Table of Contents


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C.  20549
 
FORM 10-Q
 
ý      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2016
 
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)
 
 
1990 Wittington Place
 
 
Farmers Branch, 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 ý  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 ý  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 ý

As of May 12, 2016, Monitronics International, Inc. is a wholly owned subsidiary of Ascent Capital Group, Inc.



Table of Contents

TABLE OF CONTENTS
 
 
 
Page
PART I — FINANCIAL INFORMATION
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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Item 1.  Financial Statements.
MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidated Balance Sheets
Amounts in thousands, except share amounts
(unaudited)
 
March 31,
2016
 
December 31,
2015
Assets
 

 
 

Current assets:
 

 
 

Cash and cash equivalents
$
29,003

 
$
2,580

Restricted cash

 
55

Trade receivables, net of allowance for doubtful accounts of $2,587 in 2016 and $2,762 in 2015
13,334

 
13,622

Prepaid and other current assets
11,063

 
9,890

Total current assets
53,400

 
26,147

Property and equipment, net of accumulated depreciation of $29,032 in 2016 and $27,057 in 2015
26,715

 
26,654

Subscriber accounts, net of accumulated amortization of $1,034,597 in 2016 and $975,795 in 2015
1,409,489

 
1,423,538

Dealer network and other intangible assets, net of accumulated amortization of $76,036 in 2016 and $73,578 in 2015
24,197

 
26,654

Goodwill
563,549

 
563,549

Other assets, net
3,588

 
3,725

Total assets
$
2,080,938

 
$
2,070,267

Liabilities and Stockholder's Equity
 

 
 

Current liabilities:
 

 
 

Accounts payable
$
7,560

 
$
8,621

Accrued payroll and related liabilities
3,659

 
3,479

Other accrued liabilities
47,101

 
32,522

Deferred revenue
16,267

 
16,207

Holdback liability
14,258

 
16,386

Current portion of long-term debt
5,500

 
5,500

Total current liabilities
94,345

 
82,715

Non-current liabilities:
 

 
 

Long-term debt
1,673,464

 
1,739,147

Long-term holdback liability
3,614

 
3,786

Derivative financial instruments
25,364

 
13,470

Deferred income tax liability, net
14,243

 
13,191

Other liabilities
12,313

 
16,893

Total liabilities
1,823,343

 
1,869,202

Commitments and contingencies


 


Stockholder's equity:
 

 
 

Common stock, $.01 par value. 1,000 shares authorized, issued and outstanding both at March 31, 2016 and December 31, 2015

 

Additional paid-in capital
449,813

 
361,228

Accumulated deficit
(166,827
)
 
(146,617
)
Accumulated other comprehensive loss
(25,391
)
 
(13,546
)
Total stockholder's equity
257,595

 
201,065

Total liabilities and stockholder's equity
$
2,080,938

 
$
2,070,267

 

See accompanying notes to condensed consolidated financial statements.

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MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations and Comprehensive Income (Loss)
Amounts in thousands
(unaudited)
 
 
 
Three Months Ended 
 March 31,
 
 
2016
 
2015
Net revenue
 
$
143,268

 
138,416

Operating expenses:
 
 
 
 
Cost of services
 
29,475

 
25,167

Selling, general, and administrative, including stock-based compensation
 
28,613

 
23,424

Radio conversion costs
 
9,079

 
523

Amortization of subscriber accounts, dealer network and other intangible assets
 
61,322

 
63,141

Depreciation
 
1,975

 
2,297

  Gain on disposal of operating assets
 

 
(3
)
 
 
130,464

 
114,549

Operating income
 
12,804

 
23,867

Other expense:
 
 
 
 
Interest expense
 
31,224

 
30,240

 
 
31,224

 
30,240

Loss before income taxes
 
(18,420
)
 
(6,373
)
Income tax expense
 
1,790

 
1,961

Net loss
 
(20,210
)
 
(8,334
)
Other comprehensive loss:
 
 
 
 
Unrealized loss on derivative contracts, net of tax
 
(11,845
)
 
(4,463
)
Total other comprehensive loss, net of tax
 
(11,845
)
 
(4,463
)
Comprehensive loss
 
$
(32,055
)
 
(12,797
)
 
See accompanying notes to condensed consolidated financial statements.


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MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
Amounts in thousands
(unaudited)
 
Three Months Ended 
 March 31,
 
2016
 
2015
Cash flows from operating activities:
 

 
 

Net loss
$
(20,210
)
 
(8,334
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 

 
 

Amortization of subscriber accounts, dealer network and other intangible assets
61,322

 
63,141

Depreciation
1,975

 
2,297

Stock-based compensation
522

 
374

Deferred income tax expense
1,052

 
1,021

Amortization of debt discount and deferred debt costs
1,742

 
1,460

Bad debt expense
2,544

 
2,375

Gain on disposal of operating assets

 
(3
)
Other non-cash activity, net
760

 
352

Changes in assets and liabilities:
 
 
 
Trade receivables
(2,256
)
 
(2,265
)
Prepaid expenses and other assets
(1,142
)
 
(778
)
Subscriber accounts - deferred contract costs
(660
)
 

Payables and other liabilities
9,090

 
4,416

Net cash provided by operating activities
54,739

 
64,056

Cash flows from investing activities:
 

 
 

Capital expenditures
(2,276
)
 
(2,728
)
Cost of subscriber accounts acquired
(46,670
)
 
(61,053
)
Cash paid for acquisition, net of cash acquired

 
(56,343
)
Increase in restricted cash
55

 
(105
)
Proceeds from the disposal of operating assets

 
3

Net cash used in investing activities
(48,891
)
 
(120,226
)
Cash flows from financing activities:
 

 
 

Proceeds from long-term debt
59,250

 
91,400

Payments on long-term debt
(38,675
)
 
(33,892
)
Payments of financing costs

 
(551
)
Contribution from Ascent Capital

 
22,690

Net cash provided by financing activities
20,575

 
79,647

Net increase in cash and cash equivalents
26,423

 
23,477

Cash and cash equivalents at beginning of period
2,580

 
1,953

Cash and cash equivalents at end of period
$
29,003

 
25,430

 
 
 
 
Supplemental cash flow information:
 

 
 

State taxes paid
$
19

 

Interest paid
19,139

 
17,554

 

See accompanying notes to condensed consolidated financial statements.

