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 March 31, 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 May 5, 2004 there were 24,677,858 shares of the registrant's
common stock outstanding.
1
Integrated Alarm Services Group, Inc. and Subsidiaries
Form 10-Q Index
For the Three Months Ended March 31, 2004
Description
Part I. Financial Information....................................................................................3
Item 1 Financial Statements............................................................................3
Consolidated Balance Sheets as of December 31, 2003 and March 31, 2004..........................3
Statements of Operations for the Three Months Ended March 31, 2003 and 2004.....................4
Statements of Cash Flows for the Three Months Ended March 31, 2003 and 2004.....................5
Notes to Consolidated Financial Statements......................................................6
Item 2 Management's Discussions and Analysis of Financial Condition and Results of Operations.........12
Item 3 Quantitative and Qualitative Disclosures about Market Risks....................................18
Item 4 Controls and Procedures........................................................................19
Part II Other Information.......................................................................................19
Item 1 Legal Proceedings..............................................................................19
Item 2 Changes in Securities and Use of Proceeds......................................................20
Item 6 Exhibits and Reports on Form 8-K...............................................................20
2
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
As of
------------------------------
December 31, March 31,
2003 2004
------------- -------------
Assets (unaudited)
Current assets
Cash and cash equivalents $ 35,435,817 $ 28,535,419
Current portion of notes receivable 735,149 857,314
Accounts receivable, net 4,312,990 4,960,568
Inventories 1,107,899 1,004,827
Prepaid expenses 1,548,105 1,823,404
Due from related parties 232,300 146,778
------------- -------------
Total current assets 43,372,260 37,328,310
Property and equipment, net 5,762,586 5,729,360
Notes receivable net of current portion and allowance 4,525,973 4,363,432
Dealer relationships, net 23,113,617 22,169,295
Customer contracts, net 73,571,131 75,812,077
Goodwill, net 85,515,985 85,859,069
Debt issuance costs, net 1,768,281 1,520,325
Other identifiable intangibles, net 2,187,464 2,091,115
Restricted cash and cash equivalents 1,100,000 1,100,000
Other assets 119,033 1,947,105
------------- -------------
Total assets $ 241,036,330 $ 237,920,088
============= =============
Liabilities and Stockholders' Equity
Current liabilities:
Current portion of long-term debt $ 18,765,000 $ 18,626,000
Current portion of capital lease obligations 431,555 435,995
Accounts payable 2,873,707 1,934,186
Accrued expenses 8,816,766 8,534,843
Current portion of deferred revenue 7,576,993 7,803,502
Other liabilities 139,066 280
------------- -------------
Total current liabilities 38,603,087 37,334,806
Long-term debt, net of current portion 46,977,612 46,066,612
Capital lease obligations, net of current portion 453,811 312,786
Deferred revenue, net of current portion 312,343 1,159,951
Deferred income taxes 759,425 75,658
Other liabilities 374,119 423,961
Due to related parties 153,203 3,061
------------- -------------
Total liabilities 87,633,600 85,376,835
============= =============
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 24,641,822 at March 31, 2004 24,608 24,642
Common stock subscribed 315,342 --
Paid-in capital 205,086,659 205,613,506
Accumulated deficit (52,023,879) (53,094,895)
------------- -------------
Total stockholders' equity 153,402,730 152,543,253
------------- -------------
Total liabilities and stockholders' equity $ 241,036,330 $ 237,920,088
============= =============
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 Months Ended March 31,
(unaudited)
2003 2004
------------ ------------
Revenue:
Monitoring fees $ 6,089,790 $ 5,787,406
Revenue from customer accounts 2,405,185 11,578,002
Billing fees 20,983 --
Related party monitoring fees 152,106 25,480
Related party placement fees 85,573 --
Service and subcontractor fees -- 816,862
------------ ------------
Total revenue 8,753,637 18,207,750
Cost of revenue (excluding depreciation
and amortization) 3,865,606 7,067,994
------------ ------------
4,888,031 11,139,756
------------ ------------
Operating expenses:
Selling and marketing 265,066 1,115,962
Depreciation and amortization 2,870,521 5,012,521
General and administrative 2,232,882 5,059,400
General and administrative - related party 3,245,000 --
------------ ------------
