Alarm.com Holdings, Inc. 10-Q

Item 1. FINANCIAL STATEMENTS (unaudited) ALARM.COM HOLDINGS, INC. Condensed Consolidated Statements of Operations (in thousands, except share and per share data) (unaudited) Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Revenue: SaaS and license revenue $ 133,126 $ 118,059 $ 385,826 $ 338,628 Hardware and other revenue 83,012 74,265 248,594 215,051 Total revenue 216,138 192,324 634,420 553,679 Cost of revenue (1) : Cost of SaaS and license revenue 18,437 17,425 54,019 49,782 Cost of hardware and other revenue 67,149 62,959 208,990 173,731 Total cost of revenue 85,586 80,384 263,009 223,513 Operating expenses: Sales and marketing 23,057 22,557 69,182 62,085 General and administrative 28,011 18,689 81,314 64,839 Research and development 55,581 44,143 161,227 130,101 Amortization and depreciation 7,587 7,467 23,123 22,329 Total operating expenses 114,236 92,856 334,846 279,354 Operating income 16,316 19,084 36,565 50,812 Interest expense ( 787 ) ( 4,196 ) ( 2,356 ) ( 11,718 ) Interest income 2,903 140 4,062 446 Other (expense) / income, net ( 76 ) 53 42 ( 70 ) Income before income taxes 18,356 15,081 38,313 39,470 Provision for / (benefit from) income taxes 246 1,787 472 ( 2,864 ) Net income 18,110 13,294 37,841 42,334 Net loss attributable to redeemable noncontrolling interests 222 244 412 779 Net income attributable to common stockholders $ 18,332 $ 13,538 $ 38,253 $ 43,113 Per share information attributable to common stockholders: Net income per share: Basic $ 0.37 $ 0.27 $ 0.77 $ 0.87 Diluted $ 0.35 $ 0.26 $ 0.73 $ 0.83 Weighted average common shares outstanding: Basic 49,791,465 49,954,565 49,974,925 49,776,578 Diluted 54,832,528 51,836,239 54,988,020 51,879,061 _______________ (1) Exclusive of amortization and depreciation shown in operating expenses below. See accompanying notes to the condensed consolidated financial statements. 2 ALARM.COM HOLDINGS, INC. Condensed Consolidated Balance Sheets (in thousands, except share and per share data) (unaudited) September 30, 2022 December 31, 2021 Assets Current assets: Cash and cash equivalents $ 621,347 $ 710,621 Accounts receivable, net of allowance for credit losses of $ 3,536 and $ 2,168 , and net of allowance for product returns of $ 1,535 and $ 1,181 as of September 30, 2022 and December 31, 2021, respectively 118,833 105,548 Inventory 112,319 75,276 Other current assets, net of allowance for credit losses of zero and $ 2 as of September 30, 2022 and December 31, 2021, respectively 27,498 26,175 Total current assets 879,997 917,620 Property and equipment, net 59,483 41,713 Intangible assets, net 87,171 91,406 Goodwill 150,808 112,901 Deferred tax assets 69,117 13,547 Operating lease right-of-use assets 30,915 30,479 Other assets, net of allowance for credit losses of $ 3 and $ 78 as of September 30, 2022 and December 31, 2021, respectively 32,282 24,349 Total assets $ 1,309,773 $ 1,232,015 Liabilities, redeemable noncontrolling interest and stockholders’ equity Current liabilities: Accounts payable, accrued expenses and other current liabilities $ 106,653 $ 89,816 Accrued compensation 24,585 23,495 Deferred revenue 7,879 5,697 Operating lease liabilities 12,024 10,331 Total current liabilities 151,141 129,339 Deferred revenue 10,556 9,140 Convertible senior notes, net 489,586 425,345 Operating lease liabilities 30,074 32,591 Other liabilities 11,611 9,545 Total liabilities 692,968 605,960 Commitments and contingencies (Note 12) Redeemable noncontrolling interests 23,029 12,888 Stockholders’ equity Preferred stock, $ 0.001 par value, 10,000,000 shares authorized; no shares issued and outstanding as of September 30, 2022 and December 31, 2021 — — Common stock, $ 0.01 par value, 300,000,000 shares authorized; 50,846,671 and 50,406,606 shares issued; and 49,859,269 and 50,259,453 shares outstanding as of September 30, 2022 and December 31, 2021, respectively 508 504 Additional paid-in capital 483,225 498,979 Treasury stock, at cost; 987,402 and 147,153 shares as of September 30, 2022 and December 31, 2021, respectively ( 57,015 ) ( 5,149 ) Retained earnings 167,058 118,833 Total stockholders’ equity 593,776 613,167 Total liabilities, redeemable noncontrolling interests and stockholders’ equity $ 1,309,773 $ 1,232,015 See accompanying notes to the condensed consolidated financial statements. 3 ALARM.COM HOLDINGS, INC. Condensed Consolidated Statements of Cash Flows (in thousands) (unaudited) Nine Months Ended September 30, Cash flows from operating activities: 2022 2021 Net income $ 37,841 $ 42,334 Adjustments to reconcile net income to net cash flows from operating activities: Provision for / (recovery of) credit losses on accounts receivable 1,606 ( 238 ) Reserve for product returns 3,721 1,628 Recovery of credit losses on notes receivable ( 77 ) ( 10 ) Provision for excess and obsolete inventory — 374 Amortization on patents and tooling 1,037 947 Amortization and depreciation 23,123 22,329 Amortization of debt discount and debt issuance costs 2,342 11,590 Amortization of operating leases 7,767 7,173 Deferred income taxes ( 42,566 ) ( 5,918 ) Stock-based compensation 38,053 27,362 Gain on investment ( 140 ) — Loss on early extinguishment of debt — 185 Changes in operating assets and liabilities (net of business acquisitions): Accounts receivable ( 18,321 ) ( 8,689 ) Inventory ( 37,043 ) ( 12,619 ) Other current and non-current assets ( 7,443 ) ( 8,368 ) Accounts payable, accrued expenses and other current liabilities 17,803 10,672 Deferred revenue 3,531 3,548 Operating lease liabilities ( 9,390 ) ( 8,745 ) Other liabilities 611 ( 361 ) Cash flows from operating activities 22,455 83,194 Cash flows used in investing activities: Business acquisition, net of cash acquired ( 31,730 ) — Additions to property and equipment ( 28,084 ) ( 8,939 ) Issuances of notes receivable ( 3,000 ) — Receipt of payments on notes receivable 49 42 Purchase of investment in unconsolidated entity — ( 5,000 ) Proceeds from sale of investment 140 — Cash flows used in investing activities ( 62,625 ) ( 13,897 ) Cash flows (used in) / from financing activities: Repayments of credit facility — ( 110,000 ) Proceeds from issuance of convertible senior notes — 500,000 Payments of debt issuance costs — ( 15,698 ) Payments of deferred consideration for business acquisitions — ( 1,160 ) Purchases of treasury stock ( 51,866 ) — Issuances of common stock from equity-based plans 3,391 4,409 Cash flows (used in) / from financing activities ( 48,475 ) 377,551 Net (decrease) / increase in cash, cash equivalents and restricted cash ( 88,645 ) 446,848 Cash, cash equivalents and restricted cash at beginning of the period 710,621 253,459 Cash, cash equivalents and restricted cash at end of the period $ 621,976 $ 700,307 Reconciliation of cash, cash equivalents and restricted cash: Cash and cash equivalents $ 621,347 $ 700,307 Restricted cash included in other current assets and other assets 629 — Total cash, cash equivalents and restricted cash $ 621,976 $ 700,307 See accompanying notes to the condensed consolidated financial statements. 4 ALARM.COM HOLDINGS, INC. Condensed Consolidated Statements of Equity (in thousands) (unaudited) Redeemable Noncontrolling Interests Additional Paid-In Capital Retained Earnings Total Stockholders’ Equity Preferred Stock Common Stock Treasury Stock Shares Amount Shares Amount Shares Amount Balance as of December 31, 2021 $ 12,888 — $ — 50,407 $ 504 $ 498,979 147 $ ( 5,149 ) $ 118,833 $ 613,167 Adoption of accounting standard on debt with conversion and other options — — — — — ( 56,515 ) — — 9,972 ( 46,543 ) Common stock issued in connection with equity-based plans — — — 85 1 1,079 — — — 1,080 Purchase of treasury stock — — — — — — 354 ( 23,331 ) — ( 23,331 ) Stock-based compensation expense — — — — — 12,110 — — — 12,110 Accretion adjustments of redeemable noncontrolling interest to redemption value 2,569 — — — — ( 2,569 ) — — — ( 2,569 ) Net income / (loss) attributable to common stockholders ( 176 ) — — — — — — — 9,079 9,079 Balance as of March 31, 2022 $ 15,281 — $ — 50,492 $ 505 $ 453,084 501 $ ( 28,480 ) $ 137,884 $ 562,993 Common stock issued in connection with equity-based plans — — — 205 2 581 — — — 583 Purchase of treasury stock — — — — — — 481 ( 28,168 ) — ( 28,168 ) Reclassification of subsidiary long-term incentive plan liability related to modification — — — — — 3,104 — — — 3,104 Stock-based compensation expense — — — — — 12,789 — — — 12,789 Accretion adjustments of redeemable noncontrolling interest to redemption value 860 — — — — ( 860 ) — — — ( 860 ) Net income / (loss) attributable to common stockholders ( 14 ) — — — — — — — 10,842 10,842 Balance as of June 30, 2022 $ 16,127 — $ — 50,697 $ 507 $ 468,698 982 $ ( 56,648 ) $ 148,726 $ 561,283 Common stock issued in connection with equity-based plans — — — 150 1 1,727 — — — 1,728 Purchase of treasury stock — — — — — — 5 ( 367 ) — ( 367 ) Stock-based compensation expense — — — — — 13,154 — — — 13,154 Noncontrolling interest assumed through acquisition 6,770 — — — — — — — — — Accretion adjustments of redeemable noncontrolling interest to redemption value 354 — — — — ( 354 ) — — — ( 354 ) Net income / (loss) attributable to common stockholders ( 222 ) — — — — — — — 18,332 18,332 Balance as of September 30, 2022 $ 23,029 — $ — 50,847 $ 508 $ 483,225 987 $ ( 57,015 ) $ 167,058 $ 593,776 5 ALARM.COM HOLDINGS, INC. Condensed Consolidated Statements of Equity — (Continued) (in thousands) (unaudited) Redeemable Noncontrolling Interests Preferred Stock Common Stock Additional Paid-In Capital Treasury Stock Retained Earnings Total Stockholders’ Equity Shares Amount Shares Amount Shares Amount Balance as of December 31, 2020 $ 10,691 — $ — 49,631 $ 496 $ 405,831 147 $ ( 5,149 ) $ 66,574 $ 467,752 Common stock issued in connection with equity-based plans — — — 173 2 1,987 — — — 1,989 Stock-based compensation expense — — — — — 7,888 — — — 7,888 Equity component of convertible senior notes, net — — — — — 56,515 — — — 56,515 Accretion adjustments of redeemable noncontrolling interest to redemption value 473 — — — — ( 473 ) — — — ( 473 ) Net income / (loss) attributable to common stockholders ( 280 ) — — — — — — — 14,830 14,830 Balance as of March 31, 2021 $ 10,884 — $ — 49,804 $ 498 $ 471,748 147 $ ( 5,149 ) $ 81,404 $ 548,501 Common stock issued in connection with equity-based plans — — — 237 2 876 — — — 878 Stock-based compensation expense — — — — — 10,056 — — — 10,056 Accretion adjustments of redeemable noncontrolling interest to redemption value 743 — — — — ( 743 ) — — — ( 743 ) Net income / (loss) attributable to common stockholders ( 255 ) — — — — — — — 14,745 14,745 Balance as of June 30, 2021 $ 11,372 — $ — 50,041 $ 500 $ 481,937 147 $ ( 5,149 ) $ 96,149 $ 573,437 Common stock issued in connection with equity-based plans — — — 133 1 1,541 — — — 1,542 Stock-based compensation expense — — — — — 9,418 — — — 9,418 Accretion adjustments of redeemable noncontrolling interest to redemption value 761 — — — — ( 761 ) — — — ( 761 ) Net income / (loss) attributable to common stockholders ( 244 ) — — — — — — — 13,538 13,538 Balance as of September 30, 2021 $ 11,889 — $ — 50,174 $ 501 $ 492,135 147 $ ( 5,149 ) $ 109,687 $ 597,174 See accompanying notes to the condensed consolidated financial statements. 6 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) September 30, 2022 and 2021 Note 1. Organization Alarm.com Holdings, Inc. (referred to herein as Alarm.com, the Company, or we) is the leading platform for the intelligently connected property. We offer a comprehensive suite of cloud-based solutions for the smart residential and commercial property , including interactive security, video monitoring, intelligent automation and energy management. Millions of property owners depend on our technology to intelligently secure, automate and manage their residential and commercial properties. Our solutions are delivered through an established network of trusted service provider partners, who are experts at selling, installing and supporting our solutions. The number of our service provider partners exceeded 10,900 in 2021. We derive revenue from the sale of our cloud-based Software-as-a-Service, or SaaS, services, license fees, software, hardware, activation fees and other revenue. Our fiscal year ends on December 31. Note 2. Basis of Presentation and Summary of Significant Accounting Policies Basis of Presentation The accompanying unaudited condensed consolidated financial statements include our accounts and those of our majority-owned and controlled subsidiaries after elimination of intercompany accounts and transactions. These unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States, or GAAP, for interim financial information and the applicable rules and regulations of the Securities and Exchange Commission, or SEC. Accordingly, they do not include all the information and footnotes required by GAAP for annual financial statements. They should be read together with our audited consolidated financial statements and related notes thereto for the year ended December 31, 2021 included in our Annual Report on Form 10-K filed with the SEC on February 24, 2022, or the Annual Report. The condensed consolidated balance sheet as of December 31, 2021 was derived from our audited financial statements but does not include all disclosures required by GAAP for annual financial statements. In the opinion of management, these condensed consolidated financial statements include all normal recurring adjustments necessary for a fair statement of the results of operations, financial position and cash flows for the periods presented. However, the global economy, credit markets and financial markets have and may continue to experience significant volatility