<PAGE>
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
__________________
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarter ended June 30, 1999 Commission File Number 0-13617
LIFELINE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
MASSACHUSETTS 04-2537528
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
111 LAWRENCE STREET
FRAMINGHAM, MASSACHUSETTS 01702-8156
(Address of principal executive offices) (Zip Code)
(508) 988-1000
(Registrant's telephone number, including area code)
__________________
Securities registered pursuant to Section 12(b) of the Act: NONE
Securities registered pursuant to Section 12(g) of the Act:
Common stock $0.02 par value
----------------------------
(Title of Class)
Indicate by check mark whether the registrant (i) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (ii) has been subject to such filing
requirements for the past 90 days. Yes X No
Number of shares outstanding of this issuer's class of common stock as of July
31, 1999: 5,862,198
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LIFELINE SYSTEMS, INC.
INDEX
<TABLE>
<CAPTION>
PAGE
<S> <C>
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Consolidated Balance Sheets - June 30, 1999
and December 31, 1998 3
Consolidated Statements of Income and Comprehensive Income
Three and six months ended June 30, 1999 and 1998 4
Consolidated Statements of Cash Flows - Three and six
months ended June 30, 1999 and 1998 5
Notes to Consolidated Financial Statements 6-9
ITEM 2.
Management's Discussion and Analysis of Results of
Operations and Financial Condition 10-19
ITEM 3.
Quantitative and Qualitative Disclosures about Market Risk 19
PART II. OTHER INFORMATION
ITEM 4.
Submission of Matters to a Vote of Security Holders 19
ITEM 5.
Other Information 20
ITEM 6.
Exhibits and Reports on Form 8-K 20
</TABLE>
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LIFELINE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
------------ ------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 2,391 $ 2,702
Short-term investments 1,980 6,696
Accounts receivable, net 7,743 7,459
Inventories 2,672 1,496
Net investment in sales-type leases 2,077 1,713
Prepaid expenses and other current assets 2,678 1,974
Deferred income taxes 2,786 2,238
------------ ------------
Total current assets 22,327 24,278
Property and equipment, net 26,216 20,776
Net investment in sales-type leases 6,078 5,892
Goodwill, net 995 1,134
Other assets 264 424
------------ ------------
Total assets $55,880 $52,504
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 1,217 $ 1,690
Accrued expenses 1,928 2,857
Accrued payroll and payroll taxes 1,368 2,695
Accrued income taxes 1,152 1,300
Deferred revenues 795 685
Current portion of capital lease obligation 457 10
Product warranty and other current liabilities 757 817
Accrued restructuring charge 2,315 863
------------ ------------
Total current liabilities 9,989 10,917
Deferred income taxes 3,837 3,548
Deferred compensation 1,570 1,578
Long term portion of capital lease obligation 1,904 11
Other non-current liabilities 42 159
Commitments and contingencies
Stockholders' equity:
Common stock, $.02 par value, 20,000,000 shares authorized,
6,454,746 shares issued at June 30, 1999 and 6,425,414 shares
at December 31, 1998 129 129
Additional paid-in capital 17,244 16,945
Retained earnings 25,231 23,435
------------ ------------
42,604 40,509
Less: Treasury stock at cost, 592,548 shares at June 30, 1999
and December 31, 1998 (4,028) (4,028)
Note receivable - officer (100) (100)
Accumulated other comprehensive income (loss)/
cumulative translation adjustment 62 (90)
------------ ------------
Total stockholders' equity 38,538 36,291
------------ ------------
Total liabilities and stockholders' equity $55,880 $52,504
============ ============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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<PAGE>
LIFELINE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(In thousands except for per share data)
<TABLE>
<CAPTION>
Three months ended Six months ended
June 30, June 30,
--------------------------------- -----------------------------------
1999 1998 1999 1998
-------------- -------------- --------------- ---------------
<S> <C> <C> <C> <C>
Revenues
Services $11,481 $ 9,490 $22,477 $18,500
Net product sales 5,705 6,193 10,527 11,797
Finance and rental income 389 334 797 672
-------------- -------------- --------------- ---------------
Total revenues 17,575 16,017 33,801 30,969
-------------- -------------- --------------- ---------------
Costs and expenses
Cost of services 6,512 5,511 12,692 10,611
Cost of sales 1,487 1,733 2,787 3,219
Selling, general, and administrative 6,530 6,087 13,030 12,253
Research and development 380 400 785 775
Restructuring charge 2,200 - 2,200 -
-------------- -------------- --------------- ---------------
Total costs and expenses 17,109 13,731 31,494 26,858
-------------- -------------- --------------- ---------------
Income from operations 466 2,286 2,307 4,111
-------------- -------------- --------------- ---------------
Other income (expense)
Interest income 59 149 157 256
Interest expense (31) (15) (39) (26)
Other Income - - 503 -
-------------- -------------- --------------- ---------------
Total other income, net 28 134 621 230
-------------- -------------- --------------- ---------------
Income before income taxes 494 2,420 2,928 4,341
Provision for income taxes 159 969 1,132 1,745
-------------- -------------- --------------- ---------------
Net income 335 1,451 1,796 2,596
Other comprehensive income, net of tax
Foreign currency translation adjustments 62 (23) 93 (13)
-------------- -------------- --------------- ---------------
Comprehensive income $ 397 $ 1,428 $ 1,889 $ 2,583