Total operating expenses 8,613,469 11,187,883
------------ ------------
Income (loss) from operations (3,725,438) (48,127)
Other income (expense):
Other expense, net (142,008) (3,080)
Amortization of debt issuance costs (377,675) (259,850)
Related party interest expense (424,365) --
Interest expense (3,135,709) (1,705,172)
Interest income 359,883 324,671
------------ ------------
Income (loss) before income taxes (7,445,312) (1,691,558)
Income tax expense (benefit) 3,417,288 (620,542)
------------ ------------
Net income (loss) $(10,862,600) $ (1,071,016)
============ ============
Basic and diluted income (loss) per share $ (8.44) $ (0.04)
============ ============
Weighted average number of common
shares outstanding 1,287,389 24,639,949
============ ============
Unaudited:
Pro Forma income tax to give effect to the
conversion from S to C Corporation status:
Income (loss) before benefit from income taxes $ (7,445,312) $ (1,691,558)
Income tax expense (benefit) (199,200) (620,542)
------------ ------------
Net income (loss) $ (7,246,112) $ (1,071,016)
============ ============
Basic and diluted income (loss) per share $ (5.63) $ (0.04)
============ ============
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 Three Months Ended March 31,
(unaudited)
2003 2004
------------ ------------
Cash flows from operating activities:
Net income (loss) $(10,862,600) $ (1,071,016)
Adjustments to reconcile net loss to net cash
provided by (used in) operating activities:
Depreciation and amortization 2,870,521 5,012,521
Amortization of debt issuance costs 377,675 259,850
Non-cash interest expense -- 211,539
Provision for bad debts 100,000 401,860
Deferred income taxes 3,410,879 (683,767)
Non-cash service fees 1,575,000 --
Loss (gain) on disposal of property and equipment -- 402
Changes in assets and liabilities, net of effects of acquisitions and
non-cash transactions:
Accounts receivable 386,637 (1,054,438)
Inventories -- 103,072
Prepaid expenses (14,487) (275,299)
Other assets (610,400) (71,231)
Due from/to related parties (233,206) (64,619)
Accounts payable and accrued expenses (187,392) (828,309)
Deferred revenue 94,789 (6,759)
Other liabilities (394,009) (88,944)
------------ ------------
Net cash provided by (used in) operating activities (3,486,593) 1,844,862
------------ ------------
Cash flows from investing activities:
Purchase of property and equipment (41,667) (588,027)
Proceeds from sale of property and equipment -- 400
Purchase of customer contracts (23,957) (6,137,049)
Deferred installation costs (other assets) -- (1,605,272)
Deferred installation revenue -- 1,080,876
Financing of customer loans (132,315) (43,817)
Repayment of customer loans 358,832 89,193
Decrease (increase) in restricted cash and cash equivalents 17,066 --
Business acquisitions, net of cash acquired 8,082,332 (343,084)
------------ ------------
Net cash provided by (used in) investing activities 8,260,291 (7,546,780)
------------ ------------
Cash flows from financing activities:
Proceeds of long-term debt, related party 2,000,000 --
Proceeds of long-term debt 3,432,000 --
Payments of obligations under capital leases (37,665) (136,585)
Repayment of long-term debt (3,735,722) (1,050,000)
Repayment of long-term debt, related party (53,669) --
Debt issuance costs (31,500) (11,895)
------------ ------------
Net cash provided by (used in) financing activities 1,573,444 (1,198,480)
------------ ------------
Net increase (decrease) in cash and cash equivalents for the year 6,347,142 (6,900,398)
Cash and cash equivalents at beginning of year 442,082 35,435,817
------------ ------------
Cash and cash equivalents at end of year $ 6,789,224 $ 28,535,419
============ ============
Supplemental disclosure of cash flow information:
Interest paid $ 3,277,545 $ 1,706,232
============ ============
Income taxes paid $ -- $ 15,050
============ ============
Supplemental disclosure of non-cash items:
Common stock issued to purchase IASI $ 11,559,944
============
Debt assumed from a related party $ 1,575,000
============
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 March 31, 2004 and for the three months ended
March 31, 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 ended March 31, 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 been omitted. 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 March 31, 2004
----------------- --------------
Performing loans $5,040,103 $1,376,088
Non-perfoming loans 351,873 3,970,512
Less: reserve (130,854) (125,854)
---------- ----------
Net loans 5,261,122 5,220,746
Less: current portion (735,149) (857,314)
---------- ----------
Long-term portion $4,525,973 $4,363,432
========== ==========
At March 31, 2004, we have non-performing loans aggregating $4.0 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.
