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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
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(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
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/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
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FOR THE TRANSITION PERIOD FROM ______________ TO ______________
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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 Charter) as Specified in Charter)
DELAWARE DELAWARE
(State of Other Jurisdiction of (State or Other Jurisdiction of
Incorporation or Organization) 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)
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Securities registered pursuant to Section 12(b) of the Act:
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TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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Common Stock, par value $.01 per share, of Protection One, New York Stock Exchange
Inc. 6 3/4% Convertible Senior Subordinated Notes Due 2003
of Protection One Alarm Monitoring, Inc., Guaranteed by
Protection One, Inc.
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Securities registered pursuant to Section 12(g) of the Act:
(NONE)
(Title of Class)
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
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of each registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. /X/
The aggregate market value of common stock of Protection One, Inc. held by
nonaffiliates on March 24, 2000 (based on the last sale price of such shares on
the New York Stock Exchange) was $32,213,180.
As of March 24, 2000, Protection One, Inc. had 126,945,337 shares of Common
Stock outstanding, 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 I (1)(a) and (b) for Form 10-K and is therefore filing this form
with the reduced disclosure format set forth therein.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of Protection One, Inc.'s proxy statement on Schedule 14A to be
furnished to stockholders in connection with its Annual Meeting of Stockholders
are incorporated by reference in Part III of the Form 10-K. Such proxy statement
is expected to be filed with the Commission prior to April 29, 2000.
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TABLE OF CONTENTS
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PAGE
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PART I
Item 1. Business............................................ 3
Item 2. Properties.......................................... 24
Item 3. Legal Proceedings................................... 24
Item 4. Submission of Matters to a Vote of Security
Holders................................................... 25
PART II
Item 5. Market for Registrants' Common Equity and Related
Stockholder Matters....................................... 25
Item 6. Selected Financial Data............................. 26
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations....................... 29
Item 7A. Qualitative and Quantitative Disclosure About
Market Risk............................................... 41
Item 8. Financial Statements and Supplementary Data......... 41
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure....................... 41
PART III
Item 10. Directors and Executive Officers of the
Registrants............................................... 42
Item 11. Executive Compensation............................. 42
Item 12. Security Ownership of Certain Beneficial Owners and
Management................................................ 42
Item 13. Certain Relationships and Related Transactions..... 42
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports
on Form 8-K............................................... 43
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PART I
FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K (this "Report") and the materials
incorporated by reference herein include "forward-looking statements" intended
to qualify for the safe harbor from liability established by the Private
Securities Litigation Reform Act of 1995. These forward-looking statements
generally can be identified as such because the context of the statement
includes words such as we "believe," "expect," "anticipate" or other words of
similar import. Similarly, statements herein that describe our objectives, plans
or goals also are forward-looking statements. All such forward-looking
statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from those in the forward-looking
statements. Important factors that could cause actual results to differ
materially from our expectations include, among others, the factors discussed in
the section entitled "Risk Factors." The forward-looking statements included
herein are made only as of the date of this report and we undertake no
obligation to publicly update such forward-looking statements to reflect
subsequent events or circumstances.
ITEM 1. BUSINESS
Unless the context otherwise indicates, all references in this Report to the
"Company", "Protection One," "we," "us" or "our" or similar words are to
Protection One, Inc., its direct wholly owned subsidiary, Protection One Alarm
Monitoring, Inc. ("Protection One Alarm Monitoring") and Protection One's other
wholly owned subsidiaries. Protection One's sole asset is, and Protection One
operates solely through, its investment in Protection One Alarm Monitoring and
Protection One's other wholly owned subsidiaries. Each of Protection One and
Protection One Alarm Monitoring is a Delaware corporation organized in
September 1991.
OVERVIEW
Protection One is one of the leading providers of life safety and property
monitoring services, providing electronic monitoring and maintenance of its
alarm systems in 1999 to nearly 1.6 million customers in North America and
Europe. We also provide our customers with enhanced services that include:
- extended service protection;
- patrol and alarm response;
- two-way voice communication;
- medical information service; and
- cellular back-up.
Approximately 85% of our revenues are contractually recurring for monitoring
alarm security systems and other related services. We have grown rapidly by
participating in the organic growth in the alarm industry and by acquiring other
alarm companies.
Our European operations were sold on February 29, 2000. See "Recent
Developments--Sale of European Assets and Other Transactions" below.
BUSINESS
Our principal activity is responding to the security and safety needs of our
customers. Our revenues are generated primarily from recurring monthly payments
for monitoring and maintaining the alarm systems that are installed in our
customers' homes and businesses. Security systems are designed to detect
burglaries, fires and other events. Through a network of 57 service branches and
13 satellite offices in
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North America and 65 service branches in continental Europe and the United
Kingdom, we provide maintenance service of security systems and, in certain
markets, armed response to verify that an actual emergency has occurred.
We provide our services to the residential (both single family and
multifamily residences), commercial and wholesale customers. At December 31,
1999, our customer base composition was as follows:
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MARKET SEGMENT PERCENTAGE OF TOTAL
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Single family and commercial................................ 72%
Multifamily/Apartment....................................... 18%
Wholesale................................................... 10%
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Total................................................. 100%
===
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Wholesale customers represent those customers that are served by smaller
independent alarm dealers that do not have a monitoring station and therefore
subcontract monitoring services from us.
Our company was divided into three business segments in 1999:
PROTECTION ONE NORTH AMERICA ("North America") generated approximately
$403.3 million, or 66.6%, of our revenues in 1999 and is comprised of Protection
One Alarm Monitoring-our core alarm monitoring business based in Culver City,
California.
NETWORK MULTIFAMILY ("Multifamily") generated approximately $38.9 million,
or 6.4%, of our revenues in 1999 and is comprised of our alarm monitored
business servicing the multifamily/apartment market based in Addison, Texas.
PROTECTION ONE EUROPE ("Europe") generated approximately $163.0 million, or
27.0%, of our revenues in 1999 and is comprised of:
- Protection One Continental Europe--our alarm monitoring business servicing
continental Europe, established from our purchase of Compagnie Europeenne
de Telesecurite ("CET") in September 1998, based in Paris and Vitrolles,
France and offices in Germany, Switzerland, Belgium and the Netherlands;
and
- Protection One United Kingdom--our alarm monitoring business servicing the
United Kingdom, established from our purchase of Hambro Countrywide
Security in May 1998, based in Basingstoke, United Kingdom.
Our European operations were sold on February 29, 2000. See "Recent
Developments--Sale of European Assets and Other Transactions" below.
OVERVIEW OF 1999 ACTIVITIES
DEALER PROGRAM. In 1998, we expanded our dealer program (Dealer Program)
for the North American single family residential market. As part of the Dealer
Program, we entered into contracts with dealers, typically independent alarm
companies, providing for the purchase of customer accounts generated by the
dealer on an ongoing basis. We maintained a limited internal sales staff and
relied on the Dealer Program for the generation of substantially all new
customer accounts in 1999.
In 1999, we began identifying steps that could be taken to reduce the cost
of acquired accounts and reduce attrition by acquiring higher quality accounts.
As part of this process, we began notifying dealers that we did not intend to
renew their contracts under their current terms and conditions when they expire.
The terms of dealer contracts ranges from one to five years and automatically
renews unless notice of non-renewal is given by either party as provided in the
contracts. In many cases, we entered into new contracts with existing dealers,
as well as entered into contracts with new dealers, with terms providing for
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a lower cost for acquired customer accounts based upon the multiple of monthly
recurring revenue and other revised terms that improve the quality of the
acquired customer accounts. In other cases, the existing contracts were
terminated with settlements deducted from established reserves and therefore
having no impact on earnings. These actions have resulted in a loss of dealers
and therefore fewer customer accounts available for purchase. The failure to
replace customer accounts could have a material adverse impact on our financial
condition. The number of accounts being purchased decreased significantly from
25,000 in March 1999 to approximately 3,500 in January 2000. See "Item 3--Legal
Proceedings."
Our new focus is on diversifying our customer acquisition strategy to
include a more balanced mix of dealers, internal sales, "tuck-in" acquisitions
and direct marketing, thereby placing less reliance on account generation
through the Dealer Program. See further discussion in Strategy section below.
SEC REVIEW. As previously disclosed, we were advised by the Division of
Corporation Finance of the SEC that, in the view of the staff, there are errors
in our financial statements which are material and which have had the effect of
inflating earnings commencing with the year 1997. We had extensive discussions
with the SEC staff about the methodology we used to amortize customer accounts,
the purchase price allocation to customer accounts in the Multifamily
acquisition and other matters. The SEC staff has not indicated it concurs with,
nor has the SEC staff determined not to object to, the restatements made in
1999, the change in accounting principle for customer accounts, or the change in
estimated useful life for goodwill. We cannot predict whether the SEC staff will
make additional comments or take other action that will further impact our
financial statements or the effect or timing of any such action.
IMPAIRMENT TEST. During the fourth quarter, we performed an impairment test
of our customer accounts and related goodwill under the guidance of Statement of
Financial Accounting Standards No. 121, ACCOUNTING FOR THE IMPAIRMENT OF
LONG-LIVED ASSETS AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF (SFAS 121).
Paragraph 6 of SFAS 121 indicates that an impairment loss should be recognized
only if the sum of the expected future cash flows (undiscounted and without
interest charges) is less than the carrying amount of the assets grouped at the
lowest level of identifiable cash flows. After performing the test, management
determined that there currently is not an impairment of the customer accounts.
CHANGE IN ACCOUNTING PRINCIPLE. In 1999, we announced a change in
accounting principle relating to the amortization of customer accounts.
Historically, we amortized the costs allocated to customer accounts by using the
straight-line method over a 10-year life. The straight-line method, indicated in
Accounting Principles Board Opinion No. 17 as an appropriate method for such
assets, has been the predominant method used to amortize customer accounts in
the monitored services industry. Management is not aware of whether the economic
life or the rate of realization for our customer accounts differs materially
from other monitored services companies.
The choice of a ten-year life was based on management's estimates and
judgments about the amounts and timing of expected future revenues from these
assets, the rate of attrition of such revenue over customer life, and average
customer account life. Ten years was used because, in management's opinion, it
would adequately match amortization cost with anticipated revenue from those
assets even though many accounts were expected to produce revenue over periods
substantially longer than ten years. Effectively, it expensed the asset costs
ratably over an "expected average customer life" that was shorter than the
expected life of the revenue stream, thus implicitly giving recognition to
projected revenues for a period beyond ten years.
We concluded a comprehensive review of our amortization policy that was
undertaken during the third quarter of 1999. This review was performed
specifically to evaluate the historic amortization policy in light of the
inherent declining revenue curve over the life of a pool of customer accounts,
and our historical attrition experience. After completing the review, management
identified three distinct pools, each of which has distinct attributes that
effect differing attrition characteristics. The pools correspond to our North
America, Multifamily and the former Europe business segments. The separate pools
for North
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America and Multifamily will be used going forward. The pool for Europe will no
longer be relevant to us in light of the sale of the European operations. For
the North America and Europe pools, the analyzed data indicated to management
that we can expect attrition to be greatest in years one through five of asset
life and that a change from a straight-line to a declining balance (accelerated)
method would more closely match future amortization cost with the estimated
revenue stream from these assets. Management has elected to change to that
method. No change was made in the method used for the Multifamily pool.
Our amortization rates for the North America and Europe customer pools
consider the average estimated remaining life and historical and projected
attrition rates. The average estimated remaining life for each customer pool is
as follows:
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AVERAGE
ESTIMATED
REMAINING LIFE
POOL (YEARS) METHOD
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North America......................... 8-10 Ten-year 130% declining balance
Europe................................ 10 Ten-year 125% declining balance
Multifamily........................... 12 Ten-year straight-line
</TABLE>
Adoption of the declining balance method effectively shortens the estimated
expected average customer life for these two customer pools. It is not possible
to distinguish the effect of a change in method (straight-line to declining
balance) from the change in estimated lives.
SALE OF MOBILE SERVICES GROUP. The sale of our Mobile Services Group to ATX
Technologies ("ATX") was announced on June 28, 1999 and consummated on
August 25, 1999. The sales price was approximately $20 million in cash plus a
note and a preferred stock investment in ATX. We recorded a gain on the sale of
approximately $11.2 million, net of tax.
RECENT DEVELOPMENTS
SALE OF EUROPEAN ASSETS AND OTHER TRANSACTIONS. On February 29, 2000, we
sold our European operations and certain investments to Westar Capital, Inc.
("Westar Capital"), a wholly owned subsidiary of Western Resources, Inc.
("Western Resources"), that owns approximately 85% of our common stock. We
received consideration of approximately $244 million, comprised of approximately
$183 million in cash and certain of the outstanding debt securities of
Protection One Alarm Monitoring that Westar Capital had acquired with a market
value of approximately $61 million. As part of this transaction, Westar Capital
agreed to pay us a portion of the net gain, if any, on a subsequent sale of the
European 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 provided by
Westar Capital to Protection One Alarm Monitoring.
Westar Capital also transferred to us debt securities of Protection One
Alarm Monitoring and a note for payment of certain intercompany amounts owed by
Westar Capital to us.
The aggregate carrying value of debt securities received in these
transactions was approximately $134.6 million. Upon the receipt of these
securities, we recorded an extraordinary gain from the cancellation of debt of
approximately $27 million, net of tax. See Note 19 of "Notes to Consolidated
Financial Statements" for a description of the debt transferred.
Upon the recommendation of a special committee of the Protection One Board
of Directors, the independent directors of the Protection One and Monitoring
Boards of Directors approved these transactions. The special committee received
a "fairness opinion" from an investment banker with regard to the sale of our
European operations. The independent directors of both Boards also approved the
amendment to our Senior Credit Facility described below.
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AMENDMENT TO CREDIT AGREEMENT WITH WESTAR CAPITAL. On December 17, 1999,
Westar Capital became the lender under our Senior Credit Facility. Concurrent
with the sale of our European operations discussed above, the Senior Credit
Facility was amended to, among other things, (1) reduce the commitment to
$115 million (resulting in availability of approximately $58 million after
application of proceeds from the sale of the European operations), (2) increase
the leverage ratio covenant to 5.75 to 1.0, (3) reduce the interest coverage
ratio to 2.10 to 1.0, (4) change the termination date to January 2, 2001,
(5) change the loan pricing grid to one based on leverage ratio rather than
credit rating, (6) allow for the inclusion of certain add-backs to the
calculation of EBITDA, (7) eliminate as an Event of Default Western Resources'
failure to own more than 50% of our outstanding common stock, (8) waive
compliance with the leverage ratio and interest coverage ratio covenants for the
fiscal quarters ended September 30, 1999 and December 31, 1999, and (9) provide
for an increase in the amount of the commitment by up to $40 million for the
purpose of consummating acquisitions approved by Westar Capital.
CHANGE IN ESTIMATE OF USEFUL LIFE OF GOODWILL. In conjunction with the
impairment test for customer accounts, 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 and
increased levels of attrition experienced in 1999, 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 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.
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.
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Customer attrition by business segment for the year ended December 31, 1999
and 1998 is summarized below:
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CUSTOMER ACCOUNT ATTRITION
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DECEMBER 31, 1999 DECEMBER 31, 1998
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ANNUALIZED TRAILING ANNUALIZED TRAILING
FOURTH TWELVE FOURTH TWELVE
QUARTER MONTH QUARTER MONTH
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North America........................... 16.3% 16.0% 8.3% 11.0%
Europe.................................. 15.6% 9.6% (a) (a)
Multifamily............................. 8.0% 7.6% 3.2% 4.6%
Total Company........................... 14.7% 14.0% 6.9% 9.4%
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(a) European operations acquired in 1998.
As the result of the attrition rates for the North America pool, we engaged
an appraiser to perform a current lifing study to assess the impact of our 1999
customer service issues on the estimated long-term revenues to be received from
the current North America account base. Based on the results of this study, we
determined that the current amortization rates remain appropriate. We also
reduced the period over which we amortize goodwill from 40 years to 20 years as
discussed above.
See "Strategy--Focusing on Customer Service and Reducing Attrition" for a
discussion of our efforts to reduce attrition.
STRATEGY
In prior years, our strategy was focused primarily on growing our customer
base to achieve critical mass. We believe we have reached this objective and our
strategic focus has now shifted to the following areas:
- improving customer service
- reducing attrition
- reducing customer acquisition costs, and diversifying our customer
acquisition strategy to include dealers, internal sales, tuck-in
acquisitions and direct marketing
- integrating and building infrastructure such as common platforms for our
central stations, billing and other applications
- enhancing revenues and margins by offering additional services to new and
existing customers
- establishing name recognition by targeting our growth to areas near
existing branches to increase customer density
- growing our commercial business
The primary goals with this strategy are to increase cash flow to reinvest
in the business and to reduce customer attrition. The principal components of
our strategy are as follows:
FOCUSING ON CUSTOMER SERVICE AND REDUCING ATTRITION
Our customer care centers are located in our service centers and answer
non-emergency customer inquiries. Operators answer inbound calls to our help
desk and assist customers with understanding and resolving operating issues
related to their security systems. If an operator is unable to resolve an issue
over the phone, a technician is typically dispatched through a repair order that
is entered into our centralized field scheduling system.
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Our commitment to quality customer service intensified with the addition of
150 service representatives late in the second quarter of 1999. We also
increased training and technology investments. As a result of these initiatives,
there were improvements in the third and fourth quarters of 1999 in measurements
of key performance metrics such as abandonment rates, acknowledgement time,
average speed of answer and service repair backlog. Additional customer service
initiatives are under way with a goal of reducing attrition rates. These
include, but are not limited to, special retention teams, new billing system
implementation, proactive customer interaction, and focusing the organization on
customer service. We have also started converting our multiple monitoring and
billing systems to one integrated system which management believes will further
enhance customer service. However, no assurance can be given that these efforts
will be successful in reducing customer attrition.
We expect that significant investments in our customer service response
systems and training will be required as part of our ongoing effort to become
the highest quality service provider in the industry.
CUSTOMER ACQUISITION STRATEGY
Despite the amount of significant consolidation activity that has occurred
in the alarm industry over the last several years, the industry in North America
and Europe remains highly fragmented. SDM Magazine (formerly Security
Distribution Magazine) estimates that there are over 16,000 alarm companies in
North America alone. The top 100 companies in the North American industry
represent only 25% of the total revenue in that industry. The remaining 75% are
comprised of small, local alarm companies with annual revenues typically less
than $1 million. Management estimates that the combined customer base of these
small alarm companies exceeds eight million customers, indicating that the
consolidation trend in the alarm industry will likely continue.
From November 1997 through December 1998, we completed in excess of 30
transactions, adding approximately one million new customers and establishing
our market position. In 1998, we also expanded the Dealer Program for the North
American single family residential market. While we relied primarily on the
Dealer Program for our growth in 1999, we shifted our focus to a more diverse
customer acquisition strategy including a more balanced mix of dealers, internal
sales, "tuck-in" acquisitions and direct marketing, thereby placing less
reliance on account generation through the Dealer Program.
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. This
program utilizes our existing branch infrastructure in 11 markets. We are also
pursuing alignments with strategic partners in an effort to further diversify
our marketing distribution channels.
To enhance our direct marketing efforts, we entered into an agreement with
Paradigm Direct LLC ("Paradigm"). As part of this agreement, our marketing
department moved to Paradigm with the goal to improve the return on investment
of marketing dollars. Westar Capital has a 40% ownership interest in Paradigm.
Multifamily markets its services and products primarily to developers,
owners and managers of apartment complexes and other multifamily dwellings.
Multifamily grows its business through national and regional advertising, a
nationwide professional field sales force and affiliations with professional
industry-related associations. We believe this targeted internal sales effort is
an effective means of generating sales in the multifamily market, which is
comprised primarily of developers and professionals that can be identified and
contacted with relative ease.
INTEGRATING AND BUILDING INFRASTRUCTURE
During 2000, the technology infrastructure of our North America segment will
be integrated into common customer service, monitoring, billing, collection and
financial systems. Our primary objective is to
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standardize operations nationwide. We believe the operational efficiencies from
these initiatives will improve gross profit margins and reduce attrition.
SELLING ADDITIONAL SERVICES TO INCREASE REVENUES AND MARGINS.
As a means to increase revenues and margins, we provide our new and existing
customers with an array of additional value-added services to help broaden our
customer relationships. Our enhanced services include extended service
protection, several different types of alarm verification, commercial open/close
reports, patrol services, and wireless backup services. These enhanced services
also position us as a full service provider and provides us more features to
sell in our solicitation of new customers.
ESTABLISHING NAME RECOGNITION
We believe there is a unique opportunity to build a preeminent consumer
brand name in the security industry which would enable us to add new customers
at a lower cost than our competitors and improve customer retention. We plan to
target our growth to areas near existing branches thereby increasing customer
density in those locations. Our service and response vehicles, dealer marketing
efforts, yard signs, and internet affinity advertising serve as a base from
which to launch further brand development efforts. We believe that a well
recognized brand supports our goal of becoming the industry leader and
broadening our customer relationships.
GROWING OUR COMMERCIAL BUSINESS
During the fourth quarter of 1999, we conducted a strategic evaluation of
our commercial business and decided to renew our focus on this business segment.
Through our Cranford, New Jersey and Lenexa, Kansas branches we install
commercial systems ranging from large industrial to storefront retail. Products
range from serving as an installation subcontractor, often receiving ongoing
monitoring and/or service, to a more all-inclusive role in designing,
installing, servicing and monitoring a system. These branches integrate multiple
systems, usually intrusion detection, CCTV and access control allowing the
customer to control multiple systems through one interface.
THE SECURITY ALARM INDUSTRY
The North American alarm industry is large, growing rapidly and
characterized by a high degree of fragmentation, low residential penetration and
a continuing trend towards consolidation. Over the last several years, many of
the largest security alarm companies in North America and Europe have been
acquired leaving few large national and Pan-European alarm companies. Potential
new entrants into the alarm industry are now faced with few, if any, large alarm
companies available for purchase. We believe that the larger, more cost
efficient alarm companies with access to capital will continue to grow faster
than the industry average. According to SDM Magazine, we were the third largest
electronic security systems and services company based on 1998 gross revenue.
SDM Magazine further reports that the largest 100 companies in the U.S. alarm
industry experienced growth of 23% and 14.8% in 1999 and 1998 respectively,
compared to industry growth rates of 6.8% and 8.6% in 1999 and 1998
respectively.
We believe that several favorable demographic trends, including the aging
population, two-income families, home officing as well as a strong economy and
the increased perception of crime have all contributed to an increased demand
for security alarm services. Due to our size and density in key markets and our
technology infrastructure, assuming successful completion of the enhancements in
progress, we believe we will be well positioned to take advantage of the
continued growth of the industry.
OPERATIONS
Our operations consist principally of alarm monitoring, customer service
functions and branch operations.
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CENTRALIZED MONITORING, CUSTOMER SERVICE AND CUSTOMER SOLICITATION
CUSTOMER SECURITY ALARM SYSTEMS. Security alarm systems include many
different types of devices installed at customers' premises designed to detect
or react to various occurrences or conditions, such as intrusion or the presence
of fire or smoke. In general, systems for multi-family and residential
applications tend to be smaller in size than those used by commercial customers,
and also tend to generate a lower level of alarm signals than in commercial
applications. These devices are connected to a computerized control panel that
communicates through the phone lines to a service center. In most systems,
control panels can identify the nature of the alarm and the areas within a
building where the sensor was activated, and can transmit that information to a
central monitoring station.
The basic system includes monitoring of the front and back doors of a home,
one keypad, an interior motion detection device, a central processing unit with
the ability to communicate signals to our central monitoring station, a siren,
window decals and a yard sign. This basic system often will be offered for
little or no up-front price, but will be sold to a customer with additional
equipment customized to a customer's specific needs. Such equipment add-ons
include additional perimeter and interior protection, fire protection devices
(heat and smoke detectors), environmental protection devices (freeze sensors and
water detectors), panic buttons and home automation devices (lighting or
appliance controls).
CUSTOMER CONTRACTS. Our alarm monitoring customer contracts generally have
initial terms ranging from one to five years in duration, and provide for
automatic renewals for a fixed period (typically one year) unless we or the
customer elect to cancel the contract at the end of its term. Typically,
customers sign alarm monitoring contracts that include a bundled monthly charge
for monitoring, extended service protection and a rebate against the homeowners'
insurance deductibles in the event of a loss. Extended service protection covers
the normal costs of repair of the security system after the expiration of the
security system's initial warranty period. Although a customer may elect to sign
an alarm monitoring contract that excludes extended service protection, few
customers choose to do so, and we believe the bundling of monitoring and
extended service protection provides additional value to customers and allows us
to provide more efficient field repair services.
SERVICE CENTERS. We maintain eight major service centers in North America
to provide monitoring services to the majority of our customer base. In the
United Kingdom, our service center was based in metropolitan London. In
Continental Europe, our service centers were based in Paris and in metropolitan
Marseilles, France. The table below provides additional detail about the North
American monitoring centers:
<TABLE>
<CAPTION>
CURRENT NUMBER OF CUSTOMERS
LOCATION MONITORED PRIMARY MARKETS
- -------- --------------------------- ----------------------
<S> <C> <C>
Beaverton, OR................ 305,000 Residential/Commercial
Addison, TX.................. 295,000 Multi-Family
Hagerstown, MD............... 80,000 Residential/Wholesale
Irving, TX................... 430,000 Residential/Commercial
Orlando, FL.................. 125,000 Wholesale
Wichita, KS.................. 210,000 Residential/Commercial
Ottawa, Ontario.............. 20,000 Residential
Vancouver, B.C............... 20,000 Residential
</TABLE>
Each service center incorporates the use of communications and computer
systems that route incoming alarm signals and telephone calls to operators. Each
service center currently monitors signals largely on a geographic basis. We are
currently standardizing our operating platforms so that the centers will be
effectively integrated with signals routed to the centers on a capacity basis,
rather than on a geographic basis. We expect that the use of a single operating
platform in North America will enable us to
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realize overall operating efficiencies through the ability to monitor more
effectively alarm signal patterns and adjust service center staffing levels
accordingly.
Depending upon the type of service for which the customer has contracted,
service center personnel respond to alarms by relaying information to the local
fire or police departments, notifying the subscriber, or taking other
appropriate action, such as dispatching alarm response personnel to the
customer's premises where this service is available. We also provide customers
with remote audio verification capability that enables the central monitoring
station to listen and speak directly into the customer's premises in the event
of an alarm activation. This feature allows our personnel to verify that an
emergency exists, to reassure the subscriber, and to expedite emergency
response, even if the customer is unable to reach a telephone. Remote audio
verification capability also assists us in quickly determining if the alarm was
activated inadvertently, and thus whether a response is required.
