UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________
0-24780 33-73002-01
(Commission File Number) (Commission File Number)
PROTECTION ONE, INC. PROTECTION ONE ALARM MONITORING, INC.
(Exact Name of Registrant (Exact Name of Registrant
As Specified In Its Charter) As Specified In Its Charter)
Delaware Delaware
(State or Other Jurisdiction (State or Other Jurisdiction
Of Incorporation or Organization) of Incorporation or Organization)
93-1063818 93-1064579
(I.R.S. Employer Identification No.) (I.R.S. Employer Identification No.)
600 Corporate Pointe, 12th Floor, 600 Corporate Pointe, 12th Floor,
Culver City, California 90230 Culver City, California 90230
(Address of Principal Executive Offices,(Address of Principal Executive Offices,
Including Zip Code) Including Zip Code)
(310) 342-6300 (310) 342-6300
(Registrant's Telephone Number, (Registrant's Telephone Number,
Including Area Code) Including Area Code)
Indicate by check mark whether each of the registrants (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 such
registrants were required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
As of July 28, 1999, Protection One, Inc. had outstanding 126,890,169
shares of Common Stock, par value $0.01 per share. As of such date,
Protection One Alarm Monitoring, Inc. had outstanding 110 shares of Common
Stock, par value $0.10 per share, all of which shares were owned by
Protection One, Inc. Protection One Alarm Monitoring, Inc. meets the
conditions set forth in General Instructions H(1)(a) and (b) for Form 10-Q and
is therefore filing this form with the reduced disclosure format set forth
therein.
<PAGE>
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
<TABLE>
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
<CAPTION>
(Unaudited)
June 30, December 31,
1999 1998
-------------- ----------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents......................... $ 17,981 $ 10,025
Restricted cash................................... 8,991 11,987
Marketable securities............................. 12,019 17,770
Receivables, net.................................. 66,963 61,262
Inventories....................................... 11,277 7,895
Prepaid expenses.................................. 5,014 3,867
Income tax receivable............................. 5,883 5,886
Deferred tax assets, current portion.............. 71,185 49,543
Other assets...................................... 23,154 19,605
---------- ----------
Total current assets......................... 222,467 187,840
Property and equipment, net............................. 58,395 46,959
Customer accounts, net.................................. 1,176,605 1,014,428
Goodwill and trademarks, net............................ 1,155,148 1,187,862
Deferred tax assets..................................... -- 44,028
Other................................................... 29,944 30,202
---------- ----------
Total assets......................................... $2,642,559 $2,511,319
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable.................................. $ 20,836 $ 16,374
Accrued liabilities............................... 83,047 77,412
Purchase holdbacks................................ 51,256 42,303
Long-term debt, current portion................... 38,771 40,838
Capital leases, current portion................... 1,925 1,361
Deferred revenue.................................. 63,921 57,703
---------- ----------
Total current liabilities.................... 259,756 235,991
Long-term debt, net of current portion.................. 1,036,977 926,784
Capital leases, net of current portion.................. 51 187
Deferred tax liability.................................. 12,028 --
Other liabilities....................................... 3,272 3,238
---------------- ----------------
Total liabilities.................................... 1,312,084 1,166,200
Commitments and contingencies ( See Note 4)
Stockholders' equity:
Preferred stock, $0.10 par value, 5,000,000 authorized,
none -- --
Outstanding.........................................
Common stock, $0.01 par value, 150,000,000 shares
authorized,
126,890,169 shares issued and outstanding, at June 30, 1999 1,269 1,268
and 126,838,741 at December 31, 1998...............
Additional paid-in capital........................... 1,392,346 1,392,256
Accumulated other comprehensive income, net.......... (5,316) (2,576)
Accumulated deficit................................. (57,824) (45,829)
----------- -----------
Total stockholders' equity................... 1,330,475 1,345,119
---------- ----------
Total liabilities and stockholders equity............ $2,642,559 $2,511,319
========== ==========
The accompanying notes are an integral part of these
consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)
(Unaudited)
<CAPTION>
Six Months Ended June 30,
1999 1998
--------------------- -------------
<S> <C> <C>
Revenues:
Monitoring and related services......... $255,062 $158,223
Installation and other.................. 44,286 15,613
------- -------
Total revenues..................... 299,348 173,836
Cost of revenues:
Monitoring and related services......... 59,866 44,756
Installation and other.................. 23,290 10,717
------- -------
Total cost of revenues............. 83,156 55,473
------- -------
Gross profit....................... 216,192 118,363
Selling, general and administrative expense... 84,507 46,533
Amortization of intangibles and depreciation 87,549 48,550
expense.......................................
Acquisition expense........................... 11,633 9,500
Employee severance cost....................... 2,000 --
------- --------------
Operating income................... 30,503 13,780
Other income/expense:
Interest expense, net................... 42,015 13,423
Interest expense to Parent, net......... -- 11,479
Other................................... (1,015) (13,414)
------- --------
Income (loss) before income
taxes & (10,497) 2,292
extraordinary item..........
Income tax (expense) benefit.................. (1,497) (2,092)
-------- --------
Income (loss) before extraordinary item....... (11,994) 200
Extraordinary gain, net of tax.............. -- 1,591
------- -------
Net income (loss)........................ $(11,994) $ 1,791
========= =======
Other comprehensive income:
Unrealized loss on marketable securities, $(1,647) $ --
net of tax....................................
Unrealized loss on currency translation, (1,093) --
--------------- --------------
net of tax....................................
Comprehensive income (loss): $(14,734) $ 1,791
========= =======
Net income (loss) per common share...... $ (0.09) $ 0.02
========= ========
Weighted average common shares outstanding 127,648 89,366
The accompanying notes are an integral part of these
consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)
(Unaudited)
<CAPTION>
Three Months Ended June 30,
1999 1998
--------------------- -------------
<S> <C> <C>
Revenues:
Monitoring and related services......... $127,818 $87,449
Installation and other.................. 22,983 9,592
------- -------
Total revenues..................... 150,801 97,041
Cost of revenues:
Monitoring and related services......... 30,169 24,682
Installation and other.................. 11,713 6,798
------- -------
Total cost of revenues............. 41,882 31,480
------- -------
Gross profit....................... 108,919 65,561
Selling, general and administrative expense... 43,901 26,020
Amortization of intangibles and depreciation 44,947 27,833
expense.......................................
Acquisition expense........................... 6,767 6,032
------- ---------
Operating income................... 13,304 5,676
Other income/expense:
Interest expense, net................... 21,844 6,868
Interest expense to Parent, net......... -- 6,899
Other................................... (671) (10,185)
------- --------
Income (loss) before income tax &
extraordinary item............ (7,869) 2,094
Income tax (expense) benefit.................. 428 (2,292)
------- --------
Income (loss) before extraordinary item.......
(7,441) (198)
Extraordinary gain, net of tax................ -- 1,591
---------- -------
Net income (loss)............................. $ (7,441) $ 1,393
=========== =======
Other comprehensive income:
Unrealized loss on marketable securities, $ (880) $ --
net of tax....................................
Unrealized loss on currency translation, (312) --
------------- --------------
net of tax....................................
Comprehensive income (loss): $(8,633) $ 1,393
======== =======
Net income (loss) per common share...... $ (0.06) $ 0.01
========= ========
Weighted average common shares outstanding 127,524 94,318
The accompanying notes are an integral part of these
consolidated financial statements.
