Certain statements in this Annual Report on Form 10-K constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our business, marketing and operating strategies, integration of acquired businesses, new service offerings, the availability of debt refinancing, financial prospects and anticipated sources and uses of capital. In particular, statements under Item 1. “Business,”"Business," Item 1A. “Risk Factors”"Risk Factors", Item 2. “Properties,”"Properties," Item 3. “Legal"Legal Proceedings,”" Item 7. “Management’s"Management’s Discussion and Analysis of Financial Condition and Results of Operations”Operations" and Item 7A. “Quantitative"Quantitative and Qualitative Disclosures About Market Risk”Risk" contain forward-looking statements. Where, in any forward-looking statement, we express an expectation or belief as to future results or events, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. The following include some but not all of the factors that could cause actual results or events to differ materially from those anticipated.
macroeconomic conditions and their effect on the general economy and on the U.S. housing market, in particular single family homes which represent the Company'sour largest demographic;
the competitive environment in which we operate, in particular increasing competition in the alarm monitoring industry from larger existing competitors and new market entrants, including telecommunications and cable companies;
the regulatory environment in which we operate, including the multiplicity of jurisdictions, state and federal consumer protection laws and licensing requirements to which the Companywe and/or our dealers is subject and the risk of new regulations, such as the increasing adoption of “false alarm”"false alarm" ordinances;
technological changes which could result in the obsolescence of currently utilized technology and the need for significant upgrade expenditures, including the phase-out of 2G networks by cellular carriers;
the trend away from the use of public switched telephone network lines and resultant increase in servicing costs associated with alternative methods of communication;
the outcome of any pending, threatened, or future litigation, including potential liability for failure to respond adequately to alarm activations;
the ability to continue to obtain insurance coverage sufficient to hedge our risk exposures, including as a result of acts of third parties and/or alleged regulatory violations;
changes in the nature of strategic relationships with original equipment manufacturers, dealers and our other business partners;
the availability and terms of capital, including the ability of the Company to obtain additional fundsfuture financing to grow its business;
availability of qualified personnel.
These forward-looking statements and such risks, uncertainties and other factors speak only as of the date of this Annual Report, and we expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein, to reflect any change in our expectations with regard thereto, or any other change in events, conditions or circumstances on which any such statement is based. When considering such forward-looking statements, you should keep in mind the factors described in Item 1A, “Risk Factors”"Risk Factors" and other cautionary statements contained in this Annual Report. Such risk factors and statements describe circumstances which could cause actual results to differ materially from those contained in any forward-looking statement.
(b) Financial Information About Reportable Segments
We identify our reportable segments based on financial information reviewed by our chief operating decision maker. We report financial information for our consolidated business segments that represent more than 10% of our consolidated revenue or earnings before income taxes.
Based on the foregoing criteria, we only had onetwo reportable segmentsegments as of December 31, 2014.2016, MONI and LiveWatch. For more information see below and our financial statements included in Part II of this Annual Report.
(c) Narrative Description of Business
Monitronics International Inc., a Texas corporation incorporated on August 31, 1994, is primarily engaged in the business of providing the following security alarm monitoring services: monitoring signals arising from burglaries, fires, medical alerts and other events thoughthrough security systems at subscribers’ premises, as well as providing customer service and technical support. Our principal office is located at 2350 Valley View Lane, Suite 100, Dallas,1990 Wittington Place, Farmers Branch, Texas, 75234, telephone number (972) 243-7443.
We are one of the largest security alarm monitoring companies in the U.S.,North America, with over one million subscriberscustomers under contract. With subscriberscontract in all 50 states, the District of Columbia, Puerto Rico and Canada, we provide Canada. We offer:
monitoring services for alarm signals arising from burglaries, fires, medical alerts and other events through security systems at our customers' premises;
a wide rangecomprehensive platform of mainly residential securityhome automation services, including, hands-free two-wayamong other things, remote activation and control of security systems, support for video monitoring, flood sensors, automated garage door and door lock capabilities and thermostat integration, with mobile device accessibility provided through our proprietary mobile notification system (such services collectively referred to as "HomeTouch");
hands‑free two‑way interactive voice communication with thebetween our monitoring center cellular options, and an interactiveour customers; and
customer service option which allows the customerand technical support related to control their security system remotely using a computer or smart phone.home monitoring systems and HomeTouch.
MONI Operations
Unlike many of our national competitors, we outsource the Company primarily outsources our sales, installation and most of our field service functions to our dealers. By outsourcing the low margin, high fixed-cost elements of our business to a large network of independent service providers, we are able to allocate capital to growing our revenue-generating account base rather than to local offices or depreciating hard assets.
Revenue is generated primarily from fees charged to customers under alarm monitoring contracts.agreements ("AMAs"), which include access to interactive and automation features at a higher fee. The initial contract term is typically three to five years, with automatic renewal on a month-to-month basis. We also generate additional revenue as our customers bundle our HomeTouch services with their traditional monitoring services.
We generate incremental revenue by providing additional services, such as maintenance and wholesale contract monitoring. Contract monitoring includes fees charged to other security alarm companies for monitoring their accounts on a wholesale basis. As of December 31, 2014,2016, we provided contract monitoring services for over 92,00078,000 accounts. These incremental revenue streams do not represent a significant portion of our overall revenue.
Our authorized independent dealers are typically small businesses that sell and install alarm systems. During 2014,2016, we acquired alarm monitoring contracts from more than 600430 dealers. These dealers focus on the sale and installation of security systems and generally do not retain the monitoring contracts for their customers and do not have their own facilities to monitor such systems due to the large upfront investment required to create the account and build a monitoring station. They also do not have the scale required to operate a monitoring station efficiently. These dealers typically sell the contracts to third parties and outsource the monitoring function for any accounts they retain. We have the ability to monitor a variety of signals from nearly all types of residential security systems.
We generally enter into exclusive contracts with dealers under which the dealers sell and install security systems and we have a right of first refusal to acquire the associated alarm monitoring contracts. In order to maximize revenues, we seek to attract dealers from throughout the U.S. rather than focusing on specific local or regional markets. In evaluating the quality of potential participants for the dealer program, we conduct an internal due diligence review and analysis of each dealer using information obtained from third party sources. This process includes:
background checks on the dealer, including lien searches to the extent applicable; and
a review of the dealer’sdealer's licensing status and creditworthiness.
Once a dealer is approved and signed as an authorized dealer, the primary steps in creating an account are as follows:
1. Dealer sells an alarm system to a homeowner or small business.
2. Dealer installs the alarm system, which is monitored by our central monitoring center, trains the customer on its use, and receives a signed three to five year contract for monitoring services.
3. Dealer presents the account to us for acquisition.
4. We perform diligence on the alarm monitoring account to validate quality.
5. We acquire the customer contract at a formula-based cost.
We believe our ability to maximize our return on invested capital is largely dependent on the quality of the accounts acquired. We conduct a review of each account to be acquired through our dealer network. This process typically includes:
subscriber credit score reviews;
telephone surveys to confirm satisfaction with the installation and security systems;
an individual review of each alarm monitoring contract;
confirmation that the customer is a homeowner; and
confirmation that each security system is monitored by our central monitoring station prior to origination.
We generally acquire each new customer account at a cost based on a multiple of the account’saccount's monthly recurring revenue. Our dealer contracts generally provide that if a customer account acquired by us is terminated within the first 12 months, the dealer must replace the account or refund the cost paid by us. To secure the dealer’sdealer's obligation, we typically hold back a percentage of the cost paid for the account.
We believe that this process, which includes both clearly defined customer account standards and a comprehensive due diligence process, contributes significantly to the high quality of our subscriber base. For each of theour last five calendar years, the average credit score of accounts acquired by us was 715 or higher on the FICO scale.
Approximately 94% of our subscribers are residential homeowners and the remainder are small commercial accounts. We believe that by focusing on residential homeowners, rather than renters, we can reduce attrition, because homeowners relocate less frequently than renters.
We provide monitoring services as well as billing and 24-hour telephone support through our central monitoring station, located in Dallas,Farmers Branch, Texas. This facility is Underwriters Laboratories (“UL”("UL") listed. To obtain and maintain a UL listing, an alarm monitoring center must be located in a building meeting UL’sUL's structural requirements, have back-up and uninterruptable power supplies, have secure telephone lines and maintain redundant computer systems. UL conducts periodic reviews of alarm monitoring centers to ensure compliance with their requirements. Our central monitoring station in Dallas has also received the Central Station Alarm Association’s (“CSAA”) prestigious Five Diamond Certification. Less than approximately 3% of recognized North American central monitoring stations have attainedcertification. Five Diamond Certified status.certification is achieved by having all alarm monitoring operators complete special industry training and pass an exam.
We have a back-up facility in Dallas, Texas that is capable of supporting monitoring billing and certain customer service operations in the event of a disruption at our primary monitoring and customer care center. A third party call centeroutsourcer in Mexico provides telephone support for Spanish-speaking subscribers.
Our telephone systems utilize high-capacity, high-quality, digital circuits backed up by conventional telephone lines. When an alarm signal is received at the monitoring facility, it is routed to an operator. At the same time, information concerning the subscriber whose alarm has been activated and the nature and location of the alarm signal areis delivered to the operator’soperator's computer terminal. The operator is then responsible for following standard procedures to contact the subscriber or take other appropriate action, including, if the situation requires, contacting local emergency service providers. We never dispatch our own personnel to the subscriber’ssubscriber's premises in response to an alarm event. If a subscriber lives in an area where the emergency service provider will not respond without verification of an actual emergency, we will contract with an independent third party responder if available in that area.
We seek to increase subscriber satisfaction and retention by carefully managing customer and technical service. The customer service center handles all general inquiries from subscribers, including those related to subscriber information changes, basic alarm troubleshooting, alarm verification, technical service requests and requests to enhance existing services. Our Dallas facility hasWe have a proprietary centralized information system that enables us to satisfy over 85%90% of subscriber technical inquiries over the telephone, without dispatching a service technician. If the customer requires field service, we rely on our nationwide network of independent service dealers and over 5075 employee field service technicians to provide such service. We closely monitor
service dealer performance with customer satisfaction forms, follow-up quality assurance calls and other performance metrics. In 2014,2016, we dispatched over 300approximately 330 independent service dealers around the country to handle our field service.
LiveWatch Operations
LiveWatch is a leading DIY home security provider offering professionally monitored security services through a direct-to-consumer sales channel. Similar to MONI, LiveWatch is an asset-light business and geographically unconstrained. LiveWatch customers self‑install security and home automation hardware that is shipped to them by LiveWatch. LiveWatch then professionally monitors all of these self‑installed systems. LiveWatch generates subscriber contracts through leads from direct response marketing, where MONI primarily generates subscriber contracts from a dealer network with local market presence.
Services are provided to customers throughout the United States. Revenue is generated primarily from fees charged to customers under alarm monitoring contracts and the sale of the security equipment to facilitate the alarm monitoring service and other home automation or interactive services. LiveWatch typically offers substantial equipment subsidies to initiate, renew or upgrade alarm monitoring service contracts. The initial contract term is typically one year, with automatic renewal on a month-to-month basis.
When a customer initiates the process to obtain alarm monitoring services, LiveWatch pre-configures the alarm monitoring system based on customer specifications. LiveWatch then packages and ships the equipment directly to the customer. The customer self installs the equipment on-site and activates the monitoring service over the phone. Technical support for installation is provided via telephone or online assistance via the LiveWatch website.
LiveWatch has operations in central Kansas and in a satellite office in Evanston, Illinois.
Intellectual Property
We have a registered service mark for the Monitronics name and a service mark for the Monitronics logo. We also hold registered service marks for "HomeTouch" and "MONI." LiveWatch has a registered service mark for the LiveWatch name and a service mark for the LiveWatch logo. We own certain proprietary software applications that are used to provide services to our dealers and subscribers. Wesubscribers, including various trademarks, patents and patents pending related to the "ASAPer" system employed by LiveWatch, which causes a predetermined group of recipients to receive a text message automatically once an alarm is triggered. Other than as mentioned above, we and our subsidiaries do not hold any patents or other intellectual property rights on our proprietary software applications.
Sales and Marketing
General
We believeWith the rebranding efforts beginning in 2016 and continuing through early 2017, we will continue to market the new brand directly to consumers through national advertising campaigns and partnerships with other subscription- or member-based organizations and businesses. This, coupled with our nationwide network of authorized dealers, is the mostan effective way for us to market alarm systems. Locally-based dealers are often an integral part of the communities they serve and understand the local market and how best to satisfy local needs. By combining the dealer’sdealer's local presence and reputation with our nationally marketed brand, accompanied with our high quality service and support, we are able to cost-effectively provide local services and take advantage of economies of scale where appropriate.
Our dealer network provides for the acquisition of subscriber accounts on an ongoing basis. The dealers install the alarm system and arrange for subscribers to enter into a multi-year alarm monitoring agreement in a form acceptable to us. The dealer then submits this monitoring agreement for our due diligence review.
LiveWatch offers a differentiated go-to-market strategy through direct response TV, internet and radio advertising.
Dealer Network Development
We remain focused on expanding our network of independent authorized dealers. To do so, we have established a dealer program that provides participating dealers with a variety of support services to assist them as they grow their businesses. Authorized dealers may use the MonitronicsMONI brand name in their sales and marketing activities and on the products they sell and install. Our authorized dealers benefit from their affiliation with us and our national reputation for high customer satisfaction,
as well as the support they receive from us. We also provide authorized dealers with the opportunity to obtain discounts on alarm systems and other equipment purchased by such dealers from original equipment manufacturers, including alarm systems labeled with the MonitronicsMONI logo. We also makemakes available sales, business and technical training, sales literature, co-branded marketing materials, sales leads and management support to our authorized dealers. In most cases these services and cost savings would not be available to security alarm dealers on an individual basis.
Currently, we employ sales representatives to promote our authorized dealer program, find account acquisition opportunities and sell our monitoring services. We target independent alarm dealers across the U.S. that can benefit from our dealer program services and can generate high quality monitoring customers for us. We use a variety of marketing techniques to promote the dealer program and related services. These activities include direct mail, trade magazine advertising, trade shows, internet web site marketing, publicity and telemarketing. We have experienced success in implementing initiatives designed to improve lead sourcing for our dealers and for direct‑to‑consumer sales. Providing internally sourced leads to dealers strengthens our dealer relationships and serves as another mechanism for driving customer base growth. We have been named as an exclusive partner with several nationally recognized brands.
Dealer Marketing Support
We offer our authorized dealers an extensive marketing support program. We focus on developing professionally designed sales and marketing materials that will help dealers market alarm systems and monitoring services with maximum effectiveness. Materials offered to authorized dealers include:
•sales brochures and flyers;
•yard signs;
•window decals;
•customer forms and agreements;
•sales presentation binders;
•door hangers;
•lead boxes;
•vehicle graphics;
•trade show booths; and
•clothing bearing the MonitronicsMONI brand name.
These materials are made available to dealers at prices that our management believes would not be available to dealers on an individual basis.
Our sales materials promote both the MonitronicsMONI brand and the dealer’sdealer's status as ana MONI authorized dealer. Dealers often sell and install alarm systems which display the MonitronicsMONI logo and telephone number, which further strengthens consumer recognition of their status as ourMONI authorized dealers. Management believes that the dealers’dealers' use of the Monitronicsour brand to promote their affiliation with one of the nation’s largest alarm monitoring companies boosts the dealers’dealers' credibility and reputation in their local markets and also assists in supporting their sales success.
