Alarm.com Holdings, Inc. 10-Q

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion and analysis of our financial condition and results of operations together with (1) our condensed consolidated financial statements and the related notes and other financial information included elsewhere in this Quarterly Report on Form 10-Q and (2) the audited consolidated financial statements and the related notes and management’s discussion and analysis of financial condition and results of operations for the fiscal year ended December 31, 2019 included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 filed on February 26, 2020 with the Securities and Exchange Commission, or SEC. This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, or Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or Exchange Act. These statements are often identified by the use of words such as “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “objective,” “ongoing,” “plan,” “predict,” “project,” “potential,” “should,” “will,” “would” or the negative or plural of these words or similar expressions or variations and such forward-looking statements include, but are not limited to, s tatements with respect to the anticipated impact of the global economic uncertainty and financial market conditions caused by the COVID-19 pandemic on our business, results of operations and financial condition, including on our hardware sales and our SaaS and license revenue growth rate; our business strategy, plans and objectives for future operations; continued enhan cement s of our platform and offerings; our future financial and business performance and the potential impact of trade policies and related tariffs on our cost of hardware revenue and hardware revenue margins. The events described in these forward-looking statements are subject to a number of risks, uncertainties, assumptions and other factors that could cause actual results and the timing of certain events to differ materially from future results expressed or implied by the forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified in the section titled “Risk Factors” set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q and elsewhere in this and in our other SEC filings. You should not rely upon forward-looking statements as predictions of future events. Furthermore, such forward-looking statements speak only as of the date of this report. Except as required by law, we undertake no obligation to update any forward-looking statements to reflect events or circumstances after the date of such statements. Overview Alarm.com is the leading platform for the intelligently connected property. We offer a comprehensive suite of cloud-based solutions for smart residential and commercial properties, including interactive security, video monitoring, intelligent automation, energy management and wellness solutions. Millions of property owners depend on our technology to intelligently secure, automate and manage their residential and commercial properties. In the last year alone, our platforms processed more than 200 billion data points generated by over 100 million connected devices. We believe that this scale of subscribers, connected devices and data operations makes us the leader in the connected property market. Our solutions are delivered through an established network of over 9,000 trusted service providers, who are experts at selling, installing and supporting our solutions. We primarily generate Software-as-a-Service, or SaaS, and license revenue through our service provider partners, who resell these services and pay us monthly fees. These service provider contracts typically have an initial term of one year, with subsequent renewal terms of one year. Our service provider partners have indicated that they typically have three to five-year service contracts with residential and commercial property owners who use our solutions. We also generate hardware and other revenue, primarily from our service provider partners and distributors. Our hardware sales include connected devices that enable our services, such as video cameras, video recorders, gateway modules and smart thermosta ts. We believe that the length of our service relationships with residential and commercial property owners, combined with our robust platforms and approximately 20 years of operating experience, contribute to a compelling business model. Our technology platforms are designed to make connected properties safer, smarter and more efficient. Our solutions are used in both smart residential and commercial properties, which we refer to as the connected property market and we have designed our technology platforms for all market participants. This includes not only the residential and commercial property owners who subscribe to our services, but also the hardware partners who manufacture devices that integrate with our platforms and the service provider partners who install and maintain our solutions. Our service provider partners can deploy our interactive security, video monitoring, intelligent automation, energy management and wellness solutions as stand-alone offerings or as combined solutions to address the needs of a broad range of customers. Our subscribers can seamlessly connect to their property through our family of mobile apps, websites and engagement platforms like voice control through Amazon Echo and Google Home, wearable devices like the Apple Watch and TV applications such as Apple TV and Amazon Fire TV. Highlights of Third Quarter Results We primarily generate SaaS and license revenue, our largest source of revenue, through our service provider partners who resell our services and pay us monthly fees. Our service provider partners sell, install and support Alarm.com solutions that enable residential and commercial property owners to intelligently secure, connect, control and automate their properties. Our subscribers consist of all of the properties maintained by those residential and commercial property owners to which we are delivering at least one of our solutions. We derive a portion of our revenue from licensing our intellectual property to third parties 31 on a per customer basis. SaaS and license revenue represented 63% and 64% of our revenue during the three and nine months ended September 30, 2020, respectively, as compared to 66% and 68% in the same periods in the prior year. We also generate SaaS and license revenue from monthly fees charged to service providers on a per subscriber basis for access to our non-hosted software platform, or Software platform. The non-hosted software for interactive security, automation and related solutions is typically deployed and operated by the service provider in its own network operations center. Software license revenue represented 6% of our revenue during each of the three and nine months ended September 30, 2020, as compared to 8% and 9% for the same periods in the prior year. We also generate revenue from the sale of hardware, including video cameras, video recorders, cellular radio modules, thermostats, image sensors and other peripherals, that enables our solutions. We have a rich history of innovation in cellular technology that enables our robust SaaS offering. Our hardware and other revenue also includes our revenue from the sale of perpetual licenses that provide our customers in the commercial market the right to use our video surveillance software for an indefinite period of time in exchange for a one-time license fee. Hardware and other revenue represented 37% and 36% of our revenue during the three and nine months ended September 30, 2020, respectively, as compared to 34% and 32% in the same periods in the prior year. We typically expect hardware and other revenue to fluctuate as a percentage of total revenue. Highlights of our financial performance for the periods covered in this Quarterly Report include: • SaaS and license revenue increased 18% to $100.1 million in the three months ended September 30, 2020 from $84.9 million in the three months ended September 30, 2019. SaaS and license revenue increased 16% to $287.8 million in the nine months ended September 30, 2020 from $247.3 million in the nine months ended September 30, 2019. Included in SaaS and license revenue was software license revenue, which decreased to $9.5 million in the three months ended September 30, 2020 from $10.8 million in the three months ended September 30, 2019. Software license revenue decreased to $29.0 million in the nine months ended September 30, 2020 from $32.8 million in the nine months ended September 30, 2019. • Total revenue increased 24% to $158.9 million in the three months ended September 30, 2020 from $127.9 million in the three months ended September 30, 2019. Total revenue increased 25% to $452.4 million in the nine months ended September 30, 2020 from $361.9 million in the nine months ended September 30, 2019. • Net income increased to $35.8 million in the three months ended September 30, 2020 as compared to $17.7 million in the three months ended September 30, 2019. Net income increased to $61.0 million in the nine months ended September 30, 2020 as compared to $40.5 million in the nine months ended September 30, 2019. Net income attributable to common stockholders increased to $36.1 million in the three months ended September 30, 2020 as compared to $17.7 million in the three months ended September 30, 2019. Net income attributable to common stockholders increased to $61.9 million in the nine months ended September 30, 2020 as compared to $40.5 million in the nine months ended September 30, 2019. • Adjusted EBITDA, a non-GAAP measurement of operating performance, increased to $34.5 million in the three months ended September 30, 2020 from $26.3 million in the three months ended September 30, 2019. Adjusted EBITDA increased to $92.9 million in the nine months ended September 30, 2020 from $78.3 million in the nine months ended September 30, 2019. Please see Non-GAAP Measures below in this section of this Quarterly Report for a discussion of the limitations of Adjusted EBITDA (a non-GAAP measure) and a reconciliation of Adjusted EBITDA to net income, the most comparable measurement in accordance with accounting principles generally accepted in the United States, or GAAP, for the three and nine months ended September 30, 2020 and 2019. Recent Developments