Description
Ascent Capital Group Inc. 10% Owner JOHN C MALONE bought 15,000 shares on 10-03-2012 at $ 54.66
BUSINESS OVERVIEW
General Development of Business On July 7, 2011, Ascent Media Corporation merged with its direct wholly owned subsidiary, Ascent Capital Group, Inc. (“Ascent Capital” or the “Company”), for the purpose of changing its name to Ascent Capital Group, Inc. Ascent Capital was incorporated in the state of Delaware on May 29, 2008 as a wholly-owned subsidiary of Discovery Holding Company (“DHC”). On September 17, 2008, DHC completed the spin-off of Ascent Capital to DHC’s shareholders and we became an independent, publicly traded company. In the spin-off, each holder of DHC common stock received 0.05 of a share of our Series A common stock for each share of DHC Series A common stock held and 0.05 of a share of our Series B common stock for each share of DHC Series B common stock held. 13,401,886 shares of our Series A common stock and 659,732 shares of our Series B common stock were issued in the spin-off, which was intended to qualify as a tax-free transaction.
At December 31, 2011, our assets consist primarily of our wholly-owned operating subsidiary, Monitronics International, Inc. (“Monitronics”), investments in marketable securities, real estate properties and cash and cash equivalents. At December 31, 2011, we had investments in marketable securities and cash and cash equivalents, on a consolidated basis, of $40,377,000 and $183,558,000, respectively.
During 2010 and the beginning of 2011, there were substantial changes in our operations. Historically, our principal asset was our wholly-owned operating subsidiary Ascent Media Group, LLC (“AMG”). AMG was primarily engaged in the business of providing content distribution and creative services to the media and entertainment industries. The businesses of AMG were organized into two operating segments: businesses that provide content management and delivery services (“Content Services”), and businesses that provide creative services (“Creative Services”). The Content Services segment was in turn divided into three business units: (i) the content distribution business unit (“Content Distribution”), (ii) the media management services business unit (“Media Services”) and (iii) the systems integration business unit (“Systems Integration” or “SI”).
On December 31, 2010, pursuant to a definitive agreement with Deluxe Entertainment Services Group Inc. (“Deluxe”) dated November 24, 2010, the Company completed the sale of 100% of its Creative Services business unit and 100% of its Media Services business unit (which is referred to collectively as “Creative/Media”), for an aggregate purchase price of $69 million in cash. Historically, the creative services business unit was a separate reportable segment and the media services business unit was included in the Content Services group reportable segment. The Company recorded a pre-tax loss on the sale of $27,110,000 and $7,587,000 of related income tax benefit for the year ended December 31, 2010. For further information regarding this transaction, see the MD&A section of this Annual Report. The Company has accounted for the disposition of the Creative/Media business as discontinued operations in the consolidated financial statements for all periods presented.
On December 17, 2010, we acquired 100% of Monitronics, a leading national security alarm monitoring company. The transaction value comprised $397 million of cash consideration and we also assumed $795 million of net debt (which we define as the principal amount of such debt less Monitronics cash) of Monitronics. For more information about the Monitronics business, please see “—Narrative Description of the Business—Monitronics International, Inc.” below. The fiscal year 2010 financial statements of the Company included in this Annual Report on Form 10-K include the financial position of Monitronics in the Company’s consolidated balance sheet as at December 31, 2010, and the results of operations of Monitronics on a consolidated basis for the period from December 17, 2010 through December 31, 2010.
In February 2010, AMG consummated the sale of the assets and operations of its Chiswick Park facility in the United Kingdom, which was previously included in the Content Services group, to Discovery Communications, Inc., for net cash proceeds of approximately $35 million. AMG recognized a pre-tax gain of approximately $25.5 million from the sale. For further information regarding this transaction, see the MD&A section of this Annual Report. The results of operations of the Chiswick Park facility have been treated as discontinued operations in the consolidated financial statements for all periods presented in this Annual Report.
Recent Developments
As of June 30, 2011, the Company shut down the operations of the Systems Integration business. In connection with ceasing its operations, the Company recorded exit costs of $1,119,000 related to employee severance. For further information regarding this transaction, see the MD&A section of this Annual Report. The results of operations of Systems Integration have been treated as discontinued operations in the consolidated financial statements for all periods presented in this Annual Report.
On February 28, 2011, we completed the sale of 100% of the Content Distribution business to Encompass Digital Media, Inc. and its wholly owned subsidiary (together “Encompass”). The Company received cash proceeds of approximately $104 million and recorded a pre-tax gain of approximately $66.1 million and related income tax expense of approximately $2.9 million. For further information regarding this transaction, see the MD&A section of this Annual Report. The results of operations of Content Distribution have been treated as discontinued operations in the consolidated financial statements for all periods presented in this Annual Report.
