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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
[ ]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 Charter as Specified in Charter)
Delaware Delaware
(State or Other Jurisdiction (State or Other Jurisdiction
of Incorporation or Organization) of Incorporation or Organization)
93-1063818 93-1064579
(I.R.S. Employer Identification No.) (I.R.S. Employer Identification No.)
6011 Bristol Parkway, Culver City, 6011 Bristol Parkway, Culver City,
California, 90230 California, 90230
(Address of Principal Executive (Address of Principal Executive
Offices, 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)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class On Which Registered
6 3/4% Convertible Senior Subordinated
Notes Due 2003 of Protection One Alarm
Monitoring, Inc.
Guaranteed by Protection One, Inc. New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share of Protection One, Inc.
(Title of Class)
Indicate by check mark whether each registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or 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. [ ]
The aggregate market value of the common stock of Protection One, Inc.
held by nonaffiliates on March 25, 1998 (based on the last sale price of such
shares on the Nasdaq National Market) was approximately $155,379,253.
As of March 25, 1998, Protection One, Inc. had outstanding 83,766,369
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 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 furnished to stockholders in
connection with its Annual Meeting of Stockholders to be held April 23, 1998,
are incorporated by reference in Part III of this Form 10-K. Such proxy
statement will be filed with the Commission on or about April 2, 1998.
1
Introductory Notes
Company Structure. Unless the context otherwise indicates, all
references in this Annual Report on Form 10-K (this "Report") to "the Company"
or "Protection One" are to Protection One, Inc. ("POI") and its direct wholly
owned subsidiaries, Protection One Alarm Monitoring, Inc. ("Monitoring"), Westar
Security, Inc. ("Westar") and WestSec, Inc. ("WestSec"). POI operates solely
through and maintains no other assets than its investment in its subsidiaries.
MRR, EBITDA and Adjusted EBITDA. As used in this Report, "MRR" is
monthly recurring revenue (excluding revenues from patrol services) that the
Company is entitled to receive under contracts in effect at the end of the
period, "EBITDA" means earnings before interest, taxes, depreciation and
amortization (excluding nonrecurring charges) and "Adjusted EBITDA" means EBITDA
adjusted by adding selling and marketing expenses, net of revenues, arising from
installation activities. MRR is a term commonly used in the security alarm
industry as a measure of the size of a company, but not as a measure of
profitability or performance, and does not include any allowance for future
attrition or allowance for doubtful accounts. EBITDA is derived by adding to
loss before income taxes, the sum of (i) interest expense, net, (ii)
nonrecurring charges, and (iii) amortization of intangibles and depreciation
expense. Adjusted EBITDA is derived by adding to EBITDA selling and marketing
expenses related to installations and deducting from EBITDA installation
revenues. EBITDA and Adjusted EBITDA do not represent cash flow from operations
as defined by generally accepted accounting principles, should not be construed
as alternatives to net income and are indicative neither of the Company's
operating performance nor of cash flows available to fund the Company's cash
needs. Items excluded from EBITDA and Adjusted EBITDA are significant components
in understanding and assessing the Company's financial performance. Management
believes presentation of EBITDA and Adjusted EBITDA enhances an understanding of
the Company's financial condition, results of operations and cash flows because
EBITDA and Adjusted EBITDA are used by the Company 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 and Adjusted EBITDA have been
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 and net losses.
Forward-Looking Statements. 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 the Company
or its management "believes," "expects," "anticipates" or other words of similar
import. Similarly, statements herein that describe the Company's 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 the expectations of Protection One include, among others:
Protection One's need for additional capital and history of losses; the risks
and uncertainties related to acquisitions of subscriber accounts and alarm
account portfolios and the Protection One dealer program; subscriber account
attrition; the impact of accounting differences for account purchases and new
installations; its high degree of leverage; the possible adverse effect of false
alarm ordinances and future government regulations; risks of liability from
operations; and competition in the security alarm industry. Stockholders,
potential investors and other readers are urged to consider these factors
carefully in evaluating the forward-looking statements. The forward-looking
statements included herein are made only as of the date of this Report and the
Company undertakes no obligation to publicly update such forward-looking
statements to reflect subsequent events or circumstances.
2
PART I
ITEM 1. BUSINESS
Overview
Protection One(R) is a leading provider of security alarm monitoring
and related services in the United States with approximately 1.1 million
subscribers as of March 1998. The Company has grown rapidly since its inception
by participating in both the growth and consolidation of the security alarm
monitoring industry. Protection One has focused its customer growth in major
metropolitan areas demonstrating strong demand for security alarms.
Approximately 50% of the Company's direct subscribers are located in the states
of California, Florida and Texas. The Company also has significant numbers of
direct subscribers in the states of Arizona, Georgia, Kansas, Missouri, Nevada,
New York, North Carolina, Oregon, Tennessee and Washington.
The Company provides its services to the residential, commercial and
wholesale segments of the alarm monitoring market. The Company believes the
residential segment, which represents in excess of 80% of its customer base, is
the most attractive because of its growth prospects, gross margins and size.
Within the residential segment, 62% of the Company's customer base occupy
single-family households and approximately 19% reside in multi-family complexes
such as apartments and condominiums. The remainder of the Company's customer
base is split between commercial subscribers (12% of the customer base) and
subscribers served by independent alarm dealers that subcontract monitoring
services to the Company. Protection One intends to grow its presence in each of
these key market segments, although the residential market remains the most
important for the Company's growth strategy.
Protection One's objectives are to become the largest and fastest
growing provider of high quality alarm monitoring services in the United States,
to expand customer relationships by offering additional services and to build a
preeminent brand name in the security industry. To accomplish its first
objective, the Company is pursuing a growth strategy consisting of new system
sales through its Dealer Program, supplemented by the acquisition of subscribers
from other alarm companies. Through its Dealer Program, independent companies
with residential sales, marketing and installation skills enter into exclusive
dealer contracts with Protection One to provide it with new monitoring customers
for purchase. To supplement this internally controlled marketing distribution
channel, Protection One has been an aggressive acquirer of portfolios of
security alarm subscribers and believes acquisitions remain an important source
of subscriber growth due to the high industry fragmentation. Once it has
acquired a new customer, the Company provides monitoring and field repair
services and strives to expand the customer relationship by offering an array of
enhanced services, such as extended service protection. The Company adds to its
list of services as and when its new product development area creates, tests and
refines new service offerings. Finally, the Company believes there is an
opportunity to create a well-recognized consumer brand due to a lack of consumer
awareness about the security industry. The Company's service and response
vehicles, yard signs, window decals, dealer marketing efforts and affinity
relationships serve as a platform from which to launch further brand development
efforts. The Company believes its development of a focused message about the
Protection One brand will enhance its efforts to broaden customer relationships
and will establish and reinforce Protection One's position as an industry leader
to consumers.
The Company's revenues consist primarily of subscribers' recurring
payments for monitoring and related services. The Company monitors digital
signals communicated by security systems installed at subscribers' premises.
Security systems are designed to detect burglaries, fires and other events.
Through a network of approximately 60 service branches, the Company provides
repair of security systems and, in select markets, armed response to verify that
an actual emergency, rather than a false alarm, has occurred.
Protection One believes it has a competitive cost structure and is
focused on achieving high operating margins by maintaining monitoring and field
service efficiencies and a streamlined corporate staff. To that end, Protection
One seeks to grow its subscriber base in concentrated geographic areas, thereby
enhancing field service efficiency, increasing sales referrals and brand
visibility and reducing attrition. This targeted growth also is consistent with
the Company's belief that a growing trend of municipalities requiring
verification and private response to security alarm emergencies will necessitate
subscriber concentration. To further maintain low operating expenses, Protection
One is consolidating its monitoring function into five state-of-the-art service
centers, each of which uses sophisticated and redundant communications, computer
and power equipment.
3
To enhance customer satisfaction, Protection One maintains two customer
care centers, open 24 hours per day and seven days per week, to address all
non-emergency communications with customers. Each center utilizes sophisticated
technology such as advanced telephone switches, computer-telephone interfaces
(CTI), auto-dialing and voice response units. Protection One pursues a one-call
resolution policy in its customer service centers. Customer service
representatives are trained to answer a wide variety of anticipated customer
questions about products and services and are vested with appropriate authority
to resolve billing issues. Each customer service center also has a help desk
that answers technical questions about operation and repair of security system
equipment in an effort to reduce the requirement for field service.
Historically, Protection One has offered an array of monitoring-related
services to its customer base, including extended service protection and alarm
verification services such as two-way voice communication and patrol and alarm
response services. The Company has solicited customer interest in these enhanced
services and executed a systematic price adjustment program through an internal
outbound marketing function. In the last several years, Protection One has
developed an inbound calling function housed in its customer care centers to
qualify and process prospective customer inquiries arising from an ongoing
advertising program utilizing print, radio and television media. Such
advertising has been offered as part of several of the Company's joint marketing
arrangements with the dual purpose of generating prospective new subscribers and
communicating the Protection One brand.
Recently, Protection One entered into a significant transaction that
substantially increased its size and scope of operations. On November 24, 1997,
Protection One issued approximately 68.7 million shares of its common stock, par
value $.01 per share ("Common Stock"), constituting an 82.4% ownership position,
to Western Resources, Inc. ("Western Resources"), in exchange for the security
businesses of Western Resources, consisting of Westar and WestSec, and an
aggregate of $367.4 million in cash and securities (the "Contribution"). The
Contribution immediately increased the size of Protection One from approximately
250,000 subscribers to 740,000 subscribers, and increased its geographic
coverage from the western United States to the entire country. The Contribution
also strengthened the Company's balance sheet and enhanced its access to capital
to fund its growth strategy.
