-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, WQfREcO6/FJoqqwGOHwN9itUsY4rEfIRIW44Wp3wbxRjO+WGSxt+oDTHHxUmSRmu WdqUHKLbBvOwrYtzMG6b0Q== 0000054507-99-000073.txt : 19991115 0000054507-99-000073.hdr.sgml : 19991115 ACCESSION NUMBER: 0000054507-99-000073 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 7 CONFORMED PERIOD OF REPORT: 19990930 FILED AS OF DATE: 19991112 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PROTECTION ONE ALARM MONITORING INC CENTRAL INDEX KEY: 0000916310 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MISCELLANEOUS BUSINESS SERVICES [7380] IRS NUMBER: 931065479 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 001-12181 FILM NUMBER: 99749784 BUSINESS ADDRESS: STREET 1: 600 CORPORATE POINTE STREET 2: 12TH FLOOR CITY: CULVER CITY STATE: CA ZIP: 90230 BUSINESS PHONE: 3103386930 MAIL ADDRESS: STREET 1: 3900 SW MURRAY BLVD CITY: BEAVERTON STATE: OR ZIP: 97005 10-Q 1 9/30/99 10-Q 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 September 30, 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 (Exact Name of Registrant As Specified In its Charter) As Specified In its Charter) Delaware Delaware (State or Other Jurisdiction (State of 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 November 10, 1999, Protection One, Inc. had outstanding 126,944,077 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)
September 30, December 31, 1999 1998 -------------- ---------- ASSETS (Restated) Current assets: Cash and cash equivalents......................... $ 19,101 $ 10,025 Restricted cash................................... 8,991 11,987 Marketable securities............................. 9,617 17,770 Receivables, net.................................. 67,932 61,262 Inventories....................................... 10,976 7,895 Prepaid expenses.................................. 3,703 3,867 Tax receivable & current deferred taxes........... 78,156 55,429 Other assets...................................... 20,107 19,605 ---------- ---------- Total current assets......................... 218,583 187,840 Property and equipment, net............................. 59,671 46,959 Customer accounts, net.................................. 1,164,412 1,031,956 Goodwill and trademarks, net............................ 1,118,678 1,175,153 Other................................................... 44,321 68,528 ---------- ---------- Total assets......................................... $2,605,665 $2,510,436 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable.................................. $ 21,668 $ 16,374 Accrued liabilities............................... 73,121 77,412 Purchase holdbacks................................ 45,422 42,303 Long-term debt, current portion................... 34,469 40,838 Capital leases, current portion................... 1,655 1,361 Deferred revenue.................................. 62,367 57,703 ---------- ---------- Total current liabilities.................... 238,702 235,991 Long-term debt, net of current portion.................. 1,074,731 926,784 Capital leases, net of current portion.................. -- 187 Other liabilities....................................... 3,154 3,238 ---------------- ---------------- Total liabilities.................................... 1,316,587 1,166,200 Commitments and contingencies ( See Note 6) 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, 126,890,169 shares issued and outstanding, at September 30, 1999 and 126,838,741 at December 31, 1998............... 1.269 1.268 Additional paid-in capital........................... 1,392,342 1,392,256 Accumulated other comprehensive income, net.......... (4,376) (2,576) Accumulated deficit................................. (100,157) (46,712) ---------- ---------- Total stockholders' equity................... 1,289,078 1,344,236 ---------- ---------- Total liabilities and stockholders equity............ $2,605,665 $2,510,436 ========== ========== The accompanying notes are an integral part of these consolidated financial statements.
PROTECTION ONE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (Dollars in thousands, except for per share amounts) (Unaudited)
Nine Months Ended September 30,_ 1999 1998 --------------------- ------------- (Restated) Revenues: Monitoring and related services......... $386,283 $254,749 Installation and other.................. 66,197 22,347 ------- ------ Total revenues..................... 452,480 277,096 Cost of revenues: Monitoring and related services......... 99,497 71,914 Installation and other.................. 33,472 16,113 ------- ------- Total cost of revenues............. 132,969 88,027 ------- ------- Gross profit....................... 319,511 189,069 Selling, general and administrative expense... 134,711 69,987 Amortization of intangibles and depreciation 182,606 81,064 expense....................................... Acquisition expense........................... 21,932 14,470 Employee severance and transition cost........ 4,308 -- ------- ------ Operating income................... (24,046) 23,548 Other income/expense: Interest expense, net................... 64,334 21,297 Interest expense to parent, net......... -- 16,033 Gain on sale of Mobile Services Group... (17,249) -- Other................................... (71) (20,785) ------- ------- Income (loss) before income taxes & (71,060) 7,003 extraordinary item.......... Income tax (expense) benefit.................. 17,615 (6,251) ------- ------- Income (loss)before extraordinary item........ (53,445) 752 Extraordinary gain, net of tax.............. -- 1,591 ------- ------- Net income (loss)........................ $(53,445) $ 2,343 ======== ======= Other comprehensive income: Unrealized loss on marketable securities, net of tax.................................... $(3,888) $(1,959) Unrealized loss on currency translation, net of tax.................................... (488) -- ----- -------- Comprehensive income (loss): $(57,821) $ 384 ======== ======= Income (loss) per common share........... $ (0.42) $ 0.01 ======== ======= Extraordinary gain per common share $ (0.00) $ 0.02 ======== ======= Net income(loss) per common share $ (0.42) $ 0.03 ======== ======= Weighted average common shares outstanding (in thousands)............... 126,872 102,445 The accompanying notes are an integral part of these consolidated financial statements.
PROTECTION ONE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) (Dollars in thousands, except for per share amounts) (Unaudited)
Three Months Ended September 30,_ 1999 1998 --------------------- ------------- (Restated) Revenues: Monitoring and related services......... $131,220 $96,527 Installation and other.................. 21,911 6,734 ------- ------- Total revenues..................... 153,131 103,261 Cost of revenues: Monitoring and related services......... 39,631 27,159 Installation and other.................. 10,181 5,396 ------- ------- Total cost of revenues............. 49,812 32,555 ------- ------- Gross profit....................... 103,319 70,706 Selling, general and administrative expense... 50,203 23,454 Amortization of intangibles and depreciation 94,250 31,761 expense....................................... Acquisition expense........................... 10,298 4,970 Employee severance and transition cost........ 2,309 -- ------- ------- Operating income................... (53,741) 10,521 Other income/expense: Interest expense, net................... 22,319 7,875 Interest expense to parent, net......... -- 4,554 Gain on sale of Mobile Services Group... (17,249) -- Other................................... 945 (7,372) ------- ------- Income (loss) before income tax......... (59,756) 5,464 Income tax (expense) benefit.................. 18,770 (4,489) ------- ------- Net income (loss)....................... $(40,986) $ 975 ======== ======= Other comprehensive income: Unrealized loss on marketable securities, net of tax.................................... $(3,888) $(1,959) Unrealized loss on currency translation, net of tax.................................... (488) -- ----- -------- Comprehensive income (loss): $(45,362) $ (984) ======== ======= Net income (loss) per common share........... $ (0.32) $ 0.01 ======== ======= Weighted average common shares outstanding (in thousands).............................. 126,890 127,345 The accompanying notes are an integral part of these consolidated financial statements.
PROTECTION ONE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (Unaudited)
Nine Months Ended September 30, 1999 1998 --------------------- ------------- (Restated) Cash flow from operating activities: Net income (loss)...................................... $ (53,445) $ 2,343 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Extraordinary gain................................. -- (1,591) Gain on sale of Mobile Services Group.............. (17,249) -- Gain on Guardian stock exchange transaction........ -- (2,498) Amortization and depreciation...................... 182,606 81,064 Accretion of discount note interest................ (5,057) 4,635 Deferred income taxes.............................. (20,795) 5,817 Provision for doubtful accounts.................... 16,933 7,762 Loss on sale of marketable securities.............. 1,910 -- Changes in assets and liabilities, net of effects of acquisitions: Receivables, net................................... (17,505) (3,550) Other current assets............................... (1,120) (8,765) Accounts payable................................... 5,302 (4,051) Other liabilities.................................. (15,644) 1,368 --------- ------- Net cash provided by operating activities..... 75,936 82,534 --------- ------- Cash flows from investing activities: Purchase of installed security systems............. (207,657) (228,352) Purchase of property and equipment................. (26,679) (18,933) Purchase (sale) of marketable securities........... 2,722 (14,365) Acquisition of alarm companies, net of cash received (27,408) (554,230) Proceeds from sale of Mobile Services Group, net of 19,087 -- cash paid.............................................. Investment in Guardian............................. -- (4,131) --------- ------- Net cash used in investing activities......... (239,935) (820,011) --------- -------- Cash flows from financing activities: Proceeds from equity offering...................... -- 402,322 Payments on long-term debt......................... -- (86,205) Proceeds from long term-debt....................... 171,725 247,160 Funding from parent................................ 434 113,239 Stock options and warrants exercised............... 273 820 --------- ------- Net cash provided by financing activities..... 172,432 677,336 --------- ------- Effect of exchange rate changes on cash and equivalents 643 -- --------- ------- Net increase (decrease) in cash and cash 9,076 (60,141) equivalents............................................ Cash and cash equivalents: Beginning of period................................ 10,025 75,556 --------- ------- End of period...................................... $ 19,101 $15,415 ========= ======= Interest paid during the period........................ $ 54,437 $ 7,316 ========= ======= Taxes paid during the period........................... $ 285 $ 42 ========= ======= The accompanying notes are an integral part of these consolidated financial statements.
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 September 30, 1999, Protection One is an approximately 85% owned subsidiary of Westar Capital, Inc. ("Westar Capital"), a wholly owned subsidiary of Western Resources, Inc. ("Western Resources"). The Company's unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles ("GAAP") 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/A filed with the Securities and Exchange Commission (the "SEC"). In the opinion of management of the Company, all adjustments considered necessary for a fair presentation of the financial statements have been included. All adjustments made were normal recurring adjustments except for the adjustment related to the change in accounting principle for customer accounts discussed in Note 3. The results of operations for the three and nine-month periods ended September 30, 1999 are not necessarily indicative of the results to be expected for the full year. Certain purchase price allocations for acquisitions made in 1999 were made on a preliminary basis and are subject to change. 2. Restatement of Financial Statements: The Company has restated its 1998 financial statements and its interim financial statements for the quarters ended March 31, 1999 and June 30, 1999. These restatements result from a revaluation of amounts assigned to acquired customers in the Multifamily business segment. During 1998, the Company acquired businesses in its Multifamily business segment and allocated a portion of the purchase price to the customer accounts acquired. During the third quarter of 1999, management analyzed the initial purchase price allocations for these acquisitions and increased the amount allocated to customer accounts by $19 million, reduced goodwill by $13 million and increased deferred taxes payable by $6 million. Due to the difference in periods over which customer accounts and goodwill are amortized, net income was decreased for each of the reported periods in 1999 and 1998 as follows:
As Previously Reported Restatement As Restated ---------------------------- --------------------------- --------------------------- Earnings Earnings Earnings Amount Per Share Amount Per Share Amount Per Share -------------- ------------ ------------- ------------- ------------ ------------- (Dollars in thousands, except for per share amounts) Income (loss) before extraordinary gain - ----------------------- 1998 - Quarter Ended: March 31 $ 398 $ - $(204) $ - $ 194 $ - June 30 (199) - (221) (.01) (420) (.01) September 30 1,206 .01 (229) - 977 .01 December 31 (5,459) (.05) (229) - (5,688) (.05) -------------- ------------ ------------- ------------- ------------ ------------- For the Year Ended December 31, 1998 $(4,054) $ (.04) $(883) $ (.01) $(4,937) $ (.05) ============== ============ ============= ============= ============ ============= Net income (loss) - ----------------------- 1999 - Quarter Ended: March 31 $(4,553) $ (.04) $(232) $ - $(4,785) $ (.04) June 30 (7,441) (.06) (232) - (7,673) (.06) 1998 - Quarter Ended: March 31 398 - (204) - 194 - June 30 1,392 .02 (221) (.01) 1,171 .01 September 30 1,206 .01 (229) - 977 .01 December 31 (5,459) (.05) (229) - (5,688) (.05) -------------- ============ ============= ============= ============ ============= For the Year Ended December 31, 1998 $(2,463) $ (.02) $(883) $ (.01) $(3,346) $ (.03) ============== ============ ============= ============= ============ ============= The restatements did not impact previously reported revenues and do not impact the Company's net cash flow.