Operations
Unlike many of its national competitors, Monitronics outsources the sales, installation and field service functions to its dealers. By outsourcing the low margin, high fixed-cost elements of its business to a large network of independent service providers, Monitronics is able to allocate capital to growing its revenue-generating account base rather than to local offices or depreciating hard assets.
During 2011, Monitronics purchased alarm monitoring contracts from more than 375 dealers. Monitronics generally enters into alarm monitoring purchase agreements with dealers only after a thorough review of the dealer’s qualifications, licensing and financial situation. Once a dealer has qualified, Monitronics generally obtains rights of first refusal to purchase all accounts sold by that dealer for a period of three years.
Revenue is generated primarily from fees charged to customers under alarm monitoring contracts. The initial contract term is typically three years, with automatic renewal on a month-to-month basis. Monitronics generates incremental revenue from retail customers by providing additional services, such as maintenance. Monitronics also generates revenue from fees charged to other security alarm companies for monitoring their accounts on a wholesale basis.
Monitronics believes that this process, which includes both clearly defined customer account standards and a consistently applied due diligence process, contributes significantly to the high quality of its subscriber base. For each of its last seven calendar years, the average credit score of accounts purchased by Monitronics was in excess of 700 on the FICO scale.
Approximately 94% of Monitronics subscribers are residential homeowners and the remainder are small commercial accounts. Monitronics believes by focusing on residential homeowners rather than renters it can reduce attrition, because homeowners relocate less frequently than renters.
Monitronics provides monitoring services as well as billing and 24-hour telephone support through its central monitoring station, located in Dallas, Texas. This facility is Underwriters Laboratories (“UL”) listed. To obtain and maintain a UL listing, an alarm monitoring center must be located in a building meeting UL’s structural requirements, have back-up and uninterruptable power supplies, have secure telephone lines and maintain redundant computer systems. UL conducts periodic reviews of alarm monitoring centers to ensure compliance with their requirements. Monitronics’ central monitoring station in Dallas has also received the Central Station Alarm Association’s (“CSAA”) prestigious Five Diamond Certification. According to the CSAA, less than 4% of all central monitoring stations in the U.S. have attained Five Diamond Certified status. Monitronics also has a back-up facility located in McKinney, Texas that is capable of supporting monitoring, billing and customer service operations in the event of a disruption at its primary monitoring center. A call center in Mexico provides telephone support for Spanish-speaking subscribers.
Monitronics’ telephone systems utilize high-capacity, high-quality, digital circuits backed up by conventional telephone lines. When an alarm signal is received at the monitoring facility, it is routed to an operator. At the same time, information concerning the subscriber whose alarm has been activated and the nature and location of the alarm signal are delivered to the operator’s computer terminal. The operator is then responsible for following standard procedures to contact the subscriber or take other appropriate action, including, if the situation requires, contacting local emergency service providers. Monitronics never dispatches its own personnel to the subscriber’s premises. If a subscriber lives in an area where the emergency service provider will not respond without verification of an actual emergency, Monitronics will contract with an independent third party responder if available in that area.
Monitronics seeks to increase subscriber satisfaction and retention by carefully managing customer and technical service. The customer service center handles all general inquiries from subscribers, including those related to subscriber information changes, basic alarm troubleshooting, alarm verification, technical service requests and requests to enhance existing services. Monitronics has a proprietary centralized information system that enables it to satisfy over 85% of subscriber technical inquiries over the telephone, without dispatching a service technician. If the customer requires field service, Monitronics relies on its nationwide network of over 550 service dealers to provide such service on a time and materials basis. Monitronics closely monitors service dealer performance with customer satisfaction forms, follow-up quality assurance calls and other performance metrics.
Monitronics also provides central station monitoring services on a wholesale basis for other independent alarm companies that do not have the capability to monitor systems for their customers.
Intellectual Proper ty
The Company has a registered service mark for the Monitronics name and a service mark for the Monitronics logo. It owns certain proprietary software applications that are used to provide services to its dealers and subscribers. Monitronics does not hold any patents or other intellectual property rights on its proprietary software applications.
Sales and Marketing
General . We believe Monitronics’ nationwide network of authorized dealers is the most effective way for Monitronics to market alarm systems. Locally-based dealers are often an integral part of the communities they serve and understand the local market and how best to satisfy local needs. By combining the dealer’s local presence and reputation with Monitronics’ high quality service and support, Monitronics is able to cost-effectively provide local services and take advantage of economies of scale where appropriate.
Agreements with dealers provide for the purchase of the dealer’s subscriber accounts on an ongoing basis. The dealers install the alarm system and arrange for subscribers to enter into a multi-year alarm monitoring agreement in a form acceptable to Monitronics. The dealer then submits this monitoring agreement for Monitronics’ due diligence review and purchase.