</TABLE>
<PAGE>
<TABLE>
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
<CAPTION>
Six Months Ended June 30,
1999 1998
--------------------- -------------
<S> <C> <C>
Cash flow from operating activities:
Net income (loss)...................................... $ (11,994) $ 1,791
Adjustments to reconcile net income (loss) to net cash
provided
by operating activities:
Extraordinary gain................................ -- (1,591)
Amortization and depreciation...................... 87,549 48,550
Accretion of discount note interest................ (3,345) 6,273
Deferred income taxes.............................. 1,246 (2,297)
Provision for doubtful accounts.................... 6,092 3,946
Loss on sale of marketable securities.............. 344 --
Other charges...................................... 2,000 --
Changes in assets and liabilities, net of effects of acquisitions:
Receivables, net................................... (8,278) 12,019
Inventories........................................ (1,631) (988)
Prepaid expenses and deposits...................... (1,153) (2,363)
Other current assets............................... (649) --
Accounts payable................................... 4,576 (2,065)
Accrued liabilities................................ (9,176) (8,348)
Deferred revenue................................... 6,352 2,569
--------- -------
Net cash provided by operating activities..... 71,933 57,496
--------- -------
Cash flows from investing activities:
Purchase of installed security systems............. (154,571) (126,589)
Purchase of property and equipment................. (19,534) (8,576)
Purchase (sale) of marketable securities........... 2,540 (13,956)
Acquisition of alarm companies, net of cash received (20,722) (361,039)
Investment in Guardian............................. -- (4,090)
--------- --------
Net cash used in investing activities......... (192,287) (514,250)
---------- ---------
Cash flows from financing activities:
Proceeds from equity offering...................... -- 402,741
Payments on long-term debt......................... -- (79,221)
Proceeds from long term-debt....................... 127,516 --
Funding from (payment to) Parent................... (50) 74,496
Capitalized loan fees.............................. -- (72)
Stock options and warrants exercised............... 273 703
--------- -------
Net cash provided by financing activities..... 127,739 398,647
--------- -------
Effect of exchange rate changes on cash and equivalents 571 --
--------- -------
Net increase (decrease) in cash and cash 7,956 (58,107)
equivalents............................................
Cash and cash equivalents:
Beginning of period................................ 10,025 75,556
--------- -------
End of period...................................... $ 17,981 $17,449
========= =======
Interest paid during the period........................ $ 22,184 $ 3,700
========= =======
Taxes paid during the period........................... $ 256 $ --
========= =======
The accompanying notes are an integral part of these
consolidated financial statements.
</TABLE>
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
(Unaudited)
1. Basis of Consolidation and Interim Financial Information:
Protection One, Inc., a Delaware corporation ("Protection One" or the
"Company"), is principally engaged in the business of providing security alarm
monitoring services, which include sales, installation and related servicing of
security alarm systems for residential and small business subscribers in North
America, the United Kingdom and continental Europe. The accompanying unaudited
consolidated financial statements include the accounts of Protection One and its
wholly owned subsidiaries.
As of June 30, 1999, Protection One is an approximately 85% owned subsidiary
of Westar Capital, Inc. (Westar Capital), a wholly owned subsidiary of Western
Resources, Inc. (WRI).
The Company's unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and in accordance with the instructions to Form 10-Q.
Accordingly, certain information and footnote disclosures normally included in
financial statements presented in accordance with generally accepted accounting
principles have been condensed or omitted. These financial statements should be
read in conjunction with the audited financial statements and notes thereto for
the year ended December 31, 1998, included in the Company's Annual Report on
Form 10-K/A filed with the Securities and Exchange Commission (the "SEC").
In Europe, the Company sells some of its installed security equipment,
subject to a related operating lease agreement, to third party finance
companies. For such sales in which the Company retains a substantial risk of
ownership in the installed security equipment, the proceeds received are treated
as a borrowing and revenue continues to be recognized on a straight-line basis
over the term of the rental agreement. For such sales in which the Company does
not retain a substantial risk of ownership in the installed security equipment,
a sale of the installed security equipment is recognized at the date of the sale
to the third party finance company.
In the opinion of management of the Company, all adjustments, consisting
only of normal recurring adjustments considered necessary for a fair
presentation, have been included. The results of operations for the three and
six-month periods ended June 30, 1999, are not necessarily indicative of the
results to be expected for the full year. Certain purchase price allocations for
acquisitions made in 1998 were made on a preliminary basis and are subject to
change based on the final determination of net asset values and completion of
appraisals.
These financial statements do not reflect the effect, if any, of any changes
which may occur as a result of the Company's discussions with the SEC staff and
any resulting accounting changes or adjustments to the Company's financial
statements. See Note 4 for further discussion.
<PAGE>
2. Customer Accounts:
Customer accounts are stated at cost. The cost includes amounts paid to
dealers and the estimated fair value of accounts acquired in business
acquisitions. Internal costs incurred in support of acquiring customer accounts
are expensed as incurred.
Customer accounts consist of the following:
<TABLE>
<CAPTION>
Six Months Ended
June 30, 1999 Year Ended
December 31, 1998
-------------------- --------------------
<S> <C> <C>
Customer accounts $1,130,946 $ 558,805
Acquisition of customer accounts 227,922 581,667
Non-cash charges to purchase holdbacks (1,303) (9,526)
--------------- ---------------
Total customer accounts 1,357,565 1,130,946
Less accumulated amortization 180,960 116,518
------------ ------------
Customer accounts, net $1,176,605 $1,014,428
========== ==========
</TABLE>
<PAGE>
In conjunction with certain purchases of customer accounts, the Company
withholds a portion of the purchase price as a reserve to offset qualifying
attrition of the acquired customer accounts for a specified period as provided
for in the purchase agreements, and as a reserve for purchase price settlements
of assets acquired and liabilities assumed. As of June 30, 1999, and December
31, 1998, purchase holdbacks were $51.3 million and $42.3 million, respectively.
3. Debt:
During the first half of 1999 the Company borrowed approximately $130
million on its senior credit facility. As of June 30, 1999, and December 31,
1998, total borrowings under this facility were $172 million and $42 million,
respectively. Most of these borrowings were incurred in acquiring new customers.
During the first six months, the Company added approximately 166,000 new
customers.
The Company borrows to fund operations in excess of internally generated
cash under its existing $500 million senior credit facility. The Company's
ability to borrow under the facility is subject to compliance with certain
financial covenants, including a debt to annualized EBITDA ratio ("leverage
ratio") of 5.0 to 1.0 and an annualized EBITDA to interest expense ratio
("interest coverage ratio") of 2.75 to 1.0. As of June 30, 1999, the ratios were
approximately 4.7 to 1.0 and 3.3 to 1.0. At year end 1999, the leverage ratio
will be reduced to 4.5 to 1.0. The Company currently borrows approximately $20
million per month, principally to fund the purchase of customer accounts. The
Company currently believes it is likely, absent successful implementation of
the alternatives discussed below, that it will be unable to satisfy the
current leverage and interest coverage ratio covenants in the credit facility
following the third quarter of 1999. The resolution of the accounting issues
raised by the SEC of the Company's accounting practices would most likely cause
the Company to need to otain waivers or consents under the credit facility and
could impact te Company's ability to meet te financial covenants contianed in
the credit facility. The Company is exploring alternatives to
address these covenant restrictions, including the sale of assets to reduce
debt, seeking waivers or renegotiating these covenants with lenders or
refinancing the facility. The Company believes it will be able to address this
matter in a manner so that there is no default under the credit facility or
significant impact on its liquidity, but no assurances can be given that the
Company will be able to do so or the terms thereof.