============== ============== =============== ===============
Net income per weighted average share:
Basic $ 0.06 $ 0.25 $ 0.31 $ 0.45
============== ============== =============== ===============
Diluted $ 0.05 $ 0.23 $ 0.28 $ 0.41
============== ============== =============== ===============
Weighted average shares:
Basic 5,862 5,812 5,856 5,804
============== ============== =============== ===============
Diluted 6,295 6,217 6,339 6,260
============== ============== =============== ===============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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LIFELINE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
<TABLE>
<CAPTION>
Six months ended
June 30,
----------------------------------
1999 1998
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 1,796 $ 2,596
Adjustments to reconcile net income to net cash provided
by operating activities:
Write down of fixed assets 379 -
Depreciation and amortization 2,553 1,976
Deferred compensation (8) 238
Deferred income taxes (259) 756
Changes in operating assets and liabilities:
Accounts receivable (243) 978
Inventories (1,176) 46
Net investment in sales-type leases (550) (691)
Prepaid expenses, other current assets and other assets (543) (20)
Accounts payable, accrued expenses and other liabilities (1,498) 1,480
Accrued payroll and payroll taxes (1,341) (321)
Income taxes payable (142) 281
Accrued restructuring charge 1,452 (447)
--------------- ---------------
Net cash provided by operating activities 420 6,872
--------------- ---------------
Cash flows from investing activities:
Purchases of investments (2,640) (4,735)
Sales and maturities of investments 7,356 2,977
Additions to property and equipment (5,757) (3,272)
--------------- ---------------
Net cash used in investing activities (1,041) (5,030)
--------------- ---------------
Cash flows from financing activities:
Principal payments under capital lease obligations (81) (6)
Proceeds from issuance of common stock 299 278
--------------- ---------------
Net cash provided by financing activities 218 272
--------------- ---------------
Effect of foreign exchange on cash 92 (8)
--------------- ---------------
Net increase (decrease) in cash and cash equivalents (311) 2,106
Cash and cash equivalents at beginning of period 2,702 2,019
--------------- ---------------
Cash and cash equivalents at end of period $ 2,391 $ 4,125
=============== ===============
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
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<PAGE>
LIFELINE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. The information furnished has been prepared from the accounts without audit.
In the opinion of the Company, the accompanying consolidated financial
statements contain all adjustments necessary, consisting only of those of a
normal recurring nature, to present fairly its consolidated financial
position as of June 30, 1999 and the consolidated results of its operations
and cash flows for the six months ended June 30, 1999 and 1998.
While the Company believes that the disclosures presented are adequate to
make the information not misleading, these statements should be read in
conjunction with the consolidated financial statements and the related notes
included in the Company's Annual Report on Form 10-K, as filed with the
Securities and Exchange Commission on March 16, 1999 for the year ended
December 31, 1998.
The results of operations for the six-month period ended June 30, 1999 are
not necessarily indicative of the results expected for the full year.
2. Details of certain balance sheet captions are as follows (in thousands):
<TABLE>
<CAPTION>
June 30, December 31,
1999 1998
-------- ------------
<S> <C> <C>
Inventories:
Purchased parts and assemblies $ 576 $ 556
Work-in-process 28 324
Finished goods 2,068 616
-------- --------
$ 2,672 $ 1,496
======== ========
Property and equipment:
Equipment $ 23,828 $ 11,136
Furniture and fixtures 691 684
Equipment leased to others 11,328 9,834
Equipment under capital leases 3,047 1,035
Leasehold improvements 4,398 3,439
Capital in progress 583 10,943
-------- --------
43,875 37,071
Less: accumulated depreciation and amortization (17,659) (16,295)
-------- --------
$ 26,216 $ 20,776
======== ========
</TABLE>
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<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. The calculation of per share earnings is as follows:
<TABLE>
<CAPTION>
(In thousands except per share figures)
Three months ended Six months ended
June 30, June 30,
------------------- -------------------
1999 1998 1999 1998
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Basic:
- -----
Net income $ 335 $1,451 $1,796 $2,596
Weighted average common shares outstanding 5,862 5,812 5,856 5,804
Net income per share, basic $ 0.06 $ 0.25 $ 0.31 $ 0.45
======== ======== ======== ========
Diluted:
- -------
Net income for calculating diluted earnings per share $ 335 $1,451 $1,796 $2,596
Weighted average common shares outstanding 5,862 5,812 5,856 5,804
Common stock equivalents 433 405 483 456
-------- -------- -------- --------
Total weighted average shares 6,295 6,217 6,339 6,260
Net income per share, diluted $ 0.05 $ 0.23 $ 0.28 $ 0.41
======== ======== ======== ========
</TABLE>
4. SEGMENT INFORMATION
The Company is active in one business segment: designing, marketing, monitoring
and supporting its personal response units. The Company maintains sales,
marketing and monitoring operations in both the United States and Canada. The
Canadian operations were enhanced through an acquisition in July 1996.
GEOGRAPHIC SEGMENT DATA
Net revenues to external customers are based on the location of the customer.
