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Item 1.
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Legal Proceedings
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On July 21, 2015 the FTC lodged, under seal, in the United States District Court for the District of Arizona, a motion seeking to hold us in contempt of the consent decree we entered into with the FTC in 2010 (the FTC Order). On December 17, 2015, we entered into a comprehensive settlement agreement with the FTC, pursuant to which we resolved all matters related to the FTC Contempt Action and provided a mechanism to fund a settlement of the Ebarle Class Action described below. Under the terms of the settlement, $100 million was placed into the registry of the court overseeing the FTC Contempt Action, $68 million of which was authorized to be distributed to fund the consumer redress contemplated by the Ebarle Class Action settlement. Those funds have been transferred to the supervision of the court overseeing the Ebarle Class Action Settlement and are awaiting final approval of the settlement and distribution to the class members. The remaining $32 million of the settlement remains in the registry of the Arizona court.
On January 19, 2015, plaintiffs Napoleon Ebarle and Jeanne Stamm filed a nationwide putative consumer class action lawsuit against us in the United States District Court for the Northern District of California. The plaintiffs alleged that we engaged in deceptive marketing and sales practices in connection with our membership plans in violation of the Arizona Consumer Fraud Act and seek declaratory judgment under the Federal Declaratory Judgment Act. On January 20, 2016, the court overseeing the Ebarle Class Action granted the plaintiffs’ motion for preliminary approval conditionally approving the parties’ proposed settlement agreement. On February 11, 2016, the court overseeing the FTC Action entered an order allowing the $68 million to be transferred from the court's registry to the court-ordered settlement administrator in the Ebarle Class Action to fund the settlement. Notice has been sent to the class members. The deadline for class members to object was April 14, 2016, and the deadline for class members to submit claims was April 29, 2016. A hearing on final approval was held on June 23, 2016, and we are awaiting the court’s final ruling. As of June 30, 2016 we have $13.0 million accrued for settlement of this claim, which was not included within the $100 million settlement paid to the court registry in connection with the settlement of the FTC Contempt Action and nationwide class action claims. In addition, we have $3.0 million accrued for a potential settlement with states attorneys general for related claims.
On August 1, 2014, our subsidiaries Lemon and Lemon Argentina, S.R.L. (Lemon Argentina, and together, the Lemon Entities) filed a lawsuit in Santa Clara Superior Court in San Jose, California, against Wenceslao Casares, former General Manager of Lemon, Cynthia McAdam, former General Counsel of Lemon, and Federico Murrone, Martin Apesteguia and Fabian Cuesta, each a former employee and former member of the Board of Directors of Lemon Argentina (the Argentine Executives). The complaint alleges breaches of employment-related contracts and breaches of fiduciary duties involving each named individual’s work for third-party Xapo, Inc. and/or Xapo, Ltd. during their employment by the applicable Lemon Entity. On January 30, 2015, the Lemon Entities filed a second amended complaint alleging breaches of employment-related contracts, breaches of fiduciary duties, and fraud, and seeking declaratory relief against Mr. Casares, Ms. McAdam, and the Argentine Executives. The Argentine Executives entered their appearances in the litigation on July 24, 2015 and filed a motion to dismiss for inconvenient forum on September 8, 2015. That motion was heard on December 4, 2015 and granted on January 4, 2016, with an order staying the action in its entirety. The Lemon Entities filed a notice of appeal on March 1, 2016.
Mr. Casares filed a cross-claim against us and Lemon, Inc. (now Lemon, LLC) on July 24, 2015, for breach of contract, breach of the implied covenant of good faith and fair dealing, conversion, unjust enrichment, and declaratory relief, all arising from the termination of his employment. Because of the January 4, 2016 order staying the case in its entirety, the court did not rule on the motion to dismiss. Mr. Casares filed a separate complaint against us, Lemon, LLC, and Shareholder Representative Services LLC (SRS) in Delaware Chancery Court on October 7, 2015 for breach of contract and seeking a declaratory judgment. The action concerns a December 12, 2014 settlement agreement that resolved certain disputes against other former shareholders of Lemon, Inc. arising out of our December 11, 2013 Lemon acquisition. We, along with Lemon, LLC, moved to dismiss the complaint on October 28, 2015. Mr. Casares responded by filing an amended complaint on January 8, 2016. LifeLock, Inc. and Lemon, LLC moved to dismiss the amended complaint. Briefing is complete and the matter is set for argument on September 27, 2016.
On July 22, 2015, Miguel Avila, representing himself and seeking to represent a class of persons who acquired our securities from July 30, 2014 to July 20, 2015, inclusive, filed a class action complaint in the United States District Court for the District of Arizona. His complaint alleges that Todd Davis, Christopher Power, and we violated Sections 10(b) and 20(a) of the Securities Exchange Act by making materially false or misleading statements, or failing to disclose material facts about our business, operations, and prospects, including with regard to our information security program, advertising, recordkeeping, and our compliance with the FTC Order. The complaint seeks certification as a class action, compensatory damages, and attorney’s fees and costs. On September 21, 2015, four other Company stockholders, Oklahoma Police Pension and Retirement System, Oklahoma Firefighters Pension and Retirement System, Larisa Gassel, and Donna Thompson, and their respective attorneys all filed motions seeking to be appointed the lead plaintiff and lead counsel in this class action. Lead plaintiffs moved to lift the discovery stay imposed by the Private Securities Litigation Reform Act on January 21, 2016. We, along with Mr. Davis and Mr. Power, opposed that motion on February 8, 2016. On April 22, 2016, the Court denied lead plaintiffs’ motion. We, along with
Mr. Davis and Mr. Power, moved to dismiss the amended complaint on January 29, 2016. On August 3, 2016 the Court granted our motion to dismiss and granted lead plaintiffs twenty-one days to seek leave to amend their complaint.
On March 3, 2014, and March 10, 2014, two securities class action complaints were filed in the United States District Court for the District of Arizona, against us, Mr. Davis, and Mr. Power. On June 16, 2014, the court consolidated the complaints into a single action captioned In re LifeLock, Inc. Securities Litigation and appointed a lead plaintiff and lead counsel. On August 15, 2014, the lead plaintiff filed the Consolidated Amended Class Action Complaint (the Consolidated Amended Complaint), seeking to represent a class of persons who acquired our securities from February 26, 2013 to May 16, 2014, inclusive (the Class Period). The Consolidated Amended Complaint alleged that we, along with Mr. Davis, Mr. Power, and Ms. Schneider, violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, by making materially false or misleading statements, or failing to disclose material facts regarding certain of our business, operational, and compliance policies, including with regard to certain of our services, our data security program, and Mr. Davis’ compliance with the FTC Order. The Consolidated Amended Complaint alleged that, as a result, certain of our financial statements issued during the Class Period and certain public statements made by Ms. Schneider, Mr. Davis, and Mr. Power during the Class Period, were false and misleading. The Consolidated Amended Complaint sought certification as a class action, compensatory damages, and attorneys’ fees and costs. On September 15, 2014, we, along with Ms. Schneider, Mr. Davis, and Mr. Power, filed a motion to dismiss the Consolidated Amended Complaint. On December 17, 2014, the court dismissed the Consolidated Amended Complaint and gave the lead plaintiff 21 days to seek leave to amend. On January 16, 2015, lead plaintiff filed his Second Consolidated Amended Complaint which contained similar allegations, but no longer named Ms. Schneider as a defendant. On January 30, 2015, we, along with Mr. Davis and Mr. Power, filed a motion to dismiss the Second Consolidated Amended Complaint. On July 21, 2015, the court granted the motion to dismiss, without leave to amend, and entered judgment in our favor. On August 18, 2015, the lead plaintiff along with another shareholder, City of Hallandale Beach Police and Firefighters’ Personnel Retirement Fund, moved to vacate the judgment on the grounds that the FTC’s July 21, 2015 motion seeking to hold us in contempt of the FTC Order constituted surprise and newly discovered evidence. Plaintiffs also sought permission to file a Third Consolidated Amended Complaint. We, Mr. Davis, and Mr. Power opposed plaintiffs’ motion. On September 18, 2015, the court denied plaintiffs’ motion to vacate the July 21, 2015 judgment and plaintiffs’ request to file another complaint. On September 21, 2015, plaintiffs filed a notice of appeal with the Ninth Circuit Court of Appeals. Plaintiffs appeal from the lower court’s July 21, 2015 order dismissing the Second Consolidated Amended Complaint and entering judgment in our favor, and the court’s September 18, 2015 order denying plaintiffs’ motion to vacate that judgment. Briefing of the appeal has been completed, but oral argument on the appeal has not been set by the Ninth Circuit.
On September 23, 2015, LifeLock stockholder Sridhar Manthangodu, filed a derivative complaint captioned Manthangodu v. Davis, et al., in the Superior Court of the State of Arizona, Maricopa County (Arizona Superior Court). The complaint alleged that certain of our directors (the Director Defendants) violated their fiduciary duties to LifeLock stockholders by, among other things, failing to ensure that we complied with the FTC Order. The complaint seeks unspecified monetary damages, a return to the company of all personal compensation received by the Director Defendants, unspecified corporate governance reforms, and attorney’s fees. On December 24, 2015, the Arizona Superior Court issued an Order appointing plaintiff Manthangodu lead plaintiff and his counsel lead counsel.
Following the filing of the Manthangodu action, additional substantively similar stockholder derivative actions were purportedly filed on our behalf against certain of our current and former directors and officers, seeking similar relief as the Manthangodu complaint. Specifically, on October 28, 2015, a stockholder derivative complaint captioned Gassel v. Davis, et al., was filed in the United States District Court for the District Arizona (the “Arizona Federal District Court”); on November 19, 2015 and November 25, 2015, two stockholders derivative complaints captioned Stein v. Davis, et al. and John L. Munson Revocable Trust v. Davis, et al., respectively, were filed in the Delaware Court of Chancery; and on January 22, 2016, January 26, 2016, and February 1, 2016, three stockholders derivative complaints captioned, City of Pontiac General Employees’ Retirement Sys. v. Guthrie, et al.; Jiawei v. Davis, et al.; and Sprouse v. Davis, et al., respectively, were filed in the Arizona Superior Court. The plaintiffs in the Stein and Munson actions later voluntarily dismissed their actions, and on March 23, 2016, jointly filed a derivative complaint captioned, Stein and Munson v. Davis et al., in the Arizona Superior Court. In the Arizona Superior Court actions, from February to April 2016, the Court issued separate orders consolidating the Sprouse, City of Pontiac, Jiawei, and the Stein and the Munson actions with the Manthangodu action. The consolidated action is captioned In re: LifeLock, Inc. Derivative Litigation, with plaintiff Manthangodu as the lead plaintiff in the consolidated action. In the Gassel action, on April 13, 2016, on our motion, the Arizona Federal District Court granted a non-indefinite stay of that action and directed us to file a status update on the Manthangodu action, which we and the individual defendants filed on July 12, 2016.
On June 30, 2016, we and the Director Defendants entered into a proposed settlement stipulation with lead plaintiff Manthangodu. In the proposed settlement stipulation, the lead plaintiff agreed to the dismissal, with prejudice, of the Manthangodu action as well as a release of any and all related stockholder claims against LifeLock and its current and former directors, officers, employees, and agents. In exchange, we and the Director Defendants agreed to continue and/or implement certain corporate governance measures and to pay attorney’s fees in the amount of $6 million. On July 1, 2016, lead plaintiff filed an unopposed motion for preliminary approval of the proposed settlement stipulation. On July 8, 2016, the Court preliminarily approved the proposed settlement stipulation and set a final approval hearing for August 30, 2016, at which hearing the Court will determine whether to finally approve the proposed settlement stipulation and all of its terms. The Court also set August 16, 2016, as the deadline for stockholders to object to the terms of the proposed settlement stipulation. If the Court approves the proposed settlement stipulation, we anticipate filing motions, as necessary, to effectuate the release of any pending related stockholder claims against LifeLock and its current and former directors or officers. However, there is no assurance that the proposed settlement stipulation and all of its terms will be approved by the Court.
