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ASCMA > SEC Filings for ASCMA > Form 10-Q on 9-Aug-2013All Recent SEC Filings

Show all filings for ASCENT CAPITAL GROUP, INC.

Form 10-Q for ASCENT CAPITAL GROUP, INC.


9-Aug-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Certain statements in this Quarterly Report on Form 10-Q constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our business, marketing and operating strategies, the pending Security Networks Acquisition, the anticipated amendment of Monitronics' Credit Facility in connection with the Security Networks Acquisition, new service offerings, financial prospects, and anticipated sources and uses of capital. Where, in any forward-looking statement, we express an expectation or belief as to future results or events, such expectation or belief is expressed in good faith and believed to have a reasonable basis, but there can be no assurance that the expectation or belief will result or be achieved or accomplished. The following include some but not all of the factors that could cause actual results or events to differ materially from those anticipated:

Factors relating to the Company and its consolidated subsidiaries, as a whole:

general business conditions and industry trends;

macroeconomic conditions and their effect on the general economy and on the U.S. housing market, in particular single family homes which represent Monitronics' largest demographic;

uncertainties in the development of our business strategies, including market acceptance of new products and services;

the competitive environment in which we operate, in particular increasing competition in the alarm monitoring industry from larger existing competitors and new market entrants, including telecommunications and cable companies;

integration of acquired assets and businesses;

the regulatory environment in which we operate, including the multiplicity of jurisdictions and licensing requirements to which Monitronics is subject and the risk of new regulations, such as the increasing adoption of false alarm ordinances;

technological changes which could result in the obsolescence of currently utilized technology and the need for significant upgrade expenditures;

the availability and terms of capital, including the ability of Monitronics to obtain additional funds to grow its business and to complete the anticipated financing for the Security Networks Acquisition;

the outcome of any pending, threatened, or future litigation, including potential liability for failure to respond adequately to alarm activations; and

availability of qualified personnel.

Factors relating to the business of Monitronics:

Monitronics' high degree of leverage and the restrictive covenants governing its indebtedness;

          Monitronics' anticipated growth strategies;

          the ability of Monitronics to obtain additional funds to grow its
business, including the terms of any additional financing with respect thereto;

          Monitronics' ability to acquire and integrate additional accounts,

including competition for dealers with other alarm monitoring companies which could cause an increase in expected subscriber acquisition costs;

the impact of "false alarm" ordinances and other potential changes in regulations or standards;

the operating performance of Monitronics' network, including the potential for service disruptions due to acts of nature or technology deficiencies;

potential liability for failure to respond adequately to alarm activations;

our ability to continue to obtain insurance coverage sufficient to hedge our risk exposures, including as a result of acts of third parties and/or alleged regulatory violations;

changes in the nature of strategic relationships with original equipment manufacturers, dealers and other Monitronics business partners;

the reliability and creditworthiness of Monitronics' independent alarm systems dealers and subscribers;

changes in Monitronics' expected rate of subscriber attrition;

changes in technology that may make Monitronics' service less attractive or obsolete, or require significant expenditures to update, including the phase-out of 2G networks by cellular carriers;

the development of new services or service innovations by competitors; and

the trend away from the use of public switched telephone network lines and resultant increase in servicing costs associated with alternative methods of communication.


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Factors relating to the Security Networks Acquisition:

the ability to complete the Security Networks Acquisition by September 30, 2013 (subject to extension in certain circumstances), or at all;

the ability to complete the expected incremental term loan; and

the ability to successfully integrate Security Networks into the Monitronics business.

For additional risk factors, please see Part I, Item 1A, Risk Factors, in the 2012 Form 10-K. These forward-looking statements and such risks, uncertainties and other factors speak only as of the date of this Quarterly Report, and we expressly disclaim any obligation or undertaking to disseminate any updates or revisions to any forward-looking statement contained herein, to reflect any change in our expectations with regard thereto, or any other change in events, conditions or circumstances on which any such statement is based.

The following discussion and analysis provides information concerning our results of operations and financial condition. This discussion should be read in conjunction with our accompanying condensed consolidated financial statements and the notes thereto included elsewhere herein and the 2012 Form 10-K.