The COVID-19 pandemic disrupted and may intermittently continue to disrupt our supply chain for an unknown period of time due to its impact on manufacturing, production and global transportation. The COVID-19 pandemic also disrupted and may intermittently continue to disrupt our sales channels due to restrictions on our service providers’ ability to meet with residential and commercial property owners who use our solutions. We have taken precautionary measures intended to help protect our employees, service providers and subscribers, as well as the communities in which we participate, including enabling substantially all of our employees to work remotely. In addition, the COVID-19 pandemic resulted in a global slowdown of economic activity and a recession in the United States and the economic situation remains fluid as parts of the economy appear to be recovering while others continue to struggle. Prolonged uncertainty with respect to COVID-19 could cause further economic slowdown or cause other unpredictable events, each of which could adversely affect our business, results of operations or financial condition. While our business and those of our service providers showed some resiliency beginning towards the end of the second quarter of 2020 and continuing in the third quarter, if the economy fails to fully recover or there is another shutdown of non-essential businesses due to a resurgence of COVID-19, we anticipate that our SaaS and license revenue growth rate may be lower in future periods if some consumers or small businesses defer or cancel previously anticipated purchases, with a 32 corresponding reduction in hardware revenue. The challenges posed by COVID-19 on our business continue to evolve rapidly and we will continue to evaluate our business and operations in light of future developments. Secondary Public Offering In May 2020, we completed an underwritten secondary public offering of 5,616,451 shares of common stock at a price of $47.50 per share. All of the shares sold in the secondary public offering were sold by selling stockholders, which are entities affiliated with Technology Crossover Ventures. We did not receive any proceeds from the sale of shares of common stock by the selling stockholders. We incurred expenses of approximately $0.5 million related to legal, accounting and other fees in connection with the secondary public offering during the nine months ended September 30, 2020 , which are included in general and administrative expense in our condensed consolidated statements of operations and are adjusted for when determining Adjusted EBITDA. Please see Non-GAAP Measures below in this section of this Quarterly Report for a discussion of the limitations of Adjusted EBITDA (a n on-GAAP measure) and a reconciliation of Adjusted EBITDA to net income, the most comparable measurement in accordance with GAAP, for the three and nine months ended September 30, 2020 and 2019. Other Business Metrics We regularly monitor a number of financial and operating metrics in order to measure our current performance and estimate our future performance. Our other business metrics may be calculated in a manner different from the way similar business metrics used by other companies are calculated and include the following (dollars in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 SaaS and license revenue $ 100,126 $ 84,924 $ 287,780 $ 247,313 Adjusted EBITDA 34,496 26,320 92,895 78,287 Twelve Months Ended September 30, 2020 2019 SaaS and license revenue renewal rate 94 % 94 % SaaS and License Revenue SaaS and license revenue is a GAAP measure that we use to measure our current performance and estimate our future performance. We believe that SaaS and license revenue is an indicator of the productivity of our existing service provider partner s and their ability to activate and maintain subscribers using our intelligently connected property solutions, our ability to add new service provider partners reselling our solutions, the demand for our intelligently connected property solutions and the pace at which the market for these solutions is growing. Adjusted EBITDA Adjusted EBITDA is a non-GAAP measure that represents our net income before interest expense, interest income, other income, net, provision for income taxes, amortization and depreciation expense, stock-based compensation expense, secondary offering expense, acquisition-related (benefit) / expense and legal costs and settlement fees incurred in connection with non-ordinary course litigation and other disputes, particularly costs involved in ongoing intellectual property litigation. We do not consider these items to be indicative of our core operating performance. The non-cash items include amortization and depreciation expense and stock-based compensation expense. We do not adjust for ordinary course legal expenses resulting from maintaining and enforcing our intellectual property portfolio and license agreements. Adjusted EBITDA is a key measure that our management uses to understand and evaluate our core operating performance and trends to generate future operating plans, to make strategic decisions regarding the allocation of capital, and to make investments in initiatives that are focused on cultivating new markets for our solutions. In particular, the exclusion of certain expenses in calculating Adjusted EBITDA facilitates comparisons of our operating performance on a period-to-period basis and, in the case of exclusion of acquisition-related adjustments and certain historical legal expenses, excludes items that we do not consider to be indicative of our core operating performance. Adjusted EBITDA is not a measure calculated in accordance with GAAP and should not be considered in isolation from, or as a substitute for, financial information prepared in accordance with GAAP. Please see Non-GAAP Measures in this section for a discussion of the limitations of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income, the most comparable GAAP measurement, for the three and nine months ended September 30, 2020 and 2019. 33 SaaS and License Revenue Renewal Rate Our SaaS and license revenue renewal rate is an operating metric. We measure our SaaS and license revenue renewal rate on a trailing 12-month basis by dividing (a) the total SaaS and license revenue recognized during the trailing 12-month period from our subscribers on our Alarm.com platform who were subscribers on the first day of the period, by (b) total SaaS and license revenue we would have recognized during the period from those same subscribers assuming no terminations, or service level upgrades or downgrades. The SaaS and license revenue renewal rate represents both residential and commercial properties. Our SaaS and license revenue renewal rate is expressed as an annualized percentage. Our service provider partner s, who resell our services to our subscribers, have indicated that they typically have three to five-year service contracts with our subscribers. Our SaaS and license revenue renewal rate is calculated across our entire subscriber base on the Alarm.com platform, including subscribers whose contract with their service provider reached the end of its contractual term during the measurement period, as well as subscribers whose contract with their service provider has not reached the end of its contractual term during the measurement period, and is not intended to estimate the rate at which our subscribers renew their contracts with our service provider partner s. We believe that our SaaS and license revenue renewal rate allows us to measure our ability to retain and grow our SaaS and license revenue and serves as an indicator of the lifetime value of our subscriber base. Credit Losses (Topic 326) On June 16, 2016, the Financial Accounting Standards Board, or FASB, issued Accounting Standards Update, or ASU, 2016-13, " Financial Instruments - Credit Losses (Topic 326)," or Topic 326, which provides guidance designed to provide financial statement users with more information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. From November 2018 to February 2020, amendments to Topic 326 were issued to clarify numerous accounting topics. When determining such expected credit losses, the guidance requires companies to apply a methodology that reflects expected credit losses and requires consideration of a broader range of reasonable and supportable information to inform credit loss estimates. The amendment was effective for us beginning on January 1, 2020. On January 1, 2020, we adopted Topic 326 by applying the modified retrospective approach to our trade receivables and our notes receivable that were outstanding as of that date, which required us to record the initial effect of Topic 326 as a cumulative-effect adjustment to retained earnings on January 1, 2020. The adoption of Topic 326 resulted in the recording of the following amounts on our condensed consolidated balance sheets (in thousands): Balance Sheet Caption As of January 1, 2020 Accumulated deficit $ 816 Accounts receivable, net (367) Other current assets (83) Other assets (366) The adoption of Topic 326 did not materially impact our condensed consolidated statements of operations, condensed consolidated statement of equity or our condensed consolidated statements of cash flows. Components of Operating Results Our fiscal year ends on December 31. The key elements of our operating results include: Revenue We derive our revenue from three primary sources: the sale of cloud-based SaaS services on our integrated Alarm.com platform, the sale of licenses and services on the Software platform and the sale of hardware products. We sell our platform and hardware solutions to service provider partners that resell our solutions and hardware to residential and commercial property owners, who are the service provider partners’ customers. SaaS and License Revenue . We generate the majority of our SaaS and license revenue primarily from monthly fees charged to our service provider partners on a per subscriber basis for access to our cloud-based intelligently connected property platform and related solutions. Our fees per subscriber vary based upon the service plan and features utilized. We offer multiple service level packages for our platform solutions including a range of solutions and a range of a la carte add-ons for additional features. The fee paid by our service provider partners each month for the delivery of our solutions is based on the combination of packages and add-ons enabled for each subscriber. We utilize tiered pricing plans where our service provider partners may receive prospective pricing discounts driven by volume. 