<PAGE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
------------------------
FORM 10-KSB
<TABLE>
<CAPTION>
<C> <S>
(MARK ONE)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1998
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
</TABLE>
COMMISSION FILE NUMBER 0-20770
RESPONSE USA, INC.
(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
<S> <C>
DELAWARE 22-3088639
(State or other jurisdiction of incorporation (I.R.S. Employer Identification No.)
or organization)
11-H PRINCESS ROAD, LAWRENCEVILLE, NEW JERSEY 08648
(Address of principal executive offices) (Zip Code)
</TABLE>
Registrant's telephone number, including area code: (609) 896-4500
Securities registered pursuant to Section 12(b) of the Act:
<TABLE>
<CAPTION>
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
- -------------------------------------------------------- --------------------------------------------------------
<S> <C>
None Not Applicable
</TABLE>
Securities registered pursuant to Section 12(g) of the Act:
COMMON STOCK, $.008 PAR VALUE AND COMMON STOCK PURCHASE WARRANTS
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes /X/ No / /
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K (Section 229.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant's knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-KSB or any amendment to this Form 10-KSB. /X/
The issuer's gross revenues for the most recent fiscal year were
$16,520,128.
The aggregate market value of the Voting Stock held by non-affiliates (based
upon the closing bid price) on September 25, 1998, was approximately
$22,879,072.
As of September 25, 1998 there were 6,725,442 shares of Common Stock, par
value $.008 per share (the "Common Stock"), outstanding.
Certain exhibits listed in Item 13 of Part IV have been incorporated by
reference.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
RESPONSE USA, INC.
1998 FORM 10-KSB ANNUAL REPORT
TABLE OF CONTENTS
<TABLE>
<S> <C> <C>
Item 1. Business...................................................................... 3
Item 2. Properties.................................................................... 25
Item 3. Legal Proceedings............................................................. 25
Item 4. Submission of Matters to a Vote of Security Holders........................... 26
Item 5. Market for the Registrant's Common Stock and Related Security Holder
Matters..................................................................... 27
Item 6. Management's Discussion and Analysis of Financial Condition and Results of
Operations.................................................................. 27
Item 7. Financial Statements.......................................................... 34
Item 8. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.................................................................. 34
Item 9. Directors and Executive Officers of the Registrant............................ 35
Item 10. Executive Compensation........................................................ 36
Item 11. Security Ownership of Certain Beneficial Owners and Management................ 40
Item 12. Certain Relationships and Related Transactions................................ 41
Item 13. Exhibits and Reports on Form 8-K.............................................. 43
</TABLE>
<PAGE>
PART I
ITEM 1. BUSINESS
GENERAL
As used herein, the term "Company" means, unless the context requires
otherwise, the Company and the following wholly-owned subsidiaries: United
Security Systems, Inc. ("USS"), Emergency Response Systems, Inc. ("ERS"),
Response Ability Systems, Inc. ("Systems"), The Jupiter Group, Inc. d/b/a Triple
A Patrol ("Triple A Patrol"), Organization for Enhanced Capability, Inc.
("OEC"), and Response Acquisition Corp. ("RAC"); and HealthLink, Ltd.
("HealthLink"), an entity in which the Company has a 50% equity interest.
THIS ANNUAL REPORT CONTAINS STATEMENTS WHICH CONSTITUTE FORWARD-LOOKING
STATEMENTS WITHIN THE MEANING OF THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995. THESE STATEMENTS APPEAR IN A NUMBER OF PLACES IN THIS ANNUAL REPORT AND
INCLUDE STATEMENTS REGARDING THE INTENT, BELIEF OR CURRENT EXPECTATIONS OF THE
COMPANY, WITH RESPECT TO (I) THE COMPANY'S ACQUISITION AND FINANCING PLANS, (II)
TRENDS AFFECTING THE COMPANY'S FINANCIAL CONDITION OR RESULTS OF OPERATIONS,
(III) THE IMPACT OF COMPETITION AND (IV) THE EXPANSION OF CERTAIN OPERATIONS.
ANY SUCH FORWARD-LOOKING STATEMENTS ARE NOT GUARANTEES OF FUTURE PERFORMANCE AND
INVOLVE RISKS AND UNCERTAINTIES, AND ACTUAL RESULTS MAY DIFFER MATERIALLY FROM
THOSE IN THE FORWARD-LOOKING STATEMENTS AS A RESULT OF VARIOUS FACTORS. SEE
"BUSINESS--RISK FACTORS--CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING
STATEMENTS."
The Company is a fully-integrated security systems provider engaged in the
monitoring, sale, installation and maintenance of residential and commercial
security systems and personal emergency response systems ("PERS"). The Company
is a regional provider of security alarm monitoring services for residential and
small business subscribers operating in the states of New York, New Jersey,
Pennsylvania, Delaware, Maryland and Connecticut. The Company provides security
patrol services in northeastern Pennsylvania as a supplement to its alarm
monitoring services. The Company is also a nationwide provider of PERS products
which enable individual users, such as elderly or disabled persons, to transmit
a distress signal using a portable transmitter. The Company currently has an
aggregate of approximately 64,000 alarm and PERS subscribers for which it
provides monitoring services. As a result of the Company's acquisitions of
subscriber account portfolios, the Company's monthly recurring revenue ("MRR")
has grown by approximately $450,000, to approximately $1,250,000 for the month
ended June 30, 1998 from approximately $800,000 for the month ended June 30,
1997. According to a May 1998 report published by Security Distributing and
Marketing ("SDM"), an organization which publishes industry reports, as of
December 31, 1997, the Company is the 18th largest electronic security company
in the United States, based on gross revenues, and the 16th largest electronic
security company, based on recurring annual revenues.
The Company's electronic security systems business utilizes electronic
systems installed in businesses and residences to provide (i) detection of
events such as intrusion or fire, (ii) surveillance and (iii) control of access
to property. The detection devices are currently monitored either by a
third-party monitoring station located in Euclid, Ohio (the "Euclid Monitoring
Station") or the Company's Underwriters Laboratory and Factory Mutual approved
monitoring station located in Wilkes Barre, Pennsylvania (the "Triple A
Monitoring Station," and together with the Euclid Monitoring Station, the
"Monitoring Station"). The Monitoring Station personnel verify the nature of the
emergency and contact the appropriate emergency authorities in the user's area.
In some instances, commercial customers may monitor these devices at their own
premises or the devices may be connected to local fire or police departments.
The products and services marketed in the electronic security services industry
range from residential systems
3
<PAGE>
that provide basic entry and fire protection to more sophisticated commercial
systems. During the current fiscal year, the Company anticipates transferring
all of its subscriber accounts from the Euclid Monitoring Station to the Triple
A Monitoring Station.
The Company's PERS is an electronic device which is designed to monitor,
identify and electronically report emergencies requiring medical, fire or police
assistance, to help elderly, disabled and other individuals. When activated by
the pressing of a button, or automatically, in the case of certain environmental
temperature fluctuations, the transmitter sends a radio signal to a receiving
base installed in the user's home. The receiving base relays the signal over
telephone lines to the Monitoring Station which provides continuous monitoring
services. In addition, this signal establishes two-way voice communication
between the user and the Monitoring Station personnel directly through the PERS
unit, thereby avoiding any need for the user to access a telephone.
The electronic security services industry is highly fragmented and the
Company's strategy is to grow primarily by acquisition, generate internal
growth, and grow by offering new products and services. According to an industry
report published in 1998, there are approximately 16,000 separate security
services companies nationally and, according to the May 1998 SDM report, the
electronic security services industry generates an aggregate of approximately
$14 billion in revenues annually. The Company believes that there is an
industry-wide trend towards consolidation due, in part, to the relatively high
fixed costs of maintaining a centralized monitoring station and the relatively
low incremental cost of servicing additional subscribers. The Company completed
the acquisition of an aggregate of 17 subscriber account portfolios (a total of
approximately 19,000 subscriber accounts) during the fiscal year ended June 30,
1998.
In February 1998, the Company acquired substantially all of the assets of
Triple A Security Systems, Inc. ("Triple A") including the Triple A Monitoring
Station. Triple A was engaged in the monitoring, sale and installation of
residential and commercial security systems, principally in northeastern
Pennsylvania. At the time of the acquisition by the Company, Triple A serviced
approximately 14,000 subscriber accounts which were monitored by the Triple A
Monitoring Station.
In November 1996, the Company entered into a two-year agreement granting it
the exclusive worldwide distribution rights within the health care industry to
WanderWatch,-TM- a monitoring system designed to assist in the care of patients
with Alzheimer's disease, autism, head injury, dementia or other diseases or
injuries which may involve memory loss. WanderWatch-TM- is similar to PERS,
except that the transmitter is designed to be continuously activated and
transmits a signal to the base unit. If the base unit does not receive the
requisite number of transmissions, it indicates that the patient may have
wandered outside the "safety range," and triggers an alarm in the home base
unit. If the alarm is not disabled, a signal is automatically transmitted to the
Monitoring Station, whose personnel will then place calls based upon a set
protocol established by the caregivers. The license agreement for
WanderWatch-TM- provides for automatic one-year renewals and the Company's
exclusive rights to the license are subject to forfeiture under certain
circumstances. WanderWatch-TM- is currently being test-marketed by the Company
and the Company does not anticipate commencing distribution of the product prior
to the fourth quarter of its current fiscal year.
The Company's revenues consist primarily of recurring payments under written
contracts for the monitoring and servicing of security systems and PERS
products. The Company currently monitors approximately 64,000 subscribers. For
the fiscal year ended June 30, 1998, monitoring and service revenues represented
74.8% of total revenues. MRR is a term commonly used in the alarm industry and
means monthly recurring revenue that the Company is entitled to receive under
contracts in effect at the end of the period. MRR is utilized by the alarm
industry to measure the size of a company, but not as a measure of profitability
or performance, and does not include any allowance for future attrition or
allowance for doubtful accounts. During the fiscal year ended June 30, 1998, the
Company's MRR grew by approximately $450,000, to approximately $1,250,000 from
approximately $800,000 for the fiscal year ended
4
<PAGE>
June 30, 1997. Total revenues have increased during such period from $12,722,903
to $16,520,128, a 30% increase.
ELECTRONIC SECURITY INDUSTRY
The security services industry encompasses a wide range of products and
services, which can be broadly divided into electronic monitoring products and
services which the Company provides and highly labor intensive manned guarding
and patrol services, which the Company provides on a limited basis through its
subsidiary, Triple A Patrol. Electronic monitoring products and services consist
of the sale, installation, continuous monitoring and maintenance of electronic
security systems. This business utilizes modern electronic devices installed in
customers' businesses and residences to provide (i) detection of events such as
intrusion or fire, (ii) surveillance and (iii) control of access to properties.
Event detection devices are monitored by a monitoring center, which is linked to
the customer through telephone lines. This center is often located at remote
distances from the customer's premises. In some instances, the customer may
monitor these devices at its own premises or the devices may be connected to
local fire or police departments. The products and services marketed in the
electronic security services industry range from residential systems that
provide basic entry and fire protection to sophisticated commercial systems
incorporating closed-circuit television systems and access control.
The Company believes that the electronic security services industry is
characterized by the following attributes:
- HIGH DEGREE OF FRAGMENTATION. The electronic security services industry
is comprised of a large number of local and regional companies and several
integrated national companies. The Company believes that, based on
industry studies, there are approximately 16,000 separate security
services companies nationally generating an aggregate of approximately $14
billion in revenues annually. A survey published by SDM magazine in May
1998 reported that, in 1997, based upon information provided by the
respondents, the 100 largest companies in the industry accounted for
approximately 24% of total industry revenues.
- TREND TOWARD CONSOLIDATION. The Company believes that because the central
station monitoring sector of the electronic industry has relatively high
fixed costs but relatively low incremental costs associated with servicing
additional subscribers, the industry offers significant opportunities for
consolidation. In addition, the Company believes that the fragmented
nature of the industry can be attributed to the low capital requirements
associated with performing basic installation and maintenance of
electronic security systems. However, the business of a full service,
integrated electronic security services company which provides central
station monitoring services is capital intensive, and the Company believes
that the high fixed costs of establishing both central monitoring stations
and full service operations contribute to the small number of national
competitors.
- CONTINUED PRODUCT DIVERSIFICATION AND INTEGRATION OF SERVICES. A recent
trend in the commercial electronic security services industry has been
increased integration of different types of products into single systems
provided by single vendors. The Company believes that this trend has
resulted from commercial needs for enhanced security services on a more
cost-effective basis. Whereas basic alarm systems were once adequate for
many businesses, it appears that many companies now require access control
and closed circuit television systems integrated into a single system to
provide for their overall security needs. A security system which provides
burglar and fire alarm monitoring along with closed circuit television and
access control, all integrated into one central system, not only provides
enhanced security services, but also is more cost-effective than four
separate systems installed by four separate vendors. The Company is
positioning itself to take advantage of this trend by expanding the
breadth of its electronic security service offerings.
- ADVANCES IN DIGITAL COMMUNICATIONS TECHNOLOGY. Prior to the development
of digital communications technology, alarm monitoring required a
dedicated telephone line, which made long-distance
5
<PAGE>
monitoring uneconomic. Consequently, in order to achieve a national or
regional presence, alarm monitoring companies were required to maintain a
large number of geographically dispersed monitoring stations. The
development of digital communications technology eliminated the need for
dedicated telephone lines, reducing the cost of monitoring services to the
subscriber and permitting the monitoring of subscriber accounts over a
wide geographic area from a central monitoring station. The elimination of
local monitoring stations has decreased the cost of providing alarm
monitoring services and has substantially increased the economies of scale
for larger alarm service companies. In addition, the concurrent
development of microprocessor-based control panels has substantially
reduced the cost of the equipment available to subscribers in the
residential and commercial markets and has substantially reduced service
costs because many diagnostic and maintenance functions can be performed
from a company's office without having to send a technician to the
customer's premises.
The Company believes that several factors contribute to a favorable market
for electronic security services generally in the United States:
- HIGH LEVEL OF CONCERN ABOUT CRIME. As the perception of violent crime and
the reporting of crime by the news media has increased, the belief by
Americans that crime is a significant problem has also grown.
Concurrently, demand for security systems has grown with greater awareness
of risk management within the business community. In addition to the
protection that electronic detection and surveillance systems provide, the
Company believes that such systems also have a deterrent effect against
crime.
- INSURANCE REQUIREMENTS AND PREMIUM DISCOUNTS. The increase in demand for
security systems may also be attributable, in part, to the requirement of
insurance companies that businesses install an electronic security system
as a condition of insurance coverage. The purchase of an electronic alarm
system often entitles the subscriber to obtain premium discounts as well.
In addition, in order to comply with many municipal fire codes, the
installation of an electronic fire system is required in many localities.
ELECTRONIC SECURITY SERVICES
The Company's electronically-monitored security systems involve the use on a
customer's premises of devices designed to detect or react to various
occurrences or conditions, such as intrusions, movement, fire, smoke, flooding,
environmental conditions (including temperature or humidity variations) and
other hazards. In most systems these detection devices are connected to a
microprocessor-based control panel which communicates through telephone lines to
the Monitoring Station where alarm and supervisory signals are received and
recorded. Systems may also incorporate an emergency "panic button," which when
pushed causes the control panels to transmit an alarm signal that takes priority
over other alarm signals. In most systems, control panels can identify the
nature of the alarm and the areas within a building where the sensor was
activated and transmit the information to the Monitoring Station. Depending upon
the type of service for which the subscriber has contracted, Monitoring Station
personnel respond to alarms by relaying appropriate information to the local
fire or police departments, notifying the customer or taking other appropriate
action. The Company currently has approximately 42,000 alarm subscribers for
which it provides monitoring services. Of such alarm subscribers, approximately
70% are residential and 30% are commercial.
RESIDENTIAL SYSTEMS. Residential security services consists of the sale,
installation, monitoring and maintenance of electronically monitored security
systems to detect intrusion and fire. The Company believes that the demand for
residential systems results from a general awareness of crime and security
concerns. In addition, residential customers are usually able to obtain more
favorable insurance rates if an electronically monitored security system is
installed in their home. Approximately 70% of the Company's customers are
residential. On average, fees charged for residential monitoring services are
lower than the
6
<PAGE>
fees charged for commercial monitoring services. Contracts for residential
services are generally for an initial four-year term, automatically renewing on
a multi-year basis thereafter, unless canceled.
COMMERCIAL SYSTEMS. The Company also provides electronic security services
and products to commercial businesses and facilities. These systems and products
are tailored to customers' specific needs and include electronic monitoring
services that provide intrusion and fire detection, as well as card or keypad
activated access control systems and closed circuit television systems. The
Company also markets standard security packages for specific types of commercial
customers. Certain commercial customers require more complex electronic security
systems. To meet this demand, the Company also sells integrated electronic
security systems that combine a variety of electronic security services and
products. These systems are integrated by the Company to provide a single
computer-controlled security system.
INTERNAL SALES PROGRAM. The Company has recently commenced an Internal
Sales and Marketing Program (the "Program") designed to offer entry level and
custom residential and commercial security, fire and video surveillance systems
(the "Integrated Protection Systems"). The Company offers its systems throughout
the Mid-Atlantic region from its office locations in Pennsylvania, (Frazer,
Allentown, Wilkes Barre, Scranton, Stroudsburg, and Lake Wallenpaupack) and New
Jersey (Lawrenceville). The Integrated Protection Systems are either sold or
leased and are priced competitively within the industry. Typical competitive
practice requires offering installed Integrated Protection Systems at prices
below the actual cost to the Company. The installed Integrated Protection System
then provides protection through the monitoring of the Integrated Protection
System detection sensors by the Monitoring Station and dispatching of
authorities for a monthly recurring fee. The Program is designed to develop MRR
through five-year term contracts with like period automatic renewal provisions.
The Company intends to measure key areas of the Program's performance through
the development of various metrics, including Network Lead Flow, Closing Ratios,
Average Sale Price, Daily/Weekly/Monthly Comparison Ratios and Cost Factors.
PRODUCTS. The Company sells products offered by several different
manufacturers. Systems are generally purchased by the customers, although the
Company does lease a limited number of systems. When the system is sold, the
customer pays the Company the purchase price. When the system is leased, only an
installation fee is charged. Customers agree to pay monthly service charges for
monitoring and may also subscribe for maintenance services. Uniform package
prices are offered to residential customers who purchase standard security
systems, which includes a fixed number of detection devices. Frequently,
customers add detection devices at an additional charge to expand the coverage
of the system. Pricing depends upon the monitoring components installed, the
type of alarm transmission and other services required.
INSTALLATION, SERVICE AND MAINTENANCE
As part of its effort to provide high-quality service to its residential and
commercial customers, the Company maintains a trained installation, service and
maintenance staff. These employees are trained by the Company to install and
service the various types of commercial and residential security systems which
the Company sells. The Company does not manufacture any of the components used
in its electronic security service business.
Installations of new alarm systems are performed promptly after the
completion of the sale of the account. After completing an installation, the
technician instructs the subscriber on the use of the system and furnishes a
written manual and, in many instances, an instruction video. Additional
follow-up instruction is provided by sales consultants in the branch offices on
an as-needed basis.
The increasing density of the Company's subscriber base as a result of the
Company's continuing strategy to "infill" its existing branch service areas with
new subscribers permits more efficient scheduling and routing of field service
technicians and results in economies of scale at the branch level. The increased
7
<PAGE>
efficiency in scheduling and routing also allows the Company to provide faster
field service response and support, which leads to a higher level of subscriber
satisfaction.
The Company offers an extended one-year service protection plan which
provides that, for an additional fee, the Company will cover the normal costs of
repair and maintenance of its systems during normal business hours after the
expiration of the initial warranty period.
CONTRACTS
The Company's alarm monitoring subscriber contracts generally have initial
terms ranging from four to five years in duration, and provide for automatic
renewal for a fixed period, unless the Company or subscriber elects to cancel
the contract at the end of the applicable period. The Company maintains an
individual file with a signed copy of the contract for each of its subscribers
and a computerized data base.
Substantially all of the Company's alarm monitoring agreements for the
Company's residential subscribers (which constitute approximately 70% of the
Company's alarm subscriber customer base) provide for subscriber payments of
between $20 and $32 per month. The Company's commercial subscribers typically
pay between $25 to $50 per month.
In the normal course of its business, the Company experiences customer
cancellations of monitoring and related services as a result of subscribers
relocating, the cancellation of purchased accounts in the process of
assimilation into the Company's operations, unfavorable economic conditions,
dissatisfaction with field maintenance service and other reasons. This attrition
is offset to a certain extent by revenues from the sale of additional services
to existing subscribers, price increases, the reconnection of premises
previously occupied by subscribers, conversion of accounts previously monitored
by other alarm dealers and guarantees provided by sellers of such accounts
against account cancellations for a period following the acquisition. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations--Subscriber Attrition."
THE ACQUISITION PROGRAM
The Company grows primarily by acquiring subscriber accounts from smaller
alarm companies. The Company focuses on acquisitions that allow it to increase
its subscriber density in each area in which it operates. This leads to greater
field maintenance and repair efficiencies. The Company believes that it is an
effective competitor in the acquisition market because of the substantial
experience of its management team in completing acquisitions.
During the fiscal year ended June 30, 1997, the Company consummated 14
acquisitions, purchasing approximately 5,300 subscriber accounts for an
aggregate consideration of $3,424,712 in cash and 8,333 shares of Common Stock.
During the fiscal year ended June 30, 1998, the Company consummated 17
acquisitions, purchasing approximately 19,000 subscriber accounts for an
aggregate consideration of $12,668,244 in cash and notes and 481,451 shares of
Common Stock.
The Company anticipates continuing its acquisition program. The Company
typically acquires only the subscriber accounts, and not the facilities or
liabilities, of acquired companies. As a result, the Company is able to obtain
gross margins on the monitoring of acquired subscriber accounts that are similar
to those that the Company currently generates on the monitoring of its existing
subscriber base. In addition, the Company may increase the monitoring charges
paid by those subscribers if it is determined that those currently being paid do
not reflect the market area rates. The Company is unable to predict the timing,
size or frequency of any future acquisitions. See "Risk Factors-Risks Related to
Growth Through Acquisitions."
8
<PAGE>
Since the Company's primary consideration in making an acquisition is the
amount of MRR that will be derived from such new subscribers, the price paid by
the Company is customarily based upon such MRR. To protect the Company against
the loss of acquired accounts and to encourage the seller of such accounts to
facilitate the transfer of the subscribers, management typically requires the
seller to provide guarantees against account cancellation for a period following
the acquisition, typically 9-18 months. The Company usually holds back from the
seller 10%-20% of the acquisition price, and has the contractual right to
utilize such holdback to recapture a portion of the purchase price based on the
lost MRR arising from the cancellation of acquired accounts.
In evaluating the quality of the accounts acquired, the Company relies
primarily on management's knowledge of the industry, its due diligence
procedures, its experience integrating accounts into the Company's operations,
its assumptions as to attrition rates for the acquired accounts and the
representations and warranties of the sellers.
The Company employs a comprehensive acquisition program to identify,
evaluate, and assimilate acquisitions of new subscriber accounts that includes
three stages: (i) the identification and negotiation stage; (ii) the due
diligence stage; and (iii) the assimilation stage.
The Company actively seeks to identify prospective companies and dealers
through membership in trade associations, trade magazine advertising and
contacts through various vendors and other industry participants. The Company's
use of standard form agreements and experience in identifying and negotiating
previous acquisitions, helps to facilitate the successful negotiation and
execution of acquisitions in a timely manner.
The Company conducts an extensive pre-closing review and analysis of all
facets of the seller's operations. The process includes a combination of
selective field equipment installations, individual review of substantially all
of the subscriber contracts, an analysis of all the rights and obligations under
such contracts and other types of verification of the seller's operations.
The Company develops a specific assimilation process, in conjunction with
the seller, for each acquisition. Assimilation programs typically include a
letter, approved by the Company, from the seller to its subscribers, explaining
the sale and the transition, followed by one or more letters or packages that
include the Company's subscriber service brochures, field service and monitoring
service telephone number stickers, yard signs and window decals. Thereafter,
almost all new subscribers are contacted individually by telephone by a member
of the Company's customer service department for the purpose of soliciting
certain information and addressing the subscriber's questions or concerns.
PERSONAL PROTECTION MONITORING SERVICES
PERS INDUSTRY
The personal emergency response industry generally consists of companies
that provide technological support services to help elderly or medically-at-risk
individuals live independently, without the need of supervised care. In the
Company's view, the recent growth of the emergency response market is strongly
linked to the belief of medical professionals that such individuals should be
encouraged to live independently for as long as possible. The Company believes
that the demand for emergency response systems may increase as the number of
people over 65 years of age, and the number of such persons living alone,
increases. Currently, two groups of individuals are perceived to be the
principal users of PERS products. The first group consists of elderly people who
are capable of living independently and who are seeking ways to extend their
ability to maintain their independence. The second group consists of those who
experience short-term medical needs for whom the PERS is primarily used to
reduce the length of a hospital stay and to provide short-term assistance at
home during the recuperation period. Other potential users include "latch-key"
children and others for whom immediate, automatic access to emergency assistance
is desirable.
9
<PAGE>
PERS PRODUCTS AND MONITORING SERVICES
PRODUCTS. The Company's PERS is designed to monitor, identify and
electronically report emergencies requiring medical, fire and police assistance.
The PERS unit consists of two basic components: (i) a portable pendant
transmitter that is worn around the neck (the system also includes a portable,
hand-held transmitter that can be attached to the user's belt or mounted on a
wall); and (ii) a receiving base that is installed in the user's home and
connected to the user's telephone line. The Company's PERS also includes a smoke
detector (in certain states) that transmits a distress signal to the Monitoring
Station in the event of fire, and a medical/police hand-held transmitter that
transmits a medical or police distress signal to the Monitoring Station. Both
the pendant and medical/police hand-held transmitter send a medical distress
signal to the Monitoring Station; however, the hand-held transmitter also sends
a police distress signal on a separate channel when activated.
The Company's Electronic Testing Laboratory approved PERS has a variety of
safety features, including an environmental control which detects temperature
fluctuations, a cancel function to avoid false alarms, an alternative power
source, which allows the system to remain functional in the event of a
generalized power failure, and a special transmitter designed for use by
handicapped persons. In addition, once activated, the PERS "seizes" the user's
telephone line to which the receiving base is connected and dials the Monitoring
Station until a connection is established, regardless of whether the user's
telephone is in use or off the hook. Each PERS is tested before release for sale
and is re-tested immediately after installation in a user's home.
MONITORING SERVICES
Users of the Company's PERS products initiate a distress signal by pressing
a button on the portable transmitter included in the system. Once activated, the
transmitter sends radio signals to the receiving base (the transmitter has an
effective range of approximately 150 feet), which in turn translates the radio
signal and automatically dials the Monitoring Station using a toll-free
telephone number. Once telephone contact is made with the Monitoring Station, a
coded signal automatically initiates the electronic retrieval of personal data
relating to the user who initiated the distress signal. Such data includes the
user's name and address, directions to the user's home, allergies, medications,
best route of entry into the user's home during an emergency, and the doctor and
family members that should be contacted. In addition, this signal establishes
two-way voice communication between the user and Monitoring Station personnel
directly through the PERS unit, avoiding any need for the user to access a
telephone. Monitoring personnel verify the nature of the emergency by speaking
with the individual and, if necessary, notify the predetermined emergency
authorities in the user's area. If the monitoring personnel are unable to
establish voice communication with the user, emergency agencies are notified
immediately. As of June 30, 1998, the Company monitors approximately 22,000
subscribers in approximately 45 states for whom it provides monitoring services.
The Company's monitoring service is available only to users of the Company's
PERS; PERS products cannot be programmed to permit the customer to utilize a
competitor's monitoring service.
The Company provides all of its PERS users with a 24-hours-per-day, 365
days-per-year monitoring service. The monthly charge for monitoring services
paid by the subscriber is approximately $29. The Euclid Monitoring Station and
the Triple A Monitoring Station are accessible by PERS users nationwide through
toll-free emergency telephone lines. Both monitoring facilities contain
telecommunications and computer equipment with the capacity to monitor tens of
thousands of PERS users simultaneously, and to receive and act upon a user's
emergency signal. On average, the Company receives 1,000 calls per day from its
PERS users, of which approximately 60% are made by users for test purposes. The
Company maintains a duplicate set of all customer data at the Monitoring
Station.