Overview

Ascent Capital Group, Inc. ("Ascent Capital" or the "Company") is a holding company and its assets primarily consist of its wholly-owned subsidiary, Monitronics International, Inc. ("Monitronics").

The Monitronics business provides security alarm monitoring and related services to residential and business subscribers throughout the United States and parts of Canada. Monitronics monitors signals arising from burglaries, fires, medical alerts and other events through security systems at subscribers' premises, as well as provides customer service and technical support. Nearly all of its revenues are derived from recurring monthly revenues under security alarm monitoring contracts purchased from independent dealers in its exclusive nationwide network.

Recent Developments

On July 10, 2013, Monitronics entered into a securities purchase agreement with certain funds affiliated with Oak Hill Capital Partners, certain other holders and for the limited purposes set forth therein, the Company (the "Agreement"), pursuant to which Monitronics will directly and indirectly acquire all of the equity interests of Security Networks, LLC ("Security Networks") and certain affiliated entities (the "Security Networks Acquisition"). The estimated purchase price (the "Security Networks Purchase Price") will consist of $487,500,000 in cash plus 253,333 shares of Ascent Capital's Series A common stock with an agreed value of $20,000,000 (the "Ascent Shares") based on Security Networks delivering recurring monthly revenue (as defined in the Agreement) ("Acquisition RMR") of approximately $8,800,000 (including approximately $100,000 of wholesale monitoring revenue) as of the date of closing (the "Security Networks Closing Date"). In addition to other customary post-closing adjustments, the Security Networks Purchase Price will be adjusted based on the actual amount of Security Networks' Acquisition RMR delivered as of the Security Networks Closing Date. The cash portion of the Security Networks Purchase Price will be funded by cash on hand at Ascent Capital and new debt, which is to consist of $103,500,000 of 4.00% convertible senior notes due 2020 issued by Ascent Capital (the "Convertible Notes"), $175,000,000 of 9.125% senior notes due 2020 issued by Monitronics Escrow Corporation (the "New Senior Notes") and an expected incremental term loan of $225,000,000 to be provided under Monitronics' Credit Facility (the "Incremental Term Loan"). As of June 30, 2013, Monitronics has incurred $1,438,000 of legal and professional services expense related to the Security Networks Acquisition, which are included in Selling, general, and administrative expense in the unaudited condensed consolidated statements of operations and comprehensive income (loss).

The Agreement contains certain termination rights in the event that the Security Networks Acquisition is not consummated by September 30, 2013 (subject to extension in certain circumstances), including if the failure to complete the Security Networks Acquisition by such date is attributable to certain breaches by Ascent Capital or Monitronics, Monitronics may be required to pay the sellers a $45,000,000 termination fee. Monitronics currently expects to close the Security Networks Acquisition in mid-August 2013.

Attrition

Account cancellation, otherwise referred to as subscriber attrition, has a direct impact on the number of subscribers that Monitronics services and on its financial results, including revenues, operating income and cash flow. A portion of the subscriber base can be expected to cancel its service every year. Subscribers may choose not to renew or terminate their contract for a variety of reasons, including relocation, cost and switching to a competitor's service. The largest category of canceled accounts relate to subscriber relocation or the inability to contact the subscriber. Monitronics defines its attrition rate as the number of canceled accounts in a given period divided by the weighted average of number of subscribers for that period. Monitronics considers an account canceled if payment from the subscriber is deemed uncollectible or if the subscriber cancels for various reasons. If a subscriber relocates but continues its service, this is not a cancellation. If the subscriber relocates, discontinues its service and a new subscriber takes over the original subscriber's service continuing the revenue stream (a "new owner takeover"), this is also not a cancellation. Monitronics adjusts the number of canceled accounts by excluding those that are contractually guaranteed by its dealers. The typical dealer


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contract provides that if a subscriber cancels in the first year of its contract, the dealer must either replace the canceled account with a new one or refund the purchase price. To help ensure the dealer's obligation to Monitronics, Monitronics typically holds back a portion of the purchase price for every account purchased, ranging from 5-10%. In some cases, the amount of the purchase holdback may be less than actual attrition experience.

