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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 September 30, 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
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(Commission File Number) (Commission File Number)
Protection One, Inc. Protection One Alarm Monitoring, Inc.
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(Exact Name of Registrant (Exact Name of Registrant
as Specified in Charter) as Specified in Charter)
Delaware Delaware
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(State of Other Jurisdiction (State of Other Jurisdiction
of Incorporation or Organization) of Incorporation or Organization)
93-1063818 93-1064579
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(I.R.S. Employer Identification No.) (I.R.S. Employer Identification No.)
6011 Bristol Parkway, 6011 Bristol Parkway,
Culver City, California 90230 Culver City, California 90230
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(Address of Principal Executive Offices, (Address of Principal Executive Offices,
Including Zip Code) Including Zip Code)
(310) 342-6300 (310) 342-6300
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(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 on
Title of Each Class 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 $0.1 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 December 19, 1997 (based on the last sale price of such
shares on the Nasdaq National Market) was approximately $125,639,250
As of December 19, 1997, Protection One, Inc. had outstanding
83,362,938 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 Prospectus dated January 2, 1997 as filed
pursuant to Rule 424(b), under the Securities Act of 1933 are incorporated into
Parts I and II and portions of Protection One, Inc.'s Proxy Statement dated
November 7, 1997 for the Special Meeting of Stockholders held on November 24,
1997 are incorporated by reference in Part III.
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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"), its direct wholly owned
subsidiary, Protection One Alarm Monitoring, Inc. ("Monitoring") and (following
consummation of the Western Resources transaction (as defined below)) POI's
other wholly owned subsidiaries . Each of POI and Monitoring is sometimes
referred to herein as "Registrant." POI's sole asset is, and POI operates solely
through, its investment in Monitoring and (subsequent to the Western Resources
transaction) POI's other wholly owned subsidiaries.. See "Recent Acquisitions"
included in Item 1 of this Report. Each of POI and Monitoring is a Delaware
corporation organized in September 1991.
MRR AND EBITDA. As used in this Report, "MRR" means 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 and "EBITDA" means
earnings before interest, taxes, depreciation and amortization (excluding
adjustments of purchase accounting accruals, losses or gains on disposition of
fixed assets, loss on assets held for sale, loss on abandoned acquisitions and
extraordinary items). 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, extraordinary items and cumulative effect of change in accounting
method--net of taxes, the sum of (i) loss on sales of assets, (ii) loss on
assets held for sale, (iii) amortization of debt issuance costs and original
issue discount ("OID"), (iv) interest expense, net (v) amortization of
subscriber accounts and goodwill, (vi) depreciation expense, (vii) performance
warrants compensation expense, (viii) adjustment of purchase accounting
accruals, net and (ix) loss on acquisition terminations. 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. 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 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 form the expectations of Protection One include, among others:
Protection One's high degree of leverage, 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; the possible adverse effect of false
alarm ordinances and future government regulations; risks of liability from
operations; and competition in the security alarm industry. For information with
respect to these factors, see the information included under the caption "Risk
Factors" in POI's Prospectus dated January 2, 1997, as filed with the Securities
and Exchange Commission pursuant to Rule 424(b), which information is filed as
an exhibit to this Report and incorporated herein by reference. 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.
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PART I
ITEM 1. BUSINESS
On November 24, 1997, POI acquired all of the outstanding stock of
WestSec, Inc. and Westar Security, Inc., which companies conducted the security
alarm monitoring business of Western Resources, Inc. ("Western Resources" and
such business the "Western Resources Security Business"), and certain cash and
marketable securities, and issued to Western Resources an aggregate of
68,673,402 shares of the common stock, par value $.01 per share of POI ("Common
Stock"), which shares represented approximately 82% of the shares of POI common
stock outstanding immediately after such issuance. For additional information
with respect to this transaction (the "Western Resources transaction"), see
"Recent Acquisitions" below. Except where the context indicates otherwise, the
remainder of this Item 1 describes the Company's business as of and during the
fiscal year ended September 30, 1997. Stockholders, potential investors and
other readers of this Report should be aware that the information below does
not, in general, reflect the impact that the Western Resources transaction has
had and will have on the operations or assets of the Company, and that the
business of the post-transaction Company may not follow the same historical
trends or be subject to or reflect the same dependence on the economic and
competitive factors described below.
Protection One provides security alarm monitoring services for
residential and small business subscribers. Based on its 254,478 subscribers as
of September 30, 1997 (approximately 80.1% of which are residential), Protection
One believes it was at such date the fourth largest residential security alarm
monitoring company in the United States and the largest in the seven western
states of Arizona, California, Nevada, New Mexico, Oregon, Utah and Washington.
The Company's revenues consist primarily of recurring payments under
written contracts for the monitoring and servicing of security systems and the
provision of additional enhanced security services. For the year ended September
30, 1997 ("fiscal 1997"), monitoring and service revenues represented 96.2% of
total revenues. The Company monitors digital signals arising from burglaries,
fires and other events through security systems installed at subscribers'
premises. Most of these signals are received and processed at the Company's
state-of-the-art central monitoring station located in Portland, Oregon, which,
as currently configured, has the capacity to support up to 500,000 subscribers.
The Company also sells enhanced security services, patrol and alarm response
services and alarm systems and provides local field repair services through 13
branch offices. Enhanced security services provided by the Company include,
among others, two-way voice communication, supervised monitoring services, pager
service, wireless backup service and extended service protection.
From the Company's inception, the Company's growth has become primarily
through the acquisition of portfolios of subscriber accounts. Between, September
30, 1991 and September 30, 1997, the Company acquired 131 portfolios of
subscriber portfolios, representing an aggregate of approximately 207,000
subscribers. Management believes that numerous acquisition opportunities are
available, and the Company is pursuing, and intends to continue to pursue,
acquisitions of portfolios of subscriber accounts, some of which may be
significant. Since the beginning of fiscal 1995, the Company has increased its
emphasis on its dealer program ("Dealer Program"), which became a more
significant source of growth than in prior years. For the year ended September
30, 1997, subscribers generated by the Dealer Program accounted for 58% of the
Company's total subscriber additions, as compared with 38% of the subscribers
added during the year ended September 1996. The Company plans to continue its
emphasis on the Dealer Program because of the greater predictability and
relatively lower cost of adding subscribers through the Company's dealers as
compared with acquisitions of larger portfolios of subscriber accounts. In
addition, the Dealer Program generates a comparatively steady flow of new
subscribers spread more evenly over the Company's branch offices, making it
easier for the Company's branch operations to successfully assimilate these
accounts. See "-- The Dealer Program".
RECENT ACQUISITIONS
On July 30, 1997, POI and Western Resources entered into a Contribution
Agreement dated as of July 30, 1997 (as amended, the "Contribution Agreement").
Pursuant to the Contribution Agreement, on November 24, 1997, POI
issued to Western Resources an aggregate of 68,673,402 shares (the "Shares") of
Common Stock, which shares constituted 82.4% of the shares of Common Stock
outstanding immediately after such acquisition. In consideration of the issuance
of the Shares to Western Resources (the "Share Issuance"), Western Resources
transferred to POI all of the outstanding capital stock of WestSec, Inc., a
Kansas
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corporation ("WestSec"), and Westar Security, Inc., a Kansas corporation
("Westar Security", and an aggregate of $367.4 million in cash and marketable
securities.
WestSec and Westar provide security alarm monitoring services and sell,
install and service security alarm systems for homes and businesses located
throughout the continental United States. For information with respect to the
Western Resources Security Business, reference is made to the information
included under the caption "The Western Resources Security Business" and to the
financial statements of such business included in Protection One's proxy
statement dated November 7, 1997 for the special meeting of Protection One's
stockholders held on November 24, 1997, which proxy statement (the "Proxy
Statement") is filed as an exhibit to this Report and which information and
financial statements are incorporated herein by reference.
