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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ________ to _________
0-24780 33-73002-01
(Commission File Number) (Commission File Number)
PROTECTION ONE, INC. PROTECTION ONE ALARM MONITORING, INC.
(EXACT NAME OF REGISTRANT (EXACT NAME OF REGISTRANT
AS SPECIFIED IN ITS CHARTER) AS SPECIFIED IN ITS CHARTER)
Delaware Delaware
(State or Other Jurisdiction (State 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, 6011 Bristol Parkway,
Culver City, California 90230 Culver City, California 90230
(Address of Principal Executive Offices, Address of Principal Executive Offices,
Including Zip Code) Including Zip Code)
(310) 342-6300 (310) 342-6300
(Registrant's Telephone Number, (Registrant's Telephone Number,
Including Area Code) Including Area Code)
Indicate by check mark whether each of the registrants (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that such registrants were required to file such reports) and (2) has been
subject to such filing requirements for the past 90 days.
Yes [X] No [ ]
As of May 8, 1998, Protection One, Inc. had outstanding 83,831,678
shares of Common Stock, par value $0.01 per share. As of such date, Protection
One Alarm Monitoring, Inc. had outstanding 110 shares of Common Stock, par value
$0.10 per share, all of which shares were owned by Protection One, Inc.
Protection One Alarm Monitoring, Inc. meets the conditions set forth in General
Instructions H(1)(a) and (b) for Form 10-Q and is therefore filing this form
with the reduced disclosure format set forth therein.
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PART I
ITEM 1. FINANCIAL STATEMENTS
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollar amounts in thousands, except for share amounts)
MARCH 31, DECEMBER 31,
1998 1997
------------ ------------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents ...................................... $ 11,876 $ 75,556
Marketable securities .......................................... 7,221 5,701
Receivables, net ............................................... 29,254 20,302
Inventories .................................................... 3,555 556
Prepaid expenses ............................................... 556 367
Deferred tax assets, current ................................... 45,078 45,078
Other .......................................................... 35,383 28,320
------------ ------------
Total current assets ...................................... 132,923 175,880
Property and equipment, net .......................................... 18,187 14,934
Subscriber accounts and intangibles, net ............................. 737,316 538,318
Goodwill and trademarks, net ......................................... 1,053,136 682,180
Deferred tax assets .................................................. 29,568 26,158
Other ................................................................ 13,408 9,174
------------ ------------
$ 1,984,538 $ 1,446,644
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable ............................................... $ 7,109 $ 6,235
Accrued liabilities ............................................ 110,062 83,200
Purchase holdbacks ............................................. 48,136 11,444
Acquisition transition costs ................................... 15,529 7,469
Current portion of long-term debt .............................. 8,800 21,217
Borrowing from parent ......................................... 458,886 --
Capital leases ................................................. 574 490
Customer deposits .............................................. 790 --
Deferred revenue ............................................... 42,292 33,900
------------ ------------
Total current liabilities ................................. 692,178 163,955
Long-term debt, net of current portion ............................... 337,444 337,159
Capital leases, net of current portion ............................... 402 604
Deferred tax liability ............................................... 10,788 10,325
Other ................................................................ 3,173 626
Commitments and contingencies ( See Note 7)
Stockholders' equity:
Preferred stock, $.10 par value, 5,000,000 authorized, none
outstanding ...................................................... -- --
Common Stock, $.01 par value, 150,000,000 shares authorized,
83,800,808 and 83,362,938 shares issued and outstanding,
respectively ...................................................... 838 834
Additional paid-in capital ........................................ 988,464 983,082
Accumulated deficit .............................................. (48,749) (49,941)
------------ ------------
Total stockholders' equity ................................ 940,553 933,975
------------ ------------
$ 1,984,538 $ 1,446,644
============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
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PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollar amounts in thousands, except for per share amounts)
THREE MONTHS ENDED MARCH 31,
------------------------------
1998 1997
------------ ------------
(UNAUDITED)
Revenues:
Monitoring and related services ...................... $ 70,774 $ 28,184
Installation and other ............................... 6,021 4,392
------------ ------------
Total revenues .................................. 76,795 32,576
Cost of revenues:
Monitoring and related services ...................... 20,073 7,653
Installation and other ............................... 3,920 942
------------ ------------
Total cost of revenues .......................... 23,993 8,595
------------ ------------
Gross profit .................................... 52,802 23,981
Selling, general and administrative expense ................ 19,435 14,996
Acquisition and transition expenses ........................ 2,044 --
Amortization of intangibles and depreciation expense ....... 21,429 7,850
------------ ------------
Operating income ................................ 9,894 1,135
Other income/expense:
Interest expense, net ................................ 6,555 8,087
Interest expense to parent, net ...................... 4,580 --
Other ................................................ (3,229) 163
------------ ------------
Income (loss) before income taxes .......... 1,988 (7,115)
Income tax (expense) benefit ............................... (795) 2,846
------------ ------------
Net income (loss) .................................... $ 1,193 $ (4,269)
============ ============
Net income (loss) per common share ................... $ 0.01 $ (0.06)
============ ============
Weighted average shares .............................. 83,460 68,673
The accompanying notes are an integral part of these
consolidated financial statements.
