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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark one)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from __________ to ________
Commission File No. 000-50343
INTEGRATED ALARM SERVICES GROUP, INC.
(Exact name of Registrant as specified in its charter)
Delaware
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
42-1578199
One Capital Center
99 Pine Street,3rd Floor
Albany, New York 12207
(Address of principal executive offices) (zip code)
(518) 426-1515
(Registrant's telephone number, including area code)
(Former name or former address, if changed since last report)
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 the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No___
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes___ No X
As of August 5, 2004 there were 24,681,462 shares of the registrant's
common stock outstanding.
Integrated Alarm Services Group, Inc. and Subsidiaries
Form 10-Q Index
For the Three and Six Months Ended June 30, 2004
Description
Part I. Financial Information....................................................................................3
Item 1 Financial Statements............................................................................3
Consolidated Balance Sheets as of December 31, 2003 and June 30, 2004...........................3
Statements of Operations for the Three and Six Months Ended June 30, 2003 and 2004..............4
Statements of Cash Flows for the Six Months Ended June 30, 2003 and 2004........................5
Notes to Consolidated Financial Statements......................................................6
Item 2 Management's Discussions and Analysis of Financial Condition and Results of Operations.........13
Item 3 Quantitative and Qualitative Disclosures about Market Risks....................................23
Item 4 Controls and Procedures........................................................................23
Part II Other Information.......................................................................................24
Item 1 Legal Proceedings..............................................................................24
Item 2 Changes in Securities and Use of Proceeds......................................................24
Item 4 Submission of Matters to a Vote of Security Holders............................................25
Item 6 Exhibits and Reports on Form 8-K...............................................................26
2
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
AS OF
-----------------------------------------
DECEMBER 31, JUNE 30,
2003 2004
-------------- --------------
Assets (unaudited)
Current assets:
Cash and cash equivalents $ 35,435,817 $ 5,100,975
Current portion of notes receivable 735,149 1,389,994
Accounts receivable, net 4,312,990 6,308,571
Inventories 1,107,899 1,096,517
Prepaid expenses 1,548,105 1,266,760
Due from related parties 232,300 85,844
------------- -------------
Total current assets 43,372,260 15,248,661
Property and equipment, net 5,762,586 6,027,811
Notes receivable net of current portion and allowance 4,525,973 3,192,619
Dealer relationships, net 23,113,617 21,619,136
Customer contracts, net 73,571,131 89,807,707
Goodwill, net 85,515,985 90,161,798
Debt issuance costs, net 1,768,281 1,273,141
Other identifiable intangibles, net 2,187,464 1,994,765
Restricted cash and cash equivalents 1,100,000 1,855,395
Other assets 119,033 3,440,638
------------- -------------
Total assets $ 241,036,330 $ 234,621,671
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt $ 18,765,000 $ 16,319,000
Current portion of capital lease obligations 431,555 434,335
Accounts payable 2,873,707 1,460,905
Accrued expenses 8,816,766 6,766,517
Current portion of deferred revenue 7,576,993 9,461,296
Other liabilities 139,066 -
------------- -------------
Total current liabilities 38,603,087 34,442,053
Long-term debt, net of current portion 46,977,612 44,829,112
Capital lease obligations, net of current portion 453,811 236,524
Deferred revenue, net of current portion 312,343 2,132,355
Deferred income taxes 759,425 234,328
Other liabilities 374,119 17,819
Due to related parties 153,203 3,284
------------- -------------
Total liabilities 87,633,600 81,895,475
------------- -------------
Commitments and Contingencies
Stockholders' equity
Preferred stock, $0.001 par value; authorized
3,000,000 shares and none issued and outstanding - -
Common stock, $0.001 par value; authorized
100,000,000 shares; issued and outstanding
24,607,731 shares at December 31, 2003 and
24,681,462 at June 30, 2004 24,608 24,682
Common stock subscribed 315,342 -
Paid-in capital 205,086,659 206,164,145
Accumulated deficit (52,023,879) (53,462,631)
------------- -------------
Total stockholders' equity 153,402,730 152,726,196
------------- -------------
Total liabilities and stockholders' equity $ 241,036,330 $ 234,621,671
============= =============
The accompanying notes are an integral part of the consolidated financial statements.
3
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2003 AND 2004
(UNAUDITED)
Three months ended June 30, Six months ended June 30,
---------------------------- ------------------------------
2003 2004 2003 2004
---- ---- ---- ----
Revenue:
Monitoring fees $ 5,852,761 $ 6,049,930 $ 11,942,551 $ 11,837,336
Revenue from customer accounts 3,661,950 12,101,339 6,067,135 23,679,341
Billing fees 21,514 - 42,497 -
Related party monitoring fees 130,144 76,331 282,250 101,811
Related party placement fees 4,864 - 90,437 -
Service and subcontractor fees 91,455 1,291,170 91,455 2,108,032
------------ ----------- ------------- ------------
Total revenue 9,762,688 19,518,770 18,516,325 37,726,520
Cost of revenue (excluding depreciation
and amortization) 3,887,954 7,041,508 7,753,560 14,109,502
------------ ----------- ------------- ------------
5,874,734 12,477,262 10,762,765 23,617,018
------------ ----------- ------------- ------------
Operating expenses:
Selling and marketing 190,428 1,128,964 455,494 2,244,926
Depreciation and amortization 3,549,904 5,431,052 6,420,425 10,443,573
General and administrative 2,394,397 4,505,667 4,597,279 9,565,067
General and administrative - related party 250,000 - 3,525,000 -
------------ ----------- ------------- ------------
Total operating expenses 6,384,729 11,065,683 14,998,198 22,253,566
------------ ----------- ------------- ------------
Income (loss) from operations (509,995) 1,411,579 (4,235,433) 1,363,452
Other income (expense):
Other expense, net (120,742) - (262,750) (3,080)
Amortization of debt issuance costs (529,738) (247,184) (907,413) (507,034)
Related party interest expense (27,483) - (451,848) -
Interest expense (4,533,014) (1,944,870) (7,668,723) (3,650,042)
Interest income 417,344 205,877 777,227 530,548
------------ ----------- ------------- ------------
Income (loss) before income taxes (5,303,628) (574,598) (12,748,940) (2,266,156)
Income tax expense (benefit) (50,115) (206,862) 3,367,173 (827,404)
------------ ----------- ------------- ------------
Net income (loss) $ (5,253,513) $ (367,736) $ (16,116,113) $ (1,438,752)
============ =========== ============= ============
Basic and diluted income (loss) per share $ (3.30) $ (0.01) $ (11.19) $ (0.06)
============ =========== ============= ============
Weighted average number of common
shares outstanding 1,590,911 24,668,671 1,439,989 24,654,309
============ =========== ============= ============
Unaudited:
Pro Forma income tax to give effect to
the conversion from S to C Corporation
status:
Income (loss) before benefit from income taxes $ (5,303,628) $ (574,598) $ (12,748,940) $ (2,266,156)
Income tax expense (benefit) (50,115) (206,862) (249,315) (827,404)
------------ ----------- ------------- ------------
Net income (loss) $ (5,253,513) $ (367,736) $ (12,499,625) $ (1,438,752)
============ =========== ============= ============
Basic and diluted income (loss) per share $ (3.30) $ (0.01) $ (8.68) $ (0.06)
============ =========== ============= ============
The accompanying notes are an integral part of the consolidated
financial statements.
4
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2003 AND 2004
(UNAUDITED)
2003 2004
------------- -------------
Cash flows from operating activities:
Net income (loss) $ (16,116,113) $ (1,438,752)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 6,420,425 10,443,573
Amortization of deferred installation costs, net - 46,643
Amortization of debt issuance costs 907,413 507,034
Interest expense - non-cash, notes - 474,200
Stock options issued to consultant - 13,018
Provision for (reversal of) bad debts 450,000 396,800
Deferred income taxes 3,358,504 (525,097)
Non-cash service fees 1,825,000 -
Loss (gain) on disposal of property and equipment - 3,242
Changes in assets and liabilities, net of effects of
acquisitions and non-cash transactions:
Accounts receivable (7,577) (1,577,517)
Inventories - 11,382
Prepaid expenses (82,384) 281,345
Other assets (1,000,260) (234,300)
Due (from)to related parties (151,811) (3,463)
Accounts payable and accrued expenses 670,594 (2,444,535)
Deferred revenue (16,381) 426,615
Other liabilities (494,009) (495,366)
------------- ------------
Net cash provided by (used in) operating activities (4,236,599) 5,884,822
------------- ------------
Cash flows from investing activities:
Purchase of property and equipment (82,787) (1,542,172)
Proceeds from sale of property and equipment - 1,800
Purchase of customer contracts and dealer relationships (263,933) (13,763,210)
Deferred installation costs (other assets) - (3,091,915)
Deferred installation revenue - 2,340,005
Financing of customer loans (383,550) (1,883,349)
Proceeds from maturity/sale of short-term investments 8,082,332 -
Repayment of customer loans 424,589 85,425
Decrease (increase) in restricted cash and cash equivalents 321,832 (755,395)
Business acquisitions, net of cash acquired - (13,064,952)
------------- ------------
Net cash porvided by (used in) investing activities 8,098,483 (31,673,763)
------------- ------------
Cash flows from financing activities:
Proceeds of long-term debt, related party 2,000,000 -
Proceeds of long-term debt 6,829,404 -
Payments of obligations under capital leases (73,857) (214,507)
Repayment of long-term debt (8,510,311) (4,319,500)
Repayment of long-term debt, related party (430,140) -
Debt issuance costs (136,500) (11,894)
------------- ------------
Net cash provided by (used in) financing activities (321,404) (4,545,901)
------------- ------------
Net increase (decrease) in cash and cash equivalents for the period 3,540,480 (30,334,842)
Cash and cash equivalents at beginning of year 442,082 35,435,817
------------- ------------
Cash and cash equivalents at end of period $ 3,982,562 $ 5,100,975
============= ============
The accompanying notes are an integral part of the consolidated
financial statements.