34 We also generate SaaS and license revenue from the fees paid to us when we license our intellectual property to third parties for use of our patents. In addition, in certain markets our EnergyHub subsidiary sells its demand response service for an annual service fee, with pricing based on the number of subscribers or amount of aggregate electricity demand made available for a utility’s or market’s control. Software License Revenue . Our SaaS and license revenue also includes our software license revenue from monthly fees charged to service providers on a per subscriber basis for access to our Software platform. The non-hosted software for interactive security, automation and related solutions is typically deployed and operated by the service provider in its own network operations center. Our agreements for the Software platform solution typically include software and services, such as post-contract customer support, or PCS. Software license revenue included in SaaS and license revenue is expected to continue to decline over time as we transition subscribers to our cloud-based hosted platform. Hardware and Other Revenue. We generate hardware and other revenue primarily from the sale of video cameras, video recorders and cellular radio modules that provide access to our cloud-based platforms and, to a lesser extent, the sale of other devices, including image sensors and peripherals. We primarily transfer hardware to our customers upon delivery to the customer, which corresponds with the time at which the customer obtains control of the hardware. We record a reserve against revenue for hardware returns based on historical returns. Our hardware and other revenue also includes our revenue from the sale of perpetual licenses that provide our customers in the commercial market the right to use our OpenEye video surveillance software for an indefinite period of time in exchange for a one-time license fee, which is generally paid at contract inception. Hardware and other revenue may also include activation fees charged to some of our service provider partners for activation of a new subscriber account on our platforms, as well as fees paid by service provider partners for our marketing services. The decision whether to charge an activation fee is based in part on the expected number of subscribers to be added by our service provider partners and as a result, many of our largest service provider partners do not pay an activation fee. As a result of the COVID-19 pandemic, governments, public institutions and other organizations in many countries and localities where COVID-19 has been detected have taken certain emergency measures, and may from time to time take additional emergency measures, to com bat its spread, including imposing lockdowns, shelter-in-place orders, quarantines, restrictions on travel and gatherings and the extended shutdown non-essential businesses that cannot be conducted remotely. These emergency measures remain in place to varying degrees. We have seen and anticipate we may continue to see some disruption to our hardware supply chain due to the impact of COVID-19 on manufacturing, production and global transportation, as well as to our sales channels due to restrictions on our service providers’ ability to meet with residential and commercial property owners who use our solutions, reluc tance of service providers and property owners to meet even where such restrictions have been lifted and general economic condition s. In addition, the COVID-19 pandemic has resulted in a global slowdown of economic activity and a recession in the United States and the economic situation remains fluid as parts of the economy appear to be recovering while others continue to struggle. As the future impact on global supply chains from COVID-19 is difficult to predict, the extent to which COVID-19 may negatively affect our hardware revenue is uncertain; however, if the economy fails to fully recover or there is another shutdown of non-essential businesses due to a resurgence of COVID-19, we anticipate that our SaaS and license revenue growth rate may be lower in future periods if some consumers or small businesses defer or cancel previously anticipated purchases, with a corresponding reduction in hardware revenue. Cost of Revenue Our cost of SaaS and license revenue primarily includes the amounts paid to wireless network providers and, to a lesser extent, the costs of running our network operations centers which are expensed as incurred, as well as patent and royalty costs in connection with technology licensed from third-party providers. Our cost of SaaS and license revenue also includes our cost of software license revenue, which primarily includes the payroll and payroll-related costs of the department dedicated to providing service exclusively to those service providers that host the Software platform. Our cost of hardware and other revenue primarily includes cost of raw materials, tooling and amounts paid to our third-party manufacturer for production and fulfillment of our cellular radio modules and image sensors, and procurement costs for our video cameras and video recorders, which we purchase from an original equipment manufacturer, and other devices. Our cost of hardware and other revenue also includes royalty costs in connection with technology licensed from third-party providers. We record the cost of SaaS and license revenue as expenses are incurred, which corresponds to the delivery period of our services to our subscribers. We record the cost of hardware and other revenue primarily when the hardware and other services are delivered to the service provider partner, which occurs when control of the hardware and other services transfers to the service provider partner. Our cost of revenue excludes amortization and depreciation shown in operating expenses. In 2019, the U.S. administration imposed significant changes to U.S. trade policy with respect to China. Tariffs have subjected certain Alarm.com products manufactured overseas to additional import duties of up to 25%. The amount of the import tariff and the number of products subje ct to tariffs have changed numerous times based on action by the U.S. administration. Approximately one-fifth to one-half of the finis hed goods hardware products that we sell to our service provider partners are imported from China and c ould be subject to increased tariffs. While the additional import duties resulted in an increase to our cost of hardware revenue, these import duties had a modest impact on hardware revenue margins. We continue to monitor the 35 changes in tariffs. If tariffs are increased or are expanded to apply to more of our products, such actions may increase our cost of hardware revenue and reduce our hardware revenue margins in the future. Operating Expenses Our operating expenses consist of sales and marketing, general and administrative, research and development and amortization and depreciation expenses. Salaries, bonuses, stock-based compensation, benefits and other personnel related costs are the most significant components of each of these expense categories, excluding amortization and depreciation. We include stock-based compensation expense in connection with the grant of stock options and other forms of equity compensation in the applicable operating expense category based on the respective equity award recipient’s function (sales and marketing, general and administrative or research and development). We grew from 1,043 employees as of September 30, 2019 to 1,361 employees as of September 30, 2020, and we expect to continue to hire new employees to support the projected future growth of our business. Sales and Marketing Expense. Sales and marketing expense consists primarily of personnel and related expenses for our sales and marketing teams, including salaries, bonuses, stock-based compensation, benefits, travel, and commissions. Our sales and marketing teams engage in sales, account management, service provider partner support, advertising, promotion of our products and services and marketing. The number of employees in sales and marketing functions increased from 340 as of September 30, 2019 to 450 as of September 30, 2020. We expect to continue to invest in our sales and marketing activities to expand our business both domestically and internationally. We intend to increase the size of our sales force and our service provider partner support team to provide additional support to our existing service provider partner base to drive their productivity in selling our solutions as well as to enroll new service provider partners in North America and in international markets. General and Administrative Expense. General and administrative expense consists primarily of personnel and related expenses for our administrative, legal, human resources, finance and accounting personnel, including salaries, bonuses, stock-based compensation, benefits and other personnel costs. Additional expenses included in this category are legal costs, including those that are incurred to defend and license our intellectual property, as well as non-personnel costs, such as travel related expenses, rent, subcontracting and professional fees, audit fees, tax services, and insurance expenses. Also included in general and administrative expenses are credit losses and acquisition-related expenses, which consist primarily of legal, accounting and professional service fees directly related to acquisitions and valuation gains or losses on acquisition-related contingent liabilities. The number of employees in general and administrative functions increased from 121 as of September 30, 2019 to 161 as of September 30, 2020. Excluding intellectual property litigation and acquisition-related (benefit) / expense, we expect general and administrative costs to increase prospectively as our business grows. This includes cost increases related to accounting, finance, and legal personnel, additional external legal, audit fees and other expenses associated with regulations governing