4. Commitments and Contingencies:
The Company received a letter from the Division of Corporation Finance of
the SEC on August 11, 1999. The letter raised questions about the Company's
financial statements and stated that, in the view of the staff, there are errors
in the Company's financial statements which are material and which have had the
effect of inflating earnings commencing with the year 1997. These questions
relate to the methodology used by the Company to amortize customer accounts, and
to the purchase price allocation to customer accounts in the Network Multifamily
acquisition. If a change from the average estimated life of ten years used to
amortize accounts is determined to be appropriate, the Company estimates that a
one-year to three-year reduction in estimated useful life would result in
additional amortization expense of approximately $14 million to $54 million per
year. Any such increased amortization expense would reduce earnings, but would
not affect cash flow from operations. The Company is discussing these issues
with the SEC staff. The Company cannot predict the timing or impact on its
financial statements of these discussions. The Company is reconsidering the
accounting used for amortization of customer accounts and the purchase
accounting for prior acquisitions. Such changes may require the Company to
restate prior year financial statements and may require the Company to perform
an asset impairment evaluation.
<PAGE>
Six Protection One dealers have filed a class action lawsuit in the U. S.
District Court for the Western District of Kentucky alleging breach of contract
because of the Company's interpretation of their dealer contracts. The action is
styled Total Security Solutions, Inc., et al. v. Protection One Alarm
Monitoring, Inc., Civil Action No. 3:99CV-326-H (filed May 21, 1999). Other
Protection One dealers have threatened similar litigation. The Company believes
it has complied with the terms of these contracts and intends to vigorously
defend its position. The Company cannot currently predict the impact of these
disputes with dealers which could be material.
Under the Company's agreements with dealers, the Company may be required to
purchase customer accounts on an ongoing basis. The Company is currently
spending approximately $20 million to $25 million per month to purchase these
customer accounts.
Since April 1999, four alleged class action litigations have been filed
in the United States District Court for the Central District of California
against Protection One, Inc. and certain of its present and former officers.
The four actions are: David Lyons v. Protection One, Inc., Western Resources,
Inc., James M. Mackenzie, Jr., John W. Hesse, and John E. Mack, III,
No. 99-CV-3755 (C.D.Cal.) (filed April 7, 1999); Randall Karkutt v. Protection
One, Inc., James M. Mackenzie, Jr., and John W. Hesse, No. 99-CV-3798
(C.D.Cal.) (filed April 8, 1999); David Shaev v. Protection One, Inc.,
John E. Mack, III, James H. Mackenzie, Jr., and John Hesse, No. 99-CV-4147
(C.D.Cal.) (filed April 20, 1999); and Mike Ringel v. Protection One, Inc.,
Western Resources, Inc., James M. McKenzie, Jr., John W. Hesse and
John E. Mack, III, No. 99-CV-5534 (C.D.Cal) (filed May 28, 1999). The
actions are purportedly brought on behalf of purchasers of the common stock of
Protection One, Inc. during periods beginning February 10, 1998 (Karkutt and
Ringel), February 12, 1998 (Shaev), or April 23, 1998 (Lyons), and ending
April 1, 1999. All four complaints assert claims under Sections 10(b) and 20
of the Securities Exchange Act of 1934 based on allegations that various
statements made by the defendants concerning the financial results of
Protection One, Inc. were false and misleading and not in compliance with
generally accepted accounting principles. The complaints seek unspecified
amounts of damages and an award of fees and expenses, including attorney's
fees. By an order dated August 2, 1999, the District Court consolidated the
four actions and appointed Ronald Cats as lead plaintiff in the consolidated
actions. The Court further ordered that plaintiffs will file a single
consolidated amended complaint within sixty days. Protection One believes
these actions are without merit and intends to defend against them vigorously.
The Company is a party to claims and matters of litigation incidental to the
normal course of its business. The ultimate outcome of such matters cannot
presently be determined; however, in the opinion of management of the Company,
the resolution of such matters will not have a material adverse effect upon the
Company's combined financial position or results of operations.
5. Segment Reporting:
The Company's reportable segments include Protection One North America,
which consists of Protection One Alarm Monitoring, Inc. and Network Multifamily
Security, Inc., and Protection One Europe. Protection One North America provides
security alarm monitoring services, which include sales, installation and
related servicing of security alarm systems for residential and small businesses
in the United States and Canada. Network Multifamily provides security alarm
services to apartments, condominiums and other multi-family dwellings.
Protection One Europe provides security alarm services to residential and
business customers in Europe. The Company's mobile security division is not
significant enough to be a reporting segment.
The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies in the Company's
1998 Form 10-K/A. The Company manages its business segments based on earnings
before interest and income taxes (EBIT). EBIT is calculated by adding net
interest expense to income (loss) before income taxes. Revenues are attributed
to geographic areas based on the location of the assets producing the revenues.
<PAGE>
<TABLE>
Six Months Ended June 30, 1999
<CAPTION>
Protection One North America Protection
Monitoring Multifamily Total One Europe Consolidated
<S> <C> <C> <C> <C> <C>
Revenues from customers:
Monitoring and related services......... $ 191,612 $ 16,982 $ 208,594 $ 46,468 $ 255,062
Installation and rental................. 7,508 2,249 9,757 34,529 44,286
--------- --------- --------- --------- ---------
Total.............................. 199,120 19,231 218,351 80,997 299,348
Amortization of intangibles and depreciation
expense....................................... 72,877 3,808 76,685 10,864 87,549
Earnings before interest and income taxes..... 14,349 4,337 18,686 12,832 31,518
</TABLE>
<TABLE>
Six Months Ended June 30, 1998
<CAPTION>
Protection One North America Protection
Monitoring Multifamily Total One Europe* Consolidated
<S> <C> <C> <C> <C> <C>
Revenues from customers:
Monitoring and related services......... $ 143,643 $ 13,531 $ 157,174 $ 1,049 $ 158,223
Installation and rental................. 12,508 1,927 14,435 1,178 15,613
--------- --------- --------- -------- ---------
Total............................... 156,151 15,458 171,609 2,227 173,836
Amortization of intangibles and depreciation
expense....................................... 45,552 2,805 48,357 193 48,550
Earnings before interest and income taxes..... 24,292 2,921 27,213 (19) 27,194
</TABLE>
<TABLE>
Three Months Ended June 30, 1999
<CAPTION>
Protection One North America Protection
Monitoring Multifamily Total One Europe Consolidated
<S> <C> <C> <C> <C> <C>
Revenues from customers:
Monitoring and related services......... $ 96,365 $ 8,402 $ 104,767 $ 23,051 $ 127,818
Installation and rental................. 3,739 832 4,571 18,412 22,983
--------- --------- --------- --------- ---------
Total.............................. 100,104 9,234 109,338 41,463 150,801
Amortization of intangibles and depreciation
expense....................................... 37,653 1,915 39,568 5,379 44,947
Earnings before interest and income taxes..... 6,213 1,632 7,845 6,130 13,975
</TABLE>
<TABLE>
Three Months Ended June 30, 1998
<CAPTION>
Protection One North America Protection
Monitoring Multifamily Total One Europe* Consolidated
<S> <C> <C> <C> <C> <C>
Revenues from customers:
Monitoring and related services......... $ 79,267 $ 7,133 $ 86,400 $ 1,049 $ 87,449
Installation and rental................. 6,972 1,442 8,414 1,178 9,592
--------- --------- --------- --------- ---------
Total.............................. 86,239 8,575 94,814 2,227 97,041
Amortization of intangibles and depreciation
expense....................................... 26,214 1,426 27,640 193 27,833
Earnings before interest and income taxes..... 14,327 1,553 15,880 (19) 15,861
* Protection One Europe consisted of Protection One-UK at June 30, 1998.
</TABLE>
6. Acquisition Charges and Other Charges:
During 1997, a charge of $24.3 million was recorded by the Company to
recognize an asset impairment due to higher than expected customer loss rates
and recognize certain merger related costs, including the closure of duplicate
facilities. In 1998, the Company recorded an exit charge, including severance
costs, associated with its 1998 acquisitions. Activity during the first half of
1999 related to these charges is as follows:
<TABLE>
<CAPTION>
December 31, 1998 Utilization June 30, 1999
----------------------- -------------------- ----------------------
<S> <C> <C> <C>
Closure of duplicate facilities $1,025 $(164) $861
Severance costs 897 (897) --
The remaining accrual approximates the lease obligation related to excess
space.
