All forward-looking statements and projections attributable to us or persons acting on our behalf apply only as of the date of the particular statement, and are expressly qualified in their entirety by the cautionary statements included in this report and our other filings with the SEC. We undertake no obligation to publicly update or revise forward-looking statements, including any of the projections presented herein, to reflect events or circumstances after the date made or to reflect the occurrence of unanticipated events.
PART I
| Item 1. | Business |
General
Devcon International Corp. (“Devcon” or “the Company”) was incorporated in Florida in 1951 as Zinke-Smith, Inc. and adopted its present name in October 1971. Our stock has been publicly traded on the Nasdaq Global Market System since March 1972. Today, Devcon is a holding company that provides electronic security services.
Until 2004, our primary operations were in the construction and materials industry. Between 2002 and 2004, however, our management engaged in a review of strategic alternatives to enter into new lines of business that had a prospect of providing predictable, recurring revenue. In April 2005, we began a process of reviewing in detail the operations of our materials and construction operations, which were incurring operating losses. This strategic review and shift in operational focus resulted in a series of acquisitions and divestitures which together allowed us to pursue our objective of becoming a large regional provider of electronic security services. The acquisitions and divestitures were as follows:
Acquisitions:
| • | On July 30, 2004, we acquired the issued and outstanding capital stock of Security Equipment Company, Inc., or SEC. |
| • | On February 28, 2005, we acquired certain assets and assumed certain liabilities of Starpoint Limited from Adelphia Communications. |
| • | On November 10, 2005, we acquired the issued and outstanding capital stock of Coastal Security Company. |
| • | On March 6, 2006, we acquired the issued and outstanding capital stock of Guardian International, Inc. |
Dispositions:
| • | On September 30, 2005, we sold our U.S. Virgin Islands ready-mix concrete, aggregates, concrete block and cement materials and supplies business. |
| • | On March 2, 2006, we sold all of the issued and outstanding common shares of Antigua Masonry Products, Ltd., or AMP. |
| • | On May 2, 2006, we sold the fixed assets and substantially the entire inventory of our joint venture assets of Puerto Rico Crushing Company, or PRCC. |
| • | On June 27, 2006, we sold our Boca Raton-based third-party monitoring operations. |
| • | On March 21, 2007, we sold the majority of our construction assets, construction inventory and customer lists of our construction operation. |
| • | On January 10, 2008, we sold all of the issued and outstanding stock of Societe Des Carrieres de Grand Case, or SCGC. |
Our remaining materials subsidiary is St. Maarten Masonry Products NV (“STMMP”), a ready-mix operation located in Sint Maarten, Netherland Antilles. This business is classified as a discontinued operation for all periods presented. On March 30, 2007, the Company’s Board of Directors passed a resolution which authorized management to sell the remaining assets of the construction, materials and utilities operations upon such terms and conditions, including price, as management determines to be appropriate. The Board resolution provided the Company’s management with the authority and commitment to establish a plan to sell these assets which are immediately available for sale. Therefore, in accordance with FASB No. 144, “Accounting for the Impairment and Disposal of Long-Lived Assets (“FASB No. 144”)”, the Company has classified the assets for these discontinued operations as held for sale and the related operations have been treated as discontinued operations for all periods presented.
Electronic Security Services
We are a leading regional provider of electronic security alarm monitoring services, including monitoring of burglary, fire, medical, environmental, video, and security access systems to residential (both single and multi-family homes), financial institutions, industrial and commercial businesses and complexes, warehouses, facilities of government departments and healthcare and educational facilities. We also have wholesale customers, where we monitor security systems on behalf of independent security companies. We believe the electronic security systems monitoring industry presents an attractive opportunity for predictable recurring revenues.
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Our electronic security services operates primarily in the state of Florida and in the New York City metropolitan area. We provide monitoring services to retail, commercial and wholesale customers (where we monitor a third-party security company’s customers). Many commercial customers have multiple accounts with us. We provide monitoring services to our customers from two monitoring facilities:
| Location |
Approximate number of sites monitored |
Primary Customer Types | ||
| Hollywood, FL |
141,843 | Residential, Commercial and Wholesale | ||
| New York, NY |
7,862 | Commercial & Residential |
The electronic security services industry is highly competitive and fragmented and consists of local, regional and national providers. Our business strategy is based on building a leading regional presence. Specifically, we believe that the most effective way to build brand recognition, maximize market share, and boost operating efficiencies is to become a market leader in targeted regions that have favorable long-term demographic trends. We believe that developing a familiar, community-oriented brand is more effective than developing a national brand and will allow us to reach a top market share position in the areas in which we choose to operate.
We seek to develop a leading regional presence in growth markets in regions that have favorable demographic and population growth trends, as well as customer density opportunities that can be leveraged. Our first target region is in the Southeast, with a primary focus on the state of Florida. With our acquisitions of SEC, Starpoint, Coastal and Guardian, we have achieved significant customer density in the state of Florida.