5
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. MANAGEMENT OPINION
The financial information as of June 30, 2004 and for the three months and six
months ended June 30, 2004 and 2003, in the opinion of management, includes all
adjustments, consisting only of normal recurring adjustments, that are
considered necessary for fair presentation of the financial position, results of
operations and cash flows of Integrated Alarm Services Group, Inc. and
Subsidiaries' (IASG or the "Company") for the three months and six months ended
June 30, 2004 and 2003 in accordance with accounting principles generally
accepted in the United States of America. The results for any interim period are
not necessarily indicative of results for the full year. Certain information and
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United States of
America have not been presented herein, in accordance with regulations. These
financial statements should be read in conjunction with financial statements and
notes thereto for the year ended December 31, 2003 included in the Company's
Annual Form 10-K. Certain prior period data have been reclassified to conform to
the current period presentation.
2. NOTES RECEIVABLE
The Company's notes receivable consisted of the following:
December 31, 2003 June 30, 2004
----------------------- -------------------
Performing loans $ 5,040,103 $ 3,593,514
Non-perfoming loans 351,873 1,154,953
Less: reserve (130,854) (165,854)
---------------------- ------------------
Net loans 5,261,122 4,582,613
Less: current portion (735,149) (1,389,994)
---------------------- ------------------
Long-term portion $ 4,525,973 $ 3,192,619
====================== ==================
At June 30, 2004, we have non-performing loans aggregating $1.2 million. A
non-performing loan in the amount of $2.5 million was foreclosed and
reclassified to the existing portfolio group of customer contracts. The
collateral supported the carrying value and therefore no impairment charge was
recorded. Currently the cash flows from the underlying collateral support the
carrying value of the loans. However, if the cash flows from the underlying
collateral continues to deteriorate, it may result in a future charge to
earnings.
3. GOODWILL AND INTANGIBLES
In April 2004, we received a Working Capital Adjustment (per agreement) cash
payment from Lane Industries, Inc. in the aggregate amount of $1,378,000 which
reduced the goodwill recorded by the same amount.
During May 2004, the Company acquired the alarm portfolio and certain other
assets of Alliant Protection Services, Inc. for a total purchase price of $14.5
million. The purchase price was allocated to: accounts receivable $780,000,
customer contracts $8,712,000, goodwill $6,081,000 and current liabilities
$1,072,000. Most, if not all, of this goodwill will be tax deductible and will
reside in the retail services segment. The operating results of Alliant have
been included in the Company's consolidated results since the date of
acquisition (May 21, 2004). The pro forma revenue and results of operations for
this acquisition, had the acquisition occurred at the beginning of 2003 and
2004, are not significant, and accordingly, have not been provided.
During the six months ended June 30, 2004, goodwill also decreased (net) by
approximately $57,000 due to legal and other costs offset with credits
associated with acquisitions.
The Company uses a fair value approach to test goodwill and indefinite life
intangibles for impairment. The Company recognizes an impairment charge for the
amount, if any, by which the carrying amount of goodwill and indefinite life
intangibles exceeds its fair value. The Company established fair values using
projected cash flows. When available and as appropriate, the Company used
comparative market multiples to corroborate projected cash flow results. The
Company completed its annual impairment test in the third quarter of 2003 and
did not record an impairment charge upon completion of this review as the fair
value exceeded carrying value in the third quarter of 2003. During the second
quarter of 2004, the common stock of the Company began trading below its book
value. However, management after evaluating current financial forecasts and
operating trends continues to believe that goodwill was not impaired at June 30,
2004. A non-cash goodwill impairment charge may result in a future period if
there is a decline in estimated future earnings and cash flows.
6
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
CUSTOMER CONTRACTS AND DEALER RELATIONSHIPS
SFAS No. 144 "Accounting for the Impairment of Disposal of Long Lived Assets"
requires that long-lived assets be reviewed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. Recoverability of the assets to be held and used is measured by
a comparison of the carrying amount of the assets with the future net cash flows
expected to be generated. Cash flows of dealer relationshps and retail customer
contracts are analyzed at the same group level (acquisition by acquisition and
portfolio grouping, respectively) that they are identified for amortization, the
lowest level for which independent cash flows are identifiable. All other
long-lived assets are evaluated for impairment at the Company level, using one
asset grouping. If such assets are considered to be impaired, the impairment to
be recognized is measured by the amount by which the carrying amount of the
assets exceeds the fair value of the assets. No impairment losses were required
during the six months ended June 30, 2004.
Customer contracts at June 30, 2004 consist of the following:
CONTRACTS
EXISTING DEALER ASSUMED
PORTFOLIO ACQUIRED FROM DEALER TOTAL
----------- ----------- ----------- -----------
Customer contracts December 31, 2003 $49,341,567 $23,062,462 $ 8,058,738 $80,462,767
Purchases six months 22,279,154 2,203,665 - 24,482,819
Sales and reclassifications six months (117,227) (151,569) - (268,796)
----------- ----------- ----------- -----------
Customer contracts June 30, 2004 71,503,494 25,114,558 8,058,738 104,676,790
----------- ----------- ----------- -----------
Accumulated amortization December 31, 2003 1,525,020 3,516,755 1,849,861 6,891,636
Amortization first quarter 2,027,145 1,002,232 597,930 3,627,307
Amortization second quarter 2,753,661 1,025,966 570,513 4,350,140
----------- ----------- ----------- -----------
Accumulated amortization June 30, 2004 6,305,826 5,544,953 3,018,304 14,869,083
----------- ----------- ----------- -----------
Customer contracts, net $65,197,668 $19,569,605 $ 5,040,434 $89,807,707
=========== =========== =========== ===========
Customer contract amortization expense for the six months ended June 30, 2004
and 2003 was $7,977,447 and $3,741,634, respectively. The 2004 amortization
expense was reduced by approximately $1,043,516 of attrition reserves from
contract purchase transactions. The Company is currently negotiating the
potential sale of approximately $130,000 of recurring monthly revenue.
Dealer relationships consist of the following:
DECEMBER 31, 2003 PURCHASES AMORTIZATION JUNE 30, 2004
----------------- --------- ------------ -------------
Dealer relationships $ 39,958,089 $ 422,316 $ - $ 40,380,405
Accumulated amortization (16,844,472) - (1,916,797) (18,761,269)
------------ --------- ------------ ------------
$ 23,113,617 $ 422,316 $ (1,916,797) $ 21,619,136
============ ========= ============ ============
Amortization expense for dealer relationships was $2,223,647 for the six months
ended June 30, 2003.
7
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Estimated amortization expense of customer contracts, dealer relationships and
other identifiable intangible assets for the years ending December 31, 2004
through 2008 is as follows:
OTHER
IDENTIFIABLE
CUSTOMER DEALER INTANGIBLE
YEAR CONTRACTS RELATIONSHIPS ASSETS TOTAL
- --------- ------------- ------------- ------------- ----------
2004 (six months) $5,352,518 $ 1,975,077 $ 211,150 $7,538,745
2005 9,981,312 3,083,376 403,841 13,468,529
2006 8,870,432 2,660,126 348,500 11,879,058
2007 7,688,931 2,352,426 348,500 10,389,857
2008 7,035,533 2,182,239 348,500 9,566,272
Customer contract amortization for existing portfolios acquired subsequent to
January 31, 2003 is calculated using an 18 year straight-line rate. No attrition
has been recognized in the customer contract amortization projected for future
years. The actual amortization expense in future periods will be higher due to
the impact of attrition.
4. STOCKHOLDERS' EQUITY
Stock-Based Compensation
The Company's 2003 Stock Option Plan and 2004 Stock Option Plan (approved June
15, 2004) ("SOP") permits the grant of options which may either be "incentive
stock options" ("ISOs") or "non-qualified stock options: ("NSOs"). The total
number of shares of our common stock that may be issued under the SOP may not
exceed 1,350,000, subject to possible adjustment in the future as described
below. All employees, officers, directors, consultants and independent
contractors of the Company, or of any parent, subsidiary or affiliate are
eligible to be granted options.
The exercise price of an option granted under the SOP may not be less than 100%
of the fair market value of the Company's common stock on the date of grant
(110% of such fair market value in the case of an ISO granted to an optionee who
owns or is deemed to own stock possessing more than 10% of the combined voting
power of all classes of our stock).
The number of shares of common stock authorized for issuance under the SOP may
be adjusted in the event our shares of common stock are changed into, or
exchanged for cash, or securities of another entity through a reorganization,
merger, recapitalization, reclassification, stock split, stock dividend, stock
consolidation or combination or other similar transaction. In the event of the
occurrence of any of the following, the compensation committee may adjust the
number of authorized shares under the SOP, and the options issued under the SOP,
as appropriate under the circumstances.
The following table illustrates the effect on net loss and net loss per share if
the Company had elected to recognize stock-based compensation expense based on
the fair value of the options granted at the date of grant as prescribed by SFAS
No. 123.