3. Goodwill and Intangibles
The allocation of purchase price related to the acquisition of Lane is
preliminary at March 31, 2004. In April 2004, we received a Working Capital
Adjustment (per agreement) cash payment from Lane Industries, Inc. of $1,378,000
which will reduce the goodwill recorded by the same amount.
In addition, during the three months ended March 31, 2004, goodwill increased by
approximately $343,000 due to costs associated with 2003 acquisitions.
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 three months ended March 31, 2004.
6
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated financial Statements--(Continued)
Customer contracts at March 31, 2004 consist of the following:
Contracts
Existing Dealer assumed from
March 31, 2004 Portfolio Acquired dealers Total
- ---------------------------------------------------- ---------------- --------------- --------------- ---------------
Customer contracts December 31, 2003 $49,341,567 $23,062,462 $ 8,058,738 $80,462,767
Purchases first quarter 4,826,890 1,310,159 - 6,137,049
Sales and reclassifications first quarter (117,227) (151,569) - (268,796)
---------------- --------------- --------------- ---------------
Customer contracts March 31, 2004 54,051,230 24,221,052 8,058,738 86,331,020
---------------- --------------- --------------- ---------------
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
---------------- --------------- --------------- ---------------
Accumulated amortization March 31, 2004 3,552,165 4,518,987 2,447,791 10,518,943
---------------- --------------- --------------- ---------------
Customer contracts, net $50,499,065 $19,702,065 $ 5,610,947 $75,812,077
================ =============== =============== ===============
Customer contract amortization expense for the three months ended March 31, 2004
and 2003 was $3,627,307 and $1,512,150, respectively. The March 31, 2004
amortization expense was reduced by approximately $393,000 of attrition reserves
from contract purchase transactions.
Dealer relationships consist of the following:
December 31, March 31,
2003 Amortization 2004
------------ ------------ ------------
Dealer relationships $ 39,958,089 $ -- $ 39,958,089
Accumulated amortization (16,844,472) (944,322) (17,788,794)
------------ ------------ ------------
$ 23,113,617 $ (944,322) $ 22,169,295
============ ============ ============
Amortization expense was $1,111,824 for the three months ended March 31, 2003.
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 (nine months) $6,279,671 $ 2,832,964 $ 316,726 $9,429,361
2005 8,993,427 2,955,556 403,841 12,352,824
2006 7,894,554 2,581,858 348,500 10,824,912
2007 6,725,060 2,303,889 348,500 9,377,449
2008 6,083,669 2,151,540 348,500 8,583,709
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.
7
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated financial Statements--(Continued)
4. Stockholders' Equity
Stock-Based Compensation
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.
Under the fair value method (SFAS No. 123), there would be no effect on net loss
and net loss per share for the three months ended March 31, 2003 and 2004
because there were no stock-based compensation awards vesting during such
periods.
