United
States Securities and Exchange Commission
Washington,
D.C. 20549
FORM
10-K
(Mark
One)
x
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF
1934
FOR
THE FISCAL YEAR ENDED DECEMBER
31, 2004
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT
OF 1934
FOR
THE TRANSITION PERIOD FROM
TO
Commission
File No. 000-50343
INTEGRATED
ALARM SERVICES GROUP, INC.
(Exact
name of Registrant as specified in its charter)
|
Delaware
(State
or other jurisdiction of incorporation or organization)
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42-1578199
(IRS
Employer Identification No.)
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99
Pine Street, 3rd
Floor, Albany, New York
(Address
of principal executive offices)
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12207
(Zip
code.)
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(518)
426-1515
(
Registrant’s telephone number, including area code)
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Securities
registered pursuant to Section 12(b) of the Act:
NONE
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Securities
registered pursuant to Section 12(g) of the Act:
COMMON
STOCK
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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 No x
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment
to this
Form 10-K. x
Indicate
by check mark whether the registrant is an accelerated filer (as defined
in Rule
12b-2 of the Exchange Act). Yes x
No
o
The
aggregate market value of common stock held by non-affiliates of the registrant
as of June 30, 2004, was $133,279,895.
The
number of shares outstanding of the registrant’s common stock as of June 1, 2005
was 24,681,462 shares.
Integrated
Alarm Services Group, Inc.
FORM
10-K
For
The
Fiscal Year Ended December 31, 2004
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Part
I
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Page
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Part
II
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Part
III
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Part
IV
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Signatures | S-1 |
PART
I
We
are
one of the largest providers of monitoring, financing, and business support
services to independent security alarm Dealers, which we refer to as “Dealers”,
in the United States. We offer our services to Dealers competing in both
the
residential and commercial security alarm markets. We believe our services
better allow Dealers to compete with larger, self-monitoring national alarm
companies. The major categories of services we provide include:
| · |
Monitoring.
We monitor alarm systems on behalf of Dealers who do not have the
capital
resources or critical mass to economically establish their own
monitoring
facilities and for our own accounts. We believe we are the largest
wholesale alarm monitoring company in the United States, monitoring
approximately 572,000 alarm systems on behalf of approximately
5,600
independent Dealers. We refer to this as our wholesale business
and we
currently receive approximately $3.1 million of revenue
per month to
monitor contracts owned by Dealers. Our alarm monitoring services
are
provided through two, state-of-the-art, redundant alarm monitoring
centers
located in New Jersey and California. The acquisition of the assets
of
NACC (“National Alarm Computer Center, Inc.”) discussed below provided us
with 220,000 new monitored alarm systems and approximately 600
new Dealer
relationships (these are included in the above totals) as well
as an
additional state-of-the-art alarm monitoring center in
California.
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| · |
Financing.
Since 1993, we have provided financing for Dealers in the form
of loans or
alarm monitoring contract purchases of approximately $480 million
in
the aggregate. As of December 31, 2004, we owned and monitored
a portfolio
of approximately 149,000 retail alarm monitoring contract equivalents.
A
contract equivalent is equal to $30 per month in RMR (“Recurring Monthly
Revenue”) from a typical residential customer. We refer to this as our
retail business and we currently receive approximately $4.5 million
of revenue per month from this portfolio. In addition, we hold
approximately 22,500 contracts as collateral against loans we have
made to
Dealers. The NACC acquisition added an additional 13,100 retail
alarm
monitoring contract equivalents and an additional 14,000 contracts
as
collateral against loans made to Dealers (which we assumed in the
acquisition) and these are included in the above
totals.
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| · |
Business
Support Services. For many of our Dealers, we provide billing,
collection
and marketing services as well as access to equipment discount
programs.
Because of our scale, we can generally provide these services on
a more
cost-effective basis for Dealers than they can for themselves.
In
addition, our equipment discount program allows Dealers who use
our
monitoring services to automatically receive preferential pricing
for
certain alarm equipment.
|
Our
retail portfolio is comprised of both residential subscribers, which represent
approximately 80% of our revenue in this segment, and commercial subscribers,
which represent approximately 20% of our revenue in this segment. We believe
maintaining an appropriate balance between residential and commercial customers
will be important going forward.
We
acquire alarm monitoring contracts on both a “flow business” and “bulk purchase”
basis. Flow business is the purchase of newly created alarm monitoring contracts
on a recurring, or “as originated,” basis from Dealers. We have relationships
with over 75 Dealers from which we acquire alarm monitoring contracts on
a flow
basis. Bulk purchases are the acquisition of existing portfolios of alarm
monitoring contracts with demonstrated payment histories. These alarm monitoring
contracts are typically purchased from Dealers on a non-recurring basis.
We also
acquire monitoring contracts and Dealer relationships by acquiring monitoring
call centers.
We
believe our package of services allows Dealers to compete against the large
self-monitoring national providers in the security alarm market by giving
them
access to technical sophistication, financing, back office and other services
that they would not otherwise have, while allowing them to remain the local
and
visible contact with their customer, the end-user of the security alarm system.
We intend to continue to expand the number of Dealers to which we provide
these
services through direct marketing of our services as well as acquisitions
of
Dealer relationships. See financial statement footnote #15 for segment
information.
Our
Business Strategy
Growth
Initiatives
Acquisition
of Additional Alarm Monitoring Contracts
We
intend
to expand our acquisition and financing of alarm monitoring contracts through
purchasing retail alarm monitoring contracts on both a flow business and
bulk
purchase basis. Our current target purchase multiple of RMR for flow and
bulk
purchases is less than 30x. Since our initial public offering in July 2003,
we have acquired 133,000 retail alarm monitoring contract equivalents at
an
average purchase multiple of RMR of 28x. The sources of contracts available
for
acquisition include (i) our existing Dealer network, (ii) purchases
from independent brokers representing pools of seasoned contracts and
(iii) opportunistic purchases in the normal course of
business.
Building
Additional Wholesale Monitoring Relationships with
Dealers
We
intend
to grow our wholesale business both internally and by acquiring Dealer
relationships. Our internal growth is driven by the quality of service that
we
provide to our Dealers and their end-users. Our state-of-the-art redundant
monitoring centers are important factors that enable us to attract additional
Dealers. We believe that the fact that we do not compete with Dealers in
the
sale or installation of security alarm systems provides us a competitive
advantage over many of our competitors that do compete with independent Dealers.
We also intend to purchase Dealer relationships from monitoring
companies.
Cross-Selling
Opportunities
We
have
initiated a comprehensive cross-selling program of our primary services to
Dealers. For those Dealers to whom we provide wholesale monitoring services,
we
will encourage them to use us as the purchaser when they wish to sell alarm
monitoring contracts, or as a financing source should they wish to borrow
funds
against the value of their alarm monitoring contracts. We also have a program
to
offer additional services to the Dealers’ end-users, such as two-way voice
communication, extended warranty coverage, personal emergency response service
and GPS tracking services for movable assets.
Maximize
Subscriber Retention
We
seek
to maximize subscriber retention by continuing to acquire high quality retail
alarm monitoring contracts with demonstrated payment histories (for bulk
purchases) and to increase the average life of an alarm monitoring contract
by
providing superior customer service and actively identifying subscribers
who are
relocating, the number one reason for account cancellations, and target
retention of such subscribers, we also target the new residents moving into
the
relocating subscriber’s residence.
Maximize
Economies of Scale
Our
existing infrastructure will allow us to add a substantial number of additional
alarm monitoring contracts with minimal additional costs. As we continue
to grow
our subscriber base, we believe our margins will increase as these costs
are
spread over larger recurring revenue streams. We believe our cash flows will
also benefit from our continued efforts to reduce subscriber attrition. In
addition, we believe that our ability to consolidate our Santa Fe Springs,
California activities into the NACC monitoring center we acquired, as well
as
other actions we plan to take, will allow us to realize substantial cost
savings.
Our
Industry
Overview
The
security alarm industry is characterized by a large number of privately owned
companies involved in security alarm sales, leasing, installation, repair
and
monitoring. In 2003, approximately 12,000 of such Dealers were active in
the
United States. Based on information from Barnes and Associates, approximately
42% of this market is served by companies not included in the 100 largest
companies. The top 100 companies include large self-monitoring national
providers such as ADT, Honeywell and Brinks. Our target market is the portion
of
the market served by the Dealers outside of the top 100, or approximately
42% of
the overall alarm monitoring market.
The
growth in the security alarm industry has been fueled by several factors.
We
believe the aging of the population and the increase in two-career families
have
both contributed to an increased focus on the security of the home. Many
insurance companies offer discounts to home and business owners who install
electronic security alarm systems. In fact, many commercial enterprises are
required by insurance underwriters to have monitored alarm systems. According
to
a study conducted in 2001 by two professors of economics at Temple University,
homes without security alarm systems are between 2.2 and 3.1 times (depending
on
home value) more likely to be broken into than homes with security alarm
systems. In addition, the reported losses due to burglary average $400 less
in
residences
with security alarm systems than in those without security alarm systems.
These
factors and others, including a heightened awareness of overall security
needs,
have resulted in an increasing number of homes in North America with monitored
security alarm systems. According to The Freedonia Group, Inc., the
penetration of security alarm systems in existing homes in North America
was 18%
in 2003 and is expected to exceed 20% by 2006. Additionally, we believe that
many new homes have pre-installed security alarm systems. We also anticipate
that historic growth rates in penetration will increase as technology continues
to lower the cost of security alarm systems and monitoring and increases
the
potential applications of monitoring centers.
The
performance of the security alarm industry has been impacted by numerous
factors
including the significant amount of consolidation that occurred in the
mid-to-late nineties, self-monitoring national providers such as ADT and
Protection One, private regional providers, as well as new entrants into
the
market which acquired a large number of independent Dealers (with and without
monitoring call centers) and wholesale monitoring stations. During this period
of consolidation, purchase multiples of RMR ranged from approximately 35x
to
68x. This growth was largely financed with debt. Most of these acquirers
experienced service disruptions in connection with the integration of these
newly-acquired customer accounts, which resulted in a significant loss of
customers, or “attrition,” as is referred to in the industry. Further, many
acquirers were facing and continue to face financial pressures to service
the
debt used to effect these acquisitions. Consequently, although the industry
is
still fragmented, purchase multiples of RMR have declined significantly.
We
believe that the combination of these higher service-related attrition levels
and debt service requirements, as well as the credit environment generally,
presents us with a unique opportunity to grow our business. We believe that
we
will be able to complete acquisitions at purchase multiples of RMR substantially
lower than those which existed industry-wide in the mid-to-late nineties.
Further, we expect that such acquisitions will be completed without compromising
our account underwriting and due diligence criteria.
Dealer
Operations
The
primary sources of revenue for Dealers are the sale and installation of security
alarm systems and the monthly subscription of the monitoring service. Typically,
upon installation, the end-user enters into an annual alarm monitoring contract.
Under an alarm monitoring contract, the Dealer agrees to monitor, or contract
with another company to monitor, the security alarm from a remote location
and
to take certain pre-determined actions, such as calling the police, an ambulance
service or fire department, when a security system is triggered and an alarm
signal is received. After its initial term, most alarm monitoring contracts
are
subject to automatic renewal on an annual basis unless the Dealer or end-user
notifies the other party within a defined time period that the alarm monitoring
contract will not be renewed. The average life of alarm monitoring contracts
typically ranges from 8 to 12 years.
Most
Dealers do not have the capability to monitor alarms internally, and outsource
the monitoring and/or administrative aspects of the business to an outside
wholesale alarm monitoring company. We believe that Dealers look for a partner,
such as us, who offers a wide array of services, including state-of-the-art
monitoring service, billing and collection capabilities and marketing support,
all at a reasonable cost.
Financing
support is often just as important as monitoring support since many Dealers
are
constrained by the working capital requirements required to build their
business. In many cases, the cost of the installed equipment to the end-user
is
at or below the Dealer’s cost. In these cases, much of the Dealer's capital and
financial return comes from future monthly payments under the alarm monitoring
contracts. As a result, Dealers often need or desire to monetize these alarm
monitoring contracts and will, consequently, sell or borrow against their
alarm
monitoring contracts.
Although
there is a well-developed market for the purchase and sale of alarm monitoring
contracts and several specialty finance companies have been willing to lend
against alarm monitoring contracts held by Dealers, many Dealers have not
had
access to traditional credit lending markets. Several characteristics of
the
industry, including the lack of standardization among individual alarm
monitoring contracts and the under-capitalization of most Dealers, make it
difficult for traditional lenders to comfortably lend against the value of
individual alarm monitoring contracts. Further, the ability to provide or
control monitoring service is critical to maximizing the value of the alarm
monitoring contract since service issues are the primary reasons why end-users
do not renew alarm monitoring contracts. Traditional lenders and many specialty
lenders do not have this capability.
When
acquiring alarm monitoring contracts from Dealers, purchasers typically pay
a
multiple of the RMR. According to Barnes and Associates, a financial services
provider to the security alarm industry, the average RMR purchase multiple
for
portfolios with less than $50,000 in RMR was, 31.4x in 2002, 31.1x in 2003
and
an estimated 32.5x in 2004. For example, assuming a monthly security alarm
monitoring cost to the end-user of $30, the acquisition price of the alarm
monitoring contract would be approximately $975 in 2004.
Our
Services
Our
two
primary business activities are acquiring and managing portfolios of alarm
monitoring contracts and monitoring security alarms. We also offer
administrative services, such as billing and collection, to our Dealers as
well
as new and emerging products and services. Our acquisition and financing
solutions provide capital to Dealers, allowing them to compete with larger
competitors on the initial price of equipment and installation to the
end-user.
We
also
provide Dealers with access to technical sophistication and back office services
that they may not otherwise have (or be able to profitably operate), while
allowing them to maintain visible contact with their local customers, the
end-users of the alarm. Our alarm monitoring contract acquisition, financing
solutions and monitoring services complement one another and drive growth
in
other areas of our business.
We
generally require Dealers to whom we provide alarm monitoring contract financing
to use our monitoring services for all of the alarm monitoring contracts
they
continue to own. We typically also require these Dealers to use our billing
and
collection services, enabling us to gain an additional level of control over
the
reliability of the alarm monitoring contracts’ cash flows. This places us in a
unique position to minimize alarm monitoring contract attrition because we
can
control the quality of the monitoring, billing and collection and, to a
significant extent, Dealer interaction with the end-user.
Alarm
Monitoring Contract Acquisition and Financing
Services
Generally,
Dealers have had limited access to traditional credit providers. Several
characteristics of the industry, including the lack of standardization among
many individual alarm monitoring contracts, the under capitalization of Dealers,
and their inability to provide monitoring services directly, has historically
made lenders hesitant to provide financing to Dealers. When providing financing
to Dealers, we obtain a security interest in the underlying alarm monitoring
contracts. The payment terms are generally between 36 and 72 months,
at
interest rates based on prevailing overall interest rates and market
conditions.
We
believe that we are uniquely positioned to maximize the value of alarm
monitoring contracts through the depth of our knowledge of the security alarm
industry and the integrated nature of the services we provide. We have the
ability to exercise greater control over alarm monitoring contract attrition
than most capital providers because we have direct influence over the quality
of
the monitoring, interaction with the end-user and billing and collection.
Consequently, we are able to deploy more capital and achieve higher
returns.
With
respect to purchased alarm monitoring contracts, we typically acquire them
from
the Dealers that originally sold and installed the security alarm systems
giving
rise to the alarm monitoring contracts. We structure the payment terms and
pricing of both our alarm monitoring contract purchases and loans to provide
us
with a competitive internal rate of return. In a typical transaction, the
Dealer
will sell its alarm monitoring contracts for a purchase price that is a multiple
of the RMR. The multiple paid in any actual transaction is impacted by several
factors, including average RMR, the amount of the homeowner's investment
in the
alarm system, geographic diversity of the accounts and our own due diligence
of
the Dealer.
Generally,
Dealers that sell or borrow against their alarm monitoring contracts do so
on
either a flow basis or a bulk basis. We purchase alarm monitoring contracts
on
both a flow and a bulk basis. Typically, the price paid for a flow alarm
monitoring contract is less than that paid in a bulk purchase because very
often
the bulk purchases are comprised of seasoned, performing alarm monitoring
contracts. In either instance, we typically require Dealers to replace any
cancelled alarm monitoring contracts and lost revenues for the first year
after
we purchase an alarm monitoring contract. Such replacement must be in cash
or
acceptable alarm monitoring contracts. We also hold back a portion of the
purchase proceeds to secure this Dealer obligation.
Since
alarm monitoring contract quality is a key driver of our profitability,
underwriting discipline is critical. We maintain a very strict underwriting
discipline. For example, we do not typically purchase alarm monitoring contracts
that were generated by Dealers offering “zero-down” on equipment purchases and
installation, unless the contracts have been outstanding for a minimum of
12 months and exhibit acceptable payment patterns as well as acceptable
responses to quality control calls, since the lack of such costs does not
create
an investment stake in the service by the end-user. Further, end-users attracted
to “zero-down” promotions are often of lower credit standing and therefore, may
be more likely to default.
Credit
quality of the end-user is also a key consideration when purchasing alarm
monitoring contracts on a flow basis. We require credit rating scores on
all
alarm monitoring contracts that we acquire on a flow basis. We typically
reject
those alarm monitoring contracts with Beacon Scores (a credit rating employing
a
methodology developed by Fair, Isaac and Co., primarily used by Equifax in
the
U.S. and Canada) of less than 625 and typically accept alarm monitoring
contracts with a Beacon Score of 640 or more (provided they satisfy all of
our
other due diligence criteria). Alarm monitoring contracts with a Beacon Score
between 625 and 640 are further scrutinized through an additional review
of the
end-user’s credit status. We do not conduct a credit review of the end-user for
bulk purchases because of the seasoned performance characteristics of such
alarm
monitoring contracts.
Our
due
diligence process begins with an examination of the Dealer in much the same
way
as a bank reviews a mortgage applicant. We perform judgment and lien searches,
review tax filings (corporate and personal), and obtain credit scores,
certificates of good standing and proof of licensure from the state(s) in
which
the Dealer does business. In addition, we pre-approve each Dealer's standard
end-user alarm monitoring contract and with respect to flow purchases obtain
a
credit rating for each end-user. We also require that the selling Dealers
carry
errors and omissions insurance with at least $1 million of coverage
and
provide us with a personal guarantee of the dealer recourse obligation. When
we
purchase on a flow basis, we also generally contact the end-user to ensure
that
they understand the alarm monitoring contract and know how to use the alarm
system.
When
purchasing alarm monitoring contracts on a bulk basis, we contact a significant
random sample to ensure the customers exist. In all cases, we verify that
the
alarm system generates a live signal to our monitoring call centers. We include
certain additional safeguards in our purchase and loan agreements. We generally
bill end-users directly and require that the receipts be deposited into a
segregated lock-box account for our benefit. A lock-box account is established
through a remittance processing agreement between a third party service provider
and us pursuant to which payments made under the end-user alarm monitoring
contracts are forwarded to the third party and placed in a segregated account.
The contents of the lock-box are remitted daily to an accumulation account
from
which disbursements are made first to our lenders, as required, and to us.
The
Dealers have no right in, or any right to withdraw any amounts held in the
accumulation account. For loans, we also take physical possession of the
original alarm monitoring contracts and file financing statements to perfect
our
security interest.
While
some of our monitoring competitors also claim to offer alarm monitoring contract
acquisition and financing alternatives to Dealers, many act merely as an
intermediary. In contrast, we operate as a principal and either lend directly
to
the Dealers or acquire alarm monitoring contracts for our own portfolio.
We are
not aware of any other monitoring competitor in the industry that acts as
a
principal for loans to Dealers.
A
key
element of our alarm monitoring contract acquisition and financing business
is
that we are uniquely able to mitigate attrition of the alarm monitoring
contracts we acquire. In addition to the alarm monitoring contract acquisition
and finance process described above, we generally require that Dealers use
us to
monitor all of their alarm monitoring contracts, not just those that have
been
acquired or financed. This monitoring requirement enables us to ensure the
quality of the monitoring services. Monitoring problems are a primary cause
of
alarm monitoring contract cancellation and we believe that we are the only
participant in the industry that has the ability to control every aspect
of its
acquired alarm monitoring contracts.
Monitoring
Services
We
provide monitoring to Dealers on alarm monitoring contracts that they have
entered into with an end-user. Dealers typically pay us a fixed monthly
monitoring fee for each account that we monitor on their behalf. The cost
of the
monthly monitoring fee is either based on a published list price or is
negotiated between us and the Dealer. The charges are billed to the Dealer
on a
monthly, quarterly, semi-annual or annual basis in accordance with the contract
agreement. The collection of payments by the Dealer from their end users
have no
effect on the prices charged or collected by us from the Dealer. We currently
monitor approximately 720,000 end-user accounts. Generally, when an alarm
is
activated, a signal is sent from the alarm system through a phone line, radio
transmitter or wireless service to a receiver located at one of our two
monitoring facilities. This signal is immediately routed through our automated
system and an operator personally handles each call. When the operator receives
the alarm condition, his or her computer will simultaneously display a series
of
instructions on how to handle the alarm. These instructions are prepared
by the
Dealer and the end-user in advance and are customized to the particular
logistics of the geographic area as well as the individual needs of the
end-user.
In
many
instances, the operator will call a phone number specified by the end-user
and
ask for a code word. If the operator is unable to contact the end-user or
an
incorrect code word is given, the operator will dispatch the appropriate
authority to the scene of the alarm. In the instance of a fire alarm, the
operator is typically instructed to dispatch emergency vehicles without making
an attempt to contact the end-user. In any event, after dispatching the
appropriate authority, the operator will then call any other individuals
specified in the end-user's instructions and will provide notice to the Dealer
servicing the end-user of the event. The Dealer can then provide follow-up
support with the local end-user.
In
a
typical week, our operators respond to approximately 134,000 alarm activations.
We have consistently met a response time for priority events, measured by
us as
the time between when an alarm signal arrives in our alarm monitoring centers
and our first response to that alarm, of 24 seconds, which we believe is
among
the best response times in the industry.
We
own
and operate two redundant alarm monitoring centers, which operate with
state-of-the-art equipment and a highly trained staff. Our alarm monitoring
centers are located in Wall Township, New Jersey and Irvine, California,
and are
linked via advanced software that creates a real-time queuing process. Having
two facilities located strategically in different time zones allows us to
efficiently allocate alarm responses based on time-of-day or specific event
drivers that may cause one area of the country to have a higher volume of
alarms
than others. As a result, alarm signals, which would otherwise wait for
available operators during peak periods, are routed to our other alarm
monitoring centers where they are more quickly processed. For instance, a
large
number of alarms at our New Jersey facility resulting from bad weather in
the
Northeast would result in the transfer of a portion of these calls to our
California facility.
All
of
our alarm monitoring centers are Underwriters Laboratories (R) (“UL”) listed. To
obtain and maintain a UL listing, a monitoring call center must be located
in a
building meeting UL's structural requirements, have back-up and uninterruptible
power supply, have secure and redundant telephone lines and redundant computer
systems that meet UL criteria. Access to the facility must also be strictly
controlled.
Alarm
monitoring offerings vary widely with the specific needs of the end-user
and
encompass many types of monitored alarms including burglary, hold-up, panic,
fire, two-way voice communication, industrial process control, medical emergency
and environmental alert. We monitor all of these types of alarms from our
existing monitoring call centers. Our alarm monitoring centers are also capable
of supporting a full range of add-on services such as remote video monitoring,
network intrusion detection, cellular transmission, private radio access,
personal emergency response systems and Global Positioning System (“GPS”)
monitoring and emergency dispatch services using GPS technology.
Historically,
our wholesale alarm monitoring services business has grown by adding new
Dealer
relationships generated by both direct marketing and sales activities and
by
cross-selling to those Dealers to whom we have provided financing. Additionally,
over the last three years we have acquired four wholesale alarm monitoring
companies and we expect to acquire additional alarm monitoring centers in
the
future, subject to the availability of suitable acquisition
opportunities.
We
continually monitor the efficiency of each of our alarm monitoring centers.
We
recently consolidated eight alarm monitoring centers into the two alarm
monitoring centers that we operate today, taking advantage of new technologies
that enable us to monitor large geographic areas very effectively from a
single
location. This consolidation has allowed us to increase efficiency and
productivity, and decrease duplicative expenses. However, we intend to always
maintain at least one fully redundant facility.
Other
Services
Billing
and Collection
We
create
paper invoices and mail them to end-users serviced by our Dealers. Additionally,
we may provide collection services for accounts receivable. We generally
charge
on a per account basis. In instances where we provide the billing and collection
function in addition to alarm monitoring contract acquisition and financing,
we
gain an additional level of assurance that timely payments will be made on
the
alarm monitoring contracts that we have purchased or lent against. It also
enables us to minimize billing errors, which are also a cause of alarm
monitoring contract attrition. By offering billing and collection services
to
our Dealers, we enable Dealers to focus their efforts on sales and installation,
rather than administration of alarm monitoring contracts.
Guardian
Name Brand Program
We
offer
a name brand program under the Guardian name that is designed to assist our
Dealers in the selling of more security systems by utilizing the brand awareness
of the Guardian name and the many marketing and sales tools that we provide.
The
Guardian program is operated and administered by us on an exclusive basis
and
each system that is sold and installed under the Guardian brand is required
to
be monitored by us. Under the program, a Dealer is provided with all the
marketing material, monitoring agreements and equipment necessary for the
installation of the systems as well as other sales and administrative materials
under the Guardian name. In addition, we act as the exclusive financing company
for the program should the Dealer wish to borrow against or sell alarm
monitoring contracts that are generated from sales under the Guardian
brand.
Equipment
Discount Program
We
provide our Dealers with access to discounts on equipment. For example, we
have
entered into a relationship with Alarm Device Manufacturing Company (“ADEMCO”),
which is the largest security alarm equipment manufacturer and provider in
the
world. Our understanding with ADEMCO is that any Dealer who uses our monitoring
services will automatically receive preferential pricing for all equipment
purchased from ADEMCO. This program can represent significant savings to
our
Dealers. To be eligible for this program, we require that the Dealer (i) be
an existing customer of ours, (ii) connect all of their new end-users
to
our alarm monitoring center and (iii) maintain a current standing
with
regard to their monitoring charges.
We
are
currently in discussions with other major manufacturers of alarm equipment
to
institute a similar type of discount program for their equipment. This will
give
our Dealers a choice of using different types and brands of equipment while
enjoying similar reduced pricing plans.
Sales
and Marketing
Our
sales
and marketing activities are conducted through a network of 73 in-house
professionals.
Sales
activities are structured by product area (monitoring services, financial
products and new product applications) and geography. Although sales personnel
are focused on one product area, each professional is trained to sell all
products and services. There are 6 professionals in our wholesale sales force.
Our retail segment has 63 employees involved in sales activities related
to
servicing commercial and residential customers. We also maintain two
telemarketing departments (one for monitoring and financial services and
related
products and one for new product offerings) that support the sales
force.
Our
marketing department is comprised of 4 professionals. This team is responsible
for the production and distribution of print advertising materials and direct
mail marketing pieces. The team also issues corporate communications to
employees, customers, strategic partners and other interested parties through
regular press releases and announcements of new products and services. The
group
is also responsible for business development activities including the
identification and procurement of new products and services that Dealers
can
sell to their customers.
We
believe that this multi-faceted approach to sales and marketing activities
is an
important ingredient to the successful ongoing growth in all our business
areas.
Acquisition
Process
In
2003
and 2004, we acquired three businesses that not only had a significant number
of
contracts, but also installed and serviced commercial and residential monitoring
systems.
Our
alarm
monitoring flow business includes the purchase of newly created alarm monitoring
contracts on a recurring, or as originated, basis from our Dealers. We have
engaged in flow business with over 75 Dealers, and are actively seeking to
increase the number of Dealers with whom we conduct flow business.
Bulk
purchases occur when we buy existing portfolios of alarm monitoring contracts
with demonstrated payment histories of at least six months. Bulk purchases
typically range in size from 10,000 to 20,000 alarm monitoring contracts.
These
alarm monitoring contracts are typically purchased from Dealers on a
non-recurring basis. The bulk purchases are less predictable in terms of
the
timing of account acquisitions, but are generally more predictable in terms
of
performance than flow business because the actual historical performance
of
individual alarm monitoring contracts is known. Many of the bulk purchases
made
by us are made from Dealers who are existing monitoring customers.
In
a
typical alarm monitoring contract acquisition, we retain the selling Dealer
to
service the underlying alarm system, which helps us maintain strong
relationships with the Dealers and encourages the Dealer to sell additional
alarm monitoring contracts to us as new installations are
completed.
The
impact of the acquired contracts on revenue and profitability will be affected
by the attrition rates of acquired portfolios, as well as the variable expenses
relating to such acquisitions including billing, collection and
servicing.
Risks
Related to Our Business
We
did not timely file our Annual Report on Form 10-K for the year ended December
31, 2004 or our Quarterly Report on Form 10-Q for the three months ended
March
31, 2005. Pursuant
to rules and regulations established by the Securities and Exchange Commission
(the “SEC”) and the Public Company Accounting Oversight Board to implement
Sections 404(a) and 404(b) of the Sarbanes-Oxley Act of 2002, we are required
to
include in our annual report on Form 10-K for the year ended December 31,
2004
(the “Form 10-K”) a report of our management on our internal control over
financial reporting including an assessment of the effectiveness of our
internal
control over financial reporting and an attestation report of our registered
public accounting firm on our management's assessment of our internal control
over financial reporting. Due to our delays in completing these requirements,
significant growth through acquisitions and major system changes, we were
unable
to close our books, prepare our financial statements and timely file the
Form
10-K or our Quarterly Report on Form 10-Q for the three months ended March
31,
2005.
