MONITRONICS INTERNATIONAL, INC. The following discussion and analysis provides information concerning our results of operations and financial condition. This discussion should be read in conjunction with our accompanying consolidated financial statements and the notes thereto included elsewhere herein.
Overview
Monitronics International, Inc. and its subsidiaries (collectively, "Monitronics" or the "Company", doing business as Brinks Home SecurityTM) provides residential customers and commercial client accounts with monitored home and business security systems, as well as multiple home automation, life safety and advanced security options, inthe United States ,Canada andPuerto Rico .Monitronics customers are obtained through our exclusive authorized dealer and representative network (the "Network Sales Channel") and our direct-to-consumer sales channel (the "Direct to Consumer Channel"). The Network Sales Channel provides product and installation services, as well as support to customers. The Direct to Consumer Channel offers both DIY and professional installation security solutions. We also periodically acquire alarm monitoring accounts from the 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 applied Accounting Standards Codification ("ASC") 852, Reorganizations ("ASC 852"), in preparing its consolidated financial statements (see Note 3, Emergence from Bankruptcy and Note 4, Fresh Start Accounting ). 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 Agreements Subject to Earnout Payments
OnJune 17, 2020 , the Company acquired title to over 110,000 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, which began inAugust 2020 , consisting of a portion of the revenue attributable to the Accounts, subject to adjustment for Accounts that are no longer active ("Earnout Payments" will here to be defined as contingent payments to acquire subscriber accounts in the Protect America and Select Security transactions). The transaction was accounted for as an asset acquisition with the cost of the assets acquired recorded as ofJune 17, 2020 and an estimated undiscounted liability for the Earnout Payments of 26 -------------------------------------------------------------------------------- Table of Contents 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. OnDecember 23, 2020 , the Company completed a transaction (the "Select Security Transaction") in which it will acquire approximately 32,000 residential and small business and 8,000 large commercial alarm monitoring contracts fromKourt Security Partners, LLC , doing business as Select Security (the "Seller"). The Company will take ownership of the alarm monitoring contracts through an earnout structure that includes a$10,914,000 upfront payment and Earnout Payments over a 50-month earnout period (the "Earnout Period"). Per the terms of the Select Security Transaction, the Seller transferred title of the monitoring contracts and other certain business assets toGS Security Alarm LLC ("GSSA"). GSSA is a bankruptcy-remote special purpose vehicle designed only to transact the sale of subscriber accounts and related assets to the Company. The Company was significantly involved in the design of GSSA; however, the Company does not own any equity interest in GSSA. GSSA transferred the specified business assets to the Company immediately after close as well as a certain subset of the monitoring contracts. Title to the remaining monitoring contracts will transfer from GSSA to the Company during the Earnout Period with title to all of the monitoring contracts transferred by month 50. The Company is retaining the majority of the Seller's Commercial Sales, Field Technicians and Customer Service employees, as well as certain office locations. For 90 days after the close, the Seller will provide transition services to the Company. Upon closing of the transaction, the Earnout Payments liability for GSSA was estimated as$31,300,000 based on the terms of the payout and the forecasted attrition of the GSSA subscriber base, discounted at an effective interest rate of 10.9%. The current portion of the Earnout Payments liability is included in current Other accrued liabilities on the 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. We monitor actual versus forecasted attrition on the two transactions to identify the need for potential adjustments to the Earnout Payments liability each period. 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 refunds, the deferral of certain employer payroll taxes and expands the availability of net operating loss usage. The CARES Act did not have a 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 ofDecember 31, 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 Network Sales Channel productivity starting in the latter half ofMarch 2020 . Network Sales Channel volume has shown some recovery in the last three 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 year endedDecember 31, 2020 , we have issued credits for relief to customers being impacted by hardships from the pandemic. Additionally, we have increased our allowances on collection of 27 -------------------------------------------------------------------------------- Table of Contents certain trade and dealer receivables based on the expected impact of the continuation of the pandemic into the first quarter of 2021. As a result of COVID-19, we experienced no material impact on our unit and Recurring Monthly Revenue ("RMR") attrition during the year endedDecember 31, 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 on the Company's ability to generate new customers. 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 year endedDecember 31, 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. No other long-lived assets were determined to be impaired. While we continue to assess the impact of these events, in future periods we may experience reduced revenue, reduced account acquisitions in the Network Sales Channel and Direct to Consumer Channel, increased attrition, impairment on long-lived assets and other costs as a result of the pandemic.