3. Change in Accounting Principle: The Company historically amortized the costs it allocated to its customer accounts by using the straight-line method over a ten-year life. The straight-line method, indicated in Accounting Principles Board Opinion No. 17 as the appropriate method for such assets, has been the predominant method used to amortize customer accounts in the monitored services industry. Management is not aware of whether the economic life or the rate of realization for the Company's customer accounts differs materially from other monitored services companies. The choice of a ten-year life was based on management's estimates and judgments about the amounts and timing of expected future revenues from these assets, the rate of attrition of such revenue over customer life, and average customer account life. Ten years was used because, in management's opinion, it would adequately match amortization cost with anticipated revenue from those assets even though many accounts were expected to produce revenue over periods substantially longer than ten years. Effectively, it expensed the asset costs ratably over an "expected average customer life" that was shorter than the expected life of the revenue stream, thus implicitly giving recognition to projected revenues for a period beyond ten years. The Company has recently concluded a comprehensive review of its amortization policy that was undertaken during the third quarter of 1999. This review was performed specifically to evaluate the historic amortization policy in light of the inherent declining revenue curve over the life of a pool of customer accounts, and the Company's historical attrition experience. After completing the review, management identified three distinct pools, each of which has distinct attributes that effect differing attrition characteristics. The pools correspond to the Company's North America, Multifamily and Europe business segments. These separate pools will be used going forward. For the North America and Europe pools, the analyzed data indicated to management that the Company can expect attrition to be greatest in years one through five of asset life and that a change from a straight-line to a declining balance (accelerated) method would more closely match future amortization cost with the estimated revenue stream from these assets. Management has elected to change to that method. No change was made in the method used for the Multifamily pool. The Company's amortization rates for the North America and Europe customer pools consider the average estimated remaining life and historical and projected attrition rates. The average estimated remaining life for each customer pool is as follows: Average Estimated Remaining Life Pool (Years) Method - --------------- ------------------- -------------------------------- North America 8-10 Ten-year 130% declining balance Europe 10 Ten-year 125% declining balance Multifamily 12 Ten-year straight-line Adoption of the declining balance method effectively shortens the estimated expected average customer life for these two customer pools, and does so in a way that does not make it possible to distinguish the effect of a change in method (straight-line to declining balance) from the change in estimated lives. In such cases, generally accepted accounting principles require that the effect of such a change be recognized in operations in the period of the change, rather than as a cumulative effect of a change in accounting principle. Accordingly, the effect of the change in accounting principle increased amortization expense reported in the third quarter by $47 million. Similarly, accumulated amortization recorded on the balance sheet would have been approximately $41 million higher if the Company had historically used the declining balance method through the end of the second quarter of 1999. 4. 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. Customer accounts consist of the following (in thousands):
Nine Months Ended Year Ended September 30, 1999 December 31, 1998 ------------------------ ------------------------ Customer accounts $ 1,150,342 $ 558,805 Acquisition of customer accounts 291,550 601,063 Non-cash charges to purchase holdbacks (9,918) (9,526) ----------- ----------- Total customer accounts 1,431,974 1,150,342 Less accumulated amortization 267,562 118,386 ----------- ----------- Customer accounts, net $1,164,412 $1,031,956 =========== ==========
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 September 30, 1999 and December 31, 1998, purchase holdbacks were $45.4 million and $42.3 million, respectively. As the result of the attrition rates for the North America pool, the Company intends to hire an appraiser to perform a current lifing study to assess the impact of the 1999 customer service issues on the estimated long-term revenues to be received from the current North America account base. Upon completion of the study, the Company will consider the reasonableness of the value of its North America account base and the current amortization rates. This could result in a change in amortization rate. The Company intends to perform an evaluation for potential impairment taking into account the results of this study. Amounts involved may be material and would represent a non-cash charge to earnings. 5. Debt: During the first nine months of 1999 the Company borrowed approximately $173 million on its senior credit facility. As of September 30, 1999 and December 31, 1998, total borrowings under this facility were approximately $215 million and $42 million, respectively. In addition, there were outstanding letters of credit of approximately $5 million at September 30, 1999. Available borrowings under the credit facility were approximately $30 million as of September 30, 1999 and November 10, 1999. The Company borrows to fund operations in excess of internally generated cash under its senior credit facility. The Company's ability to borrow under the facility is subject to compliance with certain financial covenants, including a leverage ratio of 5.0 to 1.0 and an interest coverage ratio of 2.75 to 1.0. At year end 1999, the leverage ratio required under the credit facility will be reduced to 4.5 to 1.0. As of September 30, 1999, the ratios were approximately 6.7 to 1.0 and 2.0 to 1.0. The indentures governing the Company's outstanding senior and subordinated notes contain similar covenants with different calculations relating to the Company's ability to incur indebtedness. The Company is in compliance with all covenants contained in these indentures. The senior credit facility lenders have waived compliance with the current leverage and interest coverage ratio covenants through December 3, 1999. In connection with the waiver, the amount of the credit facility was reduced from $500 million to $250 million. The Company will not, absent successful implementation of the alternatives discussed below, be in compliance with the current leverage and interest coverage ratio covenants in the credit facility following the expiration of the waiver. The Company is discussing waivers or amendments to the senior credit facility with the lenders and exploring other alternatives to address these covenant restrictions and the reduced amount of the credit facility, including selling assets to reduce debt or refinancing the facility. The credit facility lenders have requested that the Company obtain credit support for the facility from Western Resources or one of its affiliates. The Company's public debt contains restrictions on providing certain forms of credit support to the credit facility. Further, there can be no assurance that Western Resources or its affiliates will provide any credit support to the lenders under the facility. If the Company's negotiations with its senior credit facility lenders are not successful, the Company will be in default under the credit facility. If the lenders elect to accelerate the outstanding indebtedness under the credit facility, this action would result in defaults under the indentures governing certain of the Company's outstanding notes and the repayment of the notes could be accelerated if the defaults were not cured within applicable grace periods. The Company would not be able to repay its indebtedness if repayment is accelerated. Even if the lenders elect not to accelerate the outstanding indebtedness under the credit facility, the Company will likely experience shortfalls in liquidity which would adversely impact the Company's ability to meet its cash obligations and have a material adverse effect upon the Company's financial position and results of operations. If the Company is unable to maintain adequate liquidity, Western Resources may choose to make additional investments in the Company, but it is not obligated to do so. Management believes the Company will be able to address this matter in a manner so that there is no default under the credit facility or significant impact on its liquidity, but no assurances can be given that the Company will be able to do so or the terms thereof. See Note 11 for recent developments concerning a review of the Company's capital structure and financial alternatives. 6. Commitments and Contingencies: The Company has been advised by the Division of Corporation Finance that, in the view of the staff, there are errors in the Company's financial statements which are material and which have had the effect of inflating earnings commencing with the year 1997. The Company has had extensive discussions with the SEC staff about the methodology used by the Company to amortize customer accounts, the purchase price allocation to customer accounts in the Network Multifamily acquisition and other matters. The Company has restated its financial statements for certain prior periods and has changed the accounting principle used for the amortization of customer accounts as discussed above in Notes 2 and 3. The SEC staff has not indicated it concurs with, nor has the SEC staff determined not to object to, the restatements or the change in accounting principle. The Company cannot predict whether the SEC staff will make additional comments or take other action that will further impact its financial statements or the effect or timing of any such action. Six Protection One dealers have filed a class action lawsuit in the U. S. District Court for the Western District of Kentucky alleging breach of contract because of the Company's interpretation of their dealer contracts. The action is styled Total Security Solutions, Inc., et al. v. Protection One Alarm Monitoring, Inc., Civil Action No. 3:99CV-326-H (filed May 21, 1999). On September 10, 1999, the Court granted Protection One's motion to stay the proceeding pending the individual plaintiff's pursuit of arbitration as required by the terms of their agreements. As of November 10, 1999, none of these dealers have commenced arbitration. Other Protection One dealers have threatened litigation or arbitration based upon similar claims. The Company believes it has complied with the terms of these contracts and intends to vigorously defend its position. The Company cannot currently predict the impact of these disputes with dealers which could be material. Under the Company's agreements with dealers, the Company may be required to purchase customer accounts on an ongoing basis. The Company is currently spending approximately $15 million per month to purchase these customer accounts. The Company, its subsidiary Protection One Alarm Monitoring, Inc. ("Monitoring"), and certain present and former officers and directors of Protection One are defendants in a purported class action litigation pending in the United States District Court for the Central District of California, David Lyons v. Protection One, Inc., et al., No CV 99-3755 DT (RCx). Pursuant to an Order dated August 2, 1999 which consolidated four pending purported class actions, the plaintiffs filed a single Consolidated Amended Class Action Complaint ("Amended Complaint") on October 15, 1999. The Amended Complaint asserts claims under Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 against Protection One, Monitoring, and certain present and former officers and directors of Protection One based on allegations that various statements concerning Protection One's financial results and operations for 1997 and 1998 were false and misleading and not in compliance with generally accepted accounting principles. Plaintiffs allege, among other things, that former employees of Protection One, including an unnamed former executive officer and an unnamed former staff accountant, have reported that Protection One lacked adequate internal accounting controls and that certain accounting information was unsupported or manipulated by management in order to avoid disclosure of accurate information. The Amended Complaint further asserts claims against Western Resources and Westar Capital as controlling persons under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. A claim is also asserted under Section 11 of the Securities Act of 1933 against Protection One's auditor Arthur Andersen LLP. The Amended Complaint seeks an unspecified amount of compensatory damages and an award of fees and expenses, including attorneys' fees. The time for the defendants to respond to the Amended Complaint has not yet expired. The Company believes that all the claims asserted in the Amended Complaint are without merit and intends to defend against them vigorously. We cannot currently predict the impact of this litigation which could be material. The Company is a party to claims and matters of litigation incidental to the normal course of its business. The ultimate outcome of such matters cannot presently be determined; however, in the opinion of management of the Company, the resolution of such matters will not have a material adverse effect upon the Company's combined financial position or results of operations. 7. Segment Reporting: The Company's reportable segments include North America, Multifamily, and Europe. North America provides security alarm monitoring services, which include sales, installation and related servicing of security alarm systems in the United States and Canada. Multifamily provides security alarm services to apartments, condominiums and other multi-family dwellings. The Europe segment provides security alarm services in Europe. 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/A, subject to the change in accounting principle for amortization expense discussed in Note 3 above. The Company manages its business segments based on earnings before interest and income taxes (EBIT). Nine Months Ended September 30, 1999 (Dollars in thousands)
North America Multifamily Europe Consolidated Revenues from customers: Monitoring and related services......... $ 290,180 $ 25,680 $ 70,423 $ 386,283 Installation and rental................. 11,009 3,218 51,970 66,197 --------- --------- --------- --------- Total.............................. 301,189 28,898 122,393 452,480 EBITDA........................................ 115,170 12,170 35,528 162,868 Amortization of intangibles and depreciation 153,531 7,003 22,072 182,606 expense....................................... Other1........................................ (12,825) -- (187) (13,012) Earnings before interest and income taxes..... (25,536) 5,167 13,643 (6,726)
Nine Months Ended September 30, 1998 (Dollars in thousands)
North America Multifamily Europe2 Consolidated Revenues from customers: Monitoring and related services......... $ 231,202 $ 21,041 $ 2,506 $ 254,749 Installation and rental................. 17,613 2,351 2,383 22,347 --------- --------- -------- --------- Total.............................. 248,815 23,392 4,889 277,096 EBITDA........................................ 95,451 9,152 9 104,612 Amortization of intangibles and depreciation 74,953 5,520 591 81,064 expense....................................... Other income.................................. (20,785) -- -- (20,785) Earnings before interest and income taxes..... 41,283 3,632 (582) 44,333
Three Months Ended September 30, 1999 (Dollars in thousands)
North America Multifamily Europe Consolidated Revenues from customers: Monitoring and related services......... $ 98,568 $ 8,697 $ 23,955 $ 131,220 Installation and rental................. 3,500 970 17,441 21,911 --------- --------- --------- --------- Total.............................. 102,068 9,667 41,396 153,131 EBITDA........................................ 26,800 4,025 11,993 42,818 Amortization of intangibles and depreciation 80,655 2,388 11,207 94,250 expense....................................... Other1........................................ (13,969) -- (26) (13,995) Earnings before interest and income taxes..... (39,886) 1,637 812 (37,437)
Three Months Ended September 30, 1998 (Dollars in thousands)
North America Multifamily Europe2 Consolidated Revenues from customers: Monitoring and related services......... $ 87,560 $ 7,510 $ 1,457 $ 96,527 Installation and rental................. 5,105 424 1,205 6,734 --------- --------- --------- --------- Total.............................. 92,665 7,934 2,662 103,261 EBITDA........................................ 39,020 3,427 (165) 42,282 Amortization of intangibles and depreciation 29,400 1,963 398 31,761 expense....................................... Other income.................................. (7,372) -- -- (7,372) Earnings before interest and income taxes..... 16,992 1,464 (563) 17,893
1 "Other" includes employee severance and transition cost, gain on sale of Mobile Services Group, and other (income) expense. 2 Results for Protection One Europe do not include the operations of CET which was acquired September 30, 1998. 8. Related Party Transactions In the third quarter, the Company signed a letter of intent with Paradigm Direct LLC ("Paradigm") concerning a three year marketing relationship. Western Resources has a 40% ownership interest in Paradigm. The proposed arrangement contemplates that the Company will purchase a targeted number of accounts from Paradigm during each year of the agreement following an initial pilot program, with 50,000 accounts targeted for the first year. Paradigm will be paid $775 per installed account that generates monthly recurring revenue of $32.95 per month and meets certain other criteria and an annual fee, in arrears, of $20 for each account that remains in good standing for the life of the account. In addition, the Company will purchase leads that satisfy certain criteria at $115 per lead. The Company will have the right to terminate the agreement if Paradigm does not deliver the targeted number of accounts or attrition exceeds certain levels for accounts purchased or if the pilot program proves unsuccessful. In connection with the marketing arrangement, the Company's marketing personnel will be transferred to Paradigm. During the pilot program period and the first year of the agreement, the Company will reimburse Paradigm for the overhead associated with these persons plus 10%. Overhead is defined as current salary plus benefits, but the 10% mark-up is limited to base salaries. The number of persons for which Paradigm will be reimbursed for overhead will be adjusted annually by agreement. The Company expensed $1 million paid to Paradigm in the third quarter in connection with start up costs relative to this program. The first marketing year would start following completion of a pilot program. The Company will pay $857 per new account for up to 2,500 accounts sold during the pilot program. The pilot program is expected to be completed by the end of the first quarter 2000. The Company entered into a service agreement with Western Resources during the third quarter. Pursuant to this agreement Western Resources will provide administrative services including accounting, human resources, legal, facilities and technology. The Company accrued $450,000 for services provided in the third quarter. 9. Income Taxes The income tax benefit recorded for the nine-month period ended September 30, 1999 is 25% of the pre-tax loss. This rate represents the expected effective rate for 1999. This effective rate was adjusted in the third quarter to reflect the revised expected annual operating performance. The change in the expected annual effective rate increased the tax benefit recorded in the third quarter by approximately $3.8 million. The difference between the expected annual effective rate of 31% and the federal statutory rate of 35% is primarily attributable to non-deductible goodwill amortization. The Company has a tax sharing agreement with Western Resources which allows it to be reimbursed for tax deductions utilized by Western Resources in its consolidated tax return. 10. Sale of Mobile Services Group During the third quarter, the Company sold the assets which had comprised its Mobile Services Group. Cash proceeds of this sale approximated $20 million and the Company recorded a pre-tax gain of approximately $17 million. 11. Recent Developments: In October 1999, the Company and Western Resources jointly announced a review of the capital structure and financial alternatives for the Company, including: review of the Company's capital structure; changes in financial ownership interests, including spinning or splitting off some portion or all of Western Resources' interest; potential purchase of selected Protection One assets by Western Resources; seeking new sources of debt and equity capital; refinancing existing debt; the repurchase of Protection One debt by either Protection One or Western Resources; and other options. 