operations could be materially and adversely affected. In addition, we may experience higher attrition rates with respect to subscribers acquired in bulk buys than subscribers acquired pursuant to our authorized dealer program.
We are subject to credit risk and other risks associated with our subscribers.
Substantially allA significant amount of our revenues are derived from the recurring monthly revenue due from subscribers under the AMAs. Therefore, we are dependent on the ability and willingness of subscribers to pay amounts due under the AMAs on a monthly basis in a timely manner. Although subscribers are contractually obligated to pay amounts due under an AMA and are generally prohibited from canceling the AMA for the initial term of the AMA, subscribers' payment obligations are unsecured, which could impair our ability to collect any unpaid amounts from our subscribers. To the extent payment defaults by subscribers under the AMAs are greater than anticipated, our business and results of operations could be materially and adversely affected.
We have an arrangement with a third-party financing company to provide financing to customers who wish to finance their equipment purchases from us. This financing arrangement could increase the credit risks associated with our subscribers and any efforts to mitigate risk may not be sufficient to prevent our results of operations from being materially adversely affected.
We are subject to credit risk and other risks associated with our dealers.
Under the standard alarm monitoring contract acquisition agreements that we enter into with our dealers, if a subscriber terminates the subscriber's service with us during the first twelve months after the AMA has been acquired, the dealer is typically required to elect between substituting another AMA for the terminating AMA or compensating us in an amount based on the original acquisition cost of the terminating AMA. We are subject to the risk that dealers will breach their obligation to provide a comparable substitute AMA for a terminating AMA. Although we withhold specified amounts from the acquisition cost paid to dealers for AMAs ("holdback"), which may be used to satisfy or offset these and other applicable dealer obligations under the alarm monitoring contract acquisition agreements, there can be no guarantee that these amounts will be sufficient to satisfy or offset the full extent of the default by a dealer of its obligations under its agreement. If the holdback does prove insufficient to cover dealer obligations, we are also subject to the credit risk that the dealers may not have sufficient funds to compensate us or that any such dealer will otherwise breach its obligation to compensate us for a terminating AMA. To the extent defaults by dealers of the obligations under their agreements are greater than anticipated, our financial condition and results of operations could be materially and adversely affected. In addition, a significant portion of our accounts originate from a small number of dealers. If any of these dealers discontinue their alarm monitoring business or cease operations altogether as a result of business conditions or due to increasingly burdensome regulatory compliance, the dealer may breach its obligations under the applicable alarm monitoring contract acquisition agreement and, to the extent such dealer has originated a significant portion of our accounts, our financial condition and results of operations could be materially and adversely affected to a greater degree than if the dealer had originated a smaller number of accounts.
An inability to provide the contracted monitoring service could adversely affect our business.
A disruption to the main monitoring facility, the back-up monitoring facility and/or third-party monitoring facility could affect our ability to provide alarm monitoring services to our subscribers. Our main monitoring facility holds Underwriter Laboratories listings as a protective signaling services station and maintains certain standards of building integrity, redundant computer and communications facilities and backup power, among other safeguards. However, no assurance can be given that our main monitoring facility will not be disrupted by a technical failure, including communication or hardware failures, catastrophic event or natural disaster, fire, weather, malicious acts or terrorism. Furthermore, no assurance can be given that our back-up or third-party monitoring center will not be disrupted by the same or a simultaneous event or that it will be able to perform effectively in the event its main monitoring center is disrupted. Any such disruption, particularly one of a prolonged duration, could have a material adverse effect on our business.
A significant number of our customers with alarm monitoring systems that use 2G, 3G or CDMA telecommunications technologies which are being discontinued by telecommunications providers. The costs to upgrade such customers could materially and adversely affect our business, financial condition, results of operations and cash flows.
Certain cellular carriers recently announced their plans to retire theirof 3G and CDMA cellular networks have announced that they will be retiring these networks between February and December of 2022. Additionally other certain cellular carriers of 2G cellular networks announced in late 2019 that the 2G cellular networks will be sunsetting as of December 31, 2020. As of December 31, 2019,2020, we have approximately 415,000328,000 subscribers with 3G or CDMA equipment and 24,000which 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 until December 31, 2022. As of December 31, 2020, we have approximately 10,000 subscribers with 2G cellular equipment which may have to be upgraded as a result of these retirements. While we are inthis retirement. The remaining subscribers with 3G or 2G equipment include approximately 60,000 subscribers acquired from Protect America and Select Security. We currently estimate that the early phasetotal cost of offering equipment upgrades toconverting our 3G and 2G population, we currently estimate that we
subscribers, including those acquired from Protect America and Select Security, will incurbe between $80,000,000 and $90,000,000. For the year ended December 31, 2020, the Company incurred radio conversion costs of $21,433,000.Cumulative through December 31, 2020, we have spent approximately $70,000,000 to $90,000,000 between$25,629,000 on 3G and 2G conversions. For the year ended December 31, 2020, and the second half 2022 to complete the required upgradesCompany incurred radio conversion costs of these networks.$21,433,000. 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. If we are unable to adapt timely to changing technologies, market conditions, customer preferences, or convert a substantial portion of our current 2G, 3G and CDMA subscribers before the retirement of these networks, our business, financial condition, results of operations and cash flows could be materially and adversely affected. See also "Shifts in customer choice of, or telecommunications providers' support for, telecommunications services and equipment could adversely impact our business and require significant capital expenditures" below.
Shifts in customer choice of, or telecommunications providers' support for, telecommunications services and equipment could adversely impact our business and require significant capital expenditures.
Substantially all of our subscriber alarm systems use either cellular service or traditional land-line to communicate alarm signals from the subscribers’ locations to our monitoring facilities. The number of land-line customers has continued to decline as fewer new customers utilize land-lines and consumers give up their land-line and exclusively use cellular and IP communication technology in their homes and businesses. In addition, some telecommunications providers may discontinue land-line services in the future and cellular carriers may choose to discontinue certain cellular networks. As land-line and cellular network service is discontinued or disconnected, subscribers with alarm systems that communicate over these networks may need to have certain equipment in their security system replaced to maintain their monitoring service. The process of changing out this equipment will require us to subsidize the replacement of subscribers' outdated equipment and is likely to cause an increase in subscriber attrition. In the future, we may not be able to successfully implement new technologies or adapt existing technologies to changing market demands in the future. If we are unable to adapt timely to changing technologies, market conditions or customer preferences, our business, financial condition, results of operations and cash flows could be materially and adversely affected. See also "A significant number of our customers with alarm monitoring systems use 2G, 3G or CDMA telecommunications technologies which are being discontinued by telecommunications providers. The costs to upgrade such customers could materially and adversely affect our business, financial condition, results of operations and cash flows" above.
Our reputation as a service provider of high-quality security offerings may be adversely affected by product defects or shortfalls in customer service.
Our business depends on our reputation and ability to maintain good relationships with our subscribers, dealers and local regulators, among others. Our reputation may be harmed either through product defects, such as the failure of one or more of our subscribers' alarm systems, or shortfalls in customer service. Subscribers generally judge our performance through their interactions with the staff at the monitoring and customer care centers, dealers and technicians who perform on-site maintenance services. Any failure to meet subscribers' expectations in such customer service areas could cause an increase in attrition rates or make it difficult to recruit new subscribers. Any harm to our reputation or subscriber relationships caused by the actions of our staff at the monitoring and customer care centers, dealers, personnel or third-party service providers or any other factors could have a material adverse effect on our business, financial condition and results of operations.
Due to the ever-changing threat landscape, our products may be subject to potential vulnerabilities of wireless and Internet-of-things devices and our services may be subject to certain risks, including hacking or other unauthorized access to control or view systems and obtain private information.
Companies that collect and retain sensitive and confidential information are under increasing attack by cyber-criminals around the world. While we implement security measures within our products, services, operations and systems, those measures may not prevent cybersecurity breaches, the access, capture or alteration of information by criminals, the exposure or exploitation of potential security vulnerabilities, distributed denial of service attacks, the installation of malware or ransomware, acts of vandalism, computer viruses, misplaced data or data loss that could be detrimental to our reputation, business, financial condition, and results of operations. Third parties, including our dealers, partners and vendors, could also be a source of security risk to us in the event of a failure of their own products, components, networks, security systems, and infrastructure. In addition, we cannot be certain that advances in criminal capabilities, new discoveries in the field of cryptography, or other developments will not compromise or breach the technology protecting the networks that access our products and services.
A significant actual or perceived (whether or not valid) theft, loss, fraudulent use or misuse of customer, employee, or other personally identifiable data, whether by us, our partners and vendors, or other third parties, or as a result of employee error or malfeasance or otherwise, non-compliance with applicable industry standards or our contractual or other legal obligations regarding such data, or a violation of our privacy and information security policies with respect to such data, could result in costs, fines, litigation, or regulatory actions against us. Such an event could additionally result in unfavorable publicity and therefore materially and adversely affect the market's perception of the security and reliability of our services and our
credibility and reputation with our customers, which may lead to customer dissatisfaction and could result in lost sales and increased customer revenue attrition.
In addition, we depend on our information technology infrastructure for business-to-business and business-to-consumer electronic commerce. Security breaches of, or sustained attacks against, this infrastructure could create system disruptions and shutdowns that could negatively impact our operations. Increasingly, our products and services are accessed through the Internet, and security breaches in connection with the delivery of our services via the Internet may affect us and could be detrimental to our reputation, business, operating results, and financial condition. We continue to invest in new and emerging technology and other solutions to protect our network and information systems, but there can be no assurance that these investments and solutions will prevent any of the risks described above. While we maintain cyber liability insurance that provides both third-party liability and first-party insurance coverages, our insurance may not be sufficient to protect against all of our losses from any future disruptions or breaches of our systems or other event as described above.
Privacy concerns, such as consumer identity theft and security breaches, could hurt our reputation and revenues.
As part of our operations, we collect a large amount of private information from our subscribers, including social security numbers, credit card information, images and voice recordings. Unauthorized parties may attempt to gain access to our systems or facilities by, among other things, hacking into our systems or facilities or those of our customers, partners or vendors, or through fraud or other means of deceiving our employees, partners or vendors. In addition, hardware, software or applications we develop or obtain from third parties may contain defects in design or manufacture or other problems that could unexpectedly compromise information security. The techniques used to gain such access to our information technology systems, our data or customers' data, disable or degrade service, or sabotage systems are constantly evolving, may be difficult to detect quickly, and often are not recognized until launched against a target. We have implemented systems and processes intended to secure our information technology systems and prevent unauthorized access to or loss of sensitive data, but as with all companies, these security measures may not be sufficient for all eventualities and there is no guarantee that they will be adequate to safeguard against all data security breaches, system compromises or misuses of data. If we were to experience a breach of our data security, it may put private information of our subscribers at risk of exposure. To the extent that any such exposure leads to credit card fraud or identity theft, we may experience a general decline in consumer confidence in our business, which may lead to an increase in attrition rates or may make it more difficult to attract new subscribers. If consumers become reluctant to use our services because of concerns over data privacy or credit card fraud, our ability to generate revenues would be impaired. In addition, if technology upgrades or other expenditures are required to prevent security breaches of our network, boost general consumer confidence in our business, or prevent credit card fraud and identity theft, we may be required to make unplanned capital expenditures or expend other resources. Any such loss of confidence in our business or additional capital expenditure requirement could have a material adverse effect on our business, financial condition and results of operations.
Our independent, third-party authorized dealers may not be able to mitigate certain risks such as information technology breaches, data security breaches, product liability, errors and omissions, and marketing compliance.
We generate a portion of our new customers through our authorized dealer network. We rely on independent, third-party authorized dealers to implement mitigation plans for certain risks they may experience, including but not limited to, information technology breaches, data security breaches, product liability, errors and omissions, and marketing compliance. If our authorized dealers experience any of these risks, or fail to implement mitigation plans for their risks, or if such implemented mitigation plans are inadequate or fail, we may be susceptible to risks associated with our authorized dealers on which we rely to generate customers. Any interruption or permanent disruption in the generation of customer accounts or services provided by our authorized dealers could materially adversely affect our business, financial condition, results of operations, and cash flows.
Our business is subject to technological innovation over time.
Our monitoring services depend upon the technology (both hardware and software) of security alarm systems located at subscribers' premises as well as information technology networks and systems, including Internet and Internet-based or "cloud" computing services, to collect, process, transmit, and store electronic information. We may be required to implement new technology both to attract and retain subscribers or in response to changes in technology or other factors, which could require significant expenditures. Such changes could include making changes to legacy systems, replacing legacy systems with
successor systems with new functionality, and implementing new systems. There are inherent costs and risks associated with replacing and changing these systems and implementing new systems, including potential disruption of our sales, operations and customer service functions, potential disruption of our internal control structure, substantial capital expenditures, additional administration and operating expenses, retention of sufficiently skilled personnel to implement and operate the new systems,
demands on management time, and other risks and costs of delays or difficulties in transitioning to new systems or of integrating new systems into our current systems. In addition, our technology system implementations may not result in productivity improvements at a level that outweighs the costs of implementation, or at all. The implementation of new technology systems may also cause disruptions in our business operations and have a material adverse effect on our business, cash flows, and results of operations.
