(EDGAR Online via COMTEX) -- Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
Certain statements in this Quarterly Report on Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our business, marketing and operating strategies, 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;
For additional risk factors, please see Part I, Item 1A, Risk Factors, in our Annual Report on Form 10-K for the year ended December 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 ended June 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.
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Monitronics 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, in the United States, Canada and Puerto 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, on June 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 the United States Bankruptcy Court for the Southern District of Texas (the "Bankruptcy Court"). The Debtors' Chapter 11 Cases were jointly administered under the caption In re Monitronics International, Inc., et al., Case No. 19-33650. On August 7, 2019, the Bankruptcy 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 the Bankruptcy Court on June 30, 2019. On August 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 of May 24, 2019 (the "Merger Agreement"). Monitronics was the surviving corporation and, immediately following the Merger, was redomiciled in Delaware 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 of August 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 of Monitronics on and subsequent to September 1, 2019. References to "Predecessor" or "Predecessor Company" refer to the balance sheet and results of operations of Monitronics prior to September 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
On June 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 of Protect 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 of June 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
In December 2019, an outbreak of a novel strain of coronavirus ("COVID-19") originated in Wuhan, China and has been detected globally on a widespread basis, including in the 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 on March 27, 2020 in the U.S. The CARES Act, among other things, provides for an acceleration of alternative minimum tax credit Table of Contents
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 of September 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 of March 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 ended September 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 ended September 30, 2020.
As noted in the financial statements, as of March 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 ended September 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.
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.
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;
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;
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;
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;
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.
For the Three Months Ended September 30, 2020
During the three months ended September 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 ended September 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 Table of Contents
RMR acquired during the three months ended September 30, 2020 and 2019 was $841,000 and $1,032,000, respectively.
For the Nine Months Ended September 30, 2020
During the nine months ended September 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 ended September 30, 2020 is due to bulk buys of 113,013 accounts in June 2020 and 10,960 accounts in March 2020. There were no bulk buys during the nine months ended September 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 ended September 30, 2020 was $7,187,000, which includes RMR related to bulk buys of $4,866,000. RMR acquired during the nine months ended September 30, 2019 was $3,098,000.
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 September 30, 2020 and 2019: Twelve Months Ended September 30, 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.
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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.
We evaluate the performance of our operations based on financial measures such . . .
Nov 13, 2020
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