On December 23, 2015, we filed an insurance coverage action in Arizona state court against our 2013-2014 primary and excess directors' and officers' (D&O) liability insurance carriers. LifeLock’s complaint alleges that the primary and excess D&O insurers breached their insurance policies by wrongfully denying LifeLock defense and indemnity coverage for the various securities class action and shareholder derivative lawsuits filed against us. LifeLock’s insurance coverage action also alleges that the primary D&O insurer breached its covenant of good faith and fair dealing, violated Arizona's consumer fraud statute and committed unfair insurance practices. The insurers have filed responsive pleadings to LifeLock’s complaint and discovery is scheduled to take place through August of 2017.
Item 1A. Risk Factors
Investing in our common stock involves a high degree of risk. Before deciding to invest in our common stock, you should carefully consider each of the risk factors described in “Part I – Item 1A. Risk Factors” in our fiscal
2015
Form 10-K, and all information set forth in this Quarterly Report on Form 10-Q, and in our other filings with the Securities and Exchange Commission, or SEC. Those risks and the risks described in this Quarterly Report on Form 10-Q, including in the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, could materially harm our business, financial condition, operating results, cash flow, and prospects. If that occurs, the trading price of our common stock could decline, and you may lose all or part of your investment.
Risks Related to Our Business and Industry
Excluding the settlement with the FTC and the nationwide consumer class action in fiscal year 2015, which we believe are non-recurring expenses, we have been continuously profitable on an annual basis from 2012 through 2015 after incurring significant net losses from our inception through fiscal 2011, but we may not be able to maintain profitability on an annual basis in the future.
Excluding the settlement with the FTC and the nationwide consumer class action in fiscal 2015, we have been continuously profitable year over year after incurring significant net losses from our inception through 2011, but we cannot predict whether we will be able to maintain profitability on an annual basis in the future.
Our recent growth, including our growth in revenue and customer base, may not be sustainable or our growth rate may decline, and we may not generate sufficient revenue to maintain annual profitability. Moreover, we expect to continue to make significant expenditures to maintain and expand our business and to operate as a consolidated entity with ID Analytics and our other subsidiaries. We also may incur additional costs associated with our regulatory compliance as we are subject to a wide variety of federal, state and local laws and regulations. These expenditures may make it more difficult for us to maintain future annual profitability. Our ability to maintain annual profitability depends on a number of factors, including our ability to attract and service customers on a profitable basis. If we are unable to maintain annual profitability, we may not be able to execute our business plan, our prospects may be harmed, and our stock price could be materially and adversely affected.
If the security of confidential information used in connection with our services is breached or otherwise subject to unauthorized access, our reputation and business may be materially harmed.
Our services require us to collect, store, use, and transmit significant amounts of confidential information, including personally identifiable information, credit card information, and other critical data. We employ a range of information technology solutions, controls, procedures, and processes designed to protect the confidentiality, integrity, and availability of our critical assets, including our data and information technology systems. While we engage in a number of measures aimed to protect against security breaches and to minimize problems if a data breach were to occur, our information technology systems and infrastructure may be vulnerable to damage, compromise, disruption, and shutdown due to attacks or breaches by hackers or due to other circumstances, such as error or malfeasance by employees or third party service providers or technology malfunction. The occurrence of any of these events, as well as a failure to promptly remedy these events should they occur,
could compromise our systems, and the information stored in our systems could be accessed, publicly disclosed, lost, stolen, or damaged. Any such circumstance could adversely affect our ability to attract and maintain customers as well as strategic partners, cause us to suffer negative publicity, and subject us to legal claims and liabilities or regulatory penalties. In addition, unauthorized parties might alter information in our databases, which could adversely affect both the reliability of that information and our ability to market and perform our services. Techniques used to obtain unauthorized access or to sabotage systems change frequently, are constantly evolving and generally are difficult to recognize and react to effectively. We may be unable to anticipate these techniques or to implement adequate preventive or reactive measures. Several recent, highly publicized data security breaches at other companies have heightened consumer awareness of this issue and may embolden individuals or groups to target our systems or those of our strategic partners or enterprise customers.
Security technologies and information, including encryption and authentication technology licensed from third parties, are a key aspect of our security measures designed to secure our critical assets. While we routinely seek to update these technologies and information, advances in computer capabilities, new discoveries in the field of cryptography, or other developments may result in the technology we use becoming obsolete, breached, or compromised and cause us to incur additional expenses associated with upgrading our security systems. In addition, security information provided to us by third parties may be inaccurate, incomplete, or outdated, which could cause us to make misinformed security decisions and could materially and adversely affect our business.
Under payment card rules and our contracts with our card processors, we could be liable to the payment card issuing banks for their cost of issuing new cards and related expenses if there is a breach of payment card information that we store. In addition, if we fail to follow payment card industry security standards, even if there is no compromise of customer information, we could incur significant fines or lose our ability to give customers the option of using payment cards to fund their payments or pay their fees. If we were unable to accept payment cards, our business would be materially harmed.
Many states have enacted laws requiring companies to notify individuals of data security breaches involving their personal data. In the United States, federal and state laws provide for over 45 laws and notification regimes, all of which we are subject to, and additional requirements may be instituted in the future. In the event of a data security breach, these mandatory disclosures often lead to widespread negative publicity. In addition, complying with such numerous and complex regulations in the event of a data security breach is often expensive, difficult, and time consuming, and the failure to comply with these regulations could subject us to regulatory scrutiny and additional liability and harm our reputation.
Any actual or perceived security breach, whether successful or not and whether or not attributable to the failure of our services or our information technology systems, as well as our failure to promptly and appropriately react to a breach, would likely harm our reputation, adversely affect market perception of our services, and cause the loss of customers and strategic partners. Our property and business interruption insurance may not be adequate to compensate us for losses or failures that may occur. Our third-party insurance coverage will vary from time to time in both type and amount depending on availability, cost, and our decisions with respect to risk retention.
Our business is highly dependent upon our brand recognition and reputation, and the failure to maintain or enhance our brand recognition or reputation would likely have a material adverse effect on our business.
Our brand recognition and reputation are critical aspects of our business. We believe that maintaining and further enhancing our LifeLock and ID Analytics brands as well as our reputation will be critical to retaining existing customers and attracting new customers. We also believe that the importance of our brand recognition and reputation will continue to increase as competition in our markets continues to develop. Our success in this area will be dependent on a wide range of factors, some of which are out of our control, including the following:
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the efficacy of our marketing efforts;
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our ability to retain existing and obtain new customers and strategic partners;
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the quality and perceived value of our services;
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actions of our competitors, our strategic partners, and other third parties;
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positive or negative publicity, including material on the Internet;
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regulatory and other governmental related developments; and
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litigation related developments.
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Sales and marketing expenses have historically been our largest operating expense, and we anticipate these expenses will continue to increase in the foreseeable future as we continue to seek to grow our business and customer base and enhance our brand. These brand promotion activities may not yield increased revenue and the efficacy of these activities will depend on a number of factors, including our ability to do the following:
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determine the appropriate creative message and media mix for advertising, marketing, and promotional expenditures;
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select the right markets, media, and specific media vehicles in which to advertise;
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identify the most effective and efficient level of spending in each market, media, and specific media vehicle; and
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effectively manage marketing costs, including creative and media expenses, in order to maintain acceptable customer acquisition costs.
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Increases in the pricing of one or more of our marketing and advertising channels could increase our marketing and advertising expenses or cause us to choose less expensive but possibly less effective marketing and advertising channels. If we implement new marketing and advertising strategies, we may utilize marketing and advertising channels with significantly higher costs than our current channels, which in turn could adversely affect our operating results. Implementing new marketing and advertising strategies also would increase the risk of devoting significant capital and other resources to endeavors that do not prove to be cost effective. Further, we may over time become disproportionately reliant on one channel or strategic partner, which could limit our marketing and advertising flexibility and increase our operating expenses. We also may incur marketing and advertising expenses significantly in advance of the time we anticipate recognizing revenue associated with such expenses, and our marketing and advertising expenditures may not generate sufficient levels of brand awareness or result in increased revenue. Even if our marketing and advertising expenses result in increased revenue, the increase might not offset our related expenditures. If we are unable to maintain our marketing and advertising channels on cost-effective terms or replace or supplement existing marketing and advertising channels with similarly or more effective channels, our marketing and advertising expenses could increase substantially, our customer base could be adversely affected, and our business, operating results, financial condition, and reputation could suffer.
Furthermore, negative publicity, whether or not justified, relating to events or activities attributed to us, our employees, our strategic partners, our affiliates, or others associated with any of these parties, may tarnish our reputation and reduce the value of our brands. Damage to our reputation and loss of brand equity may reduce demand for our services and have an adverse effect on our business, operating results, and financial condition. Moreover, any attempts to rebuild our reputation and restore the value of our brands may be costly and time consuming, and such efforts may not ultimately be successful.
We face intense competition, and we may not be able to compete effectively, which could reduce demand for our services and adversely affect our business, growth, reputation, revenue, and market share.
We operate in a highly competitive business environment in both our consumer and enterprise business. Our primary competitors are credit bureaus including Experian PLC, Equifax Inc., and TransUnion, as well as other entities, such as Affinion Group, EWS (Early Warning Services), Intersections Inc., CSID, LexisNexis Group and Credit Karma and other free credit monitoring services. We are also facing competition from large enterprises in the consumer, insurance and other industries offering similar products to ours powered by our competitors and at prices lower than we offer. Many of our competitors have substantially greater financial, technical, marketing, distribution, and other resources than we possess that afford them competitive advantages. As a result, they may be able to devote greater resources to the development, promotion, and sale of services, to deliver competitive services at lower prices or for free, and to introduce new solutions and respond to market developments and customer requirements more quickly than we can. Some of our competitors may also be our vendors and may be in a position to impair our ability to compete with them as a result of such relationship. Consolidation of such competitors who are also vendors may adversely impact our ability to compete, the quality of service we receive from them or our ability to access data that was available to us prior to such consolidation. In addition, some of our competitors may have data that we do not have or cannot obtain without difficulty. Any of these factors could reduce our growth, revenue, access to valuable data, or market share.
Our ability to compete successfully in our markets depends on a number of factors, both within and outside our control, and our inability to compete successfully in our markets may reduce the demand for our services which could adversely affect our business and prospects.
Some of the factors affecting our ability to compete include the following:
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access to a breadth of identity and consumer transaction data;
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breadth and effectiveness of service offerings, including designing and introducing new services;
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effectiveness and cost-efficiency of customer acquisition;
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quality and reliability of customer service; and
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accurate identification of appropriate target markets for our business.
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Any failure by us to compete successfully in any one of these or similar areas may reduce the demand for our services and the robustness of the LifeLock ecosystem, as well as adversely affect our business, growth, reputation, revenue, and market share. Moreover, new competitors, alliances among our competitors, or new service introductions by our competitors may emerge and potentially adversely affect our business and prospects.
We could lose our access to data sources or rely on sources that prove to be ineffective or inaccurate, which could cause us competitive harm and have a material adverse effect on our business, operating results, and financial condition.
Our services depend extensively upon continued access to and receipt of credible, timely and complete data from external sources, including data received from customers, vendors who are also competitors and fulfillment partners. Our data providers could stop providing data, provide untimely data, provide inaccurate or incomplete data or increase the costs for their data for a variety of reasons, including competitive considerations impacting willingness to share the data, lack of verification of the accuracy of the data, a perception that our systems are insecure as a result of a data security breach, budgetary constraints, a desire to generate additional revenue, or a contractual dispute. In addition, upon the termination of the contracts we have with certain of our enterprise customers, we are required to remove from our repositories the data contributed by and through those customers. We could also become subject to legislative, regulatory, or judicial restrictions or mandates on the collection, disclosure, or use of such data, in particular if such data is not collected by our providers in a way that allows us to legally use the data or if the data delivered to us is inaccurate or incomplete. If we were to lose access to a substantial number of data sources or certain key data sources or certain data already in the LifeLock ecosystem, or if our access or use were restricted or became less economical or desirable, our ability to provide our services and the efficacy and attractiveness of the LifeLock ecosystem could be negatively affected, and this would adversely affect us from a competitive standpoint. This would also adversely affect our business, operating results, and financial condition. We may not be successful in maintaining our relationships with these external data source providers and may not be able to continue to obtain data from them on acceptable terms or at all. Furthermore, we cannot provide assurance that we will be able to obtain data from alternative or additional sources if our current sources become unavailable.
