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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________________ to ________________
0-24780 33-73002-01
(Commission File Number) (Commission File Number)
PROTECTION ONE, INC. PROTECTION ONE ALARM MONITORING, INC.
(Exact Name of Registrant as Specified Exact Name of Registrant as Specified
in Charter) in Charter)
DELAWARE DELAWARE
(State of Other Jurisdiction of (State or Other Jurisdiction of
Incorporation or Organization) Incorporation or Organization)
93-1063818 93-1064579
(I.R.S. Employer Identification No.) (I.R.S. Employer Identification No.)
600 CORPORATE POINTE, 12TH FLOOR, 600 CORPORATE POINTE, 12TH FLOOR,
CULVER CITY, CALIFORNIA, 90230 CULVER CITY, CALIFORNIA, 90230
(Address of Principal Executive (Address of Principal Executive
Offices, Including Zip Code) Offices, Including Zip Code)
(310) 342-6300 (310) 342-6300
(Registrant's Telephone Number, (Registrant's Telephone Number,
Including Area Code) Including Area Code)
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Securities registered pursuant to Section 12(b) of the Act:
NAME OF EACH EXCHANGE ON WHICH
TITLE OF EACH CLASS REGISTERED
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Common Stock, par value $.01 per share New York Stock Exchange
of Protection One, Inc.
6 3/4% Convertible Senior Subordinated
Notes Due 2003 of Protection One Alarm
Monitoring, Inc. Guaranteed by
Protection One, Inc.
Securities registered pursuant to Section 12(g) of the Act:
(NONE.)
(Title of Class)
Indicate by check mark whether each of the registrants (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that such
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of each registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.
The aggregate market value of common stock of Protection One, Inc. held by
nonaffiliates on February 24, 1999 (based on the last sale price of such shares
on the New York Stock Exchange) was $153,712,322.
As of March 31, 1999, Protection One, Inc. had 126,838,741 shares of Common
Stock outstanding, par value $0.01 per share. As of such date, Protection One
Alarm Monitoring, Inc. had outstanding 110 shares of Common Stock, par value
$0.10 per share, all of which shares were owned by Protection One, Inc.
Protection One Alarm Monitoring, Inc. meets the conditions set forth in General
Instructions I (1)(a) and (b) for Form 10-K and is therefore filing this form
with the reduced disclosure format set forth therein.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of Protection One, Inc.'s proxy statement on Schedule 14A to be
furnished to stockholders in connection with its Annual Meeting of Stockholders
are incorporated by reference in Part III of the Form 10-K. Such proxy statement
is expected to be filed with the Commission prior to April 30, 1999.
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TABLE OF CONTENTS
PAGE
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PART I
Item 1. Business......................................................... 1
Item 2. Facilities....................................................... 23
Item 3. Legal Proceedings................................................ 24
Item 4. Submission of Matters to a Vote of Stockholders.................. 24
PART II
Item 5. Market for Common Equity and Related Stockholder Matters......... 25
Item 6. Selected Consolidated Financial Data............................. 26
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations............................................. 29
Item 7A. Market Risk Disclosure........................................... 44
Item 8. Financial Statements and Supplementary Data...................... 45
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.............................................. 45
PART III
Item 10. Directors and Executive Officers of the Registrants.............. 46
Item 11. Executive Compensation........................................... 46
Item 12. Security Ownership of Certain Beneficial Owners and Management... 46
Item 13. Certain Relationships and Related Transactions................... 46
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form
8-K............................................................... 47
PART I
ITEM 1. BUSINESS
Unless the context otherwise indicates, all references in this Annual Report
on Form 10-K (this "Report") to the "Company", "Protection One," "we," "us" or
"our" or similar words are to Protection One, Inc., its direct wholly owned
subsidiary, Protection One Alarm Monitoring, Inc. ("Protection One Alarm
Monitoring") and Protection One's other wholly owned subsidiaries. Each of
Protection One and Protection One Alarm Monitoring is sometimes referred to
herein as "Registrant." Protection One's sole asset is, and Protection One
operates solely through, its investment in Protection One Alarm Monitoring and
Protection One's other wholly owned subsidiaries. Each of Protection One and
Protection One Alarm Monitoring is a Delaware corporation organized in September
1991.
OVERVIEW
Protection One is one of the leading providers of life safety and property
monitoring services, providing electronic monitoring and maintenance of its
alarm systems to over 1.5 million customers in North America and Europe. We also
provide our customers with enhanced services that include:
- extended service protection;
- patrol and alarm response;
- two-way voice communication;
- pager service;
- medical information service;
- cellular back-up; and
- mobile security services.
Approximately 85% of our revenues are contractually recurring for monitoring
alarm security systems and other related services. We have grown rapidly by
participating in the organic growth in the alarm industry and by acquiring other
alarm companies.
BUSINESS
Our principal activity is responding to the immediate security and safety
needs of our customers 24 hours a day. Our revenues are generated primarily from
recurring monthly payments for monitoring and maintaining the alarm systems that
are installed in our customers' homes and businesses. Security systems are
designed to detect burglaries, fires and other events. Through a network of 66
service branches and four satellite offices in North America and 49 service
branches in continental Europe and the United Kingdom, we provide maintenance
service of security systems and, in certain markets, armed response to verify
that an actual emergency has occurred.
We provide our services to the residential (both single family and
multifamily residences), commercial and wholesale segments of the alarm
monitoring industry. Although we intend to grow our presence in each of these
market segments, we believe that the residential segment, which represents in
excess of 80% of our customer base, is the most attractive segment of the alarm
business because of its lower penetration and thus stronger growth prospects,
higher gross margins and larger potential size.
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At December 31, 1998, our customer base composition was as follows:
MARKET SEGMENT PERCENTAGE OF TOTAL
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Single Family.............................................................. 57%
Multifamily/Apartment...................................................... 21%
Commercial................................................................. 12%
Wholesale.................................................................. 10%
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Total.................................................................. 100%
---
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Wholesale customers represent those customers that are served by smaller
independent alarm dealers that do not have a monitoring station and therefore
subcontract monitoring services from us. Of the approximately 10% of our
customer base that are wholesale customers, approximately 75% of those are
residential customers.
Our company is divided geographically into two business segments:
PROTECTION ONE NORTH AMERICA generated approximately $377 million, or 90%,
of our revenues in 1998 and is comprised of:
- Protection One Alarm Monitoring--our core alarm monitoring business based
in Culver City, California and
- Network Multifamily Security--our monitored alarm business servicing the
multifamily/apartment market based in Addison, Texas and
- Mobile Division--our location-based emergency, navigation and information
business servicing individuals in their automobiles based in Irving,
Texas.
PROTECTION ONE EUROPE generated approximately $44 million, or 10%, of our
revenues in 1998 and is comprised of:
- Protection One Continental Europe--our alarm monitoring business servicing
continental Europe, established from our purchase of Compagnie Europeenne
de T elesecurite ("CET") in September 1998, described below, based in
Paris and Vitrolles, France and offices in Germany, Switzerland, Belgium
and the Netherlands and
- Protection One United Kingdom--our alarm monitoring business servicing the
United Kingdom, established from our purchase of Hambro Countrywide
Security in May 1998, described below, based in Basingstoke, United
Kingdom.
Because Protection One Europe was created as a result of acquisitions that
occurred during the course of the year, only 10% of our 1998 revenues were
contributed from this business segment. This percentage is expected to increase
in 1999 as Protection One Europe contributes a full year of revenues.
RECENT DEVELOPMENTS
SUMMARY OF NOTABLE TRANSACTIONS IN 1998
Since November 1997, we have grown from a regional security alarm company in
the western United States into a nationwide provider of life safety and property
monitoring services through a series of significant strategic acquisitions and
internal growth. The most important of these acquisitions was the combination
with the security business of Western Resources, Inc., a transaction that
increased our size by approximately 500,000 customers. The combination with
Western Resources was completed in November 1997 and gave us the operational
infrastructure and financial strength to support our substantial growth in 1998.
We believe our internal growth and acquisition activity during 1998 successfully
established
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Protection One as the second largest company in the residential monitoring
segment of the industry. We added over 500,000 new customers in 1998, obtained a
leading position in the multifamily alarm monitoring segment and entered new,
high growth markets in Canada, the United Kingdom and continental Europe. In
1998, we undertook the following notable acquisitions and financings:
- THE ACQUISITION OF NETWORK MULTIFAMILY SECURITY CORPORATION. We acquired
approximately 200,000 customers by purchasing the stock of Network
Multifamily Security effective January 1, 1998 under the terms of a
purchase option granted to us by Western Resources. We paid approximately
$180 million for what we believe, based on our substantial industry
experience and knowledge, to be the leading provider of security alarm
monitoring services to apartment complexes and other multi-family
dwellings.
- THE ACQUISITION OF MULTIMEDIA SECURITY SERVICES, INC. We obtained
approximately 147,000 customers and related assets, including a service
center in Wichita, Kansas, when we purchased certain assets and
liabilities of Multimedia Security Services for approximately $233 million
in cash on March 2, 1998.
- THE ACQUISITION OF COMSEC/NARRAGANSETT SECURITY, INC. We obtained 30,000
customers located primarily in the Northeast United States when we
purchased all of the capital stock of Comsec/ Narragansett Security for
$65 million, consisting of approximately $49 million of cash and $16
million of assumed debt, on March 17, 1998.
- A CONCURRENT PUBLIC OFFERING AND PRIVATE PLACEMENT OF OUR COMMON STOCK. We
issued 4,500,000 shares of common stock to the public and 33,000,000
shares of common stock to Western Resources for aggregate proceeds of
approximately $356 million on June 8, 1998. We issued an additional
667,144 shares to the public and 4,597,500 shares to Western Resources for
aggregate proceeds of approximately $50 million on June 29, 1998. The
proceeds from these offerings were used to redeem $65.0 million of the
outstanding senior subordinated discount notes issued by Protection One
Alarm Monitoring and to repay borrowings under our credit facility with
Westar Capital, our controlling stockholder and a wholly owned subsidiary
of Western Resources.
- THE ACQUISITION OF HAMBRO COUNTRYWIDE SECURITY. We acquired all of the
capital stock of Hambro Countrywide Security, the fifth largest security
company in the United Kingdom with operations throughout the United
Kingdom, for approximately $18 million on May 18, 1998.
- THE ACQUISITION OF ROGER'S CANGUARD INC. We acquired all of the capital
stock of Rogers CanGuard Inc., a wholly-owned subsidiary of Rogers
Cablesystems Limited, on June 30, 1998. Rogers CanGuard was Canada's fifth
largest provider of residential and commercial security services with
approximately 38,000 subscribers and two central stations located in
Vancouver, British Columbia and Ottowa, Ontario, Canada.