Dealer Network Development . Monitronics remains focused on expanding its network of independent authorized dealers. To do so, Monitronics has established a dealer program that provides participating dealers with a variety of support services to assist them as they grow their businesses. Authorized dealers may use the Monitronics brand name in their sales and marketing activities and on the products they sell and install. Monitronics authorized dealers benefit from their affiliation with Monitronics and its national reputation for high customer satisfaction, as well as the support they receive from Monitronics. Authorized dealers benefit by generating operating capital and profits from the sale of their accounts to Monitronics. Monitronics also provides authorized dealers with the opportunity to obtain discounts on alarm systems and other equipment purchased by such dealers from original equipment manufacturers, including alarm systems labeled with the Monitronics logo. Monitronics also makes available sales, business and technical training, sales literature, co-branded marketing materials, sales leads and management support to its authorized dealers. In most cases these services and cost savings would not be available to security alarm dealers on an individual basis.
Currently, Monitronics employs sales representatives to promote its authorized dealer program, find account acquisition opportunities and sell Monitronics monitoring services. Monitronics targets independent alarm dealers across the U.S. that can benefit from the Monitronics dealer program services and can generate high quality monitoring customers for Monitronics. Monitronics uses a variety of marketing techniques to promote the dealer program and related services. These activities include direct mail, trade magazine advertising, trade shows, internet web site marketing, publicity and telemarketing.
Strategy
Corporate Strategy
Ascent Capital actively seeks opportunities to leverage our strong capital position through strategic acquisitions in the security alarm monitoring industry as well as acquisitions in other industries. As part of this strategy, we divested the businesses that were historically operated by our former operating subsidiary, AMG, and acquired Monitronics, a subscription-based business that delivers solid, predictable revenue and cash flow and has what we believe is a scalable and leveragable business model.
CEO BACKGROUND
John C. Malone
• Professional Background : A director of our company since January 2010. Mr. Malone has served as the Chairman of the board of directors and a director of Liberty Interactive Corporation (and its predecessors) ( Liberty Interactive ) since 1994 and as the Chief Executive Officer of Liberty Interactive’s predecessor from August 2005 to February 2006. He has also served as the Chairman of the board of directors and a director of Liberty Media Corporation ( Liberty Media ) since its split-off from Liberty Interactive in September 2011. Mr. Malone also served as the Chief Executive Officer of AT&T Broadband (formerly known as Tele-Communications, Inc. ( TCI )), a cable television company, Liberty Interactive’s former parent company, from January 1994 to March 1997 and as the Chairman of the board of directors of TCI from November 1996 until March 1999, when TCI was acquired by AT&T.
• Other Public Company Directorships : Mr. Malone has served as the Chairman of the board of directors of Liberty Global, Inc. ( LGI ) since June 2005. Previously, he served as Chairman of the board of directors of LGI’s predecessor, Liberty Media International, Inc., from March 2004 to June 2005, as Chairman of the board of directors of DIRECTV from November 2009 to June 2010, and as Chairman of the board of directors of DIRECTV’s predecessor, The DIRECTV Group, Inc., from February 2008 to November 2009. He has served as a director of Discovery Communications Inc. since September 2008 and served as Chairman of the board of directors of its predecessor, Discovery Holding Corporation ( DHC ), from March 2005 to September 2008, and as a director of DHC from May 2005 to September 2008. Mr. Malone has also served as a director of Expedia, Inc. since August 2005 and Sirius XM Radio Inc. ( Sirius ) since April 2009. Mr. Malone served as a director of (i) UnitedGlobalCom, Inc. from January 2002 to June 2005, (ii) Cablevision Systems Corp. from March 2005 to June 2005, (iii) the Bank of New York Company, Inc. from June 2005 to April 2007, (iv) InterActiveCorp from May 2006 to June 2010, and (v) Live Nation Entertainment, Inc. from January 2010 to February 2011.
• Age : 71
• Board Qualification : Mr. Malone, as President of TCI, co-founded Liberty Interactive’s predecessor and is considered one of the preeminent figures in the media and telecommunications industry. He is well known for his sophisticated problem solving and risk assessment skills and provides our Board with executive leadership experience and long-term vision.
Carl E. Vogel
• Professional Background : A director of our company since December 2009. Mr. Vogel is currently a Senior Advisor to DISH Networks Corporation ( DISH ), a publicly-traded company providing pay-TV services, and served as President of DISH from September 2006 until February 2008 and Vice Chairman of DISH from June 2005 until March 2009. Mr. Vogel is also the president and sole stockholder of Bulldog Capital, Inc., a private investment firm. From October 2007 until March 2009, Mr. Vogel served as a Senior Advisor to EchoStar Corporation ( EchoStar ), a publicly-traded company in the digital set-top box and satellite services businesses. From 2001 until 2005, Mr. Vogel served as the President and CEO of Charter Communications Inc. ( Charter ), a publicly-traded company providing cable television and broadband services. Prior to joining Charter, Mr. Vogel worked as an executive officer in various capacities for companies affiliated with Liberty Interactive and Liberty Media. Mr. Vogel held various executive positions with DISH from 1994 until 1997, including serving as the President from 1995 until 1997.
