MONITRONICS INTERNATIONAL, INC. 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, new service offerings, the availability of capital, financial prospects, 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: •business or economic disruptions or global health concerns, including the outbreak of COVID-19, may materially and adversely affect our business, financial condition, future results and cash flow; •macroeconomic conditions and their effect on the general economy and on theU.S. housing market, in particular single family homes, which represent our largest demographic; •uncertainties in the development of our business strategies, including the rebranding to Brinks Home Security 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 well-financed technology, telecommunications and cable companies; •the development of new services or service innovations by competitors; •our ability to acquire and integrate additional accounts, including the impact of restrictions on selling our services door-to-door, and competition for dealers with other alarm monitoring companies which could cause dealers to leave our program or an increase in expected costs of acquiring an account ("Subscriber Acquisition Costs"); •technological changes which could result in the obsolescence of currently utilized technology with the need for significant upgrade expenditures, including the phase out of 2G, 3G and CDMA networks by cellular carriers; •the trend away from the use of public switched telephone network lines and the resultant increase in servicing costs associated with alternative methods of communication; •our high degree of leverage and the restrictive covenants governing its indebtedness; •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, and the potential of security breaches related to network or customer information; •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 of our business partners; •the reliability and creditworthiness of our independent alarm systems dealers and subscribers; •changes in our expected rate of subscriber attrition; •availability of, and our ability to retain, qualified personnel; •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 are subject and the risk of new regulations, such as the increasing adoption of "false alarm" ordinances; and •general business conditions and industry trends. For additional risk factors, please see Part I, Item 1A, Risk Factors, in our Annual Report on Form 10-K for the year endedDecember 31, 2019 (the "2019 Form 10-K") and Part II, Item 1A, Risk Factors in our Quarterly Report on Form 10-Q for the quarter endedJune 30, 2020 . 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 2019 Form 10-K. 20 -------------------------------------------------------------------------------- Table of Contents OverviewMonitronics International, Inc. and its subsidiaries (collectively, "Monitronics" or the "Company", doing business as Brinks Home SecurityTM) provide residential customers and commercial client accounts with monitored home and business security systems, as well as interactive and home automation services, inthe United States ,Canada andPuerto Rico .Monitronics customers are obtained through our direct-to-consumer sales channel (the "Direct to Consumer Channel"), which offers both Do-It-Yourself and professional installation security solutions and our exclusive authorized dealer network (the "Dealer Channel"), which provides product and installation services, as well as support to customers. We also periodically acquire alarm monitoring accounts from other alarm companies in bulk on a negotiated basis ("bulk buys"). As previously disclosed, onJune 30, 2019 ,Monitronics and certain of its domestic subsidiaries (collectively, the "Debtors"), filed voluntary petitions for relief (collectively, the "Petitions" and, the cases commenced thereby, the "Chapter 11 Cases") under chapter 11 of title 11 of the United States Code (the "Bankruptcy Code") in theUnited States Bankruptcy Court for the Southern District of Texas (the "Bankruptcy Court "). The Debtors' Chapter 11 Cases were jointly administered under the caption In reMonitronics International, Inc. , et al., Case No. 19-33650. OnAugust 7, 2019 , theBankruptcy Court entered an order, Docket No. 199 (the "Confirmation Order"), confirming and approving the Debtors' Joint Partial Prepackaged Plan of Reorganization (including all exhibits thereto and, as modified by the Confirmation Order, the "Plan") that was previously filed with theBankruptcy Court onJune 30, 2019 . OnAugust 30, 2019 (the "Effective Date"), the conditions to the effectiveness of the Plan were satisfied and the Company emerged from Chapter 11 after completing a series of transactions through which the Company and its former parent,Ascent Capital Group, Inc. ("Ascent Capital "), merged (the "Merger") in accordance with the terms of the Agreement and Plan of Merger, dated as ofMay 24, 2019 (the "Merger Agreement").Monitronics was the surviving corporation and, immediately following the Merger, was redomiciled inDelaware in accordance with the terms of the Merger Agreement. Upon emergence from Chapter 11 on the Effective Date, the Company has applied Accounting Standards Codification ("ASC") 852, Reorganizations, in preparing its condensed consolidated financial statements. As a result of the application of fresh start accounting and the effects of the implementation of the Plan, a new entity for financial reporting purposes was created. The Company selected a convenience date ofAugust 31, 2019 for purposes of applying fresh start accounting as the activity between the convenience date and the Effective Date did not result in a material difference in the financial results. References to "Successor" or "Successor Company " relate to the balance sheet and results of operations ofMonitronics on and subsequent toSeptember 1, 2019 . References to "Predecessor" or "Predecessor Company " refer to the balance sheet and results of operations ofMonitronics prior toSeptember 1, 2019 . With the exception of interest and amortization expense, the Company's operating results and key operating performance measures on a consolidated basis were not materially impacted by the reorganization. As such, references to the "Company" could refer to either the Predecessor or Successor periods, as defined.
Asset Purchase Agreement
OnJune 17, 2020 , the Company acquired certain contracts for the provision of alarm monitoring and related services (the "Accounts") as well as the related accounts receivable, intellectual property and equipment inventory ofProtect America, Inc. The Company paid approximately$16,600,000 at closing and will make 50 subsequent monthly payments ("Earnout Payments") consisting of a portion of the revenue attributable to the Accounts, subject to adjustment for Accounts that are no longer active. The transaction was accounted for as an asset acquisition with the cost of the assets acquired recorded as ofJune 17, 2020 and an estimated liability for the Earnout Payments of approximately$86,000,000 . The Earnout Payments liability was estimated based on the terms of the payout and the forecasted attrition of the Protect America subscriber base. The current portion of the Earnout Payments liability is included in current Other accrued liabilities on the condensed consolidated balance sheets and the long-term portion of the Earnout Payments is included in non-current Other liabilities on the condensed consolidated balance sheets. The monthly Earnout Payments are classified as Cash flows from financing activities on the condensed consolidated statements of cash flows.