Our revenue from electronic security services in 2007 was primarily generated from recurring monitoring and services revenue. The other sources of revenue include non-recurring service revenue and installation revenue.
| (Dollars in thousands) | ||||||||||||||||||
| Type of Revenue |
1 Month Ending December 31, 2007 |
% | 11 Months Ending November 30, 2007 |
% | 12 Months Ending December 31, 2007 |
% | ||||||||||||
| Recurring monitoring and service revenue |
$ | 3,543 | 82 | % | $ | 39,161 | 76 | % | $ | 42,704 | 77 | % | ||||||
| Non-recurring service revenue |
258 | 6 | % | 3,686 | 7 | % | 3,944 | 7 | % | |||||||||
| Installation revenue |
525 | 12 | % | 8,619 | 17 | % | 9,144 | 16 | % | |||||||||
| $ | 4,326 | 100 | % | $ | 51,466 | 100 | % | $ | 55,792 | 100 | % | |||||||
As part of our commitment to provide high quality service to our customers, our electronic security services operation maintains a trained installation and service force. These employees are trained to install and service the various types of commercial and residential security systems marketed by us.
Security alarm systems include many different types of devices installed at a customer’s premises, which are designed to detect or react to various occurrences or conditions, such as intrusion, movement, fire, smoke, flooding, environmental conditions (including temperature or humidity variations), industrial operations (such as water, gas or steam pressure and process flow controls) and other hazards. In most systems, these detection devices, which may be hard-wired or wireless, are connected to a microprocessor-based control panel which communicates through telephone lines or wireless devices to a monitoring center where alarm and supervisory signals are received and recorded. Systems may also incorporate an emergency “panic button” which, when pushed, causes the control panel 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 one of our central monitoring stations. Commercial applications may also include access control systems and closed circuit television, tailored to the customers’ specific needs.
We do not manufacture any of the components used in our electronic security services business. Due to the general availability of the components used in our electronic security services business, we are able to obtain the components of our systems from a number of different sources and to supply our customers with the latest technology generally available in the industry. We are not dependent on any single source for our supplies and components and have not experienced any material shortages of components.
Our new retail customers are generated through our internal sales force. We have eleven sales and customer service locations which handle installations and service. In addition, we have two specialized sales units:
1) New Construction – We have two offices in Florida with dedicated representatives who market our services primarily to home builders. We market and install residential security systems, as well as a variety of other options, such as structured wiring for telephone, intercom systems and computer systems, into homes during their construction.
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2) Community Associations – This specialized subset of the residential group also markets our services to Home Owners Associations and gated communities, delivering high-quality customer care and service required by these premier communities that are prevalent in the Florida market. This group provides a full-range of services to meet the needs of planned communities and community-owned facilities, including U.L. monitoring, maintenance of existing systems, video, all levels of access control, and burglary and fire systems. Agreements range from three to twenty years in length and can represent service for hundreds to thousands of residences in each community.
Our relationship with our customers begins with an initial consultation to determine the potential customers’ needs and is followed by an equipment and service proposal. Our customers then sign contracts with us that allow us to provide ongoing electronic security system monitoring and maintenance services after the installation of an electronic security system. Most of the monitoring and service we provide is covered by multi-year contracts with contractual revenue. The length of our contracts ranges from three to twenty years, depending on the type of customer and how the contract was acquired and in certain markets provides for automatic renewals for a fixed period (typically one year) unless we or the customer elect to cancel the contract at the end of its term. Customers may also purchase an extended service protection plan, which covers the costs of normal repairs of the security system and which is billed along with the monitoring charges. Based upon the average lengths of customer relationships represented by accounts acquired by us during the last three years, we believe the average length of our customer relationships is approximately ten years.
Our two monitoring facilities operate 24 hours per day, 365 days per year. Each monitoring facility incorporates the use of communications and computer systems that route incoming alarm signals and telephone calls to operators. Each operator within a monitoring facility monitors a computer screen that displays information concerning the nature of the alarm signal, the customer whose alarm has been activated and the premises at which the alarm is located. Other non-emergency signals are generated by low battery status, arming and disarming of the alarm monitoring system by authorized users and test signals. These signals are processed automatically by the computer. Depending upon the type of service for which the customer has contracted, monitoring facility personnel respond to alarms by relaying information to local fire or police departments or other emergency providers, notifying the customer or taking other appropriate action.
Both of our central monitoring facilities hold Underwriter’s Laboratories, Inc., or UL, listings. UL specifications for monitoring centers cover building integrity, back up computer and power systems, staffing and standard operating procedures. In many jurisdictions, applicable law requires that security alarms for certain buildings be monitored by UL- listed facilities. In addition, a UL listing is required by certain commercial customers’ insurance companies as a condition to insurance coverage. In addition, our Hollywood, Florida location holds the Factory Mutual, or FM rating, the industry standard for fire alarm monitoring.
