1
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 June 30, 1997
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 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)
Indicate by check mark whether each of the registrants (1) has filed
all reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that such registrant was required to file such reports) and (2) has been subject
to such filing requirements for the past 90 days. Yes [X] No [ ]
As of August 8, 1997, Protection One, Inc. had outstanding 14,081,418
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)
SEPTEMBER 30, JUNE 30,
1996 1997
------------- -----------
(UNAUDITED)
ASSETS
Current assets:
Cash and cash equivalents.................................. $ 1,782 $ 1,105
Restricted cash............................................ 3,680 4,063
Receivables, net........................................... 12,743 15,167
Inventories................................................ 1,920 1,785
Prepaid expenses........................................... 1,221 1,722
Deferred tax asset......................................... 7,561 9,506
-------- --------
Total current assets.................................. 28,907 33,348
Property and equipment, net...................................... 9,952 14,747
Subscriber accounts and intangibles, net......................... 257,354 308,925
Assets held for sale............................................. 775 -
Deposits......................................................... 648 547
-------- --------
$297,636 $357,567
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable........................................... $ 2,278 $ 3,047
Accrued salaries, wages and benefits....................... 1,495 1,377
Other accruals............................................. 1,048 2,317
Purchase holdbacks......................................... 9,942 13,616
Acquisition transition costs............................... 4,326 6,137
Other current liabilities.................................. 1,623 536
Capital leases payable..................................... -- 481
Deferred revenue........................................... 13,827 16,391
-------- --------
Total current liabilities............................. 34,539 43,902
Long-term debt, net of current portion........................... 225,650 279,750
Deferred tax liability........................................... 7,561 8,180
Other liabilities................................................ 1,059 1,375
-------- --------
Total liabilities..................................... 268,809 333,207
-------- --------
Commitments and contingencies (Note 8)
Stockholders' equity:
Common Stock, $.01 par value, 40,000,000 shares authorized,
12,914,783 and 13,810,039 shares issued and outstanding,
at September 30, 1996 and June 30, 1997, respectively......... 129 138
Additional paid-in capital....................................... 79,767 90,400
Accumulated deficit.............................................. (51,069) (66,178)
-------- --------
Total stockholders' equity............................ 28,827 24,360
-------- --------
$297,636 $357,567
======== ========
The accompanying notes are an integral part of the
consolidated financial statements.
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3
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Dollar amounts in thousands, except for per share amounts)
NINE MONTHS ENDED JUNE 30,
---------------------------------
1996 1997
-------- ---------
(UNAUDITED)
Revenues:
Monitoring and related services............................ $ 48,550 $ 69,391
Other...................................................... 3,245 2,563
-------- --------
Total revenues........................................ 51,795 71,954
Cost of revenues:
Monitoring and related services............................ 13,583 19,054
Other...................................................... 1,990 1,715
-------- --------
Total cost of revenues................................ 15,573 20,769
-------- --------
Gross profit.......................................... 36,222 51,185
Selling, general and administrative expenses..................... 10,594 14,255
Acquisition and transition expenses.............................. 3,049 4,207
Amortization of intangibles and depreciation expense............. 17,358 27,628
-------- --------
Operating income...................................... 5,221 5,095
Other expenses:
Interest expense, net...................................... 3,052 6,450
Amortization of OID and debt issuance costs................ 13,159 15,267
Loss on sales of assets.................................... 19 --
Loss on assets held for sale............................... -- 231
-------- --------
Loss before income taxes.............................. (11,009) (16,853)
Income tax (benefit) expense..................................... 90 (1,744)
-------- --------
Net loss................................................... (11,099) (15,109)
Preferred stock dividends........................................ 248 --
-------- --------
Loss attributable to common stock.......................... $(11,347) $(15,109)
======== ========
Net loss per common share.................................. $ (1.06) $ (1.11)
The accompanying notes are an integral part of the
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 June 30,
1996 1997
------- -------
(unaudited)
Revenues:
Monitoring and related services............................ $17,585 $24,025
Other...................................................... 1,032 854
------- -------
Total revenues........................................ 18,617 24,879
Cost of revenues:
Monitoring and related services............................ 4,730 6,480
Other...................................................... 616 569
------- -------
Total cost of revenues................................ 5,346 7,049
------- -------
Gross profit.......................................... 13,271 17,830
Selling, general and administrative expenses..................... 3,680 4,721
Acquisition and transition expenses.............................. 1,122 1,574
Amortization of intangibles and depreciation expense............. 6,516 10,063
------- -------
Operating income...................................... 1,953 1,472
Other expenses:
Interest expense, net...................................... 1,196 2,395
Amortization of OID and debt issuance costs................ 4,527 5,258
Loss on assets held for sale............................... -- 64
------- -------
Loss before income taxes.............................. (3,770) (6,245)
Income tax expense............................................... 90 42
------- -------
Net loss................................................... (3,860) (6,287)
Preferred stock dividends........................................ -- --
------- -------
Loss attributable to common stock.......................... $(3,860) $(6,287)
======= =======
Net loss per common share.................................. $ (0.31) $ (0.46)
The accompanying notes are an integral part of the
consolidated financial statements.
4
5
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(DOLLAR AMOUNTS IN THOUSANDS)
Nine months ended June 30,
1996 1997
-------- ----------
(unaudited)
Cash flow from operating activities:
Net loss ...................................................... (11,099) $(15,109)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation............................................... 1,250 2,274
Amortization of intangibles............................... 16,108 25,353
Amortization of OID and debt issuance costs................ 13,159 15,267
Deferred tax benefit....................................... -- (1,326)
Provision for doubtful accounts............................ 1,518 2,426
Changes in assets and liabilities, net of effects
of acquisitions:
Receivables................................................ (5,359) (4,666)
Inventories................................................ 528 174
Prepaid expenses and deposits.............................. (505) (437)
Accounts payable........................................... 681 769
Accrued liabilities........................................ (389) 707
Deferred revenue........................................... 663 676
-------- -------
Net cash provided by operating activities............. 16,555 26,108
-------- -------
Cash flows from investing activities:
Cash restricted for acquisitions........................... -- (383)
Purchases of property and equipment........................ (4,706) (5,744)
Sales of assets previously held for sale................... -- 205
Acquisitions, net of cash received......................... (72,275) (56,182)
Payments on purchase holdbacks............................. (133) (1,099)
Deferred acquisition payments.............................. (1,438) (1,470)
Acquisition transition costs............................... (2,272) (1,632)
-------- -------
Net cash used in investing activities................. (80,824) (66,305)
-------- -------
Cash flows from financing activities:
Payments on long-term debt................................. (23,828) (7,500)
Proceeds from long-term debt............................... 72,619 47,579
Debt and equity issuance costs............................. (666) (753)
Issuance of preferred and common stock and warrants........ 23,483 194
Cash dividends paid........................................ (248) --
-------- -------
Net cash provided by financing activities............. 71,360 39,520
-------- -------
Net increase (decrease) in cash and cash equivalents.. 7,091 (677)
Cash and cash equivalents:
Beginning of period........................................ 1,256 1,782
-------- -------
End of period.............................................. $ 8,347 $ 1,105
======== =======
Interest paid during the period................................ $ 3,181 $ 4,727
======== =======
Taxes paid during current year (see Note 6).................... $ 93 $ 1,489
======== =======
The accompanying notes are an integral part of the
consolidated financial statements.