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PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollar amounts in thousands)
THREE MONTHS ENDED MARCH 31,
------------------------------
1998 1997
------------ ------------
(UNAUDITED)
Cash flow from operating activities:
Net income (loss) .................................................... $ 1,193 $ (4,269)
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Amortization and depreciation .................................... 21,429 8,382
Accretion of discount note interest .............................. 3,111 --
Deferred income taxes ............................................ 1,196 --
Provision for doubtful accounts .................................. 562 521
Changes in assets and liabilities, net of effects of acquisitions:
Receivables ...................................................... (4,162) 3,512
Inventories ...................................................... (574) (707)
Prepaid expenses and deposits .................................... (802) 215
Accounts payable ................................................. (2,776) (163)
Accrued liabilities .............................................. 1,382 (2,682)
Deferred revenue ................................................. (422) (627)
Other liabilities................................................. 1,911 --
------------ ------------
Net cash provided by operating activities ................... 22,048 4,182
------------ ------------
Cash flows from investing activities:
Purchase/Placement of Installed Security Systems ................. (64,703) (3,356)
Purchases of property and equipment .............................. (3,896) (352)
Purchase of marketable securities ................................ (1,519) --
Purchase of Comsec ............................................... (64,670) --
Purchase of Multimedia ........................................... (209,360) --
Investment in Guardian ........................................... (4,040) --
------------ ------------
Net cash used in investing activities .................. (348,188) (3,708)
------------ ------------
Cash flows from financing activities:
Payments on long-term debt ....................................... (15,243) (897)
Funding from Parent .............................................. 277,198 1,501
Stock options and warrants exercised ............................. 505 --
------------ ------------
Net cash provided by financing activities ................... 262,460 604
------------ ------------
Net (decrease) increase in cash and cash equivalents ........ (63,680) 1,078
Cash and cash equivalents:
Beginning of period .............................................. 75,556 262
------------ ------------
End of period .................................................... $ 11,876 $ 1,340
============ ============
Interest paid during the period ...................................... $ 3,181 $ --
============ ============
Taxes paid during the period ......................................... $ -- $ --
============ ============
The accompanying notes are an integral part of these
consolidated financial statements.
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PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1. BASIS OF CONSOLIDATION AND INTERIM FINANCIAL INFORMATION:
Protection One, Inc., a Delaware corporation (Protection One or the
Company) is principally engaged in the business of providing security alarm
monitoring services, which include sales, installation and related servicing of
security alarm systems for residential and small business subscribers in the
United States. The accompanying unaudited consolidated financial statements
include the accounts of Protection One and its wholly owned subsidiaries. As a
result of the November 24, 1997 reverse purchase merger (the "Combination")
between Protection One and the former Western Resources Security Business
(WRSB), the historical operating results presented for the quarter ended March
31, 1997 are those of WRSB.
As of March 31, 1998, Protection One is an 82.2% owned subsidiary of
Westar Capital, Inc. (Westar Capital), a wholly owned subsidiary of Western
Resources, Inc. (WRI).