10
<PAGE>
SALES AND MARKETING
HOME HEALTH CARE DIVISION. The Company's Home Health Care Division markets
the Company's PERS products primarily to hospitals and home health care
agencies. These entities typically agree to sign an exclusive five-year
agreement with the Company. The subscriber acquires the PERS system from the
provider, and the Company's obligations are limited to providing monitoring
services. As of June 30, 1998, the Company had under contract, approximately 360
providers of service located in 42 states. The Company supports its provider
network with a marketing plan designed to introduce the PERS concept to their
professional and family caregivers, along with ancillary materials to utilize at
the home of their patients. Additionally, the Company provides in-service
presentations to its provider network in order to facilitate subscriber
referrals to the individual provider.
GOVERNMENT PROGRAMS DIVISION. The Company's Government Programs Division
commenced operations in 1996. The division solicits the Company's PERS services
to various state and local governmental agencies. Additionally, it markets the
Company's services to local area agencies on aging, and other public and private
organizations designed to help senior citizens remain independent. The Company
is currently the exclusive provider of PERS services for the Los Angeles
Department of Aging, the Philadelphia Corporation for Aging, and Duchess County,
New York. Currently, approximately 45 states have instituted some type of
reimbursement for PERS services. The Company provides periodic in-service
presentations to social workers in the areas of geriatric care management in
order to solicit referrals for the Company's PERS services.
FRANCHISEES AND DISTRIBUTORSHIPS
The Company ceased offering new franchises for sale in 1987 and has no
current plans to resume selling franchises in the future. Existing franchisees,
however, are allowed to renew their franchise annually upon payment of a $350
renewal fee. As of August 31, 1998, approximately 50 franchisees had paid their
franchise renewal fee for the 1999 fiscal year.
Franchisees are independent contractors who purchase or lease their PERS
requirements from the Company in accordance with a schedule of prices
established by the Company, and resell PERS products in non-exclusive
territories. Franchisees also are required to contract with the Company to
provide monitoring services to the franchisee's customers. In addition, the
Company offers billing and collection services to franchisees. Franchisees are
required to pay a monthly fee to the Company for each customer monitored, the
amount of which is dependent upon the number of accounts serviced and the level
of other services (for instance, billing and collection) provided. The Company
also sells advertising and promotional materials, accessories and supplies to
its franchisees pursuant to a published price list.
PRIVATE LABEL PROGRAMS. The Company also supplies PERS products for vendors
under product names owned by the vendors. Currently, sales under these programs
are limited. Currently, all of the Company's private label vendors provide their
own monitoring services. The Company's gross profit margins on sales in its
private label programs are significantly lower than margins on its direct and
franchisee sales programs.
PRODUCTION. The principal materials utilized in the production of PERS
products consist of electronic components which are obtained from several
suppliers. The sub-contractor also purchases molded plastic, printed circuit
boards and miscellaneous hardware from several sources. The Company believes
that the required electronic components are not unique to a particular vendor
and that other sources could be obtained, although some delay in production
might result if it were necessary to find new sources for electronic components.
RECENT MATERIAL ACQUISITIONS
In February 1998, the Company acquired substantially all of the assets of
Triple A for aggregate consideration of $13,056,650, including $10,061,577 which
was paid in cash, $2,995,073 which was paid in Common Stock and $1,142,664 in
the assumption of liabilities of Triple A. At the time of the acquisition,
11
<PAGE>
Triple A was engaged in the installation, monitoring and servicing of
residential and commercial alarm systems, principally in northeastern
Pennsylvania and serviced approximately 14,000 subscriber accounts which were
monitored by Triple A's central monitoring station. As part of the acquisition,
the Company entered into an employment agreement with Robert L. May, who was, at
the time, President and sole stockholder of Triple A.
In connection with the Triple A acquisition, in February 1998, the Company
acquired all of the outstanding stock of Triple A Patrol, a patrol service
company, for aggregate consideration of $1,040,107 payable in Common Stock.
Triple A Patrol's services are principally supplied in areas in which Triple A
was a substantial provider of security systems services. The patrol service
supplements the Company's alarm monitoring service by providing routine patrol
of a subscriber's premises and neighborhood, response to alarm system
activations and "special watch" services, such as increased surveillance when
the customer is on vacation.
Triple A Patrol also offers "dedicated" patrol service to homeowners'
associations in selected markets, for which Triple A Patrol provides a marked
car for patrol exclusively in such association's neighborhood. The Company
believes that offering such services will enable it to increase sales of the
Company's alarm monitoring services within such neighborhoods.
WANDERWATCH-TM-
On November 22, 1996, the Company entered into a two-year agreement with
Sloan Electronics, Incorporated ("Sloan") granting the Company the exclusive
worldwide distribution rights within the health care industry to
WanderWatch-TM-, a wandering compliance monitoring system designed for use in
home health care and assisted living facility environments. The WanderWatch-TM-
system is designed to provide around-the-clock monitoring of patients that
suffer from Alzheimer's disease, autism, dementia, head injury or other diseases
or injuries which may involve memory loss. The WanderWatch-TM- system consists
of a wireless ankle transmitter that sends a radio frequency transmission to a
base unit, usually located centrally in a home. If the base unit does not
receive a requisite number of transmissions within a 120-second interval, it
indicates that the patient may have wandered outside of the "safety range" and
triggers a loud beeping alarm in the base unit. If the alarm is not disabled
within 60 seconds, a signal is automatically transmitted to the Monitoring
Station. The license agreement for WanderWatch-TM- has been automatically
extended until November 22, 1999 and provides for additional, automatic one-year
renewals, provided that neither party has notified the other that it has failed
to comply with the terms of the agreement within 60 days prior to the expiration
of any such renewal term. In addition, the Company's exclusive rights to the
license are subject to forfeiture in the event that the Company fails to achieve
certain targeted annual sales increases of WanderWatch-TM- and fails to use
reasonable efforts to fully and effectively promote the sale of WanderWatch-TM-.
In such event, the Company's license of WanderWatch-TM- would become
non-exclusive. The agreement also contains certain non-competition provisions
which restrict the right of both parties to produce products which could be
considered directly competitive with WanderWatch-TM-. The agreement provides for
an initial license fee of $35,000 payable by the Company, a per-unit purchase
price payable by the Company and a per-unit percentage of the monthly recurring
revenue received from WanderWatch-TM-, equal to the lesser of 20% or $7.50 from
revenues derived from end users of WanderWatch-TM-, subject to a certain maximum
fee for recurring revenues. The agreement provides that Sloan shall allocate
time and financial resources for research and development to improve
WanderWatch-TM-.
Approximately 2,800,000 patients are afflicted with Alzheimer's disease and
are being cared for in their homes. Alzheimer's disease is a progressive,
degenerative disease of the brain, and the most common form of dementia. There
are approximately four million people afflicted with Alzheimer's disease in the
United States. Approximately one in ten persons over the age of 65, and nearly
half of the people over the age of 85, have Alzheimer's disease. Over 70% of
Alzheimer's patients live at home. An Alzheimer's patient will live an average
of eight years and as many as 20 years or more from the onset of symptoms. The
WanderWatch-TM- system will be offered to the caregivers (I.E., family members
and professional
12
<PAGE>
caregivers) on a monthly rental basis. Additionally, WanderWatch-TM- will be
offered through the Company's existing distribution network of home health care
companies, hospitals, visiting nurse associations and various governmental
agencies. WanderWatch-TM- is currently being test-marketed by the Company, and
the Company does not anticipate commencing distribution of the product prior to
the fourth quarter of the Company's current fiscal year.
PENDING ACQUISITION
In September 1998, the Company entered into an agreement pursuant to which,
if consummated, the Company would acquire approximately 10,000 monitored
accounts generating MRR of approximately $250,000 as of May 31, 1998 for total
consideration of approximately $11,250,000 payable in both cash and Common
Stock. The Company to be acquired had unaudited gross revenues of approximately
$2,400,000 for its fiscal year ended May 31, 1998 and unaudited total assets of
approximately $2,363,000 at May 31, 1998. The Company is in the process of
conducting a due diligence review and the agreement is subject to a number of
conditions, including the satisfaction of conditions which are dependent upon
third parties, such as the receipt of funds from the Company's lender from
available borrowings under the Company's financing agreement, and there can be
no assurance that such acquisition will be consummated on such terms or at all.
MONITORING STATION
In April 1994, the Company entered into an agreement with Emergency Response
Center, Inc. ("ERC"), owner of the Euclid Monitoring Station, expiring in April
1999. The agreement automatically renews for successive one-year terms unless
either party gives the other written notice of termination not later than six
months prior to the end of the then current term of the agreement. The Company
intends to deliver notice to ERC which will terminate the agreement on or before
April 1999. Pursuant to the agreement, in consideration for providing monitoring
services and electronic data base storage for the Company, ERC receives
monitoring service fees based upon the number of subscribers it services and
certain other start-up and maintenance costs. Pursuant to the Triple A
acquisition, the Company acquired the Triple A Monitoring Station, which will
continue to provide monitoring services to Triple A customers, and which the
Company anticipates will provide monitoring services for all of the Company's
customers by the end of its current fiscal year.
GOVERNMENTAL REGULATION
The Company's operations are subject to a variety of federal, state, county
and municipal laws, regulations and licensing requirements. Many of the states
in which the Company operates, as well as certain local authorities, require the
Company to obtain licenses or permits to conduct a security alarm services
business. Certain governmental entities also require persons engaged in the
security alarm services business to be licensed and to meet certain standards in
the selection and training of employees and in the conduct of business. The
Company believes that it holds the required licenses and is in substantial
compliance with all licensing and regulatory requirements in each jurisdiction
in which it operates.
The security alarm industry is also subject to the oversight and
requirements of various insurance, approval, listing and standards
organizations. Adherence to the standards and requirements of such organizations
may be mandatory or voluntary depending upon the type of customer served, the
nature of security service provided and the requirements of the local
governmental jurisdiction. The Company has not had any material difficulties in
complying with such standards and requirements in the past.
The Company's electronic security business relies on the use of telephone
lines and radio frequencies to transmit signals and to communicate with field
personnel. The cost of such lines and the type of equipment which may be
utilized in telephone line transmissions are regulated by both the federal and
state governments. The operation and utilization of radio frequencies are
regulated by the Federal Communications Commission (the "FCC") and state public
utilities commissions. The Company's PERS products are regulated by the Federal
Food and Drug Administration and the FCC.
13
<PAGE>
The Company's advertising and sales practices are regulated by both the
Federal Trade Commission (the "FTC") and state consumer protection laws. Such
regulations include restrictions on the manner in which the Company promotes the
sale of its products and the obligation of the Company to provide purchasers of
its products with certain rescission rights. While the Company believes that it
has complied with these regulations in all material respects, there can be no
assurance that none of these regulations were violated in connection with the
solicitation of the Company's existing subscriber accounts, particularly with
respect to accounts acquired from third parties, or that no such violations will
occur in the future.
The Company believes that approximately 97% of alarm activations that result
in the dispatch of police or fire department personnel are not emergencies, and
thus are "false alarms." Significant concern has arisen in certain
municipalities about this high incidence of false alarms. This concern could
cause a decrease in the likelihood or timeliness of police response to alarm
activations and thereby decrease the propensity of consumers to purchase or
maintain alarm monitoring services.
A number of local governmental authorities have considered or adopted
various measures aimed at reducing the number of false alarms. Such measures
include (i) subjecting alarm monitoring companies to fines or penalties for
transmitting false alarms, (ii) licensing individual alarm systems and the
revocation of such licenses following a specified number of false alarms, (iii)
imposing fines on alarm subscribers for false alarms, (iv) imposing limitations
on the number of times the police will respond to alarms at a particular
location after a specified number of false alarms and (v) requiring further
verification of an alarm signal before the police will respond. Enactment of
such measures could adversely affect the Company's future business and
operations.
Although it ceased offering new franchises for sale in 1987, the Company's
continuing relationship with its existing franchisees is subject to regulation
under state laws and by the FTC. Moreover, the Company continues to be bound by
obligations to franchisees under certain state consent orders regarding alleged
franchise sales practices. At various times, the Company also has been named in
state actions or inquiries related to the sales practices of its franchisees.
The Company believes it is not liable for the actions of its franchisees;
however, there can be no assurance that it will not be subject to future orders.
The Company may be subject to additional regulation in the future, and changes
in laws and regulations applicable to the Company could increase the cost of
compliance and otherwise materially and adversely affect the Company in ways not
presently foreseeable.
Certain state and local authorities reimburse the Company for monitoring and
installation fees incurred by subscribers covered by Medicaid or similar
programs. The Company is required to register with, and be approved by, such
authorities in order to recover its reimbursable fees.
RISK MANAGEMENT
The nature of the services provided by the Company potentially exposes it to
greater risks of liability for employee acts or omissions, or system failures,
than may be inherent in many other service businesses. To reduce those risks,
substantially all of the Company's customers have subscriber agreements which
contain provisions for limited liability and predetermined liquidated damages to
customers and indemnification by customers against third-party claims; however,
some jurisdictions prohibit or restrict limitations on liability and liquidated
damages. The Company carries insurance of various types, including general
liability and errors and omissions insurance to insure it from liability arising
from acts or omissions of its employees. The Company's general and umbrella
liability insurance policies combined provide up to $10,000,000 of coverage,
depending on the nature of claims. Certain of the Company's insurance policies
and the laws of some states may limit or prohibit insurance coverage for
punitive or certain other kinds of damages arising from employee misconduct. In
addition, in some states the contractual limitation of liability and
indemnification provisions may be ineffective in cases of gross negligence or
intentional misconduct and in certain other situations.
14
<PAGE>
INSURANCE
The Company maintains general liability insurance policies covering various
types of liability including product liability. The product liability insurance
and the errors and omissions liability insurance have policy limits of
$1,000,000 per occurrence and $1,000,000 in the aggregate per year with a
deductible of $5,000 per occurrence payable by the Company. The Company also
maintains additional excess liability insurance in the amount of $9,000,000 in
the aggregate per year also with a deductible of $5,000 per occurrence payable
by the Company. These policies are subject to exclusions and other terms which
the Company believes are typical for policies of similarly situated companies.
The Company believes that its insurance coverage is adequate for its needs, but
there can be no assurance that the Company will not be subjected to claims in
the future which are not covered by its insurance or which exceed its insurance
coverage.
INTELLECTUAL PROPERTY
The Company owns a federal trademark registration for the trade name
"Response Ability" and holds a license for the names "WanderWatch-TM-" and
"HealthLink." The Company believes that its rights in these trademarks are of
unlimited duration and adequately protected by registration or applications to
register. In addition, the Company relies on trade secret and other laws to
protect its proprietary rights in its security systems and programs. No
assurance can be given that the Company will be able to successfully enforce or
protect its rights to its trademarks or proprietary information in the event
that any of them is subject to third-party infringement or misappropriation. The
Company's central monitoring operations utilize proprietary software which the
Company has licensed from a third party.
SUPPLIERS, MANUFACTURING AND ASSEMBLY
The Company currently has multiple sources of supply for the components used
in the electronic security and PERS products that it designs and installs. The
Company does not manufacture any of the products that it designs and installs,
or any of the components thereof. The Company's products are assembled from such
components by third-party contract assemblers. The Company believes that a
variety of alternative sources of supply are available on reasonable terms.
However, the Company has no guaranteed supply arrangements with its suppliers
and purchases components pursuant to purchase orders placed from time to time in
the ordinary course of business. There can be no assurance that shortages of
components will not occur in the future. Failure of sources of supply and the
inability of the Company to develop alternative sources of supply if required in
the future could have a material adverse effect on the Company's operations.
COMPETITION
SECURITY SERVICES
The security services business is highly competitive and new competitors are
continually entering the field. Competition is based primarily on price in
relation to quality of service. Sources of competition in the security services
business are other providers of central monitoring services, systems directly
connected to police and fire departments, local alarm systems and other methods
of protection, such as manned guarding.
The central monitoring sector of the electronic security business is
characterized by low marginal costs associated with monitoring additional
customers. Despite the opportunity for economies of scale by consolidation of
monitoring and administrative functions, the industry is highly fragmented, with
thousands of small providers.
There are also a limited number of larger competitors, including ADT
Security Services, a division of Tyco, International, Pony Express, a division
of Honeywell, Inc., Brinks Home Security, Inc., SecurityLink by Ameritech,
Alarmguard, Inc. and Protection One, Inc.
15
<PAGE>
PERS
The emergency response industry is serviced by numerous companies that
provide PERS products and services, including monitoring services. A majority of
the emergency response companies offer systems that are monitored through a
central monitoring facility. In some instances, companies which sell PERS units
establish agreements with local burglar alarm companies to provide the service
on a per-user fee basis, or have their own monitoring capability. A number of
emergency response companies offer their products through hospitals that
distribute and monitor the systems. Several companies offer systems that utilize
a direct dial/pre-recorded telephone message to selected telephone numbers
directly without a monitoring station.
The Company's principal competitors are other national or regional emergency
response providers and burglar alarm companies that offer medical emergency
features in addition to their home protection systems. Many of these companies
have greater financial resources than the Company and may enjoy a particular
competitive advantage due to their access to a larger client base. The Company
considers its principal competitors to be American Medical Alert Corp., Lifeline
Systems, Inc. and Pioneer Medical Systems. Methods of competition in the PERS
industry consist of quality, service and price of the PERS products. While price
is a factor, the customer's primary consideration in choosing a PERS supplier is
the quality of monitoring service provided and the reliability of the PERS
products. The Company believes that it competes favorably as to all of these
factors.
EMPLOYEES
At September 15, 1998, the Company employed 332 full-time employees. Of this
number, 35 are engaged in sales, 8 in quality control, 70 in field service and
installation, 36 in customer service, 35 in central station monitoring, 75
security patrol guards and 73 in administration. None of the Company's employees
are represented by a labor union, and the Company considers its employee
relations to be satisfactory.
RISK FACTORS
CAUTIONARY STATEMENTS REGARDING FORWARD-LOOKING STATEMENTS
Statements in this Annual Report on Form 10-KSB under the captions
"Business," "Management's Discussion and Analysis of Financial Condition and
Results of Operations," and elsewhere in this Annual Report, as well as
statements made in press releases and oral statements that may be made by the
Company or by officers, directors or employees of the Company acting on the
Company's behalf, that are not statements of historical fact, constitute
"forward-looking statements" within the meaning of the Private Securities
Litigation Reform Act of 1995. Such forward-looking statements involve known and
unknown risks, uncertainties and other factors, including those described in
this Annual Report on Form 10-KSB under the caption "Risk Factors," that could
cause the actual results of the Company to be materially different from the
historical results or from any future results expressed or implied by such
forward-looking statements. In addition to statements which explicitly describe
such risks and uncertainties, readers are urged to consider statements labeled
with the terms "believes," "belief," "expects," "plans," "anticipates," or
"intends," to be uncertain and forward-looking. All cautionary statements made
in this Annual Report on Form 10-KSB should be read as being applicable to all
related forward-looking statements wherever they appear. Investors should
consider the following risk factors as well as the risks described elsewhere in
this Annual Report on Form 10-KSB.
16
<PAGE>
HISTORY OF SIGNIFICANT LOSSES; SUBSTANTIAL ACCUMULATED DEFICIT; WORKING CAPITAL
DEFICIT;
NEGATIVE CASH FLOW AND UNCERTAIN FUTURE PROFITABILITY
The Company has incurred net losses of $18,054,144 and $12,875,836
(inclusive of dividends and accretion on preferred stock of $6,876,521 and
$3,210,333) for the two fiscal years ended June 30, 1997, and 1998,
respectively, and an accumulated deficit of $44,317,785 at June 30, 1998 and
negative cash flow of $1,228,215 for the fiscal year ended June 30, 1997 and a
positive cash flow of $267,589 for the fiscal year ended June 30, 1998. It is
anticipated that such losses will continue for the foreseeable future. The
Company had a net working capital deficit of $1,508,402 as of June 30, 1998. In
addition, the Company's future plans are subject to known and unknown risks and
uncertainties that may cause the Company to continue to incur substantial losses
from operations. There can be no assurance that the Company's operations will
ever become profitable or that, if it is successful in doing so, it will be able
to maintain profitability.
SIGNIFICANT RECEIVABLES ENCUMBERED
On July 30, 1998, the Company completed a restructuring of its long-term
indebtedness with McGinn, Smith Capital Holdings Corp. ("MSCH"). In connection
with such restructuring, USS sold certain of its alarm monitoring contracts (the
"Purchased Contracts") to its newly created, wholly-owned subsidiary, RAC, for
aggregate consideration of approximately $26,000,000 pursuant to a Purchase
Agreement dated as of July 30, 1998 (the "Purchase Agreement"), between USS and
RAC. The Purchased Contracts generate approximately $700,000 in monthly
recurring revenue. Also on July 30, 1998, in a related transaction, RAC entered
into a Receivable Financing Agreement dated as of July 30, 1998 (the "Financing
Agreement"), among RAC, USS and MSCH. Pursuant to the terms of the Financing
Agreement, RAC received initial financing from MSCH in the amount of $26,000,000
(the "Initial Loan") and granted MSCH a first priority perfected security
interest in the receivables derived from the Purchased Contracts (the
"Receivables"). The Initial Loan has a term of five years and bears interest at
a rate of 8% per annum. The Receivables are paid directly into a lockbox
administered by USS as Collection Agent under the Financing Agreement for which
USS will receive a monthly fee equal to $5.00 per Purchased Contract from RAC.
Under the terms of the Financing Agreement, all funds derived from the
Receivables will be paid to the lockbox account and MSCH will be paid its
monthly payment of principal and interest under the Loan out of such lockbox
account prior to any payments to USS as Collection Agent or any other funds
being distributed to the Company or its subsidiaries. RAC may finance, from time
to time, up to an additional $24,000,000 pursuant to the Financing Agreement by
pledging additional Purchased Contracts which it may purchase from USS pursuant
to the Purchase Agreement to MSCH, which funds will be provided to MSCH by
KeyBank National Association ("KeyBank"). In the event of a default under the
Financing Agreement, MSCH would be entitled to all amounts derived from the
Receivables necessary to satisfy all outstanding obligations to MSCH under the
Financing Agreement. As of August 31, 1998, $25,988,333 was outstanding under
the Financing Agreement. As a result of such borrowings, the Company's capital
structure is highly leveraged. The Company's indebtedness requires that a
significant amount of its cash flow from operations be applied to the payment of
interest, and there can be no assurance that the Company's operations will
generate sufficient cash flow to service this indebtedness.
In consideration for providing the funds for the Initial Loan, KeyBank
received a fee from MSCH in cash of $2,730,000 out of the fees which were
received by MSCH from RAC of approximately $3,900,000, $3,120,000 of which was
paid to MSCH in cash at the closing and $780,000 was paid in 119,632 shares of
Common Stock (the "Fee Shares") to be issued to MSCH. The Company has agreed to
file a registration statement to register the sale of the Fee Shares by MSCH
under the Securities Act of 1933, as amended (the "Securities Act"). The Company
has agreed that in the event the proceeds to be derived by MSCH from the sale of
the Fee Shares is less than $780,000, the Company is obligated to, at its
option, pay cash or issue additional shares equal to the amount of the
shortfall, if any.
17
<PAGE>
CERTAIN NON-CASH CHARGES
The Company may incur certain non-cash charges of up to $437,500 for the
fiscal year ended June 30, 1999 as deferred compensation expense relating to
certain performance options granted to two former officers of USS, based upon
fluctuations of the market price of the Common Stock.
RISKS RELATED TO GROWTH THROUGH ACQUISITIONS
Since fiscal year end 1994, substantially all of the Company's growth has
been through acquisitions. One of the Company's primary strategies is to
continue to increase its revenues and the markets it serves through the
acquisition of other companies in the electronic security services industry and
portfolios of alarm monitoring accounts. During the fiscal years ended June 30,
1997 and 1998, the Company consummated 14 acquisitions (an aggregate of 5,300
subscriber accounts) and 17 acquisitions (an aggregate of 19,000 subscriber
accounts), respectively. In the event that the Company targets larger
acquisitions, such acquisitions can be expected to involve significant
expenditures of capital and time, whether or not consummated. Such acquisitions
may involve certain unknown risks and uncertainties in addition to those
identified herein, which could have a material adverse effect on the Company's
financial condition and results of operations. In addition, the acquisition of
electronic security service companies may become more expensive in the future,
to the extent that demand and competition increases. There can be no assurance
that the Company will be able to identify acquisition candidates, successfully
consummate such acquisitions, acquire or profitably manage such acquisition
candidates or successfully integrate such businesses into its operations without
substantial costs, delays or other problems. In addition, the Company is unable
to predict the size or frequency of any future acquisitions, and there can be no
assurance that any businesses acquired will be profitable at the time of their
acquisition or will achieve sales and profitability that justify the investment
therein or that the Company will be able to realize expected operating and
economic efficiencies following such acquisitions. Acquisitions may involve a
number of special risks, including (i) adverse effects on the Company's reported
operating results, (ii) diversion of management's attention, (iii) increased
burdens on the Company's management resources and financial controls, (iv)
dependence on retention and hiring of key personnel, (v) risks associated with
unanticipated problems or legal liabilities and (vi) amortization of acquired
intangible assets, some or all of which could have a material adverse effect on
the Company's operations and financial performance.
In February 1998, the Company entered into an agreement to acquire Triple A
Patrol, a company engaged in the patrol service business. The Company has
limited experience in the patrol service business and such industry may involve
risks and uncertainties which are unknown to the Company and which could have a
material adverse effect on the Company's financial condition and results of
operations. In addition, the patrol service business has a significantly lower
profit margin than the other services provided by the Company, which could also
have a material adverse effect on the Company's results of operations and
financial performance.
Since the Company's primary consideration in making an acquisition is the
amount of MRR associated with the seller's subscriber accounts, the price paid
by the Company is customarily directly tied to such MRR. Frequently, no audited
historical financial information is available from the Company's acquisitions.
Therefore, the actual MRR acquired may be less than the Company anticipated.
Thus, the Company must rely on management's knowledge of the industry, due
diligence procedures, and representations and warranties of the sellers. In the
event the Company's assessment of the MRR of an acquired company is higher than
actual MRR for an acquired company, the Company's financial condition and
results of operations could be materially adversely affected.
A difference between the accounting treatment of the purchase of subscriber
accounts and the accounting treatment of the generation of subscriber accounts
through direct sales by the Company's sales force has a significant impact on
the Company's results of operations. The costs of monitoring contracts (acquired
either through the Company's dealer program or through the acquisition of
subscriber account
18
<PAGE>
portfolios) are capitalized and amortized over estimated lives ranging from five
to ten years on a straight-line basis for alarm and PERS accounts. Included in
capitalized costs are acquisition transition costs that reflect the Company's
estimate of costs associated with incorporating the acquired subscriber accounts
into its operations. In contrast, all of the Company's costs related to the
marketing, sales and installation of new alarm monitoring systems generated by
its sales force are expensed in the period in which such activities occur. The
Company's marketing, sales and installation expenses for new systems generally
exceed installation revenues. Such accounting treatment could adversely affect
the Company's financial condition and results of operations.
POTENTIAL NEED FOR ADDITIONAL FINANCING; POTENTIAL DILUTIVE IMPACT OF
ACQUISITIONS
Based on the Company's operating plan, the Company may require additional
financing. The Company believes that the cash on hand and available debt
financing under the Financing Agreement will be sufficient to satisfy its
current capital requirements for at least 12 months following the date hereof.
The Company has an additional $24,000,000 available pursuant to the Financing
Agreement, however, in the event that the Company were to make significant
acquisitions for cash consideration, in excess of such availability, or if the
lender were unwilling to loan such amounts to RAC, the Company may require
additional capital before such time. Sources of funds may include the issuance
of Common Stock or preferred stock sold in a public offering or in private
placements, debt securities or bank financing. Historically, the Company has
utilized its Common Stock to pay a portion of the consideration of its
acquisitions. To the extent the Company continues to use its Common Stock in
connection with acquisitions, the issuance of such shares could have a dilutive
impact on the Company's existing stockholders. Alternatively, to avoid such
dilution, or if the acquisition candidate is unwilling to accept Common Stock as
all or a portion of the consideration for such acquisition, the Company may be
required to utilize more of its cash resources, if available, or may be required
to seek additional funding. There can be no assurance that the Company would be
able to obtain capital on a timely basis, on favorable terms, or at all. If the
Company is unable to obtain such financing, or generate funds from operation
sufficient to meet it needs, the Company may be unable to implement its current
plans for expansion and development.
