VIVINT SMART HOME, INC. Introduction
The following discussion and analysis provides information which management believes is relevant to an assessment and understanding of our consolidated results of operations and financial condition. The discussion should be read in conjunction with the unaudited condensed consolidated financial statements and notes thereto contained herein and the consolidated financial statements and notes thereto for the year endedDecember 31, 2019 contained in Amendment No. 2 to the Current Report on Form 8-K filed with theSEC onMarch 13, 2020 . This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to, those described in the "Risk Factors" sections this Quarterly Report on Form 10-Q, our Annual Report on Form 10-K for our fiscal year 2019 and our Quarterly Report on Form 10-Q for the quarterly period endedMarch 31, 2020 . Actual results may differ materially from those contained in any forward-looking statements. Unless the context otherwise requires, references to "we", "us", "our", and "the Company" are intended to mean the business and operations ofVivint Smart Home, Inc. and its consolidated subsidiaries. The unaudited condensed consolidated financial statements for the three and six months endedJune 30, 2020 and 2019, respectively, present the financial position and results of operations ofVivint Smart Home, Inc. and its wholly-owned subsidiaries. Business Overview We are a smart home technology company. Our mission is to redefine the home experience through intelligently designed cloud-enabled solutions delivered to every home by peoplewho care. Our brand name,Vivint , represents "to live intelligently", and our solutions help our subscribers do just that. Creating a true smart home experience requires an end-to-end platform designed to drive broad consumer adoption. Our smart home platform is comprised of the following five pillars: (1) our Smart Home Operating System, (2) our AI-driven smart home automation and assistance software, Vivint Assist, (3) our portfolio of proprietary, internally developed smart devices, (4) our curated yet extensible partner-neutral ecosystem, and (5) our people delivering tech-enabled premium services, including consultative selling, professional installation, and support. We are one of the largest smart home solutions providers inNorth America . Our leading platform has over 1.6 million subscribers as ofJune 30, 2020 and manages over 20 million devices. Using our solution, subscribers are able to interact with all aspects of their home with their voice or any mobile device-anytime, anywhere. They can engage with people at their front door; view live and recorded video inside and outside their home; control thermostats, locks, lights, and garage doors; and proactively manage the comings and goings of family, friends, and strangers. Our average subscriber engages with our smart home app multiple times per day. Our go-to-market strategy is based on directly educating consumers about the value and benefits of a smart home experience. We reach consumers through a variety of highly efficient customer acquisition channels, including our direct-to-home, inside sales, and retail partnership programs. We continue to scale these efforts through our proprietary operations technology, by launching new and innovative Products and Services, and by building out our consultative sales channels. Our nationwide sales and service footprint covers 98% ofU.S. zip codes. We continue to strengthen our relationships with existing subscribers by offering them the ability to use Vivint Flex Pay to finance upgrades of their existing system and to add new devices and features to their smart homes as our portfolio of offerings expands. Transaction betweenLegacy Vivint Smart Home, Inc. andVivint Smart Home Inc. OnJanuary 17, 2020 (the "Closing Date"), we consummated the previously announced merger (the "Merger") pursuant to that certain Agreement and Plan of Merger, datedSeptember 15, 2019 , by and amongMaiden Merger Sub, Inc. , a former subsidiary of us ("Merger Sub"),Legacy Vivint Smart Home, Inc. (f/k/aVivint Smart Home, Inc. ) ("Legacy Vivint Smart Home") and us, as amended by Amendment No. 1 to the Agreement and Plan of Merger (the "Amendment" and as amended, the "Merger Agreement"), dated as ofDecember 18, 2019 , by and among the Merger Sub, Legacy Vivint Smart Home and us. In connection with the Closing, we changed our name fromMosaic Acquisition Corp. toVivint Smart Home, Inc. Our Common Stock is now listed on the NYSE under the symbol "VVNT" and warrants to purchase the Common Stock are listed on the NYSE under the symbol "VVNT WS". Key Performance Measures In evaluating our results, we review several key performance measures discussed below. We believe that the presentation of such metrics is useful to our investors and lenders because they are used to measure the value of companies such as ours with recurring revenue streams. 50 -------------------------------------------------------------------------------- Table of Contents Total Subscribers Total subscribers is the aggregate number of active smart home and security subscribers at the end of a given period. Total Monthly Revenue Total monthly revenue, or Total MR, is the average monthly total revenue recognized during the period. Average Monthly Revenue per User Average monthly revenue per user, or AMRU, is Total MR divided by average monthly Total Subscribers during a given period. Total Monthly Service Revenue Total monthly service revenue, or MSR, is the contracted recurring monthly service billings to our smart home and security subscribers, based on the Total Subscribers number as of the end of a given period. Average Monthly Service Revenue per User Average monthly service revenue per user, or AMSRU, is Total MSR divided by Total Subscribers at the end of a given period. Attrition Rate Attrition rate is the aggregate number of canceled smart home and security subscribers during the prior 12 month period divided by the monthly weighted average number of Total Subscribers based on the Total Subscribers at the beginning and end of each month of a given period. Subscribers are considered canceled when they terminate in accordance with the terms of their contract, are terminated by us or if payment from such subscribers is deemed uncollectible (when at least four monthly billings become past due). If a sale of a service contract to third parties occurs, or a subscriber relocates but continues their service, we do not consider this as a cancellation. If a subscriber transfers their service contract to a new subscriber, we do not consider this as a cancellation. Average Subscriber Lifetime Average subscriber lifetime, in number of months, is 100% divided by our expected long-term annualized attrition rate (which is currently estimated at 13%) multiplied by 12 months. Net Service Cost per Subscriber Net service cost per subscriber is the average monthly service costs incurred during the period (both period and capitalized service costs), including monitoring, customer service, field service and other service support costs, less total non-recurring Smart Home Services billings for the period divided by average monthly Total Subscribers for the same period. Net Service Margin Net service margin is the monthly average MSR for the period, less total average net service costs for the period divided by the monthly average MSR for the period. New Subscribers New subscribers is the aggregate number of net new smart home and security subscribers originated during a given period. This metric excludes new subscribers acquired by the transfer of a service contract from one subscriber to another. Net Subscriber Acquisition Costs per New Subscriber Net subscriber acquisition costs per New Subscriber is the net cash cost to create new smart home and security subscribers during a given 12 month period divided by New Subscribers for that period. These costs include commissions, Products, installation, marketing, sales support and other allocations (general and administrative and overhead); less upfront payment received from the sale of Products associated with the initial installation, and installation fees. These costs exclude capitalized contract costs and upfront proceeds associated with contract modifications. Total Monthly Service Revenue for New Subscribers Total Monthly Service Revenue for New Subscribers is the contracted recurring monthly service billings to our New Subscribers during the prior 12 month period. Total Bookings Total bookings is Total Monthly Service Revenue for New Subscribers multiplied by Average Subscriber Lifetime, plus total Product revenue to be recognized over the contract term from New Subscribers during the prior 12 month period. 51 -------------------------------------------------------------------------------- Table of Contents Total Backlog Total backlog is total unrecognized Product revenue plus total Service revenue expected to be recognized over the remaining subscriber lifetime for Total Subscribers. Adjusted EBITDA Adjusted EBITDA is defined as net income (loss) before interest, taxes, depreciation, amortization, stock-based compensation (or non-cash compensation), certain financing fees, and certain other non-recurring expenses or gains. Adjusted EBITDA is not defined under GAAP and is subject to important limitations. Non-GAAP financial measures should not be considered in isolation from, or as a substitute for, financial information presented in compliance with GAAP, and non-GAAP financial measures as used by the Company may not be comparable to similarly titled amounts used by other companies. We believe that the presentation of Adjusted EBITDA is useful to investors because it is frequently used by securities analysts, investors, and other interested parties in their evaluation of the operating performance of companies in industries similar to ours. In addition, targets based on Adjusted EBITDA are among the measures we use to evaluate our management's performance for purposes of determining their compensation under our incentive plans. Adjusted EBITDA and other non-GAAP financial measures have important limitations as analytical tools and you should not consider them in isolation or as substitutes for analysis of our results as reported under GAAP. For example, Adjusted EBITDA: •excludes certain tax payments that may represent a reduction in cash available to us; •does not reflect any cash capital expenditure requirements for the assets being depreciated and amortized, including capitalized contract costs, that may have to be replaced in the future; •does not reflect changes in, or cash requirements for, our working capital needs; •does not reflect the significant interest expense to service our debt; •does not reflect the monthly financing fees incurred associated with our obligations under Vivint Flex Pay; and •does not include non-cash stock-based employee compensation expense and other non-cash charges. We believe that the most directly comparable GAAP measure to Adjusted EBITDA is net income (loss). We have included the calculation of Adjusted EBITDA and reconciliation of Adjusted EBITDA to net loss for the periods presented below under Key Operating Metrics - Adjusted EBITDA. Recent Developments COVID-19 update InDecember 2019 , a novel coronavirus disease ("COVID-19") was reported and onMarch 11, 2020 , theWorld Health Organization (WHO ) characterized COVID-19 as a pandemic. Operational update. During the first six months of 2020, we implemented a number of operational changes to continue to provide the same level of service our customers have come to rely on, while caring for the well-being of our customers and employees: •We have transitioned more than 1,500 customer care professionals to effective work-from-home environments where they continue to provide uninterrupted customer service. •We are maintaining our geographically dispersed central monitoring stations to provide 24/7 professional monitoring services for all emergencies. • We have instituted work-from-home capabilities for most corporate employees across all our facilities, following state and local guidelines. •Based on the latestCenters for Disease Control and Prevention ("CDC") guidelines, we have implemented new operating and safety procedures to keep both our customers and employees safe, including: 52 -------------------------------------------------------------------------------- Table of Contents •Conducting daily "fitness-for-duty" assessments for all customer-facing employees, which includes a temperature and symptoms check. •Contacting customers before our visit to determine if anyone in the home is experiencing signs of illness or flu-like symptoms, or has been exposed to COVID-19, and rescheduling appointments when needed. •FollowingCDC guidelines for social distancing and hand washing, including cleaning workspaces and surfaces, and not shaking hands with customers. •Using protective sanitary equipment during service visits, such as disposable gloves, masks and hand sanitizer. •For all company campus facilities, requiring employees to wear face coverings in all common areas and meeting rooms where social distancing is not practical. •We are providing up to 14 days of paid time off for any employeewho has contracted COVID-19 or is required to be quarantined by a public health authority. In addition, we have made a change to our business inCanada . Each account sold inCanada has historically required a significant cash investment by our company. EffectiveJune 10, 2020 ,Vivint Canada, Inc. no longer sells new equipment or accounts through its door-to-door sales channel. We will continue to sell inCanada through online marketing and our inside sales channels. We will continue to operate inCanada , with dedicated support and services. During the second quarter of 2020, several of the states in which we operate began to resume business operations on a phased basis. Accordingly, we have resumed door-to-door sales activities in markets where it is possible. Due to ongoing state restrictions and phased re-openings, we were forced to delay deployment of our summer direct-to-home sales representatives by up to six weeks in some markets. This was a significant driver of the decrease in the number of new subscribers generated through our direct-to-home sales channel for the second quarter of 2020 compared to the same time period in 2019. Despite the gradual reopening on a state-specific basis,the United States continues to struggle with rolling outbreaks of the COVID-19 virus, and the full impact of the pandemic on our business and results of operations will depend on the ultimate duration of the pandemic as well as the severity of any resurgence in COVID-19 cases in the future. While we have not experienced a significant adverse financial impact from the COVID-19 pandemic through the second quarter of 2020, our business could be adversely impacted in 2020, and potentially beyond, if the COVID-19 pandemic continues for an extended period of time and/or if government stimulus programs are discontinued or reduced. Financial update. We have implemented business continuity plans intended to continue to ensure the health, safety, and well-being of our customers, employees and communities, and to protect the financial and operational strength of the company. We have reduced discretionary spending and received pricing concessions from certain of our key vendors, some of which are short-term in nature, in each case to preserve cash and improve our cost structure. This reduced spending may not be sustainable over time without negatively impacting our results of operations. As a result of the COVID-19 pandemic, during the first six months of 2020 we also drew down the full amount available to us on our revolving credit facility as a precautionary measure to increase our cash position and preserve liquidity and financial flexibility. By the end of the second quarter of 2020, we had paid back a portion of our revolving credit facility, as we gained more clarity surrounding the financial markets. As discussed above with respect to the operational challenges posed by the pandemic, the broader implications of COVID-19 on our results of operations and overall financial performance remain uncertain. Depending on the breadth and duration of the outbreak, which we are not currently able to predict, the adverse impact could be material. Our business has been affected, and could be adversely affected in the future, by COVID-19, including our ability to maintain compliance with our debt covenants, due to the following: •Our ability to generate new subscribers, particularly in our direct-to home and retail sales channels. •Increases in customer attrition and deferment or forgiveness of our customers' monthly service fees, due to the increased unemployment rates and reduced wages. These could increase our allowance for bad debt, provision for credit losses, and losses on our derivative liability associated with the consumer financing program •The impact of the pandemic and actions taken in response thereto on global and regional economies and economic activity, including the duration and magnitude of its impact on unemployment rates and consumer discretionary spending. 