<PAGE>
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2000
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________
0-24780 33-73002-01
(Commission File Number) (Commission File Number)
PROTECTION ONE, INC. PROTECTION ONE ALARM MONITORING, INC.
(Exact Name of Registrant (Exact Name of Registrant
As Specified In its Charter) As Specified In its Charter)
DELAWARE DELAWARE
(State or Other Jurisdiction (State of Other Jurisdiction
Of Incorporation or Organization) Of Incorporation or Organization)
93-1063818 93-1064579
(I.R.S. Employer Identification No.) (I.R.S. Employer Identification No.)
6011 BRISTOL PARKWAY, 6011 BRISTOL PARKWAY,
CULVER CITY, CALIFORNIA 90230 CULVER CITY, CALIFORNIA 90230
(Address of Principal Executive Offices, (Address of Principal Executive
Including Zip Code) Offices, Including Zip Code)
(310) 342-6300 (310) 342-6300
(Registrant's Telephone Number, (Registrant's Telephone Number,
Including Area Code) Including Area Code)
Indicate by check mark whether each of the registrants (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter
period that such registrants were required to file such reports) and (2) has
been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
As of May 1, 2000, Protection One, Inc. had outstanding 127,029,361
shares of Common Stock, par value $0.01 per share. As of such date,
Protection One Alarm Monitoring, Inc. had outstanding 110 shares of Common
Stock, par value $0.10 per share, all of which shares were owned by
Protection One, Inc. Protection One Alarm Monitoring, Inc. meets the
conditions set forth in General Instructions H(1)(a) and (b) for Form 10-Q
and is therefore filing this form with the reduced disclosure format set
forth therein.
<PAGE>
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
MARCH 31, DECEMBER 31,
2000 1999
-------------- -------------
ASSETS
<S> <C> <C>
Current assets:
Cash and cash equivalents ................................ $ 1,612 $ 7,658
Restricted cash .......................................... 779 11,175
Marketable securities .................................... -- 6,664
Receivables, net ......................................... 39,495 71,716
Inventories .............................................. 10,617 12,908
Prepaid expenses ......................................... 2,420 3,471
Related party tax receivable & current deferred
tax assets .............................................. 42,592 59,456
Other assets ............................................. 9,210 13,332
----------- -----------
Total current assets ................................ 106,725 186,380
Property and equipment, net .................................... 49,998 60,912
Customer accounts, net ......................................... 1,000,952 1,139,066
Goodwill, net .................................................. 933,337 1,101,788
Other .......................................................... 27,526 70,089
----------- -----------
Total assets ................................................ $ 2,118,538 $ 2,558,235
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt ........................ $ 37,774 $ 35,498
Accounts payable ......................................... 5,967 23,205
Accrued liabilities ...................................... 51,248 74,248
Purchase holdbacks ....................................... 8,763 20,213
Deferred revenue ......................................... 52,889 61,149
----------- -----------
Total current liabilities ........................... 156,641 214,313
Long-term debt, net of current portion ......................... 664,962 1,077,152
Other liabilities .............................................. 597 4,173
----------- -----------
Total liabilities ........................................... 822,200 1,295,638
Commitments and contingencies ( See Note 6)
Stockholders' equity:
Preferred stock, $0.10 par value, 5,000,000 authorized, none
outstanding ................................................. -- --
Common stock, $0.01 par value, 150,000,000 shares authorized,
126,945,337 shares issued and outstanding at March 31, 2000
and December 31, 1999 ....................................... 1,269 1,269
Additional paid-in capital .................................. 1,420,828 1,392,750
Accumulated other comprehensive income, net ................. (99) (1,805)
Accumulated deficit ........................................ (125,660) (129,617)
----------- -----------
Total stockholders' equity .......................... 1,296,338 1,262,597
----------- -----------
Total liabilities and stockholders' equity .................. $ 2,118,538 $ 2,558,235
=========== ===========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
2
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands, except for per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------------
2000 1999
---------------- ---------------
<S> <C> <C>
Revenues:
Monitoring and related services ..................... $ 116,171 $ 127,244
Installation and rental ............................. 18,552 21,303
--------- ---------
Total revenues ................................. 134,723 148,547
Cost of revenues:
Monitoring and related services ..................... 33,762 29,697
Installation and rental ............................. 10,110 11,784
--------- ---------
Total cost of revenues ......................... 43,872 41,481
--------- ---------
Gross profit ................................... 90,851 107,066
Operating expenses:
Selling, general and administrative expenses ......... 41,044 40,400
Amortization of intangibles and depreciation expense . 60,097 43,006
Acquisition expense .................................. 4,362 4,866
Severance and other nonrecurring expense ............ 3,050 2,000
--------- ---------
Total operating expenses .................................. 108,553 90,272
--------- ---------
Operating income (loss) ........................ (17,702) 16,794
Other (income) expense:
Interest expense, net ............................... 19,481 20,171
Other ............................................... (282) (345)
--------- ---------
Loss before income taxes & extraordinary gain .. (36,901) (3,032)
Income tax (expense) benefit .............................. 8,932 (1,753)
--------- ---------
Loss before extraordinary item ............................ (27,969) (4,785)
Extraordinary gain, net of tax effect of $17,191 .......... 31,926 --
--------- ---------
Net income (loss)..................................... $ 3,957 $ (4,785)
========= =========
Other comprehensive income (loss):
Unrealized gain (loss) on marketable securities, net
of tax effect of $633 and $511 ............................ $ 995 $ (767)
Unrealized gain (loss) on currency translation, net
of tax effect of $474 and $521 ............................ 711 (781)
--------- ---------
Comprehensive income (loss): .............................. $ 5,663 $ (6,333)
========= =========
Loss per common share ................................ $ (0.22) $ (0.04)
========= =========
Extraordinary gain per common share .................. $ 0.25 $ --
========= =========
Net income(loss) per common share .................... $ 0.03 $ (0.04)
========= =========
Weighted average common shares outstanding (in
thousands) .......................................... 126,945 126,839
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
3
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
-----------------------------------
2000 1999
--------------- ---------------
<S> <C> <C>
Cash flow from operating activities:
Net income (loss) ................................................ $ 3,957 $ (4,785)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Extraordinary gain ........................................... (31,926) --
Amortization of intangibles and depreciation ................. 60,097 43,006
Accretion of debt premium .................................... (1,573) (1,659)
Deferred income taxes ........................................ (9,321) 1,760
Provision for doubtful accounts .............................. 6,811 3,043
