<PAGE>
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 September 30, 2000
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________
<TABLE>
<S> <C>
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.)
6011 BRISTOL PARKWAY, 6011 BRISTOL PARKWAY,
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)
</TABLE>
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 November 1, 2000, Protection One, Inc. had outstanding 126,305,100
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>
FORWARD-LOOKING STATEMENTS
Certain matters discussed 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, restructuring the dealer
program and the methods of customer acquisition, the implementation of new
financial and billing information systems, 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, ability to enter new markets successfully and
capitalize on growth opportunities, 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; the possible separation
of Westar Industries, Inc. from Western Resources; the possible consummation of
a strategic transaction by Western Resources; competitive markets; and other
circumstances affecting anticipated operations, revenues and costs.
2
<PAGE>
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
SEPTEMBER 30, DECEMBER 31,
2000 1999
-------------- --------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents............................ $ 1,162 $ 7,658
Restricted cash...................................... 779 11,175
Marketable securities................................ -- 6,664
Receivables, net..................................... 34,811 71,716
Inventories.......................................... 10,861 12,908
Prepaid expenses..................................... 2,522 3,471
Related party tax receivable & current deferred taxes 57,304 59,456
Other assets......................................... 2,687 13,332
---------- ----------
Total current assets.............................. 110,126 186,380
Property and equipment, net............................. 47,480 60,912
Customer accounts, net.................................. 941,652 1,139,066
Goodwill, net........................................... 884,256 1,101,788
Other................................................... 43,025 70,089
---------- ----------
Total assets......................................... $2,026,539 $2,558,235
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt.................... $ 72,659 $ 35,498
Accounts payable..................................... 5,505 23,205
Accrued liabilities.................................. 43,659 74,248
Purchase holdbacks................................... 4,541 20,213
Deferred revenue..................................... 47,556 61,149
---------- ----------
Total current liabilities....................... 173,920 214,313
Long-term debt, net of current portion.................. 593,307 1,077,152
Other liabilities....................................... 307 4,173
---------- ----------
Total liabilities............................... 767,534 1,295,638
Commitments and contingencies ( See Note 6)
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, 126,324,200 and 126,945,337 shares issued
and outstanding at September 30, 2000 and December 31,
1999, respectively ..................................... 1,270 1,269
Additional paid-in capital.............................. 1,414,409 1,392,750
Accumulated other comprehensive income, net............. (633) (1,805)
Accumulated deficit..................................... (154,837) (129,617)
Treasury stock, at cost, 710,600 and no shares at
September 30, 2000 and December 31, 1999 respectively... (1,204) --
---------- ----------
Total stockholders' equity................... 1,259,005 1,262,597
---------- ----------
Total liabilities and stockholders' equity........... $2,026,539 $2,558,235
========== ==========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
3
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
(Dollars in thousands, except for per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
2000 1999
----------------- -----------------
<S> <C> <C>
Revenues:
Monitoring and related services............. $307,776 $381,770
Installation and rental..................... 27,801 66,197
-------- --------
Total revenues..................... 335,577 447,967
Cost of revenues:
Monitoring and related services......... 94,545 95,985
Installation and rental................. 16,431 33,863
-------- --------
Total cost of revenues............. 110,976 129,848
-------- --------
Gross profit....................... 224,601 318,119
Operating expenses:
Selling expense.......................... 14,002 37,298
General and administrative expense....... 85,209 96,021
Amortization of intangibles and
depreciation expense..................... 165,984 182,606
Acquisition expense...................... 8,924 21,932
Severance and other ..................... 3,050 4,308
-------- --------
Total operating expenses...................... 277,169 342,165
-------- --------
Operating loss..................... (52,568) (24,046)
Other (income) expense:
Interest expense, net................... 46,917 64,334
Gain on sale of Mobile Services Group... -- (17,249)
Other................................... (295) (71)
-------- --------
Loss before income taxes
And extraordinary gain.......... (99,190) (71,060)
Income tax benefit............................ 24,697 17,615
-------- --------
Loss before extraordinary gain................ (74,493) (53,445)
Extraordinary gain, net of tax effect
of $26,531.................................. 49,273 --
-------- --------
Net loss........................... $(25,220) $(53,445)
======== ========
Other comprehensive income/(loss):
Unrealized gain (loss) on marketable securities,
net of tax................................ $ 995 $ (3,888)
Unrealized gain (loss) on currency translation,
net of tax............................... 177 (488)
-------- --------
Comprehensive loss ............................... $(24,048) $ (57,821)
======== =========
Loss per common share ........................ $ (0.58) $ (0.42)
======== =========
Extraordinary gain per common share........... $ 0.38 $ --
======== =========
Net loss per common share................... $ (0.20) $ (0.42)
======== =========
Weighted average common shares outstanding
(in thousands).................................... 126,962 126,872
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
4
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE LOSS
(Dollars in thousands, except for per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
2000 1999
--------------------- ---------------
<S> <C> <C>
Revenues:
Monitoring and related services......... $ 94,790 $128,962
Installation and rental................. 4,837 21,911
--------- --------
Total revenues..................... 99,627 150,873
Cost of revenues:
Monitoring and related services......... 31,567 37,780
Installation and rental................. 3,023 10,280
--------- --------
Total cost of revenues............. 34,590 48,060
--------- --------
Gross profit....................... 65,037 102,813
Operating expenses:
Selling expense.......................... 2,916 11,882
General and administrative expense....... 26,264 37,815
Amortization of intangibles and
depreciation expense..................... 50,747 94,250
Acquisition expense...................... 2,248 10,298
Employee severance and other............. -- 2,309
--------- --------
Total operating expenses...................... 82,175 156,554
------- -------
Operating loss........................... (17,138) (53,741)
Other (income) expense:
Interest expense, net................... 13,826 22,319
Gain on sale of Mobile Services Group... -- (17,249)
Other................................... (5) 945
--------- --------
Loss before income taxes................ (30,959) (59,756)
Income tax benefit............................ 7,702 18,770
--------- --------
Net loss................................ (23,257) (40,986)
Other comprehensive loss:
Unrealized loss on marketable securities,
net of tax............................. $ -- $ (3,888)
Unrealized loss on currency translation,
net of tax.............................. (267) (488)
--------- --------
Comprehensive loss.............................. $ (23,524) $(45,362)
========= ========
Net loss per common share................. $ (0.18) $ (0.32)
========= ========
Weighted average common shares outstanding
(in thousands).......................... 126,581 126,890
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
5
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
2000 1999
--------------------- ---------------
<S> <C> <C>
Cash flow from operating activities:
Net loss............................................... $ (25,220) $ (53,445)
Adjustments to reconcile net loss to net cash provided
by operating activities:
Extraordinary gain................................. (49,273) --
Gain on sale of Mobile Services Group.............. -- (17,249)
Amortization and depreciation...................... 165,984 182,606
Accretion of discount note interest................ (2,595) (5,057)
Deferred income taxes.............................. (25,478) (20,795)
Provision for doubtful accounts.................... 12,943 16,933
Loss on sale of marketable securities.............. -- 1,910
Other charges...................................... (3,512) (16,106)
Changes in assets and liabilities:
Receivables, net................................... 3,120 (17,505)
Other current assets............................... (9,617) (1,120)
Accounts payable................................... (260) 5,302
Other liabilities.................................. (21,204) 462
--------- ---------
Net cash provided by operating activities..... 44,888 75,936
--------- ---------
Cash flows from investing activities:
Purchase of installed security systems, net........ (27,456) (207,657)
Purchase of property and equipment, net............ (13,918) (26,679)
Sale of European operations and other investments.. 183,025 2,722
Acquisition of alarm companies, net of cash received -- (27,408)
Proceeds from sale of Mobile Services Group, net
cash paid........................................ -- 19,087
Net cash provided by (used in) investing
activities.................................. 141,651 (239,935)
--------- ---------
Cash flows from financing activities:
Repayments on Senior Credit Facility, net ......... (153,000) --
Payments on long-term debt......................... (46,767) --
Proceeds from long-term debt....................... 6,087 171,725
Funding from Parent................................ 1,508 434
Acquisition of Treasury Stock...................... (1,204) --
Stock options and warrants exercised............... 160 273
--------- ---------
Net cash provided by (used in) financing
activities................................... (193,216) 172,432
--------- ---------
Effect of exchange rate changes on cash and equivalents 181 643
--------- ---------
Net increase (decrease) in cash and cash
equivalents.................................. (6,496) 9,076
Cash and cash equivalents:
Beginning of period................................ 7,658 10,025
--------- ---------
End of period...................................... $ 1,162 $ 19,101
========= =========
Interest paid during the period........................ $ 63,683 $ 54,437
========= =========
Taxes paid during the period........................... $ 514 $ 285
========= =========
</TABLE>
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
In the first quarter of 2000, the Company sold its European operations
for $225,000 and certain investments for $19,000 to Westar Industries, Inc.
(then named Westar Capital, Inc.). In exchange, the Company received $183,025
in cash and $60,975 market value of its outstanding bonds. Also in the first
quarter of 2000, the Company received $14,985 market value of its bonds and a
$14,198 note receivable from Westar Industries for payment of the Company's
1998 income tax receivable of $20,287 and an intercompany receivable of
$8,896. Westar Industries repaid all but $223 of the note by delivering
$13,975 in market value of the Company's debt securities in March and April
of 2000. The balance of the note was repaid in April.
The accompanying notes are an integral part of these
consolidated financial statements.
6
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
1. BASIS OF CONSOLIDATION AND INTERIM FINANCIAL INFORMATION:
Protection One, Inc., a Delaware corporation ("Protection One" or the
"Company"), is a holding company principally engaged through its subsidiaries 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, and until February
29, 2000, the United Kingdom and Continental Europe.