Customer Integration and Marketing
Our dealers typically introduce customers to us in the home when describing our central monitoring station. Following the acquisition of a monitoring agreement from a dealer, the customer is notified that Monitronics iswe are responsible for all their monitoring and customer service needs. The customer’scustomer's awareness and identification of the Monitronicsour brand as the monitoring service provider is further supported by the distribution of branded materials by the dealer to the customer at the point of sale. Such materials may include the promotional items listed above. All materials provided in the dealer model focus on the MonitronicsMONI brands and the role of Monitronicsus as the single source of support for the customer.
Negotiated Account Acquisitions
In addition to the development of our dealer network, we periodically acquire alarm monitoring accounts from other alarm companies in bulk on a negotiated basis. Management has extensive experience in identifying potential opportunities, negotiating account acquisitions and performing thorough due diligence, which helps facilitate the execution of new acquisitions in a timely manner. With the rebranding efforts, we will also begin using our own sales force and internal employee technicians to acquire subscriber alarm monitoring agreements and complete alarm system installations.
Strategy
Our goal is to maximize return on invested capital, which we believe can be achieved by pursuing the following strategies:
Maximize Subscriber RetentionCapitalize on Limited Market Penetration.
We seek to maximize subscriber retention by continuing to acquire high quality accountscapitalize on what we view as the current limited market penetration in security services and to increase the average life of an accountgrow our existing customer base through the following initiatives:
continue to develop our leading dealer position in the market to drive acquisitions of high quality AMAs;
leverage our acquisition of LiveWatch to competitively secure new DIY customers without significantly altering our existing asset‑light business model;
further develop internal lead sourcing through additional partnership opportunities to support existing direct marketing and acquisitions through our dealer program;
increase HomeTouch, home integration and ancillary product offerings; and
continue to monitor potential accretive merger and acquisition opportunities and further industry contraction.
Proactively Manage Customer Attrition
Customer attrition has historically been reasonably predictable and we regularly identify and monitor the principal drivers thereof, including our customers' credit scores, which we believe are the strongest predictors of retention. We seek to maximize customer retention by consistently offering high quality automated home monitoring services and increasing the average life of acquired AMAs through the following initiatives:
maintain the high quality of our subscribercustomer base by continuing to implement our highly disciplined accountAMA acquisition program;
continue to incentivizemotivate our dealers to obtain only high-qualityhigh‑quality accounts through quality incentives built into the costpurchase multiples and by having a performance guarantee on substantially all dealer originated accounts;
capitalize on our lead generation initiatives to supply high quality leads with strong retention indicators to our dealers;
prioritize the inclusion of HomeTouch services in the AMAs we purchase, which we believe increases customer retention;
proactively identifying customers "at‑risk" for attrition through new technology initiatives, including statistical analysis of "big data";
provide superiorhigh quality customer service on the telephone and in the field;
continue to implement initiatives to reduce core attrition, which include interactive voice recognition software, more effective initial on‑boarding of customers and competitive retention offers for departing customers; and
utilize available customer data to actively identify subscriberscustomers who are relocating the number one reason for account cancellations, and target retention of such subscribers.customers.
Maximize Economics of Business Model
Due to the scalability of our operations and the low fixed and variable costs inherent in our cost structure, weWe believe we will continue to experience high Pre-SAC Adjusted EBITDA margins as costs are spread over larger recurring revenue streams. In addition, we optimize the rate of return on investment by managing subscriber acquisition costs ("SAC"), or the costs of acquiring an account. Subscriber acquisition costs, whether capitalized or expensed, include the costs to acquire alarm monitoring contracts from our dealers, LiveWatch's equipment costs and certain sales and marketing costs. We believe our cash flows may also benefit from our continued efforts to increase subscriber retention rates and reduce response times, call duration and false alarms. As used in this annual report, the term “Adjusted EBITDA” means net income before interest expense, interest income, income taxes, depreciation, amortization (including the amortization of subscriber accounts, dealer network and other intangible assets), realized and unrealized gain/(loss) on derivative instruments, restructuring charges, stock-based compensation, and other non-cash or non-recurring charges, and “Adjusted EBITDA margin” means Adjusted EBITDA asFor a percentage of net revenue. For further discussion of Adjusted EBITDA and Pre-SAC EBITDA, see "Item 7. “Management’sManagement's Discussion and Analysis of Financial Condition and Results of Operations.”Operations".
Expand Our Network of DealersGrow Distribution Channels
OurWe plan is to continue to grow accountexpand AMA acquisitions through our dealer network by targeting new dealers that can benefit from our dealer program services and that canwhom we expect to generate high quality subscribers.customers. We believe we are an attractive partner for dealers for the following reasons:
we providethat by providing dealers with a full range of services designed to assist them in all aspects of their business, including sales leads, sales training, technical training, comprehensive on-lineon‑line account access, detailed weekly account summaries, sales support materials and discounts on security system hardware purchased through our strategic alliances with security system manufacturers;manufacturers, it is able to attract and partner with dealers that will succeed in our existing dealer network. Additionally, we expect our recent focus on internal lead sourcing and lead sourcing driven by relationships with third parties to contribute to the
individual dealers retain local name recognition and responsibility
growth of our dealer network. We will also continue to explore opportunities to leverage internally sourced leads, including through LiveWatch. We also consistently offer what we view as competitive rates for day-to-day sales and installation efforts, thereby supporting theaccount acquisition. We believe these strategies support an entrepreneurial culture at the dealer level and allowingallow us to capitalize on the considerable local market knowledge, goodwill and name recognition of our dealers; anddealers.
we reliably offer competitive rates for account acquisition.
For a description of the risks associated with the foregoing strategies, and with the Company’sCompany's business in general, see “"ITEM 1A. RISK FACTORS.”"
Industry; Competition
The security alarm industry is highly competitive and fragmented, andfragmented. Our competitors include fourtwo other major firmssecurity alarm companies with nationwide coverage, and numerous smaller providers with regional or local coverage. The four other security alarm companies with coverage acrossand certain large multi-service organizations in the U.S. are as follows:telecommunications or cable businesses. Our significant competitors for obtaining customer AMA's are:
•The ADT Corporation (“ADT”("ADT");
•Vivint, Inc., a subsidiary of APX Group Holdings,;
Guardian Protection Services;
Vector Security, Inc.;
•Protection One,Comcast Corporation and
AT&T Inc.; and
•Stanley Security Solutions, a subsidiary of Stanley Black and Decker.
TheOn May 2, 2016 ADT announced the successful completion of a previously announced merger with Prime Security Services Borrow, LLC (with its subsidiaries, Protection One). Despite this merger, the security alarm industry has remained highly competitive and fragmented over time withouthas not experienced any material change to market concentration. Competition in the security alarm industry is based primarily on reputation for quality of service, market visibility, services offered, price and the ability to identify subscriberand obtain customer accounts. Competition for subscriberscustomers has also increased in recent years from cable and telecommunication providers expanding their service offerings into the security alarm industry, as well aswith the emergence of DIY home security providers.providers and other technology companies expanding into the security alarm industry. We believe we compete effectively with other national, regional and local alarm monitoring companies, including cable and telecommunications companies, due to our reputation for reliable monitoring, customer and technical services, the quality of our services, and our lowrelatively lower cost structure. TheWe believe the dynamics of the security alarm industry often favor larger alarm monitoring companies with a nationwide focus that have greater capitalresources and benefit from economies of scale in technology, advertising and other expenditures.
Some of these largersecurity alarm monitoring companies have also adopted, in whole or in part, a dealer program similar to ours.us. In these instances, we must also compete with these programs in recruiting dealers. We believe we compete effectively with other dealer programs due to the quality of our dealer support services and our competitive acquisition terms. TheOur significant other dealer programs that we also compete with are as follows:competitors for recruiting dealers are:
ADTADT;
Central Security Group, Inc.;
Guardian Protection Services, Inc. and
Vector Security, Inc.
Of all of our competitors for both subscribers and dealers, ADT is significantly larger and has more capital.
Seasonality
Our operations are subject to a certain level of seasonality. Since more household moves take place during the second and third calendar quarters of each year, our disconnect rate and expenses related to retaining customers are typically higher in those calendar quarters than in the first and fourth quarters. There is also a slight seasonal effect resulting in higher new customer volume and related cash expenditures incurred in investment in new subscribers in the second and third quarters.
Regulatory Matters
Our operations are subject to a variety of laws, regulations and licensing requirements of federal, state and local authorities.authorities including federal and state customer protection laws. In certain jurisdictions, we are required to obtain licenses or permits to comply with standards governing employee selection and training and to meet certain standards in the conduct of our business. The security industry is also subject to requirements imposed by various insurance, approval, listing and standards organizations. Depending upon the type of subscriber served, the type of security service provided and the requirements of the
applicable local governmental jurisdiction, adherence to the requirements and standards of such organizations is mandatory in some instances and voluntary in others.
Although local governments routinely respond to panic and smoke/fire alarms, there are an increasing number of local governmental authorities that have adopted or are considering various measures aimed at reducing the number of false burglar alarms. Such measures include:
•subjecting alarm monitoring companies to fines or penalties for false alarms;
•imposing fines on alarm subscribers for false alarms;
•imposing limitations on the number of times the police will respond to false alarms at a particular location;
requiring additional verification of intrusion alarms by calling two different phone numbers prior to dispatch (“("Enhanced Call Verification”Verification"); and
requiring visual verification of an actual emergency at the premise before the police will respond to an alarm signal.
Enhanced Call Verification has been implemented as standard policy by Monitronics.us.
Security alarm systems monitored by us utilize telephone lines, internet connections, cellular networks and radio frequencies to transmit alarm signals. The cost of telephone lines, and the type of equipment which may be used in telephone line transmission, are currently regulated by both federal and state governments. The operation and utilization of cellular and radio frequencies are regulated by the Federal Communications Commission and state public utility commissions.
For a description ofadditional information on the risks associated with the foregoing strategies, and with the Company’s businessregulatory framework in general,which we operate, please see “"ITEM 1A. RISK FACTORS.”--Factors Relating to Regulatory Matters."
Employees
At December 31, 2014,2016, we had over 1,0001,370 full-time employees and over 80 part-time employees, all of which are located in the U.S.
(d) Financial Information About Geographic Areas
We perform monitoring services for subscribers located in all 50 states, the District of Columbia, Puerto Rico, and Canada.
(e) Available Information
All of our filings with the Securities and Exchange Commission (the “SEC”), including our Form 10-Ks, Form 10-Qs and Form 8-Ks, as well as amendments to such filings are available on our Internet website free of charge generally within 24 hours after we file such material with the SEC. Our website address is www.monitronics.com.www.mymoni.com.
The information contained on our website is not incorporated by reference herein.
ITEM 1A. RISK FACTORS
In addition to the other information contained in this Annual Report on Form 10-K, you should consider the following risk factors in evaluating our results of operations, financial condition, business and operations or an investment in our stock.
Although we describe below and elsewhere in this Annual Report on Form 10-K the risks we consider to be the most material, there may be other unknown or unpredictable economic, business, competitive, regulatory or other factors that also could have material adverse effects on our results of operations, financial condition, business or operations in the future. In addition, past financial performance may not be a reliable indicator of future performance and historical trends should not be used to anticipate results or trends in future periods.
If any of the events described below, individually or in combination, were to occur, our businesses, prospects, financial condition, results of operations and/or cash flows could be materially adversely affected.
Factors Relating to Our Business
We face risks in acquiring and integrating new subscribers.
The acquisition of alarm monitoring contracts involves a number of risks, including the risk that the alarm monitoring contracts acquired through our dealer network may not be profitable due to higher than expected account attrition, lower than expected revenues from the alarm monitoring contracts or, when applicable, lower than expected recoveries from dealers. The cost paidincurred to a dealer foracquire an alarm monitoring contract is affected by the monthly recurring revenue generated by the alarm monitoring contract, as well as several other factors, including the level of competition, prior experience with alarm monitoring contracts acquired from the dealer, the number of alarm monitoring contracts acquired, the subscriber’ssubscriber's credit score and the type of security equipment used by the subscriber. To the extent that the servicing costs or the attrition rates are higher than expected or the revenues from the alarm monitoring contracts or, when applicable, the recoveries from dealers are lower than expected, our business and results of operations could be adversely affected.
Our customer generation strategies and the competitive market for customer accounts may affect our future profitability.
A significant element of our business strategy is the generation of new customer accounts through our dealer network, excluding accounts acquired in the LiveWatch Acquisition, which accounted for substantially alla substantial portion of our new customer accounts for the year ended December 31, 2014.2016. Our future operating results will depend in large part on our ability to manage our generation strategies effectively. Although we currently generate accounts through hundreds of authorized dealers, a significant portion of our accounts originate from a smaller number of dealers. We experience loss of dealers from our dealer network due to various factors, such as dealers becoming inactive or discontinuing their electronic securityalarm monitoring business and competition from other alarm monitoring companies. If we experience a loss of dealers representing a significant portion of our account generation engine or if we are unable to replace or recruit dealers in accordance with our business plans, our business, financial condition and results of operations could be materially and adversely affected.
We are subject to credit risk and other risks associated with our subscribers.
Substantially all of our revenues are derived from the recurring monthly revenue due from subscribers under the alarm monitoring contracts. Therefore, we are dependent on the ability and willingness of subscribers to pay amounts due under the alarm monitoring contracts on a monthly basis in a timely manner. Although subscribers are contractually obligated to pay amounts due under an alarm monitoring contract and are prohibited from canceling the alarm monitoring contract for the initial term of the alarm monitoring contract (typically between three and five years), subscribers’ payment obligations are unsecured, which could impair our ability to collect any unpaid amounts from our subscribers. To the extent payment defaults by subscribers under the alarm monitoring contracts are greater than anticipated, our business and results of operations could be materially and adversely affected.
We rely on a significant number of our subscribers remaining with us for an extended period of time.
We incur significant upfront cash costs for each new subscriber. We require a substantial amount of time, typically exceeding the initial term of the related alarm monitoring contract, to receive cash payments (net of variable cash operating costs) from a particular subscriber that are sufficient to offset this upfront cost. Accordingly, our long-term performance is dependent on our subscribers remaining with us for as long as possible. This requires us to minimize our rate of subscriber cancellations, or attrition. Factors that can increase cancellations include subscribers who relocate and do not reconnect, prolonged downturns in the housing market, problems with service
quality, competition from other alarm monitoring companies, equipment obsolescence, adverse economic conditions, conversion of wireless spectrums and the affordability of our service. If we fail to keep our subscribers for a sufficiently long period of time, attrition rates would be higher than expected and our financial position and results of operations could be materially and adversely affected. In addition, we may experience higher attrition rates with respect to subscribers acquired in bulk buys than subscribers acquired pursuant to our authorized dealer program.
We are subject to credit risk and other risks associated with our subscribers.
Substantially all of our revenues are derived from the recurring monthly revenue due from subscribers under the alarm monitoring contracts. Therefore, we are dependent on the ability and willingness of subscribers to pay amounts due under the alarm monitoring contracts on a monthly basis in a timely manner. Although subscribers are contractually obligated to pay
amounts due under an alarm monitoring contract and are generally prohibited from canceling the alarm monitoring contract for the initial term of the alarm monitoring contract (typically between three and five years), subscribers' payment obligations are unsecured, which could impair our ability to collect any unpaid amounts from our subscribers. To the extent payment defaults by subscribers under the alarm monitoring contracts are greater than anticipated, our business and results of operations could be materially and adversely affected.