As provided in the Contribution Agreement, POI paid (i) to the holders of
record of shares of Common Stock as of the close of business on November 24,
1997 (other than Western Resources), a cash dividend of $7.00 per share (the
"Special Dividend"); (ii) to the holders of options to purchase shares of Common
Stock other than Western Resources, $7.00 in cash with respect to each share of
Common Stock issuable upon exercise of such options; and (iii) to a bank as the
holder of record of a warrant issued by POI in 1991 and to the holders of record
of warrants issued by POI in 1993, $7.00 in cash with respect to each share of
Common Stock issuable upon exercise of such warrants (together with amounts paid
under (ii), the "Option/Warrant Payments"). As a result of the payment of the
Special Dividend, each warrant issued by POI in 1995 has become exercisable for
1.629 shares of Common Stock at an exercise price of $4.05, and the 6 3/4%
Convertible Senior Subordinated Notes due 2003 issued by Monitoring (the
"Convertible Notes"), are convertible into shares of Common Stock at a
conversion price of $11.19 per share.
Prior to the Share Issuance, the certificate of incorporation of POI was
amended to increase the maximum authorized number of shares of Common Stock to
150,000,000.
As provided in the Contribution Agreement, immediately following the Share
Issuance, POI, through a subsidiary, acquired from Western Resources (i) all of
the outstanding capital stock of Centennial Security Holdings, Inc., a Delaware
corporation ("Centennial"), for a cash purchase price of $94.4 million, and (ii)
2,500,000 shares (the "Guardian Common Shares") of the Class A Voting Common
Stock, par value $.001 per share, and 1,875,000 shares (the "Guardian Preferred
Shares") of the Series A 9 3/4% Convertible Cumulative Preferred Stock of
Guardian International, Inc., a Nevada corporation ("Guardian"), for a cash
purchase price of $8.5 million. The Guardian Common Shares constitute
approximately 27.8% of the outstanding shares of Guardian common stock; the
Guardian Preferred Shares are convertible into an aggregate of 1,500,000
additional shares of Guardian common stock.
POI used a portion of the cash contributed to POI by Western Resources to pay
for the shares of Centennial and Guardian purchased by POI. The amount of such
consideration was determined in arm's-length negotiations between Protection One
and Western Resources and equaled the sum of (i) the amount paid by Western
Resources for such securities, (ii) the fees and expense incurred by Western
Resources to attorneys and other third-party advisors in connection with Western
Resources' acquisition of such securities, and (iii) a carrying charge at a rate
of 10% per annum (pro-rated on the basis of a 365-day year) for the period
Western Resources held such securities.
Centennial, based in Madison, New Jersey provides security alarm monitoring
services to residential and commercial subscribers located principally in Ohio,
Michigan, New Jersey, New York and Pennsylvania. As of September 30, 1997,
Centennial had approximately 47,000 subscribers (approximately 50% of which were
residential) and MRR of approximately $1.4 million. As of December 31, 1996,
Centennial had total assets of $47.8 million; for the year ended December 31,
1996, Centennial had total revenues of $17.3 million and a net loss of $5.0
million. Consummation of Western Resources' purchase of Centennial occurred in
November 1997. Guardian provides security alarm monitoring services to
approximately 12,000 subscribers in Florida; Guardian also monitors
approximately 16,000 additional subscribers on a "wholesale" basis for certain
third-party security alarm companies, sells alarm systems and provides field
repair services principally to commercial accounts and, to a more limited
extent, provides installation services to third-party security alarm companies.
For the year ended December 31, 1996, Guardian had total revenues of $3.6
million and a net loss of $590,000; as of that date, Guardian had total assets
of $9.0 million. Guardian's common stock trades on the OTC Bulletin Board under
the symbol "GIIS."
The Contribution Agreement also granted to Protection One an option, (the
"Network Option") exercisable at any time prior to January 30, 1998, by vote of
a majority of the Board of Directors as constituted at the time the vote is
made, to acquire from Western Resources all of the equity securities of Network
Security Holdings, Inc. ("Network") at a price
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determined in accordance with the formula used to determine the price paid by
Protection One for the shares of Centennial and Guardian, or approximately. For
the year ended December 31, 1996, Network had total revenues of $35.3 million
and annual earnings of $4.0 million; as of December 31, 1996, Network had total
assets of $69.6 million. As of the filing of this Report, POI believes that the
Network Option will probably be exercised during the first three months of
calendar year 1998.
For additional information with respect to the businesses, results of
operations and financial condition of Network and Centennial, see the
consolidated financial statements of each of Network and Centennial included in
the Proxy Statement at pages F-60 through F-95.
In connection with the transactions contemplated by the Contribution
Agreement and pursuant to a Stock Option Agreement dated as of July 30, 1997,
between POI and Western Resources (the "Stock Option Agreement"), POI granted to
Western Resources an option (the "19.9% Option") to purchase, in addition to the
Shares, up to 2,750,238 additional shares of Common Stock at a price of $15.50
per share. (If prior to the consummation of the Western Resources transaction,
certain events related to a proposed acquisition of the assets or a substantial
portion of the voting securities of POI by a party other than Western Resources
had occurred , the 19.9% Option would have been exercisable for up to the same
number of shares of Common Stock at a price of $13.50 per share.) Western
Resources' right to exercise the 19.9% Option will terminate on the earlier of
October 31, 1999 and the 45th day after the last day on which any of the
Convertible Notes remains outstanding.
In connection with the transactions contemplated by the Contribution
Agreement and pursuant to a Stock Option Agreement dated as of July 30, 1997,
between POI and Western Resources (the "Stock Option Agreement"), POI granted to
Western Resources an option (the "19.9% Option") to purchase, in addition to the
Shares, up to 2,750,238 additional shares of Common Stock at a price of $15.50
per share. (If prior to the consummation of the Western Resources transaction,
certain events related to a proposed acquisition of the assets or a substantial
portion of the voting securities of POI by a party other than Western Resources
had occurred, the 19.9% Option would have been exercisable for up to the same
number of shares of Common Stock at a price of $13.50 per share.) Western
Resources' right to exercise the 19.9% Option will terminate on the earlier of
October 31, 199 and the 45th day after the last day on which any of 6 3/4%
Convertible Senior Subordinated Notes due 2003 issued by Monitoring (the
"Convertible Notes") remains outstanding.
MARKET OVERVIEW AND TRENDS
The Company's target market consists of owners of single family residences
and small businesses. According to the most recent U.S. Census Bureau data,
there are over 10 million single-family residences and over 800,000 businesses
with 100 or fewer employees in the seven states in which the Company operates.
The security alarm industry is characterized by the following attributes:
o HIGH DEGREE OF FRAGMENTATION. The security alarm industry is currently
comprised mostly of a large number of small providers of alarm systems
and services. According to data prepared in December 1995 by the J. P.
Freeman Co. (the "Freeman Data"), there are approximately 12,700
security alarm companies nationally, and the Company estimates that
approximately 3,000 operate in the seven states served by the Company.
A survey published by SDM magazine (formerly Security Distributing and
Marketing) in May 1997 reported that in 1996, based upon information
provided by the respondents, the 100 largest companies in the industry
accounted for approximately 25% of alarm industry revenues. Based on
its acquisition experience, the Company believes that many smaller
alarm service companies, because of their size, have higher overhead
expenses as a percentage of revenues than the Company and lack access
to capital on terms as attractive as those available to the Company.
Due to a decline in security system installation prices since 1995,
security alarm monitoring companies participating in market growth are
required today to make a substantial investment in each new
subscriber. As a result, access to capital has become an increasingly
important factor in a security alarm company's success.
o RAPID GROWTH AND LOW PENETRATION. The residential security alarm
market is growing rapidly but is still characterized by a low level of
market penetration. The Freeman Data indicate that residential
security alarm monitoring revenues grew at a compounded annual rate of
9.9% between 1989 and 1995. The Company believes that several factors,
including increased concern about crime and favorable demographic
trends, have contributed to the increased demand for residential
security alarm services. In addition, based on the Freeman Data, the
Company estimates that at November 1995, the percentage of total
households in the United States with monitored security alarm systems
was approximately 10.9%.