In addition to our retail monitoring (i.e., residential, including community associations, and commercial) our wholesale business serves independent security alarm companies. Typically, we act as the sole provider of monitoring services to independent security alarm companies.
Branch customer service personnel, during business hours, answer non-emergency telephone calls regarding service, billing, payment and alarm activation issues. Outside normal business hours, customers are directed to one of our monitoring centers that operate 24 hours per day, allowing a customer to always speak with one of our representatives. In addition, overflow calls at the branches are automatically re-routed to a monitoring center in order to provide immediate assistance to customers.
Customer attrition has a direct impact on our results of operations, since it affects our revenue, amortization expense, borrowing capacity and cash flow. We define customer attrition as a ratio which measures the value of lost customer Recurring Monthly Revenue, or RMR as the numerator divided by the total value of RMR, averaged over time to represent an annualized attrition rate. Attrition occurs in our business due to many reasons, including, but not limited to, the following:
| i) | customers moving their business or home thereby discontinuing their need for our services; |
| ii) | competitors successfully convincing our customers to change their security service provider due to any number of reasons, including price, service levels or group contract changes, such as Community Association contracts; or |
| iii) | economic reasons of the customer to reduce the customer’s expenses by discontinuing security services altogether. |
Tax Exemptions and Benefits
Some of our offshore earnings are not taxed or are taxed at rates lower than U.S. statutory Federal income tax rates due to tax exemptions and tax incentives.
The U.S. Virgin Islands Economic Development Commission granted us tax exemptions on most of our U.S. Virgin Islands earnings through March 2003. We have applied for an extension of this tax exemption; however, there is no guarantee that it will be granted. The EDC completed a compliance review on our subsidiary in the U.S. Virgin Islands on February 6, 2004. The compliance review covered the period from April 1998 through March 31, 2003 and resulted from our application to request an extension of tax exemptions from the EDC. The EDC’s compliance report cited our failure to make gross receipts tax payments of $505,000 and income tax payments of $2.2 million, excluding interest and penalties. This was the first time that a position contrary to ours or any
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position on this specific issue had been raised by the EDC. In light of these events, and based on discussions with legal counsel, we established a tax accrual at December 31, 2003 for such exposure which approximated the amounts set forth in the EDC review report. In September 2005 and 2004, the statute of limitations with respect to the income tax return filed by us for the years ended December 31, 2001 and 2000, respectively, expired. Accordingly, in the third quarter of 2005 and 2004, we reversed $37,440 and $2.3 million, respectively, of the tax accrual established at December 31, 2003. We have not had recent communication with the EDC regarding this matter and if challenged by the U.S. Virgin Islands taxing authority would vigorously contest its position. These tax accrual matters have been included in the results of discontinued operations.
For periods after December 31, 2003, we have accrued, but on the advice of Virgin Islands counsel, not remitted, gross receipts taxes, which would be due should our application for an extension of benefit be withdrawn or denied. Following the sale of the U.S. Virgin Islands ready-mix concrete, aggregates, concrete block and concrete materials business in September 2005, we did not generate any additional revenue which is covered under the applications for extension of benefits. Accordingly, the accrual for this gross receipts tax exposure at December 31, 2007 and 2006 was $1.5 million at each year end and will remain unchanged in the future pending resolution of the application for extensions. In addition, at December 31, 2007 and 2006, we had accrued $0.7 million and $0.5 million, respectively, in accrued interest relating to this obligation.
U.S. tax laws provide that certain of our offshore earnings are not taxable for U.S. federal income tax purposes, and most post-April 1988 earnings from our materials business in the U.S. Virgin Islands can be distributed to us free of U.S. income tax. Any distribution to Devcon International Corp, the parent company, of: (1) earnings from our U.S. Virgin Islands operations accumulated prior to April 1, 1988; or (2) earnings from our other non-U.S. incorporated operations, would subject us to U.S. federal income tax on the amounts distributed, less applicable taxes paid in those jurisdictions according to specific rules concerning foreign tax credits.
Intellectual Property
We possess trade names used in our Caribbean operations, of which none are registered. We believe that trade names, which are normally derivatives of the corporate names of our local subsidiaries, have name recognition and are valuable to us.
Devcon International Corp. owns a State of Florida service mark registration and a federal service mark registration for the DEVCON service mark, and Devcon Security Holdings, Inc. owns a State of Florida service mark registration and a federal service mark registration for the DEVCON SECURITY SERVICES service mark. Each of the registrations covers the use of the applicable mark in connection with installation and maintenance of burglar and security alarm systems and monitoring of burglar and security alarm systems. The DEVCON SECURITY SERVICES and DEVCON federal service mark registrations were both granted in 2006. The Florida registrations were granted in 2005.
