Attached files
| file | filename |
|---|---|
| EX-31.2 - EXHIBIT 31.2 - LIFELOCK, INC. | lock-ex312x20150930x10q.htm |
| EX-31.1 - EXHIBIT 31.1 - LIFELOCK, INC. | lock-ex311x20150930x10q.htm |
| EX-32.1 - EXHIBIT 32.1 - LIFELOCK, INC. | lock-ex321x20150930x10q.htm |
| EX-10.1 - EXHIBIT 10.1 - LIFELOCK, INC. | lock-ex101xsatyavoluofferl.htm |
| EX-10.2 - EXHIBIT 10.2 - LIFELOCK, INC. | lock-ex102xsatyavolusevera.htm |
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q |
ý | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended September 30, 2015
or
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from __________ to __________.
Commission file number: 001-35671
LifeLock, Inc. (Exact name of registrant as specified in its charter) |
Delaware | 56-2508977 | |
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification No.) | |
60 East Rio Salado Parkway, Suite 400 Tempe, Arizona 85281 (Address of principal executive offices and zip code) (480) 682-5100 (Registrant’s telephone number, including area code) |
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer | ý | Accelerated filer | ¨ | |
Non-accelerated filer (Do not check if a smaller reporting company) | ¨ | Smaller reporting company | ¨ | |
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý
As of October 30, 2015, there were outstanding 95,515,268 shares of the registrant’s common stock, $0.001 par value.
LIFELOCK, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2015
TABLE OF CONTENTS
Page | |
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PART I - FINANCIAL INFORMATION
Item 1. | Financial Statements (Unaudited) |
LIFELOCK, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except share data)
(unaudited)
September 30, 2015 | December 31, 2014 | ||||||
Assets | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 135,542 | $ | 146,569 | |||
Marketable securities | 196,697 | 127,305 | |||||
Trade and other receivables, net | 10,508 | 10,220 | |||||
Deferred tax assets, net | 48,808 | 21,243 | |||||
Prepaid expenses and other current assets | 8,862 | 7,841 | |||||
Total current assets | 400,417 | 313,178 | |||||
Property and equipment, net | 25,973 | 24,204 | |||||
Goodwill | 172,139 | 159,342 | |||||
Intangible assets, net | 32,064 | 38,315 | |||||
Deferred tax assets, net – non-current | 22,713 | 22,494 | |||||
Other non-current assets | 9,593 | 5,783 | |||||
Total assets | $ | 662,899 | $ | 563,316 | |||
Liabilities and stockholders’ equity | |||||||
Current liabilities: | |||||||
Accounts payable | $ | 13,362 | $ | 11,543 | |||
Accrued expenses and other liabilities | 184,166 | 67,025 | |||||
Deferred revenue | 170,835 | 145,206 | |||||
Total current liabilities | 368,363 | 223,774 | |||||
Other non-current liabilities | 6,970 | 6,706 | |||||
Total liabilities | 375,333 | 230,480 | |||||
Commitments and contingencies | |||||||
Stockholders’ equity: | |||||||
Common stock, $0.001 par value, 300,000,000 authorized at September 30, 2015 and December 31, 2014; 95,486,687 and 93,944,742 shares issued and 95,441,078 and 93,899,968 outstanding at September 30, 2015 and December 31, 2014, respectively | 95 | 94 | |||||
Preferred stock, $0.001 par value, 10,000,000 shares authorized and no shares issued and outstanding at September 30, 2015 and December 31, 2014 | — | — | |||||
Additional paid-in capital | 524,385 | 495,912 | |||||
Accumulated other comprehensive loss | (77 | ) | (116 | ) | |||
Accumulated deficit | (236,837 | ) | (163,054 | ) | |||
Total stockholders’ equity | 287,566 | 332,836 | |||||
Total liabilities and stockholders’ equity | $ | 662,899 | $ | 563,316 | |||
See accompanying notes to condensed consolidated financial statements.
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LIFELOCK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per share amounts)
(unaudited)
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2015 | 2014 | 2015 | 2014 | ||||||||||||
Revenue: | |||||||||||||||
Consumer revenue | $ | 144,648 | $ | 116,115 | $ | 411,178 | $ | 326,448 | |||||||
Enterprise revenue | 7,304 | 6,916 | 20,139 | 19,882 | |||||||||||
Total revenue | 151,952 | 123,031 | 431,317 | 346,330 | |||||||||||
Cost of services | 33,988 | 30,327 | 103,470 | 89,675 | |||||||||||
Gross profit | 117,964 | 92,704 | 327,847 | 256,655 | |||||||||||
Costs and expenses: | |||||||||||||||
Sales and marketing | 62,850 | 51,818 | 209,470 | 166,710 | |||||||||||
Technology and development | 19,396 | 12,341 | 52,928 | 37,996 | |||||||||||
General and administrative | 120,984 | 16,781 | 160,815 | 45,489 | |||||||||||
Amortization of acquired intangible assets | 2,084 | 2,231 | 6,251 | 6,693 | |||||||||||
Total costs and expenses | 205,314 | 83,171 | 429,464 | 256,888 | |||||||||||
Income (loss) from operations | (87,350 | ) | 9,533 | (101,617 | ) | (233 | ) | ||||||||
Other income (expense): | |||||||||||||||
Interest expense | (89 | ) | (89 | ) | (265 | ) | (264 | ) | |||||||
Interest income | 219 | 73 | 498 | 189 | |||||||||||
Other, net | — | (134 | ) | (183 | ) | (151 | ) | ||||||||
Total other income (expense) | 130 | (150 | ) | 50 | (226 | ) | |||||||||
Income (loss) before income taxes | (87,220 | ) | 9,383 | (101,567 | ) | (459 | ) | ||||||||
Income tax expense (benefit) | (22,075 | ) | 3,933 | (27,784 | ) | (116 | ) | ||||||||
Net income (loss) | $ | (65,145 | ) | $ | 5,450 | $ | (73,783 | ) | $ | (343 | ) | ||||
Net income (loss) per share | |||||||||||||||
Basic | $ | (0.68 | ) | $ | 0.06 | $ | (0.78 | ) | $ | (0.00 | ) | ||||
Diluted | $ | (0.68 | ) | $ | 0.06 | $ | (0.78 | ) | $ | (0.00 | ) | ||||
Weighted-average common shares outstanding used in computing net income (loss) per share: | |||||||||||||||
Basic | 95,340 | 92,925 | 94,660 | 92,437 | |||||||||||
Diluted | 95,340 | 98,524 | 94,660 | 92,437 | |||||||||||
See accompanying notes to condensed consolidated financial statements.
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LIFELOCK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(in thousands)
(unaudited)
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2015 | 2014 | 2015 | 2014 | ||||||||||||
Net income (loss) | $ | (65,145 | ) | $ | 5,450 | $ | (73,783 | ) | $ | (343 | ) | ||||
Other comprehensive gain (loss), net of tax | |||||||||||||||
Unrealized gain (loss) on marketable securities | 117 | (78 | ) | 39 | (66 | ) | |||||||||
Comprehensive income (loss) | $ | (65,028 | ) | $ | 5,372 | $ | (73,744 | ) | $ | (409 | ) | ||||
See accompanying notes to condensed consolidated financial statements.
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LIFELOCK, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
For the Nine Months Ended September 30, | |||||||
2015 | 2014 | ||||||
Operating activities | |||||||
Net loss | $ | (73,783 | ) | $ | (343 | ) | |
Adjustments to reconcile net loss to net cash provided by operating activities: | |||||||
Depreciation and amortization | 13,292 | 12,259 | |||||
Share-based compensation | 20,287 | 13,229 | |||||
Provision for doubtful accounts | 150 | 333 | |||||
Amortization of premiums on marketable securities | 2,310 | 1,213 | |||||
Deferred income tax benefit | (27,784 | ) | (124 | ) | |||
Other | 250 | 39 | |||||
Change in operating assets and liabilities: | |||||||
Trade and other receivables | (3,469 | ) | 566 | ||||
Prepaid expenses and other current assets | (1,022 | ) | (701 | ) | |||
Other non-current assets | 357 | 716 | |||||
Accounts payable | 1,548 | 5,282 | |||||
Accrued expenses and other liabilities | 117,693 | 11,303 | |||||
Deferred revenue | 25,629 | 26,742 | |||||
Other non-current liabilities | 265 | 1,617 | |||||
Net cash provided by operating activities | 75,723 | 72,131 | |||||
Investing activities | |||||||
Acquisition of business, net of cash acquired | (12,797 | ) | — | ||||
Acquisition of property and equipment, including capitalization of internal use software | (9,057 | ) | (11,127 | ) | |||
Purchases of marketable securities | (191,846 | ) | (95,686 | ) | |||
Sales and maturities of marketable securities | 122,936 | 34,418 | |||||
Premiums paid for company-owned life insurance policies | (4,337 | ) | (4,337 | ) | |||
Net cash used in investing activities | (95,101 | ) | (76,732 | ) | |||
Financing activities | |||||||
Proceeds from stock-based compensation plans | 10,144 | 9,704 | |||||
Proceeds from warrant exercises | — | 375 | |||||
Payments for employee tax withholdings related to restricted stock units and awards | (1,793 | ) | (760 | ) | |||
Net cash provided by financing activities | 8,351 | 9,319 | |||||
Net increase (decrease) in cash and cash equivalents | (11,027 | ) | 4,718 | ||||
Cash and cash equivalents at beginning of period | 146,569 | 123,911 | |||||
Cash and cash equivalents at end of period | $ | 135,542 | $ | 128,629 | |||
See accompanying notes to condensed consolidated financial statements.
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LIFELOCK, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Corporation Information
We provide proactive identity theft protection services to our consumer subscribers, whom we refer to as our members, on an annual or monthly subscription basis. We also provide consumer risk management services to our enterprise customers.
We were incorporated in Delaware on April 12, 2005, and are headquartered in Tempe, Arizona. On March 14, 2012, we acquired ID Analytics, LLC (formerly, ID Analytics, Inc.) and its wholly owned subsidiary SageStream, LLC (formerly IDA Inc.), each of which is incorporated in Delaware. On December 11, 2013, we acquired Lemon, LLC (formerly, Lemon, Inc.), or Lemon, which is incorporated in Delaware.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America (U.S. GAAP), and applicable Securities and Exchange Commission, or SEC, rules and regulations regarding interim financial reporting. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted pursuant to such rules and regulations. Therefore, these condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, or 2014 Form 10-K.
The condensed consolidated balance sheet as of December 31, 2014 included herein was derived from the audited financial statements as of that date, but does not include all disclosures including notes required by U.S. GAAP.
The accompanying unaudited condensed consolidated financial statements reflect all normal recurring adjustments necessary to present fairly the financial position, results of operations, and cash flows for the interim periods, but are not necessarily indicative of the anticipated results of operations for the entire year ending December 31, 2015 or any future period.
Basis of Consolidation
The condensed consolidated financial statements include our accounts and those of our wholly and indirectly owned subsidiaries. We eliminate all intercompany balances and transactions, including intercompany profits, in consolidation.
Use of Estimates
The preparation of condensed consolidated financial statements in conformity with U.S. GAAP requires us to make certain estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. We continually evaluate our estimates, including those related to the allocation of the purchase price associated with acquisitions; the carrying value of long-lived assets; the amortization period of long-lived assets; the carrying value, capitalization, and amortization of software and website development costs; the carrying value of goodwill and other intangible assets; the amortization period of intangible assets; the provision for income taxes and related deferred tax accounts, and realizability of deferred tax assets, certain accrued expenses; incurred but not reported medical claims, contingencies, litigation, and related legal accruals; and the value attributed to employee stock options and other stock-based awards. We base our estimates on historical experience, current business factors, and various other assumptions that we believe are necessary to consider to form a basis for making judgments. Actual results could be materially different from these estimates.
2. Summary of Significant Accounting Policies
There have been no material changes to our significant accounting policies from those disclosed in our Form 10-K for the year ended December 31, 2014.
Recently Issued Accounting Standards
In May 2014, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers, which provides guidance for revenue recognition. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under today’s guidance. These may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price, and allocating the transaction price to each separate performance obligation. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with Customers: Deferral of the Effective Date, which defers the effective date of ASU 2014-09 for all entities for one year. Consequently, the guidance provided in ASU 2014-09 will be effective for us in the first
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quarter of our fiscal year ending December 31, 2018. Early adoption is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. The guidance permits the use of either the retrospective or cumulative effect transition method. We are currently in the process of evaluating the impact of the adoption of this guidance on our consolidated financial statements and have not yet selected a transition method.