We are subject to credit risk and other risks associated with our dealers.
Under the standard alarm monitoring contract acquisition agreements that we enter into with our dealers, if a subscriber terminates their service with us during the first twelve months after the alarm monitoring contract has been acquired, the dealer is typically required to elect between substituting another alarm monitoring contract for the terminating alarm monitoring contract or compensating us in an amount based on the original acquisition cost of the terminating alarm monitoring contract. We are subject to the risk that dealers will breach their obligation to provide a comparable substitute alarm monitoring contract for a terminating alarm monitoring contract. Although we withhold specified amounts from the acquisition cost paid to dealers for alarm monitoring contracts (“holdback”("holdback"), which may be used to satisfy or offset these and other applicable dealer obligations under the alarm monitoring contract acquisition agreements, there can be no guarantee that these amounts will be sufficient to satisfy or offset the full extent of the default by a dealer of its obligations under its agreement. If the holdback does prove insufficient to cover dealer obligations, we are also subject to the credit risk that the dealers may not have sufficient funds to compensate us or that any such dealer will otherwise breach its obligation to compensate us for a terminating alarm monitoring contract. To the extent defaults by dealers of the obligations under their agreements are greater than anticipated, our financial condition and results of operations could be materially and adversely affected.
The In addition, a significant portion of our accounts originate from a smaller number of dealers. If any of these dealers discontinue their alarm monitoring business is subjector cease operations altogether as a result of business conditions or due to macroeconomic factors thatincreasingly burdensome regulatory compliance, the dealer may negatively impactbreach its obligations under the applicable alarm monitoring contract acquisition agreement and, to the extent such dealer has originated a significant portion of our accounts, our financial condition and results of operations including prolonged downturns in the housing market.
The alarm monitoring business is dependent in part on national, regional and local economic conditions. In particular, where disposable income available for discretionary spending is reduced (such as by higher housing, energy, interest or other costs or where the actual or perceived wealth of customers has decreased because of circumstances such as lower residential real estate values, increased foreclosure rates, inflation, increased tax rates or other economic disruptions), the alarm monitoring business could experience increased attrition rates and reduced consumer demand. Although we have continued to grow our business in the most recent periods of general economic downturn, no assurance can be given that we will be able to continue acquiring quality alarm monitoring contracts or that we will not experience higher attrition rates. In addition, any deterioration in new construction and sales of existing single family homes could reduce opportunities to grow our subscriber accounts from the sales of new security systems and services and the take-over of existing security systems that had previously been monitored by our competitors. If there are prolonged durations of general economic downturn, our results of operations and subscriber account growth could be materially and adversely affected.affected to a greater degree than if the dealer had originated a smaller number of accounts.
Adverse economic conditions in states where our subscribers are more heavily concentrated may negatively impact our results of operations.
Even as economic conditions may improve in the United States as a whole, this improvement may not occur or further deterioration may occur in the regions where our subscribers are more heavily concentrated (such as Texas, California, Florida and Arizona). Although we have a geographically diverse subscriber base, adverse conditions in one or more states where our business is more heavily concentrated could have a significant adverse effect on our business, financial condition and results of operations.
If the insurance industry were to change its practice of providing incentives to homeowners for the use of alarm monitoring services, we may experience a reduction in new customer growth or an increase in our subscriber attrition rate.
It has been common practice in the insurance industry to provide a reduction in rates for policies written on homes that have monitored alarm systems. There can be no assurance that insurance companies will continue to offer these rate reductions. If these incentives were reduced or eliminated, new homeowners who otherwise may not feel the need for alarm monitoring services would be removed from our potential customer pool, which could hinder the growth of our business, and existing subscribers may choose to disconnect or not renew their service contracts, which could increase our attrition rates. In either case, our results of operations and growth prospects could be adversely affected.
Risks of liability from our business and operations may be significant.
The nature of the services we provide potentially exposes us to greater risks of liability for employee acts or omissions or system failures than may be inherent in other businesses. If subscribers believe that they incurred losses as a result of an action or failure to act by us, the subscribers (or their insurers) could bring claims against us, and we have been subject to lawsuits of this type from time to time. Similarly, if dealers believe that they incurred losses or were denied rights under the alarm monitoring contract acquisition agreements as a result of an action or failure to act by us, the dealers could bring claims against us. Although substantially all of our alarm monitoring contracts and contract acquisition agreements contain provisions limiting our liability to subscribers and dealers, respectively, in an attempt to reduce this risk, the alarm monitoring contracts or contract acquisition agreements that do not contain such provisions expose us to risks of liability that could materially and adversely affect our business. Moreover, even when such provisions are included in an alarm monitoring contract or alarm monitoring contract acquisition agreement, in the event of any such litigation, no assurance can be given that these limitations will be enforced, and the costs of such litigation or the related settlements or judgments could have a material adverse effect on our financial condition. In addition, there can be no assurance that we are adequately insured for these risks. Certain of our insurance policies and the laws of some states may limit or prohibit insurance coverage for punitive or certain other types of damages or liability arising from gross negligence. If significant uninsured damages are assessed against us, the resulting liability could have a material adverse effect on our financial condition or results of operations. See note 16, Commitments and Contingencies, to our consolidated financial statements for the year ended December 31, 2014, incorporated by reference herein.
Future litigation could result in adverse publicity for us.
In the ordinary course of business, from time to time, we are the subject of complaints or litigation from subscribers or inquiries from government officials, sometimes related to alleged violations of state consumer protection statutes (including by our dealers), negligent dealer installation or negligent service of alarm monitoring systems. We may also be subject to employee claims based on, among other things, alleged discrimination, harassment or wrongful termination claims. In addition to diverting management resources, adverse publicity resulting from such allegations may materially and adversely affect our reputation in the communities we service, regardless of whether such allegations are unfounded. Such adverse publicity could result in higher attrition rates and greater difficulty in attracting new subscribers on terms that are attractive to us or at all.
An inability to provide the contracted monitoring service could adversely affect our business.
A disruption to both the main monitoring facility, and the back-up monitoring facility and/or third party monitoring facility could affect our ability to provide alarm monitoring services to ourits subscribers. Our main monitoring facility holds UL listings as a protective signaling services station and maintains certain standards of building integrity, redundant computer and communications facilities and backup power, among other safeguards. However, no assurance can be given that our main monitoring facility will not be disrupted by a technical failure, including communication or hardware failures, a catastrophic event or natural disaster, fire, weather, malicious acts or terrorism. Furthermore, no assurance can be given that our back-up or third party monitoring center will not be disrupted by the same or a simultaneous event or that it will be able to perform effectively in the event ourits main monitoring center is disrupted. Any such disruption, particularly one of a prolonged duration, could have a material adverse effect on our business.
We rely on third parties to transmit signals to our monitoring facilities and provide other services to our subscribers.
We rely on various third party telecommunications providers and signal processing centers to transmit and communicate signals to our monitoring facilityfacilities in a timely and consistent manner. These telecommunications providers and signal processing centers could fail to transmit or communicate these signals to the monitoring facility for many reasons, including due to disruptions from fire, natural disasters, weather, transmission interruption, malicious acts or terrorism. The failure of one or more of these telecommunications providers or signal processing centers to transmit and communicate signals to the monitoring facility in a timely manner could affect our ability to provide alarm monitoring, home automation and interactive services to our subscribers. We also rely on third party technology companies to provide home automation and interactive services to our subscribers.subscribers, including video surveillance services. These technology companies could fail to provide these services consistently, or at all, which could result in our inability to meet customer demand and damage our reputation. There can be no assurance that third-party telecommunications providers, signal processing centers and other technology companies will continue to transmit, communicate signals to the monitoring facilityfacilities or provide home automation and interactive services to subscribers without disruption. Any such disruption, particularly one of a prolonged duration, could have a material adverse effect on our business. See also “"Shifts in customer choice of, or telecommunications providers’providers' support for, telecommunications services and equipment could adversely impact our business and require significant capital expenditures”expenditures" below with respect to risks associated with changes in signal transmissions.
The alarm monitoring business is subject to technological innovation over time.
Our monitoring services depend upon the technology (both hardware and software) of security alarm systems located at subscribers’ premises. We may be required to implement new technology both to attract and retain subscribers or in response to changes in land-line or cellular technology or other factors, which could require significant expenditures. In addition, the availability of any new features developed for use in our industry (whether developed by us or otherwise) can have a significant impact on a subscriber’s initial decision to choose us or our competitor’s products and a subscriber’s decision to renew with us or switch to one of our competitors. To the extent our competitors have greater capital and other resources to dedicate to responding to technological innovation over time, the products and services offered by us may become less attractive to current or future subscribers thereby reducing demand for such products and services and increasing attrition over time. Those competitors that benefit from more capital being available to them may be at a particular advantage to us in this respect. If we are unable to adapt in response to changing technologies, market conditions or customer requirements in a timely manner, such inability could adversely affect our business by increasing our rate of subscriber attrition. We also face potential competition from improvements in self-monitoring systems, which enable current or future subscribers to monitor their home environments without third-party involvement, which could further increase attrition rates over time and hinder the acquisition of new alarm monitoring contracts.
ShiftsOur reputation as a service provider of high quality security offerings may be adversely affected by product defects or shortfalls in customer choiceservice.
Our business depends on our reputation and ability to maintain good relationships with our subscribers, dealers and local regulators, among others. Our reputation may be harmed either through product defects, such as the failure of one or telecommunications providers’ support for, telecommunications services and equipment could adversely impact our business and require significant capital expenditures.
Substantially allmore of our subscribersubscribers' alarm systems, use either a traditional land-line or cellularshortfalls in customer service. Subscribers generally judge our performance through their interactions with the staff at the monitoring and customer care centers, dealers and technicians who perform on-site maintenance services. Any failure to meet subscribers' expectations in such customer service to communicate alarm signals from the subscribers’ locations to our monitoring facilities. There is a growing trend for consumers to give up their land-line and exclusively use cellular and IP communication technology in their homes and businesses. In addition, some telecommunications providers may discontinue land-line services in the future and cellular carriers may choose to discontinue certain cellular networks. One of the nation's largest cellular carriers has announced that it does not intend to support its 2G cellular network services beyond 2016 and may terminate service carried on this network. As land-line and cellular network service is discontinued or disconnected, subscribers with alarm systems that communicate over these networks may need to have certain equipment in their security system replaced to maintain their monitoring service. The process of changing out this equipment will require us to subsidize the replacement of subscribers’ outdated equipment andareas could cause an increase in attrition rates or make it difficult to recruit new subscribers. Any harm to our reputation or subscriber attrition. During 2014, we implementedrelationships caused by the actions of our dealers, personnel or third party service providers or any other factors could have a program (the "Radio Conversion Program") to upgrade subscribers' alarm monitoring systems that communicate across the 2G network we expect to be discontinued. In connection with the Radio Conversion Program, we incurred costs of $1,113,000 in 2014 and could incur incremental costs of $13,000,000 to $16,000,000 per year through 2016. We are working with the cellular carriers and other 2G network user groups to pursue strategies which could significantly reduce these costs, but there is no assurance any of these efforts will be successful. In addition to the conversion costs, this process may divert management’s attention and other important resources away from customer service and sales efforts.
In the future, we may not be able to successfully implement new technologies or adapt existing technologies to changing market demands in the future. If we are unable to adapt timely to changing technologies, market conditions or customer preferences,material adverse effect on our business, financial condition and results of operations and cash flows could be materially and adversely affected.operations.
Privacy concerns, such as consumer identity theft and security breaches, could hurt our reputation and revenues.
As part of our operations, we collect a large amount of private information from our subscribers, including social security numbers, credit card information, images and voice recordings. Unauthorized parties may attempt to gain access to our systems or facilities by, among other things, hacking into our systems or facilities or those of our customers, partners or vendors. In addition, the techniques used to gain such access to our information technology systems, our data or customers' data, disable or degrade service, or sabotage systems are constantly evolving, may be difficult to detect quickly, and often are not recognized until launched against a target. If we were to experience a breach of our data security, it may put private information of our subscribers at risk of exposure. To the extent that any such exposure leads to credit card fraud or identity theft, we may experience a general decline in consumer confidence in our business, which may lead to an increase in attrition rates or may make it more difficult to attract new subscribers. If consumers become reluctant to use our services because of concerns over data privacy or credit card fraud, our ability to generate revenues would be impaired. In addition, if technology upgrades or other expenditures are required to prevent security breaches of our network, boost general consumer confidence in our business, or prevent credit card fraud and identity theft, we may be required to make unplanned capital expenditures or expend other resources. Any such loss of confidence in our business or additional capital expenditure requirement could have a material adverse effect on our business, financial condition and results of operations.
Our reputation as a service provider of high quality security offerings may be adversely affected by product defects or shortfallsShifts in customer service.choice of, or telecommunications providers' support for, telecommunications services and equipment could adversely impact our business and require significant capital expenditures.
Our business depends onSubstantially all of our reputationsubscriber alarm systems use either cellular service or traditional land-line to communicate alarm signals from the subscribers’ locations to our monitoring facilities. The number of land-line customers has continued to decline as fewer new customers utilize land-lines and abilityconsumers give up their land-line and exclusively use cellular and IP communication technology in their homes and businesses. In addition, some telecommunications providers may discontinue land-line services in the future and cellular carriers may choose to discontinue certain cellular networks. As land-line and cellular network service is discontinued or disconnected, subscribers with alarm systems that communicate over these networks may need to have certain equipment in their security system replaced to maintain good relationships with our subscribers, dealerstheir monitoring service. The process of changing out this equipment will require us to subsidize the replacement of subscribers' outdated equipment and local regulators, among others. Our reputation may be harmed either through product defects, such as the failure of one or more of
our subscribers’ alarm systems, or shortfalls in customer service. Subscribers generally judge our performance through their interactions with the staff at the monitoring centers, dealers and technicians who perform on-site maintenance services. Any failureis likely to meet subscribers’ expectations in such customer service areas could cause an increase in attrition ratessubscriber attrition. One of the nation's largest cellular carriers, AT&T, shut down its 2G cellular network in January 2017. During 2014, we implemented a program (the "Radio Conversion Program") to upgrade subscribers' alarm monitoring systems that communicate across the AT&T 2G network that was discontinued. In connection with the Radio Conversion Program, we incurred costs of $18,422,000, $14,369,000 and $1,113,000 for the years ending December 31, 2016, 2015 and 2014, respectively. As of January 31, 2017, we had approximately 11,000 customers that had not been converted and therefore are no longer able to communicate with the central monitoring center. While we will continue to attempt to contact these customers many of them may not respond and may ultimately cancel their service. In the future, we may not be able to successfully implement new technologies or make it difficultadapt existing technologies to recruit new subscribers. Any harmchanging market demands in the future. If we are unable to our reputationadapt timely to changing technologies, market conditions or subscriber relationships caused by the actions of our dealers, personnel or third party service providers or any other factors could have a material adverse effect on ourcustomer preferences, its business, financial condition, and results of operations.operations and cash flows could be materially and adversely affected.
A lossOur business is subject to technological innovation over time.