Westar Industries, Inc., formerly named Westar Capital, Inc., ("Westar
Industries"), a wholly owned subsidiary of Western Resources, Inc. ("Western
Resources"), owns approximately 85% of the Company's common stock. The
accompanying unaudited consolidated financial statements include the accounts of
Protection One and its wholly owned subsidiaries.
The Company's unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles ("GAAP")
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, 1999, included in the Company's Annual
Report on Form 10-K filed with the Securities and Exchange Commission (the
"SEC"). See Note 6 below regarding discussions with the SEC staff concerning
certain accounting matters.
In the opinion of management of the Company, all adjustments considered
necessary for a fair presentation of the financial statements have been
included. The results of operations for the three and nine months ended
September 30, 2000 are not necessarily indicative of the results to be expected
for the full year.
The Company expects to adopt two new statements on January 1, 2001. SFAS
No. 133 and No. 137, "Accounting for Derivative Instruments and Hedging
Activities" establish accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging activities.
The statements require that an entity recognize all derivatives as either assets
or liabilities in the statement of financial position and measure those
instruments at fair value. Changes in the derivative's fair value will be
required to be recognized currently in earnings unless specific hedge accounting
criteria are met. In addition, the statements will require the Company to
formally document, designate and assess the effectiveness of transactions that
receive hedge accounting. The Company has not traditionally been required to
utilize derivative instruments in managing its business. Therefore, management
has not yet determined what, if any, impact these pronouncements will have upon
adoption.
Certain reclassifications have been made to prior year information to
conform with the current year presentation.
2. CHANGE IN ACCOUNTING ESTIMATE:
The excess of the cost over the fair value of net assets of businesses
acquired is recorded as goodwill. The Company has historically amortized
goodwill on a straight-line basis over 40 years. In the first quarter of 2000,
the Company re-evaluated the original assumptions and rationale utilized in the
establishment of the carrying value and estimated useful life of goodwill. The
Company concluded that due to continued losses, increased levels of attrition
experienced in 1999 and other factors, the estimated useful life of goodwill
should be reduced from 40 years to 20 years. As of January 1, 2000, the
remaining goodwill, net of accumulated amortization, is being amortized over its
remaining useful life based on a 20-year life. The resulting increase in annual
goodwill amortization on the Company's existing account base will be
approximately $24,000 for North America and $6,000 for Multifamily. The
additional goodwill recorded for Europe prior to its sale on February 29, 2000
was approximately $1,000.
7
<PAGE>
The change in estimate resulted in additional goodwill amortization for the
three months and nine months ended September 30, 2000 of $7,210 and $22,606
respectively. The resulting reduction to net income for those periods was $6,305
and $19,892 respectively, or a decrease in earnings per share of $0.05 and
$0.16, respectively.
Goodwill amortization expense for the nine months ended September 30, 2000
and September 30, 1999, was $41,883 and $23,190, respectively. Goodwill
amortization expense for the three months ended September 30, 2000 and September
30, 1999, was $13,474 and $7,239, respectively.
8
<PAGE>
3. PRO FORMA FINANCIAL INFORMATION:
The following unaudited pro forma consolidated results of operations for
the nine months ended September 30, 2000 and September 30, 1999 assume the sale
of the European operations occurred on January 1, 1999.
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------
2000 1999
---- ----
<S> <C> <C>
Revenues........................................ $307,673 $325,574
Loss before extraordinary item.................. (70,455) (45,432)
Net loss........................................ (21,183) (45,432)
Net loss per common share (basic and diluted):
Loss before extraordinary item................ (0.55) (0.36)
Net loss...................................... (0.17) (0.36)
</TABLE>
The pro forma financial information is not necessarily indicative of the
results of operations had the sale of the European operations to Westar
Industries been reflected for the entire period, nor do they purport to be
indicative of results which will be obtained in the future.
The following unaudited proforma consolidated assets and liabilities as of
December 31, 1999 assume the sale occurred on December 31, 1999.
<TABLE>
<CAPTION>
DECEMBER 31, 1999
----------------------
<S> <C>
Total assets................................... $2,247,479
Total liabilities.............................. 1,078,570
</TABLE>
4. CUSTOMER ACCOUNTS:
The following reflects the changes in the Company's investment in customer
accounts (at cost) for the following periods:
<TABLE>
<CAPTION>
Nine Months Ended Year Ended
September 30, 2000 December 31, 1999
------------------ --------------------
<S> <C> <C>
Beginning customer accounts, net $ 1,139,066 $ 1,031,956
Acquisition of customer accounts, net 28,846 333,195
Amortization of customer accounts, net (104,676) (189,214)
Purchase holdbacks and other (13,778) (36,871)
Sale of European operations (107,806) --
----------------- -------------------
Total customer accounts $ 941,652 $1,139,066
================= ===================
</TABLE>
Accumulated amortization of the investment in customer accounts at
September 30, 2000 and December 31, 1999 was $383,786 and $307,600 respectively.
At December 31, 1999 accumulated amortization excluding Europe was $282,399.
In conjunction with certain purchases of customer accounts, the Company
withholds a portion of the purchase price as a reserve to offset qualifying
losses 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. The estimated amount to be paid at the
end of the holdback period is capitalized and an equivalent current liability
established at the time of purchase. As of September 30, 2000 and December 31,
1999, purchase holdbacks were $4,541 and $20,213, respectively.
9
<PAGE>
5. DEBT:
During the first nine months of 2000, the Company reduced outstanding
debt by $444,459. The reduction included extinguishing debt securities in the
face amount of $221,349 for less than carrying value resulting in an
extraordinary gain of $49,273 net of tax of $26,531. The decrease resulted
primarily from the $183,025 reduction of the Senior Credit Facility and the
extinguishment of $134,552 in debt securities received in the sale of the
European operations. In the second quarter of 2000, the Company used
available cash and borrowings under the Senior Credit Facility to purchase
$70,497 of debt securities from Westar Industries and in open market
transactions for less than carrying value resulting in an extraordinary gain
of $17,347 net of tax of $9,340. In the third quarter of 2000, the Company
increased borrowings under the Senior Credit Facility by $2,000. See Note 8
below.
As of September 30, 2000 and December 31, 1999, total borrowings under the
Senior Credit Facility were $72,000 and $225,000, respectively. The remaining
availability under this facility as of September 30, 2000 and December 31, 1999
was $43,000 and $25,000, respectively. The Company's ability to borrow under the
facility is subject to compliance with certain financial covenants, including a
leverage ratio of 5.75 to 1.0 and an interest coverage ratio of 2.10 to 1.0. At
September 30, 2000, these ratios were approximately 4.6 to 1.0 and 2.5 to 1.0,
respectively.
The indentures governing the Company's outstanding senior and subordinated
notes contain similar covenants with different calculations relating to the
Company's ability to incur indebtedness. The Company is in compliance with all
covenants contained in these indentures.
6. COMMITMENTS AND CONTINGENCIES:
The Company, its subsidiary Protection One Alarm Monitoring, Inc.
("Monitoring"), and certain present and former officers and directors of
Protection One are defendants in a purported class action litigation pending
in the United States District Court for the Central District of California,
RONALD CATS, ET AL V. PROTECTION ONE, INC., ET AL., No CV 99-3755 DT (RCx).
Pursuant to an Order dated August 2, 1999, four pending purported class
actions were consolidated into a single action. In March 2000, plaintiffs
filed a Second Consolidated Amended Class Action Complaint ("Amended
Complaint"). Plaintiffs purport to bring the action on behalf of a class
consisting of all purchasers of publicly traded securities of Protection One,
including common stock and notes, during the period of February 10, 1998
through November 12, 1999. The Amended Complaint asserts claims under Section
11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange
Act of 1934 against Protection One, Monitoring, and certain present and
former officers and directors of Protection One based on allegations that
various statements concerning Protection One's financial results and
operations for 1997 and 1998 were false and misleading and not in compliance
with generally accepted accounting principles. Plaintiffs allege, among other
things, that former employees of Protection One have reported that Protection
One lacked adequate internal accounting controls and that certain accounting
information was unsupported or manipulated by management in order to avoid
disclosure of accurate information. The Amended Complaint further asserts
claims against Western Resources and Westar Industries as controlling persons
under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and
20(a) of the Securities Exchange Act of 1934. A claim is also asserted under
Section 11 of the Securities Act of 1933 against Protection One's auditor,
Arthur Andersen LLP. The Amended Complaint seeks an unspecified amount of
compensatory damages and an award of fees and expenses, including attorneys'
fees. On June 12, 2000, the Company and the other defendants filed motions to
dismiss in part the Amended Complaint. On August 31, 2000, the plaintiffs
filed their papers in opposition to our motions. These motions are currently
pending. The Company believes that all the claims asserted in the Amended
Complaint are without merit, however the Company cannot currently predict the
impact of this litigation which could be material.
Six former 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). In September 1999, the Court granted Protection One's motion
to stay the proceeding pending the individual plaintiff's pursuit of
arbitration as required by the terms of their agreements. On June 23, 2000,
the Court denied plaintiffs' motion to have collective arbitration. On or
about October 4, 2000, notwithstanding the Court's denial of plaintiffs'
motion to have collective arbitration, the six former dealers filed a Motion
to Compel Consolidated Arbitration with the American Arbitration Association
("AAA").
10
<PAGE>
Other Protection One dealers have filed or threatened litigation or
arbitration based upon a variety of theories surrounding calculations of
holdback and other payments. The Company believes it has complied with the terms
of these contracts and although the Company believes that no individual such
claim will have a material adverse effect, the Company cannot currently predict
the aggregate impact of these disputes with dealers which could be material.