In February 2015, the FASB issued ASU 2015-02, Consolidation, which changes the analysis that a reporting entity must perform to determine whether it should consolidate certain legal entities. The amendments in the standard affect limited partnerships and similar legal entities, evaluating fees paid to a decision maker or a service provider as a variable interest, the effect of fee arrangements on the primary beneficiary determination, the effect of related parties on the primary beneficiary determination, and certain investment funds. This guidance is effective for public business entities for fiscal years, and for interim fiscal periods within those fiscal years, beginning after December 15, 2015. Early adoption is permitted. We do not expect the adoption of this ASU to have a significant impact on our consolidated financial statements.
In April 2015, the FASB issued ASU 2015-03, Simplifying the Presentation of Debt Issuance Costs, which changes the presentation of debt issuance costs in financial statements. The guidance requires an entity to present such costs in the balance sheet as a direct deduction from the related debt liability rather than as an asset, with amortization of the costs continuing to be reported as interest expense. In August 2015, the FASB issued ASU 2015-15, Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line-of-Credit Arrangements, which provides that the SEC staff would not object to an entity deferring and presenting debt issuance costs as an asset and subsequently amortizing the deferred debt issuance costs ratably over the term of the line-of-credit arrangement, regardless of whether there are any outstanding borrowings on the line-of-credit arrangement. This guidance is effective for annual reporting periods beginning after December 15, 2016, and will be applied retrospectively to each prior period presented. Early adoption is permitted. We do not expect the adoption of these ASUs to have a material impact on our consolidated financial statements.
In April 2015, the FASB issued ASU 2015-05, Customer's Accounting for Fees paid in a Cloud Computing Arrangement, which provides a basis for evaluating whether a cloud computing arrangement includes a software license. If a cloud computing arrangement includes a license to internal-use software, then the software license should be accounted for in accordance with Subtopic 350-40. A license to software other than internal-use software should be accounted for in accordance with other applicable U.S. GAAP. If a cloud computing arrangement does not include a software license, then the arrangement should be accounted for as a service contract. The guidance is effective for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted. We do not expect the adoption of this ASU to have a material impact on our consolidated financial statements.
In September 2015, the FASB issued ASU 2015-16, Simplifying the Accounting for Measurement-Period Adjustments, which eliminates the requirement for an acquirer to retrospectively adjust provisional amounts recognized in a business combination. The guidance requires the acquirer to recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amount is determined. Additionally, the guidance requires the acquirer to record the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date in the same period's financial statements. An acquirer is also required to present separately on the face of the income statement or disclose in the notes to the financial statements the portion of the amount recorded in current period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the provisional amounts had been recognized as of the acquisition date. The guidance is effective for public entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted. We plan to early adopt this guidance and do not expect the adoption of this ASU to have a significant impact on our consolidated financial statements.
3. Business Combinations
Acquisition of Assets from BitYota, Inc.
On August 21, 2015, we acquired a team of product and development data experts with experience in large scale data processing from BitYota, a provider of data warehouse as a service, for an aggregate purchase price of approximately $12.8 million. The team will focus on developing new data-based products within our consumer segment.
We accounted for this asset acquisition as a business combination, using the acquisition method in accordance with ASC 805 Business Combinations. We reviewed all identifiable tangible and intangible assets acquired and determined that any fair value was immaterial based on the information available as of the acquisition date. As a result we preliminarily determined that the entire purchase price of acquired assets will be assigned to goodwill within our consumer segment, as the primary asset acquired was the assembled workforce, a team with expertise in the development of data-based products, who could use their ability to develop new products within our consumer segment. The goodwill resulting from the acquisition of BitYota is deductible for tax purposes. We expect to finalize the valuation as soon as practicable, but no later than one year from the date of acquisition.
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Acquisition related costs recognized for the nine-month period ended September 30, 2015 amounted to $3.1 million, which we have classified in technology and development and general and administrative expenses in our condensed consolidated statements of operations. Transaction costs included expenses such as signing bonuses, legal, accounting, and other professional services.
Had the acquisition of assets from BitYota occurred on January 1, 2014, our pro forma consolidated revenue for the three- and nine-month periods ended September 30, 2015 and 2014, would have increased by less than 0.1%.
4. Marketable Securities
The following is a summary of marketable securities designated as available-for-sale as of September 30, 2015 and December 31, 2014:
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | ||||||||||||
(in thousands) | |||||||||||||||
September 30, 2015 | |||||||||||||||
Corporate bonds | $ | 131,740 | $ | 6 | $ | (116 | ) | $ | 131,630 | ||||||
Municipal bonds | 17,957 | 14 | (1 | ) | 17,970 | ||||||||||
Commercial paper | 36,118 | — | — | 36,118 | |||||||||||
Agency securities | 7,279 | 7 | — | 7,286 | |||||||||||
Certificates of deposit | 2,492 | — | — | 2,492 | |||||||||||
Government securities | 1,199 | 2 | — | 1,201 | |||||||||||
Total marketable securities | $ | 196,785 | $ | 29 | $ | (117 | ) | $ | 196,697 | ||||||
December 31, 2014 | |||||||||||||||
Corporate bonds | $ | 99,592 | $ | 1 | $ | (119 | ) | $ | 99,474 | ||||||
Municipal bonds | 18,146 | 1 | (10 | ) | 18,137 | ||||||||||
Commercial paper | 9,196 | — | — | 9,196 | |||||||||||
Certificates of deposit | 498 | — | — | 498 | |||||||||||
Total marketable securities | $ | 127,432 | $ | 2 | $ | (129 | ) | $ | 127,305 | ||||||
We classify all marketable securities as current regardless of contractual maturity dates because we consider such investments to represent cash available for current operations.
As of September 30, 2015 and December 31, 2014, we did not consider any of our marketable securities to be other-than-temporarily impaired. When evaluating our investments for other-than-temporary impairment, we review factors such as the length of time and extent to which fair value has been below its cost basis, the financial condition of the issuer, our ability and intent to hold the security, and whether it is more likely than not that we will be required to sell the investment before recovery of its cost basis.
The following is a summary of amortized cost and estimated fair value of marketable securities as of September 30, 2015 and December 31, 2014, by maturity:
Amortized Cost | Gross Unrealized Gains | Gross Unrealized Losses | Estimated Fair Value | ||||||||||||
(in thousands) | |||||||||||||||
September 30, 2015 | |||||||||||||||
Due in one year or less | $ | 147,745 | $ | 13 | $ | (75 | ) | $ | 147,683 | ||||||
Due after one year | 49,040 | 16 | (42 | ) | 49,014 | ||||||||||
Total marketable securities | $ | 196,785 | $ | 29 | $ | (117 | ) | $ | 196,697 | ||||||
December 31, 2014 | |||||||||||||||
Due in one year or less | $ | 127,029 | $ | 2 | $ | (129 | ) | $ | 126,902 | ||||||
Due after one year | 403 | — | — | 403 | |||||||||||
Total marketable securities | $ | 127,432 | $ | 2 | $ | (129 | ) | $ | 127,305 | ||||||
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5. Fair Value Measurements
As of September 30, 2015 and December 31, 2014, the fair value of our financial assets was as follows:
Level 1 | Level 2 | Level 3 | Total | ||||||||||||
(in thousands) | |||||||||||||||
September 30, 2015 | |||||||||||||||
Assets: | |||||||||||||||
Money market funds (1) | $ | 18,085 | $ | — | $ | — | $ | 18,085 | |||||||
Corporate bonds (2) | — | 131,630 | — | 131,630 | |||||||||||
Municipal bonds (2) | — | 17,970 | — | 17,970 | |||||||||||
Commercial paper (3) | — | 46,171 | — | 46,171 | |||||||||||
Certificates of deposit (2) | — | 2,492 | — | 2,492 | |||||||||||
Agency securities (2) | — | 7,286 | — | 7,286 | |||||||||||
Government securities (2) | — | 1,201 | — | 1,201 | |||||||||||
Total assets measured at fair value | $ | 18,085 | $ | 206,750 | $ | — | $ | 224,835 | |||||||
December 31, 2014 | |||||||||||||||
Assets: | |||||||||||||||
Money market funds (1) | $ | 11,903 | $ | — | $ | — | $ | 11,903 | |||||||
Corporate bonds (2) | — | 99,474 | — | 99,474 | |||||||||||
Municipal bonds (2) | — | 18,137 | — | 18,137 | |||||||||||
Commercial paper (4) | — | 54,399 | — | 54,399 | |||||||||||
Certificates of deposit (2) | — | 498 | — | 498 | |||||||||||
Total assets measured at fair value | $ | 11,903 | $ | 172,508 | $ | — | $ | 184,411 | |||||||
(1) | Classified in cash and cash equivalents |
(2) | Classified in marketable securities |
(3) | Includes commercial paper with maturities of three months or less at time of purchase of $10.1 million classified in cash and cash equivalents and commercial paper with maturities of greater than three months of $36.1 million classified in marketable securities. |
(4) | Includes commercial paper with maturities of three months or less at time of purchase of $45.2 million classified in cash and cash equivalents and commercial paper with maturities of greater than three months of $9.2 million classified in marketable securities. |
6. Financing Arrangements
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 L/C issuer, 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, 2015, we had no debt outstanding under our Senior Credit Facility. For the nine-month period ended September 30, 2015, we incurred unused commitment fees of $0.1 million, which are included in interest expense in the 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.
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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, 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.
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.
On November 6, 2015, we entered into a First Amendment and Consent to our Senior Credit Facility (the “First Amendment”).
The First Amendment modifies the calculation of cash EBITDA under the Senior Credit Facility to exclude up to $130 million of expenses related to the proposed settlements with the FTC and representatives of a national class of consumers, potential settlements with certain states' attorneys general and fees incurred in relation to the litigation and potential settlements.
In addition, pursuant to the First Amendment, through the end of the fourth full fiscal quarter ending after the date on which the courts have approved the settlement agreements with the FTC and the national class of consumers (the “Settlement Date”), we are required to comply with certain additional financial and reporting covenants in the Senior Credit Facility.
Further, until the later of the one year anniversary of the Settlement Date, and the date on which we have received court approval with at least 50% of the state attorney generals that have proceedings currently pending or initiated on or before November 6, 2016 related to the issues presented in the FTC Order, if any, the revolving line of credit under the Senior Credit Facility is limited to letters of credit in the ordinary course of business not to exceed $2 million in the aggregate at any one time and certain permitted acquisitions of up to $25 million in the aggregate, unless a higher amount is consented to by the holders of 66 2/3% of the aggregate revolving commitments.
Pursuant to terms of the First Amendment, we are also subject to additional limitations and conditions on acquisitions and making certain types of payments (including dividends, redemptions or other distributions) with respect to our equity interests.
At September 30, 2015 we were in compliance with all the covenants of the Senior Credit Facility.
As of September 30, 2015, we had an outstanding letter of credit in the amount of $0.3 million.
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7. Stockholders’ Equity
Share-Based Compensation
We issue share-based awards to our employees in the form of stock options, restricted stock units, and restricted stock. We also have an Employee Stock Purchase Plan, or ESPP. The following table summarizes the components of share-based compensation expense included in our condensed consolidated statements of operations:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2015 | 2014 | 2015 | 2014 | ||||||||||||
(in thousands) | |||||||||||||||
Cost of services | $ | 449 | $ | 334 | $ | 1,286 | $ | 910 | |||||||
Sales and marketing | 1,238 | 761 | 3,385 | 2,235 | |||||||||||
Technology and development | 2,514 | 867 | 6,226 | 3,766 | |||||||||||
General and administrative | 3,662 | 2,340 | 9,390 | 6,318 | |||||||||||
Total share-based compensation | $ | 7,863 | $ | 4,302 | $ | 20,287 | $ | 13,229 | |||||||
Unrecognized share-based compensation expenses totaled $86.9 million as of September 30, 2015, which we expect to recognize over a weighted-average time period of 3.10 years.
Stock Warrants
As of September 30, 2015, we had the following warrants to purchase common stock outstanding:
Expiration Date | Shares | Exercise Price | ||||
October 3, 2016 | 2,334,044 | 0.70 | ||||
8. Net Income (Loss) Per Share
We compute basic net income (loss) per share by dividing net loss by the weighted-average number of common shares outstanding for the period. We compute diluted net income (loss) per share giving effect to all potential dilutive common stock, including awards granted under our equity compensation plans and warrants to acquire common stock.