as a result of significant worldwide events, including public health crises, such as the COVID-19 pandemic, and geopolitical upheaval, such as Russia’s incursion into Ukraine (collectively, the Macroeconomic Conditions). These Macroeconomic Conditions have and may continue to create supply chain disruptions, inventory disruptions, and fluctuations in economic growth, including fluctuations in employment rates, inflation, energy prices and consumer sentiment. In particular, the COVID-19 pandemic also disrupted and may intermittently continue to disrupt our sales channels due to restrictions imposed from time to time on our service providers’ ability to meet with residential and commercial property owners who use our solutions. It remains difficult to assess or predict the ultimate duration and economic impact of the Macroeconomic Conditions including, the path of the COVID-19 pandemic, the evolution of COVID-19 variants or the emergence of other public health crises. The results of operations for the three and nine months ended September 30, 2022 are not necessarily indicative of the results that can be expected for our entire fiscal year ending December 31, 2022, which is increasingly true in periods of extreme uncertainty, such as the uncertainty caused by the Macroeconomic Conditions. Prolonged uncertainties could cause further economic slowdown or cause other unpredictable events, each of which could adversely affect our business, results of operations or financial condition. Use of Estimates The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. As of the date of issuance of these financial statements, we are not aware of any specific event or circumstance that would require us to update our estimates, assumptions and judgments or revise the carrying value of our assets or liabilities. However, our estimates, judgments and assumptions are continually evaluated based on available information and experience and may change as new events occur and additional information is obtained. Because of the use of estimates inherent in the financial reporting process and in light of the continuing uncertainty arising from the Macroeconomic Conditions, actual results could differ from those estimates and any such differences may be material. Estimates are used when accounting for revenue recognition, allowances for credit losses, allowance for hardware returns, estimates of obsolete inventory, long-term incentive compensation, the lease term and incremental borrowing rates for leases, stock-based compensation, income taxes, legal reserves, fair value of the debt component of convertible notes and goodwill and intangible assets. Comprehensive Income Our comprehensive income for the three and nine months ended September 30, 2022 and 2021 was equal to our net income disclosed in the condensed consolidated statements of operations. 7 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 Significant Accounting Policies Other than those disclosed herein, there have been no other material changes to our significant accounting policies during the three and nine months ended September 30, 2022 from those disclosed in our Annual Report. Restricted Cash We consider all cash reserved for a specific use and not available for immediate or general business use to be restricted cash. As of September 30, 2022, we had a total of $ 0.6 million of restricted cash, of which less than $ 0.1 million was included in other current assets and $ 0.6 million was included in other assets within our condensed consolidated balance sheets. We had no restricted cash as of December 31, 2021. Redeemable Noncontrolling Interests Noncontrolling interests with redemption features that are not solely within our control are considered redeemable noncontrolling interests. Our redeemable noncontrolling interests relate to our 85 % equity ownership interest in PC Open Incorporated, a Washington corporation, doing business as OpenEye and our 85 % equity ownership interest in Noonlight, Inc., or Noonlight, a Delaware corporation (see Note 6). The OpenEye and Noonlight stockholder agreements contain a put option that gives the minority stockholders the right to sell their shares to us based on the fair value of the shares and also contain a call option that gives us the right to purchase the remaining shares from the minority stockholders based on the fair value of the shares. The put and call options related to OpenEye can each be exercised beginning in the first quarter of 2023. The put and call options related to Noonlight can each be exercised beginning in the first quarter of 2026. These redeemable noncontrolling interests are considered temporary equity and we report them between liabilities and stockholders’ equity in the consolidated balance sheets. The amount of the net income or loss attributable to the redeemable noncontrolling interests are recorded in the consolidated statements of operations and the accretion of the redemption values are recorded as an adjustment to additional paid-in capital. The aggregate redemption value of the noncontrolling interests was $ 23.0 million and $ 12.9 million as of September 30, 2022 and December 31, 2021. Stock-Based Compensation We compensate our executive officers, board of directors, employees and consultants with stock-based compensation plans under our 2015 Equity Incentive Plan, or 2015 Plan. We record stock-based compensation expense related to time-based restricted stock units based upon the award’s grant date fair value and use an accelerated attribution method, net of actual forfeitures, in which compensation cost for each vesting tranche in an award is recognized ratably from the service inception date to the vesting date for that tranche. We record stock-based compensation expense related to performance-based restricted stock units based on management’s determination of the probable outcome of the performance conditions, which requires considerable judgment. We estimate the fair value of each option granted on the date of the grant using the Black-Scholes option-pricing model, which contains uncertainties and requires us to estimate the risk-free interest rate, expected term, expected stock price volatility and dividend yield. In prior years, we used the "simplified method" to calculate the expected term, which was presumed to be the mid-point between the vesting date and the end of the contractual term. Beginning upon the first grant of options in 2022, the expected term for options granted is estimated using our historical experience, including information related to options we have granted. Recent Accounting Pronouncements Adopted On August 5, 2020, the Financial Accounting Standards Board, or FASB, issued ASU 2020-06, " Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity ," or ASU 2020-06, which simplifies the accounting for certain financial instruments with characteristics of liabilities and equity, including convertible instruments and contracts on an entity’s own equity. The new guidance eliminates two of the three models in Subtopic 470-20 that require separating embedded conversion features from convertible instruments. The guidance also addresses how convertible instruments are accounted for in the diluted earnings per share calculation. The amendment in this update is effective for fiscal years beginning after December 15, 2021. We adopted ASU 2020-06 effective January 1, 2022, using a modified retrospective adoption method, which required us to record the initial effect of this guidance as a cumulative-effect adjustment to retained earnings on January 1, 2022. Upon adoption of ASU 2020-06, we recombined the liability and equity components of the convertible senior notes assuming that the instrument was accounted for as only a liability from inception to the date of adoption. We also recombined the liability and equity components of the debt issuance costs. The issuance costs are presented as a deduction from the outstanding principal balance of the convertible senior notes and are amortized to interest expense using the effective interest method over the contractual term of the convertible senior notes. We also removed the temporary difference between the book and tax treatment of the debt 8 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 discount and adjusted the temporary difference between the book and tax treatment of the debt issuance costs of the convertible senior notes. The adoption resulted in the recording of the following increases / (decreases) on our condensed consolidated balance sheets (in thousands): Balance Sheet Caption As of January 1, 2022 Deferred tax assets $ 15,356 Additional paid-in capital ( 56,515 ) Convertible senior notes, net 61,899 Retained earnings 9,972 Our net income attributable to common stockholders increased $ 2.0 million and $ 6.0 million during the three and nine months ended September 30, 2022, respectively, as a result of adopting ASU 2020-06 due to no longer recording non-cash interest expense related to the amortization of the debt discount associated with the previous equity component of the convertible senior notes. Upon adoption of this guidance on January 1, 2022, we began using the if-converted method when calculating the dilutive impact of the convertible senior notes on net income per share, which required us to increase our diluted weighted average common shares outstanding by 3,396,950 shares for the three and nine months ended September 30, 2022. The impact of ASU 2020-06 on net income attributable to common stockholders and weighted average diluted shares resulted in an increase to basic net income attributable to common stockholders of $ 0.04 and $ 0.12 per share and an increase to diluted net income attributable to common stockholders of $ 0.03 and $ 0.10 per share, during the three and nine months ended September 30, 2022, respectively. See Note 15 for details on the components of basic and diluted earnings per share. On March 31, 2022, the FASB issued ASU 2022-02, " Financial Instruments - Credit Losses (Topic 326): Troubled Debt Restructurings and Vintage Disclosures " which includes requirements to disclose current period gross write-offs by year of origination for financing receivables. The amendment in this update is effective for fiscal years beginning after December 15, 2022, including interim periods with those fiscal years. Early adoption is permitted, including adoption in an interim period. The guidance over disclosing current period gross write-offs by year of origination for financial receivables should be applied prospectively. We adopted this guidance during the three months ended March 31, 2022 and there was no impact to the disclosures within the "Allowance for Credit Losses - Notes Receivable" section of Note 8 as there were no write-offs of notes receivable during each of the three and nine months ended September 30, 2022. On October 28, 2021, the FASB issued ASU 2021-08, " Business Combinations (Topic 606): Accounting for Contract Assets and Contract Liabilities from Contracts with Customers ," which requires that an entity recognize and measure contract assets and contract liabilities acquired in a business combination in accordance with Topic 606 as if it had originated the contracts. Generally, this should result in an acquirer recognizing and measuring the acquired contract assets and contract liabilities consistent with how they were recognized and measured in the acquiree’s financial statements, if the acquiree prepared financial statements in accordance with GAAP. The amendment in this update is effective for fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. Early adoption is permitted, including adoption in an interim period. We adopted this guidance during the three months ended September 30, 2022 and the adoption did not have a material impact on our condensed consolidated financial statements during the three and nine months ended September 30, 2022. Any future financial impact will be dependent on the magnitude and nature of future business combinations. Note 3. Revenue from Contracts with Customers Revenue Recognition 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 our non-hosted software platform, or 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. 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 also sell our hardware to distributors who resell the hardware to service provider partners. We enter into contracts with our service provider partners that establish pricing for access to our platform solutions and for the sale of hardware. These service provider c ontracts typically have an initial term of one year , with subsequent renewal terms of one year . O ur 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. 9 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 When determining the amount of consideration we expect to be entitled to for the sale of our hardware, we estimate the variable consideration associated with customer returns. We record a reserve against revenue for hardware returns based on historical returns. For the twelve months ended September 30, 2022 and 2021, our reserve against revenue for hardware returns was approximately 1 % of hardware and other revenue. We evaluate our hardware reserve on a quarterly basis or if there is an indication of significant changes in return experience. Hist orically, our returns of hardware have not significantly differed from our estimated reserve. Additionally, we provide warranties related to the intended functionality of the products and services provided and those warranties typically allow for the return of hardware up to one year past the date of sale. We determined that these warranties are not separate performance obligations as they cannot be purchased separately and do not provide a service in addition to an assurance the hardware will function as expected. 