HEMISPHERE MEDIA GROUP, INC. - Quarter Report: 2018 September (Form 10-Q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2018

 

or

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                    to                    

 

Commission file number: 001-35886

 

HEMISPHERE MEDIA GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

(305) 421-6364

(Registrant’s telephone number, including area code)

 

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x

 

Class of Stock		Shares Outstanding as of November 5, 2018
Class A common stock, par value $0.0001 per share		19,624,028 shares
Class B common stock, par value $0.0001 per share		19,720,381 shares

 

 

 

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HEMISPHERE MEDIA GROUP, INC. AND SUBSIDIARIES

INDEX TO FORM 10-Q

September 30, 2018

(Unaudited)

 

		PAGE NUMBER
PART I -	FINANCIAL INFORMATION	6
Item 1.	Financial Statements	6
	Notes to Unaudited Condensed Consolidated Financial Statements	11
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	22
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28
Item 4.	Controls and Procedures	29
PART II -	OTHER INFORMATION	30
Item 1.	Legal Proceedings	30
Item 1A.	Risk Factors	30
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	30
Item 3.	Defaults Upon Senior Securities	30
Item 4.	Mine Safety Disclosures	30
Item 5.	Other Information	30
Item 6.	Exhibits	31
SIGNATURES		32

 

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PART I

 

Unless otherwise indicated or the context requires otherwise, in this disclosure, references to the “Company,” “Hemisphere,” “registrant,” “we,” “us” or “our” refers to Hemisphere Media Group, Inc., a Delaware corporation and, where applicable, its consolidated subsidiaries; “Business” refers collectively to our consolidated operations; “Cable Networks” refers to our Networks (as defined below) with the exception of WAPA and WAPA Deportes; “Canal 1” refers to a joint venture among us and Radio Television Interamericana S.A., Compania de Medios de Informacion S.A.S. and NTC Nacional de Television y Comunicaciones S.A. to operate a broadcast television network in Colombia; “Centroamerica TV” refers to HMTV Centroamerica TV, LLC, a Delaware limited liability company; “Cinelatino” refers to Cine Latino, Inc., a Delaware corporation; “Distributors” refers collectively to satellite systems, telephone companies (“telcos”), and cable multiple system operators (“MSO”s), and the MSO’s affiliated regional or individual cable systems; “MVS” refers to Grupo MVS, S.A. de C.V., a Mexican Sociedad Anonima de Capital Variable (variable capital corporation) and its affiliates, as applicable; “Networks” refers collectively to WAPA, WAPA Deportes, WAPA America, Cinelatino, Pasiones, Centroamerica TV and Television Dominicana; “Nielsen” refers to Nielsen Media Research; “Pantaya” refers to Pantaya, LLC, a Delaware limited liability company, a joint venture among us and a subsidiary of Lions Gate Entertainment, Inc.; “Pasiones” refers collectively to HMTV Pasiones US, LLC, a Delaware limited liability company, and HMTV Pasiones LatAm, LLC, a Delaware limited liability company; “REMEZCLA” refers to Remezcla, LLC, a New York limited liability company; “Second Amended Term Loan Facility” refers to our Term Loan Facility amended on February 14, 2017 as set forth on Exhibit 10.6 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2017; “Television Dominicana” refers to HMTV TV Dominicana, LLC, a Delaware limited liability company; “Term Loan Facility” refers to our term loan facility amended on July 31, 2014 as set forth on Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2017; “WAPA” refers to Televicentro of Puerto Rico, LLC, a Delaware limited liability company; “WAPA America” refers to WAPA America, Inc., a Delaware corporation; “WAPA Deportes” refers to a sports television network in Puerto Rico operated by WAPA; “WAPA.TV” refers to a news and entertainment website in Puerto Rico operated by WAPA.

 

FORWARD-LOOKING STATEMENTS

 

CAUTIONARY STATEMENT FOR PURPOSES OF THE “SAFE HARBOR” PROVISIONS OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995.

 

Statements in this Quarterly Report on Form 10-Q (this “Quarterly Report”), including the exhibits attached hereto, future filings by us with the Securities and Exchange Commission, our press releases and oral statements made by, or with the approval of, our authorized personnel, that relate to our future performance or future events, may contain certain statements about Hemisphere Media Group, Inc. (the “Company”) and its consolidated subsidiaries that do not directly or exclusively relate to historical facts. These statements are, or may be deemed to be, “forward-looking statements” within the meaning of the U.S. Private Securities Litigation Reform Act of 1995.

 

These forward-looking statements are necessarily estimates reflecting the best judgment and current expectations, plans, assumptions and beliefs about future events (in each case subject to change) of our senior management and management of our subsidiaries (including target businesses) and involve a number of risks, uncertainties and other factors, some of which may be beyond our control that could cause actual results to differ materially from those expressed or implied in such forward-looking statements. Without limitation, any statements preceded or followed by or that include the words “targets,” “plans,” “believes,” “expects,” “intends,” “will,” “likely,” “may,” “anticipates,” “estimates,” “projects,” “should,” “would,” “expect,” “positioned,” “strategy,” “future,” “potential,” “forecast,” or words, phrases or terms of similar substance or the negative thereof, are forward-looking statements. These include, but are not limited to, the Company’s future financial and operating results (including growth and earnings), plans, objectives, expectations and intentions and other statements that are not historical facts.

 

We claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995 for all forward-looking statements.

 

Forward-looking statements are not guarantees of performance. If one or more of these factors materialize, or if any underlying assumptions prove incorrect, our actual results, performance, or achievements may vary materially from any future results, performance or achievements expressed or implied by these forward-looking statements. In addition to the risk factors described in “Item 1A—Risk Factors” in this Quarterly Report on Form 10-Q, those factors include:

 

·                  the effects of Hurricanes Irma and Maria in the short and long-term on our business, including, without limitation, affiliate fees that we receive and the advertising market in Puerto Rico as well as our customers, employees, third-party vendors and suppliers and the short and long-term migration shifts in Puerto Rico;

 

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·                  our ability to timely and fully recover proceeds under our insurance policies in Puerto Rico following Hurricanes Maria and Irma, including one of our policies with an insurance carrier which was recently placed under an order of rehabilitation;

 

·                  the reaction by advertisers, programming providers, strategic partners, the Federal Communications Commission (the “FCC”) or other government regulators to businesses that we acquire;

 

·                  the potential for viewership of our Networks’ programming to decline or unexpected reductions in the number of subscribers to our Networks;

 

·                  the risk that we may fail to secure sufficient or additional advertising and/or subscription revenue;

 

·                  the inability of advertisers or affiliates to remit payment to us in a timely manner or at all;

 