Our service centers operate 24 hours per day, seven days a week, including
all holidays. Each operator within a service center monitors a computer screen
that presents information concerning the nature of the alarm signal, the
customer whose alarm has been activated, and the premises on which such alarm is
located. Other non-emergency administrative signals are generated by low battery
status, deactivation and reactivation of the alarm monitoring system, and test
signals, and are processed automatically by computer.
All of our primary service centers in North America are listed by
Underwriters Laboratories, Inc. ("UL") as protective signaling services
stations. UL specifications for service centers include building integrity,
back-up computer and power systems, staffing and standard operating procedures.
In many jurisdictions, applicable law requires that security alarms for certain
buildings be monitored by UL listed facilities. In addition, such listing is
required by certain commercial customers' insurance companies as a condition to
insurance coverage.
WHOLESALE MONITORING. Through our service centers in Orlando, Florida,
Hagerstown, Maryland, and Vancouver, British Columbia, we provide wholesale
monitoring services to independent alarm companies. Under the typical
arrangement, alarm companies subcontract monitoring services to us, primarily
because such companies do not have their own monitoring capabilities. We may
also provide billing and other services. Dealers retain ownership of monitoring
contracts and are responsible for every other aspect of the relationship with
customers, including field repair service.
CUSTOMER CARE SERVICES. Our customer care centers are co-located in our
service centers and process non-emergency communications. Operators receive
inbound customer calls and the customer service group addresses customer
questions and concerns about billing, service, credit and alarm activation
issues. The help desk staff assists customers in understanding and resolving
mechanical and operating issues related to security systems. A field repair
scheduling function sets up technician appointments. We also operate a dedicated
customer service call center in Chatsworth, CA to address questions that
customers or potential customers have about our services, as well as outbound
sales and marketing activities and collections.
ENHANCED SERVICES. As a means to increase revenues and to enhance customer
satisfaction, we offer customers an array of enhanced security services,
including extended service protection and several different types of alarm
verification. These services position us as a full service provider and give
dealers more features to sell in their solicitation of new customers. We
actively solicit our customers for interest in these services. The following
provides additional detail on enhanced services:
- EXTENDED SERVICE PROTECTION, which covers the normal costs of repairing
the system during normal business hours, after the expiration of the
initial warranty period.
- TWO-WAY VOICE COMMUNICATION (REMOTE AUDIO VERIFICATION), which consists of
the ability, in the event of an alarm activation, to listen and to talk to
persons at the monitored premises from the
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service center through speakers and microphones located within the
premises. Among other things, such remote audio verification helps us to
determine whether an alarm activation is a false alarm.
- SUPERVISED MONITORING SERVICE, which allows the alarm system to send
various types of signals containing information on the use of the system,
such as which users armed or disarmed the system and at what time of the
day. This information is supplied to customers for use in connection with
the management of their households or businesses. Supervised monitoring
service can also include a daily automatic test feature.
- WIRELESS BACK-UP, which permits the alarm system to send signals over a
cellular telephone or dedicated radio system, in the event that regular
telephone service is interrupted.
- ALARM RESPONSE AND PATROL SERVICE, which provides customers in selected
markets with rapid, on-premises response to and verification of alarms by
armed officers.
- MEDICAL INFORMATION SERVICE, which provides a responder with our
customers' specific medical needs, as well as emergency contacts whether
home or away.
BRANCH OPERATIONS
We maintain approximately 57 service branches in North America from which we
provide field repair, customer care, alarm response and sales services and
approximately 13 satellite locations from which we provide field repair
services. Our branch infrastructure plays an important role in enhancing
customer satisfaction, reducing customer loss and building brand awareness.
FIELD REPAIR. Field repair personnel are trained by Protection One to
provide repair services for the various types of security systems utilized by
our customers. We strive to execute prompt service scheduling and first call
repair for customers. Field personnel also provide quality and related
compliance inspections for new installations performed by our dealers.
Repair services generate revenues primarily through billable field service
calls and recurring payments under our extended service protection program. The
increasing density of our customer base permits more effective scheduling and
routing of field service technicians and results in economies of scale.
ALARM RESPONSE AND PATROL. We offer our customers in Southern California
and Las Vegas alarm response and patrol enhanced services in addition to our
other services. These armed officers supplement our alarm monitoring service by
providing "alarm response service" to alarm system activations, "patrol service"
consisting of routine patrol of customers' premises and neighborhoods and, in a
few cases, "special watch" services, such as picking up mail and newspapers and
increased surveillance when the customer is traveling. Our patrol officers
observe and report potential criminal activity at a customer's home.
We believe that demand for alarm response and patrol services is likely to
increase as a result of a trend on the part of local police departments to limit
their response to alarm activations and other factors that may lead to a
decrease of police presence. The Private Sector Liaison Committee of the
International Association of Chiefs of Police has established Non-Sworn Alarm
Responder Guidelines to provide standards for private alarm response officers.
We believe that further demand for such services should enable us to further
increase customer density in our routes, thereby increasing margins. In
addition, our offer of patrol and alarm response services is a sales method used
to attract customers of other alarm monitoring companies that do not provide
such services. To the extent that further demand develops for patrol and alarm
response services, we believe that our current presence will enable us to
increase our conversions of customers to our services. No assurance can be given
that demand for such services will increase.
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SALES AND MARKETING
As discussed above, we entered into an agreement with Paradigm concerning a
three year marketing relationship. As part of this arrangement, Paradigm will
conduct marketing activities under the name Protection One Marketing Services
("POMS"). Certain marketing personnel were reallocated from Protection One to
POMS. For the first year under the agreement, we agreed to reimburse POMS on a
monthly basis for an amount estimated to approximate the current salary plus
benefits of the reallocated employees, plus a 10% mark-up.
During the last two years, we have concentrated our advertising and
marketing efforts to support the Dealer Program. Our advertising and marketing
efforts are now implemented through POMS. POMS intends to utilize television,
radio, newspaper, direct mail, and internet channels for promotional messages to
create sales leads and to increase awareness of the Protection One brand. In
addition, POMS intends to use both inbound and outbound telemarketing to
generate leads. POMS will install all new customer systems they sell over the
telephone and then sell the account to Protection One. Leads will be sold to us
if the prospective customer requests direct involvement with a company
representative.
Multifamily sales and marketing activities consist of national and regional
advertising, nationwide professional field sales efforts, centralized inbound
and outbound sales functions, prospective acquisition marketing efforts and
professional industry-related association affiliation. Services are sold
directly to the property owner, and payment is based on a lease price on a
per-unit basis. Ongoing service for the duration of the lease includes
equipment, maintenance, 24-hour monitoring from our central monitoring station,
customer service and individual market support. Property owner contracts
generally have initial terms ranging from five to ten years in duration, and
provide for automatic renewal for a fixed period (typically five years) unless
Multifamily or the subscriber elects to cancel the contract at the end of its
term.
DEALER MARKETING
The dealer marketing program provides support services to dealers as they
grow their independent businesses. On behalf of the Dealer Program participants,
we obtain purchase discounts on security systems, coordinate cooperative dealer
advertising and provide assistance in marketing and employee training support
services.
Dealer contracts provide for the purchase of the dealers' customer accounts
by us on an ongoing basis. The dealers install specified alarm systems (which
have a Protection One logo on the keypad), arrange for customers to enter into
Protection One alarm monitoring agreements, and install Protection One yard
signs and window decals. In addition, we require dealers to qualify prospective
customers by meeting a minimum credit standard. See "Overview of 1999
Developments--Dealer Program" above.
INTERNAL SALES
The Telesales department, located at the Chatsworth, California service
center, focuses on selling new systems to inbound residential callers over the
telephone. Along with sales professionals at our branch offices, the Telesales
department also tracks previous customers' homes to sign up new owners when they
move into such homes. The sales professionals also generate revenue from selling
equipment upgrades and add-ons to existing customers and by attracting
competitors' customers to our services. In 2000, we anticipate increasing our
sales force in our branch offices in an effort to create more internally
generated customers.
We operate a significant commercial sales and installation effort for
security and related monitored services. Our commercial products range from
basic intrusion and fire detection equipment to fully integrated systems with
card access, closed circuit television and voice/video monitoring.
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ACQUISITION SOLICITATION AND INTEGRATION
We actively seek to identify prospective "tuck-in" acquisitions of companies
and dealers with targeted direct mail, trade magazine advertising, trade show
participation, telemarketing, membership in key alarm industry trade
organizations, and contacts through various prominent vendors and other industry
participants.
Acquisitions are integrated through a specific program developed in
conjunction with each seller. Integration efforts typically include a letter
from the seller to our customers, explaining the sale and transition, followed
by one or more letters and packages that include our customer service brochures,
field service and monitoring phone number stickers. Thereafter, each new
customer is contacted individually by telephone by a member of our customer
service group for the purpose of addressing the customer's questions or concerns
and soliciting certain information. Finally, the customer receives a follow-up
telephone call after six months and periodically thereafter.
COMPETITION
The security alarm industry is highly competitive and highly fragmented. In
North America, there are only five alarm companies that offer services across
the U.S. and Canada with the remainder being either large regional or small,
privately held alarm companies. Based on number of residential customers, we
believe the top five alarm companies in North America are:
- ADT Security Services, a subsidiary of Tyco International, Inc. ("ADT");
- Protection One;
- SecurityLink from Ameritech, Inc., a subsidiary of Ameritech Corporation;
- Brinks Home Security Inc., a subsidiary of The Pittston Services Group of
North America; and
- Honeywell Inc.
Other alarm service companies have adopted a strategy similar to ours that
entails the purchase of alarm monitoring accounts both through acquisitions of
account portfolios and through dealer programs. Some competitors have greater
financial resources than us, or may be willing to offer higher prices than we
are prepared to offer to purchase customer accounts. The effect of such
competition may be to reduce the purchase opportunities available to us, thus
reducing our rate of growth, or to increase the price paid by us for customer
accounts, which would adversely affect our return on investment in such accounts
and our results of operations.
Competition in the security alarm industry is based primarily on reliability
of equipment, market visibility, services offered, reputation for quality of
service, price and the ability to identify and to solicit prospective customers
as they move into homes. We believe that we compete effectively with other
national, regional and local security alarm companies due to our reputation for
reliable equipment and services, our prominent presence in the areas surrounding
our branch offices and dealers, our ability to offer combined monitoring, repair
and enhanced services, our low cost structure and our marketing alliance with
Paradigm.
INTELLECTUAL PROPERTY
We own trademarks related to the name and logo for each of Protection One,
Network Multifamily Security as well as a variety of trade and service marks
related to individual services we provide. We own certain proprietary software
applications, which we use to provide services to our customers.
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REGULATORY MATTERS
A number of local governmental authorities have adopted or are considering
various measures aimed at reducing the number of false alarms. Such measures
include:
- subjecting alarm monitoring companies to fines or penalties for
transmitting false alarms;
- permitting of individual alarm systems and the revocation of such permits
following a specified number of false alarms;
- imposing fines on alarm customers for false alarms;
- imposing limitations on the number of times the police will respond to
alarms at a particular location after a specified number of false alarms;
and
- requiring further verification of an alarm signal before the police will
respond.
Our operations are subject to a variety of other laws, regulations and
licensing requirements of both domestic and foreign federal, state, and local
authorities. In certain jurisdictions, we are required to obtain licenses or
permits, to comply with standards governing employee selection and training, and
to meet certain standards in the conduct of our business. Many jurisdictions
also require certain of our employees to obtain licenses or permits. Those
employees who serve as patrol officers are often subject to additional licensing
requirements, including firearm licensing and training requirements in
jurisdictions in which they carry firearms.
The alarm industry is also subject to requirements imposed by various
insurance, approval, listing, and standards organizations. Depending upon the
type of customer served, the type of security service provided, and the
requirements of the applicable local governmental jurisdiction, adherence to the
requirements and standards of such organizations is mandatory in some instances
and voluntary in others.
Our advertising and sales practices are regulated in the United States by
both the Federal Trade Commission and state consumer protection laws. In
addition, certain administrative requirements and laws of the foreign
jurisdictions in which we operate also regulate such practices. Such laws and
regulations include restrictions on the manner in which we promote the sale of
our security alarm systems, the obligation to provide purchasers of our alarm
systems with certain rescission rights and certain foreign jurisdictions'
restrictions on a company's freedom to contract.
Our alarm monitoring business utilizes telephone lines and radio frequencies
to transmit alarm signals. The cost of telephone lines, and the type of
equipment, which may be used in telephone line transmission, are currently
regulated by both federal and state governments. The Federal Communications
Commission and state public utilities commissions regulate the operation and
utilization of radio frequencies. In addition, the laws of certain of the
foreign jurisdictions in which we operate regulate the telephone communications
with the local authorities.
RISK MANAGEMENT
The nature of the services provided by Protection One potentially exposes us
to greater risks of liability for employee acts or omissions, or system failure,
than may be inherent in other businesses. Substantially all of our alarm
monitoring agreements, and other agreements, pursuant to which we sell our
products and services contain provisions limiting liability to customers in an
attempt to reduce this risk.
Our alarm response and patrol services require our employees to respond to
emergencies that may entail risk of harm to such employees and to others. We
employ over 100 patrol and alarm response officers who are subject to
pre-employment screening and training. Officers are subject to local and federal
background checks and drug screening before being hired, and are required to
have gun and baton permits and state and city guard licenses. Officers also must
be licensed by states to carry firearms and to provide patrol services. We are
one of a few companies to have an in-house training academy that prepares
officer
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candidates for employment. Our training program includes arrest procedures,
criminal law, weaponless defense, firearms and baton usage, patrol tactics, and
first-aid and CPR. After graduating from the Protection One Patrol Academy, a
new officer rides along with a field training officer for two weeks to gain
experience. In total, an officer candidate undergoes approximately five weeks of
specific training, which amount exceeds all state requirements. Although we
conduct extensive screening and training of our employees, the nature of patrol
and alarm response service subjects us to greater risks related to accidents or
employee behavior than other types of businesses.
We carry insurance of various types, including general liability and errors
and omissions insurance in amounts management considers adequate and customary
for our industry and business. Our loss experience, and the loss experiences at
other security service companies, may affect the availability and cost of such
insurance. Certain of our insurance policies, and the laws of some states, may
limit or prohibit insurance coverage for punitive or certain other types of
damages, or liability arising from gross negligence.
EMPLOYEES
At December 31, 1999, we employed approximately 4,600 individuals on a
full-time basis, including approximately 1,500 employees in Europe.
Approximately 970 of the employees in France were covered by a collective
bargaining agreement. We believe that we have good relations with our employees.
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RISK FACTORS
CAUTIONARY STATEMENTS REGARDING FUTURE RESULTS OF OPERATIONS
You should read the following risk factors in conjunction with discussions
of factors discussed elsewhere in this and other of our filings with the SEC.
These cautionary statements are intended to highlight certain factors that may
affect our financial condition and results of operations and are not meant to be
an exhaustive discussion of risks that apply to public companies with broad
operations, such as us. Like other businesses, we are susceptible to
macroeconomic downturns in the United States or abroad that may affect the
general economic climate and our performance or that of our customers.
Similarly, the price of our securities is subject to volatility due to
fluctuations in general market conditions, differences in our results of
operations from estimates and projections generated by the investment community
and other factors beyond our control.
WE HAVE HAD A HISTORY OF LOSSES.
We incurred net losses of $82.9 million in 1999 (a net loss of
$94.1 million excluding the effect of the Mobile Services Group gain, net),
$3.3 million in 1998 (a net loss of $11.5 million excluding the effect of
non-recurring income, net), and $42.7 million in 1997. These losses reflect,
among other factors:
- substantial charges incurred by us for amortization of purchased customer
accounts;
- interest incurred on indebtedness;
- other charges required to manage operations; and
- costs associated with the integration of the acquisitions we have made.
The charges identified above will increase as we continue to purchase
customer accounts or increase indebtedness, or if interest rates on our
indebtedness increases. There can be no assurance that we will attain profitable
operations on an annual basis or at all.
THE COMPETITIVE MARKET FOR THE ACQUISITION AND CREATION OF ACCOUNTS MAY AFFECT
OUR FUTURE PROFITABILITY.
In the past, we have grown very rapidly by acquiring portfolios of alarm
monitoring accounts through acquisitions and dealer purchases. Our current
strategy is to reduce the cost of acquiring such accounts and to utilize other
customer account acquisition channels such as an internal sales force and direct
marketing to complement our existing channels of acquiring customer accounts. We
compete with major firms, some of whom have greater financial resources than we
do, or may be willing to offer higher prices than we are prepared to offer to
purchase subscriber accounts. The effect of competition may be to reduce the
purchase opportunities available to us, or to increase the price we pay for
subscriber accounts, which could have a material adverse effect on our return on
investment in such accounts on our business, and results of operations,
financial condition, prospects and ability to service debt.
THE INTEGRATION OF ACQUIRED BUSINESSES REQUIRES SUBSTANTIAL MANAGEMENT TIME AND
EFFORT.
Significant acquisitions, including the 1997 business combination with the
security businesses of Western Resources, place very significant demands on us
with respect to management, operational resources and the integration of
financial and internal control systems. Our future operating results will
depend, in part, on our ability to continue to implement and to improve our
operating and financial systems and to expand, to train and to manage our
employee base. Significant risks also exist in the consolidation of our systems,
operations and administrative functions. Significant changes in quarterly
revenues and costs may result from the execution of this business strategy,
resulting in fluctuating financial results.
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WE COULD DISCOVER PROBLEMS WITH ACQUIRED BUSINESSES AFTER THEIR ACQUISITION.
Acquisitions of subscriber account portfolios involve a number of
uncertainties. Sellers in smaller transactions typically do not have audited
historical financial information with respect to the acquired accounts.
Therefore, in making acquisition decisions, we have generally relied on
management's knowledge of the industry, due diligence procedures and
representations and warranties of the sellers. There can be no assurance that
these representations and warranties are or will be true and complete or, if
these representations and warranties are inaccurate, that we will be able to
uncover any inaccuracies in the course of its due diligence or recover damages
from the seller in an amount sufficient to fully compensate it for any resulting
losses. Risks associated with these uncertainties include, without limitation,
the following:
- the possibility of unanticipated problems not discovered prior to the
acquisition;
- additional expenses required to integrate the acquired company's systems;
- higher than expected account customer losses; and
- for acquisitions that are structured as stock purchases of other
companies, the assumption of unexpected liabilities and losses from the
disposition of unnecessary or undesirable assets of the acquired
companies.
Also, because the primary consideration in acquiring a portfolio of
subscriber accounts is the monthly recurring revenue associated with the
purchased accounts, the price we have paid has customarily been directly tied to
such monthly recurring revenue. This price varies based on the number and
quality of accounts being purchased from the seller, the historical activity of
these acquired accounts, the anticipated profit margins and other factors.
An important aspect of our acquisition program is the integration of
customer accounts into our operations after purchase. We have consummated well
over 200 acquisitions since 1992 and have experienced nearly all of the problems
and challenges described in varying degrees. We have experienced acquisitions in
which the quality of the accounts purchased, as defined by monthly recurring
revenue, were not commensurate with our expectations. We have also experienced
circumstances where the integration of an acquisition required more time than
expected, often related to differences in, or the inadequacy of, software and
accounting systems of the seller. On these occasions, circumstances have arisen
whereby we were unable to accurately track the loss of customer accounts
purchased. We have also experienced integration challenges where the servicing
of newly acquired customer accounts suffered due to lack of coordination and
systems. Depending upon the size, frequency and location of acquisitions, the
integration of customers may adversely affect our provision of field repair
services to existing customers, which may cause customer losses to increase and
monthly recurring revenue to decline. In addition, if corporate or branch
operations fail to integrate a substantial portion of or do not adequately
service acquired customer accounts, we may experience higher rates of customer
loss in the future.
WE WILL NEED ADDITIONAL FUNDING TO FINANCE OUR FUTURE GROWTH.
Our purchases of customer accounts through the Dealer Program and
acquisitions of portfolios of customer accounts and new lines of business have
historically generated cash needs that exceed the net cash provided by our
operating activities. We intend to continue to pursue customer account growth
through the Dealer Program, "tuck-in" acquisitions, Paradigm and internal sales,
even though our principal focus will shift from growth to improving our service,
reducing attrition of current customers and integrating and building
infrastructure. As a result, our cash requirements will be less in 2000 than
those in 1998 and 1999, but nonetheless are expected to exceed cash flows from
operations. As a result, additional funding from additional borrowings under our
credit facility or through the sale of additional securities is expected to be
required in the future. Our credit ratings have recently been downgraded which
may make obtaining additional funding more difficult or costly. Depending on the
price at which new equity, if any, is
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sold, the issuance of additional equity securities may dilute voting power,
percentage ownership and earnings per common share realized by then current
stockholders.
Any inability to obtain funding through external financing could adversely
affect our ability to increase our customers, revenues and cash flows from
operations. There can be no assurance that we will be able to obtain external
funding on favorable terms or at all.
WE HAVE A SUBSTANTIAL AMOUNT OF DEBT, WHICH COULD CONSTRAIN OUR GROWTH OR
OTHERWISE DISADVANTAGE STOCKHOLDERS.
We have, and will likely continue to have, a large amount of consolidated
indebtedness when compared to the equity of our stockholders. The terms of
various indentures and credit agreements governing our indebtedness, limit the
incurrence of additional indebtedness. We may incur additional indebtedness in
the future in order to fund future acquisitions of subscriber accounts.
Additionally, please be aware that:
- As of December 31, 1999, we had outstanding long-term indebtedness of
$1.077 billion, total indebtedness of $1.113 billion, an accumulated
deficit of $129.6 million and stockholders' equity of $1.263 billion. Our
ratio of total indebtedness to total capitalization was 0.47 as of
December 31, 1999. As of February 29, 2000, after giving effect to the
sale of our European assets and other transactions, we had outstanding
long-term indebtedness of $744.3 million, total indebtedness of
$744.6 million, an accumulated deficit of $129.6 million and stockholders'
equity of $1.305 billion. Our ratio of total indebtedness to total
capitalization decreased to 0.36 as of February 29, 2000.
- As of December 31, 1999, we had $225.0 million of debt outstanding under
our Senior Credit Facility, or 20.3% of total indebtedness, bearing
interest at a weighted average floating interest rate of 7.9%. At
February 29, 2000, we had approximately $57 million of debt outstanding
under our Senior Credit Facility, or 7.7% of total indebtedness, bearing
interest at a weighted average floating interest rate of 8.2%. Therefore,
our financial results are and will continue to be affected by changes in
prevailing interest rates. The Senior Credit Facility matures on
January 2, 2001. Our inability to refinance the credit facility or find
additional financing could adversely affect our ability to meet our cash
obligations.
A large amount of indebtedness could have negative consequences, including,
without limitation:
- our ability to obtain additional financing in the future for working
capital, acquisitions of subscriber accounts, capital expenditures,
general corporate purposes or other purposes;
- our ability to withstand a downturn in our business or the economy
generally; and
- our ability to compete against other less leveraged companies.
The indentures governing our debt securities require that we offer to
repurchase the securities in certain circumstances following a change of
control.
Our ability to satisfy any payment obligations will depend, in large part,
on our performance, which will ultimately be affected by general economic and
business factors, many of which will be outside management's control. We believe
that the cash flow from operations combined with borrowings under the Senior
Credit Facility will be enough to meet our expenses and interest obligations.
However, if these payment obligations cannot be satisfied, we will be forced to
find alternative sources of funds by selling assets, restructuring, refinancing
debt or seeking additional equity capital. There can be no assurance that any of
these alternative sources would be available on satisfactory terms or at all.
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WE LOSE SOME OF OUR CUSTOMERS OVER TIME.
We experience the loss of accounts as a result of, among other factors:
- relocation of customers;
- adverse financial and economic conditions;
- competition from other alarm service companies; and
- customer service and operational difficulties with integration of acquired
customers.
In addition, we experience the loss of newly acquired accounts to the extent
we do not integrate or adequately service those accounts. Because some acquired
accounts are prepaid on an annual, semiannual or quarterly basis, customer loss
may not become evident for some time after an acquisition is consummated. An
increase in this rate of customer loss could have a material adverse effect on
our revenues and earnings.
We have not historically observed that the rate of customer loss is
correlated with the terms of the customer contracts; however, contracts with
shorter terms give rise to more instances in which a customer may choose to
terminate the relationship. Although the contract term varies due to the variety
and number of sources from which we acquired them, based on our standard form of
contract and the due diligence procedures we undertake in connection with
account acquisitions, management believes that substantially all of our customer
contracts provide for an initial term of one to five years. During the initial
term, customers may not cancel the agreement without fulfilling their payment
obligations, so customers that request cancellation during the initial term are
billed for the balance of the initial term. Similarly, we believe that
substantially all of our customer contracts include an "evergreen" provision,
whereby the contract automatically renews for one to five year periods unless
either party gives prior notice of cancellation, usually 30 to 90 days prior to
expiration of the initial or any renewal term. Therefore, customers may only
cancel their agreements by providing the required notice prior to expiration of
the initial or a renewal term.
When acquiring accounts, we seek under terms of the purchase agreement to
withhold a portion of the purchase price as a partial reserve against a greater
than expected loss of customers. If the actual rate of customer loss for the
accounts acquired is greater than the assumed rate at the time of the
acquisition, and damages can not be recouped from the portion of the purchase
price held back from the seller, this loss of customers could have a material
adverse effect on our business, financial condition, results of operations,
prospects or ability to service our debt obligations. Moreover, there can be no
assurance that we will be able to obtain purchase price holdbacks in future
acquisitions, particularly acquisitions of large portfolios. We have no
assurance that actual rates of customer losses for acquired accounts will not be
greater than the rate we have assumed or historically incurred. Moreover, we are
not able to predict accurately the impact that acquired accounts will have on
the overall rate of customer losses.
As of December 31, 1999, our cost of intangible assets, net of accumulated
amortization, was approximately $2.2 billion, which constituted approximately
87.6% of the book value of our total assets. As a result of discussions with the
SEC staff in the third quarter, we reviewed our methodology for amortizing
customer accounts. A discussion of the results of this review is set forth in
the caption "Overview of 1999 Activities--Change in Accounting Principle,"
above.
The effects of the gross number of lost customers have historically been
offset by a combination of factors that has resulted in an overall increase in
the number of customers and/or revenue, including:
- adding new accounts from customers who move into premises previously
occupied by prior customers and in which security alarm systems are
installed;
- accounts for which we obtain a guarantee from the seller that allows us to
"put" back to the seller canceled accounts; and
21
<PAGE>
- revenues from price increases and the sale of enhanced services.
There can be no assurance that actual future experience will be consistent
with our past experiences and assumptions based on these experiences. There
could be a material adverse effect on our business, financial condition, results
of operations, prospects or ability to service debt obligations if actual
account attrition significantly exceeds assumed attrition and the period over
which the cost of purchased subscriber accounts is amortized is shortened.