8
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
--------------------------- ------------------------------
2003 2004 2003 2004
---- ---- ---- ----
Net loss as reported $(5,253,513) $ (367,736) $(16,116,113) $(1,438,752)
ADD: Stock-based compensation included in reported
net loss, net of related tax effect - 7,811 - 7,811
LESS: Stock-based compensation expense determined
under fair value method for all awards, net of related
tax effects (100,400) (100,400)
----------- ---------- ------------ -----------
Pro forma net loss $(5,253,513) $ (460,325) $(16,116,113) $(1,531,341)
=========== ========== ============ ===========
Net loss per share, as reported-basic and diluted $ (3.30) $ (0.01) $ (11.19) $ (0.06)
=========== ========== =========== ===========
Pro forma net loss per share-basic and diluted $ (3.30) $ (0.02) $ (11.19) $ (0.06)
=========== ========== =========== ===========
SFAS No. 123 requires the use of option valuation models that were not developed
for use in valuing employee stock options. The Black-Scholes option valuation
model was developed for use in estimating the fair value of traded options that
have no vesting restrictions and are fully transferable. In addition, option
valuation models require the input of highly subjective assumptions, including
the expected stock price volatility. Because options held by Company directors
have characteristics significantly different from those of traded options, and
because changes in the subjective input assumptions can materially affect the
fair value estimate, in the opinion of management, the existing models do not
necessarily provide a reliable single measure of the fair value of these
options.
Company stock options outstanding as of June 30, 2004 include options granted
during the third quarter of 2003 to purchase 48,000 shares of common stock at a
weighted average exercise price of $9.25 per share, with a weighted average
contractual life remaining of 9.08 years. On June 15, 2004, stock options were
issued to purchase 150,000 shares of common stock at an exercise price of $5.75
per share, with a contractual life of ten years.
Company stock options outstanding become exerciseable as follows:
Option Plan Weighted Average Shareholder Weighted Average
Period Ending Option Share Exercise Price Option Share Exercise Price
------------- ------------ ---------------- ------------ ----------------
Currently exerciseable 90,500 $7.61 - -
June 30, 2005 35,833 $5.75 570,000 $9.25
June 30, 2006 35,833 $5.75 570,000 $9.25
June 30, 2007 35,834 $5.75 760,000 $9.25
------- ---------
198,000 $6.60 1,900,000 $9.25
SFAS NO. 123 ASSUMPTIONS AND FAIR VALUE
The fair value of each option granted during the quarter and six months ended
June 30, 2004 was estimated at the date of grant using the Black-Scholes option
valuation model with the following weighted average assumption:
Risk-free interest rate............4.58%
Volatility.........................29%
Option Term (in years).............10
Dividend yield.....................0%
The weighted average estimated fair value of stock options granted during the
six months ended June 30, 2004 was $2.89 per share.
9
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
The Company accounts for activity under the employee stock plans using the
intrinsic value method prescibed by Accounting Principles Board Opinion ("APB")
No. 25, Accounting for Stock Issued to Employees, and has adopted the
disclosure-only provisions of SFAS No. 123, Accounting for Stock-Based
Compensation. Under APB No. 25, the Company generally recognizes no compensation
expense with respect to options granted to employees and directors as the option
exercise price is generally equal to or greater than the fair value of the
Company's common stock on the date of the grant.
The following table summarized the activity related to stockholders' equity for
the six months ended June 30, 2004:
Common Stock Common Total
------------------------- Stock Paid-in Accumulated Stockholders'
Shares Amount Subscribed Capital Deficit Equity
---------- -------- ---------- ------------ ------------- --------------
Balance, December 31, 2003 24,607,731 $ 24,608 $ 315,342 $205,086,659 $ (52,023,879) $ 153,402,730
Net Income (loss) - - - - (1,438,752) (1,438,752)
Issuance of contingent shares
for Criticom purchase 34,091 34 (315,342) 315,308 - -
Conversion of debt to stock 39,640 40 - 274,960 - 275,000
Issuance of stock options
to consultant - - - 13,018 - 13,018
Imputed Interest expense
associated with conversion
feature of debt - - - 474,200 - 474,200
---------- -------- --------- ------------ ------------- -------------
Balance, June 30, 2004 24,681,462 $ 24,682 $ - $206,164,145 $ (53,462,631) $ 152,726,196
========== ======== ========= ============ ============= =============
5. INCOME TAXES
As a result of the merger of KC Acquisition with IASG during January 2003, KC
Acquisition, KC Funding Corp., Morlyn Financial Group and Criticom will no
longer be considered flow through entities to their shareholders and members
and, therefore, must record current and deferred income taxes from its earnings
and losses, and recognize the tax consequences of "temporary differences"
between financial statement and the tax basis of existing assets and
liabilities. At the time of the change in tax status (S to C Corporation) of the
enterprise, the Company recorded an additional deferred tax liability of
approximately $3,505,000, which is being included in income tax expense in 2003.
A tax provision is necessary in 2004, due to the Company expecting to have
current taxes payable while any deferred tax asset established during the year
is expected to require a full valuation allowance. Additionally, any reversal of
a valuation allowance as the result of the utilization of an acquired deferred
tax asset item results in a reduction in goodwill and therefore, no recognition
of a deferred tax benefit.
6. INCOME (LOSS) PER COMMON SHARE
The income (loss) per common share is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
------------------------------- ---------------------------------
2003 2004 2003 2004
---- ---- ---- ----
Numerator
Net income(loss) $(5,253,513) $ (367,736) $ (16,116,113) $ (1,438,752)
Denominator
Weighted average shares outstanding 1,590,911 24,668,671 1,439,989 24,654,309
Net income (loss) per share $ (3.30) $ (0.01) $ (11.19) $ (0.06)
For the three and six months ended June 30, 2004, there are outstanding
promissory notes which are convertible into 753,153 shares of common stock at a
price of $6.94 per share, options outstanding to acquire 1,948,000 shares of the
Company's common stock at a per share price of $9.25 and options outstanding to
acquire 150,000 shares of the Company's common stock at a per share price of
$5.75. The shares issuable upon exercise of such options have not been included
as common stock equivalents, as their issuance would be anti-dilutive.
10
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
7. LITIGATION
In March 2003, Protection One Alarm Monitoring, Inc., ("Protection One") a
company engaged in the business of providing security and other alarm monitoring
services to residential and commercial customers, brought an action against the
Company in the Superior Court of New Jersey, Camden County for unspecified
damages in connection with the Company's purchase of certain alarm monitoring
contracts from B&D Advertising Corporation ("B&D"). B&D had previously sold
alarm monitoring contracts to Protection One. As part of such sales, B&D agreed
not to solicit any customers whose contracts had been purchased and to keep
certain information confidential. Protection One claims that the Company's
subsequent purchase of contracts from B&D constitutes tortious interference,
that the Company utilized confidential information belonging to Protection One
and that Protection One had an interest in some of the contracts that the
Company purchased from B&D. The Company plans to vigorously defend this claim.
The Company believes the resolution of this matter will not have a material
adverse effect on its financial condition, results of operations or cash flows.
In May 2003, a former employee of McGinn, Smith & Co., Inc. brought an action
against the Company, as well as McGinn, Smith & Co., Inc. and M&S Partners for
wrongful termination. The suit brought in the Supreme Court of the State of New
York seeks damages of $10,000,000. In August 2003, the Company filed a motion to
dismiss the claim against it, which was opposed by the plaintiff on August 27,
2003. The Court's decision on the motion is still pending. McGinn, Smith & Co.,
Inc. and M&S Partners have fully indemnified the Company from any damages or
legal expenses that the Company may incur as a result of the suit. This employee
of McGinn, Smith & Co., Inc. was never the Company's employee and the Company
plans to vigorously defend this claim. The Company believes the resolution of
this matter will not have a material adverse effect on its financial condition,
results of operations or cash flows.
On December 9, 2003, a complaint was filed against the Company in the United
States District Court in the southern District of New York entitled Ian Meyers
v. Integrated Alarm Services Group, Inc., et al. The Plaintiff alleges, among
other things, that the Company and its professionals engaged in transactions
with the Company that were designed to defraud plaintiff out of funds he was
entitled to pursuant to Plaintiff's agreement with First Integrated Capital
Corp. ("FICC"), his employer, and a company in which he had an equity interest.
Plaintiff was seeking damages in the amount of $3,000,000. A mediation
conference before the court was held on April 22, 2004. As a result of the
mediation conference, an agreement was reached and the Company paid $64,000 on
June 16, 2004 to settle this matter in full and the case was withdrawn with
prejudice. The Company had accrued this amount as of March 31, 2004.
The Company is involved in litigation and various legal matters that have arisen
in the ordinary course of business. The Company does not believe that the
outcome of these matters will have a material adverse effect on the Company's
financial position, results of operations or cash flows.
8. RELATED PARTY TRANSACTIONS
The Company incurred approximately $27,483 and $0 respectively, in related party
interest for the three months ended June 30, 2003 and 2004.
The Company earned monitoring and placement fees from related parties of
approximately $135,000 and $76,000 for the three months ended June 30, 2003 and
2004, respectively.
The Company earned monitoring and placement fees from related parties of
approximately $373,000 and $102,000 for the six months ended June 30, 2003 and
2004, respectively.
Included in long-term debt (junior debt) are contract certificates held by
related parties that totaled approximately $172,000 at June 30, 2004.
11
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
During April 2003, the Company assumed $250,000 of debt from Capital Center
Credit Corporation resulting in a charge to general and administrative expense
of $250,000.
During the six months ended June 30, 2003, the Company paid $1,700,000 to
Capital Center Credit Corporation ("CCCC") and assumed $1,825,000 of debt from
CCCC resulting in a charge to general and administrative expense of $3,525,000.
9. SEGMENT AND RELATED INFORMATION
Management has determined that an appropriate measure of the performance of its
operating segments would be made through an evaluation of each segment's income
(loss) before income taxes. Accordingly, the Company's summarized financial
information regarding the Company's reportable segments is presented through
income (loss) before income taxes for the three and six months ended June 30,
2003 and 2004. Prior to January 31, 2003, the Company operated in only one
segment, alarm-monitoring wholesale services. The acquisition of IASI and
affiliates established the new segment, alarm-monitoring retail services for
independent alarm-monitoring dealers. Intersegment revenues have been
eliminated.