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o ADVANCES IN DIGITAL COMMUNICATIONS TECHNOLOGY. Prior to the
development of digital communications technology, alarm monitoring
required a dedicated telephone line, which made long-distance
monitoring uneconomic. Consequently, in order to achieve a national or
regional presence, alarm monitoring companies were required to
maintain a large number of geographically dispersed monitoring
stations. The development of digital communications technology
eliminated the need for dedicated telephone lines, reducing the cost
of monitoring services to the subscriber and permitting the monitoring
of subscriber accounts over a wide geographic area from a central
monitoring station. The elimination of local monitoring stations has
decreased the cost of providing alarm monitoring services and has
substantially increased the economies of scale for larger alarm
service companies. In addition, the concurrent development of
microprocessor-based control panels has substantially reduced the cost
of the equipment available to subscribers in the residential and small
business markets. Digital technology also has enabled equipment
manufacturers to build more features into security alarm systems
(e.g., remote user interfaces, lighting and heating controls and use
programming features).
o INCREASING FALSE ALARMS. According to American City & County magazine,
police officers respond to more than 13.7 million alarm activations
annually, 94% to 98% of which are false. The magazine reports that
although alarm ownership is increasing by 11% annually, police
department budgets are rising by 3% annually. Municipalities have
responded to increasing false alarms by implementing alarm permit and
fine systems and by limiting police response to private alarms until
further verified by another response entity. Protection One believes
this trend will continue in the future.
o ENTRANCE OF TELECOMMUNICATIONS COMPANIES AND UTILITIES. Large,
consumer-oriented companies and industries facing deregulation,
including long distance and local telephone companies and electric and
gas utilities, have demonstrated an increased interest in the security
alarm industry over the last several years. Protection One believes
telecommunications and utility companies are interested in offering
their customers additional services, including security services, as a
means of enhancing customer loyalty and reducing future risk of losing
customers in a fully competitive environment.
The Company believes that several factors contribute to a favorable market
for security alarm services both generally in the United States and specifically
in the western portion of the country:
o INCREASE IN CRIME RATES. According to the Uniform Crime Report
published by the Federal Bureau of Investigation in 1996 the ("UCR"),
between 1986 and 1995 the number of violent crimes reported in the
United States increased by 20.8% and the total number of reported
criminal offenses increased by 5.0%. The UCR also reported that
although the number of reported criminal offenses decreased on a
nationwide basis from 1994 to 1995 by 0.9%, a property crime was
committed in the United States in 1995 once every three seconds. In
the states in which the Company operates, the property crime rate in
1995 was 28.1% higher than the nation as a whole, averaging
approximately 5,885 property crimes per 100,000 residents. In
California, Protection One's largest market, the 1995 property crime
and overall crimes rates were 5.9% and 10.5%, respectively, above the
national averages.
o HIGH LEVEL OF CONCERN ABOUT CRIME. As violent crime and the reporting
of crime by the news media has increased, the perception by Americans
that crime is a significant problem has also grown. In a December 1996
poll conducted by The Wall Street Journal, survey participants ranked
reducing crime as one of the two highest priorities for Congress.
o PER CAPITA POLICE PROTECTION. The UCR reported that urban areas in the
western region of the United States had the lowest ratio of law
enforcement employees per capita of the four reporting regions in
1995, the most recent period for which a UCR has been published.
According to population and law enforcement employee data presented in
the UCR, in 1994 Los Angeles had 3.2 law enforcement employees per
1,000 citizens, while New York had 6.4 and Chicago had 5.7. The number
of law enforcement employees per 1,000 citizens was 3.0 for Las Vegas,
2.8 for Phoenix, 3.0 for Salt Lake City, 2.8 for Portland, 2.3 for San
Diego, 3.3 for San Francisco, 2.4 for Tucson and 3.3 for Seattle.
o DEMOGRAPHIC TRENDS. According to the United States Census Bureau, from
1989 to 1994 the rate of population growth in the states in which the
Company operates was approximately twice the national average. Other
recent trends that are favorable to the residential security alarm
business include: the increase in women in the workforce resulting in
more children being left at home alone and creating increased demand
for security alarm services; the aging of the population in general,
as older people tend to be more concerned about security; and the
increase in people working at home, resulting in increasing demand for
security services to protect home office equipment.
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o INSURANCE DISCOUNTS. The increase in demand for security systems may
also be attributable in part to the granting by insurance companies of
discounts to homeowners who purchase alarm systems, and such discounts
are typically greater when systems are monitored by a central station.
In addition, insurance companies may require that businesses install
an alarm system as a condition of insurance coverage.
BUSINESS STRATEGY
The Company's strategy has been to enhance its position as the largest
residential security alarm monitoring company in the seven western states in
which it operates as of September 30, 1997 by pursuing a balanced growth plan
incorporating the Dealer Program, acquisitions of portfolios of subscribers, the
sale of enhanced services and new alarm systems and possible joint ventures and
other strategic alliances.
The Company's historical growth has enabled it to realize economies of
scale in its central monitoring station, branch operations and corporate
offices. As the number of subscribers monitored by the Company has increased,
the fixed costs of the central monitoring station have been spread over a larger
base, improving monitoring gross margins. Additionally, subscribers have been
added in areas surrounding the Company's branch offices, allowing the Company to
spread the branch office fixed costs over a larger base and increasing the
productivity of field service technicians through more efficient scheduling and
dispatching. Based on the Company's subscriber base at September 30, 1997, the
Company services an average of 19,500 subscribers per branch, which the Company
believes to be among the highest averages in the industry. Finally, the
Company's revenue growth has exceeded the growth of its selling, general and
administrative expenses, as the Company has realized management efficiencies and
has spread additional revenue over its fixed corporate expenses. Such economies
of scale have allowed the Company to add subscriber accounts at attractive
purchase prices.
The principal components of the Company's business strategy as
conducted during fiscal 1997 are as follows:
THE DEALER PROGRAM. The Company participates in the growth of the
residential security alarm market by providing monitoring and field repair
services to subscriber accounts generated on a monthly basis through exclusive
purchase agreements with independent alarm companies specializing in the sale
and installation of new alarm systems. The Company added approximately 53,117
subscriber accounts through its Dealer Program in the twelve months ended
September 30, 1997, an increase of approximately 45.9% over the approximately
36,405 subscribers added through the Dealer Program in the twelve months ended
September 30, 1996. As of September 30, 1997, the Company had 81 active
participants in the Dealer Program. The Company believes that participation in
the Dealer Program will expand due to: (i) the Company's concentrated presence
in areas surrounding its branch offices, which enhances the Company's name
recognition and therefore the marketability of the Company's services; (ii) the
Company's ability to obtain volume purchase discounts on security system
equipment on behalf of its dealers; (iii) the Company's support services
provided to dealers in the areas of administration, marketing and employee
training; and (iv) the Company's ability to generate new customer leads through
affinity programs and strategic alliances.
ACQUISITIONS OF PORTFOLIOS OF SUBSCRIBER ACCOUNTS. The Company also has
grown by acquiring subscriber accounts, primarily from smaller alarm companies.
These acquisitions represented approximately 51,000, 53,000, 55,000 and 39,000
subscribers in each of fiscal years 1994 to 1997, respectively. The Company has
typically acquired only the subscriber accounts, and not the facilities or
liabilities, of such companies. As a result, the Company is able to obtain gross
margins on the monitoring of acquired subscriber accounts that are similar to
those the Company currently generates on the monitoring of its existing
subscriber base. In addition, the Company institutes price increases over time
for acquired subscriber accounts where the Company determines that the charges
previously paid by those subscribers do not appropriately reflect the higher
quality of services to be provided by the Company.