- A PRIVATE OFFERING OF SENIOR NOTES. Protection One Alarm Monitoring issued
$250 million of senior unsecured notes bearing an interest rate of 7 3/8%
and due in 2005 in a private offering completed on August 17, 1998. We
used proceeds from this offering to repay borrowings under our credit
facility with Westar Capital.
- THE ACQUISITION OF CET. We established a major presence in Western Europe
by purchasing the common stock of this public company with 60,000
customers for approximately $140 million in a series of transactions
completed on September 30, 1998. We also assumed liabilities for recourse
financing contracts sold to a third party financing company in this
acquisition.
- THE REFINANCING OF OUR CREDIT FACILITY WITH WESTAR CAPITAL WITH A NEW $500
MILLION CREDIT FACILITY THROUGH A SYNDICATE OF BANKS. We obtained a
revolving credit facility from a syndicate of banks led by NationsBank
N.A., concurrent with our offering of senior subordinated notes, discussed
below, to substantially replace our credit facility with Westar Capital.
The proceeds of the new facility were
3
used to repay the borrowings under the credit facility with Westar
Capital. We can borrow under this facility at a range of interest rates
based on either the defined prime rate or an Eurodollar rate. Our weighted
average interest rate for the new senior credit facility at December 31,
1998 was 6.8%. The new senior facility matures in December 2001.
- A PRIVATE OFFERING OF SENIOR SUBORDINATED NOTES. Protection One Alarm
Monitoring issued $350.0 million of senior subordinated notes bearing an
interest rate of 8 1/8% and due in 2009 in a private offering completed on
December 21, 1998. We used proceeds from this offering to repay borrowings
under the new credit facility.
SHAREHOLDER LITIGATION
Based on public releases, we understand that purported class action lawsuits
have been filed against us and certain of our officers and directors alleging
violations of federal securities laws arising from our public announcement that
we have decided to restate our financial statements for the year ended December
31, 1997 and each of the first three quarters of 1998. We have not been served
with process and, therefore, cannot provide more details with respect to these
or any other claims alleged in these actions.
THE LIFELINE TRANSACTION
In October 1998, we announced an agreement to acquire Lifeline Systems,
Inc., ("Lifeline") a leading provider of 24-hour Personal Emergency Response and
Support Services (PERSS) in North America. Based on the average closing price of
our common stock for the three trading days prior to April 8, 1999, the value of
the consideration to be paid under the merger agreement is approximately $129.2
million or $22.05 per Lifeline share in cash and stock. Lifeline has advised us
that it is evaluating the restatement of our financial statements. The
consideration to be given in the Lifeline transaction is by design variable and
is subject to change within certain parameters until the closing date.
Interested parties should obtain the most recent proxy/registration statement
for further analysis of the merger consideration.
Each Lifeline share will be converted into the right to receive a
combination of $14.50 in cash and shares of common stock of New Protection One.
The actual amount of cash and the value of the common stock to be issued will be
based on the average closing price of our common stock on the New York Stock
Exchange over the ten-day period ending three days before the Lifeline
stockholders meeting to vote on the proposed merger, a variable exchange rate
and the number of shares of Lifeline common stock outstanding at the time the
transaction is completed. Lifeline stockholders may elect to receive additional
shares of common stock in lieu of all or a portion of the cash consideration.
Lifeline provides 24-hour PERSS to its customers who are primarily elderly
individuals with medical or age-related conditions as well as physically
challenged individuals throughout the United States and Canada. These customers
communicate with Lifeline utilizing a communicator that connects to the
telephone line in the customer's home and to a personal help button, which is
worn or carried by the individual subscriber. Lifeline has an extensive
distribution network of over 2,200 hospitals in all 50 states and Canada. The
Lifeline targeted customer base represents the fastest growing demographic
segment of the North American population.
The Lifeline acquisition is consistent with our strategy to broaden the
services offered to our customers. This acquisition will also afford us the
opportunity to cross-sell our alarm monitoring services to Lifeline's customers,
as well as cross-sell Lifeline's services to both our customers and Western
Resources' customers.
STRATEGY
Our strategy is to become the largest provider of life safety and property
monitoring services based in North America and Europe. We intend to achieve our
growth objectives by extending our leadership
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position in large and growing residential markets and adding new customers
through our dealer program, "tuck-in" acquisitions, direct sales and strategic
alliances. We are dedicated to becoming the highest quality service provider in
the industry. In addition, we are focused on:
- adding new customers at lowest cost by developing new channels of
distribution
- continuing to improve our operating efficiency and margins through further
integration of acquired accounts and better scale economies
- enhancing revenues and margins by offering additional services to new and
existing customers
- cross-selling value-added services to customers in each of our divisions
- continuing to improve our customer service and
- building a preeminent brand name in the security industry.
We believe that this strategy will lead to continued growth in revenues and
EBITDA. The principal components of our strategy are as follows:
INTERNAL GROWTH
DEALER PROGRAM. Rather than incur the costs of maintaining an internal
sales force in our core North American single-family alarm monitoring business,
we have built a dealer program that successfully generates a consistent and
reliable number of new customers each month. We believe that our dealer program
is an advantageous distribution channel because it is a source of significant
organic subscriber growth at lower cost.
Our dealer program is comprised of approximately 250 direct exclusive
dealers that are typically independent alarm companies with residential and
small commercial sales, marketing and installation skills. Our dealers enter
into exclusive contracts with us to generate new monitoring customers that we
purchase from them on an ongoing basis. We have experienced a significant
increase in the number of new customers generated in North America through our
dealer program in 1998. We anticipate developing a similar dealer program in
Europe.
NETWORK MULTIFAMILY SECURITY. Network Multifamily markets its services and
products primarily to developers, owners and managers of apartment complexes and
other multifamily dwellings. Network Multifamily grows its business through
national and regional advertising, a nationwide professional field sales force
and affiliations with professional industry-related associations. We believe
this targeted internal sales effort is the most effective means of generating
sales in the multifamily market, which is comprised primarily of developers and
professionals that can be identified and contacted with relative ease.
EUROPE. We are developing a residential dealer program for Protection One
Europe modeled after our North American dealer program and are building a
distribution network based upon a centralized marketing function to provide
promotional materials in the markets served by Protection One Europe. We also
are developing strategic alliances with leading insurance, banking and real
estate companies in Europe. We believe that the combination of a residential
dealer program, in conjunction with the development of strategic alliances, will
provide our European operations with consistent and reliable subscriber growth
at low cost, particularly as this relatively underdeveloped market matures.
GENERATE CUSTOMER GROWTH THROUGH STRATEGIC ALLIANCES.
Strategic alliances provide us with a proprietary source of prospective
customers and offer us the opportunity to generate new customers at a
substantially lower cost as well as to advertise and to build the Protection One
brand name. We have aggressively pursued alliances with companies in other
industries that have significant residential customer bases. Approximately 95%
of our strategic alliances are exclusive arrangements governed by written
contracts. Examples of companies with which we have established
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strategic alliances include electric and gas utilities, home builders, realtors,
mortgage companies and home improvement retailers.
We have several major initiatives in place for 1999 designed to help evolve
our strategic partners from generating referral sources to becoming direct
sellers of our alarm systems to the end user. This is an integral part of our
strategy to lower the cost of growth through new distribution channels.
SELL ADDITIONAL SERVICES TO INCREASE REVENUES AND MARGINS. As a means to
increase revenues and margins, we provide our new and existing customers with an
array of additional value-added services to help broaden our customer
relationships. Our enhanced services include extended service protection,
several different types of alarm verification, wireless backup and mobile
services. These enhanced services also position us as a full service provider
and give our dealers more features to sell in their solicitation of new
customers.
CROSS-SELLING OF SERVICES BETWEEN DIVISIONS. Through our strategic
partnership with Western Resources, we have access to Western Resources'
approximately 2.5 million customers, which include customers from pending
acquisitions. Management is currently working with Western Resources on
developing programs designed to cross-sell Protection One services to Western
Resources customers as a means of generating new customers at lower cost.
EXTERNAL GROWTH THROUGH ACQUISITIONS
Despite the amount of significant consolidation activity that has occurred
in the alarm industry over the last several years, the industry in North America
and Europe remains highly fragmented. SDM Magazine (formerly Security
Distribution Magazine) estimates that there are over 16,000 alarm companies in
North America alone. The top 100 companies in the North American industry
represent only 25% of the total revenue in that industry. The remaining 75% are
comprised of small, local alarm companies with annual revenues typically less
than $1 million. Management estimates that the combined customer base of these
small alarm companies exceeds eight million customers, indicating that the
consolidation trend in the alarm industry will likely continue for many years to
come. Moreover, we intend to actively pursue lower cost acquisitions in Europe
as an important component of our European growth strategy.
Since November 1997, we have completed in excess of 30 transactions, adding
approximately one million new customers and establishing our market position.
Acquisitions, in conjunction with the dealer program allow us to increase
customer density, which results in significant operating synergies. Our
acquisition strategy for 1999 and beyond is to focus on smaller, less expensive,
"tuck-in" acquisitions that can be quickly and easily integrated into our
existing operations.
INCREASE OPERATING EFFICIENCIES
We continually review our monitoring, customer service and other corporate
operating functions to maximize labor and other efficiencies. These ongoing
initiatives to analyze our cost structure result in ongoing modifications to
operating activities. We believe our economies of scale afford us a distinct
competitive advantage over our smaller competitors.
CUSTOMER SERVICE
Our customer care centers are co-located in our service centers and answer
non-emergency customer inquiries. Highly trained operators answer inbound calls
to our help desk and assist customers with understanding and resolving operating
issues related to their security systems. Our operators are knowledgeable on
virtually every type of alarm system that is installed in our customers' homes.
If an operator is unable to resolve an issue over the phone, a technician is
typically dispatched through a repair order that is entered into our centralized
field scheduling system.
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In 1998, we made a significant investment in our customer service-response
systems and training as part of our ongoing effort to become the highest quality
service provider in the industry.
ESTABLISH PREEMINENT BRAND NAME
We believe that there is a unique opportunity to build a preeminent consumer
brand name in the security industry which would enable us to add new customers
at a lower cost than our competitors and improve customer retention. Our service
and response vehicles, dealer marketing efforts and affinity relationships serve
as a base from which to launch further brand development efforts. We believe
that a well recognized brand supports our goal of becoming the industry leader
and broadening our customer relationships.