Our monitoring services depend upon the technology (both hardware and software) of experienced employeessecurity alarm systems located at subscribers' premises. We may be required to implement new technology both to attract and retain subscribers or in response to changes in land-line or cellular technology or other factors, which could require significant expenditures. In addition, the availability of any new features developed for use in our industry (whether developed by us or otherwise) can have a significant impact on a subscriber’s initial decision to choose us or our competitor’s products and a subscriber's decision to renew with us or switch to one of our competitors. To the extent our competitors have greater capital and other resources to dedicate to
responding to technological innovation over time, the products and services offered by us may become less attractive to current or future subscribers thereby reducing demand for such products and services and increasing attrition over time. Those competitors that benefit from more capital being available to them may be at a particular advantage to us in this respect. If we are unable to adapt in response to changing technologies, market conditions or customer requirements in a timely manner, such inability could adversely affect us.
Our success has been largely dependent uponour business by increasing our rate of subscriber attrition. We also face potential competition from improvements in self-monitoring systems, which enable current or future subscribers to monitor their home environments without third-party involvement, which could further increase attrition rates over time and hinder the active participationacquisition of our officers and employees. The loss of the services of key members of our management for any reason may have a material adverse effect on our operations and the ability to maintain and grow our business. We depend on the managerial skills and expertise of our management and employees to provide customer service by, among other things, monitoring and responding to alarm signals, coordinating equipment repairs, administering billing and collections under thenew alarm monitoring contracts and administering and providing dealer services under the contract acquisition agreements. There is no assurance that we will be able to retain our current management and other experienced employees or replace them satisfactorily to the extent they leave our employ. As previously announced, Michael Haislip, our President and Chief Executive Officer, intends to retire at the end of his existing employment contract on June 14, 2016. Although a search is underway for Mr. Haislip's successor, no assurance can be given as to when a suitable replacement will be found. The loss of our experienced employees’ services and expertise could materially and adversely affect our business.contracts.
The high level of competition in our industry could adversely affect our business.
The security alarm monitoring industry is highly competitive and fragmented. As of December 31, 2014,2016, we arewere one of the largest alarm monitoring companies in the U.S. when measured by the total number of subscribers under contract. We face competition from other alarm monitoring companies, including companies that have more capital and that may offer higher prices and more favorable terms to dealers for alarm monitoring contracts or charge lower prices to customers for monitoring services. In addition, two of our larger competitors, ADT and Protection One, combined into a single company in a transaction that closed in May 2016. We also face competition from a significant number of small regional competitors that concentrate their capital and other resources in targeting local markets and forming new marketing channels that may displace the existing alarm system dealer channels for acquiring alarm monitoring contracts. Further, we are facing increasing competition from telecommunications, cable and cabletechnology companies who are expanding into alarm monitoring services and bundling their existing offerings with monitored security services. The existing access to and relationship with subscribers that these companies have could give them a substantial advantage over us, especially if they are able to offer subscribers a lower price by bundling these services. Any of these forms of competition could reduce the acquisition opportunities available to us, thus slowing our rate of growth, or requiring us to increase the price paid for subscriber accounts, thus reducing our return on investment and negatively impacting our revenues and results of operations.
We may be unable to obtain future financing on terms acceptable to us or at all, which may hinder our ability to grow our business.
We intend to continue to pursue growth through the acquisition of subscriber accounts through our authorized dealer network and our direct to consumer channel in LiveWatch, among other means. To continue our growth strategy, we intend to make additional drawdowns under the revolving credit portion of our Credit Facility and may seek financing through new credit arrangements or the possible sale of new securities, any of which may lead to higher leverage or result in higher borrowing costs. In addition, any future downgrade in our credit rating could also result in higher borrowing costs. An inability to obtain funding through external financing sources on favorable terms or at all is likely to adversely affect our ability to continue or accelerate our subscriber account acquisition activities.
Our acquisition strategy may not be successful.
One focus of our strategy is to seek opportunities to grow free cash flow through strategic acquisitions, which may include leveraged acquisitions. However, there can be no assurance that we will be able to consummate that strategy, and if we are not able to invest our capital in acquisitions that are accretive to free cash flow it could negatively impact our growth. Our ability to consummate such acquisitions may be negatively impacted by various factors, including among other things:
failure to identify attractive acquisition candidates on acceptable terms;
competition from other bidders;
inability to raise any required financing; and
antitrust or other regulatory restrictions, including any requirements that may be imposed by government agencies as a condition to any required regulatory approval.
If we engage in any acquisition, we will incur a variety of costs, and may never realize the anticipated benefits of the acquisition. If we undertake any acquisition, the process of operating such acquired business may result in unforeseen operating difficulties and expenditures, including the assumption of the liabilities and exposure to unforeseen liabilities of such acquired business and the possibility of litigation or other claims in connection with, or as a result of, such an acquisition, including claims from terminated employees, customers, former stockholders or other third parties. Moreover, we may fail to realize the anticipated benefits of any acquisition as rapidly as expected or at all, and we may experience increased attrition in our subscriber base and/or a loss of dealer relationships and difficulties integrating acquired businesses, technologies and personnel into our business or achieving anticipated operations efficiencies or cost savings. Future acquisitions could cause us to incur debt and expose us to liabilities. Further, we may incur significant expenditures and devote substantial management time and
attention in anticipation of an acquisition that is never realized. Lastly, while we intend to implement appropriate controls and procedures as we integrate any acquired companies, we may not be able to certify as to the effectiveness of these companies’companies' disclosure controls and procedures or internal control over financial reporting within the time periods required by U.S. federal securities laws and regulations.
Risks of liability from our business and operations may be significant.
The nature of the services we provide potentially exposes us to greater risks of liability for employee acts or omissions or system failures than may be inherent in other businesses. If subscribers believe that they incurred losses as a result of an action or failure to act by us, the subscribers (or their insurers) could bring claims against us, and we have been subject to lawsuits of this type from time to time. Similarly, if dealers believe that they incurred losses or were denied rights under the alarm monitoring contract acquisition agreements as a result of an action or failure to act by us, the dealers could bring claims against us. Although substantially all of our alarm monitoring contracts and contract acquisition agreements contain provisions limiting our liability to subscribers and dealers, respectively, in an attempt to reduce this risk, the alarm monitoring contracts or a contract acquisition agreement that do not contain such provisions expose us to risks of liability that could materially and adversely affect our business. Moreover, even when such provisions are included in an alarm monitoring contract or alarm monitoring contract acquisition agreement, in the event of any such litigation, no assurance can be given that these limitations will be enforced, and the costs of such litigation or the related settlements or judgments could have a material adverse effect on our financial condition. In addition, there can be no assurance that we are adequately insured for these risks. Certain of our insurance policies and the laws of some states may limit or prohibit insurance coverage for punitive or certain other types of damages or liability arising from gross negligence. If significant uninsured damages are assessed against us, the resulting liability could have a material adverse effect on our financial condition or results of operations.
Future litigation could result in adverse publicity for us.
In the ordinary course of business, from time to time, the Company and our subsidiaries are the subject of complaints or litigation from subscribers or inquiries from government officials, sometimes related to alleged violations of state or federal consumer protection statutes (including by our dealers), violations of "false alarm" ordinances or other regulations, negligent dealer installation or negligent service of alarm monitoring systems. We may also be unablesubject to obtain additional fundsemployee claims based on, among other things, alleged discrimination, harassment or wrongful termination claims. In addition to diverting management resources, adverse publicity resulting from such allegations may materially and adversely affect our reputation in the communities we service, regardless of whether such allegations are unfounded. Such adverse publicity could result in higher attrition rates and greater difficulty in attracting new subscribers on terms that are attractive to us or at all.
A loss of experienced employees could adversely affect us.
The success of the Company has been largely dependent upon the active participation of its officers and employees. The loss of the services of key members of our management for any reason may have a material adverse effect on our operations and the ability to maintain and grow our business. We depend on the managerial skills and expertise of our management and employees to provide customer service by, among other things, monitoring and responding to alarm signals, coordinating equipment repairs, administering billing and collections under the alarm monitoring contracts and administering and providing dealer services under the contract acquisition agreements. There is no assurance that we will be able to retain our current management and other experienced employees or replace them satisfactorily to the extent they leave our employ. As previously announced, Michael Meyers, Chief Financial Officer of the Company has announced his intention to retire from the Company by the end of 2017. Although a search is underway for Mr. Meyers' successor, no assurance can be given as to when a suitable replacement will be found. The loss of our experienced employees' services and expertise could materially and adversely affect our business.
The alarm monitoring business is subject to macroeconomic factors that may negatively impact our results of operations, including prolonged downturns in the economy.
The alarm monitoring business is dependent in part on national, regional and local economic conditions. In particular, where disposable income available for discretionary spending is reduced (such as by higher housing, energy, interest or other costs or where the actual or perceived wealth of customers has decreased because of circumstances such as lower residential real estate values, increased foreclosure rates, inflation, increased tax rates or other economic disruptions), the alarm monitoring business could experience increased attrition rates and reduced consumer demand. In periods of economic downturn, no assurance can be given that we will be able to continue acquiring quality alarm monitoring contracts or that we will not experience higher attrition rates. In addition, any deterioration in new construction and sales of existing single family homes could reduce opportunities to grow our business.subscriber accounts from the sales of new security systems and services and the take-over of existing
We intendsecurity systems that had previously been monitored by our competitors. If there are prolonged durations of general economic downturn, our results of operations and subscriber account growth could be materially and adversely affected.
Adverse economic conditions in states where our subscribers are more heavily concentrated may negatively impact our results of operations.
Even as economic conditions may improve in the United States as a whole, this improvement may not occur or further deterioration may occur in the regions where our subscribers are more heavily concentrated such as, Texas, California, Arizona, and Florida which comprise approximately 39% of our subscribers. Although we have a geographically diverse subscriber base, adverse conditions in one or more states where our business is more heavily concentrated could have a significant adverse effect on our business, financial condition and results of operations.
If the insurance industry were to change its practice of providing incentives to homeowners for the use of alarm monitoring services, we may experience a reduction in new customer growth or an increase in our subscriber attrition rate.
It has been common practice in the insurance industry to provide a reduction in rates for policies written on homes that have monitored alarm systems. There can be no assurance that insurance companies will continue to pursueoffer these rate reductions. If these incentives were reduced or eliminated, new homeowners who otherwise may not feel the need for alarm monitoring services would be removed from our potential customer pool, which could hinder the growth through the acquisition of subscriber accounts through our authorized dealer network, among other means. To continue our growth strategy, we intend to make additional drawdowns under the revolving credit portion of our Credit Facilitybusiness, and existing subscribers may seek financing through new credit arrangements, anychoose to disconnect or not renew their service contracts, which could increase our attrition rates. In either case our results of which may lead to higher leverage or result in higher borrowing costs. An inability to obtain funding through external financing sources on favorable terms or at all is likely tooperations and growth prospects could be adversely affect our ability to continue or accelerate our subscriber account acquisition activities.affected.
We may pursue business opportunities that diverge from our current business model, which may cause our business to suffer.
We may pursue business opportunities that diverge from our current business model, including expanding our products or service offerings, investing in new and unproven technologies, adding customer acquisition channels (including, for example, increased direct marketing efforts) and forming new alliances with companies to market our services.we service. We can offer no assurance that any such business opportunities will prove to be successful. Among other negative effects, our pursuit of such business opportunities could cause our cost of investment in new customers to grow at a faster rate than our recurring revenue. Additionally, any new alliances or customer acquisition channels could have higher cost structures than our current arrangements, which could reduce operating margins and require more working capital. In the event that working capital requirements exceed operating cash flow, we might be required to draw on our Credit Facility or pursue other external financing, which may not be readily available. Any of these factors could materially and adversely affect our business, financial condition, results of operations and cash flows.
Third party claims with respect to our intellectual property, if decided against us, may result in competing uses of our intellectual property or require the adoption of new, non-infringing intellectual property.
We have received and may continue to receive notices claiming we committed intellectual property infringement, misappropriation or other intellectual property violations and third parties have claimed, and may, in the future, claim that we do not own or have rights to use all intellectual property rights used in the conduct of our business. While we do not believe that any of the currently outstanding claims are material, there can be no assurance that third parties will not assert future infringement claims against us or claim that our rights to our intellectual property are invalid or unenforceable, and we cannot guarantee that these claims will be unsuccessful. Any claims involving rights to use the “Monitronics”"MONI" mark or the "LiveWatch" mark could have a material adverse effect on our business if such claims were decided against us and we arewere precluded from using or licensing the “Monitronics”"MONI" mark or ifthe "LiveWatch" mark or others were allowed to use such mark. If we arewere required to adopt a new name, it would entail marketing costs in connection with building up recognition and goodwill in such new name. In the event that we arewere enjoined from using any of our other intellectual property, there would be costs associated with the replacement of such intellectual property with developed, acquired or licensed intellectual property. There would also be costs associated with the defense and settlement of any infringement or misappropriation allegations and any damages that may be awarded.
Factors Relating to Our Indebtedness
We have a substantial amount of indebtedness and the costs of servicing that debt may materially affect our business.
We have a significant amount of indebtedness. As of December 31, 2016, we had principal indebtedness of $1,142,050,000 related to term loans maturing in September 2022 and a revolving credit facility maturing in September 2021, both under our
Credit Facility, as well as a $585,000,000 of 9.125% senior notes (the "Senior Notes") due April 2020. At December 31, 2016, we also had outstanding a 12.5% intercompany promissory note of $12,000,000 due to Ascent Capital in October 2020. That substantial indebtedness, combined with our other financial obligations and contractual commitments, could have important consequences to us. For example, it could:
make it more difficult for us to satisfy our obligations with respect to our existing and future indebtedness, and any failure to comply with the obligations under any of the agreements governing our indebtedness could result in an event of default under such agreements;
require us to dedicate a substantial portion of any cash flow from operations (which also constitutes substantially all of our cash flow) to the payment of interest and principal due under our indebtedness, which will reduce funds available to fund future subscriber account acquisitions, working capital, capital expenditures and other general corporate requirements;
increase our vulnerability to general adverse economic and industry conditions;
limit our flexibility in planning for, or reacting to, changes in our business and the markets in which we operate;
limit our ability to obtain additional financing required to fund future subscriber account acquisitions, working capital, capital expenditures and other general corporate requirements;
expose us to market fluctuations in interest rates;
place us at a competitive disadvantage compared to some of our competitors that are less leveraged;
reduce or delay investments and capital expenditures; and
cause any refinancing of our indebtedness to be at higher interest rates and require us to comply with more onerous covenants, which could further restrict our business operations.
The agreements governing our various debt obligations, including our Credit Facility and the indenture governing the Senior Notes, impose restrictions on our business and the business of our subsidiaries and such restrictions could adversely affect our ability to undertake certain corporate actions.
The agreements governing our indebtedness restrict our ability to, among other things:
incur additional indebtedness;
make certain dividends or distributions with respect to any of our capital stock;
make certain loans and investments;
create liens;
enter into transactions with affiliates, including Ascent Capital;
restrict subsidiary distributions;
dissolve, merge or consolidate;
make capital expenditures in excess of certain annual limits;
transfer, sell or dispose of assets;
enter into or acquire certain types of alarm monitoring contracts;
make certain amendments to our organizational documents;
make changes in the nature of our business;
enter into certain burdensome agreements;
make accounting changes;
use proceeds of loans to purchase or carry margin stock; and
prepay our senior unsecured notes.