Further, the availability of any new features developed for use in our industry (whether developed by us or otherwise) can have a significant impact on a subscriber's initial decision to choose our or our competitors' products and a subscriber's decision to renew with us or switch to one of our competitors. To the extent our competitors have greater capital and other resources to dedicate to responding to technological innovation over time, the products and services offered by us may become less attractive to current or future subscribers thereby reducing demand for such products and services and increasing attrition over time. Those competitors that benefit from more capital being available to them may be at a particular advantage to us in this respect. If we are unable to adapt in response to changing technologies, market conditions or customer requirements in a timely manner, such inability could adversely affect our business by increasing our rate of subscriber attrition. We also face potential competition from improvements in self-monitoring systems, which enable current or future subscribers to monitor their home environments without third-party involvement, which could further increase attrition rates over time and hinder the acquisition of new AMAs.
The high level of competition in our industry could adversely affect our business.
The security alarm monitoring industry is highly competitive and fragmented. As of December 31, 2019,2020, we were one of the largest alarm monitoring companies in the U.S. when measured by the total number of subscribers under contract. We face competition from other alarm monitoring companies, including companies that have more capital and that may offer higher prices and more favorable terms to dealers for AMAs or charge lower prices to customers for monitoring services. We also face competition from a significant number of small regional competitors that concentrate their capital and other resources in targeting local markets and forming new marketing channels that may displace the existing alarm system dealer channels for acquiring AMAs. Further, we are facing increasing competition from telecommunications, cable and technology companies who are expanding into alarm monitoring services and bundlingbundle their existing offerings with monitored security services. The existing access to and relationship with subscribers that these companies have could give them a substantial advantage over us, especially if they are able to offer subscribers a lower price by bundling these services. Any of these forms of competition could reduce the acquisition opportunities available to us, thus slowing our rate of growth, or requiring us to increase the price paid for subscriber accounts, thus reducing our return on investment and negatively impacting our revenues and results of operations.
Risks of liability from our business and operations may be significant.
The nature of the services we provide potentially exposes us to greater risks of liability for employee acts or omissions or system failures than may be inherent in other businesses. If subscribers believe that they incurred losses as a result of an action or failure to act by us, the subscribers (or their insurers) could bring claims against us, and we have been subject to lawsuits of this type from time to time. Similarly, if dealers believe that they incurred losses or were denied rights under the alarm monitoring contract acquisition agreements as a result of an action or failure to act by us, the dealers could bring claims against us. Although substantially all of our AMAs and alarm monitoring contract acquisition agreements contain provisions limiting our liability to subscribers and dealers, respectively, in an attempt to reduce this risk, the AMAs or alarm monitoring contract acquisition agreements that do not contain such provisions expose us to risks of liability that could materially and adversely affect our business. Moreover, even when such provisions are included in an AMA or alarm monitoring contract acquisition agreement, in the event of any such litigation, no assurance can be given that these limitations will be enforced, and the costs of such litigation or the related settlements or judgments could have a material adverse effect on our financial condition. In addition, there can be no assurance that we are adequately insured for these risks. Certain of our insurance policies and the laws of some states may limit or prohibit insurance coverage for punitive or certain other types of damages or liability arising from gross negligence. If significant uninsured damages are assessed against us, the resulting liability could have a material adverse effect on our financial condition or results of operations.
Future litigation could result in reputational damage for us.
In the ordinary course of business, from time to time, the Company and our subsidiaries are the subject of complaints or litigation from subscribers or inquiries or investigations from government officials, sometimes related to alleged violations of
state or federal consumer protection statutes (including by our dealers), violations of "false alarm" ordinances or other regulations, negligent dealer installation or negligent service of alarm monitoring systems. We may also be subject to employee claims based on, among other things, alleged discrimination, harassment or wrongful termination claims. In addition to
diverting management resources, damage resulting from such allegations may materially and adversely affect our reputation in the communities we service, regardless of whether such allegations are unfounded. Such reputational damage could result in higher attrition rates and greater difficulty in attracting new subscribers on terms that are attractive to us or at all.
A loss of experienced employees could adversely affect us.
The success of the Company has been largely dependent upon the active participation of our officers and employees. The loss of the services of key members of our management for any reason may have a material adverse effect on our operations and the ability to maintain and grow our business. We depend on the managerial skills and expertise of our management and employees to provide customer service by, among other things, monitoring and responding to alarm signals, coordinating equipment repairs, administering billing and collections under the AMAs and administering and providing dealer services under the contract acquisition agreements. There is no assurance that we will be able to retain our current management and other experienced employees or replace them satisfactorily to the extent they leave our employ. The loss of our experienced employees' services and expertise could materially and adversely affect our business. Our business may also be negatively impacted if one of our senior executives or key employees is hired by a competitor or decides to resign. Our success also depends on our ability to continue to attract, manage and retain other qualified management personnel as we grow. We may not be able to continue to attract or retain such personnel in the future.
On February 26, 2020, Jeffery Gardner stepped down from his position as President and Chief Executive Officer of Brinks Home Security and from Brinks Home Security’s Board of Directors. William Niles, Brinks Home Security’s Chief Transformation Officer and General Counsel was named as interim Chief Executive Officer while we conduct a search for a Chief Executive Officer. The loss of the services of Mr. Gardner or other of our senior executives or key employees could damage our reputation, make it more difficult to retain and attract new employees and clients and have a material adverse effect on our results of operations.
The alarm monitoring business is subject to macroeconomic factors that may negatively impact our results of operations, including prolonged downturns in the economy.
The alarm monitoring business is dependent in part on national, regional and local economic conditions. In particular, where disposable income available for discretionary spending is reduced (such as by higher housing, energy, interest or other costs or where the actual or perceived wealth of customers has decreased because of circumstances such as lower residential real estate values, increased foreclosure rates, inflation, increased tax rates or other economic disruptions), the alarm monitoring business could experience increased attrition rates and reduced consumer demand. In periods of economic downturn, no assurance can be given that we will be able to continue acquiring quality AMAs or that we will not experience higher attrition rates. In addition, any deterioration in new construction and sales of existing single-family homes could reduce opportunities to grow our subscriber accounts from the sales of new security systems and services and the take-over of existing security systems that had previously been monitored by our competitors. If there are prolonged durations of general economic downturn, our results of operations and subscriber account growth could be materially and adversely affected.
Business or economic disruptions or global health concernsThe COVID-19 pandemic has and may continue to materially and adversely affect our business, financial condition, future results and cash flow.
Periods of market volatility may continue to occur in response to pandemics or other events outside of our control. These types of events could adversely affect our financial condition, future results and cash flow. In December 2019, an outbreak of a novel strain of COVID-19coronavirus ("COVID-19") originated in Wuhan, China and has now been detected globally on a widespread basis, including in the United States. As of December 31, 2020, efforts to contain COVID-19 have not succeeded in many regions, and the global pandemic remains ongoing. The COVID-19 pandemic has resulted in the temporary closure of many corporate offices, retail stores,disrupted our operations 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. As the potential impact on global markets from COVID-19 is difficult to predict, the extent to which COVID-19 may negativelywill affect our business, or the durationincluding as a result of any potential business disruption is uncertain. Some economistsgovernmental authorities imposing, stay-at-home orders, shelter-in-place orders, quarantines, executive orders and major investment banks have expressed concern that the continued spread of the virus globally could leadsimilar government orders and restrictions for their residents to a world-wide economic downturn or recession. Many manufacturers of goods throughout the world, including the United States, have seen a downturn in production due to the suspension of business and temporary closure of factories in an attempt to curbcontrol the spread of COVID-19. Preventative and protective actions that public health officials, governments or the illness. Such eventsCompany have affected,taken with respect to COVID-19 have and may in the future affect, the global and United States capital markets and our business, financial condition or results of operations. The extentwill continue to which COVID-19 mayadversely impact our business, will depend on future developments, whichsuppliers, distribution channels, and customers, including business shutdowns or disruptions for an indefinite period of time, reduced operations, reduced ability to supply products and reduced ability to service a customer’s home to service or to install a new system. For instance, in jurisdictions where local or state governments have implemented a “shelter in place” or similar order, we have instructed our dealers to cease doing door-to-door sales until such measures are highly uncertain and cannot be predicted with confidence, such as the ultimate geographic spread of the disease, the duration of the outbreak, travel restrictions and social distancing in the United States and other countries, business closures or business disruptions and the effectiveness of actions taken in the United States and other countries to contain and treat the virus. Additionally, the COVID-19 outbreak may exacerbate other pre-existing political, social and economic risks in certain countries and could result in social, economic, and
labor instability in the countries in which we, our employees, consumers, customers, suppliers, dealers and other third parties with whom we engage operate.lifted.
Our operations are dependent on the efforts of the our employees as well as our dealers and suppliers.suppliers, and their employees. In response to the COVID-19 outbreak,pandemic, the Company has implemented several initiatives to address the safety of our employees, customers and dealers. These initiatives include providing essential and non-essential employees with the capability to work from home, increased sanitation efforts in the workplace, increased PTO for employees, and use of our backup facility. In addition, we have implemented safety procedures for field technicians to allow necessary maintenance that will enable us to continue to provide monitoring services to our customers. We cannot guarantee that these measures will prevent the outbreakpandemic from materially and negatively impacting our operations. Our operations are also dependent on our supply of inventory. Weinventory, and delays in the supply of our inventory due to the COVID-19 pandemic may lead to cost increases. While we are not dependent on any one supplier and have put into place plans to ensure that our dealers are not impacted by any shortage in inventory. Whileinventory, we have implemented such plans for our dealers, we
cannot guarantee that such plans will be successful or that our dealers will not be impacted by a shortage in inventory as a result of the COVID-19 outbreak. The ongoing COVID-19 outbreak may result in delays in the supply of our inventory, which may lead to cost increases. Our operations are also dependent on the efforts of the employees of our dealers, suppliers, and third party service providers. We cannot guarantee that these businesses in affected regions will be adequately staffed due to business closings, slowdowns or delays and restrictions and limitations placed on workers, including quarantines and other limitations on the ability to travel and return to work.pandemic. We cannot presently predict the scope and severity of any potential business shutdowns or disruptions, but if we or any of the third parties with whom we engage, including the suppliers of our inventory, suppliers of our dealers, the employees of the businesses with which we interact and other third parties with whom we conduct business, were to experience shutdowns or other business disruptions, our ability to conduct our business in the manner and on the timelines presently planned could be materially and negatively impacted.
The pandemic has significantly increased economic and demand uncertainty and has caused and may exacerbate an economic slowdown, and it is possible that it could lead to a global recession. The extent to which COVID-19 may impact our business will depend on future developments, which are highly uncertain and cannot be predicted with confidence, such as the ultimate geographic spread of the disease, the duration of the pandemic, continued travel restrictions and social distancing in the United States and other countries, business closures or business disruptions and the effectiveness of actions taken in the United States and other countries to contain and treat the virus. Additionally, the COVID-19 pandemic may exacerbate other pre-existing political, social and economic risks in certain countries and could result in social, economic, and labor instability in the countries in which we, our employees, consumers, customers, suppliers, dealers and other third parties with whom we engage operate. The overall impact of the COVID-19 pandemic on our business continues to be uncertain at this time.
Adverse economic conditions or natural disasters in states where our subscribers are more heavily concentrated may negatively impact our results of operations.
Even as economic conditions may improve in the United States as a whole, this improvement may not occur or further deterioration may occur in the regions where our subscribers are more heavily concentrated such as, Texas, California, Florida and Arizona which, in the aggregate, comprise approximately 41%39% of our subscribers as of December 31, 2019.2020. Further, certain of these regions are more prone to natural disasters, such as hurricanes, floods or earthquakes. Although we have a geographically diverse subscriber base, adverse conditions in one or more states where our business is more heavily concentrated could have a significant adverse effect on our business, financial condition and results of operations.
If the insurance industry were to change its practice of providing incentives to homeowners for the use of alarm monitoring services, we may experience a reduction in new customer growth or an increase in our subscriber attrition rate.
It has been common practice in the insurance industry to provide a reduction in rates for policies written on homes that have monitored alarm systems. There can be no assurance that insurance companies will continue to offer these rate reductions. If these incentives were reduced or eliminated, new homeowners who otherwise may not feel the need for alarm monitoring services would be removed from our potential customer pool, which could hinder the growth of our business, and existing subscribers may choose to disconnect or not renew their service contracts, which could increase our attrition rates. In either case our results of operations and growth prospects could be adversely affected.
Our acquisition strategy may not be successful.
