Table of
Contents
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM 10-Q
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the
quarterly period ended March 31, 2010
or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the
transition period from
to
1-12181-01
(Commission
file number)
PROTECTION
ONE, INC.
(Exact name of
registrant
as specified in
its charter)
Delaware
(State or other
jurisdiction
of incorporation
or organization)
93-1063818
(I.R.S. Employer
Identification No.)
1035 N.
Third Street, Suite 101
Lawrence,
Kansas 66044
(Address
of principal executive offices, including zip code)
(785)
856-5500
(Registrants
telephone number,
including
area code)
Indicate by check mark whether the registrant (1) has filed all
reports required to be filed by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12 months (or for such shorter period
that such registrants were required to file such reports) and (2) has been
subject to such filing requirements for the past 90 days. Yes
x
No
o
Indicate by check mark whether the registrant has submitted
electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of
Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or
for such shorter period that the registrant was required to submit and post
such files). Yes
o
No
o
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of large
accelerated filer, accelerated filer and smaller reporting company in Rule 12b-2
of the Exchange Act.
Large
accelerated filer
o
|
|
Accelerated
filer
o
|
|
|
|
Non-accelerated
filer
o
|
|
Smaller
reporting company
x
|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes
o
No
x
The number of outstanding shares of the registrants common stock,
$0.01 par value per share, as of May 11, 2010 was 25,435,221.
Table of Contents
FORWARD-LOOKING
STATEMENTS
This Quarterly Report on Form 10-Q and the materials incorporated
by reference herein include forward-looking statements intended to qualify
for the safe harbor from liability established by the Private Securities
Litigation Reform Act of 1995.
Statements that are not historical fact are forward-looking. These forward-looking statements generally
can be identified by, among other things, the use of forward-looking language
such as the words estimate, project, intend, believe, expect, anticipate,
may, will, would, should, could, seeks, plans, intends, or
other words of similar import or their negatives. Such statements include those made on matters
such as our earnings and financial condition, the tender offer and proposed
merger pursuant to our definitive agreement with affiliates of GTCR Golder
Rauner II, L.L.C. (GTCR), litigation, accounting matters, our business, our
efforts to consolidate and reduce costs, our customer account acquisition
strategy and attrition, our liquidity and sources of funding and our capital
expenditures. All forward-looking
statements are subject to certain risks and uncertainties that could cause
actual results to differ materially from those in the forward-looking
statements. The forward-looking
statements included herein are made only as of the date of this report and we
undertake no obligation to publicly update such forward-looking statements to
reflect subsequent events or circumstances, except as required by federal
securities laws. Certain factors that
could cause actual results to differ include:
·
our substantial indebtedness and restrictive covenants
governing our indebtedness;
·
our history of losses;
·
effects from our entry into a definitive agreement to
be acquired by an affiliate of GTCR;
·
changes in technology that may make our services less
attractive or obsolete or require significant expenditures to upgrade;
·
loss of a relationship with alarm system
manufacturers, suppliers and third party service providers;
·
competition, including competition from companies that
are larger than we are and have greater resources than we do;
·
the development of new services or service innovations
by our competitors;
·
losses of our customers over time and difficulty
acquiring new customers;
·
changes in federal, state or local government or other
regulations or standards affecting our operations;
·
limited access to capital which may affect our ability
to invest in the acquisition of new customers;
·
the potential for environmental or man-made
catastrophes in areas of high customer concentration;
·
changes in conditions affecting the economy or
security alarm monitoring service providers generally;
·
potential liability for failure to respond adequately
to alarm activations; and
·
changes in management.
New factors emerge
from time to time, and it is not possible for us to predict all factors or the
impact of any factor on our business or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from
those contained in any forward-looking statements. For a discussion of these and other risks and
uncertainties that could cause actual results to differ materially from those
contained in our forward-looking statements, please refer to Risk Factors in
our Annual Report on Form 10-K for the year ended December 31, 2009.
INTRODUCTION
Unless the context otherwise indicates, all references in this report
to the Company, Protection One, we, us or our or similar words are to
Protection One, Inc. and its wholly owned subsidiaries. Protection One, Inc. is a Delaware
corporation organized in September 1991.
Stockholders and other security holders or buyers of our securities or
our other creditors should not assume that material events subsequent to the
date of this report have not occurred.
On April 26,
2010, we entered into a definitive agreement (the Merger Agreement) to be
acquired by Protection Holdings, LLC, an affiliate of GTCR. Under the terms of
the Merger Agreement, Protection Acquisition Sub, Inc,. a newly formed entity
and wholly owned subsidiary of Protection Holdings, LLC, commenced a tender
offer on May 3, 2010 to acquire all of our outstanding common stock for
$15.50 per share in cash (the Offer), to be followed by a merger (the Merger)
to acquire all remaining outstanding shares at the same price paid in the
Offer. The Offer will expire on June 2, 2010, unless extended in
accordance with the terms of the Merger Agreement. The aggregate value of the
proposed transaction is approximately $828 million. The completion of the Offer
and Merger are subject to certain conditions and termination rights set forth
in the Merger Agreement. See Item 1A Risk Factors. The statements in this
Quarterly Report on Form 10-Q are not a solicitation or recommendation of
the Company to its stockholders in connection with the proposed tender offer,
and stockholders should carefully review the Solicitation/Recommendation
Statement on Schedule 14D-9 filed by the Company on May 3, 2010 and any
amendments thereto before making any decision as to the tender offer.
2
Table of Contents
PART I FINANCIAL INFORMATION
ITEM
1. FINANCIAL STATEMENTS.
PROTECTION
ONE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(in
thousands, except for share and per share amounts)
(Unaudited)
|
|
March 31,
|
|
December 31,
|
|
|
|
2010
|
|
2009
|
|
ASSETS
|
|
|
|
|
|
Current assets:
|
|
|
|
|
|
Cash and cash equivalents
|
|
$
|
33,253
|
|
$
|
26,068
|
|
Accounts receivable, net of allowance of $7,162 at
March 31, 2010 and $7,147 at December 31, 2009
|
|
29,408
|
|
32,719
|
|
Notes receivable
|
|
632
|
|
674
|
|
Inventories, net
|
|
5,105
|
|
5,067
|
|
Prepaid expenses
|
|
4,684
|
|
4,073
|
|
Other
|
|
2,408
|
|
2,273
|
|
Total current assets
|
|
75,490
|
|
70,874
|
|
Restricted cash
|
|
2,146
|
|
2,180
|
|
Property and equipment, net
|
|
29,007
|
|
32,068
|
|
Customer accounts, net
|
|
196,057
|
|
203,453
|
|
Dealer relationships, net
|
|
34,353
|
|
34,965
|
|
Goodwill
|
|
43,853
|
|
43,853
|
|
Trade names
|
|
27,687
|
|
27,687
|
|
Notes receivable, net of current portion
|
|
2,193
|
|
2,275
|
|
Deferred customer acquisition costs
|
|
144,015
|
|
146,024
|
|
Other
|
|
8,052
|
|
8,516
|
|
Total Assets
|
|
$
|
562,853
|
|
$
|
571,895
|
|
LIABILITIES AND STOCKHOLDERS EQUITY (DEFICIENCY
IN ASSETS)
|
|
|
|
|
|
Current liabilities:
|
|
|
|
|
|
Current portion of long-term debt and capital leases
|
|
$
|
5,192
|
|
$
|
5,358
|
|
Accounts payable
|
|
2,819
|
|
5,009
|
|
Accrued liabilities
|
|
31,139
|
|
34,633
|
|
Deferred revenue
|
|
43,907
|
|
44,280
|
|
Total current liabilities
|
|
83,057
|
|
89,280
|
|
Long-term debt and capital leases, net of current
portion
|
|
435,888
|
|
436,550
|
|
Deferred customer acquisition revenue
|
|
98,585
|
|
98,323
|
|
Deferred tax liability
|
|
5,276
|
|
4,879
|
|
Other liabilities
|
|
1,825
|
|
1,926
|
|
Total Liabilities
|
|
624,631
|
|
630,958
|
|
Commitments and contingencies (see Note 9)
|
|
|
|
|
|
Stockholders equity (deficiency in assets):
|
|
|
|
|
|
Preferred stock, $.10 par value, 5,000,000 shares
authorized
|
|
|
|
|
|
Common stock, $.01 par value, 150,000,000 shares
authorized, 25,433,371 and 25,333,371 shares issued and outstanding at March 31,
2010 and December 31, 2009, respectively
|
|
254
|
|
253
|
|
Additional paid-in capital
|
|
181,487
|
|
181,296
|
|
Accumulated other comprehensive loss
|
|
(4,130
|
)
|
(5,985
|
)
|
Deficit
|
|
(239,389
|
)
|
(234,627
|
)
|
Total stockholders equity (deficiency in assets)
|
|
(61,778
|
)
|
(59,063
|
)
|
Total Liabilities and Stockholders Equity
(Deficiency in Assets)
|
|
$
|
562,853
|
|
$
|
571,895
|
|
The accompanying
notes are an integral part of these
condensed
consolidated financial statements.
4
Table of Contents
PROTECTION
ONE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS AND COMPREHENSIVE LOSS
(in
thousands, except for per share amounts)
(Unaudited)
|
|
Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
Revenue:
|
|
|
|
|
|
Monitoring and related services
|
|
$
|
77,450
|
|
$
|
83,533
|
|
Installation and other
|
|
10,865
|
|
9,469
|
|
Total revenue
|
|
88,315
|
|
93,002
|
|
|
|
|
|
|
|
Cost of revenue (exclusive of amortization and
depreciation shown below):
|
|
|
|
|
|
Monitoring and related services
|
|
23,356
|
|
25,746
|
|
Installation and other
|
|
12,761
|
|
12,041
|
|
Total cost of revenue (exclusive of amortization and
depreciation shown below)
|
|
36,117
|
|
37,787
|
|
|
|
|
|
|
|
Operating expenses:
|
|
|
|
|
|
Selling
|
|
12,276
|
|
13,063
|
|
General and administrative
|
|
20,969
|
|
21,323
|
|
Amortization and depreciation
|
|
11,118
|
|
12,349
|
|
Total operating expenses
|
|
44,363
|
|
46,735
|
|
Operating income
|
|
7,835
|
|
8,480
|
|
Other expense:
|
|
|
|
|
|
Interest expense, net
|
|
11,872
|
|
11,103
|
|
Loss before income taxes
|
|
(4,037
|
)
|
(2,623
|
)
|
Income tax expense
|
|
725
|
|
178
|
|
Net loss
|
|
(4,762
|
)
|
(2,801
|
)
|
|
|
|
|
|
|
Other comprehensive income (loss), net of tax:
|
|
|
|
|
|
Net change in fair value of derivative
|
|
1,855
|
|
341
|
|
Comprehensive loss
|
|
$
|
(2,907
|
)
|
$
|
(2,460
|
)
|
|
|
|
|
|
|
Basic and diluted per share information:
|
|
|
|
|
|
Net loss per common share
|
|
$
|
(0.19
|
)
|
$
|
(0.11
|
)
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
25,374
|
|
25,317
|
|
The accompanying
notes are an integral part of these
condensed
consolidated financial statements.
5
Table of Contents
PROTECTION
ONE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in
thousands)
(Unaudited)
|
|
Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
Cash flows from operating
activities:
|
|
|
|
|
|
Net loss
|
|
$
|
(4,762
|
)
|
$
|
(2,801
|
)
|
Adjustments to reconcile
net loss to net cash provided by operating activities:
|
|
|
|
|
|
Gain on sale of assets
|
|
(11
|
)
|
(12
|
)
|
Amortization and
depreciation
|
|
11,118
|
|
12,349
|
|
Amortization of debt costs,
discounts and premiums and adjustments to
derivatives
|
|
1,222
|
|
(122
|
)
|
Amortization of deferred
customer acquisition costs in excess of amortization of deferred revenue
|
|
7,266
|
|
7,833
|
|
Stock based compensation
expense
|
|
192
|
|
314
|
|
Deferred income taxes
|
|
397
|
|
11
|
|
Provision for doubtful
accounts
|
|
782
|
|
1,737
|
|
Impairment of assets and
other
|
|
1,285
|
|
|
|
Changes in assets and
liabilities
|
|
|
|
|
|
Accounts receivable, net
|
|
2,528
|
|
2,995
|
|
Notes receivable
|
|
124
|
|
231
|
|
Other assets
|
|
(670
|
)
|
2,580
|
|
Accounts payable
|
|
(2,190
|
)
|
(207
|
)
|
Deferred revenue
|
|
(452
|
)
|
(465
|
)
|
Accrued interest
|
|
(4,102
|
)
|
(922
|
)
|
Other liabilities
|
|
1,970
|
|
(2,524
|
)
|
Net cash provided by
operating activities
|
|
14,697
|
|
20,997
|
|
|
|
|
|
|
|
Cash flows from investing
activities:
|
|
|
|
|
|
Deferred customer
acquisition costs
|
|
(9,099
|
)
|
(10,862
|
)
|
Deferred customer
acquisition revenue
|
|
4,206
|
|
5,237
|
|
Purchase of rental
equipment
|
|
(466
|
)
|
(587
|
)
|
Purchase of property and
equipment
|
|
(790
|
)
|
(806
|
)
|
Purchases of new accounts
|
|
(25
|
)
|
|
|
Reduction of restricted
cash
|
|
35
|
|
|
|
Proceeds from disposition
of assets and other
|
|
64
|
|
49
|
|
Net cash used in investing
activities
|
|
(6,075
|
)
|
(6,969
|
)
|
|
|
|
|
|
|
Cash flows from financing
activities:
|
|
|
|
|
|
Payments on long-term debt
and capital leases
|
|
(1,376
|
)
|
(1,389
|
)
|
Debt issue costs
|
|
(61
|
)
|
|
|
Net cash used in financing
activities
|
|
(1,437
|
)
|
(1,389
|
)
|
Net increase in cash and
cash equivalents
|
|
7,185
|
|
12,639
|
|
Cash and cash equivalents:
|
|
|
|
|
|
Beginning of period
|
|
26,068
|
|
38,883
|
|
End of period
|
|
$
|
33,253
|
|
$
|
51,522
|
|
|
|
|
|
|
|
Cash paid for interest
|
|
$
|
14,713
|
|
$
|
12,164
|
|
|
|
|
|
|
|
Cash paid for income taxes
|
|
$
|
295
|
|
$
|
98
|
|
|
|
|
|
|
|
Non-cash investing and
financing activity:
|
|
|
|
|
|
Vehicle additions under
capital lease
|
|
$
|
182
|
|
$
|
382
|
|
The accompanying
notes are an integral part of these
condensed
consolidated financial statements.
6
Table of Contents
PROTECTION
ONE, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1.