The following table sets forth the computation of basic and diluted net income (loss):
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2015 | 2014 | 2015 | 2014 | ||||||||||||
(in thousands, except share and per share data) | |||||||||||||||
Net income (loss) | $ | (65,145 | ) | $ | 5,450 | (73,783 | ) | (343 | ) | ||||||
Denominator (basic): | |||||||||||||||
Weighted average common shares outstanding | 95,340,136 | 92,924,516 | 94,659,931 | 92,436,628 | |||||||||||
Denominator (diluted): | |||||||||||||||
Weighted average common shares outstanding | 95,340,136 | 92,924,516 | 94,659,931 | 92,436,628 | |||||||||||
Dilutive stock options outstanding | — | 3,136,115 | — | — | |||||||||||
Dilutive restricted stock units and awards | — | 152,357 | — | — | |||||||||||
Dilutive shares purchased under ESPP | — | 6,115 | — | — | |||||||||||
Weighted average common shares from warrants | — | 2,304,931 | — | — | |||||||||||
Net weighted average common shares outstanding | 95,340,136 | 98,524,034 | 94,659,931 | 92,436,628 | |||||||||||
Net income (loss) per share: | |||||||||||||||
Basic | $ | (0.68 | ) | $ | 0.06 | $ | (0.78 | ) | $ | (0.00 | ) | ||||
Diluted | $ | (0.68 | ) | $ | 0.06 | $ | (0.78 | ) | $ | (0.00 | ) | ||||
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Potentially dilutive securities, including common equivalent shares in which the exercise price together with other assumed proceeds exceed the average market price of common stock for the applicable period, were not included in the calculation of diluted net income (loss) per share as their impact would be anti-dilutive. The following weighted-average number of outstanding employee stock options, restricted stock units and restricted stock awards, warrants to purchase common stock, and shares purchased under our ESPP were excluded from the computation of diluted net income (loss) per share:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||
2015 | 2014 | 2015 | 2014 | ||||||||
Stock options outstanding | 10,328,593 | 5,817,422 | 8,876,984 | 7,229,252 | |||||||
Restricted stock units and restricted stock awards | 2,574,405 | 489,060 | 1,888,205 | 556,606 | |||||||
Common equivalent shares from stock warrants | 2,168,299 | — | 2,210,012 | 2,340,061 | |||||||
Shares purchased under ESPP | 54,271 | — | 67,858 | 13,088 | |||||||
15,125,568 | 6,306,482 | 13,043,059 | 10,139,007 | ||||||||
9. Income Taxes
Income taxes for the interim periods presented have been included in the accompanying condensed consolidated financial statements on the basis of an estimated annual effective tax rate. Based on an estimated annual effective tax rate and discrete items, the estimated income tax benefit for the three- and nine-month periods ended September 30, 2015 was $22.1 million and $27.8 million, respectively. The estimated income tax expense for the three-month period ended September 30, 2014 was $3,933, and the estimated income tax benefit for the nine-month period ended September 30, 2014 was $0.1 million. The determination of the interim period income tax provision utilizes the effective tax rate method, which requires us to estimate certain annualized components of the calculation of the income tax provision, including the annual effective tax rate by entity and jurisdiction.
We continually evaluate all positive and negative information to determine if our deferred tax assets are realizable in accordance with ASC 740-10-30, which states that "all available evidence shall be considered in determining whether a valuation allowance for deferred tax assets is needed". In October 2015, we reached proposed agreements with the staff of the Federal Trade Commission (“FTC”), which remains subject to approval by the Commission and entry by the court, and with representatives of a national class of consumers, which remains subject to approval by the court, on a comprehensive settlement resolving outstanding litigation relating to our past marketing representations and information security programs. As a result of these proposed settlements, as well as a reserve for potential settlements with certain states' attorneys general of $3 million, we accrued a settlement amount of $96 million in the three and nine month periods ended September 30, 2015. In the twelve month period ended December 31, 2014 we accrued $20 million based on discussions with the FTC at that time. As a result of the cumulative $116 million of accrued expenses related to the proposed settlements and potential settlements, we have three years of cumulative pre tax net losses. We reviewed the accrued expense, including performing an analysis of the proposed settlements, and determined that it was non-recurring in nature, not indicative of future performance and as such would not materially affect our ability to generate taxable income in the future. In addition to excluding the impact of the non-recurring accrued expenses for the proposed settlements we have seen improving pre-tax book income over the past 5 years and we expect to continue generating pre-tax book income. As a result of the consideration of the factors discussed above, we believe that it is more likely than not that we will be able to realize our net deferred tax assets not currently subject to a valuation allowance.
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10. Segment Reporting
We operate our business and our Chief Operating Decision Maker, or CODM, who is our Chief Executive Officer, reviews and assesses our operating performance using two reportable segments: our consumer segment and our enterprise segment. In our consumer segment, we offer proactive identity theft protection services to consumers on an annual or monthly subscription basis. In our enterprise segment, we offer consumer risk management services to our enterprise customers.
Financial information about our segments for the three-month period ended September 30, 2015 and as of September 30, 2015 was as follows:
Consumer | Enterprise | Eliminations | Total | ||||||||||||
(in thousands) | |||||||||||||||
Revenue | |||||||||||||||
External customers | $ | 144,648 | $ | 7,304 | $ | — | $ | 151,952 | |||||||
Intersegment revenue | — | 2,068 | (2,068 | ) | — | ||||||||||
Income (loss) from operations | (84,249 | ) | (3,101 | ) | — | (87,350 | ) | ||||||||
Goodwill | 112,602 | 59,537 | — | 172,139 | |||||||||||
Total assets | 561,812 | 101,761 | (674 | ) | 662,899 | ||||||||||
Financial information about our segments during the nine-month period ended September 30, 2015 was as follows:
Consumer | Enterprise | Eliminations | Total | ||||||||||||
(in thousands) | |||||||||||||||
Revenue | |||||||||||||||
External customers | $ | 411,178 | $ | 20,139 | $ | — | $ | 431,317 | |||||||
Intersegment revenue | — | 6,232 | (6,232 | ) | — | ||||||||||
Loss from operations | (90,456 | ) | (11,161 | ) | — | (101,617 | ) | ||||||||
Financial information about our segments for the three-month period ended September 30, 2014 and as of December 31, 2014 was as follows:
Consumer | Enterprise | Eliminations | Total | ||||||||||||
(in thousands) | |||||||||||||||
Revenue | |||||||||||||||
External customers | $ | 116,115 | $ | 6,916 | $ | — | $ | 123,031 | |||||||
Intersegment revenue | — | 1,718 | (1,718 | ) | — | ||||||||||
Income (loss) from operations | 12,703 | (3,170 | ) | — | 9,533 | ||||||||||
Goodwill | 99,805 | 59,537 | — | 159,342 | |||||||||||
Total assets | 455,035 | 108,905 | (624 | ) | 563,316 | ||||||||||
Financial information about our segments for the nine-month period ended September 30, 2014 was as follows:
Consumer | Enterprise | Eliminations | Total | ||||||||||||
(in thousands) | |||||||||||||||
Revenue | |||||||||||||||
External customers | $ | 326,448 | $ | 19,882 | $ | — | $ | 346,330 | |||||||
Intersegment revenue | — | 4,868 | (4,868 | ) | — | ||||||||||
Loss from operations | 11,292 | (11,525 | ) | — | (233 | ) | |||||||||
We derive all of our revenue from sales in the United States, and substantially all of our long-lived assets are located in the United States.
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11. Contingencies
As part of our consumer services, we offer 24x7x365 member service support. If a member’s identity has been compromised, our member service team and remediation specialists will assist the member until the issue has been resolved. This includes our $1 million service guarantee, which is backed by an identity theft insurance policy, under which we will spend up to $1 million to cover certain third-party costs and expenses incurred in connection with the remediation, such as legal and investigatory fees. This insurance also covers certain out-of-pocket expenses, such as loss of income, replacement of fraudulent withdrawals, and costs associated with child and elderly care, travel, stolen purse/wallet, and replacement of documents. While we have reimbursed members for claims under this guarantee, the amounts in aggregate for the three- and nine-month periods ended September 30, 2015 and 2014 were not material.
In 2010, we entered into a consent decree (the “FTC Order”) with the Federal Trade Commission ("FTC"). On July 21 2015, the FTC initiated a contempt action alleging that we had violated the FTC Order. Federal Trade Commission v. LifeLock, Inc., et al., No. CV-10-00530-PHX-JJT (D. Ariz.). On January 19, 2015 a putative class action, Napoleon Ebarle et al. v. LifeLock, Inc., No. 3:15-cv-258 (N.D. Cal.), was filed against us on behalf of all LifeLock members from September 1, 2010 to the present alleging that we misrepresented our services in various ways and failed to deliver certain promised services (the "Ebarle Class Action").
On October 28, 2015, we signed an offer of settlement that we negotiated with FTC staff to present to the FTC to resolve the contempt allegations. The offer remains subject to the FTC’s approval and entry by the court. On November 3, 2015, we signed an agreement to settle the Ebarle Class Action and release all of the class’s related claims. The Ebarle Class Action settlement remains subject to court approval. On November 4, 2015, the plaintiffs filed a motion for preliminary approval. A hearing on the motion for preliminary approval is currently scheduled for December 17, 2015. As of September 30, 2015, we have accrued $113.0 million for these two matters based on the proposed settlement agreements.
In 2010, at the same time we entered into the FTC Order, we entered into companion orders with 35 states' attorneys general that imposed on us similar injunctive provisions as the FTC Order relating to our advertising and marketing of our identity theft protection services. At this stage, no states' attorneys general have initiated proceedings against us alleging that we violated the companion orders from 2010. However, in light of our initial discussions with several states' attorneys general, we have accrued $3 million for a potential settlement with certain states' attorneys general to resolve allegations that we violated the companion orders from 2010. The ultimate resolution of the matter with the states' attorneys general is uncertain and may involve a materially higher settlement than $3 million.
On January 29, 2015, plaintiff Etan Goldman filed a California putative consumer class action complaint against us in Santa Clara Superior Court in San Jose, California. The complaint alleges that we violated California’s Automatic Renewal Law and Unfair Competition Law by failing to provide required disclosures concerning our auto renewal terms and cancellation policies. The complaint also seeks certification of a class consisting of all persons in California who had purchased subscriptions to identity theft protection services from us since December 1, 2010, injunctive relief, compensatory damages, restitution, and attorneys’ fees and costs. On May 15, 2015, the parties executed a class-wide settlement agreement. On July 24, 2015, the Court preliminarily approved the settlement. If the settlement is finally approved, current and former LifeLock members with a California billing address who were enrolled in a LifeLock protection plan or subscription service between December 1, 2010, and July 24, 2015, and paid one or more auto renewed monthly or annual membership fees will automatically receive a cash payment, unless they opt-out of the settlement. Notice of the settlement has been distributed to the class. Class members have until November 23, 2015, to object to the Settlement or opt-out of the Settlement. The final approval hearing is currently scheduled for February 5, 2016. As of September 30, 2015, we have accrued $2.5 million for this matter based on the proposed settlement agreement.
On August 1, 2014, our subsidiaries Lemon and Lemon Argentina, S.R.L. (Lemon Argentina, and together, the Lemon Entities) filed a lawsuit in Santa Clara Superior Court in San Jose, California, against Wenceslao Casares, former General Manager of Lemon, Cynthia McAdam, former General Counsel of Lemon, and Federico Murrone, Martin Apesteguia and Fabian Cuesta, each a former employee and former member of the Board of Directors of Lemon Argentina (the “Argentine Executives”). The complaint alleges breaches of employment-related contracts and breaches of fiduciary duty involving each named individual’s work for third-party Xapo, Inc. and/or Xapo, Ltd. during their employment by the applicable Lemon Entity. The parties, including the Argentine Executives, engaged in mediation in August 2014 in Buenos Aires, Argentina, and again in December 2014 in San Francisco, California, but were unable to settle any claims. On January 30, 2015, the Lemon Entities filed a second amended complaint alleging breaches of employment-related contracts, breaches of fiduciary duties, and fraud, and seeking declatory relief against Mr. Casares, Ms. McAdam, and the Argentine Executives. Mr. Casares and Ms. McAdam demurred to the Second Amended Complaint on May 1, 2015, which the court overruled in its entirety on July 2, 2015. Mr. Casares and Ms. McAdam answered the Second Amended Complaint on July 24, 2015 and are currently participating in active written discovery with the Lemon Entities. The Argentine Executives entered their appearances in the litigation on July 24, 2015. They filed a motion to dismiss for inconvenient forum on September 8, 2015, set to be heard on December 4, 2016.
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Mr. Casares also filed a cross-claim against us and Lemon, Inc. (now Lemon, LLC) on July 24, 2015, for breach of contract, breach of the implied covenant of good faith and fair dealing, conversion, unjust enrichment, and declaratory relief, all arising from the termination of his employment. He filed an amended cross-claim asserting the same causes of action on September 22, 2015. We, along with Lemon, LLC, filed a motion to dismiss the amended cross-claim on October 22, 2015.
