Protection One Is Hit by Fear Over Debt, SEC Probe

The recent performance of Protection One Inc., the nation’s No. 2 home security firm, has set off an alarm on Wall Street.

Shares of the Culver City-based company touched a 52-week low of $3.38 on Wednesday before closing up 6 cents at $3.63 on the New York Stock Exchange.

The fast-growing firm, whose sales have ballooned to a $600-million annual pace from just $73 million in 1996 as a result of numerous acquisitions, has been stumbling under a mountain of debt and rising defections among its 1.6 million customers.

And last week, Protection One disclosed in its second-quarter earnings report that the Securities and Exchange Commission staff believes there are “errors” in the company’s financial statements involving its accounting for certain costs of signing up new customers.

That disclosure follows Protection One’s decision in April to restate results for 1997 and most of 1998--reducing reported income--because of another accounting problem: The SEC had taken issue with the company’s treatment of costs related to the replacement of yard signs that identify homes protected by the company’s security systems.

The SEC’s latest problem with Protection One’s books focuses on the length of time the company takes to write off, or amortize, customer acquisition costs.

To find new customers, the company--which installs and monitors home security systems--has a network of 250 dealers that sell Protection One contracts. When a customer signs up, Protection One buys the contract from the dealer. Protection One said it has historically amortized those costs over 10 years.

The SEC has questioned whether that’s too long a write-off period. Analysts say that reflects questions about contract life spans.

The issue of customer retention has become more troublesome for Protection One this year. The company has acknowledged disruptions in its security monitoring that “have adversely affected customer service.” It blamed the disruptions on attempts to consolidate certain operations.

In turn, customer attrition was 10.5% in the 12 months ended June 30, up from 9.7% in the 12 months ended March 31. In the second quarter alone, the annualized attrition rate soared to 14.3%.

If Protection One is forced to shorten its account amortization period, it would book expenses at a faster rate--reducing net income near term. A one- to three-year reduction in the amortization period would mean additional annual expenses of $14 million to $54 million, the company said.

The company, which is second in its industry to ADT Inc., has been unprofitable since going public in 1994, but its losses have narrowed recently. In the second quarter, Protection One had a net loss of $7.4 million, or 6 cents a share.

Meanwhile, the company’s cash flow--calculated by adding noncash charges such as amortization costs back to net income--was $37.5 million in the second quarter.

Although Wall Street focuses on cash flow in judging whether a company can pay such bills as interest expenses, credit-rating agency Standard & Poor’s Corp. on Tuesday placed Protection One’s debt on credit watch “with negative implications.” The move reflects the company’s expectation that it will soon be in violation of certain covenants on a loan agreement.

Protection One’s debt load “is certainly an issue, but we don’t view it as being onerous,” said one analyst who spoke on condition of anonymity. But “if attrition is rising because of poor service or lack of growth, it truly could be detrimental.”

The company’s net interest expense was $21.8 million in the second quarter, up from $13.8 million a year earlier, in part reflecting the issuance last year of $300 million in junk bonds.

Still, Protection One has a rich parent: It is 85% owned by Western Resources, a Topeka, Kan.-based utility with $8 billion in assets.

A spokeswoman for Western Resources said Wednesday that “we’re very supportive” of Protection One, but declined to address the firm’s financial performance.

Shares of Western Resources hit a 52-week low Wednesday, falling to $22.94 before closing at $23.56, down 31 cents, on the NYSE.

Protection One Chief Executive John E. Mack III, who took over when James M. Mackenzie Jr. abruptly resigned in March, also declined to comment.

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Stock Alert

Shares of Protection One have plunged amid worries about its debt and news of an investigation into the company’s accounting practices. Monthly closes and latest:

Wednesday: $3.63

Source: Bloomberg News