On October 2, 2000, the Company as successor-in-interest to Centennial
Security, Inc., was served with a demand for arbitration by Crimebusters,
Inc., before the AAA wherein Crimebusters is seeking $7,000 in damages due to
alleged defaults by the Company under an asset purchase agreement between
Crimebusters, ET AL and Centennial Security, Inc. The Company has filed
claims alleging fraud, willful misconduct and breach of contract against
Crimebusters, ET AL in the United States District Court for the District of
Connecticut, PROTECTION ONE ALARM MONITORING, INC. V CRIMEBUSTERS, INC.,
FIRST FEDERAL SECURITY SYSTEMS, INC. AND ANTHONY PERROTTI, JR., Civil Action
No. 300CV-1932DJS, and in addition has demanded that Crimebusters withdraw
the demand for arbitration, and requested of AAA that the arbitration action
be dismissed or indefinitely stayed pending the resolution of the District
Court litigation. The ultimate outcome cannot presently be determined and the
Company cannot currently predict the impact of this litigation which could be
material.
The Company is a party to claims and matters of litigation incidental to
the normal course of its business. Additionally, the Company receives notices of
consumer complaints filed with various state agencies. The Company has developed
a dispute resolution process for addressing these administrative complaints. 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 consolidated financial
position or results of operations.
SEC REVIEW
As previously disclosed, the Company has been advised by the Staff of the
Division of Corporation Finance of the Securities and Exchange Commission that,
in its view, there are errors in the Company's previously filed financial
statements that are material and which, in the view of the Staff, have had the
effect of inflating reported earnings commencing with the year ended December
31, 1997. The Company has had extensive discussions with the Staff and exchanged
numerous letters extending over a period of more than 20 months about the
purchase price allocated to intangible customer accounts in the Westinghouse
Security Systems acquisition, the methodology used to amortize intangible
customer accounts and other matters.
In a letter from the SEC Staff dated May 16, 2000, the Staff stated that
"the information that [Protection One] provided strongly suggests the presence
of departures from GAAP in Western Resources' accounting for the acquisition of
Westinghouse Security System[s], and in the subsequent accounting for those
acquired assets by Protection One." More specifically, the Staff's letter states
that it is concerned that Western Resources and Protection One "improperly
inflated" reported earnings following the Westinghouse Security Systems
acquisition. This letter also contains comments and requests for information
concerning the initial and final valuation of Westinghouse Security Systems'
customer accounts, the $12,750 write down of the value of customer accounts
acquired from Westinghouse Security Systems that was recorded in the fourth
quarter of 1997, shortening of the estimated life of customer accounts acquired
from Westinghouse Security Systems no later than the end of 1997 and the
valuation of acquired alarm monitoring software.
The Company responded by letter dated May 31, 2000 to each of the comments
contained in the Staff`s May 16th letter, indicated its strong disagreement with
the views of the Staff and stated its belief that there are no issues of
"inflated earnings," "departures from GAAP," or "errors" in its historic
financial statements. The Company's independent public accountants, Arthur
Andersen LLP, indicated they concurred with the accounting decisions of
Protection One.
After another exchange of letters in June as a result of which the Company
supplied more information to the Staff, on July 6, 2000, Company personnel and
their advisors met with members of the Staff.
Thereafter, in a letter dated July 7, 2000 the Staff stated that Protection
One's financial statements should be "revised to reflect corrections of
accounting errors and revisions of disclosures" as more fully discussed in the
July 7th letter. The Staff's letter discussed six areas which it believed
required changes. Four of those areas relate to the acquisition of the security
business of Westinghouse. The remaining two areas related to the accounting for
ordinary amortization of security accounts and the accounting for the effects of
unanticipated customer attrition. Among other things, the Staff stated its view
that aspects of the Company's accounting for the acquisition of the Westinghouse
security business "could" be indicative of "manipulative intent"--a statement
11
<PAGE>
with which the Company strongly disagrees.
By letter dated July 25, 2000, Protection One advised the Staff of
Protection One's strong disagreement with the views of the Staff regarding these
accounting matters. Arthur Andersen LLP has reviewed the correspondence, been
consulted on responses to the SEC and have confirmed to the SEC Staff that they
are not aware of modifications needed to fairly present the Company's historical
financial statements.
On July 25, 2000, the Staff advised the Company orally that this matter had
been referred to the Enforcement Division of SEC for consideration. By letter
dated July 27, 2000, the Staff advised the Company that they had reviewed
Protection One's letter of July 25th and requested that Protection One amend its
filings "in a manner that is fully responsive to our July 7th letter without
further delay." The Staff advised that if amendments were not filed promptly,
they would consider what action, if any, would be appropriate under the
circumstances. In the Company's July 25th letter, the Company requested the
opportunity to meet again together with more senior members of the Staff to
discuss these matters further. A meeting with the Staff took place on September
8, 2000.
In October 2000, the Company was notified by the SEC of the Staff's
position on the outstanding open issues. The Staff has requested the Company
obtain an appraisal of the Westinghouse accounts and revise the purchase
price allocation for such accounts based on the fair value determined by such
appraisal, implement an eight year accelerated amortization method on the
Westinghouse accounts, revalue a financing transaction secured by customer
accounts consistent with the results of the appraisal and reverse the $12,750
write down recorded in December 1997 of the value of customer accounts
acquired in the Westinghouse transaction. Upon completion of the appraisal,
the Staff has requested the Company restate its historical financial
statements to reflect such adjustments.
The Company is in the process of hiring an appraiser to independently
determine the fair value of the Westinghouse accounts. Once completed, the
Company will evaluate the results, communicate with the Staff of the SEC and
decide upon the necessary accounting revisions. Were the Company to make
revisions to its financial statements, based upon its understanding of the
Staff's request, such revisions could result in a material adverse effect on
its financial position and results of operations.
At present, the Company is unable to predict the outcome of these
accounting matters. To date, discussions with the Staff have occurred over 20
months and the process of resolving these matters could extend over a protracted
period. The Company cannot predict what action the Staff may take, including
enforcement action, that will further impact the Company or its financial
statements, or the effect or timing of any such action if taken.
7. SEGMENT REPORTING:
The Company's reportable segments include North America, Multifamily and
until February 29, 2000, Europe. North America provides residential, commercial
and wholesale security alarm monitoring services, which include sales,
installation and related servicing of security alarm systems in the United
States and Canada. Multifamily provides security alarm services to apartments,
condominiums and other multi-family dwellings. The Europe segment provided
security alarm services to residential and business customers in Europe.
The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies in the Company's
1999 Form 10-K. The Company manages its business segments based on earnings
before interest, income taxes, depreciation and amortization (EBITDA).
NINE MONTHS ENDED SEPTEMBER 30, 2000
(Dollars in thousands)
<TABLE>
<CAPTION>
NORTH
AMERICA MULTIFAMILY EUROPE(2) CONSOLIDATED
-------- ----------- --------- ------------
<S> <C> <C> <C> <C>
Revenues...................................... $277,828 29,845 27,904 335,577
EBITDA........................................ 96,905 13,161 6,400 116,466
Amortization of intangibles and depreciation
expense..................................... 148,920 11,644 5,420 165,984
Other(1)...................................... 3,050 -- -- 3,050
Operating income (loss)....................... (55,065) 1,517 980 (52,568)
Subscriber capital expenditures............... 20,813 4,332 2,312 27,457
</TABLE>
12
<PAGE>
NINE MONTHS ENDED SEPTEMBER 30, 1999
(Dollars in thousands)
<TABLE>
<CAPTION>
NORTH
AMERICA MULTIFAMILY EUROPE CONSOLIDATED
-------- ----------- -------- ------------
<S> <C> <C> <C> <C>
Revenues...................................... $296,676 $28,898 $122,393 $447,967
EBITDA........................................ 115,170 12,170 35,528 162,868
Amortization of intangibles and depreciation
expense..................................... 153,531 7,003 22,072 182,606
Other(1)...................................... 4,308 -- -- 4,308
Operating income.............................. (42,669) 5,167 13,456 (24,046)
Subscriber capital expenditures............... 195,277 6,783 5,597 207,657
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 2000
(Dollars in thousands)
<TABLE>
<CAPTION>
NORTH
AMERICA MULTIFAMILY EUROPE(2) CONSOLIDATED
-------- ----------- --------- ------------
<S> <C> <C> <C> <C>
Revenues...................................... $89,372 10,255 -- 99,627
EBITDA........................................ 28,685 4,924 -- 33,609
Amortization of intangibles and depreciation
expense..................................... 46,822 3,925 -- 50,747
Other(1)...................................... -- -- -- --
Operating income (loss)....................... (18,137) 999 -- (17,138)
Subscriber capital expenditures............... 5,191 1,322 -- 6,513
</TABLE>
THREE MONTHS ENDED SEPTEMBER 30, 1999
(Dollars in thousands)
<TABLE>
<CAPTION>
NORTH
AMERICA MULTIFAMILY EUROPE CONSOLIDATED
------- ----------- ------ ------------
<S> <C> <C> <C> <C>
Revenues...................................... $99,810 $9,667 $41,396 $150,873
EBITDA........................................ 26,800 4,025 11,993 42,818
Amortization of intangibles and depreciation
expense..................................... 80,655 2,388 11,207 94,250
Other(1)...................................... 2,309 -- -- 2,309
Operating income.............................. (56,164) 1,637 786 (53,741)
Subscriber capital expenditures............... 51,734 2,249 (897) 53,086
</TABLE>
(1) "Other" includes employee severance in 1999, and employee severance and
costs related to the sale of the European operations in 2000.
