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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
------------------
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended June 30, 2002 Commission File Number 0-13617
LIFELINE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-2537528
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
111 Lawrence Street
Framingham, Massachusetts 01702-8156
(Address of principal executive offices) (Zip Code)
(508) 988-1000
(Registrant's telephone number, including area code)
------------------
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common stock $0.02 par value
----------------------------
(Title of Class)
Indicate by check mark whether the registrant (i) 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 (ii) has been subject to such filing
requirements for the past 90 days. Yes X No _____
-----
Number of shares outstanding of the issuer's class of common stock as of
July 31, 2002: 6,460,311
LIFELINE SYSTEMS, INC.
INDEX
PAGE
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets - June 30, 2002
and December 31, 2001 3
Consolidated Statements of Income and Comprehensive Income -
Three and six months ended June 30, 2002 and 2001 4
Consolidated Statements of Cash Flows - Six months
ended June 30, 2002 and 2001 5
Notes to Consolidated Financial Statements 6-12
ITEM 2.
Management's Discussion and Analysis of Results of
Operations and Financial Condition 13-19
ITEM 3.
Quantitative and Qualitative Disclosures about Market Risk 20
PART II. OTHER INFORMATION
ITEM 4.
Submission of Matters to a Vote of Security Holders 21
ITEM 6.
Exhibits and Reports on Form 8-K 21
SIGNATURES 22
-2-
LIFELINE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
June 30, December 31,
2002 2001
---- ----
ASSETS (Unaudited)
Current assets:
Cash and cash equivalents $ 3,355 $ 5,742
Accounts receivable, net 12,129 12,118
Inventories 5,695 4,129
Net investment in sales-type leases 2,473 2,874
Prepaid expenses and other current assets 1,524 1,947
Deferred income taxes 1,490 1,436
-------- --------
Total current assets 26,666 28,246
Property and equipment, net 30,940 30,712
Goodwill 8,202 7,226
Other intangible assets, net 5,714 6,414
Net investment in sales-type leases 4,221 4,337
Other assets 108 67
-------- --------
Total assets $ 75,851 $ 77,002
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,733 $ 1,972
Accrued expenses 3,920 2,197
Accrued payroll and payroll taxes 3,245 4,282
Accrued income taxes 1,662 730
Deferred revenues 940 1,026
Current portion of capital lease obligation 107 1,080
Current portion of long term debt - 1,105
Product warranty and other current liabilities 350 329
Accrued restructuring and other non-recurring charges, current 289 506
-------- --------
Total current liabilities 12,246 13,227
Deferred income taxes 5,790 5,799
Other non-current liabilities 75 150
Long term portion of capital lease obligation 49 1,657
Long term debt, net of current portion - 3,343
Accrued restructuring and other non-recurring charges, long term 362 617
-------- --------
Total liabilities 18,522 24,793
Commitments and contingencies
Stockholders' equity:
Common stock, $0.02 par value, 20,000,000 shares authorized, 7,074,733
shares issued at June 30, 2002 and 6,934,461 shares issued
at December 31, 2001 141 139
Additional paid-in capital 23,575 22,000
Retained earnings 38,800 35,446
Less: Treasury stock at cost, 621,089 shares at June 30, 2002
and December 31, 2001 (4,556) (4,556)
Notes receivable - officer (550) (550)
Accumulated other comprehensive loss/cumulative translation adjustment (81) (270)
-------- --------
Total stockholders' equity 57,329 52,209
-------- --------
Total liabilities and stockholders' equity $ 75,851 $ 77,002
======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
-3-
LIFELINE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(In thousands except for per share data)
(Unaudited)
Three months ended Six months ended
June 30, June 30,
-------------------- --------------------
2002 2001 2002 2001
---- ---- ---- ----
Revenues
Services $ 19,245 $ 16,945 $ 37,638 $ 32,751
Net product sales 6,878 6,834 13,033 12,219
Finance and rental income 338 319 649 692
-------- -------- -------- --------
Total revenues 26,461 24,098 51,320 45,662
-------- -------- -------- --------
Costs and expenses
Cost of services 10,995 10,552 21,612 20,062
Cost of sales 2,327 2,135 4,232 3,993
Selling, general, and administrative 9,644 8,703 18,915 16,554
Research and development 448 384 911 775
-------- -------- -------- --------
Total costs and expenses 23,414 21,774 45,670 41,384
-------- -------- -------- --------
Income from operations 3,047 2,324 5,650 4,278
-------- -------- -------- --------
Other income (expense)
Interest income 26 39 50 96
Interest expense (62) (90) (141) (162)
Other income 45 53 32 10
-------- -------- -------- --------
Total other income (expense), net 9 2 (59) (56)
-------- -------- -------- --------
Income before income taxes 3,056 2,326 5,591 4,222
Provision for income taxes 1,223 958 2,237 1,736
-------- -------- -------- --------
Net income 1,833 1,368 3,354 2,486
Other comprehensive income (loss), net of tax
Foreign currency translation adjustments 113 80 113 (22)
-------- -------- -------- --------
Comprehensive income $ 1,946 $ 1,448 $ 3,467 $ 2,464
======== ======== ======== ========
Net income per weighted average share:
Basic $ 0.29 $ 0.22 $ 0.52 $ 0.41
======== ======== ======== ========
Diluted $ 0.27 $ 0.21 $ 0.50 $ 0.39
======== ======== ======== ========
Weighted average shares:
Basic 6,429 6,144 6,389 6,096
======== ======== ======== ========
Diluted 6,778 6,486 6,737 6,393
======== ======== ======== ========
The accompanying notes are an integral part of these consolidated financial
statements.