Devcon Security Services, Inc., or DSS, owns U.S. federal trademark registrations for the mark CENTRAL ONE®, as used with installation, maintenance and monitoring of residential, commercial and industrial burglar and security alarm systems. Additionally, DSS owns State of Florida trademark registrations for CENTRAL ONE. DSS owns U.S. federal trademark registrations for the marks GIBRALTAR SECURITY ALARM SYSTEMS® and PREPARE AND PROTECT®, each as used with installation and maintenance of burglar electronic security systems, fire alarms, home and commercial security systems, voice intercom systems and closed circuit television and card access systems, as well as a U.S. federal trademark registration for its SECURITY BY GUARDIAN INTERNATIONAL and G logo® as used with installation, monitoring and maintenance of voice intercom systems and closed circuit television and card access systems. Additionally, DSS owns State of Florida trademark registrations for its GUARDIAN INTERNATIONAL as well as its G logo, each for use with installation, monitoring and maintenance of burglar electronic security systems, fire alarms, home and commercial security systems, and installation and maintenance of voice intercom systems, as well as a State of Florida trademark registration for PRECISION SECURITY SYSTEMS as used with commercial and residential electronic security system sales, service and monitoring. Currently, there are no pending or threatened litigation or claims relating to our trademarks. Also, to the best of our knowledge, there are no unasserted possible claims or assessments that may call for financial disclosure. We cannot assure you that third parties will not attempt to assert superior trademark rights in similar marks or that we will be able to successfully enforce and protect our rights in the trademarks against third party infringers.
Business Address
Our executive offices are located at 595 South Federal Highway, Suite 500, Boca Raton, Florida 33432, our telephone number is (561) 208-7200 and our web address is www.devc.com. In addition, we use www.devcon-security.com as a separate web address in connection with our electronic security services. In this document, the terms “Company”, “we”, “our”, “us” and “Devcon” refer to Devcon International Corp. and its subsidiaries.
Employees
At December 31, 2007, we employed 591 persons. As of that date, we employed 530 persons in our electronic security services business, 30 of whom are members of a union; we employed one person in our construction business who is not a member of a union; we employed 51 persons in our materials business, none of whom are members of a union; and we employed nine persons in corporate administration, none of whom are members of a union. Most employees are employed on a full-time basis. We believe employee relations are satisfactory.
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Environmental Matters
We are involved, on a continuing basis, in monitoring our compliance with environmental laws and in making capital and operating improvements necessary to comply with existing and anticipated environmental requirements. While it is impossible to predict with certainty, we currently do not foresee such expenses in the near future as having a material effect on our business, results of operations or financial condition. See Item 3, Legal Proceedings, and Note 18-Commitments and Contingencies.
Subsequent Events
Capital Source Amendment. On March 14, 2008, the Company amended the credit terms and conditions of its Credit Agreement (“Waiver and Sixth Amendment”) which included an adjustment in the Maximum Attrition Ratio under the Credit Agreement as follows (i) for the period beginning on March 14, 2008 and ending on July 31, 2008 to 13.00%; (ii) for the period beginning August 1, 2008 and ending December 31, 2008 to 12.75%; and (iii) for the period beginning January 1, 2009 and thereafter to 12.50%. Also, under the terms of the Amendment the Applicable Base Rate Margin was revised to be 5.00% and the Applicable LIBOR Margin was revised to be 6.50%. Additionally, under the terms of the Amendment, for purposes of calculating interest, the Base Rate will not be less than 6.00% and the LIBOR Rate will not be less than 3.00% so that, as of March 14, 2008, the Company’s new effective interest rate under the Credit Agreement is LIBOR plus 6.50% and its new minimum interest rate is 9.50%. The Waiver and Sixth Amendment also provided for a waiver of noncompliance matters to the extent that the noncompliance matters constituted a default or an event of default under the Credit Agreement or the other loan documents as of December 31, 2007.
Resignation of Chief Financial Officer. On January 16, 2008, Robert W. Schiller resigned from his position as the Chief Financial Officer of the Company. On January 23, 2008, the Board of Directors of the Company appointed Mark M. McIntosh, the Company’s Vice President of Finance and Strategic Business Development, to the position of Chief Financial Officer of the Company.
Sale of SCGC. On January 10, 2008, the Company sold all the issued and outstanding stock of SCGC, our quarry and ready-mix operation located in St. Martin, French West Indies, to Petit. Based on the net book value of those assets, we recorded an impairment charge in discontinued operations of $0.9 million in the fourth quarter of 2007. In addition, the Company was in litigation with the Buyer and upon the sale of SCGC the lawsuit was dismissed and a $1.0 million deposit paid to the Buyer on an option to purchase certain property was released to the Company from the escrow account at the time the agreement was consummated. See Note 22 – Subsequent Events.