We may seek opportunities to grow free cash flow through strategic acquisitions, which may include leveraged acquisitions. However, there can be no assurance that we will be able to invest our capital in acquisitions that are accretive to free cash flow which could negatively impact our growth. Our ability to consummate such acquisitions may be negatively impacted by various factors, including among other things:
•failure to identify attractive acquisition candidates on acceptable terms;
•competition from other bidders;
•inability to raise any required financing; and
•antitrust or other regulatory restrictions, including any requirements that may be imposed by government agencies as a condition to any required regulatory approval.
If we engage in any acquisition, we will incur a variety of costs, and may never realize the anticipated benefits of the acquisition. If we undertake any acquisition, the process of operating such acquired business may result in unforeseen operating difficulties and expenditures, including the assumption of the liabilities and exposure to unforeseen liabilities of such acquired
business and the possibility of litigation or other claims in connection with, or as a result of, such an acquisition, including claims from terminated employees, customers, former stockholders or other third parties. Moreover, we may fail to realize the anticipated benefits of any acquisition as rapidly as expected or at all, and we may experience increased attrition in our subscriber base and/or a loss of dealer or other strategic relationships and difficulties integrating acquired businesses, technologies and personnel into our business or achieving anticipated operations efficiencies or cost savings. Future acquisitions could cause us to incur debt and expose us to liabilities. Further, we may incur significant expenditures and devote
substantial management time and attention in anticipation of an acquisition that is never realized. Lastly, while we intend to implement appropriate controls and procedures as we integrate any acquired companies, we may not be able to certify as to the effectiveness of these companies' disclosure controls and procedures or internal control over financial reporting within the time periods required by U.S. federal securities laws and regulations.
We may pursue business opportunities that diverge from our current business model, which may cause our business to suffer.
We may pursue business opportunities that diverge from our current business model, including expanding our products or service offerings, investing in new and unproven technologies, adding or modifying the focus of our customer acquisition channels and forming new alliances with companies to market our services. We can offer no assurance that any such business opportunities will prove to be successful. Among other negative effects, our pursuit of such business opportunities could cause our cost of investment in new customers to grow at a faster rate than our recurring revenue. Additionally, any new alliances or customer acquisition channels could have higher cost structures than our current arrangements, which could reduce operating margins and require more working capital. In the event that working capital requirements exceed operating cash flow, we might be required to draw on our Credit Facilities (defined below) or pursue other external financing, which may not be readily available. Further, new alliances or customer acquisition channels may also result in the cannibalization of our products. Any of these factors could materially and adversely affect our business, financial condition, results of operations and cash flows.
Third-party claims with respect to our intellectual property, if decided against us, may result in competing uses of our intellectual property or require the adoption of new, non-infringing intellectual property.
We have received and may in the future receive notices claiming we committed intellectual property infringement, misappropriation or other intellectual property violations and third parties have claimed, and may, in the future, claim that we do not own or have rights to use all intellectual property rights used in the conduct of our business. While we do not believe that any of the claims we previously received are material, there can be no assurance that third parties will not assert future infringement claims against us or claim that our rights to our intellectual property are invalid or unenforceable, and we cannot guarantee that these claims will be unsuccessful. The "Brinks" and "Brinks Home Security" trademarks are licensed from Brink's. While Brink's is required to defend its intellectual property rights related to the "Brinks" or "Brinks Home Security" trademarks, any claims involving rights to use the "Brinks" or "Brinks Home Security" trademarks could have a material adverse effect on our business if such claims were decided against Brink's and Brink's was precluded from using or licensing the "Brinks" or "Brinks Home Security" trademarks or others were allowed to use such trademarks. If we were required to adopt a new name, it would entail marketing costs in connection with building up recognition and goodwill in such new name. In the event that we were enjoined from using any of our other intellectual property, there would be costs associated with the replacement of such intellectual property with developed, acquired or licensed intellectual property. There would also be costs associated with the defense and settlement of any infringement or misappropriation allegations and any damages that may be awarded.
We rely on third parties to transmit signals to our monitoring facilities and provide other services to our subscribers.
We rely on various third-party telecommunications providers and signal processing centers to transmit and communicate signals to our monitoring facilities in a timely and consistent manner. These telecommunications providers and signal processing centers could fail to transmit or communicate these signals to the monitoring facility for many reasons, including due to disruptions from fire, natural disasters, weather, transmission interruption, malicious acts or terrorism. The failure of one or more of these telecommunications providers or signal processing centers to transmit and communicate signals to the monitoring facility in a timely manner could affect our ability to provide alarm monitoring, home automation and interactive services to our subscribers. We also rely on third-party technology companies to provide home automation and interactive services to our subscribers, including video surveillance services. These technology companies could fail to provide these services consistently, or at all, which could result in our inability to meet customer demand and damage our reputation. There can be no assurance that third-party telecommunications providers, signal processing centers and other technology companies will continue to transmit, communicate signals to the monitoring facilities or provide home automation and interactive services to subscribers without disruption. Any such disruption, particularly one of a prolonged duration, could have a material adverse effect on our business. See also "Shifts in customer choice of, or telecommunications providers' support for,
telecommunications services and equipment will require significant capital expenditures and could adversely impact our business" above with respect to risks associated with changes in signal transmissions.
In the absence of regulation, certain providers of Internet access may block our services or charge our customers more for using our services, or government regulations relating to the Internet could change, which could materially adversely affect our revenue and growth.
Our interactive and home automation services are primarily accessed through the Internet and our security monitoring services are increasingly delivered using Internet technologies. Users who access our services through mobile devices, such as smart phones, laptops, and tablet computers must have a high-speed Internet connection, such as Wi-Fi, 3G, or 4G, to use such services. Currently, this access is provided by telecommunications companies and Internet access service providers that have significant and increasing market power in the broadband and Internet access marketplace. In the absence of government regulation, these providers could take measures that affect their customers' ability to use our products and services, such as degrading the quality of the data packets we transmit over their lines, giving our packets low priority, giving other packets higher priority than ours, blocking our packets entirely, or attempting to charge their customers more for using our products and services. To the extent that Internet service providers implement usage-based pricing, including meaningful bandwidth caps, or otherwise try to monetize access to their networks, we could incur greater operating expenses and customer acquisition and retention could be negatively impacted. Furthermore, to the extent network operators were to create tiers of Internet access service and either charge us for or prohibit our services from being available to our customers through these tiers, our business could be negatively impacted. Some of these providers also offer products and services that directly compete with our own offerings, which could potentially give them a competitive advantage.
In addition, the elimination of net neutrality rules and any changes to the rules could affect the market for broadband Internet access service in a way that impacts our business, for example, if Internet access providers provide better Internet access for their own alarm monitoring or interactive services that compete with our services or limit the bandwidth and speed for the transmission of data from our equipment, thereby depressing demand for our services or increasing the costs of services we provide.
We may be subject to litigation in the future subject to litigation with respect to the Merger, which could be time consuming and divert the resources and attention of our management.
The Company and the individual members of our board of directors may be named in lawsuits relating to the Merger Agreement and the Merger, which could, among other things, seek monetary damages. The defense of any such lawsuits may be expensive and may divert management's attention and resources, which could adversely affect our business results of operations and financial condition.
Our certificate of incorporation has designated the Court of Chancery of the State of Delaware as the sole and exclusive forum for certain types of actions and proceedings that may be initiated by our stockholders, which could limit our stockholders' ability to obtain a favorable judicial forum for disputes with us or our directors, officers, employees or agents.
Our certificate of incorporation provides that, unless we consent in writing to the selection of an alternative forum, the Court of Chancery of the State of Delaware will, to the fullest extent permitted by applicable law, be the sole and exclusive forum for any stockholder of Monitronics (including beneficial owners) to bring (i) any derivative action or proceeding brought on behalf of Monitronics, (ii) any action asserting a claim of breach of a fiduciary duty owed by any of Monitronics' directors, officers, or other employees to Monitronics or its stockholders, (iii) any action asserting a claim against Monitronics, or its directors, officers or other employees arising pursuant to any provision of the General Corporation Law of the State of Delaware, Monitronics' certificate of incorporation or Monitronics' bylaws, or (iv) any action asserting a claim against Monitronics or any of its directors or officers or other employees that is governed by the internal affairs doctrine, except as to each of (i) through (iv) above, subject to such Court of Chancery having personal jurisdiction over the indispensable parties named as defendants therein. Any person or entity purchasing or otherwise holding any interest in shares of our capital stock will be deemed to have notice of, and consented to, the provisions of our certificate of incorporation described in the preceding sentence. This choice of forum provision may limit a stockholder's ability to bring a claim in a judicial forum that it finds favorable for disputes with our directors, officers, employees or agents, which may discourage such lawsuits against us and such persons. Alternatively, if a court were to find these provisions of our certificate of incorporation inapplicable to, or unenforceable in respect of, one or more of the specified types of actions or proceedings, we may incur additional costs associated with resolving such matters in other jurisdictions, which could adversely affect its business, financial condition or results of operations.
Our certificate of incorporation provides that the exclusive forum provision will be applicable to the fullest extent permitted by applicable law. Section 27 of the Securities Exchange Act of 1934, as amended (the "Exchange Act") creates exclusive federal
jurisdiction over all suits brought to enforce any duty or liability created by the Exchange Act or the rules and regulations thereunder. Accordingly, our certificate of incorporation provides that the exclusive forum provision will not apply to suits
brought to enforce any liability or duty created by the Exchange Act, Securities Act of 1933, as amended (the "Securities Act"), or any other claim for which the federal courts have exclusive jurisdiction.
We have identified a material weakness in our internal control over financial reporting.
As further described in Item 9A of this report, in the course of completing our assessment of internal control over financial reporting as of December 31, 2019, management identified a material weakness in the Company's internal control over financial reporting related to the failure to adequately respond to changes in our business that significantly impacted risks and our system of internal control. Specifically, the Company did not completely identify and evaluate risks of misstatement associated with the accounting and reporting of significant non-routine transactions, including certain aspects of the application of fresh start accounting in accordance with Accounting Standards Codification 852, Reorganizations, and as a result failed to make the necessary modifications to the system of internal control to respond to these risks. As a result, management has concluded that, because of this material weakness, our internal control over financial reporting and our disclosure controls and procedures were not effective as of December 31, 2019.
Management is taking steps to remediate this material weakness, including revamping our risk assessment process to better respond to accounting and process risks created by future changes in the business and other non-routine transactions, increasing the depth and experience within our accounting and finance organization and designing and implementing improved processes and internal controls. However, we are unable to currently estimate how long full remediation will take, and our efforts to remediate this material weakness may not be effective or prevent any future material weakness or significant deficiency in our internal control over financial reporting. If we fail to complete the remediation of this material weakness, or after having remediated such material weakness, thereafter fail to maintain the effectiveness of our internal control over financial reporting or our disclosure controls and procedures, we could be subjected to regulatory scrutiny, civil or criminal penalties or shareholder litigation, the defense of any of which could cause the diversion of management’s attention and resources, we could incur significant legal and other expenses, and we could be required to pay damages to settle such actions if any such actions were not resolved in our favor. Continued or future failure to maintain effective internal control over financial reporting could also result in financial statements that do not accurately reflect our financial condition or results of operations. There can be no assurance that we will not conclude in the future that this material weakness continues to exist or that we will not identify any significant deficiencies or other material weaknesses that will impair our ability to report our financial condition and results of operations accurately or on a timely basis.
Factors Relating to Our Indebtedness
We have a substantial amount of indebtedness and the costs of servicing that debt may materially affect our business.
We have a significant amount of indebtedness. Our indebtedness includes a takeback term loan facility (the "Successor Takeback"Takeback Loan Facility)Facility") with an outstanding principal balance of $820,444,000$812,219,000 as of December 31, 2019,2020, a term loan facility (the "Successor Term"Term Loan Facility'Facility") with an outstanding principal balance of $150,000,000 as of December 31, 2019,2020, and a revolving credit facility (the "Successor Revolving"Revolving Credit Facility," and together with the Successor Takeback Loan Facility and Successor Term Loan Facility, the "Credit Facilities") with an outstanding balance of $16,000,000$17,000,000 as of December 31, 2019.2020. That substantial indebtedness, combined with our other financial obligations and contractual commitments, could have important consequences to us. For example, it could:
•make it more difficult for us to satisfy our obligations with respect to our existing and future indebtedness, and any failure to comply with the obligations under any of the agreements governing our indebtedness could result in an event of default under such agreements;
•require us to dedicate a substantial portion of any cash flow from operations (which also constitutes substantially all of our cash flow) to the payment of interest and principal due under our indebtedness, which will reduce funds available to fund future subscriber account acquisitions, working capital, capital expenditures and other general corporate requirements;
•increase our vulnerability to general adverse economic and industry conditions;
•limit our flexibility in planning for, or reacting to, changes in our business and the markets in which we operate;
•limit our ability to obtain additional financing required to fund future subscriber account acquisitions, working capital, capital expenditures and other general corporate requirements;
•expose us to market fluctuations in interest rates;
•place us at a competitive disadvantage compared to some of our competitors that are less leveraged;
•reduce or delay investments and capital expenditures; and
•cause any refinancing of our indebtedness to be at higher interest rates and require us to comply with more onerous covenants, which could further restrict our business operations.