-4-
LIFELINE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)
Six months ended
June 30,
--------------------
2002 2001
---- ----
Cash flows from operating activities:
Net income $ 3,354 $ 2,486
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization 4,867 4,382
Deferred income taxes (63) 328
Deferred compensation - 36
Changes in operating assets and liabilities:
Accounts receivable 38 (1,275)
Inventories (1,566) (426)
Net investment in sales-type leases 517 551
Prepaid expenses, other current assets and other assets 384 (923)
Accrued payroll and payroll taxes (1,059) (824)
Accounts payable, accrued expenses and other liabilities 1,301 (835)
Income taxes payable 923 54
Accrued restructuring charge (472) (525)
------- -------
Net cash provided by operating activities 8,224 3,029
------- -------
Cash flows from investing activities:
Additions to property and equipment (3,875) (5,078)
Business purchases and other (1,387) (3,323)
------- -------
Net cash used in investing activities (5,262) (8,401)
------- -------
Cash flows from financing activities:
Principal payments under long term obligations (7,029) (541)
Proceeds from issuance of long term debt - 2,393
Net proceeds under short-term borrowings - 248
Proceeds from issuance of common stock 1,572 1,425
------- -------
Net cash provided by (used in) financing activities (5,457) 3,525
------- -------
Effect of foreign exchange on cash 108 (11)
------- -------
Net decrease in cash and cash equivalents (2,387) (1,858)
Cash and cash equivalents at beginning of period 5,742 4,417
------- -------
Cash and cash equivalents at end of period $ 3,355 $ 2,559
======= =======
Non-cash activity:
Capital leases $ - $ 1,405
Acquisition related obligation - 1,495
Deferred compensation 5 244
The accompanying notes are an integral part of these consolidated financial
statements.
-5-
LIFELINE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. The information furnished has been prepared from the accounts without
audit. In the opinion of the Company, the accompanying consolidated
financial statements contain all adjustments necessary, consisting only of
those of a normal recurring nature, to present fairly its consolidated
financial position as of June 30, 2002 and the consolidated statements of
income and cash flows for the three and six months ended June 30, 2002 and
2001.
While the Company believes that the disclosures presented are adequate to
make the information not misleading, these statements should be read in
conjunction with the consolidated financial statements and the related
notes included in the Company's Annual Report on Form 10-K, as filed with
the Securities and Exchange Commission on March 29, 2002, for the year
ended December 31, 2001.
The results of operations for the six-month period ended June 30, 2002 are
not necessarily indicative of the results expected for the full year.
2. Details of certain balance sheet captions are as follows (in thousands):
June 30, December 31,
2002 2001
---------- ------------
Inventories:
Purchased parts and assemblies $ 1,733 $ 759
Work-in-process 127 42
Finished goods 3,835 3,328
---------- -----------
$ 5,695 $ 4,129
========== ===========
Property and equipment:
Equipment $ 29,652 $ 26,285
Furniture and fixtures 2,951 873
Equipment provided to customers 18,773 16,707
Equipment under capital leases 1,196 5,050
Leasehold improvements 5,861 5,314
Capital in progress 878 925
---------- -----------
59,311 55,154
Less: accumulated depreciation and amortization (28,371) (24,442)
---------- -----------
Total property and equipment, net $ 30,940 $ 30,712
========== ===========
-6-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
3. STOCKHOLDERS' EQUITY
The calculation of per share earnings is as follows:
(In thousands except per share figures)
Three months ended Six months ended
June 30, June 30,
------------------- -------------------
2002 2001 2002 2001
---- ---- ---- ----
Basic:
- -----
Net income $ 1,833 $ 1,368 $ 3,354 $ 2,486
Weighted average common shares outstanding 6,429 6,144 6,389 6,096
Net income per share, basic $ 0.29 $ 0.22 $ 0.52 $ 0.41
======== ======== ======== ========
Diluted:
- --------
Net income for calculating diluted earnings per share $ 1,833 $ 1,368 $ 3,354 $ 2,486
Weighted average common shares outstanding 6,429 6,144 6,389 6,096
Common stock equivalents 349 342 348 297
-------- -------- -------- --------
Total weighted average shares 6,778 6,486 6,737 6,393
Net income per share, diluted $ 0.27 $ 0.21 $ 0.50 $ 0.39
======== ======== ======== ========
For the three months ended June 30, 2002, there were no options excluded from
the computation of diluted net income per share. For the six months ended June
30, 2002, options to purchase 46,200 shares at an average exercise price of
$26.01 were not included in the computation of diluted net income per share as
their effect would have been anti-dilutive. For the three and six months ended
June 30, 2001 options to purchase 207,160 and 284,660 shares, respectively, at
an average exercise price of $21.35 and $20.17, respectively, have not been
included in the computation of diluted net income per share as their effect
would have been anti-dilutive.
4. SEGMENT INFORMATION
The Company is active in one business segment: designing, marketing, monitoring
and supporting its personal response units. The Company maintains sales,
marketing and monitoring operations in both the United States and Canada.
-7-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
4. SEGMENT INFORMATION (continued)
Geographic Segment Data
Net revenues from customers are based on the location of the customer.
