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," Item 1A. "Risk Factors", Item 2. "Properties," Item 3. "Legal Proceedings," Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations" and Item 7A. "Quantitative and Qualitative Disclosures About Market 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 our largest demographic;
uncertainties in the development of our business strategies, including our increased direct marketing efforts and market acceptance of new products and services;
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;
our ability to acquire and integrate additional accounts, including competition for dealers with other alarm monitoring companies which could cause an increase in expected subscriber acquisition costs;
the regulatory environment in which we operate, including the multiplicity of jurisdictions, state and federal consumer protection laws and licensing requirements to which we and/or itsour 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 operating performance of our network, including the potential for service disruptions at both the main monitoring facility and back-up monitoring facility due to acts of nature or technology deficiencies;
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 Monitronics business partners;
the reliability and creditworthiness of our independent alarm systems dealers and subscribers;
the availability and terms of capital, including the ability of the Company to obtain future 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" 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 had two reportable segments as of December 31, 2015, Monitronics2016, 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 1990 Wittington Place, Farmers Branch, Texas, telephone number (972) 243-7443.
We are one of the largest security alarm monitoring companies in the United States ofNorth America, (the "U.S.")., 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.
MonitronicsMONI 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, 2015,2016, we provided contract monitoring services for over 93,00078,000 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 2015,2016, we acquired alarm monitoring contracts from more than 520430 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") 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 5% 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 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 7075 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 2015,2016, we dispatched over 580approximately 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 Monitronics,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 MonitronicsMONI 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 call centersoperations in its operations center in St. Marys,central Kansas and in a satellite office in Evanston, Illinois to handle sales, monitoring activations, technical support, billing and other general inquiry matters.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.
LiveWatch has a registered service mark for the LiveWatch name and a service mark for the LiveWatch logo.
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 creationsubscriber acquisition costs ("SAC"), or the costs of acquiring an account. CreationSubscriber 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), 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 manage 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 while focusing on creation costs.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; and
we reliably offer competitive rates for account acquisition.dealers.
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, and as of February 29, 2016,fragmented. 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");
•Vivint, Inc., a subsidiary of APX Group Holdings,;
Guardian Protection Services;
Vector Security, Inc.;
•Protection One,Comcast Corporation and
AT&T Inc., a subsidiary of Apollo Global Management, Inc. ("AGM"); and
•Stanley Security Solutions, a subsidiary of Stanley Black and Decker.
On February 16,May 2, 2016 ADT announced that it would be acquired by certain funds managed by affiliatesthe successful completion of AGM and then mergeda previously announced merger with AGM's subsidiary,Prime Security Services Borrow, LLC (with its subsidiaries, Protection One, Inc. ADT and AGM expect thatOne). Despite this merger, the transaction will be completed by June 2016. The security alarm industry has remained highly competitive and has 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. There are also threats of potential new entrantsproviders and other technology companies expanding into the security alarm monitoring space from technology companies that may offer professional alarm monitoring or self monitored solutions.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 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"); 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 additional information on the regulatory framework in which we operate, please see "ITEM 1A. RISK FACTORS--Factprs--Factors Relating to Regulatory Matters."
Employees
At December 31, 2015,2016, we had over 1,5001,370 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 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 incurred to acquire 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, 2015.2016. 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 alarm monitoring business and competition from other alarm monitoring companies. If we experience a loss of dealers representing a significant portion of itsour 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 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 rely on a significant number of our subscribers remaining with us for an extended period of time.
We incur significant upfront 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"), 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 ourits obligations under ourits 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. 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 or cease operations altogether as a result of business conditions or due to increasingly burdensome regulatory compliance, the dealer may breach 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 could be materially and adversely affected to a greater degree than if the dealer had originated a smaller number of accounts.
TheAn inability to provide the contracted monitoring service could adversely affect our business.
A disruption to the main monitoring facility, the back-up monitoring facility and/or third party monitoring facility could affect our ability to provide alarm monitoring business is subjectservices to macroeconomic factors that may negatively impact our resultsits subscribers. Our main monitoring facility holds UL listings as a protective signaling services station and maintains certain standards of operations, including prolonged downturns in the economy.
The alarm monitoring business is dependent in part on national, regionalbuilding integrity, redundant computer and local economic conditions. In particular, where disposable income available for discretionary spending is reduced (such as by higher housing, energy, interest orcommunications facilities and backup power, among 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,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, 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 continue acquiring quality alarm monitoring contracts or that it 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.
Adverse economic conditions in states where our subscribers are more heavily concentrated may negatively impact our results of operations.
Even as economic conditions may improveperform effectively in the United States asevent its main monitoring center is disrupted. Any such disruption, particularly one of a whole, this improvement may not occur or further deterioration may occur in the regions where Monitronics’ subscribers are more heavily concentrated (such as Texas, California, Florida and Arizona). Although weprolonged duration, could have a geographically diverse subscriber base,material adverse conditionseffect 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 facilities 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 states whereof these telecommunications providers or signal processing centers to transmit and communicate signals to the monitoring facility in a timely manner could affect our business is more heavily concentratedability 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, 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 facilities 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' support for, telecommunications services and equipment could adversely impact our business and require significant capital expenditures" below with respect to risks associated with changes in signal transmissions.
Our reputation as a service provider of high quality security offerings may be adversely affected by product defects or shortfalls in customer service.
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 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 and customer care centers, dealers and technicians who perform on-site maintenance services. Any failure to meet subscribers' expectations in such customer service areas could cause an increase in attrition rates or make it difficult to recruit new subscribers. Any harm to our reputation 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 our business, financial condition and results of 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 the insurance industrywe were to change its practiceexperience a breach of providing incentivesour data security, it may put private information of our subscribers at risk of exposure. To the extent that any such exposure leads to homeowners for the use of alarm monitoring services,credit card fraud or identity theft, we may experience a reductiongeneral decline in new customer growth orconsumer 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.
Shifts in customer choice of, or telecommunications providers' support for, telecommunications services and equipment could adversely impact our business and require significant capital expenditures.
Substantially all of our subscriber attrition rate.
Italarm 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 been common practicecontinued to decline as fewer new customers utilize land-lines and consumers 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 insurancefuture 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 their monitoring service. The process of changing out this equipment will require us to subsidize the replacement of subscribers' outdated equipment and is likely to cause an increase in subscriber 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 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, its business, financial condition, results of operations and cash flows could be materially and adversely affected.
Our 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 providechoose us or our competitor’s products and a reductionsubscriber'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 for policies written on homesover time and hinder the acquisition of new alarm monitoring 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, 2016, we were 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 technology companies who are expanding into alarm monitoring services and bundling their existing offerings with monitored alarm systems. Theresecurity 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 insurancewe 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, will continue to offer these rate reductions. If these incentives were reduced or eliminated, new homeowners who otherwisewe may not feelbe able to certify as to the need for alarm monitoring services would be removed from our potential customer pool, which could hindereffectiveness of these companies' disclosure controls and procedures or internal control over financial reporting within the growth of our business,time periods required by U.S. federal securities laws 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.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 itsour dealers), violations of "false alarm" ordinances or other regulations, 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 the Companyus or at all.
An inability to provide the contracted monitoring service could adversely affect our business.
A disruption to the main monitoring facility, the back-up monitoring facility and/or third party monitoring facility could affect our ability to provide alarm monitoring services to our 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, 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 its 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 facilities 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. 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 facilities 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’ support for, telecommunications services and equipment could adversely impact our business and require significant capital 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.
The high level of competition in our industry could adversely affect its business.
The security alarm monitoring industry is highly competitive and fragmented. As of December 31, 2015, we were 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, Inc., may be combined into a single company in a transaction expected to be completed by June 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 and cable 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.
Shifts in customer choice of, or telecommunications providers’ support for, telecommunications services and equipment could adversely impact our business and require significant capital expenditures.
Substantially all of our subscriber alarm systems use either a traditional land-line or cellular 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 expects to 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 and is likely to cause an increase in subscriber attrition. During 2014, we implemented 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 $14,369,000 in 2015 and $1,113,000 in 2014 and could incur incremental costs of $17,000,000 to $21,000,000 in 2016. We are working with the cellular carriers and other 2G network user groups to pursue strategies which could 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, our business, financial condition, results of operations and cash flows could be materially and adversely affected.
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. 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 shortfalls in customer service.
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 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 and customer care centers, dealers and technicians who perform on-site maintenance services. Any failure to meet subscribers’ expectations in such customer service areas could cause an increase in attrition rates or make it difficult to recruit new subscribers. Any harm to our reputation 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 our business, financial condition and results of operations.
A loss of experienced employees could adversely affect us.
The success of the Company has been largely dependent upon the active participation of ourits 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’employees' services and expertise could materially and adversely affect our business.
Our acquisition strategyThe alarm monitoring business is subject to macroeconomic factors that may not be successful.negatively impact our results of operations, including prolonged downturns in the economy.
One focusThe 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 our strategy is to seek opportunities to grow free cash flow through strategic acquisitions, which may include leveraged acquisitions. However, therecustomers 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 no assurancegiven that we will be able to consummatecontinue acquiring quality alarm monitoring contracts or that strategy,we will not experience higher attrition rates. In addition, any deterioration in new construction and if wesales 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 not able to invest its capitalprolonged durations of general economic downturn, our results of operations and subscriber account growth could be materially and adversely affected.
Adverse economic conditions in acquisitions thatstates where our subscribers are accretive to free cash flow it couldmore heavily concentrated may negatively impact its growth. Our ability to consummate such acquisitionsour results of operations.
Even as economic conditions 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 agenciesimprove 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 to any required regulatory approval.and results of operations.
If we engage in any acquisition, we will incur a varietythe insurance industry were to change its practice of costs, and may never realizeproviding incentives to homeowners for the anticipated benefitsuse 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, andalarm monitoring services, we may experience increased attritiona reduction in new customer growth or an increase in our subscriber base and/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 a losseliminated, 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 dealer relationships and difficulties integrating acquired businesses, technologies and personnel into our business, and existing subscribers may choose to disconnect or achieving anticipatednot renew their service contracts, which could increase our attrition rates. In either case our results of operations efficiencies or cost savings. Future acquisitionsand growth prospects 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’ disclosure controls and procedures or internal control over financial reporting within the time periods required by U.S. federal securities laws and regulations.
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 its 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.affected.
We may pursue business opportunities that diverge from itsour current business model, which may cause itsour 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 were precluded from using or licensing the “Monitronics”"MONI" mark or the "LiveWatch" mark or others were allowed to use such mark. If we were 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 were 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, 2015,2016, we havehad principal indebtedness of $1,667,909,$1,142,050,000 related to termsterm loans maturing in September 2022 and a revolving credit facility maturing in September 2021, both under its senior secured credit agreement (together referred toour
Credit Facility, as the "Credit Facility"), andwell as a $585,000,000 of 9.125% senior notes (the "Senior Notes"). due April 2020. At December 31, 2015,2016, we also had outstanding 9.868%a 12.5% intercompany promissory note of $100,000,000$12,000,000 due to the Ascent Capital of which $88,000,000 has since been contributed to our stated capital and the remaining $12,000,000 of which is currently outstanding and subject to an amended and restated promissory note that is subject to an interest rate of 12.5%.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 our parent company, Ascent Capital;
restrict subsidiary distributions;
dissolve, merge or consolidate;
make capital expenditures in excess of certain annual limits on the amount of capital expenditures;limits;
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.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 5.00 to 1.00, a consolidated senior secured leverage ratio (as defined in the Credit Facility) of not more than 3.255.25 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 28.031.0 to 1.00 calculated quarterly, and an attrition ratea consolidated senior secured RMR leverage ratio (as defined in the Credit Facility) of no more than 15.0%,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 we or 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 Monitronics’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 or policies 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 50,000 subscribers in areas covered by these ordinances or policies, 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") 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 Companycompany (through itsour 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. We 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 dealersdealers' direct marketing efforts. In addition, although we have taken steps to insulate our 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 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 itsour 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.
"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; 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 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 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 policies of this nature could adversely effect our business.
Factors Related to Our Structure and Our Parent’sParent'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, 2015,2016, we had goodwill of $563,549,000, which represents approximately 27.2%27.7% of total assets. Goodwill was recorded in connection with the Monitronics,MONI, Security Networks, and LiveWatch acquisitions. The Company accounts for its goodwill pursuant to the provisions of FASB ASCFinancial 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). 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 Captial'sCapital'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
The CompanyMONI leases approximately 165,000 square feet in Farmers Branch, Texas to house its executive offices, monitoring and certain call centers, sales and marketing and data retention functions. WeMONI also leases approximately 16,000 square feet of office space in Dallas, Texas and 13,000 square feet in McKinney, Texas, of office space that support oursupports its monitoring operations and back up facility.
LiveWatch leases approximately 10,00011,000 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 fulfillment function and software development.office functions. Additionally, LiveWatch leases approximately 1,5006,700 square feet of office space in Evanston, Illinois for its 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 did not pay anypaid 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, 2015. We have paid $2,000,000 in dividends to Ascent Capital for the year ended December 31, 2014. From time to time we may provide dividends to Ascent Capital as permitted in our Credit Facility.