Summarized financial information for the three and six months ended ended June
30, 2003 and 2004 concerning the Company's reportable segments is shown in the
following table:
ALARM- ALARM- ALARM- ALARM-
MONITORING MONITORING MONITORING MONITORING
WHOLESALE RETAIL CONSOLIDATED WHOLESALE RETAIL CONSOLIDATED
SERVICES SERVICES TOTAL SERVICES SERVICES TOTAL
---------- ---------- ------------ ---------- ---------- ------------
THREE MONTHS ENDED JUNE, 2003 SIX MONTHS ENDED JUNE, 2003
Total revenue $ 6,100,738 $ 3,661,950 $ 9,762,688 $12,449,190 $ 6,067,135 $18,516,325
Intersegment revenue 701,703 - 701,703 1,173,611 - 1,173,611
Cost of revenue (including
depreciation and amortization) 5,167,263 2,270,595 7,437,858 10,346,534 3,827,451 14,173,985
Income (loss) from operations (511,175) 1,180 (509,995) (177,325) (4,058,108) (4,235,433)
Interest income - 417,344 417,344 - 777,227 777,227
Interest expense 1,305,530 3,254,967 4,560,497 2,607,486 5,513,085 8,120,571
Income (loss) before income taxes (2,073,961) (3,229,667) (5,303,628) (3,301,590) (9,447,350) (12,748,940)
THREE MONTHS ENDED JUNE, 2004 SIX MONTHS ENDED JUNE 30, 2004
Total revenue $ 6,126,261 $13,392,509 $19,518,770 $11,939,147 $25,787,373 $37,726,520
Intersegment revenue 921,107 - 921,107 1,410,431 - 1,410,431
Cost of revenue (including
depreciation and amortization) 4,983,380 7,489,180 12,472,560 9,897,642 14,655,433 24,553,075
Income (loss) from operations 186,526 1,225,053 1,411,579 (226,789) 1,590,241 1,363,452
Interest income 11,517 194,360 205,877 25,811 504,737 530,548
Interest expense 68,015 1,876,855 1,944,870 140,187 3,509,855 3,650,042
Income (loss) before income taxes 109,403 (684,001) (574,598) (382,415) (1,883,741) (2,266,156)
There has been no material change in the total assets of the reportable segments
since December 31, 2003. The acquisitions in the retail services segment have
been funded with cash balances residing in that segment.
12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS FOR THE THREE MONTHS AND SIX MONTHS ENDED JUNE 30, 2004.
The following discussion should be read in conjunction with the accompanying
Financial Statements and Notes thereto.
CRITICAL ACCOUNTING POLICIES.
Our discussion and analysis of results of operations, financial condition and
cash flows are based upon our financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States of
America (GAAP). The preparation of these financial statements requires us to
make estimates and judgments that effect the reported amounts of assets,
liabilities, revenues and expenses, and related disclosure of contingent assets
and liabilities. These estimates are evaluated on an on-going basis, including
those related to revenue recognition and allowance for doubtful accounts,
valuation to allocate the purchase price for a business combination, notes
receivable reserve and fair value of customer contracts on foreclosed loans,
intangible assets and goodwill, income taxes, and contingencies and litigation.
We base our estimates on historical experience and on various other assumptions
that are believed to be reasonable under the circumstances, the results of which
form the basis for making judgments about the carrying values of assets and
liabilities that are not readily apparent from other sources. Actual results may
differ from these estimates under different assumptions or conditions.
REVENUE RECOGNITION AND ALLOWANCE FOR DOUBTFUL ACCOUNTS.
All revenue is recognized on an accrual basis. Accounts receivable consists
primarily of amounts due from dealers and end-users located in the United
States. Credit is extended based upon an evaluation of the dealers and end-users
financial condition and credit history. Receivables that are deemed not
collectible have been provided for in the allowance for doubtful accounts. If
the dealers financial condition were to deteriorate, resulting in their
inability to make payments, additional allowances may be required.
VALUATION TO ALLOCATE PURCHASE PRICE FOR A BUSINESS COMBINATION.
The allocation of purchase price related to the acquisition of assets of Alliant
Protection Services, Inc. is preliminary at June 30, 2004. The purchase price
allocation is based on management's best estimate and is subject to adjustment.
NOTES RECEIVABLE RESERVE AND FAIR VALUE OF CUSTOMER CONTRACTS ON FORECLOSED
LOANS.
We make loans to dealers, which are collateralized by the dealers' portfolio of
end-user alarm monitoring contracts. Loans to dealers are carried at the lower
of the principal amount outstanding or if non-performing, the net realizable
value of the portfolio underlying the loan. Loans are generally considered
non-performing if they are 120 days in arrears of contractual terms.
Management periodically evaluates the loan portfolio to assess the
collectibility of dealer notes and adequacy of allowance for loan losses.
Management reviews certain criteria in assessing the adequacy of the allowance
for loan losses including our past loan loss experience, known and inherent
risks in the portfolio, adverse situations that may affect the borrower's
ability to repay, the estimated value of any underlying collateral and current
economic conditions. Loan impairment is identified when a portfolio's cash flow
is materially below the minimum necessary to service the loan. In most cases,
loans will be foreclosed and valued at the lower of cost (loan carrying value)
or fair value of end-user contracts using recent transaction prices and industry
benchmarks.
Notes receivable consists primarily of loans to dealers which are collateralized
by a portfolio of individual end-user monitoring contracts. When a dealer
becomes delinquent, we generally foreclose on and take ownership of the
portfolio of end-user monitoring contracts.
At June 30, 2004, we have non-performing loans aggregating $1.2 million.
Currently the cash flows from the underlying collateral support the carrying
value of the loans. However, if the cash flows from the underlying collateral
continues to deteriorate, it may result in a future charge to earnings.
INTANGIBLE ASSETS AND GOODWILL.
Alarm monitoring services for dealers' end-users are outsourced to us. We
acquire such dealer relationships from our internally generated sales efforts
and from other monitoring companies. Acquired dealer relationships are recorded
at cost which management believes approximates fair value. End-user alarm
monitoring contracts are acquired from the dealers' pre-existing portfolios of
contracts or assumed upon the foreclosure on dealers' loans.
13
Acquired end-user alarm monitoring contracts are recorded at cost which
management believes approximates fair value. End-user alarm monitoring contracts
assumed as a result of foreclosure on dealer loans are recorded at the lower of
cost (loan carrying value) or the fair value of such contracts using recent
transaction prices and industry benchmarks at the time of foreclosure.
End-user alarm monitoring contracts are amortized over the term that such
end-users are expected to remain a customer of the Company. The Company, on an
ongoing basis, conducts comprehensive reviews of its amortization policy for
end-user contracts and, when deemed appropriate, uses an independent appraisal
firm to assist in performing an attrition study.
Dealer relationships and customer (end-user) contracts are amortized using
methods and lives which are management's estimates, based upon all information
available (including industry data, attrition studies, current portfolio
trends), of the life (attrition pattern) of the underlying contracts and
relationships. If actual results vary negatively (primarily attrition) from
management assumptions, amortization will be accelerated which will negatively
impact results from operations. If amortization is not accelerated or conditions
deteriorate dramatically, the asset could become impaired. For existing
portfolio accounts purchased subsequent to January 31, 2003, the Company
amortizes such accounts using the straight-line method over an 18 year period
plus actual attrition. This methodology may cause significant variations in
amortization expense in future periods.
Dealer relationships and end-user alarm monitoring contracts are tested for
impairment on a periodic basis or as circumstances warrant. Recoverability of
dealer relationship costs and end-user alarm monitoring contracts are highly
dependent on our ability to maintain our dealers. Factors we consider important
that could trigger an impairment review include higher levels of attrition of
dealers and/or end-user alarm monitoring contracts and continuing recurring
losses.
SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets"
requires that the assets be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of the assets to be held and used is measured by a
comparison of the carrying amount of the assets with the future net cash flows
expected to be generated. Cash flows of dealer relationships and retail customer
contracts are analyzed at the same group level (acquisition by acquisition and
portfolio grouping, respectively) that they are identified for amortization, the
lowest level for which independent cash flows are identifiable. All other
long-lived assets are evaluated for impairment at the company level, using one
asset grouping. If such assets are considered to be impaired, the impairment to
be recognized is measured by the amount by which the carrying amount of the
assets exceeds the fair value of the assets.
SFAS No. 142, "Goodwill and Other Intangible Assets." SFAS 142 requires us to
account for goodwill using an impairment-only approach. We perform our
impairment test annually in the third quarter of each year or at such time a
triggering event occurs in an interim period.
We use a fair value approach to test goodwill and indefinite life intangibles
for impairment. We recognize an impairment charge for the amount, if any, by
which the carrying amount of goodwill and indefinite life intangibles exceeds
its fair value. We established fair values using projected cash flows. When
available and as appropriate, we used comparative market multiples to
corroborate projected cash flow results. We completed our annual impairment test
in the third quarter of 2003 and did not record an impairment charge upon
completion of this review as the fair value exceeded carrying value in the third
quarter of 2003. During the second quarter of 2004, the common stock of the
Company began trading below its book value. However, management after evaluating
current financial forecasts and operating trends continues to believe that
goodwill was not impaired at June 30, 2004. A non-cash goodwill impairment
charge may result in a future period if there is a decline in estimated future
earnings and cash flows.
14
INCOME TAXES.