Loss on sale of marketable securities ........................ -- 343
Other ........................................................ (3,520) (4,817)
Changes in assets and liabilities, net of effects of
acquisitions and dispositions:
Receivables, net ............................................. 4,256 (1,865)
Other current assets ......................................... (10,550) 1,253
Accounts payable ............................................. 197 380
Other liabilities ............................................ (5,082) (1,991)
--------- ---------
Net cash provided by operating activities ............... 13,346 34,668
--------- ---------
Cash flows from investing activities:
Purchase of installed security systems, net .................. (13,180) (78,601)
Purchase of property and equipment, net ...................... (5,089) (12,170)
Sale of investments .......................................... -- 2,544
Acquisition of alarm companies, net of cash received ......... -- (20,722)
Sale of European operations and other investments ............ 183,025 --
--------- ---------
Net cash provided by (used in) investing activities...... 164,756 (108,949)
--------- ---------
Payments on long-term debt ................................... (212,594) --
Proceeds from long term-debt ................................. 26,087 82,130
Funding from parent .......................................... 2,414 (222)
--------- ---------
Net cash provided by (used in) financing activities...... (184,093) 81,908
--------- ---------
Effect of exchange rate changes on cash and equivalents .......... (55) (964)
--------- ---------
Net increase (decrease) in cash and cash equivalents..... (6,046) 6,663
Cash and cash equivalents:
Beginning of period .......................................... 7,658 10,025
--------- ---------
End of period ................................................ $ 1,612 $ 16,688
========= =========
Interest paid during the period .................................. $ 31,244 $ 13,524
========= =========
Taxes paid during the period ..................................... $ 72 $ 256
========= =========
</TABLE>
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES:
In the first quarter of 2000 the Company sold its European operations
for $225,000 and certain investments for $19,000 to Westar Capital, as discussed
in Note 3. In exchange, the Company received $183,025 in cash and $60,975 market
value of its outstanding bonds. The Company also received $14,985 market value
of its bonds and a $14,198 note receivable from Westar Capital for payment of
the Company's 1998 income tax receivable of $20,287 and an intercompany
receivable of $8,896.
The accompanying notes are an integral part of these
consolidated financial statements.
4
<PAGE>
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
(UNAUDITED)
1. BASIS OF CONSOLIDATION AND INTERIM FINANCIAL INFORMATION:
Protection One, Inc., a Delaware corporation ("Protection One" or the
"Company"), is principally engaged in the business of providing security
alarm monitoring services, which include sales, installation and related
servicing of security alarm systems for residential and small business
subscribers in North America, 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. The accompanying unaudited consolidated financial
statements include the accounts of Protection One and its wholly owned
subsidiaries.
The Company's unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles ("GAAP")
for interim financial information and in accordance with the instructions to
Form 10-Q. Accordingly, certain information and footnote disclosures normally
included in financial statements presented in accordance with generally
accepted accounting principles have been condensed or omitted. These
financial statements should be read in conjunction with the audited financial
statements and notes thereto for the year ended December 31, 1999, included
in the Company's Annual Report on Form 10-K filed with the Securities and
Exchange Commission (the "SEC").
In the opinion of management of the Company, all adjustments considered
necessary for a fair presentation of the financial statements have been
included. The results of operations for the three months ended March 31, 2000
are not necessarily indicative of the results to be expected for the full
year.
The Company expects to adopt two new statements on January 1, 2001. SFAS
No. 133 and No. 137, "Accounting for Derivative Instruments and Hedging
Activities" establish accounting and reporting standards for derivative
instruments, including certain derivative instruments embedded in other
contracts, (collectively referred to as derivatives) and for hedging
activities. The statements require that an entity recognize all derivatives
as either assets or liabilities in the statement of financial position and
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.
Certain reclassifications have been made to prior year information to
conform with the current year presentation.
2. CHANGE IN ACCOUNTING ESTIMATE:
The excess of the cost over the fair value of net assets of businesses
acquired is recorded as goodwill. The Company has historically amortized
goodwill on a straight-line basis over 40 years. 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, is being amortized over its remaining useful life
based on a 20-year life. The resulting increase in annual goodwill
amortization on the Company's existing account base will be approximately
$24,000 for North America and $6,000 for Multifamily. The additional goodwill
recorded for Europe prior to its sale on February 29, 2000 was approximately
$1,000.
5
<PAGE>
The change in estimate resulted in additional goodwill amortization for
the first quarter of 2000 of $7,968. The resulting reduction to net income
was $7,064 or a decrease in earnings per share of $0.06.
Amortization expense for the three months ended March 31, 2000 and March
31, 1999, was $14,897 and $8,469, respectively.
3. 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 $183,025 in cash and
certain of the Company's outstanding debt securities Westar Capital had
acquired in open market purchases for approximately $60,975. 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 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 March 2000, the note with
Westar Capital was reduced by $9,304 through delivery of additional
outstanding debt securities of the Company.
The carrying amount for the respective debt securities received for the
above transactions were as follows:
<TABLE>
<CAPTION>
February 29 March
Debt Security (Interest Rate) Transaction Transactions Total
- ------------------------------------- ------------------- --------------- ---------------------
<S> <C> <C> <C>
Senior Subordinated Discount Notes
(13.625%) $38,892 $4,832 $43,724
Convertible Senior Subordinated
Notes (6.75%) 49,550 -- 49,550
Senior Subordinated Notes (8.125%) 46,110 10,000 56,110
------------------- --------------- ---------------------
Totals $134,552 $14,832 $149,384
=================== =============== =====================
</TABLE>
No gain or loss was recognized on the related party sale of the European
operations. Adjustments were made to Additional Paid-In Capital to reflect the
amounts that would have been considered gains or losses had the buyer not been a
related party. 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 quarters ended March 31, 2000 and March 31,1999 assume the sale of the
European operations occurred on January 1, 1999.
6
<PAGE>
<TABLE>
<CAPTION>
QUARTER ENDED MARCH 31,
-----------------------
2000 1999
---- ----
(IN THOUSANDS, EXCEPT
PER SHARE AMOUNTS)
<S> <C> <C>
Revenues .................................... $106,818 $109,014
Loss before extraordinary item .............. (24,126) (3,735)
Net income (loss) ........................... 7,800 (3,735)
Net income (loss) per common share (basic and
diluted):
Loss before extraordinary item ............ (.19) (.03)
Net income (loss) ......................... .06 (.03)
</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.
