SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
[ ]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________
0-24780 33-73002-01
(Commission File Number) (Commission File Number)
Protection One, Inc. Protection One Alarm Monitoring, Inc.
(Exact Name of Registrant (Exact Name of Registrant
as Specified in Charter as Specified in Charter)
Delaware Delaware
(State or Other Jurisdiction (State or Other Jurisdiction
of Incorporation or Organization) of Incorporation or Organization)
93-1063818 93-1064579
(I.R.S. Employer Identification No.) (I.R.S. Employer Identification No.)
6011 Bristol Parkway, Culver City, 6011 Bristol Parkway, Culver City,
California, 90230 California, 90230
(Address of Principal Executive (Address of Principal Executive
Offices, Including Zip Code) Offices, Including Zip Code)
(310) 342-6300 (310) 342-6300
(Registrant's Telephone Number, (Registrant's Telephone Number,
Including Area Code) Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Name of Each Exchange
Title of Each Class On Which Registered
6 3/4% Convertible Senior Subordinated
Notes Due 2003 of Protection One Alarm
Monitoring, Inc.
Guaranteed by Protection One, Inc. New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, par value $.01 per share of Protection One, Inc.
(Title of Class)
Indicate by check mark whether each registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or such shorter period that such
registrant was required to file such reports) and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of each registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the common stock of Protection One, Inc.
held by nonaffiliates on March 25, 1998 (based on the last sale price of such
shares on the Nasdaq National Market) was approximately $155,379,253.
As of March 25, 1998, Protection One, Inc. had outstanding 83,766,369
shares of Common Stock, par value $0.01 per share. As of such date, Protection
One Alarm Monitoring, Inc. had outstanding 110 shares of Common Stock,
par value $0.10 per share, all of which shares were owned by Protection One,
Inc.. Protection One Alarm Monitoring, Inc. meets the conditions set forth in
General Instructions I (1)(a) and (b) for Form 10-K and is therefore filing
this form with the reduced disclosure format set forth therein.
DOCUMENTS INCORPORATED BY REFERENCE:
Portions of Protection One, Inc.'s Proxy Statement furnished to stockholders in
connection with its Annual Meeting of Stockholders to be held April 23, 1998,
are incorporated by reference in Part III of this Form 10-K. Such proxy
statement will be filed with the Commission on or about April 2, 1998.
1
Introductory Notes
Company Structure. Unless the context otherwise indicates, all
references in this Annual Report on Form 10-K (this "Report") to "the Company"
or "Protection One" are to Protection One, Inc. ("POI") and its direct wholly
owned subsidiaries, Protection One Alarm Monitoring, Inc. ("Monitoring"), Westar
Security, Inc. ("Westar") and WestSec, Inc. ("WestSec"). POI operates solely
through and maintains no other assets than its investment in its subsidiaries.
MRR, EBITDA and Adjusted EBITDA. As used in this Report, "MRR" is
monthly recurring revenue (excluding revenues from patrol services) that the
Company is entitled to receive under contracts in effect at the end of the
period, "EBITDA" means earnings before interest, taxes, depreciation and
amortization (excluding nonrecurring charges) and "Adjusted EBITDA" means EBITDA
adjusted by adding selling and marketing expenses, net of revenues, arising from
installation activities. MRR is a term commonly used in the security alarm
industry as a measure of the size of a company, but not as a measure of
profitability or performance, and does not include any allowance for future
attrition or allowance for doubtful accounts. EBITDA is derived by adding to
loss before income taxes, the sum of (i) interest expense, net, (ii)
nonrecurring charges, and (iii) amortization of intangibles and depreciation
expense. Adjusted EBITDA is derived by adding to EBITDA selling and marketing
expenses related to installations and deducting from EBITDA installation
revenues. EBITDA and Adjusted EBITDA do not represent cash flow from operations
as defined by generally accepted accounting principles, should not be construed
as alternatives to net income and are indicative neither of the Company's
operating performance nor of cash flows available to fund the Company's cash
needs. Items excluded from EBITDA and Adjusted EBITDA are significant components
in understanding and assessing the Company's financial performance. Management
believes presentation of EBITDA and Adjusted EBITDA enhances an understanding of
the Company's financial condition, results of operations and cash flows because
EBITDA and Adjusted EBITDA are used by the Company to satisfy its debt service
obligations and its capital expenditure and other operational needs as well as
to provide funds for growth. In addition, EBITDA and Adjusted EBITDA have been
used by senior lenders and subordinated creditors and the investment community
to determine the current borrowing capacity and to estimate the long-term value
of companies with recurring cash flows from operations and net losses.
Forward-Looking Statements. This Report and the materials incorporated
by reference herein include "forward-looking statements" intended to qualify for
the safe harbor from liability established by the Private Securities Litigation
Reform Act of 1995. These forward-looking statements generally can be identified
as such because the context of the statement includes words such as the Company
or its management "believes," "expects," "anticipates" or other words of similar
import. Similarly, statements herein that describe the Company's objectives,
plans or goals also are forward-looking statements. All such forward-looking
statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from those in the forward-looking
statements. Important factors that could cause actual results to differ
materially from the expectations of Protection One include, among others:
Protection One's need for additional capital and history of losses; the risks
and uncertainties related to acquisitions of subscriber accounts and alarm
account portfolios and the Protection One dealer program; subscriber account
attrition; the impact of accounting differences for account purchases and new
installations; its high degree of leverage; the possible adverse effect of false
alarm ordinances and future government regulations; risks of liability from
operations; and competition in the security alarm industry. Stockholders,
potential investors and other readers are urged to consider these factors
carefully in evaluating the forward-looking statements. The forward-looking
statements included herein are made only as of the date of this Report and the
Company undertakes no obligation to publicly update such forward-looking
statements to reflect subsequent events or circumstances.
2
PART I
ITEM 1. BUSINESS
Overview
Protection One(R) is a leading provider of security alarm monitoring
and related services in the United States with approximately 1.1 million
subscribers as of March 1998. The Company has grown rapidly since its inception
by participating in both the growth and consolidation of the security alarm
monitoring industry. Protection One has focused its customer growth in major
metropolitan areas demonstrating strong demand for security alarms.
Approximately 50% of the Company's direct subscribers are located in the states
of California, Florida and Texas. The Company also has significant numbers of
direct subscribers in the states of Arizona, Georgia, Kansas, Missouri, Nevada,
New York, North Carolina, Oregon, Tennessee and Washington.
The Company provides its services to the residential, commercial and
wholesale segments of the alarm monitoring market. The Company believes the
residential segment, which represents in excess of 80% of its customer base, is
the most attractive because of its growth prospects, gross margins and size.
Within the residential segment, 62% of the Company's customer base occupy
single-family households and approximately 19% reside in multi-family complexes
such as apartments and condominiums. The remainder of the Company's customer
base is split between commercial subscribers (12% of the customer base) and
subscribers served by independent alarm dealers that subcontract monitoring
services to the Company. Protection One intends to grow its presence in each of
these key market segments, although the residential market remains the most
important for the Company's growth strategy.
Protection One's objectives are to become the largest and fastest
growing provider of high quality alarm monitoring services in the United States,
to expand customer relationships by offering additional services and to build a
preeminent brand name in the security industry. To accomplish its first
objective, the Company is pursuing a growth strategy consisting of new system
sales through its Dealer Program, supplemented by the acquisition of subscribers
from other alarm companies. Through its Dealer Program, independent companies
with residential sales, marketing and installation skills enter into exclusive
dealer contracts with Protection One to provide it with new monitoring customers
for purchase. To supplement this internally controlled marketing distribution
channel, Protection One has been an aggressive acquirer of portfolios of
security alarm subscribers and believes acquisitions remain an important source
of subscriber growth due to the high industry fragmentation. Once it has
acquired a new customer, the Company provides monitoring and field repair
services and strives to expand the customer relationship by offering an array of
enhanced services, such as extended service protection. The Company adds to its
list of services as and when its new product development area creates, tests and
refines new service offerings. Finally, the Company believes there is an
opportunity to create a well-recognized consumer brand due to a lack of consumer
awareness about the security industry. The Company's service and response
vehicles, yard signs, window decals, dealer marketing efforts and affinity
relationships serve as a platform from which to launch further brand development
efforts. The Company believes its development of a focused message about the
Protection One brand will enhance its efforts to broaden customer relationships
and will establish and reinforce Protection One's position as an industry leader
to consumers.
The Company's revenues consist primarily of subscribers' recurring
payments for monitoring and related services. The Company monitors digital
signals communicated by security systems installed at subscribers' premises.
Security systems are designed to detect burglaries, fires and other events.
Through a network of approximately 60 service branches, the Company provides
repair of security systems and, in select markets, armed response to verify that
an actual emergency, rather than a false alarm, has occurred.
Protection One believes it has a competitive cost structure and is
focused on achieving high operating margins by maintaining monitoring and field
service efficiencies and a streamlined corporate staff. To that end, Protection
One seeks to grow its subscriber base in concentrated geographic areas, thereby
enhancing field service efficiency, increasing sales referrals and brand
visibility and reducing attrition. This targeted growth also is consistent with
the Company's belief that a growing trend of municipalities requiring
verification and private response to security alarm emergencies will necessitate
subscriber concentration. To further maintain low operating expenses, Protection
One is consolidating its monitoring function into five state-of-the-art service
centers, each of which uses sophisticated and redundant communications, computer
and power equipment.
3
To enhance customer satisfaction, Protection One maintains two customer
care centers, open 24 hours per day and seven days per week, to address all
non-emergency communications with customers. Each center utilizes sophisticated
technology such as advanced telephone switches, computer-telephone interfaces
(CTI), auto-dialing and voice response units. Protection One pursues a one-call
resolution policy in its customer service centers. Customer service
representatives are trained to answer a wide variety of anticipated customer
questions about products and services and are vested with appropriate authority
to resolve billing issues. Each customer service center also has a help desk
that answers technical questions about operation and repair of security system
equipment in an effort to reduce the requirement for field service.
Historically, Protection One has offered an array of monitoring-related
services to its customer base, including extended service protection and alarm
verification services such as two-way voice communication and patrol and alarm
response services. The Company has solicited customer interest in these enhanced
services and executed a systematic price adjustment program through an internal
outbound marketing function. In the last several years, Protection One has
developed an inbound calling function housed in its customer care centers to
qualify and process prospective customer inquiries arising from an ongoing
advertising program utilizing print, radio and television media. Such
advertising has been offered as part of several of the Company's joint marketing
arrangements with the dual purpose of generating prospective new subscribers and
communicating the Protection One brand.
Recently, Protection One entered into a significant transaction that
substantially increased its size and scope of operations. On November 24, 1997,
Protection One issued approximately 68.7 million shares of its common stock, par
value $.01 per share ("Common Stock"), constituting an 82.4% ownership position,
to Western Resources, Inc. ("Western Resources"), in exchange for the security
businesses of Western Resources, consisting of Westar and WestSec, and an
aggregate of $367.4 million in cash and securities (the "Contribution"). The
Contribution immediately increased the size of Protection One from approximately
250,000 subscribers to 740,000 subscribers, and increased its geographic
coverage from the western United States to the entire country. The Contribution
also strengthened the Company's balance sheet and enhanced its access to capital
to fund its growth strategy.
Subsequent to the end of fiscal year 1997, on February 4, 1998,
Protection One announced its decision to exercise its option to purchase Network
Multi-Family Security Corporation ("Network"), the leading provider of security
alarm monitoring to multi-family dwellings with approximately 200,000
subscribers. Pursuant to the terms of the option, Protection Onewill give
Western Resources cash consideration of approximately $180 million.
On March 2, 1998, Protection One completed the acquisition of 147,000
subscribers and related assets of Multimedia Security Services, Inc.
("Multimedia") for a purchase price of approximately $233 million. The
Multimedia purchase added to the Company's market positions in California,
Florida and Texas and added substantial numbers of subscribers in Kansas and
Oklahoma. In addition, Protection One will maintain Multimedia's monitoring and
customer service center in Wichita, Kansas.
On March 17, 1998, Protection One completed the acquisition of Comsec
Narragansett Security, Inc. ("Comsec") for a cash purchase price of
approximately $45 million and the assumption of $15 million of debt. Comsec's
30,000 subscribers are located primarily in Connecticut, Maine, Massachusetts
and New Hampshire.
Industry and Markets
SDM Magazine reports that the security alarm industry grew 5.2% in
1997, reaching total revenues of approximately $14 billion. Of the industry
total, SDM Magazine estimates that alarm monitoring revenue comprised 20%, or
approximately $2.8 billion, an increase of 7.7% from $2.6 billion in 1996.
According to the results of a survey, SDM Magazine reports that the largest 100
companies in the industry experienced growth of 14.8% in 1997, compared to the
industry growth rate of 5.2%. This disparity reflects a continuing consolidation
of the security alarm industry, as larger firms are actively acquiring smaller
ones. Despite the consolidation activity, however, the security alarm industry
remains highly fragmented. For instance, SDM Magazine estimates that there are
16,000 businesses in the security alarm industry. In addition, the most recent
ranking of security alarm companies by SDM Magazine indicates that only 25
security companies generated revenues in excess of $20 million in 1996; eight of
the 25 companies have been acquired since the date of the survey.
Protection One believes larger alarm companies with internally
generated cash flow and access to
4
capital will continue to grow faster than the industry average. In most cases,
the installation of security systems requires alarm companies to fund the excess
of installation-related costs over installation revenues, a trend that continues
to be prevalent in both the residential and commercial segments. In addition,
the Company believes the growth in false alarms is causing some municipalities
to consider alternatives to response by municipal police. To the extent that
municipalities elect to require some form of private verification of an alarm
prior to police dispatch, such policies could impose additional expenses on
alarm monitoring companies. Due to Protection One's size and access to capital,
the Company believes it is well positioned to compete in the industry.
Strategy
Protection One's objectives are to become the largest and fastest
growing provider of high quality alarm monitoring services in the United States,
to expand customer relationships by offering additional services and to build a
preeminent brand name in the security industry. The Company has developed
strategies to meet each of these objectives, as described below.
Establish Leadership Position
From its inception through 1995, Protection One grew primarily through
the acquisition of portfolios of subscribers from other alarm companies.
Beginning in 1995, the Company's Dealer Program became an important source of
growth and the Company's sole means for capturing a portion of new security
system installations. Through this dual approach, Protection One believes it is
well positioned to benefit from market growth and industry consolidation. Growth
has enabled the Company to achieve economies of scale in its monitoring and
field service operations. As the number of monitored subscribers has increased,
the fixed costs of service centers have been spread over a larger base,
improving monitoring gross margins. Protection One has targeted subscriber
growth in concentrated areas surrounding branch offices. Subscriber proximity to
branch offices positions the Company to provide responsive field repair and
alarm response services, allows the Company to spread branch office fixed costs
over a larger base and increases the productivity of field service technicians
through more efficient scheduling and dispatching.
The Company continues to pursue subscriber and MRR growth in excess of
the industry average. The Company believes growth will enable it to achieve
further economies of scale, particularly with respect to the fixed costs of
general and administrative functions. In addition, achieving its growth goals
assists the Company's efforts in meeting its other goals of expanding customer
relationships and establishing a well-known brand name. Finally, the Company
believes increased market share offers an opportunity to reduce the costs to
identify and procure new subscribers.
The Dealer Program consists of independent companies with residential
and small commercial sales, marketing and installation skills that enter into
exclusive contracts with Protection One to provide it with new monitoring
customers for purchase on an ongoing basis. This program has become an
increasingly important source of growth for Protection One. The Company
anticipates a significant increase in the number of new subscribers generated by
the Dealer Program in the twelve months ended December 31, 1998 due to its
increased size and scope of operation from its combination with Westar and
WestSec. During the twelve months ended December 31, 1997, Westar and WestSec
installed approximately 50,000 new security systems through an internal sales
force. Protection One has substantially completed the conversion of the Westar
and WestSec sales forces to Dealer Program participants, and therefore
anticipates an increase in Dealer Program productivity commensurate with the
previous installation activity.
Protection One believes the Dealer Program is an advantageous marketing
distribution channel because of its high sales productivity, lower acquisition
prices and geographic flexibility. First, as independent companies, dealers are
responsible for the number of new security system installations they complete
each month, and ultimately, the success of their businesses. The Company
believes such financial motivation leads dealers to continuously seek improved
sales and marketing methods. The Company believes a sales function consisting of
salaried Company employees may not have the same financial motivation. Second,
because purchase multiples paid for alarm monitoring contracts tend to increase
with the size of the portfolio, multiples in the Dealer Program are typically
lower than those paid by Protection One for acquisitions. In addition, cash
outlays for new subscribers are entirely variable, changing as the number of
monitoring contracts presented for purchase change each month. Lowering the cost
to generate new subscribers is an important component of the Company's growth
strategy and the Dealer Program's increased contribution relative to other
growth channels is consistent with such effort. Third, Protection One supports
the expansion of successful dealers to other areas
5
of the country. Protection One may assist the dealer financially to fund startup
costs associated with new office openings. Protection One guides Dealer Program
participants to the geographic areas that are the highest priority for the
Company. Finally, because dealers are responsible for sales and marketing
activities, as well as equipment and installation costs, Protection One
maintains a minimal sales staff and infrastructure.
Strategic Alliances provide the Dealer Program with a proprietary
source of prospective customers. Protection One has aggressively pursued
alliances with other companies that have significant residential customer bases.
In particular, Protection One has targeted metropolitan electric and gas
utilities and telephone companies that have strong market positions and receive
inbound phone calls from prospective customers moving into homes. Protection One
believes this inbound lead flow will enable it to reduce its cost to generate
new subscribers in the future, and represents a valuable source of new security
system installations for Dealer Program participants. In turn, electric and gas
utilities facing deregulation have expressed to Protection One an interest in
offering security alarm services to develop more comprehensive relationships
with their customers. Protection One has entered into marketing alliances with
PacifiCorp, Salt River Project, Kansas City Power & Light, Oklahoma Natural Gas,
Kansas Power & Light and Kansas Gas and Electric. In addition, Southwestern Bell
Corporation serves as a sales agent for Protection One in its markets.
Protection One currently has additional utility alliances in
development. The Company continues to believe that the deregulation of the
electric utility industry offers opportunities for mutually beneficial marketing
alliances that will hasten growth in new subscribers and awareness of Protection
One.
In addition to utility alliances, Protection One enjoys partnerships
with leading companies in the insurance, banking, credit card, mortgage and
retail industries. Protection One also has marketing alliances with leading home
builders around the country, through which Protection One has the exclusive
right to market its security systems to new home buyers.
Acquisitions have played an important role in Protection One's growth.
Since the combination with Westar and WestSec, acquisition activity has
increased significantly, as Protection One has acquired approximately 375,000
subscribers through the acquisitions of Network, Multimedia and Comsec. The
Company believes that it has been an effective competitor in the acquisition
market because of the substantial experience of its management in acquiring
alarm companies and subscriber accounts and the Company's industry reputation as
an active purchaser of subscriber accounts. Although the Company approaches all
acquisitions with consistent due diligence, pricing and integration policies,
there are several differences between small and large acquisitions.
The Company typically pursues small acquisitions in existing areas of
operation and believes there are approximately 16,000 alarm companies in its
markets. The Company has focused on acquisitions that allow it to increase
subscriber density in areas surrounding branch operations, which in turn leads
to greater field service and armed response efficiencies. In small acquisitions,
the Company typically acquires only the subscriber accounts, and not the
facilities or liabilities, of such companies.
Because the Company's primary consideration in making an acquisition is
the amount of cash flow that can be derived from the MRR associated with the
purchased accounts, the price paid by the Company is customarily based upon such
MRR. To protect the Company against the loss of acquired accounts and to
encourage the seller of such accounts to facilitate the transfer of subscribers,
management typically requires the seller to provide guarantees against account
cancellations for a period following the acquisition. The Company usually holds
back from the seller a portion of the acquisition price, and has the contractual
right to utilize such holdback to recapture a portion of the purchase price
based on the lost MRR arising from the cancellation of acquired accounts.
In evaluating the quality of the accounts acquired, the Company relies
primarily on management's knowledge of the industry, its due diligence
procedures, its experience in integrating accounts into the Company's
operations, its determination as to attrition rates for the acquired accounts,
and the representations
6
and warranties of the sellers.
In large acquisitions, the Company strives to purchase subscribers and
related assets but often is required to purchase the stock of large alarm
companies. In such cases, the price paid by the Company reflects not only the
MRR associated with the purchase accounts, but also other assets and liabilities
that impact the value of the customer base. Purchase multiples typically
increase with the size and strategic value of a prospective acquisition.