• Other Public Company Directorships : Mr. Vogel has served on the board of directors of DISH since May 2005 and Universal Electronics Inc. since 2009. In addition, Mr. Vogel has been serving on the board of directors and audit committees of Shaw Communications, Inc. since 2006 and NextWave Wireless Inc. since November 2009 (where he has served as the chair of the audit committee since March 2010). Mr. Vogel has also been serving on the board of directors and compensation committee of Sirius since April 2011. From October 2007 until March 2009, Mr. Vogel served as the Vice Chairman of the board of directors of EchoStar. From October 2001 to January 2005, Mr. Vogel served on the board of directors of Charter.
• Age : 54
• Board Qualification : Mr. Vogel brings to our Board extensive executive leadership experience and board experience, including experience with subscription-based businesses, along with professional accounting and financial expertise.
MANAGEMENT DISCUSSION FROM LATEST 10K
Monitronics
On December 17, 2010, we signed and closed an agreement to acquire 100% of the outstanding capital stock of Monitronics, through the merger of our wholly owned subsidiary, Mono Lake Merger Sub, Inc., with and into Monitronics, with Monitronics surviving such merger. The cash consideration paid in connection with the merger was $397,088,000. We also assumed approximately $795,000,000 in net debt (which we define as the principal amount of such debt less Monitronics cash) of Monitronics. In connection with the acquisition, Monitronics entered into a credit agreement, which provides for a $60,000,000 term loan and a $115,000,000 revolving credit facility. Ascent Capital has guaranteed payment of the term loan up to the first $30,000,000 of obligations thereunder. At closing, Monitronics borrowed the full amount of the term loan and $45,000,000 under the revolving credit facility, for total initial borrowings under the credit facility of $105,000,000. The proceeds of such loans, after repayment of $5,000,000 outstanding under a previously existing credit facility, and payment of certain fees and expenses relating to the credit facility, were used to fund a portion of the aggregate merger consideration payable in connection with the acquisition of Monitronics. The remaining cash consideration paid was funded by cash on hand.
Monitronics is primarily engaged in the business of providing security alarm monitoring services: monitoring signals from burglaries, fires, medical alerts, and other events, as well as providing customer service and technical support. Nearly all of its revenues are derived from monthly recurring revenues under security alarm monitoring contracts purchased from independent dealers in its exclusive nationwide network.
Revenues are recognized as the related monitoring services are provided. Other revenues are derived primarily from the provision of third-party contract monitoring services and from field technical repair services. All direct external costs associated with the creation of subscriber accounts are capitalized and amortized over fifteen years using a 220% declining balance method beginning in the month following the date of purchase. Internal costs, including all personnel and related support costs incurred solely in connection with subscriber account acquisitions and transitions, are expensed as incurred.
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, switching to a competitors’ service, and service issues. 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 subscribers for that period. Monitronics considers an account canceled when a subscriber terminates in accordance with the terms of the contract or if payment from the subscriber is deemed uncollectible. 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 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 holds back a portion of the purchase price for every account purchased, typically 5-10%. In some cases, the amount of the purchase holdback may be less than actual attrition experience.
Adjusted EBITDA
Beginning in the first quarter of 2011, Ascent Capital changed one of the key financial measures that it uses to evaluate its performance. Ascent Capital now uses 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, non-cash or non-recurring restructuring charges and stock-based and other non-cash long-term incentive compensation (which is referred to as “Adjusted EBITDA”) instead of adjusted operating income before depreciation and amortization, and stock-based and other non-cash long-term incentive compensation (which is referred to as “Adjusted OIBDA”). Ascent Capital made this change as a result of the sale of most of its historical operating subsidiaries and the acquisition of Monitronics, a security alarm monitoring company, which is now its primary operating subsidiary. Financial information for prior periods has been revised to retrospectively reflect Ascent Capital’s change in this financial measure.
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 covenants are calculated under the agreements governing Monitronics’ debt obligations. Adjusted EBITDA does not represent cash flow from operations as defined by generally accepted accounting principles, 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.
Amortization of Subscriber Accounts and Dealer Network . Amortization expense was $159,619,000 and $5,980,000 for the years ended December 31, 2011 and 2010, respectively. For 2011, the increase in amortization expense of $153,639,000 is primarily due to a full year’s amortization occurring in 2011 as compared to 15 days in 2010. The Company had no such assets in 2009, thus no amortization was recorded for that year.
Restructuring Charges. During 2011, 2010 and 2009, we completed certain restructuring activities and recorded charges of $4,258,000, $4,604,000 and $695,000, respectively, which relate to our continuing operations.