ITEM 6. SELECTED FINANCIAL DATA
The (i) selected balance sheet data as of December 31, 2016 and 2015 and 2014 and (ii) the selected statementstatements of operations data for the fiscal years ended December 31, 2016, 2015, and 2014, and 2013,all 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, 2014, 2013 2012 and 20112012 and the statements of operations data for the years ended December 31, 20122013 and 20112012 shown below were derived from previously issued financial statements including a reclass of deferred financing costs and current deferred taxes as required by the adoption of new pronouncements from the Financial Accounting Standards Board. statements.
| | | Summary Balance Sheet Data | As of December 31, | As of December 31, |
| (Amounts in thousands): | 2015 | | 2014 | | 2013 | | 2012 | | 2011 | 2016 | | 2015 | | 2014 | | 2013 | | 2012 |
| Current assets | $ | 26,147 |
| | 23,326 |
| | 23,733 |
| | 30,561 |
| | 49,890 |
| $ | 26,406 |
| | 26,147 |
| | 23,326 |
| | 23,733 |
| | 30,561 |
|
| Property and Equipment, net | $ | 26,654 |
| | 23,280 |
| | 24,561 |
| | 20,559 |
| | 19,977 |
| $ | 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 | $ | 2,070,267 |
| | 1,997,162 |
| | 1,985,674 |
| | 1,420,720 |
| | 1,327,960 |
| $ | 2,033,717 |
| | 2,070,267 |
| | 1,997,162 |
| | 1,985,674 |
| | 1,420,720 |
|
| Current liabilities | $ | 82,715 |
| | 84,565 |
| | 86,831 |
| | 60,747 |
| | 103,142 |
| $ | 87,171 |
| | 82,715 |
| | 84,565 |
| | 86,831 |
| | 60,747 |
|
| Long-term debt | $ | 1,739,147 |
| | 1,619,624 |
| | 1,572,305 |
| | 1,080,836 |
| | 891,347 |
| $ | 1,687,778 |
| | 1,739,147 |
| | 1,619,624 |
| | 1,572,305 |
| | 1,080,836 |
|
| Stockholder’s equity | $ | 201,065 |
| | 257,566 |
| | 292,660 |
| | 258,924 |
| | 288,624 |
| |
| Stockholder's equity | | $ | 214,945 |
| | 201,065 |
| | 257,566 |
| | 292,660 |
| | 258,924 |
|
| | | Summary Statement of Operations Data | Fiscal Year Ended December 31, | Fiscal Year Ended December 31, |
| (Amounts in thousands): | 2015 | | 2014 | | 2013 | | 2012 | | 2011 | 2016 | | 2015 | | 2014 | | 2013 | | 2012 |
| Net revenue | $ | 563,356 |
| | 539,449 |
| | 451,033 |
| | 344,953 |
| | 311,898 |
| $ | 570,372 |
| | 563,356 |
| | 539,449 |
| | 451,033 |
| | 344,953 |
|
| Operating income (loss) | $ | 63,725 |
| | 93,490 |
| | 82,539 |
| | 66,167 |
| | 49,187 |
| $ | 67,649 |
| | 63,725 |
| | 93,490 |
| | 82,539 |
| | 66,167 |
|
| Net income (loss) | $ | (72,448 | ) | | (29,717 | ) | | (16,687 | ) | | (16,776 | ) | | (6,759 | ) | $ | (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 of independent dealers.
Revenues are recognized as the related monitoring services are provided. Other revenues are derived from the provision of third-party contract monitoring services and from field technical repair services. Additionally,dealers or through LiveWatch generates revenue from equipment sales that is recognized as the equipment is shipped to the customer. All direct external costs associated with the creation of subscriber accounts and certain internal direct costs, including bonus incentives for account activations at LiveWatch, are capitalized and amortized over fifteen years using a declining balance method beginning in the month following the date of acquisition.
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, 20152016 and 2014:2015:
| | | | | Twelve Months Ended
December 31, | | | Twelve Months Ended
December 31, | |
| | | 2015 | | 2014 | | | 2016 | | 2015 | |
| Beginning balance of accounts | | 1,058,962 |
| | 1,046,155 |
| | | 1,089,535 |
| | 1,058,962 |
| |
| Accounts acquired | | 188,941 |
| | 156,225 |
| | | 125,292 |
| | 188,941 |
| |
| Accounts canceled | | (147,923 | ) | | (135,842 | ) | | | (148,878 | ) | | (147,923 | ) | |
| Canceled accounts guaranteed by dealer and acquisition adjustments (a) | | (10,445 | ) | | (7,576 | ) | (b) | |
| Canceled accounts guaranteed by dealer and other adjustments (a) | | | (19,158 | ) | (b) | (10,445 | ) | |
| Ending balance of accounts | | 1,089,535 |
| | 1,058,962 |
| | | 1,046,791 |
| | 1,089,535 |
| |
| Monthly weighted average accounts | | 1,086,071 |
| | 1,052,492 |
| | | 1,069,901 |
| | 1,086,071 |
| |
| Attrition rate (c) | | (13.6 | )% | | (12.9 | )% | | |
| 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 1,101 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) | The recurring monthly revenue ("RMR") attrition rate for the twelve months ended December 31, 2015 and 2014 was 13.7% and 12.6%, 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, 2016 and 2015 was 13.9% and 2014 was 13.6% and 12.9%, 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, primarily related toas well as, our more aggressive price increase strategy. Overall attrition reflects the impact of the Pinnacle Security bulk buys. Monitronicsbuys, where we purchased approximately 113,000 accounts from Pinnacle Security in 2012 and 2013 which are now experiencing normal end-of-term attrition. The Pinnacle Security accounts are contributing approximately 100 basis points of excess attrition within the overall portfolio. 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, 20152016 and 2014,2015, we acquired 37,34926,227 and 37,99837,349 subscriber accounts, respectively.
During the yearstwelve months ended December 31, 20152016 and 2014,2015, we acquired 188,941125,292 and 156,225157,022 subscriber accounts, respectively. Accountsrespectively, excluding the 31,919 accounts acquired for the year ended December 31, 2015 include 31,919 from the LiveWatch Acquisition in February 2015. Acquired contracts for the years ended December 31, 20152016 and 20142015 also include approximately 2,0008,600 and 8,3002,000 accounts, respectively, purchased in various bulk buys throughout the periods.
RMR acquired during the three and twelve months ended December 31, 20152016 was approximately $1,720,000$1,231,000 and $8,188,000,$5,835,000, respectively. RMR acquired for the year ended December 31, 2015 included $909,000 from the LiveWatch Acquisition in February 2015. RMR acquired during the three and twelve months ended December 31, 20142015 was approximately $1,776,000$1,720,000 and $7,182,000, respectively.$7,279,000, respectively, excluding $909,000 of RMR acquired from the LiveWatch Acquisition in February 2015.
Adjusted EBITDA
We evaluate the performance of our operations based on financial measures such as revenue and "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), 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 (amounts in thousands).
| | | | Year Ended December 31, | | Year Ended December 31, | |
| | 2015 | | 2014 | | 2013 | | 2016 | | 2015 | | 2014 | |
| Net revenue (a) | $ | 563,356 |
| | 539,449 |
| | 451,033 |
| | $ | 570,372 |
| | 563,356 |
| | 539,449 |
| |
| Cost of services | 110,246 |
| | 93,600 |
| | 74,136 |
| | 115,236 |
| | 110,246 |
| | 93,600 |
| |
| Selling, general, and administrative, including stock-based compensation | 106,287 |
| | 87,943 |
| | 77,162 |
| | 114,152 |
| | 106,287 |
| | 87,943 |
| |
| Amortization of subscriber accounts, dealer network and other intangible assets | 258,668 |
| | 253,403 |
| | 208,760 |
| | 246,753 |
| | 258,668 |
| | 253,403 |
| |
| Interest expense | 125,415 |
| | 119,607 |
| | 96,145 |
| | 127,308 |
| | 125,415 |
| | 119,607 |
| |
| Income tax expense from continuing operations | 6,290 |
| | 3,600 |
| | 3,081 |
| | 7,148 |
| | 6,290 |
| | 3,600 |
| |
| Net loss | (72,448 | ) | | (29,717 | ) | | (16,687 | ) | | (76,307 | ) | | (72,448 | ) | | (29,717 | ) | |
| | | | | | | | | | | | | |
| Adjusted EBITDA (b) | $ | 354,807 |
| | 362,227 |
| | 305,250 |
| | $ | 344,848 |
| | 354,807 |
| | 362,227 |
| |
| Adjusted EBITDA as a percentage of Revenue | 63.0 | % | | 67.1 | % | | 67.7 | % | | 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 yearsyear ended December 31, 2015 and 2013 reflects the negative impact of $359,000 and $2,715,000, respectively,of fair value adjustments that reduced deferred revenue acquired in the Security Networks Acquisition and LiveWatch Acquisition, respectively.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 $7,016,000, or 1.2%, for the year ended December 31, 2016 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 157,000 accounts through the MonitronicsMONI and LiveWatch subscriber channels, as well as 31,919 accounts from the LiveWatch Acquisition in February 2015. In addition, average monthly revenue per subscriber increased from $41.64 as of December 31, 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, Monitronics'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, 2015 also reflects the negative impact of a $359,000 fair value adjustment that reduced deferred revenue acquired in the LiveWatch Acquisition.
RevenueCost of Services. Cost of services increased $88,416,000,$4,990,000 or 19.6%4.5%, for the year ended December 31, 20142016 as compared to the corresponding prior year. The increase in net revenue is primarily attributable to the growthincreased field service costs due to a higher volume of retention jobs being completed and an increase in the number of subscriber accountsacquisition costs incurred at LiveWatch, related to increased account production and the increase in average monthly revenue per subscriber. The increase in net revenue is attributableinclusion of a full first quarter of production. Furthermore, cost of services increased due to more subscribers being monitored across the growth in the numbercellular network, including home automation accounts. LiveWatch's subscriber acquisition costs include expensed equipment costs associated with new subscribers of subscriber accounts and the increase in average monthly revenue per subscriber. The growth in subscriber accounts reflects the acquisition of over 200,000 accounts from the Security Networks Acquisition in August 2013 and the acquisition of over 145,000 accounts through
Monitronics’ authorized dealer program subsequent to December 31, 2013. In addition, average monthly revenue per subscriber increased from $40.90 as of December 31, 2013 to $41.64 as of December 31, 2014. Net revenue$8,928,000 for the year ended December 31, 2013 also reflects2016, compared to $7,058,000 for the negative impact of a $2,715,000 fair value adjustment that reduced deferred revenue acquired in the Security Networks Acquisition.
year ended December 31, 2015. Cost of Services.services as a percent of net revenue increased from 19.6% for the year ended December 31, 2015 to 20.2% for the year ended December 31, 2016. Cost
Costs of services increased $16,646,000, or 17.8%, for the year ended December 31, 2015 as compared to the corresponding prior year. The increase is attributable to 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 in the number of accounts being monitored across the cellular network, including home automation accounts, and service costs to upgrade existing subscribers' equipment. Service costCost of services as a percent of net revenue increased from 17.4% for the year ended December 31, 2014 to 19.6% for the year ended December 31, 2015.
Costs of services increased $19,464,000, or 26.3%, for the year ended December 31, 2014 as compared to the corresponding prior year. The increase is attributed to subscriber growth and increases in cellular and service costs as more accounts are being monitored across the cellular network, which require additional service costs to upgrade existing subscribers' equipment. In addition, Monitronics incurred redundant staffing costs at its Dallas, Texas monitoring and call center facilities through April 2014, when the transition of Security Networks operations from Florida to Texas was complete. Cost of service as a percent of net revenue increased from 16.4% for the year ended December 31, 2013 to 17.4% for the year ended December 31, 2014.
Selling, General and Administrative. Selling, general and administrative expense (“SG&A”) increased $7,865,000, or 7.4%, for the year ended December 31, 2016 as compared to the corresponding prior year. The increases are primarily attributable to subscriber acquisition costs incurred at LiveWatch from increased account production and the inclusion of a full first quarter of production, as well as increased salaries, wages and benefits costs and $2,991,000 of rebranding expense at MONI. LiveWatch's subscriber acquisition costs, which includes marketing and sales costs related to the creation 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 Acquisition of $7,160,000. SG&A as a percent of net revenue increased from 18.9% for the year ended December 31, 2015 to 20.0% for the year ended December 31, 2016.
SG&A expense increased $18,344,000, or 20.9%, for the year ended December 31, 2015 as compared to the corresponding prior year. The primary driver of the increase in SG&A expense is attributable to $11,240,000 of LiveWatch marketing and sales expense related to the creation of new subscribers. LiveWatch SG&A also includes $3,930,000 of contingent bonuses payable to LiveWatch's key members of management in accordance with the employment agreements entered into in connection with theth LiveWatch Acquisition. Other increases in SG&A are one-time costs incurred by the Company of $946,000 related to professional services rendered in connection with the LiveWatch Acquisition and $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 ourits 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 Security Networks integration. SG&A as a percent of net revenue increased from 16.3% for the year ended December 31, 2014 to 18.9% for the year ended December 31, 2015.