(2) Information for Europe is for the two months ended February 29, 2000.
8. RELATED PARTY TRANSACTIONS:
The Company was a party to a marketing agreement with Paradigm Direct LLC
("Paradigm") which was terminated as of September 30, 2000. Westar Industries
has a 40% ownership interest in Paradigm. For the three and nine months ended
September 30, 2000, the Company expensed $1,638 and $4,290 for marketing
services provided by Paradigm pursuant to the marketing agreement. At September
30, 2000, the Company has a net balance due to Paradigm of approximately $400
for these services. Beginning in September 2000, the Company is managing all
marketing related projects in-house.
For the three and nine months ended September 30, 2000, the Company
incurred charges of approximately $2,175 and $4,674, respectively, for
administrative and other services provided by Western Resources pursuant to a
service agreement. At September 30, 2000, the Company had a net intercompany
balance due to Western Resources of $618 primarily for these services.
At September 30, 2000, the Company had outstanding borrowings of $72,000
from the Senior Credit Facility with Westar Industries. During the nine months
ended September 30, 2000, interest expense of $6,297 was accrued on borrowings
from this facility and total interest payments of $6,696 were made to Westar
Industries.
13
<PAGE>
The Company acquired approximately $59,520 of its outstanding debt
securities from Westar Industries during the first six months of 2000. These
purchases resulted in an extraordinary gain of $15,342 net of tax of $8,261
for the nine months ended September 30, 2000. No such debt was acquired
during the three months ended September 30, 2000.
At September 30, 2000 the Company had a receivable balance of $28,647
relating to the tax sharing agreement it has with Western Resources. See Note 9
for further discussion relating to income taxes.
9. INCOME TAXES:
The income tax benefit recorded for the nine-month period ended September
30, 2000 is approximately 25% of the pre-tax loss. This rate represents the
expected effective rate for 2000. The difference between the expected annual
effective rate of 25% and the federal statutory rate of 35% is primarily
attributable to non-deductible goodwill amortization. The Company has a tax
sharing agreement with Western Resources which allows it to be reimbursed for
tax deductions utilized by Western Resources in its consolidated tax return. If
the Company did not file its taxes on a consolidated basis with Western
Resources, the Company's deferred tax assets might not be realizable and the
Company might not be in a position to record a tax benefit for losses incurred.
During the third quarter of 2000 the Company reversed a deferred tax
valuation allowance of $21,890 relating to acquired net operating loss
carryforwards and reduced goodwill by this same amount. The Company
originally had determined that it was more likely than not that the NOL's
acquired through acquisitions would not be utilized and therefore established
the valuation allowance. However, due to a change in federal tax regulations
regarding the utilization of acquired NOL carryforwards, approximately
$19,000 of these NOL's were utilized in 1999 with the balance expected to be
utilized in 2000.
10. UNREALIZED GAINS AND LOSSES:
The following reflects the changes in unrealized gains and losses in
marketable securities and in currency fluctuations for the nine-months ended
September 30, 2000:
<TABLE>
<S> <C>
Unrealized loss on marketable securities $ (1,202)
Less: reclassification adjustment for
losses included in sale of European operations 2,830
--------
Net unrealized gain $ 1,628
========
Unrealized loss on currency translation $ (2,126)
Less: reclassification adjustment for
losses included in sale of European operations 2,421
--------
Net unrealized gain $ 295
========
</TABLE>
11. RECENT DEVELOPMENTS:
On March 28, 2000, Western Resources Board of Directors approved the
separation of its electric utility business from its non-electric businesses.
On May 18, 2000, Western Resources announced that its Board of Directors had
authorized management to explore strategic alternatives for the electric
utility business. Western Resources also indicated that the non-electric
businesses are expected to consist of the approximate 85% ownership interest
in the Company, an approximate 45% ownership interest in ONEOK Inc., a
Tulsa-based natural gas company, a 100% ownership interest in Protection One
Europe
14
<PAGE>
(formerly the Europe segment of the Company), and a 40% ownership in Paradigm
Direct LLC, and other investments. On October 5, 2000, Westar Industries
filed a registration statement with the SEC which covers the proposed sale of
approximately 9.9% of Westar Industries common stock now owned by Western
Resources through the exercise of non-transferable rights proposed to be
distributed by Western Resources to its shareholders. After completion of the
rights offering, assuming full exercise of the rights, Western Resources will
own approximately 90.1% of Westar Industries. The registration statement has
not yet become effective. The Company can give no assurances as to whether or
when the registration statement will become effective or the separation or
the strategic transaction may occur.
On September 15, 2000, the Company announced that it is considering new
sources of financing, including new credit facilities with third parties or
the sale of assets, including the possible sale of Network Multifamily to
Westar Industries. The credit facility with Westar Industries currently
expires on January 2, 2001. Westar has advised the Company that while it
would consider an extension of the credit facility upon terms reflecting
current market conditions, it desires the Company to find alternatives to the
credit facility upon its expiration because of the previously announced
restructuring of Westar Industries. The Company has established a special
committee of its Board of Directors to evaluate any transaction with Westar
Industries.
15
<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 primary asset
is, and Protection One operates primarily 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 1999 Annual Report on Form 10-K.
OVERVIEW
Protection One is one of the leading providers of property monitoring
services, providing electronic monitoring and maintenance of its alarm systems
to approximately 1.4 million customers in North America.
16
<PAGE>
Our company is divided into two business segments:
PROTECTION ONE NORTH AMERICA ("North America") generated approximately
$277.8 million, or 82.8%, of our revenues in the first nine months of 2000 and
is comprised of Protection One Alarm Monitoring-our core alarm monitoring
business.
MULTIFAMILY generated approximately $29.8 million, or 8.9%, of our revenues
in the first nine months of 2000 and is comprised of our alarm monitoring
business servicing the multifamily/apartment market.
On February 29, 2000, we sold Protection One Europe ("Europe") which
generated approximately $27.9 million of revenues through February 29, 2000.
Europe was comprised of:
- Protection One Continental Europe - an 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 - an alarm monitoring business servicing
the United Kingdom established from our purchase of Hambro Countrywide
Security in May 1998, based in Basingstoke, United Kingdom.
SALE OF EUROPEAN ASSETS AND OTHER TRANSACTIONS
On February 29, 2000 the Company sold its European operations and certain
investments to Westar Industries. The consideration received was approximately
$244 million, comprised of approximately $183 million in cash and certain of the
Company's outstanding debt securities Westar Industries had acquired in open
market purchases for approximately $61 million. As part of the agreement, Westar
Industries agreed to pay Protection One a portion of the net gain, if any, on a
subsequent sale of the business on a declining basis over the four years
following the closing. The cash proceeds of the sale were used to reduce the
$240 million outstanding balance under the $250 million Senior Credit Facility
between the Company and Westar Industries.
ACQUISITION OF POWERCALL SECURITY
On November 3, 2000, we signed an agreement to acquire the customer
accounts, assets and operations of PowerCall Security, a subsidiary of
Southern Company for approximately $11 million plus working capital.
PowerCall Security has approximately 17,000 security customers in Georgia,
Alabama, Florida, and Mississippi which generate over $300,000 of monthly
recurring revenue. The transaction is scheduled to close prior to December
31, 2000.
17
<PAGE>
CHANGE IN ESTIMATE OF USEFUL LIFE OF GOODWILL
In the first quarter, we re-evaluated the original assumptions and
rationale utilized in the establishment of the carrying value and estimated
useful life of goodwill. Management concluded that due to continued losses,
increased levels of attrition experienced in 1999 and other factors, the
estimated useful life of goodwill should be reduced from 40 years to 20 years.
As of January 1, 2000, the remaining goodwill, net of accumulated amortization,
will be amortized over its remaining useful life based on a 20-year life. On our
existing account base, we anticipate that this will result in an increase in
annual goodwill amortization of approximately $24 million for North America and
$6 million for Multifamily. The additional goodwill recorded for Europe prior to
its sale on February 29, 2000 was approximately $1 million.
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 gross number of lost customer accounts for
a given period, net of certain adjustments, and the denominator of which is the
average number of accounts for a given period. In some instances, we use
estimates to derive attrition data. The adjustments made to lost accounts are
primarily 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 holdback may
be less than actual attrition experience. We do not reduce the gross accounts
lost during a period by "move in" accounts, which are accounts where a new
customer moves into a home installed with the Company's security system and
vacated by a prior customer, or "competitive takeover" accounts, which are
accounts where the owner of a residence monitored by a competitor requests that
the Company provide monitoring services.
Our 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 us for a variety of
reasons, including relocation, service issues and cost. A portion of the
acquired customer base can be expected to discontinue service every year. Any
significant change in the pattern of our historical attrition experience would
have a material effect on our results of operations.
We monitor attrition each quarter based on an annualized and trailing
twelve-month basis. This method utilizes each segment's average customer account
base for the applicable period in measuring attrition. Therefore, in periods of
customer account growth, customer attrition may be understated and in periods of
customer account decline, customer attrition may be overstated. When
appropriate, we will adjust amortization of the cost of customer accounts.
18
<PAGE>
Customer attrition by business segment for the periods ended September 30,
2000 and 1999 are summarized below:
<TABLE>
<CAPTION>
CUSTOMER ACCOUNT ATTRITION
--------------------------------------------------------------------------
SEPTEMBER 30, 2000 SEPTEMBER 30, 1999
--------------- ---------------- ------------------- ------------------
ANNUALIZED TRAILING ANNUALIZED TRAILING
THIRD TWELVE THIRD TWELVE
QUARTER MONTH QUARTER MONTH
--------------- ---------------- ------------------- ------------------
<S> <C> <C> <C> <C>
North America 18.3% 15.3% 19.1% 14.2%
Multifamily 5.8% 9.4% 7.6% 6.5%
Total Company* 15.7% 14.1% 16.9% 12.7%
</TABLE>
------------------------
* Does not include Europe segment.