THE SECURITY ALARM INDUSTRY
The North American alarm industry is large, growing rapidly and
characterized by a high degree of fragmentation, low residential penetration and
a continuing trend towards consolidation. We believe that the European market is
similarly fragmented and that the residential segment in Europe is substantially
less penetrated than in North America. We further believe that the residential
penetration rate in the European alarm market today closely resembles the
residential penetration rate in the North American alarm market in the early
1980's.
LARGE AND GROWING MARKET
Management estimates that the North American Security industry grew 8.6% in
1998, reaching total revenues of approximately $16.75 billion. Of this total,
management estimates that recurring alarm monitoring and leasing revenue
comprised 20%, or approximately $3.4 billion, an increase of 10.7% from $3.1
billion in 1997. We also participate in the recurring service and maintenance
sector of the alarm industry, which comprised 19%, or approximately $3.2 billion
of total industry revenues, an increase of 8.9% from $2.9 billion in 1997. The
aggregate growth of the markets in which we operate was 9.8% in 1997. SDM
Magazine reports that the largest 100 companies in the U.S. alarm industry
experienced growth of 14.8% in 1998, compared to the industry growth rate of
8.6%. This disparity reflects the ongoing consolidation of the security alarm
industry as larger firms continue to actively acquire smaller companies. We
believe that several favorable demographic trends, including the aging
population, two-income families, home officing as well as a strong economy and
the increased perception of crime have all contributed to an increased demand
for security alarm services.
INCREASED RESIDENTIAL PENETRATION IN NORTH AMERICA AND EUROPE
Management and other industry sources estimate that there will be a
substantial amount of new residential customers created in North America and
Europe over the next several years as more and more consumers elect to include
home security in their places of living.
As the following chart indicates, only about 11% of the 122 million
households in North America currently have a monitored alarm system. With the
estimated terminal penetration and additional growth in the housing stock in
each market segment--defined as the maximum realistic alarm penetration
7
potential within each segment--management estimates that there will be
approximately 30-40 million new customers created in the residential market over
the next several years:
SEGMENT SIZE % TERMINAL
MARKET SEGMENT (IN MILLIONS) % PENETRATED PENETRATION
- ----------------------------------------- --------------- --------------- ---------------------
Single Family............................ 78 15% 30-40%
Multifamily High Rise.................... 12 0 NA
Multifamily "Garden Style"............... 22 5 20-30
Manufactured Housing..................... 10 2 10-20
--- --- -------
Total.................................... 122 11% 20-30%
The residential penetration of alarms in European households is estimated by
management to be less than 5%. With a population of over 380 million people in
the 15 European Union countries (over 100 million larger than the United States)
and crime rates in most European Union countries generally higher than the
United States in most categories except murder, management believes the
residential alarm penetration rate in Europe will increase significantly over
the next several years. We currently operate in six European countries with a
combined population of over 232 million.
TREND TOWARD CONSOLIDATION
Over the last several years, many of the largest security alarm companies in
North America and Europe have been acquired leaving few large national and
Pan-European alarm companies. Potential new entrants into the alarm industry are
now faced with few, if any, large alarm companies available for purchase. We
believe that the larger, more cost efficient alarm companies with access to
capital will continue to grow faster than the industry average. In most cases,
the installation of security systems requires alarm companies to fund the excess
of installation-related costs over installation revenues, a trend that continues
to be prevalent in both the residential and commercial segments.
In addition, we believe that the growth in false alarms is causing some
municipalities to consider alternatives to response by municipal police. To the
extent that municipalities elect to require some form of private verification of
an alarm prior to police dispatch, such policies could impose additional
expenses on alarm monitoring companies and thereby provide additional impetus
for consolidation. Due to our size, density in key markets and access to
capital, we believe we are well positioned to take advantage of consolidation
opportunities in the industry.
OPERATIONS
Our operations consist principally of alarm monitoring, customer service
functions and branch operations.
CENTRALIZED MONITORING, CUSTOMER SERVICE AND CUSTOMER SOLICITATION
CUSTOMER SECURITY ALARM SYSTEMS. Security alarm systems include many
different types of devices installed at customers' premises designed to detect
or to react to various occurrences or conditions, such as intrusion or the
presence of fire or smoke. In general, systems for multi-family and residential
applications tend to be smaller in size than those used by commercial customers,
and also tend to generate a lower level of alarm signals than in commercial
applications. These devices are connected to a computerized control panel that
communicates through the phone lines to a service center. In most systems,
control panels can identify the nature of the alarm and the areas within a
building where the sensor was activated, and can transmit that information to a
central monitoring station.
The basic system sold by our dealers includes monitoring of the front and
back doors of a home, one keypad, an interior motion detection device, a central
processing unit with the ability to communicate
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signals to our central monitoring station, a panic button, a siren, window
decals and a yard sign. This basic system often will be offered for little or no
up-front price, but will be sold to a customer with additional equipment
customized to a customer's specific needs. Such equipment add-ons include
additional perimeter and interior protection, fire protection devices (heat and
smoke detectors), environmental protection devices (freeze sensors and water
detectors), additional panic buttons and home automation devices (lighting or
appliance controls).
CUSTOMER CONTRACTS. Our alarm monitoring customer contracts generally have
initial terms ranging from one to five years in duration, and provide for
automatic renewals for a fixed period (typically one year) unless we or the
customer elects to cancel the contract at the end of its term.
Typically, dealers sign customers to alarm monitoring contracts that include
a bundled monthly charge for monitoring, extended service protection and a
rebate against the homeowners' insurance deductibles in the event of a loss.
Extended service protection covers the normal costs of repair of the security
system after the expiration of the security system's initial warranty period.
Although a customer may elect to sign an alarm monitoring contract that excludes
extended service protection, few customers choose to do so, and we believe the
bundling of monitoring and extended service protection provides additional value
to customers and allows us to provide more efficient field repair services.
SERVICE CENTERS. We maintain eight major service centers in North America
to provide monitoring services to the majority of our customer base. In the
United Kingdom, our service center is based in metropolitan London and in
Continental Europe, our service centers are based in Paris and in metropolitan
Marseilles, France. The table below provides additional detail about the North
American monitoring centers:
CURRENT NUMBER OF CAPACITY OF
LOCATION CUSTOMERS MONITORED FACILITY PRIMARY MARKETS
- ------------------------------- -------------------- ----------- --------------------------
Beaverton, OR.................. 275,000 500,000 Residential/Commercial
Irving, TX..................... 235,000 500,000 Multi-Family
Hagerstown, MD................. 65,000 150,000 Residential/Wholesale
Irving, TX..................... 340,000 750,000 Residential/Commercial
Orlando, FL.................... 100,000 500,000 Wholesale
Wichita, KS.................... 147,000 500,000 Residential/Commercial
Ottawa, Ontario................ 20,000 35,000 Residential
Vancouver, B.C................. 20,000 35,000 Residential
Each service center incorporates the use of state-of-the-art communications
and computer systems that route incoming alarm signals and telephone calls to
operators. Each service center currently monitors signals largely on a
geographic basis. We are currently standardizing our operating platforms so that
the centers will be effectively integrated with signals routed to the centers on
a capacity basis, rather than on a geographic basis. We expect that the use of a
single operating platform in North America and Europe will enable us to realize
overall operating efficiencies through the ability to monitor more effectively
alarm signal patterns and adjust service center staffing levels accordingly.
Depending upon the type of service for which the customer has contracted,
service center personnel respond to alarms by relaying information to the local
fire or police departments, notifying the subscriber, or taking other
appropriate action, such as dispatching alarm response personnel to the
customer's premises where this service is available. We also provide customers
with remote audio verification capability that enables the central monitoring
station to listen and speak directly into the customer's premises in the event
of an alarm activation. This feature allows our personnel to verify that an
emergency exists, to reassure the subscriber, and to expedite emergency
response, even if the customer is unable to reach a telephone. Remote audio
verification capability also assists us in quickly determining if the alarm was
activated inadvertently, and thus whether a response is required.
9
Our service centers operate 24 hours per day, seven days a week, including
all holidays. Each operator within a service center monitors a computer screen
that presents real-time information concerning the nature of the alarm signal,
the customer whose alarm has been activated, and the premises on which such
alarm is located. Each operator receives training that includes familiarization
with substantially every type of alarm system in our customer base. This enables
the operator to tell customers 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. All telephone conversations are automatically recorded. Other
non-emergency administrative signals are generated by low battery status,
deactivation and reactivation of the alarm monitoring system, and test signals,
and are processed automatically by computer.
All of our primary service centers in North America are listed by
Underwriters Laboratories, Inc. ("UL") as protective signaling services
stations. UL specifications for service centers include building integrity,
back-up computer and power systems, staffing and standard operating procedures.
In many jurisdictions, applicable law requires that security alarms for certain
buildings be monitored by UL listed facilities. In addition, such listing is
required by certain commercial customers' insurance companies as a condition to
insurance coverage.
WHOLESALE MONITORING. Through our service center in Orlando, Florida, we
provide wholesale monitoring services to independent dealers. The Orlando
service center is one of only a few wholesale monitoring facilities to offer
two-way voice communication on a widespread basis. Under the typical
arrangement, dealers subcontract monitoring services to us, primarily because
such dealers do not have their own monitoring capabilities. We may also provide
billing and other services. Dealers retain ownership of monitoring contracts and
are responsible for every other aspect of the relationship with customers,
including field repair service.
Our presence in wholesale monitoring provides us with another source of
prospective acquisition targets. Independent dealers who subcontract monitoring
services to us are familiar with our high quality monitoring and related
capabilities, an important consideration for a prospective seller of a portfolio
of security alarm customers.
CUSTOMER CARE SERVICES. Our customer care centers are co-located in our
service centers and process non-emergency communications. Operators receive
inbound customer calls and the customer service group addresses customer
questions and concerns about billing, service, credit and alarm activation
issues. The help desk staff assists customers in understanding and resolving
mechanical and operating issues related to security systems. A centralized field
repair scheduling function sets up technician appointments. We also operate a
dedicated customer service call center in Chatsworth, CA to address questions
that customers or potential customers have about our services, as well as
outbound sales and marketing activities and collections.
ENHANCED SERVICES. As a means to increase revenues and to enhance customer
satisfaction, we offer customers an array of enhanced security services,
including extended service protection and several different types of alarm
verification. These services position us as a full service provider and give
dealers more features to sell in their solicitation of new customers. We
actively solicit our customers for interest in these services. The following
provides additional detail on enhanced services:
- EXTENDED SERVICE PROTECTION, which covers the normal costs of repairing
the system during normal business hours, after the expiration of the
initial warranty period.
- TWO-WAY VOICE COMMUNICATION (REMOTE AUDIO VERIFICATION), which consists of
the ability, in the event of an alarm activation, to listen and to talk to
persons at the monitored premises from the service center through speakers
and microphones located within the premises. Among other things, such
remote audio verification helps us to determine whether an alarm
activation is a false alarm.