We may lose customers and significant revenue and fail to attract new customers if our existing services become less desirable or obsolete, or if we fail to develop and introduce new services with broad appeal or fail to do so in a timely or cost-effective manner.
The introduction of new services by competitors, the emergence of new industry standards, or the development of new technologies could render our existing or future services less desirable or obsolete. In addition, professional thieves continue to develop more sophisticated and creative methods to steal personal and financial information as consumers and enterprises today become increasingly interconnected and engage in a large number of daily activities that involve personal or financial information. Consequently, our financial performance and growth depends upon our ability to enhance and improve our existing services, develop and successfully introduce new services that generate customer interest, and sell our services in new markets. As our existing services mature, encouraging customers to purchase enhancements or upgrades becomes more challenging unless new service offerings provide features and functionality that have meaningful incremental value. To achieve market acceptance for our services, we must effectively anticipate and offer services that meet changing customer demands in a timely manner. Customers may require features and capabilities that our current services lack. In addition, any new markets in which we attempt to sell our services, including new industries, countries, or regions, may not be receptive to our service offerings. If we fail to enhance our existing services in a timely and cost-effective manner, successfully develop and introduce new services, or sell our services in new markets, our ability to retain our existing or attract new customers and our ability to create or increase demand for our services could be harmed, which could have an adverse effect on our business, operating results, and financial condition.
We will be required to make significant investments in developing new services and we may be unable to complete the development of new offerings and services in the anticipated time frame or cost. We also will be subject to all of the risks inherent in the development of new services, including unanticipated technical or other development problems, which could result in material delays in the launch and acceptance of the services or significantly increased costs. In some cases, we may expend a significant amount of resources and management attention on service offerings that do not ultimately succeed in their markets. Because new service offerings are inherently risky, they may not be successful and may harm our operating results and financial condition.
Our inability to develop and offer services that are attractive to the growing number of consumers who utilize mobile devices other than personal computers to access online services could adversely affect our business.
The number of people who access services through devices other than personal computers, including mobile phones, smart phones, handheld computers, tablets, and other mobile devices, has increased dramatically in recent years and is projected to continue to increase. The services we develop for users of mobile devices may not be attractive for users.
We launched a new mobile application in the second quarter of 2016. The success of our mobile application is unproven, and we have prioritized the quality of user experience with our mobile application over short-term monetization. Despite the expected growth in mobile devices, there is no guarantee that we will be able to effectively monetize our mobile application and generate meaningful revenue in the future. If our mobile application is not widely adopted or sufficiently profitable, or if we fail to continue to innovate and introduce enhanced mobile applications and other services for users of these alternative devices, our business could be adversely affected.
As new devices, platforms, and technologies are continually being adopted and released, it is difficult to predict the problems we may encounter in developing versions of our services for use with those devices, platforms, and technologies, and we may need to devote significant resources to the creation, support, and maintenance of such offerings. We are dependent on the interoperability of our mobile application with popular mobile operating systems that we do not control, such as Android and iOS, and any changes in such systems that degrade our application’s functionality or give preferential treatment to competitive products could adversely affect usage of our mobile application. Additionally, if we are slow to develop new services and technologies that are compatible with these devices, platforms, and technologies, or if our competitors are able to achieve those results more quickly than us, we will fail to capture a significant share of an increasingly important portion of the market for online services, which could adversely affect our business.
Our revenue and operating results depend significantly on our ability to retain our existing customers, and add new customers, and any decline in our retention rates or failure to add new customers will harm our future revenue and operating results.
Our revenue and operating results depend significantly on our ability to retain our existing customers and add new customers. In our consumer business from which we derive a significant portion of our revenue, we sell our services to our members on a monthly or annual subscription basis. Our members may cancel their membership with us at any time without penalty. In our enterprise business, our customers have no obligation to renew their agreements with us after the contractual term expires, and a substantial portion of our direct enterprise customers do not have monthly transaction minimums and, accordingly, may reduce their utilization of our services during the contractual term. We therefore may be unable to retain our existing members and enterprise customers on the same or on more profitable terms, if at all, and may generate lower revenue as a result of less utilization of our services by our enterprise customers. In addition, we may not be able to predict or anticipate accurately future trends in customer retention or enterprise customer utilization or effectively respond to such trends. Our customer retention rates and enterprise customer utilization may decline or fluctuate due to a variety of factors, including the following:
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our customers’ levels of satisfaction or dissatisfaction with our services;
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the quality, breadth, and prices of our services;
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our general reputation and events impacting that reputation;
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the services and related pricing offered by our competitors;
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our customer service and responsiveness to any customer complaints;
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customer dissatisfaction if they do not receive the full benefit of our services due to their failure to provide all relevant data;
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customer dissatisfaction with the methods or extent of our remediation services;
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our guarantee may not meet our customers’ expectations; and
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changes in our target customers’ spending levels as a result of general economic conditions or other factors.
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In addition, we experienced a higher level of cancellations in the second half of 2015, which we believe was driven by the announcement of the FTC litigation during the third quarter of 2015, which had a negative impact on our member retention rate. Our membership retention rate also was significantly impacted in the first six months of 2016 by the high number of cancellations of members who enrolled during the first quarter of 2015 as a result of the breach at a large health insurance company during the first quarter of 2015. We also experienced increased cancellations in the first half of 2016, coming from our Employee Benefit, oil and gas vertical, due to a downturn in the oil and gas industry.
If we do not retain our existing customers and continue to add new customers at the same rate we have historically, our revenue may grow more slowly than expected or decline, and our operating results and gross margins will be harmed. In addition, our business and operating results may be harmed if we are unable to maintain our retention rates.
We also must continually add new customers both to replace customers who cancel or elect not to renew their agreements with us and to grow our business beyond our current customer base. If we are unable to attract new customers in numbers greater than the percentage of customers who cancel or elect not to renew their agreements with us, which we call “churn,” our customer base will decrease, and our business, operating results, and financial condition will be adversely affected. Churn negatively impacts the predictability of our subscription revenue model and the efficacy and attractiveness of the LifeLock ecosystem by decreasing the amount of data being added to our data repositories.The FTC litigation has negatively impacted our member growth from the strategic partner channel as the pipeline of new partnerships slowed as a result of the FTC litigation. In addition we have focused our future growth on larger partners which has increased the time of the sales cycle. While we expect the business to recover from the impact of the FTC litigation, there is no guarantee that member growth derived from the partner channel will resume to its prior growth levels.
We depend on strategic partners in our consumer business, and our inability to maintain our existing and secure new relationships with strategic partners could harm our revenue and operating results.
We have derived, and intend to continue to derive, a significant portion of our revenue from members who subscribe to our consumer services through one of our strategic partners. In 2015, we derived just under half of our gross new members from our partner distribution channels. These distribution channels involve various risks, including the following:
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we may be unable to maintain or secure favorable relationships with strategic partners;
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our strategic partners may not be successful in expanding our membership base;
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our strategic partners may seek to renegotiate the economic terms of our relationships;
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our strategic partners may terminate their relationships with us;
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bad publicity and other issues faced by us or our strategic partners could negatively impact our relationships; and
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our strategic partners, some of which already compete with us, may present increased competition for us in the future and may elect to terminate their contracts with us or to violate their contractual obligations.
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Our inability to maintain our existing and secure new relationships with strategic partners could harm our revenue and operating results.
Many of our key strategic partnerships are governed by agreements that may be terminated without cause and without penalty by our strategic partners upon notice of as few as 30 days. Under many of our agreements with strategic partners, our partners may cease or reduce their marketing of our services at their discretion, which may cause us to lose access to prospective members and significantly reduce our revenue and operating results.
Some of our strategic partners possess significant resources and advanced technical abilities. Some offer services that are competitive with our services and more may do so in the future, either alone or in collaboration with other competitors. Those strategic partners could give a higher priority to competing services or decide not to continue to offer our services at all. If any of our strategic partners discontinue or reduce the sale or marketing of our services, promote competitive services, or, either independently or jointly with others, develop and market services that compete with our services, our business and operating results may be harmed. In addition, some of our strategic partners may experience financial or other difficulties, causing our revenue through those strategic partners to decline, which could adversely affect our operating results. Some of our strategic partners may also experience a security breach that could impact our members or systems if they are not identified early and addressed successfully or can otherwise impact our business if we have to suspend or terminate those relationships as a result.
In order for us to implement our business strategy and grow our revenue, we must effectively manage and expand our relationships with qualified strategic partners. We expend significant time and resources in attracting qualified strategic partners, training those partners in our technology and service offerings, and then maintaining relationships with those partners. In order to continue to develop and expand our distribution channels, we must continue to scale and improve our processes and procedures that support our strategic partnerships. Those processes and procedures could become increasingly complex and difficult to manage. Our competitors also use arrangements with strategic partners, and it could be more difficult for us to maintain and expand our distribution channels if they are more successful in attracting strategic partners or enter into exclusive relationships with strategic partners. If we fail to maintain our existing or secure new relationships with strategic partners, our business will be harmed.
We are subject to extensive government regulation, which could impede our ability to market and provide our services and could have a material adverse effect on our business.
Our business and the information we use in our business is subject to a wide variety of federal, state, and local laws and regulations, including the Fair Credit Reporting Act, or FCRA, the Gramm-Leach-Bliley Act, the FTC Act and comparable state laws that are patterned after the FTC Act. In addition, laws governing credit information, consumer privacy and marketing, servicing of consumer products and services, and insurance products and services, govern our business information. Moreover, we are bound by the terms of the FTC Order, the companion orders with 35 states’ attorneys general that we entered into in March 2010, and the settlement we reached with the FTC in 2015. These laws, regulations, and orders cover, among other things, advertising, automatic subscription renewal, broadband residential Internet access, consumer protection, content, copyrights, credit card processing procedures, data protection, distribution, electronic contracts, member privacy, pricing, sales and other procedures, tariffs, and taxation. In addition, it is unclear how existing laws and regulations governing issues such as property ownership, sales and other taxes, and personal privacy apply to the Internet. We incur significant costs to operate our business and monitor our compliance with these laws, regulations, and orders. Any of these laws and regulations are subject to revision and changed interpretation, and we cannot predict the impact of such changes on our business. Complying with these varying requirements, the evolving nature of all of these laws and regulations, the evolving nature of various governmental bodies’ enforcement efforts, and the possibility of new laws or changed interpretation in this area, could increase our costs or impede our ability to provide our services to our customers. The occurrence of any of these could have a material adverse effect on our business, operating results, financial condition, and future prospect.
As disclosed, on July 21 2015, the FTC initiated the FTC Contempt Action alleging that LifeLock had violated the FTC Order. On December 17, 2015, we entered into a comprehensive settlement agreement with the FTC, pursuant to which we resolved all matters related to the FTC Contempt Action, and with representatives of a national class of consumers, which we refer to as the Consumer Class Action or the Ebarle Class Action. Under the terms of the settlement, $100 million was placed into the registry of the court overseeing the FTC Contempt Action, $68 million of which is to be distributed to the court overseeing Consumer Class Action to fund the consumer redress contemplated by the Consumer Class Action settlement, and the remaining $32 million of the settlement remains in the registry of the Arizona court.
As of the date of this filing, no states’ attorneys general have initiated proceedings against us alleging that we violated the companion orders from 2010. As of June 30, 2016, we have accrued $3 million for a potential settlement with states’ attorneys general. The ultimate resolution of the matter with the states’ attorneys general is uncertain and may involve a materially higher settlement than $3 million. Engaging in settlement discussions and defending ourselves in any litigation that arises against states’ attorneys general related to this matter, and other actions that could arise, would be costly and time-consuming and would divert management’s, key personnel’s, and members of our board of directors' attention from our business operations. Any of these occurrences could have a material adverse effect on our business, reputation, product sales, financial condition, results of operation, and future prospects.