Mr. Casares filed a separate complaint against us, Lemon, LLC, and Shareholder Representative Services LLC (“SRS”) in Delaware Chancery Court on October 7, 2015 for breach of contract and seeking a declaratory judgment. The action concerns a December 12, 2014 settlement agreement that resolved certain disputes against other former shareholders of Lemon, Inc. arising out of the our December 11, 2013 Lemon acquisition. We, along with Lemon, LLC, moved to dismiss the complaint on October 28, 2015. We have been informed that SRS sought and received an extension of time to respond to the complaint on or before November 9, 2015.
On July 22, 2015, Miguel Avila, representing himself and seeking to represent a class of persons who acquired our securities from July 30, 2014 to July 20, 2015, inclusive, filed a class action complaint in the United States District Court for the District of Arizona. His complaint alleges that our CEO, our CFO, and we violated Sections 10(b) and 20(a) of the Securities Exchange Act by making materially false or misleading statements, or failing to disclose material facts about the Company’s business, operations, and prospects, including with regard to our information security program, advertising, recordkeeping, and our compliance with the FTC Order. The complaint seeks certification as a class action, compensatory damages, and attorney’s fees and costs. On September 21, 2015, four other Company stockholders, Oklahoma Police Pension and Retirement System, Oklahoma Firefighters Pension and Retirement System, Larisa Gassel, and Donna Thompson, and their respective attorneys all filed motions seeking to be appointed the lead plaintiff and lead counsel in this class action. On October 9, 2015, the Court appointed Oklahoma Police Pension and Retirement System and Oklahoma Firefighters Pension and Retirement System as Lead Plaintiffs. On October 19, 2015, the Court entered a scheduling order pursuant to which Lead Plaintiffs will file an amended complaint by December 10, 2015, and we, along with our CEO and CFO, will file a motion to dismiss that complaint by January 29, 2016.
On September 23, 2015, Sridhar Manthangodu, a stockholder of the Company, filed a derivative complaint captioned Manthangodu v. Davis, et al., in the Superior Court of the State of Arizona, Maricopa County. This derivative complaint, purportedly filed on our behalf (the Company is named as a nominal defendant in the action), alleges that certain of our directors (the “Director Defendants”) violated their fiduciary duties to LifeLock stockholders (and or aided and abetted in the violation of same) by failing to ensure that the we complied with the FTC Order. According to the complaint, the Director Defendants’ alleged breach of their fiduciary oversight duties has exposed us to “material liability,” because we must defend against the FTC’s July 21, 2015 motion seeking to hold us in contempt of the FTC Order, and the shareholder securities class action filed on July 22, 2015 discussed above. The complaint seeks unspecified monetary damages, a return to the Company of all personal compensation received by the Director Defendants, as well as unspecified corporate governance reforms. On October 16, 2015, the parties jointly moved for a transfer of this matter to the Commercial Court of Maricopa County Superior Court. On October 20, 2015, that motion was granted and the action was transferred to the Commercial Court. We anticipate filing a Joint Pre-Trial Report and Proposed Scheduling Order soon.
On October 28, 2015, Larisa Gassel, a stockholder of the Company, filed a derivative complaint captioned Gassel v. Davis, et al., in the United States District Court for the District of Arizona. This derivative complaint was purportedly filed on our behalf (the Company is named as a nominal defendant in the action), against certain of our directors (the “Individual Defendants”). The complaint alleges that the Individual Defendants violated their fiduciary duties to LifeLock stockholders (and/ or aided and abetted or conspired to commit such violations) by making materially false or misleading statements, or failing to disclose material facts regarding our business, operations, and prospects, including with regard to certain of our services, our data security program, and our compliance with the FTC Order, in certain public statements made by us, our CEO, and CFO during the period July 30, 2014 through April 30, 2015. Based on these same allegations, the complaint also makes claims of gross mismanagement, abuse of control, and unjust enrichment against the Individual Defendants. According to the complaint, the Individual Defendants’ conduct has damaged us through costs associated with the defense of the securities class actions discussed above and the compensation and benefits provided to the Individual Defendants, as well as through loss of reputation and goodwill. The complaint seeks unspecified monetary damages, unspecified restitution to the Company from the Individual Defendants, certain corporate governance reforms, and attorneys’ fees and costs. As this action was very recently filed, there has been no significant activity in the case to date.
We are subject to other legal proceedings and claims that have arisen in the ordinary course of business. Although there can be no assurance as to the ultimate disposition of these matters, we believe, based upon the information available at this time, that, except as disclosed above, a material adverse outcome related to the matters is neither probable nor estimable.
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Item 2. | Management's Discussion and Analysis of Financial Condition and Results of Operations |
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 2014 Form 10-K. 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 and our 2014 Form 10-K. 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.
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 monitoring identity-related events, such as new account openings and credit-related applications. If we detect that someone is using a member’s personally identifiable information, we offer notifications and alerts, including actionable alerts for new account openings and applications, in order to 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 take actions designed to help protect the member’s identity and help determine whether there has been an identity theft. In the event that an identity theft has actually occurred, we can take actions designed to help restore the member’s identity through our remediation services. Our remediation service team works directly with government agencies, merchants, and creditors to remediate the impact of the identity theft event utilizing our remediation expertise on behalf of our members. We protect our enterprise customers by delivering on-demand identity risk, identity-authentication, and credit 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 identity theft protection 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, as well as our comprehensive transaction and new account alerting, remediation services, and $1 million service guarantee backed by an identity theft insurance policy, 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.
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 launched 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
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as incentives to 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. In December 2013, we acquired mobile wallet innovator Lemon and launched our LifeLock Wallet mobile 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 access to our identity theft protection services.
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 includes 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 sale 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 Business Model
We operate our business and our CODM, who is our CEO, reviews and assesses 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 we acquire 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.
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. Our enterprise customers typically provide us with their customer transaction data as part of our service, allowing us to build and refine our models without incurring significant third-party data expenses. We continually evaluate third-party data sources and acquire data from such sources when we believe such data will enhance the performance of our models. New customer acquisition is often a lengthy process. We make a significant investment in the sales team, including costs related to detailed retrospective data analysis to help demonstrate the return on investment to prospective customers had our services been deployed over a specific period of time. Because most of our enterprise business expenses are fixed, we typically incur modest incremental costs when we add new enterprise customers, 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.
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Key Operating Metrics
The following table summarizes our key operating metrics:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2015 | 2014 | 2015 | 2014 | ||||||||||||
(in thousands, except percentages and per member data) (Unaudited) | |||||||||||||||
Cumulative ending members | 4,080 | 3,524 | 4,080 | 3,524 | |||||||||||
Gross new members | 251 | 264 | 989 | 912 | |||||||||||
Member retention rate | 86.6 | % | 87.5 | % | 86.6 | % | 87.5 | % | |||||||
Average cost of acquisition per member | $ | 237 | $ | 184 | $ | 202 | $ | 173 | |||||||
Monthly average revenue per member | $ | 11.91 | $ | 11.22 | $ | 11.68 | $ | 11.02 | |||||||
Enterprise transactions | 74,280 | 66,104 | 208,324 | 173,360 | |||||||||||
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, because of a breach within the enterprise. Those enterprises embed our service within a broader third- party offering, or as an employee benefit paid for by the member's employer. We monitor cumulative ending members because it provides an indication of the revenue and expenses that we expect to recognize in the future.
As of September 30, 2015, our cumulative ending member base increased 16% year over year. Several factors drove this increase, 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. Gross new members decreased 5% for the three-month period ended September 30, 2015 compared to the same period last year. The decrease in our gross new members for the three-month period ended September 30, 2015 was driven by the announcement of the FTC litigation which impacted our marketing effectiveness. In light of the FTC announcement we also reduced our marketing in certain channels.
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Gross new members increased 8% for the nine-month period ended September 30, 2015 compared to the same period last year. The year over increase in gross new members for the nine-month period ended September 30, 2015 was primarily driven by the success of our marketing campaigns, our product enhancements, including the release of our new suite of products in July 2014, increased media attention to large data breaches, during the period and the growth in our employee benefit channel. The growth in gross new members was partially offset by a decrease in enrollments through our breach channel as we had several large breach contracts in the first half of 2014.
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. Similarly, for quarterly presentations, we use 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 whom 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 affect 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.
Our member retention rate as of September 30, 2015 was significantly impacted by the high number of cancellations of breach members during the first and second quarters of 2015, who enrolled in the first half of 2014. Our breach contracts typically have a one year term. The cancellation of these breach members are expected to have a similar impact on our member retention rate for the next few quarters. In addition we experienced a higher level of cancellations driven by the announcement of the FTC litigation during the three month period ended September 30, 2015, which had a negative impact on the member retention rate.
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 short-term cost of acquisition per member increases with the expectation that it will decrease over the long term. In addition, when we introduce new partnerships, such as partnerships in our embedded product channel, our average cost of acquisition per member may decrease 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. Our average cost of acquisition per member increased for the three and nine month periods ended September 30, 2015 when compared with the three and nine month periods ended September 30, 2014 due in part to the impact of the announcement of the FTC litigation on our marketing effectiveness. In addition we reduced certain marketing initiatives with several strategic partners in light of the FTC announcement, enrollments through
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these relationships with strategic partners are typically at a lower average cost of acquisition per member. In addition, our average cost of acquisition per member increased in the nine month period ended September 30, 2015 when compared to the nine month period ended September 30, 2014 due to the high level of breach enrollments in the nine month period ended September 30, 2014, which typically have a lower average cost of acquisition per member. 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. This 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 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.
Our monthly average revenue per member increased approximately 6% for the three- and nine-month periods ended September 30, 2015, compared to the same periods last year. The increases 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, 2015.
Enterprise transactions. Our enterprise transactions are processed by ID Analytics and are calculated as the total number of enterprise transactions processed for either an identity risk or credit risk score during the relevant period. 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.
Enterprise transactions increased 12% and 20% for the three- and nine-month periods ended September 30, 2015, compared to the same periods last year. Enterprise transactions increased as we continued to add new customers and expand our offerings with our current customer base.
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Key Financial Metrics
The following table summarizes our key financial metrics:
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2015 | 2014 | 2015 | 2014 | ||||||||||||
(in thousands) | |||||||||||||||
Consumer revenue | $ | 144,648 | $ | 116,115 | $ | 411,178 | $ | 326,448 | |||||||
Enterprise revenue | 7,304 | 6,916 | 20,139 | 19,882 | |||||||||||
Total revenue | 151,952 | 123,031 | 431,317 | 346,330 | |||||||||||
Adjusted net income | 27,579 | 15,909 | 32,323 | 19,455 | |||||||||||
Adjusted EBITDA | 29,797 | 17,929 | 39,314 | 25,255 | |||||||||||
Free cash flow | 18,378 | 22,653 | 68,302 | 61,004 | |||||||||||
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. For the nine-month period ended September 30, 2015, in addition to the legal reserve for a possible settlement with a class action lawsuit occurring in the first quarter of 2015, we have also excluded the impact of legal reserves for proposed settlement agreements with the FTC and representatives of a national class of consumers, and potential settlements with certain states' attorneys general. Beginning with the third quarter of the current fiscal year, we have also excluded the expenses for the FTC and related litigation. We have included adjusted net income in this Quarterly Report on Form 10-Q because it is a key measure we used 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 that 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. |
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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 September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2015 | 2014 | 2015 | 2014 | ||||||||||||
Reconciliation of Net Income (Loss) to Adjusted Net Income: | (in thousands) | ||||||||||||||
Net income (loss) | $ | (65,145 | ) | $ | 5,450 | $ | (73,783 | ) | $ | (343 | ) | ||||
Amortization of acquired intangible assets | 2,084 | 2,231 | 6,251 | 6,693 | |||||||||||
Share-based compensation | 7,863 | 4,302 | 20,287 | 13,229 | |||||||||||
Deferred income tax expense (benefit) | (22,075 | ) | 3,926 | (27,784 | ) | (124 | ) | ||||||||
Legal reserves and settlements | 96,000 | — | 98,500 | — | |||||||||||
Expenses related to the FTC litigation | 5,733 | — | 5,733 | — | |||||||||||
Acquisition related expenses | 3,119 | — | 3,119 | — | |||||||||||
Adjusted net income | $ | 27,579 | $ | 15,909 | $ | 32,323 | $ | 19,455 | |||||||
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. For the nine-month period ended September 30, 2015, in addition to the legal reserve for a possible settlement with a class action lawsuit occurring in the first quarter of 2015, we have also excluded the impact of legal reserves for proposed settlement agreements with the FTC and representatives of a national class of consumers, and potential settlements with certain states' attorneys general. Beginning with the third quarter of the current fiscal year, we have also excluded the expenses for the FTC and related litigation. 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 that 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. |
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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 September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2015 | 2014 | 2015 | 2014 | ||||||||||||
Reconciliation of Net Loss to Adjusted EBITDA: | (in thousands) | ||||||||||||||
Net income (loss) | $ | (65,145 | ) | $ | 5,450 | $ | (73,783 | ) | $ | (343 | ) | ||||
Depreciation and amortization | 4,432 | 4,094 | 13,292 | 12,259 | |||||||||||
Share-based compensation | 7,863 | 4,302 | 20,287 | 13,229 | |||||||||||
Interest expense | 89 | 89 | 265 | 264 | |||||||||||
Interest income | (219 | ) | (73 | ) | (498 | ) | (189 | ) | |||||||
Other expense | — | 134 | 183 | 151 | |||||||||||
Income tax expense (benefit) | (22,075 | ) | 3,933 | (27,784 | ) | (116 | ) | ||||||||
Legal reserves and settlements | 96,000 | — | 98,500 | — | |||||||||||
Expenses related to the FTC litigation | 5,733 | — | 5,733 | — | |||||||||||
Acquisition related expenses | 3,119 | — | 3,119 | — | |||||||||||
Adjusted EBITDA | $ | 29,797 | $ | 17,929 | $ | 39,314 | $ | 25,255 | |||||||
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. Additionally, we will add or deduct legal settlements received or paid, and beginning with the third quarter of the current fiscal year, we have also excluded expenses paid for the FTC and related litigation. 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 (used in) operating activities, we believe it typically presents a more conservative measure of cash flow as purchases of property and equipment are necessary 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. |
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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 September 30, | For the Nine Months Ended September 30, | ||||||||||||||
2015 | 2014 | 2015 | 2014 | ||||||||||||
Reconciliation of Net Cash Provided By Operating Activities to Free Cash Flow: | (in thousands) | ||||||||||||||
Net cash provided by operating activities | $ | 20,826 | $ | 26,118 | $ | 75,723 | $ | 72,131 | |||||||
Acquisitions of property and equipment | (4,084 | ) | (3,465 | ) | (9,057 | ) | (11,127 | ) | |||||||
Expenses paid for the FTC litigation | 1,636 | — | 1,636 | — | |||||||||||
Free cash flow | $ | 18,378 | $ | 22,653 | $ | 68,302 | $ | 61,004 | |||||||
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. Since releasing our Ultimate Plus and Advantage products in the third quarter 2014 we have continued to see over 40% of our new enrollments purchase these two premium products.
