UNITED STATES
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, 1999
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
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.)
600 CORPORATE POINTE, 12TH FLOOR, 600 CORPORATE POINTE, 12TH FLOOR,
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 13, 1999, Protection One, Inc. had outstanding 126,890,169 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.
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
(Unaudited)
MARCH 31, DECEMBER 31,
1999 1998
--------- ------------
ASSETS
Current assets:
Cash and cash equivalents . . . . . . . . . . . . . . $16,688 $10,025
Restricted cash . . . . . . . . . . . . . . . . . . . 12,083 11,987
Marketable securities . . . . . . . . . . . . . . . . 13,484 17,770
Receivables, net. . . . . . . . . . . . . . . . . . . 58,824 61,262
Inventories . . . . . . . . . . . . . . . . . . . . . 9,606 7,895
Prepaid expenses. . . . . . . . . . . . . . . . . . . 3,781 3,867
Income tax receivable . . . . . . . . . . . . . . . . 5,889 5,886
Deferred tax assets, current. . . . . . . . . . . . . 70,770 49,543
Other assets. . . . . . . . . . . . . . . . . . . . . 18,716 19,605
---------- -----------
Total current assets . . . . . . . . . . . . . . 209,841 187,840
Property and equipment, net . . . . . . . . . . . . . . . . 55,207 46,959
Customer accounts, net. . . . . . . . . . . . . . . . . . . 1,073,772 1,014,428
Goodwill and trademarks, net. . . . . . . . . . . . . . . . 1,181,065 1,187,862
Deferred tax assets . . . . . . . . . . . . . . . . . . . . 21,900 44,028
Other . . . . . . . . . . . . . . . . . . . . . . . . . . . 30,254 30,202
--------- -----------
Total assets . . . . . . . . . . . . . . . . . . . . . . $2,572,039 $2,511,319
---------- -----------
---------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Long term debt, current portion . . . . . . . . . . . $35,009 $40,838
Accounts payable. . . . . . . . . . . . . . . . . . . 16,687 16,374
Accrued liabilities . . . . . . . . . . . . . . . . . 60,857 77,412
Purchase holdbacks. . . . . . . . . . . . . . . . . . 45,586 42,303
Capital leases, current portion . . . . . . . . . . . 1,052 1,361
Deferred revenue. . . . . . . . . . . . . . . . . . . 61,329 57,703
---------- -----------
Total current liabilities. . . . . . . . . . . . 220,520 235,991
Long-term debt, net of current portion. . . . . . . . . . . 1,008,845 926,784
Capital leases, net of current portion. . . . . . . . . . . 116 187
Other liabilities . . . . . . . . . . . . . . . . . . . . . 3,726 3,238
---------- -----------
Total liabilities. . . . . . . . . . . . . . . . . . . . 1,233,207 1,166,200
Commitments and contingencies (See Note 4)
Stockholders' equity:
Preferred stock, $0.10 par value, 5,000,000 authorized,
none outstanding. . . . . . . . . . . . . . . . . . . . -- --
Common stock, $0.01 par value, 150,000,000 shares authorized,
126,838,741 shares issued and outstanding, at March 31, 1999
and December 31, 1998, respectively. . . . . . . . . . 1,268 1,268
Additional paid-in capital . . . . . . . . . . . . . . . 1,392,070 1,392,256
Accumulated other comprehensive income, net. . . . . . . (4,124) (2,576)
Accumulated deficit . . . . . . . . . . . . . . . . . . (50,382) (45,829)
---------- -----------
Total stockholders' equity . . . . . . . . . . . 1,338,832 1,345,119
---------- -----------
Total liabilities and shareholders' equity . . . . . . . $2,572,039 $2,511,319
---------- -----------
---------- -----------
The accompanying notes are an integral part of these
consolidated financial statements.
