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LIFELOCK, INC. - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion of our financial condition and results of operations in conjunction with the condensed consolidated financial statements and the notes thereto included elsewhere in this Quarterly Report on Form 10-Q and with our audited consolidated financial statements included in our Form 10-K/A for the fiscal year ended December 31, 2013. This Quarterly Report on Form 10-Q contains "forward-looking statements" that involve substantial risks and uncertainties. The statements contained in this Quarterly Report on Form 10-Q that are not purely historical are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Exchange Act, including, but not limited to, statements regarding our expectations, beliefs, intentions, strategies, future operations, future financial position, future revenue, projected expenses, and plans and objectives of management. In some cases, you can identify forward-looking statements by terms such as "anticipate," "believe," "estimate," "expect," "intend," "may," "might," "plan," "project," "will," "would," "should," "could," "can," "predict," "potential," "continue," "objective," or the negative of these terms, and similar expressions intended to identify forward-looking statements. However, not all forward-looking statements contain these identifying words. These forward-looking statements reflect our current views about future events and involve known risks, uncertainties, and other factors that may cause our actual results, levels of activity, performance, or achievement to be materially different from those expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" included in this Quarterly Report on Form 10-Q, our Form 10-K/A, and our Quarterly Report on Form 10-Q/A for the fiscal quarter ended June 30, 2014. Furthermore, such forward-looking statements speak only as of the date on which they are made. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. Restatement As discussed in the Explanatory Note to this Form 10-Q and in Note 2 to the accompanying unaudited condensed consolidated financial statements, we are restating our unaudited condensed consolidated financial statements for the three- and nine-month periods ended September 30, 2013. The following discussion and analysis of our financial condition and results of operations incorporates the restated amounts. Overview We are a leading provider of proactive identity theft protection services for consumers and consumer risk management services for enterprises. We protect our members by constantly monitoring identity-related events, such as new account openings and credit-related applications. If we detect that a member's personally identifiable information is being used, we offer notifications and alerts, including proactive, near real-time, actionable alerts that provide our members peace of mind that we are monitoring use of their identity and allow our members to confirm valid or unauthorized identity use. If a member confirms that the use of his or her identity is unauthorized, we can proactively take actions designed to protect the member's identity. We also provide remediation services to our members in the event that an identity theft actually occurs. We protect our enterprise customers by delivering on-demand identity risk and authentication information about consumers. Our enterprise customers utilize this information in real time to make decisions about opening or modifying accounts and providing products, services, or credit to consumers to reduce financial losses from identity fraud. The foundation of our differentiated services is the LifeLock ecosystem. This ecosystem combines large data repositories of personally identifiable information and consumer transactions, proprietary predictive analytics, and a highly scalable technology platform. Our members and enterprise customers enhance our ecosystem by continually contributing to the identity and transaction data in our repositories. We apply predictive analytics to the data in our repositories to provide our members and enterprise customers actionable intelligence that helps protect against identity theft and identity fraud. As a result of our combination of scale, reach, and technology, we believe that we have the most proactive and comprehensive identity theft protection services available, as well as the most recognized brand in the identity theft protection services industry. On December 11, 2013, we acquired mobile wallet innovator Lemon for approximately $42.4 million in cash and launched our new LifeLock Wallet mobile application. On May 16, 2014, we announced that we had determined that certain aspects of the LifeLock Wallet mobile application were not fully compliant with applicable payment card industry (PCI) security standards. As a result, we temporarily suspended the LifeLock Wallet mobile application, and deleted the affected data from our servers, until we can operate the LifeLock Wallet mobile application in accordance with those standards. We have no indication that the data included in the LifeLock Wallet mobile application servers was compromised. The LifeLock Wallet mobile application storage processes are separate and independent from LifeLock's core identity theft protection services business, including the enrollment and related credit card storage processes used in our services. As such, we do not believe the suspension of the LifeLock Wallet mobile application impacted in any manner the core functionality or utility of the identity theft protection services we provide to our members. Those aspects of the LifeLock Wallet mobile application previously identified by us as not meeting applicable PCI security standards have now been confirmed as meeting applicable PCI security standards. On October 29, 2014, we relaunched our LifeLock Wallet mobile 14 -------------------------------------------------------------------------------- application. The LifeLock Wallet mobile application allows consumers to replicate and store a digital copy of their personal wallet contents on their smart device for records backup, as well as mobile use of items such as credit, identification, ATM, insurance, and loyalty cards. The LifeLock Wallet mobile application also offers our members one-touch access to our identity theft protection services. We derive the substantial majority of our revenue from member subscription fees. We also derive revenue from transaction fees from our enterprise customers. At the end of July 2014, we announced the launch of our LifeLock Standard, LifeLock Advantage, and LifeLock Ultimate Plus services. We will also continue to offer our LifeLock Junior services and, on a limited basis and for a limited time in connection with certain of our partnerships, our basic LifeLock, LifeLock Command Center, and LifeLock Ultimate services. We will continue to provide services to our existing members currently enrolled in our basic LifeLock, LifeLock Command Center, and LifeLock Ultimate services. Our consumer services are offered on a monthly or annual subscription basis. Our average revenue per member is lower than our retail list prices due to wholesale or bulk pricing that we offer to strategic partners in our embedded product, employee benefits, and breach distribution channels to drive our membership growth. In our embedded product channel, our strategic partners embed our consumer services into their products and services and pay us on behalf of their customers; in our employee benefit channel, our strategic partners offer our consumer services as a voluntary benefit as part of their employee benefit enrollment process; and in our breach channel, enterprises that have experienced a data breach pay us a fee to provide our services to the victims of the data breach. We also offer special discounts and promotions from time to time to incentivize prospective members to enroll in one of our consumer services. Our members pay us the full subscription fee at the beginning of each subscription period, in most cases by authorizing us to directly charge their credit or debit cards. We initially record the subscription fee as deferred revenue and then recognize it ratably on a daily basis over the subscription period. The prepaid subscription fees enhance our visibility of revenue and allow us to collect cash prior to paying our fulfillment partners. Our enterprise customers pay us based on their monthly volume of transactions with us, with approximately 30% of our enterprise customers committed to monthly transaction minimums. We recognize revenue at the end of each month based on transaction volume for that month and bill our enterprise customers at the conclusion of each month. We have historically invested significantly in new member acquisition and expect to continue to do so for the foreseeable future. Our largest operating expense is advertising for member acquisition, which we record as a sales and marketing expense. This is comprised of radio, television, and print advertisements; direct mail campaigns; online display advertising; paid search and search-engine optimization; third-party endorsements; and education programs. We also pay internal and external sales