Document
         

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
 x

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

For the quarterly period ended September 30, 2016
OR
¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission File Number: 001-37461
 
adclogohorizontal.jpg
ALARM.COM HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
 
 
Delaware
 
26-4247032
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification Number)
8281 Greensboro Drive, Suite 100, Tysons, Virginia
 
22102
(Address of principal executive offices)
 
(zip code)

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). þ Yes ¨ No
    
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, 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 þ
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 þ No  
As of November 3, 2016, there were 45,974,317 outstanding shares of the registrant's common stock, par value $0.01 per share.
 
ALARM.COM®



ALARM.COM HOLDINGS, INC.

Table of Contents
 
Page


1

PART I. FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS (unaudited)

ALARM.COM HOLDINGS, INC.
Condensed Consolidated Statements of Operations
(in thousands, except share and per share data)
(unaudited)
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015(2)
 
2016
 
2015(2)
Revenue:
 
 
 
 
 
 
 
SaaS and license revenue
$
44,630

 
$
36,158

 
$
126,652

 
$
102,247

Hardware and other revenue
23,216

 
17,849

 
64,660

 
49,720

Total revenue
67,846

 
54,007

 
191,312

 
151,967

Cost of revenue(1):
 
 
 
 
 
 
 
Cost of SaaS and license revenue
7,787

 
6,764

 
21,779

 
19,094

Cost of hardware and other revenue
18,579

 
13,205

 
50,886

 
38,171

Total cost of revenue
26,366

 
19,969

 
72,665

 
57,265

Operating expenses:
 
 
 
 
 
 
 
Sales and marketing
10,705

 
8,425

 
29,532

 
24,405

General and administrative
14,804

 
10,412

 
42,124

 
25,996

Research and development
11,477

 
9,836

 
32,224

 
26,667

Amortization and depreciation
1,659

 
1,504

 
4,863

 
4,370

Total operating expenses
38,645

 
30,177

 
108,743

 
81,438

Operating income
2,835

 
3,861

 
9,904

 
13,264

Interest expense
(49
)
 
(44
)
 
(137
)
 
(128
)
Other income / (expense), net
139

 
(7
)
 
338

 
(62
)
Income before income taxes
2,925

 
3,810

 
10,105

 
13,074

Provision for income taxes
358

 
867

 
2,927

 
4,581

Net income
2,567

 
2,943

 
7,178

 
8,493

Dividends paid to participating securities
—

 
—

 
—

 
(18,987
)
Income allocated to participating securities
—

 
(45
)
 
—

 
—

Net income / (loss) attributable to common stockholders
$
2,567

 
$
2,898

 
$
7,178

 
$
(10,494
)
 
 
 
 
 
 
 
 
Per share information attributable to common stockholders:
 
 
 
 
 
 
 
Net income / (loss) per share:
 
 
 
 
 
 
 
Basic
$
0.06

 
$
0.06

 
$
0.16

 
$
(0.62
)
Diluted
$
0.05

 
$
0.06

 
$
0.15

 
$
(0.62
)
Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
45,716,961

 
44,922,410

 
45,615,399

 
16,910,090

Diluted
48,319,952

 
46,872,695

 
47,741,365

 
16,910,090

Cash dividends declared per share
$
—

 
$
—

 
$
—

 
$
0.36

_______________

(1)
Exclusive of amortization and depreciation shown in operating expenses below.
(2)
The three and nine months ended September 30, 2015 historical condensed consolidated statement of operations have been revised (Note 2).

See accompanying notes to the condensed consolidated financial statements.

2

ALARM.COM HOLDINGS, INC.
Condensed Consolidated Balance Sheets
(in thousands, except share and per share data)
(unaudited)
 
September 30,
2016
 
December 31, 2015
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
135,050

 
$
128,358

Accounts receivable, net
28,734

 
21,348

Inventory
11,504

 
6,474

Other current assets
8,261

 
4,870

Total current assets
183,549

 
161,050

Property and equipment, net
17,645

 
15,446

Intangible assets, net
4,950

 
6,318

Goodwill
24,723

 
24,723

Deferred tax assets
14,255

 
11,915

Other assets
5,226

 
6,643

Total Assets
$
250,348

 
$
226,095

Liabilities and stockholders’ equity
 
 
 
Current liabilities:
 
 
 
Accounts payable, accrued expenses and other current liabilities
$
27,541

 
$
19,276

Accrued compensation
7,550

 
7,514

Deferred revenue
2,122

 
2,289

Total current liabilities
37,213

 
29,079

Deferred revenue
9,997

 
9,701

Long-term debt
6,700

 
6,700

Other liabilities
12,138

 
10,484

Total Liabilities
66,048

 
55,964

Commitments and contingencies (Note 11)

 

Stockholders’ equity
 
 
 
Preferred stock, $0.001 par value, 10,000,000 shares authorized; 0 shares issued and outstanding as of September 30, 2016 and December 31, 2015.
—

 
—

Common stock, $0.01 par value, 300,000,000 shares authorized; 45,932,589 and 45,581,662 shares issued; and 45,897,911 and 45,485,294 shares outstanding as of September 30, 2016 and December 31, 2015.
459

 
455

Additional paid-in capital
304,726

 
297,781

Treasury stock, 0 shares as of September 30, 2016 and 35,523 shares at a cost of $1.20 per share as of December 31, 2015.
—

 
(42
)
Accumulated other comprehensive income
—

 
—

Accumulated deficit
(120,885
)
 
(128,063
)
Total Stockholders’ Equity
184,300

 
170,131

Total Liabilities and Stockholders’ Equity
$
250,348

 
$
226,095



See accompanying notes to the condensed consolidated financial statements.

3

ALARM.COM HOLDINGS, INC.
Condensed Consolidated Statements of Cash Flows
(in thousands)(unaudited)
 
Nine Months Ended 
 September 30,
Cash flows from operating activities:
2016
 
2015(2)
Net income
$
7,178

 
$
8,493

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

 
420

Reserve for product returns
1,537

 
1,148

Amortization for patents and tooling
550

 
258

Amortization and depreciation
4,863

 
4,370

Amortization of debt issuance costs
79

 
81

Deferred income taxes
(2,340
)
 
(2,310
)
Change in fair value of contingent liability
(226
)
 
180

Undistributed losses from equity investees
60

 
285

Stock-based compensation
2,880

 
2,678

Other, net
—

 
(49
)
Changes in operating assets and liabilities (net of business acquisition):
 
 
 
Accounts receivable
(9,337
)
 
(6,043
)
Inventory
(5,030
)
 
(2,724
)
Other assets
(3,056
)
 
(1,904
)
Accounts payable, accrued expenses and other current liabilities
9,302

 
10,414

Deferred revenue
130

 
1,095

Other liabilities
1,801

 
4,784

Cash flows from operating activities
8,806

 
21,176

Cash flows used in investing activities:
 
 
 
Business acquisition, net of cash acquired
—

 
(5,849
)
Additions to property and equipment
(6,110
)
 
(6,520
)
Investment in cost method investee
(139
)
 
(54
)
Issuances of notes receivable
(73
)
 
(317
)
Repayments of notes receivable
2,441

 
—

Purchases of licenses to patents
(1,600
)
 
(1,000
)
Cash flows used in investing activities
(5,481
)
 
(13,740
)
Cash flows from financing activities:
 
 
 
Proceeds from issuance of common stock from initial public offering, net of underwriting discount and commission
—

 
97,976

Payments of debt issuance costs
(131
)
 
—

Payments of long-term consideration for business acquisitions
(417
)
 
—

Dividends paid to common stockholders
—

 
(1,013
)
Dividends paid to employees for unvested shares
—

 
(57
)
Dividends paid to redeemable convertible preferred stockholders
—

 
(18,930
)
Payments of offering costs
—

 
(2,632
)
Repurchases of common stock
(12
)
 
(1
)
Proceeds from early exercise of stock options
—

 
124

Issuances of common stock from equity-based plans
1,202

 
300

Tax windfall benefit from stock options
2,725

 
826

Cash flows from financing activities
3,367

 
76,593

Net increase in cash and cash equivalents
6,692

 
84,029

Cash and cash equivalents at beginning of the period
128,358

 
42,572

Cash and cash equivalents at end of the period
$
135,050

 
$
126,601


4


ALARM.COM HOLDINGS, INC.
Condensed Consolidated Statements of Cash Flows - Continued
(in thousands)
(unaudited)

 
Nine Months Ended 
 September 30,
Supplemental disclosure of noncash investing and financing activities:
2016
 
2015(2)
Conversion of redeemable convertible preferred stock to common stock
$
—

 
$
202,456

Cash not yet paid for business acquisitions
$
—

 
$
617

Contingent liability from business acquisition
$
5

 
$
880

Cash not yet paid for capital expenditures
$
359

 
$
232

Reclassification of deferred offering costs to additional paid-in-capital
$
—

 
$
5,024


(2) The nine months ended September 30, 2015 historical condensed consolidated statements of cash flow has been revised (Note 2).


See accompanying notes to the condensed consolidated financial statements.

5

ALARM.COM HOLDINGS, INC.
Condensed Consolidated Statement of Equity
(in thousands)
(unaudited)
 
Preferred Stock
 
Common Stock
 
Additional
Paid-In-
Capital
 
Treasury
Stock
 
Accumulated
Deficit
 
Total
Stockholders’
Equity
 
Shares
 
Amount
 
Shares
 
Amount
 
Balance as of January 1, 2016
—

 
$
—

 
45,485

 
$
455

 
$
297,781

 
$
(42
)
 
$
(128,063
)
 
$
170,131

Common stock issued in connection with equity-based plans
—

 
—

 
353

 
3

 
1,199

 
—

 
—

 
1,202

Vesting of common stock subject to repurchase
—

 
—

 
60

 
1

 
228

 
—

 
—

 
229

Stock-based compensation
—

 
—

 
—

 
—

 
2,880

 
—

 
—

 
2,880

Tax benefit from stock options, net
—

 
—

 
—

 
—

 
2,680

 
—

 
—

 
2,680

Retirement of treasury stock
—

 
—

 
—

 
—

 
(42
)
 
42

 
—

 
—

Net income
—

 
—

 
—

 
—

 
—

 
—

 
7,178

 
7,178

Balance as of September 30, 2016
—

 
$
—

 
45,898

 
$
459

 
$
304,726

 
$
—

 
$
(120,885
)
 
$
184,300


See accompanying notes to the condensed consolidated financial statements.





























6

ALARM.COM HOLDINGS, INC.
Notes to the Condensed Consolidated Financial Statements
September 30, 2016 and 2015
(unaudited)
Note 1. Organization
Alarm.com Holdings, Inc. (referred to herein as “Alarm.com”, the “Company”, or “we”) is the leading platform solution for the connected home. Through our cloud-based services, we make connected home technology broadly accessible to millions of home and business owners. Our multi-tenant software-as-a-service (“SaaS”) platform enables home and business owners to intelligently secure their properties and automate and control a broad array of connected devices through a single, intuitive interface. Our solutions are delivered through an established network of over 6,000 trusted service providers, who are experts at designing, selling, installing and supporting our solutions. Our four primary solutions are interactive security, intelligent automation, video monitoring and energy management, which can be used individually or integrated into a single user interface. We derive revenue from the sale of our SaaS solutions over an integrated platform, license fees, hardware, activation fees and other revenue. Our fiscal year ends on December 31st.
Note 2. Basis of Presentation
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include our accounts and those of our majority-owned and controlled subsidiaries after elimination of intercompany accounts and transactions.
These unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim financial information and the applicable rules and regulations of the Securities and Exchange Commission ("SEC"). Accordingly, they do not include all the information and footnotes required by GAAP for annual financial statements. They should be read together with our audited consolidated financial statements and related notes thereto for the year ended December 31, 2015 appearing in our Annual Report on Form 10-K filed on February 29, 2016 with the SEC. The condensed consolidated balance sheet data as of December 31, 2015 was derived from our audited financial statements, but does not include all disclosures required by GAAP for annual financial statements.
In the opinion of management, these condensed consolidated financial statements include all normal recurring adjustments necessary for a fair statement of the results of operations, financial position and cash flows. The results of operations for the three and nine months ended September 30, 2016 are not necessarily indicative of the results that can be expected for our entire fiscal year ending December 31, 2016.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Our estimates, judgments and assumptions are continually evaluated based on available information and experience. Because the use of estimates is inherent in the financial reporting process, actual results could differ from our estimates. Estimates are used when accounting for revenue recognition, allowances for doubtful accounts receivable, allowance for hardware returns, estimates of obsolete inventory, long-term incentive compensation, stock-based compensation, income taxes, legal reserves, contingent consideration liability, goodwill and intangible assets.
September 30, 2015 Revision
During the fourth quarter of 2015, we identified an immaterial error related to the amount of stock-based compensation expense that we recorded in the third quarter of 2015 and reported in our Quarterly Report on Form 10-Q for September 30, 2015 which was filed with the SEC on November 10, 2015. We disclosed the error in our Annual Report on Form 10-K for the year ended December 31, 2015, which was filed with the SEC on February 29, 2016 and have revised our previously reported financial results for the quarter ended September 30, 2015 to correct the error. We concluded that this correction had no impact on our previously issued quarterly financial statements or our 2015 audited consolidated financial statements. The financial results for the three and nine months ended September 30, 2015 included within this Quarterly Report on Form 10-Q for September 30, 2016 are the revised financial results.