The table below presents subscriber data for the twelve months ended June 30, 2013 and 2012:

                                                             Twelve Months Ended
                                                                  June 30,
                                                              2013         2012

Beginning balance of accounts                                 711,832     688,119
Accounts purchased (a)                                        228,040     108,600
Accounts canceled (b)                                         (98,107 )   (81,747 )
Canceled accounts guaranteed to be refunded from holdback      (3,042 )    (3,140 )
Ending balance of accounts                                    838,723     711,832
Monthly weighted average accounts                             787,735     701,515
Attrition rate                                                  (12.5 )%    (11.7 )%



(a) During the three months ended June 30, 2013 and 2012, Monitronics purchased 47,733 and 26,358 subscriber accounts, respectively. During the six months ended June 30, 2013 and 2012, Monitronics purchased 76,193 and 50,532 subscriber accounts, respectively. The account purchases for the three and six months ended June 30, 2013 reflect bulk buys of approximately 18,200 accounts purchased in the second quarter of 2013.

(b) Net of canceled accounts that are contractually guaranteed to be refunded from holdback.

The attrition rate for the twelve months ended June 30, 2013 and 2012 was 12.5% and 11.7%, respectively. Increased attrition reflects the current age of accounts in the portfolio and an increase in disconnections due to household relocations.

Monitronics also analyzes its attrition by classifying accounts into annual pools based on the year of purchase. Monitronics then tracks the number of accounts that cancel as a percentage of the initial number of accounts purchased for each pool for each year subsequent to its purchase. Based on the average cancellation rate across the pools, in recent years Monitronics has averaged less than 1% attrition within the initial 12-month period after considering the accounts which were replaced or refunded by the dealers at no additional cost to Monitronics. Over the next few years of the subscriber account life, the number of subscribers that cancel as a percentage of the initial number of subscribers in that pool gradually increases and historically has peaked following the end of the initial contract term, which is typically three to five years. The peak following the end of the initial contract term is primarily a result of the buildup of subscribers that moved or no longer had need for the service but did not cancel their service until the end of their initial contract term. Subsequent to the peak following the end of the initial contract term, the number of subscribers that cancel as a percentage of the initial number of subscribers in that pool declines.

Adjusted EBITDA

We evaluate the performance of our operations based on financial measures such as revenue and "Adjusted EBITDA." Adjusted EBITDA is defined as net income
(loss) before interest expense, interest income, income taxes, depreciation, amortization (including the amortization of subscriber accounts and dealer network), realized and unrealized gain/(loss) on derivative instruments, restructuring charges, stock-based and other non-cash long-term incentive compensation, and other non-cash or nonrecurring charges. Ascent Capital believes that Adjusted EBITDA is an important indicator of the operational strength and performance of its business, including the business' ability to fund its ongoing acquisition of subscriber accounts, its capital expenditures and to service its debt. In addition, this measure is used by management to evaluate operating results and perform analytical comparisons and identify strategies to improve performance. Adjusted EBITDA is also a measure that is customarily used by financial analysts to evaluate the financial performance of companies in the security alarm monitoring industry and is one of the financial measures, subject to certain adjustments, by which Monitronics' covenants are calculated under the agreements governing their debt obligations. Adjusted EBITDA does not represent cash flow from operations as defined by generally accepted accounting principles ("GAAP"), should not be construed as an alternative to net income or loss and is indicative neither of our results of operations nor of cash flows available to fund all of our cash needs. It is, however, a measurement that Ascent Capital believes is useful to investors in analyzing its operating performance. Accordingly, Adjusted EBITDA should be considered in addition to, but not as a substitute for, net income, cash flow provided by operating activities and other measures of financial performance prepared in accordance with GAAP. Adjusted EBITDA is a non-GAAP financial measure. As companies often define non-GAAP financial measures differently, Adjusted EBITDA as calculated by Ascent Capital should not be compared to any similarly titled measures reported by other companies.


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Results of Operations



The following table sets forth selected data from the accompanying condensed
consolidated statements of operations and comprehensive income (loss) for the
periods indicated (dollar amounts in thousands).