The Company's unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for
interim financial information and in accordance with the instructions to Form
10-Q. Accordingly, certain information and footnote disclosures normally
included in financial statements presented in accordance with generally
accepted accounting principles have been condensed or omitted. These financial
statements should be read in conjunction with audited financial statements and
notes thereto for the year ended December 31, 1997 included in the Company's
Annual Report on Form 10-K filed with the Securities and Exchange Commission on
March 30, 1998.
In the opinion of management of the Company, all adjustments, consisting
only of normal recurring adjustments considered necessary for a fair
presentation, have been included. The results of operations for the three month
period ended March 31, 1998 are not necessarily indicative of the results to be
expected for the full year.
2. PROPERTY AND EQUIPMENT:
Property and equipment are summarized as follows:
MARCH 31, 1998 DECEMBER 31, 1997
-------------- -----------------
Office equipment $ 8,313 $ 5,690
Furniture and fixtures 4,596 4,009
Data processing and telecommunication 5,931 4,634
Other 3,599 3,777
-------------- -----------------
22,439 18,110
Less accumulated depreciation and amortization 4,252 3,176
-------------- -----------------
$ 18,187 $ 14,934
============== =================
Included in furniture and fixtures at March 31, 1998 and December 31, 1997,
are $980 and $452, respectively, of assets under capital leases. Virtually all
property and equipment are depreciated over estimated useful lives ranging from
five to ten years.
3. SUBSCRIBER ACCOUNTS:
Subscriber accounts (at cost) consist of the following:
MARCH 31, 1998 DECEMBER 31, 1997
-------------- -----------------
Acquired subscriber accounts $ 781,812 $ 566,811
Less accumulated amortization 44,496 28,493
-------------- -----------------
$ 737,316 $ 538,318
============== =================
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Reconciliation of activity for acquired subscriber accounts is as follows:
QUARTER ENDED YEAR ENDED
MARCH 31, 1998 DECEMBER 31, 1997
-------------- -----------------
Balance, beginning of period $ 566,811 $ 270,038
Acquisition of subscriber accounts 216,101 296,822
Charges against acquisition holdbacks (1,100) (49)
-------------- -----------------
Balance, end of period $ 781,812 $ 566,811
============== =================
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 March 31, 1998 and December
31, 1997, purchase holdbacks were $48,136 and $11,444 respectively.
4. FINANCING:
LONG TERM FINANCING:
Long-term debt is comprised of the following:
MARCH 31, 1998 DECEMBER 31, 1997
-------------- -----------------
Senior Subordinated Discount Notes $ 195,038 $ 191,926
Convertible Senior Subordinated notes 103,500 103,500
Samco Financing 47,706 62,950
Less current portion (8,800) (21,217)
-------------- -----------------
$ 337,444 $ 337,159
============== =================
Senior Subordinated Discount Notes
The Senior Subordinated Discount Notes are unsecured subordinated
obligations of the Company's wholly owned subsidiary, Protection One Alarm
Monitoring, Inc. ("Monitoring") limited to $166 million aggregate principal
amount at maturity, and will mature on June 30, 2005. In connection with the
Combination, 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.
Convertible Senior Subordinated Notes
The Convertible Senior Subordinated 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 Combination, the Convertible Notes
maintain a conversion price of approximately $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,
and commenced on 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.
Samco Financing
Rights to certain of the Company's security alarm monitoring contracts (the
"Contracts") were previously sold to investors by Westinghouse Security (a
predecessor to the Company for accounting purposes). For financial reporting
purposes, the transaction was treated as a financing arrangement and the
proceeds received were recorded as long-term debt. Generally, principal and
interest payments on the debt consist of 65% of the monitoring revenue under the
contracts. Subject to minimum requirements, the Company has the right but not
the obligation to repurchase the Contracts at a fair market value price. During
February 1998, the Company exercised its rights and retired one of the three
outstanding tranches at a purchase price of approximately $15.2 million.
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SHORT TERM FINANCING:
Revolving Credit Facility
At December 31, 1997, Protection One had a $100 million revolving credit
facility (the "Revolving Credit Facility") which was to mature 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 2.5%. Borrowings made under the
Revolving Credit Facility were 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 Combination. The facility was
terminated in February 1998.