Strategic Initiatives
Recently, we have implemented several strategic initiatives pillars to guide the transformation of our business to meet our overall strategy of creating profitable accounts, at scale and holding them for life. While there are uncertainties related to any successful implementation of the 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.
Premium Brand
We believe establishing a premium brand will allow us to move up market in our competition for customers which will lead to higher RMR per customer. This will require robust product offerings and consistent brand standards in all channels to "make the complex simple." To establish a premium brand we have engaged a premier brand strategy research partner to complete a purchase journey map to determine buying behaviors to fully understand purchase timing, interactions, considerations and roadblocks. With this research, we have finalized our brand identity and engaged partners and affiliates to meet our 2021 plan for customer acquisitions. We expect to complete our rebranding of assets and launch our brand strategy in the second quarter of 2021.
Unit Economics
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 Network Sales Channel and Direct to Consumer Channel
with our go to market strategy either being in the field, over the phone or via
e-commerce. To improve our profitable growth in these channels, we will pursue
omnichannel lead generation initiatives and develop a tight integration between
field and phone sales to drive an in-home consultative sales experience with an
option for DIY.
We made headway on these initiatives in 2020 by right sizing our phone sales
department early in the year while still increasing new account RMR per unit in
the Direct to Consumer Channel throughout. Additional reorganizations of the
sales functions were completed in 2020 and we brought on employee field sales
teams that have been launched in several major geographical areas.
Other strategies designed to improve unit economics include our bulk account
acquisition strategy and transforming our traditional authorized dealer program.
Both strategies are centered around reducing the up-front cost to acquire
accounts by providing increased revenue sharing arrangements with the seller for
the long-term. This both drives down up-front creation costs and allows us to
share in the subscriber attrition risk with the seller. By focusing on high
quality customers and improving subscriber attrition, these strategies drive
greater long term profitably for both us and the seller. As previously
disclosed, we completed two bulk buys in 2020 utilizing this strategy and have
recently reached a long term contract extension
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with our largest dealer. We will continue to pursue these bulk opportunities as
they arise and are focused on contract extensions with our other dealers.
Customer Centricity
We believe establishing an employee centric culture will drive a customer centric experience which will reduce attrition, increase RMR while delivering on our brand promises. Our goal is to provide data analytics to our employee base that will improve the customer experience at every touchpoint. While we have experienced higher subscriber attrition rates in the past few years, our recent initiatives to improve our customer lifecycle management tools and predictive churn analytics, coupled with our customer extension efforts have led to marked improvements in unit attrition in 2020. The implementation of our new brand strategy will also focus on customer centricity with the goal to continue to improve attrition in the long term.
Accounts Acquired
During the years endedDecember 31, 2020 and 2019, we acquired 224,414 and 81,386 subscriber accounts, respectively, through our Network Sales Channel, Direct to Consumer Channel and bulk buys. The increase in accounts acquired for the year endedDecember 31, 2020 is due to bulk buys of 39,594 accounts inDecember 2020 , 113,013 accounts inJune 2020 and 10,960 inMarch 2020 . The accounts acquired through bulk buys inDecember 2020 andJune 2020 are subject to Earnout Payments. There were no bulk buys during the year endedDecember 31, 2019 . The increase was partially offset by a year-over-year decline in accounts generated in the Network Sales Channel and the Direct to Consumer Channel. The decline in the Network Sales 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 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.
RMR acquired during the year ended
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.