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>
4. CUSTOMER ACCOUNTS:
The following reflects the changes in the Company's investment in customer
accounts (at cost) for the following periods:
<TABLE>
<CAPTION>
Three Months Ended Year Ended
March 31, 2000 December 31, 1999
------------------------ -----------------------
<S> <C> <C>
Beginning customer accounts, net $ 1,139,066 $ 1,031,956
Acquisition of customer accounts, net 7,930 333,195
Amortization of customer accounts, net (36,876) (189,214)
Non-cash charges to purchase holdbacks (1,362) (36,871)
Sale of European operations (107,806) --
------------------------ -----------------------
Total customer accounts $1,000,952 $1,139,066
======================== =======================
</TABLE>
Accumulated amortization of the investment in customer accounts at March
31, 2000 and December 31, 1999 was $316,121 and $307,600 respectively. The
1999 accumulated amortization excluding Europe was $282,399.
In conjunction with certain purchases of customer accounts, the Company
withholds a portion of the purchase price as a reserve to offset qualifying
losses of the acquired customer accounts for a specified period as provided
for in the purchase agreements, and as a reserve for purchase price
settlements of assets acquired and liabilities assumed. The estimated amount
to be paid at the end of the holdback period is capitalized and an equivalent
current liability established at the time of purchase. As of March 31, 2000
and December 31, 1999, purchase holdbacks were $8,763 and $20,213,
respectively.
5. DEBT:
During the first quarter of 2000 the Company's outstanding debt decreased
by $445,201. The decrease resulted primarily from the $183,025 reduction of
the Senior Credit Facility and the extinguishment of debt securities received
in the sale of the European operations and related party transactions, as
discussed in Note 3. In March 2000, the Company used available cash to pay
down an additional $20,000 of the Senior Credit Facility and also purchased
an additional $6,000 face value of the
7
<PAGE>
Senior Subordinated Discount Notes. The total first quarter extraordinary
gain from this extinguishment of debt and the extinguishment of the debt
securities received in the transactions with Westar Capital is $31,926, net
of tax of $17,191.
As of March 31, 2000, and December 31, 1999, total borrowings under the
Senior Credit Facility were $37,000 and $225,000, respectively. The remaining
availability under this facility as of March 31, 2000, and December 31, 1999
was $78,000 and $25,000, respectively. The Company's ability to borrow under
the facility is subject to compliance with certain financial covenants,
including a leverage ratio of 5.75 to 1.0 and an interest coverage ratio of
2.10 to 1.0. At March 31, 2000, these ratios were approximately 4.4 to 1.0
and 2.7 to 1.0, respectively.
The indentures governing the Company's outstanding senior and
subordinated notes contain similar covenants with different calculations
relating to the Company's ability to incur indebtedness. The Company is in
compliance with all covenants contained in these indentures.
6. COMMITMENTS AND CONTINGENCIES:
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 and Westinghouse
Security Systems acquisitions and other matters. These discussions are
continuing. The SEC staff has not indicated it concurs with, nor has the SEC
staff determined not to object to, the restatements to the Company's
financial statements 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, its subsidiary Protection One Alarm Monitoring, Inc.
("Monitoring"), and certain present and former officers and directors of
Protection One are defendants in a purported class action litigation pending
in the United States District Court for the Central District of California,
RONALD CATS, ET AL V. PROTECTION ONE, INC., ET AL., No CV 99-3755 DT (RCx).
Pursuant to an Order dated August 2, 1999, four pending purported class
actions were consolidated into a single action. In March 2000, plaintiffs
filed a Second Consolidated Amended Class Action Complaint ("Amended
Complaint"). Plaintiffs purport to bring the action on behalf of a class
consisting of all purchasers of publicly traded securities of Protection One,
including common stock and notes, during the period of February 10, 1998
through November 12, 1999. The Amended Complaint asserts claims under Section
11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange
Act of 1934 against Protection One, Monitoring, and certain present and
former officers and directors of Protection One based on allegations that
various statements concerning Protection One's financial results and
operations for 1997 and 1998 were false and misleading and not in compliance
with generally accepted accounting principles. Plaintiffs allege, among other
things, that former employees of Protection One have reported that Protection
One lacked adequate internal accounting controls and that certain accounting
information was unsupported or manipulated by management in order to avoid
disclosure of accurate information. The Amended Complaint further asserts
claims against Western Resources and Westar 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 May 1, 2000, none of these
dealers have commenced arbitration.
8
<PAGE>
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.
7. SEGMENT REPORTING:
The Company's reportable segments include North America, Multifamily and
Europe. North America provides residential, commercial and wholesale security
alarm monitoring services, which include sales, installation and related
servicing of security alarm systems in the United States and Canada.
Multifamily provides security alarm services to apartments, condominiums and
other multi-family dwellings. The Europe segment provided security alarm
services to residential and business customers in Europe.
The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies in the Company's
1999 Form 10-K. The Company manages its business segments based on earnings
before interest, income taxes, depreciation and amortization (EBITDA).
9
<PAGE>
THREE MONTHS ENDED MARCH 31, 2000
(Dollars in thousands)
<TABLE>
<CAPTION>
North
-----
America Multifamily Europe(2) Consolidated
------- ----------- --------- ------------
<S> <C> <C> <C> <C>
Revenues...................................... $96,678 10,141 27,904 134,723
EBITDA........................................ 34,923 4,122 6,400 45,445
Amortization of intangibles and depreciation 50,843 3,834 5,420 60,097
expense.......................................
Other(1)...................................... 3,050 -- -- 3,050
Operating income (loss)....................... (18,970) 288 980 (17,702)
THREE MONTHS ENDED MARCH 31, 1999
(Dollars in thousands)
North
-----
America Multifamily Europe Consolidated
------- ----------- ------ ------------
<S> <C> <C> <C> <C>
Revenues...................................... $99,017 $9,996 $39,534 $148,547
EBITDA........................................ 45,015 4,598 12,187 61,800
Amortization of intangibles and depreciation 35,223 2,297 5,486 43,006
expense.......................................
Other(1)...................................... 2,000 -- -- 2,000
Operating income.............................. 7,792 2,301 6,701 16,794
</TABLE>
(1) "Other" includes employee severance in 1999, and employee severance and
costs related to the sale of the European operations in 2000.
(2) Information for Europe is for the two months ended February 29, 2000.
8. RELATED PARTY TRANSACTIONS:
In the first quarter, the Company expensed $1,087 for marketing services
provided under the marketing agreement it has with Paradigm Direct LLC
("Paradigm"). Westar Capital has a 40% ownership interest in Paradigm. During
the first quarter, the Company began acquiring new accounts under the
Paradigm pilot program which is anticipated to be extended through June 30,
2000. At March 31, 2000, the Company has a prepaid balance with Paradigm of
approximately $1,018 for anticipated account purchases.