Borrowing from Parent
As of March 31, 1998, Protection One had $458,886 in short-term debt
payable to Westar Capital, which bears interest at 6 11/16% and is due June
1, 1998. The borrowings were composed of a $274,000 working capital loan, which
was used for the purchase of Multimedia and Comsec (each as defined), as well as
a $184,886 note, which was used for the purchase of Network (as defined). As of
April 1, 1998, the Company entered into a $600 million senior credit facility
with Westar Capital to refinance such promissory note and to replace a previous
credit facility ("the "Senior Credit Facility.")
5. INVESTMENTS IN UNCONSOLIDATED SUBSIDIARY:
At March 31, 1998, Protection One owned common stock and preferred stock
representing a 43% ownership in Guardian International, Inc. ("Guardian") at an
aggregate cost of $13 million. 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 three months ended, March 31, 1998, Protection One's
equity in the loss of Guardian was $95. For the three months ended March 31,
1998, Protection One received $135 of preferred dividends in the form of
additional preferred stock.
6. MERGERS AND ACQUISITIONS:
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 purchased Network, effective January 1, 1998, for a purchase
price 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. 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, which was
paid off at closing. The Company funded these acquisitions with promissory note
financing provided by Westar Capital.
The following table shows the net cash paid for the above acquisitions:
Network
Comsec Multi-Family Multimedia Total
------- ------------ ---------- --------
Assets acquired $92,092 $185,961 $270,254 $548,307
Liabilities assumed (26,443) (185,961) (60,894) (273,298)
------- -------- -------- --------
Cash paid 65,649 -- 209,360 275,009
Less: cash acquired (979) -- -- (979)
------- -------- -------- --------
Net cash paid $64,670 $ -- $209,360 $274,030
======= ======== ======== ========
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The following unaudited pro forma consolidated results of operations for
the quarters ended March 31, 1998 and 1997, assume these material acquisitions
occurred as of the beginning of the respective years:
PRO FORMA
QUARTER ENDED
MARCH 31,
--------------------------
1998 1997
---------- ----------
Revenue $91,868 $88,745
Net loss before tax (1,269) (16,796)
Per share (.02) (.24)
Net loss (774) (10,246)
Per share (.01) (.15)
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. The acquisitions have been accounted for under the purchase accounting
method and asset and liabilities have been recorded as estimates of fair market
values based on preliminary purchase price allocations.
7. 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:
Years ending December 31,
1998 $ 6,592
1999 4,874
2000 3,452
2001 2,794
2002 2,504
Thereafter 6,438
-------
$26,654
=======
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 them. Management does
not believe the ultimate disposition of the matter will have a material adverse
impact on 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 upon
the Company's combined financial position or results of operations.
8. SUBSEQUENT EVENTS:
On April 17, 1998, Protection One filed with the Securities and Exchange
Commission a shelf registration on Form S-3 related to $400 million of equity
and/or debt securities to be issued by the Company from time to time as
determined by market conditions.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Unless otherwise indicated or the context otherwise requires, reference to
"Protection One" or "the Company" are to Protection One, Inc., a Delaware
corporation, and its direct and indirect, wholly owned subsidiaries; "POI" means
solely Protection One, Inc., excluding its subsidiaries; "Monitoring" means
Protection One Alarm Monitoring, Inc., a direct, wholly owned subsidiary of
Protection One, Inc.; "WestSec" means WestSec, Inc., a Kansas corporation and
wholly owned subsidiary of Monitoring; "Westar" means Westar Security, Inc. a
Kansas corporation and wholly owned subsidiary of POI. POI's sole assets are,
and POI operates solely through, its investments in Monitoring and Westar and
its other wholly owned subsidiaries. "Combination" means the transaction
consummated on November 24, 1997 in which the Company combined with WestSec and
Westar.
Certain matters discussed in this Item 2 are "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 statement
includes such words 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 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. Information with respect to these risks and
uncertainties is included in POI's prospectus supplement dated May, 1998, which
information is incorporated herein by reference.