Subsequent to the end of fiscal year 1997, on February 4, 1998,
Protection One announced its decision to exercise its option to purchase Network
Multi-Family Security Corporation ("Network"), the leading provider of security
alarm monitoring to multi-family dwellings with approximately 200,000
subscribers. Pursuant to the terms of the option, Protection Onewill give
Western Resources cash consideration of approximately $180 million.
On March 2, 1998, Protection One completed the acquisition of 147,000
subscribers and related assets of Multimedia Security Services, Inc.
("Multimedia") for a purchase price of approximately $233 million. The
Multimedia purchase added to the Company's market positions in California,
Florida and Texas and added substantial numbers of subscribers in Kansas and
Oklahoma. In addition, Protection One will maintain Multimedia's monitoring and
customer service center in Wichita, Kansas.
On March 17, 1998, Protection One completed the acquisition of Comsec
Narragansett Security, Inc. ("Comsec") for a cash purchase price of
approximately $45 million and the assumption of $15 million of debt. Comsec's
30,000 subscribers are located primarily in Connecticut, Maine, Massachusetts
and New Hampshire.
Industry and Markets
SDM Magazine reports that the security alarm industry grew 5.2% in
1997, reaching total revenues of approximately $14 billion. Of the industry
total, SDM Magazine estimates that alarm monitoring revenue comprised 20%, or
approximately $2.8 billion, an increase of 7.7% from $2.6 billion in 1996.
According to the results of a survey, SDM Magazine reports that the largest 100
companies in the industry experienced growth of 14.8% in 1997, compared to the
industry growth rate of 5.2%. This disparity reflects a continuing consolidation
of the security alarm industry, as larger firms are actively acquiring smaller
ones. Despite the consolidation activity, however, the security alarm industry
remains highly fragmented. For instance, SDM Magazine estimates that there are
16,000 businesses in the security alarm industry. In addition, the most recent
ranking of security alarm companies by SDM Magazine indicates that only 25
security companies generated revenues in excess of $20 million in 1996; eight of
the 25 companies have been acquired since the date of the survey.
Protection One believes larger alarm companies with internally
generated cash flow and access to
4
capital will continue to grow faster than the industry average. In most cases,
the installation of security systems requires alarm companies to fund the excess
of installation-related costs over installation revenues, a trend that continues
to be prevalent in both the residential and commercial segments. In addition,
the Company believes the growth in false alarms is causing some municipalities
to consider alternatives to response by municipal police. To the extent that
municipalities elect to require some form of private verification of an alarm
prior to police dispatch, such policies could impose additional expenses on
alarm monitoring companies. Due to Protection One's size and access to capital,
the Company believes it is well positioned to compete in the industry.
Strategy
Protection One's objectives are to become the largest and fastest
growing provider of high quality alarm monitoring services in the United States,
to expand customer relationships by offering additional services and to build a
preeminent brand name in the security industry. The Company has developed
strategies to meet each of these objectives, as described below.
Establish Leadership Position
From its inception through 1995, Protection One grew primarily through
the acquisition of portfolios of subscribers from other alarm companies.
Beginning in 1995, the Company's Dealer Program became an important source of
growth and the Company's sole means for capturing a portion of new security
system installations. Through this dual approach, Protection One believes it is
well positioned to benefit from market growth and industry consolidation. Growth
has enabled the Company to achieve economies of scale in its monitoring and
field service operations. As the number of monitored subscribers has increased,
the fixed costs of service centers have been spread over a larger base,
improving monitoring gross margins. Protection One has targeted subscriber
growth in concentrated areas surrounding branch offices. Subscriber proximity to
branch offices positions the Company to provide responsive field repair and
alarm response services, allows the Company to spread branch office fixed costs
over a larger base and increases the productivity of field service technicians
through more efficient scheduling and dispatching.
The Company continues to pursue subscriber and MRR growth in excess of
the industry average. The Company believes growth will enable it to achieve
further economies of scale, particularly with respect to the fixed costs of
general and administrative functions. In addition, achieving its growth goals
assists the Company's efforts in meeting its other goals of expanding customer
relationships and establishing a well-known brand name. Finally, the Company
believes increased market share offers an opportunity to reduce the costs to
identify and procure new subscribers.
The Dealer Program consists of independent companies with residential
and small commercial sales, marketing and installation skills that enter into
exclusive contracts with Protection One to provide it with new monitoring
customers for purchase on an ongoing basis. This program has become an
increasingly important source of growth for Protection One. The Company
anticipates a significant increase in the number of new subscribers generated by
the Dealer Program in the twelve months ended December 31, 1998 due to its
increased size and scope of operation from its combination with Westar and
WestSec. During the twelve months ended December 31, 1997, Westar and WestSec
installed approximately 50,000 new security systems through an internal sales
force. Protection One has substantially completed the conversion of the Westar
and WestSec sales forces to Dealer Program participants, and therefore
anticipates an increase in Dealer Program productivity commensurate with the
previous installation activity.
Protection One believes the Dealer Program is an advantageous marketing
distribution channel because of its high sales productivity, lower acquisition
prices and geographic flexibility. First, as independent companies, dealers are
responsible for the number of new security system installations they complete
each month, and ultimately, the success of their businesses. The Company
believes such financial motivation leads dealers to continuously seek improved
sales and marketing methods. The Company believes a sales function consisting of
salaried Company employees may not have the same financial motivation. Second,
because purchase multiples paid for alarm monitoring contracts tend to increase
with the size of the portfolio, multiples in the Dealer Program are typically
lower than those paid by Protection One for acquisitions. In addition, cash
outlays for new subscribers are entirely variable, changing as the number of
monitoring contracts presented for purchase change each month. Lowering the cost
to generate new subscribers is an important component of the Company's growth
strategy and the Dealer Program's increased contribution relative to other
growth channels is consistent with such effort. Third, Protection One supports
the expansion of successful dealers to other areas
5
of the country. Protection One may assist the dealer financially to fund startup
costs associated with new office openings. Protection One guides Dealer Program
participants to the geographic areas that are the highest priority for the
Company. Finally, because dealers are responsible for sales and marketing
activities, as well as equipment and installation costs, Protection One
maintains a minimal sales staff and infrastructure.
Strategic Alliances provide the Dealer Program with a proprietary
source of prospective customers. Protection One has aggressively pursued
alliances with other companies that have significant residential customer bases.
In particular, Protection One has targeted metropolitan electric and gas
utilities and telephone companies that have strong market positions and receive
inbound phone calls from prospective customers moving into homes. Protection One
believes this inbound lead flow will enable it to reduce its cost to generate
new subscribers in the future, and represents a valuable source of new security
system installations for Dealer Program participants. In turn, electric and gas
utilities facing deregulation have expressed to Protection One an interest in
offering security alarm services to develop more comprehensive relationships
with their customers. Protection One has entered into marketing alliances with
PacifiCorp, Salt River Project, Kansas City Power & Light, Oklahoma Natural Gas,
Kansas Power & Light and Kansas Gas and Electric. In addition, Southwestern Bell
Corporation serves as a sales agent for Protection One in its markets.
Protection One currently has additional utility alliances in
development. The Company continues to believe that the deregulation of the
electric utility industry offers opportunities for mutually beneficial marketing
alliances that will hasten growth in new subscribers and awareness of Protection
One.
In addition to utility alliances, Protection One enjoys partnerships
with leading companies in the insurance, banking, credit card, mortgage and
retail industries. Protection One also has marketing alliances with leading home
builders around the country, through which Protection One has the exclusive
right to market its security systems to new home buyers.
Acquisitions have played an important role in Protection One's growth.
Since the combination with Westar and WestSec, acquisition activity has
increased significantly, as Protection One has acquired approximately 375,000
subscribers through the acquisitions of Network, Multimedia and Comsec. The
Company believes that it has been an effective competitor in the acquisition
market because of the substantial experience of its management in acquiring
alarm companies and subscriber accounts and the Company's industry reputation as
an active purchaser of subscriber accounts. Although the Company approaches all
acquisitions with consistent due diligence, pricing and integration policies,
there are several differences between small and large acquisitions.
The Company typically pursues small acquisitions in existing areas of
operation and believes there are approximately 16,000 alarm companies in its
markets. The Company has focused on acquisitions that allow it to increase
subscriber density in areas surrounding branch operations, which in turn leads
to greater field service and armed response efficiencies. In small acquisitions,
the Company typically acquires only the subscriber accounts, and not the
facilities or liabilities, of such companies.
Because the Company's primary consideration in making an acquisition is
the amount of cash flow that can be derived from the MRR associated with the
purchased accounts, the price paid by the Company is customarily based upon such
MRR. To protect the Company against the loss of acquired accounts and to
encourage the seller of such accounts to facilitate the transfer of subscribers,
management typically requires the seller to provide guarantees against account
cancellations for a period following the acquisition. The Company usually holds
back from the seller a portion of the acquisition price, and has the contractual
right to utilize such holdback to recapture a portion of the purchase price
based on the lost MRR arising from the cancellation of acquired accounts.
In evaluating the quality of the accounts acquired, the Company relies
primarily on management's knowledge of the industry, its due diligence
procedures, its experience in integrating accounts into the Company's
operations, its determination as to attrition rates for the acquired accounts,
and the representations
6
and warranties of the sellers.
In large acquisitions, the Company strives to purchase subscribers and
related assets but often is required to purchase the stock of large alarm
companies. In such cases, the price paid by the Company reflects not only the
MRR associated with the purchase accounts, but also other assets and liabilities
that impact the value of the customer base. Purchase multiples typically
increase with the size and strategic value of a prospective acquisition.
