SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended December 31, 2002
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 number 0-22056
RURAL/METRO CORPORATION
(Exact name of Registrant as specified in its charter)
DELAWARE 86-0746929
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
8401 EAST INDIAN SCHOOL ROAD
SCOTTSDALE, ARIZONA
85251
(Address of principal executive offices)
(Zip Code)
(480) 606-3886
(Registrant's telephone number, including area code)
Indicate by check mark whether the Registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that 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]
At February 11, 2003, there were 16,270,399 shares of Common Stock outstanding,
exclusive of treasury shares held by the Registrant.
RURAL/METRO CORPORATION
INDEX TO QUARTERLY REPORT
ON FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED
DECEMBER 31, 2002
Page
----
Part I. Financial Information
Item 1. Financial Statements:
Consolidated Balance Sheet 3
Consolidated Statement of Operations and Comprehensive
Income (Loss) 4
Consolidated Statement of Cash Flows 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 32
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Conditions 52
Item 4. Controls and Procedures 52
Part II. Other Information
Item 1. Legal Proceedings 52
Item 6. Exhibits and Reports on Form 8-K 54
Signatures 55
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
RURAL/METRO CORPORATION
CONSOLIDATED BALANCE SHEET
DECEMBER 31, 2002 AND JUNE 30, 2002
(IN THOUSANDS)
DECEMBER 31, JUNE 30,
2002 2002
--------- ---------
(UNAUDITED)
ASSETS
CURRENT ASSETS
Cash ............................................... $ 8,963 $ 9,828
Accounts receivable, net ........................... 95,777 99,115
Inventories ........................................ 12,074 12,220
Prepaid expenses and other ......................... 8,708 9,015
--------- ---------
Total current assets ..................... 125,522 130,178
PROPERTY AND EQUIPMENT, net ........................ 45,873 48,532
GOODWILL ........................................... 41,167 41,244
OTHER ASSETS ....................................... 23,359 17,484
--------- ---------
$ 235,921 $ 237,438
========= =========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND
STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Accounts payable ................................... $ 8,830 $ 11,961
Accrued liabilities ................................ 57,870 73,719
Deferred subscription fees ......................... 15,234 15,409
Current portion of long-term debt .................. 1,406 1,633
--------- ---------
Total current liabilities ................ 83,340 102,722
LONG-TERM DEBT, net of current portion ............. 306,040 298,529
OTHER LIABILITIES .................................. 339 477
DEFERRED INCOME TAXES .............................. 650 650
--------- ---------
Total liabilities ........................ 390,369 402,378
--------- ---------
COMMITMENTS AND CONTINGENCIES
MINORITY INTEREST .................................. 379 379
--------- ---------
REDEEMABLE PREFERRED STOCK ......................... 5,390 --
--------- ---------
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock ....................................... 164 159
Additional paid-in capital ......................... 138,791 138,470
Accumulated deficit ................................ (297,933) (313,025)
Accumulated other comprehensive income (loss) ...... -- 10,316
Treasury stock ..................................... (1,239) (1,239)
--------- ---------
Total stockholders' equity (deficit) ..... (160,217) (165,319)
--------- ---------
$ 235,921 $ 237,438
========= =========
See accompanying notes
3
RURAL/METRO CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2002 AND 2001
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
---------------------- ----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
NET REVENUE ................................................... $ 123,464 $ 114,333 $ 249,029 $ 230,807
--------- --------- --------- ---------
OPERATING EXPENSES
Payroll and employee benefits ............................... 70,233 65,905 141,345 134,226
Provision for doubtful accounts ............................. 19,017 16,633 37,742 33,371
Depreciation and amortization ............................... 3,309 3,911 6,749 7,942
Other operating expenses .................................... 23,211 22,358 45,745 43,888
--------- --------- --------- ---------
Total operating expenses .............................. 115,770 108,807 231,581 219,427
--------- --------- --------- ---------
OPERATING INCOME .............................................. 7,694 5,526 17,448 11,380
Interest expense, net ......................................... (7,491) (5,651) (13,377) (12,475)
Other income (expense), net ................................... -- 9 -- 9
--------- --------- --------- ---------
INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME
TAXES, AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE ................................................... 203 (116) 4,071 (1,086)
INCOME TAX (PROVISION) BENEFIT ................................ (55) 1,625 (110) 1,605
--------- --------- --------- ---------
INCOME FROM CONTINUING OPERATIONS BEFORE CUMULATIVE EFFECT
OF CHANGE IN ACCOUNTING PRINCIPLE ........................... 148 1,509 3,961 519
INCOME FROM DISCONTINUED OPERATIONS (Including gain on the
disposition of Latin American operations of $12,488 in
the six months ended December 31, 2002) ..................... -- 1,661 12,332 1,461
--------- --------- --------- ---------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING
PRINCIPLE ................................................... 148 3,170 16,293 1,980
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE ........... -- -- -- (49,513)
--------- --------- --------- ---------
NET INCOME (LOSS) ............................................. 148 3,170 16,293 (47,533)
Less: Accretion of redeemable preferred stock ................. (1,201) -- (1,201) --
--------- --------- --------- ---------
NET INCOME (LOSS) APPLICABLE TO COMMON STOCK .................. (1,053) 3,170 15,092 (47,533)
Cumulative translation adjustments ............................ -- 4,244 (242) 4,204
Recognition of cumulative translation adjustments in
conjunction with the disposition of Latin American
operations .................................................. -- -- (10,074) --
--------- --------- --------- ---------
COMPREHENSIVE INCOME (LOSS) .................................. $ (1,053) $ 7,414 $ 4,776 $ (43,329)
========= ========= ========= =========
4
RURAL/METRO CORPORATION
CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2002 AND 2001
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31
------------------------ -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
INCOME (LOSS) PER SHARE
Basic --
Income (loss) from continuing operations before
cumulative effect of change in accounting principle
less accretion of redeemable preferred stock ........... $ (0.07) $ 0.10 $ 0.17 $ 0.03
Income (loss) from discontinued operations .............. -- 0.11 0.77 0.10
---------- ---------- ---------- ----------
Income (loss) before cumulative effect of change in
accounting principle less accretion of redeemable
preferred stock ....................................... (0.07) 0.21 0.94 0.13
Cumulative effect of change in accounting principle ..... -- -- -- (3.29)
---------- ---------- ---------- ----------
Net income (loss) applicable to each common share ..... $ (0.07) $ 0.21 $ 0.94 $ (3.16)
========== ========== ========== ==========
Diluted --
Income (loss) from continuing operations before
cumulative effect of change in accounting principle
less accretion of redeemable preferred stock ........... $ (0.07) $ 0.10 $ 0.15 $ 0.03
Income (loss) from discontinued operations .............. -- 0.11 0.69 0.10
---------- ---------- ---------- ----------
Income (loss) before cumulative effect of change in
accounting principle less accretion of redeemable
preferred stock ....................................... (0.07) 0.21 0.84 0.13
Cumulative effect of change in accounting principle ..... -- -- -- (3.26)
---------- ---------- ---------- ----------
Net income (loss) applicable to each common share ..... $ (0.07) $ 0.21 $ 0.84 $ (3.13)
========== ========== ========== ==========
AVERAGE NUMBER OF SHARES OUTSTANDING -- BASIC ............... 16,142 15,100 16,068 15,065
========== ========== ========== ==========
AVERAGE NUMBER OF SHARES OUTSTANDING -- DILUTED ............. 16,142 15,336 17,898 15,183
========== ========== ========== ==========
See accompanying notes
5
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
RURAL/METRO CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED DECEMBER 31, 2002 AND 2001
(UNAUDITED)
(IN THOUSANDS)
2002 2001
-------- --------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) .......................................... $ 16,293 $(47,533)
Adjustments to reconcile net income (loss) to cash
provided by operating activities --
Non-cash portion of gain on disposition of Latin
American operations .................................... (13,732) --
Cumulative effect of change in accounting principle ...... -- 49,513
Depreciation and amortization ............................ 6,773 8,324
Gain on sale of property and equipment ................... (359) (311)
Provision for doubtful accounts .......................... 37,742 33,515
Undistributed losses of minority shareholder ............. -- (9)
Equity earnings net of distributions received ............ (1,121) (393)
Amortization of deferred financing costs ................. 1,049 455
Amortization of debt discount ............................ 13 13
Change in assets and liabilities --
Increase in accounts receivable .......................... (34,983) (29,980)
(Increase) decrease in inventories ....................... 85 (77)
(Increase) decrease in prepaid expenses and other ........ 112 (16)
(Increase) decrease in other assets ....................... 204 (2,055)
Decrease in accounts payable ............................. (2,515) (1,331)
Decrease in accrued liabilities and other liabilities .... (4,456) (3,609)
Increase (decrease) in deferred subscription fees ........ (174) 135
-------- --------
Net cash provided by operating activities ............ 4,931 6,641
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures ....................................... (4,716) (2,864)
Proceeds from the sale of property and equipment ........... 474 965
-------- --------
Net cash used in investing activities ................ (4,242) (1,899)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Repayments on revolving credit facility .................... -- (1,263)
Repayment of debt and capital lease obligations ............ (748) (702)
Cash paid for debt issuance costs .......................... (971) --
Issuance of common stock ................................... 186 153
-------- --------
Net cash used in financing activities ................ (1,533) (1,812)
-------- --------
EFFECT OF CURRENCY EXCHANGE RATE CHANGES ON CASH ........... (21) (310)
-------- --------
INCREASE (DECREASE) IN CASH ................................ (865) 2,620
CASH, beginning of period .................................. 9,828 8,699
-------- --------
CASH, end of period ........................................ $ 8,963 $ 11,319
======== ========
See accompanying notes
6
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The accompanying unaudited consolidated financial statements have been prepared
in accordance with accounting principles generally accepted in the United States
of America for interim financial information and the instructions to Form 10-Q.
Accordingly, they do not include all information and footnotes required by
accounting principles generally accepted in the United States of America for
complete financial statements.
(1) INTERIM RESULTS
In the opinion of management, the consolidated financial statements for the
three and six month periods ended December 31, 2002 and 2001 include all
adjustments, consisting only of normal recurring adjustments, necessary for
a fair statement of the consolidated financial position and results of
operations. The results of operations for the three and six-month periods
ended December 31, 2002 and 2001 are not necessarily indicative of the
results of operations for the full fiscal year. For further information,
refer to the consolidated financial statements and footnotes thereto
included in the Company's Annual Report on Form 10-K, as amended, for the
fiscal year ended June 30, 2002. Certain financial information for prior
periods has been reclassified to conform to the current presentation. The
consolidated balance sheet as of June 30, 2002 has been derived from the
audited consolidated balance sheet included in the Company's Annual Report
on Form 10-K, as amended, for the year ended June 30, 2002 but does not
include all of the disclosures required by generally accepted accounting
principles.
(2) LIQUIDITY
During the six months ended December 31, 2002, the Company had net income
before the accretion of redeemable preferred stock of $16.3 million
compared with a net loss of $47.5 million in the six months ended December
31, 2001. Net income in the six months ended December 31, 2002 included a
$12.5 million gain related to the disposition of the Company's Latin
American operations while the six months ended December 31, 2001 included a
charge of $49.5 million relating to the adoption effective July 1, 2001 of
the new goodwill accounting standard as discussed in Note 7. During the
three months ended December 31, 2002, the Company had net income before the
accretion of redeemable preferred stock of $148,000 compared with net
income of $3.2 million for the three months ended December 31, 2001. The
Company's operating activities provided cash totaling $4.9 million in the
six months ended December 31, 2002 and $6.6 million in the six months ended
December 31, 2001.
At December 31, 2002, the Company had cash of $9.0 million, debt of $307.4
million and a stockholders' deficit of $160.2 million. The Company's debt
includes $149.9 million of 7 7/8% senior notes due 2008, $152.4 million
outstanding under its credit facility, $4.2 million payable to a former
joint venture partner and $900,000 of capital lease obligations.
As discussed in Note 4, the Company was not in compliance with certain of
the covenants contained in its revolving credit facility. On September 30,
2002, the Company entered into an amended credit facility with its lenders,
which, among other things, extended the maturity date of the facility from
March 16, 2003 to December 31, 2004, waived previous non-compliance, and
required the issuance to the lenders of 211,549 shares of the Company's
Series B redeemable preferred stock.
The Company's ability to service its long-term debt, to remain in
compliance with the various restrictions and covenants contained in its
credit agreements and to fund working capital, capital expenditures and
business development efforts will depend on its ability to generate cash
from operating activities which is subject to, among other things, its
future operating performance as well as to general economic, financial,
7
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
competitive, legislative, regulatory and other conditions, some of which
may be beyond its control.
If the Company fails to generate sufficient cash from operations, it may
need to raise additional equity or borrow additional funds to achieve its
longer-term business objectives. There can be no assurance that such equity
or borrowings will be available or, if available, will be at rates or
prices acceptable to the Company. Although there can be no assurances,
management believes that cash flow from operating activities coupled with
existing cash balances will be adequate to fund the Company's operating and
capital needs as well as enable it to maintain compliance with its various
debt agreements through December 31, 2003. To the extent that actual
results or events differ from the Company's financial projections or
business plans, its liquidity may be adversely impacted.
(3) ACCOUNTING FOR STOCK BASED COMPENSATION
At December 31, 2002, the Company had two stock compensation plans. The
Company accounts for those plans under the recognition and measurement
principles of APB Opinion No. 25, Accounting for Stock Issued to Employees,
and related interpretations. Stock-based compensation expense has not been
reflected in the consolidated statement of operations and comprehensive
income (loss), as all options granted under those plans had an exercise
price equal to the market value of the underlying common stock on the date
of grant. The following table illustrates the effect on net income and
earnings per share as if the Company had applied the fair value recognition
provisions of FASB Statement No 123, Accounting for Stock-Based
Compensation.
Three Months Ended Six Months Ended
December 31, December 31,
------------------------ -----------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Net income (loss)
applicable to common
stock $ (1,053) $ 3,170 $ 15,092 $ (47,533)
Deduct: Stock based
employee compensation
determined under the
fair value method for
all awards, net of
related tax effects (865) (154) (951) (329)
---------- ---------- ---------- ----------
Pro forma net income
(loss) applicable to
common stock $ (1,918) $ 3,016 $ 14,141 $ (47,862)
========== ========== ========== ==========
Earnings per share:
Basic - as reported $ (0.07) $ 0.21 $ 0.94 $ (3.16)
========== ========== ========== ==========
Basic - pro forma $ (0.12) $ 0.20 $ 0.88 $ (3.18)
========== ========== ========== ==========
Diluted - as reported $ (0.07) $ 0.21 $ 0.84 $ (3.13)
========== ========== ========== ==========
Diluted - pro forma $ (0.12) $ 0.20 $ 0.79 $ (3.15)
========== ========== ========== ==========
8
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(4) LONG-TERM DEBT
The Company's long-term debt consists of the following at December 31, 2002
and June 30, 2002 (in thousands):
DECEMBER 31, JUNE 30,
2002 2002
--------- ---------
7 7/8% senior notes due 2008 .................... $ 149,865 $ 149,852
Credit facility due December 2004 ............... 152,420 144,369
Note payable to former joint venture
partner, monthly payments through June 2006 ... 4,202 4,622
Capital lease and other obligations, at varying
rates from 3.5% to 12.75%, due through 2013 ... 959 1,319
--------- ---------
307,446 300,162
Less: Current maturities ........................ (1,406) (1,633)
--------- ---------
$ 306,040 $ 298,529
========= =========
In March 1998, the Company entered into a $200.0 million revolving credit
facility originally scheduled to mature March 16, 2003. The revolving
credit facility was unsecured and was unconditionally guaranteed on a joint
and several basis by substantially all of the Company's domestic
wholly-owned current and future subsidiaries. Interest rates and
availability under the revolving credit facility depended on the Company
meeting certain financial covenants, including a total debt leverage ratio,
a total debt to capitalization ratio, and a fixed charge ratio. Revolving
credit facility borrowings were initially priced at the greater of (i)
prime rate or Federal Funds rate plus 0.5% plus an applicable margin, or
(ii) a LIBOR-based rate. The LIBOR-based rates included a margin of 0.875%
to 1.75%.
In December 1999, primarily as a result of additional provisions for
doubtful accounts, the Company was not in compliance with three financial
covenants under the revolving credit facility: total debt leverage ratio,
total debt to total capitalization ratio and fixed charge coverage ratio.
The Company received a series of compliance waivers regarding these
covenant violations covering the periods from December 31, 1999 through
April 1, 2002. The waivers provided for, among other things, enhanced
reporting and other requirements and that no additional borrowings would be
available under the facility.
Pursuant to the waivers, as LIBOR contracts expired in March 2000, all
related borrowings were priced at prime plus 0.25 percentage points and
interest became payable monthly. Pursuant to the waivers, the Company was
required to accrue additional interest expense at a rate of 2.0% per annum
on the outstanding balance. The Company recorded approximately $7.4 million
of additional interest expense through September 30, 2002. In connection
with the waivers, the Company also made unscheduled principal payments
totaling $5.2 million.
Effective September 30, 2002, the Company entered into an amended credit
facility pursuant to which, among other things, the maturity date of the
credit facility was extended to December 31, 2004 and any prior
noncompliance was permanently waived.
The principal terms of the amended credit facility are as follows:
9
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
* WAIVER. Prior noncompliance was permanently waived with respect to the
covenant violations described above and with respect to certain other
noncompliance items, including non-reimbursement of approximately $2.6
million drawn by beneficiaries under letters of credit issued under
the original facility.
* MATURITY DATE. The maturity date of the facility was extended to
December 31, 2004.
* PRINCIPAL BALANCE. Accrued interest (approximately $6.9 million),
non-reimbursed letters of credit and various fees and expenses
associated with the amended credit facility (approximately $1.2
million) were added to the principal amount of the loan, resulting in
an outstanding principal balance as of the effective date of the
amendment equal to $152.4 million.
* NO REQUIRED AMORTIZATION. No principal payments are required until the
maturity date of the facility.
* INTEREST RATE. The interest rate was increased to LIBOR plus 7.0%
(8.4% as of December 31, 2002), payable monthly. By comparison, the
effective interest rate (including the 2.0% of additional accrued
interest described above) applicable to the original facility
immediately prior to the effective date of the amendment was 7.0%.