In
November 2004, we issued $125,000,000 aggregate principal amount of 12%
Senior
Secured Notes due 2011 (the “Notes”) pursuant to an indenture, dated as of
November 16, 2004 (the “Indenture”), between us, the subsidiary guarantors
parties thereto, and Wells Fargo Bank, N.A., as trustee (the “Trustee”). In
March 2005, we failed to, among other things, file with the Securities
and
Exchange Commission and to furnish to holders of the Notes our Annual Report
on
Form 10-K of the year ended December 31, 2004 (the “Form 10-K”) as required by
the Indenture. On April 5, 2005, the Trustee sent to us a notice of default
relating to the aforementioned defaults (the “Defaults”). On May 4, 2005, the
holders of a majority of the outstanding Notes waived the Defaults and
their
consequences through June 13, 2005 and compliance with the Indenture through
June 27, 2005 with respect to the timely filing of our Quarterly Report
on Form
10-Q for the period ended March 31, 2005 (the “Form 10-Q”). Our filing of our
Form 10-K has made the waivers permanent with respect to the Defaults.
If we are
unable to file the Form 10-Q by June 27, 2005, the Trustee could send us
a
notice of default with respect to such failure to file and the Trustee
or the
holders of 25% or more in aggregate principal amount of the Notes could
declare
the Notes due and payable if we are unable to file the Form 10-Q (and cure
any
other related defaults of which notice was given) within 30 days of the
giving
of the notice or obtain an additional waiver from the noteholders.
On
March
28, 2005, we were notified by Nasdaq that they had not received the Form
10-K as
required by Marketplace Rule 4310(c)(14). Accordingly, we were informed
by
Nasdaq that our common stock would be delisted from The Nasdaq Stock Market,
unless we requested a hearing in accordance with Nasdaq Marketplace Rules.
We
attended such a hearing on April 28, 2005 and, as a result, were notified
on May
9, 2005 that we had been granted an extension until June 27, 2005 to file
the
Form 10-K and the Form10-Q. If we are unable to file the Form 10-Q by June
27,
2005, our common stock could be delisted from The Nasdaq Stock
Market.
We
cannot
provide any assurance that our failure to have timely filed our Form 10-K
or
Form 10-Q will not have other legal or regulatory implications for us.
Significant
attrition, or non-renewal of retail alarm monitoring contracts or loss of
dealer
relationships would materially adversely affect our results of
operations.
We
experience attrition of Dealer customer relationships and alarm monitoring
contracts as a result of several factors including relocation of end-users,
adverse financial and economic conditions and competition from other alarm
service companies. In addition, we may lose or experience non-renewal of
certain
alarm monitoring contracts of Dealers, particularly acquired Dealer customer
relationships and alarm monitoring contracts, if we do not service those
alarm
monitoring contracts adequately or do not successfully integrate new alarm
monitoring contracts into our operations. A significant increase in attrition
or
the non-renewal of alarm monitoring contracts would have a material adverse
effect on our revenues and earnings. To the extent that actual attrition
exceeds
our expectations, our revenues, profitability, cash flow and earnings would
be
adversely affected. Attrition for acquired Dealer customer relationships
and
alarm monitoring contracts may be greater in the future than the attrition
rate
assumed or historically incurred by us. In addition, because some Dealer
customer relationships and acquired alarm monitoring contracts are prepaid
on an
annual, semi-annual or quarterly basis, attrition may not become evident
for
some time after an acquisition is consummated.
If
our
retail alarm monitoring contract attrition exceeds certain levels for certain
periods, we will be required to offer to purchase a portion of the outstanding
12% Senior Secured Notes due 2011.
Under
the same circumstances, our ability to purchase new retail alarm monitoring
contracts may be limited. If we are required to make such an offer, we may
not
have sufficient funds to purchase the Notes we are required to repurchase
or
such repurchase could adversely affect our liquidity.
We
face significant competition in the security alarm industry, which could
make it
more difficult for us to succeed in securing relationships with Dealers and
reduce the number of alarm monitoring contracts we are able to
acquire.
We are
dependent on entering into and maintaining relationships with Dealers who
will
either sell their alarm monitoring contracts directly to us, borrow from
us, or
enter into alarm monitoring contracts for us to provide wholesale monitoring
services for the alarm monitoring contracts retained by them. While we do
not
typically compete directly with many of the larger companies in the industry
because we do not primarily sell and install security systems, we are
nonetheless impacted by the competitive challenge these entrants present
to
Dealers.
There
is
the potential that larger companies in the industry may generate alarm
monitoring contracts offering "zero down" on equipment purchases and
installation. The
independent Dealer may have to offer the same "zero down" deal in order to
effectively compete. Since the end-users attracted to "zero- down" promotions
are often of lower credit standing and thereby are more likely to default,
we
will only purchase these contracts if they have been outstanding for periods
longer than 12 months and exhibit acceptable payment patterns as well as
acceptable responses to quality control calls, thus potentially limiting
the
available alarm monitoring contracts which meet our due diligence standards.
We
also compete with several companies that have alarm monitoring contract
acquisition and loan programs for Dealers and some of those competitors may
be
larger and better capitalized than we are. Some of these companies may be
able
to pay higher multiples of recurring monthly revenue for the portfolios they
acquire than we can. We
may be
required to offer higher prices for such acquisitions than we have in the
past,
thus making these acquisitions less financially advantageous. Some of the
companies we compete with include ADT, Protection One, Brinks and Honeywell.
There is also the potential for other entities such as banks or finance
companies to become more active as a source of competition for the Dealer
financing portions of our business.
We
may not be able to obtain all of the benefits of the security alarm monitoring
contracts we purchase. A
principal element of our business strategy is to acquire portfolios of alarm
monitoring contracts. Acquisitions of end- user alarm monitoring contracts
involve a number of risks, including the possibility that we will not be
able to
realize the recurring monthly revenue stream we contemplated at the time
of
acquisition because of higher than expected attrition rates or fraud. Although
we complete an extensive due diligence process prior to acquiring alarm
monitoring contracts and obtain representations and warranties from the seller,
we may not be able to detect fraud on the part of the seller, including the
possibility that the seller has misrepresented the historical attrition rates
of
the sold contracts or has sold or pledged the contracts to a third party.
If the
sale of alarm monitoring contracts involves
fraud
or
the representations and warranties are otherwise inaccurate, we may not be
able
to recover from the seller damages in the amount sufficient to fully compensate
us for any resulting losses. In such event, we may incur significant costs
in
litigating ownership or breach of acquisition contract terms.
We
may
pursue acquisitions of alarm monitoring call centers that by their nature
present risks and may not be successful.
An
element of our business strategy is to acquire additional alarm monitoring
call
centers. The following are some of the risks associated with these acquisitions:
| · |
We
may be unable to achieve anticipated revenues, earnings or cash
flow
because of higher than expected attrition rates or other reasons.
|
| · |
We
may be unable to integrate acquired call centers successfully and
realize
anticipated economic, operational and other benefits in a timely
manner.
If we are unable to integrate acquired call centers successfully,
we could
incur substantial costs and delays or other operational, technical
or
financial problems.
|
| · |
If
we are not successful in integrating acquired call centers, we
could have
increased attrition because of service-related problems.
|
| · |
Acquisitions
could disrupt our ongoing business, distract management, divert
resources
and make it difficult to maintain our current business standards,
controls
and procedures.
|
We
also face competition in identifying and purchasing suitable alarm monitoring
centers. We
compete with other firms, many of which have greater financial and other
resources than we do, for the acquisition of alarm monitoring centers. Should
this competition increase, it will be more difficult to acquire additional
alarm
monitoring centers, on terms acceptable to us.
Risk
Regarding Non-Compliance with Section 404 of the Sarbanes-Oxley Act of 2002.
Section 404
of the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") requires us
to
include in our Annual Report on Form 10-K a report of our management
regarding its assessment of our internal control over financial reporting.
This
report must contain (i) a statement of management's responsibility
for
establishing and maintaining adequate internal controls over financial
reporting, (ii) a statement identifying the framework used by management
to
conduct the required evaluation of the effectiveness of our internal controls
over financial reporting, (iii) management's assessment of the
effectiveness of our internal control over our financial reporting as of
the end
of our most recent fiscal year, including a statement as to whether or not
internal control over financial reporting is effective and (iv) a
statement
that our independent registered public accounting firm has issued an attestation
report on management's assessment of the effectiveness of our internal control
over financial reporting. Our documentation and testing to date have identified
material weaknesses in the design and effectiveness of our internal control
over
financial reporting (which are discussed in Section 9A of this report) that
we
will need to remediate. While our management has presented a plan to our
audit
committee to implement, document and test any required changes to correct
the
material weaknesses identified in order to make a positive assertion as to
the
effectiveness of our internal control over financial reporting in subsequent
periods, there can be no assurance that changes in internal control will
be made
in time to do so. If we are unable to make sufficient progress, we will be
unable to assert that we have effective internal control over financial
reporting for the year ending December 31, 2005.
Our
ability to continue to grow our business is dependent upon our ability to
obtain
additional financing.
We
intend to continue to pursue growth through the acquisition of end-user alarm
monitoring contracts and wholesale monitoring businesses. We will be required
to
seek additional funding from third party lenders and/or from the possible
sale
of additional securities, which may lead to higher leverage or the dilution
of
then existing stockholders. Our senior secured notes contain terms that limit
our ability to incur additional indebtedness which may negatively impact
our
ability to acquire additional retain monitoring contracts. Any inability
to
obtain funding through third party financing is likely to adversely affect
our
ability to continue or increase our acquisition activities. Third party funding
may not be available to us on attractive terms or at all.
Rising
interest rates could negatively affect our
profitability.
The
interest rate of our financing is generally tied to prevailing market rates.
In
the event that interest rates rise, the spread between our cost of capital
and
the amount that we can charge Dealers who borrow from us may decrease, which
will negatively affect our profitability.
We
could face liability for our failure to respond adequately to alarm
activations.
The
nature of the services we provide potentially exposes us to risks of liability
for employee acts or omissions or system failures. In an attempt to reduce
this
risk, our alarm monitoring agreements and other agreements pursuant to which
we
sell our products and
services
contain provisions limiting liability to end-users and Dealers. However,
in the
event of litigation with respect to such matters, there can be no assurance
that
these limitations will continue to be enforced. In addition, the costs of
such
litigation could have an adverse effect on us.
We
may face additional costs and potential liability as a result of "false alarm"
ordinances. Significant
concern has arisen in certain municipalities about the high incidence of
false
alarms. This concern could cause a decrease in the likelihood or timeliness
of
police response to alarm activations and thereby decrease the propensity
of
consumers to purchase or maintain alarm monitoring services.
A
number
of local governmental authorities have considered or adopted various measures
aimed at reducing the number of false alarms. Such measures include subjecting
alarm monitoring companies to fines or penalties for transmitting false alarms,
licensing individual alarm systems and the revocation of such licenses following
a specified number of false alarms, imposing fines on alarm end-users for
false
alarms, imposing limitations on the number of times the police will respond
to
alarms at a particular location after a specified number of false alarms
and
requiring sufficient further verification of an alarm signal before the police
will respond. Enactment of such measures could increase our costs and thus
adversely affect our future results of operations.
Future
government or other organization regulations and standards could have an
adverse
effect on our operations.
Our
operations are subject to a variety of laws, regulations and licensing
requirements of federal, state and local authorities. In certain jurisdictions,
we are required to obtain licenses or permits, to comply with standards
governing employee selection and training and to meet certain standards in
the
conduct of our business. The loss of such licenses, or the imposition of
conditions to the granting or retention of such licenses, could have an adverse
effect on us. We believe that we are in material compliance with applicable
laws
and licensing requirements. In the event that these laws, regulations and/or
licensing requirements change, it could require us to modify our operations
or
to utilize resources to maintain compliance with such rules and regulations.
There can be no assurance as to what new regulations will be enacted and
what
effect they may have on us.
The
loss of our Underwriters Laboratories listing could negatively impact our
competitive position.
All of
our monitoring call centers are UL listed. To obtain and maintain a UL listing,
an alarm monitoring call center must be located in a building meeting UL's
structural requirements, have back-up and uninterruptible power supply, have
secure telephone lines and maintain redundant computer systems. UL conducts
periodic reviews of monitoring call centers to ensure compliance with their
regulations. Non-compliance could result in a suspension of our UL listing.
The
loss of our UL listing could negatively impact our competitive position.
We
rely on technology which may become obsolete.
Our
monitoring services depend upon the technology (hardware and software) of
security alarm systems. We may be required to upgrade or implement new
technology which could require significant capital expenditures. There can
be no
assurance that we will be able to successfully implement new technologies
or
adapt existing technologies to changing market demands. If we are unable
to
adapt in a timely manner in response to changing market conditions or customer
requirements, such inability could adversely affect our business.
In
the event that adequate insurance is not available or our insurance is not
deemed to cover a claim we could face liability.
We carry
insurance of various types, including general liability and errors and omissions
insurance. Our loss experience and that of other security service companies
may
affect the availability and cost of such insurance. Certain of our insurance
policies and the laws of some states may limit or prohibit insurance coverage
for punitive or certain other types of damages, or liability arising from
gross
negligence. To the extent that insurance was not available, or a particular
claim was not covered or exceeded our coverage, we could be exposed to material
costs.
We
are dependent upon our senior management.
The
success of our business is largely dependent upon the active participation
of
our executive officers, who have extensive experience in the industry. As
a
result, we have entered into employment agreements with each of our executive
officers. The loss of the services of one or more of such officers for any
reason may have an adverse effect on our business. Stockholders should not
expect dividends. We do not intend to pay any cash dividends in the foreseeable
future.
Employees
As
of
December 31, 2004, we had a workforce of 874 employees. Of our total workforce,
218 are engaged in finance, administration and management, 383 are engaged
in
the monitoring business, 73 are engaged in sales and marketing, and 200 are
engaged in service and installation of monitoring systems. None of our employees
are represented by a collective bargaining agreement, nor have we experienced
work stoppages. We believe that our relations with our employees are
good.
Competition
The
security alarm industry is highly competitive and fragmented. While we generally
do not compete directly with many of the large companies in the industry
such as
ADT, Brinks, Protection One and Honeywell because we do not primarily sell
and
install security systems, we are nonetheless impacted by the competitive
challenge these companies present to Dealers. While all of these companies
provide monitoring services, some of these companies, may from time to time,
purchase portfolios of monitoring contracts.
We
compete with several companies that have alarm monitoring contract acquisition
and loan programs for Dealers and some of these competitors may be better
capitalized than us. There is also the potential for other entities such
as
banks or finance companies to gain a better understanding of the industry
and
become more active as a source of competition for alarm monitoring contract
acquisition and financing portions of our business. Further, we compete with
participants that primarily provide alarm monitoring contract acquisition
and
financing services such as Security Alarm Financing Enterprises, Inc.,
Financial Security Services, Inc., and Monitronics
International, Inc.
History
We
were
formed as King Central in 1985 in the State of New Jersey. In 1986, Thomas
Few,
Sr. our Vice Chairman, President and Chief Operating Officer joined King
Central
as Executive Vice President and Chief Operating Officer and acquired 20%
of King
Central's capital stock. In January 1998, as part of a reorganization of
King
Central, Mr. Few, Sr.'s ownership was increased to 80% and the remaining
20% was
acquired by Timothy M. McGinn, our Chief Executive Officer, and David L.
Smith,
a Director. At that time, we changed our name to KC Acquisition.
In
September 2002, KC Acquisition acquired all of the capital stock of Criticom
in
exchange for $1.0 million and 155,911 shares of our common stock. An additional
68,182 shares of our common stock have been issued to the sellers based upon
Criticom's financial performance in 2003. Criticom provides wholesale alarm
monitoring services to Dealers. In addition, it provides Global Positioning
System monitoring and asset tracking services to various customers. Curtis
Quady, an Executive Vice President, was the President, Chief Executive Officer
and principal stockholder of Criticom.
In
connection with the acquisition of Criticom, we acquired a 5.03% interest
in
Royal Thoughts, LLC. The purchase price was approximately $3.5 million net
of
cash acquired of $0.6 million as well as a note for $0.7 million. In connection
with our purchase, we received a right of first refusal to provide any
monitoring services for new technology developed by Royal Thoughts. The
investment in Royal Thoughts was valued at zero.
M&S
Partners, a New York general partnership equally owned by Mr. McGinn and
Mr.
Smith began to acquire portfolios of alarm monitoring contracts from Dealers
in
1992. Each contract was ultimately placed by M&S Partners with one of 41
leveraged trusts of which Mr. McGinn, Mr. Few, Sr. and Mr. Smith were the
beneficiaries. M&S Partners also acquired alarm monitoring contracts through
three limited liability companies (Guardian Group, LLC, Palisades Group,
LLC and
Payne Security Group, LLC) which were owned by TJF Enterprises, LLC, which
is
owned by Mr. Few, Sr., and First Integrated Capital Corporation, which is
majority owned by Mr. McGinn and Mr. Smith. They bundled those alarm monitoring
contracts and sold them as Trust Certificates collateralized by the underlying
alarm monitoring contracts and their recurring monthly revenue. We do not
expect
to engage in securitizing alarm monitoring contracts in the future.
Between
March and November 2002, IASI, a company that was controlled by Mr. McGinn,
Mr.
Smith and Mr. Few, Sr., offered the holders of the trust certificates the
right
to exchange such certificates for promissory notes of IASI. Upon completion
of
the exchanges, all but eleven of the trusts were liquidated and their assets
were transferred to IASI. The trust certificates of the remaining trusts
were
repaid with the proceeds of the offering and the assets of the trusts were
transferred to us. In January 2003, IASI entered into a merger with a wholly
owned subsidiary of ours and became our wholly owned subsidiary. In connection
with the acquisition of IASI, we issued an aggregate of 772,192 shares of
our
common stock.
Palisades
Group, LLC was the owner of approximately 38% of the alarm monitoring contracts
underlying the trusts. In January 2003, Palisades exchanged all of its ownership
interests for our stock and distributed such stock to its members, TJF
Enterprises, LLC and First Integrated Capital Corporation. In connection
with
the acquisition of Palisades, we issued an aggregate of 25,000 shares of
our
common stock. This acquisition was accounted for under the purchase method
of
accounting. In January 2003, Payne Security Group, LLC and Guardian Group,
LLC
were acquired by us and became our wholly owned subsidiaries. In connection
with
the acquisition of Payne Security Group, LLC, we issued an aggregate of 50,250
shares to TJF Enterprises, LLC, and First Integrated Capital Corporation.
In
connection with the acquisition of Guardian Group, LLC, we issued an aggregate
of 16,750 shares to TJF Enterprises, LLC, and First Integrated Capital
Corporation.
Morlyn
Financial Group, LLC was founded in May 2000 to assist Dealers who were
interested in selling their alarm monitoring contracts to IASI. Morlyn
originates alarm monitoring contracts for acquisition and provides due
diligence, billing and other related services. In connection with the
acquisition of Morlyn, in January 2003, we issued an aggregate of 17,000
shares
of our common stock to Messrs. McGinn, Few Sr., and Smith.
In
June
1999, KC Acquisition acquired all of the assets and assumed certain liabilities
of Criticom CA, Inc., a monitoring call center in Santa Fe Springs, California,
in exchange for approximately $3.2 million. In May 2000, KC Acquisition acquired
99.2% of the capital stock of Monital Signal Corporation in exchange for
approximately $10.7 million. Monital, located in Manasquan, New Jersey, was
KC
Acquisition's largest competitor in the Northeast, United States. In October
2001, KC Acquisition acquired Custom Design Security, an independent wholesale
alarm monitoring company which services the Western and Central Regions of
Florida, in exchange for approximately $1.2 million. In January 2002, KC
Acquisition acquired certain assets of RTC Alarm Monitoring Services, a large
alarm monitoring call center in California, in exchange for $5.1 million.
In
January 2003, we effected a migratory merger into KC Alarm Services Group,
Inc.,
a Delaware corporation. The sole purpose of the migratory merger was to change
our jurisdiction of incorporation from New Jersey to Delaware. Subsequent
to the
migratory merger, we assumed all of the assets and liabilities of Integrated
Alarm Services Group, Inc., a pre-existing, Delaware company whose only activity
was the sale of $5.5 million of convertible debentures. The pre-existing
Integrated Alarm Services Group, Inc. was then dissolved and we changed our
name
to Integrated Alarm Services Group, Inc.
See
heading “Acquisitions” in Item 7. Management’s Discussion and Analysis of
Financial Condition and Results of Operations for entities acquired since
our
initial public offering of common stock.
Risk
Management
We
carry
insurance of various types, including general liability and errors and omissions
insurance. Our errors and omissions coverage is $10 million per occurrence.
Our loss experience and the loss experience of other companies in the security
industry may affect the cost and availability of such insurance. Since 1998
we
have had no uninsured losses. Certain of our insurance policies and the laws
of
some states may limit or prohibit insurance coverage for punitive or other
types
of damages, or liability arising from gross negligence or wanton behavior.
See
“Risk Factors—In the event that adequate insurance is not available or our
insurance is not deemed to cover a claim we could face liability.”
The
nature of the services we provide potentially exposes us to greater risks
of
liability for employee acts or omissions or systems failure than may be inherent
in other businesses. Our agreements with Dealers and end-users contain
provisions limiting our liability to end-users and Dealers in an attempt
to
reduce this risk. However, in the event of litigation with respect to such
matters, there can be no assurance that these limitations will continue to
be
enforced. In addition, the costs of such litigation could have an adverse
effect
on us.
Regulatory
Matters
A
number
of local governmental authorities have adopted or are considering various
measures aimed at reducing the number of false alarms. Such measures include:
(i) subjecting alarm monitoring companies to fines or penalties for
transmitting false alarms, (ii) licensing individual alarm systems
and the
revocation of such licenses following a specified number of false alarms,
(iii) imposing fines on end-users for false alarms, (iv) imposing
limitations on the number of times the police will respond to alarms at a
particular location after a specified number of false alarms and
(v) requiring further verification of an alarm signal before the police
will respond.
Our
operations are subject to a variety of other laws, regulations and licensing
requirements of federal, state and local authorities. In certain jurisdictions,
we are required to obtain licenses or permits to comply with standards
governing
employee selection and training and to meet certain standards in the conduct
of
our business. Many jurisdictions also require certain of our employees to
obtain
licenses or permits.
The
alarm
industry is also subject to requirements imposed by various insurance, approval,
listing and standards organizations. Depending upon the type of end-user
served,
the type of service provided and the requirements of the relevant local
governmental jurisdiction, adherence to the requirements and standards of
such
organizations is mandatory in some instances and voluntary in
others.
Our
alarm
monitoring business utilizes radio frequencies to transmit alarm signals.
The
Federal Communications Commission and state public utilities commissions
regulate the operation and utilization of radio frequencies.
In
September 2003, the Company entered into a five-year lease for office space
for
its headquarters in Albany, New York. The lease is for approximately 21,000
square feet. The lease period is November 15, 2003 through
November 14, 2008. The lease has a five-year renewal option. Annual
rents
will be $190,000 for year one and two and $225,000 for years three through
five.
We
also
have offices and our East Coast call monitoring center in Wall Township,
New
Jersey. The facility is 7,200 square feet. We own the premises, subject to
a
mortgage in favor of LaSalle Bank, creating a first priority security interest
for the benefit of LaSalle Bank, and subject to a second mortgage in favor
of
the Trustee, creating a second priority security interest for the benefit
of the
holders of the Notes.
Morlyn’s
executive offices are located in Oakland, New Jersey. The offices are 4,705
square feet. The lease expires in April 2006 and provides for a monthly
rental of $6,959.
We
lease
space for an alarm monitoring center in California located in Santa Fe Springs.
The facility is 6,551 square feet. The premises are leased pursuant to a
two-year lease expiring in March 2005 (extended through June), at
a monthly
rental rate of approximately $5,600 per month.
We
also
have an alarm monitoring center in Minneapolis, Minnesota. The facility is
13,478 square feet. The lease expires in 2010, and provides for a net monthly
rental rate of $6,360.
We
also
have two sales, service and administration offices as well as seven sales
and
service branch offices located in California, New Mexico, Arizona and Nevada.
The leases expire at various dates through 2007 and currently have a monthly
rental rate of $34,367.
As
part
of the acquisition of NACC, we assumed the lease of office space and a
monitoring center in Irvine, California at a monthly cost of $34,047. The
lease
runs through April, 2007.
In
March
2003, Protection One, a company engaged in the business of providing security
and other alarm monitoring services to residential and commercial customers,
brought an action against us in the Superior Court of New Jersey, Camden
County
for unspecified damages in connection with our purchase of certain alarm
monitoring contracts from B&D. B&D had previously sold alarm monitoring
contracts to Protection One. As part of such sales, B&D
agreed not to solicit any customers whose contracts had been purchased and
to
keep certain information confidential. Protection One claims that our subsequent
purchase of contracts from B&D constitutes tortious interference, that we
utilized confidential information belonging to Protection One and that
Protection One had an interest in some of the contracts that we purchased
from
B&D. We plan to vigorously defend this claim. We believe the resolution of
this matter will not have a material adverse effect on our financial condition,
results of operations or cash flows.
In
May
2003, a former employee of McGinn, Smith & Co., Inc., brought an
action against us, as well as McGinn, Smith & Co., Inc. and
M&S Partners for wrongful termination. The suit brought in the Supreme Court
of the State of New York seeks damages of $10,000,000. McGinn, Smith &
Co., Inc. and M&S Partners have fully indemnified us from any damages
or legal expenses that we may incur as a result of the suit. This employee
of
McGinn, Smith & Co., Inc., was never our employee and we plan to
vigorously defend this claim. We moved to dismiss the plaintiff's complaint
against us and that motion was granted in its entirety, dismissing us from
the
lawsuit. Plaintiff has filed a notice of appeal. We believe the resolution
of
this matter will not have a material adverse effect on our financial condition,
results of operations or cash flows.
We
from
time to time experience routine litigation in the normal course of our business.
We do not believe that any pending litigation will have a material adverse
effect on our financial condition, results of operations or cash flows.
No
matters were submitted to a vote of stockholders during the fourth quarter
of
the fiscal year ended December 31, 2004, through the solicitation of proxies
or
otherwise.
Part
II
The
Company’s common stock is traded in the NASDAQ National Market System under the
symbol IASG. The Company’s common stock was first traded on the NASDAQ during
the third quarter of 2003. Quarterly high and low bid information for the
quarterly periods of 2004 and the third and fourth quarter of 2003 as reported
by NASDAQ for normal trading hours (4 pm EST closing) are set forth below:
|
Year
ended December 31, 2004
|
High
|
Low
|
||
|
First
Quarter
|
$
|
11.15
|
$
|
8.05
|
|
Second
Quarter
|
12.50
|
4.50
|
||
|
Third
Quarter
|
5.62
|
3.22
|
||
|
Fourth
Quarter
|
5.60
|
4.01
|
||
|
Year
ended December 31, 2003
|
||||
|
First
Quarter
|
N/A
|
N/A
|
||
|
Second
Quarter
|
N/A
|
N/A
|
||
|
Third
Quarter
|
9.99
|
7.75
|
||
|
Fourth
Quarter
|
9.50
|
6.95
|
||
These over the counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.
No
dividends have been paid on the common shares to date and none are anticipated
for the foreseeable future.
As
of
December 31, 2004 there were 24,681,462 common shares issued and outstanding
held by 16 shareholders of record, not including persons or entities where
stock
is held in nominee or “street” name through various brokerage firms or
banks.