Impact of COVID-19
InDecember 2019 , an outbreak of a novel strain of coronavirus ("COVID-19") originated inWuhan, China and has been detected globally on a widespread basis, including inthe United States . The COVID-19 pandemic has resulted in the closure of many corporate offices, retail stores, and manufacturing facilities and factories globally, as well as border closings, quarantines, cancellations, disruptions to supply chains and customer activity, and general concern and uncertainty. In response to the pandemic, the Coronavirus Aid, Relief, and Economic Security Act ("CARES Act") was enacted onMarch 27, 2020 in theU.S. The CARES Act, among other things, provides for an acceleration of alternative minimum tax credit 21 -------------------------------------------------------------------------------- Table of Contents refunds, the deferral of certain employer payroll taxes and expands the availability of net operating loss usage. We do not expect the CARES Act to have material impact on the Company's annual effective income tax rate for the year. With respect to our call and alarm response centers, we have established certain policies and procedures to enable full continuity of our monitoring services moving forward, including distancing staff in the call centers, activating our backup call center facility and enabling our call center operators to operate from home. For employees that can work remotely, we have instituted measures to support them, including purchasing additional equipment to enable work from home capabilities. We are also ensuring we comply with our data security measures to guarantee that all company, employee and customer data remains protected and secure. As ofSeptember 30, 2020 , substantially all of our workforce is working remotely. In addition, our existing call centers still remain fully operational on premises. Administrative personnel are also working from home and those involved in the Company's financial reporting and internal controls over financial reporting have been able to continue their normal duties by accessing the Company's systems and records remotely. Regular communications, review of supporting documentation and tests of operating effectiveness via secured virtual channels have also continued without significant interruption. In regards to our operations and dealer operations in the field, in jurisdictions where local or state governments have implemented a "shelter in place" or similar orders, we have instructed our dealers to cease doing door-to-door sales until such measures are lifted. This has negatively impacted our Dealer Channel productivity starting in the latter half ofMarch 2020 . Dealer Channel volume has shown some recovery in the second and third quarters of 2020, but remains down year over year. Subject to a scheduled service or installation request, and adhering to certain safety protocols, we continue to send field technicians out to service a customer's home to service or to install a new system. We have taken measures to protect our supply chain of alarm monitoring equipment and, to date, have not experienced significant supply chain constraints to service our customers. With respect to our receivables from our customers, for the three and nine months endedSeptember 30, 2020 , we have issued credits for relief to customers being impacted by hardships from the pandemic. We have temporarily paused standard annual rate increases on applicable customers. Additionally, we have increased our allowances on collection of certain trade and dealer receivables based on the expected impact of the continuation of the pandemic into the fourth quarter of 2020. As a result of COVID-19, we experienced no material impact on our unit and Recurring Monthly Revenue ("RMR") attrition during the three and nine months endedSeptember 30, 2020 . As noted in the financial statements, as ofMarch 31, 2020 , the Company determined that a goodwill triggering event had occurred as a result of the recent economic disruption and uncertainty due to the COVID-19 pandemic. Due to the Company's decision to cease door-to-door sales in jurisdictions with a "shelter in place" or similar orders and deteriorating economic conditions, we anticipated a reduction in projected account acquisitions. In response to the triggering event, the Company performed a quantitative goodwill impairment test at the Brinks Home Security entity level as we operate as a single reporting unit. The results of the quantitative assessment indicated that the carrying value was in excess of the fair value of the reporting unit, including goodwill, which resulted in a full goodwill impairment charge of$81,943,000 during the nine months endedSeptember 30, 2020 . The factors leading to the goodwill impairment are lower projected overall account acquisition in future periods due to the estimated impact of COVID-19 on our account acquisition channels and an increase in the discount rate applied in the discounted cash flow model based on current economic conditions. This resulted in reductions in future cash flows and a lower fair value as calculated under the income approach. While we continue to assess the impact of these events, in future periods we may experience reduced revenue, reduced account acquisitions in the Dealer Channel and Direct to Consumer Channel and increased attrition and other costs as a result of the pandemic.
Strategic Initiatives
In recent years, we have implemented several initiatives related to account growth, creation costs, attrition and margin improvements to combat decreases in the generation of new subscriber accounts and negative trends in subscriber attrition.
Account Growth
We believe that generating account growth at a reasonable cost is essential to
scaling our business and generating stakeholder value. We currently generate new
accounts through both our Dealer Channel and Direct to Consumer Channel. Our
ability to grow new accounts in the future will be impacted by our ability to
adjust to changes in consumer buying behavior and increased competition from
technology, telecommunications and cable companies. We currently have several
initiatives in place to drive profitable account growth, which include:
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•enhancing our brand recognition with consumers to create a premium customer experience; •differentiating and profitably growing our Direct to Consumer Channel under the Brinks Home Security brand through a tight integration between phone and field sales; •recruiting and retaining high quality dealers into our Authorized Dealer Program; •assisting new and existing dealers with training and marketing initiatives to increase productivity; •expanding our third party generated sales channel beyond traditional dealers; •leveraging bulk acquisition opportunities; and •offering third-party equipment financing to consumers, which is expected to assist in driving account growth at lower creation costs.