Geographic information as of June 30, 1999 and 1998 is presented as follows:
-7-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. SEGMENT INFORMATION (continued)
<TABLE>
<CAPTION>
Dollars in Three months ended Six months ended
thousands June 30, June 30,
--------------------------------------------------------------------
1999 1998 1999 1998
---------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Net Sales:
United States $16,208 $15,034 $31,284 $29,001
Canada 1,367 983 2,517 1,968
--------------------------------------------------------------------
$17,575 $16,017 $33,801 $30,969
====================================================================
Net Income:
United States $ 222 $ 1,426 $ 1,582 $ 2,496
Canada 113 25 214 100
--------------------------------------------------------------------
$ 335 $ 1,451 $ 1,796 $ 2,596
====================================================================
<CAPTION>
June 30, June 30,
1999 1998
---------------- --------------
<S> <C> <C>
Total Assets:
United States $51,647 $45,328
Canada 4,233 2,041
---------------- --------------
$55,880 $47,369
================ ==============
</TABLE>
5. RESTRUCTURING
In June 1999, the Company recorded a pre-tax restructuring charge of
approximately $2.2 million. Nearly $1.7 million was recorded as a result of the
outsourcing of the Company's equipment manufacturing operations to Ademco, an
international manufacturer of electronics equipment and a division of Pittway
Corporation. This charge included approximately $1.3 million of costs related
to the reduction in the Company's manufacturing workforce, and nearly $379,000
of costs associated with the write down of certain manufacturing fixed assets.
During the second quarter of 1999, certain events occurred which resulted in
changes to the Company's original estimates for its corporate headquarters'
relocation. As a result, the restructuring charge includes approximately
$520,000 of costs not reflected in the Company's December 1997 restructuring
charge (described below) associated with closing the Company's operations
located in Cambridge, Massachusetts.
In December 1997, the Company approved a restructuring plan to improve operating
efficiencies and reduce costs, and recorded a pre-tax restructuring charge of
$4.3 million. This charge was established to provide for a business
reorganization which included relocation of the Company's corporate
headquarters, work force reduction and write down of impaired assets in
accordance with SFAS 121.
-8-
<PAGE>
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. RESTRUCTURING (continued)
At June 30, 1999, accrued restructuring charges of $2.3 million represented
approximately $1.3 million of total remaining severance costs, $525,000 of fixed
assets to be written off upon final relocation to the Company's new corporate
headquarters and upon final transfer of the Company's manufacturing operations
to Ademco and $520,000 of costs which are associated with the delay in the
Company's complete corporate relocation.
The following is a summary of activity for the six months ended June 30, 1999:
<TABLE>
<CAPTION>
Accrued Accrued
Restructuring Charge at Amounts Amounts Restructuring Charge at
Dollars in thousands December 31, 1998 Recorded Utilized June 30, 1999
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Non-cash write down
of fixed assets $ 536 $ 379 $ (390) $ 525
Reduction of workforce
and other cash flows 327 1,301 (358) 1,270
Corporate relocation - 520 - 520
------ ------ ------ ------
Total $ 863 $2,200 $ (748) $2,315
====== ====== ====== ======
</TABLE>
6. SUBSEQUENT EVENT
In August 1999 the Company completed the stock acquisition of TelCARE
Systems, Inc. of Denver, Colorado. TelCARE provides personal response
service. The purchase price was approximately $950,000. The acquisition will
be accounted for as a purchase transaction and, as a result, the Company will
record goodwill to be amortized over an estimated life of five years. The
results of the acquired business will be included in the Company's
consolidated financial statements from the date of acquisition and will not
have a material impact on 1999 operating results.
-9-
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION
This and other reports, proxy statements, and other communications to
stockholders, as well as oral statements by the Company's officers or its
agents, may contain forward-looking statements within the meaning of Section 21E
of the Securities Exchange Act of 1934, as amended, with respect to, among other
things, the Company's future revenues, operating income, or earnings per share.
Without limiting the foregoing, the words "believes," "anticipates," "plans,"
"expects," and similar expressions are intended to identify forward-looking
statements. There are a number of factors of which the Company is aware that
may cause the Company's actual results to vary materially from those forecast or
projected in any such forward-looking statement. These factors include, without
limitation, those set forth below under the caption "Certain Factors That May
Affect Future Results." The Company's failure to successfully address any of
these factors could have a material adverse effect on the Company's future
results of operations.
RESULTS OF OPERATIONS
Total revenues for the quarter ended June 30, 1999 increased nearly 10% to $17.6
million as compared to total revenues of $16.0 million for the quarter ended
June 30, 1998. For the six months ended June 30, 1999, total revenues were
$33.8 million, or 9% greater than total revenues of $31.0 million for the same
period in 1998.
Service revenues grew 21% for the three and six months ended June 30, 1999 to
$11.5 million and $22.5 million, respectively from $9.5 million and $18.5
million, respectively for the same periods in 1998. Service revenues represent
over 66% of the Company's year to date total revenues as compared to 60% of
total revenues for the first six months of 1998. The Company continues to
experience strong growth in its service business segment as a result of its
strategy of packaging products and services into a single service offering,
which results in higher per-subscriber service revenue. The Company was
monitoring over 250,000 subscribers as of June 30, 1999, 16% more than the
216,000 subscribers monitored at June 30, 1998. The Company's ability to
sustain the current level of service revenue growth depends on its ability to
expand the market for its personal response services, convert community hospital
programs to service provided by the Company and increase its focus on referral
development and innovative partner relationships in new channels of
distribution. The Company believes that the high quality of its services and
its commitment to providing caring and rapid response to the at-risk elderly and
the physically challenged will be factors in enabling the Company to meet this
challenge.
Net product revenues for the second quarter of 1999 decreased 8% to $5.7 million
from $6.2 million for the second quarter of 1998. For the six months ended June
30, 1999, net product revenues were $10.5 million, a decrease of approximately
11% from $11.8 million for the same period in 1998. Product sales have declined
as a result of the Company's strategy of combining service and hardware
offerings to support its service business segment. As a result, the Company
expects continued declining product sales in future periods as it continues
packaging products and services into a single service offering.