2
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS)
(Dollars in thousands)
(Unaudited)
THREE MONTHS ENDED MARCH 31,
----------------------------
1999 1998
---------- ---------
Revenues:
Monitoring and related services . . . . . . . . . . . $127,244 $70,774
Installation and other. . . . . . . . . . . . . . . . 21,303 6,021
-------- -------
Total revenues . . . . . . . . . . . . . . . . . 148,547 76,795
Cost of revenues:
Monitoring and related services . . . . . . . . . . . 29,697 20,073
Installation and other. . . . . . . . . . . . . . . . 11,577 3,920
-------- -------
Total cost of revenues . . . . . . . . . . . . . 41,274 23,993
-------- -------
Gross profit . . . . . . . . . . . . . . . . . . 107,273 52,802
Selling, general and administrative expense . . . . . . . . 40,607 20,514
Amortization of intangibles and depreciation expense. . . . 42,603 20,717
Acquisition expense . . . . . . . . . . . . . . . . . . . . 4,866 3,467
Employee severance cost . . . . . . . . . . . . . . . . . . 2,000 --
-------- -------
Operating income . . . . . . . . . . . . . . . . 17,197 8,104
Other income/expense:
Interest expense, net . . . . . . . . . . . . . . . . 20,171 6,555
Interest expense to Parent, net . . . . . . . . . . . -- 4,580
Other . . . . . . . . . . . . . . . . . . . . . . . . (345) (3,229)
-------- -------
Income (loss) before income taxes . . . . . (2,629) 198
Income tax (expense) benefit. . . . . . . . . . . . . . . . (1,924) 200
-------- -------
Net income (loss) . . . . . . . . . . . . . . . . . . $(4,553) $ 398
-------- -------
-------- -------
Other comprehensive income:
Unrealized loss on marketable securities, net of tax. $ (767) $ --
Unrealized loss on currency translation, net of tax . (781) --
-------- -------
Comprehensive income (loss): $(6,101) $ 398
-------- -------
-------- -------
Net income (loss) per common share. . . . . . . . . . $ (0.04) $ 0.00
-------- -------
-------- -------
Weighted average common shares outstanding. . . . . . 126,839 83,460
The accompanying notes are an integral part of these
consolidated financial statements.
3
PROTECTION ONE, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
THREE MONTHS ENDED MARCH 31,
---------------------------
1999 1998
------------ -----------
Cash flow from operating activities:
Net income (loss) . . . . . . . . . . . . . . . . . . . . . . . . . $ (4,553) $ 398
Adjustments to reconcile net income (loss) to net cash provided
by operating activities:
Amortization and depreciation . . . . . . . . . . . . . . . . . 42,603 20,717
Accretion of discount note interest . . . . . . . . . . . . . . (1,659) 3,111
Deferred income taxes . . . . . . . . . . . . . . . . . . . . . 1,931 1,736
Provision for doubtful accounts . . . . . . . . . . . . . . . . 3,043 1,641
Loss on sale of marketable securities . . . . . . . . . . . . . 343 --
Other charges . . . . . . . . . . . . . . . . . . . . . . . . . 2,000 --
Changes in assets and liabilities, net of effects of acquisitions:
Receivables, net. . . . . . . . . . . . . . . . . . . . . . . . (1,865) (4,162)
Inventories . . . . . . . . . . . . . . . . . . . . . . . . . . (1,544) (574)
Prepaid expenses and deposits . . . . . . . . . . . . . . . . . 83 426
Other current assets. . . . . . . . . . . . . . . . . . . . . . 2,714 --
Accounts payable. . . . . . . . . . . . . . . . . . . . . . . . 380 (2,776)
Accrued liabilities . . . . . . . . . . . . . . . . . . . . . . (12,499) 42
Other liabilities . . . . . . . . . . . . . . . . . . . . . . . -- 1,911
Deferred revenue. . . . . . . . . . . . . . . . . . . . . . . . 3,691 (422)
-------- -------
Net cash provided by operating activities. . . . . . . . . 34,668 22,048
-------- -------
Cash flows from investing activities:
Purchase of installed security systems. . . . . . . . . . . . . (78,601) (64,703)
Purchase of property and equipment. . . . . . . . . . . . . . . (12,170) (3,896)
Purchase of marketable securities . . . . . . . . . . . . . . . -- (1,519)
Sale of marketable securities . . . . . . . . . . . . . . . . . 2,544 --
Acquisition of alarm companies, net of cash received. . . . . . (20,722) (274,030)
Investment in Guardian. . . . . . . . . . . . . . . . . . . . . -- (4,040)
-------- --------
Net cash used in investing activities. . . . . . . . . . . (108,949) (348,188)
-------- --------
Cash flows from financing activities:
Payments on long-term debt. . . . . . . . . . . . . . . . . . . -- (15,243)
Proceeds from long term-debt. . . . . . . . . . . . . . . . . . 82,130 --
Funding from Parent . . . . . . . . . . . . . . . . . . . . . . (222) 277,198
Stock options and warrants exercised. . . . . . . . . . . . . . -- 505
-------- --------
Net cash provided by financing activities. . . . . . . . . 81,908 262,460
-------- --------
Effect of exchange rate on cash and equivalents . . . . . . . . . . (964) --
-------- --------
Net (decrease) increase in cash and cash equivalents . . . 6,663 (63,680)
Cash and cash equivalents:
Beginning of period . . . . . . . . . . . . . . . . . . . . . . 10,025 75,556
-------- --------
End of period . . . . . . . . . . . . . . . . . . . . . . . . . $ 16,688 $ 11,876
-------- --------
-------- --------
Interest paid during the period . . . . . . . . . . . . . . . . . . $ 13,524 $ 3,181
-------- --------
-------- --------
Taxes paid during the period. . . . . . . . . . . . . . . . . . . . $ 256 $ --
-------- --------
-------- --------
The accompanying notes are an integral part of these
consolidated financial statements.