* FINANCIAL COVENANTS. The amended facility includes financial covenants
similar to the ones included in the original credit facility, with
compliance levels under such covenants adjusted to levels consistent
with the Company's current business levels and outlook. The covenants
include (i) total debt leverage ratio (initially set at 7.48), (ii)
minimum tangible net worth (initially set at a $230.1 million
deficit), (iii) fixed charge coverage ratio (initially set at 0.99),
(iv) limitation on capital expenditures of $11 million per fiscal
year; and (v) limitation on operating leases during any period of four
fiscal quarters to 3.10% of consolidated net revenues. The compliance
levels for covenants (i) through (iii) above are set at varying levels
on a quarterly basis. Compliance is tested quarterly based on
annualized or year-to-date results as applicable.
* OTHER COVENANTS. The amended credit facility includes various
non-financial covenants equivalent in scope to those included in the
original facility. The covenants include restrictions on additional
indebtedness, liens, investments, mergers and acquisitions, asset
sales, and other matters. The amended credit facility includes
extensive financial reporting obligations and provides that an event
of default occurs should we lose customer contracts in any fiscal
quarter with an aggregate EBITDA contribution of $5 million or more
(net of anticipated contributions from new contracts).
* EXISTING LETTERS OF CREDIT. Pursuant to the amended facility, letters
of credit issued pursuant to the original credit agreement were
reissued or extended, to a maximum of $3.5 million, for letter of
credit fees aggregating 1 7/8% per annum. A third letter of credit, in
the amount of $2.6 million which was previously drawn by its
beneficiary, will be reissued subject to application of the funds
originally drawn in reduction of the principal balance of the facility
and payment of a letter of credit fee equal to 7% per annum.
* EQUITY INTEREST. In consideration of the amended facility, the Company
issued shares of its Series B redeemable preferred stock to the
participants in the credit facility. See discussion of the redeemable
preferred stock in Note 5.
10
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The Company recorded approximately $7.0 million of deferred debt issuance
costs related to the amended credit facility ($4.2 million related to the
fair value of the redeemable preferred stock, $1.2 million of lender fees
which were added to the balance of the amended facility and $1.6 million of
related professional fees). The unamortized portion of these costs is
included in other assets in the accompanying consolidated balance sheet as
of December 31, 2002. These costs will be amortized to interest expense
over the life of the agreement. The fair value of the redeemable preferred
stock was estimated to be equivalent to the market value of the common
stock to be issued upon conversion of the redeemable preferred stock,
measured at the date of the amendment. The redeemable preferred stock
balance will be accreted to the greater of $15.0 million or the value of
the common shares into which the preferred shares would otherwise be
converted, over the life of the agreement or until the preferred shares are
converted to common shares.
In March 1998, the Company issued $150.0 million of its 7 7/8% Senior Notes
due 2008 (the Senior Notes) under Rule 144A under the Securities Act of
1933, as amended (Securities Act). Interest under the Senior Notes is
payable semi-annually on September 15 and March 15, and the Senior Notes
are not callable until March 2003 subject to the terms of the Indenture.
The Company incurred expenses related to the offering of approximately $5.3
million and is amortizing these costs to interest expense over the life of
the Senior Notes. In April 1998, we filed a registration statement under
the Securities Act relating to an exchange offer for the Senior Notes. The
registration statement became effective on May 14, 1998. The Senior Notes
are general unsecured obligations of the Company and are fully and
unconditionally guaranteed on a joint and several basis by substantially
all of its domestic wholly-owned current and future subsidiaries (the
Guarantors). The Senior Notes contain certain covenants that, among other
things, limit our ability to incur certain indebtedness, sell assets, or
enter into certain mergers or consolidations.
The Company does not believe that the separate financial statements and
related footnote disclosures concerning the Guarantors provide any
additional information that would be material to investors in making an
investment decision. Consolidating financial information for the Company
(the Parent), the Guarantors and the Company's remaining subsidiaries (the
Non-Guarantors) is as follows:
11
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING BALANCE SHEET
AS OF DECEMBER 31, 2002
(IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL
--------- ---------- -------------- ------------ ---------
ASSETS
CURRENT ASSETS
Cash ....................................... $ -- $ 8,964 $ (1) $ -- $ 8,963
Accounts receivable, net ................... -- 90,920 4,857 -- 95,777
Inventories ................................ -- 12,074 -- -- 12,074
Prepaid expenses and other ................. -- 8,688 20 -- 8,708
--------- --------- --------- --------- ---------
Total current assets .................... -- 120,646 4,876 -- 125,522
PROPERTY AND EQUIPMENT, net ................... -- 45,681 192 -- 45,873
GOODWILL ...................................... -- 41,167 -- -- 41,167
DUE FROM (TO) AFFILIATES ...................... 269,255 (240,518) (28,737) -- --
OTHER ASSETS .................................. 9,073 13,837 449 -- 23,359
INVESTMENT IN SUBSIDIARIES .................... (127,407) -- -- 127,407 --
--------- --------- --------- --------- ---------
$ 150,921 $ (19,187) $ (23,220) $ 127,407 $ 235,921
========= ========= ========= ========= =========
LIABILITIES, REDEEMABLE PREFERRED STOCK
AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Accounts payable ........................... $ -- $ 8,751 $ 79 $ -- $ 8,830
Accrued liabilities ........................ 3,463 56,821 (2,414) -- 57,870
Deferred subscription fees ................. -- 15,234 -- -- 15,234
Current portion of long-term debt .......... -- 1,403 3 -- 1,406
--------- --------- --------- --------- ---------
Total current liabilities ............... 3,463 82,209 (2,332) -- 83,340
LONG-TERM DEBT, net of current portion ........ 302,285 3,755 -- -- 306,040
OTHER LIABILITIES ............................. -- 339 -- -- 339
DEFERRED INCOME TAXES ......................... -- 1,814 (1,164) -- 650
--------- --------- --------- --------- ---------
Total liabilities ....................... 305,748 88,117 (3,496) -- 390,369
--------- --------- --------- --------- ---------
MINORITY INTEREST ............................. -- -- -- 379 379
--------- --------- --------- --------- ---------
REDEEMABLE PREFERRED STOCK .................... 5,390 -- -- -- 5,390
--------- --------- --------- --------- ---------
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock ............................... 164 82 8 (90) 164
Additional paid-in capital ................. 138,791 54,622 20,148 (74,770) 138,791
Retained earnings (accumulated deficit) .... (297,933) (162,008) (39,880) 201,888 (297,933)
Treasury stock ............................. (1,239) -- -- -- (1,239)
--------- --------- --------- --------- ---------
Total stockholders' equity (deficit) .... (160,217) (107,304) (19,724) 127,028 (160,217)
--------- --------- --------- --------- ---------
$ 150,921 $ (19,187) $ (23,220) $ 127,407 $ 235,921
========= ========= ========= ========= =========
12
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING BALANCE SHEET
AS OF JUNE 30, 2002
(IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL
--------- ---------- -------------- ------------ ---------
ASSETS
CURRENT ASSETS
Cash ............................................. $ -- $ 9,424 $ 404 $ -- $ 9,828
Accounts receivable, net ......................... -- 93,579 5,536 -- 99,115
Inventories ...................................... -- 12,178 42 -- 12,220
Prepaid expenses and other ....................... -- 8,864 151 -- 9,015
--------- --------- --------- --------- ---------
Total current assets .......................... -- 124,045 6,133 -- 130,178
PROPERTY AND EQUIPMENT, net ......................... -- 47,972 560 -- 48,532
GOODWILL ............................................ -- 41,167 77 -- 41,244
DUE FROM (TO) AFFILIATES ............................ 267,612 (215,197) (52,415) -- --
OTHER ASSETS ........................................ 3,031 12,163 2,290 -- 17,484
INVESTMENT IN SUBSIDIARIES .......................... (131,570) -- -- 131,570 --
--------- --------- --------- --------- ---------
$ 139,073 $ 10,150 $ (43,355) $ 131,570 $ 237,438
========= ========= ========= ========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
CURRENT LIABILITIES
Accounts payable ................................. $ -- $ 11,049 $ 912 $ -- $ 11,961
Accrued liabilities .............................. 10,171 61,280 2,268 -- 73,719
Deferred subscription fees ....................... -- 15,409 -- -- 15,409
Current portion of long-term debt ................ -- 1,620 13 -- 1,633
--------- --------- --------- --------- ---------
Total current liabilities ..................... 10,171 89,358 3,193 -- 102,722
LONG-TERM DEBT, net of current portion .............. 294,221 4,275 33 -- 298,529
OTHER LIABILITIES ................................... -- 477 -- -- 477
DEFERRED INCOME TAXES ............................... -- 1,814 (1,164) -- 650
--------- --------- --------- --------- ---------
Total liabilities ............................. 304,392 95,924 2,062 -- 402,378
--------- --------- --------- --------- ---------
MINORITY INTEREST ................................... -- -- -- 379 379
--------- --------- --------- --------- ---------
STOCKHOLDERS' EQUITY (DEFICIT)
Common stock ..................................... 159 82 17 (99) 159
Additional paid-in capital ....................... 138,470 54,622 34,942 (89,564) 138,470
Retained earnings (accumulated deficit) .......... (313,025) (140,478) (90,692) 231,170 (313,025)
Accumulated other comprehensive income (loss) .... 10,316 -- 10,316 (10,316) 10,316
Treasury stock ................................... (1,239) -- -- -- (1,239)
--------- --------- --------- --------- ---------
Total stockholders' equity (deficit) .......... (165,319) (85,774) (45,417) 131,191 (165,319)
--------- --------- --------- --------- ---------
$ 139,073 $ 10,150 $ (43,355) $ 131,570 $ 237,438
========= ========= ========= ========= =========
13
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED DECEMBER 31, 2002
(IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL
--------- ---------- -------------- ------------ ---------
NET REVENUE ................................... $ -- $ 120,884 $ 2,580 $ -- $ 123,464
--------- --------- --------- --------- ---------
OPERATING EXPENSES
Payroll and employee benefits ................. -- 68,700 1,533 -- 70,233
Provision for doubtful accounts ............... -- 18,810 207 -- 19,017
Depreciation and amortization ................. -- 3,266 43 -- 3,309
Other operating expenses ...................... -- 22,614 597 -- 23,211
--------- --------- --------- --------- ---------
Total expenses .......................... -- 113,390 2,380 -- 115,770
--------- --------- --------- --------- ---------
OPERATING INCOME .............................. -- 7,494 200 -- 7,694
Income from wholly-owned subsidiaries ......... 7,415 -- -- (7,415) --
Interest expense, net ......................... (7,267) (62) (162) -- (7,491)
--------- --------- --------- --------- ---------
INCOME FROM CONTINUING OPERATIONS BEFORE
INCOME TAXES ............................... 148 7,432 38 (7,415) 203
INCOME TAX PROVISION .......................... -- (55) -- -- (55)
--------- --------- --------- --------- ---------
INCOME FROM CONTINUING OPERATIONS ............. 148 7,377 38 (7,415) 148
INCOME (LOSS) FROM DISCONTINUED OPERATIONS .... -- -- -- -- --
--------- --------- --------- --------- ---------
NET INCOME .................................... $ 148 $ 7,377 $ 38 $ (7,415) $ 148
========= ========= ========= ========= =========
14
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE THREE MONTHS ENDED DECEMBER 31, 2001
(IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL
--------- ---------- -------------- ------------ ---------
NET REVENUE ................................. $ -- $ 111,417 $ 2,916 $ -- $ 114,333
--------- --------- --------- --------- ---------
OPERATING EXPENSES
Payroll and employee benefits ............... -- 64,025 1,880 -- 65,905
Provision for doubtful accounts ............. -- 16,382 251 -- 16,633
Depreciation and amortization ............... -- 3,862 49 -- 3,911
Other operating expenses .................... -- 21,956 402 -- 22,358
--------- --------- --------- --------- ---------
Total expenses ........................ -- 106,225 2,582 -- 108,807
--------- --------- --------- --------- ---------
OPERATING INCOME ............................ -- 5,192 334 -- 5,526
Income from wholly-owned subsidiaries ....... 6,901 -- -- (6,901) --
Interest expense, net ....................... (5,392) (15) (244) -- (5,651)
Other income (expense), net ................. -- -- -- 9 9
--------- --------- --------- --------- ---------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES ....................... 1,509 5,177 90 (6,892) (116)
INCOME TAX BENEFIT .......................... -- 1,625 -- -- 1,625
--------- --------- --------- --------- ---------
INCOME FROM CONTINUING OPERATIONS ........... 1,509 6,802 90 (6,892) 1,509
INCOME FROM DISCONTINUED OPERATIONS ......... 1,661 -- 1,661 (1,661) 1,661
--------- --------- --------- --------- ---------
NET INCOME .................................. $ 3,170 $ 6,802 $ 1,751 $ (8,553) $ 3,170
========= ========= ========= ========= =========
15
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED DECEMBER 31, 2002
(IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL
--------- ---------- -------------- ------------ ---------
NET REVENUE ................................... $ -- $ 243,838 $ 5,191 $ -- $ 249,029
--------- --------- --------- --------- ---------
OPERATING EXPENSES
Payroll and employee benefits ................. -- 138,157 3,188 -- 141,345
Provision for doubtful accounts ............... -- 37,310 432 -- 37,742
Depreciation and amortization ................. -- 6,662 87 -- 6,749
Other operating expenses ...................... -- 44,580 1,165 -- 45,745
--------- --------- --------- --------- ---------
Total expenses .......................... -- 226,709 4,872 -- 231,581
--------- --------- --------- --------- ---------
OPERATING INCOME .............................. -- 17,129 319 -- 17,448
Income from wholly-owned subsidiaries ......... 16,949 -- -- (16,949) --
Interest expense, net ......................... (12,988) (48) (341) -- (13,377)
--------- --------- --------- --------- ---------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES ......................... 3,961 17,081 (22) (16,949) 4,071
INCOME TAX PROVISION .......................... -- (110) -- -- (110)
--------- --------- --------- --------- ---------
INCOME (LOSS) FROM CONTINUING OPERATIONS ...... 3,961 16,971 (22) (16,949) 3,961
INCOME (LOSS) FROM DISCONTINUED OPERATIONS .... 12,332 12,488 (156) (12,332) 12,332
--------- --------- --------- --------- ---------
NET INCOME (LOSS) ............................. $ 16,293 $ 29,459 $ (178) $ (29,281) $ 16,293
========= ========= ========= ========= =========
16
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING STATEMENT OF OPERATIONS
FOR THE SIX MONTHS ENDED DECEMBER 31, 2001
(IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL
---------- ---------- -------------- ------------ ----------
NET REVENUE ................................................ $ -- $ 225,010 $ 5,797 $ -- $ 230,807
---------- ---------- ---------- ---------- ----------
OPERATING EXPENSES
Payroll and employee benefits .............................. -- 130,293 3,933 -- 134,226
Provision for doubtful accounts ............................ -- 32,843 528 -- 33,371
Depreciation and amortization .............................. -- 7,802 140 -- 7,942
Other operating expenses ................................... -- 43,049 839 -- 43,888
---------- ---------- ---------- ---------- ----------
Total expenses ....................................... -- 213,987 5,440 -- 219,427
---------- ---------- ---------- ---------- ----------
OPERATING INCOME ........................................... -- 11,023 357 -- 11,380
Income from wholly-owned subsidiaries ...................... 12,384 -- -- (12,384) --
Interest expense, net ...................................... (11,865) (78) (532) -- (12,475)
Other income (expense), net ................................ -- -- -- 9 9
---------- ---------- ---------- ---------- ----------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE INCOME TAXES, AND
CUMULATIVE EFFECT OF CHANGE IN
ACCOUNTING PRINCIPLE .................................... 519 10,945 (175) (12,375) (1,086)
INCOME TAX BENEFIT ......................................... -- 1,605 -- -- 1,605
---------- ---------- ---------- ---------- ----------
INCOME (LOSS) FROM CONTINUING OPERATIONS
BEFORE CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE .................................. 519 12,550 (175) (12,375) 519
INCOME FROM DISCONTINUED OPERATIONS ........................ 1,461 -- 1,461 (1,461) 1,461
---------- ---------- ---------- ---------- ----------
INCOME BEFORE CUMULATIVE EFFECT OF CHANGE
IN ACCOUNTING PRINCIPLE .................................. 1,980 12,550 1,286 (13,836) 1,980
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE ........ (49,513) (49,513) -- 49,513 (49,513)
---------- ---------- ---------- ---------- ----------
NET INCOME (LOSS) .......................................... $ (47,533) $ (36,963) $ 1,286 $ 35,677 $ (47,533)
========== ========== ========== ========== ==========
17
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED DECEMBER 31, 2002
(IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL
---------- ---------- -------------- ------------ ----------
CASH FLOW FROM OPERATING ACTIVITIES
Net income (loss) ................................... $ 16,293 $ 29,459 $ (178) $ (29,281) $ 16,293
Adjustments to reconcile net income (loss) to cash
provided by (used in) operations--
Non-cash portion of gain on disposition of Latin
American operations .............................. 139 -- (13,871) -- (13,732)
Depreciation and amortization ..................... -- 6,658 115 -- 6,773
Gain on sale of property and equipment ............ -- (224) (135) -- (359)
Provision for doubtful accounts ................... -- 37,310 432 -- 37,742
Equity earnings net of distributions received ..... -- (1,121) -- -- (1,121)
Amortization of deferred financing costs .......... 1,049 -- -- -- 1,049
Amortization of discount on Senior Notes .......... 13 -- -- -- 13
Change in assets and liabilities--
Increase in accounts receivable ................... -- (34,650) (333) -- (34,983)
(Increase) decrease in inventories ................ -- 103 (18) -- 85
(Increase) decrease in prepaid expenses and other . -- 176 (64) -- 112
(Increase) decrease in other assets ............... (263) (573) 1,040 -- 204
(Increase) decrease in due to/from affiliates ..... (16,575) (25,192) 12,507 29,260 --
Increase (decrease) in accounts payable ........... -- (2,772) 257 -- (2,515)
Increase (decrease) in accrued liabilities and
other liabilities ................................ 150 (4,597) (9) -- (4,456)
Decrease in deferred subscription fees ............ -- (174) -- -- (174)
---------- ---------- ---------- ---------- ----------
Net cash provided by (used in) operating
activities .................................. 806 4,403 (257) (21) 4,931
---------- ---------- ---------- ---------- ----------
CASH FLOW FROM INVESTING ACTIVITIES
Capital expenditures ................................ -- (4,562) (154) -- (4,716)
Proceeds from the sale of property and equipment .... -- 436 38 -- 474
---------- ---------- ---------- ---------- ----------
Net cash used in investing
activities .................................. -- (4,126) (116) -- (4,242)
---------- ---------- ---------- ---------- ----------
CASH FLOW FROM FINANCING ACTIVITIES
Repayment of debt and capital lease obligations ..... -- (737) (11) -- (748)
Cash paid for debt issuance costs ................... (971) -- -- -- (971)
Issuance of common stock ............................ 186 -- -- -- 186
---------- ---------- ---------- ---------- ----------
Net cash used in financing activities ........ (785) (737) (11) -- (1,533)
---------- ---------- ---------- ---------- ----------
EFFECT OF CURRENCY EXCHANGE RATE CHANGE ............... (21) -- (21) 21 (21)
---------- ---------- ---------- ---------- ----------
DECREASE IN CASH ...................................... -- (460) (405) -- (865)
CASH, beginning of period ............................. -- 9,424 404 -- 9,828
---------- ---------- ---------- ---------- ----------
CASH, end of period ................................... $ -- $ 8,964 $ (1) $ -- $ 8,963