The
following selected financial data have been derived from the Consolidated
Financial Statements of the Company.
|
|
Year
ended December 31,
|
|||||||||||||||
|
2000
|
|
|
2001
|
|
|
2002
|
|
|
2003
|
|
|
2004
|
||||
|
Statement
of operations data (1):
|
||||||||||||||||
|
Revenue
|
$
|
18,774,517
|
$
|
20,569,037
|
$
|
23,495,607
|
$
|
40,867,598
|
$
|
80,369,160
|
||||||
|
Total
operating expenses, inclusive of cost of revenue
|
19,455,562
|
19,691,838
|
24,267,532
|
44,517,078
|
82,495,928
|
|||||||||||
|
Income
(loss) from operations
|
(681,045
|
)
|
877,199
|
(771,925
|
)
|
(3,649,480
|
)
|
(2,126,768
|
)
|
|||||||
|
Other
(expense), net
|
(3,824,867
|
)
|
(3,914,509
|
)
|
(5,556,730
|
)
|
(14,828,508
|
)
|
(9,172,496
|
)
|
||||||
|
Income
(loss) before income taxes
|
(4,505,912
|
)
|
(3,037,310
|
)
|
(6,328,655
|
)
|
(18,477,988
|
)
|
(11,299,264
|
)
|
||||||
|
Income
tax expense (benefit)
|
(4,793,725
|
)
|
(703,784
|
)
|
(681,443
|
)
|
3,526,572
|
417,779
|
||||||||
|
Net
income (loss)
|
$
|
287,813
|
$
|
(2,333,526
|
)
|
$
|
(5,647,212
|
)
|
$
|
(22,004,560
|
)
|
$
|
(11,717,043
|
)
|
||
|
Basic
and diluted income (loss) per share
|
$
|
0.52
|
$
|
(4.21
|
)
|
$
|
(9.53
|
)
|
$
|
(1.95
|
)
|
$
|
(0.47
|
)
|
||
|
Shares
used computing basic and diluted income (loss) per common share
(3)
|
553,808
|
553,808
|
592,785
|
11,263,455
|
24,667,960
|
|||||||||||
|
Pro
forma income tax to give effect as if a C corporation
(2):
|
||||||||||||||||
|
Loss
before income tax expense (benefit)
|
(4,505,912
|
)
|
(3,037,310
|
)
|
(6,328,655
|
)
|
(18,477,988
|
)
|
||||||||
|
Income
tax expense (benefit)
|
(1,519,990
|
)
|
(955,569
|
)
|
(2,871,573
|
)
|
(89,916
|
)
|
||||||||
|
Net
income (loss)
|
$
|
(2,985,922
|
)
|
$
|
(2,081,741
|
)
|
$
|
(3,457,082
|
)
|
$
|
(18,388,072
|
)
|
||||
|
Net
income (loss) per share
|
$
|
(5.39
|
)
|
$
|
(3.76
|
)
|
$
|
(5.83
|
)
|
$
|
(1.63
|
)
|
||||
|
Balance
sheet data:
|
||||||||||||||||
|
Cash,
cash equivalents and short-term investments
|
$
|
1,151,337
|
$
|
1,224,035
|
$
|
3,442,082
|
$
|
35,435,817
|
$
|
31,554,609
|
||||||
|
Total
assets
|
38,113,543
|
36,830,768
|
45,627,797
|
241,036,330
|
302,084,181
|
|||||||||||
|
Long-term
debt
|
35,599,770
|
37,122,449
|
45,061,363
|
65,742,612
|
130,225,000
|
|||||||||||
|
Capital
lease obligations
|
145,355
|
32,549
|
507,858
|
885,366
|
1,035,489
|
|||||||||||
|
Total
stockholders' equity (deficit)
|
(7,067,197
|
)
|
(9,345,667
|
)
|
(11,562,881
|
)
|
153,402,730
|
142,849,827
|
||||||||
|
Working
capital (deficit)
|
(5,240,872
|
)
|
(7,798,161
|
)
|
(8,076,758
|
)
|
4,769,173
|
16,955,992
|
||||||||
|
Other
financial data:
|
||||||||||||||||
|
Cash
provided by (used in) operating activities
|
(1,331,125
|
)
|
1,012,251
|
2,691,844
|
(4,238,641
|
)
|
14,149,404
|
|||||||||
|
Cash
provided by (used in) investing activities
|
(11,086,367
|
)
|
(1,705,428
|
)
|
(8,863,018
|
)
|
(57,984,339
|
)
|
(77,634,164
|
)
|
||||||
|
Cash
provided (used in) financing activities
|
12,851,242
|
765,875
|
5,389,221
|
97,216,715
|
59,603,552
|
|||||||||||
(1)
Results
of operations for acquired companies are included from the date of acquisition.
As a result comparability of periods presented has been affected by our
acquisitions. For more information about our acquisition history, see
“Business”, Management’s Discussion and Analysis of Financial Condition and
Results of Operations” and Note 11 to our consolidated financial
statements.
(2)
To
give effect to the conversion of KC Acquisition from an S corporation to
a C
corporation for federal income tax purposes. The tax provision was prepared
as
if we had a combined federal and state effective tax rate of 40% and giving
effect for permanent differences.
(3)
During
July 2003, the Company successfully completed its IPO and issued a total
of
22,982,729 shares of common stock and received net proceeds of
$195,856,510.
Equity
Compensation Plan Information:
|
(a)
|
|
(b)
|
|
(c)
|
|
|
Plan
category
|
Number
of securities to be issued upon exercise of outstanding options,
warrants
and rights
|
|
Weighted-average
exercise price of outstanding options, warrants and
rights
|
|
Number
of securities remaining available for future issuance under equity
compensation plans (excluding securities reflected in column
(a))
|
|
Equity
compensation plans approved by security holders - 2003
Plan
|
144,166
|
$6.92
|
5,834
|
||
|
Equity
compensation plans approved by security holders - 2004
Plan
|
42,000
|
$5.75
|
1,158,000
|
The
Company does not have any equity compensation plans that were not approved
by
security holders.
The
following discussion and analysis of our financial condition and results
of
operations should be read together with the Consolidated Financial Statements
and Notes thereto.
Overview
We
are
one of the largest providers of monitoring, financing, and business support
services to independent security alarm Dealers which we refer to as “Dealers”,
in the United States. We offer our services to Dealers competing in both
the
residential and commercial security alarm markets. We believe our services
better allow Dealers to compete with larger, self-monitoring national alarm
companies. The major categories of services we provide include:
| · |
Monitoring.
We monitor alarm systems on behalf of Dealers who do not have the
capital
resources or critical mass to economically establish their own
monitoring
facilities and for our account. We believe we are the largest wholesale
alarm monitoring company in the United States, monitoring approximately
572,000 alarm systems on behalf of approximately 5,600 independent
Dealers. We refer to this as our wholesale business and we currently
receive approximately $3.1 million of revenue per month
to monitor
contracts owned by Dealers. Our alarm monitoring services are provided
through two, state-of-the-art, redundant alarm monitoring centers
located
in New Jersey and California. The acquisition of the assets of
NACC
discussed below provided us with 220,000 new monitored alarm systems
and
approximately 600 new Dealer relationships (these are included
in the
above totals) as well as an additional state-of-the-art alarm monitoring
center in California.
|
| · |
Financing.
Since 1993, we have provided financing for Dealers in the form
of loans or
alarm monitoring contract purchases of approximately $480 million
in
the aggregate. As of December 31, 2004, we owned and monitored
a portfolio
of approximately 149,000 retail alarm monitoring contract equivalents.
A
contract equivalent is equal to $30 per month in RMR from a typical
residential customer. We refer to this as our retail business and
we
currently receive approximately $4.5 million of revenue
per month
from this portfolio. In addition, we hold approximately 22,500
contracts
as collateral against loans we have made to Dealers. The NACC acquisition
added an additional 13,100 retail alarm monitoring contract equivalents
and an additional 14,000 contracts as collateral against loans
made to
Dealers (which we assumed in the acquisition) and these are included
in
the above totals.
|
| · |
Business
Support Services. For many of our Dealers, we provide billing,
collection
and marketing services as well as access to equipment discount
programs.
Because of our scale, we can generally provide these services on
a more
cost-effective basis for Dealers than they can for themselves.
In
addition, our equipment discount program allows Dealers who use
our
monitoring services to automatically receive preferential pricing
for
certain alarm equipment.
|
Our
retail portfolio is comprised of both residential subscribers, which represent
approximately 80% of our revenue in this segment, and commercial
subscribers, which represent approximately 20% of our revenue in this
segment. We believe maintaining an appropriate balance between residential
and
commercial customers will be important going forward.
We
believe our package of services allows Dealers to compete against
self-monitoring national providers in the security alarm market by giving
them
access to technical sophistication, financing, back office and other services
that they would not otherwise have, while allowing them to remain the local
and
visible contact with their customer, the end-user of the security alarm system.
We intend to continue to expand the number of Dealers for which we provide
these
services through direct marketing of our services as well as acquisitions
of
alarm contracts and alarm monitoring companies.
Our
revenues are derived primarily from our portfolio of retail alarm monitoring
contracts and providing wholesale alarm monitoring services to Dealers for
the
benefit of the end-user of the alarm system. We typically enter into contracts
with our Dealers to provide alarm monitoring services for periods ranging
from
one to five years. The majority of monitoring contracts entered into by
end-users with our Dealers generally permit cancellation with notice of
30-60 days before the end of the original, or any renewal, contract
term.
Some alarm monitoring contracts with Dealers have longer, more definitive
terms.
However, essentially all alarm monitoring contracts may be broken for
non-performance. Our alarm monitoring contracts with Dealers may require
the
Dealer to place its entire portfolio of end-user alarm monitoring contracts
in
our monitoring centers. Our revenues will fluctuate based upon changes in
the
net number of end-user alarm monitoring contracts and the timing of connections
and disconnections that any one Dealer has with us. Our revenues will also
fluctuate based upon the number of Dealers that are added or lost during
any
particular period. We may gain or lose Dealers based upon the quality, range
or
price of the services we provide relative to what is provided by our competitors
and the effectiveness of our sales and marketing efforts. Our revenues may
also
be affected by the application of various pricing strategies we may choose
to
use with our Dealers.
In
addition to our organic revenue growth, our revenues will increase because
of
acquisitions of retail alarm monitoring contracts and Dealer relationships
and
their related wholesale alarm monitoring business. Our RMR derived from acquired
businesses are also subject to the standard risks associated with any
acquisition and subsequent integration. We may suffer attrition because of
differences in, among other things, the application of policies and procedures,
or disruption caused by any conversion or consolidation
activity.
The
cost
of services is primarily a function of labor, telecommunication, data processing
and technical support costs. Labor costs are driven in part by the number
and
productivity of operators, supervisors and management within our alarm
monitoring centers that provide alarm monitoring services on behalf of our
Dealers' customers. Labor costs are also a function of the quality of our
data
processing, customer service and quality management functions. Labor costs
also
reflect the number of technical staff required to maintain and develop our
state-of-the-art monitoring systems. Telecommunication costs reflect, among
other things, the number of signals processed, the time required to process
any
particular signal, the number and type of lines, the design and functionality
of
our telecommunications network and the negotiated rate with our chosen
telecommunication providers. We are constantly evaluating how to improve
the
quality of our services while lowering the cost of providing those services.
After the acquisition and integration of NACC, we estimate that our monitoring
capacity will be over one million end-user customers.
Our
operating expenses are primarily comprised of general and administrative,
selling and marketing and depreciation and amortization expenses. General
and
administrative expenses are comprised primarily of office staff and officer
salaries, rent and professional fees. Fluctuations in general and administrative
expenses generally reflect net increases in staff associated with acquisitions,
changes in professional fees primarily associated with acquisition activity
and
audits of our books and records and merit compensation increases. Selling
and
marketing expenses are primarily driven by the size of our sales force,
commissions based upon successful selling activities, travel and advertising.
Depreciation and amortization expenses are primarily a function of the
acquisition of Dealer relationships and alarm monitoring contracts.
Streamlining
of Operations
Our
November 2004 acquisition of NACC’s state of the art monitoring center, located
in Irvine, California, substantially increased our capacity to provide
monitoring services. The recent consolidation of our Santa Fe Springs center
into the NACC center is expected to result in substantial cost savings
(currently estimated at $2.8 million on an annualized basis). These cost
savings
are possible due to the elimination of redundant G&A expenses and other
related costs.
Acquisitions
On
November 19, 2004, we acquired substantially all of the assets and
assumed
certain liabilities of NACC, a subsidiary of Tyco, for approximately
$50.6 million in cash, subject to certain closing adjustments. NACC
engages
in the wholesale and retail alarm monitoring business and also provides secured
financing to Dealers. NACC contributed approximately $0.8 million
of
wholesale RMR, $0.4 million of retail RMR and $0.2 million
of monthly
interest income on notes receivable from Dealers collateralized by retail
contracts to us.
In
May 2004, we acquired the alarm portfolio and certain other assets
of
Alliant Protection Services, Inc. (“Alliant”) for a total cash purchase
price of approximately $14.5 million, which included accounts receivable
(approximately $0.8 million), customer contracts (approximately
$8.7 million), goodwill (approximately $5.8 million), non-compete
agreement (approximately $.3 million) and current liabilities (approximately
$1.1 million).
In
December 2003, we acquired all of the capital stock of Lane
Security Inc. (“Lane Security”) for approximately $43.0 million in
cash, net of holdbacks for severance payments and attrition of customer
contracts. The principal operating unit of Lane Security is Protection Service
Industries, L.P. (“PSI”) whose assets included customer accounts with RMR of
approximately $1.8 million at December 31, 2003. PSI installs
and
services commercial and residential alarm systems in the western United States.
The acquisition was accounted for under the purchase method of
accounting.
On
November 21, 2003, we acquired all of the outstanding stock of American
Home Security, Inc. (“AHS”) and certain assets of Emergency Response
Network, Inc. (“ERN”), (collectively referred to as the acquirees) for
approximately $15.0 million, inclusive of direct acquisition costs.
The
acquirees install and service residential alarm monitoring systems in the
Nevada
area. The acquisition has been accounted for as a purchase and the results
of
the acquirees are included in our results of operations from the date of
acquisition.
Furthermore,
we entered into a three year employment agreement with the former owner of
AHS.
The agreement provides for annual compensation of $420,000 and an annual
bonus
commencing in 2004 equal to 19% of the amount by which AHS’s pre-tax income (as
defined therein) for such year exceeds $1.3 million. We have the option
to
make a one-time payment up to 125% of AHS’ pre-tax income to the employee under
a bonus buy-out provision as defined in the agreement, at which time we would
have no further annual bonus obligation to the employee. The employee for
calendar years 2006-2009 has the right to elect a bonus buy-out. Furthermore,
the bonus buy-out shall automatically trigger upon the expiration of the
employment term, and under other circumstances as defined in the agreement.
The
agreement also provides that during the employment term, the employee on
an
annual basis will be granted options to acquire our common stock if AHS achieves
certain earnings levels. The contingent consideration, which includes our
common
stock and stock options issuable upon the achievement of certain earnings
levels, may result in future charges to earnings. Based on the 2004 results,
no
bonus was earned or options were required to be granted.
In
January 2003, we acquired all of the capital stock of Integrated Alarm
Services, Inc. and affiliates in exchange for an aggregate of 864,192
shares of our common stock of which 525,452 shares were issued to minority
interests for an estimated total fair value of approximately $11.6 million.
The acquisition was accounted for under the purchase method of
accounting.
Prior
to
the acquisition of Integrated Alarm Services, Inc.,
Messrs. Timothy M. McGinn and David L. Smith controlled
41 trusts
and three limited liability companies which were principally created to acquire
alarm monitoring contracts. Approximately 62% of the trust certificates of
the
41 trusts were exchanged for promissory notes of Integrated Alarm
Services, Inc. and some of these notes were repaid with proceeds from
our
initial public offering. Approximately 38% of the trust certificates were
not
exchanged and were subsequently repaid out of the proceeds of our initial
public
offering. An additional $9.5 million of bank debt relating to these
contract acquisitions was also repaid with proceeds from our initial public
offering. Messrs. McGinn and Smith were residual beneficiaries of
these
trusts but have contributed their residual benefits in the trusts to us.
The
three limited liability companies, Palisades Group, LLC, Payne Security Group,
L.L.C. and Guardian Group, LLC were acquired by us in January 2003
and
Payne Security Group,
L.L.C. and Guardian Group, LLC are now our wholly owned subsidiaries. Palisades
Group, LLC was dissolved on July 22, 2004.
On
September 26, 2002, we acquired 100% of Criticom International Corporation
(“Criticom”), a Minnesota based alarm monitoring center that supports digital
alarm monitoring as well as GPS technology, for approximately $4.3 million,
net of cash acquired of $0.6 million. The total consideration consisted
of
$1.0 million in cash and 155,911 shares of our common stock as well
as a
note totaling $0.7 million. The former shareholders of Criticom may
receive
up to 68,182 additional shares of our common stock based upon the future
performance of Criticom. In 2003, Criticom achieved its performance targets;
as
a result, the former shareholders of Criticom received 68,182 shares of our
common stock with an aggregate value of approximately $0.6 million.
The
purchase of Criticom added approximately 400 Dealer relationships that service
80,000 end-user alarm monitoring contracts with approximately $0.4 million
in RMR.
In
January 2002, we acquired certain assets of RTC Alarm Monitoring Services
(“RTC”), a wholesale security system alarm monitoring business located in
Roseville, California. The total purchase price was $5.1 million,
which
included Dealer relationships ($4.4 million), accounts receivable
($0.2 million) and property and equipment ($0.5 million).
The
purchase was financed with debt totaling $5.8 million, which funded
the
purchase price, along with providing a $0.4 million working capital
infusion for us, $0.1 million in restricted cash and financing fees
totaling $0.175 million. The acquisition initially added 270 new Dealer
relationships to our Dealer count. As of January 2003, we maintained
relationships with 225 of these Dealers. We pursued a cause of action against
the seller for certain contractual misrepresentations regarding the attrition
rates related to certain Dealer alarm monitoring contracts and received a
settlement in 2003 for approximately $0.4 million.
A
related
party (at the time) placed the debt incurred for the RTC Alarm and the Custom
Design acquisitions and assumed in the acquisition of Criticom. The results
of
operations are included in our financial statements from the date of
acquisition.
As
a
result of this activity, as of December 31, 2004, we have customer contracts
of
$85,169,085, dealer relationships of $34,529,962 and goodwill of
$91,434,524.
Operations
In
December 2001, we commenced a consolidation process of our monitoring
facilities and a systems conversion for a material percentage of our Dealer
and
end-user base. The disruption caused by these activities negatively impacted
our
revenues and profitability. We have completed the consolidation of our alarm
monitoring centers. Key expenses such as payroll and telecommunication costs
have been reduced. We believe that our costs per subscriber will continue
to
decline as additional subscriber accounts are added.
Our
RMR
may include amounts billable to customers or Dealers with past due balances
which we believe are collectible. We seek to preserve the revenue stream
associated with each end-user alarm monitoring contract, primarily to maximize
our return on the investment we made to generate each alarm monitoring contract
or Dealer relationship. As a result, we actively work to collect amounts
owed to
us and to retain the end-user at the same time.
In
some
instances, we may allow more than six months to collect past due amounts,
while
evaluating the ongoing customer or Dealer relationship. After we have made
every
reasonable effort to collect past due balances, we will disconnect the
customer.
Customer
creation and marketing
Our
current customer acquisition strategy relies on both internally generated
sales
and acquiring Dealer relationships and alarm monitoring contract rights to
monitor security systems. We currently have a salaried and commissioned sales
force that operates in four regions covering the 48 contiguous states. The
internal sales program generated in the wholesale segment 84,616, 64,472
and
79,191 new monitoring contracts in 2002, 2003 and 2004, respectively.
Attrition
Wholesale
Business Segment
End-user
attrition has a direct impact on our results of operations since it affects
our
revenues, amortization expense and cash flow. We define attrition in the
wholesale alarm monitoring business as the number of end-user accounts lost,
expressed as a percentage, for a given period. We monitor end-user attrition
each month, each quarter and each year. In periods of end-user account growth,
end-user attrition may be understated and in periods of end-user account
decline, end-user attrition may be overstated. Our actual attrition experience
shows that the relationship period with any individual Dealer or end-user
can
vary significantly. Dealers discontinue service with us for a variety of
reasons, including but not limited to, the sale of their alarm monitoring
contracts, performance issues and receipt of lower pricing from competitors.
End-users may discontinue service with the Dealer and therefore with us for
a
variety of reasons, including, but not limited to, relocation, service issues
and cost. A portion of Dealer and end-user relationships, whether acquired
or
originated via our sales force, can be expected to discontinue service every
year. Any significant change in the pattern of our historical attrition
experience would have a material effect on our results of operations, financial
position or cash flows.
For
the
years ended December 31, 2002, 2003 and 2004, our trailing annual end-user
account growth rates in the wholesale monitoring segment, including acquisitions
were 24.7%, 12.3% and 31.7% respectively. For the years ended December 31,
2002,
2003 and 2004, our trailing annual end-user account growth rates in the
wholesale monitoring segment, excluding acquisitions, were (6.1%), (3.2%)
and
(6.1%) respectively. For the years ended December 31, 2002, 2003 and 2004,
our
trailing annual end-user attrition rates in the wholesale monitoring segment,
calculated as end-user losses divided by the sum of beginning end-users,
end-users added and end-users acquired, was 18.2%, 12.7% and 13.1% respectively.
Included in these totals for 2003 and 2004 are approximately 137,000 and
149,000
contracts, respectively, that are owned by our retail monitoring
segment.
Following
is a summary of our end-user accounts:
|
Year
ended December 31,
|
||||||||||
|
2002
|
|
2003
|
|
2004
|
||||||
|
Beginning
balance, January 1,
|
390,216
|
486,650
|
546,649
|
|||||||
|
Reporting
discrepancy adjustments (see Note)
|
-
|
-
|
(26,592
|
)
|
||||||
|
End-users
added, excluding acquisitions
|
84,616
|
64,472
|
79,191
|
|||||||
|
End-users
acquired
|
120,192
|
75,375
|
232,984
|
|||||||
|
End-user
losses
|
(108,374
|
)
|
(79,848
|
)
|
(112,351
|
)
|
||||
|
Ending
Balance, December 31,
|
486,650
|
546,649
|
719,881
|
|||||||
Note:
As
a result of the discovery of a discrepancy in the reporting mechanism for
the
number of wholesale accounts, an adjustment of 26,592 to the January 1, 2004
beginning balance is necessitated and is reflected in the table
above.
Attrition
for acquired Dealer customer relationships and alarm monitoring contracts
may be
greater in the future than the attrition rate assumed or historically incurred
by us. In addition, because some Dealer customer relationships and acquired
alarm monitoring contracts are prepaid on an annual, semi-annual or quarterly
basis, attrition may not become evident for some time after an acquisition
is
consummated.
Retail
Business Segment
We
employ, for contracts purchased on a bulk basis subsequent to January 31,
2003, an amortization methodology which is the total of the charges calculated
by a straight line, 18 year life; together with charges incurred as
a
result of actual contract attrition. For bulk contracts purchased prior to
that
date, we employ an amortization methodology which uses 150% declining balance
over a life of 8 years.
The
annualized attrition rates, based upon customer accounts cancelled or becoming
significantly delinquent, during the periods presented are as
follows:
|
2004
Retail Attrition Rate
|
|||||||||
|
Quarter
Ended
|
|||||||||
|
Portfolio
|
March
31,
|
|
June
30,
|
|
September
30,
|
|
December
31,
|
Year
ended
December
31,
|
|
|
Legacy
and flow
|
17.70%
|
|
10.80%
|
|
15.20%
|
|
14.60%
|
|
13.80%
|
|
Residential
since IPO
|
13.50%
|
|
9.90%
|
|
12.50%
|
|
11.30%
|
|
11.29%
|
|
Commercial
since IPO
|
9.10%
|
|
13.40%
|
|
10.40%
|
|
8.60%
|
|
9.98%
|
|
Total
|
13.40%
|
|
11.20%
|
|
12.60%
|
|
11.30%
|
|
11.59%
|
The
attrition for a given period is calculated as the quotient of: (i) the
sum
of (a) cancelled RMR plus (b) the increase (or minus the decrease)
in
“disqualified RMR” (i.e., RMR with related account receivable balances over
90 days from invoice date) minus (c) ”replacement RMR” (i.e.,
cancelled or disqualified RMR that has been replaced by the selling Dealer
with
new RMR as required by the original sales contract with the Dealer); divided
by
(ii) ”qualified RMR” (i.e., RMR with no related account receivable balances
over 90 days from invoice date).
Critical
Accounting Policies
Our
discussion and analysis of results of operations, financial condition and
cash
flows are based upon our financial statements, which have been prepared in
accordance with accounting principles generally accepted in the United States
of
America. The preparation of these financial statements requires us to make
estimates and judgments that affect the reported amounts of assets, liabilities,
revenues and expenses, and related disclosure of contingent assets and
liabilities. These estimates are evaluated on an on-going basis, including
those
related to revenue recognition and allowance for doubtful accounts, valuation
to
allocate the purchase price for a business combination, notes receivable
reserve
and fair value of customer contracts on foreclosed loans, fair value and
forecasted data to access recoverability of intangible assets and goodwill,
income taxes and contingencies and litigation. We base our estimates on
historical experience and on various other assumptions that are believed
to be
reasonable under the circumstances, the results of which form the basis for
making judgments about the carrying values of assets and liabilities that
are
not readily apparent from other sources. Actual results may differ from these
estimates under different assumptions or conditions.
Note
2 of
the "Notes to Financial Statements" includes a summary of the significant
accounting policies and methods used in the preparation of our financial
statements. The following is a brief description of the more significant
accounting policies and methods we use.
Revenue
Recognition and Allowance for Doubtful Accounts
All
revenue is recognized on an accrual basis. Accounts
receivable are recorded at the invoiced amount and do not bear interest.
Credit
is extended based upon an evaluation of the customers financial condition
and
history. The allowance for doubtful accounts is our best estimate of the
amount
of probable credit losses in our existing accounts receivable. We review
our
allowance for doubtful accounts monthly. Customer accounts, including accounts
with balances over 90 days from the invoice date are reserved based on
historical trends. Account balances are charged-off against the allowance
when
we feel it is probable the receivable will not be recovered. We do not have
any
off-balance-sheet credit exposure related to our customers.
Deferred
installation costs and revenues
Installation
revenue is deferred and recognized over the expected life of the customer
relationship. The
direct incremental costs associated with installing monitoring systems, to
the
extent of installation revenue, are deferred and recognized over the expected
life of the customer relationship. Excess direct incremental costs over
installation revenue are being amortized over the term of the
contract.
Notes
Receivable Reserve and Fair Value of Customer Contracts on Foreclosed
Loans
We
make
loans to Dealers, which are collateralized by the Dealers’ portfolio of end-user
alarm monitoring contracts. Loans to Dealers are carried at the lower of
the
principal amount outstanding or if non-performing, the net realizable value
of
the portfolio underlying the loan. Loans are generally considered non-performing
if they are 120 days in arrears of contractual terms.
Management
periodically evaluates the loan portfolio to assess the collectibility of
Dealer
notes and adequacy of allowance for loan losses. Management reviews certain
criteria in assessing the adequacy of the allowance for loan losses, including
our past loan loss experience, known and inherent risks in the portfolio,
adverse situations that may affect the borrower's ability to repay, the
estimated value of any underlying collateral and current economic conditions.
Loan impairment is identified when a portfolio's cash flow is materially
below
the minimum necessary to service the loan. In most cases, loans will be
foreclosed and valued at the lower of cost (loan carrying value) or fair
value
of end-user contracts using recent transaction prices and industry
benchmarks.
Notes
receivable consists primarily of loans to Dealers which are collateralized
by a
portfolio of individual end-user monitoring contracts. When a Dealer becomes
delinquent, we generally foreclose on and take ownership of the portfolio
of
end-user monitoring contracts.
At
December 31, 2004, we had non-performing loans to Dealers aggregating
approximately $1.4 million. In February 2005, the Company collected
$.6
million of these loans. Currently, the cash flows from the underlying collateral
support the carrying value of the loans. However, if the cash flows from
the
underlying collateral continues to deteriorate, it may result in a future
charge
to earnings.
Deferred
issuance costs
Debt
issuance costs represents direct costs incurred in connection with obtaining
financing with related parties, banks and other lenders. Debt issuance costs
are
being amortized over the life of the related obligations using the effective
interest method.
Intangible
Assets and Goodwill
Alarm
monitoring services for Dealers’ end-users are outsourced to us. We acquire such
Dealer relationships from our internally generated sales efforts and from
other
monitoring companies. Acquired Dealer relationships are recorded at cost,
which
management believes approximates fair value. End-user alarm monitoring contracts
are acquired from the Dealers’ pre-existing portfolios of contracts or assumed
upon the foreclosure on Dealers’ loans.
Acquired
end-user alarm monitoring contracts are recorded at cost which management
believes approximates fair value. End-user alarm monitoring contracts assumed
as
a result of foreclosure on dealer loans are recorded at the lower of cost
(loan
carrying value) or the fair value of such contracts using recent transaction
prices and industry benchmarks at the time of foreclosure.
End-user
alarm monitoring contracts are amortized over the term that such end-users
are
expected to remain as our customer. We, on an ongoing basis, conduct
comprehensive reviews of our amortization policy for end-user contracts and,
when deemed appropriate, uses an independent appraisal firm to assist in
performing an attrition study.
Amortization
methods for end-user contracts below consider the average estimated life
and
historical and projected attrition rates determined from actual experience
and
consists of the following portfolios:
Acquired
as a result of the IASI merger:
|
Existing
at January 31, 2003
|
Accelerated
method
|
Period
|
||
|
Existing
portfolio accounts (bulk)
|
150%
Declining balance
|
8
years
|
||
|
Dealer
acquired new accounts (flow)
|
160%
Declining balance
|
8
years
|
||
|
Contracts
assumed from dealers
|
160%
Declining balance
|
4
years
|
Acquired
subsequent to the IASI merger:
|
Acquired
after January 31, 2003
|
Accelerated
method
|
Period
|
||
|
Existing
portfolio accounts (bulk)
|
Straight-line
plus attrition
|
18
years
|
||
|
Dealer
acquired new accounts (flow)
|
200%
Declining balance
|
12
years
|
||
|
Contracts
assumed from dealers
|
200%
Declining balance
|
8
years
|
Dealer
relationships and end-user contracts are amortized using methods and lives
which
are management’s estimates, based upon all information available (including
industry data, attrition studies, current portfolio trends), of the life
(attrition pattern) of the underlying contracts and relationships. If actual
results vary negatively (primarily attrition) from management assumptions,
amortization will be accelerated, which will negatively impact results from
operations. If amortization is not accelerated or conditions deteriorate
dramatically, the asset could become impaired. For existing portfolio accounts
purchased subsequent to January 31, 2003, we amortize such accounts
using
the straight-line method over an 18-year period plus actual attrition. This
methodology may cause significant variations in amortization expense
in
future
periods. Dealer relationships and end-user alarm monitoring contracts are
tested
for impairment on a periodic basis or as circumstances warrant. Recoverability
of Dealer relationship costs and end-user alarm monitoring contracts are
highly
dependent on our ability to maintain our Dealers. Factors we consider important
that could trigger an impairment review include higher levels of attrition
of
Dealers and/or end-user alarm monitoring contracts and continuing recurring
losses.