Creation Cost Efficiency
We also consider the management of creation costs to be a key driver in improving our financial results. Generating accounts at lower creation costs per account would improve our profitability and cash flows. The initiatives related to managing creation costs include: •improving performance in our Direct to Consumer Channel including generating higher quality leads at favorable cost; increasing sales close rates and enhancing our customer activation process; •improved unit economics, including negotiating lower subscriber account purchase price multiples in our Dealer Channel; •expanding the use and availability of third-party financing, which will drive down net creation costs; and •leveraging bulk acquisition opportunities with a unique model to acquire accounts at lower multiples.
Attrition
While we have also experienced higher subscriber attrition rates in the past few years, we have continued to develop our efforts to manage subscriber attrition, which we believe will help drive increases in our subscriber base and stakeholder value. We currently have several initiatives in place to reduce subscriber attrition, which include: •maintaining high customer service levels; •effectively managing the credit quality of new customers; •expanding our efforts to both retain customers who have indicated a desire to cancel service and win-back previous customers; •using predictive modeling to identify subscribers with a higher risk of cancellation and engaging with these subscribers to obtain contract extensions on terms favorable to the Company; and •implementing effective pricing strategies.
Margin Improvement
We are also implementing initiatives to attempt to reduce expenses and improve our financial results, which include:
•right sizing the cost structure of the business and leveraging our scale; •increasing use of automation; and •implementing more sophisticated purchasing techniques. While there are uncertainties related to the successful implementation of the foregoing initiatives impacting our ability to achieve net profitability and positive cash flows in the near term, we believe they will position us to improve our operating performance, increase cash flows and create stakeholder value over the long-term. Accounts Acquired
For the Three Months Ended
During the three months endedSeptember 30, 2020 and 2019, the Company acquired 17,111 and 21,228 subscriber accounts, respectively, through our Dealer Channel and Direct to Consumer Channel. The decrease in accounts acquired for the three months endedSeptember 30, 2020 is principally due to a year-over-year decline in accounts generated in the Dealer Channel and Direct to Consumer Channel. The decline in the Dealer Channel was primarily due to the Company's election to cease purchasing accounts from two dealers in the fourth quarter of 2019 and restrictions on door-to-door selling and other impacts 23 -------------------------------------------------------------------------------- Table of Contents related to the outbreak of COVID-19 starting in the latter half ofMarch 2020 . The decline in the Direct to Consumer Channel production was primarily due to the Company's election to leverage more profitable organic leads. There were no bulk buys during the three months endedSeptember 30, 2020 and 2019.
RMR acquired during the three months ended
For the Nine Months Ended
During the nine months endedSeptember 30, 2020 and 2019, the Company acquired 171,306 and 63,974 subscriber accounts, respectively, through our Dealer Channel, Direct to Consumer Channel and bulk buys. The increase in accounts acquired for the nine months endedSeptember 30, 2020 is due to bulk buys of 113,013 accounts inJune 2020 and 10,960 accounts inMarch 2020 . There were no bulk buys during the nine months endedSeptember 30, 2019 . The increase was partially offset by a year-over-year decline in accounts generated in the Dealer Channel and the Direct to Consumer Channel as noted above. RMR acquired during the nine months endedSeptember 30, 2020 was$7,187,000 , which includes RMR related to bulk buys of$4,866,000 . RMR acquired during the nine months endedSeptember 30, 2019 was$3,098,000 .
Attrition
Account cancellations, otherwise referred to as subscriber attrition, have 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 their service every year. Subscribers may choose not to renew or to terminate their contract for a variety of reasons, including relocation, cost, switching to a competitor's service, limited use by the subscriber or low perceived value. The largest categories of cancelled accounts relate to subscriber relocation or those cancelled due to non-payment. The Company defines its attrition rate as the number of cancelled accounts in a given period divided by the weighted average number of subscribers for that period. The Company considers an account cancelled if payment from the subscriber is deemed uncollectible or if the subscriber cancels for various reasons. If a subscriber relocates but continues its service, it is not a cancellation. If the subscriber relocates, discontinues its service and a new subscriber assumes the original subscriber's service and continues the revenue stream, it is also not a cancellation. The Company adjusts the number of cancelled 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 cancelled 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 5-8% of subscriber accounts in the guarantee period. In some cases, the amount of the holdback liability is less than actual attrition experience.
The table below presents subscriber data for the twelve months ended
Twelve Months Ended
2020 2019
Beginning balance of accounts not subject to Earnout Payments 865,848 942,157
Accounts acquired 75,627 84,899
Accounts cancelled (128,736) (156,047)Cancelled accounts guaranteed by dealer and other adjustments (a)
(5,276) (5,161)
Ending balance of accounts not subject to Earnout Payments 807,463 865,848
Accounts subject to Earnout Payments 107,929 -
Ending balance of accounts 915,392 865,848
Attrition rate - Core Unit (c) 15.4 % 17.3 %
Attrition rate - Core RMR (b) (c) 17.7 % 17.6 %
(a) Includes cancelled accounts that are contractually guaranteed to be
refunded from holdback.
(b) The RMR of cancelled accounts follows the same definition as subscriber
unit attrition as noted above. RMR attrition is defined as the RMR of cancelled
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.
(c) Core Unit and RMR attrition rates exclude the impact of the Protect America
bulk buy, where the Company is funding the purchase price through an earnout
payment structure.
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The core unit attrition rate for the twelve months ended September 30, 2020 and
2019 was 15.4% and 17.3%, respectively. The core RMR attrition rate for the
twelve months ended September 30, 2020 and 2019 was 17.7% and 17.6%,
respectively. The decrease in core unit attrition rate for the twelve months
ended September 30, 2020 includes the impact of fewer subscribers, as a
percentage of the entire base, reaching the end of their initial contract term,
continued efforts around "at risk" extensions and customer retention, and the
benefit of improved credit quality in our Direct to Consumer Channel. The
increase in the core RMR attrition rate for the twelve months ended
September 30, 2020 was due to a combination of lower RMR for accounts generated
in the Direct to Consumer Channel, as a minimal equipment subsidy is offered,
lower production in the Dealer Channel, which typically has higher RMR, and rate
reductions relating to our "at risk" retention program. Further, in light of
COVID-19, starting in March 2020 , we made the decision to defer taking ordinary
course rate adjustments to our customer base, which has continued through
September 30, 2020 .