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. Our hardware and other revenue also includes our revenue from Shooter Detection Systems related to the sale of licenses that provide our customers the right to use our indoor gunshot detection solution in exchange for license fees, which are generally paid at contract inception. Our perpetual licenses and licenses to our indoor gunshot detection solution provide a right to use intellectual property that is functional in nature and has significant stand-alone functionality. Accordingly, for licenses of functional intellectual property, revenue is recognized at the point-in-time when control has been transferred to the customer, which occurs once the software has been made available to the customer. 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. Our service provider partners use services on our platforms, such as support tools and applications, to assist in the installation of our solutions in subscriber properties. This installation marks the beginning of the service period on our platforms and, on occasion, we earn activation revenue for fees charged for this service. The activation fee is non-refundable, separately negotiated and specified in our contractual arrangements with our service provider partners and is charged to the service provider partner for each subscriber activated on our platforms. 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. Activation fees are not offered on a stand-alone basis separate from our SaaS offering and are billed and received at the beginning of the arrangement. We record activation fees initially as deferred revenue and we recognize these fees ratably over the expected term of the subscribers’ account which we estimate is ten years based on our annual attrition rate. The portion of these activation fees included in current and long-term deferred revenue as of our balance sheet date represents the amounts that will be recognized ratably as revenue over the following twelve months , or longer as appropriate, until the ten-year expected term is complete. The balance of deferred revenue for activation fees was $ 5.5 million and $ 6.0 million as of September 30, 2022 and December 31, 2021, respectively, which combines current and long-term balances. SaaS and license revenue associated with our contracts is invoiced and revenue is recognized at an amount that corresponds directly with the value of the performance completed to date. Additionally, the consideration received from hardware sales corresponds directly with the stand-alone selling price of the hardware. As a result, we have elected to use the practical expedient related to the amount of transaction price allocated to the unsatisfied performance obligations and therefore, we have not disclosed the total remaining revenue expected to be recognized on all contracts or the expected period over which the remaining revenue would be recognized. Contract Assets At contract inception, we assess the goods and services promised in our contracts with customers and identify a performance obligation for each distinct promise to transfer a good or service, or bundle of goods or services. To identify the performance obligations, we consider all of the goods or services promised in the contract, whether explicitly stated or implied based on customary business practices. We record a contract asset when we satisfy a performance obligation by transferring a promised good or service. Contract assets can be conditional or unconditional depending on whether another performance obligation must be satisfied before payment can be received. We receive payments from our service provider partners based on the billing schedule established in our contracts. All of the accounts receivable presented in the condensed consolidated balance sheets represent unconditional rights to consideration. We do not have any assets from contracts containing conditional rights and we do not have any assets from satisfied performance obligations that have not been invoiced. We recognize an asset related to the costs incurred to obtain a contract only if we expect to recover those costs and we would not have incurred those costs if the contract had not been obtained. We recognize an asset from the costs incurred to fulfill a contract if the costs (i) are specifically identifiable to a contract, (ii) enhance resources that will be used in satisfying performance obligations in future and (iii) are expected to be recovered. Our assets related to costs incurred to obtain a contract consist of capitalized commission costs and upfront payments made to a customer. Based on the policy above, we capitalize a portion of our commission costs as an incremental cost of obtaining a contract. When calculating the incremental cost of obtaining a contract, we exclude any commission costs related to metrics that could be satisfied without obtaining a contract, 10 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 including training-related metrics. We amortize our commission costs over a period of three years , which is consistent with the period over which the products and services related to the commission are transferred to the customer. The three-year period was determined based on our review of historical enhancements and upgrades to our products and services. We applied the portfolio approach to account for the amortization of contract costs for those contracts that have similar characteristics. Upfront payments made to a customer are capitalized and amortized over the expected period of benefit and are recorded as a reduction to revenue. The current portion of capitalized commission costs and upfront payments made to customers is included in other current assets within our condensed consolidated balance sheets. The non-current portion of capitalized commission costs and upfront payments made to customers is reflected in other assets within our condensed consolidated balance sheets. We review the capitalized costs for impairment at least annually. Impairment exists if the carrying amount of the asset recognized from contract costs exceeds the remaining amount of consideration we expect to receive in exchange for providing the goods and services to which such asset relates, less the costs that relate directly to providing those good and services and that have not been recognized as an expense. We did no t record an impairment loss on our contract assets during the three and nine months ended September 30, 2022 and 2021. The changes in our contract assets are as follows (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Beginning of period balance $ 7,415 $ 4,771 $ 4,520 $ 4,306 Commission costs and upfront payments to a customer capitalized in period 5,253 540 9,980 2,697 Amortization of contract assets ( 1,369 ) ( 899 ) ( 3,201 ) ( 2,591 ) End of period balance $ 11,299 $ 4,412 $ 11,299 $ 4,412 Contract Liabilities Contract liabilities include payments received in advance of performance under the contract and are realized with the associated revenue recognized under the contract. All of the deferred revenue presented in the condensed consolidated balance sheets represents contract liabilities resulting from advance cash receipts from customers or amounts billed in advance to customers from the sale of services. Changes in deferred revenue are due to our performance under the contract as well as to cash received from new contracts for which services have not been provided. The changes in our contract liabilities are as follows (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Beginning of period balance $ 17,241 $ 15,019 $ 14,837 $ 12,529 Revenue deferred and acquired in period 4,373 3,682 13,750 11,131 Revenue recognized from amounts included in contract liabilities ( 3,179 ) ( 2,624 ) ( 10,152 ) ( 7,583 ) End of period balance $ 18,435 $ 16,077 $ 18,435 $ 16,077 The revenue recognized from amounts included in contract liabilities primarily relates to prepayment contracts with customers as well as payments of activation fees. 11 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 Note 4. Accounts Receivable, Net The components of accounts receivable, net are as follows (in thousands): September 30, 2022 December 31, 2021 Accounts receivable $ 123,904 $ 108,897 Allowance for credit losses ( 3,536 ) ( 2,168 ) Allowance for product returns ( 1,535 ) ( 1,181 ) Accounts receivable, net $ 118,833 $ 105,548 For the three and nine months ended September 30, 2022, we recorded a provision for credit losses of $ 1.1 million and $ 1.6 million on our accounts receivable, respectively. For the three and nine months ended September 30, 2021, we recorded a reduction to the provision for credit losses of $ 0.4 million and $ 0.2 million on our accounts receivable, respectively. For the three and nine months ended September 30, 2022, we recorded a reserve for product returns of $ 2.0 million and $ 3.7 million, respectively, as compared to $ 0.5 million and $ 1.6 million for the same periods in the prior year. Historically, we have not experienced write-offs for uncollectible accounts or sales returns that have differed significantly from our estimates. Allowance for Credit Losses - Accounts Receivable The allowance for credit losses is a valuation account that is deducted from the accounts receivable and notes receivable amortized cost basis (see Note 8) to present the net amount expected to be collected. We estimate the allowance balance by applying the loss-rate method using relevant available information from internal and external sources, including historical write-off activity, current conditions and reasonable and supportable forecasts. Historical credit loss experience provides the basis for the estimation of expected credit losses. Adjustments to historical loss information are made for changes in economic conditions, such as changes in unemployment rates. We use projected economic conditions over a period no more than twelve months based on data from external sources. For periods beyond the twelve-month reasonable and supportable forecast period, we revert to historical loss information immediately. The allowance for credit losses is measured on a pooled basis when similar risk characteristics exist. When assessing whether to measure certain financial assets on a pooled basis, we considered various risk characteristics, including the financial asset type, size and the historical or expected credit loss pattern. We identified the following two portfolio segments for our accounts receivable: (i) outstanding accounts receivable balances within Alarm.com and certain subsidiaries and (ii) outstanding accounts receivable balances within all other subsidiaries. There were no changes to our portfolio segments for our accounts receivable during the three and nine months ended September 30, 2022, and no changes to our policies or practices that influenced our estimate of expected credit losses for accounts receivable. Additionally, there were no significant changes in the amount of accounts receivable write-offs during the three and nine months ended September 30, 2022, as compared to historical periods other than a partial write-off of $ 0.7 million related to one of our distribution partners' outstanding balance during the nine months ended September 30, 2021, upon the distributor being acquired by a third party. Expected credit losses are estimated over the contractual term of the financial assets and we adjust the term for expected prepayments when appropriate. For the three and nine months ended September 30, 2022, we recorded credit loss expense for accounts receivable and notes receivable of $ 1.0 million and $ 1.3 million, respectively, in general and administrative expense in our condensed consolidated statements of operations. For the three and nine months ended September 30, 2021, we recorded a reduction of credit loss expense of $ 0.4 million, in general and administrative expense in our condensed consolidated statements of operations. The contractual term excludes expected extensions, renewals and modifications because extension and renewal options are unconditionally cancelable by us. Write-offs of the amortized cost basis are recorded to the allowance for credit losses. Any subsequent recoveries of previously written off balances are recorded as a reduction to credit loss expense. 