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PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS
(Dollar amounts in thousands)
1. BASIS OF CONSOLIDATION AND INTERIM FINANCIAL INFORMATION:
The accompanying unaudited consolidated financial statements include the
accounts of Protection One, Inc. ("POI") and its wholly owned subsidiary
Protection One Alarm Monitoring, Inc. ("Monitoring" and together with POI, the
"Company"). The assets, results of operations and stockholder's equity of
Monitoring comprise substantially all the assets, results of operations and
stockholders' equity of the Company on a consolidated basis. POI's principal
assets and sole operations are in and through its investment in Monitoring. All
significant intercompany balances and transactions have been eliminated in
consolidation. Separate financial statements for Monitoring have not been
provided because the Company does not believe such separate financial statements
are material to investors. Summarized consolidated financial information of
Monitoring is included in Note 9. 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 which mandate adherence to Rule 10-01 of Regulation
S-X. 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 the audited financial statements and notes
thereto for the year ended September 30, 1996 included in the Company's Annual
Report on Form 10-K filed with the Securities and Exchange Commission on
December 31, 1996. 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 and
nine month periods ended June 30, 1997 are not necessarily indicative of the
results to be expected for the full year.
Certain items in the September 30, 1996 financial statements have been
reclassified to conform to the June 30, 1997 presentation. See "Overview -
Changes in Presentation Format" included in Item 2 hereof.
Recent Accounting Pronouncements: In February 1997, the Financial
Accounting Standards Board (FASB) issued Statement of Financial Accounting
Standards (SFAS) No. 128 - "Earnings per Share", which is required to be adopted
in 1997. The unaudited pro forma "basic" and "diluted" earnings per share under
the new standard do not differ from the earnings per share calculated under the
existing standard.
In June 1997, FASB issued SFAS No. 130 - "Reporting Comprehensive Income",
which is required to be adopted for fiscal years beginning after December 15,
1997. The statement requires that an enterprise (a) classify items of other
comprehensive income by their nature in a financial statement and (b) display
the accumulated balance of other comprehensive income separately from retained
earnings and additional paid in capital in the equity section of a statement of
financial position. As the required disclosures will be supplementary to the
existing required financial information, the new pronouncement will not affect
previously reported results of operations.
2. RECEIVABLES:
Receivables, which consist primarily of trade accounts receivable, of
$24,393 at June 30, 1997 and $18,284 at September 30, 1996, have been reduced by
allowances for doubtful accounts of $9,226 and $5,541, respectively. Included in
receivables and deferred revenue at June 30, 1997 and September 30, 1996 are
invoices billed in advance of the periods in which services are provided
totaling $8,645 and $7,309, respectively. The provisions for doubtful accounts
for the nine months ended June 30, 1997 and 1996 were $2.4 million and $1.5
million, respectively. Bad debt expense increased from 2.9% to 3.3% of revenues
for the nine month periods ending June 30, 1996 and June 30, 1997,
respectively. This increase reflects a stricter application of the Company's
past due policies.
6
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PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (cont.)
(Dollar amounts in thousands)
3. SUBSCRIBER ACCOUNTS AND INTANGIBLES:
Subscriber accounts and intangibles (at cost) consist of the following:
September 30, June 30,
1996 1997
------------- -----------
Acquired subscriber accounts.......................... $298,767 $74,427
Debt issuance costs................................... 11,847 12,805
Goodwill and other.................................... 2,497 4,049
-------- -------
313,111 391,281
Less accumulated amortization......................... (55,757) (82,356)
-------- -------
$257,354 $308,925
======== ========
Reconciliation of acquired subscriber accounts:
Nine Months
Year Ended Ended
September 30, June 30,
1996 1997
------------- -----------
Balance, beginning of period.......................... $184,463 $298,767
Acquisition of subscriber accounts.................... 119,629 79,132
Charges against purchase holdbacks.................... (5,325) (3,472)
-------- --------
Balance, end of period................................ $298,767 $374,427
======== ========
In conjunction with certain purchases of subscriber accounts, the Company
holds back a portion of the purchase price to offset qualifying attrition of the
acquired subscriber accounts for a specified period as provided for in the
purchase agreements, and for purchase price settlements of assets acquired and
liabilities assumed.
Reconciliation of purchase holdbacks:
Nine Months
Year Ended Ended
September 30, June 30,
1996 1997
------------- -----------
Balance, beginning of period.......................... $ 4,949 $ 9,942
Purchase holdback additions........................... 13,850 8,352
Charges against subscriber accounts................... (5,325) (3,472)
Cash paid to sellers.................................. (3,532) (1,054)
Other................................................. -- (152)
-------- --------
Balance, end of period................................ $ 9,942 $ 13,616
======== ========
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8
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (cont.)
(Dollar amounts in thousands)
4. LOSS PER COMMON SHARE:
The computation of fully diluted net loss per share for each of the
periods presented was antidilutive; as such, no presentation of fully diluted
earnings per share has been included in the consolidated statements of
operations. The weighted average shares outstanding used in the computation of
the net loss attributable to common shares are as follows:
Nine Months Ended Three Months Ended
June 30, June 30,
--------------------------- --------------------------
1996 1997 1996 1997
---------- ---------- ---------- ---------
Common Stock 10,749,983 13,632,675 12,330,317 13,744,869
5. DIVIDEND RESTRICTIONS:
The Company's Amended and Restated Credit Agreement (the "Credit
Agreement") governing its revolving credit facility (the "Revolving Credit
Facility") and the Indenture governing Monitoring's 13 5/8% Senior Subordinated
Discount Notes due 2005 (the "Discount Notes") place certain restrictions on
POI's and Monitoring's ability to make dividend payments, distributions and
other asset transfers in respect of such company's capital stock. At June 30,
1997, under provisions of the Credit Agreement (the most restrictive agreement),
no amounts were available for such dividend payments, distributions or other
transfers by POI or Monitoring.
6. INCOME TAXES:
For the nine months ended June 30, 1997, the Company experienced a net
increase in its net deferred tax asset valuation allowance of $3.9 million. At
June 30, 1997, the Company had $26.4 million in Federal net operating loss
("NOL") carryforwards for regular tax purposes and $27.5 million for alternative
minimum tax ("AMT NOL") purposes, which expire in the years 2006-2010. These
carryforwards are available, subject to certain restrictions, to reduce taxable
income, alternative minimum taxable income and income taxes payable in future
years. As a result of the issuance of warrants in conjunction with the Company's
refinancing plan, as well as various prior issuances of preferred and common
stock and stock warrants, there are annual limitations on the amount of regular
tax NOL and AMT NOL carryforwards, that can be used to reduce taxable income,
alternative minimum taxable income and income tax payable. Future substantial
changes in the Company's ownership could create additional limitations. The
Company has utilized $5.9 million in net operating loss carryforwards for the
nine months ended June 30, 1997.
8
9
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (cont.)
