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APX GROUP HOLDINGS, INC. - 10-K - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS(Edgar Glimpses Via Acquire Media NewsEdge) The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of our consolidated results of operations and financial condition. This discussion covers periods both prior to and subsequent to the Transactions (as described below). Accordingly, the discussion and analysis of certain historical periods do not reflect the significant impact of the Transactions. The discussion should be read in conjunction with the "Unaudited Pro Forma Financial Information," "Selected Historical Consolidated Financial Information" and the consolidated financial statements and notes thereto contained in this annual report on Form 10-K. This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in the "Risk Factors" section of this annual report on Form 10-K. Actual results may differ materially from those contained in any forward-looking statements. Business Overview We are one of the largest residential security solutions companies and one of the largest and fastest-growing home automation services providers in North America. In February 2013, we were recognized by Forbes magazine as one of America's Most Promising Companies. Our fully integrated and remotely accessible residential services platform offers subscribers a suite of products and services that includes interactive security, life-safety, energy management and home automation. We utilize a scalable direct-to-home sales model to originate the majority of our new subscribers, which allows us control over our net subscriber acquisition costs. We have built a high-quality subscriber portfolio, with an average credit score of 717, through our underwriting criteria and compensation structure. Unlike many of our competitors, who generally focus on either subscriber origination or servicing, we originate, install, service and monitor our entire subscriber base, which allows us to control the overall subscriber experience. We seek to deliver a quality subscriber experience with a combination of innovative development of new products and services and a commitment to customer service, which together with our focus on originating high-quality new subscribers, has enabled us to achieve attrition rates that are historically at or below industry averages. Utilizing this model, we have built a portfolio of approximately 796,000 subscribers, as of December 31, 2013. Approximately 92% of our revenues during the year ended December 31, 2013 consist of contractually committed recurring revenues, which have historically resulted in consistent and predictable operating results. Recent Transactions On April 1, 2013, we completed the 2GIG Sale. Pursuant to the terms of the 2GIG Sale, Nortek acquired all of the outstanding common stock of 2GIG for aggregate cash consideration of approximately $148.9 million. In connection with the 2GIG Sale, we entered into a five-year supply agreement with 2GIG, pursuant to which they will be the exclusive provider of our control panel requirements, subject to certain exceptions as provided in the supply agreement. A portion of the net proceeds from the 2GIG Sale was used to temporarily repay $44.0 million of outstanding borrowings under our revolving credit facility. The terms of the indentures governing the notes permit us, subject to certain conditions, to distribute all or a portion of the net proceeds from the 2GIG Sale to our stockholders. In May 2013, we distributed $60.0 million of such proceeds to our stockholders. Subject to the applicable conditions, we may distribute the remaining proceeds in the future. Our results of operations include the results of 2GIG through the date of the 2GIG Sale. In May and December 2013, we issued and sold an additional $200.0 million and $250.0 million, respectively, aggregate principal amount of outstanding 2020 notes. 20 -------------------------------------------------------------------------------- Table of Contents Key Factors Affecting Operating Results Our business is driven through the generation of new subscribers and servicing and maintaining our existing subscriber base. The generation of new subscribers requires significant upfront investment, which in turn provides predictable contractual recurring monthly revenue generated from our monitoring and additional services. We market our service offerings through two sales channels, direct-to-home and inside sales. Historically, most of our new subscriber accounts were generated through direct-to-home sales, primarily from April through August. New subscribers generated through inside sales increased to 23% of total new subscriber additions in the year ended December 31, 2013, as compared to 19% of total new subscribers in the year ended December 31, 2012. Over time, we expect inside sales to continue increasing as a percentage of our overall subscriber originations, resulting from increased advertising and expansion of our direct-sales calling centers. Our operating results are impacted by the following key factors: number of subscriber additions, net subscriber acquisition costs, average RMR per subscriber, subscriber adoption rate of additional services beyond our Advanced Home Security package, subscriber attrition, the costs to monitor and service our subscribers, the level of general and administrative expenses and the availability and cost of capital required to generate new subscribers. We focus our investment decisions on generating new subscribers and servicing our existing subscribers in the most cost-effective manner, while maintaining a high level of customer service to minimize subscriber attrition. These decisions are based on the projected cash flows and associated margins generated over the expected life of the subscriber relationship. Attrition is defined as the aggregate number of cancelled subscribers during a period divided by the monthly weighted average number of total subscribers for such period. Subscribers are considered cancelled when they terminate in accordance with the terms of their contract, are terminated by us, or if payment from such subscribers is deemed uncollectible (120 days past due). Sales of contracts to third parties and certain subscriber moves are excluded from the attrition calculation. Our ability to increase subscribers depends on a number of factors, both external and internal. External factors include the overall macroeconomic environment and competition from other companies in the geographies we serve, particularly in those markets where our direct-to-home sales representatives are present. Some of our current competitors have longer operating histories, greater name recognition and substantially greater financial and marketing resources than us. In the future, other companies may also choose to begin offering services similar to ours. In addition, because such a large percentage of our new subscribers are generated through direct-to-home sales, any actions limiting this sales channel could negatively affect our ability to grow our subscriber base. Internal factors include our ability to recruit, train and retain personnel, along with the level of investment in sales and marketing efforts. We believe maintaining competitive compensation structures, differentiated product offerings and establishing a strong brand are critical to attracting and retaining high-quality personnel and competing effectively in the markets we serve. As a result, we expect to increase our investment in advertising in the markets we serve, in an effort to generate greater awareness of the Vivint brand. Successfully growing our revenue per subscriber depends on our ability to continue expanding our technology platform by offering additional value added services demanded by the market. Therefore, we continually evaluate the viability of additional service packages that could further leverage our existing technology platform and sales channels. As evidence of this focus on new services, since 2010, we have successfully expanded our service packages from residential security into energy management, security plus and home automation, which allows us to charge higher RMR for these additional service packages. In addition, during the year ended December 31, 2013, we began offering high-speed wireless internet to a limited number of residential customers. This service offering leverages our existing direct-to-home selling model for the generation of new subscribers. During the year ended December 31, 2013, approximately 61% of our new subscribers contracted for one of our additional service packages. Due to the high rate of adoption for these additional service packages, our average RMR per new subscriber has increased from $44.50 in 2009 to $58.35 for the year ended December 31, 2013, an increase of 31%, while generally not increasing prices for our services during these periods. We focus on managing the costs associated with monitoring and service without jeopardizing our award-winning service quality. We believe our ability to retain subscribers over the long-term starts with our underwriting criteria and is enhanced by maintaining our consistent quality service levels. Subscriber attrition has a direct impact on the number of subscribers who we monitor and service and on our financial results, including revenues, operating income and cash flows. A portion of the subscriber base can be expected to cancel its service every year. Subscribers may choose not to renew or may terminate their contracts for a variety of reasons, including relocation, cost, switching to a competitor's service and service issues. If a subscriber relocates but continues their service, we do not consider this as a cancellation. If a subscriber discontinues their service and transfers the original subscriber's contract to a new subscriber continuing the revenue stream, we also do not consider this as a cancellation. We analyze our attrition by tracking the number of subscribers who cancel as a percentage of the average number of subscribers at the end of each twelve month period. We caution investors that not all companies, investors and analysts in our industry define attrition in the same manner. The table below presents our subscriber data for the years ended December 31, 2013, 2012 and 2011: Year Ended December 31, 2013 2012 2011 Beginning balance of subscribers 671,818 562,006 456,392 Net new additions 219,034 180,347 151,091 Net contract sales - - (4,230 ) Attrition (95,352 ) (70,535 ) (41,247 ) Ending balance of subscribers 795,500 671,818 562,006 Growth rate 18 % 20 % 23 % Monthly average subscribers 743,544 627,809 518,769 Attrition rate 12.8 % 11.2 % 8.0 % Historically, we have experienced an increased level of subscriber cancellations in the months surrounding the expiration of such subscribers' initial contract term. Attrition in any twelve month period may be impacted by the number of subscriber contracts reaching the end of their initial term in such period. Increases in attrition in the year ended December 31, 2013, reflect the effect of the 2008 60-month pool and a portion of the 2010 42-month pools reaching the end of their initial contract terms during 2013. We believe this trend in cancellation at the end of the initial contract term is comparable to other companies within our industry. Basis of Presentation We have historically conducted business through our Vivint and 2GIG operating segments. Through the date of the Transactions, the historical results of our Vivint operating segment included the results of Vivint, Inc. and its subsidiaries, as well as those of Solar, which was historically consolidated as a variable interest 21 -------------------------------------------------------------------------------- Table of Contents entity. After the date of the Transactions, the results of our Vivint operating segment exclude the results of Solar, as it is not a subsidiary of ours and we are no longer considered a primary beneficiary of Solar. On April 1, 2013, we completed the sale of 2GIG to Nortek. See "-Recent Transactions." Therefore, 2GIG is excluded from our operating results, beginning on the date of the 2GIG Sale. The results of our 2GIG operating segment include the results of 2GIG Technologies, Inc., which prior to the Merger was a variable interest entity and after the Merger was our consolidated subsidiary until its sale to Nortek. Revenues from Solar and its subsidiaries were approximately $0.4 million, or less than 1% of our total revenues (excluding intercompany activity), for the period from January 1, 2012 through the date of the Transactions. As of the date of the Transactions, assets of Solar and its subsidiaries were approximately $43.0 million, or 5% of our total assets (excluding intercompany balances), and liabilities of Solar and its subsidiaries were approximately $27.2 million, or 2% of our total liabilities (excluding intercompany