We analyze our attrition by classifying accounts into annual pools based on the
year of acquisition. We then track the number of cancelled accounts 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, the Company's attrition rate is generally very low 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. 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 generally
normalizes. Accounts generated through the Direct to Consumer Channel have
homogeneous characteristics as accounts generated through the Dealer Channel and
follow the same attrition curves. However, accounts generated through the Direct
to Consumer Channel have attrition of approximately 10% in the initial 12 month
period following account acquisition which is higher than accounts generated in
the Dealer Channel due to the dealer guarantee period.
Adjusted EBITDA
We evaluate the performance of our operations based on financial measures such as revenue and "Adjusted EBITDA." Adjusted EBITDA is a non-GAAP financial measure and is defined as net income (loss) before interest expense, interest income, income taxes, depreciation, amortization (including the amortization of subscriber accounts, dealer network and other intangible assets), restructuring charges, stock-based compensation, and other non-cash or non-recurring charges. We believe that Adjusted EBITDA is an important indicator of the operational strength and performance of our business. In addition, this measure is used by management to evaluate operating results and perform analytical comparisons and identify strategies to improve performance. Adjusted EBITDA is also a measure that is customarily used by financial analysts to evaluate the financial performance of companies in the security alarm monitoring industry and is one of the financial measures, subject to certain adjustments, by which our covenants are calculated under the agreements governing our debt obligations. Adjusted EBITDA does not represent cash flow from operations as defined by generally accepted accounting principles inthe United States ("GAAP"), should not be construed as an alternative to net income or loss and is indicative neither of our results of operations nor of cash flows available to fund all of our cash needs. It is, however, a measurement that we believe is useful to investors in analyzing our operating performance. Accordingly, Adjusted EBITDA should be considered in addition to, but not as a substitute for, net income, cash flow provided by operating activities and other measures of financial performance prepared in accordance with GAAP. As companies often define non-GAAP financial measures differently, Adjusted EBITDA as calculated byMonitronics should not be compared to any similarly titled measures reported by other companies. 25 -------------------------------------------------------------------------------- Table of Contents Results of Operations
Three Months Ended
Fresh Start Accounting Adjustments. With the exception of interest and amortization expense, the Company's operating results and key operating performance measures on a consolidated basis were not materially impacted by the reorganization of the Company inAugust 2019 and the application of fresh start accounting. We believe that certain of our consolidated operating results for the three months endedSeptember 30, 2020 is comparable to certain operating results for the period fromJuly 1, 2019 throughAugust 31, 2019 when combined with our consolidated operating results for the period fromSeptember 1, 2019 throughSeptember 30, 2019 . Accordingly, we believe that discussing the non-GAAP combined results of operations and cash flows of thePredecessor Company and theSuccessor Company for the three month period endedSeptember 30, 2019 is useful when analyzing certain performance measures. 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). Successor Company Successor Company Predecessor Company Period from Three Months Non-GAAP Combined September 1, 2019 Period from July 1, Ended September Three Months Ended through September 2019 through August 30, September 30, 30, 31, 2020 2019 2019 2019 Net revenue$ 130,852 $ 120,878 $ 36,289 $ 84,589 Cost of services 31,383 28,962 8,976 19,986 Selling, general and administrative, including stock-based and long-term incentive compensation 31,572 32,370 11,390
20,980
Amortization of subscriber accounts, deferred contract acquisition costs and other intangible assets 57,240 49,810 17,302 32,508 Interest expense 20,033 34,586 7,474 27,112 (Loss) income before income taxes (18,447) 674,220 (10,603) 684,823 Income tax expense 717 642 204 438 Net (loss) income (19,164) 673,578 (10,807) 684,385 Adjusted EBITDA (a)$ 68,512 $ 62,502 $ 17,144 $ 45,358 Adjusted EBITDA as a percentage of Net revenue 52.4 % 51.7 % 47.2 %
53.6 %
Expensed Subscriber acquisition costs, net Gross subscriber acquisition costs (b)$ 3,102 $ 8,041 $ 2,499 $
5,542
Revenue associated with subscriber acquisition costs (1,527) (1,925) (534)
(1,391)
Expensed Subscriber acquisition costs, net$ 1,575 $ 6,116 $ 1,965 $ 4,151
(a) See reconciliation of Net income (loss) to Adjusted EBITDA below.
(b) Gross subscriber acquisition costs for the three months ended
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Net revenue. Net revenue increased $9,974,000 , or 8.3%, for the three months
ended September 30, 2020 , as compared to the corresponding prior year period.
The increase in net revenue is primarily attributable to an increase in alarm
monitoring revenue of $6,962,000 due to a higher number of average subscribers
relating to the Protect America bulk buy and prior year net revenue including
the negative impact of a $5,277,000 fair value adjustment that reduced deferred
revenue in 2019 upon the Company's emergence from bankruptcy in accordance with
ASC 852. Product, installation and service revenue increased $3,289,000 , largely
due to an increase in field service jobs associated with contract extensions
combined with higher revenue per transaction in the Direct to Consumer Channel.
Average RMR per subscriber decreased from $45.29 as of September 30, 2019 to
$43.74 as of September 30, 2020 due to a lower average RMR of $40.81 for the
Protect America bulk buy and an increase in the percentage of customers
generated through our Direct to Consumer Channel which typically have lower RMR
as a result of lower subsidization of equipment.