(Dollar amounts in thousands)
6. INCOME TAXES (CONT.):
The tax effect of temporary differences that give rise to significant
portions of deferred tax assets and liabilities are presented below:
September 30, June 30,
1996 1997
------------- ---------
Deferred tax assets:
Allowances for doubtful accounts...................... $ 2,214 $ 3,580
Acquisition transition costs and purchase holdbacks... 5,701 7,666
Performance warrants.................................. 1,662 1,685
Net operating loss carryforwards...................... 12,814 9,607
OID amortization...................................... 8,634 13,685
Other................................................. 139 61
Less valuation allowance.............................. (1,907) (5,823)
------- --------
Total deferred tax assets........................ 29,257 30,461
Deferred tax liabilities:
Differences in depreciation, amortization and
acquisition basis................................. (29,257) (29,135)
------- --------
Net deferred tax asset........................... $ -- $ 1,326
======= ========
The valuation allowances at September 30, 1996 and June 30, 1997 reflect
current estimates of limitations on utilization of NOL carryforwards for Federal
and state income tax purposes.
The balance sheet presentation of the net deferred tax asset is as
follows:
September 30, June 30,
1996 1997
------------- ---------
Current deferred tax asset............................ $7,561 $9,506
Non-current deferred tax liability.................... 7,561 8,180
------ ------
$ -- $1,326
====== ======
In October, 1996, the Company acquired all of the outstanding shares of
Security Holdings, Inc. (which was merged into Monitoring in March 1997). For
financial reporting purposes, the assets acquired and the liabilities assumed
were valued at fair market value as of the date of purchase. For income tax
reporting purposes, the acquisition was treated as a non-taxable stock purchase
with acquired assets and liabilities retaining their historical tax basis. The
deferred tax liability resulting from the acquisition basis difference exceeded
the Company's existing net deferred tax asset (before reduction for valuation
allowance) at the date of acquisition. Consequently, the existing deferred tax
asset valuation allowance as of the acquisition date was eliminated. This
resulted in a reduction to the goodwill and deferred tax liability account
balances that were recognized as a result of the acquisition. For the nine
months ended June 30, 1997, the Company generated (subsequent to the
acquisition) additional deferred tax assets which exceeded the Company's net
deferred tax liability. To the extent these additional deferred tax assets
offset the net deferred tax liability that was required to be recognized on the
acquisition, a deferred income tax benefit was recognized on the Company's
income statement. Due to uncertainties regarding the future utilization of a
portion of the deferred tax asset, a valuation allowance was recorded.
9
10
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (cont.)
(Dollar amounts in thousands)
7. SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES:
Acquisitions:
Nine months ended June 30,
-------------------------------
1996 1997
-------- -------
Subscriber accounts acquired............................... $ 95,506 $75,738
Goodwill................................................... -- 1,523
Inventories................................................ 786 39
Accounts receivable, net................................... 1,588 282
Property and equipment..................................... 1,884 18
Other assets acquired...................................... 1,674 61
-------- -------
Total assets acquired................................. 101,438 77,661
-------- -------
Cash paid to seller........................................ 72,757 54,489
Stock issued to seller..................................... 6,843 10,448
Acquisition expenses....................................... 646 752
Purchase holdbacks......................................... 8,682 8,352
Acquisition transition reserves............................ 4,781 3,443
Deferred revenue acquired.................................. 3,934 1,888
Other liabilities assumed.................................. 3,795 2,967
-------- -------
Purchase price and assumed liabilities................ $101,438 $77,661
======== =======
Cash paid to sellers, payments for acquisition expenses and payments on
liabilities assumed in conjunction with acquisitions are included in cash used
in investing activities in the period paid. Deferred revenue, which represents
advance billings to subscribers, is recognized as revenue in the period in which
the related service is provided. Such amounts are considered a non-cash
component of operations and are reflected as a reduction in cash provided by
operating activities.
The following reflects (decreases) in assets and decreases (increases) in
liabilities and capital stock resulting from non-cash investing and financing
activities which occurred in the nine months ended June 30, 1996:
Additional Series H
Purchase Common Paid-In Preferred
Intangibles Holdbacks Stock Capital Stock
----------- --------- ------ ---------- ---------
Charge off of purchase holdbacks...... $(3,911) $3,911 -- -- --
Conversion of Series H Preferred...... -- -- $ (7) $ (6,120) $6,127
Common shares issued for Metrol....... 6,843 -- (4) (6,839) --
Reclassification of stock offering
costs................................. (539) -- -- 539 --
------- ------ ---- -------- ------
$ 2,393 $3,911 $(11) $(12,420) $6,127
======= ====== ==== ======== ======
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PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (cont.)
(Dollar amounts in thousands)
7. Supplemental Disclosure of Noncash Investing and Financing Activities(cont.)
The following reflects increases (decreases) in assets and increases in
liabilities and capital stock resulting from non-cash investing and financing
activities which occurred in nine months ended June 30, 1997:
Other Assets Held Purchase Common Additional
Receivables For Sale Intangibles Holdbacks Stock Paid-In Capital
----------- ----------- ----------- --------- ------- ---------------
Chargeoff of purchase holdbacks...... ($3,472) $3,472
Common shares issued for
acquisitions....................... 10,448 ($9) ($10,439)
Sale of guard and patrol operations.. $588 ($588)
---- ----- ------- ------ --- --------
$588 ($588) $6,976 $3,472 ($9) ($10,439)
==== ===== ====== ====== === ========
8. COMMITMENTS AND CONTINGENCIES:
The Company is a party to claims and other matters of litigation
incidental to the normal course of 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 consolidated financial position, results of operations
and cash flows.
9. SUPPLEMENTAL SUBSIDIARY COMPANY SUMMARIZED FINANCIAL INFORMATION:
POI has fully and unconditionally guaranteed the Discount Notes and the
$103.5 million principal amount of Monitoring's 6 3/4% Convertible Senior
Subordinated Notes due 2003 (the "Convertible Notes") on a joint and several
basis. The assets, results of operations and stockholder's equity of Monitoring
comprise substantially all of the assets, results of operations and
stockholders' equity of the Company on a consolidated basis. POI's principal
assets and sole operations are in and through its investment in Monitoring. All
significant intercompany balances and transactions have been eliminated in
consolidation. Separate financial statements for Monitoring have not
been provided because the Company does not believe such separate financial
statements and separate summarized financial information are material to
investors. Summarized consolidated financial information of Monitoring is
presented below:
September 30, June 30,
1996 1997
------------- -----------
(unaudited) (unaudited)
Summarized Balance Sheet
Assets
Current assets............................ $ 28,907 $ 33,348
Subscriber accounts and intangibles, net.. $257,354 $308,925
Other non-current assets.................. $ 11,375 $ 15,294
Liabilities and Stockholders' Equity
Deferred revenue.......................... $ 13,827 $ 16,391
Other current liabilities................. $ 20,712 $ 27,511
Long-term debt, net of current portion.... $225,650 $279,750
Other long-term liabilities............... $ 8,620 $ 9,555
Stockholders' equity...................... $ 28,827 $ 24,360
Three Months Ended June 30, Nine Months Ended June 30,
--------------------------- --------------------------
1996 1997 1996 1997
-------- -------- -------- --------
Summarized Statements of Operations
Revenue..................................... $18,617 $24,879 $ 51,795 $ 71,954
Gross Profit................................ $ 5,346 $ 7,049 $ 36,222 $ 51,185
Net loss.................................... $(3,860) $(6,287) $(11,099) $(15,109)
11
12
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO FINANCIAL STATEMENTS (cont.)
