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TMCNet:  MONITRONICS INTERNATIONAL INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.

[August 13, 2014]

MONITRONICS INTERNATIONAL INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations.

(Edgar Glimpses Via Acquire Media NewsEdge) 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, integration of acquired assets and businesses, 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: • 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 the Company's largest demographic; • uncertainties in the development of the Company's business strategies, including market acceptance of new products and services; • the competitive environment in which the Company operates, in particular increasing competition in the alarm monitoring industry from larger existing competitors and new market entrants, including telecommunications and cable companies; • the development of new services or service innovations by competitors; • the Company's 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; • integration of acquired assets and businesses, including Security Networks; • the regulatory environment in which the Company operates, including the multiplicity of jurisdictions and licensing requirements to which it 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, including the phase-out of 2G networks by cellular carriers; • the trend away from the use of public switched telephone network lines and resultant increase in servicing costs associated with alternative methods of communication; • the operating performance of the Company's network, including the potential for service disruptions at both the main monitoring facility and back-up monitoring facility due to acts of nature or technology deficiencies; • the outcome of any pending, threatened, or future litigation, including potential liability for failure to respond adequately to alarm activations; • the 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 business partners; • the reliability and creditworthiness of the Company's independent alarm systems dealers and subscribers; • changes in the Company's expected rate of subscriber attrition; • the availability and terms of capital, including the ability to obtain additional funds to grow its business; • the Company's high degree of leverage and the restrictive covenants governing its indebtedness; and • availability of qualified personnel.


For additional risk factors, please see Part I, Item 1A, Risk Factors, in the 2013 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 2013 Form 10-K.

14-------------------------------------------------------------------------------- Table of Contents Overview The Company provides security alarm monitoring and related services to residential and business subscribers throughout the United States and parts of Canada. On August 16, 2013, the Company acquired all of the equity interests of Security Networks LLC ("Security Networks") and certain affiliated entities (the "Security Networks Acquisition"). The Company 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 the Company's revenues are derived from recurring monthly 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 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 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. The Company 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. The Company 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, this is also not a cancellation. The Company 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 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 5-10% of subscriber accounts in the guarantee period. In some cases, the amount of the holdback liability may be less than actual attrition experience.

The table below presents subscriber data for the twelve months ended June 30, 2014 and 2013: Twelve Months Ended June 30, 2014 2013 Beginning balance of accounts 838,723 711,832 Accounts acquired 352,973 228,040 Accounts canceled (125,096 ) (98,107 ) Canceled accounts guaranteed by dealer and acquisition adjustments (a) (b) (10,494 ) (3,042 ) Ending balance of accounts 1,056,106 838,723 Monthly weighted average accounts 1,014,902 787,735 Attrition rate (12.3 )% (12.5 )% (a) Canceled accounts that are contractually guaranteed to be refunded from holdback.

(b) Includes a net reduction of 561 subscriber accounts related to the Security Networks Acquisition. These acquisition adjustments include 2,064 subscriber accounts that were proactively canceled following the acquisition of Security Networks in August 2013 because they were active with both Monitronics and Security Networks. The impact of these cancellations was partially offset by a favorable adjustment of 1,503 accounts associated with multi-site subscribers that were considered single accounts prior to the completion of the Security Networks integration in April 2014.

We analyze our attrition by classifying accounts into annual pools based on the year of acquisition. We then track the number of accounts that cancel 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, in recent years we have 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 us. 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 15-------------------------------------------------------------------------------- Table of Contents 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.

Accounts Acquired During the three months ended June 30, 2014 and 2013, the Company acquired 42,851 and 47,733 subscriber accounts, respectively. During the six months ended June 30, 2014 and 2013, the Company acquired 74,625 and 76,193 subscriber accounts, respectively. Acquired contracts for the three and six months ended June 30, 2014 reflect a bulk buy of approximately 2,900 accounts purchased in the second quarter of 2014. Acquired contracts 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.

Acquired contracts for the twelve months ended June 30, 2014 includes 203,898 accounts acquired in the Security Networks Acquisition, which was completed on August 16, 2013, and approximately 2,900 accounts purchased in a bulk buy in the second quarter of 2014. In addition, subscriber accounts acquired for the twelve months ended June 30, 2013 include approximately 111,200 accounts purchased in various bulk buys throughout the period.

Recurring monthly revenue ("RMR") acquired during the three months ended June 30, 2014 and 2013 was approximately $1,948,000 and $2,090,000, respectively. RMR acquired during the six months ended June 30, 2014 and 2013 was approximately $3,399,000 and $3,367,000, respectively.

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, dealer network and other intangible assets), restructuring charges, stock-based compensation, and other non-cash or nonrecurring charges. The Company 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 the Company's covenants are calculated under the agreements governing its 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 the Company 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 Monitronics should not be compared to any similarly titled measures reported by other companies.