commissions, which we record as a sales and marketing expense. In general, increases in revenue and cumulative ending members occur during and after periods of significant and effective direct retail marketing efforts. Our revenue grew from $95.7 million for the three-month period ended September 30, 2013 to $123.0 million for the three-month period ended September 30, 2014, an increase of 29%, including year-over-year growth within our consumer segment of 31%. We generated income from operations of $9.5 million and net income of $5.5 million for the three-month period ended September 30, 2014. Our revenue grew from $267.4 million for the nine-month period ended September 30, 2013 to $346.3 million for the nine-month period ended September 30, 2014, an increase of 30%, including year-over-year growth within our consumer segment of 33%. We generated a loss from operations of $0.2 million and a net loss of $0.3 million for the nine-month period ended September 30, 2014. Our Business Model We operate our business and review and assess our operating performance using two reportable segments: our consumer segment and our enterprise segment. We review and assess our operating performance using segment revenue, income (loss) from operations, and total assets. These performance measures include the allocation of operating expenses to our reportable segments based on management's specific identification of costs associated to those segments. Consumer Services We evaluate the lifetime value of a member relationship over its anticipated lifecycle. While we generally incur member acquisition costs in advance of or at the time of the acquisition of the member, we recognize revenue ratably over the subscription period. As a result, a member relationship is not profitable at the beginning of the subscription period even though it is likely to have value to us over the lifetime of the member relationship. 15 -------------------------------------------------------------------------------- When a member's subscription automatically renews in each successive period, the relative value of that member increases because we do not incur significant incremental acquisition costs. We also benefit from decreasing fulfillment and member support costs related to that member, as well as economies of scale in our capital and operating and other support expenditures. Enterprise Services In our enterprise business, the majority of our costs relate to personnel primarily responsible for data analytics, data management, software development, sales and operations, and various support functions. We incur minimal third-party data expenses, as our enterprise customers typically provide us with their customer transaction data as part of our service. New customer acquisition is often a lengthy process requiring significant investment in the sales team, including costs related to detailed retrospective data analysis to demonstrate the return on investment to prospective customers had our services been deployed over a specific period of time. Since most of the expenses in our enterprise business are fixed in nature, as we add new enterprise customers, there are typically modest incremental costs resulting in additional economies of scale. Key Metrics We regularly review a number of operating and financial metrics to evaluate our business, determine the allocation of our resources, measure the effectiveness of our sales and marketing efforts, make corporate strategy decisions, and assess operational efficiencies. Key Operating Metrics The following table summarizes our key operating metrics for the three- and nine-month periods ended September 30: For the Three Months Ended For the Nine Months Ended September 30, September 30, 2014 2013 2014 2013 (in thousands, except percentages (in thousands, except percentages and per member data) and per member data) (Unaudited) (Unaudited) Cumulative ending members 3,524 2,864 3,524 2,864 Gross new members 264 218 912 698 Member retention rate 87.5 % 87.6 % 87.5 % 87.6 % Average cost of acquisition per member (restated as to 2013) $ 184 $ 172 $ 173 $ 167 Monthly average revenue per member $ 11.22 $ 10.48 $ 11.02 $ 10.17 Enterprise transactions 66,104 53,042 173,360 159,850 16 -------------------------------------------------------------------------------- Cumulative ending members. We calculate cumulative ending members as the total number of members at the end of the relevant period. The majority of our members are paying subscribers who have enrolled in our consumer services directly with us on a monthly or annual basis. Our remaining members receive our consumer services through third-party enterprises that pay us directly, often as a result of a breach within the enterprise or by embedding our service within a broader third-party offering or as a benefit to their employees. We monitor cumulative ending members because it provides an indication of the revenue and expenses that we expect to recognize in the future. [[Image Removed]] As of September 30, 2014, we had approximately 3.5 million cumulative ending members, an increase of 23% from September 30, 2013. This increase was driven by several factors, including the success of our marketing campaigns, increased awareness of data breaches, media coverage of identity theft, and our member retention rate. Gross new members. We calculate gross new members as the total number of new members who enroll in one of our consumer services during the relevant period. Many factors may affect the volume of gross new members in each period, including the effectiveness of our marketing campaigns, the timing of our marketing programs, the effectiveness of our strategic partnerships, and the general level of identity theft coverage in the media. We monitor gross new members because it provides an indication of the revenue and expenses that we expect to recognize in the future. For the three-month period ended September 30, 2014, we enrolled approximately 264,000 gross new members, up from approximately 218,000 for the three-month period ended September 30, 2013. For the nine-month period ended September 30, 2014, we enrolled approximately 912,000 gross new members, up from approximately 698,000 for the nine-month period ended September 30, 2013. This increase was driven by the success of our marketing campaigns, the continued success of our premium service offerings, which accounted for more than 40% our gross new members during the three- and nine-month periods ended September 30, 2014, and increased awareness of data breaches and identity theft. Member retention rate. We define member retention rate as the percentage of members on the last day of the prior year who remain members on the last day of the current year, or for quarterly presentations, the percentage of members on the last day of the comparable quarterly period in the prior year who remain members on the last day of the current quarterly period. A number of factors may increase our member retention rate, including increases in the number of members enrolled on an annual subscription, increases in the number of alerts a member receives, and increases in the number of members enrolled through strategic partners with which the member has a strong association. Conversely, factors that may reduce our member retention rate include increases in the number of members enrolled on a monthly subscription and the end of enrollment programs in our embedded product and breach channels. In addition, the length of time a member has been enrolled in one of our services will impact our member retention rate with longer term members having a positive impact. Historically, the member retention rate for our premium services has been lower than the member retention rate for our basic-level services, which we believe is driven primarily by price. 17 -------------------------------------------------------------------------------- [[Image Removed]] As of September 30, 2014, our member retention rate was 87.5%, which was our eighth consecutive quarter above 87%. The year-over -year decrease in retention rate was driven, in part, by the cancellation of breach members who enrolled in previous years and the impact of an increased number of member credit and debit cards that were replaced as a result of large data breaches in the fourth quarter of 2013. Average cost of acquisition per member. We calculate average cost of acquisition per member as our sales and marketing expense for our consumer segment during the relevant period divided by our gross new members for the period. A number of factors may influence this metric, including shifts in the mix of our media spend. For example, when we engage in marketing efforts to build our brand, our cost of acquisition per member increases in the short term with the expectation that it will decrease over the long term. In addition, when we introduce new partnerships in our embedded product channel, such as our partnership with AOL in the fourth quarter of 2011, our average cost of acquisition per member decreases due to the volume of members that enroll in our consumer services in a relatively short period of time. We monitor average cost of acquisition per member to evaluate the efficiency of our marketing programs in acquiring