Expand Customer Relationships
As a means to increase revenues, Protection One offers customers an
array of enhanced security services, including extended service protection and
several levels of alarm verification. These services position Protection One as
a full service provider and give dealers more features to sell in their
solicitation of new customers. The Company actively solicits its customers for
interest in these services. In the Las Vegas area, the Company through its
dealers offers a bundle of services consisting of monitoring, extended service
protection and alarm response. The following provides additional detail on
enhanced services:
Extended Service Protection, which covers the normal costs of repair of
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 talk to
persons at the monitored premises from the service center through speakers and
microphones located within the premises. Among other things, such remote audio
verification helps the Company 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 subscribers for use in connection with the management
of their households or businesses.
Supervised monitoring service can also include a daily automatic test feature.
Pager Service, which provides the subscriber with standard pager
services that also enable the Company to reach the subscriber in the event of an
alarm activation.
Medical Identification Card, which enables medical personnel in the
event of a medical emergency to access a subscriber's medical information (e.g.,
allergies, medications and family medical history), emergency contacts and
doctors by calling Protection One's service center.
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.
Protection One's new product development function continually seeks new
services to offer customers.
Brand Development
Based on primary market research, Protection One believes there is an
opportunity to build a preeminent consumer brand in the security industry.
Currently, consumers are unable to name any security industry competitor on an
unaided basis to a significant degree. The Company's service and response
vehicles, yard signs, window decals, dealer marketing efforts and affinity
relationships serve as a base from which to launch further brand development
efforts. The Company has developed a branding strategy to assist it in achieving
its other strategic objectives by positioning it as an industry leader and
establishing a platform for the sale of additional services. The Company
believes a nationally recognized brand supports its goals of becoming an
industry leader and broadening its customer relationships. The Company has
recently completed the first phase of a significant research effort to define a
unique selling proposition for the Protection One
7
brand. The Company will create sales and marketing materials that reflect this
positioning and will coordinate internal and external communications vehicles to
offer a single focused message about the Protection One brand. In addition, the
Company will evaluate all future opportunities for marketing alliances and joint
ventures in the context of the brand strategy, selecting those that enhance its
positioning and accelerate the growth in public awareness of the brand. Finally,
the Company intends to test the use of brand awareness advertising in
conjunction with direct response marketing, in an effort to quantify the extent
to which increased consumer awareness of the brand enhances direct marketing
activities. The Company expects to invest gradually in brand advertising over
time as the security market matures.
Operations
Protection One's operations consist principally of its service centers,
which provide alarm monitoring and customer care services, its branch
operations, which conduct field repair and patrol and alarm response services
and its subscriber acquisition and transition functions, which provide due
diligence and assimilation services to dealers and others.
8
Service Centers
Subscriber Security Alarm Systems. Security alarm systems include
devices installed at the subscribers' premises designed to detect or react to
various occurrences or conditions, such as intrusion or the presence of fire or
smoke. These devices are connected to a computerized control panel that
communicates through telephone lines to a service center. Subscribers may also
initiate an emergency signal from a device such as a "panic button." 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 the central monitoring station.
Monitoring. The Company maintains four service centers to provide
monitoring services to its customer base, and recently added a fifth with the
Multimedia acquisition. The table below provides additional detail about each
service center:
Number of Current Primary
Location Subscribers Capacity Market Segment
Beaverton, OR 250,000 500,000 Residential/Commercial
Dallas, TX 200,000 500,000 Multi-Family
Irving, TX 340,000 1,000,000 Residential/Commercial
Orlando, FL 100,000 500,000 Wholesale
Wichita, KS 147,000 200,000 Residential/Commercial
With the exception of some specialized commercial accounts, the
remainder of the Company's subscriber accounts is monitored at other service
centers and is scheduled to be consolidated into one of the facilities noted
above in 1998.
Each service center incorporates the use of advanced communications and
computer systems that route incoming alarm signals and telephone calls to
operators. Substantially all service center personnel are subject to
pre-employment screening and background checks. Each operator monitors a
computer screen that provides immediate information concerning the nature of the
alarm signal, the subscriber whose alarm has been activated, and the premises on
which such alarm is located. All telephone conversations are automatically
recorded.
Depending upon the type of service for which the subscriber 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
subscriber's premises where this service is available. The Company also provides
a substantial number of subscribers with remote audio verification capability
that enables the central monitoring station to listen and speak directly into
the subscriber's premises in the event of an alarm activation. This feature
allows the Company's personnel to verify that an emergency exists, to reassure
the subscriber, and to expedite emergency response, even if the subscriber is
unable to reach a telephone. Remote audio verification capability also assists
the Company in quickly determining if the alarm was activated inadvertently, and
thus whether a response is required.
The Company's service centers operate 24 hours per day, seven days a
week, including all holidays. Each operator receives training that includes
familiarization with substantially every type of alarm system in the Company's
subscriber base. This enables the operator to tell subscribers how to turn off
their systems in the event of a false alarm, thus reducing the instances in
which a field service person must be dispatched. 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 the Company's primary service centers 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 subscribers' insurance companies as a condition
to insurance coverage.
Wholesale Monitoring. The Company's service center in Orlando, Florida
is a leading provider of wholesale
9
monitoring services to independent dealers. The Orlando service center is one of
only a few wholesale monitoring facilities to offer two-way voice communication
on a widespread basis. Under the typical arrangement, dealers subcontract
monitoring services to the Company, primarily because such dealers do not have
their own monitoring capabilities. The Company 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.
The Company's presence in the wholesale monitoring segment provides it
with another source of prospective acquisition targets. Independent dealers who
subcontract monitoring services to the Company are familiar with the Company's
high quality monitoring and related capabilities, an important consideration for
a prospective seller of a portfolio of security alarm subscribers.
Subscriber Contracts. The Company's alarm monitoring subscriber
contracts generally have initial terms ranging from one to five years in
duration, and provide for automatic renewal for a fixed period (typically one
year) unless the Company or the subscriber elects to cancel the contract at the
end of its term.
Customer Care Services. The Company's customer care centers process
non-emergency communications with the Company's customers. A dedicated group
receives inbound customer calls and routes them to the most appropriate customer
care area. The customer service group addresses customer questions and concerns
about billing, service, credit and alarm activation issues, arising from calls
forwarded by the inbound group and customer letters. A help desk staff assists
customers in understanding and resolving mechanical and operating issues related
to security systems. A centralized field repair scheduling function sets up
technician appointments. In the Company's Irving, Texas facility, customer care
representatives also are available to monitor emergency signals if the
monitoring function requires additional staffing on a short-term basis. As the
Company continues to add geographic areas in which it offers armed response,
call centers also will serve as centralized dispatchers of response vehicles.
Branch Operations
The Company maintains approximately 60 branches nationwide from which
it provides field repair, customer care, alarm response and sales services. The
Company's branch infrastructure plays an important role in enhancing customer
satisfaction, reducing attrition and building the Company's 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
the Company's subscribers. The Company strives 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
the Company's dealers.
Repair services generate revenues primarily through billable field
service calls and recurring payments under the Company's extended service
protection program. The increasing density of the Company's subscriber base, the
result of continuing efforts to acquire new subscribers in areas surrounding
branch operations, permits more effective scheduling and routing of field
service technicians and results in economies of scale at the branch level.
Increased efficiency in scheduling and routing also allows Protection One to
provide faster field service response and support, which leads to a higher level
of customer satisfaction. The Company continually reviews available automated
work management and scheduling programs to maximize employee resources in the
field repair function.
Alarm Response and Patrol. Protection One offers its subscribers in
southern California and Las Vegas alarm response and patrol enhanced services in
addition to the Company's other services, and employs over 100 patrol officers
operating in 25 regular patrol "beats," or designated neighborhoods, to provide
such services. These armed officers supplement Protection One's alarm monitoring
service by providing "alarm response service" to alarm system activations,
"patrol service" consisting of routine patrol of subscribers' premises and
neighborhoods and, in a few cases, "special watch" services, such as picking up
mail and newspapers and increased surveillance when the subscriber is
travelling. Alarm response service requires
10
Protection One's patrol officers to observe and report any potential criminal
activity at a subscriber's home.
Protection One offers a bundle of services in Las Vegas consisting of
alarm monitoring, field repair and alarm response services billed to the
subscriber as a consistent monthly charge regardless of the number of service
calls or responses to alarm activations. Protection One believes this service
package is attractive to current and prospective subscribers because the package
(i) enables Protection One to offer a reliable and timely alarm response
service, and (ii) eliminates subscriber uncertainty arising from "per response"
charges. The Company will use this bundled service offering in other markets to
the extent private verification of alarms is required.
Patrol and alarm response officers are dispatched by 24-hour central
radio dispatch offices located in Chatsworth, California and Las Vegas, Nevada.
If the patrol officer dispatched observes potential criminal activity, the
officer will report the activity to the dispatch office, which will in turn
notify local law enforcement. The patrol officer will then maintain surveillance
until law enforcement officers arrive. If a patrol officer does not detect
criminal activity, he will report his conclusion to the dispatch office, and
police response will not be initiated.
The Company also offers "dedicated" patrol service to homeowners'
associations in selected markets, for which the Company provides a
Company-marked car for patrol exclusively in such association's neighborhood. A
significant percentage of the homeowners in such associations purchase the
Company's alarm monitoring services.