During the first quarter of 2000, the Company incurred charges of
approximately $738 for services under the services agreement with Western
Resources.
At March 31, 2000, the Company had a note receivable from Westar Capital
of $4,895, related accrued interest income of $103 and a net intercompany
balance owed to Western Capital of $1,747 primarily for intercompany billings
for services provided under the services agreement.
At March 31, 2000, the Company had outstanding borrowings of $37,000 from
the Senior Credit Facility held by Westar Capital. During the first quarter
of 2000, interest expense of $3,473 was accrued on borrowings from this
facility and total interest payments of $4,223 were made to Westar Capital.
9. INCOME TAXES:
The income tax benefit recorded for the three-month period ended March
31, 2000 is approximately 24% of the pre-tax loss. This rate represents the
expected effective rate for 2000. The difference between the expected annual
effective rate of 24% and the federal statutory rate of 35% is primarily
attributable to non-deductible goodwill amortization. The Company has a tax
sharing agreement with Western Resources which allows it to be reimbursed for
tax deductions utilized by Western Resources in its consolidated tax return.
If the Company did not file its taxes on a consolidated basis with Western
Resources, the Company's deferred tax assets might not be realizable and the
Company might not be in a position to record a tax benefit for losses
incurred.
10. UNREALIZED GAINS AND LOSSES:
The following reflects the changes in unrealized gains and losses in
marketable securities and in currency fluctuations for the quarter ended
March 31, 2000:
<TABLE>
<S> <C>
Unrealized loss on marketable securities ($1,202)
Less: reclassification adjustment for losses
included in sale of European operations (2,830)
--------
Net unrealized gain $1,628
========
Unrealized loss on currency translation ($1,236)
Less: reclassification adjustment for losses
included in sale of European operations (2,421)
--------
Net unrealized gain $1,185
========
</TABLE>
11. RECENT DEVELOPMENTS:
10
<PAGE>
On March 29, 2000, Western Resources announced that its Board of
Directors had approved the separation of its electric utility business from
its non-electric businesses. Western Resources indicated that the separation
is expected to be accomplished by means of a voluntary exchange offer. The
exchange offer will provide Western Resources shareholders with the
opportunity to exchange some or all of their Western Resources common stock
for shares in Westar Capital. Western Resources also indicated that Westar
Capital is expected to consist of the approximate 85% ownership interest in
the Company, an approximate 45% ownership interest in ONEOK Inc., a
Tulsa-based natural gas company, a 100% ownership interest in Protection One
Europe (formerly the Europe segment of the Company), and a 40% ownership in
Paradigm Direct LLC, and other investments.
The Western Resources announcement indicates that Westar Capital expects
to make a partial disposition of its interest in the Company through the
issuance of $15,000 in preferred stock to a third party.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
FORWARD-LOOKING STATEMENTS
Certain matters discussed here and elsewhere in this Form 10-Q are
forward-looking statements. The Private Securities Litigation Reform Act of 1995
has established that these statements qualify for safe harbors from liability.
Forward-looking statements may include words like the Company believes,
anticipates, expects or words of similar meaning. Forward-looking statements
describe the Company's future plans, objectives, expectations, or goals. Such
statements address future events and conditions concerning capital expenditures,
earnings, restructuring the dealer program and the methods of customer
acquisition, litigation, the outcome of accounting issues being reviewed by the
SEC staff, possible corporate restructurings, mergers, acquisitions,
dispositions, liquidity and capital resources, compliance with debt covenants,
interest, ability to enter new markets successfully and capitalize on growth
opportunities, and accounting matters. What happens in each case could vary
materially from what the Company expects because of such things as future
economic conditions; legislative developments; competitive markets; and other
circumstances affecting anticipated operations, revenues and costs.
-----------------------------------------------
Unless the context otherwise indicates, all references in this Report on
Form 10-Q (this "Report") to the "Company," "Protection One," "we," "us" or
"our" or similar words are to Protection One, Inc., its wholly owned subsidiary,
Protection One Alarm Monitoring, Inc. ("Protection One Alarm Monitoring") and
Protection One's other wholly owned subsidiaries. Protection One's primary asset
is, and Protection One operates primarily through, its investments in Protection
One Alarm Monitoring and its other wholly owned subsidiaries. Both Protection
One and Protection One Alarm Monitoring are Delaware corporations organized in
September 1991.
The following Management's Discussion and Analysis of Financial Condition
and Results of Operations updates the information provided in and should be read
in conjunction with Management's Discussion and Analysis of Financial Condition
and Results of Operations in our 1999 Annual Report on Form 10-K.
OVERVIEW
Protection One is one of the leading providers of property monitoring
services, providing electronic monitoring and maintenance of its alarm systems
to nearly 1.5 million customers in North America. We also provide our customers
with enhanced services that include:
- extended service protection;
- patrol and alarm response;
- two-way voice communication;
11
<PAGE>
- medical information service; and
- cellular back-up.
Approximately 85% of our revenues are contractually recurring for monitoring
alarm security systems and other related services.
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 servicing 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 we provide repair service of security systems and, in
certain markets, armed response to verify that an actual emergency has occurred.
We provide our services to residential (both single family and multifamily
residences), commercial and wholesale customers. In prior years, the Company's
strategy was focused primarily on growing its customer account base to achieve
critical mass. We believe we have reached such critical mass 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; and
- growing our commercial business.
Our company is divided into two business segments:
PROTECTION ONE NORTH AMERICA ("North America") generated approximately $96.7
million, or 71.8%, of our revenues in the first quarter of 2000 and is comprised
of Protection One Alarm Monitoring-our core alarm monitoring business based in
Culver City, California.
MULTIFAMILY generated approximately $10.1 million, or 7.5%, of our revenues
in the first quarter of 2000 and is comprised of our alarm monitoring business
servicing the multifamily/apartment market based in Addison, Texas.
On February 29, 2000 we sold Protection One Europe ("Europe") which
generated approximately $27.9 million of revenues through February 29, 2000.
Europe was comprised of:
- Protection One Continental Europe - an alarm monitoring business
servicing continental Europe established from our purchase of Compagnie
Europeenne de Telesecurite ("CET") in September 1998, based in Paris and
Vitrolles, France with offices in Germany, Switzerland, Belgium and the
Netherlands; and
12
<PAGE>
- Protection One United Kingdom - an alarm monitoring business servicing
the United Kingdom established from our purchase of Hambro Countrywide
Security in May 1998, based in Basingstoke, United Kingdom.