7

Recent Accounting Pronouncements
Adopted
On September 25, 2015, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2015-16, “Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments,” which requires entities to apply the guidance prospectively to adjustments to provisional amounts that occur after the effective date. Under the previous guidance, the acquirer would retrospectively adjust provisional amounts recognized as of the acquisition date with a corresponding adjustment to goodwill. Adjustments were required when new information was obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts initially recognized or would have resulted in the recognition of additional assets or liabilities. The amendments in ASU 2015-16 eliminate the requirement to retrospectively account for those adjustments. The amendment is effective for annual periods, including periods within those annual periods beginning after December 15, 2015 with early adoption permitted. We adopted this pronouncement prospectively in the first quarter of 2016, and it did not have an impact on our financial statements.
On April 15, 2015, the FASB issued ASU 2015-05, “Intangibles - Goodwill and Other - Internal- Use Software (Subtopic 350-40): Customer’s Accounting for Fees Paid in a Cloud Computing Arrangement,” which clarifies the accounting for fees paid by a customer in a cloud computing arrangement by providing guidance as to whether an arrangement includes the sale or license of software. The amendment requires a customer to determine whether a cloud computing arrangement contains a software license. If the arrangement contains a software license, the customer would account for the fees related to the software license element in a manner consistent with how the acquisition of other software licenses is accounted for under Accounting Standards Codification ("ASC") 350-40; if the arrangement does not contain a software license, the customer would account for the arrangement as a service contract. The guidance will not change GAAP for a customer’s accounting for service contracts. The amendment is effective for annual periods, including periods within those annual periods beginning after December 31, 2015 with early adoption permitted. We elected to adopt the amendments prospectively to all arrangements entered into or materially modified after the effective date. We adopted this pronouncement in the first quarter of 2016, and it did not have an impact on our financial statements.
On February 18, 2015, the FASB issued ASU 2015-02, “Consolidation (Topic 810): Amendments to the Consolidation Analysis,” which requires an entity to evaluate whether it should consolidate certain legal entities. All legal entities are subject to reevaluation under the revised consolidation model. The amendment modifies the evaluation of whether limited partnerships and similar legal entities are variable interest entities ("VIEs"). The amendment eliminates the presumption that a general partner should consolidate a limited partnership. The amendment affects the consolidation analysis of reporting entities that are involved with VIEs particularly those that have fee arrangements and related party relationships. The amendment also provides a scope exception from consolidation guidance for reporting entities that comply with the requirements for registered money market funds. We adopted this pronouncement in the first quarter of 2016, and it did not have an impact on our financial statements.
On June 19, 2014, the FASB issued ASU 2014-12, “Compensation - Stock Compensation (Topic 718),” which affects any entity that grants its employees share-based payments in which the terms of the award stipulate that a performance target that affects vesting could be achieved after the requisite service period. The amendments require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. As such, the performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. If the performance target becomes probable of being achieved before the end of the requisite service period, the remaining unrecognized compensation cost should be recognized prospectively over the remaining requisite service period. We adopted this pronouncement in the first quarter of 2016, and it did not have an impact on our financial statements.
Not yet adopted
On August 26, 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows (Topic 230) - Classification of Certain Cash Receipts and Cash Payments,” which provides guidance on the classification of certain cash receipts and payments in the statement of cash flows with the objective of reducing existing diversity in practice. The amendment is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. We are required to adopt ASU 2016-15 in the first quarter of 2018 and we do not anticipate that the adoption of this standard will have a material effect on our financial statements.
On May 9, 2016, the FASB issued ASU 2016-12, "Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients," and on April 14, 2016, the FASB issued ASU 2016-10, “Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing”. ASU 2016-12 and 2016-10 both amend the guidance in ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)," which is not yet effective. ASU 2016-12 clarifies guidance on assessing collectibility, presentation of sales taxes, noncash consideration, and completed contracts and

8

contract modification within Topic 606. ASU 2016-10 clarifies guidance related to identifying performance obligations and licensing implementation guidance. These updates are effective with the same transition requirements as ASU 2014-09, as amended. We are required to adopt ASU 2014-09 and its amendments in the first quarter of 2018, and we are currently assessing the impact of this pronouncement on our financial statements.
On March 17, 2016, the FASB issued ASU 2016-08, “Revenue from Contracts with Customers (Topic 606): Principal Versus Agent Considerations (Reporting Revenue Gross Versus Net)” which amends the guidance in ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)," which is not yet effective. The update clarifies the implementation guidance on principal versus agent considerations. The update is effective with the same transition requirements as ASU 2014-09, as amended. We are required to adopt ASU 2014-09 and its amendments in the first quarter of 2018, and we are currently assessing the impact of this pronouncement on our financial statements.
On August 12, 2015, the FASB issued ASU 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date," which defers the effective date for all entities for one year of ASU 2014-09, “Revenue from Contracts with Customers (Topic 606),” issued on May 28, 2014. ASU 2014-09 affects any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The guidance supersedes the revenue recognition guidance in Topic 605, “Revenue Recognition,” and most industry-specific guidance throughout the Industry Topics of the FASB Accounting Standards Codification. The guidance also supersedes some cost guidance included in Subtopic 605-35, “Revenue Recognition - Contract-Type and Production-Type Contracts." ASU 2014-09, as amended, is effective for annual periods, and interim periods within those years, beginning after December 31, 2017. An entity is required to apply the amendments using one of the following two methods: (1) retrospectively to each prior period presented with three possible expedients: (a) for completed contracts that begin and end in the same reporting period no restatement is required; (b) for completed contract with variable consideration an entity may use the transaction price at completion rather than restating estimated variable consideration amounts in comparable reporting periods; and (c) for comparable reporting periods before date of initial application reduced disclosure requirements related to transaction price; (2) retrospectively with the cumulative effect of initially applying the amendment recognized at the date of initial application with additional disclosures for the differences of the prior guidance to the reporting periods compared to the new guidance and an explanation of the reasons for significant changes. We are required to adopt ASU 2014-09 and its amendments in the first quarter of 2018, and we are currently assessing the impact of this pronouncement on our financial statements.
On March 30, 2016, the FASB issued ASU 2016-09, “Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting” which simplifies several aspects of the accounting for employee share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The update is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years, with early adoption permitted. An entity that elects early adoption must adopt all of the amendments in the same period. Amendments related to the timing of when excess tax benefits are recognized, minimum statutory withholding requirements, forfeitures, and intrinsic value should be applied using a modified retrospective transition method by means of a cumulative-effect adjustment to equity as of the beginning of the period in which the guidance is adopted. Amendments related to the presentation of employee taxes paid on the statement of cash flows when an employer withholds shares to meet the minimum statutory withholding requirement should be applied retrospectively. Amendments requiring recognition of excess tax benefits and tax deficiencies in the income statement and the practical expedient for estimating expected term should be applied prospectively. An entity may elect to apply the amendments related to the presentation of excess tax benefits on the statement of cash flows using either a prospective transition method or a retrospective transition method. We are required to adopt ASU 2016-09 in the first quarter of 2017, and we are currently assessing the impact of this pronouncement on our financial statements.
On February 25, 2016, the FASB issued ASU 2016-02, “Leases (Topic 842),” which requires lessees to recognize operating and financing lease liabilities and corresponding right-of-use assets on the balance sheet. The update also requires improved disclosures to help users of financial statements better understand the amount, timing and uncertainty of cash flows arising from leases. The update is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, with early adoption permitted. We are required to adopt ASU 2016-02 in the first quarter of 2019, and we are currently assessing the impact of this pronouncement on our financial statements.
On July 22, 2015, the FASB issued ASU 2015-11, “Simplifying the Measurement of Inventory,” which requires entities to measure most inventory "at the lower of cost and net realizable value," thereby simplifying the current guidance under which an entity must measure inventory at the lower of cost or market (market in this context is defined as one of three different measures). The guidance does not apply to inventories that are measured by using either the last-in, first-out method or the retail inventory method. Under current guidance, an entity subsequently measures inventory at the lower of cost or market, with market defined as replacement cost provided that it is not above the ceiling (net realizable value) or below the floor (net realizable value less an approximately normal profit margin) which is unnecessarily complex. The amendment does not change other guidance on measuring inventory. The amendment is effective for annual periods, including periods within those annual periods beginning after December 15, 2016 with early adoption permitted. We are required to adopt this pronouncement

9

prospectively in the first quarter of 2017, and we are currently assessing the impact of this pronouncement on our financial statements.
On August 27, 2014, the FASB issued ASU 2014-15, “Presentation of Financial Statements — Going Concern (Subtopic 205-40),” which requires management to perform interim and annual assessments regarding conditions or events that raise substantial doubt about a company’s ability to continue as a going concern and to provide related disclosures, if applicable. The amendment is effective for annual periods ending after December 15, 2016, and interim periods thereafter, with early adoption permitted. We are required to adopt ASU 2014-15 for our 2016 annual reporting period. We do not anticipate that the adoption of this standard will have a material effect on our financial statements.
Note 3. Accounts Receivable, Net
The components of accounts receivable, net are as follows (in thousands):
    
 
September 30,
2016
 
December 31, 2015
Accounts receivable
$
32,430

 
$
24,779

Allowance for doubtful accounts
(1,301
)
 
(1,315
)
Allowance for product returns
(2,395
)
 
(2,116
)
Accounts receivable, net
$
28,734

 
$
21,348

We recorded a $0.2 million and a $0.4 million provision for doubtful accounts receivable for the three and nine months ended September 30, 2016, respectively, as compared to less than $0.1 million and $0.4 million for the same periods in the prior year. We recorded a $0.5 million and a $1.5 million reserve for product returns in our hardware and other revenue for the three and nine months ended September 30, 2016, respectively, as compared to $0.3 million and $1.1 million for the same periods in the prior year. Historically, we have not experienced write-offs for uncollectible accounts or sales returns that have differed significantly from our estimates.
Note 4. Inventory
The components of inventory are as follows (in thousands):
    
 
September 30,
2016
 
December 31,
2015
Raw materials
$
5,364

 
$
3,026

Finished goods
6,140

 
3,448

Total inventory
$
11,504

 
$
6,474

Note 5. Acquisitions
Proposed Acquisition

During our second quarter of 2016, we entered into a definitive agreement to acquire two business units, Connect and Piper, from Icontrol Networks, Inc., or Icontrol, for a purchase price of approximately $140.0 million, or the Acquisition. Connect develops and sells a custom, on-premise software platform that powers several service providers' solutions for interactive security and automation including ADT Pulse® which was estimated to have 1.6 million subscribers as of December 31, 2015. Piper develops and sells a Wi-Fi-enabled video and home automation hub. We expect the proposed Acquisition to contribute to revenue growth and be EPS accretive on a non-GAAP basis for the full year 2017. The proposed Acquisition is subject to customary closing conditions as well as certain events that we cannot control, including regulatory approvals and the closing of the acquisition of Icontrol's Converge business unit by Comcast Cable Communications, LLC, a subsidiary of Comcast Corporation, or Comcast.

On September 12, 2016, we and Icontrol each received a request for additional information and documentary materials, or a second request, from the U.S. Federal Trade Commission, or the FTC, in connection with the FTC’s review of the proposed Acquisition. On September 22, 2016, we and Icontrol entered into a timing agreement with the FTC and agreed not to consummate the proposed Acquisition before the 45th calendar day following the date of certifying substantial compliance with the second request, unless we have received prior notice that the FTC has concluded its review. We and Icontrol are in the process of responding to the second request but ongoing review at the FTC will likely result in the proposed Acquisition not closing until the first quarter of 2017. Further, on November 2, 2016, in response to questions raised by the FTC, we and Icontrol represented to the FTC that the terms of the acquisition agreement would be modified to ensure we do not exercise any control

10

over the ongoing operations of the Icontrol business until such time as the waiting period under the Hart-Scott-Rodino Act expires or is terminated. We and Icontrol are also providing documents and information to the FTC to address these questions.