Selling, general and administrative expense (“SG&A”) increased $10,781,000, or 14.0%, for the year ended December 31, 2014 as compared to the corresponding prior year. The increase is attributable to increases in Monitronics SG&A costs which are primarily attributable to subscriber growth over the last twelve months. In addition, Monitronics incurred redundant staffing and operating costs in its Dallas, Texas headquarters through April 2014, when the transition of Security Network operations from Florida to Texas was completed. SG&A as a percent of net revenue decreased from 17.1% for the year ended December 31, 2013 to 16.3% for the year ended December 31, 2014.
Amortization of Subscriber Accounts, Dealer Network and Other Intangible Assets. Amortization of subscriber accounts, dealer network and other intangible assets increased $5,265,000 and $44,643,000decreased $11,915,000 for the yearsyear ended December 31, 20152016 and 2014,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 year ended December 31, 2014, amortization includes approximately $58,126,0002015 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 Acquisition2015 as compared to $23,599,000 for the year ended December 31, 2013.account purchases in 2014.
Interest Expense. Interest expense increased $5,808,000$1,893,000 and $23,462,000$5,808,000 for the years ended December 31, 20152016 and 2014,2015, respectively, as compared to the corresponding prior years. The increase in interest expense for the year ended December 31, 2015 is primarily attributable to increases in the Company's consolidated debt balance related to the borrowings incurred to fund the the Company's LiveWatch acquisition and the subsequent amendment of its Credit Facility term loans in February and April 2015.2015 and September 2016. Additionally, Amendment No. 6 to the Existing 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 deferred financing costs related to the Company's outstanding debt.
The increase in interest expense for the year ended December 31, 2014 is attributable to increases in the Company's consolidated debt balance related to the borrowings incurred to fund the Security Networks Acquisition. The increase is partially offset by the favorable repricing of Monitronics' credit facility interest rates effective March 25, 2013.
Amortization of debt discount and deferred debt costs included in interest expense for the years ended December 31, 2016, 2015 and 2014 was $6,936,000, $6,506,000 and 2013 was $6,506,000, $5,485,000, and $4,404,000, respectively.
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. Income tax expense for the year ended December 31, 2015,2016, is attributable to Texasthe Company's state margin tax and the deferred tax impact from amortization of deductible goodwill attributable to the LiveWatch and Security Networks acquisitions. Income tax expense for the years ended December 31, 2014 and 2013, is attributable to Texas state margin tax and the deferred tax impact from amortization of deductible goodwill attributable to the Security Networks and LiveWatch acquisitions. Income tax expense from continuing operations for the years ended December 31, 2015 and 2014 is primarily attributable to the Company's state tax expense and the deferred tax impact from amortization of deductible goodwill attributable to the Security Networks Acquisition.
Net loss. For the year ended December 31, 2013, income tax is offset by the reduction in valuation allowance as result of acquisition accounting2016, net loss increased to $76,307,000 from $72,448,000 for the Security Networks Acquisition.year ended December 31, 2015. The increase in net loss is attributable to 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.
Net loss. For the year ended December 31, 2015, net loss increased to $72,448,000 from $29,717,000 for the year endedend 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 expensed creationsubscriber acquisition costs as a result of LiveWatch's direct-to-consumer model, (which is further discussed in Adjusted EBITDA below), increased interest costs and refinancing costs of $4,468,000 related to the April 2015 amendment to Monitronics'the Company's Credit Facility.
For the year ended December 31, 2014, net loss increased to $29,717,000 from $16,687,000 for the year end December 31, 2013. The increase in net loss is primarily attributable to increased interest costs as a result of the borrowings incurred to fund the Security Networks Acquisition.
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, |
| | 2015 | | 2014 | | 2013 | 2016 | | 2015 | | 2014 |
| Adjusted EBITDA | $ | 354,807 |
| | 362,227 |
| | 305,250 |
| |
| Net loss | | $ | (76,307 | ) | | (72,448 | ) | | (29,717 | ) |
| Amortization of subscriber accounts, dealer network and other intangible assets | (258,668 | ) | | (253,403 | ) | | (208,760 | ) | 246,753 |
| | 258,668 |
| | 253,403 |
|
| Depreciation | (10,066 | ) | | (9,019 | ) | | (7,327 | ) | 8,160 |
| | 10,066 |
| | 9,019 |
|
| Stock-based compensation | (2,271 | ) | | (2,068 | ) | | (1,779 | ) | 2,598 |
| | 2,271 |
| | 2,068 |
|
| One-time severance expense (a) | (112 | ) | | — |
| | — |
| 730 |
| | 112 |
| | — |
|
| Restructuring charges | — |
| | (952 | ) | | (1,111 | ) | — |
| | — |
| | 952 |
|
| Radio Conversion Program costs | (14,369 | ) | | (1,113 | ) | | — |
| 18,422 |
| | 14,369 |
| | 1,113 |
|
| Security Networks Acquisition costs | — |
| | — |
| | (2,470 | ) | |
| Security Networks Integration costs | — |
| | (2,182 | ) | | (1,264 | ) | — |
| | — |
| | 2,182 |
|
| LiveWatch acquisition related costs | (946 | ) | | — |
| | — |
| — |
| | 946 |
| | — |
|
| LiveWatch acquisition contingent bonus charges | (3,930 | ) | | — |
| | — |
| 3,944 |
| | 3,930 |
| | — |
|
| Headquarters relocation costs | (720 | ) | | — |
| | — |
| — |
| | 720 |
| | — |
|
| Rebranding marketing program | | 2,991 |
| | — |
| | — |
|
| Software implementation/integration | | 511 |
| | — |
| | — |
|
| Cost reduction initiative | | 250 |
| | — |
| | — |
|
| Refinancing expense | (4,468 | ) | | — |
| | — |
| 9,500 |
| | 4,468 |
| | — |
|
| Gain on revaluation of Security Networks Acquisition dealer liabilities | | (7,160 | ) | | — |
| | — |
|
| Interest expense | (125,415 | ) | | (119,607 | ) | | (96,145 | ) | 127,308 |
| | 125,415 |
| | 119,607 |
|
| Income tax expense | (6,290 | ) | | (3,600 | ) | | (3,081 | ) | 7,148 |
| | 6,290 |
| | 3,600 |
|
| Net loss | $ | (72,448 | ) | | (29,717 | ) | | (16,687 | ) | |
| 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.leadership
Adjusted EBITDA decreased $9,959,000, or 2.8%, for the year ended December 31, 2016 and $7,420,000, or 2.0%, for the year ended December 31, 2015, as compared to the corresponding prior year.years. The decreases 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 iswill be negatively impactedimpacted. 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 decreased $2,602,000, or 0.7%, for the year ended December 31, 2016 and increased $6,856,000, or 1.9%, for the year ended December 31, 2015 due to LiveWatch's direct-to-consumer business, which requires it to recognize certain revenue and expenses associated with the creation of subscriber accounts. This is in contrast to Monitronics' dealer business, which capitalizes payments to dealers to acquire accounts and amortizes those payments to amortization expense over the life of the accounts. LiveWatch's expensed creation costs, net of creation revenue, included in adjusted EBITDA for the year ended December 31, 2015 was $14,276,000.
Adjusted EBITDA increased $56,977,000, or 18.7% for the year ended December 31, 2014 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, 2015,2016, we had $2,580,000$3,177,000 of cash and cash equivalents and $55,000 of current restricted 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, 2016, 2015 2014 and 2013,2014, our cash flow from operating activities was $208,844,000, $233,866,000$190,527,000, $209,162,000 and $214,649,000,$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 of 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, 2016, 2015 2014 and 2013,2014, we used cash of $201,381,000, $266,558,000 $268,160,000 and $234,914,000,$268,160,000, respectively, to fund the subscriber account acquisitions, net of holdback and guarantee obligations. In addition, during the years ended December 31, 2016, 2015 2014 and 2013,2014, we used cash of $9,178,000, $12,422,000 $7,769,000 and $9,925,000,$7,769,000, respectively, to fund our capital expenditures.
In 2015, Monitronicswe paid cash of $56,778,000 for the acquisition of LiveWatch, net of the transfer of $3,988,000 to LiveWatch upon the Closing Dateclosing date to fund LiveWatch employees' transaction bonuses and LiveWatch cash on hand of $784,000. The LiveWatch Acquisition was funded by borrowings from Monitronics'our expanded Credit FactilityFacility revolver as well as cash contributions from Ascent Capital.
In 2013, we paid cash of $478,738,000 as part of the purchase price paid to acquire Security Networks, net of Security Networks' cash on hand of $3,096,000. The Security Networks Acquisition was funded by cash contributions from Ascent Capital, the proceeds of the issuance of $175,000,000 in aggregate principal amount of 9.125% Senior Notes due 2020, the proceeds of incremental term loans of $225,000,000 issued under the Company’s existing credit facility, and the proceeds of a $100,000,000 intercompany loan from Ascent Capital (the “Ascent Intercompany Loan”). In addition to the 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 considering our liquidity requirements for 2016, we evaluated our known future commitments and obligations. We will require the availability of funds to finance our strategy to grow through the acquisition of subscriber accounts. In 2014, we implemented a Radio Conversion Program in response to one of the nation's largest carriers announcing that it does not intend to support its 2G cellular network services beyond 2016. The Company has incurred $14,369,000 and $1,113,000 in connection with the Radio Conversion Program for the years ended December 31, 2015 and 2014, respectively. Additionally, we could incur incremental costs of $17,000,000 to $21,000,000 in 2016, as we replace or upgrade equipment used in those of our subscribers' security systems that operate over this carrier's network. As of December 31, 2015, we have approximately 41% of the 2G subscriber base remaining to convert from the 2G cellular network. We considered our expected cash flow as well as the borrowing capacity of our Credit Facility revolver, under which we could borrow an additional $181,750,000 as of December 31, 2015. Based on this analysis, we expect that cash on hand, cash flow generated from operations and borrowings under our Credit Facility will provide sufficient liquidity, given our anticipated current and future requirements.
The existing long-term debt at December 31, 2015 includes the principal balance of $1,767,909,000 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, 2015. The Ascent Intercompany Loan had an outstanding principal balance of $100,000,000 as of December 31, 2015. The Credit Facility term loans have an outstanding principal balance of $949,659,000 as of December 31, 2015 and require principal payments of $1,375,000 per quarter with $403,784,000 becoming due on March 23, 2018 and the remaining amount becoming due April 9, 2022. The Credit Facility revolver has an outstanding balance of $133,250,000 as of December 31, 2015 and becomes due on December 22, 2017.
On February 29, 2016, the Board of Directors of Ascent Capital approved the contribution to the stated capital of the Company of $88,000,000 of the $100,000,000 outstanding principal amount under the Ascent Intercompany Loan. The remaining $12,000,000 principal amount will beis reflected on anthe Amended and Restated Promissory Note, which is due on October 1, 2020 and will bearbears interest at a rate equal to 12.5% per annum, payable semi-annually in cash in arrears.
In considering our liquidity requirements for 2017, we evaluated our known future commitments and obligations. We will require the availability of funds to finance our strategy to grow through the acquisition of subscriber accounts. We considered the expected cash flow, as this business is the driver of our operating cash flows, as well as the borrowing capacity of our Credit Facility revolver, under which we could borrow an additional $250,200,000 as of December 31, 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, 2016 includes the principal balance of $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, 2016. The Ascent Intercompany Loan had an outstanding principal balance of $12,000,000 as of December 31, 2016. The Credit Facility term loans have an outstanding principal balance of $1,097,250,000 as of December 31, 2016 and require principal payments of $2,750,000 per quarter and the remaining amount becoming due September 30, 2022. The Credit Facility revolver has an outstanding balance of $44,800,000 as of December 31, 2016 and becomes due on 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, 20152016 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 | $ | 3,656 |
| | 5,675 |
| | 5,767 |
| | 28,513 |
| | 43,611 |
| $ | 3,748 |
| | 6,690 |
| | 5,646 |
| | 25,466 |
| | 41,550 |
|
| Long-term debt (a) | 5,500 |
| | 548,034 |
| | 696,000 |
| | 518,375 |
| | 1,767,909 |
| 11,000 |
| | 22,000 |
| | 663,800 |
| | 1,042,250 |
| | 1,739,050 |
|
| Other (b) | 16,496 |
| | 220 |
| | 522 |
| | 5,767 |
| | 23,005 |
| 14,026 |
| | 220 |
| | 502 |
| | 4,516 |
| | 19,264 |
|
| Total contractual obligations | $ | 25,652 |
| | 553,929 |
| | 702,289 |
| | 552,655 |
| | 1,834,525 |
| $ | 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.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements are filed under this Item, beginning on page 3235. The financial statement schedules required by Regulation S-X are filed under Item 15 of this Annual Report on Form 10-K.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
In accordance with Rules 13a-15 and 15d-15 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the Company carried out an evaluation, under the supervision and with the participation of management, including its chairman, presidentchief executive officer and principal accountingchief financial officer (the "Executives"), of the effectiveness of its disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, the Executives concluded that the Company’sCompany's disclosure controls and procedures were effective as of December 31, 20152016 to provide reasonable assurance that information required to be disclosed in its reports filed or submitted under the Exchange Act (i) is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’sCommission's rules and forms.forms, and (ii) is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting
We implemented a change in internal control over financial reporting during the quarter ended December 31, 2016 related to the review of a contingent liability. This change was implemented to remediate a material weakness in the Company's risk assessment process, which led to an ineffectively designed management review control over the re-measurement of the contingent liability. This material weakness which arose in prior periods and was identified in the quarter ended December 31, 2016 resulted in a measurement error that, while not material to our consolidated financial statements, could have accumulated to a material misstatement. The Company has remediated the material weakness by enhancing its risk assessment process and the design of the management review control over the periodic re-measurement of the contingent liability. This material weakness did not have a pervasive effect on internal control over financial reporting, as it was limited to the measurement of this liability and its impact on our consolidated balance sheets and statements of operations and comprehensive income (loss).
