Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D. C.  20549

 

FORM 10-Q

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2013

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from            to           

 

Commission File Number 333-110025

 

MONITRONICS INTERNATIONAL, INC.

(Exact name of Registrant as specified in its charter)

 

State of Texas

 

74-2719343

(State or other jurisdiction of

 

(I.R.S. Employer Identification No.)

incorporation or organization)

 

 

 

 

 

2350 Valley View Lane, Suite 100

 

 

Dallas, Texas

 

75234

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (972) 243-7443

 

Indicate by check mark whether the Registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, as defined in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer o

 

Accelerated filer o

 

 

 

Non-accelerated filer x

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

As of November 14, 2013 Monitronics International, Inc. is a wholly owned subsidiary of Ascent Capital Group, Inc.

 

 

 



Table of Contents

 

TABLE OF CONTENTS

 

 

Page

PART I — FINANCIAL INFORMATION

 

 

Item 1.

Financial Statements

1

 

 

 

 

Condensed Consolidated Balance Sheets (unaudited)

1

 

 

 

 

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) (unaudited)

2

 

 

 

 

Condensed Consolidated Statements of Cash Flows (unaudited)

3

 

 

 

 

Condensed Consolidated Statement of Stockholder’s Equity (unaudited)

4

 

 

 

 

Notes to Condensed Consolidated Financial Statements

5

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

19

 

 

 

Item 3.

Quantitative and Qualitative Disclosure about Market Risk

25

 

 

 

Item 4.

Controls and Procedures

25

 

 

 

 

PART II - OTHER INFORMATION

 

 

 

Item 6.

Exhibits

26

 

 

 

 

SIGNATURES

27

 

 

 

 

EXHIBIT INDEX

28

 



Table of Contents

 

Item 1.  Financial Statements.

 

MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES

Condensed Consolidated Balance Sheets

Amounts in thousands, except share amounts

(unaudited)

 

 

 

September 30,

 

December 31,

 

 

 

2013

 

2012

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

29,446

 

$

3,433

 

Restricted cash

 

2,680

 

2,640

 

Trade receivables, net of allowance for doubtful accounts of $1,913 in 2013 and $1,436 in 2012

 

13,621

 

10,891

 

Deferred income tax assets, net

 

5,100

 

5,100

 

Prepaid and other current assets

 

13,305

 

13,597

 

Total current assets

 

64,152

 

35,661

 

 

 

 

 

 

 

Property and equipment, net of accumulated depreciation of $15,306 in 2013 and $10,189 in 2012

 

23,146

 

20,559

 

Subscriber accounts, net of accumulated amortization of $445,773 in 2013 and $308,487 in 2012

 

1,338,401

 

987,975

 

Dealer network and other intangible assets, net of accumulated amortization of $29,353 in 2013 and $20,580 in 2012

 

69,580

 

29,853

 

Goodwill

 

522,260

 

349,227

 

Other assets, net

 

29,672

 

22,156

 

Total assets

 

$

2,047,211

 

$

1,445,431

 

 

 

 

 

 

 

Liabilities and Stockholder’s Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

6,240

 

$

1,523

 

Accrued payroll and related liabilities

 

3,876

 

3,179

 

Other accrued liabilities

 

50,326

 

25,613

 

Deferred revenue

 

14,331

 

10,327

 

Purchase holdbacks

 

19,429

 

10,818

 

Current portion of long-term debt

 

9,166

 

6,950

 

Total current liabilities

 

103,368

 

58,410

 

 

 

 

 

 

 

Non-current liabilities:

 

 

 

 

 

Long-term debt

 

1,605,760

 

1,101,433

 

Long-term purchase holdbacks

 

6,756

 

 

Derivative financial instruments

 

6,491

 

12,359

 

Deferred income tax liability, net

 

9,595

 

8,849

 

Other liabilities

 

16,128

 

3,961

 

Total liabilities

 

1,748,098

 

1,185,012

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Stockholder’s equity:

 

 

 

 

 

Common stock, $.01 par value.1 share authorized, issued and outstanding at September 30, 2013 and December 31, 2012, respectively

 

 

 

Additional paid-in capital

 

337,591

 

298,932

 

Accumulated deficit

 

(33,639

)

(26,270

)

Accumulated other comprehensive loss

 

(4,839

)

(12,243

)

Total stockholder’s equity

 

299,113

 

260,419

 

Total liabilities and stockholder’s equity

 

$

2,047,211

 

$

1,445,431

 

 

See accompanying notes to condensed consolidated financial statements.

 

1



Table of Contents

 

MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)

Amounts in thousands, except share amounts

(unaudited)

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Net revenue

 

$

115,844

 

84,667

 

$

318,275

 

249,863

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

Cost of services

 

20,155

 

12,881

 

50,951

 

35,331

 

Selling, general, and administrative, including stock-based and long-term incentive compensation

 

19,968

 

14,755

 

53,984

 

43,759

 

Amortization of subscriber accounts, dealer network and other intangible assets

 

55,746

 

40,815

 

146,059

 

118,245

 

Depreciation

 

1,910

 

1,368

 

5,119

 

3,990

 

Restructuring charges

 

402

 

 

402

 

 

Gain on sale of operating assets

 

 

 

(2

)

 

 

 

98,181

 

69,819

 

256,513

 

201,325

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

17,663

 

14,848

 

61,762

 

48,538

 

 

 

 

 

 

 

 

 

 

 

Other expense:

 

 

 

 

 

 

 

 

 

Interest expense

 

25,732

 

19,243

 

66,325

 

50,212

 

Realized and unrealized loss on derivative financial instruments, net

 

 

 

 

2,044

 

Refinancing expense

 

 

 

 

6,245

 

Other expense

 

 

 

 

619

 

 

 

25,732

 

19,243

 

66,325

 

59,120

 

 

 

 

 

 

 

 

 

 

 

Loss before income taxes

 

(8,069

)

(4,395

)

(4,563

)

(10,582

)

Income tax expense

 

1,241

 

700

 

2,806

 

2,038

 

Net loss

 

(9,310

)

(5,095

)

(7,369

)

(12,620

)

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on derivative contracts

 

(4,526

)

(2,539

)

7,404

 

(13,779

)

Total other comprehensive income (loss)

 

(4,526

)

(2,539

)

7,404

 

(13,779

)

 

 

 

 

 

 

 

 

 

 

Comprehensive income (loss)

 

$

(13,836

)

(7,634

)

$

35

 

(26,399

)

 

See accompanying notes to condensed consolidated financial statements.