Effective as of August 19, 2016, or the Effective Date, our subsidiary, Alarm.com Incorporated, or Alarm.com, and ADT LLC, or ADT, amended their existing master services agreement, or the Amended MSA. The Amended MSA provides that following the closing, if any, of the proposed Acquisition, in exchange for certain incentives and service obligations provided to ADT, Alarm.com will serve as the exclusive provider of services for ADT’s professionally installed residential interactive security, automation and video service offerings for a period of up to five (5) years following the Effective Date, subject to Alarm.com achieving certain performance conditions and with certain exclusions. The Amended MSA also includes certain installation, maintenance, support, indemnity and development requirements and can be terminated if such requirements are not satisfied, including without notice if certain events occur. The foregoing description of the material terms of the Amended MSA does not purport to be complete and is subject to, and is qualified in its entirety by, reference to the full terms of the Amended MSA. We have submitted a request for confidential treatment of certain portions of the Amended MSA to the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.
SecurityTrax Acquisition
On March 13, 2015, in accordance with an asset purchase agreement, we completed our purchase of certain assets of HiValley Technology, Inc., (“SecurityTrax”) that constituted a business. SecurityTrax is a provider of SaaS-based customer relationship management software tailored for security system dealers. The consideration included $5.6 million cash paid at closing and $0.4 million of cash not yet paid and established a contingent liability of $0.7 million for earn-out considerations to be paid to the former owners. The agreement also contains $2.0 million in potential payments associated with the continued employment of key employees through March 31, 2018 that will be accounted for as compensation expense over the period.
The revenue and net income from SecurityTrax's operations since its acquisition date, March 13, 2015, were included in the Alarm.com segment for the three and nine months ended September 30, 2015 (see Note 16). The following pro forma data has been prepared as if SecurityTrax was included in our historical consolidated statements of operations beginning on January 1, 2015. These pro forma results do not necessarily represent the results that may occur in the future. We have adjusted for amortization expense assuming the fair value adjustments to intangible assets had been applied beginning January 1, 2014. We did not adjust for transaction costs as the transaction costs were recorded in the period of acquisition. We also included adjustments for income taxes associated with these pro forma adjustments. The pro forma adjustments were based on available information and upon assumptions that we believe are reasonable to reflect the impact of these acquisitions on our historical financial information on a supplemental pro forma basis. For the nine months ended September 30, 2015, our unaudited pro forma revenue was $152.2 million and our unaudited pro forma net income was $8.7 million.
The table below sets forth the consideration paid to SecurityTrax’s sellers and the estimated fair value of the tangible and intangible net assets acquired (in thousands):
    
 
March 13, 2015
Calculation of Consideration:
 
Cash paid, net of working capital adjustment
$
5,612

Cash not yet paid
400

Contingent consideration liability
700

Total consideration
$
6,712

Estimated Tangible and Intangible Net Assets:
 
Current assets
$
14

Customer relationships
1,699

Developed technology
1,407

Trade name
271

Current liabilities
(7
)
Goodwill
3,328

Total estimated tangible and intangible net assets
$
6,712

The $3.3 million goodwill balance reflects the value of acquired workforce and expected synergies from pairing SecurityTrax's solutions to security service providers with our current product offerings. The goodwill will be deductible for tax

11

purposes. We developed our estimate of the fair value of intangible net assets using a multi-period excess earnings method for customer relationships, the relief from royalty method for the developed technology, replacement cost method for the developed technology home page and the relief from royalty method for the trade name. The purchase price allocation presented above was finalized in 2015.
Fair Value of Net Assets Acquired and Intangibles
In accordance with ASC 805, the assets and liabilities of SecurityTrax we acquired were recorded at their respective fair values as of March 13, 2015, the date of the acquisition.
Customer Relationships
We recorded the customer relationships intangible asset separately from goodwill based on determination of the length, strength and contractual nature of the relationship that SecurityTrax shared with its customers. We valued two groups of customer relationships using the multi-period excess earnings method, an income approach. We used several assumptions in the income approach, including revenue growth, operating expenses, charge for contributory assets, and a 22.5% discount rate used to calculate the present value of the cash flows. For the second group of customer relationships, we used the same assumptions in addition to a customer retention rate of 90%. We are amortizing the customer relationships, valued at $1.7 million, on a straight-line basis over a weighted-average estimated useful life of seven years.
Developed Technology
Developed technology recorded separately from goodwill consists of intellectual property such as proprietary software used internally for revenue producing activities. SecurityTrax’s proprietary software is offered for sale on a SaaS hosted basis to customers. We valued the developed technology by applying the relief from royalty method, an income approach. We used several assumptions in the relief from royalty method, which included revenue growth, a market royalty rate of 25% and a 22.5% discount rate used to the calculate the present value of the cash flows. An additional component of the developed technology, which we refer to as the home page, organized customer data and functioned as the billing and administration tool. We valued the home page component by applying the replacement cost model, a cost approach. We used several assumptions in the replacement cost approach, which included analyzing costs that a company would expect to incur to recreate an asset of equivalent utility. In addition, we made an adjustment for developer’s profit of 30.4% which brought the asset to fair value on an exit-price basis. We are amortizing the developed technology, valued at $1.4 million, on a straight-line basis over a weighted-average estimated useful life of eight years.
Contingent Consideration Liability
The amount of contingent consideration liability to be paid, up to a maximum of $2.0 million, to the former owners of SecurityTrax will be determined based on revenue and EBITDA of the acquired business for the year ended December 31, 2017. We estimated the fair value of the contingent consideration liability by using a Monte Carlo simulation model for determining projected revenue by using an expected distribution of potential outcomes. The fair value of contingent consideration liability is calculated with thousands of projected revenue outcomes, the results of which are averaged and then discounted to estimate the present value. We used several assumptions including an 8.45% discount rate and a 7.5% revenue risk adjustment. We recorded the contingent consideration, valued at $0.7 million, as a contingent consideration liability in other liabilities in our condensed consolidated balance sheet. At each reporting date we will remeasure the liability and record any changes in general and administrative expense, until we pay the contingent consideration, if any, in the first quarter of 2018. We adjusted the fair value of the contingent consideration liability to less than $0.1 million as of September 30, 2016 using the same method with updated assumptions and forecast, which resulted in less than $0.1 million and $0.2 million of income for the three and nine months ended September 30, 2016. The fair value of the contingent consideration liability was $0.2 million as of December 31, 2015. For the change in the fair value of the liability from acquisition date through September 30, 2015, we recorded $0.1 million and $0.2 million of expense in general and administrative expense during the three and nine months ended September 30, 2015.
Note 6. Goodwill and Intangible Assets, Net
The following table reflects changes in goodwill by operating segment for the nine months ended September 30, 2016 (in thousands):
    
 
Alarm.com
 
Other
 
Total
Balance as of December 31, 2015
$
24,723

 
$
—

 
$
24,723

Goodwill acquired
—

 
—

 
—

Balance as of September 30, 2016
$
24,723

 
$
—

 
$
24,723


12

There were no impairments of goodwill recorded during the three and nine months ended September 30, 2016 and 2015.
The following table reflects changes in the net carrying amount of the components of intangible assets for the nine months ended September 30, 2016 (in thousands):
    
 
Customer
Relationships
 
Developed
Technology
 
Trade
Name
 
Other
 
Total
Balance as of December 31, 2015
$
4,449

 
$
1,486

 
$
273

 
$
110

 
$
6,318

Intangible assets acquired
—

 
—

 
—

 
—

 
—

Amortization
(827
)
 
(358
)
 
(95
)
 
(88
)
 
(1,368
)
Balance as of September 30, 2016
$
3,622

 
$
1,128

 
$
178

 
$
22

 
$
4,950

We recorded $0.4 million and $1.4 million of amortization related to our intangible assets for the three and nine months ended September 30, 2016, respectively, as compared to $0.6 million and $1.6 million for the same periods in the prior year.
The following tables reflect the weighted average remaining life and carrying value of finite-lived intangible assets as of September 30, 2016 and December 31, 2015 (in thousands):
    
 
September 30, 2016
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net Carrying
Value
 
Weighted-
Average
Remaining Life
Customer relationships
$
10,666

 
$
(7,044
)
 
$
3,622

 
4.0
Developed technology
5,390

 
(4,262
)
 
1,128

 
4.3
Trade name
914

 
(736
)
 
178

 
4.4
Other
234

 
(212
)
 
22

 
0.2
Total intangible assets
$
17,204

 
$
(12,254
)
 
$
4,950

 
 
    
 
December 31, 2015
 
Gross
Carrying
Amount
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Weighted-
Average
Remaining Life
Customer relationships
$
10,666

 
$
(6,217
)
 
$
4,449

 
4.5
Developed technology
5,390

 
(3,904
)
 
1,486

 
4.8
Trade name
914

 
(641
)
 
273

 
4.7
Other
234

 
(124
)
 
110

 
0.9
Total intangible assets
$
17,204

 
$
(10,886
)
 
$
6,318

 
 
The following table reflects the future estimated amortization expense for intangible assets as of September 30, 2016 (in thousands):
    
Year Ending December 31,
 
Amortization
Remainder of 2016
 
$
358

2017
 
1,400

2018
 
1,329

2019
 
579

2020 and thereafter
 
1,284

Total future amortization expense
 
$
4,950


13

Note 7. Investments in Other Entities
Cost Method Investment in Connected Home Service Provider
We own 20,000 Series A Convertible Preferred Membership Units and 2,667 Series B Convertible Preferred Membership Units of a Brazilian connected home solutions provider, which represents an interest of 12.4% on a fully diluted basis, and was purchased for $0.4 million. On April 15, 2015, we purchased 2,333 Series B-1 Convertible Preferred Membership Units at $23.31 per unit, for a purchase price of $0.1 million, which increased our aggregate equity interest to 12.6% on a fully diluted basis. On April 20, 2016, we purchased an additional 6,904 Series B-1 Convertible Preferred Membership Units at $20.19 per unit, for a purchase prices of $0.1 million, which increased our aggregate equity interest to 14.3% on a fully diluted basis. The entity resells our products and services to residential and commercial customers in Brazil. Based upon the level of equity investment at risk, the connected home service provider is a VIE. We do not control the marketing, sales, installation, or customer maintenance functions of the entity and therefore do not direct the activities of the entity that most significantly impact its economic performance. We have determined that we are not the primary beneficiary of the entity and do not consolidate its financial results into ours. We account for this investment using the cost method. As of September 30, 2016 and December 31, 2015, the fair value of this cost method investment was not estimated as there were no events or changes in circumstances that may have had a significant adverse effect on the fair value of the investment. The investment is included in other assets in our condensed consolidated balance sheets and was $0.6 million as of September 30, 2016 and $0.4 million as of December 31, 2015.
Investments in and Loans to an Installation Partner
We own 48,190 common units of an installation partner which represents an interest of 48.2% on a fully diluted basis, and was purchased for $1.0 million. The entity performs installation services for security dealers, as well as subsidiaries reported in our Other segment. Based upon the level of equity investment at risk, we determined that the installation partner was not a VIE. We accounted for this investment under the equity method because we have the ability to exercise significant influence over the operating and financial policies of the entity. Under the equity method, we recognize our share of the earnings or losses of the installation partner in other income / (expense), net in our condensed consolidated statements of operations in the periods they are reported by the installation partner.
In September 2014, we loaned $0.3 million to our installation partner under a secured promissory note that accrues interest at 8.0% per annum. Interest is payable monthly with the entire principal balance plus any accrued but unpaid interest due on the note's maturity date. This event did not cause us to reconsider our conclusion that the installation partner has sufficient equity investment at risk and therefore was not a VIE. We have continued to account for the investment under the equity method. In the fourth quarter of 2015, accumulated operating losses of our installation partner exceeded its equity contributions, and we began to record 100% of its net losses, which amounted to $0.2 million, against our $0.3 million note receivable. The note was amended in September 2016 to extend the maturity date to September 2018. In our condensed consolidated balance sheets, the $0.1 million note receivable balance was included in other assets as of September 30, 2016 and included in other current assets as of December 31, 2015.
On December 11, 2015, we purchased an additional 9,290 common units of the same company for $0.2 million, which did not change our proportional share of ownership interest. This event caused us to reconsider our conclusion that the installation partner has sufficient equity investment at risk and we now consider the installation partner to be a VIE. We do not control the ability to obtain funding, the annual operating plan, marketing, sales or cash management functions of the entity and therefore, do not direct the activities of the entity that most significantly impact its economic performance. We have determined that we are not the primary beneficiary of our installation partner and do not consolidate its financial results into ours. We continue to account for the investment under the equity method. Due to the terms of the investment, the investment partner received additional equity contributions, and we returned to recording our share of its earnings or losses against our investment.
We recorded our share of the installation partner's loss in other income / (expense), net in our condensed consolidated statements of operations, which was less than $0.1 million for the three and nine months ended September 30, 2016 as compared to $0.1 million and $0.3 million for the same periods in the prior year. Our $1.2 million investment, net of equity losses, is included in other assets in our condensed consolidated balance sheets and was $0.1 million as of September 30, 2016 and December 31, 2015.
Investments in and Loans to a Platform Partner
We have invested in the form of loans and equity investment in a platform partner which produces connected devices to provide it with the capital required to bring its devices to market and integrate them onto our connected home platform.
In 2013, we paid $3.5 million in cash to purchase 3,548,820 shares of our platform partner’s Series A convertible preferred shares, or an 18.7% interest on as-converted and fully diluted basis. In 2014, we entered into a Series 1 Preferred Stock purchase agreement with the platform partner and another investor. The other investor invested cash to purchase shares of the platform partner’s Series 1 Preferred Stock. As a result of the purchase, our 3,548,820 shares of Series A convertible preferred shares converted into 3,548,820 shares of common stock, and we now hold an 8.6% interest in the platform partner on an as converted and fully diluted basis. In conjunction with the transaction, we received a $2.5 million dividend that we recorded as a return of investment as it was in excess of the accumulated earnings and profits of the investee since the date of the investment.