</TABLE>
7. Recent Developments:
The Company will expense severance costs of approximately $1.2 million
following the resignation of the Company's president and chief operating officer
in July 1999.
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Unless the context otherwise indicates, all references in this Report on
Form 10-Q (this "Report") to the "Company," "Protection One," "we," "us" or
"our" or similar words are to Protection One, Inc., its wholly owned subsidiary,
Protection One Alarm Monitoring, Inc. ("Protection One Alarm Monitoring") and
Protection One's other wholly owned subsidiaries. Protection One's sole asset
is, and Protection One operates solely through, its investments in Protection
One Alarm Monitoring and its other wholly owned subsidiaries. Both Protection
One and Protection One Alarm Monitoring are Delaware corporations organized in
September 1991.
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations updates the information provided in and should be read
in conjunction with Management's Discussion and Analysis of Financial Condition
and Results of Operations in our 1998 Annual Report on Form 10-K/A.
Certain matters discussed here and elsewhere in this Form 10-Q are
forward-looking statements. The Private Securities Litigation Reform Act of 1995
has established that these statements qualify for safe harbors from liability.
Forward-looking statements may include words like the Company believes,
anticipates, expects or words of similar meaning. Forward-looking statements
describe the Company's future plans, objectives, expectations, or goals. Such
statements address future events and conditions concerning capital expenditures,
earnings, litigation, the outcome of accounting issues being reviewed by the SEC
staff, possible corporate restructurings, mergers, acquisitions, dispositions,
liquidity and capital resources, compliance with debt covenants, interest, Year
2000 Issue, ability to enter new markets successfully and capitalize on growth
opportunities, events in foreign markets in which investments have been made,
and accounting matters. What happens in each case could vary materially from
what the Company expects because of such things as future economic conditions;
legislative developments; competitive markets; and other circumstances affecting
anticipated operations, revenues and costs. The Company disclaims any obligation
to update any forward-looking statements as a result of developments occurring
after the date this Form 10-Q is filed with the SEC.
Overview
Protection One is one of the leading providers of property monitoring
services, providing electronic monitoring and maintenance of its alarm systems
to over 1.6 million customers in North America and Europe. We also provide our
customers with enhanced services that include:
- - extended service protection;
- - patrol and alarm response;
- - two-way voice communication;
- - pager service;
- - medical information service;
- - cellular back-up; and
- - mobile security services.
Approximately 85% of our revenues are contractually recurring for monitoring
alarm security systems and other related services. We have grown rapidly by
participating in the growth in the alarm industry and by acquiring other alarm
companies.
Our principal activity is responding to the immediate security and safety
needs of our customers 24 hours a day. Our revenues are generated primarily from
recurring monthly payments for monitoring and maintaining the alarm systems that
are installed in our customers' homes and businesses. Security systems are
designed to detect burglaries, fires and other events. Through a network of 69
service branches and five satellite offices in North America and 51 service
branches in continental Europe and the United Kingdom, we provide maintenance
service of security systems and, in certain markets, armed response to verify
that an actual emergency has occurred.
<PAGE>
We provide our services to the residential (both single family and
multifamily residences), commercial and wholesale segments of the alarm
industry. Although we intend to grow our presence in each of these market
segments, we believe the residential segment, which represents in excess of 80%
of our customer base, is the most attractive segment of the alarm business
because of its lower penetration and thus stronger growth prospects, higher
gross margins and larger potential size.
Our company is divided geographically into two business segments:
Protection One North America generated approximately $218.3 million, or
72.9%, of our revenues in the first half of 1999 and is comprised of:
- - Protection One Alarm Monitoring-our core alarm monitoring business
based in Culver City, California; and
- - Network Multifamily Security-our alarm monitoring business
servicing the multifamily/apartment market based in Addison,
Texas; and
- - Mobile Division-our location-based emergency, navigation and information
business servicing individuals in their automobiles based in Irving,
Texas.
Protection One Europe generated approximately $81.0 million, or 27.1%, of
our revenues in the first half of 1999 and is comprised of:
- - Protection One Continental Europe-our alarm monitoring business
servicing continental Europe established from our purchase of Compagnie
Europeenne de Telesecurite ("CET") in September 1998, based in Paris and
Vitrolles, France with offices in Germany, Switzerland, Belgium and the
Netherlands; and
- - Protection One United Kingdom-our alarm monitoring business servicing
the United Kingdom established from our purchase of Hambro Countrywide
Security in May 1998, based in Basingstoke, United Kingdom.
Because Protection One Europe was created as a result of acquisitions that
occurred during the course of 1998, only 10% of our revenues were contributed
from this business segment during 1998. This percentage is expected to
increase during 1999 as Protection One Europe contributes a full year of
revenues.
Attrition
Subscriber attrition has a direct impact on our results of
operations, since it affects both our revenues and amortization expense. We
define attrition as a ratio, the numerator of which is the number of lost
customer accounts for a given period, net of certain adjustments, and the
denominator, which is the average number of accounts for a given period. The
adjustments made to lost accounts are related to those accounts which are
covered under a purchase price holdback and are "put" back to the seller. We
reduce the gross accounts lost during a period by the amount of the guarantee
provided for in the purchase agreements with sellers. In some cases, the
amount of the purchase hold back may be less than actual attrition experience.
The Company has historically amortized the assets related to its customer
base as a composite pool on a straight-line method over a period of ten years.
The Company's actual attrition experience shows that the relationship period
with any individual customer can vary significantly and may be substantially
shorter or longer than ten years. Customers discontinue service with the
Company for a variety of reasons, including relocation, service issues, and
cost. A portion of the acquired customer base can be expected to discontinue
service with the Company every year. The Company is presently reconsidering
the appropriateness of using a composite pool, straight-line amortization, and
the ten-year period. Any significant change in accounting policy or in the
pattern of the Company's historical attrition experience would have a material
effect on the Company's results of operations. See Note 4 to Consolidated
Financial Statements for further discussion.
<PAGE>
During the second quarter of 1999, there were indicators that attrition
was exceeding expected levels. Attrition for the trailing twelve months ending
June 30, 1999, was 10.5% compared to 9.7% at the end of March 31, 1999.
Annualized attrition for the quarter ended June 30, 1999 was 14.3%.
In early 1999, the Company consolidated monitoring of accounts to central
locations to improve customer service. The execution of this strategy caused
service disruptions that adversely affected customer service. The Company is
attempting to address these customer service issues. In this regard, the
Company has hired approximately 150 additional service representatives.
Recent Developments
Sale of Mobile Division. The sale of our Mobile Division to ATX
Technologies ("ATX") was announced on June 28, 1999. The sales price is
approximately $20 million in cash plus a note and a preferred stock investment
in ATX. The Company will continue to deliver mobile services through a
reseller arrangement with ATX. It is anticipated the sale will be completed in
the third quarter of 1999. For the six months ended June 30, 1999, the net
loss attributable to the Mobile Division was approximately $1.9 million.
SEC Review. The Company received a letter from the Division of
Corporation Finance of the SEC on August 11, 1999. The letter raised questions
about the Company's financial statements and stated that, in the view of the
staff, there are errors in the Company's financial statements which are material
and which have had the effect of inflating earnings commencing with the year
1997. These questions relate to the methodology used by the Company to amortize
customer accounts, and to the purchase price allocation to customer accounts in
the Network Multifamily acquisition. If a change from the average estimated life
of ten years used to amortize accounts is determined to be appropriate, the
Company estimates that a one-year to three-year reduction in estimated useful
life would result in additional amortization expense of approximately $14
million to $54 million per year. Any such increased amortization expense would
reduce earnings, but would not affect cash flow from operations. The Company is
discussing these issues with the SEC staff. The Company cannot predict the
timing or impact on its financial statements of these discussions. The Company
is reconsidering the accounting used for amortization of customer accounts and
the purchase accounting for prior acquisitions. Such changes may require a
restatement of prior year financial statements and may require Protection One to
perform an asset impairment evaluation.