Organization, Basis of
Consolidation and Interim Financial Information:
Protection One, Inc. (the Company) is principally engaged in the
business of providing security alarm monitoring services, including sales,
installation and related servicing of security alarm systems for residential
and business customers. The Company also
provides monitoring and support services to independent security alarm dealers
on a wholesale basis. Affiliates of
Quadrangle Group LLC and Monarch Alternative Capital LP (collectively, the Principal
Stockholders) own approximately 70% of the Companys common stock.
The Companys unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles,
or GAAP, for interim financial information and in accordance with the
instructions to Form 10-Q.
Accordingly, certain information and footnote disclosures normally
included in financial statements presented in accordance with GAAP have been
condensed or omitted. These financial
statements should be read in conjunction with the audited financial statements
and notes thereto for the year ended December 31, 2009 included in the
Companys Annual Report on Form 10-K, filed with the Securities and
Exchange Commission, or the SEC, on March 24, 2010, as amended by the Form 10-K/A
filed by the Company with the SEC on April 30, 2010.
In the opinion of management of the Company, all
adjustments consisting of normal recurring adjustments considered necessary for
a fair presentation of the financial statements have been included. The results of operations presented for the
three months ended March 31, 2010 and 2009 are not necessarily indicative
of the results to be expected for the full year.
2.
Property and Equipment:
The following reflects the Companys carrying value in property and
equipment as of the following periods (in thousands):
|
|
March 31, 2010
|
|
December 31, 2009
|
|
Furniture, fixtures and equipment
|
|
$
|
7,480
|
|
$
|
7,463
|
|
Data processing and telecommunication
|
|
44,596
|
|
43,889
|
|
Leasehold improvements
|
|
6,564
|
|
8,123
|
|
Vehicles
|
|
6,106
|
|
6,122
|
|
Vehicles under capital leases
|
|
9,491
|
|
9,529
|
|
Buildings and other
|
|
6,440
|
|
6,403
|
|
Rental equipment
|
|
14,064
|
|
14,233
|
|
|
|
94,741
|
|
95,762
|
|
Less accumulated depreciation
|
|
(65,734
|
)
|
(63,694
|
)
|
Property and equipment, net
|
|
$
|
29,007
|
|
$
|
32,068
|
|
Depreciation expense was $3.1 million for each of the three months
ended March 31, 2010 and 2009, respectively. The amount of fixed asset additions included
in accounts payable was $0.1 million and $0.3 million as of March 31, 2010
and December 31, 2009, respectively.
Fixed Assets under Operating Leases
Rental equipment is comprised of commercial security equipment that
does not require monitoring services by the Company and is leased to customers,
typically over a 5-year initial lease term.
Accumulated depreciation of $4.3 million and $4.4 million was recorded
on these assets as of March 31, 2010 and December 31, 2009,
respectively. Deferred revenue of $5.1
million was recorded at March 31, 2010 and will be amortized to income
over the remaining lease term. The
following is a schedule, by year, of minimum future rental revenue on
non-cancelable operating leases as of March 31, 2010 and does not include
payments received at the inception of the lease which are deferred and
amortized to income over the lease term (in thousands):
Remainder
of 2010
|
|
$
|
762
|
|
2011
|
|
762
|
|
2012
|
|
583
|
|
2013
|
|
369
|
|
2014
|
|
137
|
|
2015
|
|
3
|
|
Total
minimum future rental revenue
|
|
$
|
2,616
|
|
7
Table of Contents
3.
Goodwill and Intangible Assets:
The Company monitors for events or circumstances that may indicate
potential impairment of goodwill and intangible assets each reporting
period. There were no such events or
circumstances identified during the first quarter of 2010. Fair value of the trade name in the
Multifamily segment was approximately 9% in excess of carrying value. The carrying value of the trade name was $1.9
million as of March 31, 2010. A change
in the discount rate, projected Multifamily revenue or royalty rate could
result in future impairment.
During the three months ended March 31, 2010 and 2009, there was
no change in the carrying value of goodwill or trade names, the Companys
indefinite-lived intangible assets.
The Companys amortizable intangible assets are presented in the
following table (in thousands):
|
|
March 31,
2010
|
|
December 31,
2009
|
|
Customer
Accounts
|
|
|
|
|
|
Gross
carrying amount
|
|
$
|
439,466
|
|
$
|
439,440
|
|
Less:
accumulated amortization
|
|
(243,409
|
)
|
(235,987
|
)
|
Carrying
amount, end of period
|
|
$
|
196,057
|
|
$
|
203,453
|
|
|
|
|
|
|
|
Dealer
Relationships
|
|
|
|
|
|
Gross
carrying amount
|
|
$
|
47,116
|
|
$
|
47,116
|
|
Less:
accumulated amortization
|
|
(12,763
|
)
|
(12,151
|
)
|
Carrying
amount, end of period
|
|
$
|
34,353
|
|
$
|
34,965
|
|
Amortization expense was $8.0 million and $9.3 million for the three
months ended March 31, 2010 and 2009, respectively.
The Company utilizes the declining balance method of amortization for
its amortizable intangible assets. The
Company switches from the declining balance method to the straight-line method
in the year the straight-line method results in greater amortization
expense. Amortization methods and lives
for each pool of intangible assets are described in the Companys Annual Report
on Form 10-K for the year ended December 31, 2009.
The table below reflects the estimated aggregate amortization expense
for 2010 (including amounts incurred in the first three months) and each of the
four succeeding fiscal years on the existing base of amortizable intangible
assets as of March 31, 2010 (in thousands):
|
|
2010
|
|
2011
|
|
2012
|
|
2013
|
|
2014
|
|
Estimated amortization
expense
|
|
$
|
32,203
|
|
$
|
29,209
|
|
$
|
27,818
|
|
$
|
27,543
|
|
$
|
27,543
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4.
Accrued Liabilities:
The following reflects the components of
accrued liabilities as of the periods indicated (in thousands):
|
|
March 31, 2010
|
|
December 31, 2009
|
|
Accrued interest
|
|
$
|
811
|
|
$
|
4,912
|
|
Accrued vacation pay
|
|
4,669
|
|
4,594
|
|
Accrued salaries, bonuses and employee benefits
|
|
11,102
|
|
10,282
|
|
Derivative liability
|
|
4,334
|
|
5,719
|
|
Other accrued liabilities
|
|
10,223
|
|
9,126
|
|
Total accrued liabilities
|
|
$
|
31,139
|
|
$
|
34,633
|
|
5.
Debt and Capital Leases:
Long-term debt and capital leases are as follows (in thousands):
|
|
March 31, 2010
|
|
December 31, 2009
|
|
New and Extending Term
Loans under the Senior Credit Agreement, maturing March 31, 2014,
variable at LIBOR + 4.25%, subject to a 2% LIBOR floor
|
|
$
|
276,610
|
|
$
|
277,305
|
|
Non-Extending Term Loans
under the Senior Credit Agreement, maturing March 31, 2012, variable at
LIBOR + 2.25%
|
|
56,218
|
|
56,359
|
|
Unamortized discount on New
and Extending Term Loans under the Senior Credit Agreement
|
|
(5,015
|
)
|
(5,381
|
)
|
Unsecured Term Loan,
maturing March 14, 2013, variable at Prime + 11.5%
|
|
110,340
|
|
110,340
|
|
Capital leases
|
|
2,927
|
|
3,285
|
|
|
|
441,080
|
|
441,908
|
|
Less current portion
(including $1,847 and $2,013 in capital leases as of
March 31, 2010 and
December 31, 2009, respectively)
|
|
(5,192
|
)
|
(5,358
|
)
|
Total long-term debt and
capital leases
|
|
$
|
435,888
|
|
$
|
436,550
|
|
8
Table of Contents
Senior Credit Agreement
On November 17,
2009, the Company amended its senior credit agreement (as amended, the Senior
Credit Agreement) which (i) increased term loan borrowings by $75 million
under the New Term Loans to an aggregate of $364.5 million, (ii) divided
all of its term loans into Non-Extending Term Loans equal to $86.5 million and
New and Extending Term Loans equal to $278.0 million and (iii) replaced
its $25 million revolving credit facility with a $15 million revolving credit
facility.
The
modification to the extending term loans of $203.0 million was considered a
significant modification in accordance with ASC 470-50-40-10 and extinguishment
accounting was therefore applied to $203 million of the original term
loans. The present value of the cash
flows of the modified term loans was determined to be more than 10% greater
than the present value of the cash flows of the original term loans primarily
due to the increased interest rate on the modified debt which includes an
increased interest rate margin of 2.0% and 2.0% LIBOR floor. The interest rate on these term loans prior
to the modification was 2.48%. The
interest rate at March 31, 2010, was 6.25% and 2.50% for the New and
Extending Term Loans and the Non-Extending Term Loans, respectively.
The
New and Extending Term Loans were recorded as new debt at fair value which was
determined to be at 98% of par. The fair
value determination was based on the 2% discount on the issuance of the $75
million of New Term Loans which have the same terms and conditions as the
$203.0 million of extending term loans.
Consequently, a debt discount of $5.6 million was recorded on the $278.0
million of New and Extending Term Loans.
The $203.0 million of original term loans were deemed to have been
retired at the fair value of the modified term loans resulting in an
extinguishment gain of $4.1 million which was partially offset by $0.6 million
of fees paid directly to the lenders related to the amendment and $1.5 million
of debt issue costs associated with the original debt for a net extinguishment
gain of $2.0 million. The Company
capitalized $3.9 million of debt issue costs associated with the amendment to
the Senior Credit Agreement in 2009.
Under the Senior Credit Agreement, the New and Extending Term Loans are
scheduled to mature on March 31, 2014, provided, however, that the New and
Extending Term Loans will mature on December 14, 2012 if prior to December 14,
2012, the maturity date of the unsecured term loan facility maturing March 14,
2013 (Unsecured Term Loan) is not extended to at least 91 days after March 31,
2014 or the borrowings under the Unsecured Term Loan Agreement are not
refinanced with permitted refinancing indebtedness having a maturity date at
least 91 days after March 31, 2014.
The New and Extending Term Loans bear interest at a margin of 4.25% over
the Eurodollar Base Rate (as defined in the Senior Credit Agreement and subject
to a 2% floor) for Eurodollar borrowings and 3.25% over the Base Rate (as
defined in the Senior Credit Agreement and subject to a 3% floor) for Base Rate
borrowings. The Non-Extending Term Loans
are still scheduled to mature on March 31, 2012 and bear interest at a
margin of 2.25% over the Eurodollar Base Rate for Eurodollar borrowings and
1.25% over the Base Rate for Base Rate Borrowings.
Borrowings under the Senior Credit Agreement are secured by
substantially all assets of the Company and require quarterly principal
payments of $0.8 million and potential annual prepayments based on a
calculation of Excess Cash Flow, as defined in the Senior Credit Agreement,
due in the first quarter of each subsequent fiscal year. The Company made $30.0 million in principal
prepayments on the Non-Extending Term Loans in December 2009 which were
applied toward the required Excess Cash Flow prepayment, resulting in no
additional required prepayment in the first quarter of 2010.
Unsecured
Term Loan
The Unsecured Term Loan bears interest at the prime rate plus 11.5% per
annum and matures in 2013. Interest is
payable semi-annually in arrears on March 14 and September 14 of each
year. The annual interest rate was
14.75% at March 31, 2010. The
Unsecured Term Loan lenders include, among others, entities affiliated with the
Principal Stockholders and Arlon Group.
Affiliates of the Principal Stockholders collectively owned
approximately 70% of the Companys common stock as of March 31, 2010, and
one of the Companys former directors is affiliated with Arlon Group. The Company recorded $1.6 million of related
party interest expense for each of the three months ended March 31, 2010
and 2009, respectively.
9
Table of Contents
Fair Value of Debt
The fair value of the Companys debt instruments are estimated based on
quoted market prices except for the Unsecured Term Loan, which had no available
quote and was estimated by the Company based on the terms of the loan and
comparison to fair value of its other debt.
At March 31, 2010 and December 31, 2009 the fair value and
carrying amount of the Companys debt were as follows (in thousands):
|
|
Fair Value
|
|
Carrying Value
|
|
|
|
March 31, 2010
|
|
December 31, 2009
|
|
March 31, 2010
|
|
December 31, 2009
|
|
New and Extending Term Loans under the Senior Credit
Agreement
|
|
$
|
276,610
|
|
$
|
273,145
|
|
$
|
271,595
|
|
$
|
271,924
|
|
Non-Extending Term Loans under the Senior Credit
Agreement
|
|
55,656
|
|
52,977
|
|
56,218
|
|
56,359
|
|
Unsecured Term Loan (a)
|
|
110,340
|
|
124,684
|
|
110,340
|
|
110,340
|
|
|
|
$
|
442,606
|
|
$
|
450,806
|
|
$
|
438,153
|
|
$
|
438,623
|
|
(a)
The March 31, 2010 fair value of the Unsecured
Term Loan is estimated based on the Companys expectation that the debt will be
prepaid at par upon sale of the Company, which is anticipated to be completed
in the second quarter of 2010. The December 31,
2009 fair value of the Unsecured Term Loan is estimated by the Company based on
the terms of the loan and comparison to fair value of its other debt.
The estimated fair values may not be representative of actual values of
the financial instruments that could have been realized at period end or may be
realized in the future.
Capital
Leases
The Company acquired vehicles through capital lease agreements. Accumulated depreciation on these assets as
of March 31, 2010 and December 31, 2009 was $6.6 million and $6.2
million, respectively. The following is
a schedule of future minimum lease payments under capital leases together with
the present value of net minimum lease payments as of March 31, 2010 (in
thousands):
Remainder
of 2010
|
|
$
|
1,707
|
|
2011
|
|
1,290
|
|
2012
|
|
414
|
|
2013
|
|
5
|
|
Total
minimum lease payments
|
|
3,416
|
|
Less:
Estimated executory costs
|
|
(240
|
)
|
Net
minimum lease payments
|
|
3,176
|
|
Less:
Amount representing interest
|
|
(249
|
)
|
Present
value of net minimum lease payments (a)
|
|
$
|
2,927
|
|
(a) Reflected in the condensed consolidated
balance sheet as current and non-current obligations under debt and capital
leases of $1,847 and $1,080, respectively.
Debt Covenants
At March 31, 2010, the Company was in compliance with the
financial covenants and other maintenance tests for all its debt
obligations. The Consolidated Leverage
Ratio and Consolidated Interest Coverage Ratio contained in the Senior Credit
Agreement are maintenance tests and the Consolidated Fixed Charge Coverage
Ratio contained in the Unsecured Term Loan Agreement is a debt incurrence
test. The Company cannot be deemed to be
in default solely due to failure to meet such debt incurrence tests.