It is possible that other federal or local governmental agencies, at any time, will commence additional inquiries or investigations of our business practices or our compliance with the FTC Order. Moreover, there can be no assurance that, despite our best efforts to comply with the FTC Order, the other federal or local government agencies will interpret their orders in the same way. We believe the increased governmental and regulatory scrutiny will continue for the foreseeable future and could lead to additional meetings, inquiries, or investigations by governmental and regulatory agencies that regulate our business, including the FTC, the Department of Justice, the SEC, and the New York Stock Exchange. Responding to these inquiries, investigations, and actions may cause us to incur significant expenses and could divert the attention of our management, key personnel, and members of our board of directors from our business operations. Any determination that we violated any laws, regulations, or consent decrees could result in our liability for fines, damages, or other penalties, could require us to make changes to our services and business practices, and could cause us to lose customers, any of which could have a material adverse effect on our business, operating results, financial condition, and future prospects. In addition, recently, the media have been increasingly covering perceived noncompliance with consumer protection regulations and violations of notions of fair dealing with customers. Accordingly, we may be susceptible to unfounded claims by the media and others of regulatory noncompliance and unfair dealing.
Further, with the growing public concern regarding privacy and the collection, distribution, and use of consumer personal information, we believe we are in an environment in which there is increased regulatory scrutiny concerning data collection and use practices and the provision and marketing of services, like ours, that seek to protect that information. We expect that kind of scrutiny to continue as the marketplace for services like ours continues to develop.
Compliance with these federal, state and foreign regulations is generally our responsibility, and we could be subject to a variety of investigations, enforcement actions and/or private actions for any failure or perceived failure to comply with such regulations. Consumer complaints with respect to our industry have resulted in, and may in the future result in, state, federal and foreign regulatory and other investigations. In addition, we believe there has been a recent increase in whistleblower claims made to regulatory agencies, including whistleblower claims made by former employees or other third parties, including
competitors. We believe these claims, will likely continue, in part because of the provisions enacted by the Dodd-Frank Act that provide for cash awards to persons who report alleged wrongdoing to the SEC, and because competitors may use it as a method to weaken their competitors, and others, like personnel or former personnel or vendors, may use it as means to extract payment or retaliate against the company.
Any changes to applicable regulations or new regulations could materially increase our compliance costs or impede our ability to provide our services to our customers. In addition, various governmental agencies have the authority to commence investigations and enforcement actions under these laws, regulations, and consent decrees, and private citizens as well as other third parties, such as competitors, may bring actions, including class action litigation and whistleblower claims, under some of these laws and regulations. The risk of our noncompliance with any rules and regulations interpreted differently by or otherwise enforced by a federal or state consumer protection authority or an enforcement agency in a foreign jurisdiction may subject us (and in some cases our management) to fines, consumer restitution, or various forms of civil or criminal prosecution, any of which could impede our ability to market our programs and services and reduce our revenue and profitability. While we have invested and expect to continue to invest significant resources to continuously improving our compliance practices and security measures, there is no assurance that such efforts will be sufficient when reviewed by an enforcement authority. Even an inadvertent failure to comply with these laws and regulations, as well as rapidly evolving expected standards, could adversely affect our business or our reputation. Certain types of noncompliance may also give our partners the right to terminate certain of our contracts or assert claims under our contracts. Also, the media often publicizes perceived noncompliance with consumer protection regulations and violations of notions of fair dealing with customers, and our industry is susceptible to peremptory charges by the media and others of regulatory noncompliance and unfair dealing. Any failure or perceived failure by us to comply with regulatory requirements could have a material adverse effect on our business and results of operations. Similarly, disclosure of confidential information by regulatory agencies or other third parties may harm our business or reputation.
Marketing laws and regulations may materially limit our ability to offer our services to members.
We market our consumer services through a variety of marketing channels, including mass media, direct mail campaigns, online display advertising, paid search and search-engine optimization, and inbound customer service and account activation calls. These channels are subject to both federal and state laws and regulations. Over the past several years, there has been proposed legislation in several states that may interfere with our marketing practices. For example, over the past several years many states have proposed legislation that would allow customers to limit the amount of unsolicited direct mail they receive. Additionally, several bills have been proposed in Congress that could restrict the collection and dissemination of personal information for marketing purposes. If such legislation is passed in one or more states or by Congress, it could limit our ability to market to new members or offer additional services to existing members, which may have a material adverse effect on our ability to sell our services.
The Dodd-Frank Wall Street Reform and Consumer Protection Act authorizes the newly created Bureau of Consumer Financial Protection to adopt rules and take actions that could have a material adverse effect on our business.
In 2010, the Dodd-Frank Act was enacted to reform the practices in the financial services industry. Title X of the Dodd-Frank Act established the Bureau of Consumer Financial Protection, or the CFPB, to protect consumers from abusive financial services practices. Among other things, the CFPB has broad authority to write rules affecting the business of credit reporting companies as well as to supervise, conduct examinations of, and enforce compliance as to federal consumer financial protection laws and regulations with respect to certain “non-depository covered persons” determined by the CFPB to be “larger participants” that offer consumer financial products and services.
The CFPB has broad regulatory, supervisory, and enforcement powers and may exercise authority with respect to our services, or the marketing and servicing of those services, by overseeing our financial institution or credit reporting agency customers and suppliers, or by otherwise exercising its supervisory, regulatory, or enforcement authority over consumer financial products and services. Certain of our credit reporting agency customers and suppliers that meet the definition of a “larger participant” are included under the CFPB nonbank supervision program. The CFPB also created a section of its consumer complaint database for credit reporting complaints. Further, we believe that the CFPB has commenced review of certain of our financial institution customers and vendors, including their offering of some or all fee-based products. These or other actions by the CFPB could cause our credit agency customers and suppliers and financial institution customers to limit or change their business activities or condition their engagement with us on us changing our own practices, which could have a material adverse effect on our operating results. It is not certain whether the CFPB has, or will seek to exercise, supervisory or other authority directly over us or our services. Supervision and regulation of us or our enterprise customers by the CFPB could have a material adverse impact on our business and operating results, including the costs to make changes that may be required by us, our enterprise customers, or our strategic partners, and the costs of responding to examinations by the CFPB. In addition, the costs of responding to or defending against any enforcement action that may be brought by the CFPB, and any liability that we may incur, may have a material adverse impact on our business, results of operations, and financial condition. In the future, the CFPB may choose to enact new rules or amend currently existing rules which could further extend the scope of its
jurisdiction with respect to our business activities or those of our customers and suppliers.
Changes in legislation or regulations governing consumer privacy and other consumer protection aspects may affect our ability to collect, distribute, and use personally identifiable information.
There has been increasing public concern about the use of personally identifiable information and vulnerability of security practices intended to protect it. As a result, many federal, state, and foreign government bodies and agencies have adopted or are considering adopting laws and regulations regarding the collection, disclosure, protection and use of personally identifiable information. In addition to government regulation, privacy advocates and industry groups may propose new and different self-regulatory standards that apply to us. Because the interpretation and application of privacy, data protection and other consumer protection laws are still uncertain, it is possible that these laws may be interpreted and applied in a manner that is inconsistent with our existing data management practices or the features of our services. If this is the case, in addition to the possibility of fines, lawsuits, and other claims, we could be required to fundamentally change our business activities and practices or modify our service offerings, which could have a material adverse effect on our business and our ability to retain our customers and partners. Any inability to adequately address privacy concerns, even if unfounded, or comply with applicable privacy, data protection or other consumer protection laws, regulations, and policies, could result in additional cost and liability to us, damage our reputation, affect our ability to attract new customers and maintain relationships with our existing customers, and adversely affect our business. Furthermore, the costs of compliance with, and other burdens imposed by, the laws, regulations, and policies that are applicable to the businesses of our enterprise customers and strategic partners may limit the use and adoption of, and reduce the overall demand for, our services. Privacy concerns, whether valid or not, may inhibit market adoption of our services.
Laws requiring the free issuance of credit reports by credit reporting agencies, and other services that must be provided by credit reporting agencies, or that otherwise impose restrictions or requirements related to such services, could impede our ability to obtain new members or retain existing members and could have a material adverse effect on our business.
The FCRA provides consumers the ability to receive one free consumer credit report per year from each major consumer credit reporting agency and requires each major consumer credit reporting agency to provide the consumer a credit score along with the consumer’s credit report for a reasonable fee as determined by the FTC. In addition, the FCRA and state laws give consumers other rights with respect to the protection of their credit files at the credit reporting agencies. For example, the Fair Credit Reporting Act gives consumers the right to place “fraud alerts” at the credit reporting agencies, and the laws in approximately 40 states give consumers the right to place “freezes” to block access to their credit files. The rights of consumers to obtain free annual credit reports and credit scores from consumer reporting agencies, and to place fraud alerts and credit freezes directly with them, could cause consumers to perceive that the value of our services is reduced or replaced by those benefits, which could have a material adverse effect on our business. Similarly, other laws, rules and regulations may impose restrictions or additional requirements on providing credit related services and the failure to comply with those requirements may impact our ability to enroll or retain our members, to otherwise provide services to our members.
The FTC Order, as well as the companion orders with 35 states’ attorneys general and the FTC Contempt Action imposes on us injunctive provisions that could subject us to additional injunctive and monetary remedies.
In March 2010, we and Todd Davis, our Executive Vice Chairman and former CEO, entered into the FTC Order. The FTC Order was the result of a settlement of allegations that certain of our advertising and marketing practices constituted deceptive acts or practices in violation of the FTC Act. We did not admit to those allegations. Under the FTC Order, we are enjoined from making any misrepresentation of the means, methods, procedures, effects, effectiveness, coverage, or scope of our identity theft protection services. The FTC investigation of our advertising and marketing activities occurred during the time that we relied significantly on the receipt of fraud alerts from the credit reporting agencies for our members. The FTC believed that such alerts had inherent limitations in terms of coverage, scope, and timeliness. Many of the allegations in the FTC complaint, which accompanied the FTC Order, related to the inherent limitations of using credit report fraud alerts as the foundation for identity theft protection. The FTC Order also includes injunctive provisions relating to our data security for members’ personally identifiable information. At the same time, we entered into companion orders with 35 states’ attorneys general that imposed injunctive provisions similar to those in the FTC Order.
The FTC Order provided for a consumer redress payment of $11 million, which we made in 2010 to the FTC for distribution to our members. The FTC Order also provided for an additional consumer redress payment of $24 million, which the FTC suspended based on our then-current financial condition. The FTC Order specifies that in the event the FTC were to find that the financial materials we submitted were not truthful, accurate, and complete, the court order entering the settlement could be re-opened, and the suspended judgment in the amount of the additional $24 million would become immediately due in full.
As previously disclosed, on July 21, 2015, the FTC initiated the FTC Contempt Action alleging that LifeLock had violated the FTC Order. On December 17, 2015, we entered into a comprehensive settlement agreement with the FTC, pursuant to which we resolved all matters related to the FTC Contempt Action and the Consumer Class Action. Under the terms of the settlement, $100 million was placed into the registry of the court overseeing the FTC Contempt Action, $68 million of which is to be distributed to the court overseeing Consumer Class Action to fund the consumer redress contemplated by the Consumer Class Action settlement, and the remaining $32 million of the settlement remains in the registry of the Arizona court. In addition, as of December 31, 2015 we also have $13 million accrued for payment of plaintiff legal and administrative fees related to the nationwide consumer class action.
As of the date of this filing, no states’ attorneys general have initiated proceedings against us alleging that we violated the companion orders from 2010. However, because the companion orders we entered into with 35 states’ attorneys general imposed injunctive provisions similar to those in the FTC Order, we initiated preliminary settlement discussions with certain states’ attorneys general. As of December 31, 2015, we have accrued $3 million for a potential settlement with states’ attorneys general. The ultimate resolution of the matter with the states’ attorneys general is uncertain and may involve a materially higher settlement than $3 million. Engaging in settlement discussions and defending ourselves in any litigation that arises against states’ attorneys general related to this matter, and other actions that could arise, would be costly and time-consuming and would divert the attention of our management, key personnel, and members of our board of directors from our business operations. The outcome of the settlement discussions with the states’ attorneys general and potential related actions could result in liability for damages, fines, penalties, and injunctive relief. Any of these occurrences could have a material adverse effect on our business, operating results, financial condition, and prospects.
The outcome of litigation or regulatory proceedings could subject us to significant monetary damages, restrict our ability to conduct our business, harm our reputation, and otherwise negatively impact our business.