ATTRITION OF SUBSCRIBER ACCOUNTS
The Company is heavily dependent on its recurring monitoring and service
revenues. Given the relatively fixed nature of monitoring and service expenses,
increases and decreases in monitoring and service revenues have a significant
impact on the Company's financial performance. Substantially all of the
Company's monitoring and service revenues are derived from recurring charges to
subscribers for the provision of various services. Although no single subscriber
represents more than one-half of one percent of the Company's recurring revenue
base, the Company is vulnerable to subscribers canceling their contracts. In
recent years, lost recurring revenues from such cancellations have exceeded the
new recurring revenues added by the Company's internal sales efforts.
At June 30, 1998, the cost of subscriber accounts and intangible assets, net
of previously accumulated amortization, was $31,280,805, which constituted 73.3%
of the book value of the Company's total assets. The Company's acquired
subscriber accounts are amortized on a straight-line basis over the estimated
life of the related revenues. The Company's assumed attrition rate for all of
its subscriber accounts, expressed as total accounts lost per year, net of new
accounts from new installations, conversions, subscribers who move into premises
previously occupied by Company subscribers and accounts for which the Company is
reimbursed by virtue of a guarantee by the seller of the account, is
approximately 5%. It is the Company's policy to review periodically actual
account attrition and, when necessary, adjust the remaining estimated lives of
the Company's acquired accounts to reflect assumed future attrition. There could
be a material adverse effect on the Company's results of operations and
financial condition if actual account attrition significantly exceeds assumed
attrition and the Company has to make further adjustments with respect to the
amortization of acquired subscriber accounts.
19
<PAGE>
COMPETITION
The electronic security services industry is highly competitive and
fragmented. The Company competes with national and regional companies, as well
as smaller local companies, in all of its operations. Furthermore, new
competitors continue to enter the industry and the Company may encounter
additional competition from such future industry entrants. Subject to regulatory
compliance, certain companies engaged in the telephone and cable business are
competing in the electronic security services industry and other such companies
may, in the future, enter the industry. Certain of the Company's current
competitors have, and new competitors may have, substantially greater financial
resources than the Company. There can be no assurance that the Company will be
able to compete successfully in the electronic security services industry. The
Company's principal competitors with respect to its PERS are other national or
regional emergency response providers and burglar alarm companies that offer
medical emergency features in addition to their home protection systems. Many of
these companies have greater financial resources than the Company and may enjoy
a particular competitive advantage due to their access to a larger client base.
There can be no assurance that the Company will be able to compete successfully
in the PERS industry.
DEPENDENCE ON THE MONITORING STATION
The Company is dependent on the Euclid Monitoring Station an independent
third-party monitoring station, and the Triple A Monitoring Station to monitor a
significant amount of its subscriber accounts. The Company's agreement with the
Euclid Monitoring Station expires in April 1999 and is terminable sooner under
certain circumstances. Although the Company believes that alternative monitoring
stations are available on commercially reasonable terms, any termination or
temporary interruption of services by the Euclid Monitoring Station or the
Triple A Monitoring Station for any reason including a catastrophic event such
as tornado, hurricane, earthquake, fire or other disaster which rendered the
Euclid Monitoring Station or the Triple A Monitoring Station temporarily or
permanently inoperable could adversely affect the Company's financial condition
and results of operations. The Company anticipates transferring all of its
subscriber accounts from the Euclid Monitoring Station to the Triple A
Monitoring Station by the end of its current fiscal year.
DEPENDENCE ON SUPPLIERS AND MANUFACTURERS
The Company does not manufacture any of the equipment or components that it
designs and installs. Although the Company believes that a variety of
alternative sources of supply are available on commercially reasonable terms,
the Company has no guaranteed supply arrangements with its suppliers and
purchases components pursuant to purchase orders placed from time to time in the
ordinary course of business. There can be no assurance that shortages of
components will not occur in the future. Failure of sources of supply and the
inability of the Company to develop alternative sources of supply, if required
in the future, could have a material adverse effect on the Company's operations.
PRODUCT LIABILITY AND AVAILABILITY OF INSURANCE
The nature of the security services provided by the Company potentially
exposes it to greater risk of liability claims for employee acts or omissions or
system failure than may be inherent in many other service businesses. Although
(i) substantially all of the Company's customers have subscriber agreements
which contain provisions for limited liability and predetermined liquidated
damages and (ii) the Company carries insurance which provides coverage against
certain of such liabilities, there can be no assurance that such existing
arrangements will prevent the Company from being adversely affected as a result
of damages arising from the acts of its employees, defective equipment, the acts
or omissions of the Monitoring Station or because some jurisdictions prohibit or
restrict limitations on liabilities and liquidated damages. In addition, certain
of the Company's insurance policies and the laws of some states may limit or
prohibit insurance coverage for punitive damages and for certain other kinds of
damages arising from employee
20
<PAGE>
misconduct. In addition, in some states, the contractual limitation on liability
and indemnification provisions may be ineffective in cases of gross negligence
or intentional misconduct and in certain other situations.
The sale and service of the Company's products entails the risk of product
liability claims. In addition, many of the companies with which the Company does
or may do business may require financial assurances of product reliability. The
Company has product liability insurance, but may be required to pay higher
premiums associated with new product development. Product liability insurance is
expensive and there can be no assurance that additional insurance will be
available on acceptable terms, if at all, or that it will provide adequate
coverage against potential liabilities. The inability to obtain additional
insurance at an acceptable cost or to otherwise protect against potential
product liability could prevent or inhibit commercialization of the Company's
products. A successful claim brought against the Company in excess of its
insurance coverage could have a material adverse effect on the Company.
POSSIBLE ADVERSE EFFECT OF "FALSE ALARMS" ORDINANCES AND GOVERNMENT REGULATIONS
The Company believes that approximately 97% of alarm activations that result
in the dispatch of police or fire department personnel are not emergencies, and
thus are "false alarms." Significant concern has arisen in certain
municipalities about this high incidence of false alarms. This concern could
cause a decrease in the likelihood or timeliness of police response to alarm
activations and thereby decrease the propensity of consumers to purchase or
maintain alarm monitoring services.
A number of local governmental authorities have considered or adopted
various measures aimed at reducing the number of false alarms. Such measures
include (i) subjecting alarm monitoring companies to fines or penalties for
transmitting false alarms, (ii) licensing individual alarm systems and the
revocation of such licenses following a specified number of false alarms, (iii)
imposing fines on alarm subscribers for false alarms, (iv) imposing limitations
on the number of times the police will respond to alarms at a particular
location after a specified number of false alarms and (v) requiring further
verification of an alarm signal before the police will respond. Enactment of
such measures could adversely affect the Company's future business and
operations.
The Company's operations are also subject to a variety of federal, state,
county and municipal laws, regulations and licensing requirements. Many of the
states in which the Company operates, as well as certain local authorities,
require the Company to obtain licenses or permits to conduct a security alarm
services business. Certain governmental entities also require persons engaged in
the security alarm services business to be licensed and to meet certain
standards in the selection and training of employees and in the conduct of
business. The loss of such licenses, or the imposition of conditions on the
granting or retention of such licenses, could have a material adverse effect on
the Company.
The Company's advertising and sales practices are regulated by both the FTC
and state consumer protection laws. Such regulations include restrictions on the
manner in which the Company promotes the sale of its products and the obligation
of the Company to provide purchasers of its products with certain rights. While
the Company believes that it has complied with these regulations in all material
respects, there can be no assurance that none of these regulations were violated
in connection with the solicitation of the Company's existing subscriber
accounts, particularly with respect to accounts acquired from third parties, or
that no such violations will occur in the future.
21
<PAGE>
GEOGRAPHIC CONCENTRATION
The Company's existing alarm subscriber base is geographically concentrated
in New York, New Jersey, Connecticut, Delaware, Maryland and Pennsylvania.
Accordingly, the performance of the Company may be adversely affected by
regional or local economic conditions. The Company may from time to time make
acquisitions in regions outside of its current operating area. The acquisition
of companies in other regions, or in metropolitan areas in which the Company
does not currently have subscribers, requires an investment by the Company. In
order for the Company to expand successfully into a new area, the Company must
acquire companies with a sufficient number and density of subscriber accounts in
such area to support the investment. There can be no assurance that the Company
will find such opportunities or that an expansion into new geographic areas will
generate operating profits.
GOVERNMENT REGULATION OF AND LIMITATIONS BROUGHT ON BY REIMBURSEMENT PROGRAMS
Many aspects of the medical industry in the United States are presently
subject to extensive federal and state governmental regulation, including
reimbursement rates and policies imposed by Medicare and other third-party
reimbursement programs. Laws and regulations affecting the Company's business
include federal and state "kickback laws," conflict of interest laws (such as
the federal "Stark" legislation), and licensing requirements. In addition, both
the Clinton Administration and the Congress have periodically asserted a need to
overhaul or reform the nation's healthcare system. Such legislative initiatives,
if enacted, could impose pressures on the pricing structures applicable to a
portion of the Company's PERS services. In particular, there is a possibility
that a significant portion of healthcare services will be rendered and
administered through managed care systems, which could have the effect of
forcing price concessions and reductions on the part of service providers such
as the Company. Depending on the nature and extent of any new laws and/or
regulations, or possible changes in the interpretation of existing laws and/or
regulations, any such changes may have a material adverse effect on the
Company's PERS revenues, operating margins and profitability.
The Company derives a portion of its revenues from Medicaid, and from other
third-party indemnity payors. In January 1992, the federal government
implemented, through the Medicare program, a resource-based relative value scale
("RBRVS") payment methodology. Implementation of RBRVS could reduce
reimbursement rates for certain of the Company's PERS products and services.
Policymakers have from time to time advocated that a RBRVS type of reimbursement
system be imposed on private-sector third-party payors. Implementation of such a
program would reduce reimbursements by private third-party payors, and would
adversely affect the Company's PERS operating margins to the extent that costs
on these procedures could not be concomitantly reduced. There can be no
assurance that some or any of these reduced operating margins could be recouped
through cost reductions or otherwise.
DEPENDENCE ON KEY PERSONNEL AND MANAGEMENT
The Company's success depends to a significant degree upon the continuing
contributions of its senior management and other key employees, particularly its
three current executive officers, Richard M. Brooks, the Company's Chief
Executive Officer, President, Chief Financial Officer and Chairman of the Board,
Robert L. May, the Company's Executive Vice President and Ronald A. Feldman, the
Company's Chief Operating Officer, Vice President, Secretary and Treasurer, the
loss of any one of whom might have a material adverse effect on the Company's
financial condition and results of operations. Although the Company has
employment agreements with Messrs. Brooks, May and Feldman and certain other
employees, there can be no assurance that the Company will be able to retain the
services of such individuals. It is an event of default under the Financing
Agreement if Messrs. Brooks, May and Feldman are not employed in certain
management positions. The Company has key-man life insurance policies on the
lives of Messrs. Brooks and Feldman in the amount of $3,000,000 and $1,000,000,
respectively.
22
<PAGE>
CONTROL BY DIRECTORS AND EXECUTIVE OFFICERS
The Company's directors and executive officers beneficially own
approximately 15.9% of the outstanding shares of Common Stock and, accordingly,
will have substantial influence over the outcome of any matter submitted to a
vote of stockholders, including the election of directors and the approval of
significant corporate transactions (such as acquisitions of the Company or its
assets). Such influence could delay or prevent a change of control of the
Company.
POSSIBLE VOLATILITY OF STOCK PRICE
The stock market has from time to time experienced extreme price and volume
fluctuations that have been unrelated to the operating performance of particular
companies. The market price of the Common Stock may be significantly affected by
quarterly variations in the Company's operating results, changes in financial
estimates by securities analysts or failure by the Company to meet such
estimates, litigation involving the Company, general trends in the security
alarm industry, actions by governmental agencies, national economic and stock
market conditions, industry reports and other factors, many of which are beyond
the control of the Company.
NO DIVIDENDS
The Company has never paid any cash or other dividends on its Common Stock.
Payment of dividends on the Common Stock is within the discretion of the Board
of Directors and will depend upon the Company's earnings, its capital
requirements and financial condition, and other relevant factors. For the
foreseeable future, the Board intends to retain future earnings, if any, to
finance its business operations and does not anticipate paying any cash
dividends with respect to the Common Stock.
SHARES ELIGIBLE FOR FUTURE SALE; EFFECT OF PREVIOUSLY ISSUED OPTIONS AND
WARRANTS; REGISTRATION RIGHTS
As of September 24, 1998, the Company had outstanding 6,726,442 shares of
Common Stock, 5,582,027 of which are freely tradeable without restriction or
further registration under the Securities Act and 1,144,415 of which are
"restricted securities" (as that term is defined in Rule 144 under the
Securities Act) and in the future may only be sold pursuant to a registration
statement under the Securities Act, in compliance with the exemption provisions
of Rule 144 or pursuant to another exemption under the Securities Act. In
general, under Rule 144, as currently in effect, a person (including a person
who may be deemed an "affiliate" of the Company as that term is defined under
the Securities Act) who has beneficially owned such shares for at least one year
would be entitled to sell within any three-month period a number of shares
beneficially owned for at least one year that do not exceed the greater of (i)
1% of the then outstanding shares of Common Stock or (ii) the average weekly
trading volume of the Common Stock during the four calendar weeks preceding such
sale. Sales under Rule 144 are further subject to certain restrictions relating
to the manner of sale, notice and the availability of current public information
about the Company. After two years have elapsed from the date of the issuance of
restricted securities by the Company or their acquisition from an affiliate,
such shares may be sold without limitation by persons who have not been
affiliates of the Company for at least three months. The sale, or availability
for sale, of substantial amounts of Common Stock in the public market pursuant
to Rule 144 or otherwise could materially adversely affect the market price of
the Common Stock and could impair the Company's ability to raise additional
capital through the sale of its equity securities or debt financing.
The Company has reserved from the authorized, but unissued, Common Stock,
3,268,441 shares of Common Stock issuable upon exercise of options, warrants and
convertible securities. The existence of such outstanding securities may prove
to be a hindrance to future financings, since the holders of such securities may
be expected to exercise them at a time when the Company would otherwise be able
to obtain additional equity capital on terms more favorable to the Company.
Certain of the holders of such securities have registration rights with respect
to such securities. No prediction can be made as to the
23
<PAGE>
effect, if any, that sales of such securities, or the availability of such
securities for sale, will have on the market prices prevailing from time to time
for the Common Stock. However, even the possibility that a substantial number of
the Company's securities may, in the near future, be sold in the public market
may adversely affect prevailing market prices for the Common Stock and could
impair the Company's ability to raise capital through the sale of its equity
securities.
DELAWARE ANTI-TAKEOVER STATUTE; LIMITATION OF LIABILITY OF DIRECTORS AND
OFFICERS
The Company is a Delaware corporation and is subject to the prohibitions
imposed by Section 203 of the Delaware General Corporate Law ("DGCL"), which is
generally viewed as an anti-takeover statute. In general, this statute will
prohibit the Company from entering into certain business combinations without
the approval of its Board of Directors and, as accordingly, could prohibit or
delay mergers or other attempted takeovers or changes in control with respect to
the Company. Such provisions may discourage attempts to acquire the Company.
The Company's Certificate of Incorporation includes provisions to eliminate,
to the full extent permitted by the DGCL as in effect from time to time, the
personal liability of directors of the Company for monetary damages arising from
a breach of their fiduciary duties as directors. The Certificate of
Incorporation also includes provisions to the effect that (subject to certain
exceptions) the Company shall, to the maximum extent permitted from time to time
under the law of the State of Delaware, indemnify, and upon request shall
advance expenses to, any director or officer to the extent that such
indemnification and advancement of expenses is permitted under such law, as it
may from time to time be in effect. In addition, the Company's Bylaws (the
"Bylaws") require the Company to indemnify, to the full extent permitted by law,
any director, officer, employee or agent of the Company for acts which such
person reasonably believes are not in violation of the Company's corporate
purposes as set forth in the Certificate of Incorporation. As a result of such
provisions in the Certificate of Incorporation and the Bylaws, stockholders may
be unable to recover damages against the directors and officers of the Company
for actions taken by them which constitute negligence, gross negligence or a
violation of their fiduciary duties, which may reduce the likelihood of
stockholders instituting derivative litigation against directors and officers
and may discourage or deter stockholders from suing directors, officers,
employees and agents of the Company for breaches of their duty of care, even
though such action, if successful, might otherwise benefit the Company and its
stockholders.
POSSIBLE ADVERSE EFFECTS ASSOCIATED WITH THE ISSUANCE OF "BLANK CHECK" PREFERRED
STOCK
The Company's Certificate of Incorporation authorizes the Company's Board of
Directors to issue up to 250,000 shares (of which 239,430.42 remain available)
of "blank check" preferred stock, from time to time, in one or more series,
solely on the authorization of its Board of Directors. The Board of Directors
will thus be authorized, without further approval of the stockholders, to fix
the dividend rights and terms, conversion rights, voting rights, redemption
rights and terms, liquidation preferences, and any other rights, preferences,
privileges and restrictions applicable to each new series of preferred stock.
The issuance of such stock could, among other results, adversely affect the
voting power of the holders of Common Stock and, under certain circumstances,
make it more difficult for a third party to gain control of the Company,
discourage bids for the Common Stock at a premium, or otherwise adversely affect
the market price of the Common Stock.
YEAR 2000 COMPLIANCE
Year 2000 compliance relates to the ability of computer hardware and
software to respond to the problems posed by the fact that computer programs
have traditionally been written using two digits rather than four to define the
applicable year. As a consequence, unless modified, computer programs and
systems will not be able to differentiate between the year 2000 and 1900. The
failure to address the problem could result in system failures and the
generation of erroneous data. The accounts receivable and
24
<PAGE>
billing software currently used by the Company has been tested internally and,
based upon such tests, the Company believes such software is year 2000
compliant. The Company that designs the monitoring software for the Triple A
Monitoring Station has represented to the Company that such software is year
2000 compliant. The Company plans to test such monitoring station software prior
to its use by the Company. The Company plans to install a new Windows-based
general ledger and accounts payable program, which the manufacturer has
warranted as year 2000 compliant, by January 1, 1999. To date, the Company has
not incurred any material costs historically and does not expect to incur any
material costs in the future with respect to becoming Year 2000 compliant.
However, the Company cannot predict the effect of the year 2000 problem on
entities with which the Company transacts business (including its customers,
financial institutions and vendors), and there can be no assurance that the
effects of the year 2000 problem on such entities will not have a material
adverse effect on the Company's business, financial condition or results of
operations. The Company plans to initiate communication with its financial
institutions and major suppliers concerning their readiness for the year 2000,
during the fiscal year ending June 30, 1999, in order to minimize the risk
associated with the year 2000 hardware and software problems. If the Company's
current financial institutions or major suppliers are unable to attain year 2000
compliance in a timely manner; then the Company will change to financial
institutions that will be year 2000 compliant, and seek out other suppliers for
the same product or purchase certain levels of product to enable the vendor to
become year 2000 compliant over a specified period of time.
ITEM 2. PROPERTIES
The Company leases 15,000 square feet in Lawrenceville, New Jersey, for its
executive and administrative offices, at an annual rental of $180,000. The lease
expires in June 1999, after which the Company has a five-year renewal option.
The Company also leases (i) 2,000 square feet in Los Angeles, California, for
use as a sales and installation facility, at an annual rental of $24,000, which
lease expires in October 2000; (ii) 5,000 square feet for its inventory, storage
and testing facility in Florida, which is adjacent to the Company's third-party
assembler, at an annual rental of $19,200, which lease expires in March 1999;
(iii) 12,800 square feet in Wilkes Barre, Pennsylvania which contains the Triple
A Monitoring Station and is also used as a sales and installation facility, at
an annual rental of $131,200, which lease expires in February, 2008; (iv) 2,900
square feet in Allentown, Pennsylvania, for use as a sales and installation
facility, at an annual rental of $24,000, which lease expires in November 1998,
which the Company has decided not to renew; (v) 4,600 square feet in Fall River,
Massachusetts for use as a sales and installation facility, at an annual rental
of $28,000, which lease expires in March 2000, after which the Company has a
two-year renewal option on the same terms and conditions and (vi) 2,400 square
feet in Hamlin, Pennsylvania for use as a sales and installation facility at an
annual rental of $23,760, which lease expires in February 2008.
The Company believes that its current facilities are adequate for its needs.
ITEM 3. LEGAL PROCEEDINGS
The Company experiences routine litigation in the normal course of its
business. The Company does not believe that any of such pending litigation will
have a material adverse effect on the financial condition or results of
operations of the Company.
In February 1996, the Company consented to the issuance of an Order
Instituting Proceedings pursuant to the Securities Act and the Securities
Exchange Act of 1934, as amended (the "Exchange Act") and Findings and Order of
the Securities and Exchange Commission (the "Finding"), without admitting or
denying allegations of facts contained therein. In July 1993, the Company sold
20,000 shares of Common Stock pursuant to what it claimed to be an exemption
from registration under Regulation S of the Securities Act. The Finding stated
that such sales were made under circumstances in which the Company knew or
should have known that such exemption was not available. Consequently, the
Finding stated, the sales were made in violation of the registration provisions
of the Securities Act. The Company consented
25
<PAGE>
to permanently cease and desist from committing or causing any violation, and
any future violation, of Section 5 of the Securities Act.
In January and February 1997, certain holders of the Preferred Stock
commenced litigation against the Company, challenging, among other things, the
Company's decision to suspend conversion rights of such holders and seeking,
among other things, specific performance under the Certificate of Designation to
convert their Preferred Stock to Common Stock of the Company. The Company has
entered into a Settlement Agreement with such holders. (See Note 9 of Notes to
Consolidated Financial Statements of the Company.)
Prior to its acquisition by the Company, Systems was named in a number of
civil and administrative proceedings relating to its franchise sales. The
Company does not presently offer franchises for sale; however, the Company is
bound by certain consent decrees and regulations involving its continuing
relationship with franchisees.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
None.
26
<PAGE>
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON STOCK AND RELATED SECURITY HOLDER
MATTERS
The following table sets forth, for the quarters indicated, the high and low
bid and asked prices for the Company's Common Stock in the over-the-counter
market (as adjusted to reflect the one-for-three reverse stock split effective
January 9, 1998). Such prices reflect interdealer prices, without retail
mark-up, mark-down or commission and may not necessarily represent actual
transactions.
<TABLE>
<CAPTION>
BID ASK
------------ -----------
HIGH LOW HIGH
----- --- -----
<S> <C> <C> <C>
FISCAL YEAR ENDING JUNE 30, 1998:
First Quarter.......................................................................... $ 12 $ 63/4 $ 123/4
Second Quarter......................................................................... 117/16 71/2 12
Third Quarter.......................................................................... 63/16 53/4 61/4
Fourth Quarter......................................................................... 63/4 61/4 613/16
FISCAL YEAR ENDED JUNE 30, 1997:
First Quarter.......................................................................... $ 265/8 $ 93/8 $ 273/8
Second Quarter......................................................................... 153/8 71/8 161/8
Third Quarter.......................................................................... 161/8 81/16 167/8
Fourth Quarter......................................................................... 9 45/16 93/8
<CAPTION>
LOW
---
<S> <C>
FISCAL YEAR ENDING JUNE 30, 1998:
First Quarter.......................................................................... $ 87/8
Second Quarter......................................................................... 81/8
Third Quarter.......................................................................... 515/16
Fourth Quarter......................................................................... 63/8
FISCAL YEAR ENDED JUNE 30, 1997:
First Quarter.......................................................................... $ 93/4
Second Quarter......................................................................... 77/8
Third Quarter.......................................................................... 85/8
Fourth Quarter......................................................................... 411/16
</TABLE>
On September 25, 1998, the closing bid price of the Company's Common Stock
as reported on the Nasdaq SmallCap Market was $3 11/16 per share. As of
September 23, 1998, there were 318 stockholders of record of the Common Stock.
The total monthly trading volume of the Common Stock on the Nasdaq SmallCap
Market for the month ended August 31, 1998 was 1,497,334 shares.
The Company has not paid any dividends on its Common Stock since its
inception and does not intend to pay any dividends to its stockholders in the
foreseeable future. The Company currently intends to retain earnings, if any,
for the development and expansion of its business. The declaration of dividends
in the future will be at the discretion of the Board of Directors and will
depend upon the earnings, capital requirements and financial position of the
Company, general economic conditions and other pertinent factors. The Company
anticipates that for the foreseeable future, earnings, if any, will be retained
for use in the business or for other corporate purposes, and it is not
anticipated that dividends will be paid.
ITEM 6. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the Consolidated
Financial Statements and related notes thereto.
GENERAL OVERVIEW
The Company is a fully-integrated security systems provider engaged in the
monitoring, sale, installation, and maintenance of residential and commercial
security systems and PERS. The Company is a regional provider of security alarm
monitoring services for residential and small business subscribers operating in
the states of New York, New Jersey, Pennsylvania, Delaware, Maryland and
Connecticut. The Company provides security patrol services in northeastern
Pennsylvania as a supplement to its alarm monitoring services. The Company is
also a nationwide provider of PERS products which enable individual users, such
as elderly or disabled persons, to transmit a distress signal using a portable
transmitter.
The Company's electronic security systems business utilizes electronic
devices installed in businesses and residences to provide (i) detection of
events such as intrusion or fire, (ii) surveillance, and (iii) control of access
to property. The monitoring station personnel verify the nature of the emergency
and contact the appropriate emergency authorities in the user's area. In some
instances, commercial customers may
27
<PAGE>
monitor these devices at their own premises or the devices may be connected to
local fire or police departments. The products and services marketed in the
electronic security services industry range from residential systems that
provide basic entry and fire protection to more sophisticated commercial
systems.
The Company's PERS is an electronic device which is designed to monitor,
identify and electronically report emergencies requiring medical, fire or police
assistance, to help elderly, disabled and other individuals. When activated by
the pressing of a button, or automatically in the case of certain environmental
temperature fluctuations, the transmitter sends a radio signal to a receiving
base installed in the user's home. The receiving base relays the signal over
telephone lines to a monitoring station which provides continuous monitoring
services. In addition, this signal establishes two-way voice communication
between the user and the monitoring station personnel directly through the PERS
unit, thereby avoiding any need for the user to access a telephone.
The electronic security services industry is highly fragmented and the
Company's strategy is to grow primarily by acquisition, generate internal growth
and grow by offering new products and services. The Company believes that there
is an industry-wide trend towards consolidation due, in part, to the relatively
high fixed costs of maintaining a centralized monitoring station and the
relatively low incremental cost of servicing additional subscribers. The Company
has completed the acquisition of an aggregate of 14 subscriber account
portfolios (a total of approximately 5,300 subscriber accounts) for an aggregate
consideration $3,424,712 in cash and 8,333 shares of Common Stock valued at
$75,000 during the fiscal year ended June 30, 1997 ("Fiscal 1997").
During the fiscal year ended June 30, 1998 ("Fiscal 1998"), the Company
completed the acquisition of 17 subscriber account portfolios, purchasing
approximately 19,000 subscriber accounts for an aggregate consideration of
$16,197,045. The purchase price consisted of $12,668,244 in cash and notes,
481,451 shares of Common Stock valued at $3,154,882, recorded purchase holdbacks
of $279,429, accrued transition costs of $90,164, and reduced accounts
receivable in the amount of $4,326. The Company typically acquires only the
subscriber accounts, and not the facilities or liabilities, of acquired
companies. As a result, the Company is able to obtain gross margins on the
monitoring of acquired subscriber accounts that are similar to those that the
Company currently generates on the monitoring of its existing subscriber base.
In addition, the Company may increase the monitoring charges paid by those
subscribers if it is determined that those currently being paid do not reflect
the market area rates.
A majority of the Company's revenues are derived from monthly recurring
payments for the monitoring, rental and servicing of both electronic security
systems and PERS, pursuant to contracts with initial terms up to five years.
Service revenues are derived from payments under extended warranty contracts and
for service calls performed on a time and material basis. The remainder of the
Company's revenues are generated from the sale and installation of security
systems and PERS. Monitoring and service revenues are recognized as the service
is provided. Sale and installation revenues are recognized when the required
work is completed. All direct installation costs, which include materials, labor
and installation overhead, and selling and marketing costs are expensed in the
period incurred. Alarm monitoring and rental services generate significantly
higher gross margins than do the other services provided by the Company.
During Fiscal 1998, the Company has added approximately $450,000 of MRR
primarily through acquisitions. The Company has realized a growth rate of
approximately 36% or 17,000 subscribers during the past twelve months from
47,000 subscribers at June 30, 1997 to approximately 64,000 current subscribers.