new members. For the three-month period ended September 30, 2014, our average cost of acquisition per member was $184, up from $172 (restated) for the three-month period ended September 30, 2013. For the nine-month period ended September 30, 2014, our average cost of acquisition per member was $173, up from $167 (restated) for the nine-month period ended September 30, 2013. Our member retention rate and the increasing monthly average revenue per member, primarily from the continued penetration of our premium service offerings, results in a higher lifetime value of a member relationship, which enables us to absorb a higher average cost of acquisition per member. Monthly average revenue per member. We calculate monthly average revenue per member as our consumer revenue during the relevant period divided by the average number of cumulative ending members during the relevant period (determined by taking the average of the cumulative ending members at the beginning of the relevant period and the cumulative ending members at the end of each month in the relevant period), divided by the number of months in the relevant period. A number of factors may influence this metric, including whether a member enrolls in one of our premium services; whether we offer the member any promotional discounts upon enrollment; the distribution channel through which we acquire the member, as we offer wholesale pricing in our embedded product, employee benefit, and breach channels; and whether a new member subscribes on a monthly or annual basis, as members enrolling on an annual subscription receive a discount for paying for a year in advance. While our retail list prices have historically remained unchanged, we have seen our monthly average revenue per member increase primarily due to the increased adoption of our higher priced premium services by a greater percentage of our members, a trend we expect to continue. We monitor monthly average revenue per member because it is a strong indicator of revenue in our consumer business and of the performance of our premium services. 18 -------------------------------------------------------------------------------- [[Image Removed]] Our average revenue per member for the three- and nine-month periods ended September 30, 2014 increased approximately 7% and 8% from the three- and nine-month periods ended September 30, 2013, respectively. The increase in our monthly average revenue per member resulted primarily from the continued success of our premium service offerings, which accounted for more than 40% of our gross new members for the three- and nine-month periods ended September 30, 2014. Enterprise transactions. We calculate enterprise transactions as the total number of enterprise transactions processed for either an identity risk or credit risk score during the relevant period. Our enterprise transactions are processed by ID Analytics, which we acquired in the first quarter of 2012. Enterprise transactions have historically been higher in the fourth quarter as the level of credit applications and general consumer spending increases. We monitor the volume of enterprise transactions because it is a strong indicator of revenue in our enterprise business. We processed 66.1 million enterprise transactions for the three-month period ended September 30, 2014, an increase of 25% from the three-month period ended September 30, 2013. We processed 173.4 million enterprise transactions for the nine-month period ended September 30, 2014, an increase of 8% from the nine-month period ended September 30, 2013. There are three main factors impacting the change in enterprise transactions year over year. First, in the three-month period ended September 30, 2013, we had a large telecommunication customer stop scoring its new wireline customers due to low levels of fraud in the business. We were able to reengage and commence scoring a portion of the volume in the nine-month period ended September 30, 2014, resulting in a higher volume of transactions during the three-month period ended September 30, 2014 over the three-month period ended September 30, 2013. However, the transactions scored for this customer during the nine-month period ended September 30, 2014 were lower than the transactions scored during the nine-month period ended September 30, 2013. Second, we have seen a reduction in enterprise transactions related to us giving notice of non-renewal to several customers who compete in our consumer business and allowing such contracts to lapse. Third, offsetting these reductions, we have seen enterprise transactions increase as we continue to add new customers and expand our offerings with our current customer base. Key Financial Metrics The following table summarizes our key financial metrics for the three- and nine-month periods ended September 30: For the Three Months Ended For the Nine Months Ended September 30, September 30, 2014 2013 2014 2013 (in thousands) (in thousands) Consumer revenue $ 116,115 $ 88,386 $ 326,448 $ 246,053 Enterprise revenue 6,916 7,353 19,882 21,300 Total revenue 123,031 95,739 346,330 267,353 Adjusted net income 15,909 11,595 19,455 15,394 Adjusted EBITDA 17,929 12,791 25,255 19,305 Free cash flow 22,653 16,629 61,004 46,563 19 --------------------------------------------------------------------------------Adjusted Net Income Adjusted net income is a non-U.S. GAAP financial measure that we calculate as net income (loss) excluding amortization of acquired intangible assets, share-based compensation, income tax benefits and expenses resulting from changes in our deferred tax assets, and acquisition related expenses. Historically, in calculating adjusted net income, we also excluded changes in fair value of warrant liabilities and change in fair value of embedded derivatives in the periods in which those items occurred. We do not currently have any warrant liabilities or embedded derivatives; accordingly, we will only include those items of income and expense in our reconciliation of adjusted net income for period-over-period comparisons. We have included adjusted net income in this Quarterly Report on Form 10-Q because it is a key measure used by us to understand and evaluate our core operating performance and trends. In particular, the exclusion of certain expenses in calculating adjusted net income can provide a useful measure for period-to-period comparisons of our core business. Accordingly, we believe that adjusted net income provides useful information to investors and others in understanding and evaluating our operating results in the same manner as we do. We believe the exclusion of certain items of income and expense from net income (loss) in calculating adjusted net income is useful because (i) the amount of such income and expense in any specific period may not directly correlate to the underlying operational performance of our business, and/or (ii) such income and expense can vary significantly between periods as a result of new acquisitions and full amortization of previously acquired intangible assets. Our use of adjusted net income has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our operating results as reported under U.S. GAAP. Some of these limitations include the following: · although amortization of intangible assets is a non-cash charge, additional intangible assets may be acquired in the future and adjusted net income does not reflect cash capital expenditure requirements for new acquisitions;· adjusted net income does not reflect the cash requirements for new acquisitions; · adjusted net income does not reflect changes in, or cash requirements for, our working capital needs; · adjusted net income does not consider the potentially dilutive impact of share-based compensation; · adjusted net income does not reflect the deferred income tax benefit from the release of the valuation allowance or income tax expenses which reduce our deferred tax asset for net operating losses or other net changes in deferred tax assets; · adjusted net income does not reflect the expenses incurred for new acquisitions; and · other companies, including companies in our industry, may calculate adjusted net income or similarly titled measures differently, limiting their usefulness as a comparative measure. Because of these limitations, you should consider adjusted net income alongside other financial performance measures, including various cash flow metrics, net income (loss), and our other U.S. GAAP results. The following table presents a reconciliation of net income (loss) to adjusted net income for applicable items of income and expense that impacted each of the periods indicated: For the Three Months Ended For the Nine Months Ended September 30, September 30, 2013 2013 2014 (Restated) 2014 (Restated) (in thousands) (in thousands) Reconciliation of Net Income (Loss) to Adjusted Net Income: Net income (loss) $ 5,450 $ 6,466 $ (343 ) $ 1,479 Amortization of acquired intangible assets 2,231 1,966 6,693 5,898 Share-based compensation 4,302 2,931 13,229 7,933 Deferred income tax benefit 3,926 232 (124 ) 84 Adjusted net income $ 15,909 $ 11,595 $ 19,455 $ 15,394 Adjusted EBITDA Adjusted EBITDA is a non-U.S. GAAP financial measure that we calculate as net income (loss) excluding depreciation and