The Company experienced high levels of attrition for the North America
segment in 1999 with successive quarterly annualized attrition of 11.2%, 15.9%,
19.1% and 16.3%. The quarterly annualized attrition rate for North America for
each of the first three successive quarters of 2000 is 11.9%, 14.2% and 18.3%.
In the second quarter we disclosed that we had identified approximately
30,000 customer accounts which were either incorrectly entered into our system,
represented duplicate existing accounts or represented accounts for which credit
and collection activities had not occurred. These accounts remained in our
balance of customer accounts at the end of the second quarter. During the third
quarter we completed our review of these accounts by performing additional
analysis and collection procedures. Where necessary we discontinued our
monitoring service and attrited the account.
CUSTOMER CREATION AND MARKETING
For the three and nine months ended September 30, 2000, our North
America segment added 12,574 and 37,562 accounts, respectively, although our
net number of customers decreased by 57,417 and 119,529 accounts,
respectively. The Multifamily segment added 11,451 and 30,571 accounts
respectively, with its net number of customers increasing by 7,130 and 8,508
accounts, respectively. While our previous customer acquisition strategy
relied primarily on the dealer program, our new customer acquisition strategy
relies on a mix of dealers, internal sales, and "tuck-in" acquisitions. The
number of accounts being purchased through the dealer program decreased
significantly from 172,104 for the nine months ended September 30, 1999 to
18,382 for the nine months ended September 30, 2000. For the three months
ended September 30, 2000, the dealer program produced 4,048 accounts, or
approximately 32% of the total number of accounts acquired during such
period. We expect small increases in the number of accounts purchased through
the dealer program over the remainder of 2000. In February 2000, we started a
commission only internal sales program, with a goal of acquiring accounts at
a cost lower than our external programs. We currently have a commissioned
sales force of approximately 185 persons which we plan to expand through the
remainder of the year. This program utilizes our existing branch
infrastructure in approximately 70 markets. The internal sales program
generated 8,219 accounts in the three months ended September 30, 2000. We
expect the number of accounts produced by this program to increase as it
becomes more established. Our pilot program with Paradigm Direct LLC which
utilized direct marketing to produce customer accounts was concluded on June
30, 2000 and the relationship was terminated as of September 30, 2000.
SEC REVIEW
As we have previously disclosed, we have been advised by the Staff of the
Division of Corporation Finance of the Securities and
19
<PAGE>
Exchange Commission that, in its view, there are errors in our previously filed
financial statements that are material and which, in the view of the Staff, have
had the effect of inflating reported earnings commencing with the year ended
December 31, 1997. We have had extensive discussions with the Staff and
exchanged numerous letters extending over a period of more than 20 months about
the purchase price allocated to intangible customer accounts in the Westinghouse
Security Systems acquisition, the methodology we used to amortize intangible
customer accounts and other matters.
In a letter from the SEC Staff dated May 16, 2000, the Staff stated that
"the information that [Protection One] provided strongly suggests the presence
of departures from GAAP in Western Resources' accounting for the acquisition of
Westinghouse Security System[s], and in the subsequent accounting for those
acquired assets by Protection One." More specifically, the Staff's letter states
that it is concerned that Western Resources and Protection One "improperly
inflated" reported earnings following the Westinghouse Security Systems
acquisition. This letter also contains comments and requests for information
concerning the initial and final valuation of Westinghouse Security Systems'
customer accounts, the $12.75 million write down of the value of customer
accounts acquired from Westinghouse Security Systems that was recorded in the
fourth quarter of 1997, shortening of the estimated life of customer accounts
acquired from Westinghouse Security Systems no later than the end of 1997 and
the valuation of acquired alarm monitoring software.
We responded by letter dated May 31, 2000 to each of the comments contained
in the Staff`s May 16th letter, indicated our strong disagreement with the views
of the Staff and stated our belief that there are no issues of "inflated
earnings," "departures from GAAP," or "errors" in our historic financial
statements. Our independent public accountants, Arthur Andersen LLP, indicated
they concurred with the accounting decisions of Protection One.
After another exchange of letters in June as a result of which we supplied
more information to the Staff, on July 6, 2000, Company personnel and our
advisors met with members of the Staff.
Thereafter, in a letter dated July 7, 2000 the Staff stated that Protection
One's financial statements should be "revised to reflect corrections of
accounting errors and revisions of disclosures" as more fully discussed in the
July 7th letter. The Staff's letter discussed six areas which it believed
required changes. Four of those areas relate to the acquisition of the security
business of Westinghouse. The remaining two areas related to the accounting for
ordinary amortization of security accounts and the accounting for the effects of
unanticipated customer attrition. Among other things, the Staff stated its view
that aspects of our accounting for the acquisition of the Westinghouse security
business "could" be indicative of "manipulative intent"--a statement with which
we strongly disagree.
By letter dated July 25, 2000, Protection One advised the Staff of
Protection One's strong disagreement with the views of the Staff regarding these
accounting matters. Arthur Andersen LLP has reviewed the correspondence, been
consulted on responses to the SEC and have confirmed to the SEC Staff that they
are not aware of modifications needed to fairly present our historical financial
statements.
On July 25, 2000, the Staff advised us orally that this matter had been
referred to the Enforcement Division of SEC for consideration. By letter dated
July 27, 2000, the Staff advised us that they had reviewed Protection One's
letter of July 25th and requested that Protection One amend its filings "in a
manner that is fully responsive to our July 7th letter without further delay."
The Staff advised that if amendments were not filed promptly, they would
consider what action, if any, would be appropriate under the circumstances. In
our July 25th letter, we had requested the opportunity to meet again together
with more senior members of the Staff to discuss these matters further. A
meeting with the Staff took place on September 8, 2000.
In October 2000, we were notified by the SEC of the Staff's position on
the outstanding open issues. The Staff has requested us to obtain an
appraisal of the Westinghouse accounts and revise the purchase price
allocation for such accounts based on the fair value determined by such
appraisal, implement an eight year accelerated amortization method on the
Westinghouse accounts, revalue a financing transaction secured by customer
accounts consistent with the results of the appraisal and reverse the $12.75
million write down recorded in December 1997 of the value of customer
accounts acquired in the Westinghouse transaction. Upon completion of the
appraisal, the Staff has requested that we restate our historical financial
statements to reflect such adjustments.
We are in the process of hiring an appraiser to independently determine
the fair value of the Westinghouse accounts. Once completed, we will evaluate
the results, communicate with the Staff of the SEC and decide upon the
necessary accounting revisions. Were we to make revisions to our financial
statements, based upon our understanding of the Staff's request, such
revisions could result in a material adverse effect on our financial position
and results of operations.
At present, we are unable to predict the outcome of these accounting
matters. To date, discussions with the Staff have occurred
20
<PAGE>
over 20 months and the process of resolving these matters could extend over a
protracted period. We cannot predict what action the Staff may take, including
enforcement action, that will further impact us or our financial statements, or
the effect or timing of any such action if taken.
OPERATING RESULTS
We separate our business into three reportable segments: North America,
Multifamily, and through February 29, 2000, Europe. North America provides
security alarm monitoring services, which include sales, installation and
related servicing of security alarm systems in the United States and Canada.
Multifamily provides security alarm services to apartments, condominiums and
other multi-family dwellings. The Europe segment provided security alarm
services in Europe and was sold on February 29, 2000.
NINE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1999
NORTH AMERICA SEGMENT
The following table provides for comparison of the North America operating
results for the periods presented. Next to each period's results of operations,
we provide the relevant percentage of our total revenues so that you can make
comparisons about the relative change in revenues and expenses.
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
----------------------------------------------------
2000 1999
------------------------ --------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues:
Monitoring and related services.......... $266,973 96.1% $285,668 96.3%
Installation and rental.................. 10,855 3.9 11,008 3.7
------------ ---------- ------------- -----------
Total revenues........................... 277,828 100.0 296,676 100.0
Cost of revenues:
Monitoring and related services.......... 84,935 30.6 75,576 25.5
Installation and rental.................. 7,909 2.9 9,301 3.1
------------ ---------- ------------- -----------
Total cost of revenues................... 92,844 33.5 84,877 28.6
------------ ---------- ------------- -----------
Gross profit............................. 184,984 66.5 211,799 71.4
Selling expense............................ 5,664 2.0 4,243 1.4
General and administrative expenses........ 73,709 26.5 71,466 24.1
Acquisition and transition expense......... 8,706 3.1 20,920 7.0
Amortization of intangibles and
depreciation expense..................... 148,920 53.6 153,531 51.8
Other charges.............................. 3,050 1.1 4,308 1.5
------------ ---------- ------------- -----------
Operating income (loss).................... $(55,065) (19.8)% $(42,669) (14.4)%
=========== ========== ============= ===========
</TABLE>
2000 COMPARED TO 1999. We had a net decrease of 119,529 customers in the
first nine months of 2000 as compared to a net increase of 34,498 customers
in the first nine months of 1999. The average customer base for the first
nine months of 2000 and 1999 was 1,144,878 and 1,213,296 respectively, or a
decrease of 68,418 customers. The decrease in customers is primarily because
our present customer acquisition strategies have not been able to generate
accounts in a sufficient volume to replace accounts lost through attrition.
We do not expect our customer acquisitions to replace all accounts lost
through attrition at least through the first half of 2001. Accordingly, our
total customer base is likely to decline based upon historical rates of
attrition which is likely to result in declining revenues. Our focus remains
on the completion of our current infrastructure projects, the development of
cost effective marketing programs, development of our commercial business and
the generation of positive cash flow.