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 these customers would reduce the breadth and effectiveness of our services. In addition, less than 1% of our overall revenue for the nine-month period ended September 30, 2015 was derived from direct competitors to our consumer business. As we have given notice of non-renewal to competitors in our consumer segment, 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.
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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 affect our operating results. As previously disclosed in 2010 we entered into a consent decree (the “FTC Order”) with the Federal Trade Commission ("FTC"). On July 21 2015, the FTC initiated a contempt action alleging that LifeLock had violated the FTC Order. On October 28, 2015, LifeLock signed an offer of settlement that it negotiated with FTC staff to present to the FTC to resolve the contempt allegations. The offer remains subject to the FTC’s approval and entry by the court. In 2010, at the same time we entered into the FTC Order, we entered into companion orders with 35 states' attorneys general that imposed on us similar injunctive provisions as the FTC Order relating to our advertising and marketing of our identity theft protection services. At this stage, no states' attorneys general have initiated proceedings against us alleging that we violated the companion orders from 2010. The ultimate resolution of the matter with the states' attorneys general is uncertain and may involve a materially higher settlement than $3 million.
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 could 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 a discussion of additional factors and risks facing our business, see “Risk Factors” in our 2014 Form 10-K, our Form 10-Q for the quarter ended June 30, 2015, and Part II Item 1A. of this Form 10-Q for the quarter ended September 30, 2015.
Basis of Presentation and Key Components of Our Results of Operations
We operate our business and our CODM reviews and assesses 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 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 latter 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 fraud and risk solutions, which we generally 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.
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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.
Costs of services in our enterprise segment includes primarily wages and benefits of personnel, and the facility costs that are 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. Accordingly, 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. Our gross margin can also be affected by 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, sales taxes we paid on behalf of our members, and settlements with state tax authorities, also negatively affected our gross margin. Conversely, operating efficiencies in our member services organization can improve our gross margin. We expect our gross margin to 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. We expense advertising costs as incurred, and historically, they 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, for the near term, we expect our sales and marketing expenses will continue to increase in absolute dollars and vary as a percentage of revenue, depending on the timing of those expenses.
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 are 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.
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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, 2015, we had $32.1 in 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 $8.3 million of amortization expense in the year ending December 31, 2015.
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, 2015 and 2014, approximated the U.S. federal statutory tax rate plus the impact of state taxes and permanent and other temporary differences.
Results of Operations
Comparison of the Three- and Nine-Month Periods Ended September 30, 2015 and 2014
Total Revenue
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||||||||
2015 | 2014 | % Change | 2015 | 2014 | % Change | ||||||||||||||||
(in thousands) | |||||||||||||||||||||
Consumer revenue | $ | 144,648 | $ | 116,115 | 24.6 | % | $ | 411,178 | $ | 326,448 | 26.0 | % | |||||||||
Enterprise revenue | 7,304 | 6,916 | 5.6 | % | 20,139 | 19,882 | 1.3 | % | |||||||||||||
Total revenue | $ | 151,952 | $ | 123,031 | $ | 431,317 | $ | 346,330 | |||||||||||||
Consumer revenue increased $28.5 million and $84.7 million for the three- and nine-month periods ended September 30, 2015, respectively, compared to the same periods last year. The increases resulted primarily from the increase in the number of our members, which grew 16% to approximately 4.1 million as of September 30, 2015. In addition, our monthly average revenue per member increased 6% for the three- and nine-month periods ended September 30, 2015, compared to the same periods last year. 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.
Enterprise revenue increased $0.4 million and $0.3 million for the three- and nine-month periods ended September 30, 2015, respectively, compared to the same periods last year. The increases are attributable to the growth of our enterprise customer base and expansion of our offerings to our current customer base.
Cost of Services and Gross Profit
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||||||||
2015 | 2014 | % Change | 2015 | 2014 | % Change | ||||||||||||||||
(in thousands) | |||||||||||||||||||||
Cost of services | $ | 33,988 | $ | 30,327 | 12.1 | % | $ | 103,470 | $ | 89,675 | 15.4 | % | |||||||||
Percentage of revenue | 22.4 | % | 24.6 | % | 24.0 | % | 25.9 | % | |||||||||||||
Gross profit | 117,964 | 92,704 | 27.2 | % | 327,847 | 256,655 | 27.7 | % | |||||||||||||
Percentage of revenue | 77.6 | % | 75.4 | % | 76.0 | % | 74.1 | % | |||||||||||||
Gross profit increased $25.3 million and $71.2 million for the three- and nine-month periods ended September 30, 2015, respectively, compared to the same periods last year. The increases 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 profit percentage is primarily attributable to efficiencies in our member services organization and scalability within certain third-party fulfillment contracts as our member base continued to grow.
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Sales and Marketing
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||||||||
2015 | 2014 | % Change | 2015 | 2014 | % Change | ||||||||||||||||
(in thousands) | |||||||||||||||||||||
Sales and marketing | $ | 62,850 | $ | 51,818 | 21.3 | % | $ | 209,470 | $ | 166,710 | 25.6 | % | |||||||||
Percentage of revenue | 41.4 | % | 42.1 | % | 48.6 | % | 48.1 | % | |||||||||||||
Sales and marketing expenses increased $11.0 million and $42.8 million for the three- and nine-month periods ended September 30, 2015, respectively, compared to the same periods last year. The increases resulted from increased advertising expenses, external sales commissions, and personnel costs, including increased 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.
Technology and Development
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||||||||
2015 | 2014 | % Change | 2015 | 2014 | % Change | ||||||||||||||||
(in thousands) | |||||||||||||||||||||
Technology and development | $ | 19,396 | $ | 12,341 | 57.2 | % | $ | 52,928 | $ | 37,996 | 39.3 | % | |||||||||
Percentage of revenue | 12.8 | % | 10.0 | % | 12.3 | % | 11.0 | % | |||||||||||||
Technology and development expenses increased $7.1 million and $14.9 million for the three- and nine-month periods ended September 30, 2015, respectively, compared to the same periods last year. The increases resulted primarily from increased personnel costs, including non-cash share-based compensation, which were primarily the result of a reorganization of our product and technology group. Through that effort, we invested in new talent and in a geographic consolidation of our product teams. We also incurred $3.0 million in sign-on bonuses paid to the team of product and development data experts acquired from BitYota. In addition, we also made investments in product enhancements, security, infrastructure, and market research.
General and Administrative
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||||||||
2015 | 2014 | % Change | 2015 | 2014 | % Change | ||||||||||||||||
(in thousands) | |||||||||||||||||||||
General and administrative | $ | 120,984 | $ | 16,781 | 621.0 | % | $ | 160,815 | $ | 45,489 | 253.5 | % | |||||||||
Percentage of revenue | 79.6 | % | 13.6 | % | 37.3 | % | 13.1 | % | |||||||||||||
General and administrative expenses increased $104.2 million and $115.3 million for the three- and nine-month periods ended September 30, 2015, respectively, compared to the same periods last year. The increase relates primarily to $96 million of accrued expenses related to a proposed settlements with the FTC, and a national class of consumers to resolve outstanding litigation and a potential settlement with certain states' attorneys general. We also incurred $5.7 million of expenses related to the FTC litigation. In addition, in the first quarter of 2015, we resolved, subject to court approval, two of the California consumer class action lawsuits against previously filed against us, resulting in a total settlement accrual of $2.5 million. The increase in general and administrative expenses in the nine-month period ended September 30, 2015 is also attributable to additional costs associated with our regulatory compliance, the expansion of our office facilities, and additional personnel costs, including non-cash share-based compensation.
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Amortization of Acquired Intangible Assets
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||||||||
2015 | 2014 | % Change | 2015 | 2014 | % Change | ||||||||||||||||
(in thousands) | |||||||||||||||||||||
Amortization of acquired intangible assets | $ | 2,084 | $ | 2,231 | (6.6 | )% | $ | 6,251 | $ | 6,693 | (6.6 | )% | |||||||||
Percentage of revenue | 1.4 | % | 1.8 | % | 1.4 | % | 1.9 | % | |||||||||||||
Amortization of acquired intangible assets decreased $0.1 million and $0.4 million for the three- and nine-month periods ended September 30, 2015, respectively, compared to the same periods last year, due to certain acquired intangible assets being fully amortized in previous periods.
Other Income (Expense)
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||||||||
2015 | 2014 | % Change | 2015 | 2014 | % Change | ||||||||||||||||
(in thousands) | |||||||||||||||||||||
Interest expense | $ | (89 | ) | $ | (89 | ) | — | % | $ | (265 | ) | $ | (264 | ) | 0.4 | % | |||||
Interest income | 219 | 73 | 200.0 | % | 498 | 189 | 163.5 | % | |||||||||||||
Other | — | (134 | ) | (100.0 | )% | (183 | ) | (151 | ) | 21.2 | % | ||||||||||
Total other expense | $ | 130 | $ | (150 | ) | (186.7 | )% | $ | 50 | $ | (226 | ) | (122.1 | )% | |||||||
Other expense remained consistent in the the three- and nine-month periods ended September 30, 2015, compared to the same periods last year.
Income Tax Expense (Benefit)
For the Three Months Ended September 30, | For the Nine Months Ended September 30, | ||||||||||||||||||||
2015 | 2014 | % Change | 2015 | 2014 | % Change | ||||||||||||||||
(in thousands) | |||||||||||||||||||||
Income tax expense (benefit) | $ | (22,075 | ) | $ | 3,933 | (661.3 | )% | $ | (27,784 | ) | $ | (116 | ) | 23,851.7 | % | ||||||
Effective tax rate | 25.3 | % | 41.9 | % | 27.4 | % | 25.3 | % | |||||||||||||
As a result of the accrued expense for the two proposed settlements with the FTC and representatives of a national class of consumers and potential settlements with the State Attorney’s General, we are now forecasting a net loss for the year ending December 31, 2015. As such, we only recognize deferred tax assets to the extent of our expected full year losses. Therefore our rate in this quarter does not approximate the U.S. federal statutory tax rate plus the impact of state taxes.