Dealer Program. In 1998, the Company expanded the Dealer Program (Dealer
Program) for its North American single family residential market. As part of the
Dealer Program, the Company entered into contracts with dealers, typically
independent alarm companies, providing for the purchase of customer accounts
generated by the dealer on an ongoing basis. The Company currently has a limited
internal sales capability and relies on the Dealer Program for the generation of
substantially all new customer accounts except those acquired as part of the
acquisition of other security companies.
In the second quarter, the Company established a goal of identifying steps
that could be taken to reduce the cost of acquired accounts and reduce attrition
by acquiring higher quality accounts. As a result, the Company has begun
notifying dealers that it does not intend to renew their contracts under their
current terms and conditions when they expire. The term of dealer contracts
ranges from one to five years and automatically renews unless notice of
non-renewal is given by either party as provided in the contract. The Company is
attempting to renew contracts with terms providing for a lower cost for acquired
customer accounts based upon the multiple of monthly recurring revenue and other
revised terms that improve the quality of the acquired customer accounts. The
Company cannot predict whether it will be successful in renewing existing dealer
contracts, or entering into contracts with new dealers, on acceptable terms.
This could result in a loss of dealers and fewer customer accounts available for
purchase. The failure to replace customer accounts could have a material adverse
impact on our financial condition.
Six Protection One dealers have filed a class action lawsuit in the U. S.
District Court for the Western District of Kentucky alleging breach of contract
because of the Company's interpretation of their dealer contracts. The action is
styled Total Security Solutions, Inc., et al. v. Protection One Alarm
Monitoring, Inc., Civil Action No. 3:99CV-326-H (filed May 21, 1999). Other
Protection One dealers have threatened similar litigation. The Company believes
it has complied with the terms of these contracts and intends to vigorously
defend its position. The Company cannot currently predict the impact of these
disputes with dealers which could be material.
<PAGE>
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
General. Results for the six months ended June 30, 1999, (the "first half of
1999") reflect the operations of Protection One following the acquisition of
security businesses in Europe subsequent to May, 1998, while results for the
comparable period in 1998 reflect primarily the operations of Protection One
North America. In the first half of 1998, the Company added approximately
488,000 customers through business acquisitions (the "1998 acquisitions").
Accordingly, the results of the first half of 1999 contain a full six months of
operations for such acquisitions. Increases in revenues and expense items
discussed below are attributable to four factors, as appropriate: (i) changes in
the financial results of Protection One North America; (ii) the 1998
Acquisitions (iii) the acquisition of alarm businesses in Europe in the second
quarter and late in the third quarter of 1998, and (iv) a significant increase
in the level of customers added through the Dealer Program. Discussion of
results in future periods may not include specific discussion of contributions
from the 1998 Acquisitions, which consist primarily of Comsec, Multimedia and
Network.
Revenues for the first half of 1999 increased by approximately $125.5
million, or 72.2%, to $299.3 million from $173.8 million for the comparable
period in 1998. Monitoring and related services revenues increased by
approximately $96.8 million, or 61.2%. The majority of the increase is due to
Protection One Europe, with the remaining increase attributed to the 1998
Acquisitions and the growth of Protection One North America. Approximately 62.8%
of this increase is due to Protection One Europe.
Installation and other revenues increased by $28.7 million, or 183.7% to
$44.3 million from $15.6 million, reflecting additional installation revenues of
$33.4 million from Protection One Europe and a decrease in Protection One North
America installation revenues. We maintain internal sales and installation
capabilities in certain areas, such as Network Multifamily, our commercial
installations and our European operations where we principally rent security
systems.
Cost of revenues for the first half of fiscal 1999 increased by
approximately $27.7 million, or 49.9%, to $83.2 million from $55.5 million. Cost
of revenues as a percentage of total revenue decreased to 27.8% for the first
half of fiscal 1999 from 31.9% for the comparable period in 1998. Monitoring and
related service expenses increased by approximately $15.1 million, or 33.8%,
primarily due to Protection One Europe, which accounted for approximately 81.3%
of the total increase. Monitoring and related service expenses as a percentage
of monitoring related services revenues decreased to 23.5% for the first half of
fiscal 1999, from 28.3% in the comparable period in 1998.
Installation and other cost of revenues increased by $12.6 million, or
117.3%, reflecting primarily installation activities from Protection One Europe.
Gross profit for the first half of 1999, was approximately $216.2 million,
representing an increase of $97.8 million, or 82.7%, over the $118.4 million of
gross profit recognized in the comparable period in 1998. Such increase is
primarily due to the contribution by Protection One Europe of $56.3 million, or
approximately 57.5%, with the 1998 Acquisitions and the growth of Protection One
North America comprising the remainder of the increase. Gross profit as a
percentage of total revenues was 72.2% for the first half of fiscal 1999,
compared to 68.1% for the comparable period in 1998. The increase in gross
profit as a percentage of revenues is due to the cost of revenues factors noted
above.
Selling, general and administrative expenses ("S,G&A") rose to $84.5 million
in the first half of fiscal 1999, an increase of approximately $38.0 million, or
81.6%, over S,G&A in the comparable period in 1998. The majority of the increase
(approximately $32.5 million or 85.5%) is due to Protection One Europe, the
growth of Protection One North America and the 1998 Acquisitions. S,G&A figure
as a percentage of total revenues increased from 26.8% in the first half of 1998
to 28.2% in the first half of 1999. The increase in S,G&A as a percentage of
total revenues reflects the higher percentage of S,G&A as a percentage of
revenues from Protection One Europe of approximately 41.2%. The higher
percentage of S,G&A for Protection One Europe is due to the internal sales and
installation activities.
Acquisition expenses for the first half of 1999 increased to $11.6 million,
an increase of approximately $2.1 million, or 22.5% from $9.5 million in the
comparable period in 1998. The increase is due to efforts to integrate the 1998
Acquisitions and to support the national Dealer Program.
<PAGE>
Amortization of intangibles and depreciation expense was $87.5 million for
the first half of fiscal 1999, an increase of $39.0 million, or 80.3% over the
$48.5 million in the comparable period in 1998. The increase is due primarily to
the 1998 Acquisitions and the growth in our Dealer Program in Protection One
North America. Depreciation and amortization expense from Protection One Europe
represented $10.7 million, or approximately 27.4% of the increase. See Note 4 to
Consolidated Financial Statements for further discussion.
Employee severance cost for the first half of fiscal 1999 was $2.0 million
which is the cost associated with the severance of certain of our former
officers. The Company will expense severance costs of approximately $1.2 million
following the resignation of the Company's president and chief operating officer
in July 1999.
Other income (expense) totaled $(41.0) million of expense in the first half
of 1999, as compared to $(11.5) million of expense in the comparable period in
1998. Interest expense increased by $17.1 million to $42.0 million during the
six months ended June 30, 1999, compared to $24.9 million for the six months
ended June 30 1998, reflecting the increased debt level when compared to the
second quarter of 1998. Interest expense in the first half of 1998 was
significantly offset by other income of $13.4 million, reflecting a gain on
repurchase of certain contracts.
Income tax (expense) benefit totaled ($1.5) million for the six months ended
June 30, 1999. The company's provision for income taxes is higher than the
effective rate primarily due to the non-deductibility of goodwill amortization
which was incurred as a result of its acquisition program. We consolidate with
our parent company, Western Resources, Inc. for federal tax reporting purposes.