Expand Customer Relationships
As a means to increase revenues, Protection One offers customers an
array of enhanced security services, including extended service protection and
several levels of alarm verification. These services position Protection One as
a full service provider and give dealers more features to sell in their
solicitation of new customers. The Company actively solicits its customers for
interest in these services. In the Las Vegas area, the Company through its
dealers offers a bundle of services consisting of monitoring, extended service
protection and alarm response. The following provides additional detail on
enhanced services:
Extended Service Protection, which covers the normal costs of repair of
the system during normal business hours, after the expiration of the initial
warranty period.
Two-Way Voice Communication (Remote Audio Verification), which consists
of the ability, in the event of an alarm activation, to listen and talk to
persons at the monitored premises from the service center through speakers and
microphones located within the premises. Among other things, such remote audio
verification helps the Company to determine whether an alarm activation is a
false alarm.
Supervised Monitoring Service, which allows the alarm system to send
various types of signals containing information on the use of the system, such
as which users armed or disarmed the system and at what time of the day. This
information is supplied to subscribers for use in connection with the management
of their households or businesses.
Supervised monitoring service can also include a daily automatic test feature.
Pager Service, which provides the subscriber with standard pager
services that also enable the Company to reach the subscriber in the event of an
alarm activation.
Medical Identification Card, which enables medical personnel in the
event of a medical emergency to access a subscriber's medical information (e.g.,
allergies, medications and family medical history), emergency contacts and
doctors by calling Protection One's service center.
Wireless Back-Up, which permits the alarm system to send signals over a
cellular telephone or dedicated radio system, in the event that regular
telephone service is interrupted.
Protection One's new product development function continually seeks new
services to offer customers.
Brand Development
Based on primary market research, Protection One believes there is an
opportunity to build a preeminent consumer brand in the security industry.
Currently, consumers are unable to name any security industry competitor on an
unaided basis to a significant degree. The Company's service and response
vehicles, yard signs, window decals, dealer marketing efforts and affinity
relationships serve as a base from which to launch further brand development
efforts. The Company has developed a branding strategy to assist it in achieving
its other strategic objectives by positioning it as an industry leader and
establishing a platform for the sale of additional services. The Company
believes a nationally recognized brand supports its goals of becoming an
industry leader and broadening its customer relationships. The Company has
recently completed the first phase of a significant research effort to define a
unique selling proposition for the Protection One
7
brand. The Company will create sales and marketing materials that reflect this
positioning and will coordinate internal and external communications vehicles to
offer a single focused message about the Protection One brand. In addition, the
Company will evaluate all future opportunities for marketing alliances and joint
ventures in the context of the brand strategy, selecting those that enhance its
positioning and accelerate the growth in public awareness of the brand. Finally,
the Company intends to test the use of brand awareness advertising in
conjunction with direct response marketing, in an effort to quantify the extent
to which increased consumer awareness of the brand enhances direct marketing
activities. The Company expects to invest gradually in brand advertising over
time as the security market matures.
Operations
Protection One's operations consist principally of its service centers,
which provide alarm monitoring and customer care services, its branch
operations, which conduct field repair and patrol and alarm response services
and its subscriber acquisition and transition functions, which provide due
diligence and assimilation services to dealers and others.
8
Service Centers
Subscriber Security Alarm Systems. Security alarm systems include
devices installed at the subscribers' premises designed to detect or react to
various occurrences or conditions, such as intrusion or the presence of fire or
smoke. These devices are connected to a computerized control panel that
communicates through telephone lines to a service center. Subscribers may also
initiate an emergency signal from a device such as a "panic button." In most
systems, control panels can identify the nature of the alarm and the areas
within a building where the sensor was activated, and can transmit that
information to the central monitoring station.
Monitoring. The Company maintains four service centers to provide
monitoring services to its customer base, and recently added a fifth with the
Multimedia acquisition. The table below provides additional detail about each
service center:
Number of Current Primary
Location Subscribers Capacity Market Segment
Beaverton, OR 250,000 500,000 Residential/Commercial
Dallas, TX 200,000 500,000 Multi-Family
Irving, TX 340,000 1,000,000 Residential/Commercial
Orlando, FL 100,000 500,000 Wholesale
Wichita, KS 147,000 200,000 Residential/Commercial
With the exception of some specialized commercial accounts, the
remainder of the Company's subscriber accounts is monitored at other service
centers and is scheduled to be consolidated into one of the facilities noted
above in 1998.
Each service center incorporates the use of advanced communications and
computer systems that route incoming alarm signals and telephone calls to
operators. Substantially all service center personnel are subject to
pre-employment screening and background checks. Each operator monitors a
computer screen that provides immediate information concerning the nature of the
alarm signal, the subscriber whose alarm has been activated, and the premises on
which such alarm is located. All telephone conversations are automatically
recorded.
Depending upon the type of service for which the subscriber has
contracted, service center personnel respond to alarms by relaying information
to the local fire or police departments, notifying the subscriber, or taking
other appropriate action, such as dispatching alarm response personnel to the
subscriber's premises where this service is available. The Company also provides
a substantial number of subscribers with remote audio verification capability
that enables the central monitoring station to listen and speak directly into
the subscriber's premises in the event of an alarm activation. This feature
allows the Company's personnel to verify that an emergency exists, to reassure
the subscriber, and to expedite emergency response, even if the subscriber is
unable to reach a telephone. Remote audio verification capability also assists
the Company in quickly determining if the alarm was activated inadvertently, and
thus whether a response is required.
The Company's service centers operate 24 hours per day, seven days a
week, including all holidays. Each operator receives training that includes
familiarization with substantially every type of alarm system in the Company's
subscriber base. This enables the operator to tell subscribers how to turn off
their systems in the event of a false alarm, thus reducing the instances in
which a field service person must be dispatched. Other non-emergency
administrative signals are generated by low battery status, deactivation and
reactivation of the alarm monitoring system, and test signals, and are processed
automatically by computer.
All of the Company's primary service centers are listed by Underwriters
Laboratories, Inc. ("UL") as protective signaling services stations. UL
specifications for service centers include building integrity, back-up computer
and power systems, staffing and standard operating procedures. In many
jurisdictions, applicable law requires that security alarms for certain
buildings be monitored by UL listed facilities. In addition, such listing is
required by certain commercial subscribers' insurance companies as a condition
to insurance coverage.
Wholesale Monitoring. The Company's service center in Orlando, Florida
is a leading provider of wholesale
9
monitoring services to independent dealers. The Orlando service center is one of
only a few wholesale monitoring facilities to offer two-way voice communication
on a widespread basis. Under the typical arrangement, dealers subcontract
monitoring services to the Company, primarily because such dealers do not have
their own monitoring capabilities. The Company may also provide billing and
other services. Dealers retain ownership of monitoring contracts and are
responsible for every other aspect of the relationship with customers, including
field repair service.
The Company's presence in the wholesale monitoring segment provides it
with another source of prospective acquisition targets. Independent dealers who
subcontract monitoring services to the Company are familiar with the Company's
high quality monitoring and related capabilities, an important consideration for
a prospective seller of a portfolio of security alarm subscribers.
Subscriber Contracts. The Company's alarm monitoring subscriber
contracts generally have initial terms ranging from one to five years in
duration, and provide for automatic renewal for a fixed period (typically one
year) unless the Company or the subscriber elects to cancel the contract at the
end of its term.
Customer Care Services. The Company's customer care centers process
non-emergency communications with the Company's customers. A dedicated group
receives inbound customer calls and routes them to the most appropriate customer
care area. The customer service group addresses customer questions and concerns
about billing, service, credit and alarm activation issues, arising from calls
forwarded by the inbound group and customer letters. A help desk staff assists
customers in understanding and resolving mechanical and operating issues related
to security systems. A centralized field repair scheduling function sets up
technician appointments. In the Company's Irving, Texas facility, customer care
representatives also are available to monitor emergency signals if the
monitoring function requires additional staffing on a short-term basis. As the
Company continues to add geographic areas in which it offers armed response,
call centers also will serve as centralized dispatchers of response vehicles.
Branch Operations
The Company maintains approximately 60 branches nationwide from which
it provides field repair, customer care, alarm response and sales services. The
Company's branch infrastructure plays an important role in enhancing customer
satisfaction, reducing attrition and building the Company's brand awareness.
Field Repair. Field repair personnel are trained by Protection One to
provide repair services for the various types of security systems utilized by
the Company's subscribers. The Company strives to execute prompt service
scheduling and first call repair for customers. Field personnel also provide
quality and related compliance inspections for new installations performed by
the Company's dealers.
Repair services generate revenues primarily through billable field
service calls and recurring payments under the Company's extended service
protection program. The increasing density of the Company's subscriber base, the
result of continuing efforts to acquire new subscribers in areas surrounding
branch operations, permits more effective scheduling and routing of field
service technicians and results in economies of scale at the branch level.
Increased efficiency in scheduling and routing also allows Protection One to
provide faster field service response and support, which leads to a higher level
of customer satisfaction. The Company continually reviews available automated
work management and scheduling programs to maximize employee resources in the
field repair function.
Alarm Response and Patrol. Protection One offers its subscribers in
southern California and Las Vegas alarm response and patrol enhanced services in
addition to the Company's other services, and employs over 100 patrol officers
operating in 25 regular patrol "beats," or designated neighborhoods, to provide
such services. These armed officers supplement Protection One's alarm monitoring
service by providing "alarm response service" to alarm system activations,
"patrol service" consisting of routine patrol of subscribers' premises and
neighborhoods and, in a few cases, "special watch" services, such as picking up
mail and newspapers and increased surveillance when the subscriber is
travelling. Alarm response service requires
10
Protection One's patrol officers to observe and report any potential criminal
activity at a subscriber's home.
Protection One offers a bundle of services in Las Vegas consisting of
alarm monitoring, field repair and alarm response services billed to the
subscriber as a consistent monthly charge regardless of the number of service
calls or responses to alarm activations. Protection One believes this service
package is attractive to current and prospective subscribers because the package
(i) enables Protection One to offer a reliable and timely alarm response
service, and (ii) eliminates subscriber uncertainty arising from "per response"
charges. The Company will use this bundled service offering in other markets to
the extent private verification of alarms is required.
Patrol and alarm response officers are dispatched by 24-hour central
radio dispatch offices located in Chatsworth, California and Las Vegas, Nevada.
If the patrol officer dispatched observes potential criminal activity, the
officer will report the activity to the dispatch office, which will in turn
notify local law enforcement. The patrol officer will then maintain surveillance
until law enforcement officers arrive. If a patrol officer does not detect
criminal activity, he will report his conclusion to the dispatch office, and
police response will not be initiated.
The Company also offers "dedicated" patrol service to homeowners'
associations in selected markets, for which the Company provides a
Company-marked car for patrol exclusively in such association's neighborhood. A
significant percentage of the homeowners in such associations purchase the
Company's alarm monitoring services.
The Company's patrol and alarm response officers are subject to
extensive pre-employment screening and training. Officers are subject to local
and federal background checks and drug screening before being hired, and are
required to have gun and baton permits and state and city guard licenses.
Officers also must be licensed by states to carry firearms and to provide patrol
services. Protection One is one of a few companies to have an in-house training
academy which prepares officer candidates for employment. The Company's training
program includes arrest procedures, criminal law, weaponless defense, firearms
and baton usage, patrol tactics, and first-aid and CPR. After graduating from
the Protection One patrol academy, a new officer rides along with a field
training officer for two weeks to gain experience. In total, an officer
candidate undergoes five weeks of specific training, which amount exceeds all
state requirements. Despite extensive training, however, the provision of patrol
and alarm response services subjects the Company to greater risk, relating to
accidents or employee behavior, than other types of businesses. See "--Risk
Management."
The Company believes that demand for alarm response and patrol services
is likely to increase as a result of a trend on the part of local police
departments to limit their response to alarm activations and other factors that
may lead to a decrease of police presence. The Private Sector Liaison Committee
of the International Association of Chiefs of Police has established Non-Sworn
Alarm Responder Guidelines to provide standards for private alarm response
officers. Although the Company currently incurs a loss in its patrol and alarm
response operations, the Company believes further demand for such services will
enable the Company to increase subscriber density in its routes, thereby
reducing losses. In addition, the Company's offer of patrol and alarm response
services is a sales method used to attract subscribers of other alarm monitoring
companies that do not provide such services. To the extent that further demand
develops for patrol and alarm response services, the Company believes its
current presence will enable it to increase its conversions of subscribers to
the Company's services. Additionally, the Company believes such services are an
effective impediment to subscriber attrition.
Acquisition and Transition
The Company's acquisition and transition functions manage important
aspects of the Company's Dealer Program and acquisition activity.
11
The Dealer Program offers dealers a wide variety of support services to
assist them as they grow their businesses. On behalf of Dealer Program
participants, Protection One obtains purchase discounts on security systems,
coordinates cooperative dealer advertising and provides administrative,
marketing and employee training support services. The Company believes these
cost savings and services would not be available to Dealer Program participants
on an individual basis. In addition, Protection One supplies its dealers with a
proprietary flow of prospective customers, supplementing the dealers' own
efforts and increasing their chances for success. See "--Sales and Marketing."
Dealer contracts provide for the purchase by the Company of the
dealers' subscriber accounts on an ongoing basis. A dedicated group within
Protection One works with dealers on a daily basis to provide a smooth
transition from the installation of a security system to the purchase of a
monitoring contract. The dealers install Company specified alarm systems (which
have a Protection One logo on the keypad), arrange for subscribers to enter into
Protection One alarm monitoring agreements, and install Protection One yard
signs and window decals. Protection One operators receive inbound calls and test
signals from dealer installation technicians to ensure that systems are
communicating properly. Substantially all of these subscribers are contacted
individually by Company personnel at the time of the purchase of the accounts
from the dealers, to facilitate subscriber satisfaction and quality control. In
addition, the Company requires dealers to qualify prospective subscribers by
meeting a minimum credit standard. Once Protection One has purchased a contract
from a dealer, the Company becomes the sole provider of monitoring, field
service and customer service; the dealer is prohibited from contacting the
customer.
Acquisitions also require dedicated personnel from multiple disciplines
of the Company. In both small and large acquisitions, the Company employs a
comprehensive acquisition management system to identify, evaluate, and integrate
acquisitions of new subscriber accounts that includes three components: (i) the
identification and negotiation stage; (ii) the due diligence stage; and (iii)
the integration stage.
The Company actively seeks to identify prospective companies and
dealers with targeted direct mail, trade magazine advertising, trade show
participation, membership in key alarm industry trade organizations, and
contacts through various prominent vendors and other industry participants.
Management's extensive experience in identifying and negotiating previous
acquisitions helps to facilitate the successful negotiation and execution of
acquisitions in a timely manner.
The Company conducts a pre-closing review and analysis of the seller's
operations. The process includes a combination of selective field equipment
inspections, review of certain of the subscriber contracts and other types of
verification of the seller's operations.
The Company develops a specific integration program, in conjunction
with the seller, for each acquisition. Integration efforts typically include a
letter from the seller to its subscribers, explaining the sale and transition,
followed by one or more letters and packages that include the Company's
subscriber service brochures, field service and monitoring phone number
stickers, yard signs and window decals. Thereafter, each new subscriber is
contacted individually by telephone by a member of the Company's customer
service group for the purpose of addressing the subscriber's questions or
concerns and soliciting certain information. Finally, the subscriber receives a
follow-up telephone call after six months and periodically thereafter.
Management's goal is to enhance new subscriber identification with Protection
One as the service provider and to maintain subscriber satisfaction.
Mobile Services
The Company's mobile services group provides leading edge technology
and professional response for the delivery of emergency, navigation and
information services in mobile applications. The Company became a pioneer in the
mobile security industry when it teamed with Ford Motor Company and Motorola in
1995 to develop Lincoln RESCU. This program offered the first vehicle safety
system to integrate cellular
12
phone and global positioning technology to assist motorists when they need
emergency help or roadside or routing assistance.
Sales and Marketing
Protection One's sales and marketing activities consist of a corporate
advertising and marketing function, centralized inbound and outbound sales
functions, a branch sales function and dealer marketing efforts.
The Company believes that increasing density of the Company's
subscriber base (i.e., increasing concentration of subscribers in certain areas)
has increased the overall presence and visibility of the Company. Both in the
Dealer Program and in Company sales, new subscribers are provided with highly
visible reflective yard signs placed prominently in front of their homes or
businesses. The presence of these signs develops greater awareness in a
neighborhood and leads to more inbound and referral business. The Company
encourages referrals from existing subscribers through an incentive program
promoted through newsletters, billing inserts and employee contacts. Alarm
response and service vehicles, which display the Protection One logo, also
increase the Company's visibility.
Corporate Advertising and Marketing
In the last two years, Protection One has substantially increased its
advertising and marketing efforts to support the Dealer Program. The Company
uses television, radio, newspaper and direct mail with promotional messages to
create sales leads and increase awareness of the Protection One brand. Such
sales leads are distributed to dealers based on their financial contribution to
support cooperative advertising efforts. The Company also has specifically
tailored regional advertising and promotional programs to utilize marketing
alliances where appropriate.
Protection One has marketing alliances with PacifiCorp, Salt River
Project, Kansas City Power & Light, Oklahoma Natural Gas, Kansas Power & Light
and Kansas Gas and Electric. Southwestern Bell Corporation serves as a sales
agent on behalf of Protection One in its markets. Protection One has numerous
additional utility alliances in development. The Company currently has
partnerships with other leading companies in the insurance, banking, credit
card, mortgage and retail industries. Protection One also has a number of
exclusive arrangements with homebuilders, which agreements enable the Company to
market home security systems to new home buyers through the builders.
Protection One has an inbound telemarketing function in each of its
customer service centers to receive and qualify responses to advertising
programs and telephone leads transferred from marketing partners. The Company
maintains an outbound calling function in its Beaverton service center to
solicit interest in enhanced services and to welcome acquired customers to the
Company. Based on expected activity, Protection One supplements both inbound and
outbound efforts with subcontract providers from time to time.
Based on primary market research, Protection One believes there is an
opportunity to build a preeminent consumer brand in the security industry.
Currently, consumers are unable to name any security industry competitor on an
unaided basis to a significant degree. The Company has established a coordinated
branding strategy to assist it in achieving its other strategic objectives by
positioning it as an industry leader and to build a platform for the sale of
additional services. The Company believes a nationally recognized brand supports
its goals of becoming the industry leader and broadening its customer
relationships. The Company has recently completed the first phase of a
significant research effort to define a unique selling proposition for the
Protection One brand. The Company will create sales and marketing materials that
reflect this positioning and will coordinate internal and external communication
vehicles to offer a single focused message about the Protection One brand. In
addition, the Company will evaluate all future opportunities for marketing
alliances and joint ventures in the context of the brand strategy, selecting
those that enhance its positioning and that accelerate the growth in public
awareness of the brand. Finally, the Company intends to test the use of brand
awareness advertising in conjunction with direct response marketing, in an
effort to
13
quantify the extent to which increased consumer awareness of the brand enhances
direct marketing activities. The Company expects to invest gradually in brand
advertising over time as the security market matures.
Branch Sales
The most common reason for customer attrition is customers moving out
of their homes and businesses. Sales professionals at the Company's branch
offices are responsible for tracking previous Protection One subscribers' homes
to sign up new owners when they move into such homes. The branch sales function
also generates revenue from selling equipment upgrades and add-ons to existing
subscribers, and by attracting competitors' subscribers to the Company's
services.
Through acquisitions, the Company now owns and operates a significant
commercial sales and installation effort for security and related monitored
services. At present, the primary commercial sales effort occurs in the
midwestern and northeastern United States. The Company's commercial products
range from basic intrusion and fire detection equipment to fully integrated
systems with card access, closed circuit television and voice/video monitoring.
The Company intends to grow its presence in the commercial markets in the future
and will seek opportunities to expand its commercial presence in other market
areas. The Company also is organizing a national accounts sales and customer
service function to address the special needs of chain customers, such as
restaurants and retailers.
Dealer Marketing
The Company's dealers employ a variety of marketing methods to identify
and create sales leads, including telemarketing, direct mail, local networking
and door-to-door solicitation. A majority of the Company's dealers sell and
install a hard-wired, low-cost security system manufactured by Ademco, a
subsidiary of Pittway Corporation. The basic system includes protection of the
front and back doors of a home, one interior motion detection device, a central
processing unit with the ability to communicate signals to the Company's central
monitoring station, a panic button, a siren, window decals and a lawn sign. This
basic system often will be offered for little or no up-front price, but will be
sold to a subscriber with additional equipment customized to a subscriber's
specific needs. Such equipment add-ons include additional perimeter and interior
protection, fire protection devices (heat and smoke detectors), environmental
protection devices (freeze sensors and water detectors), panic buttons and home
automation devices (lighting or appliance controls). Typically, dealers sign
subscribers to alarm monitoring contracts that include a bundled monthly charge
for monitoring and extended service protection. Extended service protection
covers the normal costs of repair of the security system after the expiration of
the security system's initial warranty period. Although a customer may elect to
sign an alarm monitoring contract that excludes extended service protection, few
customers choose to do so, and the Company believes the bundling of monitoring
and extended service protection provides additional value to subscribers and
allows the Company to more efficiently provide field repair services.
