-----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, Sodwa5nczTXHsc0mQTPhmJ1IQFWCIXnXnGVhJwIfp/cB7RhR5+2sgaijQu65ZXaT EVFn2FKvgDCZMEgoCqNEig== 0000950148-96-002058.txt : 19960921 0000950148-96-002058.hdr.sgml : 19960921 ACCESSION NUMBER: 0000950148-96-002058 CONFORMED SUBMISSION TYPE: 424B2 PUBLIC DOCUMENT COUNT: 1 FILED AS OF DATE: 19960918 SROS: NASD 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: 931064579 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 424B2 SEC ACT: 1933 Act SEC FILE NUMBER: 333-09401-01 FILM NUMBER: 96631950 BUSINESS ADDRESS: STREET 1: 6011 BRISTOL PARKWAY CITY: CULVER CITY STATE: CA ZIP: 90230 BUSINESS PHONE: 3103386930 MAIL ADDRESS: STREET 1: 3900 SW MURRAY BLVD CITY: BEAVERTON STATE: OR ZIP: 97005 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PROTECTION ONE INC CENTRAL INDEX KEY: 0000916230 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-MISCELLANEOUS BUSINESS SERVICES [7380] IRS NUMBER: 931063818 STATE OF INCORPORATION: DE FISCAL YEAR END: 0930 FILING VALUES: FORM TYPE: 424B2 SEC ACT: 1933 Act SEC FILE NUMBER: 333-09401 FILM NUMBER: 96631951 BUSINESS ADDRESS: STREET 1: 6011 BRISTOL PARKWAY CITY: CULVER CITY STATE: CA ZIP: 90230 BUSINESS PHONE: 3103386930 MAIL ADDRESS: STREET 1: 3900 SW MURRAY BLVD CITY: BEAVERTON STATE: OR ZIP: 97005 424B2 1 424B2 1 PROSPECTUS SUPPLEMENT As filed pursuant to Rule 424(b)(2) (To Prospectus dated August 29, 1996) under the Securities Act of 1933 Registration No. 333-09401 $90,000,000 PROTECTION ONE ALARM MONITORING, INC. 6 3/4% CONVERTIBLE SENIOR SUBORDINATED NOTES DUE 2003 CONVERTIBLE INTO THE COMMON STOCK OF, AND UNCONDITIONALLY GUARANTEED BY, PROTECTION ONE, INC. ------------------------ Interest payable March 15 and September 15 ------------------------ Protection One Alarm Monitoring, Inc. ("Monitoring") is a direct, wholly owned subsidiary of Protection One, Inc. ("POI"). ------------------------ The Convertible Notes are convertible into Common Stock of POI at any time after 90 days following the latest date of the original issuance thereof and prior to maturity, unless previously redeemed, at a conversion price of $17.95 per share, subject to adjustments in certain events. See "Description of Convertible Notes -- Conversion of Notes." The reported last sale price for the Common Stock on the Nasdaq National Market on September 16, 1996 was $14.50 per share. ------------------------ SEE "RISK FACTORS" COMMENCING ON PAGE S-6 FOR A DISCUSSION OF CERTAIN FACTORS THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE CONVERTIBLE NOTES OFFERED HEREBY. ------------------------ THE CONVERTIBLE NOTES ARE NOT REDEEMABLE BY MONITORING PRIOR TO SEPTEMBER 19, 1999. THEREAFTER, THE CONVERTIBLE NOTES WILL BE REDEEMABLE ON AT LEAST 30 DAYS' NOTICE AT THE OPTION OF MONITORING, IN WHOLE OR IN PART, AT ANY TIME, AT THE REDEMPTION PRICES SET FORTH IN THIS PROSPECTUS SUPPLEMENT, IN EACH CASE TOGETHER WITH ACCRUED INTEREST. THE CONVERTIBLE NOTES MAY ALSO BE REDEEMED AT THE OPTION OF THE HOLDER IF THERE IS A FUNDAMENTAL CHANGE (AS DEFINED), AT DECLINING REDEMPTION PRICES, SUBJECT TO ADJUSTMENT IN CERTAIN EVENTS AS DESCRIBED HEREIN, TOGETHER WITH ACCRUED AND UNPAID INTEREST THEREON TO THE DATE OF PURCHASE. SEE "DESCRIPTION OF CONVERTIBLE NOTES -- OPTIONAL REDEMPTION BY MONITORING" AND " -- REDEMPTION AT OPTION OF HOLDERS." THE CONVERTIBLE NOTES ARE UNCONDITIONALLY GUARANTEED ON A SENIOR SUBORDINATED BASIS BY POI. ------------------------ THE CONVERTIBLE NOTES HAVE BEEN APPROVED FOR LISTING ON THE NEW YORK STOCK EXCHANGE, SUBJECT TO OFFICIAL NOTICE OF ISSUANCE, UNDER THE SYMBOL "ALRM 03." ------------------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS SUPPLEMENT OR THE PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ------------------------ PRICE 100% AND ACCRUED INTEREST, IF ANY ------------------------
UNDERWRITING PRICE TO DISCOUNTS AND PROCEEDS TO PUBLIC(1) COMMISSIONS(2) COMPANY(3) ------------------ ------------------ ------------------ Per Convertible Note............................ 100.0% 3.0% 97.0% Total(4)........................................ $90,000,000 $2,700,000 $87,300,000
- --------------- (1) Plus accrued interest, if any, from September 20, 1996. (2) Monitoring and POI have agreed to indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act of 1933, as amended. (3) Before deducting expenses payable by the Company estimated at $750,000. (4) Monitoring has granted to the Underwriters an option, exercisable within 30 days of the date hereof, to purchase up to an additional $13,500,000 of Convertible Notes at the price to the public less underwriting discounts and commissions to cover over-allotments, if any. If the Underwriters exercise the option in full, the total price to public, underwriting discounts and commissions and proceeds to Monitoring will be $103,500,000, $3,105,000 and $100,395,000, respectively. See "Underwriters." ------------------------ The Convertible Notes are offered, subject to prior sale, when, as and if accepted by the Underwriters and subject to approval of certain legal matters by Shearman & Sterling, counsel for the Underwriters. It is expected that delivery of the Convertible Notes will be made on or about September 20, 1996, at the office of Morgan Stanley & Co. Incorporated, New York, New York, against payment therefor in immediately available funds. ------------------------ MORGAN STANLEY & CO. Incorporated BEAR, STEARNS & CO. INC. MONTGOMERY SECURITIES September 16, 1996 2 NO PERSON IS AUTHORIZED IN CONNECTION WITH THE OFFERING MADE HEREBY TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATION NOT CONTAINED OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS SUPPLEMENT OR THE ACCOMPANYING PROSPECTUS (THE "PROSPECTUS") AND ANY INFORMATION OR REPRESENTATION NOT CONTAINED OR INCORPORATED HEREIN MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR THE UNDERWRITERS. THIS PROSPECTUS SUPPLEMENT AND THE PROSPECTUS DO NOT CONSTITUTE AN OFFER TO SELL, OR A SOLICITATION OF AN OFFER TO BUY, ANY OF THE SECURITIES OFFERED HEREBY BY ANY PERSON IN ANY JURISDICTION IN WHICH IT IS UNLAWFUL FOR SUCH PERSON TO MAKE SUCH AN OFFER OR SOLICITATION. NEITHER THE DELIVERY OF THIS PROSPECTUS SUPPLEMENT OR THE PROSPECTUS AT ANY TIME NOR ANY SALE MADE HEREUNDER SHALL UNDER ANY CIRCUMSTANCES IMPLY THAT THE INFORMATION HEREIN IS CORRECT AS OF ANY DATE SUBSEQUENT TO THE DATE HEREOF. ------------------------ IN CONNECTION WITH THIS OFFERING, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICES OF THE CONVERTIBLE NOTES OFFERED HEREBY, MONITORING'S 13-5/8% SENIOR SUBORDINATED DISCOUNT NOTES DUE 2005 OR THE COMMON STOCK OF PROTECTION ONE, INC., AT LEVELS ABOVE THOSE WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NEW YORK STOCK EXCHANGE (AS TO THE CONVERTIBLE NOTES), THE NASDAQ NATIONAL MARKET (AS TO THE COMMON STOCK) OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. ------------------------ TABLE OF CONTENTS PROSPECTUS SUPPLEMENT
PAGE ---- Summary............................... S-1 Risk Factors.......................... S-6 Use of Proceeds....................... S-14 Price Range of Common Stock and Dividend Policy..................... S-14 Capitalization........................ S-15 Selected Consolidated Financial Data................................ S-16 Management's Discussion and Analysis of Financial Condition and Results of Operations....................... S-18 PAGE ---- Business.............................. S-30 Management............................ S-42 Description of Convertible Notes...... S-44 Certain Federal Income Tax Considerations...................... S-56 Underwriters.......................... S-60 Legal Opinions........................ S-61 Index to Consolidated Financial Statements (follows Prospectus)................ F-1
PROSPECTUS Available Information................. 2 Incorporation of Certain Documents by Reference........................... 3 The Company........................... 4 Risk Factors.......................... 4 Use of Proceeds....................... 4 Ratio of Earnings to Fixed Charges.... 4 Description of Debt Securities........ 4 Limitations on Issuance of Bearer Debt Securities.......................... 12 Description of Capital Stock.......... 13 Plan of Distribution.................. 15 Legal Matters......................... 16 Experts............................... 16
As used in this Prospectus Supplement, "MRR" means monthly recurring revenue (excluding revenues from patrol services) that the Company is entitled to receive under contracts in effect at the end of the period and "EBITDA" means earnings before interest, taxes, depreciation and amortization (excluding adjustments of purchase accounting accruals, losses or gains on disposition of fixed assets, loss on abandoned acquisitions and extraordinary items). MRR is a term commonly used in the security alarm industry as a measure of the size of a company, but does not measure profitability or performance, and does not include any allowance for future attrition or for doubtful accounts. EBITDA is derived by adding to loss before income taxes, extraordinary items and cumulative effect of change in accounting method -- net of taxes, the sum of (i) loss on sales of subscriber accounts, (ii) amortization of debt issuance costs and original issue discount ("OID"), (iii) interest expense, net, (iv) amortization of subscriber accounts and goodwill, (v) depreciation expense, (vi) performance warrants compensation expense, and (vii) loss on acquisition terminations. EBITDA does not represent cash flow from operations as defined by generally accepted accounting principles, should not be construed as an alternative to net income and is indicative neither of the Company's operating performance nor of cash flows available to fund the Company's cash needs. Items excluded from EBITDA are significant components in understanding and assessing the Company's financial performance. Management believes presentation of EBITDA enhances an understanding of the Company's financial condition, results of operations and cash flows because EBITDA is used by the Company to satisfy its debt service obligations and its capital expenditure and other operational needs as well as to provide funds for growth. In addition, EBITDA has been used by senior lenders and subordinated creditors and the investment community to determine the current borrowing capacity and to estimate long-term value of companies with recurring cash flows from operations and net losses. 3 SUMMARY The following summary does not purport to be complete and is qualified in its entirety by the more detailed information and financial statements, including the notes thereto, appearing elsewhere in this Prospectus Supplement or the Prospectus or incorporated by reference herein. The following contains certain forward-looking statements and potential investors should carefully review the "Risk Factors" section of this Prospectus Supplement with respect to such forward-looking statements. Unless otherwise indicated or the context otherwise requires, references to "Protection One" or "the Company" are to Protection One, Inc., a Delaware corporation, and its direct and indirect, wholly owned subsidiaries; "POI" means solely Protection One, Inc., excluding its subsidiaries; and "Monitoring" means Protection One Alarm Monitoring, Inc., a direct, wholly owned subsidiary of Protection One, Inc. THE COMPANY Protection One provides security alarm monitoring services for residential and small business subscribers. Based on its 188,132 subscribers as of June 30, 1996 (approximately 80% of which are residential), Protection One believes it is the fourth largest residential security alarm monitoring company in the United States and the largest in the six western states of Arizona, California, Nevada, New Mexico, Oregon and Washington. The Company's strategy is to enhance its position as the largest residential security alarm monitoring company in the western United States by pursuing a balanced growth plan incorporating the purchase of subscriber accounts from independent security alarm systems dealers with whom the Company has exclusive purchase agreements (the "Dealer Program"), acquisitions of portfolios of subscriber accounts, the sale of enhanced services and new alarm systems and possible joint ventures and other strategic alliances. The Company grew rapidly in the twelve months ended June 30, 1996, as illustrated by an increase of 43.4% in the number of subscriber accounts from 131,166 at June 30, 1995 to 188,132 at June 30, 1996 and a 43.8% increase in its MRR from $4.0 million at June 30, 1995 to $5.8 million at June 30, 1996. (MRR is a term commonly used in the security alarm industry as a measure of the size of a company, but not as a measure of profitability or performance, and does not include any allowance for future attrition or allowance for doubtful accounts.) Total revenues increased by 38.4% from $49.7 million for the twelve months ended June 30, 1995 to $68.7 million for the twelve months ended June 30, 1996. Revenue growth and operating efficiencies led to a 49.4% increase in EBITDA(1), from $19.8 million for the twelve months ended June 30, 1995 to $29.6 million for the twelve months ended June 30, 1996. In addition, EBITDA as a percentage of revenues increased from 39.8% for the twelve months ended June 30, 1995 to 43.0% for the twelve months ended June 30, 1996. Operating income increased by 46.6% from $5.0 million for the twelve months ended June 30, 1995 to $7.3 million for the twelve months ended June 30, 1996. The Company's loss attributable to common stock decreased from $17.5 million for the twelve months ended June 30, 1995 to $13.3 million for the twelve months ended June 30, 1996. The Company's revenues consist primarily of recurring payments under written contracts for the monitoring and servicing of security systems and the provision of additional enhanced security services. For the nine months ended June 30, 1996, monitoring and service revenues represented 89.5% of total revenues. The Company monitors digital signals arising from burglaries, fires and other events through security systems installed at subscribers' premises. Most of these signals are received and processed at the Company's state-of- the-art central monitoring station located in Portland, Oregon, which, as currently configured, has the capacity - --------------- (1) See footnote (3) to Selected Consolidated Financial Data for a discussion of how EBITDA is derived. EBITDA does not represent cash flow from operations as defined by generally accepted accounting principles, should not be construed as an alternative to net income and is indicative neither of the Company's operating performance nor of cash flows available to fund the Company's cash needs. Items excluded from EBITDA are significant components in understanding and assessing the Company's financial performance. Management believes presentation of EBITDA enhances an understanding of the Company's financial condition, results of operations and cash flows because EBITDA is used by the Company to satisfy its debt service obligations and its capital expenditure and other operational needs as well as to provide funds for growth. In addition, EBITDA has been used by senior lenders and subordinated creditors and the investment community to determine the current borrowing capacity and to estimate long-term value of companies with recurring cash flows from operations and net losses. S-1 4 to support up to 250,000 subscribers. The Company also sells enhanced security services, patrol and alarm response services and alarm systems and provides local field repair services through 11 branch offices. Enhanced security services provided by the Company include two-way voice communication, supervised monitoring services, pager service, wireless backup service and extended service protection. Management believes that numerous acquisition opportunities are available, and the Company is pursuing, and intends to continue to pursue, acquisitions of portfolios of subscriber accounts, some of which may be significant. As of the date of this Prospectus Supplement, the Company believes that no such significant acquisition is probable. During fiscal 1995 and the first nine months of fiscal 1996, the Company increased its emphasis on the Dealer Program, which became a more significant source of growth than in prior years. The Company expects to continue this emphasis because of the greater predictability and relatively lower cost of adding subscribers through its dealers as compared with acquisitions of larger portfolios of subscriber accounts. In addition, the Dealer Program generates a comparatively steady flow of new subscribers spread more evenly over the Company's branch offices, making it easier for the Company's branch operations to successfully assimilate these accounts. To evaluate other potential sources of subscriber growth, the Company analyzes companies in other industries that may have an interest in entering the residential security alarm market. In addition, certain companies in industries facing deregulation (such as the telecommunications and electric utility industries) have expressed to the Company an interest in offering security alarm services to develop more comprehensive relationships with their customers. As of the date of this Prospectus Supplement, the Company has reached an agreement in principle with PacifiCorp to offer co-branded security alarm systems and monitoring services. In addition, the Company is discussing with several other companies, and intends to continue to explore, possible joint ventures, co-marketing arrangements and other strategic alliances as a method of enhancing its subscriber growth and reducing its cost of generating new subscribers. Other than the agreement in principle with PacifiCorp, the Company has not entered into any agreement or arrangement for any such strategic alliance, nor does the Company presently consider any such agreement or arrangement to be probable. RECENT DEVELOPMENTS PACIFICORP AGREEMENT In August 1996, the Company and PacifiCorp, a Portland, Oregon-based utility holding company ("PacifiCorp"), agreed in principle to enter into a licensing agreement (the "License Agreement") pursuant to which the Company will offer co-branded security alarm systems and monitoring services (the "Co-Branded Program") to residences and small businesses in PacifiCorp's service territories in the western United States. The Company anticipates that prospective subscribers generated through marketing efforts, which may include television, radio and print advertising for the Co-Branded Program, will be forwarded to participants in the Dealer Program and that the Company will purchase, subject to its customary due diligence, the monitoring contracts obtained by the dealers in connection with the sale and installation of the co-branded alarm system. Under the contemplated terms of the License Agreement, the Company will remit to PacifiCorp a percentage of the MRR from the subscriber accounts created through the Co-Branded Program as compensation for the support of PacifiCorp's customer service and marketing staff, the use of PacifiCorp's brand name and access to PacifiCorp's customers. Although the Company believes it is probable that the License Agreement will be entered into in the next several months, there can be no assurance that such agreement will be signed or that if such agreement is signed, that the terms will not be materially different from those described above. In addition, there can be no assurance that the Co-Branded Program will be successful. METROL ACQUISITION On June 28, 1996, the Company acquired Metrol Security Services, Inc. (together with its subsidiaries, "Metrol"), for $30.7 million, including the repayment of $15.7 million of Metrol's debt. To finance the acquisition, POI issued 417,885 shares of its Common Stock to Metrol's stockholders and borrowed S-2 5 $24.0 million under Monitoring's revolving credit facility (the "Revolving Credit Facility"). At the time of the acquisition, Metrol was the 28th largest security alarm company in the United States, had approximately 18,500 subscribers (approximately 5,500 of which subscribed to Metrol's alarm response service), and provided other ancillary security services, including guard services, a national accounts program, a commercial integrated system division and a probation monitoring operation. The acquired subscriber accounts (approximately 70% of which are residential) represent approximately $500,000 of MRR and $50,000 of monthly recurring alarm response revenues. Approximately 95% of the acquired Metrol subscribers are located in Phoenix and Tucson, Arizona; the remainder are in Albuquerque and Santa Fe, New Mexico. As a result of the Metrol acquisition, the Company believes that it has enhanced its position as the largest residential security alarm monitoring company in Arizona. For additional information with respect to Metrol, see Note 20 of the Notes to Consolidated Financial Statements included herein. AMENDMENT OF CREDIT AGREEMENT On June 7, 1996, the agreement governing the Revolving Credit Facility (the "Credit Agreement") was amended to, among other things, increase the maximum amount of borrowings available under the Revolving Credit Facility to $100 million, to reduce the interest rate payable on such borrowings and to extend the term of the Revolving Credit Facility to January 3, 2000. THE OFFERING Issuer........................ Protection One Alarm Monitoring, Inc., a wholly owned subsidiary of Protection One, Inc. Securities Offered............ $90,000,000 principal amount of 6 3/4% Convertible Senior Subordinated Notes due 2003 (the "Convertible Notes") ($103,500,000 principal amount of Convertible Notes, if the Underwriters' over-allotment option is exercised in full). Interest Payment Dates........ March 15 and September 15, commencing March 15, 1997. Conversion.................... The Convertible Notes will be convertible into Common Stock, par value $.01 per share, of POI (the "Common Stock") at any time after 90 days following the latest date of original issuance thereof and prior to maturity, unless previously redeemed, at a conversion price of $17.95 per share, subject to adjustment. Subordination................. The Convertible Notes will be subordinated to all Senior Indebtedness (as defined herein) of Monitoring. As of June 30, 1996, after giving effect to the offering of the Convertible Notes and the application of the estimated net proceeds thereof to the repayment of the $80.9 million of indebtedness then outstanding under the Revolving Credit Facility, there would have been no Senior Indebtedness (excluding $1.2 million of contingent reimbursement obligations under outstanding letters of credit) and Monitoring would have had unused borrowing capacity under the Revolving Credit Facility of $100.0 million. Guarantees.................... The Convertible Notes will be fully and unconditionally guaranteed on a senior subordinated basis by POI (together with any subsidiary of POI that becomes a guarantor as provided herein, the "Guarantors"). Each such guarantee ("Note Guarantee") will be an unsecured senior subordinated obligation of the Guarantor and will rank junior in right of payment to all existing and future Guarantor Senior Indebtedness (as defined herein) of such Guarantor, including any guarantee by such Guarantor of borrowings under the Revolving Credit Facility. See "Description of Convertible Notes -- Guarantees."
S-3 6 Redemption.................... The Convertible Notes are not redeemable by Monitoring prior to September 19, 1999. Thereafter, the Convertible Notes will be redeemable on at least 30 days' notice at the option of Monitoring, in whole or in part at any time, at the redemption prices set forth in "Description of Convertible Notes," in each case together with accrued interest. Fundamental Change............ The Convertible Notes may also be redeemed at the option of the holder if there is a Fundamental Change (as defined herein), at declining redemption prices, subject to adjustment in certain events, together with accrued and unpaid interest thereon to the date of purchase. See "Description of Convertible Notes -- Redemption at Option of Holders." Use of Proceeds............... The net proceeds from the issuance of the Convertible Notes will be used to repay borrowings outstanding under the Revolving Credit Facility; any remaining proceeds will be used for general corporate purposes, including capital expenditures and working capital. See "Use of Proceeds." Listing....................... The Convertible Notes have been approved for listing on the New York Stock Exchange, subject to official notice of issuance, under the symbol "ALRM 03." Common Stock Outstanding...... 12,738,175 shares(1)
- --------------- (1) Based upon the number of shares outstanding at July 31, 1996. Excludes (i) 1,351,158 shares of Common Stock issuable upon the exercise of warrants with a weighted average exercise price of $3.19 per share, all of which warrants were exercisable at such date, and (ii) 1,272,060 shares of Common Stock issuable upon exercise of options and management performance warrants with a weighted average exercise price of $5.79 per share, of which options and performance warrants to purchase 503,980 shares of Common Stock were exercisable at such date. S-4 7 SUMMARY CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT FOR SUBSCRIBER AND PER SHARE DATA)
NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, JUNE 30, -------------------------------------- ----------------- 1992 1993 1994 1995 1995 1996 ------- ------- ------- -------- ------- ------- (UNAUDITED) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Monitoring and service revenues......... $12,408 $14,850 $27,109 $ 46,308 $32,622 $46,377 Total revenues.......................... 17,598 21,890 34,480 55,882 38,965 51,795 Operating income (loss)(1).............. (1,963) (777) 2,978 5,496 3,456 5,221 Loss attributable to common stock....... (5,033) (4,635) (9,161) (18,453) (16,521) (11,347) Net loss per common share............... $(48.40) $(44.57) $(31.10) $ (2.12) $ (1.92) $ (1.06) OTHER DATA: EBITDA(2)............................... $ 1,043 $ 3,609 $12,294 $ 22,247 $15,267 $22,579 MRR(3).................................. $ 1,015 $ 1,208 $ 2,737 $ 3,924 $ 4,011 $ 5,769 Number of subscribers at end of period................................ 35,538 39,527 85,269 129,420 131,166 188,132
AT JUNE 30, 1996 ------------------------- AS ADJUSTED(4) ACTUAL ----------- -------- (UNAUDITED) BALANCE SHEET DATA: Working capital (deficit)......................................... $(11,042) $ (5,441) Total assets...................................................... 274,429 283,480 Total debt........................................................ 207,050 216,101 Total stockholders' equity........................................ 30,909 30,909
- --------------- (1) Excludes non-cash compensation expense of approximately $4.5 million related to the vesting of management performance warrants in fiscal 1994. (2) EBITDA does not represent cash flow from operations as defined by generally accepted accounting principles, should not be construed as an alternative to net income and is indicative neither of the Company's operating performance nor of cash flows available to fund the Company's cash needs. Items excluded from EBITDA are significant components in understanding and assessing the Company's financial performance. Management believes presentation of EBITDA enhances an understanding of the Company's financial condition, results of operations and cash flows because EBITDA is used by the Company to satisfy its debt service obligations and its capital expenditure and other operational needs as well as to provide funds for growth. In addition, EBITDA has been used by senior lenders and subordinated creditors and the investment community to determine the current borrowing capacity and to estimate the long-term value of companies with recurring cash flows from operations and net losses. EBITDA is derived by adding to loss before income taxes, extraordinary items and cumulative effect of change in accounting method -- net of taxes, the sum of (i) loss on sales of subscriber accounts, (ii) amortization of debt issuance costs and OID, (iii) interest expense, net, (iv) amortization of subscriber accounts and goodwill, (v) depreciation expense, (vi) performance warrants compensation expense, and (vii) loss on acquisition terminations. (3) MRR is monthly recurring revenue (excluding revenues from patrol services) that the Company is entitled to receive under contracts in effect at the end of the period. MRR is a term commonly used in the security alarm industry as a measure of the size of a company, but not as a measure of profitability or performance, and does not include any allowance for future attrition or allowance for doubtful accounts. The Company does not have sufficient information as to the attrition of acquired subscriber accounts to predict the amount of acquired MRR that will be realized in future periods or the impact of the attrition of acquired accounts on the Company's overall rate of attrition. (4) Adjusted to give effect to the issuance of the Convertible Notes and the application of the proceeds therefrom. S-5 8 RISK FACTORS Prospective purchasers of the Convertible Notes offered hereby should consider carefully the factors set forth below, as well as other information set forth in this Prospectus Supplement and the accompanying Prospectus, in evaluating an investment in the Convertible Notes. This Prospectus Supplement contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), that involve risks and uncertainties. The Company's actual results and the timing of certain events could differ materially from those anticipated by such forward-looking statements as a result of certain factors discussed in this Prospectus Supplement, including the factors set forth below and in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and "Business." Risks Related to High Leverage. The Company is, and will continue to be after the issuance of the Convertible Notes, highly leveraged. At June 30, 1996, the Company's consolidated indebtedness was $207.1 million, and Monitoring had unused borrowing capacity of $19.1 million under the Revolving Credit Facility. As of June 30, 1996, after giving effect to the offering of the Convertible Notes and the application of the estimated net proceeds thereof, the Company's consolidated indebtedness would have been $216.1 million (excluding $1.2 million of contingent reimbursement obligations under outstanding letters of credit), and Monitoring would have had unused borrowing capacity under the Revolving Credit Facility of $100.0 million. Future additions of subscriber accounts through the Dealer Program and acquisitions of subscriber account portfolios will require additional borrowings under the Revolving Credit Facility, thereby further increasing the Company's leverage. See "-- Risks Related to Acquisitions." All borrowings then outstanding under the Revolving Credit Facility are currently due in full on January 3, 2000. See "Summary -- Recent Developments -- Amendment of Credit Agreement." Although Monitoring believes that it will be able to obtain further extensions of the maturity date of the Revolving Credit Facility from time to time, or will be able to refinance the Revolving Credit Facility prior to its present maturity date, there can be no assurance that Monitoring will be able to do so. In addition, the principal amount of Monitoring's 13 5/8% Senior Subordinated Discount Notes due 2005 (the "Discount Notes") will accrete in value until June 30, 1998, and Monitoring will be required to make cash payments of interest on the Discount Notes beginning on December 31, 1998. Based on the Discount Notes' interest rate of 13 5/8%, such interest payment will be $11.3 million semiannually, or $22.6 million per year. There can be no assurance that the Company's cash flows from operations will be sufficient to make the required interest payments on the Convertible Notes, the Discount Notes and borrowings under the Revolving Credit Facility. The indenture pursuant to which the Convertible Notes will be issued (the "Convertible Notes Indenture") does not provide for any current amortization of principal or require the establishment of any reserves or sinking funds in respect of the payment of principal. As a result, Monitoring will be required to repay the full principal amount of the Convertible Notes ($90.0 million, or $103.5 million if the Underwriters' over-allotment option is exercised in full) on September 15, 2003. There can be no assurance that the Company will have the cash necessary to repay the Convertible Notes at maturity or will be able to refinance such obligations. Monitoring's ability to pay the principal of and interest on the Convertible Notes and continue to service its other indebtedness will be subject to various business, financial and other factors, many of which are beyond the Company's control. In addition, each of the indenture governing the Discount Notes (the "Discount Notes Indenture"), the Credit Agreement and, to a lesser extent, the Convertible Notes Indenture includes covenants that restrict the operational and financial flexibility of the Company. Failure to comply with certain covenants would, in some instances, permit the holders of the Discount Notes or the lenders under the Revolving Credit Facility to accelerate the maturity of the Company's obligations thereunder, and in other instances could result in cross-defaults permitting the acceleration of all such debt and debt under other agreements. The Company's high degree of leverage may have important consequences to holders of the Convertible Notes or the Common Stock issuable upon conversion of the Convertible Notes, including the following: (i) a substantial portion of the Company's cash flow from operations is, and will continue to be, dedicated to the S-6 9 payment of the principal of and interest on the Company's indebtedness, thereby reducing the funds available to the Company for its operations and future growth or other business opportunities; (ii) the Company's ability to obtain additional financing in the future for working capital, the Dealer Program, acquisitions of portfolios of subscriber accounts, capital expenditures, general corporate purposes or other purposes may be impaired; (iii) the Convertible Notes Indenture, the Discount Notes Indenture and the Credit Agreement contain, and are expected to continue to contain, certain restrictive covenants, including certain covenants that require the Company to obtain the consent of the lenders under the Revolving Credit Facility and to maintain certain financial ratios in order to undertake significant acquisitions of portfolios of subscriber accounts; (iv) the Company's borrowings under the Revolving Credit Facility are at floating rates of interest, causing the Company to be vulnerable to increases in interest rates; (v) the Company will be more vulnerable to a downturn in the Company's business or the economy generally; and (vi) the Company's ability to compete against other less leveraged companies may be adversely affected. Subordination. The Convertible Notes and the Guarantees will be unsecured and subordinated in right of payment in full to all existing and future Senior Indebtedness (as defined herein), including borrowings under the Revolving Credit Facility. As a result of such subordination, in the event of bankruptcy, liquidation or reorganization of Monitoring or any Guarantor upon acceleration of the Convertible Notes due to an event of default, the assets of Monitoring or the applicable Guarantor will be available to pay obligations on the Convertible Notes only after all Senior Indebtedness has been paid in full, and there may not be sufficient assets remaining to pay amounts due on any or all of the Convertible Notes then outstanding. The Convertible Notes are structurally subordinated to the liabilities, including trade payables, of Monitoring's subsidiaries. The Convertible Notes Indenture does not prohibit or limit the incurrence of Senior Indebtedness or the incurrence of other indebtedness and other liabilities by the Company, and the incurrence of additional indebtedness and other liabilities by the Company could adversely affect the Company's ability to pay its obligations on the Convertible Notes. As of June 30, 1996, the Company's consolidated indebtedness was $207.1 million, and Monitoring had unused borrowing capacity of $19.1 million under the Revolving Credit Facility. As of June 30, 1996, after giving effect to the offering of the Convertible Notes and the application of the estimated net proceeds thereof, the Company's consolidated indebtedness would have been $216.1 million (excluding $1.2 million of contingent reimbursement obligations under outstanding letters of credit), and Monitoring would have had unused borrowing capacity under the Revolving Credit Facility of $100.0 million. The Company anticipates that from time to time it will incur additional indebtedness, including Senior Indebtedness, and other additional liabilities. See "Description of Convertible Notes -- Subordination of Notes." Risks Related to Acquisitions. A principal element of the Company's business strategy is to acquire portfolios of alarm monitoring accounts. During the fiscal 1992-1995 period, the Company completed 87 acquisitions of the portfolios of subscriber accounts of other alarm service companies, and those acquisitions were the primary source of the Company's growth during that period. Although the Dealer Program is anticipated to be an increasingly important component of the Company's growth, an additional 27 portfolios of subscriber accounts were acquired during the first nine months of fiscal 1996, and acquisitions of portfolios of subscriber accounts are expected to continue. See "Summary -- Recent Developments -- Metrol Acquisition." The Company faces competition for the acquisition of portfolios of subscriber accounts, and may be required to offer higher prices for acquired accounts than the Company has in the past. See "-- Competition." In addition, due to the continuing consolidation of the security alarm industry and the acquisition by the Company and other alarm companies of a number of large portfolios of subscriber accounts, there may in the future be fewer large portfolios of subscriber accounts available for acquisition. There can be no assurance that the Company will be able to find acceptable acquisition candidates or, if such candidates are identified, that acquisitions can be consummated on terms acceptable to the Company. Acquisitions of portfolios of subscriber accounts involve a number of special risks, including the possibility of unanticipated problems not discovered prior to the acquisition, account attrition and the diversion of management's attention from other business activities in order to focus on the assimilation of accounts. For acquisitions that are structured as the purchase of the stock of other alarm companies, the Company may assume unexpected liabilities and must dispose of the unnecessary assets of the acquired companies. S-7 10 Because the Company's primary consideration in acquiring a portfolio of subscriber accounts is the amount of cash flow that can be derived from the MRR associated with the purchased accounts, the price paid by the Company is customarily directly tied to such MRR. The price paid varies based on the number and quality of accounts being purchased from the seller, the historical activity of such accounts and other factors. The seller typically does not have audited historical financial information with respect to the acquired accounts; thus, in making acquisitions the Company generally has relied on management's knowledge of the industry, due diligence procedures and representations and warranties of the sellers. There can be no assurance that such representations and warranties are true and complete or, if such representations and warranties are inaccurate, that the Company will be able to recover damages from the seller in an amount sufficient to fully compensate the Company for any resulting losses. The Company expects that future acquisitions will present at least the same risks to the Company as its prior acquisitions. An important aspect of the Company's acquisition program is the assimilation of subscriber accounts into the Company's operations after purchase. Depending on the size, frequency and location of acquisitions, the assimilation of subscribers may adversely affect the provision of field repair services to existing subscribers, which may cause subscriber attrition to increase. In addition, if the Company's corporate or branch operations fail to assimilate a substantial portion of acquired subscriber accounts, the Company may experience higher attrition in the future. History of Losses. The Company incurred losses attributable to common stock of $11.3 million for the nine months ended June 30, 1996, $18.5 million for fiscal 1995, $9.2 million for fiscal 1994, $4.6 million for fiscal 1993 and $5.0 million for fiscal 1992. ("Losses attributable to common stock" means the Company's net loss, less dividends payable on preferred stock.) These losses reflect, among other factors, the substantial charges incurred by the Company for amortization of purchased subscriber accounts, interest incurred on the Company's indebtedness and extraordinary losses on early extinguishment of debt. Such charges, with the exception of the extraordinary losses, will increase as the Company continues to purchase subscriber accounts, if the Company's indebtedness increases, or if interest rates increase. The Company's earnings have been insufficient to cover its fixed charges since the Company was formed, and there can be no assurance that the Company will attain profitable operations. Risks Related to the Dealer Program. During fiscal 1995 and the first nine months of fiscal 1996, the Company increased its emphasis on the Dealer Program, which became a more significant source of growth than in prior years. The Company expects that this emphasis will continue. Several of the Company's competitors also have dealer programs, and there can be no assurance that the Company will be able to retain or expand its current dealer base or that competitive offers to the Company's dealers will not require the Company to pay higher prices to the Company's dealers for subscriber accounts than previously paid. The Company's five highest producing dealers generated 47.0% of the total subscriber accounts purchased by the Company through the Dealer Program in the first nine months of fiscal 1996. The loss of any of such dealers would negatively impact the Company's subscribers, revenues and EBITDA. Need for Additional Capital. In fiscal 1995 and the first nine months of fiscal 1996, the Company invested a total of $138.9 million in acquisitions of portfolios of subscriber accounts and purchases of subscriber accounts through the Dealer Program. Net cash provided by operating activities totaled $25.1 million during such period, and the Company used borrowings under the Revolving Credit Facility and proceeds from offerings of debt and equity securities to fund the remainder of the Company's investing activities. The Company intends to continue to pursue subscriber account growth through the Dealer Program and acquisitions. As a result, the Company will be required to seek additional funding from additional borrowing under the Revolving Credit Facility and the sale of additional securities in the future, which may lead to higher leverage or the dilution of then existing holders' investment in the Common Stock. See "-- Risks Related to High Leverage." Any inability of the Company to obtain funding through external financings is likely to adversely affect the Company's ability to increase its subscribers, revenues and EBITDA. There can be no assurance that external funding will be available to the Company on attractive terms or at all. POI Note Guarantee; Reliance on Dividends from Monitoring. POI is a holding company with no operations of its own and no significant assets other than its ownership of the capital stock of Monitoring. POI S-8 11 will, therefore, be dependent upon the receipt of dividends or other distributions from Monitoring to fund any obligations that it incurs, including obligations under its Note Guarantee. The Discount Notes Indenture and the Credit Agreement do not, however, permit distributions from Monitoring to POI, other than for certain specified purposes. Accordingly, if Monitoring should at any time be unable to pay interest on or principal of the Convertible Notes, it is unlikely that it will be permitted to distribute to POI the funds necessary to enable POI to meet its obligations under its Note Guarantee. Management of Growth. The Company's business strategy is to grow rapidly through the addition of subscriber accounts. This expansion has placed and will continue to place substantial demands on the Company's management and operational resources and system of financial and internal controls. The Company's future operating results will depend in part on the Company's ability to continue to implement and improve the Company's operating and financial controls and to expand, train and manage the Company's employee base. Significant changes in quarterly revenues and costs may result from the Company's execution of its business strategy, resulting in fluctuating financial results. Additionally, management of growth may limit the time available to the Company's management to attend to other operational, financial and strategic issues. Attrition of Subscriber Accounts. The Company experiences attrition of subscriber accounts as a result of, among other factors, relocation of subscribers, adverse financial and economic conditions, and competition from other alarm service companies. In addition, the Company loses certain accounts, particularly acquired accounts, to the extent the Company does not service those accounts adequately or does not assimilate new accounts into the Company's operations. An increase in such attrition could have a material adverse effect on the Company's revenues and earnings. When acquiring accounts, the Company seeks to withhold a portion of the purchase price as a partial reserve against excess subscriber attrition. If the actual attrition rate for the accounts acquired is greater than the rate assumed by the Company at the time of the acquisition, and the Company is unable to recoup its damages from the portion of the purchase price held back from the seller, such attrition could have a material adverse effect on the Company's financial condition or results of operations. There can be no assurance that the Company will be able to obtain purchase price holdbacks in future acquisitions, particularly acquisitions of large portfolios. The Company is not aware of any reliable historical data relating to account attrition rates prepared by companies from whom the Company has acquired accounts, and the Company has no assurance that actual account attrition for acquired accounts will not be greater than the attrition rate assumed or historically incurred by the Company. In addition, because some acquired accounts are prepaid on an annual, semi-annual or quarterly basis, attrition may not become evident for some time after an acquisition is consummated. At June 30, 1996, the cost of subscriber accounts and intangible assets, net of previously accumulated amortization, was $238.9 million, which constituted 87.1% of the book value of the Company's total assets. The Company's purchased subscriber accounts are amortized on a straight-line basis over the estimated life of the related revenues. To estimate such life, the Company first determines gross subscriber attrition, defined by the Company for a period as a quotient, the numerator of which is equal to the number of subscribers who disconnect services during such period and the denominator of which is the average of the number of subscribers at each month end during such period. Gross subscriber attrition was 18.6% and 19.9% for the twelve months ended June 30, 1995 and 1996, respectively. The Company offsets gross attrition by adding new accounts from subscribers who move into premises previously occupied by Company subscribers and in which security alarm systems are installed ("reconnects"), conversions of accounts that were previously monitored by other alarm companies to the Company's monitoring services ("conversions") and accounts for which the Company obtains a guarantee from the seller that provides for the Company to "put" back to the seller canceled accounts ("guaranteed accounts"). The