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The table below presents subscriber data for the years ended December 31, 2020
and 2019:
Years Ended December 31,
2020 2019
Beginning balance of accounts not subject to Earnout Payments 847,758 921,750
Accounts acquired 71,730 81,386
Accounts cancelled (122,655) (150,494)Cancelled accounts guaranteed by dealer and other adjustments (a)
(4,986) (4,884)
Ending balance of accounts of accounts not subject to Earnout Payments
791,847 847,758
Accounts subject to Earnout Payments 141,773 -
Ending balance of accounts 933,620 847,758
Attrition rate - Core Unit (c) 14.9 % 17.0 %
Attrition rate - Core RMR (b) (c) 15.5 % 17.9 %
(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
and Select Security bulk buys, where the Company is funding the purchase price
through an earnout payment structure.
The core unit attrition rate for the years ended December 31, 2020 and 2019 was
14.9% and 17.0%, respectively. The core RMR attrition rate for the years ended
December 31, 2020 and 2019 was 15.5% and 17.9%, respectively. The decrease in
core unit attrition rate for the year ended December 31, 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 decrease in RMR attrition was primarily
driven by a price increase on a majority of the Company's subscriber base in the
fourth quarter of 2020, offset by 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. The fourth
quarter price increase was more impactful to RMR attrition as starting in March
2020 , we had previously made the decision to defer taking ordinary course rate
adjustments to our customer base in light of COVID-19.
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 normalizes.
Accounts generated through the Direct to Consumer Channel have homogeneous
characteristics as accounts generated through the Network Sales 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 Network Sales 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
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does not represent cash flow from operations as defined by generally accepted
accounting principles in the 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 by Monitronics should not be compared
to any similarly titled measures reported by other companies.
Results of Operations
Year 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 year endedDecember 31, 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 throughDecember 31, 2019 . Accordingly, we believe that discussing the non-GAAP combined results of operations and cash flows of thePredecessor Company and theSuccessor Company for the year endedDecember 31, 2020 is useful when analyzing certain performance measures.
The following table sets forth selected data from the accompanying consolidated statements of operations and comprehensive income (loss) for the periods indicated (dollar amounts in thousands).
Successor Successor
Company Company Predecessor Company
Period from
September 1,
Year Ended Non-GAAP Combined 2019 through Period from January
December 31, Year Ended December December 31, 1, 2019 through
2020 31, 2019 2019 August 31, 2019
Net revenue $ 503,597 $ 504,505 $ 162,219 $ 342,286
Cost of services 119,390 112,274 36,988 75,286
Selling, general and administrative,
including stock-based and long-term
incentive compensation 149,314 132,509 52,144 80,365
Radio conversion costs 21,433 4,196 3,265 931
Amortization of subscriber accounts,
deferred contract acquisition costs and
other intangible assets 217,273 200,484 69,693 130,791
Interest expense 80,265 134,060 28,979 105,081
(Loss) income before income taxes (179,865) 567,561 (32,627) 600,188
Income tax expense 1,891 2,479 704 1,775
Net (loss) income (181,756) 565,082 (33,331) 598,413
Adjusted EBITDA (a) $ 253,767 $ 266,460 $ 79,087 $ 187,373
Adjusted EBITDA as a percentage of Net
revenue 50.4 % 52.8 % 48.8 % 54.7 %
Expensed Subscriber acquisition costs,
net
Gross subscriber acquisition costs (b) $ 18,787 $ 31,620 $ 11,301 $ 20,319
Revenue associated with subscriber
acquisition costs (6,208) (7,769) (2,282) (5,487)
Expensed Subscriber acquisition costs,
net $ 12,579 $ 23,851 $ 9,019 $ 14,832
(a) See reconciliation of Net (loss) income to Adjusted EBITDA below.
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(b) Gross subscriber acquisition costs for the year ended December 31, 2020
has been restated from $38,325,000 to $31,620,000 due to allocation adjustments
made to align with current period presentation of expensed subscriber
acquisition costs. See below for further explanation.