JOINT VENTURES AND OTHER STRATEGIC ALLIANCES. To evaluate other
potential sources of subscriber growth, the Company has analyzed companies in
other industries that may have an interest in entering the residential security
alarm market. In addition, certain companies in industries facing deregulation
(such as the telecommunications and electric utility industries) have expressed
to the Company an interest in offering security alarm services to develop more
comprehensive relationships with their customers. The Company has entered into a
co-branding and marketing agreements with PacifiCorp, a Portland, Oregon based
utility holding company, and Salt River Project, a multi-purpose reclamation
project that provides electricity and water in the Phoenix area. The Company has
established an affinity marketing relationship with Kaufman & Broad Home
Corporation. In addition, the Company has an agreement with Southwestern Bell
Telephone Company pursuant to which that company markets, sells, installs and
maintains
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alarm systems monitored by the Company, and acts as the Company's sales and
billing agent for purposes of alarm monitoring services provided by the Company
in Arkansas, Kansas, Missouri, Oklahoma and Texas. As of the date of this
Report, Protection One intends to continue to explore additional joint ventures,
co-marketing arrangements and other strategic alliances as a method of enhancing
the Company's subscriber growth and reducing its costs of generating new
subscribers. However, the Company does not currently believe that any such
additional joint venture or other strategic alliance is probable.
SALE OF ENHANCED SERVICES; PATROL AND ALARM RESPONSE SERVICES. The
Company seeks to increase revenues from current and newly added subscribers by
actively marketing enhanced services to such subscribers. Such services include
extended service protection, two-way voice communication, supervised monitoring
services, pager service, remote video verification and wireless back up. The
Company also offers patrol and alarm response services, principally in southern
California and Las Vegas.
CONVERSIONS, NEW OWNERS AND NEW ALARM SYSTEMS. The Company seeks to
convert subscribers from competitors' services to Company-provided services,
particularly in areas in which the Company's patrol and alarm response services
enhance the Company's presence and name recognition. The Company also generates
new subscriber accounts by signing monitoring contracts with new owners of
residences previously occupied by Protection One subscribers and through sales
of alarm systems by its own personnel.
THE DEALER PROGRAM. The dealers that the Company selects for the Dealer
Program are typically small alarm companies that specialize in selling and
installing alarm systems for residential or small business subscribers in a
specified geographic area. Such companies often cannot profitably provide
monitoring and repair services because they lack a sufficient number of
subscribers to support the fixed operating expenses associated with such
services. Also, many dealers do not have access to capital on attractive terms.
The Company enters into exclusive contracts with such dealers that provide for
the purchase by the Company of the dealers' subscriber accounts on an ongoing
basis. The dealers install 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.
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
evaluate the credit history of prospective new subscribers. The Company strives
to provide quality, responsive field service to accounts purchased from dealers;
the Company's principal competitors typically subcontract the field service of
subscriber accounts they purchase, which the Company believes increases
attrition rates and may dissuade dealers from selling their subscriber accounts
to such competitors.
The Company believes that its increased market share in the areas
surrounding its branch offices has enhanced both the Company's ability to
attract dealers and the ability of such dealers to attract new subscribers. To
further attract high quality dealers, the Company enables them to obtain volume
purchase discounts on security systems, coordinates cooperative dealer
advertising, and provides administrative, marketing and employee training
support services.
The Company's dealers employ a variety of marketing methods to identify
and create sales leads, including telemarketing, direct mail and door-to-door
solicitation. The 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 typical 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 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 encompass additional perimeter 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 by the Company's service technicians at the subscriber's
premises during normal business hours 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. Dealers also sell
the Company's enhanced security services.
THE ACQUISITION PROGRAM. The Company also has sought to grow by
acquiring portfolios of subscriber accounts from other alarm companies. The
Company has focused on acquisitions that allow it to "infill" areas surrounding
branch operations, which in turn leads to greater field maintenance repair and
patrol efficiencies. The Company estimates there are
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approximately 3,000 alarm companies in its markets, substantially all of which
are independently owned and may, from time to time, become acquisition targets.
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, both as a result of the 131
acquisitions made by the Company between September 30, 1991 and September 30,
1997 and acquisitions made by members of management when they were employed by
other alarm service companies. The Company also believes that, through its
acquisition activities, it has developed a reputation in the alarm service
industry as an active purchaser of subscriber accounts. Although most
acquisitions add subscribers in the Company's existing market areas to achieve
greater account density, the Company may also make acquisitions outside these
areas.
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 integrating accounts into the Company's operations,
its assumptions as to attrition rates for the acquired accounts, and the
representations and warranties of the sellers.
THE ACQUISITION MANAGEMENT SYSTEM
The Company employs a comprehensive acquisition management system to
identify, evaluate, and assimilate acquisitions of new subscriber accounts that
includes three components: (i) the identification and negotiation stage; (ii)
the due diligence stage; and (iii) the assimilation 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, and the Company's use of standard form agreements, help to
facilitate the successful negotiation and execution of acquisitions in a timely
manner.
The Company conducts an extensive pre-closing review and analysis of
all facets of the seller's operations. The process includes a combination of
selective field equipment inspections, individual review of substantially all of
the subscriber contracts, an analysis of the rights and obligations under such
contracts and other types of verification of the seller's operations.
The Company has a specific assimilation program, in conjunction with
the seller, for each acquisition. Assimilation efforts typically include a
letter, approved by the Company, 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 soliciting certain information and
addressing the subscriber's questions or concerns. Finally, the subscriber
receives a follow-up telephone call after six months and periodically
thereafter. The acquisition management system's goal is to enhance new
subscriber identification with Protection One as the service provider and to
maintain subscriber satisfaction, and thus realize a higher portion of the
potential value of the MRR generated by purchased subscriber accounts.
DESCRIPTION OF OPERATIONS
The Company's operations consist principally of alarm monitoring
services, enhanced security services, field repair services and patrol and alarm
response services.
ALARM MONITORING SERVICES
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
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devices are connected to a computerized control panel that communicates through
telephone lines to a central monitoring station. 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.
The Central Monitoring Station. The Company monitors substantially all
of its subscriber accounts at its central monitoring station in Portland,
Oregon. In addition, in connection with certain acquisitions, the monitoring of
certain subscriber accounts is subcontracted to independent monitoring companies
to comply with certain state regulations. However, it is the Company's policy to
transfer all monitoring services for its acquired subscriber accounts to its
central monitoring station as soon as practicable.
The central monitoring station incorporates the use of advanced
communications and computer systems that route incoming alarm signals and
telephone calls to operators. Each operator sits before a computer monitor 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.
The central monitoring station has the capacity to monitor up to
500,000 subscribers. The equipment at the central monitoring station includes:
sophisticated phone switching equipment; digital receivers that process the
incoming signals; two computers with built-in redundancy; a network of "smart"
computer terminals; a multi-channel, voice-activated recording system;
uninterruptable power supply; and dual backup generators supplied by different
fuel sources.
The Company's central monitoring station is listed by Underwriters
Laboratories Inc. ("UL") as a protective signaling services station. UL
specifications for central monitoring stations include building integrity,
back-up 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.
Operation of the Central Monitoring Station. Depending upon the type of
service for which the subscriber has contracted, central monitoring station
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 central monitoring station operates 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.
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. The Company maintains an individual file with a signed copy of
the contract for each of its subscribers and a computerized customer data base.
Substantially all of the Company's alarm monitoring agreements for the
Company's residential subscribers (which constitute approximately 80% of the
Company's total accounts) provide for subscriber payments of between $20 and $40
per month. The Company's commercial subscribers typically pay from $25 to $45
per month.
In the normal course of its business, the Company experiences customer
cancellations of monitoring and related services as a result of subscribers
relocating, the cancellation of purchased accounts in the process of
assimilation into the Company's operations, unfavorable economic conditions,
dissatisfaction with field maintenance services and other reasons.
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This attrition is offset to a certain extent by revenues from the sale of
additional services to existing subscribers, price increases, the reconnection
of premises previously occupied by subscribers, conversions of accounts
previously monitored by other alarm companies and guarantees provided by the
sellers of such accounts. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Overview -- Subscriber Attrition."
ENHANCED SECURITY SERVICES
Additional MRR is generated by the provision of enhanced security
services that the Company offers to both its existing subscribers and in
conjunction with the sales of new systems. These enhanced security services
include:
Extended Service Protection, which covers the normal costs of repair
and maintenance 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 central monitoring station 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 what 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, at discounted rates, with
standard pager services that also enable the Company to reach the subscriber in
the event of an alarm activation.