The Company's patrol and alarm response officers are subject to
extensive 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. Protection One is one of a few companies to have an in-house training
academy which prepares officer candidates for employment. The Company's 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 five weeks of specific training, which amount exceeds all
state requirements. Despite extensive training, however, the provision of patrol
and alarm response services subjects the Company to greater risk, relating to
accidents or employee behavior, than other types of businesses. See "--Risk
Management."
The Company believes 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. Although the Company currently incurs a loss in its patrol and alarm
response operations, the Company believes further demand for such services will
enable the Company to increase subscriber density in its routes, thereby
reducing losses. In addition, the Company's offer of patrol and alarm response
services is a sales method used to attract subscribers of other alarm monitoring
companies that do not provide such services. To the extent that further demand
develops for patrol and alarm response services, the Company believes its
current presence will enable it to increase its conversions of subscribers to
the Company's services. Additionally, the Company believes such services are an
effective impediment to subscriber attrition.
Acquisition and Transition
The Company's acquisition and transition functions manage important
aspects of the Company's Dealer Program and acquisition activity.
11
The Dealer Program offers dealers a wide variety of support services to
assist them as they grow their businesses. On behalf of Dealer Program
participants, Protection One obtains purchase discounts on security systems,
coordinates cooperative dealer advertising and provides administrative,
marketing and employee training support services. The Company believes these
cost savings and services would not be available to Dealer Program participants
on an individual basis. In addition, Protection One supplies its dealers with a
proprietary flow of prospective customers, supplementing the dealers' own
efforts and increasing their chances for success. See "--Sales and Marketing."
Dealer contracts provide for the purchase by the Company of the
dealers' subscriber accounts on an ongoing basis. A dedicated group within
Protection One works with dealers on a daily basis to provide a smooth
transition from the installation of a security system to the purchase of a
monitoring contract. The dealers install Company specified alarm systems (which
have a Protection One logo on the keypad), arrange for subscribers to enter into
Protection One alarm monitoring agreements, and install Protection One yard
signs and window decals. Protection One operators receive inbound calls and test
signals from dealer installation technicians to ensure that systems are
communicating properly. Substantially all of these subscribers are contacted
individually by Company personnel at the time of the purchase of the accounts
from the dealers, to facilitate subscriber satisfaction and quality control. In
addition, the Company requires dealers to qualify prospective subscribers by
meeting a minimum credit standard. Once Protection One has purchased a contract
from a dealer, the Company becomes the sole provider of monitoring, field
service and customer service; the dealer is prohibited from contacting the
customer.
Acquisitions also require dedicated personnel from multiple disciplines
of the Company. In both small and large acquisitions, the Company employs a
comprehensive acquisition management system to identify, evaluate, and integrate
acquisitions of new subscriber accounts that includes three components: (i) the
identification and negotiation stage; (ii) the due diligence stage; and (iii)
the integration stage.
The Company actively seeks to identify prospective companies and
dealers with targeted direct mail, trade magazine advertising, trade show
participation, membership in key alarm industry trade organizations, and
contacts through various prominent vendors and other industry participants.
Management's extensive experience in identifying and negotiating previous
acquisitions helps to facilitate the successful negotiation and execution of
acquisitions in a timely manner.
The Company conducts a pre-closing review and analysis of the seller's
operations. The process includes a combination of selective field equipment
inspections, review of certain of the subscriber contracts and other types of
verification of the seller's operations.
The Company develops a specific integration program, in conjunction
with the seller, for each acquisition. Integration efforts typically include a
letter from the seller to its subscribers, explaining the sale and transition,
followed by one or more letters and packages that include the Company's
subscriber service brochures, field service and monitoring phone number
stickers, yard signs and window decals. Thereafter, each new subscriber is
contacted individually by telephone by a member of the Company's customer
service group for the purpose of addressing the subscriber's questions or
concerns and soliciting certain information. Finally, the subscriber receives a
follow-up telephone call after six months and periodically thereafter.
Management's goal is to enhance new subscriber identification with Protection
One as the service provider and to maintain subscriber satisfaction.
Mobile Services
The Company's mobile services group provides leading edge technology
and professional response for the delivery of emergency, navigation and
information services in mobile applications. The Company became a pioneer in the
mobile security industry when it teamed with Ford Motor Company and Motorola in
1995 to develop Lincoln RESCU. This program offered the first vehicle safety
system to integrate cellular
12
phone and global positioning technology to assist motorists when they need
emergency help or roadside or routing assistance.
Sales and Marketing
Protection One's sales and marketing activities consist of a corporate
advertising and marketing function, centralized inbound and outbound sales
functions, a branch sales function and dealer marketing efforts.
The Company believes that increasing density of the Company's
subscriber base (i.e., increasing concentration of subscribers in certain areas)
has increased the overall presence and visibility of the Company. Both in the
Dealer Program and in Company sales, new subscribers are provided with highly
visible reflective yard signs placed prominently in front of their homes or
businesses. The presence of these signs develops greater awareness in a
neighborhood and leads to more inbound and referral business. The Company
encourages referrals from existing subscribers through an incentive program
promoted through newsletters, billing inserts and employee contacts. Alarm
response and service vehicles, which display the Protection One logo, also
increase the Company's visibility.
Corporate Advertising and Marketing
In the last two years, Protection One has substantially increased its
advertising and marketing efforts to support the Dealer Program. The Company
uses television, radio, newspaper and direct mail with promotional messages to
create sales leads and increase awareness of the Protection One brand. Such
sales leads are distributed to dealers based on their financial contribution to
support cooperative advertising efforts. The Company also has specifically
tailored regional advertising and promotional programs to utilize marketing
alliances where appropriate.
Protection One has marketing alliances with PacifiCorp, Salt River
Project, Kansas City Power & Light, Oklahoma Natural Gas, Kansas Power & Light
and Kansas Gas and Electric. Southwestern Bell Corporation serves as a sales
agent on behalf of Protection One in its markets. Protection One has numerous
additional utility alliances in development. The Company currently has
partnerships with other leading companies in the insurance, banking, credit
card, mortgage and retail industries. Protection One also has a number of
exclusive arrangements with homebuilders, which agreements enable the Company to
market home security systems to new home buyers through the builders.
Protection One has an inbound telemarketing function in each of its
customer service centers to receive and qualify responses to advertising
programs and telephone leads transferred from marketing partners. The Company
maintains an outbound calling function in its Beaverton service center to
solicit interest in enhanced services and to welcome acquired customers to the
Company. Based on expected activity, Protection One supplements both inbound and
outbound efforts with subcontract providers from time to time.
Based on primary market research, Protection One believes there is an
opportunity to build a preeminent consumer brand in the security industry.
Currently, consumers are unable to name any security industry competitor on an
unaided basis to a significant degree. The Company has established a coordinated
branding strategy to assist it in achieving its other strategic objectives by
positioning it as an industry leader and to build a platform for the sale of
additional services. The Company believes a nationally recognized brand supports
its goals of becoming the industry leader and broadening its customer
relationships. The Company has recently completed the first phase of a
significant research effort to define a unique selling proposition for the
Protection One brand. The Company will create sales and marketing materials that
reflect this positioning and will coordinate internal and external communication
vehicles to offer a single focused message about the Protection One brand. In
addition, the Company will evaluate all future opportunities for marketing
alliances and joint ventures in the context of the brand strategy, selecting
those that enhance its positioning and that accelerate the growth in public
awareness of the brand. Finally, the Company intends to test the use of brand
awareness advertising in conjunction with direct response marketing, in an
effort to
13
quantify the extent to which increased consumer awareness of the brand enhances
direct marketing activities. The Company expects to invest gradually in brand
advertising over time as the security market matures.
Branch Sales
The most common reason for customer attrition is customers moving out
of their homes and businesses. Sales professionals at the Company's branch
offices are responsible for tracking previous Protection One subscribers' homes
to sign up new owners when they move into such homes. The branch sales function
also generates revenue from selling equipment upgrades and add-ons to existing
subscribers, and by attracting competitors' subscribers to the Company's
services.
Through acquisitions, the Company now owns and operates a significant
commercial sales and installation effort for security and related monitored
services. At present, the primary commercial sales effort occurs in the
midwestern and northeastern United States. The Company's commercial products
range from basic intrusion and fire detection equipment to fully integrated
systems with card access, closed circuit television and voice/video monitoring.
The Company intends to grow its presence in the commercial markets in the future
and will seek opportunities to expand its commercial presence in other market
areas. The Company also is organizing a national accounts sales and customer
service function to address the special needs of chain customers, such as
restaurants and retailers.
Dealer Marketing
The Company's dealers employ a variety of marketing methods to identify
and create sales leads, including telemarketing, direct mail, local networking
and door-to-door solicitation. A majority of the Company's dealers sell and
install a hard-wired, low-cost security system manufactured by Ademco, a
subsidiary of Pittway Corporation. The basic system includes protection of the
front and back doors of a home, one interior motion detection device, a central
processing unit with the ability to communicate signals to the Company's central
monitoring station, a panic button, a siren, window decals and a lawn sign. This
basic system often will be offered for little or no up-front price, but will be
sold to a subscriber with additional equipment customized to a subscriber'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). Typically, dealers sign
subscribers to alarm monitoring contracts that include a bundled monthly charge
for monitoring and extended service protection. 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 the Company believes the bundling of monitoring
and extended service protection provides additional value to subscribers and
allows the Company to more efficiently provide field repair services.
Competition
The security alarm industry is highly competitive and highly
fragmented. The Company competes with major firms with substantial financial
resources, including ADT Operations Inc., a subsidiary of Tyco International,
Inc.; the security subsidiaries of the Ameritech Corporation; and Brinks Home
Security Inc., a subsidiary of The Pittston Service Group. Other alarm service
companies have adopted a strategy similar to the Company's that entails the
aggressive purchase of alarm monitoring accounts both through acquisitions of
account portfolios and through dealer programs. Some competitors have greater
financial resources than the Company, or may be willing to offer higher prices
than the Company is prepared to offer to purchase subscriber accounts.