SFAS
No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,”
requires that the assets be reviewed for impairment whenever events or changes
in circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of the assets to be held and used is measured
by a
comparison of the carrying amount of the assets with the future net cash
flows
expected to be generated. Cash flows of Dealer relationships and retail customer
contracts are analyzed at the same group level (acquisition by acquisition
and
portfolio grouping, respectively) that they are identified for amortization,
the
lowest level for which independent cash flows are identifiable. All other
long-lived assets are evaluated for impairment at the company level, using
one
asset grouping. If such assets are considered to be impaired, the impairment
to
be recognized is measured by the amount by which the carrying amount of the
assets exceeds the fair value of the assets. As of December 31, 2004,
our
long-lived assets (property and equipment, Dealer relationships and customer
contracts) aggregate approximately $127.6 million.
We
account for goodwill under Statement of Financial Accounting Standards (SFAS)
No. 142, “Goodwill and Other Intangible Assets.” Under SFAS No. 142, goodwill is
not amortized, but it is tested for impairment at least annually. Each year
we
test for impairment of goodwill according to a two-step approach. In the
first
step, we test for impairment of goodwill by estimating the fair values of
our
reporting units using the present value of future cash flows approach, subject
to a comparison for reasonableness to our market capitalization at the date
of
valuation. If the carrying amount exceeds the fair value, the second step
of the
goodwill impairment test is performed to measure the amount of the impairment
loss, if any. In the second step the implied fair value of the goodwill is
estimated as the fair value of the reporting unit used in the first step
less
the fair values of all other net tangible and intangible assets of the reporting
unit. If the carrying amount of the goodwill exceeds its implied fair market
value, an impairment loss is recognized in an amount equal to that excess,
not
to exceed the carrying amount of the goodwill. In addition, goodwill of a
reporting unit is tested for impairment between annual tests if an event
occurs
or circumstances change that would more likely than not reduce the fair value
of
a reporting unit below its carrying value. We perform our annual impairment
test
in the third quarter of each year and to date have not been required to record
an impairment charge. During the second quarter of 2004, our common stock
began
trading below its book value and has continued to do so through the fourth
quarter. Management, after evaluating current financial forecasts and operating
trends, continues to believe that goodwill was not impaired at December 31,
2004. A non-cash goodwill impairment charge may result in a future period
if
there is a decline in estimated future earnings and cash flows. Our goodwill
balance at December 31, 2004 is approximately $91.4 million.
Income
taxes
As
part
of the process of preparing our financial statements, we are required to
estimate our income taxes in each of the jurisdictions in which we operate.
This
process involves estimates of our actual current tax exposure together with
assessing temporary differences resulting from differing treatment of items,
such as depreciation and amortization, for tax and accounting
purposes.
Litigation
In
March
2003, Protection One, a company engaged in the business of providing security
and other alarm monitoring services to residential and commercial customers,
brought an action against us in the Superior Court of New Jersey, Camden
County
for unspecified damages in connection with our purchase of certain alarm
monitoring contracts from B&D Advertising Corporation (“B&D”). B&D
had previously sold alarm monitoring contracts to Protection One. As part
of
such sales, B&D agreed not to solicit any customers whose contracts had been
purchased and to keep certain information confidential. Protection One claims
that our subsequent purchase of contracts from B&D constitutes tortuous
interference, that we utilized confidential information belonging to Protection
One and that Protection One had an interest in some of the contracts that
we
purchased from B&D. We plan to vigorously defend this claim. We believe the
resolution of this matter will not have a material adverse effect on our
financial condition, results of operations or cash flows.
In
May 2003, a former employee of McGinn, Smith & Co., Inc.,
brought an action against us, as well as McGinn, Smith & Co., Inc.
and M&S Partners for wrongful termination. The suit brought in the Supreme
Court of the State of New York seeks damages of $10.0 million. McGinn,
Smith & Co., Inc. and M&S Partners have fully indemnified us
from any damages or legal expenses that we may incur as a result of the suit.
This employee of McGinn, Smith & Co., Inc. was never our employee
and we plan to vigorously defend this claim. We moved to dismiss the plaintiff's
complaint against us and that motion was granted in its entirety, dismissing
us
from the lawsuit. Plaintiff has filed a notice
of
appeal. We believe the resolution of this matter will not have a material
adverse effect on our financial condition, results of operations or cash
flows.
We
from
time to time experience routine litigation in the normal course of our business.
We do not believe that any pending litigation will have a material adverse
effect on our financial condition, results of operations or cash
flows.
The
following table sets forth, for the periods indicated, selected statements
of
operations data for IASG:
|
Years
Ended December 31,
|
||||||||||
|
2002
|
|
2003
|
|
2004
|
||||||
|
Total
revenue
|
$
|
23,495,607
|
$
|
40,867,598
|
$
|
80,369,160
|
||||
|
Cost
of revenue (excluding depreciation and amortization)
|
15,424,912
|
16,393,439
|
32,748,642
|
|||||||
|
8,070,695
|
24,474,159
|
47,620,518
|
||||||||
|
Operating
expenses:
|
||||||||||
|
Selling
and marketing
|
736,866
|
1,108,621
|
4,357,046
|
|||||||
|
Depreciation
and amortization
|
5,580,985
|
12,322,558
|
23,012,590
|
|||||||
|
General
and administrative
|
2,530,374
|
14,692,460
|
22,561,726
|
|||||||
|
Loss
(gain) on disposal of equipment
|
(5,605
|
)
|
-
|
(184,076
|
)
|
|||||
|
Total
operating expenses
|
8,842,620
|
28,123,639
|
49,747,286
|
|||||||
|
Income
(loss) from operations
|
(771,925
|
)
|
(3,649,480
|
)
|
(2,126,768
|
)
|
||||
|
Other
income, net
|
656,299
|
295,984
|
10,332
|
|||||||
|
Amortization
of debt issuance costs
|
(1,619,086
|
)
|
(3,168,315
|
)
|
(1,750,151
|
)
|
||||
|
Interest
expense
|
(4,593,943
|
)
|
(13,569,846
|
)
|
(8,885,904
|
)
|
||||
|
Interest
income
|
-
|
1,613,669
|
1,453,227
|
|||||||
|
Income
(loss) before income taxes
|
(6,328,655
|
)
|
(18,477,988
|
)
|
(11,299,264
|
)
|
||||
|
Income
tax expense (benefit)
|
(681,443
|
)
|
3,526,572
|
417,779
|
||||||
|
Net
income (loss)
|
$
|
(5,647,212
|
)
|
$
|
(22,004,560
|
)
|
$
|
(11,717,043
|
)
|
|
|
Basic
and diluted income (loss) per share
|
$
|
(9.53
|
)
|
$
|
(1.95
|
)
|
$
|
(0.47
|
)
|
|
The
following table sets forth, for the periods indicated, selected statements
of
operations data as a percentage of revenues:
|
Years
Ended December 31,
|
|||||||||
|
2002
|
|
2003
|
|
2004
|
|||||
|
Total
revenue
|
100.0
|
%
|
100.0
|
%
|
100.0
|
%
|
|||
|
Cost
of revenue (excluding depreciation and amortization)
|
65.7
|
%
|
40.1
|
%
|
40.7
|
%
|
|||
|
Operating
expenses:
|
|||||||||
|
Selling
and marketing
|
3.1
|
%
|
2.6
|
%
|
5.4
|
%
|
|||
|
Depreciation
and amortization
|
23.8
|
%
|
30.2
|
%
|
28.6
|
%
|
|||
|
General
and administrative
|
10.8
|
%
|
36.0
|
%
|
28.0
|
%
|
|||
|
Loss
(gain) on disposal of equipment
|
-
|
%
|
-
|
%
|
(0.2
|
)%
|
|||
|
Total
operating expenses
|
37.7
|
%
|
68.9
|
%
|
61.9
|
%
|
|||
|
Income
(loss) from operations
|
(3.3
|
)%
|
(8.9
|
)%
|
(2.6
|
)%
|
|||
|
Other
income, net
|
2.8
|
%
|
0.8
|
%
|
0.0
|
%
|
|||
|
Amortization
of debt issuance costs
|
6.9
|
%
|
7.8
|
%
|
(2.2
|
)%
|
|||
|
Interest
expense
|
19.6
|
%
|
33.2
|
%
|
(11.1
|
)%
|
|||
|
Interest
income
|
-
|
%
|
3.9
|
%
|
1.8
|
%
|
|||
|
Income
(loss) before benefit from income taxes
|
(27.0
|
)%
|
(45.2
|
)%
|
(14.1
|
)%
|
|||
|
Income
tax expense (benefit)
|
(3.0
|
)%
|
8.6
|
%
|
0.5
|
%
|
|||
|
Net
income (loss)
|
(24.0
|
)%
|
(53.8
|
)%
|
(14.6
|
)%
|
|||
2004
COMPARED TO 2003
Revenue
Total
revenue for the year ended December 31, 2004 was approximately $80,369,000
compared to approximately $40,868,000 for the same period during the prior
year,
an increase of approximately $39,501,000, or 96.7%.
Wholesale
monitoring revenues were approximately $24,274,000 for the year ended December
31, 2004 compared to approximately $24,393,000 for the same period in 2003,
a
decrease of approximately $119,000, or 0.5%. The decrease is due primarily
to a
decrease in the aggregate number of accounts (not owned by the Company, or
“external”) monitored during 2004. This decrease in external accounts monitored,
of approximately 44,000 resulted in a decrease in revenue of approximately
$2,625,000. This decrease was offset, in part, by an increase of approximately
$1,228,000 generated by an increase in the average revenue per account per
month
of approximately $0.28 for 2004 as compared to 2003 and a $1,278,000 increase
due to the 2004 NACC acquisition.
Revenue
from retail segment operations increased approximately $39,620,000 to
approximately $56,095,000 for the year ended December 31, 2004 from $16,475,000
for the same period in 2003. Revenue from the Q4-2003 / Q2-2004 acquisitions
accounted for approximately $32,778,000 of the increase. An additional $676,000
resulting from the 2004 NACC acquisition. In addition, 2004 reflects incremental
revenue of approximately $1,338,000 as a result of the merger of IASI which
occurred in January 31, 2003. Additional revenue, of approximately $2,654,000,
was generated due to an increase of approximately 7,800 in the average number
of
retail contracts owned per month and the balance of approximately $2,174,000
was
due to an increase in the average revenue per contract of $3.30.
Cost
of Revenue (excluding Depreciation and Amortization)
Our
cost
of revenue for the year ended December 31, 2004 was approximately $32,749,000
compared with approximately $16,393,000 for the year ended December 31, 2003,
an
increase of approximately $16,356,000, or 99.8%. This increase in the cost
of
revenue was primarily due to approximately an $10,859,000 increase of costs
in
2004 from the Q4-2003 / Q2-2004 acquisitons as compared with 2003. An additional
$1,001,000 of the increase is due to the NACC acquisition in 2004. In addition,
excluding the Q4-2003 / Q2-2004 and NACC acquisitions, the cost of revenue
for
the retail segment increased approximately $2,359,000 while the cost of revenue
for the wholesale monitoring operations increased approximately $2,137,000.
Operating
Expenses
Operating
expenses increased from approximately $28,124,000 for the year ended December
31, 2003 to approximately $49,747,000 for the comparable period in 2004,
an
increase of approximately $21,623,000, or 76.9%. The increase was primarily
due
to an increase of approximately $18,581,000 of expenses associated with the
Q4-2003 / Q2-2004 acqusitions and $368,000 of expenses associated with the
2004
NACC acquisition. Exclusive of the Q4-2003 / Q2-2004 and NACC acquisitions,
the
remaining increase consisted of $166,000 from the wholesale segment, and
$2,508,000 in the retail segment.
Selling
and marketing expenses increased approximately $3,248,000 from approximately
$1,109,000 for the year ended December 31, 2003 to approximately $4,357,000
for
same period in 2004. The increase is primarily attributable to an increase
in
expenses associated with the Q4-2003 / Q2-2004 acqusitions of approximately
$3,319,000. The increase in expenses related to the Q4-2003 / Q2-2004
acquisitions were comprised primarily of payroll, benefits and other
compensation of approximately $2,887,000, vehicle and fuel expense of
approximately $125,000, advertising of approximately $136,000 and travel
and
entertainment of approximately $61,000.
Depreciation
and amortization expenses increased from approximately $12,323,000 in the
year
ended December 31, 2003 to approximately $23,013,000 for the comparable period
in 2004, an increase of approximately $10,690,000, or 86.7%. This increase
was
partially due to the expenses related to the Q4-2003/
Q2-2004
acquisitions
of $6,002,000 and expenses relating to the NACC acquisition of $262,000.
The
remaining increase consisted of approximately $5,028,000 in retail operations,
exclusive of the Q4-2003 /
Q2-2004
and NACC acquisitions,
offset, in part, by a decrease in expenses associated with the wholesale
segment
of approximately $602,000. The retail segment increase was due to an increase
in
the amortization of customer contract costs as a result of the purchase of
a
significant amount of contracts in the later half of 2003 and during 2004.
The
decrease in wholesale operations expense is attributable to a decrease in
amortization of dealer relationship costs due to the Company’s use of declining
balance accelerated methods of amortization.
Gain
on
disposal of assets was $184,000 in 2004 as compared with $0 in 2003. The
increase was primarily due to the gain on sale of customer contracts of
approximately $143,000.
General
and administrative expenses increased approximately $7,870,000 or 53.6%,
from
approximately $14,692,000 in the year ended December 31, 2003 to approximately
$22,562,000 for the same period of 2004. Approximately $3,525,000 of the
expenses in 2003 related to a charge associated with transactions with the
Capital Center Credit Corporation (“CCCC”). Absent this 2003 charge, the
expenses for the 2004 period would have represented an increase of approximately
$11,395,000 from the expenses for the same period of 2003. Approximately
$9,260,000 of the increase was associated with the Q4-2003 / Q2-2004
acquisitions. This increase was comprised primarily of payroll, bonus and
other
compensation of approximately $4,480,000, facilities, utilities &
maintenance $773,000, telephone expense of $932,000, bad debt expense of
approximately $559,000, contract and third party services of $344,000,
collection and billing of approximately $512,000, insurance and property
taxes
of approximately $504,000, office supplies and services (including equipment,
postage and mailing) of approximately $499,000 and travel, entertainment,
vehicle and fuel expenses of approximately $157,000. An additional $93,000
of
the increase was due to the 2004 NACC acquisition. The remaining increase
in
expenses of approximately $1,858,000 is due primarily to increases in payroll,
employee benefits and other compensation of approximately $1,032,000, consulting
and other fees associated with Sarbanes-Oxley assessment activities of
approximately $641,000, directors and officers insurance of approximately
$508,000, board fees of approximately $279,000 and rent and utilities of
approximately $251,000, partially offset by decreases in bad debt expense
of
approximately $652,000 and legal, accounting and other professional fees
of
approximately $201,000.
Other
Income/Expense
Other
income for the year ended December 31, 2004 amounted to approximately $10,000
compared to other income for the same period in year 2003 of approximately
$296,000. For the most part, the other income in 2003 was due to a settlement
related to the acquisition of RTC Alarm Monitoring Services.
Amortization
of Debt Issuance Costs
The
amortization of debt issuance costs decreased approximately $1,418,000 from
approximately $3,168,000 for the year ended December 31, 2003 to approximately
$1,750,000 for the same period in 2004. The decrease in amortization of debt
issuance costs is primarily due to the acceleration of amortization in 2003
as a
result of prepayment of certain debt from the IPO proceeds, which accounts
for
approximately $1,437,000 of the decrease. An additional decrease of $649,000
is
due to normal amortization of debt in 2004. These decreases are offset in
part
by an increase of approximately $555,000 of amortization acceleration in
2004 as
compared to 2003 due to the early payoff of debt using the $125,000,000 of
proceeds from the notes offering and $113,000 increase from new debt in
2004.
Interest
Expense
Interest
expense decreased by approximately $4,684,000, or 34.5% from approximately
$13,570,000 to approximately $8,886,000 from 2003 to 2004, respectively.
This
decrease is primarily due to debt payoff in 2003, therefore
decreasing the interest paid in 2004.
Interest
Income
Interest
income decreased $161,000, or 10.0%, from approximately $1,614,000 for the
year
ended December 31, 2003 to approximately $1,453,000 for the same period of
2004.
Taxes
Income
tax expense totaled approximately $418,000 for the year ended December 31,
2004
compared with an expense of approximately $3,527,000 for the year ended December
31, 2003. The income tax expense recorded during the year ended December
31,
2004 was due primarily to the merger of Integrated Alarm Services, Inc. and
the
Company in January 2003 and the change in tax status (S to C Corporation)
for
federal income tax purposes.
The
expense recorded in 2004 represents state taxes attributable to subsidiaries
of
the Company which conduct business in separate taxing jurisdictions and deferred
taxes related to business acquisitions.
Results
of Operations by Segment
The
comparable financial results for the Company’s two operating segments;
Alarm-Monitoring, Wholesale Services and Alarm-Monitoring, Retail Services
for
the year ended December 31, 2004 compared with the year ended December 31,
2003
are discussed below.
Alarm
Monitoring, Wholesale Segment. Year ended December 31,
2004
Alarm
Monitoring, Wholesale segment total revenue decreased by approximately $119,000,
or 0.5%, to approximately $24,274,000 for the year ended December 31, 2004
from
approximately $24,393,000 for the same period in 2003. The
decrease is due primarily to a decrease in the aggregate number of accounts
(not
owned by the Company, or “external”) monitored during 2004. This decrease in
external accounts monitored, of approximately 44,000 resulted in a decrease
in
revenue of approximately $2,625,000. This decrease was offset, in part, by
an
increase
of approximately $1,228,000 generated by an increase in the average revenue
per
account per month of approximately $0.28 from 2004 as compared to the same
period of 2003 and by an increase of approximately $1,278,000 from the 2004
NACC
Acquisition.
The
wholesale segment had a loss from operations of approximately $3,635,000
for the
year ended December 31, 2004 compared with income from operations of
approximately $71,000 for the same period last year, a change of approximately
$3,706,000. The change is due to primarily to a decrease in direct margin
along
with an increase of general and administrative expenses of $952,000, offset
by
decreases in sales and marketing expenses and depreciation and amortization
expenses of $128,000 and $340,000, respectively.
The
segment had a loss before income taxes of approximately $4,935,000 for the
year
ended December 31, 2004 compared to a loss of approximately $3,304,000 for
the
year ended December 31, 2003. The decrease, of approximately $1,631,000,
is
attributable to the decrease in income from operations of $3,706,000, a decrease
in other income of approximately $348,000 and a decrease in interest income
of
approximately $106,000, offset in part by a decrease in interest expense
of
approximately $1,814,000, a decrease in amortization of debt issuance costs
of
approximately $715,000.
Alarm
Monitoring, Retail Segment. Year ended December 31,
2004
Alarm
Monitoring, Retail segment total revenue increased by approximately $39,620,000
to approximately $56,095,000 for the year ended December 31, 2004 from
approximately $16,475,000 for the same period in 2003. Revenue
from the Q4-2003 / Q2-2004 acquisitions accounted for approximately $32,778,000
of the increase. Revenue from the 2004 NACC acquisition accounts for
approximately $676,000 of the increase. In addition, 2004 reflects incremental
revenue of approximately $1,338,000 as a result of the merger of IASI which
occurred in January 31, 2003. Additional revenue, of approximately $2,654,000,
was generated due to an increase of approximately 7,800 in the average number
of
retail contracts owned per month and the balance of approximately $2,174,000
was
due to an increase in the average revenue per contract of $3.30.
For
the
year ended December 31, 2004 the segment had income from operations of
approximately $1,508,000 compared to a loss of approximately $3,721,000 for
the
year ended December 31, 2003, an improvement of approximately $5,229,000
The
improvement was primarily due to approximately $3,339,000 of income from
operations from the Q4-2003 /
Q2-2004
acquisitions
and $593,000 from the 2004 NACC acquisition.
The
segment’s loss before income taxes was approximately $6,365,000 for the year
ended December 31, 2004 compared to a loss for the year ended December 31,
2003
of approximately $15,174,000, an improvement of approximately $8,809,000.
In
addition to the aforementioned improvement in income from operations, the
remaining reduction of the loss before taxes of approximately $3,580,000
was
primarily due to a decrease of approximately $2,870,000 in interest expense
and
a decrease of approximately $704,000 in amortization of debt issuance
costs.
2003
COMPARED TO 2002
Revenue
Total
revenue for the year
ended
December
31,
2003
was approximately $40,868,000
compared to approximately $23,496,000
for
the same period during the prior year, an increase of approximately
$17,372,000
or
73.9%.
Wholesale
monitoring revenues
increased from approximately $21,701,000 in the year ended December 31, 2002
to
approximately $24,393,000 for the same period in 2003, an
increase
of approximately $2,692,000, or 12.4%. The increase is due primarily to an
increase in average revenue per account per month from $4.25 for the year
ended
December 31, 2002 to $4.68 for the comparable period of 2003 which accounts
for
approximately $2,241,000 of the total increase. The balance of the increase
in
revenue, or approximately $451,000, is due to an increase in the aggregate
number of accounts (not owned by the Company, or “external”) monitored during
the year ended December 31, 2003 as compared to the same period in the year
2002. The net increase in external accounts can be attributed to the acquisition
of approximately 80,000 accounts as a result of the purchase of Criticom;
offset, in part, by approximately 62,000 accounts owned by IASI at the time
of
its acquisition by IASG, the revenue from which is eliminated in consolidation.
The increase in the average revenue per account can be attributed to the
fact
that the average revenue on external accounts exceeds that of those owned
by
IASI.
Revenue
from customer accounts totaled approximately $15,855,000 for the year ended
December 31, 2003. Our initial purchase of customer accounts occurred with
the
acquisition of IASI and affiliates in January 2003.
Other
revenue, which includes billing and placement fees and service and subcontractor
revenue, totaled approximately $620,000, a decrease of approximately $1,174,000
compared with the prior year. The decrease is due primarily to the cessation
of
the recognition of related party placement fees as a result of the merger
of
IASI and affiliates.
Cost
of Revenue
Our
cost
of revenue totaled approximately $16,393,000, an increase of approximately
$968,000 from the same period of the prior year. For the most part, this
increase is comprised of an increase of approximately $2,157,000 and $828,000
associated with the acquisition of Criticom and costs associated with the
retail
segment operation, offset, in part, by expense reductions of approximately
$2,017,000 resulting from increased synergy achieved through the consolidation
of alarm monitoring facilities and monitoring system conversion program.
As a
result of the acquisition of customer accounts during the year 2003, incremental
revenues from these accounts exceeded the cost of the associated revenue
by
approximately $12,587,000 and, accordingly, resulted in an improvement to
the
year 2003 direct margin of 12.4%.
Operating
Expenses
Operating
expenses increased from approximately $8,843,000 to approximately $28,124,000,
or approximately $19,281,000. The increase was due primarily to the incremental
expenses associated with the acquisitions of IASI and PSI (“the retail segment
acquisitions”) and Criticom, in the amounts of approximately $16,848,000 and
$1,112,000, respectively.
Selling
and marketing expenses increased approximately $372,000, from approximately
$737,000 to approximately $1,109,000, or 50.5%. For the year ended December
31,
2003, the acqusition of Criticom and the retail segment acquistions resulted
in
incremental expenses of approximately $217,000 and $183,000, respectively.
These
incremental amounts were offset, in part, by the reductions to various other
expenses of approximately $28,000.
Depreciation
and amortization expenses increased from approximately $5,581,000 to
approximately $12,323,000, an increase of approximately $6,742,000, or 120.8%.
The increase was primarily a result of the incremental expense associated
with
the retail segment and Criticom acquistions in the amounts of approximately
$7,070,000 and $577,000, respectively, offset, in part, by a reductions to
amortization of dealer relationship costs and depreciation expense of
approximately $706,000 and $199,000, respectively.
General
and administrative expenses increased from approximately $2,530,000 for the
year
ended December 31, 2002 to approximately $14,692,000 for the year ended December
31, 2003, or approximately $12,162,000. The largest components of this increase
relates to the incremental expense associated with the retail segment
acquisitions and the acquisition of Criticom in the amounts of approximately
$9,595,000 and $313,000, respectively. The general and administrative expenses
from the retail segment acquisitions included, in part: assumption of debt
from
CCCC in the amount of $1,825,000; a cash payment to CCCC of $1,700,000; payroll
and employee benefits related expenses totaling approximately $2,203,000;
bad
debt expense totaling approximately $1,506,000; professional, billing and
collection service fees totaling approximately $492,000; bank, lock box and
line
of credit commitment fees of approximately $423,000; postage expense of
approximately $242,000; and, service expenses of approximately $241,000.
For the
most part, the balance of the increase in the Company’s general and
administrative expenses for the year ended December 31, 2003 can be attributed
to: an increase in accounting fees of approximately $1,155,000 related to
initial public offering activity; an increase in directors and officers
liability insurance expense of approximately $450,000; an increase in salaries,
payroll taxes and employee benefits of approximately $248,000; an increase
in
franchise taxes of approximately $180,000; and, an increase in board fees
of
approxiately $70,000.
Other
Income/Loss
Other
income for the year ended December 31, 2003 was approximately $296,000, due
primarily to a settlement related to the acquisition of RTC. For the comparable
period of 2002 other income was approximately $656,000, which, for the most
part, arose from the forgiveness of debt in connection with a litigation
settlement for an uncompleted merger.
Amortization
of Debt Issuance Costs
The
amortization of debt issuance costs increased approximately $1,549,000 from
approximately $1,619,000 to approximately $3,168,000. Incremental expense
resulting primarily from the prepayment of certain debt from the IPO proceeds
resulted in an increase of approximately $1,437,000 during the current year.
In
addition to the expense related to the retirement of debt from the IPO proceeds,
approximately $1,203,000 of incremental expense was recognized
in the current year as the result of the acquisition of IASI offset, in part,
by
a reduction of approximately $1,091,000 associated with the Company’s wholesale
monitoring segment.
Interest
Expense
Interest
expense increased by approximately $8,976,000 from approximately $4,594,000
to
approximately $13,570,000. In the wholesale monitoring businesses, interest
expense decreased from approximately $4,594,000 to approximately $3,033,000,
or
approximately $1,561,000. The incremental interest expense recorded in year
2003
associated with the acquisition of IASI totaled approximately
$10,537,000.
Interest
income
Interest
income increased to approximately $1,614,000 for the year ended December
31,
2003 from $0 in the comparable of year 2002. This increase is almost entirely
related to interest earned on notes receivable by IASI.
Taxes
Income
tax expense of approximately $3,527,000 was recorded in 2003 as compared
to an
income tax benefit of approximately $681,000 during the same period in 2002.
As
a result of the merger of KC Acquisition with IASG during January 2003, KC
Acquisition, KCF, Morlyn and Criticom will no longer be considered flow through
entities to their shareholders and members and, therefore, must record current
and deferred income taxes from its earnings and losses, and recognize the
tax
consequences of “temporary differences” between financial statement and the tax
basis of existing assets and liabilities. At the time of the change in tax
status of the enterprise, the Company recorded an additional deferred tax
liability of approximately $3,505,000, which is being included in income
tax
expense in 2003. In the wholesale monitoring businesses, the prior period
tax
benefit reflected the change in the deferred tax liability net of S corporate
taxes.
Results
of Operations by Segment
The
comparable financial results for the Company’s two operating segments;
Alarm-Monitoring, Wholesale Services and Alarm-Monitoring, Retail Services
for
the year ended December 31, 2003 as compared to the same period during 2002
are
discussed below. The Company purchased its Retail Services segment during
the
year 2003 and, as a result, data is not available for the comparable periods
during 2002.
Alarm
Monitoring, Wholesale Segment. The year ended December 31,
2003
Alarm
Monitoring, Wholesale segment revenue for the year ended December 31, 2003
totaled approximately $24,393,000 compared to $23,496,000 for the comparable
period during 2002, an increase of $897,000, or 3.8%.
Direct
margin increased from 34.4% for the year ended December 31, 2002 to 40.5%
for
same period of year 2003. The loss from operations decreased from approximately
$772,000 for the 2002 period to income from operations of approximately $71,000
for the same period in 2003. The improvements in the wholesale segment direct
margin and income from operations are attributable to the expense reductions
arising from the consolidation of alarm and monitoring facilities and monitoring
system conversion program.
Alarm
Monitoring, Retail Segment. The year ended December 31,
2003
Alarm
Monitoring Retail segment revenue totaled approximately $16,475,000 for the
year
ended December 31, 2003. The segment’s loss from operations for the period
totaled approximately $3,721,000, while the loss before income taxes totaled
approximately $15,174,000.
Liquidity
and Capital Resources
The
following table presents the combining cash flows of IASG and subsidiaries
(which includes Criticom from the date of acquisiiton on September 26, 2002)
and
IASI and affiliates based on the historical financial statements.