The agreements that govern our various debt obligations impose restrictions on our business and the business of our subsidiaries and such restrictions could adversely affect our ability to undertake certain corporate actions.
The agreements that govern our indebtedness restrict our ability to, among other things:
•incur additional indebtedness;
•make certain dividends or distributions with respect to any of our capital stock or repurchase any of our capital stock;
•make certain loans and investments;
•create liens;
•enter into transactions with affiliates;
•restrict subsidiary distributions;
•dissolve, merge or consolidate;
•make capital expenditures in excess of certain annual limits;
•transfer, sell or dispose of assets;
•enter into or acquire certain types of AMAs;
•make certain amendments to our organizational documents;
•make changes in the nature of our business;
•enter into certain burdensome agreements;
•make accounting changes; and
•use proceeds of loans to purchase or carry margin stock.
In addition, we are required to comply with certain financial covenants that require us to, among other things, maintain (i) a maximum senior secured debt to RMR ratio of 30.0:1.00, (ii) a maximum total debt to EBITDA ratio of 4.50:1.00 for each fiscal quarter ending on or prior to December 31, 2020, with a stepdown to 4.25:1.00 for the fiscal quarters ending on March 31, 2021, through December 31, 2021, and 4.00:1.00 beginning with the fiscal quarter ending on March 31, 2022, and for each fiscal quarter thereafter, and (iii) minimum liquidity of $25.0 million. If we fail to comply with any of the financial covenants, or if we or any of our subsidiaries fails to comply with the restrictions contained in the Credit Facilities, such failure could lead to an event of default and we may not be able to make additional drawdowns under the Successor Revolving Credit Facility, which would
limit our ability to manage our working capital requirements, and could result in the acceleration of a substantial amount of our indebtedness.
We may be unable to obtain future financing or refinance our existing indebtedness on terms acceptable to us or at all, which may hinder our ability to grow our business or satisfy our obligations and could adversely affect our ability to continue as a going concern.
We intend to continue to pursue growth through the acquisition of subscriber accounts through our authorized dealer network, our strategic relationships and our Direct to Consumer Channel, among other means. To continue our growth strategy, we intend to make additional drawdowns under the Successor Revolving Credit Facility and may seek financing through new credit arrangements or the possible sale of new securities, any of which may lead to higher leverage or result in higher borrowing costs. In addition, any future downgrade in our credit rating could also result in higher borrowing costs. An inability to obtain funding through external financing sources on favorable terms or at all is likely to adversely affect our ability to continue or accelerate our subscriber account acquisition activities.
We have a history of losses and may incur losses in the future.
We have incurred losses in each of our last five fiscal years. In future periods, we may not be able to achieve or sustain profitability on a consistent quarterly or annual basis. Failure to maintain profitability in future periods may materially and adversely affect our ability to make payments on our outstanding debt obligations.
Uncertainty relating to the LIBOR calculation process and potential phasing out of LIBOR after 2021 may adversely affect the market value of our current or future debt obligations.
The London Inter-bank Offered Rate (“LIBOR”) and certain other interest “benchmarks” may be subject to regulatory guidance and/or reform that could cause interest rates under our current or future debt agreements to perform differently than in the past or cause other unanticipated consequences. The United Kingdom’s Financial Conduct Authority, which regulates LIBOR, has announced that it intends to stop encouraging or requiring banks to submit LIBOR rates after 2021, and it is unclear if LIBOR will cease to exist or if new methods of calculating LIBOR will evolve. If LIBOR ceases to exist or if the methods of calculating LIBOR change from their current form, interest rates on our debt obligations under our Credit Facilities may be adversely affected.
Factors Relating to Our Emergence from Chapter 11 Bankruptcy
We recently emerged from bankruptcy, which could adversely affect our business and relationships.
It is possible that our having filed for bankruptcy and our recent emergence from the Chapter 11 bankruptcy proceedings could adversely affect our business and relationships with customers, vendors, contractors, employees or suppliers. Due to uncertainties, many risks exist, including the following:
key suppliers could terminate their relationship or require financial assurances or enhanced performance;
the ability to renew existing contracts and compete for new business may be adversely affected;
the ability to attract, motivate and/or retain key executives and employees may be adversely affected;
employees may be distracted from performance of their duties or more easily attracted to other employment opportunities; and
competitors may take business away from us, and our ability to attract and retain customers may be negatively impacted.
The occurrence of one or more of these events could have a material and adverse effect on our operations, financial condition and reputation. We cannot assure you that having been subject to bankruptcy protection will not adversely affect our operations in the future.
Our actual financial results after emergence from bankruptcy may not be comparable to our historical financial informationprojections disclosed in the Bankruptcy Court as a result of the implementation of the Plan and the transactions contemplated thereby and our adoption of fresh start accounting.
In connection with the disclosure statement we filed with the Bankruptcy Court (the "Disclosure Statement"), and the hearing to consider confirmation of the Plan, we prepared projected financial information to demonstrate to the Bankruptcy Court the feasibility of the Plan and our ability to continue operations upon our emergence from bankruptcy. Those projections were prepared solely for the purpose of the bankruptcy proceedings and have not been, and will not be, updated on an ongoing basis and should not be relied upon by investors. Although the financial projections disclosed in our Disclosure Statement represent our view based on then current known facts and assumptions about the future operations of the Company there is no guarantee that the financial projections will be realized. We may not be able to meet the projected financial results or achieve projected revenues and cash flows assumed in projecting future business prospects. To the extent we do not meet the projected financial results or achieve projected revenues and cash flows, we may lack sufficient liquidity to continue operating as planned and may be unable to service our debt obligations as they come due or may not be able to meet our operational needs. Any one of these failures may preclude us from, among other things, taking advantage of future opportunities and growing our businesses.
In addition, upon our emergence from bankruptcy, we adopted fresh start accounting, as a consequence of which we allocated the reorganization value to our individual assets based on their estimated fair values. Accordingly, our financial condition and results of operations from and after the fresh start date are not comparable to the financial condition or results of operations reflected in our historical financial statements. Further, as a result of the implementation of the Plan and the transactions contemplated thereby, our historical financial information may not be indicative of our future financial performance.
Upon our emergence from bankruptcy, the composition of our board of directors changed significantly.
Pursuant to the Plan, the composition of the board of directors changed significantly. Upon emergence, the board of directors is now made up of seven directors, of which six will not have previously served on the board of directors. The new directors have different backgrounds, experiences and perspectives from those individuals who previously served on the board of directors and, thus, may have different views on the issues that will determine the future of the Company. There is no guarantee that the
new board will pursue, or will pursue in the same manner, our current strategic plans. As a result, the future strategy and plans of the Company may differ materially from those of the past.
Our ability to utilize our net operating loss carryforwards ("NOLs") maywill be limited as a result of our emergence from bankruptcy.
In general, Section 382 of the Internal Revenue Code ("the Code") of 1986, as amended, provides an annual limitation with respect to the ability of a corporation to utilize its tax attributes, as well as certain built-in-losses, against future taxable income in the event of a change in ownership. Our emergence from Chapter 11 bankruptcy proceedings resulted in a change in ownership for purposes of the Section 382 of the Code, which maywill limit our ability to utilize outour NOLs to offset future taxable income.
Limitations imposed on our ability to use NOLs to offset future taxable income may cause U.S. federal income taxes to be paid earlier than otherwise would be paid if such limitations were not in effect and could cause such NOLs to expire unused, in each case reducing or eliminating the benefit of such NOLs. Similar rules and limitations may apply for state income tax purposes. Furthermore, any available NOLs would have value only to the extent there is income in the future against which such NOLs may be offset. We have recorded a full valuation allowance related to our NOLs due to the uncertainty of the ultimate realization of the future benefits of those assets.
Factors Relating to Regulatory Matters
Our business operates in a regulated industry.
Our business, operations and dealers are subject to various U.S. federal, state and local consumer protection laws, licensing regulation and other laws and regulations, and, to a lesser extent, similar Canadian laws and regulations. While there are no U.S. federal laws that directly regulate the security alarm monitoring industry, our advertising and sales practices and that of our dealer network are subject to regulation by the U.S. Federal Trade Commission (the "FTC") in addition to state consumer protection laws. The FTC and the Federal Communications Commission have issued regulations that place restrictions on, among other things, unsolicited automated telephone calls to residential and wireless telephone subscribers by means of automatic telephone dialing systems and the use of prerecorded or artificial voice messages. If the Company (through our direct marketing efforts) or our dealers were to take actions in violation of these regulations, such as telemarketing to individuals on the "Do Not Call" registry, we could be subject to fines, penalties, private actions, investigations or enforcement actions by government regulators. We have been named, and may be named in the future, as a defendant in litigation arising from alleged violations of the Telephone Consumer Protection Act (the "TCPA"). While we endeavor to comply with the TCPA, no assurance can be given that we will not be exposed to liability as a result of our or our dealers' direct marketing efforts or debt collections. For example, we recognized a legal settlement reserve in the second quarter of 2017 related to a class action lawsuit based on alleged TCPA violations. In addition, although we have taken steps to insulate our Company from any such wrongful conduct by our dealers, and to require our dealers to comply with these laws and regulations, no assurance can be given that we will not be exposed to liability as result of our dealers' conduct. If the Company or any such dealers do not comply with applicable laws, we may be exposed to increased liability and penalties and there can be no assurance, in the event of such liability, that Brinks Home Security would be adequately covered, if at all, by its insurance policies. Further, to the extent that any changes in law or regulation further restrict the lead generation activity of the Company or our dealers, these restrictions could result in a material reduction in subscriber acquisition opportunities, reducing the growth prospects of our business and adversely affecting our financial condition and future cash flows. In addition, most states in which we operate have licensing laws directed specifically toward the monitored security services industry. Our business relies heavily upon wireline and cellular telephone service to communicate signals. Wireline and cellular telephone companies are currently regulated by both federal and state governments. Changes in laws or regulations could require us to change the way we operate, which could increase costs or otherwise disrupt operations. In addition, failure to comply with any such applicable laws or regulations could result in substantial fines or revocation of our operating permits and licenses, including in geographic areas where our services have substantial penetration, which could adversely affect our business and financial condition. Further, if these laws and regulations were to change or we failed to comply with such laws and regulations as they exist today or in the future, our business, financial condition and results of operations could be materially and adversely affected.
Increased adoption of statutes and governmental policies purporting to void automatic renewal provisions in AMAs, or purporting to characterize certain charges in the AMAs as unlawful, could adversely affect our business and operations.
AMAs typically contain provisions automatically renewing the term of the contract at the end of the initial term, unless a cancellation notice is delivered in accordance with the terms of the contract. If the customer cancels prior to the end of the contract term, other than in accordance with the contract, we may charge the customer an early cancellation fee as specified in
the contract, which typically allows us to charge 80% of the amounts that would have been paid over the remaining term of the contract. Several states have adopted, or are considering the adoption of, consumer protection policies or legal precedents which purport to void or substantially limit the automatic renewal provisions of contracts such as the AMAs, or otherwise restrict the
charges that can be imposed upon contract cancellation. Such initiatives could negatively impact our business. Adverse judicial determinations regarding these matters could increase legal exposure to customers against whom such charges have been imposed, and the risk that certain customers may seek to recover such charges through litigation. In addition, the costs of defending such litigation and enforcement actions could have an adverse effect on our business and operations.
False alarm ordinances could adversely affect our business and operations.
Significant concern has arisen in certain municipalities about the high incidence of false alarms. In some localities, this concern has resulted in local ordinances or policies that restrict police response to third-party monitored burglar alarms. In addition, an increasing number of local governmental authorities have considered or adopted various measures aimed at reducing the number of false alarms; measures include alarm fines to us and/or our customers, limits on number of police responses allowed, and requiring certain alarm conditions to exist before a response is granted. In extreme situations, authorities may not respond to an alarm unless a verified problem exists.
Enactment of these measures could adversely affect our future operations and business. Alarm monitoring companies operating in areas impacted by government alarm ordinances may choose to hire third-party guard firms to respond to an alarm. If we need to hire third-party guard firms, it could have a material adverse effect on our business through either increased servicing costs, which could negatively affect the ability to properly fund our ongoing operations, or increased costs to our customers, which may limit our ability to attract new customers or increase our subscriber attrition rates. In addition, the perception that police departments will not respond to monitored burglar alarms may reduce customer satisfaction or customer demand for an alarm monitoring service. Although we currently have less than 80,000 subscribers in areas covered by these ordinances or policies, a more widespread adoption of policies of this nature could adversely affect our business.