However, failure to meet such debt incurrence tests could result in
restrictions on the Companys ability to incur additional ratio
indebtedness. The Company believes that
should it fail to meet the minimum Consolidated Fixed Charge Coverage Ratio in
its Unsecured Term Loan Agreement, its ability to borrow additional funds under
other permitted indebtedness provisions of the Unsecured Term Loan Agreement
and Senior Credit Agreement would provide sufficient liquidity for currently
foreseeable operational needs. The
Company is prohibited from paying any cash dividends to stockholders under
covenants contained in the Senior Credit Agreement.
10
Table of Contents
6.
Derivatives:
The Company holds one interest rate cap and three interest rate swaps
to manage interest rate exposure on its variable rate borrowings. The derivatives are accounted for as economic
hedges of the Companys debt subsequent to their de-designation which is
further discussed below. Prior to
de-designation, the derivatives were considered cash flow hedges and changes
resulting from fair market value adjustments were reflected in accumulated
other comprehensive loss in the condensed consolidated balance sheet and as a
component of unrealized other comprehensive loss in the condensed consolidated
statement of operations and comprehensive loss.
Subsequent to de-designation, the derivatives are considered economic
hedges and changes in fair value are recorded as interest expense.
The interest rate cap was entered into during the second quarter of
2005 as required by the Companys then existing credit agreement. The objective was to manage interest rate
exposure caused by fluctuation in the LIBOR interest rate. The cap provides protection on $75 million of
the Companys long term debt over a five-year period ending May 24, 2010
if LIBOR exceeds 6%. In the second
quarter of 2008, in connection with the interest rate swaps entered into and
described below, the interest rate cap was de-designated as a cash flow
hedge. The cap had no fair value at March 31,
2010 or December 31, 2009.
The Company entered into three interest rate swaps in the second
quarter of 2008 to fix the interest rate on $250 million of the variable rate
debt under the Companys then existing credit facility. The interest rate swaps mature from September 2010
to November 2010. The interest rate
swaps were de-designated as cash flow hedges in conjunction with the debt
refinancing that occurred in the fourth quarter of 2009. See Note 5, Debt and Capital Leases, for
additional discussion of the debt refinancing.
The fair value of the interest rate swaps are reflected in accrued
liabilities. At March 31, 2010 and December 31,
2009, the Company recorded $4.3 million and $5.7 million, respectively, in
accrued liabilities. The existing net
unrealized loss on the interest rate swaps on the date of de-designation
remains in accumulated other comprehensive loss and is amortized to interest
expense as interest payments are made.
As of December 31, 2009 the amount of accumulated other
comprehensive loss attributable to prior cash flow hedge relationships was $6.0
million. During the quarter, $1.9
million of the accumulated loss was reclassified to interest expense. The Company estimates the remaining $4.1
million of net unrealized loss in other comprehensive income at March 31,
2010 will be reclassified to earnings within the next twelve months. The table below is a summary of the Companys
derivative positions as of March 31, 2010 and December 31, 2009 (in
thousands):
Derivative
Type
|
|
Notional
|
|
March 31,
2010
Fair Value
|
|
December 31,
2009
Fair Value
|
|
Interest Rate Swaps
|
|
$
|
250,000
|
|
$
|
(4,334
|
)
|
$
|
(5,719
|
)
|
Interest Rate Cap
|
|
75,000
|
|
0
|
|
0
|
|
Total
|
|
$
|
325,000
|
|
$
|
(4,334
|
)
|
$
|
(5,719
|
)
|
Below is a summary of the amounts charged to interest expense and
accumulated other comprehensive loss for the periods indicated (in
thousands). No ineffectiveness was
recorded for any of the periods presented.
|
|
Loss
Reclassified from Accumulated Other
Comprehensive Loss to Interest Expense
|
|
Loss
Recognized in Accumulated Other
Comprehensive Loss
|
|
Derivatives
in ASC 815 Cash
|
|
Three
Months Ended March 31,
|
|
Three
Months Ended March 31,
|
|
Flow
Hedge Relationships
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
|
|
|
|
Interest Rate Swaps (a)
|
|
$
|
|
|
$
|
(1,687
|
)
|
$
|
|
|
$
|
(1,302
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(a)
Interest rate swaps were de-designated as cash flow
hedges in the fourth quarter of 2009.
|
|
Amount
of Loss on Derivatives Recognized in
Interest Expense
|
|
Derivatives
Not Designated as
|
|
Three
Months Ended March 31,
|
|
Hedging
Instruments under ASC 815
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Interest Rate Swaps (a)
|
|
$
|
(2,246
|
)
|
$
|
|
|
Interest Rate Cap (b)
|
|
(64
|
)
|
(49
|
)
|
Total
|
|
$
|
(2,310
|
)
|
$
|
(49
|
)
|
(a)
Interest rate swaps were de-designated as cash flow
hedges in the fourth quarter of 2009.
(b)
Interest rate caps were de-designated as cash flow
hedges in the second quarter of 2008.
11
Table of Contents
7. Fair
Value Measurements:
The Company applies ASC 820, Fair Value Measurements and Disclosures,
to determine fair value whenever other accounting pronouncements require or
permit assets or liabilities to be measured at fair value. ASC 820 establishes a fair value hierarchy
that prioritizes the information used to develop assumptions used to determine
the exit price. ASC 820 also establishes
valuation techniques that are used to measure fair value. To increase consistency and comparability in
fair value measurements and related disclosures, the fair value hierarchy
prioritizes the inputs to valuation techniques used to measure fair value into
three broad levels:
Level 1 quoted prices in active markets for identical assets or
liabilities;
Level 2 directly or indirectly observable inputs other than quoted
prices; and
Level 3 unobservable inputs.
ASC 820 establishes a hierarchy which requires an entity to maximize
the use of quoted market prices and minimize the use of unobservable
inputs. An asset or liabilitys level is
based on the lowest level of input that is significant to the fair value measurement.
The following table sets forth the Companys financial assets and
liabilities that were measured at fair value on a recurring basis by level
within the fair value hierarchy at the dates identified (in thousands):
|
|
Fair Value Measurements
|
|
|
|
Level 1
|
|
Level 2
|
|
Level 3
|
|
Total
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
Money Market Fund
|
|
|
|
|
|
|
|
|
|
March 31, 2010
|
|
$
|
33,253
|
|
$
|
|
|
$
|
|
|
$
|
33,253
|
|
December 31, 2009
|
|
$
|
25,492
|
|
$
|
|
|
$
|
|
|
$
|
25,492
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
Derivatives
|
|
|
|
|
|
|
|
|
|
March 31, 2010
|
|
$
|
|
|
$
|
(4,334
|
)
|
$
|
|
|
$
|
(4,334
|
)
|
December 31, 2009
|
|
$
|
|
|
$
|
(5,719
|
)
|
$
|
|
|
$
|
(5,719
|
)
|
Marketable securities are included within cash and cash equivalents in
the consolidated balance sheets, which generally consist of money market funds
with original maturities less than 90 days and were measured using a level 1
fair value measurement with carrying value equal to fair value. Derivatives consist of interest rate swap
agreements and are valued using observable benchmark rates at commonly quoted
intervals for the life of the instruments.
8.
Share-Based Employee and Director Compensation:
The
Company accounts for share-based awards under generally accepted accounting
principles which requires the measurement and recognition of compensation
expense for all share-based payment awards to employees and directors based on
estimated fair values. Share-based
compensation of $0.2 million and $0.3 million was recorded in general and
administrative expense for the three month periods ended March 31, 2010
and 2009, respectively. No tax benefit
was recorded because the Company does not have taxable income and is currently
fully reserving its federal deferred tax assets. There were no amounts capitalized relating to
share-based employee compensation in the three months ended March 31, 2010
or 2009.
On February 22,
2010 the Company granted equity awards to certain of the Senior Executives,
consisting of (i) an aggregate of 439,160 stock appreciation rights (SARs)
under the Companys 2010 Stock Appreciation Rights Plan (the 2010 SAR Plan),
which was adopted by the Company on February 22, 2010; (ii) an
aggregate of 439,160 stock options under the 2008 Long Term Incentive Plan (the
2008 LTIP); and (iii) restricted share awards for an aggregate of
100,000 shares of restricted stock under the 2008 LTIP (collectively, the equity
awards)
.
The exercise price for each stock option is $9.50, the
closing price of the Companys common stock on the date of grant. The
payout for each SAR is equal to the difference between (x) $7.50, and (y) the
lesser of: (i) $9.50, the closing price of the Companys common stock on
the date of grant, and (ii) the value of a share of Company common stock
on the date of exercise. The equity
awards vest in one-half increments on each of the second and third anniversary
of the grant date so long as the Executive is employed with the Company.
Vesting of the equity awards will accelerate upon a change of control of the
Company if (x) the Executive is employed with the Company at the time of
the change of control or (y) the change of control occurs within two years
of the date of grant and within 90 days of the Executives termination that is
a qualifying termination (as defined in each Senior Executives amended and
restated employment agreement). Both the stock options and the restricted
shares are subject to all the terms and conditions of the 2008 LTIP as well as
the individual award agreements. The SARs are subject to all of the terms
and conditions of the 2010 SAR Plan as well as the individual grant agreements.
12
Table of Contents
The Company estimated fair value of the SARs using a Monte Carlo
simulation valuation technique. The
Black-Scholes option-pricing model was used to estimate the fair value of
options. Key inputs in the valuation of
the SARs and options were stock price volatility, expected term, and risk free
rate. The fair value of the awards
granted totaled $2.7 million and will be recognized using a graded vesting
method over the vesting period. The SARs
are liability awards and the fair value and related expense will be updated
each reporting period. Restricted shares
were valued using the stock price on the date of grant.
For the three months ended March 31, 2010, the Company had 0.5
million share-based awards outstanding that represented dilutive potential
shares. These securities were not
included in the computation of diluted loss per share because to do so would
have been anti-dilutive for the period.
For the three months ended March 31, 2009, the Company had no stock
options outstanding that represented dilutive potential shares.
9.
Commitments and Contingencies:
In addition to the matters
described below, t
he
Company is a defendant in a number of pending legal proceedings incidental to
the normal course of its business and operations. The Company does not expect the outcome of
these proceedings, either individually or in the aggregate, to have a material
adverse effect on the Companys financial condition, results of operations or
liquidity.
An estimate of the probable loss, if any, or the range
of loss cannot be made for the following cases, and therefore, the Company has
not accrued loss contingencies related to the following matters.
Scardino Litigation
On April 17, 2006, the Company was named a defendant in a
litigation proceeding brought by Frank and Anne Scardino arising out of a June 2005
fire at their home in Villanova, Pennsylvania.
(
Frank and Anne Scardino v. Eagle Systems, Inc.,
Eagle Monitoring, Inc. and Protection One Alarm Monitoring, Inc.
d/b/a Dynawatch
, Delaware County, Pennsylvania Court of Common
Pleas, Cause No. 06-4485). The original complaint asserted six counts for
negligence, gross negligence, breach of contract, breach of implied warranty of
merchantability, breach of implied warranty of fitness for a particular purpose
and violation of the Unfair Trade Practices and Consumer Protection Law (UTPCPL). After extensive discovery, motion practice
and multiple amendments to the plaintiffs complaint, the Company successfully
reduced the plaintiffs claims to one count for breach of a written contract
and three counts for breach of purported oral agreements. Plaintiffs initially claimed direct and
consequential damages in excess of $3 million but later claimed damages close
to $5 million.
The Company notified its liability insurance carriers of the claim and
was defending the remaining counts. A
settlement conference was held on March 1, 2010, at which a settlement was
reached for an immaterial amount. The
settlement resolves all claims and counterclaims. The terms of the settlement were agreed in
writing and the parties have signed and exchanged a settlement agreement and
mutual release. The litigation was dismissed
with prejudice on May 11, 2010.
By the Carat, Inc. Litigation
On April 30, 2007, IASG and certain of its subsidiaries, Criticom
International Corporation and Monital Signal Corporation (collectively, the Company
defendants), were served in a lawsuit brought by By the Carat, Inc. and
John P. Humbert, Jr. and his wife, Valery Humbert, its owners, in
connection with a December 2004 armed robbery of their jewelry
business. (
By the Carat, Inc.,
John P. Humbert, Jr. and Valery Humbert v. Knightwatch Security Systems,
Criticom International Corporation, Monital Signal Corporation, Integrated
Alarm Services Group, Inc., et al
, Superior Court of New
Jersey, Monmouth County Law Division, Docket No.: MON-L-5830-06.) The complaint
sought unspecified damages for alleged bodily injury and property losses based
on various causes of action, including breach of contract, breach of the
covenant of good faith and fair dealing, consumer fraud, intentional and
negligent infliction of emotional distress, breach of warranty and gross
negligence.
On June 26, 2009, the Court dismissed plaintiffs complaint
without prejudice, due to the plaintiffs failure to comply with discovery
orders. Since the dismissal, plaintiffs
have replaced their original counsel with new attorneys. The new attorneys assisted the plaintiffs in
complying with the outstanding discovery and the complaint was reinstated.
13
Table of Contents
Fact and expert discovery are complete.
In January 2010, the parties attempted to resolve the dispute
through mediation. The mediation was not
successful, but the parties may revisit mediation in the future. Subsequent to mediation, the Company
defendants brought a motion for partial summary judgment as to plaintiffs
property damage and consumer fraud claims.
The Court denied the motion for summary judgment on April 16,
2010. The Court also denied a similar
motion brought by the co-defendant.
Notably, the Company defendants have a contractual indemnification claim
pending against that co-defendant. In
addition to its indemnification claim, the Company defendants have a number of
defenses that it intends to pursue vigorously.
A trial date has not been set.
Paradox
Litigation
On March 13, 2008, plaintiffs Paradox Security Systems, LTD.,
Samuel Hershkovitz and Pinhas Shpater filed a Second Amended Complaint in Civil
Action No. 2:06-cv-462 in the Eastern District of Texas, Marshall
Division, and added the Company as a defendant. The complaint alleges
that the Company infringes U.S. Patent No. 5,751,803 and U.S. Reissue
Patent No. 39,406 (collectively, the Patents-in-Suit), by its sale and
use of certain control panels made by Digital Security Controls, LTD. (DSC).
The Company answered the complaint by denying infringement, alleging
invalidity and unenforceability of the Patents-in-Suit, and asserting other
defenses and related declaratory judgment counterclaims.
At the April 2009 trial, the Court determined that the plaintiffs
had not presented sufficient evidence to support plaintiffs allegations
against the Company and the other defendants, and granted the defendants
motions for judgment of non-infringement as a matter of law.