In the fourth quarter of 2010, we began a new restructuring plan (the “2010 Restructuring Plan”) in conjunction with the expected sales of the Creative/Media and Content Distribution businesses. The 2010 Restructuring Plan was implemented to meet the changing strategic needs of the Company as we sold most of our media and entertainment services assets and acquired Monitronics, an alarm monitoring business. Such charges included retention costs for employees to remain employed until the sales are complete, severance costs for certain employees that were not retained by the buyers and facility costs that were no longer being used by us due to the sales.
Before we implemented the 2010 Restructuring Plan, we had just completed a restructuring plan that was implemented in 2008 and concluded in September 2010 (the “2008 Restructuring Plan”). The 2008 Restructuring Plan was implemented to align our organization with our strategic goals and how we operate, manage and market our services. The 2008 Restructuring Plan charges included severance costs from labor cost mitigation measures undertaken across all of the businesses and facility costs in conjunction with the consolidation of certain facilities in the United Kingdom and the closing of our Mexico operations.
Liquidity and Capital Resources
At December 31, 2011, we have $183,558,000 of cash and cash equivalents, $31,196,000 of current restricted cash, and $40,377,000 of marketable securities. We may use a portion of these assets to decrease debt obligations, fund stock repurchases, or fund potential strategic acquisitions or investment opportunities.
Additionally, our other source of funds is our cash flows from operating activities. In 2011, the operating cash flows were primarily generated from the operations of Monitronics, which was acquired in December 2010. In 2010 and in prior years, the operating cash flows were primarily generated from the Creative/Media, Content Distribution and Systems Integration businesses. Since we have sold both the Creative/Media and Content Distribution business and shutdown the operations of the Systems Integration business, future operating cash flows will be generated almost entirely from the operations of Monitronics. During the years ended December 31, 2011, 2010 and 2009, our cash flow from operating activities was $131,238,000, $50,300,000 and $35,974,000, respectively. The primary driver of our cash flow from operating activities is Adjusted EBITDA. Fluctuations in our Adjusted EBITDA are 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, 2011 and 2010, we used cash of $162,714,000 and $4,214,000, respectively, to fund purchases of subscriber accounts. In addition, during the years ended December 31, 2011, 2010 and 2009, we used cash of $4,242,000, $139,000 and $1,420,000, respectively, to fund our capital expenditures. In December 2010, we paid cash of $388,401,000 to acquire Monitronics, net of Monitronics cash on hand of $7,475,000, to fund a portion of the purchase price on Monitronics.
On June 16, 2011, our Board of Directors authorized the repurchase of up to $25,000,000 of our Series A common stock. During 2011, we repurchased 269,659 shares of our Series A common stock at an average purchase price of $42.60 per share for a total of approximately $11,488,000 pursuant to this authorization. These shares were returned to authorized and unissued, reducing the number of our shares outstanding.
During 2011, we purchased marketable securities primarily consisting of diversified corporate bond funds for cash of $40,253,000 in order to improve our investment rate of return. During 2010, we purchased marketable securities consisting of diversified corporate bond funds for cash of $41,757,000 and sold all of the marketable securities we held in December 2010 for cash proceeds of $96,685,000 to fund the acquisition of Monitronics. During 2009, we purchased marketable securities consisting of diversified corporate bond funds for cash of $68,126,000 in order to improve our investment rate of return. We sold a portion of these securities for cash proceeds of $16,309,000.
As part of the Monitronics acquisition, we assumed Monitronics long-term debt with a principal balance of $838 million at December 31, 2010. Such indebtedness is the obligation of Monitronics and certain of its subsidiaries and is not guaranteed by us or any of our other subsidiaries. In addition to the Monitronics’ cash on hand, we also acquired restricted cash which totaled $51 million at December 31, 2010. Also, in order to partially fund the cash consideration used for the Monitronics acquisition, Monitronics entered into a Credit Agreement with the lenders party thereto and Bank of America, N.A., as administrative agent (the “Credit Facility”). The Credit Facility provides a $60,000,000 term loan and an $115,000,000 revolving credit facility, under which Monitronics has borrowed $65,300,000 as of December 31, 2011. The term loan matures on June 30, 2012, and requires principal installments of $20,000,000 on the first day of business on or after December 31, 2011 and March 31, 2012. The revolving credit facility matures on December 17, 2013. The Credit Facility is currently subject to certain financial and nonfinancial covenants which include maximum leverage ratios and minimum fixed charge coverage ratios, and beginning June 30, 2012 will become subject to a recurring monthly revenue leverage ratio. Ascent Capital guaranteed $30,000,000 of the aggregate principal amount of the term loan outstanding under the Credit Facility.