resulting figure is used as a guideline to determine the estimated life of subscriber revenues. It is the Company's policy to review periodically actual account attrition and, when necessary, adjust the remaining estimated lives of the Company's purchased accounts to reflect assumed future attrition. In fiscal 1993, the Company made such an adjustment to the estimated life of subscriber accounts, reducing such estimated life from 12 years to 10 years. There could be a material adverse effect on the Company's results of operations and financial condition if actual account attrition significantly S-9 12 exceeds assumed attrition and the Company has to make further adjustments with respect to the amortization of purchased subscriber accounts. Impact of Accounting Differences for Account Purchases and New Installations. A difference between the accounting treatment of the purchase of subscriber accounts (including both purchases of subscriber account portfolios and purchases under ongoing agreements with independent alarm dealers) and the accounting treatment of the generation of subscriber accounts through direct sales by the Company's sales force has a significant impact on the Company's results of operations. All direct external costs associated with purchases of subscriber accounts are capitalized and amortized over 10 years on a straight-line basis. Also included in capitalized costs are certain acquisition transition costs that reflect the Company's estimate of costs associated with incorporating the purchased subscriber accounts into the Company's operations. Such costs include costs incurred by the Company in fulfilling the seller's pre-acquisition obligations to the acquired subscribers, such as providing warranty repair services. In contrast, all of the Company's costs related to the marketing, sales and installation of new alarm monitoring systems generated by the Company's sales force are expensed in the period in which such activities occur. The Company's marketing, sales and installation expenses for new systems generally exceed installation revenues. The Company's purchase activity increased significantly during fiscal 1994, fiscal 1995 and the first nine months of fiscal 1996. See "-- Risks Related to Acquisitions." In addition, during those periods the Company reduced the Company's sales of new systems and related marketing expenditures. As a result of the difference in the methods by which such activities are accounted for, the combined effect of these two factors was to improve operating results during fiscal 1994, fiscal 1995 and the first nine months of fiscal 1996. The Company does not expect to further reduce sales of new systems by Company personnel and related marketing expenditures in the remainder of fiscal 1996 or in fiscal 1997. There can be no assurance that the Company will not increase its emphasis on the marketing and sales of new alarm system installations in the future, particularly in connection with a joint venture or other strategic alliance; any such increase could adversely affect results of operations. The Company anticipates that subscriber accounts added through the proposed Co-Branded Program with PacifiCorp will be purchased through the Dealer Program rather than generated through sales of new alarm systems by Company personnel. See "Summary -- Recent Developments -- PacifiCorp Agreement." Possible Adverse Effect of "False Alarm" Ordinances. According to certain data concerning the residential security alarm market prepared in December 1995 by J.P. Freeman & Co. (the "Freeman Data"), approximately 97% of alarm activations that result in the dispatch of police or fire department personnel are not emergencies, and thus are "false alarms." Significant concern has arisen in certain municipalities about this high incidence of false alarms. This concern could cause a decrease in the likelihood or timeliness of police response to alarm activations and thereby decrease the propensity of consumers to purchase or maintain alarm monitoring services. A number of local governmental authorities have considered or adopted various measures aimed at reducing the number of false alarms. Such measures include (i) subjecting alarm monitoring companies to fines or penalties for transmitting false alarms, (ii) licensing individual alarm systems and the revocation of such licenses following a specified number of false alarms, (iii) imposing fines on alarm subscribers for false alarms, (iv) imposing limitations on the number of times the police will respond to alarms at a particular location after a specified number of false alarms, and (v) requiring further verification of an alarm signal before the police will respond. Enactment of such measures could adversely affect the Company's future business and operations. Possible Adverse Effect of Future Government Regulations; Risks of Litigation. The Company's operations are subject to a variety of laws, regulations and licensing requirements of federal, state and local authorities. In certain jurisdictions, the Company is required to obtain licenses or permits, to comply with standards governing employee selection and training, and to meet certain standards in the conduct of the Company's business. The loss of such licenses, or the imposition of conditions to the granting or retention of such licenses, could have a material adverse effect on the Company. S-10 13 The Company's advertising and sales practices are regulated by both the Federal Trade Commission and state consumer protection laws. Such regulations include restrictions on the manner in which the Company promotes the sale of security alarm systems and the obligation of the Company to provide purchasers of alarm systems with certain rescission rights. While the Company believes that it has complied with these regulations in all material respects, there can be no assurance that none of these regulations was violated in connection with the solicitation of the Company's existing subscriber accounts, particularly with respect to accounts acquired from third parties, or that no such violation will occur in the future. From time to time, subscribers have submitted complaints to state and local authorities regarding the Company's sales and billing practices, which in some instances have resulted in discussions with, or actions by, such authorities. In August 1994, as a result of certain complaints by subscribers, three California governmental authorities brought an action against the Company, and concurrently settled such action. In connection with the settlement of such action, the Company agreed to the filing of an injunction requiring the Company to provide notices of certain increases in charges for its services and to comply with certain restrictions in its marketing, billing and collection activities, and paid restitution to subscribers in the amount of $31,000 and civil penalties of $30,000. Any violation by the Company of the terms of such injunction could have a material adverse effect on the Company. The Company does not believe that any of the investigations or actions described herein has had or will have a material adverse effect on the Company. However, there can be no assurance that other actions that may be taken in the future by these or other authorities as a result of subscriber complaints will not have such adverse effect on the Company. Risks of Liability from Operations. The nature of the services provided by the Company potentially exposes it to greater risks of liability for employee acts or omissions or system failure than may be inherent in other businesses. Most of the Company's alarm monitoring agreements and other agreements pursuant to which the Company sells its products and services contain provisions limiting liability to subscribers in an attempt to reduce this risk. However, in the event of litigation with respect to such matters there can be no assurance that these limitations will be enforced, and the costs of such litigation could have an adverse effect on the Company. The Company's alarm response and patrol services require Company personnel to respond to emergencies that may entail risk of harm to such employees and to others. In most cities in which the Company provides such services, the Company's patrol officers carry firearms, which may increase such risk. Although the Company screens and trains its employees, the provision of alarm response service subjects the Company to greater risks related to accidents or employee behavior than other types of businesses. Reduction of police participation in the handling of emergencies could expose the Company's patrol officers to greater hazards and further increase the Company's risk of liability. The Company carries insurance of various types, including general liability and errors and omissions insurance providing coverage of $15.0 million on both an aggregate and a per claim basis. The loss experience of the Company and other security service companies may affect the availability and cost of such insurance. Certain of the Company's insurance policies and the laws of some states may limit or prohibit insurance coverage for punitive or certain other types of damages, or liability arising from gross negligence. Geographic Concentration. The Company's existing subscriber base is geographically concentrated in certain metropolitan areas and surrounding suburbs in the six western states in which the Company operates. Accordingly, the performance of the Company may be adversely affected by regional or local economic conditions. As a result of acquisitions or strategic alliances, the Company may from time to time expand its operations into regions outside of the Company's current operating area. The acquisition of subscriber accounts in other regions, or in metropolitan areas in which the Company does not currently have subscribers, requires an investment by the Company in local branches and personnel necessary to service such accounts. In order for the Company to expand successfully into a new area, the Company must obtain a sufficient number, S-11 14 and density, of subscriber accounts in such area to support the additional investment. There can be no assurance that an expansion into new geographic areas would generate operating profits. Competition. The security alarm industry is highly competitive and highly fragmented. The Company competes with larger national companies, as well as smaller regional and local companies, in all of the Company's operations. Furthermore, new competitors are continuing to enter the industry and the Company may encounter additional competition from such future industry entrants. Certain of the Company's current competitors have, and new competitors may have, greater financial resources than the Company. In addition, other alarm services companies have adopted a strategy similar to the Company's that entails the aggressive purchase of alarm monitoring accounts both through acquisitions of account portfolios and through dealer programs. Some of these companies may be willing to offer higher prices than the Company is prepared to offer to purchase subscriber accounts. The effect of such competition may be to reduce the purchase opportunities available to the Company, thus reducing the Company's rate of growth, or to increase the price paid by the Company for subscriber accounts, which would adversely affect the Company's return on investment in such accounts and the Company's results of operations. Dependence Upon Senior Management. The success of the Company's business is largely dependent upon the active participation of the Company's executive officers. The loss of the services of one or more of such officers for any reason may have a material adverse effect on the Company's business. Effect of Change of Control; Delaware Anti-takeover Law. The Company is required to make an offer to purchase all of the Discount Notes at a price equal to 101% of their Accreted Value (as defined in the Discount Notes Indenture) on any repurchase date prior to June 30, 1998, or at a purchase price equal to 101% of the principal amount thereof plus accrued and unpaid interest to any repurchase date on or after June 30, 1998, upon the occurrence of any "change of control" as defined in the Discount Notes Indenture. A "change of control" also constitutes an event of default under the Revolving Credit Facility. If such a triggering event were to occur, the Company may not be able to repay all of its obligations that would then become payable. Such provisions, together with certain provisions of Delaware law, could delay or prevent a change in control of the Company, could discourage acquisition proposals and could diminish the opportunities for a stockholder to participate in tender offers, including tender offers at a price above the then current market value of the Common Stock or over a stockholder's cost basis in the Common Stock. In addition, the Board of Directors, without further stockholder approval, may issue preferred stock, which could have the effect of delaying, deferring or preventing a change in control of the Company. The issuance of preferred stock could also adversely affect the voting power of the holders of Common Stock, including the loss of voting control to others. Shares Eligible for Future Sale. Of the 12,738,175 shares of Common Stock outstanding at July 31, 1996, 9,790,649 shares are freely tradeable in the public market, and an additional 2,947,526 shares are eligible for sale pursuant to Rule 144 under the Securities Act. In addition, as of July 31, 1996, an aggregate of 1,855,138 shares of Common Stock were issuable upon the exercise of outstanding warrants, performance warrants and options, most of which shares also will be freely tradeable in the public market. Certain stockholders of the Company also have certain demand and "piggyback" registration rights pursuant to a stockholders' agreement among such stockholders and the Company. Sales and potential sales of substantial amounts of Common Stock in the public market could adversely affect the prevailing market price of the Common Stock. Limitations on Redemption of Convertible Notes. Upon a Fundamental Change (as defined herein), each holder of Convertible Notes will have certain rights, at the holder's option, to require Monitoring to redeem all or a portion of such holder's Convertible Notes. If a Fundamental Change were to occur, there can be no assurance that Monitoring would have sufficient funds to pay the redemption price for all Convertible Notes tendered by the holders thereof. In addition, the terms of the Revolving Credit Facility prohibit the Company from purchasing or redeeming any Convertible Notes and also provide that a Fundamental Change would constitute an event of default thereunder. Any future credit agreements or other agreements relating to other indebtedness (including other Senior Indebtedness) to which the Company becomes a party may contain similar restrictions and provisions. In the event a Fundamental Change occurs at a time when the S-12 15 Company is prohibited from purchasing or redeeming Convertible Notes, the Company could seek the consent of its lenders to the purchase of Convertible Notes or could attempt to refinance the borrowings that contain such prohibition. If the Company does not obtain such a consent or repay such borrowings, the Company would remain prohibited from purchasing or redeeming Convertible Notes. In such case, the Company's failure to redeem tendered Convertible Notes would constitute an Event of Default under the Convertible Notes Indenture, which would, in turn, constitute a further default under the Revolving Credit Facility and the Discount Notes Indenture and may constitute a default under the terms of other indebtedness that the Company may enter into from time to time. In such circumstances, the subordination provisions in the Convertible Notes Indenture would likely restrict payments to the holders of Convertible Notes. See "Description of Convertible Notes -- Redemption at Option of Holders." Absence of Prior Public Market for the Convertible Notes. Prior to this offering, there has been no trading market for the Convertible Notes. Although the Underwriters have advised the Company that they currently intend to make a market in the Convertible Notes, they are not obligated to do so and may discontinue such market making at any time without notice. In addition, such market making activity will be subject to the limits imposed by the Securities Act and the Exchange Act. Accordingly, there can be no assurance that any market for the Convertible Notes will develop or, if one does develop, that it will be maintained. If an active market for the Convertible Notes fails to develop or be sustained, the trading price of such Convertible Notes could be materially adversely affected. Dividend Policy, Restrictions on Dividends. POI has never paid any cash dividends on the Common Stock and does not intend to pay any cash dividends in the foreseeable future. The Credit Agreement and the Discount Notes Indenture restrict POI's ability to declare or pay any dividend on, or make any other distribution in respect of, the Common Stock. See "Price Range of Common Stock and Dividend Policy." Possible Volatility of Prices of Convertible Notes and Common Stock. The stock market has from time to time experienced extreme price and volume fluctuations that have been unrelated to the operating performance of particular companies. The market prices of the Convertible Notes and the Common Stock may be significantly affected by quarterly variations in the Company's operating results, litigation involving the Company, general trends in the security alarm industry, actions by governmental agencies, national economic and stock market conditions, industry reports and other factors, many of which are beyond the control of the Company. Due to all of the foregoing factors, it is likely that the Company's operating results will fall below the expectations of the Company, securities analysts or investors in some future quarter. In such event, the trading price of the Common Stock would likely be materially and adversely affected. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." S-13 16 USE OF PROCEEDS The net proceeds to be received by Monitoring from the sale of the Convertible Notes offered hereby will be used to repay indebtedness outstanding under the Revolving Credit Facility, together with accrued interest. Any remaining net proceeds will be used for general corporate purposes, including capital expenditures and working capital. Principal repaid will be available for reborrowing, subject to meeting the borrowing requirements imposed by the Credit Agreement. As of June 30, 1996, borrowings outstanding under the Revolving Credit Facility were $80.9 million. After giving effect to the use of the estimated net proceeds of this offering as described above, there would have been no borrowings outstanding under the Revolving Credit Facility (excluding $1.2 million of contingent reimbursement obligations under outstanding letters of credit), and $100.0 million would have been available for reborrowing. Pending application of the net proceeds as described above, the remainder of the net proceeds may be invested in short-term marketable securities. All borrowings under the Revolving Credit Facility are due in full on December 3, 2000, at which time the Revolving Credit Facility will terminate if its maturity date is not further extended. The interest rate on borrowings under the Revolving Credit Facility is, at the option of Monitoring, either (a) 1.0% plus the higher of (i) the Bank Prime Loan Rate announced by the Board of Governors of the Federal Reserve System or (ii) the Federal Funds Effective Rate, or (b) LIBOR plus 2.5%. The amounts currently outstanding under the Revolving Credit Facility bear interest as of the date of this Prospectus Supplement at 8.0%. Monitoring used substantially all of the currently outstanding borrowings under the Revolving Credit Facility to acquire subscriber account portfolios and to purchase subscriber accounts through the Dealer Program, and intends to use future borrowings under the Revolving Credit Facility to fund growth and for working capital and general corporate purposes, as described above. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources," "Business -- The Dealer Program" and "Business -- The Acquisition Program." PRICE RANGE OF COMMON STOCK AND DIVIDEND POLICY The Common Stock has been traded on the Nasdaq National Market since September 29, 1994 under the symbol "ALRM." The following table sets forth, for the periods indicated, the high and low closing sales prices per share of the Common Stock, as reported on the Nasdaq National Market.
HIGH LOW ----- ----- September 29-30, 1994........................................................... $6 5/8 $6 7/32 Fiscal year ended September 30, 1995: First quarter................................................................. 7 4 7/8 Second quarter................................................................ 6 7/8 5 Third quarter................................................................. 7 4 7/1 Fourth quarter................................................................ 9 3/4 6 1/8 Fiscal year ending September 30, 1996: First quarter................................................................. 10 1/2 7 9/3 Second quarter................................................................ 14 9/16 9 Third quarter................................................................. 17 5/16 13 3/8 Fourth quarter (through September 16, 1996)................................... 16 5/8 12 3/8
On September 16, 1996 the last sale price for the Common Stock was $14 1/2 per share, as reported on the Nasdaq National Market. The Company has not paid any cash dividends on the Common Stock and has no plans to pay cash dividends on the Common Stock in the foreseeable future. In addition, the Credit Agreement and the Discount Notes Indenture restrict the payment of cash dividends on the Common Stock. S-14 17 CAPITALIZATION The following table sets forth the capitalization of the Company at June 30, 1996 and as adjusted to give effect to the sale of the Convertible Notes offered hereby (assuming the over-allotment option granted to the Underwriters is not exercised) and the application of the estimated net proceeds therefrom, including the repayment of indebtedness. See "Use of Proceeds." The financial data at June 30, 1996 in the following table is derived from the Company's unaudited condensed consolidated balance sheet as of June 30, 1996.
JUNE 30, 1996 ---------------------------- ACTUAL AS ADJUSTED -------- ----------------- (IN THOUSANDS) Long-term debt: Revolving Credit Facility......................................... $ 80,949 $ -- Discount Notes.................................................... 126,007 126,007 Convertible Notes................................................. -- 90,000 -------- --------- Total long-term debt........................................... 206,956 216,007 -------- --------- Stockholders' equity: Common Stock, $.01 par value; 24,000,000 shares authorized; 12,736,255 shares issued and outstanding, actual and as adjusted(1).................................................... 127 127 Additional paid-in capital........................................ 77,453 77,453 Accumulated deficit............................................... (46,671) (46,671) -------- --------- Total stockholders' equity..................................... 30,909 30,909 -------- --------- Total capitalization.............................................. $237,865 $ 246,916 ======== ==========
- --------------- (1) Excludes (i) 1,351,158 shares of Common Stock issuable upon the exercise of warrants exercisable at such date with a weighted average exercise price of $3.19 per share, and (ii) 1,276,980 shares of Common Stock issuable upon exercise of outstanding options and management performance warrants with a weighted average exercise price of $5.79 per share, of which options and performance warrants to purchase 504,940 shares of Common Stock were exercisable at such date. See Note 10 of the Notes to Consolidated Financial Statements. S-15 18 SELECTED CONSOLIDATED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE AND SUBSCRIBER DATA) The selected consolidated financial data for the periods of October 1, 1990 to September 16, 1991 and September 17, 1991 to September 30, 1991, and for fiscal 1992, 1993, 1994 and 1995 are derived from the consolidated financial statements of the Company that have been audited by Coopers & Lybrand L.L.P. The selected consolidated financial data for the nine months ended June 30, 1995 and 1996 are derived from unaudited condensed consolidated financial statements and the accounting records of the Company, and, in the opinion of the Company, reflect all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the financial condition and results of operations for interim periods. The selected consolidated financial data set forth below should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and the consolidated financial statements and related notes thereto included herein, or incorporated by reference in POI's reports filed under the Exchange Act that are incorporated by reference in the Prospectus. See "Incorporation of Certain Documents by Reference."
PREDECESSOR COMPANY NINE MONTHS ENDED ----------- YEAR ENDED SEPTEMBER 30, JUNE 30, 10/01/90- 9/17/91- ---------------------------------------- ------------------- 9/16/91 9/30/91 1992 1993 1994 1995 1995 1996 ----------- -------- ------- -------- -------- -------- -------- -------- (UNAUDITED) STATEMENT OF OPERATIONS DATA: Revenues: Monitoring and service............ $ 9,955 $ 469 $12,408 $ 14,850 $ 27,109 $ 46,308 $ 32,622 $ 46,377 Installation...................... 3,308 96 5,041 6,720 4,764 3,662 3,040 1,918 Other............................. -- -- 149 320 2,607 5,912 3,303 3,500 ----------- -------- ------- -------- -------- -------- -------- -------- Total revenues.................. 13,263 565 17,598 21,890 34,480 55,882 38,965 51,795 ----------- -------- ------- -------- -------- -------- -------- -------- Cost of revenues: Monitoring and service............ 4,993 97 3,784 3,547 6,520 11,795 8,151 12,651 Installation...................... 1,995 79 2,906 3,597 2,950 2,892 2,311 1,431 Other............................. -- -- 107 317 2,854 4,532 3,423 3,254 ----------- -------- ------- -------- -------- -------- -------- -------- Total cost of revenues.......... 6,988 176 6,797 7,461 12,324 19,219 13,885 17,336 ----------- -------- ------- -------- -------- -------- -------- -------- Gross profit.................... 6,275 389 10,801 14,429 22,156 36,663 25,080 34,459 Selling, general and administrative expenses.......................... 8,272 238 10,239 12,084 10,380 12,409 8,178 10,082 Loss on acquisition terminations.... -- -- -- -- 26 208 208 -- Performance warrants compensation expense........................... -- -- -- -- 4,504 -- -- -- Adjustment of purchase accounting accruals, net..................... -- -- -- (742) -- -- -- -- Acquisition and transition expenses.......................... -- -- -- -- -- 3,090 2,380 3,048 Amortization of subscriber accounts and goodwill...................... 1,385 106 2,525 3,864 8,772 15,460 10,858 16,108 ----------- -------- ------- -------- -------- -------- -------- -------- Operating income (loss)......... (3,382) 45 (1,963) (777) (1,526) 5,496 3,456 5,221 Interest expense, net............... 71 90 1,941 1,564 6,932 7,626 6,850 3,052 Amortization of debt issuance cost and OID........................... -- -- 49 185 891 6,797 2,687 13,159 Loss before income taxes, extraordinary items and cumulative effect of change in accounting method -- net of taxes......................... $(4,048) $ (45) $(3,953) $ (2,526) $ (9,349) $ (9,432) $ (6,514) $(11,009) Extraordinary item -- loss on early extinguishment of debt -- net(1).................... -- -- -- (281) (1,174) (8,906) (8,898) -- Cumulative effect of change in accounting method -- net(2)....... -- -- -- -- -- (1,955) (1,955) -- Net loss........................ $(4,048) $ (45) $(3,953) $ (2,807) $ (7,660) $(16,698) $(14,934) $(11,099) Loss attributable to common stock......................... $(4,048) $ (45) $(5,033) $ (4,635) $ (9,161) $(18,453) $(16,521) $(11,347) Loss per common share: Before extraordinary items and cumulative effect of change in accounting method -- net........ $ (0.43) $(48.40) $ (41.86) $ (27.11) $ (0.87) $ (0.66) $ (1.06) Net loss per share................ $ (0.43) $(48.40) $ (44.57) $ (31.10) $ (2.12) $ (1.92) $ (1.06)
AT SEPTEMBER 30, AT JUNE 30, ----------------------------------------------------- ----------- 1991 1992 1993 1994 1995 1996 ------- ------- ------- -------- -------- ----------- (UNAUDITED) CONSOLIDATED BALANCE SHEET DATA: Working capital (deficit)............................... $ 1,011 $(3,112) $(1,632) $(11,505) $ (9,159) $ (11,042) Subscriber accounts and intangibles, net................ 33,324 31,561 37,204 114,620 162,239 238,898 Total assets............................................ 42,193 39,071 44,472 126,085 178,669 274,429 Total debt.............................................. 23,010 20,923 23,591 86,842 146,024 207,050 Redeemable preferred stock.............................. 12,445 15,371 22,957 22,210 6,127 -- Total stockholders' equity (deficit).................... 818 (4,195) (8,796) (6,084) 6,347 30,909
S-16 19
NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, JUNE 30, 9/17/91- ---------------------------------------- ------------------- 9/30/91 1992 1993 1994 1995 1995 1996 -------- ------- -------- -------- -------- -------- -------- (UNAUDITED) OTHER DATA: EBITDA(3).................................... $ 168 $ 1,043 $ 3,609 $ 12,294 $ 22,247 $ 15,267 $ 22,579 MRR(4)....................................... $ 811 $ 1,015 $ 1,208 $ 2,737 $ 3,924 $ 4,011 $ 5,769 Number of subscribers at end of period....... 32,202 35,538 39,527 85,269 129,420 131,166 188,132 Ratio of earnings to fixed charges(5)........ -- -- -- -- -- -- -- Ratio of EBITDA to as adjusted interest expense and amortization of debt issuance cost and OID(6)............................ -- -- -- -- -- -- 1.25x
- --------------- (1) In connection with the early extinguishment of the $50.0 million principal amount of Monitoring's 12.0% senior subordinated notes, the Company incurred an extraordinary loss of approximately $8.9 million, net of the effect of taxes of $0.9 million, in fiscal 1995. (2) For information regarding this change, see "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview -- Change in Accounting Method." (3) EBITDA does not represent cash flow from operations as defined by generally accepted accounting principles, should not be construed as an alternative to net income and is indicative neither of the Company's operating performance nor of cash flows available to fund the Company's cash needs. Items excluded from EBITDA are significant components in understanding and assessing the Company's financial performance. Management believes presentation of EBITDA enhances an understanding of the Company's financial condition, results of operations and cash flows because EBITDA is used by the Company to satisfy its debt service obligations and its capital expenditure and other operational needs as well as to provide funds for growth. In addition, EBITDA has been used by senior lenders and subordinated creditors and the investment community to determine the current borrowing capacity and to estimate the long-term value of companies with recurring cash flows from operations and net losses. EBITDA is derived by adding to loss before income taxes, extraordinary items and cumulative effect of change in accounting method -- net of taxes, the sum of (i) loss on sales of subscriber accounts, (ii) amortization of debt issuance costs and OID, (iii) interest expense, net, (iv) amortization of subscriber accounts and goodwill, (v) depreciation expense, (vi) performance warrants compensation expense, and (vii) loss on acquisition terminations. The following table provides a calculation of EBITDA for each of the periods presented above:
NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, JUNE 30, 9/17/91- ----------------------------------------- ------------------- 9/30/91 1992 1993 1994 1995 1995 1996 -------- ------- ------- -------- -------- -------- -------- (UNAUDITED) Loss before income taxes, extraordinary items and cumulative effect of change in accounting method -- net of taxes........ $(45) $(3,953) $(2,526)(a) $ (9,349) $ (9,432) $ (6,514) $(11,009) Plus: Loss on sales of subscriber accounts..... -- -- -- -- 505 433 19 Amortization of debt issuance costs and OID.................................... -- 49 185 891 6,797 2,687 13,159 Interest expense, net.................... 90 1,941 1,564 6,932 7,626 6,850 3,052 Amortization of subscriber accounts and goodwill............................... 106 2,525 3,864 8,772 15,460 10,858 16,108 Depreciation expense..................... 17 481 522 518 1,083 745 1,250 Performance warrants compensation expense................................ -- -- -- 4,504 -- -- -- Loss on acquisition terminations......... -- -- -- 26 208 208 -- ---- ------- ------- ------- ------- ------- ------- EBITDA............................ $168 $ 1,043 $ 3,609 $ 12,294 $ 22,247 $ 15,267 $ 22,579 ==== ======= ======= ======= ======= ======= =======
- --------------- (a) Such amount reflects a reduction of $0.7 million for adjustment of purchase accounting accruals, net. (4) MRR is monthly recurring revenue (excluding revenues from patrol services) that the Company is entitled to receive under contracts in effect at the end of the period. MRR is a term commonly used in the security alarm industry as a measure of the size of a company, but not as a measure of profitability or performance, and does not include any allowance for future attrition or allowance for doubtful accounts. The Company does not have sufficient information as to the attrition of acquired subscriber accounts to predict the amount of acquired MRR that will be realized in future periods or the impact of the attrition of acquired accounts on the Company's overall rate of attrition. (5) In calculating the ratio of earnings to fixed charges, earnings consist of income before income taxes plus fixed charges. Fixed charges consist of interest expense and the amortization of debt issuance cost and OID and the component of rental expense believed by management to be representative of the interest factor thereon. Earnings were insufficient to cover fixed charges by $4.0 million, $2.5 million, $9.3 million, $9.4 million, $6.5 million and $11.0 million for the years ended September 30, 1992, 1993, 1994, 1995 and the nine months ended June 30, 1995 and 1996, respectively. (6) Adjusted to give effect to the issuance of the Convertible Notes and the application of the net proceeds therefrom as if such issuance had occurred at the beginning of such nine-month period. S-17 20 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW A majority of the Company's revenues are derived from recurring payments for the monitoring and servicing of security systems and additional security services, pursuant to contracts with initial terms ranging from one to five years. Service revenues are derived from payments under extended service contracts and for service calls performed on a time and materials basis. The remainder of the Company's revenues are derived from the sale and installation of security systems, add-ons and upgrades. Payment for monitoring services is typically required in advance. Monitoring and service revenues are recognized as the service is provided. Installation, add-on and upgrade revenue is recognized when the required work is completed. All direct installation costs, which include materials, labor and installation overhead, and selling and marketing costs are expensed in the period incurred. Alarm monitoring services generate a significantly higher gross margin than do the other services provided by the Company. In fact, the cost of providing patrol and alarm response services exceeds the revenues generated by such services and, while sales and installation services contribute to the Company's gross profits, the total expenses associated with alarm system installations (including not only the direct costs of providing such services but also the expenses associated with the sales and marketing of alarm systems) also exceed the revenues generated by such services. The Company's strategy, however, is to provide patrol and alarm response services and to invest in system sales and installations because the Company believes that such services and products contribute to the generation and retention of alarm monitoring subscribers. Accounting Differences for Account Purchases and New Installations. A difference between the accounting treatment of the purchase of subscriber accounts and the accounting treatment of the generation of subscriber accounts through direct sales by the Company's sales force has a significant impact on the Company's results of operations. All direct external costs associated with purchases of subscriber accounts (either through the Dealer Program or through acquisitions of subscriber account portfolios) are capitalized and amortized over 10 years on a straight-line basis. Company personnel and related support and duplicate costs incurred solely in connection with subscriber account acquisitions and transitions are expensed as incurred. Other acquisition transition costs that reflect the Company's estimate of costs associated with incorporating the purchased subscriber accounts into its operations, including costs incurred by the Company in fulfilling the seller's pre-acquisition warranty repair service and other obligations to the acquired subscribers, are capitalized and amortized as described above. In contrast, all of the Company's costs related to the sales, marketing and installation of new alarm monitoring systems generated by the Company's sales force are expensed in the period in which such activities occur. See "Risk Factors -- Impact of Accounting Differences for Account Purchases and New Installations." The Company's purchase activity increased significantly in fiscal 1994 and 1995. In addition, during that period the Company adopted a strategy of reducing its sales of new systems and related marketing expenditures. As a result of the difference in the methods by which such activities are accounted for, the combined effect of these two factors was to improve operating results during fiscal 1994, fiscal 1995 and the first nine months of fiscal 1996. The Company does not expect to further reduce sales of new systems by Company personnel and related marketing expenditures in the remainder of fiscal 1996. Change in Accounting Method. Effective October 1, 1994, the Company changed its method of accounting for certain subscriber account acquisition and transition costs. The acquisition and transition costs previously capitalized, which under the new method are expensed as incurred, are the Company personnel and related support and duplicate costs incurred solely in connection with acquisitions and transitions. The new method is consistent with the guidelines adopted by the Emerging Issues Task Force of the Financial Accounting Standards Board in Issue 95-3, Recognition of Liabilities in Conjunction with Purchase Business Combinations. See "-- Accounting Differences for Account Purchases and New Installations." In accordance with accounting rules applicable to changes in accounting policies: (i) in the quarter ended December 31, 1994, the Company recorded a non-cash, non-recurring charge of approximately $2.0 million, which S-18 21 amount represents the cumulative effect (net of income tax benefit of approximately $1.2 million) of the accounting change on prior years' results of operations; and (ii) the Company's statement of operations for fiscal 1995 includes (and subsequent statements of operations will include) a new expense item captioned "acquisition and transition expenses" to reflect the application of the new accounting method for fiscal 1995 and subsequent periods. The expense was approximately $3.1 million for fiscal 1995 (before associated tax benefit). The foregoing $2.0 million non-recurring charge and $3.1 million expense are reflected in the financial information presented in this Prospectus Supplement or the Prospectus or incorporated herein by reference. Such expenses will fluctuate from quarter to quarter based primarily on the amount of the Company's acquisition activity and its ability to require sellers to bear certain of such acquisition-related expenses. Acquisition and Dealer Program Activity. As described in this Prospectus Supplement, a significant portion of the Company's growth has been generated by the acquisition of portfolios of subscriber accounts from other alarm companies. Because the Company typically acquires only the subscriber accounts (and not the accounts receivable or other assets) of the sellers, the Company focuses its pre-acquisition review and analysis on the quality and stability of the subscriber accounts to verify the MRR represented by such accounts. If the subscriber accounts to be purchased pass such due diligence scrutiny, the Company then applies its monitoring costs to such MRR as a basis for determining the purchase price to be paid by the Company. To protect the Company against the loss of acquired accounts, the Company typically seeks to obtain from the seller a guarantee against the subscriber account cancellation for a period following the acquisition and the right to retain a portion of the acquisition price against the MRR lost due to subscriber account cancellations during the specified period. During the nine months ended June 30, 1996, the Company added (through acquisitions of 27 portfolios of subscriber accounts and through its Dealer Program) an aggregate of approximately 77,000 subscriber accounts for a total purchase price of approximately $95.5 million (including assumed liabilities of approximately $21.2 million). The MRR of the acquired accounts ranged from approximately $10.00 to $80.00, with an average of $28.56. Of the acquisitions completed during the nine months ended June 30, 1996 by the Company, the substantial majority included purchase price holdbacks. These holdbacks averaged 12% of the initial purchase price with attrition guarantee periods that ranged from four months to 12 months and averaged nine months. Approximately 80% of the acquired subscriber accounts in the nine months ended June 30, 1996 were residential. Two of the Company's acquisitions during the nine months ended June 30, 1996 involved a portfolio representing MRR that exceeded 5% of the Company's MRR at the time of the acquisition, as set forth below:
ESTIMATED PERCENTAGE OF NUMBER OF AVERAGE MRR RANGE OF MRR RESIDENTIAL SELLER ACCOUNTS PER ACCOUNT PER ACCOUNT SUBSCRIBERS ------------------------------- --------- ----------- -------------- ------------- InterCap Funds Joint Venture... 9,975 $ 27.39 $18.00 - 45.00 80% Metrol......................... 18,500 $ 27.03 $15.00 - 80.00 70%
Subscriber Attrition. Subscriber attrition has a direct impact on the Company's results of operations, since it affects both the Company's revenues and its amortization expense. See "Risk Factors -- Attrition of Subscriber Accounts." Attrition can be measured in terms of canceled subscriber accounts and in terms of decreased MRR resulting from canceled subscriber accounts. Gross subscriber attrition is defined by the Company for a particular period as a quotient, the numerator of which is equal to the number of subscribers who disconnect service during such period and the denominator of which is the average of the number of subscribers at each month end during such period. Net MRR attrition is defined by the Company for a particular period as a quotient, the numerator of which is an amount equal to gross MRR lost as the result of canceled subscriber accounts or services during such period, net of MRR generated during such period by the sale of additional services and increases in rates to existing subscribers and from reconnects and conversions and MRR associated with canceled accounts with respect to which the Company obtained an attrition guarantee, and the denominator S-19 22 of which is the average month-end MRR in effect during such period. The following table sets forth the Company's gross subscriber attrition and net MRR attrition for the periods indicated:
TWELVE MONTHS YEAR ENDED SEPTEMBER 30, ENDED JUNE 30, ------------------------------------- ----------------------- 1993 1994 1995 1995 1996 --------- --------- --------- --------- --------- Gross subscriber attrition................. 21.3% 19.6% 19.3% 18.6% 19.9% Net MRR attrition........... 7.9% 5.3% 6.6% 6.2% 7.1%
Because the Company determines payments to sellers under purchase price holdbacks subsequent to the periods to which such holdbacks apply, and because holdbacks are not allocated to specific guaranteed accounts or specific fiscal periods, the Company reduces the gross MRR lost during a period by the amount of guaranteed accounts provided for in purchase agreements with sellers. However, in some cases, the Company has not retained the full amount of such holdback to which the Company is contractually entitled. If guaranteed accounts for which the Company was not compensated by the seller were taken into account in calculating net MRR attrition, net MRR attrition would have been higher in each period presented in the table above. Generally, net MRR attrition is less than actual "net account attrition," which the Company defines as canceled subscriber accounts net of reconnects, conversions and guaranteed accounts. Estimated net account attrition is the basis upon which the Company determines the period over which it amortizes its investment in subscriber accounts. The Company amortizes such investment over 10 years based on current estimates. If actual subscriber account attrition were to exceed such estimated attrition, the Company could be required to amortize its investment in subscriber accounts over a shorter period, thus increasing amortization expense in the period in which such adjustment is made and in future periods. Since the majority of the subscriber accounts acquired by the Company since its formation were purchased recently, there can be no assurance that the actual attrition rates for such accounts will not be greater than the rate assumed by the Company. See "-- Results of Operations -- Fiscal 1995 Compared to Fiscal 1994 -- Amortization of subscriber accounts and goodwill" below. The table below sets forth the change in the Company's subscriber base for the periods indicated:
TWELVE MONTHS YEAR ENDED SEPTEMBER 30, ENDED JUNE 30, ------------------------------- ------------------- 1993 1994 1995 1995 1996 ------- ------- ------- ------- ------- Number of subscribers: Beginning of period.......... 35,538 39,527 85,269 76,112 131,166 Additions through portfolio acquisitions and Dealer Program, net of sales of subscriber accounts....... 7,315 54,211 60,909 68,891 80,967 Installations by Company personnel................. 2,951 1,646 1,502 1,644 984 Reconnects and conversions... 1,916 3,060 3,585 3,465 4,243 Gross subscriber attrition... (8,193) (13,175) (21,845) (18,946) (29,228) ------- ------- ------- ------- ------- End of period........ 39,527 85,269 129,420 131,166 188,132 ======= ======= ======= ======= =======
Impact of Statement of Financial Accounting Standards No. 121. In March of 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of," effective for financial statements for fiscal years beginning after December 15, 1995. This statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company determines the value of its "Subscriber Accounts and Intangibles, net" based on the undiscounted cash flows from the MRR stream using the most recent historical attrition rate and aggregate MRR. At June 30, 1996, the undiscounted cash flows from the MRR stream were significantly in excess of the carrying S-20 23 value of "Subscriber Accounts and Intangibles, net." The Company does not anticipate a material impact on its financial statements resulting from the adoption of this standard. Restrictions on Dividends. The Company has never paid any cash dividends on the Common Stock and does not intend to pay any cash dividends in the foreseeable future. The Credit Agreement and the Discount Notes Indenture restrict the Company's ability to declare or pay any dividend on, or make any other distribution in respect of, the Company's capital stock. RESULTS OF OPERATIONS The following table sets forth certain operating data as a percentage of total revenues for the periods indicated.