OVERVIEW
Protection One is a leading provider of security alarm monitoring
and related services in the United States, with approximately 1.2 million
subscribers as of May 1998. The Company has grown rapidly by participating in
both the expansion and the consolidation of the security alarm monitoring
industry.
Protection One's revenues consist primarily of recurring payments for
monitoring and related services. Protection One 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.
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. Of
the Company's customer base, approximately 62% reside in single-family
households and approximately 19% reside in multi-family complexes such as
apartments and condominiums. Commercial subscribers represent 12% of the
customer base and subscribers served by independent alarm dealers that
subcontract monitoring services to the Company represent 7% of the customer
base. 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.
THREE MONTHS ENDED MARCH 31, 1998 COMPARED TO THREE MONTHS ENDED MARCH 31, 1997
GENERAL. Results for the three months ended March 31, 1998 (the "first
quarter of 1998") reflect the operations of Protection One following the
Combination and the 1998 Acquisitions (as defined), while results for the
comparable period in 1997 reflect only the operations of Westar and WestSec.
During the first quarter of 1998, the Company completed three significant
acquisitions. Effective January 1, 1998, the Company acquired Network
Multi-Family Security Corporation ("Network"), the largest provider of security
alarm monitoring to multi-family dwellings with approximately 200,000
subscribers. On March 2, 1998, the Company acquired 147,000 subscribers and
related assets of Multimedia Security Services, Inc ("Multimedia') and on March
17, 1998, the Company completed the acquisition of Comsec Narragansett Security,
Inc. ("Comsec"), with its 30,000 subscribers. The acquisitions of Comsec,
Multimedia and Network are referred to as the "1998 Acquisitions." As a result,
in accordance with applicable purchase accounting rules, results for the first
quarter of 1998 include the financial results of Network for the entire period,
Multimedia since March 2, 1998 and Comsec since March 17, 1998. Increases in
revenues and expense items discussed below are attributable to three factors, as
appropriate: (i) changes in the financial results of Westar and WestSec; (ii)
the Combination; and (iii) the 1998 Acquisitions. Discussion of results in
future periods may not
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include specific discussion of contributions from the 1998 Acquisitions or the
Combination due to the integration of financial reporting.
REVENUES for the first quarter of fiscal 1998 increased by
approximately $44.2 million, or 135.7%, to $76.8 million from $32.6 million for
the comparable period in 1997 (the "first quarter of fiscal 1997"). Monitoring
and related services revenues increased by approximately $42.6 million, or
151.1%. Substantially all of the increase is due to the Combination and
approximately 10% of such increase is due to the 1998 Acquisitions. Installation
and other revenues increased by $1.6 million, or 37.1% to $6.0 million from $4.4
million, reflecting a decrease in Westar and WestSec installation revenues,
offset by additional installation revenues from the 1998 Acquisitions. The
decline in Westar and WestSec installation revenues reflects the Company's
conversion of substantially all sales and installation activities previously
conducted by an internal sales force to the Dealer Program.
COST OF REVENUES for the first quarter of fiscal 1998 increased by
approximately $15.4 million, or 179.1%, to $24.0 million from $8.6 million. Cost
of revenues as a percentage of total revenue increased to 31.2% for the first
quarter of fiscal 1998 from 26.4% for the comparable period in 1997. Monitoring
and related services expenses increased by approximately $12.4 million, or
162.3%, primarily due to the Combination. Monitoring and related services
expenses as a percentage of monitoring and related services revenues increased
to 28.4% for the first quarter of fiscal 1998 from 27.2% in the comparable
period in 1997, due to the addition of several service centers resulting from
acquisition activity, as well as a decline in MRR per subscriber. The decline in
MRR per subscriber reflects the addition of multi-family subscribers from
Network, which subscribers carry an average MRR of approximately $10.00. Other
cost of revenues increased by $3.0 million, or 316%, reflecting primarily
additional installation activities from the 1998 Acquisitions.