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MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Stockholder’s Equity
Amounts in thousands, except share amounts
(unaudited)
 
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive Loss
 
Accumulated Deficit
 
Total
Stockholder’s Equity
 
Shares
 
Amount
 
 
 
 
Balance at December 31, 2015
1,000

 
$

 
361,228

 
(13,546
)
 
(146,617
)
 
$
201,065

Net loss

 

 

 

 
(20,210
)
 
(20,210
)
Other comprehensive loss

 

 

 
(11,845
)
 

 
(11,845
)
Stock-based compensation

 

 
643

 

 

 
643

Value of shares withheld for minimum tax liability

 

 
(58
)
 

 

 
(58
)
Contribution from Ascent Capital

 

 
88,000

 

 

 
88,000

Balance at March 31, 2016
1,000

 
$

 
449,813

 
(25,391
)
 
(166,827
)
 
$
257,595

 
See accompanying notes to condensed consolidated financial statements.


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MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
 
(1)    Basis of Presentation
 
Monitronics International, Inc. and its subsidiaries (collectively, the "Company" or "Monitronics") are wholly owned subsidiaries of Ascent Capital Group, Inc. ("Ascent Capital").  On February 23, 2015, the Company 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"). On August 16, 2013, the Company acquired all of the equity interest of Security Networks LLC ("Security Networks") and certain affiliated entities . 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 at subscribers’ premises, as well as provides customer service and technical support.
 
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 March 31, 2016, and for the three months ended March 31, 2016 and 2015, 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, 2015, filed with the SEC on March 7, 2016 (the "2015 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.

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 Condensed Consolidated Statements of Operations and Other Comprehensive Income (Loss). Radio conversion costs represent all direct costs incurred during the subscribers' alarm monitoring system upgrade in relation to the 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)    Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("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 March 2016, the FASB issued additional guidance which clarifies principal versus agent considerations, and in April 2016, the FASB issued further guidance which clarifies the identification of performance obligations and the implementation guidance for licensing. 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. Early adoption will be permitted for annual and interim periods beginning after December 15, 2016. The Company is currently evaluating the impact that adopting this ASU will have on its financial position, results of operations and cash flows.

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), ("ASU 2016-02"). ASU 2016-02 introduces a lessee model that brings most leases on the balance sheet and eliminates the current requirements for a company to use bright-line tests in determining lease classification. ASU 2016-02 is effective on January 1, 2019 and requires a modified retrospective transaction. The Company is currently evaluating the impact of adopting ASU 2016-02 will have on its financial position, results of operations and cash flows.

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In March 2016, the FASB issued 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. Adoption requirements are different for each change in the reporting method and may be prospective, retrospective and/or modified retrospective. ASU 2016-09 is effective for periods beginning January 1, 2017, including interim periods with those periods. Early adoption is permitted. The Company is currently evaluating the impact of ASU 2016-09 will have on its financial position, results of operations, and cash flows.

(3)    LiveWatch Acquisition

On February 23, 2015 ("the Closing Date"), the Company acquired LiveWatch Security, LLC ("LiveWatch") for a purchase price of approximately $61,550,000 (the "LiveWatch Purchase Price"). The LiveWatch Purchase Price includes 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 Monitronics' 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 was calculated as the excess of the consideration transferred over the net assets recognized and represents the value to Monitronics 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 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.

(4)    Other Accrued Liabilities
 
Other accrued liabilities consisted of the following (amounts in thousands): 
 
March 31, 2016
 
December 31, 2015
Interest payable
$
28,309

 
$
18,226

Income taxes payable
3,317

 
2,603

Legal accrual
75

 
145

LiveWatch acquisition retention bonus
2,963

 

Other
12,437

 
11,548

Total Other accrued liabilities
$
47,101

 
$
32,522



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(5)    Long-Term Debt
 
Long-term debt consisted of the following (amounts in thousands):
 
 
March 31,
2016
 
December 31,
2015
9.125% Senior Notes due April 1, 2020 with an effective interest rate of 9.4%
$
576,691

 
$
576,241

Promissory Note to Ascent Capital due October 1, 2020 with an effective rate of 12.5% (a)
12,000

 
100,000

Term loans, mature April 9, 2022, LIBOR plus 3.5%, subject to a LIBOR floor of 1.00%, with an effective rate of 5.1%
541,157

 
542,420

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%
395,858

 
394,938

$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 5.9%
153,258

 
131,048

 
1,678,964

 
1,744,647

Less current portion of long-term debt
(5,500
)
 
(5,500
)
Long-term debt
$
1,673,464

 
$
1,739,147

 
(a)
The effective rate was 9.868% until February 29, 2016.
 
Senior Notes
 
The senior notes total $585,000,000 in principal, mature on April 1, 2020 and bear interest at 9.125% per 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 March 31, 2016, the Senior Notes had deferred financing costs, net of accumulated amortization of $8,309,000.
 