As part of the process of preparing our financial statements, we will be
required to estimate our income taxes in each of the jurisdictions in which we
operate. This process will involve estimates of our actual current tax exposure
together with assessing temporary differences resulting from differing treatment
of items, such as depreciation and amortization, for tax and accounting
purposes.
CONTINGENCIES AND LITIGATION.
In March of 2003, Protection One Alarm Monitoring, Inc., a company engaged in
the business of providing security and other alarm monitoring services to
residential and commercial customers, brought an action against us in the
Superior Court of New Jersey, Camden County for unspecified damages in
connection with our purchase of certain alarm monitoring contracts from B&D
Advertising Corporation ("B&D"). B&D had previously sold alarm monitoring
contracts to Protection One. As part of such sales, B&D agreed not to solicit
any customers whose contracts had been purchased and to keep certain information
confidential. Protection One claims that our subsequent purchase of contracts
from B&D constitutes tortuous interference, that we utilized confidential
information belonging to Protection One and that Protection One had an interest
in some of the contracts that we purchased from B&D. We plan to vigorously
defend this claim. We believe the resolution of this matter will not have a
material adverse effect on our financial condition, results of operations or
cash flows.
In May 2003, a former employee of McGinn, Smith & Co., Inc., brought an action
against us, as well as McGinn, Smith & Co., Inc. and M&S Partners for wrongful
termination. The suit brought in the Supreme Court of the State of New York
seeks damages of $10,000,000. McGinn, Smith & Co., Inc. and M&S Partners have
fully indemnified us from any damages or legal expenses that we may incur as a
result of the suit. This employee of McGinn, Smith & Co., Inc., was never our
employee and we plan to vigorously defend this claim. We believe the resolution
of this matter will not have a material adverse effect on our financial
condition, results of operations or cash flows.
On December 9, 2003, a complaint was filed against the Company in the United
States District Court in the southern District of New York entitled Ian Meyers
v. Integrated Alarm Services Group, Inc., et al. The Plaintiff alleges, among
other things, that the Company and its professionals engaged in transactions
with the Company that were designed to defraud plaintiff out of funds he was
entitled to pursuant to Plaintiff's agreement with First Integrated Capital
Corp. ("FICC"), his employer, and a company in which he had an equity interest.
Plaintiff was seeking damages in the amount of $3,000,000. A mediation
conference before the court was held on April 22, 2004. As a result of the
mediation conference, an agreement was reached and the Company paid $64,000 on
June 16, 2004 to settle this matter in full and the case was withdrawn with
prejudice. The Company had accrued this amount as of March 31, 2004.
We from time to time experience routine litigation in the normal course of our
business. We do not believe that any pending litigation will have a material
adverse effect on our financial condition, results of operations or cash flows.
RESULTS OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 2004 COMPARED TO THE THREE MONTHS ENDED JUNE 30,
2003.
REVENUE.
Total revenue for the three months ended June 30, 2004 was approximately
$19,519,000 compared to approximately $9,763,000 for the same period during the
prior year, an increase of approximately $9,756,000, or 99.9%. Approximately
$8,437,000 of the increase was due to revenue from businesses acquired in the
final quarter of 2003 and the second quarter of 2004 (the "Q4-2003 / Q2-2004
acquisitions").
Wholesale monitoring revenues were approximately $6,126,000 for the three months
ended June 30, 2004 compared to approximately $6,101,000 for the same period in
2003, an increase of approximately $25,000. The increase is due primarily to an
increase in the average revenue per account per month of approximately $.42
which generated approximately $459,000 of additional revenue which was offset,
in part, by a decrease in the aggregate number of accounts (not owned by the
Company, or "external") monitored during the first three months of 2004. This
decrease in external accounts monitored, of approximately 28,000, resulted in a
decrease in revenue of approximately $434,000.
Revenue from retail segment operations increased approximately $9,731,000 to
approximately $13,393,000 for the second quarter of 2004 from $3,662,000 for the
same period in 2003. Revenue from the Q4-2003 / Q2-2004 acquisitions accounted
for approximately $8,437,000 of the increase. Additional revenue, of
approximately $1,541,000, was generated due to an increase of approximately
16,000 in the average number of retail contracts owned per month. These
increases were partially offset by a decrease in average revenue per contract
which resulted in a decrease in revenue of approximately $247,000.
15
COST OF REVENUE (EXCLUDING DEPRECIATION AND AMORTIZATION).
Our cost of revenue for the three months ended June 30, 2004 was approximately
$7,042,000 compared with approximately $3,888,000 for the same period last year,
an increase of approximately $3,154,000. This increase in the cost of revenue
was primarily due to approximately $2,444,000 of costs associated with the
Q4-2003 / Q2-2004 acquisitons. In addition, the cost of revenue for the retail
segment, excluding the Q4-2003 / Q2-2004 acquisitions, increased approximately
$738,000 as a result of the increase in the number of accounts. The cost of
revenue for the wholesale monitoring operations decreased by approximately
$25,000.
Direct margin, as a percentage of total revenue, was 63.9% during the three
months ended June 30, 2004 compared to 60.2% for the same period during 2003.
The increase was due primarily to a greater proportion of retail segment volume
which is a higher margin business.
OPERATING EXPENSES.
Operating expenses increased from approximately $6,385,000 for the three months
ended June 30, 2003 to approximately $11,066,000 for the comparable period in
2004, an increase of approximately $4,681,000, or 73.3%. The increase was due to
approximately $4,785,000 of expenses associated with the Q4-2003 / Q2-2004
acquisitions and an increase in expenses related to the retail segment
(excluding the Q4-2003 / Q2-2004 acquisitions) of approximately $539,000 which
were offset, in part, by a decrease in expenses related to the wholesale segment
of approximately $643,000.
Selling and marketing expenses increased approximately $939,000 from
approximately $190,000 in the second quarter of 2003 to approximately $1,129,000
for the same period in 2004. The increase is attributible the expenses
associated with the Q4-2003 / Q2-2004 acquisitions which amounted to
approximately $900,000. The expenses related to the Q4-2003 / Q2-2004
acquisitions were comprised primarily of payroll, benefits and other
compensation of approximately $754,000, travel and entertainment of
approximately $75,000 and advertising of approximately $24,000.
Depreciation and amortization expenses increased from approximately $3,550,000
in the second quarter of 2003 to approximately $5,431,000 for the comparable
period in 2004, an increase of approximately $1,881,000, or 53.0%. This increase
was primarily due to the expenses related to the Q4-2003 / Q2-2004 acqusitions
of $1,657,000. The remaining increase consisted of approximately $379,000 in
retail operations, exclusive of the Q4-2003 / Q2-2004 acquisitons, offset, in
part, by a decrease in expenses associated with the wholesale segment of
approximately $155,000. The retail segment increase in depreciation and
amortization was due to an increase in the amortization of customer contract
costs as a result of the purchases of contracts throughout 2003 and the first
six months of 2004. The decrease in wholesale operations expense is attributable
to a decrease in amortization of dealer relationship costs due to the Company's
use of declining balance accelerated methods of amortization.
General and administrative expenses increased approximately $1,862,000, or
70.4%, from approximately $2,644,000 in the second quarter of 2003 to
approximately $4,506,000 for the same period of 2004. Approximately $2,228,000
of the increase was associated with the Q4-2003 / Q2-2004 acquisitions and
comprised primarily of payroll, bonus and other compensation, facilities and
utilities, collection and billing, bad debt and travel and entertainment
expenses. Excluding the expenses associated with the Q4-2003 / Q2-2004
acquisitions, general and administrative expenses decreased by approximately
$366,000. This decrease was comprised primarily from decreases of the following
expenses: bad debt decreased by approximately $556,000; legal, accounting and
other professional fees decreased by approximately $380,000; and, bank fees
decreased by approximately $80,000. These decreases were partially offset by
increases in payroll and benefits of approximately $333,000, directors and
officers insurance of approximately $270,000 and rent and utilities of
approximately $102,000.
OTHER INCOME/EXPENSE.
Other expense for the three months ended June 30, 2003 was approximately
$121,000. This expense was almost entirely related to the acquisition of RTC
Alarm Monitoring Services.
16
AMORTIZATION OF DEBT ISSUANCE COSTS.
The amortization of debt issuance costs decreased approximately $283,000 from
approximately $530,000 for the three months ended June 30, 2003 to approximately
$247,000 for the same period in 2004. The decrease is due primarily to a
decrease in debt issuance costs to be amortized as a result of the retirement of
debt during the later half of 2003.
INTEREST EXPENSE.
Interest expense decreased by approximately $2,615,000 from approximately
$4,560,000 to approximately $1,945,000, or 57.3%, for the second quarter of 2003
to the same period in 2004, respectively. The reduction is due to the reduction
of debt during the later half of 2003 primarily from the use of the proceeds
from the initial public offering of the Company's common stock.
INTEREST INCOME.
Interest income decreased from approximately $417,000 during the second quarter
of 2003 to approximately $206,000.
TAXES.
The benefits recorded are based on the effective tax rate the Company expects to
use for each of the full years.
RESULTS OF OPERATIONS BY SEGMENT
The comparable financial results for the Company's two operating segments;
Alarm-Monitoring, Wholesale Services and Alarm-Monitoring, Retail Services for
the three months ended June 30, 2004 compared with the three months ended June
30, 2003 are discussed below.
ALARM MONITORING, WHOLESALE SEGMENT. THREE MONTHS ENDED JUNE 30, 2004.
Alarm Monitoring, Wholesale segment total revenue increased by approximately
$25,000 to approximately $6,126,000 for the three months ended June 30, 2004
from approximately $6,101,000 for the same period in 2003. The increase is due
primarily to an increase in the average revenue per account per month of
approximately $0.42 which generated approximately $459,000 of additional revenue
which was offset, in part, by a decrease in the aggregate number of accounts
(not owned by the Company, or "external") monitored during the first three
months of 2004. This decrease in external accounts monitored, of approximately
28,000, resulted in a decrease in revenue of approximately $434,000.
