In consideration for these services, the Company agreed to pay an annual monitoring fee equal to the greater of (i) a minimum base fee of $2.7 million subject to adjustments if the Company engages in a business combination or disposition that is deemed significant and (ii) the amount of the monitoring fee paid in respect of the immediately preceding fiscal year, without regard to any post-fiscal year “true-up” adjustments as determined by the agreement. The Company incurred expenses of approximately $0.7 million during both the three months ended March 31, 2015 and 2014.

Under the support and services agreement, the Company also engaged BMP to arrange for Blackstone’s portfolio operations group to provide support services customarily provided by Blackstone’s portfolio operations group to Blackstone’s private equity portfolio companies of a type and amount determined by such portfolio services group to be warranted and appropriate. BMP will invoice the Company for such services based on the time spent by the relevant personnel providing such services during the applicable period but in no event shall the Company be obligated to pay more than $1.5 million during any calendar year.

Transactions involving related parties cannot be presumed to be carried out at an arm’s-length basis.

NOTE 14 – EMPLOYEE BENEFIT PLAN

Vivint offers eligible employees the opportunity to defer a percentage of their earned income into company-sponsored 401(k) plans. No matching contributions were made to the plans for the three months ended March 31, 2015 and 2014.

NOTE 15 – GUARANTOR AND NON-GUARANTOR SUPPLEMENTAL FINANCIAL INFORMATION

The 2019 notes and the 2020 notes were issued by APX. The 2019 notes and the 2020 notes are fully and unconditionally guaranteed, jointly and severally by Holdings and each of APX’s existing and future material wholly-owned U.S. restricted subsidiaries. APX’s existing and future foreign subsidiaries are not expected to guarantee the notes.

Presented below is the condensed consolidating financial information of APX, subsidiaries of APX that are guarantors (the “Guarantor Subsidiaries”), and APX’s subsidiaries that are not guarantors (the “Non-Guarantor Subsidiaries”) as of March 31, 2015 and December 31, 2014 and for the three months ended March 31, 2015 and 2014. The unaudited condensed consolidating financial information reflects the investments of APX in the Guarantor Subsidiaries and the Non-Guarantor Subsidiaries using the equity method of accounting.

 

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Table of Contents

Supplemental Condensed Consolidating Balance Sheet

March 31, 2015

(In thousands)

(unaudited)

 

     Parent      APX
Group, Inc.
     Guarantor
Subsidiaries
     Non-Guarantor
Subsidiaries
     Eliminations     Consolidated  

Assets

                

Current assets

   $ —         $ 7,671       $ 134,740       $ 14,408       $ (38,964 )   $ 117,855   

Property and equipment, net

     —           —           70,970         426         —          71,396   

Subscriber acquisition costs, net

     —           —           519,289         43,603         —          562,892   

Deferred financing costs, net

     —           53,830         —           —           —          53,830   

Investment in subsidiaries

     166,651         2,047,772         —           —           (2,214,423 )     —     

Intercompany receivable

     —           —           36,125         —           (36,125 )     —     

Intangible assets, net

     —           —           614,864         50,192         —          665,056   

Goodwill

     —           —           811,947         27,021         —          838,968   

Long-term investments and other assets

     —           184         10,452         14         (184 )     10,466   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total Assets

   $ 166,651       $ 2,109,457       $ 2,198,387       $ 135,664       $ (2,289,696 )   $ 2,320,463   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

                

Current liabilities

   $ —         $ 47,419       $ 147,519       $ 43,177       $ (38,964 )   $ 199,151   

Intercompany payable

     —           —           —           36,125         (36,125 )     —     

Notes payable and revolving line of credit, net of current portion

     —           1,895,387         —           —           —          1,895,387   

Capital lease obligations, net of current portion

     —           —           10,228         8         —          10,236   

Deferred revenue, net of current portion

     —           —           30,225         2,854         —          33,079   

Other long-term obligations

     —           —           7,314         402         —          7,716   

Deferred income tax liability

     —           —           106         8,321         (184 )     8,243   

Total equity

     166,651         166,651         2,002,995         44,777         (2,214,423 )     166,651   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 166,651       $ 2,109,457       $ 2,198,387       $ 135,664       $ (2,289,696 )   $ 2,320,463   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

Supplemental Condensed Consolidating Balance Sheet

December 31, 2014

(In thousands)

(unaudited)

 

     Parent      APX
Group, Inc.
     Guarantor
Subsidiaries
     Non-Guarantor
Subsidiaries
     Eliminations     Consolidated  

Assets

                

Current assets

   $ —         $ 9,435       $ 109,996       $ 6,626       $ (40,686 )   $ 85,371   

Property and equipment, net

     —           —           62,271         519         —          62,790   

Subscriber acquisition costs, net

     —           —           500,916         47,157         —          548,073   

Deferred financing costs, net

     —           52,158         —           —           —          52,158   

Investment in subsidiaries

     224,486         2,057,857         —           —           (2,282,343 )     —     

Intercompany receivable

     —           —           34,000         —           (34,000 )     —     

Intangible assets, net

     —           —           645,558         57,668         —          703,226   

Goodwill

     —           —           811,947         29,575         —          841,522   

Long-term investments and other assets

     —           184         10,502         31         (184 )     10,533   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total Assets

   $ 224,486       $ 2,119,634       $ 2,175,190       $ 141,576       $ (2,357,213 )   $ 2,303,673   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

                

Current liabilities

   $ —         $ 11,993       $ 119,285       $ 46,348       $ (40,686 )   $ 136,940   

Intercompany payable

     —           —           —           34,000         (34,000 )     —     

Notes payable and revolving line of credit, net of current portion

     —           1,883,155         —           —           —          1,883,155   

Capital lease obligations, net of current portion

     —           —           10,646         9         —          10,655   

Deferred revenue, net of current portion

     —           —           29,438         3,066         —          32,504   

Other long-term obligations

     —           —           6,497         409         —          6,906   

Deferred income tax liability

     —           —           107         9,104         (184 )     9,027   

Total equity

     224,486         224,486         2,009,217         48,640         (2,282,343 )     224,486   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 224,486       $ 2,119,634       $ 2,175,190       $ 141,576       $ (2,357,213 )   $ 2,303,673   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

 

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Supplemental Condensed Consolidating Statements of Operations and Comprehensive (Loss) Income

For the Three Months Ended March 31, 2015

(In thousands)

(unaudited)

 

     Parent     APX
Group, Inc.
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Consolidated  

Revenues

   $ —        $ —        $ 144,737      $ 8,230      $ (770 )   $ 152,197   

Costs and expenses

     —          —          154,900        7,766        (770 )     161,896   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income from operations

     —          —          (10,163 )     464        —          (9,699 )

Loss from subsidiaries

     (48,046 )     (10,092 )     —          —          58,138        —     

Other expense (income), net

     —          37,954        247        16        —          38,217   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income before income tax expenses

     (48,046 )     (48,046 )     (10,410 )     448        58,138        (47,916 )

Income tax expense

     —          —          40        90        —          130   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income

   $ (48,046 )   $ (48,046 )   $ (10,450 )   $ 358      $ 58,138      $ (48,046 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive (loss) income, net of tax effects:

            

Net (loss) income

   $ (48,046 )   $ (48,046 )   $ (10,450 )   $ 358      $ 58,138      $ (48,046 )

Foreign currency translation adjustment

     —          (10,578 )     (6,336 )     (4,242 )     10,578        (10,578 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive loss

     —          (10,578 )     (6,336 )     (4,242 )     10,578        (10,578 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (48,046 )   $ (58,624 )   $ (16,786 )   $ (3,884 )   $ 68,716      $ (58,624 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Supplemental Condensed Consolidating Statements of Operations and Comprehensive Loss

For the Three Months Ended March 31, 2014

(In thousands)

(unaudited)

 

     Parent     APX
Group, Inc.
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Consolidated  

Revenues

   $ —        $ —        $ 122,342      $ 8,606      $ (794 )   $ 130,154   

Costs and expenses

     —          —          135,310        7,867        (794 )     142,383   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income from operations

     —          —          (12,968 )     739        —          (12,229 )

Loss from subsidiaries

     (47,280 )     (12,013 )     —          —          59,293        —     

Other expense (incomes), net

     —          35,267        (510 )     86        —          34,843   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

(Loss) income before income tax expenses

     (47,280 )     (47,280 )     (12,458 )     653        59,293        (47,072 )

Income tax expense

     —          —          26        182        —          208   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (loss) income

   $ (47,280 )   $ (47,280 )   $ (12,484 )   $ 471      $ 59,293      $ (47,280 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive (loss) income, net of tax effects:

            

Net (loss) income

   $ (47,280 )   $ (47,280 )   $ (12,484 )   $ 471      $ 59,293      $ (47,280 )

Foreign currency translation adjustment

     —          (4,571 )     (2,424 )     (2,148 )     4,571        (4,572 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other comprehensive loss

     —          (4,571 )     (2,424 )     (2,148 )     4,571        (4,572 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive loss

   $ (47,280 )   $ (51,851 )   $ (14,908 )   $ (1,677 )   $ 63,864      $ (51,852 )
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Supplemental Condensed Consolidating Statements of Cash Flows

For the Three Months Ended March 31, 2015

(In thousands)