4
PROTECTION ONE, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(DOLLAR AMOUNTS IN THOUSANDS)
(UNAUDITED)
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 North
America, the United Kingdom and continental Europe. The accompanying unaudited
consolidated financial statements include the accounts of Protection One and its
wholly owned subsidiaries.
As of March 31, 1999, Protection One is an approximately 85% 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 the audited financial statements and notes thereto for
the year ended December 31, 1998, included in the Company's Annual Report on
Form 10-K filed with the Securities and Exchange Commission (the "SEC").
In Europe, the Company sells some of its installed security equipment, subject
to a related operating lease agreement, to third party finance companies. For
such sales in which the Company retains a substantial risk of ownership in the
installed security equipment, the proceeds received are treated as a borrowing
and revenue continues to be recognized on a straight-line basis over the term of
the rental agreement. For such sales in which the Company does not retain a
substantial risk of ownership in the installed security equipment, a sale of the
installed security equipment is recognized at the date of the sale to the third
party finance company.
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, 1999, are not necessarily indicative of the results to be expected for
the full year. Certain purchase price allocations for acquisitions made in 1998
were made on a preliminary basis and are subject to change based on the final
determination of net asset values and completion of appraisals.
2. CUSTOMER ACCOUNTS:
Customer accounts are stated at cost. The cost includes amounts paid to
dealers and the estimated fair value of accounts acquired in business
acquisitions. Internal costs incurred in support of acquiring customer accounts
are expensed as incurred.
5
Customer accounts consist of the following:
Three Months
Ended Year Ended
March 31, 1999 December 31, 1998
-------------- -----------------
Customer accounts $1,130,946 $ 558,805
Acquisition of customer accounts 92,002 581,667
Non-cash charges to purchase holdbacks (1,834) (9,526)
---------- ----------
Total customer accounts 1,221,114 1,130,946
Less accumulated amortization 147,342 116,518
---------- ----------
Customer accounts, net $1,073,772 $1,014,428
---------- ----------
---------- ----------
In conjunction with certain purchases of customer accounts, the Company
withholds a portion of the purchase price as a reserve to offset qualifying
attrition of the acquired customer 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,
1999, and December 31, 1998, purchase holdbacks were $45,586 and $42,303,
respectively.
The SEC staff has questioned the appropriateness of the amortization method
used by the Company for its intangible asset, customer accounts. These costs
are currently amortized on a straight-line basis over a 10-year period which
the Company believes is consistent with industry practices and the Company's
attrition experience. The Company routinely evaluates historical loss rates
for customer accounts on an aggregate basis and, when necessary, adjusts
amortization over the remaining estimated useful life. A change in the
Company's present amortization method which would materially accelerate the
recognition of amortization expense would have a material adverse effect on
the Company's results of operations. The Company anticipates resolution of
this issue during the second quarter of 1999.
3. DEBT:
During the first quarter of 1999 the Company borrowed approximately $82
million on its senior credit facility. As of March 31, 1999, and December 31,
1998, total borrowings under this facility were $124 million and $42 million
respectively. Remaining availability under the facility approximates $376
million at March 31, 1999. Most of these borrowings were incurred in acquiring
new customers. During the first quarter, the Company added approximately
113,000 new customers.
4. COMMITMENTS AND CONTINGENCIES:
In April 1999, three alleged class action litigations were filed in the United
States District Court for the Central District of California against Protection
One, Inc. and certain of its present and former officers. The three actions
are: DAVID LYONS V. PROTECTION ONE, INC., WESTERN RESOURCES, INC., JAMES M.
MACKENZIE, JR., JOHN W. HESSE, AND JOHN E. MACK, III, No. 99-CV-3755 (C.D.Cal.)
(filed April 7, 1999); RANDALL KARKUTT V. PROTECTION ONE, INC., JAMES M.
MACKENZIE, JR., AND JOHN W. HESSE, No. 99-CV-3798 (C.D.Cal.) (filed April 8,
1999); and DAVID SHAEV V. PROTECTION ONE, INC., JOHN E. MACK, III, JAMES H.
MACKENZIE, JR., AND JOHN HESSE, No. 99-CV-4147 (C.D.Cal.) (filed April 20,
1999). The actions are purportedly brought on behalf of purchasers of the
common stock of Protection One, Inc. during periods beginning February 10, 1998
(Karkutt), February 12, 1998 (Shaev), or April 23, 1998 (Lyons), and ending
April 1, 1999. All three complaints assert claims under Sections 10(b) and 20
of the Securities Exchange Act of 1934 based on allegations that various
statements made by the defendants concerning the financial results of Protection
One, Inc. were false and misleading and not in compliance with generally
accepted accounting principles. The complaints seek unspecified amounts of
damages and an award of fees and expenses, including attorneys fees. Protection
One believes these actions are without merit and intends to defend against them
vigorously.