In addition, we also must comply with certain financial covenants under the Credit Facility that require us to maintain a consolidated total leverage ratio (as defined in the Credit Facility) of not more than 5.25 to 1.00, a consolidated interest coverage ratio (as defined in the Credit Facility) of not less than 2.00 to 1.00, each of which is calculated quarterly on a trailing twelve-month basis. In addition, the revolving portion of the Credit Facility requires us to maintain a consolidated senior secured Eligible RMR leverage ratio (as defined in the Credit Facility) of no more than 31.0 to 1.00 and a consolidated senior secured RMR leverage ratio (as defined in the Credit Facility) of no more than 31.5 to 1.00, each calculated quarterly on a trailing twelve-month basis. If we cannot comply with any of these financial covenants, or if any of our subsidiaries fails to comply with the restrictions contained in the Credit Facility, such failure could lead to an event of default and we may not be able to make additional drawdowns under the revolving portion of the Credit Facility, which would limit our ability to manage our working capital requirements. In addition, failure to comply with the financial covenants or restrictions contained in the Credit Facility could lead to an event of default, which could result in the acceleration of a substantial amount of our indebtedness.
We have a history of losses and may incur losses in the future.
We have incurred losses in our three most recently completed fiscal years. In future periods, we may not be able to achieve or sustain profitability on a consistent quarterly or annual basis. Failure to maintain profitability in future periods may materially and adversely affect our ability to make payments on our outstanding debt obligations.
Factors Relating to Regulatory Matters
“False Alarm” ordinances could adversely affect our business and operations.
Significant concern has arisen in certain municipalities about the high incidence of false alarms. In some localities, this concern has resulted in local ordinances or policies that restrict police response to third-party monitored burglar alarms. In addition, an increasing number of local governmental authorities have considered or adopted various measures aimed at reducing the number of false alarms, including:
subjecting alarm monitoring companies to fines or penalties for transmitting false alarms;
imposing fines on alarm monitoring services customers for false alarms;
imposing limitations on the number of times the police will respond to alarms at a particular location; and
requiring further verification of an alarm signal, such as visual verification or verification to two different phone numbers, before the police will respond.
Enactment of these measures could adversely affect our future operations and business. For example, numerous cities or metropolitan areas have implemented verified response ordinances for residential and commercial burglar alarms. A verified
response policy means that police officers generally do not respond to an alarm until someone else (e.g., the resident, a neighbor or a security guard) first verifies that it is valid. Some alarm monitoring companies operating in these areas hire security guards or use third-party guard firms to verify an alarm. If we need to hire security guards or use third-party guard firms, it could have a material adverse effect on our business through either increased servicing costs, which could negatively affect the ability to properly fund our ongoing operations, or increased costs to our customers, which may limit our ability to attract new customers or increase our subscriber attrition rates. In addition, the perception that police departments will not respond to third-party monitored burglar alarms, may reduce customer satisfaction with traditional monitored alarm systems, which may also result in increased attrition rates or decreased customer demand. Although we have less than 40,000 subscribers in these areas, a more widespread adoption of such a policy or similar policies in other cities or municipalities could materially and adversely affect our business.
Our business operates in a regulated industry.
Our business, operations and dealers are subject to various U.S. federal, state and local consumer protection laws, licensing regulation and other laws and regulations, and, to a lesser extent, similar Canadian laws and regulations. While there are no U.S. federal laws that directly regulate the security alarm monitoring industry, our advertising and sales practices and that of our dealer network are subject to regulation by the U.S. Federal Trade Commission (the “FTC”"FTC") in addition to state consumer protection laws. The FTC and the Federal Communications Commission have issued regulations that place restrictions on, among other things, unsolicited automated telephone calls to residential and wireless telephone subscribers by means of automatic telephone dialing systems and the use of prerecorded or artificial voice messages. If the company (through our direct marketing efforts) or our dealers were to take actions in violation of these regulations, such as telemarketing to individuals on the “Do"Do Not Call”Call" registry, we could be subject to fines, penalties, private actions or enforcement actions by government regulators. AlthoughWe have been named, and may be named in the future, as a defendant in litigation arising from alleged violations of the Telephone Consumer Protection Act (the "TCPA"). While we endeavor to comply with the TCPA, no assurance can be given that we will not be exposed to liability as a result of our or our dealers' direct marketing efforts. In addition, although we have taken steps to insulate ourselvesour company from any such wrongful conduct by our dealers, and to require our dealers to comply with these laws and regulations, no assurance can be given that we will not be exposed to liability as a result of our dealers’dealers' conduct. If the Company or any such dealers do not comply with applicable laws, we may be exposed to increased liability and penalties. Further, to the extent that any changes in law or regulation further restrict the lead generation activity of the Company or our dealers, these restrictions could result in a material reduction in subscriber acquisition opportunities, reducing the growth prospects of our business and adversely affecting our financial condition and future cash flows. In addition, most states in which we operate have licensing laws directed specifically toward the monitored security services industry. Our business relies heavily upon wireline and cellular telephone service to communicate signals. Wireline and cellular telephone companies are currently regulated by both federal and state governments. Changes in laws or regulations could require us to change the way we operate, which could increase costs or otherwise disrupt operations. In addition, failure to comply with any such applicable laws or regulations could result in substantial fines or revocation of our operating permits and licenses, including in geographic areas where our services have substantial penetration, which could adversely affect our business and financial condition. Further, if these laws and regulations were to change or we failed to comply with such laws and regulations as they exist today or in the future, our business, financial condition and results of operations could be materially and adversely affected.
Increased adoption of statutes and governmental policies purporting to void automatic renewal provisions in the alarm monitoring contracts, or purporting to characterize certain charges in the alarm monitoring contracts as unlawful, could adversely affect our business and operations.
The alarm monitoring contracts typically contain provisions automatically renewing the term of the contract at the end of the initial term, unless a cancellation notice is delivered in accordance with the terms of the contract. If the customer cancels prior to the end of the contract term, other than in accordance with the contract, we may charge the customer an early cancellation fee as specified in the contract, which typically allows us to charge 80% of the amounts that would have been paid over the remaining term of the contract. Several states have adopted, or are considering the adoption of, consumer protection policies or legal precedents which purport to void or substantially limit the automatic renewal provisions of contracts such as the alarm monitoring contracts, or otherwise restrict the charges that can be imposed upon contract cancellation. Such initiatives could negatively impact our business. Adverse judicial determinations regarding these matters could increase legal exposure to customers against whom such charges have been imposed, and the risk that certain customers may seek to recover such charges through litigation. In addition, the costs of defending such litigation and enforcement actions could have an adverse effect on our business and operations.
Factors Relating to Our Indebtedness
We have a substantial amount of indebtedness and the costs of servicing that debt may materially affect our business.
We have a significant amount of indebtedness. As of December 31, 2014, we had principal indebtedness of $1,653,799,000, which includes terms loans and a revolving credit facility both under our senior secured credit agreement (together referred to
as the "Credit Facility"), $585,000,000 of 9.125% senior notes (the "Senior Notes") and a 9.868% promissory note of $100,000,000 due to Ascent Capital. That substantial indebtedness, combined with our other financial obligations and contractual commitments,"False Alarm" ordinances could have important consequences to us. For example, it could:
make it more difficult for us to satisfy our obligations with respect to our existing and future indebtedness, and any failure to comply with the obligations under any of the agreements governing our indebtedness could result in an event of default under such agreements;
require us to dedicate a substantial portion of any cash flow from operations to the payment of interest and principal due under our indebtedness, which will reduce funds available to fund future subscriber account acquisitions, working capital, capital expenditures and other general corporate requirements;
increase our vulnerability to general adverse economic and industry conditions;
limit our flexibility in planning for, or reacting to, changes inadversely affect our business and operations.
Significant concern has arisen in certain municipalities about the marketshigh incidence of false alarms. In some localities, this concern has resulted in local ordinances or policies that restrict police response to third-party monitored burglar alarms. In addition, an increasing number of local governmental authorities have considered or adopted various measures aimed at reducing the
number of false alarms; measures include alarm fines to us and/or our customers, limits on number of police responses allowed, and requiring certain alarm conditions to exist before a response is granted. In extreme situations, authorities may not respond to an alarm unless a verified problem exists.
Enactment of these measures could adversely affect our future operations and business. Alarm monitoring companies operating in areas impacted by government alarm ordinances may choose to hire third-party guard firms to respond to an alarm. If we need to hire third-party guard firms, it could have a material adverse effect on our business through either increased servicing costs, which we operate;
could negatively affect the ability to properly fund our ongoing operations, or increased costs to our customers, which may limit our ability to obtain additional financing required to fund futureattract new customers or increase our subscriber account acquisitions, working capital, capital expenditures and other general corporate requirements;
expose us to market fluctuations in interest rates;
place us at a competitive disadvantage compared to some of our competitors that are less leveraged;
reduce or delay investments and capital expenditures; and
cause any refinancing of our indebtedness to be at higher interest rates and require us to comply with more onerous covenants, which could further restrict our business operations.
The agreements governing our various debt obligations, including our Credit Facility and the indenture governing the Senior Notes, impose restrictions on our business and the business of our subsidiaries and such restrictions could adversely affect our ability to undertake certain corporate actions.
The agreements governing our indebtedness restrict our ability to, among other things:
incur additional indebtedness;
make certain dividends or distributions with respect to any of our capital stock;
make certain loans and investments;
create liens;
enter into transactions with affiliates, including our parent company, Ascent Capital;
restrict subsidiary distributions;
dissolve, merge or consolidate;
annual limits on the amount of capital expenditures;
transfer, sell or dispose of assets;
enter into or acquire certain types of alarm monitoring contracts;
enter into certain transactions with affiliates;
make certain amendments to our organizational documents;
make changes in the nature of our business;
enter into certain burdensome agreements;
make accounting changes;
use proceeds of loans to purchase or carry margin stock; and
allow the suspension of alarm licenses.
In addition, we also must comply with certain financial covenants under the Credit Facility that require us to maintain a consolidated total leverage ratio (as defined in the Credit Facility) of not more than 5.00 to 1.00 through June 30, 2015 and then 4.50 to 1.00 thereafter, a consolidated senior secured leverage ratio (as defined in the Credit Facility) of not more than 3.25 to 1.00 through June 30, 2015 and then 3.00 to 1.00 thereafter, a consolidated interest coverage ratio (as defined in the Credit Facility) of not less than 2.00 to 1.00, each of which is calculated quarterly on a trailing twelve-month basis.attrition rates. In addition, the revolving portionperception that police departments will not respond to monitored burglar alarms may reduce customer satisfaction or customer demand for an alarm monitoring service. Although we currently have less than 65,000 subscribers in areas covered by these ordinances or policies, a more widespread adoption of the Credit Facility requires us to maintain a consolidated senior secured RMR leverage ratio (as defined in the Credit Facility)policies of no more than 28.0 to 1.00, calculated quarterly, and an attrition rate (as defined in the Credit Facility) of no more than 15.0%, calculated quarterly on a trailing twelve-month basis. If we cannot comply with any of these financial covenants, or if the Company or any ofthis nature could adversely effect our subsidiaries fails to comply with the restrictions contained in the Credit Facility, such failure could lead to an event of default and we may not be able to make additional drawdowns under the revolving portion of the Credit Facility, which would limit our ability to manage our working capital requirements. In addition, failure to comply with the financial covenants or restrictions contained in the Credit Facility could lead to an event of default, which could result in the acceleration of a substantial amount of our indebtedness.business.
We have a history of losses and may incur losses in the future.
We have incurred losses in our three most recently completed fiscal years. In future periods, we may not be able to achieve or sustain profitability on a consistent quarterly or annual basis. Failure to maintain profitability in future periods may materially and adversely affect our ability to make payments on our outstanding debt obligations.
Factors Related to Our Parent’sStructure and Our Parent's Corporate History
Goodwill and other identifiable intangible assets represent a significant portion of our total assets, and we may never realize the full value of our intangible assets.
As of December 31, 2016, we had goodwill of $563,549,000, which represents approximately 27.7% of total assets. Goodwill was recorded in connection with the MONI, Security Networks, and LiveWatch acquisitions. The Company accounts for its goodwill pursuant to the provisions of Financial Standards Accounting Board ("FASB") Accounting Standards Codification ("ASC"), Topic 350, Intangibles-Goodwill and Other ("FASB ASC Topic 350"). In accordance with FASB ASC Topic 350, goodwill is tested for impairment annually or when events or changes in circumstances occur that would, more likely than not, reduce the fair value of an asset below its carrying value, resulting in an impairment. Impairments may result from, among other things, deterioration in financial and operational performance, declines in Ascent Capital's stock price, increased attrition, adverse market conditions, adverse changes in applicable laws and/or regulations, deterioration of general macroeconomic conditions, fluctuations in foreign exchange rates, increased competitive markets in which we operate in, declining financial performance over a sustained period, changes in key personnel and/or strategy, and a variety of other factors.
The amount of any quantified impairment must be expensed immediately as a charge to results of operations. Any impairment charge relating to goodwill or other intangible assets would have the effect of decreasing our earnings or increasing our losses in such period. At least annually, or as circumstances arise that may trigger an assessment, we will test our goodwill for impairment. There can be no assurance that our future evaluations of goodwill will not result in our recognition of impairment charges, which may have a material adverse effect on our financial statements and results of operations.
Our parent, Ascent Capital, may have substantial indemnification obligations under a tax sharing agreement it entered into in connection with the 2008 spin-off of Ascent Capital from Discovery Holding Company (“DHC”("DHC"), a subsidiary of Discovery Communications, Inc., (the "2008 spin-off") and, under the terms of this agreement, we may be responsible for any such obligations.
Pursuant to Ascent Capital’sCapital's tax sharing agreement with DHC, Ascent Capital has agreed to be responsible for all taxes attributable to Ascent Capital or any of its subsidiaries, whether accruing before, on or after the 2008 spin-off (subject to specified exceptions). Ascent Capital has also agreed to be responsible for and indemnify DHC with respect to (i) certain taxes attributable to DHC or any of its subsidiaries (other than Discovery Communications, LLC) and (ii) all taxes arising as a result of the 2008 spin-off (subject to specified exceptions). Under the terms of the tax sharing agreement, each subsidiary of Ascent Capital, including the Company, is a member of the indemnifying group and may be responsible for any payments due to DHC thereunder. Ascent Capital’s indemnification obligations under the tax sharing agreement are not limited in amount or subject to any cap and could be substantial. Pursuant to the reorganization agreement we entered into with DHC in connection with the 2008 spin-off, we assumed certain indemnification obligations designed to make our company financially responsible for substantially all non-tax liabilities that may exist relating to the business of Ascent Capital's former subsidiary, Ascent Media Group, LLC. whether incurred prior to or after the 2008 spin-off, as well as certain obligations of DHC. Any indemnification payments under the tax sharing agreement or the reorganization agreement could be substantial.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2. PROPERTIES
We leaseMONI leases approximately 110,000165,000 square feet in Dallas,Farmers Branch, Texas to house ourits executive offices, monitoring and certain call centers, sales and marketing and data retention functions. Approximately 98,000 square feet of the 110,000 square feet is under an eleven-year lease expiring June 30, 2015 and 12,000 square feet is under a seven-year lease expiring June 30, 2015. WeMONI also leaseleases approximately 53,000 square feet in Irving, Texas, to house certain call center operations and 13,000 square feet in McKinney, Texas, for the back-up monitoring facility.In 2014, we entered into a lease agreement for 165,00016,000 square feet of office space in Farmers Branch,Dallas, Texas which will become our new headquarters. The lease is expected to commence in the summer of 2015.that supports its monitoring operations and back up facility.
LiveWatch leases approximately 11,000 square feet of office space in St Marys, Kansas to house its main operations and fulfillment center and 6,800 square feet of office space in Manhattan, Kansas to house sales office functions. Additionally, LiveWatch leases approximately 6,700 square feet of office space in Evanston, Illinois for general administrative and sales office functions.