As previously disclosed, on July 21 2015, the FTC initiated the FTC Contempt Action alleging that LifeLock had violated the FTC Order. On December 17, 2015, we entered into a comprehensive settlement agreement with the FTC, pursuant to which we resolved all matters related to the FTC Contempt Action and the Consumer Class Action. Under the terms of the settlement, $100 million was placed into the registry of the court overseeing the FTC Contempt Action, $68 million of which is to be distributed to the court overseeing Consumer Class Action to fund the consumer redress contemplated by the Consumer Class Action settlement, and the remaining $32 million of the settlement remains in the registry of the Arizona court.
As of the date of this filing, no states’ attorneys general have initiated proceedings against us alleging that we violated the companion orders from 2010. However, because the companion orders we entered into with 35 states’ attorneys general imposed injunctive provisions similar to those in the FTC Order, we initiated preliminary settlement discussions with certain states’ attorneys general. The ultimate resolution of the matter with the states’ attorneys general is uncertain and may involve a settlement outside the FTC Contempt Action remaining $32 million settlement funds.
Engaging in settlement discussions and defending ourselves in any litigation that arises against states’ attorneys general related to this matter or otherwise with any other regulatory agencies, and other actions that could arise, would be costly and time-consuming. We may be unable to reach settlement on terms acceptable to us or at all and costly litigation would likely result. Further, as a result of these matters, including the settlement agreements themselves, we could face negative publicity, our reputation could be harmed, we could lose customers, including enterprise customers, and our ability to win new customers could be impeded any of which could have a material adverse effect on our business, operating results, financial condition and our future prospects.
We are also presently subject to various securities, consumer class action, and shareholder derivative complaints as described in more detail in this Form 10-Q and in our Form 10-K for the year ended December 31, 2015. The FTC settlement and the recent volatility in the trading price of our stock may result in our stockholders filing additional securities class actions and shareholder derivative complaints against us, our officers, and directors.
We cannot predict the outcome of these actions or proceedings, or any other actions or proceedings filed against us in the future, and the cost of defending such actions or proceedings could be material. Furthermore, defending such actions or proceedings could divert the attention of our management, key personnel, and members of our board of directors from our business operations. If we are found liable in any actions or proceedings, we may have to pay substantial damages, penalties, or fines, change the way we conduct our business, or lose customers, any of which may have a material adverse effect on our business, operating results, financial condition, and prospects. In addition, we are engaged in a dispute regarding insurance coverage for certain matters. If coverage is unavailable, we will be required to pay for any costs related to these matters out of pocket, which amounts may be material. There may also be negative publicity associated with litigation or regulatory proceedings that could harm our reputation or decrease acceptance of our services.
Moreover, we utilize contractors and third parties for various services, including certain advertising and promotions, which may result in misrepresentations made by such third parties being attributed to us or in additional claims or litigation against us. For example, a former service provider claimed that we misclassified her as an independent contractor, and we may be subject to other claims of this nature from time to time. These claims may be costly to defend and may result in our liability for damages, adverse tax consequences, and harm to our reputation, any of which could have a material adverse effect on our business, operating results, financial conditions, and future prospects.
We believe there has been a recent increase in whistleblower claims across our industry, including whistleblower claims arising after employee or vendor terminations or by competitors to impair competition, which will likely continue, in part because of the provisions enacted by the Dodd-Frank Act that may entitle persons who report alleged wrongdoing to the SEC to cash rewards. We anticipate that these provisions will result in a significant increase in whistleblower claims, and dealing with such claims could generate significant expenses and take up significant management and board time, even for frivolous and non-meritorious claims. Any investigations of whistleblower claims may impose additional expense on us, may divert the attention of our management, other key personnel, and members of our board of director, and may result in fines and/or reputational damage whether or not we are deemed to have violated any regulations. We believe there also has been a recent increase in claims made to regulatory agencies by former employees. Often the allegations underlying such claims to regulatory agencies lead to meetings, inquiries, or investigations by the regulatory agencies about such claims, inquiries, or investigations by the agencies that regulate our business, including the FTC. Inquiries or investigation by regulatory agencies about such claims could generate significant expense and take up significant management and board time.
Our business could be negatively affected as a result of actions of stockholders.
The actions of stockholders
could adversely affect our business. Specifically, certain actions of certain types of stockholders, including without limitation public proposals, requests to pursue a strategic combination or other transaction or special demands or requests, could disrupt our operations, be costly and time-consuming or divert the attention of our management and employees. In addition, perceived uncertainties as to our future direction in relation to the actions of our stockholders may result in the loss of potential business opportunities or the perception that we are unstable and need to make changes, which may be exploited by our competitors and make it more difficult to attract and retain personnel as well as customers, service providers and partners. Actions by our stockholders may also cause fluctuations in our stock price based on speculative market perceptions or other factors that do not necessarily reflect the underlying fundamentals and prospects of our business.
A limited number of enterprise customers provide a significant portion of our enterprise revenue, and our inability to retain these customers or attract new customers could harm our revenue and operating results and the efficacy and attractiveness of the LifeLock ecosystem.
ID Analytics has historically derived, and continues to derive, a significant portion of its revenue from a limited number of enterprise customers. For example, in 2015, 2014, and 2013, sales derived through ID Analytics’ top ten customers accounted for approximately 63%, 71%, and 65%, respectively, of ID Analytics’ revenue for those periods. Some of these customers also provide services that compete with our consumer services and, accordingly, may seek alternative services in the future. The loss of several of our enterprise customers, or of any of our large enterprise customers, could have a material adverse effect on our revenue and results of operations, as well as the efficacy and attractiveness of the LifeLock ecosystem.
In addition, new customer acquisition in our enterprise business is often a lengthy process requiring significant up-front investment. Accordingly, we may devote substantial resources in an effort to attract new enterprise customers that may not result in customer engagements or lead to an increase in revenue, which could have a material adverse effect on our business.
If we experience system failures or interruptions in our telecommunications or information technology infrastructure, it may impair the availability of our services, our revenue could decrease, and our reputation could be harmed.
Our operations depend upon our ability to protect the telecommunications and information technology systems utilized in our services against damage or system interruptions from natural disasters, technical failures, human error, and other events. We send and receive credit and other data, as well as key communications to and from our members, electronically, and this delivery method is susceptible to damage, delay, or inaccuracy. A portion of our business involves telephonic customer service and online enrollments, which depends upon the data generated from our computer systems. Unanticipated problems with our telecommunications and information technology systems may result in data loss, which could interrupt our operations. Our telecommunications or information technology infrastructure upon which we rely also may be vulnerable to computer viruses, hackers, or other disruptions.
We rely on our network and data center infrastructure and internal technology systems for many of our development, operational, support, sales, accounting, and financial reporting activities, the failure of which could disrupt our business operations and result in a loss of revenue and damage to our reputation.
We rely on our network and data center infrastructure and internal technology systems for many of our development, operational, support, sales, accounting, and financial reporting activities. We routinely invest resources to update and improve these systems and environments with the goal of better meeting the existing, as well as the growing and changing requirements of our customers. If we experience prolonged delays or unforeseen difficulties in updating and upgrading our systems and architecture, we may experience outages and may not be able to deliver certain service offerings and develop new service offerings and enhancements that we need to remain competitive. Such improvements and upgrades often are complex, costly, and time consuming. In addition, such improvements can be challenging to integrate with our existing technology systems or may result in problems with our existing technology systems. Unsuccessful implementation of hardware or software updates and improvements could result in outages, disruption in our business operations, loss of revenue, or damage to our reputation. Our systems and data are hosted by third-party data centers, and certain applications are hosted by other third-party cloud providers. If one or more of these third-party data centers or cloud providers experience any disruptions, outages, or catastrophes, it could disrupt our business and result in a loss of customers, loss of revenue, or damage to our reputation.
Natural or man-made disasters and other similar events may significantly disrupt our and our strategic partners’ or service providers’ businesses, and negatively impact our results of operations and financial condition.
Our enterprise business headquarters and the back-up data centers and cloud providers for our enterprise business are located in Southern California, which is situated on or near earthquake fault lines. Our primary data center for our enterprise business is located in Nevada. In our consumer business, we have data centers in Northern California and Arizona. Any of our or our strategic partners’ or service providers’ facilities may be harmed or rendered inoperable by natural or man-made disasters, including earthquakes, tornadoes, hurricanes, wildfires, floods, nuclear disasters, acts of terrorism or other criminal activities, infectious disease outbreaks, and power outages, which may render it difficult or impossible for us or our strategic partners or service providers to operate our respective businesses for some period of time. Our and our strategic partners’ or service providers’ facilities would likely be costly to repair or replace, and any such efforts would likely require substantial time. Any disruptions in our or our strategic partners’ or service providers’ operations could negatively impact our business and results of operations and harm our reputation. In addition, we and our strategic partners or service providers may not carry business insurance or may not carry sufficient business insurance to compensate for losses that may occur. Any such losses or damages could have a material adverse effect on our business, results of operations, and financial condition.
Changes in the economy may significantly affect our business, operating results, and financial condition.
Our business may be affected by changes in the economic environment. Our services, particularly our consumer services, are discretionary purchases, and members may reduce or eliminate their discretionary spending on our services during a difficult economic environment. Although we have not yet experienced a material increase in membership cancellations or a material reduction in our member retention rate, we may experience such an increase or reduction in the future, especially in the event of a prolonged recessionary period or a worsening of current conditions. In addition, during an economic downturn, consumers may experience a decline in their credit, which may result in less demand for our services. Conversely, consumers may spend more time using the Internet during an economic downturn and may have less time for our services in a period of economic growth. In addition, media prices may increase in a period of economic growth, which could significantly increase our marketing and advertising expenses. As a result, our business, operating results, and financial condition may be significantly affected by changes in the economic environment.
Our rapid development and growth in an evolving industry make evaluating our business and future prospects difficult and may increase the risk of an investment in our company.
Our business, prospects, and growth potential must be considered in light of the risks, expenses, delays, difficulties, uncertainties, and other challenges encountered by companies that are rapidly developing and are experiencing rapid growth in evolving industries. We may be unsuccessful in addressing the various challenges we may encounter. Our failure to do so could have a material adverse effect on our business, prospects, reputation, and growth potential as well as the value of an investment in our company.
As a result of our rapid development and growth in an evolving industry, it is difficult to accurately forecast our revenue and plan our operating expenses, and we have limited insight into trends that may emerge and affect our business. In the event that our actual results differ from our forecasts or we adjust our forecasts in future periods, our operating results and financial position could be materially and adversely affected and our stock price could decline.
These risks are increased by our acquisitions of ID Analytics and Lemon, and will be further increased by any acquisitions we may make in the future.
We restated certain prior consolidated financial statements, which may lead to additional risks and uncertainties, including shareholder litigation, loss of investor confidence, and negative impacts on our stock price.
In November 2014, we restated our audited consolidated financial statements for the year ended December 31, 2013, our unaudited condensed consolidated financial statements for the quarters ended March 31, 2013, June 30, 2013, and September 30, 2013, and our unaudited condensed consolidated financial statements for the quarters ended March 31, 2014 and June 30, 2014. The determination to restate these financial statements was made by our Audit Committee, after discussion with management and Ernst & Young LLP, following the identification of an error related to our calculation of the volatility assumption within the Black-Scholes option pricing model used to compute our share-based compensation expense since our initial public offering in October 2012, which resulted in a higher volatility and, accordingly, we materially overstated share-based compensation expense for the impacted periods. As a result of these events, we have become subject to a number of additional risks and uncertainties, including potential shareholder litigation. If litigation did occur, we would incur substantial defense costs regardless of the outcome of such litigation. Likewise, such events may cause a diversion of our management’s time and attention. If we do not prevail in any such litigation, we could be required to pay substantial damages or settlement costs. In addition, the fact that we have completed a restatement may lead to a loss of investor confidence and have negative impacts on the trading price of our common stock.
If we are unable to maintain effective internal control over financial reporting in the future, the accuracy and timeliness of our financial reporting may be adversely affected.
Pursuant to Section 404 of the Sarbanes-Oxley Act, we are required to furnish a report by our management on our internal control over financial reporting. The report contains, among other matters, an assessment of the effectiveness of our internal control over financial reporting as of the end of our fiscal year, including a statement as to whether or not our internal control over financial reporting is effective. This assessment must include disclosure of any material weaknesses in our internal control over financial reporting identified by management.