public companies. While somewhat unpredictable, we also expect to continue to incur costs related to litigation involving intellectual property. See the section of this Quarterly Report titled "Legal Proceedings" for additional information regarding litigation matters. Research and Development Expense . Research and development expense consists primarily of personnel and related expenses for our employees working on our product development and software and device engineering teams, including salaries, bonuses, stock-based compensation, benefits and other personnel costs. Also included are non-personnel costs such as consulting and professional fees paid to third-party development resources as well as acquisition costs of IPR&D with no alternative future use. The number of employees in research and development functions increased from 582 as of September 30, 2019 to 750 as of September 30, 2020. Our research and development efforts are focused on innovating new features and enhancing the functionality of our platforms and the solutions we offer to our service provider partners and subscribers. We will also continue to invest in efforts to extend our platforms to adjacent markets and internationally to maintain our leadership position in the development of intelligently connected property technology, and continued enhancement of our Enterprise Tools platform for our service provider partners. Amortization and Depreciation . Amortization and depreciation consists of amortization of intangible assets originating from our acquisitions as well as our internally-developed capitalized software. Our depreciation expense is related to investments in property and equipment. Acquired intangible assets include developed technology, customer related intangibles, trademarks and trade names. We expect in the near term that amortization and depreciation may fluctuate based on our acquisition activity, development of our platforms and capitalized expenditures. Interest Expense Interest expense consists of interest expense associated with our credit facility. On October 6, 2017, we entered into a $125.0 million senior secured revolving credit facility, or the 2017 Facility, with Silicon Valley Bank, or SVB, as administrative agent, PNC Bank, National Association, as documentation agent, and a syndicate of lenders. The 2017 Facility is available to us 36 to refinance existing debt and for general corporate and working capital purposes as permitted under the terms of the 2017 Facility. Interest expense is expected to increase in 2020 as compared to 2019 due to the $50.0 million borrowed under the 2017 Facility as a precautionary measure in order to provide financial flexibility in light of current uncertainty in the financial markets resulting from the COVID-19 pandemic. Interest Income Interest income consists of interest income earned on our cash and cash equivalents and our notes receivable. Other Income, Net Other income, net primaril y consists of gains earned on the sale of our investments and gains earned on our notes receivable and conversion of our outstanding notes receivable balance into an equity investment, partially offset by an impairment of one of our investments. Provision for Income Taxes We are subject to U.S. federal, state and local income taxes as well as foreign income taxes. During the ordinary course of business, there are many transactions and calculations for which the ultimate tax determination is uncertain. As a result, we recognize tax liabilities based on estimates of whether additional taxes will be due. Our effective tax rates were different from the statutory rate primarily due to research and development tax credits claimed, tax windfall benefits from employee stock-based payment transactions and foreign derived intangible income deductions, partially offset by the impact of state taxes and non-deductible meal and entertainment expenses. We recognize excess tax windfall benefits on a discrete basis in the quarter in which it occurs, and we anticipate that our effective tax rate will vary from quarter to quarter depending on our stock price and exercises of stock options under our equity incentive plans each period. 37 Results of Operations The following table sets forth our unaudited selected condensed consolidated statements of operations and data as a percentage of revenue for the periods presented (in thousands). Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Revenue: SaaS and license revenue $ 100,126 63 % $ 84,924 66 % $ 287,780 64 % $ 247,313 68 % Hardware and other revenue 58,725 37 42,956 34 164,647 36 114,562 32 Total revenue 158,851 100 127,880 100 452,427 100 361,875 100 Cost of revenue (1) : Cost of SaaS and license revenue 14,344 9 12,438 10 39,673 9 37,428 10 Cost of hardware and other revenue 46,839 30 35,085 27 128,495 28 93,601 26 Total cost of revenue 61,183 39 47,523 37 168,168 37 131,029 36 Operating expenses: Sales and marketing (2) 18,410 12 14,533 11 52,405 12 43,392 12 General and administrative (2) 17,410 11 18,701 15 55,634 12 51,785 14 Research and development (2) 36,914 23 29,461 23 113,280 25 84,375 23 Amortization and depreciation 6,878 4 5,467 4 20,023 5 15,833 5 Total operating expenses 79,612 50 68,162 53 241,342 54 195,385 54 Operating income 18,056 11 12,195 10 42,917 9 35,461 10 Interest expense (556) — (715) (1) (2,069) — (2,322) (1) Interest income 118 — 2,703 2 734 — 4,317 1 Other income, net 24,753 16 6,380 5 24,910 6 6,468 2 Income before income taxes 42,371 27 20,563 16 66,492 15 43,924 12 Provision for income taxes 6,546 4 2,873 2 5,471 2 3,428 1 Net income $ 35,825 23 % $ 17,690 14 % $ 61,021 13 % $ 40,496 11 % _______________ (1) Excludes amortization and depreciation shown in operating expenses below. (2) Operating expenses include stock-based compensation expense as follows (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Stock-based compensation expense data: Sales and marketing $ 734 $ 534 $ 2,263 $ 1,385 General and administrative 2,154 1,714 6,033 4,762 Research and development 4,560 2,787 12,605 8,574 Total stock-based compensation expense $ 7,448 $ 5,035 $ 20,901 $ 14,721 The following table sets forth the components of cost of revenue as a percentage of revenue: Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Components of cost of revenue as a percentage of revenue: Cost of SaaS and license revenue as a percentage of SaaS and license revenue 14 % 15 % 14 % 15 % Cost of hardware and other revenue as a percentage of hardware and other revenue 80 % 82 % 78 % 82 % Total cost of revenue as a percentage of total revenue 39 % 37 % 37 % 36 % 38 Comparison of the Three and Nine Months Ended September 30, 2020 to September 30, 2019 The following tables in this section set forth our selected condensed consolidated statements of operations (in thousands), data for the percentage change and data as a percentage of revenue for the periods presented. Revenue Three Months Ended September 30, % Change Nine Months Ended September 30, % Change 2020 2019 2020 2019 Revenue SaaS and license revenue $ 100,126 $ 84,924 18 % $ 287,780 $ 247,313 16 % Hardware and other revenue 58,725 42,956 37 164,647 114,562 44 Total revenue $ 158,851 $ 127,880 24 % $ 452,427 $ 361,875 25 % T h e $31.0 million increase in total revenue for the three months ended September 30, 2020 as compared to the same period in the prior year was primarily the result of a $15.8 million, or 37%, increase in our hardware and other revenue and a $15.2 million, or 18%, increase in our SaaS and license revenue. Our software license revenue included within SaaS and license revenue decreased $1.3 million to $9.5 million during the three months ended September 30, 2020 as compared to $10.8 million during the same period in the prior year, which decreased primarily due to the result of the continuing transition of customers from non-hosted software to our cloud based hosted platform. The $12.9 million increase in our Alarm.com segment SaaS and license revenue for the three months ended September 30, 2020 was primarily due to growth in our subscriber base, including the revenue impact from subscribers we added in 2019. The increase in hardware and other revenue for the three months ended September 30, 2020 as compared to the same period in the prior year was from the Alarm.com segment and was due an increase in the volume of video cameras sold as well as the increased revenue from our acquisition of 85% of the issued and outstanding capital stock of PC Open Incorporated, a Washington corporation, doing business as OpenEye, on October 21, 2019. The $2.3 million increase in SaaS and license revenue for our Other segment for the three months ended September 30, 2020 as compared to the same period i n the prior year was due to an increase in sales of our energy management and demand response solutions and our property management and heating, ventilation and air conditioning, or HVAC, solutions. Hardware and other revenue, net of in tersegment eliminat ions, for the three months ended September 30, 2020 in our Other segment decreased $1.7 million, or 52%, as compared to the same period in the prior year, primarily due to a decrease in sales related to our property management solution. The $90.6 million increase in total revenue for the nine months ended September 30, 2020 as compared to the same period in the prior year was primarily the result of a $50.1 million, or 44%, increase in our hardware and other revenue and a $40.5 million, or 16%, increase in our SaaS and license revenue. Our software license revenue included within SaaS and license revenue decreased $3.8 million to $29.0 million during the nine months ended September 30, 2020, as compared to $32.8 million during the same period in the prior year, which decreased primarily due to the result of the continuing transition of customers from non-hosted software to our cloud based hosted platform. The $35.7 million increase in our Alarm.com segment SaaS and license revenue for the nine months ended September 30, 2020 was primarily due to growth in our subscriber base, including the revenue impact from subscribers we added in 2019. The increase in hardware and other revenue for the nine months ended September 30, 2020, as compared to the same period in the prior year was primarily from the Alarm.com segment and was due to an increase in the volume of video cameras sold, as well as the increased revenue from our acquisition of 85% of the issued and outstanding capital stock of OpenEye, on October 21, 2019. The $4.8 million increase in SaaS and license revenue for our Other segment for the nine months ended September 30, 2020, as compared to the same period in the prior year was due to an increase in sales of our energy management and demand response solutions and our property management and HVAC solutions. Hardware and other revenue, net of intersegment eliminations, for the nine months ended September 30, 2020 in our Other segment decreased $3.1 million, or 31%, as compared to the same period in the prior year, primarily due to a decrease in sales related to our property management solution. 