Net revenue. Net revenue decreased $908,000 , or 0.2%, for the year ended
December 31, 2020 , as compared to the prior year. The decrease in net revenue is
primarily attributable to a decrease in alarm monitoring revenue of $10,247,000
due to the 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 $5,331,000 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 $10,527,000 , 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
$45.12 as of December 31, 2019 to $44.50 as of December 31, 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 $7,116,000 , or 6.3%, for the year
ended December 31, 2020 , as compared to the prior year. 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
$7,220,000 for the year ended December 31, 2020 , as compared to $8,488,000 for
the year ended December 31, 2019 . Cost of services as a percentage of net
revenue, excluding the effect of the 2019 fair value adjustment, increased from
22.0% for the year ended December 31, 2019 to 23.7% for the year ended
December 31, 2020 .
Selling, general and administrative. Selling, general and administrative costs
("SG&A") increased $16,805,000 , or 12.7%, for the year ended December 31, 2020 ,
as compared to the prior year. The increase is primarily attributable to higher
salary expense and professional fees related to the post emergence operating
structure of the Company and $4,693,000 of severance expense related to
transitioning executive leadership. 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 $11,567,000 for the year ended
December 31, 2020 , as compared to $23,132,000 for the year ended December 31,
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 2019
fair value adjustment, increased from 26.0% for the year ended December 31, 2019
to 29.6% for the year ended December 31, 2020 .
Radio conversion costs. During 2019, the Company commenced a program to replace
the 3G and CDMA cellular equipment used in many of its subscribers' security
systems upon announcements by certain carriers of plans to retire these networks
by 2022. Radio conversion costs represent the incremental cost of equipment and
labor to make the upgrade of the security systems as well as other marketing,
labor and consulting costs to engage customers and manage the program. For the
year ended December 31, 2020 , radio conversion costs totaled $21,433,000 as
compared to $4,196,000 for the year ended December 31, 2019 . The increase is
primarily attributable to a higher number of conversions completed in 2020, as
the radio conversion program only started in August of 2019 with a limited scope
in targeting customers that was expanded in 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 $16,789,000 , or 8.4%,
for the year ended December 31, 2020 , as compared to the prior year. The
increase is due to amortization of the dealer network intangible asset
recognized upon the Company's emergence from bankruptcy. Dealer network
amortization expense was $23,333,000 for the year ended December 31, 2020 as
compared to $7,778,000 for the year ended December 31, 2019 . The remaining
increase is attributable to a higher number of subscriber accounts purchased in
the last twelve months ended December 31, 2020 primarily due to the accounts
acquired from Protect America, as compared to the corresponding prior year
period, offset by the timing of amortization of subscriber accounts acquired
prior to bankruptcy which have a lower rate of amortization in 2020 as compared
to 2019.
Interest expense. Interest expense decreased $53,795,000 , or 40.1%, for the year
ended December 31, 2020 , as compared to the prior year. 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.
32-------------------------------------------------------------------------------- Table of Contents Income tax expense. The Company had pre-tax loss of$179,865,000 and income tax expense of$1,891,000 for the year endedDecember 31, 2020 . Income tax expense for the year endedDecember 31, 2020 is attributable to the Company's state tax expense incurred fromTexas margin tax. The Company had pre-tax income of$567,561,000 and income tax expense of$2,479,000 for the year endedDecember 31, 2019 . The driver behind the pre-tax income for the year endedDecember 31, 2019 is the gain on restructuring and reorganization of$669,722,000 recognized during the year endedDecember 31, 2019 , primarily due to gains recognized on the conversion from debt to equity and discounted cash settlement of thePredecessor 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 year endedDecember 31, 2020 is attributable to the Company's state tax expense incurred fromTexas margin tax. Net (loss) income. The Company had net loss of$181,756,000 for the year endedDecember 31, 2020 , as compared to net income of$565,082,000 for the year endedDecember 31, 2019 . The decrease in net (loss) income for the year endedDecember 31, 2020 is primarily attributable to no gain on restructuring and reorganization incurred in the current year period and a goodwill impairment charge of$81,943,000 combined with increases in operating expenses as discussed above. Also impacting net loss for the year endedDecember 31, 2020 were increased radio conversion costs.