Remote Video Verification, which allows video images to be sent to the
central monitoring station from small video cameras located within the monitored
premises. The Company has only recently begun offering this service and expects
that as a consequence of its cost, its primary market will be the Company's
small business accounts.
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.
FIELD REPAIR SERVICES
The Company believes one of the most effective ways of improving
customer retention is the provision of responsive field repair service by
Company employees. Field service personnel are trained by the Company to provide
repair services for the various types of security systems owned by the Company's
subscribers. Field service personnel also inspect installations performed by the
Company's installation subcontractors.
Repair services generate revenues primarily through billable field
service calls and contractual payments under the Company's extended service
program. The increasing density of the Company's subscriber base, as a result of
the Company's continuing effort to infill areas surrounding its branch
operations with new subscribers, permits more efficient scheduling and routing
of field service technicians, and results in economies of scale at the branch
level. The increased efficiency in scheduling and routing also allows the
Company to provide faster field service response and support, which leads to a
higher level of subscriber satisfaction.
ALARM RESPONSE AND PATROL SERVICES
Protection One offers its subscribers in southern California and Las
Vegas a patrol and alarm response enhanced service in addition to Protection
One'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 Protection One's
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patrol officers to observe and report to police or other emergency agencies any
potential criminal activity at a subscriber's home.
Protection One has begun to offer a new bundle of services in Las
Vegas. The bundle of services consists 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) eliminate subscriber
uncertainty arising from "per response" charges. Protection One intends to
expand the offering of this service's package to other areas within its markets
over the next several years.
Patrol and alarm response officers are dispatched by a 24-hour central
radio dispatch office located in the local dispatch office. An alarm activation
signal from a subscriber to alarm response service is automatically processed by
computer at the central monitoring station in Portland and sent electronically
to the local dispatch office. 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, which will cancel police response and thereby
reduce the potential for a false alarm fine.
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. Officers are subject to 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 the
state to carry firearms and to provide patrol services. The Company's training
program includes arrest procedures, criminal law, weaponless defense, firearms
and baton usage, patrol tactics, and first-aid and CPR. This training program
exceeds state-mandated training requirements. However, the provision of patrol
and alarm response services subjects the Company to greater risks, relating to
accidents or employee behavior, than other types of businesses.
The cost of providing patrol and alarm response services presently
exceeds the revenues generated by such services. However, the Company believes
that its ability to provide these services gives the Company a competitive
advantage in marketing its monitoring services over alarm service companies that
do not have these capabilities. Additionally, the Company believes such services
are an effective impediment to subscriber attrition.
The Company believes that demand for patrol and alarm response services
may 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. Although the Company currently incurs a loss in its
patrol and alarm response operations, the Company believes further demand for
such services would allow the Company to increase subscriber density in its
patrol routes, thereby reducing losses. In addition, the Company's provision of
patrol and alarm response services is a sales method used to convert 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 would enable it to increase its
conversions of competitors' subscribers to the Company's services.
SALES AND MARKETING
Each of the Company's 13 branch offices includes sales representatives
who track and sign up new owners and sell new systems, equipment add-ons and
upgrades and enhanced services to subscribers. Although the Company does not
actively use outbound marketing methods to sell new security alarm systems, the
Company receives in-bound telephone requests for such systems, primarily as a
result of television and radio advertising, subscriber referrals, local crime
activity and responses to yellow pages advertising. Such leads are pursued by
one of the Company's sales representatives. Alarm sales are made at the
subscriber's home, typically in a single visit by a sales representative. The
Company markets additional services through both its account sales
representatives and through a centralized telephone sales force in the Company's
corporate offices.
The Company believes that the increasing density of the Company's
subscriber base (i.e., the increasing concentration of subscribers in certain
areas) has increased the overall presence and visibility of the Company. Both in
the Dealer Program
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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 service,
which uses marked patrol cars, also increases the Company's visibility.
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 of such 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 and price. The Company believes it competes effectively with
other national, regional and local security alarm companies in the western
United States because of the Company's reputation for reliable equipment and
services, its concentrated presence in the areas surrounding its branch offices,
its ability to bundle monitoring, maintenance and repair and enhanced services
and its low cost structure.
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) licensing individual alarm systems
and the revocation of such licenses 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. From time to time
subscribers have submitted complaints to state and local authorities regarding
the Company's sales and billing practices. Such complaints can result in
regulatory action against the Company, including civil complaints seeking
monetary and injunctive remedies.
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.
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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
The Company has conducted a review of its computer systems to identify
the systems that could be affected by the "Year 2000" issue and is addressing
any potential impact to the Company from the issue. The Year 2000 problem is the
result of computer programs being written using two digits rather than four to
define the applicable year. Any of the Company's programs that have
time-sensitive software may recognize a date using "00" as the year 1900 rather
than the year 2000. This could result in a major system failure or
miscalculations. The Company presently believes that, with modications to
existing software and converting to new software, the Year 2000 problem will
not pose significant operational problems for the Company's computer systems as
so modified and converted. However, if such modifications and conversions are
not completed timely, the Year 2000 problem may have a material impact on the
operations of the Company.
EMPLOYEES
At September 30, 1997, the Company employed 852 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. The Company
believes that its relations with its employees are good.
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ITEM 2. FACILITIES
The information contained in this Item 2 describes the properties of
the Company as of September 30, 1997. For information with respect to the
properties of the Western Resources Securities Business, reference is made to
the information included under the caption "The Western Resources Security
Business" included in the Proxy Statement, which information is incorporated
herein by reference.
The Company's executive offices are located at 6011 Bristol Parkway,
Culver City, California, and its central monitoring station and administrative
office are located in the Portland, Oregon metropolitan area at 3900 S.W. Murray
Boulevard, Beaverton, Oregon. The offices at both locations are leased by the
Company. The Culver City lease expires in 1998, but can be renewed by the
Company for an addition term of five years. The Company also leases office space
in Bullhead City, Arizona; Tempe, Arizona; Las Vegas, Nevada; Albuquerque, New
Mexico; Salt Lake City, Utah; Kent, Washington; Riverside, California;
Bakersfield, California; San Leandro, California; San Diego, California; Santa
Clara, California; and Van Nuys, California. The leases for these properties
expire on various dates through 2012, and in some cases are renewable at the
option of the Company.
ITEM 3. LEGAL PROCEEDINGS
On January 8, 1997, Innovative Business Systems ("IBS") filed suit
against Westinghouse Electric Corporation ("WEC"), Westinghouse Security
Systems, Inc. ("WSS"), Western Resources, WestSec and Renee T. Kingsley in the
298th Judicial District Court, Dallas County, Texas, alleging, among other
things, breach of contract by WEC and interference with contract by Western
Resources and WestSec in connection with the sale by WEC of the assets of WSS to
WestSec. IBS alleges in the suit that WEC improperly transferred to WestSec
certain computer software that is owned by IBS and used by WestSec to support
certain monitoring and operating functions and that WestSec is not entitled to
use such software and seeks actual and punitive damages, and injunction relief
to stop WestSec from using the software. All defendants have denied IBS'
allegations are vigorously defending against them. The case is currently
scheduled for trial in March, 1998. Pursuant to the Contribution Agreement, the
first $1 million of damages, costs, expenses and other losses incurred by
WestSec in connection with this litigation will be borne by Protection One, but
Western Resources will indemnify Protection One against all losses in excess of
such amount.
On April 28, 1997, Westec Security, Inc. ("WS") filed suit against
WestSec, Western Resources and Westar Security in Superior Court of California,
Los Angeles County, West District. The case was removed by Defendants to the
U.S. District Court for the Central District of California alleging that the
defendants' use of the trademarks "Weststar" and "WestSec" infringed on and
competed unfairly with WS's rights in the trademark "Westec." The suit sought
to enjoin defendants from using the Westar and Westec marks, a constructive
trust on profits as a result of the use of the marks, monetary, general and
punitive damages. On December 10, 1997, the parties and POI entered into a
settlement agreement with respect to this litigation providing for, among other
things, the dismissal of the complaint with prejudice and the release of all
claims by WS against Westar, WestSec and POI arising out of the use of the
contested trademarks by the Western Resources Security Business in exchange for
an agreement by POI, Westar, WestSec and Western Resources to discontinue the
use of such trademarks in connection with the security alarm monitoring
business over a specified period of time.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
None.