In considering our liquidity requirements for 2012, we evaluated our known future commitments and obligations. We will require the availability of funds to finance the strategy of Monitronics, our primary operating subsidiary, which is to grow through subscriber account purchases. In addition, additional cash will be needed to meet Monitronics’ debt service obligations on its long-term debt, any settlement of Monitronics’ derivative financial instruments in advance of their scheduled terms, and capital expenditures. We also considered the expected cash flow from Monitronics, as this business will be the primary driver of our operating cash flows. In addition, we considered the borrowing capacity of Monitronics’ Credit Facility, under which Monitronics could borrow approximately $49,700,000 as of December 31, 2011. Based on this analysis, we expect that cash on hand, cash flow generated from operations and borrowings under the Monitronics’ Credit Facility will provide sufficient liquidity, given our anticipated current and future requirements.
The existing long-term debt of Monitronics at December 31, 2011 includes the principal balance of $838 million under a securitization facility. The Class A-1 term notes issued under the securitization facility in the aggregate outstanding principal amount of $450,000,000 are due in full on July 15, 2027; all other notes issued under the facility, including the variable funding notes described below, are due on July 15, 2037. However, certain terms of such securitization facility may impact our liquidity and capital structure in 2012.
As of December 31, 2011, alarm monitoring agreements for approximately 616,000 of Monitronics subscriber accounts are owned by Monitronics Funding LP, a subsidiary of Monitronics, which we refer to as “Funding”. Such alarm monitoring agreements, and the monthly recurring revenue and other proceeds thereof, are pledged as collateral to secure the obligations of Monitronics under the securitization facility. Under the terms of such facility, Issuer currently pays Monitronics Security LP (another subsidiary of Monitronics, which we refer to as “Security”) for monitoring and servicing the subscriber accounts owned by Funding, at an effective rate of $12.00 per active subscriber account plus reimbursement for field service costs related to customer moves and certain cellular monitoring cost. Fees paid from Funding to Security can be distributed to Monitronics, but cash balances at Funding must be used to service the securitization indebtedness. As the servicing fees paid by Funding to Security currently exceed the aggregate out-of-pocket costs of monitoring and servicing such subscriber accounts, the amount of such excess is available to Monitronics for other corporate purposes, including the purchase of additional subscriber accounts. However, under the terms of the securitization facility, effective July 2012, the amount of the servicing fees payable by Funding to Security will decrease from an effective rate of $12.00 per active subscriber account to $7.50 per active subscriber account and the reimbursement for field service costs related to customer moves and certain cellular monitoring cost will be eliminated. This decrease will substantially reduce or eliminate the excess cash available to Security for distribution to Monitronics. Accordingly, if Monitronics does not repay or refinance the securitization facility by July 2012, the decrease in fees could have a substantially adverse effect on our liquidity and reduce the capital resources available to Monitronics for purchasing alarm monitoring accounts. Monitronics is currently exploring opportunities to refinance or amend the terms of its securitization facility to avoid such potential adverse effects on its liquidity and capital resources. While we expect Monitronics will be able to refinance or amend the terms of the securitization facility before July 2012, there can be no assurances that such a refinancing or amendment will be available to Monitronics on terms acceptable to us, or on any terms.
In addition, if Monitronics does not repay or refinance the securitization facility by July 2012, contingent additional interest will begin to accrue at the rate of 5% per annum (including 0.5% of fees) on the two variable funding notes (or “VFNs”) under the securitization facility, which have an aggregate principal balance of $288,000,000. The effective interest rate payable by Monitroinics under $550 million notional amount of swaps relating to the term notes under the securitization facility would also increase by 5% per annum (including 0.5% of fees) beginning July 2012, if such swaps are then outstanding. Although such additional interest will not be payable in cash until all of the securitization debt has been paid off, the accrued amount would reduce the borrowing base available to Monitronics under its new credit facility and may indirectly reduce Monitronics’ ability to acquire new subscriber accounts.
We may seek external equity or 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 equity or 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.
MANAGEMENT DISCUSSION FOR LATEST QUARTER
Overview
Ascent Capital Group, Inc. 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 and other events through security systems at subscribers’ premises. Nearly all of its revenues are derived from monthly recurring revenues under security alarm monitoring contracts purchased from independent dealers in its exclusive nationwide network.
Attrition
Account cancellation, otherwise referred to as subscriber attrition, has a direct impact on the number of subscribers that Monitronics serves 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 may terminate their contract for a variety of reasons, including relocation, cost, and switching to a competitors’ 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 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 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.
Adjusted EBITDA
Ascent Capital defines “Adjusted EBITDA” as net income 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 businesses, including the businesses’ ability to fund their ongoing acquisition of subscriber accounts, their capital expenditures and to service their 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, 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.