Finance and rental income, representing revenue earned from the Company's
portfolio of sales-type leases, increased 16% in the second quarter of 1999 to
$389,000, from $334,000 for the second quarter of 1998. For the six months
ended June 30, 1999, finance and rental income rose 19% to
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<PAGE>
$797,000 from $672,000 for the same period in 1998. The growth of the Company's
leasing portfolio for its internally managed and funded leasing program
continues to result in increased finance and rental income. The Company believes
that the retention of new leases in its own portfolio will result in an increase
in finance income for the remainder of 1999.
Total recurring revenues, consisting of service revenues and finance income, was
$11.9 million for the quarter ended June 30, 1999, an increase of 21% as
compared to $9.8 million for the three months ended June 30, 1998. For the six
months ended June 30, 1999 total recurring revenues increased 21% to $23.3
million from $19.2 million for the six months ended June 30, 1998. These
increases reflect the continued expansion of the Company's service business
segment with its focus on increasing the Company's recurring revenue base.
Cost of services, as a percentage of service revenues, was 57% for the second
quarter of 1999 as compared to 58% for the second quarter of 1998. For the six
months ended June 30, 1999 cost of services, as a percentage of service
revenues, was 56% as compared to 57% for the same period in 1998. While the
Company has been able to maintain these costs at a relatively consistent level
as a percentage of service revenues, cost of services remains high due to
continued investments in personnel and additional costs of employee retention
and recruiting initiatives. These initiatives are principally associated with
the relocation of the Company's monitoring facility as part of the Company's
first quarter 1999 move to new corporate headquarters in Framingham,
Massachusetts. The Company also continues to incur high costs associated with
systems enhancements and support to maintain its current service infrastructure
while it implements its CareSystem call center platform. At June 30, 1999,
nearly 57% of the Company's total United States' monitored subscribers have been
transitioned to CareSystem. The Company anticipates completing the conversion
for its remaining United States' monitored subscribers by the end of the third
quarter of 1999. Capital expenditures for the CareSystem call center platform
have also impacted current results of operations since the platform has begun to
be placed in service.
Cost of sales was 26% of net product sales for the three and six months ended
June 30, 1999 as compared to 28% and 27% for the three and six months ended June
30, 1998, respectively. The Company continues to strive to maintain its cost of
sales at a consistent percentage of net product sales. The Company was able to
accomplish this during 1999 due to efficiencies created by higher than expected
production in anticipation of the Company outsourcing the manufacturing of its
personal response units to Ademco, as well as additional reductions in material
costs. In June 1999, the Company began the transfer of its manufacturing
operations to Ademco and expects the transition to be fully completed in the
third quarter of 1999. However, all repair and distribution of the Company's
hardware will continue from its corporate headquarters. The Company believes
that the decision to outsource to Ademco will result in technological innovation
and significant cost savings opportunities.
Selling, general and administrative expenses improved as a percentage of total
revenues to 37% for the second quarter of 1999 as compared to 38% during the
second quarter of 1998. For the six months ended June 30, 1999 selling, general
and administrative expenses were 39% of total revenues as compared to 40% for
the six months ending June 30, 1998. The Company has been able to successfully
control many of its costs included within selling, general and administrative
expenses. Specifically, for the first six months of 1999, the Company has
experienced lower expenditures in the areas of market and product development
and promotional strategies aimed at the healthcare channel. The Company also
has experienced savings in operating costs resulting from
-11-
<PAGE>
the Company's relocation to new corporate headquarters in February 1999. The
first six months of 1998 were also impacted by compensation expense that was
incurred for certain stock options that became exercisable during the first six
months of 1998. As a result, no compensation expense was recorded in 1999. These
savings were partly offset by spending associated with the Company's 1999
customer conference, the inclusion of six months of administrative costs
associated with AlertCall, Inc. of Amherst, New York which was purchased by the
Company in November 1998 and moving costs incurred in connection with the
Company's relocation to its new corporate headquarters.
Research and development expenses remained consistent at 2% of total revenues
for the three and six months ended June 30, 1999 and 1998. Research and
development efforts are focused on ongoing product improvements and
developments. The Company expects to maintain these expenses at a consistent
percentage of total revenues for the remainder of 1999.
In June 1999, the Company recorded a pre-tax restructuring charge of
approximately $2.2 million. Nearly $1.7 million was recorded as a result of the
outsourcing of the Company's equipment manufacturing operations to Ademco. This
charge included approximately $1.3 million of costs related to the reduction in
the Company's manufacturing workforce and nearly $379,000 of costs associated
with the write down of certain manufacturing fixed assets. During the second
quarter of 1999, certain events occurred which resulted in changes to the
Company's original estimates for its corporate headquarters' relocation. As a
result, the Company recorded approximately $520,000 of costs not reflected in
the Company's December 1997 restructuring charge (described below) associated
with closing the Company's operations located in Cambridge, Massachusetts.
In December 1997, the Company approved a restructuring plan to improve operating
efficiencies and reduce costs, and recorded a pre-tax restructuring charge of
$4.3 million. This charge was established to provide for a business
reorganization which included relocation of the Company's corporate
headquarters, work force reduction and write down of impaired assets in
accordance with SFAS 121.
At June 30, 1999, accrued restructuring charges of $2.3 million represents
approximately $1.3 million of total remaining severance costs, $525,000 of fixed
assets to be written off upon final relocation to the Company's new corporate
headquarters and upon final transfer of the Company's manufacturing operations
to Ademco and $520,000 of costs which are associated with the delay in the
Company's complete corporate relocation.