·                  the risk that we may become responsible for certain liabilities of the businesses that we acquire or joint ventures we enter into;

 

·                  future financial performance, including our ability to obtain additional financing in the future on favorable terms;

 

·                  the failure of our Business to produce projected revenues or cash flows;

 

·                  reduced access to capital markets or significant increases in borrowing costs;

 

·                  our ability to successfully manage relationships with customers and Distributors and other important third parties;

 

·                  continued consolidation of Distributors in the marketplace;

 

·                  a failure to secure affiliate agreements or renewal of such agreements on less favorable terms;

 

·                  disagreements with our Distributors over contract interpretation;

 

·                  our success in acquiring, investing in and integrating complementary businesses;

 

·                  the outcome of any pending or threatened litigation;

 

·                  the loss of key personnel and/or talent or expenditure of a greater amount of resources attracting, retaining and motivating key personnel than in the past;

 

·                  strikes or other union job actions that affect our operations, including, without limitation, failure to renew our collective bargaining agreements on mutually favorable terms;

 

·                  changes in technology, including changes in the distribution and viewing of television programming, expanded deployment of personal video recorders, video on demand, internet protocol television, mobile personal devices and personal tablets and their impact on subscription and television advertising revenue;

 

·                  the failure or destruction of satellites or transmitter facilities that we depend upon to distribute our Networks;

 

·                  uncertainties inherent in the development of new business lines and business strategies;

 

·                  changes in pricing and availability of products and services;

 

·                  uncertainties regarding the financial results of equity method investees and changes in the nature of key strategic relationships with partners and Distributors;

 

·                  changes in domestic and foreign laws or regulations under which we operate;

 

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·                  changes in laws or treaties relating to taxation, or the interpretation thereof, in the U.S. or in the countries in which we operate;

 

·                  the ability of suppliers and vendors to deliver products and services;

 

·                  fluctuations in foreign currency exchange rates and political unrest and regulatory changes in the international markets in which we operate;

 

·                  the deterioration of general economic conditions, either nationally or in the local markets in which we operate, including, without limitation, in the Commonwealth of Puerto Rico;

 

·                  changes in the size of the U.S. Hispanic population, including the impact of federal and state immigration legislation and policies on both the U.S. Hispanic population and persons emigrating from Latin America;

 

·                  changes in, or failure or inability to comply with, government regulations including, without limitation, regulations of the FCC, and adverse outcomes from regulatory proceedings; and

 

·                  competitor responses to our products and services.

 

The list of factors above is illustrative, but by no means exhaustive. All forward-looking statements should be evaluated with the understanding of their inherent uncertainty. All subsequent written and oral forward-looking statements concerning the matters addressed in this Quarterly Report and attributable to us or any person acting on our behalf are qualified by these cautionary statements.

 

The forward-looking statements are based on current expectations about future events and are not guarantees of future performance, and are subject to certain risks, uncertainties and assumptions. Although we believe that the expectations reflected in the forward-looking statements are reasonable, these expectations may not be achieved. We may change our intentions, beliefs or expectations at any time and without notice, based upon any change in our assumptions or otherwise. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

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PART I - FINANCIAL INFORMATION

ITEM I. FINANCIAL STATEMENTS

HEMISPHERE MEDIA GROUP, INC.

Condensed Consolidated Balance Sheets

(amounts in thousands, except share and par value amounts)

 

		September 30,			December 31,
		2018			2017
		(Unaudited)			(Audited)
Assets
Current Assets
Cash		$	95,932		$	124,299
Accounts receivable, net of allowance for doubtful accounts of $2,501 and $2,327, respectively		27,489			20,007
Due from related parties		2,834			2,169
Programming rights		10,400			7,723
Prepaids and other current assets		10,499			12,517
Total current assets		147,154			166,715
Programming rights, net of current portion		14,327			11,520
Property and equipment, net		32,372			24,433
Broadcast license		41,356			41,356
Goodwill		164,887			164,887
Other intangibles, net		41,790			51,661
Deferred income taxes		4,822			4,802
Equity method investments		46,619			30,907
Interest rate swap		3,302			773
Other assets		774			832
Total Assets		$	497,403		$	497,886
Liabilities and Stockholders’ Equity
Current Liabilities
Accounts payable		$	4,236		$	3,465
Due to related parties		3,881			1,885
Accrued agency commissions		3,175			4,064
Accrued compensation and benefits		5,510			5,540
Accrued marketing		5,602			4,997
Other accrued expenses		4,072			3,795
Programming rights payable		3,454			2,920
Investee losses in excess of investment		8,853			2,806
Current portion of long-term debt		1,601			2,133
Total current liabilities		40,384			31,605
Programming rights payable, net of current portion		3,760			1,101
Long-term debt, net of current portion		204,345			205,509
Deferred income taxes		19,089			18,763
Defined benefit pension obligation		2,139			2,004
Total Liabilities		269,717			258,982
Stockholders’ Equity
Preferred stock, $0.0001 par value; 50,000,000 shares authorized; 0 shares issued and outstanding at September 30, 2018 and December 31, 2017		—			—
Class A common stock, $.0001 par value; 100,000,000 shares authorized; 24,831,256 shares and 25,171,433 issued at September 30, 2018 and December 31, 2017, respectively		3			3
Class B common stock, $.0001 par value; 33,000,000 shares authorized; 19,720,381 shares and 20,800,998 issued and outstanding at September 30, 2018 and December 31, 2017		2			2
Additional paid-in capital		268,316			265,329
Treasury stock, at cost 5,591,680 and 5,390,107 at September 30, 2018 and December 31, 2017, respectively		(59,747		)	(57,303		)
Retained earnings		16,682			30,401
Accumulated other comprehensive income		2,430			472
Total Stockholders’ Equity		227,686			238,904
Total Liabilities and Stockholders’ Equity		$	497,403		$	497,886

 

See accompanying notes to Unaudited Condensed Consolidated Financial Statements.

 

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HEMISPHERE MEDIA GROUP, INC.