Ascent Intercompany Loan
 
On February 29, 2016, the Company retired the existing intercompany loan with an outstanding principal amount of $100,000,000 and executed and delivered a Promissory Note to Ascent Capital in a principal amount of $12,000,000 (the "Ascent Intercompany Loan"), with the $88,000,000 remaining principal to be 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 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.  The effective rate was 12.5% as of March 31, 2016 and 9.868% as of December 31, 2015. 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

The Company has senior secured term loans totaling $948,284,000 in principal with $403,784,000 maturing in March 2018 (the "2018 Term Loans") and $544,500,000 maturing in April 2022 (the "2022 Term Loans"). Monitronics also has a $315,000,000 revolving credit facility, maturing December 22, 2017 of which $155,200,000 is outstanding as of March 31, 2016 (the senior secured term loans together with the revolving credit facility, the "Credit Facility").
 
The 2018 Term Loans bear interest at LIBOR plus 3.25%, subject to a LIBOR floor of 1.00%, and mature on March 23, 2018. Interest payments on the 2018 Term Loans are due quarterly with the principal due at maturity. The 2022 Term Loans bear interest at LIBOR plus 3.50%, subject to a LIBOR floor of 1.00% and mature on April 9, 2022. Interest and principal payments of approximately $1,375,000 are due quarterly on the 2022 Term Loans with the remaining principal due at maturity.  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. 


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On March 30, 2016, the Company borrowed $40,800,000 on the Credit Facility revolver to fund its April 1, 2016 interest payment due under the Senior Notes of $26,691,000 and other business activities.
 
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 the Company and all of its existing subsidiaries and is guaranteed by all of the Company’s existing domestic subsidiaries.  Ascent Capital has not guaranteed any of the Company’s obligations under the Credit Facility.

As of March 31, 2016, the Company has deferred financing costs and unamortized discounts, net of accumulated amortization, of $13,211,000 related to 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, the Company 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”). 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, the Company's current effective weighted average interest rate on the borrowings under the Credit Facility term loans is 5.15%. See note 6, Derivatives, for further disclosures related to these derivative instruments. 
  
The terms of the Senior Notes and Credit Facility provide for certain financial and nonfinancial covenants.  As of March 31, 2016, the Company was in compliance with all required covenants.

As of March 31, 2016, principal payments scheduled to be made on the Company’s debt obligations are as follows (amounts in thousands):
Remainder of 2016
$
4,125

2017
160,700

2018
409,284

2019
5,500

2020
602,500

2021
5,500

Thereafter
512,875

Total principal payments
1,700,484

Less:
 

Unamortized deferred debt costs, discount and premium, net
21,520

Total debt on condensed consolidated balance sheet
$
1,678,964


(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 7, Fair Value Measurements, for additional information about the credit valuation adjustments.


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As of March 31, 2016 the Swaps’ outstanding notional balances, effective dates, maturity dates and interest rates paid and received are noted below:
Notional
 
Effective Date
 
Maturity Date
 
Fixed
Rate Paid
 
Variable Rate Received
$
528,000,000

 
March 28, 2013
 
March 23, 2018
 
1.884%
 
3 mo. USD-LIBOR-BBA, subject to a 1.00% floor (a)
139,925,000

 
March 28, 2013
 
March 23, 2018
 
1.384%
 
3 mo. USD-LIBOR-BBA, subject to a 1.00% floor (a)
109,390,703

 
September 30, 2013
 
March 23, 2018
 
1.959%
 
3 mo. USD-LIBOR-BBA, subject to a 1.00% floor
109,390,703

 
September 30, 2013
 
March 23, 2018
 
1.850%
 
3 mo. USD-LIBOR-BBA, subject to a 1.00% floor
191,475,002

 
March 23, 2018
 
April 9, 2022
 
2.924%
 
3 mo. USD-LIBOR-BBA, subject to a 1.00% floor
250,000,000

 
March 23, 2018
 
April 9, 2022
 
2.810%
 
3 mo. USD-LIBOR-BBA, subject to a 1.00% floor
50,000,000

 
March 23, 2018
 
April 9, 2022
 
2.504%
 
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, which were entered into in March 2012 (the "Existing Swap Agreements," as amended, the “Amended Swaps”).  The Amended Swaps are held with the same counterparties as the Existing Swap Agreements.  Upon entering into the Amended Swaps, Monitronics 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 are 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 $7,086,000.
 
The impact of the derivatives designated as cash flow hedges on the condensed consolidated financial statements is depicted below (amounts in thousands):
 
Three Months Ended 
 March 31,
 
2016
 
2015
Effective portion of loss recognized in Accumulated other comprehensive loss
$
(13,657
)
 
(6,268
)
Effective portion of loss reclassified from Accumulated other comprehensive loss into Net loss (a)
$
(1,812
)
 
(1,805
)
Ineffective portion of amount of loss recognized into Net loss on interest rate swaps (a)
$
(58
)
 
(84
)
 
(a) 
Amounts are included in Interest expense in the unaudited condensed consolidated statements of operations and comprehensive income (loss).
 

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(7)    Fair Value Measurements
 
According to the FASB ASC Topic 820, Fair Value Measurement, 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 March 31, 2016 and December 31, 2015 (amounts in thousands): 
 
Level 1
 
Level 2
 
Level 3
 
Total
March 31, 2016
 

 
 

 
 

 
 

Derivative financial instruments - liabilities

 
(25,364
)
 

 
(25,364
)
Total
$

 
(25,364
)
 

 
$
(25,364
)
December 31, 2015
 

 
 

 
 

 
 

Derivative financial instruments - liabilities

 
(13,470
)
 

 
(13,470
)
Total
$

 
(13,470
)
 

 
$
(13,470
)
 
The Company has determined that the significant inputs used to value the Swaps fall within Level 2 of the fair value hierarchy.  As a result, the Company has determined that its derivative valuations are classified in Level 2 of the fair value hierarchy.
 