ITEM 3. LEGAL PROCEEDINGS
From time to time, the Company is involved in litigation and similar claims incidental to the conduct of its business. Although no assurances can be given, in the opinion of management, none of the pending actions is likely to have a material adverse impact on the Company’sCompany's financial position or results of operations, either individually or in the aggregate.
ITEM 4. MINE SAFETY DISCLOSURES
None.
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Pursuant to the MonitronicsMONI Acquisition, the Company deauthorized all shares of Class A and Class B common stock upon its merger with Merger Sub on December 17, 2010. The newly formed entityCompany has one thousand shares of common stock issued and outstanding to Ascent Capital as of December 31, 2010. There have been no changes to the common stock issued and outstanding since the MonitronicsMONI Acquisition.
We have paid $2,000,000 in dividends to Ascent Capital in the amount of $5,000,000 and $2,000,000 for the years December 31, 2016 and 2014, respectively. No dividends were paid during the year ended December 31, 2014.2015. From time to time we may provide dividends to Ascent Capital as permitted in our Credit Facility.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth our selected consolidated financial and other operating data for the periods presented. The data relating to periods ending prior to December 17, 2010 reflects the consolidated financial data before the Monitronics Acquisition (the “Predecessor”). In connection with the Monitronics Acquisition, we changed our fiscal year end from June 30 to December 31. The data relating to periods ending after December 17, 2010, represent the consolidated financial data after the Monitronics Acquisition (the “Successor”).
The (i) selected balance sheet data as of December 31, 20142016 and 20132015 and (ii) the selected statementstatements of operations data for the fiscal years ended December 31, 2016, 2015, and 2014, 2013 and 2012all of which are set forth below, are derived from the accompanying consolidated financial statements and notes included elsewhere in this Annual Report and should be read in conjunction with those financial statements and the notes thereto. The balance sheet data as of December 31, 2011, December 31, 20102014, 2013 and June 30, 20102012 and the statementstatements of operations data for the periods July 1, 2010 to December 16, 2010 and December 17, 2010 to December 31, 2010 and years ended December 31, 20112013 and June 30, 2010 presented in this table2012 shown below were derived from previously issued financial statements, including those issued in Amendment No. 1 to Monitronics’ Registration Statement on Form S-4, filed with the Securities and Exchange Commission on June 22, 2012. statements.
| | | Successor | | | Predecessor | | | | | | | | | | | | |
Summary Balance Sheet Data | As of December 31, | | Transition Period As of December 31, | | | As of June 30, | | As of December 31, |
(Amounts in thousands): | 2014 | | 2013 | | 2012 | | 2011 | | 2010 | | | 2010 | | 2016 | | 2015 | | 2014 | | 2013 | | 2012 |
Current assets | $ | 29,893 |
| | 32,263 |
| | 35,688 |
| | 54,433 |
| | 44,110 |
| | | $ | 104,815 |
| | $ | 26,406 |
| | 26,147 |
| | 23,326 |
| | 23,733 |
| | 30,561 |
|
Property and Equipment, net | $ | 23,280 |
| | 24,561 |
| | 20,559 |
| | 19,977 |
| | 20,689 |
| | | $ | 15,718 |
| | $ | 28,270 |
| | 26,654 |
| | 23,280 |
| | 24,561 |
| | 20,559 |
|
Subscriber accounts, net | | $ | 1,386,760 |
| | 1,423,538 |
| | 1,373,630 |
| | 1,340,954 |
| | 987,975 |
|
Total assets | $ | 2,024,647 |
| | 2,019,526 |
| | 1,446,444 |
| | 1,333,874 |
| | 1,320,802 |
| | | $ | 803,564 |
| | $ | 2,033,717 |
| | 2,070,267 |
| | 1,997,162 |
| | 1,985,674 |
| | 1,420,720 |
|
Current liabilities | $ | 84,565 |
| | 86,831 |
| | 60,747 |
| | 103,142 |
| | 49,370 |
| | | $ | 33,330 |
| | $ | 87,171 |
| | 82,715 |
| | 84,565 |
| | 86,831 |
| | 60,747 |
|
Long-term debt | $ | 1,640,542 |
| | 1,597,627 |
| | 1,101,433 |
| | 892,718 |
| | 896,733 |
| | | $ | 844,188 |
| | $ | 1,687,778 |
| | 1,739,147 |
| | 1,619,624 |
| | 1,572,305 |
| | 1,080,836 |
|
Stockholder’s equity | $ | 257,566 |
| | 292,660 |
| | 258,924 |
| | 288,624 |
| | 294,990 |
| | | $ | (153,623 | ) | | |
Stockholder's equity | | $ | 214,945 |
| | 201,065 |
| | 257,566 |
| | 292,660 |
| | 258,924 |
|
| | | Successor | | | Predecessor | | | | | | | | | | | | |
Summary Statement of Operations Data | Fiscal Year Ended December 31, | | Transition Period December 17, to December 31, | | | Transition Period July 1 To December�� 16, | | Fiscal Year Ended June 30, | | Fiscal Year Ended December 31, |
(Amounts in thousands): | 2014 | | 2013 | | 2012 | | 2011 | | 2010 | | | 2010 | | 2010 | | 2016 | | 2015 | | 2014 | | 2013 | | 2012 |
Net revenue | $ | 539,449 |
| | 451,033 |
| | 344,953 |
| | 311,898 |
| | 9,129 |
| | | $ | 133,432 |
| | 271,951 |
| | $ | 570,372 |
| | 563,356 |
| | 539,449 |
| | 451,033 |
| | 344,953 |
|
Operating income (loss) | $ | 93,490 |
| | 82,539 |
| | 66,167 |
| | 49,187 |
| | (602 | ) | | | $ | 19,875 |
| | 61,829 |
| | $ | 67,649 |
| | 63,725 |
| | 93,490 |
| | 82,539 |
| | 66,167 |
|
Net income (loss) | $ | (29,717 | ) | | (16,687 | ) | | (16,776 | ) | | (6,759 | ) | | (4,230 | ) | | | $ | 4,081 |
| | (122 | ) | | $ | (76,307 | ) | | (72,448 | ) | | (29,717 | ) | | (16,687 | ) | | (16,776 | ) |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis provides information concerning our results of operations and financial condition. This discussion should be read in conjunction with our accompanying consolidated financial statements and the notes thereto included elsewhere herein.
Overview
We provide security alarm monitoring and related services to residential and business subscribers throughout the U.S. and parts of Canada. We monitor signals arising from burglaries, fires, medical alerts and other events through security systems at subscribers’subscribers' premises. We also provide interactive and home automation services to our subscribers. Nearly all of our revenues are derived from monthly recurring revenues under security alarm monitoring contracts acquired through our exclusive nationwide network.
Revenues are recognized as the related monitoring services are provided. Other revenues are derived primarily from the provisionnetwork of third-party contract monitoring services and from field technical repair services. All direct external costs associated with the creation of subscriber accounts, including new subscriber contracts obtained in connection with a subscriber move, are capitalized and amortized over fourteen to fifteen years using a declining balance method beginning in the month following the date of purchase. Internal costs, including all personnel and related support costs incurred solely in connection with subscriber account acquisitions and transitions, are expensed as incurred.independent dealers or through LiveWatch
Attrition
Account cancellation, otherwise referred to as subscriber attrition, has a direct impact on the number of subscribers that we service and on our financial results, including revenues, operating income and cash flow. A portion of the subscriber base can be expected to cancel its service every year. Subscribers may choose not to renew or terminate their contract for a variety of reasons, including relocation, cost and switching to a competitor’scompetitor's service. The largest category of canceled accounts relate to subscriber relocation or the inability to contact the subscriber. We define our attrition rate as the number of canceled accounts in a given period divided by the weighted average of number of subscribers for that period. We consider an account canceled if payment from the subscriber is deemed uncollectible or if the subscriber cancels for various reasons. If a subscriber relocates but continues its service, this is not a cancellation. If the subscriber relocates, discontinues its service and a new subscriber takes over the original subscriber’s service continuing the revenue stream, this is also not a cancellation. We adjust the number of canceled accounts by excluding those that are contractually guaranteed by our dealers. The typical dealer contract provides that if a subscriber cancels in the first year of its contract, the dealer must either replace the canceled account with a new one or refund to us the cost paid to acquire the contract. To help ensure the dealer’sdealer's obligation to us, we typically maintain a dealer funded holdback reserve ranging from 5-10%5-8% of subscriber accounts in the guarantee period. In some cases, the amount of the holdback liability may beis less than actual attrition experience.
The table below presents subscriber data for the twelve months ended December 31, 20142016 and 2013:2015:
| | | | Twelve Months Ended December 31, | | | Twelve Months Ended December 31, | |
| | 2014 | | 2013 | | | 2016 | | 2015 | |
Beginning balance of accounts | | 1,046,155 |
| | 812,539 |
| | | 1,089,535 |
| | 1,058,962 |
| |
Accounts acquired | | 156,225 |
| | 354,541 |
| | | 125,292 |
| | 188,941 |
| |
Accounts canceled | | (135,940 | ) | | (111,889 | ) | | | (148,878 | ) | | (147,923 | ) | |
Canceled accounts guaranteed by dealer and acquisition adjustments (a) | | (7,174 | ) | (b) | (9,036 | ) | (c) | |
Canceled accounts guaranteed by dealer and other adjustments (a) | | | (19,158 | ) | (b) | (10,445 | ) | |
Ending balance of accounts | | 1,059,266 |
| | 1,046,155 |
| | | 1,046,791 |
| | 1,089,535 |
| |
Monthly weighted average accounts | | 1,052,756 |
| | 908,921 |
| | | 1,069,901 |
| | 1,086,071 |
| |
Attrition rate (d) | | (12.9 | )% | | (12.3 | )% | | |
Attrition rate Unit | | | 13.9 | % | | 13.6 | % | |
Attrition rate RMR (c) | | | 12.2 | % | | 13.4 | % | |
| |
(a) | Includes canceled accounts that are contractually guaranteed to be refunded from holdback. |
| |
(b) | Includes an increaseestimated 12,177 accounts included in our Radio Conversion Program that canceled in excess of 1,503 subscriber accounts associated with multi-site subscribers that were considered single accounts prior to the completion of the Security Networks integration in April 2014.their expected attrition. |
| |
(c) | Includes 2,046 subscriber accounts that were proactively canceled during 2013 because they were active with both Monitronics and Security Networks. |
| |
(d) | The recurring monthly revenue ("RMR") attrition rate for the twelve months ended December 31, 2014 and 2013 was 12.6% and 12.2%, respectively. The RMR of canceled accounts follows the same definition as subscriber unit attrition as noted above. RMR attrition is defined as the RMR of canceled accounts in a given period, adjusted for the impact of price increases or decreases in that period, divided by the weighted average of RMR for that period. RMR attrition is a commonly used performance indicator in our industry. |
The unit attrition rate for the twelve months ended December 31, 20142016 and 20132015 was 12.9%13.9% and 12.3%13.6%, respectively. IncreasedContributing to the increase in attrition is primarily the result of an increase inwas the number of subscriber accounts with 5-year contracts reaching the end of their initial contract term in the period.period, as well as, our more aggressive price increase strategy. Overall attrition reflects the impact of the Pinnacle Security bulk buys, where we purchased approximately 113,000 accounts from Pinnacle Security in 2012 and 2013 which are now experiencing normal end-of-term attrition. The attrition rate without the Pinnacle Security accounts (core attrition) as of December 31, 2016 and 2015 is 13.4% and 12.7%, respectively. RMR attrition for the twelve months ended December 31, 2016 declined to 12.2% from 13.4% for the year ended 2015 reflecting price increases to existing customers and higher RMR for new customers.
We analyze our attrition by classifying accounts into annual pools based on the year of acquisition. We then track the number of accounts that cancel as a percentage of the initial number of accounts acquired for each pool for each year subsequent to its acquisition. Based on the average cancellation rate across the pools, we have averaged less than 1%our attrition rate is very low within the initial 12-month12 month period after considering the accounts which were replaced or refunded by the dealers at no additional cost to us. Over the next few years of the subscriber account life, the number of subscribers that cancel as a percentage of the initial number of subscribers in that pool gradually increases and historically has peaked following the end of the initial contract term, which is typically three to five years. The peak following the end of the initial contract term is primarily a result of the buildup of subscribers that moved, or no longer had need for the service but did not cancel their service until the end of their initial contract term.or switched to a competitor. Subsequent to the peak following the end of the initial contract term, the number of subscribers that cancel as a percentage of the initial number of subscribers in that pool declines.
Accounts Acquired
During the three months ended December 31, 20142016 and 2013,2015, we acquired 37,99826,227 and 37,34137,349 subscriber accounts, respectively.
During the yearstwelve months ended December 31, 20142016 and 2013,2015, we acquired 156,225125,292 and 150,643157,022 subscriber accounts, respectively, without giving effect toexcluding the Security Networks Acquisition, which included 203,89831,919 accounts acquired atfrom the completion of acquisitionLiveWatch Acquisition in August of 2013.February 2015. Acquired contracts for the years ended December 31, 20142016 and 20132015 also include approximately 8,3008,600 and 18,2002,000 accounts, respectively, purchased in various bulk buys throughout the periods.
RMR acquired during the three and twelve months ended December 31, 20142016 was approximately $1,776,000$1,231,000 and $7,182,000,$5,835,000, respectively. RMR acquired during the three and twelve months ended December 31, 20132015 was approximately $1,704,000$1,720,000 and $6,772,000,$7,279,000, respectively, without giving effect toexcluding $909,000 of RMR acquired from the Security NetworksLiveWatch Acquisition which included $8,681,000 of acquired RMR.in February 2015.
Adjusted EBITDA
We evaluate the performance of our operations based on financial measures such as revenue and “Adjusted"Adjusted EBITDA.”" Adjusted EBITDA is defined as net income (loss) before interest expense, interest income, income taxes, depreciation,
amortization (including the amortization of subscriber accounts, dealer network and other intangible assets), realized and
unrealized gain/(loss) on derivative instruments, restructuring charges, stock-based compensation, and other non-cash or non-recurring charges. We believe that Adjusted EBITDA is an important indicator of the operational strength and performance of our business, including our ability to fund our ongoing acquisition of subscriber accounts, our capital expenditures and to service our debt. In addition, this measure is used by management to evaluate operating results and perform analytical comparisons and identify strategies to improve performance. Adjusted EBITDA is also a measure that is customarily used by financial analysts to evaluate the financial performance of companies in the security alarm monitoring industry and is one of the financial measures, subject to certain adjustments, by which our covenants are calculated under the agreements governing our debt obligations. Adjusted EBITDA does not represent cash flow from operations as defined by generally accepted accounting principles (“GAAP”("GAAP"), should not be construed as an alternative to net income or loss and is indicative neither of our results of operations nor of cash flows available to fund all of our cash needs. It is, however, a measurement that we believe is useful to investors in analyzing our operating performance. Accordingly, Adjusted EBITDA should be considered in addition to, but not as a substitute for, net income, cash flow provided by operating activities and other measures of financial performance prepared in accordance with GAAP. Adjusted EBITDA is a non-GAAP financial measure.�� As companies often define non-GAAP financial measures differently, Adjusted EBITDA as calculated by MonitronicsMONI should not be compared to any similarly titled measures reported by other companies.