21
<PAGE>
The following table shows the change in the North America customer account
base:
<TABLE>
<CAPTION>
NINE MONTHS ENDED (1)
SEPTEMBER 30,
2000 1999
-------------- -------------
<S> <C> <C>
Beginning Balance, January 1,....................................... 1,204,642 1,196,047
Additions........................................................... 37,562 192,952
Customer losses not guaranteed with holdback put backs.............. (127,692) (142,288)
Customer losses guaranteed with holdback put backs and other........ (29,399) (16,166)
-------------- ------------
Ending Balance...................................................... 1,085,113 1,230,545
============= =============
Annualized attrition................................................ 15.3% 15.6%
============= =============
</TABLE>
(1) See "Attrition", above, for discussion of other adjustments.
MONITORING AND RELATED SERVICE REVENUES decreased approximately $18.7
million or 6.5% in the first nine months of 2000 as compared to the first
nine months of 1999 primarily due to the decline in our customer base. An
additional factor was the issuance of more customer credits during the first
nine months of 2000 as compared to 1999. A significant portion of these
credits were goodwill credits issued to customers in the first quarter as a
result of billing problems encountered when we implemented a new billing and
collections system in our Beaverton monitoring station late in 1999. The
problems with this system have been corrected and the issuance of credits for
this purpose has decreased.
INSTALLATION AND RENTAL REVENUES consist primarily of revenues generated
from our internal installations of new alarm systems. These revenues decreased
by approximately $0.15 million or 1.4% from the first nine months of 1999.
COST OF MONITORING AND RELATED SERVICES REVENUES for the first nine months
of 2000 increased by $9.3 million, or 12.4%, to $84.9 million from $75.6 million
for the first nine months of 1999. Compensation costs for the monitoring
stations increased by approximately $3.8 million due primarily to an increase in
personnel. The increase in employees is a direct result of our efforts to
improve the level of customer service. In addition, parts and materials costs
increased by $4.1 million and vehicle costs increased $1.3 million.
COST OF INSTALLATION AND RENTAL REVENUES was $1.4 million or 15.0% less
than in the first nine months of 1999. These costs as a percentage of
installation and rental revenues were approximately 73% for the first nine
months of 2000, as compared to approximately 84% for the first nine months of
1999. Parts and materials decreased by $2.2 million and subcontract labor
increased by $0.6 million.
SELLING EXPENSE was $1.4 million or 33.4% greater than in the first nine
months of 1999. This increase is primarily due to an increase in sales
commissions stemming from our increased emphasis on internal account growth.
GENERAL AND ADMINISTRATIVE EXPENSES increased $2.2 million from $71.5
million in the first nine months of 1999 to $73.7 million in the first nine
months of 2000. Bad debt and collection expenses decreased approximately $1.5
million. Subcontract expense for outside information technology support
increased approximately $3.6 million due primarily to work performed in
connection with the implementation of our new billing, collection and monitoring
software.
ACQUISITION EXPENSES decreased $12.2 million in the first half of 2000 from
$20.9 million in the first nine months of 1999 to $8.7 million. During these
respective periods for 2000 and 1999, third party monitoring costs decreased by
$4.3 million, signs and decals expense decreased by $1.2 million, printing
expense decreased by $1.8 million and compensation expense decreased by $0.9
million. These decreases are a direct result of the significant decline in the
number of new accounts acquired from 192,952 in the first nine months of 1999 to
37,562 accounts acquired in the first nine months of 2000. This decline is
primarily due to the restructuring of our dealer program. The decrease in third
party monitoring expense and associated increase in reprogramming expense are a
result of our concentrated effort in late 1999 to move such accounts to our own
monitoring stations. Additionally, in the third quarter of 1999, $3.7 million of
costs relating to the termination of the Lifeline merger were expensed.
AMORTIZATION OF INTANGIBLES AND DEPRECIATION EXPENSE for the first nine
months of 2000 decreased by $4.6 million, or 3.0%, to $148.9 million from $153.5
million in the first nine months of 1999. Subscriber amortization for the nine
months ended September 30, 2000 and 1999 was $97.7 million and $128.5 million,
respectively, a decrease of $30.8 million. As discussed in our 1999 Annual
Report on Form 10-K, we changed our amortization method from a 10-year straight
line method to a 10-year declining balance method as of the third quarter in
1999. The cumulative effect of this change in accounting principle was
22
<PAGE>
approximately $37.7 million including approximately $29.5 million of additional
amortization from the effect of the change on amortization in years prior to
1999.
As discussed above, we also changed our estimate of the useful life of
goodwill from 40 years to 20 years. As a result, our amortization expense
increased $16.6 million from $16.6 million in the first nine months of 1999 to
$33.2 million for the first nine months of 2000. Additionally, in the first nine
months of 2000, depreciation expense increased $9.6 million from $8.4 million
for the first nine months of 1999 to $18.0 million. This increase is due to
accelerated depreciation of the general ledger and accounts receivable systems
installed in 1999. We have decided to move to another general ledger and
accounts receivable system in 2000 which we believe is better suited to our
needs.
OTHER CHARGES for the first nine months of 1999 consisted of officer's
severance costs of $3.2 million and $1.1 million in non recurring costs incurred
to transition certain back office functions from Irving, Texas to Topeka,
Kansas. For the first nine months of 2000, these charges consist of $1.5 million
for officer's severance and $1.55 million for expenses relating to the sale of
the European operations.
INTEREST EXPENSE, NET for the first nine months of 2000 and 1999 was $45.6
million and $55.6 million, respectively. During the first nine months of 1999,
borrowings under the Senior Credit Facility increased from $42.4 million to
$215.0 million with interest rates ranging from 6.19% to 7.75%. During the first
nine months of 2000, borrowings under the Senior Credit Facility decreased from
$225.0 million to $72.0 million at interest rates ranging from 7.8% to 8.9%. In
the first half of 1999, we accrued interest charges on the $350 million Senior
Subordinated Notes at 8.125%, however, since we have not completed the required
exchange offer, the interest rate relating to this debt increased to 8.625% in
June 1999. Total debt decreased during the first nine months of 2000 from $1.1
billion to $665 million, a decrease of $444 million.
MULTIFAMILY SEGMENT
The following table provides information for comparison of the Multifamily
operating results for the periods presented. Next to each period's results of
operations, we provide the relevant percentage of total revenues so that you can
make comparisons about the relative change in revenues and expenses.
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------
2000 1999
------------------------- -----------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues:
Monitoring and related services............................ $26,486 88.7 % $25,679 88.9%
Installation and rental.................................... 3,359 11.3 3,219 11.1
------------ ----------- ---------- ----------
Total revenues............................................. 29,845 100.0 28,898 100.0
Cost of revenues:
Monitoring and related services............................ 5,907 19.8 5,591 19.3
Installation and rental.................................... 3,020 10.1 2,741 9.5
------------ ----------- ---------- -----------
Total cost of revenues..................................... 8,927 29.9 8,332 28.8
----------- ----------- ---------- ----------
Gross profit............................................... 20,918 70.1 20,566 71.2
Selling expense.............................................. 1,868 6.3 1,902 6.6
General and administrative expenses.......................... 5,889 19.7 6,181 21.4
Acquisition and transition expense........................... -- -- 313 1.1
Amortization of intangibles and depreciation expense......... 11,644 39.0 7,003 24.2
------------ ----------- ---------- -----------
Operating income............................................. $1,517 5.1% $ 5,167 17.9%
============ =========== ========== ===========
</TABLE>
2000 COMPARED TO 1999. We had a net increase of 8,508 customers in the
first nine months of 2000 as compared to a net increase of 3,294 customers in
the first nine months of 1999. The average customer base is 299,214 for the
first nine months of
23
<PAGE>
2000 compared to 287,601 for the first nine months of 1999. The change in
Multifamily's customer base for the period is shown below.
<TABLE>
<CAPTION>
NINE MONTHS ENDED
SEPTEMBER 30,
------------------------
2000 1999
----------- -----------
<S> <C> <C>
Beginning Balance, January 1,......................... 294,960 285,954
Additions............................................. 30,571 19,416
Customer losses....................................... (22,063) (16,122)
---------- ----------
Ending Balance ....................................... 303,468 289,248
========== ==========
Annualized attrition.................................. 9.8% 7.5%
========== ==========
</TABLE>
The increase in the attrition rate for Multifamily for the nine months
ended September 30, 2000 is due to nonpayment of approximately 7,000 subscribers
related to one developer. Had these accounts not attrited, the annualized
attrition would have been approximately 6.7%. The Company is pursuing
contractual remedies for nonpayment of these accounts.
MONITORING AND RELATED SERVICES REVENUES for the first nine months of 2000
increased by $0.8 million, or 3.1%, to $26.5 million from $25.7 million for the
first nine months of 1999 due primarily to the larger customer base in 2000.
COST OF MONITORING AND RELATED REVENUES for the first nine months of 2000
increased by $.3 million, or 5.7% to $5.9 million from $5.6 million for the
first nine months of 1999. Monitoring and related service expenses, as a
percentage of monitoring and related service revenues, increased to 22.3% for
the first nine months of 2000 from 21.8% for the first nine months of 1999. This
increase is primarily related to higher employment costs resulting from the
current competitive labor market and an increase in claims experience on a
self-funded medical insurance plan.