NINE MONTHS FISCAL YEAR ENDED JUNE 30, ------------------------- --------------- 1993 1994 1995 1995 1996 ----- ----- ----- ----- ----- Revenues: Monitoring and service................... 67.8% 78.6% 82.9% 83.7% 89.5% Installation............................. 30.7 13.8 6.6 7.8 3.7 Other.................................... 1.5 7.6 10.5 8.5 6.8 ----- ----- ----- ----- ----- Total revenues................... 100.0% 100.0% 100.0% 100.0% 100.0% ----- ----- ----- ----- ----- Cost of revenues: Monitoring and service................... 16.2% 18.9% 21.1% 20.9% 24.4% Installation............................. 16.4 8.6 5.2 5.9 2.8 Other.................................... 1.5 8.2 8.1 8.8 6.3 ----- ----- ----- ----- ----- Total cost of revenues........... 34.1 35.7 34.4 35.6 33.5 ----- ----- ----- ----- ----- Gross profit..................... 65.9 64.3 65.6 64.4 66.5 Selling, general and administrative expenses................................. 55.2 30.1 22.2 21.0 19.5 Loss on acquisition terminations........... -- 0.1 0.4 0.5 -- Acquisition and transition expenses........ -- -- 5.5 6.1 5.9 Performance warrants compensation expense.................................. -- 13.1 -- -- -- Adjustment of purchase accounting accruals, net...................................... (3.4) -- -- -- -- Amortization of subscriber accounts and goodwill................................. 17.7 25.4 27.7 27.9 31.1 ----- ----- ----- ----- ----- Operating income (loss).......... (3.6)% (4.4)% 9.8% 8.9% 10.1% ===== ===== ===== ===== =====
NINE MONTHS ENDED JUNE 30, 1996 COMPARED TO NINE MONTHS ENDED JUNE 30, 1995 Revenues. Revenues for the nine months ended June 30, 1996 increased by $12.8 million, or 32.9%, to $51.8 million from $39.0 million in the comparable period in fiscal 1995. Monitoring and service revenues increased by $13.8 million, or 42.2%, a substantial majority of which resulted from the addition of subscribers through the acquisition of portfolios of subscriber accounts and purchases of subscriber accounts through the Dealer Program. The Company's subscriber base increased by 43.4% to 188,132 subscribers at June 30, 1996 as compared to 131,166 subscribers at June 30, 1995. The sale of enhanced services and new subscribers generated by Company personnel comprised the remainder of revenue growth. Other revenues, consisting primarily of revenues generated by the Company's patrol and alarm response, installation and lock businesses, decreased by $0.9 million, or 14.6%, to $5.4 million. Such decrease was caused primarily by a decline in installation revenues of 36.9%, or $1.1 million. The decline in installation revenues (and the decline in installation expense described below) resulted from the Company's continued emphasis on growth through acquisitions and the Dealer Program, rather than through the sale of new alarm systems by Company personnel. Cost of revenues. Cost of revenues for the nine months ended June 30, 1996 increased by $3.5 million, or 24.9%, to $17.3 million. Cost of revenues as a percentage of total revenues declined to 33.5% for the nine months ended June 30, 1996 from 35.6% for the comparable period in fiscal 1995. Monitoring and service S-21 24 expenses increased by $4.5 million, or 55.2%, primarily due to increased activity at the Company's central monitoring station and field service branches due to a substantially larger subscriber base. Monitoring and service expenses as a percentage of monitoring and service revenues increased to 27.3% for the nine months ended June 30, 1996 from 25.0% during the comparable period in fiscal 1995. Such increase reflects a higher level of staffing at the Company's central monitoring station as well as a lower MRR per subscriber in the nine months ended June 30, 1996, due primarily to the acquisition of portfolios of subscriber accounts that had a lower average MRR per subscriber than the Company's average at that time. Other expenses decreased by approximately $1.0 million, or 18.3%, to $4.7 million for the nine months ended June 30, 1996 from $5.7 million for the first nine months of fiscal 1995. The decrease primarily was caused by a 38.1% decrease ($0.9 million) in installation expense. Gross profit. Gross profit for the nine months ended June 30, 1996 was $34.5 million, which represents an increase of approximately $9.4 million, or 37.4%, over the $25.1 million of gross profit recognized in the comparable period in fiscal 1995. Gross profit as a percentage of total revenues was 66.5% for the nine months ended June 30, 1996 compared to 64.4% for the comparable period in fiscal 1995. This increase was caused primarily by an increase in monitoring and service revenues as a percentage of total revenues to 89.5% in the nine months ended June 30, 1996 compared to 83.7% in the comparable period in fiscal 1995. Gross profit from other revenues increased slightly to $0.7 million for the first nine months of fiscal 1996 from $0.6 million for the comparable period in fiscal 1995. Selling, general and administrative expenses. Selling, general and administrative expenses rose to $10.1 million in the first nine months of fiscal 1996, which represents an increase of $1.9 million, or 23.3%, over selling, general and administrative expenses in the comparable period in fiscal 1995. Such figure as a percentage of total revenues declined to 19.5% in the nine months ended June 30, 1996 from 21.0% in the nine months ended June 30, 1995, due primarily to the growth rate in revenues exceeding that of selling, general and administrative expenses. Sales and marketing expenses declined due to the Company's continued emphasis on growth through acquisitions and the Dealer Program, rather than through sales of new alarm systems by Company personnel. The increase in general and administrative expenses was caused by increases in corporate and branch management and overhead expenses incurred to supervise a larger employee base associated with a larger subscriber base. Advertising and marketing expenses are expensed as incurred and comprised less than 1% of revenues in each of the nine month periods ended June 30, 1995 and 1996. The provision for doubtful accounts increased to $1.5 million for the nine months ended June 30, 1996 from $1.2 million for the comparable period in fiscal 1995. Acquisition and transition expenses. Acquisition and transition expenses for the nine months ended June 30, 1996 totaled approximately $3.0 million compared to $2.4 million for the comparable period in fiscal 1995. Such increase reflects the Company's increased acquisition and Dealer Program activity during the nine months ended June 30, 1996. Such expenses will fluctuate from quarter to quarter based primarily on the amount of the Company's acquisition activity and its ability to require sellers to bear certain of such acquisition-related expenses. Amortization of subscriber accounts and goodwill. Amortization expense during the nine months ended June 30, 1996 increased by $5.3 million, or 48.4%, to $16.1 million. This increase is the result of the addition to the Company's intangible asset reflecting the acquisition of portfolios of subscriber accounts and the purchase of subscriber accounts through the Dealer Program. Operating income. Operating income for the nine months ended June 30, 1996 was approximately $5.2 million, compared to $3.5 million in the comparable period in fiscal 1995. Operating income as a percentage of total revenues was 10.1% in the first nine months of fiscal 1996, compared to 8.9% in the comparable period in fiscal 1995. The increase in such figure over the comparable period in fiscal 1995 reflects the increase in gross profit as a percentage of total revenues and the achievement of economies of scale. Interest expense, net and amortization of debt issuance costs and OID. Interest expense, net and amortization of debt issuance costs and OID increased by $6.7 million, or 70.0%, to $16.2 million in the nine months ended June 30, 1996, reflecting the Company's use of debt to finance a substantial portion of its subscriber account growth. Because the Company refinanced its cash interest-paying subordinated debt in S-22 25 May of 1995 with non-cash interest-paying subordinated debt (see "-- Liquidity and Capital Resources"), amortization of debt issuance costs and OID increased during the nine months ended June 30, 1996 to approximately $13.2 million. Balance sheet data. At June 30, 1996, the Company's working capital deficit was $11.0 million, as compared to a working capital deficit of $9.2 million at September 30, 1995. The increase in the working capital deficit was caused primarily by increases in purchase holdbacks, deferred revenue and acquisition transition costs of $15.0 million offset by increases in cash, accounts receivable, inventories and prepaid expenses of $13.4 million. Subscriber accounts and intangibles, net increased to $238.9 million at June 30, 1996 from $162.2 million at September 30, 1995. This increase of $76.7 million, or 47.3%, was caused by the addition of new subscribers, net of amortization expense. Total stockholders' equity increased to $30.9 million at June 30, 1996 from $6.3 million at September 30, 1995. The increase in such figure reflects the Company's public offering of 2.5 million shares of Common Stock (resulting in $23.1 million of net proceeds), the conversion of POI's Series H Redeemable Preferred Stock to Common Stock in February 1996 ($6.1 million) and the issuance of 417,885 shares of Common Stock as a portion of the purchase price payment for the Metrol acquisition (resulting in an increase to stockholders' equity of $6.8 million), partially offset by $11.3 million of losses in the first nine months of fiscal 1996. FISCAL 1995 COMPARED TO FISCAL 1994 Revenues. Revenues for fiscal 1995 increased by $21.4 million, or 62.1%, to $55.9 million from $34.5 million for fiscal 1994. Monitoring and service revenues increased by $19.2 million, or 70.8%, a substantial majority of which resulted from the addition of approximately 53,000 subscribers from the acquisition of portfolios of subscriber accounts and approximately 10,000 subscribers from the Dealer Program. The sale of enhanced services and new subscribers generated by Company personnel comprised the remainder of revenue growth. Installation revenues declined by 23.1% to approximately $3.7 million in fiscal 1995 from $4.8 million in fiscal 1994. The decline in installation revenues resulted from the Company's increased emphasis on growth through acquisitions and the Dealer Program, rather than through sales of new alarm systems by Company personnel. Other revenues, consisting primarily of revenues generated by the Company's patrol and alarm response and lock businesses, increased by $3.3 million, or 126.8%, to $5.9 million. Such increase was caused by an increase in lock revenue of $1.4 million, as fiscal 1995 included twelve months of lock revenues and fiscal 1994 included only two months of such revenues and by an increase in patrol and alarm response revenues of 18.9%, or $0.4 million. Additionally, the Company recognized $1.6 million of other revenue arising from the sales of security alarm equipment received from a vendor. Cost of revenues. Cost of revenues for fiscal 1995 increased by $6.9 million, or 56.0%, to $19.2 million. Cost of revenues as a percentage of total revenues declined to 34.4% during fiscal 1995 from 35.7% during fiscal 1994. Monitoring and service expenses increased by $5.3 million, or 80.9%, primarily due to increased activity at the Company's central monitoring station and field service branches due to a substantially larger subscriber base. Monitoring and service expenses as a percentage of monitoring and service revenues increased to 25.5% from 24.1% during fiscal 1994. Such increase reflects a higher level of staffing at the Company's central monitoring station as well as a lower MRR per subscriber in fiscal 1995, due primarily to the acquisition of portfolios of subscriber accounts that had a lower average MRR per subscriber than the Company's average at that time. See "-- Overview -- Acquisition and Dealer Program Activity." Installation expenses declined slightly to approximately $2.9 million in fiscal 1995 from $3.0 million in fiscal 1994. Other expenses increased by $1.7 million, or 58.8%, from $2.9 million in fiscal 1994. The increase primarily was caused by a 32.8% increase in patrol and alarm response expenses, or $0.8 million, and an increase in lock expenses of approximately $0.8 million. Gross profit. Gross profit for fiscal 1995 was $36.7 million, which represents an increase of $14.5 million, or 65.5%, over the $22.2 million of gross profit recognized for fiscal 1994. Such increase was caused primarily by an increase in monitoring and service activities, which paralleled the increase in the Company's subscriber base from 85,269 at September 30, 1994 to 129,420 at September 30, 1995. Gross profit as a percentage of total revenues was 65.6% for fiscal 1995 compared to 64.3% for fiscal 1994. This increase was caused primarily by an increase in monitoring and service revenues as a percentage of total revenues. Gross profit from S-23 26 installation activities declined to $0.8 million (21.0% of installation revenues) in fiscal 1995 from $1.8 million (38.1% of installation revenues) in fiscal 1994 because of the reasons described above. Selling, general and administrative expenses. Selling, general and administrative expenses rose to $12.4 million in fiscal 1995, which represents an increase of $2.0 million, or 19.6%, over selling, general and administrative expenses in fiscal 1994. Such figure as a percentage of total revenues declined from 30.1% in fiscal 1994 to 22.2% in fiscal 1995, due primarily to a decline in sales and marketing expenses of 34.0% (or $1.3 million) and an increase of 52.1% (or $3.4 million) in general and administrative expenses. Sales and marketing expenses declined due to the Company's increased emphasis on growth through acquisitions and the Dealer Program, rather than through sales of new alarm systems by Company personnel. The increase in general and administrative expenses was caused by increases in corporate and branch overhead expenses incurred to supervise a larger employee base associated with a larger subscriber base. The percentage increase in general and administrative expenses from fiscal 1994 to fiscal 1995 was lower than the 62.1% increase in total revenues between the comparable periods, reflecting economies of scale and efficiencies realized in the Company's branch and corporate offices. Advertising and marketing expenses are expensed as incurred and comprised 1% of revenues in each of fiscal 1994 and 1995. The provision for doubtful accounts increased to approximately $1.8 million in fiscal 1995 from $0.8 million in fiscal 1994, reflecting an increase in the Company's average subscriber base of 72.1% and the Company's willingness to work with subscribers experiencing credit difficulties in order to maintain long-term subscriber relationships. Acquisition and transition expenses. Acquisition and transition expenses for fiscal 1995 totaled $3.1 million, reflecting the Company's change in its method of accounting for certain expenses, effective as of October 1, 1994. See "-- Overview -- Change in Accounting Method." Had the Company enacted the change in accounting method on October 1, 1993, acquisition and transition expenses would have been approximately $2.4 million for fiscal 1994. Amortization of subscriber accounts and goodwill. Amortization expense for fiscal 1995 increased by $6.7 million, or 76.2%, to $15.5 million. This increase was the result of the Company's purchase of approximately 63,000 subscriber accounts through the acquisition of portfolios of subscriber accounts and through the Dealer Program in fiscal 1995. Operating income. Operating income for fiscal 1995 was $5.7 million, as compared to an operating loss of $1.5 million in fiscal 1994. The operating loss in fiscal 1994 included a non-recurring charge for performance warrants compensation expense of $4.5 million. Operating income as a percentage of revenue was 10.2% in fiscal 1995, compared to 8.7% in fiscal 1994 (excluding the non-recurring charge). Comparisons of this figure for fiscal 1995 and 1994 are impacted by the change in accounting method adopted by the Company effective as of the beginning of fiscal 1995. The increase in such figure over fiscal 1994 reflects the increase in gross profit and efficiencies realized in branch office and corporate general and administrative expenses noted above. Interest expense, net and amortization of debt issuance costs and OID. These amounts increased by $6.6 million, or 84.4%, to $14.4 million in fiscal 1995, reflecting the Company's use of debt to finance a substantial portion of its subscriber account growth and refinancing of its cash interest-paying subordinated debt in May of 1995 with non-cash interest paying subordinated debt as described above. Extraordinary item. During fiscal 1995, the Company recorded an extraordinary charge of $8.9 million (net of a tax benefit of $0.9 million) due to the loss on early extinguishment of debt. The loss, which arose from the purchase of the Company's $50.0 million principal amount of 12% senior subordinated notes issued in November 1993, included the writeoff of the remaining unamortized portions of OID ($4.1 million) and the capitalized fees and expenses associated with the November 1993 note offering ($3.0 million), a 5% premium paid in the tender offer for the notes ($2.5 million) and certain fees incurred in the tender offer. Balance sheet data. At September 30, 1995, the Company's working capital deficit was $9.2 million, as compared to a working capital deficit of $11.5 million at September 30, 1994. The decline in the working capital deficit was caused primarily by an increase in accounts receivable and inventory and a decline in accrued interest. Subscriber accounts and intangibles, net increased to $162.2 million at September 30, 1995 from $114.6 million at September 30, 1994. This increase of $47.6 million, or 41.6%, was caused by the addition of new subscribers, net of amortization expense. Total stockholders' equity (deficit) increased to S-24 27 $6.3 million at September 30, 1995 from a deficit of $6.1 million at September 30, 1994. The increase in such figure reflects the conversion of redeemable preferred stock to common stock and the issuance of common stock in the initial public offering of the Common Stock completed in October 1994, offset by a loss of $18.5 million for fiscal 1995. FISCAL 1994 COMPARED TO FISCAL 1993 Revenues. Revenues for fiscal 1994 increased by $12.6 million, or 57.5%, to $34.5 million from $21.9 million for the comparable period in 1993. Monitoring and service revenues increased by $12.3 million, or 82.6%, primarily because of a net increase in the number of subscribers to the Company's alarm services resulting from acquisitions. The Company had 85,269 subscribers at September 30, 1994, as compared to 39,527 subscribers at September 30, 1993. Installation revenues decreased by $2.0 million, or 29.1%, to $4.8 million in fiscal 1994. The decline in installation revenue was caused by the Company's emphasis on growth through the acquisition of portfolios of subscriber accounts rather than through the sale of new alarm systems by Company personnel. Other revenues, consisting primarily of revenues generated by the Company's patrol and alarm response and lock businesses, increased in fiscal 1994 to $2.6 million from $0.3 million in fiscal 1993. Patrol and alarm response revenues increased by $2.0 million in fiscal 1994 primarily as a result of the Company's acquisition of the patrol service subscriber accounts of two companies in the quarter ended December 31, 1993. Cost of revenues. Cost of revenues for fiscal 1994 increased by $4.9 million, or 65.2%, compared to the comparable period in 1993, and increased as a percentage of revenues from 34.1% to 35.7%. Monitoring and service expenses increased to $6.5 million in fiscal 1994 as compared to $3.5 million in fiscal 1993, an increase of $3.0 million, or 83.8%. Monitoring and service expenses as a percentage of monitoring and service revenues increased to 24.1% in fiscal 1994 from 23.9% in fiscal 1993, primarily due to the establishment of a customer service function and the acquisition of portfolios of subscriber accounts with a lower average MRR per subscriber than the Company's average at that time. Installation expenses declined to $3.0 million in fiscal 1994 from $3.6 million in fiscal 1993. The decline of $0.6 million, or 18.0%, was caused by lower installation activity. Other expenses increased by $2.5 million to $2.9 million in fiscal 1994, primarily as a result of an increase of $2.3 million in patrol and alarm response expenses. The increase in patrol and alarm response expenses was due to the Company's acquisition of the patrol and alarm response service subscriber accounts of two companies in the quarter ended December 31, 1993. Gross profit. Gross profit for fiscal 1994 increased by $7.7 million, or 53.6%, to $22.2 million from $14.4 million in the comparable period in 1993. Gross profit as a percentage of total revenues decreased to 64.3% from 65.9%. Such decrease was caused by a substantial decline in gross profit generated by installation activities to $1.8 million (38.1% of installation revenues) in fiscal 1994 from $3.1 million (46.5% of installation revenues) in fiscal 1993, offset by an increase in monitoring and service gross profit of $9.3 million. The increase in monitoring and service gross profit of 82.2% in fiscal 1994 resulted from a 115.7% increase in the Company's subscriber base. Selling, general and administrative expenses. Selling, general and administrative expenses for fiscal 1994 decreased by $1.7 million, or 14.1%, to $10.4 million. The decline was caused primarily by a decrease in selling expenses of $1.4 million and a slight decrease in general and administrative expenses of $0.3 million. As a percentage of total revenues, selling, general and administrative expenses decreased to 30.1% during fiscal 1994 from 55.2% during fiscal 1993. Such decline as a percentage of revenues was caused by less growth in general and administrative expenses than in revenues due to efficiencies achieved in the Company's branch and corporate offices. Advertising and marketing expenses constituted 1% of revenues in fiscal 1994, as compared with 6% of revenues in fiscal 1993, and were expensed as incurred. The provision for doubtful accounts increased to $0.8 million in fiscal 1994 from $0.02 million in fiscal 1993, reflecting the increase in the Company's subscriber base of approximately 66.2% and the Company's willingness to work with subscribers experiencing credit difficulties to maintain long-term subscriber relationships. S-25 28 Amortization of subscriber accounts and goodwill. Amortization expense for fiscal 1994 increased by $4.9 million, or 127.0%, above the comparable period in 1993, as a result of the acquisition of additional subscriber accounts in fiscal 1994. Operating loss. Operating loss for fiscal 1994 was $1.5 million, compared to an operating loss of $0.8 million in the comparable period in 1993, as a result of the factors discussed above. Excluding the non-cash performance warrants compensation expense item described above, operating income for fiscal 1994 was $3.0 million. Interest expense, net and amortization of debt issuance costs and OID. Interest expense, including amortization of debt issuance costs and OID, increased by approximately 347.3%, or $6.1 million, for fiscal 1994, compared to fiscal 1993. The expense increase primarily as a result of higher outstanding principal balances during fiscal 1994 and the sale of $50.0 million principal amount of 12% senior subordinated notes in November 1993. See "--Liquidity and Capital Resources." SELECTED QUARTERLY RESULTS OF OPERATIONS The following tables present certain unaudited statement of operations and other data for each quarter of fiscal 1995 and the first three quarters of fiscal 1996, as well as such data expressed as a percentage of the Company's total revenues for the periods provided. The consolidated statement of operations data has been derived from unaudited financial statements and has been prepared on the same basis as the Company's audited financial statements which appear elsewhere in this Prospectus Supplement. In the opinion of the Company's management, this data includes all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of such data.
QUARTER ENDED ---------------------------------------------------------------------- DEC. 31 MAR. 31 JUNE 30 SEP. 30 DEC. 31 MAR. 31 JUNE 30 1994 1995 1995 1995 1995 1996 1996 ------- ------- -------- ------- ------- ------- ------- (IN THOUSANDS, EXCEPT ATTRITION DATA) CONSOLIDATED STATEMENT OF OPERATIONS DATA: Revenues: Monitoring and service........................... $9,720 $11,125 $ 11,776 $13,687 $13,828 $15,695 $16,854 Installation..................................... 1,187 1,053 800 622 652 650 616 Other............................................ 1,065 1,130 1,109 2,608 1,032 1,321 1,147 ------- ------- ------- ------- ------- ------- ------- Total revenues............................. 11,972 13,308 13,685 16,917 15,512 17,666 18,617 ------- ------- ------- ------- ------- ------- ------- Cost of revenues: Monitoring and service........................... 2,459 2,820 2,872 3,644 3,845 4,346 4,460 Installation..................................... 843 798 671 580 479 476 475 Other............................................ 1,157 1,187 1,078 1,110 1,084 1,135 1,036 ------- ------- ------- ------- ------- ------- ------- Total cost of revenues..................... 4,459 4,805 4,621 5,334 5,408 5,957 5,971 ------- ------- ------- ------- ------- ------- ------- Gross profit............................... 7,513 8,503 9,064 11,583 10,104 11,709 12,646 Selling, general and administrative expenses....... 2,534 2,939 2,705 4,231 3,129 3,427 3,526 Loss on acquisition terminations................... -- -- 208 -- -- -- -- Acquisition and transition expenses................ 871 816 693 710 755 1,172 1,121 Amortization of subscriber accounts and goodwill... 3,154 3,683 4,020 4,603 4,777 5,284 6,046 ------- ------- ------- ------- ------- ------- ------- Operating income........................... $ 954 $1,065 $ 1,438 $ 2,039 $1,443 $1,826 $1,953 ======= ======= ======= ======= ======= ======= ======= Loss before extraordinary items and cumulative effect of change in accounting method -- net of taxes............................................ $(1,059) $(1,237) $ (1,786) $(1,755) $(3,739) $(3,500) $(3,860) ======= ======= ======= ======= ======= ======= ======= Loss attributable to common stock.................. $(4,240) $(1,421) $(10,861) $(1,931) $(3,908) $(3,579) $(3,860) ======= ======= ======= ======= ======= ======= ======= OTHER DATA: Net MRR attrition for the twelve months ended.... 5.9% 5.6% 6.2% 6.6% 6.6% 7.9% 7.1%
S-26 29
QUARTER ENDED -------------------------------------------------------------------- DEC. 31 MAR. 31 JUNE 30 SEPT. 30 DEC. 31 MAR. 31 JUNE 30 1994 1995 1995 1995 1995 1996 1996 ------- ------- ------- -------- ------- ------- ------- AS A PERCENTAGE OF TOTAL REVENUES: Revenues: Monitoring and service............................. 81.2% 83.6% 86.1% 80.9% 89.1% 88.8% 90.5% Installation....................................... 9.9 7.9 5.9 3.7 4.2 3.7 3.3 Other.............................................. 8.9 8.5 8.1 15.4 6.7 7.5 6.2 ----- ----- ----- ----- ----- ----- ----- Total revenues............................... 100.0 100.0 100.0 100.0 100.0 100.0 100.0 ----- ----- ----- ----- ----- ----- ----- Cost of revenues: Monitoring and service............................. 20.5 21.2 21.0 21.5 24.8 24.6 24.0 Installation....................................... 7.0 6.0 4.9 3.4 3.1 2.7 2.6 Other.............................................. 9.7 8.9 7.9 6.6 7.0 6.4 5.6 ----- ----- ----- ----- ----- ----- ----- Total cost of revenues....................... 37.2 36.1 33.8 31.5 34.9 33.7 32.1 ----- ----- ----- ----- ----- ----- ----- Gross profit................................. 62.8 63.9 66.2 68.5 65.1 66.3 67.9 Selling, general and administrative expenses......... 21.2 22.1 19.8 25.0 20.2 19.4 18.9 Loss on acquisition terminations..................... -- -- 1.5 -- -- -- -- Acquisition and transition expenses.................. 7.3 6.1 5.1 4.2 4.9 6.6 6.0 Amortization of subscriber accounts and goodwill..... 26.3 27.7 29.3 27.2 30.8 29.9 32.5 ----- ----- ----- ----- ----- ----- ----- Operating income............................. 8.0% 8.0% 10.5% 12.1% 9.3% 10.3% 10.5% ===== ===== ===== ===== ===== ===== ===== Loss before extraordinary items and cumulative effect of change in accounting method -- net of taxes..... (8.9)% (9.3)% (13.1)% (10.4)% (24.1)% (19.8)% (20.7)% ===== ===== ===== ===== ===== ===== ===== Loss attributable to common stock.................... (35.4)% (10.7)% (79.4)% (11.4)% (25.2)% (20.3)% (20.7)% ===== ===== ===== ===== ===== ===== =====
The Company expects to experience fluctuations in quarterly operating results in the future. Such fluctuations may be caused by many factors, including, among others, the size and timing of acquisitions of portfolios of subscriber accounts, the size and timing of subscriber additions through the Dealer Program, new subscriber assimilation, attrition experience (which fluctuates based, to some extent, on seasonal patterns in purchases of homes), competitive pricing pressures, local and national crime activity and general economic conditions. The Company's expense levels are based, to some extent, on its expectations of future subscriber and revenue levels, which are dependent on estimates of acquisition and dealer activity. The Company may be unable, therefore, to adjust spending in a timely manner to compensate for any unexpected revenue shortfall due to a delay in the timing of acquisitions or purchases from dealers. Based on the foregoing, the Company believes that quarterly revenues and operating results are likely to vary significantly in the future. LIQUIDITY AND CAPITAL RESOURCES General. Since September 1991, the Company has financed its operations and growth from a combination of long-term debt, including the proceeds of the $50.0 million principal amount of 12.0% senior subordinated notes issued in November 1993 and the $166.0 million principal amount ($105.2 million net proceeds) of the Discount Notes issued in May 1995, short-term borrowings under the Company's revolving credit facilities, sales of stock and, to a lesser extent, cash flows from operations. In February 1996, the Company completed a public offering of 4.0 million shares of Common Stock (2.5 million shares of which were sold by the Company), resulting in net proceeds to the Company of $23.1 million. The Company believes that, based on the amount of net cash provided by operating activities in fiscal 1994 and 1995 and the nine months ended June 30, 1996, cash flows from operations will be sufficient to fund the Company's interest payments on its debt and capital expenditures, which are the Company's principal uses of cash other than the purchases of subscriber accounts from the Company's dealers and acquisitions of portfolios of subscriber accounts. On a long-term basis, the Company has several material commitments. At June 30, 1996, borrowings under the Revolving Credit Facility were approximately $80.9 million. After giving effect to the offering of the Convertible Notes and the application of the net proceeds thereof, there would have been no borrowings outstanding under the Revolving Credit Facility (excluding $1.2 million of contingent reimbursement obligations under outstanding letters of credit). Borrowings under the Revolving Credit Facility could be as high as $100 million through the period ended January 3, 2000, the present maturity date of such facility. While the Company believes it will be able to obtain further extensions of the maturity date of the Revolving Credit Facility from time to time, or will be able to refinance indebtedness outstanding under such facility prior to its maturity date, there can be no assurance that the Company will be able to do so. The Convertible S-27 30 Notes Indenture requires the Company to make semiannual interest payments on the principal amount of the Convertible Notes beginning on March 15, 1997, and the Discount Notes require the Company to make semiannual cash interest payments of $11.3 million beginning on December 31, 1998. As a result, a substantial portion of the Company's cash flows from operations will be required to make interest payments on the Convertible Notes and the Discount Notes, and there can be no assurance that the Company's cash flows from operations will be sufficient to meet such obligations, or that there will be sufficient funds available to the Company after such interest payments to meet other debt, capital expenditure and operational obligations. The $90.0 million principal amount of the Convertible Notes matures on September 15, 2003, and the $166.0 million principal amount of the Discount Notes matures on June 30, 2005. There can be no assurance that the Company will have the cash necessary to repay the Convertible Notes or the Discount Notes at maturity or will be able to refinance such obligations. The Company maintains a $2.0 million letter of credit sub-facility under its Revolving Credit Facility, and has extended an approximately $1.2 million letter of credit to a seller, scheduled payments under which are approximately $0.4 million during each of fiscal years 1997, 1998 and 1999. The Company intends to use the remaining cash flows from operations, together with borrowings under the Revolving Credit Facility, to finance the addition of subscriber accounts. Although the Company anticipates that it will continue to acquire portfolios of subscriber accounts, the Company cannot estimate the number, size or timing of such acquisitions. Depending on such factors, additional funds beyond those currently available to the Company may be required to continue the acquisition program, to finance the Dealer Program and to fund other growth, including strategic allegiances, and there can be no assurance that the Company will be able to obtain such financing on acceptable terms or at all. See "Risk Factors -- Need for Additional Capital." The Company has had, and expects to continue to have, a working capital deficit. At September 30, 1994 and 1995 and June 30, 1996, the Company had a working capital deficit of $11.5 million, $9.2 million and $11.0 million, respectively. There are two principal categories of current liabilities that cause the Company to have a working capital deficit: (i) purchase price holdbacks, which represent the portion of the aggregate acquisition cost of subscriber accounts retained by the Company to offset lost MRR arising from the cancellation of acquired accounts; and (ii) deferred revenue, which represents billings and cash collections received by the Company from its subscriber base in advance of performance of services. Both purchase price holdbacks and deferred revenues are recorded as a current liability on the Company's balance sheet. The Company generated approximately $16.6 million of net cash provided by operating activities in the nine months ended June 30, 1996, compared to $2.6 million in the nine months ended June 30, 1995. For fiscal 1995, the Company's net cash provided by operating activities was $8.5 million, compared to $7.4 million net cash provided by operating activities for fiscal 1994. During fiscal 1993, the Company's net cash provided by operating activities was $0.9 million. Net cash used in investing activities was approximately $80.8 million and $55.0 million in the nine months ended June 30, 1996 and 1995, respectively. The primary uses of cash in the nine months ended June 30, 1996 were acquisitions of portfolios of subscriber accounts and purchases through the Dealer Program. For fiscal 1995, the Company's net cash used in investing activities was $63.5 million, compared to $66.8 million during fiscal 1994, primarily as a result of the acquisition of subscriber accounts, including the purchases of subscriber accounts from Alert Centre, Inc. and Knight Protective Services. During fiscal 1993, the Company's net cash used in investing activities was $10.1 million, primarily as a result of acquisitions. Net cash provided by financing activities in the nine months ended June 30, 1996 was $71.4 million, compared to $52.1 million for the same period in fiscal 1995. During fiscal 1995, the Company's net cash provided by financing activities was $55.2 million, compared to $59.1 million in fiscal 1994. During fiscal 1993, the Company's net cash used in financing activities was $7.1 million. Financing activities were primarily the issuance of 2.5 million shares of Common Stock ($23.1 million net proceeds) in February 1996 and borrowings under the Revolving Credit Facility in the nine months ended June 30, 1996, the issuance of $166.0 million principal amount ($105.2 million net proceeds) of the Discount Notes in May 1995 and borrowings under the Revolving Credit Facility in fiscal 1995, the issuance of $50.0 million principal amount S-28 31 of 12.0% senior subordinated notes in fiscal 1994 (subsequently retired in fiscal 1995) and the issuance and retirement of long-term debt in fiscal 1993. The Credit Agreement and the Discount Notes Indenture contain certain restrictions on transfer of funds, such as dividends, loans and advances, by the Company. The Company believes that such restrictions have not had and will not have a significant impact on the Company's ability to meet its cash obligations. Capital Expenditures. During the nine months ended June 30, 1996, the Company made $4.7 million of capital expenditures, of which $3.0 million were made for the routine replacement and upgrading of vehicles, computers, phone switches and other capital items, and the remainder were made for the upgrading of the Company's monitoring and administrative hardware and software. The Company believes the installation of the new computer software equipment will create efficiencies in the Company's customer service, data entry and field maintenance and repair functions. The implementation of the new software is scheduled to be completed in fiscal 1997. In addition, the Company anticipates making capital expenditures totalling approximately $0.5 million over fiscal 1997 and fiscal 1998 to expand the capacity of the central monitoring station to approximately 500,000 subscribers. The Company believes cash flows from operations together with borrowings under the Revolving Credit Facility will be sufficient to fund the Company's capital expenditures in the remainder of fiscal 1996 and fiscal 1997. S-29 32 BUSINESS Protection One provides security alarm monitoring services for residential and small business subscribers. Based on its 188,132 subscribers as of June 30, 1996 (approximately 80% of which are residential), Protection One believes it is the fourth largest residential security alarm monitoring company in the United States and the largest in the six western states of Arizona, California, Nevada, New Mexico, Oregon and Washington. The Company's revenues consist primarily of recurring payments under written contracts for the monitoring and servicing of security systems and the provision of additional enhanced security services. For the nine months ended June 30, 1996, monitoring and service revenues represented 89.5% of total revenues. The Company monitors digital signals arising from burglaries, fires and other events through security systems installed at subscribers' premises. Most of these signals are received and processed at the Company's state-of- the-art central monitoring station located in Portland, Oregon, which, as currently configured, has the capacity to support up to 250,000 subscribers. The Company also sells enhanced security services, patrol and alarm response services and alarm systems and provides local field repair services through 11 branch offices. Enhanced security services provided by the Company include, among others, two-way voice communication, supervised monitoring services, pager service, wireless backup service and extended service protection. The Company grew rapidly in the twelve months ended June 30, 1996, as illustrated by an increase of 43.4% in the number of subscriber accounts from 131,166 at June 30, 1995 to 188,132 at June 30, 1996 and a 43.8% increase in its MRR from $4.0 million at June 30, 1995 to $5.8 million at June 30, 1996. (MRR is a term commonly used in the security alarm industry as a measure of the size of a company, but not as a measure of profitability or performance, and does not include any allowance for future attrition or allowance for doubtful accounts.) Total revenues increased by 38.4% from $49.7 million for the twelve months ended June 30, 1995 to $68.7 million for the twelve months ended June 30, 1996. Revenue growth and operating efficiencies led to a 49.4% increase in EBITDA, from $19.8 million for the twelve months ended June 30, 1995 to $29.6 million for the twelve months ended June 30, 1996. In addition, EBITDA as a percentage of revenues increased from 39.8% for the twelve months ended June 30, 1995 to 43.0% for the twelve months ended June 30, 1996. (See footnote (3) to "Selected Consolidated Financial Data" for a discussion of how EBITDA is derived. EBITDA does not represent cash flow from operations as defined by generally accepted accounting principles, should not be construed as an alternative to net income and is indicative neither of the Company's operating performance nor of cash flows available to fund the Company's cash needs. Items excluded from EBITDA are significant components in understanding and assessing the Company's financial performance. Management believes presentation of EBITDA enhances an understanding of the Company's financial condition, results of operations and cash flows because EBITDA is used by the Company to satisfy its debt service obligations and its capital expenditure and other operational needs as well as to provide funds for growth. In addition, EBITDA has been used by senior lenders and subordinated creditors and the investment community to determine the current borrowing capacity and to estimate long-term value of companies with recurring cash flows from operations and net losses.) Operating income increased by 46.6% from $5.0 million for the twelve months ended June 30, 1995 to $7.3 million for the twelve months ended June 30, 1996. The Company's loss attributable to common stock decreased from $17.5 million for the twelve months ended June 30, 1995 to $13.3 million for the twelve months ended June 30, 1996. From its inception, the Company has grown rapidly, primarily through the acquisition of portfolios of subscriber accounts. Between September 30, 1991 and June 30, 1996, the Company acquired 114 subscriber portfolios, representing an aggregate of approximately 165,000 subscribers. Management believes that numerous acquisition opportunities are available, and the Company is pursuing, and intends to continue to pursue, acquisitions of portfolios of subscriber accounts, some of which may be significant. (See "Recent Developments -- Metrol Acquisition.") Since the beginning of fiscal 1995, the Company has increased its emphasis on the Dealer Program, which became a more significant source of growth than in prior years. The Company plans to continue this emphasis because of the greater predictability, expected lower attrition and relatively lower cost of adding subscribers through its dealers as compared with acquisitions of larger portfolios of subscriber accounts. In addition, the Dealer Program generates a comparatively steady flow of new subscribers spread more evenly over the Company's 11 branch offices, making it easier for the Company's branch operations to successfully assimilate these accounts. See "-- The Dealer Program." S-30 33 MARKET OVERVIEW AND TRENDS The Company's target market consists of owners of single family residences and small businesses. According to the most recent U.S. Census Bureau data, there are over 10 million single-family residences and over 800,000 businesses with 100 or fewer employees in the six states in which the Company operates. The security alarm industry is characterized by the following attributes: - HIGH DEGREE OF FRAGMENTATION. The security alarm industry is currently comprised mostly of a large number of small providers of alarm systems and services. According to the Freeman Data, there are approximately 12,700 security alarm companies nationally, and the Company estimates that approximately 3,000 operate in the six states the Company currently serves. A survey published by SDM magazine (formerly Security Distributing and Marketing) in May 1996 reported that in 1995, based upon information provided by the respondents, the 100 largest companies in the industry accounted for approximately 23% of alarm industry revenues. Based on its acquisition experience, the Company believes that many smaller alarm service companies, because of their size, have higher overhead expenses as a percentage of revenues than the Company and lack access to capital on terms as attractive as those available to the Company. - RAPID GROWTH AND LOW PENETRATION. The residential security alarm market is growing rapidly but is still characterized by a low level of market penetration. The Freeman Data indicate that residential security alarm monitoring revenues grew at a compounded annual rate of 9.9% between 1989 and 1995. The Company believes that several factors, including increased concern about crime and favorable demographic trends, have contributed to the increased demand for residential security alarm services. In addition, based on the Freeman Data, the Company estimates that at November 1995, the percentage of total households in the United States with monitored security alarm systems was approximately 10.9%. - ADVANCES IN DIGITAL COMMUNICATIONS TECHNOLOGY. Prior to the development of digital communications technology, alarm monitoring required a dedicated telephone line, which made long-distance monitoring uneconomic. Consequently, in order to achieve a national or regional presence, alarm monitoring companies were required to maintain a large number of geographically dispersed monitoring stations. The development of digital communications technology eliminated the need for dedicated telephone lines, reducing the cost of monitoring services to the subscriber and permitting the monitoring of subscriber accounts over a wide geographic area from a central monitoring station. The elimination of local monitoring stations has decreased the cost of providing alarm monitoring services and has substantially increased the economies of scale for larger alarm service companies. In addition, the concurrent development of microprocessor-based control panels has substantially reduced the cost of the equipment available to subscribers in the residential and small business markets. The Company believes that several factors contribute to a favorable market for security alarm services both generally in the United States and specifically in the western portion of the country: - INCREASE IN CRIME RATES. According to the Uniform Crime Report published by the Federal Bureau of Investigation in 1995 (the "UCR"), between 1985 and 1994 the number of violent crimes reported in the United States increased by more than 40.3% and the total number of reported criminal offenses increased by 12.6%. The UCR also reported that although the number of reported criminal offenses decreased on a nationwide basis from 1993 to 1994 by 1.1%, a property crime was committed in the United States in 1994 once every three seconds. In the states in which the Company operates, the property crime rate in 1994 was 24.0% higher than the nation as a whole, averaging approximately 5,775 property crimes per 100,000 residents. In California, Protection One's largest market, the 1994 property crime and overall crimes rates were 10.8% and 14.9%, respectively, above the national averages. - HIGH LEVEL OF CONCERN ABOUT CRIME. As violent crime and the reporting of crime by the news media has increased, the perception by Americans that crime is a significant problem has also grown. A S-31 34 September 1994 poll conducted by a national news organization found that the most important factor people considered in choosing a new home was the level of neighborhood crime. - PER CAPITA POLICE PROTECTION. The UCR reported that urban areas in the western region of the United States had the lowest ratio of law enforcement employees per capita of the four reporting regions in 1994, the most recent period for which a UCR has been published. According to population and law enforcement employee data presented in the UCR, in 1994 Los Angeles had 3.0 law enforcement employees per 1,000 citizens, while New York had 5.4 and Houston had 4.0. The number of law enforcement employees per 1,000 citizens was 3.0 for Las Vegas, 2.6 for Phoenix, 2.7 for Portland, 2.3 for San Diego, 3.0 for San Francisco and 3.3 for Seattle. - DEMOGRAPHIC TRENDS. According to the United States Census Bureau, from 1989 to 1994 the rate of population growth in the states in which the Company operates was approximately twice the national average. According to the United States Department of Commerce, median income in California has been above the national average since 1989. Other recent trends that are favorable to the residential security alarm business include: the increase in women in the workforce resulting in more children being left at home alone and creating increased demand for security alarm services; the aging of the population in general, as older people tend to be more concerned about security; and the increase in people working at home, resulting in increasing demand for security services to protect home office equipment. - INSURANCE DISCOUNTS. The increase in demand for security systems may also be attributable in part to the granting by insurance companies of discounts to homeowners who purchase alarm systems, and such discounts are typically greater when systems are monitored by a central station. In addition, insurance companies may require that businesses install an alarm system as a condition of insurance coverage. BUSINESS STRATEGY The Company's strategy is to enhance its position as the largest residential security alarm monitoring company in the six western states in which it operates by pursuing a balanced growth plan incorporating the Dealer Program, acquisitions of portfolios of subscribers, the sale of enhanced services and new alarm systems and possible joint ventures and other strategic alliances. The Company's historical growth has enabled it to realize economies of scale in its central monitoring station, branch operations and corporate offices. As the number of subscribers monitored by the Company has increased, the fixed costs of the central monitoring station have been spread over a larger base, improving monitoring gross margins. Additionally, subscribers have been added in areas surrounding the Company's branch offices, allowing the Company to spread the branch office fixed costs over a larger base and increasing the productivity of field service technicians through more efficient scheduling and dispatching. Finally, the Company's revenue growth has exceeded the growth of its selling, general and administrative expenses, as the Company has realized management efficiencies and has spread additional revenue over its fixed corporate expenses. Such economies of scale have allowed the Company to add subscriber accounts at attractive purchase prices. The principal components of the Company's business strategy are as follows: - THE DEALER PROGRAM. In order to capitalize on growth in the demand for residential security alarm systems, the Company has developed the Dealer Program. Under this program, the Company provides monitoring and field repair services to subscriber accounts generated on a monthly basis through exclusive purchase agreements with independent alarm companies specializing in the sale and installation of security alarm systems. The Company added 25,444 subscriber accounts through its Dealer Program in the nine months ended June 30, 1996, an increase of 320.6% over the 6,050 subscribers added through the Dealer Program in the nine months ended June 30, 1995. As of June 30, 1996, the Company had 36 active participants in the Dealer Program. The Company believes that participation in the Dealer Program will expand due to: (i) the Company's concentrated presence in S-32 35 areas surrounding its branch offices, which enhances the Company's name recognition and therefore the marketability of the Company's services; (ii) the Company's ability to obtain volume purchase discounts on security system equipment on behalf of its dealers; and (iii) the Company's support services provided to dealers in the areas of administration, marketing and employee training. - ACQUISITIONS OF PORTFOLIOS OF SUBSCRIBER ACCOUNTS. The Company also grows by acquiring subscriber accounts, primarily from smaller alarm companies. These acquisitions represented approximately 51,000 subscribers in fiscal 1994, approximately 53,000 subscribers in fiscal 1995 and approximately 51,000 subscribers in the nine months ended June 30, 1996. The Company typically acquires only the subscriber accounts, and not the facilities or liabilities, of such companies. As a result, the Company is able to obtain gross margins on the monitoring of acquired subscriber accounts that are similar to those the Company currently generates on the monitoring of its existing subscriber base. In addition, the Company institutes price increases over time for acquired subscriber accounts where the Company determines that the charges previously paid by those subscribers do not appropriately reflect the higher quality of services to be provided by the Company. - SALE OF ENHANCED SERVICES; PATROL