OUR DEBT AGREEMENTS IMPOSE OPERATIONAL RESTRICTIONS ON US.
The indentures governing our public indebtedness require us to satisfy
certain financial covenants in order to borrow additional funds. The most
restrictive of these covenants are set forth below:
- Total debt to annualized EBITDA for the most recent quarter must be less
than 6.0;
- Annualized EBITDA for the most recent quarter to interest expense must be
greater than 2.25; and
- Senior debt to annualized EBITDA must be less than 4 to 1.
In each case, the ratio should reflect the impact of acquisitions and other
capital investments for the entire period covered by the calculation. Other
financial covenants are also described under "Management's Discussion and
Analysis of Financial Condition and Results of Operations--Liquidity and Capital
Resources--Material Commitments." Our ability to comply with the ratios and the
tests will be affected by events outside our control and there can be no
assurance that we will meet those tests. A breach of any of the covenants or
failure to meet the tests could result in an event of default which would allow
the lenders to declare all amounts outstanding immediately due and payable. In
the case of the Senior Credit Facility, if we are unable to pay the amounts due,
the lender could accelerate the indebtedness under the Senior Credit Facility,
which would in turn be an event of default under our various indentures
governing our publicly held indebtedness. There can be no assurance that our
assets would be sufficient to repay our indebtedness in full. We have had to
obtain waivers of compliance with certain covenants and provisions under the
Senior Credit Facility in the past. There can be no assurance we can obtain any
such waivers if they are required in the future.
Certain restrictions contained in our credit agreement with Westar Capital
are discussed under the caption "Recent Developments--Amendment to Credit
Agreement with Westar Capital," above.
DIVERSIFICATION OF OUR CUSTOMER ACQUISITION STRATEGY.
During the period 1995 through 1997, we increasingly began to rely on
independent dealers as a source for new accounts. Our reliance on the Dealer
Program is being reduced, however it remains an avenue of growth for the
company. Our Dealer Program competes with other major alarm monitoring firms
that also acquire accounts through these independent dealers. Some of these
firms with competitive dealer programs have substantial financial resources,
including ADT and the security subsidiaries of the Ameritech Corporation. We are
also aware of other national firms with competitive dealer programs including
Monitronics International, Inc., DMAC, as well as several large regional dealer
programs. There can be no assurance that we will be able to retain or expand our
current dealer base or that competitive offers to dealers will not require us to
pay higher prices to dealers for subscriber accounts than have previously been
paid. Such events could reduce our growth rate and increase our use of cash to
fund growth. A lower growth rate or higher use of cash could have a material
adverse effect on our business, financial condition, results of operations,
prospects and ability to service debt obligations.
We plan to diversify our customer account acquisition strategy to include
greater reliance on an internal sales force and our marketing agreement with
Paradigm. There can be no assurance that such a strategy will be successful, or
profitable and such events could reduce our rate of growth and increase our
22
<PAGE>
use of cash. A lower growth rate or increased cash needs could have a material
adverse effect on our business, financial condition, results of operations,
prospects and ability to service debt obligations.
DECLINES IN NEW CONSTRUCTION OF MULTI-FAMILY DWELLINGS MAY AFFECT OUR SALES IN
THIS MARKETPLACE.
Demand for alarm monitoring services in the multi-family alarm monitoring
market is tied to the construction of new multi-family structures. We believe
that developers of multi-family dwellings view the provision of alarm monitoring
services as an added feature that can be used in marketing newly developed
condominiums, apartments and other multi-family structures. Accordingly, we
anticipate that the growth in the multi-family alarm monitoring market will
continue so long as there is a demand for new multi-family dwellings. However,
the real estate market in general is cyclical and, in the event of a decline in
the market for new multi-family dwellings, it is likely that demand for our
alarm monitoring services to multi-family dwellings would also decline, which
could negatively impact our results of operations.
WESTAR CAPITAL IS OUR PRINCIPAL STOCKHOLDER.
Westar Capital owned approximately 85% of the outstanding common stock of
Protection One as of December 31, 1999. As long as Westar Capital continues to
beneficially own in excess of 50% of the shares of Protection One common stock
outstanding, Westar Capital will be able to direct the election of all directors
of Protection One and exercise a controlling influence over our business and
affairs, including any determinations with respect to mergers or other business
combinations involving Protection One, our acquisition or disposition of
material assets and our incurrence of indebtedness and the payment of dividends
on Protection One common stock. Similarly, Westar Capital will continue to have
the power to determine matters submitted to a vote of Protection One's
stockholders without the consent of other stockholders, to prevent or cause a
change in control of Protection One and could take other actions that might be
favorable to Western Resources and Westar Capital, whether or not these actions
would be favorable to Protection One or its stockholders generally.
WE FACE CHALLENGES ASSOCIATED WITH OUR OPERATIONAL REORGANIZATION.
In December1998, we announced that we had reorganized our operating
structure into new divisions in order to better manage the increased scale and
scope of operations. We also created a non-operating Executive Division with the
intent to focus senior management's time on key strategic and capital formation
initiatives. In 1999, we replaced several key management personnel and moved the
accounting and finance functions to Topeka, Kansas. In 1999, we also entered
into a service agreement with Western Resources pursuant to which Western
Resources provides us certain administrative services including accounting,
human resources, legal, facilities and technology. There can be no assurance
that we will be able to realize the intended benefits of our new operating
structure. Moreover, we face certain risks and uncertainties associated with
management and operational reorganizations, including those relating to:
- changes in management responsibility and reporting structures;
- potential lack of communications until new reporting and communication
structure becomes familiar;
- potential loss of cohesive operational strategies; and
- potential employee turnover.
If we are unable to manage successfully these risks and uncertainties, there
can be no assurance that the new operating structure will not have a material
adverse affect upon our business, financial condition, results of operations,
prospects and ability to service debt obligations.
23
<PAGE>
ITEM 2: PROPERTIES
We maintain our executive offices at 6011 Bristol Parkway, Culver City,
California 90230 and our main financial and administrative offices at 818 S.
Kansas Avenue, Topeka, Kansas 66612. We operate primarily from the following
facilities, although we lease office space for our approximately 57 service
branch offices and 13 satellite branches in North America.
<TABLE>
<CAPTION>
LOCATION SIZE (SQ. FT.) LEASE/OWN PRINCIPAL PURPOSE
- -------- -------------- --------- -----------------
<S> <C> <C> <C>
UNITED STATES
Addison, TX....................... 28,512 Lease Service center/administrative
headquarters
Beaverton, OR..................... 44,600 Lease Service center
Chatsworth, CA.................... 43,472 Lease Marketing call center
Culver City, CA................... 23,520 Lease Former Corporate headquarters (1)
Culver City, CA................... 8,029 Lease Current Corporate headquarters
Hagerstown, MD.................... 21,370 Lease Service center
Irving, TX........................ 53,750 Lease Service center
Irving, TX........................ 54,394 Lease Administrative functions
Orlando, FL....................... 11,020 Lease Wholesale service center
Topeka, KS........................ 6,996 Lease Financial/administrative
headquarters
Wichita, KS....................... 50,000 Own Service center/administrative
functions
CANADA
Ottawa, ON........................ 7,937 Lease Service center/administrative
headquarters
Vancouver, BC..................... 5,177 Lease Service center
EUROPE (2)
Basingstoke (London), UK.......... 3,500 Lease Financial/administrative
headquarters/ service center
Paris, FR......................... 3,498 Lease Financial/administrative
headquarters/ service center
Vitrolles (Marseilles), FR........ 13,003 Lease Administrative/service center
</TABLE>
- ------------------------
(1) In March 2000, the lease for our former corporate headquarters was
terminated.
(2) On February 29, 2000, we sold our European operations. See "Recent
Developments--Sale of European Assets and Other Transactions".
ITEM 3: LEGAL PROCEEDINGS
We and certain of our present and former officers and directors, 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 us, 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
24
<PAGE>
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 Capital 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. We believe that all the claims asserted in the
Amended Complaint are without merit and intends to defend against them
vigorously. We cannot currently predict the impact of this litigation which
could be material.
Six Protection One dealers have filed a class action lawsuit in the U. S.
District Court for the Western District of Kentucky alleging breach of contract
because of the our 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. As of March 17, 2000, none of these dealers have
commenced arbitration.
Other Protection One dealers have threatened litigation or arbitration based
upon a variety of theories surrounding calculations of holdback and other
payments. We believe we have complied with the terms of these contracts and
intend to vigorously defend our position. Although we believe that no individual
such claim will have a material adverse effect, we cannot currently predict the
aggregate impact of these disputes with dealers which could be material.
We are party to claims and matters of litigation incidental to the normal
course of business. The ultimate outcome of such matters cannot presently be
determined; however, in the opinion of management, the resolution of such
matters will not have a material adverse effect upon our financial position or
results of operations.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS
No matters were submitted to Protection One's stockholders following our
annual meeting in 1999.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET PRICE INFORMATION
Our common stock has been listed on the New York Stock Exchange since
November 6, 1998 under the symbol "POI" and was previously quoted on the
National Market System of the Nasdaq Stock Market under the symbol "ALRM". The
table below sets forth for each of the calendar quarters indicated, the high and
low sales prices per share of our common stock, as reported by the New York
Stock Exchange or the
25
<PAGE>
Nasdaq Stock Market, as applicable, and the dividends per share declared on our
common stock. All prices are as reported by the National Quotation Bureau,
Incorporated.
<TABLE>
<CAPTION>
PROTECTION ONE COMMON
STOCK
------------------------------------
HIGH LOW DIVIDENDS
---------- ----------- ---------
<S> <C> <C> <C>
1998:
First Quarter............................................... $ 13 1/2 $ 10 1/16 --
Second Quarter.............................................. 13 7/8 9 7/16 --
Third Quarter............................................... 12 1/8 5 7/8 --
Fourth Quarter.............................................. 12 1/4 7 7/8 --
1999:
First Quarter............................................... $ 9 3/8 $ 6 1/4 --
Second Quarter.............................................. 5 5/8 3 7/8 --
Third Quarter............................................... 6 1/4 2 3/4 --
Fourth Quarter.............................................. 4 1 7/16 --
</TABLE>
DIVIDEND INFORMATION
Holders of Protection One common stock are entitled to receive only
dividends declared by the board of directors from funds legally available for
dividends to stockholders.
Other than a $7.00 cash distribution paid to holders of record of Protection
One common stock as of November 24, 1997, to holders of outstanding options to
purchase Protection One common stock and to holders of warrants exercisable for
Protection One common stock, all in connection with the combination of the
Protection One and Western Resources security businesses in November 1997,
Protection One has never paid any cash dividends on its common stock and does
not intend to pay any cash dividends in the foreseeable future. The indenture
governing the 13 5/8% Senior Subordinated Discount Notes due 2005 of Protection
One Alarm Monitoring, and the credit agreement relating to its Senior Credit
Facility restrict Protection One Alarm Monitoring's ability to pay dividends or
make other distributions to its corporate parent. Consequently, these agreements
restrict our ability to declare or pay any dividend on, or make any other
distribution in respect of, our capital stock.
NUMBER OF STOCKHOLDERS
As of December 31, 1999, there were approximately 104 stockholders of record
who held shares of our common stock, as shown on the records of our transfer
agent.
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in
conjunction with Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations" and the audited consolidated financial
statements and notes to the financial statements of Protection One. All amounts
are in thousands, except per share and customer data, unless otherwise noted.
Prior to November 24, 1997, Protection One was a stand-alone security business.
On November 24, 1997, pursuant to a contribution agreement dated July 30, 1997,
between Protection One and Western Resources, Protection One acquired WestSec
and Westar Capital, which together were the Western Resources security
businesses ("WRSB"), and Centennial Security Holdings, Inc. ("Centennial"). As a
result of the November 1997 business combination, Western Resources, through its
wholly owned subsidiary Westar Capital owned approximately 85% of Protection One
at December 31, 1997.
26
<PAGE>
The November 1997 business combination was accounted for as a reverse
purchase acquisition which treats WRSB as the accounting acquiror. Accordingly,
the results of operations of Protection One and Centennial have been included in
the consolidated financial data only since November 24, 1997.
The 1996 historical financial data of Protection One are those of WRSB, the
accounting acquiror. On December 30, 1996, Western Resources, through its
indirect wholly owned subsidiary, WestSec, purchased the assets and assumed
certain liabilities comprising the security business of Westinghouse Security
Systems from Westinghouse Electric Corporation. Westinghouse Security Systems is
deemed to be a predecessor of Protection One.
Selected financial data for 1995 and 1996 were derived from the financial
statements of Westinghouse Security Systems for those years. Per share data is
omitted because Westinghouse Security Systems was wholly owned by Westinghouse
Electric Corporation.
<TABLE>
<CAPTION>
PROTECTION ONE PREDECESSOR
----------------------------------------------------------- -------------------------------
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED 53 WEEKS ENDED 52 WEEKS ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 30, DECEMBER 20,
1999 1998 1997 1996 1996 1995
------------ -------------- ------------ ------------ -------------- --------------
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS) (DOLLARS IN THOUSANDS, EXCEPT
FOR PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
STATEMENTS OF OPERATIONS DATA
Revenues...................... $ 605,176 $ 421,095 $ 144,773 $ 8,097 $110,881 $ 88,710
Cost of revenues.............. 184,006 129,083 35,669 3,348 25,960 17,280
---------- ---------- ---------- --------- -------- --------
Gross profit.................. 421,170 292,012 109,104 4,749 84,921 71,430
Selling, general and
administrative expenses..... 185,989 114,506 80,755 5,091 60,166 50,919
Acquisition and transition
expense..................... 27,451 20,298 2,108 -- 101 101
Amortization of intangibles
and depreciation expense.... 237,243 119,211 39,822 609 21,613 17,804
Other charges:
Impairment of customer
accounts.................. -- -- 12,750 -- -- --
Merger related costs........ -- -- 11,542 -- -- --
Severance and relocation
costs..................... 5,809 3,400 -- -- -- --
---------- ---------- ---------- --------- -------- --------
Operating income (loss)....... (35,322) 34,597 (37,873) (951) 3,041 2,606
Interest expense, net......... 87,037 55,990 33,483 15 10,879 12,159
Other non-recurring (income)
expense..................... (12,869) (20,570) -- -- -- --
---------- ---------- ---------- --------- -------- --------
Income (loss) before income
taxes and extraordinary
gain--net of taxes.......... (109,490) (823) (71,356) (966) (7,838) (9,553)
Income tax (expense)
benefit..................... 28,276 (4,114) 28,628 310 2,978 3,630
---------- ---------- ---------- --------- -------- --------
Income (loss) before
extraordinary gain.......... (81,214) (4,937) (42,728) (656) (4,860) (5,923)
Extraordinary gain, net of
tax......................... (1,691) 1,591 -- -- -- --
---------- ---------- ---------- --------- -------- --------
Net income (loss)............. $ (82,905) $ (3,346) $ (42,728) $ (656) $ (4,860) $ (5,923)
========== ========== ========== ========= ======== ========
Net income (loss) per share... $ (.65) $ (.03) $ (0.60) $ (0.01)
========== ========== ========== =========
CONSOLIDATED BALANCE SHEET
DATA
Working capital (deficit)..... $ (27,933) $ (90,568) $ 41,539 $ (19,447) $(19,515) $(13,035)
Customer accounts, net........ 1,139,066 1,031,956 530,312 265,530 157,969 138,620
Goodwill and trademarks,
net......................... 1,101,788 1,175,153 672,776 218,991 11,102 11,397
Total assets.................. 2,558,235 2,510,436 1,414,567 506,647 187,456 170,907
Long term debt, including
capital leases.............. 1,077,152 884,554 343,942 60,505 47,931 52,511
Total stockholders' equity.... 1,262,597 1,344,236 940,550 410,430 106,140 89,120
</TABLE>
27
<PAGE>
<TABLE>
<CAPTION>
PROTECTION ONE PREDECESSOR
----------------------------------------------------------- -------------------------------
YEAR ENDED YEAR ENDED YEAR ENDED YEAR ENDED 53 WEEKS ENDED 52 WEEKS ENDED
DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 31, DECEMBER 30, DECEMBER 20,
1999 1998 1997 1996 1996 1995
------------ -------------- ------------ ------------ -------------- --------------
(DOLLARS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS) (DOLLARS IN THOUSANDS, EXCEPT
FOR PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C> <C>
OTHER OPERATING DATA
Number of customers at end of
period...................... 1,623,201 1,557,996 756,818 424,100 313,784 265,839
EBITDA (a).................... $ 207,730 $ 162,491 $ 26,241 $ (342) $ 24,654 $ 20,410
Cash flows from operations.... $ 91,268 $ 85,150 (4,928) (91) 23,729 15,073
Cash flows used in investment
activities.................. (272,225) (893,947) (156,684) (369,536) (40,460) (43,094)
Cash flows from financing
activities.................. 177,674 744,479 237,000 369,682 16,734 28,129
</TABLE>
- ------------------------------
(a) Earnings before interest, taxes, depreciation and amortization (EBITDA) is
derived by adding to income (loss) before income taxes, the sum of:
- interest expense, net;
- other charges;
- depreciation and amortization expense; and
- deducting other non-recurring (income) expense items.
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 neither of operating performance nor cash
flows available to fund the cash needs of Protection One. Items excluded from
EBITDA are significant components in understanding and assessing the financial
performance of Protection One. Protection One believes presentation of EBITDA
enhances an understanding of financial condition, results of operations and cash
flows because EBITDA is used by Protection One to satisfy its debt service
obligations and its 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. Protection One's computation of EBITDA may
not be comparable to other similarly titled measures of other companies.
The following table provides a calculation of EBITDA for each of the periods
presented above:
<TABLE>
<CAPTION>
PROTECTION ONE PREDECESSOR
------------------------------------------ -------------------------------
YEAR ENDED DECEMBER 31, 53 WEEKS ENDED 52 WEEKS ENDED
------------------------------------------ DECEMBER 30, DECEMBER 20,
1999 1998 1997 1996 1996 1995
--------- -------- -------- -------- -------------- --------------
(DOLLARS IN THOUSANDS) (DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Loss before income taxes and extraordinary item.... $(109,490) $ (823) $(71,356) $(966) $(7,838) $(9,553)
Plus:
Interest expense, net............................ 87,037 55,990 33,483 15 10,879 12,159
Other charges.................................... 5,809 8,683 24,292 -- -- --
Amortization of intangibles and depreciation
expense........................................ 237,243 119,211 39,822 609 21,613 17,804
Less:
Other non-recurring income....................... (12,869) (20,570) -- -- -- --
EBITDA............................................. $ 207,730 $162,491 $ 26,241 $(342) $24,654 $20,410
========= ======== ======== ===== ======= =======
</TABLE>
Other charges in 1999 represents severance charges of $3.2 million and
transition costs of $2.6 million relating to the move of the finance and
accounting offices from Irving, Texas to Topeka, Kansas. Other charges in 1998
represents severance and relocation payments of $3.4 million related to our 1998
reorganization and costs of $5.3 million incurred to replace signage for WRSB
after the merger of WRSB with Protection One in 1998. Other charges in 1997
represent the write down of customer accounts and merger costs.
28
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
INTRODUCTION
In Management's Discussion and Analysis we explain our general financial
condition and operating results, including:
- What factors impact our business
- What our earnings and costs were in 1999 and 1998
- Why these earnings and costs differed from year to year
- How our earnings and costs affect our overall financial condition
- What we expect our capital expenditures to be for the years 2000 through
2002
- How we plan to pay for these future capital expenditures
- Other items we believe may materially affect our financial condition or
earnings
As you read Management's Discussion and Analysis, please refer to our
Consolidated Statements of Income. These statements show our operating results
for 1999, 1998, and 1997. In Management's Discussion and Analysis, we analyze
and explain the significant annual changes of specific line items in the
Consolidated Statements of Income.
OVERVIEW OF 1999 ACTIVITIES
GENERAL. Approximately 85% of our revenues in 1999 came from monitoring and
servicing security systems located in single family homes, apartments and
condominiums and businesses. We had over 1.6 million customers at December 31,
1999, most of whom pay us under contracts for our monitoring and other security
services. We also bill customers on a time and material basis for service visits
if they do not have extended service contracts. While we typically require
payment for monitoring services in advance, we recognize monitoring and related
services revenues only as we provide the service. The remainder of our revenue
is from the sale and installation of security systems, add-ons and upgrades. We
recognize revenues from these other activities in the period of installation.
During 1999, we experienced significant levels of attrition which had a
direct impact on our results of operations since it affects both our revenues
and amortization expense. We believe the high levels of attrition were caused by
customer service deficiencies and operational difficulties relating to the
integration of acquired customers into our operations. We hired an additional
150 service representatives late in the second quarter of the year and increased
our training and technology investments in an effort to address the customer
service concerns. We have also scaled back our growth rate which allows us to
focus more attention on the current customer base and the integration of new
customers.
SEC REVIEW. As previously disclosed, we were advised by the Division of
Corporation Finance of the SEC that, in the view of the staff, there are errors
in our financial statements which are material and which have had the effect of
inflating earnings commencing with the year 1997. We had extensive discussions
with the SEC staff about the methodology we used to amortize customer accounts,
the purchase price allocation to customer accounts in the Multifamily
acquisition and other matters. The SEC staff has not indicated it concurs with,
nor has the SEC staff determined not to object to, the restatements made in
1999, the change in accounting principle for customer accounts, or the change in
estimated useful life for goodwill. We cannot predict whether the SEC staff will
make additional comments or take other action that will further impact our
financial statements or the effect or timing of any such action.
ACCOUNTING CHANGE. We performed a review of our amortization policy
relating to customer accounts and identified three distinct pools, each of which
has distinct attributes that effect differing attrition
29
<PAGE>
characteristics. The pools correspond to our North America and Multifamily
business segments and our former European business segment. For the North
America and Europe pools, the analyzed data indicated that a change from a
straight-line to a declining balance (accelerated) method would more closely
match future amortization cost with the estimated revenue stream from these
assets. We elected to change to that method for our North America and Europe
pools of customers. No change was made in the method used for the Multifamily
pool. See Note 2 of "Notes to Consolidated Financial Statements" for further
discussion.
IMPAIRMENT TEST. We also performed an impairment test of our customer
accounts and related goodwill under the guidance of the Statement of Financial
Accounting Standards No. 121, ACCOUNTING FOR THE IMPAIRMENT OF LONG-LIVED ASSETS
AND FOR LONG-LIVED ASSETS TO BE DISPOSED OF(SFAS 121). Paragraph 6 of SFAS 121
indicates that an impairment loss should be recognized only if the sum of the
expected future cash flows (undiscounted and without interest charges) is less
than the carrying amount of the asset(s) grouped at the lowest level of
identifiable cash flows. After performing the test, management determined that
the customer accounts currently are not impaired.
SALE OF NON-STRATEGIC ASSETS. The sale of our Mobile Services Group to ATX
Technologies ("ATX") was announced on June 28, 1999 and consummated on
August 25, 1999. The sales price was approximately $20 million in cash plus a
note and a preferred stock investment in ATX. We recorded a gain on the sale of
approximately $17.2 million.
MONTHLY RECURRING REVENUE. At various times during the year, we measure all
of the monthly revenue we are entitled to receive under contracts with customers
in effect at the end of the period. We had approximately $39.7 million
($32.6 million excluding our European operations) of monthly recurring revenue
as of December 31, 1999. Historically, we have grown rapidly, often by acquiring
security alarm companies and portfolios of customer accounts. The impact of this
increase in customer accounts is included in results of operations only from the
date of acquisition, therefore, our revenues are not necessarily proportional to
the level of our investment of capital reported at the end of the period upon
which a return must be earned. We believe monthly recurring revenue enhances an
investor's understanding of our financial condition, results of operations and
cash flows because it provides a measure of the revenue that can be used to
derive estimates of annual revenue acquired in the acquisitions for a full year
of operations. As a result, monthly recurring revenue can be compared to the
level of investment in the statement of financial condition. Further, we believe
an investor's consideration of monthly recurring revenue, relative to our
customer base, helps identify trends in monthly recurring revenue per customer.
Monthly recurring revenue does not measure profitability or performance, and
does not include any allowance for future customer losses or allowance for
doubtful accounts.
We do not have sufficient information as to the losses of acquired accounts
to predict with absolute certainty the amount of acquired monthly recurring
revenue that will be realized in future periods or the impact of the losses of
acquired accounts on our overall rate of customer loss. Our computation of
monthly recurring revenue may not be comparable to other similarly titled
measures of other companies and monthly recurring revenue should not be viewed
by investors as an alternative to actual monthly revenue, as determined in
accordance with generally accepted accounting principles.
Our monthly recurring revenue includes amounts to be recognized as a result
of ongoing reductions in the liability under our recourse financing agreements.
Also included are billable amounts to customers with past due balances. We seek
to preserve the revenue stream associated with each customer contract, primarily
to maximize our return on the investment we made to generate each contract. As a
result, we actively work to collect amounts owed to us and to retain the
customer at the same time. In some instances, we may allow up to six months to
collect past due amounts, while evaluating the ongoing customer relationship.
After we have made every reasonable effort to collect past due balances, we will
disconnect the customer and include the loss in our customer loss calculations
described below.
30
<PAGE>
CUSTOMER AND REVENUE LOSSES. Like most monitored security companies, we
invest significant amounts to generate new customers, and we seek to maintain
long-term relationships with our customers by providing excellent service. We
measure the loss of our customers to verify that our investment in new customers
is generating a satisfactory rate of return and that our amortization policy is
reasonable.
We define attrition as a ratio, the numerator of which is the number of lost
customer accounts for a given period, net of certain adjustments, and the
denominator of which is the average number of accounts for a given period. In
some instances the company uses 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.
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 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 necessary
we will adjust amortization of the cost of customer accounts.
For the period ended December 31, 1999, our total company quarterly
annualized and trailing twelve month attrition rates were 14.7% and 14.0%,
respectively. The table below shows the change in our total company customer
base and the increase in attrition from 1998 to 1999:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1999 1998
---------- ----------
<S> <C> <C>
Beginning Balance, January 1,.......................... 1,557,996 937,480
Additions, net of holdback put backs................... 288,581 738,163
Customer losses, net of holdback put backs............. (223,376) (117,647)
--------- ---------
Ending Balance, December 31,........................... 1,623,201 1,557,996
========= =========
Twelve month trailing attrition........................ 14.0% 9.4%
========= =========
</TABLE>
RECENT DEVELOPMENTS
SALE OF EUROPEAN ASSETS AND OTHER TRANSACTIONS. On February 29, 2000, we
sold our European operations and certain investments to Westar Capital. We
received consideration of approximately $244 million, comprised of approximately
$183 million in cash and certain of the outstanding debt securities of
Protection One Alarm Monitoring that Westar Capital had acquired with a market
value of approximately $61 million. As part of this transaction, Westar Capital
agreed to pay us a portion of the net gain, if any, on a subsequent sale of the
European 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 provided by
Westar Capital to Protection One Alarm Monitoring.