39 Cost of Revenue Three Months Ended September 30, % Change Nine Months Ended September 30, % Change 2020 2019 2020 2019 Cost of revenue (1) Cost of SaaS and license revenue $ 14,344 $ 12,438 15 % $ 39,673 $ 37,428 6 % Cost of hardware and other revenue 46,839 35,085 34 128,495 93,601 37 Total cost of revenue $ 61,183 $ 47,523 29 % $ 168,168 $ 131,029 28 % % of total revenue 39 % 37 % 37 % 36 % _______________ (1) Excludes amortization and depreciation shown in operating expenses. T he $13.7 million increase in cost of revenue for the three months ended September 30, 2020 as compared to the same period in the prior year was the result of a $11.8 million, or 34%, increase in cost of hardware and other revenue and a $1.9 million, or 15%, increase in cost of SaaS and license revenue. Our cost of software license revenue included within cost of SaaS and license revenue was $0.3 million for each of the three months ended September 30, 2020 and 2019. The increase in cost of Alarm.com segment hardware and other revenue related primarily to an increase in the number of hardware units shipped during the three months ended September 30, 2020 as compared to the same period in the prior year as well as the increased cost of revenue from our acquisition of 85% of the issued and outstanding capital stock of OpenEye on October 21, 2019. Cost of hardware and other revenue as a percentage of hardware and other revenue was 80% for the three months ended September 30, 2020 and 82% for the same period in the prior year. Cost of SaaS and license revenue as a percentage of SaaS and license revenue was 14% for the three months ended September 30, 2020 and 15% for the same period in the prior year. Cost of software license revenue as a percentage of software license revenue was 3% for each of the three months ended September 30, 2020 and 2019. The decrease in cost of hardware and other revenue as a percentage of hardware and other revenue for the three months ended September 30, 2020 as compared to the same period in the prior year is a reflection of the mix of product sales during the periods. The $37.1 million increase in cost of revenue for the nine months ended September 30, 2020 as compared to the same period in the prior year was the result of a $34.9 million, or 37%, increase in cost of hardware and other revenue and a $2.2 million, or 6%, increase in cost of SaaS and license revenue. Our cost of software license revenue included within cost of SaaS and license revenue was $1.0 million for each of the nine months ended September 30, 2020 and 2019. The increase in cost of Alarm.com segment hardware and other revenue related primarily to an increase in the number of hardware units shipped during the nine months ended September 30, 2020 as compared to the same period in the prior year as well as the increased cost of revenue from our acquisition of 85% of the issued and outstanding capital stock of OpenEye on October 21, 2019. Cost of hardware and other revenue as a percentage of hardware and other revenue was 78% for the nine months ended September 30, 2020 and 82% for the same period in the prior year. Cost of SaaS and license revenue as a percentage of SaaS and license revenue was 14% for the nine months ended September 30, 2020 and 15% for the same period in the prior year. Cost of software license revenue as a percentage of software license revenue was 3% for each of the nine months ended September 30, 2020 and 2019. The decrease in cost of hardware and other revenue as a percentage of hardware and other revenue for the nine months ended September 30, 2020, as compared to the same period in the prior year is a reflection of the mix of product sales during the periods. Sales and Marketing Expense Three Months Ended September 30, % Change Nine Months Ended September 30, % Change 2020 2019 2020 2019 Sales and marketing $ 18,410 $ 14,533 27 % $ 52,405 $ 43,392 21 % % of total revenue 12 % 11 % 12 % 12 % The $3.9 million increase in sales and marketing expense for the three months ended September 30, 2020 as compared to the same period in the prior year was primarily due to increases in headcount for our sales team and our service provider partner support team to support our growth. As a result, our personnel and related costs for our Alarm.com segment, including salary, benefits, stock-based compensation and travel expenses, increased by $2.2 million for the three months ended September 30, 2020, net of decreased travel expenses of $1.2 million due to the COVID-19 pandemic. Additionally, marketing costs increased by $1.2 million for the three months ended September 30, 2020 for our Alarm.com segment as compared to the same period in the prior year due to an increase in advertising. Sales and marketing expense from our Other segment increased $0.4 million for the three months ended September 30, 2020 as compared to the same period in the prior year, primarily due to increases in headcount for our sales team. 40 The $9.0 million increase in sales and marketing expense for the nine months ended September 30, 2020 as compared to the same period in the prior year was primarily due to increases in headcount for our sales team and our service provider partner support team to support our growth. As a result, our personnel and related costs for our Alarm.com segment, including salary, benefits, stock-based compensation and travel expenses, increased by $7.8 million for the nine months ended September 30, 2020, net of decreased travel expenses of $2.6 million due to the COVID-19 pandemic. Additionally, costs for external consultants increased by $0.4 million for the nine months ended September 30, 2020 for our Alarm.com segment as compared to the same period in the prior year. Sales and marketing expense from our Other segment increased $0.8 million for the nine months ended September 30, 2020, as compared to the same period in the prior year, primarily due to increases in headcount for our sales team. The number of employees in sales and marketing functions increased from 340 as of September 30, 2019 to 450 as of September 30, 2020. General and Administrative Expense Three Months Ended September 30, % Change Nine Months Ended September 30, % Change 2020 2019 2020 2019 General and administrative $ 17,410 $ 18,701 (7) % $ 55,634 $ 51,785 7 % % of total revenue 11 % 15 % 12 % 14 % The $1.3 million decrease in general and administrative expense for the three months ended September 30, 2020 as compared to the same period in the prior year was primarily due to a $2.2 million decrease in costs related to an offsite internal strategy and product roadmap conference in 2019 that did not take place in 2020 and a $1.1 million decrease in the provision for credit losses for our Alarm.com segment. These decreases were partially offset by a $1.2 million increase in personnel and related costs and an $0.8 million increase in legal expenses within our Alarm.com segment resulting from intellectual property litigation during the three months ended September 30, 2020 which did not occur during the three months ended September 30, 2019. Additionally, recruiting costs and costs for external consultants increased by $0.3 million for the three months ended September 30, 2020 for our Alarm.com segment as compared to the same period in the prior year. General and administrative expenses from our Other segment decreased $0.4 million for the three months ended September 30, 2020 as compared to the same period in the prior year primarily due to an decrease in the provision for credit losses. T he $3.8 million increase in general and administrative expense for the nine months ended September 30, 2020 as compared to the same period in the prior year was primarily due to a $3.9 million increase in personnel and related costs for our Alarm.com segment due to an increase in employee headcount to support our operational growth and the reversal of a $3.3 million reserve for a promissory note with one of our hardware suppliers within our Alarm.com segment during the nine months ended September 30, 2019 which did not occur during the nine months ended September 30, 2020. Additionally, costs for external consultants increased by $1.3 million for the nine months ended September 30, 2020 for our Alarm.com segment as compared to the same period in the prior year. These increases were partially offset by a $2.4 million decrease to the contingent consideration liability from our acquisition of 85% of the issued and outstanding capital stock of OpenEye on October 21, 2019 within our Alarm.com segment as well as a $2.2 million decrease in costs related to an offsite internal strategy and product roadmap conference incurred during the nine months ended September 30, 2019 which did not occur during the nine months ended September 30, 2020. General and administrative expenses from our Other segment increased $0.3 million for the nine months ended September 30, 2020 as compared to the same period in the prior year primarily due to an increase in rent expense. The number of employees in general and administrative functions increased from 121 as of September 30, 2019 to 161 as of September 30, 2020. Research and Development Expense Three Months Ended September 30, % Change Nine Months Ended September 30, % Change 2020 2019 2020 2019 Research and development $ 36,914 $ 29,461 25 % $ 113,280 $ 84,375 34 % % of total revenue 23 % 23 % 25 % 23 % The $7.5 million increase in research and development expense for the three months ended September 30, 2020 as compared to the same period in the prior year was primarily due to an increase in headcount of