 

2



Table of Contents

 

MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statements of Cash Flows

Amounts in thousands

(unaudited)

 

 

 

Nine months ended

 

 

 

September 30,

 

 

 

2013

 

2012

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net loss

 

$

(7,369

)

(12,620

)

Adjustments to reconcile net loss to net cash provided by operating activities:

 

 

 

 

 

Amortization of subscriber accounts, dealer network and other intangible assets

 

146,059

 

118,245

 

Depreciation

 

5,119

 

3,990

 

Stock based compensation

 

1,125

 

969

 

Deferred income tax expense

 

731

 

333

 

Unrealized gain on derivative financial instruments

 

 

(6,793

)

Refinancing expense

 

 

6,245

 

Long-term debt amortization

 

623

 

4,285

 

Other non-cash activity, net

 

7,725

 

6,145

 

Changes in assets and liabilities:

 

 

 

 

 

Trade receivables

 

(6,394

)

(4,464

)

Prepaid expenses and other assets

 

1,514

 

(1,855

)

Payables and other liabilities

 

20,745

 

17,162

 

 

 

 

 

 

 

Net cash provided by operating activities

 

169,878

 

131,642

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(6,303

)

(3,387

)

Purchases of subscriber accounts

 

(174,527

)

(128,407

)

Cash paid for acquisition, net of cash acquired

 

(479,795

)

 

Proceeds from sale of operating assets

 

2

 

 

Decrease (increase) in restricted cash

 

(40

)

51,420

 

 

 

 

 

 

 

Net cash used in investing activities

 

(660,663

)

(80,374

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from long-term debt

 

591,375

 

998,100

 

Payments of long-term debt

 

(85,455

)

(979,650

)

Payments of deferred financing costs and refinancing costs

 

(8,122

)

(44,239

)

Contribution from Ascent Capital

 

20,000

 

 

Dividend to Ascent Capital

 

(1,000

)

(1,000

)

 

 

 

 

 

 

Net cash provided by (used in) financing activities

 

516,798

 

(26,789

)

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

26,013

 

24,479

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

3,433

 

2,110

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

29,446

 

26,589

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

State taxes paid

 

$

2,350

 

2,116

 

Interest paid

 

49,323

 

23,148

 

 

See accompanying notes to condensed consolidated financial statements.

 

3



Table of Contents

 

MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES

Condensed Consolidated Statement of Stockholder’s Equity

Amounts in thousands, except share amounts

(unaudited)

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

Additional

 

 

 

other

 

Total

 

 

 

Common Stock

 

paid-in

 

Accumulated

 

comprehensive

 

stockholder’s

 

 

 

Shares

 

Amount

 

capital

 

deficit

 

income (loss)

 

equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balance at December 31, 2012

 

1

 

$

 

$

298,932

 

$

(26,270

)

$

(12,243

)

$

260,419

 

Net loss

 

 

 

 

(7,369

)

 

(7,369

)

Other comprehensive income

 

 

 

 

 

7,404

 

7,404

 

Stock-based compensation

 

 

 

1,125

 

 

 

1,125

 

Value of shares withheld for tax liability

 

 

 

(189

)

 

 

(189

)

Contributions from Ascent Capital

 

 

 

38,723

 

 

 

38,723

 

Dividend paid to Ascent Capital

 

 

 

(1,000

)

 

 

(1,000

)

Balance at September 30, 2013

 

1

 

$

 

$

337,591

 

$

(33,639

)

$

(4,839

)

$

299,113

 

 

See accompanying notes to condensed consolidated financial statements.

 

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Table of Contents

 

MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES

Notes to Condensed Consolidated Financial Statements

 

(1)                                 Basis of Presentation

 

Monitronics International, Inc. and its subsidiaries (the “Company” or “Monitronics”) are wholly owned subsidiaries of Ascent Capital Group, Inc. (“Ascent Capital”).  On August 16, 2013, the Company acquired all of the equity interests of Security Networks LLC (“Security Networks”) and certain affiliated entities (the “Security Networks Acquisition”).  The Company provides 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’ premises.

 

The unaudited interim financial information of the Company has been prepared in accordance with Article 10 of the Securities and Exchange Commission’s (the “SEC”) Regulation S-X. Accordingly, it does not include all of the information required by generally accepted accounting principles in the United States (“U.S. GAAP”) for complete financial statements.  The Company’s unaudited condensed consolidated financial statements as of September 30, 2013, and for the three and nine months ended September 30, 2013 and 2012, include Monitronics and all of its direct and indirect subsidiaries.  The accompanying interim condensed consolidated financial statements are unaudited but, in the opinion of management, reflect all adjustments (consisting of normal recurring accruals) necessary for a fair presentation of the results for such periods. The results of operations for any interim period are not necessarily indicative of results for the full year.  These condensed consolidated financial statements should be read in conjunction with the Monitronics Annual Report on Form 10-K for the year ended December 31, 2012 filed with the SEC on March 1, 2013 (the “2012 Form 10-K”).

 

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of revenue and expenses for each reporting period.  The significant estimates made in preparation of the Company’s condensed consolidated financial statements primarily relate to valuation of goodwill, other intangible assets, long-lived assets, deferred tax assets, 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.

 

(2)                                 Recent Accounting Pronouncements

 

There were no new accounting pronouncements issued during the nine months ended September 30, 2013 that are expected to have a material impact on the Company.

 

(3)                               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 $501,614,000 consisted of $482,891,000 in cash and 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.

 

The cash portion of the Security Networks purchase price was funded by cash contributions from Ascent Capital, the proceeds of the Company’s July issuance of $175,000,000 in aggregate principal amount of 9.125% Senior Notes due 2020 (in connection with the merger of Monitronics Escrow Corporation, the issuer of these notes, with and into the Company on the Closing Date), the proceeds of incremental term loans of $225,000,000 million issued under the Company’s existing credit facility and the proceeds of a $100,000,000 intercompany loan from Ascent Capital.  See note 5, Long-Term Debt for further information on the debt obligations.  The Security Networks Purchase Price will be adjusted for customary post-closing adjustments.

 

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Table of Contents

 

The Security Networks Acquisition was accounted for as a business combination utilizing the acquisition method in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, Business Combinations.  Under the acquisition method of accounting, the Security Networks Purchase Price has been allocated to Security Networks’ tangible and identifiable intangible assets acquired and liabilities assumed based on their preliminary estimates of fair value as follows (amounts in thousands):

 

Cash

 

$

3,096

 

Trade receivables

 

1,305

 

Other current assets

 

1,759

 

Property and equipment

 

1,404

 

Subscriber accounts

 

307,700

 

Dealer network and other intangible assets

 

48,500

 

Goodwill

 

173,033

 

Purchase holdbacks, current and non-current

 

(9,615

)

Other current and non-current liabilities

 

(25,568

)

Fair value of consideration

 

$

501,614

 

 

The preliminary estimates of fair value of assets acquired and liabilities assumed are based on available information as of the date of this report and management assumptions, and may be revised as additional information becomes available.  Any post-closing adjustments may change the purchase price or the allocation of the purchase price, which could affect the fair values assigned to the assets and liabilities and could result in a change to the condensed consolidated financial information, including a change to goodwill.

 

Goodwill in the amount of $173,033,000 was recognized in connection with the Security Networks Acquisition and was calculated as the excess of the consideration transferred over the net assets recognized, including deferred taxes, and represents the value to Monitronics for Security Networks’ recurring revenue and cash flow streams and its unique business strategy of partnering with independent dealers to obtain customers.  Approximately $132,000,000 of the goodwill is estimated to be deductible for tax purposes.

 

The subscriber accounts acquired in the Security Networks Acquisition are amortized using the 14-year 235% declining balance method.  The dealer network and other intangible assets acquired, which consist of non-compete agreements, are amortized on a straight-line basis over their estimated useful lives of five years.

 

The Company’s results of operations for the three and nine months ended September 30, 2013 include the operations of the Security Networks business from the Closing Date. For the three and nine months ended September 30, 2013, net revenue and operating loss attributable to Security Networks was $11,494,000 and $1,591,000, respectively.  Net revenue attributable to Security Networks for the three and nine months ended reflects the negative impact of an approximate $2,500,000 fair value adjustment that reduced deferred revenue acquired in the Security Networks Acquisition.