Geographic information related to the results of operations for the periods
ended June 30, 2002 and 2001 and the financial position as of June 30, 2002 and
December 31, 2001 is presented as follows:
(In thousands)
Three months ended Six months ended
June 30, June 30,
-----------------------------------------------------
2002 2001 2002 2001
---- ---- ---- ----
Net Sales:
United States $ 24,317 $ 22,231 $ 47,268 $ 42,047
Canada 2,144 1,867 4,052 3,615
-----------------------------------------------------
$ 26,461 $ 24,098 $ 51,320 $ 45,662
=====================================================
Net Income:
United States $ 1,615 $ 1,192 $ 2,970 $ 2,174
Canada 218 176 384 312
-----------------------------------------------------
$ 1,833 $ 1,368 $ 3,354 $ 2,486
=====================================================
June 30, December 31,
2002 2001
--------------------------
Total Assets:
United States $ 68,761 $ 69,495
Canada 7,090 7,507
--------------------------
$ 75,851 $ 77,002
==========================
5. RESTRUCTURING AND NON RECURRING CHARGES
In September 2000, the Company recorded a pre-tax non-recurring charge of
approximately $2.7 million for costs it expected to incur to address erroneous
low-battery signals in some of its personal help buttons. Included in the
non-recurring charge were anticipated material and mailing costs for exchanging
buttons, providing hospital programs with higher inventory levels for the
planned swap, and the cost of installer visits to subscriber homes to replace
the buttons.
At June 30, 2002, accrued restructuring and other non-recurring charges of
approximately $651,000 represented the remaining unutilized costs associated
with the anticipated cost of addressing erroneous low-battery signals in
personal help buttons.
-8-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
5. RESTRUCTURING AND NON RECURRING CHARGES (continued)
The following is a roll-forward of accrued restructuring and non-recurring
charges for the six months ended June 30, 2002:
(In thousands)
Balance at December 31, 2001 $1,123
Less: Amounts utilized (472)
----------
Balance at June 30, 2002 $ 651
==========
6. LONG TERM DEBT
The Company has a $10.0 million line of credit agreement, which was to have
expired on June 30, 2002. The Company has received an extension on this
agreement until August 30, 2002. As of June 30, 2002 the Company did not have
any debt outstanding under this line. The agreement contains several covenants,
including the Company maintaining certain levels of financial performance and
capital structure. These financial covenants include a requirement for a current
ratio of at least 1.5 to 1.0 and a leverage ratio of no more than 1.0 to 1.0. In
addition, there are certain negative covenants that include limitations on the
Company's capital and other expenditures, restrictions on the Company's capacity
to obtain additional debt financing, restrictions on the disposition of the
Company's assets, and restrictions on its investment portfolio. The Company and
the lender under the existing line of credit are finalizing a renegotiated line
of credit, which is expected to be in the amount of $15 million. The final
agreement is anticipated to be signed on or before August 30, 2002.
7. GOODWILL AND INTANGIBLE ASSETS
During the first six months of 2002, the Company recorded intangible assets
related to provider agreements entered into with community hospitals
("customer") for conversion to services provided by the Company. The intangible
assets related to these agreements consist of the cost of purchasing the rights
to service and/or manage the personal response systems program located in
various stand-alone facilities. These agreements allow the Company to provide
monitoring and/or business support services to existing and future subscribers
of the customer in accordance with the terms of the agreements. The Company
amortizes the acquisition costs over the initial life of the agreements, which
is typically five years.
-9-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
7. GOODWILL AND INTANGIBLE ASSETS (continued)
In May 2002, the Company paid in cash approximately $1.0 million for the
acquisition of a distributor of the Company's personal response products and
services. The results of the acquired business have been included in the
Company's consolidated financial statements from the date of acquisition, and it
did not have a material effect on its results of operations for the three and
six months ended June 30, 2002. The Company anticipates finalizing the purchase
accounting associated with this acquisition during the third quarter and does
not anticipate any material changes to the current allocation, of which the
majority was recorded in goodwill.
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets", which was effective January 1, 2002. SFAS 142 requires, among other
things, the discontinuance of goodwill amortization. In addition, the standard
includes provisions for the reclassification of certain existing recognized
intangibles as goodwill, reassessment of the useful lives of existing recognized
intangibles, reclassification of certain intangibles out of previously reported
goodwill and the identification of reporting units for purposes of assessing
potential future impairments of goodwill. SFAS 142 also required the Company to
complete a transitional goodwill impairment test within six months from the date
of adoption. The Company adopted SFAS 142 in January 2002, and accordingly
ceased amortizing goodwill with a net carrying value totaling approximately $7.2
million as of the date of adoption. The Company did not record approximately
$437,000 of goodwill amortization expense for the first six months of 2002. The
Company believes that the adoption of SFAS 142 will result in an additional 1%
improvement to service margins in 2002 as a result of the exclusion of nearly
$907,000 of goodwill amortization expense.
The Company performed a transitional impairment test as required by SFAS 142 and
determined that there were no goodwill or intangible asset impairment losses
that should be recognized. The Company also determined that no reclassifications
between goodwill and intangible assets were required. Information pertaining to
intangible assets and goodwill and the effects of adopting SFAS 142 are
presented below.
Intangible Assets
At June 30, 2002 and December 31, 2001, acquired intangible assets were related
to provider agreements entered into with customers for conversion to services
provided by the Company:
(Dollars in thousands)
June 30, December 31,
2002 2001
---- ----
Gross carrying amount $10,908 $10,566
Less: accumulated amortization (5,194) (4,152)
-------------------------
Net book value $ 5,714 $ 6,414
=========================
-10-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
7. GOODWILL AND INTANGIBLE ASSETS (continued)
All of the Company's acquired intangible assets are subject to amortization.
Amortization expense for acquired intangible assets for the six months ended
June 30, 2002 and 2001 was approximately $1,033,000 and $1,018,000 respectively.