Although we remediated the material weakness we had as a result of our prior restatement, and while we determined that our internal control over financial reporting was effective as of December 31, 2015, as indicated in Management's Annual Report on Internal Control over Financial Reporting included in our Annual Report on Form 10-K for fiscal 2015, if we are otherwise unable to maintain adequate internal controls for financial reporting, or if our independent registered public accounting firm is unable to express an opinion as to the effectiveness of our internal controls as required pursuant to the Sarbanes-Oxley Act, it could result in another material misstatement of our financial statements that would require a restatement, investor confidence in the accuracy and timeliness of our financial reports may be impacted, or the market price of our common stock could be negatively impacted.
The failure to manage our growth may damage our brand recognition and reputation and harm our business and operating results.
We have experienced rapid growth in a relatively short period of time. Our revenue grew from $18.9 million in 2007 to $587.5 million in 2015, and our members increased from approximately 30,000 on December 31, 2006 to approximately 4.2 million on December 31, 2015. In addition, our acquisitions of ID Analytics in March 2012 and Lemon in December 2013 increased our revenue, facilities and number of employees, and we will continue to hire additional employees in the future. We must successfully manage our growth to achieve our objectives. Our ability to effectively manage any significant growth of our business will depend on a number of factors, including our ability to do the following:
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introduce new service offerings that are attractive to our customers and enhance our gross margins;
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develop and pursue cost-effective marketing and advertising campaigns that attract new customers;
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satisfy existing and attract new customers;
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hire, train, retain, and motivate additional employees;
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enhance our operational, financial, and management systems;
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enhance our intellectual property rights;
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effectively manage and maintain our corporate culture; and
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make sound business decisions in light of the scrutiny associated with operating as a public company.
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These enhancements and improvements will require significant expenditures and allocation of valuable management and employee resources, and our growth will continue to place a strain on our operational, financial, and management infrastructure. Our future financial performance and our ability to execute on our business plan will depend, in part, on our ability to effectively manage any future growth. There are no guarantees we will be able to do so in an efficient or timely manner, or at all. Our failure to effectively manage growth could have a material adverse effect on our business, reputation,
operating results, financial condition, and prospects.
Any future acquisitions that we undertake could disrupt our business, fail to achieve the anticipated results, harm our operating results, and dilute stockholder value.
From time to time, we may review opportunities to acquire other businesses or other assets that would expand the breadth of services that we offer, strengthen our distribution channels, enhance our intellectual property and technological know-how, augment the LifeLock ecosystem and our data repositories, or otherwise offer potential growth opportunities. For example, in March 2012, we completed our acquisition of ID Analytics, in December 2013, we completed our acquisition of Lemon, and in August 2015 we completed our acquisition of BitYota. We may in the future be unable to identify suitable acquisition candidates or to complete the acquisition of candidates that we identify. Increased competition for acquisition candidates or increased asking prices by acquisition candidates may increase purchase prices for acquisitions to levels beyond our financial capability or to levels that would not result in the returns required by our acquisition criteria. Acquisitions also may become more difficult in the future as we or others, including our competitors, acquire the most attractive candidates. Unforeseen expenses, difficulties, and delays that we may encounter in connection with rapid expansion through acquisitions could inhibit our growth and negatively impact our operating results.
Our ability to grow through acquisitions will depend upon various factors, including the following:
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the availability of suitable acquisition candidates at attractive purchase prices;
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the ability to compete effectively for available acquisition opportunities;
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the availability of cash resources, borrowing capacity, or stock at favorable price levels to provide required purchase prices in acquisitions;
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diversion of management’s attention to acquisition efforts; and
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the ability to obtain any requisite governmental or other approvals.
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As a part of our acquisition strategy, we frequently engage in acquisition discussions. In connection with these discussions, we and potential acquisition candidates often exchange confidential operational and financial information, conduct due diligence inquiries, and consider the structure, terms, and conditions of the potential acquisition. Potential acquisition discussions frequently take place over a long period of time and involve difficult business integration and other issues, including, in some cases, management succession and related matters. As a result of these and other factors, a number of potential acquisitions that from time to time appear likely to occur do not result in binding legal agreements and are not consummated, despite the expenditure of time and resources, which may affect our results.
Any borrowings made to finance future acquisitions could make us more vulnerable to a downturn in our operating results, a downturn in economic conditions, or increases in interest rates on borrowings. If our cash flow from operating activities is insufficient to meet our debt service requirements, we could be required to sell additional equity securities, refinance our obligations, or dispose of assets in order to meet our debt service requirements. If we finance any future acquisitions in whole or in part through the issuance of common stock or securities convertible into or exercisable for common stock, existing stockholders will experience dilution in the voting power of their common stock and earnings per share could be negatively impacted. The extent to which we will be able or willing to use our common stock for acquisitions will depend on the market price of our common stock from time to time and the willingness of potential sellers to accept our common stock as full or partial consideration for the sale of their businesses. Our inability to use our common stock as consideration, to generate cash from operations, or to obtain additional funding through debt or equity financings in order to pursue an acquisition program could materially limit our growth.
Any acquisitions that we undertake could be difficult to integrate, which could disrupt and harm our business.
In order to pursue a successful acquisition strategy, we will need to integrate the operations of any acquired businesses into our operations, including centralizing certain functions and pursuing programs and processes aimed at leveraging our revenue and growth opportunities. The integration of the management, operations, and facilities of acquired businesses with our own could involve difficulties, which could adversely affect our growth rate and operating results.
We may not realize all of the benefits anticipated with any acquisitions and may experience unanticipated detriments as a result of such acquisitions. As with any acquisition, we may be unable to complete effectively an integration of the management, operations, facilities, and accounting and information systems of the acquired business with our own; to manage efficiently the combined operations of the acquired business with our operations; to achieve our operating, growth, and performance goals for the acquired business; to achieve additional revenue as a result of our expanded operations; or to achieve operating efficiencies or otherwise realize cost savings as a result of anticipated acquisition synergies.
For example, we have an ongoing lawsuit and other claims against certain former executives and shareholders of Lemon, including its former General Manager, alleging breaches of employment related contracts, breaches of fiduciary duty, and fraud involving work for third party Xapo, Inc. and/or Xapo, Ltd. during their employment with Lemon. The outcome of this matter is unclear and although no counterclaims have been asserted against us, it is possible that they will be asserted in the future. In addition, in December 2014, we settled certain indemnification claims that we previously made with respect to our acquisition of Lemon, which resulted in a $5.0 million payment to us out of the escrow account established in connection with that acquisition.
The integration of acquired businesses, involves numerous risks, including the following integrating the different businesses, operations, locations, and technologies;
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communicating to customers our perceived benefits of the acquisition and addressing any related concerns they might have;
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the potential disruption of our core businesses;
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risks associated with entering markets and businesses in which we have little or no prior experience;
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diversion of management’s attention from our core businesses;
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adverse effects on existing business relationships with suppliers and customers;
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failure to retain key customers, suppliers, or personnel of acquired businesses;
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adjusting to changes in key personnel post-combination;
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adjusting to increased governmental scrutiny;
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in connection with the acquisition of companies with foreign operations, integrating operations across different cultures and languages and addressing the particular economic, currency, political, and regulatory risks associated with specific countries;
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managing the varying intellectual property protection strategies and other activities of the acquired company;
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the potential strain on our financial and managerial controls and reporting systems and procedures;
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greater than anticipated costs and expenses related to the integration of the acquired business with our business;
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potential unknown liabilities associated with the acquired company for which we are not indemnified;
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potential post-closing claims against or litigation with sellers of the acquired company;
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challenges inherent in effectively managing an increased number of employees in diverse locations;
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failure of acquired businesses to achieve expected results;
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the risk of impairment charges related to potential write-downs of acquired assets in future acquisitions; and
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difficulty of establishing uniform standards, controls, procedures, policies, and information systems.
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We may not succeed in addressing these or other risks or any other problems encountered in connection with the integration of any acquired business. The inability to integrate successfully the operations, technology, and personnel of any acquired business, or any significant delay in achieving integration, could have a material adverse effect on our business, results of operations, reputation, and prospects, and on the market price of our common stock.
We depend on key personnel, and if we fail to retain and attract skilled management and other key personnel, our business may be harmed.
Our success depends to a significant extent upon the continued services of our current management team, including Hilary Schneider, our President and Chief Executive Officer and Todd Davis, our founder and Executive Vice Chairman. The loss of Ms. Schneider or Mr. Davis or one or more of our other key executives or employees could have a material adverse effect on our business. Other than Mr. Davis, we do not maintain "key person" policies on the lives of our executive officers or any of our other employees. We employ all of our executive officers and key employees on an at-will basis, and their employment can be terminated by us or them at any time, for any reason and without notice, subject, in certain cases, to severance payment rights. In order to retain valuable employees, in addition to salary and cash incentives, we provide stock options or other share-based compensation that vests over time. The value to employees of share-based compensation that vests over time will be significantly affected by movements in our stock price that are beyond our control and may at any time be insufficient to counteract offers from other companies.
Our success also depends on our ability to attract, retain, and motivate additional skilled management and technical personnel. We plan to continue to expand our work force to continue to enhance our business and operating results. We believe that there is significant competition for qualified personnel with the skills and knowledge that we require. Many of the other companies with which we compete for qualified personnel have greater financial and other resources than we do. They also may provide more diverse opportunities and better chances for career advancement. Some of these characteristics may be more appealing to high-quality candidates than those which we have to offer. If we are not able to attract and retain the necessary qualified personnel to accomplish our business objectives, we may experience constraints that will impede significantly the achievement of our business objectives and our ability to pursue our business strategy. New hires require significant training and, in most cases, take significant time before they achieve full productivity. New employees may not become as productive as we expect, and we may be unable to hire or retain sufficient numbers of qualified individuals. If our recruiting, training, and retention efforts are not successful or do not generate a corresponding increase in revenue, our business will be harmed.
A failure of the insurance companies that underwrite the identity theft insurance provided as part of our consumer services, or refusal by those insurance companies to provide the expected insurance, or failure of our products to comply with applicable state insurance regulations, could harm our business.
Our consumer services include identity theft insurance for our members that provides coverage for certain out-of-pocket expenses to our members, such as loss of income, replacement of fraudulent withdrawals, and costs associated with child and elderly care, travel, stolen purse/wallet, and replacement of documents. This identity theft insurance also backs our $1 million service guarantee. Any failure or refusal of our insurance providers to provide the expected insurance benefits, or failure of our products to comply with applicable state insurance regulations, could damage our reputation, cause us to lose members, expose us to liability claims by our members, negatively impact our sales and marketing efforts, and have a material adverse effect on our business, operating results, and financial condition.
Events such as a security breach at a large organization that compromise a significant number of our members’ personally identifiable information or that otherwise interfaces with our systems could result in a large number of identity-related events that in turn could severely strain our operations and have a negative impact on our business.
Events such as a security breach at a large organization (including major financial institutions, retailers, and Internet service providers) could compromise the personally identifiable information of a significant number of our members. Any such event could in turn result in a large number of identity-related events that we must address, placing severe strain on our operations. Any failure in our ability to appropriately and timely process and address a large number of identity-related events taking place at the same time could result in a loss of members, harm to our reputation, and other damage to our business. Moreover, any related remediation services we provide may not meet member expectations and further exacerbate these risks. Furthermore, if these events result in significant claims made under our identity theft insurance, this could negatively impact our insurance premiums and our ability to continue to provide what we refer to as our guarantee on a cost-effective basis, or at all.
We may require significant capital to fund our business, and our inability to generate and obtain such capital could harm our business, operating results, financial condition, and prospects.
To fund our expanding business, we must have sufficient working capital to continue to make significant investments in our service offerings, advertising, technology, and other activities. As a result, in addition to the revenue we generate from our business, we may need additional equity or debt financing to provide the funds required for these endeavors. If such financing is not available on satisfactory terms or at all, we may be unable to operate or expand our business in the manner and at the rate desired. Debt financing increases expenses, may contain covenants that restrict the operation of our business, and must be repaid regardless of operating results. Equity financing, or debt financing that is convertible into equity, could result in additional dilution to our existing stockholders, and any new securities we issue could have rights, preferences, and privileges superior to those associated with our common stock.