53 -------------------------------------------------------------------------------- Table of Contents •Ability to obtain the equipment necessary to generate new subscriber accounts or service our existing subscriber base, due to potential supply chain disruption. •Limitations on our ability to enter our customer's homes to perform installs or equipment repairs. •Our ability to access capital, or to access such capital at reasonable economic terms. •Inefficiencies and potential incremental costs resulting from the requirement for many of our employees to work from home. These factors could become indicators of asset impairments in the future, depending on the significance and duration of the disruption. While short-term, temporary disruptions may not indicate an impairment; the effects of a prolonged outbreak may cause asset impairments. We continue to monitor the situation and guidance from international and domestic authorities, including federal, state and local public health authorities, and may be required or elect to take additional actions based on their recommendations. Critical Accounting Policies and Estimates In preparing our unaudited Condensed Consolidated Financial Statements, we make assumptions, judgments and estimates that can have a significant impact on our revenue, loss from operations and net loss, as well as on the value of certain assets and liabilities on our unaudited Condensed Consolidated Balance Sheets. We base our assumptions, judgments and estimates on historical experience and various other factors that we believe to be reasonable under the circumstances. Actual results could differ materially from these estimates under different assumptions or conditions. At least quarterly, we evaluate our assumptions, judgments and estimates and make changes accordingly. Historically, our assumptions, judgments and estimates relative to our critical accounting estimates have not differed materially from actual results. We believe that the assumptions, judgments and estimates involved in the accounting for revenue recognition, deferred revenue, capitalized contract costs, derivatives, retail installment contract receivables, allowance for doubtful accounts, loss contingencies, valuation of intangible assets, impairment of long-lived assets, fair value and income taxes have the greatest potential impact on our unaudited Condensed Consolidated Financial Statements; therefore, we consider these to be our critical accounting estimates. For information on our significant accounting policies, see Note 1 to our accompanying unaudited Condensed Consolidated Financial Statements. Revenue Recognition We offer our customers smart home services combining Products, including a proprietary control panel, door and window sensors, door locks, security cameras and smoke alarms; installation; and a proprietary back-end cloud platform software and Services. These together create an integrated system that allows our customers to monitor, control and protect their home. Our customers are buying this integrated system that provides them with these Smart Home Services. The number and type of Products purchased by a customer depends on their desired functionality. Because the Products and Services included in the customer's contract are integrated and highly interdependent, and because they must work together to deliver the Smart Home Services, we have concluded that installed Products, related installation and Services contracted for by the customer are generally not distinct within the context of the contract and, therefore, constitute a single, combined performance obligation. Revenues for this single, combined performance obligation are recognized on a straight-line basis over the customer's contract term, which is the period in which the parties to the contract have enforceable rights and obligations. We have determined that certain contracts that do not require a long-term commitment for monitoring services by the customer contain a material right to renew the contract, because the customer does not have to purchase Products upon renewal. Proceeds allocated to the material right are recognized over the period of benefit, which is generally three years. The majority of our subscription contracts are between three and five years in length and are generally non-cancelable. These contracts with customers generally convert into month-to-month agreements at the end of the initial term, and some customer contracts are month-to-month from inception. Payment for recurring monitoring and other Smart Home Services is generally due in advance on a monthly basis. Sales of Products and other one-time fees such as service or installation fees are invoiced to the customer at the time of sale. Any Products or Services that are considered separate performance obligations are recognized when those Products or Services are delivered. Taxes collected from customers and remitted to governmental authorities are not included in revenue. Payments received or amounts billed in advance of revenue recognition are reported as deferred revenue. 54 -------------------------------------------------------------------------------- Table of Contents We consider Products, related installation, and our proprietary back-end cloud platform software and services an integrated system that allows our customers to monitor, control and protect their homes. These Smart Home Services are accounted for as a single performance obligation that is recognized over the customer's contract term, which is generally three to five years. Deferred Revenue Our deferred revenues primarily consist of amounts for sales (including upfront proceeds) of Smart Home Services. Deferred revenues are recognized over the term of the related performance obligation, which is generally three to five years. Capitalized Contract Costs Capitalized contract costs represent the costs directly related and incremental to the origination of new contracts, modification of existing contracts or to the fulfillment of the related subscriber contracts. These include commissions, other compensation and related costs incurred directly for the origination and installation of new or upgraded customer contracts, as well as the cost of Products installed in the customer home at the commencement or modification of the contract. These costs are deferred and amortized on a straight-line basis over the expected period of benefit that we have determined to be five years. The period of benefit of five years is longer than a typical contract term because of anticipated contract renewals. We apply this period of benefit to our entire portfolio of contracts. We update our estimate of the period of benefit periodically and whenever events or circumstances indicate that the period of benefit could change significantly. Such changes, if any, are accounted for prospectively as a change in estimate. Amortization of capitalized contract costs is included in "Depreciation and Amortization" on the consolidated statements of operations. These deferred costs are periodically reviewed for impairment. Contract costs not directly related and incremental to the origination of new contracts, modification of existing contracts or to the fulfillment of the related subscriber contracts are expensed as incurred. These costs include those associated with housing, marketing and recruiting, non-direct lead generation costs, certain portions of sales commissions and residuals, overhead and other costs considered not directly and specifically tied to the origination of a particular subscriber. On the accompanying unaudited condensed consolidated statement of cash flows, capitalized contract costs are classified as operating activities and reported as "Capitalized contract costs - deferred contract costs" as these assets represent deferred costs associated with subscriber contracts. Consumer Financing Program Vivint Flex Pay became our primary sales model beginning inMarch 2017 . Under Vivint Flex Pay, customers pay separately for the products (including control panel, security peripheral equipment, smart home equipment, and related installation) ("Products") andVivint's smart home and security services ("Services"). The customer has the following three ways to pay for the Products: (1) qualified customers inthe United States may finance the purchase of Products through a third-party financing provider ("Consumer Financing Program"), (2) we offer to some customers not eligible for the Consumer Financing Program, butwho qualify under our underwriting criteria, the option to enter into a retail installment contract ("RIC") directly with us, or (3) customers may purchase the Products at the outset of the service contract by check, automatic clearing house payments ("ACH"), credit or debit card. In the future, we expect the number of new subscriber originations financed through RICs to be minimal. Under the Consumer Financing Program, qualified customers are eligible for loans provided by third-party financing providers of up to$4,000 . The annual percentage rates on these loans range between 0% and 9.99%, and are either installment loans or revolving loans with a 42 or 60 month term. Most loan terms are determined by the customer's credit quality. For certain third-party provider loans, we pay a monthly fee based on either the average daily outstanding balance of the loans or the number of outstanding loans, depending on the third-party financing provider and we share liability for credit losses, with the Company being responsible for between 5% and 100% of lost principal balances. Additionally, we are responsible for reimbursing certain third-party financing providers for the credit card transaction fees associated with the loans. Because of the nature of these provisions, we record a derivative liability at its fair value when the third-party financing provider originates loans to customers, which reduces the amount of estimated revenue recognized on the provision of the services. The derivative liability represents the estimated remaining amounts to be paid to the third-party provider by us related to outstanding loans, including the monthly fees based on either the outstanding loan balances or the number of outstanding loans, shared liabilities for credit losses and customer payment processing fees. The derivative liability is reduced as payments are made by us to the third-party financing provider. Subsequent changes to the fair value of the derivative liability are realized 55 -------------------------------------------------------------------------------- Table of Contents through other expenses (income), net in the unaudited condensed consolidated statement of operations. See Note 9 to the accompanying unaudited condensed consolidated financial statements for additional information. For other third-party loans, we receive net proceeds (net of fees and expected losses) for which we have no further obligation to the third-party. We record these net proceeds to deferred revenue. Retail Installment Contract Receivables For subscribers that enter into a RIC to finance the purchase of Products and related installation, we record a receivable for the amount financed. Gross RIC receivables are reduced for (i) expected write-offs of uncollectible balances over the term of the RIC and (ii) a present value discount of the expected cash flows using a risk adjusted market interest rate. Therefore, the RIC receivables equal the present value of the expected cash flows to be received by us over the term of the RIC, evaluated on a pool basis. RICs are pooled based on customer credit quality, contract length and geography. At the time of installation, we record a long-term note receivable within long-term notes receivables and other assets, net on the unaudited condensed consolidated balance sheets for the present value of the receivables that are expected to be collected beyond 12 months of the reporting date. The unbilled receivable amounts that are expected to be collected within 12 months of the reporting date are included as a short-term notes receivable within accounts and notes receivable, net on the unaudited condensed consolidated balance sheets. The billed amounts of notes receivables are included in accounts receivable within accounts and notes receivable, net on the unaudited condensed consolidated balance sheets. We impute the interest on the RIC receivable using a risk adjusted market interest rate and record it as a reduction to deferred revenue and to the face amount of the related receivable. The risk adjusted interest rate considers a number of factors, including credit quality of the subscriber base and other qualitative considerations such as macro-economic factors. The imputed interest income is recognized over the term of the RIC contract as recurring and other revenue on the unaudited condensed consolidated statements of operations. When we determine that there are RIC receivables that have become uncollectible, we record an adjustment to the allowance and reduce the related note receivable balance. On a regular basis, we also reassess the expected remaining cash flows, based on historical RIC write-off trends, current market conditions and both Company and third-party forecast data . In accordance with Topic 326, if we determine there is a change in expected remaining cash flows, the total amount of this change for all RICs is recorded in the current period to the provision for credit losses, which is included in general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations. We recorded a$1.5 million provision for credit losses during the six months endedJune 30, 2020 , primarily associated with the expected impact of COVID-19. Account balances are written-off if collection efforts are unsuccessful and future collection is unlikely based on the length of time from the day accounts become past due. Accounts Receivable Accounts receivable consists primarily of amounts due from subscribers for recurring monthly monitoring Services, amounts due from third-party financing providers and the billed portion of RIC receivables. The accounts receivable are recorded at invoiced amounts and are non-interest bearing and are included within accounts and notes receivable, net on the unaudited condensed consolidated balance sheets. We estimate this allowance based on historical collection experience, subscriber attrition rates, current market conditions and both Company and third-party forecast data. When we determine that there are accounts receivable that are uncollectible, they are charged off against the allowance for doubtful accounts. The provision for doubtful accounts is included in general and administrative expenses in the accompanying unaudited condensed consolidated statements of operations. During the six months endedJune 30, 2020 , we recorded a$1.1 million provision for the expected impact of COVID-19 in accordance with Topic 326. Loss Contingencies We record accruals for various contingencies including legal proceedings and other claims that arise in the normal course of business. The accruals are based on judgment, the probability of losses and, where applicable, the consideration of opinions of legal counsel. We record an accrual when a loss is deemed probable to occur and is reasonably estimable. Factors that we consider in the determination of the likelihood of a loss and the estimate of the range of that loss in respect of legal matters include the merits of a particular matter, the nature of the litigation, the length of time the matter has been pending, the procedural posture of the matter, whether we intend to defend the matter, the likelihood of settling for an insignificant amount and the likelihood of the plaintiff accepting an amount in this range. However, the outcome of such legal matters is inherently unpredictable and subject to significant uncertainties. 