Condensed Consolidated Statements of Operations

(Unaudited)

(amounts in thousands, except per share amounts)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2018			2017			2018			2017
Net revenues		$	37,239		$	32,173		$	101,065		$	100,512
Operating Expenses:
Cost of revenues		11,039			9,883			31,300			30,426
Selling, general and administrative		11,095			9,510			32,787			28,845
Depreciation and amortization		4,023			4,041			12,040			12,223
Other expenses		193			332			967			3,056
(Gain) from FCC repack and other (gain) loss		(936		)	—			(974		)	2
Total operating expenses		25,414			23,766			76,120			74,552
Operating income		11,825			8,407			24,945			25,960
Other (expenses) income:
Interest expense, net		(3,073		)	(2,863		)	(8,976		)	(8,089		)
Loss on equity method investments		(8,657		)	(2,571		)	(27,278		)	(2,450		)
Gain on insurance proceeds		2,080			—			2,080			—
Loss on impairment of fixed assets		—			(533		)	—			(533		)
Total other expenses, net		(9,650		)	(5,967		)	(34,174		)	(11,072		)
Income (loss) before income taxes		2,175			2,440			(9,229		)	14,888
Income tax expense		(3,229		)	(1,758		)	(4,490		)	(6,280		)
Net (loss) income		$	(1,054	)	$	682		$	(13,719	)	$	8,608
(Loss) earnings per share:
Basic		$	(0.03	)	$	0.02		$	(0.35	)	$	0.21
Diluted		$	(0.03	)	$	0.02		$	(0.35	)	$	0.21
Weighted average shares outstanding:
Basic		38,969			40,398			38,982			40,515
Diluted		38,969			40,925			38,982			40,831

 

See accompanying notes to Unaudited Condensed Consolidated Financial Statements.

 

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HEMISPHERE MEDIA GROUP, INC.

Condensed Consolidated Statement of Comprehensive (Loss) Income

(Unaudited)

(amounts in thousands)

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2018			2017			2018			2017
Net (loss) income		$	(1,054	)	$	682		$	(13,719	)	$	8,608
Change in fair value of interest rate swap, net of income taxes		321			132			1,958			(208		)
Comprehensive (loss) income		$	(733	)	$	814		$	(11,761	)	$	8,400

 

See accompanying notes to Unaudited Condensed Consolidated Financial Statements.

 

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HEMISPHERE MEDIA GROUP, INC.

Condensed Consolidated Statements of Changes in Stockholders’ Equity

Nine Months Ended September 30, 2018

(Unaudited)

(amounts in thousands)

 

																					Accumulated
												Additional			Class A						Other
		Class A Common Stock					Class B Common Stock					Paid-In			Treasury			Retained			Comprehensive
		Shares		Par Value			Shares		Par Value			Capital			Stock			Earnings			Income			Total
Balance at December 31, 2017		25,171		$	3		20,801		$	2		$	265,329		$	(57,303	)	$	30,401		$	472		$	238,904
Net loss		—		—			—		—			—			—			(13,719		)	—			(13,719		)
Stock-based compensation		—		—			—		—			2,967			—			—			—			2,967
Vesting of restricted stock		199		0			—		—			(0		)	(326		)	—			—			(326		)
Repurchases of Class A common Stock		—		—			—		—			—			(2,104		)	—			—			(2,104		)
Forfeiture of Class A common stock earnouts		(544	)	(0		)	—		—			0			—			—			—			—
Forfeiture of Class B common stock earnouts		—		—			(1,081	)	(0		)	0			—			—			—			—
Exercise of warrants		2		0			—		—			20			—			—			—			20
Exercise of options		3		0			—		—			0			(14		)	—			—			(14		)
Other comprehensive income, net of tax		—		—			—		—			—			—			—			1,958			1,958
Balance at September 30, 2018		24,831		$	3		19,720		$	2		$	268,316		$	(59,747	)	$	16,682		$	2,430		$	227,686

 

See accompanying notes to Unaudited Condensed Consolidated Financial Statements.

 

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HEMISPHERE MEDIA GROUP, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited)

(amounts in thousands)

 

		Nine Months Ended September 30,
		2018			2017
Reconciliation of Net (Loss) Income to Net Cash Provided by Operating Activities:
Net (loss) income		$	(13,719	)	$	8,608
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation and amortization		12,040			12,223
Program amortization		8,957			9,572
Amortization of deferred financing costs and original issue discount		440			475
Stock-based compensation		2,967			3,104
Provision for bad debts		174			48
(Gain) loss on disposition of assets		(43		)	2
Loss on equity method investments		27,278			2,450
Deferred tax expense		(265		)	(192		)
Gain from insurance proceeds		(2,080		)	—
Gain from FCC repack		(566		)	—
Loss on impairment of fixed assets		—			533
Changes in assets and liabilities:
Decrease (increase) in:
Accounts receivable		(7,656		)	275
Programming rights		(14,441		)	(13,446		)
Prepaids and other assets		2,076			(345		)
(Decrease) increase in:
Accounts payable		771			1,509
Due to related parties, net		1,331			439
Accrued expenses		(728		)	(5,210		)
Programming rights payable		3,193			1,376
Taxes payable		691			(1,583		)
Other liabilities		135			(249		)
Net cash provided by operating activities		20,555			19,589
Cash Flows From Investing Activities:
Funding of equity method investments		(36,947		)	(26,856		)
Capital expenditures		(10,064		)	(1,979		)
Insurance proceeds		2,080			—
FCC repack proceeds		566			—
Net cash used in investing activities		(44,365		)	(28,835		)
Cash Flows From Financing Activities:
Repayments of long-term debt		(2,133		)	(1,600		)
Financing fees		—			(1,114		)
Purchase of treasury stock		(2,444		)	(11,020		)
Proceeds from exercise of warrants		20			211
Net cash used in financing activities		(4,557		)	(13,523		)
Net decrease in cash		(28,367		)	(22,769		)
Cash:
Beginning		124,299			163,090
Ending		$	95,932		$	140,321
Supplemental Disclosures of Cash Flow Information:
Cash payments for:
Interest		$	8,564		$	7,654
Income taxes		$	8		$	8,268

 

See accompanying notes to Unaudited Condensed Consolidated Financial Statements.

 

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Notes to Condensed Consolidated Financial Statements (Unaudited)

 

Note 1. Nature of business

 

Nature of business:  The accompanying Unaudited Condensed Consolidated Financial Statements include the accounts of Hemisphere Media Group, Inc. (“Hemisphere” or the “Company”), the parent holding company of Cine Latino, Inc. (“Cinelatino”), WAPA Holdings, LLC (formerly known as InterMedia Español Holdings, LLC) (“WAPA Holdings”), and HMTV Cable, Inc., the parent company of the entities for the acquired networks consisting of Pasiones, Television Dominicana, and Centroamerica TV. Hemisphere was incorporated in Delaware on January 16, 2013, and consummated its initial public offering on April 4, 2013. In these notes, the terms “Company,” “we,” “us” or “our” mean Hemisphere and all subsidiaries included in our Unaudited Condensed Consolidated Financial Statements.

 

Basis of presentation:  The accompanying Unaudited Condensed Consolidated Financial Statements for Hemisphere and its subsidiaries have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X.  Accordingly, certain information and note disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to those rules and regulations, although we believe that the disclosures made are adequate to make the information not misleading. In our opinion, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair statement have been included. Our financial condition as of, and operating results, for the three and nine months ended September 30, 2018 are not necessarily indicative of the financial condition or results that may be expected for any future interim period or for the year ending December 31, 2018. These Unaudited Condensed Consolidated Financial Statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2017.