Such
table excludes the purchase accounting adjustments related to the acquisition
of
IASI by a wholly ownded subsidiary of IASG in January 2003. Such
2002
combined data is utilized in comparison to 2003 cash flows of the Registrant
discussed in the narrative below.
|
Year
Ended December 31, 2002
|
||||||||||||
|
|
IASG
|
|
|
IASI
|
|
|
Elimination
|
|
|
Total
|
||
|
|
(in
Thousands)
|
|||||||||||
|
Cash
flows provided by operating activities:
|
||||||||||||
|
Net
Loss
|
$
|
(5,646
|
)
|
$
|
(12,224
|
)
|
$
|
-
|
$
|
(17,870
|
)
|
|
|
Depreciation
and amortization
|
7,200
|
11,518
|
-
|
18,718
|
||||||||
|
Deferred
income taxes
|
(681
|
)
|
-
|
-
|
(681
|
)
|
||||||
|
Working
capital
|
2,806
|
(340
|
)
|
-
|
2,466
|
|||||||
|
Other
|
(987
|
)
|
1,271
|
-
|
284
|
|||||||
|
2,692
|
225
|
-
|
2,917
|
|||||||||
|
Cash
flows used in investing activities:
|
||||||||||||
|
Business
acquisitions, net of cash acquired
|
(4,812
|
)
|
-
|
-
|
(4,812
|
)
|
||||||
|
Purchase
of customer contracts
|
-
|
(1,733
|
)
|
-
|
(1,733
|
)
|
||||||
|
Financing
of customer loans
|
-
|
(3,241
|
)
|
(3,241
|
)
|
|||||||
|
Repayment
of customer loans
|
-
|
3,979
|
(1,494
|
)
|
2,485
|
|||||||
|
Other
|
(4,051
|
)
|
328
|
-
|
(3,723
|
)
|
||||||
|
(8,863
|
)
|
(667
|
)
|
(1,494
|
)
|
(11,024
|
)
|
|||||
|
Cash
flows provided by financing activities:
|
||||||||||||
|
Proceeds
of long-term debt
|
14,300
|
34,860
|
-
|
49,160
|
||||||||
|
Payments
of long-term debt
|
(8,161
|
)
|
(23,552
|
)
|
1,494
|
(30,219
|
)
|
|||||
|
Debt
issuance costs
|
(670
|
)
|
(2,008
|
)
|
-
|
(2,678
|
)
|
|||||
|
Capital
withdrawals
|
-
|
(7,766
|
)
|
-
|
(7,766
|
)
|
||||||
|
Other
|
(80
|
)
|
-
|
-
|
(80
|
)
|
||||||
|
5,389
|
1,534
|
1,494
|
8,417
|
|||||||||
|
Net
increase (decrease) in cash and cash equivalents
|
$
|
(782
|
)
|
$
|
1,092
|
$
|
-
|
$
|
310
|
|||
Net
cash
provided by operating activities was $14,149,000 for the year ended December
31,
2004 compared to net cash used by operating activities of $(4,239,000) for
the
year ended December 31, 2003, an increase of $18,388,000 The increase in
cash
provided by operations was primarily the result of a decrease in the net
loss of
approximately $10,288,000 and an increase in depreciation and amortization
of
approximately $10,690,000. Net cash used by operating activities was
$(4,239,000) for the year ended December 31, 2003 compared to $2,917,000
provided by operating activities for the year ended December 31, 2002. The
decrease in cash provided by operations was primarily the result of an increase
in the net loss for the period of $(4,134,000) and a decrease in depreciation
and amortization of $(6,395,000).
Net
cash
used in investing activities was $(77,634,000) for the year ended December
31,
2004 compared to $(57,984,000) for the year ended December 31, 2003. The
significant increase is primarily due to the increase in business acquisitions
of $(15,138,000), an increase in purchases of retail customer contracts of
approximately $(3,919,000) and an increase in capital expenditures of
approximately $(3,414,000). Net cash used in investing activities was
$(57,984,000) for the year ended December 31, 2003 compared to $(11,024,000)
for
the year ended December
31, 2002. The significant increase is primarily due to the acquisition of
two
operating businesses for $(49,770,000) and increased purchases of retail
customer contracts of approximately $(9,061,000).
Net
cash
provided by financing activities was $59,604,000 for the year ended December
31,
2004 compared to $97,217,000 for the year ending December 31, 2003. The decrease
is primarily due to the $(195,857,000) of proceeds from our initial public
offering in 2003, offset, in part, by an increase of $118,161,000 in proceeds
from long-term debt and a decrease of $39,931,000 in repayment of long-term
debt. Net cash provided by financing activities was $97,217,000 for the year
ended December 31, 2003 compared to $8,417,000 million for the year ending
December 31, 2002. The increase is primarily due to the $195,857,000 of proceeds
from our initial public offering, offset by $(100,174,000) used to repay
long-term debt.
The
balance sheet at December 31, 2004 reflects net working capital of approximately
$16,956,000. As of December 31, 2004, we had recurring monthly revenue (“RMR”)
of approximately $4,479,000 in our retail monitoring segment and approximately
$3,100,000 in our wholesale monitoring segment. Total debt had increased
to
approximately $130,225,000 as of December 31, 2004. $125,000,000 of the debt
is
a result of the private offering which occurred in November 2004. The balance
sheet at December 31, 2003 reflects net working capital of approximately
$4,769,000. As of December 31, 2003, we had recurring monthly revenue (“RMR”) of
approximately $3,600,000 in our retail monitoring segment and approximately
$1,900,000 in our wholesale monitoring segment. Total debt had increased
to
approximately $65,743,000 as of December 31, 2003. Approximately $60,243,000
of
that debt was acquired as a result of the IASI acquisition that remained
outstanding at December 31, 2003. These debt balances are after initial public
offering proceeds of $91,911,000 were used to pay-off existing debt in the
third
quarter of 2003.
On
July
29, 2003, the Company successfully completed its initial public offering.
A
total of 22,000,000 shares of common stock were issued at a per share price
of
$9.25. The net proceeds to the Company after underwriting commissions (7%)
and
other direct offering costs were approximately $187,403,000.
On
August
27, 2003, the underwriters exercised a portion of their over-allotment option
and an additional 982,729 shares of common stock were issued at a per share
price of $9.25. The proceeds to the Company after underwriting commissions
(7%)
were approximately $8,454,000
On
November 16, 2004, we completed a private offering of $125 million aggregate
principal amount of 12% Senior Secured Notes due November 15, 2011. The proceeds
of this offering, net of issuance costs, were approximately $120.4
million.
On
November 16, 2004, we entered into the LaSalle Credit Facility with LaSalle
Bank. The maximum amount available of $30 million is limited to 10.0x RMR
of
eligible retail alarm contracts. The interest rate initially is LIBOR plus
3.50%. The minimum fixed charge coverage ratio is 2.0:1.
Our
capital expenditures anticipated over the next twelve months include equipment
and software of approximately $1.0 million and our strategy to purchase
monitoring contracts, which we anticipate to be approximately $100 million.
This
strategy is dependent on obtaining additional financing.
As
part
of the NACC Acquisition, we agreed to assume NACC’s obligations to provide up to
$11.0 million of open lines of credit to Dealers, subject to the terms
of
the agreements with the Dealers as of December 31, 2004. We intend to fund
these
commitments with available funds and available capacity under the $30.0 million
LaSalle Credit Facility.
We
believe that our existing cash, cash equivalents, LaSalle Credit Facility
and
RMR are adequate to fund our operations (including debt payments of
$5.2 million payable in September 2005), exclusive of planned
acquisitions, for at least the next twelve months.
Recent
Accounting Pronouncements Not Yet Adopted
On
October 22, 2004 President Bush signed the American Jobs Creation Act of
2004
(the Act) into law. The Act includes many provisions that may materially
affect
our accounting for income taxes including a possible increase in our effective
tax rate and changes in our deferred assets and liabilities. In
December 2004, the FASB issued two FASB Staff Positions (FSP’s) that provide
accounting guidance on how companies should account for the effects of the
Act.
The first FSP is FSP FAS 109-1 (FAS 109-1); the second is FSP FAS 109-2 (FAS
109-2).
In FAS 109-1, the FASB concludes that the tax relief (special tax deduction
for
domestic manufacturing) from the Act should be accounted for as a “special
deduction” instead of a tax rate reduction. FAS 109-2 gives a company additional
time
to
evaluate the effects of the Act on any plan for reinvestment or repatriation
of
foreign earnings for purposes of applying FASB statement No. 109, “Accounting
for Income Taxes.” The two FSP’s will not impact us.
In
December 2004, the FASB issued Statement of Financial Accounting Standards
No.
123R, “Share-Based Payment” (“FAS 123R”), an amendment of FAS No. 123,
“Accounting for Stock-Based Compensation.” FAS 123R eliminates the ability to
account for share-based payments using Accounting Principles Board Opinion
No.
25, “Accounting for Stock Issued to Employees” and instead requires companies to
recognize compensation expense using a fair-value based method for costs
related
to share-based payments including stock options and employee stock purchase
plans. The expense will be measured as the fair value of the award at its
grant
date based on the estimated number of awards that are expected to vest, and
recorded over the applicable service period. In the absence of an observable
market price for a share-based award, the fair value would be based upon
a
valuation methodology that takes into consideration various factors, including
the exercise price of the award, the expected term of the award, the current
price of the underlying shares, the expected volatility of the underlying
share
price, the expected dividends on the underlying shares and the risk-free
interest rate. The requirements of FAS 123R are effective for our fiscal
year
beginning January 1, 2006 and apply to all awards granted, modified or cancelled
after that date.
The
standard also provides for different transition methods for past award grants,
including the restatement of prior period results. We have elected to apply
the
modified prospective transition method to all past awards outstanding and
unvested as of the effective date of January 1, 2006 and will recognize the
associated expense over the remaining vesting period based on the fair values
previously determined and disclosed as part of our pro-forma disclosures.
We
will not restate the results of prior periods. Prior to the effective date
of
FAS 123R, we will continue to provide the pro-forma disclosures for past
award
grants as required under FAS 123.
The
issuance of FAS123R is expected to result in stock option-based compensation
expense in 2006 of an immaterial amount.
In
December 2004, the FASB issued FAS No. 153, “Exchanges of Nonmonetary Assets, an
amendment of APB Opinion No. 29.” This Standard modifies the accounting for
nonmonetary exchanges of similar productive assets. We are required to adopt
the
Standard on July 1, 2005, and do not expect the adoption to have a material
effect on our financial statements.
In
November 2004, the FASB issued FAS No. 151, “Inventory costs, an amendment of
ARB No. 43, Chapter 4.” This Standard requires that items such as idle facility
expense and excess spoilage be recognized as current period charges. Under
ARB
No. 43, such costs were considered inventoriable costs unless they were
considered so abnormal as to require immediate expensing. We are required
to
adopt the Standard on January 1, 2006, and do not expect the adoption to
have a
material effect on our financial statements.
Disclosures
About Market Risk
Our
exposure to market risk is limited to interest income and expense sensitivity,
which is affected by changes in the general level of interest rates. The
primary
objective of our investment activities is to preserve principal while at
the
same time maximizing the income we receive without significantly increasing
risk. To minimize risk, we maintain our portfolio of cash, cash equivalents
and
short-term and restricted investments in a variety of interest-bearing
instruments, including United States government and agency securities,
high-grade United States corporate bonds, municipal bonds, mortgage-backed
securities, commercial paper and money market accounts at established financial
institutions. Due to the nature of our short-term and restricted investments,
we
believe that we are not subject to any material market risk exposure. We
do not
have any foreign currency risk. At December 31, 2004, we have no short-term
investments and our cash and cash equivalents are invested in money market
accounts.
Off
Balance Sheet Arrangements
The
Company is not a party to any off-balance sheet arrangements.
Contractual
Obligations and Commercial Commitments
The
Company’s significant contractual obligations as of December 31, 2004 are for
$241,787,116. Debt by year of maturity and future payments under operating
and
capital lease agreements and estimated interest expense are presented below.
The
Company has not engaged in off-balance sheet financing or commodity contract
trading.
|
Contractual
Obligations
|
Payments
due by Period
|
|||||||||||||
|
Total
|
|
Less
than 1 year
|
|
1-3
years
|
|
4-5
years
|
|
After
5 years
|
||||||
|
Long-term
debt
|
$
|
130,225,000
|
$
|
5,225,000
|
$
|
-
|
$
|
-
|
$
|
125,000,000
|
||||
|
Capital
leases
|
1,035,489
|
459,987
|
454,275
|
121,227
|
-
|
|||||||||
|
Operating
leases
|
4,988,947
|
1,596,046
|
2,428,532
|
913,411
|
50,958
|
|||||||||
|
Interest
expense (estimated)*
|
105,537,680
|
15,446,092
|
30,070,371
|
30,021,217
|
30,000,000
|
|||||||||
|
$
|
241,787,116
|
$
|
22,727,125
|
$
|
32,953,178
|
$
|
31,055,855
|
$
|
155,050,958
|
|||||
*Consists
primarily of annual interest payments of $15 million on $125 million of senior
secured notes bearing interest at 12%.
Subsequent
Events
We
did
not timely file our Form 10-K for the year ended December 31, 2004 due to
delays
encountered by our management in completing our report regarding internal
control over financial reporting required under Section 404 of Sarbanes-Oxley
Act of 2002, significant growth through acquisitions and major system changes.
On April 28, 2005, we attended a hearing with NASDAQ and we were granted
an
extension of time until June 27, 2005 to file our Form 10-K for the year
ended
December 31, 2004 and our Form 10-Q for the quarter ended March 31, 2005.
In
November 2004, we issued $125,000,000 aggregate principal amount of 12%
Senior
Secured Notes due 2011 (the “Notes”) pursuant to an indenture, dated as of
November 16, 2004 (the “Indenture”), between us, the subsidiary guarantors
parties thereto, and Wells Fargo Bank, N.A., as trustee (the “Trustee”). In
March 2005, we failed to, among other things, file with the Securities
and
Exchange Commission and to furnish to holders of the Notes our Annual Report
on
Form 10-K of the year ended December 31, 2004 (the “Form 10-K”) as required by
the Indenture. On April 5, 2005, the Trustee sent to us a notice of default
relating to the aforementioned defaults (the “Defaults”). On May 4, 2005, the
holders of a majority of the outstanding Notes waived the Defaults and
their
consequences through June 13, 2005 and compliance with the Indenture through
June 27, 2005 with respect to the timely filing of our Quarterly Report
on Form
10-Q for the period ended March 31, 2005 (the “Form 10-Q”). Our filing of our
Form 10-K has made the waivers permanent with respect to the Defaults.
If we are
unable to file the Form 10-Q by June 27, 2005, the Trustee could send us
a
notice of default with respect to such failure to file and the Trustee
or the
holders of 25% or more in aggregate principal amount of the Notes could
declare
the Notes due and payable if we are unable to file the Form 10-Q (and cure
any
other related defaults of which notice was given) within 30 days of the
giving
of the notice or obtain an additional waiver from the
noteholders.
This
Management’s Discussion and Analysis (MD&A) contains statements that are
forward-looking. These statements are based on current expectations and
assumptions that are subject to risks and uncertainties. Actual results could
differ materially because of factors discussed elsewhere in this report.
See
item
7. Management’s Discussion and Analysis of Financial Condition and Results
of Operation, Market Risk.
Our
consolidated financial statements and supplementary data, together with the
report of PricewaterhouseCoopers LLP, independent registered public accounting
firm, are included elsewhere herein. See “Index to Financial Statements” on page
F-1.
None.
Disclosure
Controls and Procedures
The
Company's management, including our Chief Executive Officer, President, and
Chief Financial Officer, evaluated the effectiveness of the Company's disclosure
controls and procedures (as defined in Exchange Act Rules 13a-15(e) and
15d-15(e)) as of the end of the period covered by this annual report on Form
10-K. Based upon that evaluation, including all matters discussed in the
paragraphs below, they have concluded that as of December 31, 2004, the
Company's disclosure controls and procedures were not effective in ensuring
that
all material information required to be disclosed in reports that the Company
files with or submits to the Securities and Exchange Commission ("SEC") is
recorded, processed, summarized and reported within the time periods specified
in the rules and the forms of the SEC. In light of the material weaknesses
described below, the Company performed additional post closing procedures
to
ensure its consolidated financial statements are prepared in accordance with
generally accepted accounting principles. Accordingly, management believes
that
the financial statements presented in Item 8 of
this
Form 10-K fairly present, in all material respects, the Company's financial
position, results of operations and cash flows for the periods
presented.
Section
404 of the Sarbanes-Oxley Act of 2002 ("SOX 404") and related rules of the
SEC
require management of public companies to periodically assess the effectiveness
of internal control over financial reporting and to annually report their
conclusions, including the disclosure of all material weaknesses in internal
control over financial reporting. In addition, SOX 404 requires the Company
to
provide a report of its independent registered public accounting firm on
management's annual assessment of the effectiveness of the Company's internal
control over financial reporting.
As
an
"accelerated filer," the Company is required to comply with SOX 404 as of
December 31, 2004 and thus management's report on the effectiveness of the
Company's internal control over financial reporting as of December 31, 2004,
as
well as the attestation report of the Company's independent registered public
accounting firm on management's assessment of the effectiveness of the Company’s
internal control over financial reporting, must be included in the Form 10-K
for
the year ended December 31, 2004. The Company was unable to file this Form
10-K
on its due date of March 16, 2005 and filed a Form 12b-25 on March 17, 2005
disclosing, among other things, the fact that its closing process was not
then
complete. The Company was still unable to complete the closing process by
March
31, 2005 and filed a Form 8-K disclosing such on March 31, 2005. Management
has
now completed its assessment as described below in Management’s Annual Report on
Internal Control over Financial Reporting.
Management’s
Annual Report on Internal Control over Financial
Reporting
Management
of the Company is responsible for establishing and maintaining adequate internal
control over financial reporting, as such term is defined in Exchange Act
Rule
13a-15(f). The Company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes
in
accordance with generally accepted accounting principles ("GAAP"). The Company’s
internal control over financial reporting includes those policies and procedures
that:
| · |
pertain
to the maintenance of records that, in reasonable detail, accurately
and
fairly reflect the transactions and dispositions of the assets
of the
Company;
|
| · |
provide
reasonable assurance that transactions are recorded as necessary
to permit
preparation of financial statements in accordance with GAAP, and
that
receipts and expenditures of the company are being made only in
accordance
with authorizations of management and directors of the Company;
and
|
| · |
provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the Company’s assets that
could have a material effect on the financial
statements.
|
Because
of its inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may
become
inadequate because of changes in conditions or that the degree of compliance
with the policies or procedures may deteriorate.
The
Company’s management, including the Company’s Chief Executive Officer,
President, and Chief Financial Officer, assessed the effectiveness of the
Company’s internal control over financial reporting as of December 31,
2004. In making its assessment of the effectiveness of the Company’s internal
control over financial reporting, management used the framework in “Internal
Control - Integrated Framework”, issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).
A
material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. As of December 31, 2004, management has identified the following
material weaknesses:
| 1. |
As
of December 31, 2004, the Company did not have an effective control
environment based on criteria established in “Internal Control -
Integrated Framework” issued by COSO. The Company failed to design
appropriate company wide policies and procedures over the accounting,
revenue, procurement, human resources, treasury and risk management
functions and did not uniformly and consistently communicate
the
importance of internal controls throughout the organization. In
addition,
the Company’s policies and procedures with respect to review and
supervision of its accounting operations at the divisional level
were not
operating effectively. This control deficiency, together
with the
control deficiencies described in Item
2
|
|
below,
indicate that the Company did not maintain an effective control
environment. This control deficiency could result in a material
misstatement of annual or interim financial statements that would
not be
prevented or detected. Accordingly, management determined that
this
control deficiency constitutes a material
weakness.
|
| 2. |
As
of December 31, 2004, the Company did not maintain a sufficient
complement
of personnel with an appropriate level of accounting knowledge,
experience
and training in the application of generally accepted accounting
principles commensurate with the Company’s financial reporting
requirements. In addition, the Company also failed to implement
processes
to ensure periodic monitoring of its existing internal control
activities
over finanical reporting. Specifically, the Company had
a shortage
of finance and accounting staff with sufficient depth and skill
in the
application of U.S. generally accepted accounting principles and
individuals in the finance function who did not have the appropriate
skills, training and experience to meet the objective that should
be
expected of these roles. This control deficiency could result in
a
misstatement of account balances or disclosures that would result
in a
material misstatement to the annual or interim financial statements
that
would not be prevented or detected. Accordingly, management has
determined
that this control deficiency constitutes a material weakness.
Additionally, this material weakness contributed to the following
individual material weaknesses as of December 31,
2004:
|
| a) |
The
Company did not maintain effective controls over the financial
reporting
process to ensure the accurate preparation and review of its financial
statements in a timely manner. Specifically, the Company’s control over
the completeness, accuracy and review of its documentation of the
close
processes relating to reconciliations, journal entries and divisional
reporting packages were ineffective in their design and execution.
In
addition, the Company did not have effective controls over the
process of
identifying and accumulation of all required supporting information
to
ensure the completeness of its footnote disclosures and the support
for
the accounting positions taken on non-routine transactions. This
control
deficiency resulted in certain audit adjustments, including those
described below, to the 2004 financial statements. Additionally,
this
control deficiency could result in a misstatement of account balances
or
disclosures that would result in a material misstatement to the
annual or
interim financial statements that would not be prevented or detected.
Accordingly, management has determined that this control deficiency
constitutes a material weakness.
|
| b) |
The
Company did not maintain effective controls over revenue and deferred
revenue accounts. Specifically, the Company’s controls were not adequate
to ensure the completeness and accuracy of revenues recorded under
standard or multiple billing arrangements. This control deficiency
resulted in certain audit adjustments to revenue and deferred revenue
to
the 2004 financial statements. Additionally, this control deficiency
could
result in a misstatement of account balances or disclosures that
would
result in a material misstatement to the annual or interim financial
statements that would not be prevented or detected. Accordingly,
management has determined that this control deficiency constitutes
a
material weakness.
|
| c) |
The
Company did not maintain effective controls over accounts payable,
accrued
liabilities and the related expense accounts at two divisions.
Specifically, the Company’s controls over the completeness, valuation, and
existence of accounts payable and accrued expenses and ensuring
that such
expenses were recorded in the proper period were not effective.
This
control deficiency resulted in certain audit adjustments to the
aforementioned accounts of the 2004 financial statements.
Additionally, this control deficiency could result in a misstatement
of
account balances or disclosures that would result in a material
misstatement to the annual or interim financial statements that
would not
be prevented or detected. Accordingly, management has determined
that this
control deficiency constitutes a material
weakness.
|
| d) |
The
Company did not maintain effective controls over certain cash accounts
and
transactions including wire transfers at one division.
Specifically, the Company’s controls were not adequate to provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the funds maintained
in
certain bank accounts of the Company. This control deficiency did
not
result in an adjustment to the 2004 annual or interim financial
statements. However, this control deficiency could result in expenditures
being made that are beyond corporate approval levels and that would
not be
prevented or detected. Accordingly, management determined that
this
condition represents a material
weakness.
|
Because
of these material weaknesses, management has concluded that the Company did
not
maintain effective internal control over financial reporting as of December
31,
2004, based on the criteria in Internal Control - Integrated
Framework.
Management
has excluded National Alarm Computer Center (NACC) from its assessment of
internal controls over financial reporting as of December 31, 2004 because
it
was acquired in a purchase business combination during 2004. NACC is a wholly
owned division of Integrated Alarm Services Group Inc. whose total assets
and
total revenues comprised 17% and 2% respectively, of the related consolidated
financial statement amounts as of and for the year ended December 31,
2004.
Management’s
assessment of the effectiveness of the Company’s internal control over financial
reporting as of December 31, 2004 has been audited by PricewaterhouseCoopers
LLP, an independent registered public accounting firm, as stated in their
report
which appears herein.
Plan
for Remediation of Material Weaknesses
At
the
direction of our board of directors and audit committee, management has spent
and continues to spend a significant amount of time, effort and resources
to
improve our control environment. This effort has been undertaken pursuant
to our
work contemplated by SOX 404 and to improve our operational and financial
reporting efficiency. The initiatives being developed by management are both
organizational and process focused, contemplating complete integration of
business units along functional and geographic lines. The organizational
changes
made since late 2004 through the date of this annual report included, among
others:
| · |
we
hired a new Chief Operating Officer, effective April
2005;
|
| · |
we
established a corporate human resource function and hired a Director
of
Human Resources;
|
| · |
we
established a corporate IT function and hired a Vice President
- Corporate
Information Technology;
|
| · |
we
have hired additional controllers with relevant accounting
experience;
|
| · |
we
have expanded and enhanced our corporate internal audit department
by
hiring a new Director of Internal Audit;
and
|
| · |
we
have updated our organizational charts as a means of providing
better
overall visibility to the company as a whole and to improve integration
and communication throughout all company divisions and
departments.
|
We
have
also implemented several process changes to improve our regular communication
channels including, among others:
| · |
we
have established a management executive committee and hold formally
scheduled meetings to discuss company wide activities, strategy,
plans and
risks to our company; and
|
| · |
we
have increased communications between members of our senior management
and
members of our board of directors to discuss key activities, plans,
and
key accounting and internal control
issues.
|
These
organizational and process changes are the foundation of a company wide
improvement in its internal control environment. For the remainder of 2005,
management, in addition to continuing the initiatives enumerated above, will
focus its efforts on:
| · |
establishing
enhanced formalized company wide monitoring
activities;
|
| · |
improving
the organizational structure to help achieve the proper level of
centralization/standardization of functional areas, as well as
the quality
and quantity of our accounting
personnel;
|
| · |
improving
and integrating systems and processes to help ensure our business
financial reporting and operational requirements are met in a timely
manner;
|
| · |
establishing
a comprehensive period-end financial reporting process to improve
the
quality and timeliness of our financial information, including
automation
of existing manual processes, reconciliations and controls over
spreadsheets, development of divisional reporting packages, a formalized
robust review process, and standardized checklists to ensure such
procedures are consistently and effectively applied throughout
the
organization;
|
| · |
establish
procedures to ensure that non-routine transactions are identified
and
escalated to senior financial management during the close process
to help
ensure proper accounting treatment;
|
| · |
refining
the regular financial and internal control certification process
at the
divisional level;
|
| · |
establishing
a formal disclosure committee to review and discuss our periodic
reports
prior to filing with the SEC;
|
| · |
discontinuing
the use of a third-party billing and cash receipts service
provider;
|
| · |
establishing
automated controls over the corporate and revenue software application
for
completeness and accuracy;
|
| · |
establishing
formal corporate wide policies concerning the requisition, account
classification, authorization and receipt of goods and
services;
|
| · |
establish
formal corporate procedures for proper cutoff at period
end;
|
| · |
reviewing
existing controls over vendor master files;
|
| · |
enhancement
of current treasury policies and
procedures;
|
| · |
establishing
an Internal Control Steering Committee in order to strengthen our
SOX 404
compliance efforts and to monitor progress of the Company’s remediation
efforts; and
|
| · |
expanding
the size of the internal audit group through hiring experienced
auditors
and/or outsourcing to assist the Internal Control Steering Committee
and
the management of the Company in its monitoring
efforts.
|
The
steps
described above, including the hiring of additional key personnel, are designed
to ensure that management’s continuous evaluation of our internal control is
thorough and complete and that a timely and appropriate remediation plan
is
implemented. Our audit committee is overseeing management’s assessment and its
implementation of a remediation plan and is prepared to take additional
measures, where necessary, to ensure that management has the required resources
in place to address known material weaknesses and to ensure that this entire
process is sustainable. The effectiveness of the steps we have taken to date
and
the steps we are still in the process of completing is subject to continued
management review, as well as audit committee oversight, and we may make
additional changes to our internal controls and procedures. Although we have
undertaken the foregoing initiatives, we cannot assure that we will not in
the
future identify further material weaknesses or significant deficiencies in
our
internal control over financial reporting that have not previously been
identified, or that all the material weaknesses identified in this report
will
be remediated by December 31, 2005.
Changes
in Internal Control over Financial Reporting
There
were no changes in the Company's internal control over financial reporting
during the quarter ended December 31, 2004, other than as described above,
that
materially affected, or are reasonably likely to materially affect, the
Company's internal control over financial reporting.
None
PART
III
The
names
of our executive officers and directors, together with a brief description
of
their employment histories, are provided below:
|
Name
|
Age
|
Position
|
|
Timothy
M. McGinn
|
56
|
Chairman
of the Board and Chief Executive Officer
|
|
Thomas
J. Few, Sr.
|
58
|
Vice
Chairman and President
|
|
Bruce
E. Quay
|
47
|
Chief
Operating Officer
|
|
Curtis
E. Quady
|
63
|
Executive
Vice President
|
|
Brian
E. Shea
|
46
|
Executive
Vice President
|
|
Robert
B. Heintz
|
49
|
Executive
Vice President-Monitoring COO
|
|
Michael
T. Moscinski
|
53
|
Chief
Financial Officer
|
|
Raymond
C. Kubacki
|
60
|
Director
|
|
John
W. Mabry
|
67
|
Director
|
|
Ralph
S. Michael III
|
50
|
Director
|
|
R.
Carl Palmer, Jr.
|
64
|
Director
|
|
David
L. Smith
|
60
|
Director
|
|
Timothy
J. Tully
|
41
|
Director
|
Mr. McGinn
has served as our Chairman of the Board and Chief Executive Officer since
January 2003. Mr. McGinn was the President of Integrated Alarm
Services, Inc. Mr. McGinn is the non-executive Chairman of
the Board
of McGinn, Smith & Co., Inc. He has served as Chairman of the
Board and as an executive officer of McGinn, Smith since 1980. He also serves
as
non-executive Vice Chairman of Pointe Financial Corp., a publicly traded
commercial bank and non-executive Chairman of its affiliate Pointe Bank.
Mr. McGinn also serves as a Director of Same Day Surgery, Inc.