14

Based upon the level of equity investment at risk, the platform partner is a VIE. We have concluded that we are not the primary beneficiary of the platform partner VIE. We do not control the product design, software development, manufacturing, marketing, or sales functions of the platform partner and therefore, we do not direct the activities of the platform partner that most significantly impact its economic performance. We account for this investment under the cost method. As of September 30, 2016 and December 31, 2015, the fair value of this cost method investment was not estimated as there were no events or changes in circumstances that may have had a significant adverse effect on the fair value of the investment.
As of September 30, 2016 and December 31, 2015, our $1.0 million cost method investment in a platform partner was recorded in other assets in our condensed consolidated balance sheets.
Note 8. Other Assets
Patent Licenses
From time to time, we enter into agreements to license patents. We have $4.9 million in patent licenses related to such agreements. We are amortizing the patent licenses over the estimated useful lives of the patents, which range from three to eleven years. The net balance as of September 30, 2016 and December 31, 2015 was $3.4 million and $2.2 million. Amortization expense on patent licenses was $0.1 million and $0.4 million for the three and nine months ended September 30, 2016, as compared to $0.2 million and $0.3 million for the three and nine months ended September 30, 2015. Amortization expense on patent licenses is included in cost of SaaS and license revenue in our condensed consolidated statements of operations.
Loan to a Distribution Partner
In 2013, we entered into a revolving loan agreement with a distribution partner. The distribution partner is also a service provider with whom we have a standard agreement to resell our connected home service and hardware. We had evaluated that our distribution partner had good credit quality through a credit review at the inception of the arrangement and by evaluating risk indications during the repayment period.
Under the terms of the revolving loan agreement, we had agreed to loan our distribution partner up to $2.8 million, with the proceeds of the loan to be used to finance the creation of new customer accounts that use our products and services. The amount that our distribution partner could draw down on the loan was based on the number of its qualifying new customer accounts created each month. The loan accrued interest at a rate of 8.0% per annum, and required monthly interest payments, with the entire principal balance due on the loan maturity date, July 24, 2018. The balance outstanding under the loan was collateralized by the customer accounts owned by our distribution partner, as well as all of the physical assets and accounts receivable associated with those customer accounts.
During the first quarter of 2016, our distribution partner repaid the loan and the revolving loan agreement was subsequently terminated. We received $2.4 million of cash, representing the entire balance outstanding and the accrued interest at the termination date. There was no outstanding balance as of September 30, 2016. As of December 31, 2015, our distribution partner's outstanding balance was $2.4 million and the note receivable was included in other assets on our condensed consolidated balance sheets.
Loan to a Distribution Partner
In September 2016, we entered into dealer and loan agreements with a new distribution partner. The dealer agreement enables the distribution partner to resell our SaaS services and hardware to their subscribers. Under the loan agreements, we agreed to loan the distribution partner up to $4.0 million, collateralized by all assets owned by the distribution partner. The loan has two advance periods which begin each year in October and end during the following January until August 31, 2019, the term date of the loan. Interest on the outstanding principal accrues at a rate per annum equal to the greater of 6% or the LIBOR rate plus 4%, as determined on the first date of each annual advance period. The borrower has the option to extend the term of the loan for two successive terms of one year each.
For the three months ended September 30, 2016, there were no amounts drawn and there was no outstanding balance for this loan as of September 30, 2016. For the three months ended September 30, 2016, there was no revenue recognized under the dealer agreement. Subsequent to September 30, 2016 and prior to the filing of this Quarterly Report on Form 10-Q, our distribution partner has drawn $2.0 million at a rate of 6% per annum.

15

Note 9. Fair Value Measurements
The following table presents our assets and liabilities measured at fair value on a recurring basis as of September 30, 2016 and December 31, 2015 (in thousands):
    
 
Fair Value Measurements on a Recurring Basis as of
September 30, 2016
Fair Value Measurements in:
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Money market account
$
126,549

 
$
—

 
$
—

 
$
126,549

Total
$
126,549

 
$
—

 
$
—

 
$
126,549

Liabilities:
 
 
 
 
 
 
 
Subsidiary unit awards
$
—

 
$
—

 
$
2,164

 
$
2,164

Contingent consideration liability from acquisition
—

 
—

 
5

 
5

Total
$
—

 
$
—

 
$
2,169

 
$
2,169

    
 
Fair Value Measurements on a Recurring Basis as of
December 31, 2015
Fair Value Measurements in:
Level 1
 
Level 2
 
Level 3
 
Total
Assets:
 
 
 
 
 
 
 
Money market account
$
122,818

 
$
—

 
$
—

 
$
122,818

Total
$
122,818

 
$
—

 
$
—

 
$
122,818

Liabilities:
 
 
 
 
 
 
 
Subsidiary unit awards
$
—

 
$
—

 
$
532

 
$
532

Contingent consideration liability from acquisition
—

 
—

 
230

 
230

Total
$
—

 
$
—

 
$
762

 
$
762


The following table summarizes the change in fair value of the Level 3 liability for the three months ended September 30, 2016 and 2015 (in thousands):
    
 
Fair Value Measurements Using Significant Unobservable Inputs
 
Three Months Ended 
 September 30, 2016
 
Three Months Ended 
 September 30, 2015
 
Subsidiary unit awards
 
Contingent consideration liability from acquisition
 
Subsidiary unit awards
 
Contingent consideration liability from acquisition
Beginning of period balance
$
834

 
$
40

 
$
152

 
$
630

Total (gains) losses included in earnings
1,330

 
(35
)
 
42

 
250

Ending of period balance
$
2,164

 
$
5

 
$
194

 
$
880


16

The following table summarizes the change in fair value of the Level 3 liability for the nine months ended September 30, 2016 and 2015 (in thousands):
 
Fair Value Measurements Using Significant Unobservable Inputs
 
Nine Months Ended 
 September 30, 2016
 
Nine Months Ended 
 September 30, 2015
 
Subsidiary unit awards
 
Contingent consideration liability from acquisition
 
Subsidiary unit awards
 
Contingent consideration liability from acquisition
Beginning of period balance
$
532

 
$
230

 
$
—

 
$
—

Total (gains) losses included in earnings
1,632

 
(225
)
 
42

 
180

Purchases
—

 
—

 
—

 
700

Transfers into Level 3
—

 
—

 
152

 
—

Ending of period balance
$
2,164

 
$
5

 
$
194

 
$
880

The money market account is included in our cash and cash equivalents in our condensed consolidated balance sheets. Our money market assets are valued using quoted prices in active markets.
The liability for the subsidiary unit awards relates to agreements established with three employees for cash awards contingent upon the subsidiary companies meeting certain financial milestones such as revenue, working capital, EBITDA and EBITDA margin. We established liabilities for the future payment of the repurchase of subsidiary units under the terms of the agreements by estimating revenue, working capital, EBITDA and EBITDA margin of the subsidiary units over the periods of the three awards through the anticipated repurchase dates. We estimated the fair value of each liability by using a Monte Carlo simulation model for determining each of the projected measures by using an expected distribution of potential outcomes. The fair value of each liability is calculated with thousands of projected outcomes, the results of which are averaged and then discounted to estimate the present value. At each reporting date until the respective payment dates, we will remeasure these liabilities, using the same valuation approach based on the applicable subsidiary's revenue, an unobservable input, and we will record any changes in general and administrative expense. The liability balances are included in accounts payable, accrued expenses and other current liabilities or other liabilities line items in our condensed consolidated balance sheets (see Note 11).
The amount of contingent consideration liability to be paid, up to a maximum of $2.0 million, from our acquisition of SecurityTrax in the first quarter of 2015, will be determined based on revenue and adjusted EBITDA for the year ended December 31, 2017. We estimated the fair value of the contingent consideration liability by using a Monte Carlo simulation model for determining projected revenue by using an expected distribution of potential outcomes. The fair value of contingent consideration liability is calculated with thousands of projected revenue outcomes, the results of which are averaged and then discounted to estimate the present value. At each reporting date until payment in first quarter of 2018, we will remeasure the contingent consideration liability, using the same valuation approach based on our subsidiary’s revenue, an unobservable input, and we will record any changes in general and administrative expense. The contingent consideration liability balance is included in our other liabilities in our condensed consolidated balance sheets (see Note 5).
We monitor the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another. In such instances, the transfer is reported at the beginning of the reporting period. There were no transfers between Levels 1, 2 or 3 during the three and nine months ended September 30, 2016 and 2015. We also monitor the value of the investments for other than temporary impairment on a quarterly basis. No other-than-temporary impairments occurred during the three and nine months ended September 30, 2016 and 2015.

17

Note 10. Liabilities
The components of accounts payable, accrued expenses and other current liabilities are as follows (in thousands):
    
 
September 30,
2016
 
December 31,
2015
Accounts payable
$
20,034

 
$
12,813

Accrued expenses
3,034

 
4,244

Other current liabilities
4,473

 
2,219

Accounts payable, accrued expenses and other current liabilities
$
27,541

 
$
19,276


The components of other liabilities are as follows (in thousands):
    
 
September 30,
2016
 
December 31,
2015
Deferred rent
$
10,079

 
$
8,435

Other liabilities
2,059

 
2,049

Other liabilities
$
12,138

 
$
10,484

Note 11. Debt, Commitments and Contingencies
The debt, commitments and contingencies described below would require us, or our subsidiaries, to make payments to third parties under certain circumstances.
Debt
In 2014, we repaid all of the outstanding principal and interest under a previous term loan, which was accounted for as an extinguishment of debt, and replaced it with a $50.0 million revolving credit facility, or the 2014 Facility, with Silicon Valley Bank, as administrative agent, and a syndicate of lenders. We utilized $6.7 million under the 2014 Facility to repay in full our indebtedness under the previous term loan. On August 10, 2016, the 2014 Facility was amended to (1) increase our current borrowing capacity from $50.0 million to $75.0 million, (2) provide for an option to further increase the borrowing capacity to $125.0 million with the consent of the lenders, (3) increase the maximum consolidated leverage ratio from 2:50:1:00 to 3.00:1.00, and (4) extend the maturity date of the 2014 Facility and the principal outstanding from May 2017 to November 2018. This amendment to the 2014 Facility was accounted for as a debt modification. The 2014 Facility is secured by substantially all of our assets, including our intellectual property.
The outstanding principal balance on the 2014 Facility accrues interest at a rate equal to either (1) the Eurodollar Base Rate, or LIBOR, plus an applicable margin based on our consolidated leverage ratio, or (2) the higher of (a) the Wall Street Journal prime rate, and (b) the Federal Funds rate plus 0.50% plus an applicable margin based on our consolidated leverage ratio, or ABR, at our option. For the nine months ended September 30, 2015, we elected for the outstanding principal balance to accrue interest at LIBOR plus 2.25%, LIBOR plus 2.5%, and LIBOR plus 2.75% when our consolidated leverage ratio was less than 1.00:1.00, greater than or equal to 1.00:1.00 but less than 2.00:1.00, and greater than or equal to 2.00:1.00, respectively. For the nine months ended September 30, 2016, we elected for the outstanding principal balance to accrue interest at LIBOR plus 2.00%, LIBOR plus 2.25%, and LIBOR plus 2.50% when our consolidated leverage ratio was less than 1.00:1.00, greater than or equal to 1.00:1.00 but less than 2.00:1.00, and greater than or equal to 2.00:1.00, respectively. For the nine months ended September 30, 2016 and 2015, the effective interest rate on the 2014 Facility was 2.73% and 2.54%.
The carrying value of the 2014 Facility was $6.7 million as of September 30, 2016 and December 31, 2015. The 2014 Facility includes a variable interest rate that approximates market rates and, as such, we determined that the carrying amount of the 2014 Facility approximates its fair value as of September 30, 2016. The 2014 Facility carries an unused line commitment fee of 0.20% to 0.25% depending on our consolidated leverage ratio. The 2014 Facility contains various financial and other covenants that require us to maintain a maximum consolidated leverage ratio not to exceed 3.00:1.00 and a consolidated fixed charge coverage ratio of at least 1.25:1.00. During the nine months ended September 30, 2016, we were in compliance with all financial and non-financial covenants and there were no events of default.