GROSS PROFIT for the first quarter of fiscal 1998 was approximately
$52.8 million, representing an increase of $28.8 million, or 120.2%, over the
$24.0 million of gross profit recognized in the comparable period in fiscal
1997. Such increase is primarily due to the Combination and the 1998
Acquisitions. Gross profit as a percentage of total revenues was 68.8% for the
first quarter of fiscal 1998 compared to 73.6% for the comparable period in
1997. The decline in gross profit as a percentage of revenues is due to the cost
of revenues factors noted above.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES ("S,G&A") rose to $19.4
million in the first quarter of fiscal 1998, an increase of approximately $4.4
million, or 29.6%, over S,G&A in the comparable period in 1997. Substantially
all of the increase is due to the Combination and the 1998 Acquisitions. Such
figure as a percentage of total revenues decreased from 46.0% in the first
quarter of fiscal 1997 to 25.3% in the first quarter of fiscal 1998. The
substantial decline in S,G&A as a percentage of total revenues reflects the
significant reduction in Westar and WestSec installation activities, as well as
the integration of branch operations and corporate administrative functions
pursuant to the Combination.
ACQUISITION AND TRANSITION EXPENSES for the first quarter of fiscal
1998 totaled $2.0 million, as compared to no expenses in the comparable period
in 1997. The Company expects acquisition and transition expenses to increase in
future periods due to the Company's efforts to integrate the 1998 Acquisitions
and to support the national expansion of its Dealer Program.
AMORTIZATION OF INTANGIBLES AND DEPRECIATION EXPENSE was $21.4 million
for the first quarter of fiscal 1998, an increase of $13.6 million, or 173.0%
over $7.9 million in the comparable period in 1997. The increase is due
primarily to the Combination and the 1998 Acquisitions, which transactions
caused the Company to record the acquired net assets at fair value and the
excess purchase price, if any, over book value as goodwill. As a result of the
Combination, Protection One recorded approximately $464.0 million of goodwill.
Subsequently, the Company added approximately $161.1 million to subscriber
intangibles and $352.2 million to goodwill in connection with the 1998
Acquisitions. The Company anticipates amortization of intangibles and
depreciation expense to increase substantially in the second quarter of 1998,
reflecting the impact of the acquisitions of Comsec and Multimedia for the
entire quarter.
OTHER INCOME (EXPENSE) totaled $(7.9) million of expense in the first
quarter of 1998, as compared to $(8.3) million of expense in the comparable
period in 1997. Interest expense increased to $11.1 million during the period,
reflecting additional borrowings to complete the 1998 Acquisitions, offset by
repayment of borrowings in connection with the Combination. Interest expense was
reduced by other income of $3.2 million during the first quarter of 1998,
reflecting a gain on repurchase of certain contracts (see Note 4 of Notes to
Consolidated Financial Statements.)
BALANCE SHEET DATA. At March 31, 1998, the Company's working capital
deficit was $100.4 million (excluding the short-term debt due to a subsidiary of
Western Resources, Inc. of $458.9 million) compared to a working capital surplus
of $11.9 million at December 31, 1997. This increase in the working capital
deficit of $112.3 million is primarily due to a decrease in cash and cash
equivalents of $63.7 million, increases in purchase holdbacks of $ 36.7 million,
accrued liabilities of $26.9 million, deferred revenues of $8.4 million and
acquisition transition costs of $8.1 million offset by increases in
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receivables of $9.0, other assets of $7.1 million and inventory of $3.0
million. Goodwill and trademarks and subscriber accounts and intangibles, net
increased to $1.8 billion at March 31, 1998 from $1.2 billion at December 31,
1997. This increase of approximately $572.8 million, or 46.9% reflects the
addition of approximately 375,000 subscribers in the 1998 Acquisitions. Total
stockholders' equity increased approximately $6.6 million to $940.6 million
from $934.0 million. The increase in such figure reflects the issuance of
approximately $4.9 million of common stock in connection with an acquisition
and net income for the three months ended March 31, 1998 of $1.2 million.
LIQUIDITY AND CAPITAL RESOURCES
General. The Company has financed its operations and growth primarily
from operating cash flows, supplemented by advances from its parent, Western
Resources, Inc. ("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 Combination: (i)
$114.1 million to make a cash distribution to holders of record of Common Stock
as of November 24, 1997, holders of 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 Security Holdings, Inc.; and (iii) $61.6
million to repay borrowings under its revolving credit facility. The remaining
$97.3 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 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 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.