                                     Three months ended           Six months ended
                                          June 30,                    June 30,
                                      2013          2012          2013         2012

Net revenue                       $    102,273       83,315    $  202,431      165,196
Cost of services                        15,594       11,391        30,796       22,450
Selling, general, and
administrative                          21,509       18,030        41,246       35,837
Amortization of subscriber
accounts and dealer network             45,998       39,349        90,313       77,430
Gain on sale of operating
assets, net                              2,065          576         5,456        1,313
Interest expense                        19,485       19,319        40,628       30,959
Realized and unrealized loss
on derivative financial
instruments                                  -            -             -        2,044
Income tax expense from
continuing operations                      914          765         1,688        1,448
Net income (loss) from
continuing operations                      212       (5,761 )       2,526      (10,691 )
Earnings (loss) from
discontinued operations, net
of income tax                             (147 )     (1,432 )         299       (1,716 )
Net income (loss)                           65       (7,193 )       2,825      (12,407 )

Adjusted EBITDA (a)
Monitronics business Adjusted
EBITDA                            $     70,408       57,218    $  139,822      113,703
Corporate Adjusted EBITDA                  816         (650 )       2,702       (1,069 )
Total Adjusted EBITDA             $     71,224       56,568    $  142,524      112,634

Adjusted EBITDA as a
percentage of Revenue
Monitronics business                      68.8 %       68.7 %        69.1 %       68.8 %
Corporate                                  0.8 %       (0.8 )%        1.3 %       (0.6 )%



(a) See reconciliation to net income (loss) from continuing operations below.

Net revenue. Net revenue increased $18,958,000, or 22.8%, and $37,235,000, or 22.5%, for the three and six months ended June 30, 2013, respectively, as compared to the corresponding prior year periods. The increase in net revenue is attributable to the growth in the number of subscriber accounts and the related increase in recurring monthly revenue ("RMR"). The growth in subscriber accounts reflects the effects of purchases of approximately 110,000 accounts through Monitronics' authorized dealer program subsequent to June 30, 2013, the purchase of approximately 93,000 accounts in a bulk buy in October 2012 and other bulk buys of which approximately 18,200 accounts were purchased in the second quarter of 2013.

RMR increased from approximately $27,030,000 as of June 30, 2012 to approximately $33,533,000 as of June 30, 2013. RMR purchased during the three months ended June 30, 2013 and 2012 was approximately $2,090,000 and $1,165,000, respectively. RMR purchased during the six months ended June 30, 2013 and 2012 was approximately $3,367,000 and $2,214,000, respectively. In addition, average monthly revenue per subscriber increased from $37.97 as of June 30, 2012 to $39.98 as of June 30, 2013.

Cost of services. Cost of services increased $4,203,000, or 36.9%, and $8,346,000, or 37.2%, for the three and six months ended June 30, 2013, respectively, as compared to the corresponding prior year periods. The increase is primarily attributable to an increased number of accounts monitored across the cellular network and having interactive and home automation services, which result in higher operating and service costs. Cost of services as a percent of net revenue increased from 13.7% and 13.6% for the three and six months ended June 30, 2012, respectively, to 15.2% for both the three and six months ended June 30, 2013.

Selling, general and administrative. Selling, general and administrative costs ("SG&A") increased $3,479,000, or 19.3%, and $5,409,000, or 15.1% for the three and six months ended June 30, 2013, respectively, as compared to the corresponding prior year periods. The increase is primarily attributable to increases in Monitronics SG&A costs. The increased Monitronics SG&A costs are attributable to increased payroll expenses of approximately $616,000 and $1,571,000 for the three and six months ended June 30,


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2013, respectively, as compared to the corresponding prior year periods and increases in professional services expenses primarily related to $1,438,000 of Security Networks Acquisition transaction costs incurred in the three and six months ended June 30, 2013. Additionally, the Company's consolidated stock-based compensation expense increased approximately $692,000 and $1,220,000 for the three and six months ended June 30, 2013, respectively, as compared to the corresponding prior year periods. This increase is related to restricted stock and option awards granted to certain employees subsequent to June 30, 2012. SG&A as a percent of net revenue decreased from 21.6% and 21.7% for the three and six months ended June 30, 2012, respectively, to 21.0% and 20.4% for the three and six months ended June 30, 2013, respectively.

Amortization of subscriber accounts and dealer network. Amortization of subscriber accounts and dealer network increased $6,649,000 and $12,883,000 for the three and six months ended June 30, 2013 as compared to the corresponding prior year periods. The increase is primarily attributable to amortization of subscriber accounts purchased subsequent to June 30, 2012.