 

As of September 30, 2013, the Company has incurred $2,470,000 of legal and professional services expense and other costs related to the Security Networks Acquisition, which are included in Selling, general, and administrative expense in the condensed consolidated statements of operations and comprehensive income (loss).

 

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The following table includes unaudited pro forma information for the Company, which includes the historical operating results of Security Networks prior to our ownership. This unaudited pro forma information gives effect to certain adjustments, including increased amortization to reflect the fair value assigned to the subscriber accounts and dealer network and other intangible assets acquired and increased interest expense relating to the debt transactions entered into to fund the Security Networks Acquisition. The unaudited pro-forma results assume that the Security Networks Acquisition and the debt transactions had occurred on January 1, 2012 for all periods presented. They are not necessarily indicative of the results of operations that would have occurred if the acquisition had been made at the beginning of the periods presented or that may be obtained in the future.

 

 

 

Three months ended September 30,

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

(amounts in thousands, except per share amounts)

 

As reported:

 

 

 

 

 

 

 

 

 

Net revenue

 

$

115,844

(a)

84,667

 

$

318,275

(a)

249,863

 

Net loss

 

(9,310

)

(5,095

)

(7,369

)

(12,620

)

 

 

 

 

 

 

 

 

 

 

Supplemental pro-forma:

 

 

 

 

 

 

 

 

 

Net revenue

 

$

131,951

 

105,587

 

$

382,789

 

303,483

(b)

Net loss (c)

 

(6,270

)

(16,161

)

(20,717

)

(54,164

)

 


(a)         As reported net revenue for the three and nine months ended September 30, 2013 reflects the negative impact of an approximate $2,500,000 fair value adjustment that reduced deferred revenue acquired in the Security Networks Acquisition.

(b)         Pro-forma net revenue for the nine months ended September 30, 2012 reflects the negative impact of an approximate $2,700,000 fair value adjustment that would have reduced deferred revenue acquired in the Security Networks Acquisition.

(c)          The pro-forma net loss from continuing operations amounts for the three and nine months ended September 30, 2013 include non-recurring acquisition costs incurred by the Company of $1,032,000 and $2,470,000, respectively.

 

(4)                               Other Accrued Liabilities

 

Other accrued liabilities consisted of the following (amounts in thousands):

 

 

 

September 30,
2013

 

December 31,
2012

 

 

 

 

 

 

 

Interest payable

 

$

28,114

 

$

9,624

 

Income taxes payable

 

1,954

 

2,286

 

Legal accrual

 

10,270

 

9,324

 

Other

 

9,988

 

4,379

 

Total Other accrued liabilities

 

$

50,326

 

$

25,613

 

 

(5)                             Long-Term Debt

 

Long-term debt consisted of the following (amounts in thousands):

 

 

 

September 30,
2013

 

December 31,
2012

 

 

 

 

 

 

 

9.125% Senior Notes due April 1, 2020

 

$

585,000

 

$

410,000

 

9.868% Promissory Note in favor of Ascent Capital due October 1, 2020

 

100,000

 

 

Term loans, mature March 23, 2018, LIBOR plus 3.25%, subject to a LIBOR floor of 1.00% (a)

 

904,326

 

685,583

 

$225 million revolving credit facility, matures December 22, 2017, LIBOR plus 3.75%, subject to a LIBOR floor of 1.00% (b)

 

25,600

 

12,800

 

 

 

1,614,926

 

1,108,383

 

Less current portion of long-term debt

 

(9,166

)

(6,950

)

Long-term debt

 

$

1,605,760

 

$

1,101,433

 

 


(a)         The interest rate on the term loan was LIBOR plus 4.25%, subject to a LIBOR floor of 1.25%, until March 25, 2013.

(b)         The interest rate on the revolving credit facility was LIBOR plus 4.25%, subject to a LIBOR floor of 1.25%, until March 25, 2013.

 

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Table of Contents

 

Senior Notes

 

On March 23, 2012, the Company closed on a $410,000,000 privately placed debt offering of 9.125% Senior Notes due 2020 (the “Existing Senior Notes”).  In August 2012, the Company completed an exchange of the Existing Senior Notes for identical securities in a registered offering under the Securities Act of 1933, as amended.

 

On July 17, 2013, an additional $175,000,000 of 9.125% Senior Notes (the “New Senior Notes”) were issued by Monitronics Escrow Corporation (the “Escrow Issuer”), a wholly-owned subsidiary of Ascent Capital. The proceeds from this offering were placed in escrow and were released upon the Closing Date.  Upon the Closing Date, the Escrow Issuer was merged into the Company and the Company assumed the New Senior Notes (the New Senior Notes, together with the Existing Senior Notes, are collectively referred to as the “Senior Notes”).  The Company has offered to exchange the New Senior Notes for identical securities in a registered offering under the Securities Act of 1933, as amended.  The exchange offer is expected to expire on December 4, 2013.  See note 12, Subsequent Events, for further information.

 

The Senior Notes mature on April 1, 2020 and bear interest at 9.125% per annum.  Interest payments are due semi-annually on April 1 and October 1 of each year, beginning on October 1, 2012.

 

The Senior Notes are guaranteed by all of the Company’s existing subsidiaries.  Ascent Capital has not guaranteed any of the Company’s obligations under the Senior Notes.

 

In the third quarter of 2013, Ascent Capital purchased $5,000,000 in aggregate principal amount of the Company’s Senior Notes.

 

Ascent Intercompany Loan

 

On August 16, 2013, in connection with the Security Networks Acquisition, the Company executed and delivered a Promissory Note in favor of Ascent Capital in a principal amount of $100,000,000 (the “Ascent Intercompany Loan”).  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% per annum, payable semi-annually in cash in arrears on January 12th and July 12th of each year, commencing on January 14, 2014.  Borrowings under the Ascent Intercompany Loan constitute unsecured obligations of the Company and are not guaranteed by any of the Company’s subsidiaries.

 

Credit Facility

 

On March 23, 2012, the Company entered into a senior secured credit facility with the lenders party thereto and Bank of America, N.A., as administrative agent, which provided a $550,000,000 term loan at a 1% discount and a $150,000,000 revolving credit facility (the “Credit Agreement”).  Proceeds from the Credit Agreement and the Senior Notes, together with cash on hand, were used to retire all outstanding borrowings under the Company’s former credit facility, securitization debt, and to settle all related derivative contracts (the “Refinancing”).

 

On November 7, 2012, the Company entered into an amendment to the Credit Agreement (“Amendment No. 1”), which provided an incremental term loan with an aggregate principal amount of $145,000,000.  The incremental term loan was used to fund the acquisition of approximately 93,000 subscriber accounts for a purchase price of approximately $131,000,000.

 

On March 25, 2013, the Company entered into a second amendment to the Credit Agreement (“Amendment No. 2”). Pursuant to Amendment No. 2, the Company repriced the interest rates applicable to the Credit Agreement’s facility (the “Repricing”) which is comprised of the term loans and revolving credit facility noted above. Concurrently with the Repricing, the Company extended the maturity of the revolving credit facility by nine months to December 22, 2017.