(unaudited)

 

     Parent      APX
Group, Inc.
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Consolidated  

Cash flows from operating activities:

             

Net cash (used in) provided by operating activities (restated)

   $ —        $ (268 )   $ 9,884      $ 6,716      $ —        $ 16,332   

Cash flows from investing activities:

             

Subscriber acquisition costs – company owned equipment (restated)

     —           —          (6,815 )     (31     —          (6,846 )

Capital expenditures (restated)

     —           —          (10,002 )     —          —          (10,002 )

Proceeds from sale of assets

     —           —          188        —          —          188   

Investment in subsidiary

     —           (9,869 )     —          —          9,869        —     

Acquisition of intangible assets

     —           —          (736 )     —          —          (736 )

Proceeds from insurance claims

     —           —          2,984        —          —          2,984   

Acquisition of other assets

     —           —          (81 )     14        —          (67 )
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities (restated)

     —           (9,869 )     (14,462 )     (17     9,869        (14,479 )

Cash flows from financing activities:

             

Borrowings from revolving line of credit

     —           22,500        —          —          —          22,500   

Repayments on revolving line of credit

     —           (10,000 )     —          —          —          (10,000 )

Intercompany receivable

     —           —          (2,125 )     —          2,125        —     

Intercompany payable

     —           —          9,869        2,125        (11,994 )     —     

Repayments of capital lease obligations

     —           —          (2,279 )     (1 )     —          (2,280 )

Deferred financing costs

     —           (4,233 )     —          —          —          (4,233 )
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash provided by financing activities

     —           8,267        5,465        2,124        (9,869 )     5,987   

Effect of exchange rate changes on cash

     —           —          —          (601 )     —          (601 )
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (decrease) increase in cash

     —           (1,870 )     887        8,222        —          7,239   

Cash:

             

Beginning of period

     —           9,432        (2,233 )     3,608        —          10,807   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

End of period

   $ —        $ 7,562      $ (1,346 )   $ 11,830      $ —        $ 18,046   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Supplemental Condensed Consolidating Statements of Cash Flows

For the Three Months Ended March 31, 2014

(In thousands)

(unaudited)

 

     Parent      APX
Group, Inc.
    Guarantor
Subsidiaries
    Non-Guarantor
Subsidiaries
    Eliminations     Consolidated  

Cash flows from operating activities:

             

Net cash (used in) provided by operating activities (restated)

   $ —        $ (207 )   $ (15,432   $ 4,614      $ (207 )   $ (11,232

Cash flows from investing activities:

             

Subscriber acquisition costs – company owned equipment (restated)

     —           —          (1,340 )     —          —          (1,340 )

Capital expenditures (restated)

     —           —          (6,439 )     (58 )     —          (6,497 )

Investment in subsidiary

     —           (32,984 )     —          —          32,984        —     

Acquisition of intangible assets

     —           —          (2,240 )     —          —          (2,240 )

Net cash used in acquisition

     —           —          (3,500 )     —          —          (3,500 )

Change in restricted cash

     —           —          161        —          —          161   

Investment in marketable securities

     —           (60,000 )     —          —          —          (60,000 )

Investment in convertible note

     —           —          (3,000 )     —          —          (3,000 )
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash used in investing activities (restated)

     —           (92,984 )     (16,358 )     (58 )     32,984        (76,416 )

Cash flows from financing activities:

             

Proceeds from issuance of notes

     —           —          (207 )     —          207        —     

Intercompany receivable

     —           —          (2,640 )     —          2,640        —     

Intercompany payable

     —           —          32,984        2,640        (35,624 )     —     

Proceeds from contract sales

     —           —          2,261        —          —          2,261   

Repayments of capital lease obligations

     —           —          (1,971 )     —          —          (1,971 )

Deferred financing costs

     —           (311 )     —          —          —          (311 )
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net cash (used in) provided by financing activities

     —           (311 )     30,427        2,640        (32,777 )     (21 )

Effect of exchange rate changes on cash

     —           —          —          (174 )     —          (174 )
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net (decrease) increase in cash

     —           (93,502 )     (1,363 )     7,022        —          (87,843 )

Cash:

             

Beginning of period

     —           248,908        8,291        4,706        —          261,905   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

End of period

   $ —        $ 155,406      $ 6,928      $ 11,728      $ —        $ 174,062   
  

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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NOTE 16 – SUBSEQUENT EVENTS

Subsequent to March 31, 2015, the omnibus incentive plan pursuant to which the Vivint SARs were granted, and all outstanding SARs, reserved SARs, and SARs remaining available for issuance, as well as the remaining unissued Vivint Wireless SARs, were assumed by Vivint Group, Inc., the immediate parent of Vivint and Vivint Wireless. The issued and outstanding Vivint SARs were adjusted using a conversion ratio of 1.4868 to preserve the intrinsic value of the SARs in connection with the conversion. The issued and outstanding Vivint Wireless SARs remained under the Vivint Wireless plan while the overall plan was reduced by the number of unissued SARs, from 150,000 to 81,000. As a result, in connection with the conversion to SARs relating to shares of Vivint Group, the number of SARs assumed under the new plan that may be granted under the incentive plan was adjusted from 43,256,697 to 64,314,057 and then increased to 80,640,142 to reflect the reduction in the number of SARs that may be issued by Vivint Wireless and an additional number of SARs that were made available under the Vivint Group plan.

 

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

Introduction

The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of our consolidated results of operations and financial condition. The discussion should be read in conjunction with the consolidated financial statements and notes thereto contained in Amendment No. 1 on Form 10-K/A to the Annual Report on Form 10-K for the year ended December 31, 2014. This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in the “Risk Factors” section of this Form 10-A/Q. Actual results may differ materially from those contained in any forward-looking statements. Unless the context otherwise requires, references to “we”, “us”, “our”, and “the Company” are intended to mean the business and operations of APX Group Holdings, Inc. and its consolidated subsidiaries. The unaudited condensed consolidated financial statements for the three months ended March 31, 2015 and 2014, respectively, present the financial position and results of operations of APX Group Holdings, Inc. and its wholly-owned subsidiaries.

Business Overview

We are one of the largest Smart Home companies in North America. In 2015, we were recognized by Forbes magazine as one of America’s Best Employers, and in 2013 as one of America’s Most Promising Companies. Our fully integrated and remotely accessible residential services platform offers subscribers a suite of products and services that includes interactive security, life-safety, energy management, home automation, data cloud storage and internet services. We utilize a scalable “direct-to-home” sales model to originate a majority of our new subscribers, which allows us control over our net subscriber acquisition costs. We have built a high-quality subscriber portfolio, with an average credit score of 714, as of March 31, 2015, through our underwriting criteria and compensation structure. Unlike many of our competitors, who generally focus on either subscriber origination or servicing, we originate, install, service and monitor our entire subscriber base, which allows us to control the overall subscriber experience. We seek to deliver a quality subscriber experience with a combination of innovative new products and services and a commitment to customer service, which together with our focus on originating high-quality new subscribers, has enabled us to achieve attrition rates that we believe are historically at or below industry averages. Utilizing this model, we have built a portfolio of approximately 890,000 security and home automation subscribers and approximately 13,000 wireless customers, as of March 31, 2015. Approximately 96% of our revenues during the three months ended March 31, 2015, consisted of contractually committed recurring revenues, which have historically resulted in consistent and predictable operating results.

Key Operating Metrics

In evaluating our results, we review the key performance measures discussed below. We believe that the presentation of key performance measures is useful to investors and lenders because they are used to measure the value of companies such as ours with recurring revenue streams.

Total Subscribers

Total subscribers is the aggregate number of our active security and home automation subscribers at the end of a given period.

Total Recurring Monthly Revenue

Total RMR is the aggregate RMR billed to all security and home automation subscribers. This revenue is earned for Smart Protect, Smart Protect & Control, Smart Complete, and additional service offerings.

Average RMR per Subscriber

Average RMR per subscriber is the total RMR divided by the total subscribers. This is also commonly referred to as Average Revenue per User, or ARPU.

Attrition Rate

Attrition rate is the aggregate number of cancelled security and home automation subscribers during a period divided by the monthly weighted average number of total security and home automation subscribers for such period. Subscribers are considered cancelled when they terminate in accordance with the terms of their contract, are terminated by us or if payment from such subscribers is deemed uncollectible (when at least four monthly billings become past due).

 

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Table of Contents

Recent Transactions

On March 6, 2015, we amended and restated the credit agreement governing our revolving credit facility to provide for, among other things, (1) an increase in the aggregate commitments previously available to us from $200.0 million to $289.4 million and (2) the extension of the maturity date with respect to certain of the previously available commitments. See “—Liquidity and Capital Resources—Revolving Credit Facility.”

On October 10, 2014, in connection with the completion of its initial public offering, V Solar Holdings, Inc. (“Solar”), repaid loans to APX, our wholly-owned subsidiary, and to our parent entity. Our parent entity, in turn, returned a portion of such proceeds to APX as a capital contribution. These transactions resulted in the receipt by APX of an aggregate amount of $55.0 million.

Also in connection with Solar’s initial public offering, we negotiated on an arm’s-length basis and entered into certain agreements with Solar related to services and other support that we have provided and will provide to Solar (see Note 13 to the accompanying unaudited condensed consolidated financial statements).