SALE OF EUROPEAN ASSETS AND OTHER TRANSACTIONS
On February 29, 2000 the Company sold its European operations and certain
investments to Westar Capital. The consideration received was approximately $244
million, comprised of approximately $183 million in cash and certain of the
Company's outstanding debt securities Westar Capital had acquired in open market
purchases for approximately $61 million. 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 million outstanding balance under the $250 million 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 million (resulting in availability
of approximately $58 million 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 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.
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 March 2000, the note with
Westar Capital was reduced by $9.3 million through delivery of additional
outstanding debt securities of the Company.
The carrying amount for the respective debt securities received for the
above transactions were as follows:
<TABLE>
<CAPTION>
February 29 March
Debt Security (Interest Rate) Transaction Transactions Total
------------------------------------- ---------------- --------------- ----------------
(in thousands)
<S> <C> <C> <C>
Senior Subordinated Discount Notes
(13.625%) $38,892 $4,832 $43,724
Convertible Senior Subordinated
Notes (6.75%) 49,550 -- 49,550
Senior Subordinated Notes (8.125%) 46,110 10,000 56,110
---------------- --------------- ----------------
Totals $134,552 $14,832 $149,384
================ =============== ================
</TABLE>
No gain or loss was recognized on the related party sale of the European
operations. Adjustments were made to Additional Paid-In Capital to reflect
the amounts that would have been considered gains or losses had the buyer not
been a related party. 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.
CHANGE IN ESTIMATE OF USEFUL LIFE OF GOODWILL
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
13
<PAGE>
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.
Customer attrition by business segment for the three months ended March 31,
2000 and 1999 is summarized below:
<TABLE>
<CAPTION>
CUSTOMER ACCOUNT ATTRITION
--------------------------------------------------------------------------
-------------------------------- --------------------------------------
MARCH 31, 2000 MARCH 31, 1999
--------------- ---------------- ------------------- ------------------
ANNUALIZED TRAILING ANNUALIZED TRAILING
FIRST QUARTER TWELVE FIRST TWELVE
MONTH QUARTER MONTH
--------------- ---------------- ------------------- ------------------
<S> <C> <C> <C> <C>
North America 11.9% 16.1% 11.2% 8.9%
Europe (a) 10.9% 10.2% 4.4% (c)
Multifamily 7.9% 8.3% 4.9% 4.5%
Total Company (b) 11.1% 14.3% 10.0% 8.1%
- ------------------------
</TABLE>
(a) Europe represents annualized activity through February 29, 2000.
(b) Does not include Europe.
(c) European operations were acquired in 1998 and disposed of on
February 29, 2000.
The Company experienced high levels of attrition for the North America
segment in 1999 with quarterly annualized attrition reaching peak levels of
19.1% and 16.3% in the third and fourth quarters, respectively. The quarterly
annualized attrition rate for North America in the first quarter of 2000 was
11.9% as compared to 11.2% in the first quarter of 1999. Management believes
the significant decrease in attrition for North America over the last three
quarters is a result of efforts to improve customer service and collections
of outstanding accounts. The increase in attrition for Multifamily is partly
due to an adjustment to the calculation of attrition for certain accounts
related to businesses acquired by Multifamily in 1998.
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 the
Company's 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
14
<PAGE>
customer accounts, the purchase price allocation to customer accounts in the
Network Multifamily and Westinghouse Security Systems acquisitions and other
matters. These discussions are continuing. The SEC staff has not indicated it
concurs with, nor has the SEC staff determined not to object to, the
restatements to the Company's financial statements made in 1999, the change in
accounting principle for customer accounts, or the change in estimated useful
life 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.
DEALER PROGRAM
The number of accounts being purchased through the dealer program has
decreased significantly from over 25,000 in March 1999 to less than 2,500 in
March 2000. While our previous customer acquisition strategy relied primarily on
the dealer program, our new customer acquisition strategy relies on a more
balanced mix of dealers, internal sales, "tuck-in" acquisitions and direct
marketing. 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 have therefore decreased our reliance on account generation through
the dealer program.
THREE MONTHS ENDED MARCH 31, 2000 COMPARED TO THREE MONTHS ENDED MARCH 31, 1999
We separate our business into three reportable segments: North America,
Multifamily, and through February 29, 2000, Europe. North America provides
security alarm monitoring services, which include sales, installation and
related servicing of security alarm systems in the United States and Canada.
Multifamily provides security alarm services to apartments, condominiums and
other multi-family dwellings. The Europe segment provided security alarm
services in Europe and was sold on February 29, 2000.
NORTH AMERICA SEGMENT
We present the table below for comparison of the North America operating
results for the periods presented. Next to each period's results of operations,
we provide the relevant percentage of total revenues so that you can make
comparisons about the relative change in revenues and expenses.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
----------------------------------------------------
2000 1999
------------------------ --------------------------
Revenues: (DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Monitoring and related services............. $93,167 96.4% $95,247 96.2%
Installation and rental..................... 3,511 3.6 3,770 3.8
------------ ---------- ------------- -----------
Total revenues.............................. 96,678 100.0 99,017 100.0
Cost of revenues:
Monitoring and related services............. 28,125 29.1 23,833 24.1
Installation and rental..................... 3,224 3.3 3,561 3.6
------------ ---------- ------------- -----------
Total cost of revenues...................... 31,349 32.4 27,394 27.7
------------ ---------- ------------- -----------
Gross profit................................ 65,329 67.6 71,623 72.3
Selling, general and administrative expenses.. 26,261 27.2 21,889 22.1
Acquisition and transition expense............ 4,145 4.3 4,719 4.8
Amortization of intangibles and
depreciation expense........................ 50,843 52.6 35,223 35.5
Other charges................................. 3,050 3.1 2,000 2.0
------------ ---------- ------------- -----------
Operating income (loss)....................... $(18,970) (19.6)% $7,792 7.9%
============ ========== ============= ===========
</TABLE>
2000 COMPARED TO 1999. We had a net decrease of 26,246 customers in the
first quarter of 2000 as compared to a net increase of 32,367 customers in the
first quarter of 1999. The average customer base for the first quarters of 2000
and 1999 were 1,191,519 and 1,212,231, respectively, or a decrease of 20,712
customers. The decrease in customers is primarily attributable to
15
<PAGE>
the significant decrease in the number of accounts being purchased from dealers
which has not yet been offset by growth from our other customer acquisition
strategies.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
-----------------------------
2000 1999
-------------- -------------
<S> <C> <C>
Beginning Balance, January 1,....................................... 1,204,642 1,196,047
Additions, net of holdback put backs................................ 9,280 66,269
Customer losses, net of holdback put backs.......................... (35,526) (33,902)
-------------- -------------
Ending Balance, March 31,........................................... 1,178,396 1,228,414
============== =============
Annualized quarterly attrition...................................... 11.9% 11.2%
============== =============
</TABLE>
MONITORING AND RELATED SERVICE REVENUES decreased approximately $2.3
million in the first quarter of 2000 as compared to the first quarter of 1999
due to the smaller average customer base. The average monthly revenue per
account based on the average number of customers for the respective period was
$26.06 for 2000 and $26.19 for 1999. Although we have had some price increases
during the past year, an increase in customer credits issued in the first
quarter of 2000 more than offset the higher monthly rates. We issued additional
customer credits to maintain customer goodwill because of billing problems
encountered when we implemented a new billing and collections system in our
Beaverton monitoring station. We believe these problems have been corrected and
therefore expect the level of credits to decrease in the second quarter of 2000.