 

On August 16, 2013, in connection with the Security Networks Acquisition, the Company entered into a third amendment (“Amendment No. 3”) to the Credit Agreement to provide for, among other things, (i) an increase in the commitments under the revolving credit facility in a principal amount of $75,000,000, resulting in an aggregate principal amount of $225,000,000, (ii) new term loans in an aggregate principal amount of $225,000,000 (the “Incremental Term Loans”) at a 0.5% discount and (iii) certain other amendments to the Credit Agreement, each as set forth in Amendment No. 3 (the Credit Agreement together with Amendment No. 1, Amendment No. 2 and Amendment No. 3, the “Credit Facility”).

 

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The Credit Facility term loans bear interest at LIBOR plus 3.25%, subject to a LIBOR floor of 1.00%, and mature on March 23, 2018.  Principal payments of approximately $2,292,000 and interest on the term loans are due quarterly.  The Credit Facility revolver bears interest at LIBOR plus 3.75%, subject to a LIBOR floor of 1.00%, and matures on December 22, 2017.  There is an annual commitment fee of 0.50% on unused portions of the Credit Facility revolver.  As of September 30, 2013, $199,400,000 is available for borrowing under the revolving credit facility.

 

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.

 

On September 28, 2013, the Company borrowed $25,600,000 on the Credit Facility revolver to fund its October 1, 2013 interest payment due under the Senior Notes of approximately $26,691,000.

 

The Credit Facility is secured by a pledge of all of the outstanding stock of the Company and all of its existing subsidiaries and is guaranteed by all of the Company’s existing subsidiaries.  Ascent Capital has not guaranteed any of the Company’s obligations under the Credit Facility.

 

As of September 30, 2013, the Company has deferred financing costs, net of accumulated amortization, of $26,319,000 related to the Senior Notes and Credit Facility.  These costs are included in Other assets, net on the accompanying condensed consolidated balance sheet and will be amortized over the remaining term of the respective debt instruments using the effective-interest method.

 

As a result of the Refinancing, the Company accelerated amortization of the securitization debt premium and certain deferred financing costs related to the former senior secured credit facility, and expensed certain other refinancing costs. The components of the Refinancing expense, reflected in the condensed consolidated statement of operations and comprehensive income (loss) as a component of Other income (expense) for the nine months ended September 30, 2012, are as follows (amounts in thousands):

 

 

 

For the nine
months ended

 

 

 

September
30, 2012

 

 

 

 

 

Accelerated amortization of deferred financing costs

 

$

389

 

Accelerated amortization of securitization debt discount

 

6,679

 

Other refinancing costs

 

7,628

 

Gain on early termination of derivative instruments

 

(8,451

)

Total refinancing expense

 

$

6,245

 

 

In order to reduce the financial risk related to changes in interest rates associated with the floating rate term loans under the Credit Facility, the Company entered into two interest rate swap agreements (each with separate counterparties) in 2012, with terms similar to the Credit Facility term loans (the “Existing Swap Agreements”).  On March 25, 2013, the Company negotiated amendments to the terms of the Existing Swap Agreements to coincide with the Repricing.  In the third quarter of 2013, the Company entered into two additional interest rate swap agreements in conjunction with the Incremental Term Loans (all outstanding interest rate swap agreements are collectively referred to as the “Swaps”).

 

The Swaps have a maturity date of March 23, 2018 to match the term of the Credit Facility term loans.  The Swaps have been designated as effective hedges of the Company’s variable rate debt and qualify for hedge accounting.  See note 6, Derivatives, for further disclosures related to these derivative instruments.  As a result of the Swaps, the interest rate on the borrowings under the Credit Facility term loans have been effectively converted from a variable rate to a weighted average fixed rate of 5.06%.

 

The terms of the Senior Notes and Credit Facility provide for certain financial and nonfinancial covenants.  As of September 30, 2013, the Company was in compliance with all required covenants.

 

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Principal payments scheduled to be made on the Company’s debt obligations are as follows (amounts in thousands):

 

Remainder of 2013

 

$

2,292

 

2014

 

9,166

 

2015

 

9,166

 

2016

 

9,166

 

2017

 

34,767

 

2018

 

870,800

 

Thereafter

 

685,000

 

Total principal payments

 

1,620,357

 

Less:

 

 

 

Unamortized discount on the Credit Facility term loans

 

5,431

 

Total debt on condensed consolidated balance sheet

 

$

1,614,926

 

 

(6)                             Derivatives

 

The Company utilizes interest rate swap agreements to reduce the interest rate risk inherent in the Company’s variable rate Credit Facility term loans.  The valuation of these instruments is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves and implied volatility. The Company incorporates credit valuation adjustments to appropriately reflect the respective counterparty’s nonperformance risk in the fair value measurements.  See note 9, Fair Value Measurements, for additional information about the credit valuation adjustments.

 

The Swaps’ outstanding notional balance as of September 30, 2013 and terms are noted below:

 

Notional

 

Effective Date

 

Fixed
Rate Paid

 

Variable Rate Received

 

 

 

 

 

 

 

 

 

$

 541,750,000

 

March 28, 2013

 

1.884

%

3 mo. USD-LIBOR-BBA, subject to a 1.00% floor (a)

 

143,550,000

 

March 28, 2013

 

1.384

%

3 mo. USD-LIBOR-BBA, subject to a 1.00% floor (a)

 

112,217,337

 

September 30, 2013

 

1.959

%

3 mo. USD-LIBOR-BBA, subject to a 1.00% floor

 

112,217,337

 

September 30, 2013

 

1.850

%

3 mo. USD-LIBOR-BBA, subject to a 1.00% floor

 

 


(a)         On March 25, 2013, the Company negotiated amendments to the terms of these interest rate swap agreements to coincide with the Repricing (the “Amended Swaps”).  The Amended Swaps are held with the same counterparties as the Existing Swap Agreements.  Upon entering into the Amended Swaps, the Company simultaneously dedesignated the Existing Swap Agreements and redesignated the Amended Swaps as cash flow hedges for the underlying change in the swap terms.  The amounts previously recognized in Accumulated other comprehensive loss relating to the dedesignation will be recognized in Interest expense over the remaining life of the Amended Swaps.

 

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 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 loss are reclassified to Interest expense when the hedged interest payments on the underlying debt are recognized.  Amounts in Accumulated other comprehensive loss expected to be recognized in Interest expense in the coming 12 months total approximately $6,911,000.

 

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The impact of the derivatives designated as cash flow hedges on the condensed consolidated financial statements is depicted below (amounts in thousands):

 

 

 

For the three months ended September
30,

 

For the nine months ended September
30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Effective portion of gain (loss) recognized in Accumulated other comprehensive loss

 

$

(5,734

)

(3,668

)

$

3,830

 

(16,125

)

 

 

 

 

 

 

 

 

 

 

Effective portion of loss reclassified from Accumulated other comprehensive loss into Net income (a)

 

$

(1,208

)

(1,129

)

$

(3,574

)

(2,346

)

 

 

 

 

 

 

 

 

 

 

Ineffective portion of amount of gain (loss) recognized into Net income on interest rate swaps (a)

 

$

(50

)

 

$

30

 

 

 


(a)         Amounts are included in Interest expense in the unaudited condensed consolidated statements of operations and comprehensive income (loss).

 

On March 23, 2012, in connection with the Refinancing, the Company terminated all of its previously outstanding derivative financial instruments and recorded a gain of $8,451,000.  These derivative financial instruments were not designated as hedges.  For the nine months ended September 30, 2012, the realized and unrealized loss on derivative financial instruments includes settlement payments of $8,837,000 partially offset by a $6,793,000 unrealized gain related to the change in the fair value of these derivatives prior to their termination in March 2012.