Gain on sale of operating assets, net. During the six months ended June 30, 2013, the Company sold an equity investment which resulted in a pre-tax gain of $3,250,000. Additionally, the Company sold certain land and building property for $4,620,000 resulting in a pre-tax gain of $2,204,000. During the six months ended June 30, 2012, the Company sold land and building improvements for $5,066,000, resulting in a pre-tax gain of $1,845,000. This gain was partially offset by the sale of the Company's 50% interest in an equity method investment for $1,420,000 resulting in a pre-tax loss of $532,000.

Interest Expense. Interest expense increased $166,000 and $9,669,000 for the three and six months ended June 30, 2013 as compared to the corresponding prior year period. The increase in interest expense for the three months ended June 30, 2013 is primarily attributable to the increase in term loan debt outstanding under Monitronics' Credit Facility offset by decreased interest rates on the outstanding term loan debt in conjunction with the March 25, 2013 repricing of the Credit Facility term loan.

The increase in interest expense for the six months ended June 30, 2013 is primarily due to the presentation of interest cost related to the Company's current derivative instruments. Interest cost related to the Company's current derivative instruments is presented in Interest expense on the statement of operations as the related derivative instrument is an effective cash flow hedge of the Company's interest rate risk for which hedge accounting is applied. As the Company did not apply hedge accounting on its prior derivative instruments, the related interest costs incurred prior to March 23, 2012 are presented in Realized and unrealized loss on derivative financial instruments in the condensed consolidated statements of operations and comprehensive income
(loss). This increase was offset by decreased interest rates on the Credit Facility term loans, as noted above, and a decrease in amortization of debt discount, as the debt discount related to the securitized debt structure outstanding prior to the March 23, 2012 refinancing exceeded the debt discount on the Credit Facility. Amortization of debt discount for the six months ended June 30, 2013 and 2012 was $387,000 and $4,101,000, respectively.

Realized and unrealized loss on derivative financial instruments. There was no realized and unrealized gain or loss on derivative financial instruments for the three and six months ended June 30, 2013, as hedge accounting was applied on Monitronics' outstanding derivative instruments. Realized and unrealized loss on derivative financial instruments for the six months ended June 30, 2012 was $2,044,000, which includes settlement payments of $8,837,000 partially offset by a $6,793,000 unrealized gain related to the change in the fair value of the derivative financial instruments that were terminated on March 23, 2012.

Income tax expense from continuing operations. The Company had pre-tax income from continuing operations of $1,126,000 and $4,214,000 for the three and six months ended June 30, 2013, respectively, and income tax expense of $914,000 and $1,688,000 for the three and six months ended June 30, 2013, respectively. The Company had a pre-tax loss from continuing operations of $4,996,000 and $9,243,000 for the three and six months ended June 30, 2012, respectively, and income tax expense of $765,000 and $1,448,000 for the three and six months ended June 30, 2012, respectively. Income tax expense for all periods presented primarily relates to state taxes recognized on the Monitronics business.

Earnings (loss) from discontinued operations, net of income taxes. Earnings
(loss) from discontinued operations, net of income taxes, were $(147,000) and $299,000 for the three and six months ended June 30, 2013, respectively, and $(1,432,000) and $(1,716,000) for the three and six months ended June 30, 2012, respectively. Earnings from discontinued operations include recoveries of prior period expenses associated with discontinued operations for the six months ended June 30, 2013. Loss from discontinued operations includes contract termination costs and other loss contingencies for the three months ended June 30, 2013 and three and six months ended June 30, 2012.


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Adjusted EBITDA. The following table provides a reconciliation of total Adjusted EBITDA to net income (loss) from continuing operations (amounts in thousands):

                                        Three months ended         Six months ended
                                             June 30,                  June 30,
                                         2013          2012        2013         2012

Total Adjusted EBITDA                 $    71,224      56,568    $ 142,524     112,634
Amortization of subscriber
accounts and dealer network               (45,998 )   (39,349 )    (90,313 )   (77,430 )
Depreciation                               (2,141 )    (2,696 )     (4,055 )    (4,602 )
Stock-based and long-term
incentive compensation                     (1,963 )    (1,271 )     (3,783 )    (2,563 )
Acquisition related costs                  (1,438 )         -       (1,438 )         -
. . .
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