In addition, the current economic environment may make it difficult for us to raise additional capital or obtain additional credit, when needed, on acceptable terms or at all.
Our inability to generate or obtain the financial resources needed to fund our business and growth strategies may require us to delay, scale back, or eliminate some or all of our operations or the expansion of our business, which may have a material adverse effect on our business, operating results, financial condition, and prospects.
If we are unable to protect our intellectual property, including our LifeLock brand, the value of our brand and other intangible assets may be diminished, and our business may be adversely affected.
The success of our business depends in part on our ability to protect our intellectual property and the LifeLock brand. We rely on a combination of federal, state, and common law trademark, patent, and trade secret laws, confidentiality procedures, and contractual provisions to protect our intellectual property. However, these measures afford only limited protection and might be challenged, invalidated, or circumvented by third parties. The measures we take to protect our intellectual property may not be sufficient or effective, and in some instances we have not undertaken comprehensive searches with respect to certain of our intellectual property. We have limited protections in countries outside the United States, such as registrations for key trademarks. Moreover, our competitors may independently develop similar intellectual property.
While we generally obtain non-disclosure agreements from each of our employees and independent contractors, there are former independent contractors from whom we have not obtained these agreements. Therefore, these former independent contractors may inappropriately disclose our confidential information or use that confidential information illegally, which could harm our business.
We currently have a number of issued and pending patents and trademarks, many of which were procured in connection with our acquisition of ID Analytics. We cannot assure you that any patents will issue from our currently pending patent applications in a manner that gives us the protection that we seek, if at all, or that any future patents issued to us will not be challenged, invalidated, or circumvented. Any patents that may issue in the future from pending or future patent applications may not provide sufficiently broad protection or may not prove to be enforceable in actions against alleged infringers. We also cannot assure you that any future trademark or service mark registrations will be issued from pending or future applications or that any registered trademarks or service marks will be enforceable or provide adequate protection of our proprietary rights.
We may find it necessary to take legal action in the future to enforce or protect our intellectual property rights, and such action may be expensive and time consuming. In addition, we may be unable to obtain a favorable outcome in any such intellectual property litigation.
Our services may infringe the intellectual property rights of others, which may cause us to pay unexpected litigation costs or damages or prevent us from selling our services.
From time to time, third parties may claim that our services infringe or otherwise violate their intellectual property rights. We may be subject to legal proceedings and claims, including claims of alleged infringement by us of the intellectual property rights of third parties. Any dispute or litigation regarding intellectual property could be expensive and time consuming, regardless of the merits of any claim, and could divert our management and key personnel from our business operations.
If we were to discover or be notified that our services potentially infringe or otherwise violate the intellectual property rights of others, we may need to obtain licenses from these parties in order to avoid infringement. We may not be able to obtain the necessary licenses on acceptable terms, or at all, and any such license may substantially restrict our use of the intellectual property. Moreover, if we are sued for infringement and lose the lawsuit, we could be required to pay substantial damages or be enjoined from offering the infringing services. Our intellectual property portfolio may not be useful in asserting a counterclaim, or negotiating a license, in response to a claim of intellectual property infringement. Any of the foregoing could cause us to incur significant costs and prevent us from selling our services.
Our business depends on our ability to utilize intellectual property, technology, and content owned by third parties, the loss of which could harm our business.
Our services utilize intellectual property, technology, and content owned by third parties. From time to time, we may be required to renegotiate with these third parties or negotiate with other third parties to include or continue using their intellectual property, technology, or content in our existing service offerings, in new versions of our service offerings, or in new services that we offer. We may not be able to obtain the necessary rights from these third parties on commercially reasonable terms, or at all, and the third-party intellectual property, technology, and content we use or desire to use may not be appropriately supported, maintained, or enhanced by the third parties. If we are unable to obtain the rights necessary to use or continue to use third-party intellectual property, technology, and content in our services, or if those third parties are unable to support, maintain, and enhance their intellectual property, technology, and content, we could experience increased costs or delays or reductions in our service offerings, which in turn may harm our financial condition, damage our brand, and result in the loss of customers.
We are building our intellectual property portfolio internally and through acquisitions, such as our acquisitions of ID Analytics. We may be required to incur substantial expenses to do so, and our efforts may not be successful.
Our use of “open source” software could negatively affect our ability to sell our services and subject us to possible litigation.
Software code that is freely shared in the software development community is referred to as open source software. A portion of the technologies licensed by us incorporates such open source software, and we may incorporate open source software in the future. Such open source software is generally licensed by its authors under open source licenses. Use and distribution of open source software may entail greater risks than use of third-party commercial software, as open source licensors generally do not provide warranties or other contractual protections regarding infringement claims or the quality of the code. Some open source licenses, such as the GNU General Public License, require that source code subject to the license be disclosed to third parties, grant such third parties the right to modify and redistribute that source code and a requirement that the source code for any software derived from it be disclosed. If we combine our proprietary software with open source software in a certain manner, we could, under certain open source licenses, be required to release the source code of our proprietary software to the public. This would allow our competitors to create similar services and platforms with lower development effort and time and ultimately could reduce or eliminate our ability to commercialize or profit from our services.
Although we have established internal review and approval processes with respect to the use of open source software to avoid subjecting our technologies to conditions we do not intend, we cannot be certain that all open source software is submitted for approval prior to use in our services. The terms of many open source licenses have not been interpreted by the U.S. courts, and there is a risk that these licenses could be construed in a way that imposes unanticipated conditions or restrictions on our ability to commercialize our services. In this event, we could be required to seek licenses from third parties to continue offering our services, to make generally available, in source code form, our proprietary code, or to discontinue the sale of our services, any of which could adversely affect our business, operating results, and financial condition.
Our operating results may vary significantly and be unpredictable, which could cause the trading price of our stock to decline, make period-to-period comparisons less meaningful, and make our future results difficult to predict.
We may experience significant fluctuations in our revenue, expenses, and operating results in future periods. Our operating results may fluctuate in the future as a result of a number of factors, many of which are beyond our control. These fluctuations may result in declines in our stock price. Moreover, these fluctuations may make comparing our operating results on a period-to-period basis less meaningful and make our future results difficult to predict. You should not rely on our past results as an indication of our future performance. In addition, if our reported revenue does not meet our expectations, our operating results and ability to execute on our business plan are likely to be harmed. In addition to the other factors listed in this “Risk Factors” section, factors that could affect our operating results include the following:
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our ability to expand our customer base and the market for our services;
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our ability to generate revenue from existing customers;
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our ability to establish and maintain relationships with strategic partners;
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fluctuations in our expense and capital expenditure levels;
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service introductions or enhancements and market acceptance of new services by us and our competitors;
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pricing and availability of competitive services, which may put pressure on our pricing;
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our ability to address competitive factors successfully;
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changes in the competitive landscape as a result of mergers, acquisitions, or strategic alliances that could allow our competitors to gain market share, or the emergence of new competitors;
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changes or anticipated changes in economic conditions; and
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changes in legislation and regulatory requirements related to our business.
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Due to these and other factors, our financial results for any quarterly or annual period may not meet our expectations or the expectations of investors or analysts that follow our stock and may not be meaningful indications of our future performance.
Because we recognize revenue in our consumer business from our members over the term of their subscription periods, fluctuations in sales or retention may not be immediately reflected in our operating results.
We recognize revenue in our consumer business from our members ratably over the term of their subscription periods. As a result, a large portion of the revenue we recognize in any period is deferred revenue from memberships purchased during previous periods. Consequently, a decline in new members or a decrease in member retention in any particular period will not necessarily be fully reflected in the consumer revenue in that period and will negatively affect our revenue in future periods. In addition, we may be unable to adjust our cost structure to reflect this reduced revenue. Accordingly, the effect of significant fluctuations in new members or member retention and market acceptance of our services may not be fully reflected in our
operating results until future periods. Our subscription model also makes it difficult for us rapidly to increase our revenue through additional sales in any period, as revenue from new members is recognized ratably over the applicable subscription periods.
We may be subject to assertions that taxes must be collected based on sales and use of our services in various states, which could expose us to liability and cause material harm to our business, financial condition, and results of operations.
Whether sales of our services are subject to state sales and use taxes is uncertain, due in part to the nature of our services and the relationships through which our services are offered, as well as changing state laws and interpretations of those laws. In 2012 we entered into a settlement agreement with the New York State Department of Taxation and Finances regarding our historic and ongoing tax collection obligations. We currently collect and remit sales tax in several states related to the sale of our consumer services. Additional states or one or more countries or other jurisdictions may seek to impose sales or other tax collection obligations on us in the future. A successful assertion by any state, country, or other jurisdiction that we should be collecting sales or other taxes on the sale of our services could, among other things, increase the cost of our services, create significant administrative burdens for us, result in substantial tax liabilities for past sales, discourage current members and other consumers from purchasing our services, or otherwise substantially harm our business and operating results.
Increases in credit card processing fees would increase our operating expenses and adversely affect our operating results, and the termination of our relationship with any major credit card company would have a severe, negative impact on our business.
A substantial majority of our members pay for our services using credit cards. From time to time, the major credit card companies or the issuing banks may increase the fees that they charge for each transaction using their cards. An increase in those fees would require us to either increase the prices we charge for our services or suffer a negative impact on our margins, either of which could adversely affect our business, operating results, and financial condition.
In addition, our credit card fees may be increased by credit card companies if our chargeback rate, or the rate of payment refunds, exceeds certain minimum thresholds. If we are unable to maintain our chargeback rate at acceptable levels, our credit card fees for chargeback transactions, or for all credit card transactions, may be increased, and, if the problem significantly worsens, credit card companies may further increase our fees or terminate their relationship with us. In addition, changes in billing systems in the future could increase the per transaction cost that we pay. Any increases in our credit card fees could adversely affect our operating results, particularly if we elect not to raise the retail list price for our consumer services to offset the increase. The termination of our ability to process payments on any major credit card would significantly impair our business.
Any indebtedness could adversely affect our business and limit our ability to expand our business or respond to changes, and we may be unable to generate sufficient cash flow to satisfy our debt service obligations.
As of
June 30, 2016
, we had no outstanding debt. We may incur indebtedness in the future, including borrowings available under our credit facility with Bank of America. Any substantial indebtedness and the fact that a substantial portion of our cash flow from operating activities could be needed to make payments on this indebtedness could have adverse consequences, including the following:
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reducing the availability of our cash flow for our operations, capital expenditures, future business opportunities, and other purposes;
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limiting our flexibility in planning for, or reacting to, changes in our business and the industries in which we operate, which could place us at a competitive disadvantage compared to our competitors that may have less debt;
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limiting our ability to borrow additional funds;
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increasing our vulnerability to general adverse economic and industry conditions; and
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failing to comply with the covenants in our debt agreements could result in all of our indebtedness becoming immediately due and payable.
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Our ability to borrow any funds needed to operate and expand our business will depend in part on our ability to generate cash. Our ability to generate cash is subject to the performance of our business as well as general economic, financial, competitive, legislative, regulatory, and other factors that are beyond our control. If our business does not generate sufficient cash flow from operating activities or if future borrowings are not available to us under our senior credit facility or otherwise in amounts sufficient to enable us to fund our liquidity needs, our operating results, financial condition, and ability to expand our business may be adversely affected. Moreover, our inability to make scheduled payments on our debt obligations in the future would require us to refinance all or a portion of our indebtedness on or before maturity, sell assets, delay capital expenditures, or seek additional equity.
Covenants in our senior credit facility impose, and any future debt arrangements may impose, significant operating and financial restrictions that may adversely affect our business and ability to operate our business.
The agreement governing our senior credit facility with Bank of America contains covenants that limit various actions that we may take, including the following:
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incurring additional indebtedness;
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granting additional liens;
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making certain investments and distributions;
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merging, dissolving, liquidating, consolidating, or disposing of all or substantially all of our assets;
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prepaying and modifying debt instruments; and
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entering into transactions with affiliates.