56 -------------------------------------------------------------------------------- Table of ContentsGoodwill and Intangible Assets Purchase accounting requires that all assets and liabilities acquired in a transaction be recorded at fair value on the acquisition date, including identifiable intangible assets separate from goodwill. For significant acquisitions, we obtain independent appraisals and valuations of the intangible (and certain tangible) assets acquired and certain assumed obligations as well as equity. Identifiable intangible assets include customer relationships and other purchased and internally developed technology.Goodwill represents the excess of cost over the fair value of net assets acquired. The estimated fair values and useful lives of identified intangible assets are based on many factors, including estimates and assumptions of future operating performance and cash flows of the acquired business, estimates of cost avoidance, the nature of the business acquired, the specific characteristics of the identified intangible assets and our historical experience and that of the acquired business. The estimates and assumptions used to determine the fair values and useful lives of identified intangible assets could change due to numerous factors, including product demand, market conditions, regulations affecting the business model of our operations, technological developments, economic conditions and competition. We conduct a goodwill impairment analysis annually in the fourth fiscal quarter, as ofOctober 1 , and as necessary if changes in facts and circumstances indicate that the fair value of our reporting units may be less than their carrying amounts. When indicators of impairment do not exist and certain accounting criteria are met, we are able to evaluate goodwill impairment using a qualitative approach. When necessary, our quantitative goodwill impairment test consists of two steps. The first step requires that we compare the estimated fair value of our reporting units to the carrying value of the reporting unit's net assets, including goodwill. If the fair value of the reporting unit is greater than the carrying value of its net assets, goodwill is not considered to be impaired and no further testing is required. If the fair value of the reporting unit is less than the carrying value of its net assets, we would be required to complete the second step of the test by analyzing the fair value of its goodwill. If the carrying value of the goodwill exceeds its fair value, an impairment charge is recorded. Our reporting units are determined based on our current reporting structure, which as ofJune 30, 2020 consisted of one reporting unit. As ofJune 30, 2020 , there were no changes in facts and circumstances since the most recent annual impairment analysis to indicate impairment existed. Property, Plant and Equipment and Long-lived Assets Property, plant and equipment are stated at cost and depreciated on the straight-line method over the estimated useful lives of the assets or the lease term for assets under finance leases, whichever is shorter. Intangible assets with definite lives are amortized over the remaining estimated economic life of the underlying technology or relationships, which ranges from two to ten years. Definite-lived intangible assets are amortized on the straight-line method over the estimated useful life of the asset or in a pattern in which the economic benefits of the intangible asset are consumed. Amortization expense associated with leased assets is included with depreciation expense. Routine repairs and maintenance are charged to expense as incurred. We review long-lived assets, including property, plant and equipment, capitalized contract costs, and definite-lived intangibles for impairment when events or changes in circumstances indicate that the carrying amount may not be recoverable. We consider whether or not indicators of impairment exist on a regular basis and as part of each quarterly and annual financial statement close process. Factors we consider in determining whether or not indicators of impairment exist include market factors and patterns of customer attrition. If indicators of impairment are identified, we estimate the fair value of the assets. An impairment loss is recognized if the carrying amount of a long-lived asset is not recoverable and exceeds its fair value. We conduct an indefinite-lived intangible impairment analysis annually as ofOctober 1 , and as necessary if changes in facts and circumstances indicate that the fair value of our indefinite-lived intangibles may be less than the carrying amount. When indicators of impairment do not exist and certain accounting criteria are met, we are able to evaluate indefinite-lived intangible impairment using a qualitative approach. When necessary, our quantitative impairment test consists of two steps. The first step requires that we compare the estimated fair value of our indefinite-lived intangibles to the carrying value. If the fair value is greater than the carrying value, the intangibles are not considered to be impaired and no further testing is required. If the fair value is less than the carrying value, an impairment loss in an amount equal to the difference is recorded. Income Taxes We account for income taxes based on the asset and liability method. Under the asset and liability method, deferred tax assets and deferred tax liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit 57 -------------------------------------------------------------------------------- Table of Contents carryforwards. Valuation allowances are established when necessary to reduce deferred tax assets when it is determined that it is more likely than not that some portion, or all, of the deferred tax asset will not be realized. We recognize the effect of an uncertain income tax position on the income tax return at the largest amount that is more likely than not to be sustained upon audit by the relevant taxing authority. An uncertain income tax position will not be recognized if it has less than a 50% likelihood of being sustained. Our policy for recording interest and penalties is to record such items as a component of the provision for income taxes. Changes in tax laws and rates could also affect recorded deferred tax assets and liabilities in the future. We record the effect of a tax rate or law change on our deferred tax assets and liabilities in the period of enactment. Future tax rate or law changes could have a material effect on our results of operations, financial condition, or cash flows. Recent Accounting Pronouncements See Note 1 to our accompanying unaudited Condensed Consolidated Financial Statements. Key Factors Affecting Operating Results Our future operating results and cash flows are dependent upon a number of opportunities, challenges and other factors, including our ability to efficiently grow our subscriber base, expand our Product and Service offerings to generate increased revenue per user, provide high quality Products and subscriber service to maximize subscriber lifetime value and improve the leverage of our business model. Key factors affecting our operating results include the following: Subscriber Lifetime Our ability to retain subscribers has a significant impact on our financial results, including revenues, operating income, and operating cash flows. Because we operate a business built on recurring revenues, subscriber lifetime is a key determinant of our operating success. Our Average Subscriber Lifetime is approximately 92 months (or 8 years) as ofJune 30, 2020 . If our expected long-term annualized attrition rate increased by 1% to 14%, Average Subscriber Lifetime would decrease to approximately 86 months. Conversely, if our expected attrition decreased by 1% to 12%, our Average Subscriber Lifetime would increase to approximately 100 months. A portion of the subscriber base can be expected to cancel its service every year. Subscribers may choose not to renew or may terminate their contracts for a variety of reasons, including, but not limited to, relocation, cost, switching to a competitor's service or service issues. We analyze our retention by tracking the number of subscriberswho remain as a percentage of the monthly average number of subscribers at the end of each 12 month period. We caution investors that not all companies, investors and analysts in our industry define retention in this manner.
The table below presents our smart home and security subscriber data for the
twelve months ended
Twelve months ended Twelve months ended
June 30, 2020 June 30, 2019
Beginning balance of subscribers 1,507,664 1,393,635
New subscribers 315,319 308,314
Attrition (212,341) (194,285)
Ending balance of subscribers 1,610,642 1,507,664
Monthly average subscribers 1,553,432 1,446,630
Attrition rate 13.7 % 13.4 %
Historically, we have experienced an increased level of subscriber cancellations
in the months surrounding the expiration of such subscribers' initial contract
term. Attrition in any twelve month period may be impacted by the number of
subscriber contracts reaching the end of their initial term in such period.
Attrition in the twelve months ended June 30, 2020 reflects the effect of the
2014 60-month, 2015 60-month and 2016 42-month contracts reaching the end of
their initial contract term. Attrition in the twelve months ended June 30, 2019
reflects the effect of the 2013 60-month, 2014 60-month and 2015 42-
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month contracts reaching the end of their initial contract term. We believe this
trend in cancellations at the end of the initial contract term is comparable to
other companies within our industry.
Our subscribers are the foundation of our recurring revenue-based model. Our
operating results are affected by the level of our net acquisition costs to
generate those subscribers and the value of Products and Services purchased by
them. A reduction in net subscriber acquisition costs or an increase in the
total value of Products or Services purchased by a new subscriber increases the
life-time value of that subscriber, which in turn, improves our operating
results and cash flows over time.
The net upfront cost of adding incremental subscribers is a key factor impacting
our ability to scale. Vivint Flex Pay has made it more affordable to accelerate
the growth in New Subscribers. Prior to Vivint Flex Pay, we recovered the cost
of equipment installed in subscribers' homes over time through their monthly
service billings. From the introduction of Vivint Flex Pay in early 2017 through
June 30, 2020 , 20% of subscribers have financed their equipment purchases
through RICs, which we fund through our balance sheet. We expect the percentage
of subscriber contracts financed through RICs to continue decreasing over time,
as we expect the number of future new subscriber originations financed through
RICs to be minimal . In addition, since the introduction of Vivint Flex Pay in
2017, 100% of new subscribers have either opted to use this program to finance
their equipment costs or paid for their equipment themselves at the time of
contract origination. This has greatly reduced our net cost per acquisition, as
well as the balance sheet impact of acquiring subscribers. Moving forward, we
will continue to explore ways to grow our subscriber base in a cost-effective
manner through our existing sales and marketing channels, through the growth of
our financing programs, as well as through strategic partnerships and new
channels, as these opportunities arise.
We believe the Vivint Flex Pay program will result in higher retention and thus
greater subscriber lifetime values over time. Existing subscribers are also able
to use Vivint Flex Pay to upgrade their systems or to add new Products and
Services, which we believe further increases subscriber lifetime value. This
positively impacts our operating performance, and we anticipate that adding
additional financing options to the Vivint Flex Pay program will generate
additional revenue growth and a subsequent increase in subscriber lifetime
value.
Sales and Marketing Efficiency
Our continued ability to attract and sign new subscribers in a cost-effective
manner will be a key determinant of our future operating performance. Because
our direct-to-home and national inside sales channels are currently our primary
means of subscriber acquisition, we have invested heavily in scaling these
teams. There is a lag in the productivity of new hires, which we anticipate will
improve over the course of their tenure, impacting our subscriber acquisition
rates and overall operating success. These Smart Home Pros are instrumental to
subscriber growth in the regions we cover, and their continued productivity is
vital to our future success.
Generating subscriber growth through these investments in our sales teams
depends, in part, on our ability to launch cost-effective marketing campaigns,
both online and offline. This is particularly true for our national inside sales
channel, because national inside sales fields inbound requests from subscribers
who find us using online search and submitting our on-site contact form. Our
marketing campaigns are created to attract potential subscribers and build
awareness of our brand across all our sales channels. We also believe that
building brand awareness is important to countering the competition we face from
other companies selling their solutions in the geographies we serve,
particularly in those markets where our direct-to-home sales representatives are
present.