Factors Relating to Our Common Stock
We have filed a Form 15 with the Securities and Exchange Commission to deregister under the Exchange Act, which will result in a reduction in the amount and frequency of publicly-available information about us.
On February 16, 2021, we filed a Form 15 with the SEC to voluntarily deregister our common stock with the SEC and terminate our reporting obligations under the Exchange Act. Deregistration of our common stock will result in a reduction in the amount and frequency of publicly-available information about the Company because we will no longer be required to file Exchange Act reports with the SEC, such as annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and proxy statements. As a result of the suspension of our reporting obligations, investors have significantly less information about the Company and may find it more difficult to obtain accurate quotations as to the market value of the Company’s common stock. In addition, there has been limited liquidity in the common stock and the ability of stockholders to sell the Company’s securities in the secondary market is limited.
The market price of our common stock is volatile.
The trading price of our common stock and the price at which we may sell common stock in the future are subject to large fluctuations in response to any of the following:
•consequences of our reorganization under Chapter 11 of the Bankruptcy Code, from which we emerged on August 30, 2019;
•consequences of our de-registration under the Exchange Act;
•limited trading volume in our common stock;
•variations in operating results;
•our involvement in litigation;
•general U.S. or worldwide financial market conditions;
•announcements by us and our competitors;
•our liquidity and access to capital;
•our ability to raise additional funds;
•lack of trading market;
•changes in government regulations; and
•other events.
There may be circumstances in which the interests of our significant stockholders could be in conflict with the interests of our other stockholders.
A large portion of our common stock is beneficially owned by a relatively small number of stockholders. Circumstances may arise in which these stockholders may have an interest in pursuing or preventing acquisitions, divestitures, hostile takeovers or other transactions, including the payment of dividends or the issuance of additional equity or debt, that, in their judgment, could enhance their investment in us or another company in which they invest. Such transactions might adversely affect us or other holders of our common stock. In addition, our significant concentration of share ownership may adversely affect the trading price of our common stock because investors may perceive disadvantages in owning shares in companies with significant stockholder concentrations.
We do not anticipate paying dividends on our common stock in the near future.
We do not currently anticipate paying any cash dividends on our common stock in the foreseeable future. We currently intend to retain all future earnings to fund the development and growth of our business. Any future determination relating to our dividend policy will be at the discretion of our board of directors and will depend on our results of operations, financial condition, capital requirements and other factors deemed relevant by our board of directors. We are also restricted in our ability to pay dividends under our Credit Facilities.
Certain anti-takeover provisions may affect your rights as a stockholder.
Our certificate of incorporation, which became effective upon our emergence from bankruptcy, authorizes our board of directors to set the terms of and issue preferred stock, subject to certain restrictions. Our board of directors could use the preferred stock as a means to delay, defer or prevent a takeover attempt that a stockholder might consider to be in our best interest. In addition, our Credit Facilities contain terms that may restrict our ability to enter into change of control transactions, including requirements to repay borrowings under our Credit Facilities on a change in control. These provisions, along with specified provisions of the Delaware General Corporation Law and our certificate of incorporation and our bylaws, may discourage or impede transactions involving actual or potential changes in our control, including transactions that otherwise could involve payment of a premium over prevailing market prices to holders of our common stock.
We are not subject to compliance with rules requiring the adoption of certain corporate governance measures and as a result our stockholders have limited protections against interested director transactions, conflicts of interest and similar matters.
The Sarbanes-Oxley Act, as well as resulting rule changes enacted by the SEC, the New York Stock Exchange and the NASDAQ Stock Market, require the implementation of various measures relating to corporate governance. These measures are designed to enhance the integrity of corporate management and the securities markets and apply to securities which are listed on those exchanges. Because we are not listed on the NASDAQ Stock Market or the New York Stock Exchange, we are not presently required to comply with many of the corporate governance provisions. Until we comply with such corporate governance measures, regardless of whether such compliance is required, the absence of such standards of corporate governance may leave our stockholders without protections against interested director transactions, conflicts of interest and similar matters.
We do not have a class of our securities registered under Section 12 of the Exchange Act. Until we do, we will not be required to provide certain reports to our stockholders.
We do not have a class of our securities registered under Section 12 of the Exchange Act. Until we do, we will not be required to provide certain reports to our stockholders. We are currently required to file periodic reports with the SEC by virtue of Section 15(d) of the Exchange Act. However, until we register a class of our securities under Section 12 of the Exchange Act, we are not subject to the SEC's proxy rules, and large holders of our capital stock will not be subject to beneficial ownership reporting requirements under Sections 13 or 16 of the Exchange Act and their related rules. As a result, our stockholders and potential investors may not have available to them as much or as robust information as they may have if and when we become subject to those requirements.
Sales of our common stock could cause the price of our common stock to decrease.
We may also sell shares of common stock in public offerings. The issuance of any securities for acquisitions, financing, upon conversion or exercise of convertible securities, or otherwise may result in a reduction of the book value and market price of our outstanding common stock. If we issue any such additional securities, the issuance will cause a reduction in the proportionate ownership and voting power of all current stockholders. We cannot predict the size of future issuances of our common stock or securities convertible into common stock or the effect, if any, that future issuances and sales of shares of our common stock will have on the market price of our common stock. Sales our common stock (including shares issued in connection with an acquisition), or the perception that sales could occur, may adversely affect prevailing market prices of our common stock.
There is a limited trading market for our securities and the market price of our securities is subject to volatility.
Upon our emergence from bankruptcy, our old common stock was cancelled and we issued new common stock. Our common stock is not listed on any national or regional securities exchange. The market price of our common stock could be subject to wide fluctuations in response to, and the level of trading that develops with our common stock may be affected by, numerous
factors, many of which are beyond our control. These factors include, among other things, our new capital structure as a result of the transactions contemplated by the Plan, our limited trading history subsequent to our emergence from bankruptcy, our limited trading volume, the concentration of holdings of our common stock, the lack of comparable historical financial information due to our adoption of fresh start accounting, the lack of publicly available information following our de-registration under the Exchange Act, actual or anticipated variations in our operating results and cash flow, the nature and content of our earnings releases, announcements or events that impact our products, customers, competitors or markets, business conditions in our markets and the general state of the securities markets and the market stocks in our industry, as well as general economic and market conditions and other factors that may affect our future results, including those related to the novel coronavirus outbreak. No assurance can be given that an active market will develop for the common stock or as to the liquidity of the trading market for the common stock. The common stock may be traded only infrequently in transactions arranged through brokers or otherwise, and reliable market quotations may not be available. Holders of our common stock may experience difficulty in reselling, or an inability to sell, their shares. In addition, if an active trading market does not develop or is not maintained, significant sales of our common stock, or the expectation of these sales, could materially and adversely affect the market price of our common stock.
There is currently no active public trading market for our common stock. Therefore, you may be unable to liquidate your investment in our common stock.
Our common stock is quoted on the OTCQX BestOTC Pink Open Market of(the “Pink Sheets”), a centralized electronic quotation service for over-the-counter securities, so long as market makers demonstrate an interest in trading in the OTC Markets Group Inc. under the symbol "SCTY". Although our common stock. We can give no assurance that trading in its common stock is quotedwill continue on the OTCQX, there is currently no active public trading market of our common stock and the market price of our common stock may be difficult to ascertain. As a result, investors in ourPink Sheets or any other securities may not be able to resell their shares atexchange or above the purchase price paid by them or may not be able to resell them at all.quotation medium.
Factors Relating to Our Structure
Our identifiable intangible assets represent a significant portion of our total assets, and we may never realize the full value of our intangible assets.
As of December 31, 2019,2020, we had subscriber accounts of $1,064,311,000,$1,102,977,000 and dealer network of $136,778,000 and goodwill of $81,943,000,$113,010,000, which represents approximately 90% of our total assets. Subscriber accounts relate primarily to the cost of acquiring portfolios of monitoring service contracts from independent dealers. All direct and incremental costs, including bonus incentives related to account activation in the Direct to Consumer Channel, associated with the creation of subscriber accounts, are capitalized. 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.
Dealer network is an intangible asset that relates to the dealer relationships that existed as of the application of fresh start accounting. 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 dealer network asset may not be recoverable. If an indicator that the dealer network asset may not be recoverable exists, management tests the dealer network asset for impairment. 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.
Goodwill was recorded in connection with the application of fresh start accounting. The Company accounts for its goodwill pursuant to the provisions of Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 350, Intangibles-Goodwill and Other ("FASB ASC Topic 350"). In accordance with FASB ASC Topic 350, goodwill is tested for impairment annually or when events or changes in circumstances occur that would, more likely than not, reduce the fair value of an asset below its carrying value, resulting in an impairment. Impairments may result from, among other things, deterioration in financial and operational performance, declines in stock price, increased attrition, adverse market conditions, adverse changes in applicable laws and/or regulations, deterioration of general macroeconomic conditions, fluctuations in foreign exchange rates, increased competitive markets in which we operate in, declining financial performance over a sustained period, changes in key personnel and/or strategy, and a variety of other factors.
The amount of any quantified impairment must be expensed immediately as a charge to results of operations. Any impairment charge relating to goodwill or other intangible assets would have the effect of decreasing our earnings or increasing our losses in such period. At least annually, or as circumstances arise that may trigger an assessment, we will test our goodwill for impairment. There can be no assurance that our future evaluations of goodwill will not result in our recognition of impairment charges, which may have a material adverse effect on our financial statements and results of operations.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
ITEM 2. PROPERTIES
Brinks Home Security leases office space in Farmers Branch, Texas to house our executive offices, monitoring and certain call centers, sales and marketing and data retention functions. Brinks Home Security also leases office space in Dallas, Texas that supports our monitoring operations and back up facility.
Additionally, Brinks Home Security leases officefacility, and warehouse space in St. Marys, Kansas to house sales office functions and our fulfillment center and leases office space in Manhattan, Kansas to house sales office functions.center.
ITEM 3. LEGAL PROCEEDINGS
In the ordinary course of business, from time to time, the Company and its subsidiaries are the subject of complaints or litigation from subscribers or inquiries or investigations from government officials, sometimes related to alleged violations of state or federal consumer protection statutes. The Company and its subsidiaries may also be subject to employee claims based on, among other things, alleged discrimination, harassment or wrongful termination claims. Although no assurances can be given, in the opinion of management, none of the pending actions is likely to have a material adverse impact on the Company's financial position or results of operations, either individually or in the aggregate.
ITEM 4. MINE SAFETY DISCLOSURES
None.
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Market Information
In connection with the Restructuring Support Agreement, on August 30, 2019, all shares of Ascent Capital's Series A Common Stock, par value $0.01 per share (the "Ascent Capital Series A Common Stock") and all shares of Ascent Capital's Series B Common Stock, par value $0.01 per share (the "Ascent Capital Series B Common Stock" and, together with the Series A Common Stock, the "Ascent Capital Common Stock"), in each case, issued and outstanding immediately prior to the effective time of the Merger, were converted into the right to receive 1,309,757 shares of our common stock. Simultaneously with the conversion of the Ascent Capital Common Stock, we issued 21,190,243 additional shares of our common stock primarily to holders of certain classes of claims in the Chapter 11 Cases.
Our common stock iswas quoted on the OTCQX Best Market of the OTC Markets Group Inc. under the symbol "SCTY". Our common stock began quoting on the OTCQX on September 5, 2019. No established public trading market existed for our common stock prior to that date. Although our common stock is quoted on the OTCQX, there is currently no active public trading market in our common stock and trading has been limited and sporadic. Over-the-counter market quotations reflect interdealer prices, without retailer markup, markdown, or commission and may not necessarily represent actual transactions. Following the de-registration, our common stock will be quoted on the Pink Sheets, a centralized electronic quotation service for over-the-counter securities, so long as market makers demonstrate an interest in trading in our common stock. However, we can give no assurance that trading in our common stock will continue on the Pink Sheets or any other securities exchange or quotation medium.
The following table sets forth the high and low last reported sales prices per share of our common stock, as reported on the OTCQX, of which we are aware for the periodperiods indicated.
| | | | | | | | | | | |
| High | | Low |
2019: | | | |
Third quarter (beginning September 5, 2019 and through September 30, 2019) | $ | 9.50 | | | $ | 7.00 | |
Fourth quarter | $ | 10.00 | | | $ | 7.50 | |
2020: | | | |
First quarter | $ | 9.35 | | | $ | 4.00 | |
Second quarter | $ | 7.40 | | | $ | 1.00 | |
Third quarter | $ | 4.22 | | | $ | 3.11 | |
Fourth quarter | $ | 15.25 | | | $ | 3.00 | |
|
| | | | | | | |
| High | | Low |
Common stock: | | | |
Third quarter (beginning September 5, 2019 and through September 30, 2019) | $ | 9.50 |
| | $ | 7.00 |
|
Fourth quarter | $ | 10.00 |
| | $ | 7.50 |
|
Holders
As of February 10, 2020,3, 2021, we had 152168 holders of record of our common stock, based on information provided by our transfer agent. Such amounts do not include the number of stockholders whose shares are held of record by banks, brokers or other nominees, but include each such institution as one holder.
