<PAGE>
REPORT OF MANAGEMENT
June 25, 1999
To Our Shareholders:
We are pleased with a number of initiatives we have completed at Vicom during
the past six months as we transform the business into a more dynamic, growth
oriented organization. The acquisition of the Midwest region of Enstar
Networking Corporation brought Vicom three significant benefits. They are,
specifically, advanced capabilities and market presence within the data
networking industry, improved financial liquidity, and a new group of dynamic
people to add to the Vicom team.
Our goal is to be the leading one-stop provider of telecommunication and data
products and services. We believe that the demand for our systems will
increase since most organizations, whether public or private, are looking to
providers such as Vicom to handle the headaches associated with developing
and maintaining the flow of communications within their business. While many
system integrators are looking to develop a more consultative approach to the
market (i.e. all service, no product sales), we believe the services side of
the telecommunications industry can still yield a successful business model.
We are particularly pleased with some of the projects we have addressed during
the first part of 1999. They include:
- - Completion of a $1.2 million structured wiring and network upgrade at a
school district in central Wisconsin involving one of the largest Level 7
wiring designs in the area along with the installation of over 120 network
switches and devices from Nortel Networks (formerly Bay Networks).
Completing a substantial portion of this work during the school year was a
challenge our associates met with success.
- - Installation of a state-of-the-art wireless telephone system for 200 users
of a trade show booth manufacturer. This system utilized the latest
technology from Tadiran, Coral Air. Coral Air uses lightweight, pocket size
wireless handsets which provide users with the same extensive range of
features as wired desktop digital telephones.
- - Commencement of a project at a private school in northern Wisconsin,
involving an upgrade of the data cabling and LAN/WAN infrastructure along
with new telephone and voice mail systems. This is a significant project as
we look to fully implement our strategy as a one-stop provider.
For the remainder of 1999, we have a number of challenges that our management
team will be addressing. First, we will continue to integrate the sales and
operations of our data networking and telephony businesses in order to
properly leverage our customer base and maximize revenue opportunities.
Second, we are looking to expand the capabilities of our Technical Assistance
Center (TAC) in order to provide our customers more alternatives for data and
voice communications support along with improved customer service. Third, we
are working diligently on our new computer systems implementation in order to
achieve Year 2000 compliance and integrate all of our divisions on a single
information system. This task will consume significant capital and human
resources for the remainder of year and is expected to negatively impact our
earnings. However, we believe that we will reap significant benefits through
improved labor utilization and other operating efficiencies moving forward to
2000 and beyond.
Lastly, we continue to shape the "new Vicom culture" through new personnel,
associate programs and different approaches to traditional business
practices. We have added new executives to the management team and expect
that they will make significant contributions towards building the
appropriate internal infrastructure to support our future growth and improve
our overall operations.
We are increasingly excited about our prospects as we strive to build a
successful, profitable business that delivers value to our shareholders. We
thank you for your continued support.
Sincerely,
James L. Mandel
Chief Executive Officer
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CORPORATE PROFILE
DESCRIPTION OF BUSINESS
Vicom, Incorporated ("Vicom" or the "Company") provides products and services
to integrate voice, video and data technologies for commercial, professional
and institutional users. Vicom installs services and supports products and
equipment from Cisco Systems, NEC America, Inc., Nortel Networks, MCI
WorldCom, Inc., Hitachi, Ltd., Tadiran Telecommunications and other
manufacturers of communications equipment.
The Company was organized under the laws of the State of Minnesota in 1975.
Effective December 31, 1998, the Company acquired the assets of the Midwest
region of Enstar Networking Corporation ("ENC"). ENC is a network integrator
that designs, builds, maintains and protects network infrastructures.
BUSINESS STRATEGY
Vicom's objective is to be a leading provider of information technology
services to manage voice, video and data communications networks. Vicom
believes its strong background in the installation and service of telephony
interconnect systems along with the recently acquired capabilities in data
networking uniquely positions them as single source provider for
telecommunication services for its customers. To achieve its objectives, the
Company is pursuing the following strategies:
- - Expand its service offerings to include a suite of customized
voice/data/video integration solutions to assist customers with the
implementation of CTI technologies. The demand for voice/data integration
is expected to increase due to demands of corporations for reducing costs,
deploying new business applications and improving network performance. The
Company believes they are well positioned to take advantage of this area
due to their strong technical knowledge of WAN infrastructures in addition
to their relationships with the leading manufacturers of voice/data
products.
- - Develop and market its maintenance service offering which provide network
monitoring capabilities to customers looking to outsource the management of
its LAN / WAN. Through the Company's existing Technical Assistance Center
(TAC) and staff of system engineers they can provide remote network
monitoring, remote security management and network administration.
- - Creating close and long-term relationships with a focused group of
customers to develop a source for repeatable business and as a result of
high satisfaction ratios, a source of business referrals. During 1998,
approximately 2,000 customers purchased products or services from Vicom. In
1999, the Company intends to concentrate its sales and marketing efforts on
a more focused number of customers in order to provide its full array of
service offerings and develop more successful long-term customer
relationships.
- - Maintain strong relationships with the leading manufacturers in the
networking industry in order to offer its customers high quality solutions.
Vicom has developed relationships with Cisco Systems, Inc., Check Point
Software Technologies, Ltd., NEC America, Inc., Nortel Networks (formerly
Bay Networks) and Tadiran Telecommunications, Inc.
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- - Expand its market presence and geographic coverage through the addition of
new sales, engineering and technical personnel in new Midwest locations,
with primary focus on Central / Western Wisconsin, Iowa and South Dakota.
The Company believes there is a significant level of demand for network
infrastructure upgrades within these Midwest markets. The Company's
strategy will be to open smaller offices consisting of a one to two
personnel that are supported by its larger operations in Fargo, ND and
Minneapolis, MN.
- - Focus a portion of its sales and marketing efforts towards expanding the
number of corporate (versus government or educational) customers. During
1998 approximately 40% of revenues were derived from corporate customers.
The Company is looking to expand the mix of corporate end-user customers in
order to expand its base of repeatable business which is generally more
profitable than educational and governmental business.
PRODUCTS AND SERVICES
Vicom provides a wide range of information technology services through the
following divisions:
CARRIER SERVICES DIVISION
Vicom recently expanded its efforts to establish itself within the rapidly
evolving telecommunications industry. The Telecommunications Act of 1996
("Telecom Act") mandated deregulation of the last important area of monopoly
concentration in the industry - providing local dial tone to consumers and
businesses. This service previously was provided almost exclusively by the
Regional Bell Operating Companies ("RBOCs"). In the wake of this deregulation,
large companies such as MCI Communications Corporation ("MCI") and Sprint
Corporation have invested billions of dollars to install proprietary fiber
optic networks to provide local dial tone service (in direct competition with
the RBOCs), long distance calling and Internet access over their networks.
To capitalize on these new opportunities in network services, Vicom announced
in July 1998 its designation as an MCI Communications Master Agent. MCI
recently combined with WorldCom, Inc. to create MCI WorldCom, Inc. with
annual revenue of more than $30 billion and operations in more than 65
countries. Through MCI WorldCom, Inc. partnership, Vicom joins a select group
of companies within the United States and enhances and expands its ability to
offer three of the four communication products and services most critical to
business today, consisting of local dial tone, long distance service and
Internet access. To facilitate the sale of these services, the Company formed
Nationwide Communications, Inc. (NCI), a wholly owned subsidiary, in October
of 1998 to develop a network of subagents throughout the United States.
NETWORK INTEGRATION DIVISION
Provides integrated solutions to support high performance local area networks
(LAN) and wide area networks (WAN). These services include network design,
structured wiring services, network implementation, network maintenance and
network security.