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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 September 30, 1996
First Quarter................................................................... $10 1/2 $ 7 9/32
Second Quarter.................................................................. 14 9/16 9
Third Quarter................................................................... 17 5/16 13 3/8
Fourth Quarter.................................................................. 16 7/8 11 3/4
Fiscal Year Ended September 30, 1997
First Quarter................................................................... $15 $ 8 3/4
Second Quarter.................................................................. 11 1/8 7 3/8
Third Quarter................................................................... 14 1/8 9 1/4
Fourth Quarter.................................................................. 21 3/4 13 3/8
As of December 19, 1997, there were 99 holders of record of the Common
Stock. The Company believes there are in excess of 400 beneficial owners of the
Common Stock.
POI has never paid any cash dividends on the Common Stock other than
the Special Dividend, 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. Monitoring's $100.0 million revolving
credit facility (the "Revolving Credit Facility"), the indenture (the "Discount
Note Indenture") pursuant to which Monitoring's 13 5/8% Senior Subordinated
Discount Notes due 2005 (the "Discount Notes") were issued and the indenture
(the "Convertible Note Indenture") pursuant to which Monitoring's 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. For
additional information with respect to the Special Dividend, see note 19 of the
notes to the consolidated financial statements of POI included in Item 14 of
this Report.
Pursuant to the terms of the credit agreement (the "Credit Agreement")
governing the Revolving Credit Facility, Monitoring is restricted from making
dividend payments on its common 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.
14
17
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected consolidated financial data for fiscal 1993, 1994, 1995,
1996 and 1997 are derived from the consolidated financial statements of the
Company that have been audited by Coopers & Lybrand L.L.P. The selected
consolidated 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, included elsewhere in this Report.
YEAR ENDED SEPTEMBER 30,
----------------------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
STATEMENT OF OPERATIONS DATA: ...................... IN THOUSANDS, EXCEPT PER SHARE AND SUBSCRIBER DATA
Revenues:
Monitoring and service ......................... $ 15,043 $ 29,297 $ 48,909 $ 68,778 $ 94,702
Other .......................................... 6,847 5,183 6,973 4,679 3,791
-------- -------- -------- -------- --------
Total revenues ............................... 21,890 34,480 55,882 73,457 98,493
-------- -------- -------- -------- --------
Cost of revenues:
Monitoring and service ......................... 3,664 8,355 13,627 19,065 25,653
Other .......................................... 3,562 3,225 3,887 2,513 2,291
-------- -------- -------- -------- --------
Total cost of revenues ....................... 7,226 11,580 17,514 21,578 27,944
-------- -------- -------- -------- --------
Gross profit ................................. 14,664 22,900 38,368 51,879 70,549
Selling, general and administrative
expenses ....................................... 11,797 10,607 13,031 15,478 19,978
Loss on acquisition terminations ................. -- 26 208 -- --
Performance warrants compensation
expense ........................................ -- 4,504 -- -- --
Adjustment of purchase accounting
Accruals, net .................................. (742) -- -- -- --
Acquisition and transition expenses .............. -- -- 3,090 4,219 5,920
Amortization of intangibles accounts and
depreciation ................................... 4,386 9,289 16,543 25,121 38,227
-------- -------- -------- -------- --------
Operating income (loss) ...................... (777) (1,526) 5,496 7,061 6,424
Interest expense, net(a) ......................... 1,564 6,932 7,626 4,885 9,136
Amortization of debt issuance costs
and OID ........................................ 185 891 6,797 17,812 20,706
Loss on assets held for sale ..................... -- -- -- 89 339
Loss (gain) on sales of assets ................... -- -- 505 19 (100)
-------- -------- -------- -------- --------
Loss before income taxes,
extraordinary items and cumulative
effect of change in accounting
method - net of taxes ..................... (2,526) (9,349) (9,432) (15,744) (23,657)
Income tax benefit ............................... -- 2,863 3,595 247 1,744
Extraordinary item -- loss on early
extinguishment of debt -- net (b) .............. (281) (1,174) (8,906) -- --
Cumulative effect of change in
accounting method -- net (c) .................. -- -- (1,955) -- --
-------- -------- -------- -------- --------
Net loss ..................................... $ (2,807) $ (7,660) $(16,698) $(15,497) $(21,913)
======== ======== ======== ======== ========
Loss attributable to common stock ............ $ (4,635) $ (9,161) $(18,453) $(15,745) $(21,913)
Loss per common share:
Before extraordinary items and
cumulative effect of change in
Accounting method ............................ $ (41.86) $ (27.11) $ (0.87) $ (1.40) $ (1.59)
Net loss per share ................................. $ (44.57) $ (31.10) $ (2.12) $ (1.40) $ (1.59)
YEAR ENDED SEPTEMBER 30,
---------------------------------------------------------------------
1993 1994 1995 1996 1997
--------- --------- --------- --------- ---------
CONSOLIDATED BALANCE SHEET DATA:
Working capital (deficit) ...................... $ (1,632) $ (11,505) $ (9,159) $ (5,632) $ (14,834)
Subscriber accounts and intangibles ............ 37,204 114,620 162,239 257,354 326,748
Total assets ................................... 44,472 126,085 178,669 297,636 369,191
Long-term debt ............................... 23,591 86,842 146,023 225,650 303,880
Redeemable preferred stock ................... 22,957 22,210 6,127 -- --
Total stockholders' equity (deficit) ......... (8,796) (6,084) 6,347 28,827 17,371
YEAR ENDED SEPTEMBER 30,
------------------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
OTHER OPERATING DATA:
MRR (d) ........................................ $ 1,208 $ 2,737 $ 3,924 $ 6,187 $ 8,003
Number of subscribers net at end of period ..... 39,527 85,269 129,420 196,531 254,478
EBITDA (e) ..................................... $ 3,609 $ 12,294 $ 22,247 $ 32,181 $ 44,651
15
18
- ---------------
(a) Includes interest expense to related parties of $0.3 million in fiscal 1993.
(b) In connection with the early extinguishment of the $50.0 million principal
amount of the Company's 12% Senior Subordinated Notes, the Company incurred
an extraordinary loss of approximately $8.9 million, net of the effect of
taxes of $0.9 million, in fiscal 1995.
(c) For information regarding this change, see "Management's Discussion and
Analysis of Financial Condition and Results of Operations -- Overview --
Recent Change in Accounting Method" included in Item 7 below and Note 2 of
Notes to Consolidated Financial Statements included in Item 14 below.
(d) MRR means 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. 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. 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.
(e) EBITDA is derived by adding to loss before income taxes, extraordinary items
and cumulative effect of change in accounting method--net of taxes the sum
of (i) loss on sales of subscriber accounts, (ii) amortization of debt
issuance costs and OID, (iii) interest expense, net, (iv) amortization of
subscriber accounts and goodwill, (v) depreciation expense, (vi) performance
warrants compensation expense, (vii) adjustment of purchase accounting
accruals, net and (viii) loss on acquisition terminations. 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.