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 solicit prospective
subscribers as they move into homes. The Company believes it competes
effectively with other national, regional and local security alarm companies due
to the Company's reputation for reliable equipment and services, its prominent
presence in the areas surrounding its branch offices, its ability to offer
combined monitoring, repair and enhanced services, its low cost structure and
its marketing alliances.
14
Intellectual Property
The Company owns trademarks related to the name and logo for Protection
One, as well as a variety of trade and service marks related to individual
services the Company provides. The Company owns certain proprietary software
applications which the Company uses to provide services to its customers. The
Company also licenses software provided by various software vendors.
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: (i) subjecting alarm monitoring companies to fines or
penalties for transmitting false alarms, (ii) permitting of individual alarm
systems and the revocation of such permits following a specified number of false
alarms, (iii) imposing fines on alarm subscribers for false alarms, (iv)
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 (v)
requiring further verification of an alarm signal before the police will
respond.
The Company's operations are subject to a variety of other laws,
regulations and licensing requirements of federal, state, and local authorities.
In certain jurisdictions, the Company is required to obtain licenses or permits,
to comply with standards governing employee selection and training, and to meet
certain standards in the conduct of its business. Many jurisdictions also
require certain of the Company's 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 subscriber 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.
The Company's advertising and sales practices are regulated by both the
Federal Trade Commission and state consumer protection laws. Such laws and
regulations include restrictions on the manner in which the Company promotes the
sale of its security alarm systems and the obligation of the Company to provide
purchasers of its alarm systems with certain recision rights.
The Company's 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 operation and
utilization of radio frequencies are regulated by the Federal Communications
Commission and state public utilities commissions.
Risk Management
The nature of the services provided by the Company potentially exposes
it to greater risks of liability for employee acts or omissions, or system
failure, than may be inherent in other businesses. Substantially all of the
Company's alarm monitoring agreements, and other agreements pursuant to which it
sells its products and services, contain provisions limiting liability to
subscribers in an attempt to reduce this risk.
The Company's alarm response and patrol services require Company
personnel to respond to emergencies that may entail risk of harm to such
employees and to others. In most cities in which the Company provides such
services, the Company's patrol officers carry firearms, which may increase such
risk. Although the Company conducts extensive screening and training of its
employees, the provision of patrol and alarm response service subjects it to
greater risks related to accidents or employee behavior than other types of
businesses.
The Company carries insurance of various types, including general
liability and errors and omissions insurance. The loss experience of the
Company, and other security service companies, may affect the availability and
cost of such insurance. Certain of the Company's 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.
Year 2000 Issue
15
The Company is reviewing its computer and signal processing to identify
and correct any components that could be affected by the change of the date to
January 1, 2000 (the "Y2K Issue"). Results of the review thus far indicate that
key infrastructure components including processing systems, application software
and telecommunications systems are unaffected by the Y2K Issue. The Company will
continue its review until January 1, 2000, particularly with respect to
acquisitions of security businesses that include additional computer systems and
equipment. In addition, changes in the state of compliance or preparedness
within companies that provide services or equipment to the Company will require
the Company to continue its evaluation. Based on its ongoing review, Management
believes the Y2K Issue does not pose material operational problems and the costs
associated with the assessment of risk and the execution of corrective action
will not be material.
Employees
At December 31, 1997, the Company employed 3,136 individuals on a
full-time basis. Currently, none of the Company's employees is represented by a
labor union or covered by a collective bargaining agreement.
ITEM 2. FACILITIES
The Company maintains its executive offices at 6011 Bristol Parkway,
Culver City, California, and its main financial and administrative offices in
Irving, Texas. The Company leases its service centers in Orlando, Florida,
Portland, Oregon, and Addison and Irving, Texas and owns its service center in
Wichita, Kansas. The service centers in aggregate comprise 188,600 square feet.
The Company also currently leases 64 facilities in 31 states that serve as
branch offices.
ITEM 3. LEGAL PROCEEDINGS
On January 8, 1997, Innovative Business Systems, Ltd. ("IBS") filed
suit against Western Resources, Westinghouse Electric Corporation ("WEC"),
Westinghouse Security Systems, Inc. ("WSS") and WestSec in Dallas County, Texas
district court (Cause No. 97-00184) alleging, among other things, breach of
contract against WEC and interference with contract against Western Resources
and WestSec in connection with the sale by WEC of the assets of WSS to Western
Resources and WestSec. IBS claims that WEC improperly transferred software owned
by IBS to Western Resources and WestSec and that Western Resources and WestSec
are not entitled to its use. Western Resources and WestSec have demanded that
WEC defend and indemnify them. WEC, Western Resources and WestSec have denied
IBS' allegations and are vigorously defending against them. Management does not
believe the ultimate disposition of the matter will have a material adverse
effect upon the Company's overall financial condition or results of operations.
The Company is a party to claims and matters of litigation incidental
to the normal course of its business. The ultimate outcome of these matters
cannot presently be determined; however, in the opinion of management of the
Company, the resolution of these matters will not have a material adverse effect
on the Company's combined financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
On November 24, 1997, Protection One held a special meeting of stockholders
to vote upon a proposal to increase the authorized shares of Common Stock from
40,000,000 shares to 150,000,000 shares and to approve the issuance to Western
Resources of 68,673,402 shares of Common Stock in connection with the
Contribution (the "Stock Acquisition Proposal"). In addition, stockholders were
asked to approve the 1997 Long-Term Incentive Plan as a replacement for
Protection One's 1994 stock option plan. Out of a total of 14,493,722 shares of
Common Stock outstanding and entitled to vote, 9,807,358 shares were present in
person or by proxy, representing approximately 68% of the total. On the Stock
Acquisition Proposal, the results were as follows:
16
For 9,807,358
Against --
Abstain --
On the proposal to replace the 1994 stock option plan with the 1997
Long-Term Incentive Plan, the results were as follows:
For 8,904,764
Against 886,094
Abstain 16,500
There were no broker non-votes for the matters voted on by the stockholders
at the special meeting.
17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The following table sets forth the range of high and low sales prices
reported on the Nasdaq National Market for the Common Stock for the fiscal
periods indicated:
High Low
Fiscal Year Ended December 31, 1996
First Quarter............................... $14 3/4 $ 9
Second Quarter.............................. 17 7/8 13 1/4
Third Quarter............................... 16 7/8 11 3/4
Fourth Quarter.............................. 15 8 3/4
Fiscal Year Ended December 31, 1997
First Quarter............................... $11 1/8 $ 7 3/8
Second Quarter.............................. 14 1/8 9 1/4
Third Quarter............................... 21 3/4 13 3/8
Fourth Quarter.............................. 20 1/8 10 3/4
As of March 24, 1998, there were 83 holders of record of the Common
Stock. The Company believes there are in excess of 400 beneficial owners of the
Common Stock.
Other than the cash distribution paid to holders of record of Common
Stock as of November 24, 1997, holders of outstanding options to purchase Common
Stock and holders of certain warrants exercisable for Common Stock, all in
connection with the Contribution by Western Resources, POI has never paid any
cash dividends on the Common Stock and does not intend to pay any cash dividends
in the foreseeable future. The Company intends to retain its cash flows for the
operation and expansion of its business. The indenture (the "Discount Note
Indenture") pursuant to which Monitoring's 135/8% Senior Subordinated Discount
Notes due 2005 (the "Discount Notes") were issued and the indenture (the
"Convertible Note Indenture") pursuant to which Monitoring's 6 3/4% Convertible
Notes due 2003 were issued restrict POI's ability to declare or pay any dividend
on, or make any other distribution in respect of, POI's capital stock.
The Discount Note Indenture contains restrictions on dividends paid by
Monitoring that are similar to the restrictions summarized above. During fiscal
1995, Monitoring paid dividends to POI of approximately $0.2 million. No
dividends were paid by Monitoring to POI in fiscal 1996 or fiscal 1997.
18
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements and the
related notes thereto of the Company and the financial statements and the
related notes thereto of Westinghouse Security, included elsewhere in this
report. All amounts are in thousands, except per share and subscriber data,
unless otherwise noted.