========== ========== ========== ========== ==========
18
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
CONSOLIDATING STATEMENT OF CASH FLOWS
FOR THE SIX MONTHS ENDED DECEMBER 31, 2001
(IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL
---------- ---------- -------------- ------------ ----------
CASH FLOW FROM OPERATING ACTIVITIES
Net loss ............................................ $ (47,533) $ (36,963) $ 1,286 $ 35,677 $ (47,533)
Adjustments to reconcile net loss to cash provided
by (used in) operations--
Cumulative effect of a change in accounting
principle ....................................... -- 49,513 -- -- 49,513
Depreciation and amortization ..................... -- 7,802 522 -- 8,324
(Gain) loss on sale of property and equipment ..... -- 122 (433) -- (311)
Provision for doubtful accounts ................... -- 32,843 672 -- 33,515
Undistributed losses of minority shareholders ..... -- -- -- (9) (9)
Equity earnings net of distributions received ..... -- (393) -- -- (393)
Amortization of deferred financing costs .......... 455 -- -- -- 455
Amortization of discount on Senior Notes .......... 13 -- -- -- 13
Change in assets and liabilities--
Increase in accounts receivable ................... -- (29,797) (183) -- (29,980)
(Increase) decrease in inventories ................ -- (99) 22 -- (77)
(Increase) decrease in prepaid expenses and other . (51) 244 (209) -- (16)
(Increase) decrease in other assets ............... (910) 1,184 (2,329) -- (2,055)
(Increase) decrease in due to/from affiliates ..... 48,224 (11,960) (286) (35,978) --
Increase (decrease) in accounts payable ........... -- (2,423) 1,092 -- (1,331)
Increase (decrease) in accrued liabilities and
other liabilities ................................ 1,222 (3,518) (1,313) -- (3,609)
Increase in deferred subscription fees ............ -- 108 27 -- 135
---------- ---------- ---------- ---------- ----------
Net cash provided by (used in) operating
activities .................................. 1,420 6,663 (1,132) (310) 6,641
---------- ---------- ---------- ---------- ----------
CASH FLOW FROM INVESTING ACTIVITIES
Capital expenditures ................................ -- (2,498) (366) -- (2,864)
Proceeds from the sale of property and equipment .... -- 365 600 -- 965
---------- ---------- ---------- ---------- ----------
Net cash provided by (used in) investing
activities .................................. -- (2,133) 234 -- (1,899)
---------- ---------- ---------- ---------- ----------
CASH FLOW FROM FINANCING ACTIVITIES
Repayments on revolving credit facility, net ........ (1,263) -- -- -- (1,263)
Repayment of debt and capital lease obligations ..... -- (684) (18) -- (702)
Issuance of common stock ............................ 153 -- -- -- 153
---------- ---------- ---------- ---------- ----------
Net cash used in financing activities ........ (1,110) (684) (18) -- (1,812)
---------- ---------- ---------- ---------- ----------
EFFECT OF CURRENCY EXCHANGE RATE CHANGE ............... (310) -- (310) 310 (310)
---------- ---------- ---------- ---------- ----------
INCREASE (DECREASE) IN CASH ........................... -- 3,846 (1,226) -- 2,620
CASH, beginning of period ............................. -- 6,763 1,936 -- 8,699
---------- ---------- ---------- ---------- ----------
CASH, end of period ................................... $ -- $ 10,609 $ 710 $ -- $ 11,319
========== ========== ========== ========== ==========
19
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(5) REDEEMABLE PREFERRED STOCK
In consideration of the amended facility, the Company issued shares of its
Series B redeemable preferred stock to the participants in the credit
facility. The redeemable preferred stock is convertible into 2,115,490
common shares (10% of the sum of the common shares outstanding on a diluted
basis, as defined). The conversion ratio is subject to upward adjustment if
the Company issues common stock or securities convertible into the
Company's common stock for consideration less than the fair market value of
such securities at the time of such transaction. Because a sufficient
number of common shares are not currently available to permit conversion,
the Company intends to seek stockholder approval to amend its certificate
of incorporation to authorize additional common shares. Conversion of the
preferred shares occurs automatically upon notice from the Company,
assuming approval by the Company's stockholders of sufficient common shares
to permit conversion. Should the Company's stockholders fail to approve
such a proposal by December 31, 2004, the Company will be required to
redeem the preferred stock for a price equal to the greater of $15 million
or the value of the common shares into which the preferred shares would
otherwise have been convertible. In addition, should the Company's
stockholders fail to approve such a proposal, the redeemable preferred
stock enjoys a preference upon a sale of the Company, a sale of its assets
and in certain other circumstances; this preference equals the greater of
(i) the value of the common shares into which the redeemable preferred
stock would otherwise have been convertible or (ii) $12.5 million or $15
million depending on whether the triggering event occurs prior to December
31, 2003 or December 31, 2004, respectively. At the election of the holder,
the preferred shares carry voting rights as if such shares were converted
into common shares. The preferred shares do not bear a dividend. The
preferred shares (and common shares issuable upon conversion of the
preferred shares) are entitled to certain registration rights. The terms of
the preferred shares limit the Company from issuing senior or pari passu
preferred shares and from paying dividends on, or redeeming, shares of
junior stock. The Company has recorded accretion of the redeemable
preferred stock totaling $1.2 million during the three and six months ended
December 31, 2002.
(6) DISPOSITION OF LATIN AMERICAN OPERATIONS
Due to the deteriorating economic conditions and continued devaluation of
the local currency, the Company reviewed its strategic alternatives with
respect to the continuation of operations in Latin America, including
Argentina and Bolivia, and determined that the Company would benefit from
focusing on its domestic operations. Effective September 27, 2002, the
Company sold its Latin American operations to local management for the
assumption of net liabilities. The gain resulting from the disposition of
the Latin American operations totaled $12.5 million and is included in the
income from discontinued operations for the six months ended December 31,
2002. The gain includes the assumption by the buyer of net liabilities of
$3.3 million (including accounts receivable of $0.6 million and accrued
liabilities of $4.8 million) as well as the recognition of related
cumulative translation adjustments of $10.1 million.
Revenue related to the Company's Latin American operations totaled $2.4
million and $18.6 million for the six months ended December 31, 2002 and
2001, respectively. Revenue related to Company's Latin American operations
totaled $9.4 million for the three months ended December 31, 2001. The
Company's Latin American operations generated losses of $156,000 for the
six months ended December 31, 2002 and income of $1.5 million for the six
months ended December 2001.The Company's Latin American operations
generated income of $1.7 million for the three months ended December 31,
2001. The Argentine operations and Bolivian medical transportation
operations were included in the Company's medical transportation and
20
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
related service segment. The Bolivian fire operations were included in the
Company's Fire and Other segment.
(7) RESTRUCTURING CHARGE AND OTHER
During fiscal 2001, the Company decided to close or downsize nine service
areas and in connection therewith, recorded restructuring charges in
accordance with Emerging Issues Task Force 94-3 "Liability Recognition for
Certain Employee Termination Benefits and Other Costs to Exit an Activity
(including Certain Costs Incurred in a Restructuring)" (EITF 94-3) as well
as other related charges totaling $9.1 million. These charges included $1.5
million to cover severance costs associated with the termination of
approximately 250 employees, all of whom were expected to leave by the end
of fiscal 2002, lease termination and other exit costs of $2.4 million, and
asset impairment charges for goodwill and property and equipment of $4.1
million and $1.1 million, respectively, related to the impacted service
areas. Approximately 109 of the impacted employees have been terminated, as
of December 31, 2002.
The previously mentioned charge included accrued severance, lease
termination and other costs totaling $1.5 million relating to an under
performing service area that the Company had planned to exit at the time of
contract expiration in December 2001. During fiscal 2002, the contract was
extended for a one-year period at the request of the municipality to enable
it to transition medical transportation service to a new provider. The
operating environment in this service area has improved and the Company was
recently awarded a new multi-year contract. The contract related to this
award was finalized during the quarter ended December 31, 2002 and as a
result, the remaining reserve of $1.3 million was released to income. This
reversal was reflected in the accompanying consolidated statement of
operations in other operating expenses.
A summary of activity in the Company's restructuring reserves is as follows
(in thousands):
LEASE
SEVERANCE TERMINATION OTHER EXIT
COSTS COSTS COSTS TOTAL
------- ------- ------- -------
Balance at June 30, 2002 ........... $ 757 $ 1,514 $ 32 $ 2,303
Fiscal 2003 Usage ................ (24) (137) (76) (237)
Adjustments ...................... (314) 145 169 --
Restructuring charge reversals ... (414) (873) (114) (1,401)
------- ------- ------- -------
Balance at December 31, 2002 ....... $ 5 $ 649 $ 11 $ 665
======= ======= ======= =======
(8) GOODWILL
The Company adopted SFAS No. 142, Goodwill and Other Intangible Assets
(SFAS 142) effective July 1, 2001 and discontinued amortization of goodwill
as of that date. During the first quarter of fiscal 2002, the Company
identified its various reporting units which consist of the individual cost
centers within its medical transportation and fire and other operating
segments for which separately identifiable cash flow information is
available. During the second quarter of fiscal 2002, the Company completed
the first step impairment test as of July 1, 2001at which time potential
impairments were identified in certain reporting units. During the fourth
quarter of fiscal 2002, the Company completed the second step test and
determined that all or a portion of the goodwill applicable to certain of
its reporting units was impaired as of July 1, 2001 resulting in an
aggregate charge of $49.5 million. The fair value of the reporting units
was determined using the discounted cash flow method and a discount rate of
15.0%. This charge has been reflected in the accompanying consolidated
statement of operations as the cumulative effect of change in accounting
21
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
principle. Additionally, the Company's results for the first quarter of
fiscal 2002 have been restated to reflect this charge in that period as
required by SFAS 142. The Company has selected June 30 as the date on which
it will perform its annual goodwill impairment test.
(9) NET INCOME (LOSS) PER SHARE
A reconciliation of the numerators and denominators (weighted average
number of shares outstanding) of the basic and diluted income (loss) per
share computations for the three and six-month periods ended December 31,
2002 and 2001 is as follows (in thousands, except per share amounts):
Three Months Ended Six Months Ended
December 31, December 31,
-------------------- --------------------
2002 2001 2002 2001
-------- -------- -------- --------
Income (loss) from continuing operations before
cumulative effect of change in accounting
principle $ 148 $ 1,500 $ 3,961 $ 519
Less: Accretion of redeemable preferred stock (1,201) -- (1,201) --
-------- -------- -------- --------
Income (loss) from continuing operations before
cumulative effect of change in accounting
principle less accretion of redeemable preferred
stock $ (1,053) $ 1,500 $ 2,760 $ 519
======== ======== ======== ========
Average number of shares outstanding - Basic 16,142 15,100 16,068 15,065
Add: Incremental shares for:
Dilutive effect of stock options -- 236 1,830 118
-------- -------- -------- --------
Average number of shares outstanding - Diluted 16,142 15,336 17,898 15,183
======== ======== ======== ========
Income (loss) per share - Basic
Income (loss) from continuing operations before
cumulative effect of change in accounting
principle $ 0.00 $ 0.10 $ 0.24 $ 0.03
Less: Accretion of redeemable preferred stock (0.07) -- (0.07) --
-------- -------- -------- --------
Income (loss) from continuing operations before
cumulative effect of change in accounting
principle less accretion of redeemable
preferred stock $ (0.07) $ 0.10 $ 0.17 $ 0.03
======== ======== ======== ========
Income (loss) per share - Diluted
Income (loss) from continuing operations before
cumulative effect of change in accounting
principle $ 0.00 $ 0.10 $ 0.22 $ 0.03
Less: Accretion of redeemable preferred stock (0.07) -- (0.07) --
-------- -------- -------- --------
Income (loss) from continuing operations before
cumulative effect of change in accounting
principle less accretion of redeemable
preferred stock $ (0.07) $ 0.10 $ 0.15 $ 0.03
======== ======== ======== ========
Stock options with exercise prices above the applicable market prices have
been excluded from the calculation of diluted earnings per share. Such
options totaled 4.5 million and 5.4 million at December 31, 2002 and 2001,
22
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
respectively. As a result of anti-dilutive effects, approximately 1.9
million option shares which had exercise prices below the applicable market
prices, were not included in the computation of diluted loss per share for
the three months ended December 31, 2002.
Earnings per share is affected by the accretion of the redeemable preferred
stock of approximately $1.2 million per quarter. Additionally, upon
approval of the stockholders of additional common shares and notice from
the Company to holders of the redeemable preferred stock, 2,115,490 common
shares will be included in the denominator of the earnings per share
calculation.
(10) SEGMENT REPORTING
For financial reporting purposes, the Company has classified its operations
into two reporting segments that correspond with the manner in which such
operations are managed: the Medical Transportation and Related Services
Segment and the Fire and Other Segment. Each reporting segment consists of
cost centers (operating segments) representing the Company's various
service areas that have been aggregated on the basis of the type of
services provided, customer type and methods of service delivery.
The Medical Transportation and Related Services Segment includes emergency
ambulance services provided to individuals pursuant to contracts with
counties, fire districts, and municipalities, as well as non-emergency
ambulance services provided to individuals requiring either advanced or
basic levels of medical supervision during transport. The Segment also
includes alternative transportation services, operational and
administrative support services related to the Company's public/private
alliance with the City of San Diego.
The Fire and Other Segment includes a variety of fire protection services
including fire prevention, suppression, training, alarm monitoring,
dispatch, fleet and billing services.
The accounting policies as described in the Company's Annual Report on Form
10-K, as amended, have also been followed in the preparation of the
accompanying financial information for each reporting segment. For internal
management purposes, the Company's measure of segment profitability is
defined as income (loss) from continuing operations before interest, income
taxes, depreciation and amortization. Additionally, segment assets are
defined as consisting solely of accounts receivable.
The following tables summarize the information required to be presented by
SFAS 131, Disclosures about Segments of an Enterprise and Related
Information, as of and for the three and six months ended December 31, 2002
and 2001. The Company has revised certain of the information presented
below as of and for the three and six months ended December 31, 2001. Such
revisions consist of:
* The inclusion of alternative transportation services ($2.6 million in
the three months ended December 31, 2001 and $5.4 million in the six months
ended December 31, 2001) as well as operational and administrative support
services related to the Company's public/private alliance with the City of
San Diego ($3.7 million in the three months ended December 31, 2001 and
$7.3 million in the six months ended December 31, 2001) within the Medical
Transportation and Related Services Segment (such services were previously
included in the Fire and Other Segment);
23
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
* The clarification of the measure of segment profitability as well as
the definition of segment assets to correspond with the manner in which the
Company has historically managed its operations; and
* The addition of a reconciliation of the segment financial information
to corresponding amounts contained in the Consolidated Financial
Statements.
These revisions had no impact on the Company's consolidated financial
position, results of operations or cash flows.
24
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
Information by reporting segment is set forth below:
MEDICAL
TRANSPORTATION
AND RELATED FIRE AND
SERVICES OTHER CORPORATE TOTAL
---------- ---------- ---------- ----------
(IN THOUSANDS)
THREE MONTHS ENDED DECEMBER 31, 2002
Net revenues from external customers .. $ 102,895 $ 20,569 $ -- $ 123,464
Segment profit (loss) ................. 11,818 2,740 (3,555) 11,003
Segment assets ........................ 94,691 1,086 -- 95,777
THREE MONTHS ENDED DECEMBER 31, 2001
Net revenues from external customers .. $ 96,059 $ 18,274 $ -- $ 114,333
Segment profit (loss) ................. 11,630 2,106 (4,299) 9,437
Segment assets ........................ 96,867 1,590 -- 98,457
SIX MONTHS ENDED DECEMBER 31, 2002
Net revenues from external customers .. $ 206,689 $ 42,340 $ -- $ 249,029
Segment profit (loss) ................. 24,515 6,751 (7,069) 24,197
Segment assets ........................ 94,691 1,086 -- 95,777
SIX MONTHS ENDED DECEMBER 31, 2001
Net revenues from external customers .. $ 193,874 $ 36,933 $ -- $ 230,807
Segment profit (loss) ................. 21,923 5,095 (7,696) 19,322
Segment assets ........................ 96,867 1,590 -- 98,457
A reconciliation of segment profit (loss) to income (loss) from continuing
operations before income taxes and cumulative effect of change in
accounting principle is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
------------------------ ------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
Segment profit (loss) ............................. $ 11,003 $ 9,437 $ 24,197 $ 19,322
Depreciation and amortization ..................... (3,309) (3,911) (6,749) (7,942)
Interest expense, net ............................. (7,491) (5,651) (13,377) (12,475)
Other expense, net ................................ -- 9 -- 9
---------- ---------- ---------- ----------
Income (loss) from continuing operations before
income taxes, and cumulative effect of change
in accounting principle ....................... $ 203 $ (116) $ 4,071 $ (1,086)
========== ========== ========== ==========
25
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
A reconciliation of segment assets to total assets is as follows:
AS OF DECEMBER 31,
-----------------------
2002 2001
---------- ----------
Segment assets ............................. $ 95,777 $ 98,457
Cash ....................................... 8,963 11,319
Inventories ................................ 12,074 13,241
Prepaid expenses and other ................. 8,708 5,027
Property and equipment, net ................ 45,905 51,989
Goodwill ................................... 41,167 92,345
Other assets ............................... 23,327 14,365
---------- ----------
$ 235,921 $ 286,743
========== ==========
(11) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation -- Transition and Disclosure, an amendment of SFAS No. 123."
SFAS No. 148 amended SFAS No. 123, "Accounting for Stock-Based
Compensation," to provide alternative methods of transition for an entity
that voluntarily changes to the fair value based method of accounting for
stock-based employee compensation. It also amends the disclosure provisions
of SFAS No. 123 to require prominent disclosure about the effects on
reported net income of an entity's accounting policy decisions with respect
to stock-based employee compensation. In addition, SFAS No. 148 amends
Accounting Principles Board Opinion No. 28, "Interim Financial Reporting",
to require disclosure about those effects in interim financial information.