 

Net (loss) earnings per common share:  Basic (loss) earnings per share (“EPS”) are computed by dividing income attributable to common stockholders by the number of weighted-average outstanding shares of common stock.  Diluted EPS reflects the effect of the assumed exercise of stock options and vesting of restricted shares only in the periods in which such effect would have been dilutive.

 

The following table sets forth the computation of the common shares outstanding used in determining basic and diluted EPS (amounts in thousands, except per share amounts):

 

		Three Months Ended September 30,						Nine Months Ended September 30,
		2018			2017			2018			2017
Numerator for (loss) earnings per common share calculation:
Net (loss) income		$	(1,054	)	$	682		$	(13,719	)	$	8,608
Denominator for (loss) earnings per common share calculation:
Weighted-average common shares, basic		38,969			40,398			38,982			40,515
Effect of dilutive securities
Stock options, restricted stock and warrants		—			527			—			316
Weighted-average common shares, diluted		38,969			40,925			38,982			40,831
(Loss) earnings per share
Basic		$	(0.03	)	$	0.02		$	(0.35	)	$	0.21
Diluted		$	(0.03	)	$	0.02		$	(0.35	)	$	0.21

 

We apply the treasury stock method to measure the dilutive effect of our outstanding warrants (for the nine months ended September 30, 2018), stock options and restricted stock awards and include the respective common share equivalents in the denominator of our diluted income per common share calculation. Per the Accounting Standards Codification (“ASC”) 260 accounting guidance, under the treasury stock method, the incremental shares (difference between the number of shares assumed issued and the number of shares assumed purchased) shall be included in the denominator of the diluted EPS computation (ASC 260-10-45-23). The assumed exercise only occurs when the securities are “In the Money” (exercise price is lower than the average market price for the period). If the securities are “Out of the Money” (exercise price is higher than the average market price for the period), the exercise is not assumed since the result would be anti-dilutive. Potentially dilutive securities representing 1.2 million and 1.7 million shares of common stock as of the three and nine months ended September 30, 2018, respectively, were excluded from the computation of diluted income per common share for this period because their effect would have been anti-dilutive. The net (loss) income per share amounts are the same for our Class A common stock, par value $0.0001 per share (“Class A common stock”) and

 

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Class B common stock, par value $0.0001 per share (“Class B common stock”), because the holders of each class are legally entitled to equal per share distributions whether through dividends or in liquidation.

 

As a result of the net loss for the three and nine months ended September 30, 2018, 0.3 million outstanding awards were not included in the computation of diluted earnings per share because their effect was anti-dilutive.

 

Use of estimates:  In preparing these financial statements, management had to make estimates and assumptions that affected the reported amounts of assets and liabilities and the disclosures of contingent assets and liabilities as of the balance sheet dates, and the reported revenues and expenses for the three and nine months ended September 30, 2018 and 2017. Such estimates are based on historical experience and other assumptions that are considered appropriate in the circumstances. However, actual results could differ from those estimates.

 

Recently adopted Accounting Standards: On January 1, 2018, we adopted, on a modified retrospective basis, Financial Accounting Standards Board (the “FASB”) ASC Topic 606, Revenue from Contracts with Customers (“ASC 606”) (the “new revenue standard”), which provides accounting guidance that establishes a new revenue recognition framework in GAAP for all companies and industries. The core principle of the new revenue framework is that an entity should recognize revenue from the transfer of promised goods or services to customers in an amount that reflects the consideration the entity expects to receive for those goods or services. The revenue framework includes a five-step model to determine the timing and amount of revenue to recognize related to contracts with customers. In addition, this revenue framework requires new or expanded disclosures related to the amounts of revenue recognized and judgments made by companies when following this framework.

 

The adoption of the new accounting guidance did not result in changes in the way the Company records affiliate fees, advertising revenue or content licensing fees. Guidance pertaining to the evaluation of whether revenue should be presented on a gross or net basis was changed in connection with the new revenue standard and the application of such change has been made in the presentation of revenues in the consolidated financial statements. The adoption of the new revenue standard did not have a material impact to our unaudited statement of operations for the three and nine months ended September 30, 2018, and did not have a material impact to our unaudited consolidated balance sheet as of September 30, 2018. For more information, see Note 2, “Revenue Recognition” of Notes to Unaudited Condensed Consolidated Financial Statements.

 

Accounting guidance not yet adopted: In June 2018, the FASB issued Accounting Standards Update (“ASU”) 2018-07—Compensation —Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting. The amendments in this ASU apply to any entity that enters into share-based payment transactions with nonemployees. The amendments in this ASU are effective for public business entities for fiscal years beginning after December 15, 2018. Early adoption is permitted, but no earlier than an entity’s adoption date of ASC 606. We are currently evaluating the impact of this Update on our consolidated financial statements.

 

In February 2018, the FASB issued ASU 2018-02—Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of certain tax effects from Accumulated other comprehensive income. The amendments in this ASU apply to any entity that has items of other comprehensive income (“OCI”) for which the related tax effects are presented in OCI, as previously required by GAAP. This ASU allows a one time reclassification from OCI to Retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act enacted on December 22, 2017. The amendments in this ASU are effective for all entities for annual periods beginning after December 31, 2018.  Early adoption is permitted and the effect of the adoption should be reflected as of the beginning of the fiscal year of adoption. We are currently evaluating the impact of this Update on our consolidated financial statements.

 

In August 2017, the FASB issued ASU 2017-12 — Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities.  The amendments in this ASU apply to any entity that elects to apply hedge accounting and is intended to better align an entity’s risk management activities and financial reporting for hedging relationships. The ASU amends effectiveness testing requirements, income statement presentation and disclosures and permits additional risk management strategies to qualify for hedge accounting.  The amendments in this ASU are effective for fiscal years beginning after December 15, 2019.  Early application is permitted; the effect of the adoption should be reflected as of the beginning of the fiscal year of adoption.  We are currently evaluating the impact of this Update on our consolidated financial statements.

 

In February 2016, the FASB issued ASU 2016-02—Leases (Topic 842). ASU 2016-02 amends the FASB ASC, creating Topic 842, Leases. Topic 842 affects any entity that enters into a lease, with specified scope exemptions, and supersedes Topic 840, Leases. The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases, including operating leases. The recognition, measurement and presentation of expenses and cash flows from a lease by a lessee have not changed significantly from previous GAAP. The principle difference from previous guidance is that the assets and liabilities arising from an operating lease should be recognized in the statement of financial position. The guidance will be effective for the first interim

 

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period of our 2019 fiscal year. Early application of the amendments in this update is permitted. We are currently evaluating the impact of this Update on our consolidated financial statements.