The following table provides a calculation of EBITDA for each of the
periods presented above:
YEARS ENDED SEPTEMBER 30,
----------------------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
Loss before income taxes, extraordinary
items and cumulative effect of change in
accounting method-net of taxes (a) ............... $ (2,526) $ (9,349) $ (9,432) $(15,744) $(23,657)
Plus:
Loss (gain) on sales of assets ................... -- -- 505 19 (100)
Loss on assets held for sale ..................... -- -- -- 89 339
Amortization of debt issuance costs and OID ...... 185 891 6,797 17,812 20,706
Interest expense, net ............................ 1,564 6,932 7,626 4,885 9,136
Amortization of subscriber accounts goodwill
And amortization ............................... 3,864 8,772 15,460 23,275 34,975
Depreciation expense ............................. 522 518 1,083 1,845 3,252
Performance warrants compensation expense ........ -- 4,504 -- -- --
Loss on acquisition terminations ................. -- 26 208 -- --
-------- -------- -------- -------- --------
EBITDA ........................................ $ 3,609 $ 12,294 $ 22,247 $ 32,181 $ 44,651
======== ======== ======== ======== ========
- ---------------
(a) Such adjustment caused such loss to be reduced by approximately $0.7
million for fiscal 1993.
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 based on the Company's business, operations and financial
condition as of and for the year ended September 30, 1997. Stockholders,
potential investors and other readers of this Report should be aware that the
information below does not, in general, reflect the impact that the Western
Resources transaction will have on the future business, operations, revenues,
expenses and net income or loss, or the future liquidity and capital resources,
of the Company, Western Resources and that the business, results of operations
and financial condition of the post-transaction Company may not follow the same
historical trends or be subject to or reflect the same dependence on the
economic and competitive factors described below.
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 initial terms ranging from one to
five years. 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 from revenues from the sale and
installation of security systems, add-ons and upgrades. Payment for monitoring
services is typically required in advance. Monitoring and service
19
revenues are recognized as the service is provided. Installation, add-on and
upgrade revenue is recognized when the required work is completed. All direct
installation costs, which include materials, labor and installation overhead,
and selling and marketing costs are expensed in the period incurred.
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 the revenues generated by
patrol services, and although sales and installation services contribute to the
Company's gross profits, the total expenses associated with alarm system
installations (including not only the direct costs of providing such services
but also the expenses associated with the sales and marketing of alarm systems)
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 to the generation and retention of alarm monitoring
subscribers.
Accounting Differences for Account Purchases and New Installations. A
difference between the 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 has a significant impact on
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 10 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
capitalized and amortized as described above. In contrast, all of the Company's
costs related to the sales, marketing and installation of new alarm monitoring
systems generated by the Company's sales force are expensed in the period in
which such activities occur.
Change in Accounting Method. In the third quarter of fiscal 1995, the
Company changed its method of accounting for certain subscriber account
acquisition and transition costs, effective as of October 1, 1994. The
acquisition and transition costs previously capitalized, which under the new
method are expensed as incurred, are the Company personnel and related support
and duplicate costs incurred solely in connection with acquisitions and
transitions.
The new method is consistent with emerging guidelines as published on
July 21, 1995 by the Emerging Issue Task Force of the Financial Accounting
Standards Board. See Note 2 of the Notes to Consolidated Financial Statements
included in Item 14 hereof.
As a result of the change in accounting method: (i) in the quarter
ended December 31, 1994, the Company recorded a non-cash, non-recurring charge
of approximately $2.0 million, which amount represents the cumulative effect
(net of income tax benefit of approximately $1.2 million) of the accounting
change on prior years' results of operations; and (ii) the Company's statement
of operations for fiscal 1995 includes (and subsequent statements of operations
will include) a new expense item captioned "acquisition and transition expenses"
to reflect the application of the new accounting method for fiscal 1995 and
subsequent periods. The expense was approximately $3.1 million for fiscal 1995
(before associated tax benefit). The foregoing non-recurring charge and expenses
are reflected in the financial information presented in this report. Such
expenses will fluctuate from quarter to quarter based primarily on the amount of
the Company's acquisition activity and its ability to require sellers to bear
certain of such acquisition-related expenses.
Acquisition and Dealer Program Activity. A significant portion of
Protection One's growth has been generated by the purchase of subscriber
accounts through Protection One's Dealer Program and through the acquisition of
portfolios of subscriber accounts from other alarm companies. Protection One's
Dealer Program consists of exclusive purchase agreements with independent alarm
companies specializing in the sale and installation of new alarm systems. Dealer
Program participants install 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.
Substantially all of these subscribers are contacted individually by Protection
One personnel, at the time of purchase of the accounts from the dealer, to
facilitate
17
20
customer satisfaction and quality control. In addition, Protection
One requires dealers to evaluate the credit history of prospective new
subscribers.
Protection One also purchases portfolios of subscriber accounts.
Because Protection One typically acquires only the subscriber accounts (and not
the accounts receivable or similar assets) of the sellers, Protection One
focuses its pre-acquisition review and analysis on the quality and stability of
the subscriber accounts to verify the monthly recurring revenue ("MRR")
represented by such accounts. If the subscriber accounts to be purchased pass
such due diligence scrutiny, Protection One then applies its monitoring and
other servicing costs to such MRR as a basis for determining the purchase price
to be paid by Protection One. To protect Protection One against the loss of
acquired accounts, Protection One typically seeks to obtain from the seller a
guarantee against the subscriber account cancellation for a period following the
acquisition and the right to retain a portion of the acquisition price (a
"purchase price holdback") against the MRR lost due to subscriber account
cancellations during the specified period. Protection One obtains a similar
purchase price holdback in its purchases through the Dealer Program.
During fiscal 1997, the Company added (through acquisitions of 14
portfolios of subscriber accounts and through its Dealer Program) an aggregate
of approximately 92,000 subscriber accounts for a total purchase price of
approximately $108.9 million (including assumed liabilities of approximately
$20.7 million). The MRR of the acquired accounts ranged from approximately
$10.00 to $40.00, with an average of $29.25. Of the acquisitions completed
during fiscal 1997 by the Company, the substantial majority included purchase
price holdbacks in amounts that ranged from 0% to 20% of the initial purchase
price (and averaged 12.3% of the initial purchase price) and attrition
guarantees for periods that ranged from six months to 12 months (and averaged
11.9 months).
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 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)
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. The following table sets forth the
Company's gross subscriber attrition and net MRR attrition for the periods
indicated:
TWELVE MONTHS ENDED SEPTEMBER 30,
---------------------------------
1995 1996 1997
-------- -------- --------
Gross subscriber attrition 19.3% 18.3% 17.3%
Net MRR attrition ........ 6.6 7.0 7.8
Management has established target ranges for gross subscriber attrition
and net MRR attrition of 16%-18% and 6%-8%, respectively. Fluctuations in gross
subscriber attrition reflect changes in levels of acquisition activity, at the
rate at which subscribers move, the number of subscribers that the Company
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 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. In each of fiscal
years 1995, 1996 and 1997, gross subscriber attrition declined and net MRR
attrition increased. For each such period, while the gross number of subscriber
disconnects as a percentage of the average subscriber balance decreased, such
disconnects covered by purchase holdbacks declined and net MRR attrition
increased.
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
18
21
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 monitoring center and are included in the
calculation of gross subscriber and net MRR attrition.
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 in the table above.
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 10 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 in 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 -- Fiscal 1997 Compared to Fiscal 1996 -- Amortization of subscriber
accounts and goodwill" below and Note 7 of Notes to Consolidated Financial
Statements included in Item 14 of this Report.
The table below sets forth the change in the Company's subscriber base
over fiscal years 1995-1997:
YEAR ENDED SEPTEMBER 30,
------------------------------------
1995 1996 1997
-------- -------- --------
Beginning of period ................................ 85,269 129,420 196,531
Additions through portfolio acquisitions and Dealer
Program, net of sales of subscriber accounts ..... 60,909 91,325 92,059
Installations by Company personnel ................. 1,502 881 232
Reconnects and conversions ......................... 3,585 4,633 4,981
Gross subscriber attrition ......................... (21,845) (29,728) (39,325)
-------- -------- --------
End of period ................................... 129,420 196,531 254,478
======== ======== ========
Changes in Statement of Operations Presentation Format. Beginning with
its Quarterly Report on Form 10-Q for the first quarter of fiscal 1997,
Protection One made changes to its presentation of income statement information.
First, Protection One has reclassified revenues and cost of revenues associated
with its alarm response and patrol operations from the "other" category to
"monitoring and related services." The "other" category now reflects solely
results from Protection One's installation, lock and other operations.