Adjusted EBITDA
Year Ended
The following table provides a reconciliation of Net (loss) income to total Adjusted EBITDA for the periods indicated (amounts in thousands):
Successor Successor Predecessor
Company Company Company
Period from
September 1, Period from
Year Ended Non-GAAP Combined 2019 through January 1, 2019
December 31, Year Ended December 31, through August
2020 December 31, 2019 2019 31, 2019
Net (loss) income $ (181,756) $ 565,082 $ (33,331) $ 598,413
Amortization of subscriber accounts,
deferred contract acquisition costs and
other intangible assets 217,273 200,484 69,693 130,791
Depreciation 13,844 11,125 3,777 7,348
Radio conversion costs 21,433 4,196 3,265 931
Stock-based compensation - 42 - 42
Long-term incentive compensation 393 774 184 590
LiveWatch acquisition contingent bonus
charges - 63 - 63
Legal settlement reserve (related
insurance recovery) (700) (4,800) - (4,800)
Severance expense (a) 4,693 - - -
Integration / implementation of company
initiatives 9,593 12,545 7,702 4,843
Select Security acquisition costs 1,036 - - -
Select Security integration costs 60 - - -
COVID-19 costs 1,866 - - -
Loss / (gain) on revaluation of
acquisition dealer liabilities 1,933 (1,886) (1,886) -
Goodwill impairment 81,943 - - -
Gain on restructuring and
reorganization, net - (669,722) - (669,722)
Interest expense 80,265 134,060 28,979 105,081
Realized and unrealized loss, net on
derivative financial instruments - 6,804 - 6,804
Refinancing expense - 5,214 - 5,214
Income tax expense 1,891 2,479 704 1,775
Adjusted EBITDA $ 253,767 $ 266,460 $ 79,087 $ 187,373
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(a) Severance expense for the year ended
Adjusted EBITDA decreased$12,693,000 , or 4.8%, for the year endedDecember 31, 2020 , as compared to the prior year period. The decrease for the year endedDecember 31, 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 cost of services related to field service jobs associated with contract extensions for our high propensity to churn population and incremental impacts from the Protect America customer base. These increases were offset by decreases in our expensed subscriber acquisition costs. COVID-19 costs excluded from Adjusted EBITDA relate to one-time price concessions granted to customers experiencing hardships, bad debt reserve increases due to estimates of non-payment on certain receivables and other miscellaneous costs to transition the majority of our employees to working from home. Expensed Subscriber Acquisition Costs, net. Subscriber acquisition costs, net decreased to$12,579,000 for the year endedDecember 31, 2020 , as compared to$23,851,000 for the year endedDecember 31, 2019 . Expensed subscriber acquisition costs, net, for the year endedDecember 31, 2019 was restated from$30,556,000 to$23,851,000 to be comparable with how acquisition costs were allocated for the year endedDecember 31, 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 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 savings measures 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 ofDecember 31, 2020 , we had$6,123,000 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 years endedDecember 31, 2020 and 2019, our cash flow from operating activities was$128,621,000 and$114,135,000 , 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 years endedDecember 31, 2020 and 2019, we used cash of$101,840,000 and$111,139,000 , respectively, to fund subscriber account acquisitions, net of holdback obligations. In addition, during the years endedDecember 31, 2020 and 2019, we used cash of$14,707,000 and$11,623,000 , respectively, to fund our capital expenditures. Our capital expenditures are primarily related to computer systems and software. Our existing long-term debt atDecember 31, 2020 includes an aggregate principal balance of$979,219,000 under the Takeback Loan Facility, Term Loan Facility and the Revolving Credit Facility. The Takeback Loan Facility has an outstanding principal balance of$812,219,000 as ofDecember 31, 2020 and requires principal payments of$2,056,250 per quarter, beginningDecember 31, 2019 , with the remaining amount becoming due onMarch 29, 2024 . The Term Loan Facility has an outstanding principal balance of$150,000,000 as ofDecember 31, 2020 . The Revolving Credit Facility has an outstanding balance of$17,000,000 as ofDecember 31, 2020 . We also had$600,000 available under a standby letter of credit issued as ofDecember 31, 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 agreements with Protect America and GSSA each provide for 50 monthly Earnout Payments consisting of a portion of the revenue attributable to the subscriber base, subject to adjustment for subscribers that are no longer active. The estimated undiscounted liability for the remaining Earnout Payments as ofDecember 31, 2020 is approximately$122,867,000 . 