16-------------------------------------------------------------------------------- Table of Contents 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 June 30, Six Months Ended June 30, 2014 2013 2014 2013 Net revenue $ 134,696 102,273 $ 267,560 202,431 Cost of services 22,982 15,594 45,072 30,796 Selling, general, and administrative 23,127 18,113 46,099 34,016 Amortization of subscriber accounts, dealer network and other intangible assets 63,261 45,998 125,041 90,313 Restructuring charges 371 - 918 - Interest expense 29,638 19,466 58,982 40,593 Income tax expense 1,713 791 3,312 1,565 Net income (loss) (8,525 ) 592 (16,376 ) 1,941 Adjusted EBITDA (a) $ 90,261 70,408 $ 179,536 139,822 Adjusted EBITDA as a percentage of Net Revenue 67.0 % 68.8 % 67.1 % 69.1 % (a) See reconciliation to net income (loss) below.

Net revenue. Net revenue increased $32,423,000, or 31.7%, and $65,129,000, or 32.2%, for the three and six months ended June 30, 2014 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 increase in average RMR per subscriber. The growth in subscriber accounts reflects the effects of the Security Networks Acquisition in August 2013, which included over 200,000 subscriber accounts, and the acquisition of over 146,000 accounts through the Company's authorized dealer program subsequent to June 30, 2013. In addition, average monthly revenue per subscriber increased from $39.98 as of June 30, 2013 to $41.26 as of June 30, 2014.

Cost of services. Cost of services increased $7,388,000, or 47.4%, and $14,276,000, or 46.4%, for the three and six months ended June 30, 2014 as compared to the corresponding prior year periods. The increase is primarily attributable to subscriber growth over the last twelve months, as well as increases in cellular and service costs. Cellular costs have increased due to more accounts being monitored across the cellular network, which often include interactive and home automation services. This has also resulted in higher service costs as existing subscribers upgrade their systems. Cost of services as a percent of net revenue increased from 15.2% for both the three and six months ended June 30, 2013 to 17.1% and 16.8% for the three and six months ended June 30, 2014, respectively.

Selling, general and administrative. Selling, general and administrative costs ("SG&A") increased $5,014,000, or 27.7%, and $12,083,000, or 35.5%, for the three and six months ended June 30, 2014 as compared to the corresponding prior year periods. The increase is attributable to subscriber growth over the last twelve months and redundant staffing and operating costs at our Dallas, Texas headquarters in advance of transitioning Security Networks' operations from Florida to Texas. This transition was completed in April 2014. In addition, the Company incurred integration costs of $1,123,000 and $2,182,000 for the three and six months ended June 30, 2014, respectively, which primarily were for professional services rendered related to the transition. SG&A as a percent of net revenue decreased from 17.7% for the three months ended June 30, 2013 to 17.2% for the three months ended June 30, 2014. SG&A as a percent of net revenue increased from 16.8% for the six months ended June 30, 2013 to 17.2% for the six months ended June 30, 2014.

Amortization of subscriber accounts, dealer network and other intangible assets. Amortization of subscriber accounts, dealer network and other intangible assets increased $17,263,000 and $34,728,000 for the three and six months ended June 30, 2014 as compared to the corresponding prior year periods. The increase is attributable to amortization of subscriber accounts acquired subsequent to June 30, 2013, including amortization of approximately $15,313,000 and $31,830,000 for the three and six months ended June 30, 2014, respectively, related to the definite lived intangible assets acquired in the Security Networks Acquisition.

17-------------------------------------------------------------------------------- Table of Contents Restructuring charges. In connection with the Security Networks Acquisition, management approved a restructuring plan to transition Security Networks' operations in West Palm Beach and Kissimmee, Florida to Dallas, Texas (the "2013 Restructuring Plan"). The 2013 Restructuring Plan provides certain employees with a severance package that entitles them to receive benefits upon completion of the transition in 2014. Severance costs related to the 2013 Restructuring Plan were recognized ratably over the future service period. During the three and six months ended June 30, 2014, the Company recorded $371,000 and $918,000, respectively, of restructuring charges related to employee termination benefits under the 2013 Restructuring Plan. The transition of Security Networks' operations to Dallas was completed in the second quarter of 2014.

There were no restructuring charges recorded in continuing operations for the three and six months ended June 30, 2013.

The following table provides the activity and balance of the Company's restructuring plan (amounts in thousands): December 31, 2013 Additions Payments June 30, 2014 2013 Restructuring Plan Severance and retention $ 1,570 918 (2,042 ) 446 Interest expense. Interest expense increased $10,172,000 and $18,389,000 for the three and six months ended June 30, 2014 as compared to the corresponding prior year periods. The increases in interest expense is primarily attributable to increases in the Company's consolidated debt balance related to the borrowings incurred to fund the Security Networks Acquisition. For the six months ending June 30, 2014, the increase is partially offset by the favorable repricing of Monitronics credit facility interest rates effective March 25, 2013.