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. Protection One's primary asset is, and Protection One operates primarily 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 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/A. Certain matters discussed here and elsewhere in this Form 10-Q are forward-looking statements. The Private Securities Litigation Reform Act of 1995 has established that these statements qualify for safe harbors from liability. Forward-looking statements may include words like the Company believes, anticipates, expects or words of similar meaning. Forward-looking statements describe the Company's future plans, objectives, expectations, or goals. Such statements address future events and conditions concerning capital expenditures, earnings, restructuring the dealer program and the methods of customer acquisition, litigation, the outcome of accounting issues being reviewed by the SEC staff, possible corporate restructurings, mergers, acquisitions, dispositions, liquidity and capital resources, compliance with debt covenants, interest, Year 2000 Issue, ability to enter new markets successfully and capitalize on growth opportunities, events in foreign markets in which investments have been made, and accounting matters. What happens in each case could vary materially from what the Company expects because of such things as future economic conditions; legislative developments; competitive markets; and other circumstances affecting anticipated operations, revenues and costs. Overview Protection One is one of the leading providers of 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 security and safety needs of our customers. Our revenues are generated primarily from recurring monthly payments for monitoring and maintaining the alarm systems that are installed in our customers' homes and businesses. Security systems are designed to detect burglaries, fires and other events. Through a network of 57 service branches and 11 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 residential (both single family and multifamily residences), commercial and wholesale customers. We believe residential customers, who represent in excess of 80% of our customer base, are most attractive because of lower penetration in this market and thus stronger growth prospects, higher gross margins and larger potential size. In prior years, the Company's strategy was focused primarily on growing its customer account base to achieve critical mass. We believe we have reached such critical mass and our strategic focus has now shifted to the following areas: - - Improving customer service; - - Reducing attrition; - - Reducing customer acquisition costs; and - - Integrating and building infrastructure such as common platforms for our central stations, billing, and other applications. Our company is divided into three business segments: Protection One North America ("North America") generated approximately $301.2 million, or 66.6%, of our revenues in the first nine months of 1999 and is comprised of Protection One Alarm Monitoring-our core alarm monitoring business based in Culver City, California. Multifamily generated approximately $28.9 million, or 6.4%, of our revenues in the first nine months of 1999 and is comprised of our alarm monitoring business servicing the multifamily/apartment market based in Addison, Texas. Protection One Europe ("Europe") generated approximately $122.4 million, or 27.0%, of our revenues in the first nine months 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 with 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. Attrition Subscriber attrition has a direct impact on our results of operations since it affects both our revenues and amortization expense. We define attrition as a ratio, the numerator of which is the number of lost customer accounts for a given period, net of certain adjustments, and the denominator of which is the average number of accounts for a given period. The adjustments made to lost accounts are primarily related to those accounts which are covered under a purchase price holdback and are "put" back to the seller. We reduce the gross accounts lost during a period by the amount of the guarantee provided for in the purchase agreements with sellers. In some cases, the amount of the purchase holdback may be less than actual attrition experience. The Company's actual attrition experience shows that the relationship period with any individual customer can vary significantly and may be substantially shorter or longer than ten years. Customers discontinue service with the Company for a variety of reasons, including relocation, service issues and cost. A portion of the acquired customer base can be expected to discontinue service with the Company every year. Any significant change in the pattern of the Company's historical attrition experience would have a material effect on the Company's results of operations. The Company monitors attrition each quarter based on an annualized and trailing twelve-month basis. This method utilizes each segment's average customer account base for the applicable period in measuring attrition. Therefore, in periods of customer account growth, customer attrition may be understated and in periods of customer account decline, customer attrition may be overstated. When necessary the Company will adjust amortization of the cost of customer accounts. During 1999, the Company has experienced an increase in customer attrition. Total attrition for the trailing twelve months ended September 30, 1999 was 12.2% compared to 10.5% for the trailing twelve months ended June 30, 1999. Annualized total attrition for the quarter ended September 30, 1999 was 16.0% compared to 14.3% for the quarter ended June 30, 1999. Customer attrition by business segment for the period ended September 30, 1999 is summarized below: Customer Account Attrition September 30, 1999 --------------------------------- Annualized Trailing Current Twelve Quarter Month ------------- ------------- North America 19.1% 14.2% Europe 4.5% 4.8% Multifamily 7.6% 6.5% Total Company 16.0% 12.2% As the result of the attrition rates for the North America pool, the Company intends to engage an appraiser to perform a current lifing study to assess the impact of the 1999 customer service issues on the estimated long-term revenues to be received from the current North America account base. Upon completion of the study, the Company will consider the reasonableness of the value of its North America account base and the current amortization rates. This could result in a change in amortization rate. The Company intends to perform an evaluation for potential impairment taking into account the results of this study. Amounts involved may be material and would represent a non-cash charge to earnings. The Company is addressing customer service issues which management believes have impacted attrition. In this regard, 150 service representatives were added in the second quarter and the Company has increased training and technology investments. As a result of these initiatives, there were improvements in the third quarter in measurements of key performance metrics such as abandonment rates, acknowledgement time, average speed of answer and service repair backlog. Additional customer service initiatives are under way with a goal of reducing attrition rates. These include, but are not limited to, special retention teams, new billing system implementation, proactive customer interaction, and focusing the organization on customer service. No assurance can be given that these efforts will be successful in reducing customer attrition. Recent Developments Change in Accounting Principle. The Company historically amortized the costs it allocated to its customer accounts by using the straight-line method over a ten-year life. The straight-line method, indicated in Accounting Principles Board Opinion No. 17 as the appropriate method for such assets, has been the predominant method used to amortize customer accounts in the monitored services industry. Management is not aware of whether the economic life or the rate of realization for the Company's customer accounts differs materially from other monitored services companies. The choice of a ten-year life was based on management's estimates and judgments about the amounts and timing of expected future revenues from these assets, the rate of attrition of such revenue over customer life, and average customer account life. Ten years was used because, in management's opinion, it would adequately match amortization cost with anticipated revenue from those assets even though many accounts were expected to produce revenue over periods substantially longer than ten years. Effectively, it expensed the asset costs ratably over an "expected average customer life" that was shorter than the expected life of the revenue stream, thus implicitly giving recognition to projected revenues for a period beyond ten years. The Company has recently concluded a comprehensive review of its amortization policy that was undertaken during the third quarter of 1999. This review was performed specifically to evaluate the historic amortization policy in light of the inherent declining revenue curve over the life of a pool of customer accounts, and the Company's historical attrition experience. After completing the review, management identified three distinct pools, each of which has distinct attributes that effect differing attrition characteristics. The pools correspond to the Company's North America, Multifamily and Europe business segments. These separate pools will be used going forward. For the North America and Europe pools, the analyzed data indicated to management that the Company can expect attrition to be greatest in years one through five of asset life and that a change from a straight-line to a declining balance (accelerated) method would more closely match future amortization cost with the estimated revenue stream from these assets. Management has elected to change to that method. No change was made in the method used for the Multifamily pool. The Company's amortization rates for the North America and Europe customer pools consider the average estimated remaining life and historical and projected attrition rates. The average estimated remaining life for each customer pool is as follows: Average Estimated Remaining Life Pool (Years) Method - --------------- --------------------- ----------------------------- North America 8-10 Ten-year 130% declining balance Europe 10 Ten-year 125% declining balance Multifamily 12 Ten-year straight-line Adoption of the declining balance method effectively shortens the estimated expected average customer life for these two customer pools, and does so in a way that does not make it possible to distinguish the effect of a change in method (straight-line to declining balance) from the change in estimated lives. In such cases, generally accepted accounting principles require that the effect of such a change be recognized in operations in the period of the change, rather than as a cumulative effect of a change in accounting principle. Accordingly, the effect of the change in accounting principle increased amortization expense reported in the third quarter by $47 million. Similarly, accumulated amortization recorded on the balance sheet would have been approximately $41 million higher if the Company had historically used the declining balance method through the end of the second quarter of 1999. Sale of Mobile Services Group. The sale of our Mobile Services Group to ATX Technologies ("ATX") was announced on June 28, 1999 and consummated on August 25, 1999. The sales price was approximately $20 million in cash plus a note and a preferred stock investment in ATX. The Company will continue to deliver mobile services through a reseller arrangement with ATX. For the nine months ended September 30, 1999, the net loss attributable to the Mobile Services Group was approximately $2.6 million. In August, the Company recorded a gain on the sale of approximately $11.2 million, net of tax. SEC Review. The Company has been advised by the Division of Corporation Finance that, in the view of the staff, there are errors in the Company's financial statements which are material and which have had the effect of inflating earnings commencing with the year 1997. The Company has had extensive discussions with the SEC staff about the methodology used by the Company to amortize customer accounts, the purchase price allocation to customer accounts in the Network Multifamily acquisition and other matters. The Company has restated its financial statements for certain prior periods and has changed the accounting principle used for the amortization of customer accounts as discussed above in Notes 2 and 3 to the Consolidated Financial Statements. The SEC staff has not indicated it concurs with, nor has the SEC staff determined not to object to, the restatements or the change in accounting principle. The Company cannot predict whether SEC staff will make additional comments or take other action that will further impact its financial statements or the effect or timing of any such action. Dealer Program. In 1998, the Company expanded the Dealer Program (Dealer Program) for its North American single family residential market. As part of the Dealer Program, the Company entered into contracts with dealers, typically independent alarm companies, providing for the purchase of customer accounts generated by the dealer on an ongoing basis. The Company currently has a limited internal sales capability and relies on the Dealer Program for the generation of substantially all new customer accounts except those acquired as part of the acquisition of other security companies. In the third quarter, the Company continued to identify steps that could be taken to reduce the cost of acquired accounts and reduce attrition by acquiring higher quality accounts. As a result, the Company began notifying dealers that it does not intend to renew their contracts under their current terms and conditions when they expire. The term of dealer contracts ranges from one to five years and automatically renews unless notice of non-renewal is given by either party as provided in the contract. The Company is attempting to renew contracts with terms providing for a lower cost for acquired customer accounts based upon the multiple of monthly recurring revenue and other revised terms that improve the quality of the acquired customer accounts. The Company cannot predict whether it will be successful in renewing existing dealer contracts, or entering into contracts with new dealers, on acceptable terms. This could result in a loss of dealers and fewer customer accounts available for purchase. The failure to replace customer accounts could have a material adverse impact on our financial condition. Efforts to date have reduced the number of accounts being purchased from dealers each month from 25,000 in March to 10,600 in October. Six Protection One dealers have filed a class action lawsuit in the U. S. District Court for the Western District of Kentucky alleging breach of contract because of the Company's interpretation of their dealer contracts. The action is styled Total Security Solutions, Inc., et al. v. Protection One Alarm Monitoring, Inc., Civil Action No. 3:99CV-326-H (filed May 21, 1999). On September 10, 1999, the Court granted Protection One's motion to stay the proceeding pending the individual plaintiff's pursuit of arbitration as required by the terms of their agreements. As of November 10, 1999, none of these dealers have commenced arbitration. Other Protection One dealers have threatened litigation or arbitration based upon similar claims. The Company believes it has complied with the terms of these contracts and intends to vigorously defend its position. The Company cannot currently predict the impact of these disputes with dealers which could be material. Termination of Lifeline Proposed Merger. In September 1999, Protection One and Lifeline Systems, Inc. terminated their proposed merger due to delays in obtaining effectiveness of the registration statement covering the proposed issuance of shares of Protection One in the transaction. Protection One recorded a charge of approximately $3.7 million for costs related to the transaction, including a termination fee of $1 million. Sale of Canadian Operations. In September 1999, Protection One and VOXCOM, Incorporated ("VOXCOM") entered into a definitive purchase agreement for the sale of Protection One's Canadian operations to VOXCOM for approximately $27 million, including approximately $23 million in cash. The parties subsequently terminated the purchase agreement because VOXCOM was unable to obtain financing for the transaction. The Company continues to evaluate options for its Canadian operations. Capital Structure Review. In October 1999, Protection One and Western Resources jointly announced a review of the capital structure and financial alternatives for the Company, including: review of Protection One's capital structure; changes in financial ownership interests, including spinning or splitting off some portion or all of Western Resources' interest; potential purchase of selected Protection One assets by Western Resources; seeking new sources of debt and equity capital; refinancing existing debt; the repurchase of Protection One debt either by Protection One or Western Resources; and other options. It is anticipated the review process will be completed by the end of the first quarter of 2000. If Western Resources ceases to own specified percentages of Protection One's equity securities, an event of default will occur under the agreement governing the senior credit facility and the Company will be obligated to make an offer to purchase its outstanding notes under the indentures governing the notes. Protection One cannot prevent Western Resources from pursuing a financial alternative that could result in such an event of default. Administrative Services. In October 1999, the Company entered into a services agreement with Western Resources to provide administrative services to the Company, including accounting, legal, facilities, human resources, information technology, and supply chain services. The Company will pay Western Resources for these services based upon various hourly charges, negotiated fees and out of pocket expenses. Lifing Study. The Company hired an independent appraiser to perform a lifing study of the estimated average remaining life, as of the date of the acquisition, of customer accounts acquired by the Company in five major acquisitions. The results of the lifing study are summarized below: Estimated Acquisition Average Remaining Life Westinghouse 8 Protection One 10 Multimedia 9.5 - 10 Network Multifamily 12 CET 10 Nine Months Ended September 30, 1999 Compared to Nine Months Ended September 30, 1998 General. Results for the nine months ended September 30, 1999 (the "first three quarters of 1999") reflect a full nine months of operations for security businesses acquired by Protection One in Europe subsequent to May, 1998, while results for the comparable period in 1998 reflect primarily the operations of Protection One North America. In the first three quarters of 1998, the Company added approximately 680,000 customers through acquisitions that were completed at various times throughout the period. Accordingly, the results of the first three quarters of 1999 contain a full nine months of operations for such acquisitions. Increases in revenues and expense items discussed below are attributable to five 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; (iv) a significant increase in the level of customers added through the Dealer Program; and (v) the change in accounting principle adopted during the third quarter. 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 three quarters of 1999 increased by approximately $175.4 million, or 63.3%, to $452.5 million from $277.1 million for the comparable period in 1998. The primary reason for the increase in revenues is due to acquired businesses included in Protection One Europe, which had revenue increases of $117.5 million or 67.0% of the total increase in revenues. Approximately $26.4 million of this amount was recognized as a result of ongoing reductions in the liability under the Company's recourse financing agreements. Protection One Europe contributed $4.9 million of revenues in the comparable period in 1998 compared to $122.4 million for the nine months ended September 30, 1999. Monitoring and related services revenues increased by approximately $131.5 million, or 51.6%. Approximately 51.6% of the increase in such revenues is due to Protection One Europe, with most of the remaining increase attributed to the 1998 Acquisitions and the growth of Protection One North America and Multifamily. Installation and other revenues increased by $43.8 million, or 196.2% to $66.2 million from $22.3 million, reflecting additional installation and other revenues of $49.6 million from Protection One Europe and a decrease of $6.6 million in Protection One North America installation revenues. We maintain internal sales and installation capabilities in certain areas, such as Network Multifamily, our commercial installations and our European operations where we principally lease security systems to customers. Cost of revenues for the first three quarters of 1999 increased by approximately $44.9 million, or 51.0%, to $133.0 million from $88.0 million. Protection One Europe contributed $34.0 million or 75.6%, of the increase in cost of revenues. Cost of revenues for Protection One North America increased $11.9 million or 26.4%. Cost of revenues for Multifamily decreased $0.9 million, or 2%. Cost of revenues as a percentage of total revenue decreased to 29.4% for the first three quarters of 1999 from 31.8% for the comparable period in 1998. Protection One Europe's cost of revenues as a percentage of total revenues decreased to 29.9% for the nine months ended September 30, 1999 compared to 54.5% for the nine months ended September 30, 1998. It should be noted that for the nine months ended September 30, 1998, Protection One Europe consisted only of Hambro Countrywide Security, which was acquired in May 1998, which had total revenues of $4.9 million and cost of revenues of $2.7 million for the period. Protection One North America cost of revenues as a percentage of total revenues decreased to 29.4% for the nine months ended September 30, 1999 from 30.8% in the comparable period in 1998. Monitoring and related service expenses increased by approximately $27.6 million, or 38.4%, primarily due to Protection One Europe, which accounted for approximately 49.3% of the total increase and Protection One North America which contributed 45.8% or $12.6 million of the increase. Monitoring and related service expenses as a percentage of monitoring related services revenues decreased to 25.8% for the first three quarters of 1999, from 28.2% in the comparable period in 1998. Installation and other cost of revenues increased by $17.4 million, or 107.7%, reflecting primarily installation activities from Protection One Europe. Gross profit for the first three quarters of 1999 was approximately $319.5 million, representing an increase of $130.4 million or 69.0%, over the $189.1 million of gross profit recognized in the comparable period in 1998. Such increase is primarily due to the contribution by Protection One Europe of $83.5 million, or approximately 64.0%, with the 1998 Acquisitions and the growth of Protection One North America comprising the remainder of the increase. Gross profit as a percentage of total revenues was 70.6% for the first three quarters of 1999, compared to 68.2% 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 $134.7 million in the first three quarters of 1999, an increase of approximately $64.7 million, or 92.5%, over S,G&A in the comparable period in 1998. Approximately $47.3 million or 73.1% of the increase is due to Protection One Europe, with the growth and integration efforts of Protection One North America and the 1998 Acquisitions contributing 22.1% of the increase. Such figure as a percentage of total revenues increased from 25.3% in the first three quarters of 1998 to 29.9% in the first three quarters 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 40.5%. The higher percentage of S,G&A for Protection One Europe is due to the internal sales and installation activities. Acquisition expenses for the first three quarters of 1999 increased to $21.9 million, an increase of approximately $7.4 million, or 51.6% from $14.5 million in the comparable period in 1998. Approximately half of the increase is due to the termination costs related to the Lifeline merger. Efforts to integrate the 1998 Acquisitions and costs related to the national Dealer Program comprise the balance. Amortization of intangibles and depreciation expense was $182.6 million for the first three quarters of 1999, an increase of $101.5 million, or 125.3% over the $81.0 million in the comparable period in 1998. Approximately half of the increase ($47.0 million or 46.3%) is due to the change in accounting method and finalization of certain purchase price allocations. Approximately $31.6 million or 31.1% of 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 $21.5 million, or approximately 21.2% of the increase. See Note 3 to Consolidated Financial Statements. Employee severance and transition cost for the first three quarters of 1999 was $4.3 million. Approximately $3.2 million is the cost associated with the severance of certain of our former officers and the balance of the costs are related to the transition of the Company's financial functions from Irving, Texas to Topeka, Kansas. Other income (expense) totaled $(47.0) million of expense in the first nine months of 1999, as compared to $(16.5) million of expense in the comparable period in 1998. Interest expense increased by $27.0 million to $64.3 million during the nine months ended September 30, 1999, compared to $37.3 million for the nine months ended September 30 1998, reflecting the increased debt level when compared to the third quarter of 1998 and the recognition of $7.1 million of interest being recorded as a result of ongoing reductions in the liability under the Company's recourse financing agreements in Europe. Other expense in the first three quarters of 1999 was offset by the gain on the sale of the Company's Mobile Services Group in the amount of $17.2 million. Other expense in the first three quarters of 1998 was significantly offset by other income of $20.8 million, reflecting a gain on repurchase of certain contracts. Income tax (expense) benefit totaled $17.6 million for the nine months ended September 30, 1999. The increase in the benefit for the nine months ended September 30, 1999 is due primarily to the change in accounting method. Typically, the Company's provision for income taxes is higher than the effective rate primarily due to the non-deductibility of goodwill amortization which was incurred as a result of its acquisition program. We consolidate with our parent company, Western Resources, Inc. for federal tax reporting purposes. We do not consolidate Protection One Europe for tax reporting purposes. Balance sheet data. At September 30, 1999, the Company's working capital deficit was $20.1 million compared to a working capital deficit of $48.2 million at December 31, 1998. This decrease in the working capital deficit of $28.1 million is primarily due to an increase in current deferred tax assets of $22.7 million and net receivables of $6.7 million. Goodwill and trademarks, net and customer accounts, net, increased to $2.3 billion at September 30, 1999, from $2.2 billion at December 31, 1998. This net increase of approximately $76.0 million, or 3.5% reflects the addition of approximately 264,000 customer accounts, offset by amortization expense for the first nine months of 1999 of $171.4 million. See Note 4 to Consolidated Financial Statements for further discussion. Total stockholders' equity decreased approximately $55.1 million to $1,289.1 million from $1,344.2 million at December 31, 1998. The decrease in such figure reflects the net loss of $53.4 million for the nine months ended September 30, 1999 and the increase in the unrealized loss on marketable securities and currency translation. Three Months Ended September 30, 1999 Compared to Three Months Ended September 30, 1998 Revenues for the third quarter of 1999 increased by approximately $49.8 million, or 48.3%, to $153.1 million from $103.3 million for the comparable period in 1998. Approximately 77.7% or $38.7 million of this increase is due to acquired businesses included in Protection One Europe. Approximately $8.1 million of the increase at Protection One Europe was recognized as a result of ongoing reductions in the liability under the Company's recourse financing agreements. Protection One North America contributed $9.4 million or 18.9% of the total increase in revenues. Monitoring and related services revenues increased by approximately $34.7 million, or 35.9%. The majority of the increase is due to Protection One Europe (approximately $22.5 million or 64.8%) with the 1998 Acquisitions and the growth of Protection One North America comprising $11.0 million or 31.7% of the increase. Installation and other revenues increased by $15.2 million, or 225.4% to $21.9 million from $6.7 million, reflecting additional installation revenues of $16.2 million from Protection One Europe and $0.5 million from Multifamily offset by a decrease of $1.6 million 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 subsidiary, our commercial installations and our European operations where we principally rent security systems. Cost of revenues for the third quarter of 1999 increased by approximately $17.3 million, or 53.0%, to $49.8 million from $32.5 million. Protection One Europe contributed $11.5 million or 66.4% of the increase in cost of revenues. Protection One North America's cost of revenues increased by $5.4 million or 31.5% of the increase. Cost of revenues as a percentage of total revenue increased to 32.5% for the third quarter of 1999 from 31.5% for the comparable period in 1998. Protection One North America cost of revenues as a percentage of total revenues for the quarter ended September 30, 1999 increased to 33.2% from 30.7% for the quarter ended September 30, 1998. Such increase for Protection One North America is attributable to increased staffing in the Company's customer care centers. Monitoring and related services expenses increased by approximately $12.5 million, or 45.9%, primarily due to Protection One Europe, which accounts for approximately $5.3 million or 42.7% of the total increase. Monitoring and related services expenses as a percentage of monitoring and related services revenues increased to 30.2% for the third quarter of 1999, from 28.1% in the comparable period in 1998. Protection One North America monitoring and related expenses as a percentage of monitoring and related revenues increased to 31.9% for the quarter ended September 30, 1999 from 28.6% for the quarter ended September 30, 1998. As noted above, such increase is due to higher staffing levels at the Company's customer care centers. Installation and other cost of revenues increased by $4.8 million, or 88.7%, reflecting primarily installation activities from Protection One Europe in the amount of $6.1 million offset by a decrease of $1.0 million and $0.3 million in the installation activities of Protection One North America and Multifamily, respectively. Gross profit for the third quarter of 1999 was approximately $103.3 million, representing an increase of $32.6 million, or 46.1%, over the $70.7 million of gross profit recognized in the comparable period in 1998. Such increase is primarily due to the contribution by Protection One Europe of $27.3 million, or approximately 83.6%, with the 1998 Acquisitions and the growth of Protection One North America comprising approximately $4.0 million or 12.2% and Multifamily the remainder of the increase. Gross profit as a percentage of total revenues was 67.5% for the third quarter of 1999, compared to 68.5% for the comparable period in 1998. The decrease 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 $50.2 million in the third quarter of 1999, an increase of approximately $26.8 million, or 114.0%, over S,G&A in the comparable period in 1998. Approximately $14.8 million or 55.2% of the increase is due to Protection One Europe. Protection One North America S,G&A expenses increased $11.1 million or 55.5% for the quarter ended September 30, 1999 compared to the quarter ended September 30, 1998. The majority of the increase in such expenses is due to a larger customer account base and efforts to integrate the 1998 Acquisitions. Other items contributing to the increased expense include higher professional fees, higher provision for bad debt expense and additional costs associated with changes in the dealer program. Such figure as a percentage of total revenues increased from 22.7% in the third quarter of 1998 to 32.8% in the third quarter of 1999 due to the factors previously listed. 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 39.0%. The higher percentage of S,G&A for Protection One Europe is due to the internal sales and installation activities. Acquisition expenses for the third quarter of 1999 increased to $10.3 million, an increase of approximately $5.3 million, or 107.2% from $5.0 million in the comparable period in 1998. $3.7 million of the increase is related to the termination of the Lifeline merger. Efforts to integrate the 1998 Acquisitions and costs related to the national Dealer Program comprise the balance. Amortization of intangibles and depreciation expense was $94.3 million for the third quarter of 1999, an increase of $62.5 million, or 196.8% over the $31.8 million in the comparable period in 1998. Approximately $46.9 million or 75.1% of the increase is related to the change in accounting method. The balance of the increase in Protection One North America amortization and depreciation expense is due to the higher amortization and depreciation expense related to the 1998 Acquisitions and the growth in our Dealer Program. Depreciation and amortization expense from Protection One Europe represented $10.8 million, or approximately 17.3% of the increase. See Note 3 to Consolidated Financial Statements for further discussion. Other income (expense) totaled $(6.0) million of expense in the third quarter of 1999, as compared to $(5.1) million of expense in the comparable period in 1998. Interest expense increased by $9.9 million, or 79.6% to $22.3 million during the quarter ended September 30, 1999, compared to $12.4 million for the quarter ended September 30, 1998, reflecting the increased debt level when compared to the third quarter of 1998 and the recognition of $2.1 million of interest being recorded as a result of ongoing reductions in the liability under the Company's recourse financing agreements in Europe. The increase in debt was used to fund accounts purchased under the Dealer Program, acquisitions and operations. Other expense in the third quarter of 1999 was significantly offset by other income of $17.3 million, reflecting a gain on sale of the Company's Mobile Services Group. Other expense in the third quarter of 1998 was significantly offset by other income of approximately $7.4 million, reflecting the gain on the repurchase of certain contracts. Income tax (expense) benefit totaled $18.8 million for the quarter ended September 30, 1999. The income tax benefit recorded by the Company is primarily due to the impact of the change in accounting method related to subscriber accounts. Typically, the Company's provision for income taxes is higher than the effective rate primarily due to the non-deductibility of goodwill amortization which was incurred as a result of its acquisition program. We consolidate with our parent company, Western Resources, Inc. for federal tax reporting purposes. We do not consolidate Protection One Europe for tax reporting purposes. Liquidity and Capital Resources The Company borrows to fund operations in excess of internally generated cash under its senior credit facility. The Company's ability to borrow under the facility is subject to compliance with certain financial covenants, including a leverage ratio of 5.0 to 1.0 and an interest coverage ratio of 2.75 to 1.0. At year end 1999, the leverage ratio required under the credit facility will be reduced to 4.5 to 1.0. As of September 30, 1999, the ratios were approximately 6.7 to 1.0 and 2.0 to 1.0. The Company currently borrows approximately $20 million per month, principally to fund the purchase of customer accounts. The indentures governing the Company's outstanding senior and subordinated notes contain similar covenants with different calculations relating to the Company's ability to incur indebtedness. The Company is in compliance with all covenants contained in these indentures. The senior credit facility lenders have waived compliance with the current leverage and interest coverage ratio covenants through December 3, 1999. In connection with the waiver, the amount of the credit facility was reduced from $500 million to $250 million. The Company will not, absent successful implementation of the alternatives discussed below, be in compliance with the current leverage and interest coverage ratio covenants in the credit facility following the expiration of the waiver. The Company is discussing waivers or amendments to the senior credit facility with the lenders and exploring other alternatives to address these covenant restrictions and the reduced amount of the credit facility, including selling assets to reduce debt or refinancing the facility. The credit facility lenders have requested that the Company obtain credit support for the facility from Western Resources or one of its affiliates. The Company's public debt contains restrictions on providing certain forms of credit support to the credit facility. Further, there can be no assurance that Western Resources or its affiliates will provide any credit support to the lenders under the facility. If the Company's negotiations with its senior credit facility lenders are not successful, the Company will be in default under the credit facility. If the lenders elect to accelerate the outstanding indebtedness under the credit facility, this action would result in defaults under the indentures governing certain of the Company's outstanding notes and the repayment of the notes could be accelerated if the defaults were not cured within applicable grace periods. The Company would not be able to repay its indebtedness if repayment is accelerated. Even if the lenders elect not to accelerate the outstanding indebtedness under the credit facility, the Company will likely experience shortfalls in liquidity which would adversely impact the Company's ability to meet its cash obligations and have a material adverse effect upon the Company's financial position and results. The Company has been advised by its independent public accountants that if the issues related to the Company's credit facility have not been resolved prior to the completion of their audit of the Company's financial statements for the year ending December 31, 1999, their auditors' report on those financial statements may be qualified as being subject to the ultimate outcome of that contingency. If the Company is unable to maintain adequate liquidity, Western Resources may choose to make additional investments in the Company, but it is not obligated to do so. Management believes the Company will be able to address this matter in a manner so that there is no default under the credit facility or significant impact on its liquidity, but no assurances can be given that the Company will be able to do so or the terms thereof. See Note 11 to the Consolidated Financial Statements for recent developments concerning a review of the Company's capital structure and financial alternatives. Cash will also be generated from recurring revenue from our security alarm monitoring services customer base, which generated $162.9 million of EBITDA in the nine months ended September 30, 1999. Cash flow from operations per the statement of cash flows was $75.9 million. EBITDA is derived by adding to income (loss) before income taxes, the sum of interest expense, depreciation and amortization expense and employee severance and transition costs, and deducting the gain on sale of Mobile Services Group and other income. 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. 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 $75.9 million of net cash provided by operating activities for the nine months ended September 30, 1999, compared to the $85.5million net cash provided by operating activities in the nine months ended September 30, 1998. The decrease in net cash provided by operating activities reflects the impact of approximately $23 million in interest payments on debt incurred in 1998. We used $239.4 million of net cash in investing activities for the nine months ended September 30, 1999, compared to the use of $820.0 million for the comparable period in 1998. Investing activities during the nine months ended September 30, 1999, included Dealer Program purchases and enterprise-wide software expenditures. Investing activities during the nine months ended September 30, 1998, included the acquisition of Multimedia, Campagnie Europeenne de Telesecurite ("CET"), Comsec, Canguard and Hambro as well as Dealer Program purchases. We generated $172.4 million of net cash through financing activities for the nine months ended September 30, 1999, compared to generating $677.3 million for the nine months ended September 30, 1998. We obtained funding of approximately $173 million through our $250 million senior credit facility. In response to liquidity and operational issues and the announcement by Western Resources that it is exploring strategic alternatives for Protection One (See "Recent Developments- Capital Structure Review"), Moody's, S & P and Fitch downgraded their ratings on our credit facility and outstanding securities. These ratings as of November 10, 1999 were as follows: Senior Senior Unsecured Subordinated Debt Unsecured Debt ----------------- --------------------- S & P BB B+ Moody's Ba3 B2 Fitch BB B+ The indentures governing the Senior Subordinated Discount Notes and Senior Subordinated Notes contain certain restrictions on the transfer of Company funds, including dividends, loans and advances made by the Company. Refer to the Company's 1998 Form 10-K/A for additional information on these notes. As a result of the Company's failure to complete an exchange offer for the outstanding senior subordinated notes issued in December 1998, the interest rate on the notes increased to 8 5/8% per annum in June 1999. Material Commitments. Under the Company's agreements with dealers, the Company may be required to purchase customer accounts on an ongoing basis. The Company is currently spending approximately $15 million per month to purchase these customer accounts. Capital Expenditures. We anticipate making capital expenditures in 1999 of approximately $35 million, including $20.0 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 $10.0 million for other capital items. These are estimates, but actual expenditures in 1999 for these and possibly other items not presently anticipated are not expected to vary materially from these estimates. Tax Matters. Protection One is consolidated into income tax returns filed by its parent, Western Resources. The two parties have entered into a tax sharing agreement whereby Western Resources will make cash payments to us for current tax benefits utilized for income tax return purposes and which 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 for the nine months ended September 30, 1999. In the future, if and when we generate income for tax return purposes, we 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 have reviewed our computer programs, computer hardware and embedded systems identified as critical to our businesses and operational needs to assess and to correct any components that could be affected by the change of date to January 1, 2000, as well as other dates in 2000. In addition, we engaged an outside consulting firm with an international reputation in Year 2000 compliance to conduct an independent validation and verification (IV&V) of our Y2K readiness programs. We have completed the review and assessment of our systems, although changes in the state of compliance or preparedness within companies that provide services or equipment to us will require us to continue our evaluations of these third-party vendors as the need arises or as prudence dictates, until January 1, 2000 or later if need be. A number of our accounts are monitored by other firms on Protection One's behalf. In the Protection One North America monitoring division, we are assimilating these accounts into our own facilities, but will not have completed this effort prior to January 1, 2000. We therefore evaluated these third-party monitoring (TPM) firms and their facilities for Y2K readiness and used the results of this evaluation as inputs to our account-assimilation priorities. In the European division, TPMs will be continued in operation in Germany, Belgium, Netherlands and Switzerland until superceded by Protection One-owned facilities. Evaluation of these third-party monitoring firms (one for each of the four countries) will be completed prior to the end of November 1999. U.K. accounts have been consolidated into the Protection One U.K. monitoring facility in London, with the exception of one remaining TPM. This TPM is now being evaluated for Y2K compliance. Network Multifamily does not use TPMs. The total number of TPM accounts is less than 7% of all accounts as of September 30, 1999, and is expected to be less than 4% at year-end 1999. 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 concluded in October 1999. Testing and refinement of contingency plans, and mobilization for "Millennium Day", commenced in the third quarter and will conclude in the fourth quarter of 1999. Protection One North America's equipment testing is scheduled to be completed by December 20, 1999. We have largely completed the remediation and readiness verification phase of our plans with respect to our Protection One North America monitoring operations where problems that were identified are being corrected and re-tested. Our highest priority has been to ensure the Y2K-readiness of Protection One's call centers responsible for alarm monitoring and for responding to customer telephone calls. At this time we believe that our call centers will continue to be able to receive and act upon alarm signals and in-person telephone calls, so long as infrastructure elements over which Protection One has no control (such as electrical power, telephones, and governmental services) are not disrupted or overwhelmed by consumer demand. The majority of our current efforts are now concentrated in contingency planning, and concluding our Year 2000 readiness verification testing. In the Protection One North America Monitoring division, remediation of known non-compliant computer-based systems has been completed except for one billing system serving some 50,000 accounts. Remediation and testing of this system is scheduled to be completed by the end of November. Remediation and testing of systems at Network Multifamily is complete. In Europe and UK, remediation of in-house systems will conclude in November 1999. In all divisions, readiness verification (testing of business-critical systems previously assessed as Y2K-compliant) is proceeding in priority order, and will continue throughout the calendar year, as a double-check. A substantial amount of readiness verification has already been completed on Protection One North America Monitoring major systems, with only non-critical errors found. We have estimated the total cost to update all critical operating systems for Year 2000 readiness to be less than $5.0 million. As of September 30, 1999, approximately $3.5 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. To date, the costs of the Year 2000 readiness program have been substantially 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. The costs of the Year 2000 project and the date on which we plan to complete the Year 2000 modification, estimated to be during 1999, are 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; 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. The table below summarizes the status of the components of the Year 2000 Readiness Program as of September 30, 1999.