Pre-SAC Adjusted EBITDA
LiveWatch is a direct-to-consumer business, and as such recognizes certain revenue and expenses associated with subscriber acquisition (subscriber acquisition costs, or "SAC"). This is in contrast to MONI, which capitalizes payments to dealers to acquire accounts. "Pre-SAC Adjusted EBITDA" is a measure that eliminates the impact of acquiring accounts at the LiveWatch business that is recognized in operating income. Pre-SAC Adjusted EBITDA is defined as total Adjusted EBITDA excluding LiveWatch's SAC and the related revenue. We believe Pre-SAC Adjusted EBITDA is a meaningful measure of the Company's financial performance in servicing its customer base. Pre-SAC Adjusted EBITDA should be considered in addition to, but not as a substitute for, net income, cash flow provided by operating activities and other measures of financial performance prepared in accordance with GAAP. Pre-SAC Adjusted EBITDA is a non-GAAP financial measure. As companies often define non-GAAP financial measures differently, Pre-SAC Adjusted EBITDA as calculated by the Company should not be compared to any similarly titled measures reported by other companies.
Results of Operations
The following table sets forth selected data from the accompanying consolidated statements of operations for the periods indicated. The results of operations for Security Networks are included from August 16, 2013, the date of the Security Networks Acquisitionindicated (amounts in thousands).
| | | Year Ended December 31, | | Year Ended December 31, | |
| 2014 | | 2013 | | 2012 | | 2016 | | 2015 | | 2014 | |
Net revenue(a) | $ | 539,449 |
| | 451,033 |
| (a) | 344,953 |
| | $ | 570,372 |
| | 563,356 |
| | 539,449 |
| |
Cost of services | 94,713 |
| | 74,136 |
| | 49,978 |
| | 115,236 |
| | 110,246 |
| | 93,600 |
| |
Selling, general, and administrative, including stock-based compensation | 87,943 |
| | 77,162 |
| | 60,054 |
| | 114,152 |
| | 106,287 |
| | 87,943 |
| |
Amortization of subscriber accounts, dealer network and other intangible assets | 253,403 |
| | 208,760 |
| | 163,468 |
| | 246,753 |
| | 258,668 |
| | 253,403 |
| |
Restructuring charges | 952 |
| | 1,111 |
| | — |
| | |
Interest expense | 119,607 |
| | 96,145 |
| | 71,405 |
| | 127,308 |
| | 125,415 |
| | 119,607 |
| |
Income tax expense | 3,600 |
| | 3,081 |
| | 2,619 |
| | |
Income tax expense from continuing operations | | 7,148 |
| | 6,290 |
| | 3,600 |
| |
Net loss | (29,717 | ) | | (16,687 | ) | | (16,776 | ) | | (76,307 | ) | | (72,448 | ) | | (29,717 | ) | |
| | | | | | | | | | | | |
Adjusted EBITDA (b) | $ | 362,227 |
| | 305,250 |
| | 235,675 |
| | $ | 344,848 |
| | 354,807 |
| | 362,227 |
| |
Adjusted EBITDA as a percentage of Revenue | 67.1 | % | | 67.7 | % | | 68.3 | % | | 60.5 | % | | 63.0 | % | | 67.1 | % | |
| | | | | | | |
Pre-SAC Adjusted EBITDA (c) | | $ | 366,481 |
| | 369,083 |
| | 362,227 |
| |
Pre-SAC Adjusted EBITDA as a percentage of Pre-SAC net revenue (d) | | 64.8 | % | | 66.0 | % | | 67.1 | % | |
(a) Net revenue for the year ended December 31, 20132015 reflects the negative impact of a $2,715,000$359,000 of fair value adjustmentadjustments that reduced deferred revenue acquired in the Security NetworksLiveWatch Acquisition.
(b) See reconciliation to net loss below.
(c)See reconciliation of Adjusted EBITDA to Pre-SAC Adjusted EBITDA below.
(d)Presented below is the reconciliation of Net revenue to Pre-SAC net revenue (amounts in thousands): |
| | | | | | | | | |
| Year ended December 31, |
| 2016 | | 2015 | | 2014 |
Net revenue, as reported | $ | 570,372 |
| | 563,356 |
| | 539,449 |
|
LiveWatch revenue related to SAC | (4,493 | ) | | (4,022 | ) | | — |
|
Pre-SAC net revenue | $ | 565,879 |
| | 559,334 |
| | 539,449 |
|
Net Revenue. Revenue increased $88,416,000,$7,016,000, or 19.6%1.2%, for the year ended December 31, 20142016 as compared to the corresponding prior year. The increase in net revenue is attributable to an increase in average RMR per subscriber, as well as, the inclusion of a full first quarter's impact of LiveWatch revenue. Average RMR per subscriber increased from $41.92 as of December 31, 2015 to $43.10 as of December 31, 2016 and was the result of price increases enacted throughout the year as well as an increase in average RMR per new subscriber acquired. These increases were partially offset by a decrease in the monthly weighted average number of accounts from 2015 to 2016.
Revenue increased $23,907,000, or 4.4%, for the year ended December 31, 2015 as compared to the corresponding prior year. The increase in net revenue is attributable to the growth in the number of subscriber accounts and the increase in average monthly revenueRMR per subscriber. The growth in subscriber accounts reflects the acquisition of over 200,000157,000 accounts through the MONI and LiveWatch subscriber channels, as well as 31,919 accounts from the Security NetworksLiveWatch Acquisition in August 2013 and the acquisition of over 145,000 accounts through our authorized dealer program subsequent to December 31, 2013.February 2015. In addition, average monthly revenue per subscriber increased from $40.90 as of December 31, 2013 to $41.64 as of December 31, 2014.2014 to $41.92 as of December 31, 2015. Excluding accounts acquired through the LiveWatch Acquisition, which had an average monthly revenue per subscriber of $28.46, our average monthly revenue per subscriber increased from $41.64 to $42.33 for the period ending December 31, 2015. Net revenue for the year ended December 31, 20132015 also reflects the negative impact of a $2,715,000$359,000 fair value adjustment that reduced deferred revenue acquired in the Security Networks Acquisition.
Revenue increased $106,080,000, or 30.8%, for the year ended December 31, 2013 as compared to the corresponding prior year. The increase in net revenue is attributable to the growth in the number of subscriber accounts and the increase in average monthly revenue per subscriber. The growth in subscriber accounts reflects the effects of the Security Networks Acquisition in August 2013, which included over 200,000 subscriber accounts, the acquisition of over 136,000 accounts through Monitronics’ authorized dealer program subsequent to December 31, 2012, and the purchase of approximately 18,200 accounts in various
bulk buys throughout 2013. In addition, average monthly revenue per subscriber increased from $39.50 as of December 31, 2012 to $40.90 as of December 31, 2013. Net revenue for the year ended December 31, 2013 also reflects the negative impact of a $2,715,000 fair value adjustment that reduced deferred revenue acquired in the Security NetworksLiveWatch Acquisition.
Cost of Services. Cost of services increased $20,577,000$4,990,000 or 27.8%4.5%, for the year ended December 31, 20142016 as compared to the corresponding prior year. The increase is attributedprimarily attributable to subscriber growth and increases in cellular andincreased field service costs asdue to a higher volume of retention jobs being completed and an increase in subscriber acquisition costs incurred at LiveWatch, related to increased account production and the inclusion of a full first quarter of production. Furthermore, cost of services increased due to more accounts aresubscribers being monitored across the cellular network, which require additional serviceincluding home automation accounts. LiveWatch's subscriber acquisition costs to upgrade existing subscribers' equipment. In addition, we incurred redundant staffinginclude expensed equipment costs at our Dallas, Texas monitoring and call center facilities through April 2014, when the transitionassociated with new subscribers of Security Networks operations from Florida to Texas was complete. Service cost$8,928,000 for the year ended December 31, 2014 also included $1,113,000 incurred in relation2016, compared to $7,058,000 for the Radio Conversion Program, which was implemented in 2014 to upgrade subscribers' alarm monitoring systems that communicate across certain 2G networks that are expected to be discontinued in the near future.year ended December 31, 2015. Cost of services as a percent of net revenue increased from 16.4%19.6% for the year ended December 31, 20132015 to 17.6%20.2% for the year ended December 31, 2014.2016.
Costs of services increased $24,158,000,$16,646,000, or 48.3%17.8%, for the year ended December 31, 20132015 as compared to the corresponding prior year period.year. The increase is primarily attributable subscriberto the inclusion of LiveWatch, which expensed equipment costs associated with the creation of new subscribers of $7,058,000. The increase is also attributable to the growth as well as increases in cellular and service costs. Cellular costs have increased due to morethe number of accounts being monitored across the cellular network, which often include interactive andincluding home automation services. This has also resulted in higheraccounts, and service costs asto upgrade existing subscribers upgrade their systems. In addition, cost of services includes Security Networks costs of $8,233,000 for the year ended December 31, 2013.subscribers' equipment. Cost of serviceservices as a percent of net revenue increased from 14.5%17.4% for the year ended December 31, 20122014 to 16.4%19.6% for the year ended December 31, 2013.2015.
Selling, General and Administrative. Selling, general and administrative expense (“SG&A”) increased $10,781,000,$7,865,000, or 14.0%7.4%, for the year ended December 31, 20142016 as compared to the corresponding prior year. The increase isincreases are primarily attributable to subscriber growth over the last twelve monthsacquisition costs incurred at LiveWatch from increased account production and the recognitioninclusion of redundant staffinga full first quarter of production, as well as increased salaries, wages and operatingbenefits costs and $2,991,000 of rebranding expense at our Dallas, Texas headquarters through April 2014, whenMONI. LiveWatch's subscriber acquisition costs, which includes marketing and sales costs related to the transitioncreation of new subscribers, was $17,198,000 and $11,240,000 for the years ended December 31, 2016 and 2015. These increases were partially offset by a fourth quarter gain on the revaluation of a dealer liability related to the Security Networks operations from Florida to Texas was completed.Acquisition of $7,160,000. SG&A as a percent of net revenue decreasedincreased from 17.1%18.9% for the year ended December 31, 20132015 to 16.3%20.0% for the year ended December 31, 2014.2016.
Selling, general and administrativeSG&A expense (“SG&A”) increased $17,108,000,$18,344,000, or 28.5%20.9%, for the year ended December 31, 20132015 as compared to the corresponding prior year. The primary driver of the increase in SG&A is attributable to increased payroll expenses$11,240,000 of approximately $2,379,000,LiveWatch marketing and sales expense related to the inclusioncreation of Security Networksnew subscribers. LiveWatch SG&A also includes $3,930,000 of $6,456,000 and othercontingent bonuses payable to LiveWatch's key members of management in accordance with the employment agreements entered into in connection with th LiveWatch Acquisition. Other increases due to Monitronics’ subscriber growth in 2013. TheSG&A are one-time costs incurred by the Company also incurred acquisition and integration costs of $2,470,000 and $1,264,000, respectively,$946,000 related to professional services rendered in connection with the LiveWatch Acquisition and other$720,000 costs incurred to relocate our headquarters in July 2015. These increases are partially offset by decreases in our staffing and operating costs incurred at its headquarters as a result of the Security Networks' integration being completed in April 2014. SG&A for the year ended December 31, 2014 also includes $2,182,000 of incremental costs incurred in connection with the Security Networks Acquisition.integration. SG&A as a percent of net revenue decreasedincreased from 17.4%16.3% for the year ended December 31, 20122014 to 17.1%18.9% for the year ended December 31, 2013.2015.
Amortization of Subscriber Accounts, Dealer Network and Other Intangible Assets. Amortization of subscriber accounts, dealer network and other intangible assets increased $44,643,000 and $45,292,000decreased $11,915,000 for the yearsyear ended December 31, 20142016 and 2013,increased $5,265,000 for the year ended December 31, 2015, respectively, as compared to the corresponding prior years. The increases aredecrease in 2016 is attributable to the timing of amortization of subscriber accounts acquired subsequentprior to each of the preceding years ended. In addition, for the years ended December 31, 2014 and 2013, amortization includes approximately $58,126,000 and $23,599,000, respectively,2015 which have a lower rate of amortization expense relatedin 2016 and are not offset by amortization on 2016 subscriber accounts due to decreased purchases occurring in 2016. The increase in 2015 is attributable to the definite lived intangible assets acquiredtiming and amortization impact of account purchases in the Security Networks Acquisition.
Restructuring Charges. In connection with the Security Networks Acquisition, management approved a restructuring plan2015 as compared to transition Security Networks’ operationsaccount purchases in West Palm Beach and Kissimmee, Florida to Dallas, Texas (the “2013 Restructuring Plan”). The 2013 Restructuring Plan provides certain employees with a severance package that entitles them to receive benefits upon completion of the transition in 2014. Severance costs related to the 2013 Restructuring Plan were recognized ratably over the future service period. During the years ended December 31, 2014 and 2013 the Company recorded $952,000 and $1,111,000, respectively, of restructuring charges related to employee termination benefits under the 2013 Restructuring Plan. The transition of Security Networks' operations to Dallas was completed in the second quarter of 2014.
The following tables provide the activity and balances of the 2013 Restructuring Plan (amounts in thousands):
|
| | | | | | | | | | | | | | | |
| December 31, 2013 | | Additions | | Payments | | Other | | December 31, 2014 |
2013 Restructuring Plan | |
| | |
| | |
| | | | |
|
Severance and retention | $ | 1,570 |
| | 952 |
| | (2,388 | ) | | — |
| | 134 |
|
|
| | | | | | | | | | | | | | | |
| December 31, 2012 | | Additions | | Payments | | Other | | December 31, 2013 |
2013 Restructuring Plan | | | | | | | | | |
Severance and retention | $ | — |
| | 1,111 |
| | (33 | ) | | 492 |
| (a) | 1,570 |
|
(a)Amount was recorded upon the acquisition of Security Networks.
Interest Expense. Interest expense increased $23,462,000$1,893,000 and $24,740,000$5,808,000 for the years ended December 31, 20142016 and 2013,2015, respectively, as compared to the corresponding prior years. The increase in interest expense for the year ended December 31, 2014 is primarily attributable to increases in the Company's consolidated debt balance related to the borrowings incurred to fund the Security Networks Acquisition. This increase is partially offset by the favorable repricing of Monitronics credit facility interest rates effective March 25, 2013 (the "Repricing").
The increase in interest expense for the year ended December 31, 2013 is attributable to increases in the Company's consolidated debt balance related to the borrowings incurredamendment of its Credit Facility term loans in February and April 2015 and September 2016. Additionally, Amendment No. 6 to fund the Security Networks AcquisitionExisting Credit Agreement increased the applicable margin interest rates, which contributed to increased interest expense in the fourth quarter of 2016. The increase includes the impact of the amortization of the debt discount and the presentation of interest costdeferred financing costs related to the Company’s derivative instruments. Interest cost related to the Company’s derivative instruments in place in 2013 is presented in Interest expense on the statement of operations, as the related derivative instrument is an effective cash flow hedge of the Company’s interest rate risk for which hedge accounting is applied. As the Company did not apply hedge accounting on its prior derivative instruments in place through March 2012, the related interest costs incurred prior to March 23, 2012 are presented in Realized and unrealized loss on derivative financial instruments in the consolidated statements of operations and comprehensive income (loss).
Company's outstanding debt. Amortization of debt discount and deferred debt costs included in interest expense for the years ended December 31, 2016, 2015 and 2014 2013was $6,936,000, $6,506,000 and 2012 was $1,081,000, $883,000 and $4,473,000,$5,485,000, respectively. These increases were offset by decreased interest expense on the Ascent intercompany loan, as Ascent Capital effectively retired $88,000,000 of the loan through a capital contribution in February of 2016.