The Company's MRR increased by approximately $450,000 or 56% from $800,000 to
$1,250,000 for the same comparable period. Recurring security patrol revenues
derived from preventive patrol services through vehicles covering residential
neighborhood communities are included in the Company's MRR.
28
<PAGE>
RESULTS OF OPERATIONS
FISCAL YEARS 1997 AND 1998
The following table sets forth certain operating data as a percentage of
total revenues for the fiscal years ended June 30, 1997 and 1998:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
--------------------------------------------------
1997 1998
------------------------ ------------------------
<S> <C> <C> <C> <C>
Operating Revenues:
Product sales............................................... $ 2,938,618 23.1% $ 3,310,876 20.0%
Monitoring and service...................................... 9,784,285 76.9% 12,358,368 74.8%
Security patrol............................................. 850,884 5.2%
------------- --------- ------------- ---------
12,722,903 100.0% 16,520,128 100.0%
------------- --------- ------------- ---------
Cost of Revenues:
Product sales............................................... 1,970,158 15.5% 2,374,095 14.4%
Monitoring and service...................................... 2,930,137 23.0% 3,631,796 22.0%
Security patrol............................................. 672,247 4.1%
------------- --------- ------------- ---------
4,900,295 38.5% 6,678,138 40.5%
------------- --------- ------------- ---------
Gross Profit.................................................. 7,822,608 61.5% 9,841,990 59.5%
Selling, general and administrative........................... 8,323,761 65.4% 7,912,072 47.9%
Compensation--Options/Contracts............................... 3,689,700 29.0% 537,541 3.3%
Depreciation and amortization................................. 2,976,433 23.4% 4,334,381 26.2%
Nonrecurring charges.......................................... 838,581 5.1%
Interest expense (net)........................................ 1,337,304 10.5% 2,915,434 17.6%
Joint venture loss............................................ 123,325 1.0% 2,969,484 18.0%
------------- --------- ------------- ---------
Operating loss................................................ $ (8,627,915) (67.8%) $ (9,665,503) (58.6%)
------------- --------- ------------- ---------
------------- --------- ------------- ---------
</TABLE>
RESULTS OF OPERATIONS
Operating revenues increased by $3,797,225 or 30% for Fiscal 1998 as
compared to Fiscal 1997. The acquisitions of Triple A, Triple A Patrol, and OEC,
during February 1998, accounted for additional operating revenues as follows:
(i) product sales--$885,806; (ii) monitoring and service revenues-- $1,844,864;
and (iii) security patrol revenues--$850,884; for an aggregate totaling
$3,581,554. Product sales increased by $372,258 or 13% for Fiscal 1998, as
compared to Fiscal 1997. The increase in product sales was due to the additional
sales generated from the above acquisitions totaling $885,806 and an increase
from the sale of electronic security systems to commercial customers of
$100,879; these increases were offset by decreases in the sales of PERS to home
healthcare agencies and private label wholesalers totaling $675,111. The
significant growth in monitoring and service revenues of $2,574,083 or 26% for
Fiscal 1998 as compared to Fiscal 1997, was due to additional monitoring and
service revenues from the aforementioned acquisitions totaling $1,844,864, and
the continued growth of the Company through purchases of monitoring contracts.
The Company, through its acquisition of Triple A Patrol, has expanded its
operating revenue base to include security patrol revenue, which totaled
$850,884 for the year ended June 30, 1998.
Gross Profit for Fiscal 1998 was $9,841,990, which represents an increase of
$2,019,382 or 26%, as compared to the $7,822,608 of gross profit recognized in
Fiscal 1997. The Gross Profit Margin ("GPM"), as a percentage of sales, for
Fiscal 1997 and Fiscal 1998 were 61% and 60%, respectively. The decrease in GPM
on product sales, from 33% for Fiscal 1997 to 28% for Fiscal 1998 was primarily
due to the significant decline in the sales of PERS to home health care
agencies. Sales to home health care agencies result in significantly higher
gross profit margins than other product sales. The GPM on monitoring and
29
<PAGE>
service revenues increased slightly, as a percentage of sales, from 70% to 71%
for Fiscal 1997 and Fiscal 1998, respectively. The increase is due to rate
increases in the rental and monitoring fees, and an improvement in the
efficiency of the service department. This slight increase in GPM occurred,
despite additional costs incurred in servicing the existing customer base due to
telephone area code changes within the Company's operating region, implemented
by the local telephone companies, during Fiscal 1998. For Fiscal 1998 the GPM on
the security patrol revenue was 21%.
Selling, general and administrative expenses decreased by $411,689 or 5%,
from $8,323,761 for Fiscal 1997, to $7,912,072 for Fiscal 1998. Selling, general
and administrative expenses, as a percentage of total operating revenues,
decreased significantly from 65% for Fiscal 1997 to 48% for Fiscal 1998. The
reduction in selling, general and administrative expenses is attributable to the
notable improvements in both the service and collection department policies.
Management's efforts to provide immediate and efficient service to its existing
customer base along with improved collection procedures has resulted in a
decline in bad debt expense from $728,000 or 6% to $184,000 or 1%, as a
percentage of revenues, for Fiscal 1997 and Fiscal 1998, respectively.
Professional fees decreased by approximately $950,000 during Fiscal 1998 as
compared to Fiscal 1997, primarily due to legal expenses of $475,000 incurred in
connection with the preferred stock litigation and the non-cash charge of
$689,000 for consulting fees during Fiscal 1997. Corporate overhead expenses
declined, as a percentage of revenues, from 49% during Fiscal 1997 to 45% for
Fiscal 1998. This decrease reflects efficiencies realized in the Company's
corporate offices, to assimilate newly acquired customers into its customer base
and to support the larger subscriber base. The Company anticipates that its
current level of selling, general and administrative expenses, as a percentage
of sales, will decrease as a result of the Company's continuing strategy to
consolidate the support infrastructure and fully integrate the operations of the
newly acquired companies.
On December 16, 1996, the Company granted to employees non-qualified stock
options at $.30 per share, expiring November 27, 2001, and, on June 27, 1997,
reduced the exercise price of options, granted to certain officers and directors
of the Company from $4.50 to $.03 and, as a result thereof, the Company recorded
compensation expense of $2,032,200 for Fiscal 1997. In addition, the Company
recorded deferred compensation expense of $1,657,500 and $537,541 for Fiscal
1997 and Fiscal 1998, respectively, in connection with two employment contracts
with former officers of USS (see Note 13 of Notes to Consolidated Financial
Statements of the Company).
Amortization and depreciation expenses increased by $1,357,948, or 46%, from
$2,976,433 to $4,334,381 for Fiscal 1997 and Fiscal 1998, respectively. This
increase in amortization and depreciation expense is the result of the Company's
purchase of monitoring contracts totaling approximately $16,200,000 and property
and equipment totaling approximately $3,200,000 (including equipment held for
lease of $819,139) during Fiscal 1998.
30
<PAGE>
During the fourth quarter of Fiscal 1998, the Company recorded nonrecurring
charges totaling $838,581, of which $286,692 has been accrued for by the
Company. The majority of these charges were in connection with management's plan
to reduce costs and improve operating efficiencies for the monitoring and
servicing of its existing customer base. The plan involves the transfer of its
subscriber base to its own central station and the consolidation of the support
infrastructure. At June 30, 1998, nonrecurring charges, consisted of the
following: (i) employee severance and related costs of $693,504, (ii) abandoned
leases of $60,000 and (iii) other restructuring and integration costs of $85,077
(see Note 4 of Notes to Consolidated Financial Statements of the Company).
Interest expense increased by $1,578,130 or 118% for Fiscal 1998, as
compared to Fiscal 1997. On June 30, 1996 through July 3, 1996, the Company
completed a restructuring of its long-term debt. The restructuring resulted in
an extraordinary charge of $2,549,708 for early extinguishment of debt in Fiscal
1997. The Company obtained a $15,000,000 revolving credit facility from Mellon
Bank, N.A. ("Mellon"), which was increased to $15,500,000 on January 14, 1998
and increased to $18,000,000 on February 13, 1998, and issued $7,500,000 of its
1996 Series A Convertible Preferred Stock to institutional and individual
domestic and foreign investors. The proceeds of the financing were utilized to
repay the Company's existing long-term indebtedness. Interest expense on
additional borrowings for acquisitions and working capital accounted for
$628,079 of the increase, with the increase in amortization of deferred
financing costs of $950,051 accounting for the remainder of the increase.
Subsequent to June 30, 1998, the Company entered into the Financing Agreement
with MSCH, (see "--Liquidity and Capital Resources") and satisfied the existing
indebtedness with Mellon.
On March 4, 1997, the Company entered into a joint venture agreement with
BKR, Inc. to acquire a 50% interest in HealthLink Ltd. The equity losses of the
joint venture consists of the Company's share, $123,325 and $436,712, of
HealthLink's losses for Fiscal 1997 and Fiscal 1998, respectively. In the fourth
quarter of Fiscal 1998, the Company decided to discontinue HealthLink's
operations, other than providing monitoring services to existing HealthLink
customers and the Company recorded a non-cash impairment loss of $2,532,772,
related to the write-down of its investment in the joint venture, including
approximately $1,300,000 in goodwill. The Company considered the continued
operating losses of the joint venture, the inability to find a media partner,
and the projected future cash flows from the joint venture to be its primary
indicators of an impairment loss.
The net loss applicable to common shareholders (net loss adjusted for
dividends and accretion on Preferred Stock) for Fiscal 1997 and Fiscal 1998 were
$18,054,144 or ($12.14) per share based on 1,487,574 shares outstanding, and
$12,875,836 or ($3.48) per share based on 3,696,372 shares outstanding,
respectively. The net loss for Fiscal 1998, was $9,665,503 or ($2.61) per share,
as compared to a net loss of $11,177,623 or ($7.51) per share for Fiscal 1997.
The net loss for Fiscal 1998 is primarily attributable to non-cash charges
totaling $9,181,131, consisting of (i) depreciation and amortization of
$4,334,381, (ii) compensation--employment contracts of $537,541, (iii)
amortization of deferred financing costs of $1,339,725 and (iv) joint venture
loss of $2,969,484.
Earnings before interest, taxes, depreciation and amortization ("EBITDA"),
excluding charges for: (i) compensation expense--options/employment agreements;
(ii) nonrecurring charges--1998; (iii) loss on joint venture; (iv) loss on debt
extinguishment--1997; (v) loss recognized on available-for-sale securities; (vi)
legal fees incurred in connection with the preferred stock litigation--1997; and
(vii) a non-cash charge for consulting fees--1997, were $1,979,918 for the
Fiscal 1998 as compared to $880,847 for the Fiscal 1997; an improvement of
$1,099,071 or 125%. The significant improvement in the Company's EBITDA is the
result of the Company's ability to assimilate newly acquired monitoring
contracts into the existing customer base without incurring substantial
increases in overhead expenses.
31
<PAGE>
ACCOUNTING DIFFERENCES FOR ACCOUNT PURCHASES AND NEW INSTALLATIONS.
A difference between the accounting treatment of the purchase of subscriber
accounts and the accounting treatment of the generation of new accounts through
direct sales by the Company's sales force has a significant impact on the
Company's results of operations. The costs of monitoring contracts (acquired
either through the Company's dealer program or through acquisition of subscriber
account portfolios) are capitalized and amortized over estimated lives ranging
from 5 to 10 years, on a straight-line basis, for alarm and PERS accounts.
Included in capitalized costs are certain acquisition transition costs
associated with incorporating the purchased subscriber accounts into the
Company's operations, if necessary. Such costs include costs incurred by the
Company in fulfilling the Seller's preacquisition obligations to the acquired
subscribers, such as providing warranty repair services. In contrast, all of the
Company's costs related to the sales, marketing and installation of new alarm
monitoring systems generated by the Company's sales force are expensed in the
period in which such activities occur.
SUBSCRIBER ATTRITION.
Subscriber attrition has a direct impact on the Company's results of
operations, since it affects both the Company's revenues and its amortization
expense. Attrition can be measured in terms of canceled subscriber accounts and
in terms of decreased MRR resulting from canceled subscriber accounts. The
Company experiences attrition of subscriber accounts as a result of several
factors, including relocation of subscribers, adverse financial and economic
conditions and competition from other alarm service companies. In addition, the
Company may lose certain subscriber accounts, particularly subscriber accounts
acquired as part of an acquisition, if the Company does not service those
subscriber accounts successfully or does not assimilate such accounts into the
Company's operations. Subscriber attrition is defined by the Company for a
particular period as a quotient, the numerator of which is equal to the number
of subscribers who disconnect during such period, net of the number of
subscribers during such period (i) resulting from new installations, (ii)
resulting from reconnections from premises previously occupied by subscribers of
the Company or of prior subscribers of the Company, (iii) resulting from
conversions, and (iv) associated with cancelled accounts with respect to which
the Company obtained an account guarantee, and the denominator of which is the
average of the number of subscribers at each month end during such period. MRR
attrition is defined by the Company for a particular period as a quotient, the
numerator of which is an amount equal to gross MRR lost as the result of
canceled subscriber accounts during such period, net of MRR during such period
(i) resulting from new installations, (ii) resulting from upgrades of current
alarm systems, (iii) generated by increases in rates to existing subscribers,
(iv) resulting from the reconnection of premises previously occupied by
subscribers of the Company or of prior subscribers of the Company, (v) resulting
from conversions and (vi) associated with canceled accounts with respect to
which the Company obtained an account guarantee, and the denominator of which is
the average month-end MRR in effect during such period. Although the Company
believes that its formulas of subscriber attrition and MRR attrition are similar
to those used by other security alarm companies, there can be no assurance that
subscriber attrition and MRR attrition, as presented by the Company, are
comparable to other similarly titled measures of other alarm monitoring
companies. During Fiscal 1998, the Company experienced subscriber attrition of
approximately 5% and MRR attrition of approximately 5%.
LIQUIDITY AND CAPITAL RESOURCES
In July 1996, as part of a restructuring of its long-term debt, the Company
obtained a $15,000,000 revolving credit facility from Mellon, which was
increased to $15,500,000 on January 14, 1998 and increased to $18,000,000 on
February 13, 1998; and issued $7,500,000 of its 1996 Series A Convertible
Preferred Stock, par value $1,000 per share (the "Preferred Stock"), to
institutional and individual domestic and foreign investors. The restructuring
resulted in an extraordinary charge of $2,549,708 for early extinguishment of
debt in Fiscal 1997. The proceeds of the financing were utilized to repay the
Company's long-term indebtedness.
32
<PAGE>
Subsequent to June 30, 1998, the Company completed a restructuring of its
long-term debt to Mellon. Pursuant to such restructuring, USS sold the Purchased
Contracts to its newly created, wholly-owned subsidiary, RAC, for aggregate
consideration of $26,000,000 pursuant to the Purchase Agreement. In connection
with such refinancing the Company incurred a charge for loss on debt
extinguishment of approximately $2,600,000, during the quarter ending September
30, 1998. Also on July 30, 1998, in a related transaction, RAC entered into the
Financing Agreement with USS and MSCH. Pursuant to the terms of the Financing
Agreement, RAC received the Initial Loan and granted MSCH a first priority
perfected security interest in the Receivables. KeyBank provided the funds
utilized by MSCH to provide the Initial Loan to RAC. The Initial Loan has a term
of five years and bears interest at a rate of 8% per annum. RAC may finance,
from time to time, up to an additional $24,000,000 pursuant to the Financing
Agreement by pledging additional Purchased Contracts, which it may purchase from
USS pursuant to the Purchase Agreement, to MSCH. A portion of the proceeds from
the Initial Loan was used to repay all outstanding indebtedness of the Company
to Mellon and the remaining amount will be used for acquisitions and general
working capital. In the event of default under the Financing Agreement, MSCH
would be entitled to all amounts derived from the Receivables necessary to
satisfy all outstanding obligations to MSCH under the Financing Agreement.
The Company will record deferred financing costs of approximately
$3,900,000, of which $3,120,000 was paid in cash at the closing and $780,000 was
paid in 119,632 shares of Common Stock. The deferred financing costs will be
amortized over the life of the loan using the effective interest method. The
Company has agreed to file a registration statement to register the sale of the
Fee Shares by MSCH under the Securities Act. The Company has agreed that in the
event the proceeds to be derived by MSCH from the sale of the Fee Shares is less
than $780,000, the Company is obligated to, at its option, pay cash or issue
additional shares equal to the amount of the shortfall, if any.
The Company's working capital decreased by $484,597 from a working capital
deficiency of $1,023,805 to a working capital deficiency of $1,508,402 at June
30, 1998. The Company believes its cash flows from operations will be sufficient
to fund the Company's principal and interest payments on its debt and capital
expenditures, which are the Company's principal uses of cash other than the
acquisitions of portfolios of subscriber accounts.
Net cash provided by operating activities for Fiscal 1998 was $1,164,746, as
compared to net cash used in operating activities of $3,538,693 for Fiscal 1997.
A net loss of $9,665,503 including non-cash transactions totaling $9,598,588,
resulted in net cash used in operating activities in the amount of $66,675. The
non-cash transactions are as follows: (i) depreciation and amortization of
$5,674,104; (ii) compensation expense in connection with employment agreements
of $905,000; (iii) a loss on joint venture of $2,969,484 (see Note 3 of Notes to
Consolidated Financial Statements of the Company); and (iv) a loss recognized on
available-for-sale securities of $50,000. Net cash provided by operating
activities included significant changes in inventory, accounts payable and
accrued expenses and other current liabilities, and deferred revenues totaling
$1,398,987. The increase in inventory of $425,094 is primarily attributable to
the purchase of WanderWatch systems, a monitoring device designed to provide
around-the-clock monitoring of patients that suffer from Alzheimer's disease and
other diseases or injuries which may involve memory loss, in preparation of the
distribution of this new product; and inventory purchased as part of the Triple
A acquisition. Accounts payable and accrued expenses increased by $754,527, due
to costs incurred in connection with the refinancing of the Mellon line of
credit (see Note 15 of Notes to Consolidated Financial Statements of the
Company), accrued employee severance and related costs associated with the
restructuring of the Company, and an increase in accounts payable and accrued
expenses from the daily operations of the recently acquired companies. Deferred
revenues increased by $1,069,554, as a result of the acquisition of
approximately 19,000 subscriber accounts during the current fiscal year.
Net cash used in investing activities for Fiscal 1998 was $14,278,809.
Purchases of monitoring contracts (including purchase holdback payments) and
noncompete covenants accounted for $12,582,817 of the cash used in investing
activities. Other investing activities included the purchase of property and
equipment of
33
<PAGE>
$1,812,030 (including equipment used for rentals in the amount of $819,139), and
proceeds from the sale of marketable securities and equipment of $116,038.
Net cash provided by financing activities was $13,381,652 for Fiscal 1998.
The Company received net proceeds of $17,994,326 from its secondary offering,
after giving effect to underwriter commissions and other expenses of the
offering. Proceeds from the exercise of stock options and warrants totaled
$135,291. The Company, on February 10, 1998, redeemed all of the outstanding
Preferred Stock, including all deemed dividends, totaling $8,676,935. Net
proceeds received from a line of credit of $4,175,000 were used primarily for
the acquisition of monitoring contracts, and expenses incurred in connection
with the secondary offering. Costs incurred in connection with the prior years
refinancing totaled $65,029. Principal payments on long-term debt totaling
$181,001 were made during Fiscal 1998.
Systems filed a petition for reorganization under Chapter 11 of the United
States Bankruptcy Code in October 1987. Systems' Plan of Reorganization became
effective in February 1990 and provided for, among other things, long-term
payments to creditors totaling approximately $2,800,000. As of June 30, 1998
deferred payment obligations to such pre-reorganization creditors totaled
$181,532, which is payable in varying installments through the year 2000.
The Company anticipates transferring all of its subscriber accounts from the
Euclid Monitoring Station to the Triple A Monitoring Station, as well as
incurring additional costs for the integration of the security businesses
totaling approximately $1,000,000, including capital expenditures of
approximately $500,000, during the next twelve months. The Company has no other
material commitments for capital expenditures during the next twelve months and
believes that its current cash and working capital position and future cash flow
from operations will be sufficient to meet its working capital needs for twelve
months.
The Company intends to use borrowings under the Financing Agreement (see
Note 15 of Notes to Consolidated Financial Statements of the Company) together
with the remaining cash flow from operations to continue to acquire monitoring
contracts. Additional funds beyond those currently available could be required
to continue the acquisition program, and there can be no assurance that the
Company will be able to obtain such financing.
INFLATION
The company does not believe that inflation has a material effect on its
operations.
ITEM 7. FINANCIAL STATEMENTS
The response to this Item is submitted as a separate section of this report
commencing on page F-1.
ITEM 8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
34
<PAGE>
PART III
ITEM 9. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The current executive officers and directors of the Company are set forth
below:
<TABLE>
<CAPTION>
NAME AGE POSITION
- ------------------------------ --- -------------------------------------------------
<S> <C> <C>
Richard M. Brooks(1).......... 49 Chief Executive Officer, President, Chief
Financial Officer and Chairman of the Board
Ronald A. Feldman............. 35 Vice President, Chief Operating Officer,
Secretary-Treasurer and Director
Robert L. May................. 41 Executive Vice President and Director
A. Clinton Allen(1)(2)........ 54 Director
Stuart R. Chalfin(1)(2)....... 57 Director
</TABLE>
- ------------------------
(1) Member of Audit Committee
(2) Member of Stock Option and Compensation Committees
Directors are elected to serve until the next annual meeting of stockholders
and until their successors have been elected and have qualified. Directors do
not receive remuneration for their services as such, but may be reimbursed for
expenses incurred in connection therewith, such as the cost of travel to Board
meetings. Officers serve at the pleasure of the Board of Directors until their
successors have been elected and have qualified.
Richard M. Brooks has been Chief Executive Officer and Chairman of the
Company since July 1994, a director of the Company since August 1990, and has
served as the President and Chief Financial Officer of the Company since
February 1990. Mr. Brooks was Chief Operating Officer of the Company from
February 1990 until July 1994. From August 1986 to February 1990, Mr. Brooks was
general counsel to Systems. Mr. Brooks served as Regional Counsel Mid-Atlantic
Region for the Interstate Commerce Commission from May 1979 to March 1983 and
was a senior attorney for the United States Treasury Department from March 1974
to April 1979. Mr. Brooks received his Bachelor of Science Degree in Business
Administration in June 1970 from Temple University, and graduated from Temple
University School of Law in 1973.
Ronald A. Feldman has been a Director and Secretary-Treasurer of the Company
(including one of its subsidiaries prior to its acquisition by the Company)
since August 1990 and Chief Operating Officer since July 1994. He has also
served as the Secretary and Treasurer of Systems from June 1990 and Vice
President of the Company since April 1992. From August 1986 through September
1989, he was the supervisor of Systems' manufacturing operations and supervised
the Company's monitoring activities since March 1987. Mr. Feldman attended
Temple University from 1980 to 1982.
Robert L. May has served as Executive Vice President and Director of the
Company since December 1997. Mr. May also served as President of Triple A, a
security services company since 1981 and President of Triple A Patrol, a company
which provides guards, patrol and alarm response services since 1992 prior to
their acquisition by the Company. Mr. May also serves as director of Integral
Technologies, Inc., an industry software provider, and is the director of the
Central Station Alarm Association. Mr. May has previously served as President of
the Pennsylvania Burglar and Fire Alarm Association and the Alarm Dealers
Association.
A. Clinton Allen has served as a Director of the Company since December
1997. Mr. Allen also serves as Vice Chairman and a director of The DeWolfe
Companies Inc., a home ownership service company, since 1991. Mr. Allen is
Chairman and Chief Executive Officer of A.C. Allen & Company, Inc., an
investment banking consulting firm. Mr. Allen also serves as a director of Swiss
Army Brands, Inc., a distributor of knives, cutlery and watches and is a member
of its Executive Committee, and is a director of
35
<PAGE>
SweetWater, Inc., a water technology company. Mr. Allen also serves as a
director and Vice Chairman of Psychemedics Corporation, a drug testing services
company. Mr. Allen was the first outside director of Blockbuster Entertainment,
was Chairman of its Compensation Committee and served in such capacities until
it was sold to Viacom/Paramount in 1994. Mr. Allen is a party to a one-year
renewable consulting agreement with the Company commencing February 1998. See
"Certain Relationships and Related Transactions".
Stuart R. Chalfin has been a Director of the Company since October 1, 1997.
Since 1975, Mr. Chalfin has been a principal of Fishbein & Company, P.C.,
independent public accountants, where he specializes in advising closely held
businesses and professionals. Mr. Chalfin is affiliated with the Committee on
Relations with Colleges and Universities and the Linda Creed Foundation and is a
member of the American Institute of Certified Public Accountants. Mr. Chalfin is
also a member of the Pennsylvania Institute of Certified Public Accountants,
President of Stuart Financial Corp., a financial services firm and President of
Monitoring Acquisition Corp., a dealer in monthly recurring revenue products.
ITEM 10. EXECUTIVE COMPENSATION
<TABLE>
<CAPTION>
LONG-TERM COMPENSATION
AWARDS
ANNUAL COMPENSATION ---------------------------
--------------------------------------- SECURITIES LONG-TERM
OTHER ANNUAL RESTRICTED UNDERLYING INCENTIVE
SALARY BONUS COMPENSATION STOCK OPTIONS/ PLAN
NAME AND PRINCIPAL POSITION YEAR ($) ($) ($)(1) AWARD(S) SARS (#) PAYOUTS
- --------------------------------- ---- ---------- --------- ------------ ------------ ------------ ------------
<S> <C> <C> <C> <C> <C> <C> <C>
Richard M. Brooks,............... 1998 $ 231,731 -- -- -- 87,500 --
President, Chief Executive 1997 $ 220,673 -- -- -- 236,111 --
Officer and Chief Financial 1996 $ 217,980 -- -- -- -- --
Officer
Ronald A. Feldman,............... 1998 $ 150,096 -- -- -- 37,500 --
Chief Operating Officer, Vice 1997 $ 137,307 -- -- -- 86,689 --
President, Secretary and 1996 $ 135,654 -- -- -- -- --
Treasurer
Robert L. May,................... 1998 $ 51,903 -- -- -- 175,000 --
Executive Vice President
<CAPTION>
ALL OTHER
COMPENSATION
NAME AND PRINCIPAL POSITION ($)
- --------------------------------- -------------------
<S> <C>
Richard M. Brooks,............... --
President, Chief Executive --
Officer and Chief Financial --
Officer
Ronald A. Feldman,............... --
Chief Operating Officer, Vice --
President, Secretary and --
Treasurer
Robert L. May,................... --
Executive Vice President
</TABLE>
- --------------------------
(1) Excludes perquisites and other personal benefits, securities and properties
otherwise categorized as salary or bonuses which in the aggregate, for each
of the officers listed above did not exceed the lesser of either $50,000 or
10% of the total annual salary reported for such person.
OPTION/SAR GRANTS IN LAST FISCAL YEAR
The following table sets forth information concerning options granted to or
held by the Named Executive Officers during the fiscal year ended June 30, 1998:
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-----------------------------------------------------
PERCENT OF
NUMBER OF TOTAL
SECURITIES OPTIONS
UNDERLYING GRANTED TO EXERCISE OR
OPTIONS EMPLOYEES IN BASE EXPIRATION
NAME GRANTED FISCAL YEAR PRICE ($/SH) DATE
- --------------------------------------------------------------------------- ----------- ------------ ------------- -----------
<S> <C> <C> <C> <C>
Richard M. Brooks.......................................................... 87,500 29.2% $ 6.03 02/04/03
Ronald A. Feldman.......................................................... 37,500 12.5% $ 6.03 02/04/03
Robert L. May.............................................................. 175,000 58.3% $ 6.03 02/04/03
</TABLE>
36
<PAGE>
AGGREGATED OPTION/SAR EXERCISES IN LAST FISCAL YEAR AND
FY-END OPTION/SAR VALUES
<TABLE>
<CAPTION>
NUMBER VALUE OF
OF SECURITIES UNEXERCISED IN-
UNDERLYING THE-MONEY
UNEXERCISED OPTIONS/SARS
SHARES VALUE SARS AT FY-END AT FY-END
ACQUIRED ON REALIZED EXERCISEABLE/ EXERCISEABLE/
NAME EXERCISE # ($) UNEXERCISEABLE UNEXERCISEABLE(1)
- ------------------------------------------------- --------------- ----------- ---------------- ---------------------
<S> <C> <C> <C> <C>
Richard Brooks,
President, Chief Executive and Financial
Officer...................................... -- -- 236,111/87,500 $ 1,572,499/$57,750
Ronald A. Feldman,
Chief Operating Officer, Vice President,
Secretary and Treasurer...................... -- -- 86,689/37,500 $ 577,349/$24,750
Robert L. May,
Executive Vice President....................... -- -- 105,000/70,000 $ 69,300/$46,200
</TABLE>
- ------------------------
(1) The value of unexercised options is determined by multiplying the number of
options held by the difference between the closing price of the Common Stock
of $6.69 at June 30, 1998, as reported by the Nasdaq SmallCap Market, and
the exercise price of the options.