SFAS 148 is effective for financial statements for fiscal years ending
after December 15, 2002, including certain amendments to required
disclosures related to stock-based compensation included in condensed
financial statements for interim periods beginning after December 15, 2002.
The Company has complied with the disclosure requirements of SFAS No. 148
and does not anticipate voluntarily changing to the fair value based method
of accounting for stock-based employee compensation.
In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45),
"Guarantor's Accounting and Disclosure Requirements for Guarantees,
Including Indirect Guarantees of Indebtedness of Others". FIN 45 clarifies
the requirements of FASB Statement No. 5, "Accounting for Contingencies",
relating to the guarantor's accounting for, and disclosure of, the issuance
of certain types of guarantees. FIN 45 is to be applied on a prospective
basis to guarantees issued or modified after December 31, 2002. The Company
does not expect the application of FIN 45 to have a material impact on its
financial condition or results of operations.
(12) COMMITMENTS AND CONTINGENCIES
MEDICARE FEE SCHEDULE
On April 1, 2002, the Medicare Ambulance Fee Schedule Final Rule became
effective. The final rule categorizes seven levels of ground ambulance
services, ranging from basic life support to specialty care transport, and
two categories of air ambulance services. The base rate conversion factor
for services to Medicare patients was set at $170.54, plus separate mileage
payments based on specified relative value units for each level of
ambulance service. Adjustments also were included to recognize differences
in relative practice costs among geographic areas, and higher
transportation costs that may be incurred by ambulance providers in rural
areas with low population density. The Final Rule requires ambulance
providers to accept the assigned reimbursement rate as full payment, after
patients have submitted their deductible and 20 percent of Medicare's fee
for service. In addition, the Final Rule calls for a five-year phase-in
period to allow time for providers to adjust to the new payment rates. The
fee schedule will be phased in at 20-percent increments each year, with
payments being made at 100 percent of the fee schedule in 2006 and
thereafter.
The Company currently believes that the Medicare Ambulance Fee Schedule
will have a neutral net impact on its medical transportation revenue at
incremental and full phase-in periods, primarily due to the geographic
diversity of its operations. These rules could, however, result in contract
renegotiations or other actions to offset any negative impact at the
regional level that could have a material adverse effect on the Company's
business, financial condition, cash flows, and results of operations.
Changes in reimbursement policies or other governmental action, together
with the financial challenges of some private, third-party payers and
budget pressures on other payer sources could influence the timing and,
potentially, the receipt of payments and reimbursements. A reduction in
coverage or reimbursement rates by third-party payers, or an increase in
the Company's cost structure relative to the rate increase in the Consumer
Price Index (CPI), or costs incurred to implement the mandates of the fee
schedule could have a material adverse effect on the Company's business,
financial condition, cash flows, and results of operations.
26
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
LEGAL PROCEEDINGS
From time to time, the Company is subject to litigation and regulatory
investigations arising in the ordinary course of business. The Company
believes that the resolution of currently pending claims or legal
proceedings will not have a material adverse effect on its business,
financial condition, cash flows or results of operations. However, the
Company is unable to predict with certainty the outcome of pending
litigation and regulatory investigations. In some cases, insurance coverage
may not be adequate to cover all liabilities arising out of such claims. In
addition, due to the nature of the Company's business, Center for Medicare
and Medicaid Services (CMS) and other regulatory agencies are expected to
continue their practice of performing periodic reviews and initiating
investigations related to the Company's compliance with billing
regulations. Unfavorable resolutions of pending or future litigation,
regulatory reviews and/or investigations, either individually or in the
aggregate, could have a material adverse effect on the Company's business,
financial condition, cash flows and results of operations.
The Company, Warren S. Rustand, the former Chairman of the Board and Chief
Executive Officer of the Company, James H. Bolin, the former Vice Chairman
of the Board, and Robert E. Ramsey, Jr., the former Executive Vice
President and former Director, were named as defendants in two purported
class action lawsuits: HASKELL V. RURAL/METRO CORPORATION, ET AL., Civil
Action No. C-328448 filed on August 25, 1998 in Pima County, Arizona
Superior Court and RUBLE V. RURAL/METRO CORPORATION, ET AL., CIV
98-413-TUC-JMR filed on September 2, 1998 in United States District Court
for the District of Arizona. The two lawsuits, which contain virtually
identical allegations, were brought on behalf of a class of persons who
purchased the Company's publicly traded securities including its common
stock between April 28, 1997 and June 11, 1998. Haskell v. Rural/Metro
seeks unspecified damages under the Arizona Securities Act, the Arizona
Consumer Fraud Act, and under Arizona common law fraud, and also seeks
punitive damages, a constructive trust, and other injunctive relief. Ruble
v. Rural/Metro seeks unspecified damages under Sections 10(b) and 20(a) of
the Securities Exchange Act of 1934, as amended. The complaints in both
actions allege that between April 28, 1997 and June 11, 1998 the defendants
issued certain false and misleading statements regarding certain aspects of
the Company's financial status and that these statements allegedly caused
the Company's common stock to be traded at artificially inflated prices.
The complaints also allege that Mr. Bolin and Mr. Ramsey sold stock during
this period, allegedly taking advantage of inside information that the
stock prices were artificially inflated.
On May 25, 1999, the Arizona State Court granted a request for a stay of
the Haskell action until the Ruble action is finally resolved. The Company
and the individual defendants moved to dismiss the Ruble action. On January
25, 2001, the Court granted the motion to dismiss, but granted the
plaintiffs leave to replead. On March 31, 2001, the plaintiffs filed a
second amended complaint. The Company and the individual defendants moved
to dismiss the second amended complaint. On March 8, 2002, the Court
granted the motions to dismiss of Mr. Ramsey and Mr. Bolin with leave to
replead and denied the motions to dismiss of the Company and Mr. Rustand.
The result is that Mr. Ramsey and Mr. Bolin have been dismissed from the
Ruble v. Rural/Metro case although the Court has permitted plaintiffs leave
to file another complaint against those individuals. Mr. Rustand and the
Company remain defendants.
The parties have commenced discovery in the Ruble v. Rural/Metro case.
During discovery, the parties conduct investigation through formal
processes such as depositions, subpoenas and requests for production of
documents. This phase is currently expected to run through November 2003.
In addition, Plaintiffs have moved to certify the class in the Ruble v.
Rural/Metro case. Defendants, without waiving the right to object in the
future, at this juncture expect to stipulate to the certification of the
class.
27
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
The Company and the individual defendants are insured by primary and excess
insurance policies, which were in effect at the time the lawsuits were
filed (the "D&O Policies"). The Company's primary carrier had been funding
the costs of the litigation and attorney's fees over approximately the last
four years. Recently, however, the Company's primary carrier notified all
defendants that it is taking the position that there is no coverage. The
primary carrier purports to base this decision on the actions of one of the
Company's former officers, whom the primary carrier claims assisted the
Plaintiffs in the Ruble v. Rural/Metro case in such a way as to trigger an
exclusion under the policy. The Company and the carrier have agreed in
principle to an interim funding agreement, subject to final documentation
under which the carrier would advance defense costs in the underlying
litigations pending a court determination of the coverage dispute. While
the Company intends to vigorously pursue its rights under the D&O Policies,
the Company is unable to predict with certainty the outcome of these
matters. A final and binding adverse judgment on the coverage dispute could
have a material adverse effect on the Company's business, financial
condition, cash flows and results of operations. Based on the information
currently available, the Company does not have the ability to estimate it's
potential liability, if any, related to this matter.
The Company, Arthur Andersen LLP, Cor Clement and Jane Doe Clement, Randall
L. Harmsen and Jane Doe Harmsen, Warren S. Rustand and Jane Doe Rustand,
James H. Bolin and Jane Doe Bolin, Jack E. Brucker and Jane Doe Brucker,
Robert B. Hillier and Jane Doe Hillier, John S. Banas III and Jane Doe
Banas, Louis G. Jekel and Karen Whitmer, Mary Anne Carpenter and John Doe
Carpenter, William C. Turner and Jane Doe Turner, Henry G. Walker and Jane
Doe Walker, Louis A. Witzeman and Jane Doe Witzeman, John Furman and Jane
Doe Furman, and Mark Liebner and Jane Doe Liebner were named as defendants
in a purported class action lawsuit: STEVEN A. SPRINGBORN V. RURAL/METRO
CORPORATION, ET AL., Civil Action No. CV 2002-019020 filed on September 30,
2002 in Maricopa County, Arizona Superior Court. The lawsuit was brought on
behalf of a class of persons who purchased our publicly traded securities
including our common stock from July 1, 1996 through June 30, 2001. The
primary allegations of the complaint include violations of various state
and federal securities laws, breach of contract, common law fraud, and
mismanagement of the Company's 401(k) plan, Employee Stock Purchase Plan
and Employee Stock Ownership Plan. The Plaintiffs seek unspecified
compensatory and punitive damages. The Plaintiffs amended the Complaint on
October 17, 2002 adding Barry Landon and Jane Doe Landon as defendents and
making certain additional allegations and claims. On October 30, 2002,
Defendant Arthur Andersen LLP removed the action to the United States
District Court, District of Arizona, CIV-02-2183-PHX-JWS. The Company and
the individual defendants have consented to this removal. The Company and
the individual defendants have been served with the summons and complaint
and are in the process of responding to the Amended Complaint. Based on the
information currently available, the Company does not have the ability to
estimate it's potential liability, if any, related to this matter.
As previously reported, LaSalle Ambulance, Inc., a New York corporation
which is a subsidiary of Rural/Metro Corporation, was sued in the case of
Ann Bogucki and Patrick Bogucki v. LaSalle Ambulance Service, et al., Index
No. I 1995 2128, in the Supreme Court of the State of New York, Erie
County. In January 2003, the parties reached an agreement in principle to
settle the matter. The agreement in principle, which does not result in the
Company recording any additional claims expense, provides for a full
release of LaSalle Ambulance in April 2003 subject to completion of final
settlement documentation and plaintiff's receipt of agreed consideration.
28
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
GENERAL LIABILITY AND WORKERS' COMPENSATION POLICIES
With respect to the Company's liability insurance policies (including it's
general liability, auto liability and professional liability policies) for
the policy years commencing in June 2000, 2001 and 2002, the Company is
required by each policy to set aside $100,000 per month into a designated
"loss fund" account which cash is restricted to the payment of our
retention obligations as required under such policies. The Company expects
to fund these deposits on a monthly basis in subsequent years until such
time as the total loss fund deposits equal the contractual ceiling on our
aggregate retention obligation under these policies. The loss fund balances
vary during the course of the year depending upon the frequency and
severity of claims payments; however, the Company typically maintains a
minimum balance in each loss fund of at least $250,000. If claims payments
within the Company's retention layer exceed the applicable loss fund
balance required for that policy year, the current monthly funding
obligation will be accelerated to the extent of such excess. Such
accelerated payments could have a material adverse effect on the Company's
business, financial condition, results of operations and cash flows.
The Company's liability insurance policies for the policy years commencing
in June 2000 and June 2001 were issued by Legion Insurance Company (Legion)
as fronting carrier and are 100% reinsured by an "A++" rated insurance
carrier unrelated to Legion. At the time the coverage was purchased, Legion
was an "A" rated insurance carrier. Under these policies, the obligation of
the reinsurer to pay covered losses effectively commences once the Company
satisfies it's self-insured retention obligations on a per occurrence or
aggregate basis. As of December 31, 2002, all closed liability claims under
these policies have been resolved within the retention layer. However, as
remaining claims develop, the Company anticipates that the retention layer
will be exhausted, at which point the reinsurer will be obligated to fund
all losses and expenses related to such claims. On April 1, 2002, the
Pennsylvania Insurance Department (the "Department") placed Legion under
rehabilitation. The Department is conducting the rehabilitation process,
subject to judicial review by the Commonwealth Court of Pennsylvania. Based
upon the information currently available, the Company believes that it's
reinsurance proceeds will be available to pay claims in excess of the
retention as originally contracted notwithstanding the rehabilitation
process. However, if the Court deems the Company's reinsurance to be a
general asset of Legion, then reinsurance proceeds to fund covered
liability losses in excess of the retention may be substantially reduced,
delayed or unrecoverable. In such an event, the Company may be required to
fund liability losses for these policy years in excess of the retention to
the extent that such losses are not covered by state guaranty funds
(whether due to liability coverage caps or other circumstances applicable
to such guaranty funds).
For the policy year commencing May 1, 2001 through May 1, 2002, the Company
purchased a workers' compensation policy issued by Legion, which included a
deductible to be paid by the Company for each occurrence (subject to an
aggregate maximum limit). The Company also concurrently purchased a
deductible reimbursement policy issued by Mutual Indemnity (Bermuda) Ltd.
(Mutual Indemnity), an affiliate of Legion. The deductible reimbursement
policy requires Mutual Indemnity to fully cover the Company's deductible
obligations under the workers compensation policy. Under the deductible
reimbursement policy, the Company pre-paid all of it's anticipated
deductible obligations for the policy year by making contributions of
approximately $6.5 million into a loss fund account held by Mutual
Indemnity.
As noted above, the Department placed Legion into rehabilitation in April
2002. In January 2003, the Commonwealth Court of Pennsylvania ordered the
Legion rehabilitator and Mutual Indemnity to establish a trust account, to
be funded by deposits held by Mutual Indemnity (including deposits in our
loss fund account), for the benefit of the insureds which had placed the
29
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
deposits with Mutual Indemnity. It is the Company's understanding that the
Legion rehabilitator intends to appeal the decision of the court to enforce
this trust mechanism and that the rehabilitator has asserted, on behalf of
Legion, that funds held by Mutual Indemnity (including deposits in our loss
fund account) are assets of Legion that should be available to its general
creditors. Pending resolution of this matter, Mutual Indemnity has
suspended funding workers compensation claims from the amounts we
previously deposited with it and some claims are being handled by state
guaranty funds or paid directly by the Company. The Company believes the
rehabilitator's appeal lacks merit based upon the facts and circumstances.
The Company is actively participating in the court proceedings to cause
such a trust account mechanism to be created and to operate so as to fully
cover all it's deductible obligations as originally intended and to return
to the Company any remaining deposit balance once all claims are closed.
However, if the funds on deposit with Mutual Indemnity are determined to be
general assets of Legion, then use of the Company's loss fund deposits to
pay workers compensation claims within it's deductible may be substantially
reduced, delayed or unrecoverable. In such an event, the Company may be
required to fund the deductible portion of workers compensation claims
arising in this policy year, without access to existing deposits in the
loss fund account held by Mutual Indemnity. To the extent that workers'
compensation claims exceed our deductible portion, the Company currently
anticipates that the applicable state guaranty funds will provide coverage
for such excess at no additional cost to the Company.
During fiscal years 1992 through 2001, the Company purchased certain
portions of it's workers' compensation coverage from Reliance Insurance
Company ("Reliance"). At the time coverage was purchased, Reliance was an
"A" rated insurance company. In connection with this coverage, the Company
provided Reliance with various amounts and forms of collateral (e.g.,
letters of credit, surety bonds and cash deposits) to secure it's
performance under the respective policies as was customary and required in
the workers' compensation marketplace at the time. As of December 31, 2002,
Reliance held $3.0 million of cash collateral under this coverage. On May
29, 2001, Reliance was placed under rehabilitation by the Department and on
October 3, 2001 was placed into liquidation. It is the Company's
understanding that the collateral held by the Reliance liquidator will be
returned to it once all related claims have been satisfied so long as we
have satisfied the claim payment obligations under the related policies. To
the extent that certain of the Company's workers' compensation claims have
exceeded the deductible under the Reliance policies, the applicable state
guaranty funds have provided such excess coverage at no additional cost to
the Company. We currently anticipate that the state guaranty funds will
continue to provide such excess coverage.
Based upon the information currently available, the Company believes that
the amounts on deposit with Reliance and Mutual Indemnity are fully
recoverable and will either be returned to the Company or used to pay
claims on our behalf as originally intended, and that state guaranty funds
will provide coverage for claims in excess of the deductible. The Company
further believe that reinsurance proceeds for it's liability policies for
policy years commencing in June 2000 and June 2001 will be available to
cover claims in excess of the retention as originally intended or that
state guaranty funds will provide coverage for such excess subject to
applicable limitations. The Company's inability to access the funds on
deposit with Reliance or Mutual Indemnity or to access our liability
reinsurance proceeds, or claims in excess of the deductible or retention
limitations that are not covered by state guaranty funds, could have a
material adverse effect on the Company's business, financial condition,
results of operations and cash flows.
30
RURAL/METRO CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FIRE CONTRACT
The Company was recently notified that an initiative to form a municipal
fire department in one of the municipalities to which it provides fire
protection services, would be voted on in May 2003. Should the initiative
pass, the Company's contract will be terminated. This contract represented
$4.2 million and $8.4 million of net revenue for the three and six months
ended December 31, 2002, respectively.
31
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT RESULTS
Statements in this Report that are not historical facts are hereby identified as
"forward-looking statements" as that term is used under the securities laws. We
caution readers that such "forward-looking statements," including those relating
to our future business prospects, working capital, accounts receivable
collection, liquidity, cash flow, capital needs, operating results and
compliance with debt facilities, wherever they appear in this Report or in other
statements attributable to us, are necessarily estimates reflecting our best
judgment and involve a number of risks and uncertainties that could cause actual
results to differ materially from those suggested by the "forward-looking
statements." You should consider such "forward looking-statements" in light of
various important factors, including those set forth below and others set forth
from time to time in our reports and registration statements filed with the
Securities and Exchange Commission.
All references to "we," "our," "us," or "Rural/Metro" refer to Rural/Metro
Corporation, and its predecessors, operating divisions, direct and indirect
subsidiaries, and affiliates. Rural/Metro Corporation, a Delaware corporation,
is strictly a holding company. All services, operations, and management
functions are provided through its subsidiaries and affiliated entities.
This Report should be read in conjunction with our Annual Report on Form 10-K,
as amended, for the fiscal year ended June 30, 2002.
INTRODUCTION
We derive our revenue primarily from fees charged for ambulance and fire
protection services. We provide ambulance services in response to emergency
medical calls (911 emergency ambulance services) and non-emergency transport
services (general transport services) to patients on both a fee-for-service and
nonrefundable subscription fee basis. Per transport revenue depends on various
factors, including the mix of rates between existing markets and new markets and
the mix of activity between 911 emergency ambulance services and non-emergency
transport services as well as other competitive factors. Fire protection
services are provided either under contracts with municipalities, fire districts
or other agencies or on a nonrefundable subscription fee basis to individual
homeowners or commercial property owners.