The Company (a) Westinghouse Security (Predecessor)(b)
Year Ended December 31, 53 Weeks Ended 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended
December 30, December 20, December 20, December 16,
1997 1996 1996 1995 1994 1993
-------- -------- -------- -------- -------- ------
Statement of operations data:
Revenues $ 144,773 $ 8,097 $110,881 $ 88,710 $ 67,253 $ 47,985
Cost of revenues 35,669 3,348 25,960 17,280 15,224 11,615
Gross profit 109,104 4 ,749 84,921 71,430 52,029 36,370
Selling, general and
administrative expenses 77,203 5,091 60,166 50,919 27,448 30,674
Acquisition and transition
expense 1,308 - 101 101 - -
Amortization of intangibles and
depreciation expense 39,822 609 21,613 17,804 13,959 13,009
Nonrecurring charges 40,144 - - - - -
Operating income (loss) (49,373) (951) 3,041 2,606 10,622 (7,313)
Interest expense, net 32,900 15 10,879 12,159 13,467 7,511
Loss before income taxes (82,273) (966) (7,838) (9,553) (2,845) (14,824)
Income tax benefit 32,970 310 2,978 3,630 1,081 5,633
Net loss $ (49,303) $ (656) $ (4,860) $ (5,923) $ (1,764) $ (9,191)
============ =========== ========== ========== ========== ==========
Net loss per share $ (0.70) $ (0.01) (b) (b) (b) (b)
Consolidated balance sheet data:
Working capital (deficit) $ 11,925 $ (19,447) $(19,515) $ (13,035) $ (11,551) $ (2,550)
Subscriber accounts, net 538,318 265,530 157,969 138,620 114,236 94,148
Goodwill and trademarks 682,180 218,991 11,102 11,397 11,691 -
Total assets 1,446,644 506,647 187,456 170,907 145,062 109,593
Long-term debt, including
capital leases 337,763 60,505 47,931 52,511 58,475 35,883
Total stockholders' equity $ 933,975 $ 410,430 $ 106,140 $ 89,120 $ 60,108 $ 55,803
Other operating data:
MRR (c) $ 19,137 $ 8,974 $ 7,870 $ 6,437 $ 5,231 $ 4,288
Number of subscribers net, at
end of period 756,818 424,100 313,784 265,839 214,785 224,960
EBITDA (d) $ 30,593 $ (342) $ 24,654 $ 20,410 $ 24,581 $ 5,696
Adjusted EBITDA (d) $ 50,462 $ (22) $ 37,327 $ 31,918 $ 27,559 $ 4,228
(a) Prior to November 24, 1997, Protection One was a standalone 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 (together the "Western Resources Security Business" or
"WRSB") and Centennial Security Holdings, Inc. ("Centennial"). As a result of
the transaction Western Resources owns approximately 82% of Protection One at
December 31, 1997.
The transaction has been accounted for as a reverse purchase acquisition which
treats WRSB as the accounting acquiror. Accordingly, the results of operation 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 the accounting
acquiror, WRSB.
19
(a) (cont.)The operating results of WRSB for the year ended December 31, 1995,
can be considered nominal in relation to the accompanying consolidated
statements of operations. The 1995 results are comprised of only two months of
start-up activity.
Summarized operating results are as follows:
Revenue $344
Gross Profit 189
Net Income 18
(b) On December 30, 1996, WRI, through its indirect wholly owned subsidiary,
WestSec, purchased the assets and assumed certain liabilities comprising the
security business of Westinghouse Security Systems ("WSS") from Westinghouse
Electric Corporation ("WEC"). WSS is deemed to be a predecessor of Protection
One.
Selected financial data for 1993 through 1996 were derived from the financial
statements of WSS for those years. Per share data is omitted because WSS was
wholly owned by WEC.
(c) MRR is monthly recurring revenue (excluding patrol services) that the
Company is entitled to receive under contracts in effect at the end of the
period. MRR is a term commonly used in the security alarm business, but not as a
measure of profitability or performance, and does not allow for future attrition
or allowance for doubtful accounts. The Company does not have sufficient
information as to the attrition of acquired subscriber accounts to predict the
amount of acquired MRR that will be realized in future periods or the impact of
the attrition of acquired accounts on the Company's overall rate of attrition.
(d) EBITDA is derived by adding to loss before income taxes, the sum of (i)
interest expense, net, (ii) nonrecurring charges, and (iii) amortization of
intangibles and depreciation expense. EBITDA does not represent cash flow from
operations as defined by generally accepted accounting principles, should not be
construed as an alternative to net income and is indicative neither of the
Company's operating performance nor of cash flows available to fund all the
Company's cash needs. Items excluded from EBITDA are significant components in
understanding and assessing the Company's financial performance. Management
believes presentation of EBITDA enhances an understanding of the Company's
financial condition, results of operations and cash flows because EBITDA is used
by the Company 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 has been 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 and net
losses.
Adjusted EBITDA is derived by adding to EBITDA selling and marketing expenses,
net of revenues, arising from installation activities during the period.
Adjusted EBITDA does not represent cash flow from operations as defined by
generally accepted accounting principles, should not be construed as an
alternative to net income and is indicative neither of the Company's operating
performance nor of cash flows available to fund the Company's cash needs. The
Company presents Adjusted EBITDA as a measure which the Company believes
provides a more appropriate comparison to EBITDA presented by companies that
grow through a dealer program or acquisitions.
The following table provides a calculation of EBITDA and Adjusted
EBITDA for each of the periods presented above:
The Company Westinghouse Security (Predecessor)
Year Ended December 31, 53 Weeks Ended 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended
December 30, December 20, December 20, December 16,
1997 1996 1996 1995 1994 1993
-------- -------- -------- -------- -------- ------
Loss before income taxes $(82,273) $ (966) $ (7,838) $ (9,553) $ (2,845) $ (14,824)
Plus:
Interest expense, net 32,900 15 10,879 12,159 13,467 7,511
Nonrecurring charges 40,144 - - - - -
Amortization of intangibles and
depreciation expense 39,822 609 21,613 17,804 13,959 13,009
---------- --------- ---------- ---------- ---------- ----------
EBITDA 30,593 (342) 24,654 20,410 24,581 5,696
Plus:
Selling and marketing expenses
related to installations 34,998 2,156 29,074 24,633 9,493 324
Less: (15,129) (1,836) (16,401) (13,125) (6,515) (1,792)
---------- --------- ---------- ----------- ----------- -----------
Installation revenues
Adjusted EBITDA $ 50,462 $ (22) $ 37,327 $ 31,918 $ 27,559 $ 4,228
========== ========= ========= ========= ========== ==========
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Except where the context indicates otherwise, the information contained
in this Item 7 is based on the Company's business, operations and financial
condition as of and for the year ended December 31, 1997.
Note that all numbers presented are in thousands unless otherwise indicated.
Background
The Company is principally engaged in the business of monitoring and
servicing security systems.
On November 24, 1997, pursuant to a Contribution Agreement dated July
30, 1997, between Protection One and Western Resources (as amended, the
"Contribution Agreement"), Protection One acquired all of the outstanding stock
of WestSec and Westar which represented the security alarm monitoring business
of Western Resources (such business the "Western Resources Security Business" or
"WRSB"), and certain cash and securities. Under the terms of the Contribution
Agreement, Western Resources was issued an aggregate of 68,673,402 shares of
Common Stock of Protection One, which represented approximately 82.4% of the
shares of Common Stock outstanding immediately after such issuance. Accordingly,
although Protection One is the legal parent of WRSB, the transaction was
accounted for as a recapitalization of WRSB and a purchase by WRSB of Protection
One (a reverse acquisition in which WRSB is considered the acquiror for
accounting purposes). The Company recorded approximately $464 million of
goodwill related to this transaction. The financial statements of the Company
for the periods prior to November 24, 1997, are those of WRSB and its
predecessor entity, Westinghouse Security Systems ("WSS"). The assets and
liabilities of Protection One are recorded at their estimated fair values and
the accounts of Protection One are included in the consolidated financial
statements from the date of acquisition.
On December 30, 1996, WestSec purchased 310,000 subscribers and assets,
and assumed certain liabilities and obligations, of WSS from Westinghouse
Electric Corporation ("WEC") for $358 million in cash, subject to adjustments.
WRSB initially recorded approximately $275 million of goodwill as a result of
this transaction. Westar, formed in 1995, acquired six security businesses
and/or portfolios of subscriber accounts from November 1995, through September
1996. In aggregate, such acquisitions represented approximately 100,000
subscribers, and a purchase price of $25 million paid in cash and Western
Resources stock. Goodwill recorded by WRSB related to these acquisitions totaled
approximately $23 million.
Overview
A majority of the Company's revenues are derived from recurring
payments for the monitoring and servicing of security systems and additional
security services, pursuant to contracts with an initial noncancellable term.
Service revenues are derived from payments under extended service contracts and
for service calls performed on a time and materials basis. The remainder of the
Company's revenues are derived primarily from revenues from the sale and
installation by Company personnel of security systems, add-ons and upgrades.
Payment for monitoring services is typically required in advance. Monitoring and
service revenues are recognized as the service is provided. Installation, add-on
and upgrade revenue is recognized in the period of installation.
Alarm monitoring services generate a significantly higher gross margin
than do the other services provided by the Company. In fact, the cost of
providing patrol and alarm response services exceeds revenues generated by such
services, and although sales and installation services contribute to the
Company's gross profits, the total expenses associated with alarm system
installations also exceed the revenues generated by such services. The Company's
strategy, however, is to provide patrol and alarm response services and to
invest in system sales and installation because the Company believes that such
services and products contribute
21
to the generation and retention of alarm monitoring subscribers. The Company
expects that system sales and installation activity will decline in 1998, as a
result of converting substantially all of WRSB's internal sale force to
participants in the Dealer Program..
Accounting Differences for New Installations and Account Purchases. In
the past, Protection One, which sold systems outright, and WRSB, which has
primarily leased systems, have accounted for expenses associated with alarm
system installations differently. Protection One's direct installation costs,
which include materials, labor and installation overhead, and related selling
and marketing costs were expensed in the period incurred. WRSB's direct
installation costs were capitalized while selling and marketing costs and
indirect overhead were expensed in the period incurred. Such capitalized costs
were amortized over the average estimated subscriber life of ten years.
Subsequent to November 24, 1997, Protection One has adopted WRSB's policy with
respect to installation. Due to the Company's strategy to rely primarily on the
Dealer Program and acquisitions to meet its growth objectives, the Company
anticipates a substantial reduction in installation activities in 1998.