Westar Capital also transferred to us debt securities of Protection One
Alarm Monitoring and a note for payment of certain intercompany amounts owed by
Westar Capital to us.
The aggregate carrying value of debt securities received in these
transactions was approximately $134.6 million. Upon the receipt of these
securities, we recorded an extraordinary gain from the
31
<PAGE>
cancellation of debt of approximately $27 million, net of tax. See Note 19 of
"Notes to Consolidated Financial Statements" for a description of the debt
transferred.
Upon the recommendation of a special committee of the Protection One Board
of Directors, the independent directors of the Protection One and Monitoring
Boards of Directors approved these transactions. The special committee received
a "fairness opinion" from an investment banker with regard to the sale of our
European operations. The independent directors of both Boards also approved the
amendment to our Senior Credit Facility as discussed below.
SENIOR CREDIT FACILITY. At the beginning of 1999, we had a $500 million
Senior Credit Facility from a group of lenders. The amount of the credit
facility was reduced to $250 million at the end of the third quarter in
connection with obtaining a waiver of compliance with the then applicable
leverage and interest ratio coverage covenants. We attempted to renegotiate the
terms of the Senior Credit Facility during the fourth quarter but were
unsuccessful. As a result, Westar Capital purchased the outstanding loans from
our lenders and became the lender under the Senior Credit Facility.
Concurrently with the sale of our European operations to Westar Capital on
February 29, 2000, the outstanding principal balance of the facility was reduced
to $57 million and the facility was amended to, among other things, (1) reduce
the commitment to $115 million (resulting in availability of approximately
$58 million after application of proceeds from the sale of the European
operations), (2) increase the leverage ratio covenant to 5.75 to 1.0,
(3) reduce the interest coverage ratio to 2.10 to 1.0, (4) change the
termination date to January 2, 2001, (5) change the loan pricing grid to one
based on leverage ratio rather than credit rating, (6) allow for the inclusion
of certain add-backs to the calculation of EBITDA, (7) eliminate as an Event of
Default Western Resources' failure to own more than 50% of our outstanding
common stock, (8) waive compliance with the leverage ratio and interest coverage
ratio covenants for the fiscal quarters ended September 30, 1999 and
December 31, 1999, and (9) provide for an increase in the amount of the
commitment by up to $40 million for the purpose of consummating acquisitions
approved by Westar Capital.
CHANGE IN ESTIMATE OF USEFUL LIFE OF GOODWILL. In conjunction with the
impairment test for customer accounts, 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 and
increased levels of attrition experienced in 1999, 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.
RESULTS OF OPERATIONS
We separate our business into three reportable segments: North America,
Multifamily and 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 provides security alarm services in Europe and was sold in
February 2000.
NORTH AMERICA SEGMENT
We present the table below to show how the North America operating results
have changed over the past three years. Next to each year'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. The 1997
results reflect WRSB for the entire year, and one month of the operations of
Protection One and
32
<PAGE>
Centennial Security each, while 1998 results reflect an entire year of WRSB,
Protection One, Centennial Security and all of the acquisitions since their
respective closing dates.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------
1999 1998 1997
------------------- ------------------- -------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
Revenues:
Monitoring and related services...... $387,962 96.2% $321,085 93.4% $126,630 87.5%
Installation and rental.............. 15,307 3.8 22,869 6.6 18,143 12.5
-------- ----- -------- ----- -------- -----
Total revenues....................... 403,269 100.0 343,954 100.0 144,773 100.0
Cost of revenues:
Monitoring and related services...... 108,875 27.0 93,569 27.2 32,656 22.5
Installation and rental.............. 12,646 3.1 14,030 4.1 3,013 2.1
-------- ----- -------- ----- -------- -----
Total cost of revenues............... 121,521 30.1 107,599 31.3 35,669 24.6
-------- ----- -------- ----- -------- -----
Gross profit......................... 281,748 69.9 236,355 68.7 109,104 75.4
Selling, general and administrative
expenses............................. 106,482 26.4 86,843 25.2 80,755 55.8
Acquisition and transition expense..... 26,405 6.6 20,275 5.9 2,108 1.5
Amortization of intangibles and
depreciation expense................. 198,264 49.2 107,545 31.3 39,822 27.5
Other charges.......................... 5,809 1.4 3,400 1.0 24,292 16.8
-------- ----- -------- ----- -------- -----
Operating income (loss)................ $(55,212) (13.7)% $ 18,292 5.3% $(37,873) (26.2)%
======== ===== ======== ===== ======== =====
</TABLE>
1999 COMPARED TO 1998. We had a net increase of 8,595 customers in 1999 as
compared to a net increase of 445,156 customers in 1998. Accordingly, results
for 1999 include a full year of operations with the customers added throughout
1998. We believe this to be the primary reason for our increase in revenues and
associated cost of revenues in 1999 as compared to 1998. Further analysis
between the two years is discussed below.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1999 1998
---------- ----------
<S> <C> <C>
Beginning Balance, January 1,.......................... 1,196,047 750,891
Additions, net of holdback put backs................... 200,407 552,015
Customer losses, net of holdback put backs............. (191,812) (106,859)
--------- ---------
Ending Balance, December 31,........................... 1,204,642 1,196,047
========= =========
Twelve month trailing attrition........................ 16.0% 11.0%
========= =========
</TABLE>
MONITORING AND RELATED SERVICE REVENUES for 1999 increased by
$66.9 million, or 20.8%, to $388.0 million from $321.1 million for 1998. The
primary reason for the increase in 1999 revenues is because we had a full year
of revenues from the additional customers added throughout 1998. An increase in
our base monitoring and service fees also increased revenue in 1999.
INSTALLATION AND RENTAL REVENUES, which consist primarily of revenues
generated from our internal installations of new alarm systems, decreased by
33.2% to $15.3 million in 1999, compared to $22.9 million in 1998. This decrease
in revenues is due primarily to the reduction of our internal sales and
installation activities that resulted from our reliance on the Dealer Program
for residential customers in 1999. We continued our internal sales program and
recorded installation revenues through the first half of 1998, but then relied
almost entirely on the Dealer Program to acquire new customers for the balance
of 1998 and all of 1999.
33
<PAGE>
COST OF MONITORING AND RELATED SERVICES REVENUES for 1999 increased by
$15.3 million, or 16.3%, to $108.9 million from $93.6 million for 1998. Cost of
monitoring and related services revenues as a percentage of the related revenues
decreased from 29.1% during 1998 to 28.0% during 1999. Monitoring and related
services expense for 1999 increased primarily due to a full year of operations
of the three major service centers and three smaller satellite monitoring
facilities acquired in 1998. We also incurred additional expense in 1999
relating to the addition of customer service representatives in the second
quarter.
COST OF INSTALLATION AND RENTAL REVENUES for 1999 decreased by
$1.4 million, or 9.9%, to $12.6 million from $14.0 million in 1998. This
decrease corresponds with the decrease in the internal installations in 1999.
Installation and other cost of revenues as a percentage of installation and
other revenues increased to 82.6% in 1999 from 61.4% in 1998.
GROSS PROFIT for 1999 increased by $45.3 million, or 19.2%, to
$281.7 million from $236.4 million in 1998. Contribution of new customers by the
Dealer Program and acquisitions produced the increase in gross profit. As a
percentage of total revenues, gross profit was 69.9% for 1999 compared to 68.7%
for 1998. The increase in gross profit as a percentage of total revenues
reflects cost savings from the consolidation of some of our monitoring
operations, offset by a partial year of expense associated with additional
customer service representatives. Gross margin will be negatively impacted in
the future by the full year impact of additional customer service
representatives reflected in cost of monitoring and related service revenues.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES for 1999 increased by
$19.6 million, or 22.6%, to $106.5 million from $86.8 million in 1998. The
increase is attributable to costs associated with the overall increase in the
average number of customers billed, additional bad debt expense of approximately
$10.5 million resulting from higher attrition, costs associated with Year 2000
compliance, professional fees and salary increases.
ACQUISITION EXPENSES for 1999 increased by $6.1 million, or 30.2%, to
$26.4 million from $20.3 million in 1998. We aggregate expenses incurred in the
acquisition and integration of customers in this line item. These expenses
include yard signs, the cost of monitoring acquired accounts by a third party,
and the reprogramming of alarm panels for new customers. The increase in 1999 is
primarily attributable to costs of $4.0 million associated with the
restructuring of the Dealer Program and $3.7 million of costs related to the
unsuccessful merger with Lifeline, offset by reduced transition expenses
associated with acquisitions. In 1998 we incurred $5.3 million in additional
customer transition expenses, primarily yard signs for WRSB customers related to
the merger of WRSB and Protection One. We incurred expenses to develop and
manage our Dealer Program, as well as to contact, assimilate and solicit
acquired and new customers for new services.
AMORTIZATION OF INTANGIBLES AND DEPRECIATION EXPENSE for 1999 increased by
$90.8 million, or 84.4%, to $198.3 million from $107.5 million in 1998. As
discussed above in "Overview of 1999 Activities", we changed our amortization
method from a 10-year straight line method to a 10-year declining balance method
which resulted in an increase in amortization expense in 1999 of approximately
$50 million. The balance of the increase is primarily attributed to a full year
of amortization expense on subscribers acquired during 1998. In 1999 and 1998,
we amortized goodwill over 40 years using a straight-line method. Goodwill
amortization expense increased $3.1 million to $21.6 million in 1999.
OTHER CHARGES for 1999 increased by $2.4 million, to $5.8 million from
$3.4 million in 1998. We incurred $5.8 million for severance and relocation
expenses associated with a reorganization of our operations in 1999 and
$3.4 million for such expenses in late 1998.
INTEREST EXPENSE, NET for 1999 increased by $23.7 million, or 45.2%, to
$76.1 million from $52.4 million in 1998, reflecting our use of debt to finance
a substantial portion of our customer account growth.
OTHER NON-RECURRING (INCOME) EXPENSE in 1999 totaled $12.7 million of income
compared to $20.5 million of income in 1998. In 1999, other income consisted
primarily of a gain on the sale of our Mobile Services
34
<PAGE>
Group of $17.2 million and dividend income reduced by losses on sales of
marketable securities of $7.7 million. In 1998, we recognized a non-recurring
gain on the repurchase of customer contracts covered by a financing arrangement
with New York Life Secured Asset Management Company, Ltd. (SAMCO), a third
party, of approximately $16.4 million. Also during 1998, we restructured our
investment in a security monitoring company and recognized a non-recurring gain
of approximately $3.0 million.
1998 COMPARED TO 1997. The 1997 results reflect WRSB for the entire year,
and one month of the operations of Protection One and Centennial Security each,
while 1998 results reflect an entire year of WRSB, Protection One, Centennial
Security and all of the acquisitions since their respective closing dates. The
1998 results also include a partial year of operations resulting from the
additions of customers throughout the year from various acquisitions and the
dealer program.
MONITORING AND RELATED SERVICE REVENUES for 1998 increased by
$194.4 million, or 153.6%, to $321.1 million from $126.6 million for 1997.
Monitoring and related service revenues increased due to our acquisitions and
new customers purchased through our dealer program. The majority of additional
revenues in 1998 were attributable to North America's dealer program and
acquisitions. We added approximately $5.3 million of monthly recurring revenue
from our dealer program and approximately $7.3 million of monthly recurring
revenue from our acquisitions. Because purchases from the dealer program and
acquisitions occurred throughout the year, not all of the $12.6 million of
acquired monthly recurring revenue is reflected in 1998 results.
INSTALLATION AND RENTAL REVENUES, which consist primarily of revenues
generated from installing new alarm systems, increased by $4.8 million, or 26.0%
to $22.9 million in 1998, compared to $18.1 million in 1997. At the time of the
combination of WRSB with Protection One, we committed to a plan to wind down
internal sales activities and increase reliance on the Dealer Program as a
source of new customers. The scaling back of these activities took place through
the first half of 1998.
COST OF MONITORING AND RELATED SERVICES REVENUES for 1998 increased by
$60.9 million, or 186.5% to $93.6 million from $32.7 million for 1997. Total
cost of revenues as a percentage of total revenues increased to 31.3% during
1998 from 24.6% during 1997. Monitoring and related services expenses for 1998
increased due to the acquisition of three major service centers and three
smaller satellite monitoring facilities in the U.S. Monitoring and service
activities at our existing facilities increased as well, due to new customers
generated by our Dealer Program. Monitoring and related services expenses as a
percentage of monitoring and related services revenues increased to 29.1% in
1998 from 25.8% during 1997. The percentage increased due to the expenses of the
acquired facilities, as well as expenses from several higher cost subcontract
monitoring agreements.
COST OF INSTALLATION AND RENTAL REVENUES for 1998 increased by
$11.0 million, or 365.6%, to $14.0 million from $3.0 million in 1997. The
increase in expense reflects the cost of equipment, installation labor and other
expenses incurred in the installation of security alarm systems. Installation
and other cost of revenues as a percentage of installation and other revenues
increased to 61.4% in 1998 from 16.6% in 1997. Acquired commercial installation
activities generated lower profit margins due to declining installation revenues
and the selling outright, rather than leasing, of security alarm systems.
GROSS PROFIT for 1998 increased by $127.3 million, or 116.6%, to
$236.4 million from $109.1 million in 1997. Contribution of new customers by the
Dealer Program and acquisitions produced the increase in gross profit. As a
percentage of total revenues, gross profit was 68.7% for 1998 compared to 75.4%
for 1997. The decline in gross profit as a percentage of total revenues reflects
the higher monitoring, field service and installation expenses noted above.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES for 1998 increased by
$6.1 million, or 7.5%, to $86.8 million from $80.8 million in 1997. The increase
in expenses resulted primarily from acquisitions, partially offset by a
reduction in sales and related expenses. The transition of our primary
distribution channel from an internal sales force to the Dealer Program resulted
in sales commissions declining by approximately
35
<PAGE>
$9.0 million. We also reduced advertising and telemarketing activities that
formerly supported the internal sales force.
ACQUISITION EXPENSES for 1998 increased by $18.2 million, or 861.8%, to
$20.3 million from $2.1 million in 1997. We aggregate expenses incurred in the
acquisition and integration of customers in this line item. These expenses
include the replacement of yard signs and the reprogramming of alarm panels for
new customers. In 1998, we incurred $5.3 million in additional customer
transition costs, primarily yard signs for WRSB customers related to the merger
of WRSB and Protection One. We incurred expenses to develop and manage our
Dealer Program, as well as to contact, assimilate and solicit acquired and new
customers for new services. Other acquisition expenses were incurred in
connection with our dealer program and the costs related to maintaining an
acquisition department.
AMORTIZATION OF INTANGIBLES AND DEPRECIATION EXPENSE for 1998 increased by
$67.7 million, or 170.1%, to $107.5 million from $39.8 million in 1997. We spent
approximately $442.6 million to purchase customer accounts and incurred
$211.0 million in cost allocated to goodwill during 1998 from our purchases of
security alarm companies, portfolios of customer accounts, and individual new
customers through our Dealer Program. In 1998, we amortized customer accounts
over a 10-year straight-line method and goodwill over 40 years using a
straight-line method. Additional considerations relating to our treatment of
customer accounts are discussed under the heading "Risk Factors--We lose some of
our customers over time."
OTHER CHARGES for 1998 decreased by $20.9 million, or 86.0% to $3.4 million
from $24.3 million in 1997. We incurred $3.4 million for severance and
relocation expenses associated with a reorganization of our operations in 1998.
Other charges for 1997 of consisted of $12.8 million for impairment of customer
accounts and $11.5 million of merger related costs. The merger related costs
consisted of $3.6 million for inventory and other asset losses, $4.1 million for
disposition of fixed assets, $2.0 million for closure of duplicate facilities
and approximately $1.9 million for severance compensation and benefits.
INTEREST EXPENSE, NET for 1998 increased by $18.9 million, or 56.4%, to
$52.4 million from $33.5 million in 1997, reflecting our use of debt to finance
a substantial portion of our customer account growth.
OTHER NON-RECURRING (INCOME) EXPENSE in 1998 totaled $20.6 million of income
compared to zero in 1997. In 1998, we recognized a non-recurring gain on the
repurchase of customer contracts covered by a financing arrangement with New
York Life Secured Asset Management Company, Ltd. (SAMCO), a third party, in the
amount of $16.4 million. Also during 1998, we restructured our investment in a
security monitoring company and recognized a non-recurring gain of approximately
$3.0 million.
MULTIFAMILY SEGMENT
Our Multifamily segment was created when we acquired Multifamily effective
January 1, 1998 under the terms of a purchase option granted to us by Western
Resources. We paid approximately $180 million for what we believe to be the
leading provider of security alarm monitoring services to apartment complexes
and other multifamily dwellings. The change in Multifamily's customer base for
1998 and 1999 is shown below:
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,
-------------------
1999 1998
-------- --------
<S> <C> <C>
Beginning Balance, January 1,............................. 285,954 186,590
Additions, net of holdback put backs...................... 30,973 110,152
Customer losses, net of holdback put backs................ (21,967) (10,788)
------- -------
Ending Balance, December 31,.............................. 294,960 285,954
======= =======
Twelve month trailing attrition........................... 7.6% 4.6%
======= =======
</TABLE>
36
<PAGE>
We present the table below to show how the 1999 Multifamily operating
results compare with the 1998 operating results. During 1998, over 80,000
accounts were acquired in two acquisitions that increased monthly recurring
revenues by approximately $550,000, or $6.6 million per year. About 39,000 of
these accounts were acquired in May with the balance acquired in September. The
1999 results reflect a full year of operations with these acquired accounts
which is the primary reason that revenues and associated expenses are higher in
1999.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------
1999 1998
------------------- -------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues:
Monitoring and related services........................... $34,309 88.2% $29,356 87.8%
Installation and rental................................... 4,592 11.8 4,061 12.2
------- ----- ------- -----
Total revenues............................................ 38,901 100.0 33,417 100.0
Cost of revenues:
Monitoring and related services........................... 7,565 19.4 5,852 17.5
Installation and rental................................... 3,448 8.9 3,820 11.4
------- ----- ------- -----
Total cost of revenues.................................... 11,013 28.3 9,672 28.9
------- ----- ------- -----
Gross profit.............................................. 27,888 71.7 23,745 71.1
Selling, general and administrative expenses................ 11,339 29.2 9,767 29.2
Acquisition and transition expense.......................... 313 0.8 0 0.0
Amortization of intangibles and depreciation expense........ 9,507 24.4 7,721 23.1
------- ----- ------- -----
Operating income............................................ $ 6,729 17.3% $ 6,257 18.7%
======= ===== ======= =====
</TABLE>
MONITORING AND RELATED SERVICES REVENUES for 1999 increased by
$5.0 million, or 16.9%, to $34.3 million from $29.4 million for 1998.
Multifamily's additional revenues in 1999 were primarily attributable to the
1998 acquisitions.
COST OF MONITORING AND RELATED REVENUES for 1999 increased by $1.7 million,
or 29.3%, to $7.6 million from $5.9 million for 1998. Monitoring and related
services expenses as a percentage of monitoring and related services revenues
increased to 22.0% in 1999 from 19.9% during 1998. The percentage increase is
due primarily to the lower contracted recurring revenues on the accounts
acquired in 1998.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES for 1999 increased by
$1.5 million, or 15.3%, to $11.3 million from $9.8 million in 1998. The increase
resulted primarily from increased selling expense attributable to a 20% increase
in contract sales and increased general and administrative expenses principally
associated with the 1998 acquisitions.
ACQUISITION EXPENSES for 1999 was $0.3 million and zero in 1998. We
aggregate expenses incurred in the acquisition and integration of customers in
this line item. These expenses principally relate to the conversion of customer
account data into Multifamily's monitoring database from the 1998 acquisitions.
AMORTIZATION OF INTANGIBLES AND DEPRECIATION EXPENSE for 1999 increased by
$1.8 million, or 23.1%, to $9.5 million from $7.7 million in 1998. We amortize
customer accounts over 10 years using a straight-line method and goodwill over
40 years using a straight-line method. Additional considerations relating to our
treatment of customer accounts are discussed under the heading "Risk Factors--We
lose some of our customers over time."
EUROPE SEGMENT
On May 18, 1998, we acquired all of the capital stock of Hambro Countrywide
Security, the fifth largest security company in the United Kingdom with
operations throughout the United Kingdom, for approximately $18 million. On
September 30, 1998, we established a major presence in Western Europe by
37
<PAGE>
purchasing the common stock of Compagnie Europeenne de Telesecurite ("CET"), a
public company with 60,000 customers for approximately $140 million. We also
assumed liabilities for recourse financing contracts sold to a third party
financing company in the acquisition.
In 1999, we acquired approximately 34,000 additional customers through four
acquisitions in the United Kingdom. These additional customers produced an
increase in monthly recurring revenues of approximately $1.0 million. The change
in our customer base for 1999 is shown below:
<TABLE>
<CAPTION>
1999
--------
<S> <C>
Beginning Balance, January 1,...................... 75,995
Additions, net of holdback put backs............... 57,201
Customer losses, net of holdback put backs......... (9,597)
-------
Ending Balance, December 31,....................... 123,599
=======
Twelve month trailing attrition.................... 9.6%
=======
</TABLE>
The results of operations for 1999 include a full year of operations for the
1998 acquisitions as well as a partial year of operations for the 1999
acquisitions. We experienced a net increase of 47,604 customers in 1999 or a
62.6% increase over the ending 1998 amount of 75,995. The operating results
below reflect the partial year of operations reported in 1998 and the
significant increase in customers during 1999.
<TABLE>
<CAPTION>
YEAR ENDED PERIOD ENDED
DECEMBER 31, 1999 DECEMBER 31, 1998
------------------- -------------------
1999 1998
------------------- -------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues:
Monitoring and related services......... $ 92,793 56.9% $25,400 58.1%
Installation and rental................. 70,213 43.1 18,324 41.9
-------- ----- ------- -----
Total revenues.......................... 163,006 100.0 43,724 100.0
Cost of revenues:
Monitoring and related services......... 21,110 13.0 4,100 9.4
Installation and rental................. 30,361 18.6 7,712 17.6
-------- ----- ------- -----
Total cost of revenues.................. 51,471 31.6 11,812 27.0
-------- ----- ------- -----
Gross profit............................ 111,535 68.4 31,912 73.0
Selling, general and administrative
expenses................................ 68,169 41.8 17,897 40.9
Acquisition and transition expense........ 733 0.4 22 0.1
Amortization of intangibles and
depreciation expense.................... 29,472 18.1 3,945 9.0
-------- ----- ------- -----
Operating income.......................... $ 13,161 8.1% $10,048 23.0%
======== ===== ======= =====
</TABLE>
CET has recognized as a financing transaction, cash received through the
sale of security equipment and future cash flows to be received under security
equipment operating lease agreements with customers to a third-party financing
company. A liability has been recorded for the proceeds of these sales as the
finance company has recourse to CET in the event of nonpayment by customers of
their equipment rental obligations. The average implicit interest rate in the
financing is approximately 18%. Accordingly, the liability is reduced, rental
revenue is recognized, and interest expense is being recorded as these recourse
obligations are reduced through the cash receipts paid to the financing company
over the term of the related equipment rental agreements which average four
years. The liability is increased as new security monitoring equipment and
equipment rental agreements are sold to the finance company that have recourse
provisions.
38
<PAGE>
Revenues of approximately $33.8 million in 1999 and 10.2 million in 1998
were recognized as revenue as a result of ongoing reductions in the liability
under these recourse obligations. In relation to this revenue, we have also
recognized interest expense of approximately $8.9 million and $3.0 million and
depreciation expense of approximately $5.8 million and $1.8 million for 1999 and
1998 respectively.
As discussed above in "Overview of 1999 Activities", we changed our
amortization method from a 10-year straight line method to a 10-year declining
balance method which resulted in an increase in amortization expense in 1999 of
approximately $2.5 million. The balance of the increase is primarily attributed
to a full year of amortization expense on subscribers acquired during 1998. In
1999 and 1998, we amortized goodwill over 40 years using a straight-line method.
Goodwill amortization expense increased $2.3 million to $3.7 million in 1999.
YEAR 2000 ISSUE.
We experienced no business disruptions as a result of the transition from
December 31, 1999 to January 1, 2000, or as a result of "leap day" on
February 29, 2000. As of December 31, 1999, we expensed $4.3 million to complete
remediation and testing of mission critical systems necessary to continue to
provide monitored services to its customers. We expect to incur minimal costs in
2000 to complete remediation of less important systems as we expect no Year 2000
issues to arise in 2000.
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 million Senior Credit Facility, which had
approximately $58 million of availability at February 29, 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
$207.7 million of positive EBITDA in 1999. Cash flow from operations reflected
in the statement of cash flows was $91.3 million. 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
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.
OPERATING CASH FLOWS FOR THE YEAR ENDED DECEMBER 31, 1999. Our operating
activities provided net cash flows of $91.3 million, an increase of
$6.1 million from 1998. We believe this improvement is due to increased
recurring revenue generated from the customer accounts added in 1998 primarily
through business combinations and the Dealer Program, as well as the net
additions in customers during 1999.
INVESTING CASH FLOWS DURING 1999. We used a net $272.2 million in investing
activities, primarily to purchase new customer accounts from our external
dealers. This was significantly less than the prior year use of $893.9 million.
This decrease was primarily due to a decline in acquisitions of alarm companies
of approximately $521.8 million.
FINANCING CASH FLOWS DURING 1999. We increased our borrowings under our
credit facility by $183.0 million, primarily to fund purchases of new customer
accounts. During 1999, borrowings under the facility were at interest rates
based on either the Prime Rate or a Eurodollar Rate. At December 31, 1999
39
<PAGE>
the facility had a weighted average interest rate of 7.9% and an outstanding
balance of $225 million. This credit facility was amended on February 29, 2000.
See "Recent Developments" above.
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 December 31, 1999 and as of February 29, 2000
(after the completion of the sale of the European operations):
<TABLE>
<CAPTION>
DECEMBER 31, FEBRUARY 29,
DEBT SECURITY MATURITY DATE 1999 2000
- ------------- -------------- ------------ ------------
<S> <C> <C> <C>
Convertible Senior Subordinated
Notes (a)........................... September 2003 $ 103,500 $ 53,950
Senior Subordinated Discount
Notes............................. June 2005 107,900 72,200
Senior Unsecured Notes.............. August 2005 250,000 250,000
Senior Subordinated Notes........... January 2009 350,000 303,890
Senior Credit Facility.............. January 2001 225,000 57,000
---------- --------
$1,036,400 $737,040
========== ========
</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.