INSTALLATION AND RENTAL REVENUES consist primarily of revenues
generated from our internal installations of new alarm systems. These revenues
decreased by approximately $0.26 million or 6.9% from the first quarter of 1999.
COST OF MONITORING AND RELATED SERVICES REVENUES for the first quarter
of 2000 increased by $4.3 million, or 18.0%, to $28.1 million from $23.8 million
for the first quarter of 1999. Compensation costs for the monitoring stations
increased by approximately $2.7 million due primarily to an increase in
personnel from approximately 1,090 to 1,300 employees. The increase in employees
is a direct result of our efforts to improve the level of customer service. In
addition, telecom costs increased $0.4 million, vehicle costs increased $0.6
million and parts and materials costs increased $0.8 million.
COST OF INSTALLATION AND RENTAL REVENUES was $0.34 million or 9.5% less
than in the first quarter of 1999. These costs as a percentage of installation
and rental revenues were approximately 92% for the first quarter of 2000 as
compared to approximately 94% for the first quarter of 1999.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES increased $4.4 million
from $21.9 million in the first quarter of 1999 to $26.3 million in the first
quarter of 2000. The increase is generally comprised of an increase in bad debt
and collection expenses of approximately $2.1 million, and an increase of $1.6
million in subcontract expense primarily for outside information technology
support. We attribute these increases to problems encountered in connection with
the implementation of our new billing and collection software which started in
November 1999. We believe the significant problems have been resolved and that
these costs will decrease in the second quarter.
ACQUISITION EXPENSES generally decreased due to the reduced level of
account acquisitions in the first quarter of 2000 as compared to 1999. In the
first quarter of 1999 we acquired nearly 27,000 new accounts, over 90% of which
were through the dealer program. In the first quarter of 2000 we acquired 4,239
accounts, approximately 50% of which were through the dealer program. The most
significant decrease was third party monitoring expense which dropped from $1.9
million to $0.8 million. This decrease was a direct result of our concentrated
effort in late 1999 to move such accounts to our own monitoring stations. The
overall decrease was partially offset by increases in costs related to the old
dealer program of $1.9 million.
AMORTIZATION OF INTANGIBLES AND DEPRECIATION EXPENSE for the first
quarter of 2000 increased by $15.6 million, or 44.3%, to $50.8 million from
$35.2 million in the first quarter of 1999. As discussed in our 1999 Annual
Report on Form 10-K, we changed our amortization method from a 10-year straight
line method to a 10-year declining balance method as of the third quarter in
1999. Therefore, the amortization expense for the first quarter of 1999 was
calculated using a straight line method whereas the
16
<PAGE>
amortization expense for the first quarter of 2000 is calculated using the
declining balance method. Subscriber amortization for these periods increased
from $26.7 million for the first quarter of 1999 to $32.4 million for the first
quarter of 2000.
As discussed above, we also changed our estimate of the useful life of
goodwill from 40 years to 20 years. As a result, in amortization expense
increased $5.0 million from $6.0 million in the first quarter of 1999 to $11.0
million for the first quarter of 2000. Additionally, in the first quarter of
2000 depreciation expense increased $4.8 million from $2.6 million for the
first quarter of 1999 to $7.4 million in the first quarter of 2000. This
increase is due to accelerated depreciation of the general ledger and accounts
receivable systems installed in 1999. We have decided to move to another
general ledger and accounts receivable system in 2000 which we believe is
better suited to our needs. Depreciation charges for the old system have been
accelerated so that no remaining costs will be left unamortized when we move to
the new systems later in 2000.
OTHER CHARGES for the first quarter of 1999 consisted of officer's
severance costs of $2.0 million. For the first quarter of 2000, these charges
consist of $1.5 million for officer's severance and $1.55 million for expenses
relating to the sale of the European operations.
INTEREST EXPENSE, NET for the first quarter was $18.4 million and $17.1
million for 2000 and 1999, respectively. During the first quarter of 1999,
borrowings under the Senior Credit Facility rose from $42.4 million to $124.0
million with interest rates as low as 6.2%. During the first quarter of 2000,
borrowings under the Senior Credit Facility decreased from $225.0 million to
$37.0 million at interest rates ranging from 7.8% to 8.4%. In the first quarter
of 1999 we accrued interest charges on the $350 million Senior Subordinated
Notes at 8.125%, however, since we have not completed the required exchange
offer, the interest rate relating to this debt increased to 8.625% in June 1999.
Total debt decreased during the first quarter of 2000 from $1,048.1 million to
$702.4 million.
MULTIFAMILY SEGMENT
We present the table below for comparison of the Multifamily operating
results for the periods presented. Next to each period's results of operations,
we provide the relevant percentage of total revenues so that you can make
comparisons about the relative change in revenues and expenses.