balances). Revenues from 2GIG and its subsidiary were approximately $17.5 million, or 3% of our total revenues and $58.1 million, or 13% of our total revenues during the year ended December 31, 2013 and the Pro Forma Year ended December 31, 2012, respectively. As of March 31, 2013, assets of 2GIG and its subsidiary were approximately $138.5 million, or 6% of our total assets (excluding intercompany balances), and liabilities of 2GIG and its subsidiary were approximately $63.2 million, or 4% of our total liabilities (excluding intercompany balances). Historically, a substantial majority of 2GIG's revenues were generated from Vivint through (i) sales of its security systems and (ii) fees billed to Vivint associated with a third-party monitoring platform. Sales to Vivint represented approximately 71%, 45%, 54% and 80% of 2GIG's total revenues on a stand-alone basis for the period January 1, 2013 through the date of the 2GIG Sale, the Successor Period ended December 31, 2012, the Predecessor Period from January 1, 2012 through November 16, 2012 and the year ended December 31, 2011, respectively. The results of 2GIG's operations through the date of the 2GIG Sale discussed in this annual report on Form 10-K exclude intercompany activity with Vivint, as these transactions are eliminated in consolidation. The consolidated financial statements for the year ended December 31, 2012 are presented for the Predecessor Period from January 1, 2012 through November 16, 2012 and the Successor Period ended December 31, 2012, which relate to the period preceding the Merger and the period succeeding the Merger, respectively. The consolidated financial statements of the Predecessor are presented for the Issuer and its wholly-owned subsidiaries. The audited consolidated financial statements for the Successor Period reflect the Transactions presenting the financial position and results of operations of the Parent Guarantor and its wholly-owned subsidiaries. The financial position and results of the Successor are not comparable to the financial position and results of the Predecessor due to the Transactions and the application of purchase accounting in accordance with ASC 805 Business Combinations. The Transactions have had and are expected to continue having, a significant effect on our future financial condition and results of operations. For instance, as a result of the Transactions, our borrowings have increased significantly, although at lower rates of interest. Also, the application of purchase accounting in accordance with ASC 805 Business Combinations required that our assets and liabilities be adjusted to their fair value. These adjustments resulted in a decrease in our revenues, primarily related to activation fees billed to our subscribers prior to the Transactions. The revenue associated with activation fees is deferred upon billing and recognized over the estimated life of the subscriber relationships. There was deemed to be no fair value associated with the deferred activation fee revenues at the time of these Transactions. As a result, the recognition of the deferred revenues associated with these activation fees was eliminated. Our amortization expense also increased due to intangible assets acquired in the Transactions. We also incurred significant non-recurring charges in connection with the Transactions, including (i) equity-based compensation expense relating to management awards that vested upon the closing of the Transactions, (ii) payment to employees of bonuses and other compensation related to the Transactions and (iii) certain expenses related to the Transactions that may be required to be expensed by accounting standards. The unaudited Pro Forma Year statement of operations for the year ended December 31, 2012 has been prepared to give pro forma effect to the Transactions as if they had occurred on January 1, 2012. The pro forma financial information is for informational purposes only and should not be considered indicative of actual results that would have been achieved had the Transactions actually been consummated on the dates indicated and do not purport to indicate results of operations as of any future date or for any future period. See "Unaudited Pro Forma Financial Information." How We Generate Revenue Vivint Our primary source of revenue is generated through monitoring services provided to our subscribers in accordance with their subscriber contracts. The remainder of our revenue is generated through additional services, activation fees, upgrades, maintenance and the sale of subscriber contracts. Monitoring revenues accounted for 95%, 96%, 94% and 92% of total revenues respectively for the year ended December 31, 2013, the Successor Period ended December 31, 2012, the Predecessor Period from January 1, 2012 through November 16, 2012 and the year ended December 31, 2011. Monitoring revenue. Monitoring services for our subscriber contracts are billed in advance, generally monthly, pursuant to the terms of subscriber contracts and recognized ratably over the service period. The amount of RMR billed is dependent upon which of our service packages the subscriber contracts for. We generally realize higher RMR for our Home Automation, Energy Management and Security Plus service packages than our Home Security service package. Historically, we have generally offered contracts to subscribers that range in length from 36 to 60 months that are subject to automatic annual or monthly renewal after the expiration of the initial term. At the end of each monthly period, the portion of monitoring fees related to services not yet provided are deferred and recognized as these services are provided. Activation fees. Activation fees represent upfront one-time charges billed to subscribers at the time of installation. The revenue associated with these fees is deferred and recognized using a 150% declining balance method over 12 years and converts to a straight-line methodology when the resulting revenue recognition is greater than that from the accelerated method for the remaining estimated life. Service and other sales revenue. Our service and other sales revenue is primarily comprised of amounts charged for selling additional equipment, and maintenance and repair. These amounts are billed, and the associated revenue recognized, at the time of installation or when the services are performed. Service and other sales revenue also includes contract fulfillment revenue, which relates to amounts paid by subscribers who cancel their monitoring contract in-term and for which we have no future service obligation to them. We recognize this revenue upon receipt of payment from the subscriber. Contract sales. Historically, we generated a portion of our revenues through the sale to third parties of certain subscriber contracts. However, we do not expect such sales to represent a material component of future revenues. These sales are recognized when ownership of the contracts transfers to the purchaser and we have no long-term ongoing involvement with any deferred revenue associated with these contracts also recognized at that time. 2GIG 2GIG's primary source of revenue was generated through the sale of electronic home security and automation products to dealers and distributors throughout North America. The remainder of the revenue was earned from monthly recurring service fees. System sales, which are included in service and other sales revenue on our consolidated statements of operations through March 31, 2013, accounted for approximately 3%, 13%, 12%, 13% and 8% of total consolidated revenues for the year ended December 31, 2013, the Pro Forma Year, the Successor Period ended December 31, 2012, the Predecessor Period from January 1, 2012 through November 16, 2012 and the year ended December 31, 2011, respectively. Product sales accounted for approximately 97%, 87%, 81%, 88% and 99% of 2GIG's total revenues on a stand-alone basis for the period January 1, 2013 through the date of the 2GIG Sale, the Pro Forma Year, the Successor Period ended December 31, 2012, the Predecessor Period from January 1, 2012 through November 16, 2012 and the year ended December 31, 2011, respectively. 22-------------------------------------------------------------------------------- Table of Contents Service and other sales revenue. Net sales revenue from distribution of the 2GIG products was recognized when title to the products transferred to the customer, which occurred upon shipment from our third-party logistics provider's facility to the customer. Invoicing occurred at the time of shipment and in certain cases, included freight costs based on specific vendor contracts. Recurring services revenue. Net recurring services revenue was based on back-end services for all panels sold to distributors and direct-sell dealers and subsequently placed in service in end-user locations. The back-end services are provided by Alarm.com, an independent platform services provider. 2GIG received a fixed monthly amount from Alarm.com for each of our systems installed with customers that used the Alarm.com platform. Costs and Expenses Vivint Operating expenses. Operating expenses primarily consists of direct labor associated with monitoring and servicing subscribers and labor and equipment expenses related to field service. In addition, a portion of general and administrative expenses, comprised of certain human resources, facilities and information technologies costs are allocated to operating expenses. This allocation is primarily based on employee headcount and facility square footage occupied. Because our field service technicians perform most subscriber installations generated through our inside sales channels, the costs incurred by the field service associated with these installations are allocated to capitalized subscriber acquisition costs. Cost of contract sales. Costs of contract sales reflect the unamortized portion of capitalized subscriber acquisition costs for subscriber contracts, which we sell to third parties. As noted above, we do not expect contract sales to third parties to represent a material component of our future revenues. Selling expenses. Selling expenses are primarily comprised of costs associated with housing for our direct-to-home sales representatives, marketing and recruiting, certain portions of sales commissions, overhead (including allocation of certain general and administrative expenses) and other costs not directly tied to a specific subscriber origination. These costs are expensed as incurred. General and administrative expenses. General and administrative expenses consist largely of finance, legal, human resources, information technology and executive management expenses, including stock-based compensation expense. Stock-based compensation expense is recorded within various components of our costs and expenses. We allocate approximately one-third of our gross general and administrative expenses into operating and selling expenses in order to reflect the overall costs of those components of the business. In addition, in connection with a sublease agreement, we sublease corporate office space and provide certain other administrative services to Solar and charge Solar the costs associated with this sublease agreement (See Note 7). Depreciation and amortization. Depreciation and amortization consists of depreciation from property and equipment, equipment leased under capital leases and amortization of capitalized subscriber acquisition costs and intangible assets. 2GIG Operating expenses. 2GIG did not directly manufacture, assemble, warehouse or ship any of the products it sold. Its products were produced by contract manufacturers, and warehoused and fulfilled through third-party logistics providers. Operating expenses primarily consisted of cost of goods sold, freight charges, royalty fees on licensed technology, warehouse expenses, and fulfillment service fees charged by its logistics providers. General and administrative expenses. General and administrative expenses consisted largely of finance, research and development ("R&D"), including third-party engineering costs, legal, operations, sales commissions, and executive management costs. 2GIG's personnel-related costs were included in general and administrative expense. Depreciation and amortization. Depreciation and amortization consisted of depreciation of property and equipment. Key Operating Metrics In evaluating our results, we review the key performance measures discussed below. We believe that the presentation of key performance measures is useful to investors and lenders because they are used to measure the value of companies such as ours with recurring revenue streams. Total Subscribers Total subscribers is the aggregate number of our active subscribers at the end of a given period. Total Recurring Monthly Revenue Total RMR is the aggregate RMR billed to all subscribers. This revenue is earned for Home Automation, Energy Management, Security Plus and Home Security service offerings. Average RMR per Subscriber Average RMR per subscriber is the total RMR divided by the total subscribers. This is also commonly referred to as Average Revenue per User, or ARPU. Critical Accounting Estimates In preparing our Consolidated Financial Statements, we make assumptions, judgments and estimates that can have a significant impact on our revenue, (loss) income from operations and net loss, as well as on the value of certain assets and liabilities on our Consolidated Balance Sheets. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. At least quarterly, we evaluate our assumptions, judgments and estimates and make changes accordingly. Historically, our assumptions, judgments and estimates relative to our critical accounting estimates have not differed materially from actual results. We believe that the assumptions, judgments and estimates involved in the accounting for income taxes, allowance for doubtful accounts, valuation of intangible assets, and fair value have the greatest potential impact on our Consolidated Financial Statements; therefore, we consider these to be our critical accounting estimates. For information on our significant accounting policies, see Note 2 to our Consolidated Financial Statements. 23 -------------------------------------------------------------------------------- Table of Contents Revenue Recognition We recognize revenue principally on four types of transactions: (i) monitoring, which includes RMR, (ii) activation fees on the subscriber contracts, which are amortized over the estimated life of the subscriber relationship, (iii) service and other sales, which includes non-recurring service fees charged to our subscribers provided on contracts, contract fulfillment revenues and sales of products that are not part of our service offerings and (iv) sales of subscriber contracts to third parties. Monitoring services for our subscriber contracts are billed in advance, generally monthly, pursuant to the terms of subscriber contracts and recognized ratably over the service period. RMR is recognized monthly as services are provided in accordance with the rates set forth in our subscriber contracts. Costs of providing ongoing monitoring services are expensed in the period incurred. Activation fees are typically charged upon the generation of a new subscriber. This revenue is deferred and recognized over a pattern that reflects the estimated life of a subscriber relationship. Any services included in service and other sales revenue are recognized upon provision of the applicable services. Revenue from 2GIG product sales was recognized when title passed to the customer, which was generally upon shipment from the warehouse of our third-party logistics provider. Revenue generated by Vivint from the sale of products that are not part of the service offerings is recognized upon installation. Contract fulfillment revenue represents fees received from subscribers at the time of, or subsequent to, the in-term termination of their contract. This revenue is recognized when payment is received from the subscriber. Revenue from the sale of subscriber contracts to third parties is recognized when ownership of the contracts has transferred to the purchaser. Any unamortized deferred revenue and costs related to contract sales are recognized at that time of the sale. Subscriber Acquisition Costs A portion of the direct costs of acquiring new subscribers, primarily sales commissions, equipment, and installation costs, are deferred and recognized over a pattern that reflects the estimated life of the subscriber relationships. We amortize these costs using a 150% declining balance method over 12 years and convert to a straight-line methodology when the resulting amortization charge is greater than that from the accelerated method for the remaining estimated life in both the Successor Period and Predecessor Period. We evaluate attrition on a periodic basis, utilizing observed attrition rates for our subscriber contracts and industry information and, when necessary, make adjustments to the estimated life of the subscriber relationship and amortization method. Subscriber acquisition costs represent the costs related to the origination of new subscribers. A portion of subscriber acquisition costs is expensed as incurred, which includes costs associated with the direct-to-home sale housing, marketing and recruiting, certain portions of sales commissions (residuals), overhead and other costs, considered not directly and specifically tied to the origination of a particular subscriber. The remaining portion of the costs is considered to be directly tied to subscriber acquisition and consist primarily of certain portions of sales commissions, equipment, and installation costs. These costs are deferred and recognized in a pattern that reflects the estimated life of the subscriber relationships. Subscriber acquisition costs are largely correlated to the number of new subscribers originated. Accounts Receivable Accounts receivables consist primarily of amounts due from subscribers for RMR services and, prior to the 2GIG Sale, balances related to 2GIG product shipments to third parties. Accounts receivable are recorded at invoiced amounts and are non-interest bearing. The gross amount of accounts receivable has been reduced by an allowance for doubtful accounts of approximately $1.9 million and $2.3 million at December 31, 2013 and 2012, respectively. We estimate this allowance based on historical collection rates, attrition rates, and contractual obligations underlying the sale of the subscriber contracts to third parties. As of December 31, 2013 and 2012, no accounts receivable were classified as held for sale. Provision for doubtful accounts recognized and included in general and administrative expenses in the accompanying consolidated statements of operations totaled $10.4 million for the year ended December 31, 2013, $1.3 million for the Successor Period ended December 31, 2012, $8.2 million for the Predecessor Period ended November 16, 2012 and $7.0 million for the year ended December 31, 2011. Loss Contingencies We record accruals for various contingencies including legal proceedings and other claims that arise in the normal course of business. The accruals are based on judgment, the probability of losses and, where applicable, the consideration of opinions of legal counsel. We record an accrual when a loss is deemed probable to occur and is reasonably estimable. Factors that we consider in the determination of the likelihood of a loss and the estimate of the range of that loss in respect of legal matters include the merits of a particular matter, the nature of the litigation, the length of time the matter has been pending, the procedural posture of the matter, whether we intend to defend the matter, the likelihood of settling for an insignificant amount and the likelihood of the plaintiff accepting an amount in this range. However, the outcome of such legal matters is inherently unpredictable and subject to significant uncertainties. Goodwill and Intangible Assets As discussed above, the Merger was completed on November 16, 2012, and was financed by a combination of borrowings under our revolving credit facility, the issuance of the outstanding 2019 notes and the outstanding 2020 notes, cash on hand and the equity investment of the Investors. The purchase price in respect of the acquisitions of the Issuer and 2GIG, was approximately $1.9 billion, of which $94.6 million was disposed of as part of the 2GIG Sale. Purchase accounting requires that all assets and liabilities be recorded at fair value on the acquisition date, including identifiable intangible assets separate from goodwill. Identifiable intangible assets include customer relationships, trade names and trademarks and developed technology, which equaled $840.7 million at December 31, 2013. Goodwill represents the excess of cost over the fair value of net assets acquired and was $836.3 million at December 31, 2013. The estimated fair values and useful lives of identified intangible assets are based on many factors, including estimates and assumptions of future operating performance and cash flows of the acquired business, estimates of cost avoidance, the nature of the business acquired, the specific characteristics of the identified intangible assets and our historical experience and that of the acquired business. The estimates and assumptions used to determine the fair values and useful lives of identified intangible assets could change due to numerous factors, including product demand, market conditions, regulations affecting the business model of our operations, technological developments, economic conditions and competition. The carrying values and useful lives for amortization of identified intangible assets are reviewed annually during our fourth fiscal quarter and as necessary if changes in facts and circumstances indicate that the carrying value may not be recoverable and any resulting changes in estimates could have a material adverse effect on our financial results. When we determine that the carrying value of intangible assets, goodwill and long-lived assets may not be recoverable, an impairment charge is recorded. Impairment is generally measured based on valuation techniques considered most appropriate under the circumstances, including a projected discounted cash flow method using a discount rate determined by our management to be commensurate with the risk inherent in our current business model or prevailing market rates of investment securities, if available. We conduct a goodwill impairment analysis annually in our fourth fiscal quarter, and as necessary if changes in facts and circumstances indicate that the fair value of our reporting units may be less than their carrying amount. Under applicable accounting guidance, we are permitted to use a qualitative approach to evaluating goodwill impairment when no indicators of impairment exist and if certain accounting criteria are met. To the extent that indicators exist or the criteria are not met, we use a quantitative approach to evaluate goodwill impairment. Such quantitative impairment assessment is performed using a two-step, fair value based test. The first 24-------------------------------------------------------------------------------- Table of Contents step requires that we compare the estimated fair value of our reporting units to the carrying value of the reporting unit's net assets, including goodwill. If the fair value of the reporting unit is greater than the carrying value of its net assets, goodwill is not considered to be impaired and no further testing is required. If the fair value of the reporting unit is less than the carrying value of its net assets, we would be required to complete the second step of the test by analyzing the fair value of its goodwill. If the carrying value of the goodwill exceeds its fair value, an impairment charge is recorded. Property and Equipment Property and equipment are stated at cost and depreciated on the straight-line method over the estimated useful lives of the assets or the lease term, whichever is shorter. Amortization expense associated with leased assets is included with depreciation expense. Routine repairs and maintenance are charged to expense as incurred. We periodically assess potential impairment of our property and equipment and perform an impairment review whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Income Taxes We account for income taxes based on the asset and liability method. Under the asset and liability method, deferred tax assets and deferred tax liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and operating loss and tax credit carryforwards. Valuation allowances are established when necessary to reduce deferred tax assets when it is determined that it is more likely than not that some portion of the deferred tax asset will not be realized. We recognize the effect of an uncertain income tax position on the income tax return at the largest amount that is more-likely-than-not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Our policy for recording interest and penalties is to record such items as a component of the provision for income taxes. Recent Accounting Pronouncements In September 2011, the FASB issued authoritative guidance which amends the process of testing goodwill for impairment. The guidance permits an entity to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not (defined as having a likelihood of more than fifty percent) that the fair value of a reporting unit is less than its carrying amount. If an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, performing the traditional two-step goodwill impairment test is unnecessary. If an entity concludes otherwise, it would be required to perform the first step of the two-step goodwill impairment test. If the carrying amount of the reporting unit exceeds its fair