Competition
The security alarm industry is highly competitive and highly
fragmented. The Company competes with major firms with substantial financial
resources, including ADT Operations Inc., a subsidiary of Tyco International,
Inc.; the security subsidiaries of the Ameritech Corporation; and Brinks Home
Security Inc., a subsidiary of The Pittston Service Group. Other alarm service
companies have adopted a strategy similar to the Company's that entails the
aggressive purchase of alarm monitoring accounts both through acquisitions of
account portfolios and through dealer programs. Some competitors have greater
financial resources than the Company, or may be willing to offer higher prices
than the Company is prepared to offer to purchase subscriber accounts.
Competition in the security alarm industry is based primarily on
reliability of equipment, market visibility, services offered, reputation for
quality of service, price and the ability to identify and solicit prospective
subscribers as they move into homes. The Company believes it competes
effectively with other national, regional and local security alarm companies due
to the Company's reputation for reliable equipment and services, its prominent
presence in the areas surrounding its branch offices, its ability to offer
combined monitoring, repair and enhanced services, its low cost structure and
its marketing alliances.
14
Intellectual Property
The Company owns trademarks related to the name and logo for Protection
One, as well as a variety of trade and service marks related to individual
services the Company provides. The Company owns certain proprietary software
applications which the Company uses to provide services to its customers. The
Company also licenses software provided by various software vendors.
Regulatory Matters
A number of local governmental authorities have adopted or are
considering various measures aimed at reducing the number of false alarms. Such
measures include: (i) subjecting alarm monitoring companies to fines or
penalties for transmitting false alarms, (ii) permitting of individual alarm
systems and the revocation of such permits following a specified number of false
alarms, (iii) imposing fines on alarm subscribers for false alarms, (iv)
imposing limitations on the number of times the police will respond to alarms at
a particular location after a specified number of false alarms, and (v)
requiring further verification of an alarm signal before the police will
respond.
The Company's operations are subject to a variety of other laws,
regulations and licensing requirements of federal, state, and local authorities.
In certain jurisdictions, the Company is required to obtain licenses or permits,
to comply with standards governing employee selection and training, and to meet
certain standards in the conduct of its business. Many jurisdictions also
require certain of the Company's employees to obtain licenses or permits. Those
employees who serve as patrol officers are often subject to additional licensing
requirements, including firearm licensing and training requirements in
jurisdictions in which they carry firearms.
The alarm industry is also subject to requirements imposed by various
insurance, approval, listing, and standards organizations. Depending upon the
type of subscriber served, the type of security service provided, and the
requirements of the applicable local governmental jurisdiction, adherence to the
requirements and standards of such organizations is mandatory in some instances
and voluntary in others.
The Company's advertising and sales practices are regulated by both the
Federal Trade Commission and state consumer protection laws. Such laws and
regulations include restrictions on the manner in which the Company promotes the
sale of its security alarm systems and the obligation of the Company to provide
purchasers of its alarm systems with certain recision rights.
The Company's alarm monitoring business utilizes telephone lines and
radio frequencies to transmit alarm signals. The cost of telephone lines, and
the type of equipment which may be used in telephone line transmission, are
currently regulated by both federal and state governments. The operation and
utilization of radio frequencies are regulated by the Federal Communications
Commission and state public utilities commissions.
Risk Management
The nature of the services provided by the Company potentially exposes
it to greater risks of liability for employee acts or omissions, or system
failure, than may be inherent in other businesses. Substantially all of the
Company's alarm monitoring agreements, and other agreements pursuant to which it
sells its products and services, contain provisions limiting liability to
subscribers in an attempt to reduce this risk.
The Company's alarm response and patrol services require Company
personnel to respond to emergencies that may entail risk of harm to such
employees and to others. In most cities in which the Company provides such
services, the Company's patrol officers carry firearms, which may increase such
risk. Although the Company conducts extensive screening and training of its
employees, the provision of patrol and alarm response service subjects it to
greater risks related to accidents or employee behavior than other types of
businesses.
The Company carries insurance of various types, including general
liability and errors and omissions insurance. The loss experience of the
Company, and other security service companies, may affect the availability and
cost of such insurance. Certain of the Company's insurance policies, and the
laws of some states, may limit or prohibit insurance coverage for punitive or
certain other types of damages, or liability arising from gross negligence.
Year 2000 Issue
15
The Company is reviewing its computer and signal processing to identify
and correct any components that could be affected by the change of the date to
January 1, 2000 (the "Y2K Issue"). Results of the review thus far indicate that
key infrastructure components including processing systems, application software
and telecommunications systems are unaffected by the Y2K Issue. The Company will
continue its review until January 1, 2000, particularly with respect to
acquisitions of security businesses that include additional computer systems and
equipment. In addition, changes in the state of compliance or preparedness
within companies that provide services or equipment to the Company will require
the Company to continue its evaluation. Based on its ongoing review, Management
believes the Y2K Issue does not pose material operational problems and the costs
associated with the assessment of risk and the execution of corrective action
will not be material.
Employees
At December 31, 1997, the Company employed 3,136 individuals on a
full-time basis. Currently, none of the Company's employees is represented by a
labor union or covered by a collective bargaining agreement.
ITEM 2. FACILITIES
The Company maintains its executive offices at 6011 Bristol Parkway,
Culver City, California, and its main financial and administrative offices in
Irving, Texas. The Company leases its service centers in Orlando, Florida,
Portland, Oregon, and Addison and Irving, Texas and owns its service center in
Wichita, Kansas. The service centers in aggregate comprise 188,600 square feet.
The Company also currently leases 64 facilities in 31 states that serve as
branch offices.
ITEM 3. LEGAL PROCEEDINGS
On January 8, 1997, Innovative Business Systems, Ltd. ("IBS") filed
suit against Western Resources, Westinghouse Electric Corporation ("WEC"),
Westinghouse Security Systems, Inc. ("WSS") and WestSec in Dallas County, Texas
district court (Cause No. 97-00184) alleging, among other things, breach of
contract against WEC and interference with contract against Western Resources
and WestSec in connection with the sale by WEC of the assets of WSS to Western
Resources and WestSec. IBS claims that WEC improperly transferred software owned
by IBS to Western Resources and WestSec and that Western Resources and WestSec
are not entitled to its use. Western Resources and WestSec have demanded that
WEC defend and indemnify them. WEC, Western Resources and WestSec have denied
IBS' allegations and are vigorously defending against them. Management does not
believe the ultimate disposition of the matter will have a material adverse
effect upon the Company's overall financial condition or results of operations.
The Company is a party to claims and matters of litigation incidental
to the normal course of its business. The ultimate outcome of these matters
cannot presently be determined; however, in the opinion of management of the
Company, the resolution of these matters will not have a material adverse effect
on the Company's combined financial position or results of operations.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
On November 24, 1997, Protection One held a special meeting of stockholders
to vote upon a proposal to increase the authorized shares of Common Stock from
40,000,000 shares to 150,000,000 shares and to approve the issuance to Western
Resources of 68,673,402 shares of Common Stock in connection with the
Contribution (the "Stock Acquisition Proposal"). In addition, stockholders were
asked to approve the 1997 Long-Term Incentive Plan as a replacement for
Protection One's 1994 stock option plan. Out of a total of 14,493,722 shares of
Common Stock outstanding and entitled to vote, 9,807,358 shares were present in
person or by proxy, representing approximately 68% of the total. On the Stock
Acquisition Proposal, the results were as follows:
16
For 9,807,358
Against --
Abstain --
On the proposal to replace the 1994 stock option plan with the 1997
Long-Term Incentive Plan, the results were as follows:
For 8,904,764
Against 886,094
Abstain 16,500
There were no broker non-votes for the matters voted on by the stockholders
at the special meeting.
17
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
The following table sets forth the range of high and low sales prices
reported on the Nasdaq National Market for the Common Stock for the fiscal
periods indicated:
High Low
Fiscal Year Ended December 31, 1996
First Quarter............................... $14 3/4 $ 9
Second Quarter.............................. 17 7/8 13 1/4
Third Quarter............................... 16 7/8 11 3/4
Fourth Quarter.............................. 15 8 3/4
Fiscal Year Ended December 31, 1997
First Quarter............................... $11 1/8 $ 7 3/8
Second Quarter.............................. 14 1/8 9 1/4
Third Quarter............................... 21 3/4 13 3/8
Fourth Quarter.............................. 20 1/8 10 3/4
As of March 24, 1998, there were 83 holders of record of the Common
Stock. The Company believes there are in excess of 400 beneficial owners of the
Common Stock.
Other than the cash distribution paid to holders of record of Common
Stock as of November 24, 1997, holders of outstanding options to purchase Common
Stock and holders of certain warrants exercisable for Common Stock, all in
connection with the Contribution by Western Resources, POI has never paid any
cash dividends on the Common Stock and does not intend to pay any cash dividends
in the foreseeable future. The Company intends to retain its cash flows for the
operation and expansion of its business. The indenture (the "Discount Note
Indenture") pursuant to which Monitoring's 135/8% Senior Subordinated Discount
Notes due 2005 (the "Discount Notes") were issued and the indenture (the
"Convertible Note Indenture") pursuant to which Monitoring's 6 3/4% Convertible
Notes due 2003 were issued restrict POI's ability to declare or pay any dividend
on, or make any other distribution in respect of, POI's capital stock.
The Discount Note Indenture contains restrictions on dividends paid by
Monitoring that are similar to the restrictions summarized above. During fiscal
1995, Monitoring paid dividends to POI of approximately $0.2 million. No
dividends were paid by Monitoring to POI in fiscal 1996 or fiscal 1997.
18
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The selected financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the consolidated financial statements and the
related notes thereto of the Company and the financial statements and the
related notes thereto of Westinghouse Security, included elsewhere in this
report. All amounts are in thousands, except per share and subscriber data,
unless otherwise noted.
The Company (a) Westinghouse Security (Predecessor)(b)
Year Ended December 31, 53 Weeks Ended 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended
December 30, December 20, December 20, December 16,
1997 1996 1996 1995 1994 1993
-------- -------- -------- -------- -------- ------
Statement of operations data:
Revenues $ 144,773 $ 8,097 $110,881 $ 88,710 $ 67,253 $ 47,985
Cost of revenues 35,669 3,348 25,960 17,280 15,224 11,615
Gross profit 109,104 4 ,749 84,921 71,430 52,029 36,370
Selling, general and
administrative expenses 77,203 5,091 60,166 50,919 27,448 30,674
Acquisition and transition
expense 1,308 - 101 101 - -
Amortization of intangibles and
depreciation expense 39,822 609 21,613 17,804 13,959 13,009
Nonrecurring charges 40,144 - - - - -
Operating income (loss) (49,373) (951) 3,041 2,606 10,622 (7,313)
Interest expense, net 32,900 15 10,879 12,159 13,467 7,511
Loss before income taxes (82,273) (966) (7,838) (9,553) (2,845) (14,824)
Income tax benefit 32,970 310 2,978 3,630 1,081 5,633
Net loss $ (49,303) $ (656) $ (4,860) $ (5,923) $ (1,764) $ (9,191)
============ =========== ========== ========== ========== ==========
Net loss per share $ (0.70) $ (0.01) (b) (b) (b) (b)
Consolidated balance sheet data:
Working capital (deficit) $ 11,925 $ (19,447) $(19,515) $ (13,035) $ (11,551) $ (2,550)
Subscriber accounts, net 538,318 265,530 157,969 138,620 114,236 94,148
Goodwill and trademarks 682,180 218,991 11,102 11,397 11,691 -
Total assets 1,446,644 506,647 187,456 170,907 145,062 109,593
Long-term debt, including
capital leases 337,763 60,505 47,931 52,511 58,475 35,883
Total stockholders' equity $ 933,975 $ 410,430 $ 106,140 $ 89,120 $ 60,108 $ 55,803
Other operating data:
MRR (c) $ 19,137 $ 8,974 $ 7,870 $ 6,437 $ 5,231 $ 4,288
Number of subscribers net, at
end of period 756,818 424,100 313,784 265,839 214,785 224,960
EBITDA (d) $ 30,593 $ (342) $ 24,654 $ 20,410 $ 24,581 $ 5,696
Adjusted EBITDA (d) $ 50,462 $ (22) $ 37,327 $ 31,918 $ 27,559 $ 4,228
(a) Prior to November 24, 1997, Protection One was a standalone security
business. On November 24, 1997, pursuant to a Contribution Agreement dated July
30, 1997, between Protection One and Western Resources, Protection One acquired
WestSec and Westar (together the "Western Resources Security Business" or
"WRSB") and Centennial Security Holdings, Inc. ("Centennial"). As a result of
the transaction Western Resources owns approximately 82% of Protection One at
December 31, 1997.
The transaction has been accounted for as a reverse purchase acquisition which
treats WRSB as the accounting acquiror. Accordingly, the results of operation of
Protection One and Centennial have been included in the consolidated financial
data only since November 24, 1997.
The 1996 historical financial data of Protection One are those of the accounting
acquiror, WRSB.
19
(a) (cont.)The operating results of WRSB for the year ended December 31, 1995,
can be considered nominal in relation to the accompanying consolidated
statements of operations. The 1995 results are comprised of only two months of
start-up activity.
Summarized operating results are as follows:
Revenue $344
Gross Profit 189
Net Income 18
(b) On December 30, 1996, WRI, through its indirect wholly owned subsidiary,
WestSec, purchased the assets and assumed certain liabilities comprising the
security business of Westinghouse Security Systems ("WSS") from Westinghouse
Electric Corporation ("WEC"). WSS is deemed to be a predecessor of Protection
One.
Selected financial data for 1993 through 1996 were derived from the financial
statements of WSS for those years. Per share data is omitted because WSS was
wholly owned by WEC.
(c) MRR is monthly recurring revenue (excluding patrol services) that the
Company is entitled to receive under contracts in effect at the end of the
period. MRR is a term commonly used in the security alarm business, but not as a
measure of profitability or performance, and does not allow for future attrition
or allowance for doubtful accounts. The Company does not have sufficient
information as to the attrition of acquired subscriber accounts to predict the
amount of acquired MRR that will be realized in future periods or the impact of
the attrition of acquired accounts on the Company's overall rate of attrition.
(d) EBITDA is derived by adding to loss before income taxes, the sum of (i)
interest expense, net, (ii) nonrecurring charges, and (iii) amortization of
intangibles and depreciation expense. EBITDA does not represent cash flow from
operations as defined by generally accepted accounting principles, should not be
construed as an alternative to net income and is indicative neither of the
Company's operating performance nor of cash flows available to fund all the
Company's cash needs. Items excluded from EBITDA are significant components in
understanding and assessing the Company's financial performance. Management
believes presentation of EBITDA enhances an understanding of the Company's
financial condition, results of operations and cash flows because EBITDA is used
by the Company to satisfy its debt service obligations and its capital
expenditure and other operational needs as well as to provide funds for growth.
In addition, EBITDA has been used by senior lenders and subordinated creditors
and the investment community to determine the current borrowing capacity and to
estimate the long-term value of companies with recurring cash flows and net
losses.
Adjusted EBITDA is derived by adding to EBITDA selling and marketing expenses,
net of revenues, arising from installation activities during the period.
Adjusted EBITDA does not represent cash flow from operations as defined by
generally accepted accounting principles, should not be construed as an
alternative to net income and is indicative neither of the Company's operating
performance nor of cash flows available to fund the Company's cash needs. The
Company presents Adjusted EBITDA as a measure which the Company believes
provides a more appropriate comparison to EBITDA presented by companies that
grow through a dealer program or acquisitions.
The following table provides a calculation of EBITDA and Adjusted
EBITDA for each of the periods presented above:
The Company Westinghouse Security (Predecessor)
Year Ended December 31, 53 Weeks Ended 52 Weeks Ended 52 Weeks Ended 52 Weeks Ended
December 30, December 20, December 20, December 16,
1997 1996 1996 1995 1994 1993
-------- -------- -------- -------- -------- ------
Loss before income taxes $(82,273) $ (966) $ (7,838) $ (9,553) $ (2,845) $ (14,824)
Plus:
Interest expense, net 32,900 15 10,879 12,159 13,467 7,511
Nonrecurring charges 40,144 - - - - -
Amortization of intangibles and
depreciation expense 39,822 609 21,613 17,804 13,959 13,009
---------- --------- ---------- ---------- ---------- ----------
EBITDA 30,593 (342) 24,654 20,410 24,581 5,696
Plus:
Selling and marketing expenses
related to installations 34,998 2,156 29,074 24,633 9,493 324
Less: (15,129) (1,836) (16,401) (13,125) (6,515) (1,792)
---------- --------- ---------- ----------- ----------- -----------
Installation revenues
Adjusted EBITDA $ 50,462 $ (22) $ 37,327 $ 31,918 $ 27,559 $ 4,228
========== ========= ========= ========= ========== ==========
20
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Except where the context indicates otherwise, the information contained
in this Item 7 is based on the Company's business, operations and financial
condition as of and for the year ended December 31, 1997.
Note that all numbers presented are in thousands unless otherwise indicated.
Background
The Company is principally engaged in the business of monitoring and
servicing security systems.
On November 24, 1997, pursuant to a Contribution Agreement dated July
30, 1997, between Protection One and Western Resources (as amended, the
"Contribution Agreement"), Protection One acquired all of the outstanding stock
of WestSec and Westar which represented the security alarm monitoring business
of Western Resources (such business the "Western Resources Security Business" or
"WRSB"), and certain cash and securities. Under the terms of the Contribution
Agreement, Western Resources was issued an aggregate of 68,673,402 shares of
Common Stock of Protection One, which represented approximately 82.4% of the
shares of Common Stock outstanding immediately after such issuance. Accordingly,
although Protection One is the legal parent of WRSB, the transaction was
accounted for as a recapitalization of WRSB and a purchase by WRSB of Protection
One (a reverse acquisition in which WRSB is considered the acquiror for
accounting purposes). The Company recorded approximately $464 million of
goodwill related to this transaction. The financial statements of the Company
for the periods prior to November 24, 1997, are those of WRSB and its
predecessor entity, Westinghouse Security Systems ("WSS"). The assets and
liabilities of Protection One are recorded at their estimated fair values and
the accounts of Protection One are included in the consolidated financial
statements from the date of acquisition.
On December 30, 1996, WestSec purchased 310,000 subscribers and assets,
and assumed certain liabilities and obligations, of WSS from Westinghouse
Electric Corporation ("WEC") for $358 million in cash, subject to adjustments.
WRSB initially recorded approximately $275 million of goodwill as a result of
this transaction. Westar, formed in 1995, acquired six security businesses
and/or portfolios of subscriber accounts from November 1995, through September
1996. In aggregate, such acquisitions represented approximately 100,000
subscribers, and a purchase price of $25 million paid in cash and Western
Resources stock. Goodwill recorded by WRSB related to these acquisitions totaled
approximately $23 million.
Overview
A majority of the Company's revenues are derived from recurring
payments for the monitoring and servicing of security systems and additional
security services, pursuant to contracts with an initial noncancellable term.
Service revenues are derived from payments under extended service contracts and
for service calls performed on a time and materials basis. The remainder of the
Company's revenues are derived primarily from revenues from the sale and
installation by Company personnel of security systems, add-ons and upgrades.
Payment for monitoring services is typically required in advance. Monitoring and
service revenues are recognized as the service is provided. Installation, add-on
and upgrade revenue is recognized in the period of installation.
Alarm monitoring services generate a significantly higher gross margin
than do the other services provided by the Company. In fact, the cost of
providing patrol and alarm response services exceeds revenues generated by such
services, and although sales and installation services contribute to the
Company's gross profits, the total expenses associated with alarm system
installations also exceed the revenues generated by such services. The Company's
strategy, however, is to provide patrol and alarm response services and to
invest in system sales and installation because the Company believes that such
services and products contribute
21
to the generation and retention of alarm monitoring subscribers. The Company
expects that system sales and installation activity will decline in 1998, as a
result of converting substantially all of WRSB's internal sale force to
participants in the Dealer Program..
Accounting Differences for New Installations and Account Purchases. In
the past, Protection One, which sold systems outright, and WRSB, which has
primarily leased systems, have accounted for expenses associated with alarm
system installations differently. Protection One's direct installation costs,
which include materials, labor and installation overhead, and related selling
and marketing costs were expensed in the period incurred. WRSB's direct
installation costs were capitalized while selling and marketing costs and
indirect overhead were expensed in the period incurred. Such capitalized costs
were amortized over the average estimated subscriber life of ten years.
Subsequent to November 24, 1997, Protection One has adopted WRSB's policy with
respect to installation. Due to the Company's strategy to rely primarily on the
Dealer Program and acquisitions to meet its growth objectives, the Company
anticipates a substantial reduction in installation activities in 1998.