Company stock options outstanding as of March 31, 2004 include fully vested
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 9.33 years. As of March 31, 2004
all of the options outstanding were exerciseable. No stock options were issued
during the quarters ended March 31, 2003 and 2004.
The following table summarized the activity related to stockholders' equity for
the three months ended March 31, 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) ................. -- -- -- -- (1,071,016) (1,071,016)
Issue of contingent shares
for Criticom purchase ........... 34,091 34 (315,342) 315,308 -- --
Imputed Interest expense associated
with conversion feature of debt . -- -- -- 211,539 -- 211,539
------------- ---------- ------------- ------------- ------------- -------------
Balance, March 31, 2004 ........... 24,641,822 $ 24,642 $ -- $ 205,613,506 $ (53,094,895) $ 152,543,253
============= ========== ============= ============= ============= =============
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.
8
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated financial Statements--(Continued)
6. Income (Loss) per Common Share
The income (loss) per common share is as follows:
Three months ended
March 31,
------------------------------
2003 2004
------------- -------------
Numerator
Net income(loss) .................. $(10,862,600) $ (1,071,016)
Denominator
Weighted average shares outstanding 1,287,389 24,639,949
Net income (loss) per share .......... $ (8.44) $ (0.04)
For the three months ended March 31, 2004, there are outstanding promissory
notes which are convertible into 792,793 shares of common stock at a price of
$6.94 per share and , options outstanding to acquire 1,948,000 shares of the
Company's common stock at a per share price of $9.25. The shares have not been
included as common stock equivalents, as they would be anti-dilutive.
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, we filed a motion to dismiss
the claim against us, 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.
FICC was also an affiliate of the Company that sold a portfolio of alarm
contracts to the Company. In particular, plaintiff alleges that the Company and
certain of its principals removed valuable revenue-generating assets from FICC
and transferred the FICC contracts to the Company for less than fair value.
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, a verbal agreement was reached and documents are being
drafted requiring the Company to pay $64,000 to settle this matter. The Company
has accrued this amount as of March 31, 2004.
9
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated financial Statements--(Continued)
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 $424,365 and $0 respectively, in related
party interest for the three months ended March 31, 2003 and March 31, 2004 of
which approximately $167,359 in 2003 was to IASI.
The Company earned monitoring fees from trusts that are related parties of
approximately $152,106 and $25,480 for the three months ended March 31, 2003 and
2004, respectively.
Included in long-term debt (junior debt) are contract certificates held by
related parties that totaled approximately $222,000 at March 31, 2004.
During the three months ended March 31, 2003, the Company paid $1,700,000 to
Capital Center Credit Corporation ("CCCC") and assumed $1,575,000 of debt from
CCCC resulting in a charge to general and administrative expense of $3,245,000.
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 months ended March 31, 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.
10
INTEGRATED ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
Notes to Consolidated financial Statements--(Continued)
Summarized financial information for the three months ended ended March 31, 2003
and 2004 concerning the Company's reportable segments is shown in the following
table:
Alarm- Alarm-
Monitoring Monitoring
Wholesale Retail Consolidated
Services Services Total
----------------------------------------------------------
Three Months ended March 31, 2003
Total revenue $ 6,348,452 $ 2,405,185 $ 8,753,637
Intersegment revenue 471,908 - -
Cost of revenue (including depreciation and amortization) 5,179,271 1,556,856 6,736,127
Income (loss) from operations 333,850 (4,059,288) (3,725,438)
Interest income - 359,883 359,883
Interest expense 1,301,956 2,258,118 3,560,074
Income (loss) before income taxes (1,227,629) (6,217,683) (7,445,312)
Three Months ended March 31, 2004
Total revenue $ 5,812,886 $ 12,394,864 $ 18,207,750
Intersegment revenue 489,324 - -
Cost of revenue (including depreciation and amortization) 4,914,260 7,166,255 12,080,515
Income (loss) from operations (413,315) 365,188 (48,127)
Interest income 14,294 310,377 324,671
Interest expense 72,172 1,633,000 1,705,172
Income (loss) before income taxes (491,818) (1,199,740) (1,691,558)
There was no material change in the total assets of the reportable segments
during the three months ended March 31, 2004.