Expansion of Platform Monetization
As smart home technology develops, we will continue expanding the breadth and
depth of our offerings to reflect the growing needs of our subscriber base and
focus on expanding our platform through the addition of new smart home
experiences and use cases. As a result of our investments to date, we have over
1.6 million active customers on our smart home platform. We will continue to
develop our Smart Home Operating System to include new complex automation
capabilities, use case scenarios, and comprehensive device integrations. Our
platform supports over 20 million connected devices, as of June 30, 2020 .
With each new Product, Service, or feature we add to our platform, we create an
opportunity to generate revenue, either through sales to our existing
subscribers or through the acquisition of new subscribers. As a result, we
anticipate that offering a broader range of smart home experiences will allow us
to grow revenue, because it improves our ability to offer tailored service
packages to subscribers with different needs. We believe this expansion of our
Product and Service offerings will allow us to build our subscriber base, while
maintaining or improving margins.
Whether we upsell existing subscribers or acquire new ones, expansion of our
platform and corresponding monetization strategies directly impacts our revenue
growth and our average revenue per user, and therefore, our operating results.
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Subscribers who contract for a smart home are signing up for our combined
proprietary smart home devices and tech-enabled service offerings. At the time
of signing, subscribers choose the equipment that matches their smart home
needs. Because we cover 98% of US zip codes, our service costs greatly impact
our operating margins. Over time, as our organization grows, we should achieve
economies of scale on our service costs. While we anticipate that our service
costs per subscriber will decline over time, an unanticipated increase in
service costs could negatively impact our profitability moving forward.
Investment in Future Projects
To date, we have made significant investments in the development of our
organization, and expect to leverage these investments to continue expanding our
Product and Service offerings over time, including integration with third party
products to drive future revenue. Our ability to expand our smart home platform
and to monetize the platform as it develops will significantly impact our
operating performance and profitability in the future.
We believe that the smart home of the future will be an ecosystem in which
businesses will seek to deliver products and services to subscribers in a way
that addresses the individual subscriber's lifestyle and needs. As the smart
home becomes the setting for the delivery of a wide range of these products and
services, including healthcare, entertainment, home maintenance, elder care,
beauty, and consumer goods, we hope to become the hub of this ecosystem and the
strategic partner of choice for the businesses delivering these products and
services.
Our success in connecting with business partners who integrate with our Smart
Home Operating System in order to reach and interact with our subscriber base is
expected to be a key determinant of our continued operating success. We expect
that additional partnerships will generate incremental revenue, because we will
share in the revenue generated by each partner-provided product or service sale
that occurs as a result of integration with our smart home platform. If we are
able to continue expanding our curated set of partnerships with influential
companies, as we already have with Google , Amazon, Chamberlain and Philips, we
believe that this will help us to increase our revenue and resulting
profitability.
Our ability to introduce a full suite of high-quality innovative new offerings
that further expands our existing smart home platform will affect our ability to
retain, grow and further monetize our subscriber base. Furthermore, we believe
that by vertically integrating the development and design of our Products and
Services with our existing sales and subscriber service activities allows us to
more quickly respond to market needs, and better understand our subscribers'
interactions and engagement with our Products and Services. This provides
critical data that we expect to enable us to continue improving the power,
usability and intelligence of these Products and Services. We expect to continue
investing in technologies that will make our platform more valuable and engaging
for subscribers.
Basis of Presentation
We conduct business through one operating segment,
Components of Results of Operations
Total Revenues
Recurring and other revenue. Our revenues are generated through the sale and
installation of our Smart Home Services contracted for by our subscribers.
Recurring Smart Home Services for our subscriber contracts are billed directly
to the subscriber in advance, generally monthly, pursuant to the terms of
subscriber contracts and recognized ratably over the service period. Revenues
from Products are deferred and generally recognized on a straight-line basis
over the customer contract term, the amount of which is dependent on the total
sales price of Products sold. Imputed interest associated with RIC receivables
is recognized over the initial term of the RIC. The amount of revenue from
Services is dependent upon which of our service offerings is included in the
subscriber contracts. Our smart home and video offerings generally provide
higher service revenue than our base smart home service offering. Historically,
we have generally offered contracts to subscribers that range in length from 36
to 60 months that are subject to automatic monthly renewal after the expiration
of the initial term. In addition, to a lesser extent, we have contracts that are
offered as month-to-month at the time of origination. At the end of each monthly
period, the portion of recurring fees related to services not yet provided are
deferred and recognized as these services are provided.
Total Costs and Expenses
Operating expenses. Operating expenses primarily consists of labor associated
with monitoring and servicing subscribers and labor and expenses associated with
Products used in service repairs. We also incur equipment costs associated
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with excess and obsolete inventory and rework costs related to Products removed
from subscribers' homes. In addition, a portion of general and administrative
expenses, comprised of certain human resources, facilities and information
technology costs are allocated to operating expenses. This allocation is
primarily based on employee headcount and facility square footage occupied.
Because our full-time smart home professionals ("Smart Home Pros") perform most
subscriber installations related to customer moves, customer upgrades or
generated through our national inside sales channels, the costs incurred within
field service associated with these installations are allocated to capitalized
contract costs. We generally expect our operating expenses to increase in
absolute dollars as the total number of subscribers we service continues to
grow, but to remain relatively constant in the near to intermediate term as a
percentage of our revenue.
Selling expenses. Selling expenses are primarily comprised of costs associated
with housing for our direct-to-home sales representatives, advertising and lead
generation, marketing and recruiting, certain portions of sales commissions
(residuals), stock-based compensation, overhead (including allocation of certain
general and administrative expenses) and other costs not directly tied to a
specific subscriber origination. These costs are expensed as incurred. We
generally expect our selling expenses to increase in absolute dollars as the
total number of subscriber originations continues to grow, but to remain
relatively constant in the near to intermediate term as a percentage of our
revenue.
General and administrative expenses. General and administrative expenses consist
largely of finance, legal, research and development ("R&D"), human resources,
information technology and executive management expenses, including stock-based
compensation expense. Stock-based compensation expense is recorded within
various components of our costs and expenses. General and administrative
expenses also include the provision for doubtful accounts. We allocate
approximately one-third of our gross general and administrative expenses,
excluding the provision for doubtful accounts, into operating and selling
expenses in order to reflect the overall costs of those components of the
business. We generally expect our general and administrative expenses to
increase in absolute dollars to support the overall growth in our business, but
to decrease in the near to intermediate term as a percentage of our revenue.
Depreciation and amortization. Depreciation and amortization consists of
depreciation from property, plant and equipment, amortization of equipment
leased under finance leases, capitalized contract costs and intangible assets.
We generally expect our depreciation and amortization expenses to increase in
absolute dollars as we grow our business and increase the number of new
subscribers originated on an annual basis, but to remain relatively constant in
the near to intermediate term as a percentage of our revenue.
Restructuring Expenses. Restructuring expenses are comprised of costs incurred
in relation to activities to exit or dispose of portions of our business that do
not qualify as discontinued operations. Expenses for related termination
benefits are recognized at the date we notify the employee, unless the employee
must provide future service, in which case the benefits are expensed ratably
over the future service period. Liabilities related to termination of a contract
are measured and recognized at fair value when the contract does not have any
future economic benefit to the entity and the fair value of the liability is
determined based on the present value of the remaining obligation.
Results of operations
Six Months Ended June
Three Months Ended June 30, 30,
2020 2019 2020 2019
(in thousands)
Total revenues $ 306,002 $ 281,053 $ 609,234 $ 557,302
Total costs and expenses 346,302 331,882 697,077 636,109
Loss from operations (40,300) (50,829) (87,843) (78,807)
Other expenses 45,845 65,619 137,214 127,098
Loss before taxes (86,145) (116,448) (225,057) (205,905)
Income tax expense (benefit) 882 (552) 94 (853)
Net loss $ (87,027) $ (115,896) $ (225,151) $ (205,052)
Key operating metrics
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As of June 30,
2020 2019
Total Subscribers (in thousands) 1,610.6
1,507.7
Total MSR (in thousands) $ 80,263 $ 79,345
AMSRU $ 49.83 $ 52.63
Net subscriber acquisition costs per new subscriber
1,064
Average subscriber lifetime (months) 92 92
Six Months Ended June
Three Months Ended June 30, 30,
2020 2019 2020 2019
Total MR (in thousands) $ 102,001 $ 93,684 $ 101,539 $ 92,884
AMRU $ 64.66 $ 63.35 $ 64.96 $ 63.56
Net service cost per subscriber $ 9.93 $ 13.13 $ 10.84 $ 13.48
Net service margin 80 % 75 % 79 % 75 %
Adjusted EBITDA
The following table sets forth a reconciliation of Adjusted EBITDA to net loss
(in millions):
Six Months Ended June
Three Months Ended June 30, 30,
2020 2019 2020 2019
Net loss $ (87.0) $ (115.9) $ (225.1) $ (205.1)
Interest expense, net 54.5 65.8 119.6 129.5
Income tax benefit, net 0.9 (0.6) 0.1 (0.9)
Depreciation 5.2 7.1 10.9 13.0
Amortization (1) 135.0 127.4 268.6 252.7
Stock-based compensation (2) 46.8 0.9 63.8 1.7
MDR fee (3) 6.0 3.8 11.2 7.2
Restructuring expenses (4) - - 20.9 -
Other (gain) expense, net (8.7) (0.2) 17.6 (2.5)
Adjusted EBITDA $ 152.7 $ 88.3 $ 287.6 $ 195.6
____________________
(1)Excludes loan amortization costs that are included in interest expense.
(2)Reflects non-cash compensation costs related to employee and director stock
incentive plans.
(3)Costs related to financing fees incurred under the Vivint Flex Pay program.
(4)Employee severance and termination benefits expenses associated with
restructuring plans.
Three Months Ended June 30, 2020 Compared to the Three Months Ended June 30,
2019
Revenues
The following table provides our revenue for the three month periods ended
June 30, 2020 and June 30, 2019 (in thousands, except for percentage):
Three Months Ended June 30,
2020 2019 % Change
Recurring and other revenue $ 306,002 $ 281,053 9 %
Recurring and other revenue for the three months ended June 30, 2020 increased
$24.9 million , or 9%, as compared to the three months ended June 30, 2019 . An
increase of approximately 7% in Total Subscribers accounted for approximately
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$19.2 million of the increase in recurring and other revenue, while an increase
in AMRU provided an increase of approximately $7.5 million . This increase in
revenues was offset by a decrease of $1.2 million associated with our former
wireless internet business, which was spun out in July 2019 . When compared to
the three months ended June 30, 2019 , currency translation negatively affected
recurring and other revenues by $0.6 million , as computed on a constant foreign
currency basis.
Costs and Expenses
The following table provides the significant components of our costs and
expenses for the three month periods ended June 30, 2020 and June 30, 2019 (in
thousands, except for percentages):
Three Months Ended June 30,
2020 2019 % Change
Operating expenses $ 82,011 $ 92,013 (11) %
Selling expenses 64,733 57,926 12 %
General and administrative 59,383 47,439 25 %
Depreciation and amortization 140,175 134,504 4 %
Total costs and expenses $ 346,302 $ 331,882 4 %
Operating expenses for the three months ended June 30, 2020 decreased $10.0
million , or 11%, as compared to the three months ended June 30, 2019 . This
decrease included a $4.0 million increase in stock-based compensation primarily
associated with grants of equity awards in the first and second quarter of 2020.