NETWORK DESIGN
Through the combination of its advanced engineering and project
management teams, Vicom assists its customers with network discovery
programs including traffic analysis, on-site hardware survey and
mapping, network baseline audits and implementation planning. These
services are designed to provide a customer with a broad overview of
their current networking capabilities and prepare a "roadmap" to help
them move to future technologies. These services are either offered as
part of an overall project or arranged separately as a billable
service.
3
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STRUCTURED WIRING SERVICES
Vicom provides solutions to build network cabling infrastructure for
voice and data communications. The speed and performance of a network
is dependent upon the adequacy and bandwidth of its cable plant. The
Company has a staff of project managers, technicians and installers
that provide project management, design and installation of standards
based category 5 and fiber optic cabling systems. Vicom will oversee
the design and implementation of projects involving multiple LANs
across a WAN, consisting of multi-vendor hardware products and several
thousand nodes. These projects generally range in size from $10,000 to
$250,000.
NETWORK IMPLEMENTATION
Vicom supplies, implements and supports a select range of suppliers of
electronics and software platforms from manufacturers such as Cisco
Systems Inc., Nortel Networks Inc. (formerly Bay Networks, Inc.) and
Compaq Computer Corporation. Vicom's line of network products include
concentrators, hubs, switches and routers for technologies such as
Ethernet, Token Ring, FDDI, Fast Ethernet, Gig Ethernet, Asynchronous
Transfer Mode ("ATM") and Voice over IP. In addition, Vicom provides
and installs network management systems that provide its customers with
the capability of network troubleshooting, diagnostics, security,
optimization and proactive network maintenance all from a single
workstation. Vicom also offers remote access products and services that
allow the end-user to operate outside of his or her office while still
being able to connect to his or her LAN.
NETWORK MAINTENANCE
Vicom provides a broad line of maintenance services including fixed fee
network support, telephone support, guaranteed response times, next
business day on-site response for problem resolution,
"spare-in-the-air" hardware replacement and cabling system diagnosis
and repair. Through the Company's existing Technical Assistance Center
(TAC), Vicom can provide remote diagnostic capabilities as part of its
maintenance services. The TAC is capable of receiving a customer call,
remotely diagnosing the problem, searching for an application solution
and, if necessary, dispatching a regional engineer to perform on-site
troubleshooting.
NETWORK SECURITY
These services involve the planning, installation and maintenance of
products that assist customers with security architecture enforcement
including firewalls, encryption, identification, authorization, and
content security. Vicom is an authorized reseller of the CheckPoint
Fire Wall - 1, a security product offered by CheckPoint Software
Technologies, Ltd.,
TELEPHONY DIVISION
Vicom has provided clients with telephone communications products and services
since its inception in 1975. As of December 31, 1998, the Company was providing
telephone equipment and service to more than 2,000 customers, with approximately
20,000 lines furnished to users by U.S. West and other line providers and
approximately 40,000 telephones in service. Telecommunications systems sold by
the Company are intended to provide users with flexible, cost-effective
alternatives to systems available from major telephone companies such as those
formerly comprising the Bell System and from other interconnect telephone
companies. Vicom's systems include equipment and components manufactured or
supplied by other companies. It installs and services NEC, Tadiran, Hitachi
and other leading telecommunications industry products and systems.
4
<PAGE>
MARKETING AND CUSTOMERS
Vicom provides its products and services to commercial, professional and
institutional users within the Midwest region of the United States. Vicom's
customers represent various industries such as financial services,
hospitality, legal, manufacturing and education. The Company currently has
sales personnel in Illinois, Minnesota, Nebraska, North Dakota and Wisconsin.
Customer relationships are developed both face-to-face via an outside account
manager and via telephone through an inside sales representative. The Company
employs 10 outside account managers in addition to 3 inside sales
representatives. The sales force is supplemented by 5 systems engineers, 7
project managers and 4 customer service representatives. Vicom sales
representatives undergo continuous training and attend vendor-sponsored
training and education programs mandated by such vendors in order for the
Company to qualify as an authorized reseller of their products.
Vicom uses several techniques to pursue new customer opportunities including
advertising, participation in trade shows, seminars and telemarketing. In
addition, the Company has worked closely with data communication consultants
who are engaged by end users to select vendors for LAN/WAN implementation
projects. Generally the Company's system engineers and/or account managers
will provide design or technical assistance to the consultants without charge
which can enhance Vicom's position with vendor selection.
SUPPLIERS
Vicom supplies, implements and supports products, including hardware and
software from manufacturers such as Cisco Systems, Inc., Compaq Corporation,
NEC America, Inc., Nortel Networks, Hitachi, Ltd., Check Point Software
Technologies, Ltd., Internet Security Systems, Inc. and Tadiran
Telecommunications, Inc. Vicom purchases a number of its networking products
through large distributors such as Tech Data Corporation and Ingram Micro,
Inc.
EMPLOYEES
The Company employs approximately 95 associates, the majority of which are
employed in sales and technical capacities. The Company believes its
relationship with its employees to be good.
INDUSTRY AND COMPETITION
The markets in which the Company competes are intensely competitive and
rapidly changing. The Company has many large competitors that have
substantially greater financial, development, technical, marketing and sales
resources than the Company. As a result of these factors, the Company's
competitors and potential competitors may be able to respond more quickly to
new or emerging technologies and changes in customer requirements or to
devote greater resources to the development, promotion and sale of their
products or services than the Company. Vicom's principal competitors include
Lucent Technologies, Inc., Norstan, Inc. and certain of the RBOC's, which are
the regional operating companies formed as a result of the 1985 divestiture
of American Telephone and Telegraph Company. Moreover, the passage of the
Telecom Act has increased competition by providing access to the number of
entities that were previously precluded from the industry.
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As a result of the Telecom Act, the pace of consolidation in the industry
accelerated. These changes in the regulatory environment could potentially
affect Vicom's ability to compete successfully. Vicom's competitors in
communication services market include participants from a variety of market
segments, including national accounting firms, systems consulting and
implementation firms, application software firms, service groups of computer
equipment companies, facilities management companies, general management
consulting firms and programming companies. In addition, the Company competes
with its customers internal resources, particularly when these resources
represent a fixed cost to the customer. Such competition may impose
additional pricing pressures on the Company.
PROPERTIES
Vicoms' headquarters, including its administration, sales, customer service
and technical support are located in New Hope, Minnesota, which consists of
approximately 47,000 square feet of leased space. Vicom also has regional
operations in leased facilities in Fargo, North Dakota (3,500 square feet)
and Omaha, Nebraska (750 square feet).
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MARKET FOR COMMON STOCK
Vicom's common stock trades on the local over-the-counter bulletin board
under the symbol VICM. The following are reported stock prices of the
Company's common stock as of the end of each quarter:
<TABLE>
<CAPTION>
Low High
<S> <C> <C>
1999 (by quarter)
First $1.75 $3.00
Second (through 6/25/99) $1.44 $2.31
1998 (by quarter)
First $0.31 $0.62
Second $0.44 $0.75
Third $0.56 $1.19
Fourth $0.87 $1.50
</TABLE>
The number of common shareholders of record as of June 1, 1999 was 210.
Management does not anticipate that cash dividends will be paid on Vicom's
common stock in the foreseeable future.