employees in research and development functions. Our personnel and related costs for our Alarm.com segment increased by $7.1 million for the three months ended September 30, 2020 as compared to the same period in the prior year. Additionally, the increase in research and development expense is due to a $0.5 million increase in expenses for external consultants for the three months ended September 30, 2020, as compared to the same period in the prior year. These increases for our Alarm.com segment were partially offset by a $1.0 million decrease in research and development expense due to in-process research and development we acquired during the three months ended September 30, 2019 that did not occur during the three months ended September 30, 2020. Research and development expense from our Other segment increased $0.7 million for the three months ended 41 September 30, 2020 as compared to the same period in the prior year, primarily due to personnel and related costs, including salary, benefits and stock-based compensation. The $28.9 million increase in research and development expense for the nine months ended September 30, 2020 as compared to the same period in the prior year was primarily due to an increase in headcount of employees in research and development functions. Our personnel and related costs for our Alarm.com segment increased by $21.7 million for the nine months ended September 30, 2020, as compared to the same period in the prior year and our expenses for external consultants increased by $1.5 million. Additionally, the increase in research and development expense is due to $4.4 million of in-process research and development we acquired during the nine months ended September 30, 2020, partially offset by the $1.0 million of in-process research and development we acquired during the nine months ended September 30, 2019. Research and development expense from our Other segment increased $1.6 million for the nine months ended September 30, 2020 as compared to the same period in the prior year, primarily due to personnel and related costs, including salary, benefits and stock-based compensation. The number of employees in research and development functions increased from 582 as of September 30, 2019 to 750 as of September 30, 2020. Amortization and Depreciation Three Months Ended September 30, % Change Nine Months Ended September 30, % Change 2020 2019 2020 2019 Amortization and depreciation $ 6,878 $ 5,467 26 % $ 20,023 $ 15,833 26 % % of total revenue 4 % 4 % 5 % 5 % Amortization and depreciation increased $1.4 million and $4.2 million for the three and nine months ended September 30, 2020, respectively, as compared to the same periods in the prior year, primarily due to the intangible assets that were acquired in connection with the purchase of 85% of the issued and outstanding capital stock of OpenEye on October 21, 2019. Interest Expense Three Months Ended September 30, % Change Nine Months Ended September 30, % Change 2020 2019 2020 2019 Interest expense $ (556) $ (715) (22) % $ (2,069) $ (2,322) (11) % % of total revenue — % (1) % — % (1) % Interest expense decreased $0.2 million and $0.3 million for the three and nine months ended September 30, 2020, respectively, as compared to the same periods in the prior ye ar pri marily due to the decrease in the effective interest rate on the 2017 Facility resulting from decreases in the Eurodollar Base Rate, or LIBOR. These decreases were partially offset by an increase in the carrying value of the 2017 Facility due to the $50.0 million borrowed on March 25, 2020. Interest Income Three Months Ended September 30, % Change Nine Months Ended September 30, % Change 2020 2019 2020 2019 Interest income $ 118 $ 2,703 (96) % $ 734 $ 4,317 (83) % % of total revenue — % 2 % — % 1 % Interest incom e decreased $2.6 million and $3.6 million for the three and nine months ended September 30, 2020, respectively, as compa red to the same periods in the prior year, primarily due to a decrease in interest income earned on our notes receivable with one of our hardware suppliers as well as a decrease in interest income earned on our cash balance due to a decrease in interest rates. 42 Other Income, Net Three Months Ended September 30, % Change Nine Months Ended September 30, % Change 2020 2019 2020 2019 Other income, net $ 24,753 $ 6,380 288 % $ 24,910 $ 6,468 285 % % of total revenue 16 % 5 % 6 % 2 % Other income , net increased $18.4 million for each of the three and nine months ended September 30, 2020 as compared to the same periods in the prior year. The increase in other income, net is primarily due to recording a gain on the sale of an investment in one of our platform partners of $24.7 million within our Alarm.com segment during the three and nine months ended September 30, 2020 which did not occur during the same periods in the prior year as well a $0.6 million impairment of one of our investments recorded during the three and nine months ended September 30, 2019 which did not occur during the three and nine months ended September 30, 2020. These increases in other income, net, were partially offset by the $6.9 million gain recorded during the three and nine months ended September 30, 2019 related to a promissory note with one of our hardware suppliers within our Alarm.com segment which did not occur during the three and nine months ended September 30, 2020. Provision for Income Taxes Three Months Ended September 30, % Change Nine Months Ended September 30, % Change 2020 2019 2020 2019 Provision for income taxes $ 6,546 $ 2,873 128 % $ 5,471 $ 3,428 60 % % of total revenue 4 % 2 % 2 % 1 % The provision for income taxes increased $3.7 million and $2.0 million for the three and nine months ended September 30, 2020, respectively, as compared to the same periods in the prior year. Our effective tax rates were 15.4% and 8.2% for the three and nine months ended September 30, 2020, respectively, as compared to 14.0% and 7.8% for the same periods in the prior year. The increase in the provision for income taxes was primarily du e to higher income before income taxes during the three and nine months ended September 30, 2020 as compared to the same periods in the prior year. Segment Information We have two reportable segm ents: Alarm.com and Other. Our Alarm.com segment represents our cloud-based and Software platforms for the intelligently connected property and related solutions that contributed 94% of our revenue for each of the three and nine months ended September 30, 2020, as compared to 94% and 93%, respectively, for the same periods in the prior year. Our Other segment is focused on researching, developing and offering residential and commercial automation solutions and energy management products and services in adjacent markets. The consolidated subsidiaries that make up our Other segment are in the investment stage and have incurred significant operating expenses relative to their revenue. Our Alarm.com segment increased from 959 employees as of September 30, 2019 to 1,257 employees as of September 30, 2020. Our Other segment increased from 84 employees as of September 30, 2019 to 104 employees as of September 30, 2020. Inter-segment revenue includes sales of hardware between our segments. 43 The following table presents our revenue, inter-segment revenue and operating expenses by segment (in thousands): Three Months Ended September 30, 2020 2019 SaaS and license revenue Hardware and other revenue Operating expenses SaaS and license revenue Hardware and other revenue Operating expenses Alarm.com $ 92,834 $ 57,726 $ 73,973 $ 79,954 $ 41,016 $ 63,261 Other 7,292 2,545 5,639 4,970 5,484 4,901 Intersegment Alarm.com — (554) — — (1,287) — Intersegment Other — (992) — — (2,257) — Total $ 100,126 $ 58,725 $ 79,612 $ 84,924 $ 42,956 $ 68,162 Nine Months Ended September 30, 2020 2019 SaaS and license revenue Hardware and other revenue Operating expenses SaaS and license revenue Hardware and other revenue Operating expenses Alarm.com $ 269,168 $ 159,800 $ 224,267 $ 233,459 $ 107,884 $ 181,209 Other 18,612 13,030 17,075 13,854 15,810 14,176 Intersegment Alarm.com — (2,118) — — (3,364) — Intersegment Other — (6,065) — — (5,768) — Total $ 287,780 $ 164,647 $ 241,342 $ 247,313 $ 114,562 $ 195,385 Our SaaS and license revenue for the Alarm.com segment included software license revenue of $9.5 million and $29.0 million for the three and nine months ended September 30, 2020, respectively, as compared to $10.8 million and $32.8 million for the same periods in the prior year. There was no software license revenue recorded for the Other segment during the three and nine months ended September 30, 2020 and 2019. Critical Accounting Policies and Significant Judgments and Estimates Our management’s discussion and analysis of our financial condition and results of operations is based on our condensed consolidated financial statements, which have been prepared in accordance with GAAP. The preparation of these condensed consolidated financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the condensed consolidated financial statements and the reported amounts of revenue, costs and expenses during the reported period. In accordance with GAAP, we base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Because of the use of estimates inherent in the financial reporting process and given the additional unknowable duration and effects of the COVID-19 pandemic, actual results could differ from those estimates and any such differences may be material. To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operations and cash flows will be affected. During the first quarter of 2020, we adopted Topic 326. See Note 2 to our condensed consolidated financial statements for more information. Except as disclosed in Note 2, there were no other material changes to our use of estimates or other critical accounting policies from those disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 filed with the SEC on February 26, 2020, or Annual Report. Recently Issued Accounting Standards See Note 2 of our condensed consolidated financial statements for information related to recently issued accounting standards. 