On September 14, 2009, final judgment was entered by the court,
and on September 23, 2009, plaintiffs filed a notice of appeal to the
Federal Circuit Court. On December 21,
2009, plaintiffs filed their opening appellate brief, wherein they asserted
that the trial court erred in entering judgments as a matter of law in favor of
the defendants. The Companys reply
brief, and the reply briefs of the other defendants, was filed in February 2010. Oral arguments are scheduled to be conducted
on June 7, 2010, and a final decision by the Federal Circuit Court is
expected in late 2010.
Contract
Settlement
The Company settled and accelerated termination of an existing
operating lease agreement with the landlord at one of its branch
facilities. The Company has agreed to pay the landlord $1.525 million in
satisfaction of all obligations under the lease agreement as a part of the
settlement. In connection with the exit of the lease agreement, the
Company recorded an impairment charge of approximately $1.0 million primarily
related to leasehold improvements at the facility during the three months ended
March 31, 2010.
Shareholder Litigation
On May 6, 2010, Donald Rensch, a purported stockholder of
Protection One, filed a complaint (the Rensch Complaint) on behalf of himself
and as a putative class action on behalf of the Companys public stockholders,
against the Company, each member of the Companys board of directors,
Quadrangle Group LLC, POI Acquisition L.L.C., Monarch Alternative Capital LP,
Protection Holdings, LLC, Protection Acquisition Sub, Inc. and GTCR Golder
Rauner II, L.L.C. in the Court of Chancery of the State of Delaware (
Donald Rensch v. Protection One, Inc. et al,
C.A. No. 5468-VCS). On May 10, 2010, Trading Strategies
Fund, a purported stockholder of the Company, filed a complaint (the TSF
Complaint) on behalf of itself and as a putative class action on behalf of the
Companys public stockholders, against the Company, each member of the Companys
board of directors and GTCR Golder Rauner II, L.L.C. in the district court of
Douglas County, Kansas. On May 12, 2010, The Law Offices of Mark Kotlarsky
Pension Plan, a purported stockholder of the Company, filed a complaint (the
Pension Plan Complaint) on behalf of itself and as a putative class action on
behalf of the Companys public stockholders against the Company, each member of
the Companys board of directors, Quadrangle Group LLC, POI Acquisition,
L.L.C., Monarch Alternative Capital LP, Protection Holdings, LLC, Protection
Acquisition Sub, Inc. and GTCR Golder Rauner II, L.L.C. in the Court of
Chancery of the State of Delaware. These complaints allege that the defendants
breached their fiduciary duties or aided and abetted the alleged breach of
fiduciary duties in connection with the Offer and the Merger contemplated by
the Merger Agreement and alleges that the disclosures contained in the
documents filed with the United States Securities and Exchange Commission by
the Company (and Purchaser in the case of the Rensch Complaint) are materially
misleading and omit material facts. None
of the complaints state how many shares of Company common stock are purportedly
held by the respective plaintiffs. The
TSF Complaint seeks, among other things, declarations that the action brought
by the complaint is properly maintainable as a class action, that certain of
the defendants have breached their fiduciary duties to the named plaintiff and
the class, that certain of the defendants aided and abetted breaches of
fiduciary duty by other defendants, awarding of appropriate damages to the
plaintiff and other members of the class, and awarding the plaintiffs costs,
including attorneys and experts fees.
The Rensch Complaint and the Pension Plan Complaint seek the same
relief, and in addition, an order enjoining the transactions contemplated by
the Merger Agreement. The Company
believes that the Rensch Complaint, the TSF Complaint and the Pension Plan
Complaint are wholly without merit and intends to defend the cases vigorously.
Consumer
Complaints
The Company occasionally receives notices of consumer complaints filed
with various state agencies. The Company
has developed a dispute resolution process for addressing these administrative
complaints. The ultimate outcome of such
matters cannot presently be determined; however, in the opinion of management,
the resolution of such matters will not have a material adverse effect on the
Companys consolidated financial position, results of operations or liquidity.
14
Table of Contents
Funding Commitment
Notes receivable were $2.8
million and $2.9 million at March 31, 2010 and December 31,
2009, respectively, and represent loans to dealers collateralized by the
dealers portfolios of customer monitoring contracts. The Company has obligations to provide open
lines of credit to dealers, subject to the terms of the agreements with the
dealers. At March 31, 2010 and December 31,
2009, the amount available to dealers under these lines of credit was $0.3
million and $0.2 million, respectively.
10.
Segment Reporting:
The Company organizes its operations into three business segments: Retail, Wholesale and Multifamily. The Companys operating segments are defined
as components for which separate financial information is available that is
evaluated regularly by the chief operating decision maker. The operating segments are managed separately
because each operating segment represents a strategic business unit that serves
different markets. All of the Companys
reportable segments operate in the United States of America.
The Companys Retail segment provides security alarm monitoring
services, which include sales, installation and related servicing of security
alarm systems for residential and business customers. The Companys Wholesale segment provides
monitoring, financing and business support services to independent security
alarm dealers. The Companys Multifamily
segment provides security alarm services to apartments, condominiums and other
multi-family dwellings.
The accounting policies of the operating segments are the same as those
described in the summary of significant accounting policies in the Companys
Annual Report on Form 10-K for the year ended December 31, 2009. The Company manages its business segments
based on earnings before interest, income taxes, depreciation, amortization
(including amortization of deferred customer acquisition costs and revenue) and
other items, referred to as Adjusted EBITDA.
Reportable segments (in thousands):
|
|
Three Months Ended March 31, 2010
|
|
|
|
Retail
|
|
Wholesale
|
|
Multifamily
|
|
Adjustments(1)
|
|
Consolidated
|
|
Revenue
|
|
$
|
71,801
|
|
$
|
10,149
|
|
$
|
6,365
|
|
$
|
|
|
$
|
88,315
|
|
Adjusted EBITDA(2)
|
|
23,336
|
|
2,682
|
|
3,265
|
|
|
|
29,283
|
|
Amortization and
depreciation expense
|
|
9,323
|
|
1,054
|
|
741
|
|
|
|
11,118
|
|
Amortization of deferred
costs in excess of amortization of deferred revenue
|
|
6,747
|
|
|
|
519
|
|
|
|
7,266
|
|
Segment assets
|
|
450,290
|
|
72,393
|
|
44,971
|
|
(4,801
|
)
|
562,853
|
|
Property additions,
exclusive of rental equipment
|
|
637
|
|
296
|
|
39
|
|
|
|
972
|
|
Investment in new accounts
and rental equipment, net
|
|
5,289
|
|
|
|
95
|
|
|
|
5,384
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, 2009
|
|
|
|
Retail
|
|
Wholesale
|
|
Multifamily
|
|
Adjustments(1)
|
|
Consolidated
|
|
Revenue
|
|
$
|
72,667
|
|
$
|
12,763
|
|
$
|
7,572
|
|
$
|
|
|
$
|
93,002
|
|
Adjusted EBITDA(2)
|
|
21,832
|
|
3,265
|
|
3,947
|
|
|
|
29,044
|
|
Amortization and
depreciation expense
|
|
10,280
|
|
1,201
|
|
868
|
|
|
|
12,349
|
|
Amortization of deferred
costs in excess of amortization of deferred revenue
|
|
7,289
|
|
|
|
544
|
|
|
|
7,833
|
|
Segment assets
|
|
521,875
|
|
73,674
|
|
48,922
|
|
(12,011
|
)
|
632,460
|
|
Property additions,
exclusive of rental equipment
|
|
995
|
|
193
|
|
|
|
|
|
1,188
|
|
Investment in new accounts
and rental equipment, net
|
|
5,261
|
|
|
|
951
|
|
|
|
6,212
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(1) Adjustment to eliminate inter-segment
accounts receivable.
(2) Adjusted EBITDA, which is a non-GAAP measure, is used by the
Companys management and reviewed by the Board of Directors in evaluating
segment performance and determining how to allocate resources across segments
for investments in customer acquisition activities, capital expenditures and
spending in general. The Company believes it is also utilized by the investor
community which follows the security monitoring industry. Adjusted EBITDA
is useful because it allows investors and management to evaluate and compare
operating results from period to period in a meaningful and consistent manner
in addition to standard GAAP financial measures. Specifically, Adjusted
EBITDA allows the chief operating decision maker to evaluate segment results of
operations, including operating performance of monitoring and service
activities, effects of investments in creating new customer relationships, and
sales and installation of security systems, without the effects of non-
15
Table of Contents
cash amortization and depreciation. This information should not
be considered as an alternative to any measure of performance as promulgated
under GAAP, such as loss before income taxes or cash flow from operations. Items excluded from Adjusted EBITDA are
significant components in understanding and assessing the consolidated
financial performance of the Company.
See the table below for the reconciliation of Adjusted EBITDA to
consolidated loss before income taxes. The Companys calculation of Adjusted
EBITDA may be different from the calculation used by other companies and
comparability may be limited.
Reconciliation of loss before income taxes to Adjusted EBITDA (in
thousands):
|
|
Consolidated
|
|
|
|
Three Months Ended
March 31,
|
|
|
|
2010
|
|
2009
|
|
Loss before income taxes
|
|
$
|
(4,037
|
)
|
$
|
(2,623
|
)
|
Plus:
|
|
|
|
|
|
Interest expense, net
|
|
11,872
|
|
11,103
|
|
Amortization and
depreciation expense
|
|
11,118
|
|
12,349
|
|
Amortization of deferred
costs in excess of
amortization of deferred revenue
|
|
7,266
|
|
7,833
|
|
Stock based compensation
expense
|
|
192
|
|
314
|
|
Other costs (a)
|
|
2,872
|
|
68
|
|
Adjusted
EBITDA
|
|
$
|
29,283
|
|
$
|
29,044
|
|
(a)
Other costs in 2010 include $2.1 million
related to the contract settlement as discussed in Note 9, Commitments and
Contingencies.
11.
Income
Taxes:
During the three months ended March 31, 2010, actual effective
income tax expense differed from tax expense using the U.S. federal statutory
tax rate of 35% primarily due to the impact of the deferred tax valuation
allowance. The Company recorded income
tax expense of $0.7 million and $0.2 million for the three months ended March 31,
2010 and 2009, respectively.
Management believes the Companys net federal deferred
tax assets, including those related to net operating losses, are not likely
realizable and therefore its net federal deferred tax assets are fully
reserved. In assessing whether deferred
taxes are realizable, management considers whether it is more likely than not
that some portion or all deferred tax assets will be realized. The ultimate realization of deferred tax
assets is dependent upon the generation of future taxable income during the
periods in which those temporary differences become deductible. Management considers the Companys projected
future taxable income and tax planning strategies in making this assessment.
The Company has indefinite-lived intangible assets
consisting of trade names and goodwill which are not amortized for financial
reporting purposes. These
indefinite-lived intangible assets are tax deductible, and therefore, are
amortized over fifteen years for tax purposes.
The tax-deductibility of these indefinite-lived intangible assets
results in a deferred tax liability which only reverses at the time of
impairment of the related asset or ultimate sale of the underlying intangible
asset. Due to the uncertain timing of
this reversal, the difference cannot be considered as a source of future
taxable income and cannot be used to offset the Companys deferred tax
assets. As a result, the Company does
not net such deferred tax liabilities against the Companys deferred tax
assets, which related primarily to net operating loss carry-forwards, when
determining its valuation allowance.
12. New
Accounting Standards:
In November 2009, the Financial Accounting Standards Board (the FASB)
issued Accounting Standards Update (ASU) 2009-13 and ASU 2009-14 on revenue
arrangements with multiple deliverables and software revenue recognition. ASU 2009-13 addresses the unit of accounting
for arrangements involving multiple deliverables. The guidance revises the determination of
when the individual deliverables included in a multiple-element arrangement may
be treated as separate units of accounting.
The guidance also revises the manner in which the transaction
consideration is allocated across the separately identified deliverables. ASU 2009-14 addresses revenue arrangements
that contain both hardware elements and software elements. ASU 2009-13 and ASU 2009-14 are effective for
fiscal years beginning on or after June 15, 2010. The Company is currently evaluating the
impact, if any, adoption of ASU 2009-13 and ASU 2009-14 will have on its
consolidated financial statements.
16
Table of Contents
13.
Subsequent Events:
On April 26,
2010, the Company entered into a definitive agreement to be acquired by
Protection Holdings, LLC, an affiliate of GTCR. Under the terms of the Merger
Agreement, Protection Acquisition Sub, Inc., a newly formed entity and
wholly owned subsidiary of Protection Holdings, LLC, commenced a tender offer
on May 3, 2010 to acquire all of the Companys outstanding common stock
for $15.50 per share in cash, to be followed by a Merger to acquire all
remaining outstanding shares at the same price paid in the tender offer. The
completion of the Offer and Merger are subject to certain conditions and
termination rights of the parties set forth in the Merger Agreement.
ITEM
2. MANAGEMENTS DISCUSSION AND
ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following Managements Discussion and Analysis of Financial
Condition and Results of Operations updates the information provided in, and
should be read in conjunction with, Managements Discussion and Analysis of
Financial Condition and Results of Operations in our Annual Report on Form 10-K
for the year ended December 31, 2009.
Overview
We believe we are the third largest provider of electronic security
installation and monitoring in the United States, as measured by recurring
monthly revenue, or RMR. As of March 31, 2010, we served approximately
745,000 residential and business customers and monitored approximately 680,000
sites through our Wholesale operations. Generating cash flow to fund
growth and investment in new customers, as well as for debt service, is
essential to our operations.
We organize our operations into the following three business segments:
Retail.
Our Retail segment provides monitoring and maintenance services for
electronic security systems directly to residential and business customers. We
also sell and install electronic security systems for homes and businesses
through our Retail segment in order to meet their security needs. As of March 31, 2010, we served
approximately 534,000 retail
customers across the nation, with no single customer comprising more than 1% of
our total consolidated revenue. Our
Retail segment accounted for 80.2% of our recurring monthly revenue at March 31,
2010, of which approximately 30.4% was attributable to commercial customers.
Wholesale
.
We contract with independent security alarm dealers nationwide to
provide alarm system monitoring services to their residential and business
customers. As of March 31, 2010,
our Wholesale segment served approximately 4,100 dealers by monitoring
approximately 680,000 homes and businesses on their behalf. We also provide business support services for
these independent dealers including, in certain instances, financing in the
form of loans secured by customer accounts.
Our top ten wholesale dealers, based on RMR, accounted for 28.9% of
Wholesale monitored sites and 14.3% of Wholesale recurring monthly revenue as
of March 31, 2010.
Multifamily.
We provide monitoring and maintenance services for
electronic security systems to tenants of multifamily residences, including
apartments, condominiums and other multifamily dwellings, under long-term
contracts with building owners and managers.
We provided alarm monitoring services to approximately 211,000 units in nearly 475 cities as
of March 31, 2010.