We do not consolidate Protection One Europe for tax reporting purposes.
Balance sheet data. At June 30, 1999, the Company's working capital deficit
was $37.3 million compared to a working capital deficit of $48.2 million at
December 31, 1998. This decrease in the working capital deficit of $10.9 million
is primarily due to an increase in current deferred tax assets of $21.6 million
offset by an increase in purchase holdbacks of $9.0 million.
Goodwill and trademarks, net and customer accounts, net, increased to $2.3
billion at June 30, 1999, from $2.2 billion at December 31, 1998. This net
increase of approximately $129.5 million, or 5.9% reflects the addition of
approximately 166,000 customer accounts, offset by amortization expense for the
first half of 1999 of $80.0 million. See Note 4 to Consolidated Financial
Statements for further discussion.
Total stockholders' equity decreased approximately $14.6 million to $1,330.5
million from $1,345.1 million. The decrease in such figure reflects the net loss
of $12.0 million for the six months ended June 30, 1999 and the increase in the
unrealized loss on marketable securities and currency translation.
Three Months Ended June 30, 1999 Compared to Three Months Ended June 30, 1998
Revenues for the second quarter of 1999 increased by approximately $53.8
million, or 55.4%, to $150.8 million from $97.0 million for the comparable
period in 1998. Approximately 73.0% of this increase is due to Protection One
Europe. Monitoring and related services revenues increased by approximately
$40.4 million, or 46.2%. The majority of the increase is due to Protection One
Europe, the 1998 Acquisitions and the growth of Protection One North America.
Monitoring and related service from our Mobile Division increased 32.6% to $0.12
million in the second quarter of 1999 from $0.09 million in the comparable
period in 1998.
Installation and other revenues increased by $13.4 million, or 139.6% to
$23.0 million from $9.6 million, reflecting additional installation revenues of
$17.2 million from Protection One Europe offset by a decrease in Protection One
North America installation revenues. The decline in Protection One North America
installation revenues reflects our conversion of substantially all sales and
installation activities previously conducted by an internal sales force to the
Dealer Program. We maintain internal sales and installation capabilities in
certain areas, such as our Network Multifamily Security subsidiary our
commercial installations and our European operations where we principally rent
security systems.
Cost of revenues for the second quarter of fiscal 1999 increased by
approximately $10.4 million, or 33.0%, to $41.9 million from $31.5 million. Cost
of revenues as a percentage of total revenue decreased to 27.8% for the second
quarter of fiscal 1999 from 32.4% for the comparable period in 1998. Monitoring
and related services expenses increased by approximately $5.5 million, or 22.2%,
primarily due to Protection One Europe, which accounts for approximately 74.6%
of the total increase. Monitoring and related services expenses as a percentage
of monitoring and related services revenues decreased to 23.6% for the second
quarter of fiscal 1999, from 28.2% in the comparable period in 1998.
Installation and other cost of revenues increased by $4.9 million, or 72.3%,
reflecting primarily installation activities from Protection One Europe in the
amount of $7.1 million.
Gross profit for the second quarter of 1999, was approximately $108.9
million, representing an increase of $43.4 million, or 66.1%, over the $65.6
million of gross profit recognized in the comparable period in 1998. Such
increase is primarily due to the contribution by Protection One Europe of $28.1
million, or approximately 64.8%, with the 1998 Acquisitions and the growth of
Protection One North America comprising the remainder of the increase. Gross
profit as a percentage of total revenues was 72.2% for the second quarter of
fiscal 1999, compared to 67.6% for the comparable period in 1998. The increase
in gross profit as a percentage of revenues is due to the cost of revenues
factors noted above.
Selling, general and administrative expenses ("S,G&A") rose to $43.9 million
in the second quarter of fiscal 1999, an increase of approximately $17.9
million, or 68.7%, over S,G&A in the comparable period in 1998. The majority of
the increase (approximately $16.6 million or 93.1%) is due to Protection One
Europe, the growth of Protection One North America and the 1998 Acquisitions.
Such figure as a percentage of total revenues increased from 26.8% in the second
quarter of 1998 to 29.1% in the second quarter of 1999. The increase in S,G&A as
a percentage of total revenues reflects the higher percentage of S,G&A as a
percentage of revenues from Protection One Europe of approximately 42.3%. The
higher percentage of S,G&A for Protection One Europe is due to the internal
sales and installation activities.
Acquisition expenses for the second quarter of 1999, increased to $6.8
million, an increase of approximately $0.8 million, or 12.2% from $6.0 million
in the comparable period in 1998. The increase is due to efforts to integrate
the 1998 Acquisitions and to support the national Dealer Program.
Amortization of intangibles and depreciation expense was $44.9 million for
the second quarter of fiscal 1999, an increase of $17.1 million, or 61.5% over
the $27.8 million in the comparable period in 1998. The increase is due
primarily to the 1998 Acquisitions and the growth in our Dealer Program in
Protection One North America. Depreciation and amortization expense from
Protection One Europe represented $5.2 million, or approximately 30.3% of the
increase. See Note 4 to Consolidated Financial Statements for further
discussion.
Other income (expense) totaled $(21.2) million of expense in the second
quarter of 1999, as compared to $(3.6) million of expense in the comparable
period in 1998. Interest expense increased by $8.0 million, or 58.7% to $21.8
million during the quarter ended June 30, 1999, compared to $13.8 million for
the quarter ended June 30, 1998, reflecting the increased debt level when
compared to the second quarter of 1998. The increase in debt was used to fund
accounts purchased under the Dealer Program, acquisitions and operations.
Interest expense in the second quarter of 1998 was significantly offset by other
income of $10.2 million, reflecting a gain on repurchase of certain contracts.
Income tax (expense) benefit totaled $0.4 million for the quarter ended June
30, 1999. The Company's provision for income taxes is higher than the effective
rate primarily due to the non-deductibility of goodwill amortization which was
incurred as a result of its acquisition program. We consolidate with our parent
company, Western Resources, Inc. for federal tax reporting purposes. We do not
consolidate Protection One Europe for tax reporting purposes.
Liquidity and Capital Resources
The Company borrows to fund operations in excess of internally generated
cash under its existing $500 million senior credit facility. The Company's
ability to borrow under the facility is subject to compliance with certain
financial covenants, including a debt to annualized EBITDA ratio ("leverage
ratio") of 5.0 to 1.0 and an annualized EBITDA to interest expense ratio
("interest coverage ratio") of 2.75 to 1.0. As of June 30, 1999, the ratios were
approximately 4.7 to 1.0 and 3.3 to 1.0. At year end 1999, the leverage ratio
will be reduced to 4.5 to 1.0. The Company currently borrows approximately $20
million per month, principally to fund the purchase of customer accounts. The
Company currently believes it is likely, absent successful implementation of the
alternatives discussed below, that it will be unable to satisfy the current
leverage and interest coverage ratio covenants in the credit facility following
the third quarter of 1999. The resolution of the accounting issues raised by the
SEC of the Company's accounting practices would most likely cause the Company to
need to obtain waivers or consents under the credit facility and could impact
the Company's ability to meet the financial covenants contained in the credit
facility. The Company is exploring alternatives to address these covenant
restrictions, including the sale of assets to reduce debt, seeking waivers or
renegotiating these covenants with lenders, or refinancing the facility. The
Company believes it will be able to address this matter in a manner so that
there is no default under the credit facility or significant impact on its
liquidity, but no assurance can be given that the Company will be able to do so
or the terms thereof.