Mr. McGinn was also the Chairman of Capital Center Credit Corporation,
a
private company which provides financing to the Residential Security and
Alarm
Industry, from 1995 to 2002. From November 2000 to June 2002,
Mr. McGinn also served as Chairman of First Integrated Capital Corporation,
a financial services firm majority owned by Mr. McGinn and
Mr. Smith.
Mr. Few,
Sr. is our Vice Chairman, President and Chief Operating Officer and has over
35 years of experience in the security alarm industry. Mr. Few,
Sr.
has been with KC Acquisition and its predecessors since 1985, where he started
as Executive Vice President. Prior thereto, Mr. Few, Sr. held senior
positions with Holmes Protection, Inc., ADEMCO, Guardian and ADT.
Prior to
his work with these firms, Mr. Few, Sr. owned and operated an independent
alarm company and central station in New Jersey.
Mr.
Quay
is our Chief Operating Officer. He joined the Company in April 2005. Prior
to
serving in his current role, Mr. Quay was Executive Vice President and Principal
of Aquatic Development Group, a privately held company servicing the aquatics
industry through its project services and equipment systems divisions from
2003
to 2005. Prior to Aquatic Development Group, he served as President and Chief
Executive Officer of Cookson Plastic Molding Group from 1998 to 2002. Cookson
Plastic Molding Group is a wholly owned subsidiary of Cookson Group, PLC,
which
is a global leader in the supply of plastic products to the material handling,
pool construction, office equipment and lawn and garden markets. Prior to
Cookson Plastic Molding Group, Mr. Quay held various senior level management
positions with Heldor Industries, a leading national manufacturer and
distributor of swimming pool products.
Mr. Quady
founded Criticom, which we acquired in September 2002. Mr. Quady has
served
as an Executive Vice President since October 2002. He has more than
20
years of experience in the security industry. Prior to founding Criticom,
Mr. Quady served as a pilot in the United States Army and was an airline
captain for a major international airline for 18 years. Mr. Quady
is the
Chief Manager of Royal Thoughts, LLC, in which we have a minority ownership
position.
Mr. Shea
has served as an Executive Vice President since March 2003. In this
role,
he heads our retail account acquisition division, including portfolio
management, due diligence, performance monitoring and billing and collection.
Prior to serving in his current role, he was our Chief Financial Officer
and had
served as the Chief Financial Officer of IASI and its predecessor companies
since 1992. Prior thereto, he was Vice President of Finance/Controller of
Hiland
Park, a real estate development company. Prior to joining Hiland Park, he
was an
Analyst at Galesi Group and a Financial Manager for General Electric
Corporation, where he graduated from GE's Financial Management Training
Program.
Mr. Heintz
has served as our Executive Vice President-Monitoring Services since February
2005. Prior to serving in his current role, he was our Vice President, Finance
and Administration—Monitoring Services since January 2003. He was
previously our Chief Financial Officer, a position he held since
April 2000. Prior to joining KC Acquisition, he was Vice President
and
Chief Financial Officer of Monital Signal Corporation, from January 1997
to
April 2000, which we acquired in April 2000. Before working for Monital,
he
was Vice President Finance & Information Services for Brownstone
Studio, Inc., a garment cataloger and manufacturer, where he worked
from
1994 to 1996. Before Brownstone, he spent 14 years with the Dun &
Bradstreet Corporation where he held several finance and accounting
positions.
Mr. Moscinski
has served as our Chief Financial Officer since March 2003. Prior
to
serving in his current role, Mr. Moscinski served IASG and its predecessor
companies in various financial positions since April 2002. Prior to joining
IASG, he served as Vice President, Corporate Controller and Interim Chief
Financial Officer for United Road Services, Inc., a public company
based in
Albany, New York, where he worked from 1998 through 2001. From 1987 to 1998,
Mr. Moscinski was the Director of Corporate Accounting for National
Micronetics, Inc. From 1976 to 1987, Mr. Moscinski was with
KPMG
International and its predecessor firms, where he was a Senior Manager in
audit.
Mr. Moscinski is a Certified Public Accountant and a member of the
American
Institute of Certified Public Accountants and the New York State Society
of
Certified Public Accountants.
Mr.
Kubacki has served as a director since June 2004. Mr. Kubacki has been President
and Chief Executive Officer of Psychemedics Corporation, a biotechnology
company
with a proprietary drug test product, since July 1991. He has also served
as
Chairman of the Board since November 2003. Prior to joining Psychemedics,
he
held senior management positions in marketing and operations with Reliance
Electric Company and ACME Cleveland Corporation. He is also a trustee for
the
Center for Excellence in Education based in Washington, D.C.
Mr. Mabry
has served as a director of IASG since March 2003. Mr. Mabry
has
approximately 35 years of experience in the alarm industry. In 1969
he
founded and began building the American Alarm Company that was purchased
by
Honeywell in 1983. He remained with Honeywell through 1993 with responsibilities
for operations, sales and business development. From 1993 to 2000,
Mr. Mabry was President of Security Network of America. Mr. Mabry
serves on numerous alarm industry associations' boards and was President
of the
National Burglary and Fire Alarm Association.
Mr. Michael
has served as a director of IASG since January 2003. In 2003
Mr. Michael was named Executive Vice President of U.S. Bank, N.A.
and
President of U.S. Bank -- Oregon. From 1979 to 2002, Mr. Michael held
management and executive positions with PNC Financial Services Group.
Mr. Michael also serves on the boards of Ohio Casualty Corp. and Key
Energy
Services. Mr. Michael is Chairman of the IASG audit committee.
Mr. Palmer
has served as a director of IASG since January 2003. Mr. Palmer
is the
market President for South Florida for Mercantile Bank, a wholly owned
subsidiary of the South Financial Group, Inc. Prior to its May 2005 merger
into
Mercantile Bank, Mr. Palmer was Chairman of the Board and has been CEO of
Pointe
Financial Corp. a publicly traded commercial bank, since 1995. Prior to joining
Pointe, Mr. Palmer held several executive positions within the banking
industry.
Mr. Smith
has served as a director of IASG since October 2002. Mr. Smith
is the
President and a Director of McGinn, Smith & Co., where he has served in
this capacity since the company's founding in 1980. Previously he was with
Paine
Webber. Mr. Smith also serves on the board and as an executive officer
of
several privately held companies.
Mr. Tully
has served as a director of IASG since January 2003. Mr. Tully
is a
managing member of Tully Capital Partners, LLC, a diversified private investment
firm that he co-founded in 1997.
Committees
of the Board
The
Audit
Committee appoints and provides for the compensation of the Company’s
independent auditors; oversees and evaluates the work and performance of
the
independent auditors; reviews the scope of the audit; examines the results
of
audits and quarterly reviews; considers comments made by the independent
auditors with respect to accounting procedures and internal controls and
the
consideration given thereto by the Company’s management; approves all
professional services to be provided to the Company by its independent auditors;
reviews internal accounting procedures and controls with the Company’s financial
and accounting staff; oversees a procedure that provides for the receipt,
retention and treatment of complaints received by the Company and of
confidential and anonymous submissions by employees regarding questionable
accounting or auditing matters; and performs related duties as set forth
in
applicable securities laws, NASDAQ corporate governance guidelines, and the
Audit Committee
charter. The Board functions pursuant to the Audit Committee charter adopted
by
the Board in August 2003.
The
members of the Company’s Audit Committee are Messrs. Michael, Mabry, Tully and
Palmer and Kubacki. Mr. Ralph S. Michael III is the Audit Committee Chairman.
The Audit Committee met ten (10) times during the fiscal year ended December
31,
2004. Mr. Kubacki was elected to the Audit Committee in June 2004. Because
Mr.
McGinn, our Chairman and CEO, has been a member of the Compensation Committee
of
Pointe Bank within the past three years, of which Mr. Palmer is an executive
officer, Mr. Palmer is deemed to be a “non-independent” Director under the rules
of the NASDAQ Stock Market. As permitted under the NASDAQ requirements, the
Board carefully considered Mr. Palmer’s non-independence as well as his
accounting and financial expertise and determined that it is in the best
interest of the Company and its shareholders that he continue to serve as
a
member of the Audit Committee. Each of Messrs. Michael, Mabry, Kubacki and
Tully
are independent Directors under the rules of the NASDAQ Stock Market. Each
of
the members of the Audit Committee are able to read and understand fundamental
financial statements. While more than one member of the Company’s Audit
Committee qualifies as an “audit committee financial expert” under Item 401(h)
of Regulation S-K, Mr. Michael is the designated audit committee financial
expert.
The
Compensation Committee has such powers as may be assigned to it by the Board
of
Directors from time to time and is currently charged with, among other things,
reviewing and recommending compensation packages for our officers, administering
our Stock Option Plan and establishing and reviewing general policies relating
to compensation and benefits of the Company’s employees. The Compensation
Committee met two (2) times during fiscal 2004. In February 2004, the Board
elected Mr. Mabry to replace Mr. Meriwether on the Compensation Committee
and
Messrs. Tully and Allen to remain on the Compensation Committee for fiscal
2004,
each of whom are independent Directors under the rules of the NASDAQ Stock
Market. Mr. Tully is the Compensation Committee Chairman. During fiscal 2004
the
members of the Compensation Committee were Messrs. Mabry, Tully and Allen.
The
Board
does not have a Nominating Committee; however, the nominees selected for
the
Board of Directors for fiscal 2004 were nominated by the independent Directors
of the Company’s Board.
We
have
adopted a Code of Ethics for our officers, including our principal executive
officer, principal financial officer, principal accounting officer, persons
performing similar functions and directors.
Shareholders
may request a free copy of the Code of Ethics and/or Annual Report from:
Integrated
Alarm Services Group, Inc.
Attn:
Investor Relations
99
Pine
Street, 3rd
floor
Albany,
NY 12207
(518) 426-1515
Any
amendment of our Code of Ethics or waiver thereof applicable to any of our
principal executive officer, principal financial officer, principal accounting
officer or persons performing similar functions will be disclosed on our
website
within 5 days of the date of such amendment or waiver. In the case
of a
waiver, the nature of the waiver, the name of the person to whom the waiver
was
granted and the date of the waiver will also be disclosed.
The
following table sets forth certain information regarding compensation paid
or
accrued by us to our Chief Executive Officer and to each of our executive
officers who were paid in excess of $100,000 in salary and bonus for all
services rendered to us in all capacities during the years ended December
31,
2004, 2003 and 2002.
|
Annual
Compensation
|
|||||||||
|
Name
and Principal Position
|
Year
|
|
Salary
|
Other
Annual Compensation
|
Bonus
|
||||
|
Timothy
M. McGinn
|
2004
|
416,000
|
|
14,400
|
(2)
|
100,000
|
(1)
|
||
|
Chairman
and Chief Executive Officer
|
2003
|
380,000
|
14,400
|
(2)
|
175,000
|
(1)
|
|||
|
2002
|
100,000
|
(5)
|
-
|
-
|
|||||
|
Thomas
J. Few, Sr.
|
2004
|
416,000
|
14,677
|
(2)
|
100,000
|
(1)
|
|||
|
Vice
Chairman and President
|
2003
|
378,463
|
14,400
|
(2)
|
175,000
|
(1)
|
|||
|
2002
|
364,639
|
-
|
-
|
||||||
|
Curtis
E. Quady
|
2004
|
200,000
|
14,801
|
(2,4)
|
-
|
||||
|
Executive
Vice President
|
2003
|
203,846
|
14,400
|
(2)
|
-
|
||||
|
2002
|
100,000
|
|
38,747
|
(3)
|
-
|
||||
|
Brian
E. Shea
|
2004
|
170,000
|
|
4,440
|
(4)
|
-
|
|||
|
Executive
Vice President
|
2003
|
129,923
|
|
3,500
|
(4)
|
22,500
|
|||
|
2002
|
10,833
|
(5)
|
-
|
-
|
|||||
|
Michael
T. Moscinski
|
2004
|
145,000
|
|
3,996
|
(4)
|
-
|
|||
|
Chief
Financial Officer
|
2003
|
116,597
|
|
3,500
|
(4)
|
22,500
|
|||
|
2002
|
33,667
|
(5)
|
-
|
-
|
|||||
|
Robert
B. Heintz
|
2004
|
135,291
|
|
12,537
|
(2,4)
|
-
|
|||
|
Executive
Vice President
|
2003
|
130,000
|
|
15,000
|
(2)
|
12,500
|
|||
|
2002
|
120,789
|
|
-
|
16,864
|
|||||
| 1) |
Includes
a fixed contractual bonus of $100,000 and a discretionary merit
bonus of
$75,000 paid in 2004 for performance in 2003. No discretionary
bonus was
granted for performance in 2004.
|
| 2) |
Represents
payments of automobile allowance.
|
| 3) |
Represents
payment of personal expenses on behalf of Mr.
Quady.
|
| 4) |
Represents
Company’s matching contribution under 401 (k)
plan.
|
| 5) |
Messrs.
McGinn, Shea and Moscinski were not employed by us until August
2002.
|
Employment
Agreements
We
have
entered into employment agreements with Messrs. McGinn, Few, Sr., Quady,
Shea,
Moscinski and Heintz. The employment agreements for Messrs. McGinn and Few,
Sr.,
were entered into on January 31, 2003 and have a term of three years. Mr.
Few,
Sr.’s employment agreement automatically extends for an additional three (3)
year period and thereafter automatically extends for additional one (1) year
periods unless either party elects, not less than 90 days prior to the
anniversary date, not to extend the term. The employment agreements with
Messrs., Quady and Heintz, were entered into on October 1, 2002, and have
a term
of three years. The employment agreements with Messrs. Moscinski and Shea
were
entered into on March 2003 and also have a term of three years. The term
of the
employment agreements automatically extends for additional one (1) year periods,
unless either party elects, not less than 90 days prior to the annual
anniversary date, not to extend the employment term. Under the agreements,
Messrs. McGinn and Few, Sr. each receive an annual salary of $416,000, and
Messrs. Quady, Shea, Moscinski and Heintz receive annual salaries of $200,000,
$170,000, $145,000, and $155,000, respectively. Messrs. McGinn, Few, Sr.
and
Quady also receive a leased car paid for by us ranging from $1,000 to $1,200
per
month. In addition, each of the employees may receive an annual bonus at
the
discretion of our Board of Directors. Messrs. McGinn and Few, Sr. have a
minimum
bonus guarantee of $100,000 per year. The Board of Directors may also provide
additional benefits to the employees, including but not limited to, health
insurance, disability insurance and life insurance.
We
may
terminate the agreements for Cause (as defined below) and in such event we
will
not be responsible for the payment of any compensation under the agreement
other
than amounts accrued as of the termination date. In the event of an employee’s
death, the agreement automatically terminates, except that the respective
employee’s estate shall receive any accrued salary or bonus as of the date of
death. “Cause” is defined as: (i) employee’s misconduct as could reasonably be
expected to have a material adverse effect on our business and affairs; (ii)
employee’s disregard of lawful instructions of our Board of Directors consistent
with employee’s position relating to our business or neglect of duties or
failure to act, which, in each case, could reasonably be expected to have
a
material adverse
effect on our business and affairs; (iii) engaging by the employee in conduct
that constitutes activity in competition with us; (iv) the conviction of
employee for the commission of a felony; or (v) the habitual abuse of alcohol
or
controlled substances. In no event shall the alleged incompetence of an
employee, in the performance of such employee’s duties, be deemed grounds for
termination for Cause.
If
an
employee is terminated without Cause, or in breach of the agreement, or if
an
employee terminates following the occurrence of certain Events (as defined
below), the effected employee is entitled to receive an amount equal to 12
months salary and payment of any previously declared bonus. An “Event” includes:
(i) failure to be elected or appointed to the position then held by the
employee; (ii) a material change in the employee’s duties or responsibilities;
(iii) a relocation of place of employment by more than 30 miles; (iv) a material
reduction in the base compensation or other benefits to the employee; (v)
failure by us to obtain the assumption of this Agreement by any successor,
or,
termination of employment following (a) a breach of the employment agreement
by
us, or (b) a change of control.
In
the
event that employment is terminated following a change of control or if such
individuals are required to relocate to an unacceptable location within two
years of the change of control, Messrs. McGinn, Few, Sr., Quady, Shea, Moscinski
and Heintz shall be entitled to: (i) a cash bonus, equal on an after-tax
basis
to two times their average compensation, including salary, bonus, and any
other
compensation, for the three previous fiscal years (with the exception of
the
agreements of Messrs. McGinn, Quady and Few, Sr. which call for a cash bonus
equal to three times the employee’s average compensation, including salary,
bonus, and any other compensation, for the three previous fiscal years),
and
(ii) the vesting and acceleration of any stock options or warrants held by
such
person.
In
the
event that any of the payments to be made thereunder or otherwise upon
termination of employment are deemed to constitute a “parachute payment” within
the meaning of Section 280G of the Internal Revenue Code of 1986, as amended
(the “Code”), we shall assume all liability for the payment of any exercise tax
imposed on such parachute payment under the Code, and we shall immediately
reimburse such person on a “gross-up” basis for any income taxes attributable to
them from our payment of the exercise tax and reimbursements.
A
“change
in control” means: (i) the acquisition by any person or group of 50% or more of
the combined voting power of our then outstanding securities, (ii) a majority
of
our Board of Directors-nominated slate of candidates for our Board of Directors
is not elected, (iii) we consummate a merger in which we are not the surviving
entity, (iv) the sale of substantially all of our assets, or (v) our
stockholders approve the dissolution or liquidation of our company.
Under
the
employment agreements, the employee may terminate the agreement by providing
30
days written notice. In such event, the employee is only entitled to any
accrued
and unpaid compensation as of the date of the termination.
The
following table sets forth certain information, as of the date hereof, with
respect to the beneficial ownership of the common stock by each beneficial
owner
of more than 5% of the outstanding shares thereof, by each director, each
nominee to become a director and each executive named in the Summary
Compensation Table and by all executive officers, directors and nominees
to
become our directors. As of the date hereof, we had 24,681,462 shares of
our
common stock outstanding. Pursuant to the rules and regulations of the
Securities and Exchange Commission, shares of common stock that an individual
or
group has a right to acquire within 60 days pursuant to the exercise of options
or warrants are deemed to be outstanding for the purposes of computing the
percentage ownership of such individual or group, but are not deemed to be
outstanding for the purposes of computing the percentage ownership of any
other
person shown in the table:
|
Name
and Address of Beneficial Owner (1)
|
Number
of Shares of Common Stock Beneficially Owned
|
Percentage
of Outstanding Common Stock Beneficially Owned
|
|||
|
Thomas
J. Few, Sr. (2)
|
817,550
|
3.31
|
%
|
||
|
Timothy
M. McGinn (3) (7)
|
448,425
|
1.82
|
%
|
||
|
Curtis
E. Quady (4)
|
82,644
|
*
|
|||
|
David
L. Smith (5) (7)
|
360,925
|
1.46
|
%
|
||
|
Brian
E. Shea
|
500
|
*
|
|||
|
Robert
B. Heintz
|
1,000
|
*
|
|||
|
Michael
T. Moscinski
|
1,000
|
*
|
|||
|
A.
Clinton Allen (8)
|
23,000
|
*
|
|||
|
R.
Carl Palmer (8)
|
25,000
|
*
|
|||
|
Timothy
J. Tully (8)
|
36,000
|
*
|
|||
|
Ralph
S. Michael, III (8)
|
20,000
|
*
|
|||
|
John
W. Mabry (8)
|
18,500
|
*
|
|||
|
Raymond
C. Kubacki (6)
|
7,000
|
*
|
|||
|
All
Executive Officers, and Directors, As a Group 13
persons
|
1,841,544
|
7.46
|
%
|
||
_____________________
*
represents persons who beneficially own less than 1% of our common
stock.
| (1) |
The
address of each of such individuals is c/o Integrated Alarm Services
Group, Inc., One Capital Center, 99 Pine Street, 3rd Floor, Albany,
New
York, 12207.
|
| (2) |
Includes
49,600 shares of common stock owned by TJF Enterprises, LLC, which
is
owned by Mr. Few, Sr. Does not include up to 890,876 shares issuable
upon
the exercise of options.
|
| (3) |
Does
not include 356,524 shares issuable upon the exercise of
options.
|
| (4) |
Does
not include 97,506 shares issuable upon the exercise of
options.
|
| (5) |
Does
not include 361,524 shares issuable upon the exercise of
options.
|
| (6) |
Includes
5,000 shares of common stock issuable upon the exercise of currently
exercisable options.
|
| (7) |
Includes
an aggregate of 42,400 shares owned by First Integrated Capital
Corporation, which is majority owned and controlled by Messrs.
McGinn and
Smith.
|
| (8) |
Includes
13,000 shares of common stock issuable upon the exercise of currently
exercisable stock options.
|
The
Integrated Alarm Services Group, Inc. 2003 Stock Incentive
Plan
We
have
adopted, and our shareholders have approved, our equity compensation plan:
The
Integrated Alarm Services Group, Inc. 2003 Stock Option Plan (the “2003 Plan”).
The purpose of the 2003 Plan is to attract, motivate retain and reward high
quality executives and other employees, officers, director and affiliates
by
enabling such persons to acquire or increase a proprietary interest in us
in
order to strengthen the mutuality of interest between such persons and our
shareholders and providing such persons with annual and long-term performance
incentives to expend their maximum efforts in the creation of shareholder
value.
The
2003
Plan permits the grant of options which may either be incentive stock options
(“ISOs”), within the meaning of Section 422 of the Code or non-qualified stock
options (“NSOs”), which do not meet the requirements of Section 422 of the Code.
The total number of shares of our common stock that may be issued under the
2003
Plan may not exceed 150,000, subject to possible adjustment in the future
as
described below. As of December 31, 2004, 150,000 options have been granted
under this plan.
All
of
our employees, officers, directors, consultants and independent contractors,
or
of any subsidiary or affiliate are eligible to be granted
options.
Within
the limits of the 2003 Plan, the compensation committee has exclusive authority,
among other things, to select those to whom options shall be granted, to
determine the number of shares of common stock to be covered by each option
and
to determine the other terms of each option, including, but not limited to,
the
exercise price and duration. Only employees may be granted ISOs.
The
exercise price of an option granted under the 2003 Plan may not be less than
100% of the fair market value of our common stock on the date of grant (110%
of
such fair market value in the case of an ISO granted to an optionee who owns
or
is deemed to own stock possessing more than 10% of the combined voting power
of
all classes of our stock).
Options
are not transferable or assignable other than by will or the laws of descent
and
distribution and may be exercised during the holder’s lifetime only by the
holder.
The
number of shares of common stock authorized for issuance under the 2003 Plan
may
be adjusted in the event our shares of common stock are changed into, or
exchanged for cash, or securities of another entity through a reorganization,
merger, recapitalization, reclassification, stock split, stock dividend,
stock
consolidation or combination or other similar transaction. In the event of
the
occurrence of any of the following, the compensation committee may adjust
the
number of authorized shares under the 2003 Plan, and the options issued under
the 2003 Plan, as appropriate under the circumstances.
The
Integrated Alarm Services Group, Inc. 2004 Stock Incentive
Plan
We
have
adopted, and our shareholders have approved, our equity compensation plan:
The
Integrated Alarm Services Group, Inc. 2004 Stock Incentive Plan (the “2004
Plan”). Our Board of Directors believes that it is in our best interests and the
best interests of our shareholders to adopt a new plan that will allow us
to
provide a variety of equity-based incentives to our key employees and
consultants. The adoption and approval of the 2004 Plan did not amend or
modify
the 2003 Plan or adversely affect rights under any outstanding stock options
previously granted under the 2003 Plan.
The
2004
Plan is administered by our compensation committee. The compensation committee
has the full authority to select the recipients of awards granted under the
2004
Plan, to determine the type and size of awards, and to determine and amend
the
terms, restrictions and conditions of awards. Eligibility for awards under
the
2004 Plan is limited to our key employees (including employees who are also
officers and/or directors) and consultants as selected by the committee based
on, among other things, their duties and the compensation committee’s assessment
of their present and potential contributions to our success.
Awards
under the 2004 Plan may be granted in the form of ISOs that qualify under
Section 422 of the Code, NSOs, stock appreciation rights, restricted stock,
deferred stock awards and performance awards. The number of shares of our
common
stock reserved for issuance under the 2004 Plan is 1,200,000, subject to
adjustment. As of December 31, 2004, 48,000 options have been granted under
the
2004 Plan.
The
exercise price of options granted under the 2004 Plan is determined at the
discretion of the compensation committee, but the exercise price per share
generally may not be less than the fair market value of a share of our common
stock on the grant date of the option. In the case of ISOs granted to any
holder
on the date of grant of more than 10% (directly or by attribution through
relatives or entities in which the holder has an ownership interest) of the
total combined voting power of all classes of our stock or a parent or
subsidiary corporation (a “10% Shareholder”), the exercise price per share may
not be less than 110% of the fair market value of a share of our common stock
on
the grant date.
The
following table sets forth information regarding our existing compensation
plan
and individual compensation arrangements pursuant to which our equity securities
are authorized for issuance to employees or non-employees (such as directors,
consultants, advisors, vendors, customers, suppliers or lenders) in exchange
for
consideration in the form of goods or services.
|
|
(a)
|
|
(b)
|
|
(c)
|
|
Plan
category
|
Number
of securities to be issued upon exercise of outstanding options,
warrants
and rights
|
|
Weighted-average
exercise price of outstanding options, warrants and
rights
|
|
Number
of securities remaining available for future issuance under equity
compensation plans (excluding securities reflected in column
(a))
|
|
Equity
compensation plans approved by security holders - 2003
Plan
|
144,166
|
|
$6.92
|
|
5,834
|
|
Equity
compensation plans approved by security holders - 2004
Plan
|
42,000
|
|
$5.75
|
|
1,158,000
|
Option
Grants in Last Fiscal Year
We
issued
30,500 stock options in total to four of our executive officers during
2004.
Retirement
Plans
We
have a
401k plan under which we may, but are not obligated to, make matching
contributions.
Compensation
Committee Interlocks and Insider Participation
In
February 2004, our Board of Directors elected Mr. Mabry to replace Mr.
Meriwether on the Compensation Committee and Messrs. Tully and Allen to remain
on the Compensation Committee for fiscal 2004, each of whom is an independent
director under the rules of the Nasdaq Stock Market. Mr. Tully became the
Compensation Committee Chairman in May 2005.
During
the fiscal year ended December 31, 2003, Mr. McGinn, our Chairman and CEO,
served on the Compensation Committee of the Board of Directors of Pointe
Financial Corp. Mr. Palmer, one of our Directors is the Chairman and CEO
of
Pointe Financial Corp and has served as such since 1995. In January, 2004,
Mr.
McGinn resigned from the Compensation Committee of the Board of Directors
of
Pointe Financial Corp.; however, Mr. McGinn remained a member of the Board
of
Directors of Pointe Financial Corp. until its sale in May 2005.
In
January 2003, we acquired all of the capital stock of IASI in exchange for
an
aggregate of 772,192 shares of our common stock. IASI was owned by Messrs.
McGinn, Smith and Few, Sr.. Minority interests (Messrs. McGinn and Smith)
were
issued 483,052 shares that were valued at $10,627,144, based on a price of
$22
per share. The 289,140 shares issued to Mr. Few, Sr. have a value of $6,361,080,
based on a price of $22 per share.
In
January 2003, we acquired all of the membership interests of Morlyn in exchange
for 17,000 shares of our common stock. Morlyn was owned by Messrs. McGinn,
Smith
and Few, Sr.. Minority interests (Messrs. McGinn and Smith) were issued 3,400
shares that were valued at $74,800, based on a price of $22 per share. The
13,600 shares issued to Mr. Few, Sr. have a value of $299,200, based on a
price
of $22 per share.
Palisades
Group, LLC (“Palisades”) an entity owned by TJF Enterprises, LLC (“TJF
Enterprises”) and First Integrated Capital Corporation (“FICC”), was the owner
of approximately 38% of the alarm monitoring contracts underlying the trusts.
In
January 2003, Palisades exchanged all of its ownership interests for 25,000
shares of our stock, became a wholly owned subsidiary of ours and distributed
such stock to its shareholders, TJF Enterprises, an entity owned by Mr. Few
and
FICC, an entity majority owned by Messrs. McGinn and Smith. A minority interest
in FICC was issued 12,500 shares that were valued at $275,000, based on a
price
of $22 per share. The 12,500 shares issued to TJF have a value of $275,000,
based on a price of $22 per share. Palisades was dissolved on July 22,
2004.
In
January 2003, Payne Security Group, L.L.C. (“Payne”) and Guardian Group, LLC
(“Guardian”), two limited liability companies originally formed to acquire alarm
monitoring contracts, were acquired by us and became our wholly owned
subsidiaries. In connection with the acquisition of Payne and Guardian, we
issued an aggregate of 50,250 and 16,750 shares of our common stock,
respectively. Payne and Guardian were owned by TJF Enterprises and FICC.
The
minority interest (FICC) was issued 22,425 and 7,475 shares, respectively
in the
Payne and Guardian acquisitions that were valued at $493,350 and $164,450,
respectively, based on a price of $22 per share. The 27,825 shares
issued to TJF Enterprises in the Payne acquisition and the 9,275 shares issued
to TJF Enterprises in connection with the Guardian acquisition have values
of
$612,150 and $204,050 respectively, based on a price of $22 per share.
Pointe
Bank, for which Mr. McGinn served as Chairman of the Board of Directors and
R.
Carl Palmer Jr. served as Chief Executive Officer, loaned us an aggregate
of
$2.6 million. The loan bore interest at an annual rate of 9.75% per annum.
This
loan was repaid by us utilizing a portion of the proceeds of the $5.5 million
Convertible Note offering in September 2002.