- SUPERVISED MONITORING SERVICE, which allows the alarm system to send
various types of signals containing information on the use of the system,
such as which users armed or disarmed the system
10
and at what time of the day. This information is supplied to customers for
use in connection with the management of their households or businesses.
Supervised monitoring service can also include a daily automatic test
feature.
- PAGER SERVICE, which provides the customer with standard pager services
that also enables us to reach the customer in the event of an alarm
activation.
- WIRELESS BACK-UP, which permits the alarm system to send signals over a
cellular telephone or dedicated radio system, in the event that regular
telephone service is interrupted.
- ALARM RESPONSE AND PATROL SERVICE, which provides customers in selected
markets with rapid, on-premises response to and verification of alarms by
armed officers.
- MEDICAL INFORMATION SERVICE,which provides a responder with our customers'
specific medical needs, as well as emergency contacts whether home or
away.
MOBILE SERVICES, which provides professional response for the delivery of
emergency, navigation and information services in mobile applications. We became
a pioneer in the mobile security industry when we teamed with Ford Motor Company
and Motorola in 1995 to develop Lincoln RESCU. This program offered the first
vehicle safety system to integrate cellular phone and global positioning
technology to assist motorists when they need emergency help, roadside or
routing assistance. We recently contracted with Nissan to provide similar
services in connection with equipment built into its Infiniti line of cars.
Mercedes-Benz also recently announced that our mobile security services would be
standard across its entire S-Class model line. We are actively pursuing similar
contracts with other car manufacturers.
BRANCH OPERATIONS
We maintain approximately 66 service branches in North America from which we
provide field repair, customer care, alarm response and sales services and
approximately 4 satellite locations from which we provide field repair services.
We also have approximately 49 service branches in Europe from which we provide
field repair, customer care, alarm response and sales services. Our branch
infrastructure plays an important role in enhancing customer satisfaction,
reducing customer loss and building brand awareness.
FIELD REPAIR. Field repair personnel are trained by Protection One to
provide repair services for the various types of security systems utilized by
our customers. We strive to execute prompt service scheduling and first call
repair for customers. Field personnel also provide quality and related
compliance inspections for new installations performed by our dealers.
Repair services generate revenues primarily through billable field service
calls and recurring payments under our extended service protection program. The
increasing density of our customer base, the result of our successful dealer
program and our continuing efforts to acquire new customers in areas surrounding
branch operations, permit more effective scheduling and routing of field service
technicians and results in economies of scale.
These economies of scale give us a distinct competitive advantage over our
smaller competitors. For example, our customer density grants us increased
efficiency in scheduling and routing and allows us to provide faster field
service response and support, which leads to a higher level of customer
satisfaction and each technician is able to make more service calls per day. We
continually review available automated work management and scheduling programs
to maximize employee resources in the field repair function.
ALARM RESPONSE AND PATROL. We offer our customers in Southern California
and Las Vegas alarm response and patrol enhanced services in addition to our
other services. These armed officers supplement our alarm monitoring service by
providing "alarm response service" to alarm system activations, "patrol service"
consisting of routine patrol of customers' premises and neighborhoods and, in a
few cases, "special watch" services, such as picking up mail and newspapers and
increased surveillance when the customer is travelling. Alarm response service
requires our patrol officers to observe and to report any potential criminal
activity at a customer's home.
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We believe that demand for alarm response and patrol services is likely to
increase as a result of a trend on the part of local police departments to limit
their response to alarm activations and other factors that may lead to a
decrease of police presence. The Private Sector Liaison Committee of the
International Association of Chiefs of Police has established Non-Sworn Alarm
Responder Guidelines to provide standards for private alarm response officers.
Although we currently incur a loss in our patrol and alarm response operations,
we believe that further demand for such services will enable us to increase
customer density in our routes, thereby reducing losses. In addition, our offer
of patrol and alarm response services is a sales method used to attract
customers of other alarm monitoring companies that do not provide such services.
To the extent that further demand develops for patrol and alarm response
services, we believe that our current presence will enable us to increase our
conversions of customers to our services. Additionally, we believe that such
services are an effective impediment to the loss of customers.
SALES AND MARKETING
Our core North American sales and marketing activities consist of corporate
advertising and marketing functions, centralized inbound and outbound sales
functions, a branch sales function and dealer and prospective acquisition
marketing efforts.
We believe that the increasing density of our customer base has increased
our overall presence and visibility. We encourage referrals from existing
customers through an incentive program promoted through newsletters, billing
inserts and employee contacts. Alarm response and service vehicles, which
display the Protection One logo, also increase our visibility, coupled with
advertising campaigns.
Network Multifamily Security's sales and marketing activities consist of
national and regional advertising, nationwide professional field sales efforts,
centralized inbound and outbound sales functions, prospective acquisition
marketing efforts and professional industry-related association affiliation.
Services are sold directly to the property owner, and payment is based on a
lease price on a per-unit basis. Ongoing service for the duration of the lease
includes equipment, maintenance, 24-hour monitoring from our central monitoring
station, customer service and individual market support. Property owner
contracts generally have initial terms ranging from five to ten years in
duration, and provide for automatic renewal for a fixed period (typically five
years) unless Network or the subscriber elects to cancel the contract at the end
of its term.
Protection One Europe primarily addresses the professional and commercial
markets in Europe through a network of wholly owned subsidiaries. Each
subsidiary has a series of branch offices from which a direct sales force
develops customer contacts. We encourage referrals from existing subscribers by
way of business partnerships to develop local market presence. Further market
penetration is also achieved by delivering to our customer a broad product
range, including alarm monitoring, video (closed-circuit) and
video-surveillance.
Protection One Europe is developing a residential dealer program and a
distribution network based upon a centralized marketing function to provide
promotional material. Additionally, Protection One Europe is developing
strategic alliances with leading companies in the insurance, banking and real
estate industries.
CORPORATE ADVERTISING AND MARKETING
In the last two years, we have substantially increased our advertising and
marketing efforts to support the dealer program. We use television, radio,
newspaper and direct mail with promotional messages to create sales leads and to
increase awareness of the Protection One brand. Such sales leads are distributed
to dealers based on their financial contribution to support cooperative
advertising efforts. We also have specifically tailored regional advertising and
promotional programs to utilize marketing alliances where appropriate.
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Based on primary market research, we believe that there is an opportunity to
build a preeminent consumer brand in the security industry. According to a 1998
SDM Magazine consumer survey on home security conducted with us, consumers are
unable to name any security industry competitor on an unaided basis to a
significant degree. We have established a coordinated branding strategy to
assist us in achieving our other strategic objectives by positioning us as an
industry leader and to build a platform for the sale of additional services. We
believe that a nationally recognized brand supports our goals of becoming the
industry leader and broadening our customer relationships.
In addition, we will evaluate all future opportunities for marketing
alliances and joint ventures in the context of the brand strategy, selecting
those that enhance our positioning and that accelerate the growth in public
awareness of our brand. Finally, we intend to test the use of brand awareness
advertising in conjunction with direct response marketing, in an effort to
quantify the extent to which increased consumer awareness of the brand enhances
direct marketing activities. We expect to invest gradually in brand advertising
over time as the security market matures.
DEALER MARKETING
The dealer program provides support services to dealers as they grow their
independent businesses. On behalf of the dealer program participants, we obtain
purchase discounts on security systems, coordinate cooperative dealer
advertising and provide assistance in marketing and employee training support
services.
Dealer contracts provide for the purchase of the dealers' customer accounts
by Protection One on an ongoing basis. The dealers install specified alarm
systems (which have a Protection One logo on the keypad), arrange for customers
to enter into Protection One alarm monitoring agreements, and install Protection
One yard signs and window decals. In addition, we require dealers to qualify
prospective customers by meeting a minimum credit standard.
BRANCH SALES
The most common reason for the loss of customers is customers moving out of
their homes and businesses. Sales professionals and centralized telesales
representatives at our branch offices and Chatsworth, CA customer service center
are responsible for tracking previous customers' homes to sign up new owners
when they move into such homes. The branch sales function also generates revenue
from selling equipment upgrades and add-ons to existing customers and by
attracting competitors' customers to our services.
We operate a significant commercial sales and installation effort for
security and related monitored services both in North America and Europe. Our
commercial products range from basic intrusion and fire detection equipment to
fully integrated systems with card access, closed circuit television and
voice/video monitoring. We are also organizing a national account sales and
customer service function to address the special needs of chain customers, such
as restaurants and retailers.
ACQUISITION SOLICITATION AND INTEGRATION
We actively seek to identify prospective "tuck-in" acquisitions of companies
and dealers with targeted direct mail, trade magazine advertising, trade show
participation, telemarketing, membership in key alarm industry trade
organizations, and contacts through various prominent vendors and other industry
participants. Our extensive experience in identifying and negotiating previous
acquisitions helps to facilitate the successful negotiation and execution of
acquisitions in a timely manner.
Acquisitions are integrated through a specific program developed in
conjunction with each seller. Integration efforts typically include a letter
from the seller to our customers, explaining the sale and transition, followed
by one or more letters and packages that include our customer service brochures,
field service and monitoring phone number stickers. Thereafter, each new
customer is contacted individually by telephone by a member of our customer
service group for the purpose of addressing the customer's
13
questions or concerns and soliciting certain information. Finally, the customer
receives a follow-up telephone call after six months and periodically
thereafter.
COMPETITION
The security alarm industry is highly competitive and highly fragmented in
both North America and Europe. In North America, there are only five alarm
companies that offer services across the U.S. and Canada with the remainder
being either large regional or small, privately held alarm companies. Based on
number of residential customers, the top five alarm companies in North America
as estimated by management, are:
- ADT Security Services, a subsidiary of Tyco International, Inc. ("ADT");
- Protection One;
- SecurityLink from Ameritech, Inc., a subsidiary of Ameritech Corporation;
- Brinks Home Security Inc., a subsidiary of The Pittston Services Group of
North America; and
- Honeywell Inc.
In Europe, we compete with ADT, SecurityLink from Ameritech, Initial
Shorrock (Rentokil Initial PLC) and Chubb Group Services Ltd. (Williams PLC), as
well as the securities subsidiaries of Securitas AB.
Other alarm service companies have adopted a strategy similar to ours that
entails the purchase of alarm monitoring accounts both through acquisitions of
account portfolios and through dealer programs. Some competitors have greater
financial resources than us, or may be willing to offer higher prices than we
are prepared to offer to purchase customer accounts. The effect of such
competition may be to reduce the purchase opportunities available to us, thus
reducing our rate of growth, or to increase the price paid by us for customer
accounts, which would adversely affect our return on investment in such accounts
and our results of operations.