value, then the entity is required to perform the second step of the goodwill impairment test. However, an entity has the option to bypass the qualitative assessment in any period and proceed directly to step one of the impairment test. The guidance became effective for us in the fourth quarter of fiscal year 2013. The adoption of this guidance did not have a material impact on our financial position, results of operations or cash flows. In July 2012, the FASB issued authoritative guidance which amends the process of testing indefinite-lived intangible assets for impairment. This guidance permits an entity to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not (defined as having a likelihood of more than fifty percent) that the indefinite-lived intangible asset is impaired. If an entity determines it is not more likely than not that the indefinite-lived intangible asset is impaired, the entity will have an option not to calculate the fair value of an indefinite-lived asset annually. The guidance became effective for us in the fourth quarter of fiscal year 2013. The adoption of this guidance did not have a material impact on our financial position, results of operations or cash flows. In February 2013, the FASB issued authoritative guidance which expands the disclosure requirements for amounts reclassified out of accumulated other comprehensive income ("AOCI"). The guidance requires an entity to provide information about the amounts reclassified out of AOCI by component and present, either on the face of the income statement or in the notes to financial statements, significant amounts reclassified out of AOCI by the respective line items of net income but only if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts, an entity is required to cross-reference to other disclosures required under GAAP that provide additional detail about those amounts. This guidance does not change the current requirements for reporting net income or OCI in financial statements. The guidance is effective for us in the first quarter of fiscal year 2014. The adoption of this guidance is not expected to have a material impact on our financial position, results of operations or cash flows. In July 2013, the FASB issued authoritative guidance which amends the guidance related to the presentation of unrecognized tax benefits and allows for the reduction of a deferred tax asset for a net operating loss carryforward whenever the net operating loss carryforward or tax credit carryforward would be available to reduce the additional taxable income or tax due if the tax position is disallowed. This guidance is effective for annual and interim periods for fiscal years beginning after December 15, 2013, and early adoption is permitted. The adoption of this guidance is not expected to have a material impact on our financial position, results of operations or cash flows. Unaudited Pro Forma Financial Information The following unaudited pro forma consolidated statement of operations data is presented for supplemental information purposes only. The unaudited pro forma consolidated statement of operations data does not purport to represent what our results of operations would have been had the Merger occurred on the dates specified, and it does not purport to project our results of operations or financial condition for any future period. The unaudited pro forma consolidated statement of operations data should be read in conjunction with this "Management's Discussion and Analysis of Financial Condition and Results of Operations," as well as "Selected Historical Consolidated Financial Information" and our audited consolidated financial statements and related notes thereto appearing elsewhere in this annual report on Form 10-K. The pro forma adjustments are based upon available information and certain assumptions that we believe are reasonable. All pro forma adjustments and their underlying assumptions are described more fully in the notes to our unaudited pro forma consolidated statements of operations. We are providing information on a pro forma basis, giving effect to the Transactions, to provide a supplemental analysis of our results of operations. The unaudited consolidated pro forma statements of operations data has been derived by applying pro forma adjustments to our historical consolidated statements of operations contained elsewhere in this annual report on Form 10-K. The Merger, which occurred on November 16, 2012, was accounted for as a business combination. As a result of the Merger, we applied purchase accounting in accordance with ASC 805 Business Combinations, which required that our assets and liabilities be recorded at their respective fair values as of the Merger date. Our historical consolidated financial statements for the year ended December 31, 2012 are presented for two periods: the Predecessor Period from January 1, 2012 through November 16, 2012 and the Successor Period ended December 31, 2012, which relate to the period preceding the Merger and the period succeeding the Merger, respectively. The unaudited pro forma consolidated statement of operations data for the year ended December 31, 2012 has been derived by (i) adding the historical audited consolidated statement of operations for the Predecessor Period from January 1, 2012 through November 16, 2012 and the historical audited consolidated statement of operations for the Successor Period ended December 31, 2012 and (ii) applying pro forma adjustments to give effect to the Transactions as if they had occurred on January 1, 2012. 25 -------------------------------------------------------------------------------- Table of Contents The pro forma consolidated statements of operations data included in this annual report on Form 10-K include the results of Solar, which was considered a variable interest entity. As a result of the Merger, while Solar remains a variable interest entity, we are no longer its primary beneficiary. Accordingly, Solar is no longer required to be included in the consolidated financial statements of the Company. In addition, the pro forma statements of operations included in this annual report on Form 10-K include the results of 2GIG. On April 1, 2013, we completed the 2GIG Sale. Solar and 2GIG do not and will not provide any credit support for any of our indebtedness, including indebtedness incurred under our revolving credit facility, our 2019 notes or our 2020 notes. 26 -------------------------------------------------------------------------------- Table of Contents Unaudited Pro Forma Condensed Statements of Operations Fiscal Year Ended December 31, 2012 Successor Predecessor Period from Period from November 17, January 1, Pro Forma through through Year December 31, November 16, Ended 2012 2012 December 31, (Actual) (Actual) Adjustments 2012 (dollars in thousands) Revenue: Monitoring revenue Vivint $ 48,984 $ 324,691 $ (834 )(1) $ 372,841 2GIG 138 580 - 718 Total monitoring revenue 49,122 325,271 (834 ) 373,559 Service and other sales revenue Vivint 1,796 16,091 - 17,887 2GIG 6,677 50,720 - 57,397 Total service and other sales revenue 8,473 66,811 - 75,284 Activation fees Vivint 11 5,331 (3,989 )(1) 1,353 2GIG - - - - Total activation fees 11 5,331 (3,989 ) 1,353 Contract sales Vivint - 157 - 157 Total contract sales - 157 - 157 Total revenues Vivint 50,791 346,270 (4,823 ) 392,238 2GIG 6,815 51,300 - 58,115 Total revenues 57,606 397,570 (4,823 ) 450,353 Costs and expenses: Operating expenses Vivint 16,115 114,258 (1,571 )(2) 128,802 2GIG 4,584 31,539 1,912 (3) 38,035 Total operating expenses 20,699 145,797 341 166,837 Cost of contract sales Vivint - 95 - 95 Total cost of contract sales - 95 - 95 Selling expenses Vivint 12,284 91,559 (34,022 )(2) 78,075 8,318 (4) (64 )(5) Total selling expenses 12,284 91,559 (25,768 ) 78,075 27 -------------------------------------------------------------------------------- Table of Contents Successor Predecessor Period from Period from November 17, January 1, Pro Forma through through Year December 31, November 16, Ended 2012 2012 December 31, (Actual) (Actual) Adjustments 2012 (dollars in thousands) General and administrative expenses Vivint $ 6,946 $ 78,772 $ (35,048 )(2) $ 52,225 1,209 (6) 2,243 (7) (1,716 )(5) (181 )(8) 2GIG 2,575 21,200 (436 )(5) 23,339 Total general and administrative expenses 9,521 99,972 (33,929 ) 75,564 Transaction related expenses Vivint 28,118 22,219 (50,337 )(9) - 2GIG 3,767 1,242 (5,009 )(9) - Total transaction related expenses 31,885 23,461 (55,346 ) - Depreciation and amortization Vivint 10,896 80,616 75,740 (10) 167,252 2GIG 514 (937 ) 6,481 (10) 6,058 Total depreciation and amortization expenses 11,410 79,679 82,221 173,310 Total costs and expenses Vivint 74,359 387,519 (35,429 ) 426,449 2GIG 11,440 53,044 2,948 67,432 Total costs and expenses 85,799 440,563 (32,481 ) 493,881 Loss from operations (28,193 ) (42,993 ) 27,658 (43,528 ) Other expenses: Interest expense, net (12,641 ) (106,559 ) 15,234 (11) (103,966 ) Other expenses (171 ) (122 ) (287 )(12) (580 ) Loss from continuing operations before income taxes (41,005 ) (149,674 ) 42,605 (148,074 ) Income tax (benefit) expense (10,903 ) 4,923 - (13) (5,980 ) Net loss from continuing operations $ (30,102 ) $ (154,597 ) $ 42,605 $ (142,094 ) See Notes to Unaudited Pro Forma Condensed Statements of Operations 28-------------------------------------------------------------------------------- Table of Contents Notes to Unaudited Pro Forma Condensed Statements of Operations (1) Reflects the adjustment to revenue as a result of the reduction of deferred revenue to its fair value in connection with the Transactions in accordance with the FASB Accounting Standards Codification Business Combination Topic. (2) Represents nonrecurring bonuses and other payments to employees directly related to the Merger. (3) Represents the impact on the cost of systems sold by 2GIG to third parties resulting from the revaluation of inventory to its fair value as of the beginning of the period. (4) Reflects Company obligations settled in conjunction with the Merger that have an ongoing service requirement. (5) Reflects the elimination of stock-related compensation expenses associated with equity awards fully vested and settled in connection with the Merger. (6) Reflects the monitoring fee payable by us pursuant to the support and services agreement with an affiliate of Blackstone. See "Certain Relationships and Related Party Transactions." (7) Reflects stock-based compensation costs related to equity awards granted in connection with the Merger. (8) Reflects the elimination of certain liabilities as a result of the Merger. (9) Reflects the elimination of non-recurring accounting, investment banking, legal and professional fees that were directly associated with the Merger. (10) Represents the net increase in depreciation and amortization expense due to fair value adjustments made as part of purchase price accounting related to definite-lived intangible assets with estimated useful lives as follows: Estimated Useful Life Annual Fair Value (Years) Amortization Calculation of annualized amortization of definite-lived intangible assets: Customer contracts(1) $ 990,777 10 $ 157,093 2GIG customer relationships 45,000 10 3,710 2GIG 2.0 technology 17,000 8 - 2GIG 1.0 technology 8,000 6 3,172 CMS technology 2,300 5 460 $ 1,063,077 $ 164,435 Calculation of the pro forma adjusted to depreciation and amortization: Annual total amortization (from table above) $ 164,435 Historical amortization for 2012 Successor and Predecessor periods (10,058 ) Pro Forma adjustment-acquired intangibles amortization 154,377 Subscriber acquisition costs amortization 181 Historical subscriber acquisition costs amortization in Successor period (72,337 ) Pro Forma adjustment-subscriber acquisition costs (72,156 ) Total Pro Forma adjustment-depreciation and amortization $ 82,221 (1) Subscriber acquisition costs before the Merger are now included in customer contracts. Identifiable long-lived intangible assets are amortized on a basis that approximates the underlying net cash flows resulting from the associated intangible asset. 