North American Network Multi-Family Protection One Europe Phase: Monitoring ------------------------ ------------------------ ------------------------ Identification and assessment Completed Completed Completed Remediation and unit testing 95% Complete Completed 90% Complete Comprehensive Y2K readiness verification: Guidelines and tools Completed Completed Completed Testing 70% Complete Completed 85% Complete Contingency planning: Guidelines and tools Completed Completed Completed Plan development Completed Completed 90% Complete Contingency plan testing and resourcing: Guidelines and tools Completed Completed Completed Testing and resourcing In progress Sept-Nov In progress Sept-Nov In progress Sept-Nov 1999 1999 1999 Mobilization, alert, and standby In progress Nov-Dec In progress Nov-Dec In progress Nov-Dec 1999 1999 1999
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/A dated December 31, 1998. PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS. The Company, its subsidiary Protection One Alarm Monitoring, Inc. ("Monitoring"), and certain present and former officers and directors of Protection One are defendants in a purported class action litigation pending in the United States District Court for the Central District of California, David Lyons v. Protection One, Inc., et al., No CV 99-3755 DT (RCx). Pursuant to an Order dated August 2, 1999 which consolidated four pending purported class actions, the plaintiffs filed a single Consolidated Amended Class Action Complaint ("Amended Complaint") on October 15, 1999. The Amended Complaint asserts claims under Section 11 of the Securities Act of 1933 and Section 10(b) of the Securities Exchange Act of 1934 against Protection One, Monitoring, and certain present and former officers and directors of Protection One based on allegations that various statements concerning Protection One's financial results and operations for 1997 and 1998 were false and misleading and not in compliance with generally accepted accounting principles. Plaintiffs allege, among other things, that former employees of Protection One, including an unnamed former executive officer and an unnamed former staff accountant, have reported that Protection One lacked adequate internal accounting controls and that certain accounting information was unsupported or manipulated by management in order to avoid disclosure of accurate information. The Amended Complaint further asserts claims against Western Resources and Westar Capital as controlling persons under Sections 11 and 15 of the Securities Act of 1933 and Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. A claim is also asserted under Section 11 of the Securities Act of 1933 against Protection One's auditor Arthur Andersen LLP. The Amended Complaint seeks an unspecified amount of compensatory damages and an award of fees and expenses, including attorneys' fees. The time for the defendants to respond to the Amended Complaint has not yet expired. The Company believes that all the claims asserted in the Amended Complaint are without merit and intends to defend against them vigorously. We cannot currently predict the impact of this litigation which could be material. Six Protection One dealers have filed a class action lawsuit in the U. S. District Court for the Western District of Kentucky alleging breach of contract because of the Company's interpretation of their dealer contracts. The action is styled Total Security Solutions, Inc., et al. v. Protection One Alarm Monitoring, Inc., Civil Action No. 3:99CV-326-H (filed May 21, 1999). On September 10, 1999, the Court granted Protection One's motion to stay the proceeding pending the individual plaintiff's pursuit of arbitration as required by the terms of their agreements. As of November 10, 1999, none of these dealers have commenced arbitration. Other Protection One dealers have threatened litigation or arbitration based upon similar claims. The Company believes it has complied with the terms of these contracts and intends to vigorously defend its position. The Company cannot currently predict the impact of these disputes with dealers which could be material. 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 10.1 Waiver letter dated as of September 30, 1999 among Protection One Alarm Monitoring, Inc., Bank of America, N.A., as Administrative Agent, and the Syndication Agent, the Documentation Agent and the Lenders named in the Credit Agreement dated as of December 21, 1998 to which all such persons are a party. 10.2 Waiver letter dated as of October 29, 1999 among Protection One Alarm Monitoring, Inc., Bank of America, N.A., as Administrative Agent, and the Syndication Agent, the Documentation Agent and the Lenders named in the Credit Agreement dated as of December 21, 1998 to which all such persons are a party. 10.3 Service Agreement dated as of April 1, 1999 between Western Resources, Inc. and Protection One, Inc. and Exhibits 3 and 4 thereto dated October 14, 1999. 10.4 Letter of Intent dated September 16, 1999 between Paradigm Direct LLC and Protection One Alarm Monitoring, Inc. 18.1 Letter of Arthur Andersen LLP regarding Change in Accounting Principle 27.1 Financial Data Schedule - --------- (b) During the quarter ended September 30, 1999, the Company filed six Reports on Form 8-K. A Current Report on Form 8-K dated July 2, 1999, reported the proposed sale of the Company's Mobile Services Group. A Current Report on Form 8-K dated August 12, 1999, reported second quarter earnings. A Current Report on Form 8-K/A dated August 13, 1999, reported a correction in the Form 8-K filed on August 12, 1999. A current report on Form 8-K dated August 26, 1999, reported the sale of the Company's Mobile Services Group to ATX Technologies. A current report on Form 8-K dated September 3, 1999, reported the termination of the proposed merger with Lifeline Systems, Inc. A current report on Form 8-K dated September 29, 1999, reported the proposed sale of the Company's Canadian operations. 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: November 12, 1999 PROTECTION ONE, INC. -------------------- PROTECTION ONE ALARM MONITORING, INC. By: /s/ Anthony D. Somma Anthony D. Somma Chief Financial Officer Exhibit List Exhibit Number Exhibit Description 10.1 Waiver letter dated as of September 30, 1999 among Protection One Alarm Monitoring, Inc., Bank of America, N.A., as Administrative Agent, and the Syndication Agent, the Documentation Agent and the Lenders named in the Credit Agreement dated as of December 21, 1998 to which all such persons are a party. 10.2 Waiver letter dated as of October 29, 1999 among Protection One Alarm Monitoring, Inc., Bank of America, N.A., as Administrative Agent, and the Syndication Agent, the Documentation Agent and the Lenders named in the Credit Agreement dated as of December 21, 1998 to which all such persons are a party. 10.3 Service Agreement dated as of April 1, 1999 between Western Resources, Inc. and Protection One, Inc. and Exhibits 3 and 4 thereto dated October 14, 1999. 10.4 Letter of Intent dated September 16, 1999 between Paradigm Direct LLC and Protection One Alarm Monitoring, Inc. 18.1 Letter of Arthur Andersen LLP regarding Change in Accounting Principle 27.1 Financial Data Schedule EX-10 2 EX-10.1 WAIVER LETTER DATED AS OF SEPTEMBER30,1999 As of September 30, 1999 Protection One Alarm Monitoring, Inc. 818 South Kansas Avenue P.O. Box 889 Topeka, Kansas 66601 Re: Request for Waiver Gentlemen: Reference is hereby made to that certain Credit Agreement dated as of December 21, 1998, executed by Protection One Alarm Monitoring, Inc., a Delaware corporation ("Borrower"), NationsBank, N.A. (now known as Bank of America, N.A.), as Administrative Agent ("Administrative Agent"), the Syndication Agent defined therein, the Documentation Agent defined therein, and the Lenders defined therein (as modified, amended, renewed, extended, and restated from time to time, the "Credit Agreement"). Capitalized terms used herein shall, unless otherwise indicated, have the respective meanings set forth in the Credit Agreement. Borrower has notified Administrative Agent that, as of September 30, 1999, Borrower may not be in compliance with the Leverage Ratio set forth in Section 10.13(a) of the Credit Agreement and the Interest Coverage Ratio set forth in Section 10.13(b) of the Credit Agreement (the "Covenant Violations"). By execution of this letter in the space provided below, each Lender executing this letter (collectively, "Consenting Lenders"), subject to the terms and conditions of this letter, hereby waives the existence of the Covenant Violations and any Default created thereby until 5:00 p.m. (Dallas, Texas time) on November 1, 1999. As a condition precedent to each Consenting Lender's execution of this letter, Borrower hereby notifies Administrative Agent that, pursuant to Section 2.3 of the Credit Agreement, Borrower elects to partially terminate the Total Commitment in an amount equal to $250,000,000 and, after giving effect to such partial termination, the Total Commitment shall equal $250,000,000. Borrower and Consenting Lenders agree that such partial termination of the Total Commitment shall be effective as of the date hereof (notwithstanding the notice requirements set forth in Section 2.3 of the Credit Agreement. As a material inducement to the Credit Parties to execute this letter, Borrower hereby represents and warrants to the Credit Parties that, after giving effect to this letter and the waiver contained herein: (a) other than the Covenant Violations, all of the representations and warranties contained in the Credit Agreement and the other Loan Documents are true and correct as of the date hereof as though made as of such date (unless they speak to a specific date or are based upon facts which have changed by transactions expressly contemplated or permitted by the Credit Agreement); and (b) other than the Covenant Violations, no Potential Default or Default exists. Protection One Alarm Monitoring, Inc. As of September 30, 1999 Page 2 By execution of this letter in the space provided below, Borrower ratifies and confirms that the Credit Agreement and all other Loan Documents, and all renewals, extensions, and restatements of, and amendments and supplements to, any of the foregoing, are and remain in full force and effect in accordance with their respective terms. The waiver hereby granted by Consenting Lenders does not (a) constitute a waiver or modification of any other terms or provisions set forth in the Credit Agreement or any other Loan Document and shall not impair any right that any Credit Party may now or hereafter have under or in connection with the Credit Agreement or any other Loan Document, and (b) impair any Credit Party's rights to insist upon strict compliance with the Credit Agreement, as amended or otherwise modified hereby, or the other Loan Documents. The Loan Documents continue to bind and inure to Borrower and the Credit Parties and their respective successors and permitted assigns. This letter, when countersigned by the Required Lenders, shall be a "Loan Document" as defined and referred to in the Credit Agreement and the other Loan Documents, and may be signed in any number of counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. THIS LETTER SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS. THIS LETTER, THE CREDIT AGREEMENT, AND THE OTHER LOAN DOCUMENTS EMBODY THE FINAL, ENTIRE AGREEMENT AMONG THE PARTIES HERETO AND SUPERSEDE ANY AND ALL PRIOR COMMITMENTS, AGREEMENTS, REPRESENTATIONS, AND UNDERSTANDINGS, WHETHER WRITTEN OR ORAL, RELATING TO THE SUBJECT MATTER HEREOF, AND MAY NOT BE CONTRADICTED OR VARIED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OR DISCUSSIONS OF THE PARTIES HERETO. THERE ARE NO ORAL AGREEMENTS AMONG THE PARTIES HERETO. Please execute a copy of this letter in the space provided below to acknowledge your agreement to the foregoing. [Remainder of Page Intentionally Left Blank; Signature Pages to Follow.] SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN Sincerely, BANK OF AMERICA, N.A., (f/k/a Bank of America National Trust and Savings Association, successor by merger to Bank of America, N.A., f/k/a NationsBank, N.A.), as Administrative Agent and a Lender By: /s/ David E. Sisler David E. Sisler Principal SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN FIRST UNION NATIONAL BANK, as Syndication Agent and a Lender By: /s/ Michael J. Kolosowsly Name: Michael J. Kolosowsly Title: Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN TORONTO DOMINION (TEXAS) INC., as Documentation Agent and a Lender By: /s/ Debbie A. Greene Name: Debbie A. Green Title: Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN TORONTO DOMINION (TEXAS) INC., as Documentation Agent and a Lender By: /s/ Michael Bandzierz Name: Michael Banzierz Title: Managing Director SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN MORGAN STANLEY SENIOR FUNDING, INC., as a Lender By: /s/ T. Morgan Edwards II Name: T. Morgan Edwards II Title: Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN CHASE MANHATTAN BANK, as a Lender By: /s/ Paul V. Farrell Name: Paul V. Farrell Title: Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN WESTDEUTSCHE LANDESBANK GIROZENTRALE, NEW YORK BRANCH, as a Lender By: /s/ Duncan M. Robertson Name: Duncan M. Robertson Title: Vice President By: /s/ Walter T. Duffy III Name: Walter T. Duffy III Title: Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN BANK ONE, NA (formerly known as THE FIRST NATIONAL BANK OF CHICAGO), as a Lender By: /s/ Mary Lu D. Cramer Name: Mary Lu D. Cramer Title: Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN UBS AG, STAMFORD BRANCH, as a Lender By: /s/ Paul R. Morrison Name: Paul R. Morrison Title: Executive Director By: /s/ Andrew N. Taylor Name: Andrew N. Taylor Title: Associate Director SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN MERITA BANK PLC, as a Lender By: /s/ Charles I. Lansdown Name: Charles I. Lansdown Title: Senior Vice President By: /s/ Joseph A. Ciccolini Name: Joseph A. Ciccolini Title: Assistant Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN GUARANTY FEDERAL BANK, F.S.B., as a Lender By: /s/ Robert S. Hays Name: Robert S. Hays Title: Senior Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN VIA BANQUE, as a Lender By: Name: Title: SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN MERCANTILE BANK NATIONAL ASSOCIATION, as a Lender By: /s/ Gail F. Scannell Name: Gail F. Scannell Title: Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN AGREED TO AND ACCEPTED AS OF THE DATE FIRST WRITTEN ABOVE. PROTECTION ONE ALARM MONITORING INC., a Delaware corporation, as Borrower By: /s/ Anthony D. Somma Name: Anthony D. Somma Title: CFO, Secretary & Treasurer SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN To induce the Credit Parties to enter into this letter, each of the undersigned (a) consents and agrees to this letter's execution and delivery, (b) ratifies and confirms that all guaranties, assurances, and Liens, if any, granted, conveyed, or assigned to the Credit Parties under the Loan Documents are not released, diminished, impaired, reduced, or otherwise adversely affected by this letter and continue to guarantee, assure, and secure the full payment and performance of all present and future Obligation (except to the extent specifically limited by the terms of such guaranties, assurances, or Liens), (c) agrees to perform such acts and duly authorize, execute, acknowledge, deliver, file, and record such additional guaranties, assignments, security agreements, deeds of trust, mortgages, and other agreements, documents, instruments, and certificates as the Credit Parties may reasonably deem necessary or appropriate in order to create, perfect, preserve, and protect those guaranties, assurances, and Liens, and (d) waives notice of acceptance of this consent and agreement, which consent and agreement binds the undersigned and its successors and permitted assigns and inures to the Credit Parties and their respective successors and permitted assigns. PROTECTION ONE, INC., a Delaware corporation By: /s/ Anthony D. Somma Name: Anthony D. Somma Title: C.F.O. COMSEC/NARRAGANSETT SECURITY, INC., a Delaware corporation By: /s/ Anthony D. Somma Name: Anthony D. Somma Title: Treasurer NETWORK MULTI-FAMILY SECURITY CORPORATION, a Delaware corporation By: /s/ Anthony D. Somma Name: Anthony D. Somma Title: Asst. Secretary PROTECTION ONE INTERNATIONAL, INC., a Delaware corporation By: /s/ Anthony D. Somma Name: Anthony D. Somma Title: Secretary and Treasurer PROTECTION ONE INVESTMENTS, INC., a Delaware corporation By: /s/ Anthony D. Somma Name: Anthony D. Somma Title: Secretary and Treasurer EX-10 3 EX-10.2 WAIVER LETTER DATED AS OF OCTOBER 29, 1999 As of October 29, 1999 Protection One Alarm Monitoring, Inc. 818 South Kansas Avenue P.O. Box 889 Topeka, Kansas 66601 Re: Request for Waiver Gentlemen: Reference is hereby made to that certain Credit Agreement dated as of December 21, 1998, executed by Protection One Alarm Monitoring, Inc., a Delaware corporation ("Borrower"), NationsBank, N.A. (now known as Bank of America, N.A.), as Administrative Agent ("Administrative Agent"), the Syndication Agent defined therein, the Documentation Agent defined therein, and the Lenders defined therein (as modified, amended, renewed, extended, and restated from time to time, the "Credit Agreement"). Capitalized terms used herein shall, unless otherwise indicated, have the respective meanings set forth in the Credit Agreement. Borrower has notified Administrative Agent that, as of September 30, 1999, Borrower may not be in compliance with the Leverage Ratio set forth in Section 10.13(a) of the Credit Agreement and the Interest Coverage Ratio set forth in