Cost of services. Cost of services increased $2,421,000 , or 8.4%, for the three
months ended September 30, 2020 , as compared to the corresponding prior year
period. The increase is primarily attributable to the cost to serve the
incremental Protect America customers. The increase is partially offset by a
decline in subscriber acquisition costs in our Direct to Consumer Channel.
Subscriber acquisition costs, which include expensed equipment and labor costs
associated with the creation of new subscribers, decreased to $1,809,000 for the
three months ended September 30, 2020 , as compared to $2,130,000 for the three
months ended September 30, 2019 . Cost of services as a percentage of net
revenue, excluding the effect of the previously discussed fair value adjustment,
increased from 23.0% for the three months ended September 30, 2019 to 24.0% for
the three months ended September 30, 2020 .
Selling, general and administrative. Selling, general and administrative costs
("SG&A") decreased $798,000 , or 2.5%, for the three months ended September 30,
2020 , as compared to the corresponding prior year period. The decrease is
attributable to reduced subscriber acquisition costs and consulting fees on
integration and implementation of company initiatives. Subscriber acquisition
costs included in SG&A decreased to $1,293,000 for the three months ended
September 30, 2020 , as compared to $5,911,000 for the three months ended
September 30, 2019 due to the impact of cost saving measures implemented in the
first quarter of 2020. These decreases are partially offset by higher salary
expense and professional fees related to the post emergence operating structure
of the Company. SG&A as a percentage of net revenue, excluding the effect of the
fair value adjustment, decreased from 25.7% for the three months ended
September 30, 2019 to 24.1% for the three months ended September 30, 2020 .
Amortization of subscriber accounts, deferred contract acquisition costs and
other intangible assets. Amortization of subscriber accounts, deferred contract
acquisition costs and other intangible assets increased $7,430,000 , or 14.9%,
for the three months ended September 30, 2020 , as compared to the corresponding
prior year period. The increase is due to amortization of the dealer network
intangible asset recognized upon the Company's emergence from bankruptcy.
Additionally, as part of the fresh start accounting adjustments, the existing
subscriber accounts as of August 31, 2019 were stated at fair value and are
amortized on the 14-year, 235% double-declining curve. This curve is shorter
than the methodology utilized on newly generated subscriber accounts, due to the
various aged vintages of the Company's subscriber base at August 31, 2019 . The
shorter amortization curve results in higher amortization expense per period.
Also contributing to the increase is a higher number of subscriber accounts
purchased in the last twelve months ended September 30, 2020 primarily due to
the accounts acquired from Protect America, as compared to the corresponding
prior year period.
Interest expense. Interest expense decreased $14,553,000 , or 42.1%, for the
three months ended September 30, 2020 , as compared to the corresponding prior
year period. The decrease in interest expense is attributable to the Company's
decreased outstanding debt balances upon the reorganization, primarily related
to the retirement of the Predecessor Company's 9.125% Senior Notes.
Income tax expense. The Company had pre-tax loss of $18,447,000 and income tax
expense of $717,000 for the three months ended September 30, 2020 . Income tax
expense for the three months ended September 30, 2020 is attributable to the
Company's state tax expense incurred from Texas margin tax. The Company had
pre-tax income of $674,220,000 and income tax expense of $642,000 for the three
months ended September 30, 2019 . The driver behind the pre-tax income for the
three months ended September 30, 2019 is the gain on restructuring and
reorganization of $702,824,000 recognized during the three months ended
September 30, 2019 , primarily due to gains recognized on the conversion of debt
to equity and discounted cash settlement of the Predecessor Company's high yield
senior notes in accordance with the Company's bankruptcy Plan. There are no
income tax impacts from this gain due to net operating loss carryforwards
available for the 2019 tax year. Income tax expense for the three months ended
September 30, 2019 is attributable to the Company's state tax expense incurred
from Texas margin tax.
Net income (loss). The Company had net loss of $19,164,000 for the three months
ended September 30, 2020 , as compared to a net income of $673,578,000 for the
three months ended September 30, 2019 . The decrease in net income (loss) for the
three months ended September 30, 2020 is primarily attributable to no gain on
restructuring and reorganization incurred
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in the current year period combined with increased radio conversion costs and
amortization expense. These decreases were partially offset by higher revenues
and lower interest expense.
Nine Months Ended
Fresh Start Accounting Adjustments. With the exception of interest and amortization expense, the Company's operating results and key operating performance measures on a consolidated basis were not materially impacted by the reorganization of the Company inAugust 2019 and the application of fresh start accounting. We believe that certain of our consolidated operating results for the nine months endedSeptember 30, 2020 is comparable to certain operating results for the period fromJanuary 1, 2019 throughAugust 31, 2019 when combined with our consolidated operating results for the period fromSeptember 1, 2019 throughSeptember 30, 2019 . Accordingly, we believe that discussing the non-GAAP combined results of operations and cash flows of thePredecessor Company and theSuccessor Company for the nine month period endedSeptember 30, 2019 is useful when analyzing certain performance measures. The following table sets forth selected data from the accompanying condensed consolidated statements of operations and comprehensive income (loss) for the periods indicated (dollar amounts in thousands). Successor Predecessor Company Successor Company Company Period from Nine Months Non-GAAP Combined September 1, 2019 Period from Ended September Nine Months Ended through September January 1, 2019 30, September 30, 30, through August 31, 2020 2019 2019 2019 Net revenue$ 374,235 $ 378,575 $ 36,289 342,286 Cost of services 87,017 84,262 8,976 75,286 Selling, general and administrative, including stock-based and long-term incentive compensation 108,566 91,755 11,390 80,365 Amortization of subscriber accounts, deferred contract acquisition costs and other intangible assets 164,889 148,093 17,302 130,791 Interest expense 60,582 112,555 7,474 105,081 (Loss) income before income taxes (152,884) 589,585 (10,603) 600,188 Income tax expense 1,937 1,979 204 1,775 Net (loss) income (154,821) 587,606 (10,807) 598,413 Adjusted EBITDA (a)$ 191,354 $ 204,517 $ 17,144 $ 187,373 Adjusted EBITDA as a percentage of Net revenue 51.1 % 54.0 % 47.2 % 54.7
%
Expensed Subscriber acquisition costs, net Gross subscriber acquisition costs (b)$ 14,693 $ 22,818 $ 2,499 $ 20,319 Revenue associated with subscriber acquisition costs (4,831) (6,021) (534)
(5,487)
Expensed Subscriber acquisition costs, net$ 9,862 $ 16,797 $ 1,965 $ 14,832
(a) See reconciliation of Net income (loss) to Adjusted EBITDA below.