Income tax expense. The Company had a pre-tax loss of $6,812,000 and $13,064,000 for the three and six months ended June 30, 2014, respectively, and income tax expense of $1,713,000 and $3,312,000 for the three and six months ended June 30, 2014, respectively. The Company had pre-tax income of $1,383,000 and $3,506,000 for the three and six months ended June 30, 2013, respectively, and income tax expense of $791,000 and $1,565,000 for the three and six months ended June 30, 2013. Income tax expense for the three and six months ended June 30, 2014 is attributable to Texas state margin tax incurred on the Company's operations and the deferred tax impact from amortization of deductible goodwill related to the Security Networks Acquisition. Income tax expense for the three and six months ended June 30, 2013 is primarily attributable to Texas state margin tax incurred on the Company's operations.

Adjusted EBITDA. The following table provides a reconciliation of total Adjusted EBITDA to net income (loss) for the periods indicated (amounts in thousands): Three Months Ended Six Months Ended June 30, June 30, 2014 2013 2014 2013 Total Adjusted EBITDA $ 90,261 70,408 $ 179,536 139,822 Amortization of subscriber accounts, dealer network and other intangible assets (63,261 ) (45,998 ) (125,041 ) (90,313 ) Depreciation (2,198 ) (1,721 ) (4,581 ) (3,209 ) Stock-based compensation (482 ) (402 ) (896 ) (763 ) Restructuring charges (371 ) - (918 ) - Security Networks acquisition related costs - (1,438 ) - (1,438 ) Security Networks integration related costs (1,123 ) - (2,182 ) - Interest expense (29,638 ) (19,466 ) (58,982 ) (40,593 ) Income tax expense (1,713 ) (791 ) (3,312 ) (1,565 ) Net income (loss) $ (8,525 ) 592 $ (16,376 ) 1,941 Adjusted EBITDA increased $19,853,000, or 28.2%, and $39,714,000, or 28.4% for the three and six months ended June 30, 2014 as compared to the respective prior year periods. The increase in Adjusted EBITDA was primarily due to revenue growth.

Liquidity and Capital Resources At June 30, 2014, we had $6,099,000 of cash and cash equivalents and $112,000 of current restricted cash. Our primary sources of funds are our cash flows from operating activities which are generated from alarm monitoring and related service revenues. During the six months ended June 30, 2014 and 2013, our cash flow from operating activities was $114,357,000 and 18-------------------------------------------------------------------------------- Table of Contents $100,714,000, 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, 2014 and 2013, the Company used cash of $126,640,000 and $113,199,000, respectively, to fund subscriber account acquisitions, net of holdback and guarantee obligations. In addition, during the six months ended June 30, 2014 and 2013, the Company used cash of $3,212,000 and $3,978,000, respectively, to fund its capital expenditures.

In considering our liquidity requirements for 2014, 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.

Additionally, as a result of announcements by AT&T and certain other telecommunication providers that they intend to discontinue 2G services in the near future, we expect to incur expenditures over the next few years as we replace the 2G equipment used in many of our subscribers' security systems.

Costs incurred and subscriber attrition resulting from the 2G phase-out will, to some extent, be dependent on the level of advance notice received from the telecommunication providers. We expect costs associated with the phase-out to be relatively small in 2014 and then increase in 2015 and 2016. In addition, we considered the borrowing capacity of our Credit Facility revolver, under which we could borrow an additional $183,500,000 as of June 30, 2014. Based on this analysis, we expect that cash on hand, cash flow generated from operations and borrowings under our Credit Facility will provide sufficient liquidity, given our anticipated current and future requirements.

The existing long-term debt at June 30, 2014 includes the principal balance of $1,629,382,000 under our Senior Notes, the Ascent Intercompany Loan, our Credit Facility, and our Credit Facility revolver. The Senior Notes have an outstanding principal balance of $585,000,000 as of June 30, 2014 and mature on April 1, 2020. The Ascent Intercompany Loan has an outstanding principal balance of $100,000,000 and matures on October 1, 2020. The Credit Facility term loans have an outstanding principal balance of $902,882,000 as of June 30, 2014 and require principal payments of approximately $2,292,000 per quarter with the remaining outstanding balance becoming due on March 23, 2018. The Credit Facility revolver has an outstanding balance of $41,500,000 as of June 30, 2014 and becomes due on December 22, 2017.

We may seek capital contributions from Ascent Capital 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 capital contributions from Ascent Capital 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.

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