 

(7)                                 Restructuring charges

 

In connection with the Security Networks Acquisition, management approved a restructuring plan to transition Security Networks operations in West Palm Beach and Kissimmee, Florida to Dallas, Texas (the “Security Networks Restructuring Plan”).   The Security Networks Restructuring Plan provides certain employees with a severance package that entitles them to benefits upon completion of the transition in 2014.  Severance costs related to the Security Networks Restructuring Plan are recognized ratably over the future service period.  During the three and nine months ended September 30, 2013, the Company recorded $402,000 of restructuring charges related to employee termination benefits.

 

Additionally, in connection with Security Networks Restructuring Plan, the Company allocated approximately $492,000 of the Security Networks Purchase Price to accrued restructuring in relation to the Security Networks’ severance agreement entered into with its former Chief Executive Officer.

 

The following table provides the activity and balances of the Security Networks Restructuring Plan (amounts in thousands):

 

 

 

Nine months ended September 30, 2013

 

 

 

Opening
balance

 

Additions

 

Deductions

 

Other

 

Ending balance

 

 

 

 

 

 

 

 

 

 

 

 

 

Severance and retention

 

$

 

402

 

 

492

(a)

894

 

 


(a)         Amount was recorded upon the acquisition of Security Networks.

 

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(8)                                 Accumulated Other Comprehensive Income (Loss)

 

The following table provides a summary of the changes in Accumulated other comprehensive income (loss) for the period presented (amounts in thousands):

 

 

 

Accumulated
other
comprehensive
income (loss)

 

 

 

 

 

As of December 31, 2012

 

(12,243

)

Unrealized gain on derivatives recognized through Accumulated other comprehensive income (loss)

 

3,830

 

Reclassifications of unrealized loss on derivatives into net income (a)

 

3,574

 

As of September 30, 2013

 

(4,839

)

 


(a)         Amounts reclassified into net income are included in Interest expense on the condensed consolidated statement of operations.  See note 6, Derivatives, for further information.

 

(9)                             Fair Value Measurements

 

According to the Fair Value Measurements and Disclosures Topic of the Financial Accounting Standards Board Accounting Standards Codification, fair value is defined as the amount that would be received for selling an asset or paid to transfer a liability in an orderly transaction between market participants and requires that assets and liabilities carried at fair value are classified and disclosed in the following three categories:

 

·                  Level 1 - Quoted prices for identical instruments in active markets.

·                  Level 2 - Quoted prices for similar instruments in active or inactive markets and valuations derived from models where all significant inputs are observable in active markets.

·                  Level 3 - Valuations derived from valuation techniques in which one or more significant inputs are unobservable in any market.

 

The following summarizes the fair value level of assets and liabilities that are measured on a recurring basis at September 30, 2013 and December 31, 2012 (amounts in thousands):

 

 

 

Level 1

 

Level 2

 

Level 3

 

Total

 

 

 

 

 

 

 

 

 

 

 

September 30, 2013

 

 

 

 

 

 

 

 

 

Derivative financial instruments - assets (a)

 

$

 

1,954

 

 

1,954

 

Derivative financial instruments - liabilities

 

 

(6,491

)

 

(6,491

)

Total

 

$

 

(4,537

)

 

(4,537

)

 

 

 

 

 

 

 

 

 

 

December 31, 2012

 

 

 

 

 

 

 

 

 

Derivative financial instruments - assets (a)

 

$

 

116

 

 

116

 

Derivative financial instruments - liabilities

 

 

(12,359

)

 

(12,359

)

Total

 

$

 

(12,243

)

 

(12,243

)

 


(a)         Included in Other assets, net on the condensed consolidated balance sheets

 

The Company has determined that the majority of the inputs used to value the Swaps fall within Level 2 of the fair value hierarchy.  The credit valuation adjustments associated with the derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by their counterparties.  As the counterparties have publicly available credit information, the credit spreads over LIBOR used in the calculations represent implied credit default swap spreads obtained from a third-party credit data provider.  However, as of September 30, 2013, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of the Swaps.  As a result, the Company has determined that its derivative valuations are classified in Level 2 of the fair value hierarchy.

 

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The following table presents the activity in the Level 3 balances (amounts in thousands):

 

 

 

Nine months ended September 30,

 

 

 

2013

 

2012

 

 

 

 

 

 

 

Beginning balance

 

$

 

(16,959

)

Unrealized gain recognized

 

 

16,959

 

Ending balance

 

$

 

 

 

Carrying values and fair values of financial instruments that are not carried at fair value are as follows (amounts in thousands):

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

 

 

 

 

Long term debt, including current portion:

 

 

 

 

 

Carrying value

 

$

1,614,926

 

$

1,108,383

 

Fair value (a)

 

1,642,946

 

1,130,978

 

 


(a)         The fair value is based on valuations from third party financial institutions and is classified as Level 2 in the hierarchy.

 

The Company’s other financial instruments, including cash and cash equivalents, accounts receivable and accounts payable are carried at cost, which approximates their fair value because of their short-term maturity.

 

(10)                          Commitments, Contingencies and Other Liabilities

 

The Company is involved in litigation and similar claims incidental to the conduct of its business, including from time to time, contractual disputes, claims related to alleged security system failures and claims related to alleged violations of the U.S. Telephone Consumer Protection Act. Matters that are probable of unfavorable outcome to the Company and which can be reasonably estimated are accrued. Such accruals are based on information known about the matters, management’s estimate of the outcomes of such matters and experience in contesting, litigating and settling similar matters.  In management’s opinion, none of the pending actions is likely to have a material adverse impact on the Company’s financial position or results of operations.

 

Based on events occurring in the State of Georgia in 2006, a monitoring service subscriber filed suit against the Company and Tel-Star Alarms, Inc., a Monitronics authorized dealer, alleging negligence.  On November 16, 2011, a Georgia trial court awarded the plaintiff $8,600,000, of which $6,000,000 is expected to be covered by the Company’s general liability insurance policies.  The Company funded approximately $2,640,000 into an escrow account for the excess liability above the insurance coverage, classified as restricted cash on the September 30, 2013 and December 31, 2012 condensed consolidated balance sheets.  In July 2013, the trial court’s ruling was affirmed by the Georgia Court of Appeals.  The Company was seeking review of the Court of Appeals’ ruling in Georgia’s Supreme Court, which was subsequently denied on November 4, 2013.   As of September 30, 2013, the Company has recorded legal reserves of approximately $9,653,000 and an insurance receivable of approximately $7,013,000, related to this matter.

 

(11)                          Consolidating Guarantor Financial Information

 

The Senior Notes were issued and the Credit Facility was entered into by Monitronics (the “Parent Issuer”) and both are guaranteed by all of the Company’s existing U.S. subsidiaries (“Subsidiary Guarantors”).  Ascent Capital has not guaranteed any of the Company’s obligations under the Senior Notes or Credit Facility.

 

Consolidating guarantor financial information has not been presented for the year ended December 31, 2012, and three and nine months ended September 30, 2012, as substantially all of the Company’s operations were conducted by the Parent Issuer entity. The Company believes that disclosing such information would not provide investors with any additional information that would be material in evaluating the sufficiency of the guarantees.