Lydia Security Monitoring. On March 11, 2008, Lydia Security and Devcon/Coastal reached a settlement agreement in principal wherein in exchange for assets and cash, the parties would settle their lawsuit. At December 31, 2007, the Company included a provision for the amount of the settlement in accrued liabilities in the accompanying consolidated balance sheet. See Item 3. Legal Proceedings-Lydia Security Monitoring and see Note 22-Subsequent Events.
| Item 1A. | Risk Factors |
You should read and consider carefully each of the following factors, as well as the other information contained in, attached to or incorporated by reference in this report. If any of the following risks materialize, our financial condition and results of operations could be materially and adversely affected and the value of our stock could decline. The risks and uncertainties described below are those that we currently believe may materially affect us. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially and adversely affect our business operations.
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General Risk Factors Relating to our Business
Our officers and directors have the ability to significantly influence the outcome of any matters submitted to a vote of our shareholders.
Certain of our officers and directors through their affiliation with Coconut Palm Capital Investors I, Inc. have the power to vote, in their sole discretion, all of the securities owned by the former limited partners of Coconut Palm Capital Investors I, Ltd. Determining the current holdings of the former limited partners is a time-consuming task and is performed annually to coincide with the record date for the Annual Shareholders’ Meeting.
As of March 7, 2008, the directors and executive officers, as a group, beneficially owned 61.61% of our common stock, assuming beneficial ownership is defined as including common stock ownership after exercising all warrants or options exercisable within 60 days of this date and net of treasury shares. Therefore, they have the ability to significantly influence the outcome of any matters submitted to a vote of our shareholders. Risks that may result from this ability are largely focused on the following variables:
| • | the potential for making decisions which are based on a return on investment timetable which is based on the individual preferences and interests of the directors and executive officers which may be different and in conflict with the more immediate horizon which may be expected in public equity markets at any point in time. |
| • | the potential for investing in operating strategies which reflect a higher or lower relationship of risk and returns on investment than other common equity investors of the Company. |
Our future success is dependent, in part, on key personnel and failure to retain these key personnel would adversely affect our operation.
We are highly dependent on the skills, experience and services of key personnel. As a result, we have entered into employment agreements with certain members of senior management. The loss of such key personnel could have a material adverse effect on our business, operating results or financial condition. We do not maintain key man life insurance with respect to these key individuals. Employment and retention of qualified personnel is important due to the competitive nature of our industry. Our inability to hire new personnel with the requisite skills could impair our ability to manage and operate our business effectively. On January 16, 2008, Robert W. Schiller resigned from his position as the Chief Financial Officer of the Company. On January 23, 2008, the Board of Directors of the Company appointed Mark M. McIntosh, the Company’s Vice President of Finance and Strategic Business Development, to the position of Chief Financial Officer of the Company.
We are subject to significant debt, debt service, dividend service and redemption obligations which could have an adverse effect on our results of operations.
Our electronic security services operation has a $105.0 million CapitalSource Revolving Credit Facility and, as of December 31, 2007 and December 31, 2006, we had $94.4 million and $89.1 million, respectively, of borrowings outstanding. In addition, we have an aggregate of 38,000 shares of Series A Convertible Preferred Stock (the “Preferred Stock”) with an aggregate liquidation preference of $41.9 million at December 31, 2007, which includes $3.9 million of capitalized dividends. These shares of Preferred Stock are subject to regular dividend payment and redemption obligations. We have the option of paying the dividends in-kind thereby not depleting our cash resources for these dividend payments. As a result of the foregoing transactions, we are incurring significant interest expense and accruing significant dividend liabilities. The degree to which we are leveraged could have significant consequences, including the following:
| • | our ability to obtain additional financing in the future for capital expenditures, potential acquisitions, and other purposes may be limited or financing may not be available on terms favorable to us or at all; |
| • | a substantial portion of our cash flows from operations must be used to pay our interest expense and repay our senior debt, dividend and redemption obligations under the terms of the Preferred Stock, which reduces the funds that would otherwise be available to us for our operations and future business opportunities; and |
| • | fluctuations in market interest rates will affect the cost of our borrowings to the extent not covered by interest rate hedge agreements because our credit facility bears interest at variable rates. |
The CapitalSource Revolving Credit Facility contains financial covenants that require our subsidiaries which comprise our electronic security services to meet a number of financial ratios and tests, and imposes restrictions on our electronic security services operations ability to, among other things:
| • | incur more debt including any sale-leaseback or synthetic lease transaction; |
| • | pay dividends, redeem or repurchase stock or make other distributions or impair the ability of any subsidiary to make such payments to the borrower; |
| • | make acquisitions or investments; |
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| • | use assets as security in other transactions, or otherwise create liens on our assets |
| • | enter into transactions with affiliates (including extending loans to employees); |
| • | impair the terms of any material contract; and |
| • | guarantee obligations of another. |
Failure to comply with the obligations in the CapitalSource Revolving Credit Facility could result in an event of default, which, if not cured or waived, could permit acceleration of this indebtedness or of other indebtedness, allowing our senior lenders to foreclose on our electronic security services assets. At December 31, 2007, we were not in compliance with the required attrition ratio and have obtained an amendment and waiver from CapitalSource which cured this default. See Note 8-Debt and Note 22- Subsequent Events.