Competition in the security alarm industry is based primarily on reliability
of equipment, market visibility, services offered, reputation for quality of
service, price and the ability to identify and to solicit prospective customers
as they move into homes. We believe that we compete effectively with other
national, regional and local security alarm companies due to our reputation for
reliable equipment and services, our prominent presence in the areas surrounding
our branch offices and dealers, our ability to offer combined monitoring, repair
and enhanced services, our low cost structure and our marketing alliances.
INTELLECTUAL PROPERTY
We own trademarks related to the name and logo for each of Protection One,
Network Multifamily Security and CET, as well as a variety of trade and service
marks related to individual services we provide. We own certain proprietary
software applications, which we use to provide services to our customers.
REGULATORY MATTERS
A number of local governmental authorities have adopted or are considering
various measures aimed at reducing the number of false alarms. Such measures
include:
- subjecting alarm monitoring companies to fines or penalties for
transmitting false alarms;
- permitting of individual alarm systems and the revocation of such permits
following a specified number of false alarms;
- imposing fines on alarm customers for false alarms;
14
- imposing limitations on the number of times the police will respond to
alarms at a particular location after a specified number of false alarms;
and
- requiring further verification of an alarm signal before the police will
respond.
Our operations are subject to a variety of other laws, regulations and
licensing requirements of both domestic and foreign federal, state, and local
authorities. In certain jurisdictions, we are required to obtain licenses or
permits, to comply with standards governing employee selection and training, and
to meet certain standards in the conduct of our business. Many jurisdictions
also require certain of our employees to obtain licenses or permits. Those
employees who serve as patrol officers are often subject to additional licensing
requirements, including firearm licensing and training requirements in
jurisdictions in which they carry firearms.
The alarm industry is also subject to requirements imposed by various
insurance, approval, listing, and standards organizations. Depending upon the
type of customer served, the type of security service provided, and the
requirements of the applicable local governmental jurisdiction, adherence to the
requirements and standards of such organizations is mandatory in some instances
and voluntary in others.
Our advertising and sales practices are regulated in the United States by
both the Federal Trade Commission and state consumer protection laws. In
addition, certain administrative requirements and laws of the foreign
jurisdictions in which we operate also regulate such practices. Such laws and
regulations include restrictions on the manner in which we promote the sale of
our security alarm systems, the obligation to provide purchasers of our alarm
systems with certain rescission rights and certain foreign jurisdictions'
restrictions on a company's freedom to contract.
Our alarm monitoring business utilizes telephone lines and radio frequencies
to transmit alarm signals. The cost of telephone lines, and the type of
equipment, which may be used in telephone line transmission, are currently
regulated by both federal and state governments. The Federal Communications
Commission and state public utilities commissions regulate the operation and
utilization of radio frequencies. In addition, the laws of certain of the
foreign jurisdictions in which we operate regulate the telephone communications
with the local authorities.
RISK MANAGEMENT
The nature of the services provided by Protection One potentially exposes us
to greater risks of liability for employee acts or omissions, or system failure,
than may be inherent in other businesses. Substantially all of our alarm
monitoring agreements, and other agreements, pursuant to which we sell our
products and services contain provisions limiting liability to customers in an
attempt to reduce this risk.
Our alarm response and patrol services require our employees to respond to
emergencies that may entail risk of harm to such employees and to others. We
employ over 100 patrol and alarm response officers who are subject to extensive
pre-employment screening and training. Officers are subject to local and federal
background checks and drug screening before being hired, and are required to
have gun and baton permits and state and city guard licenses. Officers also must
be licensed by states to carry firearms and to provide patrol services. We are
one of a few companies to have an in-house training academy that prepares
officer candidates for employment. Our training program includes arrest
procedures, criminal law, weaponless defense, firearms and baton usage, patrol
tactics, and first-aid and CPR. After graduating from the Protection One Patrol
Academy, a new officer rides along with a field training officer for two weeks
to gain experience. In total, an officer candidate undergoes five weeks of
specific training, which amount exceeds all state requirements. Although we
conduct extensive screening and training of our employees, the nature of patrol
and alarm response service subjects us to greater risks related to accidents or
employee behavior than other types of businesses.
We carry insurance of various types, including general liability and errors
and omissions insurance in amounts management considers adequate and customary
for our industry and business. Our loss experience, and the loss experiences at
other security service companies, may affect the availability and cost of
15
such insurance. Certain of our insurance policies, and the laws of some states,
may limit or prohibit insurance coverage for punitive or certain other types of
damages, or liability arising from gross negligence.
EMPLOYEES
At December 31, 1998, we employed approximately 4,577 individuals on a
full-time basis. Currently, approximately 800 of our employees in France are
covered by a collective bargaining agreement. We believe that we have good
relations with our employees.
WHERE YOU CAN FIND MORE INFORMATION
Protection One (File No. 0-24780) and Protection One Alarm Monitoring (File
No. 33-73002-01) file annual, quarterly and special reports, proxy statements
and other information with the Securities and Exchange Commission (which we
refer to as the "SEC"). You may read and copy any reports, statements and other
information filed by Protection One at the SEC's public reference room, at 450
Fifth Street, N.W., Washington, D.C., as well as at public reference rooms in
New York, New York, and Chicago, Illinois. Please call (800) SEC-0330 for
further information on the public reference rooms. Our filings are also
available to the public from commercial document retrieval services and at the
internet web site maintained by the SEC at http://www.sec.gov. Also, we maintain
an internet web site at www.protectionone.com.
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 we "believe," "expect,"
"anticipate" or other words of similar import. Similarly, statements herein that
describe our objectives, plans or goals also are forward-looking statements. All
such forward-looking statements are subject to certain risks and uncertainties
that could cause actual results to differ materially from those in the
forward-looking statements. Important factors that could cause actual results to
differ materially from the expectations of Protection One include, among others,
the factors discussed in the following section entitled "Cautionary Statements
Regarding Future Results of Operations." The forward-looking statements included
herein are made only as of the date of this report and we undertake no
obligation to publicly update such forward-looking statements to reflect
subsequent events or circumstances.
CAUTIONARY STATEMENTS REGARDING FUTURE RESULTS OF OPERATIONS
You should read the following cautionary statements in conjunction with
discussions of factors discussed elsewhere in this and other of our filings with
the SEC and in materials incorporated by reference in these filings. These
cautionary statements are intended to highlight certain factors that may affect
our financial condition and results of operations and are not meant to be an
exhaustive discussion of risks that apply to public companies with broad
operations, such as us. Like other businesses, we are susceptible to
macroeconomic downturns in the United States or abroad that may affect the
general economic climate and our performance or that of our customers.
Similarly, the price of our securities is subject to volatility due to
fluctuations in general market conditions, differences in our results of
operations from estimates and projections generated by the investment community
and other factors beyond our control.
WE HAVE HAD A HISTORY OF LOSSES.
We incurred a net loss of $2.5 million in 1998 (a net loss of $10.7 million
excluding the effect of non-recurring income, net), $42.7 million (restated) in
1997, and $0.7 million in 1996, and Westinghouse Security (our predecessor for
accounting purposes) reported net losses of $4.9 million, $5.9 million,
16
$1.8 million and $9.2 million in fiscal 1996, 1995, 1994 and 1993, respectively.
These losses reflect, among other factors:
- substantial charges incurred by us and Westinghouse Security for
amortization of purchased customer accounts and
- interest incurred on indebtedness and
- other charges required to manage operations.
The charges identified above will increase as we continue to purchase
customer accounts or increase indebtedness, or if interest rates on our
indebtedness increases. There can be no assurance that we will attain profitable
operations on an annual basis or at all.
THE COMPETITIVE MARKET FOR THE ACQUISITION OF ACCOUNTS MAY AFFECT OUR FUTURE
PROFITABILITY.
A principal element of our business strategy will be to continue to grow
rapidly by acquiring portfolios of alarm monitoring accounts. During the
1992-1998 period, acquisitions were the primary source of our growth. Since
November 1997, we have completed in excess of 30 transactions, adding
approximately one million subscribers. Growth via our authorized dealer program
through which we acquire subscriber accounts has become an increasingly
important component of our growth. We compete with major firms, some of whom
have greater financial resources than we do, or may be willing to offer higher
prices than we are prepared to offer to purchase subscriber accounts. The effect
of competition may be to reduce the purchase opportunities available to us, thus
reducing our rate of growth, or to increase the price we pay for subscriber
accounts, which could have a material adverse effect on our return on investment
in such accounts on our business, and results of operations, financial
condition, prospects and ability to service debt.
THE INTEGRATION OF ACQUIRED BUSINESSES REQUIRES SUBSTANTIAL MANAGEMENT TIME
AND EFFORT, WHICH COULD DIVERT MANAGEMENT'S ATTENTION FROM OTHER MATTERS.
Significant acquisitions, including the 1997 business combination with the
security businesses of Western Resources and the pending Lifeline transaction,
place very significant demands on us with respect to management, operational
resources and financial and internal control systems. Our future operating
results will depend, in part, on our ability to continue to implement and to
improve our operating and financial controls and to expand, to train and to
manage our employee base. Significant risks also exist in the consolidation of
our systems, operations and administrative functions. We also face risks
associated with entering new lines of business, as with the Lifeline
transaction, and will be dependent on the management of these business lines as
we integrate operations, systems and/or financial controls. Significant changes
in quarterly revenues and costs may result from the execution of this business
strategy, resulting in fluctuating financial results. Additionally, managing the
growth of the business may limit the time available to our management to attend
to other operational, financial and strategic issues.
WE COULD DISCOVER PROBLEMS WITH ACQUIRED BUSINESSES AFTER THEIR ACQUISITION.
Acquisitions of subscriber account portfolios involve a number of
uncertainties. Sellers in smaller transactions typically do not have audited
historical financial information with respect to the acquired accounts.
Therefore, in making acquisition decisions, we have generally relied on
management's knowledge of the industry, due diligence procedures and
representations and warranties of the sellers. There can be no assurance that
these representations and warranties are or will be true and complete or, if
these representations and warranties are inaccurate, that we will be able to
uncover any inaccuracies in the course of its due diligence or recover damages
from the seller in an amount sufficient to fully compensate it for any resulting
losses. Risks associated with these uncertainties include, without limitation,
the following:
- the possibility of unanticipated problems not discovered prior to the
acquisition;
17
- additional expenses required to integrate the acquired company's systems;
- higher than expected account customer losses; and
- for acquisitions that are structured as stock purchases of other
companies, the assumption of unexpected liabilities and losses from the
disposition of unnecessary or undesirable assets of the acquired
companies.