The table below identifies our consolidated revenue by segment for the
periods presented (dollars in thousands):
|
|
Three months ended March 31,
|
|
|
|
2010
|
|
2009
|
|
Segment
|
|
Revenue
|
|
Percent
|
|
Revenue
|
|
Percent
|
|
Retail
|
|
$
|
71,801
|
|
81.3
|
%
|
$
|
72,667
|
|
78.1
|
%
|
Wholesale
|
|
10,149
|
|
11.5
|
|
12,763
|
|
13.7
|
|
Multifamily
|
|
6,365
|
|
7.2
|
|
7,572
|
|
8.2
|
|
Total
|
|
$
|
88,315
|
|
100.0
|
%
|
$
|
93,002
|
|
100.0
|
%
|
Summary
of Important Matters
Net Loss
.
We incurred a net loss of $4.8 million and
$2.8 million for the three months ended March 31, 2010 and 2009,
respectively. The net loss in the three months ended March 31, 2010 and
2009 reflects (1) substantial charges incurred by us for amortization of
customer accounts and previously deferred customer acquisition costs and
interest incurred on indebtedness and (2) in the first quarter of 2010, a
loss of $2.1 million in connection with an early termination of a lease
agreement and related settlement payment and leasehold asset impairment.
17
Table of Contents
Due to business and consumer concerns regarding the U.S. economy as
well as limited access to consumer credit, we identified fewer opportunities to
sell security systems in 2009 compared to previous periods. We believe security system sales have
stabilized thus far in 2010.
Recurring
Monthly Revenue.
We measure all of the RMR we are entitled to
receive under contracts with customers in effect at the end of each reporting
period. Our computation of RMR may not
be comparable to other similarly titled measures of other companies. RMR should not be viewed by investors as an
alternative to actual monthly revenue, as determined in accordance with
generally accepted accounting principles, or GAAP, and is a non-GAAP
measure. RMR was $24.9 million and $26.5
million as of March 31, 2010 and 2009, respectively. A significant portion of the decrease in RMR
as of March 31, 2010 is a result of our agreement with APX, which resulted
in a reduction of Wholesale RMR, as well as lower Retail investment in customer
acquisition activities.
Each segments share of our total RMR and monitored sites at March 31
for the years presented were as follows:
|
|
Percentage of Total
|
|
|
|
2010
|
|
2009
|
|
|
|
RMR
|
|
Sites
|
|
RMR
|
|
Sites
|
|
Retail
|
|
80.2
|
%
|
37.5
|
%
|
77.2
|
%
|
31.9
|
%
|
Wholesale
|
|
12.2
|
|
47.7
|
|
15.0
|
|
55.8
|
|
Multifamily
|
|
7.6
|
|
14.8
|
|
7.8
|
|
12.3
|
|
Total
|
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
Our RMR includes amounts billable to customers with past due balances
which we believe are collectible. We seek to preserve the revenue stream
associated with each customer contract, primarily to maximize our return on the
investment we made to generate each contract.
As a result, we actively work to collect amounts owed to us and to
retain the customer at the same time. As
a general rule, we accrue for the cancellation of customer RMR when a balance
of more than one times the customers RMR becomes 120 days past due. Exceptions to this rule are made when an
evaluation of the ongoing customer relationship indicates that payment for the
past due balance is likely to be received.
Even though our proportions of Retail, Wholesale and Multifamily RMR
may differ significantly from other companies RMR mix, and contributions from
each type of RMR vary, we believe the presentation of RMR is useful to
investors because the measure is used by investors and lenders to value
companies such as ours with recurring revenue streams. Management monitors RMR, among other things,
to evaluate our ongoing performance. In
order to enhance the investors understanding of the components of our RMR, we
include roll-forwards for each segment below.
The table below reconciles our RMR to revenue reflected on our
consolidated statements of operations (in thousands):
|
|
Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
Recurring Monthly Revenue at March 31
|
|
$
|
24,949
|
|
$
|
26,475
|
|
Amounts excluded from RMR:
|
|
|
|
|
|
Amortization of deferred revenue
|
|
1,270
|
|
1,194
|
|
Installation and other revenue (a)
|
|
3,445
|
|
3,322
|
|
Revenue (GAAP basis):
|
|
|
|
|
|
March
|
|
29,664
|
|
30,991
|
|
January - February
|
|
58,651
|
|
62,011
|
|
Total period revenue
|
|
$
|
88,315
|
|
$
|
93,002
|
|
(a) Revenue that is not pursuant to monthly
contractual billings.
The following
table identifies RMR by segment and in total for the periods indicated (in
thousands):
|
|
Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
Retail
|
|
Whole-
sale
|
|
Multi-
family
|
|
Total
|
|
Retail
|
|
Whole-
sale
|
|
Multi-
family
|
|
Total
|
|
Beginning RMR balance
|
|
$
|
20,107
|
|
$
|
3,031
|
|
$
|
1,919
|
|
$
|
25,057
|
|
$
|
20,543
|
|
$
|
3,998
|
|
$
|
2,205
|
|
$
|
26,746
|
|
RMR additions from direct
sales
|
|
423
|
|
|
|
8
|
|
431
|
|
450
|
|
|
|
27
|
|
477
|
|
RMR from account purchases
|
|
3
|
|
|
|
|
|
3
|
|
|
|
|
|
|
|
|
|
RMR losses (a)
|
|
(600
|
)
|
|
|
(31
|
)
|
(631
|
)
|
(682
|
)
|
|
|
(185
|
)
|
(867
|
)
|
Net change in wholesale
|
|
|
|
16
|
|
|
|
16
|
|
|
|
(11
|
)
|
|
|
(11
|
)
|
Price increases and other
|
|
68
|
|
|
|
5
|
|
73
|
|
122
|
|
|
|
8
|
|
130
|
|
Ending RMR balance
|
|
$
|
20,001
|
|
$
|
3,047
|
|
$
|
1,901
|
|
$
|
24,949
|
|
$
|
20,433
|
|
$
|
3,987
|
|
$
|
2,055
|
|
$
|
26,475
|
|
(a)
RMR losses include price decreases
18
Table of Contents
Monitoring and
Related Services Margin.
Monitoring and related services revenue
comprised more than 85% of our total revenue for each of the three month
periods ended March 31, 2010 and 2009.
The table below identifies the monitoring and related services gross
margin and gross margin as a percentage of monitoring and related services
revenue for the presented periods (in thousands):
|
|
Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
Retail
|
|
Whole-
sale
|
|
Multi-
Family
|
|
Total
|
|
Retail
|
|
Whole-
sale
|
|
Multi-
family
|
|
Total
|
|
Monitoring and related
services revenue
|
|
$
|
62,017
|
|
$
|
9,270
|
|
$
|
6,163
|
|
$
|
77,450
|
|
$
|
63,717
|
|
$
|
12,579
|
|
$
|
7,237
|
|
$
|
83,533
|
|
Cost of monitoring and
related services (exclusive of depreciation)
|
|
16,836
|
|
4,807
|
|
1,713
|
|
23,356
|
|
17,203
|
|
6,769
|
|
1,774
|
|
25,746
|
|
Gross margin
|
|
$
|
45,181
|
|
$
|
4,463
|
|
$
|
4,450
|
|
$
|
54,094
|
|
$
|
46,514
|
|
$
|
5,810
|
|
$
|
5,463
|
|
$
|
57,787
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross margin %
|
|
72.9
|
%
|
48.1
|
%
|
72.2
|
%
|
69.8
|
%
|
73.0
|
%
|
46.2
|
%
|
75.5
|
%
|
69.2
|
%
|
For the three months ended March 31, 2010, our total monitoring
and related services gross margin percentage increased slightly from the prior
period primarily due to reductions in costs. Retail gross margin percentage
for the three months ended March 31, 2010, remained consistent with the
three months ended March 31, 2009. Wholesale
gross margin percentage improved in the three months ended March 31, 2010
compared to the three months ended March 31, 2009 primarily because gross
margin on the APX accounts was typically lower than average gross margin in
those periods that included monitoring of APX accounts. See -APX Agreement. The Wholesale gross margin percentage is
typically lower than Retail and Multifamily gross margin percentages due to the
reduced number of services we provide to dealers compared to services provided
to our Retail and Multifamily customers.
Acquisition costs per monitored wholesale site are also significantly
lower. For the three months ended March 31,
2010, monitoring and related services gross margin percentage in our
Multifamily segment was lower than in the prior period because revenue in this
segment decreased faster than we were able to reduce costs. Multifamily monitoring and related services
revenue for the first three months of 2009 also included higher than normal
revenue resulting from accelerated billing for cancellations prior to
contractual maturity in monitoring and related services revenue.
Customer Creation and Marketing
. Our current customer acquisition strategy for our
Retail segment relies primarily on internally generated sales, utilizing
personnel in our existing branch infrastructure. The internal sales program for our Retail
segment generated $0.4 million and $0.5 million of new RMR in the three months
ended March 31, 2010 and 2009, respectively. We operate a dedicated telesales center from
which we respond to questions that customers or potential customers have about
our services and provide quality control follow-up calls to customers for whom
we recently provided installation or maintenance services. In late 2009 we created an internal sales
group to sell systems and services over the phone.
Our integrated marketing programs focus on awareness for the Protection
One® brand name nationally and the generation of new lead sources and
opportunities. We reach out to targeted
customers, both residential and commercial, through a variety of mediums in a
planned and sequenced manner. These
channels include, but are not limited to, on-line programs and placements,
third-party purchases and outbound calling and traditional mass communications,
such as radio, print and direct mail.
We expect to continue to analyze opportunities for alliance
partnerships which benefit our Retail segment.
We are disciplined in our assessment of alliance opportunities, taking
into account many factors such as brand impact, sales channel consideration and
financial return.
RMR Attrition.
Attrition has
a direct impact on our results of operations since it affects our revenue,
amortization expense and cash flow. We
monitor attrition on a quarterly annualized and trailing twelve-month
basis. This method utilizes each segments
average RMR base for the applicable period in measuring attrition. Therefore, in periods of RMR growth, the
computation of RMR attrition may result in a number less than would be expected
in periods when RMR remains stable. In periods of RMR decline, the
computation of RMR attrition may result in a number greater than would be
expected in periods when RMR remains stable. We believe the presentation of RMR attrition
is useful to investors and lenders in valuing companies such as ours with
recurring revenue streams. In addition,
we believe RMR attrition information is more useful than customer account
attrition because it reflects the economic impact of customer losses.
19
Table of Contents
In the table below, we define attrition as a ratio, the numerator of
which is the gross amount of lost RMR, which includes price decreases, for a
given period, net of the adjustments described below, and the denominator of
which is the average amount of RMR for a given period. In some instances, we use estimates to derive
attrition data. In the calculations
directly below, we do not reduce the gross RMR lost during a period by RMR added
from new owner accounts, which are accounts where a new customer moves into a
location installed with our security system and vacated by a prior customer, or
from relocation accounts, which are accounts where an existing customer moves
and transfers service to their new location.
As defined above, RMR gross attrition by business segment is summarized
at March 31, 2010 and 2009. Our
Retail gross attrition improved in the first three months of 2010 compared to
the first three months of 2009 due to a decrease in cancellations for
non-payment and other financial reasons.
Multifamily attrition was lower in the first quarter of 2010 compared to
the first quarter of 2009 because the first quarter of 2009 includes the
termination of several large customers for financial reasons.
|
|
Recurring Monthly Revenue Attrition
|
|
|
|
March 31, 2010
|
|
March 31, 2009
|
|
|
|
Annualized
First
Quarter
|
|
Trailing
Twelve
Months
|
|
Annualized
First
Quarter
|
|
Trailing
Twelve
Months
|
|
Retail
|
|
12.0
|
%
|
13.0
|
%
|
13.3
|
%
|
13.7
|
%
|
Multifamily
|
|
6.4
|
%
|
12.2
|
%
|
34.9
|
%
|
22.7
|
%
|
In the table below, in order to enhance the comparability of our Retail
segment attrition results with those of other industry participants, many of
which report attrition net of new owner and relocation accounts and exclude
price decreases, we define the denominator the same as above but define the
numerator as the gross amount of lost RMR, excluding price decreases, for a
given period reduced by RMR added from new owners and relocation accounts.
|
|
Recurring Monthly Revenue Attrition
|
|
|
|
March 31, 2010
|
|
March 31, 2009
|
|
|
|
Annualized
First
Quarter
|
|
Trailing
Twelve
Months
|
|
Annualized
First
Quarter
|
|
Trailing
Twelve
Months
|
|
Retail
|
|
9.0
|
%
|
9.9
|
%
|
10.6
|
%
|
10.5
|
%
|
Our actual attrition experience shows that the relationship period with
any individual customer can vary significantly.
Customers discontinue service with us for a variety of reasons,
including relocation, service issues, cost and other financial issues. A portion of our acquired customer base can
be expected to discontinue service every year.
Any significant change in the pattern of our historical attrition
experience would have a material effect on our results of operations. We also believe that high unemployment could
contribute to elevated attrition levels for the next several quarters, which
would have a negative impact on our revenue.
We evaluate the
Wholesale segment based on the net change in RMR because added RMR typically
does not require an up-front investment by us.
Wholesale RMR fluctuates as our customers, the independent dealers, add
and lose their customers for whom we are providing monitoring and other
services. The net change in Wholesale
RMR did not vary significantly during the first three months of 2010 or 2009,
however Wholesale RMR as of March 31, 2010 is significantly lower due to
the impact of the APX agreement discussed below. The net change in Wholesale RMR for the first
three months of 2010 was an increase of $16,000, or a 0.5% increase, in RMR for
the period. The net change in RMR for
the first three months of 2009 was a decrease of $11,000, or a 0.3% decrease,
in RMR for the period.
APX
Agreement.
On October 2, 2009, we entered into an
agreement with Apx Alarm Security Solutions, Inc. (APX) under which APX
assumed operating control of our monitoring center located in South St. Paul,
Minnesota, effective November 1, 2009.
As a result of this arrangement, APX now provides the monitoring
services to their customer base that we previously provided through our South
St. Paul, Minnesota facility (the Facility).
We agreed to, among other things, (i) license to APX certain
intellectual property used in the operation of the Facility, (ii) assign
ownership to APX of the fixed assets at the Facility, and (iii) provide
support services to APX, including emergency technical services and disaster
recovery planning and recovery services, through December 31, 2010, all in
exchange for a monthly service fee. We will cease providing any services
to APX after December 31, 2010. APX
accounted for approximately 283,000 of our Wholesale monitored sites and $0.8
million of Wholesale RMR at March 31, 2009. Wholesale monitoring revenue and cost of
monitoring revenue have declined as a result of this arrangement, although
other revenue has increased.