Excluding stock-based compensation, operating expenses decreased by $14.0
million , or 15%, primarily due to decreases of $13.2 million in personnel and
related support costs as we experienced lower service call volumes, $2.5 million
in costs associated with our former wireless internet business which was spun
out in July 2019 and $1.4 million in costs associated with our sales pilot
programs. These decreases were partially offset by increases of $2.0 million in
third-party contracted servicing costs and $0.7 million in equipment and related
costs.
Selling expenses, excluding capitalized contract costs, increased by $6.8
million , or 12%, for the three months ended June 30, 2020 as compared to the
three months ended June 30, 2019 . This increase included a $19.5 million
increase in stock-based compensation primarily associated with grants of equity
awards in the first and second quarter of 2020. Excluding stock-based
compensation, selling expenses decreased by $12.7 million , or 22%, primarily due
to decreases of $3.7 million in facility and housing related costs mainly from
the delayed deployment of our summer direct-to-home sales, $3.3 million in costs
associated with our sales pilot programs, $3.0 million in personnel and related
costs, $1.1 million in marketing costs and $0.7 million in customer credit
reporting costs.
General and administrative expenses increased $11.9 million , or 25%, for the
three months ended June 30, 2020 as compared to the three months ended June 30,
2019 . This increase included a $22.3 million increase in stock-based
compensation primarily associated with grants of equity awards in the first and
second quarter of 2020. Excluding stock-based compensation, general and
administrative expenses decreased by $10.4 million , or 22%, primarily due to
decreases of $6.1 million in personnel and related support costs, $2.4 million
in costs associated with our former wireless internet business which was spun
out in July 2019 , $0.7 million in research and development costs and $0.7
million in provisions for bad debt and credit losses.
Depreciation and amortization for the three months ended June 30, 2020 increased
$5.7 million , or 4%, as compared to the three months ended June 30, 2019 ,
primarily due to increased amortization of capitalized contract costs related to
new subscribers.
Other Expenses, net
The following table provides the significant components of our other expenses,
net for the three month periods ended June 30, 2020 and June 30, 2019 (in
thousands, except for percentages):
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Three Months Ended June 30,
2020 2019 % Change
Interest expense $ 54,515 $ 65,817 (17) %
Interest income (32) - NM
Other income, net (8,638) (198) NM
Total other expenses, net $ 45,845 $ 65,619 (30) %
Interest expense decreased $11.3 million , or 17%, for the three months ended
June 30, 2020 , as compared with the three months ended June 30, 2019 , primarily
due to lower outstanding debt as a result of the use of proceeds from the
Business Combination to pay down debt and the refinancing transaction that
occurred in February 2020 (See Note 3 to the accompanying unaudited condensed
consolidated financial statements).
Other income, net increased to $8.6 million for the three months ended June 30,
2020 , from $0.2 million for the three months ended June 30, 2019 . The other net
income during the three months ended June 30, 2020 was primarily due to a change
of $4.2 million from our debt modification and extinguishment in February 2020 ,
a foreign currency exchange gain of $2.8 million and a $2.0 million gain on
settlement of outstanding receivables from Wireless which was previously deemed
uncollectible. The other income, net during the three months ended June 30, 2019
was primarily due to a gain on foreign currency exchange of $1.2 million , offset
by a loss of $0.8 million on debt modification and extinguishment.
Income Taxes
The following table provides the significant components of our income tax
expense (benefit) for the three month periods ended June 30, 2020 and June 30,
2019 (in thousands, except for percentages):
Three Months Ended June 30,
2020 2019 % Change
Income tax expense (benefit) $ 882 $ (552) NM
Income tax expense was $0.9 million for the three months ended June 30, 2020 , as
compared to a tax benefit of $0.6 million for the three months ended June 30,
2019 . The income tax expense for the three months ended June 30, 2020 resulted
primarily from US state minimum taxes, offset by losses from our Canadian
subsidiary. The income tax benefit for the three months ended June 30, 2019
resulted primarily from changes in our valuation allowance and losses from our
Canadian subsidiary, offset by US state minimum taxes.
Six Months Ended June 30, 2020 Compared to the Six Months Ended June 30, 2019
Revenues
The following table provides the significant components of our revenue for the
six month periods ended June 30, 2020 and June 30, 2019 (in thousands, except
for percentages):
Six Months Ended June 30,
2020 2019 % Change
Recurring and other revenue $ 609,234 $ 557,302 9 %
Recurring and other revenue increased $51.9 million , or 9% for the six months
ended June 30, 2020 as compared to the six months ended June 30, 2019 . An
increase in Total Subscribers of approximately 7% led to an increase of
approximately $39.7 million in recurring and other revenue and an increase in
AMRU resulted in an increase of approximately $15.4 million in recurring and
other revenue. This increase in revenues was offset by a decrease of $2.4
million associated with our former wireless internet business which was spun out
in July 2019 . When compared to the six months ended June 30, 2019 , currency
translation negatively affected recurring and other revenue by $0.8 million , as
computed on a constant foreign currency basis.
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Costs and Expenses
The following table provides the significant components of our costs and
expenses for the six month periods ended June 30, 2020 and June 30, 2019 (in
thousands, except for percentages):
Six Months Ended June 30,
2020 2019 % Change
Operating expenses $ 165,351 $ 175,089 (6) %
Selling expenses 118,960 101,517 17 %
General and administrative 112,401 93,778 20 %
Depreciation and amortization 279,424 265,725 5 %
Restructuring expenses 20,941 - NM
Total costs and expenses $ 697,077 $ 636,109 10 %
Operating expenses for the six months ended June 30, 2020 decreased $9.7
million , or 6%, as compared to the six months ended June 30, 2019 . This decrease
included a $5.5 million increase in stock-based compensation primarily
associated with grants of equity awards in the first and second quarters of
2020. Excluding stock-based compensation, operating expenses decreased by $15.2
million , or 9%, primarily due to decreases of $14.7 million in personnel and
related support costs as we experienced lower service call volumes, $4.7 million
in costs associated with our former wireless internet business which was spun
out in July 2019 and $1.4 million in costs associated with our retail channel
and other sales pilots. These decreases were partially offset by increases of
$3.6 million in third-party contracted servicing and $1.7 million in equipment
costs.
Selling expenses, excluding capitalized contract costs, increased by $17.4
million , or 17%, for the six months ended June 30, 2020 as compared to the six
months ended June 30, 2019 . This increase included a $26.9 million increase in
stock-based compensation primarily associated with grants of equity awards in
the first and second quarters of 2020. Excluding stock-based compensation,
selling expenses decreased by $9.5 million , or 9%, primarily due to decreases of
$4.7 million in costs associated with our retail channel and other sales pilots,
$4.6 million in facility and housing costs primarily associated with the delayed
deployment of our summer direct-to-home sales and $1.2 million in personnel and
related support costs. These decreases were offset by an increase of $2.0
million in information technology costs.
General and administrative expenses increased $18.6 million , or 20%, for the six
months ended June 30, 2020 as compared to the six months ended June 30, 2019 .
This increase included a $29.7 million increase in stock-based compensation
primarily associated with grants of equity awards in the first and second
quarters of 2020. Excluding stock-based compensation, general and administrative
expenses decreased by $11.1 million , or 12%, primarily due to decreases of $7.7
million in personnel and related support costs, $4.5 million in costs associated
with our former wireless internet business which was spun out in July 2019 , $1.5
million in research and development costs and $0.8 million in information
technology costs. These decreases were partially offset by increases of $3.0
million in provisions for bad debt and credit losses, of which $2.6 million is
associated with the implementation of ASC Topic 326 which was primarily driven
by expected credit losses and bad debt associated with the COVID-19 pandemic
(see Note 1 in the accompanying unaudited financials for further discussion).
Depreciation and amortization for the six months ended June 30, 2020 increased
$13.7 million , or 5%, as compared to the six months ended June 30, 2019 ,
primarily due to increased amortization of capitalized contract costs related to
new subscribers.
Restructuring expenses for the six months ended June 30, 2020 related to
employee severance and termination benefits expenses (See Note 16 to the
accompanying unaudited condensed consolidated financial statements).
Other Expenses, net
The following table provides the significant components of our other expenses,
net for the six month periods ended June 30, 2020 and June 30, 2019 (in
thousands, except for percentages):
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Six Months Ended June 30,
2020 2019 % Change
Interest expense $ 119,808 $ 129,565 (8) %
Interest income (261) (23) NM
Other loss (income), net 17,667 (2,444) NM
Total other expenses, net $ 137,214 $ 127,098 8 %
Interest expense decreased $9.8 million , or 8%, for the six months ended
June 30, 2020 , as compared with the six months ended June 30, 2019 , due
primarily to lower outstanding debt as a result of the use of proceeds from the
Business Combination to pay down debt and the refinancing transaction that
occurred in February 2020 (See Note 3 to the accompanying unaudited condensed
consolidated financial statements).
Other loss (income), net was a net loss of $17.7 million for the six months
ended June 30, 2020 , as compared to net income of $2.4 million for the six
months ended June 30, 2019 . The other net loss during the six months ended
June 30, 2020 was primarily due to a $12.7 million loss on our debt modification
and extinguishment in February 2020 , a foreign currency exchange loss of $3.5
million , a loss on our derivative instrument of $2.2 million and a $2.1 million
loss on disposal of assets, partially offset by a $2.0 million gain on
settlement of outstanding receivables from Wireless which was previously deemed
uncollectible. The other net income during the six months ended June 30, 2019
was primarily due to a gain on foreign currency exchange of $2.9 million and a
gain on sale of securities of $2.3 million , partially offset by a loss on our
derivative instrument of $1.4 million , a loss of $0.8 million on debt
modification and extinguishment and a loss of $0.4 million on disposal of
assets.
See Note 3 to our accompanying unaudited Condensed Consolidated Financial
Statements for further information on our long-term debt related to other
expenses, net.
Income Taxes
The following table provides the significant components of our income tax
expense (benefit) for the six month periods ended June 30, 2020 and June 30,
2019 (in thousands, except for percentages):
Six Months Ended June 30,
2020 2019 % Change
Income tax expense (benefit) $ 94 $ (853) NM
Income tax expense was $0.1 million for the six months ended June 30, 2020 , as
compared to a benefit of $0.9 million for the six months ended June 30, 2019 .
The income tax expense for the six months ended June 30, 2020 resulted primarily
from US state minimum taxes, offset by losses in our Canadian subsidiary. The
income tax benefit for the six months ended June 30, 2019 resulted primarily
from changes in our valuation allowance and losses in our Canadian subsidiary,
offset by US state minimum taxes.
Liquidity and Capital Resources
Cash from operations could be affected by various risks and uncertainties,
including, but not limited to, the continued effects of the COVID-19 pandemic
and other risks detailed in the Risk Factors section of this report and our
Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2020 .
Despite the challenging economic environment caused by the pandemic, based on
our current business plan and revenue prospects, we continue to believe that our
existing cash and cash equivalents, our anticipated cash flows from operations
and our available credit facility will be sufficient to meet our working capital
and operating resource expenditure requirements for at least the next twelve
months from the date of this filing.