 

Note 2. Revenue Recognition

 

We transitioned to the FASB ASC 606, from ASC 605, Revenue Recognition, on January 1, 2018 using the modified retrospective method. Our condensed consolidated financial statements reflect the application of ASC 606 guidance beginning January 1, 2018, while our condensed consolidated financial statements for prior periods were prepared under ASC 605 guidance. There were no cumulative effects of our transition to ASC 606. For more information, see Note 1, “Basis of Presentation” of Notes to Unaudited Condensed Consolidated Financial Statements.

 

The following table presents the revenues disaggregated by revenue source (amounts in thousands):

 

		Three months ended September 30,
Revenues by type		2018			2017
Affiliate fees		$	20,287		$	19,021
Advertising revenue		15,855			12,518
Other revenue		1,097			634
Total revenue		$	37,239		$	32,173

 

		Nine months ended September 30,
Revenues by type		2018			2017
Affiliate fees		$	58,231		$	58,008
Advertising revenue		40,539			40,962
Other revenue		2,295			1,542
Total revenue		$	101,065		$	100,512

 

The following is a description of principal activities from which we generate our revenue:

 

Affiliate fees: We enter into arrangements with multi-channel video distributors, such as cable, satellite and telecommunications companies (referred to as “MVPDs”) to provide a continuous feed of our programming generally based on a per subscriber fee pursuant to multi-year contracts, referred to as “affiliation agreements”, which typically provide for annual rate increases. We have used the practical expedient related to the right to invoice and recognize revenue at the amount to which we have the right to invoice for services performed. The specific affiliate fees we earn vary from period to period, distributor to distributor and also vary among our Networks, but are generally based upon the number of each distributor’s paying subscribers who receive our Networks. Changes in affiliate fees are primarily derived from changes in contractual per subscriber rates charged for our Networks and changes in the number of subscribers. MVPDs report their subscriber numbers to us generally on a two month lag. We record revenue based on estimates of the number of subscribers utilizing the most recently received remittance reporting of each MVPD, which is consistent with our past practice and industry practice.  Revenue is recognized on a month by month basis when the performance obligations to provide service to the MVPDs is satisfied. Payment is typically received within sixty days.

 

Advertising revenue: Advertising revenues are generated from the sale of commercial time, which is typically sold pursuant to sale orders with advertisers providing for an agreed upon commitment and price per spot. We recognize revenue from the sale of advertising as performance obligations are satisfied upon airing of the advertising; therefore, revenue is recognized at a point in time when each advertising spot is transmitted. Agency fees are calculated based on a stated percentage applied to gross billing revenue for our advertising inventory and are reported as a reduction of advertising revenue. Payment is typically due and received within thirty days.

 

Other revenue: Other revenues are derived primarily through the licensing of our content. We enter into agreements to license content and recognize revenue when the performance obligation is satisfied and control is transferred, which is generally upon delivery of the content.

 

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Comparison to amounts if ASC 605 had been in effect

 

The following table reflects the impact of adoption of ASC 606 on our condensed consolidated statements of operations for the three and nine months ended September 30, 2018, and the amounts as if ASC 605 was still in effect (“ASC 605 Presentation”) (amounts in thousands):

 

		Three months ended September 30, 2018
		ASC 606 Reported			Reclassification			ASC 605 Presentation
Net revenues		$	37,239		$	(993	)	$	36,246
Operating expenses		25,414			(993		)	24,421
Operating income		$	11,825		$	—		$	11,825

 

		Nine months ended September 30, 2018
		ASC 606 Reported			Reclassification			ASC 605 Presentation
Net revenues		$	101,065		$	(2,684	)	$	98,381
Operating expenses		76,120			(2,684		)	73,436
Operating income		$	24,945		$	—		$	24,945

 

Note 3. Related party transactions

 

The Company has various agreements with MVS, a Mexican media and television conglomerate, which has directors and stockholders in common with the Company as follows:

 

·                  An agreement through August 1, 2017, pursuant to which MVS provides Cinelatino with satellite and support services including origination, uplinking and satellite delivery of two feeds of Cinelatino’s channel (for U.S. and Latin America), master control and monitoring, dubbing, subtitling and closed captioning, and other support services (the “Satellite and Support Services Agreement”). This agreement was amended on May 20, 2015, to expand the services MVS provides to Cinelatino to include commercial insertion and editing services to support advertising sales on Cinelatino’s U.S. feed. We continue to operate under the terms of this agreement while we negotiate the renewal. Expenses incurred under this agreement are included in cost of revenues in the accompanying unaudited condensed consolidated statements of operations. Total expenses incurred were $0.6 million for each of the three months ended September 30, 2018 and 2017, and $2.0 million and $1.9 million for the nine months ended September 30, 2018 and 2017, respectively. Amounts due to MVS pursuant to the agreements noted above amounted to $3.9 million and $1.9 million at September 30, 2018 and December 31, 2017, respectively.

 

·                  An affiliation agreement through August 1, 2017, for the distribution and exhibition of Cinelatino’s programming service through Dish Mexico (d/b/a Comercializadora de Frecuencias Satelitales, S. de R.L. de C.V.), an MVS affiliate that transmits television programming services throughout Mexico. We continue to operate under the terms of this agreement while we negotiate the renewal. Total revenues recognized were $0.5 million for each of the three months ended September 30, 2018 and 2017, and $1.4 million and $1.6 million for the nine months ended September 30, 2018 and 2017, respectively. Amounts due from Dish Mexico amounted to $0.3 million at September 30, 2018 and December 31, 2017.

 

·                  In 2017, we granted MVS the non-exclusive right to duplicate, distribute and exhibit Cinelatino’s service via cable, satellite or by any other means in Mexico. Pursuant to the arrangement, Cinelatino receives revenues net of MVS’s distribution fee, which is presently equal to 13.5% of all license fees collected from third party distributors managed by MVS to the extent that distribution is not owned by MVS. Total revenues recognized were $0.3 million for each of the three months ended September 30, 2018 and 2017. Total revenues recognized were $0.8 million and $1.3 million for the nine months ended September 30, 2018 and 2017, respectively. Amounts due from MVS pursuant to the agreements noted above amounted to $2.5 million and $1.8 million at September 30, 2018 and December 31, 2017, respectively.