Section 10.13(b) of the Credit Agreement (the "Covenant Violations"). Pursuant to a letter dated as of September 30, 1999, the Required Lenders waived the existence of the Covenant Violations until 5:00 p.m. (Dallas, Texas time) on November 1, 1999 (the "Waiver Period"). By execution of this letter in the space provided below, each Lender executing this letter (collectively, "Consenting Lenders"), subject to the terms and conditions of this letter, hereby extend the Waiver Period until 5:00 p.m. (Dallas, Texas time) on December 3, 1999. As a material inducement to the Credit Parties to execute this letter, Borrower hereby represents and warrants to the Credit Parties that, after giving effect to this letter and the waiver contained herein: (a) other than the Covenant Violations, all of the representations and warranties contained in the Credit Agreement and the other Loan Documents are true and correct as of the date hereof as though made as of such date (unless they speak to a specific date or are based upon facts which have changed by transactions expressly contemplated or permitted by the Credit Agreement); and (b) other than the Covenant Violations, no Potential Default or Default exists. By execution of this letter in the space provided below, Borrower ratifies and confirms that the Credit Agreement and all other Loan Documents, and all renewals, extensions, and restatements of, and amendments and supplements to, any of the foregoing, are and remain in full force and effect in accordance with their respective terms. Protection One Alarm Monitoring, Inc. As of October 29, 1999 Page 2 The waiver hereby granted by Consenting Lenders does not (a) constitute a waiver or modification of any other terms or provisions set forth in the Credit Agreement or any other Loan Document and shall not impair any right that any Credit Party may now or hereafter have under or in connection with the Credit Agreement or any other Loan Document, and (b) impair any Credit Party's rights to insist upon strict compliance with the Credit Agreement, as amended or otherwise modified hereby, or the other Loan Documents. The Loan Documents continue to bind and inure to Borrower and the Credit Parties and their respective successors and permitted assigns. This letter, when countersigned by the Required Lenders, shall be a "Loan Document" as defined and referred to in the Credit Agreement and the other Loan Documents, and may be signed in any number of counterparts, each of which shall be deemed an original, but all of which together shall constitute one and the same instrument. THIS LETTER SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF TEXAS. THIS LETTER, THE CREDIT AGREEMENT, AND THE OTHER LOAN DOCUMENTS EMBODY THE FINAL, ENTIRE AGREEMENT AMONG THE PARTIES HERETO AND SUPERSEDE ANY AND ALL PRIOR COMMITMENTS, AGREEMENTS, REPRESENTATIONS, AND UNDERSTANDINGS, WHETHER WRITTEN OR ORAL, RELATING TO THE SUBJECT MATTER HEREOF, AND MAY NOT BE CONTRADICTED OR VARIED BY EVIDENCE OF PRIOR, CONTEMPORANEOUS, OR SUBSEQUENT ORAL AGREEMENTS OR DISCUSSIONS OF THE PARTIES HERETO. THERE ARE NO ORAL AGREEMENTS AMONG THE PARTIES HERETO. Please execute a copy of this letter in the space provided below to acknowledge your agreement to the foregoing. [Remainder of Page Intentionally Left Blank; Signature Pages to Follow.] SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN Sincerely, BANK OF AMERICA, N.A., (f/k/a Bank of America National Trust and Savings Association, successor by merger to Bank of America, N.A., f/k/a NationsBank, N.A.), as Administrative Agent and a Lender By: /s/ Wade B. Sample Wade B. Sample Managing Director SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN FIRST UNION NATIONAL BANK, as Syndication Agent and a Lender By: /s/ Joe K. Daney Name: Joe K. Daney Title: Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN TORONTO DOMINION (TEXAS) INC., as Documentation Agent and a Lender By: /s/ Debbie A. Greene Name: Debbie A. Greene Title: Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN MORGAN STANLEY SENIOR FUNDING, INC., as a Lender By: /s/ T. Morgan Edwards II Name: T. Morgan Edwards II Title: Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN CHASE MANHATTAN BANK, as a Lender By: /s/ Paul V. Farrell Name: Paul V. Farrell Title: Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN WESTDEUTSCHE LANDESBANK GIROZENTRALE, NEW YORK BRANCH, as a Lender By: /s/ Duncan M. Robertson Name: Duncan M. Robertson Title: Vice President By: /s/ Walter T. Duffy III Name: Walter T. Duffy III Title: Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN BANK ONE, NA (formerly known as THE FIRST NATIONAL BANK OF CHICAGO), as a Lender By: /s/ Mary Lu D. Cramer Name: Mary Lu D. Cramer Title: Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN UBS AG, STAMFORD BRANCH, as a Lender By: /s/ Paul R. Morrison Name: Paul R. Morrison Title: Executive Director By: /s/ Andrew N. Taylor Name: Andrew N. Taylor Title: Associate Director SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN MERITA BANK PLC, as a Lender By: /s/ Charles J. Lansdown Name: Charles J. Lansdown Title: Senior Vice President By: /s/ Frank Maffei Name: Frank Maffei Title: Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN GUARANTY FEDERAL BANK, F.S.B., as a Lender By: Name: Title: SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN VIA BANQUE, as a Lender By: Name: Title: SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN MERCANTILE BANK NATIONAL ASSOCIATION, as a Lender By: /s/ Gail F. Scannell Name: Gail F. Sannell Title: Vice President SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN AGREED TO AND ACCEPTED AS OF THE DATE FIRST WRITTEN ABOVE. PROTECTION ONE ALARM MONITORING INC., a Delaware corporation, as Borrower By: /s/ Anthony D. Somma Name: Anthony D. Somma Title: CFO, Secretary and Treasurer SIGNATURE PAGE TO LETTER AGREEMENT BETWEEN PROTECTION ONE ALARM MONITORING, INC., BANK OF AMERICA, N.A., AS ADMINISTRATIVE AGENT, THE SYNDICATION AGENT DEFINED THEREIN, THE DOCUMENTATION AGENT DEFINED THEREIN, AND THE LENDERS DEFINED THEREIN To induce the Credit Parties to enter into this letter, each of the undersigned (a) consents and agrees to this letter's execution and delivery, (b) ratifies and confirms that all guaranties, assurances, and Liens, if any, granted, conveyed, or assigned to the Credit Parties under the Loan Documents are not released, diminished, impaired, reduced, or otherwise adversely affected by this letter and continue to guarantee, assure, and secure the full payment and performance of all present and future Obligation (except to the extent specifically limited by the terms of such guaranties, assurances, or Liens), (c) agrees to perform such acts and duly authorize, execute, acknowledge, deliver, file, and record such additional guaranties, assignments, security agreements, deeds of trust, mortgages, and other agreements, documents, instruments, and certificates as the Credit Parties may reasonably deem necessary or appropriate in order to create, perfect, preserve, and protect those guaranties, assurances, and Liens, and (d) waives notice of acceptance of this consent and agreement, which consent and agreement binds the undersigned and its successors and permitted assigns and inures to the Credit Parties and their respective successors and permitted assigns. PROTECTION ONE, INC., a Delaware corporation By: /s/ Anthony D. Somma Name: Anthony D. Somma Title: CFO, Secretary and Treasurer COMSEC/NARRAGANSETT SECURITY, INC., a Delaware corporation By: /s/ Anthony D. Somma Name: Anthony D. Somma Title: Secretary and Treasurer NETWORK MULTI-FAMILY SECURITY CORPORATION, a Delaware corporation By: /s/ Anthony D. Somma Name: Anthony D. Somma Title: Assistant Secretary PROTECTION ONE INTERNATIONAL, INC., a Delaware corporation By: /s/ Anthony D. Somma Name: Anthony D. Somma Title: Secretary and Treasurer PROTECTION ONE INVESTMENTS, INC., a Delaware corporation By: /s/ Anthony D. Somma Name: Anthony D. Somma Title: Secretary and Treasuer EX-10 4 EX-10.3 SERVICE AGREEMENT SERVICE AGREEMENT WESTERN RESOURCES, INC. and PROTECTION ONE, INC. THIS SERVICE AGREEMENT (together with one or more Exhibits which may be incorporated into this agreement from time to time, the "Agreement") is made and entered into as of this 1st day of April, 1999 by and between WESTERN RESOURCES, INC., a Kansas corporation, ("Western") and PROTECTION ONE, INC., a Delaware corporation ("Protection One"). WHEREAS, Protection One has requested that Western assist it by providing to Protection One and certain of its subsidiaries and affiliates identified in the respective individual Exhibits which may, from time to time be attached hereto (each such entity a "Client Group Member", and collectively the "Client Group") the services described in the Exhibits hereto (the "Services"), and Western has agreed to provide such Services to Client Group Members, subject to the terms and conditions of this Agreement. NOW THEREFORE, for and in consideration of the mutual covenants set forth herein, as well as other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties agree as follows: 1. Services. Protection One hereby retains Western to cause the Services described in Section 1 of each Exhibit to this Agreement to be provided to each Client Group Member (as defined in Section 3 of such respective Exhibit), and Western agrees to cause such Services to be provided, subject to the terms and conditions of this Agreement. 2. Payment for Services. In exchange for the Services, Protection One shall cause Western to be paid in accordance with the terms set forth in Section 4 of each respective Exhibit to this Agreement. Protection One shall be solely responsible, without right of reimbursement, for the satisfaction of any tax, other than income tax, imposed by a state or local taxing authority with respect to, or arising out of, the Services provided under this Agreement or payment thereof ("Transaction Taxes"). 3. Term and Termination. The term for which a particular Service shall be provided shall be set forth in Section 2 of each respective Exhibit to this Agreement. 4. Notices. All notices which are required or may be given pursuant to the terms of this Agreement shall be in writing and shall be sufficient in all respects if given in writing and delivered personally or by registered or certified mail, return receipt requested, and such notice shall be deemed to be given on the date hand-delivered or on the third day after the date deposited in the United States mail, or other comparable commercial delivery system, with postage or delivery charges thereon prepaid, addressed as follows: If to Western: If to Protection One: Rita A. Sharpe John E. Mack III 818 South Kansas 600 Corporate Pointe, 12th Floor Topeka, Kansas 66612 Culver City, California 90230 with copy to: with copy to: General Counsel 5. Governing Law. This Agreement shall be governed by and construed according to the internal laws of, and without regard to conflicts of law provisions, the State of Kansas. 6. Amendment. This Agreement may be amended only by a writing executed with the same formality as this Agreement. 7. Contractual Arrangement. It is expressly acknowledged by the parties hereto that Western is an independent contractor. Nothing contained herein is intended or shall be construed to create an employer-employee relationship, joint venture or partnership between Western and Protection One and/or any Client Group Member. The parties acknowledge and agree that Protection One will not withhold from the compensation payable to Western hereunder any sums for income tax, employment insurance, workers compensation, Social Security, or any other withholding pursuant to any state or federal law or requirement of any governmental agency. 8. Limitations on Liability for Work Performed. Western agrees to perform the work in a good and workmanlike manner consistent with the customs and practices of the industry providing services substantially similar to the Services. WESTERN EXPRESSLY EXCLUDES ALL OTHER GUARANTEES, WARRANTIES OR REPRESENTATIONS OF ANY KIND WHATSOEVER. WESTERN WILL NOT BE RESPONSIBLE FOR ANY INDIRECT, SPECIAL, PUNITIVE, CONSEQUENTIAL, OR OTHER DAMAGES WITH WESTERN'S SOLE LIABILITY BEING LIMITED TO THE REPAIR AND REASONABLE COSTS OF CORRECTING ANY ERRORS WHICH ARE ATTRIBUTABLE TO THE WORK OF WESTERN, NOT TO EXCEED IN THE AGGREGATE THE AMOUNTS PAID TO WESTERN WITH RESPECT TO THE APPLICABLE EXHIBIT. 9. Indemnification. Protection One shall indemnify and hold Western, its members, directors, officers, employees, parents, affiliates, subsidiaries and independent contractors ("Indemnitees") harmless against any and all claims, losses, costs, damages and expenses, including, but not limited to Transaction Taxes and attorney fees, arising out of or in connection with the services provided to each Client Group Member by Western hereunder or from any breach by Western of any provision of this Agreement, or any act, omission or neglect by Western, or any Indemnitee. 10. Confidential Information. Western and Protection One, on behalf of itself and of each Client Group Member agree that any information received by either in connection with this contract, which concerns the confidential personal, financial or other affairs of the other will be treated in full confidence and will not be revealed to any other persons, firms or organizations except as may be required by judicial process, applicable law or regulation. 11. Entire Agreement. This Agreement contains the entire agreement and understanding between Protection One and Western and supersedes all prior agreements and understandings, if any, relating to the subject matter hereof. Except for those set forth in this Agreement, the parties hereby agree that no obligation or contractual commitment of any kind, other than as specifically set out in this Agreement, (or definitive agreement(s) as may be entered into between the parties, if any, including agreements with respect to Additional Services), shall be deemed to exist between the parties, and with respect to subject matter hereof, and none of Protection One, and any Client Group Member, or Western shall be under any legal obligation of any kind whatsoever to enter into any transaction or agreement by virtue of this Agreement. 12. Third Party Beneficiaries. There are no third party beneficiaries, express or implied, intended or unintended, to this Agreement. 13. Binding Effect and Assignment. This Agreement and the rights and obligations under this Agreement shall not be assignable or transferable by the parties (including by operation of law in connection with a merger, consolidation or sale of all or substantially all the assets of a party) without the prior written consent of the other party hereto, except that Western may assign and transfer all its rights and obligations under this Agreement to an affiliate of Western without such written consent; provided any such assignment or transfer shall not release Western Resources of its obligations hereunder. Western will provide prompt notice to Protection One of any such assignment and transfer. All the terms and provisions of this Agreement shall be binding upon and inure to the benefit of and be enforceable by the respective successors and assigns of the parties hereto, whether so expressed or not. 14. Prior Negotiations. This Agreement supersedes all prior negotiations and agreements between the parties hereto relative to the transaction contemplated by this Agreement, which contains the entire understanding of the parties hereto. 15. Waiver of Breach. The waiver by any party hereto of a breach of any provision of this Agreement shall not operate as or be construed to be a waiver of any subsequent breach by any party. 16. Dispute Resolution. Each of Protection One, for itself and each Client Group Member, and Western hereby agrees that (i) it shall, promptly upon its dispute of a matter arising under this Agreement which may involve a claim(s) against the other, or a Client Group member, as the case may be, of more that $5,000 or injunctive relief, provide appropriate written notification ("Notice") of such dispute ("Dispute") to such other party(ies), (ii) it will attempt in good faith to resolve the Dispute through meeting(s) and discussions ("Discussions") with the other party(ies) to the Dispute, such Discussions to be held from time to time during the 30 calendar days immediately after the date of the Notice, and (iii) it shall designate in the Notice appropriate senior management to actively participate in the Discussions for the purpose of resolving the Dispute, proposed alternative dates and locations of such meetings, and the nature of the Dispute. Protection One, for itself and each Client Group Member, and Western each hereby agree that none of Protection One, Western, or any Client Group Member, shall bring a legal action against any Client Group Member, Western, or Protection One, as the case may be, without first having complied with the provisions set forth in this Section 16. 17. Venue. Any dispute not resolved pursuant to paragraph 16 above, if raised in litigation, shall be brought in state or federal court having situs in Shawnee County, Kansas, as the parties agree that venue for all such disputes shall be in Shawnee County, Kansas. 