Also, because the primary consideration in acquiring a portfolio of
subscriber accounts is the monthly recurring revenue associated with the
purchased accounts, the price we have paid has customarily been directly tied to
such monthly recurring revenue. This price varies based on the number and
quality of accounts being purchased from the seller, the historical activity of
these acquired accounts, the anticipated profit margins and other factors.
An important aspect of our acquisition program is the integration of
customer accounts into our operations after purchase. We have consummated well
over 200 acquisitions since 1992 and have experienced nearly all of the problems
and challenges described in varying degrees. We have experienced acquisitions in
which the quality of the accounts purchased, as defined by monthly recurring
revenue, were not commensurate with our expectations. We have also experienced
circumstances where the integration of an acquisition required more time than
expected, often related to differences in, or the inadequacy of, software and
accounting systems of the seller. On these occasions, circumstances have arisen
whereby we were unable to accurately track the loss of customer accounts
purchased. We have also experienced integration challenges where the servicing
of newly acquired customer accounts suffered due to lack of coordination and
systems. Depending upon the size, frequency and location of acquisitions, the
integration of customers may adversely affect our provision of field repair
services to existing customers, which may cause customer losses to increase and
monthly recurring revenue to decline. In addition, if corporate or branch
operations fail to integrate a substantial portion of or do not adequately
service acquired customer accounts, we may experience higher rates of customer
loss in the future.
WE WILL NEED ADDITIONAL FUNDING TO FINANCE OUR FUTURE GROWTH.
Our purchases of customer accounts through the dealer program and
acquisitions of portfolios of customer accounts and new lines of business have
generated cash needs that exceed the net cash provided by our operating
activities. We intend to continue to pursue customer account growth through the
dealer program and acquisitions. As a result, we will need additional funding
from additional borrowings under our credit facility or through the sale of
additional securities in the future. Depending on the price at which new equity,
if any, is sold, the issuance of additional equity securities may dilute voting
power, percentage ownership and earnings per common share realized by then
current stockholders. Any inability to obtain funding through external financing
could adversely affect our ability to increase our customers, revenues and cash
flows from operations. There can be no assurance that we will be able to obtain
external funding on favorable terms or at all.
WE HAVE A SUBSTANTIAL AMOUNT OF DEBT, WHICH COULD CONSTRAIN OUR GROWTH OR
OTHERWISE DISADVANTAGE STOCKHOLDERS.
We have, and will continue to have, a large amount of consolidated
indebtedness when compared to the equity of our stockholders. The terms of
various indentures and credit agreements that govern our indebtedness limit, but
do not prohibit, the incurrence of additional indebtedness. We expect to incur
additional indebtedness in the future in order to fund future acquisitions of
subscriber accounts.
Additionally, please be aware that:
- As of December 31, 1998, we had outstanding long-term indebtedness,
excluding capital leases, of $926.8 million, total indebtedness of $967.6
million, an accumulated deficit of $45.8 million and stockholders' equity
of $1,345.1 million. Our ratio of total indebtedness to stockholders'
equity was 0.72 and total indebtedness to total capitalization was 0.42 as
of December 31, 1998.
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- As of December 31, 1998, we had $42.4 million of debt outstanding under
our revolving credit facility, or 5% of total indebtedness, bearing
interest at a weighted average floating interest rate of 6.8%. Therefore,
our financial results are and will continue to be affected by changes in
prevailing interest rates.
A large amount of indebtedness could have negative consequences, including,
without limitation:
- our ability to obtain additional financing in the future for working
capital, acquisitions of subscriber accounts, capital expenditures,
general corporate purposes or other purposes;
- our ability to withstand a downturn in our business or the economy
generally; and
- our ability to compete against other less leveraged companies may be
adversely affected.
Our ability to satisfy any payment obligations will depend, in large part,
on our performance, which will ultimately be affected by general economic and
business factors, many of which will be outside management's control. We believe
that the cash flow from operations combined with borrowings under the senior
credit facility will be enough to meet our expenses and interest obligations.
However, if these payment obligations can't be satisfied, we will be forced to
find alternative sources of funds by selling assets, restructuring, refinancing
debt or seeking additional equity capital. There can be no assurance that any of
these alternative sources would be available on satisfactory terms or at all.
WE LOSE SOME OF OUR CUSTOMERS OVER TIME.
We experience the loss of accounts as a result of, among other factors:
- relocation of customers;
- adverse financial and economic conditions; and
- competition from other alarm service companies.
In addition, we experience the loss of newly acquired accounts to the extent
we do not integrate or adequately service those accounts. Because some acquired
accounts are prepaid on an annual, semiannual or quarterly basis, customer loss
may not become evident for some time after an acquisition is consummated. An
increase in this rate of customer loss could have a material adverse effect on
our revenues and earnings.
We have not historically observed that the rate of customer loss is
correlated with the terms of the customer contracts; however, contracts with
shorter terms give rise to more instances in which a customer may choose to
terminate the relationship. Although the contract term varies due to the variety
and number of sources from which we acquired them, based on our standard form of
contract and the due diligence procedures we undertake in connection with
account acquisitions, management believes that substantially all of our customer
contracts provide for an initial term of one to five years. During the initial
term, customers may not cancel the agreement without fulfilling their payment
obligations, so customers that request cancellation during the initial term are
billed for the balance of the initial term. Similarly, we believe that
substantially all of our customer contracts include an "evergreen" provision,
whereby the contract automatically renews for one to five year periods unless
either party gives prior notice of cancellation, usually 30 to 90 days prior to
expiration of the initial or any renewal term. Therefore, customers may only
cancel their agreements by providing the required notice prior to expiration of
the initial or a renewal term.
19
When acquiring accounts, we seek under terms of the purchase agreement, to
withhold a portion of the purchase price as a partial reserve against a greater
than expected loss of customers. If the actual rate of customer loss for the
accounts acquired is greater than the assumed rate at the time of the
acquisition, and damages can not be recouped from the portion of the purchase
price held back from the seller, this loss of customers could have a material
adverse effect on our business, financial condition, results of operations,
prospects or ability to service our debt obligations. Moreover, there can be no
assurance that we will be able to obtain purchase price holdbacks in future
acquisitions, particularly acquisitions of large portfolios. We have no
assurance that actual rates of customer losses for acquired accounts will not be
greater than the rate we have assumed or historically incurred. Moreover, we are
not able to predict accurately the impact that acquired accounts will have on
the overall rate of customer losses.
As of December 31, 1998, our cost of intangible assets, net of accumulated
amortization, was approximately $2.2 billion, which constituted approximately
87.7% of the book value of our total assets. In contrast to the 10-year life for
amortization of subscriber accounts, we amortize goodwill over a 40-year life.
As a result of discussions with the SEC staff, we are reviewing our methodology
for amortizing customer accounts. While we believe our amortization method is
consistent with industry practices, a significant change in the amortization
method would likely have a material effect on our consolidated results of
operations but would not reduce EBITDA. We also believe that the use of a
40-year estimated useful life for goodwill is appropriate because the many
intangibles associated with our acquisitions will survive the estimated useful
life of our customer accounts and management believes should add value to the
organization over an extended period of time.
The effects of the gross number of lost customers have historically been
offset by a combination of factors that has resulted in an overall increase in
the number of customers and/or revenue, including:
- adding new accounts from customers who move into premises previously
occupied by prior customers and in which security alarm systems are
installed;
- conversions of accounts that were previously monitored by other alarm
companies to Protection One monitoring services;
- accounts for which we obtain a guarantee from the seller that allows it to
"put" back to the seller canceled accounts; and
- revenues from price increases and the sale of enhanced services.
There can be no assurance that actual future experience will be consistent
with our past experiences and assumptions based on these experiences. There
could be a material adverse effect on our business, financial condition, results
of operations, prospects or ability to service debt obligations if actual
account attrition significantly exceeds assumed attrition and the period over
which the cost of purchased subscriber accounts is amortized is shortened.
OUR RECENT ENTRANCE INTO EUROPE PRESENTS NEW OPERATIONAL CHALLENGES AND
EXPOSES US TO FOREIGN CURRENCY FLUCTUATION.
As a result of our acquisitions of CET in France and Hambro Countrywide
Security plc in the United Kingdom, we will generate a portion of our revenues
and operating income from operations in Europe. Although our European operations
did not generate any significant earnings in 1998, they did generate
approximately $44 million, or 10%, of revenues in 1998. We currently do not
engage in hedging activities intended to offset the risk of exchange rate
fluctuations, although we may in the future. Both the revenues from
international operations and obligations of CET and Hambro denominated in
foreign currency are subject in varying degrees to risks inherent in doing
business outside the United States. Such risks include economic instability,
currency exchange rate fluctuations, changes in import duties, trade
restrictions, work stoppages, currency restrictions, the ability of CET to
conduct business in the new European currency, known as the "euro," and other
restraints and taxes. With respect to our exposure to fluctuations in
20
currency exchange rates, we anticipate that substantially all of our foreign
exchange transactions will be denominated in the euro (as discussed below). Any
significant change in the value of the currencies of the countries in which we
do business against the U.S. dollar could affect our ability to control our cost
structure and satisfy foreign denominated obligations, which, in turn, could
have a material adverse effect on our business, results of operations, financial
condition, prospects and ability to service debt. Furthermore, depreciation of
the value of the U.S. dollar against foreign currencies in which we transact
business may have a negative impact on the income from operations of foreign
operations.
On January 1, 1999, eleven of the fifteen member countries of the European
Union, not including the United Kingdom, established fixed conversion rates
between their sovereign currencies, known as the "legacy currencies," and the
euro. During a transition period from January 1, 1999 through December 31, 2001,
legacy currencies will continue in use; however, the value of these currencies
will be set at fixed and irrevocable conversion rates to the euro. Beginning in
January 2002, new euro-denominated bills and coins will be issued and the legacy
currencies will be withdrawn from circulation. We are addressing issues raised
by the conversion to the euro, in ways such as adapting our information
technology systems and assessing whether cross-border price transparency will
limit CET's flexibility to charge different prices for similar products. CET's
efforts to adapt its systems differ at its various European operations.
Currently, none of CET's systems are capable of accommodating euro-denominated
invoicing and purchasing transactions. Management believes the conversion to the
euro has not affected our ability to subscribe new customers, pay vendors and
employees or otherwise service existing customers since January 1, 1999. To the
extent that existing or prospective vendors, customers or employees require CET
to engage in euro-denominated transactions prior to CET's implementing systems
capable of accommodating euro transactions, CET could lose these vendors,
customers or employees. CET's significant European operations have formulated
plans to accommodate all euro-denominated transactions and triangulation
conventions by January 1, 2002.