 

The unaudited condensed consolidating financial information for the Parent Issuer, the Subsidiary Guarantors and the non-guarantors as of and for the three and nine months ended September 30, 2013, are as follows:

 

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MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES

Condensed Consolidating Balance Sheets

(unaudited)

 

 

 

As of September 30, 2013

 

 

 

Parent Issuer

 

Subsidiary
Guarantors

 

Non-Guarantors

 

Eliminations

 

Consolidated

 

 

 

(amounts in thousands)

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

27,647

 

1,799

 

 

 

29,446

 

Restricted cash

 

2,680

 

 

 

 

2,680

 

Trade receivables, net

 

11,720

 

1,901

 

 

 

13,621

 

Deferred income tax assets, net

 

5,100

 

 

 

 

5,100

 

Prepaid and other current assets

 

15,849

 

1,307

 

 

(3,851

)

13,305

 

Total current assets

 

62,996

 

5,007

 

 

(3,851

)

64,152

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment in subsidiaries

 

499,391

 

 

 

(499,391

)

 

Property and equipment, net

 

21,836

 

1,310

 

 

 

23,146

 

Subscriber accounts, net

 

1,026,558

 

311,843

 

 

 

1,338,401

 

Dealer network and other intangible assets, net

 

22,293

 

47,287

 

 

 

69,580

 

Goodwill

 

349,227

 

173,033

 

 

 

522,260

 

Other assets, net

 

29,672

 

 

 

 

29,672

 

Total assets

 

$

2,011,973

 

538,480

 

 

(503,242

)

2,047,211

 

 

 

 

 

 

 

 

 

 

 

 

 

Liabilities and Stockholder’s Equity

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

 

 

 

 

Accounts payable

 

$

4,508

 

1,732

 

 

 

6,240

 

Accrued payroll and related liabilities

 

2,787

 

1,089

 

 

 

3,876

 

Other accrued liabilities

 

44,720

 

9,457

 

 

(3,851

)

50,326

 

Deferred revenue

 

10,599

 

3,732

 

 

 

14,331

 

Purchase holdbacks

 

16,440

 

2,989

 

 

 

19,429

 

Current portion of long-term debt

 

9,166

 

 

 

 

9,166

 

Total current liabilities

 

88,220

 

18,999

 

 

(3,851

)

103,368

 

 

 

 

 

 

 

 

 

 

 

 

 

Non-current liabilities:

 

 

 

 

 

 

 

 

 

 

 

Long-term debt

 

1,605,760

 

 

 

 

1,605,760

 

Long-term purchase holdbacks

 

 

6,756

 

 

 

6,756

 

Derivative financial instruments

 

6,491

 

 

 

 

6,491

 

Deferred income tax liability, net

 

9,144

 

451

 

 

 

9,595

 

Other liabilities

 

3,245

 

12,883

 

 

 

16,128

 

Total liabilities

 

1,712,860

 

39,089

 

 

(3,851

)

1,748,098

 

 

 

 

 

 

 

 

 

 

 

 

 

Total stockholder’s equity

 

299,113

 

499,391

 

 

(499,391

)

299,113

 

Total liabilities and stockholder’s equity

 

$

2,011,973

 

538,480

 

 

(503,242

)

2,047,211

 

 

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MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES

Condensed Consolidating Statements of Operations and Comprehensive Income (Loss)

(unaudited)

 

 

 

Three months ended September 30, 2013

 

 

 

Parent Issuer

 

Subsidiary
Guarantors

 

Non-Guarantors

 

Eliminations

 

Consolidated

 

 

 

(amounts in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenue

 

$

104,350

 

11,494

 

 

 

115,844

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Cost of services

 

17,482

 

2,673

 

 

 

20,155

 

Selling, general, and administrative, including stock-based and long-term incentive compensation

 

17,820

 

2,148

 

 

 

19,968

 

Amortization of subscriber accounts, dealer network and other intangible assets

 

48,096

 

7,650

 

 

 

55,746

 

Depreciation

 

1,698

 

212

 

 

 

1,910

 

Restructuring charges

 

 

402

 

 

 

 

402

 

 

 

85,096

 

13,085

 

 

 

98,181

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

19,254

 

(1,591

)

 

 

17,663

 

 

 

 

 

 

 

 

 

 

 

 

 

Other expense:

 

 

 

 

 

 

 

 

 

 

 

Equity in loss of subsidiaries

 

2,223

 

 

 

(2,223

)

 

Interest expense

 

25,572

 

160

 

 

 

25,732

 

 

 

27,795

 

160

 

 

(2,223

)

25,732

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss before income taxes

 

(8,541

)

(1,751

)

 

2,223

 

(8,069

)

Income tax expense

 

769

 

472

 

 

 

1,241

 

Net loss

 

(9,310

)

(2,223

)

 

2,223

 

(9,310

)

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive loss:

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on derivative contracts

 

(4,526

)

 

 

 

(4,526

)

Total other comprehensive loss

 

(4,526

)

 

 

 

(4,526

)

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive loss

 

$

(13,836

)

(2,223

)

 

2,223

 

(13,836

)

 

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MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES

Condensed Consolidating Statements of Operations and Comprehensive Income (Loss)

(unaudited)

 

 

 

Nine months ended September 30, 2013

 

 

 

Parent Issuer

 

Subsidiary
Guarantors

 

Non-Guarantors

 

Eliminations

 

Consolidated

 

 

 

(amounts in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net revenue

 

$

306,781

 

11,494

 

 

 

318,275

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

Cost of services

 

48,278

 

2,673

 

 

 

50,951

 

Selling, general, and administrative, including stock-based and long-term incentive compensation

 

51,836

 

2,148

 

 

 

53,984

 

Amortization of subscriber accounts, dealer network and other intangible assets

 

138,409

 

7,650

 

 

 

146,059

 

Depreciation

 

4,907

 

212

 

 

 

5,119

 

Restructuring charges

 

 

402

 

 

 

 

402

 

Gain on sale of operating assets

 

(2

)

 

 

 

 

 

 

(2

)

 

 

243,428

 

13,085

 

 

 

256,513

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

63,353

 

(1,591

)

 

 

61,762

 

 

 

 

 

 

 

 

 

 

 

 

 

Other expense:

 

 

 

 

 

 

 

 

 

 

 

Equity in loss of subsidiaries

 

2,223

 

 

 

(2,223

)

 

Interest expense

 

66,165

 

160

 

 

 

66,325

 

 

 

68,388

 

160

 

 

(2,223

)

66,325

 

 

 

 

 

 

 

 

 

 

 

 

 

Loss before income taxes

 

(5,035

)

(1,751

)

 

2,223

 

(4,563

)

Income tax expense

 

2,334

 

472

 

 

 

2,806

 

Net loss

 

(7,369

)

(2,223

)

 

2,223

 

(7,369

)

 

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain (loss) on derivative contracts

 

7,404

 

 

 

 

7,404

 

Total other comprehensive income

 

7,404

 

 

 

 

7,404

 

 

 

 

 

 

 

 

 

 

 

 

 

Comprehensive income loss

 

$

35

 

(2,223

)

 

2,223

 

35

 

 

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MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES

Condensed Consolidating Statement of Cash Flows

(unaudited)

 

 

 

Nine months ended September 30, 2013

 

 

 

Parent Issuer

 

Subsidiary
Guarantors

 

Non-Guarantors

 

Eliminations

 

Consolidated

 

 

 

(amounts in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

160,606

 