29 -------------------------------------------------------------------------------- Table of Contents (11) Reflects the net decrease in interest expense resulting from elimination of the interest expense incurred on predecessor debt that was repaid at the time of the Merger, partially offset by interest expense on our new long-term debt issued in connection with the Merger and without giving pro forma effect to interest expense associated with the 2013 Notes Offerings as follows: Interest on Senior Secured Notes due 2019 $ 51,751 Interest on Senior Notes due 2020 29,186 Interest on revolving line of credit and unused fees 1,358 Amortization of deferred loan costs 7,413 Total interest related to new debt issued 89,708 Less: Historical obligations settled in Merger: Interest related to historical term loans 87,322 Interest on historical revolving line of credit and unused fees 2,320 Amortization of deferred loan costs on historical debt 6,458 Imputed interest on liabilities settled in Merger 8,842 Total interest on obligations settled in Merger 104,942 Pro Forma adjustment $ 15,234 (12) Reflects the fair value adjustment related to warrant liabilities settled in the Merger. (13) No income tax expense (benefit) relating to the pro forma adjustments herein was recognized as we continue to be in a net operating loss position and net operating loss carryforwards have been offset by a valuation allowance. Results of operations Successor Predecessor Period from Period from November 17 January 1 Pro Forma Year Ended through through Year Ended Year Ended December 31, December 31, November 16, December 31, December 31, 2013 2012 2012 2011 2012 (unaudited) (in thousands) Revenue Vivint $ 483,401 $ 50,791 $ 346,270 $ 312,422 $ 392,238 2GIG 17,507 6,815 51,300 27,526 58,115 Total revenue 500,908 57,606 397,570 339,948 450,353 Transaction related costs Vivint - 28,118 22,219 - - 2GIG - 3,767 1,242 - - Total transaction related costs - 31,885 23,461 - - Costs and expenses Vivint 536,502 46,241 365,300 267,973 426,449 2GIG 19,286 7,673 51,802 32,961 67,432 Total costs and expenses 555,788 53,914 417,102 300,934 493,881 (Loss) income from continuing operations Vivint (53,101 ) (23,568 ) (41,249 ) 44,449 (34,211 ) 2GIG (1,779 ) (4,625 ) (1,744 ) (5,435 ) (9,317 ) Total (loss) income from continuing operations (54,880 ) (28,193 ) (42,993 ) 39,014 (43,528 ) Other expenses 66,041 12,812 106,681 102,241 104,546 Loss before taxes (120,921 ) (41,005 ) (149,674 ) (63,227 ) (148,074 ) Income tax expense (benefit) 3,592 (10,903 ) 4,923 (3,739 ) (5,980 ) Net loss from continuing operations (124,513 ) (30,102 ) (154,597 ) (59,488 ) $ (142,094 ) Loss from discontinued operations - - (239 ) (2,917 ) Less net (loss) income attributable to non-controlling interests - - (1,319 ) 6,141 Net loss attributable to APX Group Holdings, Inc. $ (124,513 ) $ (30,102 ) Net loss attributable to APX Group, Inc. $ (153,517 ) $ (68,546 ) Key operating metrics (1) Total Subscribers (thousands), as of December 31 795.5 671.8 N/A 562.0 671.8 Total RMR (thousands) (end of period) $ 42,202 $ 34,276 N/A $ 27,092 $ 34,276 Average RMR per Subscriber $ 53.05 $ 51.02 N/A $ 48.21 $ 51.02 (1) Reflects Vivint metrics only for all periods presented. 30 -------------------------------------------------------------------------------- Table of Contents Year Ended December 31, 2013 compared to the Pro Forma Year Ended December 31, 2012-Vivint Revenues The following table provides the significant components of our revenue for the year ended December 31, 2013, the Successor Period ended December 31, 2012, the Predecessor Period ended November 16, 2012 and the Pro Forma Year ended December 31, 2012: Successor Predecessor % Change Period from Period from November 17 January 1 Pro Forma Year Ended through through Year Ended December 31, December 31, November 16, December 31, 2013 Actual vs. 2013 2012 2012 2012 Pro Forma 2012 (unaudited) Monitoring revenue $ 459,681 $ 48,984 $ 324,691 $ 372,841 23 % Service and other sales revenue 22,077 1,796 16,091 17,887 23 Activation fees 1,643 11 5,331 1,353 21 Contract Sales - - 157 157 - Total revenues $ 483,401 $ 50,791 $ 346,270 $ 392,238 23 % Total revenues increased $91.2 million, or 23%, for the year ended December 31, 2013 as compared to the Pro Forma year ended December 31, 2012, primarily due to the growth in monitoring revenue, which increased $86.8 million, or 23%. This increase resulted from $74.2 million of fees from the net addition of approximately 124,000 subscribers and a $19.0 million increase from continued growth in the percentage of our subscribers contracting for new products and service packages, partially offset by an increase of $5.8 million in refunds and other adjustments resulting from the revenue growth. Service and other sales revenue increased $4.2 million, or 23%, for the year ended December 31, 2013 as compared to the Pro Forma year ended December 31, 2012. This growth was primarily due to an increase in upgrade revenue related to subscriber service upgrades and purchases of additional equipment. Activation fees increased $0.3 million, or 21%, for the year ended December 31, 2013 as compared to the Pro Forma year ended December 31, 2012, primarily due an increase in the number of subscribers being billed activation fees. Costs and Expenses Successor Predecessor % Change Period from Period from November 17 January 1 Pro Forma Year Ended through through Year Ended December 31, December 31, November 16, December 31, 2013 Actual vs. 2013 2012 2012 2012 Pro Forma 2012 (unaudited) Operating expenses $ 152,554 $ 16,115 $ 114,258 $ 128,802 18 % Cost of contract sales - - 95 95 - Selling expenses 98,884 12,284 91,559 78,075 27 General and administrative 91,696 6,946 78,772 52,225 76 Transaction related expenses - 28,118 22,219 - - Depreciation and amortization 193,368 10,896 80,616 167,252 16 Total costs and expenses $ 536,502 $ 74,359 $ 387,519 $ 426,449 26 % Operating expenses increased $23.8 million, or 18%, for the year ended December 31, 2013 as compared to the Pro Forma year ended December 31, 2012, primarily to support the growth in our subscriber base. This increase was principally comprised of $10.0 million in personnel costs within our monitoring, customer support and field service functions, a $7.7 million increase in inventory used in subscriber upgrades and service repairs, a $3.6 million increase in cellular communications fees related to our monitoring services and a $3.1 million increase in shipping expenses resulting from the growth in our subscriber base. Selling expenses, excluding amortization of capitalized subscriber acquisition costs, increased $20.8 million, or 27%, for the year ended December 31, 2013 as compared to the Pro Forma year ended December 31, 2012, primarily due to a $7.2 million increase in personnel costs and a $4.7 million increase in facility and information technology costs, all to support the increase in our subscriber contract originations. In addition, advertising costs increased by $7.7 million, primarily in support of the growth in our inside sales subscriber contract originations. General and administrative expenses increased $39.5 million, or 76%, for the year ended December 31, 2013 as compared to the Pro Forma year ended December 31, 2012, primarily due to an $11.9 million increase in personnel costs, a $6.6 million increase in outside contracted services, primarily related to increased legal and compliance costs, a $2.9 million increase in monitoring, advisory and consulting services under a support and services agreement with Blackstone Management Partners L.L.C, a $1.5 million increase in facility costs and a $1.1 million increase in sponsorship and advertising costs, all to support the growth in our business. We also reserved $6.0 million related to legal contingencies and incurred $5.4 million in bonus and other transaction costs related to the 2GIG Sale. Depreciation and amortization increased $26.1 million, or 16%, for the year ended December 31, 2013 as compared to the Pro Forma year ended December 31, 2012. The increase was primarily due to increased amortization of subscriber contract costs. 31-------------------------------------------------------------------------------- Table of Contents Year Ended December 31, 2013 compared to the Pro Forma Year Ended December 31, 2012-2GIG All intercompany revenue and expenses between Vivint and 2GIG have been eliminated in consolidation and from the amounts presented below. Successor Predecessor % Change Period from Period from November 17 January 1 Pro Forma Year Ended through through Year Ended December 31, December 31, November 16, December 31, 2013 Actual vs. 2013 2012 2012 2012 Pro Forma 2012 (unaudited) Total revenue $ 17,507 $ 6,815 $ 51,300 $ 58,115 (70 )% Operating expenses (11,667 ) (4,584 ) (31,539 ) (38,035 ) (69 ) General and administrative (5,481 ) (2,575 ) (21,200 ) (23,339 ) (77 ) Transaction related expenses - (3,767 ) (1,242 ) - - Other (expenses) income (2,138 ) (514 ) 937 (6,058 ) (65 ) Loss from operations $ (1,779 ) $ (4,625 ) $ (1,744 ) $ (9,317 ) (81 )% Revenues Revenues decreased $40.6 million, or 70%, for the year ended December 31, 2013 as compared to the Pro Forma year ended December 31, 2012, primarily due to the sale of 2GIG on April 1, 2013. Following the 2GIG Sale, we excluded 2GIG's results of operations from our statement of operations. Costs and Expenses Operating expenses decreased $26.4 million, or 69%, for the year ended December 31, 2013 as compared to the Pro Forma year ended December 31, 2012, primarily due to the 2GIG Sale on April 1, 2013. General and administrative expenses decreased $17.9 million, or 77%, for the year ended December 31, 2013 as compared to the Pro Forma year ended December 31, 2012, also primarily due to the 2GIG Sale. Other expenses in the year ended December 31, 2013 primarily represented amortization of intangible assets acquired in the Merger. Year Ended December 31, 2013 compared to the Pro Forma Year Ended December 31, 2012-Consolidated Other Expenses, net Successor Predecessor % Change Period from Period from November 17 January 1 Pro Forma Year Ended through through Year Ended December 31, December 31, November 16, December 31, 2013 Actual vs. 2013 2012 2012 2012 Pro Forma 2012 (unaudited) Interest expense $ 114,476 $ 12,645 $ 106,620 $ 104,031 10 % Interest income (1,493 ) (4 ) (61 ) (65 ) - Gain on 2GIG Sale (46,866 ) - - - - Other (income) expenses (76 ) 171 122 580 (113 ) Total other expenses, net $ 66,041 $ 12,812 $ 106,681 $ 104,546 (37 )% Interest expense increased $10.4 million, or 10%, for the year ended December 31, 2013 as compared to the Pro Forma year ended December 31, 2012, primarily due to a higher principal balance associated with the May 2013 Notes Offering. During the year ended December 31, 2013, we realized a gain of $46.9 million as a result of the 2GIG Sale. See Note 3 to the accompanying consolidated financial statements for additional information. 32-------------------------------------------------------------------------------- Table of Contents Income Tax From Continuing Operations Successor Predecessor % Change Period from Period from November 17 January 1 Pro Forma Year Ended through through Year Ended December 31, December 31, November 16, December 31, 2013 Actual vs. 2013 2012 2012 2012 Pro Forma 2012 (unaudited)Income tax expense (benefit) $ 3,592 $ (10,903 ) $ 4,923 $ (5,980 ) (160 )% Income tax expense was $3.6 million for the year ended December 31, 2013 as compared to an income tax benefit of $6.0 million for the Pro Forma year ended December 31, 2012. The increase of approximately $9.6 million, or 160%, was primarily related to the elimination of 2GIG's deferred tax liability in conjunction with the 2GIG Sale. As a result, after the 2GIG Sale, we were in a net deferred tax asset position and recorded an off-setting valuation allowance. Pro Forma Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011-Vivint Revenues The following table provides the significant components of our revenue for the Pro Forma Year ended December 31, 2012, the Successor Period ended December 31, 2012, the Predecessor Period ended November 16, 2012 and the year ended December 31, 2011 (dollars in thousands): Successor Predecessor % Change Period from Period from Pro Forma November 17 January 1 Year Ended through through Year Ended Pro Forma December 31, December 31, November 16, December 31, 2012 vs. 2011 2012 2012 2012 2011 Actual (unaudited) Monitoring revenue $ 372,841 $ 48,984 $ 324,691 $ 287,778 30 % Service and other sales revenue 17,887 1,796 16,091 11,215 59 Activation fees 1,353 11 5,331 4,890 (72 ) Contract sales 157 - 157 8,539 (98 ) Total revenues $ 392,238 $ 50,791 $ 346,270 $ 312,422 26 % Total revenues increased $79.8 million, or 26%, for the Pro Forma Year ended December 31, 2012, as compared with 2011, primarily due to the growth in total Monitoring Revenue, which increased $85.1 million, or 30%. The year over year increase in monitoring revenue resulted from $69.6 million of fees from a net increase of approximately 110,000 in our subscriber base and a $15.1 million increase from continued growth in the percentage of our subscribers contracting for new products and service packages for the Pro Forma Year ended December 31, 2012. Service and other sales revenue increased $6.7 million, or 59%, for the Pro Forma Year ended December 31, 2012 as compared with 2011. This growth was primarily due to an increase of $6.4 million in upgrade revenue related to subscriber service upgrades and purchases of additional equipment during the Pro Forma Year ended December 31, 2012. Activation fees decreased $3.5 million, or 72%, for the Pro Forma Year ended December 31, 2012, as compared with 2011, primarily due to the adjustment to reduce the fair value