All of these debt instruments contain restrictions based on "EBITDA". The
definition of EBITDA varies among the various indentures and the Senior Credit
Facility. EBITDA is generally derived by adding to income (loss) before income
taxes, the sum of interest expense and depreciation and amortization expense.
However, under the varying definitions of the indentures, various and numerous
additional adjustments are sometimes required.
Our Senior Credit Facility and the indentures relating to our public notes
contain the financial covenants summarized below:
<TABLE>
<CAPTION>
DEBT INSTRUMENT FINANCIAL COVENANT
- --------------- -------------------------------------
<S> <C>
Senior Credit Facility (as amended on
February 29, 2000)................. Total consolidated debt/annualized
most recent quarter EBITDA
less than 5.75 to 1.0.
Consolidated annualized most recent
quarter EBITDA/latest four fiscal
quarters interest expense
greater than 2.10 to 1.0
Senior Subordinated Notes............ Current fiscal quarter EBITDA/current
fiscal quarter interest expense
greater than 2.25 to 1.0
Senior Subordinated Discount Notes... Total debt/annualized fourth quarter
EBITDA
less than 6.0 to 1.0
Senior debt/annualized fourth quarter
EBITDA
less than 4.0 to 1.0
</TABLE>
From September 30, 1999 through February 29, 2000, we received waivers from
compliance with the then-applicable leverage and interest coverage ratio
covenants under the Senior Credit Facility. At
40
<PAGE>
December 31, 1999, we were in compliance with the covenants under the Senior
Credit Facility and the indentures relating to our public debt. See further
discussion in "Recent Developments" below.
These debt instruments also restrict our ability to pay dividends to
stockholders, but do not otherwise restrict our ability to fund cash
obligations.
CREDIT RATINGS. In November 1999, in response to liquidity and operational
issues and the announcement by Western Resources that it is exploring strategic
alternatives for Protection One, Moody's, S & P and Fitch downgraded their
ratings on our credit facility and outstanding debt securities. S & P and Fitch
currently have our ratings on negative watch. On March 24, 2000, Moody's further
downgraded their ratings on our outstanding securities with outlook remaining
negative. As of March 24, 2000, these ratings were as follows:
<TABLE>
<CAPTION>
SENIOR SENIOR
UNSECURED SUBORDINATED
DEBT UNSECURED DEBT
--------- --------------
<S> <C> <C>
S & P............................... BB- B
Moody's............................. B2 Caa1
Fitch............................... BB B+
</TABLE>
CAPITAL EXPENDITURES. We anticipate making capital expenditures of
approximately $85 million in 2000. Of such amount, we believe we will invest
approximately $65 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 and 2002 are expected to be approximately $123 million
each year of which approximately $108 million would be to acquire accounts and
$15 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.
ITEM 7A. MARKET RISK DISCLOSURE
We are exposed to market risk, including changes in the market price,
foreign currency exchange rates, equity instrument investment prices, as well as
interest rates.
- FOREIGN CURRENCY EXCHANGE RATES. During 1998, we acquired overseas
operations which have functional currencies other than the US dollar. As
of December 31, 1999 the unrealized loss on currency translation,
presented as a separate component of stockholders' equity and reported
within other comprehensive income was approximately $1.3 million pretax. A
10% change in the currency exchange rates would have an immaterial effect
on other comprehensive loss.
- EQUITY INSTRUMENT INVESTMENTS. We have approximately $33.1 million of
marketable securities and other investments, as of December 31, 1999. We
do not hedge these investments and are exposed to the risk of changing
market prices. A 10% change in the market value of these instruments would
have approximately a $2.1 million impact on other comprehensive loss.
- INTEREST RATE EXPOSURE. We have approximately $225.0 million of long-term
variable rate debt as of December 31, 1999. A 100 basis point change in
the debt benchmark rate would impact net income by approximately
$1.5 million.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Our consolidated financial statements and supplementary data, together with
the reports of Arthur Andersen LLP, independent public accountants, are included
elsewhere herein. See "Index to Financial Statements" on page F-1.
41
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS
Information relating to our directors and nominees for directors is set
forth under the heading "Election of Directors" in the Proxy Statement relating
to the Annual Meeting of Stockholders to be held May 23, 2000, which will be
filed with the Securities and Exchange Commission prior to April 29, 2000, and
which is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information relating to our executive officers and executive compensation is
set forth under the heading "Executive Officers; Executive Compensation and
Related Information" in the Proxy Statement relating to the Annual Meeting of
Stockholders to be held May 23, 2000, which will be filed with the Securities
and Exchange Commission prior to April 29, 2000, and which is incorporated
herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information relating to the security ownership of certain beneficial owners
and management is set forth under the headings "Security Ownership of certain
Beneficial Owners" in the Proxy Statement relating to the Annual Meeting of
Stockholders to be held May 23, 2000 which will be filed with the Securities and
Exchange Commission prior to April 29, 2000, and which is incorporated herein by
reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information relating to certain relationships and related transactions
concerning directors and executive officers is set forth under the heading
"Certain Relationships and Related Transactions" in the Proxy Statement relating
to the Annual Meeting of Stockholders to be held May 23, 2000, which will be
filed with the Securities and Exchange Commission prior to April 29, 2000, and
which is incorporated herein by reference.
42
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this report:
1. The financial statements and financial statement schedules listed on
the accompanying Index to Financial Statements.
2. The following Exhibits:
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- ------------------------------------------------------------
<C> <S>
2.1 Contribution Agreement dated as of July 30, 1997 (the
"Contribution Agreement"), between Western Resources and
Protection One, Inc. ("POI") (incorporated by reference to
Exhibit 2.1 to the Current Report on Form 8-K filed by
POI(1) and Protection One Alarm Monitoring, Inc.
("Monitoring")(2) dated July 30, 1997 (the "July 1997 Form
8-K")).
2.2 Amendment No. 1 dated October 2, 1997, to the Contribution
Agreement (incorporated by reference to Exhibit 99.1 to the
Current Report of Form 8-K filed by POI and Monitoring dated
October 2, 1997).
2.3 Conditional Purchase Agreement, dated as of August 6, 1998,
between certain directors and/or officers of Compagnie
Europeenne de Telesecurite and Monitoring.
2.4 Amended and Restated Agreement and Plan of Contribution and
Merger dated as of October 21, 1998 by and among POI,
Protection Acquisition Holding Corporation, P-1 Merger Sub,
Inc. (Mass.), P-1 Merger Sub, Inc. (Del.) and Lifeline
Systems, Inc. (incorporated by reference to Exhibit 2.1 to
Registration Statement on Form S-4 of Petroleum One
Acquisition Holding Corporation filed on December 10, 1998).
2.5 Amendment No. 2 dated February 29, 2000 to the Contribution
Agreement (incorporated by reference to Exhibit 10.2 to the
Current Report on Form 8-K filed by POI and Monitoring dated
February 29, 2000).
3.1 Fifth Amended and Restated Certificate of Incorporation of
POI, as amended (incorporated by reference to Exhibit 3.1 to
the Annual Report on Form 10-K filed by POI and Monitoring
for the year ended September 30, 1997 (the "Fiscal 1997 Form
10-K")).
3.2 Amendment dated as of November 24, 1997 to Fifth Amended and
Restated Certificate of Incorporation of Protection One.
3.3 By-laws of POI (incorporated by reference to Exhibit 3.1 to
the Quarterly Report on Form 10-Q filed by POI and
Monitoring for the quarter ended March 31, 1996).
3.4 Certificate of Incorporation of Monitoring, as amended
(incorporated by reference to Exhibit 3.2 to the
Registration Statement on Form S-3 (Registration Number
333-09401) originally filed by Monitoring and, inter alia,
POI on August 1,1996 (the "August 1996 Form S-3")).
</TABLE>
43
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- ------------------------------------------------------------
<C> <S>
3.5 Bylaws of Monitoring (incorporated by reference to Exhibit
3.2 to the Annual Report on Form 10-K filed by POI and,
inter alia, Monitoring for the year ended September 30,
1994).
4.1 Indenture dated as of May 17, 1995, among Monitoring, as
Issuer, POI, inter alia, as Guarantor, and The First
National Bank of Boston ("FNBB"), as Trustee (incorporated
by reference to Exhibit 4.1 to the Registration Statement on
Form S-4 (Registration No. 33-94684) originally filed by POI
and, inter alia, Monitoring on July 18, 1995 (the "1995 Form
S-4")).
4.2 First Supplemental Indenture dated as of July 26, 1996,
among Monitoring, as Issuer, POI, inter alia, as Guarantor
and State Street Bank and Trust Company ("SSBTC") as
successor to FNBB as Trustee (incorporated by reference to
Exhibit 4.2 to the Annual Report on Form 10-K filed by POI
and Monitoring for the year ended September 30, 1996 (the
"Fiscal 1996 Form 10-K")).
4.3 Second Supplemental Indenture dated as of October 28, 1996,
among Monitoring as Issuer, POI inter alia, as Guarantor and
SSBTC as Trustee (incorporated by reference to Exhibit 4.3
to the Fiscal 1996 Form 10-K)).
4.4 Subordinated Debt Shelf Indenture dated as of August 29,
1996, among Monitoring as Issuer, POI as Guarantor and SSBTC
as Trustee (incorporated by reference to Exhibit 4.3 to the
August 1996 Form S-3).
4.5 Supplemental Indenture No. 1 dated as of September 20, 1996,
among Monitoring as Issuer, POI, inter alia, as Guarantor
and SSBTC as Trustee (incorporated by reference to Exhibit
4.1 to the Current Report on Form 8-K filed by POI and
Monitoring and dated September 20,1996 (the "September 1996
Form 8-K")).
4.6 Supplemental Indenture No. 2 dated as of October 28, 1996,
among Monitoring as Issuer, POI, inter alia, as Guarantor
and SSBTC as Trustee (incorporated by reference to Exhibit
4.6 to the Fiscal 1996 Form 10-K).
4.7 Indenture, dated as of August 17, 1998, among Monitoring, as
issuer, POI as guarantor, and The Bank of New York, as
trustee (incorporated by reference to Exhibit 4.1 to the
Registration Statement on Form 9-4 filed by POI and
Monitoring on September 22, 1998).
4.8 Indenture, dated as of December 21, 1998, among Monitoring,
as issuer, POI, as guarantor, and The Bank of New York, as
trustee (incorporated by reference to Exhibit 4.8 to the
Annual Report on Form 10-K filed by POI and Monitoring for
the year ended December 31, 1998 (the "Fiscal 1998 Form
10-K)).
10.1 Stock Purchase Warrant dated as of September 16, 1991,
issued by POI to Merita Bank, Ltd. (formerly
Kansallis-Osake-Pankki) (incorporated by reference to
Exhibit 10.25 to the Quarterly Report on Form 10-Q filed by
POI and, inter alia, Monitoring for the quarter ended March
31, 1994).
10.2 Warrant Agreement dated as of November 3, 1993, between
Monitoring and United States Trust Company of New York, as
Warrant Agent (incorporated by reference to Exhibit 4.3 to
the Registration Statement on Form S-4 (Registration
Statement 33-73002) originally filed by POI, Monitoring and
certain former subsidiaries of Monitoring on December 15,
1993 (the "1993 Form S-4")).
</TABLE>
44
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- ------------------------------------------------------------
<C> <S>
10.3 Registration Rights Agreement dated as of November 3, 1993,
among Monitoring, POI, certain former subsidiaries of
Monitoring and Bear, Stearns & Co., Inc. (incorporated by
reference to Exhibit 4.4 to the 1993 Form S-4).
10.4 Warrant Agreement dated as of May 17, 1995, between POI and
The First National Bank of Boston, as Warrant Agent
(incorporated by reference to Exhibit 10.40 to the 1995 Form
S-4).
10.5 Employment Agreement dated as of November 24, 1997, between
Protection One and John E. Mack, III (incorporated by
reference to Exhibit 10.6 to the November 1997 Form 8-K).*
10.6 Consulting Agreement dated as of February 19, 1996, between
POI and Dr. Ben Enis (incorporated by reference to Exhibit
10.7 to the Quarterly Report on Form 10-Q filed by POI and
Monitoring for the quarter ended June 30, 1996).*
10.7 1994 Stock Option Plan of POI, as amended (incorporated by
reference to Exhibit 10.23 to the Fiscal 1996 Form 10-K).*
10.8 1997 Long-Term Incentive Plan of POI (incorporated by
reference to Appendix F to POI's proxy statement dated
November 7, 1997).*
10.9 Notes Registration Rights Agreement dated as of May 17,
1995, among POI, Monitoring, Morgan Stanley & Co.,
Incorporated and Montgomery Securities (incorporated by
reference to Exhibit 4.2 to the 1995 Form S-4).
10.10 Credit Facility Agreement between Westar Capital, Inc., as
Lender, and Monitoring, as borrower, dated as of April 1,
1998 (incorporated by reference to Exhibit 99.1 to the
Current Report on Form 8-K filed by POI and Monitoring on
May 15, 1998).
10.11 Revolving Credit Agreement among Monitoring, borrower,
NationsBank, N.A., administrative agent, First Union
National Bank, syndication agent, Toronto Dominion (Texas),
Inc., documentation agent, and Lenders named therein, dated
December 21, 1998 (the "Revolving Credit Agreement")
(incorporated by reference to Exhibit 10.11 to the Fiscal
1998 Form 10-K).
10.12 First Amendment to the Revolving Credit Agreement, dated as
of February 26, 1999 (incorporated by reference to Exhibit
10.12 to the Fiscal 1998 Form 10-K).
10.13 Agreement, dated as of February 29, 2000, by and among POI,
Monitoring, and Westar Capital, Inc. (incorporated by
reference to Exhibit 10.1 to the Current Report on Form 8-K
filed by POI and Monitoring dated February 29, 2000).
10.14 Second Amendment of Credit Agreement, effective as of
February 29, 2000, between Monitoring and Westar Capital,
Inc., as Administrative Agent and a Lender (incorporated by
reference to Exhibit 10.3 to the Current Report on Form 8-K
filed by POI and Monitoring dated February 29, 2000).
10.15 Registration Rights Agreement, dated December 21, 1998,
among Monitoring, POI and various subsidiary guarantors and
Morgan Stanley & Co. Incorporated, Chase Securities Inc;
First Union Capital Markets, NationsBanc Montgomery
Securities LLC and TD Securities (USA), Inc. (the "Placement
Agents").
10.16 Form of Change of Control Agreements with Annette M. Beck
and Anthony Somma.+
</TABLE>
45
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. EXHIBIT DESCRIPTION
- ----------- ------------------------------------------------------------
<C> <S>
12.1 Statement regarding Computation of Earnings to Fixed
Charges.+
16.1 Letter from Coopers & Lybrand to the Securities and Exchange
Commission re: Change in Certifying Accountant (incorporated
by reference to Exhibit 16 to Amendment No. 1 to the Current
Report on Form 8-K filed by POI and Monitoring dated
February 5, 1998).
21.1 Subsidiaries of POI and Monitoring.+
23.1 Consent of Arthur Andersen LLP.+
27 Financial Data Schedule.+
</TABLE>
- ------------------------
* Each Exhibit marked with an asterisk constitutes a management contract or
compensatory plan or arrangement required to be filed or incorporated by
reference as an Exhibit to this report pursuant to Item 14(c) of Form 10-K.
+ Filed herewith.
(b) During the last quarter of the fiscal year covered by this Report, POI and
Monitoring filed six Reports on Form 8-K. A Current Report on Form 8-K dated
October 1, 1999 reported the receipt of a 30-day waiver on Monitoring's
Senior Credit Facility and a reduction in the amount of the facility to
$250 million. A Current Report on Form 8-K dated October 7, 1999 reported
Western Resources and POI were reviewing the capital structure and financial
alternatives for POI. A Current Report on Form 8-K dated November 1, 1999
reported the extension until December 3, 1999 of the Senior Credit Facility
bank waiver. A Current Report on Form 8-K dated November 16, 1999 reported
the change in accounting principle relating to amortization of customer
accounts and third quarter earnings. A Current Report on Form 8-K dated
December 3, 1999 reported the extension until December 17, 1999 of the
Senior Credit Facility bank waiver. A Current Report dated December 20, 1999
reported the assumption by Westar Capital of the lenders' obligations under
Monitoring's Senior Credit Facility and the extension until January 15, 2000
of the Senior Credit Facility bank waiver.
46
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
--------
<S> <C>
PROTECTION ONE, INC. AND SUBSIDIARIES
Report of Independent Public Accountants.................. F-2
Consolidated Balance Sheets as of December 31, 1999 and
1998.................................................... F-3
Consolidated Statements of Operations and Comprehensive
Loss for the Years Ended December 31, 1999, 1998 and
1997.................................................... F-4
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1999, 1998 and 1997........................ F-5
Consolidated Statements of Stockholders' Equity for the
Years Ended December 31, 1999, 1998, 1997 and 1996...... F-6
Notes to Consolidated Financial Statements................ F-7
FINANCIAL SCHEDULES
Protection One, Inc. and Subsidiaries--Schedule
II--Valuation and Qualifying Accounts................... S-1
</TABLE>
F-1
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Protection One, Inc.:
We have audited the accompanying consolidated balance sheets of Protection
One, Inc. and subsidiaries as of December 31, 1999 and 1998 and the related
consolidated statements of operations and comprehensive loss, stockholders'
equity, and cash flows for each of the three years in the period ended
December 31, 1999. These consolidated financial statements are the
responsibility of the Company's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the financial position of Protection One, Inc. and
subsidiaries as of December 31, 1999 and 1998, and the consolidated results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1999 in conformity with accounting principles generally
accepted in the United States.
As explained in Note 2(f) to the financial statements, effective
September 1, 1999, the Company changed its method of amortization for customer
accounts for its North America and Europe segments from the straight-line method
to a declining balance (accelerated) method.
Our audits were made for the purpose of forming an opinion on the basic
financial statements taken as a whole. Schedule II--Valuation and Qualifying
Accounts is presented for purposes of complying with the Securities and Exchange
Commission's rules and is not part of the basic financial statements. This
schedule has been subjected to the auditing procedures applied in the audits of
the basic financial statements and, in our opinion, fairly states in all
material respects the financial data required to be set forth therein in
relation to the basic financial statements taken as a whole.
Arthur Andersen LLP
Kansas City, Missouri
March 10, 2000
F-2
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
1999 1998
---------- ----------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents................................. $ 7,658 $ 10,025
Restricted cash........................................... 11,175 11,987
Marketable securities..................................... 6,664 17,770
Receivables, net.......................................... 71,716 61,262
Inventories............................................... 12,908 7,895
Prepaid expenses.......................................... 3,471 3,867
Related party tax receivable.............................. 31,056 5,886
Deferred tax assets, current.............................. 28,400 49,543
Other..................................................... 13,332 19,605
---------- ----------
Total current assets...................................... 186,380 187,840
Property and equipment, net................................. 60,912 46,959
Customer accounts, net...................................... 1,139,066 1,031,956
Goodwill, net............................................... 1,101,788 1,175,153
Deferred tax assets......................................... 30,771 38,326
Other....................................................... 39,318 30,202
---------- ----------
Total Assets................................................ $2,558,235 $2,510,436
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt......................... $ 35,498 $ 84,616
Accounts payable.......................................... 23,205 16,374
Accrued liabilities....................................... 74,248 77,412
Purchase holdbacks........................................ 20,213 42,303
Deferred revenue.......................................... 61,149 57,703
---------- ----------
Total current liabilities................................. 214,313 278,408
Long-term debt, net of current portion...................... 1,077,152 884,554
Other liabilities........................................... 4,173 3,238
---------- ----------
Total Liabilities........................................... 1,295,638 1,166,200
Commitments and contingencies (see Note 16)
Stockholders' equity:
Preferred stock, $.10 par value, 5,000,000 shares
authorized................................................ -- --
Common Stock, $.01 par value, 150,000,000 shares authorized,
126,945,337 shares and 126,838,741 shares issued and
outstanding at December 31, 1999 and 1998, respectively... 1,269 1,268
Additional paid-in capital.................................. 1,392,750 1,392,256
Unrealized loss on marketable securities, net of tax........ (995) (1,848)
Unrealized loss on currency translation, net of tax......... (810) (728)
Retained losses............................................. (129,617) (46,712)
---------- ----------
Total stockholders' equity................................ 1,262,597 1,344,236
---------- ----------
Total Liabilities and Stockholders' Equity.................. $2,558,235 $2,510,436
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------
1999 1998 1997
-------- -------- --------
<S> <C> <C> <C>
Revenues:
Monitoring and related services........................... $515,065 $375,840 $126,630
Installation and rental................................... 90,111 45,255 18,143
-------- -------- --------
Total revenues............................................ 605,176 421,095 144,773
Cost of revenues:
Monitoring and related services........................... 137,551 103,521 32,656
Installation and rental................................... 46,455 25,562 3,013
-------- -------- --------
Total cost of revenues.................................... 184,006 129,083 35,669
-------- -------- --------
Gross profit.............................................. 421,170 292,012 109,104
-------- -------- --------
Operating Expenses:
Selling, general and administrative expenses.............. 185,989 114,506 80,755
Acquisition expense....................................... 27,451 20,298 2,108
Amortization of intangibles and depreciation expense...... 237,243 119,211 39,822
Other charges:
Impairment of customer accounts........................... -- -- 12,750
Merger related costs...................................... -- -- 11,542
Severance and relocation costs............................ 5,809 3,400 --
-------- -------- --------
Total operating expenses.................................... 456,492 257,415 146,977
-------- -------- --------
Operating income (loss)................................... (35,322) 34,597 (37,873)
Interest expense:
Interest expense, net..................................... 87,037 33,869 33,483
Related party interest expense, net....................... -- 22,121 --
Other (income) expense:
Non-recurring gain on contract repurchase................. -- (16,348) --
Gain on sale of Mobile Services Group..................... (17,249) -- --
Other..................................................... 4,380 (4,222) --
-------- -------- --------
Loss before income taxes and extraordinary gain............. (109,490) (823) (71,356)
Income tax (expense) benefit................................ 28,276 (4,114) 28,628
-------- -------- --------
Loss before extraordinary gain.............................. (81,214) (4,937) (42,728)
Extraordinary gain (loss), net of tax effect of $911 and
$2,730.................................................... (1,691) 1,591 --
-------- -------- --------
Net loss.................................................. $(82,905) $ (3,346) $(42,728)
======== ======== ========
Other comprehensive loss:
Unrealized loss on marketable securities, net of tax
effect of $664 and $1,107............................... $ (995) $ (1,848) $ --
Unrealized loss on currency translation, net of tax effect
of $540 and $485........................................ (810) (728) --
-------- -------- --------
Comprehensive loss.......................................... $(84,710) $ (5,922) $(42,728)
======== ======== ========
Net loss per common share (basic and diluted):
Loss before extraordinary gain per common share........... $ (.64) $ (.05) $ (.60)
Extraordinary gain (loss) per common share................ (.01) .02 --
-------- -------- --------
Net loss per common share................................. $ (.65) $ (.03) $ (.60)
======== ======== ========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------
1999 1998 1997
--------- --------- ---------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................................... $ (82,905) $ (3,346) $ (42,728)
Adjustments to reconcile net loss to net cash provided by
(used in) operating activities:
Extraordinary loss (gain)................................. 1,691 (1,591) --
Gain on sale of Mobile Services Group..................... (17,249) -- --
Gain on exchange transaction.............................. -- (3,000) --
Gain on contract repurchase............................... -- (16,348) --
Amortization of intangibles and depreciation.............. 237,243 119,211 39,822
Accretion of debt premium................................. (6,799) 3,034 1,026
Net deferred taxes........................................ (31,072) 12,531 (3,888)
Provision for doubtful accounts........................... 25,534 10,567 3,657
Loss (gain) on sale of marketable securities.............. 7,666 (185) --
Other..................................................... (26,383) (3,561) 36,592
Changes in assets and liabilities, net of effects of
acquisitions:
Receivables............................................... (28,473) (19,040) (2,467)
Inventories............................................... (3,246) (3,810) 940
Prepaid expenses.......................................... 586 (3,821) 294
Other current assets...................................... (604) (13,615) (28,988)
Accounts payable.......................................... 6,877 (2,710) 492
Accrued liabilities....................................... 4,923 13,071 (10,350)
Deferred revenue.......................................... 3,479 (2,237) 670
--------- --------- ---------
Net cash provided by (used in) operating activities....... 91,268 85,150 (4,928)
Cash flows from investing activities:
Purchase of property and equipment, net................... (32,644) (32,711) (3,826)
Purchase of installed security systems.................... (241,000) (277,667) (29,043)
Sale (purchase) of equity securities...................... 9,739 (20,149) --
Distribution to equityholders in acquisition
transaction............................................. -- -- (106,321)
Proceeds from sale of Mobile Services Group, net of cash
paid.................................................... 19,087 -- --
Acquisition of alarm companies, net of cash received...... (27,407) (549,196) (17,494)
Other investments......................................... -- (14,224) --
--------- --------- ---------
Net cash used in investing activities..................... (272,225) (893,947) (156,684)
Cash flows from financing activities:
Proceeds from equity offering............................. -- 406,264 --
Payments on long-term debt................................ (39,008) (512,190) (63,749)
Proceeds from long-term debt issuances.................... 213,310 642,417 --
Issuance costs and other.................................. 3,372 (5,922) --
Proceeds from related party debt.......................... -- 213,910 300,749
--------- --------- ---------
Net cash provided by financing activities................. 177,674 744,479 237,000
--------- --------- ---------
Effect of exchange rate changes on cash and cash
equivalents................................................. 916 (1,213) --
--------- --------- ---------
Net (decrease) increase in cash and cash equivalents...... (2,367) (65,531) 75,388
Cash and cash equivalents:
Beginning of period....................................... 10,025 75,556 168
--------- --------- ---------
End of period............................................. $ 7,658 $ 10,025 $ 75,556
========= ========= =========
Cash paid for interest...................................... $ 68,420 $ 18,422 $ 10,202
========= ========= =========
Cash paid for taxes......................................... $ 783 $ 311 $ --
========= ========= =========
Non-cash financing:
Contribution of net assets from Parent...................... $ -- $ -- $ 109,219
========= ========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
ACCUMULATED
COMMON STOCK ADDITIONAL OTHER TOTAL
----------------------- CONTRIBUTED PAID-IN RETAINED COMPREHENSIVE STOCKHOLDERS'
SHARES AMOUNT CAPITAL CAPITAL LOSSES LOSS EQUITY
------------ -------- ----------- ----------- --------- ------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
COMMON STOCK
DECEMBER 31, 1996............... $ -- $ -- $ 411,068 $ -- $ (638) $ -- $ 410,430
Net investment and advances from
Western Resources............. -- -- 43,827 -- -- -- 43,827
Recapitalization................ 68,673,402 687 (454,895) 454,208 -- -- --
Shares issuedYreverse purchase
acquisition................... 14,689,230 147 -- 528,874 -- -- 529,021
Exercise of options............. 306 -- -- -- -- -- --
Net loss........................ -- -- -- -- (42,728) -- (42,728)
------------ ------- --------- ----------- --------- ------- ----------
DECEMBER 31, 1997............... 83,362,938 834 -- 983,082 (43,366) -- 940,550
Equity offerings, net of cost... 42,764,644 427 -- 401,397 -- -- 401,824
Shares issued--acquisitions..... 539,584 5 -- 6,716 -- -- 6,721
Shares issuedYESPP.............. 61,980 1 -- 532 -- -- 533
Exercise of options and
warrants...................... 109,595 1 -- 529 -- -- 530
Unrealized loss--marketable
securities.................... -- -- -- -- -- (1,848) (1,848)
Unrealized loss--currency
translation................... -- -- -- -- -- (728) (728)
Net loss........................ -- -- -- -- (3,346) -- (3,346)
------------ ------- --------- ----------- --------- ------- ----------
DECEMBER 31, 1998............... 126,838,741 $ 1,268 -- $ 1,392,256 $ (46,712) $(2,576) $1,344,236
Shares issued--acquisitions..... 3,613 -- -- 39 -- -- 39
Shares issued--ESPP............. 102,983 1 -- 455 -- -- 456
Unrealized loss--marketable
securities.................... -- -- -- -- -- 853 853
Unrealized loss--currency
translation................... -- -- -- -- -- (82) (82)
Net loss........................ -- -- -- -- (82,905) -- (82,905)
------------ ------- --------- ----------- --------- ------- ----------
DECEMBER 31, 1999............... 126,945,337 $ 1,269 $ -- $ 1,392,750 $(129,617) $(1,805) $1,262,597
============ ======= ========= =========== ========= ======= ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
1. THE COMPANY:
Protection One, Inc. ("Protection One", a Delaware corporation; the
"Company") is a publicly traded security alarm monitoring company. Protection
One is principally engaged in the business of providing security alarm
monitoring services, which include sales, installation and related servicing of
security alarm systems for residential and small business customers in North
America, and until February 29, 2000, the United Kingdom and Continental Europe.