On September 3, 2014, APX paid a dividend in the amount of $50.0 million to APX Group Holdings, Inc., its sole stockholder, which in turn paid a dividend in the amount of $50.0 million to its stockholders.

On July 1, 2014, we issued and sold an additional $100.0 million aggregate principal amount of the 2020 notes.

Key Factors Affecting Operating Results

Our business is driven through the generation of new subscribers and servicing and maintaining our existing subscriber base. The generation of new subscribers requires significant upfront investment, which in turn provides predictable contractual recurring monthly revenue generated from our monitoring and additional services. We market our service offerings through two sales channels, direct-to-home and inside sales. Historically, most of our new subscriber accounts were generated through direct-to-home sales, primarily from April through August. New subscribers generated through inside sales was approximately 24% of total new subscriber additions in twelve months ended March 31, 2015, as compared to 23% of total new subscribers in the twelve months ended March 31, 2014. Over time we expect the number of subscribers originated through inside sales to continue to increase, resulting from increased advertising and expansion of our direct-sales calling centers.

Our operating results are impacted by the following key factors: number of subscriber additions, net subscriber acquisition costs, average RMR per subscriber, subscriber adoption rate of additional services beyond our Smart Protect service package, subscriber attrition, the costs to monitor and service our subscribers, the level of general and administrative expenses and the availability and cost of capital required to generate new subscribers. We focus our investment decisions on generating new subscribers and servicing our existing subscribers in the most cost-effective manner, while maintaining a high level of customer service to minimize subscriber attrition. These decisions are based on the projected cash flows and associated margins generated over the expected life of the subscriber relationship.

Attrition is defined as the aggregate number of cancelled subscribers during a period divided by the monthly weighted average number of total subscribers for such period. Subscribers are considered cancelled when they terminate in accordance with the terms of their contract, are terminated by us, or if payment from such subscribers is deemed uncollectible (when at least four monthly billings become past due). Sales of contracts to third parties and certain subscriber moves are excluded from the attrition calculation.

The term “net subscriber acquisition costs” as used in this report refers to the direct and indirect costs to create a new security and home automation subscriber. These include commissions, equipment, installation, marketing and other allocations (G&A and overhead); less activation fees and up sell revenue. These costs exclude residuals and long-term equity direct-to-home expenses.

The term “RMR” is the recurring monthly revenue billed to an individual security and home automation subscriber. The term “total RMR” is the aggregate RMR billed to all security and home automation subscribers. The term “total subscribers” is the aggregate number of our active security and home automation subscribers at the end of a given period. The term “average RMR per subscriber” is the total RMR divided by the total subscribers. This is also commonly referred to as Average Revenue per User, or “ARPU.” The term “average RMR per new subscriber” is the aggregate RMR for new subscribers originated during a period divided by the number of new subscribers originated during such period.

 

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Table of Contents

Our ability to increase subscribers depends on a number of factors, both external and internal. External factors include the overall macroeconomic environment and competition from other companies in the geographies we serve, particularly in those markets where our direct-to-home sales representatives are present. Some of our current competitors have longer operating histories, greater name recognition and substantially greater financial and marketing resources than us. In the future, other companies may also choose to begin offering services similar to ours. In addition, because such a large percentage of our new subscribers are generated through direct-to-home sales, any actions limiting this sales channel could negatively affect our ability to grow our subscriber base. We are continually evaluating ways to improve the effectiveness of our subscriber acquisition activities in both our direct-to-home and inside sales channels.

Internal factors include our ability to recruit, train and retain personnel, along with the level of investment in sales and marketing efforts. As a result, we expect to increase our investment in advertising in the markets we serve. We believe maintaining competitive compensation structures, differentiated product offerings and establishing a strong brand are critical to attracting and retaining high-quality personnel and competing effectively in the markets we serve. Successfully growing our revenue per subscriber depends on our ability to continue expanding our technology platform by offering additional value added services demanded by the market. Therefore, we continually evaluate the viability of additional service packages that could further leverage our existing technology platform and sales channels. As evidence of this focus on new services, since 2010, we have successfully expanded our service packages from residential security into energy management and home automation, which allows us to charge higher RMR for these additional service packages. During 2013, we began offering high-speed wireless Internet to a limited number of residential customers. In August 2014, we also acquired a data cloud storage technology solution that we began selling on a limited basis in late 2014. These service offerings leverage our existing direct-to-home selling model for the generation of new subscribers. During the three months ended March 31, 2015, approximately 67% of our new subscribers contracted for one of our packages that included services in addition to our Smart Protect offering. Due to the high rate of adoption for these additional service packages, our average RMR per new subscriber has increased from $44.50 in 2009 to $61.46 for the three months ended March 31, 2015, an increase of 38%.

We focus on managing the costs associated with monitoring and service without jeopardizing our award-winning service quality. We believe our ability to retain subscribers over the long-term starts with our underwriting criteria and is enhanced by maintaining our consistent quality service levels.

Subscriber attrition has a direct impact on the number of subscribers who we monitor and service and on our financial results, including revenues, operating income and cash flows. A portion of the subscriber base can be expected to cancel its service every year. Subscribers may choose not to renew or may terminate their contracts for a variety of reasons, including, but not limited to, relocation, cost, switching to a competitor’s service, or service issues. If a subscriber relocates but continues their service, we do not consider this as a cancellation. If a subscriber discontinues their service and transfers the original subscriber’s contract to a new subscriber continuing the revenue stream, we also do not consider this as a cancellation. We analyze our attrition by tracking the number of subscribers who cancel as a percentage of the average number of subscribers at the end of each twelve month period. We caution investors that not all companies, investors and analysts in our industry define attrition in the same manner.

The table below presents our security and home automation subscriber data for the twelve months ended March 31, 2015 and year the ended December 31, 2014:

 

     Twelve Months
Ended March 31,
2015
    Year Ended
December 31,
2014
 

Beginning balance of subscribers

     793,816        795,500   

Net new additions

     205,269        204,464   

Attrition

     (108,960 )     (105,789 )
  

 

 

   

 

 

 

Ending balance of subscribers

     890,125        894,175   
  

 

 

   

 

 

 

Monthly average subscribers

     873,883        849,454   
  

 

 

   

 

 

 

Attrition rate

     12.5 %     12.5 %
  

 

 

   

 

 

 

Historically, we have experienced an increased level of subscriber cancellations in the months surrounding the expiration of such subscribers’ initial contract term. Attrition in any twelve month period may be impacted by the number of subscriber contracts reaching the end of their initial term in such period. We believe this trend in cancellations at the end of the initial contract term is comparable to other companies within our industry.

 

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Table of Contents

How We Generate Revenue

Our primary source of revenue is generated through monitoring services provided to our subscribers in accordance with their subscriber contracts. The remainder of our revenue is generated through additional services, activation fees, upgrades and maintenance and repair fees. Recurring revenues accounted for 96% of total revenues for both the three months ended March 31, 2015 and 2014.

Recurring revenue. Monitoring services for our subscriber contracts are billed in advance, generally monthly, pursuant to the terms of subscriber contracts and recognized ratably over the service period. The amount of RMR billed is dependent upon which of our service packages is included in the subscriber contracts. We generally realize higher RMR for our Smart Protect & Control and Smart Complete service packages than our Smart Protect service package. Subscribers also have the option to upgrade their Smart Protect & Control and Smart Complete service packages with additional equipment for an increased RMR fee. The increase in RMR is dependent upon the amount and type of additional equipment contracted for by the subscriber. Historically, we have generally offered contracts to subscribers that range in length from 36 to 60 months that are subject to automatic annual or monthly renewal after the expiration of the initial term. At the end of each monthly period, the portion of monitoring fees related to services not yet provided are deferred and recognized as these services are provided.

Service and other sales revenue . Our service and other sales revenue is primarily comprised of amounts charged for selling additional equipment, and maintenance and repair. These amounts are billed, and the associated revenue recognized, at the time of installation or when the services are performed. Service and other sales revenue also includes contract fulfillment revenue, which relates to amounts paid by subscribers who cancel their monitoring contract in-term and for which we have no future service obligation to them. We recognize this revenue upon receipt of payment from the subscriber.

Activation fees. Activation fees represent upfront one-time charges billed to subscribers at the time of installation and are deferred. These fees are recognized over the estimated customer life of 12 years using a 150% declining balance method, which converts to a straight-line methodology after approximately five years.

Costs and Expenses

Operating expenses. Operating expenses primarily consists of labor associated with monitoring and servicing subscribers and labor and equipment expenses related to upgrades and service repairs. We also incur equipment costs associated with excess and obsolete inventory and rework costs related to equipment removed from subscriber’s homes. In addition, a portion of general and administrative expenses, comprised of certain human resources, facilities and information technologies costs are allocated to operating expenses. This allocation is primarily based on employee headcount and facility square footage occupied. Because our Field Service Professionals (“FSP“s) perform most subscriber installations generated through our inside sales channels, the costs incurred by our field service organization associated with these installations are allocated to capitalized subscriber acquisition costs.