<TABLE>
<CAPTION>
THREE MONTHS ENDED MARCH 31,
---------------------------------------------------
2000 1999
------------------------- -----------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues:
Monitoring and related services............................ $8,688 85.7% $8,580 85.8%
Installation and rental.................................... 1,453 14.3 1,416 14.2
------------ ----------- ---------- -----------
Total revenues............................................. 10,141 100.0 9,996 100.0
Cost of revenues:
Monitoring and related services............................ 1,935 19.1 1,676 16.8
Installation and rental.................................... 1,382 13.6 1,042 10.4
------------ ----------- ---------- -----------
Total cost of revenues..................................... 3,317 32.7 2,718 27.2
----------- ----------- ---------- ----------
Gross profit............................................... 6,824 67.3 7,278 72.8
Selling, general and administrative expenses................. 2,702 26.7 2,680 26.8
Amortization of intangibles and depreciation expense......... 3,834 37.8 2,297 23.0
------------ ----------- ---------- -----------
Operating income............................................. $288 2.8% $2,301 23.0%
============ =========== ========== ===========
</TABLE>
2000 COMPARED TO 1999. We increased our customer base a total of 6,719
customers, or 2.3%, from March 31, 1999 to March 31, 2000. The average customer
base was 295,982 for the first quarter of 2000 compared to 288,119 for the first
quarter of 1999. The change in Multifamily's customer base for the period is
shown below.
17
<PAGE>
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------
2000 1999
----------- -----------
<S> <C> <C>
Beginning Balance, January 1,....................................... 294,960 285,954
Additions, net of holdback put backs................................ 7,868 7,849
Customer losses, net of holdback put backs.......................... (5,825) (3,519)
----------- -----------
Ending Balance ..................................................... 297,003 290,284
=========== ===========
Annualized quarterly attrition...................................... 7.9% 4.9%
=========== ===========
</TABLE>
MONITORING AND RELATED SERVICES REVENUES for the first quarter
increased by $0.1 million, or 1.2%, to $8.7 million from $8.6 million for the
first quarter of 1999.
COST OF MONITORING AND RELATED REVENUES for the first quarter of 2000
increased by $0.2 million, or 15.4% to $1.9 million from $1.7 million for the
first quarter of 1999. Monitoring and related service expenses as a percentage
of monitoring and related service revenues increased to 22.2% from 19.5% during
1999. The percentage increase is primarily related to an increase in salaries as
a result of the current competitive labor market.
COST OF INSTALLATION AND RENTAL REVENUES increased by $0.4 million or
32.6% to $1.4 million in the first quarter of 2000 from $1.0 million in the
first quarter of 1999. Installation and rental cost of revenues increased
primarily due to the significant number of installations in 1999 which used less
sophisticated monitoring equipment than Multifamily's standard contracts,
combined with the increased use in 2000 of wireless systems which is expected to
reduce future service costs.
AMORTIZATION OF INTANGIBLES AND DEPRECIATION EXPENSE for the first
quarter of 2000 increased by $1.9 million, or 102.5% to $3.8 million in 1999
reflecting a change in estimate of goodwill life to 20 years which will increase
annual goodwill amortization by approximately $5 million.
EUROPE SEGMENT
The results of operations for the first quarter of 2000 reflect only those
results through February 29, 2000. The operating results for the first quarter
of 1999 reflect activity for the three months ended March 31, 1999.
<TABLE>
<CAPTION>
TWO MONTHS ENDED THREE MONTHS ENDED
FEBRUARY 29, MARCH 31,
-------------------------- -------------------------
2000 1999
-------------------------- -------------------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
Revenues:
Monitoring and related services............................ $14,316 51.3% $23,417 59.2%
Installation and rental.................................... 13,588 48.7 16,117 40.8
------------- ----------- ------------ ----------
Total revenues............................................. 27,904 100.0 39,534 100.0
Cost of revenues:
Monitoring and related services............................ 3,702 13.3 4,187 10.6
Installation and rental.................................... 5,504 19.7 7,181 18.2
------------- ----------- ------------ ----------
Total cost of revenues..................................... 9,206 33.0 11,368 28.8
------------- ----------- ------------ ----------
Gross profit............................................... 18,698 67.0 28,166 71.2
Selling, general and administrative expenses................. 12,081 43.3 15,831 40.0
Acquisition and transition expense........................... 217 0.8 148 0.4
Amortization of intangibles and depreciation expense......... 5,420 19.4 5,486 13.9
------------- ----------- ------------ ----------
Operating income............................................. $980 3.5% $6,701 16.9%
============= =========== ============ ==========
</TABLE>
18
<PAGE>
2000 COMPARED TO 1999. The change in our customer base from January 1, 2000
through February 29, 2000 is shown below:
<TABLE>
<CAPTION>
TWO MONTHS
ENDED
FEBRUARY 29,
----------------
2000
----------------
<S> <C>
Beginning Balance, January 1,....................................... 123,599
Additions, net of holdback put backs................................ 5,718
Customer losses, net of holdback put backs.......................... (2,285)
----------------
Ending Balance ..................................................... 127,032
================
Annualized attrition for two months ended February 29, 2000........ 10.9%
================
</TABLE>
Revenues of approximately $4.5 million in the first two months of 2000 and
$9.5 million in the first quarter of 1999 were recognized as revenue as a result
of ongoing reductions in the liability under recourse obligations. In relation
to this revenue, we also recognized interest expense of approximately $1.0
million and $2.7 million and depreciation expense of approximately $0.8 million
and $1.6 million for the respective periods.
LIQUIDITY AND CAPITAL RESOURCES
We believe we currently maintain the ability to generate sufficient cash to
fund future operations of the business. Generally, cash will be generated from a
combination of our existing $115.0 million Senior Credit Facility, which had
approximately $78 million of availability at March 31, 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 $39.0
million of positive EBITDA from the North America and Multifamily operations in
the first quarter of 2000. EBITDA does not represent cash flow from operations
as defined by generally accepted accounting principles, should not be construed
as an alternative to operating income and is indicative 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.
The Senior Credit Facility matures on January 2, 2001. As of May 4, 2000, we
have borrowed $49.0 million from this facility. We intend to refinance the
Senior Credit Facility with a third party lender prior to the maturity date.
There is no assurance we will be able to obtain financing on similar terms with
no disruption to our operations or liquidity, or at all.
OPERATING CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2000. Our
operating activities provided net cash flows of $13.3 million, a decrease of
$21.3 million from the comparable period for 1999, primarily due to a decrease
in EBITDA of $16.4 million from $61.8 million in the first quarter of 1999 to
45.4 million in the first quarter of 2000.
INVESTING CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2000. Our
investing activities provided net cash flows of $164.8 million in the first
quarter of 2000 compared to a use of cash of $108.9 in the first quarter of
1999. This increase is due to the sale of the European operations and certain
other investments to Westar Capital for $183.0 million in cash along with $61.0
million in other consideration. We also reduced the purchases of customer
accounts and fixed assets by $93.2 million from $111.5 million in the first
quarter of 1999 to $18.3 million in the first quarter of 2000.