Medical transportation and related services revenue includes 911 emergency and
non-emergency ambulance and alternative transportation service fees as well as
municipal subsidies and subscription fees. Ambulance and alternative
transportation service fees are recognized as the services are provided and are
recorded net of estimated Medicare, Medicaid and other contractual discounts.
Ambulance subscription fees, which are generally received in advance, are
deferred and recognized on a pro rata basis over the term of the subscription
agreement, which is generally one year.
Payments received from third-party payers represent a substantial portion of our
ambulance service fee receipts. We maintain an allowance for Medicare, Medicaid
and contractual discounts and doubtful accounts based on credit risks applicable
to certain types of payers, historical collection trends and other relevant
information. This allowance is examined on a quarterly basis and is revised for
changes in circumstances surrounding the collectibility of receivables.
Provisions for Medicare, Medicaid and contractual reimbursement limitations are
included in the calculation of medical transportation services revenue.
Because of the nature of our ambulance services, it is necessary to respond to a
number of calls, primarily 911 emergency ambulance service calls, which may not
result in transports. Results of operations are discussed below on the basis of
actual transports because transports are more directly related to revenue.
Expenses associated with calls that do not result in transports are included in
operating expenses. The percentage of calls not resulting in transports varies
substantially depending upon the mix of non-emergency ambulance and 911
emergency ambulance service calls in individual markets and is generally higher
in service areas in which the calls are primarily 911 emergency ambulance
service calls. Rates in our markets take into account the anticipated number of
32
calls that may not result in transports. We do not separately account for
expenses associated with calls that do not result in transports.
Revenue generated under fire protection service contracts is recognized over the
life of the contract. Subscription fees received in advance are deferred and
recognized over the term of the subscription agreement, which is generally one
year.
Other revenue primarily consists of revenue generated from dispatch, fleet,
billing, training and home health care services and is recognized when the
services are provided.
CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS
The discussion and analysis of our financial condition and results of operations
is based upon our financial statements, which have been prepared in accordance
with accounting principles generally accepted in the United States of America.
In connection with the preparation of these financial statements, we are
required to make estimates and judgments that affect the reported amounts of
assets, liabilities, revenue, and expenses, and related disclosure of contingent
assets and liabilities. On an ongoing basis, we evaluate our estimates,
including those related to revenue recognition, allowance for Medicare, Medicaid
and other contractual discounts and doubtful accounts, and general liability and
workers' compensation claim reserves. We base our estimates on historical
experience and on various other assumptions that we believe are reasonable under
the circumstances. Such historical experience and assumptions 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.
We have identified the accounting policies below as critical to our business
operations and the understanding of our results of operations. The impact of
these policies on our business operations is discussed throughout Management's
Discussion and Analysis of Financial Condition and Results of Operations where
such policies affect our reported and expected financial results. The discussion
below is not intended to be a comprehensive list of our accounting policies. For
a detailed discussion on the application of these and other accounting policies,
see Note 1 in the Notes to the Consolidated Financial Statements included in our
Annual Report on Form 10-K, as amended, for the year ended June 30, 2002, which
contains accounting policies and other disclosures required by accounting
principles generally accepted in the United States of America.
MEDICAL TRANSPORTATION AND RELATED FEE REVENUE RECOGNITION -- Ambulance and
alternative transportation service fees are recognized when services are
provided and are recorded net of a provision for Medicare, Medicaid, and other
contractual reimbursement limitations. Because of the length of the collection
cycle with respect to ambulance and alternative transportation service fees, it
is necessary to estimate the amount of these reimbursement limitations at the
time revenue is recognized. Estimates of amounts uncollectible due to such
reimbursement limitations are based on historical collection data, historical
write-off activity and current relationships with payers, and are computed
separately for each service area. The estimated uncollectibility is translated
into a percentage of total revenue which is applied to calculate the provision.
If the historical data used to calculate these estimates does not properly
reflect the collectibility of the current revenue stream, revenue could be
overstated or understated. Provisions made for reimbursement limitations on
ambulance and alternative transportation service fees are included in the
calculation of medical transportation and related service revenue and totaled
$32.9 million and $32.3 million for the three months ended December 31, 2002 and
2001, respectively and $66.5 and $66.3 for the six months ended December 31,
2002 and 2001, respectively.
PROVISION FOR DOUBTFUL ACCOUNTS FOR MEDICAL TRANSPORTATION AND RELATED FEES --
Ambulance and alternative transportation service fees are billed to various
payer sources. As discussed above, provisions for uncollectibility due to
Medicare, Medicaid and contractual reimbursement limitations are recorded as
provisions against revenue. We estimate additional provisions related to the
potential uncollectibility of other payers based on historical collection data
and historical write-off activity. The provision for doubtful accounts
percentage that is applied to ambulance and alternative transportation service
33
fee revenue is calculated as the difference between the total expected
collection percentage less provision percentages applied for Medicare, Medicaid
and contractual reimbursement limitations. If historical data used to calculate
these estimates does not properly reflect the collectibility of the current net
revenue stream, the provision for doubtful accounts may be overstated or
understated. The provision for doubtful accounts on ambulance and alternative
transportation service revenue totaled $19.0 million and $16.5 million for the
three months ended December 31, 2002 and 2001, respectively and $37.7 million
and $33.2 million for the six months ended December 31, 2002 and 2001,
respectively.
WORKERS' COMPENSATION RESERVES -- Beginning May 1, 2002, we purchased a
corporate-wide "first-dollar" workers' compensation insurance policy, under
which we have no obligation to pay any deductible amounts on claims occurring
during the policy period. This policy covers all workers' compensation claims
made by our employees. Accordingly, provisions for workers' compensation expense
for claims arising on and after May 1, 2002 are reflective of premium costs
only. Prior to May 1, 2002, our workers' compensation policies included a
deductible obligation of $250,000 per claim, which was increased in recent years
to $500,000 per claim, with no aggregate limit. Claims relating to these prior
policy years remain outstanding. Claim reserves were estimated based on
historical claims data and the ultimate projected value of those claims. For
claims occurring prior to May 1, 2002, our third-party administrator established
initial estimates at the time a claim was reported and periodically reviews the
development of the claim to confirm that the estimates are adequate. In fiscal
2002, we engaged an outside insurance expert to review the estimates set by our
third-party administrator on certain claims and to participate in our periodic
internal claim reviews. We also periodically engage actuaries to assist us in
the determination of the adequacy of our workers' compensation claim reserves.
If the ultimate development of these claims is significantly different than
those that have been estimated, the reserves for workers' compensation claims
could be overstated or understated. Reserves related to workers' compensation
claims totaled $13.0 million and $15.9 million at December 31, 2002 and June 30,
2002, respectively.
GENERAL LIABILITY RESERVES -- We are subject to litigation arising in the
ordinary course of our business. In order to minimize the risk of our exposure,
we maintain certain levels of coverage for comprehensive general liability,
automobile liability, and professional liability claims. Internally and
throughout this report, we refer to these three types of policies collectively
as "general liability" policies. The coverage provided by these policies
currently is, and historically has been, subject to a retention or deductible.
Provisions are made to record the cost of premiums as well as that portion of
the claims that is our responsibility. In general, our retention obligation for
policies issued in fiscal years prior to 2001 ranges from $100,000 to $250,000
per claim (with no aggregate limit), depending on the policy year and line of
coverage. Beginning in fiscal 2001, our deductible amount increased to
$1,000,000 per claim; however, we also purchased a liability ceiling for each of
those policy years, which permanently caps our maximum aggregate retention
obligation. Our third-party administrator establishes initial estimates at the
time a claim is reported and periodically reviews the development of the claim
to confirm that the estimates are adequate. In fiscal 2002, we engaged an
outside insurance expert to review the estimates set by our third-party
administrator on certain claims and to participate in our periodic internal
reviews. We also periodically engage actuaries to assist us in the determination
of our general liability claim reserves. If the ultimate development of these
claims is significantly different than those that have been estimated, the
reserves for general liability claims could be overstated or understated.
Reserves related to general liability claims totaled $14.8 million and $15.4
million at December 31, 2002 and June 30, 2002, respectively.
Two of the Company's insurers under its general liability and workers
compensation programs for various policy years have entered rehabilitation or
liquidation proceedings in Pennsylvania. See "Liquidity and Capital Resources."
CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS
We have certain cash contractual obligations related to our debt instruments
that come due at various times. In addition, we have other commitments in the
form of standby letters of credit and surety bonds. As reported in our 2002
Annual Report on Form 10-K, as amended, we have contractual obligations related
34
to our credit facility of $152.4 million and Senior Notes of $150.0 million, as
well as other commitments related to standby letters of credit of $3.5 million
and preferred stock redemption amounts totaling $15.0 million. Other contractual
obligations for capital leases and notes payable and operating leases as well as
commitments related to surety bonds have not changed substantially since
year-end.
THREE MONTHS ENDED DECEMBER 31, 2002 COMPARED TO THREE MONTHS ENDED DECEMBER 31,
2001
REVENUE
Net revenue increased approximately $9.2 million, or 8.0%, from $114.3 million
for the three months ended December 31, 2001 to $123.5 million for the three
months ended December 31, 2002.
MEDICAL TRANSPORTATION AND RELATED SERVICES -- Medical transportation and
related service revenue increased $6.8 million, or 7.1%, from $96.1 million for
the three months ended December 31, 2001 to $102.9 million for the three months
ended December 31, 2002. This increase is comprised of a $7.7 million increase
in same service area revenue attributable to rate increases, call screening and
other factors. Additionally, there was a $700,000 increase in revenue related to
a new 911 contract that went into effect during the first quarter of fiscal 2003
offset by a $1.5 million decrease related to service areas identified for
closure in fiscal 2001.
Total transports, including alternative transportation, decreased 14,000, or
4.8%, from approximately 294,000 (approximately 256,000 ambulance and
approximately 38,000 alternative transportation) for the three months ended
December 31, 2001 to approximately 280,000 (approximately 257,000 ambulance and
approximately 23,000 alternative transportation) for the three months ended
December 31, 2002. Service areas identified for closure in fiscal 2001 accounted
for a decrease of approximately 4,000 transports. Transports in areas that we
served in both the three months ended December 31, 2002 and 2001 decreased by
approximately 11,000 transports. These decreases were offset by an increase of
approximately 1,000 transports related to a new 911 contract that went into
effect during the first quarter of fiscal 2003.
FIRE AND OTHER -- Fire protection services revenue increased by $1.8 million, or
11.8%, from $15.3 million for the three months ended December 31, 2001 to $17.1
million for the three months ended December 31, 2002. Fire protection services
revenue increased primarily due to rate and utilization increases in our
subscription fire programs of $759,000 and rate increases on existing contracts
and additional fire contracts of $718,000. We were notified that an initiative
to form a municipal fire department in one of the municipalities to which we
provide fire protection services would be voted on in May 2003. Should the
initiative pass, our contract with the municipality would be terminated. This
contract represented $4.2 million of fire protection services revenue for the
three months ended December 31, 2002.
Other revenue increased by $600,000, or 20.7%, from $2.9 million for the three
months ended December 31, 2001 to $3.5 million for the three months ended
December 31, 2002. Other revenue increases are primarily related to increased
revenue related to the public/private alliance with the City of San Diego of
$311,000.
OPERATING EXPENSES
PAYROLL AND EMPLOYEE BENEFITS -- Payroll and employee benefit expenses increased
approximately $4.3 million, or 6.5%, from approximately $65.9 million for the
three months ended December 31, 2001 to $70.2 million for the three months ended
December 31, 2002. The increase is primarily related to increased workers
compensation expense of $1.1 million due to increased insurance rates as well as
general wage increases. Payroll and employee benefits as a percentage of net
revenue was 56.8% for the three months ended December 31, 2002 compared to 57.7%
for the three months ended December 31, 2001 with the decrease attributable to
increased rates on medical transportation revenue.
35
PROVISION FOR DOUBTFUL ACCOUNTS -- The provision for doubtful accounts increased
$2.4 million, or 14.5%, from $16.6 million, or 14.5% of total revenue, for the
three months ended December 31, 2001 to $19.0 million, or 15.4% of total
revenue, for the three months ended December 31, 2002.
The provision for doubtful accounts on ambulance and alternative transportation
service revenue was 19.2% for the three months ended December 31, 2002 and 17.9%
for the three months ended December 31, 2001. The increase primarily reflects
the mix between ambulance and alternative transportation services as well as
slightly increased bad debt rates on ambulance services. The bad debt rate on
alternative transportation services is significantly lower than that on
ambulance services. Due to the Company's restructuring efforts, revenue relating
to alternative transportation services is becoming a smaller percentage of our
overall medical transportation revenue. Ambulance services bad debt as a
percentage of ambulance service revenue was 19.4% for the three months ended
December 31, 2002 and 18.2% for the three months ended December 31, 2001.
DEPRECIATION - Depreciation decreased $0.6 million, or 15.4%, from $3.9 million
for the three months ended December 31, 2001 to $3.3 million for the three
months ended December 31, 2002. The decrease is primarily due to decreased
capital expenditures in recent years. Depreciation was 3.4% and 2.9% of net
revenue for the three months ended December 31, 2001 and 2002, respectively.
OTHER OPERATING EXPENSES -- Other operating expenses consist primarily of rent
and related occupancy expenses, vehicle and equipment maintenance and repairs,
insurance, fuel and supplies, travel, and professional fees. Other operating
expenses increased approximately $800,000, or 3.6%, from $22.4 million for the
three months ended December 31, 2001 to $23.2 million for the three months ended
December 31, 2002. The increase in other operating expenses is primarily due to
increases in general liability expenses of $1.0 million due to increased premium
rates in the new policy year as well as general increases in other operating
expense categories. These increases were offset by the reversal of a portion of
the fiscal 2001 restructuring charge. A charge was recorded in fiscal 2001
relating to an underperforming service area that we had planned to exit at the
time of contract expiration in December 2001. During fiscal 2002, the contract
was extended for a one-year period at the request of the municipality to enable
it to transition medical transportation service to a new provider. The operating
environment in this service area has improved and we were awarded a new
multi-year contract. The contract related to this award was finalized during the
three months ended December 31, 2002 and as a result, the remaining reserve of
$1.3 million was released to income. Other operating expenses decreased from
19.6% of net revenue for the three months ended December 31, 2001 to 18.8% of
net revenue for the three months ended December 31, 2002 (19.9% excluding the
reversal of the fiscal 2001 restructuring charge described above).
INTEREST EXPENSE -- Interest expense increased by $1.8 million, or 31.6%, from
$5.7 million for the three months ended December 31, 2001 to $7.5 million for
the three months ended December 31, 2002. This increase was primarily caused by
increased effective rates due to the renegotiation of the credit facility.
Amortization of deferred financing costs totaled $913,000 in the three months
ended December 31, 2002. In addition, the average rate charged on the credit
facility increased from 7.75% for the three months ended December 31, 2001 to
8.71% for the three months ended December 31, 2002. The principal balance on the
credit facility was $141.8 million at December 31, 2001 compared to $152.4
million at December 31, 2002. See further discussion on the amended credit
facility, which became effective September 30, 2002, in "Liquidity and Capital
Resources."
INCOME TAXES -- We recorded an income tax provision of $55,000 for the three
months ended December 31, 2002 as compared to an income tax benefit of $1.6
million for the three months ended December 31, 2001. The provision for the
three months ended December 31, 2002 is primarily related to provisions for
state income taxes. The benefit recorded in the three months ended December 31,
2001 is primarily related to a $1.6 million income tax refund received during
the period.
INCOME (LOSS) FROM DISCONTINUED OPERATIONS - Due to the deteriorating economic
conditions and continued devaluation of the local currency, we reviewed our
strategic alternatives with respect to the continuation of operations in Latin
36
America, including Argentina and Bolivia, and determined that we would benefit
from focusing on our domestic operations. Effective September 27, 2002, we sold
our Latin American operations to local management in exchange for the assumption
of net liabilities. Our Latin American operations generated $1.7 million of
income for the three months ended December 31, 2001.
SIX MONTHS ENDED DECEMBER 31, 2002 COMPARED TO SIX MONTHS ENDED DECEMBER 31,
2001
REVENUE
Net revenue increased approximately $18.2 million, or 7.9%, from $230.8 million
for the six months ended December 31, 2001 to $249.0 million for the six months
ended December 31, 2002.
MEDICAL TRANSPORTATION AND RELATED SERVICES -- Medical transportation and
related service revenue increased $12.8 million, or 6.6%, from $193.9 million
for the six months ended December 31, 2001 to $206.7 million for the six months
ended December 31, 2002. This increase is comprised of a $15.7 million increase
in same service area revenue attributable to rate increases, call screening and
other factors. Additionally, there was a $1.3 million increase in revenue
related to a new 911 contract that went into effect during the first quarter of
fiscal 2003 offset by a $2.0 million decrease related to the loss of the 911
contract in Arlington, Texas and a $2.2 million decrease related to service
areas identified for closure in fiscal 2001.
Total transports, including alternative transportation, decreased 30,000, or
5.0%, from approximately 598,000 (approximately 521,000 ambulance and
approximately 77,000 alternative transportation) for the six months ended
December 31, 2001 to approximately 568,000 (approximately 520,000 ambulance and
approximately 48,000 alternative transportation) for the six months ended
December 31, 2002. The loss of the 911 contract in Arlington, Texas accounted
for a decrease of approximately 4,000 transports. Service areas identified for
closure in fiscal 2001 accounted for a decrease of approximately 8,000
transports. Transports in areas that we served in both the six months ended
December 31, 2002 and 2001 decreased by approximately 20,000 transports. These
decreases were offset by an increase of approximately 2,000 transports related
to a new 911 contract that went into effect during the first quarter of fiscal
2003.
FIRE AND OTHER -- Fire protection services revenue increased by approximately
$4.1 million, or 13.3%, from approximately $30.9 million for the six months
ended December 31, 2001 to approximately $35.0 million for the six months ended
December 31, 2002. Fire protection services revenue increased primarily due to
increases in forestry revenue of $1.0 million due to a particularly active
wildfire season and to rate and utilization increases in our subscription fire
programs of $1.5 million and rate increases on existing contracts and additional
fire contracts of $1.3 million. We were notified that an initiative to form a
municipal fire department in one of the municipalities to which we provide fire
protection services would be voted on in May 2003. Should the initiative pass,
our contract with the municipality would be terminated. This contract
represented $8.4 million of fire protection services revenue for the six months
ended December 31, 2002.