There hashave been no changeother changes in the Company’s internal control over financial reporting identified during the three months ended December 31, 20152016 that has materially affected, or isare reasonably likely to materially affect, its internal control over financial reporting.
MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Monitronics’MONI's management is responsible for establishing and maintaining adequate internal control over the Company’sCompany's financial reporting. The Company’sCompany's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements and related disclosures in accordance with generally accepted accounting principles. The Company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of the consolidated financial statements and related disclosures in accordance with generally accepted accounting principles; (3) provide reasonable assurance that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (4) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the consolidated financial statements and related disclosures.
Because of inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies and procedures may deteriorate.
The Company assessed the design and effectiveness of internal control over financial reporting as of December 31, 2015.2016. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control—Integrated Framework (2013).
Based upon our assessment using the criteria contained in COSO, management has concluded that, as of December 31, 2015, Monitronics’2016, MONI's internal control over financial reporting is effectively designed and operating effectively.
The Company acquired LiveWatch during 2015, and management excluded from its assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2015, LiveWatch's internal control over financial reporting associated with total assets of $63,267,000 and total revenues of $14,734,000 included in the consolidated financial statements of the Company as of and for the year ended December 31, 2015.
The effectiveness of our internal control over financial reporting as of December 31, 20152016 has been audited by KPMG LLP, the independent registered public accounting firm that audited our financial statements. Their report appears on the next page 33 of this Annual Report on Form 10-K.
ITEM 9B. OTHER INFORMATION
None.
Report of Independent Registered Public Accounting Firm
The Board of Directors
Monitronics International, Inc.
We have audited Monitronics International Inc.’s internal control over financial reporting as of December 31, 2015,2016, based on criteria established inInternal Control —- Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Monitronics International Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting in Item 9A. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Monitronics International Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015,2016, based on criteria established in Internal Control —- Integrated Framework (2013)(2013) issued by the COSO.Committee of Sponsoring Organizations of the Treadway Commission (COSO).
Monitronics International, Inc. acquired LiveWatch Security, LLC. during 2015, and management excluded from its assessment of the effectiveness of Monitronics International, Inc.'s internal control over financial reporting as of December 31, 2015, LiveWatch Security, LLC’s internal control over financial reporting associated with total assets of $63,267,000 and total revenues of $14,734,000 included in the consolidated financial statements of Monitronics International, Inc. (and subsidiaries) as of and for the year ended December 31, 2015. Our audit of internal control over financial reporting of Monitronics International, Inc. also excluded an evaluation of the internal control over financial reporting of LiveWatch Security, LLC.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Monitronics International Inc. and subsidiaries as of December 31, 20152016 and 2014,2015, and the related consolidated statements of operations and comprehensive income (loss), cash flows and stockholder’s equity cash flows for each of the years in the three-yearthree‑year period ended December 31, 2015,2016, and our report dated March 7, 201610, 2017 expressed an unqualified opinion on those consolidated financial statements.
|
| |
| | /s/ KPMG LLP |
| Dallas, Texas | |
March 7, 201610, 2017 | |
Report of Independent Registered Public Accounting Firm
The Board of Directors
Monitronics International, Inc.:
We have audited the accompanying consolidated balance sheets of Monitronics International, Inc. and subsidiaries as of December 31, 20152016 and 2014,2015, and the related consolidated statements of operations and comprehensive income (loss), cash flows and stockholder’s equity for each of the years in the three-yearthree‑year period ended December 31, 2015.2016. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Monitronics International, Inc. and subsidiaries as of December 31, 20152016 and 2014,2015, and the results of their operations and their cash flows for each of the years in the three-yearthree‑year period ended December 31, 2015,2016, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 32 to the consolidated financial statements, during 2015, Monitronics International, Inc. adoptedhas changed its method of accounting for several aspects of accounting for employee share-based payment transactions, including accounting for income taxes, forfeitures, and statutory tax withholding requirements as well as classification of certain elements in the statement of cash flows, in the three-year period ended December 31, 2016, due to the adoption of Financial Accounting StandardsStandard Board Accounting Standards Update ("ASU") 2015-03,2016-19, Interest - Imputation of Interest (Subtopic 835-30) and ASU 2015-17, Income TaxesCompensation-Stock Compensation (Topic 740)718), Balance Sheet Classification of Deferred TaxesImprovements to Employee Share-Based Payment Accounting.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Monitronics International Inc.’s internal controlscontrol over financial reporting as of December 31, 2015,2016, based on criteria established in Internal Control —- Integrated Framework (2013)(2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 7, 201610, 2017 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
|
| |
| | /s/ KPMG LLP |
| | |
| Dallas, Texas | |
March 7, 201610, 2017 | |
MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
Amounts in thousands, except share amounts
| | | | As of December 31, | As of December 31, |
| | 2015 | | 2014 | 2016 | | 2015 |
| Assets | |
| | |
| | | |
| Current assets: | |
| | |
| | | |
| Cash and cash equivalents | $ | 2,580 |
| | $ | 1,953 |
| $ | 3,177 |
| | $ | 2,580 |
|
| Restricted cash | 55 |
| | 18 |
| — |
| | 55 |
|
| Trade receivables, net of allowance for doubtful accounts of $2,762 in 2015 and $2,120 in 2014 | 13,622 |
| | 13,796 |
| |
| Trade receivables, net of allowance for doubtful accounts of $3,043 in 2016 and $2,762 in 2015 | | 13,869 |
| | 13,622 |
|
| Prepaid and other current assets | 9,890 |
| | 7,559 |
| 9,360 |
| | 9,890 |
|
| Total current assets | 26,147 |
| | 23,326 |
| 26,406 |
| | 26,147 |
|
| Property and equipment, net of accumulated depreciation of $27,057 in 2015 and $24,254 in 2014 | 26,654 |
| | 23,280 |
| |
| Subscriber accounts, net of accumulated amortization of $975,795 in 2015 and $736,824 in 2014 | 1,423,538 |
| | 1,373,630 |
| |
| Dealer network and other intangible assets, net of accumulated amortization of $73,578 in 2015 and $54,077 in 2014 | 26,654 |
| | 44,855 |
| |
| Property and equipment, net of accumulated depreciation of $28,825 in 2016 and $27,057 in 2015 | | 28,270 |
| | 26,654 |
|
| Subscriber accounts, net of accumulated amortization of $1,212,468 in 2016 and $975,795 in 2015 | | 1,386,760 |
| | 1,423,538 |
|
| Dealer network and other intangible assets, net of accumulated amortization of $32,976 in 2016 and $73,578 in 2015 | | 16,824 |
| | 26,654 |
|
| Goodwill | 563,549 |
| | 527,502 |
| 563,549 |
| | 563,549 |
|
| Other assets, net | 3,725 |
| | 4,569 |
| 11,908 |
| | 3,725 |
|
| Total assets | $ | 2,070,267 |
| | $ | 1,997,162 |
| $ | 2,033,717 |
| | $ | 2,070,267 |
|
| Liabilities and Stockholder’s Equity | |
| | |
| |
| Liabilities and Stockholder's Equity | | | | |
| Current liabilities: | |
| | |
| | | |
| Accounts payable | $ | 8,621 |
| | $ | 6,710 |
| $ | 11,461 |
| | $ | 8,621 |
|
| Accrued payroll and related liabilities | 3,479 |
| | 3,604 |
| 4,068 |
| | 3,479 |
|
| Other accrued liabilities | 32,522 |
| | 31,094 |
| 31,579 |
| | 32,522 |
|
| Deferred revenue | 16,207 |
| | 14,945 |
| 15,147 |
| | 16,207 |
|
| Holdback liability | 16,386 |
| | 19,046 |
| 13,916 |
| | 16,386 |
|
| Current portion of long-term debt | 5,500 |
| | 9,166 |
| 11,000 |
| | 5,500 |
|
| Total current liabilities | 82,715 |
| | 84,565 |
| 87,171 |
| | 82,715 |
|
| Non-current liabilities: | |
| | |
| | | |
| Long-term debt | 1,739,147 |
| | 1,619,624 |
| 1,687,778 |
| | 1,739,147 |
|
| Long-term holdback liability | 3,786 |
| | 5,156 |
| 2,645 |
| | 3,786 |
|
| Derivative financial instruments | 13,470 |
| | 5,780 |
| 16,948 |
| | 13,470 |
|
| Deferred income tax liability, net | 13,191 |
| | 9,204 |
| 17,330 |
| | 13,191 |
|
| Other liabilities | 16,893 |
| | 15,267 |
| 6,900 |
| | 16,893 |
|
| Total liabilities | 1,869,202 |
| | 1,739,596 |
| 1,818,772 |
| | 1,869,202 |
|
| Commitments and contingencies |
|
| |
|
|
|
| |
|
|
| Stockholder’s equity: | |
| | |
| |
| Common stock, $.01 par value. 1,000 shares authorized, issued and outstanding both at December 31, 2015 and December 31, 2014 | — |
| | — |
| |
| Stockholder's equity: | | | | |
| Common stock, $.01 par value. 1,000 shares authorized, issued and outstanding both at December 31, 2016 and December 31, 2015 | | — |
| | — |
|
| Additional paid-in capital | 361,228 |
| | 336,540 |
| 446,826 |
| | 361,228 |
|
| Accumulated deficit | (146,617 | ) | | (74,169 | ) | (222,924 | ) | | (146,617 | ) |
| Accumulated other comprehensive income (loss) | (13,546 | ) | | (4,805 | ) | (8,957 | ) | | (13,546 | ) |
| Total stockholder’s equity | 201,065 |
| | 257,566 |
| |
| Total liabilities and stockholder’s equity | $ | 2,070,267 |
| | $ | 1,997,162 |
| |
| Total stockholder's equity | | 214,945 |
| | 201,065 |
|
| Total liabilities and stockholder's equity | | $ | 2,033,717 |
| | $ | 2,070,267 |
|
See accompanying notes to consolidated financial statements.
MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Consolidated Statements of Operations and Comprehensive Income (Loss)
Amounts in thousands
| | | | Year Ended December 31, | Year Ended December 31, |
| | 2015 | | 2014 | | 2013 | | 2016 | | 2015 | | 2014 | |
| Net revenue | $ | 563,356 |
| | 539,449 |
| | 451,033 |
| | $ | 570,372 |
| | 563,356 |
| | 539,449 |
| |
| Operating expenses: | |
| | |
| | | | | | | | | |
| Cost of services | 110,246 |
| | 93,600 |
| | 74,136 |
| | 115,236 |
| | 110,246 |
| | 93,600 |
| |
| Selling, general, and administrative, including stock-based compensation | 106,287 |
| | 87,943 |
| | 77,162 |
| | 114,152 |
| | 106,287 |
| | 87,943 |
| |
| Radio conversion costs | 14,369 |
| | 1,113 |
| | — |
| | 18,422 |
| | 14,369 |
| | 1,113 |
| |
| Amortization of subscriber accounts, dealer network and other intangible assets | 258,668 |
| | 253,403 |
| | 208,760 |
| | 246,753 |
| | 258,668 |
| | 253,403 |
| |
| Depreciation | 10,066 |
| | 9,019 |
| | 7,327 |
| | 8,160 |
| | 10,066 |
| | 9,019 |
| |
| Restructuring charges | — |
| | 952 |
| | 1,111 |
| | — |
| | — |
| | 952 |
| |
| Gain on disposal of operating assets, net | (5 | ) | | (71 | ) | | (2 | ) | | — |
| | (5 | ) | | (71 | ) | |
| | 499,631 |
| | 445,959 |
| | 368,494 |
| | 502,723 |
| | 499,631 |
| | 445,959 |
| |
| Operating income | 63,725 |
| | 93,490 |
| | 82,539 |
| | 67,649 |
| | 63,725 |
| | 93,490 |
| |
| Other expense, net: | |
| | |
| | | | | | | | | |
| Interest expense | 125,415 |
| | 119,607 |
| | 96,145 |
| | 127,308 |
| | 125,415 |
| | 119,607 |
| |
| Refinancing expense | 4,468 |
| | — |
| | — |
| | 9,500 |
| | 4,468 |
| | — |
| |
| | 129,883 |
| | 119,607 |
| | 96,145 |
| | 136,808 |
| | 129,883 |
| | 119,607 |
| |
| Loss before income taxes | (66,158 | ) | | (26,117 | ) | | (13,606 | ) | | (69,159 | ) | | (66,158 | ) | | (26,117 | ) | |
| Income tax expense | 6,290 |
| | 3,600 |
| | 3,081 |
| | 7,148 |
| | 6,290 |
| | 3,600 |
| |
| Net loss | (72,448 | ) | | (29,717 | ) | | (16,687 | ) | | (76,307 | ) | | (72,448 | ) | | (29,717 | ) | |
| Other comprehensive income (loss): | |
| | |
| | | | | | | | | |
| Unrealized gain (loss) on derivative contracts, net | (8,741 | ) | | (4,879 | ) | | 12,317 |
| | 4,589 |
| | (8,741 | ) | | (4,879 | ) | |
| Total other comprehensive income (loss), net of tax | (8,741 | ) | | (4,879 | ) | | 12,317 |
| | 4,589 |
| | (8,741 | ) | | (4,879 | ) | |
| Comprehensive loss | $ | (81,189 | ) | | (34,596 | ) | | (4,370 | ) | | $ | (71,718 | ) | | (81,189 | ) | | (34,596 | ) | |
See accompanying notes to consolidated financial statements.
MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Amounts in thousands
| | | | Year Ended December 31, | Year Ended December 31, |
| | 2015 | | 2014 | | 2013 | 2016 | | 2015 | | 2014 |
| Cash flows from operating activities: | |
| | |
| | | | | | | |
| Net loss | $ | (72,448 | ) | | (29,717 | ) | | (16,687 | ) | $ | (76,307 | ) | | (72,448 | ) | | (29,717 | ) |
| Adjustments to reconcile net loss to net cash provided by operating activities: | |
| | |
| | | | | | | |
| Amortization of subscriber accounts, dealer network and other intangible assets | 258,668 |
| | 253,403 |
| | 208,760 |
| 246,753 |
| | 258,668 |
| | 253,403 |
|
| Depreciation | 10,066 |
| | 9,019 |
| | 7,327 |
| 8,160 |
| | 10,066 |
| | 9,019 |
|
| Stock-based compensation | 2,271 |
| | 2,068 |
| | 1,779 |
| 2,598 |
| | 2,271 |
| | 2,068 |
|
| Deferred income tax expense | 3,986 |
| | 74 |
| | 254 |
| 4,140 |
| | 3,986 |
| | 74 |
|
| Gain on disposal of operating assets, net | (5 | ) | | (71 | ) | | (2 | ) | — |
| | (5 | ) | | (71 | ) |
| Amortization of debt discount and deferred debt costs | 6,506 |
| | 5,485 |
| | 4,404 |
| 6,936 |
| | 6,506 |
| | 5,485 |
|
| Unrealized gain on derivative financial instruments | — |
| | — |
| | — |
| |
| Bad debt expense | | 10,785 |
| | 9,735 |
| | 8,149 |
|
| Refinancing expense | 4,468 |
| | — |
| | — |
| 9,500 |
| | 4,468 |
| | — |
|
| Other non-cash activity, net | 14,132 |
| | 7,550 |
| | 7,564 |
| (4,595 | ) | | 4,715 |
| | (183 | ) |
| Changes in assets and liabilities: | |
| | |
| | | |
| | |
| | |
| Trade receivables | (9,378 | ) | | (8,926 | ) | | (8,165 | ) | (11,032 | ) | | (9,378 | ) | | (8,926 | ) |
| Prepaid expenses and other assets | (4,115 | ) | | (1,306 | ) | | 8,361 |
| 446 |
| | (4,115 | ) | | (1,306 | ) |
| Subscriber accounts - deferred contract costs | (1,773 | ) | | — |
| | — |
| (2,947 | ) | | (1,773 | ) | | — |
|
| Payables and other liabilities | (3,534 | ) | | (3,713 | ) | | 1,054 |
| (3,910 | ) | | (3,534 | ) | | (3,713 | ) |
| Net cash provided by operating activities | 208,844 |
| | 233,866 |
| | 214,649 |
| 190,527 |
| | 209,162 |
| | 234,282 |
|
| Cash flows from investing activities: | |
| | |
| | | | | | | |
| Capital expenditures | (12,422 | ) | | (7,769 | ) | | (9,925 | ) | (9,178 | ) | | (12,422 | ) | | (7,769 | ) |
| Cost of subscriber accounts acquired | (266,558 | ) | | (268,160 | ) | | (234,914 | ) | (201,381 | ) | | (266,558 | ) | | (268,160 | ) |
| Cash paid for acquisition, net of cash acquired | (56,778 | ) | | — |
| | (478,738 | ) | — |
| | (56,778 | ) | | — |
|
| Increase in restricted cash | (37 | ) | | 22 |
| | 2,600 |
| 55 |
| | (37 | ) | | 22 |
|
| Proceeds from disposal of operating assets | 5 |
| | 241 |
| | 2 |
| — |
| | 5 |
| | 241 |
|
| Other investing activities | — |
| | (436 | ) | | (100 | ) | — |
| | — |
| | (436 | ) |
| Net cash used in investing activities | (335,790 | ) | | (276,102 | ) | | (721,075 | ) | (210,504 | ) | | (335,790 | ) | | (276,102 | ) |
| Cash flows from financing activities: | |
| | |
| | | | | | | |
| Proceeds from long-term debt | 778,000 |
| | 169,000 |
| | 630,575 |
| 1,280,700 |
| | 778,000 |
| | 169,000 |
|
| Payments on long-term debt | (666,640 | ) | | (127,166 | ) | | (133,048 | ) | (1,238,059 | ) | | (666,640 | ) | | (127,166 | ) |
| Payments of financing costs | (6,477 | ) | | — |
| | (8,179 | ) | (16,946 | ) | | (6,477 | ) | | — |
|
| Value of shares withheld for share-based compensation | | (121 | ) | | (318 | ) | | (416 | ) |
| Contribution from Ascent Capital | 22,690 |
| | — |
| | 20,000 |
| — |
| | 22,690 |
| | — |
|
| Dividend to Ascent Capital | — |
| | (2,000 | ) | | (2,000 | ) | (5,000 | ) | | — |
| | (2,000 | ) |
| Net cash provided by financing activities | 127,573 |
| | 39,834 |
| | 507,348 |
| 20,574 |
| | 127,255 |
| | 39,418 |
|
| Net increase in cash and cash equivalents | 627 |
| | (2,402 | ) | | 922 |
| |
| Net increase (decrease) in cash and cash equivalents | | 597 |
| | 627 |
| | (2,402 | ) |
| Cash and cash equivalents at beginning of period | 1,953 |
| | 4,355 |
| | 3,433 |
| 2,580 |
| | 1,953 |
| | 4,355 |
|
| Cash and cash equivalents at end of period | $ | 2,580 |
| | 1,953 |
| | 4,355 |
| $ | 3,177 |
| | 2,580 |
| | 1,953 |
|
| | | | | | | | | | | |
| Supplemental cash flow information: | |
| | |
| | | | | | | |
| State taxes paid | $ | 3,245 |
| | 2,734 |
| | 2,365 |
| $ | 2,645 |
| | 3,245 |
| | 2,734 |
|
| Interest paid | 117,840 |
| | 111,409 |
| | 88,250 |
| 123,763 |
| | 117,840 |
| | 111,409 |
|
| Cash remaining to be paid for property and equipment | | 558 |
| | 1,214 |
| | 548 |
|
See accompanying notes to consolidated financial statements.
MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Consolidated Statements of Stockholder’sStockholder's Equity
Amounts in thousands, except share amounts
| | | | Common Stock | | Additional paid-in capital | | Accumulated other comprehensive income (loss) | | Accumulated deficit | | Total stockholder’s equity | Common Stock | | Additional paid-in capital | | Accumulated other comprehensive income (loss) | | Accumulated deficit | | Total stockholder's equity |
| | Shares | | Amount | | Shares | | Amount | |
| Balance at December 31, 2012 | 1,000 |
| | — |
| | 298,932 |
| | (12,243 | ) | | (27,765 | ) | | 258,924 |
| |
| Net loss | — |
| | — |
| | — |
| | — |
| | (16,687 | ) | | (16,687 | ) | |
| Other comprehensive income | — |
| | — |
| | — |
| | 12,317 |
| | — |
| | 12,317 |
| |
| Contributions from Ascent Capital | — |
| | — |
| | 38,723 |
| | — |
| | — |
| | 38,723 |
| |
| Dividends paid to Ascent Capital | — |
| | — |
| | (2,000 | ) | | — |
| | — |
| | (2,000 | ) | |
| Stock-based compensation | — |
| | — |
| | 1,779 |
| | — |
| | — |
| | 1,779 |
| |
| Value of shares withheld for tax liability | — |
| | — |
| | (396 | ) | | | | | | (396 | ) | |
| Balance at December 31, 2013 | 1,000 |
| | — |
| | 337,038 |
| | 74 |
| | (44,452 | ) | | 292,660 |
| 1,000 |
| | — |
| | 337,038 |
| | 74 |
| | (44,452 | ) | | 292,660 |
|
| Net loss | — |
| | — |
| | — |
| | — |
| | (29,717 | ) | | (29,717 | ) | — |
| | — |
| | — |
| | — |
| | (29,717 | ) | | (29,717 | ) |
| Other comprehensive loss | — |
| | — |
| | — |
| | (4,879 | ) | | — |
| | (4,879 | ) | — |
| | — |
| | — |
| | (4,879 | ) | | — |
| | (4,879 | ) |
| Dividends paid to Ascent Capital | — |
| | — |
| | (2,000 | ) | | — |
| | — |
| | (2,000 | ) | — |
| | — |
| | (2,000 | ) | | — |
| | — |
| | (2,000 | ) |
| Stock-based compensation | — |
| | — |
| | 1,918 |
| | — |
| | — |
| | 1,918 |
| — |
| | — |
| | 1,918 |
| | — |
| | — |
| | 1,918 |
|
| Value of shares withheld for tax liability | — |
| | — |
| | (416 | ) | | — |
| | — |
| | (416 | ) | — |
| | — |
| | (416 | ) | | — |
| | — |
| | (416 | ) |
| Balance at December 31, 2014 | 1,000 |
| | — |
| | 336,540 |
| | (4,805 | ) | | (74,169 | ) | | 257,566 |
| 1,000 |
| | — |
| | 336,540 |
| | (4,805 | ) | | (74,169 | ) | | 257,566 |
|
| Net loss | — |
| | — |
| | — |
| | — |
| | (72,448 | ) | | (72,448 | ) | — |
| | — |
| | — |
| | — |
| | (72,448 | ) | | (72,448 | ) |
| Other comprehensive loss | — |
| | — |
| | — |
| | (8,741 | ) | | — |
| | (8,741 | ) | — |
| | — |
| | — |
| | (8,741 | ) | | — |
| | (8,741 | ) |
| Contributions from Ascent Capital | — |
| | — |
| | 22,690 |
| | — |
| | — |
| | 22,690 |
| — |
| | — |
| | 22,690 |
| | — |
| | — |
| | 22,690 |
|
| Stock-based compensation | — |
| | — |
| | 2,316 |
| | — |
| | — |
| | 2,316 |
| — |
| | — |
| | 2,316 |
| | — |
| | — |
| | 2,316 |
|
Value of Shares held for tax
liability | — |
| | — |
| | (318 | ) | | — |
| | — |
| | (318 | ) | — |
| | — |
| | (318 | ) | | — |
| | — |
| | (318 | ) |
| Balance at December 31, 2015 | 1,000 |
| | $ | — |
| | $ | 361,228 |
| | $ | (13,546 | ) | | $ | (146,617 | ) | | $ | 201,065 |
| 1,000 |
| | $ | — |
| | $ | 361,228 |
| | $ | (13,546 | ) | | $ | (146,617 | ) | | $ | 201,065 |
|
| Net loss | | — |
| | — |
| | — |
| | — |
| | (76,307 | ) | | (76,307 | ) |
| Other comprehensive loss | | — |
| | — |
| | — |
| | 4,589 |
| | — |
| | 4,589 |
|
| Contributions from Ascent Capital | | — |
| | — |
| | 88,000 |
| | — |
| | — |
| | 88,000 |
|
| Dividends paid to Ascent Capital | | — |
| | — |
| | (5,000 | ) | | — |
| | — |
| | (5,000 | ) |
| Stock-based compensation | | — |
| | — |
| | 2,719 |
| | — |
| | — |
| | 2,719 |
|
Value of Shares held for tax
liability | | — |
| | — |
| | (121 | ) | | — |
| | — |
| | (121 | ) |
| Balance at December 31, 2016 | | 1,000 |
| | $ | — |
| | $ | 446,826 |
| | $ | (8,957 | ) | | $ | (222,924 | ) | | $ | 214,945 |
|
See accompanying notes to consolidated financial statements.
MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements
(1) Basis of Presentation
Monitronics International, Inc. and subsidiaries (the “Company”"Company" or “Monitronics”"MONI") provide security alarm monitoring and related services to residential and business subscribers throughout the United States and parts of Canada. The Company monitors signals arising from burglaries, fires, medical alerts, and other events through security systems installed by independent dealers at subscribers’subscribers' premises.
On December 17, 2010, Ascent Capital Group, Inc. (“("Ascent Capital”Capital") acquired 100% of the outstanding capital stock of the Company through the merger of Mono Lake Merger Sub, Inc. (“("Merger Sub”Sub"), a direct wholly owned subsidiary of Ascent Capital established to consummate the merger, with and into the Company, with the Company as the surviving corporation in the merger (the “Monitronics Acquisition”"MONI Acquisition"). On August 16, 2013, MonitronicsMONI acquired all of the equity interests of Security Networks LLC (“("Security Networks”) and certain affiliated entities (the “Security"Security Networks Acquisition”Acquisition"). On February 23, 2015, MonitronicsMONI acquired LiveWatch Security, LLC ("LiveWatch"), a Do-It-Yourself home security firm, offering professionally monitored security services through a direct-to-consumer sales channel (the "LiveWatch Acquisition").
The consolidated financial statements contained in this Annual Report have been prepared in accordance with accounting principles generally accepted in the United States of America (“("U.S. GAAP”GAAP") for all periods presented.
The Company has reclassifiedreclassed certain prior periodperiods amounts to conform to the current period's presentation including the adoption of Financial Accounting Standards Board ("FASB") Accounting Standards Update ("ASU") 2015-03,2016-09, Interest-Imputation of Interest (Subtopic 835-30) Compensation--Stock Compensation (Topic 718), Improvements to Employee Share-Based Payment Accountingand ASU 2015-17, Income Taxes (Topic 740), Balance Sheet Classification of Deferred Taxes. . See note 3, Recent2 Summary of Significant Accounting PronouncementsPolicies for the changes in the presentation of those items. Additionally, the Company has reclassified certain prior period amounts related to Radio conversion costs to conform to the current period's presentation. These costs were previously reported in Cost of services on the Consolidated Statements of Operations and Other Comprehensive Income (Loss). Radio conversion costs represent all direct costs incurred by Monitronics during the subscribers' alarm monitoring system upgrade in relation to the Company's' Radio Conversion Program as well as indirect retention costs for impacted subscribers. The Radio Conversion program was implemented in 2014 in response to one of the nation's largest carriers announcing that it does not intend to support its 2G cellular services beyond 2016.
(2) Summary of Significant Accounting Policies
Consolidation Principles
The consolidated financial statements include the accounts of the Company and its majority owned subsidiaries over which the Company exercises control. All intercompany accounts and transactions have been eliminated in consolidation.
Cash and Cash Equivalents
The Company considers investments with original purchased maturities of three months or less when acquired to be cash equivalents.
Restricted Cash
Restricted cash is cash that is restricted for a specific purpose and cannot be included in the cash and cash equivalents account.
Trade Receivables
Trade receivables consist primarily of amounts due from customers for recurring monthly monitoring services over a wide geographical base. The Company performs extensive credit evaluations on the portfolios of subscriber accounts prior to acquisition and requires no collateral on the accounts that are acquired. The Company has established 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. The allowance for doubtful accounts as of December 31, 2016 and 2015 was $3,043,000 and 2014 was $2,762,000, and $2,120,000, respectively.
A summary of activity in the allowance for doubtful accounts is as follows (amounts in thousands):
| | | | Balance Beginning of Year | | Charged to Expense | | Write-Offs and Other | | Balance End of Year | Balance Beginning of Year | | Charged to Expense | | Write-Offs and Other | | Balance End of Year |
| 2016 | | $ | 2,762 |
| | 10,785 |
| | (10,504 | ) | | 3,043 |
|
| 2015 | $ | 2,120 |
| | 9,735 |
| | (9,093 | ) | | 2,762 |
| $ | 2,120 |
| | 9,735 |
| | (9,093 | ) | | 2,762 |
|
| 2014 | $ | 1,937 |
| | 8,149 |
| | (7,966 | ) | | 2,120 |
| $ | 1,937 |
| | 8,149 |
| | (7,966 | ) | | 2,120 |
|
| 2013 | $ | 1,436 |
| | 7,342 |
| | (6,841 | ) | | 1,937 |
| |
Concentration of Credit Risk
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of trade accounts receivable. The Company performs extensive credit evaluations on the portfolios of subscriber accounts prior to acquisition and requires no collateral on the subscriber accounts that are acquired. Concentrations of credit risk with respect to trade accounts receivable are generally limited due to the large number of subscribers comprising the Company's customer base.
Fair Value of Financial Instruments
Fair values of cash equivalents, current accounts receivable and current accounts payable approximate the carrying amounts because of their short-term nature. The Company’sCompany's debt instruments are recorded at amortized cost on the consolidated balance sheet. See note 10, Fair Value Measurements, for further fair value information on the Company’s debt instruments.
Property and Equipment
Property and equipment are carried at cost and depreciated using the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized over the shorter of their estimated useful lives or the term of the underlying lease. Estimated useful lives by class of asset are as follows:
|
| | |
| Leasehold improvements | | 15 years or lease term, if shorter |
| Machinery and equipment | | 5 - 7 years |
| | 3 - 5 years |
Management reviews the realizability of its property and equipment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In evaluating the value and future benefits of long-term assets, their carrying value is compared to management’s best estimate of undiscounted future cash flows over the remaining economic life. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying value of the assets exceeds the estimated fair value of the assets. If necessary, the Company would use both the income approach and market approach to estimate fair value.
Subscriber Accounts
Subscriber accounts primarily relate to the cost of acquiring monitoring service contracts from independent dealers. The subscriber accounts acquired in the Monitronics,MONI, Security Networks and the LiveWatch acquisitions were recorded at fair value under the acquisition method of accounting. All other acquired subscriber accounts are recorded at cost. All direct externaland incremental costs, including bonus incentives related to account activation at LiveWatch, associated with the creation of subscriber accounts, and certain internal direct costs, including bonus incentives for account activations at LiveWatch,new subscriber contracts obtained in connection with a subscriber move, are capitalized and and amortized over fifteen years using a declining balance method beginning in the month following the date of acquisition.capitalized.
The costs of subscriber accounts acquired in the Monitronics,MONI, Security Networks and LiveWatch acquisitions, as well as certain accounts acquired in bulk purchases, are amortized using the 14-year 235% declining balance method. The costs of all other subscriber accounts are amortized using the 15-year 220% declining balance method, beginning in the month following the date of acquisition. The amortization methods were selected to provide an approximate matching of the amortization of the subscriber accounts intangible asset to estimated future subscriber revenues based on the projected lives of individual subscriber contracts. Amortization of subscriber accounts was $236,673,000, $238,800,000 $233,327,000 and $195,010,000$233,327,000 for the fiscal years ended December 31, 2016, 2015 2014 and 2013,2014, respectively.
Based on subscriber accounts held at December 31, 2015,2016, estimated amortization of subscriber accounts in the succeeding five fiscal years ending December 31 is as follows (amounts in thousands):
| | | 2016 | $ | 220,860 |
| |
| 2017 | $ | 186,295 |
| $ | 215,369 |
|
| 2018 | $ | 157,168 |
| $ | 181,708 |
|
| 2019 | $ | 132,735 |
| $ | 153,417 |
|
| 2020 | $ | 117,419 |
| $ | 134,817 |
|
| 2021 | | $ | 120,391 |
|
The Company reviews the subscriber accounts at least annually 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.at each reporting period. For purposes of recognition and measurement of an impairment loss, the Company views subscriber accounts as a single pool because of the assets’assets' homogeneous characteristics, and 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.
Dealer Network and Other Intangible Assets
Dealer network is an intangible asset that relates to the dealer relationships that were acquired as part of the Monitronics Acquisition and the Security Networks Acquisition. Other intangible assets consist of non-compete agreements signed by the seller of Security Networks and certain key Security Networks executives and the LiveWatch trade mark asset.executives. These intangible assets will beare amortized on a straight-line basis over their estimated useful lives of five5 years. The LiveWatch trade mark asset is amortized over 10 years. Amortization of dealer network and other intangible assets was $9,830,000, $19,501,000 $19,780,000 and $13,717,000$19,780,000 for the fiscal years ended December 31, 2016, 2015 2014 and 2013,2014, respectively.
The Company reviews the dealer network and other intangible assets at least annually for impairment or a change in amortization period whenever events or changes indicate that the carrying amount of the assets may not be recoverable or the lives should be shortened.method at each reporting period.
Goodwill
The Company accounts for its goodwill pursuant to the provisions of Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC")FASB ASC Topic 350, Intangibles — Goodwill and Other (“("FASB ASC Topic 350”350"). In accordance with FASB ASC Topic 350, goodwill is not amortized, but rather tested for impairment at least annually.
The Company assesses the recoverability of the carrying value of goodwill during the fourth quarter of its fiscal year or whenever events or changes in circumstances indicate that the carrying amount of the goodwill of a reporting unit may not be fully recoverable. Recoverability is measured at the reporting unit level based on the provisions of FASB ASC Topic 350.
To the extent necessary, recoverability of goodwill at a reporting unit level is measured using a discounted cash flow model incorporating discount rates commensurate with the risks involved, which is classified as a Level 3 measurement under FASB ASC Topic 820, Fair Value Measurements and Disclosures. The key assumptions used in the discounted cash flow valuation model include discount rates, growth rates, cash flow projections and terminal value rates. Discount rates, growth rates and cash flow projections are the most sensitive and susceptible to change as they require significant management judgment. If the calculated fair value is less than the current carrying value, impairment of the reporting unit may exist. When the recoverability test indicates potential impairment, the Company will calculate an implied fair value of goodwill for the reporting unit. The implied fair value of goodwill is determined in a manner similar to how goodwill is calculated in a business combination. If the implied fair value of goodwill exceeds the carrying value of goodwill assigned to the reporting unit, there is no impairment. If the carrying value of goodwill assigned to a reporting unit exceeds the implied fair value of the goodwill, an impairment loss is recorded to write down the carrying value. An impairment loss cannot exceed the carrying value of goodwill assigned to the reporting unit but may indicate certain long-lived and amortizable intangible assets associated with the reporting unit may require additional impairment testing.
Deferred Financing Costs
Deferred financing costs are recorded as a reduction to long-term debt when the related debt is issued or when revolving credit lines increase the borrowing capacity of the Company. Deferred financing costs are amortized over the term of the related debt using the effective interest method.
Holdback Liability
The Company typically withholds payment of a designated percentage of the acquisition cost when it acquires subscriber accounts from dealers. The withheld funds are recorded as a liability until the guarantee period provided by the dealer has expired. The holdback is used as a reserve to cover any terminated subscriber accounts that are not replaced by the dealer during the guarantee period. At the end of the guarantee period, the dealer is responsible for any deficit or is paid the balance of the holdback.
Derivative Financial Instruments
The Company uses derivative financial instruments to manage exposure to movement in interest rates. The use of these financial instruments modifies the exposure of these risks with the intention of reducing the risk or cost. The Company does not use derivatives for speculative or trading purposes. The Company recognizes the fair value of all derivative instruments as either assets or liabilities at fair value on the consolidated balance sheets. Fair value is based on market quotes for similar instruments with the same duration. For derivative instruments that qualify for hedge accounting under the provisions of FASB ASC Topic 815, Derivatives and Hedging, unrealized gains and losses on the derivative instruments are reported in accumulated other comprehensive income (loss), to the extent the hedges are effective, until the underlying transactions are recognized in earnings. Derivative instruments that do not qualify for hedge accounting are marked to market at the end of each accounting period with the change in fair value recorded in earnings.
Revenue Recognition
Revenue is generated from security alarm monitoring and related services provided by the Company and its subsidiaries. Revenue related to alarm monitoring services is recognized ratably over the life of the contract. Revenue related to maintenance and other services is recognized as the services are rendered. Deferred revenue includes payments for monitoring services to be provided in future periods. Additionally, equipment sales are recognized as the equipment is shipped to the customer.
Income Taxes
The Company accounts for income taxes under FASB ASC Topic 740, Income Taxes ("FASB ASC Topic 740"), which prescribes an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’sCompany's consolidated financial statements or tax returns. In estimating future tax consequences, the Company generally considers all expected future events other than proposed changes in the tax law or rates. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. Income tax expense is the tax payable or refundable for the period plus or minus the change during the period in deferred tax assets and liabilities.
FASB ASC Topic 740 specifies the accounting for uncertainty in income taxes recognized in a company’s financial statements and prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In instances where the Company has taken or expects to take a tax position in its tax return and the Company believes it is more likely than not that such tax position will be upheld by the relevant taxing authority, the Company records the benefits of such tax position in its consolidated financial statements.