In addition, the Preferred Stock contains a financial covenant imposing a restriction on our ability to incur additional indebtedness. As a result, so long as any shares of Preferred Stock remain outstanding, we will not be able to allow our indebtedness ratio to exceed a specified maximum leverage amount. Our failure to comply with this indebtedness ratio covenant, which is effective on June 30, 2008, could result in an event of default, which, if not cured or waived, could permit holders of the Preferred Stock to require us to redeem all, or a portion of, the outstanding principal amount of the Preferred Stock and pay all accrued but unpaid dividends.
As of December 31, 2007, our current debt service obligation and Preferred Stock dividend expenses are summarized in the chart below:
| Principal Value | Approximate 2008 Annual Interest Expense or Dividend 1 | |||||
| (dollars in thousands) | ||||||
| Debt Service: |
||||||
| Revolving Credit Facility (LIBOR plus 6.5%) |
$ | 94,420 | $ | 8,980 | ||
| Other |
68 | 3 | ||||
| Preferred Stock (10% Dividends) |
41,920 | 4,352 | ||||
| Total Debt Service |
$ | 136,408 | $ | 13,335 | ||
| Revolving Credit Facility |
Convertible Preferred Stock | |||||
| Maturity of Debt: |
||||||
| 2008 |
$ | — | $ | — | ||
| 2009 |
— | — | ||||
| 2010 |
94,420 | 13,973 | ||||
| 2011 |
— | 13,973 | ||||
| 2012 |
— | 13,974 | ||||
| Total |
$ | 94,420 | $ | 41,920 | ||
| 1 |
- Effective March 14, 2008, the Company’s new effective interest rate under the Credit Agreement is LIBOR plus 6.50% and its new minimum interest rate is 9.50%. |
If we do not successfully implement our business strategy, we may not be able to repay or refinance our senior debt or comply with the terms of the Preferred Stock.
We may not be able to successfully implement our business strategy or realize our anticipated financial results. Accordingly, our cash flows and capital resources may not be sufficient to pay the interest charges and principal payments on our senior debt or comply with redemption provisions of the Preferred Stock. Failure to pay our interest expense, make our principal payments, or effect a redemption would result in a default. If this occurs, our substantial indebtedness and the redemption amount for the Preferred Stock could have important consequences to us and may, among other things:
| • | limit our ability to obtain additional financing to fund growth, working capital, capital expenditures, debt service and dividend service requirements or other purposes; |
| • | limit our ability to use operating cash flow in other areas of our business because we must dedicate a substantial portion of these funds to make principal payments and fund debt and dividend service and redemption requirements; |
| • | cause us to be unable to satisfy our obligations under our debt agreements or the terms of the Preferred Stock; |
| • | make us more vulnerable to adverse general economic and industry conditions; |
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| • | limit our ability to compete with others who are not as highly leveraged as we are; |
| • | limit our flexibility in planning for, or reacting to, changes in our business, industry and market conditions; |
| • | cause us to sell assets; and |
| • | cause us to obtain additional equity capital or refinance or restructure all or a portion of our outstanding senior debt. |
In the event that we are unable to refinance our senior debt or Preferred Stock, we may be left without sufficient liquidity and may not be able to repay our senior debt or comply with the terms of the Preferred Stock. In that case, the senior lenders would be able to foreclose on our assets. Even if new financing is available, it may not be on terms that are acceptable to us.
Similarly, if we are not able to successfully implement our business strategy or realize our anticipated financial results, we may not be able to comply with the terms of the Preferred Stock requiring us to redeem, for cash, all outstanding shares of Preferred Stock, in equal installments, on the fourth, fifth and sixth anniversary of completion of the private placement. If we fail to effect any required redemption of the Preferred Stock, the applicable redemption amount per unredeemed share of Preferred Stock will bear interest at the rate of 1.5% per month until paid in full and the investors will have the option to require us to convert any of those unredeemed shares into shares of our common stock substituting market prices for the conversion price, which market prices may be lower than the conversion price resulting in a larger number of shares of our common stock being issued, resulting in greater dilution to our existing shareholders.
Our stock is thinly traded.