We
leased
our executive offices in Albany, New York from Pine Street Associates LLC,
an
entity equally owned by Timothy M. McGinn and David L. Smith. The lease was
for
a period of five years, at an annual rental of $0.1 million. We believe that
the
rental rate was at market and that the terms were at least as favorable as
could
be obtained from a third party. In October 2003, Messrs. McGinn and Smith
sold
the building to an unaffiliated entity.
For
the
period January 1, 2000 to January 31, 2003, McGinn, Smith & Co., Inc. acted
as a placement agent or an investment banker in connection with financings,
as
well as an investment banker in connection with certain of our acquisitions.
Mr.
McGinn is non-executive Chairman and a Director of McGinn, Smith & Co., Inc.
McGinn, Smith & Co., Inc., a NASD registered broker dealer, received
aggregate commissions and/or investment banking fees of $4.5 million for
acting
in such capacity. McGinn, Smith & Co., Inc. acted as an underwriter in our
initial public offering and may act as an investment banker to procure debt
or
secured additional capital in the future. We believe the fees charged for
such
services are no less favorable than we could obtain from unrelated third
parties
providing similar services. During this period, McGinn, Smith & Co., Inc.
was owned equally by Mr. Smith and Mr. McGinn.
In
September 2002, we (as a successor to KC Acquisition), acquired all of the
capital stock of Criticom International Corporation in a merger transaction
in
consideration for the issuance of 155,911 shares of our common stock, $1.0
million in cash and a contingent payment of 68,182 shares of our common stock
tied to Criticom’s financial performance. Curtis Quady, one of our Executive
Vice Presidents, was the President of Criticom. Mr. Quady and certain members
of
his family who owned approximately 72% of Criticom received 112,836 shares
of
our common stock pursuant to the KC Acquisition Merger Agreement. The shares
were valued at $1,241,196, based on a price of $11 per share. During December
2003 and January 2004, an additional 68,182 shares of our common stock were
issued as a purchase price adjustment to the former shareholders of Criticom
as
a result of Criticom’s financial performance in 2003. Mr. Quady and certain
members of his family received 49,344 of these additional shares.
In
connection with the acquisition of Criticom, we acquired a 5.03% interest
in
Royal Thoughts, LLC. The purchase price for Criticom was approximately $3.5
million net of cash acquired of $0.6 million as well as a note for $0.7 million.
In connection with our purchase, we received a right of first refusal to
provide
any monitoring services for new technology developed by Royal Thoughts, LLC.
Mr.
Quady is also the Chief Manager of Royal Thoughts, LLC. Mr. Quady and his
immediate family members owned 53.7% of Royal Thoughts, LLC. We paid off
the
remaining balance of approximately $0.6 million of indebtedness incurred
in
connection with this acquisition out of the net proceeds of the initial public
offering. The investment in Royal Thoughts, LLC was valued at zero at the
time
of acquisition.
In
October 2002, Lynn A. Smith, the wife of David L. Smith, one of our Directors,
loaned us $3 million. The loan, which was being utilized by us for working
capital, bore interest at a rate equal to the preferred broker call rate
charged
by Bear Stearns Securities Corp. to its corresponding broker dealers, plus
2.5%
per annum, which rate was initially 6.25%. The principal of the loan was
repayable on March 15, 2004. In March 2003, Mrs. Smith extended the maturity
date of the loan to April 30, 2004. Interest was payable monthly. In January
2003, IASI borrowed $3 million from Mrs. Smith. The interest rate was 12%.
The
entire principal and interest was due on January 15, 2004. In March 2003,
Mrs.
Smith extended the maturity date of the loan to April 30, 2004. IASI loaned
$2
million of such amount to IASG on the same terms. In March 2003, IASI extended
the maturity date of the loan to IASG to June 15, 2005. We repaid those loans
out of the net proceeds of the initial public offering.
In
January 2002, we borrowed an aggregate of $5.8 million from RTC Trust. RTC
Trust
is controlled by Mr. McGinn and Mr. Smith, although they are not the beneficial
owners of the RTC Trust. A related entity owned by Messrs. McGinn and Smith
procured the debt and received a placement fee of $175,000 in connection
with
this placement. This loan was repaid out of the proceeds of the initial public
offering.
Suzanne
Sweeney, the daughter of Mr. Few, Sr. is Director of Legal Affairs, and has
received aggregate compensation of approximately $108,000, $121,000 and $130,000
for fiscal years 2002, 2003 and 2004, respectively.
Jeffrey
Few, the son of Mr. Few, Sr. is Vice President of Sales for Morlyn, and has
received aggregate compensation of approximately $105,000, $112,000 and $135,000
for fiscal years 2002, 2003 and 2004, respectively.
Thomas
J.
Few, Jr., the son of Mr. Few, Sr. is Vice President of Sales and Marketing
West
Coast Operations—Criticom International Corp., and has received aggregate
compensation of approximately $93,000, $97,000 and $127,000 for fiscal years
2002, 2003 and 2004, respectively.
Robert
W.
Few, the son of Mr. Few, Sr. is Vice President of East Coast Operations—Criticom
International Corp., and has received aggregate compensation of approximately
$55,000, $80,000 and $96,000 for fiscal years, 2002, 2003 and 2004,
respectively.
All
compensation matters related to the children of Mr. Few Sr. are determined
by
either their direct supervisor or Mr. McGinn, without input from Mr. Few
Sr.
Mary
Ann
McGinn, the wife Mr. McGinn (Chairman of the Board and Chief Executive Officer),
was Senior Vice President-Legal Affairs and remain a consultant through
2005. She has received aggregate compensation of approximately $5,000,
$95,000 and $132,000 for fical years 2002, 2003 and 2004,
respectively.
While
we
and IASI were separate entities, IASI often provided financing to us which
was
used to purchase portfolios of accounts and Dealer relationships. These
transactions were memorialized in two series of promissory notes. One series
of
notes totaled $1.7 million, with maturity dates from February 2001 to August
2005. Fixed interest rates ranged from 23% to 31% and were collateralized
by
accounts receivables. The other series of notes totaled $2.3 million, with
maturity dates ranging from August 2005 to April 2006. Fixed interest rates
ranged from 12.5% to 17.3% and were collateralized by financed receivables.
This
indebtedness was extinguished as a result of the merger of IASI and
IASG.
During
the year ended December 31, 2002, IASI assumed approximately $3.9 million
of
debt from CCCC (an entity controlled by Messrs. Smith and McGinn) (of which
$0.9
million is due to M&S Partners, an entity controlled by Messrs. Smith and
McGinn, and approximately $3.0 million is due to a non-related party), which
resulted in a return of capital in a corresponding amount. The $0.9 million
was
repaid to M&S Partners out of the net proceeds of the initial public
offering. In January and February 2003, we made net distributions aggregating
approximately $2.1 million to CCCC, after taking into account the issuance
of
$0.7 million of one-year, 9% notes to CCCC, due April 2004 and a $0.3 million
cash contribution. CCCC had previously contributed capital to us in excess
of
the amount of these distributions.
In
August
2001, IASI loaned Criticom an aggregate of $2.0 million. Criticom utilized
such
amounts for working capital. Upon our merger with IASI, this indebtedness
was
extinguished.
In
March
and April 2003, IASI assumed $1.6 million and $0.2 million, respectively,
of
debt from CCCC in a non-cash transaction through which debt of CCCC, consisting
of $0.5 million of one year notes and $1.3 million of two year notes, was
transferred to IASI. CCCC performed tasks including billing, collections,
service and other administrative services relative to IASI and its affiliates
and thus incurred various debts relative to executing these functions.
Consequently, we agreed to enter into these transactions to discharge the
debt
of CCCC. We have no further liability to CCCC and will not have any further
business dealings with them. CCCC is an affiliate of McGinn, Smith & Co.
Inc. and M&S Partners. CCCC is an entity controlled and managed by Messrs.
McGinn and Smith.
In
addition, prior to our wholly owned subsidiary’s acquisition of IASI, we
provided alarm monitoring services to accounts owned by related parties.
Revenues earned from these alarm monitoring services were $0.5 million and
$1.6
million, for the years ended December 31, 2001 and 2002, respectively. Of
such
amounts, $0.4 million and $1.4 million were from IASI. In connection with
a
dispute regarding such alarm monitoring services, we granted IASI concessions
on
monitoring expenses of $993,000 and $35,000 for the years ended December
31,
2001 and 2002, respectively. IASI is now a wholly owned subsidiary of
ours.
In
February 2003, we borrowed $600,000 at a 9% per annum interest rate from
an
investment fund which was managed by McGinn, Smith and Co., Inc. Principal
was
due on April 30, 2004 and was repaid in August 2003 with proceeds from the
IPO.
During
2002, Morlyn performed advisory services for IASI and charged IASI $1.2
million. Morlyn provides IASI with customer care services and other advisory
services, including due diligence on contract acquisitions. From September
2001
through January 2003, Morlyn charged IASI a weekly fee of $25,000 for customer
care and certain advisory services. During 2002, M&S Partners assumed a note
receivable owned by IASI which resulted in a distribution of capital to M&S
Partners of approximately $0.8 million.
Four
trusts, for which M&S Partners acts as a trustee (Security Participation
Trust, Security Participation Trust II, Security Participation Trust III,
and
Security Participation Trust IV) receive monitoring services from us at a
discounted rate of approximately $3.00 per account, per month, and billing
and
collection services from us, at no cost. These trusts purchase alarm monitoring
contracts on a monthly basis, with the final trust maturing on December 1,
2004.
Messrs. McGinn and Smith serve as trustees of these trusts. Neither Messrs.
McGinn or Smith, nor M&S Partners has any beneficial ownership in such
trusts. During 2004, these trusts were purchased by entities controlled
by
Messrs. McGinn and Smith and we continue to provide services.
Concurrent
with the initial public offering, Messrs. McGinn, Few, Sr., Smith, Quady
and the
former shareholders of Criticom, were issued, in the aggregate, options to
purchase 1,900,000 shares of our common stock. The options vest as follows:
(i)
30% will vest and be immediately exercisable on the first anniversary of
the
offering; (ii) 30% will vest and be immediately exercisable on the second
anniversary of the offering; and (iii) 40% will vest and become immediately
exercisable on the third anniversary of the offering. The exercise price
of the
options was equal to the per share offering price and thus have no intrinsic
value.
Prior
to
our acquisition of the affiliated entities, their ownership was as
follows:
|
Integrated
Alarm Services, Inc.
|
|
|
M&S
Partners LLC (1)
|
62.5%
|
|
TJF
Enterprises LLC (2)
|
37.5%
|
|
Morlyn
Financial Group
|
|
|
Thomas
J. Few, Sr.
|
80%
|
|
Timothy
M. McGinn
|
10%
|
|
David
L. Smith
|
10%
|
|
Payne
Security Group, LLC
|
|
|
First
Integrated Capital Corporation (3)
|
50%
|
|
TCJ
Enterprises LLC (2)
|
50%
|
|
Criticom
International Corporation
|
|
|
Curtis
Quady
|
52.4%
|
|
Duane
Plowman
|
14.4%
|
|
Jill
Quady (4)
|
10.0%
|
|
Lisa
Fischer (4)
|
9.9%
|
|
Raymond
Menard
|
7.3%
|
|
David
Speed
|
5.0%
|
|
Vincent
Erickson
|
*
|
|
Palisades
Group LLC
|
|
|
First
Integrated Capital Corporation (3)
|
50%
|
|
TJF
Enterprises LLC (2)
|
50%
|
|
Guardian
Group, LLC
|
|
|
First
Integrated Capital Corporation (3)
|
50%
|
|
TJF
Enterprises LLC (2)
|
50%
|
_______________________
(*)
Less
than one percent
| (1) |
M&S
Partners LLC is owned by Messrs. McGinn and Smith.
|
| (2) |
TJF
Enterprises LLC is owned by Thomas J. Few,
Sr.
|
| (3) |
First
Integrated Capital Corporation is majority owned by Messrs. McGinn
and
Smith.
|
| (4) |
Jill
Quady is the spouse and Lisa Fischer is the daughter of Curtis
Quady, an
Executive Vice President.
|
Policy
Regarding Transactions with Affiliates
Although
we believe the foregoing transactions were fair and in our best interests
we did
not have any formal policy in place. Our Board of Directors adopted a policy
in
May 2003, that any future transactions with affiliates, including without
limitation, our officers, Directors, and principal stockholders, will be
on
terms no less favorable to us than we could have obtained from unaffiliated
third parties. Any such transactions will be approved by a majority of our
Board
of Directors, including a majority of the independent and disinterested members,
or, if required by law, a majority of our disinterested
stockholders.
Section
16(a) Beneficial Ownership Reporting Compliance
Section
16(a) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)
requires our Officers and Directors and persons who own more than 10% of
our
common stock to file reports of ownership and changes in ownership of our
common
stock with the Securities and Exchange Commission and Nasdaq. One of our
Officers and Directors, Curtis Quady, acquired shares without properly filing
a
Form 4, he subsequently filed a Form 5 disclosing the acquisition. Based
solely
on a review of the copies of such reports and written representations from
the
reporting persons that no other reports were required, we believe that, other
than Mr. Quady’s report, during the fiscal year ended December 31, 2003 and nine
month period ended September 30, 2004, our executive officers, Directors
and
greater than ten percent shareholders filed on a timely basis all reports
due
under Section 16(a) of the Exchange Act.
For
the
year ended December 31, 2004, we paid PricewaterhouseCoopers LLP approximately
$1,035,900.
The
information presented below discloses the aggregated fees billed to us for
each
of the last two fiscal years by PricewaterhouseCoopers LLP.
Audit
Fees
Fiscal
2004—$833,770. Fiscal 2003—$270,570.
This
category includes fees for professional services rendered for the audit of
our
annual financial statements, the review of financial statements included
in our
Form 10-Q, the audit of our internal control over financial reporting as
of
December 31, 2004, and services that are normally provided by the accountant
in
connection with statutory and regulatory filings or engagements. The 2004
fees
include fees related to our audits, acquisitions and senior notes
offering.
Audit
Related Fees
Fiscal
2004—$16,675
This
category consists of an audit of one of our employee benefit plans in
2004.
Tax
Fees
Fiscal
2004—$185,455. Fiscal 2003—$85,493.
This
category includes fees for professional services that are rendered for tax
compliance, tax advice, and tax planning. The nature of the services comprising
the fees disclosed in this category for fiscal 2004 are tax return
preparation.
All
Other Fees
There
were no other fees for products and services that are not disclosed in the
previous categories.
Audit
Committee Pre-approval Policies and Procedures
The
audit
committee, or one of its members who has been delegated pre-approval authority,
considers and has approval authority over all engagements of the independent
auditors. If a decision on an engagement is made by an individual member,
the
decision is presented at the next meeting of the audit
committee.
PART
IV
(a) The
following documents are filed as a part of this report:
| 1. |
The
financial statements listed on the accompanying Index to Financial
Statements on page F-1.
|
| 2. |
Financial
statement schedules
|
Schedules
have been omitted since they are either not required, are not applicable
or the
required information is shown in the consolidated financial statements or
related notes.
| 3. |
The
following Exhibits:
|
Exhibit
Description
Exhibit
No.
|
2.1
|
(1)
|
Merger
Agreement by and between KC Alarm Services Group (Delaware
Corporation)
and the registrant
|
|
2.2
|
(1)
|
Merger
Agreement by and between registrant and Criticom International
Corporation
|
|
2.2(a)
|
(1)
|
Amendments
to Merger Agreement by and registrant and Criticom International
Corporation
|
|
2.3
|
(1)
|
Contribution
Agreement between Morlyn Financial Group LLC and the
registrant
|
|
2.4
|
(1)
|
Contribution
Agreement by and between Payne Security Group LLC and the
registrant
|
|
2.5
|
(1)
|
Contribution
Agreement by and between Guardian Group, LLC and the
registrant
|
|
2.6
|
(1)
|
Contribution
Agreement by and between Palisades Group, LLC and the
registrant
|
|
2.7
|
(1)
|
Merger
Agreement between IASI, Inc., IASG Acquisition Corp. and the
registrant
|
|
2.8
|
(1)
|
Asset
Purchase Agreement by and between Roseville Telephone Company,
RTC Alarm
Monitoring Services and the registrant
|
|
2.9
|
(1)
|
Asset
Purchase Agreement by and between Custom Design Security, Inc.
and Central
Digital Station Monitoring Services, Inc. and the
registrant
|
|
2.10
|
|
Stock
Purchase Agreement dated as of December 15, 2003 between Integrated
Alarm
Services Group, Inc. and Lane Industries, Inc. (incorporated
by reference
to Exhibit 99.1 to the Current Report on Form 8-K filed by
IASG dated
December 22, 2003)
|
|
|
||
|
3.1
|
(1)
|
Certificate
of Incorporation of registrant
|
|
3.1(a)
|
(1)
|
Certificate
of Amendment to the Certificate of Incorporation
|
|
3.2
|
(1)
|
Amendment
to Certificate of Incorporation of registrant
|
|
3.3(a)
|
(1)
|
Amended
and Restated By-Laws of registrant
|
|
|
||
|
|
||
|
|
||
|
|
Exhibit No.
|
|
||
|
|
||
|
|
||
|
|
||
|
10.1**
|
(1)
|
2003
Stock Option Plan
|
|
10.2**
|
(1)
|
Amended
and Restated Employment Agreement by and between the registrant
and
Timothy M. McGinn
|
|
10.3**
|
(1)
|
Employment
Agreement by and between the registrant and Thomas J. Few,
Sr.
|
|
10.4**
|
(1)
|
Employment
Agreement by and between the registrant and Curtis Quady.
|
|
10.5**
|
(1)
|
Employment
Agreement by and between the registrant and Brian E. Shea
|
|
10.6**
|
(1)
|
Employment
Agreement by and between the registrant and Robert Heintz
|
|
10.7
|
(1)
|
Assignment
and Assumption Agreement
|
|
10.8
|
(1)
|
Lease
Agreement between the registrant and Pine Street Associates,
LLC for the
Albany, New York Office space
|
|
10.9
|
(1)
|
Lease
Agreement between Morlyn and Robert Gallo for the Oakland,
New Jersey
Office
|
|
10.10
|
(1)
|
Form
of Convertible Note
|
|
10.11
|
(1)
|
Form
of Two-year Note
|
|
10.12
|
(1)
|
Form
of Five-year Note
|
|
10.13
|
(1)
|
Form
of Three-year Note
|
|
10.14
|
(1)
|
Form
of One-year Note
|
|
10.15
|
(1)
|
$3
million principal amount promissory note issued by registrant
to Lynn A.
Smith
|
|
10.16
|
(1)
|
Right
of First Refusal Agreement by and between registrant and
Criticom IDC
Corporation, and Royal Thoughts LLC
|
|
10.17
|
(1)
|
ADEMCO
Letter
|
|
10.18
|
(1)
|
Installing
company Monitoring Receivable Financing Agreement by and
between the
registrant and M&S Partners
|
|
10.19
|
(1)
|
Receivable
Financing Purchase Agreement between McGinn, Smith Acceptance
Corp.,
Pointe Bank, and King Trust 01
|
|
10.20**
|
(1)
|
Form
of Indemnification Agreement between registrant and member
of the Board of
Directors
|
|
10.21
|
(1)
|
Form
of note due April 2004
|
|
10.22**
|
(1)
|
Employment
Agreement by and between the registrant and Michael
Moscinski
|
|
10.23**
|
|
2004
Stock Incentive Plan (incorporated by reference to Appendix
A to the
Definitive Proxy Statement filed by IASG dated April 29,
2004)
|
Exhibit No.
|
|
||
|
|
||
|
|
||
|
|
||
|
|
||
|
|
||
|
23.3
|
(1)
|
Consent
of Barnes & Associates
|
|
23.4
|
(1)
|
Consent
of Standard & Poor’s Corporate Value Consulting
|
|
25.1
|
|
Form
T-1 Statement of Eligibility under the Trust Indenture Act
of 1939 of
Wells Fargo Bank, N.A.
|
|
|
||
|
|
||
|
|
|
(1)
|
Incorporated
by reference to Exhibit of same number to the Registration Statement
on
Form S-1 Registration Number
333-101159)
|
(2) Incorporated
by reference to our annual report filed on form 10-K for the year ended December
31, 2003
on
March
30, 2004
|
**
|
Constitutes
a management contract or compensatory plan or arrangement required
to be
filed or incorporated by reference as an Exhibit to this report
pursuant
to item 15(c) of Form 10-K
|
INTEGRATED
ALARM SERVICES GROUP, INC.
Index
F-1
To
the
Board of Directors and Stockholders of
Integrated
Alarm Services Group, Inc.
We
have
completed an integrated audit of Integrated Alarm Services Group, Inc.’s 2004
consolidated financial statements and of its internal control over financial
reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated
financial statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Our opinions, based on our audits,
are presented below.
Consolidated
financial statements
In
our
opinion, the consolidated financial statements listed in the index under
item
15(a)(1) present fairly, in all material respects, the financial position
of
Integrated Alarm Services Group, Inc. and its subsidiaries at December 31,
2004
and 2003, and the results of their operations and their cash flows for each
of
the three years in the period ended December 31, 2004 in conformity with
accounting principles generally accepted in the United States of America.
These
financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements based
on
our audits. We conducted our audits of these statements in accordance with
the
standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit of financial statements includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our
opinion.
Internal
control over financial reporting
Also,
we
have audited management's assessment, included in Management’s Annual Report on
Internal Control over Financial Reporting appearing under Item 9A, that
Integrated Alarm Services Group, Inc. did not maintain effective internal
control over financial reporting as of December 31, 2004, because the Company
did not have an effective control environment, did not maintain effective
controls on the financial reporting process, and did not maintain effective
controls over the monitoring of its accounting functions at the divisional
level
as identified in management’s assessment, based on criteria established in
Internal
Control - Integrated Framework
issued
by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
The Company's management is responsible for maintaining effective internal
control over financial reporting and for its assessment of the effectiveness
of
internal control over financial reporting. Our responsibility is to express
opinions on management's assessment and on the effectiveness of the Company's
internal control over financial reporting based on our audit.
We
conducted our audit of internal control over financial reporting in accordance
with the standards of the Public Company Accounting Oversight Board (United
States). Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether effective internal control over financial
reporting was maintained in all material respects. An audit of internal control
over financial reporting includes obtaining an understanding of internal
control
over financial reporting, evaluating management's assessment, testing and
evaluating the design and operating effectiveness of internal control, and
performing such other procedures as we consider necessary in the circumstances.
We believe that our audit provides a reasonable basis for our
opinions.
A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (i) pertain
to the maintenance of records that, in reasonable detail, accurately and
fairly
reflect the transactions and dispositions of the assets of the company;
(ii) provide reasonable assurance that transactions are recorded as
necessary to permit preparation of financial statements in accordance with
generally accepted accounting principles, and that receipts and expenditures
of
the company are being made only in accordance with authorizations of management
and directors of the company; and (iii) provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition, use,
or
disposition of the company’s assets that could have a material effect on the
financial statements.
F-2
Because
of its inherent limitations, internal control over financial reporting may
not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may
become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
A
material weakness is a control deficiency, or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected. The following material weaknesses have been identified and included
in management’s assessment.
| 1. |
As
of December 31, 2004, the Company did not have an effective
control
environment based on criteria established in “Internal Control -
Integrated Framework” issued by COSO. The Company failed to design
appropriate company wide policies and procedures over the
accounting,
revenue, procurement, human resources, treasury and risk management
functions and did not uniformly and consistently communicate the
importance of internal controls throughout the organization. The
Company’s
policies and procedures with respect to review and supervision
of its
accounting operations at the divisional level were not operating
effectively. This control deficiency, together with the
control
deficiencies described in Item 2 below, indicate that the Company
did not
maintain an effective control environment. This control
deficiency
could result in a material misstatement of annual or interim financial
statements that would not be prevented or
detected.
|
| 2. |
As
of December 31, 2004, the Company did not maintain a sufficient
complement
of personnel with an appropriate level of accounting knowledge,
experience
and training in the application of generally accepted accounting
principles commensurate with the Company’s financial reporting
requirements. In addition, the Company also failed to implement
processes
to ensure periodic monitoring of its existing internal control
activities
over financial reporting. Specifically, the Company had
a shortage
of finance and accounting staff with sufficient depth and skill
in the
application of U.S. generally accepted accounting principles and
individuals in the finance function who did not have the appropriate
skills, training and experience to meet the objective that should
be
expected of these roles. This control deficiency could result in
a
misstatement of account balances or disclosures that would result
in a
material misstatement to the annual or interim financial statements
that
would not be prevented or detected. Additionally, this material
weakness
contributed to the following individual material weaknesses as
of December
31, 2004:
|
| a) |
The
Company did not maintain effective controls over the financial
reporting
process to ensure the accurate preparation and review of its financial
statements in a timely manner. Specifically, the Company’s control over
the completeness, accuracy and review of its documentation of the
close
processes relating to reconciliations, journal entries, and divisional
reporting packages were ineffective in their design and execution.
In
addition, the Company did not have effective controls over the
process of
identifying and accumulation of all required supporting information
to
ensure the completeness of its footnote disclosures and the support
for
the accounting positions taken on non-routine transactions. This
control
deficiency resulted in certain audit adjustments, including those
described below, to the 2004 financial statements. Additionally,
this
control deficiency could result in a misstatement of account balances
or
disclosures that would result in a material misstatement to the
annual or
interim financial statements that would not be prevented or detected.
|
| b) |
The
Company did not maintain effective controls over revenue and deferred
revenue accounts. Specifically, the Company’s controls were
not adequate to ensure the completeness and accuracy of revenues
recorded
under standard or multiple billing arrangements. This control deficiency
resulted in certain audit adjustments to revenue and deferred revenue
to
the 2004 financial statements. Additionally, this control deficiency
could
result in a misstatement of account balances or disclosures that
would
result in a material misstatement to the annual or interim financial
statements that would not be prevented or detected.
|
F-3
| c) |
The
Company did not maintain effective controls over accounts payable,
accrued
liabilities and the related expense accounts at two divisions.
Specifically, the Company’s controls over the completeness, valuation, and
existence of account payable and accrued expenses and ensuring
that such
expenses were recorded in the proper period were not effective.
This
control deficiency resulted in certain audit adjustments to the
aforementioned accounts of the 2004 financial statements. Additionally,
this control deficiency could result in a misstatement of account
balances
or disclosures that would result in a material misstatement to
the annual
or interim financial statements that would not be prevented or
detected.
|
| d) |
The
Company did not maintain effective controls over certain cash accounts
and
transactions including wire transfers at one division. Specifically,
the
Company’s controls were not adequate to provide reasonable assurance
regarding prevention or timely detection of unauthorized acquisition,
use
or disposition of the funds maintained in certain bank accounts
of the
Company. This control deficiency did not result in an adjustment
to the
2004 annual or interim financial statements. However, this control
deficiency could result in expenditures being made that are beyond
corporate approval levels and that would not be prevented or detected.
.
|
These
material weaknesses were considered in determining the nature, timing, and
extent of audit tests applied in our audit of the December 31, 2004 consolidated
financial statements, and our opinion regarding the effectiveness of the
Company’s internal control over financial reporting does not affect our opinion
on those consolidated financial statements.
As
described in Management’s Annual Report on Internal Control over Financial
Reporting, management has excluded National Alarm Computer Center (NACC)
from
its assessment of internal control over financial reporting as of December
31,
2004, because it was acquired by the Company in a purchase business combination
during 2004. We have also excluded NACC from our audit of internal control
over
financial reporting. NACC
is a
wholly owned division of Integrated Alarm Services Group, Inc. whose total
assets and total revenues comprised 17% and 2%, respectively, of the related
consolidated financial statement amounts as of and for the year ended December
31, 2004.
In
our
opinion, management's assessment that Integrated Alarm Services Group, Inc.
did
not maintain effective internal control over financial reporting as of December
31, 2004, is fairly stated, in all material respects, based on criteria
established in Internal
Control - Integrated Framework
issued
by the COSO. Also, in our opinion, because of the effect of the material
weaknesses described above on the achievement of the objectives of the control
criteria, Integrated Alarm Services Group, Inc. has not maintained effective
internal control over financial reporting as of December 31, 2004, based
on
criteria established in Internal
Control - Integrated Framework
issued
by the COSO.