Share-Based Compensation
The Company adopted ASU 2016-09, Compensation--Stock Compensation (Topic 718): Improvements to Employee Share Based Accounting ("ASU 2016-09"). ASU 2016-09 simplifies several aspects of accounting for employee share-based payment transactions, including accounting for income taxes, forfeitures, and statutory tax withholding requirements as well as classification of certain elements in the statement of cash flows. The adoption of ASU 2016-09 resulted in the tax effected amount of excess tax benefits of $443,000 as of December 31, 2015 (associated with the exercise of non-qualified stock options and vesting of restricted stock awards from the Company's incentive plans), that did not reduce current income taxes payable in the year deducted, being recognized as net operating loss deferred income taxes, fully offset by an increase in the valuation allowance as of December 31, 2015. The adoption of ASU 2016-09 also resulted in an increase in Net cash provided by operating activities of $318,000 and $416,000 and a decrease in Net Cash provided by financing activities $318,000 and $416,000 for the for the years ended December 31, 2015 and 2014, respectively. These amounts represent reclassifications of the value of shares withheld on vesting of certain stock awards by the Company to settle payroll tax liabilities from an operating cash flow to a financing cash flow.
The Company accounts for share-based awards pursuant to FASB ASC Topic 718, Compensation — Stock Compensation ("FASB ASC Topic 718"), which requires companies to measure the cost of employee services received in exchange for an award of equity instruments (such as stock options and restricted stock) based on the grant-date fair value of the award, and to recognize that cost over the period during which the employee is required to provide service (usually the vesting period of the award). Forfeitures of awards are recognized as they occur.
The grant-date fair value of the Ascent Capital stock options granted to the Company’s employees was calculated using the Black-Scholes model. The expected term of the awards was calculated using the simplified method included in FASB ASC Topic 718. The volatility used in the calculation is based on the historical volatility of peer companies and the risk-free rate is based on Treasury Bonds with a term similar to that of the subject options. A dividend rate of zero was utilized for all granted stock options.
Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions and judgments that affect the reported amounts of revenue and expenses for each reporting period. The significant estimates made in preparation of the Company’s consolidated financial statements primarily relate to valuation of goodwill, other intangible assets, long-lived assets, deferred tax assets, convertible debt arrangements, derivative financial instruments, and the amount of the allowance for doubtful accounts. These estimates are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors and adjusts them when facts and circumstances change. As the effects of future events cannot be determined with any certainty, actual results could differ from the estimates upon which the carrying values were based.
(3) Recent Accounting Pronouncements
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606).. Under the update, revenue will be recognized based on a five-step model. The core principle of the model is that revenue will be recognized when the transfer of promised goods or services to customers is made in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In the third quarter of 2015, the FASB deferred the effective date of the standard to annual and interim periods beginning after December 15, 2017. EarlyIn March and April 2016, the FASB issued amendments to provide clarification on assessment of collectability criteria, presentation of sales taxes and measurement of non-cash consideration. In addition, the amendment provided clarification and included simplification to transaction guidance on contract modifications and completed contracts at transaction. In December 2016, the FASB issued amendments to provide clarification on codification and guidance application. The standard allows the option of either a full retrospective adoption, will be permitted for annual and interimmeaning the standard is applied to all periods beginning after December 15, 2016.presented, or modified retrospective adoption, meaning the standard is applied only to the most current period. The Company is currentlyin the process of assessing revenue recognition policies across each type of its contracts and evaluating the impact that adopting thisof the adoption ASU will have2014-09 on its financial position, results of operations and cash flows.
In April 2015, the FASB issued ASU 2015-03, Interest - Imputation of Interest (Subtopic 835-30). Under this update, the cost of issuing debt will no longer be recorded as a separate asset, unless it is incurred before the receipt of the funding from the associated debt liability. Instead, debt issuance costs will be presented as a direct deduction from the debt liability, similar to the presentation of debt discounts. The costs will continue to be amortized to interest expense using the effective interest rate method. The ASU requires retrospective application to all prior periods presented in the financial statements and is effective for annual and interim periods beginning after December 15, 2015. The Company elected to early adopt the ASU for the financial statements ending December 31, 2015, The change reclassified $20,918,000 from other assets net to long-term debt on the consolidated balance sheet for the period ending December 31, 2014. The adoption of the ASU did not impact results of operations or cash flows.
In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805). Under the update, an acquirer in a business combination is no longer required to account for measurement-period adjustments retrospectively, and, instead, will recognize a measurement-period adjustment during the period in which it determines the amount of the adjustment. The effective date of the standard is for fiscal years beginning after December 15, 2015, and interim periods within those years. The Company does not expect the impact of adopting this ASU to be material to the Company's financial statements and related disclosures.
In November 2015, the FASB issued ASU 2015-17, Income Taxes (Topic 740), Balance Sheet Classification of Deferred Taxes. Under the update, deferred taxes would be classified as noncurrent in the statement of financial position instead of being separated into current and non-current amounts. The ASU is effective for financial statements issued after January 1, 2017 with early adoption permitted. Additionally, the Company may apply the standard either prospectively or retrospectively. The Company elected to early adopt the ASU for the financial statements ending December 31, 2015 and to apply the change retrospectively. The change reclassified $6,567,000 from the current asset for deferred income taxes, net to the non-current deferred income tax liability, Net for the period ending December 31, 2014 on the consolidated balance sheet. The adoption of the ASU did not impact results of operations or cash flows.Consolidated Financial Statements.
In February 2016, the FASB issued ASU 2016-02,Leases Leases (Topic 842) ("ASU 2016-02"). ASU 2016-02 requires the lessee to recognize assets and liabilities for leases with lease terms of more than twelve months. For leases with a term of twelve months or less, the Company is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and lease liabilities. Further, the lease requires a finance lease to recognize both an interest expense and an amortization of the associated expense. Operating leases generally recognize the associated expense on a straight line basis. ASU 2016-02 requires the Company to adopt the standard using a modified retrospective approach and adoption beginningbecomes effective on January 1, 2019. The Company is currently evaluating the impact that ASU 2016-02 will have on its financial position, results of operations and cash flows.
In January 2017, the FASB issued ASU 2017-04, Intangibles--Goodwill and Other (Topic 350), Simplifying the Test for Goodwill Impairment ("ASU 2017-04"). Currently, the fair value of the reporting unit is compared with the carrying value of the reporting unit (identified as "Step 1"). If the fair value of the reporting unit is lower than its carrying amount then, the implied fair value of goodwill is calculated. If the implied fair value of goodwill is lower than the carrying value of goodwill an impairment is recognized (identified as "Step 2"). ASU 2017-04 eliminates Step 2 from the impairment test; therefore, a goodwill impairment will be recognized as the difference of the fair value and the carrying value. ASU 2017-04 becomes effective on January 1, 2020 with early adoption permitted. The Company is currently evaluating the impact that ASU 2017-04 will have on its financial position, results of operations and cash flows.
(4) Acquisitions
The Company accounts for business combinations utilizing the acquisition method in accordance with FASB ASC Topic 805, Business Combinations. Under the acquisition method of accounting, the fair value of the consideration transferred has been allocated to the tangible and identifiable intangible assets acquired and liabilities assumed based on their preliminary estimates of fair value.
LiveWatch Acquisition
On February 23, 2015 ("the Closing(the "Closing Date"), the Company acquired LiveWatch for a purchase price of approximately $61,550,000 (the "LiveWatch Purchase Price"). The LiveWatch Purchase Price includesincluded approximately $3,988,000 of cash transferred directly to LiveWatch to fund transaction bonuses payable to LiveWatch employees as of the Closing Date. This cash is not included in the fair value of consideration transferred for the LiveWatch Acquisition. The LiveWatch Purchase Price also includes post-closing adjustments of $435,000 which were paid in the third quarter of 2015. The LiveWatch acquisition was funded by borrowings from the Company's revolving credit facility, as well as cash contributions from Ascent Capital. Goodwill in the amount of $36,047,000 was recognized in connection with the LiveWatch Acquisition and all of the goodwill is estimated to be deductible for tax purposes.
In connection with the LiveWatch Acquisition, Monitronicswe entered into employment agreements with certain key members of the LiveWatch management team which provide for retention bonuses of $5,400,000 (the "LiveWatch Retention Bonuses") to be paid on the second anniversary of the Closing Date, and performance based bonus arrangements payable on the fourth anniversary of the Close Date (the "LiveWatch Performance Bonuses"). The LiveWatch Performance Bonuses are estimated to yield an aggregate payout of approximately $7,600,000.$6,200,000. The LiveWatch Retention Bonuses and LiveWatch Performance Bonuses (together, the "LiveWatch Acquisition Contingent Bonuses") are contingent upon the continued employment of the key members of the LiveWatch management team. As such, the LiveWatch Acquisition Contingent Bonuses are expensed ratably over the service period based on the estimated value of the payouts. For the year ended December 31, 2015, the Company recognized $3,930,000 related to the LiveWatch Acquisition Contingent Bonuses, which are included in Selling, general and administrative expense in the consolidated statements of operations and comprehensive income (loss).
The table below represents the fair value of the assets and liabilities assumed in the LiveWatch Acquisition (dollars in thousands):
|
| | | |
| Cash | $ | 784 |
|
| Trade receivables | 273 |
|
| Other current assets | 706 |
|
| Property and equipment | 362 |
|
| Subscriber accounts | 24,900 |
|
| Other intangible asset | 1,300 |
|
| Goodwill | 36,047 |
|
| Current liabilities | (6,810 | ) |
| Fair value of consideration transferred | $ | 57,562 |
|
The preliminary estimates of the fair value of assets acquired and liabilities assumed are based on available information as of the date of this report and may be revised as additional information becomes available, which primarily includes the finalization of the valuation of assets and liabilities acquired.
Goodwill in the amount of $36,047,000 was recognized in connection with the LiveWatch Acquisition and was calculated as the excess of the consideration transferred over the net assets recognized and represents the value to the Company for LiveWatch's recurring revenue and cash flow streams and its diversified business model and marketing channel. All of the goodwill acquired in the LiveWatch Acquisition is estimated to be deductible for tax purposes.
The subscriber accounts acquired in the LiveWatch Acquisition are amortized using the 14-year 235% declining balance method. The other intangible asset acquired, which represents LiveWatch's trademark asset, is amortized on a straight-line basis over its estimated useful life of 10 years.
The Company incurred $946,000 of legal and professional services expense and other costs related to the LiveWatch Acquisition, which are included in Selling, general and administrative expense in the condensed consolidated statements of operations and comprehensive income (loss).
The Company's results of operations for the period ended December 31, 2015 include the operations of LiveWatch from the Closing Date. The effect of the LiveWatch Acquisition was not material to the Company's consolidated results for the periods presented and, accordingly, proforma financial disclosures have not been presented.
Security Networks Acquisition
On August 16, 2013 (the "Closing Date"), the Company acquired all of the equity interests of Security Networks and certain affiliated entities. The purchase price (the "Security Networks Purchase Price") of $500,557,000 consisted of $481,834,000 in cash and 253,333 shares of Ascent Capital’s Series A common stock, par value $0.01 per share, with a Closing Date fair value of $18,723,000. The Security Networks Purchase Price includes post-closing adjustments of $1,057,000. The Company recognized goodwill of $177,289,000.
(5) Property and Equipment
Property and equipment consist of the following (amounts in thousands):
| | | | As of December 31, | As of December 31, |
| | 2015 | | 2014 | 2016 | | 2015 |
| Property and equipment, net: | |
| | |
| |
| | |
|
| Buildings and leasehold improvements | $ | 1,222 |
| | $ | 3,359 |
| $ | 1,404 |
| | $ | 1,222 |
|
| Machinery and equipment | 52,489 |
| | 44,175 |
| 55,691 |
| | 52,489 |
|
| | 53,711 |
| | 47,534 |
| 57,095 |
| | 53,711 |
|
| Accumulated depreciation | (27,057 | ) | | (24,254 | ) | (28,825 | ) | | (27,057 | ) |
| | $ | 26,654 |
| | 23,280 |
| $ | 28,270 |
| | 26,654 |
|
Depreciation expense for property and equipment was $8,160,000, $10,066,000 $9,019,000 and $7,327,000$9,019,000 for the years ended December 31, 2016, 2015 2014 and 2013,2014, respectively.
(6) Goodwill
The following table provides the activity and balances of goodwill (amounts in thousands):
| | | Balance at December 31, 2013 | $ | 527,502 |
| |
| Period activity | — |
| |
| Balance at December 31, 2014 | 527,502 |
| $ | 527,502 |
|
| LiveWatch Acquisition | 36,047 |
| 36,047 |
|
| Balance at December 31, 2015 | $ | 563,549 |
| 563,549 |
|
| Period activity | | — |
|
| Balance at December 31, 2016 | | $ | 563,549 |
|
The Company accounts for its goodwill pursuant to the provisions of FASB ASC Topic 350, Intangibles - Goodwill and Other("FASB ASC Topic 350"). In accordance with FASB ASC Topic 350, goodwill is not amortized, but rather tested for impairment annually or if an event occurs, or circumstances change, that indicate the fair value of the entity may be below its
carrying amount (a "triggering event"). In connection with the Company's annual goodwill impairment assessment, which is performed in the fourth quarter using October 31 balances, the Company did not record anestimated fair value for each of the Company's reporting units exceeded the carrying amount of the underlying assets, thus no impairment loss to goodwill.was indicated.