20
Table of Contents
Adjusted EBITDA
Adjusted EBITDA, which is a non-GAAP measure, is used by management and
reviewed by the Board of Directors in evaluating segment performance and
determining how to allocate resources across segments for investments in
customer acquisition activities, capital expenditures and spending in
general. We believe it is also utilized
by the investor community that follows the security monitoring industry. Adjusted EBITDA is useful because it allows
investors and management to evaluate and compare operating results from period
to period in a meaningful and consistent manner in addition to standard GAAP
financial measures. Specifically,
Adjusted EBITDA allows management to evaluate segment results of operations,
including operating performance of monitoring and service activities, effects
of investments in creating new customer relationships, and sales and
installation of security systems, without the effects of non-cash amortization
and depreciation. This information
should not be considered as an alternative to any measure of performance as
promulgated under GAAP, such as loss before income taxes or cash flow from
operations. Items excluded from Adjusted
EBITDA are significant components in understanding and assessing our
consolidated financial performance. Our
calculation of Adjusted EBITDA may be different from the calculation used by
other companies and comparability may be limited. Adjusted EBITDA by segment
for the three months ended March 31, 2010 and 2009 was as follows (in
thousands)
:
|
|
For the three months ended March 31,
|
|
|
|
2010
|
|
2009
|
|
Retail
|
|
$
|
23,336
|
|
$
|
21,832
|
|
Wholesale
|
|
2,682
|
|
3,265
|
|
Multifamily
|
|
3,265
|
|
3,947
|
|
|
|
|
|
|
|
|
|
Retail Adjusted EBITDA increased $1.5 million for the three months
ended March 31, 2010, compared to the three months ended March 31,
2009 due to a decrease in general and administrative costs partially offset by
a decline in monitoring and related services gross margin. Wholesale Adjusted EBITDA decreased $0.6 million
for the three months ended March 31, 2010, compared to the three months
ended March 31, 2009 primarily due to a decrease in monitoring and related
services gross margin partially offset by an increase in other revenue for the
APX agreement. Multifamily Adjusted
EBITDA decreased $0.7 million for the three months ended March 31, 2010,
compared to the three months ended March 31, 2009, primarily due to a
decrease in monitoring and related services revenue.
The following table provides a reconciliation of loss before income
taxes to Adjusted EBITDA by segment (in thousands):
|
|
For the three months ended
March 31,
|
|
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
2010
|
|
2009
|
|
|
|
Retail
|
|
Wholesale
|
|
Multifamily
|
|
(Loss) income before
income taxes
|
|
$
|
(7,666
|
)
|
$
|
(7,155
|
)
|
$
|
1,628
|
|
$
|
2,020
|
|
$
|
2,001
|
|
$
|
2,512
|
|
Plus:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense, net
|
|
11,868
|
|
11,098
|
|
|
|
|
|
4
|
|
5
|
|
Amortization and
depreciation expense
|
|
9,323
|
|
10,280
|
|
1,054
|
|
1,201
|
|
741
|
|
868
|
|
Amortization of deferred
costs in excess of
amortization of deferred revenue
|
|
6,747
|
|
7,289
|
|
|
|
|
|
519
|
|
544
|
|
Stock based compensation
expense
|
|
192
|
|
314
|
|
|
|
|
|
|
|
|
|
Other costs
|
|
2,872
|
|
6
|
|
|
|
44
|
|
|
|
18
|
|
Adjusted
EBITDA
|
|
$
|
23,336
|
|
$
|
21,832
|
|
$
|
2,682
|
|
$
|
3,265
|
|
$
|
3,265
|
|
$
|
3,947
|
|
Critical Accounting Policies and Estimates
The preparation of our financial statements requires management to make
estimates, judgments and assumptions that affect the reported amounts of
assets, liabilities, revenue and expenses during the periods presented. Our Annual Report on Form 10-K for the
fiscal year ended December 31, 2009 includes a summary of the critical
accounting policies we believe are the most important to aid in understanding
our financial results. There have been
no material changes to the critical accounting policies that impacted our reported
amounts of assets, liabilities, revenue or expenses during the first three
months of 2010.
21
Table of Contents
Revenue and Expense Recognition
Revenue is
recognized when security services are provided.
System installation revenue, sales revenue on equipment upgrades and direct
and incremental costs of installations and sales are deferred for residential
customers with monitoring service contracts.
For commercial customers and our national account customers, revenue
recognition is dependent upon each specific customer contract. In instances when we pass title to a system,
we recognize the associated revenue and costs related to the sale of the
equipment in the period that title passes regardless of whether the sale is
accompanied by a service agreement. In
cases where we retain title to the system, we defer and amortize revenue and
direct costs.
Deferred system
and upgrade installation revenue are recognized over the estimated life of the
customer utilizing an accelerated method for our Retail customers. We amortize deferred revenue from customer
acquisitions related to our Retail customers over a fifteen-year period on an
accelerated basis. The associated
deferred customer acquisition costs are amortized, annually and in total, over
a fifteen-year period on an accelerated basis in amounts that are equal to the
amount of revenue amortized, annually and in total, over the fifteen-year
period. The deferred customer
acquisition costs in excess of the deferred customer acquisition revenue are
amortized over the initial term of the contract.
We amortize
deferred customer acquisition costs and revenue related to our Retail customers
using an accelerated basis because we believe this method best approximates the
results that would be obtained if we accounted for these deferred costs and
revenue on a specific contract basis utilizing a straight-line amortization
method with write-off upon customer termination. We do not track deferred
customer acquisition costs and revenue on a contract by contract basis in our
Retail segment, and as a result, we are not able to write-off the remaining
balance of a specific contract when the customer relationship terminates.
Deferred customer acquisition costs and revenue are accounted for using pools,
with separate pools based on the month and year of acquisition.
We periodically
perform a lifing study with the assistance of a third-party appraisal firm to
estimate the average expected life and attrition pattern of our
customers. The lifing study is based on historical customer
terminations. The results of our lifing studies indicate that our
customer pools can expect a declining revenue stream. We evaluate the
differing rates of declining revenue streams for each customer pool and select
an amortization rate that closely matches the respective decline curves.
Such analysis is used to establish the amortization rates of our customer
account pools in order to reflect the pattern of future benefit.
Given that the
amortization lives and methods are developed using historical attrition
patterns and consider actual customer termination experience, we believe such
amortization lives and methods approximate the results of amortizing on a
specific contract basis with write-off upon termination.
For our Multifamily segment, we track the deferred revenues on a
contract by contract basis which are recognized over the estimated life of the
customer utilizing a straight-line method.
The deferred customer acquisition costs in excess of the deferred
customer acquisition revenues are amortized over the initial term of the
contract. We write off the unamortized
portion of the Multifamily deferred customer acquisition revenues and costs
when the customer relationship terminates.
The tables below reflect the impact of our accounting policy on the
respective line items of the Statement of Operations for the three months ended
March 31, 2010 and 2009. The Total
Amount Incurred line represents the current amount of billings that were made
and the current costs that were incurred for the period. We then subtract the deferral amount and add
back the amortization of previous deferral amounts to determine the amount we
report in the Statement of Operations (in thousands):
|
|
Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
Revenue-
other
|
|
Cost of
revenue-other
|
|
Selling
Expense
|
|
Revenue-
other
|
|
Cost of
revenue-other
|
|
Selling
Expense
|
|
Retail segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total amount incurred
|
|
$
|
10,237
|
|
$
|
12,223
|
|
$
|
10,003
|
|
$
|
10,549
|
|
$
|
11,881
|
|
$
|
10,705
|
|
Amount deferred
|
|
(4,206
|
)
|
(6,664
|
)
|
(2,340
|
)
|
(5,231
|
)
|
(7,187
|
)
|
(2,718
|
)
|
Amount amortized
|
|
3,753
|
|
6,565
|
|
3,935
|
|
3,632
|
|
6,514
|
|
4,407
|
|
Amount included in
Statement of Operations
|
|
9,784
|
|
12,124
|
|
11,598
|
|
8,950
|
|
11,208
|
|
12,394
|
|
Wholesale segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total amount incurred (a)
|
|
879
|
|
|
|
520
|
|
184
|
|
|
|
457
|
|
Multifamily segment:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total amount incurred
|
|
168
|
|
217
|
|
120
|
|
304
|
|
1,152
|
|
269
|
|
Amount deferred
|
|
|
|
(76
|
)
|
(19
|
)
|
(6
|
)
|
(843
|
)
|
(114
|
)
|
Amount amortized
|
|
34
|
|
496
|
|
57
|
|
37
|
|
524
|
|
57
|
|
Amount included in
Statement of Operations
|
|
202
|
|
637
|
|
158
|
|
335
|
|
833
|
|
212
|
|
Total company:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total amount incurred
|
|
11,284
|
|
12,440
|
|
10,643
|
|
11,037
|
|
13,033
|
|
11,431
|
|
Amount deferred
|
|
(4,206
|
)
|
(6,740
|
)
|
(2,359
|
)
|
(5,237
|
)
|
(8,030
|
)
|
(2,832
|
)
|
Amount amortized
|
|
3,787
|
|
7,061
|
|
3,992
|
|
3,669
|
|
7,038
|
|
4,464
|
|
Amount reported in
Statement of Operations
|
|
$
|
10,865
|
|
$
|
12,761
|
|
$
|
12,276
|
|
$
|
9,469
|
|
$
|
12,041
|
|
$
|
13,063
|
|
22
Table of Contents
(a)
The wholesale segment revenue-other
represents interest and fee income generated from our dealer loan program and,
in 2010, income recorded under the APX Agreement.
In addition to the
amounts reflected in the table above relating to our costs incurred to create
new accounts, our Retail segment also capitalized purchases of rental equipment
in the amount of $0.5 million and $0.6 million for the three months ended March 31,
2010 and 2009, respectively. We
purchased customer accounts valued at $25 thousand during the three months ended
March 31, 2010. We did not purchase
any customer accounts during the three months ended March 31, 2009.
New accounting
standards
See Note 12 of the Condensed Consolidated Financial
Statements for new accounting standards, including the expected dates of
adoption and estimated effects on our Condensed Consolidated Financial
Statements, included in Part I of this Quarterly Report on Form 10-Q,
which information is incorporated herein by reference.
Operating Results
Three
Months Ended March 31, 2010 Compared to Three Months Ended March 31,
2009
Protection One Consolidated
Revenue
decreased $4.7 million, or 5.0%, to $88.3 million in
the first quarter of 2010 compared to $93.0 million in the first quarter of
2009. Monitoring and related services
revenue decreased $6.1 million, to $77.5 million, primarily due to the impact
of the APX agreement on Wholesale monitoring and related services revenue as
well as a decline in Retail and Multifamily monitoring and services revenue. Installation and other revenue increased $1.4
million, or 14.7%, to $10.9 million in the first quarter of 2010 compared to
$9.5 million in the first quarter of 2009 primarily due to an increase in sales
of equipment to commercial customers and the APX agreement.
Cost of revenue
decreased $1.7 million, or 4.4%, to $36.1 million in
the first quarter of 2010 compared to $37.8 million in the first quarter of
2009. The decrease is primarily due to
the decrease in Wholesale monitoring costs related to the APX agreement
partially offset by an increase in system equipment sales to commercial
customers.
Amortization and depreciation
decreased $1.2 million, or 10.0%, to
$11.1 million in the first quarter of 2010 compared to $12.3 million in the
first quarter of 2009 due to use of a declining balance method of amortization
for our amortizable intangible assets.
Net interest expense
increased $0.8 million, or 6.9%, to
$11.9 million for the first quarter of 2010 compared to $11.1 million in the
first quarter of 2009 primarily due to amortization of our debt discount on the
New and Extending Term Loans issued in the fourth quarter of 2009.
Net loss
of $4.8 million, or loss per diluted share of common
stock of $0.19, was recorded in the first quarter of 2010 compared to a net
loss of $2.8 million, or loss per diluted share of common stock of $0.11, in
the first quarter of 2009 due primarily to the decline in revenue and cost of
revenue previously mentioned. Selling
expense decreased by $0.8 million, or 6.0%, to $12.3 million in the first
quarter of 2010 compared to $13.1 million in the first quarter of 2009, due to
a reduction in costs associated with an annual sales reward program and a
reduction in amortization of previously deferred sales expense. General and administrative costs reflected a
slight decrease of $0.3 million, or 1.7%, to $21.0 million in the first quarter
of 2010 compared to $21.3 million in the first quarter of 2009
23
Table of Contents
Retail Segment
The table below presents operating results for our
Retail segment for the periods presented.
Next to each periods results of operations, we provide the relevant
percentage of total revenue so you can make comparisons about the relative
changes in revenue and expenses (dollars in thousands):
|
|
Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
Monitoring and related services
|
|
$
|
62,017
|
|
86.4
|
%
|
$
|
63,717
|
|
87.7
|
%
|
Installation and other
|
|
9,784
|
|
13.6
|
|
8,950
|
|
12.3
|
|
Total revenue
|
|
71,801
|
|
100.0
|
|
72,667
|
|
100.0
|
|
Cost of revenue (exclusive of amortization and
depreciation shown below)
|
|
|
|
|
|
|
|
|
|
Monitoring and related services
|
|
16,836
|
|
23.4
|
|
17,203
|
|
23.7
|
|
Installation and other
|
|
12,124
|
|
16.9
|
|
11,208
|
|
15.4
|
|
Total cost of revenue (exclusive of amortization and
depreciation shown below)
|
|
28,960
|
|
40.3
|
|
28,411
|
|
39.1
|
|
Operating Expenses
|
|
|
|
|
|
|
|
|
|
Selling expense
|
|
11,598
|
|
16.2
|
|
12,394
|
|
17.1
|
|
General and administrative expense
|
|
17,718
|
|
24.6
|
|
17,638
|
|
24.3
|
|
Amortization of intangibles and depreciation expense
|
|
9,323
|
|
13.0
|
|
10,280
|
|
14.1
|
|
Total operating expenses
|
|
38,639
|
|
53.8
|
|
40,312
|
|
55.5
|
|
Operating income
|
|
$
|
4,202
|
|
5.9
|
%
|
$
|
3,944
|
|
5.4
|
%
|
The change in our Retail segment customer base for the
period is shown below.
|
|
Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Beginning Balance,
January 1
|
|
540,968
|
|
574,001
|
|
Customer additions
|
|
8,551
|
|
9,775
|
|
Customer losses
|
|
(15,704
|
)
|
(18,781
|
)
|
Other adjustments
|
|
228
|
|
(219
|
)
|
Ending Balance,
March 31
|
|
534,043
|
|
564,776
|
|
Revenue
decreased $0.9 million, or 1.2%, to $71.8 million in
the first quarter of 2010 compared to $72.7 million in the first quarter of
2009. Monitoring and related services
revenue decreased $1.7 million in the first quarter of 2010 compared to the
first quarter of 2009 due to lower monitoring revenue and the related decline
in Retail RMR as well as lower service call volume. See Summary of Important MattersRecurring
Monthly Revenue, above for a roll-forward of RMR and additional information regarding
the change in recurring monthly revenue in the first quarter of 2010. Installation and other revenue increased $0.8
million in the first quarter of 2010 compared to the first quarter of 2009 due
to an increase in revenue from sales of equipment to commercial customers. Revenue consists primarily of (1) contractual
revenue derived from providing monitoring and maintenance service, (2) revenue
from our installations of new alarm systems, consisting primarily of sales of
burglar alarm, CCTV, fire alarm and card access control systems to commercial
customers and (3) amortization of previously deferred revenue.