of deferred activation fees to zero in conjunction with the Transactions. The Pro Forma Year includes only revenue from activation fees billed during 2012. We did not have material contract sales to third parties during the Pro Forma Year ended December 31, 2012. Costs and Expenses Successor Predecessor % Change Period from Period from Pro Forma November 17 January 1 Year Ended through through Year Ended Pro Forma December 31, December 31, November 16, December 31, 2012 vs. 2011 2012 2012 2012 2011 Actual (unaudited) (dollars in thousands) Operating expenses $ 128,802 $ 16,115 $ 114,258 $ 106,348 21 % Cost of contract sales 95 - 95 6,425 (99 ) Selling expenses 78,075 12,284 91,559 48,978 59 General and administrative 52,225 6,946 78,772 37,561 39 Transaction related expenses - 28,118 22,219 - - Depreciation and amortization 167,252 10,896 80,616 68,661 144 Total costs and expenses $ 426,449 $ 74,359 $ 387,519 $ 267,973 59 % 33 -------------------------------------------------------------------------------- Table of Contents Operating expenses increased $22.5 million, or 21%, for the Pro Forma Year ended December 31, 2012, as compared with 2011, primarily to support the growth in our subscriber base. This increase was principally comprised of $5.8 million in personnel costs within our monitoring, customer support and field service functions and a $7.8 million increase in cellular communications fees related to our monitoring services resulting from our increased subscriber base and the higher percentage of subscribers contracting for additional services above our interactive securities package. We did not have material contract sales to third parties during the Pro Forma Year ended December 31, 2012. Selling expenses, net of capitalized subscriber acquisition costs, increased $29.1 million, or 59%, for the Pro Forma Year ended December 31, 2012, as compared with 2011, primarily due to $10.6 million in personnel costs to support the increase in direct-to-home subscriber contracts, $8.3 million of non-cash compensation charges related to incentive plans and continued growth in our inside sales organization, along with a $11.6 million increase in advertising costs, primarily in support of our inside sales. These increases were partially offset by a $2.3 million decrease in sales representative housing costs. General and administrative expenses increased $14.7 million, or 39%, for the Pro Forma Year ended December 31, 2012, as compared with 2011, primarily due to $6.3 million in personnel costs to support the growth in our business, $2.7 million related to the Blackstone monitoring fee and $2.2 million of bad debt associated with our increased revenues. We incurred costs associated with the Transactions of approximately $28.1 million in the Successor Period ended December 31, 2012 and approximately $22.2 million in the Predecessor Period from January 1, 2012 through November 16, 2012. These costs primarily consist of accounting, investment banking, legal and professional fees associated with the Transactions and are included in the accompanying consolidated statements of operations included elsewhere in this annual report on Form 10-K. Depreciation and amortization increased $98.6 million, or 144%, for the Pro Forma Year ended December 31, 2012, as compared with 2011. The increase was primarily due to amortization of intangible assets acquired in the Transactions. See Note 10 of our Consolidated Financial Statements for additional information. Pro Forma Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011-2GIG All intercompany revenue and expenses between Vivint and 2GIG have been eliminated in consolidation and from the amounts presented below. Successor Predecessor % Change Period from Period from Pro Forma November 17 January 1 Year Ended through through Year Ended Pro Forma December 31, December 31, November 16, December 31, 2012 vs. 2011 2012 2012 2012 2011 Actual (unaudited) (dollars in thousands) Total revenue $ 58,115 $ 6,815 $ 51,300 $ 27,526 111 % Operating expenses (38,035 ) (4,584 ) (31,539 ) (20,215 ) 88 General and administrative (23,339 ) (2,575 ) (21,200 ) (12,949 ) 80 Transaction related expenses - (3,767 ) (1,242 ) - - Other (expenses) income (6,058 ) (514 ) 937 203 (3,084 ) Loss from operations $ (9,317 ) $ (4,625 ) $ (1,744 ) $ (5,435 ) 71 % Revenues Revenues increased $30.6 million, or 111%, for the Pro Forma Year ended December 31, 2012, as compared with 2011, primarily due to continued growth in product shipments to third party customers. Costs and Expenses Operating expenses increased $17.8 million, or 88%, for the Pro Forma Year ended December 31, 2012, as compared with 2011, primarily due to the equipment costs associated with the increased product shipments. General and administrative expenses increased $10.4 million, or 80%, for the Pro Forma Year ended December 31, 2012, as compared with 2011, primarily due to an increase of $3.0 million in personnel costs associated with higher headcount in the Pro Forma Year ended December 31, 2012 to support the growth in our business, an increase of $2.3 million in legal settlement expense, an increase of $1.5 million of costs and materials related to R&D and an increase of $0.8 million in commissions. We incurred costs associated with the Transactions of approximately $3.8 million in the Successor Period ended December 31, 2012 and approximately $1.2 million in the Predecessor Period from January 1, 2012 through November 16, 2012. These costs primarily consist of accounting, investment banking, legal and professional fees associated with the Transactions and are included in the accompanying consolidated statements of operations included elsewhere in this annual report on Form 10-K. Other expenses in the Pro Forma Year ended December 31, 2012 primarily represented amortization of intangible assets acquired in the Merger. 34-------------------------------------------------------------------------------- Table of Contents Pro Forma Year Ended December 31, 2012 Compared to the Year Ended December 31, 2011-Consolidated Other Expenses, net Successor Predecessor % Change Period from Period from Pro Forma November 17 January 1 Year Ended through through Year Ended Pro Forma December 31, December 31, November 16, December 31, 2012 vs. 2011 2012 2012 2012 2011 Actual (unaudited) (dollars in thousands) Interest expense $ 104,031 $ 12,645 $ 106,620 $ 102,069 2 % Interest income (65 ) (4 ) (61 ) (214 ) 70 Other expenses 580 171 122 386 50 Total other expenses $ 104,546 $ 12,812 $ 106,681 $ 102,241 2 % Interest expense increased $2.0 million, or 2%, for the Pro Forma Period ended December 31, 2012, as compared with 2011, primarily due to an overall higher amount of outstanding debt throughout the Pro Forma Period ended December 31, 2012, as compared with 2011 and recognition in the Successor Period ended December 31, 2012 of $1.0 million of deferred financing costs associated with the Transactions. Income Tax From Continuing Operations Successor Predecessor % Change Period from Period from Pro Forma November 17 January 1 Year Ended through through Year Ended Pro Forma December 31, December 31, November 16, December 31, 2012 vs. 2011 2012 2012 2012 2011 Actual (unaudited) (dollars in thousands) Income tax (benefit) expense $ (5,980 ) $ (10,903 ) $ 4,923 $ (3,739 ) 60 % The income tax (benefit) increased $2.2 million, or 60%, for the Pro Forma Period ended December 31, 2012 compared with 2011. The increase was primarily due to the Successor Period tax benefit, which resulted from our net deferred tax liability position after recording the tax effect of the Transactions. 35-------------------------------------------------------------------------------- Table of Contents Unaudited Quarterly Results of Operations The following tables present our unaudited quarterly consolidated results of operations for the four Successor quarters ended December 31, 2013, the Successor Period from November 17, 2012 through December 31, 2012, the Predecessor Period from October 1, 2012 through November 16, 2012 and the three Predecessor quarters ended September 30, 2012. This unaudited quarterly consolidated information has been prepared on the same basis as our audited consolidated financial statements and, in the opinion of management, the statement of operations data includes all adjustments, consisting of normal recurring adjustments, necessary for the fair presentation of the results of operations for these periods. You should read these tables in conjunction with our audited consolidated financial statements and related notes located elsewhere in this annual report on Form 10-K. The results of operations for any quarter are not necessarily indicative of the results of operations for a full year or any future periods. Successor Three Months Ended December 31, September 30, June 30, March 31, 2013 2013 2013 2013 (in thousands) Statement of operations data Revenue $ 132,711 $ 129,503 $ 114,252 $ 124,442 Loss from operations (14,470 ) (8,689 ) (23,729 ) (7,992 ) Net loss (37,172 ) (34,905 ) (21,527 ) (30,909 ) Successor Predecessor Period Period from November 17, from October 1, Three Months Ended through through December 31, November 16, September 30, June 30, March 31, 2012 2012 2012 2012 2012 (in thousands) (in thousands) Statement of operations data Revenue $ 57,606 $ 63,093 $ 124,561 $ 111,820 $ 98,095 (Loss) income from operations (28,193 ) (98,571 ) 21,948 14,548 19,083 Net loss from continuing operations (30,102 ) (114,990 ) (10,515 ) (19,008 ) (10,085 ) Income (loss) from discontinued operations - - - 96 (335 ) Net loss (30,102 ) (110,114 ) (12,212 ) (22,581 ) (8,610 ) Liquidity and Capital Resources Our primary source of liquidity has historically been cash from operations and borrowing availability under our revolving credit facility. As of December 31, 2013, we had $261.9 million of cash and $197.8 million of availability under our revolving credit facility (after giving effect to $2.2 million of letters of credit outstanding). Cash Flow and Liquidity Analysis Significant factors influencing our liquidity position include cash flows generated from monitoring and other fees received from the subscribers we service and the level of investment in capitalized subscriber acquisition costs. Our cash flows provided by operating activities include cash received from RMR, along with upfront activation fees, upgrade and other service fees. Cash used in operating activities includes the cash costs to monitor and service those subscribers, and certain costs, principally marketing and the portion of subscriber acquisition costs that are expensed and general and administrative costs. Except for the year ended December 31, 2011 and the Successor Period from November 17 through December 31, 2012, we have historically generated, and expect to continue generating, positive cash flows from operating activities. The net cash used in operating activities for the year ended December 31, 2011, was primarily due to higher than normal inventories at the end of the year. Historically, we financed the subscriber acquisition costs through our operating cash flows, the issuance of debt, and to a lesser extent, through the issuance of equity and contract sales to third parties. The direct-to-home sales are seasonal in nature. We make investments in the recruitment of our direct-to-home sales force and the inventory for the April through August sales period prior to each sales season. We experience increases in subscriber acquisition costs, as well as costs to support the sales force throughout North America, during this time period. 