(b) Gross subscriber acquisition costs for the nine months ended
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Net revenue. Net revenue decreased $4,340,000 , or 1.1%, for the nine months
ended September 30, 2020 , as compared to the corresponding prior year period.
The decrease in net revenue is primarily attributable to a decrease in alarm
monitoring revenue of $12,531,000 due to a lower average number of subscribers
in the first six months of 2020, partially offset by incremental revenue from
the Protect America bulk buy. Prior year net revenue also reflects the negative
impact of a $5,277,000 fair value adjustment that reduced deferred revenue upon
the Company's emergence from bankruptcy in accordance with ASC 852. Product,
installation and service revenue increased $9,178,000 , largely due to an
increase in field service jobs associated with contract extensions combined with
higher revenue per transaction in the Direct to Consumer Channel. Average RMR
per subscriber decreased from $45.29 as of September 30, 2019 to $43.74 as of
September 30, 2020 due to a lower average RMR of $40.81 for the Protect America
bulk buy and an increase in the percentage of customers generated through our
Direct to Consumer Channel which typically have lower RMR as a result of lower
subsidization of equipment.
Cost of services. Cost of services increased $2,755,000 , or 3.3%, for the nine
months ended September 30, 2020 , as compared to the corresponding prior year
period. The increase is primarily attributable to the cost to serve the
incremental Protect America customers and an increase in field service jobs
associated with contract extensions for our high propensity to churn population.
The increase is partially offset by a decline in subscriber acquisition costs in
our Direct to Consumer Channel. Subscriber acquisition costs, which include
expensed equipment and labor costs associated with the creation of new
subscribers, decreased to $5,217,000 for the nine months ended September 30,
2020 , as compared to $6,716,000 for the nine months ended September 30, 2019 .
Cost of services as a percentage of net revenue, excluding the effect of the
previously discussed fair value adjustment, increased from 22.0% for the nine
months ended September 30, 2019 to 23.3% for the nine months ended September 30,
2020 .
Selling, general and administrative. Selling, general and administrative costs
("SG&A") increased $16,811,000 , or 18.3%, for the nine months ended
September 30, 2020 , as compared to the corresponding prior year period. The
increase is partially attributable to higher consulting fees incurred on
integration and implementation of company initiatives during the first six
months of the year, severance expense related to transitioning executive
leadership and higher salary expense and professional fees related to the post
emergence operating structure of the Company. Additionally, the Company received
a $700,000 insurance settlement in the second quarter of 2020, as compared to
$4,800,000 received in the second quarter of 2019. These insurance receivable
settlements were related to coverage provided by our insurance carriers in the
2017 class action litigation of alleged violation of telemarketing laws. These
increases are partially offset by lower subscriber acquisition costs. Subscriber
acquisition costs included in SG&A decreased to $9,476,000 for the nine months
ended September 30, 2020 , as compared to $16,102,000 for the nine months ended
September 30, 2019 due to the impact of cost saving measures implemented in the
first quarter of 2020. SG&A as a percentage of net revenue, excluding the effect
of the fair value adjustment, increased from 23.9% for the nine months ended
September 30, 2019 to 29.0% for the nine months ended September 30, 2020 .
Amortization of subscriber accounts, deferred contract acquisition costs and
other intangible assets. Amortization of subscriber accounts, deferred contract
acquisition costs and other intangible assets increased $16,796,000 , or 11.3%,
for the nine months ended September 30, 2020 , as compared to the corresponding
prior year period. The increase is due to amortization of the dealer network
intangible asset recognized upon the Company's emergence from bankruptcy.
Additionally, as part of the fresh start accounting adjustments, the existing
subscriber accounts as of August 31, 2019 were stated at fair value and are
amortized on the 14-year, 235% double-declining curve. This curve is shorter
than the methodology utilized on newly generated subscriber accounts, due to the
various aged vintages of the Company's subscriber base at August 31, 2019 . The
shorter amortization curve results in higher amortization expense per period.
Also contributing to the increase is a higher number of subscriber accounts
purchased in the last twelve months ended September 30, 2020 primarily due to
the accounts acquired from Protect America, as compared to the corresponding
prior year period.
Interest expense. Interest expense decreased $51,973,000 , or 46.2%, for the nine
months ended September 30, 2020 , as compared to the corresponding prior year
period. The decrease in interest expense is attributable to the Company's
decreased outstanding debt balances upon the reorganization, primarily related
to the retirement of the Company's 9.125% Senior Notes.