amortization, share-based compensation, interest expense, interest income, other income (expense), income tax (benefit) expense, and acquisition related expenses. Historically, in calculating adjusted EBITDA, we also excluded changes in fair value of warrant liabilities and change in fair value of embedded derivatives in the periods in which those items occurred. We do not currently have any warrant liabilities or embedded derivatives; accordingly, we will only include those items of income and expense in our reconciliation 20 -------------------------------------------------------------------------------- of adjusted EBITDA for period-over-period comparisons. We have included adjusted EBITDA in this Quarterly Report on Form 10-Q because it is a key measure used by us to understand and evaluate our core operating performance and trends, to prepare and approve our annual budget, and to develop short- and long-term operational plans. In particular, the exclusion of certain expenses in calculating adjusted EBITDA can provide a useful measure for period-to-period comparisons of our core business. Additionally, adjusted EBITDA is a key financial measure used in determining management's incentive compensation. Accordingly, we believe that adjusted EBITDA provides useful information to investors and others in understanding and evaluating our operating results in the same manner as we do. We believe the exclusion of certain items of income and expense from net income (loss) in calculating adjusted EBITDA is useful because (i) the amount of such income and expense in any specific period may not directly correlate to the underlying operational performance of our business, and/or (ii) such income and expense can vary significantly between periods as a result of new acquisitions and full amortization of previously acquired intangible assets. Our use of adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our operating results as reported under U.S. GAAP. Some of these limitations include the following: · although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements; · adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs; · adjusted EBITDA does not consider the potentially dilutive impact of share-based compensation; · adjusted EBITDA does not reflect cash interest income or expense; · adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us; · adjusted EBITDA does not reflect the expenses incurred for new acquisitions; and · other companies, including companies in our industry, may calculate adjusted EBITDA or similarly titled measures differently, limiting their usefulness as a comparative measure. Because of these limitations, you should consider adjusted EBITDA alongside other financial performance measures, including various cash flow metrics, net income (loss), and our other U.S. GAAP results. The following table presents a reconciliation of net income (loss) to adjusted EBITDA for applicable items of income and expense that impacted each of the periods indicated: For the Three Months Ended For the Nine Months Ended September 30, September 30, 2013 2013 2014 (Restated) 2014 (Restated) (in thousands) (in thousands) Reconciliation of Net Income (Loss) to Adjusted EBITDA: Net income (loss) $ 5,450 $ 6,466 $ (343 ) $ 1,479 Depreciation and amortization 4,094 3,124 12,259 9,484 Share-based compensation 4,302 2,931 13,229 7,933 Interest expense 89 82 264 228 Interest income (73 ) (29 ) (189 ) (75 ) Other expense 134 7 151 11 Income tax (benefit) expense 3,933 210 (116 ) 245 Adjusted EBITDA $ 17,929 $ 12,791 $ 25,255 $ 19,305 Free Cash Flow Free cash flow is a non-U.S. GAAP financial measure that we calculate as net cash provided by operating activities less net cash used in investing activities for acquisitions of property and equipment. We use free cash flow as a measure of our operating performance; for planning purposes, including the preparation of our annual operating budget; to allocate resources to enhance the financial performance of our business; to evaluate the effectiveness of our business strategies; to provide consistency and comparability with past financial performance; to determine capital requirements; to facilitate a comparison of our results with those of other companies; and in communications with our board of directors concerning our financial performance. We use free cash flow to evaluate our business because, although it is similar to net cash provided by operating activities, we believe it typically presents a more conservative measure of cash flow as purchases of property and equipment are necessary 21 -------------------------------------------------------------------------------- components of ongoing operations. We believe that this non-U.S. GAAP financial measure is useful in evaluating our business because free cash flow reflects the cash surplus available to fund the expansion of our business after payment of capital expenditures relating to the necessary components of ongoing operations. We also believe that the use of free cash flow provides consistency and comparability with our past financial performance, facilitates period-to-period comparisons of operations, and also facilitates comparisons with other companies, many of which use similar non-U.S. GAAP financial measures to supplement their U.S. GAAP results. Although free cash flow is frequently used by investors in their evaluations of companies, free cash flow has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our operating results as reported under U.S. GAAP. Some of these limitations include the following: · free cash flow does not reflect our future requirements for contractual commitments to third-party providers; · free cash flow does not reflect the non-cash component of employee compensation or depreciation and amortization of property and equipment; and · other companies, including companies in our industry, may calculate free cash flow or similarly titled measures differently, limiting their usefulness as comparative measures. Because of these limitations, you should consider free cash flow alongside other financial performance measures, including net cash provided by operating activities, net income (loss), and our other U.S. GAAP results. The following table presents a reconciliation of net cash provided by operating activities to free cash flow for each of the periods indicated: For the Three Months Ended For the Nine Months Ended September 30, September 30, 2014 2013 2014 2013 (in thousands) (in thousands) Reconciliation of Net Cash Provided By Operating Activities to Free Cash Flow: Net cash provided by operating activities $ 26,118 $ 18,241 $ 72,131 $ 51,827 Acquisitions of property and equipment (3,465 ) (1,612 ) (11,127 ) (5,264 ) Free cash flow $ 22,653 $ 16,629 $ 61,004 $ 46,563 Factors Affecting Our Performance Customer acquisition costs. We expect to continue to make significant expenditures to grow our member and enterprise customer bases. Our average cost of acquisition per member and the number of new members we generate depends on a number of factors, including the effectiveness of our marketing campaigns, changes in cost of media, the competitive environment in our markets, the prevalence of identity theft issues in the media, publicity about our company, and the level of differentiation of our services. Shifts in the mix of our media spend also influence our member acquisition costs. For example, when we engage in marketing efforts to build our brand, our member acquisition costs increase in the short term with the expectation that they will decrease over the long term. We also continually test new media outlets, marketing campaigns, and call center scripting, each of which impacts our average cost of acquisition per member. In addition, given the past success of our premium services, we expect to be able to absorb a higher average cost of acquisition per member and still recognize value over the lifetime of our member relationships. Mix of members by services, billing cycle, and distribution channel. Our performance is affected by the mix of members subscribing to our various consumer services, by billing cycle (annual versus monthly), and by the distribution channel through which we acquire the member. Our adjusted EBITDA, adjusted net income, free cash flow, and average cost of acquisition per member are all affected by this mix. We have seen a recent shift to more monthly members, in large part due to the increase in the number of members enrolling through our embedded product and employee benefits channels in which our members enroll on a monthly basis. We also have seen an increase in the number of members enrolling in our premium services as a percentage of our gross new members. Customer retention. Our ability to maintain our current member retention rate may be affected by a number of factors, including the effectiveness of our services, the performance of our member services organization, external media coverage of identity theft, the continued evolution of our service offerings, the competitive environment, the effectiveness of our media spend, the timing of employee benefit and breach service enrollments, and other developments. Our enterprise business relies on the retention of enterprise customers to maintain the