Carrying values and fair values of financial instruments that are not carried at fair value are as follows (amounts in thousands):
 
March 31, 2016
 
December 31, 2015
Long term debt, including current portion:
 

 
 

Carrying value
$
1,678,964

 
$
1,744,647

Fair value (a)
1,513,579

 
1,603,375

 
(a)
T he fair value is based on market quotations 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.


11

Table of Contents

(8)    Accumulated Other Comprehensive Loss
 
The following table provides a summary of the changes in Accumulated other comprehensive loss for the period presented (amounts in thousands):
 
 
Accumulated
other
comprehensive
loss
As of December 31, 2015
$
(13,546
)
Unrealized loss on derivatives recognized through Accumulated other comprehensive loss
(13,657
)
Reclassifications of unrealized loss on derivatives into net income, net of income tax of $0 (a)
1,812

As of March 31, 2016
$
(25,391
)
 
(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)    Commitments, Contingencies and Other Liabilities
 
The Company is involved in litigation and similar claims incidental to the conduct of its business. 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.

(10)     Reportable Segments

Description of Segments

The Company operates through two reportable business segments according to the nature and economic characteristics of its services as well as the manner in which the information issued internally by the Company's key decision maker, who is the Company's Chief Executive Officer. The Company's business segments are as follows:

Monitronics

The Monitronics segment is primarily engaged in the business of providing security alarm monitoring services: monitoring signals arising from burglaries, fires, medical alerts and other events through security systems at subscribers' premises, as well as providing customer service and technical support. Monitronics outsources the sales, installation and most of its field service functions to its dealers. By outsourcing the low margin, high fixed-cost elements of its business to a large network of independent service providers, Monitronics is able to allocate capital to growing its revenue-generating account base rather than to local offices or depreciating hard assets.

LiveWatch

LiveWatch is a do-it-yourself ("DIY") home security provider offering professionally monitored security services through a direct-to-consumer sales channel. LiveWatch offers a differentiated go-to-market strategy through direct response TV, internet and radio advertising. When a customer initiates the process to obtain 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.

As they arise, transactions between segments are recorded on a arm's length basis using relevant market prices. Prior to the acquisition of LiveWatch in February 2015, Ascent Capital had one operating segment. Therefore, the LiveWatch segment only includes amounts incurred from the purchase date. The following table sets forth selected data from the accompanying condensed consolidated statements of operations for the periods indicated (amounts in thousands):


12

Table of Contents

 
 
Monitronics
 
LiveWatch
 
Consolidated
 
 
Three months ended March 31, 2016
Net revenue
 
$
138,096

 
$
5,172

 
$
143,268

Depreciation and amortization
 
$
62,152

 
$
1,145

 
$
63,297

Net loss from continuing operations before income taxes
 
$
(13,151
)
 
$
(5,269
)
 
$
(18,420
)
 
 
 
 
 
 
 
 
 
Three months ended March 31, 2015
Net revenue
 
$
136,901

 
$
1,515

 
$
138,416

Depreciation and amortization
 
$
64,996

 
$
442

 
$
65,438

Net loss from continuing operations before income taxes
 
$
(4,637
)
 
$
(1,736
)
 
$
(6,373
)

The following table sets forth selected data from the accompanying condensed consolidated balance sheets for the periods indicated (amounts in thousands):

 
 
Monitronics
 
LiveWatch
 
Eliminations
 
Consolidated
 
 
Balance at March 31, 2016
Subscriber accounts, net of amortization
 
$
1,386,853

 
$
22,636

 
$

 
$
1,409,489

Goodwill
 
$
527,502

 
$
36,047

 
$

 
$
563,549

Total assets
 
$
2,096,891

 
$
63,157

 
$
(79,110
)
 
$
2,080,938

 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
Subscriber accounts, net of amortization
 
$
1,400,515

 
$
23,023

 
$

 
$
1,423,538

Goodwill
 
$
527,502

 
$
36,047

 
$

 
$
563,549

Total assets
 
$
2,033,180

 
$
63,267

 
$
(26,180
)
 
$
2,070,267


(11)    Consolidating Guarantor Financial Information

The Senior Notes were issued by Monitronics (the “Parent Issuer”) and are fully and unconditionally guaranteed, on a joint and several basis, by all of the Company’s existing domestic subsidiaries (“Subsidiary Guarantors”).  Ascent Capital has not guaranteed any of the Company’s obligations under the Senior Notes. The unaudited condensed consolidating financial information for the Parent Issuer, the Subsidiary Guarantors and the non-guarantors are as follows:

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Table of Contents

MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidating Balance Sheet
(unaudited)
 
 
As of March 31, 2016
 
Parent Issuer
 
Subsidiary
Guarantors
 
Non-Guarantors
 
Eliminations
 
Consolidated
 
(amounts in thousands)
Assets
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
28,107

 
896

 

 

 
$
29,003

Trade receivables, net
12,927

 
407

 

 

 
13,334

Prepaid and other current assets
36,022

 
1,971

 

 
(26,930
)
 
11,063

Total current assets
77,056

 
3,274

 

 
(26,930
)
 
53,400

 
 
 
 
 
 
 
 
 
 
Investment in subsidiaries
38,779

 

 

 
(38,779
)
 

Property and equipment, net
25,570

 
1,145

 

 

 
26,715

Subscriber accounts, net
1,376,419

 
33,070

 

 

 
1,409,489

Dealer network and other intangible assets, net
23,038

 
1,159

 

 

 
24,197

Goodwill
527,191

 
36,358

 