A difference between accounting treatment of the purchase of subscriber
accounts and the accounting treatment of the generation of subscriber accounts
through direct sales by the Company's sales force impacts the Company's results
of operations. All direct external costs associated with purchases of subscriber
accounts (either through the Dealer Program or through acquisitions of
subscriber account portfolios) are capitalized and amortized over ten years on a
straight-line basis. Company personnel and related support and duplicate costs
incurred solely in connection with subscriber account acquisitions and
transitions are expensed as incurred. Other acquisition transition costs that
reflect the Company's estimate of costs associated with incorporating the
purchased subscriber accounts into its operations, including costs incurred by
the Company in fulfilling the seller's pre-acquisition warranty repair service
and other obligations to the acquired subscribers are also capitalized and
amortized over a ten year period as described above. Direct costs related to
alarm system installations are capitalized and amortized over a ten year period.
Indirect costs related to alarm system installations are expensed in the period
incurred.
Subscriber Attrition. Subscriber attrition has a direct impact on the
Company's results of operations, since it affects both the Company's revenues
and its amortization of intangibles expense. Attrition can be measured in terms
of canceled subscriber accounts and in terms of decreased MRR resulting from
canceled subscriber accounts. Gross subscriber attrition is defined by the
Company for a particular period as a quotient, the numerator of which is equal
to the number of subscribers who disconnect service during such period and the
denominator of which is the average of the number of subscribers at each
month-end during such period. Net MRR attrition is defined by the Company for a
particular period as a quotient, the numerator of which is an amount equal to
gross MRR lost as the result of canceled subscriber accounts or services during
such period, net of (i) MRR generated during such period by the sale of
additional services and increases in rates to existing subscribers, (ii) MRR
generated during such period from the connection of subscribers who move into
premises previously occupied by subscribers and in which existing systems are
installed and from conversion of accounts that were previously monitored by
other companies to the Company's monitoring service (i.e., "reconnects" and
"conversions"); and (iii) MRR attributable to canceled accounts that, by virtue
of a purchase holdback, are "put" back to the seller of such accounts during
such period (i.e., "guaranteed accounts"); and the denominator of which is the
average month-end MRR in effect during such period. While the Company reduces
the gross MRR lost during a period by the amount of guaranteed accounts provided
for in purchase agreements with sellers, in some cases the Company may not
collect all or any of the reimbursement due it from the seller. During 1997, the
Company experienced gross subscriber attrition of 15.4% and net MRR attrition of
13.0%. As the Company has no economic investment in wholesale accounts, these
accounts are excluded from the calculation.
Management has established target ranges for gross subscriber attrition
and net MRR attrition of 16%- 18% and 7%-9%, respectively. Fluctuations in gross
subscriber attrition reflect changes in levels of acquisition activity, the rate
at which subscribers move, the number of subscribers that the Company
22
disconnects for non-payment and customer satisfaction with Protection One's
customer service and field repair functions. Changes in net MRR attrition are
caused by the factors impacting gross subscriber attrition, as well as by
changes in Protection One's ability to generate reconnects and conversions, to
create MRR through the sale of additional services and price increases and to
obtain purchase holdbacks covering the loss of acquired subscribers.
Because the Company determines payments to sellers under purchase price
holdbacks subsequent to the periods to which such holdbacks apply, and because
holdbacks are not allocated to specific guaranteed accounts or specific fiscal
periods, the Company reduces gross MRR lost during a period by the amount of
guaranteed accounts provided for in purchase agreements with sellers. However,
in some cases, the Company has not retained the full amount of such holdback to
which the Company is contractually entitled. If guaranteed accounts for which
the Company was not compensated by the seller were taken into account in
calculating net MRR attrition, net MRR attrition would have been higher in each
period presented above.
MRR represents the monthly recurring revenue Protection One is entitled
to receive under subscriber contracts in effect at the end of the period.
Included in MRR and the number of subscribers are amounts associated with
subscribers with past due balances. It is the policy and practice of Protection
One that every effort be made to preserve the revenue stream associated with
these contractual obligations. To this end, Protection One actively works to
both collect amounts owed and to retain the subscriber. In certain instances,
this collection and evaluation period may exceed six months in length. When, in
the judgment of Protection One's collection personnel, all reasonable efforts
have been made to collect balances due, subscribers are disconnected from
Protection One's service centers and are included in the calculation of gross
subscriber and net MRR attrition.
Generally, net MRR attrition is less than actual "net account
attrition," which the Company defines as canceled subscriber accounts net of
reconnects, conversions and guaranteed accounts. Estimated net account attrition
is the basis upon which the Company determines the period over which it
amortizes its investment in subscriber accounts. The Company amortizes such
investment over ten years based on current estimates. If actual subscriber
account attrition were to exceed such estimated attrition, the Company could be
required to amortize its investment in subscriber accounts over a shorter
period, thus increasing amortization expense in the period in which such
adjustment is made and future periods. Since the majority of the subscriber
accounts acquired by the Company since its formation were purchased recently,
there can be no assurance that the actual attrition rates for such accounts will
not be greater than the rate assumed by the Company. See-"Results of Operations
- - 1997 Compared to Fiscal 1996 - Amortization of intangibles and depreciation
expense" below.
The table below sets forth the change in the Company's subscriber base
over fiscal years 1995-1997.
23
The changes for 1995 and 1996 are changes for WSS as predecessor of
WestSec. The results for WSS and WRSB are combined in the 1996 column. The
changes for 1997 reflect changes for WRSB through November 24, 1997, and the
Company for the remainder of 1997. All residential, commercial, and wholesale
accounts are reflected in the numbers:
Year Ended December 31,
1997 1996 1995
Beginning of period 424,100 265,839 214,785
Internal installations 61,765 75,232 69,866
Account acquisitions 25,072 9,129 10,264
WRSB - 110,316 -
Protection
One/Centennial 303,783 - -
Account attrition (57,902) (36,416) (29,076)
-------- -------- -------
End of period 756,818 424,100 265,839
======== ======== =======
Results of Operations
The following table sets forth certain operating data as dollar amounts
and as a percentage of total revenues for the periods indicated. The amounts and
percentages for 1997 represent WRSB operations through November 24, 1997 and the
operations of the Company from November 24, 1997 through December 31, 1997.
Amounts and percentages are presented for WRSB's operations in 1996. Amounts and
percentages are also presented for 1995 and 1996 related to WSS, as predecessor
of Protection One.
Fiscal Year Fiscal Year
1996 1995
1997 1996 Westinghouse Westinghouse
The Company The Company (Predecessor) (Predecessor)
Revenues:
Monitoring and related services $126,630 87.5% $6,382 78.8% $ 93,765 84.6% $74,911 84.4%
Other 18,143 12.5 1,715 21.2 17,116 15.4 13,799 15.6
Total revenues $144,773 100.0% $8,097 100.0% $110,881 100.0% $88,710 100.0%
Cost of revenues:
Monitoring and related services $ 32,656 22.5% $1,761 21.7% $ 24,987 22.5% $16,843 19.0%
Other 3,013 2.1 1,587 19.6 973 0.9 437 0.5
Total cost of revenues 35,669 24.6 3,348 41.3 25,960 23.4 17,280 19.5
Gross profit 109,104 75.4 4,749 58.7 84,921 76.6 71,430 80.5
Selling, general and administrative
expenses 77,203 53.3 5,091 62.9 60,166 54.3 50,919 57.4
Acquisition and transition expense 1,308 0.9 - - 101 0.1 101 0.1
Amortization of intangibles and
depreciation expense 39,822 27.5 609 7.5 21,613 19.5 17,804 20.1
Nonrecurring charges 40,144 27.8 - - - - - -
Operating income (loss) $(49,373) (34.1)% $ (951) (11.7)% $ 3,041 2.7% $ 2,606 2.9%
======== ===== ======= ===== ========= ===== ========= ====
1997 Compared to 1996
Revenues for 1997 were $144.8 million with $131.3 million related to
the WRSB entities, $2.7 million related to Centennial, and $10.8 million related
to Protection One. WRSB's revenues for 1996 were $8.1 million and WSS revenues
for 1996 were $110.9 million for a total of $119.0 million. Monitoring and
related services revenues for the WRSB entities increased by $14.0 million, or
14.0%, substantially all of which resulted from average account base growth.
Other revenues related to the WRSB entities decreased by $1.7 million, or 9.0%.
The decrease is related primarily to a reduction of 25% in total internally
placed accounts added, offset partially by an increase in average placement
revenue
24
per account of 14%. The significant decrease in internally placed accounts added
is due to a sales force transition related to the transactions involving WSS and
WRSB and WRSB and Protection One.
Cost of revenues for 1997 was $35.7 million with $31.4 million related
to the WRSB entities, $1.0 million related to Centennial, and $3.3 million
related to Protection One. Cost of revenues for 1996 was $3.3 million for WRSB
and $26.0 million for WSS for a total of $29.3 million. Monitoring and related
services expenses for the WRSB entities increased by $2.2 million, or 8.2%,
primarily due to the additional personnel required to provide service to the
larger account base.
Gross profit for 1997 was $109.1 million with $99.9 million related to
the WRSB entities, $1.6 million related to Centennial, and $7.5 million related
to Protection One. Gross profit for 1996 was $4.7 million for WRSB and $84.9
million for WSS for a total of $89.6 million. Gross profit for the WRSB
increased $10.3 million, or 11.5%, reflecting the growth in the average account
base.
Selling, general and administrative expense ("SG&A") for 1997 was $77.2
million with $74.1 million related to the WRSB entities, $0.8 million related to
Centennial, and $2.3 million related to Protection One. SG&A for 1996 was $5.1
million for WRSB and $60.2 million for WSS for a total of $65.3 million. SG&A
increased $8.8 million, or 13.5%, for the WRSB entities primarily because of the
new advertising efforts required to establish market awareness of the "Westar
Security Services" business name in support of placement activities.