7
<PAGE>
SELECTED FINANCIAL DATA
<TABLE>
<CAPTION>
Three Months Ended
March 31, (unaudited) Years Ended December 31,
-----------------------------------------------------------------
1999 1998 1998 1997 1996 1995 1994
<S> <C> <C> <C> <C> <C> <C> <C>
STATEMENT OF OPERATIONS DATA
Revenues $4,646,142 $1,087,337 $6,458,113 $6,639,026 $5,514,532 $6,378,838 $4,965,848
Operating & product costs 3,387,328 861,772 4,841,111 4,095,990 3,929,573 4,750,024 3,440,258
-------------------------------------------------------------------------------------------
Gross profit 1,258,814 225,565 1,617,002 2,543,036 1,584,959 1,628,814 1,525,590
% of revenues 27.1% 20.7% 25.0% 38.3% 28.7% 25.5% 30.7%
Operating expenses 1,192,001 665,690 2,839,862 2,317,388 2,617,620 1,515,090 1,521,059
% of revenues 25.7% 61.2% 44.0% 34.9% 47.5% 23.8% 30.6%
-------------------------------------------------------------------------------------------
Income (loss) from operations 66,813 (440,125) (1,222,860) 225,648 (1,032,661) 113,724 4,531
Other expense, net 47,055 35,264 170,888 141,471 108,130 (374,686) 114,040
Amortization expense 13,479 0 0 0 0 0 0
-------------------------------------------------------------------------------------------
Income (loss) before taxes 6,279 (475,389) (1,393,748) 84,177 (1,140,791) 488,410 (109,509)
Income tax provision 0 0 50,000 28,000 0 352,000 (34,400)
-------------------------------------------------------------------------------------------
Income (loss) before extraordinary 6,279 (475,389) (1,443,748) 56,177 (1,140,791) 136,410 (75,109)
Extraordinary items 0 0 0 0 0 0 497,000
-------------------------------------------------------------------------------------------
Net income (loss) $ 6,279 $(475,389) $(1,443,748) $ 56,177 $(1,140,791) $ 136,410 $ 421,891
===========================================================================================
Income (loss) per share $ 0.00 $ (0.23) $ (0.68) $ 0.03 $ (0.55) $ 0.06 $ 0.20
===========================================================================================
Weighted average shares
outstanding 3,506,236 2,106,236 2,129,387 2,098,944 2,084,279 2,107,020 2,140,531
===========================================================================================
BALANCE SHEET DATA (END OF PERIOD)
Total assets 6,972,494 3,936,451 6,630,917 4,418,239 3,994,584 4,596,536 4,500,939
Long-term debt 1,721,335 1,763,387 1,804,497 1,429,848 1,449,848 1,236,326 1,072,511
Shareholders' equity 730,385 941,303 689,775 973,792 892,615 2,036,493 1,920,696
===========================================================================================
</TABLE>
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS
AND FINANCIAL CONDITION
The following discussion of the financial condition and results of operations
of the Company should be read in conjunction with the Consolidated Financial
Statements and the Notes thereto included elsewhere in this report.
FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of Section
27A of the Securities Act of 1933, as amended, and Section 21E of the
Securities Exchange of 1934, as amended and are made in reliance under the
safe harbor provisions of the Securities Litigation Reform Act of 1995. These
statements include statements regarding the intent, belief or current
expectations of the Company and its management. Shareholders and prospective
investors are cautioned that any such forward-looking statements are not
guarantees of future performance and involve a number of risks and
uncertainties that may cause the Company's actual results to differ
materially from the results discussed in the forward-looking statements.
Among the factors that could cause actual results to differ materially from
those indicated by such forward-looking statements are general economic
conditions, telecommunications and data networking industry conditions,
uncertainty and risks associated with the development and offering of new
products and services that may not be commercially successful, the rapid
technological changes occurring in the markets in which the Company operates,
failure to successfully execute the integration of the Company's voice and
data operations, dependence on and the need to recruit and retain key
personnel, dependence on key suppliers and product supply, the substantial
competition in the markets in which the Company operates and the integration
of the Company's voice and data operations.
RESULTS OF OPERATIONS
THREE MONTHS ENDED MARCH 31, 1999 VERSUS 1998 (UNAUDITED)
Revenues increased approximately $3.6 million, or 327%, to $4.6 million.
Revenues from the network integration business acquired from ENC were
approximately $2.8 million, including approximately $750,000 of sales from
the installation project for one customer which is expected to be completed
in the second quarter of 1999. Revenues from the telephony division increased
approximately $800,000, or 74% to $1.9 million in 1999 versus $1.1 million
in 1998. The remaining increase is primarily due to overall higher demand
between years.
Gross profit, as a percent of revenues, was 27.1% in 1999 versus 20.7% in
1998. The cost of products and services in 1998 reflects $150,000 of
adjustments to the allowance for inventory obsolescence. The Company expects
its gross profit margins to decline for the remainder of 1999 due to expected
competitive pricing pressures on its products and services.
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Operating expenses increased approximately $526,000, or 79% to approximately
$1.2 million in 1999 compared to $666,000 in 1998. Included in this increase
is approximately $415,000 of operating expenses of the network integration
business acquired from ENC. The remaining increase of approximately $111,000
is primarily reflects the addition of new executives and higher costs
associated with the Company's new employee benefit program implemented in the
first quarter. In addition, the operating expenses for the three months ended
March 31, 1998 reflect approximately $155,000 of non-cash adjustments for the
write-down of certain accounts and notes receivables.
Other expense increased approximately $12,000 which primarily reflects
reduced finance income charged between years. Amortization expense of
approximately $13,500 is a result of the goodwill from the acquisition of ENC.
YEAR ENDED DECEMBER 31, 1998 VERSUS 1997
Revenues decreased approximately $181,000, or 3%, to $6.4 million. Revenues
from sales of telephone and voice mail systems (including installation) were
$4,086,000 in 1998 versus $4,166,000 in 1997, a decrease of 2%. Included in
the 1998 amounts is approximately $995,000 of revenues from the Minneapolis
Public Schools project. Revenues from services were $2,372,000 in 1998 versus
$2,473,000 in 1997, a decrease of 4%. This overall decline in revenues is
primarily attributable to lower sales of smaller key telephone systems due
the Company's shift in focus to larger PBX systems.
Gross profit on sales represents revenues less the cost of products and
services. Gross profit, as a percent of revenues, was 25.0% in 1998 versus
38.3% in 1997. Decreased margins in 1998 reflect $660,000 of inventory
write-downs along with a higher volume of sales to schools and governmental
agencies, which generally have lower gross profit margins.
Operating expenses increased approximately $523,000, or 22.6% to $2,840,000
in 1998 compared to $2,317,000 in 1997. Of this amount $340,000 reflects
non-cash adjustments related to the write-down of certain assets. See Note 13
to the Consolidated Financial Statements. The remaining increase in operating
expenses is primarily due to the addition of sales and customer service
personnel.
Other expense consists principally of interest expense on notes and
installment obligations payable, net of finance income and interest income on
notes receivable. Other expense increased approximately $29,000 which
primarily reflects reduced finance income charged between years along with
higher interest expense due to additional borrowings of notes payable.
The income tax provision in 1998 and 1997 reflects adjustments to the
valuation allowance of net deferred tax assets resulting from net operating
loss carryforwards. See Note 8 to the Consolidated Financial Statements.
YEAR ENDED DECEMBER 31, 1997 VERSUS 1996
Revenues increased approximately $1.1 million, or 20.4%, to $6.6 million.
Revenues from sales of telephone and voice mail systems (including
installation) increase approximately $658,000, or 19% to $4,166,000 in 1997
versus $3,508,000 in 1996. Revenues from services increased approximately
$467,000, or 23% to $2,473,000 in 1997 versus $2,006,000 in 1996. The
increase in revenues is primarily due to overall higher demand between years.
Gross profit, as a percent of revenues, was 38.3% in 1997 versus 28.7% in
1996. The cost of products and services in 1996 reflects $176,000 of
adjustments to the allowance for inventory obsolescence.
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Operating expenses decreased approximately $300,000 to $2,317,000 in 1997
compared to $2,618,000 in 1996. For 1996, the Company increased its allowance
for doubtful accounts by $75,000 and recorded an adjustment of $292,000 to
write-off certain prepaid advertising costs. Excluding the effect of these
adjustments operating expenses did not significantly change between years.
Other expense increased approximately $33,000 which primarily reflects
reduced finance income charged between years.