12 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 The changes in our allowance for credit losses for accounts receivable are as follows (in thousands): Three Months Ended September 30, 2022 Three Months Ended September 30, 2021 Nine Months Ended September 30, 2022 Nine Months Ended September 30, 2021 Alarm.com and Certain Subsidiaries All Other Subsidiaries Alarm.com and Certain Subsidiaries All Other Subsidiaries Alarm.com and Certain Subsidiaries All Other Subsidiaries Alarm.com and Certain Subsidiaries All Other Subsidiaries Beginning of period balance $ ( 2,450 ) $ ( 58 ) $ ( 3,443 ) $ ( 131 ) $ ( 2,035 ) $ ( 133 ) $ ( 4,442 ) $ ( 254 ) (Provision for) / recovery of expected credit losses ( 1,057 ) ( 2 ) 415 ( 27 ) ( 1,676 ) 70 268 ( 30 ) Write-offs 30 1 25 3 234 4 1,171 129 End of period balance $ ( 3,477 ) $ ( 59 ) $ ( 3,003 ) $ ( 155 ) $ ( 3,477 ) $ ( 59 ) $ ( 3,003 ) $ ( 155 ) Note 5. Inventory The components of inventory are as follows (in thousands): September 30, 2022 December 31, 2021 Raw materials $ 32,803 $ 15,823 Finished goods 79,516 59,453 Total inventory $ 112,319 $ 75,276 Note 6. Acquisitions Acquisition of a Business - Noonlight On September 23, 2022, Alarm.com Incorporated, one of our wholly-owned subsidiaries, acquired 85 % of the issued and outstanding shares of capital stock of Noonlight. Noonlight provides a connected safety and event management software and services platform that enables new applications and provides enhanced emergency response capabilities. We believe the acquisition of Noonlight will enhance our comprehensive suite of interactive cloud-based services and allow us to expand markets for emergency response services as well as accelerate innovation in those services. In consideration for the purchase of 85 % of the issued and outstanding shares of capital stock of Noonlight, we paid $ 31.9 million in cash on September 23, 2022, after deducting $ 1.5 million related to an outstanding loan issued to Noonlight during May of 2022 and $ 4.9 million related to agreed holdback provisions. See Note 8 for further details on the loan to Noonlight, including the settlement of the outstanding principal and interest. Pursuant to the terms of the stock purchase agreement, following the preliminary determination of the working capital of Noonlight as of the closing date, the purchase price decreased by $ 0.2 million. The working capital adjustment is expected to be finalized by the first quarter of 2023 and $ 0.1 million of the holdback is expected to be paid to the stockholders of Noonlight at that time. The remaining amount of the holdback of $ 4.6 million is expected to be paid to the stockholders of Noonlight by the end of the first quarter of 2024, subject to off set for any indemnification obligations. As a result of the acquisition of Noonlight, we recorded approximately $ 0.7 million in acquisition-related costs for each of the three and nine months ended September 30, 2022. These costs include expenses directly related to acquiring Noonlight, are expensed as incurred and are included in general and administrative expense in our condensed consolidated statements of operations. The purchase price allocation was not finalized as of the filing date of this Quarterly Report on Form 10-Q and is pending the final determination of the working capital adjustment as well as tax adjustments, including the assessment of any net operating losses acquired and the related limitations on any identified net operating losses. 13 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 The table below sets forth the purchase consideration and the preliminary allocation used to estimate the fair value of the tangible and intangible net assets acquired (in thousands): September 23, 2022 Calculation of Purchase Consideration: Cash paid, net of working capital adjustment $ 31,674 Outstanding principal and interest of loan provided to Noonlight 1,537 Holdback consideration 4,910 Total consideration $ 38,121 Estimated Tangible and Intangible Net Assets: Cash $ 188 Accounts receivable 291 Other current and non-current assets 180 Property and equipment 45 Developed technology 9,335 Trade names 150 Accounts payable ( 433 ) Accrued expenses and other current liabilities ( 352 ) Deferred tax liability ( 2,353 ) Deferred revenue ( 67 ) Redeemable noncontrolling interest ( 6,770 ) Goodwill 37,907 Total estimated tangible and intangible net assets $ 38,121 Goodwill of $ 37.9 million reflects the value of acquired workforce and synergies we expect to achieve from integrating Noonlight's suite of emergency response cloud-managed application program interfaces into our existing comprehensive suite of interactive cloud-based services. None of the goodwill recognized is expected to be deductible for income tax purposes in future periods. We allocate goodwill to reporting units based on expected benefit from synergies and have allocated the goodwill to the Alarm.com segment. Fair Value of Net Assets Acquired and Intangibles The acquired activities and assets in the purchase of Noonlight constituted a business and with the exception of contract liabilities accounted for under Topic 606, in accordance with accounting standards codification, or ASC 805, the assets and liabilities were recorded at their respective fair values as of September 23, 2022. We developed our estimate of the fair value of intangible net assets using a multi-period excess earnings method for developed technology and the relief from royalty method for the trade name. Developed Technology Developed technology primarily consists of intellectual property of proprietary software that is marketed for sale. We valued the developed technology using the multi-period excess earnings method, an income approach. The significant assumptions used in the income approach include estimates about future expected cash flows from the developed technology, the obsolescence factor and the discount rate. We are amortizing the Noonlight developed technology, valued at $ 9.3 million, on an attribution method based on the discounted cash flows of the model over an estimated useful life of seven years . Trade Names We valued the trade names acquired using a relief from royalty method. The significant assumptions used in the income approach include future expected cash flows from the trade name, the royalty rate and the discount rate. We are amortizing the trade names, valued at $ 0.2 million, on an attribution basis derived from the discounted cash flows of the model over an estimated useful life of five years . 14 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 Redeemable Noncontrolling Interests Our redeemable noncontrolling interest relates to our 85 % equity ownership interest in Noonlight. The Noonlight stockholder agreement contains a put option that gives the minority Noonlight stockholders the right to sell their remaining 15 % equity ownership interest to us based on the fair value of the shares and also contains a call option that gives us the right to purchase the remaining Noonlight shares from the minority Noonlight stockholders based on the fair value of the shares. The put and call options can each be exercised beginning in the first quarter of 2026. The redeemable noncontrolling interest was recorded at fair value on September 23, 2022, by applying the income approach using unobservable inputs for projected cash flows, including projected financial results and a discount rate, which are considered Level 3 inputs. This redeemable noncontrolling interest is considered temporary equity and we report it between liabilities and stockholders’ equity in the condensed consolidated balance sheets. The redemption value of the Noonlight noncontrolling interest was $ 6.8 million as of September 23, 2022 and September 30, 2022. Business Combinations in Operations - Noonlight The operations of the Noonlight business combination discussed above were included in the condensed consolidated financial statements as of the acquisition date. The pro forma information as well as the revenue and net losses of the business combination were not material to the condensed consolidated financial statements for the three and nine months ended September 30, 2022. Asset Acquisition On December 16, 2021, EnergyHub, Inc., one of our wholly-owned subsidiaries, acquired certain assets of an unrelated third party. Substantially all of the acquired assets consisted of developed technology. We believe the acquisition of the developed technology will continue to advance our load-shaping energy management solution allowing additional devices to participate in utility programs that reduce or shift power consumption during peak demand periods. In consideration for the purchase of the developed technology, we paid $ 4.2 million in cash in December 2021, with the remaining $ 0.9 million expected to be paid 18 months following the acquisition date, subject to offset for any indemnification obligations. Additionally, we incurred $ 0.2 million in direct transaction costs related to legal fees during 2021 that were capitalized as a component of the consideration transferred. The combined $ 5.3 million consideration related to developed technology was recorded as an intangible asset at the time of the asset acquisition and will be amortized on a straight-line basis over an estimated useful life of seven years . Note 7. Goodwill and Intangible Assets, Net The changes in goodwill by reportable segment are outlined below (in thousands): Alarm.com Other Total Balance as of January 1, 2022 $ 112,901 $ — $ 112,901 Goodwill acquired 37,907 — 37,907 Balance as of September 30, 2022 $ 150,808 $ — $ 150,808 On September 23, 2022, we acquired 85 % of the issued and outstanding shares of capital stock of Noonlight and recorded $ 37.9 million of goodwill in the Alarm.com segment. There were no impairments of goodwill during the three and nine months ended September 30, 2022 and 2021. The following table reflects changes in the net carrying amount of the components of intangible assets (in thousands): Customer Relationships Developed Technology Trade Name Total Balance as of January 1, 2022 $ 59,426 $ 30,157 $ 1,823 $ 91,406 Intangible assets acquired — 9,335 150 9,485 Amortization ( 8,928 ) ( 4,349 ) ( 443 ) ( 13,720 ) Balance as of September 30, 2022 $ 50,498 $ 35,143 $ 1,530 $ 87,171 We recorded $ 4.6 million and $ 13.7 million of amortization related to our intangible assets for the three and nine months ended September 30, 2022, respectively, as compared to $ 4.3 million and $ 12.8 million for the same periods in the prior year. There were no impairments of long-lived intangible assets during the three and nine months ended September 30, 2022 and 2021. During the nine months ended September 30, 2022, we wrote-off $ 0.7 million in fully amortized intangible assets in the 15 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 Alarm.com segment that were acquired in 2014 related to customer relationships, developed technology, trade name and other intangible assets that no longer existed as of January 1, 2022. The following tables reflect the weighted average remaining life and carrying value of finite-lived intangible assets (in thousands, except weighted-average remaining life): September 30, 2022 Gross Carrying Amount Accumulated Amortization Net Carrying Value Weighted- Average Remaining Life (in years) Customer relationships $ 125,885 $ ( 75,387 ) $ 50,498 7.2 Developed technology 58,478 ( 23,335 ) 35,143 6.1 Trade name 3,937 ( 2,407 ) 1,530 2.6 Total intangible assets $ 188,300 $ ( 101,129 ) $ 87,171 6.7 December 31, 2021 Gross Carrying Amount Impairment of Intangible Assets Accumulated Amortization Net Carrying Value Weighted- Average Remaining Life (in years) Customer relationships $ 126,093 $ ( 86 ) $ ( 66,581 ) $ 59,426 7.9 Developed technology 49,371 — ( 19,214 ) 30,157 6.5 Trade name 3,815 — ( 1,992 ) 1,823 3.1 Other 234 — ( 234 ) — 0.0 Total intangible assets $ 179,513 $ ( 86 ) $ ( 88,021 ) $ 91,406 7.4 Note 8. Other Assets Purchases of Patents and Patent Licenses From time to time, we enter into agreements to purchase patents or patent licenses. The carrying value, net of amortization, of our purchased patents and patent licenses was $ 1.7 million and $ 2.2 million as of September 30, 2022 and December 31, 2021, respectively. As of September 30, 2022 and December 31, 2021, $ 0.5 million and $ 0.6 million of patent costs were included in other current assets and $ 1.2 million and $ 1.6 million of patent costs were included in other assets, respectively. We have $ 7.0 million of historical cost in purchased patents and patent licenses as of September 30, 2022. We are amortizing the patent costs over the estimated useful lives of the patents, which range from three years to 18 years. Patent amortization cost of $ 0.1 million and $ 0.3 million was included in cost of SaaS and license revenue in our condensed consolidated statements of operations for each of the three and nine months ended September 30, 2022 and 2021, respectively. Patent amortization cost of $ 0.1 million and $ 0.2 million was included in amortization and depreciation in our condensed consolidated statements of operations for each of the three and nine months ended September 30, 2022 and 2021, respectively. Loan to a Distribution Partner In June 2020, we amended an existing term loan with our distribution partner and also amended an existing subordinated credit agreement with the affiliated entity of the distribution partner. At the time of the amended term loan and subordinated credit agreement in June 2020, the outstanding balance of the term loan was $ 3.0 million and the outstanding balance of the subordinated credit agreement was $ 3.0 million. Under the amended terms, the distribution partner paid us $ 2.0 million in principal for the term loan on June 9, 2020 and the remaining $ 1.0 million was transferred to the amended subordinated credit agreement with the affiliated entity of the distribution partner. As of September 30, 2022 and December 31, 2021, there was no remaining amount outstanding related to the amended term loan. The amended subordinated credit agreement with the affiliated entity of the distribution partner matures on September 9, 2025 and interest on the outstanding principal balance accrues at a rate of 9.0 % per annum and is payable in kind. As of September 30, 2022 and December 31, 2021, $ 4.9 million and $ 4.6 million of the notes receivable balance related to the subordinated credit agreement was included in other assets in our condensed consolidated balance sheets, respectively. 