Other revenue increased by $1.4 million, or 23.3%, from $6.0 million for the six
months ended December 31, 2001 to $7.4 million for the six months ended December
31, 2002. Other revenue increases are primarily related to increased revenue
related to the public/private alliance with the City of San Diego of $834,000.
OPERATING EXPENSES
PAYROLL AND EMPLOYEE BENEFITS -- Payroll and employee benefit expenses increased
approximately $7.1 million, or 5.3%, from approximately $134.2 million for the
six months ended December 31, 2001 to $141.3 million for the six months ended
December 31, 2002. The increase is primarily related to increased workers
compensation expense of $588,000 due to increased insurance rates as well as
general wage increases. Additionally, there was an increase of $814,000 in
management incentives which is primarily reflective of a $500,000 reversal made
in the six months ended December 31, 2001 for unused accrued amounts. Payroll
and employee benefits as a percentage of net revenue was 56.7% for the six
37
months ended December 31, 2002 compared to 58.1% for the six months ended
December 31, 2001 with the decrease attributable to increased rates on medical
transportation revenue.
PROVISION FOR DOUBTFUL ACCOUNTS -- The provision for doubtful accounts increased
$4.3 million, or 12.9%, from $33.4 million, or 14.5% of total revenue, for the
six months ended December 31, 2001 to $37.7 million, or 15.1% of total revenue,
for the six months ended December 31, 2002.
The provision for doubtful accounts on ambulance and alternative transportation
service revenue was 18.9% for the six months ended December 31, 2002 and 17.8%
for the six months ended December 31, 2001. The increase primarily reflects the
mix between ambulance and alternative transportation services as well as
slightly increased bad debt rates on ambulance services. The bad debt rate on
alternative transportation services is significantly lower than that on
ambulance services. Due to the Company's restructuring efforts, revenue relating
to alternative transportation services is becoming a smaller percentage of our
overall medical transportation revenue. Ambulance services bad debt as a
percentage of ambulance service revenue was 19.2% for the six months ended
December 31, 2002 and 18.0% for the six months ended December 31, 2001.
DEPRECIATION - Depreciation decreased $1.2 million, or 15.2%, from $7.9 million
for the six months ended December 31, 2001 to $6.7 million for the six months
ended December 31, 2002. The decrease is primarily due to decreased capital
expenditures in recent years. Depreciation was 3.4% and 2.7% of net revenue for
the six months ended December 31, 2001 and 2002, respectively.
OTHER OPERATING EXPENSES -- Other operating expenses consist primarily of rent
and related occupancy expenses, vehicle and equipment maintenance and repairs,
insurance, fuel and supplies, travel, and professional fees. Other operating
expenses increased approximately $1.8 million, or 4.1%, from $43.9 million for
the six months ended December 31, 2001 to $45.7 million for the six months ended
December 31, 2002. The increase in other operating expenses is primarily due to
increases in general liability expenses of $1.8 million due to increased premium
rates in the new policy year as well as general increases in other operating
expense categories. This increase was offset by the reversal of a portion of the
fiscal 2001 restructuring charge. A charge was recorded in fiscal 2001 relating
to an underperforming service area that we had planned to exit at the time of
contract expiration in December 2001. During fiscal 2002, the contract was
extended for a one-year period at the request of the municipality to enable it
to transition medical transportation service to a new provider. The operating
environment in this service area has improved and we were awarded a new
multi-year contract. The contract related to this award was finalized during the
six months ended December 31, 2002 and as a result, the remaining reserve of
$1.3 million was released to income. Other operating expenses decreased from
19.0% of net revenue for the six months ended December 31, 2001 to 18.4% of net
revenue for the six months ended December 31, 2002 (18.9% excluding the reversal
of the fiscal 2001 restructuring charge described above).
INTEREST EXPENSE -- Interest expense increased by approximately $900,000, or
7.2%, from $12.5 million for the six months ended December 31, 2001 to $13.4
million for the six months ended December 31, 2002. This increase was primarily
due to increased effective interest rates related to the renegotiation of the
credit facility. Amortization of deferred financing costs totaled $1.0 million
in the six months ended December 31, 2002 See further discussion on the amended
credit facility, which became effective September 30, 2002, in "Liquidity and
Capital Resources."
INCOME TAXES -- We recorded an income tax provision of $110,000 for the six
months ended December 31, 2002 as compared to an income tax benefit of $1.6
million for the six months ended December 31, 2001. The provision for the six
months ended December 31, 2002 is primarily related to provisions for state
income taxes. The benefit recorded in the six months ended December 31, 2001 is
primarily related to a $1.6 million income tax refund received during that
period.
INCOME (LOSS) FROM DISCONTINUED OPERATIONS - Due to the deteriorating economic
conditions and continued devaluation of the local currency, we reviewed our
strategic alternatives with respect to the continuation of operations in Latin
America, including Argentina and Bolivia, and determined that we would benefit
from focusing on our domestic operations. Effective September 27, 2002, we sold
our Latin American operations to local management in exchange for the assumption
38
of net liabilities. The gain on the disposition of our Latin American operations
totaled $12.5 million and is included in income from discontinued operations for
the six months ended December 31, 2002. Our Latin American operations generated
a loss of $156,000 and income of $1.5 million for the six months ended December
31, 2002 and 2001, respectively.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE -- We adopted the new rules
on accounting for goodwill and other intangible assets effective July 1, 2001.
Under the transitional provisions of Statement of Financial Accounting Standards
(SFAS) No. 142, "Goodwill and Other Intangible Assets," we performed impairment
tests on the net goodwill and other intangible assets associated with each of
our reporting units with the assistance of independent valuation experts, using
a valuation date of July 1, 2001, and determined that a transitional goodwill
impairment charge of $49.5 million, net of $0 income taxes, was required. This
impairment primarily relates to our medical transportation and related services
segment. The impairment charge is non-cash and non-operational in nature and is
reflected as a cumulative effect of change in accounting principle in the
accompanying consolidated statement of operations, retroactively applied to the
quarter ended September 30, 2001, in accordance with the provisions of SFAS No.
142.
LIQUIDITY AND CAPITAL RESOURCES
During the six months ended December 31, 2002, we recorded net income before the
accretion of redeemable preferred stock of $16.3 million compared with a net
loss of $47.5 million for the six months ended December 31, 2001. Net income for
the six months ended December 31, 2002 includes a gain on the disposal of our
Latin American operations of $12.5 million while the net loss for the six months
ended December 31, 2001 includes a charge of $49.5 million relating to the
adoption effective July 1, 2001 of the new goodwill standard. Cash provided by
operating activities totaled $4.9 million for the six months ended December 31,
2002 and $6.6 million for the six months ended December 31, 2001.
At December 31, 2002, we had cash of $9.0 million, total debt of $307.4 million
and a stockholders' deficit of $160.2 million. Our total debt at December 31,
2002 included $149.9 million of our 7 7/8% senior notes due 2008, $152.4 million
outstanding under our revolving credit facility, $4.2 million payable to a
former joint venture partner and $900,000 of capital lease obligations.
On September 30, 2002, we entered into an amended credit facility with our
lenders which, among other things, extended the maturity date of the facility
from March 16, 2003 through December 31, 2004, waived previous non-compliance,
and required the issuance to the lenders of 211,549 shares of our Series B
redeemable preferred stock.
Our ability to service our long-term debt, to remain in compliance with the
various restrictions and covenants contained in our credit agreements and to
fund working capital, capital expenditures and business development efforts will
depend on our ability to generate cash from operating activities which is
subject to, among other things, our future operating performance as well as to
general economic, financial, competitive, legislative, regulatory and other
conditions, some of which may be beyond our control.
If we fail to generate sufficient cash from operations, we may need to raise
additional equity or borrow additional funds to achieve our longer-term business
objectives. There can be no assurance that such equity or borrowings will be
available or, if available, will be at rates or prices acceptable to us.
Although there can be no assurances, management believes that cash flow from
operating activities coupled with existing cash balances will be adequate to
fund our operating and capital needs as well as enable us to maintain compliance
with our various debt agreements through December 31, 2003. To the extent that
actual results or events differ from our financial projections or business
plans, our liquidity may be adversely impacted.
39
During the six months ended December 31, 2002, cash flow provided by operations
was $5.0 million resulting primarily from net income of $16.3 million, offset by
the non-cash effect of the disposal of our Latin American operations of $13.7
million, non-cash depreciation and amortization expense of $6.8 million and
provision for doubtful accounts of $37.7 million. Additionally, cash flow from
operating activities was negatively impacted by a decrease in accrued
liabilities of $4.5 million and an increase in accounts receivable of $35.0
million. Cash flow provided by operations was $6.6 million for the six months
ended December 31, 2001.
Cash used in investing activities was $4.2 million for the six months ended
December 31, 2002 due primarily to capital expenditures of approximately $4.8
million offset by proceeds from the sale of property and equipment of $500,000.
Cash used in investing activities was $1.9 million for the six months ended
December 31, 2001, due to capital expenditures of $2.9 million net of proceeds
from the sale of property and equipment of $1.0 million.
Cash used in financing activities was approximately $1.5 million for the six
months ended December 31, 2002, primarily due to repayments on capital lease
obligations and other debt and cash paid for debt issuance costs. Cash used in
financing activities was approximately $1.8 million for the six months ended
December 31, 2001.
Our accounts receivable, net of the allowance for Medicare, Medicaid and
contractual discounts and doubtful accounts, were $95.8 million and $99.1
million as of December 31, 2002 and June 30, 2002, respectively. The decrease in
net accounts receivable is due to many factors, including the disposal of the
Latin American operations, collection of outstanding receivables related to
closed service areas and overall improvement in collections on existing
operations.
The allowance for Medicare, Medicaid, contractual discounts and doubtful
accounts was $32.7 million at June 30, 2002 compared to $30.6 million at
December 31, 2002. The change in the allowance for Medicare, Medicaid,
contractual discounts and doubtful accounts is due to the write-off of
uncollectible receivables offset by the current period provision for doubtful
accounts. We have instituted several initiatives to improve our collection
procedures. While management believes that we have a predictable method of
determining the realizable value of our accounts receivable, based on continuing
difficulties in the healthcare reimbursement environment, there can be no
assurance that there will not be additional future write-offs. See Risk Factors
- -- "We depend on reimbursements by third-party payers and individuals."
With respect to our liability insurance policies (including our general
liability, auto liability and professional liability policies) for the policy
years commencing in June 2000, 2001 and 2002, we are required by each policy to
set aside $100,000 per month into a designated "loss fund" account which cash is
restricted to the payment of our retention obligations as required under such
policies. We expect to fund these deposits on a monthly basis in subsequent
years until such time as our total loss fund deposits equal the contractual
ceiling on our aggregate retention obligation under these policies. The loss
fund balances vary during the course of the year depending upon the frequency
and severity of claims payments; however, we typically maintain a minimum
balance in each loss fund of at least $250,000. If claims payments within our
retention layer exceed the applicable loss fund balance required for that policy
year, our current monthly funding obligation will be accelerated to the extent
of such excess. Such accelerated payments could have a material adverse effect
on our business, financial condition, results of operations and cash flows.
Our liability insurance policies for the policy years commencing in June 2000
and June 2001 were issued by Legion Insurance Company (Legion) as fronting
carrier and are 100% reinsured by an "A++" rated insurance carrier unrelated to
Legion. At the time we purchased coverage, Legion was an "A" rated insurance
carrier. Under these policies, the obligation of our reinsurer to pay covered
losses effectively commences once we satisfy our self-insured retention
obligations on a per occurrence or aggregate basis. As of December 31, 2002, all
closed liability claims under these policies have been resolved within our
retention layer. However, as remaining claims develop, we anticipate that our
retention layer will be exhausted, at which point our reinsurer will be
40
obligated to fund all losses and expenses related to such claims. On April 1,
2002, the Pennsylvania Insurance Department (the "Department") placed Legion
under rehabilitation. The Department is conducting the rehabilitation process,
subject to judicial review by the Commonwealth Court of Pennsylvania. Based upon
the information currently available, we believe that our reinsurance proceeds
will be available to pay claims in excess of our retention as originally
contracted notwithstanding the rehabilitation process. However, if the Court
deems our reinsurance to be a general asset of Legion, then reinsurance proceeds
to fund covered liability losses in excess of our retention may be substantially
reduced, delayed or unrecoverable. In such an event, we may be required to fund
liability losses for these policy years in excess of our retention to the extent
that such losses are not covered by state guaranty funds (whether due to
liability coverage caps or other circumstances applicable to such guaranty
funds).
For the policy year commencing May 1, 2001 through May 1, 2002, we purchased a
workers' compensation policy issued by Legion, which included a deductible to be
paid by us for each occurrence (subject to an aggregate maximum limit). We also
concurrently purchased a deductible reimbursement policy issued by Mutual
Indemnity (Bermuda) Ltd. (Mutual Indemnity), an affiliate of Legion. The
deductible reimbursement policy requires Mutual Indemnity to fully cover our
deductible obligations under the workers compensation policy. Under the
deductible reimbursement policy, we pre-paid all of our anticipated deductible
obligations for the policy year by making contributions of approximately $6.5
million into a loss fund account held by Mutual Indemnity.
As noted above, the Department placed Legion into rehabilitation in April 2002.
In January 2003, the Commonwealth Court of Pennsylvania ordered the Legion
rehabilitator and Mutual Indemnity to establish a trust account, to be funded by
deposits held by Mutual Indemnity (including deposits in our loss fund account),
for the benefit of the insureds which had placed the deposits with Mutual
Indemnity. It is our understanding that the Legion rehabilitator intends to
appeal the decision of the court to enforce this trust mechanism and that the
rehabilitator has asserted, on behalf of Legion, that funds held by Mutual
Indemnity (including deposits in our loss fund account) are assets of Legion
that should be available to its general creditors. Pending resolution of this
matter, Mutual Indemnity has suspended funding workers compensation claims from
the amounts we previously deposited with it and some claims are being handled by
state guaranty funds or paid directly by us. We believe the rehabilitator's
appeal lacks merit based upon the facts and circumstances. We are actively
participating in the court proceedings to cause such a trust account mechanism
to be created and to operate so as to fully cover all our deductible obligations
as originally intended and to return to us any remaining deposit balance once
all claims are closed. However, if our funds on deposit with Mutual Indemnity
are determined to be general assets of Legion, then use of our loss fund
deposits to pay workers compensation claims within our deductible may be
substantially reduced, delayed or unrecoverable. In such an event, we may be
required to fund the deductible portion of workers compensation claims arising
in this policy year, without access to existing deposits in the loss fund
account held by Mutual Indemnity. To the extent that workers' compensation
claims exceed our deductible portion, we currently anticipate that the
applicable state guaranty funds will provide coverage for such excess at no
additional cost to us.
During fiscal years 1992 through 2001, we purchased certain portions of our
workers' compensation coverage from Reliance Insurance Company ("Reliance"). At
the time we purchased the coverage, Reliance was an "A" rated insurance company.
In connection with this coverage, we provided Reliance with various amounts and
forms of collateral (e.g., letters of credit, surety bonds and cash deposits) to
secure our performance under the respective policies as was customary and
required in the workers' compensation marketplace at the time. As of December
31, 2002, Reliance held $3.0 million of cash collateral under this coverage. On
May 29, 2001, Reliance was placed under rehabilitation by the Department and on
October 3, 2001 was placed into liquidation. It is our understanding that the
collateral held by the Reliance liquidator will be returned to us once all
related claims have been satisfied so long as we have satisfied our claim
payment obligations under the related policies. To the extent that certain of
our workers' compensation claims have exceeded our deductible under the Reliance
policies, the applicable state guaranty funds have provided such excess coverage
41
at no additional cost to us. We currently anticipate that the state guaranty
funds will continue to provide such excess coverage.
Based upon the information currently available, we believe that the amounts on
deposit with Reliance and Mutual Indemnity are fully recoverable and will either
be returned to us or used to pay claims on our behalf as originally intended,
and that state guaranty funds will provide coverage for claims in excess of our
deductible. We further believe that reinsurance proceeds for our liability
policies for policy years commencing in June 2000 and June 2001 will be
available to cover claims in excess of our retention as originally intended or
that state guaranty funds will provide coverage for such excess subject to
applicable limitations. Our inability to access the funds on deposit with
Reliance or Mutual Indemnity or to access our liability reinsurance proceeds, or
claims in excess of our deductible or retention limitations that are not covered
by state guaranty funds, could have a material adverse effect on our business,
financial condition, results of operations and cash flows.
We had working capital of $42.2 million at December 31, 2002, including cash of
$9.0 million compared with working capital of $27.5 million, including cash of
$9.8 million at June 30, 2002. The increase in working capital is primarily due
to the $15.8 million decrease in accrued liabilities which is related to a
decrease in accrued interest due to the conversion of accrued interest to
principal in the amended credit facility as well as the assumption of the
Argentine liabilities by the buyer in the disposition of our Latin American
operations.
In March 1998, we entered into a $200.0 million revolving credit facility
originally scheduled to mature March 16, 2003. The credit facility is unsecured
and was unconditionally guaranteed on a joint and several basis by substantially
all of our domestic wholly owned current and future subsidiaries. Interest rates
and availability under the revolving credit facility depended on our meeting
certain financial covenants, including total debt leverage ratios, total debt to
capitalization ratios, and fixed charge ratios.
The revolving credit facility initially was priced at the greater of (i) prime
rate or Federal Funds rate plus 0.5% plus the applicable margin, or (ii) a
LIBOR-based rate. The LIBOR-based rates ranged from LIBOR plus 0.875% to LIBOR
plus 1.75%.
In December 1999, primarily as a result of additional provisions for doubtful
accounts, we were not in compliance with three financial covenants under the
revolving credit facility: total debt leverage ratio, total debt to total
capitalization ratio and fixed charge coverage ratio. We received a series of
compliance waivers regarding the financial covenants covering the periods from
December 31, 1999 through April 1, 2002. The waivers provided among other
things, for enhanced reporting and other requirements and that no additional
borrowings would be available to us.
Pursuant to the waivers, as LIBOR contracts expired in March 2000, all
borrowings were priced at prime rate plus 0.25 percentage points and interest
became payable monthly. Pursuant to the waivers, we also were required to accrue
additional interest expense at a rate of 2.0% per annum on the outstanding
balance on the revolving credit facility. We recorded approximately $7.4 million
of additional interest expense through September 30, 2002. In connection with
the waivers, we also made principal payments in an aggregate amount of $5.2
million.