(Dollar amounts in thousands)
10. SUBSEQUENT EVENTS:
On July 30, 1997, POI entered into a Contribution Agreement dated as of
July 30, 1997 (the "Contribution Agreement"), with Western Resources, Inc., a
Kansas corporation ("Western Resources"). Pursuant to, and on and subject to the
terms and conditions of, the Contribution Agreement, Western Resources will
contribute to POI all of the outstanding capital stock of WestSec, Inc and
Westar Security, Inc., which provide security alarm monitoring services under
the Westinghouse, Westar and other trade names, and an aggregate of
approximately $320 million in cash, net; in consideration of such contribution,
POI will issue to Western Resources (the "Share Issuance") that number of shares
of the Common Stock, par value $.01 per share, of POI ("POI Common Stock") equal
to the product of (x) .801 and (y) the sum of (A) the aggregate number of shares
of POI Common Stock outstanding immediately following the issuance (including,
for this purpose, shares issued pursuant to the Contribution Agreement, but
excluding any shares issued pursuant to the Stock Option Agreement (as defined
below) and (B) the aggregate number of shares of POI Common Stock issuable as of
the closing under the Contribution Agreement (the "Closing") pursuant to then
outstanding options and warrants of POI. Following the Closing Date, POI will
(i) pay to the holders of record of POI Common Stock on the Closing Date a
dividend of $7.00 per share, (ii) pay a cash bonus to POI Common Stock option
holders an amount equal to $7.00 per share of Common Stock issuable upon the
exercise of options held by such persons, (iii) pay to the holders of record of
certain warrants who are entitled, pursuant to the terms governing other
warrants, to receive such payment, $7.00 with respect to each share of Common
Stock issuable upon exercise of such warrants. In accordance with the agreements
and other documents governing other warrants issued by POI, POI will reduce the
exercise price of, and/or increase the number of shares of POI Common Stock
issuable upon exercise of, such warrants.
Consummation of the Share Issuance is subject to, among other things, the
approval of the Share Issuance by the stockholders of POI and regulatory
approvals, including expiration or termination of the waiting period required
under the Hart-Scott-Rodino Antitrust Improvements Act of 1976.
Concurrently with entering into the Contribution Agreement, POI and
Western Resources entered into a Stock Option Agreement dated as of July 30,
1997 (the "Stock Option Agreement"), pursuant to which POI granted Western
Resources an option to purchase up to 2,750,238 shares (subject to adjustment)
of POI Common Stock, which option is exercisable under certain circumstances (i)
if the Contribution Agreement is terminated, at a price of $13.50 per share, and
(ii) if the Share Issuance occurs, at a price of $15.50 per share. In addition,
the directors and officers of POI and certain other POI stockholders (the
"Stockholders") have entered into an Option and Voting Agreement dated as of
July 30, 1997 (the "Option and Voting Agreement"), with Western Resources
pursuant to which the Stockholders have agreed, among other things, (i) to grant
Western Resources an option under certain circumstances to buy all shares of POI
Common Stock owned by the Stockholders, and (ii) to grant Western Resources an
irrevocable proxy to vote all shares of POI Common Stock owned by the
Stockholders so as to facilitate consummation of the Share Issuance.
Copies of the Contribution Agreement, Stock Option Agreement and the
Option and Voting Agreements are attached as Exhibits 2.1, 10.1 and 10.2,
respectively, to the Company's Current Report on Form 8-K filed with the
Securities and Exchange Commission on August 1, 1997.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
On July 30, 1997, Protection One, Inc. announced that it had entered into an
agreement with Western Resources, Inc. ("Western Resources") pursuant to which
POI would acquire the security alarm monitoring businesses of Western Resources,
and would issue to Western Resources a sufficient number of shares of POI common
stock to cause POI to become a more that 80%-owned subsidiary of Western
Resources. For additional information with respect to the proposed transaction,
see Note 10 to the consolidated financial statements of the Company included in
Item 1 of this report.
This Management's Discussion and Analysis is based on the Company's own
historical financial results of operations and financial condition, and includes
certain forward-looking statements based on that information. Consummation of
the transaction with Western Resources is subject to the approval of the
Company's stockholders, the receipt of certain regulatory approvals and various
other conditions, and is not expected to occur, if at all, prior to the end of
the Company's current fiscal year. Investors should be aware that the discussion
below does not, in general, reflect the impact that the proposed transaction
with Western Resources will have on the future revenues, expenses and net income
or loss, or the future liquidity and capital resources, of the post-acquisition
Company, and that the results of operations and financial condition of the
post-acquisition Company may not follow the same historical trends or be subject
to or reflect the same dependence on the economic and competitive factors
described below.
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 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 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 on pages 5-11 of POI's
prospectus dated January 2, 1997, which information is incorporated herein by
reference. POI's sole asset is, and all of POI's operations are conducted
through, POI's investment in Monitoring; in addition, all of Monitoring's
long-term debt has been guaranteed on a full and unconditional basis by POI.
Accordingly, no separate analysis of results of operations of Monitoring has
been included herein.
OVERVIEW
For an overview of the Company's accounting policies and specific
discussions of, among other things, a change in the method of accounting for
certain acquisition and transition expenses and the impact of SFAS 121 on the
Company's financial statements, see the Company's Annual Report on Form 10-K for
the fiscal year ended September 30, 1996.
Acquisition and Dealer Program Activity. A significant portion of the
Company's growth has been generated by the purchase of subscriber accounts
through the Company's Dealer Program and through the acquisition of portfolios
of subscriber accounts from other alarm companies. The Company's Dealer Program
consists of exclusive purchase agreements with independent alarm companies
specializing in the sale and installation of new alarm systems. Dealer Program
participants install alarm systems (which have a Protection One logo on the
keypad), arrange for subscribers to enter into Protection One alarm monitoring
agreements, and install Protection One yard signs and window decals.
Substantially all of these subscribers are contacted individually by Company
personnel, at the time of purchase of the accounts from the dealer, to
facilitate customer satisfaction and quality control. In addition, the Company
requires dealers to evaluate the credit history of prospective new subscribers.
The Company also purchases portfolios of subscriber accounts. Because the
Company typically acquires only the subscriber accounts (and not the accounts
receivable or similar assets) of the sellers, the Company focuses its
pre-acquisition review and analysis on the quality and stability of the
subscriber accounts to verify the monthly recurring revenue ("MRR") represented
by such accounts. If the subscriber accounts to be purchased pass such due
diligence scrutiny, the Company then applies its monitoring and other servicing
costs to such MRR as a basis for determining the purchase price to be paid by
the Company. To protect the Company against the loss of acquired accounts, the
Company typically seeks to obtain from the seller a guarantee against the
subscriber account cancellation for a period following the acquisition and the
right to retain a portion of the acquisition price (a "purchase price holdback")
against the MRR lost due to subscriber account cancellations during the
specified period. The Company obtains a similar purchase price holdback in its
purchases through the Dealer Program.