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations for the Three Months Ended March 31, 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 Lane is
preliminary at March 31, 2004. In April 2004, we received a Working Capital
Adjustment (per agreement) cash payment from Lane Industries, Inc. of $1,378,000
which will reduce the goodwill recorded by the same amount.
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 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 March 31, 2004, we have non-performing loans aggregating $4.0 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.
12
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 will
amortize 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. To date no impairment charges have
been required.
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.
13
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.
FICC was also an affiliate of the Company that sold a portfolio of alarm
contracts to the Company. In particular, plaintiff alleges that the Company and
certain of its principals removed valuable revenue-generating assets from FICC
and transferred the FICC contracts to the Company for less than fair value.
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, a verbal agreement was reached and documents are being
drafted requiring the Company to pay $64,000 to settle this matter. The Company
has 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 March 31, 2004 compared to the three months ended March 31,
2003.
Revenue.
Total revenue for the three months ended March 31, 2004 was approximately
$18,208,000 compared to approximately $8,754,000 for the same period during the
prior year, an increase of approximately $9,454,000, or 108.0%. Approximately
$7,706,000 of the increase was due to revenue from businesses acquired in the
final quarter of 2003 (the "Q4-2003 acquisitions").
Wholesale monitoring revenues decreased from approximately $6,349,000 for the
three months ended March 31, 2003 to approximately $5,813,000 for the same
period in 2004, a decrease of approximately $536,000, or 8.4%. 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 three months of 2004.
This decrease in external accounts monitored, of approximately 54,000, resulted
in a decrease in revenue of approximately $784,000. This decrease was offset, in
part, by an increase of approximately $248,000 generated by an increase in the
average revenue per account per month from $4.88 for the three months ended
March 31, 2003 to $5.10 for the comparable period of 2004.
Revenue from retail segment operations increased approximately $9,990,000 to
approximately $12,395,000 for the first quarter of 2004 from $2,405,000 for the
same period in 2003. Revenue from the Q4-2003 acquisitions accounted for
approximately $7,706,000 of the increase. In addition, the first quarter 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 $560,000, was generated due to an increase of approximately 9,000
in the average number of retail contracts owned per month. The balance of the
increase, or approximately $241,000, was due to an increase the average revenue
per contract.
Cost of Revenue.
Our cost of revenue for the three months ended March 31, 2004 was approximately
$7,068,000 compared with approximately $3,866,000 for the same period last year,
an increase of approximately $3,202,000. This increase in the cost of revenue
was primarily due to approximately $2,772,000 of costs associated with the
Q4-2003 acquisitions. In addition, the cost of revenue for the retail segment,
exclusive of the Q4-2003 acquisitions, increased approximately $455,000. The
increases in the retail segment were partially offset by a decrease in wholesale
monitoring operations of approximately $25,000.
Direct margin, as a percent of total revenue, was 55.8% during the three months
ended March 31, 2003 compared to 61.2% for the same period during 2004. The
increase was due primarily to a greater proportion of retail segment volume
which is a higher margin business.
14
Operating Expenses.
Operating expenses increased from approximately $8,613,000 for the three months
ended March 31, 2003 to approximately $11,188,000 for the comparable period in
2004, an increase of approximately $2,575,000, or 29.9%. The increase was due to
approximately $5,046,000 of expenses associated with the Q4-2003 acquisitions
offset, in part, by decreases in the retail and wholesale segments of
approximately $2,236,000 and $235,000, respectively.