The income tax provision in 1997 reflects adjustments to the valuation
allowance of net deferred tax assets resulting from net operating loss
carryforwards. See Note 8 to the Consolidated Financial Statements.
CAPITAL RESOURCES AND LIQUIDITY
The financial condition of the Company as of December 31, 1998 was
significantly impacted by the acquisition of the assets of the Midwest region
of Enstar Networking Corporation ("ENC"). See Note 2 to the Consolidated
Financial Statements. The purchase price included approximately $1.5 million
of net tangible assets and $549,000 of goodwill acquired. The consideration
consisted of 1,350,000 shares of the Company's common stock with an assigned
value of $797,000, a $750,000 subordinated promissory note at 9%, a payable
of $340,000 for purchase price adjustments and acquisition related costs of
$148,000.
Net cash used by operations was approximately $137,000 in 1998 versus cash
provided by operations of approximately $94,000 in 1997. The cash flow
deficits from operations in 1998, excluding the $1 million of non-cash
adjustments for the writedown of the carrying amounts of certain assets, are
due primarily to the loss from operations in addition to increase in
receivables and inventories associated with various large school projects.
These cash flow deficits resulted in an increase in accounts payable due to
which reflects higher average days payments to vendors.
In May 1998, the Company amended its bank loan agreement to provide a
$500,000 term note at prime rate plus 2.5%, payable in monthly principal and
interest installments of $10,846 with the balance due May 1, 2003, and a
$100,000 line of credit at prime plus 2.5% due April 30, 1999 (subsequently
extended to May 31, 1999). At December 31, 1998 the Company was not in
compliance with certain financial covenants under this agreement. This
indebtedness was repaid in June 1999.
In December 1998, the Company authorized 275,000 shares of 8% Class A
Cumulative Convertible Preferred Stock and 60,000 shares of 10% Class B
Cumulative Convertible Preferred. The Class B Preferred was offered to
certain notes payable holders at a conversion of $10 per Class B share.
The Company has historically relied on borrowings from related parties and
individuals to fund its operations. These borrowings are unsecured with
interest from 9% to 15%. Activity under these notes consisted of net cash
repayments of approximately $17,000 in 1998 and net borrowings of
approximately $189,000 in 1997. In July 1998, approximately $25,000 of notes
payable were converted into 50,000 shares of common stock. In December 1998
approximately $350,000 of notes payable were converted to 35,050 shares Class
B Preferred Stock.
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<PAGE>
In June 1999, the Company entered into a new $2 million revolving credit
agreement with Wells Fargo Business Credit. Borrowings under this facility
are based on eligible accounts receivable and inventory with interest at
prime plus 1.75%. The agreement contains certain restrictive covenants,
including the maintenance of minimum net income levels and limitations on
capital expenditures. The Company used approximately $465,000 of proceeds
from this new facility to repay outstanding borrowings under its previous
term note and line of credit. As of June 28, 1999 the Company had outstanding
borrowings of $465,000 and approximately $645,000 of available borrowings
under this agreement.
During 1999 Vicom's operating plans include approximately $500,000 of capital
expenditures primarily related to its computer system upgrade. Vicom expects
to be able to fund its working capital and capital expenditures with cash
flow from operations along with amounts available under its revolving credit
facility. In addition, the Company intends to finance a significant portion
of its capital spending through lease financing arrangements.
YEAR 2000 COMPLIANCE
The Company's primary computer applications require modifications made
necessary by the upcoming year 2000. The Company has developed a plan to
replace its existing computer systems during 1999 to address the Year 2000
issue and integrate the operations of the network integration business
acquired from ENC. In the event the Company is not able to complete the
implementation of its new systems implementation, it has the ability to
upgrade its existing computer applications to a version that is compliant
with the Year 2000. The overall estimated cost of the new computer system
consists of capital spending of new hardware and software of approximately
$400,000 along with an additional operating costs of approximately $350,000
which will be expensed as incurred during 1999.
Vicom sells products to customers under non-exclusive agreements with its
suppliers. Vicom is not an agent for its suppliers and cannot make
representations regarding the Year 2000 compliance or readiness of its
suppliers.
The potential impact of Year 2000 issues will depend to a large extent on the
Year 2000 efforts of the Company's vendors, customers, service providers,
utilities, governmental agencies and other entities with which the Company
does business. The Company is communicating with certain of these parties to
determine their efforts to prepare for the Year 2000 and to evaluate and
likely impact on the Company. These communications are focused on third
parties that the Company believes could have a greatest impact on its
business and operations. This process will continue throughout 1999. The
efforts of third parties are not within the control of the Company and their
failure to remedy Year 2000 issues successfully could result in business
disruption, loss of revenue and increased operating cost for the Company.
The Company has not yet established contingency plans in the event that it is
unable to complete its remediation effots by December 31, 1999. These
contingency plans are expected to be developed during the fourth quarter of
1999.
There can be no assurance that the Company's efforts to address the Year 2000
problem will be entirely successful, and the failure to fully address
associated issues could result in material adverse financial consequences to
the Company. In addition, there can be no assurances the systems of other
companies on which the Company's systems and other operations rely will
become Year 2000 compliant in a timely manner, and any such failure could
have a material adverse effect on the Company's operations.
12
<PAGE>
VICOM, INCORPORATED
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
UNAUDITED INTERIM FINANCIAL STATEMENTS
Condensed Statement of Operations for the Three Months Ended March 31, 1999 and 1998.............................14
Condensed Balance Sheet as of March 31, 1999 and December 31, 1998...............................................15
AUDITED FINANCIAL STATEMENTS FOR THE YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
Independent Auditor's Reports....................................................................................16
Financial Statements
Consolidated balance sheets..................................................................................17
Consolidated statements of operations........................................................................18
Consolidated statements of stockholders' equity..............................................................19
Consolidated statements of cash flows........................................................................20
Notes to consolidated financial statements ..................................................................21
Independent Auditor's Report - Supplementary Information.........................................................33
Valuation and qualifying accounts............................................................................34
</TABLE>
13
<PAGE>
VICOM, INCORPORATED
CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended March 31,
-------------------------------------------
1999 1998
------------------- --------------------
<S> <C> <C>
Revenues $4,646,142 $1,087,337
Cost of products and services 3,387,328 861,772
------------------- --------------------
Gross profit 1,258,814 225,565
Selling, general, and administrative expenses 1,192,001 665,690
------------------- --------------------
Income (loss) from operations 66,813 (440,125)
Other expense (income) 47,055 35,264
Amortization expense 13,479 0
------------------- --------------------
Income (loss) before income taxes 6,279 (475,389)
Income tax provision (benefit) 0 0
------------------- --------------------
Net income (loss) $6,279 ($475,389)
=================== ====================
Basic and diluted income (loss) per share - $0.00 ($0.23)
=================== ====================
Weighted average shares outstanding 3,506,236 2,106,236
=================== ====================
</TABLE>
14
<PAGE>
VICOM, INCORPORATED
CONDENSED CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
December 31, March 31,
1998 1999
---- ----
(Unaudited)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Accounts receivable:
Billed, net of allowances $ 2,869,912 $ 3,569,062
Unbilled 239,131 252,907
Inventories, net of allowances 1,858,008 1,523,497
Other 104,440 66,155
------------ ------------
TOTAL CURRENT ASSETS 5,071,491 5,411,621
------------ ------------
PROPERTY AND EQUIPMENT 647,356 635,358
------------ ------------
NONCURRENT ASSETS
Goodwill 549,101 535,373
Deferred income taxes 249,200 249,200
Other 113,769 140,942
------------ ------------
912,070 925,515
------------ ------------
$ 6,630,917 $ 6,972,494
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Checks issued in excess of deposits $ 207,219 $ 127,254
Notes and installment obligations payable - current maturities 978,007 876,625
Accounts payable 2,213,018 2,526,773
Accrued liabilities 447,052 1,056,843
Due to ENStar 340,188 99,171
Deferred service revenue 929,168 710,733
------------ ------------
TOTAL CURRENT LIABILITIES 5,114,652 5,397,399
NOTES AND INSTALLMENT OBLIGATIONS PAYABLE 826,490 844,710
STOCKHOLDERS' EQUITY 689,775 730,385
------------ ------------
$ 6,630,917 $ 6,972,494
============ ============
</TABLE>
15
<PAGE>
INDEPENDENT AUDITOR'S REPORT
Board of Directors and Stockholders
Vicom, Incorporated and Subsidiary
New Hope, Minnesota
We have audited the accompanying consolidated balance sheets of VICOM,
INCORPORATED AND SUBSIDIARY as of December 31, 1998 and 1997, and the related
consolidated statements of operations, stockholders' equity, and cash flows
for each of the three years in the period ended December 31, 1998. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the consolidated financial
statements are free of material misstatement. An audit includes examining, on
a test basis, evidence supporting the amounts and disclosures in the
consolidated financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position
of VICOM, INCORPORATED AND SUBSIDIARY as of December 31, 1998 and 1997, and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles.