Dividends
We have not paid any cash dividends on our common stock and do not currently anticipate paying any cash dividends on our common stock in the foreseeable future. We currently intend to retain all future earnings to fund the development and growth of our business. Any future determination relating to our dividend policy will be at the discretion of our board of directors and will depend on our results of operations, financial condition, capital requirements and other factors deemed relevant by our board. We are also restricted in our ability to pay dividends under our Credit Facilities.
Purchases of Equity Securities by the Issuer and Affiliated Purchasers
None.
Recent Sales of Unregistered Securities
None.
ITEM 6. SELECTED FINANCIAL DATA
The balance sheet data asPursuant to the early adoption of December 31, 2019 forSEC Final Rule Release No. 33-10890, Management's Discussion and Analysis, Selected Financial Data, and Supplementary Financial Information, the Successor Company and December 31, 2018 for the Predecessor Company and the statements of operations data for the Successor Company period September 1, 2019 through December 31, 2019, the Predecessor Company period January 1, 2019 through August 31, 2019 and the Predecessor Company years ended December 31, 2018 and 2017, all of which are set forth below, are derived from the accompanying consolidated financial statements and notes included elsewhere in this Annual Report and should be read in conjunction with those financial statements and the notes thereto. The balance sheet data as of December 31, 2017, 2016 and 2015 for the Predecessor Companyhas elected to omit Item 6. Selected Financial Data.
and the statements of operations data for the years ended December 31, 2016 and 2015 for the Predecessor Company shown below were derived from previously issued financial statements.
|
| | | | | | | | | | | | | | | | | | | | |
| Successor Company | | | Predecessor Company |
| December 31, 2019 | | | December 31, 2018 | | December 31, 2017 | | December 31, 2016 | | December 31, 2015 |
Summary Balance Sheet Data (amounts in thousands): | | | | | | | | | | |
Current assets | $ | 52,279 |
| | | $ | 43,676 |
| | $ | 26,615 |
| | $ | 26,406 |
| | $ | 26,147 |
|
Property and equipment, net of accumulated depreciation | $ | 42,096 |
| | | $ | 36,539 |
| | $ | 32,789 |
| | $ | 28,270 |
| | $ | 26,654 |
|
Subscriber accounts, net of accumulated amortization | $ | 1,064,311 |
| | | $ | 1,195,463 |
| | $ | 1,302,028 |
| | $ | 1,386,760 |
| | $ | 1,423,538 |
|
Total assets | $ | 1,419,312 |
| | | $ | 1,305,768 |
| | $ | 1,914,315 |
| | $ | 2,033,717 |
| | $ | 2,070,267 |
|
Current liabilities | $ | 70,247 |
| | | $ | 1,884,207 |
| | $ | 98,737 |
| | $ | 87,171 |
| | $ | 82,715 |
|
Long-term debt, excluding current portion | $ | 978,219 |
| | | $ | — |
| | $ | 1,707,297 |
| | $ | 1,687,778 |
| | $ | 1,739,147 |
|
Stockholders' equity (deficit) | $ | 346,078 |
| | | $ | (588,975 | ) | | $ | 102,736 |
| | $ | 214,945 |
| | $ | 201,065 |
|
|
| | | | | | | | | | | | | | | | | | | | | | | | |
| Successor Company | | | Predecessor Company |
| Period from September 1, 2019 through December 31, 2019 | | | Period from January 1, 2019 through August 31, 2019 | | Year Ended December 31, 2018 | | Year Ended December 31, 2017 | | Year Ended December 31, 2016 | | Year Ended December 31, 2015 |
| | | | | | | | | | | | |
Summary Statement of Operations Data (amounts in thousands): | | | | | | | | | | | | |
Net revenue | $ | 162,219 |
| | | $ | 342,286 |
| | $ | 540,358 |
| | $ | 553,455 |
| | $ | 570,372 |
| | $ | 563,356 |
|
Operating (loss) income | $ | (3,648 | ) | | | $ | 47,565 |
| | $ | (494,143 | ) | | $ | 32,304 |
| | $ | 67,649 |
| | $ | 63,725 |
|
Net (loss) income | $ | (33,331 | ) | | | $ | 598,413 |
| | $ | (678,750 | ) | | $ | (111,295 | ) | | $ | (76,307 | ) | | $ | (72,448 | ) |
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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) provideprovides residential customers and commercial client accounts with monitored home and business security systems, as well as interactive andmultiple home automation, services,life safety and advanced security options, in the United States, Canada and Puerto 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"), which offers both DIY and professional installation security solutions and our exclusive authorized dealer network (the "Dealer Channel"), which. 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, on June 30, 2019, (the "Petition Date"), 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. 19-33650.19-33650. 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" "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 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 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. 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. 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 Agreements Subject to Earnout Payments Strategic Initiatives
In recent years, we have implemented several initiativesOn June 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 of Protect America, Inc. The Company paid approximately $16,600,000 at closing and will make 50 subsequent monthly payments, which began in August 2020, consisting of a portion of the revenue attributable to account growth, creation costs, attrition and margin improvementsthe Accounts, subject to combat decreasesadjustment for Accounts that are no longer active ("Earnout Payments" will here to be defined as contingent payments to acquire subscriber accounts in the generationProtect America and Select Security transactions). The transaction was accounted for as an asset acquisition with the cost of newthe assets acquired recorded as of June 17, 2020 and an estimated undiscounted 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.
On December 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 from Kourt 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 to GS Security Alarm LLC (“GSSA”). GSSA is a bankruptcy-remote special purpose vehicle designed only to transact the sale of subscriber accounts and negative trendsrelated 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 attrition.base, discounted at an effective interest rate of 10.9%.
Account GrowthThe 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
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 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 believeare also ensuring we comply with our data security measures to guarantee that generating account growth atall company, employee and customer data remains protected and secure. As of December 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 reasonable cost is essential“shelter in place” or similar orders, we have instructed our dealers to scalingcease doing door-to-door sales until such measures are lifted. This has negatively impacted our businessNetwork Sales Channel productivity starting in the latter half of March 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 generating stakeholder value.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 currentlyhave 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 ended December 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
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 ended December 31, 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 on the Company's ability to generate new accounts through bothcustomers. 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 ended December 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 Dealeraccount 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. Our abilityChannel, 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 grow new accounts inguide the future will be impacted bytransformation of our abilitybusiness 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 drivemeet our overall strategy of creating profitable account growth, which include:
enhancing our brand recognition with consumers, which we believe is bolstered by the rebranding to Brinks Home Security,
differentiating and profitably growing our Direct to Consumer Channel under the Brinks Home Security brand,
recruiting and retaining high quality dealers into our Authorized Dealer Program,
assisting new and existing dealers with training and marketing initiatives to increase productivity, 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 profitabilityscale 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,
negotiating lower subscriber account purchase price multiples in our Dealer Channel, and
expanding the use and availability of third-party financing, which will drive down net creation costs.
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 have also adopted initiatives to reduce expenses and improve our financial results, which include:
reducing our operating costs by right sizing the cost structure to the business and leveraging our scale,
increasing use of automation, and
implementing more sophisticated purchasing techniques.
holding them for life. While there are uncertainties related to theany 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.
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
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 ended December 31, 20192020 and 2018,2019, we acquired 81,386224,414 and 112,92081,386 subscriber accounts, respectively, through our DealerNetwork Sales Channel, and Direct to Consumer Channel.Channel and bulk buys. The decreaseincrease in accounts acquired for the year ended December 31, 20192020 is due to year over year declinebulk buys of 39,594 accounts in December 2020, 113,013 accounts generated in our Direct to Consumer ChannelJune 2020 and fewer10,960 in March 2020. The accounts acquired from negotiated account acquisitions. The declinethrough bulk buys in accounts acquired in our DirectDecember 2020 and June 2020 are subject to Consumer Channel was largely due to the reduction of product subsidies in an effort to improve the credit quality of customers acquired.Earnout Payments. There were no bulk buys during the year ended December 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 as comparedand restrictions on door-to-door selling and other impacts related to approximately 17,800 accountsthe outbreak of COVID-19 starting in the latter half of March 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 from negotiated account acquisitions during the year ended December 31, 2018.
2020 was approximately $9,756,000, which includes RMR related to bulk buys of $6,763,000. RMR acquired during the yearsyear ended December 31, 2019 and 2018 was approximately $3,929,000 and $5,326,000, respectively.$3,929,000.
Attrition
Account cancellations, otherwise referred to as subscriber attrition, hashave 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 years ended December 31, 20192020 and 2018:2019: | | | | | | | | | | Years Ended December 31, |
| | Years Ended December 31, | | | 2020 | | 2019 |
| | 2019 | | 2018 | |
Beginning balance of accounts | | 921,750 |
| | 975,996 |
| |
Beginning balance of accounts not subject to Earnout Payments | | Beginning balance of accounts not subject to Earnout Payments | | 847,758 | | | 921,750 | |
Accounts acquired | | 81,386 |
| | 112,920 |
| Accounts acquired | | 71,730 | | | 81,386 | |
Accounts cancelled | | (150,494 | ) | | (162,579 | ) | Accounts cancelled | | (122,655) | | | (150,494) | |
Cancelled accounts guaranteed by dealer and other adjustments (a) | | (4,884 | ) | | (4,587 | ) | Cancelled accounts guaranteed by dealer and other adjustments (a) | | (4,986) | | | (4,884) | |
Ending balance of accounts of accounts not subject to Earnout Payments | | Ending balance of accounts of accounts not subject to Earnout Payments | | 791,847 | | | 847,758 | |
Accounts subject to Earnout Payments | | Accounts subject to Earnout Payments | | 141,773 | | | — | |
Ending balance of accounts | | 847,758 |
| | 921,750 |
| Ending balance of accounts | | 933,620 | | | 847,758 | |
Monthly weighted average accounts | | 884,337 |
| | 950,705 |
| |
Attrition rate - Unit | | 17.0 | % | | 17.1 | % | |
Attrition rate - RMR (b) | | 17.9 | % | | 14.9 | % | |
Attrition rate - Core Unit (c) | | Attrition rate - Core Unit (c) | | 14.9 | % | | 17.0 | % |
Attrition rate - Core RMR (b) (c) | | 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. |
(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 2018 was 17.0% and 17.1%, respectively. The core RMR attrition rate for the years ended December 31, 2020 and 2019 was 15.5% and 2018 was 17.9% and 14.9%, respectively. The increasedecrease in the RMRcore unit attrition rate for the year ended December 31, 20192020 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 attributable todriven by a more aggressive price increase strategyon a majority of the Company's subscriber base in the prior year.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 DealerNetwork 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 DealerNetwork 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
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
For a discussion of our results of operations for the year ended December 31, 2017, including a year-to-year comparison between 2018 and 2017, refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our final prospectus filed pursuant to Item 424(b)(3) on January 9, 2020.
Year Ended December 31, 20192020 Compared to Year Ended December 31, 20182019
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.reorganization of the Company in August 2019 and the application of fresh start accounting. We believe that certain of our consolidated operating results for the year ended December 31, 2020 is comparable to certain operating results for the period from January 1, 2019 through August 31, 2019 when combined with our consolidated operating results for the period from September 1, 2019 through December 31, 2019, is comparable to certain operating results from the comparable prior year period.2019. Accordingly, we believe that discussing the non-GAAP combined results of operations and cash flows of the Predecessor Company and the Successor Company for the year ended December 31, 20192020 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 Company | | | | | | Successor Company | | | Predecessor Company |
| Year Ended December 31, 2020 | | | Non-GAAP Combined Year Ended December 31, 2019 | | | Period from September 1, 2019 through December 31, 2019 | | | Period from January 1, 2019 through 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 | |
|
| | | | | | | | | | | | | | | | | |
| | | | Successor Company | | | Predecessor Company |
| Non-GAAP Combined Year Ended December 31, 2019 | | | Period from September 1, 2019 through December 31, 2019 | | | Period from January 1, 2019 through August 31, 2019 | | Year Ended December 31, 2018 |
Net revenue | $ | 504,505 |
| | | $ | 162,219 |
| | | $ | 342,286 |
| | $ | 540,358 |
|
Cost of services | 112,274 |
| | | 36,988 |
| | | 75,286 |
| | 128,939 |
|
Selling, general and administrative, including stock-based and long-term incentive compensation | 132,509 |
| | | 52,144 |
| | | 80,365 |
| | 118,940 |
|
Amortization of subscriber accounts, deferred contract acquisition costs and other intangible assets | 200,484 |
| | | 69,693 |
| | | 130,791 |
| | 211,639 |
|
Interest expense | 134,060 |
| | | 28,979 |
| | | 105,081 |
| | 180,770 |
|
Income (loss) before income taxes | 567,561 |
| | | (32,627 | ) | | | 600,188 |
| | (690,302 | ) |
Income tax expense (benefit) | 2,479 |
| | | 704 |
| | | 1,775 |
| | (11,552 | ) |
Net income (loss) | 565,082 |
| | | (33,331 | ) | | | 598,413 |
| | (678,750 | ) |
| | | | | | | | | |
Adjusted EBITDA (a) | $ | 266,460 |
| | | $ | 79,087 |
| | | $ | 187,373 |
| | $ | 289,448 |
|
Adjusted EBITDA as a percentage of Net revenue | 52.8 | % | | | 48.8 | % | | | 54.7 | % | | 53.6 | % |
| | | | | | | | | |
Expensed Subscriber acquisition costs, net | | | | | | | | | |
Gross subscriber acquisition costs | $ | 38,325 |
| | | $ | 13,381 |
| | | $ | 24,944 |
| | $ | 47,874 |
|
Revenue associated with subscriber acquisition costs | (7,769 | ) | | | (2,282 | ) | | | (5,487 | ) | | (4,678 | ) |
Expensed Subscriber acquisition costs, net | $ | 30,556 |
| | | $ | 11,099 |
| | | $ | 19,457 |
| | $ | 43,196 |
|
| |
(a)
| See reconciliation of Net income (loss) to Adjusted EBITDA below. |
(a)See reconciliation of Net (loss) income to Adjusted EBITDA below.