Net revenue. Net revenue increased $5,738,000, or 7.4%, and $13,719,000, or 9.1%, for the three and six months ended June 30, 2012, respectively, as compared to the corresponding prior year periods. The increase in net revenue is attributable to an increase in the number of subscriber accounts from 688,119 as of June 30, 2011 to 711,832 as of June 30, 2012. In addition, average monthly revenue per subscriber increased from $36.80 as of June 30, 2011 to $37.97 as of June 30, 2012. The increase in net revenue for the six months ended June 30, 2012 is also attributable to a $2,295,000 fair value adjustment, associated with deferred revenue acquired in the Monitronics acquisition, which reduced net revenue for the six months ended June 30, 2011.
Cost of services . Cost of services increased $1,794,000, or 18.7%, and $3,723,000, or 19.9%, for the three and six months ended June 30, 2012, 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, which result in higher telecommunications and service costs. Cost of services as a percent of net revenue increased to 13.7% and 13.6% for the three and six months ended June 30, 2012, respectively, as compared to 12.4% for the three and six months ended June 30, 2011.
Selling, general and administrative. Selling, general and administrative costs (“SG&A”) decreased $436,000, or 2.4%, and $2,586,000, or 6.7%, for the three and six months ended June 30, 2012, respectively, as compared to the corresponding prior year periods. The decrease is primarily attributable to decreased administrative and corporate expenses as a result of the sale of the Content Distribution business and shutdown of the Systems Integration business in 2011. The decrease was partially offset by an increase in Monitronics SG&A costs and stock-based compensation expense. The increased Monitronics SG&A costs are attributable to increased payroll and marketing expenses of $517,000 and $937,000 for the three and six months ended June 30, 2012, respectively, as compared to prior year corresponding periods. Stock-based compensation expense increased $85,000 to $1,271,000 for the three months ended June 30, 2012 and increased $750,000 to $2,563,000 for the six months ended June 30, 2012. The increase in stock-based compensation expense is related to restricted stock and stock option awards granted to certain employees and directors during 2011 and 2012. SG&A as a percent of net revenue decreased from 23.8% for the three months ended June 30, 2011 to 21.6% for the three months ended June 30, 2012 and decreased from 25.4% for the six months ended June 30, 2011 to 21.7% for the six months ended June 30, 2012
Amortization of subscriber accounts and dealer network. Amortization of subscriber accounts and dealer networks increased $324,000 and $689,000 for the three and six months ended June 30, 2012, respectively, as compared to the corresponding prior year periods. The increase in subscriber account amortization is primarily attributable to increased subscribers as compared to the prior year corresponding periods.
Restructuring Charges. The Company recorded restructuring charges from continuing operations of $407,000 and $4,186,000 for the three and six months ended June 30, 2011, respectively. There were no restructuring charges recorded during the three and six months ended June 30, 2012.
In the fourth quarter of 2010, we began a new restructuring plan (the “2010 Restructuring Plan) in conjunction with the expected sales of the Creative/Media and Content Distribution businesses. The 2010 Restructuring Plan was implemented to meet the changing strategic needs of the Company as we sold most of our media and entertainment services assets and acquired Monitronics, an alarm monitoring business. Such changes include retention costs for corporate employees to remain employed until the sales were complete, severance costs for certain employees and costs for facilities that were no longer being used by us due to the Creative/Media and Content Distribution sales.
Before we implemented the 2010 Restructuring Plan, we had just completed a restructuring plan that was implemented in 2008 and concluded in September 2010 (the “2008 Restructuring Plan”). The 2008 Restructuring Plan was implemented to align our organization with our strategic goals and how we operated, managed and sold our services. The 2008 Restructuring Plan charges included severance costs from labor cost mitigation measures undertaken across all of the businesses and facility costs in conjunction with the consolidation of certain facilities in the United Kingdom and the closing of our Mexico operations.
Loss (gain) on the sale of assets . 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. In addition, during the six months ended June 30, 2012, the Company sold its 50% interest in an equity method investment for $1,420,000 resulting in a pre-tax loss of $532,000. During the six months ended June 30, 2011, the Company disposed of certain property and equipment resulting in a pre-tax loss of $459,000.
Interest Expense. Interest expense increased $8,922,000 and $10,161,000 for the three and six months ended June 30, 2012, respectively, as compared to the corresponding prior year periods. The increase in 2012 interest expense as compared to the respective prior year period is primarily due to the presentation of interest cost related to the Company’s current derivative instrument. Interest cost related to the Company’s current derivative instrument is presented in Interest expense on the statement of operations as the related derivative instrument is an effective 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). In addition, the increase in interest expense is due to the increase in debt and the increase in interest rates associated with the Senior Notes and Credit Facility as compared to the Company’s prior debt obligations. Interest expense for the three and six months ended June 30, 2012 includes amortization of debt discount of $186,000 and $4,101,000, respectively. Interest expense for the three and six months ended June 30, 2011 includes amortization of debt discount of $4,228,000 and $8,331,000, respectively.