Selling expenses. Selling expenses are primarily comprised of costs associated with housing for our direct-to-home sales representatives, advertising and lead generation, marketing and recruiting, certain portions of sales commissions, overhead (including allocation of certain general and administrative expenses) and other costs not directly tied to a specific subscriber origination. These costs are expensed as incurred.

General and administrative expenses. General and administrative expenses consist largely of finance, legal, research and development (“R&D”), human resources, information technology and executive management expenses, including stock-based compensation expense. Stock-based compensation expense is recorded within various components of our costs and expenses. General and administrative expenses also include the provision for doubtful accounts. We allocate approximately one-third of our gross general and administrative expenses, excluding the provision for doubtful accounts, into operating and selling expenses in order to reflect the overall costs of those components of the business. In addition, in connection with certain service agreements with Solar, we subleased corporate office space to them through October 2014 and provide certain other administrative services to Solar. We charge Solar the costs associated with these service agreements (See Note 13).

Depreciation and amortization. Depreciation and amortization consists of depreciation from property and equipment, amortization of equipment leased under capital leases, capitalized subscriber acquisition costs and intangible assets.

 

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Table of Contents

Results of operations

 

     Three Months Ended March 31,  
     2015     2014  
     (in thousands)  

Total revenues (a)

   $ 152,197      $ 130,154   

Total costs and expenses

     161,896        142,383   
  

 

 

   

 

 

 

Loss from continuing operations

     (9,699 )     (12,229 )

Other expenses

     38,217        34,843   
  

 

 

   

 

 

 

Loss before taxes

     (47,916 )     (47,072 )

Income tax expense

     130        208   
  

 

 

   

 

 

 

Net loss (b)

   $ (48,046 )   $ (47,280 )
  

 

 

   

 

 

 

Key operating metrics

    

Total Subscribers, as of March 31 (thousands)

     890.1        793.8   

Attrition rate

     12.5 %     13.6 %

Total RMR (thousands) (end of period)

   $ 48,299      $ 42,110   

Average RMR per Subscriber

   $ 54.26      $ 53.05   

 

(a) Amount in the three months ended March 31, 2015 and 2014 is $2.3 million more and $0.3 million less, respectively, than that reported in our earnings release, due to a correction identified after the earnings release. See “Note 1. Basis of Presentation” to the Notes to the unaudited condensed consolidated financial statements.
(b) Net loss in the three months ended March 31, 2015 and 2014 is $2.3 million less and $0.3 million more, respectively, than that reported in our earnings release, due to a correction identified after the earnings release. See “Note 1. Basis of Presentation” to the Notes to the unaudited condensed consolidated financial statements.

Three Months Ended March 31, 2015 Compared to the Three Months Ended March 31, 2014

Revenues

The following table provides the significant components of our revenue for the three month period ended March 31, 2015 and the three month period ended March 31, 2014:

 

     Three Months Ended March 31,         
     2015      2014      % Change  

Recurring revenue

   $ 145,664       $ 124,554         17 %

Service and other sales revenue

     5,225         4,834         8   

Activation fees

     1,308         766         71   
  

 

 

    

 

 

    

 

 

 

Total revenues

   $ 152,197       $ 130,154         17 %
  

 

 

    

 

 

    

 

 

 

Total revenues increased $22.0 million, or 17%, for the three months ended March 31, 2015 as compared to the three months ended March 31, 2014, primarily due to the growth in recurring revenue, which increased $21.1 million, or 17%. This increase resulted from $14.0 million of fees from the net addition of approximately 96,000 subscribers at March 31, 2015 as compared to March 31, 2014, a $5.1 million increase from continued growth in the percentage of our subscribers contracting for new products and service packages, and a $2.0 million out-of-period adjustment, as described in “Note 1. Basis of Presentation” to the Notes to the unaudited condensed consolidated financial statements.

Service and other sales revenue increased $0.4 million, or 8%, for the three months ended March 31, 2015 as compared to the three months ended March 31, 2014. This increase was primarily due to an increase of $0.5 million in other revenue related to subscriber service upgrades and contract fulfillments offset by a decrease in service revenue of $0.1 million.

The revenue associated with activation fees is deferred upon billing and recognized over the estimated life of the subscriber relationship. There was deemed to be no fair value associated with deferred activation fee revenues at the time of our acquisition by an investor group led by affiliates of our sponsor, The Blackstone Group L.P. (the “Sponsor”) on November 16, 2012 (the “Transactions”). Thus, revenues recognized related to activation fees increased $0.5 million, or 71%, for the three months ended March 31, 2015 as compared to the three months ended March 31, 2014, primarily due to the increase in the number of subscribers from whom we have collected activation fees since the date of the Transactions.

 

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Costs and Expenses

The following table provides the significant components of our costs and expenses for the three month period ended March 31, 2015 and the three month period ended March 31, 2014:

 

     Three Months Ended March 31,         
     2015      2014      % Change  

Operating expenses

   $ 51,330       $ 41,317         24 %

Selling expenses

     25,275         25,579         (1 )

General and administrative

     28,234         25,135         12   

Depreciation and amortization

     57,057         50,352         13   
  

 

 

    

 

 

    

 

 

 

Total costs and expenses

   $ 161,896       $ 142,383         14 %
  

 

 

    

 

 

    

 

 

 

Operating expenses increased $10.0 million, or 24%, for the three months ended March 31, 2015 as compared to the three months ended March 31, 2014, primarily to support the growth in our subscriber base and our wireless Internet business. This increase was principally comprised of $6.8 million in non-capitalized equipment costs related to subscriber upgrades and service repairs, $1.9 million in personnel costs within our monitoring, customer support and field service functions, and $0.8 million in information technology costs, partially offset by an $0.8 million decrease in vehicle operating expenses.

Selling expenses, excluding amortization of capitalized subscriber acquisition costs, decreased $0.3 million, or 1%, for the three months ended March 31, 2015 as compared to the three months ended March 31, 2014, primarily due to the consolidation of our inside sales channel operations in 2014.

General and administrative expenses increased $3.1 million, or 12%, for the three months ended March 31, 2015 as compared to the three months ended March 31, 2014, partly due to a $1.7 million increase in facility, administrative and information technology costs and a $1.3 million increase in personnel costs, primarily related to information technologies, R&D and management staffing. These increases were all to support the expected growth in our security and home automation and wireless Internet businesses.

Depreciation and amortization increased $6.7 million, or 13%, for the three months ended March 31, 2015 as compared to the three months ended March 31, 2014. The increase was primarily due to increased amortization of subscriber acquisition costs.

Other Expenses, net

The following table provides the significant components of our other expenses, net for the three month period ended March 31, 2015 and the three month period ended March 31, 2014:

 

     Three Months Ended March 31,         
     2015      2014      % Change  

Interest expense

   $ 38,257       $ 35,640         7

Interest income

     —          (552 )      (100 )%

Other (income) expenses, net

     (40 )      (245 )      (84
  

 

 

    

 

 

    

 

 

 

Total other expenses, net

   $ 38,217       $ 34,843         10
  

 

 

    

 

 

    

 

 

 

Interest expense increased $2.6 million, or 7%, for the three months ended March 31, 2015, as compared with the three months ended March 31, 2014, due to a higher principal balance on our debt. The $0.6 million decrease in interest income for the three months ended March 31, 2015 was primarily attributable to the repayment of the Subordinated Note and Loan Agreement with Solar in 2014 (see Note 13 to the accompanying unaudited condensed consolidated financial statements). The decrease in other income is attributable to fewer gains on the disposal of assets.

Income Taxes

The following table provides the significant components of our income tax expense for the three month period ended March 31, 2015 and the three month period ended March 31, 2014:

 

     Three Months Ended March 31,         
     2015      2014      % Change  

Income tax expense

   $ 130       $ 208         (38 )%

 

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Income tax expense was $0.1 million for the three months ended March 31, 2015 as compared to an income tax expense of $0.2 million for the three months ended March 31, 2014. The income tax expense for the three months ended March 31, 2015 and 2014 each resulted primarily from earnings in the Company’s Canadian jurisdiction, as well as from minimum state taxes in the U.S. jurisdiction.

Liquidity and Capital Resources

Our primary source of liquidity has historically been cash from recurring revenues, proceeds from the issuance of debt securities and borrowing availability under our revolving credit facility. As of March 31, 2015, we had $18.0 million of cash and $253.1 million of availability under our revolving credit facility (after giving effect to $3.8 million of outstanding letters of credit and $32.5 million of borrowings as of March 31, 2015).

As market conditions warrant, we and our major equity holders, including the Sponsor and its affiliates, may from time to time, seek to repurchase debt securities that we have issued or loans that we have borrowed, including the notes and borrowings under our revolving credit facility, in privately negotiated or open market transactions, by tender offer or otherwise. Any such repurchases may be funded by incurring new debt, including additional borrowings under our revolving credit facility. Any new debt may be secured debt. We may also use available cash on our balance sheet. The amounts involved in any such transactions, individually or in the aggregate, may be material. Further, any such purchases may result in our acquiring and retiring a substantial amount of any particular series, with the attendant reduction in the trading liquidity of any such series. Depending on conditions in the credit and capital markets and other factors, we will, from time to time, consider various financing transactions, the proceeds of which could be used to refinance our indebtedness or for other purposes.