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
6
resolution of these matters will not have a material adverse effect upon the
Company's combined financial position or results of operations.
5. SEGMENT REPORTING:
The Company's reportable segments include Protection One North America,
which consists of Monitoring and Multifamily, and Protection One Europe.
Protection One North America provides security alarm monitoring services,
which include sales, installation and related servicing of security alarm
systems for residential and small businesses in the United States and Canada.
Multifamily provides security alarm services to apartments, condominiums and
other multi-family dwellings. Protection One Europe provides security alarm
services to residential and business customers in Europe. The Company's
mobile security division is not significant enough to be a reporting segment.
The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies in the Company's
1998 Form 10-K. The Company manages its business segments based on earnings
before interest and income taxes (EBIT). It is calculated by adding net
interest expense to income (loss) before income taxes. Revenues are attributed
to geographic areas based on the location of the assets producing the revenues.
THREE MONTHS ENDED MARCH 31, 1999
Protection One North America Protection Total
------------------------------- ---------- ------------
Monitoring Multifamily Total One Europe Consolidated
---------- ----------- ----- ---------- ------------
Revenues from external customers:
Monitoring and related services. . . . . . . . . . . . $95,247 $8,580 $103,827 $23,417 $127,244
Installation and rental. . . . . . . . . . . . . . . . 3,770 1,416 5,186 16,117 21,303
Total . . . . . . . . . . . . . . . . . . . . . . 99,017 9,996 109,013 39,534 148,547
Amortization of intangibles and depreciation expense . . . . 35,223 1,893 37,116 5,487 42,603
Earnings before interest and income taxes. . . . . . . . . . 8,136 2,705 10,841 6,701 17,542
THREE MONTHS ENDED MARCH 31, 1998
Protection One North America Protection Total
------------------------------- ----------- ------------
Monitoring Multifamily Total One Europe* Consolidated
---------- ----------- ----- ----------- ------------
Revenues from external customers:
Monitoring and related services. . . . . . . . . . . . $64,376 $6,398 $70,774 $-- $70,774
Installation and rental. . . . . . . . . . . . . . . . 5,536 485 6,021 -- 6,021
Total . . . . . . . . . . . . . . . . . . . . . . 76,112 683 76,795 -- 76,795
Amortization of intangibles and depreciation expense . . . . 19,339 1,378 20,717 -- 20,717
Earnings before interest and income taxes. . . . . . . . . . 9,965 1,368 11,333 -- 11,333
* Protection One Europe was not in existence during the first quarter of 1998.
6. ACQUISITION CHARGES AND OTHER CHARGES:
During 1997, a charge of $24.3 million was recorded by the Company to
recognize an asset impairment due to higher than expected customer loss rates
and recognize certain merger related costs, including the closure of duplicate
facilities. In 1998, the Company recorded an exit charge, including severance
costs, associated with its 1998 acquisitions. Activity during the first quarter
of 1999 related to these charges is as follows:
December 31, 1998 Paid March 31, 1999
----------------- ------ --------------
Closure of duplicate facilities $1,025 $(153) $872
Severance costs 897 429 468
7
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Unless the context otherwise indicates, all references in this Report on
Form 10-Q (this "Report") to the "Company," "Protection One," "we," "us" or
"our" or similar words are to Protection One, Inc., its wholly owned
subsidiary, Protection One Alarm Monitoring, Inc. ("Protection One Alarm
Monitoring") and Protection One's other wholly owned subsidiaries. Each of
Protection One and Protection One Alarm Monitoring is sometimes referred to
herein as "Registrant." Protection One's sole asset is, and Protection One
operates solely through, its investments in Protection One Alarm Monitoring
and its other wholly owned subsidiaries. Both Protection One and Protection
One Alarm Monitoring are Delaware corporations organized in September 1991.
The following Management's Discussion and Analysis of Financial Condition and
Results of Operations updates the information provided in the 1998 Annual Report
on Form 10-K and should be read in conjunction with Management's Discussion and
Analysis of Financial Condition and Results of Operations in our 1998 Annual
Report on Form 10-K.
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.
OVERVIEW
Protection One is one of the leading providers of life safety and property
monitoring services, providing electronic monitoring and maintenance of its
alarm systems to over 1.6 million customers in North America and Europe. We
also provide our customers with enhanced services that include:
-- extended service protection;
-- patrol and alarm response;
-- two-way voice communication;
-- pager service;
-- medical information service;
-- cellular back-up; and
-- mobile security services.
Approximately 85% of our revenues are contractually recurring for monitoring
alarm security systems and other related services. We have grown rapidly by
participating in the growth in the alarm industry and by acquiring other alarm
companies.
Our principal activity is responding to the immediate security and safety
needs of our customers 24 hours a day. Our revenues are generated primarily
from recurring monthly payments for monitoring and maintaining the alarm systems
that are installed in our customers' homes and businesses. Security systems are
designed to detect burglaries, fires and other events.