Protection One made this change to better reflect its efforts to sell a bundle
of monitoring, field service and alarm response services to both existing and
new subscribers. Second, Protection One has reclassified depreciation expense
from monitoring and service cost of revenues, other cost of revenues and the
selling, general and administrative expenses category, and included depreciation
expense in a line item entitled "amortization of intangibles and depreciation
expense." Protection One made this change to allow readers to more easily
calculate the aggregate amount of non-cash charges in the income statement.
Finally, Protection One has reclassified customer service expense from
monitoring and service cost of revenues to selling, general and administrative
expenses. This change reflects Protection One's move to centralize all customer
service functions into a single facility in Chatsworth, California. Customer
service personnel formerly dedicated to the support of monitoring and related
services are responsible for Protection One's entire customer service efforts.
Results reported in this Report for fiscal 1997 have been modified to reflect
these changes and make the information for such periods comparable to
information for the year ended September 30, 1997. Amounts in the audited
financial statements as of September 30, 1995 and 1996 and for the two years
ended September 30, 1996 included in this Report have also been reclassified to
reflect these changes.
19
22
The Financial Accounting Standards Board (FASB) has issued several
accounting pronouncements that the Company will be required to adopt in future
fiscal reporting periods.
FASB Statement No. 128 "Earnings per Share" establishes new guidelines
for the calculation of and disclosures regarding earnings per share. The Company
will adopt the provisions of Statement No. 128 for financial statements for
periods after December 15, 1997, and at such time will be required to present
basic and diluted earnings per share and to restate all prior periods. There
will be no impact on the calculation of basic earnings per share for the three
months and nine months ended September 30, 1997 and 1996. Diluted earnings per
share is not expected to differ materially from basis earnings per share.
The Company will adopt FASB Statement No. 129 "Disclosure of
Information About Capital Structure" for financial statements for periods after
December 15, 1997. The Company does not expect that adoption of the disclosure
requirements of this pronouncement will have a material impact on its financial
statements.
FASB Statement No. 130 "Reporting Comprehensive Income," which the
Company will adopt for fiscal years beginning after December 15, 1997,
establishes standards for reporting and display of comprehensive income and its
components in financial statements. Comprehensive income generally represents
all changes in shareholders' equity except those resulting from investments by
or distributions to shareholders. Such changes are generally not significant to
the Company; and the adoption of Statement No. 130, including the required
comparative presentation for prior periods, is not expected to have a material
impact on its financial statements.
Restrictions on Dividends. The Company has never paid any cash
dividends on the Common Stock (with the exception of the Special Dividend
associated with the Western Resources transaction) and does not intend to pay
any cash dividends in the foreseeable future. Both the Revolving Credit Facility
and the Discount Note Indenture restrict POI's ability to declare or pay any
dividend on, or make any other distribution in respect of, POI's capital stock.
RESULTS OF OPERATIONS
The following table sets forth certain operating data as a percentage
of total revenues for the periods indicated.
FISCAL YEAR
------------------------------
1995 1996 1997
------ ------ ------
Revenues:
Monitoring and service ................... 87.5% 93.6% 96.2%
Other .................................... 12.5 6.4 3.8
------ ------ ------
Total revenues ................... 100.0% 100.0% 100.0%
------ ------ ------
Cost of revenues:
Monitoring and service ............... 24.4% 26.0% 26.1%
Other .................................... 6.9 3.4 2.3
------ ------ ------
Total cost of revenues ........... 31.3 29.4 28.4
------ ------ ------
Gross profit ..................... 68.7 70.6 71.6
Selling, general and administrative expenses 23.3 21.1 20.3
Loss on acquisition terminations ........... 0.4
Acquisition and transition expenses ........ 5.6 5.7 6.0
Amortization of intangibles and
depreciation expenses ................... 29.6 34.2 38.8
------ ------ ------
Operating income ................. 9.8% 9.6% 6.5%
====== ====== ======
FISCAL 1997 COMPARED TO FISCAL 1996
Revenues for fiscal 1997 increased by $25.0 million, or 34.1%, to $98.5
million from $73.5 million for fiscal 1996. Monitoring and related service
revenues increased by $25.9 million, or 37.7%, substantially all of which
resulted from the addition of approximately 53,000 subscribers from the Dealer
Program and approximately 39,000 subscribers from the acquisition of portfolios
of subscriber accounts. Other revenues declined by approximately 19.0% to
approximately $3.8 million in fiscal 1997 from $4.7 million in fiscal 1996. The
decline in other revenues reflects a decrease in installation revenue of $0.6
million and a decrease in lock revenue of $0.1 million. The decline in
installation revenues resulted from the Company's continued emphasis on growth
through acquisitions and the Dealer Program, rather than through sales of new
alarm systems by Company personnel.
20
23
Cost of revenues for fiscal 1997 increased by $6.4 million, or 29.5% to
$27.9 million. Cost of revenues as a percentage of total revenues declined to
28.4% during fiscal 1997 from 29.4% during fiscal 1996. Monitoring and related
services expenses increased by $6.6 million, or 34.6%, primarily due to
increased activity at the Company's central monitoring station and field service
branches due to a substantially larger subscriber base. Monitoring and related
services expenses as a percentage of monitoring and related services revenues
decreased to 27.1% from 27.7% during fiscal 1996. Such decrease reflects
increased efficiencies in the monitoring and field services areas noted above.
See "-Overview-Acquisition and Dealer Program Activity" above. Other expenses
declined by $0.2 million to $2.3 million in fiscal 1997 from $2.5 million in
fiscal 1996, reflecting the decline in installation activities.
Gross profit for fiscal 1997 was $70.5 million, which represents an
increase of $18.7 million, or 36.0%, over the $51.9 million of gross profit
recognized in fiscal 1996. Such increase was caused primarily by an increase in
monitoring and service activities, which paralleled the increase in the
Company's subscriber base from 196,531 at September 30, 1996 to 254,478 at
September 30, 1997. Gross profit as a percentage of total revenues was 71.6% for
fiscal 1997 compared to 70.6% for fiscal 1996. This increase was caused
primarily by an increase in monitoring and related services revenues as a
percentage of total revenues.
Selling, general and administrative expenses rose to $20.0 million in
fiscal 1997, an increase of $4.5 million, or 29.1%, over such expenses in fiscal
1996, but declined as a percentage of total revenues from 21.1% in fiscal 1996
to 20.3% in fiscal 1997. The increase in general and administrative expenses was
caused by increases in corporate and branch overhead expenses incurred to
supervise a larger employee base associated with a larger subscriber base.
Advertising and marketing expenses are expensed as incurred and comprised less
than 1% of revenues in each of fiscal 1996 and 1997. The provision for doubtful
accounts increased to approximately $3.3 million in fiscal 1997 from $2.6
million in fiscal 1996, reflecting the 38.4% increase in the Company's average
subscriber base from fiscal 1996 to fiscal 1997.
Acquisition and transition expenses for fiscal 1997 totaled $5.9
million compared to $4.2 million for fiscal 1996. Such expenses will fluctuate
from quarter to quarter based primarily on the amount of the Company's
acquisition activity and its ability to require sellers to bear certain of such
acquisition-related expenses.
Amortization of intangibles and depreciation expenses for fiscal 1997
increased by $13.1 million, or 52.2%, to $38.2 million. This increase is the
result of the Company's purchase of approximately 92,000 subscriber accounts
through the acquisition of portfolios of subscriber accounts and through the
Dealer Program, as well as increases in depreciation expense associated with the
Company's new software implementation.
Operating income for fiscal 1997 was $6.4 million, compared to an
operating income of $7.1 million in fiscal 1996. Operating income as a
percentage of total revenues declined to 6.5% in fiscal 1997, compared to 9.6%
in fiscal 1996 due primarily to increases in amortization of subscriber accounts
and goodwill.
Interest expense, net and amortization of debt issuance costs and OID.
These amounts increased by $7.1 million, or 31.5%, to $29.8 million in fiscal
1997, reflecting the Company's use of