A difference between accounting treatment of the purchase of subscriber
accounts and the accounting treatment of the generation of subscriber accounts
through direct sales by the Company's sales force impacts the Company's results
of operations. All direct external costs associated with purchases of subscriber
accounts (either through the Dealer Program or through acquisitions of
subscriber account portfolios) are capitalized and amortized over ten years on a
straight-line basis. Company personnel and related support and duplicate costs
incurred solely in connection with subscriber account acquisitions and
transitions are expensed as incurred. Other acquisition transition costs that
reflect the Company's estimate of costs associated with incorporating the
purchased subscriber accounts into its operations, including costs incurred by
the Company in fulfilling the seller's pre-acquisition warranty repair service
and other obligations to the acquired subscribers are also capitalized and
amortized over a ten year period as described above. Direct costs related to
alarm system installations are capitalized and amortized over a ten year period.
Indirect costs related to alarm system installations are expensed in the period
incurred.
Subscriber Attrition. Subscriber attrition has a direct impact on the
Company's results of operations, since it affects both the Company's revenues
and its amortization of intangibles expense. Attrition can be measured in terms
of canceled subscriber accounts and in terms of decreased MRR resulting from
canceled subscriber accounts. Gross subscriber attrition is defined by the
Company for a particular period as a quotient, the numerator of which is equal
to the number of subscribers who disconnect service during such period and the
denominator of which is the average of the number of subscribers at each
month-end during such period. Net MRR attrition is defined by the Company for a
particular period as a quotient, the numerator of which is an amount equal to
gross MRR lost as the result of canceled subscriber accounts or services during
such period, net of (i) MRR generated during such period by the sale of
additional services and increases in rates to existing subscribers, (ii) MRR
generated during such period from the connection of subscribers who move into
premises previously occupied by subscribers and in which existing systems are
installed and from conversion of accounts that were previously monitored by
other companies to the Company's monitoring service (i.e., "reconnects" and
"conversions"); and (iii) MRR attributable to canceled accounts that, by virtue
of a purchase holdback, are "put" back to the seller of such accounts during
such period (i.e., "guaranteed accounts"); and the denominator of which is the
average month-end MRR in effect during such period. While the Company reduces
the gross MRR lost during a period by the amount of guaranteed accounts provided
for in purchase agreements with sellers, in some cases the Company may not
collect all or any of the reimbursement due it from the seller. During 1997, the
Company experienced gross subscriber attrition of 15.4% and net MRR attrition of
13.0%. As the Company has no economic investment in wholesale accounts, these
accounts are excluded from the calculation.
Management has established target ranges for gross subscriber attrition
and net MRR attrition of 16%- 18% and 7%-9%, respectively. Fluctuations in gross
subscriber attrition reflect changes in levels of acquisition activity, the rate
at which subscribers move, the number of subscribers that the Company
22
disconnects for non-payment and customer satisfaction with Protection One's
customer service and field repair functions. Changes in net MRR attrition are
caused by the factors impacting gross subscriber attrition, as well as by
changes in Protection One's ability to generate reconnects and conversions, to
create MRR through the sale of additional services and price increases and to
obtain purchase holdbacks covering the loss of acquired subscribers.
Because the Company determines payments to sellers under purchase price
holdbacks subsequent to the periods to which such holdbacks apply, and because
holdbacks are not allocated to specific guaranteed accounts or specific fiscal
periods, the Company reduces gross MRR lost during a period by the amount of
guaranteed accounts provided for in purchase agreements with sellers. However,
in some cases, the Company has not retained the full amount of such holdback to
which the Company is contractually entitled. If guaranteed accounts for which
the Company was not compensated by the seller were taken into account in
calculating net MRR attrition, net MRR attrition would have been higher in each
period presented above.
MRR represents the monthly recurring revenue Protection One is entitled
to receive under subscriber contracts in effect at the end of the period.
Included in MRR and the number of subscribers are amounts associated with
subscribers with past due balances. It is the policy and practice of Protection
One that every effort be made to preserve the revenue stream associated with
these contractual obligations. To this end, Protection One actively works to
both collect amounts owed and to retain the subscriber. In certain instances,
this collection and evaluation period may exceed six months in length. When, in
the judgment of Protection One's collection personnel, all reasonable efforts
have been made to collect balances due, subscribers are disconnected from
Protection One's service centers and are included in the calculation of gross
subscriber and net MRR attrition.
Generally, net MRR attrition is less than actual "net account
attrition," which the Company defines as canceled subscriber accounts net of
reconnects, conversions and guaranteed accounts. Estimated net account attrition
is the basis upon which the Company determines the period over which it
amortizes its investment in subscriber accounts. The Company amortizes such
investment over ten years based on current estimates. If actual subscriber
account attrition were to exceed such estimated attrition, the Company could be
required to amortize its investment in subscriber accounts over a shorter
period, thus increasing amortization expense in the period in which such
adjustment is made and future periods. Since the majority of the subscriber
accounts acquired by the Company since its formation were purchased recently,
there can be no assurance that the actual attrition rates for such accounts will
not be greater than the rate assumed by the Company. See-"Results of Operations
- - 1997 Compared to Fiscal 1996 - Amortization of intangibles and depreciation
expense" below.
The table below sets forth the change in the Company's subscriber base
over fiscal years 1995-1997.
23
The changes for 1995 and 1996 are changes for WSS as predecessor of
WestSec. The results for WSS and WRSB are combined in the 1996 column. The
changes for 1997 reflect changes for WRSB through November 24, 1997, and the
Company for the remainder of 1997. All residential, commercial, and wholesale
accounts are reflected in the numbers:
Year Ended December 31,
1997 1996 1995
Beginning of period 424,100 265,839 214,785
Internal installations 61,765 75,232 69,866
Account acquisitions 25,072 9,129 10,264
WRSB - 110,316 -
Protection
One/Centennial 303,783 - -
Account attrition (57,902) (36,416) (29,076)
-------- -------- -------
End of period 756,818 424,100 265,839
======== ======== =======
Results of Operations
The following table sets forth certain operating data as dollar amounts
and as a percentage of total revenues for the periods indicated. The amounts and
percentages for 1997 represent WRSB operations through November 24, 1997 and the
operations of the Company from November 24, 1997 through December 31, 1997.
Amounts and percentages are presented for WRSB's operations in 1996. Amounts and
percentages are also presented for 1995 and 1996 related to WSS, as predecessor
of Protection One.
Fiscal Year Fiscal Year
1996 1995
1997 1996 Westinghouse Westinghouse
The Company The Company (Predecessor) (Predecessor)
Revenues:
Monitoring and related services $126,630 87.5% $6,382 78.8% $ 93,765 84.6% $74,911 84.4%
Other 18,143 12.5 1,715 21.2 17,116 15.4 13,799 15.6
Total revenues $144,773 100.0% $8,097 100.0% $110,881 100.0% $88,710 100.0%
Cost of revenues:
Monitoring and related services $ 32,656 22.5% $1,761 21.7% $ 24,987 22.5% $16,843 19.0%
Other 3,013 2.1 1,587 19.6 973 0.9 437 0.5
Total cost of revenues 35,669 24.6 3,348 41.3 25,960 23.4 17,280 19.5
Gross profit 109,104 75.4 4,749 58.7 84,921 76.6 71,430 80.5
Selling, general and administrative
expenses 77,203 53.3 5,091 62.9 60,166 54.3 50,919 57.4
Acquisition and transition expense 1,308 0.9 - - 101 0.1 101 0.1
Amortization of intangibles and
depreciation expense 39,822 27.5 609 7.5 21,613 19.5 17,804 20.1
Nonrecurring charges 40,144 27.8 - - - - - -
Operating income (loss) $(49,373) (34.1)% $ (951) (11.7)% $ 3,041 2.7% $ 2,606 2.9%
======== ===== ======= ===== ========= ===== ========= ====
1997 Compared to 1996
Revenues for 1997 were $144.8 million with $131.3 million related to
the WRSB entities, $2.7 million related to Centennial, and $10.8 million related
to Protection One. WRSB's revenues for 1996 were $8.1 million and WSS revenues
for 1996 were $110.9 million for a total of $119.0 million. Monitoring and
related services revenues for the WRSB entities increased by $14.0 million, or
14.0%, substantially all of which resulted from average account base growth.
Other revenues related to the WRSB entities decreased by $1.7 million, or 9.0%.
The decrease is related primarily to a reduction of 25% in total internally
placed accounts added, offset partially by an increase in average placement
revenue
24
per account of 14%. The significant decrease in internally placed accounts added
is due to a sales force transition related to the transactions involving WSS and
WRSB and WRSB and Protection One.
Cost of revenues for 1997 was $35.7 million with $31.4 million related
to the WRSB entities, $1.0 million related to Centennial, and $3.3 million
related to Protection One. Cost of revenues for 1996 was $3.3 million for WRSB
and $26.0 million for WSS for a total of $29.3 million. Monitoring and related
services expenses for the WRSB entities increased by $2.2 million, or 8.2%,
primarily due to the additional personnel required to provide service to the
larger account base.
Gross profit for 1997 was $109.1 million with $99.9 million related to
the WRSB entities, $1.6 million related to Centennial, and $7.5 million related
to Protection One. Gross profit for 1996 was $4.7 million for WRSB and $84.9
million for WSS for a total of $89.6 million. Gross profit for the WRSB
increased $10.3 million, or 11.5%, reflecting the growth in the average account
base.
Selling, general and administrative expense ("SG&A") for 1997 was $77.2
million with $74.1 million related to the WRSB entities, $0.8 million related to
Centennial, and $2.3 million related to Protection One. SG&A for 1996 was $5.1
million for WRSB and $60.2 million for WSS for a total of $65.3 million. SG&A
increased $8.8 million, or 13.5%, for the WRSB entities primarily because of the
new advertising efforts required to establish market awareness of the "Westar
Security Services" business name in support of placement activities.
Amortization of intangibles and depreciation expenses for 1997 were
$39.8 million with $35.5 million related to the WRSB entities, $0.6 million
related to Centennial, and $3.7 million related to Protection One. Amortization
and depreciation expenses for 1996 were $0.6 million for WRSB and $21.6 million
for WSS for a total of $22.2 million. Depreciation and amortization increased
$13.3 million, or 59.9% for the WRSB entities. The increase is due to the
amortization of the $196 million of goodwill arising from WestSec's acquisition
of the WSS business from WEC. The goodwill is being amortized over a 40 year
life. Related to the acquisition of WSS by WRSB on December 30, 1996, the
subscriber accounts purchased were written up to fair market value. These
amounts are being amortized over 10 years and have consequently increased
amortization expense in 1997 compared to 1996.
The non-recurring charges were taken in connection with the November
24, 1997, acquisition transaction. The Company incurred nonrecurring charges of
$40.1 million, in order to reflect business activities of the accounting
acquiror, WRSB, that are no longer of continuing value to the combined entity
and that will be phased out in conjunction with the merger. These charges have
been separately identified as a component of operating income in the
accompanying statements of operations.
Generally, management intends to bring all security operations under
the Protection One brand and to eliminate redundant facilities, systems and
activities in specific locations where such exist. Additionally, costs will be
incurred to transition individual customer accounts from the former service
providers with respect to operations, billing and network systems and to close
down these operations. Management intends to complete these exit activities by
the fourth quarter of 1998.
25
Charges for the year ended December 31, 1997, are as follows:
Inventory and other asset losses $17,697
Customer account transition 12,337
Disposition of excess fixed assets 4,128
Closure of duplicate facilities 1,991
Severance compensation and benefits 1,865
Other 2,126
---------
$40,144
1996 Compared to 1995 - Westinghouse Security (Predecessor to WestSec)
WSS revenues for 1996 increased by $22.2 million, or 25.0%, to $110.9
million from $88.7 million for 1995. Monitoring and related services revenues
increased by $18.9 million, or 25.2%, substantially all of which resulted from
the addition of approximately 75,000 subscribers from internal sales and
installations of subscriber accounts and approximately 7,000 subscribers
purchased from dealers. Other revenues increased by 24.0% to $17.1 million in
1996 from $13.8 million in 1995. The increase in other revenues reflects an
increase in installation revenues as a result of additional installed accounts
and the sale of equipment upgrades.
Costs of revenues for 1996 increased by $8.7 million, or 50.3%, to
$26.0 million. Costs and expenses as a percentage of total revenues increased to
23.4% during 1996 from 19.5% during 1995. Monitoring and related services
expenses increased by $8.1 million, or 48.4% from 1995 to 1996, primarily due to
increased activity at WSS' central monitoring station and an expansion in
service activities in the field branches. Monitoring and related services
expenses as a percentage of monitoring and related services revenues increased
to 26.6% in 1996 from 22.5% during 1995. Such increase reflects a high level of
staffing at WSS' central monitoring station.
Gross profit for 1996 was $84.9 million, which represents an increase
of $13.5 million, or 18.9%, over the $71.4 million of gross profit recognized in
1995. Such increase was due primarily to an increase in monitoring activities,
which reflected the increase in WSS' subscriber base from approximately 265,000
at December 20, 1995 to 314,000 at December 30, 1996.
Selling, general and administrative expenses ("SG&A") rose to $60.3
million in 1996, an increase of $9.2 million, or 18.1%, over such expenses in
1995, but declined as a percentage of total revenues from 57.5% in 1995 to 54.4%
in 1996. The increase in general and administrative expenses was caused by
increases in corporate and branch overhead expenses associated with a larger
customer base and higher numbers of installations. Advertising and marketing
expenses comprised approximately 2% of revenues in both 1995 and 1996.
Amortization of intangibles and depreciation expense for 1996 increased
by $3.8 million, or 21.4%, to $21.6 million. This increase was partially due to
the 75,000 new internally placed accounts and 7,000 dealer program accounts
purchased during 1996. WSS amortized subscriber accounts over 10 years.
Operating income for 1996 was $3.0 million, compared to operating
income of $2.6 million in fiscal 1995. Operating income as a percentage of
revenue was 2.7% in 1996 compared to 2.9% in 1995.
The effective income tax benefit for 1996, 1995, and 1994 has been
estimated at 38%. The historical net operating income or losses prior to the
WestSec purchase were included in WEC's consolidated federal income tax return.
Capital Resources and Liquidity
26
In general, the Company has financed its operations and growth
primarily from operating cash flows, supplemented by advances from its parent,
Western Resources.
Recent Developments. On November 24, 1997, pursuant to the Contribution
Agreement, Protection One received $367.4 million of cash and securities from
Western Resources, and made the following disbursements, either concurrently
with or within several days of the closing of the Western Resources transaction:
(i) $114.1 million to make a cash distribution to holders of record of Common
Stock as of November 24, 1997, holders of outstanding options to purchase Common
Stock and holders of certain warrants exercisable for Common Stock; (ii) $94.4
million to pay the cash purchase price of Centennial; and (iii) $61.6 million to
repay borrowings under its revolving credit facility. The remaining $97.3
million included $14.8 million of marketable securities, which amount included
common and preferred shares in Guardian International, Inc., and $82.5 million
of cash.
The amounts contributed by Western Resources have substantially
enhanced the Company's liquidity. In addition, the Company believes the issuance
of 68.7 million shares of Common Stock to Western Resources has improved its
access to the public equity markets. The Company intends to use cash flow
provided by operations, cash on hand, funding by Western Resources, and capital
raised in debt and equity offerings, as needed, to fund its ongoing operations
and growth activities. The Company believes that cash required to fund its
growth activities will continue to exceed cash flow provided by operations for
the foreseeable future.
Subsequent to the end of fiscal year 1997, on February 4, 1998,
Protection One announced its decision to exercise its option to purchase Network
Multi-Family Security Corporation ("Network"), the leading provider of security
alarm monitoring to multi-family dwellings with approximately 200,000
subscribers. Pursuant to the terms of the option, Protection One will give
Western Resources cash consideration of approximately $180 million.
On March 2, 1998, Protection One completed the acquisition of 147,000
subscribers and related assets of Multimedia Security Services, Inc.
("Multimedia") for a purchase price of approximately $233 million. The
Multimedia purchase added to the Company's market positions in California,
Florida and Texas and added substantial numbers of subscribers in Kansas and
Oklahoma. In addition, Protection One will maintain Multimedia's monitoring and
customer service center in Wichita, Kansas.
On March 17, 1998, Protection One completed the acquisition of Comsec
Narragansett Security, Inc. ("Comsec") for a cash purchase price of
approximately $45 million and the assumption of $15 million of debt. Comsec's
30,000 subscribers are located primarily in Connecticut, Maine, Massachusetts
and New Hampshire.
Material Commitments. The Company has several long-term commitments.
The 6 3/4% Convertible Senior Subordinated Notes (the "Convertible Notes"),
which total $103.5 million in aggregate principal amount, mature on September
15, 2003, and the Company must make a payment of $166.0 million on September 30,
2005 at the maturity of the 135/8% Senior Subordinated Discount Notes (the
"Discount Notes"). Cash interest payable on the Convertible Notes and Discount
Notes will total $18.3 million in 1998 and $29.6 million thereafter until
maturity. (See Note 6 of Protection One, Inc. Notes to Consolidated Financial
Statements, for further information regarding the Convertible Notes and Discount
Notes.) In addition, Protection One has assumed, as part of the Western
Resources transaction, approximately $60 million of the WestSec indebtedness
from agreements entered into by WSS, of which approximately $26 million is
payable in 1998 and $34 million in 1999. Under the agreements, Protection One
monitors and services subscriber accounts for which certain rights were
transferred to a third party. Protection One is required to purchase the rights
in the contracts as the underlying third party notes mature.
On March 2, 1998, the Company entered into a promissory note with
Westar Capital, Inc., a subsidiary of Western Resources. The 6 11/16% promissory
note has a principal amount of $274 million and is due on June 1, 1998. Prior to
the maturity of the promissory note, the Company anticipates entering into
27
a longer term financing arrangement with Westar Capital, Inc.
Fiscal 1997 results. For fiscal 1997, the Company's net cash flows used
in operating activities was $4.9 million, compared to $0.1 million used by WRSB
and $23.7 million provided by WSS for 1996. This shift from a net cash inflow in
1996 to a net cash outflow in 1997 is primarily due to the timing of tax
payments.
Net cash flows used in investing activities of the Company in 1997 were
$156.7 million, compared to $369.5 million used by WRSB and $40.5 million used
by WSS in 1996. The Company paid $107.7 million in special distributions to
equityholders related to the Contribution. WRSB paid WEC $357.3 million in cash
in 1996 to purchase WSS. The remaining cash used for account acquisitions and
placements for WRSB in 1996 was $11.3 million and $39.2 million for WSS. This
total is comparable to the $46.5 million spent by the Company in 1997 for
account acquisitions and placements.
The Company generated $237.0 million of net cash through financing
activities in 1997. The Company received $300.7 million in funding from Western
Resources in 1997, approximately $258.0 million of which was related to the
Contribution Agreement . All of the borrowings ($61.6 million) under the
Company's Revolving Credit Facility were paid off with proceeds received under
the Contribution Agreement. In 1996, WRSB generated $369.7 million through
financing activities while WSS generated $16.7 million. Substantially all of
WRSB's financing came from Western Resources in 1996. WSS received $21.9 in
proceeds from WEC in 1996. WSS also made payments of $5.1 million related to
repayments of amounts owed under the agreements discussed in Footnote 6 of Notes
to Consolidated Financial Statements.
The indentures governing the Discount Notes and Convertible Notes
contain certain restrictions on the transfer of Company funds, including
dividends, loans and advances made by the Company. The Company believes such
restrictions have not had and will not have a significant impact on the
Company's ability to meet its cash obligations.
Capital Expenditures. The Company anticipates making capital
expenditures in fiscal 1998 of approximately $15 million, including $5 million
to upgrade branch operations, $5 million for integration activities, and $5
million for service center improvements and other capital items.
28
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The Company's consolidated financial statements and supplementary data,
together with the report of Arthur Andersen LLP, independent accountants, are
included elsewhere herein. See "Index to Financial Statements" on page F-1.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE
None.
29
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANTS
Information relating to the Company's directors and nominees for
directors is set forth under the heading "Election of Directors" in the Proxy
Statement relating to the Annual Meeting of Stockholders to be held April 23,
1998, which will be filed with the Securities and Exchange Commission on or
about April 2, 1998, and which is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
Information relating to the Company's executive officers and executive
compensation is set forth under the heading "Executive Officers; Executive
Compensation and Related Information" in the Proxy Statement relating to the
Annual Meeting of Stockholders to be held April 23, 1998, which will be filed
with the Securities and Exchange Commission on or about April 2, 1998, and which
is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT
Information relating to the security ownership of certain beneficial
owners and management is set forth under the headings "Security Ownership of
Management" and "Security Ownership of Certain Beneficial Owners" in the Proxy
Statement relating to the Annual Meeting of Stockholders to be held April 23,
1998, which will be filed with the Securities and Exchange Commission on or
about April 2, 1998, and which is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information relating to certain relationships and related transactions
concerning directors and executive officers is set forth under the heading
"Certain Relationships and Related Transactions" in the Proxy Statement relating
to the Annual Meeting of Stockholders to be held April 23, 1998, which will be
filed with the Securities and Exchange Commission on or about April 2, 1998, and
which is incorporated herein by reference.