8
Through a network of 66 service branches and four satellite offices in North
America and 51 service branches in continental Europe and the United Kingdom,
we provide maintenance service of security systems and, in certain markets,
armed response to verify that an actual emergency has occurred.
We provide our services to the residential (both single family and
multifamily residences), commercial and wholesale segments of the alarm
industry. Although we intend to grow our presence in each of these market
segments, we believe the residential segment, which represents in excess of
80% of our customer base, is the most attractive segment of the alarm
business because of its lower penetration and thus stronger growth prospects,
higher gross margins and larger potential size.
Our company is divided geographically into two business segments:
PROTECTION ONE NORTH AMERICA generated approximately $109.0 million, or 73.4%,
of our revenues in the first quarter of 1999 and is comprised of:
-- Protection One Alarm Monitoring-our core alarm monitoring business based
in Culver City, California; and
-- Network Multifamily Security-our alarm monitoring business servicing the
multifamily/apartment market based in Addison, Texas; and
-- Mobile Division-our location-based emergency, navigation and information
business servicing individuals in their automobiles based in Irving,
Texas.
PROTECTION ONE EUROPE generated approximately $39.5 million, or 26.6%, of our
revenues in the first quarter of 1999 and is comprised of:
-- Protection One Continental Europe-our alarm monitoring business servicing
continental Europe established from our purchase of Compagnie Europeenne
de Telesecurite ("CET") in September 1998, based in Paris and Vitrolles,
France and offices in Germany, Switzerland, Belgium and the Netherlands;
and
-- Protection One United Kingdom-our alarm monitoring business servicing
the United Kingdom established from our purchase of Hambro Countrywide
Security in May 1998, based in Basingstoke, United Kingdom.
Because Protection One Europe was created as a result of acquisitions that
occurred during the course of 1998, only 10% of our revenues were contributed
from this business segment during 1998. This percentage is expected to
increase during 1999 as Protection One Europe contributes a full year of
revenues.
THREE MONTHS ENDED MARCH 31, 1999 COMPARED TO THREE MONTHS ENDED MARCH 31, 1998
GENERAL. Results for the three months ended March 31, 1999, (the "first
quarter of 1999") reflect the operations of Protection One following the
acquisition of security businesses in Europe subsequent to March 31, 1998, while
results for the comparable period in 1998, only reflect the operations of
Protection One North America. In the first quarter of 1998, the Company added
approximately 374,000 customers through business acquisitions. Accordingly, the
results of the first quarter of 1999, contain a full quarter of operations for
such acquisitions. Increases in revenues and expense items discussed below are
attributable to three factors, as appropriate: (i) changes in the financial
results of Protection One North America; (ii) the 1998 Acquisitions (iii) the
acquisition of alarm businesses in Europe in the second quarter and late in the
third quarter of 1998, and (iv) a significant increase in the level of customers
added through the Dealer Program. Discussion of results in future periods may
not include specific discussion of contributions from the 1998 Acquisitions,
which consist primarily of Comsec, Multimedia and Network.
REVENUES for the first quarter of 1999 increased by approximately $71.8
million, or 93.4%, to $148.6 million from $76.8 million for the comparable
period in 1998. Monitoring and related services revenues increased by
approximately $56.5 million, or 79.8%. The majority of the increase is due to
the 1998 Acquisitions and the growth of Protection One North
9
America. Approximately 41.4% of this increase is due to Protection One
Europe. Monitoring and related service from our Mobile Division increased
33.1% to $0.1 million in the first quarter of 1999.
INSTALLATION AND OTHER REVENUES increased by $15.3 million, or 253.8% to
$21.3 million from $6.0 million, reflecting additional installation revenues
of $16.1 million from Protection One Europe offset by a decrease in
Protection One North America installation revenues. The decline in Protection
One North America installation revenues reflects our conversion of
substantially all sales and installation activities previously conducted by
an internal sales force to the Dealer Program. We maintain internal sales
and installation capabilities in certain areas, such as our Network
Multifamily Security division, our commercial installations and our European
operations where we principally rent security systems.
COST OF REVENUES for the first quarter of fiscal 1999 increased by
approximately $17.3 million, or 72.0%, to $41.3 million from $24.0 million.
Cost of revenues as a percentage of total revenue decreased to 27.8% for the
first quarter of fiscal 1999 from 31.2% for the comparable period in 1998.
Monitoring and related services expenses increased by approximately $9.6
million, or 47.9%, primarily due to Protection One Europe. Monitoring and
related services expenses from our Mobile Division increased to $0.4 million
in the first quarter of 1999. Monitoring and related services expenses as a
percentage of monitoring and related services revenues decreased to 23.3% for
the first quarter of fiscal 1999, from 28.4% in the comparable period in 1998.