AND ALARM RESPONSE SERVICES. The Company seeks to increase revenues from current and newly added subscribers by actively marketing enhanced services to such subscribers. Such services include extended service protection, two-way voice communication, supervised monitoring services, pager service, remote video verification and wireless back-up. The Company also offers patrol and alarm response services, principally in southern California, Las Vegas and Phoenix. - CONVERSIONS, NEW OWNERS AND NEW ALARM SYSTEMS. The Company seeks to convert subscribers from competitors' services to the Company's services, particularly in areas in which the Company's patrol and alarm response services enhance the Company's presence and name recognition. The Company also generates new subscriber accounts by signing monitoring contracts with new owners of residences previously occupied by Protection One subscribers and through sales of alarm systems by its own personnel. - POSSIBLE JOINT VENTURES AND OTHER STRATEGIC ALLIANCES. To evaluate other potential sources of subscriber growth, the Company analyzes companies in other industries that may have an interest in entering the residential security alarm market. In addition, certain companies in industries facing deregulation (such as the telecommunications and electric utility industries) have expressed to the Company an interest in offering security alarm services to develop more comprehensive relationships with their customers. As of the date of this Prospectus Supplement, the Company has reached an agreement in principle with PacifiCorp to offer co-branded security alarm systems and monitoring services (see "Summary -- Recent Developments -- PacifiCorp Agreement"); in addition, the Company is discussing with certain other companies, and intends to continue to explore, possible joint ventures, co-marketing arrangements and other strategic alliances as a method of enhancing its subscriber growth and reducing its costs of generating new subscribers. Other than the agreement in principle with PacifiCorp, the Company has not entered into any agreement or arrangement for any such strategic alliance, and does not believe that any such joint venture or other strategic alliance is probable. The Company believes the successful execution of its growth strategy will lead to increases in subscribers and high margin monitoring revenues in excess of the growth in selling, general and administrative expenses. Historically, the Company has realized an increase in EBITDA as a percentage of revenues. Such measure increased from 39.8% for the twelve months ended June 30, 1995 to 43.0% for the twelve months ended June 30, 1996. (See footnote (3) to "Selected Consolidated Financial Data" for a description of how EBITDA is derived. EBITDA does not represent cash flow from operations as defined by generally accepted accounting principles, should not be construed as an alternative to net income and is indicative neither of the Company's operating performance nor of cash flows available to fund the Company's cash needs. Items excluded from EBITDA are significant components in understanding and assessing the Company's financial performance. Management believes presentation of EBITDA enhances an understanding of the Company's financial condition, results of operations and cash flows because EBITDA is used by the Company to satisfy its S-33 36 debt service obligations and its capital expenditure and other operational needs as well as to provide funds for growth. In addition, EBITDA has been used by senior lenders and subordinated creditors and the investment community to determine the current borrowing capacity and to estimate long-term value of companies with recurring cash flows from operations and net losses.) In addition, the Company intends to continue to grow primarily in the areas surrounding its branch offices. As the density of its subscriber account base in such areas increases, the Company expects to achieve further economies of scale in the scheduling and dispatching of field service technicians and patrol cars. In the twelve months ended June 30, 1996, the Company's net cash provided by operations grew to $22.4 million, an increase of 200.1% over the $7.5 million generated in the twelve months ended June 30, 1995. Net cash used in investing activities increased from $74.1 million during the twelve months ended June 30, 1995 to $89.4 million during the twelve months ended June 30, 1996. Net cash provided by financing activities during the twelve months ended June 30, 1996 was $74.4 million, a 15.3% increase over the $64.6 million provided during the twelve months ended June 30, 1995. THE DEALER PROGRAM The dealers that the Company selects for the Dealer Program are typically small alarm companies that specialize in selling and installing alarm systems for residential or small business subscribers in a specified geographic area. Such companies often cannot profitably provide monitoring and repair services because they lack a sufficient number of subscribers to support the fixed operating expenses associated with such services. Also, many dealers do not have access to capital on attractive terms. The Company enters into exclusive contracts with such dealers that provide for the purchase by the Company of the dealers' subscriber accounts on an ongoing basis. The dealers install alarm systems (which have a Protection One logo on the keypad), arrange for subscribers to enter into Protection One alarm monitoring agreements, and install Protection One yard signs and window decals. All of these subscribers are contacted individually by Company personnel, at the time of the purchase of the accounts from the dealers, to facilitate subscriber satisfaction and quality control. In addition, the Company requires dealers to evaluate the credit history of prospective new subscribers. The Company strives to provide quality, responsive field service to accounts purchased from dealers; the Company's principal competitors typically subcontract the field service of subscriber accounts they purchase, which the Company believes increases attrition rates and may dissuade dealers from selling their subscriber accounts to such competitors. The Company believes that its increased market share in the areas surrounding its branch offices has enhanced both the Company's ability to attract dealers and the ability of such dealers to attract new subscribers. To further attract high quality dealers, the Company enables them to obtain volume purchase discounts on security systems, coordinates cooperative dealer advertising, and provides administrative, marketing and employee training support services. The Company's dealers employ a variety of marketing methods to identify and create sales leads, including telemarketing, direct mail and door-to-door solicitation. The majority of the Company's dealers sell and install a hard-wired, low-cost security system manufactured by Ademco, a subsidiary of Pittway Corporation. The typical system includes protection of the front and back doors of a home, one interior motion detection device, a central processing unit with the ability to communicate signals to the Company's central monitoring station, a siren, window decals and a lawn sign. This basic system often will be offered for little or no up-front price, but will be sold to a subscriber with additional equipment customized to a subscriber's specific needs. Such equipment add-ons encompass additional perimeter protection, fire protection devices (heat and smoke detectors), environmental protection devices (freeze sensors and water detectors), panic buttons and home automation devices (lighting or appliance controls). Typically, dealers sign subscribers to alarm monitoring contracts that include a bundled monthly charge for monitoring and extended service protection. Extended service protection covers the normal costs of repair of the security system by the Company's service technicians at the subscriber's premises during normal business hours after the expiration of the security system's initial warranty period. The Company believes the bundling of monitoring and extended service protection provides additional value to subscribers and allows the Company to more efficiently provide field repair services. Dealers also sell the Company's enhanced security services. S-34 37 THE ACQUISITION PROGRAM The Company also seeks to grow by acquiring portfolios of subscriber accounts from other alarm companies. The Company focuses on acquisitions that allow it to "infill" areas surrounding branch operations, which in turn leads to greater field maintenance, repair and patrol efficiencies. The Company estimates there are approximately 3,000 alarm companies in its markets, substantially all of which are independently owned and may, from time to time, become acquisition targets. The Company believes that it is an effective competitor in the acquisition market because of the substantial experience of its management in acquiring alarm companies and subscriber accounts, both as a result of the 114 acquisitions made by the Company between September 30, 1991 and June 30, 1996 and acquisitions made by members of management when they were employed by other alarm service companies. The Company also believes that, through its acquisition activities, it has developed a reputation in the alarm service industry as an active purchaser of subscriber accounts. The Company offers sellers cash, Common Stock or a combination thereof as determined by the requirements of both the sellers and the Company. (See "Summary -- Recent Developments -- Metrol Acquisition.") Although most acquisitions add subscribers in the Company's existing market areas to achieve greater account density, the Company may also make acquisitions outside these areas. Because the Company's primary consideration in making an acquisition is the amount of cash flow that can be derived from the MRR associated with the purchased accounts, the price paid by the Company is customarily based upon such MRR. To protect the Company against the loss of acquired accounts and to encourage the seller of such accounts to facilitate the transfer of subscribers, management typically requires the seller to provide guarantees against account cancellations for a period following the acquisition. The Company usually holds back from the seller a portion of the acquisition price, and has the contractual right to utilize such holdback to recapture a portion of the purchase price based on the lost MRR arising from the cancellation of acquired accounts. In evaluating the quality of the accounts acquired, the Company relies primarily on management's knowledge of the industry, its due diligence procedures, its experience integrating accounts into the Company's operations, its assumptions as to attrition rates for the acquired accounts, and the representations and warranties of the sellers. THE ACQUISITION MANAGEMENT SYSTEM The Company employs a comprehensive acquisition management system to identify, evaluate, and assimilate acquisitions of new subscriber accounts that includes three components: the identification and negotiation stage, the due diligence stage and the assimilation stage. The Company actively seeks to identify prospective companies and dealers with targeted direct mail, trade magazine advertising, trade show participation, membership in key alarm industry trade organizations, and contacts through various prominent vendors and other industry participants. Management's extensive experience in identifying and negotiating previous acquisitions, and the Company's use of standard form agreements, help to facilitate the successful negotiation and execution of acquisitions in a timely manner. The Company conducts an extensive pre-closing review and analysis of all facets of the seller's operations. The process includes a combination of selective field equipment inspections, individual review of substantially all of the subscriber contracts, an analysis of the rights and obligations under such contracts and other types of verification of the seller's operations. The Company develops a specific assimilation program, in conjunction with the seller, for each acquisition. Assimilation efforts typically include a letter, approved by the Company, from the seller to its subscribers, explaining the sale and transition, followed by one or more letters and packages that include the Company's subscriber service brochures, field service and monitoring phone number stickers, yard signs and window decals. Thereafter, each new subscriber is contacted individually by telephone by a member of the Company's customer service group for the purpose of soliciting certain information and addressing the subscriber's questions or concerns. Finally, the subscriber receives a follow-up telephone call after six months and periodically thereafter. The acquisition management system's goal is to enhance new subscriber S-35 38 identification with Protection One as the service provider and to maintain subscriber satisfaction, and thus realize a higher portion of the potential value of the MRR generated by purchased subscriber accounts. DESCRIPTION OF OPERATIONS The Company's operations consist principally of alarm monitoring services, enhanced security services, field repair services and patrol and alarm response services. ALARM MONITORING SERVICES Subscriber Security Alarm Systems. Security alarm systems include devices installed at the subscribers' premises designed to detect or react to various occurrences or conditions, such as intrusion or the presence of fire or smoke. These devices are connected to a computerized control panel that communicates through telephone lines to a central monitoring station. Subscribers may also initiate an emergency signal from a device such as a "panic button." In most systems, control panels can identify the nature of the alarm and the areas within a building where the sensor was activated, and can transmit that information to the central monitoring station. The Central Monitoring Station. The Company monitors substantially all of its subscriber accounts at its central monitoring station in Portland, Oregon. In addition, in connection with certain acquisitions, the monitoring of certain subscriber accounts is subcontracted to the seller or to independent monitoring companies to provide for the orderly transition of the subscriber accounts or to comply with certain state regulations. However, it is the Company's policy to transfer all monitoring services for its acquired subscriber accounts to its central monitoring station as soon as practicable. The central monitoring station incorporates the use of advanced communications and computer systems that route incoming alarm signals and telephone calls to operators. Each operator sits before a computer monitor that provides immediate information concerning the nature of the alarm signal, the subscriber whose alarm has been activated, and the premises on which such alarm is located. All telephone conversations are automatically recorded. The central monitoring station has the capacity to monitor up to 250,000 subscribers. The Company anticipates making capital expenditures totalling $0.5 million over fiscal 1997 and fiscal 1998 to expand the capacity of the central monitoring station to approximately 500,000 subscribers. The equipment at the central monitoring station includes: sophisticated phone switching equipment; digital receivers that process the incoming signals; two computers with built-in redundancy; a network of "smart" computer terminals; a multi-channel, voice-activated recording system; uninterruptable power supply; and dual backup generators supplied by different fuel sources. The Company's central monitoring station is listed by Underwriters Laboratories Inc. ("UL") as a protective signaling services station. UL specifications for central monitoring stations include building integrity, back-up systems, staffing and standard operating procedures. In many jurisdictions, applicable law requires that security alarms for certain buildings be monitored by UL-listed facilities. In addition, such listing is required by certain commercial subscribers' insurance companies as a condition to insurance coverage. Operation of the Central Monitoring Station. Depending upon the type of service for which the subscriber has contracted, central monitoring station personnel respond to alarms by relaying information to the local fire or police departments, notifying the subscriber, or taking other appropriate action, such as dispatching alarm response personnel to the subscriber's premises where this service is available. The Company also provides a substantial number of subscribers with remote audio verification capability that enables the central monitoring station to listen and speak directly into the subscriber's premises in the event of an alarm activation. This feature allows the Company's personnel to verify that an emergency exists, to reassure the subscriber, and to expedite emergency response, even if the subscriber is unable to reach a telephone. Remote audio verification capability also assists the Company in quickly determining if the alarm was activated inadvertently, and thus whether a response is required. S-36 39 The Company's central monitoring station operates 24 hours per day, seven days a week, including all holidays. Each operator receives training that includes familiarization with substantially every type of alarm system in the Company's subscriber base. This enables the operator to tell subscribers how to turn off their systems in the event of a false alarm, thus reducing the instances in which a field service person must be dispatched. Other non-emergency administrative signals are generated by low battery status, deactivation and reactivation of the alarm monitoring system, and test signals, and are processed automatically by computer. Subscriber Contracts. The Company's alarm monitoring subscriber contracts generally have initial terms ranging from one to five years in duration, and provide for automatic renewal for a fixed period (typically one year) unless the Company or the subscriber elects to cancel the contract at the end of its term. The Company maintains an individual file with a signed copy of the contract for each of its subscribers and a computerized customer data base. Substantially all of the Company's alarm monitoring agreements for the Company's residential subscribers provide for subscriber payments of between $20 and $40 per month. The Company's commercial subscribers typically pay from $25 to $45 per month. In the normal course of its business, the Company experiences customer cancellations of monitoring and related services as a result of subscribers relocating, the cancellation of purchased accounts in the process of assimilation into the Company's operations, unfavorable economic conditions, dissatisfaction with field maintenance services and other reasons. This attrition is offset to a certain extent by revenues from the sale of additional services to existing subscribers, price increases, the reconnection of premises previously occupied by subscribers, conversions of accounts previously monitored by other alarm companies and guarantees provided by the sellers of such accounts. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Overview -- Subscriber Attrition." ENHANCED SECURITY SERVICES Additional MRR is generated by the provision of enhanced security services that the Company offers to both its existing subscribers and in conjunction with the sales of new systems. These enhanced security services include: Extended Service Protection, which covers the normal costs of repair of the system during normal business hours, after the expiration of the initial warranty period. Two-Way Voice Communication (Remote Audio Verification), which consists of the ability, in the event of an alarm activation, to listen and talk to persons at the monitored premises from the central monitoring station through speakers and microphones located within the premises. Among other things, such remote audio verification helps the Company to determine whether an alarm activation is a false alarm. Supervised Monitoring Service, which allows the alarm system to send various types of signals containing information on the use of the system, such as what users armed or disarmed the system and at what time of the day. This information is supplied to subscribers for use in connection with the management of their households or businesses. Supervised monitoring service can also include a daily automatic test feature. Pager Service, which provides the subscriber, at discounted rates, with standard pager services that also enable the Company to reach the subscriber in the event of an alarm activation. Remote Video Verification, which allows video images to be sent to the central monitoring station from small video cameras located within the monitored premises. The Company has only recently begun offering this service and expects that as a consequence of its cost, its primary market will be the Company's business accounts. Wireless Back-Up, which permits the alarm system to send signals over a cellular telephone or dedicated radio system, in the event that regular telephone service is interrupted. S-37 40 FIELD REPAIR SERVICES The Company believes one of the most effective ways of improving customer retention is the provision of quality, responsive field repair service by Company employees. Field service personnel are trained by the Company to provide repair services for the various types of security systems owned by the Company's subscribers. Field service personnel also inspect installations performed by the Company's installation subcontractors. Repair services generate revenues primarily through billable field service calls and contractual payments under the Company's extended service program. The increasing density of the Company's subscriber base, as a result of the Company's continuing effort to infill areas surrounding its branch operations with new subscribers, permits more efficient scheduling and routing of field service technicians, and results in economies of scale at the branch level. The increased efficiency in scheduling and routing also allows the Company to provide faster field service response and support, which leads to a higher level of subscriber satisfaction. PATROL AND ALARM RESPONSE SERVICES The Company employs over 100 patrol officers operating in 29 regular patrol "beats," or designated neighborhoods, in southern California, Las Vegas and Phoenix. These armed officers supplement the Company's alarm monitoring service by providing "patrol service" consisting of routine patrol of subscribers' premises and neighborhoods, "alarm response service" to alarm system activations, and "special watch" services, such as picking up mail and newspapers and increased surveillance when the subscriber is travelling. Alarm response service requires the Company's patrol officers to observe and report to police or other emergency agencies any potential criminal activity at a subscriber's home. Patrol officers are dispatched by a 24-hour central radio dispatch office located in the local dispatch office. An alarm activation signal from a subscriber to alarm response service is automatically processed by computer at the central monitoring station and sent electronically to the local dispatch office. If the patrol officer dispatched observes potential criminal activity, the officer will report the activity to the dispatch office, which will in turn notify local law enforcement. The patrol officer will then maintain surveillance until law enforcement officers arrive. If a patrol officer does not detect criminal activity, the officer will report that conclusion to the dispatch office, which will cancel police response and thereby reduce the potential for a false alarm fine. The Company also offers "dedicated" patrol service to homeowners' associations in selected markets, for which the Company provides a Company-marked car for patrol exclusively in such association's neighborhood. A significant percentage of the homeowners in such associations purchase the Company's alarm monitoring services. The Company's patrol officers are subject to extensive pre-employment screening. Officers are subject to background checks and drug screening before being hired, and are required to have gun and baton permits and state and city guard licenses. Officers also must be licensed by the state to carry firearms and to provide patrol services. The Company's training program includes arrest procedures, criminal law, weaponless defense, firearms and baton usage, patrol tactics, and first-aid and CPR. This training program exceeds state-mandated training requirements. However, the provision of patrol and alarm response services subjects the Company to greater risks, relating to accidents or employee behavior, than other types of businesses. The cost of providing patrol and alarm response services presently exceeds the revenues generated by such services. However, the Company believes that its ability to provide these services gives the Company a competitive advantage in marketing its monitoring services over alarm service companies that do not have these capabilities. Additionally, the Company believes such services are an effective impediment to subscriber attrition. The Company believes that demand for patrol and alarm response services may increase as a result of a trend on the part of local police departments to limit their response to alarm activations and other factors that may lead to a decrease of police presence. Although the Company currently incurs a loss in its patrol and alarm response operations, the Company believes further demand for such services would allow the Company to increase subscriber density in its patrol routes, thereby reducing losses. In addition, the Company's S-38 41 provision of patrol and alarm response services is a sales method used to convert subscribers of other alarm monitoring companies that do not provide such services. To the extent that further demand developed for patrol and alarm response services, the Company believes its current presence would enable it to increase its conversions of competitors' subscribers to the Company's services. SALES AND MARKETING Each of the Company's 11 branch offices includes sales representatives who sell new systems, equipment add-ons and upgrades and enhanced services to subscribers. Although the Company does not actively use outbound marketing methods to sell new security alarm systems, the Company receives in-bound telephone requests for such systems, primarily as a result of subscriber referrals, local crime activity and responses to yellow pages advertising. Such leads are pursued by one of the Company's sales representatives. Alarm sales are made at the subscriber's home, typically in a single visit by a sales representative. The Company markets additional services through both its account sales representatives and through a centralized telephone sales force in the Company's corporate offices. The Company believes that the increasing density of the Company's subscriber base (i.e., the increasing concentration of subscribers in certain areas) has increased the overall presence and visibility of the Company. Both in the Dealer Program and in Company sales, new subscribers are provided with highly visible reflective yard signs placed prominently in front of their homes or businesses. The presence of these signs develops greater awareness in a neighborhood and leads to more inbound and referral business. The Company encourages referrals from existing subscribers through an incentive program promoted through newsletters, billing inserts and employee contacts. Alarm response service, which uses marked patrol cars, also increases the Company's visibility. COMPETITION The security alarm industry is highly competitive and highly fragmented. The Company competes with major firms with substantial financial resources, including ADT Operations Inc.; Ameritech Corporation; Borg-Warner Security Corporation (under the Wells Fargo, Bel Air Patrol and Pony Express names); Honeywell, Inc.; The Pittston Brinks Group; Westinghouse Electric Corporation; and Republic Industries. Other alarm service companies have adopted a strategy similar to the Company's that entails the aggressive purchase of alarm monitoring accounts both through acquisitions of account portfolios and through dealer programs. Some of such competitors have greater financial resources than the Company, or may be willing to offer higher prices than the Company is prepared to offer to purchase subscriber accounts. See "Risk Factors -- Competition." Competition in the security alarm industry is based primarily on reliability of equipment, market visibility, services offered, reputation for quality of service and price. The Company believes it competes effectively with other national, regional and local security alarm companies in the western United States because of the Company's reputation for reliable equipment and services, its concentrated presence in the areas surrounding its branch offices, its ability to bundle monitoring, maintenance and repair and enhanced services and its low cost structure. REGULATORY MATTERS A number of local governmental authorities have adopted or are considering various measures aimed at reducing the number of false alarms. Such measures include: (i) subjecting alarm monitoring companies to fines or penalties for transmitting false alarms, (ii) licensing individual alarm systems and the revocation of such licenses following a specified number of false alarms, (iii) imposing fines on alarm subscribers for false alarms, (iv) imposing limitations on the number of times the police will respond to alarms at a particular location after a specified number of false alarms, and (v) requiring further verification of an alarm signal before the police will respond. The Company's operations are subject to a variety of other laws, regulations and licensing requirements of federal, state, and local authorities. In certain jurisdictions, the Company is required to obtain licenses or S-39 42 permits, to comply with standards governing employee selection and training, and to meet certain standards in the conduct of its business. Many jurisdictions also require certain of the Company's employees to obtain licenses or permits. Those employees who serve as patrol officers are often subject to additional licensing requirements, including firearm licensing and training requirements in jurisdictions in which they carry firearms. The alarm industry is also subject to requirements imposed by various insurance, approval, listing, and standards organizations. Depending upon the type of subscriber served, the type of security service provided, and the requirements of the applicable local governmental jurisdiction, adherence to the requirements and standards of such organizations is mandatory in some instances and voluntary in others. The Company's advertising and sales practices are regulated by both the FTC and state consumer protection laws. Such laws and regulations include restrictions on the manner in which the Company promotes the sale of its security alarm systems and the obligation of the Company to provide purchasers of its alarm systems with certain recision rights. From time to time subscribers have submitted complaints to state and local authorities regarding the Company's sales and billing practices. Such complaints can result in regulatory action against the Company, including civil complaints seeking monetary and injunctive remedies. The Company's alarm monitoring business utilizes telephone lines and radio frequencies to transmit alarm signals. The cost of telephone lines, and the type of equipment which may be used in telephone line transmission, are currently regulated by both federal and state governments. The operation and utilization of radio and cellular frequencies are regulated by the Federal Communications Commission and state public utilities commissions. LEGAL PROCEEDINGS The Company experiences routine litigation in the normal course of its business. The Company does not believe that any of such pending litigation will have a material adverse effect on the financial condition or results of operations of the Company. RISK MANAGEMENT The nature of the services provided by the Company potentially exposes it to greater risks of liability for employee acts or omissions, or system failure, than may be inherent in other businesses. Substantially all of the Company's alarm monitoring agreements, and other agreements pursuant to which it sells its products and services contain provisions limiting liability to subscribers in an attempt to reduce this risk. The Company's alarm response and patrol services require Company personnel to respond to emergencies that may entail risk of harm to such employees and to others. In most cities in which the Company provides such services, the Company's patrol officers carry firearms, which may increase such risk. Although the Company conducts extensive screening and training of its employees, the provision of alarm response and patrol service subjects it to greater risks related to accidents or employee behavior than other types of businesses. The Company carries insurance of various types, including general liability and errors and omissions insurance. The loss experience of the Company, and other security service companies, may affect the availability and cost of such insurance. Certain of the Company's insurance policies, and the laws of some states, may limit or prohibit insurance coverage for punitive or certain other types of damages, or liability arising from gross negligence. EMPLOYEES At June 30, 1996, the Company employed 1,094 individuals on a full-time basis. Currently, none of the Company's employees is represented by a labor union or covered by a collective bargaining agreement. The Company believes that its relations with its employees are good. S-40 43 FACILITIES The Company's executive offices are located at 6011 Bristol Parkway, Culver City, California, and its central monitoring station and administrative office are located in the Portland, Oregon metropolitan area at 3900 S.W. Murray Boulevard, Beaverton, Oregon. The offices at both locations are leased by the Company. The Culver City lease expires in 1998, but can be renewed by the Company for an additional term of five years. The Beaverton lease expires in 2005, but can be renewed by the Company for two additional terms of five years each. The Company also leases office space in Bullhead City, Phoenix, Tempe and Tucson, Arizona; Bakersfield, Irvine, Riverside, San Leandro, San Diego, Santa Clara and Van Nuys, California; Las Vegas, Nevada; Albuquerque, New Mexico; and Kent, Washington. The leases for these properties expire on various dates through 2005, and in some cases are renewable at the option of the Company. S-41 44 MANAGEMENT DIRECTORS AND EXECUTIVE OFFICERS The name, age as of June 30, 1996 and current position(s) of each director and executive officer of POI are as set forth below. Each of such individuals other than Mr. Weinstock also serves in the same capacities for Monitoring.
NAME AGE POSITION - ------------------------ --- -------------------------------------------- James M. Mackenzie, Jr. 48 President and Chief Executive Officer and Director John W. Hesse 46 Executive Vice President, Chief Financial Officer and Secretary John E. Mack, III 37 Executive Vice President -- Business Development and Assistant Secretary Thomas K. Rankin 38 Executive Vice President -- Branch Management and Assistant Secretary George A. Weinstock 58 Executive Vice President and Assistant Secretary Robert M. Chefitz 36 Director Dr. Ben Enis 53 Director James Q. Wilson 65 Director
James M. Mackenzie, Jr. has been President and Chief Executive Officer and a director of POI since 1991. Mr. Mackenzie served as President of Westec Security Inc. from 1988 to 1991, as President of Sonitrol Management Corporation from 1986 to 1988, and as President of API Alarm Systems, Inc. from 1978 to 1986. John W. Hesse has been Executive Vice President, Chief Financial Officer and Secretary of POI since 1991. He served as President and Chief Financial Officer of Network Security Corporation from 1981 to 1987, and was a private investor from 1987 to 1991. John E. Mack, III was Vice President -- Business Development of POI from 1991 until August 1996, and has been Executive Vice President -- Business Development of POI since August 1996 and Assistant Secretary since October 1994. Mr. Mack served as Director -- Southern Region for Westec Security Inc. from 1989 to 1991, as Vice President -- Sales and Marketing for AllGuard Alarm Systems Inc. from 1987 to 1989 and as Vice President -- Sales and Marketing for Knight Security of Northern California Inc. from 1985 to 1987. Thomas K. Rankin was Vice President -- Branch Management of POI from 1991 until August 1996, and has been Executive Vice President -- Branch Management of POI since August 1996 and Assistant Secretary since October 1994. Mr. Rankin served as Director -- Northern Region of Westec Security Inc. from 1989 to 1991, as Director -- Ohio Operations of Security Link Midwest Corporation from 1987 to 1989 and as Director -- Major Systems Division of API Alarm Systems, Inc. from 1979 to 1987. George A. Weinstock was Executive Vice President of Monitoring from November 1993 until May 1996, and has been Executive Vice President of POI since June 1994 and Assistant Secretary since October 1994. He also served as a director of POI from November 1993 to May 1994. For the 10 years prior to November 1993, Mr. Weinstock served as President of American Home Security, Inc., which was acquired by the Company in November 1993. Robert M. Chefitz has been a director of POI since 1991 and was Assistant Secretary from 1991 until October 1994. Mr. Chefitz joined Patricof & Co. Ventures, Inc. in 1987, where he serves as a Vice President and General Partner to various venture capital partnerships it manages. Prior to 1987, Mr. Chefitz was a Senior Associate with Golder Thoma Cressey & Co., a leading private equity investment firm. Mr. Chefitz currently serves on the Board of Directors of Xpedite Systems, Inc., and is also a director of several private companies (including Casi-Rusco, Inc., R.E. Harrington, Inc. and TME, Inc.) and of the New York Venture Capital Forum. S-42 45 Dr. Ben Enis has been a director of POI since 1994. He has been a Professor of Marketing at the University of Southern California since 1982. Dr. Enis currently serves on the Board of Directors of Countywide Credit Industries, Inc. James Q. Wilson has been a director of POI since June 1996. Mr. Wilson has been a Professor of Management and Public Policy at the University of California at Los Angeles since 1985; prior to that time, he was a Professor of Government at Harvard University. Mr. Wilson is currently a director of the American Enterprise Institute, New England Electric System, the RAND Corporation and State Farm Mutual Life Insurance Company. EXECUTIVE COMPENSATION The following table summarizes the compensation for fiscal 1995 and 1994 of the Chief Executive Officer and the other executive officers of POI during those periods.
LONG-TERM COMPENSATION --------------- SECURITIES ANNUAL COMPENSATION UNDERLYING NAME AND ------------------------ OPTIONS GRANTED PRINCIPAL POSITION YEAR SALARY ($) BONUS ($) (#) - ----------------------------------------------- ---- ---------- --------- --------------- James M. Mackenzie, Jr. ....................... 1995 $ 267,347 $ 100,000(1) -- President and Chief Executive Officer 1994 264,995 65,000 18,000 John W. Hesse.................................. 1995 226,600 100,000(1) -- Executive Vice President, Chief Financial 1994 202,834 65,000 30,000 Officer and Secretary John E. Mack, III.............................. 1995 162,000 100,000(1) -- Vice President -- Business Development and 1994 144,881 65,000 36,000 Assistant Secretary Thomas K. Rankin............................... 1995 162,000 100,000(1) -- Vice President -- Branch Management and 1994 144,881 65,000 36,000 Assistant Secretary George A. Weinstock............................ 1995 157,500 25,000 -- Executive Vice President and Assistant 1994 136,750 50,000 12,000 Secretary
- --------------- (1) $20,000 of this amount was paid in the form of 2,500 shares of Common Stock. Value was calculated based upon the $8.00 per share closing price of the Common Stock as reported by the Nasdaq National Market on the date the award was made (November 15, 1995). Other compensation in the form of perquisites and other personal benefits has been omitted from the above table as the aggregate amount of such perquisites and other personal benefits constituted the lesser of $50,000 or 10% of the total annual salary and bonus of the named executive officer for such year. In November 1995, the Board of Directors granted (i) an option for 6,000 shares to Dr. Enis, (ii) options for 100,000 shares to each of Messrs. Mackenzie, Hesse, Mack and Rankin and (iii) options for an aggregate of 168,000 shares to approximately 35 other employees of the Company. Such grants were subject to approval by the stockholders of the Company, which approval was obtained on January 26, 1996. All of such options have a 10-year term, vest at a rate of 20% per year commencing in November 1996 and (except for the options granted to the Company's executive officers) are exercisable at a price of $8.00 per share. Each of the options granted to Messrs. Mackenzie, Hesse, Mack and Rankin is exercisable at a price of (i) $8.00 per share as to 70,000 shares, and (ii) $15.00 per share as to 30,000 shares. S-43 46 DESCRIPTION OF CONVERTIBLE NOTES The following description of the particular terms of the Convertible Notes offered hereby (referred to in the Prospectus as the "Offered Debt Securities") supplements, and to the extent inconsistent therewith replaces, the description of the general terms and provisions of Debt Securities set forth in the Prospectus, to which description reference is hereby made. The Convertible Notes will be issued under a supplemental indenture to the Subordinated Debt Indenture referred to in the Prospectus. Such Subordinated Debt Indenture, as so supplemented, is referred to in this Prospectus Supplement as the "Indenture." A copy of the form of the Indenture will be available from the Trustee upon request by a registered holder of Convertible Notes. The following summaries of certain provisions of the Convertible Notes and the Indenture do not purport to be complete and are subject to, and are qualified in their entirety by reference to, all of the provisions of the Convertible Notes and the Indenture, including the definitions therein of certain terms which are not otherwise defined in this Prospectus Supplement. Wherever particular provisions or defined terms of the Indenture (or the form of Convertible Note which is a part thereof) are referred to, such provisions or defined terms are incorporated herein by reference. GENERAL The Convertible Notes will represent unsecured general obligations of Monitoring (a direct wholly owned subsidiary of POI) subordinate in right of payment to certain other obligations of Monitoring as described under "-- Subordination of Notes" and convertible into Common Stock of POI as described under "-- Conversion of Notes." The Convertible Notes will be limited to $90,000,000 aggregate principal amount ($103,500,000 if the Underwriters' over-allotment option is exercised in full), will be issued only in denominations of $1,000 or any multiple thereof and will mature on September 15, 2003, unless earlier redeemed at the option of Monitoring or at the option of the holder upon a Fundamental Change (as defined below). The Indenture does not contain any financial covenants or restrictions on the payment of dividends, the incurrence of Senior Indebtedness (as defined below) or the issuance or repurchase of securities of Monitoring, except to the extent described under "-- Subordination of Notes." The Indenture contains no covenants or other provisions to afford protection to holders of Convertible Notes in the event of a highly leveraged transaction or a change in control of Monitoring or POI except to the extent described under "-- Redemption at Option of Holders." The Convertible Notes will bear interest at the annual rate set forth on the cover page hereof from September 20, 1996, payable semi-annually on March 15 and September 15, commencing on March 15, 1997, to holders of record at the close of business on the preceding March 1 and September 1, respectively, except (i) that the interest payable upon redemption (unless the date of redemption is an interest payment date) will be payable to the person to whom principal is payable and (ii) as set forth in the next succeeding sentence. In the case of any Convertible Note (or portion thereof) which is converted into Common Stock during the period from (but excluding) a record date to (but excluding) the next succeeding interest payment date, either (i) if such Convertible Note (or portion thereof) has been called for redemption on a redemption date which occurs during such period, or is to be redeemed in connection with a Fundamental Change on a Repurchase Date (as defined below) which occurs during such period, the Company shall not be required to pay interest on such next succeeding interest payment date in respect of any such Convertible Note (or portion thereof) or (ii) if otherwise, any Convertible Note (or portion thereof) submitted for conversion during such period shall be accompanied by funds equal to the interest payable on such next succeeding interest payment date on the principal amount so converted. See "-- Conversion of Notes." Interest may, at Monitoring's option, be paid either (i) by check mailed to the address of the person entitled thereto as it appears in the Convertible Note register or (ii) by transfer to an account maintained by such person located in the United States; provided, however, that payments to The Depository Trust Company, New York, New York (the "Debt Depositary") will be made by wire transfer of immediately available funds to the account of the Debt Depositary or its nominee. Interest will be computed on the basis of a 360-day year composed of twelve 30-day months. S-44 47 The Convertible Notes have been approved for listing on the New York Stock Exchange, subject to official notice of issuance, under the symbol "ALRM 03." BOOK ENTRY; DELIVERY AND FORM The Convertible Notes will be issued in fully registered form, without coupons, in denominations of $1,000 and any multiple thereof. The Convertible Notes will be evidenced by one or more global notes (each, a "Global Note") which will be deposited with, or on behalf of, the Debt Depository and registered in the name of Cede & Co. ("Cede") as the Debt Depositary's nominee. So long as Cede, as the nominee of the Debt Depositary, is the registered owner of a Global Note, Cede for all purposes will be considered the sole holder of such Global Note. Except as provided in the accompanying Prospectus under "Description of Debt Securities -- Global Securities," owners of beneficial interests in a Global Note will not be entitled to have certificates registered in their names, will not receive or be entitled to receive physical delivery of certificates in definitive form, and will not be considered the holders thereof. Neither Monitoring nor any Guarantor nor the Trustee (or any registrar, paying agent or conversion agent under the Indenture) will have any responsibility for the performance of the Debt Depositary or its participants or indirect participants of their respective obligations under the rules and procedures governing their operations. The Debt Depositary has advised Monitoring and POI that it will take any action permitted to be taken by a holder of Convertible Notes (including, without limitation, the presentation of Convertible Notes for exchange as described below) only at the direction of one or more participants to whose account with the Debt Depositary interests in a Global Note are credited, and only in respect of the principal amount of the Convertible Notes represented by a Global Note as to which such participant or participants has or have given such direction. The Debt Depositary has advised Monitoring and POI as follows: the Debt Depositary is a limited purpose trust company organized under the laws of the State of New York, a member of the Federal Reserve System, a "clearing corporation" within the meaning of the Uniform Commercial Code and a "clearing agency" registered pursuant to the provisions of Section 17A of the Exchange Act. The Debt Depositary was created to hold securities for its participants and to facilitate the clearance and settlement of securities transactions between participants through electronic book-entry changes to accounts of its participants, thereby eliminating the need for physical movement of certificates. Participants include securities brokers and dealers, banks, trust companies and clearing corporations and may include certain other organizations. Certain of such participants (or their representatives), together with other entities, own the Debt Depositary. Indirect access to the Debt Depositary's system is available to others such as banks, brokers, dealers and trust companies that clear through, or maintain a custodial relationship, with a participant, either directly or indirectly. A further description of the Debt Depositary's procedures with respect to a Global Note is set forth in the Prospectus under "Description of Debt Securities -- Global Securities." The Debt Depositary has confirmed to Monitoring, POI, the Underwriters and the Trustee that it intends to follow such procedures with respect to the Convertible Notes. CONVERSION OF NOTES The holders of Convertible Notes will be entitled at any time after 90 days following the latest date of original issuance thereof through the close of business on the final maturity date of the Convertible Notes, subject to prior redemption, to convert any Convertible Note or portion thereof (in denominations of $1,000 or multiples thereof) into Common Stock of POI, at the conversion price set forth on the cover page of this Prospectus Supplement, subject to adjustment as described below. Except as described below, no payment or other adjustment will be made on conversion of any Convertible Note for interest accrued thereon or for dividends on any Common Stock issued. If any Convertible Note not called for redemption is converted after a record date for the payment of interest and prior to the next succeeding interest payment date, such Convertible Note must be accompanied by funds equal to the interest payable on such succeeding interest payment date on the principal amount so converted. POI is not required to issue fractional shares of Common S-45 48 Stock upon conversion of Convertible Notes and, in lieu thereof, will pay a cash adjustment based upon the market price of the Common Stock on the last business day prior to the date of conversion. In the case of Convertible Notes called for redemption, conversion rights will expire at the close of business on the business day preceding the day fixed for redemption unless Monitoring defaults in payment of the redemption price. A Convertible Note in respect of which a holder is exercising its option to require redemption upon a Fundamental Change may be converted only if such holder withdraws its election to exercise its option in accordance with the terms of the Indenture. The initial conversion price of $17.95 per share of Common Stock is subject to adjustment under formulae set forth in the Indenture upon the occurrence of certain events, including: (i) the issuance of Common Stock as a dividend or distribution on Common Stock of POI; (ii) certain subdivisions and combinations of the Common Stock; (iii) the issuance to all holders of Common Stock of certain rights or warrants to purchase Common Stock; (iv) the distribution to all holders of Common Stock of capital stock of POI (other than Common Stock) or evidences of indebtedness of Monitoring, POI or any Subsidiary of POI or of assets (including securities, but excluding those rights, warrants, dividends and distributions referred to above or paid in cash); (v) distributions consisting of cash, excluding any quarterly cash dividend on the Common Stock to the extent that the aggregate cash dividend per share of Common Stock in any quarter does not exceed the greater of (x) the amount per share of Common Stock of the next preceding quarterly cash dividend on the Common Stock to the extent that such preceding quarterly dividend did not require an adjustment of the conversion price pursuant to this clause (v) (as adjusted to reflect subdivisions or combinations of the Common Stock), and (y) 3.75% of the average of the last reported sales price of the Common Stock during the ten consecutive trading days immediately prior to the date of declaration of such dividend, and excluding any dividend or distribution in connection with the liquidation, dissolution or winding up of POI. If an adjustment is required to be made as set forth in this clause (v) as a result of a distribution that is a quarterly dividend, such adjustment would be based upon the amount by which such distribution exceeds the amount of the quarterly cash dividend permitted to be excluded pursuant to this clause (v). If an adjustment is required to be made as set forth in this clause (v) as a result of a distribution that is not a quarterly dividend, such adjustment would be based upon the full amount of the distribution; (vi) payment in respect of a tender or exchange offer by POI, Monitoring or any Subsidiary of POI for the Common Stock to the extent that the cash and value of any other consideration included in such payment per share of Common Stock exceeds the Current Market Price (as defined in the Indenture) per share of Common Stock on the trading day next succeeding the last date on which tenders or exchanges may be made pursuant to such tender or exchange offer; (vii) payment in respect of a tender offer or exchange offer by a person other than POI, Monitoring or any Subsidiary of POI in which, as of the closing date of the offer, the Board of Directors of POI is not recommending rejection of the offer. The adjustment referred to in this clause (vii) above will only be made if the tender offer or exchange offer is for an amount which increases the offeror's ownership of Common Stock to more than 25% of the total shares of Common Stock outstanding, and if the cash and value of any other consideration included in such payment per share of Common Stock exceeds the Current Market Price per share of Common Stock on the business day next succeeding the last date on which tenders or exchanges may be made pursuant to such tender or exchange offer. The adjustment referred to in this clause (vii) will generally not be made, however, if, as of the closing of the offer, the offering documents with respect to such offer disclose a plan or an intention to cause POI to engage in a consolidation or merger of POI or a sale of all or substantially all of the assets of POI; and (viii) the issuance of Common Stock or securities convertible into, or exchangeable for, Common Stock at a price per share (or having a conversion or exchange price per share) that is less than the then S-46 49 Current Market Price of the Common Stock (but excluding, among other things, issuances: (a) pursuant to any bona fide plan for the benefit of employees, directors or consultants of POI, Monitoring or any Subsidiary of POI now or hereafter in effect; (b) to acquire all or any portion of a business in an arm's-length transaction between the Company and an unaffiliated third party including, if applicable, issuances upon exercise of options or warrants assumed in connection with such an acquisition; (c) in a bona fide public offering pursuant to a firm commitment underwriting or sales at the market pursuant to a continuous offering stock program; (d) pursuant to the exercise of warrants, rights (including, without limitation, earnout rights) or options, or upon the conversion of convertible securities, which are issued and outstanding on the date hereof, or which may be issued in the future at fair value and with an exercise price or conversion price at least equal to the Current Market Price of the Common Stock at the time of issuance of such warrant, right, option or convertible security; and (e) pursuant to a dividend reinvestment plan or other plan hereafter adopted for the reinvestment of dividends or interest provided that such Common Stock is issued at a price at least equal to 95% of the market price of the Common Stock at the time of such issuance). In the case of (i) any reclassification or change of the Common Stock or (ii) a consolidation, merger or combination involving POI or a sale or conveyance to another person of the property and assets of POI as an entirety or substantially as an entirety, in each case as a result of which holders of Common Stock shall be entitled to receive stock, other securities, other property or assets (including cash) with respect to or in exchange for such Common Stock, the holders of the Convertible Notes then outstanding will be entitled thereafter to convert such Convertible Notes into the kind and amount of shares of stock, other securities or other property or assets which they would have owned or been entitled to receive upon such reclassification, change, consolidation, merger, combination, sale or conveyance had such Convertible Notes been converted into Common Stock immediately prior to such reclassification, change, consolidation, merger, combination, sale or conveyance assuming that a holder of Convertible Notes would not have exercised any rights of election as to the stock, other securities or other property or assets receivable in connection therewith. In the event of a taxable distribution to holders of Common Stock or in certain other circumstances requiring conversion price adjustments, the holders of Convertible Notes may, in certain circumstances, be deemed to have received a distribution subject to United States income tax as a dividend; in certain other circumstances, the absence of such an adjustment may result in a taxable dividend to the holders of Common Stock. See "Certain Federal Income Tax Considerations." Monitoring and POI from time to time may to the extent permitted by law reduce the conversion price by any amount for any period of at least 20 days, in which case Monitoring shall give at least 15 days' notice of such reduction, if the Boards of Directors of Monitoring and POI have made a determination that such reduction would be in the best interests of the Company, which determination shall be conclusive. Monitoring and POI together may, at their option, make such reductions in the conversion price, in addition to those set forth above, as the Boards of Directors of Monitoring and POI deem advisable to avoid or diminish any income tax to holders of Common Stock resulting from any dividend or distribution of stock (or rights to acquire stock) or from any event treated as such for income tax purposes. See "Certain Federal Income Tax Considerations." No adjustment in the conversion price will be required unless such adjustment would require a change of at least 1% in the conversion price then in effect; provided that any adjustment that would otherwise by required to be made shall be carried forward and taken into account in any subsequent adjustment. Except as stated above, the conversion price will not be adjusted for the issuance of Common Stock or any securities convertible into or exchangeable for Common Stock or carrying the right to purchase any of the foregoing. OPTIONAL REDEMPTION BY MONITORING The Convertible Notes are not entitled to any sinking fund. The Convertible Notes are not redeemable at the option of Monitoring prior to September 19, 1999. At any time on or after such date, the Convertible Notes will be redeemable at Monitoring's option on at least 30 days' notice as a whole or, from time to time, in S-47 50 part at the following prices (expressed as percentages of the principal amount), together with accrued interest to, but excluding, the date fixed for redemption: If redeemed during the 12-month period beginning September 15:
YEAR REDEMPTION PRICE ------------------------------------------------------------- ---------------- 1999......................................................... 103.857% 2000......................................................... 102.893 2001......................................................... 101.929 2002......................................................... 100.964
and 100% at September 15, 2003; provided that any semi-annual payment of interest becoming due on the date fixed for redemption shall be payable to the holders of record on the relevant record date of the Convertible Notes being redeemed. Notwithstanding the foregoing, Monitoring may not redeem any Convertible Notes unless all accrued and unpaid interest has been paid on all outstanding Convertible Notes for all interest payment periods terminating on or prior to the last interest payment date before the date of redemption. If fewer than all the Convertible Notes are to be redeemed, the Trustee shall select the Convertible Notes to be redeemed in principal amounts of $1,000 or multiples thereof in compliance with the requirements, as certified to the Trustee by Monitoring, of the principal national securities exchange on which the Convertible Notes are listed, or if the Convertible Notes are not so listed, by lot or, in the Trustee's discretion, on a pro rata basis or by another method the Trustee considers fair and appropriate. If any Convertible Note is to be redeemed in part only, a new Convertible Note or Convertible Notes in principal amount equal to the unredeemed principal portion thereof will be issued. If a portion of a holder's Convertible Notes is selected for partial redemption and such holder converts a portion of such Convertible Notes, such converted portion shall be deemed to be taken from the portion selected for redemption. The Credit Agreement (as defined herein) contains a provision prohibiting the optional redemption of the Convertible Notes. REDEMPTION AT OPTION OF HOLDERS If, at any time prior to September 15, 2003, there occurs a Fundamental Change (as defined below), each holder of Convertible Notes shall have the right, at the holder's option, to require Monitoring to redeem all of such holder's Convertible Notes or portions thereof (in denominations of $1,000 or multiples thereof) on the date (the "Repurchase Date") that is 30 days after the date of Monitoring's notice of such Fundamental Change referred to below. Monitoring shall redeem such Convertible Notes at a price (expressed as a percentage of the principal amount) equal to (i) 106.750% if the Repurchase Date is during the 12-month period beginning September 15, 1996, (ii) 105.786% if the Repurchase Date is during the 12-month period beginning September 15, 1997, (iii) 104.821% if the Repurchase Date is during the 12-month period beginning September 15, 1998 and (iv) thereafter at the redemption price set forth under "Optional Redemption by Monitoring" which would be applicable to a redemption at the option of Monitoring on the Repurchase Date; provided that, if the Applicable Price (as defined below) is less than the Reference Market Price (as defined below), Monitoring shall redeem such Convertible Notes at a price equal to the foregoing redemption price multiplied by the fraction obtained by dividing the Applicable Price by the Reference Market Price. In each case, Monitoring shall also pay accrued interest on the redeemed Convertible Notes to, but excluding, the Repurchase Date; provided that, if such Repurchase Date is an interest payment date, then the interest payable on such date shall be paid to the holder of record of the Convertible Note on the relevant record date. On or before the 10th day after the occurrence of a Fundamental Change, Monitoring is required to notify by mail all holders of record of the Convertible Notes of the occurrence of such Fundamental Change and of the redemption right arising as a result thereof. Monitoring is also required to deliver a copy of such notice to the Trustee and to issue a press release announcing the occurrence of such Fundamental Change and of the redemption right arising as a result thereof. To exercise the redemption right, a holder of Convertible Notes must deliver, on or before the 30th day after the date of Monitoring's notice of a Fundamental Change S-48 51 (the "Fundamental Change Expiration Term"), written notice of the holder's exercise of such right, together with the Convertible Notes to be so redeemed, duly endorsed for transfer, to Monitoring (or an agent designated by Monitoring for such purpose) and the Trustee. Payment for Convertible Notes surrendered for redemption (and not withdrawn) prior to the Fundamental Change Expiration Time will be made promptly following the Repurchase Date. The term "Fundamental Change" means the occurrence of any transaction or event in connection with which all or substantially all of the Common Stock shall be exchanged for, converted into, acquired for or constitute the right to receive consideration (whether by means of an exchange offer, liquidation, tender offer, consolidation, merger, combination, reclassification, recapitalization or otherwise) which is not all or substantially all common stock which is (or, upon consummation of or immediately following such transaction or event, will be) listed on a United States national securities exchange or approved for quotation on the Nasdaq National Market or any similar United States system of automated dissemination of quotations of securities prices. The term "Applicable Price" means (i) in the event of a Fundamental Change in which the holders of Common Stock receive only cash, the amount of cash received by the holder of one share of Common Stock and (ii) in the event of any other Fundamental Change, the average of the last reported sale price for the Common Stock during the ten trading days prior to the record date for the determination of the holders of Common Stock entitled to receive cash, securities, property or other assets in connection with such Fundamental Change, or, if there is no such record date, the date upon which the holders of the Common Stock shall have the right to receive such cash, securities, property or other assets in connection with the Fundamental Change. The term "Reference Market Price" shall initially mean $9.67 (which is equal to 66 2/3% of the reported last sale price for the Common Stock on September 16, 1996, as reflected on the cover page of this Prospectus Supplement) and in the event of any adjustment to the conversion price described above pursuant to the provisions of the Indenture, the Reference Market Price shall also be adjusted so that the ratio of the Reference Market Price to the conversion price after giving effect to any such adjustment shall always be the same as the ratio of $9.67 to the conversion price specified on the cover page of this Prospectus Supplement (without regard to any adjustment thereto). The Company will comply with the provisions of Rule 13e-4 and other tender offer rules under the Exchange Act which may then be applicable in connection with the redemption rights of holders of the Convertible Notes in the event of a Fundamental Change. The redemption rights of the holders of Convertible Notes could discourage a potential acquiror of the Company. The Fundamental Change redemption feature, however, is not the result of management's knowledge of any specific effort to obtain control of the Company by means of a merger, tender offer, solicitation or otherwise, or part of a plan by management to adopt a series of anti-takeover provisions. The Company could, in the future, enter into certain transactions, including certain recapitalizations of the Company, that would not constitute a Fundamental Change, but that would substantially increase the amount of Senior Indebtedness outstanding at such time. Further, the payment of the Fundamental Change redemption price on the Convertible Notes is subordinated to the prior payment of Senior Indebtedness as described under "-- Subordination of Notes" below, and is prohibited by the Credit Agreement. There are no restrictions in the Indenture on the creation of additional Senior Indebtedness or other indebtedness. Under certain circumstances, the incurrence of additional indebtedness could have a material adverse effect on Monitoring's ability to service its indebtedness, including the Convertible Notes. If a Fundamental Change were to occur, there can be no assurance that Monitoring would have sufficient funds to pay the Fundamental Change redemption price for all Convertible Notes tendered by the holders thereof. A default by Monitoring on its obligations to pay the Fundamental Change redemption price would result in acceleration of the payment of other indebtedness of the Company at the time outstanding pursuant to cross-default provisions. SUBORDINATION OF NOTES The indebtedness evidenced by the Convertible Notes will be senior subordinated indebtedness of Monitoring. The payment of the Senior Subordinated Obligations (as defined herein) will, to the extent set forth in the Indenture, be subordinated in right of payment to the prior payment in full, in cash or cash equivalents, of all Senior Indebtedness, including, without limitation, Monitoring's obligations under the S-49 52 Revolving Credit Facility. It is intended that the Convertible Notes will rank pari passu with the Discount Notes. After giving effect to the offering of the Convertible Notes and the application of the proceeds thereof, as of June 30, 1996, Monitoring would have had $216.1 million of Indebtedness (as defined herein) outstanding, none of which would have been Senior Indebtedness. See "Capitalization." Monitoring is the borrower under the Revolving Credit Facility and its obligations thereunder are guaranteed by POI. In addition, POI's obligations are secured by a pledge of all of the capital stock of Monitoring and Monitoring's obligations are secured by a first priority lien on substantially all of its assets. All liabilities of the Subsidiaries of Monitoring will be effectively senior in right of payment to the Convertible Notes, except to the extent any such Subsidiary is a Guarantor. At the Closing Date, Monitoring will have no Subsidiary that is a Guarantor. As of June 30, 1996, Monitoring would not have had any indebtedness that would have ranked subordinate to the Convertible Notes. "Senior Subordinated Obligations" means all principal of, premium, if any, or interest on the Convertible Notes payable pursuant to the terms of the Convertible Notes or upon acceleration, including any amounts received upon the exercise of rights of rescission or other rights of action (including claims for damages) or otherwise, to the extent relating to the purchase price of the Convertible Notes or amounts corresponding to such principal, premium, if any, or interest on the Convertible Notes. Upon any payment or distribution of assets or securities of Monitoring of any kind or character, whether in cash, property or securities, in connection with any dissolution or winding up or total or partial liquidation or reorganization or Monitoring, whether voluntary or involuntary, or in bankruptcy, insolvency, receivership or other proceedings, all amounts due or to become due upon all Senior Indebtedness shall first be paid in full, in cash or cash equivalents, before the holders of Convertible Notes or the Trustee on their behalf shall be entitled to receive any payment by Monitoring on account of Senior Subordinated Obligations, or any payment to acquire any of the Convertible Notes for cash, property or securities, or any distribution with respect to the Convertible Notes of any cash, property or securities. Before any payment may be made by, or on behalf of, Monitoring on any Senior Subordinated Obligations in connection with any such dissolution, winding up, liquidation or reorganization, any payment or distribution of assets or securities of Monitoring of any kind or character, whether in cash, property or securities, to which the holders of Convertible Notes or the Trustee on their behalf would be entitled, but for the subordination provisions of the Indenture, shall be made by Monitoring or by any receiver, trustee in bankruptcy, liquidating trustee, agent or other similar Person making such payment or distribution or by the holders or the Trustee if received by them or it, directly to the holders of the Senior Indebtedness (pro rata to such holders on the basis of the respective amounts of Senior Indebtedness held by such holders) or their representatives or to any trustee or trustees under any indenture pursuant to which any such Senior Indebtedness may have been issued, as their respective interests appear, to the extent necessary to pay all such Senior Indebtedness in full, in cash or cash equivalents, after giving effect to any concurrent payment, distribution or provision therefor to or for the holders of such Senior Indebtedness. No direct or indirect payment by or on behalf of Monitoring of Senior Subordinated Obligations, whether pursuant to the terms of the Convertible Notes or upon acceleration or otherwise, shall be made if, at the time of such payment, there exists a default in the payment of all or any portion of the obligations on any Senior Indebtedness, and such default shall not have been cured or waived or the benefits of this provision waived by or on behalf of the holders of such Senior Indebtedness. In addition, during the continuance of any other event of default with respect to (i) the Credit Agreement pursuant to which the maturity thereof may be accelerated and (a) upon receipt by the Trustee of written notice from the Credit Agreement Agent (as defined herein) or (b) if such event of default under the Credit Agreement results from the acceleration of the Convertible Notes, from and after the date of such acceleration, no payment of Senior Subordinated Obligations may be made by or on behalf of Monitoring upon or in respect of the Convertible Notes for a period (a "Payment Blockage Period") commencing on the earlier of the date of receipt of such notice or the date of such acceleration and ending 179 days thereafter (unless such Payment Blockage Period shall be terminated by written notice to the Trustee from the Credit Agreement Agent or by repayment in full in cash or cash equivalents of such Senior Indebtedness or such event of default has been cured or waived) or (ii) any other Designated Senior Indebtedness (as defined herein) pursuant to which the maturity thereof may be accelerated, upon receipt by the Trustee of written notice from the trustee or other representative for the S-50 53 holders of such other Designated Senior Indebtedness (or the holders of at least a majority in principal amount of such other Designated Senior Indebtedness then outstanding), no payment of Senior Subordinated Obligations may be made by or on behalf of Monitoring upon or in respect of the Convertible Notes for a Payment Blockage Period commencing on the date of receipt of such notice and ending 119 days thereafter (unless, in each case, such Payment Blockage Period shall be terminated by written notice to the Trustee from such trustee of, or other representative for, such holders or by repayment in full in cash or cash equivalents of such Designated Senior Indebtedness or such event of default has been cured or waived). Not more than one Payment Blockage Period may be commenced with respect to the Convertible Notes during any period of 360 consecutive days; provided that, subject to the limitations set forth in the next sentence, the commencement of a Payment Blockage Period by the representatives for, or the holders of, Designated Senior Indebtedness, other than under the Credit Agreement or under clause (i)(b) of this paragraph, shall not bar the commencement of another Payment Blockage Period by the Credit Agreement Agent within such period of 360 consecutive days. Notwithstanding anything in the Indenture to the contrary, there must be 180 consecutive days in any 360-day period in which no Payment Blockage Period is in effect. No event of default that existed or was continuing (it being acknowledged that any subsequent action that would give rise to an event of default pursuant to any provision under which an event of default previously existed or was continuing shall constitute a new event of default for this purpose) on the date of the commencement of any Payment Blockage Period with respect to the Designated Senior Indebtedness initiating such Payment Blockage Period shall be, or shall be made, the basis for the commencement of a second Payment Blockage Period by the representative for, or the holders of, such Designated Senior Indebtedness, whether or not within a period of 360 consecutive days, unless such event of default shall have been cured or waived for a period of not less than 90 consecutive days. By reason of the subordination provisions described above, in the event of bankruptcy, liquidation, insolvency or similar events, creditors of Monitoring who are not holders of Senior Indebtedness may recover less, ratably, than holders of Senior Indebtedness and may recover more, ratably, than holders of the Convertible Notes. Under the terms of the Indenture, POI will not, and will not permit any Subsidiary Guarantor to, Incur any Indebtedness that is expressly made subordinate in right of payment to any Senior Indebtedness or Guarantor Senior Indebtedness (as defined herein), as the case may be, unless such Indebtedness, by its terms or by the terms of any agreement or instrument pursuant to which such Indebtedness is outstanding, is expressly made pari passu with, or subordinate in right of payment to, the Convertible Notes or the Note Guarantee, as the case may be, pursuant to provisions substantially similar to those contained in the Indenture. Under the terms of the Indenture, POI will not, and will not permit Monitoring or any Subsidiary Guarantor to, Incur any Indebtedness that is senior in right of payment to the Convertible Notes unless (i) in the case of such Indebtedness that is secured, there is no outstanding unsecured Senior Indebtedness or Guarantor Senior Indebtedness of Monitoring or any Guarantor, and (ii) in the case of such Indebtedness that is unsecured Senior Indebtedness or unsecured Guarantor Senior Indebtedness, there is no outstanding secured Indebtedness of Monitoring or any Guarantor, other than Capital Lease Obligations (as defined herein) outstanding at any time in an aggregate amount not to exceed $2.0 million. The limitation in the preceding paragraph will be of no further force and effect if (a) a supplemental indenture which eliminates the subordination provisions set forth in the Indenture, in form and substance satisfactory to the Trustee, shall have been executed and delivered to the Trustee, (b) the Trustee shall have received necessary consents with respect to all outstanding Senior Indebtedness and Guarantor Senior Indebtedness from the holders thereof approving such supplemental indenture, (c) the Trustee shall have received such Opinions of Counsel as the Trustee may reasonably request, and (d) immediately before and immediately after giving affect to such supplemental indenture, no Default or Event of Default shall have occurred and be continuing. "Senior Indebtedness" means the following obligations of Monitoring, whether outstanding on the date of the Indenture or thereafter Incurred (as defined herein): (i) all Indebtedness and all other monetary S-51 54 obligations (including expenses, fees and other monetary obligations) of Monitoring under the Credit Agreement and (ii) all other Indebtedness of Monitoring (other than the Convertible Notes and the Discount Notes), including principal and interest on such Indebtedness, if, in the case of this clause (ii), (A) in the event such Indebtedness is unsecured, a notice to the effect that such Indebtedness constitutes "Senior Indebtedness" under the Indenture is delivered by Monitoring to the Trustee, and (B) such Indebtedness, by its terms or by the terms of any agreement or instrument pursuant to which such Indebtedness is issued, does not expressly state that it is pari passu with, or subordinated in right of payment to, the Convertible Notes; provided that the term "Senior Indebtedness" shall not include (a) any Indebtedness of Monitoring that, when Incurred and without respect to any election under Section 1111(b) of the United States Bankruptcy Code, was without recourse to Monitoring, (b) any Indebtedness of Monitoring to POI or any Subsidiary of POI or to a joint venture in which Monitoring or any Affiliate has an interest, (c) any Indebtedness of Monitoring not permitted by the Indenture; provided, however, that this clause (c) shall not be applicable with respect to Indebtedness under clause (i) of this definition that consists of up to $200 million of principal outstanding at any time under the Credit Agreement, all interest accrued under the Credit Agreement on up to $200 million of principal and all other monetary obligations (other than principal and interest) under the Credit Agreement, (d) any repurchase, redemption or other obligation in respect of Redeemable Stock (as defined herein), (e) any Indebtedness of Monitoring to any employee, officer or director of Monitoring or any of its Affiliates, (f) any liability for federal, state, local or other taxes owed or owing by Monitoring, (g) Indebtedness under the Discount Note Indenture, which shall be pari passu with the Convertible Notes, and (h) any Trade Payables of Monitoring. Senior Indebtedness will also include interest accruing subsequent to events of bankruptcy of Monitoring and its Subsidiaries at the rate provided for in the document governing such Senior Indebtedness, whether or not such interest is an allowed claim enforceable against the debtor under the United States Bankruptcy Code or similar laws relating to insolvency. To the extent any payment of Senior Indebtedness (whether by or on behalf of Monitoring, as proceeds of security or enforcement of any right of setoff or otherwise) is declared to be fraudulent or preferential, set aside or required to be paid to any receiver, trustee in bankruptcy, liquidating trustee, agent or other similar Person under any bankruptcy, insolvency, receivership, fraudulent conveyance or similar law, then if such payment is recovered by, or paid over to, such receiver, trustee in bankruptcy, liquidating trustee, agent or other similar Person, the Senior Indebtedness or part thereof originally intended to be satisfied shall be deemed to be reinstated and outstanding as if such payment had not occurred. To the extent the obligation to repay any Senior Indebtedness is declared to be fraudulent, invalid or otherwise set aside under any bankruptcy, insolvency, receivership, fraudulent conveyance or similar law, then the obligations so declared fraudulent, invalid or otherwise set aside (and all other amounts that would come due with respect thereto had such obligation not been so affected) shall be deemed to be reinstated and outstanding as Senior Indebtedness for all purposes of the Indenture as if such declaration, invalidity or setting aside had not occurred. "Designated Senior Indebtedness" means (i) Indebtedness and all other monetary obligations (including expenses, fees and other monetary obligations) under the Credit Agreement and (ii) any other Indebtedness constituting Senior Indebtedness that, at any date of determination, has an aggregate principal amount of at least $25 million and is specifically designated by Monitoring in the instrument creating or evidencing such Senior Indebtedness as "Designated Senior Indebtedness." "Trade Payables" means, with respect to any Person, any accounts payable or any other indebtedness or monetary obligation to trade creditors created, assumed or Guaranteed by such Person or any of its Subsidiaries arising in the ordinary course of business in connection with the acquisition of goods or services. GUARANTEES Monitoring's obligations under the Convertible Notes are fully and unconditionally guaranteed on a senior subordinated basis by POI and, under certain circumstances, may be guaranteed in the future by certain Subsidiaries of Monitoring (so long as they remain Subsidiaries of Monitoring) (each, a "Subsidiary Guarantor"). Accordingly, each Note Guarantee is subordinated to the Guarantor Senior Indebtedness of the issuer of such Note Guarantee on the same basis as provided above with respect to the subordination of Senior Subordinated Obligations of Monitoring to Senior Indebtedness of Monitoring. POI has no material assets S-52 55 other than all the outstanding capital stock of Monitoring, which has been pledged to secure POI's Guarantee of the obligations of Monitoring under the Revolving Credit Facility. After giving effect to the offering of the Convertible Notes and the application of the proceeds thereof, as of June 30, 1996, POI would not have had any Indebtedness outstanding. The Indenture provides that if either Metrol Security Services, Inc. (a direct wholly owned subsidiary of Monitoring) or its subsidiary Sonitrol of Arizona, Inc. has not been merged into Monitoring by the 30th day after the Convertible Notes are issued, such Subsidiary will become a Guarantor on such 30th day. In addition, any new Subsidiary with assets in excess of $2 million shall become a Guarantor not later than 30 days after becoming a Subsidiary. "Guarantor Senior Indebtedness" means, with respect to each Guarantor, the following obligations of such Guarantor, whether outstanding on the date of the Indenture or thereafter Incurred: (i) all Indebtedness and all other monetary obligations (including expenses, fees and other monetary obligations) of such Guarantor under the Credit Agreement, including any Guarantee of Senior Indebtedness of Monitoring under the Credit Agreement and (ii) all other Indebtedness of such Guarantor (other than the Note Guarantee and the Guarantee by such Guarantor of the obligations of Monitoring under the Discount Notes), including principal and interest on such Indebtedness if, in the case of this clause (ii), (A) in the event such Indebtedness is unsecured, a notice to the effect that such Indebtedness constitutes "Guarantor Senior Indebtedness" under the Indenture is delivered by Monitoring or such Guarantor to the Trustee, and (B) such Indebtedness, by its terms or by the terms of any agreement or instrument pursuant to which such Indebtedness is issued, does not expressly state that it is pari passu with, or subordinated in right of payment to, the Note Guarantee; provided that the term "Guarantor Senior Indebtedness" shall not include (a) any Indebtedness of such Guarantor that, when Incurred and without respect to any election under Section 1111(b) of the United States Bankruptcy Code, was without recourse to such Guarantor, (b) any Indebtedness of such Guarantor to POI or any Subsidiary of POI or to a joint venture in which such Guarantor or any Affiliate has an interest (unless, in the case of such Indebtedness of a Subsidiary Guarantor to Monitoring, (1) such Indebtedness is evidenced by a note or other similar instrument that is pledged to secure Senior Indebtedness, and (2) such note evidences an obligation by such Subsidiary Guarantor to repay proceeds of such Senior Indebtedness which at the time of any enforcement of the Convertible Notes were loaned to such Subsidiary Guarantor), (c) any Indebtedness of such Guarantor not permitted by the Indenture; provided, however, that this clause (c) shall not be applicable with respect to Indebtedness under clause (i) of this definition that consists of up to $200 million of principal outstanding at any time under the Credit Agreement, all interest accrued under the Credit Agreement on up to $200 million of principal and all other monetary obligations (other than principal and interest) under the Credit Agreement, (d) any repurchase, redemption or other obligation in respect of Redeemable Stock, (e) any Indebtedness of such Guarantor to any employee, officer or director of such Guarantor or any of its Affiliates, (f) any liability for federal, state, local or other taxes owed or owing by such Guarantor, (g) Indebtedness of such Guarantor pursuant to its Guarantee of any Indebtedness under the Discount Note Indenture, which Indebtedness of such Guarantor shall be pari passu with the Note Guarantee of such Guarantor, and (h) any Trade Payables of such Guarantor. Guarantor Senior Indebtedness will also include interest accruing subsequent to events of bankruptcy of such Guarantor and its Subsidiaries at the rate provided for in the document governing such Guarantor Senior Indebtedness, whether or not such interest is an allowed claim enforceable against the debtor under the United States Bankruptcy Code or similar laws relating to insolvency. The Indenture provides that if all or substantially all of the assets of any Subsidiary Guarantor or all of the Capital Stock of any Subsidiary Guarantor is sold (including by issuance or otherwise) by Monitoring or any of its Subsidiaries in a transaction constituting an Asset Sale that does not otherwise violate the Indenture, then such Subsidiary Guarantor (in the event of a sale or other disposition of all of the Capital Stock of such Subsidiary Guarantor) or the corporation acquiring such assets (in the event of a sale or other disposition of all or substantially all of the assets of such Subsidiary Guarantor) shall be released and discharged of its obligations under the Note Guarantee. S-53 56 CERTAIN DEFINITIONS Set forth below is a summary of certain of the defined terms used in the Indenture. Reference is made to the Indenture for the full definition of all terms as well as any other capitalized term used herein for which no definition is provided. "Accounts" means alarm monitoring accounts or alarm service accounts of customers pursuant to which POI or any of its Subsidiaries provides alarm monitoring or other security services or sell, install or service security alarms or services ancillary thereto. "Affiliate" means, as applied to any Person, any other Person directly or indirectly controlling, controlled by, or under direct or indirect common control with, such Person. For purposes of this definition, "control" (including, with correlative meanings, the terms "controlling," "controlled by" and "under common control with"), as applied to any Person, means the possession, directly or indirectly, of the power to direct or cause the direction of the management and policies of such Person, whether through the ownership of voting securities, by contract or otherwise. "Asset Sale" means any sale, transfer or other disposition (including by way of merger, consolidation or lease-back transactions) in one transaction or a series of related transactions by POI or any of its Subsidiaries to any Person other than POI or any other Subsidiary of (i) all or any of the Capital Stock of any Subsidiary, (ii) all or substantially all of the property and assets of an operating unit or business of POI or any of its Subsidiaries or (iii) any other property and assets of POI or any of its Subsidiaries outside the ordinary course of business of POI or such Subsidiary; provided that sales or other dispositions of inventory, receivables and other current assets shall not be included within the meaning of "Asset Sale." "Board of Directors" means the Board of Directors of POI or the Board of Directors of Monitoring, as the case may be, or any committee of either such Board of Directors, as the case may be, duly authorized to act under the Indenture. "Capital Stock" means, with respect to any Person, any and all shares, interests, participations or other equivalents (however designated, whether voting or non-voting) in equity of such Person, whether now outstanding or issued after the date of the Indenture, including, without limitation, all Common Stock and Preferred Stock. "Capitalized Lease" means, as applied to any Person, any lease of any property (whether real, personal or mixed) of which the discounted present value of the rental obligations of such Person as lessee, in conformity with GAAP, is required to be capitalized on the balance sheet of such Person; and "Capitalized Lease Obligation" is defined to mean the rental obligations, as aforesaid, under such lease. "Credit Agreement" means the Amended and Restated Credit Agreement dated as of June 7, 1996, as amended, among Monitoring and Heller Financial, Inc., as agent and as lender, and certain other lenders, together with all other agreements, instruments and documents executed or delivered pursuant thereto or in connection therewith, in each case as such Credit Agreement, agreements, instruments or documents (or such agents or lenders) may be amended, supplemented, extended, renewed, replaced, substituted or otherwise modified from time to time, including, without limitation, replacement or substitution in its entirety with one or more agreements, agents or syndicates of financial institutions; provided, that with respect to any one or more loan agreements providing for the refinancing of Indebtedness under the Credit Agreement, such loan agreement or loan agreements shall be the Credit Agreement under the Indenture only if a notice to that effect has been delivered by Monitoring to the Trustee and there shall be at any time only one Credit Agreement Agent. "Credit Agreement Agent" means (i) if one loan agreement constitutes the Credit Agreement, the sole lender thereunder or the agent for the financial institutions from time to time party to such Credit Agreement and any successor or successors of such agent or (ii) if more than one loan agreement constitutes the Credit Agreement, the representative of the financial institutions from time to time parties to such agreements and any successor or successors of such representative, which representative shall have been identified in a written notice delivered by Monitoring to the Trustee. S-54 57 "Deferred Account Acquisition Price" means, in connection with (i) the purchase of Accounts, or (ii) the acquisition of all of the outstanding Capital Stock of a Person where the principal purpose of such acquisition is to acquire Accounts, that portion of the purchase price of such Accounts or Capital Stock that has been deferred to provide an offset for future purchase price adjustments. "Default" means any event that is, or after notice or passage of time or both would be, an Event of Default. "Discount Notes" means Monitoring's 13 5/8% Senior Subordinated Discount Notes due 2005. "Discount Note Indenture" means the Indenture dated as of May 17, 1995, as amended, between Monitoring, as issuer, POI, as guarantor, and State Street Bank and Trust Company, as successor trustee, relating to the Discount Notes. "GAAP" means generally accepted accounting principles in the United States of America as in effect as of the date of the Indenture, including, without limitation, those set forth in the opinions and pronouncements of the Accounting Principles Board of the American Institute of Certified Public Accountants and statements and pronouncements of the Financial Accounting Standards Board or in such other statements by such other entity as approved by a significant segment of the accounting profession. All ratios and computations based on GAAP contained in the Indenture shall be computed in conformity with GAAP applied on a consistent basis. "Guarantee" means any obligation, contingent or otherwise, of any Person directly or indirectly guaranteeing any Indebtedness or other obligation of any other Person and, without limiting the generality of the foregoing, any obligation, direct or indirect, contingent or otherwise, of such Person (i) to purchase or pay (or advance or supply funds for the purchase or payment of) such Indebtedness or other obligation of such other Person (whether arising by virtue of partnership arrangements, or by agreement to keep-well, to purchase assets, goods, securities or services, to take-or-pay, or to maintain financial statement conditions or otherwise) or (ii) entered into for purposes of assuring in any other manner the obligee of such Indebtedness or other obligation of the payment thereof or to protect such obligee against loss in respect thereof (in whole or in part); provided that the term "Guarantee" shall not include endorsements for collection or deposit in the ordinary course of business. The term "Guarantee" used as a verb has a corresponding meaning. "Incur" means, with respect to any Indebtedness, to incur, create, issue, assume, Guarantee or otherwise become liable for or with respect to, or become responsible for, the payment of, contingently or otherwise, such Indebtedness, including an Incurrence of Indebtedness by reason of the acquisition of more than 50% of the Capital Stock of any Person; provided that none of the accrual of interest, the accrual of dividends payable on Redeemable Stock or the accretion of original issue discount shall be considered an Incurrence of Indebtedness. "Indebtedness" means, with respect to any Person at any date of determination (without duplication), (i) all indebtedness of such Person for borrowed money, (ii) all obligations of such Person evidenced by bonds, debentures, notes or other similar instruments (except, with respect to Monitoring, the promissory notes issued by Monitoring in favor of Ion Leasing (which obligations have been defeased by a cash deposit in a segregated trust account)), (iii) all obligations of such Person in respect of letters of credit or other similar instruments (including reimbursement obligations with respect thereto), (iv) all obligations of such Person to pay the deferred and unpaid purchase price of property or services, which purchase price is due more than six months after the date of placing such property in service or taking delivery and title thereto or the completion of such service, except (A) Trade Payables, (B) all obligations to pay any Deferred Account Acquisition Price, provided that the maximum amount excluded from the definition of "Indebtedness" under this clause (B) shall not exceed $5 million in the aggregate at any date of determination and (C) compensation payable to employees of such Person (or any subsidiary thereof) under employee benefit plans of such Person, which compensation is deferred in the ordinary course of business of such Person (or such subsidiary) and in accordance with such plans, (v) all Capitalized Lease Obligations of such Person, (vi) all Indebtedness of other Persons secured by a Lien on any asset of such Person, whether or not such Indebtedness is assumed by such Person; provided that the amount of such Indebtedness shall be the lesser of (A) the fair market value of such asset at such date of determination and (B) the amount of such Indebtedness, (vii) all Indebtedness of S-55 58 other Persons Guaranteed by such Person to the extent such Indebtedness is Guaranteed by such Person, (viii) all outstanding Redeemable Stock issued by such Person and (ix) to the extent not otherwise included in this definition, obligations under Currency Agreements and Interest Rate Agreements. The amount of Indebtedness of any Person at any date shall be the outstanding balance at such date of all unconditional obligations as described above and, with respect to contingent obligations (other than those described in clause (vii)), the maximum liability upon the occurrence of the contingency giving rise to the obligations (including with respect to any premium which may be payable on the redemption of Redeemable Stock), provided (i) that the amount outstanding at any time of any Indebtedness issued with original issue discount is the face amount of such Indebtedness less the remaining unamortized portion of the original issue discount of such Indebtedness at such time as determined in conformity with GAAP and (ii) that Indebtedness shall not include any liability for federal, state, local or other taxes that are not delinquent. "Person" means an individual, a corporation, a partnership, a limited liability company, an association, a trust or any other entity or organization, including a government or political subdivision or an agency or instrumentality thereof. "Redeemable Stock" means any class or series of Capital Stock of any Person that by its terms or otherwise is (i) required to be redeemed prior to the Stated Maturity of the Convertible Notes, (ii) redeemable at the option of the holder of such class of series of Capital Stock at any time prior to the Stated Maturity of the Convertible Notes or (iii) convertible into or exchangeable for Capital Stock referred to in clause (i) or (ii) above or Indebtedness having a scheduled maturity prior to the Stated Maturity of the Convertible Notes provided that any Capital Stock that would not constitute Redeemable Stock but for provisions thereof giving holders thereof the right to require such Person to repurchase or redeem such Capital Stock upon the occurrence of an "asset sale" or "change of control" occurring prior to the Stated Maturity of the Discount Notes shall not constitute Redeemable Stock if the "asset sale" or "change of control" provisions applicable to such Capital Stock are no more favorable to the holders of such Capital Stock than certain corresponding provisions contained in the Discount Note Indenture and such Capital Stock specifically provides that such Person will not repurchase or redeem any such stock pursuant to such provisions prior to Monitoring's repurchase of such Discount Notes as are required to be repurchased pursuant to such corresponding provisions of the Discount Note Indenture. "Stated Maturity" means, (i) with respect to any debt security, the date specified in such debt security as the fixed date on which the final installment of principal of such debt security is due and payable and (ii) with respect to any scheduled installment of principal of or interest on any debt security, the date specified in such debt security as the fixed date on which such installment is due and payable. "Subsidiary" means, with respect to any Person, any corporation, association or other business entity of which more than 50% of the outstanding Voting Stock is owned, directly or indirectly, by such Person and one or more other Subsidiaries of such Person. "Voting Stock" means with respect to any Person, Capital Stock of any class or kind ordinarily having the power to vote for the election of directors, managers or other voting members of the governing body of such Person. CERTAIN FEDERAL INCOME TAX CONSIDERATIONS The following is a general discussion of certain United States federal income tax considerations relevant to holders of the Convertible Notes. This discussion is based upon the Internal Revenue Code of 1986, as amended (the "Code"), Treasury Regulations, Internal Revenue Service ("IRS") rulings and judicial decisions now in effect, all of which are subject to change (possibly with retroactive effect) or different interpretations. This discussion does not purport to deal with all aspects of federal income taxation that may be relevant to a particular investor's decision to purchase the Convertible Notes, and it is not intended to be wholly applicable to all categories of investors, some of which, such as dealers in securities, banks, insurance companies, tax-exempt organizations and non-United States persons, may be subject to special rules. In addition, this discussion is limited to persons that will hold the Convertible Notes represented thereby as a S-56 59 "capital asset" within the meaning of Section 1221 of the Code. Further, this discussion does not address United States federal estate taxes that may be applicable to holders of the Convertible Notes. ALL PROSPECTIVE PURCHASERS OF THE CONVERTIBLE NOTES ARE ADVISED TO CONSULT THEIR OWN TAX ADVISORS REGARDING THE FEDERAL, STATE, LOCAL AND FOREIGN TAX CONSEQUENCES OF THE PURCHASE, OWNERSHIP AND DISPOSITION OF THE CONVERTIBLE NOTES AND THE COMMON STOCK. As used herein the term "United States Holder" means a holder of Convertible Notes or Common Stock that is for United States federal income tax purposes (i) a citizen or resident of the United States, (ii) a corporation, partnership or other entity created or organized in or under the laws of the United States or of any political subdivision thereof, or (iii) an estate or trust the income of which is subject to United States federal income taxation regardless of its source. As used herein, the term "Foreign Holder" means a holder of Convertible Notes or Common Stock that is, for United States federal income tax purposes, (i) a nonresident alien individual, (ii) a foreign corporation, (iii) a nonresident alien fiduciary of a foreign estate or trust or (iv) a foreign partnership one or more of the members of which is, for United States federal income tax purposes, a nonresident alien individual, a foreign corporation or a nonresident alien fiduciary of a foreign estate or trust. TAX CONSEQUENCES TO U.S. HOLDERS STATED INTEREST A United States Holder of a Convertible Note will be required to include interest on a Convertible Note in gross income for Federal income tax purposes in accordance with the holder's method of tax accounting. CONVERSION OF CONVERTIBLE NOTES INTO COMMON STOCK Under the position of the Internal Revenue Service, a United States Holder of a Convertible Note will recognize gain or loss on conversion of the Convertible Note into Common Stock of POI, although the issue is not free from doubt. In such case, the United States Holder will recognize gain or loss in the same manner as described in "Sale, Exchange or Redemption of a Convertible Note or Common Stock" below. The holding period of the Common Stock received on conversion of a Convertible Note generally will not include the period during which the Convertible Note was held, and the United States Holder's aggregate tax basis in the Common Stock received upon the conversion generally will be equal to the amount of cash and the fair market value of the Common Stock used in computing gain or loss on the conversion. ADJUSTMENTS TO CONVERSION PRICE The conversion price of the Convertible Notes is subject to adjustment under certain circumstances. Section 305 of the Code and the Treasury Regulations issued thereunder may treat the holders of the Convertible Notes as having received a constructive distribution, resulting in ordinary income (subject to a possible dividends-received deduction in the case of corporate holders) to the extent of the Company's current and/or accumulated earnings and profits, if, and to the extent that certain adjustments in the conversion price that may occur in limited circumstances (particularly an adjustment to reflect a taxable dividend to holders of Common Stock) increase the proportionate interest of a holder of Convertible Notes in the fully diluted Common Stock, whether or not such holder ever exercises its conversion privilege. Moreover, if there is not a full adjustment to the conversion ratio of the Convertible Notes to reflect a stock dividend or other event increasing the proportionate interest of the holders of outstanding Common Stock in the assets or earnings and profits of POI, then such increase in the proportionate interest of the holders of the Common Stock generally will be treated as a distribution to such holders, taxable as ordinary income (subject to a possible dividends-received deduction in the case of corporate holders) to the extent of POI's current and/or accumulated earnings and profits. S-57 60 DISTRIBUTIONS ON COMMON STOCK A distribution on a share of Common Stock