Liquidity and Capital Resources
As of September 30, 2015, we had $135.5 million in cash and cash equivalents, which consisted of cash, money market funds, open commercial paper with original maturity dates of less than three months at the time of purchase, and municipal bonds with an original maturity date of less than three months at the time of purchase, and $196.7 million in marketable securities, which consisted of corporate bonds, municipal bonds, commercial paper, and certificates of deposit. We classify our marketable securities as short-term regardless of contractual maturity based on our ability to liquidate those investments for use in current operations. Additionally, we have a revolving line of credit, described below. We did not draw on the line of credit during the nine-month period ended September 30, 2015. As of September 30, 2015, we had no outstanding debt. We believe that our existing cash and cash equivalents and marketable securities together with cash generated from operations will be sufficient to fund our operations for at least the next 12 months, including amounts reserved for potential legal settlements. However, our future liquidity and capital requirements may vary materially from our expectations depending on many factors, including, but not limited to our revenues and gross margins, our cash flows from operations, the timing of payments with respect to the settlements, expenses and judgments related to our litigation matters, and the availability of our revolving line of credit. We may need to seek additional capital and such capital may not be available on terms acceptable to us or at all.
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Operating Activities
For the nine-month period ended September 30, 2015, operating activities generated $75.7 million in cash as a result of a net loss of $73.8 million, adjusted by non-cash items such as depreciation and amortization of $13.3 million, share-based compensation of $20.3 million, and an income tax benefit of $27.8 million. In addition we recognized an accrual of $96 million for the proposed settlements with the FTC and representatives of a national class of consumers along with potential settlements with certain states' attorneys general, none of which had been paid as of September 30, 2015. The ultimate resolution of the matter with the states' attorneys general is uncertain. We also had an increase in deferred revenue related to the overall growth of our business provided operating cash of $25.6 million and positive net operating cash flows of $19.4 million from other operating assets and liabilities.
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, and an 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 a decrease in operating cash as a result of changes in other operating assets and liabilities of $18.8 million.
Investing Activities
Our investing activities consist primarily of purchases and sales of marketable securities and purchases of property and equipment. For the nine-month period ended September 30, 2015, we acquired BitYota, Inc. for $12.8 million, used $9.1 million of cash to acquire property and equipment primarily attributable to the expansion of our office locations, invested a net $68.9 million of cash in marketable securities, and paid $4.3 million for premiums for company-owned life insurance policies. For the nine-month period ended September 30, 2014, we used $11.1 million of cash to acquire property and equipment, invested a net $61.3 million of cash in marketable securities, and paid $4.3 million for premiums for company-owned life insurance policies.
Financing Activities
Our financing activities consist primarily of net proceeds from stock option exercises, warrant exercises, and our stock purchase plan, and payments for employee withholding taxes related to net distributions of restricted stock units and restricted stock. For the nine-month period ended September 30, 2015, financing activities generated net cash of $8.4 million as a result of cash received from the exercise of stock options of $10.1 million, offset by $1.8 million paid for employee withholding tax related to net distributions of restricted stock units and restricted stock. 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 $0.7 million paid for employee withholding tax related to net distributions of restricted stock units.
Debt Obligations
Senior Credit Facility
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 L/C issuer, 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, 2015, we had no debt outstanding under our Senior Credit Facility. For the nine-month period ended September 30, 2015, we incurred unused commitment fees of $0.1 million, which are included in interest expense in the 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.
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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, 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.
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.
On November 6, 2015, we entered into a First Amendment and Consent to our Senior Credit Facility (the “First Amendment”).
The First Amendment modifies the calculation of cash EBITDA under the Senior Credit Facility to exclude up to $130 million of expenses related to the proposed settlements with the FTC and representatives of a national class of consumers, potential settlements with certain states' attorneys general and fees incurred in relation to the litigation and potential settlements.
In addition, pursuant to the First Amendment, through the end of the fourth full fiscal quarter ending after the date on which the courts have approved the settlement agreements with the FTC and the national class of consumers (the “Settlement Date”), we are required to comply with certain additional financial and reporting covenants in the Senior Credit Facility.
Further, until the later of the one year anniversary of the Settlement Date and the date on which we have received court approval with at least 50% of the state attorney generals that have proceedings pending or initiated on or before November 6, 2016 related to issues presented in the FTC Order, if any, the revolving line of credit under the Senior Credit Facility is limited to letters of credit in the ordinary course of business not to exceed $2 million in the aggregate at any one time and certain permitted acquisitions of up to $25 million in the aggregate, unless a higher amount is consented to by the holders of 66 2/3% of the aggregate revolving commitments.
Pursuant to terms of the First Amendment, the Company is also subject to additional limitations and conditions on making certain types of payments (including dividends, redemptions or other distributions) with respect to Company equity interests.
At September 30, 2015 we were in compliance with all the covenants of the Senior Credit Facility.
As of September 30, 2015, we had an outstanding letter of credit in the amount of $0.3 million.
Contractual Obligations
There were no material changes in our commitments under contractual obligations to those disclosed in our Form 10-K for the fiscal year ended December 31, 2014.
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.
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Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America. 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 2014 Form 10-K.
Item 3. | Quantitative and Qualitative Disclosures About Market Risk |
There have been no material changes in our primary market risk exposures or how we manage those exposures from the information disclosed in Part II, Item 7A of our 2014 Form 10-K. For further discussion of quantitative and qualitative disclosures about market risk, reference is made to our 2014 Form 10-K.
Item 4. | Controls and Procedures |
Evaluation of Disclosure Controls and Procedures
Management, together with our CEO and CFO, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our CEO and CFO concluded that, as of such date, our disclosure controls and procedures were effective as of September 30, 2015.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting identified in management's evaluation pursuant to Rules 13a-15(d) or 15d-15(d) of the Exchange Act during the period covered by this Quarterly Report on Form 10-Q that materially affected, or are reasonably likely to material affect, our internal control over financial reporting.
Limitations on Effectiveness of Controls and Procedures
Management, including our CEO and CFO, does not expect that our disclosure controls and procedures or our internal controls over financial reporting will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, misstatements, errors, and instances of fraud, if any, within our company have been or will be prevented or detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. Controls also can be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part on certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Projections of any evaluation of controls effectiveness to future periods are subject to risks that internal controls may become inadequate as a result of changes in conditions, or through the deterioration of the degree of compliance with policies or procedures.
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PART II - OTHER INFORMATION
Item 1. | Legal Proceedings |
On March 13, 2014, we received a request from the FTC for documents and information related to our compliance with the FTC Order. Prior to our receipt of the FTC’s request, we met with FTC Staff on January 17, 2014, 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 October 29, 2014, we completed our responses to the FTC’s March 13, 2014 request for information, and on January 5, 2015, we provided responses to subsequent FTC requests for additional information. On July 21, 2015 the FTC lodged, under seal, in the United States District Court for the District of Arizona, a motion seeking to hold us in contempt of the FTC Order. On October 28, 2015, we signed an offer of settlement with the FTC staff to present to the FTC to resolve the contempt allegations. The offer remains subject to the FTC's approval and entry by the court.
On January 19, 2015, plaintiffs Napoleon Ebarle and Jeanne Stamm filed a nationwide putative consumer class action lawsuit against us in the United States District Co. for the Northern District of California. The plaintiffs allege that we have engaged in deceptive marketing and sales practices in connection with our membership plans in violation of the Arizona Consumer Fraud Act and seek declaratory judgment under the Federal Declaratory Judgment Act. On March 27, 2015, plaintiffs filed an amended complaint, adding an additional plaintiff, Brian Litton, adding a breach of contract claim, and expanding the class period to include all members enrolled in one of the company’s identity theft protection plans since January 1, 2010, through the present. On November 3, 2015, LifeLock signed an agreement to settle the Ebarle Class Action and release all of the class’s related claims. The Ebarle Class Action settlement remains subject to court approval. On November 4, 2015, plaintiffs filed a motion for preliminary approval. A hearing on the motion for preliminary approval is currently scheduled for December 17, 2015.
On January 29, 2015, plaintiff Etan Goldman filed a California putative consumer class action complaint against us in Santa Clara Superior Court in San Jose, California. The complaint alleges that we violated California’s Automatic Renewal Law and Unfair Competition Law by failing to provide required disclosures concerning our auto renewal terms and cancellation policies. The complaint also seeks certification of a class consisting of all persons in California who had purchased subscriptions to identity theft protection services from us since December 1, 2010, injunctive relief, compensatory damages, restitution, and attorneys’ fees and costs. On May 15, 2015, the parties executed a class-wide settlement agreement. On July 24, 2015, the Court preliminarily approved the settlement. If the settlement is finally approved, current and former LifeLock members with a California billing address who were enrolled in a LifeLock protection plan or subscription service between December 1, 2010, and July 24, 2015, and paid one or more auto renewed monthly or annual membership fees will automatically receive a cash payment, unless they opt-out of the settlement. Notice of the settlement has been distributed to the class. Class members have until November 23, 2015, to object to the Settlement or opt-out of the Settlement. The final approval hearing is currently scheduled for February 5, 2016.
On March 20, 2014, Michael D. Peters filed a complaint in United States District Court for the District of Arizona against us, Kim Jones, and Cristy Schaan. Mr. Peters’ claim against Mr. Jones, who is not affiliated with us, and Ms. Schaan, who was our Chief Information Security Officer, are no longer pending in the case due to a settlement between Mr. Peters and Mr. Jones and the court’s dismissal of Mr. Peters’ claim against Ms. Schaan. In his complaint, Mr. Peters alleges that we violated the whistleblower protection provisions of the Sarbanes-Oxley Act and the Dodd-Frank Act by terminating Mr. Peters' employment as a result of alleged disclosures that he made to us. Mr. Peters' complaint seeks two times his back pay, two times the value of certain stock options and bonus, moving expenses, damages for emotional harm and anxiety, damages for harm to reputation, litigation costs including attorneys' fees, and interest. On April 21, 2014, we filed an answer, affirmative defenses, and counterclaims, answering Mr. Peters' claim under the Sarbanes-Oxley Act and asserting counterclaims against Mr. Peters for fraud, negligent misrepresentation, breach of contract, and unjust enrichment, based on our allegations that we were induced to hire Mr. Peters by his false statements and misrepresentations regarding his employment history and seeking to recover actual and consequential damages, punitive damages, attorneys' fees, and the signing bonus paid to Mr. Peters. Mr. Peters answered our counterclaims on May 7, 2014. On April 21, 2014, we also filed a motion to dismiss Mr. Peters' claim under the Dodd-Frank Act. On June 2, 2014, Mr. Peters filed a motion for judgment on the pleadings directed to our unjust enrichment counterclaim, one of the four counterclaims we brought against Mr. Peters. The court ruled on all of the pending motions on September 19, 2014, denying our motion and the motion filed by Mr. Peters. On October 3, 2014, we filed an amended answer responding to both of the claims Mr. Peters asserted against us. On January 22, 2015, the court entered a scheduling order containing certain deadlines for the case, including the completion of all discovery by October 30, 2015, the filing of any dispositive motions by December 4, 2015, and the filing of certain pre-trial submissions by March 4, 2016. On October 28, 2015, we entered into a Settlement Agreement and Mutual Release of Claims with Mr. Peters that resolves the case in its entirety and provides for the case, including all claims and counterclaims, to be dismissed with prejudice no later than early December.
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On August 1, 2014, our subsidiaries Lemon and Lemon Argentina, S.R.L. (Lemon Argentina, and together, the Lemon Entities) filed a lawsuit in Santa Clara Superior Court in San Jose, California, against Wenceslao Casares, former General Manager of Lemon, Cynthia McAdam, former General Counsel of Lemon, and Federico Murrone, Martin Apesteguia and Fabian Cuesta, each a former employee and former member of the Board of Directors of Lemon Argentina (the “Argentine Executives”). The complaint alleges breaches of employment-related contracts and breaches of fiduciary duty involving each named individual’s work for third-party Xapo, Inc. and/or Xapo, Ltd. during their employment by the applicable Lemon Entity. The parties, including the Argentine Executives, engaged in mediation in August 2014 in Buenos Aires, Argentina, and again in December 2014 in San Francisco, California, but were unable to settle any claims. On January 30, 2015, the Lemon Entities filed a second amended complaint alleging breaches of employment-related contracts, breaches of fiduciary duties, and fraud, and seeking declatory relief against Mr. Casares, Ms. McAdam, and the Argentine Executives. Mr. Casares and Ms. McAdam demurred to the Second Amended Complaint on May 1, 2015, which the court overruled in its entirety on July 2, 2015. Mr. Casares and Ms. McAdam answered the Second Amended Complaint on July 24, 2015 and are currently participating in active written discovery with the Lemon Entities. The Argentine Executives entered their appearances in the litigation on July 24, 2015. They filed a motion to dismiss for inconvenient forum on September 8, 2015, set to be heard on December 4, 2016.