44 Liquidity and Capital Resources Working Capital The following table summarizes our cash and cash equivalents, accounts receivable, net and working capital, for the periods indicated (in thousands): September 30, 2020 December 31, 2019 Cash and cash equivalents $ 247,176 $ 119,629 Accounts receivable, net of allowance for credit losses of $2,400 and $2,584, respectively, and net of allowance for product returns of $1,341 and $1,075, respectively 81,883 76,373 Working capital 304,284 167,879 We define working capital as current assets minus current liabilities. Our cash and cash equivalents as of September 30, 2020 are available for working capital purposes. We do not enter into investments for trading purposes, and our investment policy is to invest any excess cash in short term, highly liquid investments that limit the risk of principal loss; therefore, our cash and cash equivalents are held in demand deposit accounts that generate very low returns. Liquidity and Capital Resources As of September 30, 2020, we had $247.2 million in cash and cash equivalents. We consider all highly liquid instruments purchased with an original maturity from the date of purchase of three months or less to be cash equivalents. To date, we have principally financed our operations through cash generated by operating activities and, to a lesser extent, through private and public equity financings. We believe our existing cash and cash equivalents, together with our 2017 Facility, and our future cash flows from operating activities will be sufficient to meet our anticipated operating cash needs f or at least the next 12 months. Over the final three months of fiscal year 2020, we expect our capital expenditure requirements to be approximately $3.0 million, primarily related to the continued build out of our leased office space as well as purchases of computer software and equipment. In 2013, we paid $3.5 million in cash to purchase 3,548,820 Series A convertible preferred shares from one of our platform partners. In 2014, we entered into a Series 1 Preferred Stock purchase agreement with the platform partner and another investor. The other investor purchased shares of the platform partner’s Series 1 Preferred Stock. As a result of the purchase, our 3,548,820 shares of Series A convertible pr eferred shares converted into 3,548,820 shares of common stock. On July 31, 2020, the platform partner was acquired by an unrelated third party and, as a result of the sale, we received proceeds of $25.7 million in exchange for our shares of common stock. Our future working capital and capital expenditure requirements will depend on many factors, including the impact of the COVID-19 pandemic on the economy and our operations, the rate of our revenue growth, the amount and timing of our investments in human resources and capital equipment, future acquisitions and investments, and the timing and extent of our introduction of new solutions and platform and solution enhancements. As the impact of the COVID-19 pandemic on the economy and our operations evolves, we will continue to assess our liquidity needs. To the extent our cash and cash equivalents, together with our 2017 Facility, and cash flows from operating activities are insufficient to fund our future activities, we may need to borrow additional funds through our bank credit arrangements or raise funds from public or private equity or debt financings. If we raise additional funds through the incurrence of indebtedness, such indebtedness would likely have rights that are senior to holders of our equity securities and could contain covenants that restrict our operations. Any additional equity financing would be dilutive to our current stockholders. Sources of Liquidity Our 2017 Facility is a revolving credit facility with SVB, as administrative agent, and a syndicate of lenders to finance working capital and certain permitted acquisitions and investments. The 2017 Facility is available to us to refinance existing debt and for general corporate and working capital purposes including acquisitions, and has a current borrowing capacity of $125.0 million. We have the option to increase the borrowing capacity of the 2017 Facility to $175.0 million with the consent of the lenders. On March 25, 2020, we borrowed $50.0 million under the 2017 Facility as a precautionary measure in order to provide financial flexibility in light of current unc ertainty in the financial markets resulting from the COVID-19 pandemic. As of September 30, 2020, $111.0 million was outstanding under the 2017 Facility, no letters of credit were outstanding and $14.0 million remained available for borrowing under the 2017 Facility. The 2017 Facility contains various financial and other covenants that require us to maintain a maximum consolidated leverage ratio and a fixed charge coverage ratio, and limit our capacity to incur other indebtedness, liens, make certain payments inc luding dividends, and enter into other transactions without approval of the lenders. The 2017 Facility is secured by substantially all of our assets, including our intellectual property. As of 45 September 30, 2020 , we were in compliance with all covenants under the 2017 Facility. Our outstanding amounts under the 2017 Facility are due at maturity in October 2022. The 2017 Facility is di scussed in more detail below under “Debt Obligations.” Dividends We did not declare or pay dividends during the three and nine months ended September 30, 2020 and 2019. We cannot provide any assurance that we will declare or pay cash dividends on our common stock in the future. We currently anticipate that we will retain all of our future earnings, if any, for use in the operation and expansion of our business and we do not anticipate paying cash dividends in the foreseeable future. Additionally, our ability to pay dividends on our common stock is limited by restrictions under the terms of the agreements governing the 2017 Facility. Payment of future cash dividends, if any, will be at the discretion of the board of directors after taking into account various factors, including our financial condition, operating results, current and anticipated cash needs, the requirements of current or then-existing debt instruments and other factors the board of directors deems relevant. Historical Cash Flows The following table sets forth our cash flows for the periods indicated (in thousands): Nine Months Ended September 30, 2020 2019 Cash flows from operating activities $ 66,670 $ 23,847 Cash flows from / (used in) investing activities 12,236 (5,889) Cash flows from financing activities 48,641 304 Operating Activities Cash flows from operating activities have typically been generated from our net income and by changes in our operating assets and liabilities, particularly from accounts receivable and inventory, adjusted for non-cash expense items such as amortization and depreciation, deferred income taxes and stock-based compensation. For the nine months ended September 30, 2020, cash flows from operating activities were $66.7 million, compared to $23.8 million for the same period in the prior year. This $42.9 million increase in cash flows from operating activities was due to a $27.6 million increase in cash from operating assets and liabilities and a $20.5 million increase in net income, partially offset by a $5.2 million decrease in non-cash and other reconciling items. The $27.6 million increase in cash from operating assets and liabilities was primarily due to differences in timing of payments of disbursements and collection of receipts totaling $37.2 million, due in part to the $28.0 million payment made during the nine months ended September 30, 2019 for the agreement reached to settle the legal matter alleging violations of the Telephone Consumer Protection Act that did not occur during the nine months ended September 30, 2020. This increase in cash from operating assets and liabilities was partially offset by a $9.2 million change in inventory resulting from additional purchased inventory during the nine months ended September 30, 2020 that did not occur during the same period in the prior year, which is due in part to the impacts of the COVID-19 pandemic and the uncertainty surrounding the potential disruption to our supply chain. The $5.2 million decrease in non-cash and other reconciling items was primarily due to a $24.7 million gain on the sale of an investment in one of our platform partners during the nine months ended September 30, 2020 that did not occur during the same period in the prior year, which was reclassified and presented as cash flows from investing activities. This decrease in non-cash and other reconciling items was partially offset by a gain of $6.9 million related to a promissory note with one of our hardware suppliers recorded during the nine months ended September 30, 2019 that did not occur during the nine months ended September 30, 2020. Additionally, the decrease in non-cash and other reconciling items was also partially offset by a $6.2 million increase in stock-based compensation resulting from additional grants of stock options and restricted stock units during the nine months ended September 30, 2020 and a $4.2 million increase in amortization and depreciation expense primarily from intangible assets that were acquired in connection with the purchase of 85% of the issued and outstanding capital stock of OpenEye on October 21, 2019. Investing Activities Our investing activities typically include acquisitions, capital expenditures, investments, notes receivable issued to companies with offerings complementary to ours and proceeds from the repayment of those notes receivable. Our capital expenditures have primarily been for general business use, including leasehold improvements as we have expanded our office space to accommodate our growth in headcount, computer equipment used internally and expansion of our network operations centers. 