In February 1999, the Company negotiated a buyout of its old corporate
headquarters facility lease. Pursuant to the arrangement, payments of
approximately $1 million were to be made to the Company during 1999, as space
becomes available in the old facility. Lifeline received a payment of
approximately $0.5 million during the first quarter of 1999, net of applicable
negotiation fees, and recorded these payments as other income. As of June 30,
1999 the Company still occupied space in the old corporate facility.
The Company's effective tax rate was 38.7% for the six months ended June 30,
1999 compared to 40.2% for the six months ended June 30, 1998.
-12-
<PAGE>
LIQUIDITY AND CAPITAL RESOURCES
During the six months ended June 30, 1999, the Company's portfolio of cash, cash
equivalents and investments decreased over $5.0 million to $4.4 million at June
30, 1999 from $9.4 million at December 31, 1998. The decrease was mainly
attributable to continued purchases of property and equipment of $5.7 million
during 1999. Expenditures of nearly $1.3 million were associated with the
continued development of the Company's new CareSystem response center platform
at its primary monitoring facility and approximately $1.5 million was for
Company-owned equipment provided directly to customers under comprehensive
service agreements and to subscribers not serviced by local Lifeline programs.
The Company also spent an additional $2.2 million for its new corporate facility
including purchases of a heating, ventilation and air conditioning system, a
computer room and network infrastructure, a telephone and voicemail system,
furniture and leasehold improvements. During the first six months of 1999, the
Company also incurred a higher than normal increase of inventory in anticipation
of the Company outsourcing its manufacturing function. As a result, the Company
spent approximately $1.2 million, net of sales of inventory, for additional raw
material purchases. These increases are reflected in higher finished goods
inventory levels. The payments of sales and management bonuses as well as
expenditures related to the Company's old corporate headquarters also
contributed to the decrease. Profitable operations of $4.5 million helped to
offset the effects of the expenditures for the first six months of 1999.
During the first six months of 1999, the Company continued its investment in new
information technology for its response center platform. The Company began to
transition subscribers to its new CareSystem platform in February 1999 and
currently monitors approximately 57% of its total United States' monitored
subscriber base on the new platform. The Company has invested nearly $12.0
million in the CareSystem platform through June 30, 1999 and anticipates it will
spend approximately an additional $1.5 million during 1999 for this flexible,
scaleable, and fault tolerant response center platform at its primary monitoring
facility to support its growing subscriber base.
As of June 30, 1999, the Company entered into Master Lease Agreements for up to
$2.7 million for furniture, computers, security systems and other related
equipment purchased in connection with the Company's move to its new corporate
facility and other purchases. For financial reporting purposes, these leases
were recorded as capital leases and accordingly assets were recorded and are
being depreciated over their estimated useful life. As of June 30, 1999 the
Company made purchases of approximately $2.4 million under these agreements.
The Company is party to a ten-year lease for an 84,000 square foot facility in
Framingham, Massachusetts for its corporate headquarters. The Company began
occupying this new facility in February 1999. Annual base rental payments under
the lease approximate $772,000. The lease contains two five-year options to
renew at the end of the initial lease term. The Company incurred expenditures of
approximately $6.9 million through June 30, 1999 for capital associated with its
new corporate facility, as described above, including purchases for the
development of a computer center for its new monitoring platform, its corporate
infrastructure and additional capacity to handle future subscriber growth.
Purchases of furniture and fixtures and leasehold improvements were also
included in the aforementioned total capital expenditures amount. The Company
incorporated approximately $2.2 million of its purchases in the Master Lease
Agreements noted above. The Company expects to spend an additional $0.5 million
in 1999 for similar items of which some will be incorporated as part of the
Master Lease Agreements noted above.
-13-
<PAGE>
In October 1998, the Company entered into a five-year lease to rent an
additional 16,000 square feet of a facility located in Framingham, Massachusetts
to maintain its inventory. The Company intends to occupy this new facility by
the end of 1999. Annual base rental payments will be approximately $79,000.
The lease contains two five-year renewal options.
In April 1998, the Company obtained a $10.0 million line of credit. The
agreement contains several covenants, including the Company maintaining certain
levels of financial performance and capital structure. These financial
covenants include a requirement for a current ratio of at least 1.5 to 1.0 and a
leverage ratio of no more than 1.0 to 1.0. In addition, there are certain
negative covenants that include limitations on the Company's capital and other
expenditures, restrictions on the Company's capacity to obtain additional debt
financing, restrictions on the disposition of the Company's assets, and
restrictions on its investment portfolio. This line of credit matures on June
30, 2004, and no amounts were outstanding at June 30, 1999.
In July, 1998, the Company's Board of Directors adopted a Shareholder Rights
Plan in which common stock purchase rights were distributed as a dividend at the
rate of one Right for each share of the Company's Common Stock outstanding as of
the close of business on August 3, 1998. This plan was adopted as a means of
deterring possible coercive or unfair takeover tactics and to prevent a
potential acquirer from gaining control of the Company without offering a fair
price to all of the Company's shareholders. In connection with the Merger
Agreement between the Company and Protection One, an amendment to this Rights
Plan was adopted on October 18, 1998, providing, in part, that Protection One
and its Affiliates are not Acquiring Persons, that no Distribution Date, Stock
Acquisition Date, or Triggering Event shall be deemed to have occurred, and that
no holder of Rights is entitled to exercise such Rights (as all such terms are
defined in the Rights Plan), by virtue of the execution of the Merger Agreement.