INSTALLATION AND OTHER COST OF REVENUES increased by $7.7 million, or 195.3%,
reflecting primarily installation activities from Protection One Europe in the
amount of $7.2 million.
GROSS PROFIT for the first quarter of 1999, was approximately $107.3 million,
representing an increase of $54.5 million, or 103.2%, over the $52.8 million of
gross profit recognized in the comparable period in 1998. Such increase is
primarily due to the contribution by Protection One Europe of $28.2 million, or
approximately 51.7%, with the 1998 Acquisitions and the growth of Protection One
North America comprising the balance of the increase. Gross profit as a
percentage of total revenues was 72.2% for the first quarter of fiscal 1999,
compared to 68.8% for the comparable period in 1998. The increase 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 $40.6 million
in the first quarter of fiscal 1999, an increase of approximately $20.1 million,
or 98.0%, over S,G&A in the comparable period in 1998. The majority of the
increase (approximately $15.8 million or 78.8%) is due to Protection One Europe,
the growth of Protection One North America and the 1998 Acquisitions. Such
figure as a percentage of total revenues increased from 26.7% in the first
quarter of 1998 to 27.3% in the first quarter of 1999. The increase in S,G&A as
a percentage of total revenues reflects the higher percentage of S,G&A as a
percentage of revenues from Protection One Europe of approximately 40.0%. The
higher percentage of S,G&A for Protection One Europe is due to the internal
sales and installation activities. S,G&A expenses for our Mobile Division
increased by $0.6 million, or approximately 191.6% to $0.9 million in the first
quarter of 1999 from $0.3 million in the comparable period in 1998.
ACQUISITION EXPENSES for the first quarter of 1999, increased to $4.9 million,
an increase of approximately $1.4 million, or 40.3% from $3.5 million in the
comparable period in 1998. The increase is due to efforts to integrate the 1998
Acquisitions and to support the national expansion of our Dealer Program.
AMORTIZATION OF INTANGIBLES AND DEPRECIATION EXPENSE was $42.6 million for the
first quarter of fiscal 1999, an increase of $21.9 million, or 105.6% over $20.7
million in the comparable period in 1998. The increase is due primarily to the
1998 Acquisitions and the growth in our Dealer Program in Protection One North
America. Depreciation and amortization expense from Protection One Europe
represented $5.5 million, or approximately 25.0% of the increase.
EMPLOYEE SEVERANCE COST for the quarter was $2.0 million which is the cost
associated with the severance of one of our former employees.
OTHER INCOME (EXPENSE) totaled $(19.8) million of expense in the first quarter
of 1999, as compared to $(7.9) million of expense in the comparable period in
1998. Interest expense increased by $9.1 million to $20.2 million during the
quarter ended March 31, 1999, compared to $11.1 million for the quarter ended
March 31, 1998, reflecting the increased debt level when compared to the first
quarter of 1998. The increase in debt was used for operations and the
acquisition of Hambro.
10
Interest expense in the first quarter of 1998 was partially offset by other
income of $3.2 million, reflecting a gain on repurchase of certain contracts.
BALANCE SHEET DATA. At March 31, 1999, the Company's working capital deficit
was $10.7 million compared to a working capital deficit of $48.2 million at
December 31, 1998. This decrease in the working capital deficit of $37.5 million
is primarily due to an increase in current deferred tax assets and a decrease in
accrued liabilities.
Goodwill and trademarks, net and customer accounts, net, increased to $2.3
billion at March 31, 1999, from $2.2 billion at December 31, 1998. This increase
of approximately $52.5 million, or 2.4% reflects the addition of approximately
113,000 customer accounts, offset by amortization for the quarter of $39.2
million.
Total stockholders' equity decreased approximately $6.3 million to $1,339
million from $1,345 million. The decrease in such figure reflects the net loss
for the quarter ended March 31, 1999.
LIQUIDITY AND CAPITAL RESOURCES
GENERAL. As of March 31, 1999, we believe we maintain the ability to generate
sufficient cash to fund future operations of the business. Generally, the cash
will be generated from our existing $500 million senior credit facility, which
had approximately $376 million of availability at the end of the first quarter
of 1999. The senior credit facility is subject to compliance with the debt
covenants in the agreement. Cash will also be generated from recurring revenue
from our security alarm monitoring services customer base which generated $61.8
million of positive recurring EBITDA in the quarter ended March 31, 1999. Cash
flow from operations per the statement of cash flows was $34.7 million. EBITDA
is derived by adding to income (loss) before income taxes, the sum of interest
expense and depreciation and amortization expense. EBITDA does not represent
cash flow from operations as defined by generally accepted accounting
principles, should not be construed as an alternative to operating income and is
indicative of neither operating performance nor cash flows available to fund our
cash needs. Items excluded from EBITDA are significant components in
understanding and assessing our financial performance. We believe that
presentation of EBITDA enhances an understanding of our financial condition,
results of operations and cash flows because EBITDA is used to satisfy our debt
service obligations and our capital expenditure and other operational needs as
well as provide funds for future growth. In addition, EBITDA is used by senior
lenders and subordinated creditors and the investment community to determine the
current borrowing capacity and to estimate the long-term value of companies with
recurring cash flows from operations. Our computation of EBITDA may not be
comparable to other similarly titled measures of other companies.