will be taxable as ordinary dividend income to the extent it is paid from current or accumulated earnings and profits of POI. To the extent a distribution is not paid out of POI's earnings and profits, it is a tax-free return of the United States Holder's basis in the share of Common Stock to the extent thereof, and any excess is treated as gain from the sale or exchange of the share of Common Stock. SALE, EXCHANGE OR REDEMPTION OF A CONVERTIBLE NOTE OR COMMON STOCK Upon a taxable sale, exchange or redemption of a Convertible Note or upon a taxable sale or exchange of Common Stock into which a Convertible Note is converted, a United States Holder generally will recognize gain or loss equal to the difference between (i) the amount of cash plus the fair market value of any property received (other than any amount received attributable to accrued interest on a Convertible Note that was not previously included in gross income, which amount will be treated as interest income) and (ii) the holder's adjusted tax basis in the Convertible Note or Common Stock. Provided on the date of sale, exchange or redemption the Convertible Note or Common Stock is a capital asset in the hands of the United States Holder and has been held for more than one year, any gain or loss recognized by the holder generally will be long-term capital gain or loss. BACKUP WITHHOLDING A United States Holder of Convertible Notes or Common Stock may be subject to "backup withholding" at a rate of 31% with respect to certain "reportable payments", including interest payments, dividend payments and, under certain circumstances, principal payments on the Convertible Notes. These backup withholding rules apply if the holder, among other things, (i) fails to furnish a social security number or other taxpayer identification number ("TIN") certified under penalties of perjury within a reasonable time after the request therefor, (ii) furnishes an incorrect TIN, (iii) fails to report properly interests or dividends, or (iv) under certain circumstances, fails to provide a certified statement signed under penalties of perjury, that the TIN furnished is the correct number and that such holder is not subject to backup withholding. A United States Holder who does not provide the Company with its correct TIN also may be subject to penalties imposed by the IRS. Any amount withheld from a payment to a holder under the backup withholding rules is creditable against the holder's federal income tax liability, provided the required information is furnished to the IRS. Backup withholding will not apply, however, with respect to payments made to certain holders, including corporations, tax exempt organizations and certain foreign persons, provided their exemption from backup withholding is properly established. The Company will report to the holders of Notes and Common Stock and to the IRS the amount of any "reportable payments" for each calendar year and the amount of tax withheld, if any, with respect to such payments. TAX CONSEQUENCES TO FOREIGN HOLDERS Payments of principal and interest on the Convertible Notes to a Foreign Holder will not be subject to United States Federal withholding tax provided that (a) the holder does not actually or constructively own 10% or more of the total combined voting power of all classes of stock of Monitoring entitled to vote, (b) the holder is not a controlled foreign corporation that is related to Monitoring through stock ownership and (c) either (1) the beneficial owner of the Convertible Note, under penalties of perjury, provides the Company or its agent with its name and address and certifies that it is not a United States person or (2) a securities clearing organization, bank, or other financial institution that holds customers' securities in the ordinary course of its trade or business (a "financial institution") certifies to the Company or its agent, under penalties of perjury, that such a statement has been received from the beneficial owner by it or another financial institution and furnishes to the Company or its agent a copy thereof. Income received by a Foreign Holder in the form of interest on Convertible Notes or dividends on Common Stock will be subject to a United States Federal withholding tax at a 30% rate upon the actual S-58 61 payment of the dividends or interest except as described above and except where an applicable tax treaty provides for the reduction or elimination of such withholding tax. However, a Foreign Holder generally will be taxed in the same manner as a United States corporation or resident with respect to such income if it is effectively connected with the conduct of a trade or business in the United States. Such effectively connected income received by a Foreign Holder which is a corporation may in certain circumstances be subject to an additional "branch profits tax" at a 30% rate or, if applicable, a lower treaty rate. To determine the applicability of a tax treaty providing for a lower rate of withholding, dividends paid to an address in a foreign country are presumed under current Treasury Regulations to be paid to a resident of that country. Treasury Regulations proposed in April 1996 would, if adopted in final form, require Foreign Holders to file a "withholding certificate" with the Company's withholding agent, or, under certain circumstances, a "qualified intermediary," to obtain the benefit of an applicable tax treaty providing for a lower rate of withholding tax. Such certificate would have to contain the name and address of the Foreign Holder and the basis for any reduced rate claimed. These withholding certificates would be required for payments made after December 31, 1997. Dividends paid to Foreign Holders that are subject to the withholding tax described above will generally be exempt from United States backup withholding tax and United States information reporting requirements, other than reporting of dividend payments for purposes of the withholding tax noted above. Backup withholding and information reporting generally will not apply to payments of interest if the certification described above is received, provided the payor does not have actual knowledge that the holder is a United States person. Payment of the proceeds of the sale of Convertible Notes or Common Stock to or through a United States office of a broker will be subject to information reporting and possible backup withholding at a rate of 31% unless the owner certifies its non-United States status under penalties of perjury or otherwise establishes an exemption. Payment of the proceeds of the sale of Convertible Notes or Common Stock to or through a foreign office of a broker generally will not be subject to backup withholding tax. However, in the case of the payment of proceeds from the disposition of Convertible Notes or Common Stock through a foreign office of a broker that is (i) a United States person, (ii) a "controlled foreign corporation" for United States Federal income tax purposes, or (iii) a foreign person 50% or more of whose gross income from all sources for a specified period is derived from activities that are effectively connected with the conduct of a United States trade or business, information reporting is required on the payment unless the broker has documentary evidence in its files that the owner is a non-United States person and the broker has no actual knowledge to the contrary. Any amounts withheld under the backup withholding rules from a payment to a Foreign Holder will be allowed as a refund or a credit against such Foreign Holder's United States Federal income tax, provided that the required information is furnished to the IRS. A Foreign Holder generally will not be subject to United States Federal income or withholding tax on gain realized on the sale or exchange of Convertible Notes or Common Stock unless (i) the holder is an individual who was present in the United States for 183 days or more during the taxable year and (a) such holder has a "tax home" in the United States or (b) the gain is attributable to an office or other fixed place of business maintained in the United States by such holder or (ii) the gain is effectively connected with the conduct of a trade or business of the holder in the United States. The foregoing discussion for Foreign Holders assumes that POI is not considered a "United States real property holding corporation" ("USRPHC") within the meaning of Section 897(c) of the Code. In general, if POI is determined to be a USRPHC then certain Foreign Holders may be subject to (i) United States federal income tax on the sale, exchange, retirement or other disposition of a Convertible Note (possibly including the conversion of a Convertible Note into Common Stock) and to withholding at a rate of 10% on such disposition and (ii) United States federal income tax (but not withholding tax) on the sale, exchange, or other disposition of the Common Stock received upon conversion of a Convertible Note. However, a Foreign Holder will not be subject to these special rates even if POI is determined to be a USRPHC provided that such Holder did not during a specified five-year period actually or constructively own more than 5% of the Common Stock of POI (including any Common Stock that may be received in exchange for a Convertible Note). POI does not believe it is a USRPHC. S-59 62 UNDERWRITERS Under the terms of and subject to the conditions set forth in the Underwriting Agreement between Monitoring and POI and Morgan Stanley & Co. Incorporated, Bear, Stearns & Co. Inc. and Montgomery Securities (the "Underwriters") dated September 16, 1996 (the "Underwriting Agreement"), each of the Underwriters named below has severally agreed to purchase, and Monitoring has agreed to sell to each of the Underwriters severally, the respective principal amounts of the Convertible Notes set forth after their names below at a purchase price of 97.0% of the principal amount thereof, plus accrued interest, if any, from September 20, 1996 to the date of payment and delivery:
UNDERWRITING PRINCIPAL AMOUNT ------------------------------------------------------------- ---------------- Morgan Stanley & Co. Incorporated............................ $ 63,000,000 Bear, Stearns & Co. Inc...................................... 13,500,000 Montgomery Securities........................................ 13,500,000 ------------ Total.............................................. $ 90,000,000 ============
The Underwriting Agreement provides that the obligations of the Underwriters to pay for and accept delivery of the Convertible Notes is subject to approval of certain legal matters by their counsel and to certain other conditions. Each Underwriter is obligated to take and pay for its allocation of the Convertible Notes offered hereby (other than those covered by the over-allotment described below) if any are taken. Monitoring has granted to the Underwriters an option, exercisable within 30 days of the date of this Prospectus Supplement, to purchase up to an additional $13,500,000 principal amount of Convertible Notes solely for the purpose of covering over-allotments, if any. To the extent such option is exercised, each Underwriter will become obligated, subject to certain conditions, to purchase approximately the same percentage of such additional shares as the number set forth next to such Underwriter's name in the preceding table bears to the total number of shares of Common Stock offered hereby. The Underwriters initially propose to offer the Convertible Notes to the public at the public offering price set forth on the cover page hereof, plus accrued interest, if any, from September 20, 1996, and to certain dealers at such price less a concession of 1.8% of the principal amount of the Convertible Notes. After the initial offering of the Convertible Notes, the public offering price and other selling terms may be changed. Monitoring, POI and the directors, executive officers and certain stockholders of POI have agreed with Morgan Stanley & Co. Incorporated that, for a period of 90 days after the date of this Prospectus Supplement, they will not offer, pledge, sell, contract to sell, sell any option or contract to purchase, purchase any option or contract to sell, grant any option, right or warrant to purchase, make any short sale, or otherwise transfer or dispose of, directly or indirectly, any shares of Common Stock or any securities convertible into or exercisable or exchangeable for Common Stock, or enter into any swap or similar agreement that transfers, in whole or in part, any of the economic consequences of ownership of the Common Stock or such other securities, without the prior written consent of Morgan Stanley & Co. Incorporated, subject to certain limited exceptions, including the exception set forth in the following sentence. POI may issue Common Stock having an aggregate market value at the time of issuance not exceeding $11,250,000 (the "Acquisition Stock") as compensation in connection with acquisitions by Monitoring of portfolios of subscriber accounts, subject to the condition that POI obtain and deliver to Morgan Stanley written agreements from each of the proposed recipients of such Acquisition Stock that such recipients collectively will not (i) for a period of 90 days after the date of this Prospectus Supplement make any sale or transfer in the nature provided in the preceding sentence of Acquisition Stock having an aggregate market value of $10,000,000 (determined at the time of the issuance of such Acquisition Stock), and (ii) for a period of 30 days after the date of the Prospectus Supplement make any sale or transfer in the nature provided in the preceding sentence of any Acquisition Stock. The Underwriting Agreement provides that Monitoring and POI will indemnify the Underwriters against certain liabilities, including liabilities under the Securities Act. The Convertible Notes have been approved for listing on the New York Stock Exchange, subject to official notice of issuance, under the symbol "ALRM 03." The Underwriters have advised Monitoring that S-60 63 they presently intend to make a market in the Convertible Notes as permitted by applicable laws and regulations. The Underwriters are not obligated, however, to make a market in the Convertible Notes and any such market making may be discontinued at any time at the sole discretion of the Underwriters. Accordingly, no assurance can be given as to the liquidity of, or trading markets for, the Convertible Notes. The Underwriters have engaged in transactions with and performed various investment banking and other services for the Company in the past, and may do so from time to time in the future. LEGAL OPINIONS The validity of the Convertible Notes being offered hereby and the Common Stock issuable upon conversion of the Convertible Notes will be passed upon for the Company by Mitchell, Silberberg & Knupp LLP, Los Angeles, California. The validity of the Convertible Notes being offered hereby will be passed upon for the Underwriters by Shearman & Sterling, San Francisco, California. S-61 64 (THIS PAGE INTENTIONALLY LEFT BLANK) 65 PROSPECTUS $150,000,000 PROTECTION ONE ALARM MONITORING, INC. DEBT SECURITIES PROTECTION ONE, INC. GUARANTOR Protection One Alarm Monitoring, Inc., a Delaware corporation ("Monitoring"), may from time to time offer its unsecured debt securities ("Debt Securities"), consisting of debentures, notes or other unsecured evidences of indebtedness, including indebtedness convertible into shares of Common Stock, par value $.01 per share ("Common Stock"), of Protection One, Inc., a Delaware corporation ("POI") and Monitoring's direct parent, and indebtedness guaranteed by POI, in each case separately or as units and in any combination. The Debt Securities will have an aggregate initial offering price not to exceed $150,000,000 and will be offered on terms determined at the time of offering. Monitoring may offer and issue from time to time Debt Securities in one or more series. Debt Securities may be issuable in registered form without coupons or in bearer form with or without coupons attached. Monitoring will offer Debt Securities to the public on terms determined by market conditions. Debt Securities may be sold for U.S. dollars, foreign denominated currency or currency units; principal of and any interest on Debt Securities may likewise be payable in U.S. dollars, foreign denominated currency or currency units -- in each case, as Monitoring specifically designates. Specific terms of the Debt Securities and Common Stock (collectively, the "Securities") in respect of which this Prospectus is being delivered will be set forth in an accompanying Prospectus Supplement ("Prospectus Supplement"), together with the terms of the offering of the offered Securities and the initial price and net proceeds to POI and its consolidated subsidiaries (collectively the "Company") from the sale thereof. The Prospectus Supplement will set forth with regard to the particular offered Securities, without limitation, the following: (i) in the case of Debt Securities, the specific designation, aggregate principal amount, ranking as senior or subordinated debt, authorized denomination, maturity, rate or rates of interest (or method of calculation thereof) and dates for payment thereof, any exchangeability, conversion, redemption, prepayment or sinking fund provisions, and any listing on a national securities exchange or designation for trading on any automated quotation system; and (ii) in the case of Common Stock, the number of shares of Common Stock and the terms of the offering and sale thereof and any listing on a national securities exchange or designation for trading on any automated quotation system. The accompanying Prospectus Supplement will also contain information, where applicable, about certain federal income tax considerations relating to the Securities covered by the Prospectus Supplement. In addition, the accompanying Prospectus Supplement will set forth the name of and compensation to each dealer, underwriter or agent (if any) involved in the sale of the Securities being offered and the managing underwriters with respect to any Securities sold to or through underwriters. SEE "RISK FACTORS" ON PAGE 4 OF THIS PROSPECTUS FOR INFORMATION THAT SHOULD BE CONSIDERED BY PROSPECTIVE PURCHASERS OF THE SECURITIES OFFERED HEREBY. ------------------------ THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. ------------------------ Prior to issuance there will have been no market for the Debt Securities, and there can be no assurance that a secondary market for the Debt Securities will develop. This Prospectus may not be used to consummate sales of Securities unless accompanied by a Prospectus Supplement. Securities may be offered through dealers, underwriters or agents designated from time to time, as set forth in the accompanying Prospectus Supplement. Net proceeds to the Company will be the purchase price in the case of sales to a dealer, the public offering price less discount in the case of sales to an underwriter or the purchase price less commission in the case of sales through an agent -- in each case, less other expenses attributable to issuance and distribution. See "Plan of Distribution" for possible indemnification arrangements for dealers, underwriters and agents. ------------------------ THE DATE OF THIS PROSPECTUS IS AUGUST 29, 1996. 66 NO DEALER, SALESMAN OR ANY OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED OR INCORPORATED BY REFERENCE IN THIS PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY OR ANY UNDERWRITER, DEALER OR AGENT. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY SECURITIES BY ANYONE IN ANY JURISDICTION IN WHICH SUCH OFFER OR SOLICITATION IS NOT AUTHORIZED OR IN WHICH THE PERSON MAKING SUCH OFFER OR SOLICITATION IS NOT QUALIFIED TO DO SO OR TO ANY PERSON TO WHOM IT IS UNLAWFUL TO MAKE SUCH OFFER OR SOLICITATION. ------------------------ AVAILABLE INFORMATION The Company has filed with the Securities and Exchange Commission (the "Commission") a registration statement on Form S-3 (together with all amendments and exhibits thereto, the "Registration Statement") under the Securities Act of 1933, as amended (the "Securities Act"), with respect to the Securities. This Prospectus, which constitutes part of the Registration Statement, does not contain all of the information set forth in the Registration Statement, certain portions of which have been omitted in accordance with the Rules and Regulations of the Commission. Statements contained in this Prospectus as to the contents of any contract or other document are not necessarily complete, and in each instance, reference is made to the copy of such contract or document filed as an exhibit to the Registration Statement, each such statement being qualified in all respects by such reference. For further information with respect to the Company, reference is made to the Registration Statement. The Company is subject to the informational requirements of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and in accordance therewith files reports, proxy statements and other information with the Commission. Such reports, proxy statements and other information can be inspected and copied at the offices of the Commission at Room 1024, Judiciary Plaza, 450 Fifth Street, N.W., Washington D.C. 20549, as well as at the following regional offices of the Commission: Citicorp Center, 500 West Madison Street, Suite 1400, Chicago, Illinois 60661; and 7 World Trade Center, Suite 1300, New York, New York 10048. Copies of such material can be obtained from the Public Reference Section of the Commission at 450 Fifth Street, N.W., Washington, D.C. 20549 at prescribed rates. Such reports, proxy statements and other information concerning the Company may be inspected at the office of the National Association of Securities Dealers, Inc., 1735 K Street, N.W., Washington, D.C. 20006. In addition, the Commission maintains a World Wide Web site on the Internet at http://www.sec.gov that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. 2 67 INCORPORATION OF CERTAIN DOCUMENTS BY REFERENCE The following documents have been filed with the Commission and are incorporated herein by reference: (a) The Annual Report on Form 10-K of POI, Monitoring and Protection One Alarm Services, Inc. ("Services") for the fiscal year ended September 30, 1995, as amended; (b) The Quarterly Reports on Form 10-Q of POI, Monitoring and Services for the quarters ended December 31, 1995, March 31, 1996 and June 30, 1996; (c) The Current Reports on Form 8-K of POI and Monitoring reporting events dated December 18, 1995, May 23, 1996 and June 7, 1996, as amended; and (d) The description of the Common Stock contained in POI's Registration Statement on Form 8-A dated September 8, 1994. All documents filed by the Company pursuant to Section 13(a), 13(c), 14 or 15(d) of the Exchange Act after the initial filing with the Commission of the Registration Statement of which this Prospectus is a part and prior to the termination of the offering of the Securities shall be deemed to be incorporated by reference in this Prospectus and to be a part hereof from the date of filing such documents. Any statement contained in a document incorporated or deemed to be incorporated by reference herein shall be deemed to be modified or superseded for purposes of this Prospectus to the extent that a statement contained herein or in any other subsequently filed document which also is or is deemed to be incorporated by reference herein modifies or supersedes such statement. Any statement so modified or superseded shall not be deemed, except as so modified or superseded, to constitute a part of this Prospectus. Subject to the foregoing, all information appearing in this Prospectus is qualified in its entirety by the information appearing in the documents incorporated by reference. The Company will provide without charge to each person to whom this Prospectus is delivered, upon the request of such person, a copy of any or all documents incorporated herein by reference, other than exhibits to such documents (unless such exhibits are specifically incorporated by reference into such documents). Requests for such documents should be directed to Montgomery W. Cornell, Director of Investor Relations, Protection One, Inc., 3900 S.W. Murray Blvd., Beaverton, Oregon 97005. --------------------- "Protection One" is a registered trademark of the Company. All rights are fully reserved. This Prospectus also contains other trademarks of the Company and refers to trademarks of other companies. --------------------- IN CONNECTION WITH THE OFFERING OF CERTAIN SECURITIES, THE UNDERWRITERS MAY OVER-ALLOT OR EFFECT TRANSACTIONS WHICH STABILIZE OR MAINTAIN THE MARKET PRICES OF SUCH SECURITIES, OTHER SECURITIES OF THE COMPANY OR ANY SECURITIES THE PRICES OF WHICH MAY BE USED TO DETERMINE PAYMENTS OF SUCH SECURITIES AT LEVELS ABOVE THOSE WHICH MIGHT OTHERWISE PREVAIL IN THE OPEN MARKET. SUCH TRANSACTIONS MAY BE EFFECTED ON THE NEW YORK STOCK EXCHANGE, IN THE OVER-THE-COUNTER MARKET OR OTHERWISE. SUCH STABILIZING, IF COMMENCED, MAY BE DISCONTINUED AT ANY TIME. 3 68 THE COMPANY The Company provides security alarm monitoring services for residential and small business subscribers. The Company monitors digital signals arising from burglaries, fires and other events through security systems installed at subscribers' premises. Most of these signals are received and processed at the Company's central monitoring station located in Portland, Oregon. The Company also sells enhanced security services, patrol and alarm response services and alarm systems and provides local field repair services through 11 branch offices. Enhanced security services provided by the Company include two-way voice communication, supervised monitoring services, pager service, wireless backup service and extended service protection. Protection One, Inc. ("POI") and Protection One Alarm Monitoring, Inc. ("Monitoring") were incorporated under the laws of the State of Delaware in September 1991. The Company's executive offices are located at 6011 Bristol Parkway, Culver City, California 90230 and its telephone number is (310) 338-6930. Unless the context otherwise requires, the term "Company" means POI and its consolidated subsidiaries. RISK FACTORS Prior to making an investment decision with respect to the Securities offered hereby, prospective investors should carefully consider the specific factors set forth under the caption "Risk Factors" in the applicable Prospectus Supplement pertaining thereto, together with all of the other information appearing herein or therein, in light of their particular investment objectives and financial circumstances. USE OF PROCEEDS Unless otherwise set forth in the accompanying Prospectus Supplement, the net proceeds from the sale of the Debt Securities will be used to repay indebtedness outstanding under the Company's revolving credit facility (the "Revolving Credit Facility"). All borrowings under the Revolving Credit Facility are due in full on January 3, 2000. The interest rate on borrowings under the Revolving Credit Facility is, at the option of Monitoring, either (a) 1.0% plus the higher of (i) the Bank Prime Loan Rate announced by the Board of Governors of the Federal Reserve System or (ii) the Federal Funds Effective Rate, or (b) LIBOR plus 2.5%. Monitoring used substantially all of the currently outstanding borrowings under the Revolving Credit Facility to purchase subscriber accounts, and intends to use future borrowings under the Revolving Credit Facility to add subscriber accounts, to fund potential joint ventures, co-marketing arrangements and other strategic alliances and for working capital and general corporate purposes. RATIO OF EARNINGS TO FIXED CHARGES The Company's earnings were insufficient to cover fixed charges by approximately $4.0 million, $2.5 million, $9.3 million, $9.4 million, $3.7 million and $7.2 million for the years ended September 30, 1992, 1993, 1994 and 1995, and the six months ended March 31, 1995 and 1996, respectively. For the purpose of calculating the ratio of earnings to fixed charges, earnings consist of income before income taxes plus fixed charges. Fixed charges consist of interest expense, amortization of debt issuance costs and original issue discount, and the component of rental expense believed by management to be representative of the interest factor thereon. DESCRIPTION OF DEBT SECURITIES The Debt Securities will constitute either senior or subordinated debt of Monitoring and will be issued, in the case of Debt Securities that will be senior debt securities ("Senior Debt Securities"), under an Indenture (as it may be supplemented from time to time, the "Senior Debt Indenture") to be entered into between Monitoring and the party to be named as trustee in a Prospectus Supplement, as trustee under the Senior Indenture (the "Senior Trustee"). In the case of Debt Securities that will be subordinated debt securities ("Subordinated Debt Securities"), the Debt Securities will be issued under an Indenture (as it may be supplemented from time to time, the "Subordinated Debt Indenture") between Monitoring and State Street 4 69 Bank and Trust Company, as trustee (the "Subordinated Trustee"). The Senior Debt Indenture and Subordinated Debt Indenture are sometimes hereinafter referred to individually as an "Indenture" and collectively as the "Indentures." The Debt Securities offered by this Prospectus and the accompanying Prospectus Supplement are referred to herein as the "Offered Debt Securities." The Senior Trustee and the Subordinated Trustee, respectively, are hereinafter referred to individually as a "Trustee" and collectively as the "Trustees." The forms of the Senior Debt Indenture and the Subordinated Debt Indenture are filed as exhibits to the registration statement of which this Prospectus is a part. See "Available Information." The particular terms of each series of Debt Securities, as well as any modifications or additions to the general terms of the Indenture which may applicable in the case of such Debt Securities, will be described in the Prospectus Supplement relating to such Debt Securities. Accordingly, for a description of the terms of a particular issue of Debt Securities reference must be made to the Prospectus Supplement relating thereto and to the following description. The following summaries of certain provisions of the Indentures and the Debt Securities do not purport to be complete and such summaries are subject to the detailed provisions of the applicable Indenture to which reference is hereby made for a full description of such provisions, including the definition of certain terms used herein, and for other information regarding the Debt Securities. Numerical references in parentheses below are to sections in the applicable Indenture. Wherever particular sections or defined terms of the applicable Indenture are referred to, such sections or defined terms are incorporated herein by reference as part of the statement made, and the statement is qualified in its entirety by such reference. The Indentures are substantially identical, except for the provisions relating to subordination and Monitoring's negative pledge. See "Subordinated Debt" and "Certain Covenants." GENERAL Neither of the Indentures limits the amount of additional indebtedness that Monitoring or any of its subsidiaries may incur. The Debt Securities will be unsecured senior or subordinated obligations of Monitoring. Certain of the assets of Monitoring are owned by its subsidiaries. Therefore, Monitoring's rights and the rights of its creditors, including holders of Debt Securities, to participate in the assets of any subsidiary upon such subsidiary's liquidation or recapitalization will be subject to the prior claims of such subsidiary's creditors, except to the extent that Monitoring may itself be a creditor with recognized claims against the subsidiary. The Indentures provide that Debt Securities may be issued from time to time in one or more series and may be denominated and payable in foreign currencies or units based on or relating to foreign currencies, including European Currency Units. Special United States federal income tax considerations applicable to any Debt Securities so denominated are described in the relevant Prospectus Supplement. Reference is made to the Prospectus Supplement for the following terms of and information relating to the Offered Debt Securities (to the extent such terms are applicable to such Debt Securities): (i) classification as senior or subordinated Debt Securities, the specific designation, aggregate principal amount, purchase price and denomination; (ii) currency or units based on or relating to currencies in which such Debt Securities are denominated and/or in which principal (and premium, if any) and/or interest will or may be payable; (iii) any date of maturity; (iv) interest rate or rates (or the method by which such rate or rates will be determined), if any; (v) the dates on which any such interest will be payable; (vi) the place or places where the principal of, premium, if any, and interest, if any, on the Offered Debt Securities will be payable; (vii) any repayment, redemption, prepayment or sinking fund provisions; (viii) whether the Offered Debt Securities will be issuable in registered form or bearer form ("Bearer Securities") or both and, if Bearer Securities are issuable, any restrictions applicable to the exchange of one form for another and to the offer, sale and delivery of Bearer Securities; (ix) the terms, if any, on which such Debt Securities may be converted into or exchanged for stock or other securities of POI or other entities, any specific terms relating to the adjustment thereof and the period during which such Debt Securities may be so converted or exchanged; (x) any applicable United States federal income tax consequences, including whether and under what circumstances Monitoring will pay additional amounts on Offered Debt Securities held by a person who is not 5 70 a United States person (as defined herein) in respect of any tax, assessment or governmental charge withheld or deducted and, if so, whether Monitoring will have the option to redeem such Debt Securities rather than pay such additional amounts; and (xi) any other specific terms of the Offered Debt Securities, including any additional events of default or covenants provided for with respect to such Debt Securities, and any terms which may be required by or advisable under applicable laws or regulations. Debt Securities may be presented for exchange and registered Debt Securities may be presented for transfer in the manner, at the places and subject to the restrictions set forth in the Debt Securities and the Prospectus Supplement. Such services will be provided without charge, other than any tax or other governmental charge payable in connection therewith, but subject to the limitations provided in the applicable Indenture. Debt Securities in bearer form and the coupons, if any, appertaining thereto will be transferable by delivery. Debt Securities will bear interest at a fixed rate or a floating rate. Debt Securities bearing no interest or interest at a rate that at the time of issuance is below the prevailing market rate will be sold at a discount below their stated principal amount. Special United States federal income tax considerations applicable to any such discounted Debt Securities or to certain Debt Securities issued at par which are treated as having been issued at a discount for United States federal income tax purposes will be described in the relevant Prospectus Supplement. Debt Securities may be issued, from time to time, with the principal amount payable on any principal payment date, or the amount of interest payable on any interest payment date, to be determined by reference to one or more currency exchange rates, securities or baskets of securities, commodity prices or indices. Holders of such Debt Securities may receive a payment of principal on any principal payment date, or a payment of interest on any interest payment date, that is greater than or less than the amount of principal or interest otherwise payable on such dates, depending upon the value on such dates of the applicable currency, security or basket of securities, commodity or index. Information as to the methods for determining the amount of principal or interest payable on any date, the currencies, securities or baskets of securities, commodities or indices to which the amount payable on such date is linked and certain additional tax considerations will be set forth in the applicable Prospectus Supplement. GLOBAL SECURITIES The registered Debt Securities of a series may be issued in the form of one or more fully registered global Securities (a "Registered Global Security") that will be deposited with a depositary (a "Debt Depositary") or with a nominee for a Debt Depositary identified in the Prospectus Supplement relating to such series and registered in the name of such Debt Depositary or nominee thereof. In such case, one or more Registered Global Securities will be issued in a denomination or aggregate denominations equal to the portion of the aggregate principal amount of outstanding registered Debt Securities of the series to be represented by such Registered Global Securities. Unless and until it is exchanged in whole for Debt Securities in definitive registered form, a Registered Global Security may not be transferred except as a whole by the Debt Depositary for such Registered Global Security to a nominee of such Debt Depositary or by a nominee of such Debt Depositary to such Debt Depositary or another nominee of such Debt Depositary or by such Debt Depositary or any such nominee to a successor of such Debt Depositary or a nominee of such successor. The specific terms of the depositary arrangement with respect to any portion of a series of Debt Securities to be represented by a Registered Global Security will be described in the Prospectus Supplement relating to such series. Monitoring anticipates that the following provisions will apply to all depositary arrangements. Ownership of beneficial interests in a Registered Global Security will be limited to persons that have accounts with the Debt Depositary for such Registered Global Security ("participants") or persons that may hold interests through participants. Upon the issuance of a Registered Global Security, the Debt Depositary for such Registered Global Security will credit, on its book-entry registration and transfer system, the participants' accounts with the respective principal amounts of the Debt Securities represented by such Registered Global Security beneficially owned by such participants. The accounts to be credited will be designated by any dealers, underwriters or agents participating in the distribution of such Debt Securities. 6 71 Ownership of beneficial interests in such Registered Global Security will be shown on, and the transfer of such ownership interests will be effected only through, records maintained by the Debt Depositary for such Registered Global Security (with respect to interests of participants) and on the records of participants (with respect to interests of persons holding through participants). The laws of some states may require that certain purchasers of securities take physical delivery of such securities in definitive form. Such limits and such laws may impair the ability to own, transfer or pledge beneficial interests in Registered Global Securities. So long as the Debt Depositary for a Registered Global Security, or its nominee, is the registered owner of such Registered Global Security, such Debt Depositary or such nominee, as the case may be, will be considered the sole owner or holder of the Debt Securities represented by such Registered Global Security for all purposes under the applicable Indenture. Except as set forth below, owners of beneficial interests in a Registered Global Security will not be entitled to have the Debt Securities represented by such Registered Global Security registered in their names, will not receive or be entitled to receive physical delivery of such Debt Securities in definitive form and will not be considered the owners or holders thereof under the applicable Indenture. Accordingly, each person owning a beneficial interest in a Registered Global Security must rely on the procedures of the Debt Depositary for such Registered Global Security and, if such person is not a participant, on the procedures of the participant through which such person owns its interest, to exercise any rights of a holder under the applicable Indenture. Monitoring understands that under existing industry practices, if it requests any action of holders or if an owner of a beneficial interest in a Registered Global Security desires to give or take any action which a holder is entitled to give or take under the applicable Indenture, the Debt Depositary for such Registered Global Security would authorize the participants holding the relevant beneficial interests to give or take such action, and such participants would authorize beneficial owners owning through such participants to give or take such action or would otherwise act upon the instructions of beneficial owners holding through them. Principal, premium, if any, and interest payments on Debt Securities represented by a Registered Global Security registered in the name of a Debt Depositary or its nominee will be made to such Debt Depositary or its nominee, as the case may be, as the registered owner of such Registered Global Security. None of Monitoring, the Trustees or any other agent of Monitoring or agent of the Trustees will have any responsibility or liability for any aspect of the records relating to or payments made on account of beneficial ownership interests in such Registered Global Security or for maintaining, supervising or reviewing any records relating to such beneficial ownership interests. Monitoring expects that the Debt Depositary for any Debt Securities represented by a Registered Global Security, upon receipt of any payment of principal, premium or interest in respect of such Registered Global Security, will immediately credit participants' accounts with payments in amounts proportionate to their respective beneficial interests in such Registered Global Security as shown on the records of such Debt Depositary. Monitoring also expects that payments by participants to owners of beneficial interests in such Registered Global Security held through such participants will be governed by standing customer instructions and customary practices, as is now the case with the securities held for the accounts of customers in bearer form or registered in "street name," and will be the responsibility of such participants. If the Debt Depositary for any Debt Securities represented by a Registered Global Security is at any time unwilling or unable to continue as Debt Depositary or ceases to be a clearing agency registered under the Exchange Act, and a successor Debt Depositary registered as a clearing agency under the Exchange Act is not appointed by Monitoring within 90 days, Monitoring will issue such Debt Securities in definitive form in exchange for such Registered Global Security. In addition, Monitoring may at any time and in its sole discretion determine not to have any of the Debt Securities of a series represented by one or more Registered Global Securities and, in such event, will issue Debt Securities of such series in definitive form in exchange for all of the Registered Global Security or Securities representing such Debt Securities. Any Debt Securities issued in definitive form in exchange for a Registered Global Security will be registered in such name or names as the Debt Depositary shall instruct the relevant Trustee. It is expected that such instructions will be based upon directions received by the Debt Depositary from participants with respect to ownership of beneficial interests in such Registered Global Security. 7 72 The Debt Securities of a series may also be issued in the form of one or more bearer global Securities (a "Bearer Global Security") that will be deposited with a common depositary for the Euroclear System currently operated by Morgan Guaranty Trust Company of New York, Brussels Office, or its successor as operator of the Euroclear System ("Euroclear") and Cedel Bank, societe anonyme or its successor ("Cedel"), or with a nominee for such depositary identified in the Prospectus Supplement relating to such series. The specific terms and procedures, including the specific terms of the depositary arrangement, with respect to any portion of a series of Debt Securities to be represented by a Bearer Global Security will be described in the Prospectus Supplement relating to such series. SENIOR DEBT The Debt Securities and, in the case of Bearer Securities, any coupons appertaining thereto (the "Coupons"), that will be Senior Debt Securities will be issued under the Senior Debt Indenture and will rank pari passu with all other unsecured and unsubordinated debt of Monitoring. SUBORDINATED DEBT Each Series of Debt Securities and Coupons that will be Subordinated Debt Securities will be issued under the Subordinated Debt Indenture and will be subordinate and junior in right of payment, to the extent and in the manner provided in an indenture supplemental to the Subordinated Debt Indenture and as described in the Prospectus Supplement relating to such series, to all "Senior Indebtedness" (as defined in such supplemental indenture and as described in such Prospectus Supplement) of Monitoring. If this Prospectus is being delivered in connection with a series of Subordinated Debt Securities, the accompanying Prospectus Supplement or the information incorporated herein by reference will set forth the approximate amount of Senior Indebtedness outstanding as of the end of the most recent fiscal quarter. GUARANTEES Monitoring's obligations under the Debt Securities will be fully and unconditionally guaranteed by POI and, under certain circumstances, by certain Subsidiaries (as defined in the Indentures) of POI that are Restricted Subsidiaries (as defined herein) (so long as they remain Subsidiaries of POI; each, a "Subsidiary Guarantor", and together with POI, the "Guarantors"). Each guarantee ("Note Guarantee") of Monitoring's obligations under Senior Debt Securities will constitute part of the senior debt of each of the Guarantors and will rank pari passu with all other unsecured and unsubordinated debt of each such Guarantor. Each Note Guarantee with respect to Subordinated Debt Securities will be subordinated to the "Guarantor Senior Indebtedness" (as defined in the supplemental indenture to the Subordinated Debt Indenture and described in the Prospectus Supplement applicable to the series of Subordinated Debt Securities to which such Note Guarantee relates) of the issuer of such Note Guarantee on the same basis as provided above with respect to the subordination of Subordinated Debt Securities to Senior Indebtedness of Monitoring. (Subordinated Debt Indenture, 14.01) POI has no material assets other than all the outstanding capital stock of Monitoring, which has been pledged to secure POI's guarantee of the obligations of Monitoring under the Revolving Credit Facility. As of June 30, 1996, POI did not have any Indebtedness outstanding. The Indentures provide that any new Subsidiary of Monitoring with assets in excess of $2.0 million that becomes a Restricted Subsidiary after the Indenture is executed shall become a Guarantor (i) not later than 30 days after becoming a Restricted Subsidiary if such Subsidiary is a Significant Subsidiary and (ii) not later than 180 days after such Subsidiary becomes a Restricted Subsidiary if such Restricted Subsidiary is not a Significant Subsidiary. (Senior Debt Indenture, Section 3.08; Subordinated Debt Indenture, Section 3.07) "Significant Subsidiary" means, at any date of determination, any Subsidiary of POI or Monitoring that, together with its Subsidiaries, (i) for the most recent fiscal year of POI, accounted (or, on a pro forma basis, would have accounted) for more than 10% of the consolidated revenues of POI and its Restricted Subsidiaries or (ii) as of the end of such fiscal year, was the owner (or, on a pro forma basis, would have been the owner) of more than 10% of the consolidated assets of POI and its Restricted Subsidiaries, all as set forth on the most recently available consolidated financial statements of POI for such fiscal year. (Indentures, Section 1.01) 8 73 The Indentures define "Restricted Subsidiary" to mean Monitoring and any Subsidiary of Monitoring that is not designated an "Unrestricted Subsidiary" by POI. "Unrestricted Subsidiary" is defined by the Indentures to mean (i) any Subsidiary of POI (other than Monitoring) that is not also a Subsidiary of Monitoring, (ii) any Subsidiary of Monitoring that at the time of determination shall be designated an Unrestricted Subsidiary by the Board of Directors of POI in the manner provided below and (iii) any Subsidiary of an Unrestricted Subsidiary. The Board of Directors of POI may designate any Subsidiary of Monitoring (including any newly acquired or newly formed Subsidiary of Monitoring) to be an Unrestricted Subsidiary unless such Subsidiary owns any capital stock of, or owns or holds any pledge, lien or other encumbrance on any property or assets of, POI or any Restricted Subsidiary; provided that either (A) the Subsidiary to be so designated has total assets of $1,000 or less or (B) if such Subsidiary has assets greater than $1,000, such designation would be permitted under the Indenture dated as of May 17, 1995 (the "Discount Notes Indenture") between Monitoring, POI, as Guarantor, and State Street Bank and Trust Company, as Trustee, as then in effect. If at the time in question the notes issued pursuant to the Discount Notes Indenture (the "Discount Notes") have been paid in full or the Discount Notes Indenture shall have been otherwise discharged, no Subsidiary with total assets of more than $1,000 may be designated an Unrestricted Subsidiary unless such Subsidiary could have been designated an Unrestricted Subsidiary under the Discount Notes Indenture as in effect at the time the Discount Notes were repaid in full or the Discount Notes Indenture was otherwise discharged. The Board of Directors of POI may designate any Unrestricted Subsidiary (other than a Subsidiary of POI that is not a Subsidiary of Monitoring) to be a Restricted Subsidiary; provided that immediately after giving effect to such designation no Default or Event of Default shall have occurred and be continuing. (Indentures, Section 1.01) The Indentures also provide that if all or substantially all of the assets of any Subsidiary Guarantor or all of the capital stock of any Subsidiary Guarantor is sold (including by issuance or otherwise) by Monitoring or any of its Subsidiaries in a transaction constituting an Asset Sale (as defined in the Indentures) that does not otherwise violate the particular Indenture, then such Subsidiary Guarantor (in the event of a sale or other disposition of all of the capital stock of such Subsidiary Guarantor) or the corporation acquiring such assets (in the event of a sale or other disposition of all or substantially all of the assets of such Subsidiary Guarantor) shall be released and discharged of its obligations under the Note Guarantee. (Senior Debt Indenture, Section 12.03; Subordinated Debt Indenture, Section 13.03) POI is a holding company with no operations of its own and no significant assets other than its ownership of the capital stock of Monitoring. POI will, therefore, be dependent upon the receipt of dividends or other distributions from Monitoring to fund any obligations that it incurs, including obligations under the Note Guarantee. The Indentures and the Revolving Credit Facility do not, however, permit distributions from Monitoring to POI, other than for certain specified purposes. Accordingly, if Monitoring should at any time be unable to pay interest on or principal of the Debt Securities, it is unlikely that it will be permitted to distribute to POI the funds necessary to enable POI to meet its obligations under the Note Guarantee. CERTAIN COVENANTS Negative Pledge. The Senior Debt Indenture provides that POI will not, and will not permit Monitoring or any Subsidiary to, create, assume, incur or guarantee any indebtedness for borrowed money secured by a pledge, lien or other encumbrance (except for certain liens specifically permitted by the Senior Debt Indenture) on the shares of Capital Stock (as defined in the Senior Debt Indenture) or Indebtedness of any Subsidiary or on any of its assets or properties, without making effective provision whereby the Debt Securities issued under such Indenture will be secured equally and ratably with such secured indebtedness. (Senior Debt Indenture, Section 3.07) Merger, Consolidation, Sale, Lease or Conveyance. Each Indenture provides that neither Monitoring nor any Guarantor will merge or consolidate with any other corporation or sell, lease or convey all or substantially all its assets to any person, unless Monitoring or such Guarantor, as the case may be, shall be the continuing corporation, or the successor corporation or person that acquires all or substantially all the assets of Monitoring or such Guarantor shall be a corporation organized under the laws of the United States or a state thereof or the District of Columbia and shall expressly assume all obligations of Monitoring or such 9 74 Guarantor, as the case may be, under such Indenture and the Debt Securities and Note Guarantee issued thereunder, and immediately after such merger, consolidation, sale, lease or conveyance, Monitoring or such Guarantor, as the case may be, such person or such successor corporation shall not be in default in the performance of the covenants and conditions of such Indenture to be performed or observed by Monitoring or such Guarantor, as the case may be. (Indentures, Section 9.01) This covenant would not apply to a recapitalization