Realized and unrealized loss on derivative financial instruments. Realized and unrealized loss on derivative financial instruments for the three and six months ended June 30, 2012 was $0 and $2,044,000, respectively . Realized and unrealized loss on derivative financial instruments for the three and six months ended June 30, 2011 was $5,833,000 and $6,307,000, respectively. For the three and six months ended June 30, 2012, the realized and unrealized loss on derivative financial instruments 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 these derivatives prior to their termination on March 23, 2012. For the three months ended June 30, 2011, the realized and unrealized loss on derivative financial instruments includes settlement payments of $9,431,000 partially offset by a $3,598,000 unrealized gain related to the change in the fair value of these derivatives. For the six months ended June 30, 2011, the realized and unrealized loss on derivative financial instruments includes settlement payments of $19,066,000 partially offset by a $12,759,000 unrealized gain related to the change in the fair value of these derivatives.
Income tax benefit (expense) from continuing operations. The Company had a pre-tax loss from continuing operations of $4,996,000 and $9,243,000 for the three months and six months ended June 30, 2012, respectively, and an income tax expense of $765,000 and $1,448,000 for the three and six months ended June 30, 2012, respectively. The Company had a pre-tax loss from continuing operations of $6,712,000 and $15,272,000 for the three months and six months ended June 30, 2011, respectively, and an income tax benefit of $1,783,000 and $3,289,000 for the three and six months ended June 30, 2012, respectively. The Company recorded charges of $3,263,000 and $1,943,000 to increase the valuation allowance which reduced our net income tax benefit (expense) from continuing operations for the six months ended June 30, 2012 and 2011, respectively.
Discontinued Operations
During the three and six months ended June 30, 2012, the Company recorded additional costs of approximately $1,506,000 and $1,790,000, respectively, related to contract termination and other loss contingencies associated with discontinued operations.
As of June 30, 2011, Ascent Capital shut down the operations of the Systems Integration business. In connection with ceasing its operations, the Company recorded exit costs of $1,119,000 related to employee severance. The operations of the Systems integration business has been treated as a discontinued operation in the condensed consolidated financial statements for all applicable periods presented.
On February 28, 2011, Ascent Capital completed the sale of 100% of the Content Distribution business to Encompass. Ascent Capital received cash proceeds of approximately $104,000,000. Ascent Capital recorded a gain on the sale of $66,136,000 and the related income tax expense of $2,906,000 for the quarter ended March 31, 2011. The Content Distribution business has been treated as a discontinued operation in the condensed consolidated financial statements for all applicable periods presented.
Liquidity and Capital Resources
At June 30, 2012, we had $84,448,000 of cash and cash equivalents, $7,717,000 of current restricted cash, and $140,637,000 of marketable securities on a consolidated basis. We may use a portion of these assets to decrease debt obligations, fund stock repurchases, or fund potential strategic acquisitions or investment opportunities.
Additionally, our other source of funds is our cash flows from operating activities which are primarily generated from the operations of Monitronics. During the six months ended June 30, 2012 and 2011, our cash flow from operating activities was $79,107,000 and $59,823,000, respectively. The primary driver of our cash flow from operating activities is Adjusted EBITDA. Fluctuations in our Adjusted EBITDA and the components of that measure are 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 six months ended June 30, 2012 and 2011, the Company used cash of $78,885,000 and $76,336,000, respectively, to fund purchases of subscriber accounts net of holdback and guarantee obligations. In addition, during the six months ended June 30, 2012 and 2011, the Company used cash of $2,657,000 and $1,779,000, respectively, to fund our capital expenditures. In order to improve our investment rate of return, the Company purchased marketable securities consisting primarily of diversified corporate bond funds for cash of $99,667,000 during the six months ended June 30, 2012.
In considering our liquidity requirements for 2012, we evaluated our known future commitments and obligations. We will require the availability of funds to finance the strategy of Monitronics, our primary operating subsidiary, which is to grow through subscriber account purchases. We also considered the expected cash flow from Monitronics, as this business is the driver of our operating cash flows. In addition, we considered the borrowing capacity under Monitronics’ new Credit Facility, under which Monitronics could borrow $150,000,000. Based on this analysis, we expect that cash on hand, cash flow generated from operations and borrowings under the Monitronics’ Credit Facility will provide sufficient liquidity to fund our anticipated current requirements.
The existing long-term debt of Monitronics at June 30, 2012 includes the principal balance of $958,625,000 under its Senior Notes and Credit Facility. The Senior Notes have an outstanding principal balance of $410,000,000 as of June 30, 2012 and mature on April 1, 2020. The Credit Facility term loan has an outstanding principal balance of $548,625,000 as of June 30, 2012 and requires principal payments of $1,375,000 per quarter with the remaining outstanding balance becoming due on March 23, 2018.
We may seek external equity or 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 equity or debt financing on terms that would be acceptable to us. 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.
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Fund Letters