Cash Flow and Liquidity Analysis

Significant factors influencing our liquidity position include cash flows generated from recurring revenue and other fees received from the subscribers we service and the level of investment in capitalized subscriber acquisition costs and general and administrative expenses. Our cash flows provided by operating activities include cash received from RMR, along with upfront activation fees, upgrade and other maintenance and repair fees. Cash used in operating activities includes the cash costs to monitor and service those subscribers, and certain costs, principally marketing and subscriber acquisition costs associated with customer owned equipment and general and administrative costs. Historically, we financed subscriber acquisition costs through our operating cash flows, the issuance of debt, and to a lesser extent, through the issuance of equity and contract sales to third parties.

The direct-to-home sales are seasonal in nature. We make investments in the recruitment of our direct-to-home sales force and the inventory for the April through August sales period prior to each sales season. We experience increases in subscriber acquisition costs, as well as costs to support the sales force throughout North America, during this time period.

The following table provides a summary of cash flow data (in thousands):

 

     Three Months Ended March 31,         
     2015      2014      % Change  

Net cash provided by (used in) operating activities (restated)

   $ 16,332       $ (11,232      (245 )%

Net cash used in investing activities (restated)

     (14,479 )      (76,416 )      (81 )%

Net cash provided by (used for) financing activities

     5,987         (21 )      NM   

Cash Flows from Operating Activities

We generally reinvest the cash flows from our recurring revenues into our business, primarily to (1) maintain and grow our subscriber base, (2) expand our infrastructure to support this growth, (3) enhance our existing service offerings and (4) develop new service offerings. These investments are focused on generating new subscribers, increasing the revenue from our existing subscriber base, enhancing the overall quality of service provided to our subscribers, increasing the productivity and efficiency of our workforce and back-office functions necessary to scale our business.

 

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For the three months ended March 31, 2015, net cash provided by operating activities was $16.3 million. This cash was primarily generated from a net loss of $48.0 million, adjusted for $60.1 million in non-cash amortization, depreciation and stock-based compensation, a $21.8 million increase in accrued expenses and other liabilities, primarily related to an increase in accrued interest payable offset partially by a decrease in accrued payroll and commissions and other accrued liabilities, and a $37.2 million increase in accounts payable, primarily related to purchases of inventory. This was partially offset by a $34.7 million increase in subscriber acquisition costs, a $21.4 million increase in inventories due to the seasonality of our inventory purchases and usage, as well as a $1.8 increase in accounts receivable.

For the three months ended March 31, 2014, net cash used in operating activities was $11.2 million. This cash was primarily from a net loss of $47.3 million, adjusted for $53.1 million in non-cash amortization, depreciation and stock-based compensation, a $34.4 million increase in subscriber acquisition costs and a $14.7 million increase in inventories due to the seasonality of our inventory purchases and usage. This was partially offset by a $16.4 million increase in accrued expenses and other liabilities, primarily related to an increase in accrued interest payable offset partially by a decrease in accrued payroll and commissions and a $16.3 million increase in accounts payable, primarily related to purchases of inventory.

Cash Flows from Investing Activities

Historically, our investing activities have primarily consisted of capitalized subscriber acquisition costs, capital expenditures, business combinations and technology acquisitions. Capital expenditures primarily consist of periodic additions to property and equipment to support the growth in our business.

For the three months ended March 31, 2015 and 2014, net cash used in investing activities was $14.5 million and $76.4 million, respectively. For the three months ended March 31, 2015, our cash used in investing activities primarily consisted of capital expenditures of $10.0 million and capitalized subscriber acquisition costs of $6.8 million, offset by $3.0 million in insurance proceeds related to the 2014 facility fire. For the three months ended March 31, 2014, our cash used in investing activities primarily consisted of $60.0 million of investments in certificates of deposit, capital expenditures of $6.5 million and business and intangible asset acquisitions of $5.7 million.

Cash Flows from Financing Activities

Historically, our cash flows provided by financing activities primarily related to the issuance of debt to fund the portion of upfront costs associated with generating new subscribers that are not covered through our operating cash flows. Uses of cash for financing activities are generally associated with the payment of dividends to our stockholders and the repayment of debt.

For the three months ended March 31, 2015, net cash provided by financing activities was $6.0 million, consisting primarily of $22.5 million in borrowings on the revolving line of credit, partially offset by $10.0 million of repayments on the revolving line of credit, $2.3 million of repayments under our capital lease obligations, and $4.2 million in deferred financing costs. For the three months ended March 31, 2014, net cash provided by financing activities was $0, consisting primarily of $2.3 million of proceeds from contract sales partially offset by $2.0 million of repayments under our capital lease obligations and deferred financing costs of $0.3 million.

Long-Term Debt

We are a highly leveraged company with significant debt service requirements. As of March 31, 2015, we had approximately $1,887.5 million of total debt outstanding, consisting of $925.0 million of outstanding 2019 notes and $930.0 million of outstanding 2020 notes, and $32.5 million outstanding under the revolving credit facility. As of March 31, 2015, we had approximately $253.1 million of availability under the revolving credit facility (after giving effect to $3.8 million of letters of credit outstanding and $32.5 million of borrowings and giving effect to the March 6, 2015 amendment and restatement of our revolving credit facility discussed below).

Revolving Credit Facility

On November 16, 2012, we entered into a $200.0 million senior secured revolving credit facility, with a five year maturity. In addition, we may request one or more term loan facilities, increased commitments under the revolving credit facility or new revolving credit commitments, in an aggregate amount not to exceed $225.0 million. Availability of such incremental facilities and/or increased or new commitments will be subject to certain customary conditions.

On June 28, 2013, we amended and restated the credit agreement to provide for a new repriced tranche of revolving credit commitments with a lower interest rate. Nearly all of the existing tranches of revolving credit commitments was terminated and converted into the repriced tranche, with the unterminated portion of the existing tranche continuing to accrue interest at the original rate.

 

 

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On March 6, 2015, we amended and restated the credit agreement to provide for, among other things, (1) an increase in the aggregate commitments previously available to us from $200.0 million to $289.4 million and (2) the extension of the maturity date with respect to certain of the previously available commitments. As of March 31, 2015, $253.1 million was undrawn and available under the revolving credit facility (after giving effect to $3.8 million of outstanding letters of credit and $32.5 million of borrowings as of March 31, 2015).

Borrowings under the amended and restated revolving credit facility bear interest at a rate per annum equal to an applicable margin plus, at our option, either (1) the base rate determined by reference to the highest of (a) the Federal Funds rate plus 0.50%, (b) the prime rate of Bank of America, N.A. and (c) the LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for an interest period of one month, plus 1.00% or (2) the LIBOR rate determined by reference to the London interbank offered rate for dollars for the interest period relevant to such borrowing. The applicable margin for base rate-based borrowings (1)(a) under the Series A Revolving Commitments of approximately $247.5 million and Series C Revolving Commitments of approximately $20.8 million is currently 2.0% per annum and (b) under the Series B Revolving Commitments of approximately $21.2 million is currently 3.0% and (2)(a) the applicable margin for LIBOR rate-based borrowings (a) under the Series A Revolving Commitments and Series C Revolving Commitments is currently 3.0% per annum and (b) under the Series B Revolving Commitments is currently 4.0%. The applicable margin for borrowings under the revolving credit facility is subject to one step-down of 25 basis points based on our meeting a consolidated first lien net leverage ratio test at the end of each fiscal quarter.

In addition to paying interest on outstanding principal under the revolving credit facility, we are required to pay a quarterly commitment fee (which will be subject to one interest rate step-down of 12.5 basis points, based on our meeting a consolidated first lien net leverage ratio test) to the lenders under the revolving credit facility in respect of the unutilized commitments thereunder. We also pay customary letter of credit and agency fees.

We are not required to make any scheduled amortization payments under the revolving credit facility. The principal amount outstanding under the revolving credit facility will be due and payable in full on (1) with respect to the non-extended commitments under the Series C Revolving Credit Facility, November 16, 2017 and (2) with respect to the extended commitments under the Series A Revolving Credit Facility and Series B Revolving Credit Facility, March 31, 2019.

2019 Notes

On November 16, 2012, we issued $925.0 million of the 2019 notes. Interest on the 2019 notes is payable semi-annually in arrears on each June 1 and December 1.

We may, at our option, redeem at any time and from time to time prior to December 1, 2015, some or all of the 2019 notes at 100% of their principal amount thereof plus accrued and unpaid interest to the redemption date plus a “make-whole premium.” Prior to December 1, 2015, during any twelve month period, we also may, at our option, redeem at any time and from time to time up to 10% of the aggregate principal amount of the issued 2019 notes at a price equal to 103% of the principal amount thereof, plus accrued and unpaid interest. From and after December 1, 2015, we may, at our option, redeem at any time and from time to time some or all of the 2019 notes at 104.781%, declining ratably on each anniversary thereafter to par from and after December 1, 2018, in each case, plus any accrued and unpaid interest to the date of redemption. In addition, on or prior to December 1, 2015, we may, at our option, redeem up to 35% of the aggregate principal amount of the 2019 notes with the proceeds from certain equity offerings at 106.37%, plus accrued and unpaid interest to the date of redemption.