 

 
563,549

Other assets, net
3,579

 
9

 

 

 
3,588

Total assets
$
2,071,632

 
75,015

 

 
(65,709
)
 
$
2,080,938

 
 
 
 
 
 
 
 
 
 
Liabilities and Stockholder's Equity
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
Accounts payable
$
6,331

 
1,229

 

 

 
$
7,560

Accrued payroll and related liabilities
3,415

 
244

 

 

 
3,659

Other accrued liabilities
43,742

 
30,289

 

 
(26,930
)
 
47,101

Deferred revenue
15,147

 
1,120

 

 

 
16,267

Holdback liability
13,792

 
466

 

 

 
14,258

Current portion of long-term debt
5,500

 

 

 

 
5,500

Total current liabilities
87,927

 
33,348

 

 
(26,930
)
 
94,345

 
 
 
 
 
 
 
 
 
 
Non-current liabilities:
 
 
 
 
 
 
 
 
 
Long-term debt
1,673,464

 

 

 

 
1,673,464

Long-term holdback liability
3,614

 

 

 

 
3,614

Derivative financial instruments
25,364

 

 

 

 
25,364

Deferred income tax liability, net
13,221

 
1,022

 

 

 
14,243

Other liabilities
10,447

 
1,866

 

 

 
12,313

Total liabilities
1,814,037

 
36,236

 

 
(26,930
)
 
1,823,343

 
 
 
 
 
 
 
 
 
 
Total stockholder's equity
257,595

 
38,779

 

 
(38,779
)
 
257,595

Total liabilities and stockholder's equity
$
2,071,632

 
75,015

 

 
(65,709
)
 
$
2,080,938


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Table of Contents

MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidating Balance Sheet
(unaudited)
 
 
As of December 31, 2015
 
Parent Issuer
 
Subsidiary
Guarantors
 
Non-Guarantors
 
Eliminations
 
Consolidated
 
(amounts in thousands)
Assets
 
 
 
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
 
 
 
Cash and cash equivalents
$
1,513

 
1,067

 

 

 
$
2,580

Restricted cash
55

 

 

 

 
55

Trade receivables, net
13,224

 
398

 

 

 
13,622

Prepaid and other current assets
30,542

 
1,807

 

 
(22,459
)
 
9,890

Total current assets
45,334

 
3,272

 

 
(22,459
)
 
26,147

 
 
 
 
 
 
 
 
 
 
Investment in subsidiaries
43,920

 

 

 
(43,920
)
 

Property and equipment, net
25,842

 
812

 

 

 
26,654

Subscriber accounts, net
1,390,493

 
33,045

 

 

 
1,423,538

Dealer network and other intangible assets, net
25,462

 
1,192

 

 

 
26,654

Goodwill
527,191

 
36,358

 

 

 
563,549

Other assets, net
3,718

 
7

 

 

 
3,725

Total assets
$
2,061,960

 
74,686

 

 
(66,379
)
 
$
2,070,267

 
 
 
 
 
 
 
 
 
 
Liabilities and Stockholder's Equity
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
Accounts payable
$
7,383

 
1,238

 

 

 
$
8,621

Accrued payroll and related liabilities
2,894

 
585

 

 

 
3,479

Other accrued liabilities
32,224

 
22,757

 

 
(22,459
)
 
32,522

Deferred revenue
15,151

 
1,056

 

 

 
16,207

Holdback liability
15,986

 
400

 

 

 
16,386

Current portion of long-term debt
5,500

 

 

 

 
5,500

Total current liabilities
79,138

 
26,036

 

 
(22,459
)
 
82,715

 
 
 
 
 
 
 
 
 
 
Non-current liabilities:
 
 
 
 
 
 
 
 
 
Long-term debt
1,739,147

 

 

 

 
1,739,147

Long-term holdback liability
3,786

 

 

 

 
3,786

Derivative financial instruments
13,470

 

 

 

 
13,470

Deferred income tax liability, net
12,391

 
800

 

 

 
13,191

Other liabilities
12,963

 
3,930

 

 

 
16,893

Total liabilities
1,860,895

 
30,766

 

 
(22,459
)
 
1,869,202

 
 
 
 
 
 
 
 
 
 
Total stockholder's equity
201,065

 
43,920

 

 
(43,920
)
 
201,065

Total liabilities and stockholder's equity
$
2,061,960

 
74,686

 

 
(66,379
)
 
$
2,070,267



15

Table of Contents

MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
(unaudited)
 
 
Three Months Ended March 31, 2016
 
Parent Issuer
 
Subsidiary
Guarantors
 
Non-Guarantors
 
Eliminations
 
Consolidated
 
(amounts in thousands)
Net revenue
$
137,307

 
5,961

 

 

 
$
143,268

 
 
 
 
 
 
 
 
 
0

Operating expenses:
 

 
 

 
 

 
 

 
0

Cost of services
26,242

 
3,233

 

 

 
29,475

Selling, general, and administrative, including stock-based compensation
22,531

 
6,082

 

 

 
28,613

Radio conversion costs
9,079

 

 

 

 
9,079

Amortization of subscriber accounts, dealer network and other intangible assets
59,828

 
1,494

 

 

 
61,322

Depreciation
1,910

 
65

 

 

 
1,975

Gain on disposal of operating assets

 

 
0

 

 

 
119,590

 
10,874

 

 

 
130,464

Operating income (loss)
17,717

 
(4,913
)
 

 

 
12,804

Other expense:
 

 
 

 
 

 
 

 
 

Equity in loss of subsidiaries
5,141

 

 

 
(5,141
)
 

Interest expense
31,220

 
4

 

 

 
31,224

 
36,361

 
4

 