Direct margin increased approximately $54,000 from approximately $2,250,000 for
the three months ended June 30, 2003 to approximately $2,304,000 for the
comparable period of 2004. As a percent of total revenue, the direct margin was
36.9% for the three months ended June 30, 2003 compared with 37.6% for the three
months ended June 30, 2004.
The wholesale segment had income from operations of approximately $187,000 for
the three months ended June 30, 2004 compared with a loss from operations of
approximately $511,000 for the same period last year, an improvement of
approximately $698,000. The change is primarily due to decreases in general and
administrative expenses of approximately $491,000 and a reduction in
depreciation and amortization of approximately $155,000.
The segment had income before income taxes of approximately $109,000 for the
three months ended June 30, 2004 compared to a loss of approximately $2,074,000
for the three months period ended June 30, 2003. The improvement, of
approximately $2,183,000, is primarily attributable to the aforementioned
improvement in income from operations and a decrease in interest expense
(resulting from debt repayments), of approximately $1,238,000.
ALARM MONITORING, RETAIL SEGMENT. THREE MONTHS ENDED JUNE 30, 2004.
Alarm Monitoring, Retail segment total revenue increased by approximately
$9,731,000 to approximately $13,393,000 for the three months ended June 30, 2004
from approximately $3,662,000 for the same period in 2003. Revenue from the
Q4-2003 / Q2-2004 acquisitions accounted for approximately $8,437,000 of the
increase. Additional revenue, of approximately $1,541,000, was generated due to
an increase of approximately 16,000 in the average number of retail contracts
owned per month. These increases were offset, in part, by a decrease in average
revenue per contract which resulted in a decrease in revenue of approximately
$247,000.
17
Direct margin increased approximately $6,548,000 to approximately $10,173,000
for the second quarter of 2004. The increase is due primarily to the incremental
margin associated with the Q4-2003 / Q2-2004 acqusitions in the amount of
approximately $5,993,000. The balance of the increase, or approximately
$555,000, was due to the margin realized on the incremental revenues generated
other than by the Q4-2003 / Q2-2004 acquisitions.
For the three months ended June 30, 2004 the segment had income from operations
of approximately $1,225,000 compared to income of approximately $1,000 for the
three months ended June 30, 2003, an improvement of approximately $1,224,000.
The improvement was primarily a result of approximately $1,208,000 of income
from the Q4-2003 / Q2-2004 acquisitions.
The segment's loss before income taxes was approximately $684,000 for the three
months ended June 30, 2004 compared to a loss for the three months period ended
June 30, 2003 of approximately $3,230,000, an improvement of approximately
$2,546,000. The improvement is primarily attributible to the improvement in the
income/loss from operations and a decrease in interest expense.
SIX MONTHS ENDED JUNE 30, 2004 COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2003.
REVENUE.
Total revenue for the six months ended June 30, 2004 was approximately
$37,727,000 compared to approximately $18,516,000 for the same period during the
prior year, an increase of approximately $19,211,000, or 103.7%. Approximately
$16,143,000 of the increase was due to revenue from the Q4-2003 / Q2-2004
acquisitions.
Wholesale monitoring revenues were approximately $12,449,000 for the six months
ended June 30, 2003 compared to approximately $11,939,000 for the same period in
2004, a decrease of approximately $510,000, or 4.1%. The decrease is due
primarily to a decrease in the aggregate number of accounts (not owned by the
Company, or "external") monitored during the first six months of 2004. This
decrease in external accounts monitored, of approximately 46,000, resulted in a
decrease in revenue of approximately $1,356,000. This decrease was offset, in
part, by an increase of approximately $846,000 generated by an increase in the
average revenue per account per month of approximately $0.37. from the first
half of 2003 as compared to the first half of 2004
Revenue from retail segment operations increased approximately $19,720,000 to
approximately $25,787,000 for the first half of 2004 from $6,067,000 for the
same period in 2003. Revenue from the Q4-2003 / Q2-2004 acquisitions accounted
for approximately $16,143,000 of the increase. In addition, the first half of
2004 reflects incremental revenue of approximately $1,483,000 as a result of the
merger of IASI which occurred in January 31, 2003. Additional revenue, of
approximately $2,152,000, was generated due to an increase of approximately
13,000 in the average number of retail contracts owned per month. These
increases were offset, in part, by a decrease in average revenue per contract
which resulted in a decrease in revenue of approximately $58,000.
COST OF REVENUE (EXCLUDING DEPRECIATION AND AMORTIZATION).
Our cost of revenue for the six months ended June 30, 2004 was approximately
$14,110,000 compared with approximately $7,754,000 for the same period last
year, an increase of approximately $6,356,000. This increase in the cost of
revenue was primarily due to approximately $5,216,000 of costs associated with
the Q4-2003 / Q2-2004 acquisitons. In addition, the cost of revenue for the
retail segment, excluding the Q4-2003 / Q2-2004 acquisitions, increased
approximately $1,190,000. The cost of revenue for the wholesale monitoring
operations decreased approximately $50,000.
Direct margin, as a percentage of total revenue, was 62.6% during the six months
ended June 30, 2004 compared to 58.1% for the same period during 2003. The
increase was due primarily to a greater proportion of retail segment volume
which is a higher margin business.
OPERATING EXPENSES.
Operating expenses increased from approximately $14,998,000 for the six months
ended June 30, 2003 to approximately $22,254,000 for the comparable period in
2004, an increase of approximately $7,256,000, or 48.4%. The increase was due to
approximately $9,831,000 of expenses associated with the Q4-2003 / Q2-2004
acqusitions offset, in part, by decreases in the retail and wholesale segments
of approximately $2,164,000 and $411,000, respectively.
18
Selling and marketing expenses increased approximately $1,790,000 from
approximately $455,000 in the first half of 2003 to approximately $2,245,000 for
same period in 2004. The increase is attributible to expenses associated with
the Q4-2003 / Q2-2004 acqusitions which amounted to approximately $1,810,000.
The expenses related to the Q4-2003 / Q2-2004 acquisitions were comprised
primarily of payroll, benefits and other compensation of approximately
$1,515,000, travel and entertainment of approximately $149,000 and advertising
of approximately $54,000.
Depreciation and amortization expenses increased from approximately $6,420,000
in the first half of 2003 to approximately $10,444,000 for the comparable period
in 2004, an increase of approximately $4,024,000, or 62.7%. This increase was
primarily due to the expenses related to the Q4-2003 / Q2-2004 acqusitions of
$3,435,000. The remaining increase consisted of approximately $988,000 in retail
operations, exclusive of the Q4-2003 / Q2-2004 acquisitons, offset, in part, by
a decrease in expenses associated with the wholesale segment of approximately
$399,000. The retail segment increase was due to an increase in the amortization
of customer contract costs as a result of the purchase of contracts throughout
2003 and the first six months of 2004. The decrease in wholesale operations
expense is attributable to a decrease in amortization of dealer relationship
costs due to the Company's use of declining balance accelerated methods of
amortization.
General and administrative expenses increased approximately $1,443,000, or
17.8%, from approximately $8,122,000 in the first half of 2003 to approximately
$9,565,000 for the same period of 2004. Approximately $3,525,000 of the expenses
in the first half of 2003 related to a charge associated with a transaction with
the Capital Center Credit Corporation ("CCCC"). Absent this 2003 charge, the
expenses for the 2004 period would have represented an increase of approximately
$4,968,000, or 61.2%, from the expenses for the same period of 2003.
Approximately $4,586,000 of the increase was associated with the Q4-2003 /
Q2-2004 acquisitions and comprised primarily of payroll, bonus and other
compensation, facilities and utilities, bad debt, collection and billing,
insurance and travel and entertainment expenses. The additional increase in
expenses, of approximately $382,000, is due primarily to increases in directors
and officers insurance of approximately $540,000, payroll and benefits of
approximately $485,000, rent and utilities of approximately $176,000, travel and
entertainment of approximately $133,000, board and transfer agent fees of
approxiamately $131,000 and litigation settlments of approximately $65,000,
partially offset by decreases in legal, accounting and other professional fees
of approximately $790,000, bad debt expense of approximately $309,000 and bank
fees of approximately $65,000.
OTHER INCOME/EXPENSE.
Other expense for the six months ended June 30, 2004 amounted to approximately
$3,000 compared to other expense for the same period in year 2003 of
approximately $263,000. For the most part, the decrease is due to expenses
recorded in 2003 related to the acquisition of RTC Alarm Monitoring Services.
AMORTIZATION OF DEBT ISSUANCE COSTS.
The amortization of debt issuance costs decreased approximately $400,000 from
approximately $907,000 for the six months ended June 30, 2003 to approximately
$507,000 for the same period in 2004. The decrease is due primarily to a
decrease in debt issuance costs to be amortized as a result of the retirement of
debt during the later half of 2003.
INTEREST EXPENSE.
Interest expense decreased by approximately $4,471,000 from approximately
$8,121,000 to approximately $3,650,000, or 55.1%, for the first six months of
2003 to the same period in 2004, respectively. Approximately $4,223,000 of the
decrease was due to the reduction of debt during 2003 primarily to the use of
the proceeds from the initial public offering of the Company's common stock. The
balance of the decrease, or approximately $248,000, was due to an adjustment of
the accrual for debt related costs.
INTEREST INCOME.
Interest income decreased from approximately $777,000 during the first half of
2003 to approximately $531,000.
19
TAXES.