16 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 For the three and nine months ended September 30, 2022, we recognized $ 0.8 million and $ 2.3 million of revenue from the distribution partner associated with these loans, respectively, as compared to $ 0.8 million and $ 2.4 million for the same periods in the prior year. Loan to a Service Provider Partner In July 2020, we entered into a loan agreement with a service provider partner, under which we agreed to loan the service provider partner up to $ 2.5 million, collateralized by the assets of the service provider partner. Interest on the outstanding principal accrues at a rate per annum equal to 9.0 % and monthly interest and principal payments began in April 2021. The maturity date of the loan is July 24, 2025. As of September 30, 2022 and December 31, 2021, $ 1.1 million and $ 1.2 million of principal was outstanding from the service provider partner under the loan agreement, respectively. For three and nine months ended September 30, 2022, we recognized less than $ 0.1 million and $ 0.1 million of revenue from the service provider partner associated with this loan, respectively, as compared to $ 0.1 million for the same periods in the prior year. Loan to Noonlight In May 2022, we entered into an agreement with Noonlight, under which we agreed to loan $ 1.5 million, collateralized by the assets of Noonlight. Interest on the outstanding principal accrued at a rate per annum equal to 7.0 %. The outstanding interest and principal balances were previously included in other current assets in our condensed consolidated balance sheet and were used to reduce the payment we made on September 23, 2022 to acquire 85 % of the issued and outstanding shares of capital stock of Noonlight. As of September 30, 2022, no principal or interest was outstanding from Noonlight under the loan agreement. Prior to the acquisition of Noonlight on September 23, 2022, for the three and nine months ended September 30, 2022 and 2021, we did not record any revenue from Noonlight. Loan to a Technology Partner In June 2022, we entered into a convertible promissory note with a technology partner, under which we agreed to loan the technology partner $ 1.5 million. Interest on the outstanding principal accrues at a rate per annum equal to 6.5 %, starting one year from the effective date of the loan. Interest and principal payments are due on the maturity date of the loan, which is June 27, 2029, unless the loan is converted prior to the maturity date, which may occur upon a qualified financing event, as defined in the convertible promissory note, upon a sale of the technology partner or upon our election on the maturity date of the loan. As of September 30, 2022, $ 1.5 million of principal was outstanding from the technology partner under the convertible promissory note. For the three and nine months ended September 30, 2022 and 2021, we did not record any revenue from the technology partner associated with this convertible promissory note. Investment in a Hardware Supplier In October 2018, we entered into a subordinate convertible promissory note with one of our hardware suppliers. In July 2019, we converted the outstanding notes receivable balance of $ 5.6 million into 9,520,832 shares of Series B preferred stock in the hardware supplier. We concluded that the $ 5.6 million equity investment, which is included in the Alarm.com segment, does not meet the criteria for consolidation and will be accounted for using the measurement alternative. Under the alternative, we measure investments without readily determinable fair values at cost, less impairment, adjusted for observable price changes from orderly transactions for identical or similar investments. As of September 30, 2022 and December 31, 2021, our investment in the hardware supplier was $ 5.6 million. Investment in a Technology Partner In December 2016, we paid $ 0.3 million for a convertible promissory note with a technology partner. In April 2018, the $ 0.3 million convertible promissory note converted into 135,135 shares of Series A-1 Preferred Stock. At the time of conversion, we determined there was no value related to the Series A-1 Preferred Stock. Based on observable price changes from orderly transactions for similar investments, we increased the amount of our investment by $ 0.7 million and recorded a gain within other (expense) / income, net , in our consolidate d statements of operations during the year ended December 31, 2020. In February 2021, we paid $ 5.0 million in cash to purchase 1,000,000 shares of Series B-2 Preferred Stock from the same technology partner as part of a financing round that included other investors. The $ 5.0 million equity investment, which is included in the Alarm.com segment, does not meet the criteria for consolidation and is accounted for using the measurement alternative. Under the alternative, we measure investments without readily determinable fair values at cost, less impairment, 17 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 adjusted for observable price changes from orderly transactions for identical or similar investments. As of September 30, 2022 and December 31, 2021, our investment in the technology partner was $ 5.7 million. Allowance for Credit Losses - Notes Receivable We identified the following two portfolio segments for our notes receivable: (i) loan receivables and (ii) hardware financing receivables. There were no changes to our portfolio segments for our notes receivable during the three and nine months ended September 30, 2022, and no changes to our policies or practices involving the issuance of notes receivable, customer acquisitions or any other factors that influenced our estimate of expected credit losses for notes receivable. There were no hardware financing receivables outstanding as of September 30, 2022. We do not accrue interest on notes receivable that are considered impaired or are 90 days or greater past due based on their contractual payment terms. Notes receivable that are 90 days or greater past due are placed on nonaccrual status. Notes receivable may be placed on nonaccrual status earlier if, in management’s opinion, a timely collection of the full principal and interest becomes uncertain. After a note receivable has been placed on nonaccrual status, interest will be recognized when cash is received. A note receivable may be returned to accrual status after all of the customer’s delinquent balances of principal and interest have been settled, and collection of all remaining contractual amounts due is reasonably assured. We have elected not to measure an allowance for credit losses for accrued interest receivables . We write-off any accrued interest on notes receivable that are considered impaired or are 90 days or greater past due based on their contractual payment terms by reversing interest income. The accrued interest receivable as of September 30, 2022 and December 31, 2021 was less than $ 0.1 million, and is reflected in other current assets within our condensed consolidated balance sheets and excluded from the amortized cost basis of the notes receivable . We did not write-off any accrued interest receivable during the three and nine months ended September 30, 2022 and 2021. There were no purchases or sales of financial assets during the three and nine months ended September 30, 2022 and 2021. There were no significant changes in the amount of note receivable write-offs during the three and nine months ended September 30, 2022, as compared to historical periods. The changes in our allowance for credit losses for notes receivable are as follows (in thousands): Three Months Ended September 30, 2022 Three Months Ended September 30, 2021 Nine Months Ended September 30, 2022 Nine Months Ended September 30, 2021 Loan Receivables Hardware Financing Receivables Loan Receivables Hardware Financing Receivables Loan Receivables Hardware Financing Receivables Loan Receivables Hardware Financing Receivables Beginning of period balance $ ( 2 ) $ — $ ( 74 ) $ ( 4 ) $ ( 79 ) $ ( 1 ) $ ( 73 ) $ ( 16 ) (Provision for) / recovery of expected credit losses ( 1 ) — ( 3 ) 2 76 1 ( 4 ) 14 Write-offs — — — — — — — — End of period balance $ ( 3 ) $ — $ ( 77 ) $ ( 2 ) $ ( 3 ) $ — $ ( 77 ) $ ( 2 ) We manage our notes receivables using delinquency as a key credit quality indicator. The following tables reflect the current and delinquent notes receivable by class of financing receivables and by year of origination (in thousands): September 30, 2022 Loan Receivables: 2022 2021 2020 2019 2018 Prior Total Current $ 1,500 $ — $ 1,107 $ 2 $ — $ 4,921 $ 7,530 30-59 days past due — — — — — — — 60-89 days past due — — — — — — — 90-119 days past due — — — — — — — 120+ days past due — — — — — — — Total $ 1,500 $ — $ 1,107 $ 2 $ — $ 4,921 $ 7,530 18 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 December 31, 2021 Loan Receivables: 2021 2020 2019 2018 2017 Prior Total Current $ — $ 1,151 $ 7 $ — $ 4,602 $ — $ 5,760 30-59 days past due — — — — — — — 60-89 days past due — — — — — — — 90-119 days past due — — — — — — — 120+ days past due — — — — — — — Total $ — $ 1,151 $ 7 $ — $ 4,602 $ — $ 5,760 Hardware Financing Receivables: Current $ — $ — $ 4 $ — $ — $ — $ 4 30-59 days past due — — 6 — — — 6 60-89 days past due — — 11 — — — 11 90-119 days past due — — — — — — — 120+ days past due — — — — — — — Total $ — $ — $ 21 $ — $ — $ — $ 21 There were no notes receivables placed on nonaccrual status as of September 30, 2022 and December 31, 2021. During the three and nine months ended September 30, 2022 and 2021, there was no interest income recognized related to notes receivables that were in nonaccrual status. As of September 30, 2022 and December 31, 2021, there were no notes receivables placed in nonaccrual status for which there was not a related allowance for credit losses. As of September 30, 2022 and December 31, 2021, there were no notes receivables that were 90 days or greater past due for which we continued to accrue interest income. Prepaid Expenses As of September 30, 2022 and December 31, 2021, $ 17.1 million and $ 17.7 million of prepaid expenses were included in other current assets, respectively, primarily related to software licenses, insurance and long lead-time parts related to our inventory. Note 9. Fair Value Measurements The following tables present our assets and liabilities measured at fair value on a recurring basis (in thousands): Fair Value Measurements on a Recurring Basis Assets: Level 1 Level 2 Level 3 Total Money market accounts as of September 30, 2022 $ 553,498 $ — $ — $ 553,498 Money market accounts as of December 31, 2021 679,278 — — 679,278 Liabilities: Subsidiary long-term incentive plan as of September 30, 2022 $ — $ — $ — $ — Subsidiary long-term incentive plan as of December 31, 2021 — — 3,351 3,351 19 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 The following table summarizes the change in fair value of the Level 3 liabilities for the subsidiary long-term incentive plan with significant unobservable inputs (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Beginning of period balance $ — $ 1,010 $ 3,351 $ 1,000 Changes in fair value included in earnings — ( 194 ) ( 247 ) ( 184 ) Reclassification to additional paid in capital upon modification — — ( 3,104 ) — End of period balance $ — $ 816 $ — $ 816 As of September 30, 2022, $ 552.9 million of our money market accounts was included in cash and cash equivalents, less than $ 0.1 million was included in other current assets and $ 0.6 million was included in other assets in our condensed consolidated balance sheets. As of December 31, 2021, $ 679.3 million was included in cash and cash equivalents in our condensed consolidated balance sheets. Our money market assets are valued using quoted prices in active markets. See Note 12 for the carrying amount and estimated fair value of our convertible senior notes as of September 30, 2022 and December 31, 2021. The liability for the subsidiary long-term incentive plan consisted of the potential cash payment contingent upon meeting certain financial milestones related to the agreement established with certain employees of one of our subsidiaries. This incentive plan was established in November 2017 and the amount of compensation awarded to employees depended on the fair market value of the subsidiary, which was determined in part by the subsidiary’s projected financial results. We accounted for the subsidiary long-term incentive plan using fair value and established liabilities for the future payments under the terms of the incentive plan based on estimating revenue, EBITDA and EBITDA margin of the subsidiary over the period of the incentive plan through the anticipated achievement of the milestones. We estimated the fair value of the liability by using a Monte Carlo simulation model which involves several Level 3 unobservable inputs. The significant unobservable inputs used in the valuation included a weighted average revenue volatility and the revenue risk adjustment. The revenue volatility was weighted using revenue volatility results from the subsidiary’s peer group as well as market transaction metrics. The revenue risk adjustment was calculated using capital structure allocations from the subsidiary’s peer group, market transaction metrics as well as United States Treasury yields. In May 2022, we terminated the subsidiary long-term incentive plan. The fair value of the liability related to the subsidiary long-term incentive plan as of the termination date was consistent with the liability as of March 31, 2022. Concurrent with the termination of the subsidiary long-term incentive plan, we granted performance-based restricted stock units to those employees who previously participated in the subsidiary long-term incentive plan. We accounted for the termination of the subsidiary long-term incentive plan and concurrent grant of performance-based restricted stock units as a modification of the original subsidiary long-term incentive plan. As a result, we reclassified the $ 3.1 million liability related to the subsidiary long-term incentive plan to additional paid-in capital during the three months ended June 30, 2022. Additionally, we recorded $ 1.2 million in incremental compensation costs as additional stock-based compensation expense to the applicable operating expense category based on the respective employee’s function (sales and marketing, general and administrative or research and development) during the three months ended June 30, 2022. The incremental compensation costs represented the excess of the fair value of the performance-based restricted stock units over the fair value of the subsidiary long-term incentive plan as of the modification date of the subsidiary long-term incentive plan. We monitor the availability of observable market data to assess the appropriate classification of financial instruments within the fair value hierarchy. Changes in economic conditions or model-based valuation techniques may require the transfer of financial instruments from one fair value level to another. There were no transfers in or out of Level 3 during the three and nine months ended September 30, 2022 and 2021. We also monitor the value of the investments for other-than-temporary impairment on a quarterly basis. No other-than-temporary impairments occurred during the three and nine months ended September 30, 2022 and 2021. Note 10. Leases We lease office space, data centers and office equipment under non-cancelable operating leases with various expiration dates through 2027. In August 2014, we signed a lease for office space in Tysons, Virginia, where we relocated our headquarters to in February 2016. We have subsequently entered into amendments to this lease to provide us with additional office space. The lease term ends in 2026, includes a five-year renewal option and a cumulative tenant improvement allowance of $ 12.1 million. 