2020 Notes

On November 16, 2012, we issued $380.0 million of the 2020 notes. Interest on the 2020 notes is payable semi-annually in arrears on each June 1 and December 1. During the year ended December 31, 2013, we issued an additional $450.0 million of the 2020 notes and during 2014 we issued an additional $100.0 million of the 2020 notes, each under the indenture dated as of November 16, 2012.

We may, at our option, redeem at any time and from time to time prior to December 1, 2015, some or all of the 2020 notes at 100% of their principal amount thereof plus accrued and unpaid interest to the redemption date plus a “make-whole premium.” From and after December 1, 2015, we may, at our option, redeem at any time and from time to time some or all of the 2020 notes at 106.563%, declining ratably on each anniversary thereafter to par from and after December 1, 2018, in each case, plus any accrued and unpaid interest to the date of redemption. In addition, on or prior to December 1, 2015, we may, at our option, redeem up to 35% of the aggregate principal amount of the 2020 notes with the proceeds from certain equity offerings at 108.75%, plus accrued and unpaid interest to the date of redemption.

 

 

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Guarantees and Security

All of our obligations under the revolving credit facility, the 2019 notes and the 2020 notes are guaranteed by APX Group Holdings, Inc. and each of our existing and future material wholly-owned U.S. restricted subsidiaries to the extent such entities guarantee indebtedness under the revolving credit facility or our other indebtedness. See Note 15 of our unaudited condensed consolidated financial statements included elsewhere in this Amendment No. 1 on Form 10-Q/A to our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2015 for additional financial information regarding guarantors and non-guarantors.

The obligations under the revolving credit facility and the 2019 notes are secured by a security interest in (i) substantially all of the present and future tangible and intangible assets of APX, and the guarantors, including without limitation equipment, subscriber contracts and communication paths, intellectual property, fee-owned real property, general intangibles, investment property, material intercompany notes and proceeds of the foregoing, subject to permitted liens and other customary exceptions, (ii) substantially all personal property of APX and the guarantors consisting of accounts receivable arising from the sale of inventory and other goods and services (including related contracts and contract rights, inventory, cash, deposit accounts, other bank accounts and securities accounts), inventory and intangible assets to the extent attached to the foregoing books and records of the Issuer and the guarantors, and the proceeds thereof, subject to permitted liens and other customary exceptions, in each case held by the Issuer and the guarantors and (iii) a pledge of all of the capital stock of APX, each of its subsidiary guarantors and each restricted subsidiary of APX and its subsidiary guarantors, in each case other than excluded assets and subject to the limitations and exclusions provided in the applicable collateral documents.

Under the terms of the applicable security documents and intercreditor agreement, the proceeds of any collection or other realization of collateral received in connection with the exercise of remedies will be applied first to repay amounts due under the revolving credit facility, and up to an additional $60.0 million of “superpriority” obligations that we may incur in the future, before the holders of the 2019 notes receive any such proceeds.

Debt Covenants

The credit agreement governing the revolving credit facility and the indentures governing the notes contain a number of covenants that, among other things, restrict, subject to certain exceptions, our and our restricted subsidiaries’ ability to:

 

    incur or guarantee additional debt or issue disqualified stock or preferred stock;

 

    pay dividends and make other distributions on, or redeem or repurchase, capital stock;

 

    make certain investments;

 

    incur certain liens;

 

    enter into transactions with affiliates;

 

    merge or consolidate;

 

    enter into agreements that restrict the ability of restricted subsidiaries to make dividends or other payments to APX;

 

    designate restricted subsidiaries as unrestricted subsidiaries; and

 

    transfer or sell assets.

The credit agreement governing the revolving credit facility and the indentures governing the notes contain change of control provisions and certain customary affirmative covenants and events of default. As of March 31, 2015, we were in compliance with all restrictive covenants related to our long-term obligations.

Subject to certain exceptions, the credit agreement governing the revolving credit facility and the indentures governing the notes permit us and our restricted subsidiaries to incur additional indebtedness, including secured indebtedness.

Our future liquidity requirements will be significant, primarily due to debt service requirements. The actual amounts of borrowings under the revolving credit facility will fluctuate from time to time. We believe that amounts available through our revolving credit facility and incremental facilities will be sufficient to meet our operating needs for the next twelve months, including working capital requirements, capital expenditures, debt repayment obligations and potential new acquisitions.

 

 

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Covenant Compliance

Under the indentures governing our notes and the credit agreement governing our revolving credit facility, our ability to engage in activities such as incurring additional indebtedness, making investments, refinancing certain indebtedness, paying dividends and entering into certain merger transactions is governed, in part, by our ability to satisfy tests based on Adjusted EBITDA. Adjusted EBITDA is a supplemental measure that is not required by, or presented in accordance with, accounting principles generally accepted in the United States (“GAAP”). It is not a measurement of our financial performance under GAAP and should not be considered as an alternative to net income or any other measure derived in accordance with GAAP or as an alternative to cash flows from operating activities as a measure of our liquidity. We define “Adjusted EBITDA” as net income (loss) before interest expense (net of interest income), income and franchise taxes, and depreciation and amortization (including amortization of capitalized subscriber acquisition costs), further adjusted to exclude the effects of certain contract sales to third parties, non-capitalized subscriber acquisition costs, stock based compensation, the historical results of Solar and certain unusual, non-cash, non-recurring and other items permitted in certain covenant calculations under the indentures governing our existing senior secured notes and our existing senior unsecured notes and the credit agreement governing our revolving credit facility. We caution investors that amounts presented in accordance with our definition of Adjusted EBITDA may not be comparable to similar measures disclosed by other issuers, because not all issuers and analysts calculate Adjusted EBITDA in the same manner. We believe that Adjusted EBITDA provides useful information about flexibility under our covenants to investors, lenders, financial analysts and rating agencies since these groups have historically used EBITDA-related measures in our industry, along with other measures, to estimate the value of a company, to make informed investment decisions, and to evaluate a company’s ability to meet its debt service requirements. Adjusted EBITDA eliminates the effect of non-cash depreciation of tangible assets and amortization of intangible assets, much of which results from acquisitions accounted for under the purchase method of accounting. Adjusted EBITDA also eliminates the effects of interest rates and changes in capitalization which management believes may not necessarily be indicative of a company’s underlying operating performance. Adjusted EBITDA is also used by us to measure covenant compliance under the indentures governing our existing senior secured notes and our existing senior unsecured notes and the credit agreement governing our revolving credit facility.

The following table sets forth a reconciliation of net loss before non-controlling interests to Adjusted EBITDA (in thousands):

 

     Three Months
Ended March 31,
2015
     Twelve Months
Ended March 31,
2015
 

Net loss

   $ (48,046 )    $ (239,424 )

Interest expense, net

     38,257         149,225   

Other income, net

     (40 )      (1,574 )

Income tax expense

     130         436   

Depreciation and amortization (1)

     37,666         160,228   

Amortization of capitalized creation costs

     19,391         67,802   

Non-capitalized subscriber acquisition costs (2)

     34,878         142,998   

Non-cash compensation (3)

     756         2,198   

Other adjustments (4)

     6,552         39,173   
  

 

 

    

 

 

 

Adjusted EBITDA

   $ 89,545       $ 321,062   
  

 

 

    

 

 

 

 

(1) Excludes loan amortization costs that are included in interest expense.
(2) Reflects subscriber acquisition costs that are expensed as incurred because they are not directly related to the acquisition of specific subscribers. Certain other industry participants purchase subscribers through subscriber contract purchases, and as a result, may capitalize the full cost to purchase these subscriber contracts, as compared to our organic generation of new subscribers, which requires us to expense a portion of our subscriber acquisition costs under GAAP.
(3) Reflects non-cash compensation costs related to employee and director stock and stock option plans. Excludes non-cash compensation costs included in non-capitalized subscriber acquisition costs.

 

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(4) Other adjustments represent primarily the following items (in thousands):

 

     Three Months
Ended March 31,
2015
     Twelve Months
Ended March 31,
2015
 

Product development (a)

   $ 2,431       $ 12,801   

Fire related recoveries (b)

     —          (1,635 )

Purchase accounting deferred revenue fair value adjustment (c)

     1,229         5,098   

Information technology implementation (d)

     469         2,355   

Subcontracted monitoring agreement (e)

     —          1,100   

Monitoring fee (f)

     693         3,195   

Start-up of new strategic initiatives (g)

     92         2,976   

Non-operating legal and professional fees

     1,035         1,884   

One-time compensation-related payments (h)

     192         5,888   

One-time deferred revenue adjustment (i)

     (2,022 )      (2,022 )

Excess inventory (j)

     733         733   

All other adjustments

     1,700         6,800   
  

 

 

    

 

 

 

Total other adjustments

   $ 6,552       $ 39,173   
  

 

 

    

 

 

 

 

(a) Costs related to the development of future products and services, including associated software.
(b) Represents insurance recoveries in excess of fire related expenses incurred during the twelve months ended March 31, 2015. (See Note 9 to the accompanying unaudited condensed consolidated financial statements).
(c) Add back revenue reduction directly related to purchase accounting deferred revenue adjustments.
(d) Costs related to the implementation of new information technologies.
(e) Run-rate savings from committed future reductions in subcontract monitoring fees.
(f) Blackstone Management Partners L.L.C monitoring fee (See Note 13 to the accompanying unaudited condensed consolidated financial statements).
(g) Costs related to the start-up of potential new service offerings and sales channels.
(h) Run-rate savings related to reduction-in-force (“RIF”), along with severance payments associated with the RIF and other non-recurring employee compensation payments.
(i) Represents a one-time adjustment to exclude $2.0 million of recurring revenue recognized in the three months ended March 31, 2015, related to prior periods in connection with deferred revenue. (See Note 1 to the accompanying unaudited condensed consolidated financial statements.)
(j) Represents reserve for excess inventory associated with discontinued product offerings.