18

Commitments and Contingencies
Repurchase of Subsidiary Units
In 2012, we formed a subsidiary to develop and market home and commercial energy management devices and services. We granted an award of subsidiary stock to the founder and president. The terms of the award for the founder, who is also our employee, require a payment in cash on either the third or the fourth anniversary from the date the subsidiary first makes its products and services commercially available, which was determined to be April 1, 2014. The vesting of the award is based on the subsidiary meeting certain minimum financial targets. We recorded a liability of zero and $0.1 million related to this commitment in other liabilities in our condensed consolidated balance sheets as of September 30, 2016 and December 31, 2015.
In 2011, we formed a subsidiary that offers to professional residential property management and vacation rental management companies technology solutions for remote monitoring and control of properties, including access control and energy management. Since its formation, we granted awards of subsidiary stock to two employees, a key employee and the president who is also the founder. The terms of the awards, as amended, required a payment in cash on the fourth anniversary of the date that the subsidiary’s products and services first become commercially available, which was determined to be June 1, 2013. The vesting of the awards is based on the subsidiary meeting certain minimum financial targets. We recorded a liability of $2.2 million related to these commitments in accounts payable, accrued expenses and other current liabilities in our condensed consolidated balance sheet as of September 30, 2016. We recorded $0.5 million related to these commitments in other liabilities in our condensed consolidated balance sheet as of December 31, 2015.
At each reporting date until the respective payment dates, we will remeasure these liabilities, and we will record any changes in fair value in general and administrative expense (see Note 9).
Leases
We lease office space and office equipment under non-cancelable operating leases with various expiration dates through 2026. In August 2014, we signed a lease for new office space in Tysons, Virginia, where we relocated our headquarters in February 2016. This lease term ends in 2026 and includes a five-year renewal option, an $8.0 million tenant improvement allowance and scheduled rent increases. During 2016, we entered into amendments to this lease which provide for 30,662 square feet of additional office space and an additional $1.7 million in tenant improvement allowances. We will take possession of the additional space on January 1, 2017 and we are allowed to utilize the tenant improvement allowance for design prior to moving into the space.
As of September 30, 2016, we have utilized $6.9 million of our total $9.7 million tenant improvement allowance. Rent expense was $1.2 million and $3.8 million for the three and nine months ended September 30, 2016 and $1.2 million and $3.6 million for the same periods in the prior year.
Indemnification Agreements
We have various agreements that may obligate us to indemnify the other party to the agreement with respect to certain matters. Generally, these indemnification provisions are included in contracts arising in the normal course of business. Although we cannot predict the maximum potential amount of future payments that may become due under these indemnification agreements, we do not believe any potential liability that might arise from such indemnity provisions is probable or material.
Letters of Credit

As of September 30, 2016, we had outstanding letters of credit under our 2014 Facility to our manufacturing partners in the amount of $0.3 million. As of December 31, 2015, we had no letters of credit outstanding under our 2014 Facility.


19

Legal Proceedings
On June 2, 2015, Vivint, Inc., or Vivint, filed a lawsuit against us in U.S. District Court, District of Utah, alleging that our technology directly and indirectly infringes six patents that Vivint purchased. Vivint is seeking permanent injunctions, enhanced damages and attorney’s fees. We answered the complaint on July 23, 2015. Among other things, we asserted defenses based on non-infringement and invalidity of the patents in question. On August 19, 2016, the U.S. District Court, District of Utah stayed the litigation pending inter partes review by the U.S. Patent Trial and Appeal Board of certain patents in suit. Should Vivint prevail on its claims that one or more elements of our solution infringe one or more of its patents, we could be required to pay damages of Vivint’s lost profits and/or a reasonable royalty for sales of our solution, enjoined from making, using and selling our solution if a license or other right to continue selling such elements is not made available to us or we are unable to design around such patents, and required to pay ongoing royalties and comply with unfavorable terms if such a license is made available to us. The outcome of the legal claim and proceeding against us cannot be predicted with certainty. We believe we have valid defenses to Vivint’s claims. Based on currently available information, we determined a loss is not probable or reasonably estimable at this time.
On December 30, 2015, a putative class action lawsuit was filed against us in the U.S. District Court for the Northern District of California, alleging violations of the Telephone Consumer Protection Act, or TCPA. The complaint does not allege that Alarm.com violated the TCPA, but instead seeks to hold us responsible for the marketing activities of our service providers under principles of agency and vicarious liability. The complaint seeks monetary damages under the TCPA, injunctive relief, and other relief, including attorney’s fees. We answered the complaint on February 26, 2016. On March 24, 2016, we filed a motion to transfer the matter to the U.S. District Court for the Northern District of West Virginia to be consolidated with 23 other similar and related pending TCPA actions. That motion was denied on June 2, 2016. Discovery has commenced, and the matter remains pending in the U.S. District Court for the Northern District of California. Based on currently available information, we determined a loss is not probable or reasonably estimable at this time.
On February 9, 2016, we were sued along with one of our service providers in the Circuit Court for the City of Virginia Beach, Virginia by the estate of a deceased service provider customer alleging wrongful death, among other claims. The suit seeks a total of $7 million in compensatory damages and $350,000 in punitive damages. We filed our answer on March 22, 2016. Discovery has commenced, and the matter remains pending. Based on currently available information, we determined a loss is not probable or reasonably estimable at this time.
From time to time, we may be a party to litigation and subject to claims incident to the ordinary course of business. Although the results of litigation and claims cannot be predicted with certainty, we currently believe that the final outcome of these ordinary course matters will not have a material adverse effect on our business.
Other than the preceding matters, we are not a party to any lawsuit or proceeding that, in the opinion of management, is reasonably possible or probable of having a material adverse effect on our financial position, results of operations or cash flows. We reserve for contingent liabilities based on ASC 450, “Contingencies,” when it is determined that a liability, inclusive of defense costs, is probable and reasonably estimable. Litigation is subject to many factors that are difficult to predict, so there can be no assurance that, in the event of a material unfavorable result in one or more claims, we will not incur material costs.

20

Note 12. Stock-Based Compensation

Stock-based compensation expense is included in the following line items in the accompanying condensed consolidated statements of operations for the three and nine months ended September 30, 2016 and 2015 (in thousands):
    
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Sales and marketing
$
130

 
$
114

 
$
422

 
$
260

General and administrative
444

 
785

 
907

 
2,305

Research and development
512

 
390

 
1,551

 
890

Total stock-based compensation expense
$
1,086

 
$
1,289

 
$
2,880

 
$
3,455

The following table summarizes the components of non-cash stock-based compensation expense for the three and nine months ended September 30, 2016 and 2015 (in thousands):
    
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Stock options
$
1,030

 
$
1,289

 
$
2,787

 
$
2,485

Restricted stock units
34

 
—

 
34

 
—

Employee stock purchase plan
22

 
—

 
59

 
—

Compensation related to the sale of common stock
—

 
—

 
—

 
193

Compensation related to the cash settlement of stock options
—

 
—

 
—

 
777

Total stock-based compensation expense
$
1,086

 
$
1,289

 
$
2,880

 
$
3,455

Tax benefit from equity-based plans
$
2,221

 
$
618

 
$
2,680

 
$
859

Stock Options
We issue stock options pursuant to our 2015 Equity Incentive Plan (the "2015 Plan"). The 2015 Plan allows for the grant of incentive stock options to employees and for the grant of nonqualified stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards ("RSUs"), performance-based stock awards, and other forms of equity compensation to our employees, directors and non-employee directors and consultants.
In June 2015, our board of directors adopted and our stockholders approved our 2015 Plan pursuant to which we initially reserved a total of 4,700,000 shares of common stock for issuance under the 2015 Plan, which included shares of our common stock previously reserved for issuance under our Amended and Restated 2009 Stock Incentive Plan (the "2009 Plan"). The number of shares of common stock reserved for issuance under the 2015 Plan will automatically increase on January 1 each year, for a period of not more than ten years, commencing on January 1, 2016 through January 1, 2024, by 5% of the total number of shares of common stock outstanding on December 31 of the preceding calendar year, or a lesser number of shares as may be determined by the board of directors. As a result of the adoption of the 2015 Plan, no further grants may be made under the 2009 Plan. As of September 30, 2016, 6,414,041 shares remained available for future grant under the 2015 Plan.
Stock options under the 2015 Plan have been granted at exercise prices based on the closing price of our common stock on the date of grant. Stock options under the 2009 Plan were granted at exercise prices as determined by the board of directors to be the fair market value of our common stock. Our stock options generally vest over a five-year period and each option, if not exercised or forfeited, expires on the tenth anniversary of the grant date.
Certain stock options granted under the 2015 Plan and previously granted under the 2009 Plan may be exercised before the options have vested. Unvested shares issued as a result of early exercise are subject to repurchase by us upon termination of employment or services at the original exercise price. The proceeds from the early exercise of stock options are initially recorded as a current liability and are reclassified to common stock and additional paid-in capital as the awards vest and our repurchase right lapses. There were 34,678 and 96,368 unvested shares of common stock outstanding subject to our right of repurchase as of September 30, 2016 and December 31, 2015. We repurchased 232 and 2,156 unvested shares of common stock related to early exercised stock options in connection with employee terminations during the three and nine months ended September 30, 2016 and we repurchased zero and 287 unvested shares of common stock during the same periods in the prior year. As of

21

September 30, 2016 and December 31, 2015, we recorded $0.2 million and $0.4 million in accounts payable, accrued expenses and other current liabilities on our condensed consolidated balance sheets for the proceeds from the early exercise of the unvested stock options.
Included in the stock-based compensation expense for the nine months ended September 30, 2015 was $0.8 million related to the cash settlement of exercised stock options of a terminated employee, at the company's election. We accounted for this cash settlement as a liability modification of the stock option awards.
We account for stock-based compensation awards based on the fair value of the award as of the grant date. We recognize stock-based compensation expense using the accelerated attribution method, net of estimated forfeitures, in which compensation cost for each vesting tranche in an award is recognized ratably from the service inception date to the vesting date for that tranche.

There were 588,900 and 514,276 stock options granted during the nine months ended September 30, 2016 and 2015. We declared and paid dividends in June 2015 in anticipation of our IPO, which we closed on July 1, 2015. Subsequent to the IPO, we do not expect to declare or pay dividends on a recurring basis. As such, we assume that the dividend rate is zero.

The following table summarizes the assumptions used for estimating the fair value of stock options granted during the three and nine months ended September 30, 2016 and 2015:
    
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Volatility
49.7
%
 
51.0
%
 
48.3 - 50.6%

 
48.5 - 51.8%

Expected term
6.3 years

 
6.3 years

 
5.6 - 6.3 years

 
4.5 - 6.3 years

Risk-free interest rate
1.3
%
 
1.8
%
 
1.3 - 1.4%

 
1.3 - 1.8%

Dividend rate
—
%
 
—
%
 
—
%
 
—
%
The following table presents stock option activity for the nine months ended September 30, 2016:
    
 
Number of Options
 
Weighted Average Exercise Price per Share
 
Weighted Average Remaining Contractual Life
(in years)
 
Aggregate Intrinsic Value
(in thousands)
Outstanding as of December 31, 2015
3,547,913

 
$
4.17

 
6.6
 
$
44,411

Granted
588,900

 
16.76

 

 

Exercised
(321,286
)
 
1.86

 

 
7,576

Forfeited
(86,099
)
 
9.35

 

 

Expired
—

 
—

 

 

Outstanding as of September 30, 2016
3,729,428

 
$
6.23

 
6.5
 
$
84,430

Vested and expected to vest as of September 30, 2016
3,682,475

 
$
6.14

 
6.4
 
$
83,650

Exercisable as of September 30, 2016
2,266,851

 
$
3.02

 
5.3
 
$
58,571

The weighted average grant date fair value for our stock options granted during the nine months ended September 30, 2016 and 2015 was $8.25 and $5.79. The total fair value of stock options vested during the nine months ended September 30, 2016 and 2015 was $1.7 million and $2.3 million. The aggregate intrinsic value of stock options exercised during the nine months ended September 30, 2016 and 2015 was $7.6 million and $3.1 million. As of September 30, 2016, the total compensation cost related to nonvested awards not yet recognized was $4.6 million, which will be recognized over a weighted average period of 2.1 years.