On February 4, 1998, Protection One announced its decision to exercise
its option to purchase 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 purchased Network, effective
January 1, 1998, for a purchase price of approximately $180 million. On March 2,
1998 Protection One completed the acquisition of 147,000 subscribers and related
assets of Multimedia for a purchase price of approximately $233 million. On
March 17, 1998, Protection One completed the acquisition of Comsec for a cash
purchase price of approximately $45 million and the assumption of $15 million of
debt. The Company funded these acquisitions with promissory note financing by
Westar Capital, Inc. ("Westar Capital"), a wholly owned subsidiary of Western
Resources.
Material Commitments. The Company has several long-term commitments.
The 6 3/4% Senior Subordinated Convertible 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 13 5/8% 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 4 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 Combination,
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 the
subscriber accounts for which certain rights were transferred to a third party.
Protection One has the right, but not the obligation, to purchase the rights to
the contracts as the underlying third party notes mature. The Company made
payments of approximately $15.2 million in February 1998 to repurchase a portion
of such contracts.
As discussed above, Westar Capital extended two promissory notes to the
Company to enable it to fund the 1998 Acquisitions. The 6 11/16% promissory
notes had an aggregate principal amount of $458.9 million at March 31, 1998 and
were due June 1, 1998. As of April 1, 1998, the Company converted its promissory
notes into a $600 million senior credit facility
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with Westar Capital ("the Senior Credit Facility.") The Company may borrow,
subject to certain financial covenants and restrictions, at varying interest
rates ranging from LIBOR plus 1.125% to the Prime Rate plus 1.125%. The Senior
Credit Facility matures on March 30, 1999.
The Company generated $22.0 million of net cash provided by operating
activities for the three months ended March 31, 1998, compared to the $4.2
million net cash provided by operating activities in the three months ended
March 31, 1997. The increase in net cash provided by operating activities
reflects the Company's substantial growth in due to the Combination and, to a
lesser extent, the 1998 Acquisitions.
The Company used $348.2 million of net cash in investing activities
compared to the use of $3.7 million for the comparable period in 1997. Investing
activities during the three months ended March 31, 1998 included the acquisition
of Comsec and Multimedia as well as dealer program purchases.
The Company generated $262.5 million of net cash through financing
activities for the three months ended March 31, 1998 compared to generating $0.6
million for the three months ended March 31, 1997. The Company received funding
of approximately $277.2 million from Westar Capital and reduced other
indebtedness by approximately $15.2 million.
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 1998 of approximately $22.5 million, including $5.0 million to
upgrade branch operations, $12.5 for integration activities, and $5.0 million
for service center improvements and other capital items.
Tax Matters. As a result of the Combination, Protection One will be
consolidated into future returns filed by its parent, WRI. The two parties have
entered into a tax sharing agreement, whereby WRI will make cash payments to the
Company for current tax benefits utilized for income tax return purposes and
will require cash payments from the Company for current tax expenses incurred
for income tax return purposes. This arrangement has allowed Protection One to
provide a current tax benefit for the year ended December 31, 1997 as well as
the quarter ended March 31, 1998.
On a go-forward basis, if and when the Company, or its parent,
generates income for tax return purposes, it will proportionately over time
utilize existing net operating loss carryforwards in amounts up to approximately
$50 million. Currently, the deferred tax assets related to the net operating
loss carryforwards are fully reserved due to uncertainty as to their future
realizability. However, when net operating loss carryforwards are utilized, the
relief of the corresponding reserve will not create a benefit, but, as required
by generally accepted accounting principles, will reduce the Company's goodwill
balances. The net financial statement of this treatment will cause the Company
to recognize deferred tax expense it might otherwise not recognize.
YEAR 2000 ISSUE
The Company is reviewing its computer and signal processing systems to
identify and correct any components that could be affected by the change of the
date to January 1, 2000 (the "Year 2000 Issue".) Results of the review thus far
indicate that key infrastructure components including processing systems,
application software and telecommunications systems are unaffected by the Year
2000 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 Year 2000 Issue does not pose material
operational problems and the cost associated with the assessment of risk and the
execution of corrective action will not be material.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
None.