<PAGE>
Cash will also be generated from recurring revenue from our security alarm
monitoring services customer base which generated $120.0 million of recurring
EBITDA in the six months ended June 30, 1999. Cash flow from operations per the
statement of cash flows was $71.9 million. EBITDA is derived by adding to income
(loss) before income taxes, the sum of interest expense and depreciation and
amortization expense. EBITDA does not represent cash flow from operations as
defined by generally accepted accounting principles, should not be construed as
an alternative to operating income and is indicative of neither operating
performance nor cash flows available to fund our cash needs. Items excluded from
EBITDA are significant components in understanding and assessing our financial
performance. EBITDA is used by senior lenders and subordinated creditors and the
investment community to determine the current borrowing capacity and to estimate
the long-term value of companies with recurring cash flows from operations. Our
computation of EBITDA may not be comparable to other similarly titled measures
of other companies.
We generated $71.9 million of net cash provided by operating activities for
the six months ended June 30, 1999, compared to the $57.5 million net cash
provided by operating activities in the six months ended June 30, 1998. The
increase in net cash provided by operating activities reflects the increases in
our customer base from which recurring monthly revenue is derived.
We used $192.3 million of net cash in investing activities for the six
months ended June 30, 1999, compared to the use of $514.3 million for the
comparable period in 1998. Investing activities during the six months ended June
30, 1999, included Dealer Program purchases and enterprise-wide software
expenditures. Investing activities during the six months ended June 30, 1998,
included the acquisition of Comsec, Multimedia, Hambro and Canguard as well as
Dealer Program purchases.
We generated $127.7 million of net cash through financing activities for the
six months ended June 30, 1999, compared to generating $398.7 million for the
six months ended June 30, 1998. We obtained funding of approximately $130
million through our $500 million senior credit facility.
The indentures governing the Senior Subordinated Discount Notes and
Convertible Senior Subordinated Notes contain certain restrictions on the
transfer of Company funds, including dividends, loans and advances made by the
Company. Refer to the Company's 1998 Form 10-K/A for additional information
on these notes.
Material Commitments. Under the Company's agreements with dealers, the
Company may be required to purchase customer accounts on an ongoing basis. The
Company is currently spending approximately $20 million to $25 million per month
to purchase these customer accounts.
Capital Expenditures. We anticipate making capital expenditures in 1999 of
approximately $25.0 million, including $15.0 million to complete the development
and installation of our new software platforms, $5.0 million for computer
hardware to replace and upgrade existing operations and $5.0 million for other
capital items. These are estimates and actual expenditures for these and
possibly other items not presently anticipated, may vary from these estimates
during the course of 1999.
Tax Matters. Protection One is consolidated into income tax returns filed by
its parent, WRI. The two parties have entered into a tax sharing agreement,
whereby WRI will make cash payments to us for current tax benefits utilized for
income tax return purposes and will require cash payments from us for current
tax expenses incurred for income tax return purposes. This arrangement has
allowed us to provide a current tax benefit for the year ended December 31,
1998, as well as for the six months ended June 30, 1999.
On a go-forward basis, if and when we, or WRI, generate income for tax
return purposes, it will proportionately over time utilize existing net
operating loss carryforwards in amounts up to approximately $60 million.
Currently, the deferred tax assets related to the net operating loss
carryforwards are fully reserved due to uncertainty as to their future
realizability. However, when net operating loss carryforwards are utilized, the
relief of the corresponding reserve will not create a benefit, but, as required
by generally accepted accounting principles, will reduce our goodwill balances.
The net financial statement effect of this treatment will cause us to recognize
deferred tax expense we might otherwise not recognize.
<PAGE>
Year 2000 Issue
An issue exists for all companies that rely on computers as the year 2000
approaches. The "Year 2000" problem is the result of the past practice in the
computer industry of using two digits rather than four to identify the
applicable year. This practice could result in incorrect results when computers
perform arithmetic operations, comparisons, or data field sorting involving
years later than 1999.
We are reviewing our computer programs, computer hardware and embedded
systems identified as critical to our businesses and operational needs to assess
and to correct any components that could be affected by the change of date to
January 1, 2000, as well as other dates in 2000. In addition, we engaged an
outside consulting firm with an international reputation in Year 2000 to conduct
an independent validation and verification (IV&V) of our Y2K readiness programs.
We have substantially completed the review and assessment of our systems,
although changes in the state of compliance or preparedness within companies
that provide services or equipment to us will require us to continue our
evaluations of these third-party vendors as the need arises or as prudence
dictates, until January 1, 2000 or later if need be. Our ongoing review will
also focus on the acquisition of businesses that include additional information
technology systems, or non-information technology systems and equipment such as
electrical, heating and cooling systems.
A number of our accounts are monitored by other firms on Protection One's
behalf. In the Protection One North America monitoring division, we are
assimilating these accounts into our own facilities, but will not have completed
this effort prior to January 1, 2000. We are therefore actively evaluating these
third-party monitoring (TPM) firms at this time for Y2K readiness and using the
results of this evaluation as inputs to our account-assimilation priorities. In
the European division, international third-party-monitored accounts (Germany,
Belgium, Netherlands, Switzerland) cannot be assimilated into our French
monitoring facilities because of restrictions on trans-border alarm signal flow,
and establishing owned monitoring centers in these countries is not feasible at
this time. Evaluation of these four third-party monitoring firms (one for each
of the four countries) will be completed prior to the end of October, 1999.
Consolidation of all U.K. accounts, both those currently monitored by TPMs and
those monitored in Protection One-owned facilities, will be consolidated into
the Protection One U.K. monitoring facility by the end of October (from TPMs),
and by year-end 1999 (from other Protection One-owned facilities). Network
Multifamily does not use TPMs. The total number of TPM accounts is less than 7%
of all accounts at this time, and is expected to be less than 5% at year-end
1999.
Our Year 2000 policy requires testing as a method for verifying the Year
2000 readiness of business-critical items. For those items that are impossible
to test, other methods may be used to identify the readiness status, provided
adequate contingency plans are established to provide a workaround or backup for
the item. Development of contingency plans commenced in January 1999 and is
scheduled to conclude in September, 1999. Testing of contingency plans, and
mobilization for "Millennium Day", will be done in the third and fourth quarters
of 1999. Protection One North America's equipment testing is scheduled to be
completed by December 20, 1999.
We have largely completed the remediation and readiness verification phase
of our plans with respect to our Protection One North America monitoring
operations where problems that were identified are being corrected and
re-tested. Our highest priority has been to ensure the Y2K-readiness of
Protection One's call centers responsible for alarm monitoring and for
responding to customer telephone calls. At this time we believe that our call
centers will continue to be able to receive and act upon alarm signals and
in-person telephone calls, so long as infrastructure elements over which
Protection One has no control (such as electrical power, telephones, and
governmental services) are not disrupted or overwhelmed by consumer demand. The
majority of our current efforts are now concentrated in contingency planning,
and concluding our Year 2000 readiness verification testing.
In the Protection One North America Monitoring division, remediation of
known non-compliant computer-based systems has been completed except for one
billing system serving some 50,000 accounts. Remediation and testing of this
system is scheduled to be completed by year end. Remediation and testing of
systems at Network Multifamily is complete except for one vendor upgrade to a
monitoring application, expected to be completed by end of August. In Europe,
remediation of in-house systems is complete, and remediation (software
migration) of a U.K. TPM system is under way. We expect to have removed all
Protection One accounts from this TPM system by end of October, however,
readiness verification (testing of business-critical systems previously assessed
as Y2K-compliant) is proceeding in priority order, and will continue throughout
the calendar year, as a double-check. A substantial amount of readiness
verification has already been completed on Protection One North America
Monitoring major systems, with only non-critical errors found.
<PAGE>
We have estimated the total cost to update all critical operating systems
for Year 2000 readiness to be approximately $5.0 million. As of June 30, 1999,
approximately $2.5 million of these costs had been incurred. These costs include
labor for both company employees and contract personnel used in the Year 2000
program and non-labor costs for software tools used in the remediation and
testing efforts, replacement software, replacement hardware, replacement
embedded devices, and other such costs associated with testing and replacement.