Our primary source of liquidity has historically been cash from operations,
proceeds from issuances of debt and equity securities, borrowings under our
credit facilities and, to a lesser extent, capital contributions. As of June 30,
2020 , we had $249.0 million of cash and cash equivalents and $229.2 million of
availability under our revolving credit facility (after giving effect to $15.6
million of letters of credit outstanding and $105.2 million of borrowings).
As market conditions warrant, we and our equity holders, including the Sponsor,
its affiliates and members of our management, may from time to time, seek to
purchase our outstanding debt securities or loans in privately negotiated or
open market transactions, by tender offer or otherwise. Subject to any
applicable limitations contained in the agreements governing our indebtedness,
any purchases made by us may be funded by the use of cash on our balance sheet
or the incurrence of new
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secured or unsecured debt, including additional borrowings under our revolving
credit facility. The amounts involved in any such purchase transactions,
individually or in the aggregate, may be material. Any such purchases may be
with respect to a substantial amount of a particular class or series of debt,
with the attendant reduction in the trading liquidity of such class or series.
In addition, any such purchases made at prices below the "adjusted issue price"
(as defined for U.S. federal income tax purposes) may result in taxable
cancellation of indebtedness income to us, which amounts may be material, and in
related adverse tax consequences to us. Depending on conditions in the credit
and capital markets and other factors, we will, from time to time, consider
various financing transactions, the proceeds of which could be used to refinance
our indebtedness or for other purposes.
Cash Flow and Liquidity Analysis
Our cash flows provided by operating activities include recurring monthly
billings, cash received from the sale of Products to our subscribers that either
pay-in-full at the time of installation or finance their purchase of Products
under the Consumer Financing Program and other fees received from the
subscribers we service. Cash used in operating activities includes the cash
costs to monitor and service our subscribers, a portion of subscriber
acquisition costs and general and administrative costs. Historically, we
financed subscriber acquisition costs through our operating cash flows, the
issuance of debt, and to a lesser extent, through the issuance of equity and
sale of contracts to third parties. Currently, the upfront proceeds from the
Consumer Finance Program, and those that are paid-in-full at the time of the
sale of Products, offset a portion of the upfront investment associated with
subscriber acquisition costs.
Sales from our direct-to-home channel are seasonal in nature. We make
investments in the recruitment of our direct-to-home sales representatives,
inventory and other support costs for the April through August sales period
prior to each sales season. We experience increases in capitalized contract
costs, as well as costs to support the sales force throughout North America ,
prior to and during this time period. The incremental inventory purchased to
support the direct-to-home sales season is generally consumed prior to the end
of the calendar year in which it is purchased.
The following table provides a summary of cash flow data (in thousands, except
for percentages):
Six Months Ended June 30,
2020 2019 % Change
Net cash provided by (used in) operating activities
$ (130,990) NM Net cash (used in) provided by investing activities (5,666) 128 NM Net cash provided by financing activities 172,576 121,210 42 % Cash Flows from Operating Activities We generally reinvest the cash flows from our recurring monthly billings and cash received from the sale of Products associated with the initial installation into our business, primarily to (1) maintain and grow our subscriber base, (2) expand our infrastructure to support this growth, (3) enhance our existing Smart Home Services offerings, (4) develop new Smart Home Services offerings and (5) expand into new sales channels. These investments are focused on generating new subscribers, increasing the revenue from our existing subscriber base, enhancing the overall quality of service provided to our subscribers, and increasing the productivity and efficiency of our workforce and back-office functions necessary to scale our business. For the six months endedJune 30, 2020 , net cash provided by operating activities was$77.5 million . This cash provided was primarily from a net loss of$225.2 million , adjusted for: •$345.3 million in non-cash amortization, depreciation, and stock-based compensation; •a$12.7 million loss on early extinguishment of debt; •$11.1 million in non-cash restructuring expenses; and •provisions for doubtful accounts and credit losses of$13.1 million . Cash provided by operating activities resulting from changes in operating assets and liabilities, including: •a$128.2 million increase in deferred revenue due primarily to the growth in deferred revenues associated with the sale of Products under the Vivint Flex Pay plan and the increased subscriber base, •a$68.7 million increase in accrued payroll and commissions, accrued expenses, other current and long-term liabilities; 67 -------------------------------------------------------------------------------- Table of Contents •a$15.6 million decrease in long-term notes receivables and other assets, net primarily due to decreases in RIC receivables, •a$7.3 million increase in accounts payable due primarily to increased inventory purchases, and •a$3.8 million decrease in right of use assets. These sources of operating cash were partially offset by the following changes in operating assets and liabilities: •a$259.3 million increase in capitalized contract costs, •a$18.1 million increase in inventories to support our direct-to-home summer selling season, •a$16.9 million increase in accounts receivable driven primarily by the increase in amounts due under the Consumer Financing Program; •a$4.1 million increase in prepaid expenses and other current assets, and •a$4.2 million decrease in right of use liabilities. For the six months endedJune 30, 2019 , net cash used in operating activities was$131.0 million . This cash used was primarily from a net loss of$205.1 million , adjusted for: •$269.9 million in non-cash amortization, depreciation, and stock-based compensation •a provision for doubtful accounts of$11.6 million , and •a$2.3 million gain on equity securities. Cash used in operating activities resulting from changes in operating assets and liabilities, including: •a$264.6 million increase in capitalized contract costs, •a$88.7 million increase in inventories to support our direct-to-home summer selling season, •a$29.8 million increase in accounts receivable driven primarily by the increase in RIC billings under Vivint Flex Pay and the growth in the number of our Total Subscribers, •a$5.4 million increase in long-term notes receivables and other assets, net, •a$5.5 million increase in prepaid expenses and other current assets, and •a$3.9 million decrease in the right-of-use liabilities associated with operating leases. These uses of operating cash were partially offset by the following changes in operating assets and liabilities: •a$91.7 million increase in deferred revenue due primarily to the growth in deferred revenues associated with the sale of Products under the Vivint Flex Pay plan and the increased subscriber base, •a$66.5 million increase in accounts payable due primarily to increased inventory purchases, •a$30.2 million increase in accrued payroll and commissions, accrued expenses, other current and long-term liabilities, and current and long-term operating lease liabilities due primarily to an increase in the derivative liability associated with the Consumer Financing Program of$18.7 million , an increase in accrued payroll and commissions of$14.0 million , and •a$3.5 million decrease in right-of-use assets primarily due to amortization of these assets. Net cash interest paid for the six months endedJune 30, 2020 and 2019 related to our indebtedness (excluding finance or capital leases) totaled$114.2 million and$130.3 million , respectively. Our net cash flows from operating activities for the six months endedJune 30, 2020 and 2019, before these interest payments, were cash inflows of$191.7 million and cash outflows of$0.7 million , respectively. Accordingly, our net cash provided by operating activities were sufficient to cover interest payments for the six months endedJune 30, 2020 and insufficient for the six months endedJune 30, 2019 . Cash Flows from Investing Activities
Historically, our investing activities have primarily consisted of capital expenditures, business combinations and technology acquisitions. Capital expenditures primarily consist of periodic additions to property, plant and equipment to support the growth in our business.
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For the six months ended June 30, 2020 , net cash used in investing activities
was $5.7 million primarily associated with capital expenditures of $5.9 million ,
offset by proceeds from the sale of assets of $1.4 million .
For the six months ended June 30, 2019 , net cash provided by investing
activities was $0.1 million primarily associated with the sale of equity
securities of $5.4 million , offset by capital expenditures of $4.7 million and
acquisition of intangible assets of $0.7 million .
Cash Flows from Financing Activities
Historically, our cash flows provided by financing activities primarily related
to the issuance of equity securities and the issuance of debt by our
subsidiaries, primarily to fund the portion of upfront costs associated with
generating new subscribers that are not covered through our operating cash flows
or through our Vivint Flex Pay program. Uses of cash for financing activities
are generally associated with the return of capital to our stockholders, the
repayment of debt and the payment of financing costs associated with the
issuance of debt.
For the six months ended June 30, 2020 , net cash provided by financing
activities was $172.6 million , consisting of proceeds from the issuance of
$1,550.0 million aggregate principal amount of 2027 Notes and Term Loans, $465.0
million capital contribution associated with the Merger, $359.2 million in
borrowings on our revolving credit facility and $74.6 million from the exercise
of warrants. These cash proceeds were offset by $1,749.5 million of repayments
on existing notes, $499.0 million of repayments on our revolving credit
facility, $12.3 million in financing costs and $4.4 million of repayments under
our finance lease obligations,.
For the six months ended June 30, 2019 , net cash provided by financing
activities was $121.2 million , consisting primarily of $160.0 million in
borrowings on our revolving credit facility and proceeds from the issuance of
$225.0 million aggregate principal amount of 2024 notes. These cash proceeds
were offset by $229.1 million of repayments on existing notes and $4.3 million
of repayments under our finance lease obligations.
Long-Term Debt
We are a highly leveraged company with significant debt service requirements. As
of June 30, 2020 , we had $2.95 billion of total debt outstanding, consisting of
$677.0 million of outstanding 7.875% senior secured notes due 2022 (the "2022
notes"), $400.0 million of outstanding 7.625% senior notes due 2023 (the "2023
notes"), $225.0 million of outstanding 8.50% senior secured notes due 2024 (the
"2024 notes"), $600.0 million of outstanding 6.75% senior secured notes due 2027
(the "2027 notes," and together with the 2022 notes, 2023 notes and 2024 notes,
the "Notes"), $947.6 million of borrowings outstanding under the 2025 Term Loan
B (as defined below) and $105.2 million of borrowings outstanding under our
revolving credit facility (with $229.2 million of additional availability under
the revolving credit facility after giving effect to $15.6 million of letters of
credit outstanding).
2022 Notes
As of June 30, 2020 , APX had $677.0 million outstanding aggregate principal
amount of its 2022 notes. Interest on the 2022 notes is payable semi-annually in
arrears on June 1 and December 1 of each year.
We may, at our option, redeem at any time and from time to time some or all
of the 2022 notes at the redemption prices specified in the indenture governing
the 2022 notes, in each case, plus any accrued and unpaid interest to the date
of redemption.
The 2022 notes mature on December 1, 2022 , or on such earlier date when any
outstanding pari passu lien indebtedness matures as a result of the operation of
any springing maturity provisions set forth in the agreements governing such
pari passu lien indebtedness.
2023 Notes
As of June 30, 2020 , APX had $400.0 million outstanding aggregate principal
amount of its 2023 notes. Interest on the 2023 notes is payable semi-annually in
arrears on September 1 and March 1 of each year. The 2023 notes mature on
September 1, 2023 .
We may, at our option, redeem at any time and from time to time some or all
of the 2023 notes at the redemption prices specified in the indenture governing
the 2023 notes, in each case, plus any accrued and unpaid interest to the date
of redemption.
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2024 Notes
As of June 30, 2020 , APX had $225.0 million outstanding aggregate principal
amount of its 2024 notes. Interest on the 2024 notes is payable semi-annually in
arrears on May 1 and November 1 of each year.
We may, at our option, redeem at any time and from time to time prior to May
1, 2021 , some or all of the 2024 notes at 100% of the principal amount thereof
plus accrued and unpaid interest to the redemption date plus the applicable
"make-whole premium." From and after May 1, 2021 , we may, at our option, redeem
at any time and from time to time some or all of the 2024 notes at 104.25%,
declining to par from and after May 1, 2023 , in each case, plus any accrued and
unpaid interest to the date of redemption. In addition, on or prior to May 1,
2021 , we may, at our option, redeem up to 40% of the aggregate principal amount
of the 2024 notes with the proceeds from certain equity offerings at 108.50%,
plus accrued and unpaid interest to the date of redemption. In addition, on or
prior to May 1, 2021 , during any 12 month period, we also may, at our option,
redeem at any time and from time to time up to 10% of the aggregate principal
amount of the 2024 notes at a price equal to 103% of the principal amount
thereof, plus accrued and unpaid interest, to but excluding the redemption date.