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 ofDecember 31, 2020 , we have approximately 328,000 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 ofDecember 31, 2020 , we have approximately 10,000 subscribers with 2G cellular equipment which may have to be upgraded as 34 -------------------------------------------------------------------------------- Table of Contents a result of this retirement. The remaining subscribers with 3G or 2G equipment include approximately 60,000 subscribers acquired from Protect America and Select Security. 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 and Select Security, will be between$80,000,000 to$90,000,000 . For the year endedDecember 31, 2020 , the Company incurred radio conversion costs of$21,433,000 . Cumulative throughDecember 31, 2020 , we have spent approximately$25,629,000 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 Network Sales and Direct to Consumer Channels or potential bulk buy opportunities, as well as completing our payment obligations under the Protect America and GSSA earnout liabilities. 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$127,400,000 as ofDecember 31, 2020 , subject to certain financial covenants. Based on this analysis, we expect that cash on hand, cash flow generated from operations and available borrowings under the Revolving Credit Facility will provide sufficient liquidity for the next twelve months, given our anticipated current and future requirements. Subject to restrictions set forth in our credit agreements, we may seek debt financing in the event of any new investment opportunities, additional capital expenditures or our operations requiring additional funds, but there can be no assurance that we will be able to obtain debt financing on terms that would be acceptable to us or at all. Our ability to seek additional sources of funding depends on our future financial position and results of operations, which are subject to general conditions in or affecting our industry and our customers and to general economic, political, financial, competitive, legislative and regulatory factors beyond our control.
Contractual Obligations
Information concerning the amount and timing of required payments under our contractual obligations as ofDecember 31, 2020 is summarized below (amounts in thousands): Payments Due by Period Less than 1 Year 1-3 Years 3-5 Years After 5 Years Total Operating leases$ 3,609 $ 6,731 $ 6,172 $ 14,157 $ 30,669 Long-term debt (a)$ 8,225 $ 16,450 $ 954,544 $ -$ 979,219 Interest payments on long-term debt (b)$ 73,744 $ 145,575 $ 18,018 $ -$ 237,337 Earnout Payments (c)$ 34,854 $ 63,689 $ 24,324 $ -$ 122,867 Other (d)$ 8,646 $ 220
(a) Amounts reflect principal amounts owed.
(b) Interest payments are based on variable interest rates. Future interest
expense is estimated using the interest rate in effect on
(c) Amounts reflect the undiscounted estimated remaining payout of the
Earnout Payments liability as of
(d) Primarily represents our holdback liability whereby we withhold payment
of a designated percentage of acquisition cost when we acquire subscriber
accounts from dealers. The holdback is used as a reserve to cover any terminated
subscriber accounts that are not replaced by the dealer during the guarantee
period. At the end of the guarantee period, the dealer is responsible for any
deficit or is paid the balance of the holdback.
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We have contingent liabilities related to legal proceedings and other matters
arising in the ordinary course of business. Although it is reasonably possible
we may incur losses upon conclusion of such matters, an estimate of any loss or
range of loss cannot be made. In the opinion of management, it is expected that
amounts, if any, which may be required to satisfy such contingencies will not be
material in relation to the accompanying consolidated financial statements.
Off-Balance Sheet Arrangements
None.