 
(5,141
)
 
31,224

Loss before income taxes
(18,644
)
 
(4,917
)
 

 
5,141

 
(18,420
)
Income tax expense
1,566

 
224

 

 

 
1,790

Net loss
(20,210
)
 
(5,141
)
 

 
5,141

 
(20,210
)
Other comprehensive income:
 

 
 

 
 

 
 

 
 

Unrealized gain on derivative contracts
(11,845
)
 

 

 

 
(11,845
)
Total other comprehensive income
(11,845
)
 

 

 

 
(11,845
)
Comprehensive loss
$
(32,055
)
 
(5,141
)
 

 
5,141

 
$
(32,055
)

16

Table of Contents

MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidating Statement of Operations and Comprehensive Income (Loss)
(unaudited)
 
 
Three Months Ended March 31, 2015
 
Parent Issuer
 
Subsidiary
Guarantors
 
Non-Guarantors
 
Eliminations
 
Consolidated
 
(amounts in thousands)
Net revenue
$
136,599

 
1,817

 

 

 
$
138,416

 
 
 
 
 
 
 
 
 
0

Operating expenses:
 

 
 

 
 

 
 

 
0

Cost of services
24,185

 
982

 

 

 
25,167

Selling, general, and administrative, including stock-based compensation
21,501

 
1,923

 

 

 
23,424

Radio conversion costs
523

 

 

 

 
523

Amortization of subscriber accounts, dealer network and other intangible assets
62,508

 
633

 

 

 
63,141

Depreciation
2,291

 
6

 

 

 
2,297

Gain on disposal of operating assets
(3
)
 

 

 

 
(3
)
 
111,005

 
3,544

 

 

 
114,549

Operating income (loss)
25,594

 
(1,727
)
 

 

 
23,867

Other expense:
 

 
 

 
 

 
 

 
 

Equity in loss of subsidiaries
1,929

 

 

 
(1,929
)
 

Interest expense
30,238

 
2

 

 

 
30,240

 
32,167

 
2

 

 
(1,929
)
 
30,240

Loss before income taxes
(6,573
)
 
(1,729
)
 

 
1,929

 
(6,373
)
Income tax expense
1,761

 
200

 

 

 
1,961

Net loss
(8,334
)
 
(1,929
)
 

 
1,929

 
(8,334
)
Other comprehensive loss:
 

 
 

 
 

 
 

 
 

Unrealized loss on derivative contracts
(4,463
)
 

 

 

 
(4,463
)
Total other comprehensive loss
(4,463
)
 

 

 

 
(4,463
)
Comprehensive loss
$
(12,797
)
 
(1,929
)
 

 
1,929

 
$
(12,797
)



17

Table of Contents

MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidating Statement of Cash Flows
(unaudited)
 
 
Three Months Ended March 31, 2016
 
Parent Issuer
 
Subsidiary
Guarantors
 
Non-
Guarantors
 
Eliminations
 
Consolidated
 
(amounts in thousands)
Net cash provided by operating activities
$
53,632

 
1,107

 

 

 
$
54,739

Investing activities:
 

 
 

 
 

 
 

 
 

Capital expenditures
(1,877
)
 
(399
)
 

 

 
(2,276
)
Cost of subscriber accounts acquired
(45,791
)
 
(879
)
 

 

 
(46,670
)
Increase in restricted cash
55

 

 

 

 
55

Net cash used in investing activities
(47,613
)
 
(1,278
)
 

 

 
(48,891
)
Financing activities:
 

 
 

 
 

 
 

 
 

Proceeds from long-term debt
59,250

 

 

 

 
59,250

Payments on long-term debt
(38,675
)
 

 

 

 
(38,675
)
Net cash provided by financing activities
20,575

 

 

 

 
20,575

Net increase in cash and cash equivalents
26,594

 
(171
)
 

 

 
26,423

Cash and cash equivalents at beginning of period
1,513

 
1,067

 

 

 
2,580

Cash and cash equivalents at end of period
$
28,107

 
896

 

 

 
$
29,003



18

Table of Contents


MONITRONICS INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidating Statement of Cash Flows
(unaudited)
 
 
Three Months Ended March 31, 2015
 
Parent Issuer
 
Subsidiary
Guarantors
 
Non-
Guarantors
 
Eliminations
 
Consolidated
 
(amounts in thousands)
Net cash provided by operating activities
$
67,742

 
(3,686
)
 

 

 
$
64,056

Investing activities:
 

 
 

 
 

 
 

 
 

Capital expenditures
(2,693
)
 
(35
)
 

 

 
(2,728
)
Cost of subscriber accounts acquired
(60,519
)
 
(534
)
 

 

 
(61,053
)
Cash acquired (paid) on acquisition
(61,115
)
 
4,772

 
 
 
 
 
(56,343
)
Increase in restricted cash
(105
)
 

 

 

 
(105
)
Proceeds from disposal of operating assets
3

 

 

 
 
 
3

Net cash used in investing activities
(124,429
)
 
4,203

 

 

 
(120,226
)
Financing activities:
 

 
 

 
 

 
 

 
 

Proceeds from long-term debt
91,400

 

 
 
 

 
91,400

Payments on long-term debt
(33,892
)
 

 

 

 
(33,892
)
Payments of financing costs
(551
)
 

 

 

 
(551
)
Contribution from Ascent Capital
22,690

 

 

 

 
22,690

Net cash provided by financing activities
79,647

 

 

 

 
79,647

Net increase in cash and cash equivalents
22,960

 
517

 

 

 
23,477

Cash and cash equivalents at beginning of period
1,713

 
240

 

 

 
1,953

Cash and cash equivalents at end of period
$
24,673

 
757

 

 

 
$
25,430



19

Table of Contents

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, integration of acquired assets and businesses, 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:
 
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 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;
the development of new services or service innovations by competitors;
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;
integration of acquired assets and businesses;
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 our dealers is subject and the risk of new regulations, such as the increasing adoption of “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 other Monitronics business partners;
the reliability and creditworthiness of our independent alarm systems dealers and subscribers;
changes in our expected rate of subscriber attrition;
the availability and terms of capital, including the ability of the Company to obtain future financing to grow its business;
our high degree of leverage and the restrictive covenants governing its indebtedness; and
availability of qualified personnel.