Income tax expense totaled approximately $3,367,000 for the six months ended
June 30, 2003 compared with a benefit of approximately $827,000 for the six
months ended June 30, 2004. The income tax expense recorded during the six
months ended June 30, 2003 was due primarily the merger of Integrated Alarm
Services, Inc. and the Company in January 2003 and the change in tax status (S
to C Corporation) for federal income tax purposes. The benefit recorded in the
first half of 2004 is based on the effective tax rate the Company expects to use
for the full year of 2004.
RESULTS OF OPERATIONS BY SEGMENT
The comparable financial results for the Company's two operating segments;
Alarm-Monitoring, Wholesale Services and Alarm-Monitoring, Retail Services for
the six months ended June 30, 2004 compared with the six months ended June 30,
2003 are discussed below.
ALARM MONITORING, WHOLESALE SEGMENT. SIX MONTHS ENDED JUNE 30, 2004.
Alarm Monitoring, Wholesale segment total revenue decreased by approximately
$510,000, or 4.1%, to approximately $11,939,000 for the six months ended June
30, 2004 from approximately $12,449,000 for the same period in 2003. The
decrease is due primarily to a decrease in the aggregate number of accounts (not
owned by the Company, or "external") monitored during the first six months of
2004. This decrease in external accounts monitored, of approximately 46,000,
resulted in a decrease in revenue of approximately $1,356,000. This decrease was
offset, in part, by an increase of approximately $846,000 generated by an
increase in the average revenue per account per month of approximately $.37.
Direct margin decreased approximately $460,000 from approximately $4,781,000 for
the six months ended June 30, 2003 to approximately $4,321,000 for the
comparable period of 2004. The decrease in the direct margin is primarily
attributible the decrease in revenue.
The wholesale segment had a loss from operations of approximately $227,000 for
the six months ended June 30, 2004 compared with a loss from operations of
approximately $177,000 for the same period last year, a change of approximately
$50,000. The change is due to primarily to a decrease in direct margin offset,
in part, by a reduction in depreciation and amortization of approximately
$399,000.
The segment had a loss before income taxes of approximately $382,000 for the six
months ended June 30, 2004 compared to a loss of approximately $3,302,000 for
the six months period ended June 30, 2003. The improvement, of approximately
$2,920,000, is primarily attributable to a decrease in interest expense, of
approximately $2,467,000, a reduction to other losses of approximately $262,000
and a decrease in amortization of debt issuance costs of approximately $213,000.
ALARM MONITORING, RETAIL SEGMENT. SIX MONTHS ENDED JUNE 30, 2004.
Alarm Monitoring, Retail segment total revenue increased by approximately
$19,720,000 to approximately $25,787,000 for the six months ended June 30, 2004
from approximately $6,067,000 for the same period in 2003. Revenue from the
Q4-2003 / Q2-2004 acquisitions accounted for approximately $16,143,000 of the
increase. In addition, the first half of 2004 reflects incremental revenue of
approximately $1,483,000 as a result of the merger of IASI which occurred in
January 31, 2003. Additional revenue, of approximately $2,152,000, was generated
due to an increase of approximately 13,000 in the average number of retail
contracts owned per month. These increases were offset, in part, by a decrease
in average revenue per contract which resulted in a decrease in revenue of
approximately $58,000.
Direct margin increased approximately $13,315,000 to approximately $19,296,000
for the first half of 2004. The increase is due primarily to the incremental
margin associated with the Q4-2003 / Q2-2004 acqusitions in the amount of
approximately $10,927,000. The balance of the increase, or approximately
$2,388,000, was due to the margin realized on the incremental revenues of the
balance of the retail segment.
For the six months ended June 30, 2004 the segment had income from operations of
approximately $1,590,000 compared to a loss of approximately $4,058,000 for the
six months ended June 30, 2003, an improvement of approximately $5,648,000. The
improvement was a result of a decrease of approximately $3,187,000 in general
and administrative expenses and an increase of approximately $2,387,000 in
direct margin which was offset, in part, by an increase in depreciation and
amortization of approximately $979,000, none of which included results of the
operations of the Q4-2003 / Q2-2004 acqusitions. The Q4-2003 / Q2-2004
acquisitions had income from operations of approximately $1,097,000.
20
The segment's loss before income taxes was approximately $1,884,000 for the six
months ended June 30, 2004 compared to a loss for the six months period ended
June 30, 2003 of approximately $9,447,000, an improvement of approximately
$7,563,000. In addition to the aforementioned improvement in income from
operations, the reduction of the loss before taxes was due to a decrease of
approximately $2,003,000 in interest expense.
LIQUIDITY AND CAPITAL RESOURCES.
Net cash provided by operating activities was approximately $5,800,000 for the
six months ended June 30, 2004, compared to approximately ($4,200,000) used by
operating activities for the six months ended June 30, 2003. The increase in
cash provided by operations was primarily the result of a decrease of
approximately $14,700,000 in the net loss for the period and an increase in
depreciation and amortization of approximately $4,000,000. The 2003 period had
offsetting benefits of cash provided of approximately $5,000,000 from non-cash
expenses including deferred income taxes.
Net cash used in investing activities was approximately $31,600,000 for the six
months ended June 30, 2004 compared to approximately $8,100,000 provided by
investing activities for the six months ended June 30, 2003. The significant
increase in net cash used in investing activities is primarily due to the
acquisition of customer contracts and businesses of approximately $26,800,000 in
2004 and an increase in cash as a result of the IASI acquisition of
approximately $8,100,000 in 2003.
Net cash used in financing activities was approximately $4,500,000 for the six
months ended June 30, 2004 compared to approximately $300,000 in net cash used
in financing activities for the six months ended June 30, 2003. The change is
primarily due to the new borrowing approximating repayments in 2003 and there
being no borrowings but debt repayments of $4,500,000 during the same six months
in 2004.
The balance sheet at June 30, 2004 reflects a net working capital deficit of
approximately $19,200,000. As of June 30, 2004, we had recurring monthly revenue
("RMR") of approximately $4,400,000 in our retail monitoring segment and
approximately $2,000,000 in our wholesale monitoring segment. Total debt
decreased by approximately $4,800,000 from December 31, 2003 to June 30, 2004.
Our capital expenditures anticipated over the next twelve months include
equipment and software of approximately $1.6 million and our strategy to
purchase monitoring contracts, which we anticipate to be approximately $126
million. This strategy is dependent on obtaining additional financing. We are
currently in discussions with investment bankers and commercial bankers
regarding a combination of privately placed debt securities and commercial bank
credit facilities. We have no commitment from them at this time.
We believe that our existing cash, cash equivalents and RMR are adequate to fund
our operations, including debt payments of $14 million payable over the next six
months, exclusive of planned contract acquisitions, for at least the next twelve
months.
CONTRACTUAL OBLIGATIONS AND COMMERCIAL COMMITMENTS.
The Company's significant contractual obligations as of June 30, 2004 are for
approximately $65,000,000. Debt by year of maturity and future rental payments
under operating lease agreements are presented below. The Company has not
engaged in off-balance sheet financing or commodity contract trading.
21
CONTRACTUAL OBLIGATIONS PAYMENTS DUE BY PERIOD
06/05 06/07 06/09
- -----------------------------------------------------------------------------------------------------------------------------------
Total Less than 1 year 1-3 years 4-5 years After 5 years
Long-term debt $ 61,148,112 $ 16,319,000 $ 38,854,112 $ 5,975,000 $ -
Capital leases 670,859 434,335 236,524 - -
Operating leases 3,542,334 1,078,795 1,560,340 810,849 92,350
------------ ------------ ------------ ----------- --------
Total $ 65,361,305 $ 17,832,130 $ 40,650,976 $ 6,785,849 $ 92,350
============ ============ ============ =========== ========
ATTRITION.
Alarm-Monitoring Wholesale Services
End-user attrition has a direct impact on our results of operations since it
affects our revenues, amortization expense and cash flow. We define attrition in
the wholesale alarm monitoring business as the number of end-user accounts lost,
expressed as a percentage, for a given period. In some instances, we use
estimates to derive attrition data. We monitor end-user attrition each month,
each quarter and each year. In periods of end-user account growth, end-user
attrition may be understated and in periods of end- user account decline,
end-user attrition may be overstated. Our actual attrition experience shows that
the relationship period with any individual Dealer or end-user can vary
significantly. Dealers discontinue service with us for a variety of reasons,
including but not limited to, the sale of their alarm monitoring contracts,
performance issues and receipt of lower pricing from competitors. End-users may
discontinue service with the Dealer and therefore with us for a variety of
reasons, including, but not limited to, relocation, service issues and cost. A
portion of Dealer and end-user relationships, whether acquired or originated via
our sales force, 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, financial position or cash
flows.
For the quarters ended June 30, 2003 and 2004, our annualized end-user account
growth rates in the wholesale monitoring segment, excluding acquisitions were
(4.4%) and (17.9%), respectively. For the quarters June 30, 2003 and 2004, our
annualized end-user attrition rates in the wholesale monitoring segment,
calculated as end-user losses divided by the sum of beginning end-users, end-
users added and end-users acquired, was 18.2% and 38.4%, respectively. This
decline is a result of one alarm company bringing in-house to their call center
approximately 25,000 accounts that IASG managed on a month to month basis. Given
that this company has greatly reduced its acquisition activities we anticpated
this retrenchment but its timing was uncertain. This business was lower margin
than our typical wholesale relationship and we have no further wholesale
business with this company.