Unless the Rights are redeemed or exchanged earlier, they will expire on July
24, 2008. No rights were exercised at June 30, 1999.
The Company expects that funding requirements for operations and in support of
future growth are expected to be met primarily from operating cash flow,
existing cash and marketable securities and its $10.0 million line of credit.
The Company expects these sources will be sufficient to finance the cash needs
of the Company through 1999 including the continued investment in its new
response center platform, the remaining expenditures needed for its move to new
corporate headquarters, the 1999 requirements of its internally funded lease
financing program, any potential acquisitions and other investments in support
of its current business.
PENDING ACQUISITION
As previously announced, Protection One, Inc. and the Company executed an
Amended and Restated Agreement and Plan of Merger and Contribution, dated as of
October 28, 1998 ("The Merger Agreement") as well as related voting agreements
between parties to the Merger Agreement and certain Protection One and Company
stockholders. The termination deadline in such agreements was not extended
beyond June 1, 1999. As a result, the related voting agreements also terminated
and either Protection One or the Company may unilaterally terminate the Merger
Agreement. In the absence of any action taken to terminate the Merger
Agreement, it will remain in effect. The delay has resulted, in part, from a
decision by the staff of the Securities and Exchange Commission to review
Protection One's methodology used to amortize customer accounts. The Company
continues to believe that the proposed merger makes strategic sense.
-14-
<PAGE>
SUBSEQUENT EVENT
In August 1999 the Company completed the stock acquisition of TelCARE Systems,
Inc. of Denver, Colorado. TelCARE provides personal response service. The
purchase price was approximately $950,000. The acquisition will be accounted
for as a purchase transaction and, as a result, the Company will record goodwill
to be amortized over an estimated life of five years. The results of the
acquired business will be included in the Company's consolidated financial
statements from the date of acquisition and will not have a material impact on
1999 operating results.
CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS
The following important factors, among others, could cause actual results to
differ materially from those indicated by forward-looking statements made in
this Quarterly Report on Form 10-Q and presented elsewhere by management from
time to time.
The Company entered into a Merger Agreement with Protection One, Inc. and a
subsidiary of Protection One, Inc. (the "Merger Sub"), pursuant to which,
subject to the terms and conditions of the Merger Agreement, the Company would
become a wholly-owned subsidiary of a newly formed holding company for
Protection One. There can be no assurance that the Merger will be consummated.
If the Merger is not consummated, there can be no assurance that the Company's
results of operations and financial condition will not have been adversely
affected by the Merger negotiations or the announcement of the Merger, by the
passage of time following the signing of the Merger Agreement, or by other
factors. If the Merger is consummated, stockholders of the Company will become
stockholders of the holding company, and as such will have the risks associated
with an investment in that company.
In June 1999 the Company began to outsource the manufacturing of its personal
response equipment to Ademco, a division of Pittway Corporation. This decision
represents a change in the Company's manufacturing strategy, as it will no
longer support a manufacturing site at its corporate location although repair
and distribution of the Company's hardware are expected to continue from its
corporate headquarters. There can be no assurance that the Company will realize
the intended cost savings it anticipates, or that Ademco will not incur delays
in manufacturing products for the Company as a result of process difficulties,
component shortages or for other reasons. Any such delay could have a material
adverse effect on the Company's business, financial condition, or results of
operations.
The Company's results are partially dependent on its ability to develop services
and products that keep pace with continuing technological changes, evolving
industry standards, changing subscriber preferences and new service and product
introductions by the Company's competitors. Lifeline's future success will
depend on its ability to enhance its existing services and products (including
accessories), to introduce new service and product offerings to meet and adapt
to changing customer requirements and emerging technologies on a timely basis
and to offer such products and services at competitive prices. There can be no
assurance that Lifeline will be successful in identifying, developing,
manufacturing or marketing new services and products or enhancing its existing
services and products on a timely basis or that Lifeline will be able to offer
such services and products at competitive prices. Also, there can be no
assurance that services, products or technologies developed by others will not
render Lifeline's services or products noncompetitive or obsolete.
-15-
<PAGE>
The Company has begun to transition its subscribers to its new CareSystem call
center platform and may experience risks and uncertainties associated with this
new information technology. These include the risks that such implementation
effort may not be completed on schedule, or at all, or within budget, or that
future developments in information technology will render the Company's system
non-competitive; the risks that the Company does not realize the intended
benefits from the new system, once subscribers are fully transitioned; and the
uncertainty associated with the substantial commitment of funds to this new
system, including the risks that the Company will have available significantly
less cash to finance its operations, other capital expenditures and future
growth, including acquisitions. The Company's existing call center platform,
CORMIS, which is being replaced by the new CareSystem platform, may not be Year
2000 compliant. Because the Company was monitoring approximately 57% of its
United States' monitored subscribers on the CareSystem call center platform as
of June 30, 1999, and expects to transition its remaining subscribers to
CareSystem by the end of the third quarter of 1999, it has not devoted resources
to making CORMIS Year 2000 compliant.
The Company's growth is dependent on its ability to increase the number of
subscribers served by its monitoring centers. The Company's ability to continue
to increase service revenue is a key factor in its long-term growth, and there
can be no assurance that the Company will be able to do so. The Company's
failure to increase service revenue could have a material adverse effect on the
Company's business, financial condition, or results of operations.
The Company's equipment revenue has been declining over the last several
quarters as a result of its strategy of combining service and hardware offerings
to support the transition to a service oriented business. As the Company
continues growing its service business segment to increase its recurring
revenue, there can be no assurance that service revenue will increase at a rate
sufficient to offset the expected decrease in higher margin equipment revenue
both on a quarterly and annual basis.