 
For additional risk factors, please see Part I, Item 1A, Risk Factors, in the 2015 Form 10-K.  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 2015 Form 10-K.


20

Table of Contents

Overview
 
The Company provides security alarm monitoring and related services to residential and business subscribers throughout the United States and parts of Canada.  On February 23, 2015 (the "Closing Date"), the Company 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"). On August 16, 2013, the Company acquired all of the equity interest of Security Networks LLC (“Security Networks”) and certain affiliated entities.  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 the Company’s revenues are derived from monthly recurring revenues under security alarm monitoring contracts purchased from independent dealers in its exclusive nationwide network.

The Company's attrition analysis and results of operations for the three months ended March 31, 2016 include the operations of the LiveWatch business from the Closing Date.
 
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, 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 to the Company the cost paid to acquire the contract. 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 holdback liability may be less than actual attrition experience.
 
The table below presents subscriber data for the twelve months ended March 31, 2016 and 2015:
 
 
Twelve Months Ended
March 31,
 
 
 
2016
 
2015
 
Beginning balance of accounts
 
1,090,612

 
1,046,785

 
Accounts acquired
 
152,078

 
190,525

 
Accounts canceled
 
(148,787
)
 
(139,605
)
 
Canceled accounts guaranteed by dealer and other adjustments (a)
 
(13,177
)
(b)
(7,093
)
(c)
Ending balance of accounts
 
1,080,726

 
1,090,612

 
Monthly weighted average accounts
 
1,089,346

 
1,060,206

 
Attrition rate - Unit
 
(13.7
)%
 
(13.2
)%
 
Attrition rate - RMR (d)
 
(13.4
)%
 
(13.0
)%
 
 
(a)
Includes canceled accounts that are contractually guaranteed to be refunded from holdback.
(b)
Includes an estimated 3,170 accounts included in our Radio Conversion Program that canceled in excess of their expected attrition.
(c)
Includes a favorable adjustment of 1,101 accounts associated with multi-site subscribers that were considered single accounts prior to the completion of the Security Networks integration in April 2014.
(d)
The recurring monthly revenue ("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.

The unit attrition rate for the twelve months ended March 31, 2016 and 2015 was 13.7% and 13.2%, respectively. Increased attrition is primarily the result of an increase in the number of subscriber accounts reaching the end of their initial contract term

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in the period primarily related to the Pinnacle Security bulk buys. Monitronics purchased approximately 113,000 accounts from Pinnacle Security in 2012 and 2013 which are now experiencing normal end-of-term attrition. The attrition rate without the Pinnacle Security accounts (core attrition) for the twelve months ended March 31, 2016 and 2015 was 12.9% and 12.6%, respectively.

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, in recent years we have 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 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.  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 March 31, 2016 and 2015, the Company acquired 29,211 and 66,074 subscriber accounts, respectively. Accounts acquired for the three months ended March 31, 2016 reflect bulk buys of approximately 400 accounts. Accounts acquired for the three months ended March 31, 2015 includes approximately 1,100 of bulk buys and 31,919 accounts from the LiveWatch Acquisition in February 2015.

RMR acquired during the three months ended March 31, 2016 and 2015 was $1,324,000 and $2,490,000, respectively. RMR acquired for the three months ended March 31, 2015 includes approximately $909,000 of RMR 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), stock-based 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, to fund 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 our 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 we believe 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 Monitronics 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 Monitronics, 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.


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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 
 March 31,
 
2016
 
2015
Net revenue
$
143,268

 
138,416

Cost of services
29,475

 
25,167

Selling, general, and administrative
28,613

 
23,424

Amortization of subscriber accounts, dealer network and other intangible assets
61,322

 
63,141

Interest expense
31,224

 
30,240

Income tax expense
1,790

 
1,961

Net loss
(20,210
)
 
(8,334
)
 
 
 
 
Adjusted EBITDA (a)
$
87,020

 
91,667

Adjusted EBITDA as a percentage of Net revenue
60.7
%

66.2
%
 
 
 
 
Pre-SAC Adjusted EBITDA (b)
91,894

 
92,803

Pre-SAC Adjusted EBITDA as a percentage of Pre-SAC net revenue (c)
64.6
%
 
67.3
%
 
(a) 
See reconciliation of net loss to Adjusted EBITDA below.
(b) 
See reconciliation of Adjusted EBITDA to Pre-SAC Adjusted EBITDA below.
(c)
Presented below is the reconciliation of Net revenue to Pre-SAC net revenue (amounts in thousands):
 
 
Three Months Ended March 31,
 
 
 
2016
 
2015
 
Net revenue, as reported
 
$
143,268

 
138,416

 
LiveWatch revenue related to SAC
 
(1,125
)
 
(496
)
 
Pre-SAC net revenue
 
142,143

 
137,920

 
 
Net revenue.  Net revenue increased $4,852,000, or 3.5% for the three months ended March 31, 2016, as compared to the corresponding prior year period.  The increase in net revenue is attributable to the inclusion of a full quarter's impact of LiveWatch revenue and an increase in average RMR per subscriber. Average monthly revenue per subscriber increased from $41.43 as of March 31, 2015 to $42.17 as of March 31, 2016.
 