Based on the Company's intangible assets currently owned, estimated amortization
expense for the current fiscal year and the succeeding four years is as follows:
Fiscal Year Ended
December 31, Amount
------------- ------
2002 $2,068
2003 2,018
2004 1,650
2005 727
2006 205
Goodwill
The following information reflects pro forma adjustments to exclude goodwill
amortization expense and related tax effects:
For the three months ended For the six months ended
(Dollars in thousands, except per share data) June 30, June 30,
----------------------------------------------------------
2002 2001 2002 2001
---- ---- ---- ----
Net income:
Reported net income $1,833 $1,368 $3,354 $2,486
Add back: goodwill amortization, net of taxes -- 85 -- 207
----------------------------------------------------------
Adjusted net income $1,833 $1,453 $3,354 $2,693
==========================================================
Basic earnings per share:
Weighted average common shares outstanding 6,429 6,144 6,389 6,096
Reported net income $ 0.29 $ 0.22 $ 0.52 $ 0.41
Add back: goodwill amortization, net of taxes -- 0.01 -- 0.03
----------------------------------------------------------
Adjusted net income $ 0.29 $ 0.23 $ 0.52 $ 0.44
==========================================================
Diluted earnings per share:
Total weighted average shares 6,778 6,486 6,737 6,393
Reported net income $ 0.27 $ 0.21 $ 0.50 $ 0.39
Add back: goodwill amortization, net of taxes -- 0.01 -- 0.03
----------------------------------------------------------
Adjusted net income $ 0.27 $ 0.22 $ 0.50 $ 0.42
==========================================================
-11-
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)
8. NEWLY ISSUED ACCOUNTING STANDARDS
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS 144 supercedes FASB Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long Lived Assets to
Be Disposed Of." SFAS 144 applies to all long-lived assets (including
discontinued operations) and consequently amends Accounting Principles Board
Opinion No. 30, "Reporting Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business." SFAS 144 is effective for financial
statements issued for fiscal years beginning after December 15, 2001. The
Company adopted SFAS 144 in January 2002 and it did not have a significant
effect on its financial statements.
9. CONTINGENT LIABILITIES AND COMMITMENTS
The Company is currently being audited by Revenue Canada asserting deficiencies
in goods and services tax and sales tax for the Company's 1993 to 1999 tax
years. On March 26, 2002, the Company received a proposed tax assessment, (which
includes penalties and interest), of CAN$1,050,000 (approximately US$690,000
based on current exchange rates at June 30, 2002). The Company believes that it
should be able to reduce the amount of the proposed tax deficiency following
further discussions with and by providing additional documentation to Revenue
Canada. However, there is no assurance that the Company will be successful in
its discussions. The Company does not believe that the payment of any such
deficiency will have a material adverse effect on the Company's financial
position or results of operations or cash flows.
10. SUBSEQUENT EVENT
In August 1999, the Company loaned $300,000 to its Chief Executive Officer,
pursuant to a secured promissory note, for the exercise of a stock option which
was to expire. The note, which bears interest at a rate of 6.77% per annum,
payable annually in arrears, was due August 23, 2004 and was secured by a pledge
of 16,552 shares of common stock of the Company. In April 2000, the Company
loaned $250,000 to its Chief Executive Officer, pursuant to a collateralized
promissory note. The note, which bears interest at a rate of 6.94%, payable
annually in arrears, was due April 5, 2005 and was collateralized by 25,641
shares of common stock of the Company. On July 15, 2002, the Company's Chief
Executive Officer repaid both notes in full.
-12-
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
This and other reports, proxy statements, and other communications to
stockholders, as well as oral statements by the Company's officers or its
agents, may contain forward-looking statements within the meaning of Section 21E
of the Securities Exchange Act of 1934, as amended, with respect to, among other
things, the Company's future revenues, operating income, or earnings per share.
Without limiting the foregoing, the words "believes," "anticipates," "plans,"
"expects," and similar expressions are intended to identify forward-looking
statements. There are a number of factors of which the Company is aware that may
cause the Company's actual results to vary materially from those forecast or
projected in any such forward-looking statement. These factors include, without
limitation, those set forth below under the caption "Certain Factors That May
Affect Future Results." The Company's failure to successfully address any of
these factors could have a material adverse effect on the Company's future
results of operations.
RESULTS OF OPERATIONS
Total revenues for the quarter ended June 30, 2002 increased approximately 10%
to $26.5 million as compared to total revenues of $24.1 million for the quarter
ended June 30, 2001. For the six months ended June 30, 2002, total revenues were
$51.3 million, 12% greater than total revenues of $45.7 million for the same
period in 2001.
Service revenues grew 14% for the three months ended June 30, 2002 to $19.2
million from $16.9 million for the same period in 2001. For the six months ended
June 30, 2002, services revenues were $37.6 million, an increase of 15% from
$32.8 million for the first half of 2001. Service revenues represent nearly 73%
of the Company's year to date total revenues as compared to 72% of total
revenues for the first six months of 2001. This growth is a result of the
Company's continued success with its service offerings and effective yields on
its pricing strategies and also reflects the positive impact from the inclusion
of a full period of revenue from the assets of SOS Industries, Inc., which the
Company acquired in April 2001 and which represented 20% of the year-to-date
growth in service revenues. Overall, the Company achieved a 7% increase in its
monitored subscriber base to 356,000 subscribers as of June 30, 2002 from
332,000 as of June 30, 2001. The Company's ability to sustain the current level
of service revenue growth depends on its ability to continue to make
improvements in service delivery, expand the market for its personal response
services, convert community hospital programs to services provided by the
Company and increase its focus on referral development and innovative partner
relationships in new channels of distribution. The Company believes that the
high quality of its services and its commitment to providing caring and rapid
response to the at-risk elderly and the physically challenged will be factors in
meeting this goal.