20 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 Supplemental information related to leases is presented in the table below (in thousands, except weighted-average term and discount rate): Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Operating lease cost $ 2,702 $ 2,478 $ 7,767 $ 7,173 Cash paid for amounts included in the measurement of operating lease liabilities 3,290 3,068 9,390 8,745 Operating lease right-of-use assets obtained in exchange for new operating lease liabilities 1,415 1,431 7,127 2,446 September 30, 2022 December 31, 2021 Weighted-average remaining lease term — operating leases 3.6 years 4.2 years Weighted-average discount rate — operating leases 3.8 % 3.6 % Maturities of lease liabilities are as follows (in thousands): Year Ended December 31, Operating Leases (1) Remainder of 2022 $ 3,325 2023 13,299 2024 12,078 2025 9,765 2026 5,538 2027 and thereafter 1,090 Total lease payments 45,095 Less: imputed interest (2) 2,997 Present value of lease liabilities $ 42,098 _______________ (1) Operating lease payments exclude $ 6.3 million of legally binding minimum lease payments for leases executed but not yet commenced and include $ 1.0 million for options to extend lease terms that were reasonably certain of being exercised. (2) Imputed interest was calculated using the incremental borrowing rate applicable for each lease. We did no t have any finance leases or subleases as of September 30, 2022 or December 31, 2021. Our lease agreements do not contain any material residual value guarantees, restrictive covenants or variable lease payments. Short-term lease costs were immaterial for the three and nine months ended September 30, 2022 and 2021. 21 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 Note 11. Liabilities The components of accounts payable, accrued expenses and other current liabilities are as follows (in thousands): September 30, 2022 December 31, 2021 Accounts payable $ 49,497 $ 64,751 Accrued expenses 16,899 19,894 Income taxes payable 33,003 — Other current liabilities 7,254 5,171 Accounts payable, accrued expenses and other current liabilities $ 106,653 $ 89,816 The components of other liabilities are as follows (in thousands): September 30, 2022 December 31, 2021 Holdback liability from asset acquisition and business combination $ 4,560 $ 850 Subsidiary long-term incentive plan — 3,351 Other liabilities 7,051 5,344 Other liabilities $ 11,611 $ 9,545 Note 12. Debt, Commitments and Contingencies The debt, commitments and contingencies described below would require us, or our subsidiaries, to make payments to third parties under certain circumstances. Convertible Senior Notes On January 20, 2021, we issued $ 500.0 million aggregate principal amount of 0 % convertible senior notes due January 15, 2026 in a private placement to qualified institutional buyers, or the 2026 Notes. The terms of the 2026 Notes are governed by an Indenture, or the Indenture, by and between Alarm.com Holdings, Inc. and U.S. Bank National Association, as trustee. The 2026 Notes are senior unsecured obligations that do not bear regular interest and the principal amount of the 2026 Notes will not accrete. The 2026 Notes may bear special interest under specified circumstances related to our failure to comply with our reporting obligations under the Indenture. Special interest, if any, will be payable semiannually in arrears on January 15 and July 15 of each year, beginning on July 15, 2021. We received proceeds from the issuance of the 2026 Notes of $ 484.3 million, net of $ 15.7 million of transaction fees and other debt issuance costs. We may not redeem the 2026 Notes prior to January 20, 2024. We may redeem for cash, all or any portion of the 2026 Notes, at our option, on or after January 20, 2024, at a redemption price equal to 100 % of the principal amount of the 2026 Notes to be redeemed, plus accrued and unpaid special interest, if any, to, but excluding, the redemption date, if the last reported sale price of our common stock has been at least 130 % of the conversion price for the 2026 Notes then in effect for at least 20 trading days (whether or not consecutive) during any 30 consecutive trading day period (including the last trading day of such period) ending on, and including, the trading day immediately preceding the date on which we provide notice of redemption. No sinking fund is provided for the 2026 Notes. The 2026 Notes will be convertible at the option of the holders at any time prior to the close of business on the business day immediately preceding August 15, 2025, only under the following circumstances: (1) during any calendar quarter commencing after the calendar quarter ending on June 30, 2021 (and only during such calendar quarter), if the last reported sale price of our common stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on, and including, the last trading day of the immediately preceding calendar quarter is greater than or equal to 130 % of the conversion price for the 2026 Notes on each applicable trading day; (2) during the five business day period immediately after any 10 consecutive trading day period in which, for each trading day of that period, the trading price per $1,000 principal amount of 2026 Notes for such trading day was less than 98 % of the product of the last reported sale price of our common stock and the conversion rate for the 2026 Notes on each such trading day; (3) if we call any or all of the 2026 Notes for redemption, at any time prior to the close of business on the scheduled trading day immediately preceding the redemption date, but only with respect to the 2026 Notes called (or deemed called) for redemption; or (4) upon the occurrence of specified corporate events as set forth in the Indenture. 22 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 On or after August 15, 2025, until the close of business on the second scheduled trading day immediately preceding the maturity date of the 2026 Notes, holders of the 2026 Notes may convert all or any portion of their 2026 Notes at any time, regardless of the foregoing conditions. Upon conversion, we may satisfy our conversion obligation by paying or delivering, as the case may be, cash, shares of our common stock or a combination of cash and shares of our common stock, at our election. It is our current intent to settle the principal amount of the 2026 Notes with cash. The initial conversion rate for the 2026 Notes is 6.7939 shares of our common stock per $1,000 principal amount of 2026 Notes, which is equivalent to an initial conversion price of $ 147.19 per share of our common stock, subject to adjustment under certain circumstances in accordance with the terms of the Indenture. In addition, following certain corporate events that occur prior to the maturity date of the 2026 Notes or if we deliver a notice of redemption in respect of the 2026 Notes, we will, under certain circumstances, increase the conversion rate of the 2026 Notes for a holder who elects to convert its 2026 Notes (or any portion thereof) in connection with such a corporate event or convert its 2026 Notes called (or deemed called) for redemption during the related redemption period (as defined in the Indenture), as the case may be. If we undergo a fundamental change (as defined in the Indenture), subject to certain exceptions and except as described in the Indenture, holders may require us to repurchase for cash all or any portion of their 2026 Notes at a fundamental change repurchase price equal to 100 % of the principal amount of the 2026 Notes to be repurchased, plus accrued and unpaid special interest, if any, to, but excluding, the fundamental change repurchase date. The Indenture includes customary covenants and sets forth certain events of default after which the 2026 Notes may be declared immediately due and payable and sets forth certain types of bankruptcy or insolvency events of default involving us after which the 2026 Notes become automatically due and payable. We used some of the proceeds to repay the $ 110.0 million outstanding principal balance under our credit facility and also used some of the proceeds to pay accrued interest, fees and expenses related to our credit facility (see the section titled "2017 Facility" below). We are using the remaining net proceeds from the issuance of the 2026 Notes for working capital and other general corporate purposes, which may include acquisitions or strategic investments in complementary businesses or technologies. As discussed in Note 2, we adopted ASU 2020-06, " Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity " effective January 1, 2022, using a modified retrospective adoption method. Prior to the adoption of the standard, the 2026 Notes were separated into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar debt instrument that did not have an associated convertible feature. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the 2026 Notes. The equity component was recorded in additional paid-in capital and was not remeasured as it continued to meet the conditions for equity classification. The debt discount for conversion option, debt issuance costs and net carrying amount of the equity component was $ 77.2 million, $ 2.4 million and $ 74.8 million, respectively, as of December 31, 2021. The excess of the principal amount of the liability component over its carrying amount was amortized to interest expense over the contractual term of the 2026 Notes at an effective interest rate of 4.0 %. Prior to the adoption of ASU 2020-06, the difference between the book and tax treatment of the debt discount and debt issuance costs of the 2026 Notes resulted in a difference between the carrying amount and tax basis of the 2026 Notes. This taxable temporary difference resulted in the recognition of a $ 18.3 million net deferred tax liability which was recorded as an adjustment to additional paid-in capital during the three months ended March 31, 2021. Upon adoption of ASU 2020-06 on January 1, 2022, we recombined the liability and equity components of the 2026 Notes assuming that the instrument was accounted for as only a liability from inception to the date of adoption. We also recombined the liability and equity components of the debt issuance costs. The issuance costs are presented as a deduction from the outstanding principal balance of the 2026 Notes and are amortized to interest expense using the effective interest method over the contractual term of the 2026 Notes at a rate of 0.6 %. Upon adoption of ASU 2020-06 on January 1, 2022, we also removed the temporary difference between the book and tax treatment of the debt discount and adjusted the temporary difference between the book and tax treatment of the debt issuance costs of the 2026 Notes. As of September 30, 2022 and December 31, 2021, the fair value of our 2026 Notes was $ 412.8 million and $ 452.5 million, respectively. The fair value was determined based on the quoted price of the 2026 Notes in an inactive market on the last traded day of the quarter and has been classified as Level 2 in the fair value hierarchy. Based on the closing price of our common stock of $ 64.86 on the last trading day of the quarter, the if-converted value of the 2026 Notes did not exceed the principal amount of $ 500.0 million as of September 30, 2022. 23 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 The net carrying amount of the liability component of the 2026 Notes is as follows (in thousands): September 30, 2022 December 31, 2021 Principal $ 500,000 $ 500,000 Unamortized debt discount — ( 63,520 ) Unamortized debt issuance costs ( 10,414 ) ( 11,135 ) Net carrying amount $ 489,586 $ 425,345 Interest expense related to the 2026 Notes is as follows (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Amortization of debt discount $ — $ 3,622 $ — $ 10,026 Amortization of debt issuance costs 782 569 2,342 1,558 Total interest expense $ 782 $ 4,191 $ 2,342 $ 11,584 2017 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. 