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During the nine months ended June 30, 1997, the Company added (through its
Dealer Program and acquisitions of nine portfolios of subscriber accounts) an
aggregate of approximately 66,700 subscriber accounts for a total purchase price
of approximately $79.1 million. The MRR of the acquired accounts ranged from
approximately $15.00 to $60.00, with an average MRR of $28.87. Of the nine
acquisitions completed during the first nine months of fiscal 1997 by the
Company, purchase price holdbacks ranged from 0% to 20% of the initial purchase
price (and averaged 12.4% of the initial purchase price) and attrition guarantee
periods ranged from 0 months to 12 months (and averaged 11.9 months).
Subscriber Attrition. Subscriber attrition has a direct impact on the
Company's results of operations, since it affects both the Company's revenues
and its amortization expense. Attrition can be measured in terms of canceled
subscriber accounts and in terms of decreased MRR resulting from canceled
subscriber accounts. Gross subscriber attrition is defined by the Company for a
particular period as a quotient, the numerator of which is equal to the number
of subscribers who disconnect service during such period and the denominator of
which is the average of the number of subscribers at each month end during such
period. Net MRR attrition is defined by the Company for a particular period as a
quotient, the numerator of which is an amount equal to gross MRR lost as the
result of canceled subscriber accounts or services during such period, net of
(i) MRR generated during such period by the sale of additional services and
increases in rates to existing subscribers; (ii) MRR generated during such
period from the connection of subscribers who move into premises previously
occupied by subscribers and in which existing systems are installed and from
conversion of accounts that were previously monitored by other companies to the
Company's monitoring service (i.e., "reconnects" and "conversions"); and (iii)
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 sellers.
The following table sets forth the Company's gross subscriber attrition and
net MRR attrition for the periods indicated:
Twelve Months Ended
-------------------------------------------------------------
6/30/96 9/30/96 12/31/96 3/31/97 6/30/97
-------------------------------------------------------------
Gross subscriber attrition....... 19.9% 18.3% 16.6% 17.6% 16.5%
Net MRR attrition................ 7.1 7.0 6.5 6.9 6.7
Management has established target ranges for gross subscriber attrition and
net MRR attrition of 16-18% and 6-8% respectively. Fluctuations in gross
subscriber attrition reflect changes in levels of acquisition activity, the rate
at which subscribers move, the number of subscribers who the Company disconnects
for non-payment and customer satisfaction with the Company's customer service
and field repair functions. Changes in net MRR attrition are caused by the
factors impacting gross subscriber attrition, as well as changes in the
Company'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. Gross subscriber and net
MRR attrition declined during the twelve months ended June 30, 1997 from the
twelve months ended March 31, 1997 due to fewer cancellations arising from
acquired customer assimilation and better customer service performance. The
Company anticipates a slight increase in net MRR attrition for the twelve month
period ending September 30, 1997 due to a decrease in the level of acquired
customers covered by purchase holdbacks. Although management believes net MRR
attrition for the period will fall within the 6-8% target range discussed above,
there can be no assurance that such target range will be met, however.
MRR represents the monthly recurring revenue the Company 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 past due
balances. It is the policy and practice of the Company that every effort be made
to preserve the revenue stream associated with these contractual obligations. To
this end, the Company actively works to both collect amounts owed and to retain
the customer. In certain instances, the collection and evaluation period may
exceed six months in length. When, in the judgment of the Company's collection
personnel, all reasonable efforts have been made to collect balances due,
subscribers are disconnected from the Company's monitoring center and are
included in the calculation of gross subscriber and net MRR attrition.
Because the Company determines payments to sellers under purchase price
holdbacks subsequent to the periods to which such holdbacks apply, and because
holdbacks are not allocated to specific guaranteed accounts or specific fiscal
periods, the Company reduces gross MRR lost during a period by the amount of
guaranteed accounts provided for in purchase agreements with sellers. However,
in some cases, the Company has not retained the full amount of such holdback to
which the Company is contractually entitled. If guaranteed accounts for which
the Company was not compensated by the seller were taken into account in
calculating net MRR attrition, net MRR attrition would have been higher in each
period presented in the table above.
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Generally, net MRR attrition is less than actual "net account attrition,"
which the Company defines as canceled subscriber accounts net of reconnects,
conversions and guaranteed accounts. Estimated net account attrition is the
basis upon which the Company determines the period over which it amortizes its
investment in subscriber accounts. The Company amortizes such investment over 10
years based on current estimates. If actual subscriber account attrition were to
exceed such estimated attrition, the Company could be required to amortize its
investment in subscriber accounts over a shorter period, thus increasing
amortization expense in the period in which such adjustment is made and in
future periods. There can be no assurance that the actual attrition rates for
such accounts will not be greater than the rate assumed by the Company.
The table below sets forth the change in the Company's subscriber base over
the periods indicated below:
Twelve Months
Ended June 30,
------------------
1996 1997
---- ----
Number of subscribers:
Beginning of period................................. 131,166 184,352
Additions through portfolio acquisitions and Dealer
Program, net of sales of subscriber accounts...... 77,187 81,886
Installations by Company personnel.................. 984 391
Reconnects and conversions.......................... 4,243 4,938
Gross subscriber attrition.......................... (29,228) (35,326)
------- -------
End of period.................................... 184,352 236,241
======= =======
Change in Presentation Format. Beginning with its Quarterly Report on Form
10-Q for the first quarter of fiscal 1997, the Company made changes to its
presentation of income statement information. First, the Company has
reclassified revenues and cost of revenues associated with its alarm response
and patrol operations from the "other" category to "monitoring and related
services." The "other" category now reflects solely results from the Company's
installation, lock and other operations. The Company made this change to better
reflect its efforts to sell a bundle of monitoring, field service and alarm
response services to both existing and new subscribers. Second, the Company has
reclassified depreciation expense from monitoring and service cost of revenues,
other cost of revenues and the selling, general and administrative expenses
category, and included depreciation expense in a line item entitled
"amortization of intangibles and depreciation expense." The Company made this
change to allow readers to more easily calculate the aggregate amount of
non-cash charges in the income statement. Finally, the Company has reclassified
customer service expense from monitoring and service cost of revenues to
selling, general and administrative expenses. This change reflects the Company's
move to centralize all customer service functions into a single facility in
Chatsworth, California. Customer service personnel formerly dedicated to the
support of monitoring and related services are responsible for the Company's
entire customer service efforts. Results reported in this Quarterly Report for
the three and nine months ended June 30, 1996 have been modified to reflect
these changes and make the information for such periods comparable to
information for the three and nine months ended June 30, 1997.
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The table below displays selected income statement data for fiscal years
1994-1996 after giving effect to the changes described above:
Year Ended September 30,
-------------------------------------------
1994 1995 1996
------- ------- --------
Revenues:
Monitoring and related services....................... $29,297 $48,909 $68,778
Other.................................................. 5,183 6,973 4,679
------- ------- -------
Total revenues..................................... 34,480 55,882 73,457
Cost of revenues:
Monitoring and related services....................... 8,355 13,627 19,065
Other................................................. 3,224 3,887 2,513
------- ------- -------
Total cost of revenues............................. 11,579 17,514 21,578
------- ------- -------
Gross profit............................................. 22,901 38,368 51,879
Selling, general and administrative expense.............. 10,607 13,031 15,478
Loss on acquisition terminations......................... 26 208 --
Performance warrants compensation expense................ 4,504 -- --
Acquisition and transition expenses...................... -- 3,090 4,219
Amortization of intangibles and depreciation expense..... 9,290 16,543 25,121
------- ------- -------
Operating income (loss)............................. $(1,526) $ 5,496 $ 7,061
======== ======= =======
RESULTS OF OPERATIONS
The following table sets forth certain operating data as a percentage of
total revenues for the periods indicated.