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These restrictions could limit our ability to finance our future operations or capital needs, make acquisitions, or pursue available business opportunities. Our senior credit facility also requires us to maintain specified financial ratios and satisfy financial condition tests at the end of each fiscal quarter. Our ability to meet these financial ratios and tests can be affected by events beyond our control, and we may not meet those tests. We may be required to take action to reduce our indebtedness or to act in a manner contrary to our business objectives to meet these ratios and satisfy these covenants. For example, under the terms of the recent amendment to our senior credit facility we are required to comply with certain additional financial and reporting covenants, including maintaining a minimum cash EBITDA. Pursuant to the amendment, we are also subject to certain limitations and conditions on borrowing, on acquisitions, and on making certain types of payments with respect to our equity interests. We could also incur additional indebtedness in the future having even more restrictive covenants.
Failure to comply with any of the covenants under our senior credit facility, or any other indebtedness we may incur, could result in a default under such agreements, which could result in an acceleration of the timing of payments on all of our outstanding indebtedness and other negative consequences. In addition, since our senior credit facility with Bank of America is secured by substantially all of our assets, a default under that facility could result in Bank of America exercising its lien on substantially all of our assets. Any of these events could have a material adverse effect on our business, operating results, and financial condition.
The requirements of being a public company may strain our resources, divert management’s attention, and affect our ability to attract and retain qualified board members.
We incur significant legal, accounting, and other expenses as a public company, including costs resulting from public company reporting obligations under the Exchange Act and the rules and regulations regarding corporate governance practices, including those under the Sarbanes-Oxley Act, the Dodd-Frank Act, and the listing requirements of the stock exchange on which our securities are listed. Compliance with these reporting requirements, rules, and regulations has increased and will continue to increase our legal and financial compliance costs, make some activities more difficult, time-consuming, or costly, and increase demand on our systems and resources. As a result, management’s attention may be diverted from other business concerns, which could harm our business and operating results.
In addition, changing laws, regulations, and standards relating to corporate governance and public disclosure are creating uncertainty for public companies, increasing legal and financial compliance costs, and making some activities more time consuming. These laws, regulations, and standards are subject to varying interpretations, in many cases due to their lack of specificity, and, as a result, their application in practice may evolve over time as new guidance is provided by regulatory and governing bodies. This could result in continuing uncertainty regarding compliance matters and higher costs necessitated by ongoing revisions to disclosure and governance practices. We intend to invest resources to comply with evolving laws, regulations, and standards, and this investment may result in increased general and administrative expenses and a diversion of management’s time and attention from revenue-generating activities to compliance activities. If our efforts to comply with new laws, regulations, and standards are unsuccessful, regulatory authorities may initiate legal proceedings against us and our business may be harmed.
Our ability to use our net operating loss carry-forwards and certain other tax attributes may be limited, which could potentially result in increased tax liabilities to us in the future.
As of December 31, 2015, we had approximately $231.3 million of federal and approximately $99.9 million of state net operating loss carry-forwards. Under Section 382 of the Internal Revenue Code of 1986, as amended, or the Internal Revenue Code, if a corporation undergoes an “ownership change” (generally defined as a greater than 50% change (by value) in its equity ownership over a three-year period), a corporation’s ability to use its pre-change net operating loss carry-forwards and other pre-change tax attributes (such as research tax credits) to offset its post-change income may be limited. In 2013, we completed an analysis of prior year ownership changes and determined that in prior years we had experienced an “ownership change” as defined by Section 382 of the Internal Revenue Code. However, we determined that none of our federal and state net operating loss carry-forwards will expire solely as a result of our prior ownership changes. We may also experience an “ownership change” in the future as a result of subsequent shifts in our stock ownership. As a result, if we earn net taxable income, our ability to use our pre-change net operating loss carry-forwards to offset taxable income may be subject to limitations, which could potentially result in increased future tax liability to us.
Risks Related to Ownership of Our Common Stock
Our stock price has been and will likely continue to be volatile, and the value of an investment in our common stock may decline.
The trading price of our common stock has been, and is likely to continue to be, volatile. In addition to the risk factors described in this Quarterly Report on Form 10-Q, in our Annual Report on Form 10-K for fiscal 2015, and in our other filings with the SEC, factors that may cause the price of our common stock to fluctuate include the following:
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financial guidance we may provide to the public, any changes in such guidance, or our failure to meet such guidance;
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failure of industry or securities analysts to maintain coverage of our company, changes in financial estimates by any industry or securities analysts that follow our company, or our failure to meet such estimates;
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various market factors or perceived market factors, including rumors, whether or not correct, involving us, our customers, our strategic partners, or our competitors;
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sales, or anticipated sales, of large blocks of our common stock;
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short selling of our common stock by investors;
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actions of activist shareholders;
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additions or departures of key personnel;
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announcements of technological innovations by us or by our competitors;
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introductions of new services or new pricing policies by us or by our competitors;
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regulatory or political developments;
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litigation and governmental or regulatory investigations;
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acquisitions or strategic alliances by us or by our competitors; and
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general economic, political, and financial market conditions or events.
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Furthermore, the stock markets have experienced extreme price and volume fluctuations that have affected and continue to affect the market prices of equity securities of many companies. These fluctuations often have been unrelated or disproportionate to the operating performance of those companies. These and other factors may cause the market price and demand for our common stock to fluctuate substantially, which may limit or prevent investors from readily selling their shares of common stock, may induce shareholder activism and may otherwise negatively affect the price or liquidity of our common stock. In addition, when the market price of a stock has been volatile, holders of that stock have sometimes instituted securities class action litigation against the company that issued the stock. For example, as described in more detail in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K for fiscal 2015, we are subject to a securities class action lawsuit filed against us. As a result of this class action complaint, or if any of our stockholders were to bring a lawsuit against us in the future, we could incur substantial costs defending the lawsuits or paying for settlements or damages. Such lawsuits could also divert the time and attention of our management from our business.
Future sales of our common stock in the public market by our existing stockholders, or the perception that such sales might occur or not occur, could depress the market price of our common stock.
The market price of our common stock could decline as a result of sales of a large number of shares of our common stock in the market, and even the perception that these sales could occur or not occur may depress the market price. As of
June 30, 2016
, we had approximately
91.7 million
shares of common stock outstanding. These shares may be sold in the public market, subject to prior registration or qualification for an exemption from registration, including, in the case of shares held by affiliates, compliance with the volume restrictions of Rule 144. In addition, shares issued or issuable upon the exercise of options and warrants, and shares delivered under restricted stock unit or restricted stock awards, are also eligible for sale. Sales of stock by these stockholders could have a material adverse effect on the trading price of our common stock.
Former holders of our preferred stock are entitled, under contracts providing for registration rights, to require us to register our securities owned by them for public sale. Registration of these shares under the Securities Act would result in the shares becoming freely tradable without restriction under the Securities Act, except for shares held by our affiliates. Any sales of securities by these stockholders could have a material adverse effect on the trading price of our common stock.
Sales of common stock as restrictions end or pursuant to registration rights may make it more difficult for us to sell equity securities in the future at a time and at a price that we deem appropriate.
Future sales and issuances of our common stock or rights to purchase common stock by us, including pursuant to our equity incentive plans, could result in additional dilution of the percentage ownership of our stockholders and could cause our stock price to fall.
We intend to issue additional securities pursuant to our equity incentive plans and may issue equity or convertible securities in the future. To the extent we do so, our stockholders may experience substantial dilution. We may sell common stock, convertible securities, or other equity securities in one or more transactions at prices and in a manner we determine from time to time. If we sell common stock, convertible securities, or other equity securities in more than one transaction, investors may be materially diluted by subsequent sales and new investors could gain rights superior to our existing stockholders.
Anti-takeover provisions could impair a takeover attempt and adversely affect existing stockholders.
Certain provisions of our certificate of incorporation and bylaws and applicable provisions of Delaware law may have the effect of rendering more difficult, delaying, or preventing an acquisition of our company, even when this would be in the best interest of our stockholders.
Our certificate of incorporation and bylaws include provisions that provide for the following:
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authorize our board of directors to issue, without further action by the stockholders, up to 10,000,000 shares of undesignated preferred stock;
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require that any action to be taken by our stockholders be effected at a duly called annual or special meeting and not by written consent;
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specify that special meetings of our stockholders can be called only by our board of directors, the chairperson of our board of directors, our chief executive officer, or our president (in the absence of a chief executive officer);
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establish an advance notice procedure for stockholder proposals to be brought before an annual meeting, including proposed nominations of persons for election to our board of directors;
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establish that our board of directors is divided into three classes, Class I, Class II, and Class III, with each class serving three-year staggered terms;
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prohibit cumulative voting in the election of directors;
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provide that our directors may be removed only for cause;
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provide that vacancies on our board of directors may be filled only by a majority of directors then in office, even though less than a quorum; and
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require the approval of our board of directors or the holders of a supermajority of our outstanding shares of capital stock to amend our bylaws and certain provisions of our certificate of incorporation.
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In addition, we are subject to Section 203 of the Delaware General Corporation Law, which generally prohibits a Delaware corporation from engaging in any of a broad range of business combinations with an interested stockholder for a period of three years following the date on which the stockholder became an interested stockholder, unless such transactions are approved by our board of directors. This provision could have the effect of delaying or preventing a change of control of our company, whether or not it is desired by or beneficial to our stockholders. In addition, other provisions of Delaware law may
also discourage, delay, or prevent someone from acquiring us or merging with us.
These provisions, alone or together, could delay or prevent hostile takeovers and changes in control or changes in our management. Any provision of our certificate of incorporation or bylaws or Delaware law that has the effect of delaying or deterring a change in control could limit the opportunity for our stockholders to receive a premium for their shares of our common stock and could also affect the price that some investors are willing to pay for our common stock.
If securities or industry analysts do not publish or cease publishing research or reports about us, our business, or our market, or if they adversely change their recommendations regarding our stock, our stock price and trading volume could decline.
The trading market for our common stock will be influenced by the research and reports that securities or industry analysts may publish about us, our business, our market, or our competitors. If adequate research coverage is not established or maintained on our company or if any of the analysts who may cover us downgrade our stock or publish inaccurate or unfavorable research about our business or provide relatively more favorable recommendations about our competitors, our stock price would likely decline. If any analyst who may cover us were to cease coverage of our company or fail to regularly publish reports on us, we could lose visibility in the financial markets, which in turn could cause our stock price or trading volume to decline.
Since we do not expect to pay any cash dividends for the foreseeable future, our stockholders may be forced to sell their stock in order to obtain a return on their investment.
We have never declared or paid any cash dividends on our capital stock and do not anticipate declaring or paying any cash dividends in the foreseeable future. In addition, our senior credit facility with Bank of America restricts our ability to pay cash dividends. We plan to retain any future earnings to finance our operations and growth plans discussed elsewhere in this Annual Report on Form 10-K. Accordingly, investors must rely on sales of shares of their common stock after price appreciation, which may never occur, as the only way to realize any return on their investment.
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Item 2.
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Unregistered Sales of Equity Securities and Use of Proceeds
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Issuer Purchases of Equity Securities
The following table provides information regarding repurchases of our common stock during the three-months ended
June 30, 2016
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Period
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Total Number of Shares Purchased
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Average Price Paid Per Share
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Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs
(a)
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Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs
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April 1, 2016 - April 30, 2016
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49,905
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$
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11.57
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49,905
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$
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48,077,108
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May 1, 2016 - May 31, 2016
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3,546,668
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$
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11.54
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3,541,208
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$
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—
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June 1, 2016 - June 30, 2016
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28,555
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$
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11.97
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25,982
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$
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—
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Total
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3,625,128
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(b)
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3,617,095
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(a)
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On November 30, 2015, we announced that the Board of Directors had approved a share repurchase program which authorized the purchase up to $100 million of our common stock. The share repurchase program was completed during the first half of fiscal 2016, with final settlement of shares under our accelerated share repurchase program, completed in the third quarter of fiscal 2016.
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(b)
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Includes approximately 76,000 shares acquired in the final settlement of an issuer forward repurchase transaction confirmation executed during the first quarter of 2016, 3.5 million shares acquired in the initial delivery of an issuer forward repurchase transaction confirmation executed in the second quarter of fiscal 2016, and approximately 8,000 shares surrendered to us to satisfy tax withholding obligations associated with the vesting of restricted stock.
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