Net product revenues for the second quarter of 2002 remained consistent with the
second quarter of 2001 at $6.8 million. For the six months ended June 30, 2002,
net product revenues were $13.0 million, an increase of nearly 7% from $12.2
million for the same period in 2001. The majority of the increase for the first
six months was the result of sales of the Company's site-monitoring platform,
which was introduced in the second quarter of 2001, for those customers who
perform their own monitoring at their local facilities. However, with a finite
number of these types of customers, the Company believes that equipment sales
for the year ended December 31, 2002 may be consistent with or lower than 2001.
It also continues to believe that equipment sales may remain flat or decline in
periods subsequent to 2002 as it has experienced little or no growth in sales of
its home
-13-
communicators since it began providing its customers' subscribers with the
Lifeline service under its Business Management Services ("BMS") program, which
includes monitoring and the use of Company-owned home communicators for a single
fee. During 2002, the Company launched its new Senior Living initiative, under
which it will seek to develop alliances with senior living facilities to provide
them with a cost-effective and distinctive safety feature to appeal to residents
and their families. Because of this initiative, the Company believes that sales
of residence response systems to these facilities may mitigate the decline in
product revenue in periods subsequent to 2002.
Finance and rental income, representing revenue earned from the Company's
portfolio of sales-type leases, increased approximately 6% in the second quarter
of 2002 to $338,000, from $319,000 for the second quarter of 2001. For the six
months ended June 30, 2002, however, finance and rental income decreased
approximately 6% to $649,000 from $692,000 for the same period in 2001. With the
Company's focus on its service offerings it expects finance income to decline in
future periods because such income is directly related to product sales.
Total recurring revenues, consisting of service revenues and finance and rental
income, increased 13% for the three months ended June 30, 2002 to $19.6 million
from $17.3 million for the same period in 2001. For the six months ended June
30, 2002, total recurring revenues increased 14% to $38.3 million from $33.4
million for the first half of 2001. Recurring revenues represented 74% and 75%
of total revenue for the three and six months ended June 30, 2002, respectively,
as compared to 72% and 73% for the respective three and six month periods in
2001. With the Company's continued focus on its service offerings, it expects
its recurring revenues to continue to increase in future periods.
Cost of services, as a percentage of service revenues, improved to 57% for the
three and six months ended June 30, 2002 as compared to 62% and 61%,
respectively for the three and six months ended June 30, 2001. The improvement
is mainly attributable to the Company's goal of making its service offerings
more profitable with productivity improvements, leveraging the capabilities of
the CareSystem monitoring platform and effective pricing. On a dollar basis,
cost of services increased by approximately $1.5 million for the six months
ended June 30, 2002 as compared to the first six months of 2001 as a result of
the following factors. The growth in the number of subscribers serviced under
the Company's BMS program resulted in an increase in depreciation of the cost of
home communicators provided to those subscribers served under this model. This
growth in the number of subscribers also resulted in an increase in costs
associated with handling the day-to-day administrative tasks, such as customer
service, billing and service order intake, for the Lifeline service under this
particular model. The acquisition of SOS Industries, Inc. in the second quarter
of 2001 resulted in two months of operational costs for the first six months of
2001 as compared to a full six months of operational costs for the period ended
June 30, 2002, and thereby also contributed to some of the increase in the costs
noted above.
The Company adopted SFAS 142 in January 2002, which requires, among other
things, the discontinuance of goodwill amortization. The Company did not record
approximately $227,000 and $437,000 of goodwill amortization expense for the
three and six-month periods ended June 30, 2002. The Company believes that the
adoption of SFAS 142 will result in an additional 1% improvement to service
margins in 2002 as a result of the exclusion of nearly $907,000 of goodwill
amortization expense. The Company expects continued positive service margin
improvements for the remainder of 2002.
-14-
Cost of sales, as a percentage of net product sales, was 34% for the three
months ended June 30, 2002 as compared to 31% for the three months ended June
30, 2001. For the six months ended June 30, 2002, cost of sales, as a percentage
of net product sales, improved to 32% as compared to 33% for the same period in
2001. The Company experienced increased manufacturing costs during 2002 as it
has been transitioning from outsourcing its manufacturing to an outside
electronics product manufacturer to in house assembly and production. The
Company expects these higher costs to be non-recurring and without these
anticipates cost of sales for 2002 to be relatively consistent as a percentage
of net product sales with results achieved in 2001.
Selling, general and administrative ("SG&A") expenses as a percentage of total
revenues were 36% for the second quarter of 2002 and 2001. For the six months
ended June 30, 2002 SG&A expenses were 37% of total revenues as compared to 36%
for the same period in 2001. On a dollar basis, SG&A expenditures increased $2.4
million to $18.9 million for the six months ended June 30, 2002 from $16.5
million for the same period in 2001. The Company's increased expenditures are
attributable to a variety of factors. The Company is incurring costs associated
with its new senior living initiative launched in the beginning of 2002. The
Company also incurred expenditures in the first half of 2002 which were higher
than the first half of 2001, related to its commitment to install its
site-monitoring platform for those customers who perform their own monitoring at
their local facilities. As a result of overall insurance industry increases, the
Company is also incurring higher insurance premiums and deductibles. The Company
is also experiencing a higher level of business and marketing initiatives in the
first half of 2002, coupled with information technology costs associated with
those initiatives, as compared to the first six months of 2001. The Company
believes that SG&A expenses could increase as a percentage of revenue in 2002 as
it continues with its business initiatives and incurs higher insurance premiums
and deductibles.