2003 2004
------------- -------------
Beginning balance, March 31, 482,141 525,306
End-users added, excluding acquisitions 17,428 32,250
End-users acquired 263 22,428
End-user losses (22,768) (55,705)
------------- -------------
Ending Balance, June 30, 477,064 524,279
============= =============
Alarm-Monitoring Retail Services
The annualized attrition rates, based upon customer accounts cancelled or
becoming significantly delinquent, during the second quarter of 2004 are as
follows:
Active RMR at
Portfolio Attrition Rate June 30, 2004
- -------------------------------- ---------------- -----------------
Legacy and flow 10.8% $ 1,046,263
Residential since IPO 9.9% 2,223,774
Commercial since IPO 13.4% 1,120,525
-----------
Total 11.2% $ 4,390,562
===========
22
The increase in Commercial attrition from the 9.1% last quarter is due primarily
from the loss of one account, a California school district, and we believe it to
be a discrete event. Attrition for acquired Dealer customer relationships and
alarm monitoring contracts may be greater in the future than the attrition rate
assumed or historically incurred by us. In addition, because some Dealer
customer relationships and acquired alarm monitoring contracts are prepaid on an
annual, semi-annual or quarterly basis, attrition may not become evident for
some time after an acquisition is consummated. We are currently negotiating the
potential sale of approximately $130,000 of recurring monthly revenue.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk is limited to interest income and expense
sensitivity, which is effected by changes in the general level of interest
rates. The primary objective of our investment activities is to preserve
principal while at the same time maximizing the income we receive without
significantly increasing risk. To minimize risk, we maintain our portfolio of
cash, cash equivalents and short-term and restricted investments in a variety of
interest-bearing instruments including United States government and agency
securities, high-grade United States corporate bonds, municipal bonds,
mortgage-backed securities, commercial paper and money market accounts at
established financial institutions. Due to the nature of our short-term and
restricted investments, we believe that we are not subject to any material
market risk exposure. We do not have any foreign currency. At June 30, 2004, we
had $7.2 million of variable rate debt outstanding.
ITEM 4. CONTROLS AND PROCEDURES
EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES
Our management, with the participation of our principal executive officer and
principal financial officer, has evaluated the effectiveness of our disclosure
controls and procedures (as such term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")) pursuant to Rule 13a-15(c) under the Exchange Act as of the end of the
period covered by this Quarterly Report on Form 10-Q. While our Chief Executive
Officer and Chief Financial Officer have concluded that, our disclosure controls
and procedures were effective as of the end of the period covered by this report
our significant growth through acquisitions of companies with complex accounting
and revenue systems not readily adaptable to our own, has required us to undergo
major system changes as disclosed in previous filings. Several of our
information technology projects, although making progress, are running behind
schedule. As a result, we can provide no assurance that we will not identify
significant deficiencies or material weaknesses in internal controls over
financial reporting under definitions established by the SEC and PCAOB We
continue to commit significant resources to the project and have hired a
consulting firm specializing in this area, but our numerous system and control
changes have hindered their progress.
Section 404 of the Sarbanes-Oxley Act of 2002 requires that management document
and test the internal controls over financial reporting and to assert in our
Annual Report on Form 10-K for the year-ended December 31, 2004, whether the
internal controls over financial reporting as of December 31, 2004 are
effective. Any material weakness in internal controls over financial reporting
existing at that date will preclude management's making a positive assertion.
While management intends to complete its assessment of internal controls over
financial reporting and to implement, document and test any required changes to
correct any material weaknesses identified in order to make a positive assertion
as to the effectiveness of internal controls over financial reporting, there can
be no assurance that sufficient progress will be made in time to do so.
CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING
The changes in our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the
period covered by this Quarterly Report on Form 10-Q that have materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting are as follows.
The Company is undergoing major system changes and software conversions in
revenue, billing, receivables and other accounting systems. Although the Company
believes the process is properly controlled, it is too early to predict the
successful completion of these major information technology projects.
The Company completed the acquisition of two operating companies in the second
half of the fourth quarter of 2003. The Company has not completed its
documentation and testing of the accounting systems of these acquired companies
at this time.
23
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
In March of 2003, Protection One Alarm Monitoring, Inc., a company engaged in
the business of providing security and other alarm monitoring services to
residential and commercial customers, brought an action against us in the
Superior Court of New Jersey, Camden County for unspecified damages in
connection with our purchase of certain alarm monitoring contracts from B&D
Advertising Corporation ("B&D"). B&D had previously sold alarm monitoring
contracts to Protection One. As part of such sales, B&D agreed not to solicit
any customers whose contracts had been purchased and to keep certain information
confidential. Protection One claims that our subsequent purchase of contracts
from B&D constitutes tortuous interference, that we utilized confidential
information belonging to Protection One and that Protection One had an interest
in some of the contracts that we purchased from B&D. We plan to vigorously
defend this claim. We believe the resolution of this matter will not have a
material adverse effect on our financial condition, results of operations or
cash flows.
In May 2003, a former employee of McGinn, Smith & Co., Inc., brought an action
against us, as well as McGinn, Smith & Co., Inc. and M&S Partners for wrongful
termination. The suit brought in the Supreme Court of the State of New York
seeks damages of $10,000,000. McGinn, Smith & Co., Inc. and M&S Partners have
fully indemnified us from any damages or legal expenses that we may incur as a
result of the suit. This employee of McGinn, Smith & Co., Inc., was never our
employee and we plan to vigorously defend this claim. We believe the resolution
of this matter will not have a material adverse effect on our financial
condition, results of operations or cash flows.
On December 9, 2003, a complaint was filed against the Company in the United
States District Court in the southern District of New York entitled Ian Meyers
v. Integrated Alarm Services Group, Inc., et al. The Plaintiff alleges, among
other things, that the Company and its professionals engaged in transactions
with the Company that were designed to defraud plaintiff out of funds he was
entitled to pursuant to Plaintiff's agreement with First Integrated Capital
Corp. ("FICC"), his employer, and a company in which he had an equity interest.
Plaintiff was seeking damages in the amount of $3,000,000. A mediation
conference before the court was held on April 22, 2004. As a result of the
mediation conference, an agreement was reached and the Company paid $64,000 on
June 16, 2004 to settle this matter in full and the case was withdrawn with
prejudice. The Company had accrued this amount as of March 31, 2004.
We from time to time experience routine litigation in the normal course of our
business. We do not believe that any pending litigation will have a material
adverse effect on our financial condition, results of operations or cash flows.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
The Company filed a Registration Statement (333-101159) with the Securities and
Exchange Commission on June 27, 2003 to register up to 25,300,000 shares of
common stock for sale at an aggregate offering price of approximately
$278,300,000. The offering commenced on July 23, 2003 and terminated on August
22, 2003. Upon completion, the managing underwriter, Friedman, Billings, Ramsey
& Co., Inc., successfully sold 22,982,729 shares at $9.25 per share for an
aggregate offering price of approximately $ 212,590,243. Concurrently with the
offering, 792,793 shares of common stock were registered on behalf of certain
holders of convertible promissory notes. During the quarter ended June 30, 2004,
39,640 shares of common stock were issued to holders converting $275,000 of
notes. All of the shares of common stock were sold by us and none of the selling
security holders' shares were underwritten in the offering.
24
USE OF PROCEEDS (THROUGH JUNE 30, 2004)
Repayment of debt $ 95,058,242
Acquisition of contracts and businesses 94,622,648
New dealer loans 4,956,665
Working capital 1,218,957
-------------
Total Uses $ 195,856,512
=============
TEMPORARY INVESTMENTS AS OF JUNE 30, 2004
$ -
-------------
$ -
=============
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Company held its Annual Shareholders' meeting on June 15, 2004. All of the
current Directors stood for election and were elected at the meeting. The
tabulation of votes for each Director is as follows:
Votes For Votes Against
------------------ -----------------
Timothy M. McGinn 20,566,468 276,534
Thomas J. Few 20,566,468 276,534
A. Clinton Allen 20,601,948 241,054
Raymond C. Kubacki 20,619,048 223,954
John W. Mabry 20,619,048 223,954
Ralph S. Michael III 20,619,048 223,954
R. Carl Palmer 12,575,345 8,267,657
David L. Smith 20,566,468 276,534
Timothy J. Tully 20,619,048 223,954
In addition, the Shareholders voted on these proposals:
Votes For Votes Against Votes Abstain Broker Non-Votes
--------- ------------- ------------- ----------------
To approve the Company's 2004 Stock
Incentive Plan 13,787,528 1,688,798 27,371 5,339,305
To approve the appointment of
PricewaterhouseCoopers, LLP as
independent accountants of the
Company or the fiscal year ending
December 31, 2004 20,830,256 10,200 2,546 -
ITEM 5. OTHER INFORMATION
Not Applicable.
25
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit 11.1: Statement of computation of earnings per share.
Exhibit 31. Rule 13a-14(a)/15d-14(a) Certifications.
Exhibit 32(a). Certification by the Chief Executive Officer Relating to a
Periodic Report Containing Financial Statements.*
Exhibit 32(b). Certification by the Chief Financial Officer Relating to a
Periodic Report Containing Financial Statements.*
* The Exhibit attached to this Form 10-Q shall not be deemed "filed" for
purposes of Section 18 of the Securities Exchange Act of 1934 (the "Exchange
Act") or otherwise subject to liability under that section, nor shall it be
deemed incorporated by reference in any filing under the Securities Act of 1933,
as amended, or the Exchange Act, except as expressly set forth by specific
reference in such filing.
(b) Reports on Form 8-K
None
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
August 16, 2004 INTEGRATED ALARM SERVICES GROUP, INC.
By: /s/ Timothy M. McGinn
-------------------------------
Name: Timothy M. McGinn
Title: Chief Executive Officer
By: /s/ Michael T. Moscinski
-------------------------------
Name: Michael T. Moscinski
Title: Chief Financial Officer
26