Other Factors Affecting Liquidity and Capital Resources

Vehicle Leases. Since 2010, we have leased, and expect to continue leasing, vehicles primarily for use by our FSPs. For the most part, these leases have 36 month durations and we account for them as capital leases. At the end of the lease term for each vehicle we have the option to either (i) purchase it for the estimated end-of-lease fair market value established at the beginning of the lease term; or (ii) return the vehicle to the lessor to be sold by them and in the event the sale price is less than the estimated end-of-lease fair market value we are responsible for such deficiency. As of March 31, 2015, our total capital lease obligations were $16.0 million, of which $5.7 million is due within the next 12 months.

Aircraft Lease. In December 2012, we entered into an aircraft lease agreement for the use of a corporate aircraft, which is accounted for as an operating lease. Upon execution of the lease, we paid a $5.9 million security deposit which is refundable at the end of the lease term. Beginning January 2013, we are required to make 156 monthly rental payments of approximately $83,000 each. In January 2015, an amendment to the agreement was made which, among other changes, increased the required monthly rental payments to approximately $87,000 each. We also have the option to extend the lease for an additional 36 months upon expiration of the initial term. The lease agreement also provides us the option to purchase the aircraft on certain specified dates for a stated dollar amount, which represents the current estimated fair value as of the purchase date.

Off-Balance Sheet Arrangements

Currently we do not engage in off-balance sheet financing arrangements.

 

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Critical Accounting Policies and Estimates

In preparing our unaudited Condensed Consolidated Financial Statements, we make assumptions, judgments and estimates that can have a significant impact on our revenue, income (loss) from operations and net loss, as well as on the value of certain assets and liabilities on our unaudited Condensed Consolidated Balance Sheets. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. At least quarterly, we evaluate our assumptions, judgments and estimates and make changes accordingly. Historically, our assumptions, judgments and estimates relative to our critical accounting estimates have not differed materially from actual results. We believe that the assumptions, judgments and estimates involved in the accounting for income taxes, allowance for doubtful accounts, valuation of intangible assets, and fair value have the greatest potential impact on our unaudited Condensed Consolidated Financial Statements; therefore, we consider these to be our critical accounting estimates. For information on our significant accounting policies, see Note 1 to our unaudited Condensed Consolidated Financial Statements.

Revenue Recognition

We recognize revenue principally on three types of transactions: (i) recurring revenue, which includes RMR, (ii) service and other sales, which includes non-recurring service fees charged to our subscribers provided on contracts, contract fulfillment revenues and sales of products that are not part of our service offerings, and (iii) activation fees on the subscriber contracts, which are amortized over the estimated life of the subscriber relationship.

Recurring revenue for our subscriber contracts are billed in advance, generally monthly, pursuant to the terms of subscriber contracts and recognized ratably over the service period. RMR is recognized monthly as services are provided in accordance with the rates set forth in our subscriber contracts. Costs of providing ongoing monitoring services are expensed in the period incurred.

Any services included in service and other sales revenue are recognized upon provision of the applicable services. Revenue generated by Vivint from the sale of products that are not part of the service offerings is recognized upon installation. Contract fulfillment revenue represents fees received from subscribers at the time of, or subsequent to, the in-term termination of their contract. This revenue is recognized when payment is received from the subscriber.

Activation fees represent upfront one-time charges billed to subscribers at the time of installation and are deferred. These fees are recognized over the estimated customer life of 12 years using a 150% declining balance method, which converts to a straight-line methodology after approximately five years.

Subscriber Acquisition Costs

A portion of the direct costs of acquiring new security and home automation subscribers, primarily sales commissions, equipment, and installation costs, are deferred and recognized over a pattern that reflects the estimated life of the subscriber relationships. We amortize these costs over 12 years using a 150% declining balance method, which converts to a straight-line methodology after approximately 5 years. We evaluate attrition on a periodic basis, utilizing observed attrition rates for our subscriber contracts and industry information and, when necessary, make adjustments to the estimated life of the subscriber relationship and amortization method.

On the condensed consolidated statement of cash flows, subscriber acquisition costs that are comprised of equipment and related installation costs purchased for or used in subscriber contracts in which we retain ownership to the equipment are classified as investing activities and reported as “Subscriber acquisition costs – company owned equipment”. All other subscriber acquisition costs are classified as operating activities and reported as “Subscriber acquisition costs – deferred contract costs” on the condensed consolidated statements of cash flows as these assets represent deferred costs associated with customer contracts.

Subscriber acquisition costs represent the costs related to the origination of new subscribers. A portion of subscriber acquisition costs is expensed as incurred, which includes costs associated with the direct-to-home sale housing, marketing and recruiting, certain portions of sales commissions (residuals), overhead and other costs, considered not directly and specifically tied to the origination of a particular subscriber. The remaining portion of the costs is considered to be directly tied to subscriber acquisition and consist primarily of certain portions of sales commissions, equipment, and installation costs. These costs are deferred and recognized in a pattern that reflects the estimated life of the subscriber relationships. Subscriber acquisition costs are largely correlated to the number of new subscribers originated.

Accounts Receivable

Accounts receivable consist primarily of amounts due from subscribers for RMR services. Accounts receivable are recorded at invoiced amounts and are non-interest bearing. The gross amount of accounts receivable has been reduced by an allowance for doubtful accounts of approximately $2.9 million and $3.4 million at March 31, 2015 and December 31, 2014, respectively. We estimate this allowance based on historical collection rates, attrition rates, and contractual obligations underlying the sale of the subscriber contracts to third parties. As of March 31, 2015 and December 31, 2014, no accounts receivable were classified as held for sale. Provision for doubtful accounts recognized and included in general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations totaled $3.6 million and $2.5 million for the three months ended March 31, 2015 and 2014, respectively.

 

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Loss Contingencies

We record accruals for various contingencies including legal proceedings and other claims that arise in the normal course of business. The accruals are based on judgment, the probability of losses and, where applicable, the consideration of opinions of legal counsel. We record an accrual when a loss is deemed probable to occur and is reasonably estimable. Factors that we consider in the determination of the likelihood of a loss and the estimate of the range of that loss in respect of legal matters include the merits of a particular matter, the nature of the litigation, the length of time the matter has been pending, the procedural posture of the matter, whether we intend to defend the matter, the likelihood of settling for an insignificant amount and the likelihood of the plaintiff accepting an amount in this range. However, the outcome of such legal matters is inherently unpredictable and subject to significant uncertainties.

Goodwill and Intangible Assets

Purchase accounting requires that all assets and liabilities acquired in a transaction be recorded at fair value on the acquisition date, including identifiable intangible assets separate from goodwill. For significant acquisitions, we obtain independent appraisals and valuations of the intangible (and certain tangible) assets acquired and certain assumed obligations as well as equity. Identifiable intangible assets include customer relationships, trade names and trademarks and developed technology, which equaled $665.1 million at March 31, 2015. Goodwill represents the excess of cost over the fair value of net assets acquired and was $839.0 million at March 31, 2015.

The estimated fair values and useful lives of identified intangible assets are based on many factors, including estimates and assumptions of future operating performance and cash flows of the acquired business, estimates of cost avoidance, the nature of the business acquired, the specific characteristics of the identified intangible assets and our historical experience and that of the acquired business. The estimates and assumptions used to determine the fair values and useful lives of identified intangible assets could change due to numerous factors, including product demand, market conditions, regulations affecting the business model of our operations, technological developments, economic conditions and competition. The carrying values and useful lives for amortization of identified intangible assets are reviewed annually during our fourth fiscal quarter and as necessary if changes in facts and circumstances indicate that the carrying value may not be recoverable and any resulting changes in estimates could have a material adverse effect on our financial results.

When we determine that the carrying value of intangible assets, goodwill and long-lived assets may not be recoverable, an impairment charge is recorded. Impairment is generally measured based on valuation techniques considered most appropriate under the circumstances, including a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model or prevailing market rates of investment securities, if available.

We conduct a goodwill impairment analysis annually in our fourth fiscal quarter, as of October 1, and as necessary if changes in facts and circumstances indicate that the fair value of our reporting units may be less than their carrying amount. Under applicable accounting guidance, we are permitted to use a qualitative approach to evaluate goodwill impairment when no indicators of impairment exist and if certain accounting criteria are met. To the extent that indicators exist or the criteria are not met, we use a quantitative approach to evaluate goodwill impairment. Such quantitative impairment assessment is performed using a two-step, fair value based test. The first step requires that we compare the estimated fair value of our reporting units to the carrying value of the reporting unit’s net assets, including goodwill. If the fair value of the reporting unit is greater than the carrying value of its net assets, goodwill is not considered to be impaired and no further testing is required. If the fair value of the reporting unit is less than the carrying value of its net assets, we would be required to complete the second step of the test by analyzing the fair value of its goodwill. If the carrying value of the goodwill exceeds its fair value, an impairment charge is recorded.