The 2024 notes mature on November 1, 2024 , unless, under "Springing
Maturity" provisions, on June 1, 2023 (the 91st day prior to the maturity of the
2023 notes) more than an aggregate principal amount of $125.0 million of such
2023 notes remain outstanding or have not been refinanced as permitted under the
note purchase agreement for the 2023 notes, in which case the 2024 Notes will
mature on June 1, 2023 .
2027 Notes
As of June 30, 2020 , APX had $600.0 million outstanding aggregate principal
amount of its 2027 notes. Interest on the 2027 notes is payable semiannually in
arrears on February 15 and August 15 each year.
We may, at our option, redeem at any time and from time to time prior to
February 15, 2023 , some or all of the 2027 notes at 100% of the principal amount
thereof plus accrued and unpaid interest to the redemption date plus the
applicable "make-whole premium." From and after February 15, 2023 , we may, at
our option, redeem at any time and from time to time some or all of the 2027
notes at 103.375%, declining to par from and after May 1, 2025 , in each case,
plus any accrued and unpaid interest to the date of redemption. In addition, on
or prior to February 15, 2021 , we may, at our option, redeem up to 40% of the
aggregate principal amount of the 2027 notes with the proceeds from certain
equity offerings at 100% plus an applicable premium, plus accrued and unpaid
interest to the date of redemption. In addition, on or prior to February 15,
2023 , during any 12 month period, we also may, at our option, redeem at any time
and from time to time up to 10% of the aggregate principal amount of the 2027
notes at a price equal to 103% of the principal amount thereof, plus accrued and
unpaid interest, to but excluding the redemption date.
The 2027 notes will mature on February 15, 2027 , unless, under "Springing
Maturity" provisions on June 1, 2023 (the 91st day prior to the maturity of the
2023 notes) more than an aggregate principal amount of $125.0 million of such
2023 notes remain outstanding or have not been refinanced as permitted under the
note purchase agreement for the 2023 notes, in which case the 2027 Notes will
mature on June 1, 2023 . The 2027 notes are secured, on a pari passu basis, by
the collateral securing obligations under the existing senior secured notes, the
revolving credit facility and the Term Loan, in each case, subject to certain
exceptions and permitted liens.
2025 Term Loan B
On February 14, 2020 APX Group incurred $950 million of term loans (the "2025
Term Loan B"), the proceeds of which were used, in part, to refinance the 2024
Term Loan B.
Pursuant to the terms of the 2025 Term Loan B, quarterly amortization payments
are due in an amount equal to 0.25% of the aggregate principal amount of the
2025 Term Loan B outstanding on the closing date. The remaining principal amount
outstanding under the 2025 Term Loan B will be due and payable in full on (x) if
the Term Springing Maturity Condition (as defined below) does not apply,
December 31, 2025 and (y) if the Term Springing Maturity Condition does apply,
the 2023 Springing Maturity Date (which date is the date that is 91 days before
the maturity date with respect to the 2023 Notes).
The "Term Springing Maturity Condition" applies if on the 2023 Springing
Maturity Date (which date is the date that is 91 days before the maturity date
with respect to the 2023 Notes), an aggregate principal amount of the 2023 Notes
in excess of $125.0 million are either outstanding or have not been repaid or
redeemed.
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Revolving Credit Facility
On February 14, 2020 , we amended and restated the credit agreement governing the
senior secured revolving credit facility (the "Fourth Amended and Restated
Credit Agreement") to provide for, among other things, (1) an increase in the
aggregate commitments previously available to us to $350.0 million and (2) the
extension of the maturity date with respect to certain of the previously
available commitments.
As of June 30, 2020 we had $229.2 million of availability under our revolving
credit facility (after giving effect to $15.6 million of letters of credit
outstanding and $105.2 million of borrowings). Borrowings under the Fourth
Amended and Restated Credit Agreement bear interest at a rate per annum equal to
an applicable margin plus, at our option, either (1) the base rate determined by
reference to the highest of (a) the Federal Funds rate plus 0.50%, (b) the prime
rate of Bank of America, N.A . and (c) the LIBOR rate determined by reference to
the costs of funds for U.S. dollar deposits for an interest period of one month,
plus 1.00% or (2) the LIBOR rate determined by reference to the London interbank
offered rate for dollars for the interest period relevant to such borrowing. The
applicable margin for base rate-based borrowings (1)(a) under the Series A
Revolving Commitments of approximately $10.9 million and the Series C Revolving
Commitments of approximately $330.8 million is currently 2.0% and (b) under the
Series B Revolving Commitments of approximately $8.3 million is currently 3.0%
and (2) the applicable margin for LIBOR rate-based borrowings (a) under the
Series A Revolving Commitments and the Series C Revolving Commitments is
currently 3.0% per annum and (b) under the Series B Revolving Commitments is
currently 4.0%. The applicable margin for borrowings under the revolving credit
facility is subject to one step-down of 25 basis points based on our meeting a
consolidated first lien net leverage ratio test.
In addition to paying interest on outstanding principal under the revolving
credit facility, APX is required to pay a quarterly commitment fee (which is
subject to one interest rate step-down of 12.5 basis points, based on APX
meeting a consolidated first lien net leverage ratio test) to the lenders under
the revolving credit facility in respect of the unutilized commitments
thereunder. APX also pays a customary letter of credit and agency fees.
APX is not required to make any scheduled amortization payments under the
revolving credit facility. The principal amount outstanding under the revolving
credit facility will be due and payable in full on March 31, 2021 with respect
to the commitments under the Series A Revolving Credit Facility and Series B
Revolving Credit Facility and on February 14, 2025 (or the applicable springing
maturity date if the Revolving Springing Maturity Condition applies) with
respect to the $330.8 million of Series C Revolving Credit Commitments. The
"Revolver Springing Maturity Condition" applies if (i) on the 2022 Springing
Maturity Date, an aggregate principal amount of the Borrower's 7.875% Senior
Secured Notes Due 2022 (the "2022 Notes") in excess of $350.0 million are either
outstanding or have not been repaid or redeemed with certain qualifying proceeds
specified in the Fourth Amended and Restated Credit Agreement, (ii) on the 2023
Springing Maturity Date, an aggregate principal amount of the 2023 Notes in
excess of $125.0 million are either outstanding or have not been repaid or
redeemed with certain qualifying proceeds specified in the Fourth Amended and
Restated Credit Agreement or (iii) on the 2024 Springing Maturity Date, an
aggregate principal amount of the Borrower's 8.500% Senior Secured Notes Due
2024 (the "2024 Notes") in excess of $125.0 million are either outstanding or
have not been repaid or redeemed with certain qualifying proceeds specified in
the Fourth Amended and Restated Credit Agreement. The "2022 Springing Maturity
Date" means the date that is 91 days before the maturity date with respect to
the 2022 Notes, the "2023 Springing Maturity Date" means the date that is 91
days before the maturity date with respect to the 2023 Notes and the "2024
Springing Maturity Date" means the date that is 91 days before the maturity date
with respect to the 2024 Notes.
Guarantees and Security (Revolving Credit Facility, 2025 Term Loan B and Notes)
All of the obligations under the credit agreement governing the revolving credit
facility, the credit agreement governing the 2025 Term Loan B and the debt
agreements governing the Notes are guaranteed by APX Group Holdings, Inc. and
each of APX Group, Inc.'s existing and future material wholly-owned U.S.
restricted subsidiaries (subject to customary exclusions and qualifications).
However, such subsidiaries shall only be required to guarantee the obligations
under the debt agreements governing the Notes for so long as such entities
guarantee the obligations under the revolving credit facility, the credit
agreement governing the 2025 Term Loan B or our other indebtedness. All of the
obligations under the Notes are also guaranteed by Vivint Smart Home, Inc.
The obligations under the revolving credit facility, 2025 Term Loan B, 2022
notes, the 2024 notes and the 2027 notes (collectively with the 2022 notes and
2024 notes, the "existing senior secured notes") are secured by a security
interest in (1) substantially all of the present and future tangible and
intangible assets of APX Group, Inc. , and the guarantors, including without
limitation equipment, subscriber contracts and communication paths, intellectual
property, material fee-owned real property, general intangibles, investment
property, material intercompany notes and proceeds of the foregoing, subject to
permitted liens and other customary exceptions, (2) substantially all personal
property of APX Group, Inc. and the guarantors consisting of accounts receivable
arising from the sale of inventory and other goods and services (including
related contracts and contract rights, inventory, cash, deposit accounts, other
bank accounts and securities accounts), inventory and intangible
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assets to the extent attached to the foregoing books and records of APX Group,
Inc. and the guarantors, and the proceeds thereof, subject to permitted liens
and other customary exceptions, in each case held by APX Group, Inc. and the
guarantors and (3) a pledge of all of the capital stock of APX Group, Inc. , each
of its subsidiary guarantors and each restricted subsidiary of APX Group, Inc.
and its subsidiary guarantors, in each case other than excluded assets and
subject to the limitations and exclusions provided in the applicable collateral
documents.
Under the terms of the applicable security documents and intercreditor
agreement, the proceeds of any collection or other realization of collateral
received in connection with the exercise of remedies will be applied first to
repay up to $350.0 million of amounts due under the revolving credit facility,
before the holders of the existing senior secured notes or 2025 Term Loan B
receive any such proceeds.
Guarantor Summarized Financial Information
In May 2020 , the Company provided a parent guarantee of APX Group's obligations
under the indentures governing the Notes, in each case, in order to enable APX
Group to satisfy its reporting obligations under the indentures governing the
Notes by furnishing financial information relating to the Company.
We are providing the following information with respect to the Revolving Credit
Facility, 2025 Term Loan B and the Notes. The financial information of Vivint
Smart Home, Inc. , APX Group Holdings, Inc. , APX Group, Inc. and each guarantor
subsidiary (collectively the "Guarantors") is presented on a combined basis with
intercompany balances and transactions between the Guarantors eliminated. The
Guarantors' amounts due from, amounts due to, and transactions with
non-guarantor subsidiaries are separately disclosed.
Six months ended Twelve months ended
June 30, 2020 December 31, 2019
(in thousands)
Recurring and other revenues $ 574,832 $ 1,084,749
Intercompany revenues 10,421 18,790
Total revenues 585,253 1,103,539
Total costs and expenses 673,495 1,246,351
Loss from operations (88,242) (142,812)
Other expenses 133,605 255,554
Income tax expense 292 237
Net loss $ (222,139) $ (398,603)
June 30, 2020 December 31, 2019
(in thousands)
Current assets $ 404,366 $ 130,995
Amounts due from Non-Guarantor Subsidiaries 234,302 71,523
Non-current assets:
Capitalized contract costs 1,183,703 1,147,860
Goodwill 810,130 810,130
Intangible assets, net 132,407 164,330
Other non-current assets 116,875 201,273
Total non-current assets 2,243,115 2,323,593
Current liabilities 621,692 991,368
Amounts due to Non-Guarantor Subsidiaries 171,475 149,757
Non-current liabilities $ 3,580,954 $ 3,354,638
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Debt Covenants
The credit agreement governing the revolving credit facility, the credit
agreement governing the 2025 Term Loan B and the debt agreements governing the
Notes contain a number of covenants that, among other things, restrict, subject
to certain exceptions, APX Group, Inc. and its restricted subsidiaries' ability
to:
•incur or guarantee additional debt or issue disqualified stock or preferred
stock;
•pay dividends and make other distributions on, or redeem or repurchase, capital
stock;
•make certain investments;
•incur certain liens;
•enter into transactions with affiliates;
•merge or consolidate;
•materially change the nature of their business;
•enter into agreements that restrict the ability of restricted subsidiaries to
make dividends or other payments to APX Group, Inc. ;
•designate restricted subsidiaries as unrestricted subsidiaries;
•amend, prepay, redeem or purchase certain subordinated debt; and
•transfer or sell certain assets.