18. Invalid Provision. The invalidity or unenforceability of any provision of this Agreement shall not affect the other provisions hereof, and this Agreement shall be construed in all respects as if such invalid or unenforceable provision were omitted. IN WITNESS WHEREOF, the parties have executed this Agreement on the day and year first-above written. WESTERN RESOURCES, INC. PROTECTION ONE, INC. Signature: /s/ Signature: /s/ By: Rita A. Sharpe By: John E. Mack III Its: Vice President Shared Services Its: Chief Financial Officer Date: 5/3/99 Date: 5/3/99 EXHIBIT 3 This Exhibit 3 is incorporated as of October14, 1999 ("Exhibit 3 Effective Date") to that certain Service Agreement ("Service Agreement") made and entered into as of the 3rd day of May 1999 ("Effective Date") by and between WESTERN RESOURCES, INC., a Kansas corporation ("Western"), and PROTECTION ONE, INC., a Delaware corporation ("Protection One"). For purposes of this Exhibit 3, the term "Agreement" means, and is limited to, the Service Agreement together with this Exhibit 3. Section 1. SERVICES INCLUDED. Western shall cause the Services described below to be provided upon Protection One's reasonable request for itself, and for its more than 50% owned subsidiaries that are identified in Section 3 (each a "Client Group Member", and, collectively "Client Group"). Generally. Western will, as more specifically set forth in this Exhibit 3, provide, or cause to be provided, Services to one or more Client Group Members. Unless expressly indicated otherwise, all references to Sections and subsections in this Exhibit 3 are references to such respective Sections and subsections in this Exhibit 3. Certain Definitions. "Accounting Services" means accounting oversight, tax compliance, cash management, general leger financial reporting, and similar services. "Facilities Services" means facility management services, project services, duplication services, mail services, real estate services, facility administration services, facility services, and other similar services. "Human Resources Services" means employment administration, benefits administration, training services, payroll services, and other similar services. "Information Technology Services" means (i) Help Desk Call Center Support including 1. single point of contact end user support on a 24 x 7 basis, 2. high quality, responsive support according to defined service levels, 3. escalation of issues to Western Resources and third party resources, 4. management of service levels provided by Western Resources and third party resources, 5. performance and analysis reporting, 6. end user satisfaction surveys performed by a third party organization; EXHIBIT 3 (ii) IT Asset Leasing including procurement, leased asset procurement services, lease administration services and coordination of lease expiration functions; (iii)Budget/SLA Development and Management including development of the annual budget and service level agreements, monthly budget analysis and development of special budget reports; (iv) Technical Support including technical services requested via the Help Desk Call Center, the e-mail request system, and IT-Request, for the following products and services: (a) PC, telephone and related peripherals adds/moves/changes, (b) software and hardware installations and modifications, (c) provide high quality, skilled technicians and electronic workflow management; (v) Internet services including access to the Internet through Western Resources firewall; (vi) Support and administration of Lotus Notes SmartSuite desktop clients, and (vii)telephone services including access to Company network, voice mail, toll free dialing to all network locations and all other ISDN features. 1. These services will be billed at the monthly rate of $5.00 per phone number. 2. Phoneset hardware and PBX port charges will be billed separately. 3. Actual long distance usage and calling card charges will be billed on a monthly basis. "Legal Services" means legal representation and counseling services, and other similar services. "Supply Chain Services" means accounts payable management services and oversight, accounts payable transition activities, processing invoices, check printing, invoice document services, credit card (travel and entertainment, procurement and fleet) related activities, strategic sourcing management services and oversight, procurement of goods and services related activities, materials management services and oversight, supply chain related administrative services (budget, SLAs, etc.) and similar services. "Services" means one or more of services composing Accounting Services, Facilities Services, Human Resources Services, Information Technology Services, Legal Services, and Supply Chain Services. EXHIBIT 3 ADDITIONAL SERVICES Additional Services shall be provided only pursuant to a definitive written agreement, if any, as may be entered into between Western Resources and Protection One. For purposes of this Exhibit 3, the term "Additional Services" means services constituted or represented by any material increase, expansion, or broadening of Western's obligations hereunder, relative to the Services to otherwise be provided hereunder by Western to Client Group. Protection One, for itself, and for each Client Group Member, and Western hereby agree, with respect to Additional Services, if any, that Protection One and Western shall, from time to time, attempt to negotiate in good faith a mutually agreeable definitive agreement for the performance of such Additional Services by Western for Protection One and Client Group, as contemplated by Section 1; provided, except as expressly set forth in this Exhibit 3, nothing shall be deemed to create any legal obligation of any kind whatsoever upon any party to enter into any agreement with respect to Additional Services. Section 2. TERM. a. Unless terminated pursuant to Section 2(b), this Agreement shall be effective from the Exhibit 3 Effective Date and shall automatically terminate upon the earlier of (i) June 30, 2000, unless thereafter extended by written mutual agreement on a month to month basis or (ii) Closing, as defined in the merger agreement dated March 18, 1998 between Western Resources, Inc. and Kansas City Power & Light Company ("Merger Agreement"), of the Merger Agreement. b. Termination. This Agreement may also terminate: i. At any time by written mutual agreement of the parties; or iii. Upon sixty (60) calendar days prior written notice from one party to the other stating that party's intent to terminate this Agreement for "cause." For the purposes of this Agreement, the term "cause" means, and is limited to, a material breach of this Agreement by either party which remains uncured more than 30 days after written notice of such breach has been provided. Section 3. CLIENT GROUP. For purposes of providing the Services described in Section 1, the term "Client Group" means, and is limited to: EXHIBIT 3 Protection One Alarm Monitoring, Inc. Protection One, Inc. Security Monitoring Services, Inc. Comsec Narragansett Security, Inc Protection One International, Inc. Comsec Systems, Inc. P-1 Merger Sub (Del) Network Multifamily Security Corporation, Inc. P-1 Merger Sub (Mass) Protection One Investments, Inc. Protection One Canada, Inc. Canguard, Inc. Protection One U.K., Inc. Compagnie Euorpeenne de Telesecurete, S.A. CET Benelux, S.A. CET Swisse CET Technishe Sicherheirsdienste GmbH Eurocontact Europ Telesecurite Grance Reseau Telesecurite Actar Aldis Servelance Electroreque de France Croese Larroch E.S. Beveliging Protection One Acquisition Holding Protection One Alarm Monitoring of Corporation, Inc. Mass, Inc. Section 4. CONSIDERATION. (a) Subject to Sections 4(b), (c), (d), and (e) Protection One shall cause to be paid in cash to Western, in exchange for the Services, an amount equal to the sum of (i) the aggregate of the mathematical products of the total Chargeable Hours for such Services and the respective hourly rate(s) set forth on Attachment A to this Exhibit 3; (ii) Western's out-of-pocket costs including without limitation, travel, lodging meals, long distance charges and overnight mail as itemized on a statement; and (iii) any other costs for services and/or products that are not susceptible to hourly rate pricing which are directly provided or contracted out by Western to be provided to Protection One. Any amount due under Section 4 shall be paid by the 10th calendar day of the month coinciding with or next following the date on which Protection One receives from Western a statement itemizing such amounts due. For purposes of this Exhibit 3, the term "Chargeable Hour" means an actual labor hour worked by a person in the classification of personnel set forth on Attachment A. (b) Each of the parties hereby agrees that, notwithstanding anything to the contrary in this Agreement, if Western Resources determines during the term of this Agreement that the aggregate amount paid or payable as of such determination by Protection One under Section 4(a) is less than 90% (ninety percent) of the actual costs incurred and as documented by Western in EXHIBIT 3 providing the related Services, then the amount payable by Protection One for Services provided after such determination shall be automatically increased as described in Section 4(c). (c) The amount payable by Protection One for Services shall be increased, if at all, as contemplated by Section 4(b), such that the amount then payable by Protection One for Services provided after any such determination is at least 90% (ninety percent) of the actual costs incurred by Western in providing Services under this Agreement after such determination. (d) Any change in the organizational structure of either Western or Protection One which also results in a change of Services contrary to this Agreement, will result in negotiations to determine the proper payable amount in light of those changes. (e) Notwithstanding anything to the contrary in this Exhibit 3, in no event shall the aggregate amount payable by Protection One under Section 4 exceed $3.5 million (three million five hundred thousand dollars). Unless otherwise agreed to in writing all payments shall be made by wire transfer to the account identified immediately below. Bank of America, Dallas, Texas Western Resources, Inc. Acct # 375-095-4775 Routing No. 111000012 IN WITNESS WHEREOF, the parties have executed this Exhibit 3 on the day and year first-above written. WESTERN RESOURCES, INC. PROTECTION ONE, INC. Signature:/s/ Rita A. Sharpe Signature:/s/ Annette Beck By: Rita A. Sharpe By: Annette Beck Title: Vice President Shared Services Title: President Date: Date: October 29, 1999 Attachment A to Exhibit 3 DESCRIPTION HOURLY RATE Clerical $24 Staff $38 Senior Staff $55 Manager $66 Director $82 Executive Director $95 EXHIBIT 4 This Exhibit 4 is incorporated as of October 14, 1999 ("Exhibit 4 Effective Date") to that certain Service Agreement ("Service Agreement") made and entered into as of the 3rd day of May 1999 ("Effective Date") by and between WESTERN RESOURCES, INC., a Kansas corporation ("Western"), and PROTECTION ONE, INC., a Delaware corporation ("Protection One"). For purposes of this Exhibit 4, the term "Agreement" means, and is limited to, the Service Agreement together with this Exhibit 4. Section 1. SERVICES. Western will, as more specifically set forth in this Exhibit 4, provide, or cause to be provided, SSMS to one or more Client Group Members. Unless expressly indicated otherwise, all references to Sections and subsections in this Exhibit 4 are references to such respective Sections and subsections in this Exhibit 4. Generally. Western shall cause the Shared Services Management Services ("SSMS") to be provided upon Protection One's reasonable request for itself, and for its more than 50% owned subsidiaries that are identified in Section 3 (each a "Client Group Member", and, collectively "Client Group"). Certain Definitions. "Services" has the meaning ascribed to such term in Exhibit 3 to the Service Agreement. "Shared Services Management Services" means, and is limited to, oversight and coordination of the provision of any one or more of the Services and/or supervision of Protection One employees engaged in providing similar services. Additional Services. Additional Services shall be provided only pursuant to a definitive written agreement, if any, as may be entered into between Western and Protection One. For purposes of this Exhibit 4, the term "Additional Services" means services constituted or represented by any material increase, expansion, or broadening of Western's obligations hereunder, relative to the SSMS to otherwise be provided hereunder by Western to Client Group. Protection One, for itself, and for each Client Group Member, and Western hereby agree, with respect to Additional Services, if any, that Protection One and Western shall, from time to time, attempt to negotiate in good faith a mutually agreeable definitive agreement for the performance of such Additional Services by Western for Protection One and Client Group, as contemplated by Section 1; provided, except as expressly set forth in this Exhibit 4, nothing shall be deemed to create any legal obligation of any kind whatsoever upon any party to enter into any agreement with respect to Additional Services. EXHIBIT 4 Section 2. TERM. a.Unless terminated pursuant to Section 2(b), this Agreement shall be effective from the Exhibit 4 Effective Date and shall automatically terminate upon the earlier of (i) June 30, 2000, unless thereafter extended by written mutual agreement on a month to month basis, or (ii) Closing, as defined in the merger agreement dated March 18, 1998 between Western Resources, Inc. and Kansas City Power & Light Company ("Merger Agreement"), of the Merger Agreement. b. Termination. This Agreement may also terminate i. at any time by written mutual agreement of the parties; or ii. upon sixty (60) calendar days prior written notice from one party to the other stating that party's intent to terminate this Agreement for "cause." For the purposes of this Agreement, the term "cause" means, and is limited to, a material breach of this Agreement by either party which remains uncured more than 30 days after written notice of such breach has been provided. Section 3. CLIENT GROUP. For purposes of providing the SSMS described in Section 1, the term "Client Group" means, and is limited to: Protection One Alarm Monitoring, Inc. Protection One, Inc. Security Monitoring Services, Inc. Comsec Narragansett Security, Inc. Protection One International, Inc. Comsec Sytems, Inc. P-1 Merger Sub (Del) Network MultiFamily Security Corporation, Inc. P-1 Merger Sub (Mass) Protection One Investments, Inc. Protection One Canada, Inc. Canguard, Inc. Protection One U.K., Inc. Compagnie Euorpeenne de Telesecurete, S.A. CET Benelux, S.A. CET Swisse CET Technishe Sicherheirsdienste GmbH Eurocontact Europ Telesecurite Grance Reseau Telesecurite Actar Aldis Servelance Electoreque de France Croese Larroch E.S. Beveliging Protection One Acquisition Holding Protection One Alarm Monitoring of Corporation, Inc. Mass, Inc. EXHIBIT 4 Section 4. CONSIDERATION. (a) Subject to Sections 4(b), (c), (d), and (e) Protection One shall cause to be paid in cash to Western, (i) in exchange for the SSMS, $54,000 (fifty-four thousand dollars) per month in 1999 and $38,000 (thirty-eight thousand dollars) per month in 2000 for each month this Agreement is in effect. In the event this Agreement extends past 2000, the amount due each month in exchange for SSMS will be determined by mutual written agreement; and (ii) Western's out-of-pocket costs including without limitation, travel, lodging meals, long distance charges and overnight mail as itemized on a statement. Any amount due under Section 4 shall be paid by the 10th calendar day of the month coinciding with or next following the date on which Protection One receives from Western a statement itemizing such amounts due. (b) Each of the parties hereby agrees that, notwithstanding anything to the contrary in this Agreement, if Western determines during the term of this Agreement that the aggregate amount paid or payable as of such determination by Protection One under Section 4(a) is less than 90% (ninety percent) of the actual costs incurred and as documented by Western in providing the related SSMS, then the amount payable by Protection One for SSMS provided after such determination shall be automatically increased as described in Section 4(c). (c) The amount payable by Protection One for SSMS shall be increased, if at all, as contemplated by Section 4(b), such that the amount then payable by Protection One for SSMS provided after any such determination is at least 90% (ninety percent) of the actual costs incurred by Western in providing SSMS under this Agreement after such determination. (d) Any change in the organizational structure of either Western or Protection One which also results in a change of Services contrary to this Agreement, will result in negotiations to determine the proper payable amount in light of those changes. (e) Notwithstanding anything to the contrary in this Exhibit 4, in no event shall the aggregate amount payable by Protection One under Section 4 exceed $1.5 million (one million five hundred thousand dollars). EXHIBIT 4 Unless otherwise agreed to in writing all payments shall be made by wire transfer to the account identified immediately below. Bank of America, Dallas, Texas Western Resources, Inc. Acct # 375-095-4775 Routing No. 111000012 IN WITNESS WHEREOF, the parties have executed this Exhibit 4 on the day and year first above written. WESTERN RESOURCES, INC. PROTECTION ONE, INC. Signature:/s/ Rita A. Sharpe Signature:/s/ Annette Beck By: Rita A. Sharpe By: Annette Beck Title: Vice President Shared Services Title: President Date: Date: October 29, 1999 EX-10 5 EX-10.4 LETTER OF INTENT September 16, 1999 Mr. Marc Byron Chief Executive Officer Paradigm Direct LLC Two Executive Drive Fort Lee, NJ 07024 RE: LETTER OF INTENT Dear Marc: This is to set forth the letter of intent between Protection One Alarm Monitoring, Inc., 600 Corporate Pointe, Suite 1200, Culver City, California 90230 (herein "Protection One") and Paradigm Direct, LLC, Two Executive Drive, Fort Lee, New Jersey 07024 (herein "Paradigm") with respect to the proposed marketing relationship which will be memorialized in a more comprehensive and final agreement ("Marketing Agreement') between Protection One and Paradigm. However, in order to allow the parties to commence a pilot program, we have committed to putting forth our intentions in this letter. 