Nine Months Ended Three Months Ended
June 30, June 30,
----------------- ---------------------
1996 1997 1996 1997
---- ---- ----- ----
Revenues:
Monitoring and related services................... 93.7% 96.4% 94.5% 96.6%
Other............................................. 6.3 3.6 5.5 3.4
----- ----- ----- -----
Total revenues............................ 100.0% 100.0% 100.0% 100.0%
----- ----- ----- -----
Cost of revenues:
Monitoring and related services............. 26.2% 26.5% 25.4% 26.0%
Other............................................ 3.9 2.4 3.3 2.3
------ ----- ----- -----
Total cost of revenues.................... 30.1 28.9 28.7 28.3
------ ----- ----- -----
Gross profit.............................. 69.9% 71.1 71.3 71.7
Selling, general and administrative expense......... 20.5 19.8 19.8 19.0
Acquisition and transition expenses................. 5.8 5.8 6.0 6.3
Amortization of intangibles and depreciation expense 33.5 38.4 35.0 40.5
------ ----- ----- -----
Operating income ......................... 10.1% 7.1% 10.5% 5.9%
===== ===== ===== =====
NINE MONTHS ENDED JUNE 30, 1997 COMPARED TO NINE MONTHS ENDED JUNE 30, 1996
Revenues for the nine months ended June 30, 1997 increased by approximately
$20.2 million, or 38.9%, to $72.0 million from $51.8 million for the comparable
period in 1996. Monitoring and related services revenues increased by
approximately $20.8 million, or 42.9%, a substantial majority of which increase
resulted from the addition of subscribers through the Dealer Program and the
acquisition of portfolios of subscriber accounts. The Company's subscriber base
increased by 28.1% to 236,241 subscribers at June 30, 1997 as compared to
184,352 subscribers at June 30, 1996. The sale of enhanced services and new
subscribers generated by Company personnel comprised the remainder of revenue
growth. Other revenues, consisting primarily of revenues generated by the
Company's installation and lock businesses, decreased by $0.7 million, or 21.0%,
to $2.6 million. Such decrease was caused primarily by a decline in installation
revenues of 30.3%, or approximately $0.6 million. The decline in installation
revenues resulted from the Company's continued emphasis on growth through the
Dealer Program and acquisitions, rather than through the sale of new alarm
systems by Company personnel.
Cost of revenues for the nine months ended June 30, 1997 increased by
approximately $5.2 million, or 33.4%, to $20.8 million. Cost of revenues as a
percentage of total revenues declined to 28.9% for the nine months ended June
30, 1997 from 30.1% for the comparable period in fiscal 1996. This decline
reflects improved performance in the Company's
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monitoring and related services, as well as an increase in monitoring
and related services revenues as a percentage of total revenues.
Monitoring and related services expenses increased by approximately $5.5
million, or 40.3%, reflecting increased activity at the Company's central
monitoring station and field service branches due to a substantially larger
subscriber base. Monitoring and related services expenses as a percentage of
monitoring and related services revenues decreased to 27.5% for the nine months
ended June 30, 1997 from 28.0% during the comparable period in fiscal 1996. Such
decrease was generated by efficiencies realized in the monitoring center and by
greater service technician productivity. Other expenses decreased by
approximately $0.3 million, or 13.8%, to $1.7 million for the nine months ended
June 30, 1997 from $2.0 million for the nine months ended June 30, 1996. The
decrease primarily was caused by a 17.4% decrease ($0.2 million) in installation
expense associated with reduced installation activities.
Gross profit for the nine months ended June 30, 1997 was approximately $51.2
million, representing an increase of approximately $15.0 million, or 41.3%, over
the $36.2 million of gross profit recognized in the comparable period in fiscal
1996. Such increase was caused primarily by an increase in monitoring and
related services activities, which paralleled the increase in the Company's
subscriber base noted above. Gross profit as a percentage of total revenues was
71.1% for the nine months ended June 30, 1997 compared to 69.9% for the
comparable period in fiscal 1996. This increase was caused by both an
improvement in the gross profit margin for monitoring and related services and
an increase in monitoring and related services revenues as a percentage of total
revenues (96.4% for the nine months ended June 30, 1997 compared to 93.7% for
the nine months ended June 30, 1996). Gross profit from other revenues declined
to approximately $0.8 million for the nine months ended June 30, 1997 from $1.3
million for the comparable period in fiscal 1996. Such decline was caused
primarily by a decrease in the gross profit from reduced installation
activities.
Selling, general and administrative expenses rose to approximately $14.3
million in the nine months ended June 30, 1997, which represents an increase of
approximately $3.7 million, or 34.6%, over selling, general and administrative
expenses in the comparable period in fiscal 1996. The majority of the increase
reflects higher general and administrative expenses arising from the Company's
growth, including the addition of two branch offices and the implementation of a
24 hour, 7 day a week customer service call center. Such figure as a percentage
of total revenues decreased from 20.5% in the nine months ended June 30, 1996 to
19.8% in the nine months ended June 30, 1997. Advertising and marketing
expenses, net of reimbursements, are expensed as incurred and comprised less
than 1% of revenues in each of the nine month periods ended June 30, 1996 and
1997. The provision for doubtful accounts increased to approximately $2.4
million for the nine months ended June 30, 1997 from $1.5 million for the
comparable period in fiscal 1996, reflecting a corresponding increase of $4
million in accounts receivable.
Acquisition and transition expenses for the nine months ended June 30, 1997
totaled $4.2 million compared to $3.0 million for the comparable period in
fiscal 1996. Such expenses will fluctuate from quarter to quarter based
primarily on the amount of the Company's acquisition and Dealer Program activity
and its ability to require sellers to bear certain of such acquisition-related
expenses.
Amortization of intangibles and depreciation expense for the nine months
ended June 30, 1997 increased by approximately $10.3 million, or 59.2%, to $27.6
million. This increase is primarily the result of the addition of subscriber
accounts through the acquisition of portfolios of subscriber accounts and
through the Dealer Program as well as increases in depreciation expense
associated with the Company's new software implementation.
Operating income for the nine months ended June 30, 1997 was $5.1 million,
compared to $5.2 million in the comparable period in fiscal 1996. Operating
income as a percentage of total revenues was 7.1% in the nine months ended June
30, 1997, compared to 10.1% in the comparable period in fiscal 1996. The
decrease in such figure over the comparable period in fiscal 1996 reflects
substantial increases in operating expenses and amortization and depreciation
expense, offset by improvement in the Company's gross profit and higher
revenues.
Interest expense, net and amortization of debt issuance costs and OID
increased by $5.5 million, or 34.0%, to $21.7 million in the nine months ended
June 30, 1997, reflecting the Company's use of debt to finance a substantial
portion of its subscriber account growth.