Westar Capital, Inc. ("Westar Capital"), a wholly-owned subsidiary of Western
Resources, Inc. ("Western Resources"), owns approximately 85% of the Company's
common stock.
Prior to November 24, 1997, Protection One was a stand-alone security
business. On November 24, 1997, Protection One acquired Western Resources
security business ("WRSB") and Centennial Security Holdings, Inc.
("Centennial"), which was accounted for as a reverse purchase acquisition.
Accordingly, the results of operations of Protection One and Centennial are not
included in the consolidated financial statements prior to November 24, 1997.
The Company prepares its financial statements in conformity with generally
accepted accounting principles. The preparation of financial statements in
conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosures of contingent assets and
liabilities at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ
from those estimates. The accompanying consolidated financial statements include
the accounts of Protection One's wholly owned subsidiaries. The Company's
principal subsidiaries include Protection One Alarm Monitoring, Inc.
("Monitoring"), Network Multifamily Security Corporation ("Multifamily"), and
Compagnie Europeenne de Telesecurite ("CET"). All significant intercompany
balances have been eliminated in consolidation.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
(A) REVENUE RECOGNITION
Revenues are recognized when monitoring, extended service protection,
patrol, repair and other services are provided. Deferred revenues result from
customers who are billed for monitoring, extended service protection and patrol
and alarm response services in advance of the period in which such services are
provided, on a monthly, quarterly or annual basis.
(B) INVENTORIES
Inventories, comprised of alarm systems and parts, are stated at the lower
of average cost or market.
(C) PROPERTY AND EQUIPMENT
Property and equipment are stated at cost and depreciated using the
straight-line method over estimated useful lives. Gains or losses from
retirements and dispositions of property and equipment are recognized in income
in the period realized. Repair and maintenance costs are expensed as incurred.
F-7
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
Estimated useful lives of property and equipment are as follows:
<TABLE>
<S> <C>
Furniture, fixtures and equipment........................... 5--10 years
Data processing and telecommunication....................... 8 mos--5 years
Leasehold improvements...................................... 5--10 years
Vehicles.................................................... 5 years
Buildings................................................... 40 years
</TABLE>
(D) INCOME TAXES
The Company recognizes a liability or asset for the deferred tax
consequences of temporary differences between the tax basis of assets and
liabilities and their reported amounts in the financial statements. These
temporary differences will result in taxable or deductible amounts in future
years when reported amounts of the assets or liabilities are recovered or
settled. The deferred tax assets are periodically reviewed for recoverability.
The Company has a tax sharing agreement with Western Resources. This pro
rata tax sharing agreement enables the Company to be reimbursed for tax benefits
utilized by Western Resources. The Company has recorded an income tax receivable
for amounts due from Western Resources pursuant to this agreement. If the
Company did not file its taxes on a consolidated basis with Western Resources,
the Company's deferred tax assets may not be realizable and the Company may not
be in a position to record a tax benefit for losses incurred.
(E) COMPREHENSIVE LOSS
During 1998, the Company adopted the provisions of Statement of Financial
Accounting Standards ("SFAS") No. 130 "Reporting Comprehensive Income".
Comprehensive loss comprises net loss plus the unrealized gains and losses
associated with foreign currency translations and available-for-sale investment
securities.
(F) CUSTOMER ACCOUNTS
Customer accounts are stated at cost. The cost includes amounts paid to
dealers and the estimated fair value of accounts acquired in business
acquisitions. Internal costs incurred in support of acquiring customer accounts
are expensed as incurred.
The Company historically amortized the costs it allocated to its customer
accounts by using the straight-line method over a ten-year life. The
straight-line method, indicated in Accounting Principles Board Opinion No. 17 as
the appropriate method for such assets, has been the predominant method used to
amortize customer accounts in the monitored services industry. Management is not
aware of whether the economic life or the rate of realization for the Company's
customer accounts differs materially from other monitored services companies.
The choice of a ten-year life was based on management's estimates and
judgments about the amounts and timing of expected future revenues from these
assets, the rate of attrition of such revenue over customer life, and average
customer account life. Ten years was used because, in management's opinion, it
F-8
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
would adequately match amortization cost with anticipated revenue from those
assets even though many accounts were expected to produce revenue over periods
substantially longer than ten years. Effectively, it expensed the asset ratably
over an "expected average customer life" that was shorter than the expected life
of the revenue stream, thus implicitly giving recognition to projected revenues
for a period beyond ten years.
The Company conducted a comprehensive review of its amortization policy
during the third quarter of 1999. This review was performed specifically to
evaluate the historic amortization policy in light of the inherent declining
revenue curve over the life of a pool of customer accounts, and the Company's
historical attrition experience. After completing the review, management
identified three distinct pools, each of which has distinct attributes that
effect differing attrition characteristics. The pools correspond to the
Company's North America, Multifamily and Europe business segments. For the North
America and Europe pools, the analyzed data indicated to management that the
Company can expect attrition to be greatest in years one through five of asset
life and that a change from a straight-line to a declining balance (accelerated)
method would more closely match future amortization cost with the estimated
revenue stream from these assets. Management has elected to change to that
method. No change was made in the method used for the Multifamily pool.
The Company's amortization rates for the North America and Europe customer
pools consider the average estimated remaining life and historical and projected
attrition rates. The average estimated remaining life for each customer pool is
as follows:
<TABLE>
<CAPTION>
AVERAGE ESTIMATED
POOL REMAINING LIFE (YEARS) METHOD
- ---- ---------------------- ----------------------------
<S> <C> <C>
North America............... 8-10 Ten-year 130% declining
balance
Europe...................... 10 Ten-year 125% declining
balance
Multifamily................. 12 Ten-year straight-line
</TABLE>
Adoption of the declining balance method effectively shortens the estimated
expected average customer life for these two customer pools, and does so in a
way that does not make it possible to distinguish the effect of a change in
method (straight-line to declining balance) from the change in estimated lives.
In such cases, generally accepted accounting principles require that the effect
of such a change be recognized in operations in the period of the change, rather
than as a cumulative effect of a change in accounting principle. We changed to
the declining balance method in the third quarter of 1999. Accordingly, the
effect of the change in accounting principle increased amortization expense
reported in the third quarter of 1999 by $47,000. Accumulated amortization
recorded on the balance sheet would have been approximately $41,000 higher
through the end of the second quarter of 1999 if the Company had historically
used the declining balance method.
In accordance with SFAS No. 121, "Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to be Disposed Of", long-lived
assets held and used by Protection One are evaluated for recoverability on a
periodic basis or as circumstances warrant. An impairment would be recognized
when the undiscounted expected future operating cash flows derived from customer
accounts is less than the carrying value of capitalized customer accounts and
goodwill.
F-9
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
Due to the high level of customer attrition experienced in 1999 and the
decline in market value of the Company's publicly traded equity and debt
securities, management performed an impairment test on its customer account
asset in the fourth quarter and concluded that no impairment has occurred. The
Company also reevaluated its amortization estimates and concluded no change was
needed.
(G) GOODWILL
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. The carrying value of goodwill
was included in the Company's evaluation of recoverability of customer accounts.
No reduction in the carrying value was necessary at December 31, 1999.
In conjunction with the impairment test for customer accounts, 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 and increased levels of attrition
experienced in 1999, 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. 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.
Amortization expense was $29,960, $24,032 and $6,543 for the years ended
December 31, 1999, 1998, 1997 respectively. Accumulated amortization was $62,687
and $31,095 at December 31, 1999 and 1998 respectively.
(H) CASH AND CASH EQUIVALENTS
All highly liquid investments purchased with a remaining maturity of three
months or less at the date acquired are cash equivalents. These investments,
consisting of money market funds, are stated at cost, which approximates market.
(I) RESTRICTED CASH
Restricted cash primarily consists of cash held in escrow pursuant to one of
the Company's 1998 acquisitions.
(J) RECEIVABLES
Gross receivables, which consist primarily of trade accounts receivable, of
$102,405 at December 31, 1999 and $78,255 at December 31, 1998, have been
reduced by allowances for doubtful accounts of $30,689 and $16,993,
respectively.
(K) MARKETABLE SECURITIES
Management classifies its marketable securities as "Available-for-Sale" in
accordance with SFAS No. 115 "Accounting for Certain Investments in Debt and
Equity Securities". Accordingly, any unrealized
F-10
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
gains and losses are reported as a component of Other Comprehensive Income
(Loss) in accordance with SFAS No. 130 "Reporting Comprehensive Income". Gains
or losses on securities sold are calculated based on the specific identification
method.
(L) ADVERTISING COSTS
Printed materials are generally expensed as incurred. Broadcast advertising
costs are generally expensed upon the first broadcast of the respective
advertisement. Total advertising expense was $3,005, $3,659, and $9,906 during
the years ended December 31, 1999, 1998, and 1997, respectively.
(M) CONCENTRATIONS OF CREDIT RISK
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of trade receivables from a
large number of customers, including both residential and commercial, dispersed
across a wide geographic base. The Company extends credit to its customers in
the normal course of business, performs periodic credit evaluations and
maintains allowances for potential credit losses. The Company has customers
located throughout the United States and Canada. The Company does not believe a
significant risk of loss from a concentration of credit risk exists.
(N) ACCOUNTING PRONOUNCEMENTS
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 measures 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, the impact these pronouncements will have
upon adoption. These Statements are effective for all fiscal years, beginning
after June 15, 2000. The Company expects to adopt these statements on
January 1, 2001.
(O) LOSS PER SHARE
Loss per share is presented in accordance with SFAS No. 128 "Earnings Per
Share". Weighted average shares outstanding were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------------------
1999 1998 1997
----------- ----------- ----------
<S> <C> <C> <C>
Weighted average shares outstanding.................... 126,889,802 107,998,917 70,202,716
</TABLE>
F-11
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: (CONTINUED)
(P) PRIOR YEAR RECLASSIFICATIONS
Certain reclassifications have been made to prior year information to
conform with current year presentation.
3. ACQUISITION TRANSACTIONS:
The Company acquired a significant number of security companies in 1998 and
1997. The largest acquisitions included Protection One in November 1997,
Multifamily in January 1998, Multimedia Security Services, Inc. in March 1998,
and CET in September 1998. All companies acquired have been accounted for using
the purchase method. The principal assets acquired in the acquisitions are
customer accounts. The excess of the purchase price over the estimated fair
value of the net assets acquired is recorded as goodwill. The resulted
operations have been included in the consolidated results of operations of the
Company from the date of the acquisition.
The following unaudited pro forma consolidated results of operations for the
years ended December 31, 1998 and 1997, assume all material business
combinations occurred at January 1, 1997.
<TABLE>
<CAPTION>
YEARS ENDED
DECEMBER 31
-------------------
1998(A) 1997(A)
-------- --------
<S> <C> <C>
Revenues................................................ $562,130 $449,957
Loss before extraordinary items......................... (23,243) (20,420)
Net loss................................................ (23,139) (20,420)
Per common share, basic and diluted
Loss before extraordinary items....................... (.22) (.29)
Net loss.............................................. (.21) (.29)
</TABLE>
- ------------------------
(A) Excludes other charges of $3,400 in 1998 and $24,292 in 1997 and
nonrecurring gains of $20,570 in 1998.
The pro forma financial information is not necessarily indicative of the
results of operations had the entities been combined for the entire period nor
do they purport to be indicative of results which will be obtained in the
future.
During 1999, the Company completed four acquisitions, all in the United
Kingdom, for a combined purchase price of approximately $32,000. The Company's
purchase price allocations for the 1999 acquisitions are preliminary and may be
adjusted as additional information is obtained.
F-12
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
4. EQUITY SECURITIES:
MARKETABLE SECURITIES
At December 31, 1999 and 1998, respectively, the Company has equity security
investments classified as available-for-sale. The cost, unrealized holding gains
and losses, and fair value of the available-for-sale securities were as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1999 1998
-------- --------
<S> <C> <C>
Cost...................................................... $ 8,292 $20,725
Unrealized loss........................................... (1,628) (2,955)
------- -------
Aggregate fair value...................................... $ 6,664 $17,770
------- -------
Proceeds.................................................. $ 4,737 $ 2,584
------- -------
Realized gain (loss)...................................... $(7,666) $ 185
======= =======
</TABLE>
OTHER INVESTMENTS
The Company owns preferred stock in a security monitoring company. The total
amount invested approximates $26,517 and $26,397 at December 31, 1999 and 1998,
respectively. The Company accounts for this investment using the cost method.
5. PROPERTY AND EQUIPMENT:
Property and equipment are summarized as follows:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1999 1998
-------- --------
<S> <C> <C>
Furniture, fixtures and equipment......................... $16,401 $18,679
Data processing and telecommunication..................... 60,548 36,057
Leasehold improvements.................................... 2,219 1,826
Vehicles.................................................. 7,019 3,720
Buildings and other....................................... 3,732 777
------- -------
89,919 61,059
Less accumulated depreciation............................. (29,007) (14,100)
------- -------
Property and equipment, net............................... $60,912 $46,959
======= =======
</TABLE>
Depreciation expense was $19,187, $7,221, and $1,938 for the years ended
December 31, 1999, December 31, 1998 and December 31, 1997 respectively.
F-13
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
6. CUSTOMER ACCOUNTS:
The following is a rollforward of the investment in customer accounts (at
cost) for the following years:
<TABLE>
<CAPTION>
DECEMBER 31,
-----------------------
1999 1998
---------- ----------
<S> <C> <C>
Beginning customer accounts, net..................... $1,031,956 $ 530,312
Acquisition of customer accounts..................... 333,195 601,063
Amortization of customer accounts.................... (189,214) (89,893)
Non-cash charges against purchase holdbacks.......... (36,871) (9,526)
---------- ----------
Ending customer accounts, net........................ $1,139,066 $1,031,956
========== ==========
</TABLE>
Accumulated amortization of the investment in customer accounts at
December 31, 1999 and 1998 was $307,600 and $118,400, respectively.
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 expected amount to be
paid at the end of the holdback period is capitalized and an equivalent current
liability established at the time of purchase.
The following is a rollforward of purchase holdbacks for the following
years:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1999 1998
-------- --------
<S> <C> <C>
PURCHASE HOLDBACKS:
Balance, beginning of year................................ $42,303 $11,444
Additions................................................. 26,499 72,673
Non-cash charges against customer accounts................ (36,871) (9,526)
Cash payments to sellers.................................. (11,718) (32,288)
------- -------
Balance, end of year...................................... $20,213 $42,303
======= =======
</TABLE>
Purchase holdback periods are negotiated between Protection One and sellers
or dealers, but typically range from zero to 12 months. At the end of the period
prescribed by the purchase holdback, Protection One verifies customer losses
experienced during the period and calculates a final payment to the seller or
dealer. The purchase holdback is extinguished at the time of final payment and a
corresponding adjustment is made in the customer intangible to the extent the
final payment varies from the estimated liability established at the time of
purchase.
F-14
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
7. LONG-TERM DEBT:
Long-term debt and the fixed or weighted average interest rates are as
follows:
<TABLE>
<CAPTION>
DECEMBER 31
---------------------
1999 1998
---------- --------
<S> <C> <C>
Senior Credit Facility with Westar Capital, maturing January
2001, variable rate 7.9% (a).............................. $ 225,000 $ --
Senior Credit Facility, maturing December 2001, variable
rate 6.8% (a)............................................. -- 42,417
Senior Subordinated Notes, maturing January 2009, fixed rate
8.125%.................................................... 350,000 350,000
Senior Unsecured Notes, maturing August 2005, fixed
7.375%.................................................... 250,000 250,000
Senior Subordinated Discount Notes, maturing June 2005,
effective rate of 6.4%.................................... 118,791 125,590
Convertible Senior Subordinated Notes, maturing September
2003, fixed 6.75%......................................... 103,500 103,500
CET Recourse Financing Agreements, average effective rate
18% and 15%, in 1999 and 1998, respectively............... 60,838 93,541
Other, including capital leases............................. 4,521 4,122
---------- --------
1,112,650 969,170
Less current portion........................................ (35,498) (84,616)
---------- --------
Total long-term debt........................................ $1,077,152 $884,554
========== ========
</TABLE>
- ------------------------
(a) Represents weighted average of borrowings under facility at year end.
SENIOR CREDIT FACILITY WITH WESTAR CAPITAL
In December 1999, the Company obtained a Senior Credit Facility with Westar
Capital. The facility originally provided for revolving borrowings of up to
$250,000 and was to expire in December 2001. This facility has been subsequently
amended to (1) reduce the facility to $115,000, (2) revise certain financial
covenants, and (3) change the maturity date to January 2, 2001. The interest
rate on this facility will be variable. At February 29, 2000, the average rate
on borrowings from this facility was 8.2%.
SENIOR CREDIT FACILITY
During 1999, Westar Capital acquired the Senior Credit Facility from
Protection One's lenders. Accordingly, the Company recognized an extraordinary
loss of $1,691, net of tax on this transaction.
SENIOR SUBORDINATED NOTES
In 1998, the Company issued $350,000 of unsecured Senior Subordinated Notes.
The notes are redeemable at the Company's option, in whole or in part, at a
predefined price.
The Company did not complete a required exchange offer during 1999. As a
result, the interest rate on this facility increased to 8 5/8% in June, 1999. If
the exchange offer is completed, the interest rate will revert back to 8 1/8%.
Interest on this facility is payable semi-annually on January 15 and July 15.
F-15
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
7. LONG-TERM DEBT: (CONTINUED)
SENIOR UNSECURED NOTES
In 1998, the Company issued $250,000 of Senior Unsecured Notes. Interest is
payable semi-annually on February 15 and August 15. The notes are redeemable at
the Company's option, in whole or in part, at a predefined price.
SENIOR SUBORDINATED DISCOUNT NOTES
In 1995, the Company issued $166,000 of unsecured Senior Subordinated
Discount Notes with a fixed interest rate of 13 5/8%. Interest payments began in
1999 and are payable semi-annually on June 30 and December 31. In connection
with the acquisition of Protection One in 1997, these notes were restated to
fair value reflecting a current market yield of approximately 6.4%. This
resulted in bond premium being recorded to reflect the increase in value of the
notes as a result of the decline in interest rates since the note issuance. The
revaluation had no impact on the expected cash flow to existing noteholders.
In 1998, the Company redeemed notes with a book value of $69,370 and
recorded an extraordinary gain on the extinguishment of $1,591, net of tax. The
remaining notes are redeemable at the Company's option, in whole or in part, at
anytime on or after June 30, 2000, at a predefined price.
CONVERTIBLE SENIOR SUBORDINATED NOTES
In 1996, the Company issued $103,500 of Convertible Senior Subordinated
Notes. Interest is payable semi-annually on March 15 and September 15. The notes
are convertible at any time at a conversion price of $11.19 per share. The notes
are redeemable, at the Company's option, at a specified redemption price,
beginning September 19, 1999.
CET RECOURSE FINANCING AGREEMENTS
The Company's subsidiary CET has recognized as a financing transaction cash
received through the sale of security equipment and future cash flows to be
received under security equipment operating lease agreements with customers to a
third-party financing company. A liability has been recorded for the proceeds of
these sales as the finance company has recourse to CET in the event of
nonpayment by customers of their equipment rental obligations. The average
implicit interest rate in the financing is 18% at December 31, 1999.
Accordingly, the liability is reduced, rental revenue is recognized, and
interest expense is being recorded as these recourse obligations are reduced
through the cash receipts paid to the financing company over the term of the
related equipment rental agreements which average four years. The liability is
increased as new security monitoring equipment and equipment rental agreements
are sold to the finance company that have recourse provisions.
F-16
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
7. LONG-TERM DEBT: (CONTINUED)
DEBT MATURITIES
Debt maturities over the next five years are as follows:
<TABLE>
<S> <C>
2000........................................................ $ 35,498
2001........................................................ 247,676
2002........................................................ 5,574
2003........................................................ 105,111
2004........................................................ --
2005 and thereafter......................................... 718,791
----------
Total....................................................... $1,112,650
==========
</TABLE>
EXTINGUISHMENT OF DEBT IN 2000
Subsequent to year end and in connection with the sale of its European
operations and certain other assets, the Company acquired its bonds held by
Westar Capital with a book value of $134,552. The acquisition of these bonds
will be accounted for as an extinguishment of debt in the first quarter of 2000.
See Note 19 for additional information.
FINANCIAL AND OPERATING COVENANTS
All of these debt instruments contain restrictions based on "EBITDA". The
definition of EBITDA varies among the various indentures and the Senior Credit
Facility. EBITDA is generally derived by adding to income (loss) before income
taxes, the sum of interest expense and depreciation and amortization expense.
However, under the varying definitions of the indentures, various and numerous
additional adjustments are sometimes required.
The Company's credit facilities contain financial and operating covenants
which may restrict the Company's ability to incur additional debt, pay
dividends, make loans or advances and sell assets. The financial covenants as of
December 31, 1999 unless noted otherwise, are summarized as follows:
<TABLE>
<CAPTION>
DEBT INSTRUMENT FINANCIAL COVENANT
- --------------- ---------------------------------------------
<S> <C>
Senior Credit Facility (as amended on Total consolidated debt/annualized most
February 29, 2000)......................... recent quarter EBITDA-less than 5.75 to 1.0
Consolidated annualized most recent quarter
EBITDA/latest four fiscal quarters interest
expense-greater than 2.10 to 1.0
Senior Subordinated Notes.................... Current fiscal quarter EBITDA/current fiscal
quarter interest expense-greater than 2.25 to
1.0
Senior Subordinated Discount Notes........... Total debt/annualized fourth quarter EBITDA
less than 6.0 to 1.0 Senior debt/annualized
fourth quarter EBITDA-less than 4.0 to 1.0
</TABLE>
From September 30, 1999 through February 29, 2000, we received waivers from
compliance with the then-applicable leverage and interest coverage ratio
covenants under the Senior Credit Facility. We are
F-17
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
7. LONG-TERM DEBT: (CONTINUED)
currently in compliance with the financial covenants under the Senior Credit
Facility and the indentures relating to our public debt. See Note 19 for
additional information.
The indentures governing the Company's debt securities require that the
Company offer to repurchase the securities in certain circumstances following a
change of control.
8. RELATED PARTY TRANSACTIONS
The Company entered into a three year marketing agreement with Paradigm
Direct LLC ("Paradigm") during 1999. Westar Capital has a 40% ownership interest
in Paradigm. Under the arrangement, the Company will purchase a targeted number
of accounts from Paradigm during each year of the agreement following an initial
pilot program. During 1999, the Company expensed $1,000 paid to Paradigm in the
third quarter in connection with start up costs relative to this program and has
prepaid approximately $1,000 for anticipated account purchases.
The Company also entered into a service agreement with Western Resources
during the third quarter of 1999. Pursuant to this agreement, Western Resources
provides administrative services including accounting, human resources, legal,
facilities and technology. Since entering into the agreement, the Company
incurred charges of approximately $2,000, which were based upon various hourly
charges, negotiated fees and out of pocket expenses.
Debt repayments of $512,190 in 1998 were primarily paid to Westar Capital
after obtaining proceeds from the issuance of the Senior Subordinated Notes.
See Note 12 Income Taxes for information with respect to the tax sharing
agreement with Western Resources and Note 19 Subsequent Events for information
with respect to the sale to Westar Capital of our European operations.
9. SALE OF MOBILE SERVICES GROUP
During the third quarter of 1999, the Company sold the assets which
comprised its Mobile Services Group. Cash proceeds of this sale approximated
$20,000 and the Company recorded a pre-tax gain of approximately $17,000.
10. OTHER CHARGES:
In December 1997, Protection One incurred charges of $12,750 to write down
the value of the customer account base due to excessive losses associated with a
specific acquisition and $11,542 to reflect the closing of business activities
of WRSB that were no longer of continuing value to the combined operations.
F-18
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
11. STOCK WARRANTS AND OPTIONS:
The Company accounts for employee stock options in accordance with
Accounting Principles Board Opinion No. 25 (APB No. 25), "Accounting for stock
issued to Employees." Under ABP No. 25, the Company recognizes no compensation
expense related to employee stock options, as no options are granted at a price
below the market price on the day of grant.