Selling and marketing expenses increased approximately $851,000 from
approximately $265,000 in the first quarter of 2003 to approximately $1,116,000
for same period in 2004. The expenses associated with the Q4-2003 acquisitions
accounted for an increase of approximately $910,000 which was partially offset
by a $59,000 decrease in wholesale segement operations. The expenses related to
the Q4-2003 acquisitions were comprised primarily of payroll, benefits and other
compensation of approximately $755,000, travel and entertainment of
approximately $76,000 and advertising of approximately $29,000.
Depreciation and amortization expenses increased from approximately $2,871,000
in the first quarter of 2003 to approximately $5,013,000 for the comparable
period in 2004, an increase of approximately $2,142,000, or 74.6%. This increase
was primarily due to the expenses related to the Q4-2003 acquisitions of
$1,778,000. The remaining increase consisted of approximately $604,000 in retail
operations, exclusive of the Q4-2003 acquisitions, offset, in part, by a
decrease in expenses associated with the wholesale segment of approximately
$240,000. The retail segment increase 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 three 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 decreased approximately $418,000, or 7.6%,
from approximately $5,478,000 in the first quarter of 2003 to approximately
$5,060,000 for the same period of 2004. Approximately $3,275,000 of the expenses
in the first quarter 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 $2,857,000 from the expenses for the same period of 2003. Expenses
associated with the Q4-2003 acquisitions, comprised primarily of payroll, bonus
and other compensation, telephone, bad debt and rent expenses, represented
approximately $2,358,000 of the 2004 expense. The additional increase in
expenses (absent the CCCC charge), of approximately $499,000, is due primarily
to increases in bad debt of approximately $302,000, directors and officers
insurance of approximately $270,000, payroll and benefits of approximately
$152,000, postage of approximately $101,000, litigation settlement of
approximately $64,000, travel and entertainment of approximately $63,000, office
rent of approximately $61,000 and board fees of approximately $52,000 partially
offset by decreases in legal, accounting and other professional fees of
approximately $621,000.
Other Income/Expense.
Other expense for the three months ended March 31, 2004 of approximately $3,000
compares to other expense for the same period in year 2003 of approximately
$142,000. 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 $118,000 from
approximately $378,000 for the three months ended March 31, 2003 to
approximately $260,000 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 $1,855,000 from approximately
$3,560,000 to approximately $1,705,000, or 52.1%, for the first three months of
2003 to the same period in 2004, respectively. Approximately $1,607,000 of the
decrease was due to the reduction of debt during 2003 primarily from 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.
15
Interest Income.
Interest income decreased from approximately $360,000 during the first quarter
of 2003 to approximately $325,000, or approximately $35,000.
Taxes.
Income tax expense totaled approximately $3,417,000 for the three months ended
March 31, 2003 compared with a benefit of approximately $621,000 for the three
months ended March 31, 2004. The income tax expense recorded during the three
months ended March 31, 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 quarter 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 three months ended March 31, 2004 compared with the three months ended March
31, 2003 are discussed below.
Alarm Monitoring, Wholesale Segment. Three month ended March 31, 2004.
Alarm Monitoring, Wholesale segment total revenue decreased by approximately
$536,000, or 8.4%, to approximately $5,813,000 for the three months ended March
31, 2004 from approximately $6,349,000 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 three months of 2004.
This decrease in external accounts monitored, of approximately 54,000, resulted
in a decrease in revenue of approximately $784,000. This decrease was offset, in
part, by an increase of approximately $248,000 generated by an increase in the
average revenue per account per month from $4.88 for the three months ended
March 31, 2003 to $5.10 for the comparable period of 2004.
Direct margin decreased approximately $511,000, or 20.2% from approximately
$2,528,000 for the three months ended March 31, 2003 to approximately $2,017,000
for the comparable period of 2004. As a percent of total revenue, the direct
margin was 39.8% for the three months ended March 31, 2003 compared with 34.7%
for the three months ended March 31, 2004. The decrease in the direct margin is
almost entirely due to the decrease in revenue.