effectiveness of our services because our enterprise customers typically provide us with their customer transaction data as part of our service. Losing a significant number of 22 -------------------------------------------------------------------------------- these customers would reduce the breadth and effectiveness of our services. In addition, approximately 6% of the revenue of ID Analytics for the nine-month period ended September 30, 2014, or less than 1% of our overall revenue for such period, was derived from direct competitors to our consumer business. As we have given notice of non-renewal to competitors in our consumer business, we have allowed such contracts to lapse and, accordingly, this percentage may decline over time. Investments to grow our business. We will continue to invest to grow our business. Investments in the development and marketing of new services, including the new services we introduced in July 2014, and the continued enhancement of our existing services will increase our operating expenses in the near term and thus may negatively impact our operating results in the short term, although we anticipate that these investments will grow and improve our business over the long term. Regulatory developments. Our business is subject to regulation by federal, state, local, and foreign authorities. Any changes to the existing applicable laws, regulations, or rules; any determination that other laws, regulations, or rules are applicable to us; or any determination that we have violated any of these laws, regulations, or rules could adversely impact our operating results. In addition, as previously disclosed, on January 17, 2014, we met with FTC Staff, at our request, to discuss issues regarding allegations that have been asserted in a whistleblower claim against us relating to our compliance with the FTC Order. On March 13, 2014, we received a request from the FTC for documents and information related to our compliance with the FTC Order. On October 29, 2014, we completed our responses to the FTC's March 13, 2014 request for information along with the FTC's subsequent requests for clarification regarding certain information that we previously submitted. The FTC may request additional information or clarification on the information submitted or may request that we discuss with the FTC the issues relating thereto. In addition, on May 16, 2014, we announced that we had determined that certain aspects of the LifeLock Wallet mobile application were not fully compliant with applicable payment card industry (PCI) security standards. As a result, we temporarily suspended the LifeLock Wallet mobile application, and deleted the affected data from our servers, until we can operate the LifeLock Wallet mobile application in accordance with those standards. We have no indication that the data included in the LifeLock Wallet mobile application servers was compromised. The LifeLock Wallet mobile application storage processes are separate and independent from LifeLock's core identity theft protection services business, including the enrollment and related credit card storage processes used in our standard LifeLock service and our LifeLock Ultimate service. As such, we do not believe the suspension of the LifeLock Wallet mobile application impacted in any manner the core functionality or utility of the identity theft protection services we provide to our members. On May 15, 2014, on our own initiative, we informed the FTC Staff of these issues; at this point we do not expect to receive further requests for information from the FTC about these issues. Those aspects of the LifeLock Wallet mobile application previously identified by us as not meeting applicable PCI security standards have now been confirmed as meeting applicable PCI security standards. On October 29, 2014, we relaunched our LifeLock Wallet mobile application. A determination that we are in violation of the FTC Order, including as a result of the FTC's review of our information security program and alert and notification processing or our PCI non-compliance in connection with the LifeLock Wallet mobile application, could result in liability for fines, damages, or other penalties or require us to make changes to our services and business practices, and cause us to lose customers, any of which could have a material adverse impact on our business, operating results, financial condition, and prospects. We also collect and remit sales tax in several states related to the sale of our consumer services. Other states or one or more countries or other jurisdictions may seek to impose sales or other tax collection obligations on us in the future. A successful assertion by any state, country, or other jurisdiction that we should be collecting sales or other taxes on the sale of our services could, among other things, increase the cost of our services, create significant administrative burdens for us, result in substantial tax liabilities, discourage current members and other consumers from purchasing our services, or otherwise substantially harm our business and operating results. For additional factors and risks facing our business, see "Risk Factors." Basis of Presentation and Key Components of Our Results of Operations We operate our business and review and assess our operating performance using two reportable segments: our consumer segment and our enterprise segment. We review and assess our operating performance using segment revenue, income (loss) from operations, and total assets. These performance measures include the allocation of operating expenses to our reportable segments based on management's specific identification of costs associated to those segments. Revenue We derive revenue in our consumer segment primarily from fees paid by our members for identity theft protection services offered on a subscription basis. Our members subscribe to our consumer services on a monthly or annual, automatically renewing basis, and pay us the full subscription fee at the beginning of each subscription period, in most cases by authorizing us to directly 23 -------------------------------------------------------------------------------- charge their credit or debit cards. In some cases, we offer members a free trial period, which is typically 30 days. Our members may cancel their membership with us at any time without penalty and, when they do, we issue a refund for the unused portion of the canceled membership. We recognize revenue for member subscriptions ratably on a daily basis from the later of cash receipt, activation of a member's account, or expiration of free trial periods to the end of the subscription period. We also provide consumer services for which the primary customer is an enterprise purchasing identity theft protection services on behalf of its employees or customers. In such cases, we defer revenue for each member until the member's account has been activated. We then recognize revenue ratably on a daily basis over the term of the subscription period. We derive revenue in our enterprise segment from fees paid by our enterprise customers for consumer risk management solutions, which we provide under multi-year contracts, many of which renew automatically. Our enterprise customers pay us based on their monthly volume of transactions with us, and approximately 30% of them are committed to paying monthly minimum fees. We recognize revenue based on a negotiated fee per transaction. Transaction fees in excess of any of the monthly minimum fees are billed and recorded as revenue in addition to the monthly minimum fees. In some instances, we receive up-front non-refundable payments against which the monthly minimum fees are applied. The up-front non-refundable payments are recorded as deferred revenue and recognized as revenue monthly over the usage period. If an enterprise customer does not meet its monthly minimum fee, we bill the negotiated monthly minimum fee and recognize revenue for that amount. We derive a small portion of our enterprise revenue from special projects in which we are engaged to deliver a report at the end of the analysis, which we record upon delivery and acceptance of the report. Cost of Services Cost of services in our consumer segment consists primarily of costs associated with our member services organization and fulfillment partners. Our member support operations include wages and benefits for personnel performing these functions and facility costs directly associated with our sales and service delivery functions. We also pay fees to third-party service providers related to the fulfillment of our consumer services, including the premiums associated with the identity theft insurance that we provide to our members, and merchant credit card fees. Cost of services in our enterprise segment includes the costs related to data analytics and data management, primarily consisting of wages and benefits of personnel and facility costs directly associated with the data analytics and data management. We expect our cost of services to increase if we continue to increase the number of our members and enterprise customers. Our cost of services is heavily affected by prevailing salary levels, which affect our internal direct costs and fees paid to third-party service