30
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON
FORM 8-K
(a) The following documents are filed as a part of this report:
1. The financial statements and financial statement schedules
listed on the accompanying Index to Financial Statements.
2. The following Exhibits:
Exhibit
Number Exhibit Description
2.1 Contribution Agreement dated as of July 30, 1997 (the "Contribution Agreement"), between
Western Resources and POI (incorporated by reference to Exhibit 2.1 to the Current Report
on Form 8-K filed by POI1 and Monitoring2 dated July 30, 1997 (the "July 1997 Form 8-
K")).
2.2 Amendment No. 1 dated October 2, 1997, to the Contribution Agreement (incorporated by
reference to Exhibit 99.1 to the Current Report of Form 8-K filed by POI and Monitoring
dated October 2, 1997).
2.3 Assignment and Assumption Agreement (Centennial Security Holdings, Inc.) dated as of
November 24, 1997, among Western Resources, Westar Capital, Inc. ("Westar Capital"),
Westar Security, Inc. ("Westar Security") and POI (incorporated by reference to Exhibit 2.3
to the Current Report on Form 8-K filed by POI and Monitoring dated November 24, 1997
(the "November 1997 Form 8-K")).
2.4 Assignment and Assumption Agreement (Guardian International, Inc.) dated as of November
24, 1997, among Western Resources, Westar Capital, Westar Security and POI (incorporated
by reference to Exhibit 2.4 to the November 1997 Form 8-K).
2.5 Stock Purchase Agreement dated as of October 2, 1997, among Centennial Security
Holdings, Inc. ("Centennial"), the shareholders of Centennial and Westar Capital
(incorporated by reference to Exhibit 2.5 to the November 1997 Form 8-K).
2.6 Stock Subscription Agreement dated as of October 4, 1997, between Guardian International,
Inc. ("Guardian") and Westar Capital (incorporated by reference to Exhibit 2.6 to the
November 1997 Form 8-K).
3.1 Fifth Amended and Restated Certificate of Incorporation of POI, as amended (incorporated
by reference to Exhibit 3.1 to the Annual Report on Form 10-K filed by POI and Monitoring
for the year ended September 30, 1997 (the "Fiscal 1997 Form 10-K")).
3.2 By-laws of POI (incorporated by reference to Exhibit 3.1 to
the Quarterly Report on Form 10-Q filed by POI and Monitoring
for the quarter ended March 31, 1996).
- --------
1 The Commission File Number of POI is 0-24780.
2 The Commission File Number of Protection One Alarm Monitoring is 33-73002-01.
31
3.3 Certificate of Incorporation of Monitoring, as amended (incorporated by reference to Exhibit
3.2 to the Registration Statement of Form S-3 (Registration Number 333-09401) originally
filed by Monitoring and, inter alia, POI on August 1, 1996 (the "August 1996 Form S-3")).
3.4 Bylaws of Monitoring (incorporated by reference to Exhibit 3.2 to the Annual Report on
Form 10-K filed by POI and, inter alia, Monitoring for the year ended September 30, 1994).
4.1 Indenture dated as of May 17, 1995, among Monitoring, as Issuer, POI, inter alia, as
Guarantor, and The First National Bank of Boston ("FNBB"), as Trustee (incorporated by
reference to Exhibit 4.1 to the Registration Statement on Form S-4 (Registration No. 33-
94684) originally filed by POI and, inter alia, Monitoring on July 18, 1995 (the "1995 Form
S-4")).
4.2 First Supplemental Indenture dated as of July 26, 1996, among Monitoring, as Issuer, POI,
inter alia, as Guarantor and State Street Bank and Trust Company ("SSBTC") as successor
to FNBB as Trustee (incorporated by reference to Exhibit 4.2 to the Annual Report on Form
10-K filed by POI and Monitoring for the year ended September 30, 1996 (the "Fiscal 1996
Form 10-K")).
4.3 Second Supplemental Indenture dated as of October 28, 1996, among Monitoring as Issuer,
POI inter alia, as Guarantor and SSBTC as Trustee (incorporated by reference to Exhibit 4.3
to the Fiscal 1996 Form 10-K).
4.4 Subordinated Debt Shelf Indenture dated as of August 29, 1996, among Monitoring as Issuer,
POI as Guarantor and SSBTC as Trustee (incorporated by reference to Exhibit 4.3 to the
August 1996 Form S-3).
4.5 Supplemental Indenture No. 1 dated as of September 20, 1996, among Monitoring as Issuer,
POI, inter alia, as Guarantor and SSBTC as Trustee (incorporated by reference to Exhibit 4.1
to the Current Report on Form 8-K filed by POI and Monitoring and dated September 20,
1996 (the "September 1996 Form 8-K")).
4.6 Supplemental Indenture No. 2 dated as of October 28, 1996, among Monitoring as Issuer,
POI, inter alia, as Guarantor and SSBTC as Trustee (incorporated by reference to Exhibit 4.6
to the Fiscal 1996 Form 10-K).
4.7 Amended and Restated Credit Agreement dated as of June 7, 1996, among Monitoring,
Heller Financial, Inc. ("Heller Financial") as Agent and the financial institutions signatory
thereto (the "Lenders") (incorporated by reference to Exhibit 10.2 to the Quarterly Report on
Form 10-Q filed by POI and Monitoring for the quarter ended June 30, 1996).
4.8 Consent and First Amendment to Credit Agreement dated as of September 16, 1996, among
Monitoring, Heller Financial as Agent and the Lenders (incorporated by reference to Exhibit
10.1 to the September 1996 Form 8-K).
4.9 Second Amendment to Amended and Restated Credit Agreement dated as of March 31,
1997, among Monitoring, Heller Financial as Agent and the Lenders (incorporated by
reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q filed by POI and Monitoring
for the quarter ended March 31, 1997).
4.10 Third Amendment to Amended and Restated Credit Agreement dated
as of September 30, 1997, among Monitoring, Heller Financial
as Agent and the Lenders (incorporated by
32
reference to Exhibit 4.10 to the Fiscal 1997 Form 10-K.)
4.11 Form of Revolving Note executed by Monitoring in favor of each Lender pursuant to the
Amended and Restated Credit Agreement filed as Exhibit 4.7 (incorporated by reference to
Exhibit 4.9 to the Fiscal 1996 Form 10-K).
4.12 Amended and Restated Guaranty dated as of June 7, 1996, executed by POI in favor of
Heller Financial as Agent (incorporated by reference to Exhibit 4.10 to the Fiscal 1996 Form
10-K).
4.13 Amended and Restated Stock Pledge Agreement dated as of June 7, 1996, between POI and
Heller Financial as Agent (incorporated by reference to Exhibit 4.11 to the Fiscal 1996 Form
10-K).
4.14 Amended and Restated Security Agreement dated as of June 7, 1996, between Monitoring
and Heller Financial as Agent (incorporated by reference to Exhibit 4.12 to the Fiscal 1996
Form 10-K).
4.15 Amended and Restated Continuing Security Interest and Conditional Assignment of Patents,
Trademarks, Copyrights and Licenses dated as of June 7, 1996, between Monitoring and
Heller Financial as Agent (incorporated by reference to Exhibit 4.13 to the Fiscal 1996 Form
10-K).
10.1 Stock Purchase Warrant dated as of September 16, 1991, issued by POI to Merita Bank. Ltd.
(formerly Kansallis-Osake-Pankki) (incorporated by reference to Exhibit 10.25 to the
Quarterly Report on Form 10-Q filed by POI and, inter alia, Monitoring for the quarter
ended March 31, 1994).
10.2 Amended and Restated Stockholders' Agreement dated as of August 15, 1994, among POI
and the stockholders of POI named therein (incorporated by reference to Exhibit 10.42 to the
Registration Statement of Form S-1 (Registration No. 33-81292) originally filed by POI on
July 8, 1994).
10.3 Warrant Agreement dated as of November 3, 1993, between Monitoring and United States
Trust Company of New York, as Warrant Agent (incorporated by reference to Exhibit 4.3
to the Registration Statement on Form S-4 (Registration Statement 33-73002) originally filed
by POI, Monitoring and certain former subsidiaries of Monitoring on December 15, 1993
(the "1993 Form S-4")).
10.4 Registration Rights Agreement dated as of November 3, 1993, among Monitoring, POI,
certain former subsidiaries of Monitoring and Bear, Stearns & Co., Inc. (incorporated by
reference to Exhibit 4.4 to the 1993 Form S-4).
10.5 Warrant Agreement dated as of May 17, 1995, between POI and
The First National Bank of Boston, as Warrant Agent
(incorporated by reference to Exhibit 10.40 to the 1995 Form
S-4).
10.6 Common Stock Registration Rights Agreement dated May 17,1995, among POI, Morgan
Stanley & Co. Incorporated and Montgomery Securities (incorporated by reference to Exhibit
10.41 to the 1995 Form S-4).
10.7 Employment Agreement dated as of November 24, 1997, between Protection One and James
33
M. Mackenzie, Jr. (incorporated by reference to Exhibit 10.4 to the November 1997 Form
8-K).*
10.8 Employment Agreement dated as of November 24, 1997, between
Protection One and John W. Hesse (incorporated by reference to
Exhibit 10.5 to the November 1997 Form 8-K).*
10.9 Employment Agreement dated as of November 24, 1997, between
Protection One and John E. Mack, III (incorporated by
reference to Exhibit 10.6 to the November 1997 Form 8-K).*
10.10 Employment Agreement dated as of November 24, 1997, between Protection One and
Thomas K. Rankin (incorporated by reference to Exhibit 10.7 to the November 1997 Form
8-K).*
10.11 Employment Agreement dated as of November 3, 1993, between
Monitoring and George A. Weinstock (incorporated by reference
to Exhibit 10.13 to the 1993 Form S-4).*
10.12 Non-Competitive and Non-Solicitation Agreement dated as November 3, 1993, between
Monitoring and George A. Weinstock (incorporated by reference to Exhibit 10.14 to the
1993 Form S-4).*
10.13 Consulting Agreement dated as of February 19, 1996, between POI and Dr. Ben Enis
(incorporated by reference to Exhibit 10.7 to the Quarterly Report on Form 10-Q filed by
POI and Monitoring for the quarter ended June 30, 1996).*
10.14 1994 Stock Option Plan of POI, as amended (incorporated by reference to Exhibit 10.23 to
the Fiscal 1996 Form 10-K).*
10.15 1997 Long-Term Incentive Plan of POI (incorporated by reference to Appendix F to POI's
proxy statement dated November 7, 1997).*
10.16 Notes Registration Rights Agreement dated as of May 17, 1995, among POI, Monitoring,
Morgan Stanley & Co., Incorporated and Montgomery Securities (incorporated by reference
to Exhibit 4.2 to the 1995 Form S-4),
10.17 Agreement for Purchase and Sale of Assets, dated May 25, 1995,
between Alert Centre, Inc. and Monitoring (incorporated by
reference to Exhibit 4.2 to the 1995 Form S-4).
10.18 Agreement to Purchase and Sell Stock dated as of May 23, 1996, among Metrol, the persons
named therein as the "Shareholders" (the "Metrol Shareholders"), Monitoring and POI
(incorporated by reference to Exhibit 2.1 to the Registration Statement on Form S-3
(Registration NO. 33-5849) originally filed by POI on June 12, 1996 (the "June 1996 Form
S-3)).
10.19 Amendment No. 1 to Agreement dated as of June 28, 1996, among Metrol, the Metrol
Shareholders, Monitoring and POI (incorporated by reference to Exhibit 2.2 to the June 1996
Form S-3).
10.20 Escrow Agreement dated May 31, 1996, among Metrol, the Metrol Shareholders,
Monitoring, POI and First National Bank of Denver, N.A. as the Escrow Agent (incorporated
by reference to Exhibit 2.3 to the Current Report on Form 8-K filed by POI and Monitoring
34
dated June 7, 1996 (the "June 1996 Form 8-K)).*
10.21 Registration Rights Agreement dated as of June 28, 1996, among
POI and the Metrol Shareholders (incorporated by reference to
Exhibit 99.1 to the June 1996 Form 8-K).
10.22 Stock Option Agreement dated as of July 30, 1997, between
Western Resources and Protection One (incorporated by
reference to Exhibit 10.1 to the July 1997 Form 8-K).
10.23 Option and Voting Agreement dated as of July 30, 1997, between
Western Resources and Protection One (incorporated by
reference to Exhibit 10.2 to the July 1997 Form 8-K).
10.24 Promissory Note dated as of March 2, 1998 between Westar Capital, Inc, and Protection One
(incorporated by reference to Exhibit 99.1 to the Current Report on Form 8-K filed by POI
and Monitoring dated March 17, 1998.)
16.1 Letter from Coopers & Lybrand to the Securities and Exchange Commission re: Change in
Certifying Accountant (incorporated by reference to Exhibit 16 to Amendment No. 1 to the
Current Report on Form 8-K filed by POI and Monitoring dated February 5, 1998.)
21.1 Subsidiaries of POI and Monitoring.
23.1 Consent of Arthur Andersen LLP.
27 Financial Data Schedule.
*Each exhibit marked with an asterisk constitutes a management
contract or compensatory plan or arrangement required to be
filed or incorporated by reference as an exhibit to this
report pursuant to Item 14(c) of Form 10-K.
(b)During the last quarter of the fiscal year covered by this
Report, POI and Monitoring filed three Reports on Form 8-K.
Amendment No. 1 to the Current Report on Form 8-K dated
October 2, 1997 reported an amendment to the Contribution
Agreement and the Stock Option Agreement filed in the July
1997 Form 8-K. A Current Report on Form 8-K dated November 7,
1997 reported in response to Item 5 the record date and
special meeting of stockholders date in connection with
transactions provided for in the Contribution Agreement. A
Current Report on Form 8-K dated November 24, 1997 reported in
response to Item 2 the execution of the Contribution
Agreeement.
35
PROTECTION ONE, INC. AND SUBSIDIARIES
INDEX TO FINANCIAL STATEMENTS
Page
PROTECTION ONE, INC. AND SUBSIDIARIES
Report of Independent Public Accountants...........................................................F-2
Consolidated Balance Sheets as of December 31, 1997 and 1996.......................................F-3
Consolidated Statements of Operations for the years ended December 31, 1997 and 1996...............F-4
Consolidated Statements of Cash Flows for the years ended December 31, 1997 and 1996...............F-5
Consolidated Statement of Changes in Stockholders' Equity for the
years ended December 31, 1997 and 1996..........................................................F-6
Notes to Consolidated Financial Statements.........................................................F-7
WESTINGHOUSE SECURITY
Report of Independent Public Accountants...........................................................F-22
Statements of Operations for the 53-week period ended December 30, 1996,
and the 52-week period ended December 20, 1995..................................................F-23
Statements of Cash Flows for the 53-week period ended December 30, 1996,
and the 52-week period ended December 20, 1995..................................................F-24
Notes to Financial Statements......................................................................F-25
FINANCIAL SCHEDULES
Protection One, Inc. and Subsidiaries-
Schedule II - Valuation and Qualifying Accounts.................................................S-1
Westinghouse Security-
Schedule II - Valuation and Qualifying Accounts.................................................S-2
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Protection One, Inc.:
We have audited the consolidated financial statements of Protection
One, Inc. and subsidiaries listed in the index on page F-1 of this Annual Report
on Form 10-K. These consolidated financial statements are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the financial position of Protection One, Inc.
and subsidiaries as of December 31, 1997 and 1996, and its consolidated results
of operations and cash flows for each of the periods presented in conformity
with generally accepted accounting principles.
Our audit was made for the purpose of forming an opinion on the basic
financial statements taken as a whole. The schedules listed in the index of
financial statements are presented for purposes of complying with the Securities
and Exchange Commission rules and are not part of the basic financial
statements. The schedules have been subjected to the auditing procedures applied
in the audit of the basic financial statements and, in our opinion, fairly
states in all material respects the financial data required to be set forth
therein in relation to the basic financial statements taken as a whole.
ARTHUR ANDERSEN LLP
Dallas, Texas,
January 29, 1998
F-2
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands, except for per share amounts)
ASSETS December 31, 1997 December 31, 1996
-----------------------------------------
Current assets:
Cash and cash equivalents........................................ $ 75,556 $ 168
Restricted cash.................................................. - 94
Marketable securities............................................ 5,701 -
Receivables, net................................................. 20,302 12,572
Inventories...................................................... 556 2,892
Prepaid expenses................................................. 367 407
Deferred tax asset, current...................................... 45,078 -
Other............................................................ 28,320 132
------------- ------------
Total current assets......................................... 175,880 16,265
Property and equipment, net...................................... 14,934 5,446
Subscriber accounts, net......................................... 538,318 265,530
Goodwill and trademarks.......................................... 682,180 218,991
Deferred tax asset............................................... 26,158 -
Other............................................................ 9,174 415
-------------- ------------
$1,446,644 $506,647
========== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable................................................. $ 6,235 $ 1,585
Accrued liabilities.............................................. 83,200 16,579
Purchase holdbacks............................................... 11,444 -
Acquisition transition costs..................................... 7,469 -
Current portion of long-term debt................................ 21,217 4,548
Capital leases................................................... 490 -
Deferred revenue................................................. 33,900 13,000
------------- ------------
Total current liabilities.................................... 163,955 35,712
Long-term debt, net of current portion........................... 337,159 60,505
Capital leases, net of current portion........................... 604 -
Deferred tax liability........................................... 10,325 -
Other liabilities................................................ 626 -
Commitments and contingencies (Note 11) Stockholders' equity:
Contributed Capital........................................... - 411,068
Preferred stock, $.10 par value, 5,000,000 shares authorized.. - -
Common Stock, $.01 par value, 150,000,000 shares
authorized, 83,362,938 shares issued
and outstanding at December 31, 1997 (Note 1).............. 834 -
Additional paid-in capital....................................... 983,082 -
Retained losses.................................................. (49,941) (638)
------------ --------------
Total stockholders' equity.................................... 933,975 410,430
------------ ------------
$1,446,644 $ 506,647
========== ===========
The accompanying notes are an integral part of these consolidated financial statements.
F-3
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Note 14)
(Dollar amounts in thousands, except for per share amounts)
Year Ended Year Ended
December 31, 1997 December 31, 1996
----------------------------------------
Revenues:
Monitoring and related services $126,630 $6,382
Installation and other 18,143 1,715
---------- -------
Total revenues 144,773 8,097
Costs and expenses:
Monitoring and related services 32,656 1,761
Other 3,013 1,587
----------- -------
Total costs and expenses 35,669 3,348
---------- -------
Gross profit 109,104 4,749
Selling, general and administrative expenses 77,203 5,091
Acquisition and transition expense 1,308 -
Amortization of intangibles and depreciation
expense 39,822 609
Nonrecurring charges 40,144 -
---------- --------
Operating loss (49,373) (951)
Other (income) expenses:
Interest expense, net 32,900 15
---------- ---------
Loss before income taxes (82,273) (966)
---------- --------
Income tax benefit 32,970 310
----------- --------
Net loss $ (49,303) $ (656)
=========== ========
Net loss per share $ (.70) $ (.01)
============ ========
The accompanying notes are an integral part of these consolidated financial statements.
F-4
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollar amounts in thousands)
Year Ended Year Ended
December 31, 1997 December 31, 1996
----------------------------------------
Cash flow from operating activities:
Net loss $(49,303) $ (656)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Amortization of intangibles and depreciation 39,822 609
Accretion of debt premium 1,026 -
Net deferred taxes (8,230) -
Provision for doubtful accounts 3,657 184
Non-recurring charges 40,144 -
Changes in assets and liabilities, net of effects of acquisitions:
Receivables (2,467) (1,424)
Inventories 940 (540)
Prepaid expenses and deposits 294 (32)
Other current assets (28,988) (200)
Accounts payable 492 41
Accrued liabilities (2,985) 1,749
Deferred revenue 670 178
----------- ------------
Net cash used in operating activities (4,928) (91)
Cash flows from investing activities:
Purchases of property and equipment (3,826) (977)
Placement of installed security systems (29,043) (1,392)
Cash acquired in acquisition transaction 1,374 -
Distribution to equityholders in acquisition transaction (107,695) -
WSS acquisition, net of cash received - (357,269)
Account acquisitions, net of cash received (17,494) (9,898)
--------- -----------
Net cash used in investing activities (156,684) (369,536)
Cash flows from financing activities:
Payments on long-term debt (63,749) -
Proceeds from long-term debt - 53
Funding from Parent 300,749 369,629
-------- ---------
Net cash provided by financing activities 237,000 369,682
--------- ---------
Net increase in cash and cash equivalents 75,388 55
Cash and cash equivalents:
Beginning of period $ 168 $ 113
=========== ===========
End of period $ 75,556 $ 168
========= ===========
Cash paid for interest $ 10,202 $ -
========= ==========
Cash paid for taxes $ - $ -
=========== ==========
Non-cash financing:
Contribution of net assets from Parent $109,219 $ -
======== =========
The accompanying notes are an integral part of these consolidated financial statements.