Effective September 30, 2002, we entered into an amended credit facility
pursuant to which, among other things, the maturity date of the credit facility
was extended to December 31, 2004 and our prior noncompliance was permanently
waived.
The principal terms of the amended and restated credit agreement are as
follows:
* WAIVER. Prior noncompliance was permanently waived with respect to the
covenant violations described above and with respect to certain other
noncompliance items, including non-reimbursement of approximately $2.6
42
million drawn by beneficiaries under letters of credit issued under the
original facility.
* MATURITY DATE. The maturity date of the facility was extended to December
31, 2004.
* PRINCIPAL BALANCE. Accrued interest (approximately $6.9 million),
non-reimbursed letters of credit and various fees and expenses associated
with the amended credit facility (approximately $1.2 million) were added to
the principal amount of the loan, resulting in an outstanding principal
balance as of the effective date of the amendment equal to $152.4 million.
* NO REQUIRED AMORTIZATION. No principal payments are required until the
maturity date of the facility.
* INTEREST RATE. The interest rate was increased to LIBOR plus 7.0% (8.4% as
of December 31, 2002), payable monthly. By comparison, the effective
interest rate (including the 2.0% of additional accrued interest described
above) applicable to the original facility immediately prior to the
effective date of the amendment was 7.0%.
* FINANCIAL COVENANTS. The amended facility includes financial covenants
similar to the ones included in the original credit facility, with
compliance levels under such covenants adjusted to levels consistent with
current business levels and outlook. The covenants include (i) total debt
leverage ratio (initially set at 7.48), (ii) minimum tangible net worth
(initially set at a $230.1 million deficit), (iii) fixed charge coverage
ratio (initially set at 0.99), (iv) limitation on capital expenditures of
$11 million per fiscal year; and (v) limitation on operating leases during
any period of four fiscal quarters to 3.10% of consolidated net revenues.
The compliance levels for covenants (i) through (iii) above are set at
varying levels on a quarterly basis. Compliance is tested quarterly based
on annualized or year-to-date results as applicable.
* OTHER COVENANTS. The amended credit facility includes various non-financial
covenants equivalent in scope to those included in the original facility.
The covenants include restrictions on additional indebtedness, liens,
investments, mergers and acquisitions, asset sales, and other matters. The
amended credit facility includes extensive financial reporting obligations
and provides that an event of default occurs should we lose customer
contracts in any fiscal quarter with EBITDA contribution of $5 million or
more (net of anticipated contributions from new contracts).
* EXISTING LETTERS OF CREDIT. Pursuant to the amended facility, letters of
credit issued pursuant to the original credit agreement were reissued or
extended, to a maximum of $3.5 million, for letter of credit fees
aggregating 1 7/8% per annum. A third letter of credit, in the amount of
$2.6 million which was previously drawn by its beneficiary, will be
reissued subject to application of the funds originally drawn in reduction
of the principal balance of the facility and payment of a letter of credit
fee equal to 7% per annum.
* EQUITY INTEREST. As additional consideration for entering into the amended
credit facility, we issued shares of our Series B redeemable preferred
stock to the participants in the amended credit facility. The redeemable
preferred stock is convertible into 2,115,490 common shares (10% of the
post-conversion common shares outstanding on a diluted basis, as defined).
The conversion ratio is subject to upward adjustment if we issue common
stock or securities convertible into our common stock for consideration
less than the fair market value of such securities at the time of such
transaction. Because a sufficient number of common shares are not currently
available to permit conversion, we intend to seek stockholder approval to
amend our certificate of incorporation to authorize additional common
shares. Conversion of the preferred shares occurs automatically upon notice
from the Company, assuming approval by our stockholders of sufficient
common shares to permit conversion. Should our stockholders fail to approve
such a proposal by December 31, 2004, we will be required to redeem the
preferred stock for a price equal to the greater of $15 million or the
value of the common shares into which the preferred shares would otherwise
have been convertible. In addition, should our stockholders fail to approve
such a proposal, the redeemable preferred stock enjoys a preference upon a
sale of our company, a sale of our assets and in certain other
circumstances; this preference equals the greater of (i) the value of the
43
common shares into which the redeemable preferred stock would otherwise
have been convertible or (ii) $12.5 million or $15 million depending on
whether the triggering event occurs prior to December 31, 2003 or December
31, 2004, respectively. At the election of the holder, the preferred shares
carry voting rights as if such shares were converted into common shares.
The preferred shares do not bear a dividend. The preferred shares (and
common shares issuable upon conversion of the preferred shares) are
entitled to certain registration rights. The terms of the preferred shares
limit us from issuing senior or pari passu preferred shares and from paying
dividends on, or redeeming, shares of junior stock.
We recorded approximately $7.0 million of deferred debt issuance costs related
to the amended credit facility ($4.2 million related to the fair value of the
redeemable preferred stock, $1.2 million of lender fees which were added to the
principal balance of the facility and $1.6 million of related professional
fees). These costs are included in other assets in the accompanying consolidated
balance sheet as of December 31, 2002. These costs will be amortized to interest
expense over the life of the agreement. The fair value of the redeemable
preferred stock was estimated to be the market value of the common stock to be
acquired upon conversion of the redeemable preferred stock, measured at the date
of the amendment. The redeemable preferred stock balance will be accreted to the
greater of $15.0 million or the value of the common shares into which the
preferred shares would otherwise be converted over the life of the agreement or
until the preferred shares are converted to common shares. Due to the higher
interest rate associated with the amended credit facility, we anticipate that
our cash interest expense will increase approximately $5.6 million annually.
In March 1998, we issued $150.0 million of 7 7/8% Senior Notes due 2008 (the
Notes) under Rule 144A under the Securities Act of 1933, as amended (Securities
Act). Interest under the Notes is payable semi-annually on September 15 and
March 15, and the Notes are not callable until March 2003 subject to the terms
of the Indenture. We incurred expenses related to the offering of approximately
$5.3 million and are amortizing these costs to interest expense over the life of
the Notes. In April 1998, we filed a registration statement under the Securities
Act relating to an exchange offer for the Notes. The registration became
effective on May 14, 1998. The Notes are general unsecured obligations of our
company and are unconditionally guaranteed on a joint and several basis by
substantially all of our domestic wholly owned current and future subsidiaries.
The Notes contain certain covenants that, among other things, limit our ability
to incur certain indebtedness, sell assets, or enter into certain mergers or
consolidations.
Since March 2000, we have satisfied all of our cash needs through cash flow from
operations and our cash reserves. Similarly, we expect that cash flow from
operations and our existing cash reserves will be sufficient to meet our
regularly scheduled debt service and our planned operating and capital needs for
the 12 months subsequent to December 31, 2002. Through our restructuring program
we have closed or downsized several locations that were negatively impacting our
cash flow. In addition, we have significantly reduced our corporate overhead. We
have improved the quality of our revenue and have experienced an upward trend in
daily cash collections.
There can be no assurance that we will meet our targeted levels of operating
cash flow or that we will not incur significant unanticipated liabilities.
Similarly, there can be no assurance that we will be able to obtain additional
debt or equity financing on terms satisfactory to us, or at all, should cash
flow from operations and our existing cash resources prove to be inadequate. As
discussed above, though we have successfully negotiated an amendment and
extension of our credit facility, we will not have access to additional
borrowings under such facility. If we are required to seek additional financing,
any such arrangement may involve material and substantial dilution to existing
stockholders resulting from, among other things, issuance of equity securities
or the conversion of all or a portion of our existing debt to equity. In such
event, the percentage ownership of our current stockholders will be materially
reduced, and such equity securities may have rights, preferences or privileges
senior to our current common stockholders. If we require additional financing
but are unable to obtain it, our business, financial condition, cash flows and
results of operations may be materially adversely affected.
44
EFFECTS OF FOREIGN CURRENCY EXCHANGE FLUCTUATIONS
As a result of the sale of our Latin American operations in September 2002, it
is not anticipated that future fluctuations in the currency exchange rates will
have an adverse effect on us.
RISK FACTORS
The following risk factors, in addition to those discussed elsewhere in this
report, should be carefully considered in evaluating us and our business.
WE HAVE SIGNIFICANT INDEBTEDNESS.
We have significant indebtedness. As of December 31, 2002, we have approximately
$307.4 million of consolidated indebtedness, consisting primarily of $150.0
million of 7 7/8% senior notes due in 2008 and approximately $152.4 million
outstanding under our credit facility.
Our ability to service our debt depends on our future operating performance,
which is affected by governmental regulations, the state of the economy,
financial factors, and other factors, certain of which are beyond our control.
We may not generate sufficient funds to enable us to make our periodic debt
payments. Failure to make our periodic debt payments could have a material
adverse effect on our business, financial condition, results of operations and
cash flows.
OUR LOAN AGREEMENTS REQUIRE US TO COMPLY WITH NUMEROUS COVENANTS AND
RESTRICTIONS.
The agreement governing the terms of the senior notes contains certain covenants
limiting our ability to:
* incur certain additional debt * create certain liens
* pay dividends * issue guarantees
* redeem capital stock * enter into transactions with
* make certain investments affiliates
* issue capital stock of * sell assets
subsidiaries * complete certain mergers and
consolidations
The amended credit facility contains other more restrictive covenants and
requires us to satisfy certain financial tests, including a total debt leverage
ratio, a minimum tangible net worth amount, and a fixed charge ratio. Our
ability to satisfy those covenants can be affected by events both within and
beyond our control, and we may be unable to meet these covenants.
A breach of any of the covenants or other terms of our debt could result in an
event of default under the amended credit facility or the senior notes or both,
which could have a material adverse effect on our business, financial condition,
results of operations and cash flows.
WE MAY NOT BE ABLE TO GENERATE SUFFICIENT OPERATING CASH FLOW.
Despite significant net losses in fiscal 2001 and 2000, our restructuring
efforts have enabled us to self-fund our operations since March 2000 from
existing cash reserves and operating cash flow. However, we may be unable to
sustain our targeted levels of operating cash flow. Our ability to generate
operating cash flow will depend upon various factors, including industry
conditions, economic conditions, competitive conditions, and other factors, many
of which are beyond our control. Because of our significant indebtedness, a
substantial portion of our cash flow from operations is dedicated to debt
service and is not available for other purposes. The terms of our amended credit
facility do not permit additional borrowings thereunder. In addition, the
amended credit facility and the senior notes also restrict our ability to
provide collateral to any prospective lender.
If we are unable to meet our targeted levels of operating cash flow, or in the
event of an unanticipated cash requirement (such as an adverse litigation
outcome, reimbursement delays, significantly increased costs of insurance or
other matters) we will need to pursue additional debt or equity financing. Any
45
such financing may not be available on terms acceptable to us, or at all. If we
issue equity securities in connection with any such arrangement, the percentage
ownership of our current stockholders will be materially reduced, and such
equity securities may have rights, preferences or privileges senior to our
current common stockholders. Failure to maintain adequate operating cash flow
will have a material adverse effect on our business, financial condition,
results of operations and cash flows.
WE FACE SIGNIFICANT DILUTION OF OUR COMMON STOCK
In conjunction with the amended credit facility we issued shares of our Series B
redeemable preferred stock to the participants in the amended credit facility.
The redeemable preferred stock is convertible into 2,115,490 common shares.
Because sufficient common shares are not currently available to permit
conversion, we intend to seek stockholder approval to authorize additional
common shares. Conversion of the redeemable preferred stock to common shares
will result in dilution of approximately 12%. Until such time as the additional
common shares are authorized, the fair value of the redeemable preferred stock
will be accreted to the greater of $15.0 million or the value of which the
redeemable preferred stock would have otherwise been converted. This accretion
will be a reduction in income available to common stockholders.
WE DEPEND ON REIMBURSEMENTS BY THIRD-PARTY PAYERS AND INDIVIDUALS.
We receive a substantial portion of our payments for ambulance services from
third-party payers, including Medicare, Medicaid, and private insurers. We
received approximately 90.0% of our ambulance fee collections from such third
party payers during the three months ended December 31, 2002, including
approximately 27.3% from Medicare. In the three months ended December 31, 2001
we received 87.8% of ambulance fee collections from these third parties,
including 25.1% from Medicare. We received approximately 90.0% of our ambulance
fee collections from such third-party payers during the six months ended
December 31, 2002, including approximately 26.5% from Medicare. In the six
months ended December 31, 2001, we also received approximately 87.2% of
ambulance fee collections from these third parties, including approximately
25.0% from Medicare.
The reimbursement process is complex and can involve lengthy delays. From time
to time, we experience these delays. Third-party payers are continuing their
efforts to control expenditures for health care, including proposals to revise
reimbursement policies. We recognize revenue when we provide ambulance services;
however, there can be lengthy delays before we receive payment. In addition,
third-party payers may disallow, in whole or in part, requests for reimbursement
based on assertions that certain amounts are not reimbursable or additional
supporting documentation is necessary. Retroactive adjustments may change
amounts realized from third-party payers. Due to the nature of our business and
our participation in the Medicare and Medicaid reimbursement programs, we are
involved from time to time in regulatory reviews or investigations by
governmental agencies of matters such as compliance with billing regulations. We
may be required to repay these agencies if a finding is made that we were
incorrectly reimbursed, or we may lose eligibility for certain programs in the
event of certain types of noncompliance. Delays and uncertainties in the
reimbursement process adversely affect the level of accounts receivable,
increase the overall costs of collection, and may adversely affect our working
capital and cause us to incur additional borrowing costs. Unfavorable
resolutions of pending or future regulatory reviews or investigations, either
individually or in the aggregate, could have a material adverse effect on our
business, financial condition, cash flows and results of operations.
We also face the continuing risk of non-reimbursement to the extent that
uninsured individuals require emergency ambulance service in service areas where
an adequate subsidy is not provided. Amounts not covered by third-party payers
are the obligations of individual patients. We may not receive whole or partial
reimbursement from these uninsured individuals. We continually review the mix of
activity between emergency and general medical transport in view of the
reimbursement environment and evaluate methods of recovering these amounts
through the collection process.
46
We establish an allowance for Medicare, Medicaid and contractual discounts and
doubtful accounts based on credit risk applicable to certain types of payers,
historical trends, and other relevant information. We review our allowance for
doubtful accounts on an ongoing basis and may increase or decrease such
allowances from time to time, including in those instances when we determine
that the level of effort and cost of collection of certain accounts receivable
is unacceptable.
The risks associated with third-party payers and uninsured individuals and the
inability to monitor and manage accounts receivable successfully could have a
material adverse effect on our business, financial condition, cash flows, and
results of operations. Our collection policies or our allowance for Medicare,
Medicaid and contractual discounts and doubtful accounts receivable may not be
adequate.
WE HAVE EXPERIENCED MATERIAL INCREASES IN THE COST OF OUR INSURANCE AND SURETY
PROGRAMS AND IN RELATED COLLATERALIZATION REQUIREMENTS.
We have experienced a substantial rise in the costs associated with both our
insurance and surety bonding programs in comparison to prior years. We have
experienced significant increases both in the premiums we have had to pay, and
in the collateral or other advance funding required. We also have increased our
deductible and self-insurance retentions under several coverages. Many counties,
municipalities, and fire districts also require us to provide a surety bond or
other assurance of financial and performance responsibility, and the cost and
collateral requirements associated with obtaining such bonds have increased. A
significant factor is the overall hardening of the insurance, surety and
re-insurance markets, which has resulted in demands for larger premiums,
collateralization of payment obligations and increasingly rigorous underwriting
requirements. Our higher costs also result from our claims history and from
vendors' past perception of our financial position due to our current debt
structure and cash position, as well as the qualified opinion formerly issued
with respect to our audited financial statements. Sustained and substantial
annual increases in premiums and requirements for collateral or pre-funded
deductible obligations may have a material adverse effect on our business,
financial condition, cash flow and results of operations.
CLAIMS AGAINST US COULD EXCEED OUR INSURANCE COVERAGE.
We are subject to a significant number of accident, injury and professional
liability claims as a result of the nature of our business and the day-to-day
operation of our vehicle fleet. The coverage limits of our policies may not be
adequate. Liabilities in excess of our insurance coverage could have a material
adverse effect on our business, financial condition, cash flows, and results of
operations. Claims against us, regardless of their merit or outcome, also may
have an adverse effect on our reputation and business.
OUR RESERVES MAY PROVE INADEQUATE.
Under our general liability and employee medical insurance programs, and under
our workers' compensation programs prior to May 1, 2002, we are responsible for
deductibles in varying amounts. Our insurance coverages in prior years generally
did not include an aggregate limitation on our liability. We have established
reserves for losses and loss adjustment expenses under these policies. Our
reserves are estimates based on industry data and historical experience, and
include judgments of the effects that future economic and social forces are
likely to have on our experience with the type of risk involved, circumstances
surrounding individual claims and trends that may affect the probable number and
nature of claims arising from losses not yet reported. Consequently, loss
reserves are inherently uncertain and are subject to a number of highly variable
and difficult to predict circumstances. For these reasons, there can be no
assurance that our ultimate liability will not materially exceed our reserves.
If our reserves prove to be inadequate, we will be required to increase our
reserves with a corresponding reduction, which may be material, to our operating
results in the period in which the deficiency is identified. We periodically
engage actuaries in order to verify the reasonableness of our reserve estimates.
However, our reserves may prove inadequate and may have a material adverse
effect on our business, financial condition, cash flows and results of
operations.
47
TWO INSURANCE COMPANIES WITH WHICH WE HAVE PREVIOUSLY DONE BUSINESS ARE IN
FINANCIAL DISTRESS.
Two previous insurers (Reliance Insurance Company and Legion Insurance Company)
under our workers' compensation and general liability programs are currently in
liquidation and rehabilitation proceedings, respectively, in Pennsylvania. With
respect to the affected policy years, these proceedings may result in the loss
of all or part of the collateral and/or funds deposited by us for payment of
claims within our deductible or self-insured retention relating to our workers'
compensation programs, and may result in restricted access to reinsurance
proceeds relating to our general liability program. Based upon the information
currently available, we believe that the amounts on deposit are fully
recoverable and will either be returned to us or used to pay claims on our
behalf as originally intended. We further believe that reinsurance proceeds for
our liability policies will be available to cover claims in excess of our
retention as originally intended. Our inability to access the funds on deposit
or to access our liability reinsurance proceeds could have a material adverse
effect on our business, financial condition, results of operations and cash
flows. To the extent that claims exceed our deductible limits and our insurers
do no satisfy their coverage obligations, we may be forced to satisfy a portion
of those claims directly, which could have a material adverse effect on our
business, financial condition, result of operations and cash flows.