9,272

 

 

 

169,878

 

 

 

 

 

 

 

 

 

 

 

 

 

Investing activities:

 

 

 

 

 

 

 

 

 

 

 

Capital expenditures

 

(6,184

)

(119

)

 

 

(6,303

)

Purchases of subscriber accounts

 

(164,077

)

(10,450

)

 

 

(174,527

)

Cash acquired (paid) on acquisition

 

(482,891

)

3,096

 

 

 

(479,795

)

Proceeds from sale of operating assets

 

2

 

 

 

 

2

 

Decrease in restricted cash

 

(40

)

 

 

 

(40

)

 

 

 

 

 

 

 

 

 

 

 

 

Net cash used in investing activities

 

(653,190

)

(7,473

)

 

 

(660,663

)

 

 

 

 

 

 

 

 

 

 

 

 

Financing activities:

 

 

 

 

 

 

 

 

 

 

 

Proceeds from long-term debt

 

591,375

 

 

 

 

591,375

 

Payments of long-term debt

 

(85,455

)

 

 

 

(85,455

)

Payments of deferred financing costs and refinancing costs

 

(8,122

)

 

 

 

(8,122

)

Contribution from Ascent Capital

 

20,000

 

 

 

 

20,000

 

Dividend to Ascent Capital

 

(1,000

)

 

 

 

(1,000

)

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by financing activities

 

516,798

 

 

 

 

516,798

 

 

 

 

 

 

 

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

24,214

 

1,799

 

 

 

26,013

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents at beginning of period

 

3,433

 

 

 

 

3,433

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

27,647

 

1,799

 

 

 

29,446

 

 

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(12)                          Subsequent Events

 

On November 4, 2013, the Company commenced an exchange offer (the “Exchange Offer”) in which up to $175,000,000 aggregate principal amount of exchange notes (the “Exchange Notes”) registered under the Securities Act were offered in exchange for the same principal amount of the outstanding New Senior Notes.  The terms of the Exchange Notes and the outstanding New Senior Notes are substantially identical, except that the transfer restrictions and registration rights relating to the New Senior Notes do not apply to the Exchange Notes.  The Exchange Offer was commenced in order to satisfy the Company’s obligations under the registration rights agreement related to the outstanding New Senior Notes.  The Exchange Offer is expected to expire on December 4, 2013.

 

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Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 

Certain statements in this Quarterly Report on Form 10-Q 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, the completion of the Company’s Exchange Offer,  new service offerings, financial prospects, and anticipated sources and uses of capital. 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:

 

Factors relating to the Company and its consolidated subsidiaries, as a whole:

 

·                  general business conditions and industry trends;

·                  macroeconomic conditions and their effect on the general economy and on the U.S. housing market, in particular single family homes which represent the Company’s largest demographic;

·                  uncertainties in the development of our business strategies, including 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;

·                  integration of acquired assets and businesses;

·                  the regulatory environment in which we operate, including the multiplicity of jurisdictions and licensing requirements to which the Company is subject and the risk of new regulations, such as the increasing adoption of false alarm ordinances;

·                  the availability and terms of capital, including the ability of the Company to obtain additional funds to grow its business;

·                  the Company’s high degree of leverage and the restrictive covenants governing its indebtedness;

·                  the outcome of any pending, threatened, or future litigation, including potential liability for failure to respond adequately to alarm activations;

·                  our 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;

·                  availability of qualified personnel;

·                  the Company’s anticipated growth strategies;

·                  the Company’s 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 operating performance of the Company’s network, including the potential for service disruptions due to acts of nature or technology deficiencies;

·                  changes in the nature of strategic relationships with original equipment manufacturers, dealers and other business partners;

·                  the reliability and creditworthiness of the Company’s independent alarm systems dealers and subscribers;

·                  changes in the Company’s expected rate of subscriber attrition;

·                  changes in technology that may make the Company’s service less attractive or obsolete, or require significant expenditures to update, including the phase-out of 2G networks by cellular carriers;

·                  the development of new services or service innovations by competitors;

·                  the trend away from the use of public switched telephone network lines and resultant increase in servicing costs associated with alternative methods of communication; and

·                  the ability to successfully integrate Security Networks into the Company’s business.

 

For additional risk factors, please see the Risk Factors section in our Registration Statement on Form S-4, filed with the Securities and Exchange Commission on October 18, 2013.  These forward-looking statements and such risks, uncertainties and other factors speak only as of the date of this Quarterly 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.

 

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 condensed consolidated financial statements and the notes thereto included elsewhere herein and the 2012 Form 10-K.

 

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Overview

 

The Company provides security alarm monitoring and related services to residential and business subscribers throughout the United States and parts of Canada.  On August 16, 2013, the Company acquired all of the equity interests of Security Networks LLC (“Security Networks”) and certain affiliated entities (the “Security Networks Acquisition”).  The Company monitors signals arising from burglaries, fires, medical alerts and other events through security systems at subscribers’ premises, as well as provides customer service and technical support.  Nearly all of its revenues are derived from recurring monthly revenues under security alarm monitoring contracts purchased from independent dealers in its exclusive nationwide network.

 

Attrition

 

Account cancellation, otherwise referred to as subscriber attrition, has a direct impact on the number of subscribers that the Company services and on its 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’s service.  The largest category of canceled accounts relate to subscriber relocation or the inability to contact the subscriber.  The Company defines its attrition rate as the number of canceled accounts in a given period divided by the weighted average of number of subscribers for that period.  The Company considers 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 (a “new owner takeover”), this is also not a cancellation.  The Company adjusts the number of canceled accounts by excluding those that are contractually guaranteed by its 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 the purchase price. To help ensure the dealer’s obligation to the Company, the Company typically maintains a dealer funded holdback reserve ranging from 5-10% of subscriber accounts in the guarantee period.  In some cases, the amount of the purchase holdback may be less than actual attrition experience.

 

The table below presents subscriber data for the twelve months ended September 30, 2013 and 2012:

 

 

 

Twelve Months Ended
September 30,

 

 

 

2013

 

2012

 

 

 

 

 

 

 

Beginning balance of accounts

 

717,488

 

697,581

 

Accounts purchased

 

437,860

 

106,582

 

Accounts canceled

 

(106,859

)

(84,523

)

Canceled accounts guaranteed by dealer and acquisition adjustment (a) (b)

 

(6,749

)

(2,152

)

Ending balance of accounts

 

1,041,740

 

717,488

 

Monthly weighted average accounts

 

847,673

 

706,752

 

Attrition rate

 

(12.6

)%

(12.0

)%

 


(a)         Canceled accounts that are contractually guaranteed to be refunded from holdback.

(b)         Includes 1,946 subscriber accounts that were proactively cancelled during the third quarter of 2013 which were active with both Monitronics and Security Networks, upon acquisition.

 

The attrition rate for the twelve months ended September 30, 2013 and 2012 was 12.6% and 12.0%, respectively.  Increased attrition reflects the current age of accounts in the portfolio and an increase in disconnections due to household relocations.

 

The Company also analyzes its attrition by classifying accounts into annual pools based on the year of purchase.  The Company then tracks the number of accounts that cancel as a percentage of the initial number of accounts purchased for each pool for each year subsequent to its purchase.  Based on the average cancellation rate across the pools, in recent years the Company has averaged less than 1% attrition within the initial 12-month period after considering the accounts which were replaced or refunded by the dealers at no additional cost to the Company.  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.  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.