A summary of warrant and option activity for Protection One from
November 1997 through December 31, 1999 is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE
WARRANTS EXERCISE
AND OPTIONS PRICE
----------- --------
<S> <C> <C>
Outstanding and exercisable at November 24, 1997 (1)........ 2,366,741 $ 5.805
Granted..................................................... -- --
Exercised................................................... (306) 0.050
Surrendered................................................. -- --
---------- -------
Outstanding and exercisable at December 31, 1997............ 2,366,435 $ 5.805
Granted..................................................... 1,246,500 11.033
Exercised................................................... (109,595) 5.564
Surrendered................................................. (117,438) 10.770
Adjustment to May 1995 warrants............................. 36,837 --
---------- -------
Outstanding at December 31, 1998............................ 3,422,739 $ 7.494
========== =======
Exercisable at December 31, 1998............................ 2,263,239 $ 5.681
========== =======
Outstanding and exercisable at December 31, 1998............ 3,422,739 $ 7.494
Granted..................................................... 1,092,908 7.905
Exercised................................................... 0 --
Surrendered................................................. (956,511) 10.124
---------- -------
Outstanding at December 31, 1999............................ 3,559,136 $12.252
========== =======
Exercisable at December 31, 1999............................ 2,313,309 $ 6.358
========== =======
</TABLE>
- ------------------------
(1) As WRSB had no outstanding stock at or prior to November 24, 1997 there were
no related options.
F-19
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
11. STOCK WARRANTS AND OPTIONS: (CONTINUED)
The table below summarizes stock options and warrants outstanding as of
December 31, 1999:
<TABLE>
<CAPTION>
WEIGHTED-
NUMBER OF AVERAGE WEIGHTED
SHARES OF REMAINING AVERAGE
RANGE OF COMMON CONTRACTUAL EXERCISE
DESCRIPTION EXERCISE PRICE STOCK LIFE IN YEARS PRICE
- ----------- --------------- --------- ------------- --------
<S> <C> <C> <C> <C>
EXERCISABLE
Fiscal 1995.................................. $6.375-$9.125 64,800 5 years $ 6.491
Fiscal 1996.................................. 8.00-10.313 178,400 6 years 8.031
Fiscal 1996.................................. 13.750-15.5 69,000 6 years 14.924
Fiscal 1997.................................. 9.500 136,000 7 years 9.500
Fiscal 1997.................................. 15.000 25,000 7 years 15.000
Fiscal 1997.................................. 14.268 50,000 2 years 14.268
Fiscal 1998.................................. 11.000 367,499 8 years 11.000
Fiscal 1998.................................. 8.5625 16,331 8 years 8.5625
Fiscal 1999.................................. 8.9275 87,600 9 years 8.9275
KOP Warrants................................. 3.633 103,697 1 years 3.633
1993 Warrants................................ 0.167 428,400 4 years 0.167
1995 Note Warrants........................... 3.890 786,277 5 years 3.890
Other........................................ 0.050 305 7 years 0.050
---------
2,313,309
NOT EXERCISABLE
1998 options................................. $ 11.000 333,001 8 years $11.000
1998 options................................. 8.5625 32,660 8 years 8.5625
1999 options................................. 8.9275 686,500 9 years 8.9275
1999 options................................. 3.875-6.125 193,666 9 years 5.855
---------
1,245,827
---------
OUTSTANDING.................................. 3,559,136
=========
</TABLE>
On July 9, 1997, Protection One granted an option to purchase an aggregate
of 50,000 shares of common stock in connection with an acquisition. The option
has a term of four years. The purchase price of the shares issuable pursuant to
the option is greater than the fair market value of the common stock at the date
of the option grant.
1994 STOCK OPTION PLAN
The 1994 Stock Option Plan (the "Plan"), approved by the Protection One
stockholders in June 1994, provides for the award of incentive stock options to
directors, officers and key employees under the Plan. 1,300,000 shares are
reserved for issuance, subject to such adjustment as may be necessary to reflect
changes in the number or kinds of shares of common stock or other securities of
Protection One. The Plan provides for the granting of options that qualify as
incentive stock options under the Internal Revenue Code and options that do not
so qualify.
F-20
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
11. STOCK WARRANTS AND OPTIONS: (CONTINUED)
A summary of options issued under the Plan by fiscal year are as follows:
<TABLE>
<CAPTION>
SHARES GRANTED TOTAL SHARES
TO OFFICERS GRANTED
-------------- ------------
<S> <C> <C>
1995............................................... 132,000 266,000
1996............................................... 400,000 638,800
1997............................................... 100,000 375,444
</TABLE>
The purchase price of the shares issuable pursuant to the options is equal
to (or greater than) the fair market value of common stock at the date of option
grant. The vesting period was accelerated on November 24, 1997 and all remaining
options are currently exercisable.
1997 LONG-TERM INCENTIVE PLAN
The 1997 Long-Term Incentive Plan (the "LTIP"), approved by the Protection
One stockholders on November 24, 1997, provides for the award of incentive stock
options to directors, officers and key employees. Under the LTIP, 4,200,000
shares are reserved for issuance, subject to such adjustment as may be necessary
to reflect changes in the number or kinds of shares of common stock or other
securities of Protection One. The LTIP provides for the granting of options that
qualify as incentive stock options under the Internal Revenue Code and options
that do not so qualify.
A summary of options issued under the LTIP by fiscal year are as follows:
<TABLE>
<CAPTION>
SHARES GRANTED TOTAL SHARES
TO OFFICERS GRANTED
-------------- ------------
<S> <C> <C>
1998............................................... 690,000 1,246,500
1999............................................... 399,700 1,092,908
</TABLE>
Each option has a term of 10 years and vests ratably over 3 years. The
purchase price of the shares issuable pursuant to the options is equal to (or
greater than) the fair market value of the common stock at the date of the
option grant.
The weighted average fair value of options granted during 1999 and 1998 and
estimated on the date of grant were $6.87 and $5.41, respectively. The fair
value was calculated for the respective year using the following assumptions:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1999 1998
-------- --------
<S> <C> <C>
Dividend yield......................................... 0.00% 0.00%
Expected stock price volatility........................ 64.06% 61.72%
Risk free interest rate................................ 6.76% 5.50%
Expected option life................................... 6 years 6 years
</TABLE>
No compensation cost has been recognized for issuance under the plans in
1999 and 1998. Had compensation cost for the plan been determined based on the
fair value at the grant date consistent with
F-21
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
11. STOCK WARRANTS AND OPTIONS: (CONTINUED)
SFAS No. 123 "Accounting for Stock-Based Compensation," the Company's net income
and income per share would have been as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1999 1998
-------- --------
<S> <C> <C>
Net loss:
As reported......................................... $(82,905) $(3,346)
Pro forma........................................... (85,837) (4,816)
Net loss per common share (basic and diluted):
As reported......................................... $ (.65) $ (.03)
Pro forma........................................... (.68) (.04)
</TABLE>
As there were no options granted by the Company during 1997, there is no
related compensation expense.
12. INCOME TAXES:
Components of income tax (expense) benefit are as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1999 1998
-------- --------
<S> <C> <C>
Federal--
Current.............................................. $10,769 $ 6,798
Deferred............................................. 20,226 (9,481)
State--
Current.............................................. -- 1,541
Deferred............................................. (374) (3,050)
Foreign tax expense, current........................... (1,434) (2,652)
------- -------
29,187 (6,844)
Tax on extraordinary item.............................. (911) 2,730
------- -------
Total................................................ $28,276 $(4,114)
======= =======
</TABLE>
The difference between the income tax (expense) benefit at the federal
statutory rate and income tax (expense) benefit in the accompanying statements
of operations is as follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-------------------------
1999 1998
-------- --------
<S> <C> <C>
Federal statutory tax rate........................... 35 % 35 %
State income taxes, net of Federal benefit........... - 5 %
Non-deductible goodwill.............................. (9)% (540)%
------- -------
26 % (500)%
======= =======
</TABLE>
F-22
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
12. INCOME TAXES: (CONTINUED)
A tax sharing agreement between Protection One and Western Resources
provides for payments to Protection One for tax benefits utilized by Western
Resources. Accordingly, the receivable of $31,100 at December 31, 1999 reflects
a receivable of $20,300 for the tax benefit Western Resources utilized in its
1998 consolidated income tax return, and $10,800 for the estimated tax benefit
to be utilized by Western Resources in its 1999 consolidated income tax return.
In February 2000, Protection One received payment from Western Resources for the
1998 tax receivable.
Prior to the November 24, 1997 transaction with Western Resources,
Protection One had net operating loss carryforwards for federal income tax
return purposes. Current tax regulations limit the use of these NOL
carryforwards first to 1) the taxable income earned by Protection One and
consolidated subsidiaries subsequent to November 24, 1997, and 2) as a result of
an ownership change of Protection One, as defined in Section 382 of the Internal
Revenue Code, realization of these amounts is subject to further certain annual
limitations for total taxable income generated. As a result, management has
determined that it is more likely than not that the NOL carryforwards will not
be utilized and that a valuation allowance of $27,327 is appropriate in
accordance with Statements of Financial Accounting Standards No. 109 "Accounting
for Income Taxes".
Deferred income tax assets and liabilities were composed of the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------
1999 1998
-------- --------
<S> <C> <C>
Deferred tax asset, current:
Accrued liabilities..................................... $ 3,009 $12,127
Accounts receivable, due to allowance................... 8,167 15,583
Acquisition and dealer.................................. 15,023 12,238
Other................................................... 2,201 9,595
------- -------
$28,400 $49,543
======= =======
Deferred tax asset, noncurrent:
Recourse financing contracts............................ $25,908 $30,162
Customer accounts....................................... 13,346 9,506
Property & equipment.................................... (10,756) (1,762)
OID amortization........................................ 7,742 6,592
Other................................................... (5,469) (6,172)
------- -------
$30,771 $38,326
======= =======
</TABLE>
13. EMPLOYEE BENEFIT PLANS:
401(K) PLAN
The Company maintains a tax-qualified, defined contribution plan that meets
the requirements of Section 401(k) of the Internal Revenue Code (the "Protection
One 401(k) Plan"). The Company, at its election, also may make contributions to
the Protection One 401(k) Plan, which contributions will be allocated among
participants based upon the respective contributions made by the participants
through salary reductions during the applicable plan year. The Company's
matching contribution may be made in
F-23
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
13. EMPLOYEE BENEFIT PLANS: (CONTINUED)
Common Stock, in cash or in a combination of both stock and cash. For the years
ended December 31, 1999, 1998, and 1997, Protection One made a matching
contribution to the plan of $944, $992, and $34, respectively.
WRSB also maintained a savings plan which qualified under Section 401(k).
The savings plan allowed eligible employees to contribute up to 15% of their
income on a pretax basis, with a discretionary employer match of 50% of the
employee's contribution up to the first 6% of the employee's compensation.
During the year ended December 31, 1997, matching contributions equal to $721
were made. The plan sponsor merged this plan into the Protection One 401(k) Plan
on July 1, 1998.
Through Protection One's 1998 acquisitions, a number of defined contribution
plans have been acquired. These plans either have been merged or will be merged
into the Protection One 401(k) Plan.
EMPLOYEE STOCK PURCHASE PLAN
The Employee Stock Purchase Plan is designed to qualify as an "Employee
Stock Purchase Plan" within the meaning of Section 423 of the Internal Revenue
Code, and will allow eligible employees to acquire shares of common stock at
periodic intervals through their accumulated payroll deductions. A total of
650,000 shares of common stock have been reserved for issuance under the
Employee Stock Purchase Plan.
The purchase price of shares of common stock purchased under the Employee
Stock Purchase Plan during any purchase period will be the lower of 85% of the
fair market value of the common stock on the first day of that purchase period
and 85% of the fair market value of the common stock on the purchase date.
Termination of a participant's employment for any reason (including death,
disability or retirement) cancels participation in the Employee Stock Purchase
Plan immediately. The Employee Stock Purchase Plan will in all events terminate
upon the earliest to occur of
- the last business day in September 2005
- the date on which all shares available for issuance under the plan have
been sold, and
- the date on which all purchase rights are exercised in connection with an
acquisition of Protection One of all or substantially all of its assets.
F-24
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
14. LEASES:
The Company leases office facilities for lease terms maturing through 2012.
Future minimum lease payments under non-cancelable operating leases are as
follows:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
- -----------------------
<S> <C>
2000...................................................... $10,068
2001...................................................... 9,081
2002...................................................... 7,670
2003...................................................... 5,653
2004...................................................... 3,838
Thereafter................................................ 4,496
-------
$40,806
=======
</TABLE>
Total rent expense for the years ended December 31, 1999, 1998 and 1997, was
$10,635, $7,220, and $4,654, respectively.
15. FAIR MARKET VALUE OF FINANCIAL INSTRUMENTS:
For certain of the Company's financial instruments, including cash and cash
equivalents, accounts receivable, accounts payable and other accrued
liabilities, the carrying amounts approximate fair market value due to their
short maturities.
The carrying value of the Company's marketable securities were approximately
$1,628 greater than their fair value, based on quoted market prices.
Because of the related party nature of the Company's Senior Credit Facility,
it is not possible to estimate the fair value of this obligation.
The fair value of the Company's publicly traded and other long-term debt are
estimated based on quoted market prices for the issues. Fair value of other
long-term debt is estimated at carrying value. At
F-25
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
15. FAIR MARKET VALUE OF FINANCIAL INSTRUMENTS: (CONTINUED)
December 31, 1999, the fair value and carrying amount of the Company's other
long-term debt was as follows:
<TABLE>
<CAPTION>
CARRYING
FAIR VALUE VALUE
---------- --------
<S> <C> <C>
Publicly Traded Debt:
Senior Subordinated Notes (8.125%).................... $178,500 $350,000
Senior Unsecured Notes (7.375%)....................... 182,500 250,000
Senior Subordinated Discount Notes (13.625%).......... 69,056 118,791
Convertible Senior Subordinated Notes (6.75%)......... 51,750 103,500
-------- --------
Total Publicly Traded Debt.............................. $481,806 $822,291
======== ========
Other Long-Term Debt:
CET Recourse Financing Agreements..................... $ 28,606 $ 28,606
Other CET Debt........................................ 988 988
Other Debt............................................ 267 267
-------- --------
Total Other Long-Term Debt:............................. 29,861 29,861
-------- --------
$511,667 $852,152
======== ========
</TABLE>
At December 31, 1998, the fair value of the Company's long-term debt was
$841,209, compared to a carrying value of $831,664. The estimated fair values
may not be representative of actual values of the financial instruments that
could have been realized at year-end or may be realized in the future.
16. COMMITMENTS AND CONTINGENCIES
As previously disclosed, the Company has been advised by the Division of
Corporation Finance of the SEC that, in the view of the staff, there are errors
in the Company's financial statements which are material and which have had the
effect of inflating earnings commencing with the year 1997. The Company has had
extensive discussions with the SEC staff about the methodology used by the
Company to amortize customer accounts, the purchase price allocation to customer
accounts in the Multifamily acquisition and other matters. The SEC staff has not
indicated it concurs with, nor has the SEC staff determined not to object to,
the restatements made in 1999, the change in accounting principle for customer
accounts, or the change in estimated useful life for goodwill. The Company
cannot predict whether the SEC staff will make additional comments or take other
action that will further impact its financial statements or the effect or timing
of any such action.
The Company, 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
F-26
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
16. COMMITMENTS AND CONTINGENCIES (CONTINUED)
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 Capital 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. The Company
believes that all the claims asserted in the Amended Complaint are without merit
and intends to defend against them vigorously. We cannot currently predict the
impact of this litigation which could be material.
Six Protection One dealers have filed a class action lawsuit in the U. S.
District Court for the Western District of Kentucky alleging breach of contract
because of the Company's interpretation of their dealer contracts. The action is
styled TOTAL SECURITY SOLUTIONS, INC., ET AL. V. PROTECTION ONE ALARM
MONITORING, INC., Civil Action No. 3:99CV-326-H (filed May 21, 1999). 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. As of March 17, 2000, none of these dealers have
commenced arbitration.
Other Protection One dealers have 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 intends to vigorously defend its position. 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.
The Company is a party to claims and matters of litigation incidental to the
normal course of its business. The ultimate outcome of such matters cannot
presently be determined; however, in the opinion of management of the Company,
the resolution of such matters will not have a material adverse effect upon the
Company's consolidated financial position or results of operations.
Under the Company's agreements with dealers, the Company may be required to
purchase customer accounts on an ongoing basis. The Company is currently
spending less than $5,000 per month to purchase these customer accounts.
17. SEGMENT REPORTING
The Company's operating segments are defined as components for which
separate financial information is available that is evaluated regularly by the
chief operating decision maker. The operating segments are managed separately
because each operating segment represents a strategic business unit that serves
different markets.
Protection One's reportable segments include North America, Multifamily, and
Europe. North America provides residential, commercial, and wholesale security
alarm monitoring services, which include
F-27
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
17. SEGMENT REPORTING (CONTINUED)
sales, installation and related servicing of security alarm systems for
residential and business customers in the United States and Canada. Multifamily
provides security alarm services to apartments, condominiums and other
multi-family dwellings. Europe provides 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. The Company manages
its business segments based on earnings before interest, income taxes,
depreciation and amortization (EBITDA).
Reportable segments (in thousands):
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1999
-----------------------------------------------------------
NORTH AMERICA MULTIFAMILY EUROPE CONSOLIDATED TOTAL
------------- ----------- -------- ------------------
<S> <C> <C> <C> <C>
Revenue.................................... $ 403,269 $ 38,901 $163,006 $ 605,176
EBITDA..................................... 148,861 16,236 42,633 207,730
Amortization of intangibles and
depreciation expense..................... 198,264 9,507 29,472 237,243
Operating income (loss).................... (55,212) 6,729 13,161 (35,322)
Segment assets............................. 1,991,211 225,550 341,474 2,558,235
Expenditures for property, net............. 27,008 826 4,810 32,644
Expenditures for subscriber accounts,
net...................................... 224,855 9,715 6,430 241,000
</TABLE>
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31, 1998
-----------------------------------------------------------
NORTH AMERICA MULTIFAMILY EUROPE CONSOLIDATED TOTAL
------------- ----------- -------- ------------------
<S> <C> <C> <C> <C>
Revenue.................................... $ 343,954 $ 33,417 $ 43,724 $ 421,095
EBITDA..................................... 129,237 13,978 13,993 157,208
Amortization of intangibles and
depreciation expense..................... 107,545 7,721 3,945 119,211
Operating Income........................... 18,292 6,257 10,048 34,597
Segment assets............................. 1,986,695 222,657 301,084 2,510,436
Expenditures for property, net............. 29,092 950 2,669 32,711
Expenditures for subscriber accounts,
net...................................... 271,399 4,365 1,903 277,667
</TABLE>
Protection One currently has international operations. International data
for these locations for 1999 and 1998, respectively, is as follows:
<TABLE>
<CAPTION>
1999 1998
------------------- -------------------
EUROPE CANADA EUROPE CANADA
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Total Revenues........................................ $163,006 $ 8,073 $ 43,724 $ 3,756
Total Assets.......................................... 341,474 26,854 301,084 30,129
</TABLE>
In 1997, Protection One operated under a single reportable segment providing
alarm monitoring services to over 750,000 residential and small business
customers in the United States. Accordingly, no further segment presentation
beyond the consolidated financial statements is warranted.
F-28
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
17. SEGMENT REPORTING (CONTINUED)
See Note 19 Subsequent Events for information with respect to the sale to
Western Resources of the Company's European operations on February 29, 2000.
18. UNAUDITED QUARTERLY FINANCIAL INFORMATION
The following is a summary of the unaudited quarterly financial information
for 1999 and 1998, respectively:
<TABLE>
<CAPTION>
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 TOTAL
-------- -------- ------------ ----------- --------
(AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
<S> <C> <C> <C> <C> <C>
1999
Revenues............................... $148,547 $150,801 $153,131 $152,697 $605,176
Gross profit........................... 107,273 108,919 103,319 101,659 421,170
Loss before extraordinary loss......... (4,785) (7,673) (40,986) (27,770) (81,214)
Net loss............................... (4,785) (7,673) (40,986) (29,461) (82,905)
Basic and diluted loss per share:
Loss before extraordinary loss....... (.04) (.06) (.32) (.22) (.64)
Net loss............................. (.04) (.06) (.32) (.23) (.65)
1998
Revenues............................... $ 76,795 $ 97,041 $103,261 $143,998 $421,095
Gross profit........................... 52,802 65,561 70,706 102,943 292,012
Net income (loss) before extraordinary
gain................................. 194 (420) 977 (5,688) (4,937)
Net income (loss)...................... 194 1,171 977 (5,688) (3,346)
Loss before extraordinary gain....... - (.01) .01 (.05) (.05)
Net loss............................. - .01 .01 (.05) (.03)
</TABLE>
19. SUBSEQUENT EVENTS:
RELATED PARTY SALE AND AMENDMENT TO REVOLVING CREDIT AGREEMENT. On
February 29, 2000 the Company sold its European operations and certain
investments to Westar Capital. The consideration received was approximately
$244,000, comprised of approximately $183,000 in cash and certain of the
Company's outstanding debt securities Westar Capital had acquired in open market
purchases for approximately $61,000. As part of the agreement, Westar Capital
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 $240,000
outstanding balance under the $250,000 Senior Credit Facility between the
Company and Westar Capital.
Concurrently, the Senior Credit Facility was amended to, among other things,
(1) reduce the commitment to $115,000 (resulting in availability of
approximately $58,000 after the sale of the European operations), (2) increase
the leverage ratio covenant to 5.75 to 1.0, (3) reduce the interest coverage
ratio to 2.10 to 1.0, (4) change the termination date to January 2, 2001,
(5) change the loan pricing grid to one based on leverage ratio rather than
credit rating, (6) allow for the inclusion of certain add-backs to the
calculation of EBITDA, (7) eliminate as an Event of Default Western Resources'
failure to own more than 50% of the Company, (8) waive compliance with the
leverage ratio and interest coverage ratio covenants
F-29
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
19. SUBSEQUENT EVENTS: (CONTINUED)
for the fiscal quarters ended September 30, 1999 and December 31, 1999, and
(9) provide for an increase in the amount of the commitment by up to $40,000 for
the purpose of consummating acquisitions approved by Westar Capital.
Westar Capital also transferred to Protection One certain outstanding debt
securities of the Company and a note for payment of certain intercompany amounts
owed by Westar Capital to the Company. In connection with that transaction and
the sale of our European operations and certain other investments to Westar
Capital, the carrying amount for the respective debt securities received were as
follows:
<TABLE>
<CAPTION>
DEBT SECURITY (COUPON) CARRYING AMOUNT
- ---------------------- ---------------
<S> <C>
Senior Subordinated Discount Notes
(13.625%).................................. $ 38,892
Convertible Senior Subordinated Notes
(6.75%).................................... $ 49,550
Senior Subordinated Notes (8.125%)........... $ 46,110
--------
Total........................................ $134,552
========
</TABLE>
The Company will record an extraordinary gain of approximately $27,000 (net
of tax effect) in the first quarter of 2000 for the difference between the
carrying value of the debt and the basis of the debt securities acquired by the
Company. No gain or loss was recognized on the related party sale of the
European operations. The transactions were approved by the independent directors
of the Protection One and Monitoring Boards of Directors upon the recommendation
of a special committee of the Protection One Board of Directors. The special
committee obtained a "fairness opinion" from an investment banker with regard to
the sale of the European operations.
PRO FORMA FINANCIAL INFORMATION:
The following unaudited pro forma consolidated results of operations for the
year ended December 31, 1999, assume the sale of the Company's European
operations occurred at January 1, 1999.
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31, 1999
---------------------
(IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
<S> <C>
Revenues.................................................. $442,170
Loss before extraordinary item............................ (53,140)
Net loss.................................................. (54,831)
Net loss per common share (basic and diluted):
Loss before extraordinary item.......................... (.42)
Net loss................................................ (.43)
</TABLE>
The pro forma financial information is not necessarily indicative of the
results of operations had the sale of the European operations to Westar Capital
been reflected for the entire period, nor do they purport to be indicative of
results which will be obtained in the future.
F-30
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
19. SUBSEQUENT EVENTS: (CONTINUED)
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
-----------------
(IN THOUSANDS)
<S> <C>
Total assets................................ $2,247,479
Total liabilities........................... 1,078,570
</TABLE>
F-31
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
SCHEDULE IIYVALUATION AND QUALIFYING ACCOUNTS
(DOLLAR AMOUNTS IN THOUSANDS)
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO
BEGINNING CHARGED TO COSTS OTHER BALANCE AT
DESCRIPTION OF PERIOD AND EXPENSES ACCOUNTS (A) DEDUCTIONS (B) END OF PERIOD
- ----------- ---------- ---------------- ------------ -------------- -------------
<S> <C> <C> <C> <C> <C>
Year ended December 31, 1997
Allowances deducted from assets
for doubtful accounts......... 4,413 3,657 4,578 (7,441) 5,207
Year ended December 31, 1998
Allowances deducted from assets
for doubtful accounts, as
restated...................... 5,207 10,567 2,289 (1,070) 16,993
Year ended December 31, 1999
Allowances deducted from assets
for doubtful accounts......... 16,993 21,641 - (7,945) 30,689
</TABLE>
- ------------------------
(a) Allowances associated with receivables purchased in conjunction with
acquisition of customer accounts and business acquisitions.
(b) Results from write-offs of accounts receivable.
S-1
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 and 15(d) of the Securities
Exchange Act of 1934, the Registrants have duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<C> <S> <C>
/s/ JOHN E. MACK III Chief Executive Officer
------------------------------------------- (Principal Executive March 28, 2000
John E. Mack III Officer)
Chief Financial Officer,
/s/ TONY SOMMA Secretary and Treasurer
------------------------------------------- (Principal Financial and March 28, 2000
Tony Somma Accounting Officer)
/s/ ANNETTE BECK
------------------------------------------- Director March 28, 2000
Annette M. Beck
/s/ HOWARD A. CHRISTENSEN
------------------------------------------- Director March 28, 2000
Howard A. Christensen
/s/ JOHN B. DICUS
------------------------------------------- Director March 28, 2000
John B. Dicus
/s/ MARIA DE LOURDES DUKE
------------------------------------------- Director March 28, 2000
Maria de Lourdes Duke
/s/ BEN M. ENIS
------------------------------------------- Director March 28, 2000
Ben M. Enis
/s/ DONALD A. JOHNSTON
------------------------------------------- Director March 28, 2000
Donald A. Johnston
/s/ DOUGLAS T. LAKE
------------------------------------------- Director March 28, 2000
Douglas T. Lake
/s/ CARL M. KOUPAL, JR.
------------------------------------------- Director March 28, 2000
Carl M. Koupal, Jr.
/s/ JOHN H. ROBINSON
------------------------------------------- Director March 28, 2000
John H. Robinson
/s/ JAMES Q. WILSON
------------------------------------------- Director March 28, 2000
James Q. Wilson
</TABLE>
<PAGE>
Page 1
EXHIBIT 10.16
PROTECTION ONE, INC.