Management continues to review the projected costs associated with the Year 2000
readiness. To date, the costs of the Year 2000 readiness program have been
substantially information-technology related. Non-information technology systems
are highly critical to our business, but are largely beyond our ability to
control. This includes telephones, electricity, water, transportation, and
governmental infrastructure.
The costs of the Year 2000 project and the date on which we plan to complete
the Year 2000 modification, estimated to be during 1999, are based on the best
estimates, which were derived utilizing numerous assumptions of future events
including the continued availability of certain resources, third party
modification plans, and other factors. However, there can be no guarantee that
these estimates will be achieved; actual results could differ materially from
those plans. Specific factors that might cause such material differences
include, but are not limited to, the availability and cost of personnel trained
in this area, the ability to locate and correct all relevant computer codes, and
similar uncertainties.
<TABLE>
The table below summarizes the status of the components of the Year 2000 Readiness Program as of June 30, 1999.
<CAPTION>
North American Network Multi-Family Protection One Europe
Phase: Monitoring
------------------------ ------------------------ ------------------------
<S> <C> <C> <C>
Identification and assessment Completed Completed 85% Complete
Remediation and unit testing 95% Complete Completed 83% Complete
Comprehensive Y2K readiness
verification:
Guidelines and tools Completed Completed Completed
Testing 50% Complete 90% Complete 80% Complete
Contingency planning:
Guidelines and tools Completed Completed Completed
Plan development 70% Complete Completed 20% Complete
Contingency plan testing and
resourcing:
Guidelines and tools Completed Completed Completed
Testing and resourcing To do Sept-Nov 1999 To do Sept-Nov 1999 To do Sept-Nov 1999
Mobilization, alert, and standby To do Nov-Dec 1999 To do Nov-Dec 1999 To do Nov-Dec 1999
</TABLE>
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has not experienced any significant changes in its exposure to
market risk since December 31, 1998. For additional information on the Company's
market risk, see the Form 10-K/A dated December 31, 1998.
<PAGE>
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Since April 1999, four alleged class action litigations have been filed
in the United States District Court for the Central District of California
against Protection One, Inc. and certain of its present and former officers.
The four actions are: David Lyons v. Protection One, Inc., Western Resources,
Inc., James M. Mackenzie, Jr., John W. Hesse, and John E. Mack, III,
No. 99-CV-3755 (C.D.Cal.) (filed April 7, 1999); Randall Karkutt v. Protection
One, Inc., James M. Mackenzie, Jr., and John W. Hesse, No. 99-CV-3798
(C.D.Cal.) (filed April 8, 1999); David Shaev v. Protection One, Inc.,
John E. Mack, III, James H. Mackenzie, Jr., and John Hesse, No. 99-CV-4147
(C.D.Cal.) (filed April 20, 1999); and Mike Ringel v. Protection One, Inc.,
Western Resources, Inc., James M. McKenzie, Jr., John W. Hesse and
John E. Mack, III, No. 99-CV-5534 (C.D.Cal) (filed May 28, 1999). The
actions are purportedly brought on behalf of purchasers of the common stock of
Protection One, Inc. during periods beginning February 10, 1998 (Karkutt and
Ringel), February 12, 1998 (Shaev), or April 23, 1998 (Lyons), and ending
April 1, 1999. All four complaints assert claims under Sections 10(b) and 20
of the Securities Exchange Act of 1934 based on allegations that various
statements made by the defendants concerning the financial results of
Protection One, Inc. were false and misleading and not in compliance with
generally accepted accounting principles. The complaints seek unspecified
amounts of damages and an award of fees and expenses, including attorney's
fees. By an order dated August 2, 1999, the District Court consolidated the
four actions and appointed Ronald Cats as lead plaintiff in the consolidated
actions. The Court further ordered that plaintiffs will file a single
consolidated amended complaint within sixty days. Protection One believes
these actions are without merit and intends to defend against them vigorously.
Six Protection One dealers have filed a class action lawsuit in the U. S.
District Court for the Western District of Kentucky alleging breach of contract
because of the Company's interpretation of their dealer contracts. The action is
styled Total Security Solutions, Inc., et al. v. Protection One Alarm
Monitoring, Inc., Civil Action No. 3:99CV-326-H (filed May 21, 1999). Other
Protection One dealers have threatened similar litigation. The Company believes
it has complied with the terms of these contracts and intends to vigorously
defend its position. The Company cannot currently predict the impact of these
disputes with dealers which could be material.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
<PAGE>
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS.
The 1999 annual meeting of Protection One, Inc.'s stockholders (the "Annual
Meeting") was held on May 12, 1999. All directors nominated were elected at the
Annual Meeting. For the election of directors, the results were as follows:
<TABLE>
<CAPTION>
Nominee Votes For Votes Withheld
<S> <C> <C> <C>
Charles Q. Chandler IV 120,774,895 232,263
Robert M. Chefitz 120,991,501 15,657
Howard A. Christensen 120,774,714 232,444
Maria de Lourdes Duke 120,774,895 232,263
John E. Mack III 120,797,812 209,346
Ben M. Enis 117,096,478 3,910,680
Carl M .Koupal, Jr. 120,774,795 232,363
Douglas T. Lake 120,774,795 232,363
John C. Nettels, Jr. 120,967,336 39,822
Thomas K. Rankin 120,986,075 21,083
Anthony D. Somma 120,774,747 232,411
James Q. Wilson 120,977,565 29,593
</TABLE>
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits. The following exhibits are filed with this Current Report on
Form 10-Q or incorporated by reference.
Exhibit
Number Exhibit Description
27.1 Financial Data Schedule.*
- ---------
* Filed herewith
(b) During the quarter ended June 30, 1999, the company filed four Reports on
Form 8-K. A Current Report on Form 8-K dated April 1, 1999, reported the
extension of filing of the Company's Form 10-K. A Current Report on Form 8-K
dated July 2, 1999, reported the proposed sale of the Company's Mobile Division.
A Current Report on Form 8-K dated August 12, 1999, reported second quarter
earnings. A Current Report on Form 8-K/A dated August 13, 1999, reported a
correction in Form 8-K filed on August 12, 1999.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized.
Date: August 16, 1999 PROTECTION ONE, INC.
---------------------
PROTECTION ONE ALARM MONITORING, INC.
By: /s/ Anthony D. Somma
Anthony D. Somma
Chief Financial Officer
<PAGE>
Exhibit List
Exhibit
Number Exhibit Description
27.1 Financial Data Schedule.
<PAGE>
<TABLE> <S> <C>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 6-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> JUN-30-1999
<CASH> 17,981
<SECURITIES> 12,019
<RECEIVABLES> 91,599
<ALLOWANCES> 24,636
<INVENTORY> 11,277
<CURRENT-ASSETS> 222,467
<PP&E> 78,830
<DEPRECIATION> 20,435
<TOTAL-ASSETS> 2,642,559
<CURRENT-LIABILITIES> 259,756
<BONDS> 825,745
<COMMON> 1,269
0
0
<OTHER-SE> 1,329,206
<TOTAL-LIABILITY-AND-EQUITY> 2,642,559
<SALES> 299,348
<TOTAL-REVENUES> 299,348
<CGS> 83,156
<TOTAL-COSTS> 83,156
<OTHER-EXPENSES> (1,015)
<LOSS-PROVISION> 6,092
<INTEREST-EXPENSE> 42,015
<INCOME-PRETAX> (10,497)
<INCOME-TAX> 1,497
<INCOME-CONTINUING> (11,994)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (11,994)
<EPS-BASIC> (0.09)
<EPS-DILUTED> (0.09)
</TABLE>