 

We renewed a three-year consulting agreement effective April 9, 2016 with James M. McNamara, a member of the Company’s board of directors, to provide the development, production and maintenance of programming, affiliate relations, identification and negotiation of carriage opportunities, and the development, identification and negotiation of new business initiatives including sponsorship, new channels, direct-to-consumer programs and other interactive initiatives. Total expenses incurred under this agreement are included in selling, general and administrative expenses and amounted to $0.1 million for each of the three months

 

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ended September 30, 2018 and 2017, and $0.4 million for each of the nine months ended September 30, 2018 and 2017. No amounts were due to this related party at September 30, 2018 and December 31, 2017.

 

We entered into agreements effective February 1, 2015, to license the rights to motion pictures from Lions Gate Films, Inc. (“Lionsgate”) for a total license fee of $1.0 million. Some of the titles are owned or controlled by Pantelion Films, LLC (“Pantelion”), for which Lionsgate acts as Pantelion’s exclusive licensing agent. Pantelion is a joint venture made up of several organizations, including Panamax (an entity owned by James M. McNamara), Lionsgate and Grupo Televisa. Fees paid by Cinelatino to Lionsgate may be remunerated to Pantelion in accordance with their financial arrangements. Expenses incurred under this agreement are included in cost of revenues in the accompanying unaudited condensed consolidated statements of operations, and amounted to $0.0 million and $0.1 million for the three months ended September 30, 2018 and 2017, respectively, and $0.1 million and $0.2 million for the nine months ended September 30, 2018 and 2017, respectively. At September 30, 2018 and December 31, 2017, $0.0 million and $0.1 million, respectively, is included in programming rights in the accompanying condensed consolidated balance sheets.

 

We have entered into an output agreement with Pantelion for the licensing of movie titles.  Expenses incurred under this agreement are included in cost of revenues in the accompanying unaudited condensed consolidated statements of operations and amounted to $0.0 million for each of the three and nine months ended September 30, 2018. At September 30, 2018, $0.1 million is included in programming rights in the accompanying condensed consolidated balance sheets related to these agreements.

 

Note 4. Goodwill and intangible assets

 

Goodwill and intangible assets consist of the following as of September 30, 2018 and December 31, 2017 (amounts in thousands):

 

		September 30,			December 31,
		2018			2017
Broadcast license		$	41,356		$	41,356
Goodwill		164,887			164,887
Other intangibles		41,790			51,661
Total intangible assets		$	248,033		$	257,904

 

A summary of changes in the Company’s goodwill and other indefinite-lived intangible assets, on a net basis, for the nine months ended September 30, 2018 is as follows (amounts in thousands):

 

		Net Balance at December 31, 2017			Additions			Impairment			Net Balance at September 30, 2018
Broadcast license		$	41,356		$	—		$	—		$	41,356
Goodwill		164,887			—			—			164,887
Brands		15,986			—			—			15,986
Other intangibles		700			—			—			700
Total indefinite-lived intangibles		$	222,929		$	—		$	—		$	222,929

 

A summary of the changes in the Company’s other amortizable intangible assets for the nine months ended September 30, 2018 is as follows (amounts in thousands):

 

		Net Balance at December 31, 2017			Additions			Amortization			Net Balance at September 30, 2018
Affiliate relationships		$	32,343		$	—		$	(9,053	)	$	23,290
Advertiser relationships		1,240			—			(412		)	828
Non-compete agreement		1,235			—			(412		)	823
Other intangibles		157			65			(59		)	163
Total finite-lived intangibles		$	34,975		$	65		$	(9,936	)	$	25,104

 

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The aggregate amortization expense of the Company’s amortizable intangible assets was $3.3 million for each of the three months ended September 30, 2018 and 2017, and $9.9 million and $10.0 million for the nine months ended September 30, 2018 and 2017, respectively.  The weighted average remaining amortization period is 3.0 years at September 30, 2018.

 

Future estimated amortization expense is as follows (amounts in thousands):

 

Year Ending December 31,		Amount
Remainder of 2018		$	3,311
2019		8,508
2020		6,080
2021		5,767
2022 and thereafter		1,438
Total		$	25,104

 

Note 5. Equity method investments

 

The Company makes investments that support its underlying business strategy and enable it to enter new markets. The carrying values of the Company’s equity method investments are typically consistent with its ownership in the underlying net assets of the investees, with the exception of Canal 1 and Pantaya. Due to losses in excess of capital contributions, the Company has recorded nearly 100% of the losses on Canal 1. The Company has recorded losses in excess of the amount invested in Pantaya. Certain of the Company’s equity investments are variable interest entities, for which the Company is not the primary beneficiary.

 

On November 3, 2016, we acquired a 25% interest in Pantaya, a newly formed joint venture with Lionsgate, to launch a Spanish-language OTT movie service. The service launched on August 1, 2017. The investment is deemed a variable interest entity (“VIE”) that is accounted for under the equity method. As of September 30, 2018, we have not funded any capital contributions to Pantaya. In accordance with U.S. GAAP, since we are committed to provide future capital contributions to Pantaya, we continue to record our proportionate share of losses on a one quarter lag. For the three and nine months ended September 30, 2018, we have recorded $1.6 million and $6.0 million, respectively in loss on equity method investments related to Pantaya, which is presented as a liability in the accompanying condensed consolidated balance sheets. For each of the three and nine months ended September 30, 2017, we recorded $0.4 million in Loss on equity method investments related to Pantaya, which is presented as a liability in the accompanying condensed consolidated balance sheets. The net balance recorded in investee losses in excess of investment related to Pantaya joint venture was $8.9 million and $2.8 million at September 30, 2018 and December 31, 2017, respectively, and is included in investee losses in excess of investment in the accompanying condensed consolidated balance sheets.

 

On November 30, 2016, we, in partnership with Colombian content producers, Radio Television Interamericana S.A., Compania de Medios de Informacion S.A.S. and NTC Nacional de Television y Comunicaciones S.A., were awarded a ten (10) year renewable television broadcast concession license for Canal 1 in Colombia. Canal 1 is one of only three national broadcast television networks in Colombia. The partnership began operating Canal 1 on May 1, 2017. On February 7, 2018, Colombian regulatory authorities approved an increase in our ownership in the joint venture to 40%. The joint venture is deemed a VIE that is accounted for under the equity method. We earn a preferred return on the capital funded, which is recorded quarterly as an offset to the loss on the investment. As of September 30, 2018, we have recorded $71.9 million in equity method investments related to Canal 1. We record the income or loss on investment on a one quarter lag. For the three and nine months ended September 30, 2018, we recorded $7.1 million and $21.1 million, net of preferred return, in loss on equity method investments, respectively. For the three and nine months ended September 30, 2017, we recorded $2.3 million and $2.2 million, net of preferred return, in loss on equity method investments, respectively. The Canal 1 joint venture losses to date have exceeded the capital contributions of the common equity partners and in accordance with equity method accounting, equity losses in excess of the common equity have been recorded against the next layer of the capital structure, in this case, preferred equity. The Company is currently the sole preferred equity holder in Canal 1 and therefore, the Company has recorded nearly 100% of the losses of the joint venture. For the three and nine months ended September 30, 2018, we recorded $2.3 million and $5.6 million of income, as an offset to losses incurred in loss on equity method investments, respectively. For the three and nine months ended September 30, 2017, we recorded $0.6 million and $0.8 million of income, as an offset to losses incurred in loss on equity method investments, respectively. The net balance recorded in equity method investments related to Canal 1 joint venture was $41.7 million and $25.9 million at September 30, 2018 and December 31, 2017, respectively, and is included in equity method investments in the accompanying condensed consolidated balance sheets.