LURIE, BESIKOF, LAPIDUS & CO., LLP
April 20, 1999, except for Note 6, as to
which the date is April 30, 1999
16
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997
<TABLE>
<CAPTION>
ASSETS 1998 1997
------------- -------------
<S> <C> <C>
CURRENT ASSETS
Accounts receivable:
Billed, net of allowance of $115,000 and $40,000 $ 2,869,912 $ 1,407,715
Unbilled 239,131 -
Inventories, net of allowance of $910,000 and $250,000 1,858,008 1,590,571
Other 104,440 148,293
------------ ------------
TOTAL CURRENT ASSETS 5,071,491 3,146,579
------------ ------------
PROPERTY AND EQUIPMENT 647,356 738,431
------------ ------------
NONCURRENT ASSETS
Goodwill 549,101 -
Deferred income taxes 249,200 299,200
Other 113,769 234,029
------------ ------------
912,070 533,229
------------ ------------
$ 6,630,917 $ 4,418,239
------------ ------------
------------ ------------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Checks issued in excess of deposits $ 207,219 $ 108,104
Notes and installment obligations payable - current maturities 978,007 755,412
Accounts payable 2,213,018 1,362,200
Accrued liabilities 447,052 112,858
Due to ENStar 340,188 -
Deferred service revenue 929,168 431,437
------------ ------------
TOTAL CURRENT LIABILITIES 5,114,652 2,770,011
NOTES AND INSTALLMENT OBLIGATIONS PAYABLE 826,490 674,436
STOCKHOLDERS' EQUITY 689,775 973,792
------------ ------------
$ 6,630,917 $ 4,418,239
------------ ------------
------------ ------------
</TABLE>
See notes to consolidated financial statements.
17
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------- -------------
<S> <C> <C> <C>
REVENUES $ 6,458,113 $ 6,639,026 $ 5,514,532
COSTS AND EXPENSES
Cost of products and services 4,841,111 4,095,990 3,929,573
Selling, general and administrative expenses 2,839,862 2,317,388 2,617,620
----------- ------------ ------------
7,680,973 6,413,378 6,547,193
----------- ------------ ------------
INCOME (LOSS) FROM OPERATIONS ( 1,222,860) 225,648 ( 1,032,661)
OTHER EXPENSE, net 170,888 141,471 108,130
----------- ------------ ------------
INCOME (LOSS) BEFORE INCOME TAXES ( 1,393,748) 84,177 ( 1,140,791)
INCOME TAX PROVISION 50,000 28,000 -
----------- ------------ ------------
NET INCOME (LOSS) ($ 1,443,748) $ 56,177 ($ 1,140,791)
----------- ------------ ------------
----------- ------------ ------------
NET INCOME (LOSS) PER COMMON SHARE -
BASIC AND DILUTED ($ .68) $ .03 ($ .55)
----------- ------------ ------------
----------- ------------ ------------
WEIGHTED AVERAGE COMMON SHARES
OUTSTANDING 2,129,387 2,098,944 2,084,279
----------- ------------ ------------
----------- ------------ ------------
</TABLE>
See notes to consolidated financial statements.
18
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
PREFERRED STOCK * COMMON STOCK ** RETAINED
--------------------------- ------------------------------- EARNINGS
SHARES AMOUNT SHARES AMOUNT (DEFICIT) TOTAL
---------- ------------ ------------- ------------- ------------- -----------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1995 - $ - 2,084,411 $ 1,274,518 $ 761,975 $2,036,493
Repurchase of stock - - ( 3,175) ( 3,776) 689 ( 3,087)
Net loss - 1996 - - - - ( 1,140,791) ( 1,140,791)
--------- ------------ ------------- -------------- ------------- -----------
BALANCE, DECEMBER 31, 1996 - - 2,081,236 1,270,742 ( 378,127) 892,615
Issuance of stock - - 25,000 25,000 - 25,000
Net income - 1997 - - - - 56,177 56,177
--------- ------------ ------------- -------------- ------------- -----------
BALANCE, DECEMBER 31, 1997 - - 2,106,236 1,295,742 ( 321,950) 973,792
Conversion of notes payable, net
of issuance costs 35,050 337,419 50,000 25,000 - 362,419
Acquisition of ENC (Note 2) - - 1,350,000 797,312 - 797,312
Net loss - 1998 - - - - ( 1,443,748) ( 1,443,748)
--------- ------------ ------------- -------------- ------------- -----------
BALANCE, DECEMBER 31, 1998 35,050 $ 337,419 3,506,236 $ 2,118,054 ($ 1,765,698) $ 689,775
--------- ------------ ------------- -------------- ------------- -----------
--------- ------------ ------------- -------------- ------------- -----------
</TABLE>
* In December 1998, authorized 275,000 shares of 8% Class A Cumulative
Convertible Preferred, no par value, and 60,000 shares of 10% Class B
Cumulative Convertible Preferred, no par value. All shares issued in 1998
are Class B
** Authorized 50,000,000 shares, no par value
See notes to consolidated financial statements.
19
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------- -------------
<S> <C> <C> <C>
OPERATING ACTIVITIES
Net income (loss) ($ 1,443,748) $ 56,177 ($ 1,140,791)
Adjustments to reconcile net income (loss) to cash
provided (used) by operating activities, net of
business acquisition effect:
Depreciation 228,931 251,725 174,772
Loss on investments - - 15,000
Deferred income taxes 50,000 28,000 -
Changes in operating assets and liabilities:
Accounts receivable ( 228,607) ( 408,101) ( 66,816)
Inventories ( 102,505) ( 147,948) 364,853
Other assets 78,676 ( 44,845) 332,963
Accounts payable and accrued liabilities 962,015 381,912 41,463
Deferred service revenue 318,442 ( 23,074) 197,308
----------- ------------ ------------
Net cash provided (used) by operating activities ( 136,796) 93,846 ( 81,248)
----------- ------------ ------------
INVESTING ACTIVITIES
Purchases of property and equipment ( 34,824) ( 75,706) ( 278,594)
Proceeds from investments - - 361,400
Collections on notes receivable 43,045 41,704 45,963
Issuance of notes receivable - ( 45,363) -
Other 42,392 - -
----------- ------------ ------------
Net cash provided (used) by investing activities 50,613 ( 79,365) 128,769
----------- ------------ ------------
FINANCING ACTIVITIES
Checks issued in excess of deposits 99,115 3,640 89,633
Net borrowings (payments) under credit agreements ( 299,839) 78,329 88,031
Proceeds from notes payable 578,455 - -
Principal payments on notes and installment
obligations ( 278,467) ( 121,450) ( 222,098)
Stock issuance costs ( 13,081) - -
Proceeds from issuance (repurchase) of common stock - 25,000 ( 3,087)
----------- ------------ ------------
Net cash provided (used) by financing activities 86,183 ( 14,481) ( 47,521)
----------- ------------ ------------
CHANGE IN CASH - - -
CASH
Beginning of year - - -
----------- ------------ ------------
End of year $ - $ - $ -
----------- ------------ ------------
----------- ------------ ------------
</TABLE>
See notes to consolidated financial statements.