providers. Increases in the market rate for wages would increase our cost of services. Gross Margin Gross profit as a percentage of total revenue, or gross margin, has been and will continue to be affected by a variety of factors. Increases in personnel and facility costs directly associated with the provision of our services can negatively affect our gross margin, as can higher fulfillment costs due to enhancements in our services or the introduction of new services, such as the addition of insurance coverage in our consumer services. A significant increase in the number of members we enroll through our strategic partner distribution channels can also negatively affect our gross margin because we offer wholesale pricing to our strategic partners. In prior periods, our gross margin has also been negatively impacted by sales taxes we paid on behalf of our members and settlements with state tax authorities. Conversely, operating efficiencies in our member services organization can improve our gross margin. We expect that our gross margin may fluctuate from period to period depending on all of these factors. Sales and Marketing Sales and marketing expenses consist primarily of direct response advertising and online search costs, commissions paid on a per-member basis to our online affiliates and on a percentage of revenue basis to our co-marketing partners, and wages and benefits for sales and marketing personnel. Direct response marketing costs include television, radio, and print advertisements as well as costs to create and produce these advertisements. Online search costs consist primarily of pay-per-click payments to search engines and other online advertising media, such as banner ads. Advertising costs are expensed as incurred and historically have occurred unevenly across periods. Our sales and marketing expenses also include payments related to our sponsorship and promotional partners. In order to continue to grow our business and the awareness of our services, we plan to continue to commit substantial resources to our sales and marketing efforts. As a result, we expect our sales and marketing expenses will continue to increase in absolute dollars for the foreseeable future and vary as a percentage of revenue depending on the timing of those expenses. 24 --------------------------------------------------------------------------------Technology and Development Technology and development expenses consist primarily of personnel costs incurred in product development, maintenance and testing of our websites, enhancing our existing services and developing new services, internal information systems and infrastructure, data privacy and security systems, third-party development, and other internal-use software systems. Our development costs are primarily incurred in the United States and directed at enhancing our existing service offerings and developing new service offerings. In order to continue to grow our business and enhance our services, we plan to continue to commit resources to technology and development. In addition, ID Analytics has historically spent a higher portion of its revenue on technology and development. As a result, we expect our technology and development expenses will continue to increase in absolute dollars for the foreseeable future. General and Administrative General and administrative expenses consist primarily of personnel costs, professional fees, and facility-related expenses associated with our executive, finance, human resources, legal, and governmental affairs organizations. Our professional fees principally consist of outside legal, auditing, accounting, and other consulting fees. Legal costs included within our general and administrative expenses also include costs incurred to litigate and settle various legal matters. We expect our general and administrative expenses will increase in absolute dollars for the foreseeable future as we hire additional personnel and expand our office facilities to support our overall growth and incur additional costs associated with our public company and regulatory compliance. Amortization of Acquired Intangible Assets Amortization of acquired intangible assets is the amortization expense associated with core technology, customer relationships, and trade names and trademarks resulting from business acquisitions. As of September 30, 2014, we had $40.5 million in acquired intangible assets, net of amortization, as a result of our acquisitions of ID Analytics and Lemon. The acquired intangible assets have useful lives of between one and ten years and we expect to recognize approximately $8.9 million of amortization expense in the year ending December 31, 2014. Provision for Income Taxes We are subject to federal income tax as well as state income tax in various states in which we conduct business. Our effective tax rate for the three- and nine-month periods ended September 30, 2014 approximates the U.S. federal statutory tax rate plus the impact of state taxes and permanent and other temporary differences. For the three- and nine-month periods ended September 30, 2013, our effective tax rate differed from the statutory rate primarily as a result of our valuation allowance on our deferred taxes, state taxes, and non-deductible expenses. Results of Operations Comparison of the Three- and Nine-Month Periods Ended September 30, 2014 and 2013 Total Revenue For the Three Months Ended For the Nine Months Ended September 30, September 30, 2014 2013 % Change 2014 2013 % Change (in thousands) (in thousands) Consumer revenue $ 116,115 $ 88,386 31.4 % $ 326,448 $ 246,053 32.7 % Enterprise revenue 6,916 7,353 -5.9 % 19,882 21,300 -6.7 % Total revenue $ 123,031 $ 95,739 $ 346,330 $ 267,353 Consumer revenue for the three-month period ended September 30, 2014 was $116.1 million, an increase of $27.7 million, or 31.4%, over consumer revenue for the three-month period ended September 30, 2013. The increase in our consumer revenue related primarily to an increase in the number of our members, which grew from 2.9 million as of September 30, 2013 to 3.5 million as of September 30, 2014, an increase of 23%. In addition, our monthly average revenue per member increased 7% to $11.22 for the three-month period ended September 30, 2014 from $10.48 for the three-month period ended September 30, 2013. The increase in members and monthly average revenue per member resulted from the continued success of our premium service offerings, including the release of our new LifeLock Advantage and LifeLock Ultimate Plus services at the end of July 2014, and our advertising and marketing campaigns designed to increase the overall awareness of our services and identity theft. 25 -------------------------------------------------------------------------------- Consumer revenue for the nine-month period ended September 30, 2014 was $326.4 million, an increase of $80.4 million, or 32.7%, over consumer revenue for the nine-month period ended September 30, 2013. This increase was primarily attributable to the 23% growth in our member base from 2.9 million as of September 30, 2013 to 3.5 million as of September 30, 2014. Our monthly average revenue per member increased 8% to $11.02 for the nine-month period ended September 30, 2014 from $10.17 for the nine-month period ended September 30, 2013, primarily due to the continued success of our premium service offerings and our advertising and marketing campaigns, which drove member growth. Enterprise revenue for the three-month period ended September 30, 2014 was $6.9 million, a decrease of $0.4 million, or 6%, from enterprise revenue for the three-month period ended September 30, 2013. This reduction was primarily attributable to the reduction in revenue as a result of us giving notice of non-renewal to several customers who compete in our consumer business and allowing such contracts to lapse, which was partially offset by growth as we continue to add new customers and expand our offerings within our current customer base. Enterprise revenue for the nine-month period ended September 30, 2014 was $19.9 million, a decrease of $1.4 million, or 7%, from enterprise revenue for the nine-month period ended September 30, 2013. This reduction was primarily attributable to the reduction in revenue as a result of us giving notice of non-renewal to several customers who compete in our consumer business and allowing such contracts to lapse, which was partially offset by growth as we continue to add new customers and expand our offerings within our current customer base. Cost of Services and Gross Profit For the Three Months Ended For the Nine Months Ended September 30, September 30, 2013 2013 2014 (Restated) % Change 2014 (Restated) % Change (in thousands) (in thousands) Cost of services $ 30,327 $ 24,887 21.9 % $ 89,675 $ 73,870 21.4 % Percentage of revenue 24.6 % 26.0 % 25.9 % 27.6 % Gross profit $ 92,704 $ 70,852 30.8 % $ 256,655 $ 193,483 32.6 % Percentage of revenue 75.4 % 74.0 % 74.1 % 72.4 % Gross profit for the three-month period ended September 30, 2014 was $92.8 million, or 75.4% of revenue, an increase of $21.9 million, or 30.8%, over gross profit of $70.9 million, or 74.0% of revenue, for the three-month period ended September 30, 2013. The increase in our gross profit resulted