22

Restricted Stock Units
On August 15, 2016, we granted an aggregate of 25,640 RSUs to certain of our employees. Each of these awards vest over a five-year period from the vesting commencement date, which is generally the grant date. We account for RSUs based on the fair value of the award as of the grant date. We recognize stock-based compensation expense using the accelerated attribution method, net of estimated forfeitures, in which compensation cost for each vesting tranche in an award is recognized ratably from the grant date to the vesting date for that tranche. The RSUs condition for vesting is based on continued employment and a forfeiture rate is estimated for recognizing compensation expense based on historical forfeiture rates of stock-option awards. As of September 30, 2016, the total unrecognized compensation expense related to restricted stock unit awards granted amounted to $0.7 million, which is expected to be recognized over a weighted average period of 3.25 years.
The following table summarizes RSU activity for the nine months ended September 30, 2016:
    
 
Number of RSUs
 
Weighted Average Grant Date Fair Value
 
Aggregate
Intrinsic Value
(in thousands)
Outstanding as of December 31, 2015
—

 
$
—

 
$
—

Granted
25,640

 
32.93

 
844

Vested
—

 
—

 
—

Forfeited
—

 
—

 
—

Outstanding as of September 30, 2016
25,640

 
32.93

 
740

Vested and expected to vest after September 30, 2016
23,214

 
$
32.93

 
$
670

Employee Stock Purchase Plan
Our board of directors adopted our 2015 Employee Stock Purchase Plan ("2015 ESPP") in June 2015. As of September 30, 2016, 1,624,019 shares have been reserved for future grant under the 2015 ESPP, with provisions established to increase the number of shares available on January 1 of each subsequent year for nine years. The annual automatic increase in the number of shares available for issuance under the 2015 ESPP is the lesser of 1% of each class of common stock outstanding as of December 31 of the preceding fiscal year, 1,500,000 shares of common stock, or such lesser number as determined by the board of directors. The 2015 ESPP allows eligible employees to purchase shares of our common stock at 90% of the fair market value, rounded up to the nearest cent, based on the closing price of our common stock on the purchase date. The maximum number of shares of our common stock that a participant may purchase during any calendar year shall not exceed such number of shares having a fair market value equal to the lesser of $15,000 or 10% of the participant's base compensation for that year.
The 2015 ESPP is considered compensatory for purposes of stock-based compensation expense due to the 10% discount on the fair market value of our common stock. For the nine months ended September 30, 2016, an aggregate of 31,797 shares were purchased by employees. We recognized less than $0.1 million of compensation expense for the three and nine months ended September 30, 2016. No shares were purchased by employees during the three and nine months ended September 30, 2015, so no compensation expense was recognized during these periods. Compensation expense is recognized for the amount of the discount, net of forfeitures, over the purchase period, based on the monthly closing price of our common stock as an estimate of the final purchase price for the offering period. This estimate is adjusted at each reporting period until the purchase is finalized.
Warrants
On March 30, 2015, we issued performance-based warrants to two employees, which give these individuals the right to purchase up to 54,694 shares of our common stock in the aggregate if certain performance targets are achieved. The performance-based warrants, each for 27,347 shares of our common stock, have an exercise price of $10.97 per share and we may elect to terminate the warrants in exchange for a one-time cash settlement in the event we have a change in control. If the warrants become exercisable, the number of shares that become exercisable which cannot exceed 27,347 shares for each warrant, is based upon the achievement of certain minimum annual revenue targets. These warrants will expire upon the earlier of March 2025 or the date upon which the holder of the warrant is no longer our employee or an employee of an affiliate of ours. We believe that the achievement of the minimum annual revenue targets is probable, and we began recognizing expense related to these performance-based warrants as of April 1, 2015. These warrants were not exercisable as of September 30, 2016 and December 31, 2015 because the performance requirements had not been met. We recorded less than $0.1 million of expense associated with the performance-based warrants during the three and nine months ended September 30, 2016 and 2015.

23

Sale of Common Stock Subscriptions
In 2013, we sold 238,500 shares of our common stock to one of our executive officers for $0.7 million, or $2.95 per share, an amount below fair value. Under the terms of the sale, we had the right to repurchase the shares for $2.95 per share subject to certain triggering events prior to April 2, 2017. Our repurchase right expired on July 1, 2015, the date of the closing of our IPO. The excess of the fair value over the sale price was being recorded to stock-based compensation expense, on a straight-line basis, over the four-year term of the repurchase agreement. In 2015, we recognized the remaining unamortized expense upon the expiration of our repurchase right. No expense was recognized related to this sale for the three months ended September 30, 2015. We recognized $0.2 million related to this sale in general and administrative expense in our condensed consolidated statement of operations for the nine months ended September 30, 2015. No expense was recognized related to this sale for the three and nine months ended September 30, 2016.
Note 13. Earnings Per Share
Basic and Diluted Earnings Per Share ("EPS")
The components of basic and diluted EPS are as follows (in thousands, except share and per share amounts):
    
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015(1)
 
2016
 
2015(1)
Net income
$
2,567

 
$
2,943

 
$
7,178

 
$
8,493

Less: dividends paid to participating securities
—

 
—

 
—

 
(18,987
)
Less: income allocated to participating securities
$
—

 
$
(45
)
 
$
—

 
$
—

Net income / (loss) attributable to common stockholders (A)
$
2,567

 
$
2,898

 
$
7,178

 
$
(10,494
)
Weighted average common shares outstanding — basic (B)
45,716,961

 
44,922,410

 
45,615,399

 
16,910,090

Dilutive effect of stock options
2,602,991

 
1,950,285

 
2,125,966

 
—

Weighted average common shares outstanding — diluted (C)
48,319,952

 
46,872,695

 
47,741,365

 
16,910,090

Net income / (loss) per share:
 
 
 
 
 
 
 
Basic (A/B)
$
0.06

 
$
0.06

 
$
0.16

 
$
(0.62
)
Diluted (A/C)
$
0.05

 
$
0.06

 
$
0.15

 
$
(0.62
)
(1) The three and nine months ended September 30, 2015 historical condensed consolidated statements of operations have been revised (Note 2).
The following securities have been excluded from the calculation of diluted weighted average common shares outstanding because the effect is anti-dilutive for the three and nine months ended September 30, 2016 and 2015:
    
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Stock options
112,350

 
32,000

 
132,350

 
537,525

RSU's
25,640

 
—

 
25,640

 
—

Common stock subject to repurchase
34,678

 
124,791

 
34,678

 
124,791

Note 14. Significant Service Providers
During the three and nine months ended September 30, 2016, our 10 largest revenue service providers accounted for 60.3% and 60.5% of our revenue, respectively, as compared to 63.7% and 63.7% for the same periods in the prior year. One of our service providers individually represented greater than 10% but not more than 15% of our revenue for the three and nine months ended September 30, 2016. One of our service providers individually represented greater than 15% but not more than 20% of our revenue for the three and nine months ended September 30, 2015.
Trade accounts receivable from two service providers totaled $2.9 million each as of September 30, 2016. No other individual service provider represented more than 10% of accounts receivable as of September 30, 2016. Trade accounts

24

receivable from two service providers totaled $3.1 million and $2.7 million as of December 31, 2015. No other individual service provider represented more than 10% of accounts receivable as of December 31, 2015.
Note 15. Income Taxes
For purposes of interim reporting, our annual effective income tax rate is estimated in accordance with ASC 740-270, "Interim Reporting." This rate is applied to the pre-tax book income of the entities expected to be benefited during the year. Discrete items that impact the tax provision were recorded in the period incurred.
Our effective income tax rates were 12.2% and 29.0% for the three and nine months ended September 30, 2016, respectively, as compared to 22.8% and 35.0% for the same periods in the prior year. Our effective tax rate differs from the statutory rate primarily due to the benefit of the research and development tax credit, partially offset by the impact of state taxes and nondeductible meal and entertainment expenses. The increased benefit of the research and development tax credit between 2015 and 2016 related primarily to the permanent extension of the research and development tax credit which we recorded during the nine months ended September 30, 2016.
We recognize a valuation allowance if, based on the weight of available evidence, both positive and negative, it is more likely than not that some portion, or all, of the net deferred tax assets will not be realized. Based on our historical and expected future taxable earnings, we believe it is more likely than not that we will realize all of the benefit of the existing deferred tax assets as of September 30, 2016 and December 31, 2015. Accordingly, we have not recorded a valuation allowance as of September 30, 2016 and December 31, 2015.
We apply guidance for uncertainty in income taxes that requires the application of a more likely than not threshold to the recognition and de-recognition of uncertain tax positions. If the recognition threshold is met, this guidance permits us to recognize a tax benefit measured at the largest amount of the tax benefit that, in our judgment, is more likely than not to be realized upon settlement. For the three and nine months ended September 30, 2016, we recorded an unrecognized tax benefit of $0.2 million related to research and development tax credits for the 2016 tax year. For the three and nine months ended September 30, 2016, we recorded interest for the period on prior year research and development tax credits we claimed. Our liability for uncertain tax positions was $0.8 million and $0.5 million as of September 30, 2016 and December 31, 2015.
Note 16. Segment Information
We have two reportable segments:
•
Alarm.com segment
•
Other segment
Our chief operating decision maker is our chief executive officer. Management determined the operational data used by the chief operating decision maker is that of the two reportable segments. Management bases strategic goals and decisions on these segments and the data presented below is used to measure financial results. Our Alarm.com segment represents our cloud-based platform for the connected home and related solutions. Our Alarm.com segment also includes SecurityTrax, a provider of SaaS-based, customer relationship management software tailored for security system dealers. This segment contributed 94% of our revenue for the three and nine months ended September 30, 2016 and 97% for the same periods in the prior year. Our Other segment is focused on researching and developing home and commercial automation, and energy management products and services in adjacent markets. Inter-segment revenue includes sales of hardware between our segments.

25

Management evaluates the performance of its segments and allocates resources to them based on operating income. The reportable segment operational data is presented in the table below for the three and nine months ended September 30, 2016 and 2015 and as of September 30, 2016 and December 31, 2015 (in thousands):
 
Alarm.com
 
Other
 
Intersegment Alarm.com
 
Intersegment Other
 
Total
For the Three Months Ended September 30, 2016
 
 
 
 
 
 
 
 
 
Revenue
$
64,420

 
$
5,355

 
$
(700
)
 
$
(1,229
)
 
$
67,846

Operating income
4,930

 
(2,024
)
 
(62
)
 
(9
)
 
2,835

 
 
 
 
 
 
 
 
 
 
For the Three Months Ended September 30, 2015
 
 
 
 
 
 
 
 
 
Revenue
$
52,684

 
$
2,073

 
$
(50
)
 
$
(700
)
 
$
54,007

Operating income
8,385

 
(4,561
)
 
4

 
33

 
3,861

 
 
 
 
 
 
 
 
 
 
For the Nine Months Ended September 30, 2016
 
 
 
 
 
 
 
 
 
Revenue
$
182,205

 
$
13,289

 
$
(2,040
)
 
$
(2,142
)
 
$
191,312

Operating income
16,173

 
(6,259
)
 
(188
)
 
178

 
9,904

 
 
 
 
 
 
 
 
 
 
For the Nine Months Ended September 30, 2015
 
 
 
 
 
 
 
 
 
Revenue
$
148,302

 
$
5,714

 
$
(570
)
 
$
(1,479
)
 
$
151,967

Operating income
26,715

 
(13,467
)
 
(167
)
 
183

 
13,264

 
 
 
 
 
 
 
 
 
 
As of September 30, 2016
 
 
 
 
 
 
 
 
 
Assets
$
237,987

 
$
12,361

 
$
—

 
$
—

 
$
250,348

 
 
 
 
 
 
 
 
 
 
As of December 31, 2015
 
 
 
 
 
 
 
 
 
Assets
$
215,315

 
$
10,780

 
$
—

 
$
—

 
$
226,095

We derived substantially all of our revenue from North America for the three and nine months ended September 30, 2016 and 2015. Substantially all of our long lived assets were located in North America as of September 30, 2016 and December 31, 2015.
Note 17. Related Party Transactions
Our installation partner in which we have a 48.2% ownership interest performs installation services for security dealers and also provides installation services for us and certain of our subsidiaries. We recorded $0.2 million and $0.9 million of cost of hardware and other revenue in connection with this installation partner for the three and nine months ended September 30, 2016, respectively, as compared to $0.2 million and $0.5 million for the same periods in the prior year. As of September 30, 2016 and December 31, 2015, the accounts payable balance was $0.1 million and $0.5 million. In September 2014, we loaned $0.3 million to our installation partner under a secured promissory note that accrues interest at 8.0%. Interest is payable monthly with the entire principal balance plus accrued but unpaid interest due at maturity in September 2018. We recorded $6,000 and $18,000 of interest income related to this note receivable for the three and nine months ended September 30, 2016, respectively, as compared to $6,000 and $19,000 for the same periods in the prior year.