Research and development expenses were nearly 2% of total revenues for the three
and six months ended June 30, 2002 and 2001. Research and development efforts
are focused on ongoing product improvements and developments. The Company
expects to maintain these expenses, as a percentage of total revenues, at a
relatively consistent level for the remainder of 2002.
The Company's effective tax rate was 40% for the three and six months ended June
30, 2002 as compared to 41% for the same period in 2001. The reduction in the
effective tax rate is due to the benefit of a previously disclosed tax credit
earned under a Tax Increment Finance agreement with the town of Framingham,
Massachusetts.
LIQUIDITY AND CAPITAL RESOURCES
During the six months ended June 30, 2002, the Company's portfolio of cash and
cash equivalents decreased nearly $2.4 million to $3.3 million at June 30, 2002
from $5.7 million at December 31, 2001. The majority of the decrease was
attributable to the Company taking advantage of its overall improvement in cash
flow to pay off nearly $7.0 million in debt and outstanding capital lease
obligations. The Company also purchased property and equipment of $3.9 million
and had a net inventory increase of nearly $1.6 million as it fulfilled its
obligation to purchase certain amounts of inventory in accordance with the
termination provisions of its contract with an outside electronics product
manufacturer as well as for support of its manufacturing site at its corporate
location to minimize the risk of supply interruption as it completes the
transition from outsourced manufacturing to internal manufacturing. Profitable
operations of $8.2 million, proceeds from stock option exercises of $1.6 million
and an increase in its accounts payable and accrued expenses of $1.3
-15-
million, primarily as a result of the timing of expenditures related to its
business and marketing initiatives helped to offset the decrease.
As noted above, as of June 30, 2002, the Company paid off substantially all of
its capital lease obligations associated with Master Lease Agreements. The
Company is currently seeking to enter into new Master Lease Agreements for
potential future capital purchases, but expects to have sufficient operating
cash flow in the near term for its budgeted capital purchases without the
proceeds of a new leasing facility.
The Company has a $10.0 million line of credit agreement, which was to have
expired on June 30, 2002. The Company has received an extension on this
agreement until August 30, 2002. As of June 30, 2002 the Company did not have
any debt outstanding under this line. The agreement contains several covenants,
including the Company maintaining certain levels of financial performance and
capital structure. These financial covenants include a requirement for a current
ratio of at least 1.5 to 1.0 and a leverage ratio of no more than 1.0 to 1.0. In
addition, there are certain negative covenants that include limitations on the
Company's capital and other expenditures, restrictions on the Company's capacity
to obtain additional debt financing, restrictions on the disposition of the
Company's assets, and restrictions on its investment portfolio. The Company and
the lender under the existing line of credit are finalizing a renegotiated line
of credit which is expected to be in the amount of $15 million. The final
agreement is anticipated to be signed on or before August 30, 2002.
The following summarizes the Company's existing contractual obligations at June
30, 2002 and the effect such obligations are expected to have on its liquidity
and cash flows in future periods:
(Dollars in thousands)
2002 2003 2004 2005 2006 Thereafter (1)
---- ---- ---- ---- ---- --------------
Contractual
Obligations (2):
Capital leases $ 157 $ 100 $ 6 - - -
Operating leases 1,283 1,378 1,514 $1,462 $1,367 $9,166
----------------------------------------------------------------------------------------
Total Obligations $1,440 $1,478 $1,520 $1,462 $1,367 $9,166
========================================================================================
(1) Represents contractual obligations on the Company's corporate
facility lease through the year 2013 and its second U.S. call
center through 2012.
(2) The table does not include the existing line of credit, with respect
to which no amounts were outstanding at June 30, 2002, or the new
line of credit, for up to $15 million, which the Company is
negotiating.
The Company expects that funding requirements for operations and in support of
future growth are expected to be met primarily from operating cash flow,
existing cash and marketable securities and the availability from time to time
under its extended line of credit and new line of credit, once finalized. The
Company expects these sources will be sufficient to finance the cash needs of
the Company through the next twelve months. This includes the continued
investment in its response center platform, the requirements of its internally
funded lease financing program, any future potential acquisitions and other
investments in support of its current business.
-16-
CRITICAL ACCOUNTING POLICIES
The discussion and analysis of financial condition and results of operations are
based upon the Company's consolidated financial statements. The preparation of
these consolidated financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates. The Company
has identified the following accounting policies as critical to understanding
the preparation of its consolidated financial statements and results of
operations.
Revenue recognition
Service revenues, associated primarily with providing monitoring services under
the Company's Lifeline Monitoring Services ("LMS") and Business Management
Services ("BMS") programs, are recognized in the period the service is provided.
Deferred revenue represents billings to customers for annual service contracts
for which revenue has not been recognized because the service has not yet been
provided. Service revenues are then recognized ratably over the contractual
period. Product revenues from the sale of personal response products are
recognized upon shipment. While the Company does not have a specific right of
return policy, it does record a provision for an estimated amount of future
returns based on historical experience and any notification received of an error
in type of product shipped. Such returns have historically been immaterial to
the Company's total product revenue, and the Company does not foresee any change
that could have a material adverse effect on the Company's operating results for
the period or periods in which such returns materialize. Finance income
attributable to sales-type lease contracts is initially recorded as unearned
income and subsequently recognized under the interest method over the term of
the leases.
Allowance for doubtful accounts
The Company maintains an allowance for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. It
estimates the allowance based upon historical collection experience, analysis of
accounts receivable by aging categories and customer credit quality. If the
financial condition of the Company's customers were to deteriorate, resulting in
an impairment of their ability to make payments, additional allowances may be
required.