Cost of revenue
increased $0.6 million, or 1.9%, to $29.0 million in
the first quarter of 2010 compared to $28.4 million in the first quarter of
2009. Cost of monitoring and related
services decreased $0.3 million in the first quarter of 2010 compared to the
first quarter of 2009 due to the reduction in monitoring and related revenues. Cost of installation and other revenue
increased $0.9 million, or 8.2%, in the first quarter of 2010 compared to the
first quarter of 2009 due to an increase in system equipment sales to
commercial customers. Cost of revenue
includes the costs of monitoring, billing, customer service, field operations,
and equipment and labor charges to install alarm systems, CCTV, fire alarms and
card access control systems sold to our commercial customers, as well as
amortization of previously deferred customer acquisition costs.
Operating expense
decreased $1.7 million, or 4.2%, to $38.6 million in
the first quarter of 2010 compared to $40.3 million in the first quarter of
2009. Amortization and depreciation
decreased $1.0 million in the first quarter of 2010 compared to the first
quarter of 2009 due to use of a declining balance method of amortization for
amortizable intangible assets. Selling
expense decreased $0.8 million in the first quarter of 2010 compared to the
first quarter of 2009as a result of a reduction in costs associated with an
annual sales reward program and a reduction in amortization of previously
deferred sales expense. General and
administrative expenses were consistent.
24
Table of Contents
Wholesale Segment
The following table provides information for
comparison of the Wholesale segment operating results for the periods
presented. Next to each periods results
of operations, we provide the relevant percentage of total revenue so that you
can make comparisons about the relative changes in revenue and expenses
(dollars in thousands):
|
|
Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
Monitoring and related services
|
|
$
|
9,270
|
|
91.3
|
%
|
$
|
12,579
|
|
98.6
|
%
|
Other
|
|
879
|
|
8.7
|
|
184
|
|
1.4
|
|
Total revenue
|
|
10,149
|
|
100.0
|
|
12,763
|
|
100.0
|
|
Cost of revenue (exclusive of amortization and
depreciation shown below)
|
|
|
|
|
|
|
|
|
|
Monitoring and related services
|
|
4,807
|
|
47.4
|
|
6,769
|
|
53.1
|
|
Operating Expenses
|
|
|
|
|
|
|
|
|
|
Selling expense
|
|
520
|
|
5.1
|
|
457
|
|
3.6
|
|
General and administrative expense
|
|
2,140
|
|
21.1
|
|
2,316
|
|
18.1
|
|
Amortization of intangibles and depreciation expense
|
|
1,054
|
|
10.4
|
|
1,201
|
|
9.4
|
|
Total operating expenses
|
|
3,714
|
|
36.6
|
|
3,974
|
|
31.1
|
|
Operating income
|
|
$
|
1,628
|
|
16.0
|
%
|
$
|
2,020
|
|
15.8
|
%
|
The change in our Wholesale segment monitored site
base for the period is shown below.
|
|
Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Beginning Balance,
January 1
|
|
677,286
|
|
991,014
|
|
Monitored site additions
|
|
32,338
|
|
45,916
|
|
Monitored site losses
|
|
(29,613
|
)
|
(49,249
|
)
|
Other adjustments
|
|
|
|
67
|
|
Ending Balance,
March 31
|
|
680,011
|
|
987,748
|
|
For a roll-forward of Wholesale segment RMR, please
see the segment table in the Summary of Important MattersRecurring Monthly
Revenue, above. Wholesale ending RMR at
March 31, 2010 was significantly lower than as of March 31, 2009 due
to the impact of the APX agreement. See Summary
of Important Matters-APX Agreement, above, for additional information related
to the agreement.
Revenue
decreased $2.6 million, or 20.5%, to $10.2 million in
the first quarter of 2010 compared to $12.8 million in the first quarter of
2009 primarily due to the APX agreement.
We recorded $0.8 million of other revenue as a result of the APX
agreement, which was offset by a decrease in monitoring and related services
revenue. Revenue consists primarily of
contractual revenue derived from providing monitoring service, as well as
interest and fee income generated from our dealer loan program.
Cost of revenue
decreased $2.0 million, or 29.0%, to $4.8 million in
the first quarter of 2010 compared to $6.8 million in the first quarter of 2009
due to the APX agreement. These costs
generally relate to the cost of providing monitoring service, including the
costs of monitoring and dealer care.
Cost of monitoring and related services revenue as a percent of the
related revenue improved to 51.9% for the first quarter of 2010 compared to
53.1% in the first quarter of 2009 due to the APX agreement.
Operating expense
decreased $0.3 million or 6.5%, to $3.7 million in
the first quarter of 2010 compared to $4.0 million in the first quarter of 2009
but increased as a percentage of revenue for the first quarter of 2010 to 36.6%
compared to 31.1% for the first quarter of 2009 due to lower revenue discussed
above.
Multifamily Segment
The following table provides information for
comparison of our Multifamily segment operating results for the periods
presented. Next to each periods results
of operations, we provide the relevant percentage of total revenue so that you
can make comparisons about the relative change in revenue and expenses (dollars
in thousands):
25
Table of Contents
|
|
Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
Revenue
|
|
|
|
|
|
|
|
|
|
Monitoring and related services
|
|
$
|
6,163
|
|
96.8
|
%
|
$
|
7,237
|
|
95.6
|
%
|
Installation and other
|
|
202
|
|
3.2
|
|
335
|
|
4.4
|
|
Total revenue
|
|
6,365
|
|
100.0
|
|
7,572
|
|
100.0
|
|
Cost of revenue (exclusive of amortization and
depreciation shown below)
|
|
|
|
|
|
|
|
|
|
Monitoring and related services
|
|
1,713
|
|
26.9
|
|
1,774
|
|
23.4
|
|
Installation and other
|
|
637
|
|
10.0
|
|
833
|
|
11.0
|
|
Total cost of revenue (exclusive of amortization and
depreciation shown below)
|
|
2,350
|
|
36.9
|
|
2,607
|
|
34.4
|
|
Operating Expenses
|
|
|
|
|
|
|
|
|
|
Selling expense
|
|
158
|
|
2.5
|
|
212
|
|
2.8
|
|
General and administrative expense
|
|
1,111
|
|
17.5
|
|
1,369
|
|
18.1
|
|
Amortization of intangibles and depreciation expense
|
|
741
|
|
11.6
|
|
868
|
|
11.5
|
|
Total operating expenses
|
|
2,010
|
|
31.6
|
|
2,449
|
|
32.4
|
|
Operating income
|
|
$
|
2,005
|
|
31.5
|
%
|
$
|
2,516
|
|
33.2
|
%
|
The change in our Multifamily segment monitored site
base for the period is shown below.
|
|
Three Months Ended March 31,
|
|
|
|
2010
|
|
2009
|
|
|
|
|
|
|
|
Beginning Balance,
January 1,
|
|
213,025
|
|
240,648
|
|
Monitored site additions
|
|
707
|
|
2,392
|
|
Monitored site losses
|
|
(2,960
|
)
|
(24,288
|
)
|
Ending Balance,
March 31,
|
|
210,772
|
|
218,752
|
|
Multifamily experienced elevated site losses in 2009 arising from the
termination of several large customers for financial reasons. For a roll-forward of Multifamily segment
RMR, please see the segment table in the Summary of Important MattersRecurring
Monthly Revenue, above.
Revenue
decreased $1.2 million, or 15.9%, to $6.4 million in
the first quarter of 2010 compared to $7.6 million in the first quarter of 2009
due to a decline in monitoring and service revenue from a declining customer
base. This revenue consists primarily of
contractual revenue derived from providing monitoring and maintenance service,
the installation of alarm systems and amortization of previously deferred
customer acquisition revenue.
Cost of revenue
decreased $0.3 million, or 9.9%, to $2.3 million in
the first quarter of 2010 compared to $2.6 million in the first quarter of 2009
primarily due to the decline in monitoring and related services revenue. Cost of revenue includes monitoring, billing,
customer service and field operations related to providing our monitoring
services, as well as the cost to install access control systems and amortization
of previously deferred costs.
Operating expenses
decreased $0.4 million, or 17.9%, to $2.0 million in
the first quarter of 2010 compared to $2.4 million in the first quarter of
2009. This decrease is primarily
attributable to decreases in bad debt expense and amortization expense.
Liquidity
and Capital Resources
We expect to generate cash flow in excess of that required for
operations and interest and principal payments required under all of our debt
obligations during the twelve months following the date of the financial
statements included in this report.
Credit Risk
Our cash and cash equivalents are deposited in a mutual fund invested
exclusively in U.S. Treasury securities.
Although the mutual fund is permitted seven days to satisfy withdrawal
requests, the financial institution has never exercised the provision with
us. We believe, based on information
available to management at this time, that there is minimal risk regarding
liquidity of our approximately $33.3 million cash and cash equivalents as of March 31,
2010.
We have also assessed our credit exposure to various other factors
including (1) our ability to draw funds under our revolving credit
facility; (2) counterparty default risk associated with our interest rate
cap and swaps; (3) our need to enter the capital markets; and (4) exposure
related to our existing insurance policies. We believe we have sufficient
liquidity for our currently foreseeable operational needs. With respect to our interest rate swaps and
cap, we believe that counterparty default is not probable. Lastly, we have assessed exposure on our
existing insurance policies and believe the insurers are financially solvent
and well-capitalized.
We have three interest rate swap agreements to fix the variable
component of the interest rate on $250 million of our LIBOR-based variable debt
under the senior credit facility at 3.15% to 3.19%. The interest rate swaps mature from September 2010
to November 2010. With the current
applicable margin on our LIBOR-based borrowings under our senior credit
facility at 2.25%, the effective interest rate on the swapped debt ranges from
5.40% to 5.44%. The interest rate swaps
were de-designated as cash flow hedges in conjunction with the debt refinancing
that occurred in the fourth quarter of 2009.
26
Table of Contents
Debt Obligations
On November 17, 2009, we amended our senior credit agreement which
(i) increased term loan borrowings by $75 million under the New Term Loans
to an aggregate of $364.5 million, (ii) divided all of our term loans into
Non-Extending Term Loans equal to $86.5 million and New and Extending Term
Loans equal to $278.0 million and (iii) replaced our $25 million revolving
credit facility with a $15 million revolving credit facility. We intend to use any borrowings under the
revolving credit facility, from time to time, for working capital and general corporate
purposes.
The New and Extending Term Loans are scheduled to mature on March 31,
2014, provided, however, that the New and Extending Term Loans will mature on December 14,
2012 if prior to December 14, 2012 the maturity date for our Unsecured
Term Loan Agreement is not extended to at least 91 days after March 31,
2014 or the borrowings under the Unsecured Term Loan Agreement are not
refinanced with permitted refinancing indebtedness having a maturity date at
least 91 days after March 31, 2014.
The New and Extending Term Loans bear interest at a margin of 4.25% over
the Eurodollar Base Rate (as defined in the Senior Credit Agreement and subject
to a 2% floor) for Eurodollar borrowings and 3.25% over the Base Rate (as
defined in the Senior Credit Agreement and subject to a 3% floor) for Base Rate
borrowings. The Non-Extending Term Loans
are scheduled to mature on March 31, 2012 and bear interest at a margin of
2.25% over the Eurodollar Base Rate for Eurodollar borrowings and 1.25% over
the Base Rate for Base Rate Borrowings.
Prior to the amendment of the senior credit facility in November of
2009, our borrowings under the senior credit agreement bore interest at a
margin of 2.25% over the Eurodollar Base Rate for Eurodollar borrowings and
1.25% over the Base Rate for Base Rate Borrowings. The interest rate at March 31, 2010, was
6.25% and 2.50% for the New and Extending Term Loans and the Non-Extending Tern
Loans, respectively, not including the impact of interest rate swaps. The interest rate at December 31, 2009,
was 6.25% and 2.48% for the New and Extending Term Loans and the Non-Extending
Tern Loans, respectively, not including the impact of interest rate swaps.
The revolving credit facility is scheduled to mature on March 31,
2013, provided, however, that the revolving credit facility will mature on December 14,
2012 if prior to December 14, 2012 the maturity date of our Unsecured Term
Loan Agreement is not extended to at least 91 days after March 31, 2014 or
the borrowings under the Unsecured Term Loan Agreement are not refinanced with
permitted refinancing indebtedness having a maturity date at least 91 days
after March 31, 2014. Borrowings
under the revolving credit facility will bear interest at a margin of 4.25%
over the Eurodollar Base Rate for Eurodollar borrowings and 3.25% over the Base
Rate for Base Rate borrowings. The
revolving credit facility includes an unused commitment fee equal to 1.0%. We may request letters of credit to be issued
under the revolving credit facility of up to $7.5 million, with any outstanding
letters of credit reducing the total amount available for borrowing under the
revolving credit facility. Approximately
$11.0 million remained available for borrowing under our revolving credit
facility as of May 11, 2010 after reducing total availability by approximately
$4.0 million for an outstanding letter of credit.
On March 14, 2008, we borrowed approximately $110.3 million under
an unsecured term loan facility to allow us to redeem all of the senior
subordinated notes then outstanding. The
Unsecured Term Loan bears interest at the prime rate plus 11.5% per annum and
matures in 2013.
The senior credit facility is secured by substantially all of our
assets, requires quarterly principal payments of $0.8 million and requires
potential annual prepayments based on a calculation of Excess Cash Flow, as
defined in the Senior Credit Agreement, due in the first quarter of the
subsequent year. We made $30.0 million
in principal prepayments on the Non-Extending Term Loans in December 2009
which were applied to offset any required Excess Cash Flow prepayment. As a result, we were not required to make
additional principal prepayments in the first quarter of 2010. We are currently not able to estimate whether
any Excess Cash Flow prepayment will be required for the year ending December 31,
2010.