EMPLOYMENT AND CONSULTING AGREEMENTS
Mr. Brooks, Mr. Feldman and Mr. May each have employment agreements,
expiring June 30, 2000, June 30, 2000 and February 10, 2001, respectively, to
act in the capacities listed above for the Company. Such agreements provide for
annual base salaries of $275,000, $165,000 and $150,000 for the years ending
June 30, 1998, June 30, 1998 and February 10, 1999, respectively. Under their
employment agreements, Messrs. Brooks, Feldman and May also receive life
insurance, disability, hospitalization, major medical, vacation and other
employee benefits, reimbursement of reasonable business expenses incurred on
behalf of the Company, a non-accountable expense allowance of up to $1,000 per
month, in the case of Mr. Brooks, $500 per month, in the case of Mr. Feldman,
and $1,000, in the case of Mr. May, under certain circumstances and use of
Company-owned vehicles. The employment agreements are terminable only upon
certain circumstances, such as for cause, disability and death, and if
terminated for any other reason, Messrs. Brooks and Feldman shall be entitled to
receive the present value of all compensation and benefits through June 30, 2000
and Mr. May shall be entitled to receive the present value of all compensations
and benefits through February 10, 2001. The Company maintains and is the
beneficiary of key person life insurance policies in the amount of $3,000,000
and $1,000,000 on the lives of Messrs. Brooks and Feldman, respectively.
In addition to cash compensation and other benefits, in connection with
amendments to their employment agreements executed in August 1992, Messrs.
Brooks and Feldman received options to purchase 44,445 and 28,356 shares of
Common Stock, respectively, at a price equal to $11.25. These options are
exercisable until November 14, 2004. Messrs. Brooks and Feldman also received
options to purchase 200,000 and 66,667 shares of Common Stock, respectively,
awarded under the Company's Non-Qualified Stock Option Plan. In November 1995,
the exercise price on Messrs. Brooks' and Feldman's options were reduced to the
prevailing market price of $7.50 and subsequently reduced to $4.50 on June 15,
1997 and to $0.03 on June 27, 1997. During February 1996, Messrs. Brooks and
Feldman both exercised options to purchase 8,334 shares of Common Stock. In
addition, on February 5, 1998, the Company granted options to purchase 87,500
and 37,500 shares of Common Stock to Mr. Brooks and Mr. Feldman, respectively,
at an exercise price equal to $6.03 per share. Such options will vest in three
equal annual installments commencing on the first anniversary of the date of
grant of such options.
37
<PAGE>
In connection with the acquisitions of Triple A and Triple A Patrol and his
employment agreement, Mr. May received options to purchase 175,000 shares of
Common Stock on February 5, 1998 at an exercise price equal to $6.03 per share.
Of such options, 105,000 vested on February 5, 1998 and the remaining 70,000 of
such options will vest in three equal annual installments commencing on the
first anniversary of the date of such grant.
1997 STOCK OPTION PLAN
In October 1997, the Board of Directors of the Company adopted the 1997
Plan, which was subsequently approved by the Company's stockholders on January
6, 1998.
The 1997 Plan provides for the grant of options to purchase up to, but not
in excess of, 600,000 shares of Common Stock to key employees, including but not
limited to officers, directors, agents, consultants and independent contractors
of the Company or any parent or subsidiary of the Company (excluding members of
the Administrator (as defined in the 1997 Plan)), 500,000 of which have been
granted and 100,000 of which are available for grant. Options may be either
"incentive stock options" within the meaning of Section 422 of the Code, or
non-qualified options. Incentive stock options may be granted only to employees
of the Company or a subsidiary of the Company, while non-qualified options may
be issued to non-employee directors, as well as to employees of the Company or
its subsidiary.
The 1997 Plan is administered by a committee selected by the Board of
Directors (the "Administrator"), which determines, among other things, those
individuals who receive options, the time period during which the options may be
exercised, the number of shares of Common Stock issuable upon the exercise of
each option and the option exercise price. Pursuant to the 1997 Plan, the
Administrator determines, among other things, those individuals who receive
options, the time period during which the grants will be made, the number of
shares of Common Stock to be granted and the price (if any) to be paid by such
key employees therefor.
The exercise price per share of Common Stock subject to an incentive option
may not be less than the fair market value per share of Common Stock on the date
the option is granted. The per share exercise price of the Common Stock subject
to a non-qualified option may be established by the Administrator. If the
aggregate fair market value (determined as of the date the option is granted) of
Common Stock for which any person may be granted incentive stock options which
first become exercisable in any calendar year exceeds $100,000, such stock
option shall be treated, to the extent of such excess, as an option which does
not qualify as an incentive stock option. No person who owns, directly or
indirectly, at the time of the granting of an incentive stock option to such
person, 10% or more of the total combined voting power of all classes of stock
of the Company (a "10% Shareholder") shall be eligible to receive any incentive
stock options under the 1997 Plan unless the exercise price is at least 110% of
the fair market value of the shares of Common Stock subject to the option,
determined on the date of grant. Non-qualified options are not subject to such
limitation.
No stock option may be transferred by an optionee other than by will or the
laws of descent and distribution, and, during the lifetime of an optionee, the
option will be exercisable only by the optionee. In the event of termination of
employment other than by death, retirement, permanent and total disability,
unless extended by the Administrator on or before such employee's date of
termination of employment, the optionee will have no more than three months
after such termination during which the optionee shall be entitled to exercise
all or any part of such employee's option, unless otherwise determined by the
Administrator. Upon termination of employment of an optionee by reason of death,
retirement, permanent or total disability, such optionee's options remain
exercisable for one year thereafter to the extent such options were exercisable
on the date of such termination.
Options under the 1997 Plan must be issued within 10 years from the
effective date of the Plan. The effective date of the 1997 Plan is September
1997. Incentive stock options granted under the 1997 Plan cannot be exercised
more than 10 years from the date of grant. Incentive stock options issued to a
10%
38
<PAGE>
Shareholder are limited to five-year terms. All options granted under the 1997
Plan provide for the payment of the exercise price in cash or check or by
delivery to the Company of shares of Common Stock already owned by the optionee
having a fair market value equal to the exercise price of the options being
exercised, or by a combination of such methods, or by such other methods
approved by the Administrator pursuant to the 1997 Plan. Therefore, an optionee
may be able to tender shares of Common Stock to purchase additional shares of
Common Stock and may theoretically exercise all of such optionee's stock options
with no additional investment other than the purchase of the original shares.
Any unexercised options that expire or that terminate upon an employee's
ceasing to be employed by the Company become available again for issuance under
the 1997 Plan.
As of the date hereof, options to purchase 500,000 shares of Common Stock
have been granted pursuant to the 1997 Plan as follows: (i) 75,000 shares of
Common Stock to Mr. Allen, a director, (ii) 175,000 shares of Common Stock to
Mr. May, an officer and director, (iii) 75,000 shares of Common Stock to Mr.
Rubin, a former director, (iv) 25,000 shares of Common Stock to Mr. Luehrs, a
former director, (v) 25,000 shares of Common Stock to Mr. Chalfin, a director,
(vi) 87,500 shares of Common Stock to Mr. Brooks, an officer and director and
(vii) 37,500 shares of Common Stock to Mr. Feldman, an officer and director, all
of which options were granted in February 1998 at an exercise price equal to
$6.03 and are subject to certain vesting requirements. See "Principal
Stockholders."
INCENTIVE STOCK OPTION PLAN
In March 1992, the Company's Board of Directors and stockholders adopted and
approved an Incentive Stock Option Plan ("ISO Plan"). The ISO Plan provides for
the grant to key employees of the Company of stock options intended to qualify
as "incentive stock options" under the provisions of Section 422 of the Internal
Revenue Code of 1986, as amended (the "Code"). A total of 13,334 shares of
Common Stock have been reserved for issuance under the ISO Plan, all of which
shares have been granted as of June 30, 1998.
NON-QUALIFIED STOCK OPTIONS
In August 1990, the Company's Board of Directors approved a Nonqualified
Stock Option Plan (the "NQO Plan") pursuant to which the Company may grant stock
options to directors, officers, key employees and consultants. A total of 3,453
shares of Common Stock were reserved for issuance under the NQO Plan, all of
which shares have been granted as of June 30, 1998.
REDUCTION OF EXERCISE PRICE OF CERTAIN STOCK OPTIONS
On June 15, 1997, the Company reduced the exercise price of options to
purchase 622,800 shares of Common Stock granted to officers, directors, and a
key employee of the Company, from $7.50 to $4.50, or the prevailing market
price. On June 27, 1997, the Company further reduced the exercise price of
options to purchase 422,800 shares of Common Stock granted to officers and
directors of the Company, from $4.50 to $0.03, which resulted in a compensation
expense of $1,889,916.
39
<PAGE>
ITEM 11. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The following table sets forth, as of June 30, 1998, the record and
beneficial ownership of Common Stock of the Company by each officer and
director, all officers and directors as a group, and each person known to the
Company to own beneficially or of record five percent or more of the outstanding
shares of the Company:
<TABLE>
<CAPTION>
AMOUNT AND NATURE PERCENTAGE OF
NAME AND ADDRESS OF BENEFICIAL OUTSTANDING
OF BENEFICIAL OWNER(2) OWNERSHIP(1) STOCK OWNED(3)
- ----------------------------------------------------------------------- ------------------------ ---------------
<S> <C> <C>
TJS Partners, L.P.(4).................................................. 945,550 15.0%
Ariel Management Corp.(5).............................................. 334,800 5.3%
Westar Capital, Inc.(6)................................................ 877,192 13.9%
Richard M. Brooks(7)................................................... 236,772 3.6%
Ronald A. Feldman(8)................................................... 87,356 1.4%
Stuart R. Chalfin(9)................................................... 15,000 *
Robert L. May(10)...................................................... 694,620 10.8%
A. Clinton Allen(11)................................................... 45,000 *
Executive Officers and Directors as a group (five persons)(12)......... 1,078,748 15.9%
</TABLE>
- ------------------------
* Less than one percent.
(1) For purposes of the above table, a person or group of persons is deemed to
have "beneficial ownership" of any shares that such person or group has the
right to acquire within 60 days after such date; and for purposes of
computing the percentage of outstanding shares held by each person or group
on a given date, such shares are deemed to be outstanding, but are not
deemed to be outstanding for the purpose of computing the percentage
ownership of any other person.
Beneficial ownership is determined in accordance with Rule 13d-3 under the
Exchange Act, and is generally determined by voting power and/or investment
power with respect to securities. Except as indicated by footnote, and
subject to community property laws where applicable, the Company believes
that the persons named in the table above have sole voting and investment
power with respect to all shares of Common Stock shown as beneficially owned
by them.
(2) The address for the referenced individuals who beneficially owns 5% or more
of the outstanding Common Stock of the Company is c/o Response USA, Inc.,
11-H Princess Road, Lawrenceville, New Jersey, except for TJS Partners, L.P.
whose address is 115 East Putnam Avenue, Greenwich, Connecticut, Ariel
Management Corp. whose address is 450 Park Avenue, New York, New York and
Westar Capital, Inc. whose address is 1021 Main Street, Suite 1270, Houston,
Texas. Information as to TJS Partners, L.P., Ariel Management Corp. and
Westar Capital, Inc. was derived from the Schedule 13D filed by such
stockholder, and, except for the percentage ownership, reflects the
information contained therein as of the date such 13D was filed.
(3) Individual percentages have been rounded to the nearest 0.1%.
(4) TJS Management, L.P. and Thomas J. Salvatore, in their respective capacities
as general partners of TJS Partners, L.P. (the "Partnership"), and each of
TJS Corporation and Mr. Salvatore, in their respective capacities as general
partners of TJS Management, L.P., may be deemed to own beneficially (as
defined in Rule 13d-3 promulgated under the Securities Act) the shares owned
by the Partnership. Each of such persons disclaims beneficial ownership of
such Shares except to the extent of its or his pecuniary interest therein.
In addition, each of such persons may be deemed to share with the
Partnership the power to vote or direct the vote and to dispose or to direct
the disposition of the Shares owned beneficially by the Partnership.
40
<PAGE>
(5) As the sole shareholder and president of Ariel Management Corp., J. Ezra
Merkin may be deemed to be the beneficial owner of 334,800 shares of Common
Stock, or 5.3% of the outstanding shares of Common Stock.
(6) Westar Security, Inc., Protection One, Inc., Westar Capital, Inc., and
Western Resources, Inc., are affiliated companies and may be collectively
deemed to be the beneficial owners of the Common Stock.
(7) Includes 236,111 shares issuable upon exercise of currently exercisable
options. Does not include 87,500 shares issuable upon exercise of options
granted on February 5, 1998, which options shall vest in three equal annual
installments commencing on the first anniversary of the date of grant of
such options. See "Employment and Consulting Agreements."
(8) Includes 86,689 shares issuable upon exercise of currently exercisable
options. Does not include options to purchase 37,500 shares issuable upon
exercise of options granted on February 5, 1998, which options shall vest in
three equal annual installments commencing on the first anniversary of the
date of grant of such options. See "Employment and Consulting Agreements."
(9) Includes 15,000 shares issuable upon exercise of the vested portion of
options granted. Does not include 10,000 shares issuable upon exercise of
options granted on February 5, 1998, which options shall vest one year from
the date of grant of such options.
(10) Includes 105,000 shares issuable upon exercise of the vested portion of
options granted on February 5, 1998. Does not include 70,000 shares issuable
upon exercise of options granted on February 5, 1998, which options shall
vest in three equal annual installments commencing on the first anniversary
of the date of grant of such options. See "Employment and Consulting
Agreements."
(11) Includes 45,000 shares issuable upon exercise of the vested portion of
options granted on February 5, 1998. Does not include 30,000 shares issuable
upon exercise of options granted on February 5, 1998, which options shall
vest one year from the date of grant of such options.
(12) Includes 487,800 shares issuable upon exercise of currently exercisable
options and the vested portion of options granted on February 5, 1998
referred to in notes (7), (8), (9), (10) and (11) above.
ITEM 12. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Except as described below or under "Directors and Executive Officers of the
Registrant" and "Executive Compensation," the Company has not engaged in any
transactions with individuals who, at the time of such transaction, were
officers, directors, principal stockholders or affiliates thereof during the
three fiscal years ended June 30, 1998.
In connection with the appointment of A. Clinton Allen as a director of the
Company, the Company entered into a one-year renewable consulting agreement with
A.C. Allen & Co., a company owned by Mr. Allen, commencing February 1998,
pursuant to which A.C. Allen & Co. will receive $4,000 per month in
consideration for Mr. Allen providing certain consulting services to the
Company. Such consulting agreement was approved by the Company's independent
directors.
Stuart R. Chalfin, a director of the Company is President of Stuart
Financial Corp. which performed consulting services for the Company in
connection with acquisitions by the Company. To date, Stuart Financial Corp.
received consulting fees in connection with such services in the amount of
$13,500.
The Company intends that all future material affiliated transactions and
loans will be made or entered into on terms that are no less favorable to the
Company than those that can be obtained from unaffiliated third parties and that
all future material affiliated transactions and loans, and any forgiveness of
loans, must be approved by a majority of the Company's independent directors who
do not have an interest in the transactions and who had access, at the Company's
expense, to the Company's or independent legal
41
<PAGE>
counsel. In addition, the Company has agreed to maintain at least two
independent directors on its Board of Directors.
Robert L. May, a director and executive officer of the Company is the
landlord for the Company's leased properties located in Wilkes Barre and Hamlin,
Pennsylvania. During Fiscal 1998, the Company made rental payments to Mr. May in
the amount of $61,667.
42
<PAGE>
PART IV
ITEM 13. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits (numbered in accordance with Item 601 of Regulation S-B).
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- ------------------------------------------------------------------------------------------------
<C> <S> <C>
2(a) Agreement and Plan of Reorganization dated August 9, 1990, by and among the Company (Corsica
Capital Corp.), Management of Corsica Capital Corp. and Lifecall Systems, Inc.(1)
2(b) Plan and Agreement of Merger dated March 18, 1992 by and between Response USA, Inc. (Delaware)
and Lifecall America, Inc.(1)
2(c) Delaware Certificate of Ownership and Merger Merging Response USA, Inc., a Nevada Corporation
with and into its wholly-owned subsidiary Response USA, Inc., a Delaware corporation(1)
2(d) Nevada Articles of Merger of Response USA, Inc. (formerly Lifecall America, Inc.), a Nevada
corporation, into Response USA, Inc., a Delaware corporation(1)
3(a) Certificate of Incorporation of the Company(3)
3(b) Bylaws of the Company(1)
4(a) Form of Common Stock Certificate(1)
4(b) Form of Warrant Agreement(1)
4(c) Form of Class A Warrant Certificate(1)
4(d) Form of Class B Warrant Certificate(1)
4(e) Form of Class C Warrant Certificate(1)
4(f) Form of Preferred Warrant Certificate(2)
4(g) Incentive Stock Option Plan of the Company adopted by the Company's Board on March 18, 1992, and
approved by the Company's stockholders on March 1992(1)
4(h) Restricted Stock Option Plan of the Company adopted by the Company's Board on August 20, 1990,
as amended August 30, 1991, January 2, 1992 and March 18, 1992(1)
4(i) 1997 Stock Option Plan of the Company adapted by the Company's Board in September 1997(3)
10(a) Lifecall Systems, Inc. Third Amended Plan of Reorganization with Order Affirming Third Amended
Plan of Reorganization dated January 9, 1990(1)
10(b) Employment Agreement dated August 28, 1992, by and between the Company and Richard R. Brooks,
and Addendum thereto dated October 1, 1992, as amended(2)
10(c) Employment Agreement dated August 28, 1992, by and between the Company and Ronald A. Feldman,
and Addendum thereto dated October 1, 1992, as amended(2)
10(d) Employment Agreement dated February 10, 1998, by and between the Company and Robert L. May
10(e) Agreement dated as of November 22, 1996 between Sloan Electronics, Incorporated and the
Company(2)
10(f) Asset Purchase Agreement dated October 1, 1997 between the Company and Triple A Security
Systems, Inc.(2)
10(g) Loan and Security Agreement dated as of June 30, 1996 between Mellon Bank, N.A. and the
Company(2)
10(h) Purchase Agreement dated as of March 4, 1997, among BKR, Inc., the Company and HealthLink,
Ltd.(2)
10(i) Operating Agreement of HealthLink, Ltd. dated as of March 4, 1997(2)
10(j) Agreement dated as of June 18, 1997, by and among the Company and the holder of the Preferred
Stock who are signatories thereto and Amendment No. 1 thereto.(3)
</TABLE>
43
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- ------------------------------------------------------------------------------------------------
<C> <S> <C>
10(k) Purchase Agreement dated as of July 30, 1998, between Response Acquisition Corp. and United
Security Systems, Inc. (excluding all exhibits and schedules)(4)
10(l) Receivable Financing Agreement dated as of July 30, 1998, among McGinn, Smith Capital Holdings
Corp., Response Acquisition Corp. and United Security Systems, Inc. (excluding all exhibits
and schedules)(4)
11 Statement re: computation of earnings (loss) per share
21 Subsidiaries of the registrant
27 Financial Data Schedule
</TABLE>
- ------------------------
(1) Incorporated by reference to the Company's Registration Statement on Form
S-1 (registration number 33-47589).
(2) Incorporated by reference to the Company's Annual Report on Form 10-KSB for
the fiscal year ended June 30, 1997.
(3) Incorporated by reference to the Company's Registration Statement on Form
SB-2 (registration number 333-37595).
(4) Incorporated by reference to a Report filed by the Company on Form 8-K dated
July 30, 1998.
(b) Reports on Form 8-K--The Company filed a Report on Form 8-K dated July
30, 1998 in connection with its financing transaction with MSCH; The
Company filed a Report on Form 8-K dated February 11, 1998 in connection
with certain acquisitions; The Company filed a Report on Form 8-K dated
July 2, 1997 in connection with a change of accountants.
44
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
---------
<S> <C>
RESPONSE USA, INC. AND SUBSIDIARIES
Independent Auditors' Report............................................................................... F-2
Consolidated Balance Sheet at June 30, 1998................................................................ F-3
Consolidated Statements of Operations for the Fiscal Years Ended June 30, 1997
and June 30, 1998........................................................................................ F-4
Consolidated Statements of Stockholders' Equity for the Fiscal Years Ended June 30, 1997
and June 30, 1998........................................................................................ F-5
Consolidated Statement of Cash Flows for the Fiscal Years Ended June 30, 1997
and June 30, 1998........................................................................................ F-6
Notes to Consolidated Financial Statements................................................................. F-9
</TABLE>
F-1
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Board of Directors of Response USA, Inc.:
We have audited the accompanying consolidated balance sheet of Response USA,
Inc. and subsidiaries, as of June 30, 1998 and the related consolidated
statements of operations, stockholders' equity and cash flows for the years
ended June 30, 1997 and 1998. These financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures 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 financial statement presents fairly, in all material
respects, the financial position of the Company as of June 30, 1998 and the
results of its operations and cash flows for the years ended June 30, 1997 and
1998 in conformity with generally accepted accounting principles.
DELOITTE & TOUCHE LLP
/s/ Deloitte & Touche LLP
Philadelphia, Pennsylvania
September 16, 1998
F-2
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
JUNE 30, 1998
<TABLE>
<S> <C>
ASSETS
CURRENT ASSETS
Cash....................................................................... $ 966,140
Marketable securities...................................................... 25,000
Accounts receivable
Trade--Net of allowance for doubtful accounts of $547,969.............. 2,338,359
Inventory.................................................................. 1,648,250
Prepaid expenses and other current assets.................................. 581,627
----------
Total current assets............................................... 5,559,376
----------
MONITORING CONTRACT COSTS--Net of accumulated amortization of $8,566,717....... 31,280,805
----------
PROPERTY AND EQUIPMENT--Net of accumulated depreciation and amortization of
$3,102,367................................................................... 2,892,181
----------
OTHER ASSETS
Deferred financing costs--Net of accumulated amortization of $1,594,379.... 2,679,450
Other noncurrent assets.................................................... 275,084
----------
2,954,534
----------
$42,686,896
----------
----------
</TABLE>
<TABLE>
<S> <C>
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Current portion of long-term debt
Notes payable............................................................... $ 682,418
Capitalized lease obligations............................................... 54,194
Accounts payable--Trade....................................................... 917,316
Purchase holdbacks............................................................ 431,378
Accrued expenses and other current liabilities................................ 1,931,419
Deferred revenue.............................................................. 3,051,053
----------
Total current liabilities............................................... 7,067,778
----------
LONG-TERM LIABILITIES--Net of current portion
Long-term debt
Notes payable............................................................... 16,434,961
Capitalized lease obligations............................................... 55,195
Purchase holdbacks............................................................ 169,242
Deferred compensation expense................................................. 2,562,500
----------
19,221,898
----------
COMMITMENTS AND CONTINGENCIES (See Note 13)
STOCKHOLDERS' EQUITY
Common stock--Par value $.008
Authorized 37,500,000 shares
Issued and outstanding 6,317,023 shares................................... 50,537
Additional paid-in capital.................................................... 60,664,468
Accumulated deficit........................................................... (44,317,785)
----------
16,397,220
----------
$42,686,896
----------
----------
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
------------------------------
<S> <C> <C>
1997 1998
-------------- --------------
OPERATING REVENUES
Product sales................................................................... $ 2,938,618 $ 3,310,876
Monitoring and service.......................................................... 9,784,285 12,358,368
Security patrol................................................................. 850,884
-------------- --------------
12,722,903 16,520,128
-------------- --------------
COST OF REVENUES
Product sales................................................................... 1,970,158 2,374,095
Monitoring and service.......................................................... 2,930,137 3,631,796
Security patrol................................................................. 672,247
-------------- --------------
4,900,295 6,678,138
-------------- --------------
GROSS PROFIT...................................................................... 7,822,608 9,841,990
-------------- --------------
OPERATING EXPENSES
Selling, general and administrative............................................. 8,323,761 7,912,072
Compensation--Options/Employment contracts...................................... 3,689,700 537,541
Depreciation and amortization................................................... 2,976,433 4,334,381
Nonrecurring charges (see Note 4)............................................... 838,581
-------------- --------------
14,989,894 13,622,575
-------------- --------------
LOSS FROM OPERATIONS.............................................................. (7,167,286) (3,780,585)
-------------- --------------
OTHER INCOME/(EXPENSE)
Interest expense, net........................................................... (1,337,304) (2,915,434)
Joint venture loss (see Note 3)................................................. (123,325) (2,969,484)
-------------- --------------
(1,460,629) (5,884,918)
-------------- --------------
LOSS BEFORE EXTRAORDINARY ITEM.................................................... (8,627,915) (9,665,503)
EXTRAORDINARY ITEM
Loss on debt extinguishment..................................................... (2,549,708)
-------------- --------------
NET LOSS.......................................................................... (11,177,623) (9,665,503)
Dividends and accretion on preferred stock...................................... (6,876,521) (3,210,333)
-------------- --------------
NET LOSS APPLICABLE TO COMMON SHAREHOLDERS........................................ $ (18,054,144) $ (12,875,836)
-------------- --------------
-------------- --------------
Loss per common share--Basic and diluted
Loss before extraordinary item.................................................. ($5.80) ($2.61)
Extraordinary item.............................................................. ($1.71) $0.00
-------------- --------------
Net loss........................................................................ ($7.51) ($2.61)
-------------- --------------
-------------- --------------
Net loss applicable to common shareholders...................................... ($12.14) ($3.48)
-------------- --------------
-------------- --------------
Weighted average number of shares outstanding..................................... 1,487,574 3,696,372
-------------- --------------
-------------- --------------
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
YEARS ENDED JUNE 30, 1997 AND 1998
<TABLE>
<CAPTION>
UNREALIZED
PREFERRED STOCK PREFERRED STOCK HOLDING
SERIES -A SERIES -B COMMON STOCK LOSSES ON
---------------------- ------------------------ ---------------------- ADDITIONAL AVAILABLE-
NUMBER NUMBER NUMBER PAID-IN FOR-SALE
OF SHARES AMOUNT OF SHARES AMOUNT OF SHARES AMOUNT CAPITAL SECURITIES
----------- --------- --------- ------------- --------- ----------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance--June 30, 1996..... 7,500 $1,605,000 1,284,982 $ 10,280 $24,971,800 ($193,343)
Accretion on preferred
stock.................... 5,895,000
Discount on and deemed
dividends on preferred
stock.................... 876,521
Exercise of stock options
and warrants............. 55,650 445 407,508
Issuance of warrants to
consultants in connection
with the exercise of
warrants................. 689,000
Repricing of stock purchase
warrants................. 2,848,765
Conversion of convertible
subordinated promissory
notes--Net of related
costs of $5,068.......... 3,704 30 44,902
Acquisitions............... 13,900 111 74,889
Issuance of stock
options.................. 2,032,200
Investment in joint
venture.................. 364,721 2,918 3,297,082
Conversion of preferred
stock.................... (610) (618,738) 63,446 508 618,230
Issuance of warrants to
preferred shareholders... 105,000
Issuance of warrants in
connection with the
obtaining of preferred
stock.................... 350,000
Cancellation of common
stock held in escrow..... (16,667) (134) 134
Unrealized holding losses
on available-for-sale
securities............... 193,343
Net loss...................
--
----------- --------- --------- --------- ----------- ---------- -----------
Balance--June 30, 1997..... 6,890 7,757,783 1,769,736 14,158 35,439,510 0
Secondary offering......... 3,268,800 26,150 17,968,176
Exercise of stock
options.................. 19,972 160 135,132
Exercise of warrants by
lender................... 3,069.58 31 107,263 858 (889)
Issuance of common stock to
lender................... 40,000 320 267,180
Issuance of common stock to
consultant............... 15,000 120 89,880
Discount on and deemed
dividends on preferred
stock.................... 2,044,152
Conversion of preferred
stock--Series A.......... (1,000) (1,125,000) 300,000 2,400 1,272,600
Conversion of preferred
stock--Series B.......... (3,069.58) (31) 102,319 819 (788)
Redemption of preferred
stock.................... (5,890) (8,676,935)
Issuance of warrants to
preferred shareholders... 1,016,181
Issuance costs incurred in
connection with the
preferred stock
settlement............... (16,081)
Acquisitions............... 686,898 5,496 4,483,623
Employee bonus............. 1,334 11 9,989
Other...................... 5,701 45 (45)
Net loss...................