26

ITEM 2: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition and results of operations together with (1) our condensed consolidated financial statements and the related notes and other financial information included elsewhere in this Quarterly Report on Form 10-Q, and (2) the audited consolidated financial statements and the related notes and management’s discussion and analysis of financial condition and results of operations for the fiscal year ended December 31, 2015 included in our Annual Report on Form 10-K filed on February 29, 2016 with the Securities and Exchange Commission (the "SEC"). This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). These statements are often identified by the use of words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “project,” “will,” “would” or the negative or plural of these words or similar expressions or variations. Such forward-looking statements are subject to a number of risks, uncertainties, assumptions and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified in this Quarterly Report on Form 10-Q and those discussed in the section titled “Risk Factors”, set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q and in our other SEC filings. You should not rely upon forward-looking statements as predictions of future events. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements.
Overview
Alarm.com is the leading platform solution for the connected home. Through our cloud-based services, we make connected home technology broadly accessible to millions of home and business owners. Our multi-tenant software-as-a-service, or SaaS, platform enables home and business owners to intelligently secure their properties and automate and control a broad array of connected devices through a single, intuitive user interface.
As of December 31, 2015, our connected home platform had more than 2.6 million residential and business subscribers and connects to tens of millions of devices. More than 20 billion data points were generated and processed by those subscribers and devices in 2015 alone. We believe that this scale of subscribers, devices and data makes us the leader in the smart home services market.
Our solutions are delivered through an established network of over 6,000 trusted service providers, who are experts at designing, selling, installing and supporting our solutions. Our technology platform was purpose-built for the entire connected home ecosystem, including the consumers who use it, the service providers who deliver it and the hardware partners whose devices are enabled by the platform. Our solutions are used by both home and business owners, and we refer to this market as the connected home market.
We invest in solutions that connect people in new ways with their properties and devices, making them safer, smarter and more efficient. Our scalable, flexible platform is designed to meet a wide range of user needs with its breadth of services, depth of feature capability and broad support for the growing Internet of Things devices in the home. We power four primary solutions, which can be used individually or combined, and are integrated within a single user interface accessible through the web and mobile apps: interactive security, intelligent automation, video monitoring and energy management. These solutions are delivered through our cloud-based platform enabling our connected home solutions together or provided on a standalone basis. We enable quick, intuitive access to the consumer through our mobile app as well as enabling new ways to engage with the home through wearables like Apple Watch, through the TV with Apple TV and Amazon Fire TV and by using smart home voice control through Amazon Echo.
Executive Overview and Highlights of Third Quarter Results
We primarily generate SaaS and license revenue, our largest source of revenue, through our service providers who resell our services and pay us monthly fees. Our service providers sell, install and support Alarm.com solutions that enable home and business owners to intelligently secure, connect, control and automate their properties. Our service providers have indicated that they typically have three to five year service contracts with home or business owners, whom we call subscribers. We also derive a portion of our revenue from licensing our intellectual property to service providers on a per customer basis. SaaS and license revenue represented 66% and 67% of our revenue for the nine months ended September 30, 2016 and 2015, and 66% and 67% of our revenue in the third quarters of 2016 and 2015.
We also generate revenue from the sale of hardware that enables our solutions, including cellular radio modules, video cameras, image sensors, thermostats and other peripherals. We have a rich history of innovation in cellular technology that enables our robust SaaS offering. Hardware and other revenue represented 34% and 33% of our revenue for the nine months ended September 30, 2016 and 2015, and 34% and 33% of our revenue in the third quarters of 2016 and 2015. We typically expect hardware and other revenue to fluctuate as a percentage of total revenue.

27

To date, nearly all of our revenue growth has been organic. We have completed small acquisitions, but those acquisitions have been related to technology or services complementary to our core offerings and have not contributed materially to our revenue. We have focused on growing our business and plan to continue to invest in growth.
Highlights of our financial performance for the periods covered in this report include:
•
Revenue increased 26% from $152.0 million in the first nine months of 2015 to $191.3 million in the first nine months of 2016. Revenue increased 26% from $54.0 million in the third quarter of 2015 to $67.8 million in the third quarter of 2016.
•
SaaS and license revenue increased 24% from $102.2 million in the first nine months of 2015 to $126.7 million in the first nine months of 2016. SaaS and license revenue increased 23% from $36.2 million in the third quarter of 2015 to $44.6 million in the third quarter of 2016.
•
Net income was $7.2 million in the first nine months of 2016 and $8.5 million in the first nine months of 2015. Net income was $2.6 million in the third quarter of 2016 and $2.9 million in the third quarter of 2015.
•
Adjusted EBITDA, a non-GAAP measurement of operating performance, increased from $24.6 million in the first nine months of 2015 to $34.3 million in the first nine months of 2016. Adjusted EBITDA increased from $9.7 million in the third quarter of 2015 to $11.7 million in the third quarter of 2016.
Please see Non-GAAP Measures in this section of this Quarterly Report for a discussion of the limitations of Adjusted EBITDA (a non-GAAP measure) and a reconciliation of Adjusted EBITDA to net income, the most comparable measurement in accordance with accounting principles generally accepted in the United States, or GAAP, for the third quarter and first nine months of 2016 and 2015.
Recent Developments Regarding Our Proposed Acquisition of Two Business Units from Icontrol Networks

During our second quarter of 2016, we entered into a definitive agreement to acquire two business units, Connect and Piper, from Icontrol Networks, Inc., or Icontrol, for a purchase price of approximately $140.0 million, or the Acquisition. Connect develops and sells a custom, on-premise software platform that powers several service providers' solutions for interactive security and automation including ADT Pulse® which was estimated to have 1.6 million subscribers as of December 31, 2015. Piper develops and sells a Wi-Fi-enabled video and home automation hub. We expect the proposed Acquisition to contribute to revenue growth and be EPS accretive on a non-GAAP basis for the full year 2017. The proposed Acquisition is subject to customary closing conditions as well as certain events that we cannot control, including regulatory approvals and the closing of the acquisition of Icontrol's Converge business unit by Comcast Cable Communications, LLC, a subsidiary of Comcast Corporation, or Comcast.

On September 12, 2016, we and Icontrol each received a request for additional information and documentary materials, or a second request, from the U.S. Federal Trade Commission, or the FTC, in connection with the FTC’s review of the proposed Acquisition. On September 22, 2016, we and Icontrol entered into a timing agreement with the FTC and agreed not to consummate the proposed Acquisition before the 45th calendar day following the date of certifying substantial compliance with the second request, unless we have received prior notice that the FTC has concluded its review. We and Icontrol are in the process of responding to the second request but ongoing review at the FTC will likely result in the proposed Acquisition not closing until the first quarter of 2017. Further, on November 2, 2016, in response to questions raised by the FTC, we and Icontrol represented to the FTC that the terms of the acquisition agreement would be modified to ensure we do not exercise any control over the ongoing operations of the Icontrol business until such time as the waiting period under the Hart-Scott-Rodino Act expires or is terminated. We and Icontrol are also providing documents and information to the FTC to address these questions. For additional information regarding other factors which may affect the conditions or approvals required to complete the Acquisition, please see “Risk Factors - Risks Related to our Acquisition of Connect and Piper Business Units from Icontrol Networks, Inc.”

Effective as of August 19, 2016, or the Effective Date, our subsidiary, Alarm.com Incorporated, or Alarm.com, and ADT LLC, or ADT, amended their existing master services agreement, or the Amended MSA.  The Amended MSA provides that following the closing, if any, of the proposed Acquisition, in exchange for certain incentives and service obligations provided to ADT, Alarm.com will serve as the exclusive provider of services for ADT’s professionally installed residential interactive security, automation and video service offerings for a period of up to five (5) years following the Effective Date, subject to Alarm.com achieving certain performance conditions and with certain exclusions.  The Amended MSA also includes certain installation, maintenance, support, indemnity and development requirements and can be terminated if such requirements are not satisfied, including without notice if certain events occur.  The foregoing description of the material terms of the Amended MSA does not purport to be complete and is subject to, and is qualified in its entirety by, reference to the full terms of the Amended MSA. We have submitted a request for confidential treatment of certain portions of the Amended MSA to the Securities and Exchange Commission pursuant to Rule 24b-2 under the Securities Exchange Act of 1934, as amended.


28

Key Metrics
We use the key business metrics in the table below to help us monitor the performance of our business and to identify trends affecting our business (dollars in thousands):
    
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
SaaS and license revenue
$
44,630

 
$
36,158

 
$
126,652

 
$
102,247

Adjusted EBITDA
11,658

 
9,654

 
34,274

 
24,602

 
 
 
 
 
 
 
 
 
 
 
 
 
Twelve Months Ended September 30,
 
 
 
 
 
2016
 
2015
SaaS and license revenue renewal rate
 
 
 
 
94
%
 
93%

SaaS and License Revenue
We believe that SaaS and license revenue is an indicator of the productivity of our existing service providers and their ability to activate and maintain subscribers using the Alarm.com connected home solutions, our ability to add new service providers reselling the Alarm.com solutions, the demand for our connected home solutions, and the pace at which the market for connected home solutions is growing.
Adjusted EBITDA
Adjusted EBITDA represents our net income before interest expense and other income / (expense), net, provision for income taxes, amortization and depreciation expense, stock-based compensation expense, acquisition-related expense and legal costs incurred in connection with non-ordinary course litigation, particularly costs involved in ongoing intellectual property litigation. We do not consider these items to be indicative of our core operating performance. The non-cash items include amortization and depreciation expense and stock-based compensation expense. We do not adjust for ordinary course legal expenses resulting from maintaining and enforcing our intellectual property portfolio and license agreements.
Adjusted EBITDA is a key measure that our management uses to understand and evaluate our core operating performance and trends to generate future operating plans, to make strategic decisions regarding the allocation of capital, and to make investments in initiatives that are focused on cultivating new markets for our solutions. In particular, the exclusion of certain expenses in calculating Adjusted EBITDA facilitates comparisons of our operating performance on a period-to-period basis and, in the case of exclusion of acquisition-related adjustments and certain historical legal expenses, excludes items that we do not consider to be indicative of our core operating performance. Adjusted EBITDA is not a measure calculated in accordance with GAAP. Please see Non-GAAP Measures below for a discussion of the limitations of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income, the most comparable GAAP measurement, for the third quarter and first nine months of 2016 and 2015.
SaaS and License Revenue Renewal Rate
We measure our SaaS and license revenue renewal rate on a trailing 12-month basis by dividing (a) the total SaaS and license revenue recognized during the trailing 12-month period from subscribers on our SaaS platform who were subscribers on the first day of the period, by (b) total SaaS and license revenue we would have recognized during the period from those same subscribers assuming no terminations, or service level upgrades or downgrades. The SaaS and license revenue renewal rate represents both residential and commercial properties. Our SaaS and license revenue renewal rate is expressed as an annualized percentage. Our service providers, who resell our services to our subscribers, have indicated that they typically have three to five year service contracts with our subscribers. Our SaaS and license revenue renewal rate is calculated across our entire subscriber base, including subscribers whose contract with their service provider reached the end of its contractual term during the measurement period, as well as subscribers whose contract with their service provider has not reached the end of its contractual term during the measurement period, and is not intended to estimate the rate at which our subscribers renew their contracts with our service providers. We believe that our SaaS and license revenue renewal rate allows us to measure our ability to retain and grow our SaaS and license revenue and serves as an indicator of the lifetime value of our subscriber base.
Components of Operating Results
Please note that because we are constrained in the information we can provide regarding the projected post-Acquisition financial performance of the combined companies until the proposed Acquisition closes, while the discussion below considers acquisition-related expenses and interest expense, it does not include discussion of the impact of the closing of the proposed Acquisition.