primarily from increased revenue associated with the growth in the number of our members and increased monthly average revenue per member. The increase in our gross margin is attributable to efficiencies in our member services organization and scalability within certain third-party fulfillment contracts as our member base continued to grow. Gross profit for the nine-month period ended September 30, 2014 was $256.7 million, or 74.1% of revenue, an increase of $63.2 million, or 32.7%, over gross profit of $193.5 million, or 72.4% of revenue, for the nine-month period ended September 30, 2013. The increase in gross profit resulted primarily from increased revenue associated with the growth in the number of our members and increased monthly average revenue per member. The increase in our gross margin is attributable to efficiencies in our member services organization and scalability within certain third-party fulfillment contracts as our member base continued to grow. Sales and Marketing For the Three Months Ended For the Nine Months Ended September 30, September 30, 2013 2013 2014 (Restated) % Change 2014 (Restated) % Change (in thousands) (in thousands) Sales and marketing $ 51,818 $ 40,423 28.2 % $ 166,710 $ 125,334 33.0 % Percentage of revenue 42.1 % 42.2 % 48.1 % 46.9 % Sales and marketing expenses for the three-month period ended September 30, 2014 were $51.8 million, or 42.1% of revenue, compared with $40.4 million, or 42.2% of revenue, for the three-month period ended September 30, 2013. The increase in our sales and marketing expenses resulted from increases in our advertising expenses, external sales commissions, and personnel costs, specifically non-cash share-based compensation. The increase in our sales and marketing expenses reflected our investment to drive new membership growth, our continued advertising of our premium service offerings, and our efforts to highlight the growing identity theft issue and to educate consumers. 26 -------------------------------------------------------------------------------- Sales and marketing expenses for the nine-month period ended September 30, 2014 were $166.7 million, or 48.1% of revenue, compared with $125.3 million, or 46.9% of revenue, for the nine-month period ended September 30, 2013. We continue to invest heavily in our sales and marketing initiatives to highlight our services and educate consumers on identity theft in an effort to drive new membership growth. Increases in external sales commissions and personnel costs, specifically non-cash share based compensation, also contributed to the increase in sales and marketing expenses for the nine-month period ended September 30, 2014. Technology and Development For the Three Months Ended For the Nine Months Ended September 30, September 30, 2013 2013 2014 (Restated) % Change 2014 (Restated) % Change (in thousands) (in thousands) Technology and development $ 12,341 $ 10,462 18.0 % $ 37,996 $ 29,564 28.5 % Percentage of revenue 10.0 % 10.9 % 11.0 % 11.1 % Technology and development expenses for the three-month period ended September 30, 2014 were $12.3 million, or 10.0% of revenue, compared with $10.5 million, or 10.9% of revenue, for the three-month period ended September 30, 2013. The increase in our technology and development expenses resulted primarily from increases in our personnel costs, including non-cash share-based compensation, as we continue to invest in the talent within the organization. Technology and development expenses for the nine-month period ended September 30, 2014 were $38.0 million, or 11.0% of revenue, compared with $29.6 million, or 11.1% of revenue, for the nine-month period ended September 30, 2013. The increase in our technology and development expenses resulted primarily from increases in our personnel costs, including non-cash share-based compensation. General and Administrative For the Three Months Ended For the Nine Months Ended September 30, September 30, 2013 2013 2014 (Restated) % Change 2014 (Restated) % Change (in thousands) (in thousands) General and administrative $ 16,781 $ 11,265 49.0 % $ 45,489 $ 30,799 47.7 % Percentage of revenue 13.6 % 11.8 % 13.1 % 11.5 % General and administrative expenses for the three-month period ended September 30, 2014 were $16.8 million, or 13.6% of revenue, compared with $11.3 million, or 11.8% of revenue, for the three-month period ended September 30, 2013. The increase in general and administrative expenses resulted primarily from additional costs associated with our regulatory compliance, acquisition integration and related intellectual property audits, the expansion of our office facilities, and additional personnel costs, including non-cash share-based compensation. General and administrative expenses for the nine-month period ended September 30, 2014 were $45.5 million, or 13.1% of revenue, compared with $30.8 million, or 11.5% of revenue, for the nine-month period ended September 30, 2013. The increase in general and administrative expenses resulted primarily from additional costs associated with our regulatory compliance, acquisition integration and related intellectual property audits, the expansion of our office facilities, and additional personnel costs, including non-cash share-based compensation. Amortization of Acquired Intangible Assets For the Three Months Ended For the Nine Months Ended September 30, September 30, 2014 2013 % Change 2014 2013 % Change (in thousands) (in thousands) Amortization of acquired intangible assets $ 2,231 $ 1,966 13.5 % $ 6,693 $ 5,898 13.5 % Percentage of revenue 1.8 % 2.1 % 1.9 % 2.2 % 27 -------------------------------------------------------------------------------- Amortization of acquired intangible assets was $2.2 million for the three-month period ended September 30, 2014, an increase of $0.3 million over the three-month period ended September 30, 2013. Amortization of acquired intangible assets was $6.7 million for the nine-month period ended September 30, 2014, an increase of $0.8 million over the nine-month period ended September 30, 2013. The increase in amortization of acquired intangible assets for the three- and nine-month periods ended September 30, 2014 resulted from our amortization of the intangible assets acquired in our acquisition of Lemon in December 2013. Other Expense For the Three Months Ended For the Nine Months Ended September 30, September 30, 2014 2013 % Change 2014 2013 % Change (in thousands) (in thousands) Interest expense $ (89 ) $ (82 ) 8.5 % $ (264 ) $ (228 ) 15.8 % Interest income 73 29 151.7 % 189 75 152.0 % Other (134 ) (7 ) 1814.3 % (151 ) (11 ) 1272.7 % $ (150 ) $ (60 ) 150.0 % $ (226 ) $ (164 ) 37.8 % Other expense for the three- and nine-month periods ended September 30, 2014 was $0.2 million, compared with other expense of less than $0.1 million and $0.2 million for the three- and nine-month periods ended September 30, 2013, respectively. The increase in other expense related primarily to the change in cash surrender value on our company-owned life insurance policies. Income Tax (Benefit) Expense For the Three Months Ended For the Nine Months Ended September 30, September 30, 2013 2013 2014 (Restated) % Change 2014 (Restated) % Change (in thousands) (in thousands) Income tax (benefit) expense $ 3,933 $ 210 1772.9 % $ (116 ) $ 245 -147.3 % Effective tax rate 41.3 % 3.1 % 49.8 % 13.0 % Income tax expense for the three-month period ended September 30, 2014 was $3.9 million compared with an income tax expense of $0.2 million for the three-month period ended September 30, 2013. Income tax benefit for the nine-month period ended September 30, 2014 was $0.1 million compared with income tax expense of $0.2 million for the nine-month period ended September 30, 2013. In the fourth quarter of 2013, in consideration of all available positive and negative evidence, including our historical operating results, current financial condition, and potential future taxable income, we released substantially all of our valuation allowance on our deferred tax assets. As such, for the three- and nine-month periods ended September 30, 2014, our effective tax rate approximated the U.S. federal statutory tax rate plus the impact of state taxes. Liquidity and Capital Resources As of September 30, 2014, we had $128.6 million in cash and cash equivalents, which consisted of cash, money market funds, and open commercial paper, and $109.7 million in marketable securities, which consisted of corporate bonds, municipal bonds, and certificates of deposit. We classify our marketable securities as short-term regardless of contractual maturity based on our ability to liquidate such investments for use in current operations. Additionally, we have an $85 million revolving line of credit, although we have made no draws on the line of credit to date. As of September 30, 2014, we had no outstanding debt. We believe that our existing cash and cash equivalents, marketable securities, and the cash surrender values of our company-owned life insurance policies, together with cash generated from operations, will be sufficient to fund our operations for at least the next 12 months. Operating Activities For the nine-month period ended September 30, 2014, operating activities generated $72.1 million in cash as a result of a net loss of $0.3 million, adjusted by non-cash items such as depreciation and amortization of $12.3 million, share-based compensation of $13.2 million, provision for doubtful accounts of $0.3 million, amortization of premium on marketable securities of $1.2 million, and a deferred income tax benefit of $0.1 million. An increase in deferred revenue related to the overall growth of our business provided operating cash of $26.7 million and we had an increase in operating cash as a result of changes in other operating assets and liabilities of $18.8 million. 