(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 $35,853,000,$908,000, or 6.6%0.2%, for the year ended December 31, 2019,2020, as compared to the prior year. The decrease in net revenue is primarily attributable to a decrease in alarm monitoring revenue of $31,418,000$10,247,000 due to the lower average number of subscribers in 2019. Additionally, average RMR per subscriber decreasedthe first six months of 2020, partially offset by incremental revenue from $45.27 as of December 31, 2018 to $45.12 as of December 31, 2019 due to changing mix of customers generated through the Direct to Consumer Channel that typically have lower RMR as a result of the elimination of equipment subsidy. MonitoringProtect 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 decreased $6,673,000increased $10,527,000, largely due to the declinean increase in accounts acquired in the Direct to Consumer Channel in 2019 and a decrease in pre-emergence field service jobs associated with contract extensions. These decreases were partially offset byextensions 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 other revenuethe percentage of $2,238,000customers generated through our Direct to Consumer Channel which typically have lower RMR as a result of the full year impactlower subsidization of paper statement fees implemented in the fourth quarter of 2018.equipment.
Cost of services. Cost of services decreased $16,665,000,increased $7,116,000, or 12.9%6.3%, for the year ended December 31, 2019,2020, as compared to the prior year. The decrease for the year ended December 31, 2019increase is primarily attributable to lower labor costs duethe cost to year over yearserve 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 customers as well as other pre-emergence cost saving measures.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 $8,977,000$7,220,000 for the year ended December 31, 2019,2020, as compared to $14,722,000$8,488,000 for the year ended December 31, 2018, due to lower product sales volume in the Company's Direct to Consumer Channel as discussed above.2019. Cost of services as a percentage of net revenue, excluding the effect of the 2019 fair value adjustment, decreasedincreased from 23.9% for the year ended December 31, 2018 to 22.0% for the year ended December 31, 2019.2019 to 23.7% for the year ended December 31, 2020.
Selling, general and administrative. Selling, general and administrative costs ("SG&A") increased $13,569,000,$16,805,000, or 11.4%12.7%, for the year ended December 31, 2019,2020, as compared to the prior year. The increase is primarily attributable to increased consultinghigher salary expense and professional fees on integration and implementation of various company initiatives and increased duplicative labor costs duerelated to the outsourcingpost emergence operating structure of a customer care call center for a portionthe Company and $4,693,000 of 2019.severance expense related to transitioning executive leadership. Additionally, the Company received a $4,800,000$700,000 insurance settlement in 2019the second quarter of 2020, as compared to an aggregate settlement of $12,500,000$4,800,000 received in 2018 from multiple carriers.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 decreases in rebranding expense and severance expense. Rebranding expense and severance expense recognized in the year ended December 31, 2018 was $7,410,000 and $1,059,000, respectively, with no corresponding expenses in the year ended December 31, 2019.lower subscriber acquisition costs. Subscriber acquisition costs included in SG&A decreased to $29,348,000$11,567,000 for the year ended December 31, 2020, as compared to $23,132,000 for the year ended December 31, 2019, as compared to $33,152,000 for the year ended December 31, 2018, due to reduced subscriber acquisition selling and marketing costs associated with the creationimpact of new subscribers.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 22.0% for the year ended December 31, 2018 to 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 decreased $11,155,000,increased $16,789,000, or 5.3%8.4%, for the year ended December 31, 2019,2020, as compared to the prior year. The decreaseincrease is relateddue 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 lowerhigher number of subscriber accounts purchased in the last yeartwelve months ended December 31, 2019,2020 primarily due to the accounts acquired from Protect America, as compared to the corresponding prior year. This decrease is partiallyyear period, offset by the impacttiming of the fresh start adjustments, in which the existingamortization of subscriber accounts acquired prior to bankruptcy which have a lower rate of amortization in 2020 as of August 31, 2019 were stated at fair value and set up on the 14-year 235% double-declining curve. This curve is shorter than the methodology utilized on newly generated subscriber accounts, duecompared 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. Additionally contributing to the offset is amortization on the newly established Dealer Network asset recognized upon the Company's emergence from bankruptcy.
Interest expense. Interest expense decreased $46,710,000,$53,795,000, or 25.8%40.1%, for the year ended December 31, 2019,2020, 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,Notes.
Income tax expense. The Company had pre-tax loss of $179,865,000 and income tax expense of $1,891,000 for the impact of accelerated amortization of deferred financing costs and debt discount relatedyear ended December 31, 2020. Income tax expense for the year ended December 31, 2020 is attributable to the Company's predecessor debt agreements of $26,085,000 recognized in interest expense in the fourth quarter of 2018. Offsetting the decreases seen in the successor period of 2019 were increases in interest expense prior to and in the bankruptcy, due to higher debt outstanding and higher interest rates.
Incomestate tax expense (benefit).incurred from Texas margin tax. The Company had pre-tax income of $567,561,000 and income tax expense of $2,479,000 for the year ended December 31, 2019. The driver behind the pre-tax income for the year ended December 31, 2019 is the gain on restructuring and reorganization of $669,722,000 recognized during the year ended December 31, 2019, primarily due to gains recognized on the conversion from 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 year ended December 31, 20192020 is attributable to the Company's state tax expense incurred from Texas margin tax.
Net (loss) income. The Company had pre-
taxnet loss of $690,302,000 and income tax benefit of $11,552,000$181,756,000 for the year ended December 31, 2018. The income tax benefit for the year ended December 31, 2018 is attributable2020, as compared to the deferred tax impact of the goodwill impairment of $563,549,000, partially offset by the Company's state tax expense incurred from Texas margin tax.
Net income (loss). The Company had net income of $565,082,000 for the year ended December 31, 2019, as compared to a2019. The decrease in net loss of $678,750,000 for the year ended December 31, 2018. Net(loss) income for the year ended December 31, 20192020 is primarily attributable to theno gain on restructuring and reorganization incurred in the current year period and a goodwill impairment charge of $669,722,000. The gain on restructuring and reorganization is primarily due to gains recognized on the conversion from debt to equity and discounted cash settlement of the Predecessor Company's high yield senior notes$81,943,000 combined with increases in accordance with the Company's bankruptcy plan. This gain was offset by net loss generated from normal operationsoperating expenses as discussed above. TheAlso impacting net loss for the year ended December 31, 2018 was primarily attributable to the goodwill impairment of $563,549,000 and net losses generated from normal operations.2020 were increased radio conversion costs.
Adjusted EBITDA
Year Ended December 31, 20192020 Compared to Year Ended December 31, 20182019
The following table provides a reconciliation of Net (loss) income (loss) to total Adjusted EBITDA for the periods indicated (amounts in thousands):
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Successor Company | | | | | | Successor Company | | | Predecessor Company |
| Year Ended December 31, 2020 | | | Non-GAAP Combined Year Ended December 31, 2019 | | | Period from September 1, 2019 through December 31, 2019 | | | Period from January 1, 2019 through August 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 | |
|
| | | | | | | | | | | | | | | | | |
| | | | Successor Company | | | Predecessor Company |
| Non-GAAP Combined Year Ended December 31, 2019 | | | Period from September 1, 2019 through December 31, 2019 | | | Period from January 1, 2019 through August 31, 2019 | | Year Ended December 31, 2018 |
Net income (loss) | $ | 565,082 |
| | | $ | (33,331 | ) | | | $ | 598,413 |
| | $ | (678,750 | ) |
Amortization of subscriber accounts, deferred contract acquisition costs and other intangible assets | 200,484 |
| | | 69,693 |
| | | 130,791 |
| | 211,639 |
|
Depreciation | 11,125 |
| | | 3,777 |
| | | 7,348 |
| | 11,434 |
|
Radio conversion costs | 4,196 |
| | | 3,265 |
| | | 931 |
| | — |
|
Stock-based compensation | 42 |
| | | — |
| | | 42 |
| | 474 |
|
Long-term incentive compensation | 774 |
| | | 184 |
| | | 590 |
| | — |
|
LiveWatch acquisition contingent bonus charges | 63 |
| | | — |
| | | 63 |
| | 250 |
|
Legal settlement reserve (related insurance recovery) | (4,800 | ) | | | — |
| | | (4,800 | ) | | (12,500 | ) |
Severance expense (a) | — |
| | | — |
| | | — |
| | 1,059 |
|
Rebranding marketing program | — |
| | | — |
| | | — |
| | 7,410 |
|
Integration / implementation of company initiatives | 12,545 |
| | | 7,702 |
| | | 4,843 |
| | 516 |
|
Gain on revaluation of acquisition dealer liabilities | (1,886 | ) | | | (1,886 | ) | | | — |
| | (240 | ) |
Loss on goodwill impairment | — |
| | | — |
| | | — |
| | 563,549 |
|
Gain on restructuring and reorganization, net | (669,722 | ) | | | — |
| | | (669,722 | ) | | — |
|
Interest expense | 134,060 |
| | | 28,979 |
| | | 105,081 |
| | 180,770 |
|
Realized and unrealized (gain) loss, net on derivative financial instruments | 6,804 |
| | | — |
| | | 6,804 |
| | 3,151 |
|
Refinancing expense | 5,214 |
| | | — |
| | | 5,214 |
| | 12,238 |
|
Income tax expense (benefit) | 2,479 |
| | | 704 |
| | | 1,775 |
| | (11,552 | ) |
Adjusted EBITDA | $ | 266,460 |
| | | $ | 79,087 |
| | | $ | 187,373 |
| | $ | 289,448 |
|
| |
(a)
| Severance expense for the year ended December 31, 2018 related to a reduction in headcount event. |
(a)Severance expense for the year ended December 31, 2020 related to transitioning executive leadership.