COST OF INSTALLATION AND RENTAL REVENUES increased by $.3 million or 10.2%
to $3.0 million from $2.7 million in 1999. Installation and rental cost of
revenues, as a percentage of installation and rental revenues, increased to
89.9% in the first nine months of 2000 from 85.2% in the first nine months of
1999. This increase is primarily due to the significant number of installations
in 1999 which used less sophisticated monitoring equipment than Multifamily's
standard contracts, combined with the increased use in 2000 of wireless systems,
which are more expensive but expected to reduce future service costs.
AMORTIZATION OF INTANGIBLES AND DEPRECIATION EXPENSE for the first nine
months of 2000 increased by $4.6 million, or 66.3% from $7.0 million in 1999 to
$11.6 million in 2000. This increase is primarily due to the change in estimate
of goodwill life from 40 years to 20 years resulting in an increase in goodwill
amortization expense of $3.7 million. Subscriber amortization increased by $0.8
million due to the increasing customer base being amortized.
THREE MONTHS ENDED SEPTEMBER 30, 2000 COMPARED TO THREE MONTHS ENDED
SEPTEMBER 30, 1999
NORTH AMERICA SEGMENT
The following table provides information for comparison of the North
America operating results for the periods presented. Next to each period's
results of operations, we provide the relevant percentage of total revenues so
that you can make comparisons about the relative change in revenues and
expenses.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------
2000 1999
------------------------ -------------------------
Revenues: (DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Monitoring and related services.......... $ 85,682 95.9% $ 96,310 96.5%
Installation and rental.................. 3,690 4.1 3,500 3.5
------------ ---------- ------------- ----------
Total revenues........................... 89,372 100.0 99,810 100.0
24
<PAGE>
Cost of revenues:
Monitoring and related services.......... 29,570 33.1 29,646 29.7
Installation and rental.................. 2,115 2.4 2,335 2.3
------------ ---------- ------------- ----------
Total cost of revenues................... 31,685 35.5 31,981 32.0
------------ ---------- ------------- ----------
Gross profit............................. 57,687 64.5 67,829 68.0
Selling expense............................ 2,363 2.6 1,329 1.3
General and administrative expenses........ 24,391 27.3 29,673 29.8
Acquisition and transition expense......... 2,248 2.5 10,027 10.0
Amortization of intangibles and
depreciation expense..................... 46,822 52.4 80,655 80.8
Other charges.............................. -- -- 2,309 2.3
------------ ---------- ------------- ----------
Operating income (loss).................... $ (18,137) (20.3)% $(56,164) (56.2)%
============ ========== ============= ==========
</TABLE>
2000 COMPARED TO 1999. We had a net decrease of 57,417 customers in the
third quarter of 2000 as compared to a net decrease of 16,219 customers in
the third quarter of 1999. The average customer base for the third quarters
of 2000 and 1999 was 1,113,822 and 1,238,655, respectively, or a decrease of
124,833 customers. The decrease in customers is primarily because our present
customer acquisition strategies have not been able to generate accounts in a
sufficient volume to replace accounts lost through attrition. We do not
expect our customer acquisitions to replace customers lost through attrition
at least through the first half of 2001. Accordingly, our total customer base
is likely to decline based upon historical rates of attrition which is likely
to result in declining revenues. Our focus remains on the completion of our
current infrastructure projects, the development of cost effective marketing
programs, the development of our commercial business and the generation of
positive cash flow.
The following table shows the change in the North America customer account
base:
<TABLE>
<CAPTION>
THREE MONTHS ENDED (1)
SEPTEMBER 30
-----------------------------
2000 1999
------------- -------------
<S> <C> <C>
Beginning Balance, July 1........................................... 1,142,530 1,246,764
Additions........................................................... 12,574 50,321
Customer losses not guaranteed with holdback putbacks............... (51,080) (59,049)
Customer losses guaranteed with holdback putbacks and other ........ (18,911) (7,491)
------------ ------------
Ending Balance...................................................... 1,085,113 1,230,545
============ ============
Annualized quarterly attrition...................................... 18.3% 19.1%
============= ============
</TABLE>
(1) See "Attrition", above, for discussion of other adjustments.
MONITORING AND RELATED SERVICE REVENUES decreased approximately $10.6
million or 11.0% in the third quarter of 2000 as compared to the third
quarter of 1999 primarily due to the decline in our customer base.
INSTALLATION AND RENTAL REVENUES consist primarily of revenues generated
from our internal installations of new alarm systems. These revenues increased
by approximately $0.2 million or 5.4% from the third quarter of 1999.
COST OF MONITORING AND RELATED SERVICES REVENUES for the third quarter of
2000 decreased by $0.1 million, or 0.2%, to $29.5 million from $29.6 million for
the third quarter of 1999. Parts and materials costs increased by $1.6 million
and telecom costs decreased $1.7 million.
COST OF INSTALLATION AND RENTAL REVENUES was $0.22 million or 9.4% less
than in the third quarter of 1999. These costs as a percentage of installation
and rental revenues were approximately 57% for the third quarter of 2000 as
compared to
25
<PAGE>
approximately 67% for the third quarter of 1999. Parts and materials
decreased by $0.6 million. Partially offsetting this decrease, compensation and
subcontract labor costs increased approximately $0.3 million.
SELLING EXPENSE was $1.0 million or 77.8% greater than in the third quarter
of 1999. This increase is primarily due to an increase in sales commissions and
employee compensation stemming from our increased emphasis on internal account
growth.
GENERAL AND ADMINISTRATIVE EXPENSES decreased $5.3 million from $29.7
million in the third quarter of 1999 to $24.4 million in the third quarter of
2000. Bad debt and collection expenses decreased $6.4 million primarily due to
adjustments made during the third quarter of 1999 increasing the valuation
allowance on accounts receivable. Subcontract expense related to outside
information technology support increased approximately $1.0 million due
primarily to work performed in connection with the implementation of our new
billing, collection and monitoring software.
ACQUISITION EXPENSES decreased $7.8 million in the third quarter of 2000
from $10.0 million in the third quarter of 1999 to $2.2 million. During these
respective periods for 2000 and 1999, third party monitoring costs decreased by
$1.8 million and costs related to winding down the old dealer program decreased
by $2.3 million. Additionally, in the third quarter of 1999, $3.7 million of
costs were expensed relating to the termination of the Lifeline merger.
AMORTIZATION OF INTANGIBLES AND DEPRECIATION EXPENSE for the third
quarter of 2000 decreased by $33.8 million, or 41.9%, to $46.8 million from
$80.7 million in the third quarter of 1999. Subscriber amortization for the
three months ended September 30, 2000 and 1999 was $32.7 million and $72.8
million, respectively, a decrease of $40.1 million. As discussed in our 1999
Annual Report on Form 10-K, we changed our amortization method from a 10-year
straight line method to a 10-year declining balance method as of the third
quarter in 1999. The cumulative effect of this change in accounting principle
was approximately $37.7 million.
As discussed above, we also changed our estimate of the useful life of
goodwill from 40 years to 20 years. As a result, in amortization expense
increased $5.9 million from $5.2 million in the third quarter of 1999 to $11.1
million for the third quarter of 2000. Additionally, in the third quarter of
2000 depreciation expense increased $0.3 million from $2.7 million for the third
quarter of 1999 to $3.0 million in the third quarter of 2000.
INTEREST EXPENSE, NET for the third quarter was $13.8 million and $19.8
million for 2000 and 1999, respectively. During the third quarter of 1999,
borrowings under the Senior Credit Facility rose from $172.0 million to $215.0
million with interest rates ranging from 6.50% to 7.75%. During the third
quarter of 2000, the Senior Credit Facility increased from $70.0 million to
$72.0 million at interest rates approximating 8.9%. Total debt at September 30,
2000 and 1999 was $665.7 million and $1.1 billion respectively.
MULTIFAMILY SEGMENT
The following table provides information for comparison of the
Multifamily operating results for the periods presented. Next to each
period's results of operations, we provide the relevant percentage of total
revenues so that you can make comparisons about the relative change in
revenues and expenses.
<TABLE>
<CAPTION>
THREE MONTHS ENDED SEPTEMBER 30,
---------------------------------------------------
2000 1999
------------------------- -----------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues:
Monitoring and related services.................... $9,108 88.8% $8,697 90%
Installation and rental............................ 1,147 11.2 970 10
------------ ----------- ---------- ---------
Total revenues..................................... 10,255 100.0 9,667 100.0
Cost of revenues:
Monitoring and related services.................... 1,997 19.4 2,153 22.3
Installation and rental............................ 908 8.9 955 9.9
------------ ----------- ---------- ---------
Total cost of revenues............................. 2,905 28.3 3,108 32.2
----------- ----------- ---------- ------
26
<PAGE>
Gross profit....................................... 7,350 71.7 6,559 67.8
Selling expenses..................................... 552 5.4 463 4.8
General and administrative expenses.................. 1,874 18.3 2,071 21.4
Amortization of intangibles and depreciation expense. 3,925 38.3 2,388 24.7
------------ ----------- ---------- ----------
Operating income..................................... $999 9.7% $1,637 16.9%
============ =========== ========== ==========
</TABLE>
2000 COMPARED TO 1999. We had a net increase of 7,130 customers in the
third quarter of 2000 as compared to a net decrease of 902 customers in the
third quarter of 1999. The average customer base was 299,903 for the third
quarter of 2000 compared to 289,699 for the third quarter of 1999. The change in
Multifamily's customer base for the period is shown below.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
SEPTEMBER 30,
-----------------------
2000 1999
---------- -----------
<S> <C> <C>
Beginning Balance, July 1,.............................. 296,338 290,150
Additions............................................... 11,451 4,634
Customer losses......................................... (4,321) (5,536)
--------- ----------
Ending Balance ......................................... 303,468 289,248
========= ===========
Annualized quarterly attrition.......................... 5.8% 7.6%
========== ===========
</TABLE>
MONITORING AND RELATED SERVICES REVENUES for the third quarter of 2000
increased by $0.4 million, or 4.6%, to $9.1 million from $8.7 million for the
third quarter of 1999 due primarily to the larger customer base in 2000.