F-5
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY
(Dollar amounts in thousands)
Common Stock Additional Total
Preferred Contributed Paid-In Accumulated Stockholders'
Stock Shares Amount Capital Capital Earnings (losses) Equity
December 31, 1995 - - $ - $ 5,373 $ - $ 18 $ 5,391
Net investment and advances
from WRI - - - 379,229 - - 379,229
Contribution by WRI of Small Subs - - - 26,466 - - 26,466
Net loss - - - - (656) (656)
-----------------------------------------------------------------------------------------------
December 31, 1996 - - - 411,068 - (638) 410,430
Net investment and advances
from WRI - - - 43,827 - - 43,827
Recapitalization - 68,673,402 687 (454,895) 454,208 - -
Issuance of shares in reverse
purchase acquisitions - 14,689,230 147 - 528,874 - 529,021
Exercise of options - 306 - - - - -
Net loss - - - - - (49,303) (49,303)
-----------------------------------------------------------------------------------------------
December 31, 1997 $ - 83,362,938 $ 834 $ - $983,082 $(49,941) $933,975
==============================================================================================
The accompanying notes are an integral part of these consolidated financial statements.
F-6
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Dollar amounts in thousands, except for per share amounts)
1. The Company and Summary of Significant Accounting Policies:
Basis of Consolidation and Business
Protection One, Inc. (Protection One, a Delaware corporation; the Company)
is principally engaged in the business of providing security alarm monitoring
services, which include sales, installation and related servicing of security
alarm systems for residential and small business subscribers in the United
States.
Prior to November 24, 1997, Protection One was a standalone security
business based in Culver City, California. On November 24, 1997, pursuant to the
Contribution Agreement dated July 30, 1997, between Protection One and Western
Resources, Inc. (a publicly traded utility company based in Topeka, Kansas;
"WRI"), Protection One acquired Centennial Security Holdings, Inc.
("Centennial"), WestSec, Inc., and Westar Security, Inc. (WestSec and Westar,
respectively; together the "Western Resources Security Business" or "WRSB").
(See Note 2 for discussion of consideration exchanged.) As a result of the
transaction, WRI owns approximately 82.4% of Protection One at December 31,
1997.
The transaction has been accounted for as a reverse purchase acquisition
which treats WRSB as the accounting acquiror. Accordingly, the results of
operation of Protection One and Centennial have been included in the
consolidated financial statements since November 24, 1997 following principles
of purchase accounting. Furthermore, the 1996 and 1995 (see Note 14) historical
financial statements of Protection One are those of the accounting acquiror,
WRSB.
On December 30, 1996, WRI, through its indirect wholly owned subsidiary,
WestSec, purchased the assets and assumed certain liabilities comprising the
security business of Westinghouse Security Systems ("WSS") from Westinghouse
Electric Corporation ("WEC"). WSS is deemed to be a predecessor entity of
Protection One. As such, WSS's 1996 and 1995 results of operations are presented
separately from Protection One's consolidated financial statements elsewhere in
this document.
All significant intercompany balances and transactions have been eliminated
in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Revenues
Revenues are recognized when installation of security alarm systems occurs
and when monitoring, extended service protection, patrol, repair and other
services are provided. The Company does not receive separate connection fees in
any aspect of its business. Deferred revenues result from subscribers who are
billed for monitoring, extended service protection and patrol and alarm response
services in advance of the period in which such services are provided, on a
monthly, quarterly or annual basis. Deferred revenues relating to subscriber
accounts acquired are recorded as part of the allocation of the purchase price
and are amortized to income during the period in which service is provided.
Costs of providing service and installations, including inventory, are charged
to income in the period incurred and when the installation occurs. Losses on
contracts for which future costs are anticipated to exceed revenues are accrued
in the period such losses are identified. Costs of services provided to dealers
are expensed as incurred and are included in acquisition and transition
expenses. Contracts for services are generally for an initial noncancelable term
of one to five years with automatic renewal
F-7
on an annual basis thereafter unless terminated by either party.
Inventories
Inventories, comprised of alarm systems and parts, are stated at the lower
of average cost or market.
Property and Equipment
Property and equipment are stated at cost and depreciated using the
straight-line method over estimated useful lives. Costs of property and
equipment of purchased businesses are based on fair market value at the date of
acquisition. When property and equipment are retired or sold, the cost and the
related allowance for depreciation are eliminated from the property and
allowance accounts. Gains or losses from retirements and dispositions of
property and equipment are recognized in income in the period realized. Repair
and maintenance costs are expensed as incurred.
Income Taxes
Deferred tax assets and liabilities reflect the tax effect of temporary
differences between the financial statement and tax basis of assets and
liabilities and the availability of net operating losses and tax credits.
Subscriber Accounts and Intangibles
Subscriber accounts acquired and intangible assets are stated at cost. The
cost of acquired subscriber accounts includes the cost of accounts purchased and
the estimated fair value of accounts acquired in business acquisitions at the
date of acquisition, including an accrual for estimated acquisition transition
costs. The Company's personnel and related support costs incurred solely in
support of acquiring and transitioning subscriber accounts are expensed as
incurred. Direct and incremental external costs associated with the acquisition
of subscriber accounts are capitalized. If the acquisition is terminated prior
to completion of the purchase transaction the costs are recorded as a loss in
the period of termination. The accrual for transition costs includes liabilities
assumed and incremental external costs related to customer changeover and
transition, warranty obligations costs, employee and lease termination costs and
other related costs. Costs related to sales and marketing of systems for
accounts internally generated are expensed as incurred.
The cost of subscriber accounts is amortized on a straight-line basis over
a 10-year period. It is the Company's policy to evaluate acquired subscriber
account attrition on a quarterly basis utilizing historical attrition rates for
the subscriber accounts in total and, when necessary, adjust the remaining
useful lives.
Intangible assets include goodwill, which is amortized on a straight-line
basis over 40 years and debt issuance costs, which are amortized over the
respective lives of associated debt using the interest method.
Cash and Cash Equivalents
All highly liquid investments purchased with a remaining maturity of three
months or less at the date acquired are cash equivalents. These investments,
consisting of money market funds, are stated at cost, which approximates market.
Receivables
Receivables, which consist primarily of trade accounts receivable, of
$25,509 at December 31, 1997 and $16,985 at December 31, 1996, have been reduced
by allowances for doubtful accounts of $5,207 and $4,413, respectively.
F-8
Marketable Securities
Management has determined that the Company's marketable securities are
considered held-for-sale securities. As of December 31, 1997, no material
difference existed between the cost and market value of the portfolio, and as
such, no mark-to-market adjustment has been recorded.
Restricted Cash
Restricted cash as of December 31, 1996, was held in escrow to guarantee
payment to certain third parties for licensing and insurance related matters.
Advertising Costs
The Company expenses advertising costs based on the timing of the release
of the advertising materials. Printed materials, due to the short lead time
between incurrence of cost and the release, are generally expensed as incurred,
whereas broadcast advertising costs are generally recognized upon the first
broadcast of the respective advertisement. Total advertising expense was $9,906
and $2,320 during the years ended December 31, 1997 and 1996, respectively.
Concentrations of Credit Risk
Financial instruments which potentially subject the Company to
concentrations of credit risk consist principally of trade receivables from a
large number of customers, including both residential and commercial, dispersed
across a wide geographic base. The Company extends credit to its customers in
the normal course of business, performs periodic credit evaluations and
maintains allowances for potential credit losses.
Accounting Pronouncement
The Financial Accounting Standards Board (FASB) has issued several
accounting pronouncements that the Company will be required to adopt in future
fiscal reporting periods.
FASB Statement No. 130, "Reporting Comprehensive Income," which the Company
will adopt for periods beginning after December 15, 1997, establishes standards
for reporting and display of comprehensive income and its components in
financial statements. Comprehensive income generally represents all changes in
shareholders' equity except those resulting from investments by or distributions
to shareholders. Such changes are generally not significant to the Company; and
the adoption of Statement No. 130, including the required comparative
presentation for prior periods, is not expected to have a material impact on its
financial statements.
FASB Statement No. 131, "Disclosures about Segments of an Enterprise and
Related Information," establishes standards for the way that public business
enterprises report information about operating segments in interim and annual
financial statements. Operating segments are defined as components of an
enterprise about which separate financial information is available that is
evaluated regularly by the chief operating decision maker in deciding how to
allocate resources and in assessing performance. The Company will adopt the
provisions of SFAS 131 for financial statements for periods beginning after
December 15, 1997. Management does not expect that the adoption of the
disclosure requirements of this pronouncement will be materially different than
that of its current presentation.
Reclassifications
Certain prior period amounts were reclassified to conform to the December
31, 1997, presentation. Such reclassifications did not affect previously
reported net losses.
F-9
Loss Per Share
Loss per share has been computed and presented in accordance with SFAS 128
"Earnings Per Share." The incremental shares that would have been outstanding
upon the assumed exercise of dilutive stock options and warrants do not result
in a change to net loss per share for the year ended December 31, 1997. As such,
no presentation of diluted earnings per share has been included in the
consolidated statements of operations. The weighted average shares outstanding
used in the computation of net loss attributable to common shares was 70,202,716
for the year ended December 31, 1997, and, while there were no actual shares
issued or outstanding for prior fiscal years, for purposes of calculating loss
per share there were deemed to be 68,673,402 shares (number of new shares issued
to effect the transaction) for all prior fiscal years.
2. Acquisition Transaction:
Pursuant to the Contribution Agreement, on November 24, 1997, the Company
issued to WRI an aggregate of 68,673,402 (the Shares) of Common Stock, which
shares constituted 82.4% of the shares of Common Stock (the only voting
securities of the Company) outstanding immediately after such acquisition (the
Acquisition Transaction). In consideration of the issuance of the Shares to WRI
(the Share Issuance), WRI transferred to the Company all of the outstanding
capital stock of WestSec, and Westar, and an aggregate of $367.4 million in cash
and securities.
As provided in the Contribution Agreement, the Company paid (i) to the
holders of record of shares of Protection One Common Stock as of the close of
business on November 24, 1997 (other than WRI), a cash dividend of $7.00 per
share (the Special Dividend); (ii) to the holders of options to purchase shares
of Protection One Common Stock (other than WRI) $7.00 in cash with respect to
each share of Common Stock issuable upon exercise of such options; and (iii) to
a bank as the holder of record of a warrant issued by the Company in 1991 and to
the holders of record of warrants issued by the Company in 1993, $7.00 in cash
with respect to each share of Common Stock issuable upon exercise of such
warrants. As a result of the payment of the Special Dividend, each warrant
issued by the Company in 1995 has become exercisable for 1.629 shares of
Protection One Common Stock at an exercise price of $4.05, and the 6 3/4%
Convertible Senior Subordinated Notes due 2003 issued by Protection One Alarm
Monitoring, Inc., a Delaware corporation, will be convertible into shares of
Common Stock at a conversion price of $11.19 per share.
Included in the marketable securities the Company received from WRI was (i)
all of the outstanding capital stock of Centennial Security Holdings, Inc., a
Delaware corporation (Centennial), and (ii) 2,885,000 shares (the Guardian
Common Shares) of the Class A Voting Common Stock, par value $.001 per shares,
and 1,875,000 shares (the Guardian Preferred Shares) of the Series A 9 3/4%
Convertible Cumulative Preferred Stock of Guardian International, Inc., a Nevada
corporation (Guardian). The Guardian Preferred Shares are convertible into an
aggregate of 1,500,000 additional shares of Guardian common stock.
The Acquisition Transaction has been accounted for as a reverse purchase
acquisition and, accordingly, the operating results of Protection One and
Centennial have been included in the consolidated financial statements since
November 24, 1997. The excess of the aggregate purchase price over the fair
market value of net assets acquired of approximately $410 million related to
Protection One and approximately $50 million related to Centennial is being
amortized over 40 years.
F-10
The following unaudited pro forma consolidated results of operations for
the years ended December 31, 1997 and 1996, assume the Protection One,
Centennial, and WSS acquisitions occurred as of the beginning of the respective
years:
1997 (A) 1996
--------------- --------
Revenues $256,063 $216,861
Net loss (73,360) (28,910)
Earnings per common share (0.88) (0.35)
(A) Excludes nonrecurring charges from 1997 presentation.
The pro forma financial information is not necessarily indicative of the
results of operations had the entities been combined for the entire period nor
do they purport to be indicative of results which will be obtained in the
future.
In conjunction with the acquisition of Protection One by WRSB on November
24, 1997, and the acquisition of WSS by WRSB on December 30, 1996, net cash paid
was as follows:
Protection One WSS
Assets acquired $998,758 $451,344
Liabilities assumed (362,042) (93,844)
Shares issued (529,021) -
--------- ---------
Cash paid 107,695 357,500
Less- cash acquired (1,374) (231)
----------- ------------
Net cash paid $106,321 $357,269
======== ========
3. Nonrecurring Charges:
In connection with the Acquisition Transaction, the Company incurred
nonrecurring charges of $40.1 million, in order to reflect business activities
of the accounting acquiror, WRSB, that are no longer of continuing value to the
combined entity and that will be phased out in the integration of operations.
These charges have been separately identified as a component of operating income
in the accompanying statements of operations.
Generally, management intends to bring all security operations under the
Protection One brand and to eliminate redundant facilities, systems and
activities in specific locations where such exist. Additionally, costs must be
incurred to transition individual customer accounts from the former service
providers with respect to operations, billing and network systems, and to close
down these operations. Management intends to complete these exit activities by
the fourth quarter of 1998.
Charges for the year ended December 31, 1997, are as follows:
Inventory and other asset losses $17,697
Customer account transition 12,337
Disposition of excess fixed assets 4,128
Closure of duplicate facilities 1,991
Severance compensation and benefits 1,865
Other 2,126
---------
$40,144
F-11
4. Property and Equipment:
Property and equipment are summarized as follows:
December 31,
1997 1996
------------ --------
Office equipment $ 5,690 $ 3,285
Furniture and fixtures 4,009 986
Data processing and telecommunication 4,634 1,413
Other 3,777 -
--------- -------
18,110 5,684
Less accumulated depreciation and amortization 3,176 238
--------- ----------
$14,934 $ 5,446
======= ========
Included in furniture and fixtures at December 31, 1997, are $452 of assets
under capital leases. Virtually all property and equipment is depreciated over
estimated useful lives ranging from five to ten years.
5. Subscriber Accounts:
Subscriber accounts (at cost) consist of the following:
December 31,
1997 1996
------------ --------
Acquired subscriber accounts $566,811 $270,038
Less accumulated amortization 28,493 4,508
---------- -----------
$538,318 $265,530
Reconciliation of activity for acquired subscriber accounts is as follows:
December 31,
1997 1996
------------ --------
Balance, beginning of year $270,038 $ -
Acquisition of subscriber accounts 296,822 270,038
Charges against acquisition holdbacks (49) -
------------ ---------
Balance, end of year $566,811 $270,038
======== ========
In conjunction with certain purchases of subscriber accounts the Company
withholds a portion of the purchase price as a reserve to offset qualifying
attrition of the acquired subscriber accounts for a specified period as provided
for in the purchase agreements, and as a reserve for purchase price settlements
of assets acquired and liabilities assumed. As of December 31, 1997, purchase
holdbacks were $11,444. Virtually all of this amount was brought forward in the
Acquisition Transaction. Also in connection with the Acquisition Transaction,
the Company took a nonrecurring charge for excess subscriber attrition as the
Company integrated the operations of WSS (see Note 2).
F-12
6. Long-Term Debt:
Long-term debt is comprised of the following:
December 31,
1997 1996
------------ --------
Senior Subordinated Discount Notes $191,926 $ -
Convertible Senior Subordinated Notes 103,500 -
SAMCO financing 62,950 65,053
Less current portion (21,217) (4,548)
-------- ---------
$337,159 $ 60,505
======== =========
Senior Subordinated Discount Notes
The Senior Subordinated Discount Notes are unsecured subordinated
obligations of the Company's wholly owned Protection One Alarm Monitoring
subsidiary (Monitoring) (see Note 13), limited to $166 million aggregate
principal amount at maturity, and will mature on June 30, 2005. In connection
with the Acquisition Transaction, the notes were restated to fair market value
for book purposes reflecting a current market yield of approximately 6.4%. This
resulted in bond premium being recorded to reflect the increase in value of the
notes as a result of the decline in interest rates since the note issuance. The
revaluation has no impact on the expected cash flow to existing noteholders.
Although for federal income tax purposes a significant amount of original
issue discount, taxable as ordinary income, will be recognized by a holder as
such discount accrues from the issue date, no interest will be payable prior to
December 31, 1998. From and after June 30, 1998, cash interest on the notes will
accrue at the rate of 13 5/8% per annum, payable in cash semiannually on June 30
and December 31, of each year, commencing December 31, 1998.
The Senior Subordinated Discount Notes are fully, unconditionally and
jointly and severally guaranteed on a senior subordinated basis by Protection
One.
The Senior Subordinated Discount Notes contain covenants which, among other
matters, limit the Company and its Subsidiaries' ability to incur indebtedness,
pay dividends, sell assets, make stock distributions or sell shares of certain
subsidiaries.
Convertible Senior Subordinated Notes
The Convertible Notes are unsecured subordinated obligations of Monitoring
and rank equal to the Senior Subordinated Discount Notes. The Convertible Notes
mature on September 15, 2003, and previously were convertible, at any time, into
Common Stock at a price of $17.95 per share, subject to adjustment. Subsequent
to the Acquisition Transaction, the Convertible Notes maintain a conversion
price of $11.19 per share.
Interest on the Convertible Notes accrues at the rate of 6 3/4% per annum,
payable in cash semiannually on March 15 and September 15 of each year,
commencing March 15, 1997. The Convertible Notes are redeemable, at the
Company's option, in whole or in part, at any time or from time to time, on or
after September 19, 1999, and prior to maturity, upon not less than 30 days
prior notice at certain specified redemption prices plus accrued and unpaid
interest.
The Convertible Notes are fully, unconditionally and jointly and severally
guaranteed on a senior subordinated basis by Protection One.
The indenture under which the Convertible Notes were issued contains
covenants which limit the Company and its subsidiaries' ability to incur certain
indebtedness.
Revolving Credit Facility
At December 31, 1997, Protection One had a $100 million revolving credit
facility (the "Revolving Credit Facility")
F-13
which matures in January 2000. Borrowings under the Revolving Credit Facility
bear interest at the lesser of the bank's prime rate plus 1.00% or LIBOR plus
2.50%. Borrowings made under the Revolving Credit Facility are collateralized by
substantially all of the Company's assets. The outstanding balance of the
Revolving Credit Facility was paid on November 25, 1997, with proceeds from the
Acquisition Transaction. The facility was terminated in February of 1998.
SAMCO
During 1992 and through 1994, WSS entered into a series of agreements (the
"SAMCO Agreements") to sell certain rights in security alarm monitoring
contracts (the "Contracts") to an investor for approximately $76.9 million in
cash. The investor financed the transactions through the issuance of three
series of secured five-year notes (the "Investor Notes"). For financial
reporting purposes, WEC accounted for the transactions as a financing
arrangement and recorded the proceeds received from the investor as long-term
debt. The amounts recorded as debt were amortized using the interest method.
Generally, principal and interest payments on the debt consist of 65% of the
monitoring revenues collected under the Contracts. In addition, as part of the
SAMCO Agreements, Westinghouse provided the investor with certain guarantees
with respect to accounts which terminate prior to the completion of the contract
period.
Under the SAMCO Agreements, WEC had the right but not the obligation,
exercisable not more than 15 months or less than 12 months prior to the stated
maturity of any series of Investor Notes to repurchase the Contracts or cause
the disposition of Contracts securing a particular series of Investor Notes, for
an amount equal to the then fair market value of such Contracts, provided such
fair market value will not be less than the amount necessary to satisfy all
obligations of the investor related to such series of Investor Notes plus
certain taxes, if any (the "Minimum Purchase Price"). In the event of an
unsolicited third party offer in excess of the then Minimum Purchase Price to
purchase such Contracts prior to 12 months before the stated maturity of any
series of Investor Notes, the Agreements provided WEC a right of first refusal
to buy such Contracts. In addition, the Agreements provided that WEC would
receive 60% of the excess of the fair market value over the Minimum Purchase
Price, if any, if WEC repurchases or arranges the sale of such Contracts.