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 was set to mature in October 2022 and included 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 were being amortized as interest expense over the term of the 2017 Facility. The 2017 Facility was 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. On January 20, 2021, we repaid the entire outstanding principal balance of $ 110.0 million of the 2017 Facility with proceeds from the 2026 Notes. The 2017 Facility was terminated on January 20, 2021 and we recognized an extinguishment loss of $ 0.2 million in other (expense) / income, net in our condensed consolidated statements of operations during the nine months ended September 30, 2021 for previously capitalized debt issuance costs related to the 2017 Facility that were unamortized at the time of the termination of the 2017 Facility. The outstanding principal balance on the 2017 Facility accrued 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. During 2021, until the termination of the 2017 Facility on January 20, 2021, 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 carried an unused line commitment fee of 0.20 %. The carrying value of the 2017 Facility was zero as of September 30, 2022 and December 31, 2021. Commitments and Contingencies Indemnification Agreements We have various agreements that may obligate us to indemnify the other party to the agreement with respect to certain matters. Generally, these indemnification provisions are included in contracts arising in the normal course of business. Although we cannot predict the maximum potential amount of future payments that may become due under these indemnification agreements, we do not believe any potential liability that might arise from such indemnity provisions is probable or material. 24 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 Legal Proceedings On June 2, 2015, Vivint, Inc., or Vivint, filed a lawsuit against us in U.S. District Court, District of Utah, alleging that our technology directly and indirectly infringes six patents that Vivint purchased. Vivint is seeking permanent injunctions, enhanced damages and attorneys' fees. We answered the complaint on July 23, 2015. Among other things, we asserted defenses based on non-infringement and invalidity of the patents in question. In 2017 and 2019, the U.S. Patent Trial and Appeal Board, or PTAB, issued final written decisions in inter partes reviews finding all or some of the claims in five of the asserted patents unpatentable. These decisions were affirmed on appeal. Discovery closed on October 29, 2021. Vivint has moved for partial summary judgment and Alarm.com has moved for summary judgment; both motions are pending decision. Vivint has also moved to assert previously abandoned claims from two of the patents in a new proceeding. We have opposed the motion. No trial date has been set. Should Vivint prevail in proving Alarm.com infringes one or more of its patent claims, we could be required to pay damages of Vivint’s lost profits and/or a reasonable royalty for sales of our solution. Since all remaining patent claims in the litigation have expired, Vivint shall not be entitled to injunctive relief as a remedy in this matter. While we believe we have valid defenses to Vivint’s claims, any of these outcomes could result in a material adverse effect on our business. Based on currently available information, we have determined a loss is not probable or reasonably estimable at this time. Further related to Vivint, on October 27, 2022, we filed a demand for arbitration of a dispute arising under the Patent Cross License agreement between Alarm.com and Vivint executed in November 2013. Vivint notified us it will stop paying license fees to Alarm.com under the agreement. Vivint has paid the required license fees to Alarm.com since the agreement was executed in November 2013. Alarm.com disputes Vivint's refusal of payment and is seeking continued payments of license fees in the arbitration, as well as interest and declaratory relief. There can be no assurance that Alarm.com will be successful in the arbitration proceedings. As a result of Vivint’s refusal to pay license fees under the agreement, beginning with the fourth quarter of 2022, Alarm.com believes that quarterly SaaS and license revenue and total revenue will be impacted by approximately $ 6.0 million. Alarm.com also believes that quarterly earnings and cash flow will be impacted by the aforementioned $ 6.0 million, plus additional legal fees. On January 10, 2022, EcoFactor, Inc., or EcoFactor, filed a lawsuit against us in U.S. District Court, District of Oregon, alleging Alarm.com’s products and services directly and indirectly infringe five U.S. patents owned by EcoFactor. EcoFactor is seeking permanent injunctions, enhanced damages and attorneys' fees. We moved to dismiss the case for failure to state a claim on March 28, 2022. EcoFactor had previously asserted two of the same patents against us in an October 2019 complaint with the U.S. International Trade Commission, or ITC. In July 2021, the ITC found in favor of Alarm.com. EcoFactor appealed the decision but withdrew its appeal in December 2021. Two of the other three asserted patents are currently in ex parte reexamination proceedings at the PTO, and all claims of the third were found unpatentable by the PTAB in inter partes review on April 18, 2022. Also on April 18, 2022, the district court stayed the case at the request of the parties pending the disposition of other proceedings involving the asserted patents, including the reexamination proceedings. Should EcoFactor prevail in its lawsuit we could be required to pay damages and/or a reasonable royalty for sales of our solution, we could be enjoined from making, using and selling our solution if a license or other right to continue selling such elements is not made available to us, and we could be required to pay ongoing royalties and comply with unfavorable terms if such a license is made available to us. While we believe we have valid defenses to EcoFactor’s claims, the outcome of these legal claims cannot be predicted with certainty and any of these outcomes could result in an adverse effect on our business. Based on currently available information, we have determined a loss is not probable or reasonably estimable at this time. On July 22, 2021, Causam Enterprises, Inc., or Causam, filed a lawsuit against us in U.S. District Court, Western District of Texas, alleging that Alarm.com’s smart thermostats infringe four U.S. patents owned by Causam. Causam is seeking preliminary and permanent injunctions, enhanced damages and attorneys’ fees. We have not yet responded to the complaint. On September 3, 2021, the court issued an order staying the lawsuit until the ITC investigation described below is finally resolved. On July 28, 2021, Causam filed a complaint with the ITC naming Alarm.com Incorporated, Alarm.com Holdings, Inc., and EnergyHub, Inc., among others, as proposed respondents. The complaint alleges infringement of the same four patents Causam asserted in district court. Causam is seeking a permanent limited exclusion order and permanent cease and desist order. On August 27, 2021, the ITC instituted an investigation into Causam’s allegations naming Alarm.com Incorporated, Alarm.com Holdings, Inc., EnergyHub Inc. and others as respondents. We answered the complaint on October 4, 2021. Among other things, we asserted defenses based on non-infringement and invalidity of the patents in question. An evidentiary hearing in the investigation was held from June 28, 2022 through July 1, 2022. An initial decision by the presiding administrative judge is expected by November 16, 2022. The target date for completion of the investigation is March 16, 2023. 25 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 Should Causam prevail in an ITC investigation, Alarm.com thermostats manufactured abroad could be excluded from importation into the United States. Should Causam prevail in its district court lawsuit we could be required to pay damages and/or a reasonable royalty for sales of our solution, we could be enjoined from making, using and selling our solution if a license or other right to continue selling such elements is not made available to us, and we could be required to pay ongoing royalties and comply with unfavorable terms if such a license is made available to us. While we believe we have valid defenses to Causam’s claims, the outcome of these legal claims cannot be predicted with certainty, and any of these outcomes could result in an adverse effect on our business. Based on currently available information, we have determined a loss is not probable or reasonably estimable at this time. In addition to the matters described above, we may be required to provide indemnification to certain of our service provider partners for certain claims regarding our solutions. For example, we are incurring costs associated with the indemnification of our service provider ADT, LLC in ongoing patent infringement suits. On February 25, 2021, Vivint filed a lawsuit against ADT LLC a/k/a ADT LLC of Delaware d/b/a ADT Security Services in U.S. District Court, District of Utah, alleging that ADT Pulse, Control, and Blue each infringe one or more patents owned by Vivint. Vivint is seeking damages and attorneys’ fees. Vivint filed a second amended complaint on March 8, 2022. ADT answered the second amended complaint on March 22, 2022, asserted defenses based on non-infringement and invalidity of all five asserted patents and counterclaimed for declaratory judgement of invalidity of all five asserted patents. Two of the asserted patents are under inter partes review at the PTAB. On June 17, 2022, the court entered an order staying the case in view of the pending proceedings before the PTAB, with the exception of certain discovery of source code. Should Vivint prevail on the claims that one or more elements of ADT’s products infringe, we could be required to indemnify ADT for damages in the form of a reasonable royalty or ADT could be enjoined from making, using and selling our solution if a license or other right to continue selling our technology is not made available or we are unable to design around such patents, and required to pay ongoing royalties and comply with unfavorable terms if such a license is made available to us. The outcome of these legal claims cannot be predicted with certainty. We believe there are valid defenses to the claims made by Vivint. Based on currently available information, we have determined a loss is not probable or reasonably estimable at this time. We may also be a party to litigation and subject to claims incident to the ordinary course of business. Although the results of litigation and claims cannot be predicted with certainty, we currently believe that the final outcome of these ordinary course matters will not have a material adverse effect on our business. Other than the preceding matters, we are not a party to any lawsuit or proceeding that, in the opinion of management, is reasonably possible or probable of having a material adverse effect on our financial position, results of operations or cash flows. We reserve for contingent liabilities based on ASC 450, " Contingencies ," when it is determined that a liability, inclusive of defense costs, is probable and reasonably estimable. Litigation is subject to many factors that are difficult to predict, so there can be no assurance that, in the event of a material unfavorable result in one or more claims, we will not incur material costs. Note 13. Stockholders' Equity Stock Repurchase Program On December 3, 2020, our board of directors authorized a stock repurchase program, under which we are authorized to purchase up to an aggregate of $ 100.0 million of our outstanding common stock during the three-year period ending December 3, 2023. During the three and nine months ended September 30, 2022, we repurchased 5,595 and 840,249 shares of our common stock under this program for $ 0.4 million and $ 51.9 million, respectively, which includes applicable commissions and fees. No shares of our common stock were repurchased under this program during the three and nine months ended September 30, 2021. 