20
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies -
ORGANIZATION
Vicom, Incorporated (Vicom) provides products and services to integrate
voice, video and data networking technologies. Operations consist
primarily of selling and servicing telecommunication and networking
equipment. The Company sells its products and services primarily to
customers in the Midwest region of the United States. The Company
operates as one reportable segment.
PRINCIPLES OF CONSOLIDATION
The consolidated financial statements include the accounts of Vicom,
Incorporated and its wholly-owned subsidiary Vicom Midwest
Telecommunication Systems, Inc. (collectively referred to as the
Company). All significant intercompany accounts and transactions are
eliminated.
USE OF ESTIMATES
The preparation of these financial statements in conformity with
generally accepted accounting principles requires management to make
estimates and assumptions that may affect the reported amounts and
disclosures in the financial statements and accompanying notes. Actual
results could differ from these estimates. Significant management
estimates relate to the allowances for doubtful accounts, inventory
obsolescence and valuation of deferred income tax assets.
INVENTORIES
Inventories, consisting principally of purchased telecommunication
equipment and parts, are stated at the lower of cost or market, with cost
determined using an average cost method. Nonmonetary exchanges of
inventory items with third parties are recorded at net book value of the
items exchanged with no gains or losses recognized.
PROPERTY AND EQUIPMENT
Equipment and leasehold improvements are stated at cost. Equipment is
depreciated principally by the straight-line method over three to eight
years, the estimated useful lives of the related assets. Leasehold
improvements are depreciated over the shorter of the life of the
improvement or the term of the respective lease.
GOODWILL
Goodwill represents the excess of acquisition price over the fair value
of net assets acquired and is amortized straight-line over ten years. The
Company evaluates goodwill annually for impairment by comparing the net
carrying value to undiscounted future cash flows of the related assets.
(continued)
21
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies -
(continued)
REVENUE AND COST RECOGNITION
The Company recognizes revenues from product sales at the time equipment
is shipped to customers. Revenue from equipment maintenance contracts is
deferred and recognized on a straight-line basis over the term of each
contract. The costs of service under the contracts are charged to expense
as incurred.
For any significant long-term contracts, revenue is recognized under the
percentage of completion method. The amount of revenue recognized is the
portion that the cost expended to date bears to the anticipated final
total contract cost, based on current estimates of cost to complete.
Contract cost includes all labor and materials unique to or installed in
the project, as well as subcontract costs. Revenue earned on contracts in
progress in excess of billings is classified as unbilled revenues.
Warranty costs incurred on new equipment sales are substantially
reimbursed by the equipment suppliers.
FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts of financial instruments consisting of accounts
receivables, notes receivable, checks issued in excess of deposits, notes
and installment obligations payable to nonrelated parties, and accounts
payable approximate their fair values. It is not practical to determine
the fair value of the related party notes payable due to the related
party nature of the transactions.
CREDIT RISK
Financial instruments that potentially subject the Company to credit risk
consist primarily of cash and trade accounts and notes receivables. The
Company restricts cash and investments to financial institutions with
high credit standing. Credit risk on trade receivables is minimized as a
result of the large and diverse nature of the Company's customer base.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for employee stock options under Accounting
Principles Board Opinion (APB) No. 25, ACCOUNTING FOR STOCK ISSUED TO
EMPLOYEES, and provides the pro forma disclosures required by Statement
of Financial Accounting Standards (SFAS) No. 123, ACCOUNTING FOR
STOCK-BASED COMPENSATION. Options and warrants to nonemployees are
recorded as required by SFAS No. 123.
22
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Summary of Significant Accounting Policies -
(continued)
NET INCOME (LOSS) PER COMMON SHARE
Net income (loss) per common share - basic is determined by dividing net
income (loss) less preferred stock dividends by the weighted average
common shares outstanding. Net income (loss) per common share - diluted
is computed by dividing net income (loss) less preferred stock dividends
by the weighted average common shares outstanding and common share
equivalents (stock options, stock warrants and convertible preferred
shares). Common share equivalents are not included in the computations as
their effects were either antidilutive.
ADVERTISING EXPENSES
The Company expenses advertising costs as incurred. Sales brochures and
materials are recorded as prepaid expenses until they are consumed or
determined to be obsolete. Advertising expenses were approximately
$108,000, $22,000, and $304,000 for 1998, 1997, and 1996, respectively.
RECLASSIFICATIONS
Certain reclassifications were made to the 1997 and 1996 financial
statements to present them on a basis comparable with 1998. The
reclassifications had no effect on previously reported net income (loss),
shareholders' equity or net cash flows.
RECENT ACCOUNTING PRONOUNCEMENT
In June 1998, the Financial Accounting Standard Board issued Statement on
Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities," effective for years beginning after
June 15, 1999. The statement establishes accounting and reporting
standards for derivative instruments and hedging activities. Management
believes this pronouncement will not significantly effect its financial
statements.
2. Business Acquisition -
Effective December 31, 1998, Vicom purchased the assets of the Midwest
region of Enstar Networking Corporation (ENC) from its parent company
ENStar Inc. (ENStar). The purchase price was allocated to assets and
liabilities acquired as follows:
<TABLE>
<S> <C>
Accounts receivable:
Billed $ 1,233,590
Unbilled 239,131
Inventories 164,932
Property and equipment 103,032
Deferred service revenue ( 179,289)
Billings in excess of cost ( 74,997)
-----------
Total net tangible assets acquired 1,486,399
Goodwill 549,101
-----------
Total purchase price $ 2,035,500
-----------
-----------
</TABLE>
23
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
2. Business Acquisition - (continued)
The consideration consisted of 1,350,000 of Vicom's common shares with an
assigned value of $797,312, a $750,000 subordinated promissory note at
9%, a payable of $340,188 for purchase price adjustments, and acquisition
related costs of $148,000.
The following unaudited pro forma financial information assumes the
acquisition of ENC occurred on January 1, 1998. This information is based
on the historical operations of ENC and does not necessarily reflect
actual operations, nor is it indicative of future operations. Historical
operations of ENC for 1997 and 1996 are not available.
<TABLE>
<CAPTION>
UNAUDITED
----------------
<S> <C>
Sales $ 16,930,000
Loss from operations ( 1,036,000)
Net loss ( 1,340,000)
Net loss per common share -
basic and diluted ($ .39)
Weighted average common shares
outstanding 3,479,387
</TABLE>
3. Property and Equipment -
Property and equipment are as follows:
<TABLE>
<CAPTION>
1998 1997
------------ -------------
<S> <C> <C>
Cost:
Leasehold improvements $ 72,950 $ 69,829
Equipment - owned 1,199,781 1,083,545
Equipment under capital leases 337,947 337,947
----------- ------------
1,610,678 1,491,321
----------- ------------
Less accumulated depreciation and amortization:
Leasehold improvements 36,305 24,252
Equipment - owned 708,908 570,735
Equipment under capital leases 218,109 157,903
----------- ------------
963,322 752,890
----------- ------------
$ 647,356 $ 738,431
----------- ------------
----------- ------------
</TABLE>
Amortization expense on equipment under capital leases is included in
depreciation expense.