 

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Accounts Purchased

 

During the three and nine months ended September 30, 2013, the Company purchased 37,109 and 113,302 accounts, respectively, without giving effect to the Security Networks Acquisition.  In addition, the Company acquired 203,898 accounts in the Security Networks Acquisition, which was completed on August 16, 2013.  Account purchases for the nine months ended September 30, 2013 reflect bulk buys of approximately 18,200 accounts purchased in the second quarter of 2013.  During the three and nine months ended September 30, 2012, the Company purchased 31,187 and 81,719 subscriber accounts, respectively.

 

Recurring monthly revenue (“RMR”) purchased during the three and nine months ended September 30, 2013 was approximately $1,701,000 and $5,068,000, respectively, without giving effect to the Security Networks Acquisition.  In addition, RMR of approximately $8,861,000 was acquired in the Security Networks Acquisition.  RMR purchased during the three and nine months ended September 30, 2012 was approximately $1,387,000 and $3,601,000, respectively.

 

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 and dealer network), realized and unrealized gain/(loss) on derivative instruments, restructuring charges, stock-based and other non-cash long-term incentive compensation, and other non-cash or nonrecurring charges.   The Company believes that Adjusted EBITDA is an important indicator of the operational strength and performance of its business, including the business’ ability to fund its ongoing acquisition of subscriber accounts, its capital expenditures and to service its 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 the Company’s covenants are calculated under the agreements governing their debt obligations.  Adjusted EBITDA does not represent cash flow from operations as defined by generally accepted accounting principles (“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 the Company believes is useful to investors in analyzing its 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 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 condensed consolidated statements of operations and comprehensive income (loss) for the periods indicated (dollar amounts in thousands).

 

 

 

Three months ended

 

Nine months ended

 

 

 

September 30,

 

September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Net revenue

 

$

115,844

(a)

84,667

 

$

318,275

(a)

249,863

 

Cost of services

 

20,155

 

12,881

 

50,951

 

35,331

 

Selling, general, and administrative

 

19,968

 

14,755

 

53,984

 

43,759

 

Amortization of subscriber accounts, dealer network and other intangible assets

 

55,746

 

40,815

 

146,059

 

118,245

 

Restructuring charges

 

402

 

 

402

 

 

Interest expense

 

25,732

 

19,243

 

66,325

 

50,212

 

Realized and unrealized loss on derivative financial instruments

 

 

 

 

2,044

 

Income tax expense from continuing operations

 

1,241

 

700

 

2,806

 

2,038

 

Net loss

 

(9,310

)

(5,095

)

(7,369

)

(12,620

)

 

 

 

 

 

 

 

 

 

 

Adjusted EBITDA (b)

 

$

77,649

 

57,420

 

$

217,472

 

171,123

 

Adjusted EBITDA as a percentage of Revenue

 

67.0

%

67.8

%

68.3

%

68.5

%

 


(a)         Net revenue for the three and nine months ended September 30, 2013 reflects the negative impact of an approximate $2,500,000 fair value adjustment that reduced deferred revenue acquired in the Security Networks Acquisition.

(b)  See reconciliation to net loss below.

 

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Net revenue.  Net revenue increased $31,177,000, or 36.8%, and $68,412,000, or 27.4%, for the three and nine months ended September 30, 2013, respectively, as compared to the corresponding prior year periods.  The increase in net revenue is attributable to the growth in the number of subscriber accounts and the increase in average monthly revenue per subscriber.  The growth in subscriber accounts reflects the effects of the acquisition of Security Networks in August 2013, which included over 200,000 subscriber accounts, purchases of over 120,000 accounts through the Company’s authorized dealer program subsequent to September 30, 2012, and the purchase of approximately 111,000 accounts in various bulk buys over the last 12 months.  In addition, average monthly revenue per subscriber increased from $38.28 as of September 30, 2012 to $40.70 as of September 30, 2013.  Net revenue for the three and nine months ended September 30, 2013 also reflects the negative impact of an approximate $2,500,000 fair value adjustment that reduced deferred revenue acquired in the Security Networks Acquisition.

 

Cost of services.  Cost of services increased $7,274,000, or 56.5%, and $15,620,000, or 44.2%, for the three and nine months ended September 30, 2013, respectively, as compared to the corresponding prior year periods.  The increase for both the three and nine months ended September 30, 2013 is primarily attributable to an increased number of accounts monitored across the cellular network and having interactive and home automation services, which result in higher operating and service costs.  In addition, cost of services for the three and nine months ended September 30, 2013, includes Security Networks monitoring costs of $2,673,000.  Cost of services as a percent of net revenue increased from 15.2% and 14.1% for the three and nine months ended September 30, 2012, respectively, to 17.4% and 16.0% for the three and nine months ended September 30, 2013, respectively.

 

Selling, general and administrative.  Selling, general and administrative costs (“SG&A”) increased $5,213,000, or 35.3%, and $10,225,000, or 23.4% for the three and nine months ended September 30, 2013, respectively, as compared to the corresponding prior year periods.  The increase is attributable to increased payroll expenses of approximately $581,000 and $2,152,000 for the three and nine months ended September 30, 2013, respectively, as compared to the corresponding prior year periods, the inclusion of Security Networks SG&A costs of $2,148,000 for both the three and nine months ended September 30, 2013 and acquisition and integration costs related to professional services rendered and other costs incurred in connection with the Security Networks Acquisition.  Acquisition costs recognized in the three and nine months ended September 30, 2013 are $1,032,000 and $2,470,000, respectively.   Integration costs recognized in both the three and nine months ended September 30, 2013 are $535,000.  SG&A as a percent of net revenue decreased from 17.4% and 17.5% for the three and nine months ended September 30, 2012, respectively, to 17.2% and 17.0% for the three and nine months ended September 30, 2013, respectively.

 

Amortization of subscriber accounts, dealer network and other intangible assets.  Amortization of subscriber accounts, dealer network and other intangible assets increased $14,931,000 and $27,814,000 for the three and nine months ended September 30, 2013 as compared to the corresponding prior year periods.  The increase for both the three and nine months ended September 30, 2013 is primarily attributable to amortization of subscriber accounts purchased subsequent to September 30, 2012.  Additionally, the three and nine months ended includes amortization of approximately $7,650,000 related to the definite lived intangible assets acquired in the Security Networks Acquisition.

 

Restructuring charges. In connection with the Security Networks Acquisition, management approved a restructuring plan to transition Security Networks operations in West Palm Beach and Kissimmee, Florida to Dallas, Texas (the “Security Networks Restructuring Plan”).   The Security Networks Restructuring Plan provides certain employees with a severance package that entitles them to benefits upon completion of the transition in 2014.  Severance costs related to the Security Networks Restructuring Plan are recognized ratably over the future service period.  During the three and nine months ended September 30, 2013, the Company recorded $402,000 of restructuring charges related to employee termination benefits.

 

Additionally, in connection with Security Networks Restructuring Plan, the Company allocated approximately $492,000 of the Security Networks Purchase Price to accrued restructuring in relation to the Security Networks’ severance agreement entered into with its former Chief Executive Officer.

 

The following table provides the activity and balances of the Security Networks Restructuring Plan (amounts in thousands):

 

 

 

Nine months ended September 30, 2013

 

 

 

Opening
balance

 

Additions

 

Deductions

 

Other

 

Ending balance