Critical Accounting Policies and Estimates
Valuation of Subscriber Accounts
Subscriber accounts, which totaled$1,102,977,000 net of accumulated amortization, atDecember 31, 2020 , relate primarily to the monitoring service contracts acquired from independent dealers. The subscriber accounts asset was adjusted to fair value in connection with the Company's application of fresh start accounting under ASC 852 upon the Company's emergence from Chapter 11. The valuation of subscriber accounts was based on the projected cash flows to be generated by the existing subscribers as of the Effective Date. Subscriber accounts acquired after the Company's emergence from bankruptcy are recorded at cost. All direct and incremental costs associated with the acquisition of monitoring service contracts from its independent dealers are capitalized (the "subscriber accounts asset"). Upon adoption of Accounting Standards Update 2014-19, Revenue from Contracts with customers (Topic 606), as amended, all costs on new subscriber contracts obtained in connection with a subscriber move ("Moves Costs") are expensed, whereas prior to adoption, certain Moves Costs were capitalized on the balance sheet. Also included in the subscriber accounts are capitalized contract costs related to bonus incentives and other incremental costs associated with accounts originated in the Direct to Consumer Channel. The fair value of subscriber accounts as of the Company's emergence from Chapter 11, as well as certain accounts acquired in bulk purchases, are amortized using the 14-year 235% declining balance method. The costs of all other subscriber accounts are amortized using the 15-year 220% declining balance method, beginning in the month following the date of acquisition. The amortization methods were selected to provide an approximate matching of the amortization of the subscriber accounts intangible asset to estimated future subscriber revenues based on the projected lives of individual subscriber contracts. The realizable value and remaining useful lives of these assets could be impacted by changes in subscriber attrition rates, which could have an adverse effect on our earnings. The Company has processes and controls in place, including the review of key performance indicators, to assist management in identifying events or circumstances that indicate the subscriber accounts asset may not be recoverable. If an indicator that the asset may not be recoverable exists, management tests the subscriber accounts asset for impairment. For purposes of recognition and measurement of an impairment loss, we view subscriber accounts as a single pool because of the assets' homogeneous characteristics, and the pool of subscriber accounts is the lowest level for which identifiable cash flows are largely independent of the cash flows of the other assets and liabilities. If such assets are considered to be impaired, the impairment loss to be recognized is measured as the amount by which the carrying value of the assets exceeds the estimated fair value, as determined using the income approach.
In addition, the Company reviews the subscriber accounts asset amortization methodology annually to ensure the methodology is consistent with actual experience.
Valuation of Deferred Tax Assets
In accordance with FASB ASC Topic 740, Income Taxes, we review the nature of each component of our deferred income taxes for the ability to realize the future tax benefits. As part of this review, we rely on the objective evidence of our current performance and the subjective evidence of estimates of our forecast of future operations. Our estimates of realizability are subject to judgment since they include such forecasts of future operations. After consideration of all available positive and negative evidence and estimates, we have determined that it is more likely than not that we will not realize the tax benefits associated with ourUnited States deferred tax assets and certain foreign deferred tax assets, and as such, we have a valuation allowance which totaled$63,881,000 and$24,457,000 as ofDecember 31, 2020 and 2019, respectively.
Valuation of
During the year endedDecember 31, 2020 , we recorded a full goodwill impairment of$81,943,000 .Goodwill was recorded in connection with the Company's application of fresh start accounting under ASC 852 upon the Company's emergence from 36
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Table of Contents Chapter 11. The Company accounts for its goodwill pursuant to the provisions of FASB ASC Topic 350, Intangibles -Goodwill and Other ("ASC 350"). In accordance with ASC 350, goodwill is not amortized, but rather tested for impairment at least annually. To the extent necessary, goodwill for the reporting unit is measured using a discounted cash flow model incorporating discount rates commensurate with the risks involved, which is classified as a Level 3 measurement under FASB ASC Topic 820, Fair Value Measurements and Disclosures. The key assumptions used in the discounted cash flow valuation model include discount rates, growth rates, cash flow projections and terminal value rates. Discount rates, growth and attrition rates and cash flow projections are the most sensitive and susceptible to change as they require significant management judgment. An impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit's fair value.
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