ITEM 2. CHANGES IN SECURITIES.
Pursuant to an Asset Purchase Agreement dated as of March 13, 1998 (the
"Asset Purchase Agreement") with Central Security Corporation and Ronald H.
Cats, on March 13, 1998, Protection One Alarm Monitoring, Inc. ("Monitoring")
purchased substantially all of the assets of the business. As a part of the
consideration for the acquisition, Monitoring delivered to the sole stockholder
an aggregate of 379,767 shares of Common Stock ("the Shares") newly issued by
POI, which number was derived by dividing $4,865,765 by an average of the
closing price of the Common Stock on the Nasdaq National Market during the
period of the 10 most recent trading days on the second day prior to the signing
of the Asset Purchase Agreement with Mr. Cats.
The offer and sale of the Shares was not registered under the
Securities Act in reliance on Section 4(2) thereof and Rule 506 thereunder. Mr.
Cats certified to POI that he is an "accredited investor" as such term is
defined in Rule 501 under the Securities Act and was otherwise able to bear the
economic risk of the investment, and was provided with registration statements
and reports of, and access to information concerning, POI. No underwriter
participated in the offer or sale of any of these securities and no
underwriter's fees or commissions were paid.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K.
Exhibits. The following exhibits are filed with this Current Report on
Form 10-Q or incorporated by
reference.
Exhibit Number Exhibit Description
10.1 Promissory Note dated as of March 2, 1998 between Westar
Capital, Inc., and Protection One Alarm Monitoring Inc.
(incorporated by reference to Exhibit 99.1 to the Current
Report on Form 8-K filed by POI and Monitoring dated March 17,
1998).
10.2 Assignment, Assumption, and Guaranty Agreement dated as of
January 1, 1998 between Westar Capital, Inc. and Protection
One Alarm Monitoring, Inc. whereby Westar Capital assigned
its interest in Network Holdings, Inc. to Protection One Alarm
Monitoring, Inc.*
10.3 Asset Purchase Agreement Among Multimedia Security Service,
Inc., Multimedia Cablevision, Inc. and Protection One Alarm
Monitoring, Inc. Dated January 15, 1998.*
27.1 Financial Data Schedule.*
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* Filed herewith
(b) Form 8-K.
8-K filed January 21, 1998 reporting in Item 5 of the Form 8-K,
registrant's agreement to acquire the assets of Multimedia Security
Services, Inc. (incorporated by reference thereto.)
8-K filed January 26, 1998 reporting in Item 4 of the Form 8-K , a
change in the registrant's certifying accountants to Arthur Andersen
L.L.P. (incorporated by reference thereto.)
8-K/A filed February 6, 1998, amending the 8-K filed January 26, 1998
by attaching in Item 7, a letter from Coopers & Lybrand, L.L.P. re:
Change in Certifying Accountants (incorporated by reference thereto.)
8-K filed February 12, 1998, reporting in Item 2 of the Form 8-K,
registrant's acquisition of the stock of Network Holdings, Inc.
(incorporated by reference thereto.)
8-K filed March 17, 1998, reporting in Item 2 of the Form 8-K,
registrant's acquisition of the stock of Comsec Narragansett Security,
Inc. (incorporated by reference thereto.)
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrants have duly caused this report to be signed on their behalf by the
undersigned thereunto duly authorized.
May 6, 1998 PROTECTION ONE, INC.
PROTECTION ONE ALARM MONITORING, INC.
By: /s/ John W. Hesse
-------------------------------------
John W. Hesse
Executive Vice President
and Chief Financial Officer
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Exhibit List
Exhibit Number Exhibit Description
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10.2 Assignment, Assumption, and Guaranty Agreement dated as of
January 1, 1998 between Westar Capital, Inc. and Protection
One Alarm Monitoring, Inc. whereby Westar Capital assigned
its interest in Network Holdings, Inc. to Protection One Alarm
Monitoring, Inc.
10.3 Asset Purchase Agreement Among Multimedia Security Service,
Inc., Multimedia Cablevision, Inc. and Protection One Alarm
Monitoring, Inc. Dated January 15, 1998.
27.1 Financial Data Schedule.
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