On December 30, 1996, WEC assigned to WestSec all of WEC's rights, title
and interest, and WestSec agreed to assume all of WEC liabilities and
obligations under the SAMCO Agreements in connection with WestSec's purchase of
WSS. This assumption of liabilities requires WestSec to purchase the Contracts
on the respective stated maturity date of the Investor Notes. The purchase price
payable by WestSec is equal to the greater of a) Minimum Purchase Price plus 40%
of the excess of the fair market value over the minimum purchase price or b) 30
times total monthly recurring revenue related to the Contracts. As a condition
of assuming the debt obligation, WestSec issued a letter of credit for $85
million to ensure the debt holder the obligation would be repaid. Protection One
pays interest on this obligation on a monthly basis and amounts of interest
actually paid approximated interest expense for the years ended December 31,
1997 and 1996.
The effective interest rate related to these Agreements approximates 15%.
The estimated minimum principal payment for each of the years subsequent to
December 31, 1997, based upon current estimates of fair value are as follows:
1998 - $21.2 million and 1999 - $41.7 million.
F-14
7. Investments in Unconsolidated Subsidiary:
At December 31, 1997, Protection One owned common stock and preferred stock
representing a 41% ownership interest in Guardian International, Inc.,
("Guardian") at an aggregate cost of $9.2 million. Such securities were
contributed by WRI to Protection One pursuant to the Contribution Agreement.
Since Protection One does not exercise control over Guardian's operations,
Protection One accounts for the investment under the equity method of
accounting, recognizing the proportionate share of income or losses of Guardian.
For the 36 days ended December 31, 1997, Protection One's equity in income of
the unconsolidated subsidiary, Guardian, was $25.
8. Stock Warrants and Options:
The following is a detail of previously issued options and warrants of
Protection One:
In January 1993, Protection One issued 103,697 warrants ("KOP Warrants") to
purchase shares of Common Stock at an exercise price of $3.633 per share. The
outstanding warrants expire in January 2001.
On November 3, 1993, Protection One issued 1,400,000 warrants to purchase
840,000 shares of Common Stock as part of a Units offering. Each warrant, when
exercised, will entitle the holder to receive six-tenths (0.6) of one share of
Common Stock at an exercise price of $0.167 per share, subject to adjustment.
The outstanding warrants expire on November 1, 2003.
The 1994 Stock Option Plan (the Plan), approved by the Protection One
stockholders in June 1994, provides for the award of incentive stock options to
directors, officers and key employees. One million three hundred thousand
(1,300,000) shares are reserved for issuance under the Plan, subject to such
adjustment as may be necessary to reflect changes in the number or kinds of
shares of Common Stock or other securities of Protection One. The Option Plan
provides for the granting of options that qualify as incentive stock options
under the Internal Revenue Code and options that do not so qualify.
During fiscal year 1995, Protection One granted options to purchase an
aggregate of 266,000 shares of Common Stock including 132,000 shares to officers
of Protection One. Each option has a term of 10 years and vests 20% on each of
the third through seventh anniversaries of the commencement of the participant's
employment with the Protection One. The purchase price of the shares issuable
pursuant to the options is equal to fair market value of Common Stock at the
date of option grant. Pursuant to the Acquisition Transaction, the vesting of
these options accelerated on November 24, 1997 and all remaining options are
currently exercisable.
In connection with the issuance of the Senior Subordinated Discount Notes
in May 1995, Protection One issued warrants to purchase 531,200 shares of common
stock at an exercise price of $6.60 per share. The outstanding warrants expire
in May 2005.
During fiscal year 1996, Protection One granted options to purchase an
aggregate of 638,800 shares of Common Stock including 400,000 shares granted to
officers of Protection One. Each option has a term of 10 years and vests 20% on
each of the first through fifth anniversaries of the later of November 15, 1995,
or the commencement of the participant's employment with Protection One. The
purchase price of the shares issuable pursuant to the options is equal to (or
greater than) the fair market value of the Common Stock at the date of the
option grant. Pursuant to the Acquisition Transaction, the vesting of these
options accelerated on November 24, 1997 and all remaining options are currently
exercisable.
On July 9, 1997, Protection One granted options to purchase an aggregate of
50,000 shares of common stock. Each option has a term of four years. The
purchase price of the shares issuable pursuant to the options is greater than
the fair market value of the Common Stock at the date of the option grant.
F-15
During fiscal year 1997, Protection One granted options to purchase an
aggregate of 375,444 shares of Common Stock to employees including 100,000
shares granted to officers of Protection One. Each option has a term of 10 years
and vests 20% on each of the first through fifth anniversaries of the later of
December 6, 1996, or the commencement of the participant's employment with
Protection One. The purchase price of the shares issuable pursuant to the
options is equal to (or greater than) the fair market value of the Common Stock
at the date of the option grant. Pursuant to the Acquisition Transaction, the
vesting of these options accelerated on November 24, 1997 and all remaining
options are currently exercisable.
A summary of warrant and option activity for Protection One from the date
of the Acquisition Transaction is as follows:
Warrants
and Options Price Range
Outstanding and exercisable at November 24, 1997 1 2,198,389 $0.05 to $16.375
Granted - -
Exercised (306) $0.05
Surrendered - -
----------- ----------------
Outstanding and exercisable at December 31, 1997 2,198,083 $0.05 - $16.375
=========== ================
1 As WRSB had no outstanding stock at or prior to November 24, 1997 there
were no related options.
The table summarizes stock options outstanding as of December 31, 1997:
Number Weighted-
Outstanding Average Weighted-
Range of and Remaining Average
Description Exercise Price Exercisable Contractual Life Exercise Price
Fiscal 1995 Options $5.875 - $9.125 159,360 8 years $6.602
Fiscal 1996 Options $8.00 - $10.313 384,300 8 years $8.088
Fiscal 1996 Options $12.125 - $16.375 148,000 8 years $14.857
Fiscal 1997 Options $9.50 253,000 9 years $9.50
Fiscal 1997 Options $15.00 50,000 9 years $15.00
1997 Options $14.268 50,000 4 years $14.268
Phillips Options $0.05 1,425 9 years $0.05
KOP Warrants $3.633 103,697 4 years $3.633
November 1993 Warrants $0.167 462,001 6 years $0.167
May 1995 Note Warrants $6.60 466,400 8 years $6.60
In connection with the acquisition transaction, Protection One issued to
Western Resources a call option on an additional 2,750,238 shares of common
stock at a price of $15.50 per share. The option expires on the earlier of a) 45
days following the last date on which any Protection One convertible notes are
still outstanding, and b) October 31, 1999.
F-16
9. Income Taxes:
Components of the income tax benefit are as follows:
Year Ended Year Ended
December 31, 1997 December 31, 1996
Federal-
Current $21,640 $ 265
Deferred 7,210 -
State-
Current 3,090 45
Deferred 1,030 -
Total $32,970 $ 310
======= =======
The difference between the income tax benefit at the federal statutory rate
and income tax benefit in the accompanying statements of operations is as
follows:
Year Ended Year Ended
December 31, 1997 December 31, 1996
Federal statutory tax rate (35)% (35)%
State income taxes, net
of Federal benefit (6)% (6)%
Non-deductible goodwill 1% 9%
-- --
(40)% (32)%
Protection One
Components of the income tax benefit from losses recorded for the year
ended December 31, 1997, include Protection One from the date of the Acquisition
Transaction and WRSB for the calendar year then ended. Protection One and
subsidiaries will be included in the tax returns filed by Western Resources for
calendar year 1997. A tax sharing agreement between Protection One and Western
Resources provides for the payment to Protection One by Western Resources for
tax benefits utilized by Western Resources and accordingly, the receivable of
$24.7 million related to the current tax benefit for the year ended December 31,
1997, has been included in other current assets in the accompanying consolidated
balance sheet.
At December 31, 1997, consolidated Protection One had approximately $50
million in net operating loss carryforwards for income tax return purposes.
Current tax regulations limit the use of these NOL carryforwards to 1) the
extent Protection One earns taxable income subsequent to November 24, 1997, and
2) certain annual use levels, even if taxable income is generated. As a result,
Management has determined that a valuation allowance is appropriate in
accordance with SFAS 109 "Accounting for Income Taxes."
F-17
At December 31, 1997, deferred income tax assets and liabilities were
composed of the following:
Deferred tax asset (liability) current-
Accrued liabilities $24,305
Accounts receivable, due to allowance 2,083
Acquisition reserves and holdbacks 6,684
Prepaids 1,501
Other 10,505
--------
$45,078
Deferred tax asset (liability) noncurrent-
Net operating loss carryforwards $16,943
Valuation allowance (16,943)
Subscriber accounts 1,348
Property, plant & equipment 3,429
Noncompete agreements 1,101
Capitalized Direct installation costs (10,200)
OID amortization 16,824
Debt offering costs 3,331
---------
$15,833
WRSB
The income tax attributes of WRSB were consolidated into the tax returns filed
by Western Resources for calendar year 1996. As a result, the cumulative tax
losses were utilized by Western Resources. No cash was paid for income taxes for
the year ended December 31, 1996. The resulting net deferred tax asset was
contributed to Western Resources and was recorded as a reduction of additional
paid-in capital in the accompanying balance sheet. Therefore, there were no
deferred tax assets and liabilities recorded at December 31, 1996.
10. Employee Benefit Plans:
401(k) Plan
The Company maintains a tax-qualified, defined contribution plan that meets
the requirements of Section 401(k) of the Internal Revenue Code (the "401(k)
Plan"). The Company at its election also may make contributions to the 401(k)
Plan, which contributions will be allocated among participants based upon the
respective contributions made by the participants through salary reductions
during the applicable plan year. The Company's matching contribution may be made
in Common Stock, in cash or in a combination of both stock and cash. As of
year-end, Protection One made a matching contribution to the plan of $34.
WRSB also maintained a savings plan which qualified under Section 401(k).
The savings plan allowed eligible employees to contribute up to 15% of their
income on a pretax basis, with a discretionary employer match of 50% of the
employee's contribution up to the first 6% of the employee's compensation.
During the year ended December 31, 1997, WRSB made matching contributions equal
to $721. Management intends to merge the two 401(k) employee benefit plans as
soon as practically possible.
Employee Stock Purchase Plan
The Employee Stock Purchase Plan is designed to qualify as an "Employee
Stock Purchase Plan" within the meaning of Section 423 of the Internal Revenue
Code, and will allow eligible employees to acquire shares of Common Stock at
periodic intervals through their accumulated payroll deductions. A total of
650,000 shares of Common Stock have been reserved for issuance under the
Employee Stock Purchase Plan, which is administered by the Compensation
Committee.
The purchase price of shares of Common Stock purchased under the Employee
Stock Purchase Plan during any purchase period will be the lower of (i) 85% of
the fair market value of the Common Stock on the first day of that purchase
period or (ii) 85% of the fair market value of the Common Stock on the purchase
date.
Termination of a participant's employment for any reason (including death,
disability or retirement) cancels participation in the Employee Stock Purchase
Plan immediately. The Employee Stock Purchase Plan will in all events terminate
upon the earliest to occur of (i) the last business day in September 2005, (ii)
the date on which all shares available for issuance under the plan have been
sold or (ii) the date on which all purchase rights are exercised in connection
with an acquisition of the Company or all or substantially all of its assets.
11. Commitments and Contingencies:
The Company leases office facilities for lease terms maturing through 2012.
Future minimum lease payments under noncancelable operating leases are as
follows:
Year ended December 31
1998............................................ $ 6,592
1999............................................ 4,874
F-18
2000............................................ 3,452
2001............................................ 2,794
2002............................................ 2,504
Thereafter...................................... 6,438
---------
$26,654
Total rent expense for the years ended December 31, 1997, and 1996, was
$4,654 and $3,409, respectively.
On January 8, 1997, Innovative Business Systems, Ltd. ("IBS") filed
suit against Western Resources, Westinghouse Electric Corporation ("WEC"),
Westinghouse Security Systems, Inc. ("WSS") and WestSec in Dallas County, Texas
district court (Cause No. 97-00184) alleging, among other things, breach of
contract by WEC and interference with contract against Western Resources and
WestSec in connection with the sale by WEC of the assets of WSS to Western
Resources and WestSec. IBS claims that WEC improperly transferred software owned
by IBS to Western Resources and WestSec and that Western Resources and WestSec
are not entitled to its use. Western Resources and WestSec have demanded that
WEC defend and indemnify them. WEC, Western Resources and WestSec have denied
IBS' allegations and are vigorously defending against them. Management does not
believe the ultimate disposition of the matter will have a material adverse
effect upon the Company's overall financial condition or results of operations.
The Company is a party to claims and matters of litigation incidental to
the normal course of its business. The ultimate outcome of these matters cannot
presently be determined; however, in the opinion of management of the Company,
the resolution of these matters will not have a material adverse effect on the
Company's combined financial position or results of operations.
12. Fair Market Value of Financial Instruments:
For certain of the Company's financial instruments, including cash and cash
equivalents, accounts receivable, accounts payable and other accrued
liabilities, the carrying amounts approximate fair market value due to their
short maturities.
Due to the adjustments recorded in purchase accounting, as of December 31,
1997, Protection One debt is believed to be reflected in the financial
statements as an amount approximating fair market value.
The estimated fair values may not be representative of actual values of the
financial instruments that could have been realized at year-end or may be
realized in the future.
F-19
13. Supplemental Subsidiary Company Summarized Financial Information
Protection One is a guarantor of all outstanding debt of Monitoring.
Protection One has no other assets or operation outside the investments in its
subsidiaries. Separate audited financial statements for Monitoring as debt
issuer have not been provided because Monitoring is wholly-owned and the
guarantee is full and unconditional.
The summarized financial information of Monitoring from the date of the
Acquisition Transaction through December 31, 1997, is presented below:
Summarized Balance Sheet December 31, 1997
Assets
Current assets $110,350
Subscriber accounts and intangibles, net 229,366
Goodwill and patents 408,295
Other noncurrent assets 46,418
Liabilities and Stockholders' Equity
Deferred revenue 16,457
Other current liabilities 55,216
Long-term debt, net of current position 295,426
Other long-term liabilities 703
Stockholders' equity 457,511
For the period from
November 24, 1997, to
December 31,1997
Summarized Statement of Operations
Revenues $10,812
Gross profit 7,527
Net loss (1,124)
14. 1995 Operating Results of Protection One
The operating results of the WRSB for the year ended December 31, 1995, can
be considered nominal in relation to the accompanying consolidated statements of
operations. The 1995 results are comprised of only two months of start-up
activity. Summarized operating results are as follows:
Revenue $344
Gross Profit 189
Net Income 18
F-20
15. Subsequent Events - Mergers and Acquisitions (Unaudited):
Subsequent to the end of fiscal year 1997, on February 4, 1998,
Protection One announced its decision to exercise its option to purchase Network
Multi-Family Security Corporation ("Network"), the leading provider of security
alarm monitoring to multi-family dwellings with approximately 200,000
subscribers. Pursuant to the terms of the option, Protection One will give
Western Resources cash consideration of approximately $180 million.
On March 2, 1998, Protection One completed the acquisition of 147,000
subscribers and related assets of Multimedia Security Services, Inc.
("Multimedia") for a purchase price of approximately $233 million. The
Multimedia purchase added to the Company's market positions in California,
Florida and Texas and added substantial numbers of subscribers in Kansas and
Oklahoma. In addition, Protection One will maintain Multimedia's monitoring and
customer service center in Wichita, Kansas.
On March 17, 1998, Protection One completed the acquisition of Comsec
Narragansett Security, Inc. ("Comsec") for a cash purchase price of
approximately $45 million and the assumption of $15 million of debt. Comsec's
30,000 subscribers are located primarily in Connecticut, Maine, Massachusetts
and New Hampshire.
F-21
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders of Protection One, Inc.
We have audited the accompanying statements of operations and cash
flows of Westinghouse Security (a predecessor of Protection One, Inc.) for the
52 weeks ended December 20, 1995, and the 53 weeks ended December 30, 1996.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present
fairly, in all material respects, the results of its operations and cash flows
of Westinghouse Security (a predecessor of Protection One, Inc.) for the 52
weeks ended December 20, 1995, and the 53 weeks ended December 30, 1996, in
conformity with generally accepted accounting principles.
ARTHUR ANDERSEN LLP
Kansas City, Missouri
August 22, 1997
F-22
WESTINGHOUSE SECURITY
STATEMENTS OF OPERATIONS
(Predecessor financial statements for Protection One, Inc.)
(Dollar amounts in thousands)
For the For the
53 weeks ended 52 weeks ended
December 30, 1996 December 20, 1995
Revenues:
Monitoring and related services $ 93,765 $74,911
Installation and other 17,116 13,799
---------- --------
Total revenues 110,881 88,710
Costs and expenses:
Monitoring and related services 24,987 16,843
Other 973 437
------------ ----------
Total costs and expenses 25,960 17,280
---------- --------
Gross profit 84,921 71,430
Selling, general and administrative expenses 60,166 50,919
Acquisition and transition expense 101 101
Amortization of intangibles and depreciation expense 21,613 17,804
---------- --------
Operating income (loss) 3,041 2,606
Other income/expense:
Interest expense, net 10,879 12,159
---------- --------
Loss before income taxes (7,838) (9,553)
----------- ---------
Income tax benefit 2,978 3,630
----------- ---------
Net loss $ (4,860) $(5,923)
========== =======
The accompanying notes are an integral part of these financial statements.
F-23
WESTINGHOUSE SECURITY
STATEMENTS OF CASH FLOWS
(Predecessor financial statements for Protection One, Inc.)
(Dollar amounts in thousands)
For the For the
53 weeks ended 52 weeks ended
December 30, 1996 December 20, 1995
Cash flow from operating activities:
Net loss $ (4,860) $ (5,923)
Adjustments to reconcile net loss to net cash
provided by operating activities:
Depreciation 1,052 975
Amortization of intangibles 20,562 16,829
Provision for doubtful accounts 3,108 2,542
Changes in assets and liabilities, net of effects of acquisitions:
Restricted cash 119 (5)
Receivables (2,170) (3,449)
Inventories 1,491 (755)
Prepaid expenses and deposits (182) 311
Other current assets (65) 909
Accounts payable (1,835) 385
Accrued liabilities 5,876 922
Deferred revenue 633 2,332
------------ -----------
Net cash provided by operating activities 23,729 15,073
Cash flows from investing activities:
Purchases of property and equipment (1,219) (2,794)
Subscriber account installations and purchases (39,241) (40,300)
--------- ---------
Net cash used in investing activities (40,460) (43,094)
Cash flows from financing activities:
Funding from Westinghouse 21,880 34,935
Repayments of long-term debt (5,146) (6,806)
---------- ----------
Net cash provided by financing activities 16,734 28,129
---------- ----------
Net increase in cash and cash equivalents $ 3 $ 108
============= ==========
Cash and cash equivalents:
Beginning of period $ 134 $ 26
=========== ===========
End of period $ 137 $ 134
=========== ==========
The accompanying notes are an integral part of these financial statements.
F-24
WESTINGHOUSE SECURITY
NOTES TO FINANCIAL STATEMENTS
(Predecessor financial statements for Protection One, Inc.)
(Dollar amounts in thousands)
1. Background Information and Summary of Significant Accounting Policies
General
On December 30, 1996, Western Resources, Inc. ("Western Resources"),
through its indirect wholly owned subsidiary, WestSec, Inc. ("WestSec"),
purchased the assets and assumed certain liabilities comprising the security
business of Westinghouse Security Systems ("WSS") (the "Company"), from
Westinghouse Electric Corporation ("Westinghouse"). The historical results of
operations of WSS are presented herein (as predecessor financial statements for
Protection One, Inc.) and do not reflect the adjustments related to the Western
Resources' purchase at December 30, 1996. Prior to 1996, WSS closed its fiscal
year on December 20.
WSS provided alarm monitoring services and sold, installed and serviced
security alarm systems principally for residential and small business
subscribers. Most of the WSS customers were in the southern portion of the
United States.
Revenues
Monitoring revenues, generally derived from contracts for an initial
noncancelable term, are recognized monthly as services are provided. Amounts
billed in advance are deferred and are recognized in the month service occurs.
Installation revenues are recognized in the period of installation of the alarm
system. Service revenues are recognized in the period that the services are
provided.
Inventories
Inventories, comprised of alarm systems and parts, held for installation
and service, are stated at the lower of average cost or market. For the 52 weeks
ended December 20, 1995, and the 53 weeks ended December 30, 1996, approximately
$650 and $1,634, respectively, was charged to expense resulting from the
writedown of inventory to its respective market values.
Property and Equipment
Property and equipment is stated at cost and depreciated using the
straight-line method over its estimated useful life (five to ten years for
furniture and other equipment). When property and equipment is retired or sold,
the cost and the related accumulated depreciation is eliminated from their
respective accounts. Gains or losses from retirements and dispositions of
property and equipment are recognized in the period realized. Repair and
maintenance costs are expensed as incurred.