The credit agreement governing the revolving credit facility, the credit
agreement governing the 2025 Term Loan B and the debt agreements governing the
Notes contain change of control provisions and certain customary affirmative
covenants and events of default. As of June 30, 2020 , APX Group, Inc. was in
compliance with all covenants related to its long-term obligations.
Subject to certain exceptions, the credit agreement governing the revolving
credit facility, the credit agreement governing the 2025 Term Loan B and the
debt agreements governing the Notes permit APX Group, Inc. and its restricted
subsidiaries to incur additional indebtedness, including secured indebtedness.
Our future liquidity requirements will be significant, primarily due to debt
service requirements. The actual amounts of borrowings under the revolving
credit facility will fluctuate from time to time.
Our liquidity and our ability to fund our capital requirements is dependent on
our future financial performance, which is subject to general economic,
financial and other factors that are beyond our control and many of which are
described under "Part II. Item 1A-Risk Factors" in our Quarterly Report on Form
10-Q for the quarterly period ended March 31, 2020 and this Quarterly Report on
Form 10-Q. If those factors significantly change or other unexpected factors
adversely affect us, our business may not generate sufficient cash flow from
operations or we may not be able to obtain future financings to meet our
liquidity needs. We anticipate that to the extent additional liquidity is
necessary to fund our operations, it would be funded through borrowings under
the revolving credit facility, incurring other indebtedness, additional equity
or other financings or a combination of these potential sources of liquidity. We
may not be able to obtain this additional liquidity on terms acceptable to us or
at all.
Covenant Compliance
Under the credit agreement governing the revolving credit facility, the credit
agreement governing the 2025 Term Loan B and the debt agreements governing the
Notes, our subsidiary, APX Group's ability to engage in activities such as
incurring additional indebtedness, making investments, refinancing certain
indebtedness, paying dividends and entering into certain merger transactions is
governed, in part, by our ability to satisfy tests based on Covenant Adjusted
EBITDA (which measure is defined as "Consolidated EBITDA" in the credit
agreements governing the revolving credit facility and 2025 Term Loan B and
"EBITDA" in the debt agreements governing the existing notes) for the applicable
four-quarter period. Such tests include an incurrence-based maximum consolidated
secured debt ratio and consolidated total debt ratio of 4.00 to 1.0 (or, in the
case of each of the credit agreements governing the revolving credit facility
and the 2025 Term Loan B, 4.25 to 1.00), an incurrence-based minimum fixed
charge coverage ratio of 2.00 to 1.0, and, solely in the case of the credit
agreement governing the revolving credit facility, a maintenance-based maximum
consolidated first lien secured debt ratio of 5.95 to 1.0, each as
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determined in accordance with the credit agreement governing the revolving
credit facility, the credit agreement governing the 2025 Term Loan B and the
debt agreements governing the Notes, as applicable. Non-compliance with these
covenants could restrict our ability to undertake certain activities or result
in a default under the credit agreement governing the revolving credit facility,
the credit agreement governing the 2025 Term Loan B and the debt agreements
governing the Notes. As of June 30, 2020 , our consolidated first lien secured
debt ratio was 3.18 to 1.0, our consolidated total debt ratio was 4.07 to 1.0
and our fixed charge coverage ratio was 3.31 to 1.0, in each case based on
Covenant Adjusted EBITDA for the four quarters ended June 30, 2020 and as
calculated in accordance with the applicable debt agreements.
"Covenant Adjusted EBITDA" is defined as net income (loss) before interest
expense (net of interest income), income and franchise taxes and depreciation
and amortization (including amortization of capitalized subscriber acquisition
costs), further adjusted to exclude the effects of certain contract sales to
third parties, non-capitalized subscriber acquisition costs, stock based
compensation and certain unusual, non-cash, non-recurring and other items
permitted in certain covenant calculations under the agreements governing our
Notes, the credit agreement governing the 2025 Term Loan B and the credit
agreement governing our revolving credit facility.
We believe that the presentation of Covenant Adjusted EBITDA is appropriate to
provide additional information to investors about the calculation of, and
compliance with, certain financial covenants contained in the agreements
governing the Notes, the credit agreements governing the revolving credit
facility and the 2025 Term Loan B. We caution investors that amounts presented
in accordance with our definition of Covenant Adjusted EBITDA may not be
comparable to similar measures disclosed by other issuers, because not all
issuers and analysts calculate Covenant Adjusted EBITDA in the same manner.
Covenant Adjusted EBITDA is not a measurement of our financial performance under
GAAP and should not be considered as an alternative to net loss or any other
performance measures derived in accordance with GAAP or as an alternative to
cash flows from operating activities as a measure of our liquidity.
The following table sets forth a reconciliation of net loss to Covenant Adjusted EBITDA (in thousands):
Twelve months
ended June 30,
2020
Net loss $ (416,023)
Interest expense, net 249,996
Other expense, net 12,446
Income tax expense, net 2,260
Restructuring expenses (1) 20,941
Depreciation and amortization (2) 98,342
Amortization of capitalized contract costs 458,797
Non-capitalized contract costs (3) 259,315
Stock-based compensation (4) 65,887
Other adjustments (5) 62,846
Adjustment for a change in accounting principle (Topic 606) (6) (86,093)
Covenant Adjusted EBITDA $ 728,714
____________________
(1)Restructuring expenses related to employee severance and termination
benefits.
(2)Excludes loan amortization costs that are included in interest expense.
(3)Reflects subscriber acquisition costs that are expensed as incurred because
they are not directly related to the acquisition of specific subscribers.
Certain other industry participants purchase subscribers through subscriber
contract purchases, and as a result, may capitalize the full cost to purchase
these subscriber contracts, as compared to our organic generation of new
subscribers, which requires us to expense a portion of our subscriber
acquisition costs under GAAP. (See Note 1 to the accompanying unaudited
condensed consolidated financial statements)
(4)Reflects non-cash compensation costs related to employee and director stock
and stock incentive plans.
(5)Other adjustments represent primarily the following items (in thousands):
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Twelve months ended
June 30, 2020 Product development (a)$ 16,279 Consumer financing fees (b) 14,464 Hiring, retention and termination payments (c) 4,817 Certain legal and professional fees (d) 7,700 Projected run-rate restructuring cost savings (e) 11,609 Monitoring fee (f) 7,004 All other adjustments (g) 973 Total other adjustments$ 62,846 ____________________ (a)Costs related to the development of control panels, including associated software, and peripheral devices. (b)Monthly financing fees incurred under the Consumer Financing Program. (c)Expenses associated with retention bonus, relocation and severance payments to management. (d)Legal and professional fees associated with strategic initiatives and financing transactions. (e)Projected run-rate savings related toMarch 2020 reduction-in-force. (f)BMP monitoring fee (See Note 14 to the accompanying unaudited condensed consolidated financial statements). (g)Other adjustments primarily reflect adjustments to eliminate the impact of changes in other accounting principles, add back revenue reduction directly related to purchase accounting deferred revenue adjustments and costs associated with payments to third parties related to various strategic, legal and financing activities.
(6)The adjustments to eliminate the impact of the Company's adoption of Topic 606, are as follows (in thousands):
Twelve months ended June 30, 2020
Net loss $ 68,475
Amortization of capitalized contract costs
(458,798)
Amortization of subscriber acquisition costs 302,402 Income tax (benefit) expense 1,828 Topic 606 adjustments $ (86,093) Other Factors Affecting Liquidity and Capital Resources Vivint Flex Pay. Vivint Flex Pay became our primary sales model beginning inMarch 2017 . Under the Consumer Financing Program, qualified customers are eligible for loans provided by third-party financing providers up to$4,000 . The annual percentage rates on these loans range between 0% and 9.99%, and are either installment loans or revolving loans with a 42 or 60 month term. Most loan terms are determined by the customer's credit quality. For certain third-party provider loans, we pay a monthly fee based on either the average daily outstanding balance of the loans or the number of outstanding loans, depending on the third-party financing provider. Additionally, we share in the liability for credit losses depending on the credit quality of the customer, with our Company being responsible for between 5% to 100% of lost principal balances, depending on factors specified in the agreement with such provider. Because of the nature of these provisions, we record a derivative liability at its fair value when the third-party financing provider originates loans to customers, which reduces the amount of estimated revenue recognized on the provision of the services. The derivative liability represents the estimated remaining amounts to be paid to the third-party provider by us related to outstanding loans, including the monthly fees based on either the outstanding loan balances or the number of outstanding loans, shared liabilities for credit losses and customer payment processing fees. The derivative liability is reduced as payments are made by us to the third-party financing provider. Subsequent changes to the fair value of the derivative liability are realized through other expenses (income), net in the Condensed Consolidated Statement of Operations. As ofJune 30, 2020 andDecember 31, 2019 , the fair value of this derivative liability was$180.0 million and$136.9 million , respectively. As we continue to use of Vivint Flex Pay as our 75 -------------------------------------------------------------------------------- Table of Contents primary sales model, we expect our liability to third-party providers to continue to increase substantially and the rate of such increases may accelerate. For other third-party provider loans, we receive net proceeds (net of fees and expected losses) for which we have no further obligation to the third-party. We record these net proceeds to deferred revenue. Vehicle Leases. Since 2010, we have leased, and expect to continue leasing, vehicles primarily for use by our Smart Home Pros. For the most part, these leases have 36 month durations and we account for them as finance leases. At the end of the lease term for each vehicle we have the option to either (i) purchase it for the estimated end-of-lease fair market value established at the beginning of the lease term; or (ii) return the vehicle to the lessor to be sold by them and in the event the sale price is less than the estimated end-of-lease fair market value we are responsible for such deficiency. As ofJune 30, 2020 , our total finance lease obligations were$9.2 million , of which$5.2 million is due within the next 12 months. Aircraft Lease. InDecember 2012 , we entered into an aircraft lease agreement for the use of a corporate aircraft, which is accounted for as an operating lease. Upon execution of the lease, we paid a$5.9 million security deposit which is refundable at the end of the lease term. BeginningJanuary 2013 , we are required to make 156 monthly rental payments of approximately$83,000 each. InJanuary 2015 , an amendment to the agreement was made which, among other changes, increased the required monthly rental payments to approximately$87,000 each. We also have the option to extend the lease for an additional 36 months upon expiration of the initial term. The lease agreement also provides us the option to purchase the aircraft on certain specified dates for a stated dollar amount, which represents the current estimated fair value as of the purchase date. Off-Balance Sheet Arrangements Currently we do not engage in off-balance sheet financing arrangements, as defined in Item 303(a)(4)(ii) of Regulation S-K. 76
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