COST OF MONITORING AND RELATED REVENUES for the quarter ending September
30, 2000 decreased by $.2 million, or 7.3% to $2.0 million from $2.2 million for
the third quarter of 1999. Monitoring and related service expenses, as a
percentage of monitoring and related service revenues decreased to 21.9% for the
quarter ended September 30, 2000 from 24.8% for the quarter ended September 30,
1999. This is primarily due to reduced employment cost resulting from the
increased call center automation.
COST OF INSTALLATION AND RENTAL REVENUES decreased by $0.05 million or
5% to $0.91 million in the third quarter of 2000 from $0.96 million in the
third quarter of 1999. Installation and rental cost of revenues, as a
percentage of installation and rental revenues, decreased to 79.1% for the
third quarter of 2000 from 98.5% for the third quarter of 1999. This decline
is principally due to the sale of certain access control contracts which
provided greater installation margins than standard alarm sales.
GENERAL AND ADMINISTRATIVE EXPENSE decreased 9.5%, or $.2 million in 2000
to $1.9 million from $2.1 million as a result of a temporary decline in the
sales force.
AMORTIZATION OF INTANGIBLES AND DEPRECIATION EXPENSE for the third quarter
in 2000 increased by $1.5 million, or 64.4% from $2.4 million in 1999 to $3.9
million in 2000. This increase is primarily due to the change in estimate of
goodwill life from 40 to 20 years resulting in an increase in goodwill
amortization expense of $1.2 million. Subscriber amortization increased by $0.3
million due to the increasing customer base being amortized.
LIQUIDITY AND CAPITAL RESOURCES
We believe we currently maintain the ability to generate sufficient cash to
fund future operations of the business. Generally, cash will be generated from a
combination of our existing $115.0 million Senior Credit Facility, which had
approximately $43 million of availability at September 30, 2000, subject to
compliance with the provisions of the debt covenants in the agreement, as well
as revenue from our security monitoring customer base which generated $110.1
million of positive EBITDA from the North America and Multifamily operations in
the first nine months of 2000. 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
27
<PAGE>
neither of 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. We believe that presentation of EBITDA
enhances an understanding of our financial condition, results of operations and
cash flows because EBITDA is used to satisfy our debt service obligations and
our capital expenditure and other operational needs as well as to provide funds
for growth. In addition, 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.
On September 15, 2000, we announced that we are considering new sources
of financing, including new credit facilities with third parties or the sale
of assets, including the possible sale of Multifamily to Westar Industries.
The credit facility with Westar Industries currently expires on January 2,
2001. Westar Industries has advised us that while it would consider an
extension of the credit facility upon terms reflecting current market
conditions, it prefers we find alternatives to the credit facility upon its
expiration because of the previously announced restructuring of Westar
Industries. We have established a special committee of our Board of Directors
to evaluate any transaction with Westar Industries. Due to our credit
downgrades received in 2000 by rating agencies, higher interest rates and a
more difficult lending market, it is not known on what terms a credit
facility could be obtained or if a credit facility could be obtained at all.
Similarly, there is no assurance we will be able to sell assets.
OPERATING CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000. Our
operating activities provided net cash flows of $44.9 million, a decrease of
$31.0 million from the comparable period for 1999, primarily due to a decrease
in EBITDA of $46.4 million from $162.9 million for the first nine months of 1999
to $116.5 million for the first nine months of 2000.
INVESTING CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000. Our
investing activities provided net cash flows of $141.7 million in the first nine
months of 2000 compared to a use of cash of $239.9 million in the first nine
months of 1999. This increase is due to the sale of the European operations and
certain other investments to Westar Industries for $183.0 million in cash along
with $61.0 million in other consideration. We also reduced the purchases of
customer accounts and fixed assets by $192.9 million from $234.3 million in the
first nine months of 1999 to $41.4 million in the first nine months of 2000.
FINANCING CASH FLOWS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2000. We
decreased our net borrowings under our Senior Credit Facility by $153.0 million
during the first nine months of 2000. We paid down $183.0 million as a result of
the sale of our European operations to Westar Industries. Excluding this
transaction, we had net borrowings of $30.0 million under our Senior Credit
Facility during the first nine months of 2000. We also repurchased certain of
our outstanding debt securities for cash totaling $46.8 million during this
period. At September 30, 2000, the Senior Credit Facility had a weighted average
interest rate of 8.9% and outstanding borrowings of $72.0 million.
During the nine months ended September 30, 2000 we purchased 710,600 shares
of our outstanding common stock for a total of $1.2 million. These shares are
reflected in our equity section of the balance sheet as treasury stock, at cost.
We may continue to acquire additional shares of our common stock based upon
market conditions and other factors.
We may also continue to acquire additional debt securities in the open
market or through negotiated transactions based upon market conditions and other
factors. We expect that we would also realize an extraordinary gain on
extinguishment of debt on any such purchases.
MATERIAL COMMITMENTS
We have future, material, long-term commitments made in the past several
years in connection with our growth. We believe these commitments will be met
through a combination of borrowings under our Senior Credit Facility,
refinancings and positive operating cash flows. The following reflects these
commitments as of September 30, 2000 and as of September 30, 1999.
<TABLE>
<CAPTION>
SEPTEMBER 30, SEPTEMBER 30,
DEBT SECURITY MATURITY DATE 2000 1999 (b)
------------------------------------------- ---------------------- ------------------ -----------------
(in thousands) (in thousands)
<S> <C> <C> <C>
Convertible Senior Subordinated
Notes (a) September 2003 $ 28,185 $103,500
=======================================================================================================
28
<PAGE>
Senior Subordinated Discount Notes June 2005 49,826 107,900
Senior Unsecured Notes August 2005 250,000 250,000
Senior Subordinated Notes January 2009 262,040 350,000
Senior Credit Facility January 2001 72,000 215,000
------------------ ----------------
$662,051 $1,026,400
================== ================
--------------
</TABLE>
(a) These notes are convertible into Protection One common stock at a
price of $11.19 per share, which is currently above the price at
which our shares are traded in the public stock markets.
(b) Excludes the debt of our European segment which was sold to Westar
Industries on February 29, 2000.
We are in compliance with the financial covenants under the amended Senior
Credit Facility and the indentures for the third quarter ended September 30,
2000.
In March 2000, Moody's, S & P and Fitch downgraded their ratings on our
outstanding securities with outlook remaining negative. As of November 1, 2000,
these ratings were as follows:
<TABLE>
<CAPTION>
Senior Senior
Unsecured Subordinated
Debt Unsecured Debt
----------------- ---------------------
<S> <C> <C>
S & P B+ B-
Moody's B2 Caa1
Fitch B+ B-
</TABLE>
CAPITAL EXPENDITURES
We anticipate making capital expenditures of approximately $65 million in
2000. Of such amount, we plan to invest approximately $45 million to acquire
customer accounts, $10 million to complete the development and installation of
our new software platforms, $5 million for replacement of vehicles, and $5
million for other capital items. Capital expenditures for 2001 are expected to
be approximately $84 million of which approximately $67 million would be to
acquire accounts and $17 million for vehicles and other capital items. Capital
expenditures for 2002 are expected to be approximately $108 million of which
approximately $92 million would be to acquire accounts and $16 million for
vehicles and other capital items. These estimates are prepared for planning
purposes and may be revised. Actual expenditures for these and possibly other
items not presently anticipated may vary from these estimates during the course
of the years presented.
TAX MATTERS
Protection One is consolidated into income tax returns filed by its parent,
Western Resources. The two parties have entered into a tax sharing agreement
whereby Western Resources will make cash payments to us for current tax benefits
utilized for income tax return purposes and which 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, 1999, as well as for the nine months ended September 30, 2000. If
the Company did not file its taxes on a consolidated basis with Western
Resources, the Company's deferred tax assets might not be realizable and the
Company might not be in a position to record a tax benefit for losses
incurred. We would cease filing consolidated tax returns with Western
Resources upon its consummation of a strategic transaction and the completion
of our separation from Western Resources.
During the third quarter of 2000 we reversed a deferred tax valuation
allowance of $21.9 million relating to acquired net operating loss
carryforwards and reduced goodwill by this same amount. We originally had
determined that it was more likely than not that the NOL's acquired through
acquisitions would not be utilized and therefore established the valuation
allowance. However, due to a change in federal tax regulations regarding the
utilization of acquired NOL carryforwards, approximately $19 million of these
NOL's were utilized in 1999 with the balance expected to be utilized in 2000.
29
<PAGE>
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, 1999. For additional information on the Company's
market risk, see the Form 10-K for the year ended December 31, 1999.
30
<PAGE>
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
Information relating to legal proceedings is set forth in Note 6 of the
Notes to Consolidated Financial Statements included in Part I of this report,
which information is incorporated herein by reference.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits. The following exhibit is filed with this Current Report on
Form 10-Q or incorporated by reference.
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
-------- -------------------
27.1 Financial Data Schedule.
---------
(b) During the quarter ended September 30, 2000, the Company filed one
Current Report on Form 8-K filed July 28, 2000, disclosing the status of the SEC
Staff review of Company accounting matters.
31
<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: November 6, 2000 PROTECTION ONE, INC.
----------------------------- PROTECTION ONE ALARM MONITORING, INC.
By: /s/ Anthony D. Somma
-----------------------------------
Anthony D. Somma
Chief Financial Officer
32