Amortization of intangibles and depreciation expenses for 1997 were
$39.8 million with $35.5 million related to the WRSB entities, $0.6 million
related to Centennial, and $3.7 million related to Protection One. Amortization
and depreciation expenses for 1996 were $0.6 million for WRSB and $21.6 million
for WSS for a total of $22.2 million. Depreciation and amortization increased
$13.3 million, or 59.9% for the WRSB entities. The increase is due to the
amortization of the $196 million of goodwill arising from WestSec's acquisition
of the WSS business from WEC. The goodwill is being amortized over a 40 year
life. Related to the acquisition of WSS by WRSB on December 30, 1996, the
subscriber accounts purchased were written up to fair market value. These
amounts are being amortized over 10 years and have consequently increased
amortization expense in 1997 compared to 1996.
The non-recurring charges were taken in connection with the November
24, 1997, acquisition transaction. The Company incurred nonrecurring charges of
$40.1 million, in order to reflect business activities of the accounting
acquiror, WRSB, that are no longer of continuing value to the combined entity
and that will be phased out in conjunction with the merger. These charges have
been separately identified as a component of operating income in the
accompanying statements of operations.
Generally, management intends to bring all security operations under
the Protection One brand and to eliminate redundant facilities, systems and
activities in specific locations where such exist. Additionally, costs will be
incurred to transition individual customer accounts from the former service
providers with respect to operations, billing and network systems and to close
down these operations. Management intends to complete these exit activities by
the fourth quarter of 1998.
25
Charges for the year ended December 31, 1997, are as follows:
Inventory and other asset losses $17,697
Customer account transition 12,337
Disposition of excess fixed assets 4,128
Closure of duplicate facilities 1,991
Severance compensation and benefits 1,865
Other 2,126
---------
$40,144
1996 Compared to 1995 - Westinghouse Security (Predecessor to WestSec)
WSS revenues for 1996 increased by $22.2 million, or 25.0%, to $110.9
million from $88.7 million for 1995. Monitoring and related services revenues
increased by $18.9 million, or 25.2%, substantially all of which resulted from
the addition of approximately 75,000 subscribers from internal sales and
installations of subscriber accounts and approximately 7,000 subscribers
purchased from dealers. Other revenues increased by 24.0% to $17.1 million in
1996 from $13.8 million in 1995. The increase in other revenues reflects an
increase in installation revenues as a result of additional installed accounts
and the sale of equipment upgrades.
Costs of revenues for 1996 increased by $8.7 million, or 50.3%, to
$26.0 million. Costs and expenses as a percentage of total revenues increased to
23.4% during 1996 from 19.5% during 1995. Monitoring and related services
expenses increased by $8.1 million, or 48.4% from 1995 to 1996, primarily due to
increased activity at WSS' central monitoring station and an expansion in
service activities in the field branches. Monitoring and related services
expenses as a percentage of monitoring and related services revenues increased
to 26.6% in 1996 from 22.5% during 1995. Such increase reflects a high level of
staffing at WSS' central monitoring station.
Gross profit for 1996 was $84.9 million, which represents an increase
of $13.5 million, or 18.9%, over the $71.4 million of gross profit recognized in
1995. Such increase was due primarily to an increase in monitoring activities,
which reflected the increase in WSS' subscriber base from approximately 265,000
at December 20, 1995 to 314,000 at December 30, 1996.
Selling, general and administrative expenses ("SG&A") rose to $60.3
million in 1996, an increase of $9.2 million, or 18.1%, over such expenses in
1995, but declined as a percentage of total revenues from 57.5% in 1995 to 54.4%
in 1996. The increase in general and administrative expenses was caused by
increases in corporate and branch overhead expenses associated with a larger
customer base and higher numbers of installations. Advertising and marketing
expenses comprised approximately 2% of revenues in both 1995 and 1996.
Amortization of intangibles and depreciation expense for 1996 increased
by $3.8 million, or 21.4%, to $21.6 million. This increase was partially due to
the 75,000 new internally placed accounts and 7,000 dealer program accounts
purchased during 1996. WSS amortized subscriber accounts over 10 years.
Operating income for 1996 was $3.0 million, compared to operating
income of $2.6 million in fiscal 1995. Operating income as a percentage of
revenue was 2.7% in 1996 compared to 2.9% in 1995.
The effective income tax benefit for 1996, 1995, and 1994 has been
estimated at 38%. The historical net operating income or losses prior to the
WestSec purchase were included in WEC's consolidated federal income tax return.
Capital Resources and Liquidity
26
In general, the Company has financed its operations and growth
primarily from operating cash flows, supplemented by advances from its parent,
Western Resources.
Recent Developments. On November 24, 1997, pursuant to the Contribution
Agreement, Protection One received $367.4 million of cash and securities from
Western Resources, and made the following disbursements, either concurrently
with or within several days of the closing of the Western Resources transaction:
(i) $114.1 million to make a cash distribution to holders of record of Common
Stock as of November 24, 1997, holders of outstanding options to purchase Common
Stock and holders of certain warrants exercisable for Common Stock; (ii) $94.4
million to pay the cash purchase price of Centennial; and (iii) $61.6 million to
repay borrowings under its revolving credit facility. The remaining $97.3
million included $14.8 million of marketable securities, which amount included
common and preferred shares in Guardian International, Inc., and $82.5 million
of cash.
The amounts contributed by Western Resources have substantially
enhanced the Company's liquidity. In addition, the Company believes the issuance
of 68.7 million shares of Common Stock to Western Resources has improved its
access to the public equity markets. The Company intends to use cash flow
provided by operations, cash on hand, funding by Western Resources, and capital
raised in debt and equity offerings, as needed, to fund its ongoing operations
and growth activities. The Company believes that cash required to fund its
growth activities will continue to exceed cash flow provided by operations for
the foreseeable future.
Subsequent to the end of fiscal year 1997, on February 4, 1998,
Protection One announced its decision to exercise its option to purchase Network
Multi-Family Security Corporation ("Network"), the leading provider of security
alarm monitoring to multi-family dwellings with approximately 200,000
subscribers. Pursuant to the terms of the option, Protection One will give
Western Resources cash consideration of approximately $180 million.
On March 2, 1998, Protection One completed the acquisition of 147,000
subscribers and related assets of Multimedia Security Services, Inc.
("Multimedia") for a purchase price of approximately $233 million. The
Multimedia purchase added to the Company's market positions in California,
Florida and Texas and added substantial numbers of subscribers in Kansas and
Oklahoma. In addition, Protection One will maintain Multimedia's monitoring and
customer service center in Wichita, Kansas.
On March 17, 1998, Protection One completed the acquisition of Comsec
Narragansett Security, Inc. ("Comsec") for a cash purchase price of
approximately $45 million and the assumption of $15 million of debt. Comsec's
30,000 subscribers are located primarily in Connecticut, Maine, Massachusetts
and New Hampshire.
Material Commitments. The Company has several long-term commitments.
The 6 3/4% Convertible Senior Subordinated Notes (the "Convertible Notes"),
which total $103.5 million in aggregate principal amount, mature on September
15, 2003, and the Company must make a payment of $166.0 million on September 30,
2005 at the maturity of the 135/8% Senior Subordinated Discount Notes (the
"Discount Notes"). Cash interest payable on the Convertible Notes and Discount
Notes will total $18.3 million in 1998 and $29.6 million thereafter until
maturity. (See Note 6 of Protection One, Inc. Notes to Consolidated Financial
Statements, for further information regarding the Convertible Notes and Discount
Notes.) In addition, Protection One has assumed, as part of the Western
Resources transaction, approximately $60 million of the WestSec indebtedness
from agreements entered into by WSS, of which approximately $26 million is
payable in 1998 and $34 million in 1999. Under the agreements, Protection One
monitors and services subscriber accounts for which certain rights were
transferred to a third party. Protection One is required to purchase the rights
in the contracts as the underlying third party notes mature.
On March 2, 1998, the Company entered into a promissory note with
Westar Capital, Inc., a subsidiary of Western Resources. The 6 11/16% promissory
note has a principal amount of $274 million and is due on June 1, 1998. Prior to
the maturity of the promissory note, the Company anticipates entering into
27
a longer term financing arrangement with Westar Capital, Inc.
Fiscal 1997 results. For fiscal 1997, the Company's net cash flows used
in operating activities was $4.9 million, compared to $0.1 million used by WRSB
and $23.7 million provided by WSS for 1996. This shift from a net cash inflow in
1996 to a net cash outflow in 1997 is primarily due to the timing of tax
payments.
Net cash flows used in investing activities of the Company in 1997 were
$156.7 million, compared to $369.5 million used by WRSB and $40.5 million used
by WSS in 1996. The Company paid $107.7 million in special distributions to
equityholders related to the Contribution. WRSB paid WEC $357.3 million in cash
in 1996 to purchase WSS. The remaining cash used for account acquisitions and
placements for WRSB in 1996 was $11.3 million and $39.2 million for WSS. This
total is comparable to the $46.5 million spent by the Company in 1997 for
account acquisitions and placements.
The Company generated $237.0 million of net cash through financing
activities in 1997. The Company received $300.7 million in funding from Western
Resources in 1997, approximately $258.0 million of which was related to the
Contribution Agreement . All of the borrowings ($61.6 million) under the
Company's Revolving Credit Facility were paid off with proceeds received under
the Contribution Agreement. In 1996, WRSB generated $369.7 million through
financing activities while WSS generated $16.7 million. Substantially all of
WRSB's financing came from Western Resources in 1996. WSS rece