19
<PAGE>
FINANCING CASH FLOWS FOR THE THREE MONTHS ENDED MARCH 31, 2000. We
decreased our borrowings under our Senior Credit Facility by $188.0 million. At
March 31, 2000 the Senior Credit Facility had a weighted average interest rate
of 8.4% and an outstanding balance of $37.0 million.
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 March 31, 2000 and as of March 31, 1999:
<TABLE>
<CAPTION>
MARCH 31, MARCH 31,
DEBT SECURITY MATURITY DATE 2000 1999
- ------------------------------------------- ---------------------- ----------------- ---------------
<S> <C> <C> <C>
Convertible Senior Subordinated
Notes (a) September 2003 $ 53,950 $103,500
Senior Subordinated Discount Notes June 2005 61,765 107,900
Senior Unsecured Notes August 2005 250,000 250,000
Senior Subordinated Notes January 2009 293,890 350,000
Senior Credit Facility January 2001 37,000 124,000
----------------- ---------------
$696,605 $935,400
================= ===============
</TABLE>
- -----------------
(a) These notes are convertible into Protection One common stock at a price of
$11.19 per share, which is currently above the price at which our shares are
traded in the public stock markets.
We are in compliance with the financial covenants under the amended Senior
Credit Facility and the indentures for the first quarter of 2000.
In March 2000, Moody's, S & P and Fitch downgraded their ratings on our
outstanding securities with outlook remaining negative. As of May 4, 2000, these
ratings were as follows:
<TABLE>
<CAPTION>
Senior Senior
Unsecured Subordinated
Debt Unsecured Debt
----------------- ---------------------
<S> <C> <C>
S & P B+ B-
Moody's B2 Caa1
Fitch B+ B-
</TABLE>
In April, we purchased an additional $21.9 million face value of our debt
securities which resulted in an extraordinary gain, net of tax, of $4.8 million
in the second quarter. We may also acquire additional debt securities in the
open market or through negotiated transactions based upon market conditions
and other factors. We expect that we would also realize an extraordinary gain
on extinguishment of debt on any such purchases.
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.
20
<PAGE>
TAX MATTERS
Protection One is consolidated into income tax returns filed by its parent,
Western Resources. The two parties have entered into a tax sharing agreement
whereby Western Resources will make cash payments to us for current tax benefits
utilized for income tax return purposes and which will require cash payments
from us for current tax expenses incurred for income tax return purposes. This
arrangement has allowed us to provide a current tax benefit for the year ended
December 31, 1999, as well as for the three months ended March 31, 2000. If the
Company did not file its taxes on a consolidated basis with Western Resources,
the Company's deferred tax assets might not be realizable and the Company might
not be in a position to record a tax benefit for losses incurred.
In the future, if and when we generate income for tax return purposes, we
will proportionately over time utilize existing net operating loss carryforwards
in amounts up to approximately $60 million. Currently, the deferred tax assets
related to the net operating loss carryforwards are fully reserved due to
uncertainty as to their future realizability. However, when net operating loss
carryforwards are utilized, the relief of the corresponding reserve will not
create a benefit, but, as required by generally accepted accounting principles,
will reduce our goodwill balances. The net financial statement effect of this
treatment will cause us to recognize deferred tax expense we might otherwise not
recognize.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has not experienced any significant changes in its exposure to
market risk since December 31, 1999. For additional information on the Company's
market risk, see the Form 10-K for the year ended December 31, 1999.
21
<PAGE>
PART II
OTHER INFORMATION [UPDATE]
ITEM 1. LEGAL PROCEEDINGS.
Information relating to legal proceedings is set forth in Note 6 of the
Notes to Consolidated Financial Statements included in Part I of this report,
which information is incorporated herein by reference.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS.
None.
ITEM 5. OTHER INFORMATION.
None.
22
<PAGE>
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. [UPDATE]
(a) Exhibits. The following exhibit is filed with this Current Report on
Form 10-Q or incorporated by reference.
<TABLE>
<CAPTION>
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
------ -------------------
<S> <C>
27.1 Financial Data Schedule.
</TABLE>
- ---------
(b) During the quarter ended March 31, 2000, the Company filed five Reports on
Form 8-K. A Current Report on Form 8-K dated January 18, 2000, reported the
receipt of a waiver on Monitoring's Senior Credit Facility until January 31,
2000. A Current Report on Form 8-K dated January 26, 2000, reported Western
Resources reached agreement with its banks to eliminate the cross-default
provisions relating to the Company. A Current Report on Form 8-K dated February
1, 2000, reported the receipt of a waiver on Monitoring's Senior Credit Facility
until February 29, 2000. A current report on Form 8-K dated February 29, 2000,
reported the sale of the Company's European operations and certain investments
to Westar Capital. A Current Report on Form 8-K dated March 29, 2000, reported
fourth quarter and 1999 year-end earnings.
23
<PAGE>
SIGNATURES [UPDATE]
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized.
Date: May 4, 2000 PROTECTION ONE, INC.
-------------------------------
PROTECTION ONE ALARM MONITORING, INC.
By: /s/ Anthony D. Somma
-----------------------------------
Anthony D. Somma
Chief Financial Officer
24
<PAGE>
EXHIBIT LIST
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------ -------------------
27.1 Financial Data Schedule.
25
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<CIK> 0000916310
<NAME> PROTECTION ONE ALARM MONITORING INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-END> MAR-31-2000
<CASH> 1,612
<SECURITIES> 0
<RECEIVABLES> 62,967
<ALLOWANCES> 23,472
<INVENTORY> 10,617
<CURRENT-ASSETS> 106,725
<PP&E> 80,640
<DEPRECIATION> 30,642
<TOTAL-ASSETS> 2,118,538
<CURRENT-LIABILITIES> 156,641
<BONDS> 664,827
0
0
<COMMON> 1,269
<OTHER-SE> 1,295,069
<TOTAL-LIABILITY-AND-EQUITY> 2,118,538
<SALES> 134,723
<TOTAL-REVENUES> 134,723
<CGS> 43,872
<TOTAL-COSTS> 43,872
<OTHER-EXPENSES> (282)
<LOSS-PROVISION> 6,811
<INTEREST-EXPENSE> 19,481
<INCOME-PRETAX> (36,901)
<INCOME-TAX> 8,932
<INCOME-CONTINUING> (27,969)
<DISCONTINUED> 0
<EXTRAORDINARY> 31,926
<CHANGES> 0
<NET-INCOME> 3,957
<EPS-BASIC> 0.03
<EPS-DILUTED> 0.03
</TABLE>