OUR DEBT AGREEMENTS IMPOSE OPERATIONAL RESTRICTIONS ON US.
The Credit Facility requires us to maintain certain financial covenants, and
the indentures governing our public indebtedness requires us to satisfy certain
financial covenants in order to borrow additional funds. The most restrictive of
these covenants are set forth in the Credit Facility and require the following:
- Total debt to annualized EBITDA for the most recent quarter must be less
than 5.0 through December 31, 1999 and less than 4.5 thereafter and
- Annualized EBITDA for the most recent quarter to interest expense must be
greater than 2.75.
- Senior debt to annualized EBITDA must be less than 4 to 1.
In each case, the ratio should reflect the impact of acquisitions and other
capital investments for the entire period covered by the calculation. Moreover,
we are required to obtain approval of the lenders under the credit facility in
order to make acquisitions valued at $125.0 million or more or in businesses
outside our current scope of operations. Other financial covenants are also
described under "Management's Discussion and Analysis of Financial Condition and
Results of Operations--Liquidity and Capital Resources--Material Commitments."
Our ability to comply with the ratios and the tests will be affected by events
outside our control and there can be no assurance that we will meet those tests.
A breach of any of the covenants or failure to meet the tests could result in an
event of default which would allow the lenders to declare all amounts
outstanding immediately due and payable. In the case of the senior credit
facility, if we are unable to pay the amounts due, the lenders could accelerate
the indebtedness under the senior credit facility, which would in turn be an
event of default under our various indentures governing our publicly held
indebtedness. If the amounts outstanding under the senior credit facility are
accelerated, there can be no assurance that our assets would be sufficient to
repay the amount in full.
21
OUR INCREASING RELIANCE ON DEALERS FOR GROWTH MEANS WE MUST CONTINUE TO
ACQUIRE ACCOUNTS IN AN INCREASINGLY COMPETITIVE MARKET.
During the period 1995 through 1997, we increasingly began to rely on
independent dealers as a source for new accounts. We expect that this emphasis
will continue. Our dealer program competes with other major alarm monitoring
firms that also acquire accounts through these independent dealers. Some of
these firms with competitive dealer programs have substantial financial
resources, including ADT Operations, Inc., a subsidiary of Tyco International,
Inc., and the security subsidiaries of the Ameritech Corporation. We are also
aware of other national firms with competitive dealer programs including
Monitronics International, Inc., DMAC, as well as several large regional dealer
programs. There can be no assurance that we will be able to retain or expand our
current dealer base or that competitive offers to dealers will not require us to
pay higher prices to dealers for subscriber accounts than have previously been
paid. Such events could reduce our growth rate and increase our use of cash to
fund growth. A lower growth rate or higher use of cash could have a material
adverse effect on our business, financial condition, results of operations,
prospects and ability to service debt obligations.
DECLINES IN NEW CONSTRUCTION OF MULTI-FAMILY DWELLINGS MAY AFFECT OUR SALES
IN THIS MARKETPLACE.
Demand for alarm monitoring services in the multi-family alarm monitoring
market is tied to the construction of new multi-family structures. We believe
that developers of multi-family dwellings view the provision of alarm monitoring
services as an added feature that can be used in marketing newly developed
condominiums, apartments and other multi-family structures. Accordingly, we
anticipate that the growth in the multi-family alarm monitoring market will
continue so long as there is a demand for new multi-family dwellings. However,
the real estate market in general is cyclical and, in the event of a decline in
the market for new multi-family dwellings, it is likely that demand for our
alarm monitoring services to multi-family dwellings would also decline, which
could negatively impact our results of operations.
WESTERN RESOURCES IS OUR PRINCIPAL STOCKHOLDER AND CONTROLS OUR ACTIONS.
Western Resources, through Westar Capital, Inc., a wholly owned subsidiary
of Western Resources, owned approximately 85.4% of the outstanding common stock
of Protection One as of December 31, 1998. Westar Capital has indicated that it
may acquire additional shares of Protection One common stock prior to
consummation of the Lifeline transaction in an amount sufficient for it to
maintain an ownership position in excess of 80% of the issued and outstanding
shares of Protection One common stock following the consummation of the
transaction, although it is not bound by any agreement with us that would either
obligate it to or prevent it from acquiring additional shares of Protection One
common stock prior to or after the transaction. As long as Westar Capital
continues to beneficially own in excess of 50% of the shares of Protection One
common stock outstanding, Westar Capital will be able to direct the election of
all directors of Protection One and exercise a controlling influence over our
business and affairs, including any determinations with respect to mergers or
other business combinations involving Protection One, our acquisition or
disposition of material assets and our incurrence of indebtedness and the
payment of dividends on Protection One common stock. Similarly, Westar Capital
will continue to have the power to determine matters submitted to a vote of
Protection One's stockholders without the consent of other stockholders, to
prevent or cause a change in control of Protection One and could take other
actions that might be favorable to Western Resources and Westar Capital, whether
or not these actions would be favorable to Protection One or its stockholders
generally.
WE FACE CHALLENGES ASSOCIATED WITH OUR OPERATIONAL REORGANIZATION.
On December 9, 1998, we announced that we had reorganized our operating
structure into new divisions in order to better manage the increased scale and
scope of operations. We contemplate that, upon the consummation of the Lifeline
transaction, Lifeline will become another operating division. We also created a
non-operating Executive Division with the intent to focus senior management's
time on key
22
strategic and capital formation initiatives. There can be no assurance that we
will be able to realize the intended benefits of its new operating structure.
Moreover, we face certain risks and uncertainties associated with management and
operational reorganizations, including those relating to:
- changes in management responsibility and reporting structures
- potential lack of communications until new reporting and communication
structure becomes familiar
- potential loss of cohesive operational strategies and
- potential employee turnover.
If we are unable to manage successfully these risks and uncertainties, there
can be no assurance that the new operating structure will not have a material
adverse affect upon our business, financial condition, results of operations,
prospects and ability to service debt obligations.
ITEM 2: FACILITIES
We maintain our executive offices at 600 Corporate Pointe, 12th Floor,
Culver City, CA 90230 and our main financial and administrative offices in
Irving, Texas. We operate primarily from the following facilities, although we
lease office space for our approximate 66 service branch offices and 4
satellites in 33 states and Canada, 7 branch offices in the UK and 42 in
continental Europe.
SIZE (SQ.
LOCATION FT.) LEASE/OWN PRINCIPAL PURPOSE
- --------------------------------------- ----------- ----------- -----------------------------------------------
UNITED STATES
Addison, TX............................ 28,512 Lease Service center/administrative headquarters
Beaverton, OR.......................... 44,600 Lease Service center
Chatsworth, CA......................... 43,472 Lease Marketing call center
Culver City, CA........................ 23,520 Lease Corporate headquarters
Culver City, CA........................ 8,029 Lease Administrative functions
Hagerstown, MD......................... 21,370 Lease Service center
Irving, TX............................. 53,750 Lease Service center
Irving, TX............................. 54,394 Lease Financial/administrative headquarters
Orlando, FL............................ 11,020 Lease Wholesale service center
Wichita, KS............................ 50,000 Own Service center/administrative headquarters
CANADA
Ottawa, ON............................. 7,937 Lease Service center/administrative headquarters
Vancouver, BC.......................... 5,177 Lease Service center
EUROPE
Basingstoke (London), UK............... 3,500 Lease Financial/administrative headquarters/ service
center
Paris, FR.............................. 3,498 Lease Financial/administrative headquarters/ service
center
Vitrolles (Marseilles), FR............. 13,003 Lease Administrative/service center
23
ITEM 3: LEGAL PROCEEDINGS
SHAREHOLDER LITIGATION
Based on public releases, we understand that purported class action lawsuits
have been filed against us and certain of our officers and directors alleging
violations of federal securities laws arising from our public announcement that
we have decided to restate our financial statements for the year ended December
31, 1997 and each of the first three quarters of 1998. We have not been served
with process and, therefore, cannot provide more details with respect to these
or any other claims alleged in these actions.
We are a party to claims and matters of litigation incidental to the normal
course of our business. The ultimate outcome of these matters cannot presently
be determined; however, in our opinion, the resolution of these matters will not
have a material adverse effect on our overall financial condition or results of
operations.
ITEM 4: SUBMISSION OF MATTERS TO A VOTE OF STOCKHOLDERS
No matters were submitted to Protection One's stockholders following our
annual meeting in 1998.
24
PART II
ITEM 5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET PRICE INFORMATION
The Protection One common stock has been listed on the New York Stock
Exchange since November 6, 1998 under the symbol "POI" and was previously quoted
on the National Market System of the Nasdaq Stock Market under the symbol
"ALRM". The table below sets forth for each of the calendar quarters indicated,
the high and low sales prices per share of Protection One common stock, as
reported by the New York Stock Exchange or the Nasdaq Stock Market, as
applicable, and the dividends per share declared on the Protection One common
stock. All prices are as reported by the National Quotation Bureau,
Incorporated, as adjusted for applicable stock splits.
PROTECTION ONE COMMON STOCK
-----------------------------------
HIGH LOW DIVIDENDS(1)
---- ------ --------------
1997:
First Quarter..................................... $111/8 $ 73/8 --
Second Quarter.................................... 141/8 91/4 --
Third Quarter..................................... 213/4 133/8 --
Fourth Quarter.................................... 201/8 103/4 $ 7.00
1998:
First Quarter..................................... $131/2 $ 101/16 --
Second Quarter.................................... 137/8 97/16 --
Third Quarter..................................... 121/8 57/8 --
Fourth Quarter.................................... 121/4 77/8 --
- ------------------------
(1) On July 31, 1997, Protection One declared a cash distribution of $7.00 per
share to all holders of record of its common stock, which was subsequently
paid on November 24, 1997.
DIVIDEND INFORMATION
Holders of Protection One common stock are entitled to receive only
dividends declared by the board of directors from funds legally available for
dividends to stockholders.
Other than the cash distribution paid to holders of record of Protection One
common stock as of November 24, 1997, to holders of outstanding options to
purchase Protection One common stock and to holders of warrants exercisable for
Protection One common stock, all in connection with the combination of the
Protection One and Western Resources security businesses in November 1997,
Protection One has never paid any cash dividends on its common stock and does
not intend to pay any cash dividends in the foreseeable future. The indenture
governing the 13 5/8% Senior Subordinated Discount Notes due 2005 of Protection
One Alarm Monitoring, and the credit agreement relating to its senior credit
facility restrict Protection One Alarm Monitoring's ability to pay dividends or
make other distributions to its corporate parent. Consequently, these agreements
restrict our ability to declare or pay any dividend on, or make any other
distribution in respect of, its capital stock.