36-------------------------------------------------------------------------------- Table of Contents The following table provides a summary of cash flow data (dollars in thousands): Successor Predecessor Period from Period from November 17, January 1, Year ended through through Year ended December 31, December 31, November 16, December 31, 2013 2012 2012 2011Net cash provided by (used in) operating activities $ 79,425 $ (25,243 ) $ 95,371 $ (36,842 ) Net cash used in investing activities (176,477 ) (1,949,454 ) (270,094 ) (207,603 ) Net cash provided by financing activities 350,986 1,982,746 189,352 244,178 Cash Flows from Operating Activities We generally reinvest the cash flows from operating activities into our business, primarily to maintain and grow our subscriber base and to expand our infrastructure to support this growth and enhance our existing, and develop new, service offerings. These investments are focused on generating new subscribers, increasing the revenue from our existing subscriber base, enhancing the overall quality of service provided to our subscribers, increasing the productivity and efficiency of our workforce and back-office functions necessary to scale our business. For the year ended December 31, 2013, net cash provided by operating activities was $79.4 million. This cash was primarily generated from a net loss of ($124.5) million, adjusted for $206.1 million in non-cash amortization, depreciation and stock-based compensation, a $22.0 million increase in accrued expenses and other liabilities, primarily related to management bonus and incentive plans and contingent liabilities, and a $24.4 million increase in fees paid by subscribers in advance of when the associated revenue is recognized. This was partially offset by an $8.4 million increase in inventories due to the seasonality of our inventory purchases and usage. For the Successor Period ended December 31, 2012, net cash used in operating activities was $25.2 million. This cash used was primarily from a net loss of ($30.1) million, adjusted for $12.4 million in non-cash amortization and depreciation, a $13.1 million change in deferred income taxes and a $14.3 million increase in accrued expenses and other liabilities. For the Predecessor Period from January 1, 2012 through November 16, 2012, net cash provided by operating activities was $95.4 million. This cash was primarily generated from a net loss of ($154.8) million, including discontinued operations, adjusted for $88.7 million in non-cash amortization, depreciation and stock-based compensation expenses, a $109.5 million increase in accrued expenses and other liabilities, principally related to bonuses and other payments to employees directly related to the Transactions and commissions associated with direct-to-home sales. Operating cash was also generated from $26.3 million in fees paid by subscribers in advance of when the associated revenue is recognized. During 2011, we used $36.8 million of cash in operating activities. This use of cash was primarily related to a net loss of ($62.4) million, including discontinued operations, $42.3 million in increased inventories, a $6.0 million increase in prepaid expenses and other current assets and an $18.4 million decrease in accrued expenses and other liabilities. This was partially offset by $77.6 million in non-cash amortization, depreciation and stock-based compensation expenses and $13.7 million in fees paid by subscribers in advance of when the associated revenue is recognized and an $8.1 million increase in accounts payable. Cash Flows from Investing Activities Historically, our investing activities have primarily consisted of capitalized subscriber acquisition costs and capital expenditures. Capital expenditures primarily consist of periodic additions to property and equipment to support the growth in our business. For the year ended December 31, 2013, net cash used in investing activities was $176.5 million, consisting primarily of $298.6 million of capitalized subscriber acquisition costs, $8.7 million of capital expenditures and $4.3 million of intangible asset acquisition costs, partially offset by $144.8 million of proceeds from the 2GIG Sale. For the Successor Period ended December 31, 2012 and the Predecessor Period from January 1, 2012 through November 16, 2012, net cash used in investing activities was $1,949.5 million and $270.1 million, respectively. In the Successor Period, our cash used in investing activities primarily consisted of $1,915.5 million of cash used to complete the Transactions, capitalized subscriber acquisition costs of $12.9 million and capital expenditures of $1.5 million. In the Predecessor Period, cash used in investing activities primarily consisted of $263.7 million of capitalized subscriber acquisition costs and capital expenditures of $5.9 million. We used $207.6 million of cash in investing activities during 2011, which primarily related to $203.6 million in capitalized subscriber acquisition costs and $6.5 million of capital expenditures, partially offset by a $2.3 million reduction in other long term assets. Cash Flows from Financing Activities Historically, our cash flows from financing activities were primarily to fund the portion of upfront costs associated with generating new subscribers that are not covered through our operating cash flows. For the year ended December 31, 2013, net cash provided by financing activities was $351.0 million from the issuance of $457.3 million of senior unsecured notes payable, $22.5 million of borrowings from our revolving line of credit, partially offset by $60.0 million of payments of dividends from the 2GIG sale proceeds and $50.5 million of repayments of our revolving line of credit. For the Successor Period ended December 31, 2012 and the Predecessor Period from January 1, 2012 through November 16, 2012, net cash provided by financing activities was $1,982.7 million and $189.4 million, respectively. In the Successor Period, our net cash provided by financing activities was primarily from $1,305.0 million of proceeds from the issuance of $925.0 million aggregate principal amount of 2019 notes and $380.0 million aggregate principal amount of 2020 notes, borrowings under our revolving credit facility of $28.0 million and $708.5 million from the issuance of our common stock in connection with the Transactions, partially offset by $58.4 million in payments of deferred financing costs. For the Predecessor Period, our net cash provided by financing activities primarily consisted of $116.2 million of proceeds under our previous credit agreement and $105.0 million of borrowings under our revolving credit facility, partially offset by $42.2 million of repayments of the revolving credit facility, $6.7 million in payments of deferred financing costs and $4.1 million in repayments of capital lease obligations. 37-------------------------------------------------------------------------------- Table of Contents Net cash provided by financing activities in 2011 was $244.2 million, comprised of $199.6 million in net proceeds from borrowings under our historical revolving credit facility, and $50.3 million from the issuance of preferred stock and warrants, partially offset by $2.4 million repayment of capital lease obligations and $2.0 million payments of deferred financing costs. Long-Term Debt Following the Transactions, we remain a highly leveraged company with significant debt service requirements. As of December 31, 2013, we had approximately $1,755.0 million of total debt outstanding, consisting of $925.0 million of outstanding 2019 notes and $830.0 million of outstanding 2020 notes, with $197.8 million of availability (after giving effect to $2.2 million of letters of credit outstanding). Revolving Credit Facility In connection with the Transactions, we entered into a $200.0 million senior secured revolving credit facility, with a five year maturity, of which $197.8 million was undrawn and available as of December 31, 2013 (after giving effect to $2.2 million of outstanding letters of credit). In addition, we may request one or more term loan facilities, increased commitments under the revolving credit facility or new revolving credit commitments, in an aggregate amount not to exceed $225.0 million. Availability of such incremental facilities and/or increased or new commitments will be subject to certain customary conditions. On June 28, 2013, we amended and restated the credit agreement to provide for a new repriced tranche of revolving credit commitments with a lower interest rate. Nearly all of the existing tranches of revolving credit commitments was terminated and converted into the repriced tranche, with the unterminated portion of the existing tranche continuing to accrue interest at the original higher rate. Borrowings under the revolving credit facility bear interest at a rate per annum equal to an applicable margin plus, at our option, either (1) the base rate determined by reference to the highest of (a) the Federal Funds rate plus 0.50%, (b) the prime rate of Bank of America, N.A. and (c) the LIBOR rate determined by reference to the costs of funds for U.S. dollar deposits for an interest period of one month, plus 1.00% or (2) the LIBOR rate determined by reference to the London interbank offered rate for dollars for the interest period relevant to such borrowing. The applicable margin for base rate-based borrowings (1)(a) under the repriced tranche is currently 2.0% per annum and (b) under the former tranche is currently 3.0% and (2)(a) the applicable margin for LIBOR rate-based borrowings (a) under the repriced tranche is currently 3.0% per annum and (b) under the former tranche is currently 4.0%. The applicable margin for borrowings under the revolving credit facility is subject to one step-down of 25 basis points based on our consolidated first lien net leverage ratio at the end of each fiscal quarter, commencing with delivery of our consolidated financial statements for the first full fiscal quarter ending after the closing date. In addition to paying interest on outstanding principal under the revolving credit facility, we are required to pay a quarterly commitment fee (which will be subject to one step-down based on our consolidated first lien net leverage ratio) to the lenders under the revolving credit facility in respect of the unutilized commitments thereunder. We also pay customary letter of credit and agency fees. 2019 Notes In connection with the Transactions, we issued $925.0 million of the 2019 notes. Interest on the 2019 notes is payable semi-annually in arrears on each June 1 and December 1, commencing June 1, 2013. We may, at our option, redeem at any time and from time to time prior to December 1, 2015, some or all of the 2019 notes at 100% of their principal amount thereof plus accrued and unpaid interest to the redemption date plus a "make-whole premium." Prior to December 1, 2015, during any 12 month period, we also may, at our option, redeem at any time and from time to time up to 10% of the aggregate principal amount of the issued 2019 notes at a price equal to 103% of the principal amount thereof, plus accrued and unpaid interest. From and after December 1, 2015, we may, at our option, redeem at any time and from time to time some or all of the 2019 notes at 104.781%, declining ratably on each anniversary thereafter to par from and after December 1, 2018, in each case, plus any accrued and unpaid interest to the date of redemption. In addition, on or prior to December 1, 2015, we may, at our option, redeem up to 35% of the aggregate principal amount of the 2019 notes with the proceeds from certain equity offerings at 106.37%, plus accrued and unpaid interest to the date of redemption. 2020 Notes In connection with the Transactions, we issued $380.0 million of outstanding 2020 notes. Interest on the outstanding 2020 notes is payable semi-annually in arrears on each June 1 and December 1, commencing June 1, 2013. In May 2013, we issued an additional $200.0 million of outstanding 2020 notes under the indenture dated as of November 16, 2012. In December 2013, we issued an additional $250.0 million of outstanding 2020 notes under the indenture dated as of November 16, 2012. We may, at our option, redeem at any time and from time to time prior to December 1, 2015, some or all of the 2020 notes at 100% of their principal amount thereof plus accrued and unpaid interest to the redemption date plus a "make-whole premium." From and after December 1, 2015, we may, at our option, redeem at any time and from time to time some or all of the 2020 notes at 106.563%, declining ratably on each anniversary thereafter to par from and after December 1, 2018, in each case, plus any accrued and unpaid interest to the date of redemption. In addition, on or prior to December 1, 2015, we may, at our option, redeem up to 35% of the aggregate principal amount of the 2020 notes with the proceeds from certain equity offerings at 108.75%, plus accrued and unpaid interest to the date of redemption. Guarantees and Security All of our obligations under the revolving credit facility, the 2019 notes and the 2020 notes are guaranteed by Parent Guarantor and each of our existing and future material wholly-owned U.S. restricted subsidiaries to the extent such entities guarantee indebtedness under the revolving credit facility or our other indebtedness. See Note 18 of our Consolidated Financial Statements included elsewhere in this annual report on Form 10-K for additional financial information regarding guarantors and non-guarantors. The obligations under the revolving credit facility and the 2019 notes are secured by a security interest in (i) substantially all of the present and future tangible and intangible assets of the Issuer and the guarantors, including without limitation equipment, subscriber contracts and communication paths, intellectual property, fee-owned real property, general intangibles, investment property, material intercompany notes and proceeds of the foregoing, subject to permitted liens and other customary exceptions, (ii) substantially all personal property of the Issuer and the guarantors consisting of accounts receivable arising from the sale of inventory and other goods and services (including related contracts and contract rights, inventory, cash, deposit accounts, other bank accounts and securities accounts), inventory and intangible assets to the extent attached to the foregoing books and records of the Issuer and the guarantors, and the proceeds thereof, subject to permitted liens and other customary exceptions, in each case held by the Issuer and the guarantors and (iii) a pledge of all of the Capital Stock of the Issuer, each of its subsidiary guarantors and each restricted subsidiary of the Issuer and its subsidiary guarantors, in each case other than excluded assets and subject to the limitations and exclusions provided in the applicable collateral documents. 