We generated $34.7 million of net cash provided by operating activities for
the three months ended March 31, 1999, compared to the $22.0 million net cash
provided by operating activities in the three months ended March 31, 1998. The
increase in net cash provided by operating activities reflects the increases in
our customer base from which recurring monthly revenue is derived.
We used $108.9 million of net cash in investing activities for the three
months ended March 31, 1999, compared to the use of $348.2 million for the
comparable period in 1998. Investing activities during the three months ended
March 31, 1999, included Dealer Program purchases and enterprise-wide software
expenditures. Investing activities during the three months ended March 31,
1998, included the acquisition of Comsec and Multimedia as well as Dealer
Program purchases.
We generated $81.9 million of net cash through financing activities for the
three months ended March 31, 1999, compared to generating $262.5 million for the
three months ended March 31, 1998. We obtained funding of approximately $82
million through our $500 million senior credit facility.
The indentures governing the Senior Subordinated Discount Notes and
Convertible Senior Subordinated Notes contain certain restrictions on the
transfer of Company funds, including dividends, loans and advances made by the
Company. We believe such restrictions have not had and will not have a
significant impact on our ability to meet cash obligations. Refer to the
Company's 1998 Form 10-K for additional information on these notes.
MATERIAL COMMITMENTS. As a result of the 1998 financing activities, as well
as prior year activity, we have future, material, long-term commitments, which
are listed below.
11
-- Convertible Senior Subordinated Notes: $103.5 million principal is due in
September of 2003. These notes are convertible into Protection One common
stock at a price of $11.19 per share, which is currently above the price
at which our shares are traded in the public stock markets.
-- Senior Subordinated Discount Notes: $107.9 million principal is due in
June 2005. The current book value of the notes is $123.7 million.
-- Senior Unsecured Notes: $250 million principal is due in August 2005.
-- Senior Subordinated Notes: $350 million principal is due January 2009.
-- Senior Credit Facility: At March 31, 1999, $124.0 million was drawn on
our $500.0 million senior credit facility, which expires in December 2001.
At December 31, 1998, we were in compliance with all of these financial
covenants except for a violation of the provisions of the senior credit facility
resulting from the need to restate our financial statements for 1997 and the
first three quarters of 1998. We obtained a waiver of this requirement from the
lenders under the senior credit facility until such time that our restated
financial statements were filed with and accepted under the senior credit
facility. We have filed our restated financial statements with our lenders and
they have accepted them. At March 31, 1999, we are in compliance with all of
our financial covenants.
CAPITAL EXPENDITURES. We anticipate making capital expenditures in 1999 of
approximately $25.0 million, including $15.0 million to complete the development
and installation of our new software platforms, $5.0 million for computer
hardware to replace and upgrade existing operations and $5.0 million for other
capital items. These are estimates and actual expenditures for these and
possibly other items not presently anticipated, may vary from these estimates
during the course of 1999.
TAX MATTERS. Protection One will be consolidated into future income tax
returns filed by its parent, WRI. The two parties have entered into a tax
sharing agreement, whereby WRI will make cash payments to us for current tax
benefits utilized for income tax return purposes and will require cash payments
from us for current tax expenses incurred for income tax return purposes. This
arrangement has allowed us to provide a current tax benefit for the year ended
December 31, 1998, as well as the three months ended March 31, 1999.
On a go-forward basis, if and when we, or WRI, generate income for tax return
purposes, it will proportionately over time utilize existing net operating loss
carryforwards in amounts up to approximately $60 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 our goodwill balances. The net financial
statement effect of this treatment will cause us to recognize deferred tax
expense we might otherwise not recognize.
YEAR 2000 ISSUE
An issue exists for all companies that rely on computers as the year 2000
approaches. The "Year 2000" problem is the result of the past practice in the
computer industry of using two digits rather than four to identify the
applicable year. This practice could result in incorrect results when computers
perform arithmetic operations, comparisons or data field sorting involving years
later than 1999. We are reviewing our computer programs, computer hardware and
embedded systems that we have identified as critical to our businesses and
operational needs to assess and correct any components that could be affected by
the change of the data to January 1, 2000. We have substantially completed the
review and assessment of our systems; however, we will continue our review of
systems as the need arises or prudency dictates, until January 1, 2000,
particularly with respect to the acquisition of businesses that include the
acquisition of additional information technology systems or non-information
technology systems and equipment, such as electrical, heating and cooling
systems. In addition, changes in the state of compliance or preparedness within
companies that provide services or equipment to us will require us to continue
the evaluations.