--
----------- --------- --------- --------- ----------- ---------- -----------
Balance--June 30, 1998..... 0 $ 0 0 $ 0 6,317,023 $ 50,537 $60,664,468 $ 0
--
--
----------- --------- --------- --------- ----------- ---------- -----------
----------- --------- --------- --------- ----------- ---------- -----------
<CAPTION>
ACCUMULATED
DEFICIT TOTAL
------------ ----------
<S> <C> <C>
Balance--June 30, 1996..... ($13,387,805) $13,005,932
Accretion on preferred
stock.................... (5,895,000) 0
Discount on and deemed
dividends on preferred
stock.................... (876,521) 0
Exercise of stock options
and warrants............. 407,953
Issuance of warrants to
consultants in connection
with the exercise of
warrants................. 689,000
Repricing of stock purchase
warrants................. 2,848,765
Conversion of convertible
subordinated promissory
notes--Net of related
costs of $5,068.......... 44,932
Acquisitions............... 75,000
Issuance of stock
options.................. 2,032,200
Investment in joint
venture.................. 3,300,000
Conversion of preferred
stock.................... 0
Issuance of warrants to
preferred shareholders... (105,000) 0
Issuance of warrants in
connection with the
obtaining of preferred
stock.................... 350,000
Cancellation of common
stock held in escrow..... 0
Unrealized holding losses
on available-for-sale
securities............... 193,343
Net loss................... (11,177,623) (11,177,623)
------------ ----------
Balance--June 30, 1997..... (31,441,949) 11,769,502
Secondary offering......... 17,994,326
Exercise of stock
options.................. 135,292
Exercise of warrants by
lender................... 0
Issuance of common stock to
lender................... 267,500
Issuance of common stock to
consultant............... 90,000
Discount on and deemed
dividends on preferred
stock.................... (2,044,152) 0
Conversion of preferred
stock--Series A.......... (150,000) 0
Conversion of preferred
stock--Series B.......... 0
Redemption of preferred
stock.................... (8,676,935)
Issuance of warrants to
preferred shareholders... (1,016,181) 0
Issuance costs incurred in
connection with the
preferred stock
settlement............... (16,081)
Acquisitions............... 4,489,119
Employee bonus............. 10,000
Other...................... 0
Net loss................... (9,665,503) (9,665,503)
------------ ----------
Balance--June 30, 1998..... ($44,317,785) $16,397,220
------------ ----------
------------ ----------
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CASH FLOWS
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
----------------------------
<S> <C> <C>
1997 1998
------------- -------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net Loss......................................................................... ($ 11,177,623) ($ 9,665,503)
Adjustments to reconcile net loss to net cash provided by (used in) operating
activities
Depreciation and amortization................................................ 2,976,433 4,334,380
Amortization of deferred financing costs and debt discount................... 389,674 1,339,724
(Gain) loss on sale of property and equipment................................ 15,389 (3,657)
Loss on sale of marketable securities........................................ 3,777
Loss recognized on available-for-sale securities............................. 218,343 50,000
Loss on joint venture (see Note 3)........................................... 123,325 2,969,484
Issuance of warrants for consulting fees..................................... 689,000
Compensation expense in connection with the issuance of stock options and
employment agreements...................................................... 3,689,700 905,000
Increase in accounts receivable--Trade....................................... (29,004) (158,140)
Increase in inventory........................................................ (146,263) (425,094)
(Increase) decrease in prepaid expenses and other current assets............. (98,554) 10,021
(Increase) decrease in deposits.............................................. 2,697 (19,327)
Increase in accounts payable--Trade.......................................... 130,672 324,657
Increase (decrease) in accrued expenses and other current liabilities........ (712,877) 429,870
Increase in deferred revenues................................................ 390,395 1,069,554
------------- -------------
Net cash provided by (used in) operating activities...................... (3,538,693) 1,164,746
------------- -------------
CASH FLOWS FROM INVESTING ACTIVITIES
Investment in joint venture...................................................... (12,810)
Proceeds from the sale of marketable securities.................................. 113,138
Purchase of monitoring contracts (net of purchase holdbacks)..................... (3,863,360) (12,562,817)
Purchase of noncompete covenants related to acquisitions......................... (20,000)
Proceeds from the sale of property and equipment................................. 39,864 2,900
Purchase of property and equipment............................................... (636,659) (1,812,030)
------------- -------------
Net cash used in investing activities.................................... (4,472,965) (14,278,809)
------------- -------------
CASH FLOWS FROM FINANCING ACTIVITIES
Proceeds from the secondary offering............................................. 21,247,200
Costs incurred in connection with the secondary offering......................... (3,252,874)
Proceeds from the issuance of preferred stock.................................... 7,500,000
Redemption of preferred stock.................................................... (8,676,935)
Costs incurred in connection with the preferred stock issuance................... (1,012,449) (16,081)
Costs incurred in connection with common stock issuances......................... (34,220)
Deferred financing costs incurred................................................ 22,761 (48,948)
Proceeds of long-term notes payable.............................................. 15,235,000 6,094,673
Principal payments on long-term debt
Notes payable................................................................ (15,292,934) (2,035,553)
Capitalized lease obligations................................................ (82,460) (65,121)
Net proceeds from the exercise of stock options and warrants..................... 447,745 135,291
------------- -------------
Net cash provided by financing activities................................ 6,783,443 13,381,652
------------- -------------
NET INCREASE (DECREASE) IN CASH.................................................... (1,228,215) 267,589
CASH--BEGINNING.................................................................... 1,926,766 698,551
------------- -------------
CASH--ENDING....................................................................... $ 698,551 $ 966,140
------------- -------------
------------- -------------
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash paid during the year for interest........................................... $ 1,280,340 $ 1,568,093
Cash paid during the year for income taxes....................................... -- --
</TABLE>
See notes to consolidated financial statements.
F-6
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
STATEMENT OF CASH FLOWS
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCIAL ACTIVITIES
During Fiscal 1997 and Fiscal 1998, long-term notes payable of $74,028 and
$182,230, respectively, were incurred for the purchase of property and
equipment. Capitalized lease obligations of $143,100 and $31,623 were incurred
for the acquisition of property and equipment for the same comparable periods
ended June 30, 1997 and 1998, respectively.
During Fiscal 1997, convertible subordinated promissory notes of $50,000
were converted to Common Stock. As a result, the Company reduced deferred
financing costs and additional paid-in capital in the amount of $5,068.
During Fiscal 1997, the Company recorded accretion to Preferred Stock in the
amount of $5,895,000 with a corresponding charge to accumulated deficit. The
accretion represents the intrinsic value of the beneficial conversion feature
contained within the Preferred Stock.
During Fiscal 1997, the Company recorded $350,000 as additional paid-in
capital, related to the issuance of warrants to a consultant in connection with
the sale of Preferred Stock.
During Fiscal 1997 and Fiscal 1998, the Company recorded deemed dividends
and accretion on such deemed dividends totaling $876,521 and $2,044,152,
respectively, in connection with the Preferred Stock issuance, with a
corresponding charge to accumulated deficit.
During Fiscal 1997 and Fiscal 1998, $610,000 and $1,000,000 of Preferred
Stock, and $8,738 and $125,000 in deemed dividends and accretion on such deemed
dividends were converted into 63,446 and 300,000 shares of Common Stock,
respectively (see Note 9 of Notes to Consolidated Financial Statements of the
Company).
During Fiscal 1997 and Fiscal 1998, the Company recorded additional paid-in
capital of $105,000 and $1,016,181, respectively, with corresponding charges to
accumulated deficit, to reflect the fair value of the additional warrants issued
to the preferred shareholders (see Note 9 of Notes to Consolidated Financial
Statements of the Company).
During Fiscal 1997, the Company decreased the put obligation payable
associated with warrants issued to the Company's lender and the corresponding
charge to deferred financing costs by $315,155, in connection with the
refinancing at June 30, 1996. On June 24, 1997, the Company, in return for the
holder of the warrants forgiving the put obligation feature, reduced the
exercise price of such warrants from $9.75 to $4.50. In connection with the
repricing of these stock purchase warrants, the Company recorded deferred
financing costs and additional paid-in capital of $2,848,765. On August 13,
1997, the Holder exercised the warrants and received 107,263 shares of Common
Stock and shares of Series B Preferred Stock convertible into 102,319 shares of
Common Stock (see Note 7 of Notes to Consolidated Financial Statements of the
Company).
On February 13, 1998, the Company entered into an amended and restated Loan
and Security Agreement with Mellon increasing the Credit Line to $18,000,000. In
connection with the Company's amended and restated Loan and Security Agreement,
the Company issued 40,000 shares of Common Stock, valued at $267,500, to APT
Holdings Corporation (an affiliate of Mellon), and 15,000 shares of Common Stock
, valued at $90,000, to a consultant (see Note 7 of Notes to Consolidated
Financial Statements of the Company).
See notes to consolidated financial statements.
F-7
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
STATEMENT OF CASH FLOWS (CONTINUED)
SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCIAL ACTIVITIES
(CONTINUED)
During Fiscal 1998, the Company increased monitoring contract costs and the
corresponding transition costs liability (included in accrued expenses and other
current liabilities) in the amount of $90,164.
During Fiscal 1997 and Fiscal 1998, the Company issued 8,333 and 686,664
shares of Common Stock, valued at $75,000 and $4,489,119, respectively, in
connection with acquisitions (see Note 2 of Notes to Consolidated Financial
Statements of the Company).
During Fiscal 1997 and Fiscal 1998, the Company issued 5,567 and 2,900
shares of Common Stock, respectively, pursuant to guarantees of stock
valuations, in connection with past acquisitions of monitoring contracts. The
Company, also, canceled 2,666 shares of Common Stock pursuant to guarantees of
stock valuations, during Fiscal 1998.
During Fiscal 1997 and Fiscal 1998, the Company reduced amounts receivable
and recorded monitoring contract costs in the amount of $154,570 and $4,326,
respectively, in connection with the purchase of monitoring contracts.
During Fiscal 1998, the Company recorded a note payable in the amount of
$200,000 and recorded monitoring contract costs for the same amount, in
connection with an acquisition.
During Fiscal 1997, the Company reduced monitoring contracts and the
corresponding purchase holdbacks in the amount of $306,808.
In March 1997, the Company issued 364,721 shares of Common Stock, valued at
$3,300,000 in connection with a Joint Venture.
During Fiscal 1997, the Company recorded consulting fees in the amount of
$689,000 in connection with the exercise of warrants.
During Fiscal 1998, the Company issued 1,334 shares of Common Stock, valued
at $10,000, as an employee bonus.
See notes to consolidated financial statements.
F-8
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES OF CONSOLIDATION
The accompanying consolidated financial statements include the accounts of
Response USA, Inc., its wholly-owned subsidiaries Response Ability Systems,
Inc., United Security Systems, Inc., Emergency Response Systems, Inc.,
Organization for Enhanced Capability, Inc., and The Jupiter Group, Inc. All
significant intercompany transactions and balances have been eliminated.
Certain amounts in the 1997 annual financial statements have been
reclassified to conform to the 1998 presentation.
NATURE OF BUSINESS AND REVENUE RECOGNITION
The Company is a fully integrated security systems provider engaged in the
monitoring, sale, installation and maintenance of residential and commercial
security systems and PERS. The Company is a regional provider of security alarm
monitoring services for residential and small business subscribers operating in
the states of New York, New Jersey, Pennsylvania, Delaware, Maryland and
Connecticut. The Company provides security patrol services in the northeast
region of Pennsylvania, as a supplement to its alarm monitoring services. The
Company is also a nationwide provider of PERS products which enable individual
users, such as elderly or disabled persons, to transmit a distress signal using
a portable transmitter. Revenues from the sale of PERS are recognized upon
shipment. Revenues under contracts for monitoring and service are deferred and
recognized ratably over the contract period. Revenues from the sale of security
and fire alarm systems are recognized when installed.
The Company leases certain equipment to customers under month-to-month
operating leases, with revenues recognized as income ratably over the lease
terms.
The Company sells extended warranty and product maintenance contracts to its
customers. Revenues from these contracts are deferred and recorded as income
using the straight-line method over the term of the contracts. The Company also
provides for estimated future warranty costs as necessary.
USE OF ESTIMATES
The presentation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
CONCENTRATION OF CREDIT RISK
The Company's products are sold directly and through distributors in the
United States to hospitals, home healthcare agencies and individual consumers.
The Company performs ongoing credit evaluations of its customers and, in the
case of sales-type leases; the leased equipment serves as collateral in the
transactions. The Company maintains reserves for potential credit losses. An
allowance for doubtful accounts is provided by the Company based on historical
collection experience and a review of the current status of existing
receivables.
F-9
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
MARKETABLE SECURITIES
The Company's investments in marketable securities have been categorized as
available-for-sale and are stated at fair value. Realized gains and losses,
determined using the specific identification method are included in operations;
temporary unrealized holding gains and losses are reported as a separate
component of stockholders' equity.
INVENTORY
Inventory is stated at the lower of cost (first-in, first-out method) or
market.
MONITORING CONTRACT COSTS AND AMORTIZATION
Monitoring contracts acquired are stated at cost. The costs of acquired
monitoring contracts includes the costs of accounts purchased and any
contractual rights to related monitoring revenues purchased from alarm system
dealers and emergency response system dealers, and the estimated fair value of
the accounts acquired in business acquisitions, including an accrual for
estimated acquisition transition costs, if necessary. The estimated transition
costs include costs associated with transferring the customers to the Company's
central monitoring station, notification of change in service provider, and
service calls to customer premises. Costs related to sales, marketing and
installation of systems for accounts internally generated are charged to expense
as incurred.
The Company records purchase holdbacks, in connection with its acquisitions
of monitoring contracts, as a liability for delinquent accounts and for future
cancellations within an agreed upon time period. Monitoring contract costs and
the corresponding purchase holdback liabilities are reduced for delinquent
accounts and cancellations as specified in each agreement.
The costs of acquired monitoring contracts purchased from emergency response
system dealers and alarm system dealers are amortized using the straight-line
method over estimated lives ranging from five to ten years. It is the Company's
policy to periodically review actual account attrition and, if necessary, to
adjust downward the remaining estimated lives of acquired account pools to
reflect their anticipated future revenue streams.
PROPERTY AND EQUIPMENT AND DEPRECIATION AND AMORTIZATION
Property and equipment are stated at cost. Expenditures for additions,
renewals and betterments are capitalized; expenditures for maintenance and
repairs are charged to expense as incurred. Upon retirement or disposal of
assets, the cost and accumulated depreciation or amortization is eliminated from
the accounts and any resulting gain or loss is credited or charged to
operations. Depreciation and amortization are provided using the straight-line
method over the estimated useful lives of the assets.
DEFERRED FINANCING COSTS AND AMORTIZATION
Costs incurred in connection with various financing have been deferred;
amortization is provided using the straight-line method over the terms of the
financing, and is included in interest expense.
F-10
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
IMPAIRMENT OF LONG-LIVED ASSETS
The Company reviews long-lived assets and intangibles for impairment
whenever events or changes in circumstances indicate that the carrying value of
the asset may not be recoverable. The Company determines the value of subscriber
accounts based on the cash flows from the MRR stream using the most recent
historical attrition rate.
ACCOUNTING FOR STOCK-BASED COMPENSATION
The Company accounts for transactions in which goods or services are
received in return for the issuance of equity instruments based on the fair
value of the equity instruments or the goods or services received, whichever is
more reliably measured.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1997, the FASB issued SFAS NO. 130, REPORTING COMPREHENSIVE INCOME.
This statement, which establishes standards for reporting and disclosure of
comprehensive income, is effective for interim and annual periods beginning
after December 15, 1997, although earlier adoption is permitted.
Reclassification of financial information for earlier periods presented for
comparative purposes are required under SFAS NO. 130. As this statement only
requires additional disclosures in the Company's financial statements, its
adoption will not have any impact on the Company's financial position or results
of operations. The Company expects to adopt SFAS NO. 130 effective for the year
beginning July 1, 1998.
In June 1997, the FASB issued SFAS NO. 131, DISCLOSURES ABOUT SEGMENTS OF AN
ENTERPRISE AND RELATED INFORMATION. This statement, which establishes standards
for the reporting of information about operating segments and requires the
reporting of selected information about operating segments in financial
statements, is effective for fiscal years beginning after December 15, 1997,
although earlier application is permitted. Reclassification of segment
information for earlier periods presented for comparative purposes are required
under SFAS NO. 131. As this statement only requires additional disclosures in
the Company's financial statements, its adoption will not have any impact on the
company's financial position or results of operations. The Company expects to
adopt SFAS NO. 131 effective for the year beginning July 1, 1998.
In June 1998, the FASB issued SFAS NO. 133, ACCOUNTING FOR DERIVATIVE
INSTRUMENTS AND HEDGING ACTIVITIES. This statement, which establishes accounting
and reporting standards for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities, is
effective for all interim and annual periods beginning after June 15, 1999. This
statement, which the Company will adopt for the year beginning July 1, 1999, is
not expected to have a material impact on the Company's financial position or
results of operations.
INCOME TAXES
The liability method is used in accounting for income taxes. Under this
method, deferred tax assets and liabilities are determined based on differences
between financial reporting and tax bases of assets and liabilities and are
measured using enacted tax rates and laws that will be in effect when the
differences are expected to reverse. Also, the tax benefits resulting from the
utilization of net operating loss carryforwards are recorded as ordinary income.
A valuation allowance is established for deferred tax assets not expected to be
realized.
F-11
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
INCOME TAXES (CONTINUED)
Principal differences between the Company's financial reporting and tax
bases include accounts receivable reserves, inventory reserves, depreciation and
amortization of property and equipment, amortization of capitalized costs, and
deferred revenue.
LOSS PER COMMON SHARE
Loss per common share is computed based on the weighted average number of
common shares outstanding during each period after deducting dividends and
accretion on preferred stock.
In January 1998, the Board of Directors and Stockholders authorized and
approved a one-for-three reverse stock split (the "Reverse Stock Split"). The
Reverse Stock Split became effective on the 9th of January 1998 (see Note 10).
The loss per common share gives effect to this transaction effective as of July
1, 1996.
In February 1997, the FASB issued SFAS No. 128, EARNINGS PER SHARE, which
was adopted by the Company effective for the year ended June 30, 1998, as
required by the statement. For the years ended June 30, 1998 and 1997, the
potential common shares have an antidilutive effect on the computation of
diluted loss per common share, and have, therefore, been excluded. Accordingly,
diluted loss per common share has not been presented.
The following table summarizes those securities that could potentially
dilute loss (earnings) per common share for common shareholders in the future
that were not included in determining loss per common share, as the effect is
antidilutive.
<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1998 1997
---------- ----------
<S> <C> <C>
Potential Common Shares resulting from:
Stock options..................................................... 1,159,681 679,653
Warrants.......................................................... 2,008,760 1,972,222
Convertible preferred stock....................................... 1,396,000
---------- ----------
3,168,441 4,047,875
---------- ----------
---------- ----------
</TABLE>
2. ACQUISITIONS
During Fiscal 1997, the Company purchased monitoring contracts for an
aggregate of $4,168,525. As consideration, the Company paid $3,424,712 in cash,
reduced amounts receivable by $154,570, incurred acquisition costs of $104,941,
recorded purchase holdbacks of $409,302 (which are payable over periods of up to
twenty-four months based on performance guarantees of the seller), and issued
8,333 shares of its common stock valued at $75,000.
On February 11, 1998, the Company acquired substantially all of the assets
of Triple A. Triple A is engaged in the installation, servicing and monitoring
of electronic security systems. In consideration of the acquisition of
approximately 14,000 subscriber accounts, the Company paid Triple A an aggregate
of $13,056,650, consisting of $10,061,577 in cash (including acquisition costs
incurred of $61,577) and 460,780 shares of its common stock, valued at
$2,995,073; additionally the Company assumed certain liabilities
F-12
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACQUISITIONS (CONTINUED)
totaling $1,142,664. The purchase price was allocated based on the fair market
value of the assets acquired and liabilities assumed.
On February 11, 1998, the Company acquired all of the outstanding stock of
Triple A Patrol, a patrol service company. Robert L. May, the sole stockholder
of Triple A, was an 80% shareholder of Triple A Patrol. Triple A Patrol's
services are principally supplied in areas in which the Company is a substantial
provider of security systems services. The patrol service supplements the
Company's alarm monitoring service by providing routine patrol of a subscriber's
premises and neighborhood, response to alarm system activation's and "special
watch" services, such as increased surveillance when the customer is on
vacation. In consideration of the acquisition, the Company issued 161,050 shares
of Common Stock, valued at $1,040,107, subject to adjustment. The purchase price
was allocated based on the fair market value of the assets acquired and
liabilities assumed.
The following unaudited pro forma combined operating information for the
years ended June 30, 1998 and 1997 gives effect for the following: (i) the
Company's acquisitions of Triple A and Triple A Patrol, and (ii) the issuances
of Common Stock for the acquisitions of Triple A and Triple A Patrol and the
conversion and redemption of Preferred Stock (see Notes 9 and 10) as if all such
transactions had occurred on July 1, 1996. The pro forma information is based on
the historical financial statements of the Company, Triple A, and Triple A
Patrol, giving effect to the purchase method of accounting.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED JUNE 30,
----------------------------
<S> <C> <C>
1997 1998
------------- -------------
Operating revenues............................................. $ 19,503,250 $ 21,403,533
Loss before extra-ordinary item................................ (9,360,995) (10,013,221)
Net loss....................................................... (11,910,703) (10,013,221)
Net loss per common share...................................... ($ 2.09) ($ 1.63)
Weighted average number of shares outstanding.................. 5,695,276 6,147,828
</TABLE>
The unaudited pro forma combined operating information may not be indicative
of the results that actually would have occurred, or the results that may be
obtained in the future, if the transactions described above had occurred on July
1, 1996.
During the year ended June 30, 1998, the Company acquired additional
monitoring contracts for an aggregate purchase price of $3,723,189. As
consideration, the Company paid $2,695,331 in cash, including acquisition and
assimilation costs of $172,653, a note payable in the amount of $200,000 payable
over two years, issued 64,834 shares of the Company's common stock valued at
$453,939, recorded purchase holdbacks of $279,429 (which are payable over
periods of up to two years based on performance guarantees of the seller),
accrued transition costs of $90,164, and reduced accounts receivable in the
amount of $4,326. The purchase price was allocated based on the fair market
value of the assets acquired and liabilities assumed. The pro forma effects of
these acquisitions are not considered material.
3. INVESTMENT IN JOINT VENTURE
On March 4, 1997, the Company entered into a purchase agreement with BKR,
Inc. ("BKR"), a Nevada corporation and HealthLink. The parties agreed to the
purchase by the Company of a 50% interest in the assets of BKR, the contribution
of BKR's remaining 50% interest in the assets to HealthLink, and the
contribution of the Company's 50% interest in BKR's assets to HealthLink.
F-13
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENT IN JOINT VENTURE (CONTINUED)
HealthLink is engaged in the sale and monitoring of PERS to the general public
primarily through national retail and pharmacy chains. In consideration of the
Joint Venture, the Company issued 364,721 shares of Common Stock, valued at
$3,300,000, to BKR for their 50% interest in HealthLink.
At the date of the Company's investment in HealthLink, the investment in
HealthLink exceeded the Company's share of the underlying net assets by
$1,500,000. The excess was being amortized by the straight-line method over 10
years.
The Company's investment in HealthLink at June 30, 1998 is summarized as
follows:
<TABLE>
<S> <C>
Initial Investment.............................................. $3,312,809
Equity in net losses of HealthLink -- Fiscal 1997............... (123,325)
Equity in net losses of HealthLink -- Fiscal 1998............... (436,712)
Cumulative amortization of Goodwill............................. (220,000)
Impairment of long lived asset.................................. (2,532,772)
---------
$ 0
---------
---------
</TABLE>
In the fourth quarter of fiscal 1998, the Company recorded a non-cash
impairment loss of $2,532,772, related to the write-down of its investment in
the joint venture, including approximately $1,300,000 in goodwill. The Company
considered the continued operating losses of the joint venture, the inability to
find a media partner, and the projected future cash flows from the joint venture
to be its primary indicators of an impairment loss.
BKR, as part of the purchase agreement, is entitled to exercise warrants to
purchase shares of the Company's common stock subject to the following
provisions: (i) for each 10,000 PERS placed on-line by HealthLink, 10,000 shares
of Common Stock may be purchased at an exercise price of $9.00 per share, and
(ii) in no event shall such warrant be exercisable to purchase more than 150,000
shares of Common Stock. This warrant may be exercised in whole or in part at any
time, or from time to time, commencing on March 4, 1997 and expiring on March 3,
2002.
F-14
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. INVESTMENT IN JOINT VENTURE (CONTINUED)
The following summary of financial data has been derived from the unaudited
Financial Statements of HealthLink for the four months ended June 30, 1997 and
the year ended June 30, 1998:
<TABLE>
<CAPTION>
JUNE 30,
--------------------------
1997 1998
------------ ------------
<S> <C> <C>
Operating Revenues.................................................................... $ 305,750 $ 106,830
Cost of Revenues...................................................................... 192,059 76,446
------------ ------------
Gross Profit.......................................................................... 113,691 30,384
Selling, general and administrative expenses.......................................... 335,962 865,604
Interest Expense...................................................................... 4,380 38,203
------------ ------------
Net Loss.............................................................................. $ (246,651) $ (873,423)
------------ ------------
------------ ------------
Current Assets........................................................................ $ 117,870 $ 7,012
Working capital (deficiency).......................................................... (117,391) (600,719)
Total Assets.......................................................................... 3,568,176 3,067,223
Current Liabilities................................................................... 235,261 607,731
Stockholders' Equity.................................................................. 3,332,915 2,459,492
</TABLE>
4. NONRECURRING CHARGES
During the fourth quarter of Fiscal 1998, the Company recorded nonrecurring
charges totaling $838,581. The majority of these charges were in connection with
management's plan to reduce costs and improve operating efficiencies for the
monitoring and servicing of its existing customer base. The plan involves the
transfer of its subscriber base to its own central station and the consolidation
of its support infrastructure. At June 30, 1998, the Company has recorded an
accrual in the amount of $286,692, which is primarily for severance and related
costs.
As of June 30, 1998, nonrecurring charges consisted of the following:
<TABLE>
<S> <C>
Employee severance and related costs.............................. $ 693,504
Abandoned leases.................................................. 60,000
Other............................................................. 85,077
---------
$ 838,581
---------
---------
</TABLE>
5. INVENTORY
As of June 30, 1998, inventory consisted of the following:
<TABLE>
<S> <C>
Parts Inventory................................................. $1,174,528
Finished Goods.................................................. 473,722
---------
$1,648,250
---------
---------
</TABLE>
F-15
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. PROPERTY AND EQUIPMENT
As of June 30, 1998, property and equipment consisted of the following:
<TABLE>
<CAPTION>
ESTIMATED
USEFUL
LIVES
-----------
<S> <C> <C>
Office furniture and equipment...................................... 5 years $ 3,298,293
Equipment held for lease............................................ 5 years 1,619,694
Automotive equipment................................................ 3 years 848,227
Leasehold improvements.............................................. 5 years 228,334
----------- ------------
5,994,548
Less accumulated depreciation and amortization (Includes $692,424
for equipment held for lease)..................................... 3,102,367
------------
$ 2,892,181
------------
------------
</TABLE>
7. LONG-TERM NOTES PAYABLE
LINE OF CREDIT AGREEMENT
<TABLE>
<S> <C>
Note payable with interest only due through February 28, 1999 at prime plus
1 3/4% on the outstanding loan balance and the reduction in principal in the
amount of $250,000 per quarter, thereafter; a commitment fee of .5% is
payable on the average daily-unused credit; collateralized by all assets of
the Company.................................................................. $16,410,000
</TABLE>
EQUIPMENT FINANCING
<TABLE>
<S> <C>
Payable in monthly installments aggregating $17,621 including interest at rates
ranging from 2.94% to 11.83%; final payments due October, 1998 through
August, 2002; collateralized by related equipment............................ 387,681
</TABLE>
REORGANIZATION DEBT
<TABLE>
<S> <C>
As part of the 1990 plan of reorganization of a 1987 bankruptcy, the U.S.