 

On April 28, 2017, we acquired a 25.5% interest in REMEZCLA, a digital media company targeting English speaking and bilingual U.S. Hispanic millennials through innovative content. As of September 30, 2018, we have recorded $5.0 million in equity method investments related to REMEZCLA. We record the income or loss on investment on a one quarter lag. Additionally, we earn a preferred return on the capital funded, which is recorded quarterly as an offset to the loss on the investment. For the three months

 

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ended September 30, 2018, we recorded a $0.0 million gain inclusive of the preferred return, as an offset to loss on equity method investment. For the nine months ended September 30, 2018, we recorded a $0.1 million loss, net of preferred return, in loss on equity method investment. For each of the three and nine months ended September 30, 2017, we have recorded a $0.1 million gain inclusive of preferred return as an offset to loss on equity method investment related to this investment. For the three and nine months ended September 30, 2018, we recorded $0.2 million and $0.5 million of preferred return, as an offset to the Loss on equity method investments, respectively. For each of the three and nine months ended September 30, 2017, we recorded $0.3 million of preferred return, as an offset to the Loss on equity method investments. The net investment recorded in Equity method investments was $4.9 million and $5.0 million at September 30, 2018 and December 31, 2017, respectively, and is included in equity method investments in the accompanying condensed consolidated balance sheets. We have no additional commitment to fund the operations of the venture, which limits the maximum exposure to loss on our investment in Remezcla to our investment of $5.0 million.

 

The Company records the income or loss on investments on a one quarter lag. Summary unaudited financial data for our equity investments in the aggregate as of and for the nine months ended June 30, 2018 are included below (amounts in thousands):

 

		Total Equity Investees
Current assets		$	16,777
Non-current assets		$	54,253
Current liabilities		$	50,424
Non-current liabilities		$	77,381
Redeemable stock and noncontrolling interests		$	14,187
Net revenue		$	14,763
Operating loss		$	(46,729	)
Net loss		$	(53,359	)

 

Note 6. Income taxes

 

The 2017 Tax Cut and Jobs Act (“Tax Act”) was signed into law on December 22, 2017. The Tax Act revised the U.S. corporate income tax by, among other things, lowering the statutory corporate tax rate from 35% to 21% in 2018, eliminating certain deductions, imposing a mandatory one-time transition tax, or deemed repatriation tax on accumulated earnings of foreign subsidiaries as of 2017 that were previously tax deferred. The Company generates income in higher tax rate foreign locations, which result in foreign tax credits. The lower federal corporate tax rate reduces the likelihood or our utilization of foreign tax credits created by income taxes paid in Puerto Rico and Latin America, resulting in a valuation allowance.

 

For the nine months ended September 30, 2018 and 2017, our income tax expense has been computed utilizing the estimated annual effective rates of 41.6% and 36.1%, respectively. The difference between the annual effective rate of 41.6% and the statutory Federal income tax rate of 21% in the nine month period ended September 30, 2018, is primarily due to the impact of the Tax Act and the related impact to the valuation allowance on foreign tax credits. The annual effective tax rate related to income generated in the U.S. is 22.4%.  Due to the reduced U.S. tax rate, the Company determined that a portion of its foreign income, which is taxed at a higher rate, will result in the generation of excess foreign tax credits that will not be available to offset U.S. tax.  As a result, 19.2% of the annual effective rate relates to the required valuation allowance against the excess foreign tax credits, bringing the annual effective tax rate for the nine month period ended September 30, 2018 to 41.6%. The difference between the annual effective rate of 36.1% and the statutory Federal income tax rate of 35% in the nine month period ended September 30, 2017, was primarily due to foreign withholding taxes and foreign permanent differences, which were offset by foreign tax credits.

 

The Company evaluated the impact of the interest income limitation from the Tax Act and does not expect that there will be a limitation on the ability to deduct interest expense for tax purposes for the year ended December 31, 2018.

 

Income tax expense was $3.2 million and $1.8 million for the three month period ended September 30, 2018 and 2017, respectively. Income tax expense was $4.5 million and $6.3 million for the nine months ended September 30, 2018 and 2017, respectively. The income tax expense for the current year period includes a discrete tax benefit of $0.5 million related to adjustments to the 2017 filed tax returns primarily related to hurricane relief credits and an increase to foreign tax credit utilization.

 

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Note 7. Long-term debt

 

Long-term debt as of September 30, 2018 and December 31, 2017 consists of the following (amounts in thousands):

 

		September 30, 2018			December 31, 2017
Senior Notes due February 2024		$	205,946		$	207,642
Less: Current portion		1,601			2,133
		$	204,345		$	205,509

 

On February 14, 2017 (the “Closing Date”), the Borrowers amended the Term Loan Facility (the “Second Amended Term Loan Facility”). The Second Amended Term Loan Facility provides for a $213.3 million senior secured term loan B facility, which matures on February 14, 2024. The Second Amended Term Loan Facility, bears interest at the Borrowers’ option of either (i) London Inter-bank Offered Rate (“LIBOR’) plus a margin of 3.50% (decreased from a margin of 4.00% under the Term Loan Facility) or (ii) an Alternate Base Rate (“ABR”) plus a margin of 2.50% (decreased from a margin of 3.00% under the Term Loan Facility). There is no LIBOR floor (a decrease from a LIBOR floor of 1.00% under the Term Loan Facility). The Second Amended Term Loan Facility, among other terms, provides for an uncommitted incremental loan option (the “Incremental Facility”) allowing for increases for borrowings under the Second Amended Term Loan Facility and borrowing of new tranches of term loans, up to an aggregate principal amount equal to (i) $65.0 million plus (ii) an additional amount (the “Incremental Facility Increase”) provided, that after giving effect to such Incremental Facility Increase (as well as any other additional term loans), on a pro forma basis, the First Lien Net Leverage Ratio (as defined in the Second Amended Term Loan Facility) for the most recent four consecutive fiscal quarters does not exceed 4.00:1.00 and the Total Net Leverage Ratio (as defined in the Second Amended Term Loan Facility) for the most recent four consecutive fiscal quarters does not exceed 6.00:1.00. The First Lien Net Leverage Ratio and the Total Net Leverage Ratio each cap the cash netted against debt up to a maximum amount of $60.0 million (increased from $45.0 million under the Term Loan Facility). Additionally, the Second Amended Term Loan Facility also provides for an uncommitted incremental revolving loan option (the “Incremental Revolving Facility”) allowing for an aggregate principal amount of up to $30.0 million, which will be secured on a pari passu basis by the collateral securing the Second Amended Term Loan Facility.