As of December 31, 2015, the Company determined that a triggering event had occurred due to a sustained decrease in Ascent Capital's market capitalization. In response to the triggering event, the Company performed a goodwill impairment test in accordance with FASB ASC Topic 350 and determined that there was no impairment.
(7) Other Accrued Liabilities
Other accrued liabilities consisted of the following (amounts in thousands):
| | | | December 31, 2015 | | December 31, 2014 | December 31, 2016 | | December 31, 2015 |
| Interest payable | $ | 18,226 |
| | $ | 18,251 |
| $ | 14,588 |
| | $ | 18,226 |
|
| Income taxes payable | 2,603 |
| | 3,494 |
| 2,947 |
| | 2,603 |
|
| Legal accrual | 145 |
| | 222 |
| 271 |
| | 145 |
|
| LiveWatch acquisition retention bonus | | 4,990 |
| | — |
|
| Other | 11,548 |
| | 9,127 |
| 8,783 |
| | 11,548 |
|
| Total Other accrued liabilities | $ | 32,522 |
| | $ | 31,094 |
| $ | 31,579 |
| | $ | 32,522 |
|
(8) Long-Term Debt
Long-term debt consisted of the following (amounts in thousands):
| | | | December 31,
2015 | | December 31,
2014 | December 31,
2016 | | December 31,
2015 |
| 9.125% Senior Notes due April 1, 2020 with an effective rate of 9.4% | $ | 576,241 |
| | $ | 574,517 |
| $ | 578,078 |
| | $ | 576,241 |
|
9.868% Promissory Note to Ascent Capital due October 1, 2020 with an effective rate of 9.868% | 100,000 |
| | 100,000 |
| |
| Term loans, mature March 23, 2018, LIBOR plus 3.25%, subject to a LIBOR floor of 1.00% with an effective rate of 5.0% | 394,938 |
| | 885,928 |
| |
| Term loans, mature April 9, 2022, LIBOR plus 3.5%, subject to a LIBOR floor of 1.00% with an effective interest rate of 5.1% | 542,420 |
| | — |
| |
Promissory Note to Ascent Capital due October 1, 2020 with an effective rate of 12.5% (a) | | 12,000 |
| | 100,000 |
|
| Term loan, matures September 30, 2022, LIBOR plus 5.5% subject to a LIBOR floor of 1.00% with an effective rate of 7.2% | | 1,066,130 |
| | — |
|
| $295 million revolving credit facility, matures September 30, 2021, LIBOR plus 4.00% subject to a LIBOR floor of 1.00% with an effective rate of 5.3% | | 42,570 |
| | — |
|
| Term loan, mature March 23, 2018, LIBOR plus 3.25%, subject to a LIBOR floor of 1.00% with an effective rate of 5.0% | | — |
| | 394,938 |
|
| Term loan, mature April 9, 2022, LIBOR plus 3.5%, subject to a LIBOR floor of 1.00% with an effective interest rate of 5.1% | | — |
| | 542,420 |
|
| $315 million revolving credit facility, matures December 22, 2017, LIBOR plus 3.75%, subject to a LIBOR floor of 1.00% with an effective rate of 6.7% | 131,048 |
| | 68,345 |
| — |
| | 131,048 |
|
| | 1,744,647 |
| | 1,628,790 |
| 1,698,778 |
| | 1,744,647 |
|
| Less current portion of long-term debt | (5,500 | ) | | (9,166 | ) | (11,000 | ) | | (5,500 | ) |
| Long-term debt | $ | 1,739,147 |
| | $ | 1,619,624 |
| $ | 1,687,778 |
| | $ | 1,739,147 |
|
(a)The effective rate was 9.868% until February 29, 2016.
Senior Notes
On July 17, 2013, the Company closed on a $175,000,000 privately placed debt offering of 9.125% Senior Notes (the “New Senior Notes”). In December 2013, the Company completed an exchange of the New Senior Notes for identical securities in a registered offering under the Securities Act of 1933, as amended.
The New Senior Notes, together with the existing $410,000,000 of 9.125% Senior Notes due 2020 (collectively, the “Senior Notes”),senior notes total $585,000,000 in principal, mature on April 1, 2020 and bear interest at 9.125% per annum.annum (the "Senior Notes"). Interest payments are due semi-annually on April 1 and October 1 of each year. The Senior Notes are guaranteed by all of the Company's existing domestic subsidiaries. Ascent Capital has not guaranteed any of the Company's obligations under the Senior Notes. As of December 31, 2015,2016, the senior notes had deferred financing costs, net of accumulated amortization of $8,760,000.$6,922,000.
Ascent Intercompany Loan
On August 16, 2013, in connectionFebruary 29, 2016, the Company retired the existing intercompany loan with the Security Networks Acquisition, the Companyan outstanding principal amount of $100,000,000 and executed and delivered a Promissory Note to Ascent Capital in a principal amount of $100,000,000$12,000,000 (the “Intercompany Loan”"Ascent Intercompany Loan")., with the $88,000,000 remaining principal being treated as a capital contribution. The entire principal amount under the Ascent Intercompany Loan is due on October 1, 2020. The Company may prepay any portion of the balance of the Ascent Intercompany Loan at any time from time to time without fee, premium or penalty (subject to certain financial covenants associated with the Company’s other indebtedness). Any unpaid balance of the Ascent Intercompany Loan bears interest at a rate equal to 9.868%12.5% per annum, payable semi-annually in cash in arrears on January 12 and July 12 of each year, commencing on January 12, 2014.year. Borrowings under the Ascent Intercompany Loan constitute unsecured obligations of the Company and are not guaranteed by any of the Company’s subsidiaries.
On February 29, 2016, the Board of Directors of Ascent Capital approved the contribution to the stated capital of the Company of $88,000,000 of the $100,000,000 outstanding principal amount under the Ascent Intercompany Loan. The remaining $12,000,000 principal amount will be reflected on an Amended and Restated Promissory Note, which is due on October 1, 2020 and will bear interest at a rate equal to 12.5% per annum, payable semi-annually in cash in arrears. See note 20, Subsequent Events for further information.Credit Facility
On February 17, 2015, MonitronicsSeptember 30, 2016, the Company entered into an amendment ("Amendment No. 4"6") with the lenders of its existing senior secured credit agreement dated March 23, 2012, and as amended and restated on April 9, 2015, February 17, 2015, August 16, 2013, March 25, 2013, and November 7, 2012 (the "Existing Credit Agreement"). Amendment No. 46 provided for, among other things, the increased commitment under the revolving credit facility in a principal amount of $315,000,000.
On April 9, 2015, Monitronics entered into Amendment No. 5 ("Amendment No. 5") to its Existing Credit Agreement. Pursuant to Amendment No. 5, Monitronics completed the issuance of an incremental $550,000,000a new $1,100,000,000 senior secured Term Loan B offeringterm loan at a 0.5%1.5% discount withand a maturity date of April 9, 2022new $295,000,000 super priority revolver (the "2022 Term Loans"). Monitronics use the net proceeds to retire approximately $492,000,000 of its existing term loans due March 2018 (the "2018 Term Loans") and repaid $49,900,000 of its revolving credit facility. Amendment No 5 (the Existing Credit Agreement together with Amendment No. 4 and Amendment No. 5,6, the "Credit Facility") also incorporates certain covenant changes, including the removal of the third quarter 2015 step downs of the senior secured and total leverage ratios, both as defined in the Credit Facility..
The Company used the net proceeds from the new term loan to retire $403,784,000 of its existing term loan due in March 2018 Term Loans bearand $543,125,000 of its existing term loan due in April 2022. Additionally, the Company retired its existing $315,000,000 revolving credit facility in the amount of $138,900,000.
As a result of the refinancing, the Company accelerated amortization of certain deferred financing costs and debt discounts related to the extinguished term loans, and expensed certain other refinancing costs. The components of the refinancing expense is reflected below (amounts in thousands):
|
| | | | |
| | | Twelve Months Ended
December 31, 2016 |
| Accelerated amortization of deferred financing costs | | $ | 4,160 |
|
| Accelerated amortization of debt discount | | 3,416 |
|
| Other refinancing costs | | 1,924 |
|
| Total refinancing expense | | $ | 9,500 |
|
As of December 31, 2016, the Credit Facility term loan has a principal amount of $1,097,250,000 maturing on September 30, 2022. The term loan requires quarterly interest payments and quarterly principal payments of $2,750,000. The term loan bears interest at LIBOR plus 3.25%5.5%, subject to a LIBOR floor of 1.00%,1.0%. The Credit Facility revolver has a principal amount outstanding of $44,800,000 as of December 31, 2016 and maturematures on March 23, 2018. Interest on the 2018 Term Loans are due quarterly with the principal due at maturity. The 2022 Term Loans bear interest at LIBOR plus 3.5%, subject to a LIBOR floor of 1.00% Principal payments of approximately $1,375,000 and interest on the term loans are due quarterly on the 2022 Term Loans.September 30, 2021. The Credit Facility revolver bears interest at LIBOR plus 3.75%4.0%, subject to a LIBOR floor of 1.00%, and matures on December 22, 2017.1.0%. There is an annuala commitment fee of 0.5% on unused portions of the Credit Facility revolver. As of December 31, 2015, $181,750,0002016, $250,200,000 is available for borrowing under the revolving credit facility. As of December 31, 2015, the Company has deferred debt costs, net of accumulated amortization, of $9,058,000 related to the Credit Facility.
The Credit Facility is secured by a pledge of all of the outstanding stock of Monitronics and all of its existing subsidiaries and is guaranteed by all of Monitronics’ existing domestic subsidiaries. Ascent Capital has not guaranteed any of Monitronics’ obligations under the Credit Facility.revolver.
At any time after the occurrence of an event of default under the Credit Facility, the lenders may, among other options, declare any amounts outstanding under the Credit Facility immediately due and payable and terminate any commitment to make further loans under the Credit Facility. In addition, failure to comply with restrictions contained in the Senior Notes could lead to an event of default under the Credit Facility. The Credit Facility is secured by a pledge of all of the outstanding stock of MONI and all of its existing subsidiaries and is guaranteed by all of our existing domestic subsidiaries. Ascent Capital has not guaranteed any of our obligations under the Credit Facility,
In order to reduce the financial risk related to changes in interest rates associated with the floating rate term loans under the Credit Facility term loans, MonitronicsMONI has entered into interest rate swap agreements with terms similar to the Credit Facility term loans (all outstanding interest rate swap agreements are collectively referred to as the “Swaps”"Swaps"). The Swaps have been designated as effective hedges of the Company’s variable rate debt and qualify for hedge accounting. As a result of these interest rate swaps, Monitronics'MONI's current effective weighted average interest rate on the borrowings under the Credit Facility term loans is 5.15%7.15%. See note 9, Derivatives, for further disclosures related to these derivative instruments. .
The terms of the Senior Notes and the Credit Facility provide for certain financial and nonfinancial covenants. As of December 31, 2015,2016, the Company was in compliance with all required covenants.
Principal payments scheduled to be made on the Company’s debt obligations are as follows (amounts in thousands):
| | | 2016 | $ | 5,500 |
| |
| 2017 | 138,750 |
| $ | 11,000 |
|
| 2018 | 409,284 |
| 11,000 |
|
| 2019 | 5,500 |
| 11,000 |
|
| 2020 | 690,500 |
| 608,000 |
|
| 2021 | 5,500 |
| 55,800 |
|
| Thereafter | 512,875 |
| 1,042,250 |
|
| Total principal payments | 1,767,909 |
| 1,739,050 |
|
| Less: | |
| |
|
| Unamortized discounts, premium and deferred debt costs, net | 23,262 |
| 40,272 |
|
| Total debt on consolidated balance sheet | $ | 1,744,647 |
| $ | 1,698,778 |
|
The objective of the swap derivative instruments was to reduce the risk associated with the Company's term loan variable interest rates. In effect, the swap derivative instruments convert variable interest rates into fixed interest rates on the Company’s term loan borrowings.
All of the Swaps are designated and qualify as cash flow hedging instruments, with the effective portion of the Swaps' change in fair value recorded in accumulated other comprehensive income (loss). Any ineffective portions of the Swaps' change in fair value are recognized in current earnings in interest expense. Changes in the fair value of the Swaps recognized in accumulated other comprehensive income (loss) are reclassified to Interestinterest expense when the hedged interest payments on the underlying debt are recognized. Amounts in accumulated other comprehensive income (loss) expected to be recognized in Interest expense in the coming 12 months total approximately $7,092,000.$5,521,000.
The impact of the derivatives designated as cash flow hedges on the consolidated financial statements is depicted below (amounts in thousands):