Impairment of long-lived assets, goodwill and other intangibles
The Company assesses the impairment of goodwill and other intangibles on an
annual basis or, along with long-lived assets, whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. It uses
an estimate of the future undiscounted net cash flows of the related asset or
asset grouping over the remaining life in measuring whether assets are
recoverable. Based on the Company's expectation of future undiscounted net cash
flows, an impairment loss would be recorded by writing down the assets to their
estimated realizable values. Any resulting impairment loss could have a material
adverse effect on the Company's results of operations.
Inventories
The Company values its inventories at the lower of cost or market, as determined
by the first-in, first-out method. It regularly reviews inventory quantities on
hand and records a provision for excess or obsolete inventory based upon its
estimated forecast of product demand. If actual future demand is less than the
projections made by management, then additional provisions may be required.
-17-
Warranty
The Company's products are generally under warranty against defects in material
and workmanship. The Company provides an accrual for estimated warranty costs at
the time of sale of the related products based upon historical return rates and
repair costs at the time of the sale. A significant increase in product return
rates could have a material adverse effect on the Company's results of
operations.
NEWLY ISSUED ACCOUNTING STANDARDS
In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets", which was effective January 1, 2002. SFAS 142 requires, among other
things, the discontinuance of goodwill amortization. In addition, the standard
includes provisions for the reclassification of certain existing recognized
intangibles as goodwill, reassessment of the useful lives of existing recognized
intangibles, reclassification of certain intangibles out of previously reported
goodwill and the identification of reporting units for purposes of assessing
potential future impairments of goodwill. SFAS 142 also requires the Company to
complete a transitional goodwill impairment test within six months from the date
of adoption. The Company adopted SFAS 142 in January 2002, and as a result did
not record approximately $437,000 of goodwill amortization expense for the first
six months of 2002. The Company believes that the adoption of SFAS 142 will
result in an additional 1% improvement to service margins in 2002 as a result of
the exclusion of nearly $907,000 of goodwill amortization expense. The Company
performed a transitional impairment test as required by SFAS 142 and determined
that there were no goodwill or intangible asset impairment losses that should be
recognized. The Company also determined that no reclassifications between
goodwill and intangible assets were required.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS 144 supercedes FASB Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long Lived Assets to
Be Disposed Of." SFAS 144 applies to all long-lived assets (including
discontinued operations) and consequently amends Accounting Principles Board
Opinion No. 30, "Reporting Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business." SFAS 144 is effective for financial
statements issued for fiscal years beginning after December 15, 2001. The
Company adopted SFAS 144 in January 2002 and it did not have a significant
impact on its financial statements.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
The following important factors, among others, could cause actual results to
differ materially from those indicated by forward-looking statements made in
this Quarterly Report on Form 10-Q and presented elsewhere by management from
time to time.
The Company recorded a non-recurring charge of approximately $2.7 million in the
third quarter of 2000 for costs it expected to incur to address a previously
disclosed battery-related issue, including anticipated material and mailing
costs for exchanging buttons, providing hospital programs with higher inventory
levels for the planned swap, and support for the cost of installer visits to
subscriber homes to replace the button. The Company cannot be certain that the
charge it recorded to address this issue will be sufficient to cover all of its
associated expenses. In addition, the Company has changed its battery vendor.
The Company cannot be certain that it will not experience disruption related to
such change.
In 2002 the Company has transitioned to once again supporting a manufacturing
site at its corporate location to assemble its personal response equipment. In
connection with this, the Company ended its outsourcing arrangement with an
outside electronics product manufacturer. The Company has not
-18-
supported a manufacturing site for the past two years and as a result there can
be no assurance that the transition from outsourced manufacturing to internal
manufacturing for its personal response equipment will not have a negative
adverse effect on its results of operations or that the Company will not
experience difficulties in successfully transitioning the assembly process of
its personal response equipment to its corporate location. There also can be no
assurance that the decision to assemble its equipment will result in the
anticipated cost containment or that the Company will maintain cost of sales at
a relatively consistent percentage of product sales in 2002. This could have a
material adverse effect on the Company's business, financial condition, or
results of operations.
The Company's results are partially dependent on its ability to develop services
and products that keep pace with continuing technological changes, evolving
industry standards, changing subscriber preferences and new service and product
introductions by the Company's competitors. There can be no assurance that
services, products or technologies developed by others will not render
Lifeline's services or products noncompetitive or obsolete.
The Company's revenue growth is partially dependent on its ability to increase
the number of subscribers served by its monitoring centers by an amount which
exceeds the number of subscribers lost. The Company's ability to continue to
increase service revenue is a key factor in its long-term growth, and there can
be no assurance that the Company will be able to do so. The Company's failure to
increase service revenue could have a material adverse effect on the Company's
business, financial condition, or results of operations.
The Company's monitoring operations are concentrated principally in its
corporate headquarters facility. Although the Company believes that it has
constructed safeguards to protect against system failures, the disruption of
service at its monitoring facility, whether due to telephone or electrical
failures, earthquakes, fire, weather or other similar events or for any other
reason, could have a material adverse effect on the Company's business,
financial condition, or results of operations. In order to mitigate any
potential negative effect of a disruption of service, the Company recently
signed a lease for a second U.S. call center. The Company expects to occupy the
new facility in early 2003. There can be no assurance, however, that the Company
will meet the intended date of occupation, that costs incurred in connection
with the start-up of the new facility will not have a material adverse effect on
the Company's business, financial condition or results of operations, or that
the second call center, which is located within one mile of the Company's
headquarters, will not be affected by the same disruption that affects the
corporate headquarters facility.