24
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
4. Other Assets -
Other assets are as follows:
<TABLE>
<CAPTION>
1998 1997
---------- -----------
<S> <C> <C>
Current assets:
Notes receivable - current maturities $ 34,823 $ 64,192
Prepaid expenses and other 69,617 84,101
--------- ----------
$ 104,440 $ 148,293
--------- ----------
--------- ----------
Noncurrent assets:
Notes receivable, less current maturities $ 94,865 $ 216,515
Prepaid expenses and other 18,904 17,514
--------- ----------
$ 113,769 $ 234,029
--------- ----------
--------- ----------
</TABLE>
5. Accrued Liabilities -
Accrued liabilities are as follows:
<TABLE>
<S> <C> <C>
Acquisition costs $ 148,000 $ -
Payroll related 115,333 24,232
Billings in excess of cost 74,997 -
Other 108,722 88,626
----------- ------------
$ 447,052 $ 112,858
----------- ------------
----------- ------------
</TABLE>
6. Notes and Installment Obligations Payable -
Notes and installment obligations payable are as follows:
<TABLE>
<CAPTION>
1998 1997
------------ -------------
<S> <C> <C>
Notes payable to bank, interest at prime rate plus 2.5%,
due May 1999. $ 100,000 $ 403,306
Note payable to bank, interest at prime rate plus 2.5%,
due May 2003. 454,034 -
Capital lease obligations, monthly installments including
interest at 4.8% to 27.2% through 2002. 174,119 307,868
Notes payable to related parties, interest at 9.0% to
15.0%, due through December 1999, unsecured. 228,311 440,400
Notes payable to individuals, interest at 10.0% to 12.0%,
due through December 1999, unsecured. 98,033 278,274
Subordinated note payable to ENStar, interest at 9.0%,
due December 2003, unsecured. 750,000 -
----------- ------------
1,804,497 1,429,848
Less current maturities 978,007 755,412
----------- ------------
$ 826,490 $ 674,436
----------- ------------
----------- ------------
</TABLE>
25
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
6. Notes and Installment Obligations Payable - (continued)
Future maturities are as follows:
<TABLE>
<CAPTION>
YEAR AMOUNT
---- ------------
<S> <C>
1999 $ 978,007
2000 38,906
2001 20,629
2002 16,061
2003 750,894
-----------
$ 1,804,497
-----------
-----------
</TABLE>
The prime rate at December 31, 1998 and 1997 was 7.75% and 8.50%,
respectively.
In May 1998, the Company amended its bank loan agreement to provide a
$500,000 term note at prime rate plus 2.50%, payable in monthly principal
and interest installments of $10,846 with the balance due May 1, 2003,
and $100,000 line of credit at prime plus 2.50%, due April 30, 1999
(subsequently extended to May 31, 1999). These borrowings are
collateralized by substantially all Company assets and two
stockholder/officer guarantees and contain financial covenants. At
December 31, 1998, the Company was not in compliance with certain
financial covenants, and, accordingly, the term note is classified with
current maturities. The Company believes it is able to obtain new credit
agreements at substantially the same terms and conditions.
The ENStar note requires payment of the outstanding amount in the event
of certain equity offerings or transactions.
Interest expense for 1998, 1997 and 1996 was $180,434, $189,869 and
$150,031, respectively (approximately $47,000, $38,000 and $50,000 to
related parties, respectively).
7. Stockholders' Equity -
PREFERRED STOCK
Dividends on Class A Preferred are payable quarterly at 8% per annum.
Dividends on Class B Preferred are payable monthly at 10% per annum. The
Class B Preferred was offered to certain notes payable holders at a
conversion of $10.00 per Class B share. Each share of Class A Preferred
and Class B Preferred is nonvoting and convertible into five shares of
common stock. Issuance of a share of preferred stock gives the holder a
five year warrant to purchase one share of common stock at $3.00 per
share, subject to adjustment.
(continued)
26
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Stockholders' Equity - (continued)
STOCK OPTIONS
In 1997, the Company adopted the 1997 Stock Option Plan which permits the
issuance of incentive stock options to key employees and agents. The Plan
reserves 700,000 shares of common stock for issuance and provides that
the term and vesting of each grant be determined by the Board of
Directors. Under the Plan, the exercise price of the stock options may
not be less than the fair market value of the stock on the grant date,
and the options are exercisable for a period not to exceed ten years from
grant date. The Plan limits the annual aggregate fair market value of
stock granted under the Plan to $600,000, plus unused carryovers.
A previous stock option plan was allowed to expire, and no options were
granted or exercised under that plan after December 31, 1993.
Stock option activity was as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
----------------
EXERCISE FAIR
OPTIONS PRICE VALUE
------------ ------------ ---------
<S> <C> <C> <C>
OUTSTANDING, December 31, 1996 - $ - $ -
Granted 278,000 .88 .20
Terminated ( 33,500) .94 .24
----------
OUTSTANDING, December 31, 1997 244,500 .88 .19
Granted 450,000 .55 .13
Terminated ( 4,000) 1.03 .18
----------
OUTSTANDING, December 31, 1998 690,500 .66 .15
----------
----------
</TABLE>
At December 31, 1998, the outstanding options had a weighted average
contractual life of 4.10 years. The range of exercise prices was $.50 to
$1.03. Options totaling 240,500 were exercisable at a weighted average
exercise price of $.88.
If the Company recognized stock option compensation expense based on
grant date fair value consistent with the method prescribed by SFAS No.
123, net income (loss) for 1998 and 1997 would be approximately
($1,469,000) ($.69 per share) and $21,000 ($.01 per share), respectively.
The fair value of stock options is the estimated present value at grant
date using the Black-Scholes Option-Pricing Model with the following
weighted average assumptions:
<TABLE>
<CAPTION>
1998 1997
-------- --------
<S> <C> <C>
Risk-free interest rate 5.41% 6.08%
Expected life 5 years 5 years
Expected volatility 0%* 0%*
Expected dividend rate 0% 0%
</TABLE>
(continued)
27
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
7. Stockholders' Equity - (continued)
STOCK WARRANTS
Stock warrant activity was as follows:
<TABLE>
<CAPTION>
WEIGHTED AVERAGE
----------------
EXERCISE FAIR
WARRANTS PRICE VALUE
---------- ------------ ---------
<S> <C> <C> <C>
OUTSTANDING, December 31, 1996 99,999 $ 2.00 $ -
Granted 135,000 .75 .21
----------
OUTSTANDING, December 31, 1997 234,999 1.28 .12
Granted 35,051 3.00 -
----------
OUTSTANDING, December 31, 1998 270,050 1.50 .11
----------
----------
</TABLE>
The warrants granted in 1998 were issued in connection with the preferred
stock. The warrants granted in 1997 were issued in connection with a note
payable.
All warrants outstanding at December 31, 1998 are exercisable and have a
weighted average contractual life of approximately 3.5 years.
The warrants issued to nonemployees were nominal in amount and,
therefore, the effects were not recorded in the financial statements.
The fair value of stock warrants is the estimated present value at grant
date using the Black-Scholes Option-Pricing Model with the following
weighted average assumptions:
<TABLE>
<CAPTION>
1998 1997
---------- ---------
<S> <C> <C>
Risk free interest rate 4.34% 6.50%
Expected life 5 years 5 years
Expected volatility 0%* 0%*
Expected dividend rate 0% 0%
</TABLE>
* Since the stock is minimally traded, expected volatility was set at 0%,
resulting in minimum value.