38 -------------------------------------------------------------------------------- Table of Contents Under the terms of the applicable security documents and intercreditor agreement, the proceeds of any collection or other realization of collateral received in connection with the exercise of remedies will be applied first to repay amounts due under the revolving credit facility, and up to an additional $150.0 million of "superpriority" obligations that we may incur in the future, before the holders of the 2019 notes receive any such proceeds. Debt Covenants The credit agreement governing the revolving credit facility and the indentures governing the notes contain a number of covenants that, among other things, restrict, subject to certain exceptions, our and our restricted subsidiaries' ability to: • incur or guarantee additional debt or issue disqualified stock or preferred stock; • pay dividends and make other distributions on, or redeem or repurchase, capital stock; • make certain investments; • incur certain liens; • enter into transactions with affiliates; • merge or consolidate; • enter into agreements that restrict the ability of restricted subsidiaries to make dividends or other payments to the Issuer; • designate restricted subsidiaries as unrestricted subsidiaries; and • transfer or sell assets. The credit agreement governing the revolving credit facility and the indentures governing the notes contain change of control provisions and certain customary affirmative covenants and events of default. As of December 31, 2013, we were in compliance with all restrictive covenants related to our long-term obligations. Subject to certain exceptions, the credit agreement governing the revolving credit facility, the indentures governing the notes permit us and our restricted subsidiaries to incur additional indebtedness, including secured indebtedness. Our future liquidity requirements will be significant, primarily due to debt service requirements. The actual amounts of borrowings under the revolving credit facility will fluctuate from time to time. We believe that amounts available through our revolving credit facility and incremental facilities will be sufficient to meet our operating needs for the next twelve months, including working capital requirements, capital expenditures, debt repayment obligations and potential new acquisitions. As market conditions warrant, we and our major equity holders, including the Sponsor and its affiliates, may from time to time, seek to repurchase debt securities that we have issued or loans that we have borrowed, including the notes and borrowings under our revolving credit facility, in privately negotiated or open market transactions, by tender offer or otherwise. Covenant Compliance Under the indentures governing our notes and the credit agreement governing our revolving credit facility, our ability to engage in activities such as incurring additional indebtedness, making investments, refinancing certain indebtedness, paying dividends and entering into certain merger transactions is governed, in part, by our ability to satisfy tests based on Adjusted EBITDA. "Adjusted EBITDA" is defined as net income (loss) before interest expense (net of interest income), income and franchise taxes and depreciation and amortization (including amortization of capitalized subscriber acquisition costs), further adjusted to exclude the effects of certain contract sales to third parties, non-capitalized subscriber acquisition costs, stock based compensation, the historical results of Solar and certain unusual, non-cash, non-recurring and other items permitted in certain covenant calculations under the indentures governing our notes and the credit agreement governing our revolving credit facility. We believe that the presentation of Adjusted EBITDA is appropriate to provide additional information to investors about the calculation of, and compliance with, certain financial covenants in the indentures governing our notes and the credit agreement governing our revolving credit facility. We caution investors that amounts presented in accordance with our definition of Adjusted EBITDA may not be comparable to similar measures disclosed by other issuers, because not all issuers and analysts calculate Adjusted EBITDA in the same manner. Adjusted EBITDA is not a measurement of our financial performance under GAAP and should not be considered as an alternative to net income (loss) or any other performance measures derived in accordance with GAAP or as an alternative to cash flows from operating activities as a measure of our liquidity. 39-------------------------------------------------------------------------------- Table of Contents The following table sets forth a reconciliation of net loss before non-controlling interests to Adjusted EBITDA (in thousands): Successor Combined Successor Predecessor Period from Period from November 17, January 1, Year ended Year ended through through Year ended December 31, December 31, December 31, November 16, December 31, 2013 2012 2012 2012 2011 Net loss before non-controlling interests $ (124,513 ) $ (184,938 ) $ (30,102 ) $ (154,836 ) $ (62,405 ) Interest expense, net 112,983 119,200 101,855 Other (income) expense (76 ) 293 386 Gain on 2GIG Sale (1) (46,866 ) - - Income tax (benefit) expense 3,592 (5,980 ) (3,739 ) Amortization of capitalized creation costs 22,214 72,186 61,546 Depreciation and amortization (2) 173,292 18,903 6,912 Transaction costs related to 2GIG Sale (3) 5,519 - - Transaction related costs (4) 811 132,360 - Non-capitalized subscriber acquisition costs (5) 100,985 70,362 51,350 Non-cash compensation (6) 1,899 874 475 Adjustment for Solar business (7) - 7,077 385 Other adjustments (8) 42,450 13,641 18,421 Adjusted EBITDA $ 292,290 $ 243,978 $ 175,186 (1) Non-recurring gain on the 2GIG Sale. (2) Excludes loan amortization costs that are included in interest expense. (3) Bonuses and transaction related costs associated with the 2GIG Sale. (4) Reflects total bonus and other payments to employees, and legal and consulting fees to third-parties, directly related to the Transactions. (5) Reflects subscriber acquisition costs that are expensed as incurred because they are not directly related to the acquisition of specific subscribers. Certain other industry participants purchase subscribers through subscriber contract purchases, and as a result, may capitalize the full cost to purchase these subscriber contracts, as compared to our organic generation of new subscribers, which requires us to expense a portion of our subscriber acquisition costs under GAAP. (6) Reflects non-cash compensation costs related to employee and director stock and stock option plans. (7) Reflects the exclusion of Solar results from the time it commenced operations in 2011. (8) Other adjustments represent primarily the following items (in thousands): Successor Combined Predecessor Year ended Year ended Year ended December 31, December 31, December 31, 2013 2012 2011 Product development (a) $ 12,318 $ - $ - Purchase accounting deferred revenue fair value adjustment (b) 6,894 1,606 - Non-cash contingent liabilities 6,500 2,124 - Non-operating legal and professional fees 5,356 554 2,194 Start-up of new strategic initiatives (c) 3,084 - - Monitoring fee (d) 2,918 - - Information technology implementation (e) 1,230 - - Subcontracted monitoring agreement (f) 1,078 - - Solar-business costs (g) 34 4,165 1,371 Discontinued operations (h) - 239 2,917 Benefit from sales of subscriber contracts - - (2,142 ) Securitization transaction costs - - 6,135 Technology licensing disputes (i) - 2,239 964 Rebranding - 1,409 5,762 All other adjustments 3,038 1,305 1,220 Total other adjustments $ 42,450 $ 13,641 $ 18,421 (a) Costs related to the development of future control panels, including associated software. (b) Add back revenue reduction directly related to purchase accounting deferred revenue adjustments. (c) Costs related to the start-up of potential new service offerings and sales channels. (d) Blackstone Management Partners L.L.C monitoring fee (See Note 15 to the accompanying consolidated financial statements). (e) Costs related to the implementation of new information technologies. (f) Run-rate savings from committed future reductions in subcontract monitoring fees. (g) Costs incurred by Vivint on behalf of the Solar business, prior to the Transactions. (h) Costs associated with our Smart Grid business, which discontinued operations in 2011. (i) Settlement costs and reserves associated with technology licensing disputes. Other Factors Affecting Liquidity and Capital Resources Vehicle Leases. We lease, and expect to continue leasing, vehicles primarily for use by our field service technicians. For the most part, these leases have 36 to 48 month durations and we account for them as capital leases. At the end of the lease term for each vehicle, we have the option to either (i) purchase it for the estimated end-of-lease fair market value established at the beginning of the lease term; or (ii) return the vehicle to the lessor to be sold by them and in the event the sale price is less than the estimated end-of-lease fair market value we are responsible for such deficiency. As of December 31, 2013, our total capital lease obligations were $10.5 million, of which $4.2 million is due within the next 12 months. 40 -------------------------------------------------------------------------------- Table of Contents Aircraft Lease. In December 2012, we entered into an aircraft lease agreement for the use of a corporate aircraft, which is accounted for as an operating lease. Upon execution of the lease, we paid a $5.9 million security deposit which is refundable at the end of the lease term. Beginning January 2013, we are required to make 156 monthly rental payments of approximately $83,000 each. We also have the option to extend the lease for an additional 36 months upon expiration of the initial term. The lease agreement also provides us the option to purchase the aircraft on certain specified dates for a stated dollar amount, which represents the current estimated fair value as of the purchase date. Off-Balance Sheet Arrangements Currently we do not engage in off-balance sheet financing arrangements. Contractual Obligations The following table summarizes our contractual obligations as of December 31, 2013. Certain contractual obligations are reflected on our consolidated balance sheet, while others are disclosed as future obligations under GAAP. Payments Due by Period Less than More than Total 1 Year 1 - 3 Years 3 - 5 Years 5 Years (dollars in thousands) Long-term debt obligations (1) $ 1,762,049 $ - $ - $ - $ 1,762,049 Interest on long-term debt (2) 849,531 132,608 265,215 264,074 187,634 Capital lease obligations 10,467 4,393 4,276 1,798 - Operating lease obligations 116,769 8,241 18,769 19,714 70,045 Purchase obligations (3) 6,477 4,051 2,360 66 - Other long-term obligations 3,817 499 875 642 1,801 Total contractual obligations $ 2,749,110 $ 149,792 $ 291,495 $ 286,294 $ 2,021,529 (1) Does not reflect borrowings under our revolving credit facility. Our revolving credit facility provides for availability of $200.0 million and matures November 16, 2017. As of December 31, 2013, there were no amounts outstanding and approximately $197.8 million of availability under our revolving credit facility (after giving effect to $2.2 million of outstanding letters of credit). (2) Represents aggregate interest payments on $925.0 million of the outstanding 2019 notes and $830.0 million of outstanding 2020 notes, as well letter of credit and commitment fees for the unused portion of our revolving credit facility. Does not reflect interest payments on future borrowings under our revolving credit facility. (3) Purchase obligations consist of commitments for purchases of goods and services. We have contingent liabilities related to legal proceedings and other matters arising in the ordinary course of business. Although it is reasonably possible we may incur losses upon conclusion of such matters, an estimate of any loss or range of loss cannot be made at this time. In the opinion of management, it is expected that amounts, if any, which may be required to satisfy such contingencies will not be material in relation to the accompanying consolidated financial statements. |