Balance sheet data. At June 30, 1997, the Company's working capital deficit
was $10.5 million as compared to a working capital deficit of $5.6 million at
September 30, 1996. This increase of $4.9 million in the working capital deficit
was caused primarily by an increase in purchase holdbacks of $3.7 million,
deferred revenues of $2.6 million, acquisition transition costs of $1.8 million,
other accruals of $1.3 million and capital leases payable of $0.5 million,
offset by increases in accounts receivable of $2.4 million and deferred tax
assets of $1.9 million. Subscriber accounts and intangibles, net increased to
$308.9 million at June 30, 1997 from $257.4 million at September 30, 1996. This
increase of $51.5 million, or 20.0%, was caused by the addition of new
subscribers, net of amortization expense. Total stockholders' equity decreased
by $4.4 million to approximately $24.4 million at June 30, 1997 from $28.8
million at September 30, 1996. The decrease in
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such figure reflects the Company's net loss of $15.1 million for the nine months
ended June 30, 1997 offset by the issuance of shares of the Company's Common
Stock as a portion of the purchase price of Security Holdings, Inc.
(approximately $7.3 million), Phillips Electronics, Inc. (approximately $2.0
million), Able Alarms of Arizona, Inc. (approximately $0.8 million) and pursuant
to the exercise of options (approximately $0.3 million).
THREE MONTHS ENDED JUNE 30, 1997 COMPARED TO THREE MONTHS ENDED JUNE 30, 1996
Revenues for the three months ended June 30, 1997 (the "third quarter of
fiscal 1997") increased by approximately $6.3 million, or 33.6%, to $24.9
million from $18.6 million for the comparable period in 1996 (the "third quarter
of fiscal 1996"). Monitoring and related services revenues increased by
approximately $6.4 million, or 36.6%, a substantial majority of this increase
resulted from the addition of subscribers through the Dealer Program and the
acquisition of portfolios of subscriber accounts. The sale of enhanced services
and new subscribers generated by Company personnel comprised the remainder of
revenue growth. Other revenues, consisting primarily of revenues generated by
the Company's installation and lock businesses, decreased by $0.2 million, or
17.3%, to $0.9 million. Such decrease was caused by a decline in installation
revenues of 34.6%, or approximately $0.2 million.
Cost of revenues for the third quarter of fiscal 1997 increased by
approximately $1.7 million, or 31.8%, to $7.0 million. Cost of revenues as a
percentage of total revenues declined to 28.3% for the third quarter of fiscal
1997 from 28.7% for the comparable period in fiscal 1996. Monitoring and related
services expenses increased by approximately $1.8 million, or 37.0%, primarily
due to increased activity at the Company's central monitoring station and field
service branches due to a substantially larger subscriber base. Monitoring and
related services expenses as a percentage of monitoring and related services
revenues increased slightly to 27.0% for the third quarter of fiscal 1997 from
26.9% during the comparable period in fiscal 1996.
Gross profit for the third quarter of fiscal 1997 was approximately $17.8
million, representing an increase of approximately $4.6 million, or 34.4 %, over
the $13.3 million of gross profit recognized in the comparable period in fiscal
1996. Such increase was caused primarily by an increase in monitoring and
related services activities, which paralleled the increase in the Company's
subscriber base noted above. Gross profit as a percentage of total revenues was
71.7% for the third quarter of fiscal 1997 compared to 71.3% for the comparable
period in fiscal 1996. This increase was caused primarily by an increase in
monitoring and related services revenues as a percentage of total revenues
(96.6% for the third quarter of fiscal 1997 compared to 94.5% for the third
quarter of fiscal 1996). Gross profit from other revenues declined to
approximately $0.3 million for the third quarter of fiscal 1997 from $0.4
million for the comparable period in fiscal 1996. Such decline was caused
primarily by a decrease in the gross profit from reduced installation
activities.
Selling, general and administrative expenses rose to $4.7 million in the
third quarter of fiscal 1997, which represents an increase of approximately $1.0
million, or 28.3%, over selling, general and administrative expenses in the
comparable period in fiscal 1996. The majority of the increase reflects higher
general and administrative expenses arising from the Company's growth, including
the addition of two branch offices. Such figure as a percentage of total
revenues decreased from 19.8% in the third quarter of fiscal 1996 to 19.0% in
the third quarter of fiscal 1997. Advertising and marketing expenses, net of
reimbursements, are expensed as incurred and comprised less than 1% of revenues
in each of the quarters ending June 30, 1996 and 1997. The provision for
doubtful accounts increased to approximately $0.6 million for the third quarter
of fiscal 1997 from $0.5 million for the comparable period in fiscal 1996.
Acquisition and transition expenses for the third quarter of fiscal 1997
totaled $1.6 million compared to $1.1 million for the comparable period in
fiscal 1996. As described above, such expenses will fluctuate from quarter to
quarter based primarily on the amount of the Company's acquisition and Dealer
Program activity and its ability to require sellers to bear certain of such
acquisition-related expenses.
Amortization of intangibles and depreciation expense for the third quarter
of fiscal 1997 increased by approximately $3.5 million, or 54.4%, to $10.1
million. This increase is primarily the result of the addition of subscriber
accounts through the acquisition of portfolios of subscriber accounts and
through the Dealer Program and through the Dealer Program as well as increases
in depreciation expense associated with the Company's implementation of a
software upgrade.
Operating income for the second quarter of fiscal 1997 was $1.5 million,
compared to $2.0 million in the comparable period in fiscal 1996. Operating
income as a percentage of total revenues was 5.9% in the third quarter of fiscal
1997, compared to 10.5% in the comparable period in fiscal 1996. The decrease in
such figure over the comparable period in fiscal 1996 reflects substantial
increases in operating expenses and amortization expense, offset by improvement
in the Company's gross profit and higher revenues.
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Interest expense, net and amortization of debt issuance costs and OID. These
amounts increased by $1.9 million, or 33.7%, to $7.7 million in the third
quarter of fiscal 1997, reflecting the Company's use of debt to finance a
substantial portion of its subscriber account growth.
LIQUIDITY AND CAPITAL RESOURCES
General. Since its formation in September 1991, the Company has financed its
operations and growth from a combination of capital raised through debt and
equity offerings and to a lesser extent, cash flow from operations. During the
fiscal 1994-1996 period, the Company completed three long-term debt offerings,
including the proceeds of the $50.0 million principal amount of senior
subordinated notes issued in November 1993 (which notes were retired in fiscal
1995), $166.0 million principal amount ($105.2 million net proceeds) of senior
subordinated discount notes issued in May 1995 and $103.5 million principal
amount of senior subordinated convertible notes issued in September and October
of 1996. The Company also has utilized borrowings under its Revolving Credit
Facility to fund acquisitions and the Dealer Program. In September 1994, the
Company raised $18.3 million in net proceeds from its initial public offering of
Common Stock and in February 1996, the Company raised $23.1 million in net
proceeds from another public offering of the Common Stock. The Company intends
to continue to use cash flows from operations, together with borrowings under
the Revolving Credit Facility, to finance the addition of subscriber accounts
and capital expenditures. Although the Company anticipates that it will continue
to acquire portfolios of subscriber accounts, the Company cannot estimate the
number, the size, or timing of such acquisitions. Depending on such factors,
additional funds beyond those currently available to the Company may be required
to continue the acquisition program and to finance the Dealer Program, and there
can be no assurance that the Company will be able to obtain such financing on
acceptable terms or at all.