The wholesale segment had a loss from operations of approximately $413,000 for
the three months ended March 31, 2004 compared with income from operations of
approximately $334,000 for the same period last year, a change of approximately
$747,000. The majority of the change was attributable to the decrease in the
revenue.
The segment had a loss before income taxes of approximately $492,000 for the
three months ended March 31, 2004 compared to a loss of approximately $1,228,000
for the three months period ended March 31, 2003. The reduction to the loss , of
approximately $736,000, is primarily attributable to decreases in net interest
expense, of approximately $1,244,000 and other expenses of approximately
$239,000 offset, in part, by the increased loss from operations.
Alarm Monitoring, Retail Segment Three months ended March 31, 2004.
Alarm Monitoring, Retail segment total revenue increased by approximately
$9,990,000 to approximately $12,395,000 for the three months ended March 31,
2004 from approximately $2,405,000 for the same period in 2003. Revenue from the
Q4-2003 acquisitions accounted for approximately $7,706,000 of the increase. In
addition, the first quarter 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 $560,000, was generated
due to an increase of approximately 9,000 in the average number of retail
contracts owned per month. The balance of the increase, or approximately
$241,000, was due to an increase the average revenue per contract.
Direct margin increased approximately $6,762,000 to approximately $9,123,000 for
the first quarter of 2004. The increase is due to an increase in revenue of
approximately $9,990,000 offset, in part, by an increase in cost of revenue of
approximately $3,272,000. The increase in cost of revenue was primarily
attributable to the Q4-2003 acquistions.
For the three months ended March 31, 2004 the segment had income from operations
of approximately $365,000 compared to a loss of approximately $4,059,000 for the
three months ended March 31, 2003, an improvement of approximately $4,424,000.
The improvement was primarily due to the increase in the direct margin and a
reduction to general and administrative expenses offset, in part, by increases
in depreciation and amortization and sales and marketing expenses.
16
The segment's loss before income taxes was approximately $1,200,000 for the
three months ended March 31, 2004 compared to a loss for the three months period
ended March 31, 2003 of approximately $6,218,000, an improvement of
approximately $5,018,000. The improvement was primarily due to the reductions to
the loss from operations and net interest expense.
Liquidity and Capital Resources.
Net cash provided (used) by operating activities was approximately $1,800,000
for the three months ended March 31, 2004, compared to approximately
($3,500,000) used by operating activities for the three months ended March 31,
2003. The increase in cash provided by operations was primarily the result of a
decrease of approximately $9,800,000 in the net loss for the period and an
increase in depreciation and amortization of approximately $2,100,000. 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 ($7,500,000) for the
three months ended March 31, 2004 compared to approximately $8,300,000 provided
by investing activities for the three months ended March 31, 2003. The
significant increase in net cash used in investing activities is primarily due
to the acquisition of customer contracts of approximately ($6,100,000) 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 ($1,200,000) for the
three months ended March 31, 2004 compared to approximately $1,600,000 net cash
provided by financing activities for the three months ended March 31, 2003. The
change is primarily due to the borrowing of approximately $5,400,000 in 2003
offset by repayments in 2003 that were approximately ($2,700,000) higher than
for the same three months in 2004.
The balance sheet at March 31, 2004 reflects net working capital deficit of
approximately $6,000. As of March 31, 2004, we had recurring monthly revenue
("RMR") of approximately $3,600,000 in our retail monitoring segment and
approximately $2,100,000 in our wholesale monitoring segment. Total debt
decreased by approximately ($1,200,000) from December 31, 2003 to March 31,
2004.
On May 9, 2003, we received a permanent bank waiver from LaSalle through April
1, 2003 for certain past covenant violations. With respect to an attrition
covenant, the Company in 2003 and January 2004 has provided LaSalle with a
security interest in approximately $181,000 of additional alarm contract
recurring monthly revenue. After giving effect to the waiver described above, we
are not currently in default of our covenants.