Mr. Casares also filed a cross-claim against us and Lemon, Inc. (now Lemon, LLC) on July 24, 2015, for breach of contract, breach of the implied covenant of good faith and fair dealing, conversion, unjust enrichment, and declaratory relief, all arising from the termination of his employment. He filed an amended cross-claim asserting the same causes of action on September 22, 2015. We, along with Lemon, LLC, filed a motion to dismiss the amended cross-claim on October 22, 2015.
Mr. Casares filed a separate complaint against us, Lemon, LLC, and Shareholder Representative Services LLC (“SRS”) in Delaware Chancery Court on October 7, 2015 for breach of contract and seeking a declaratory judgment. The action concerns a December 12, 2014 settlement agreement that resolved certain disputes against other former shareholders of Lemon, Inc. arising out of our December 11, 2013 Lemon acquisition. We, along with Lemon, LLC, moved to dismiss the complaint on October 28, 2015. We have been informed that SRS sought and received an extension of time to respond to the complaint on or before November 9, 2015.
On July 22, 2015, Miguel Avila, representing himself and seeking to represent a class of persons who acquired our securities from July 30, 2014 to July 20, 2015, inclusive, filed a class action complaint in the United States District Court for the District of Arizona. His complaint alleges that our CEO, our CFO, and we violated Sections 10(b) and 20(a) of the Securities Exchange Act by making materially false or misleading statements, or failing to disclose material facts about our business, operations, and prospects, including with regard to our information security program, advertising, recordkeeping, and our compliance with the FTC Order. The complaint seeks certification as a class action, compensatory damages, and attorney’s fees and costs. On September 21, 2015, four other Company stockholders, Oklahoma Police Pension and Retirement System, Oklahoma Firefighters Pension and Retirement System, Larisa Gassel, and Donna Thompson, and their respective attorneys all filed motions seeking to be appointed the lead plaintiff and lead counsel in this class action. On October 9, 2015, the Court appointed Oklahoma Police Pension and Retirement System and Oklahoma Firefighters Pension and Retirement System as Lead Plaintiffs. On October 19, 2015, the Court entered a scheduling order pursuant to which Lead Plaintiffs will file an amended complaint by December 10, 2015, and we, along with our CEO and CFO, will file a motion to dismiss that complaint by January 29, 2016.
On March 3, 2014, and March 10, 2014, two securities class action complaints were filed in the United States District Court for the District of Arizona, against us, our CEO, and our CFO, for alleged violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. On June 16, 2014, the court consolidated the complaints into a single action captioned In re LifeLock, Inc. Securities Litigation and appointed a lead plaintiff and lead counsel. On August 15, 2014, the lead plaintiff filed the Consolidated Amended Class Action Complaint, or the Consolidated Amended Complaint, seeking to represent a class of persons who acquired our securities from February 26, 2013 to May 16, 2014, inclusive, or the Class Period. The Consolidated Amended Complaint alleged that we, along with our CEO, our CFO, and our President, violated Sections 10(b) and 20(a) of the Exchange Act by making materially false or misleading statements, or failing to disclose material facts regarding certain of our business, operational, and compliance policies, including with regard to certain of our services, our data security program, and our CEO’s compliance with the FTC Order. The Consolidated Amended Complaint alleged that, as a result, certain of our financial statements issued during the Class Period and certain public statements made by our President, our CEO, and our CFO during the Class Period, were false and misleading. The Consolidated Amended Complaint sought certification as a class action, compensatory damages, and attorneys’ fees and costs. On September 15, 2014, we, along with our President, our CEO, and our CFO, filed a motion to dismiss the Consolidated Amended Complaint. On December 17, 2014, the court dismissed the Consolidated Amended Complaint and gave the lead plaintiff 21 days to seek leave to amend. The lead plaintiff filed his Second Consolidated Amended Complaint on January 16, 2015. It contained similar allegations, but no longer named our President as a defendant. On January 30, 2015, we, along with our CEO and our CFO, filed a motion to dismiss the Second Consolidated Amended Complaint. On July 21, 2015, the court granted the motion to dismiss, without leave to amend, and entered judgment in our favor. On August 18, 2015, the lead plaintiff along with another shareholder, City of Hallandale Beach Police and Firefighters’ Personnel Retirement Fund, moved to vacate the judgment on the grounds that the FTC’s July 21, 2015 motion
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seeking to hold us in contempt of the FTC Order constituted surprise and newly discovered evidence. Plaintiffs also sought permission to file a Third Consolidated Amended Complaint. We, our CEO, and our CFO opposed plaintiffs’ motion. On September 18, 2015, the court denied plaintiffs’ motion to vacate the July 21, 2015 judgment and plaintiffs’ request to file another complaint.
On September 21, 2015, plaintiffs filed a notice of appeal with the Ninth Circuit Court of Appeals. Plaintiffs appeal from the lower court’s July 21, 2015 order dismissing the Second Consolidated Amended Complaint and entering judgment in our favor, and the court’s September 18, 2015 order denying plaintiffs’ motion to vacate that judgment. Pursuant to the appellate court’s scheduling order, the parties’ briefing of this appeal will be completed by February 16, 2016.
On September 23, 2015, Sridhar Manthangodu, a stockholder of ours, filed a derivative complaint captioned Manthangodu v. Davis, et al., in the Superior Court of the State of Arizona, Maricopa County. This derivative complaint, purportedly filed on our behalf (we are named as a nominal defendant in the action), alleges that certain of our directors (the “Director Defendants”) violated their fiduciary duties to LifeLock stockholders (and or aided and abetted in the violation of same) by failing to ensure that the we complied with the FTC Order. According to the complaint, the Director Defendants’ alleged breach of their fiduciary oversight duties has exposed us to “material liability,” because we must defend against the FTC’s July 21, 2015 motion seeking to hold us in contempt of the FTC Order, and the shareholder securities class action filed on July 22, 2015 discussed above. The complaint seeks unspecified monetary damages, a return to the company of all personal compensation received by the Director Defendants, as well as unspecified corporate governance reforms. On October 16, 2015, the parties jointly moved for a transfer of this matter to the Commercial Court of Maricopa County Superior Court. On October 20, 2015, that motion was granted and the action was transferred to the Commercial Court. We anticipate filing a Joint Pre-Trial Report and Proposed Scheduling Order soon.
On October 28, 2015, Larisa Gassel, a stockholder of ours, filed a derivative complaint captioned Gassel v. Davis, et al., in the United States District Court for the District of Arizona. This derivative complaint was purportedly filed on our behalf (we are named as a nominal defendant in the action), against certain of our directors (the “Individual Defendants”). The complaint alleges that the Individual Defendants violated their fiduciary duties to LifeLock stockholders (and/ or aided and abetted or conspired to commit such violations) by making materially false or misleading statements, or failing to disclose material facts regarding our business, operations, and prospects, including with regard to certain of our services, our data security program, and our compliance with the FTC Order, in certain public statements made by us, our CEO, and CFO during the period July 30, 2014 through April 30, 2015. Based on these same allegations, the complaint also makes claims of gross mismanagement, abuse of control, and unjust enrichment against the Individual Defendants. According to the complaint, the Individual Defendants’ conduct has damaged us through costs associated with the defense of the securities class actions discussed above and the compensation and benefits provided to the Individual Defendants, as well as through loss of reputation and goodwill. The complaint seeks unspecified monetary damages, unspecified restitution to the company from the Individual Defendants, certain corporate governance reforms, and attorneys’ fees and costs. As this action was very recently filed, there has been no significant activity in the case to date.
We are subject to other legal proceedings and claims that have arisen in the ordinary course of business. Although there can be no assurance as to the ultimate disposition of these matters, we believe, based upon the information available at this time, that, except as disclosed above, a material adverse outcome related to the matters is neither probable nor estimable.
Item 1A. Risk Factors
Investing in our common stock involves a high degree of risk. Before deciding to invest in our common stock, you should carefully consider each of the risk factors described in “Part I – Item 1A. Risk Factors” in our 2014 Form 10-K, and all information set forth in this Quarterly Report on Form 10-Q. Those risks and the risks described in this Quarterly Report on Form 10-Q, including in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, could materially harm our business, financial condition, operating results, cash flow, and prospects. If that occurs, the trading price of our common stock could decline, and you may lose all or part of your investment.
Except as set forth below, there have been no material changes to the other Risk Factors set forth under Part I - Item 1A. Risk Factors in our 2014 Form 10-K and Part II - Item 1.A Risk Factors in our Form 10-Q for the quarter ended June 30, 2015.
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We are subject to extensive government regulation, that could impede our ability to market and provide our services and that could have a material adverse effect on our business.
Our business and the information we use in our business is subject to a wide variety of federal, state, and local laws and regulations, including the FCRA, the Gramm-Leach-Bliley Act, the FTC Act and comparable state laws that are patterned after the FTC Act. In addition, laws governing credit information, consumer privacy and marketing, servicing of consumer products and services, and insurance products and services govern our business and business information. Moreover, we are bound by the terms of the FTC Order, as well as the companion orders with 35 states’ attorneys general that we entered into in March 2010. These laws, regulations, and orders cover, among other things, advertising, automatic subscription renewal, broadband residential Internet access, consumer protection, content, copyrights, credit card processing procedures, data protection, distribution, electronic contracts, member privacy, pricing, sales and other procedures, tariffs, and taxation. In addition, it is unclear how existing laws and regulations governing issues such as property ownership, sales and other taxes, and personal privacy apply to the Internet. We incur significant costs to operate our business and monitor our compliance with these laws, regulations, and orders. Any of these laws and regulations is subject to revision, and we cannot predict the impact of such changes on our business. Complying with these varying requirements, the evolving nature of all of these laws and regulations, the evolving nature of various governmental bodies’ enforcement efforts, and the possibility of new laws in this area, could increase our costs or impede our ability to provide our services to our customers. The occurrence of any these could have a material adverse effect on our business, operating results, financial condition, and future prospects.
In addition, various governmental agencies have the authority to commence investigations and enforcement actions under these laws, regulations, and consent decrees, and private citizens may bring actions, including class action litigation and whistleblower claims, under some of these laws and regulations.
As previously disclosed, on October 28, 2015, we signed an offer of settlement with FTC Staff to present to the FTC to resolve the contempt allegations. The offer remains subject to the FTC's approval and entry by the court. On November 3, 2015, we signed an agreement to settle the Ebarle Class Action and release all of the class's related claims. The Ebarle Class Action settlement remains subject to court approval. If these settlements are not approved, we would need to have further discussions, which would divert further the attention of our management, key personnel and members of our board of directors, and we would likely incur additional costs for the negotiation and settlement of these matters with no assurance that we would be able to reach settlements on terms that are acceptable to us or at all. If the litigation proceeds, the legal and other costs associated with the defense of this action and the ultimate outcome of this action could have a material adverse effect on our business, reputation, product sales, financial condition, results of operation, and future prospects.
Because the companion orders we entered into with 35 states’ attorneys general imposed injunctive provisions similar to those in the FTC Order, we initiated preliminary settlement discussions with certain states’ attorneys general. We believe it is likely that some or all of those 35 states’ attorneys general will respond to us in settlement discussions or proceed with filing similar motions against us. Engaging in settlement discussions and defending ourselves in any litigation that arises against states’ attorneys general related to this matter, and other actions that could arise, will be costly and time-consuming and will divert management’s, key personnel’s, and members of our board of directors' attention from our business operations. Any of these occurrences could have a material adverse effect on our business, reputation, product sales, financial condition, results of operation, and future prospects.
It is also possible that other federal or local governmental agencies, at any time, will commence additional inquiries or investigations of our business practices and our compliance with the FTC Order. Moreover, there can be no assurance that, despite our best efforts to comply with the FTC Order, the other federal or local government agencies will interpret its orders in the same way. We believe the increased governmental and regulatory scrutiny will continue for the foreseeable future and could lead to additional meetings, inquiries, or investigations by governmental and regulatory agencies that regulate our business, including the FTC, the Department of Justice, the SEC, and the New York Stock Exchange. Responding to these inquiries, investigations, and actions may cause us to incur significant expenses and could divert the attention of our management, key personnel, and members of our board of directors from our business operations. Any determination that we violated any laws, regulations, or consent decrees could result in our liability for fines, damages, or other penalties, could require us to make changes to our services and business practices, and could cause us to lose customers, any of which could have a material adverse effect on our business, operating results, financial condition, and future prospects. In addition, recently, the media have been increasingly covering perceived noncompliance with consumer protection regulations and violations of notions of fair dealing with customers. Accordingly, we may be susceptible to peremptory charges by the media and others of regulatory noncompliance and unfair dealing.