The Company may expand its operations through the acquisition of additional
businesses. There can be no assurance that the Company will be able to
identify, acquire or profitably manage additional businesses or successfully
integrate any acquired businesses into the Company without substantial expenses,
delays or other operational or financial problems. In addition, acquisitions
may involve a number of special risks, including diversion of management's
attention, failure to retain key acquired personnel, unanticipated events,
contingent liabilities and amortization of acquired intangible assets. There can
be no assurance that the acquired businesses, if any, will achieve anticipated
revenues or earnings.
The Company's equipment sales are ordinarily made to healthcare providers that
establish their own Lifeline programs. These healthcare providers typically
rent, rather than sell, the Lifeline products to subscribers and accordingly
following such time as a product is no longer used by a subscriber, it is
returned to the healthcare provider and becomes available for rent to another
subscriber. As a result of this use and reuse of the Company's products, sales
of such products are dependent on growth in the number of subscribers and on the
ability of the Company to encourage its healthcare provider customers to replace
their existing inventory by continuing to enhance its products with new
features.
The Company's monitoring operations are concentrated principally in its
corporate headquarters facility. Although the Company believes that it has
constructed safeguards to protect against system failures, the disruption of
service at its corporate monitoring facility, whether due to telephone or
-16-
<PAGE>
electrical failures, earthquakes, fire, the continued transition of its
monitoring operations to its new corporate headquarters, or other similar events
or for any other reason, could have a material adverse effect on the Company's
business, financial condition, or results of operations.
IMPACT OF THE YEAR 2000 ISSUE
The Year 2000 Issue is the result of computer programs being written using two
digits rather than four to define the applicable year. This could result in
computer programs that have date-sensitive software recognizing a date using
"00" as the year 1900 rather than the year 2000. Such errors could cause a
system failure or miscalculations causing disruptions of operations, including,
among other things, an inability to respond to subscriber calls, send invoices,
or engage in similar normal business activities.
The Company has implemented a formal six-phase Year 2000 program to determine
the extent of its own Year 2000 exposures. The Awareness Phase is ongoing and
involves continuous communication, both internally and externally with customers
and vendors. The Assessment Phase identifies the Company's products, services
and equipment that contain micro-controllers, as well as all information
technology hardware and software to identify two-digit year exposures. The
Planning Phase is the Company's decision-making phase, and it prioritizes the
schedule of resolutions to be implemented. In the Resolution Phase, the Company
will modify, replace or retire systems where necessary. The Testing Phase tests
the Company's readiness to roll out its results. Finally the Rollout Phase
implements the entire process into production.
The Company has utilized internal resources to test all currently marketed
products for Year 2000 issues. This product-testing phase has revealed only
minor product behaviors in date keeping relating to the year 2000 that do not,
in the Company's judgment, cause significant operational impact. The Company
has provided its customers with written information on how to correct such Year
2000 conditions.
As part of its Year 2000 program, the Company assessed all of its manufacturing
equipment and systems it has used to manufacture its personal response equipment
and categorized them as either mission-critical or non-mission-critical. In
June 1999 the Company began to outsource the manufacturing of its personal
response equipment to Ademco, a division of Pittway Corporation. This decision
represents a change in the Company's manufacturing strategy, as it will no
longer support a manufacturing site at its corporate location. The Company
believes that its own remaining mission critical manufacturing equipment and
systems to support its repair and distribution functions are Year 2000 ready.
Based on oral representations from Ademco, the Company believes that Ademco's
ability to perform its manufacturing responsibilities will not be affected by
the Year 2000 problem.
The Company's information technology systems, which include its networks,
desktops, data servers and applications, have entered the Testing Phase of the
Company's Year 2000 program. The Company has designed its new CareSystem call
center platform to be in compliance with the Year 2000. The Company's system
integration provider conducted and completed CareSystem unit, integration, and
system testing which included Year 2000 testing. The Company's Information
Technology department's CareSystem Acceptance Test Plan included the change to
the year 2000 as well as time changes in the year 2000. The Company began to
transition subscribers to its new CareSystem platform in February 1999 and
currently monitors approximately 57% of its United
-17-
<PAGE>
States monitored subscriber base on the new platform. The Company believes that
it will incur a smooth transition of its remaining subscribers during 1999 and
believes that the implementation of its new platform will be complete in the
third quarter of 1999. However, there can be no assurance that the
implementation effort will be completed on schedule, or at all. The Company has
not allocated any resources for its current CORMIS monitoring platform to ensure
that it is Year 2000 ready. As a result, there can be no assurance that the
Company will not need to incur material costs in order to ensure that the
CareSystem monitoring platform is operational in 1999. The Company believes,
however, that it has the necessary resources to ensure that CareSystem is
implemented in 1999.
The Company has completed the Assessment Phase of its remaining mission critical
information technology systems, is finalizing the Planning and Resolution Phase
and has entered the Testing Phase. Of all of the Company's material systems,
software replacements and upgrades in the ordinary course of business (without
acceleration for Year 2000 issues) have enhanced the Company's Year 2000
readiness without material incremental costs. The Company estimates that nearly
90% of its mission critical systems are Year 2000 ready with the remaining 10%
expected to be Year 2000 ready during the fourth quarter of 1999. The Company
has completed the Assessment Phase of its existing desktop computers. As it
completes the Planning and Resolution Phase and enters the Testing Phase the
Company believes that approximately 90% of its existing desktop computers are
Year 2000 compliant with the remaining 10% either requiring some modification to
ensure Year 2000 compliance or needing to be retired. The Company anticipates
that any remaining Year 2000 modifications will be completed during the third
quarter of 1999.