28 -------------------------------------------------------------------------------- For the nine-month period ended September 30, 2013, operating activities generated $51.8 million in cash as a result of a net income of $1.5 million (restated), adjusted by non-cash items such as depreciation and amortization of $9.5 million and share-based compensation of $7.9 million (restated). An increase in deferred revenue related to the overall growth of our business provided operating cash of $24.9 million and we had an increase in operating cash as a result of changes in other operating assets and liabilities of $7.7 million. Investing Activities For the nine-month period ended September 30, 2014, we used $11.1 million of cash to acquire property and equipment, primarily attributable to expansion of our office locations, invested net cash of $61.3 million in the purchase of marketable securities, and invested cash of $4.3 million in the purchase of company-owned life insurance policies. For the nine-month period ended September 30, 2013, we invested $24.2 in marketable securities and used $5.3 million of cash to acquire property and equipment, primarily attributable to investments in infrastructure to enable continued scalable growth. Financing Activities For the nine-month period ended September 30, 2014, our financing activities generated net cash of $9.3 million as a result of cash received from the exercise of stock options and warrants of $10.1 million, offset by $0.8 million paid for employee withholding tax related to net distributions of restricted stock awards and restricted stock units. For the nine-month period ended September 30, 2013, financing activities generated net cash of $11.4 million as a result of cash received from the exercise of stock options of $11.8 million, offset by cash used of $0.4 million related to the payment of debt issuance costs associated with the refinancing of our credit agreement. Debt Obligations Credit Agreement On January 9, 2013, we refinanced our existing credit agreement and entered into a new credit agreement, or the Credit Agreement, with Bank of America, N.A. as administrative agent, swing line lender and issuer of letters of credit, Silicon Valley Bank as syndication agent, Merrill Lynch, Pierce, Fenner & Smith Incorporated as sole lead arranger and sole book manager, and the lenders from time to time party thereto. We refer to the Credit Agreement and related documents as the Senior Credit Facility. The Senior Credit Facility provides for an $85.0 million revolving line of credit, which we can increase to $110.0 million subject to the conditions set forth in the Credit Agreement. The revolving line of credit also includes a letter of credit subfacility of $10.0 million and a swing line loan subfacility of $5.0 million. The Senior Credit Facility has a maturity date of January 9, 2018. As of September 30, 2014, we had no debt outstanding under our Senior Credit Facility. For the three- and nine-month periods ended September 30, 2014 and 2013, we paid an unused commitment fee of less than $0.1 million, which is included in interest expense in the condensed consolidated statements of operations. Borrowings under the Senior Credit Facility bear interest at a per annum rate equal to, at our option, either (a) a base rate equal to the highest of (i) the Federal Funds Rate plus 0.50%, (ii) the rate of interest in effect for such day as publicly announced from time to time by Bank of America as its "prime rate," and (iii) the eurodollar rate for base rate loans plus 1.00%, plus an applicable rate ranging from 0.50% to 1.25%, or (b) the eurodollar rate for eurodollar rate loans plus an applicable rate ranging from 1.50% to 2.25%. The initial applicable rate is 0.50% for base rate loans and 1.50% for eurodollar rate loans, subject to adjustment from time to time based upon our achievement of a specified consolidated leverage ratio. In addition to paying interest on the outstanding principal under the Senior Credit Facility, we are also required to pay a commitment fee to the administrative agent at a rate per annum equal to the product of (a) an applicable rate ranging from 0.25% to 0.50% multiplied by (b) the actual daily amount by which the aggregate revolving commitments exceed the sum of (1) the outstanding amount of revolving borrowings, and (2) the outstanding amount of letter of credit obligations. The initial applicable rate is 0.25%, subject to adjustment from time to time based upon our achievement of a specified consolidated leverage ratio. We also will pay a letter of credit fee to the administrative agent for the account of each lender in accordance with its applicable percentage of a letter of credit for each letter of credit, which fee will be equal to the applicable rate then in effect, multiplied by the daily maximum amount available to be drawn under the letter of credit. The initial applicable rate for the letter of credit is 1.50%, subject to adjustment from time to time based upon our achievement of a specified consolidated leverage ratio. 29 -------------------------------------------------------------------------------- We have the right to prepay our borrowings under the Senior Credit Facility from time to time in whole or in part, without premium or penalty, subject to the procedures set forth in the Senior Credit Facility. All of our obligations under the Senior Credit Facility are unconditionally and jointly and severally guaranteed by each of our existing and future, direct or indirect, domestic subsidiaries, subject to certain exceptions. In addition, all of our obligations under the Senior Credit Facility, and the guarantees of those obligations, are secured, subject to permitted liens and certain other exceptions, by a first-priority lien on our and our subsidiaries' tangible and intangible personal property, including a pledge of all of the capital stock of our subsidiaries. The Senior Credit Facility requires us to maintain certain financial covenants. In addition, the Senior Credit Facility requires us to maintain all material proprietary databases and software with a third-party escrow agent in accordance with an escrow agreement that we reaffirmed in connection with the Senior Credit Facility. The Senior Credit Facility also contains certain affirmative and negative covenants limiting, among other things, additional liens and indebtedness, investments and distributions, mergers and acquisitions, liquidations, dissolutions, sales of assets, prepayments and modification of debt instruments, transactions with affiliates, and other matters customarily restricted in such agreements. The Senior Credit Facility also contains customary events of default, including payment defaults, breaches of representations and warranties, covenant defaults, cross defaults to other contractual agreements, events of bankruptcy and insolvency, and a change of control. As of September 30, 2014, we were in compliance with all financial covenants under the Senior Credit Facility. As of September 30, 2014, we had an outstanding letter of credit issued in connection with the revolving line of credit in our Senior Credit Facility in the total amount of $0.1 million. Off-Balance Sheet Arrangements We do not engage in any off-balance sheet financing activities, nor do we have any interest in entities referred to as variable interest entities. Contractual Obligations There were no material changes in our commitments under contractual obligations to those disclosed in our Form 10-K/A for the fiscal year ended December 31, 2013. Critical Accounting Policies Our condensed consolidated financial statements are prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. These estimates form the basis for judgments we make about the carrying values of our assets and liabilities, which are not readily apparent from other sources. We base our estimates and judgments on historical experience and on various other assumptions that we believe are reasonable under the circumstances. On an ongoing basis, we evaluate our estimates and assumptions. Our actual results may differ from these estimates under different assumptions or conditions. We believe that the assumptions and estimates associated with revenue recognition for payments and other fees, income taxes, and share-based compensation have the greatest potential impact on our condensed consolidated financial statements. Therefore, we consider these to be our critical accounting policies and estimates. There have been no material changes to our critical accounting policies and estimates as compared to the critical accounting policies and estimates described in our Form 10-K/A for the fiscal year ended December 31, 2013. |