12
We have largely completed the remediation and initial testing phase of our
plan with respect to our North American monitoring operations where problems
that were identified are being corrected and tested. The majority of our
current efforts are in the planning and verification of Year 2000 readiness,
although our mobile services and European business units are expending the
majority of their current efforts on the identification, remediation and testing
phase of our plan. Our Year 2000 policy requires testing as a method for
verifying the Year 2000 readiness of business-critical items. For those items
that are impossible to test, other methods may be used to identify the readiness
status, provided adequate contingency plans are established to provide a
workaround or backup for the item. Development of contingency plans commenced
in January 1999 and is scheduled to conclude in June 1999, except for our
European business unit, which is expected to conclude this phase in the third
quarter of 1999.
We estimate the total cost to update all critical operating systems for
Year 2000 readiness will be approximately $5.0 million, although no
assurances can be given that costs will not materially exceed this amount.
As of March 31, 1999, approximately $1.8 million of these costs had been
incurred. These costs include labor for both company employees and contract
personnel used in the Year 2000 program, and non-labor costs for software
tools used in the remediation and testing efforts, replacement software,
replacement hardware, replacement embedded devices and other such costs
associated with testing and replacement. Management continues to review the
projected costs associated with the Year 2000 readiness program; however,
there can be no assurance that our actual cost of compliance will be as
projected. To date, the costs of the Year 2000 readiness program have been
substantially all information-technology related. Non-information technology
systems are highly critical to our business, but are largely beyond our
ability to control. This includes, telephones, electricity, water,
transportation and governmental infrastructure.
We estimate the cost associated with the assessment of risk and the execution
of corrective action to be approximately $5.0 million. The costs of the Year
2000 project and the date on which Protection One plans to complete the Year
2000 modifications, estimated to be during 1999, is based on the best estimates,
which were derived utilizing numerous assumptions of future events including the
continued availability of certain resources, third party modification plans and
other factors. However, there can be no guarantee that these estimates will be
achieved and actual results could differ materially from those plans. Specific
factors that might cause such material differences include, but are not limited
to, the availability and cost of personnel trained in this area, the ability to
locate and correct all relevant computer codes, and similar uncertainties.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has not experienced any significant changes in its exposure to
market risk since December 31, 1998. For additional information on the
Company's market risk, see the Form 10-K dated December 31, 1998.
13
PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
In April 1999, three alleged class action litigations were filed in the United
States District Court for the Central District of California against Protection
One, Inc., and certain of its present and former officers. The three actions
are: DAVID LYONS V. PROTECTION ONE, INC., WESTERN RESOURCES, INC., JAMES M.
MACKENZIE, JR., JOHN W. HESSE, AND JOHN E. MACK, III, No. 99-CV-3755 (C.D.Cal.)
(filed April 7, 1999); RANDALL KARKUTT V. PROTECTION ONE, INC., JAMES M.
MACKENZIE, JR., AND JOHN W. HESSE, No. 99-CV-3798 (C.D.Cal.) (filed April 8,
1999); and DAVID SHAEV V. PROTECTION ONE, INC., JOHN E. MACK, III, JAMES H.
MACKENZIE, JR., AND JOHN HESSE, No. 99-CV-4147 (C.D.Cal.) (filed April 20,
1999). The actions are purportedly brought on behalf of purchasers of the
common stock of Protection One, Inc. during periods beginning February 10, 1998
(Karkutt), February 12, 1998 (Shaev) or April 23, 1998 (Lyons) and ending April
1, 1999. All three complaints assert claims under Sections 10(b) and 20 of the
Securities Exchange Act of 1934 based on allegations that various statements
made by the defendants concerning the financial results of Protection One, Inc.
were false and misleading and not in compliance with generally accepted
accounting principles. The complaints seek unspecified amounts of damages and
an award of fees and expenses, including attorneys fees. Protection One
believes these actions are without merit and intends to defend against them
vigorously.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS.
None.
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.
(a) Exhibits. The following exhibits are filed with this Current Report on
Form 10-Q or incorporated by reference.
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- -------------------
27.1 Financial Data Schedule.*
_________
* Filed herewith
(b) Reports on Form 8-K. January 27, 1999, reporting registrant's results of
operations for the year ended December 31, 1998, and March 19, 1999,
reporting a change in the registrant's president and chief executive
officer.
14
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.
Date: May 14, 1999 PROTECTION ONE, INC.
PROTECTION ONE ALARM MONITORING, INC.
By: /s/ Anthony D. Somma
-----------------------------------
Anthony D. Somma
Acting Chief Financial Officer
15
EXHIBIT LIST
EXHIBIT
NUMBER EXHIBIT DESCRIPTION
- ------- -------------------
27.1 Financial Data Schedule.
16