The Senior Credit Agreement and Unsecured Term Loan Agreement contain
certain covenants and restrictions, including with respect to our ability to
incur debt, based on earnings before interest, taxes, depreciation and amortization,
or EBITDA. While the definition of
EBITDA varies slightly among the Senior Credit Agreement and Unsecured Term
Loan Agreement, EBITDA is generally derived by adding to income (loss) before
income taxes, the sum of interest expense, depreciation and amortization
expense, including amortization of deferred customer acquisition costs less
amortization of deferred customer acquisition revenue.
27
Table of Contents
The following table presents the financial ratios required by our
Senior Credit Agreement and Unsecured Term Loan Agreement through December 31,
2010 and our actual ratios as of March 31, 2010.
Debt
Instrument
|
|
Financial
Covenants
|
|
Ratio
Requirements
|
|
Actual
Ratio as of
March 31, 2010
|
Senior Credit Agreement
|
|
Consolidated Leverage Ratio (consolidated total debt on last day of
period/consolidated EBITDA for most recent four fiscal quarters)
|
|
Q4 2009 through Q3 2010: Less than 5.5:1.0
Q4 2010; less than 5.25:1.0
|
|
3.09:1.0
|
|
|
|
|
|
|
|
|
|
Consolidated Interest Coverage Ratio (consolidated EBITDA for most
recent four fiscal quarters/consolidated interest expense for most recent
four fiscal quarters)
|
|
Q4 2009 through Q3 2010: Greater than 2.0:1.0
Q4 2010; Greater than 2.05:1.0
|
|
3.26:1.0
|
|
|
|
|
|
|
|
Unsecured Term Loan Agreement
|
|
Consolidated Fixed Charge Coverage Ratio (consolidated EBITDA for most
recent four fiscal quarters/consolidated interest expense for most recent
four fiscal quarters)
|
|
Greater than 2.25:1.0
|
|
2.95:1.0
|
At March 31, 2010, we were in compliance with the financial
covenants and other maintenance tests for all our debt obligations. The Consolidated Leverage Ratio and
Consolidated Interest Coverage Ratio contained in our Senior Credit Agreement
are maintenance tests and the Consolidated Fixed Charge Coverage Ratio
contained in our Unsecured Term Loan Agreement is a debt incurrence test. We cannot be deemed to be in default solely
due to failure to meet debt incurrence tests.
However, failure to meet debt incurrence tests could result in
restriction on our ability to incur additional ratio indebtedness. We believe that should we fail to meet the
minimum Consolidated Fixed Charge Coverage Ratios in our Unsecured Term Loan
Agreement, our ability to borrow additional funds under other permitted
indebtedness provisions in our Unsecured Term Loan Agreement and Senior Credit
Agreement would provide us with sufficient liquidity for our currently
foreseeable operational needs. We are
prohibited from paying cash dividends to our stockholders under covenants
contained in our Senior Credit Agreement.
Cash Flow
Operating Cash Flows for the Three Months Ended March 31, 2010.
Our operations provided cash of $14.7 million and $21.0 million in the
first three months of 2010 and 2009, respectively. We expect to continue to generate cash from
operating activities in excess of the cash required for operations and interest
payments due in the twelve months following the date of the financial
statements included in this report.
Working capital was a deficit of $7.6 million and $18.4 million as of March 31,
2010 and December 31, 2009, respectively.
The improvement in the working capital deficit at March 31, 2010 is
primarily related to improvements in operating results including higher cash
balances at March 31, 2010.
Investing Cash Flows for the
Three Months Ended March 31, 2010.
We used a net
$6.1 million and $7.0 million for our investing activities for the first three
months of 2010 and 2009, respectively.
We invested a net $5.4 million in cash to install and acquire new
accounts (including rental equipment) and $0.8 million to acquire fixed assets
in the first three months of 2010. We
also received $0.1 million from the sale of accounts and other assets. We invested a net $6.2 million in cash to
install and acquire new accounts (including rental equipment) and $0.8 million
to acquire fixed assets in the first three months of 2009.
Financing Cash Flows for the
Three Months Ended March 31, 2010.
Financing activities used a net $1.4
million in each of the first three months of 2010 and 2009, respectively,
related to the repayment of borrowings under our senior credit facility and
capital leases.
Capital Expenditures
Assuming we have available funds, net capital
expenditures for 2010 (inclusive of $6.2 million spent through March 31,
2010) are expected to be $43 million, of which $6 million is expected to be
used for fixed asset purchases, with the balance to be used for net customer
acquisition costs and non-monitored leased equipment. These estimates are prepared for planning
purposes and are revised from time to time.
Actual expenditures for these and other items not presently anticipated
may vary materially from these estimates during the course of the years
presented.
28
Table of Contents
Material Commitments
Our contractual cash obligations are disclosed in our
Annual Report on Form 10-K for the year ended December 31, 2009. There were no significant changes in these
commitments from that reported in our Annual Report on Form 10-K for the
year ended December 31, 2009. We
have future, material, long-term commitments, which, as of March 31, 2010,
included $332.8 million related to the senior credit facility and $110.3
million related to the Unsecured Term Loan.
Off-Balance Sheet Arrangements
We had no off-balance sheet transactions or
commitments as of or for the three months ended March 31, 2010, other than
as disclosed in this report.
Credit
Ratings
Standard & Poors (S&P) and Moodys Investors Service
(Moodys) are independent credit-rating agencies that rate our debt
securities. As of May 11, 2010, our
senior credit facility was rated as follows (our Unsecured Term Loan is not
rated).
|
|
Senior
Credit
Facility
|
|
Outlook
|
|
S & P
|
|
BB
|
|
Stable
|
|
Moodys
|
|
Ba3
|
|
Stable
|
|
Tax
Matters
We generally do not expect to be in a position to record tax benefits
for losses incurred in the future.
ITEM
3. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK.
Our Unsecured Term Loan is a variable rate debt instrument with
borrowings of $110.3 million outstanding as of May 11, 2010. Our senior credit facility is a variable rate
debt instrument, and as of May 11, 2010, we had borrowings of $332.8
million outstanding. The New and
Extending Term Loans of the senior credit facility bear interest at a margin of
4.25% over the Eurodollar Base Rate (subject to a 2.0% LIBOR floor) and 3.25%
over the Base Rate (subject to a 3.0% Prime Rate floor). We have three interest rate swap agreements
to fix the interest rate of $250 million of our variable rate debt under the
senior credit facility, which fix the interest rate at a one month LIBOR rate
of 3.15% to 3.19%. The interest rate
swaps were de-designated as cash flow hedges in conjunction with the debt
refinancing that occurred in the fourth quarter of 2009.
As of May 11, 2010, the one-month LIBOR was 0.34% and the prime
rate was 3.25%. The table below reflects
the impact on pre-tax income of changes in the rates at May 11, 2010 in
LIBOR and the prime rate on our debt and the impact on pre-tax income of
changes in LIBOR on the interest rate swaps (in thousands):
(Decrease) Increase in
index rate
|
|
(2.00
|
)%
|
(1.00
|
)%
|
0.00
|
%
|
1.00
|
%
|
2.00
|
%
|
3.00
|
%
|
4.00
|
%
|
Increase (Decrease) in
pre-tax income:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Debt
|
|
$
|
2,398
|
|
$
|
1,295
|
|
$
|
0
|
|
$
|
(1,666
|
)
|
$
|
(4,272
|
)
|
$
|
(8,703
|
)
|
$
|
(13,135
|
)
|
Interest rate swaps
|
|
(549
|
)
|
(549
|
)
|
0
|
|
1,537
|
|
3,073
|
|
4,610
|
|
6,147
|
|
Net increase (decrease) in
pre-tax income:
|
|
$
|
1,849
|
|
$
|
746
|
|
$
|
0
|
|
$
|
(129
|
)
|
$
|
(1,199
|
)
|
$
|
(4,093
|
)
|
$
|
(6,988
|
)
|
ITEM
4. CONTROLS AND PROCEDURES.
Disclosure Controls and Procedures.
As of March 31, 2010, the end of the period
covered by this report, the Companys management, under the supervision and
with the participation of our chief executive officer and our chief financial
officer, concluded that its disclosure controls and procedures are effective (a) to
ensure that information required to be disclosed by the Company in reports that
it files or submits under the Securities Exchange Act of 1934 (the Exchange
Act) is recorded, processed, summarized and reported within the time periods
specified in Securities and Exchange Commission rules and forms and (b) include,
without limitation, controls and procedures designed to ensure that information
required to be disclosed by us in reports filed or submitted under the Exchange
Act is accumulated and communicated to management, including our chief
executive officer and chief financial officer, as appropriate to allow timely
decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting.
There were no changes in the Companys internal
control over financial reporting that have materially affected, or are
reasonably likely to materially affect, its internal control over financial
reporting during the quarter ended March 31, 2010.
29
Table of Contents
PART II - OTHER INFORMATION
ITEM
1. LEGAL PROCEEDINGS.
Information relating to legal proceedings is set forth
in Note 9 of the Notes to Condensed Consolidated Financial Statements included
in Part I of this Quarterly Report on Form 10-Q, which information is
incorporated herein by reference.
ITEM
1A. RISK FACTORS.
The market price of our common stock has
been, and may continue to be, materially affected by the proposed Offer and
Merger and could be materially affected by the termination of the Merger
Agreement.
The
current market price of our common stock may reflect, among other things, the
commencement and anticipated completion of the Offer and Merger. The current market price is higher than the
price before the proposed Offer was announced on April 26, 2010 and higher
than the price before we announced the commencement of the process to explore
and evaluate strategic alternatives. The
completion of the Offer and Merger are subject to conditions and termination
rights contained in the Merger Agreement.
Accordingly, there can be no assurance that the proposed Offer and
Merger will be completed. In the event
that the Offer and Merger are not completed, our stock price may be materially
and adversely affected.
Litigation and uncertainties associated
with the transactions contemplated by the Merger Agreement may have a material
adverse effect on our ability to complete the transaction.
Litigation
has been instituted by purported stockholders of ours, on behalf of themselves
and as putative class actions, against us and our board of directors, among
others involved, as a result of the proposed transactions. See Note 9
Commitments and Contingencies Shareholder Litigation to our Condensed
Consolidated Financial Statements for additional information. Also,
various law firms have announced that they are investigating possible claims
against our board of directors as a result of the proposed transactions which
may result in new litigation relating to the proposed transactions. Litigation
relating to the proposed transactions may require us to expend significant
amounts of money, may require significant time from our management, and may
result in an adverse settlement, injunction barring or delaying the proposed
transactions, or judgment against us or our directors which could have a
material adverse effect on our ability to complete the transactions which could
be detrimental to our stockholders.
In
addition, the following uncertainties, among others, could have a material
adverse effect on our business operations and financial results which could be
detrimental to our stockholders if the Offer and Merger are not completed:
·
the
uncertainty associated with a potential change in control of our Company could
negatively affect our ability to retain and attract key management, sales,
marketing and other personnel which we rely on to operate our business;
·
our customers, suppliers and marketing
partners may delay or defer decisions relating to their ongoing and future
relationships with us or terminate their relationships with us, which could
negatively affect our revenues, earnings and cash flows;
·
we will incur significant costs,
including financial and legal advisory fees, relating to the proposed Offer and
Merger even if the proposed transactions are not completed; and
·
under
the Merger Agreement, we may be required to pay to Protection Holdings, LLC a
termination fee of $8.0 million if the Merger Agreement is terminated
under certain circumstances.
The Merger Agreement contains restrictive
covenants that may limit our ability to respond to changes in market conditions
or pursue business opportunities.
The
Merger Agreement contains restrictive covenants that limit our ability to take
certain actions during the period prior to the completion of the proposed Offer
and Merger. Although the Merger
Agreement provides that Protection Holdings, LLC will not unreasonably withhold
its consent to us taking otherwise prohibited actions, there can be no
assurances that Protection Holdings, LLC will grant such consent. These restrictions include limitations on our
ability to, among other things, make certain acquisitions, incur additional indebtedness,
terminate, amend or enter into any material contract, make capital expenditures
or enter into new lines of business, each of which may materially adversely
affect our ability to react to changes in market conditions or take advantage
of business opportunities, which could be detrimental to our stockholders in
the event the Offer and Merger are not completed.
ITEM
2. UNREGISTERED SALES OF EQUITY
SECURITIES AND USE OF PROCEEDS.
None.
30
Table of Contents
ITEM
3. DEFAULTS UPON SENIOR SECURITIES.
None.
ITEM
5. OTHER INFORMATION.
None.
ITEM
6. EXHIBITS.
Exhibits. The following exhibits are filed or furnished with this
Quarterly Report on Form 10-Q:
Exhibit
Number
|
|
Exhibit Description
|
|
|
|
2.1
|
|
Agreement and Plan of Merger, dated as of April 26, 2010, by and
among Protection Holdings, LLC, Protection Acquisition Sub, Inc. and
Protection One, Inc. (incorporated by reference to Exhibit 2.1 of
the Current Report on Form 8-K dated April 26, 2010).
|
2.2
|
|
Tender and Support Agreement, dated as of April 26, 2010, by and
among POI Acquisition, L.L.C., Protection Holdings, LLC and Protection
Acquisition Sub, Inc. (incorporated by reference to Exhibit 2.2 of
the Current Report on Form 8-K dated April 26, 2010).
|
2.3
|
|
Tender and Support Agreement, dated as of April 26, 2010, by and
among Monarch Alternative Capital LP, Protection Holdings, LLC and Protection
Acquisition Sub, Inc. (incorporated by reference to Exhibit 2.3 of
the Current Report on Form 8-K dated April 26, 2010).
|
2.4
|
|
Guaranty dated as of April 26, 2010, by GTCR Fund IX/A, L.P. in
favor of Protection One, Inc. (incorporated by reference to
Exhibit 10.1 of the Current Report on Form 8-K dated April 26,
2010).
|
2.5
|
|
Letter Agreement, dated as of April 26, 2010, by and among POI
Acquisition, L.L.C., Monarch Alternative Capital, LP and the Company
(incorporated by reference to Exhibit (e)(7) of the Schedule 14D-9
filed on May 3, 2010).
|
31.1
|
|
Certification pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 for Protection One, Inc.+
|
31.2
|
|
Certification pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002 for Protection One, Inc.+
|
32.1
|
|
Certification of Principal Executive Officer pursuant to 18 U.S.C
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002 for Protection One, Inc.+
|
32.2
|
|
Certification of Principal Financial Officer pursuant to 18 U.S.C
Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 for Protection One, Inc.+
|
+ Filed or furnished herewith
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrants have duly caused this report to be signed on their behalf by
the undersigned thereunto duly authorized.
Date
:
|
May 13,
2010
|
|
PROTECTION ONE,
INC.
|
|
|
|
|
|
|
|
By:
|
/s/ Darius G.
Nevin
|
|
|
|
|
Darius G. Nevin,
Executive Vice President and Chief Financial Officer (duly authorized officer
and principal financial officer)
|
31
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