Income Taxes
WSS historically has been included in the consolidated federal income tax
return filed by Westinghouse. Income taxes have been allocated to WSS as if they
were filing a separate tax return. WSS accounts for income taxes in accordance
with Statement of Financial Accounting Standards No. 109 which requires that
deferred tax assets and liabilities be established for the basis differences
between the reported amounts of assets and liabilities for financial reporting
purposes and income tax purposes.
F-25
Advertising Costs
WSS generally expensed broadcast and print advertising costs based on the timing
of the release of the advertising materials. Advertising costs are generally
recognized upon the first broadcast of the respective advertisement.
Subscriber Accounts
Subscriber accounts installed are stated at cost. Direct costs of installed
accounts are capitalized. These direct costs include materials and equipment on
subscriber premises, direct installation labor, and other direct installation
costs. Accounts purchased are capitalized at amounts paid to acquire these
accounts. Such capitalized costs are amortized on a straight-line basis over the
average subscriber life estimated to be ten years.
Goodwill
Goodwill, which represents the excess of purchase price over the fair value
of net assets acquired, is amortized on a straight-line basis over 40 years.
Cash and Cash Equivalents
Westinghouse historically performed cash management functions for WSS.
Disbursements were funded and deposits were swept centrally by Westinghouse and
intercompany accounts were used to accumulate net amounts owed or borrowed. WSS
maintained certain bank accounts primarily related to payroll, permit fees and
customer referral payments. The balances of such accounts are included in cash
and cash equivalents in the accompanying balance sheet.
For purposes of the statement of cash flows, WSS considered all highly
liquid investments purchased with a remaining maturity of three months or less
at the date acquired to be cash equivalents.
Related Party Transactions
WSS received a number of administrative and support services from
Westinghouse, participated in certain Westinghouse employee benefit plans, and
its results of operations were included in certain of Westinghouse's
consolidated income tax returns. Further information about such relationships
and transactions is included in Notes 2, 3, and 4.
Concentration of Credit Risk
Financial instruments which potentially subject WSS to concentrations of
credit risk consist principally of trade receivables from a large number of
customers, including both residential and commercial, dispersed across a wide
geographic base. WSS extended credit to its customers in the normal course of
business, performs periodic credit evaluations and maintains allowances for
potential credit losses.
Use of Estimates
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
F-26
2. Income Taxes:
Components of the income tax benefit are as follows:
52 Weeks Ended 53 Weeks Ended
December 20, 1995 December 30, 1996
Federal-
Current $11,650 $9,462
Deferred (8,865) (7,172)
State-
Current 1,605 1,303
Deferred (760) (615)
Total $ 3,630 $2,978
======== =======
The difference between the income tax benefit at the federal statutory rate
and income tax benefit in the accompanying statements of operations is as
follows:
52 Weeks Ended 53 Weeks Ended
December 20, 1995 December 30, 1996
Federal statutory tax rate (35)% (35)%
State income taxes, net
of Federal benefit (3)% (3)%
---- ----
(38)% (38)%
==== ====
No cash was paid for income taxes for the 52 weeks ended December 20, 1995,
and the 53 weeks ended December 30, 1996.
3. Related Party Transactions
During 1995 and 1996, WSS purchased products from and sold products to
other Westinghouse operations on a limited basis. WSS was charged directly for
the costs of certain services that Westinghouse provided. These services
included information system support, certain accounting functions, such as
transaction processing, legal services, human resources and telecommunications.
Westinghouse also provided WSS with other services, as needed, including
printing, productivity and other consulting services. For the 52 weeks ended
December 20, 1995, amounts charged for these services were not significant. For
the 53 weeks ended December 30, 1996, approximately $1.1 million was charged to
WSS for these services, primarily for telecommunications. Historically, these
transactions were not settled in cash, but instead recorded in intercompany
payable accounts. Since this obligation was not repaid by WSS to Westinghouse,
amounts accrued were recorded as contributed capital.
Westinghouse allocated a portion of its corporate expenses to its business
units and subsidiaries. These allocated costs include certain corporate
overhead, including among others, corporate legal, environmental and insurance.
These corporate expenses were allocated primarily based on payroll costs and
revenue. Such allocations were not necessarily indicative of actual results and
it is not practical for management to estimate the level of expenses that might
have been incurred had WSS operated as a standalone entity. Amounts allocated to
WSS by Westinghouse approximated $660 and $802 in 1995 and 1996, respectively.
4. Employee Benefit Plans
WRSB maintained savings plans which qualify under Section 401(k) of the
Internal Revenue Code. The savings plans allowed eligible employees to
contribute up to 15% of their income on a pretax basis to such savings plans.
WSS, at its discretion, may have elected to match 50% of the employee's
contribution up to the first 6% of the employee's compensation. The charge to
operations for WSS' matching contribution approximated $376 and $449 in 1995 and
1996, respectively.
F-27
5. Commitments and Contingencies
WSS leased office space and other equipment under noncancellable operating
leases that require aggregate minimum future rentals of:
Year ending December 31
1997............................................ $2,206
1998............................................ 1,739
1999............................................ 1,248
2000............................................ 882
2001............................................ 642
Thereafter...................................... 1,701
-------
$8,418
Total rental expense recognized for the 52 weeks ended December 20, 1995,
and the 53 weeks ended December 30, 1996, for operating leases was approximately
$3,356 and $3,409, respectively.
During the 52 weeks ended December 31, 1995, WSS recognized losses related
to a remaining purchase commitment of $650 based upon management's estimate of
the current market value of certain equipment inventory which was substantially
less than the remaining contractual commitment.
WSS was a party to claims and matters of litigation incidental to the
normal course of its business. The resolution of these matters is not expected
to have a material adverse effect on WSS's financial position or results of
operations.
F-28
PROTECTION ONE, INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(Dollar amounts in thousands)
Balance at Charged to
beginning Charged to costs other Balance at
Description of period and expenses accounts (a) Deductions (b) end of period
--------- ------------ -------- ---------- -------------
Year ended December 31, 1996
Allowances deducted from assets
for doubtful accounts . . . . . . . . . . $ 50 $ 184 $4,179 $ - $4,413
Year ended December 31, 1997
Allowances deducted from assets
for doubtful accounts . . . . . . . . . . 4,413 3,657 4,578 (7,441) 5,207
(a) Allowances recorded on receivables purchased in conjunction with acquisition of customer accounts.
(b) Results from write-offs of accounts receivable.
S-1
WESTINGHOUSE SECURITY (PREDECESSOR ENTITY)
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
(Dollar amounts in thousands)
Balance at Charged to
beginning Charged to costs other Balance at
Description of period and expenses accounts (a) Deductions (b) end of period
--------- ------------ -------- ---------- -------------
52 weeks ended December 20, 1995
Allowances deducted from assets
for doubtful accounts . . . . . . . . . . $ 454 $2,542 $ - $(340) $2,656
53 weeks ended December 30, 1996
Allowances deducted from assets
for doubtful accounts . . . . . . . . . . 2,656 3,108 - (1,585) 4,179
(a) Allowances recorded on receivables purchased in conjunction with acquisition of customer accounts.
(b) Results from write-offs of accounts receivable.
S-2
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
PROTECTION ONE, INC.
PROTECTION ONE ALARM MONITORING, INC.
By:
John W. Hesse
Executive Vice President and
Chief Financial Officer
Date: March 26, 1998
Pursuant to the requirements of the Securities Exchange Act of
1934, this report has been signed below by the following persons on behalf of
the registrant and in the capacities and on the dates indicated.
Signature Title Date
President, Chief Executive Officer March 26, 1998
- -----------------------------------
James M. Mackenzie, Jr. and Director (principal executive
officer)
Executive Vice President, March 26, 1998
John W. Hesse Chief Financial Officer and Secretary
(principal financial and accounting
officer)
Director March 26, 1998
Robert M. Chefitz
Director March 26, 1998
James Q. Wilson
Director March 26, 1998
Ben Enis
Director March 26, 1998
Steven L. Kitchen
Director March 26, 1998
Carl M. Koupal, Jr.
Director March 26, 1998
Peter C. Brown
Director March 26, 1998
Howard A. Christensen
Director March 26, 1998
Joseph J. Gardner
Director March 26, 1998
William J. Gremp
Director March 26, 1998
John C. Nettles
Director March 26, 1998
Jane Dresner Sadaka
Exhibit List
Exhibit Number Exhibit Description
2.1 Contribution Agreement dated as of July 30, 1997 (the "Contribution Agreement"),
between Western Resources and POI (incorporated by reference to Exhibit 2.1 to the
Current Report on Form 8-K filed by POI3 and Monitoring4 dated July 30, 1997 (the
"July 1997 Form 8-K")).
2.2 Amendment No. 1 dated October 2, 1997, to the Contribution Agreement
(incorporated by reference to Exhibit 99.1 to the Current Report of Form 8-K filed
by POI and Monitoring dated October 2, 1997).
2.3 Assignment and Assumption Agreement (Centennial Security Holdings, Inc.) dated
as of November 24, 1997, among Western Resources, Westar Capital, Inc. ("Westar
Capital"), Westar Security, Inc. ("Westar Security") and POI (incorporated by
reference to Exhibit 2.3 to the Current Report on Form 8-K filed by POI and
Monitoring dated November 24, 1997 (the "November 1997 Form 8-K")).
2.4 Assignment and Assumption Agreement (Guardian International, Inc.) dated as of
November 24, 1997, among Western Resources, Westar Capital, Westar Security
and POI (incorporated by reference to Exhibit 2.4 to the November 1997 Form 8-K).
2.5 Stock Purchase Agreement dated as of October 2, 1997, among Centennial Security
Holdings, Inc. ("Centennial"), the shareholders of Centennial and Westar Capital
(incorporated by reference to Exhibit 2.5 to the November 1997 Form 8-K).
2.6 Stock Subscription Agreement dated as of October 4, 1997, between Guardian
International, Inc. ("Guardian") and Westar Capital (incorporated by reference to
Exhibit 2.6 to the November 1997 Form 8-K).
3.5 Fifth Amended and Restated Certificate of Incorporation of POI, as amended
(incorporated by reference to Exhibit 3.1 to the Annual Report on Form 10-K filed
by POI and Monitoring for the year ended September 30, 1997 (the "Fiscal 1997
Form 10-K")).
3.2 By-laws of POI (incorporated by reference to Exhibit 3.1 to
the Quarterly Report on Form 10-Q filed by POI and Monitoring
for the quarter ended March 31, 1996).
3.3 Certificate of Incorporation of Monitoring, as amended (incorporated by reference
to Exhibit 3.2 to the Registration Statement of Form S-3 (Registration Number 333-
09401) originally filed by Monitoring and, inter alia, POI on August 1, 1996 (the
"August 1996 Form S-3")).
3.4 Bylaws of Monitoring (incorporated by reference to Exhibit 3.2 to the Annual
- --------
3 The Commission File Number of POI is 0-24780.
4 The Commission File Number of Protection One Alarm Monitoring is 33-73002-01.
Report on Form 10-K filed by POI and, inter alia, Monitoring
for the year ended September 30, 1994).
4.1 Indenture dated as of May 17, 1995, among Monitoring, as Issuer, POI, inter alia,
as Guarantor, and The First National Bank of Boston ("FNBB"), as Trustee
(incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-4
(Registration No. 33-94684) originally filed by POI and, inter alia, Monitoring on
July 18, 1995 (the "1995 Form S-4")).
4.2 First Supplemental Indenture dated as of July 26, 1996, among Monitoring, as
Issuer, POI, inter alia, as Guarantor and State Street Bank and Trust Company
("SSBTC") as successor to FNBB as Trustee (incorporated by reference to Exhibit
4.2 to the Annual Report on Form 10-K filed by POI and Monitoring for the year
ended September 30, 1996 (the "Fiscal 1996 Form 10-K")).
4.3 Second Supplemental Indenture dated as of October 28, 1996, among Monitoring
as Issuer, POI inter alia, as Guarantor and SSBTC as Trustee (incorporated by
reference to Exhibit 4.3 to the Fiscal 1996 Form 10-K).
4.4 Subordinated Debt Shelf Indenture dated as of August 29, 1996, among Monitoring
as Issuer, POI as Guarantor and SSBTC as Trustee (incorporated by reference to
Exhibit 4.3 to the August 1996 Form S-3).
4.5 Supplemental Indenture No. 1 dated as of September 20, 1996, among Monitoring
as Issuer, POI, inter alia, as Guarantor and SSBTC as Trustee (incorporated by
reference to Exhibit 4.1 to the Current Report on Form 8-K filed by POI and
Monitoring and dated September 20, 1996 (the "September 1996 Form 8-K")).
4.6 Supplemental Indenture No. 2 dated as of October 28, 1996, among Monitoring as
Issuer, POI, inter alia, as Guarantor and SSBTC as Trustee (incorporated by
reference to Exhibit 4.6 to the Fiscal 1996 Form 10-K).
4.7 Amended and Restated Credit Agreement dated as of June 7, 1996, among
Monitoring, Heller Financial, Inc. ("Heller Financial") as Agent and the financial
institutions signatory thereto (the "Lenders") (incorporated by reference to Exhibit
10.2 to the Quarterly Report on Form 10-Q filed by POI and Monitoring for the
quarter ended June 30, 1996).
4.8 Consent and First Amendment to Credit Agreement dated as of September 16, 1996,
among Monitoring, Heller Financial as Agent and the Lenders (incorporated by
reference to Exhibit 10.1 to the September 1996 Form 8-K).
4.9 Second Amendment to Amended and Restated Credit Agreement dated as of March
31, 1997, among Monitoring, Heller Financial as Agent and the Lenders
(incorporated by reference to Exhibit 10.1 to the Quarterly Report on Form 10-Q
filed by POI and Monitoring for the quarter ended March 31, 1997).
4.10 Third Amendment to Amended and Restated Credit Agreement dated as of
September 30, 1997, among Monitoring, Heller Financial as Agent and the Lenders
(incorporated by reference to Exhibit 4.10 to the Fiscal 1997 Form 10-K.)
4.11 Form of Revolving Note executed by Monitoring in favor of each Lender pursuant
to the Amended and Restated Credit Agreement filed as Exhibit 4.7 (incorporated
by reference to Exhibit 4.9 to the Fiscal 1996 Form 10-K).
4.12 Amended and Restated Guaranty dated as of June 7, 1996, executed by POI in favor
of Heller Financial as Agent (incorporated by reference to Exhibit 4.10 to the Fiscal
1996 Form 10-K).
4.13 Amended and Restated Stock Pledge Agreement dated as of June 7, 1996, between
POI and Heller Financial as Agent (incorporated by reference to Exhibit 4.11 to the
Fiscal 1996 Form 10-K).
4.14 Amended and Restated Security Agreement dated as of June 7, 1996, between
Monitoring and Heller Financial as Agent (incorporated by reference to Exhibit 4.12
to the Fiscal 1996 Form 10-K).
4.15 Amended and Restated Continuing Security Interest and Conditional Assignment of
Patents, Trademarks, Copyrights and Licenses dated as of June 7, 1996, between
Monitoring and Heller Financial as Agent (incorporated by reference to Exhibit 4.13
to the Fiscal 1996 Form 10-K).
10.1 Stock Purchase Warrant dated as of September 16, 1991, issued by POI to Merita
Bank. Ltd. (formerly Kansallis-Osake-Pankki) (incorporated by reference to Exhibit
10.25 to the Quarterly Report on Form 10-Q filed by POI and, inter alia, Monitoring
for the quarter ended March 31, 1994).
10.2 Amended and Restated Stockholders' Agreement dated as of August 15, 1994,
among POI and the stockholders of POI named therein (incorporated by reference
to Exhibit 10.42 to the Registration Statement of Form S-1 (Registration No. 33-
81292) originally filed by POI on July 8, 1994).
10.3 Warrant Agreement dated as of November 3, 1993, between Monitoring and United
States Trust Company of New York, as Warrant Agent (incorporated by reference
to Exhibit 4.3 to the Registration Statement on Form S-4 (Registration Statement 33-
73002) originally filed by POI, Monitoring and certain former subsidiaries of
Monitoring on December 15, 1993 (the "1993 Form S-4")).
10.4 Registration Rights Agreement dated as of November 3, 1993, among Monitoring,
POI, certain former subsidiaries of Monitoring and Bear, Stearns & Co., Inc.
(incorporated by reference to Exhibit 4.4 to the 1993 Form S-4).
10.5 Warrant Agreement dated as of May 17, 1995, between POI and The First National
Bank of Boston, as Warrant Agent (incorporated by reference to Exhibit 10.40 to the
1995 Form S-4).
10.6 Common Stock Registration Rights Agreement dated May 17,1995, among POI,
Morgan Stanley & Co. Incorporated and Montgomery Securities (incorporated by
reference to Exhibit 10.41 to the 1995 Form S-4).
10.7 Employment Agreement dated as of November 24, 1997, between Protection One
and James M. Mackenzie, Jr. (incorporated by reference to Exhibit 10.4 to the
November 1997 Form 8-K).
10.8 Employment Agreement dated as of November 24, 1997, between Protection One
and John W. Hesse (incorporated by reference to Exhibit 10.5 to the November 1997
Form 8-K).
10.9 Employment Agreement dated as of November 24, 1997, between Protection One
and John E. Mack, III (incorporated by reference to Exhibit 10.6 to the November
1997 Form 8-K).
10.10 Employment Agreement dated as of November 24, 1997, between Protection One
and Thomas K. Rankin (incorporated by reference to Exhibit 10.7 to the November
1997 Form 8-K).
10.11 Employment Agreement dated as of November 3, 1993, between Monitoring and
George A. Weinstock (incorporated by reference to Exhibit 10.13 to the 1993 Form
S-4).
10.12 Non-Competitive and Non-Solicitation Agreement dated as November 3, 1993,
between Monitoring and George A. Weinstock (incorporated by reference to Exhibit
10.14 to the 1993 Form S-4).
10.13 Consulting Agreement dated as of February 19, 1996, between POI and Dr. Ben Enis
(incorporated by reference to Exhibit 10.7 to the Quarterly Report on Form 10-Q
filed by POI and Monitoring for the quarter ended June 30, 1996).
10.14 1994 Stock Option Plan of POI, as amended (incorporated by reference to Exhibit
10.23 to the Fiscal 1996 Form 10-K).
10.15 1997 Long-Term Incentive Plan of POI (incorporated by reference to Appendix F
to POI's proxy statement dated November 7, 1997).
10.16 Notes Registration Rights Agreement dated as of May 17, 1995, among POI,
Monitoring, Morgan Stanley & Co., Incorporated and Montgomery Securities
(incorporated by reference to Exhibit 4.2 to the 1995 Form S-4).
10.17 Agreement for Purchase and Sale of Assets, dated May 25, 1995, between Alert
Centre, Inc. and Monitoring (incorporated by reference to Exhibit 4.2 to the 1995
Form S-4).
10.18 Agreement to Purchase and Sell Stock dated as of May 23, 1996, among Metrol, the
persons named therein as the "Shareholders" (the "Metrol Shareholders"),
Monitoring and POI (incorporated by reference to Exhibit 2.1 to the Registration
Statement on Form S-3 (Registration NO. 33-5849) originally filed by POI on June
12, 1996 (the "June 1996 Form S-3)).
10.19 Amendment No. 1 to Agreement dated as of June 28, 1996, among Metrol, the
Metrol Shareholders, Monitoring and POI (incorporated by reference to Exhibit 2.2
to the June 1996 Form S-3).
10.20 Escrow Agreement dated May 31, 1996, among Metrol, the Metrol Shareholders,
Monitoring, POI and First National Bank of Denver, N.A. as the Escrow Agent
(incorporated by reference to Exhibit 2.3 to the Current Report on Form 8-K filed
by POI and Monitoring dated June 7, 1996 (the "June 1996 Form 8-K)).*
10.21 Registration Rights Agreement dated as of June 28, 1996, among
POI and the Metrol Shareholders (incorporated by reference to
Exhibit 99.1 to the June 1996 Form 8-K).
10.22 Stock Option Agreement dated as of July 30, 1997, between Western Resources and
Protection One (incorporated by reference to Exhibit 10.1 to the July 1997 Form 8-K).
10.23 Option and Voting Agreement dated as of July 30, 1997, between Western
Resources and Protection One (incorporated by reference to Exhibit 10.2 to the July
1997 Form 8-K).
10.24 Promissory Note dated as of March 2, 1998 between Westar Capital, Inc, and
Protection One (incorporated by reference to Exhibit 99.1 to the Current Report on
Form 8-K filed by POI and Monitoring dated March 17, 1998.)
16.1 Letter from Coopers & Lybrand to the Securities and Exchange Commission re:
Change in Certifying Accountant (incorporated by reference to Exhibit 16 to
Amendment No. 1 to the Current Report on Form 8-K filed by POI and Monitoring
dated February 5, 1998.)
21.1* Subsidiaries of POI and Monitoring.
23.1* Consent of Arthur Andersen LLP.
27* Financial Data Schedule.
* Filed herewith.