The Company believes that its future success will depend in large part upon its
ability to attract and retain key personnel. Although the Company believes it is
making progress in retaining and recruiting well-trained, highly capable people,
there can be no assurance that the Company will continue to be successful in
attracting and retaining such personnel.
The Company may expand its operations through the acquisition of additional
businesses, similar to its recent acquisition in May 2002. There can be no
assurance that the Company will be able to identify, acquire or profitably
manage additional businesses or successfully integrate any acquired businesses
into the Company without substantial expenses, delays or other operational or
financial problems. In addition, acquisitions may involve a number of special
risks, including diversion of management's attention, failure to retain key
acquired personnel, unanticipated events, contingent liabilities and
amortization of acquired intangible assets. There can be no assurance that the
acquired businesses, if any, will achieve anticipated revenues or earnings.
-19-
ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company has considered the provisions of Financial Reporting Release No. 48
"Disclosure of Accounting Policies for Derivative Financial Instruments and
Derivative Commodity Instruments, and Disclosure of Quantitative and Qualitative
Information about Market Risk Inherent in Derivative Financial Instruments,
Other Financial Instruments and Derivative Commodity Instruments." The Company
had no holdings of derivative financial or commodity-based instruments or other
market risk sensitive instruments entered into for trading purposes at June 30,
2002. As described in the following paragraphs, the Company believes that it
currently has no material exposure to interest rate and foreign currency
exchange rate risks in its instruments entered into for other than trading
purposes.
Interest rates
The Company's balance sheet periodically includes an outstanding balance
associated with a revolving credit facility and a term loan that are subject to
interest rate risk. Both loans are typically priced at floating rates of
interest, with the working capital line of credit being based on LIBOR and the
fixed loan being based on the bank's prime interest rate at the Company's
option. As a result of these factors, at any given time, a change in interest
rates could result in either an increase or decrease in the Company's interest
expense. As of June 30, 2002, the Company did not have any outstanding balances
associated with either facility and therefore its consolidated financial
position, results of operations or cash flows would not be affected by near-term
changes in interest rates.
Foreign currency exchange rates
The Company's earnings are affected by fluctuations in the value of the U.S.
Dollar as compared to the Canadian Dollar, as a result of the sale of its
products and services in Canada and translation adjustments associated with the
conversion of the Company's Canadian subsidiary into the reporting currency
(U.S. Dollar). As such, the Company's exposure to changes in Canadian exchange
rates could impact the Company's consolidated financial position, results of
operations or cash flows. The Company performed a sensitivity analysis as of
June 30, 2002 to assess the potential effect of a 10% increase or decrease in
Canadian foreign exchange rates and concluded that short-term changes in
Canadian exchange rates should not materially affect the Company's consolidated
financial position, results of operations or cash flows. The Company's
sensitivity analysis of the effects of changes in foreign currency exchange
rates in such magnitude did not factor in a potential change in sales levels or
local prices for its services/products.
-20-
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The Annual Meeting of Stockholders of the Company was held on May 15, 2002. The
stockholders of the Company elected members of the Board of Directors and
ratified the selection of PricewaterhouseCoopers LLP as the Company's
accountants for 2002.
NUMBER OF SHARES OF COMMON STOCK
--------------------------------
BROKER
FOR AGAINST ABSTAINED NON-VOTES
--- ------- --------- ----------
Everett N. Baldwin 6,007,835 - - 58,651
L. Dennis Shapiro 6,007,835 - - 58,651
Ratification of appointment of
PricewaterhouseCoopers LLP 6,055,838 9,826 822 -
The directors whose terms in office continued after the meeting were Ronald
Feinstein, Joseph E. Kasputys, Carolyn C. Roberts and Gordon C. Vineyard.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Reports on Form 8-K - The Company filed a report on Form 8-K on July 12,
2002.
(b) Exhibits - The Exhibits which are filed with this Report or which are
incorporated herein by reference are set forth in the Exhibit Index
which appears on page 23 hereof
-21-
LIFELINE SYSTEMS, INC.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
August 12, 2002 LIFELINE SYSTEMS, INC.
- ------------------ ----------------------
Date Registrant
/s/ Ronald Feinstein
----------------------
Ronald Feinstein
Chief Executive Officer
/s/ Dennis M. Hurley
----------------------
Dennis M. Hurley
Senior Vice President of Finance and
Administration, Principal Financial
and Accounting Officer
-22-
EXHIBIT INDEX
The following designated exhibits are, as indicated below, either filed herewith
or have heretofore been filed with the Securities and Exchange Commission under
the Securities Act of 1933 or the Securities and Exchange Act of 1934 and are
referred to and incorporated herein by reference to such filings.
Exhibit No. Exhibit SEC Document Reference
- ----------- ------- ----------------------
3.1 Amended and Restated By-laws
4.1 Amendment No. 2 to Shareholder Rights
Plan dated as of June 30, 2002 8-K dated July 12, 2002
10.01 Agreement, dated as of June 30, 2002, among the
Registrant and (a) ValueAct Capital Partners, L.P.,
(b) ValueAct Capital Partners II, L.P.,
(c) ValueAct Capital International, Ltd.,
(d) VA Partners, L.L. C., (e) Jeffrey W. Uben,
(f) George F. Hammel, Jr. and (g) Peter H. Kamin 8-K dated July 12, 2002
10.02 Second Amendment to Revolving
Credit Agreement dated June 28, 2002
10.03 Third Amendment to Revolving Credit
Agreement dated July 23, 2002
10.04 Lease Agreement between Registrant and Clarks
Hill, LLC dated June 21, 2002
99.1 Certification of CEO and CFO
-23-