FORM OF CHANGE OF CONTROL AGREEMENT
Dear :
Protection One, Inc. (the "Company") considers sound management
essential to protecting the interests of the Company and its shareholders. The
Company recognizes that the possibility of a change in control could arise which
may result in the distraction of management to the detriment of the Company and
its shareholders. It is important that you be able to advise the Board whether a
proposed change in control would be in the best interests of the Company and its
shareholders and to take action regarding such proposal as the Board directs,
without being influenced by the uncertainties of your own situation.
To induce you to remain in the employ of the Company, this Agreement,
approved by the Board of Directors (the "Board"), sets forth the benefits which
will be provided to you if your employment is terminated subsequent to a "change
in control".
1. AGREEMENT TO PROVIDE SERVICES; RIGHT TO TERMINATE.
(i) Except as otherwise provided in paragraph (ii) below, the
Company or you may terminate your employment at any time, subject to this
Agreement.
(ii) If Western Resources, Inc., a Kansas corporation and the
parent of the Company, ("Western") announces that it intends to sell the
Company's outstanding securities ordinarily having the right to vote at
elections of directors ("Voting Securities") which would reduce Western's and
its affiliate's ownership of Voting Securities below 50%, you agree that you
will not leave the employ of the Company (other than for Disability or upon
Retirement) and will render the services contemplated in this Agreement until
such transaction has been abandoned or a change in control has occurred.
"Person" shall mean any individual, corporation, partnership, group, association
or other "person", as such term is used in Section 14(d) of the Securities
Exchange Act of 1934 (the "Exchange Act"), other than the Company, a wholly
owned subsidiary of the Company or any employee benefit plan(s) sponsored by the
Company or a subsidiary of the
<PAGE>
Page 2
Company. "Affiliate" shall mean any entity, association, corporation, or
partnership controlled 30% or more by Western; or under common control with
Western and any employee benefit plan(s) sponsored by the Company, Western or
any affiliate of Western.
2. TERM OF AGREEMENT. This Agreement shall continue until January 1,
2001, and on such date and each January 1 thereafter, the term shall be extended
for one year unless at least 90 days prior to such January 1st date, the Company
or you shall have given notice to cancel this Agreement. Notwithstanding any
such notice, this Agreement shall continue in effect for 12 months after a
change in control which occurs during the term of this Agreement, as extended.
This Agreement shall terminate if your employment terminates prior to a change
in control.
3. CHANGE IN CONTROL. A "change in control" shall be deemed to have
occurred when (a) any Person other than Western or any affiliate of Western,
becomes the "beneficial owner" (as defined in Rule 13d-3 under the Exchange
Act), directly or indirectly, of 50% or more of the Voting Securities; (b)
individuals who constitute the Board on the date hereof (the "Incumbent Board")
cease to constitute a majority thereof, provided that any person who becomes a
director by approval of at least three quarters of the directors comprising the
Incumbent Board (either by a specific vote or by approval of the proxy statement
in which such person is named as a nominee for director, without objection to
such nomination) shall be considered a member of the Incumbent Board; (c) the
liquidation or dissolution of the Company; or (d) the sale of all or
substantially all of the assets of the Company to any Person other than Western
or an affiliate of Western. No change in control shall be deemed to have
occurred by virtue of any transaction which results in you, or a group of
Persons which includes you, acquiring, directly or indirectly, 30% or more of
the voting power of the Voting Securities.
4. TERMINATION FOLLOWING CHANGE IN CONTROL. Upon a change in control,
you shall be entitled to the benefits provided in Section 5 hereof upon the
termination of your employment with the Company within 12 months after such
event, unless such termination is (a) because of your death or Retirement, (b)
by the Company for Cause or Disability or (c) by you other than for Good Reason.
(i) DISABILITY. Termination based on "Disability" shall mean
termination because of your absence from your duties on a full time basis for
180 consecutive days due to physical or mental illness, unless within 30 days
after Notice of Termination is given to you following such absence you shall
have returned to the full time performance of your duties.
<PAGE>
Page 3
(ii) RETIREMENT. Termination based on "Retirement" shall mean
termination on or after age 65 with five or more years of service with the
Company.
(iii) CAUSE. Termination for "Cause" shall mean termination
upon (a) the willful and continued failure by you to perform substantially your
duties (unless due to physical or mental illness) after a demand for substantial
performance is delivered to you by the Chairman of the Board of the Company
which specifically identifies the manner in which you have not substantially
performed your duties, or (b) the willful engaging by you in illegal conduct
which is materially injurious to the Company. "Willful" means in bad faith and
without reasonable belief that your act or omission was in, or not opposed to,
the best interests of the Company. Any act, or failure to act, based upon
authority given by the Board or upon the advice of counsel for the Company shall
be deemed to be in the best interests of the Company. Your attention to matters
not directly related to the business of the Company shall not provide a basis
for termination for Cause if the Company has approved such activities. You shall
not be deemed to have been terminated for Cause unless there shall have been
delivered to you a resolution by the affirmative vote of three quarters of the
Board at a meeting called for the purpose (after reasonable notice to you and an
opportunity for you, together with your counsel, to be heard before the Board)
of determining if you have been guilty of the conduct set forth above in (a) or
(b) of this paragraph (iii) and specifying the particulars thereof.
(iv) GOOD REASON. Termination for "Good Reason" shall mean
termination based on any of the following events, provided that you give the
Company written notice thereof within six months of the event constituting "Good
Reason":
(A) a determination by you that there has been an
adverse change in your status or position(s) as an officer of
the Company as in effect immediately prior to the change in
control, including, without limitation, any diminution in your
responsibilities or the assignment to you of any
responsibilities which are inconsistent with such status or
position(s), or any removal of you from or any failure to
reappoint or reelect you to such position(s) (except in
connection with the termination of your employment for Cause,
Disability or Retirement or as a result of your death or by
you other than for Good Reason);
(B) a reduction in your base salary as in effect
immediately prior to the change in control;
(C) the failure to continue in effect any Plan in
which you are participating at the time of the change in
control (or Plans providing you with at least
<PAGE>
Page 4
substantially similar benefits) other than as a result of the
normal expiration of any such Plan under its terms as in
effect at the time of the change in control, or the taking of
any action, or the failure to act, by the Company which would
adversely affect your continued participation in any of such
Plans on at least as favorable a basis to you as is the case
on the date of the change in control or which would materially
reduce your benefits in the future under any of such Plans or
deprive you of any material benefit enjoyed by you at the time
of the change in control;
(D) the failure to credit you with the number of paid
vacation days to which you are then entitled under the normal
vacation policy as in effect immediately prior to the change
in control;
(E) the Company's requiring you to be based anywhere
other than where your office is located immediately prior to
the change in control except for required travel on the
Company's business to an extent substantially consistent with
the business travel obligations which you undertook prior to
the change in control;
(F) the failure of the Company to obtain from any
successor the assent to this Agreement contemplated by Section
6 hereof;
(G) any purported termination of your employment
which is not effected pursuant to a Notice of Termination
satisfying the requirements of paragraph (v) below (and, if
applicable, paragraph (iii) above); and for purposes of this
Agreement, no such purported termination shall be effective;
or
(H) any refusal by the Company to continue to allow
you to engage in activities not directly related to the
business of the Company which, prior to the change in control,
you were permitted by the Company to engage in.
"Plan" shall mean any compensation plan such as an incentive, stock option or
restricted stock plan or any employee benefit plan such as a salary continuation
program, saving, deferred compensation, pension, profit sharing, medical,
disability, accident, or life insurance plan or a relocation plan or policy or
any other plan, program or policy of the Company intended to benefit employees.
(v) NOTICE OF TERMINATION. Any purported termination following
a change in control shall be communicated by written Notice of Termination to
the other party hereto. A "Notice of
<PAGE>
Page 5
Termination" shall indicate the specific termination provision in this Agreement
relied upon.
(vi) DATE OF TERMINATION. "Date of Termination" following a change in
control shall mean (a) if your employment is to be terminated for Disability, 30
days after Notice of Termination is given (provided that you shall not have
returned to the performance of your duties on a full-time basis during such 30
day period), (b) if your employment is to be terminated by the Company for Cause
or by you pursuant to Sections 4(iv)(F) or 6 hereof or for any other Good
Reason, the date specified in the Notice of Termination, or (c) if your
employment is to be terminated by the Company for any reason other than Cause,
the date specified in the Notice of Termination shall be 90 days after the
Notice of Termination is given, unless an earlier date has been expressly agreed
to by you in writing.
In the case of termination for Cause, if you have not previously
expressly agreed in writing to the termination, then within 30 days after
receipt by you of the Notice of Termination, you may notify the Company that a
dispute exists concerning the termination, in which event the Date of
Termination shall be the date set either by mutual written agreement of the
parties or by the arbitrators in a proceeding as provided in Section 13 hereof.
During the pendency of any such dispute, the Company will continue to pay you
your full compensation and benefits in effect just prior to the time the Notice
of Termination is given and until the dispute is resolved in accordance with
Section 13.
5. COMPENSATION UPON TERMINATION OR DURING DISABILITY; OTHER
AGREEMENTS.
(i) After a change in control if you fail to perform your
duties as a result of physical or mental illness, you shall continue to receive
your salary at the rate then in effect and any benefits or awards under any
Plans shall continue to accrue during such period, to the extent not
inconsistent with such Plans, until your employment is terminated under
paragraphs 4(i) and 4(vi) hereof. Thereafter, your benefits shall be determined
under the Plans then in effect.
(ii) If your employment shall be terminated for Cause
following a change in control, the Company shall pay you your salary through the
Date of Termination at the rate in effect just prior to the time a Notice of
Termination is given plus any benefits or awards (including both the cash and
stock components) which have been earned. Thereupon the Company shall have no
further obligations to you under this Agreement.
(iii) Subject to Section 8 hereof, if, within 12 months after
a change in control, your employment shall be terminated (a) by the Company
other than for Cause, Disability or Retirement or (b) by you for Good Reason,
then the Company shall
<PAGE>
Page 6
pay to you, by the fifth day following the Date of Termination, without regard
to any contrary provisions of any Plan, the following:
(A) your base compensation through the Date of
Termination at the rate in effect just prior to the time a
Notice of Termination is given plus (A) any accrued vacation
pay and (B) a pro rata share of any benefits or awards
(including both the cash and stock components) which but for
your Termination would have been earned, but which have not
yet been paid to you;
(B) 2.99 times the higher of (A) your annual base
compensation on the Date of Termination or (B) your annual
base salary in effect immediately prior to the change in
control;
(C) 2.99 times the average of the incentive
compensation (including both the cash and stock components)
awarded to you for the three completed bonus periods prior to
the Date of Termination. If you have not been employed by
Protection One for a year or more, the short-term incentive
amount for the previous year would be assumed to be at a 50%
payout level.
"Base salary" shall include any amounts deducted by the Company for your account
under any agreement which the Company or Section 125 and 401(k) of the Internal
Revenue Code of 1986, as amended, (the "Code").
(iv) If, within 12 months after a change in control, your
employment shall be terminated (a) by the Company other than for Cause,
Disability or Retirement or (b) by you for Good Reason, then the Company shall
maintain in effect, for the continued benefit of you and your dependents until
the earliest of (a) three years after the Date of Termination, (b) the
commencement date of equivalent benefits from a new employer or (c) your
retirement date, all employee welfare benefit plans in which you were entitled
to participate immediately prior to the Date of Termination, provided that your
continued participation is possible under the provisions of such Plans (and any
applicable funding media) and you continue to pay your regular contribution
under such Plans. If your participation in any such Plan is barred, the Company,
at its expense, shall arrange to have issued individual policies of insurance
providing benefits substantially similar (on an after-tax basis) to those which
you otherwise would have been entitled to receive or, if such insurance is not
available at a reasonable cost, the Company shall otherwise provide you and your
dependents with equivalent benefits (on an after-tax basis). You shall not be
required to pay any amount greater than you would have paid to participate in
such Plans.
<PAGE>
Page 7
(v) Except as provided in paragraph (iv) above, the payment
provided for in this Section 5 shall not be reduced by any compensation earned
by you after the Date of Termination.
(vi) If the payments provided by Section 5 (iii) hereof (the
"Agreement Payments") become subject to the tax (the "Excise Tax") imposed by
Section 4999 of the Code as in effect on the date of this Agreement (or any
similar tax), you will be responsible for the Excise Tax and the Company will
not pay you an additional amount (the "Gross-up Payment"). If, however, the
"Agreement Payments" become subject to the Excise Tax (or any similar tax) by
virtue of changes in the Code which occur after the date of this Agreement, the
Company shall pay to you at the time specified in Subsection (vii) below a
"Gross-up Payment" such that the net amount retained by you, after deduction of
any Excise Tax on the Total Payments (as hereinafter defined), and any federal,
state and local income tax and Excise Tax upon the Gross-up Payment provided for
this Subsection (vi) shall be equal to what the Total Payments would have been
had such changes in the Code not occurred.
For purposes of determining whether any of the Agreement Payments will
be subject to the Excise Tax and the amount of such Excise Tax, (a) any other
payments or benefits received or to be received by you in connection with a
change in control or your termination of employment (under this Agreement or any
other agreement with the Company or any person whose actions result in a change
of control or any person affiliated with the Company) (which, together with the
Agreement Payments, shall constitute the "Total Payments") shall be treated as
"parachute payments" within the meaning of Section 280G(b)(2) of the Code, and
all "excess parachute payments" within the meaning of Section 280G(b)(1) of the
Code shall be treated as subject to the Excise Tax, unless in the opinion of tax
counsel selected by the Company's independent auditors such other payments or
benefits (in whole or in part) are not subject to the Excise Tax, (b) the amount
of the Total Payments which shall be treated as subject to the Excise Tax shall
be equal to the lesser of (1) the Total Payments or (2) the amount of excess
parachute payments within the meaning of Section 280G(b)(1) of the Code (after
applying clause (a), above), and (c) the value of any non-cash benefits or any
deferred payment or benefit shall be determined by the Company's independent
auditors in accordance with the principles of Sections 280G(d)(3) and (4) of the
Code.
For purposes of determining the Gross-up Payment, you shall be deemed
to pay federal, state, and local income taxes at the highest applicable marginal
rate for the calendar year in which the Gross-up Payment is to be made net of
the maximum reduction in federal income taxes which could be obtained from
deduction of such state and local taxes. If the Excise Tax is finally determined
to be less than the amount taken into account at the time the Gross-up Payment
is made, you shall repay the portion
<PAGE>
Page 8
attributable to such reduction (plus the portion of the Gross-up Payment
attributable to a reduction in Excise Tax and/or a federal and state and local
income tax deduction), plus interest on the amount of such repayment at the rate
provided in Section 1274(b)(2)(B) of the Code. If the Excise Tax is later
determined to exceed the amount taken into account at the time the Gross-up
Payment is made, the Company shall make an additional Gross-up Payment (plus any
interest payable with respect to such excess at the rate provided in Section
1274(b)(2)(B) of the Code) when such excess is finally determined.
(vii) The Gross-up Payment or portion thereof provided for in
Subsection (vi) above shall be paid not later than the thirtieth day following
payment of any amounts under Section 5(iii); provided, however, that if the
amount of such Gross-up Payment or portion thereof cannot be finally determined
on or before such day, the Company shall pay to you on such day an estimate, as
determined in good faith by the Company, of the minimum amount of such payments
and shall pay the remainder of such payments (together with interest at the rate
provided in Section 1274(b)(2)(B) of the Code) as soon as the amount thereof can
be determined, but in no event later than the forty-fifth day after payment of
any amounts under Section 5(iii). If the amount of the estimated payments
exceeds the amount subsequently determined to have been due, such excess shall
constitute a loan by the Company to you, payable on the fifth day after demand
by the Company (together with interest at the rate provided in Section
1274(b)(2)(B) of the Code).
(viii) In the event it shall be determined by the Company's
independent auditor that the Agreement Payments would subject you to the Excise
Tax, it shall also be determined whether a certain reduction in the Agreement
Payments would result in an after-tax amount with a greater net present value
than would occur without such reduction. If so, the Agreement Payments shall be
reduced by the minimum amount necessary to obtain such result.
If such reduced payments incorrectly result in an overpayment
or underpayment to you, the underpayment shall be promptly paid to you and, if
an overpayment shall have occurred, it shall be treated for all purposes as a
loan to you by the Company which you shall repay on the fifth day after demand
by the Company, in each case together with interest at the applicable rate
provided for in Section 1274(b)(2)(B) of the Code.
6. SUCCESSORS; BINDING AGREEMENT.
(i) The Company will seek, by written request at least five
business days prior to the time a Person becomes a Successor, to have such
Person, in form satisfactory to you, assent to the fulfillment of the Company's
obligations under this
<PAGE>
Page 9
Agreement. Failure of such Person to furnish such assent by the later of (A)
three business days prior to the time such Person becomes a Successor or (B) two
business days after such Person receives a written request to so assent shall
constitute Good Reason for termination by you of your employment if a change in
control occurs or has occurred. "Successor" shall mean any Person that succeeds
to, or has the practical ability to control (either immediately or with the
passage of time), the Company's business directly, by merger or consolidation,
or indirectly, by purchase of the Voting Securities or otherwise.
(ii) This Agreement shall be enforceable by your personal or
legal representatives. If you should die while any amount would still be payable
to you hereunder if you had continued to live, all such amounts, unless
otherwise provided herein, shall be paid in accordance with the terms of this
Agreement to your designee or, if there be no such designee, to your estate.
(iii) The "Company" shall include any continuing entity from
any business combination in which the Company ceases to exist.
7. FEES AND EXPENSES; MITIGATION.
(i) The Company shall reimburse you, on a current basis, for
all legal fees and related expenses incurred by you in connection with the
Agreement following a change in control, including, without limitation, (a) all
such fees and expenses, if any, incurred in contesting any termination of your
employment or incurred by you in seeking advice with respect to the matters set
forth in Section 8 hereof or (b) your seeking to enforce any benefit provided by
this Agreement, in each case, regardless of whether or not your claim is upheld
by a court of competent jurisdiction; provided, however, you shall be required
to repay any such amounts to the extent that a court issues a final and
non-appealable order determining that your position was frivolous. In addition
to the fees and expenses provided herein, you shall also be paid interest on any
disputed amount ultimately paid to you at the prime rate announced from time to
time by Chase Bank, New York, from the date payment should have been made until
paid in full.
(ii) You shall not be required to mitigate any payment the
Company becomes obligated to make to you under this Agreement.
8. TAXES. All payments under this Agreement will be subject to required
withholding of federal, state and local income and employment taxes.
9. SURVIVAL. The respective obligations of, and benefits afforded to,
the Company and you as provided in Section 5, 6(ii),
<PAGE>
Page 10
7, 8 and 14 of this Agreement shall survive termination of this Agreement.
10. NOTICE. Notices and all other communications under this Agreement
shall be in writing and shall be deemed to have been duly given when mailed by
United States registered mail, return receipt requested, postage prepaid and
addressed, in the case of the Company, to the address set forth on the first
page of this Agreement or, in the case of the undersigned employee, to the
address set forth below his signature, provided that all notices to the Company
shall be directed to the attention of the Chairman of the Board or President of
the Company, with a copy to the Secretary of the Company, or to such other
address as either party may have furnished to the other in writing in accordance
herewith, except that notice of change of address shall be effective only upon
receipt.
ll. MISCELLANEOUS. No provision of this Agreement may be modified,
waived or discharged unless such modification, waiver or discharge is agreed to
in a writing signed by you and the Chairman of the Board or President of the
Company. No waiver by either party hereto at any time of any breach by the other
party hereto of, or of compliance with, any condition or provision of this
Agreement to be performed by such other party shall be deemed a waiver of
similar of dissimilar provisions or conditions at the same or at any prior or
subsequent time. No agreements or representations, oral or otherwise, express or
implied, with respect to the subject matter hereof have been made by either
party which are not expressly set forth in this Agreement. The validity,
interpretation, construction and performance of this Agreement shall be governed
by the laws of the State of Delaware.
12. VALIDITY. The invalidity or unenforceability of any provision of
this Agreement shall not affect the validity or enforceability of any other
provisions of this Agreement, which shall remain in full force and effect.
13. ARBITRATION. Any dispute or controversy arising under or in
connection with this Agreement shall be settled exclusively by arbitration by
three arbitrators in accordance with the rules of the American Arbitration
Association then in effect. Judgment may be entered on the arbitrators' award in
any court having jurisdiction; provided, however, that you shall be entitled to
seek specific performance of your right to be paid until the Date of Termination
during the pendency of any dispute or controversy arising under or in connection
with this Agreement. The Company shall bear all costs and expenses arising in
connection with any arbitration proceeding pursuant to this Section 13.
14. RELATED AGREEMENTS. If any provision of any other agreement between
the Company or any of its subsidiaries and you shall, qualify or be inconsistent
with any provision of this Agreement, then, while this Agreement remains in
force, this
<PAGE>
Page 11
Agreement shall control and such provision of such other agreement shall be
deemed to have no force or effect.
15. COUNTERPARTS. This Agreement may be executed in several
counterparts, each of which shall be deemed to be an original but all of which
together will constitute one and the same instrument.
If this letter correctly sets forth our agreement, kindly sign and
return to the Company the enclosed copy of this letter.
Sincerely,
Douglas T. Lake
Chairman
ACCEPTED:
- -----------------------------
Date
- -----------------------------
Name
- -----------------------------
Street Address
- -----------------------------
City State ZIP
<PAGE>
PROTECTION ONE
AMORTIZATION OF CAPITALIZED DEBT COSTS
FOR EXHIBIT 12.1 IN 10K
DECEMBER 31, 1999
<TABLE>
<CAPTION>
Capitalized Costs Accumulated Amort Book Value Extraordinary Loss
<S> <C> <C> <C> <C>
Revolver (BV w/o on 12/17/99) 3,541,796 1,200,736 2,341,060 1,691,704
Senior Notes 7 3/8 3,331,179 618,769 2,712,410
Senior Subordinated Notes 8 1/8 7,347,413 665,448 6,681,965
Per books at 12/31/99 10,678,592 1,284,217 9,394,375 0
Add revolver accumulated amort 1,200,736
Total accum amort (incl revolver) 2,484,953
Amortization recorded in 1998 139,000
(per 1998 10K filed exhibit 12.1)
Amortization expense recorded
in 1999 (as interest expense) 2,345,953
</TABLE>
<PAGE>
EXHIBIT 12.1
PROTECTION ONE, INC.
COMPUTATION OF RATIO OF EARNINGS TO FIXED CHARGES
(IN THOUSANDS)
<TABLE>
<CAPTION>
PROTECTION ONE
--------------------------------------------------------------------
Year Ended Year Ended Year Ended Year Ended
December December December December
31, 1999 31, 1998 31, 1997 31, 1996
--------------------------------------------------------------------
<S> <C> <C> <C> <C>
Earnings:
Net loss $ (82,905) $ (3,346) $ (42,728) $ (656)
Adjustments:
Extraordinary loss 1,691 (1,591) -- --
Consolidated provision for income taxes 28,276 (4,114) 28,628 (310)
Fixed charges less interest income 87,037 56,129 33,483 15
--------------- -------------- -------------- --------------
Earnings as adjusted (A) 34,099 47,078 19,383 (951)
=============== ============== ============== ==============
Fixed Charges:
Interest on debt and capitalized leases 84,691 55,990 33,483 15
Amortization of deferred financing costs 2,346 139 -- --
--------------- -------------- -------------- --------------
Fixed Charges (B) 87,037 56,129 33,483 15
=============== ============== ============== ==============
Ratio of earnings to fixed charges (A) divided by (B) -- -- -- --
Deficiency of earnings to fixed charges 52,938 9,051 14,100 966
<CAPTION>
[CONTINUED]
PREDECESSOR
---------------------------------
53 Weeks 52 Weeks
Ended Ended
December December
30, 1996 20, 1995
---------------------------------
<S> <C> <C>
Earnings:
Net loss $ (4,860) $ (5,923)
Adjustments:
Extraordinary loss -- --
Consolidated provision for income taxes (2,978) (3,630)
Fixed charges less interest income 10,879 12,159
--------------- --------------
Earnings as adjusted (A) 3,041 2,606
=============== ==============
Fixed Charges:
Interest on debt and capitalized leases 10,879 12,159
Amortization of deferred financing costs -- --
--------------- --------------
Fixed Charges (B) 10,879 12,159
=============== ==============
Ratio of earnings to fixed charges (A) divided by (B) -- --
Deficiency of earnings to fixed charges 7,838 9,553
</TABLE>
<PAGE>
PROTECTION ONE, INC.
EXHIBIT 21 - SUBSIDIARIES
DECEMBER 31, 1999
ENTITY JURISDICTION
Protection One Alarm Monitoring, Inc. Delaware
Network Multifamily Security Corporation Delaware
Security Monitoring Services, Inc. Florida
Protection One U.K., Inc. United Kingdom
Protection One Canada Ontario
Canguard, Inc. Ontario
Protection One International, Inc. Delaware
Protection One France, EURL France
Compagnie Europeenne de Telesecurite France
Protection One Investments, Inc. Delaware
<PAGE>
EXHIBIT 23.1
CONSENT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Protection One, Inc.:
As independent public accountants, we hereby consent to the incorporation by
reference in this Form 10-K of our report dated March 10, 2000, into the
Company's previously filed Registration Statement File Numbers 033-83494,
033-99220, 033-95702, 033-97542, 333-02828, 333-02892, 333-20245, 333-24493,
333-50383, 333-64021, 333-77295 and 333-30328.
Arthur Andersen LLP
Kansas City, Missouri
March 28, 2000
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<CIK> 0000916310
<NAME> PROTECTION ONE ALARM MONITORING, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 12-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-END> DEC-31-1999
<CASH> 7,658
<SECURITIES> 6,664
<RECEIVABLES> 102,405
<ALLOWANCES> 30,689
<INVENTORY> 12,908
<CURRENT-ASSETS> 186,380
<PP&E> 89,919
<DEPRECIATION> 29,007
<TOTAL-ASSETS> 2,558,235
<CURRENT-LIABILITIES> 214,313
<BONDS> 822,291
1,269
0
<COMMON> 0
<OTHER-SE> 1,261,328
<TOTAL-LIABILITY-AND-EQUITY> 2,558,235
<SALES> 605,176
<TOTAL-REVENUES> 605,176
<CGS> 184,006
<TOTAL-COSTS> 184,006
<OTHER-EXPENSES> (12,869)
<LOSS-PROVISION> 21,641
<INTEREST-EXPENSE> 87,037
<INCOME-PRETAX> (109,490)
<INCOME-TAX> (28,276)
<INCOME-CONTINUING> (81,214)
<DISCONTINUED> 0
<EXTRAORDINARY> (1,691)
<CHANGES> 0
<NET-INCOME> (82,905)
<EPS-BASIC> (0.65)
<EPS-DILUTED> (0.65)
</TABLE>