29

Our fiscal year ends on December 31st. The key elements of our operating results include:
Revenue
We generate revenue primarily through the sale of our SaaS solutions over our cloud-based connected home platform through our service provider channel. We also generate revenue from the sale of hardware products that enable our solutions.
SaaS and License Revenue
We generate the majority of our SaaS and license revenue primarily from monthly recurring fees charged to our service providers sold on a per subscriber basis for access to our cloud-based connected home platform and related solutions. Our fees per subscriber vary based upon the service plan and features utilized. We enter into contracts with our service providers that establish our pricing as well as other business terms and conditions. These contracts typically have an initial term of one year, with subsequent annual renewal terms. Our service providers typically enter into underlying contracts with their end-user customers, which we refer to as our subscribers, for their engagement with our solutions. Our service providers have indicated that those contracts generally range from three to five years in length.
We offer multiple service level packages for our solutions, including integrated solutions and a range of a la carte add-ons for additional features. The price paid by our service providers each month for the delivery of our solutions is based on the combination of packages and add-ons enabled for each subscriber. We use tiered pricing plans where our service providers may receive prospective pricing discounts driven by volume. We recognize our SaaS and license revenue on a monthly basis as we deliver our solutions to our subscribers.
We define our subscribers as the number of residential or commercial properties to which we are delivering at least one of our solutions. A subscriber who subscribes to one of our service level packages as well as one or more of our a la carte add-ons is counted as one subscriber. The number of subscribers represents our number of subscribers, rounded to the nearest thousand, on the last day of the applicable year. Our number of subscribers does not include the customers of our service providers to whom we license our intellectual property as they do not utilize our SaaS platform.
We also generate SaaS and license revenue from the fees paid to us when we license our intellectual property to service providers on a per customer basis for use of our patents. In November 2013, we entered into a license agreement with Vivint Inc., or Vivint, who represented at least 10% but not more than 15% of our revenue in 2013 and 2014, pursuant to which we granted Vivint a license to use the intellectual property associated with our connected home solutions. Vivint began generating customers and paying us license revenue in the second quarter of 2014. Pursuant to this arrangement, Vivint has transitioned from selling our SaaS solutions directly to its customers to selling its own home automation product to its new customers. We receive less revenue from Vivint related to license fees as compared to revenue for SaaS solutions for its subscribers that continue to utilize our SaaS platform. We continue to receive revenue from Vivint for both our SaaS solutions and from licensing our intellectual property. Vivint represented less than 10% of our revenue in 2015 and for the first nine months of 2016. Additionally, in some markets, our EnergyHub subsidiary sells its demand response software with an annual service fee, with pricing based on the number of subscribers or amount of aggregate electricity demand made available for a utility’s or market’s control.
Hardware and Other Revenue
We generate hardware and other revenue primarily from the sale of cellular radio modules that provide access to our cloud-based platform, video cameras and the sale of other devices, including image sensors and other peripherals. We sell hardware to our service providers as well as distributors. The purchase of hardware occurs in a transaction that is separate and typically in advance of the purchase of our platform services. We recognize hardware and other revenue when the hardware is delivered to our service providers or distributors, net of a reserve for estimated returns. Our terms for hardware sales typically allow service providers to return hardware up to one year past the date of original sale.
Hardware and other revenue also includes activation fees charged to service providers for activation of a subscriber’s account on our platform. We record activation fees initially as deferred revenue and we recognize these fees on a straight-line basis over an estimated life of the subscriber relationship, which is currently ten years. Hardware and other revenue also includes fees paid by service providers for our marketing services.
Cost of Revenue
Our cost of SaaS and license revenue primarily includes the amounts paid to wireless network providers and, to a lesser extent, the costs of running our network operating centers. Our cost of hardware and other revenue primarily includes cost of raw materials and amounts paid to our third-party manufacturer for production and fulfillment of our cellular radio modules and image sensors, and procurement costs for our video cameras, which we purchase from an original equipment manufacturer, and other devices.

30

We record the cost of SaaS and license revenue as expenses are incurred, which corresponds to the delivery period of our services to our subscribers. We record the cost of hardware and other revenue when the hardware and other services are delivered to the service provider, which is when title transfers. Our cost of revenue excludes amortization and depreciation.
Operating Expenses
Our operating expenses consist of sales and marketing, general and administrative, research and development, and amortization and depreciation expenses. Salaries, bonuses, stock-based compensation, benefits and other personnel related costs are the most significant components of each of these expense categories, excluding amortization and depreciation. We include stock-based compensation expense in connection with the grant of stock options in the applicable operating expense category based on the respective equity award recipient’s function (sales and marketing, general and administrative or research and development). We grew from 400 employees as of January 1, 2015 to 579 employees as of September 30, 2016, and we expect to continue to hire new employees to support future growth of our business.
Sales and Marketing Expense. Sales and marketing expense includes personnel and related expenses for our sales and marketing teams, including salaries, bonuses, stock-based compensation, benefits, travel, and commissions. Our sales and marketing teams engage in sales, account management, service provider support, advertising, promotion of our products and services and marketing.
The number of employees in sales and marketing functions grew from 159 as of January 1, 2015 to 211 as of September 30, 2016. We expect to continue to invest in our sales and marketing activities to expand our business both domestically and internationally and, as a result, expect our sales and marketing expense to increase on an absolute dollar basis. We intend to increase the size of our sales force and our service provider support team to provide additional support to our existing service provider base to drive their productivity in selling and supporting our solutions as well as to enroll new service providers in North America and in international markets. We also intend to increase our marketing investments in the form of marketing programs to support our service providers’ efforts to enroll new subscribers and expand the adoption of our solutions.
General and Administrative Expense. General and administrative expense consists primarily of personnel and related expenses for our administrative, legal, information technology, human resources, finance and accounting personnel, including salaries, bonuses, stock-based compensation, benefits and other personnel costs. Additional expenses included in this category are legal costs incurred to defend and license our intellectual property and non-personnel costs, such as travel related expenses, rent, subcontracting and professional fees, audit fees, tax services, and insurance expenses. Also included in general and administrative expenses are acquisition-related expenses, which consist primarily of legal, accounting and professional services fees directly related to acquisitions, valuation gains or losses on acquisition-related contingent liabilities and goodwill and intangible asset impairment.
The number of employees in general and administrative functions grew from 54 as of January 1, 2015 to 64 as of September 30, 2016. We expect our general and administrative expense in 2016 to increase on an absolute dollar basis primarily from the inclusion of incremental intellectual property litigation expenses and acquisition-related expenses. Acquisition-related expenses are external incremental costs directly related to completing the proposed Acquisition and any resulting integration of Connect and Piper business units. We anticipate that we will incur additional costs for personnel and professional services as we continue to operate as a public company. These costs include increases in our accounting, finance and legal personnel, additional external legal and audit fees and expenses associated with compliance with the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and other regulations governing public companies. We also expect to continue to incur increased costs relating to higher premiums for directors’ and officers’ liability insurance as a public company.
Research and Development Expense. Research and development expense consists primarily of personnel and related expenses for our employees working on our product development and software and device engineering teams, including salaries, bonuses, stock-based compensation, benefits and other personnel costs. Also included are non-personnel costs such as consulting and professional fees paid to third-party development resources.
The number of employees in research and development functions grew from 187 as of January 1, 2015 to 304 as of September 30, 2016. Our research and development efforts are focused on innovating new features and enhancing the functionality of our platform and the solutions we offer to our service providers and subscribers. We will also continue to invest in efforts to extend our platform to adjacent markets and internationally. We expect research and development expenses to continue to increase on an absolute dollar basis and as a percentage of revenue in the short term to maintain our leadership position in the development of smart home and enterprise technology, and continued enhancement of our Enterprise Tools platform for our service provider partners.
Amortization and Depreciation. Amortization and depreciation consists of amortization of intangible assets originating from our acquisitions as well as our internally-developed capitalized software. Our depreciation expense is related to investments in property and equipment. Acquired intangible assets include developed technology, customer related intangibles, trademarks and trade names. We expect in the near term that amortization and depreciation may fluctuate based on our acquisition activity, development of our platform and capitalized expenditures.

31

Interest Expense
Interest expense consists of interest expense associated with our revolving credit facility, or the 2014 Facility, with Silicon Valley Bank, as administrative agent, and a syndicate of lenders (see Note 11). The 2014 Facility is available to us to refinance existing debt and for general corporate and working capital purposes, including financing the proposed Acquisition and other acquisitions as permitted under the terms of the 2014 Facility. We expect interest expense to increase in the event we utilize the 2014 Facility for the proposed Acquisition.
Other income / (expense), net
Other income / (expense), net consists of our portion of the income or loss from our minority investments in other businesses accounted for under the equity method and interest income earned on our cash and cash equivalents and our notes receivable.
Provision for Income Taxes
We are subject to U.S. federal, state and local income taxes as well as foreign income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. As a result, we recognize tax liabilities based on estimates of whether additional taxes will be due. Our effective tax rate differs from the statutory rate primarily due to the tax impact of state taxes, non-deductible meals and entertainment and the impact of research and development tax credits.


32

Results of Operations
The following table sets forth our unaudited selected condensed consolidated statements of operations and data as a percentage of revenue for the periods presented (in thousands):
    
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015(2)
 
2016
 
2015(2)
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
SaaS and license revenue
$
44,630

 
66
 %
 
$
36,158

 
67
 %
 
$
126,652

 
66
 %
 
$
102,247

 
67
 %
Hardware and other revenue
23,216

 
34

 
17,849

 
33

 
64,660

 
34

 
49,720

 
33

Total revenue
67,846

 
100

 
54,007

 
100

 
191,312

 
100

 
151,967

 
100

Cost of revenue(1):
 
 


 
 
 


 
 
 
 
 
 
 
 
Cost of SaaS and license revenue
7,787

 
11

 
6,764

 
13

 
21,779

 
11

 
19,094

 
13

Cost of hardware and other revenue
18,579

 
27

 
13,205

 
24

 
50,886

 
27

 
38,171

 
25

Total cost of revenue
26,366

 
39

 
19,969

 
37

 
72,665

 
38

 
57,265

 
38

Operating expenses:
 
 


 
 
 


 
 
 
 
 
 
 
 
Sales and marketing (3)
10,705

 
16

 
8,425

 
16

 
29,532

 
15

 
24,405

 
16

General and administrative (3)
14,804

 
22

 
10,412

 
19

 
42,124

 
22

 
25,996

 
17

Research and development (3)
11,477

 
17

 
9,836

 
18

 
32,224

 
17

 
26,667

 
18

Amortization and depreciation
1,659

 
2

 
1,504

 
3

 
4,863

 
3

 
4,370

 
3

Total operating expenses
38,645

 
57

 
30,177

 
56

 
108,743

 
57

 
81,438

 
54

Operating income
2,835

 
4

 
3,861

 
7

 
9,904

 
5

 
13,264

 
9

Interest expense
(49
)
 
—

 
(44
)
 
—

 
(137
)
 
—

 
(128
)
 
—

Other income / (expense), net
139

 
—

 
(7
)
 
—

 
338

 
—

 
(62
)
 
—

Income before income taxes
2,925

 
4

 
3,810

 
7

 
10,105

 
5

 
13,074

 
9

Provision for income taxes
358

 
1

 
867

 
2

 
2,927

 
2

 
4,581

 
3

Net income
$
2,567

 
4
 %
 
$
2,943

 
5
 %
 
$
7,178

 
4
 %
 
$
8,493

 
6
 %
_______________

(1)
Exclusive of amortization and depreciation shown in operating expenses below.
(2)
The three and nine months ended September 30, 2015 historical condensed consolidated statement of operations have been revised (See Note 2 of the condensed consolidated financial statements).
(3)
Operating expenses include stock-based compensation expense as follows (in thousands):
    
 
Three Months Ended 
 September 30,
 
Nine Months Ended 
 September 30,
 
2016
 
2015
 
2016
 
2015
Stock-based compensation expense data:
 
 
 
 
 
 
 
Sales and marketing
$
130

 
$
114

 
$
422

 
$
260

General and administrative
444

 
785

 
907

 
2,305

Research and development
512

 
390

 
1,551

 
890

Total stock-based compensation expense
$