1. Name: Paradigm would conduct business under the Marketing Agreement under the name Protection One Marketing Services ("POMS"). 2. Term: The term of the Marketing Agreement would be for three years (each referred to herein as a "Marketing Year") following the completion of the Pilot Program as described below. The first Marketing Year would start following completion of the Pilot Program, which would be such time as Paradigm has delivered 2,500 accounts to Protection One; Paradigm would use its best efforts to produce these first 2,500 sales within the 5 month time frame or sooner. 3. New Accounts: Protection One currently anticipates that it could accept up to 50,000 new accounts during the first year. Protection One would pay Paradigm $775.00 per installed account with monthly recurring revenue of $32.95 per month and meeting the criteria set forth in the Marketing Agreement ("Qualified Account(s)"). A sample of customary account criteria for installed accounts is attached to this letter as Exhibit A, and Exhibit A shall be the required account criteria during the Pilot Program. No later than ninety days prior to the end of the first Marketing Year the parties would agree on the targeted number of sales, the minimum monthly recurring revenue per account and the amount to be paid for those sales for the second Marketing Year. The same process would occur with respect to the third Marketing Year. 4. Termination: Protection One would be free to terminate the agreement in the event the Pilot Program is not concluded within 5 months from the effective date of this letter of intent. Marc Byron, Letter of Intent September 16, 1999, p.2 Additionally, Protection One would be free to cancel the agreement after the first year in any of the following circumstances: Paradigm does not deliver the targeted number of accounts for the previous Marketing Year (or any lesser minimum established by Protection One), subject to a 10% cushion for the targeted number, or in the event attrition on accounts delivered by Paradigm exceeds by 25% or greater, that of a statistically valid random sample of Protection One's traditional dealer business over a similar period of time, or in the event either Marc Byron or David Graf are no longer employees of either Paradigm or an organization that owns a controlling interest in Paradigm; or are no longer actively involved in the management of POMS or the program created by the Marketing Agreement. Management Fee: Upon signing of this letter of intent, Paradigm will bill Protection One in full for a $1million management fee, which will constitute payment in full for all services provided by Paradigm during June, July and August of 1999. Protection One will pay the management fee upon the sooner of the signing of the Marketing Agreement or thirty (30) days following the signing of this Letter of Intent. The parties intend to enter into the Marketing Agreement no later than the end of September, and earlier if possible. 6. Pre-payment of Pilot Programs: Protection One would prepay Paradigm for the 2,500 Pilot Program Qualified Accounts in the amount of $856.70 per account, or an aggregate of $2,141,750. One-half of this amount would be billed in November of 1999 and the balance would be billed in January of 2000. These invoices would be due net 30 days. In the event the program is terminated as provided for above, and the 2500 Pilot Program accounts have not been delivered by Paradigm, then Protection One shall be entitled to a refund of the full purchase price of $856.70 for each such Qualified Account less than 2500, that is delivered to Protection One. Such refund would be due net 30 days from termination of the program. 7. Continuing Fees: Protection One would pay Paradigm $20 for each account that remains an account in good standing (paid through the term) for each twelve month period of time for the life of the account, regardless of whether or not the Marketing Agreement is in effect. Protection One would provide a list of such active and current accounts to Paradigm at the end of each twelve month period, and Paradigm will bill Protection One for those accounts for which the $20 payment is due. Provided that the Marketing Agreement remains in effect and Paradigm is not in breach of any of the terms thereof, Protection One would allow a limited-term grace period (to be defined in the Marketing Agreement) following the expiration of each year, for the accounts to become current. If upon the expiration of such grace period, such accounts become current, then Paradigm would be entitled to the $20 payment for such account. Notwithstanding anything to the contrary contained in this section, in the event the Marketing Agreement is terminated, Marc Byron, Letter of Intent September 16, 1999, p.3 Protection One would have the option to make a one time lump sum payment of $75.00 per account at the time of termination in lieu of any further $20 obligations. Additionally, Paradigm would have the option to request a one time lump sum payment of $60.00 per account at the time of termination in lieu of any further $20 obligations, provided, however, that such lump sum payment does not cause Protection One to default on its debt covenants. Payment of the lump payment would be due within 30 days of the effective time of termination. 8. Overhead: Protection One would pay Paradigm, for the Pilot Period and the First Marketing Year, the Overhead, plus 10%, for the marketing personnel reallocated from Protection One to Paradigm/POMS. For the purposes of this letter of intent, "Overhead" is defined as current salary plus benefits, however, the 10% mark up shall apply to base salaries only. Ninety days prior to the end of the first year and similarly in each rolling twelve month period, Paradigm and Protection One would agree upon the appropriate employee headcount that Protection One will reimburse to Paradigm (plus the 10% mark-up) for the succeeding year. Paradigm would have sole discretion as to whether or not to continue the employment of any persons whose Overhead is not reimbursed by Protection One. Paradigm would conduct normal course of business personnel reviews every six months for each employee to determine appropriateness for raises, bonuses, new assignments or other normal course of business review procedures. The Marketing Agreement would include a specific listing of all personnel and salaries at that time who will be transitioned to Paradigm/POMS, and also would include some specific benchmarks for salary increases and benefits. Those reallocated employees who would have been eligible had they remained Protection One employees, will be eligible for participation in Protection One's short term incentive plans for 1999 and 2000, provided, however, such employees will be subject to the same criteria for pay out under those plans as regular Protection One employees. Additionally, for those reallocated employees who have been awarded stock options under Protection One's stock option or long term incentive plans, continuing employment with POMS shall be treated as continuing employment with Protection One for the purpose of determining vesting under those plans. The reallocation of personnel will occur upon signing of this Letter and Overhead charges will accrue as of that date. Protection One shall pay the Overhead payments monthly, in advance, with the first payment, including sums incurred prior to such date, being due upon signing of the Marketing Agreement. 9. Leads Management: Paradigm would generate qualified leads for sale to Protection One. In order to qualify for sale, a lead must be (a) subject to taped verification of customer's agreement to a sales appointment; (b) within the service territory of Protection One, as amended from time to time; (c) credit scored at a minimum of 600 FICO score. Protection One's service territory will be defined in the Marketing Agreement but would generally be described as a geographic territory within a certain radius of existing Protection One operations facilities. Paradigm would sell the qualified leads to Protection One for $115.00 each. Payment would be due net 30. Leads generated during the Pilot Period will be subject to the terms of this paragraph. Marc Byron, Letter of Intent September 16, 1999, p.4 10. Miscellaneous: A) Agency and consulting fees: Any agency or consultancy fees sought to be reimbursed by Paradigm from Protection One would require pre-approval in writing. Protection One would establish in advance a minimum budget per quarter for such expenses. B) Paradigm would submit a plan for monthly sales. In the event Paradigm wishes to exceed that forecast by more than 20%, Paradigm would obtain prior consent in writing from Protection One. C) ADEMCO rebate: Protection One would retain the rebate in full. D) Management of dealer program: Protection One would retain management of its dealer program. E) Credit scoring: The Marketing Agreement would contain credit scoring criteria for POMS new customers, with a floor of FICO 600 or the equivalent. POMS would obtain Protection One's prior written approval before marketing to the sub 600 marketplace. F) The Marketing Agreement would provide a budget for certain specified direct expenses incurred by POMS to be billed directly to Protection One and paid net 30 days. 90 days prior to the end of each year of the Marketing Agreement, a budget for such expenses would be provided by POMS to Protection One for approval. G) The Marketing Agreement shall contain such indemnities as are customary to contracts of that type and during the Pilot Period, the parties agree that each of them shall hold harmless and indemnify the other and each of their parent, subsidiary, or affiliated companies and their officers, directors, shareholders, employees, attorneys and agents, from all claims, demands, causes of action and liabilities of every kind or nature, including reasonable attorneys fees, arising out of or related to this Letter or the Marketing Agreement, asserted by any past, present or future officer, director, shareholder, employee, attorney, agent or creditor of the indemnifying party, any of such party's affiliated companies, any prospective or actual customer of the services contemplated by this letter, and any other third parties, except any such claims, demands, causes of action or liabilities arising solely out of the action or inaction of such party seeking indemnification. H) Paradigm agrees that for as long as this Letter and the Marketing Agreement are in effect, it will not enter into any marketing or other relationship with any other security alarm service company or other competitor of Protection One offering the same or similar services to those of Protection One. Additionally, the Marketing Agreement will contain provisions customary in the industry regarding solicitation of customer accounts. Marc Byron, Letter of Intent September 16, 1999, p.5 I) Each party agrees that it will keep the terms of this Letter and the Marketing Agreement confidential and will only disclose the details thereof to those persons associated with each party that have a need to know or as necessary to comply with applicable law. The Marketing Agreement will contain such further terms regarding confidentiality and disclosure as are agreed to by the parties. Neither party shall make any press releases concerning the subject matter of this Letter or the Marketing Agreement without the express written consent of the other party. 11. Approvals: Except as specifically set forth in section 12 below, the transactions contemplated by this letter of intent are subject to: the approval of the transactions contemplated hereby by the Boards of Directors of each party, and, the negotiation, execution and delivery of the Marketing Agreement by Protection One and Paradigm upon mutually agreeable terms and conditions, and theapproval and or licensing as may be required by any governmental agency or administrative body necessary to lawfully consummate the transactions contemplated hereby. 12. Failure to Agree: In the event the Marketing Agreement is not entered into by December 31, 1999 for any reason, the following shall occur: Paradigm shall be entitled to retain the $1,000,000 management fee, Protection One shall reimburse Paradigm for each Pilot Period account delivered to Protection One during such period at the rate set forth in paragraph 6 above, Protection One shall reimburse Paradigm for each qualified lead delivered to Protection One during such period at the rate set forth in paragraph 9 above, Thepersonnel reallocated to POMS would return to Protection One employment, and accrued but unpaid Overhead, if any, would be paid to Paradigm. Other than as set forth in A, B, C and D above, neither party shall have any further obligation to the other. IN WITNESS WHEREOF, this letter of intent is entered into by each of the parties as set forth below, to be effective as of September 15, 1999. Protection One Alarm Monitoring, Inc. Paradigm Direct, LLC By:/s/ Annette Beck By:/s/ Marc Byron Title: President & COO Title: CEO Marc Byron, Letter of Intent September 16, 1999, p.6 EXHIBIT A INSTALLED CUSTOMER ACCOUNT REQUIREMENTS Each Customer Account offered to Protection One must comply with the following: theinstallation of the alarm system to be installed pursuant to the applicable Dealer Contract and P-ONE Contract shall be completed and the alarm system shall be fully operational, capable of being monitored by Protection One's monitoring facility, and capable of being billed for monitoring and repair services by Protection One, with Protection One having a reasonable expectation of payment therefor; Protection One shall have received, in it's reasonable judgment, a satisfactory result from it's telephone survey to the Customer; the Customer Account shall have met the criteria set forth in the definition of Customer Account; alloriginal documentation (including monitoring codes, upload codes, download codes, installer codes and programming codes) shall have been delivered to Protection One; thealarm system shall have sent test signals to Protection One's monitoring facility in a manner reasonably acceptable to Protection One; the Customer shall have paid or financed: (i) the complete sales price for the alarm system or (ii) the complete installation and labor charges for a non-sold system; theCustomer shall have met Protection One's minimum credit requirements as set forth in the Letter of Intent dated September 15, 1999, at the time such Customer's credit score was run by Paradigm; and theinstallation of the alarm system shall be compliant with the standard as set forth in the P-ONE Installation Manual. EX-18 6 EX-18.1 LETTER FROM ARTHUR ANDERSEN Protection One, Inc. Re: Form 10-Q Report for the quarter ended September 30, 1999. Gentlemen/Ladies: This letter is written to meet the requirements of Regulation S-K calling for a letter from a registrant's independent accountants whenever there has been a change in accounting principle or practice. We have been informed that, as of July 1, 1999, Protection One, Inc. (the Company) changed from the straight-line method of accounting for amortizing customer acquisition costs for its North America and Europe customer account pools to a declining balance (accelerated) method. According to the management of the Company, this change was made to more closely match future amortization cost with the estimated revenue stream from these assets. A complete coordinated set of financial and reporting standards for determining the preferability of accounting principles among acceptable alternative principles has not been established by the accounting profession. Thus, we cannot make an objective determination of whether the change in accounting described in the preceding paragraph is to a preferable method. However, we have reviewed the pertinent factors, including those related to financial reporting, in this particular case on a subjective basis, and our opinion stated below is based on our determination made in this manner. We are of the opinion that the Company's change in method of accounting is to an acceptable alternative method of accounting, which, based upon the reasons stated for the change and our discussions with you, is also preferable under the circumstances in this particular case. In arriving at this opinion, we have relied on the business judgment and business planning of your management. We have not audited the application of this change to the financial statements of any period subsequent to December 31, 1998. Further, we have not examined and do not express any opinion with respect to your financial statements for the three and nine months ended September 30, 1999. Very truly yours, ARTHUR ANDERSEN LLP EX-27 7 EX-27.1 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from the Balance Sheet at September 30, 1999, and the Statement of Income for the nine months ended September 30, 1999, and is qualified in its entirety by reference to such financial statements. 1,000 9-MOS DEC-31-1999 SEP-30-1999 19,101 9,617 94,416 26,484 10,976 218,583 82,249 22,578 2,605,665 238,702 824,032 0 0 1,269 1,287,809 2,605,665 452,480 452,480 132,969 132,969 (71) 16,933 64,334 (71,060) (17,615) (53,445) 0 0 0 (53,445) (0.42) (0.42)
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