26 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 Note 14. Stock-Based Compensation Stock-based compensation expense is included in the following line items in the condensed consolidated statements of operations (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Sales and marketing $ 983 $ 1,189 $ 3,481 $ 3,232 General and administrative 3,953 1,974 11,135 7,217 Research and development 8,218 6,255 23,437 16,913 Total stock-based compensation expense $ 13,154 $ 9,418 $ 38,053 $ 27,362 The following table summarizes the components of non-cash stock-based compensation expense (in thousands): Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Stock options and assumed options $ 1,015 $ 1,042 $ 2,742 $ 2,818 Restricted stock units 12,087 8,331 35,165 24,404 Employee stock purchase plan 52 45 146 140 Total stock-based compensation expense $ 13,154 $ 9,418 $ 38,053 $ 27,362 Tax windfall benefit from stock-based awards $ 916 $ 1,100 $ 1,949 $ 6,780 We granted 87,000 and 182,000 stock options pursuant to our 2015 Plan during each of the three and nine months ended September 30, 2022 as compared to an aggregate of 7,500 and 141,200 stock options for the same periods in the prior year. There were 62,324 and 101,586 stock options exercised during the three and nine months ended September 30, 2022, respectively, as compared to 74,932 and 211,190 stock options for the same periods in the prior year. There was an aggregate of 229,400 and 819,824 restricted stock units without performance conditions granted to certain of our employees and directors, during the three and nine months ended September 30, 2022, respectively, as compared to an aggregate of 173,005 and 608,101 restricted stock units without performance conditions for the same periods in the prior year. There was an aggregate of 96,289 and 168,223 restricted stock units with performance conditions granted to certain of our employees during the three and nine months ended September 30, 2022, respectively, as compared to zero and 120,314 restricted stock units with performance conditions for the same periods in the prior year. There were 75,452 and 312,947 restricted stock units without performance conditions that vested during the three and nine months ended September 30, 2022, respectively, as compared to 49,263 and 292,186 restricted stock units without performance conditions vested during the same periods in the prior year. There were zero restricted stock units with performance conditions that vested during the three and nine months ended September 30, 2022 as compared to zero and 20,000 restricted stock units with performance conditions for the same periods in the prior year. 27 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 Note 15. Earnings Per Share Basic and Diluted Earnings Per Share The components of basic and diluted earnings per share are as follows (in thousands, except share and per share amounts): Three Months Ended September 30, Nine Months Ended September 30, Numerator: 2022 2021 2022 2021 Net income $ 18,110 $ 13,294 $ 37,841 $ 42,334 Net loss attributable to redeemable noncontrolling interests 222 244 412 779 Net income attributable to common stockholders - basic (A) 18,332 13,538 38,253 43,113 Add back interest expense, net of tax, attributable to convertible senior notes 588 — 1,761 — Net income attributable to common stockholders - diluted (B) $ 18,920 $ 13,538 $ 40,014 $ 43,113 Denominator: Weighted average common shares outstanding — basic (C) 49,791,465 49,954,565 49,974,925 49,776,578 Dilutive effect of convertible senior notes, stock options and restricted stock units 5,041,063 1,881,674 5,013,095 2,102,483 Weighted average common shares outstanding — diluted (D) 54,832,528 51,836,239 54,988,020 51,879,061 Net income per share: Basic (A/C) $ 0.37 $ 0.27 $ 0.77 $ 0.87 Diluted (B/D) $ 0.35 $ 0.26 $ 0.73 $ 0.83 The following securities have been excluded from the calculation of diluted weighted average common shares outstanding as the inclusion of these securities would have an anti-dilutive effect: Three Months Ended September 30, Nine Months Ended September 30, 2022 2021 2022 2021 Stock options 346,283 141,200 396,742 141,200 Restricted stock units 128,675 11,630 248,792 71,258 Our redeemable noncontrolling interests are related to our 85 % equity ownership interests in OpenEye and Noonlight. See Notes 2 and 6 for details on the put options and call options contained in the OpenEye and Noonlight stockholder agreements. Prior to the adoption of ASU 2020-06, since we expected to settle the principal amount on our outstanding 2026 Notes in cash and any excess in cash or shares of our common stock, we used the treasury stock method for calculating any potential dilutive effect of the conversion spread on diluted net income per share, if applicable. The conversion spread had a dilutive impact on diluted net income per share of common stock when the average market price of our common stock for a given period exceeded the conversion price of $ 147.19 per share for the 2026 Notes. Based on the initial conversion price and the average market price of our common stock for the three and nine months ended September 30, 2021, there was no dilutive effect of the 2026 Notes on our earnings per share during the three and nine months ended September 30, 2021. Upon adoption of ASU 2020-06 on January 1, 2022, we began using the if-converted method when calculating the dilutive impact of the 2026 Notes on net income per share. As a result, we included 3,396,950 shares related to the 2026 Notes within the weighted average shares outstanding when calculating the diluted net income per share for the three and nine months ended September 30, 2022. Additionally, we included $ 0.6 million and $ 1.8 million of debt issuance cost amortization, net of tax, within the numerator of the diluted net income per share for the three and nine months ended September 30, 2022, respectively . 28 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 Note 16. Significant Service Providers During the three and nine months ended September 30, 2022 our 10 largest revenue service provider partners accounted for 52 % and 49 % of our consolidated revenue, respectively, as compared to 48 % and 49 % for the same periods in the prior year. One of our service provider partners within the Alarm.com segment individually represented greater than 15 % but not more than 20 % of our revenue for each of the three and nine months ended September 30, 2022 and 2021. Two service provider partners in the Alarm.com segment each represented more than 10% of accounts receivable as of September 30, 2022. One service provider partner in the Alarm.com segment represented greater than 10% of accounts receivable as of December 31, 2021. Note 17. Income Taxes For purposes of interim reporting, our annual effective income tax rate is estimated in accordance with ASC 740-270, "Interim Reporting." This rate is applied to the pre-tax book income of the entities expected to be benefited during the year. Discrete items that impact the tax provision are recorded in the period incurred. For the three and nine months ended September 30, 2022, we recorded a provision for income taxes of $ 0.2 million and $ 0.5 million, respectively, resulting in an effective income tax rate of 1.3 % and 1.2 % for those periods. For the three and nine months ended September 30, 2021, we recorded a provision for income taxes of $ 1.8 million and a benefit from income taxes of $ 2.9 million, respectively, resulting in an effective income tax rate of 11.8 % and ( 7.3 )% for those periods. Our effective tax rates were below the 21.0% 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, foreign withholding taxes and other nondeductible expenses. We recognize a valuation allowance if, based on the weight of available evidence, both positive and negative, it is more likely than not that some portion, or all, of net deferred tax assets will not be realized. Due to the uncertainty of realization of certain deferred tax assets acquired in 2017 related to our Canadian net operating losses and research and development tax credits, we established a valuation allowance of $ 0.3 million during the second quarter of 2019, which remained at $ 0.3 million as of December 31, 2021 and decreased to $ 0.2 million as of September 30, 2022. During 2020, we established a valuation allowance of $ 1.3 million for state research and development tax credit carryforwards, which increased to $ 1.9 million as of December 31, 2021 and increased to $ 2.0 million as of September 30, 2022. We apply guidance for uncertainty in income taxes that requires the application of a more likely than not threshold to the recognition and de-recognition of uncertain tax positions. If the recognition threshold is met, this guidance permits us to recognize a tax benefit measured at the largest amount of the tax benefit that, in our judgment, is more likely than not to be realized upon settlement. We recorded an increase to the unrecognized tax benefits liability of $ 2.1 million primarily for research and development tax credits claimed during the nine months ended September 30, 2022. We recorded an increase to the unrecognized tax benefits liability of $ 2.1 million for research and development tax credits claimed during the nine months ended September 30, 2021. Our tax returns are subject to on-going review and examination by various tax authorities. Tax authorities may not agree with the treatment of items reported in our tax returns, and therefore the outcome of tax reviews and examinations can be unpredictable. On October 13, 2021, the Internal Revenue Service commenced an examination of our federal income tax return for 2018, which is ongoing. On August 12, 2022, the Internal Revenue Service expanded the examination to include our federal income tax return for 2019, which is ongoing. The anticipated completion date of the Internal Revenue Service examinations cannot be estimated at this time. As of September 30, 2022 and December 31, 2021, we accrued $ 0.2 million of total interest expense related to unrecognized tax benefits. We recognize interest and penalties related to unrecognized tax benefits as a component of income tax expense. In August 2022, the Inflation Reduction Act of 2022 was enacted in the United States which, among other provisions, includes a minimum 15.0% tax on companies that have a three-year average annual adjusted financial statement income of more than $1.0 billion and a 1.0% excise tax on the value of net corporate stock repurchases. Both provisions are effective for tax years beginning after December 31, 2022. We do not currently believe the 15.0% corporate minimum tax or the 1.0% tax on net corporate stock repurchases will have a material impact on our financial condition or results of operations. 29 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 Note 18. Segment Information We have two reportable segments: • Alarm.com segment • Other segment Our chief operating decision maker is our chief executive officer. Management determined the operational data used by the chief operating decision maker is that of the two reportable segments. Management bases strategic goals and decisions on these segments and the data presented below is used to measure financial results. 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, net of intersegment eliminations, for each of the three and nine months ended September 30, 2022, as compared to 94 % and 95 % 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. Inter-segment revenue includes sales of hardware between our segments. 30 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 Management evaluates the performance of its segments and allocates resources to them based on operating income / (loss) as compared to prior periods and current performance levels. The reportable segment operational data is presented in the tables below (in thousands): Three Months Ended September 30, 2022 Alarm.com Other Intersegment Alarm.com Intersegment Other Total SaaS and license revenue $ 122,555 $ 10,571 $ — $ — $ 133,126 Hardware and other revenue 82,300 1,876 ( 1,059 ) ( 105 ) 83,012 Total revenue 204,855 12,447 ( 1,059 ) ( 105 ) 216,138 Operating income / (loss) 20,874 ( 4,738 ) 105 75 16,316 Three Months Ended September 30, 2021 Alarm.com Other Intersegment Alarm.com Intersegment Other Total SaaS and license revenue $ 109,170 $ 8,889 $ — $ — $ 118,059 Hardware and other revenue 73,310 2,445 ( 847 ) ( 643 ) 74,265 Total revenue 182,480 11,334 ( 847 ) ( 643 ) 192,324 Operating income / (loss) 19,968 ( 1,021 ) 244 ( 107 ) 19,084 Nine Months Ended September 30, 2022 Alarm.com Other Intersegment Alarm.com Intersegment Other Total SaaS and license revenue $ 357,031 $ 28,795 $ — $ — $ 385,826 Hardware and other revenue 245,679 6,834 ( 3,302 ) ( 617 ) 248,594 Total revenue 602,710 35,629 ( 3,302 ) ( 617 ) 634,420 Operating income / (loss) 50,545 ( 14,467 ) 459 28 36,565 Nine Months Ended September 30, 2021 Alarm.com Other Intersegment Alarm.com Intersegment Other Total SaaS and license revenue $ 315,329 $ 23,299 $ — $ — $ 338,628 Hardware and other revenue 212,194 7,368 ( 2,531 ) ( 1,980 ) 215,051 Total revenue 527,523 30,667 ( 2,531 ) ( 1,980 ) 553,679 Operating income / (loss) 57,130 ( 6,717 ) 632 ( 233 ) 50,812 Alarm.com Other Intersegment Alarm.com Intersegment Other Total Assets as of September 30, 2022 $ 1,350,821 $ 40,088 $ ( 81,251 ) $ 115 $ 1,309,773 Assets as of December 31, 2021 1,264,416 37,198 ( 69,595 ) ( 4 ) 1,232,015 Our SaaS and license revenue for the Alarm.com segment included software license revenue of $ 6.5 million and $ 20.5 million for the three and nine months ended September 30, 2022, respectively, as compared to $ 7.9 million and $ 24.9 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, 2022 and 2021. Depreciation and amortization expense was $ 7.3 million and $ 22.2 million for the Alarm.com segment for the three and nine months ended September 30, 2022, respectively, as compared to $ 7.3 million and $ 22.0 million for the same periods in the prior year. Depreciation and amortization expense was $ 0.3 million and $ 0.9 million for the Other segment for the three and nine months ended September 30, 2022, respectively, as compared to $ 0.1 million and $ 0.3 million for the same periods in the prior year. Additions to property and equipment were $ 1.9 million and $ 27.6 million for the Alarm.com segment for the three and nine 31 ALARM.COM HOLDINGS, INC. Notes to the Condensed Consolidated Financial Statements (Unaudited) — (Continued) September 30, 2022 and 2021 months ended September 30, 2022, respectively, as compared to $ 1.2 million and $ 7.4 million for the same periods in the prior year. Additions to property and equipment were less than $ 0.1 million and $ 0.2 million for the Other segment for the three and nine months ended September 30, 2022, respectively, as compared to $ 0.2 million and $ 0.3 million for the same periods in the prior year. We derived substantially all revenue from North America for the three and nine months ended September 30, 2022 and 2021. Substantially all of our long-lived assets were in North America as of September 30, 2022 and December 31, 2021. 32