While our stock trades on Nasdaq, our stock is thinly traded and you may have difficulty in reselling your shares quickly. The low trading volume of our common stock is outside of our control and we cannot guarantee that the trading volume will increase in the near future or that, even if it does increase in the future, it will be maintained. Without a large float, our common stock is less liquid than the stock of companies with broader public ownership and, as a result, the trading prices of our common stock may be more volatile. In addition, in the absence of an active public trading market, an investor may be unable to liquidate his investment in us. Trading of a relatively small volume of our common stock may have a greater impact on the trading price of our stock than would be the case if our public float was larger. We cannot predict the prices at which our common stock will trade in the future.
We do not currently pay any dividends on our common stock.
We have not paid any dividends on our common stock in the last fifteen years. We anticipate that for the foreseeable future we will continue to retain any earnings for use in the operation of our business, except as we may elect to pay dividends on the Preferred Stock. Any future determination to pay cash dividends will be at the discretion of our board of directors, after consideration of any restrictions on cash dividends as defined by our credit and preferred stock agreements, and will depend on our earnings, capital requirements, financial condition and other factors deemed relevant by our board of directors.
The common stock warrants and shares of Preferred Stock are deemed under generally accepted accounting principles to contain embedded derivative financial instruments, the periodic valuation of which may result in us recognizing charges due to changes in the market value of these derivative financial instruments.
In accordance with FASB 133 “Accounting for Derivative Instruments and Hedging Activities” and EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock” the common stock warrants and embedded derivatives in the Preferred Stock are classified as derivative liabilities and, therefore, their fair values are recorded as derivative liabilities on our balance sheet. Changes in the fair value of the warrants and derivatives will result in adjustments to the amount of the recorded derivative liabilities and the corresponding gain or loss will be recorded in our statement of operations. We are required to assess these fair values of derivative liabilities each quarter and as the value of the warrants and derivatives is quite sensitive to changes in the market price of our stock, among other things, fluctuations in such value could be substantial and could cause our results to not meet the expectations of securities analysts and investors. These fluctuations will continue to impact our results of operations as described above for as long as the warrants and Preferred Stock are outstanding. For the year ended December 31, 2007, we recognized income of $3.0 million related to the change in the fair value of these derivatives. See Note 10, Derivative Instruments.
We have incurred and will continue to incur increased costs as a result of securities laws and regulations relating to corporate governance matters and public disclosures.
The Sarbanes-Oxley Act of 2002 and the Securities and Exchange Commission’s rules implementing that Act have required changes in some of our corporate governance practices and may require further changes. These rules and regulations have increased our legal and financial compliance costs and have made some activities more difficult, time-consuming or costly. These rules and regulations could also make it more difficult for us to attract and retain qualified independent members of our board of directors and qualified members of our management team.
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We are taking steps to comply with the laws and regulations in accordance with the deadlines by which compliance is required, however, we are not able to estimate the additional costs that we may incur to respond by these deadlines.
Risk Factors Relating to our Electronic Security Services Operation
Our inability to acquire businesses in the electronic security services industry within our current market area could have adverse consequences on our results of operations.
Due to the continuing consolidation of the electronic security systems industry and the acquisition by us and other electronic security systems companies of a number of large portfolios of subscriber accounts, there may in the future be fewer large portfolios of subscriber accounts available for acquisition. We face competition for the acquisition of portfolios of subscriber accounts, and we may be required to offer higher prices for subscriber accounts we acquire in the future than we have offered in the past. The inability to achieve scale in certain markets may impact the profit potential of our business in those markets.
Integrating our acquired businesses may be disruptive to or cause an interruption of our business which could have a material adverse effect on our operating results and financial condition.
The process of integrating our acquired businesses may be disruptive to our business and may cause an interruption or a loss of momentum in our business as a result of the following factors, among others:
| • | loss of key employees or customers; |
| • | higher than expected account attrition; |
| • | failure to maintain the quality of services that the companies have historically provided; and |
| • | the need to coordinate geographically diverse organizations. |
These disruptions and difficulties, if they occur, may cause us to fail to realize the cost savings, revenue enhancements and other benefits from that integration and may cause material adverse short and long-term effects on our operating results and financial condition.
We have encountered and may continue to encounter difficulties implementing our business plan.
These challenges and difficulties relate to our ability to do the following:
Attract new customers and retain existing customers. Within the electronic security services operation, customers, particularly residential customers, move from the locations at which our security systems were installed. This creates expected and ongoing attrition. There are no guarantees that persons or businesses moving into these locations will use our company, or any company, for security services. In the event of a slow down in the real estate or new home construction in our key market in Florida, we could experience periods in which we are not able to replace the natural attrition of residential customers.