Bankruptcy Court approved a 30.5% settlement on the total unsecured claims
submitted; payments are due March 1 of each year, as follows: 3% ($86,817)
each year--1999 through 2000; interest imputed at 14%; net of imputed
interest of $30,676.......................................................... 142,958
Federal priority tax claims payable in annual installments of $2,211 through
March, 1999, and $1,896 thereafter........................................... 7,898
</TABLE>
OTHER
<TABLE>
<S> <C>
Notes payable in monthly installments aggregating $9,046 including interest at
8%; final payments due March 2000; collateralized by related monitoring
contracts.................................................................... 168,842
----------
17,117,379
Less Current Portion........................................................... 682,418
----------
$16,434,961
----------
----------
</TABLE>
F-16
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. LONG-TERM NOTES PAYABLE (CONTINUED)
Principal payments on long-term notes payable for the next five years are
due as follows: Years ending June 30, 1999-$682,418; 2000-$1,261,361;
2001-$1,056,202; 2002-$1,039,210; 2003-$1,001,522.
On June 30, 1996, the Company entered into a four-year $15,000,000 revolving
bank line of credit agreement, which was increased to $15,500,000 on January 14,
1998 and increased to $18,000,000 on February 13, 1998 (see below). Loans
outstanding bear interest at prime plus 1 3/4%, are collateralized by all assets
of the Company, and are subject to certain restrictive covenants. The agreement
also provides for a commitment fee payable monthly in arrears, of .5% based on
the average daily-unused credit. As of June 30, 1998, the Company has available
on its revolving credit facility the amount of $1,590,000.
With the proceeds received from the issuance of preferred stock (see Note 9)
and a $10,500,000 advance on July 1, 1996, from a line of credit, the Company
paid off notes payable with balances aggregating $12,072,668 at June 30, 1996
plus a prepayment penalty. The prepayment penalty of $2,415,877 and unamortized
deferred financing costs of $133, 831 associated with the notes paid have been
recorded as an extraordinary item during the year ended June 30, 1997.
In connection with obtaining the line of credit, the Company issued a stock
purchase warrant (the "Warrant") to an affiliate of the bank which provided the
line of credit. The terms of this Warrant, which were subsequently modified (see
below), included the following: (i) number of shares, 344,045; (ii) exercise
price, $9.75 per share; (iii) expiration date, June 30, 2006; and (iv) put
obligation feature, which the Holder of the warrant can require, during the
period between July 1, 2000 and June 30, 2001 upon 10 days notice, the Company
to purchase the Warrant for the difference between the market price of the
Company's Common Stock and the exercise price times 344,045 shares.
The Company recorded deferred financing costs of approximately $6,800,000
related to this warrant (based on an independent valuation) and a related put
obligation payable amount. The deferred financing costs were originally to be
amortized over the life of the related line of credit (four years) using the
straight-line method. The put obligation and the deferred financing costs were
adjusted quarterly based upon the value (market price less exercise price of the
obligation).
On June 24, 1997, the Company, in return for the holder of the Warrant
forgiving the put obligation feature, reduced the exercise price of the Warrant
to $4.50. This resulted in the Company recording deferred financing costs for
the difference between the fair value of the existing Warrant and the fair value
of the revised Warrant ($2,800,000 based on an independent valuation), crediting
additional paid-in capital for the same amount. The remaining deferred financing
costs will be amortized using the straight-line method over the remaining life
of the line of credit.
Also in connection with this agreement, the Company issued warrants to a
consultant to purchase 33,334 shares of the Company's Common Stock at an
exercise price of $13.50 per share; these warrants expire June 30, 2000. The
value of these warrants ($350,000) is being amortized over four years.
On August 13, 1997 the holder of the Warrant exercised the Warrant and
received 107,263 shares of Common Stock and blank check preferred stock
convertible into 102,319 shares of Common Stock, taking advantage of its noncash
conversion feature whereby the number of shares issued was reduced from 344,045
to 209,582 and no cash was paid by the holder of the Warrant. On March 24, 1998,
such holder converted all of its preferred stock into Common Stock.
On February 13, 1998, the Company entered into an amended and restated Loan
and Security Agreement with Mellon increasing its credit line to $18,000,000.
Pursuant to the restated Loan and
F-17
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. LONG-TERM NOTES PAYABLE (CONTINUED)
Security Agreement, the amended amortization on the outstanding loan balance is
interest only for one year, and the reduction of principal in the amount of
$250,000 per quarter, thereafter. In connection with the Company's amended and
restated Loan and Security Agreement, the Company issued 40,000 shares of Common
Stock, valued at $267,500, to APT Holdings Corporation (an affiliate of Mellon),
and 15,000 shares of Common Stock, valued at $90,000, to a consultant.
The Company was not in compliance with certain covenants as of June 30,
1998, September 30, 1997 and June 30, 1997. On June 18, 1997, October 1, 1997,
and November 13, 1997, Mellon amended certain financial covenants in the Loan
and Security Agreement dated June 30, 1996, as follows: (i) ratio of cash flow
to interest expense; (ii) ratio of senior funded debt to cash flow; (iii) net
income (loss); and (iv) capital expenditures. The Company was in compliance with
the terms of the amended debt covenants at June 30, 1997, and for the interim
quarters through March 31, 1998. Subsequent to June 30, 1998, the Company
entered into the Financing Agreement with MSCH (see Note 15) and satisfied the
existing indebtedness with Mellon.
F-18
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. CAPITALIZED LEASE OBLIGATIONS
The Company leases office furniture and equipment with a cost of $218,339
and a net book value of $150,546 at June 30, 1998, under capital leases. The
following is a schedule by years of future minimum lease payments under these
leases together with the present value of the net minimum lease payments as of
June 30, 1998.
<TABLE>
<CAPTION>
YEAR ENDING JUNE 30,
- ----------------------------------------------------------------------------------
<S> <C>
1999.............................................................................. $ 62,908
2000.............................................................................. 49,654
2001.............................................................................. 3,678
2002.............................................................................. 3,678
2003.............................................................................. 3,372
----------
Total minimum lease payments...................................................... 123,290
Less amount representing interest................................................. 13,901
----------
Present value of net minimum lease payments....................................... $ 109,389
----------
----------
</TABLE>
9. PREFERRED STOCK
In May 1996, the Company authorized the issuance of 7,500 shares of
1996--Series A Convertible Preferred Stock. The Preferred Stock was convertible
into a number of shares of Common Shares determined based on the premium plus
$1,000, divided by the conversion price. The premium equates to an annual ten
percent "deemed" dividend and the conversion price was equal to the lesser of
$15.00 or 80% of the average closing bid price of the Company's Common Stock for
the five days immediately preceding the date of conversion. The holders of the
Preferred Stock were not entitled to receive dividends and have no voting
rights.
Up to fifty percent of the Preferred Stock may have been converted by the
holder beginning 45 days after closing and the balance may have been converted
beginning 70 days after closing. Since the Preferred Stock contained a
beneficial conversion feature at the date of issue, the company allocated a
portion of the proceeds equal to the value of that feature ($5,895,000) to
additional paid-in capital. This amount was amortized over the 70-day minimum
period the preferred shareholders were required to hold the Preferred Stock
before conversion was allowed. The Preferred Stock was then accreted to their
face value by recording $5,895,000 as a charge to accumulated deficit.
The Company, during Fiscal 1997, suspended conversion of its Preferred
Stock, due to the negative impact on the Common Stock price caused by the
unexpectedly large volume of conversion requests. Subsequent to the suspension
of the conversion of the Preferred Stock, the Company reached two separate
settlement agreements with the preferred shareholders.
Pursuant to the terms of the Settlement Agreement, on June 26, 1997, each
Holder other than Halifax Fund, L.P. received 5,000 warrants (the "Preferred
Warrants") to purchase Common Stock of the Company for $6.00 per share for each
100 shares of Preferred Stock held, as of June 26, 1997, an aggregate of 98,166
Preferred Warrants. Fifty percent of said warrants are exercisable after one
year of issuance and the remaining fifty percent are exercisable after two years
from issuance. The Preferred Warrants expire after June 30, 2006. The value of
the Preferred Warrants, $90,000, was recorded as a dividend to the preferred
shareholders.
F-19
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. PREFERRED STOCK (CONTINUED)
On June 30, 1997 the Company reached an agreement with Halifax, L. P. where
the Company agreed to convert the 1,000 shares of Preferred Stock owned by this
group into 300,000 shares of the Company's Common Stock and assisted in locating
a purchaser for the 300,000 shares from the preferred shareholders. The Company
also agreed to reimburse these preferred shareholders $150,000 for legal fees.
In July 1997, the 1,000 shares of Preferred Stock and deemed dividends with a
total book value of $1,125,000 were converted into 300,000 shares of the
Company's Common Stock. As a result, the Company recorded Common Stock of
$2,400, additional paid-in capital of $1,272,600, charged accumulated deficit
$150,000, and reduced the Preferred Stock account for $1,125,000, which included
a reduction of the discount on the outstanding Preferred Stock in the amount of
$25,000. The Company also issued to these former preferred shareholders 5,000
warrants to purchase Common Stock of the Company for $6.00 per share for each
100 shares of Preferred Stock held, an aggregate of 16,667 Preferred Warrants.
Fifty percent of said warrants are exercisable after one year of issuance and
the remaining fifty percent are exercisable after two years from issuance.
In connection with the amendment executed on November 30, 1997, each Holder
received an additional 7,500 Warrants (the "Additional Warrants") for each 100
shares of Preferred Stock held as of November 30, 1997, an aggregate of 147,250
Additional Warrants. The Additional Warrants, which are redeemable by the
Company, are exercisable at a price per share of $10.125 and entitle the holder
thereof to purchase one share of Common Stock per Additional Warrant. The value
of these Additional Warrants, $1,016,181, was recorded as a dividend to the
preferred shareholders. Of such Additional Warrants, fifty percent are
exercisable after December 1, 1998 and fifty percent are exercisable after
December 1, 1999. The Additional Warrants expire after November 30, 2007.
In consideration of the issuance of the Preferred Warrants as amended, and
subject to the terms and conditions set forth in the Settlement Agreement, each
Holder agreed (i) to give its proxy and its consent in favor of the Amendment
and (ii) to refrain from any and all conversions of such Holder's Preferred
Stock, pursuant to the terms of the original Certificate of Designation, until
the earlier of February 12, 1998 or upon the occurrence of defaults on certain
dates. On February 10, 1998, all outstanding shares of Preferred Stock were
redeemed for cash of $8,676,935.
During the years ended June 30, 1998 and 1997, deemed convertible preferred
stock dividends totaling $1,970,528 and $704,271, respectively, were recorded
relating to the Preferred Stock. As a result of the beneficial conversion
feature contained within the preferred stock dividend, the Company recorded a
discount on Preferred Stock in the amount of $73,624 and $172,250, respectively.
10. COMMON STOCK AND ADDITIONAL PAID-IN CAPITAL
In January 1998, the Board of Directors and Stockholders authorized and
approved a one-for-three reverse stock split (the "Reverse Stock Split"). The
Reverse Stock Split became effective on the 9th of January 1998. The Reverse
Stock Split reduced the number of issued and outstanding shares of Common Stock
from 6,637,787 to 2,212,741. The Company amended its Certificate of
Incorporation to increase the authorized number of shares of Common Stock from
12,500,000 to 37,500,000. All share and per share amounts in the accompanying
financial statements have been retroactively restated.
On February 10, 1998, the Company completed a public offering whereby it
issued 3,000,000 shares of its Common Stock, at $6.50 per share. The
underwriters exercised their overallotment option to purchase an additional
268,800 shares of the Company's Common Stock on March 31, 1998. As a result, the
F-20
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK AND ADDITIONAL PAID-IN CAPITAL (CONTINUED)
Company received net proceeds from such offering of approximately $18,000,000,
after giving effect to underwriting discounts and commissions and other expenses
of the offering. The net proceeds from the sale of Common Stock were used for
the acquisition of Triple A (see Note 2), and the reduction of amounts
outstanding under the Credit Line, which amounts were subsequently borrowed to
fund the redemption of the Company's Preferred Stock (see Note 9). In connection
with the offering, the Underwriters received warrants to purchase up to an
aggregate of 300,000 shares of Common Stock, at an exercise price of $9.10.
The Company has a 1992 Incentive Stock Option Plan which provides for the
grant of stock options to key employees of the Company to purchase a maximum of
13,334 shares of Common Stock, all of which have been granted. In addition, the
Company has a 1990 Restricted Stock Option Plan (Amended in March 1992) which
provides for the grant of stock options to officers, directors, employees,
consultants or advisors of the Company to purchase a maximum of 3,453 shares of
Common Stock, all of which have been granted. The Company had issued Incentive
Stock Options to employees in excess of the plan and converted the 9,017
Incentive Stock Options to Non-Qualified Stock Options during Fiscal 1998.
On December 16, 1996, the Company granted 18,783 Non-Qualified Stock Options
("NQO") outside of the Restricted Stock Option Plan at $.30 per share, expiring
November 27, 2001 to employees. As a result, the Company recorded compensation
expense and increased additional paid-in capital in the amount of $142,284. In
addition, the Company granted 8,334 NQO's and 1,334 Incentive Stock Options to
employees at $7.875, the prevailing market price, expiring November 27, 2001.
On June 15, 1997, the Company reduced the exercise price of options for
622,800 shares of Common Stock, granted to officers, directors and a key
employee of the Company, from $7.50 to $4.50, the market price on such date. On
June 27, 1997, the Company further reduced the exercise price of options for
422,800 shares of Common Stock, granted to officers and a director of the
Company, from $4.50 to $.03, which resulted in a compensation expense of
$1,889,916.
The Company has a 1997 Stock Option Plan which provides for the grant of
stock options to key employees of the Company to purchase a maximum of 600,000
shares of Common Stock. On January 6, 1998, and effective February 5, 1998, the
Board of Directors granted incentive stock options to Directors and Officers of
the Company to purchase 500,000 shares of Common Stock at an exercise price
equal to the average of the closing bid and ask prices as quoted on the NASDAQ
Small Cap Market on the effective date of the Company's secondary public
offering, or $6.03, expiring on February 8, 2003. The vesting schedule for the
incentive stock options are as follows: (i) 225,000 options vested as of
February 5, 1998; (ii) 195,000 options will vest at one-third annually on each
anniversary date of grant; and (iii) the remaining 80,000 options vest ratably
over a period of one year from the date of grant. In the event of a change in
control of the Company, all options will vest immediately.
F-21
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK AND ADDITIONAL PAID-IN CAPITAL (CONTINUED)
The following is a summary of stock option activity:
<TABLE>
<CAPTION>
WEIGHTED
OPTION AVERAGE
NUMBER PRICE EXERCISE
OF SHARES PER SHARE(RANGE) PRICE
---------- ------------------- -------------
<S> <C> <C> <C>
Options outstanding at June 30, 1996............................. 669,394 $ 7.50 -$105.00 $ 7.911
Options granted................................................ 28,450 $ .03 -$ 7.875 $ 2.874
Options exercised.............................................. (14,983) $ .30 -$11.625 $ .93
Options canceled or expired.................................... (3,208) $11.625-$105.00 $ 17.688
---------- ------------------- -------------
Options outstanding at June 30, 1997............................. 679,653 $ .03 -$ 13.35 $ 2.061
Options granted................................................ 500,000 $ 6.03 $ 6.03
Options exercised.............................................. (19,972) $ .30 -$ 7.875 $ 6.775
---------- ------------------- -------------
Options outstanding at June 30, 1998............................. 1,159,681 $ .03 -$ 13.35 $ 3.691
---------- ------------------- -------------
---------- ------------------- -------------
Options exercisable at June 30, 1998............................. 918,016 $ .03 -$ 13.35 $ 3.075
---------- ------------------- -------------
---------- ------------------- -------------
</TABLE>
The following table summarizes information about the Company's stock options
outstanding at June 30, 1998:
<TABLE>
<CAPTION>
NUMBER WEIGHTED
OUTSTANDING WEIGHTED AVERAGE
RANGE OF AT JUNE 30, AVERAGE REMAINING EXERCISE
EXERCISE PRICE 1998 CONTRACTUAL LIFE PRICE
- ------------------------------------------ --------------- ----------------- -------------
<S> <C> <C> <C>
$.03 - .30 424,531 77 months $ 0.031
$4.50 200,000 77 months $ 4.500
$6.03 - 7.875 521,400 111 months $ 6.106
$13.35 13,750 85 months $ 13.350
</TABLE>
The Company accounts for the Plans in accordance with Accounting Principles
Board Opinion No. 25, under which no compensation cost has been recognized for
stock option awards. Had compensation cost for the Plans been determined
consistent with Statement of Financial Accounting Standards No. 123, "Accounting
for Stock--Based Compensation" (SFAS123), the Company's pro forma net loss and
loss per share for June 30, 1998 and 1997 would have been as follows:
<TABLE>
<CAPTION>
REPORTED PRO FORMA
------------- -------------
<S> <C> <C>
1998 Net Loss.................................................. $ 9,665,503 $ 10,715,390
1998 Net Loss Applicable to
Common shareholders........................................ $ 12,875,836 $ 13,925,723
1998 Net Loss per Share--Basic and diluted..................... $ 3.48 $ 3.77
1997 Net Loss.................................................. $ 11,177,623 $ 11,368,594
1997 Net Loss Applicable to
Common shareholders........................................ $ 18,054,144 $ 18,245,115
1997 Net Loss per Share--Basic and diluted..................... $ 12.14 $ 12.27
</TABLE>
The fair value of the stock options issued during the fiscal years ended
June 30, 1997 and 1998 ranged from $3.68 to $7.62.
F-22
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. COMMON STOCK AND ADDITIONAL PAID-IN CAPITAL (CONTINUED)
The fair value of options granted under the Plans during Fiscal 1997 and
Fiscal 1998 were estimated on the date of grant using the Black-Scholes option
pricing model with the following weighted average assumptions used:
(i) no dividend yield
(ii) expected volatility of 75% and 79% for 1997 and 1998, respectively
(iii) risk free interest rate of between 5.44% and 6.01%
(iv) expected lives ranging from 2 to 7 years
The following is a summary of warrant activity:
<TABLE>
<CAPTION>
NUMBER EXERCISE PRICE
OF SHARES PER SHARE
---------- ----------------
<S> <C> <C>
Warrants outstanding at June 30, 1996.......................... 1,681,389 $ 4.50-24.00
Warrants issued in connection with preferred stock
litigation................................................... 114,833 $ 6.00
Warrants issued in connection with the Joint Venture........... 150,000 $ 9.00
Warrants exercised in connection with 12% Notes-- Class A...... (30,667) $ 7.50
Warrants exercised in connection with 10% Notes-- Class C...... (10,000) $16.875
---------- ----------------
Warrants outstanding at June 30, 1997.......................... 1,905,555 $ 4.50-24.00
Warrants granted to underwriter................................ 300,000 $ 9.10
Warrants issued to preferred shareholders...................... 147,250 $10.13
Warrants exercised in connection with refinancing.............. (209,582) $ 4.50
Warrants canceled in connection with refinancing............... (134,463) $ 4.50
---------- ----------------
Warrants outstanding at June 30, 1998.......................... 2,008,760 $ 6.00-24.00
---------- ----------------
---------- ----------------
</TABLE>
11. INCOME TAXES
The differences between the provision for income taxes and income taxes
computed using the federal income statutory tax rate are as follows:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
----------------------------
<S> <C> <C>
1997 1998
------------- -------------
Amount computed using the statutory rate........................ ($ 3,800,392) ($ 3,286,271)
Increase (decrease) in taxes resulting from:
Nondeductible expenses........................................ 12,626 13,478
State taxes, net of federal taxes............................. 0 0
Federal tax valuation allowance............................... 3,787,766 3,272,793
------------- -------------
Income taxes (benefit).......................................... $ -- $ --
------------- -------------
------------- -------------
</TABLE>
F-23
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. INCOME TAXES (CONTINUED)
At June 30, 1998, the cumulative temporary differences resulted in net
deferred tax assets or liabilities consisting primarily of:
<TABLE>
<S> <C>
Deferred tax assets:
Capital loss carryover....................................... $ 20,000
Deferred restructuring costs................................. 43,200
Deferred consulting.......................................... 310,600
Deferred compensation........................................ 1,025,000
Other........................................................ 49,330
Accounts receivable reserves................................. 180,576
Inventory reserves........................................... (108)
Property..................................................... 1,441,565
Warranty reserves............................................ 113,305
Accrued vacation accrual..................................... 48,390
Uncollected interest revenue................................. 110,643
Net operating loss carryforwards............................. 8,550,299
-----------
11,892,800
Less valuation allowance..................................... (11,892,800)
-----------
$ 0
-----------
-----------
</TABLE>
For income tax reporting, the Company has net operating loss carryforwards
available to reduce future federal and state income taxes. If not used, the
carryforwards will expire as follows:
<TABLE>
<CAPTION>
YEAR ENDING JUNE 30, FEDERAL STATE
- --------------------------------------------------------------- ------------- -------------
<S> <C> <C>
2000........................................................... $ 1,072,825
2001........................................................... 3,340,647
2002........................................................... 3,206,000
2003........................................................... $ 254,200 3,540,961
2004........................................................... 23,100 2,466,732
2005........................................................... 840,989
2006........................................................... 15,000
2007...........................................................
2008........................................................... 136,300
2009........................................................... 3,605,100 390,100
2010........................................................... 2,997,000 147,800
2011........................................................... 3,504,400 160,100
2012........................................................... 4,925,067 217,357
2013........................................................... 7,093,886 107,509
------------- -------------
$ 22,417,753 $ 15,627,320
------------- -------------
------------- -------------
</TABLE>
The Company's ability to utilize the net operating loss carryforward amounts
disclosed above may be significantly limited under Internal Revenue Code ("IRC")
Section 382 as a result of various changes affecting the Company's capital
structure during 1998 and prior years.
F-24
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
12. PROFIT SHARING PLAN
Effective June 1, 1995, the Company established a qualified profit sharing
plan under section 401(k) of the Internal Revenue Code, covering certain of its
salaried employees. The Company contributes 75% of each participant's elective
deferral up to maximum Company contributions of 3.75% of eligible salaries.
Contributions to the plan by the Company for Fiscal 1997 and Fiscal 1998, were
$36,981 and $92,950, respectively.
13. COMMITMENTS AND CONTINGENCIES
EMPLOYMENT AGREEMENTS
The Company has employment contracts with certain key personnel for terms
expiring through February 2001. At June 30, 1998 these contracts provide for
annual base salaries aggregating $590,000.
The Company entered into an employment contract with the former President of
Triple A for a term expiring February 2001. The contract provides for an initial
base salary of $150,000 with incremental increases pursuant to the employment
agreement. Additional compensation is due annually, provided certain financial
performance criteria are achieved. The Company granted the employee 175,000
incentive stock options, of which, 105,000 options are currently vested, and the
remaining options will vest in three equal annual installments commencing on the
first anniversary of the date of such grant. In the event of a change in control
of the Company, all options will vest immediately.
The Company has employment contracts with two former key employees of USS
for terms expiring March 1999. The contracts provide for initial base salaries
aggregating $240,000 which are subject to incremental increases as determined by
the Board of Directors. Additional compensation is due provided the following
conditions are realized: (i) if the Company increases its net alarm system
subscriber accounts by at least 10,000 accounts before March 1999, the Company
shall pay each employee $1,000,000 less the gross proceeds from the sale or
exercise of their options; (ii) if the Company increases its net alarm system
subscriber accounts by at least 15,000 accounts before March, 1999, the Company
shall pay each employee $1,500,000 less the gross proceeds from the sale or
exercise of their options; (iii) any increases in net alarm systems between
10,000 and 15,000 accounts shall entitle certain employees to a pro rated amount
between $1,000,000 and $1,500,000 as determined in provisions (i) and (ii)
above. At June 30, 1997 and 1998 the increase in net alarm systems exceeded
15,000 accounts. As a result, the Company recorded compensation expense and a
deferred compensation liability at June 30, 1997 and 1998 of $1,657,500 and
$520,625, respectively. The total liability under these agreements was
$2,562,500 at June 30, 1998. Under the employment agreements, such amounts are
to be paid within one year of the expiration date of March 1999. On March 31,
1998, the Company elected to terminate the two employees, effective June 28,
1998. The Company will be required to make payments totaling $178,692, which
have been accrued for at June 30, 1998, in connection with such termination,
during the first quarter of the fiscal year ending June 30, 1999.
CONSULTING AGREEMENT
In April, 1996, the Company entered into a two-year consulting agreement
commencing October, 1996, which provides for a minimum annual fee of $42,000. In
March, 1997, the consulting agreement was terminated. As a result of the
termination of the agreement, the Company recorded a charge of $63,000 to
consulting fees for Fiscal 1997.
F-25
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. COMMITMENTS AND CONTINGENCIES (CONTINUED)
The Company entered into a one-year renewable consulting agreement
commencing on February 1, 1998, with a director of the Company, in which the
director of the Company will receive $4,000 per month in consideration for
providing certain consulting services to the Company.
MONITORING AGREEMENT
In April, 1994, the Company entered into a three-year monitoring agreement,
that automatically renews for successive one year periods unless the Company
gives notice of cancellation six months prior to the renewal date. The agreement
provides for a minimum annual cost of $420,000 plus increases based on the
number of subscribers as defined, for monitoring services previously provided
directly by the Company. Total cost under this agreement was $703,470 and
$758,166 for Fiscal 1997 and Fiscal 1998, respectively.
LEASE COMMITMENTS
The Company leases its facilities and various equipment under operating
leases expiring at various dates through February 2008. The following is a
schedule of future minimum rental payments required under these leases:
<TABLE>
<CAPTION>
YEAR ENDING JUNE 30,
- --------------------------------------------------------------------------------
<S> <C>
1999............................................................................ $ 450,891
2000............................................................................ 230,351
2001............................................................................ 171,442
2002............................................................................ 154,960
2003............................................................................ 154,960
------------
$ 1,162,604
------------
------------
</TABLE>
The leases provide that the Company pay as additional rent taxes, insurance
and other operating expenses applicable to the leased premises. Total rent
expense under all operating leases aggregated $344,117 and $431,662 for Fiscal
1997 and Fiscal 1998, respectively.
OTHER COMMITMENTS
The Company anticipates transferring all of its subscriber accounts from the
Euclid Monitoring Station to the Triple A Monitoring Station, as well as
incurring additional costs for the integration of the security businesses
totaling approximately $1,000,000, including capital expenditures of
approximately $500,000.
CONTINGENCIES
In the normal course of business, the Company is subject to litigation, none
of which is expected to have a material effect on the consolidated financial
position, results of operations or cash flows of the Company.
As part of certain acquisitions and a joint venture, the Company has
guaranteed the value of its common stock at various prices ranging from $6.50 to
$9.05 for periods expiring at various dates through February 2001. As of June
30, 1998, the Company's contingent liabilities under these agreements aggregated
approximately $175,600, which may be settled in cash or by the issuance of
common stock.
F-26
<PAGE>
RESPONSE USA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amount of cash approximates its fair value because of its short
maturity. The carrying amount of marketable securities, none of which are held
for trading purposes, is fair value (see Note 1.)
The carrying amount of the line of credit approximates its fair value
because the interest rates on this obligation approximate market rates.
It was not deemed practicable to estimate the fair value of the
reorganization debt due to the nature of the financing arrangements.
The carrying amount of equipment financing and capitalized lease obligations
approximates its fair value because the interest rates on these obligations
approximate market rates.
15. SUBSEQUENT EVENTS
On July 30, 1998, USS, sold the Purchased Contracts to RAC, for aggregate
consideration of $26,000,000 pursuant to the Purchase Agreement. Also on July
30, 1998, in a related transaction, RAC entered into the Financing Agreement
with USS and MSCH pursuant to which RAC received the Initial Loan and granted
MSCH a first priority perfected security interest in the Receivables. KeyBank
provided the funds utilized by MSCH to provide the Initial Loan to RAC. The
Initial Loan has a term of five years and bears interest at a rate of 8% per
annum. Principal payments on the Initial Loan for the next five years are due as
follows: years ending June 30, 1999--$132,699; 2000--$326,875; 2001--$2,360,609;
2002-- $3,597,866; 2003--$4,545,881. RAC may finance, from time to time, up to
an additional $24,000,000 pursuant to the Financing Agreement by pledging
additional Purchased Contracts which it may purchase from USS pursuant to the
Purchase Agreement to MSCH. A portion of the proceeds from the Initial Loan was
used to satisfy existing indebtedness of the Company and the remaining amount
will be used for acquisitions and general working capital.