46 For the nine months ended September 30, 2020, our cash flows from investing activities was $12.2 million, as compared to cash flows used in investing activities $5.9 million for the same period in the prior year. The $18.1 million change in cash flows from investing activities was primarily due to $25.7 million in proceeds received from the sale of an investment in one of our platform partners during the nine months ended September 30, 2020, which did not occur during the nine months ended September 30, 2019, a payment of $22.4 million in 2019 to acquire a promissory note as well as $3.7 million of funding provided to one of our hardware suppliers that did not occur during the nine months ended September 30, 2020. These increases in cash flows from investing activities were partially offset by $30.7 million received from one of our hardware suppliers for the amounts due under various promissory notes during the nine months ended September 30, 2019 that did not occur during the nine months ended September 30, 2020. Financing Activities Cash generated by financing activities includes borrowings under the 2017 Facility and proceeds from the issuance of common stock from employee stock option exercises and from our employee stock purchase plan. Cash used in financing activities typically includes repurchases of common stock and repayments of debt. For the nine months ended September 30, 2020, cash flows from financing activities was $48.6 million, compared to $0.3 million for the same period in the prior year. The $48.3 million increase in cash flows from financing activities was primarily due to the borrowing of $50.0 million under our 2017 Facility during the nine months ended September 30, 2020 which was partially offset by our use of $5.1 million to purchase shares of treasury stock during the nine months ended September 30, 2020 that did not occur during the same period in the prior year. Contractual Obligations As of September 30, 2020, there were no material changes in our contractual obligations and commitments from those disclosed in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report, other than the $50.0 million borrowed under our 2017 Facility in March 2020 and the amendment to the lease for our corporate headquarters executed in March 2020, which includes maturities of lease liabilities as follows: $0.1 million in 2020, $0.6 million in 2021, $0.8 million in 2022, $0.7 million in 2023, $0.5 million in 2024 and $0.8 million in 2025 and beyond. Off-Balance Sheet Arrangements We do not have any relationships with unconsolidated entities or financial partnerships, including entities sometimes referred to as structured finance or special purpose entities that were established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. We do not engage in off-balance sheet financing arrangements. In addition, we do not engage in trading activities involving non-exchange traded contracts. Debt Obligations On October 6, 2017, we entered into a $125.0 million senior secured revolving credit facility, or the 2017 Facility, with SVB, as administrative agent, PNC Bank, National Association, as documentation agent, and a syndicate of lenders. Upon entry into the 2017 Facility, we borrowed $72.0 million, which was used to repay the previously outstanding balance under our previous credit facility. The 2017 Facility matures in October 2022 and includes an option to further increase the borrowing capacity to $175.0 million with the consent of the lenders. Costs incurred in connection with the 2017 Facility were capitalized and are being amortized as interest expense over the term of the 2017 Facility. The 2017 Facility is secured by substantially all of our assets, including our intellectual property. On March 25, 2020, we borrowed $50.0 million under the 2017 Facility as a precautionary measure in order to provide financial flexibility in light of current uncertainty in the financial markets resulting from the COVID-19 pandemic. During the three and nine months ended September 30, 2020, we repaid $1.0 million and $2.0 million of the outstanding balance of the 2017 Facility, respectively. During the three and nine months ended September 30, 2019, we repaid $1.0 million and $3.0 million of the outstanding balance of the 2017 Facility, respectively. The outstanding principal balance on the 2017 Facility accrues interest at a rate equal to, at our option, either (1) LIBOR, plus an applicable margin based on our consolidated leverage ratio, or (2) the highest of (a) the Wall Street Journal prime rate, (b) the Federal Funds rate plus 0.50%, or (c) LIBOR plus 1.00% plus an applicable margin based on our consolidated leverage ratio. For each of the three and nine months ended September 30, 2020, we elected for the outstanding principal balance to accrue interest at LIBOR plus 1.50%, LIBOR plus 1.75%, LIBOR plus 2.00%, and LIBOR plus 2.50% when our consolidated leverage ratio is less than 1.00:1.00, greater than or equal to 1.00:1.00 but less than 2.00:1.00, greater than or equal to 2.00:1.00 but less than 3.00:1.00 and greater than or equal to 3.00:1.00, respectively. The 2017 Facility also carries an unused line commitment fee of 0.20%. For the nine months ended September 30, 2020, the effective interest rate on the 2017 Facility was 2.92%, as compared to 4.61% for the same period in the prior year. The carrying value of the 2017 Facility was $111.0 million and $63.0 million as of September 30, 2020 and December 31, 2019, respectively. The 2017 Facility includes a variable interest rate that approximates market rates and, as such, we classified the liability as Level 2 within the fair value hierarchy and determined that the carrying amount of the 2017 Facility approximated its fair value as of September 30, 2020 and December 31, 2019. The 2017 Facility contains various financial and other covenants that require us to maintain a maximum consolidated leverage ratio not to exceed 3.25:1.00 and a consolidated fixed 47 charge coverage ratio of at least 1.25:1.00. As of September 30, 2020, we were in compliance with all financial and non-financial covenants and there were no events of default. The 2017 Facility also contains customary conditions to borrowings and events of default and contains various negative covenants, including covenants that restrict our ability to dispose of assets, merge with or acquire other entities, incur indebtedness, incur encumbrances, make certain payments including dividends, make investments or engage in transactions with affiliates without approval of the lenders. On November 30, 2018, we amended the 2017 Facility to incorporate the parameters that must be met for us to repurchase our outstanding common stock under the stock repurchase program authorized by our board of directors on November 29, 2018. Non-GAAP Measures We define Adjusted EBITDA as our net income before interest expense, interest income, other income, net, provision for income taxes, amortization and depreciation, stock-based compensation expense, secondary offering expense, acquisition-related (benefit) / expense and legal costs and settlement fees incurred in connection with non-ordinary course litigation and other disputes, particularly costs involved in ongoing intellectual property litigation. We do not consider these items to be indicative of our core operating performance. The non-cash items include amortization and depreciation expense, stock-based compensation expense related to stock options and other forms of equity compensation, including, but not limited to, the sale of common stock. We do not adjust for ordinary course legal expenses resulting from maintaining and enforcing our intellectual property portfolio and license agreements. Adjusted EBITDA is not a measure calculated in accordance with GAAP. See the table below for a reconciliation of Adjusted EBITDA to net income, the most directly comparable financial measure calculated and presented in accordance with GAAP. We have included Adjusted EBITDA in this report because it is a key measure that our management uses to understand and evaluate our core operating performance and trends, to generate future operating plans, to make strategic decisions regarding the allocation of capital and to make investments in initiatives that are focused on cultivating new markets for our solutions. We also use certain non-GAAP financial measures, including Adjusted EBITDA, as performance measures under our executive bonus plan. Further, we believe the exclusion of certain expenses in calculating Adjusted EBITDA facilitates comparisons of our operating performance on a period-to-period basis and, in the case of exclusion of acquisition-related (benefit) / expense and certain historical legal expenses, excludes items that we do not consider to be indicative of our core operating performance. Accordingly, we believe that Adjusted EBITDA provides useful information to investors and others in understanding and evaluating our operating results in the same manner as our management and board of directors. Our use of Adjusted EBITDA has limitations as an analytical tool, and you should not consider it in isolation or as a substitute for analysis of our financial results as reported under GAAP. Some of these limitations are: (a) although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and Adjusted EBITDA does not reflect cash capital expenditure requirements for such replacements or for new capital expenditure requirements; (b) Adjusted EBITDA does not reflect changes in, or cash requirements for, our working capital needs; (c) Adjusted EBITDA does not reflect the potentially dilutive impact of equity-based compensation; (d) Adjusted EBITDA does not reflect tax payments that may represent a reduction in cash available to us; and (e) other companies, including companies in our industry, may calculate Adjusted EBITDA or similarly titled measures differently, which reduces its usefulness as a comparative measure. Because of these and other limitations, you should consider Adjusted EBITDA alongside our other GAAP-based financial performance measures, net income and our other GAAP financial results. The following table presents a reconciliation of Adjusted EBITDA to net income, the most directly comparable GAAP measure, for each of the periods indicated (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2020 2019 2020 2019 Adjusted EBITDA: Net income $ 35,825 $ 17,690 $ 61,021 $ 40,496 Adjustments: Interest expense, interest income and other income, net (24,315) (8,368) (23,575) (8,463) Provision for income taxes 6,546 2,873 5,471 3,428 Amortization and depreciation expense 6,878 5,467 20,023 15,833 Stock-based compensation expense 7,448 5,035 20,901 14,721 Secondary offering expense — — 543 — Acquisition-related (benefit) / expense (304) 1,590 2,044 1,590 Litigation expense 2,418 2,033 6,467 10,682 Total adjustments (1,329) 8,630 31,874 37,791 Adjusted EBITDA $ 34,496 $ 26,320 $ 92,895 $ 78,287 48