NUMBER OF STOCKHOLDERS
As of December 31, 1998, there were approximately 88 stockholders of record
who held shares of Protection One common stock, as shown on the records of
Protection One's transfer agent.
25
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected financial data set forth below should be read in conjunction
with "Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations" and the audited consolidated financial statements and
notes to the financial statements of Protection One and the audited financial
statements and the related notes to the financial statements of Westinghouse
Security, included in Item 8 of this report. The Company has restated its
consolidated financial statements as of December 31, 1997 and for the year then
ended. See Note 2(a) to the Consolidated Financial Statements. All amounts are
in thousands, except per share and customer data, unless otherwise noted. Prior
to November 24, 1997, Protection One was a standalone security business. On
November 24, 1997, pursuant to a contribution agreement dated July 30, 1997,
between Protection One and Western Resources, Protection One acquired WestSec
and Westar, which together were the Western Resources security businesses, and
Centennial Security Holdings, Inc. ("Centennial"). As a result of the November
1997 business combination, Western Resources, through its wholly owned
subsidiary Westar Capital, Inc. owned approximately 85.4% of Protection One at
December 31, 1997.
The November 1997 business combination was accounted for as a reverse
purchase acquisition which treats the Western Resource security businesses as
the accounting acquiror. Accordingly, the results of operations of Protection
One and Centennial have been included in the consolidated financial data only
since November 24, 1997.
The 1996 historical financial data of Protection One are those of the
Western Resources security businesses, the accounting acquiror.
The operating results of the Western Resources security businesses for the
year ended December 31, 1995, can be considered nominal in relation to the
accompanying consolidated statements of operations. The 1995 results are
comprised of only two months of start-up activity. Summarized operating results
are as follows (in thousands):
Revenue............................................................................... $ 344
Gross Profit.......................................................................... 189
Net income............................................................................ 18
On December 30, 1996, Western Resources, through its indirect wholly owned
subsidiary, WestSec, purchased the assets and assumed certain liabilities
comprising the security business of Westinghouse Security Systems from
Westinghouse Electric Corporation. Westinghouse Security Systems is deemed to be
a predecessor of Protection One.
Selected financial data for 1994 through 1996 were derived from the
financial statements of Westinghouse Security Systems for those years. Per share
data is omitted because Westinghouse Security Systems was wholly owned by
Westinghouse Electric Corporation.
26
SELECTED CONSOLIDATED FINANCIAL DATA (CONTINUED)
(dollars in thousands, except for per share amounts)
PROTECTION ONE PREDECESSOR
----------------------------------------- -------------------------------------------
YEAR ENDED 53 WEEKS 52 WEEKS 52 WEEKS
YEAR ENDED DECEMBER 31, YEAR ENDED ENDED ENDED ENDED
DECEMBER 31, 1997 DECEMBER 31, DECEMBER 30, DECEMBER 20, DECEMBER 20,
1998 RESTATED 1996 1996 1995 1994
------------ ------------ ------------- ------------- ------------- -------------
STATEMENTS OF OPERATIONS DATA
Revenues....................... $ 421,095 $ 144,773 $ 8,097 $ 110,881 $ 88,710 $ 67,253
Cost of revenues............... 131,791 35,669 3,348 25,960 17,280 15,224
------------ ------------ ------------- ------------- ------------- -------------
Gross profit................... 289,304 109,104 4,749 84,921 71,430 52,029
Selling, general and
administrative expenses...... 111,798 80,755 5,091 60,166 50,919 27,448
Acquisition and transition
expense...................... 20,298 2,108 -- 101 101 --
Amortization of intangibles and
depreciation expense......... 117,651 39,822 609 21,613 17,804 13,959
Other charges:
Impairment of customer
accounts................... -- 12,750 -- -- -- --
Merger related costs......... 11,542 -- -- -- --
Employee severance costs..... 3,400 -- -- -- -- --
------------ ------------ ------------- ------------- ------------- -------------
Operating income (loss)........ 36,157 (37,873) (951) 3,041 2,606 10,622
Interest expense, net.......... 55,990 33,483 15 10,879 12,159 13,467
Other non-recurring (income)
expense...................... (20,570) -- -- -- -- --
------------ ------------ ------------- ------------- ------------- -------------
Income (loss) before income
taxes and extraordinary
gain--net of taxes........... 737 (71,356) (966) (7,838) (9,553) (2,845)
Income tax (expense) benefit... (4,791) 28,628 310 2,978 3,630 1,081
------------ ------------ ------------- ------------- ------------- -------------
Income (loss) before
extraordinary gain........... (4,054) (42,728) (656) (4,860) (5,923) (1,764)
Extraordinary gain, net of
tax.......................... 1,591 -- -- -- -- --
------------ ------------ ------------- ------------- ------------- -------------
Net income (loss).............. $ (2,463) $ (42,728) $ (656) $ (4,860) $ (5,923) $ (1,764)
------------ ------------ ------------- ------------- ------------- -------------
------------ ------------ ------------- ------------- ------------- -------------
Net income (loss) per share.... $ (.02) $ (0.60) $ (0.01)
------------ ------------ -------------
------------ ------------ -------------
CONSOLIDATED BALANCE SHEET DATA
Working capital (deficit)...... $ (48,151) $ 41,539 $ (19,447) $ (19,515) $ (13,035) $ (11,551)
Customer accounts, net......... 1,014,428 530,312 265,530 157,969 138,620 114,236
Goodwill and trademarks, net... 1,187,862 672,776 218,991 11,102 11,397 11,691
Total assets................... 2,511,319 1,414,567 506,647 187,456 170,907 145,062
Long term debt, including
capital leases............... 926,971 343,942 60,505 47,931 52,511 58,475
Total stockholders' equity..... 1,345,119 940,550 410,430 106,140 89,120 60,108
OTHER OPERATING DATA
MRR (a)........................ $ 37,920 $ 19,137 $ 8,974 $ 7,870 $ 6,437 $ 5,231
Number of customers at end of
period....................... 1,541,526 756,818 424,100 313,784 265,839 214,785
Ratio of earnings to fixed
charges (b).................. -- -- -- -- -- --
EBITDA (c)..................... $ 162,491 $ 26,241 $ (342) $ 24,654 $ 20,410 $ 24,581
Cash flows from operations..... $ 85,150 (4,928) (91) 23,729 15,073 21,644
Cash flows used in investment
activities................... (893,947) (156,684) (369,536) (40,460) (43,094) (46,741)
Cash flows from financing
activities................... 744,479 237,000 369,682 16,734 28,129 22,287
- ------------------------
(a) Monthly recurring revenue (MRR) is revenue that Protection One is
entitled to receive under contracts in effect at the end of the period. Because
Protection One has grown rapidly, often by acquiring security alarm companies
and portfolios of customer accounts which are included in revenues only from the
date of acquisition, Protection One's revenues are not proportional to the level
of its investment of capital reported to the end of the period upon which a
return must be earned. Management believes
27
monthly recurring revenue enhances an investor's understanding of Protection
One's financial condition, results of operations and cash flows because it
provides a measure of Protection One's revenue that can be used to derive
estimated annual revenues acquired in acquisitions for a full year of
operations. As a result, monthly recurring revenue can be compared to the level
of investment in the statement of financial condition at the end of the period.
By comparing monthly recurring revenue to cash, debt and equity balances at the
end of a period, an investor can assess Protection One's investment track
record. Further, management believes an investor's consideration of monthly
recurring revenue relative to the Protection One's customer base helps identify
trends in monthly recurring revenue per customer. Monthly recurring revenue does
not measure profitability or performance, and does not include any allowance for
future losses of customers or allowance for doubtful accounts. Protection One
does not have sufficient information as to the losses of acquired customers
accounts to predict with absolute certainty the amount of acquired monthly
recurring revenue that will be realized in future periods or the impact of the
loss of acquired accounts on our overall rate of customer loss. Our computation
of monthly recurring revenue may not be comparable to other similarly titled
measures of other companies and monthly recurring revenue should not be viewed
by investors as an alternative to actual monthly revenue as determined in
accordance with generally accepted accounting principles.
(b) Earnings were insufficient to cover fixed charges by $8,845, $14,100,
$966, $7,838, $9,553 and $2,845 for 1998, 1997, and 1996 for Protection One and
1996, 1995 and 1994 for its relevant predecessor, respectively.
(c) Recurring earnings before interest, taxes, depreciation and amortization
(EBITDA) is derived by adding to income (loss) before income taxes, the sum of:
- interest expense, net;
- other charges;
- depreciation and amortization expense; and
- deducting other non-recurring (income) expense items.
Recurring EBITDA does not represent cash flow from operations as defined by
generally accepted accounting principles, should not be construed as an
alternative to operating income and is indicative neither of operating
performance nor cash flows available to fund the cash needs of Protection One.
Items excluded from EBITDA are significant components in understanding and
assessing the financial performance of Protection One. Protection One believes
presentation of EBITDA enhances an understanding of financial condition, results
of operations and cash flows because EBITDA is used by Protection One to satisfy
its debt service obligations and its capital expenditure and other operational
needs, as well as to provide funds for growth. In addition, EBITDA is used by
senior lenders and subordinated creditors and the investment community to
determine the current borrowing capacity and to estimate the long-term value of
companies with recurring cash flows from operations. Protection One's
computation of EBITDA may not be comparable to other similarly titled measures
of other companies.
28
The following table provides a calculation of recurring EBITDA for each of
the periods presented above:
PROTECTION ONE
------------------------------- PREDECESSOR
-------------------------------------
YEAR ENDED DECEMBER 31, 53 WEEKS 52 WEEKS 52 WEEKS
------------------------------- ENDED ENDED ENDED
1997 DECEMBER DECEMBER DECEMBER
1998 RESTATED 1996 30, 1996 20, 1995 20, 1994
--------- --------- --------- ----------- ----------- -----------
(DOLLARS IN THOUSANDS) (DOLLARS IN THOUSANDS)
Income (loss) before income
taxes and extraordinary
item....................... $ 737 $ (71,356) $ (966) $ (7,838) $ (9,553) $ (2,845)
Plus:
Interest expense, net...... 55,990 33,483 15 10,879 12,159 13,467
Other charges.............. 8,683 24,292 -- -- -- --
Amortization of intangibles
and depreciation
expense.................. 117,651 39,822 609 21,613 17,804 13,959
Less:
Other non-recurring
(income) expense......... (20,570) -- -- -- -- --
--------- --------- --------- ----------- ----------- -----------
EBITDA....................... $ 162,491 $ 26,241 $ (342) $ 24,654 $ 20,410 $ 24,581
--------- --------- --------- ----------- ----------- -----------