28
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Income Taxes -
The income tax provision is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- ----------
<S> <C> <C> <C>
Current $ - $ - $ -
Deferred 50,000 28,000 -
--------- --------- ---------
$ 50,000 $ 28,000 $ -
--------- --------- ---------
--------- --------- ---------
</TABLE>
Components of net deferred income tax assets are as follows:
<TABLE>
<CAPTION>
1998 1997
------------ -------------
<S> <C> <C>
Deferred income tax assets:
Net operating loss carryforwards $ 3,102,000 $ 2,966,000
Tax credits carryforwards 190,000 226,000
Nondeductible allowances 567,200 233,000
----------- ------------
3,859,200 3,425,000
Less valuation allowance 3,542,500 3,072,800
----------- ------------
316,700 352,200
Deferred income tax liabilities:
Equipment depreciation 67,500 53,000
----------- ------------
Net deferred income tax assets $ 249,200 $ 299,200
----------- ------------
----------- ------------
</TABLE>
Income tax computed at the U.S. federal statutory rate reconciled to the
effective tax rate is as follows:
<TABLE>
<CAPTION>
1998 1997 1996
------------- ------------- -------------
<S> <C> <C> <C>
Statutory rate (benefit) ( 34.0%) 34.0% ( 34.0%)
Change in valuation allowance 11.1 ( .7) -
Net operating loss not recognized 24.9 - 34.0
Other 1.6 - -
----------- ------------- ------------
Effective rate 3.6% 33.3% -%
----------- ------------- ------------
----------- ------------- ------------
</TABLE>
In 1998 the valuation allowance increased by $469,700 primarily from the
Company's inability to utilize its net operating loss carryforwards. The
valuation allowance decreased by $266,000 in 1997 primarily because of
lapsed net operating loss carryforwards.
(continued)
29
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
8. Income Taxes - (continued)
Tax credits are accounted for on the flow-through method, which
recognizes the benefit in the year of utilization. The Company has the
following net operating loss and tax credit carryforwards at December 31,
1998, for federal income tax purposes:
<TABLE>
<CAPTION>
NET
YEAR OF OPERATING
EXPIRATION LOSS TAX CREDITS
---------- ------------- -----------
<S> <C> <C>
1999 $ 48,000 $ 88,000
2000 871,000 102,000
2001 307,000 -
2002 3,152,000 -
2004 1,050,000 -
2005 599,000 -
2007 501,000 -
2008 59,000 -
2009 22,000 -
2011 595,000 -
2012 25,000 -
2013 526,000 -
------------ ----------
$ 7,755,000 $ 190,000
------------ ----------
------------ ----------
</TABLE>
State and foreign income tax effects are not material and therefore not
separately shown.
9. Employee Benefit Plan -
The Company has a 401(k) profit sharing plan covering employees over age
21 who work at least 1,000 hours in a year. Employee contributions are
limited to the maximum amount allowable by the Internal Revenue Code.
Company contributions, which are discretionary, were $-0- in 1998 and
1997, and $2,669 in 1996.
10. Related Party Commitments -
Facilities are leased under a related party operating lease, expiring in
2006. In addition to basic monthly rent of the higher of $9,000 or 1.5%
of revenues, the Company must pay building maintenance costs and real
estate taxes. The Company also has the option to renew the lease for two
additional five year periods. Total facilities rent expense for 1998,
1997 and 1996 was approximately $181,000, $151,000 and $206,000,
respectively. Basic rent charged by the related party in 1998, 1997 and
1996 was $117,000, $99,000 and $36,000, respectively.
(continued)
30
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
10. Related Party Commitments - (continued)
In addition, the Company leases vans under operating leases from an
entity owned by a relative of a stockholder/officer. During 1998, 1997
and 1996 the Company was charged rent of approximately $21,000, $14,000
and $26,000, respectively, by this related entity.
Future minimum rent commitments are as follows:
<TABLE>
<CAPTION>
YEAR AMOUNT
------------ ----------
<S> <C>
1999 $ 108,000
2000 108,000
2001 108,000
2002 108,000
2003 108,000
Thereafter 288,000
----------
$ 828,000
----------
----------
</TABLE>
11. Supplementation Disclosures of Cash Flow Information -
<TABLE>
<CAPTION>
1998 1997 1996
------------ ----------- -----------
<S> <C> <C> <C>
Cash paid for:
Interest $ 180,434 $ 194,262 $ 145,638
Income taxes 3,000 3,000 5,516
Noncash investing and financing transactions:
Notes payable converted to stock 375,500 - -
Acquisition of ENC 2,035,500 - -
Capitalized lease equipment purchases - 23,121 347,589
</TABLE>
12. Significant Customers and Suppliers -
During 1998, one customer represented approximately 15% of consolidated
revenues.
During 1998, 1997 and 1996, the Company purchased materials from three
major suppliers as follows:
<TABLE>
<CAPTION>
SUPPLIER
-----------------------------------
A B C
---- ------ ----
<S> <C> <C> <C>
1998 60 % 19 % 15 %
1997 42 5 7
1996 35 16 13
</TABLE>
31
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
13. Financial Statement Adjustments -
During 1998, the Company recorded approximately $1,000,000 of noncash
adjustments in connection with the writedown of the carrying amounts of
certain assets as follows:
<TABLE>
<CAPTION>
EXPENSE INCLUDED WITHIN
--------------------------------------------
COST OF
PRODUCTS OPERATING
SOLD EXPENSES TOTAL
----------- ----------- ------------
<S> <C> <C> <C>
Inventory obsolescence $ 660,000 $ - $ 660,000
Accounts and notes receivable - 240,000 240,000
Prepaid expenses and other - 100,000 100,000
---------- ---------- -----------
$ 660,000 $ 340,000 $ 1,000,000
---------- ---------- -----------
---------- ---------- -----------
</TABLE>
During 1996, the Company recorded adjustments of $552,000 to increase the
allowances for doubtful accounts, inventory obsolescence and doubtful
utilization of prepaid expense by $84,000, $176,000 and $292,000,
respectively. Similar adjustments for 1997 are considered immaterial.
The effect of these adjustments in 1998 and 1996 was to increase the
net loss per common share by $.47 and $.27, respectively.
33
<PAGE>
INDEPENDENT AUDITOR'S REPORT - SUPPLEMENTARY INFORMATION
Board of Directors and Stockholders
Vicom, Incorporated and Subsidiary
New Hope, Minnesota
Our report on our audits of the basic consolidated financial statements of
VICOM, INCORPORATED AND SUBSIDIARY for 1998, 1997 and 1996 appears on page 16.
Those audits were made for the purpose of forming an opinion on the basic
consolidated financial statements taken as a whole. The supplementary
information on page 34 is presented for purposes of additional analysis and is
not a required part of the basic consolidated financial statements. Such
information has been subjected to the auditing procedures applied in the audits
of the basic consolidated financial statements and, in our opinion, is fairly
stated in all material respects in relation to the basic consolidated financial
statements taken as a whole.
LURIE, BESIKOF, LAPIDUS & CO., LLP
April 20, 1999
33
<PAGE>
VICOM, INCORPORATED AND SUBSIDIARY
VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
BALANCE AT CHARGED TO BALANCE
BEGINNING COSTS AND AT END
DESCRIPTION OF YEAR EXPENSES DEDUCTIONS OF YEAR
- --------------------------------------------- ------------ ------------ --------------- -----------
<S> <C> <C> <C> <C>
ALLOWANCE DEDUCTED FROM
ASSET TO WHICH IT APPLIES
Allowance for doubtful accounts accounts receivable:
1998 $ 40,000 $ 125,000 $ 50,000 (A) $ 115,000
1997 115,000 20,493 95,493 (A) 40,000
1996 40,000 84,000 9,000 (A) 115,000
Allowance for inventory obsolescence:
1998 250,000 660,000 - 910,000
1997 260,000 - 10,000 (B) 250,000
1996 84,000 176,000 - 260,000
Notes receivable:
1998 - 115,000 - 115,000
1997 - - - -
1996 - - - -
Allowance for doubtful utilization of prepaid advertising:
1998 292,000 100,000 392,000
1997 292,000 - - 292,000
1996 - 292,000 - 292,000
</TABLE>
(A) Write-off uncollectible trade receivables
(B) Write-off obsolete inventory
(C) Write-off prepaid advertising
(D) Reversal
See independent auditor's report - supplementary information and notes to
consolidated financial statements.
34