Our capital expenditures anticipated over the next twelve months include
equipment and software of approximately $2.5 million and our strategy to
purchase monitoring contracts, which we anticipate to be approximately $150
million. This strategy is dependent on obtaining additional financing.
We believe that our existing cash, cash equivalents and RMR are adequate to fund
our operations, 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 March 31, 2004 are for
approximately $69,312,000. 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.
Contractual Obligations Payments Due by Period
03/05 03/07 03/09
- ------------------------------------------------------------------------------------------------------------------------------
Total Less than 1 year 1-3 years 4-5 years After 5 years
Long-term debt $64,692,612 $18,626,000 $39,386,612 $ 6,680,000 $ --
Capital leases 748,781 435,995 312,786 -- --
Operating leases 3,870,487 1,195,705 1,599,097 937,160 138,525
----------- ----------- ----------- ----------- -----------
Total $69,311,880 $20,257,700 $41,298,495 $ 7,617,160 $ 138,525
=========== =========== =========== =========== ===========
17
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 March 31, 2003 and 2004, our annualized end-user account
growth rates in the wholesale monitoring segment, excluding acquisitions were
(3.7%) and 4.0%, respectively. For the quarters March 31, 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 16.1% and 13.4%, respectively. As a
result of the discovery of a discrepancy in the reporting mechanism for the
number of wholesale accounts, an adjustment of 26,592 to the January 1, 2004
beginning balance is necessitated and is reflected in the table below.
2003 2004
------- -------
Beginning balance, January 1, 486,650 546,649
Reporting discrepancy adjustment -- (26,592)
End-users added, excluding acquisitions 15,715 19,905
End-users acquired -- 3,658
End-user losses (20,224) (18,314)
------- -------
Ending Balance, March 31, 482,141 525,306
======= =======
Alarm-Monitoring Retail Services
The annualized attrition rates, based upon customer accounts cancelled or
becoming significantly delinquent, during the first quarter of 2004 are as
follows:
Active RMR at
Portfolio Attrition Rate March 31, 2004
- ---------------------- -------------- --------------
Legacy and flow 17.7% $1,058,453
Residential since IPO 13.5% 1,569,124
Commercial since IPO 9.1% 964,958
----------
Total 13.4% $3,592,535
==========
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.
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 March 31, 2004, we
had $8.1 million of variable rate debt outstanding.
18
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. Based on this evaluation,
our Chief Executive Officer and Chief Financial Officer have concluded that, as
of such date, our disclosure controls and procedures are effective to provide
reasonable assurance that information required to be disclosed by us in reports
that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in applicable SEC rules and
forms.
Changes in Internal Control Over Financial Reporting
There was no change 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 has materially
affected, or is reasonably likely to materially affect, our internal control
over financial reporting except 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.
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.
FICC was also an affiliate of the Company that sold a portfolio of alarm
contracts to the Company. In particular, plaintiff alleges that the Company and
certain of its principals removed valuable revenue-generating assets from FICC
and transferred the FICC contracts to the Company for less than fair value.
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, a verbal agreement was reached and documents are being
drafted requiring the Company to pay $64,000 to settle this matter. The Company
has accrued this amount as of March 31, 2004.
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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 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. All of the shares of common stock were sold by us
and none of the selling security holders' shares were underwritten in the
offering.
Use of Proceeds (through March 31, 2004)
Repayment of debt $ 91,910,820
Acquisition of contracts and businesses 74,274,619
New dealer loans 3,117,133
Working capital 1,013,296
------------
Total Uses $170,315,868
============
Temporary Investments as of March 31, 2004
Cash and cash equivalents $ 25,540,644
------------
Total temporary investments $ 25,540,644
============
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
ITEM 5. OTHER INFORMATION
Not Applicable.
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.*
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* 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
On March 1, 2004, the Company filed a report on Form 8-K/A pursuant to Item 7,
amending its previously filed report on Form 8-K dated December 22, 2003.
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.
May 17, 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
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