Income Tax Expense. For the year ended December 31, 2016, we had a pre-tax loss of $69,159,000 and income tax expense of $7,148,000. For the year ended December 31, 2015, we had a pre-tax loss of $66,158,000 and income tax expense
of $6,290,000. For the year ended December 31, 2014, we had a pre-tax loss of $26,117,000 and income tax expense of $3,600,000. For the year ended December 31, 2013, we had a pre-tax loss of $13,606,000 and income tax expense of $3,081,000. For the year ended December 31, 2012, we had a pre-tax loss of $14,157,000 and income tax expense of $2,619,000. Income tax expense for the year ended December 31, 2014,2016, is attributable to Texasthe Company's state margin tax expense and the deferred tax impact from amortization of deductible goodwill attributable to the Security Networks Acquisition, offset by changes in state deferred taxes.and LiveWatch acquisitions. Income tax expense from continuing operations for the yearyears ended December 31, 2013,2015 and 2014 is primarily attributable to Texasthe Company's state margin tax expense and the deferred tax impact from amortization of deductible goodwill attributable to the Security Networks Acquisition, offset byAcquisition.
Net loss. For the reduction in valuation allowance as a result of acquisition accounting for the Security Networks Acquisition. Income tax expenseyear ended December 31, 2016, net loss increased to $76,307,000 from $72,448,000 for the year ended December 31, 20122015. The increase in net loss is primarily attributable to Texas state margin tax.increase in costs incurred under the Company's Radio Conversion Program, increased equipment, sales and marketing costs incurred by LiveWatch related to the acquisition of new subscribers and increases in debt refinance expenses related to the size and cost of the 2016 Credit Facility refinancing as compared to the 2015 refinancings.
TableFor the year ended December 31, 2015, net loss increased to $72,448,000 from $29,717,000 for the year end December 31, 2014. The increase in net loss is attributable to a $13,256,000 increase in costs incurred under the Company's Radio Conversion Program, the negative impact of Contentssubscriber acquisition costs as a result of LiveWatch's direct-to-consumer model, increased interest costs and refinancing costs of $4,468,000 related to the April 2015 amendment to the Company's Credit Facility.
Adjusted EBITDA. The following table provides a reconciliation of totalnet loss to Pre-SAC Adjusted EBITDA to net loss (amounts in thousands): | | | Year Ended December 31, | Year Ended December 31, |
| 2014 | | 2013 | | 2012 | 2016 | | 2015 | | 2014 |
Adjusted EBITDA | $ | 362,227 |
| | 305,250 |
| | 235,675 |
| |
Net loss | | $ | (76,307 | ) | | (72,448 | ) | | (29,717 | ) |
Amortization of subscriber accounts, dealer network and other intangible assets | (253,403 | ) | | (208,760 | ) | | (163,468 | ) | 246,753 |
| | 258,668 |
| | 253,403 |
|
Depreciation | (9,019 | ) | | (7,327 | ) | | (5,286 | ) | 8,160 |
| | 10,066 |
| | 9,019 |
|
Stock-based compensation | (2,068 | ) | | (1,779 | ) | | (1,384 | ) | 2,598 |
| | 2,271 |
| | 2,068 |
|
One-time severance expense (a) | | 730 |
| | 112 |
| | — |
|
Restructuring charges | (952 | ) | | (1,111 | ) | | — |
| — |
| | — |
| | 952 |
|
Radio Conversion Program costs | (1,113 | ) | | — |
| | — |
| 18,422 |
| | 14,369 |
| | 1,113 |
|
Security Networks Acquisition costs | — |
| | (2,470 | ) | | — |
| |
Security Networks Integration costs | (2,182 | ) | | (1,264 | ) | | — |
| — |
| | — |
| | 2,182 |
|
Realized and unrealized loss on derivative financial instruments | — |
| | — |
| | (2,044 | ) | |
LiveWatch acquisition related costs | | — |
| | 946 |
| | — |
|
LiveWatch acquisition contingent bonus charges | | 3,944 |
| | 3,930 |
| | — |
|
Headquarters relocation costs | | — |
| | 720 |
| | — |
|
Rebranding marketing program | | 2,991 |
| | — |
| | — |
|
Software implementation/integration | | 511 |
| | — |
| | — |
|
Cost reduction initiative | | 250 |
| | — |
| | — |
|
Refinancing expense | — |
| | — |
| | (6,245 | ) | 9,500 |
| | 4,468 |
| | — |
|
Gain on revaluation of Security Networks Acquisition dealer liabilities | | (7,160 | ) | | — |
| | — |
|
Interest expense | (119,607 | ) | | (96,145 | ) | | (71,405 | ) | 127,308 |
| | 125,415 |
| | 119,607 |
|
Income tax expense | (3,600 | ) | | (3,081 | ) | | (2,619 | ) | 7,148 |
| | 6,290 |
| | 3,600 |
|
Net loss | $ | (29,717 | ) | | (16,687 | ) | | (16,776 | ) | |
Adjusted EBITDA | | 344,848 |
| | 354,807 |
| | 362,227 |
|
Gross subscriber acquisition cost expenses | | 26,126 |
| | 18,298 |
| | — |
|
Revenue associated with subscriber acquisition cost | | (4,493 | ) | | (4,022 | ) | | — |
|
Pre-SAC Adjusted EBITDA | | $ | 366,481 |
| | 369,083 |
| | 362,227 |
|
(a)Severance expense related to a reduction in headcount event and transitioning executive leadership
Adjusted EBITDA increased $56,977,000,decreased $9,959,000, or 18.7%2.8%, for the year ended December 31, 20142016 and $7,420,000, or 2.0%, for the year ended December 31, 2015, as compared to the corresponding prior year.years. The increase indecreases are primarily driven by LiveWatch's subscriber acquisition costs that LiveWatch incurs to create its customers through its direct-to-consumer business model. As
LiveWatch creates more subscribers, Adjusted EBITDA was primarily due to revenue growth.will be negatively impacted. LiveWatch's subscriber acquisition costs were $21,633,000 and $14,276,000 for the years ended December 31, 2016 and 2015, respectively.
Pre-SAC Adjusted EBITDA increased $69,575,000,decreased $2,602,000, or 29.5%0.7%, for the year ended December 31, 20132016 and increased $6,856,000, or 1.9%, for the year ended December 31, 2015 as compared to the corresponding prior year. The increase in Adjusted EBITDA was primarily due to revenue growth.years.
Liquidity and Capital Resources
At December 31, 2014,2016, we had $1,953,000$3,177,000 of cash and cash equivalents. We may use a portion of these assets to decrease debt obligations, or fund potential strategic acquisitions or investment opportunities. Our primary source of funds is our cash flows from operating activities, which are generated from alarm monitoring and related service revenues. During the years ended December 31, 2014, 20132016, 2015 and 2012,2014, our cash flow from operating activities was $233,866,000, $214,649,000$190,527,000, $209,162,000 and $167,284,000,$234,282,000, respectively. The primary driver of our cash flow from operating activities is Adjusted EBITDA. Fluctuations in our Adjusted EBITDA and the components of that measure are discussed in “Results"Results of Operations”Operations" above. In addition, our cash flow from operating activities may be significantly impacted by changes in working capital.
During the years ended December 31, 2014, 20132016, 2015 and 2012,2014, we used cash of $268,160,000, $234,914,000$201,381,000, $266,558,000 and $304,665,000,$268,160,000, respectively, to fund the acquisition of subscriber accounts,account acquisitions, net of holdback and guarantee obligations. In addition, during the years ended December 31, 2014, 20132016, 2015 and 2012,2014, we used cash of $7,769,000, $9,925,000$9,178,000, $12,422,000 and $5,868,000,$7,769,000, respectively, to fund our capital expenditures.
In 2013,2015, we paid cash of $478,738,000 as part$56,778,000 for the acquisition of LiveWatch, net of the purchase price paidtransfer of $3,988,000 to acquire Security Networks, net of Security Networks'LiveWatch upon the closing date to fund LiveWatch employees' transaction bonuses and LiveWatch cash on hand of $3,096,000.$784,000. The Security NetworksLiveWatch Acquisition was funded by borrowings from our expanded Credit Facility revolver as well as cash contributions from Ascent Capital.
On February 29, 2016, the Board of Directors of Ascent Capital approved the proceedscontribution to the stated capital of the issuanceCompany of $175,000,000 in aggregate$88,000,000 of the $100,000,000 outstanding principal amount of 9.125% Senior Notes due 2020, the proceeds of incremental term loans of $225,000,000 million issued under the Company’s existing credit facility,Ascent Intercompany Loan. The remaining $12,000,000 principal amount is reflected on the Amended and the proceeds ofRestated Promissory Note, which is due on October 1, 2020 and bears interest at a $100,000,000 intercompany loan from Ascent Capital (the “Ascent Intercompany Loan”). In additionrate equal to the12.5% per annum, payable semi-annually in cash paid, the purchase price also consisted of 253,333 shares of Ascent Capital’s Series A common stock (the “Ascent Shares”), par value $0.01 per share, which were contributed to the Company by Ascent Capital. The Ascent Shares had a Closing Date fair value of $18,723,000.in arrears.
In considering our liquidity requirements for 2015,2017, we evaluated our known future commitments and obligations. We will require the availability of funds to finance our strategy which is to grow through the acquisition of subscriber account acquisitions. In 2014, we implemented a Radio Conversion Program in response to one ofaccounts. We considered the nation's largest carriers announcing that it does not intend to support its 2G cellular network services beyond 2016. In connection withexpected cash flow, as this business is the Radio Conversion Program, we could incur incremental costs of $13,000,000 to $16,000,000 per year through 2016, as we replace or upgrade equipment used in thosedriver of our subscribers' security systems that operate over this carrier's network. In addition, we consideredoperating cash flows, as well as the borrowing capacity of our Credit Facility revolver, under which we could borrow an additional $154,500,000$250,200,000 as of December 31, 2014.2016. Based on this
analysis, we expect that cash on hand, cash flow generated from operations and borrowings under the our Credit Facility will provide sufficient liquidity, given our anticipated current and future requirements.
The existing long-term debt at December 31, 20142016 includes the principal balance of $1,653,799,000$1,739,050,000 under our Senior Notes, the Ascent Intercompany Loan, our Credit Facility, and our Credit Facility revolver. The Senior Notes have an outstanding principal balance of $585,000,000 as of December 31, 2014 and mature on April 1, 2020.2016. The Ascent Intercompany Loan hashad an outstanding principal balance of $100,000,000$12,000,000 as of December 31, 2014 and matures on October 1, 2020.2016. The Credit Facility term loans have an outstanding principal balance of $898,299,000$1,097,250,000 as of December 31, 20142016 and require principal payments of $2,292,000$2,750,000 per quarter withand the remaining outstanding balanceamount becoming due on March 23, 2018.September 30, 2022. The Credit Facility revolver has an outstanding balance of $70,500,000$44,800,000 as of December 31, 20142016 and becomes due on December 22, 2017.September 30, 2021.
We may seek capital contributions from Ascent Capital or debt financing in the event of any new investment opportunities, additional capital expenditures or our operations requiring additional funds, but there can be no assurance that we will be able to obtain capital contributions from Ascent Capital or debt financing on terms that would be acceptable to us or at all. Our ability to seek additional sources of funding depends on our future financial position and results of operations, which are subject to general conditions in or affecting our industry and our customers and to general economic, political, financial, competitive, legislative and regulatory factors beyond our control.
Contractual Obligations
Information concerning the amount and timing of required payments under our contractual obligations at December 31, 20142016 is summarized below (amounts in thousands): | | | Payments Due by Period | Payments Due by Period |
| Less than 1 Year | | 1-3 Years | | 3-5 Years | | After 5 Years | | Total | Less than 1 Year | | 1-3 Years | | 3-5 Years | | After 5 Years | | Total |
Operating leases | $ | 2,775 |
| | 5,657 |
| | 5,345 |
| | 30,785 |
| | 44,562 |
| $ | 3,748 |
| | 6,690 |
| | 5,646 |
| | 25,466 |
| | 41,550 |
|
Long-term debt (a) | 9,166 |
| | 88,833 |
| | 870,800 |
| | 685,000 |
| | 1,653,799 |
| 11,000 |
| | 22,000 |
| | 663,800 |
| | 1,042,250 |
| | 1,739,050 |
|
Other (b) | 19,156 |
| | 220 |
| | 476 |
| | 7,247 |
| | 27,099 |
| 14,026 |
| | 220 |
| | 502 |
| | 4,516 |
| | 19,264 |
|
Total contractual obligations | $ | 31,097 |
| | 94,710 |
| | 876,621 |
| | 723,032 |
| | 1,725,460 |
| $ | 28,774 |
| | 28,910 |
| | 669,948 |
| | 1,072,232 |
| | 1,799,864 |
|
We have contingent liabilities related to legal proceedings and other matters arising in the ordinary course of business. Although it is reasonably possible we may incur losses upon conclusion of such matters, an estimate of any loss or range of loss cannot be made. In the opinion of management, it is expected that amounts, if any, which may be required to satisfy such contingencies will not be material in relation to the accompanying consolidated financial statements.
None.
The Company reviews the subscriber accounts for impairment or a change in amortization method and period whenever events or changes indicate that the carrying amount of the asset may not be recoverable or the life should be shortened. For purposes of recognition and measurement of an impairment loss, we view subscriber accounts as a single pool because of the assets’ homogeneous characteristics, and because the pool of subscriber accounts is the lowest level for which identifiable cash flows are largely independent of the cash flows of the other assets and liabilities.
We perform impairment tests for our long-lived assets, primarily property and equipment, if an event or circumstance indicates that the carrying amount of our long-lived assets may not be recoverable. We are subject to the possibility of impairment of long-lived assets arising in the ordinary course of business. We regularly consider the likelihood of impairment and may recognize impairment if the carrying amount of a long-lived asset or intangible asset is not recoverable from its undiscounted cash flows. Impairment is measured as the difference between the carrying amount and the fair value of the asset. We use both the income approach and market approach to estimate fair value. Our estimates of fair value are subject to a high degree of judgment since they include a long-term forecast of future operations. Accordingly, any value ultimately derived from our long-lived assets may differ from our estimate of fair value.
We must make estimates of the collectability of our trade receivables. We perform extensive credit evaluations on the portfolios of subscriber accounts prior to acquisition and require no collateral on the accounts that are acquired. We establish an allowance for doubtful accounts for estimated losses resulting from the inability of subscribers to make required payments. Factors such as historical-loss experience, recoveries and economic conditions are considered in determining the sufficiency of the allowance to cover potential losses. Our trade receivables balance was $13,796,000,$13,869,000, net of allowance for doubtful accounts of $2,120,000,$3,043,000, as of December 31, 2014.2016. As of December 31, 2013,2015, our trade receivables balance was $13,019,000,$13,622,000, net of allowance for doubtful accounts of $1,937,000.$2,762,000.
We perform our annual goodwill impairment analysis during the fourth quarter of each fiscal year. In the event that we are not able to achieve expected cash flow levels, or other factors indicate that goodwill is impaired, we may need to write off all or part of our goodwill, which would adversely impact our operating results and financial position.
The table below provides information about our debt obligations and derivative financial instruments that are sensitive to changes in interest rates. Interest rate swaps are presented at fair value and by maturity date. Debt amounts represent principal payments by maturity date.