Income tax expense. The Company had pre-tax loss of $152,884,000 and income tax
expense of $1,937,000 for the nine months ended September 30, 2020 . Income tax
expense for the nine months ended September 30, 2020 is attributable to the
Company's state tax expense incurred from Texas margin tax. The Company had
pre-tax income of $589,585,000 and income tax expense of $1,979,000 for the nine
months ended September 30, 2019 . The driver behind the pre-tax income for the
nine months ended September 30, 2019 is the gain on restructuring and
reorganization of $669,722,000 recognized during the nine months ended September
30, 2019 , primarily due to gains recognized on the conversion of debt to equity
and discounted cash settlement of the Predecessor Company's high yield senior
notes in accordance with the Company's bankruptcy Plan. There are no income tax
impacts from this gain due to net operating loss carryforwards available for the
2019 tax year. Income
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tax expense for the nine months ended September 30, 2019 is attributable to the
Company's state tax expense incurred from Texas margin tax.
Net income (loss). The Company had net loss of $154,821,000 for the nine months
ended September 30, 2020 , as compared to net income of $587,606,000 for the nine
months ended September 30, 2019 . The decrease in net income (loss) for the nine
months ended September 30, 2020 are primarily attributable to no gain on
restructuring and reorganization incurred in the current year period and a
goodwill impairment charge recorded of $81,943,000 combined with a decline in
net revenue and increases in operating expenses as discussed above. Also
impacting net loss for the nine months ended September 30, 2020 were increased
radio conversion costs.
Adjusted EBITDA
Three Months Ended
The following table provide a reconciliation of Net loss to total Adjusted EBITDA for the periods indicated (amounts in thousands):
Successor
Company Successor Company Predecessor Company
Non-GAAP Combined Period from
Three Months Three Months September 1, 2019 Period from July 1,
Ended September Ended September through September 2019 through August
30, 30, 30, 31,
2020 2019 2019 2019
Net (loss) income $ (19,164) $ 673,578 $ (10,807) $ 684,385
Amortization of subscriber accounts, deferred
contract acquisition costs and other
intangible assets 57,240 49,810 17,302 32,508
Depreciation 3,459 1,998 925 1,073
Radio conversion costs 5,612 1,756 825 931
Stock-based compensation - 266 - 266
Long-term incentive compensation 2 107 67 40
Severance expense (a) 47 - - -
Integration / implementation of company
initiatives 566 2,583 1,154 1,429
Gain on restructuring and reorganization, net - (702,824) - (702,824)
Interest expense 20,033 34,586 7,474 27,112
Income tax expense 717 642 204 438
Adjusted EBITDA $ 68,512 $ 62,502 $ 17,144 $ 45,358
(a) Severance expense related to transitioning executive leadership in 2020.
Adjusted EBITDA increased$6,010,000 , or 9.6%, for the three months endedSeptember 30, 2020 , as compared to the corresponding prior year period. The increase for the three months endedSeptember 30, 2020 is attributable to the negative impact of the$5,277,000 fair value adjustment for deferred revenue recognized during the three months endedSeptember 30, 2019 and decreases in expensed subscriber acquisition costs. These increases were partially offset by increases in post-bankruptcy emergence salary and professional fees expenses that were curtailed in the third quarter of 2019 due to the bankruptcy proceedings. Expensed Subscriber acquisition costs, net. Subscriber acquisition costs, net, decreased to$1,575,000 for the three months endedSeptember 30, 2020 , as compared to$6,116,000 for the three months endedSeptember 30, 2019 . Expensed subscriber acquisition costs, net, for the three months endedSeptember 30, 2019 was restated from$7,785,000 to$6,116,000 to be comparable with how acquisition costs were allocated for the three months endedSeptember 30, 2020 . The change in subscriber acquisition cost allocation was done to better align us with how peer companies in the industry present subscriber acquisition costs. This change had no impact on the unaudited condensed consolidated statements of operations and comprehensive income (loss) because it is an allocation of expenses within each of Cost of services and Selling, general and 30 -------------------------------------------------------------------------------- Table of Contents administrative. The decrease in subscriber acquisition costs, net is primarily attributable to the impact of cost saving measures implemented in the first quarter of 2020.
Nine Months Ended
The following table provide a reconciliation of Net loss to total Adjusted EBITDA for the periods indicated (amounts in thousands):
Successor
Company Successor Company Predecessor Company
Period from
Nine Months Non-GAAP Combined September 1, 2019 Period from January
Ended September Nine Months Ended through September 1, 2019 through
30, September 30, 30, August 31,
2020 2019 2019 2019
Net (loss) income $ (154,821) $ 587,606 $ (10,807) $ 598,413
Amortization of subscriber accounts, deferred
contract acquisition costs and other
intangible assets 164,889 148,093 17,302 130,791
Depreciation 10,019 8,273 925 7,348
Radio conversion costs 14,103 1,756 825 931
Stock-based compensation - 42 - 42
Long-term incentive compensation 403 657 67 590
LiveWatch acquisition contingent bonus charges - 63 -
63
Legal settlement reserve (related insurance recovery) (700) (4,800) - (4,800) Severance expense (a) 4,289 - - - Integration / implementation of company initiatives 8,710 5,997 1,154 4,843 Goodwill impairment 81,943 - - - Gain on restructuring and reorganization, net - (669,722) - (669,722) Interest expense 60,582 112,555 7,474 105,081 Realized and unrealized loss, net on derivative financial instruments - 6,804 - 6,804 Refinancing expense - 5,214 - 5,214 Income tax expense 1,937 1,979 204 1,775 Adjusted EBITDA$ 191,354 $ 204,517 $ 17,144 $ 187,373
(a) Severance expense related to transitioning executive leadership in 2020.