transaction, a change of control of Monitoring or POI or a highly leveraged transaction unless such transactions or change of control were structured to include a merger or consolidation or sale, lease or conveyance of all or substantially all of the assets of Monitoring or POI, as the case may be. In addition, Monitoring or any other Restricted Subsidiary may enter into any of the transactions described in this paragraph with a wholly owned Restricted Subsidiary that is a Guarantor and that (in the case of any wholly owned Restricted Subsidiary other than Monitoring) has a positive net worth; provided that in connection with any such merger or consolidation, no consideration (other than common stock of the surviving entity, Monitoring or the Guarantor) shall be issued or distributed to the stockholders of Monitoring or the Guarantor. Except as may be described in a Prospectus Supplement applicable to a particular series of Debt Securities, there are no covenants or other provisions in the Indentures providing for a put or increased interest or otherwise that would afford holders of Debt Securities additional protection in the event of a recapitalization transaction, a change of control of Monitoring or a highly leveraged transaction. EVENTS OF DEFAULT An Event of Default is defined under each Indenture with respect to Debt Securities of any series issued under such Indenture as being: (a) default in payment of any principal of the Debt Securities of such series, either at maturity (or upon any redemption), by declaration or otherwise; (b) default for 30 days in payment of any interest on any Debt Securities of such series; (c) default for 60 days after written notice in the observance or performance of any other covenant or agreement in the Debt Securities of such series or such Indenture other than a covenant included in such Indenture solely for the benefit of a series of Debt Securities other than such series; (d) certain events of bankruptcy, insolvency or reorganization; (e) failure by Monitoring or any Guarantor to make any payment at maturity, including any applicable grace period, in respect of Indebtedness (as defined below) in an outstanding principal amount in excess of $5.0 million in the aggregate for all such issues of all such Persons and continuance of such failure for a period of 30 days after written notice thereof to Monitoring by the Trustee, or to Monitoring and the Trustee by the holders of not less than 25% in principal amount of such outstanding Debt Securities (treated as one class) issued under such Indenture; or (f) default with respect to any Indebtedness of Monitoring, any Guarantor or any Subsidiary, which default results in the acceleration of Indebtedness in an amount in excess of $5.0 million in the aggregate for all such issues of all such Persons without such Indebtedness having been discharged or such acceleration having been cured, waived, rescinded or annulled for a period of 30 days after written notice thereof to Monitoring by the Trustee, or to Monitoring and the Trustee by the holders of not less than 25% in principal amount of such outstanding Debt Securities (treated as one class) issued under such Indenture; provided, however, that if any such failure, default or acceleration referred to in clause (e) or clause (f) above shall cease or be cured, waived, rescinded or annulled, then the Event of Default by reason thereof shall be deemed likewise to have been thereupon cured. Unless otherwise defined in a supplemental indenture with respect to a particular series of Securities and Coupons, if any, and described in the applicable Prospectus Supplement, the term "Indebtedness" means obligations (other than nonrecourse obligations or the Debt Securities of such series issued under the applicable Indenture) of, or guaranteed or assumed by, Monitoring, any Guarantor or any Subsidiary for borrowed money or evidenced by bonds, debentures, notes or other similar instruments. (Indentures, Sections 1.01 and 5.01) Each Indenture provides that (a) if an Event of Default due to the default in payment of principal of, premium, if any, or interest on, any series of Debt Securities issued under such Indenture or due to the default in the performance or breach of any other covenant or warranty of Monitoring or any Guarantor applicable to the Debt Securities of such series but not applicable to all outstanding Debt Securities issued under such Indenture shall have occurred and be continuing, either the Trustee or the holders of not less than 25% in principal amount of such Debt Securities of each such affected series (treated as one class) issued under such 10 75 Indenture and then outstanding may then declare the principal of all Debt Securities of each such affected series and interest accrued thereon to be due and payable immediately; and (b) if an Event of Default due to a default in the performance of any other of the covenants or agreements in such Indenture applicable to all outstanding Debt Securities issued under such Indenture and then outstanding (other than those with respect to certain events of bankruptcy, insolvency or reorganization of Monitoring or any Guarantor) shall have occurred and be continuing, either the Trustee or the holders of not less than 25% in principal amount of all Debt Securities issued under such Indenture and then outstanding (treated as one class) may declare the principal of all such Debt Securities and interest accrued thereon to be due and payable immediately, but upon certain conditions such declarations may be annulled and past defaults may be waived (except a continuing default in payment of principal of (or premium, if any) or interest on such Debt Securities) by the holders of a majority in principal amount of the Debt Securities of all such affected series then outstanding. In the case of certain events of bankruptcy, insolvency or reorganization of Monitoring or any Guarantor, the principal of, premium, if any, and accrued interest on all Debt Securities then outstanding shall automatically become and be immediately due and payable. (Indentures, Sections 5.01 and 5.10) Each Indenture contains a provision entitling the Trustee, subject to the duty of the Trustee during a default to act with the required standard of care, to be indemnified by the holders of Debt Securities (treated as one class) issued under such Indenture before proceeding to exercise any right or power under such Indenture at the request of such holders. (Indentures, Section 6.02) Subject to such provisions in each Indenture for the indemnification of the Trustee and certain other limitations, the holders of a majority in principal amount of the outstanding Debt Securities (treated as one class) issued under such Indenture may direct the time, method and place of conducting any proceeding for any remedy available to the Trustee, or exercising any trust or power conferred on the Trustee. (Indentures, Section 5.09) Each Indenture provides that no holder of Debt Securities issued under such Indenture may institute any action against Monitoring under such Indenture (except actions for payment of overdue principal or interest) unless such holder previously shall have given to the Trustee written notice of default and continuance thereof and unless the holders of not less than 25% in principal amount of the Debt Securities of each affected series (treated as one class) issued under such Indenture and then outstanding shall have requested the Trustee to institute such action and shall have offered the Trustee reasonable indemnity, the Trustee shall not have instituted such action within 60 days of such request and the Trustee shall not have received direction inconsistent with such written request by the holders of a majority in principal amount of the Debt Securities of each affected series (treated as one class) issued under such Indenture and then outstanding. (Indentures, Sections 5.06 and 5.09) Each Indenture contains a covenant that Monitoring will file annually with the Trustee a certificate of no default or a certificate specifying any default that exists. (Indentures, Section 3.05) DISCHARGE, DEFEASANCE AND COVENANT DEFEASANCE Unless otherwise provided in the applicable Prospectus Supplement, Monitoring can discharge or defease its obligations under an Indenture as set forth below. (Indentures, Section 10.01) Under terms satisfactory to the Trustee, Monitoring may discharge certain obligations to holders of any series of Debt Securities issued under such Indenture which have not already been delivered to the Trustee for cancellation and which have either become due and payable or are by their terms due and payable within one year (or scheduled for redemption within one year) by irrevocably depositing with the Trustee cash or, in the case of Debt Securities payable only in U.S. dollars, U.S. Government Obligations (as defined in such Indenture), as trust funds in an amount certified to be sufficient to pay at maturity (or upon redemption) the principal of and interest on such Debt Securities. Monitoring may also discharge any and all of the obligations to holders of any series of Debt Securities issued under an Indenture at any time ("defeasance"), but may not thereby avoid any duty to register the transfer or exchange of such series of Debt Securities, to replace any mutilated, destroyed, lost, or stolen Debt Securities of such series or to maintain an office or agency in respect of such series of Debt Securities. Under terms satisfactory to the relevant Trustee, Monitoring may instead be released with respect to any outstanding 11 76 series of Debt Securities issued under the relevant Indenture from the obligations imposed by Sections 3.07 (in the case of the Senior Debt Indenture) and 9.01 (which Sections contain the covenants described above limiting liens and consolidations, mergers, asset sales and leases), and elect not to comply with such Sections without creating an Event of Default ("covenant defeasance"). Defeasance or covenant defeasance may be effected only if, among other things: (i) Monitoring irrevocably deposits with the relevant Trustee cash or, in the case of Debt Securities payable only in U.S. dollars, U.S. Government Obligations, as trust funds in an amount certified to be sufficient to pay at maturity (or upon redemption) the principal of and interest on all outstanding Debt Securities of such series issued under such Indenture; (ii) Monitoring delivers to the relevant Trustee an opinion of counsel to the effect that the holders of such series of Debt Securities will not recognize income, gain or loss for United States federal income tax purposes as a result of such defeasance or covenant defeasance and that defeasance or covenant defeasance will not otherwise alter such holders' United States federal income tax treatment of principal and interest payments on such series of Debt Securities (in the case of a defeasance, such opinion must be based on a ruling of the Internal Revenue Service or a change in United States federal income tax law occurring after the date of such Indenture, since such a result would not occur under current tax law); and (iii) in the case of a series of Subordinated Debt Securities, any requirements set forth in the Prospectus Supplement applicable to such series of Subordinated Debt Securities are satisfied. MODIFICATION OF THE INDENTURES Each Indenture provides that Monitoring and the Trustee may enter into supplemental indentures without the consent of the holders of Debt Securities to: (a) secure any Debt Securities, (b) evidence the assumption by a successor corporation of the obligations of Monitoring or any Guarantor, (c) add covenants for the protection of the holders of Debt Securities, (d) cure any ambiguity or correct any inconsistency in such Indenture or in any supplemental indenture, provided that no such action adversely affects the interests of any holder of Debt Securities in any material respect, (e) establish the forms or terms of Debt Securities of any series, (f) make any change that does not adversely affect the rights under such Indenture of any holder of Debt Securities thereunder, (g) add any Note Guarantee or release any Note Guarantee pursuant to the provisions thereof, (h) release any Note Guarantee from a Subsidiary Guarantor that has ceased to be a Subsidiary of Monitoring, (i) evidence the acceptance of appointment by a successor trustee and (j) to comply with any requirements of the Commission in connection with the qualification of the Indenture under the Trust Indenture Act of 1939, as amended. (Indentures, Section 8.01) Each Indenture also contains provisions permitting Monitoring and the Trustee, with the consent of the holders of not less than a majority in principal amount of Debt Securities of all series issued under such Indenture then outstanding and affected (voting as one class), to add any provisions to, or change in any manner or eliminate any of the provisions of, such Indenture or modify in any manner the rights of the holders of the Debt Securities of each series so affected; provided that Monitoring and the Trustee may not, without the consent of the holder of each outstanding Debt Security affected thereby, (a) extend the final maturity of the principal of any Debt Security, or reduce the principal amount thereof or reduce the rate or extend the time of payment of interest thereon, or reduce any amount payable on redemption thereof or change the currency in which the principal thereof (including any amount in respect of original issue discount), premium, if any, or interest thereon is payable or reduce the amount of any original issue discount security payable upon acceleration or provable in bankruptcy or alter certain provisions of such Indenture relating to the Debt Securities issued thereunder not denominated in U.S. dollars or impair the right to institute suit for the enforcement of any payment on any Debt Security when due or (b) reduce the aforesaid percentage in principal amount of Debt Securities of any series issued under such Indenture, the consent of the holders of which is required for any such modification. (Indentures, Section 8.02) LIMITATIONS ON ISSUANCE OF BEARER DEBT SECURITIES In compliance with United States federal income tax laws and regulations, Bearer Securities (including Bearer Securities in global form) will not be offered, sold, resold or delivered, directly or indirectly, in the United States or its possessions or to United States persons (as defined below), except as otherwise permitted 12 77 by United States Treasury Regulations Section 1.163-5(c)(2)(i)(D). Any underwriters, agents or dealers participating in the offerings of Bearer Securities, directly or indirectly, must agree that they will not, in connection with the original issuance of any Bearer Securities or during the restricted period (as defined in United States Treasury Regulations Section 1.163-5(c)(2)(i)(D)(7)) (the "restricted period"), offer, sell, resell or deliver, directly or indirectly, any Bearer Securities in the United States or its possessions or to United States persons (other than as permitted by the applicable Treasury Regulations described above). In addition, any such underwriters, agents or dealers must have procedures reasonably designed to ensure that its employees or agents who are directly engaged in selling Bearer Securities are aware of the above restrictions on the offering, sale, resale or delivery of Bearer Securities. Moreover, Bearer Securities (other than temporary global Debt Securities and Bearer Securities that satisfy the requirements of United States Treasury Regulations Section 1.163-5(c)(2)(i)(D)(3)(iii)) and any Coupons appertaining thereto will not be delivered in definitive form unless Monitoring has received a signed certificate in writing (or an electronic certificate described in United States Treasury Regulations Section 1.163-5(c)(2)(i)(D)(3)(ii)) stating that on such date such Bearer Security (i) is owned by a person that is not a United States person, (ii) is owned by a United States person that (a) is a foreign branch of a United States financial institution (as defined in United States Treasury Regulations Section 1.165-12(c)(1)(v)) (a "financial institution") purchasing for its own account or for resale, or (b) is acquiring such Bearer Security through a foreign branch of a United States financial institution and who holds the Bearer Security through such financial institution through such date (and in either case (a) or (b) above, each such United States financial institution agrees, on its own behalf or through its agent, that Monitoring may be advised that it will comply with the requirements of Section 165(j)(3)(A), (B) or (C) of the Internal Revenue Code of 1986, as amended, and the regulations thereunder) or (iii) is owned by a United States or foreign financial institution for the purposes of resale during the restricted period and, in addition, if the owner of such Bearer Security is a United States or foreign financial institution described in clause (iii) above (whether or not also described in clause (i) or clause (ii) above), such financial institution certifies that it has not acquired the Bearer Security for purposes of resale directly or indirectly to a United States person or to a person within the United States or its possessions. Bearer Securities (other than temporary global Debt Securities) and any Coupons appertaining thereto will bear a legend substantially to the following effect: "Any United States person who holds this obligation will be subject to limitations under the United States federal income tax laws, including the limitations provided in Sections 165(j) and 1287(a) of the United States Internal Revenue Code." The sections referred to in such legend provide that, with certain exceptions, a United States person will not be permitted to deduct any loss and will not be eligible for capital gain treatment with respect to any gain, realized on the sale, exchange or redemption of such Bearer Security or Coupon. As used herein, "United States person" means a citizen, national or resident of the United States, a corporation, partnership or other entity created or organized in or under the laws of the United States or any political subdivision thereof, or an estate or trust the income of which is subject to United States federal income taxation regardless of its source. DESCRIPTION OF CAPITAL STOCK The authorized capital stock of Protection One, Inc. consists of 24,000,000 shares of Common Stock, $.01 par value per share, and 5,000,000 shares of Preferred Stock, $.10 par value per share. As of July 31, 1996, there were 12,738,175 shares of Common Stock and no shares of Preferred Stock outstanding. COMMON STOCK The holders of Common Stock are entitled to one vote for each share held of record on all matters to be voted on by the stockholders. The holders of Common Stock do not possess cumulative voting rights, and members of the Board of Directors of POI are elected by a plurality. The holders of Common Stock are entitled to receive ratably such dividends as may be declared from time to time by the Board of Directors out of funds legally available therefor, subject to the rights of the holders of any series of Preferred Stock then outstanding. In the event of the liquidation, dissolution or winding up of POI, the holders of Common Stock are entitled to share ratably in all assets remaining after payment of liabilities to creditors, subject to prior liquidation rights of Preferred Stock, if any, then outstanding. The Common Stock has no preemptive rights, 13 78 conversion rights or other subscription rights. There are no redemption or sinking funds provisions applicable to the Common Stock. All outstanding shares of Common Stock are, and the shares of Common Stock issued upon conversion of any Debt Securities will be, fully paid and non-assessable. The Transfer Agent and Registrar for the Common Stock is, as of the date of this Prospectus, Wells Fargo Bank. Effective as of September 8, 1996, the Transfer Agent and Registrar for the Common Stock will be ChaseMellon Shareholder Services. PREFERRED STOCK The Amended and Restated Certificate of Incorporation of POI authorizes 5,000,000 shares of Preferred Stock. The Board of Directors has the authority to issue the Preferred Stock in one or more series and to fix the rights, preferences, privileges and restrictions thereof, including dividend rights, dividend rates, conversion rights, voting rights, terms of redemption, redemption prices, liquidation preferences and the number of shares constituting any series or the designation of such series, without further vote or action by the stockholders. The issuance of Preferred Stock may have the effect of delaying, deferring or preventing a change in control of the Company without further action by the stockholders and may adversely affect the voting and other rights of the holders of Common Stock, including the loss of voting control to others. DELAWARE ANTI-TAKEOVER LAW Each of POI and Monitoring is a Delaware corporation and as such is subject to Section 203 of the Delaware General Corporation Law. In general, Section 203 prohibits a publicly held Delaware corporation from engaging in a "business combination" (as defined below) with an "interested stockholder" (as defined below) for a period of three years following the date such stockholder became an "interested stockholder," unless: (i) prior to such date, the board of directors of the corporation approves either the business combination or the transaction which resulted in the stockholder becoming an interested stockholder; (ii) upon consummation of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding voting stock owned by directors who are also officers of the corporation or held in employee benefit plans that do not provide employees a confidential right to determine whether to tender (or how to vote) stock held by the plan; or (iii) on or subsequent to such date the business combination is approved by the board of directors of the corporation and by the holders of two-thirds of the outstanding voting stock of the corporation not owned by the interested stockholder. A "business combination" includes certain mergers, stock or asset sales and other transactions resulting in a financial benefit to the interested stockholder. An "interested stockholder" is generally a person who, together with affiliates and associates, owns (or within three years did own) 15% or more of the corporation's voting stock. AMENDED STOCKHOLDERS' AGREEMENT POI, the original holders of the 5,760,839 shares of Common Stock outstanding prior to the initial public offering of the Common Stock (the "Initial Public Offering"), the holders of warrants issued to two prior lenders to the Company (the "Bank Warrants") and four executive officers of POI are party to an Amended and Restated Stockholders' Agreement dated as of August 15, 1994 (the "Amended Stockholders' Agreement"). Pursuant to the Amended Stockholders' Agreement, the holders of a majority of the shares of Common Stock that were issued to six original investors in connection with the Initial Public Offering have the right to demand on two occasions that POI register such shares of Common Stock under the Securities Act for resales by those stockholders. The Amended Stockholders' Agreement further provides that, subject to certain limitations and exclusions, in the event that POI proposes to register under the Securities Act shares of Common Stock in connection with an underwritten public offering of those shares, upon the request of the other parties to the Amended Stockholders' Agreement POI will include in the applicable registration statement the shares of Common Stock owned by those securityholders (or that those securityholders had the right to acquire) at the time of the Initial Public Offering. Those parties to the Amended Stockholders' Agreement who hold the Bank Warrants or who are affiliates of POI also are entitled under the Amended Stockholders' Agreement to certain piggyback registration rights with respect to those securities (or, in the case of affiliates, the shares of Common Stock owned by them at the time of the Initial Public Offering) in the 14 79 event of certain non-underwritten offerings of Common Stock registered by POI. The Amended Stockholders' Agreement will terminate on September 16, 2001 unless otherwise extended or earlier terminated by a written instrument signed by each party thereto. PLAN OF DISTRIBUTION Monitoring may sell the Debt Securities being offered hereby through agents, underwriters, dealers or remarketing firms. Offers to purchase Debt Securities may be solicited by agents designated by Monitoring from time to time. Any such agent, who may be deemed to be an underwriter as that term is defined in the Securities Act, involved in the offer or sale of the Debt Securities in respect of which this Prospectus is delivered will be named, and any commissions payable by Monitoring to such agent set forth, in the Prospectus Supplement. Any such agent will be acting on a reasonable efforts basis for the period of its appointment or, if indicated in the applicable Prospectus Supplement, on a firm commitment basis. Agents may be entitled under agreements which may be entered into with Monitoring to indemnification by Monitoring against certain civil liabilities, including liabilities under the Securities Act, and may be customers of, engage in transactions with or perform services for Monitoring or POI in the ordinary course of business. If any underwriters are utilized in the sale of the Debt Securities in respect of which this Prospectus is delivered, Monitoring will enter into an underwriting agreement with such underwriters at the time of sale to them and the names of the underwriters and the terms of the transaction will be set forth in the Prospectus Supplement, which will be used by the underwriters to make resales of the Debt Securities in respect of which this Prospectus is delivered to the public. The underwriters may be entitled, under the relevant underwriting agreement, to indemnification by Monitoring against certain liabilities, including liabilities under the Securities Act, and may be customers of, engage in transactions with or perform services for Monitoring or POI in the ordinary course of business. If a dealer is utilized in the sale of the Debt Securities in respect of which the Prospectus is delivered, Monitoring will sell such Debt Securities to the dealer, as principal. The dealer may then resell such Debt Securities to the public at varying prices to be determined by such dealer at the time of resale. Dealers may be entitled to indemnification by Monitoring against certain liabilities, including liabilities under the Securities Act, and may be customers of, engage in transactions with or perform services for Monitoring or POI in the ordinary course of business. Debt Securities may also be offered and sold, if so indicated in the Prospectus Supplement, in connection with a remarketing upon their purchase, in accordance with their terms, by one or more firms ("remarketing firms"), acting as principals for their own accounts or as agents for Monitoring. Any remarketing firm will be identified and the terms of its agreement, if any, with Monitoring and its compensation will be described in the Prospectus Supplement. Remarketing firms may be entitled under agreements which may be entered into with Monitoring to indemnification by Monitoring against certain civil liabilities, including liabilities under the Securities Act, and may be customers of, engage in transactions with or perform services for Monitoring or POI in the ordinary course of business. If so indicated in the applicable Prospectus Supplement, Monitoring will authorize agents, underwriters or dealers to solicit offers by certain purchasers to purchase Offered Debt Securities from Monitoring at the public offering price set forth in the Prospectus Supplement pursuant to delayed delivery contracts providing for payment and delivery on a specified date in the future. Such contracts will be subject to only those conditions set forth in the Prospectus Supplement, and the Prospectus Supplement will set forth the commission payable for solicitation of such offers. 15 80 LEGAL MATTERS Mitchell, Silberberg & Knupp LLP has rendered an opinion with respect to the validity of the issuance of the Securities offered pursuant to this Prospectus. Certain legal matters in connection with offerings made by this Prospectus may be passed upon for any underwriters, dealers or agents by counsel named in the Prospectus Supplement. EXPERTS The consolidated balance sheets of Protection One, Inc. and subsidiaries as of September 30, 1995 and 1994 and the related consolidated statements of operations, cash flows and changes in stockholders' equity (deficit) for each of the three years in the period ended September 30, 1995 incorporated by reference in this Prospectus, have been incorporated herein in reliance on the report, which includes an explanatory paragraph with respect to a change in method of accounting for certain subscriber account acquisition and transition costs, of Coopers & Lybrand L.L.P., independent accountants, given on the authority of that firm as experts in accounting and auditing. The consolidated balance sheets of Metrol Security Services, Inc. and subsidiaries as of December 31, 1995 and 1994 and the related consolidated statements of operations, stockholders' deficiencies and cash flows for each of the three years in the period ended December 31, 1995, incorporated by reference in this Prospectus have been incorporated herein in reliance on the report of KPMG Peat Marwick LLP, independent accountants, given on the authority of that firm as experts in accounting and auditing. 16 81 PROTECTION ONE, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- Report of Independent Accountants..................................................... F-2 Consolidated Balance Sheets as of September 30, 1994 and 1995 and (unaudited) June 30, 1996................................................................................ F-3 Consolidated Statements of Operations for the years ended September 30, 1993, 1994 and 1995 and (unaudited) the nine months ended June 30, 1995 and 1996................... F-4 Consolidated Statements of Cash Flows for the years ended September 30, 1993, 1994 and 1995 and (unaudited) the nine months ended June 30, 1995 and 1996................... F-5 Consolidated Statements of Changes in Stockholders' Equity (Deficit) for the years ended September 30, 1993, 1994 and 1995 and (unaudited) the nine months ended June 30, 1996............................................................................ F-6 Notes to Consolidated Financial Statements............................................ F-7
F-1 82 REPORT OF INDEPENDENT ACCOUNTANTS Board of Directors Protection One, Inc. Culver City, California We have audited the accompanying consolidated balance sheets of Protection One, Inc. and Subsidiaries as of September 30, 1995 and 1994, and the related consolidated statements of operations, cash flows and changes in stockholders' equity (deficit) for each of the three years in the period ended September 30, 1995. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Protection One, Inc. and Subsidiaries as of September 30, 1995 and 1994, and their consolidated results of operations and cash flows for each of the three years in the period ended September 30, 1995, in conformity with generally accepted accounting principles. As discussed in Note 2, effective October 1, 1994, the Company changed its method of accounting for certain subscriber account acquisition and transition costs. COOPERS & LYBRAND L.L.P. Portland, Oregon December 12, 1995 F-2 83 PROTECTION ONE, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS) ASSETS
AT SEPTEMBER 30, --------------------- AT JUNE 30, 1994 1995 1996 -------- -------- ----------- (UNAUDITED) Current assets: Cash equivalents.............................................. $ 1,057 $ 1,256 $ 8,347 Restricted cash............................................... 456 -- -- Receivables, net.............................................. 4,724 5,806 11,146 Inventories................................................... 1,589 3,125 3,461 Prepaid expenses.............................................. 316 547 1,172 -------- -------- --------- Total current assets....................................... 8,142 10,734 24,126 Property and equipment, net..................................... 3,118 5,307 10,956 Subscriber accounts and intangibles, net........................ 114,620 162,239 238,898 Deposits........................................................ 205 389 449 -------- -------- --------- $126,085 $178,669 $ 274,429 ======== ======== ========= LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) Current liabilities: Current portion of long-term debt............................. $ 334 $ 1 $ 94 Accounts payable.............................................. 2,200 2,078 2,462 Accrued salaries, wages and benefits.......................... 1,036 1,401 1,208 Accrued interest.............................................. 2,689 318 216 Other accruals................................................ 450 210 412 Purchase holdbacks............................................ 4,250 4,949 12,588 Acquisition transition costs.................................. 1,269 970 3,779 Other current liabilities..................................... 634 800 646 Deferred revenue.............................................. 6,785 9,166 13,763 -------- -------- --------- Total current liabilities.................................. 19,647 19,893 35,168 Long-term debt, net of current portion.......................... 86,508 146,023 206,956 Deferred income taxes........................................... 3,504 -- 792 Other liabilities............................................... 300 279 604 -------- -------- --------- Total liabilities.......................................... 109,959 166,195 243,520 -------- -------- --------- Commitments and contingencies (Note 16) Redeemable preferred stock, redemption value $22,992 and $6,127 at September 30, 1994 and 1995, respectively.................. 22,210 6,127 -- -------- -------- --------- Stockholders' equity (deficit): Common Stock, $.01 par value ($.10 at September 30, 1994), 24,000,000 shares authorized, 203,836, 9,047,638 and 12,736,255 shares issued and outstanding at September 30, 1994 and 1995 and June 30, 1996, respectively.............. 2 90 127 Class B Common Stock, $.10 par value, 181,269 shares authorized, issued and outstanding at September 30, 1994... 18 -- -- Series A cumulative convertible Preferred Stock, $.10 par value, 672,485 shares authorized, 670,550 shares issued and outstanding at September 30, 1994.......................... 67 -- -- Series G cumulative convertible Preferred Stock, $.10 par value, 4,000 shares authorized, 2,236 shares issued and outstanding at September 30, 1994 Additional paid-in capital.................................... 12,750 41,829 77,453 Stockholders' notes receivable................................ (47) -- -- Accumulated deficit........................................... (18,874) (35,572) (46,671) -------- -------- ---------- Total stockholders' equity (deficit)....................... (6,084) 6,347 30,909 -------- -------- --------- $126,085 $178,669 $ 274,429 ======== ======== =========
The accompanying notes are an integral part of the consolidated financial statements. F-3 84 PROTECTION ONE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (DOLLAR AMOUNTS IN THOUSANDS, EXCEPT FOR PER SHARE AMOUNTS)
NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, JUNE 30, -------------------------------- --------------------- 1993 1994 1995 1995 1996 ------- ------- -------- -------- -------- (UNAUDITED) Revenues: Monitoring and service.............. $14,850 $27,109 $ 46,308 $ 32,622 $ 46,377 Installation........................ 6,720 4,764 3,662 3,040 1,918 Other............................... 320 2,607 5,912 3,303 3,500 ------- ------- -------- ------- ------- Total revenues................... 21,890 34,480 55,882 38,965 51,795 ------- ------- -------- ------- ------- Cost of revenues: Monitoring and service.............. 3,547 6,520 11,795 8,151 12,651 Installation........................ 3,597 2,950 2,892 2,311 1,431 Other............................... 317 2,854 4,532 3,422 3,254 ------- ------- -------- ------- ------- Total cost of revenues........... 7,461 12,324 19,219 13,885 17,336 ------- ------- -------- ------- ------- Gross profit..................... 14,429 22,156 36,663 25,080 34,459 Selling, general and administrative expenses............................ 12,084 10,380 12,409 8,178 10,082 Loss on acquisition terminations...... -- 26 208 208 -- Performance warrants compensation expense............................. -- 4,504 -- -- -- Adjustment of purchase accounting accruals, net....................... (742) -- -- -- -- Acquisition and transition expenses... -- -- 3,090 2,380 3,048 Amortization of subscriber accounts and goodwill........................ 3,864 8,772 15,460 10,858 16,108 ------- ------- -------- ------- ------- Operating income (loss).......... (777) (1,526) 5,496 3,456 5,221 Other expenses: Interest expense, net............... 1,564 6,932 7,626 6,850 3,052 Amortization of debt issuance costs and OID.......................... 185 891 6,797 2,687 13,159 Loss on sales of subscriber accounts......................... -- -- 505 433 19 ------- ------- -------- ------- ------- Loss before income taxes, extraordinary items and cumulative effect of change in accounting method.............. (2,526) (9,349) (9,432) (6,514) (11,009) Income tax benefit (expense).......... -- 2,863 3,595 2,432 (90) ------- ------- -------- ------- ------- Loss before extraordinary items and cumulative effect of change in accounting method........... (2,526) (6,486) (5,837) (4,082) (11,099) Extraordinary items -- losses on early extinguishment of debt -- net....... (281) (1,174) (8,906) (8,898) -- Cumulative effect of change in accounting method -- net............ -- -- (1,955) (1,955) -- ------- ------- -------- ------- ------- Net loss......................... (2,807) (7,660) (16,698) (14,934) (11,099) Preferred stock dividends............. 653 748 958 791 248 Accretion of redeemable preferred stock............................... 1,175 753 797 796 -- ------- ------- -------- ------- ------- Loss attributable to common stock.......................... $(4,635) $(9,161) $(18,453) $(16,521) $(11,347) ======= ======= ======== ======= ======= Loss per common share: Before extraordinary items and cumulative effect of change in accounting method................ $(41.86) $(27.11) $ (0.87) $ (0.66) $ (1.06) Net loss per common share........... $(44.57) $(31.10) $ (2.12) $ (1.92) $ (1.06)
The accompanying notes are an integral part of the consolidated financial statements. F-4 85 PROTECTION ONE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLAR AMOUNTS IN THOUSANDS)
NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, JUNE 30, ------------------------------ ------------------- 1993 1994 1995 1995 1996 -------- -------- -------- -------- -------- (UNAUDITED) Cash flows from operating activities: Net loss................................................. $ (2,807) $ (7,660) $(16,698) $(14,934) $(11,099) Adjustments to reconcile net loss to net cash provided by operating activities: Depreciation.......................................... 522 518 1,083 745 1,250 Amortization of subscriber accounts and goodwill...... 3,864 8,772 15,460 10,858 16,108 Amortization of debt issuance costs and OID........... 185 891 6,797 2,687 13,159 Performance warrants earned........................... -- 4,504 -- -- -- Cumulative effect of change in accounting method...... -- -- 1,955 1,955 -- Loss on sales and abandonments........................ -- -- 713 433 -- Inventory received in settlement of claim............. -- -- (1,562) -- -- Adjustment of purchase accounting accruals............ (1,203) -- -- -- -- Deferred income tax benefit........................... -- (2,863) (3,595) (2,432) -- Extraordinary items................................... 281 1,174 8,906 8,898 -- Provision for doubtful accounts....................... 21 789 1,751 1,238 1,518 Other................................................. (61) -- -- -- -- Changes in assets and liabilities, net of effects of acquisitions: Receivables........................................... (1,217) (1,362) (2,795) (2,292) (5,359) Inventories........................................... (108) (355) 89 (3) 528 Prepaid expenses and deposits......................... (485) 383 (408) (831) (505) Accounts payable...................................... 614 621 (121) (904) 681 Accrued liabilities................................... 217 2,662 (2,247) (2,546) (389) Deferred revenue...................................... 1,082 (675) (832) (239) 663 -------- -------- -------- -------- -------- Net cash provided by operating activities............. 905 7,399 8,496 2,633 16,555 -------- -------- -------- -------- -------- Cash flows from investing activities: Purchases of property and equipment...................... (321) (1,417) (3,268) (1,946) (4,706) Acquisitions, net of cash received....................... (7,972) (60,069) (52,249) (46,136) (72,275) Acquisition payments held in escrow...................... -- (456) 456 -- -- Payments on purchase holdbacks........................... (201) (941) (3,626) (3,059) (133) Deferred acquisition payments............................ (131) (469) (2,167) (1,996) (1,438) Acquisition transition costs............................. (987) (3,136) (2,558) (1,777) (2,272) Payment of other liabilities............................. (484) (322) (109) (72) -- -------- -------- -------- -------- -------- Net cash used in investing activities............ (10,096) (66,810) (63,521) (54,986) (80,824) -------- -------- -------- -------- -------- Cash flows from financing activities: Payments on long-term debt............................... (19,536) (25,805) (118,699) (118,678) (23,828) Proceeds from long-term debt............................. 28,853 88,328 168,005 164,428 72,619 Debt and equity issuance costs........................... (1,807) (6,444) (6,780) (6,420) (666) Payments on stockholders' notes receivable............... 34 15 47 47 -- Issuance of preferred and common stock and warrants...... -- 5,494 20,219 20,164 23,483 Redemption of preferred stock............................ -- (1,500) (2,125) (2,125) -- Note redemption and premium costs........................ -- -- (2,627) (2,627) -- Cash dividends paid on preferred stock................... (435) (965) (2,816) (2,648) (248) -------- -------- -------- -------- -------- Net cash provided by financing activities........ 7,109 59,123 55,224 52,141 71,360 -------- -------- -------- -------- -------- Net increase (decrease) in cash and cash equivalents.................................... (2,082) (288) 199 (212) 7,091 Cash and cash equivalents: Beginning of period...................................... 3,427 1,345 1,057 1,057 1,256 -------- -------- -------- -------- -------- End of period............................................ $ 1,345 $ 1,057 $ 1,256 $ 845 $ 8,347 ======== ======== ======== ======== ======== Interest paid during the period............................ $ 1,270 $ 4,563 $ 9,968 $ 9,266 $ 3,181 ======== ======== ======== ======== ======== Supplemental disclosure (see Note 14)
The accompanying notes are an integral part of the consolidated financial statements. F-5 86 PROTECTION ONE, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) (DOLLAR AMOUNTS IN THOUSANDS)
CLASS B PREFERRED STOCK ADDITIONAL STOCKHOLDERS' COMMON COMMON ------------------- PAID-IN NOTES ACCUMULATED STOCK STOCK SERIES A SERIES G CAPITAL RECEIVABLE DEFICIT TOTAL ------ ------ -------- -------- ---------- ------------- ----------- -------- September 30, 1992............... $ 10 $962 $ 7 $ (96) $ (5,078) $ (4,195) Net loss......................... (2,807) (2,807) Accretion of Series C, D and E Redeemable Preferred Stock..... (1,175) (1,175) Payments on stockholders' notes receivable..................... 34 34 Dividends on Series F Redeemable Preferred Stock................ (653) (653) ---- ---- ---- ---- ------- ---- -------- -------- September 30, 1993............... 10 962 7 (62) (9,713) (8,796) Net loss......................... (7,660) (7,660) Restatement of par value......... (9) (895) 904 Issuance of preferred shares..... 2,358 2,358 Cancellation of preferred shares......................... (122) (122) Issuance of Class B common shares......................... $ 18 982 1,000 Issuance of common stock warrants....................... 4,494 4,494 Stock and warrant issuance costs.......................... (376) (376) Accretion of Series C and E Redeemable Preferred Stock..... (753) (753) Payments on stockholders' notes receivable..................... 15 15 Dividends on Series F Redeemable Preferred Stock................ (748) (748) Exercise of stock purchase warrant........................ 1 (1) Performance warrants............. 4,504 4,504 ---- ---- ---- ---- ------- ---- -------- -------- September 30, 1994............... 2 18 67 12,750 (47) (18,874) (6,084) Net loss......................... (16,698) (16,698) Issuance of common stock and warrants....................... 30 20,120 20,150 Exercise of stock purchase warrants....................... 2 71 73 Common stock and warrant issuance costs.......................... (2,283) (2,283) Accretion of Series C and E Redeemable Preferred Stock..... (797) (797) Dividends on Series A, F, and H Preferred Stock................ (876) (876) Conversion of preferred shares to common stock................... 56 (18) (67) 12,844 12,815 Payments on stockholders' notes receivable..................... 47 47 ---- ---- ---- ---- ------- ---- -------- -------- September 30, 1995............... 90 41,829 (35,572) 6,347 Net loss......................... (11,099) (11,099) Exercise of stock options........ 36 36 Exercise of Performance Warrants....................... 1 10 11 Issuance of Common Stock for cash........................... 25 23,658 23,683 Conversion of Redeemable Preferred Shares to Common Stock.......................... 7 6,120 6,127 Issuance of Common Stock for Metrol Security Services, Inc............................ 4 6,841 6,845 Common Stock issuance costs...... (793) (793) Dividends on Series H Redeemable Preferred Stock................ (248) (248) ---- ---- ---- ---- ------- ---- -------- -------- June 30, 1996 (unaudited)........ $127 $ -- $ -- $ -- $ 77,453 $ -- $ (46,671) $ 30,909 ==== ==== ==== ==== ======= ==== ======== ========
The accompanying notes are an integral part of the consolidated financial statements. F-6 87 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) 1. THE COMPANY AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES: Basis of Consolidation and Business The consolidated financial statements of Protection One, Inc. (POI) and its subsidiaries (the Company), include the accounts of POI, POI's wholly-owned subsidiary, Protection One Alarm Monitoring, Inc. (Monitoring), Monitoring's wholly owned subsidiary, Metrol Security Services, Inc. (see Note 20), and Monitoring's former wholly-owned subsidiary, Protection One Alarm Services, Inc. (Services). On May 13, 1996, Services was merged into Monitoring. The assets, results of operations and stockholder's equity of Monitoring comprise substantially all of the assets, results of operations and stockholders' equity of the Company on a consolidated basis. POI's principal assets and sole operations are in and through its investment in Monitoring. Results of operations of acquired companies are included in the Company's consolidated financial statements from date of acquisitions. All significant intercompany balances and transactions have been eliminated in consolidation. See Note 19 for separate consolidated financial information of Monitoring. The accompanying interim consolidated financial statements as of June 30, 1995 and for the nine months ended June 30, 1995 and 1996 and the related notes to consolidated financial statements are unaudited. Accordingly, these statements do not include all information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management of the Company, all adjustments, consisting only of normal recurring adjustments, considered necessary for a fair presentation have been included. The results of operations for the nine month period ended June 30, 1996 are not necessarily indicative of the results to be expected for the full fiscal year. The Company provides security alarm monitoring services and sells, installs and services security alarm systems for residential and small business subscribers principally in the western United States. Revenues Revenues are recognized when installation of security alarm systems occurs and when monitoring, extended service protection, patrol and repair services are provided. The Company does not receive separate connection fees in any aspect of its business. Subscribers are billed for monitoring, extended service protection and patrol and alarm response services in advance of the period in which such services are provided, on a monthly, quarterly or annual basis. Deferred revenues result from billings in advance of performance of monitoring, extended service protection and patrol service. Deferred revenues relating to subscriber accounts acquired are recorded as part of the allocation of the purchase price and are amortized to income during the period in which service is provided. Costs of providing service and installations, including inventory, are charged to income in the period incurred and when installation occurs. Losses on contracts for which future costs are anticipated to exceed revenues are accrued in the period such losses are identified. Costs of services provided to dealers are expensed as incurred and are included in acquisition and transition expenses. Contracts for services are generally for an initial non-cancellable term of one to five years with automatic renewal on an annual basis thereafter unless terminated by either party. A substantial number of contracts are now on an automatic renewal basis. Inventories Inventories, comprised of alarm systems and parts, are stated at the lower of average cost or market. F-7 88 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) Property and Equipment Property and equipment are stated at cost and depreciated using the straight-line method over the estimated useful lives. Costs of property and equipment of purchased businesses are based on estimated replacement costs at the date of acquisition. When property and equipment are retired or sold, the cost and the related allowance for depreciation are eliminated from the property and allowance accounts. Gains or losses from retirements and dispositions of property and equipment are recognized in the period realized. Repair and maintenance costs are expensed as incurred. Income Taxes Deferred tax liabilities and assets reflect the tax effect of temporary differences between the financial statement and tax bases of assets and liabilities and the availability of net operating losses and tax credits. Subscriber Accounts and Intangibles Subscriber accounts acquired and intangible assets are stated at cost. The cost of acquired subscriber accounts includes the cost of accounts purchased and the estimated fair value at the date of acquisition of the accounts acquired in business acquisitions, including an accrual for estimated acquisition transition costs. The Company's personnel and related support costs and duplicate costs incurred solely in support of acquiring and transitioning subscriber accounts are expensed as incurred. Direct and incremental external costs associated with the acquisition of subscriber accounts are capitalized. If the acquisition is terminated prior to completion of the purchase transaction the costs are recorded as a loss in the period of termination. The accrual for transition costs includes liabilities assumed and incremental external costs related to customer changeover and transition, warranty obligation costs, employee and lease termination costs and other related costs. Costs related to sales, marketing and installation of systems for accounts internally generated are expensed as incurred. The cost of subscriber accounts acquired is amortized on a straight-line basis over a 10 year period. It is the Company's policy to evaluate acquired subscriber account attrition on a quarterly basis utilizing historical attrition rates for the subscriber accounts in total and, when necessary, adjust the remaining useful lives. The Company periodically estimates future cash flows from the subscriber accounts. Because the expected cash flows have exceeded the unamortized cost of the subscriber accounts the Company has not recorded an impairment loss. Intangible assets include goodwill, which is amortized on a straight-line basis over the estimated life of 10 years and debt issuance costs, which are amortized over the respective lives of associated debt using the interest method. Cash and Cash Equivalents All highly liquid investments purchased with a remaining maturity of three months or less at the date acquired are cash equivalents. These investments, consisting of money market funds, are stated at cost, which approximates market. Restricted Cash Restricted cash is held in escrow pursuant to an acquisition agreement pending final determination of the purchase price of the assets acquired by the Company. F-8 89 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) Concentration of Credit Risk Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of trade receivables from a large number of customers, including both residential and commercial, dispersed across a wide geographic base. The Company extends credit to its customers in the normal course of business, performs periodic credit evaluations and maintains allowances for potential credit losses. New Accounting Pronouncements In March of 1995, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of", effective for financial statements for fiscal years beginning after December 15, 1995. This statement requires that long-lived assets and certain identifiable intangibles to be held and used by an entity be reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company determines the value of its subscriber accounts and intangibles, net based on the undiscounted cash flows from the MRR stream using the most recent historical attrition rate and aggregate MRR. Based on estimates made as of September 30, 1995, the Company does not anticipate that a material impact on its financial statements or those of the registrant will result from the adoption of the standard. In October of 1995, the FASB issued SFAS 123 "Accounting For Stock Based Compensation," which is effective for fiscal years beginning after December 15, 1995. The Company has not made a decision with regard to adoption of the optional provisions of the new standard. Reclassifications Certain prior period amounts were reclassified to conform to the September 30, 1995 presentation. Such reclassifications did not affect previously reported net loss. 2. CHANGE IN ACCOUNTING METHOD: In the third quarter of fiscal 1995, the Company changed its method of accounting for certain subscriber account acquisition and transition costs, effective as of October 1, 1994. Under the new method the Company's personnel and related support costs and duplicate costs incurred solely in support of acquiring and transitioning subscriber accounts are expensed as incurred. Capitalizable costs include the direct costs of accounts purchased and the estimated fair value at the date of acquisition of the accounts acquired in business acquisitions, including an accrual for estimated acquisition transition costs. Such capitalized transition costs include incremental external costs related to customer changeover and transition, warranty obligation costs, employee and lease termination costs and other related costs. The new method is consistent with the guidelines adopted by the Emerging Issues Task Force of the FASB in Issue 95-3, Recognition of Liabilities in Conjunction with Purchase Business Combinations. The consolidated financial statements for the year ended September 30, 1995 reflect the change in accounting method as of October 1, 1994. The effect of the change on such year was to increase the loss before cumulative effect of the accounting change, net loss and loss attributable to Common Stock by approximately $1.5 million or $0.17 per share. The cumulative effect of the change as of October 1, 1994 was approximately $2.0 million or $0.23 per share, net of income taxes of $1.2 million, and is reported separately in the consolidated statement of operations for the year ended September 30, 1995. F-9 90 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) The following unaudited pro forma amounts reflect the results of operations as if the change in accounting method had been retroactively applied:
YEAR ENDED SEPTEMBER 30, --------------------------------- 1993 1994 1995 ------- -------- -------- Pro forma: Loss before extraordinary items................... $(3,544) $ (7,333) $ (5,837) Net loss.......................................... $(3,825) $ (8,508) $(14,743) Net loss attributable to common stock............. $(5,653) $(10,008) $(16,498) Loss per common share: Before extraordinary item...................... $(51.65) $ (29.99) $ (.87) Net loss per common share...................... $(54.36) $ (33.97) $ (1.90) Actual: Net loss per common share......................... $(44.57) $ (31.10) $ (2.12)
3. INITIAL PUBLIC OFFERING AND CONVERSION OF PREFERRED STOCK: Initial Public Offering and Borrowing Under Revolving Credit Facility On October 6, 1994, the Company issued 2,700,000 shares of common stock at $6.50 per share in an initial public offering (IPO). On November 4, 1994, the Company's underwriters exercised their option to purchase an additional 330,000 shares of common stock at $6.50 per share. In conjunction with the issuance of shares on October 6, 1994, the Company borrowed $3 million under its revolving credit facility to pay accumulated unpaid dividends, stock conversion inducements and accounts payable. Conversion of Shares In conjunction with the IPO, all outstanding shares of the Company's Series A, C, E and G Preferred Stock and Class B Common Stock were converted into a total of 5,557,003 shares of the Company's Common Stock. At the time of conversion, the Company paid accumulated unpaid dividends totaling $2,104 to the holders of the Company's Series A, C and E Preferred Stock and payments totaling $82 to the holders of the Company's Series A Preferred Stock to induce conversion of the shares into Common Stock. As a result of the conversion, the Company recorded a charge to additional paid in capital of $1,043 which reflects: (i) the accrual of dividends on the Series C and E Redeemable Preferred Stock from September 30, 1994 through October 6, 1994 totaling $15, (ii) the acceleration of accretion to redemption value of the Company's Series C and E Redeemable Preferred Stock totaling $782, (iii) payment of dividends to the holders of the Company's Series A Preferred Stock totaling $164 and (iv) payments of conversion inducements to the holders of the Series A Preferred Stock totaling $82. F-10 91 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) 4. EXTRAORDINARY ITEMS: The extraordinary items are losses on early extinguishment of debt and include the following components:
YEAR ENDED SEPTEMBER 30, -------------------------- 1993 1994 1995 ---- ------ ------ Unamortized debt issuance costs.................... $281 $1,174 $3,044 Unamortized OID.................................... -- -- 4,138 Conversion and tender fees and expenses............ -- -- 2,635 ---- ------ ------ 281 1,174 9,817 Deferred tax benefit............................... -- -- (911) ---- ------ ------ $281 $1,174 $8,906 ==== ====== ======
5. RECEIVABLES: Receivables, which consist primarily of trade accounts receivable of $15,580 at June 30, 1996 and $8,309 at September 30, 1995, have been reduced by allowances for doubtful accounts of $4,434 and $2,503, respectively. Included in receivables and deferred revenue at June 30, 1996 and September 30, 1995 are July 1996 and October 1995 invoices billed in advance of the periods in which the services are provided totaling $6,321 and $4,667, respectively. The provisions for doubtful accounts for the years ended September 30, 1993, 1994, and 1995 and the nine months ended June 30, 1995 and 1996 were $21, $789, $1,751, $1,238 and $1,518 respectively. 6. PROPERTY AND EQUIPMENT: Property and equipment are summarized as follows:
AT SEPTEMBER 30, ------------------- 1994 1995 ------- ------- Furniture and fixtures................................... $ 1,808 $ 2,004 Data processing.......................................... 1,499 2,563 Vehicles................................................. 1,106 2,568 Leasehold improvements................................... 194 634 ------- ------- 4,607 7,769 Less accumulated amortization............................ (1,489) (2,462) ------- ------- $ 3,118 $ 5,307 ======= =======
F-11 92 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) 7. SUBSCRIBER ACCOUNTS AND INTANGIBLES: Subscriber accounts and intangibles (at cost) consist of the following:
AT SEPTEMBER 30, --------------------- AT JUNE 30, 1994 1995 1996 -------- -------- ----------- (UNAUDITED) Acquired subscriber accounts.............. $122,330 $184,463 $ 276,058 Debt issuance costs....................... 5,204 7,405 8,645 Initial Public Offering Costs............. 1,305 -- -- Goodwill and other........................ 1,641 1,641 2,495 -------- -------- -------- 130,480 193,509 287,198 Less accumulated amortization............. (15,860) (31,270) (48,300) -------- -------- -------- $114,620 $162,239 $ 238,898 ======== ======== ========
Reconciliation of acquired subscriber accounts:
YEAR ENDED SEPTEMBER 30, NINE MONTHS ----------------------- ENDED JUNE 30, 1994 1995 1996 -------- -------- -------------- (UNAUDITED) Balance, beginning of period........ $ 41,986 $122,330 $184,463 Cumulative effect of change in accounting method................. -- (3,802) -- Acquisition of subscriber accounts.......................... 81,525 70,105 95,506 Charges against acquisition holdbacks......................... (1,059) (2,025) (3,911) Cancellation of Series G preferred stock............................. (122) -- -- Sale of subscriber accounts......... -- (2,145) -- -------- -------- -------- Balance, end of period.............. $122,330 $184,463 $276,058 ======== ======== ======== Number of subscriber accounts acquired during the period........ 54,211 63,611 76,848 ======== ======== ========
In conjunction with certain purchases of subscriber accounts the Company withholds a portion of the purchase price as a reserve to offset qualifying attrition of the acquired subscriber accounts for a specified period as provided for in the purchase agreements, and as a reserve for purchase price settlements of assets acquired and liabilities assumed. During the year ended September 30, 1994, purchase holdbacks as a percentage of total purchase price ranged from 0% to 20% and extended for periods of up to 12 months. During the year ended September 30, 1995, purchase holdbacks as a percentage of total purchase price ranged from 0% to 20% and extended for periods of up to 30 months. During the nine months ended June 30, 1996, purchase holdbacks as a percentage of total purchase price ranged from 0% to 30% and extended for periods up to 12 months. F-12 93 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) Reconciliation of purchase holdbacks:
YEAR ENDED NINE MONTHS SEPTEMBER 30, ENDED --------------------- JUNE 30, 1994 1995 1996 ------- ------- ----------- (UNAUDITED) Balance, beginning of period............ $ 846 $ 4,250 $ 4,949 Purchase holdbacks additions............ 5,404 6,349 11,682 Charges against subscriber accounts..... (1,059) (2,025) (3,911) Cash payments to sellers................ (941) (3,625) (132) ------- ------- ------- Balance, end of period.................. $ 4,250 $ 4,949 $12,588 ======= ======= =======
Included in subscriber account acquisitions for the year ended September 30, 1995 is the acquisition of Custom House, Inc. This acquisition has been reflected as asset purchase because (i) substantially all of the costs were allocable on the basis of fair values to the subscriber accounts acquired, which will be serviced through the Company's central monitoring station, and (ii) the business acquired is not representative of the Company's operations and therefore will be discontinued and the Company intends to abandon the trade names, dispose of most of the other assets and liquidate the corporate entity, provisions for which are reflected in the allocation of the purchase price and the accrual of transition costs. Unaudited pro forma results are not presented for the Custom House, Inc. acquisition as it is not material to the consolidated results of operations. The purchase of Metrol Security Services, Inc. (see Note 20) and its subscriber accounts was the major source of such additions for the nine months ended June 30, 1996. 8. LONG-TERM DEBT Long-term debt is comprised of the following:
AT SEPTEMBER 30, -------------------- AT JUNE 30, 1994 1995 1996 ------- -------- ----------- (UNAUDITED) Notes payable under credit agreements: Senior Subordinated Notes................. $50,000 $ -- $ -- Senior Subordinated Discount Notes........ -- 166,000 166,000 Unamortized original issue discount....... (4,292) (52,229) (39,993) Revolving credit facility................. 40,800 32,252 80,949 Other..................................... 334 1 94 ------- -------- --------- 86,842 146,024 207,050 Less current portion........................ (334) (1) (94) ------- -------- --------- $86,508 $146,023 $ 206,956 ======= ======== =========
On November 3, 1993, the Company issued 50,000 units (the Units) with each Unit consisting of one, $1,000 face value, 12%, Series A Senior Subordinated Note (the Notes) and 28 detachable Warrants to purchase shares of the Company's Common Stock. The Notes had an aggregate principal amount of $50,000 and were scheduled to mature on November 1, 2003. Interest was payable semi-annually on May 1 and November 1, commencing in May 1994. The Notes had optional redemption provisions and mandatory redemption provisions in the event of change of control of the Company. A portion of the proceeds from the Units were assigned as the value attributable to the warrants resulting in a $4,494 original issue discount F-13 94 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) (OID) which is being amortized over the maturity period of the Notes using the effective interest method. The Company recorded discount amortization of $202 and $155 which is included in the consolidated statement of operations as a component of interest expense for the years ended September 30, 1994 and 1995, respectively. The Units were issued in a private placement to qualified institutional buyers as defined under Rule 144A under the Securities Act of 1933. In December 1993, the Company filed a registration statement with respect to the issuance of Series B Senior Subordinated Notes (Series B Notes) which were identical in all material respects to those issued. This registration statement became effective on May 16, 1994 and the holders of the Notes subsequently exchanged the Notes for the Series B Notes. On November 3, 1993, the Company entered into a $30 million revolving credit facility with a financial institution which was originally scheduled to mature in 1996. Borrowings under the Revolving Credit Facility bear interest at the lesser of the bank's prime rate plus 1.25% (10% at September 30, 1995) or LIBOR plus 3% (9.125% at September 30, 1995). On June 30, 1995, the Revolving Credit Facility was amended to increase the maximum amount available thereunder to $75 million, to add two banks as lenders and to modify certain financial covenants and availability tests. On June 7, 1996, the Revolving Credit Facility was further amended to increase the maximum amount available thereunder to $100 million, to reduce the interest rate payable on such borrowings, to extend the term of the Revolving Credit Facility to January 3, 2000 and to further modify certain financial covenants and availability tests. The notes payable under the credit agreement are collateralized by substantially all of the Company's assets and the Company's rights and interests in subscriber contracts and agreements. Availability of funds under the credit agreement is subject to certain financial covenants and ratios including: (i) maximum senior debt to annualized earnings before interest, taxes, depreciation and amortization (EBITDA); (ii) maximum total debt to annualized EBITDA; and (iii) maximum senior debt to monthly recurring revenues (MRR). At June 30, 1996, borrowings under the agreement amounted to $80,949 of which $28,432 bears interest at LIBOR plus 2.5% and $52,517 bears interest at prime plus 1.0%. In May 1995, the Company completed a refinancing plan (the Refinancing) to increase its operating and financial flexibility and provide additional funds to finance the acquisition of subscriber accounts. The principal components of the Refinancing were: 1. The offering of $166 million Senior Subordinated Discount Notes and warrants to purchase 531,200 shares of common stock at $6.60 per share. The net proceeds of $105.2 million were used to (i) repurchase all $50 million principal amount of the Series B Notes for an aggregate $52.5 million; (ii) repay $51.1 million of the Company's borrowings under its revolving credit facility; (iii) finance the repurchase of 25% of the outstanding shares of the Series F Preferred Stock from the holder thereof; and (iv) pay accrued interest on the Series B Notes to the date of repurchase, accrued dividends on the Series F Preferred Stock to the date of repurchase and certain fees relating to the extension of the maturity date of the Revolving Credit Facility. 2. The execution of an amendment to the Revolving Credit Facility in order to permit the consummation of the Refinancing and to provide for the extension of the maturity date of the Revolving Credit Facility from November 1996 to November 1997. 3. The repurchase by POI of 25% of the outstanding shares of Series F Preferred Stock from the holder thereof for consideration consisting of approximately $2.0 million in cash and the exchange of the remaining shares of Series F Preferred Stock for Series H Cumulative Convertible Preferred Stock. F-14 95 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) The Senior Subordinated Discount Notes are unsecured subordinated obligations of Monitoring, limited to $166 million aggregate principal amount at maturity, and will mature on June 30, 2005. These notes were sold at a substantial discount from their principal amount, and will accrete to face value through June 30, 1998. Although for federal income tax purposes a significant amount of original issue discount, taxable as ordinary income, will be recognized by a holder as such discount accrues from the issue date, no interest will be payable prior to December 31, 1998. From and after June 30, 1998, cash interest on the notes will accrue at the rate of 13 5/8% per annum, payable in cash semiannually on June 30 and December 31, of each year, commencing December 31, 1998. The Senior Subordinated Discount Notes are redeemable, at Monitoring's option, in whole or in part, at any time or from time to time, on or after June 30, 2000 and prior to maturity, upon not less than 30 nor more than 60 days' prior notice at certain specified redemption prices plus accrued and unpaid interest. The Senior Subordinated Discount Notes are fully, unconditionally and jointly and severally guaranteed on a senior subordinated basis by POI and by Services. As of September 30, 1995, Services is the only subsidiary of Monitoring. The Senior Subordinated Discount Notes contain covenants which, among other matters, limit the Company and its Subsidiaries' ability to incur indebtedness, pay dividends, sell assets, make stock distributions or sell shares of certain subsidiaries. Scheduled maturities of long-term debt as of June 30, 1996 are as follows: Fiscal Year Ending September 30, 1996.................................................... $ 94 1997.................................................... -- 1998.................................................... -- 1999.................................................... -- 2000.................................................... 80,949 Thereafter.............................................. 166,000 -------- 247,043 Less unamortized OID...................................... (39,993) -------- $207,050 ========
9. OTHER LIABILITIES: Other liabilities are comprised of the following:
AT SEPTEMBER 30, AT JUNE 30, ----------------- ------------------- 1994 1995 1995 1996 ---- ------ ------ ------ (UNAUDITED) Deferred acquisition payments...... $820 $1,057 $ 850 $1,088 Other.............................. 114 22 365 162 ---- ------ ------ ------ $934 $1,079 $1,215 $1,250 ==== ====== ====== ====== Classified as follows: Other current liabilities........ $634 $ 800 $ 843 $ 646 Other liabilities................ 300 279 372 604 ---- ------ ------ ------ $934 $1,079 $1,215 $1,250 ==== ====== ====== ======
F-15 96 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) At September 30, 1995 deferred acquisition payments are due as follows: Fiscal Year Ending September 30: 1996...................................................... $ 782 1997...................................................... 220 1998...................................................... 45 1999...................................................... 10 ------- $1,057 =======
10. STOCK WARRANTS AND OPTIONS: Performance Warrants to purchase 500,472 shares of Common Stock at an exercise price of $0.167 per share were issued to certain officers of the Company on September 16, 1991 and were to be earned upon attainment of certain return on investment objectives and were to vest over a five year period of employment after the date of issuance. Such objectives were not achieved as of June 29, 1994, when the Board of Directors and the officers modified the earnings and vesting criteria such that vesting occurred on that date for all Performance Warrants. The modified Performance Warrant agreements provide that the officers will not exercise more than 40% and 70% of the Warrants prior to September 16, 1995 and 1996, respectively. In the event the Company is acquired, such restriction on exercise by officers would be released. Accordingly, compensation expense in an amount equal to the excess of the fair market value of the Common Stock issuable on exercise of the Performance Warrants over the exercise price is reflected as a non-cash expense in the amount of $4,504 in the year ended September 30, 1994. The outstanding warrants are exercisable and expire in September of 2002. On November 3, 1993, the Company issued 50,000 units (the Units) with each Unit consisting of one, $1,000 face value, 12%, Series A Senior Subordinated Note and 28 detachable Warrants (total of 1,400,000 warrants) to purchase shares of the Company's Common Stock. Each warrant, when exercised, will entitle the holder to receive six-tenths of one share of the Company's Common Stock at an exercise price of $.167 per share, subject to adjustment. The outstanding warrants are exercisable and will automatically expire on November 1, 2003. In June 1994, the Board of Directors adopted, and the stockholders of the Company approved, the 1994 Stock Option Plan (the Plan). The Plan provides for the award of incentive stock options to directors, officers and key employees. Three hundred fifty four thousand (354,000) shares are reserved for issuance under the Plan, subject to such adjustment as may be necessary to reflect changes in the number or kind of share of Common Stock or other securities of the Parent Company. The Plan provides for the granting of options that qualify as incentive stock options under the Internal Revenue Code and options that do not so qualify. During the year ended September 30, 1995, the Company granted options to purchase an aggregate of 273,600 shares of Common Stock, including options for 132,000 shares granted to officers of the Company. Each option has a term of 10 years and vests 20% on each of the third through seventh anniversaries of the later of (i) the commencement of the participant's employment with the Company or (ii) September 16, 1991. The purchase price of the shares issuable pursuant to these options is equal to fair market value of the Common Stock at the date of grant. During the nine months ended June 30, 1996, the Plan was amended to increase the total number of shares of Common Stock for which options may be issued to 944,000, and the Company granted options to purchase an aggregate of 609,200 shares of Common Stock, including options for 400,000 shares granted to F-16 97 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) officers of the Company. Each option has a term of 10 years and vests in equal annual installments over a five-year period that generally begins on the first anniversary of the grant date. The purchase prices of the shares issuable pursuant to these options is equal to the fair market value of the Common Stock at the date of grant. In connection with the issuance of the Senior Subordinated Discount Notes in May of 1995, the Company issued warrants to purchase of 531,200 shares of Common Stock at an exercise price of $6.60 per share. The outstanding warrants are immediately exercisable and expire in May of 2005. A summary of warrant and option activity is as follows:
WARRANTS AND OPTIONS PRICE RANGE ----------- ---------------- Outstanding September 30, 1992.................. 705,274 $0.167 - 3.663 Granted......................................... 128,260 2.533 Exercised....................................... -- --------- Outstanding September 30, 1993.................. 833,534 0.167 - 3.663 Granted......................................... 840,000 0.167 Exercised....................................... (99,841) 0.167 Surrendered..................................... (1,264) 0.167 --------- Outstanding September 30, 1994.................. 1,572,429 0.167 - 3.663 Granted......................................... 804,800 5.875 - 9.125 Exercised....................................... (256,799) 0.167 - 6.50 Surrendered..................................... (14,400) 6.50 --------- Outstanding September 30, 1995.................. 2,106,030 0.167 - 9.125 Granted......................................... 609,200 8.00 - 15.00 Exercised....................................... (72,332) 0.167 - 6.50 Surrendered..................................... (14,760) 6.50 - 8.00 --------- Outstanding June 30, 1996 2,628,138 ========= Exercisable at: September 30, 1995............................ 1,907,310 0.167 - 6.50 June 30, 1996................................. 1,856,098 0.167 - 15.00
11. CAPITAL STOCK:
AT SEPTEMBER 30, ------------------ 1994 1995 ------- ------ REDEEMABLE PREFERRED STOCK: Series C Cumulative Convertible Preferred Stock, $.10 par value; 10,900 shares authorized, 10,897 issued and outstanding at September 30, 1994........................................... $11,882 $ -- Series E Cumulative Convertible Preferred Stock, $.10 par value; 2,000 shares authorized, 2,000 issued and outstanding at September 30, 1994........................................... 2,158 -- Series F Cumulative Preferred Stock, $.10 par value; 9,670 shares authorized, 8,170 shares issued and outstanding at September 30, 1994........................................... 8,170 -- Series H Cumulative Convertible Preferred Stock, $.10 par value; 6,127 shares authorized, issued and outstanding at September 30, 1995..................................................... -- 6,127 -------- ------- $22,210 $6,127 ======== =======
F-17 98 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) On November 3, 1993, the Company: issued 2,358 shares of Series G Cumulative Convertible Preferred Stock in conjunction with the acquisition of Home Security Specialists (HSS); issued its Class B Common Stock and redeemed 1,500 shares of its Series F Cumulative Preferred Stock. 122 Shares of Series G Cumulative Convertible Preferred Stock were subsequently cancelled in conjunction with the final determination of the purchase price of HSS. In May 1995, the Company repurchased all of the outstanding shares of Series F Cumulative Preferred Stock from the holder thereof for a consideration consisting of approximately $2.0 million in cash and 6,127 newly issued shares of Series H Cumulative Convertible Preferred Stock. Conversion Rights The Series H Cumulative Convertible Preferred Stock is convertible into Common Stock at the option of the stockholder. The initial conversion price, which is subject to antidilution adjustments is $9.00 per share. Voting Rights The holder of Series H Cumulative Convertible Preferred Stock generally has no voting rights except under certain circumstances such as failure of the Company to pay dividends. The holders of the Common Stock have voting rights equal to the number of shares held. Liquidation Preferences and Dividends The Series H Cumulative Convertible Preferred Stock has a liquidation preference to the Common Stock and receives annual cash dividends at the rate of $110 per share, payable quarterly. Dividends for Series H Cumulative Convertible Preferred stock are subject to increase if the Company fails to redeem shares under mandatory redemption provisions. As described in Note 3, all accumulated unpaid dividends were paid on October 6, 1994 in conjunction with the conversion of preferred shares into common stock. Loss Per Common Share The computation of fully diluted net loss per share for the years ended September 30, 1993, 1994 and 1995 was antidilutive; as such, no presentation of fully diluted earnings per share has been included in the consolidated statements of operations. The weighted average shares outstanding used in the computation of net loss attributable to common shares are as follows:
NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, JUNE 30, --------------------------------- ------------------------- 1993 1994 1995 1995 1996 ------- ------- --------- --------- ----------- (UNAUDITED) Common Stock........................ 103,995 129,705 8,695,395 8,604,864 10,749,983 Class B Common Stock................ 164,880 2,792 -- -- ------- ------- --------- --------- ---------- 103,995 294,585 8,698,187 8,604,864 10,749,983 ======= ======= ========= ========= ==========
Mandatory Redemption Generally, any holder of the Series H Cumulative Preferred Stock may require the Company to redeem all of the holder's outstanding shares of such stock on December 31, 2005. In addition, the preferred F-18 99 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) stockholders may accelerate their redemption rights upon the occurrence of certain events, such as merger or disposition of substantially all of the Company's assets. The redemption price for all redemptions is 100% of the applicable issue price for such series plus accumulated dividends, whether or not declared. The redeemable preferred stock was recorded at fair value on the date of issuance less issue costs. The excess of redemption value over the carrying value is being accreted by periodic charges over the maturity of the issue. For the year ended September 30, 1995, the accretion was charged to additional paid in capital. Previously such accretions were charged to accumulated deficit. During the years ended September 30, 1993, 1994 and 1995, the accretion charges were comprised of:
YEAR ENDED SEPTEMBER 30, ------------------------ 1993 1994 1995 ------ ---- ---- Amortization of stock issuance costs................ $ 460 $ 91 $782 Accrual of Series C, D, and E Preferred Stock Dividends......................................... 715 662 15 ------ ----- ----- $1,175 $753 $797 ====== ===== =====
The difference between the carrying value and redemption value of these shares consists of the unamortized portion of stock issuance costs which aggregated $782 at September 30, 1994. Optional Redemption The Company, at the option of the Board of Directors, may redeem all of the outstanding shares or any portion, thereof, of the Series H Cumulative Preferred Stock at the minimum amount of $500 per share. The redemption price of the shares is equal to 100% of the issue price plus accumulated dividends whether or not earned or declared. All of the Series H Cumulative Preferred Stock was converted to shares of POI common stock in February, 1996. 12. RELATED PARTIES: Two directors each received consulting fees of $50 during the years ended September 30, 1993 and 1994. During the year ended September 30, 1993 the Company paid interest to a related party totaling $287 relating to notes payable which were repaid in December 1992 with the issuance of Series F Preferred Stock. The Company paid approximately $168 to an affiliate of a preferred stockholder during the year ended September 30, 1994 as consideration for the services rendered under a Finder's Agreement, and the Finder's Agreement was terminated. 13. INCOME TAXES: For the years ended September 30, 1994 and 1995, the Company recognized continuing operations' federal and state deferred tax benefits of $2,863 and $3,595, respectively. Such benefits were recognized because valuation allowances were reduced as a result of utilization of net operating losses to offset temporary differences that generate deferred tax liabilities during the carryforward period. At June 30, 1996, the Company had $33.4 million in NOL carryforwards for regular federal tax purposes and $26.7 million for alternative minimum tax (AMT NOL) purposes which expire in the years 2006-2010. The Company also has certain general business and job credit carryforwards. These carryforwards are available, subject to certain restrictions, to reduce taxable income, alternative minimum taxable income and income taxes payable in future years. As a result of the warrants to purchase common stock issued in conjunction with the Company's refinancing plan, as well as various prior issuances of preferred and common stock and stock warrants, or if there are future substantial changes in the Company's ownership, there may be annual limitations on the F-19 100 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) amount of NOL and AMT NOL carryforwards, as well as tax credits, that can be used to reduce taxable income, alternative minimum taxable income and income taxes payable. The components of deferred tax assets and liabilities are:
AT SEPTEMBER 30, --------------------- AT JUNE 30, 1994 1995 1996 -------- -------- ----------- (UNAUDITED) Deferred tax assets: Accounts receivable, due to allowances for doubtful accounts................ $ 383 $ 1,000 $ 1,772 Acquisition reserves and holdbacks...... 2,158 2,365 5,465 Performance warrants.................... 1,761 1,800 1,800 Net operating loss carryforwards........ 10,854 15,688 13,340 OID amortization........................ -- 2,174 6,936 Other................................... 151 37 56 Less valuation allowance................ (620) (3,573) (506) -------- -------- -------- Total deferred tax assets....... 14,687 19,491 28,863 Deferred tax liabilities: Differences in depreciation and amortization......................... (18,191) (19,491) (29,655) -------- -------- -------- Net deferred tax liabilities.... $ (3,504) $ -- $ (792) ======== ======== ========
During the year ended September 30, 1994, the Company acquired American Home Security, Home Security Specialists, Statewide Security, Alarmtek, Inc., Nevada Central, Inc. and A-Able Lock & Alarm, Inc. During the year ended September 30, 1995, the Company acquired Custom House, Inc. For financial reporting purposes, the assets acquired and liabilities assumed were valued at fair market value as of the date of purchase. For income tax purposes, the acquisitions were treated as stock purchases with the acquired assets and liabilities retaining their historical tax basis. The net basis increase for financial reporting purposes of approximately $43 million has no federal and state income tax basis and is not deductible for tax purposes. The deferred tax liability resulting from the acquisition basis difference, together with the Company's deferred tax liability, exceeded the Company's deferred tax assets at the dates of purchases. The temporary differences creating the deferred tax liabilities are expected to reverse within the carryforward period of the Company's NOL and AMT NOL. The valuation allowances at September 30, 1994 and September 30, 1995 reflect current estimates of limitations on utilization of NOL carryforwards for federal and state income tax purposes. The income tax benefit (expense) is comprised of the following:
YEAR ENDED SEPTEMBER 30, JUNE 30, ---------------------------- ---------------- 1993 1994 1995 1995 1996 ------ ------ ------ ------ ----- Current Federal.............................. $ -- $ -- $ -- $ -- $ (90) State................................ -- -- -- -- -- --- ------ ------ ------ ----- Total current................ -- -- -- -- (90) --- ------ ------ ------ ----- Deferred Federal.............................. -- 2,663 4,594 3,854 -- State................................ -- 200 1,120 704 -- --- ------ ------ ------ ----- Total deferred............... -- 2,863 5,714 4,559 -- --- ------ ------ ------ ----- Total income tax benefit (expense)... $ -- $2,863 $5,714 $4,559 $ (90) === ====== ====== ====== =====
F-20 101 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) The differences between the income tax benefit at the Company's effective tax rate differed from the benefit at the statutory rate as follows:
FOR THE NINE MONTHS YEAR ENDED SEPTEMBER 30, ENDED JUNE 30, --------------------------- ------------------- 1993 1994 1995 1995 1996 ----- ------ ------ ------- ------- Computed "expected" tax benefit......... $ 859 $3,178 $7,620 $ 6,626 $ 3,774 State income tax benefit, net........... 121 537 1,336 1,162 666 Other................................... (15) (8) (289) 14 (136) Loss for which no tax benefits were provided.............................. (965) (844) (2,953) (3,243) (4,304) ----- ------ ------ ------ ------ Total income tax benefit................ $ -- $2,863 $5,714 $ 4,559 $ -- ===== ====== ====== ====== ====== Income tax benefits included in the statement of operations are as follows: Continuing operations................... $ -- $2,863 $3,595 $ 2,432 $ -- Extraordinary item -- loss on early extinguishment of debt................ -- -- 911 919 -- Cumulative effect of change in accounting method..................... -- -- 1,208 1,208 -- ----- ------ ------ ------ ------ $ -- $2,863 $5,714 $ 4,559 $ -- ===== ====== ====== ====== ======
The tax benefit of the extraordinary item and change in accounting method resulted from recognition of the benefit of the related NOL carryforward to the extent of available deferred tax credits. Such credits permitted full recognition of the benefit related to the change in accounting method and limited the recognition of the benefit of the extraordinary item to $911. A valuation allowance was required equal to the benefit of the unused federal and state NOL carryforwards at September 30, 1995. At June 30, 1996, a valuation allowance was required equal to the benefit of the unused state NOL carryforward. 14. SUPPLEMENTAL DISCLOSURE OF NONCASH INVESTING AND FINANCING ACTIVITIES: Acquisitions
NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, JUNE 30, ------------------------------ ----------------------- 1993 1994 1995 1995 1996 ------ ------- ------- ------- ----------- (UNAUDITED) Subscriber accounts acquired.............. $8,758 $81,525 $70,105 $63,161 $ 95,506 Goodwill................ -- 1,641 -- -- -- Cash acquired........... -- 240 -- -- -- Other assets acquired... 254 2,584 113 81 5,932 ------ ------- ------- ------- --------- Total assets acquired......... 9,012 85,990 70,218 63,242 101,438 ====== ======= ======= ======= ========= Cash paid to seller..... 6,216 58,404 49,361 44,992 72,757 Stock issued to seller................ -- 2,358 -- -- 6,843 Acquisition expenses.... 615 1,905 1,451 500 646 Deferred revenue assumed............... 389 4,567 3,213 3,117 3,934 Other assumed liabilities........... 1,792 18,756 16,193 14,633 17,258 ------ ------- ------- ------- --------- Purchase price and assumed liabilities... $9,012 $85,990 $70,218 $63,242 $ 101,438 ====== ======= ======= ======= =========
Cash paid to sellers, payments for acquisition expenses and payments on liabilities assumed in conjunction with acquisitions are included in cash used in investing activities in the period paid. Deferred revenue, which represents advance payments by subscribers, is recognized as revenues in the period in which F-21 102 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) the related service is provided. Such amounts are considered a non-cash component of operations and are reflected as a reduction in cash provided by operating activities. The following reflects increases (decreases) in assets and accumulated deficit, and decreases (increases) in liabilities and capital stock resulting from noncash investing and financing activities which occurred during the year ended September 30, 1993:
PROPERTY REDEEMABLE SUBSCRIBER AND OTHER PURCHASE LONG-TERM PREFERRED ACCUMULATED ACCOUNTS EQUIPMENT LIABILITIES HOLDBACKS DEBT STOCK DEFICIT ---------- --------- ----------- --------- --------- ---------- ----------- Adjustment to acquisition transition costs............... $ (203) $ 203 Charge-off of purchase holdbacks...................... (131) $ 131 MRR guarantee.................... (259) $ 259 Debt exchanged for Series F Preferred Stock................ $ 6,670 (6,670) Dividends declared............... $(218) $ 218 Accretion to redemption value of preferred stock................ (1,175) 1,175 ----- ----- ---- ---- ------ ------- ------ $ (593) $(218) $ 203 $ 131 $ 6,670 $ (7,586) $ 1,393 ===== ===== ==== ==== ====== ======= ======
The following reflects increases (decreases) in assets and accumulated deficit, and decreases (increases) in liabilities and capital stock resulting from noncash investing and financing activities which occurred during the year ended September 30, 1994:
REDEEMABLE ADDITIONAL SUBSCRIBER PURCHASE COMMON PREFERRED PREFERRED PAID-IN ACCUMULATED ACCOUNTS HOLDBACKS STOCK STOCK STOCK CAPITAL DEFICIT ---------- --------- ------ ---------- -------- ---------- ----------- Restatement of par value............. $ 9 $895 $ (904) Charge-off of purchase holdbacks..... $ (1,059) $ 1,059 Cancellation of Series G preferred stock.............................. (122) 122 Exercise of stock purchase warrants........................... (1) 1 Accretion to redemption value of preferred stock.................... $ (753) $ 753 ------- ------ --- ----- ---- ----- ---- $ (1,181) $ 1,059 $ 8 $ (753) $895 $ (781) $ 753 ======= ====== === ===== ==== ===== ====
The following reflects increases (decreases) in assets and accumulated deficit, and decreases (increases) in liabilities and capital stock resulting from noncash investing and financing activities which occurred during the year ended September 30, 1995:
CLASS B COMMON REDEEMABLE AND ADDITIONAL SUBSCRIBER PURCHASE COMMON PREFERRED PREFERRED PAID-IN ACCOUNTS HOLDBACKS STOCK STOCK STOCK CAPITAL ---------- --------- ------ ---------- --------- ---------- Accretion to redemption value of preferred stock............................ $ (15) $ 15 Charge-off of purchase holdbacks............. $ (2,025) $ 2,025 Accelerated accretion upon conversion of preferred stock............................ (782) 782 Reclassification of IPO costs................ (1,305) 1,305 Conversion of Class B common and preferred stock...................................... $(56) 12,897 $ 85 (12,926) ------- ------ ---- ------- --- -------- $ (3,330) $ 2,025 $(56) $ 12,100 $ 85 $(10,824) ======= ====== ==== ======= === ========
F-22 103 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) The following reflects increases (decreases) in assets, and decreases (increases) in liabilities and additional paid-in capital resulting from non-cash investing and financing activities which occurred in the nine months ended June 30, 1996 (unaudited) (dollar amounts in thousands):
PURCHASE COMMON ADDITIONAL PAID SERIES H INTANGIBLES HOLDBACKS STOCK IN CAPITAL PREFERRED STOCK ----------- --------- ------ --------------- --------------- Charge off of purchase holdbacks....... $(3,911) $ 3,911 -- -- -- Conversion of Series H preferred stock................................ -- -- $ (7) $ (6,120) $ 6,127 Common Shares issued for Metrol........ 6,843 -- (4) (6,839) -- Reclassification of stock offering costs................................ (539) -- -- 539 -- ------- ------ --- ------- ------ $ 2,393 $ 3,911 $(11) $ (12,420) $ 6,127 ======= ====== === ======= ======
In fiscal 1995 the Company received inventory from a supplier in settlement of a claim. The estimated fair value of the inventory was determined through a subsequent sale to an independent third party. In connection with such settlement, the Company recorded revenue of approximately $1.6 million, which is reflected in other revenues in the Company's statement of operations. 15. EMPLOYEE BENEFIT PLANS: 401(k) Plan The Company maintains a tax-qualified, defined contribution plan that meets the requirements of Section 401(k) of the Internal Revenue Code (the 401(k) Plan). The Company at its election also may make contributions to the 401(k) Plan, which contributions will be allocated among participants based upon the respective contributions made by the participants through salary reductions during the applicable plan year. The Company's matching contribution may be made in Common Stock, in cash or in a combination of both stock and cash. There were no contributions made to the plan by the Company during the three year period ended September 30, 1995. Employee Stock Purchase Plan In August 1995, the Board of Directors of the Company voted to adopt the Protection One, Inc. Employee Stock Purchase Plan, subject to approval of the Employee Stock Purchase Plan by the affirmative vote of a majority of the shares of Common Stock outstanding and present in person or by proxy at the next annual meeting of the Company's stockholders. The Employee Stock Purchase Plan is designed to qualify as an "Employee Stock Purchase Plan" within the meaning of Section 423 of the Internal Revenue Code, and will allow eligible employees to acquire shares of Common Stock at periodic intervals through their accumulated payroll deductions. A total of 650,000 shares of Common Stock have been reserved for issuance under the Employee Stock Purchase Plan, which is administered by the Compensation Committee. The purchase price of shares of Common Stock purchased under the Employee Stock Purchase Plan during any purchase period will be the lower of (i) 85% of the fair market value of the Common Stock on the first day of that purchase period or (ii) 85% of the fair market value of the Common Stock on the purchase date. Termination of a participant's employment for any reason (including death, disability or retirement) cancels participation in the Employee Stock Purchase Plan immediately. The Employee Stock Purchase Plan will in all events terminate upon the earliest to occur of (i) the last business day in September 2005, (ii) the date on which all shares available for issuance under the plan have been sold or (iii) the date on which all F-23 104 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) purchase rights are exercised in connection with an acquisition of the Company or all or substantially all of its assets. 16. COMMITMENTS AND CONTINGENCIES: The Company leases office facilities for lease terms maturing through 2005. At September 30, 1995 future minimum lease payments under noncancelable operating leases are as follows:
Year ending September 30, 1996........................................... $1,355 1997........................................... 1,227 1998........................................... 1,107 1999........................................... 889 2000........................................... 719 Thereafter..................................... 3,010 ------- $8,307 =======
Total rent expense for the years ended September 30, 1993, 1994 and 1995 was $581, $787 and $1,261, respectively. The Company is a party to claims and matters of litigation incidental to the normal course of its business. The ultimate outcome of these matters cannot presently be determined; however, in the opinion of management of the Company, the resolution of these matters will not have a material adverse effect on the Company's consolidated financial position, results of operations and cash flows. 17. PURCHASE ACCOUNTING ACCRUAL ADJUSTMENTS: In connection with the acquisition of the Company from its previous owners on September 16, 1991, the Company accrued liabilities associated with reprogramming installed systems due to planned telephone area code changes in Southern California and Washington and anticipated costs of extended service commitments made to certain customers by independent alarm dealers from whom the Predecessor Company purchased the customer accounts. These anticipated future costs were included in the original purchase price allocation. Due primarily to customer moves, the resigning of customers under new contracts and account attrition, the anticipated future cost associated with extended service commitments was reduced by $1,203. This reduction, and $461 in additional costs incurred related to the area code change have been reflected in the consolidated statement of operations for the year ended September 30, 1993 as follows: Additional cost of system reprogramming............................ $ 461 Extended service adjustment........................................ (1,203) ----- Adjustment of purchase accounting accruals......................... $ (742) =====
18. FAIR VALUE OF FINANCIAL INSTRUMENTS For certain of the Company's financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and other accrued liabilities, the carrying amounts approximate fair value due to their short maturities. The Company's Revolving Credit Facility, which bears a floating market rate of interest, and the Series H Redeemable Preferred Stock are carried at amounts which approximate fair value. F-24 105 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) At September 30, 1995, the Senior Subordinated Discount Notes have an estimated fair value of approximately $131,389 based on their quoted market price as compared to their carrying value of $113,771. The estimated fair values may not be representative of actual values of the financial instruments that could have been realized at year end or may be realized in the future. 19. SUPPLEMENTAL SUBSIDIARY COMPANY SUMMARIZED FINANCIAL INFORMATION: Protection One, Inc. has fully and unconditionally guaranteed the Senior Subordinated Discount Notes of Monitoring on a joint and several basis. POI has no independent operations and the consolidated revenues and costs of operations are substantially reflected in the accounts of Monitoring. The operations of Monitoring are significantly interconnected and share common management, employees and facilities and serve a common customer base. Separate summarized financial information of Services is not presented because management believes that such separate summarized financial information is not material to investors. The summarized consolidated financial information of Monitoring and its subsidiary Services is presented below.
AT SEPTEMBER 30, ----------------------------- AT JUNE 30, 1994 1995 1996 -------- -------- ----------- (UNAUDITED) Summarized Balance Sheet Assets Current assets............................. $ 8,141 $ 10,733 $24,126 Subscriber accounts and intangibles, net... 114,620 162,239 238,898 Other non-current assets................... 3,323 5,696 11,405 Liabilities and Stockholder's Equity Deferred revenue........................... $ 6,785 $ 9,166 $13,763 Other current liabilities.................. 12,862 10,727 21,405 Long-term debt, net of current portion..... 86,508 146,023 206,956 Other long-term liabilities................ 3,804 279 604 Stockholder's equity....................... 16,125 12,473 30,909
NINE MONTHS ENDED YEAR ENDED SEPTEMBER 30, JUNE 30, ----------------------------- --------------------- 1993 1994 1995 1995 1996 -------- ------- -------- ------- ----------- (UNAUDITED) Summarized Statements of Operations Revenues................................... $ 21,890 $34,480 $ 55,882 $38,965 $51,795 Gross profit............................... 14,429 22,156 36,663 25,080 34,459 Loss before extraordinary items and cumulative effect of change in accounting method -- net................ (2,531) (6,492) (5,839) (4,082) (11,099) Net loss................................... (2,812) (7,666) (16,700) (14,934) (11,099)
20. ACQUISITION (UNAUDITED) On June 28, 1996 the Company acquired all of the outstanding stock of Metrol Security Services, Inc. ("Metrol"). Metrol sells, installs, services and monitors security alarm systems and provides guard and patrol services to residential and commercial subscribers in Arizona and New Mexico. F-25 106 PROTECTION ONE, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) (DOLLAR AMOUNTS IN THOUSANDS EXCEPT FOR PER SHARE AMOUNTS) The purchase price was allocated to the assets and subscriber accounts acquired and the liabilities assumed on the basis of fair values at June 28, 1996 as follows (in thousands): Subscriber accounts acquired............................... $30,294 Inventories................................................ 754 Receivables, net........................................... 1,711 Property and equipment..................................... 1,884 Other assets acquired...................................... 622 ------- $35,265 ======= Cash paid to seller........................................ $21,296 Stock issued to seller..................................... 6,843 Acquisition costs.......................................... 88 Purchase holdback.......................................... 3,000 Acquisition transition costs............................... 500 Deferred revenue........................................... 1,730 Other liabilities assumed.................................. 1,808 ------- $35,265 =======
The following unaudited pro forma condensed consolidated results of operations present information as if the acquisition had occurred as of the beginning of each of the nine month periods ended June 30, 1995 and 1996. The pro forma information is presented after giving effect to certain adjustments for the amortization of subscriber accounts, interest expense and the disposition of Metrol's guard operations. Certain of Metrol's expenses were estimated based on annual amounts incurred. Management believes the estimates provide a reasonable approximation of actual results. The pro forma information is provided for informational purposes only. It is based on historical information and is not necessarily indicative of future results of operations.
PRO FORMA FOR THE NINE MONTHS ENDED JUNE 30, --------------------- 1995 1996 ------- ------- Revenues............................................... $46,139 $60,651 Net loss before extraordinary item and cumulative effect of change in accounting method................ (6,255) (9,877) Net loss............................................... (14,281) (9,877) Net loss before extraordinary item and cumulative effect of change in accounting method, per share..... (0.87) (0.91) Net loss per common share.............................. (1.76) (0.91)
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