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With the growing public concern regarding privacy and the collection, distribution, and use of consumer personal information, we believe we are in an environment in which there is increased regulatory scrutiny concerning data collection and use practices and the provision and marketing of services, like ours, that seek to protect that information. We expect that kind of scrutiny to continue as the marketplace for services like ours continues to develop. In addition, we believe there has been a recent increase in whistleblower claims made to regulatory agencies, including whistleblower claims made by former employees. We believe these claims, will likely continue, in part because of the provisions enacted by the Dodd-Frank Act that provide for cash awards to persons who report alleged wrongdoing to the SEC. Often, the allegations underlying such claims to regulatory agencies, result in federal and state governmental inquiries and investigations.
The FTC Order, as well as the companion orders with 35 states’ attorneys general, could subject us to additional injunctive and monetary remedies.
In March 2010, we and Todd Davis, our Chairman and CEO, entered into the FTC Order. The FTC Order was the result of a settlement of allegations that certain of our advertising and marketing practices constituted deceptive acts or practices in violation of the FTC Act. We did not admit to those allegations. Under the FTC Order, we are enjoined from making any misrepresentation of the means, methods, procedures, effects, effectiveness, coverage, or scope of our identity theft protection services. The FTC investigation of our advertising and marketing activities occurred during the time that we relied significantly on the receipt of fraud alerts from the credit reporting agencies for our members. The FTC believed that such alerts had inherent limitations in terms of coverage, scope, and timeliness. Many of the allegations in the FTC complaint, which accompanied the FTC Order, related to the inherent limitations of using credit report fraud alerts as the foundation for identity theft protection. The FTC Order also includes injunctive provisions relating to our data security for members’ personally identifiable information. At the same time, we entered into companion orders with 35 states’ attorneys general that imposed injunctive provisions similar to those in the FTC Order.
The FTC Order provided for a consumer redress payment of $11 million, which we made in 2010 to the FTC for distribution to our members. The FTC Order also provided for an additional consumer redress payment of $24 million, which the FTC suspended based on our then-current financial condition. The FTC Order specifies that in the event the FTC were to find that the financial materials we submitted were not truthful, accurate, and complete, the court order entering the settlement could be re-opened, and the suspended judgment in the amount of the additional $24 million would become immediately due in full.
As previously disclosed, on October 28, 2015, we signed an offer of settlement with FTC Staff to present to the FTC to resolve the contempt allegations. The offer remains subject to the FTC's approval and entry by the court. On November 3, 2015, we signed an agreement to settle the Ebarle Class Action and release all of the class's related claims. The Ebarle Class Action settlement remains subject to court approval. If these settlements are not approved, we would need to have further discussions which would divert further the attention of our management, key personnel and members of our board of directors, and there can be no assurance that we would be able to reach settlements on terms that are acceptable to us or at all. If the litigation proceeds, the legal and other costs associated with the defense of this action and the ultimate outcome of this action could have a material adverse effect on our business, reputation, product sales, financial condition, results of operation, and future prospects.
As of September 30, 2015, we have accrued $116 million for this matter, including a $3 million accrual for a potential settlement with certain states’ attorneys general for related claims. If these settlements are not approved, we will likely incur additional costs related to the negotiation and settlement of the matters. Because the companion orders we entered into with 35 states’ attorneys general imposed injunctive provisions similar to those in the FTC Order, we initiated preliminary settlement discussions with certain states’ attorneys general. We believe it is likely that some or all of those 35 states’ attorneys general will respond to us in settlement discussions or proceed with filing similar motions against us.
We cannot, however, predict the outcome of the matter with respect to the states’, and therefore, the ultimate resolution of the matter is not estimable. Engaging in settlement discussions and defending ourselves in any litigation that arises against states’ attorneys general related to this matter, and other actions that could arise, could be costly and time consuming, could divert our management's, key personnel's, and members of our board of directors' attention from our business operations, could lead to additional claims, and could cause us to lose customers. The outcome of the settlement discussions with the states’ attorneys general and potential related actions could result in liability for damages, fines, penalties, and injunctive relief. Any of these occurrences could have a material adverse effect on our business, operating results, financial condition, and prospects.
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The outcome of litigation or regulatory proceedings could subject us to significant monetary damages, restrict our ability to conduct our business, harm our reputation, and otherwise negatively impact our business.
As previously disclosed, on October 28, 2015, we signed an offer of settlement with FTC Staff to present to the FTC to resolve the contempt allegations. The offer remains subject to the FTC's approval and entry by the court. On November 3, 2015, we signed an agreement to settle the Ebarle Class Action and release all of the class's related claims. The Ebarle Class Action settlement remains subject to court approval. In light of these agreements, we have accrued $116 million in total reserves, including $3 million reserve for a potential settlement with certain states’ attorneys general for related claims. If these settlement agreements are not approved, we will likely incur additional costs and expenses for the negotiation and settlement of these matters. If we are required to renegotiate these settlements, we may be unable to reach settlement on terms acceptable to us or at all and costly litigation would likely result. Further, as a result of these matters, including the settlement agreements themselves, we could face negative publicity, our reputation could be harmed, we could lose customers, including enterprise customers, and our ability to win new customers could be impeded any of which could have a material adverse effect on our business, operating results, financial condition and our future prospects.
We are also presently subject to various securities, consumer class action, and shareholder derivative complaints as described in more detail in this Form 10-Q. We also anticipate that the FTC settlement and the recent volatility in the trading price of our stock may result in our stockholders filing additional securities class actions and shareholder derivative complaints against us, our officers, and directors.
We cannot predict the outcome of these actions or proceedings, or any other actions or proceedings filed against us in the future, and the cost of defending such actions or proceedings could be material. Furthermore, defending such actions or proceedings could divert our management’s, key personnel’s, and members of our board of directors’ attention from our business operations. If we are found liable in any actions or proceedings, we may have to pay substantial damages, penalties, or fines, change the way we conduct our business, or lose customers, any of which may have a material adverse effect on our business, operating results, financial condition, and prospects. There may also be negative publicity associated with litigation or regulatory proceedings that could harm our reputation or decrease acceptance of our services.
Moreover, we utilize contractors and third parties for various services, including certain advertising, which may result in additional claims or litigation against us. For example, a former service provider claimed that we misclassified her as an independent contractor, and we may be subject to other claims of this nature from time to time. These claims may be costly to defend and may result in our liability for damages, adverse tax consequences, and harm to our reputation, any of which could have a material adverse effect on our business, operating results, financial conditions, and future prospects.
We believe there has been a recent increase in whistleblower claims across our industry, including whistleblower claims arising after employee terminations, which will likely continue, in part because of the provisions enacted by the Dodd-Frank Act that may entitle persons who report alleged wrongdoing to the SEC to cash rewards. We anticipate that these provisions will result in a significant increase in whistleblower claims, and dealing with such claims could generate significant expenses and take up significant management and board time, even for frivolous and non-meritorious claims. Any investigations of whistleblower claims may impose additional expense on us, may divert our management’s, other key personnel’s, and members of our board of directors’ attention, and may result in fines and/or reputational damage whether or not we are deemed to have violated any regulations. We believe there also has been a recent increase in claims made to regulatory agencies by former employees. Often the allegations underlying such claims to regulatory agencies lead to meetings, inquiries, or investigations by the regulatory agencies about such claims, inquiries, or investigations by the agencies that regulate our business, including the FTC. Inquiries or investigation by regulatory agencies about such claims could generate significant expense and take up significant management and board time.
Covenants in our senior credit facility impose, and any future debt arrangements may impose, significant operating and financial restrictions that may adversely affect our business and ability to operate our business.
The agreement governing our senior credit facility with Bank of America contains covenants that limit various actions that we may take, including the following:
•incurring additional indebtedness;
•granting additional liens;
•making certain investments and distributions;
•merging, dissolving, liquidating, consolidating, or disposing of all or substantially all of our assets;
•certain acquisitions;
•prepaying and modifying debt instruments; and
•entering into transactions with affiliates.
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These restrictions could limit our ability to finance our future operations or capital needs, make acquisitions, or pursue available business opportunities. Our senior credit facility also requires us to maintain specified financial ratios and satisfy financial condition tests at the end of each fiscal quarter. Our ability to meet these financial ratios and tests can be affected by events beyond our control, and we may not meet those tests. We may be required to take action to reduce our indebtedness or to act in a manner contrary to our business objectives to meet these ratios and satisfy these covenants. For example, under the terms of the recent amendment to our senior credit facility we are required to comply with certain additional financial and reporting covenants, including maintaining a minimum cash EBITDA. Pursuant to the amendment, we are also subject to certain limitations and conditions on borrowing, on acquisitions, and on making certain types of payments with respect to our equity interests. We could also incur additional indebtedness in the future having even more restrictive covenants.
Failure to comply with any of the covenants under our senior credit facility, or any other indebtedness we may incur, could result in a default under such agreements, which could result in an acceleration of the timing of payments on all of our outstanding indebtedness and other negative consequences. In addition, since our senior credit facility with Bank of America is secured by substantially all of our assets, a default under that facility could result in Bank of America exercising its lien on substantially all of our assets. Any of these events could have a material adverse effect on our business, operating results, and financial condition.
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds |
The following table provides information regarding our repurchases of common stock during the three-months ended September 30, 2015. All of the shares of common stock were surrendered to us to satisfy tax withholding obligations associated with the vesting of restricted stock.
Period | Total Number of Shares Purchased | Average Price Paid Per Share | Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs | Maximum Number (or Approximate Dollar Value) of Shares that May Yet Be Purchased Under the Plans or Programs | |||||||||
July 1, 2015 - July 31, 2015 | — | — | — | — | |||||||||
August 1, 2015 - August 31, 2015 | — | — | — | — | |||||||||
September 1, 2015 - September 30, 2015 | 3,216 | $ | 8.84 | — | — | ||||||||
Item 5. | Other Information |
Entry Into a Material Definitive Agreement.
On November 6, 2015, we entered into a First Amendment and Consent (the “First Amendment”) to our Credit Agreement, with Bank of America, N.A. as administrative agent, swing line lender and L/C issuer, 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 (the “Credit Agreement”). We refer to the Credit Agreement and related documents, as amended by the First Amendment, as the Senior Credit Facility.
The First Amendment modifies the calculation of cash EBITDA under the Senior Credit Facility to exclude up to $130 million of expenses related to the proposed settlements with the FTC and representatives of a national class of consumers, potential settlements with certain state attorney’s general and fees incurred in relation to the litigation and potential settlements.
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In addition, pursuant to the First Amendment, through the end of the fourth full fiscal quarter ending after the date on which the courts have approved the settlement agreements with the FTC and the national class of consumers (the “Settlement Date”), we are required to comply with certain additional financial and reporting covenants in the Senior Credit Facility.
Further, until the later of the one year anniversary of the Settlement Date and the date on which we have received court approval with at least 50% of the state attorney generals that have proceedings pending or initiated on or before November 6, 2016 related to issues presented in the FTC Order, if any, the revolving line of credit under the Senior Credit Facility is limited to letters of credit in the ordinary course of business not to exceed $2 million in the aggregate at any one time and certain permitted acquisitions of up to $25 million in the aggregate, unless a higher amount is consented to by the holders of 66 2/3% of the aggregate revolving commitments.
Pursuant to terms of the First Amendment, we are also subject to additional limitations and conditions on making certain types of payments (including dividends, redemptions or other distributions) with respect to our equity interests.
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Item 6. | Exhibits. |
Exhibit No. | ||
10.1 | Offer Letter Agreement between LifeLock, Inc. and Ramakrishna (“Schwark”) Satyavolu, dated September 2, 2015. | |
10.2 | Severance Agreement between LifeLock, Inc. and Ramakrishna (“Schwark”) Satyavolu, dated September 2, 2015. | |
31.1 | Certification of Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
31.2 | Certification of Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |
32.1 | Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |
101.INS | XBRL Instance Document. | |
101.SCH | XBRL Taxonomy Extension Schema Document. | |
101.CAL | XBRL Taxonomy Extension Calculation Linkbase Document. | |
101.DEF | XBRL Taxonomy Extension Definition Linkbase Document. | |
101.LAB | XBRL Taxonomy Extension Label Linkbase Document. | |
101.PRE | XBRL Taxonomy Extension Presentation Linkbase Document. | |
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
LIFELOCK, INC. | |||
Date: | November 9, 2015 | By: | /s/ Todd Davis |
Name: | Todd Davis | ||
Title: | Chairman and Chief Executive Officer | ||
(Principal Executive Officer) | |||
Date: | November 9, 2015 | By: | /s/ Chris Power |
Name: | Chris Power | ||
Title: | Chief Financial Officer | ||
(Principal Financial and Accounting Officer) | |||
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