The Company has moved to new corporate headquarters effective February 1999. As
part of this process, the Company has determined that all embedded systems
contained in its new building, such as its elevators, heating, air conditioning
and security systems, are Year 2000 compliant.
The Company continues to assess whether third parties with whom it has
significant relationships are Year 2000 compliant. The Company sent formal
communications to third parties to determine the extent to which the Company is
vulnerable in the event those third parties fail to resolve their own Year 2000
issues. Responses to these letters are still being received, but of those
received to date, approximately 90% of the Company's certified vendors have
confirmed their Year 2000 readiness in writing and most other third parties have
informed the Company, either verbally or in writing, that they believe they are
or will be Year 2000 ready. The Company defines certified vendors as those that
have satisfied certain key criteria established by the Company. However, there
can be no assurance that the systems of these companies on which the Company's
systems rely will not experience problems associated with the Year 2000 and, if
so, that such problems would not have a material adverse effect on the Company's
business, financial condition, or results of operations. Vendors that the
Company determines are not Year 2000 compliant, or those that have not provided
adequate information, are being assessed and if needed replacements will be
sought.
The Company believes that its most reasonably likely worse case Year 2000
scenario is significant interruptions in the supply of necessary services and
products caused by third party suppliers that do not resolve their own Year 2000
issues. These disruptions could have a material adverse effect on the Company's
monitoring operations, and accordingly, its business, financial condition or
results of operations. The Company's major provider of telephone service is
AT&T. Based on information received directly from AT&T and from its website,
AT&T has an established Year 2000 compliance plan relating to its products,
services, desktop, infrastructure and vendor supplied products. This
information indicated that AT&T has achieved 100% assessment, repair,
certification and
-18-
<PAGE>
deployment of systems and network elements that directly impact its customers
and therefore believes that it is Year 2000 ready. The Company has selected
Ademco as the primary manufacturer for Lifeline personal response units.
Although the Company believes that Ademco's ability to perform its manufacturing
responsibilities will not be affected by the Year 2000 problem, there can be no
assurance that Ademco will not incur delays in manufacturing products for the
Company as a result of its inability to resolve its own Year 2000 issues.
Lifeline is in the process of defining arrangements with Ademco. The Company is
developing contingency plans to prepare for the inability of its remaining key
third-party suppliers to resolve their own Year 2000 issues. There can be no
assurance that these contingency plans will be adequate to meet the Company's
needs.
Through June 30, 1999, the Company has spent nearly $100,000 related to Year
2000 issues, consisting principally of personnel costs incurred in the scope of
normal operations and consulting costs. The total cost of the Year 2000
project, estimated to be approximately $200,000, and the date on which the
Company plans to complete the Year 2000 modifications, estimated to be during
1999, are based on management's best estimates, which were derived utilizing
numerous assumptions of future events including the continued availability of
certain resources, third party modification plans and other factors. However,
there can be no guarantee that these estimates will be achieved and actual
results could differ materially from those plans. Specific factors that might
cause such material differences include, but are not limited to, the
availability and cost of personnel trained in this area, the ability to locate
and correct all relevant computer codes, and similar uncertainties.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not applicable.
PART II. OTHER INFORMATION
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
The annual meeting of stockholders of the Company was held on June 17, 1999.
The stockholders of the Company elected members of the Board of Directors and
ratified the selection of PricewaterhouseCoopers LLP as the Company's auditors
for 1999.
NUMBER OF SHARES OF COMMON STOCK
--------------------------------
<TABLE>
<CAPTION>
BROKER
FOR AGAINST ABSTAINED NON- VOTES
-------------- -------------- ----------------- -------------------
<S> <C> <C> <C> <C>
L. Dennis Shapiro 4,167,280 - 14,169 -
Everett N. Baldwin 4,167,280 - 14,169 -
Selection of
PricewaterhouseCoopers LLP 4,179,302 1,200 947 -
</TABLE>
-19-
<PAGE>
ITEM 5. OTHER INFORMATION
As previously announced, Protection One, Inc. and the Company executed an
Amended and Restated Agreement and Plan of Merger and Contribution, dated as of
October 28, 1998 ("The Merger Agreement") as well as related voting agreements
between parties to the Merger Agreement and certain Protection One and Company
stockholders. The termination deadline in such agreements was not extended
beyond June 1, 1999. As a result, the related voting agreements also terminated
and either Protection One or the Company may unilaterally terminate the Merger
Agreement. In the absence of any action taken to terminate the Merger
Agreement, it will remain in effect. The delay has resulted, in part, from a
decision by the staff of the Securities and Exchange Commission to review
Protection One's methodology used to amortize customer accounts. The Company
continues to believe that the proposed merger makes strategic sense.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Reports on Form 8-K - No reports on Form 8-K were filed for the three
months ended June 30, 1999.
-20-
<PAGE>
LIFELINE SYSTEMS, INC.
SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
August 11, 1999 LIFELINE SYSTEMS, INC.
- --------------- ----------------------
Date Registrant
/s/ Ronald Feinstein
--------------------
Ronald Feinstein
Chief Executive Officer
/s/ Dennis M. Hurley
--------------------
Dennis M. Hurley
Vice President of Finance and
Administration, Principal Financial
and Accounting Officer
-21-
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