Adjusted EBITDA decreased $22,988,000,$12,693,000, or 7.9%4.8%, for the year ended December 31, 2019,2020, as compared to the prior year period. The decrease for the year ended December 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 is primarilydue to the result of decreased revenue, including the effect of the $5,331,000 fair value adjustment for 2019, partially offset by favorable decreasesbankruptcy 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 Subscriber Acquisition Costs.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 $30,556,000$12,579,000 for the year ended December 31, 2020, as compared to $23,851,000 for the year ended December 31, 2019. Expensed subscriber acquisition costs, net, for the year ended December 31, 2019 as comparedwas restated from $30,556,000 to $43,196,000$23,851,000 to be comparable with how acquisition costs were allocated for the year ended December 31, 2018.2020. 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 a decreasethe impact of cost savings measures implemented in planned spend while the Company was going through its restructuring.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 of December 31, 2019,2020, we had $14,763,000$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 ended December 31, 20192020 and 2018,2019, our cash flow from operating activities was $114,135,000$128,621,000 and $104,503,000,$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 ended December 31, 20192020 and 2018,2019, we used cash of $111,139,000$101,840,000 and $140,450,000,$111,139,000, respectively, to fund subscriber account acquisitions, net of holdback and guarantee obligations. In addition, during the years ended December 31, 20192020 and 2018,2019, we used cash of $11,623,000$14,707,000 and $14,903,000,$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 at December 31, 20192020 includes an aggregate principal balance of $986,444,000$979,219,000 under the Successor Takeback Loan Facility, Successor Term Loan Facility and the Successor Revolving Credit Facility. The Successor Takeback Loan Facility has an outstanding principal balance of $820,444,000$812,219,000 as of December 31, 20192020 and requires principal payments of $2,056,250 per quarter, beginning December 31, 2019, with the remaining amount becoming due on March 29, 2024. The Successor Term Loan Facility has an outstanding principal balance of $150,000,000 as of December 31, 2019 and becomes due on July 3, 2024.2020. The Successor Revolving Credit Facility has an outstanding balance of $16,000,000$17,000,000 as of December 31, 2019.2020. We also had an aggregate of $1,000,000$600,000 available under twoa standby lettersletter of credit issued as of December 31, 2019. One letter of credit for $400,000 expired as of January 31, 2020 and was not renewed.2020. The maturity date of the loans made under the Successor Term Loan Facility and Successorthe Revolving Credit Facility is July 3, 2024, subject to a springing maturity of March 29, 2024, or earlier, depending on any repayment, refinancing or changes in the maturity date of the Successor 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 of December 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 of December 31, 2019,2020, we have approximately 415,000328,000 subscribers with 3G or CDMA equipment which may have to be upgraded as a result of these retirements. Additionally, in the month of September of 2019, otherour cellular provider has informed us that a certain cellular carriers of 2G cellular networks have announced that thenetwork carrier has extended their sunset of its 2G cellular networks will be sunsetting as ofnetwork until December 31, 2020.2022. As of December 31, 2019,2020, we have approximately 24,00010,000 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 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 wethe total cost of converting our 3G and 2G subscribers, including those acquired from Protect America and Select Security, will incur approximately $70,000,000be between $80,000,000 to $90,000,000 between 2020 and the second half of 2022 to complete the required upgrades of these networks.$90,000,000. For the year ended December 31, 2019,2020, the Company incurred radio conversion costs of $4,196,000.$21,433,000. Cumulative through December 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.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 Successor Revolving Credit Facility, under which we could borrow an additional $128,000,000$127,400,000 as of December 31, 2019, excluding a minimum liquidity requirement of $25,000,000 under the terms of the Company's credit agreements. As of March 31, 2019, we borrowed an incremental $50,000,000 under our Successor Revolving Credit Facility in response2020, subject to uncertainties surrounding the COVID-19 outbreak.certain financial covenants. Based on this analysis, we expect that cash on hand, cash flow generated from operations and available borrowings under the Successor 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 of December 31, 20192020 is summarized below (amounts in thousands): | | | Payments Due by Period | | Payments Due by Period |
| Less than 1 Year | | 1-3 Years | | 3-5 Years | | After 5 Years | | Total | | Less than 1 Year | | 1-3 Years | | 3-5 Years | | After 5 Years | | Total |
Operating leases | $ | 3,963 |
| | $ | 6,693 |
| | $ | 6,152 |
| | $ | 17,264 |
| | $ | 34,072 |
| Operating leases | $ | 3,609 | | | $ | 6,731 | | | $ | 6,172 | | | $ | 14,157 | | | $ | 30,669 | |
Long-term debt (a) | $ | 8,225 |
| | $ | 16,450 |
| | $ | 961,769 |
| | $ | — |
| | $ | 986,444 |
| Long-term debt (a) | $ | 8,225 | | | $ | 16,450 | | | $ | 954,544 | | | $ | — | | | $ | 979,219 | |
Interest payments on long-term debt (b) | $ | 80,107 |
| | $ | 158,167 |
| | $ | 97,468 |
| | $ | — |
| | $ | 335,742 |
| Interest payments on long-term debt (b) | $ | 73,744 | | | $ | 145,575 | | | $ | 18,018 | | | $ | — | | | $ | 237,337 | |
Earnout Payments (c) | | Earnout Payments (c) | $ | 34,854 | | | $ | 63,689 | | | $ | 24,324 | | | $ | — | | | $ | 122,867 | |
Other (c)(d) | $ | 8,301 |
| | $ | 220 |
| | $ | 568 |
| | $ | 3,724 |
| | $ | 12,813 |
| $ | 8,646 | | | $ | 220 | | | $ | 568 | | | $ | 2,654 | | | $ | 12,088 | |
Total contractual obligations | $ | 100,596 |
| | $ | 181,530 |
| | $ | 1,065,957 |
| | $ | 20,988 |
| | $ | 1,369,071 |
| Total contractual obligations | $ | 129,078 | | | $ | 232,665 | | | $ | 1,003,626 | | | $ | 16,811 | | | $ | 1,382,180 | |
(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 December 31, 2019.2020.
| |
(c) | 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. |
(c)Amounts reflect the undiscounted estimated remaining payout of the Earnout Payments liability as of December 31, 2020. The Earnout Payments liability was estimated based on the terms of the payout and the forecasted attrition of the Protect America and Select Security subscriber base acquired in 2020.
(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.
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 $1,064,311,000$1,102,977,000 net of accumulated amortization, at December 31, 2019,2020, relate primarily to the cost of acquiring monitoring service contracts acquired from independent dealers. The subscriber accounts balanceasset 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 including bonus incentives related to account activation in the Direct to Consumer Channel, associated with the creationacquisition of subscriber accounts,monitoring service contracts from its independent dealers are capitalized (the "subscriber accounts asset"). Upon adoption of ASC 606,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 CostsCosts") 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 our United States deferred tax assets and certain foreign deferred tax assets, and as such, we have a valuation allowance which totaled $24,457,000$63,881,000 and $148,419,000$24,457,000 as of December 31, 2020 and 2019, and 2018, respectively.
Valuation of Goodwill
As ofDuring the year ended December 31, 2019,2020, we hadrecorded a full goodwill impairment of $81,943,000, which represents approximately 6% of total assets.$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
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 FASB ASC Topic 350, goodwill is not amortized, but rather tested for impairment at least annually.
To the extent necessary, recoverability of 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 MeasurementMeasurements 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.
The Company assesses An impairment charge is recognized for the recoverability of the carrying value of goodwill during the fourth quarter of its fiscal year, based on October 31 financial information, or whenever events or changes in circumstances indicate thatamount by which the carrying amount of the goodwill of a reporting unit may not be fully recoverable. The Company has one reporting unit, Brinks Home Security, and recoverability is measured atexceeds the reporting unit level based on the provisions of FASB ASC Topic 350.unit's fair value.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
We have exposure to changes in interest rates related to the terms of our debt obligations. The Company uses an interest rate cap derivative instrument to manage the exposure related to the movement in interest rates. The derivative is designated as a cash flow hedge and was entered into with the intention of reducing the risk associated with the variable interest rates on the Successor Takeback Loan Facility. We do not use derivative financial instruments for trading purposes.
Tabular Presentation of Interest Rate Risk
The table below provides information about our outstanding debt obligations that are sensitive to changes in interest rates. Debt amounts represent principal payments by stated maturity date as of December 31, 20192020 (amounts in thousands):
| | | | | | | | |
Year of Maturity | | Variable Rate Debt |
2021 | | 8,225 | |
2022 | | 8,225 | |
2023 | | 8,225 | |
2024 | | 954,544 | |
2025 | | — | |
Thereafter | | — | |
Total | | $ | 979,219 | |
|
| | | | |
Year of Maturity | | Variable Rate Debt |
2020 | | $ | 8,225 |
|
2021 | | 8,225 |
|
2022 | | 8,225 |
|
2023 | | 8,225 |
|
2024 | | 953,544 |
|
Thereafter | | — |
|
Total | | $ | 986,444 |
|
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements are filed under this Item, beginning on page 4041. The financial statement schedules required by Regulation S-X are filed under Item 15 of this Annual Report on Form 10-K.
Report of Independent Registered Public Accounting Firm
To the Stockholders and Board of Directors
Monitronics International, Inc.:
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Monitronics International, Inc. and subsidiaries (the Company) as of December 31, 20192020 and 2018,2019, the related consolidated statements of operations and comprehensive income (loss), cash flows, and stockholders’ equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 2019,2020, and the related notes (collectively, the consolidated financial statements). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 20192020 and 2018,2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2019,2020, in conformity with U.S. generally accepted accounting principles.
Fresh Start Accounting
As described in Note 4 to the consolidated financial statements, the Company emerged from bankruptcy protection on August 30, 2019. In connection with its emergence from bankruptcy, the Company selected a convenience date of August 31, 2019 and applied the guidance for fresh start accounting in conformity with FASB ASC Topic 852, Reorganizations as of that date. Accordingly, the Company’s consolidated financial statements prior to August 31, 2019 are not comparable to its consolidated financial statements for periods after August 31, 2019.
Changes in Accounting Principles
As discussed in Note 25 to the consolidated financial statements, in 2018,2020, the Company has changed its method of accounting for revenue transactions with customerscredit losses due to the adoption of Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, as amended.2016-13, Financial Instruments - Credit Losses (Topic 326).
As discussed in Note 519 to the consolidated financial statements, in 2019, the Company has changed its method of accounting for leases due to the adoption of Accounting Standards Update No. 2016-02, Leases.
Fresh Start Accounting
As described in Note 1 to the consolidated financial statements, the Company filed a petition for reorganization under Chapter 11 of the United States Bankruptcy Code on June 30, 2019. The Company's plan of reorganization became effective and the Company emerged from bankruptcy protection on August 30, 2019. In connection with its emergence from bankruptcy, the Company adopted the guidance for fresh start accounting in conformity with FASB ASC Topic 852, Reorganizations. Accordingly, the Company's consolidated financial statements prior to December 31, 2019 are not comparable to its consolidated financial statements for periods after December 31, 2019.
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or
complex judgments. The communication of a critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinion on the critical audit matters or on the accounts or disclosures to which they relate.
Revenue recognition for contracts with multiple performance obligations
As discussed in Note 2 to the consolidated financial statements, the transaction price under subscriber alarm monitoring agreements is allocated to alarm monitoring revenue and, if applicable, to products and installation revenue. The allocation is based on the standalone selling prices of each performance obligation. The process of changing out or setting up equipment may require the Company to subsidize the alarm monitoring equipment and installation services. As discussed in Note 18 to the consolidated financial statements, the Company reported net revenue of $503.6 million.
We identified the evaluation of the sufficiency of audit evidence obtained related to the Company’s identification of contracts with multiple performance obligations as a critical audit matter. Challenging auditor judgment was required to evaluate management’s identification of contracts that contain multiple performance obligations due to the risk that subsidized alarm monitoring equipment and installation services may not be reported when changing out or setting up equipment.
The following are the primary procedures we performed to address this critical audit matter. We applied auditor judgment to determine the nature and extent of procedures to be performed over the Company’s identification of contracts with multiple performance obligations. We evaluated the design of an internal control related to the identification of contracts with multiple performance obligations. We tested the completeness of management’s population of contracts with multiple performance obligations by (1) selecting a sample of product and installation service expenses, (2) assessing if the product and installation services related to a contract with multiple performance obligations, and (3) evaluating if the contract was included in the population used by management to record revenue from contracts with multiple performance obligations. We evaluated the sufficiency of audit evidence obtained by assessing the results of procedures performed, including the appropriateness of the nature and extent of such evidence.
Initial fair value measurement of the subscriber account intangible asset and consideration paid
As discussed in Note 6 to the consolidated financial statements, on December 23, 2020, the Company completed a transaction in which it will acquire approximately 40,000 alarm monitoring contracts from Kourt Security Partners, LLC, doing business as Select Security (the Seller). The Company will take legal ownership of the alarm monitoring contracts through a special purpose vehicle as payments are made under an earnout agreement over a term of 50 months. The transaction has been recorded as an asset acquisition effected through a special purpose vehicle that management concluded is a variable interest entity. As a result, the subscriber accounts intangible asset and the consideration paid were recorded at fair value of $42.5 million and $42.3 million , respectively. The determination of the acquisition date fair values of the subscriber accounts intangible asset and the consideration paid required the Company to make significant estimates and assumptions regarding customer attrition and the discount rates.
We identified the initial measurement of the acquisition date fair values of the subscriber accounts intangible asset and the consideration paid as a critical audit matter. Specifically, subjective auditor judgment was required to evaluate the significant assumptions related to customer attrition and the discount rates used by the Company to estimate the fair values as there was no directly observable market data. In addition, assessing the Company’s selection and application of the valuation model to determine the consideration paid required the use of valuation professionals with specialized skills and knowledge.
The following are the primary procedures we performed to address this critical audit matter. We evaluated the design of certain internal controls related to the Company’s acquisition-date valuation process, including controls over the valuation models, customer attrition, and the discount rates. We compared the customer attrition rates to historical data of the Company and the Seller. We involved valuation professionals with specialized skills and knowledge to assist with evaluating the valuation models and certain assumptions by:
–evaluating the Company’s selection of the valuation model used to estimate the fair value of the consideration paid.
–recalculating the fair value of the subscriber account intangible asset using the Company’s customer attrition rates and discount rate assumptions
–developing independent discount rates for the subscriber accounts intangible asset and fair value of consideration paid by using publicly available market data and comparing the results to the Company’s discount rates
| | | | | |
| /s/ KPMG LLP |
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| /s/ KPMG LLP |
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We have served as the Company's auditor since 2011. | |
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Dallas, Texas | |
March 30, 202018, 2021 | |
See accompanying notes to consolidated financial statements.