Cost of services.  Cost of services increased $4,308,000, or 17.1%, for the three months ended March 31, 2016, as compared to the corresponding prior year period. $2,216,000 of the increase is attributable to the inclusion of a full quarter's impact of LiveWatch's cost of services. LiveWatch's cost of services includes expensed equipment costs associated with the creation of new subscribers of $2,252,000 and $643,000 for three months ended March 31, 2016 and 2015, respectively. The increase also reflects higher cellular and field service costs at Monitronics related to the increase in the number of subscribers with interactive and home automation services. Cost of services as a percent of net revenue increased from 18.2% for the three months ended March 31, 2015 to 20.6% for the three months ended March 31, 2016, respectively.
 
Selling, general and administrative.  Selling, general and administrative costs ("SG&A") increased $5,189,000, or 22.2% for the three months ended March 31, 2016, as compared to the corresponding prior year period.  The increase is attributable to the inclusion of a full quarter's impact of LiveWatch's SG&A which includes marketing and sales costs related to the creation of new subscribers of $3,747,000 and $990,000 for the three months ended March 31, 2016 and 2015, respectively. For the three months ended March 31, 2016 and 2015, LiveWatch SG&A also includes $900,000 and $519,000, respectively, in LiveWatch Acquisition Contingent Bonuses payable to LiveWatch's key members of management in accordance with the employment agreements entered into in connection with the LiveWatch Acquisition. The increase in SG&A is also attributable to increased salaries, wages, and benefits at Monitronics as compared to the prior year. In connection with certain cost cutting initiatives, the Company executed a reduction in force in March 2016 at the Company's Dallas, Texas headquarters. This action resulted in an additional $245,000 in SG&A expense for one-time termination benefits being recognized during the three

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months ended March 31, 2016. SG&A as a percent of net revenue increased from 16.9% for the three months ended March 31, 2015 to 20.0% for the three months ended March 31, 2016, respectively.
 
Amortization of subscriber accounts, dealer network and other intangible assets.  Amortization of subscriber accounts, dealer network and other intangible assets decreased $1,819,000 for the three months ended March 31, 2016, respectively, as compared to the corresponding prior year period.  The decrease is related to the timing of amortization of subscriber accounts acquired prior to the first quarter of 2015, which have a lower rate of amortization in 2016 based on the applicable double declining balance amortization method. The decrease is partially offset by increased amortization related to accounts acquired subsequent to March 31, 2015.
 
Interest expense.  Interest expense increased $984,000 for the three months ended March 31, 2016, as compared to the corresponding prior year period, respectively. The increase in interest expense is primarily attributable to increases in the Company’s consolidated debt balance related to the refinancing of our Credit Facility term loans in April of 2015. 
 
Income tax expense.  The Company had pre-tax loss of $18,420,000 for the three months ended March 31, 2016, and income tax expense of $1,790,000 for the three months ended March 31, 2016.  The Company had pre-tax loss of $6,373,000 and income tax expense of $1,961,000 for the three months ended March 31, 2015. Income tax expense for the three months ended March 31, 2016 and 2015 is attributable to Texas state margin tax incurred on the Company's operations and the deferred tax impact from amortization of deductible goodwill related to the Company's recent acquisitions.

Net loss. For the three months ended March 31, 2016, net loss increased to $20,210,000 from $8,334,000 for the three months ended March 31, 2015. The increase in net loss is primarily attributable to a $8,556,000 increase in costs incurred under the Company's Radio Conversion Program and a full quarter's worth of the impact of expensed creation costs as a result of LiveWatch's direct-to-customer model (which is further discussed in Adjusted EBITDA below).

Adjusted EBITDA and Pre-SAC Adjusted EBITDA. The following table provides a reconciliation of net loss to total Adjusted EBITDA to Pre-SAC Adjusted EBITDA for the periods indicated (amounts in thousands):
 
Three Months Ended 
 March 31,
 
2016
 
2015
Net loss
$
(20,210
)
 
(8,334
)
Amortization of subscriber accounts, dealer network and other intangible assets
61,322

 
63,141

Depreciation
1,975

 
2,297

Stock-based compensation
522

 
374

Radio conversion costs
9,079

 
523

LiveWatch acquisition related costs

 
946

LiveWatch acquisition contingent bonus charges
900

 
519

Reduction in force separation costs
245

 

Rebranding marketing program
173

 

Interest expense
31,224

 
30,240

Income tax expense
1,790

 
1,961

Adjusted EBITDA
87,020

 
91,667

Gross subscriber acquisition cost expenses
5,999

 
1,632

Revenue associated with subscriber acquisition cost
(1,125
)
 
(496
)
Pre-SAC Adjusted EBITDA
$
91,894

 
$
92,803

 
Adjusted EBITDA decreased $4,647,000, or 5.1%, for the three months ended March 31, 2016 as compared to the corresponding prior year period.  Adjusted EBITDA decreased for the three months ended March 31, 2016 primarily due to the full quarter impact of LiveWatch's subscriber acquisition costs. LiveWatch's expensed creation costs, net of creation revenue, included in Adjusted EBITDA for the three months ended March 31, 2016 and 2015, are $4,874,000 and $1,136,000 respectively.

Pre-SAC Adjusted EBITDA decreased $909,000 or 1.0%, for the three months ended March 31, 2016 as compared to the corresponding prior year period. The decrease is attributable to the full quarter impact of LiveWatch's cost of services and SG&A that are not related to subscriber acquisition costs, as well as increasing field service and cellular costs at Monitronics as discussed above.

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