 

The Second Amended Term Loan Facility requires the Borrowers to make amortization payments (in quarterly installments) equal to 1.00% per annum with respect to the Second Amended Term Loan Facility with any remaining amount due at final maturity. The Second Amended Term Loan Facility principal payments commenced on March 31, 2017, with a final installment due on February 14, 2024. Voluntary prepayments are permitted, in whole or in part, subject to certain minimum prepayment requirements.

 

In addition, pursuant to the terms of the Second Amended Term Loan Facility, within 90 days after the end of each fiscal year, the Borrowers are required to make a prepayment of the loan principal in an amount equal to a percentage of the excess cash flow of the most recently completed fiscal year. Excess cash flow is generally defined as net (loss) income plus depreciation and amortization expense, less mandatory prepayments of the term loan, income taxes and capital expenditures, and adjusted for the change in working capital. The percentage of the excess cash flow used to determine the amount of the prepayment of the loan declines from 50% to 25%, and again to 0% at lower leverage ratios. Pursuant to the terms of the Second Amended Term Loan Facility, our net leverage ratio was 2.95x at December 31, 2017, resulting in an excess cash flow percentage of 25% and therefore, an excess cash flow payment of $2.1 million was made in March 2018. As permitted under the Second Amended Term Loan Facility, the excess cash flow payment was allocated in direct order of maturity, accordingly, we were not required to make the scheduled quarterly loan amortization payment in the current quarter and will not be required to make the full amount of the scheduled payment at the end of next quarter.

 

As of September 30, 2018, the original issue discount balance was $1.8 million, net of accumulated amortization of $1.7 million and was recorded as a reduction to the principal amount of the Second Amended Term Loan Facility outstanding as presented on the unaudited condensed consolidated balance sheet and will be amortized as a component of interest expense over the term of the Second Amended Term Loan Facility. In accordance with ASU 2015-15 Interest—Imputation of Interest (Subtopic 835-30) Presentation and Subsequent Measurement of Debt Issuance Costs Associated with Line of Credit Arrangements, deferred financing fees of $1.3 million, net of accumulated amortization of $2.0 million, are presented as a reduction to the Second Amended Term Loan Facility outstanding at September 30, 2018 as presented on the unaudited condensed consolidated balance sheet, and will be amortized as a component of interest expense over the term of the Second Amended Term Loan Facility.

 

The carrying value of the long-term debt approximates fair value at September 30, 2018 and December 31, 2017 and was derived from quoted market prices by independent dealers (Level 2 in the fair value hierarchy under ASC 820, Fair Value Measurements and Disclosures). The following are the maturities of our long-term debt as of September 30, 2018 (amounts in thousands):

 

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Year Ending December 31,		Amount
Remainder of 2018		$	—
2019		2,133
2020		2,133
2021		2,133
2022 and thereafter		202,682
Total		$	209,081

 

Note 8. Derivative instruments

 

We use derivative financial instruments in the management of our interest rate exposure. Our strategy is to eliminate the cash flow risk on a portion of the variable rate debt caused by changes in the designated benchmark interest rate, LIBOR. The Company does not enter into or hold derivative financial instruments for speculative trading purposes.

 

On May 4, 2017, we entered into two identical pay-fixed, receive-variable, interest rate swaps with two different counter parties, to hedge the variability in the LIBOR interest payments on an aggregate notional value of $100.0 million of our Second Amended Term Loan Facility beginning May 31, 2017, through the expiration of the swaps on June 30, 2022. At inception, these interest rate swaps were designated as cash flow hedges of interest rate risk, and as such, the effective portion of unrealized changes in market value is recorded in Accumulated other comprehensive income (“AOCI”). Any losses from hedge ineffectiveness will be recognized in current operations.

 

The change in the fair value of the interest rate swap agreements for the three and nine months ended September 30, 2018, resulted in an unrealized gain of $0.4 million and $2.5 million, respectively, and was included in AOCI net of taxes. The Company received $0.0 million of net interest on the settlement of the interest rate swap agreements for the three months ended September 30, 2018. The Company paid $0.0 million of net interest on the settlement of the interest rate swap agreements for the nine months ended September 30, 2018. As of September 30, 2018, the Company estimates that none of the unrealized gain included in AOCI related to these interest rate swap agreements will be realized and reported in operations within the next twelve months. No gain or loss was recorded in operations for the three or nine months ended September 30, 2018.

 

The aggregate fair value of the interest rate swaps was $3.3 million and $0.8 million as of September 30, 2018 and December 31, 2017, respectively. These were recorded in Swap assets in non-current assets on the accompanying condensed consolidated balance sheets.

 

By entering into derivative instrument contracts, we are exposed to counterparty credit risk. Counterparty credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is in an asset position, the counterparty has a liability to us, which creates credit risk for us. We attempt to minimize this risk by selecting counterparties with investment grade credit ratings and regularly monitoring our market position with each counterparty. Our derivative instruments do not contain any credit-risk related contingent features.

 

Note 9. Fair Value Measurements

 

Our derivatives are valued using a discounted cash flow analysis that incorporates observable market parameters, such as interest rate yield curves, classified as Level 2 within the valuation hierarchy. Derivative valuations incorporate credit risk adjustments that are necessary to reflect the probability of default by us or the counterparty.

 

The following table presents our assets and liabilities measured at fair value on a recurring basis and the levels of inputs used to measure fair value, which include derivatives designated as cash flow hedging instruments, as well as their location on our accompanying condensed consolidated balance sheets as of September 30, 2018 and December 31, 2017 (amounts in thousands):

 

Estimated Fair Value

September 30, 2018

Category

Balance Sheet Location

Level 1

Level 2

Level 3

Total

Cash flow hedges:

Interest rate swap

Interest rate swap - Asset

—

$

3,302

—

$

3,302

 

Estimated Fair Value

December 31, 2017

Category

Balance Sheet Location

Level 1

Level 2

Level 3

Total

Cash flow hedges:

Interest rate swap

Interest rate swap - Asset

—

$

773

—

$

773

 

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