Property and Equipment

Property and equipment are stated at cost and depreciated on the straight-line method over the estimated useful lives of the assets or the lease term, whichever is shorter. Amortization expense associated with leased assets is included with depreciation expense. Routine repairs and maintenance are charged to expense as incurred. We periodically assess potential impairment of our property and equipment and perform an impairment review whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

Income Taxes

We account for income taxes based on the asset and liability method. Under the asset and liability method, deferred tax assets and deferred tax liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carryforwards. Valuation allowances are established when necessary to reduce deferred tax assets when it is determined that it is more likely than not that some portion of the deferred tax asset will not be realized.

 

 

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We recognize the effect of an uncertain income tax position on the income tax return at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Our policy for recording interest and penalties is to record such items as a component of the provision for income taxes.

Recent Accounting Pronouncements

In April 2015, the Financial Accounting Standards Board issued authoritative guidance to simplify the presentation of debt issuance costs. This update requires debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The guidance is effective for fiscal years beginning after December 15, 2015, and for interim periods within fiscal years beginning after December 15, 2016. Early adoption is permitted. We are currently evaluating the impact the adoption of this guidance will have on our consolidated financial statements.

In February 2015, the Financial Accounting Standards Board issued authoritative guidance which provides guidance on consolidation of certain legal entities. These updates requires management to change the analysis that a reporting entity must perform to determine whether it should consolidate certain types of legal entities. The guidance is effective for fiscal years beginning after December 15, 2016, and for interim periods within fiscal years beginning after December 15, 2017. Early adoption is permitted, and the guidance allows for either a retrospective adoption or a “modified retrospective” approach by recording a cumulative-effect adjustment to equity as of the beginning of the fiscal year of adoption. We are currently evaluating the impact the adoption of this guidance will have on our consolidated financial statements.

In August 2014, the Financial Accounting Standards Board issued authoritative guidance which provides guidance on determining when and how to disclose going-concern uncertainties in the financial statements. The new standard requires management to perform interim and annual assessments of an entity’s ability to continue as a going concern within one year of the date the financial statements are issued. This ASU is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2016, with early adoption permitted. We are evaluating the new guidance and plan to provide additional information about its expected impact at a future date.

In May 2014, the FASB issued authoritative guidance which clarifies the principles used to recognize revenue for all entities. The new guidance requires companies to recognize revenue when it transfers goods or services to a customer in an amount that reflects the consideration to which a company expects to be entitled. The guidance is effective for annual and interim periods beginning after December 15, 2016. The guidance allows for either a “full retrospective” adoption or a “modified retrospective” adoption, however early adoption is not permitted. We are currently evaluating the impact the adoption of this guidance will have on our consolidated financial statements.

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Our operations include activities in the United States, Canada and New Zealand. These operations expose us to a variety of market risks, including the effects of changes in interest rates and foreign currency exchange rates. We monitor and manage these financial exposures as an integral part of our overall risk management program.

Interest Rate Risk

On November 16, 2012, we entered into a revolving credit facility that bears interest at a floating rate. As a result, we may be exposed to fluctuations in interest rates to the extent of our borrowings under the revolving credit facility. Our long-term debt portfolio is expected to primarily consist of fixed rate instruments. To help manage borrowing costs, we may from time to time enter into interest rate swap transactions with financial institutions acting as principal counterparties. Assuming the borrowing of all amounts available under our revolving credit facility (after giving effect to the amendment and restatement of our revolving credit facility on March 6, 2015), if interest rates related to our revolving credit facility increase by 1% due to normal market conditions, our interest expense will increase by approximately $2.9 million per annum.

We had $32.5 million in borrowings under the revolving credit facility as of March 31, 2015.

Foreign Currency Risk

We have exposure to the effects of foreign currency exchange rate fluctuations on the results of our Canadian operations. Our Canadian operations use the Canadian dollar to conduct business but our results are reported in U.S. dollars. Our operations in New Zealand

 

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are immaterial to our overall operating results. We are exposed periodically to the foreign currency rate fluctuations that affect transactions not denominated in the functional currency of our U.S. and Canadian operations. We do not use derivative financial instruments to hedge investments in foreign subsidiaries since such investments are long-term in nature.

 

ITEM 4. CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

We maintain disclosure controls and procedures (as that term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) that are designed to ensure that information required to be disclosed in our reports under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosures. Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives.

Internal Control Over Financial Reporting

Internal Control Procedures

Our management, with the participation of our principal executive officer and principal financial officer, has evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of March 31, 2015. Based upon that evaluation, our principal executive officer and principal financial officer were unable to conclude that our disclosure controls and procedures were effective at a reasonable assurance level as of March 31, 2015, because the material weakness previously described in Amendment No. 1 on Form 10-K/A to the Company’s Annual Report on Form 10-K, for the fiscal year ended December 31, 2014 and below, had not yet been fully remediated.

Description of Material Weakness

In connection with the preparation and audit of our consolidated financial statements as of December 31, 2014 and the preparation and review of our condensed consolidated financial statements for the three month period ended March 31, 2015, we and our independent registered public accounting firm identified a material weakness in internal control over financial reporting. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis.

The material weakness we identified related to deficiencies in the completeness and effectiveness of our Information Technology General Control (ITGC) environment and the controls associated with our financial close process. The deficiencies with our financial close process included reviews of account reconciliations and journal entries and deficiencies related to the review of our consolidated statement of cash flows, resulting in a number of audit adjustments, primarily in the areas of capitalized subscriber acquisition costs, inventory and accrued expenses and resulting in the restatement of our condensed consolidated statement of cash flows for certain periods as discussed in Note 2 of the financial statements.

We are continuing our remediation efforts of these controls in the financial statement close process initiated during the first quarter of 2015. The remediation includes, but is not limited to, expanding technical accounting skill sets, enhancing reconciliation and review procedures, and adding additional information technology system related controls.

Changes in Internal Control Over Financial Reporting

Except as described above, there have been no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) during the fiscal quarter ended March 31, 2015 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.

 

Part II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

We are engaged in the defense of certain claims and lawsuits arising out of the ordinary course and conduct of our business and have certain unresolved claims pending, the outcomes of which are not determinable at this time. Our subscriber contracts include exculpatory provisions as described under “—Subscriber Contracts—Other Terms” in Amendment No. 1 on Form 10-K/A to our Annual Report on Form 10-K for the year ended December 31, 2014. We also have insurance policies covering certain potential losses where such coverage is available and cost effective. In our opinion, any liability that might be incurred by us upon the resolution of any claims or lawsuits will not, in the aggregate, have a material adverse effect on our financial condition or results of operations. See Note 12 of our unaudited Condensed Consolidated Financial Statements included elsewhere in this Amendment No. 1 on Form 10-Q/A to the Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2015 for additional information.

 

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ITEM 1A. RISK FACTORS

For a discussion of the Company’s potential risks or uncertainties, please see “Risk Factors” in Amendment No. 1 on Form 10-K/A to our Annual Report on Form 10-K for the fiscal year ended December 31, 2014 (the “Annual Report”). There have been no material changes to the risk factors disclosed in the Annual Report.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None.

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

 

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ITEM 5. OTHER INFORMATION

Pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012, which added Section 13(r) of the Exchange Act, the Company hereby incorporates by reference herein Exhibit 99.1 of this report, which includes disclosure publicly filed by Travelport Worldwide Limited which may be considered the Company’s affiliate.

 

ITEM 6. EXHIBITS

Exhibits

 

                        Incorporated by
Reference
      

Exhibit

Number

  

Exhibit Title

   Form      File No.      Exhibit
No.
     Filing Date    Provided
Herewith
 
31.1    Certification of the Registrant’s Chief Executive Officer, Todd Pedersen, pursuant to Rule 13a-14 of the Securities Exchange Act of 1934                  X   
31.2    Certification of the Registrant’s Principal Financial Officer, Mark Davies, pursuant to Rule 13a-14 of the Securities Exchange Act of 1934                  X   
32.1    Certification of the Registrant’s Chief Executive Officer, Todd Pedersen, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                  X   
32.2    Certification of the Registrant’s Principal Financial Officer, Mark Davies, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002                  X   
99.1    Section 13(r) Disclosure      10-Q         333-191132-02        
 
99.1 August
10, 2015
  
  
     
101.INS    XBRL Instance Document.                  X   
101.SCH    XBRL Taxonomy Extension Schema Document.                  X   
101.CAL    XBRL Taxonomy Extension Calculation Linkbase Document.                  X   
101.DEF    XBRL Taxonomy Extension Schema Document.                  X   
101.LAB    XBRL Taxonomy Extension Label Linkbase Document.                  X   
101.PRE    XBRL Taxonomy Extension Presentation Linkbase Document.                  X   

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

    APX Group Holdings Inc.
Date: August 27, 2015     By:  

/S/ TODD PEDERSEN

      Todd Pedersen
     

Chief Executive Officer and Director

(Principal Executive Officer)

Date: August 27, 2015     By:  

/S/ MARK DAVIES

      Mark Davies
     

Chief Financial Officer

(Principal Financial Officer)

 

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