Adjusted EBITDA decreased$13,163,000 , or 6.4%, for the nine months endedSeptember 30, 2020 , as compared to the corresponding prior year period. The decrease for the nine months endedSeptember 30, 2020 is attributable to lower net revenues due to a lower average number of subscribers in the first six months of 2020, increases in post-bankruptcy emergence salary and professional fees expenses that were curtailed for much of 2019 due to the bankruptcy proceedings and an increase in field service jobs associated with contract extensions for our high propensity to churn population. These decreases were offset by decreases in our expensed subscriber acquisition costs. Expensed Subscriber acquisition costs, net. Subscriber acquisition costs, net, decreased to$9,862,000 for the nine months endedSeptember 30, 2020 , as compared to$16,797,000 for the nine months endedSeptember 30, 2019 . Expensed subscriber acquisition costs, net, for the nine months endedSeptember 30, 2019 was restated from$21,881,000 to$16,797,000 to be comparable with how acquisition costs were allocated for the nine months endedSeptember 30, 2020 . The change in subscriber acquisition cost allocation was done to better align us with how peer companies in the industry present subscriber acquisition costs. This change had no impact on the unaudited condensed consolidated statements of operations and comprehensive income (loss) because it is an allocation of expenses within each of Cost of services and Selling, general and administrative. The decrease in subscriber acquisition costs, net is primarily attributable to the impact of cost saving measures 31 -------------------------------------------------------------------------------- Table of Contents implemented in the first quarter of 2020 as well as lower production volume in the Company's Direct to Consumer Channel year over year.
Liquidity and Capital Resources
As ofSeptember 30, 2020 , we had$12,759,000 of cash and cash equivalents. Our primary sources of funds is our cash flows from operating activities which are generated from alarm monitoring and related service revenues. During the nine months endedSeptember 30, 2020 and 2019, our cash flow from operating activities was$92,397,000 and$92,948,000 , respectively. The primary drivers of our cash flow from operating activities are the fluctuations in revenues and operating expenses as discussed in "Results of Operations" above. In addition, our cash flow from operating activities may be significantly impacted by changes in working capital. During the nine months endedSeptember 30, 2020 and 2019, we used cash of$84,253,000 and$91,826,000 , respectively, to fund subscriber account acquisitions, net of holdback and guarantee obligations. In addition, during the nine months endedSeptember 30, 2020 and 2019, we used cash of$10,530,000 and$8,223,000 , respectively, to fund our capital expenditures. Our existing long-term debt atSeptember 30, 2020 includes the aggregate principal balance of$987,775,000 under the Takeback Loan Facility, Term Loan Facility and the Revolving Credit Facility. The Takeback Loan Facility has an outstanding principal balance of$814,275,000 as ofSeptember 30, 2020 and requires principal payments of$2,056,250 per quarter, with the remaining amount becoming due onMarch 29, 2024 . The Term Loan Facility has an outstanding principal balance of$150,000,000 as ofSeptember 30, 2020 . The Revolving Credit Facility has an outstanding balance of$23,500,000 as ofSeptember 30, 2020 . We also had$600,000 available under a standby letter of credit issued as ofSeptember 30, 2020 . The maturity date of the loans made under the Term Loan Facility and the Revolving Credit Facility isJuly 3, 2024 , subject to a springing maturity ofMarch 29, 2024 , or earlier, depending on any repayment, refinancing or changes in the maturity date of the Takeback Loan Facility.
The Asset Purchase Agreement with Protect America provides for 50 monthly
Earnout Payments consisting of a portion of the revenue attributable to the
Accounts, subject to adjustment for Accounts that are no longer active. The
estimated liability for the remaining Earnout Payments as of
Radio Conversion Costs Certain cellular carriers of 3G and CDMA cellular networks have announced that they will be retiring these networks between February and December of 2022. As ofSeptember 30, 2020 , we have approximately 356,000 subscribers with 3G or CDMA equipment which may have to be upgraded as a result of these retirements. Additionally, our cellular provider has informed us that a certain 2G cellular network carrier has extended their sunset of its 2G cellular network untilDecember 31, 2022 . As ofSeptember 30, 2020 , we have approximately 14,000 subscribers with 2G cellular equipment which may have to be upgraded as a result of this retirement. The remaining subscribers with 3G or 2G equipment include approximately 50,000 subscribers acquired from Protect America. While we are in the early phase of offering equipment upgrades to our 3G and 2G population, we currently estimate that the total cost of converting our 3G and 2G subscribers, including those acquired from Protect America, will be between$80,000,000 and$90,000,000 . For the three and nine months endedSeptember 30, 2020 , the Company incurred radio conversion costs of$5,612,000 and$14,103,000 , respectively. Cumulative throughSeptember 30, 2020 , we have spent approximately$18,299,000 on 3G and 2G conversions. Total costs for the conversion of such customers are subject to numerous variables, including our ability to work with our partners and subscribers on cost sharing initiatives, and the costs that we actually incur could be materially higher than our current estimates.
Liquidity Outlook
In considering our liquidity requirements for the next twelve months, we evaluated our known future commitments and obligations. We will require the availability of funds to finance our strategy to grow through the acquisition of subscriber accounts through our Dealer and Direct to Consumer Channels or potential bulk buy opportunities, as well as completing our payment obligations under the Protect America earnout liability. We considered our expected operating cash flows as well as the borrowing capacity of our Revolving Credit Facility, under which we could borrow an additional$120,900,000 as ofSeptember 30, 2020 , subject to certain financial covenants. Based on this analysis, we expect that cash on hand, cash flow generated from operations and available borrowings under the Revolving Credit Facility will provide sufficient liquidity for the next twelve months, given our anticipated current and future requirements. Subject to our credit agreements, we may seek debt financing in the event of any new investment opportunities, additional capital expenditures or our operations requiring additional funds, but there can be no assurance that we will be able to obtain 32
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