In connection with the refinancing the Company will incur a charge for loss
on debt extinguishment of approximately $2,600,000, during the quarter ending
September 30, 1998. In the event of default under the Financing Agreement, MSCH
would be entitled to all amounts derived from the Receivables necessary to
satisfy all outstanding obligations to MSCH under the Financing Agreement.
The Company will record deferred financing costs of approximately
$3,900,000, of which $3,120,000 was paid in cash at the closing and $780,000 was
paid in 119,632 shares of Common Stock. The deferred financing costs will be
amortized over the life of the loan using the effective interest method. The
Company has agreed to file a registration statement to register the sale of the
Fee Shares by MSCH under the Securities Act. The Company has agreed that in the
event the proceeds to be derived by MSCH from the sale of the Fee Shares is less
than $780,000, the Company is obligated to, at its option, pay cash or issue
additional shares equal to the amount of the shortfall, if any.
In September 1998, the Company entered into an agreement pursuant to which,
if consummated, the Company would acquire approximately 10,000 monitored
accounts generating MRR of approximately $250,000 as of May 31, 1998 for total
consideration of approximately $11,250,000 in both cash and the Company's Common
Stock. The Company to be acquired had unaudited gross revenues of approximately
$2,400,000 for its fiscal year ended May 31, 1998 and unaudited total assets of
approximately $2,363,000 at May 31, 1998. The Company is in the process of
conducting a due diligence review and the agreement is subject to a number of
conditions, including the satisfaction of conditions which are dependent upon
third parties, such as the receipt of funds from the Company's lender from
available borrowings under the Company's financing agreement, and there can be
no assurance that such acquisition will be consummated on such terms or at all.
F-27
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this Annual Report on Form
10-KSB to be signed on its behalf by the undersigned, thereunto duly authorized.
<TABLE>
<S> <C> <C>
RESPONSE USA, INC.
By: /s/ RICHARD M. BROOKS
-----------------------------------------
Richard M. Brooks
PRESIDENT, CHIEF EXECUTIVE,
AND FINANCIAL OFFICER AND A DIRECTOR
</TABLE>
Dated: September 28, 1998
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons, which include the Chief
Executive Officer, the Chief Financial Officer and a majority of the Board of
Directors, on behalf of the Registrant and in the capacities and on the dates
indicated:
<TABLE>
<CAPTION>
NAME TITLE DATE
- ------------------------------ -------------------------- -------------------
<C> <S> <C>
President, Chief Executive
and Financial Officer
/s/ RICHARD M. BROOKS and a Director
- ------------------------------ (Principal Executive, September 28, 1998
Richard M. Brooks Financial and Accounting
Officer)
Chief Operating Officer,
/s/ RONALD A. FELDMAN Vice President,
- ------------------------------ Secretary, Treasurer and September 28, 1998
Ronald A. Feldman a Director
/s/ ROBERT L. MAY
- ------------------------------ Executive Vice President September 28, 1998
Robert L. May and a Director
/s/ A. CLINTON ALLEN
- ------------------------------ Director September 28, 1998
A. Clinton Allen
/s/ STUART R. CHALFIN
- ------------------------------ Director September 28, 1998
Stuart R. Chalfin
</TABLE>
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<C> <S>
2(a) Agreement and Plan of Reorganization dated August 9, 1990, by and among the Company (Corsica Capital
Corp.), Management of Corsica Capital Corp. and Lifecall Systems, Inc.(1)
2(b) Plan and Agreement of Merger dated March 18, 1992 by and between Response USA, Inc. (Delaware) and
Lifecall America, Inc.(1)
2(c) Delaware Certificate of Ownership and Merger Merging Response USA, Inc., a Nevada Corporation with and
into its wholly-owned subsidiary Response USA, Inc., a Delaware corporation(1)
2(d) Nevada Articles of Merger of Response USA, Inc. (formerly Lifecall America, Inc.), a Nevada corporation,
into Response USA, Inc., a Delaware corporation(1)
3(a) Certificate of Incorporation of the Company(3)
3(b) Bylaws of the Company(1)
4(a) Form of Common Stock Certificate(1)
4(b) Form of Warrant Agreement(1)
4(c) Form of Class A Warrant Certificate(1)
4(d) Form of Class B Warrant Certificate(1)
4(e) Form of Class C Warrant Certificate(1)
4(f) Form of Preferred Warrant Certificate(2)
4(g) Incentive Stock Option Plan of the Company adopted by the Company's Board on March 18, 1992, and
approved by the Company's stockholders on March 1992(1)
4(h) Restricted Stock Option Plan of the Company adopted by the Company's Board on August 20, 1990, as
amended August 30, 1991, January 2, 1992 and March 18, 1992(1)
4(i) 1997 Stock Option Plan of the Company adapted by the Company's Board in September 1997(3)
10(a) Lifecall Systems, Inc. Third Amended Plan of Reorganization with Order Affirming Third Amended Plan of
Reorganization dated January 9, 1990(1)
10(b) Employment Agreement dated August 28, 1992, by and between the Company and Richard R. Brooks, and
Addendum thereto dated October 1, 1992, as amended(2)
10(c) Employment Agreement dated August 28, 1992, by and between the Company and Ronald A. Feldman, and
Addendum thereto dated October 1, 1992, as amended(2)
10(d) Employment Agreement dated February 10, 1998, by and between the Company and Robert L. May
10(e) Agreement dated as of November 22, 1996 between Sloan Electronics, Incorporated and the Company(2)
10(f) Asset Purchase Agreement dated October 1, 1997 between the Company and Triple A Security Systems,
Inc.(2)
10(g) Loan and Security Agreement dated as of June 30, 1996 between Mellon Bank, N.A. and the Company(2)
10(h) Purchase Agreement dated as of March 4, 1997, among BKR, Inc., the Company and HealthLink, Ltd.(2)
10(i) Operating Agreement of HealthLink, Ltd. dated as of March 4, 1997(2)
10(j) Agreement dated as of June 18, 1997, by and among the Company and the holder of the Preferred Stock who
are signatories thereto and Amendment No. 1 thereto(3)
10(k) Purchase Agreement dated as of July 30, 1998, between Response Acquisition Corp. and United Security
Systems, Inc. (excluding all exhibits and schedules)(4)
10(l) Receivable Financing Agreement dated as of July 30, 1998, among McGinn, Smith Capital Holdings Corp.,
Response Acquisition Corp. and United Security Systems, Inc. (excluding all exhibits and schedules)(4)
</TABLE>
<PAGE>
<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
- ----------- --------------------------------------------------------------------------------------------------------
<C> <S>
11 Statement re: computation of earnings (loss) per share
21 Subsidiaries of the registrant
27 Financial Data Schedule
</TABLE>
- ------------------------
(1) Incorporated by reference to the Company's Registration Statement on Form
S-1 (registration number 33-47589).
(2) Incorporated by reference to the Company's Annual Report on Form 10-KSB for
the fiscal year ended June 30, 1997.
(3) Incorporated by reference to the Company's Registration Statement on Form
SB-2 (registration number 333-37595).
(4) Incorporated by reference to a Report filed by the Company on Form 8-K dated
July 30, 1998.
<PAGE>
Exhibit 10(d)
EMPLOYMENT AGREEMENT
This Employment Agreement (the "Agreement") is made
this 10 day of February, 1998, between ROBERT L. MAY ("Employee")
and RESPONSE USA, INC. (the "Company").
WHEREAS, pursuant to the terms of a certain Asset Purchase
Agreement dated the 30th day of September, 1997, the Company's subsidiary,
United Security Systems, Inc. ("United"), is to acquire substantially all of the
assets of Triple A Security Systems, Inc. ("Triple A") (the "Acquisition");
WHEREAS, it is a condition to the Acquisition that the
Employee enter into this Employment Agreement;
WHEREAS, the Employee was the President of Triple A
prior to the Acquisition; and
WHEREAS, the Company and the Employee desire to set forth,
among other things, the terms and conditions pursuant to which the Employee
shall be employed by the Company.
NOW, THEREFORE, in consideration of the mutual premises herein
contained, and intending to be legally bound hereby, the parties covenant and
agree as follows:
1. Employment.
----------
The Company hereby employs Employee as Executive Vice
President of the Company (or as may be agreed upon in writing by Company and
Employee) for the Employment Term (as such term is
<PAGE>
defined in Section 2 hereof) and Company shall cause United and The Jupiter
Group, Inc. ("Jupiter") to employ Employee as Chief Executive Officer for
the Employment Term, and Employee hereby accepts such employment all upon
the terms set forth herein. Company shall cause Employee to be appointed
or elected to Company's, United's and Jupiter's Boards of Directors for
the Employment Term.
2. Term.
----
The term of Employee's employment by the Company under this
Agreement shall commence on the date hereof and continue for a minimum of three
(3) years (the "Initial Term")and thereafter from year to year, unless sooner
terminated in accordance with Section 7 hereof (the "Employment Term").
3. Services To Be Rendered.
------------------------
The Employee shall devote his full time, ability and attention
to the Company's business during the Employment Term. The Employee will not,
during the Employment Term, without the Company's prior written approval, engage
in any activity requiring him to render any services of a business, commercial
or professional nature to any other person or entity, provided that he shall be
permitted to discharge such civic or community responsibilities as he has
assumed or may assume; provided that such activities do not interfere with the
performance of the Employee's duties hereunder.
The Employee shall perform such executive duties as are
reasonable, appropriate and consistent with his offices.
<PAGE>
Employee shall report only to the Board of Directors of the Company or Richard
M. Brooks ("Brooks") or, in the event that Brooks is not employed by the
Company, to Brooks' successor as Chief Executive Officer ("CEO") of the Company
or, in the event Employee is the CEO, to the Board of Directors of the Company
and to no one else. Except for Brooks and Ronald Feldman ("Feldman"), all
employees of Company, Jupiter and United, and their Affiliates (as defined in
Section 12 hereof) and respective subsidiaries involved in the electronic
security alarm business or guard, patrol or response business, shall report to
Employee pursuant to the organization charts of Company, Jupiter and United
attached as Exhibit A. Subject to written employment agreements in place as of
the date of this Agreement, all such employees shall serve the Company, Jupiter
or United, or their respective Affiliates and subsidiaries, at the discretion of
Employee.
Employee's principal and secondary business offices shall be
at those business premises of Company, Jupiter or United, or their respective
subsidiaries, as Employee shall determine in his discretion.
4. Consideration.
-------------
In consideration of the Employee's services to the Company
hereunder, the Company shall pay to the Employee the amounts set forth below:
4.1. During the Employment Term, the Company
will pay to the Employee the yearly base salary set forth on the
<PAGE>
attached Exhibit B, payable in equal installments in conformance with the
regular payroll practices and dates for salaried personnel of the Company but in
no event less frequently than monthly (the "Base Salary").
4.2. During the Employment Term, the Employee
shall be entitled to deferred compensation in the form of a yearly cash bonus
payment depending upon the financial and other performance criteria outlined on
the attached Exhibit C (the "Deferred Compensation"). All Deferred Compensation
shall be calculated (i) for the initial period commencing on the date of this
Agreement to March 31, 1999, and (ii) for subsequent periods annually as of
March 31 for the preceding twelve (12) months on or before ninety (90) days
after March 31 of each year (the "Determination Date"). Any cash bonus due
pursuant to Exhibit C and the written computations and explanations concerning
amount and entitlement shall be paid and delivered to Employee on or before
thirty (30) days after each Determination Date.
4.3. Except for termination by the Company for
Cause (as defined in Section 7.2.(a)-(e) hereof), or termination by the Employee
pursuant to Section 7.1.(ii) hereof, in the event of any actual or constructive
termination of the Employee's employment hereunder, the Company shall pay to the
Employee (or his estate, personal representative or designee) an amount equal to
the present value (based on a 6% discount factor) of the Base Salary to which
Employee would have been entitled as provided in Section 4.1. hereof, computed
from the date of (i) receipt of any
<PAGE>
notice of termination, or (ii) termination of employment (the "Termination
Date"), whichever is earlier through the end of the term of this Agreement, but
in no event less than the Base Salary to be paid in the final year of this
Agreement, plus the maximum amount of Deferred Compensation payable to Employee
from the Termination Date through the end of the term of this Agreement (the
"Severance Compensation"). In addition to the Severance Compensation, the
Company shall pay or deliver to Employee (a) all Base Salary and Deferred
Compensation earned (on a pro-rata basis) and all unpaid reimbursable expenses
incurred on or before the Termination Date, (b) subject to Section 5.2. hereof,
all benefits of employment for one (1) year after the Termination Date, (c) such
other benefits that may be required under law, (d) all disability and death
payments and benefits due by reason of Employee's death and/or disability
including, without limitation, any insurance proceeds and/or benefits due under
any plan or program maintained by Company (or any of its Affiliates, as such
term is defined in Section 12 hereof), and (e) all life, disability and other
insurance that is assignable or convertible to Employee.
4.4. In the event Employee's employment is
terminated under Section 7.2.(a)-(e) or Section 7.1.(ii) hereof, Company shall
pay or deliver to Employee (i) all amounts due under (a) of Section 4.3 hereof,
(ii) all benefits due under this Agreement or any employee benefit plans and
unpaid as of the Termination Date, (iii) such other benefits that may be
required
<PAGE>
under law, and (iv) all life, disability and other insurance that is assignable
or convertible to Employee.
4.5. In the event Employee's employment is
not renewed, Company shall pay or deliver to Employee all severance and other
compensation, benefits, etc. which are included in any written agreement entered
into by Brooks with Company and any Affiliate, either before or after the date
hereof, all of which provisions shall be deemed incorporated herein by reference
as if set forth in full.
4.6. The Company shall not be entitled under
any circumstances to set off, reduce or delay any payments or benefits due to
Employee pursuant to this Agreement.
4.7. The Company shall pay or perform all
obligations as set forth in this Article 4 when due, but in no event later than
thirty (30) days after the Termination Date.
5. Benefits.
--------
5.1. The Employee will be entitled to receive
such benefits of employment as are provided or made available to Brooks (on no
less favorable terms) for the Employment Term, but in no event less than those
set forth on the attached Exhibit D.
5.2. In the event this Agreement is
terminated or is not renewed before Employee is fully vested under any qualified
benefits plan, Company shall provide and pay for all benefits lost under such
qualified benefits plan until such time as Employee is one hundred percent
(100%) vested.
<PAGE>
6. Stock Option.
------------
In consideration for Employee's entry into this Agreement, the
Company grants to Employee options to purchase 175,000 shares of Common Stock of
Company (the "Option Shares").
(a) Exercise Price. The Option Shares shall be
exercisable at a price per share: six and one-thirty-second
($6 1/32) dollars (the "Exercise Price").
(b) Vesting. 105,000 Option Shares are fully
vested as of the date of this Agreement. 70,000 Option Shares shall fully vest
pursuant to the following schedule: (i) 23,333.33 on the first anniversary date
of this Agreement; (ii) 23,333.33 on the second anniversary date of this
Agreement, and (iii) 23,333.34 on the third anniversary date of this agreement.
(c) Right to Exercise. Employee may exercise any
Option Shares at any time or times after said Option Shares vest pursuant to
this Agreement. Notwithstanding the foregoing, in the event (i) all or
substantially all of the assets of the Company are sold to other than an
Affiliate, (ii) fifty percent (50%) or more of the Company's outstanding common
stock is acquired by any person or entity other than an Affiliate, (iii) the
Company merges with another entity other than an Affiliate, or (iv) Employee's
employment is terminated (or this Agreement is terminated) for other than Cause
(as defined in Section 7.2 of this Agreement), Employee shall be permitted to
exercise any non-
<PAGE>
vested Option Shares effective immediately prior to the event giving rise to the
said right of exercise (the "Right of Acceleration"), on the sole condition that
Employee deliver notice to Company of the election to exercise the Right of
Acceleration at any time or times on or before the date of the closing of any
transaction referred to in (i), (ii) or (iii) of this Section 6(c), or at any
time or times after the termination of Employee's employment or this Agreement
referred to in (iv) of this Section 6(c).
(d) Exercise of Options. To exercise an option,
Employee shall deliver a signed, written notice to Company stating the number of
Option Shares with respect to which the option is being exercised, together with
payment of the Exercise Price therefor. The Exercise Price may be paid in cash
or by check, bank draft or money order payable to the order of the Company or in
such other manner as Company may permit. Upon the exercise of the option in
accordance with this Agreement and collection of the Exercise Price, Company
shall deliver to Employee a certificate or certificates for the Option Shares;
provided, however, that the time of such delivery may be postponed by Company
for such period as may be required for it with reasonable diligence to comply
with any applicable listing requirements of any national securities exchange or
to comply with any state or federal securities laws. The Employee may acquire
such Option Shares pursuant to any cashless exercise program approved by the
Company.
<PAGE>
(e) Transferability of Options. The options granted herein
shall be transferable by Employee in accordance with the terms and conditions
of the Company's 1997 Stock Option Plan.
(f) Securities Registration. The Option Shares have been
registered with the Securities and Exchange Commission as of the date of this
Agreement.
7. Termination.
-----------
7.1. The Employee shall have the right to terminate this
Agreement at any time (i) for Cause upon giving the Company thirty (30) days'
advance written notice and opportunity to cure specifying with particularly
the acts, errors or omissions constituting such Cause, and making specific
reference to this Section 7.1, and (ii) upon giving the Company one hundred
eighty (180) days' advance written notice without Cause. For the purposes of
this Section 7.1, "Cause" shall mean the following:
(a) A material breach by the Company (or any affiliate) of
any provision of (i) this Agreement, (ii) any other agreement between Company
(or any Affiliate) and Employee, or (iii) Company's Personnel or Employee
Manual, as amended from time to time;
(b) Any conviction (or plea of nolo contendere) for fraud
by the Company;
(c) Company's conviction (or plea of nolo contendere) of a
felony;
<PAGE>
(d) The failure of Brooks to continuously be (i) Chairman
of the Board of Directors of Company, (ii) President and CEO of Company, or
(iii) the person to whom Employee exclusively reports;
(e) Company sells all or substantially all of its assets,
merges with another entity which is not controlled by the Company, or 50% or
more of Company's outstanding common stock is acquired by any person or
entity;
(f) Any material change in the working conditions of
Employee;
(g) Any constructive termination of this Agreement; or
(h) The actual or constructive demotion of Employee
including, without limitation, any change in title or authority without
Employee's prior written consent.
7.2. The Company shall have the right to terminate this
Agreement (i) for Cause upon giving the Employee thirty (30) days' advance
written notice and opportunity to cure specifying with particularity the
acts, errors or omissions constituting such Cause, and making specific
reference to this Section 7.2, and (ii) after the Initial Term, upon giving
the Employee one hundred eighty (180) days' advance written notice at any
time without Cause. For the purpose of this Section 7.2, "Cause" shall mean
the following:
(a) Employee's conviction of a crime punishable by
imprisonment of more than one (1) year under the laws of the
<PAGE>
jurisdiction in which convicted which involves theft, embezzlement of funds
or fraud;
(b) Willful misconduct by Employee in the performance of
his duties hereunder, provided that no act or failure to act on Employee's
part shall be considered "willful" unless done or omitted to be done by
Employee in bad faith and without reasonable belief that his action or
omission was in the best interests of the Company;
(c) Subject to local, state and federal laws, chronic (i)
alcoholism, or (ii) illegal substance addiction if such condition materially
impairs or precludes performance of Employee's duties on a regular and
recurrent basis;
(d) Intentional and knowing misappropriation of money or
property of Company by Employee;
(e) Employee's refusal, after written notice to Employee
by the Company's Board of Directors and a reasonable opportunity to cure, to
carry out a written reasonable directive to Employee from the Board of
Directors of Company which related to the performance of his executive duties
as set forth herein and is not unlawful, unethical, inconsistent with his
position or status in Company's management structure as contemplated herein
or which may result in civil or criminal liability of Employee or Company;
(f) Subject to applicable local, state and federal laws,
the total and permanent disability of Employee ("Employee Disability"). For
purposes of this Section 7.2.(f),
<PAGE>
the term "Employee Disability" shall have the same meaning as contained in
any insurance policy maintained by Company which applies to Employee's long
term disability, or, in the absence of such a policy, the inability of
Employee to perform one or more important duties of his office for a period
of more than one hundred eighty (180) consecutive days due to physical,
mental or emotional impairment certified in writing by Employee's medical
doctor or Company's medical doctor specializing in the Employee's specific
physical, mental or emotional impairment and licensed to practice medicine in
the Employee's state of residence; or
(g) Employee's death.
8. Severability.
------------
If any provisions of this Agreement shall be or become illegal or
unenforceable in whole or in part for any reason whatsoever, the parties
hereto agree that any court of appropriate jurisdiction may modify or reform
any such provisions to make it enforceable in such jurisdiction and that the
remaining provisions hereof shall nevertheless be valid and binding.
9. Notices.
-------
All notices, demands or communications ("Notices") between the parties to
this Agreement shall be in writing and shall be deemed to have been duly
given, made and received upon personal delivery, three business days after
mailing if mailed by certified mail, postage prepaid, return receipt
requested, one business day after delivery to a recognized national overnight
courier service (with acknowledgement of receipt required), or one business
day
<PAGE>
after transmission and receipt by facsimile (with automatic confirmation of
receipt by the facsimile transmitting equipment), addressed to the party at
the address set forth below, provided any party may alter the address to
which Notices are directed by giving Notice in conformity herewith.
To The Company:
Response USA, Inc.
11-K Princess Road
Lawrenceville, NJ 08648
Attn: Richard M. Brooks
Fax: (609)896-3535
With a Copy To:
Squadron, Ellenoff, Pleasant &
Sheinfeld, LLP
551 Fifth Avenue
New York, NY 10176
Attn: Joseph B. Volman, Esquire
Fax: (212) 697-6686
To The Employee:
Robert L. May
235 Boyle Road
RR 1, Box 235
Dallas, PA 18612
Fax: (717)639-2322
With a Copy To:
Tannenbaum & Chanin, LLP
1515 Market Street, Tenth Floor
Philadelphia, PA 19102
Attn: Carl S. Tannenbaum, Esquire
Fax: (215)523-5339
10. Waiver.
------
Neither the failure nor any delay on the part of either party to exercise
any right, remedy, power or privilege under this Agreement or at law or in
equity shall operate as a waiver
<PAGE>
thereof, nor shall any single or partial exercise of any right, remedy, power
or privilege with respect to any occurrence be construed as a waiver of any
other right, remedy, power or privilege with respect to any other occurrence.
No waiver by any party to this Agreement of any breach or default of this
Agreement shall be effective unless the same shall be in writing and signed
by the party. No waiver by any party of any breach or default of this
Agreement shall be construed to constitute a waiver of, or consent to, the
present or future breach or default of the same or any other term or
provision hereof.
11. Assignability.
-------------
This is a contract for personal services by the Employee and may not be
assigned by the Employee or the Company without the written consent of the
other party. Subject to the foregoing, this Agreement shall inure to the
benefit of and be binding upon the parties hereto and their respective heirs,
personal representatives, successors and permitted assigns.
12. Affiliated Companies.
--------------------
For the purposes of this Agreement, references to Affiliates of the
Company shall include:
a. Any entity of which fifty percent (50%) or more of its issued
and outstanding common stock is owned directly or indirectly by the Company
and/or any person or entity under common control with Company; or
b. Any person(s) or entity(ies) which owns individually or in the
aggregate, directly or indirectly, fifty
<PAGE>
percent (50%) or more of the Company's issued and outstanding Common Stock.
13. Governing Law, Jurisdiction and Venue.
-------------------------------------
The parties agree that the irrevocable and exclusive jurisdiction and
venue for resolution of any disputes arising out of or from, in connection
with or related to this Agreement shall be either the Court of Common Pleas
of Luzern County, Pennsylvania or the United States District Court for the
Middle District of Pennsylvania.
This Agreement shall not be interpreted in favor of or against either
party on account of such party having drafted or prepared this Agreement or
any section hereof.
This Agreement shall be governed by and construed in accordance with the
laws of the Commonwealth of Pennsylvania, not withstanding any conflicts of
laws doctrines or laws of any jurisdiction to the contrary.
14. Counterparts.
------------
This Agreement may be executed in several counterparts, each of which
shall be an original, but all of which together shall constitute one and the
same agreement.
15. Third Parties.
-------------
Except as expressed in this Agreement, this Agreement is not intended to
give to, nor shall it be construed to confer upon, any third party any rights
or remedies.
<PAGE>
16. Merger and Amendments.
---------------------
This Agreement and the Exhibits attached hereto, each of which is hereby
incorporated herein, set forth all of the promises, covenants, agreements,
conditions and undertakings between the parties hereto relating to the
subject matter hereof and supersedes all prior and contemporaneous agreements
and understandings, inducements or conditions, express or implied, oral or
written, except as herein contained. The express terms hereof control and
supersede any course of performance and/or usage of the trade inconsistent
with any of the terms hereof. This Agreement may not be modified, amended,
altered or supplemented except upon the execution and delivery of a written
agreement executed by both parties hereto.
17. Effect of Headings.
------------------
The headings herein are for convenience only and shall not affect the
construction hereof.
IN WITNESS WHEREOF, each of the parties hereto, intending to be legally
bound hereby, has executed or caused this Agreement to be duly executed on
the date first above written.
RESPONSE USA, INC.
By: /s/ Richard M. Brooks
------------------------------
Richard M. Brooks,
President, Secretary
By: /s/ Robert L. May
------------------------------
Robert L. May
<PAGE>
EXHIBIT 11
COMPUTATION OF LOSS PER SHARE
FOR THE FISCAL YEARS ENDED JUNE 30, 1998 AND 1997
<TABLE>
<CAPTION>
1998 1997
-------------------------------
<S> <C> <C>
Net loss $ (9,665,503) $(11,177,623)
Deduct:
Accretion, discount and dividends on preferred stock 3,210,333 6,876,521
-------------------------------
Net loss applicable to common shareholders $(12,875,836) $(18,054,144)
-------------------------------
Weighted average number of common shares outstanding 3,696,372 1,487,574
===============================
Basic loss per share $ (3.48) $ (12.14)
===============================
Net loss for diluted loss per share computation $ (9,665,503) $(11,177,623)
===============================
Weighted average number of common shares outstanding 3,696,372 1,487,574
Common share equivalent applicable to:
Warrants - Class A 411,127 411,991
Warrants - Class B 493,983 493,983
Warrants - Class C 16,567 17,028
Warrants - Other 882,724 768,796
Stock options 862,446 673,529
Less common stock acquired with net proceeds (2,505,145) (1,629,687)
-------------------------------
Weighted average number of common shares and
common share equivalents used to compute diluted
loss per share 3,858,074 2,223,214
===============================
Diluted loss per share $ (2.51) $ (5.03)
===============================
</TABLE>
<PAGE>
EXHIBIT 21
Subsidiaries of the Company
1. Response Ability Systems, Inc.; incorporated in New Jersey.
2. United Security Systems, Inc.; incorporated in New Jersey.
3. Emergency Response Systems, Inc.; incorporated in Delaware; also does
business in the state of California under the name Personnel Emergency
Response Systems, Inc.
4. MSG Security Systems, Inc.; incorporated in Pennsylvania.
5. Shelton Security, Inc.; incorporated in New Jersey.
6. The Jupiter Group, Inc.; incorporated in Pennsylvania.
7. Organization for Enhanced Capabilities, Inc.; incorporated in
Massachusetts.
8. Liberty Security Systems, Inc.; incorporated in Pennsylvania.
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-END> JUN-30-1998
<CASH> 966
<SECURITIES> 25
<RECEIVABLES> 2,886
<ALLOWANCES> 548
<INVENTORY> 1,648
<CURRENT-ASSETS> 5,559
<PP&E> 5,994
<DEPRECIATION> 3,102
<TOTAL-ASSETS> 42,687
<CURRENT-LIABILITIES> 7,068
<BONDS> 0
0
0
<COMMON> 51
<OTHER-SE> 16,346
<TOTAL-LIABILITY-AND-EQUITY> 42,687
<SALES> 3,311
<TOTAL-REVENUES> 16,520
<CGS> 2,374
<TOTAL-COSTS> 6,678
<OTHER-EXPENSES> 19,507
<LOSS-PROVISION> 184
<INTEREST-EXPENSE> 2,915
<INCOME-PRETAX> (9,666)
<INCOME-TAX> 0
<INCOME-CONTINUING> (9,666)
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (9,666)
<EPS-PRIMARY> (3.48)
<EPS-DILUTED> (3.48)
</TABLE>