On a long-term basis, the Company has several material commitments.
Borrowings under the Revolving Credit Facility were approximately $31.9 million
at June 30, 1997 and could be as high as $100.0 million through the period ended
January 3, 2000, the current maturity date of the Revolving Credit Facility.
While the Company believes it will be able to obtain further extensions of the
maturity date of the Revolving Credit Facility from time to time, or will be
able to refinance the Revolving Credit Facility prior to its maturity date,
there can be no assurance that the Company will be able to do so. The
Convertible Notes require the Company to make semi-annual cash interest payments
of $3.5 million, the first of which was made on March 15, 1997. The Discount
Notes require the Company to begin to make interest payments on such obligations
on December 31, 1998. Based on an interest rate of 13 5/8%, such payment will be
approximately $11.3 million semiannually, or approximately $22.6 million on an
annual basis. As a result, a substantial portion of the Company's cash flows
from operations will be required to make interest payments on the Convertible
Notes and the Discount Notes, and there can be no assurance that the Company's
cash flow from operations will be sufficient to meet such obligation, or that
there will be sufficient funds available to the Company after such interest
payments to meet other debt, capital expenditure and operational obligations.
The $103.5 million principal amount of the Convertible Notes matures on
September 15, 2003, although the Receivable Notes may be converted into Common
Stock at any time prior to such date. The $166.0 million principal amount of
Discount Notes matures on June 30, 2005. There can be no assurance that the
Company will have the cash necessary to repay either the Convertible Notes or
the Discount Notes at maturity or will be able to refinance such obligations.
The Company maintains a $2.0 million letter of credit sub-facility under its
Revolving Credit Facility, and has extended an approximately $0.8 million letter
of credit to a seller, scheduled payments under which are approximately $0.4
million during each of fiscal 1998 and 1999.
The Company has had, and expects to continue to have, a working capital
deficit. At June 30, 1997, the Company had a working capital deficit of $10.5
million. There are two principal categories of current liabilities that cause
the Company to have a working capital deficit: (i) "purchase holdbacks," which
represent the portion of the aggregate acquisition cost of subscriber accounts
retained by the Company to offset lost MRR arising from the cancellation of
acquired accounts; and (ii) "deferred revenue," which represents billings and
cash collections received by the Company from its subscriber base in advance of
performance of services. Both purchase holdbacks and deferred revenues are
recorded as a current liability on the Company's balance sheet.
The Company generated $26.1 million of net cash provided by operating
activities in the nine months ended June 30, 1997, compared to $16.6 million net
cash provided by operating activities for the comparable period in fiscal 1996.
The increase in net cash provided by operating activities reflects the Company's
substantial growth in MRR and number of subscribers.
In the nine months ended June 30, 1997, the Company's net cash used in
investing activities was $66.3 million, compared to $80.8 million during the
nine months ended June 30, 1996. Investing activities during the nine months
ended June 30, 1997 included purchases through the Dealer Program, as well as
the acquisition of portfolios of subscriber accounts, including the purchase of
Security Holdings, Inc., Phillips Electronics, Inc and Able Alarms of Arizona,
Inc.
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During the nine months ended June 30, 1997, the Company's net cash provided
by financing activities was $39.5 million, compared to $71.4 million for the
nine months ended June 30, 1996. The Company's primary financing activities
during the nine months ended June 30, 1997 were the issuance of $13.5 million of
Convertible Notes pursuant to the underwriters' exercise of an over-allotment
option and $9.3 million of Common Stock in connection with the acquisitions of
Security Holdings, Inc. ($7.3 million), Phillips Electronics, Inc. ($2.0
million) and Able Alarms of Arizona, Inc.
($0.8 million).
The Discount Notes Indenture, the Indenture governing the Convertible Notes
and the Credit Agreement contain certain restrictions on transfers of funds,
such as dividends, loans and advances, by the Company. The Company believes that
such restrictions have not had and will not have a significant impact on the
Company's ability to meet its cash obligations. The Company does not anticipate
payment of dividends on Common Stock, except as disclosed in Note 10 in the
Notes to Financial Statements, and such dividends are currently prohibited by
the Credit Agreement and the Discount Notes Indenture.
Capital Expenditures. The Company anticipates making capital expenditures in
the remainder of fiscal 1997 of approximately $1.0 million for routine
replacement and upgrading of vehicles, computers and other capital items. In
addition, the Company anticipates making capital expenditures of approximately
$0.5 million to complete a project to upgrade its monitoring and administrative
hardware and software. The Company believes the complete implementation of the
new software will not occur until fiscal 1998. The Company believes cash flows
from operations, together with borrowing under the Revolving Credit Facility,
will be sufficient to fund the Company's capital expenditures in fiscal 1997.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
None.
ITEM 2. CHANGES IN SECURITIES
Pursuant to two Stock Purchase Agreements each dated as of June 20, 1997
(the "Stock Purchase Agreement"), with Jeffrey E. Kerr and The Kerr Charitable
Trust, on June 30, 1997, Protection One Alarm Monitoring, Inc. ("Monitoring")
purchased all of the outstanding capital stock of Able Alarms of Arizona, Inc.,
an Arizona corporation ("Able") engaged in the security alarm monitoring
business. In consideration of the acquisition, Monitoring (i) paid to the two
stockholders of Able an aggregate of approximately $4,592,946, $551,000 of which
has been deferred for six months pending certain purchase price adjustments, and
(ii) delivered to Mr. Kerr 58,797 shares of Common Stock (the "Shares") newly
issued by POI, which number was derived by dividing $765,836 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 ending on the second trading day prior
to the signing of the Stock Purchase Agreement with Mr. Kerr. The Stock Purchase
Agreements also required Monitoring to pay approximately $269,500 to JK Alarms
of Arizona, Inc., a company affiliated with Mr. Kerr. As provided for in a
Registration Rights Agreement with Mr. Kerr, Protection One, Inc. ("POI") filed
a registration statement on Form S-3 (Registration No. 333-29767) under the
Securities Act of 1933 (the "Securities Act") to afford Mr. Kerr the opportunity
to resell the Shares in a public transaction. Such registration statement is
subject to amendment and has not been declared effected by the Securities and
Exchange Commission.
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. Kerr
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 other 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
Not applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
ITEM 5. OTHER INFORMATION
None.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
Exhibits. The following exhibits are filed with this Current Report
on Form 10-Q:
Exhibit
Number Exhibit
- ------- -------
27.1 Financial Data Schedule.
99.1 Information included under the caption "Risk Factors" on
pages 5-11 of POI's Prospectus dated January 2, 1997, as
filed pursuant to Rule 424(b) (incorporated by reference
to said Prospectus, which is a part of POI's Registration
Statement of Form S-3 (Registration No. 333-18159).
(b) Form 8-K. A Current Report on Form 8-K dated June 23, 1997, was filed
by the Registrants with the Securities and Exchange Commission on that date,
reporting in response to Item 5 the entering into by Protection One Alarm
Monitoring, Inc. of an agreement with Southwestern Bell Telephone Company.
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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.
August 12, 1997 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 INDEX
Exhibit Number
- --------------
27.1 Financial Data Schedule