/s/
PricewaterhouseCoopers LLP
Albany,
New York
June
13,
2005
F-4
INTEGRATED
ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
|
As
of December 31,
|
|||||||
|
2003
|
2004
|
||||||
|
Assets
|
|||||||
|
Current
assets
|
|||||||
|
Cash
and cash equivalents
|
$
|
35,435,817
|
$
|
31,554,609
|
|||
|
Current
portion of notes receivable
|
735,149
|
5,186,965
|
|||||
|
Accounts
receivable less allowance for doubtful
|
|||||||
|
accounts
of $750,000 in 2003 and $985,553 in 2004
|
4,312,990
|
6,289,787
|
|||||
|
Inventories
|
1,107,899
|
1,233,785
|
|||||
|
Prepaid
expenses
|
1,548,105
|
1,127,581
|
|||||
|
Due
from related parties
|
232,300
|
70,655
|
|||||
|
Total
current assets
|
43,372,260
|
45,463,382
|
|||||
|
Property
and equipment, net
|
5,762,586
|
7,926,324
|
|||||
|
Notes
receivable net of current portion and allowance
|
|||||||
|
for
doubtful accounts of $131,854 for 2003 and $245,854 in
2004
|
4,525,973
|
22,211,283
|
|||||
|
Dealer
relationships, net
|
23,113,617
|
34,529,962
|
|||||
|
Customer
contracts, net
|
73,571,131
|
85,169,085
|
|||||
|
Goodwill,
net
|
85,515,985
|
91,434,524
|
|||||
|
Debt
issuance costs, net
|
1,768,281
|
5,322,089
|
|||||
|
Other
identifiable intangibles, net
|
2,187,464
|
3,054,247
|
|||||
|
Restricted
cash and cash equivalents
|
1,100,000
|
757,104
|
|||||
|
Deferred
installation costs
|
-
|
5,946,059
|
|||||
|
Other
assets
|
119,033
|
270,122
|
|||||
|
Total
assets
|
$
|
241,036,330
|
$
|
302,084,181
|
|||
|
Liabilities
and Stockholders' Equity
|
|||||||
|
Current
liabilities:
|
|||||||
|
Current
portion of long-term debt
|
$
|
18,765,000
|
$
|
5,225,000
|
|||
|
Current
portion of capital lease obligations
|
431,555
|
459,987
|
|||||
|
Accounts
payable
|
2,873,707
|
3,720,197
|
|||||
|
Accrued
expenses
|
8,816,766
|
9,185,263
|
|||||
|
Current
portion of deferred revenue
|
7,576,993
|
9,756,134
|
|||||
|
Other
liabilities
|
139,066
|
160,809
|
|||||
|
Total
current liabilities
|
38,603,087
|
28,507,390
|
|||||
|
Long-term
debt, net of current portion
|
46,977,612
|
125,000,000
|
|||||
|
Capital
lease obligations, net of current portion
|
453,811
|
575,502
|
|||||
|
Deferred
revenue, net of current portion
|
312,343
|
4,034,675
|
|||||
|
Deferred
income taxes
|
759,425
|
1,112,778
|
|||||
|
Other
liabilities
|
374,119
|
-
|
|||||
|
Due
to related parties
|
153,203
|
4,009
|
|||||
|
Total
liabilities
|
87,633,600
|
159,234,354
|
|||||
|
Commitments
and Contingencies (Note 10)
|
|||||||
|
Stockholders'
equity
|
|||||||
|
Preferred
stock, $0.001 par value; authorized
|
|||||||
|
3,000,000
shares and none issued and outstanding
|
-
|
-
|
|||||
|
Common
stock, $0.001 par value; authorized
|
|||||||
|
100,000,000
shares; issued and outstanding
|
|||||||
|
24,607,731
shares at December 31, 2003 and
|
|||||||
|
24,681,462
at December 31, 2004
|
24,608
|
24,682
|
|||||
|
Common
stock subscribed
|
315,342
|
-
|
|||||
|
Paid-in
capital
|
205,086,659
|
206,566,067
|
|||||
|
Accumulated
deficit
|
(52,023,879
|
)
|
(63,740,922
|
||||
|
Total
stockholders' equity
|
153,402,730
|
142,849,827
|
|||||
|
Total
liabilities and stockholders' equity
|
$
|
241,036,330
|
$
|
302,084,181
|
|||
The
accompanying notes are an integral part of the financial
statements.
F-5
INTEGRATED
ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
Combined
for the Year Ended December 31, 2002 and
Consolidated
for the Years Ended December 31, 2003 and 2004
|
Years
ended December 31,
|
|||||||||||||
|
2002
|
2003
|
2004
|
|||||||||||
|
Revenue:
|
|||||||||||||
|
Monitoring
fees
|
$
|
20,136,016
|
$
|
24,099,653
|
$
|
24,103,270
|
|||||||
|
Revenue
from customer accounts
|
-
|
15,854,509
|
50,758,967
|
||||||||||
|
Billing
fees
|
558,347
|
112,127
|
-
|
||||||||||
|
Related
party monitoring fees
|
1,565,017
|
292,968
|
170,876
|
||||||||||
|
Related
party placement fees
|
1,236,227
|
90,437
|
-
|
||||||||||
|
Service
and installation revenue
|
-
|
417,904
|
5,336,047
|
||||||||||
|
Total
revenue
|
23,495,607
|
40,867,598
|
80,369,160
|
||||||||||
|
|
|||||||||||||
|
Cost
of revenue (excluding depreciation and
amortization)
|
15,424,912
|
16,393,439
|
32,748,642
|
||||||||||
|
8,070,695
|
24,474,159
|
47,620,518
|
|||||||||||
|
Operating
expenses:
|
|||||||||||||
|
Selling
and marketing
|
736,866
|
1,108,621
|
4,357,046
|
||||||||||
|
Depreciation
and amortization
|
5,580,985
|
12,322,558
|
23,012,590
|
||||||||||
|
Loss
(gain) on sale of assets
|
(5,605
|
)
|
-
|
(184,076
|
)
|
||||||||
|
General
and administrative
|
2,530,374
|
11,167,460
|
22,561,726
|
||||||||||
|
General
and administrative-related party
|
-
|
3,525,000
|
-
|
||||||||||
|
Total
operating expenses
|
8,842,620
|
28,123,639
|
49,747,286
|
||||||||||
|
Income
(loss) from operations
|
(771,925
|
)
|
(3,649,480
|
)
|
(2,126,768
|
)
|
|||||||
|
Other
income (expense):
|
|||||||||||||
|
Other
income, net
|
656,299
|
295,984
|
10,332
|
||||||||||
|
Amortization
of debt issuance costs
|
(1,619,086
|
)
|
(3,168,315
|
)
|
(1,750,151
|
)
|
|||||||
|
Related
party interest expense
|
(1,284,922
|
)
|
(914,229
|
)
|
-
|
||||||||
|
Interest
expense
|
(3,309,021
|
)
|
(12,655,617
|
)
|
(8,885,904
|
)
|
|||||||
|
Interest
income
|
-
|
1,613,669
|
1,453,227
|
||||||||||
|
Income
(loss) before income taxes
|
(6,328,655
|
)
|
(18,477,988
|
)
|
(11,299,264
|
)
|
|||||||
|
Income
tax expense (benefit)
|
(681,443
|
)
|
3,526,572
|
417,779
|
|||||||||
|
Net
income (loss)
|
$
|
(5,647,212
|
)
|
$
|
(22,004,560
|
)
|
$
|
(11,717,043
|
)
|
||||
|
Basic
and diluted income (loss) per share
|
$
|
(9.53
|
)
|
$
|
(1.95
|
)
|
$
|
(0.47
|
)
|
||||
|
Weighted
average number of common
|
|||||||||||||
|
shares
outstanding
|
592,785
|
11,263,455
|
24,667,960
|
||||||||||
|
Unaudited:
|
|||||||||||||
|
Pro
Forma income tax to give effect to
|
|||||||||||||
|
the
conversion from S to C Corporation
|
|||||||||||||
|
status
(Note 2):
|
|||||||||||||
|
Income
(loss) before benefit from income taxes
|
$
|
(6,328,655
|
)
|
$
|
(18,477,988
|
)
|
|||||||
|
Income
tax expense (benefit)
|
(2,871,573
|
)
|
(89,916
|
)
|
|||||||||
|
Net
income (loss)
|
$
|
(3,457,082
|
)
|
$
|
(18,388,072
|
)
|
|||||||
|
Basic
and diluted income (loss) per share
|
$
|
(5.83
|
)
|
$
|
(1.63
|
)
|
|||||||
The
accompanying notes are an integral part of the financial
statements.
F-6
INTEGRATED
ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
Combined
For the Year Ended December 31, 2002 and
Consolidated
For the Years Ended December 31, 2003 and 2004
|
Common
Stock
|
|
|
|
Common
Stock
|
|
Paid-in
|
|
Accumulated
|
|
Total
Stockholders'
|
|
|
|
Shares
|
|
Amount
|
|
Subscribed
|
|
Capital
|
|
Deficit
|
|
(Deficit)
Equity
|
|
Balance,
January 1, 2002
|
553,808
|
$
554
|
$
-
|
$
2,124,446
|
$
(11,470,667)
|
$
(9,345,667)
|
|||||
|
Net
income (loss)
|
-
|
-
|
-
|
-
|
(5,647,212)
|
(5,647,212)
|
|||||
|
Issuance
of common shares for
|
|||||||||||
|
acquisition
of Criticom
|
155,911
|
155
|
-
|
3,429,843
|
-
|
3,429,998
|
|||||
|
Balance,
December 31, 2002
|
709,719
|
709
|
-
|
5,554,289
|
(17,117,879)
|
(11,562,881)
|
|||||
|
Net
income (loss)
|
-
|
-
|
-
|
-
|
(22,004,560)
|
(22,004,560)
|
|||||
|
Issuance
of common shares for
|
|||||||||||
|
acquisition
of IASI and affiliates
|
864,192
|
865
|
-
|
11,559,079
|
-
|
11,559,944
|
|||||
|
Predeccessor
basis in IASI
|
-
|
-
|
-
|
(17,113,351)
|
(4,351,440)
|
(21,464,791)
|
|||||
|
Issuance
of common shares for
|
|||||||||||
|
consolidation
of Morlyn
|
17,000
|
17
|
-
|
(17)
|
-
|
-
|
|||||
|
Issuance
of common shares for initial public
|
|||||||||||
|
offering
of Company's common stock
|
22,000,000
|
22,000
|
-
|
187,380,587
|
-
|
187,402,587
|
|||||
|
Issuance
of common shares for exercise of
|
|||||||||||
|
underwriters'
over allotment option
|
982,729
|
983
|
-
|
8,452,943
|
-
|
8,453,926
|
|||||
|
Contingent
shares for Criticom purchase
|
34,091
|
34
|
315,342
|
315,308
|
-
|
630,684
|
|||||
|
Imputed
interest expense associated with
|
|||||||||||
|
conversion
feature of debt
|
-
|
-
|
-
|
387,821
|
-
|
387,821
|
|||||
|
Shareholder
options
|
-
|
-
|
-
|
8,550,000
|
(8,550,000)
|
-
|
|||||
|
Balance,
December 31, 2003
|
24,607,731
|
|
24,608
|
|
315,342
|
|
205,086,659
|
|
(52,023,879)
|
|
153,402,730
|
|
Net
income (loss)
|
(11,717,043)
|
(11,717,043)
|
|||||||||
|
Issuance
of contingent shares for Criticom
|
|||||||||||
|
purchase
|
34,091
|
34
|
(315,342)
|
315,308
|
-
|
-
|
|||||
|
Conversion
of debt to stock
|
39,640
|
40
|
-
|
274,960
|
-
|
275,000
|
|||||
|
Issuance
of stock options to consultant
|
-
|
-
|
-
|
13,018
|
-
|
13,018
|
|||||
|
Imputed
interest expense associated with
|
|||||||||||
|
conversion
feature of debt
|
-
|
-
|
-
|
876,122
|
-
|
876,122
|
|||||
|
Balance,
December 31, 2004
|
24,681,462
|
$
24,682
|
$
-
|
$206,566,067
|
$
(63,740,922)
|
$
142,849,827
|
The
accompanying notes are an integral part of the financial
statements.
F-7
INTEGRATED
ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
Combined
For the Year Ended December 31, 2002 and
Consolidated
For the Years Ended December 31, 2003 and 2004
|
Years
ended December 31,
|
|||||||||||||
|
2002
|
2003
|
|
2004
|
||||||||||
|
Cash
flows from operating activities:
|
|||||||||||||
|
Net
income (loss)
|
$
|
(5,647,212
|
)
|
$
|
(22,004,560
|
)
|
$
|
(11,717,043
|
)
|
||||
|
Adjustments
to reconcile net loss to net cash
|
|||||||||||||
|
provided
by (used in) operating activities:
|
|||||||||||||
|
Depreciation
and amortization
|
5,580,985
|
12,322,558
|
23,012,590
|
||||||||||
|
Amortization
of deferred installation costs, net
|
-
|
-
|
197,115
|
||||||||||
|
Amortization
of debt issuance costs
|
1,619,086
|
3,168,315
|
1,750,151
|
||||||||||
|
Interest
expense - non-cash, notes
|
97,725
|
387,821
|
876,122
|
||||||||||
|
Litigation
settlement
|
(957,275
|
)
|
-
|
-
|
|||||||||
|
Stock
options issued to consultant
|
-
|
-
|
13,018
|
||||||||||
|
Provision
for (reversal of) bad debts
|
(120,736
|
)
|
1,564,729
|
1,389,857
|
|||||||||
|
Deferred
income taxes
|
(346,775
|
)
|
3,339,330
|
353,353
|
|||||||||
|
Non-cash
service fees
|
-
|
1,825,000
|
-
|
||||||||||
|
Earned
discount on notes receivable
|
-
|
-
|
(151,493
|
)
|
|||||||||
|
Loss
(gain) on sale of property and equipment
|
(5,605
|
)
|
-
|
(135,498
|
)
|
||||||||
|
Loss
(gain) on sale of notes receivable
|
-
|
-
|
(48,578
|
)
|
|||||||||
|
Changes
in assets and liabilities, net of effects of
|
|||||||||||||
|
acquisitions
and non-cash transactions:
|
|||||||||||||
|
Accounts
receivable
|
892,034
|
(1,405,553
|
)
|
(1,157,770
|
)
|
||||||||
|
Inventories
|
-
|
(11,613
|
)
|
(57,097
|
)
|
||||||||
|
Prepaid
expenses
|
28,782
|
(1,024,357
|
)
|
465,473
|
|||||||||
|
Other
assets
|
(342,291
|
)
|
454,070
|
(192,528
|
)
|
||||||||
|
Deferred
installation costs (other assets)
|
-
|
-
|
(6,351,381
|
)
|
|||||||||
|
Due
from/to related parties
|
1,203,019
|
(17,790
|
)
|
12,452
|
|||||||||
|
Accounts
payable and accrued expenses
|
1,386,547
|
(3,250,941
|
)
|
2,252,420
|
|||||||||
|
Deferred
revenue
|
(363,800
|
)
|
707,501
|
(1,006,380
|
)
|
||||||||
|
Deferred
installation revenue
|
-
|
-
|
4,996,997
|
||||||||||
|
Other
liabilities
|
(332,640
|
)
|
(293,151
|
)
|
(352,376
|
)
|
|||||||
|
Net
cash provided by (used in) operating activities
|
2,691,844
|
(4,238,641
|
)
|
14,149,404
|
|||||||||
|
Cash
flows from investing activities:
|
|||||||||||||
|
Purchase
of property and equipment
|
(944,970
|
)
|
(603,769
|
)
|
(4,018,202
|
)
|
|||||||
|
Proceeds
from sale of property and equipment
|
7,500
|
-
|
177,216
|
||||||||||
|
Purchase
of customer contracts and dealer relationships
|
-
|
(10,794,192
|
)
|
(14,713,026
|
)
|
||||||||
|
Financing
of dealer loans
|
-
|
(3,456,867
|
)
|
(4,670,019
|
)
|
||||||||
|
Short-term
investments
|
(3,000,000
|
)
|
3,000,000
|
-
|
|||||||||
|
Repayment
of dealer loans
|
-
|
730,049
|
5,558,603
|
||||||||||
|
Decrease
(increase) in restricted cash and cash equivalents
|
(113,538
|
)
|
2,909,979
|
342,896
|
|||||||||
|
Proceeds
from sale of customer contract portfolio
|
-
|
-
|
4,596,292
|
||||||||||
|
Business
acquisitions, net of cash acquired
|
(4,812,010
|
)
|
(49,769,539
|
)
|
(64,907,924
|
)
|
|||||||
|
Net
cash used in investing activities
|
(8,863,018
|
)
|
(57,984,339
|
)
|
(77,634,164
|
)
|
|||||||
|
Cash
flows from financing activities:
|
|||||||||||||
|
Proceeds
of initial public offering
|
-
|
195,856,510
|
-
|
||||||||||
|
Proceeds
of long-term debt, related party
|
8,800,000
|
2,000,000
|
-
|
||||||||||
|
Proceeds
of long-term debt
|
5,500,000
|
6,839,404
|
125,000,000
|
||||||||||
|
Payments
of obligations under capital leases
|
(79,273
|
)
|
(146,540
|
)
|
150,124
|
||||||||
|
Repayment
of long-term debt
|
(6,144,329
|
)
|
(100,173,855
|
)
|
(60,242,612
|
)
|
|||||||
|
Repayment
of long-term debt, related party
|
(2,017,177
|
)
|
(6,909,765
|
)
|
-
|
||||||||
|
Debt
issuance costs
|
(670,000
|
)
|
(249,039
|
)
|
(5,303,960
|
)
|
|||||||
|
Net
cash provided by financing activities
|
5,389,221
|
97,216,715
|
59,603,552
|
||||||||||
|
Net
increase (decrease) in cash and cash equivalents for the
year
|
(781,953
|
)
|
34,993,735
|
(3,881,208
|
)
|
||||||||
|
Cash
and cash equivalents at beginning of year
|
1,224,035
|
442,082
|
35,435,817
|
||||||||||
|
Cash
and cash equivalents at end of year
|
$
|
442,082
|
$
|
35,435,817
|
$
|
31,554,609
|
|||||||
|
Supplemental
disclosure of cash flow information:
|
|||||||||||||
|
Interest
paid
|
$
|
4,049,719
|
$
|
13,432,321
|
$
|
5,486,423
|
|||||||
|
Income
taxes paid
|
$
|
-
|
$
|
-
|
$
|
416,803
|
|||||||
|
Supplemental
disclosure of non-cash items:
|
|||||||||||||
|
Common
stock issued to purchase IASI
|
$
|
11,559,944
|
|||||||||||
|
Debt
assumed from a related party
|
$
|
1,825,000
|
|||||||||||
|
Debt
converted to common stock
|
$
|
275,000
|
|||||||||||
|
Notes
receivable converted to customer contracts
|
$
|
2,441,434
|
|||||||||||
The
accompanying notes are an integral part of the financial
statements.
F-8
INTEGRATED
ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
1.
Description of Business
Integrated
Alarm Services Group, Inc. and Subsidiaries (“IASG” or the “Company”) is the
successor to KC Acquisition Corporation. In January 2003 KC Acquisition was
re-incorporated by merging into Integrated Alarm Services Group, Inc. (IASG)
(Note 11). IASG provides alarm-monitoring services to independent alarm dealers
and other telemetry customers on a contract basis. IASG operates three
Underwriters Laboratories listed call centers that provide alarm receiving,
processing, notification and related services for the monitoring of various
types of alarm systems. In addition to its call centers, IASG maintains six
regional dealer care locations designed to provide customized services to
independent alarm dealers. Alarm monitoring services for subscribers of
independent alarm dealers are outsourced to IASG. Subscribers contract with
alarm dealers for services like alarm installation, maintenance and monitoring.
In connection with the Company acquisitions in the fourth quarter of 2003,
more
fully described in Note 11, the Company has begun to perform installations
and
provide maintenance service to some of its customers.
Morlyn
Financial Group (Morlyn), a limited liability company, was formed in May
2000 to
assist independent alarm dealers in selling their retail portfolios to
Integrated Alarm Services, Inc. (IASI), a related party of Morlyn. Morlyn
provides due diligence and other related services for IASI and also earns
fees
from independent alarm dealers by providing billing services. In January
2003
Morlyn (formerly under common ownership) was acquired by IASG and became
a
wholly owned subsidiary.
Criticom-IDC
(Criticom) is a wholly owned subsidiary of IASG. Criticom provides
alarm-monitoring services to independent alarm dealers and other telemetry
customers as well as Global Positioning Systems (GPS) technology that customers
use to track various types of moveable assets. Criticom operates an Underwriters
Laboratories listed call center that provides alarm receiving, processing,
notification and related services for the monitoring of various types of
alarm
systems.
Integrated
Alarm Services, Inc. (IASI) which was acquired on January 31, 2003 provides
financing and capital to independent security alarm dealers throughout the
United States. IASI provides working capital to the independent dealers
necessary for the growth of the dealers’ business and financing for
acquisitions. IASI has built a vertically integrated infrastructure, capable
of
handling all aspects of a financing for independent alarm dealers including
due
diligence, billing and collections and the securitizing of alarm contracts
assumed upon the foreclosure of loans to dealers for which it provides
monitoring services (through IASG and other non-affiliated entities) to its
customers.
Lane
Security, Inc. (Lane) was acquired in December 2003. Its primary operating
entity, Protection Service Industries, L.P., installs, services and monitors
commercial and residential alarm systems in Arizona, California and New
Mexico.
2.
Summary of Significant Accounting Policies
Principles
of consolidated financial statements
The
consolidated financial statements include the accounts of IASG and its
subsidiaries from the date of their acquisition. All inter-company balances
and
transactions have been eliminated. Prior to the acquisition of Morlyn in
January
2003, the financial statements were presented as combined financial
statements.
Use
of estimates
The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to
make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date
of
the financial statements and reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
Segment
information
The
Company operates two reportable segments: (1) Alarm-Monitoring wholesale
services and (2) Alarm- Monitoring retail services. (see Note 15).
F-9
INTEGRATED
ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS (continued)
2.
Summary of Significant Accounting Policies (cont.)
Comprehensive
income
No
statement of comprehensive income has been included in the accompanying
financial statements since the Company does not have any other comprehensive
income to report.
Revenue
recognition
IASI
provides monitoring services to customers under contracts ranging from one
to
five years in duration. Such contracts are cancelable with notice sixty days
prior to the contract expiration date and contain no upfront fees or set
up
service. Customers are notified, if required, prior to the maturity date
and
contracts automatically renew for an annual term if no action is taken. Revenue
from customer contracts is recognized as services are provided over the related
monitoring contract period when a written contract is in place and collection
is
probable. Services may be billed in advance on a monthly, quarterly or annual
basis and amounts billed but not earned are recorded as deferred revenues.
Revenues deferred are recognized on a straight line basis over the term of
the
service agreement as the alarm monitoring services are provided.
Interest
income from dealer notes receivable is recognized using the interest method.
Accrual of interest income on notes receivable is suspended when a dealer
portfolio is contractually delinquent for one hundred twenty days or more.
The
accrual is resumed when the dealer portfolio becomes contractually current,
and
past due interest income is recognized at that time. Generally, IASI forecloses
on delinquent accounts and takes ownership of the related contracts which
collateralize the notes. Refunds are granted only upon request from the customer
when a payment is made on a closed account or a payment was processed where
the
funds were not payable to IASI.
The
Company provides monitoring and billing services for a monthly fee for the
subscribers of independent alarm dealers. The majority of the contracts are
annual. Such contracts contain no upfront fees or setup service. Monitoring
and
billing revenue is recognized as the monitoring and billing services are
provided. Deferred revenue represents amounts billed and or collected in
advance
of services being provided. Revenues deferred are recognized over the term
of
the service agreement as the alarm monitoring and billing services are provided.
Morlyn
assists independent alarm dealers in selling their portfolios of subscriber
contracts to IASI. Morlyn receives placement fees for this assistance in
selling
the subscriber portfolios. Since these placement fees are contingent they
are
recognized generally when the transactions are consummated. Deal related
costs
are expensed as incurred.
Installation
revenues associated with installing monitoring systems are deferred and
recognized over the expected life of the customer relationship.
Cash
and cash equivalents
Cash
and
cash equivalents include cash, certificates of deposit, and money market
funds
with original maturities of three months or less at the time of purchase.
The
carrying amount of cash and cash equivalents approximates fair value.
The
Company maintains cash and cash equivalents in accounts with financial
institutions in excess of the amount insured by the Federal Deposit Insurance
Corporation. At December 31, 2003 and 2004, cash and cash equivalent balances
in
excess of FDIC limits approximated $14,663,000 and $29,929,000, respectively.
Restricted
cash and cash equivalents
Cash
and
cash equivalents restricted under the terms of the Company's debt obligations
and letters of credit are classified to correspond with the classification
of
the
F-10
INTEGRATED
ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS (continued)
2.
Summary of Significant Accounting Policies (cont.)
Notes
receivable
IASI
which was acquired on January 31, 2003, makes loans to dealers, which are
collateralized by the dealers’ portfolio of customer monitoring contracts. Loans
to dealers are carried at the lower of the principal amount outstanding or
the
net realizable value of the portfolio underlying the loan. Loans are generally
considered nonperforming if they are 120 days in arrears of contractual terms.
Interest income stops accruing on non-performing loans. Management periodically
evaluates the loan portfolio to assess the collectibility of dealer notes
and
adequacy of the allowance for loan losses. Management reviews certain criteria
in assessing the adequacy of the allowance for loan losses including IASI’s past
loan loss experience, known and inherent risks in the portfolio, adverse
situations that may affect the borrower’s ability to repay, the estimated value
of any underlying collateral and current economic conditions. Loan impairment
is
identified when a portfolio’s cash flow is materially below the minimum
necessary to service the loan. In most cases, loans will be foreclosed and
valued at the lower of cost (loan carrying value) or fair value of customer
contracts using recent transaction prices and industry benchmarks. When a
dealer
becomes delinquent, the Company generally forecloses on and takes ownership
of
the portfolio of customer monitoring contracts.
The
Company’s notes receivable consisted of the following at December
31:
|
2003
|
|
2004
|
||||
|
Performing
loans
|
$
|
5,040,103
|
$
|
30,011,184
|
||
|
Non-perfoming
loans
|
351,873
|
1,390,581
|
||||
|
Total
Loans
|
5,391,976
|
31,401,765
|
||||
|
Less:
Reserves
|
(130,854
|
)
|
(245,854)
|
|||
|
Purchase
Discount
|
-
|
(3,757,663)
|
||||
|
Net
loans
|
$ |
5,261,122
|
$ |
27,398,248
|
||
At
December 31, 2004, we have non-performing loans aggregating $ 1.4 million.
In
February 2005, the Company collected $0.6 million of these loans. During
the
year ending 2004, a non-performing loan in the amount of $2.5 million was
foreclosed and reclassified to the existing portfolio group of customer
contracts. The collateral supported the carrying value and therefore no
impairment charge was recorded. Currently the cash flows from the underlying
collateral support the carrying value of the loans. However, if the cash
flows
from the underlying collateral continues to deteriorate, it may result in
a
future charge to earnings.
As
part
of the acquisition of NACC, the Company agreed to assume NACC’s obligations to
provide up to $11.0 million of open lines of credit to Dealers, subject to
the
terms of the agreements with the Dealers as of December 31, 2004. The Company
intends to fund these commitments with available funds and available capacity
under the $30 million LaSalle Credit Facility.
The
purchase discount resulted from the acquisition of National Alarm Computer
Center (Note 11).
Allowance
for doubtful accounts—Notes Receivable
Changes
in the allowance for doubtful accounts were as follows:
|
2003
|
2004
|
|||||
|
January
1,
|
$
|
-
|
$
|
130,854
|
||
|
Provisions
|
522,549
|
115,000
|
||||
|
Write-offs
|
(391,695
|
)
|
-
|
|||
|
December
31,
|
$
|
130,854
|
$
|
245,854
|
||
F-11
INTEGRATED
ALARM SERVICES GROUP, INC. AND SUBSIDIARIES
NOTES
TO FINANCIAL STATEMENTS (continued)
2.
Summary of Significant Accounting Policies (cont.)
Contractual
maturities of notes receivable as of December 31, 2004 are as
follows:
|
2005.................................................................................................................................................
|
$
|
5,186,965
|
|
2006.................................................................................................................................................
|
19,092,008
|
|
|
2007.................................................................................................................................................
|
3,299,580
|
|
|
2008.................................................................................................................................................
|
2,363,375
|
|
|
2009.................................................................................................................................................
|
1,453,489
|
|
|
2010
and
thereafter.......................................................................................................................
|
6,348
|
|
|
$
|
31,401,765
|
At
December 31, 2004 notes receivable from dealers was collateralized by customer
monitoring contracts with recurring monthly revenue of approximately $721,000.
Interest income on notes receivable was $1,425,249 and $682,067 for the years
ended December 31, 2003 and 2004, respectively, and is included in interest
income in the statement of operations.
Deferred
revenue-notes receivable
Deferred
revenue on notes receivable represents amounts paid by the dealers for services
the Company will render in the future. In connection with the loans to dealers,
the Company withholds a portion of the amount loaned to cover services for
the
remaining term of the contract. The deferred fees are recognized as revenues
as
the billing and collection services are provided to the dealers. Amounts
withheld are nonrefundable. Amounts recognized as revenue in 2002, 2003 and
2004
were $0, $348,681, and $107,758, respectively.
Accounts
receivable and allowance for doubtful accounts
Accounts
receivable are recorded at the invoiced amount and do not bear interest.
Credit
is extended based upon an evaluation of the customers financial condition
and
history. The allowance for doubtful accounts is the Company’s best estimate of
the amount of probable credit losses in its existing accounts receivable.
The
Company reviews its allowance for doubtful accounts monthly. Customer accounts
including accounts with balances over 90 days from the invoice date are reserved
based upon historical trends. Account balances are charged-off against the
allowance when the Company believes it is probable the receivable will not
be
recovered. The Company does not have any off-balance-sheet credit exposure
related to its customers.
Changes
in the allowance for doubtful accounts were as follows:
|
January
1, 2002
|
$
|
314,736
|
|
|
Reversal
of provisions
|
(120,736
|
)
|
|
|
December
31, 2002
|
194,000
|
||
|
Provisions
|
1,042,180
|
||
|
Write-offs
|
(1,063,598
|
)
|
|
|
Recoveries
|
577,418
|
||
|
December
31, 2003
|
750,000
|
||
|
Provisions
|
1,274,857
|
||
|
Write-offs
|
(2,069,832
|
)
|
|
|
Recoveries
|
1,030,528
|
||
|
December
31, 2004
|
$
|
985,553
|
Inventories