RECENTLY ENACTED RULES MAY ADVERSELY AFFECT OUR REIMBURSEMENT RATES OF COVERAGE.
On April 1, 2002, the Medicare Ambulance Fee Schedule Final Rule became
effective. The Final Rule categorizes seven levels of ground ambulance services,
ranging from basic life support to specialty care transport, and two categories
of air ambulance services. The base rate conversion factor for services to
Medicare patients was set at $170.54, plus separate mileage payment based on
specified relative value units for each level of ambulance service. Adjustments
also were included to recognize differences in relative practice costs among
geographic areas, and higher transportation costs that may be incurred by
ambulance providers in rural areas with low population density. The Final Rule
requires ambulance providers to accept the assigned reimbursement rate as full
payment, after patients have submitted their deductible and 20 percent of
Medicare's fee for service. In addition, the Final Rule calls for a five-year
phase-in period to allow time for providers to adjust to the new payment rates.
The fee schedule will be phased in at 20-percent increments each year, with
payments being made at 100 percent of the fee schedule in 2006 and thereafter.
We believe the Medicare Ambulance Fee Schedule will cause a neutral net impact
on our medical transportation revenue at incremental and full phase-in periods,
primarily due to the geographic diversity of our U.S. operations. These rules
could, however, result in contract renegotiations or other actions by us to
offset any negative impact at the regional level that could have a material
adverse effect on our business, financial condition, cash flows, and results of
operations. Changes in reimbursement policies, or other governmental action,
together with the financial challenges of some private, third-party payers and
budget pressures on other payer sources could influence the timing and,
potentially, the receipt of payments and reimbursements. A reduction in coverage
or reimbursement rates by third-party payers, or an increase in our cost
structure relative to the rate increase in the Consumer Price Index (CPI), or
costs incurred to implement the mandates of the fee schedule could have a
material adverse effect on our business, financial condition, cash flows, and
results of operations.
CERTAIN STATE AND LOCAL GOVERNMENTS REGULATE RATE STRUCTURES AND LIMIT RATES OF
RETURN.
State or local government regulations or administrative policies regulate rate
structures in most states in which we conduct ambulance operations. In certain
service areas in which we are the exclusive provider of services, the
municipality or fire district sets the rates for emergency ambulance services
pursuant to a master contract and establishes the rates for general ambulance
services that we are permitted to charge. Rates in most service areas are set at
the same amounts for emergency and general ambulance services. For example, the
State of Arizona establishes a rate of return on sales we are permitted to earn
in determining the ambulance service rates we may charge in that state.
Ambulance services revenue generated in Arizona accounted for approximately
19.7% and 15.4% of net revenue for the three months ended December 31, 2002 and
48
2001, respectively. Ambulance services revenue generated in Arizona accounted
for approximately 19.3% and approximately 15.8% of net revenue for the six
months ended December 31, 2002 and 2001, respectively. We may be unable to
receive ambulance service rate increases on a timely basis where rates are
regulated or to establish or maintain satisfactory rate structures where rates
are not regulated.
Municipalities and fire districts negotiate the payments to be made to us for
fire protection services pursuant to master contracts. These master contracts
are based on a budget and on level of effort or performance criteria desired by
the municipalities and fire districts. We could be unsuccessful in negotiating
or maintaining profitable contracts with municipalities and fire districts.
NUMEROUS GOVERNMENTAL ENTITIES REGULATE OUR BUSINESS.
Numerous federal, state, local, and foreign laws, rules and regulations govern
various aspects of the business of ambulance service and fire fighting service
providers, covering matters such as licensing, rates, employee certification,
environmental matters, radio communications and other factors. Certificates of
necessity may be required from state or local governments to operate ambulance
services in a designated service area. Master contracts from governmental
authorities are subject to risks of cancellation or unenforceability as a result
of budgetary and other factors and may subject us to certain liabilities or
restrictions that traditionally have applied only to governmental bodies.
Federal, state, local, or foreign governments could:
* change existing laws, rules or regulations,
* adopt new laws, rules or regulations that increase our cost of doing
business,
* lower reimbursement levels,
* choose to provide services for themselves, or
* otherwise adversely affect our business, financial condition, cash
flows, and results of operations.
We could encounter difficulty in complying with all applicable laws, rules and
regulations.
HEALTH CARE REFORMS AND COST CONTAINMENT MAY AFFECT OUR BUSINESS.
Numerous legislative proposals have been considered that would result in major
reforms in the U.S. health care system. We cannot predict which, if any, health
care reforms may be proposed or enacted or the effect that any such legislation
would have on our business. The Health Insurance Portability and Accountability
Act of 1996 (HIPAA), which protects the privacy of patients' health information
handled by health care providers and establishes standards for its electronic
transmission, was enacted on August 21, 1996. The final rule, which took effect
on April 14, 2001, requires covered entities to comply with the final rule's
provisions by April 14, 2003, and covers all individually identifiable health
information used or disclosed by a covered entity. Our HIPAA Subcommittee of the
Corporate Compliance Committee is addressing the impact of HIPAA and considering
changes to or enactment of policies, training and/or procedures which may need
to be implemented to comply under the final rule. Because the impact of HIPAA on
the health care industry is not known at this time, we may incur significant
costs associated with implementation and continued compliance with HIPAA or
further legislation which may have a material adverse effect on our business,
financial condition, cash flows, or results of operations.
In addition, managed care providers are focusing on cost containment measures
while seeking to provide the most appropriate level of service at the most
appropriate treatment facility. Changing industry practices could have an
adverse effect on our business, financial condition, cash flows, and results of
operations.
49
WE DEPEND ON CERTAIN BUSINESS RELATIONSHIPS.
We depend to a great extent on certain contracts with municipalities or fire
districts to provide 911 emergency ambulance services and fire protection
services. Our six largest contracts accounted for approximately 18.4% and 16.3%
of net revenue for the three months ended December 31, 2002 and 2001,
respectively. Our six largest contracts accounted for approximately 18.4% and
approximately 17.2% of net revenue for the six months ended December 31, 2002
and 2001, respectively. One of these contracts accounted for approximately 4.3%
and 3.7% of net revenue for the three months ended December 31, 2002 and 2001,
respectively. One of these contracts accounted for approximately 4.3% and
approximately 3.8% of net revenue for the six months ended December 31, 2002 and
2001, respectively. Contracts with municipalities or fire districts may have
certain budgetary approval constraints. Failure to allocate funds for a contract
may adversely affect our ability to continue to perform services without
suffering significant losses. The loss or cancellation of several of these
contracts could have a material adverse effect on our business, financial
condition, cash flow, and results of operations. We may not be successful in
retaining our existing contracts or in obtaining new contracts for emergency
ambulance services or for fire protection services.
Our contracts with municipalities and fire districts and with managed care
organizations and health care providers are short term or open-ended or for
periods ranging from two years to five years. During such periods, we may
determine that a contract is no longer favorable and may seek to modify or
terminate the contract. When making such a determination, we may consider
factors, such as weaker than expected transport volume, geographical issues
adversely affecting response times, and delays in implementing technology
upgrades. We face certain risks in attempting to terminate unfavorable contracts
prior to their expiration because of the possibility of forfeiting performance
bonds and the potential adverse political and public relations consequences. Our
inability to terminate or amend unfavorable contracts could have a material
adverse effect on our business, financial condition, cash flows, and results of
operations. We also face the risk that areas in which we provide fire protection
services through subscription arrangements with residents and businesses will be
converted to tax-supported fire districts or annexed by municipalities.
WE FACE RISKS ASSOCIATED WITH OUR PRIOR RAPID GROWTH, INTEGRATION, AND
ACQUISITIONS.
We must integrate and successfully operate the ambulance service providers that
we have acquired. The process of integrating management, operations, facilities,
and accounting and billing and collection systems and other information systems
requires continued investment of time and resources and can involve
difficulties, which could have a material adverse effect on our business,
financial condition, cash flows, and results of operations. Unforeseen
liabilities and other issues also could arise in connection with the operation
of businesses that we have previously acquired or may acquire in the future. For
example, we recently became aware of, and have taken corrective action with
respect to, various issues arising primarily from the transition to us from
various acquired operations of Federal Communications Commission (FCC) licenses
for public safety and private wireless radio frequencies used in the ordinary
course of our business. While we do not currently anticipate that action with
respect to these issues by the FCC's enforcement bureau will result in material
monetary fines or license forfeitures, there can be no assurance that this will
be the case. Our acquisition agreements contain purchase price adjustments,
rights of set-off, indemnification, and other remedies in the event that certain
unforeseen liabilities or issues arise in connection with an acquisition.
However, these purchase price adjustments, rights of set-off, indemnification,
and other remedies expire and may not be sufficient to compensate us in the
event that any liabilities or other issues arise.
WE FACE ADDITIONAL RISKS ASSOCIATED WITH OUR INTERNATIONAL OPERATIONS.
Due to the deteriorating economic conditions and continued devaluation of the
local currency, we have reviewed our strategic alternatives with respect to the
continuation of operations in Latin America, including Argentina and Bolivia. We
have determined that we would benefit from focusing on our domestic operations.
Effective September 27, 2002, we sold our Latin American operations to local
management. We believe that both the structure of our pre-sale operations and of
the sale transaction itself shield us from liabilities associated with past or
future activities of our former Latin American operations. However, due to the
50
nature of local laws and regulatory requirements and the uncertain economic and
political environment, particularly in Argentina, there can be no assurance that
we will not be required to defend against future claims. Unanticipated claims
successfully asserted against us could have an adverse effect on our business,
financial condition, cash flows, and results of operations.
WE ARE IN A HIGHLY COMPETITIVE INDUSTRY.
The ambulance service industry is highly competitive. Ambulance and general
transport service providers compete primarily on the basis of quality of
service, performance, and cost. In order to compete successfully, we must make
continuing investments in our fleet, facilities, and operating systems. We
believe that counties, fire districts, and municipalities consider the following
factors in awarding a contract:
* quality of medical care,
* historical response time performance,
* customer service,
* financial stability, and
* personnel policies and practices.
We currently compete with the following entities to provide ambulance services:
* governmental entities (including fire districts),
* hospitals,
* other national ambulance service providers,
* large regional ambulance service providers, and
* local and volunteer private providers.
Municipalities, fire districts, and health care organizations that currently
contract for ambulance services could choose to provide ambulance services
directly in the future. We are experiencing increased competition from fire
departments in providing emergency ambulance service. Some of our current
competitors and certain potential competitors have or have access to greater
capital and other resources than us.
Tax-supported fire districts, municipal fire departments, and volunteer fire
departments represent the principal providers of fire protection services for
residential and commercial properties. Private providers represent only a small
portion of the total fire protection market and generally provide services where
a tax-supported municipality or fire district has decided to contract for these
services or has not assumed the financial responsibility for fire protection. In
these situations, we provide services for a municipality or fire district on a
contract basis or provide fire protection services directly to residences and
businesses who subscribe for this service. We cannot provide assurance that:
* we will be able continue to maintain current contracts or subscription
or to obtain additional fire protection business on a contractual or
subscription basis;
* fire districts or municipalities will not choose to provide fire
protection services directly in the future; or
* areas in which we provide services through subscriptions will not be
converted to tax-supported fire districts or annexed by
municipalities.
WE DEPEND ON OUR MANAGEMENT AND OTHER KEY PERSONNEL.
Our success depends upon our ability to recruit and retain key personnel. We
could experience difficulty in retaining our current key personnel or in
attracting and retaining necessary additional key personnel. Low unemployment in
certain market areas currently makes the recruiting, training, and retention of
full-time and part-time personnel more difficult and costly, including the cost
of overtime wages. Our internal growth will further increase the demand on our
51
resources and require the addition of new personnel. We have entered into
employment agreements with certain of our executive officers and certain other
key personnel. Failure to retain or replace our key personnel may have an
adverse effect on our business.
IT MAY BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE US.
Certain provisions of our certificate of incorporation, shareholders' rights
plan and Delaware law could make it more difficult for a third party to acquire
control of our company, even if a change in control might be beneficial to
stockholders. This could discourage potential takeover attempts and could
adversely affect the market price of our common stock.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK CONDITIONS.
Our primary exposure to market risk consists of changes in interest rates on our
borrowing activities. We face the possibility of increased interest expense in
connection with our amended credit facility which bears interest at LIBOR plus
7.0%. A 1% increase in the LIBOR rate would increase our interest expense on an
annual basis by approximately $1.5 million. The remainder of our debt is
primarily at fixed interest rates. We continually monitor this risk and review
the potential benefits of entering into hedging transactions, such as interest
rate swap agreements, to mitigate the exposure to interest rate fluctuations.
ITEM 4. CONTROLS AND PROCEDURES
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our reports under the Securities
Exchange Act of 1934, as amended (the "Exchange Act") is recorded, processed,
summarized and reported within the time periods specified in the SEC's rules and
forms, and that such information is accumulated and communicated to the
management, including the Chief Executive Officer and Vice President of Finance,
as appropriate, to allow timely decisions regarding required disclosure.
Management necessarily applies its judgment in assessing the costs and benefits
of such controls and procedures, which, by their nature, can provide only
reasonable assurance regarding management's control objectives.
Within 90 days prior to the date of filing of this report, we carried out an
evaluation, under the supervision and with the participation of management,
including the Chief Executive Officer along with the Vice President of Finance,
of the effectiveness of the design and operation of our disclosure controls and
procedures pursuant to Exchange Act Rule 13a-14. Based upon the foregoing, the
Chief Executive Officer along with the Vice President of Finance concluded that
our disclosure controls and procedures are designed to ensure that the
information required to be disclosed by us in the reports filed or submitted by
us under the Exchange Act is recorded, processed, summarized and reported within
the applicable time periods. There have been no significant changes in our
internal controls or in other factors that could significantly affect internal
controls subsequent to the date we carried out the evaluation.
RURAL/METRO CORPORATION AND SUBSIDIARIES
PART II. OTHER INFORMATION.
ITEM 1 -- LEGAL PROCEEDINGS.
From time to time, we are subject to litigation and regulatory investigations
arising in the ordinary course of business. We believe that the resolutions of
currently pending claims or legal proceedings will not have a material adverse
effect on our business, financial condition, cash flows and results of
operations. However, we are unable to predict with certainty the outcome of
pending litigation and regulatory investigations. In some pending cases, our
insurance coverage may not be adequate to cover all liabilities arising out of
such claims. In addition, due to the nature of our business, Center for Medicare
52
and Medicaid Services (CMS) and other regulatory agencies are expected to
continue their practice of performing periodic reviews and initiating
investigations related to the Company's compliance with billing regulations.
Unfavorable resolutions of pending or future litigation, regulatory reviews
and/or investigations, either individually or in the aggregate, could have a
material adverse effect on our business, financial condition, cash flows and
results of operations.
As previously reported, the Company, Arthur Andersen LLP and certain of the
Company's current and former officers and directors and their spouses were named
as defendants in a purported class action lawsuit: Steven A. Springborn v.
Rural/Metro Corporation, et al., filed on September 30, 2002 in Maricopa County,
Arizona Superior Court. The Plaintiffs amended the Complaint on October 17, 2002
adding Barry Landon and Jane Doe Landon as defendents and making certain
additional allegations and claims. On October 30, 2002, Defendant Arthur
Andersen LLP removed the action to the United States District Court, District of
Arizona. The Company and the individual defendants have consented to this
removal. The Company and the individual defendants have been served with the
summons and complaint and are in the process of responding to the Amended
Complaint.
As previously reported, LaSalle Ambulance, Inc., a New York corporation which is
a subsidiary of Rural/Metro Corporation, was sued in the case of Ann Bogucki and
Patrick Bogucki v. LaSalle Ambulance Service, et al., Index No. I 1995 2128, in
the Supreme Court of the State of New York, Erie County. In January 2003, the
parties reached an agreement in principle, which does not result in any
additional claims expense, to settle the matter. The agreement in principle
provides for a full release of LaSalle Ambulance in April 2003 subject to
completion of final settlement documentation and plaintiff's receipt of agreed
consideration.
53
ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K.
(a) Exhibits
3.1 (c) Amendment No. 1 to the Rights Agreement dated as of August
23, 1995 between the Registrant and American Securities
Transfer, Inc., the Rights Agent. *
10.16 (o) Form of Change of Control Agreement by and between the
Registrant and the following executive officers: (i) Jack E.
Brucker, dated April 25, 2002; and (ii) John S. Banas III,
dated September 27, 2002. *
(b) Reports on Form 8-K
Form 8-K filed October 15, 2002 relating to the sale of Latin American
operations (via the sale of the stock of applicable subsidiaries) to
local management for assumption of net liabilities. An amendment to
this Form 8-K filed December 10, 2002 included a pro forma condensed
balance sheet as of June 30, 2002 and pro forma condensed statements
of operations for each of the years in the three year period ended
June 30, 2002 reflecting such sale.
Form 8-K filed October 16, 2002 relating to the amended credit
facility with our bank lenders which among other provisions, extended
the maturity date of the facility from March 16, 2003 through December
31, 2004, waived previous non-compliance, and required the issuance to
the lenders of 211,549 shares of our Series B redeemable preferred
stock.
Form 8-K filed October 22, 2002 relating to the notice from the Nasdaq
Listing Qualifications Panel indicating we evidenced compliance with
the requirements necessary for continued listing on the Nasdaq
SmallCap Market.
- ----------
* Filed herewith
54
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.
RURAL/METRO CORPORATION
Dated: February 14, 2003
By: /s/ Jack E. Brucker
------------------------------------
Jack E. Brucker, President & Chief
Executive Officer (Principal
Executive Officer)
By: /s/ Randall L. Harmsen
------------------------------------
Randall L. Harmsen, Vice President
of Finance (Principal Financial
Officer and Principal Accounting
Officer)
55
CERTIFICATION
I, Jack E. Brucker, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Rural/Metro
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: February 14, 2003
/s/ Jack E. Brucker
----------------------------------------
President and Chief Executive Officer
Rural/Metro Corporation
56
CERTIFICATION
I, Randall L. Harmsen, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Rural/Metro
Corporation;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material fact
necessary to make the statements made, in light of the circumstances
under which such statements were made, not misleading with respect to
the period covered by this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and
cash flows of the registrant as of, and for, the periods presented in
this report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant
and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based
on our most recent evaluation, to the registrant's auditors and the
audit committee of registrant's board of directors (or persons
performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in
internal controls or in other factors that could significantly affect
internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: February 14, 2003
/s/ Randall L. Harmsen
----------------------------------------
Vice President of Finance
(Principal Financial Officer and
Principal Accounting Officer)
Rural/Metro Corporation
57