Generate sufficient cash flow from operations or through additional debt or equity financings to support our operations. Our security operations face significant competition and pricing pressure from other national and regional service providers in our industry. If we are unable to compete successfully with these companies, our sales and profitability could be adversely affected. Our rates of customer attrition may affect our ability to remain in compliance with certain covenants in our debt agreements and the capital needed to replace the customers lost through attrition is reliant on availability of operating cash flow after servicing our debt agreements and availability from existing credit facilities.
Install and implement new financial and other operating systems, procedures and controls to support our operations. Our operating plan depends on achieving operating cost efficiencies by servicing more customers through a single more efficient infrastructure.
If we fail to generate sufficient cash flow from operations, it may be necessary to take additional actions, which could divert management’s attention and strain our operational and financial resources. We may not successfully address any or all of these challenges, and our failure to do so would adversely affect our business plan and results of operations, our ability to raise additional capital and our ability to achieve enhanced profitability.
We have a history of losses which are likely to continue.
We incurred net losses from continuing operations of $17.3 million and $23.7 million for the years ended December 31, 2007, and 2006, respectively.
These losses reflect the following, among other factors:
| • | substantial charges incurred by us for amortization of acquired customer accounts; |
| • | impairment of assets due to actual loss of customer accounts; |
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| • | interest incurred on indebtedness; |
| • | acquisition integration costs; |
| • | costs relating to additional financing in 2006 and 2007; |
| • | a reduction of deferred tax assets in 2006; and |
| • | other charges required to manage operations. |
We will continue to incur a substantial amount of interest expense and amortization of customer accounts and we do not expect to attain profitability in the near future.
Our electronic security services operations are geographically concentrated making us vulnerable to economic and environmental risks inherent to those locations.
Our subscriber base is geographically concentrated in Florida and New York. Accordingly, our performance may be adversely affected by regional or local economic and environmental conditions, including weather conditions, particularly in Florida, which is susceptible to the impact of hurricanes, lightning and tornadoes. Local environmental conditions such as hurricanes making landfall in Florida have caused damage to infrastructure such as electric power and telecommunications, both of which are required to provide service to our security customers. If electric power is not available for an extended period of time, we would be unable to provide our services and would therefore be unable to bill our customers. If the hurricanes destroy or cause severe damage to homes, then we are at risk of losing our customer base.
Our electronic security services operate in a highly competitive environment and we may not be able to compete effectively for customers, causing us to lose all or a portion of our market share.
Our electronic security services business in the United States is highly competitive. New competitors are continually entering the field. Competition is based primarily on price in relation to quality of service. Sources of competition in the electronic security services industry are other providers of central monitoring services, local electronic security systems and other methods of protection, such as manned guarding.
Our electronic security services competes with other major firms which have substantial resources, including ADT Security Services, Inc. (a subsidiary of Tyco International Limited), Brinks Home Security, a division of The Brinks Company, Protection One and HSM Electronic Protection Services, a division of the StanleyWorks, as well as many regional and local companies. Many of these competitors are larger and have significantly greater resources than we do and may possess greater local market knowledge as well. We may not be able to continue to compete effectively for existing or potential customers, causing us to lose all or a portion of our market share.
Increased adoption of “false alarm” ordinances by local governments may adversely affect our business.
An increasing number of local governmental authorities have adopted, or are considering the adoption of, laws, regulations or policies aimed at reducing the perceived costs to municipalities of responding to false alarm signals. Such measures could include:
| • | requiring permits for the installation and operation of individual alarm systems and the revocation of such permits following a specified number of false alarms; |
| • | imposing fines on alarm customers or alarm monitoring companies for false alarms; |
| • | imposing limitations on the number of times the police will respond to alarms at a particular location after a specified number of false alarms; |
| • | requiring further verification of an alarm signal before the police will respond |
Enactment of these measures could adversely affect our future business and operations. In addition, concern over false alarms in communities adopting these ordinances could cause a decrease in the timeliness of police response to alarm activations and thereby decrease the propensity of consumers to purchase or maintain alarm monitoring services.
Future government regulations or other standards could have an adverse effect on our operations.
Our operations are subject to a variety of laws, regulations and licensing requirements of federal, state and local authorities. In certain jurisdictions, we are required to obtain licenses or permits, to comply with standards governing employee selection and training and to meet certain standards in the conduct of our business. The loss of such licenses, or the imposition of conditions to the granting or retention of such licenses, could have an adverse effect on us. In the event that these laws, regulations and/or licensing requirements change, we may be required to modify our operations or to utilize resources to maintain compliance with such rules and regulations. In addition, new regulations may be enacted that could have an adverse effect on us.
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Increased adoption of statutes and governmental policies purporting to void automatic renewal provisions in our customer contracts, or purporting to characterize certain of our charges as unlawful, may adversely affect our business.
Our customer contracts typically contain provisions automatically renewing the term of the contract at the end of the initial term, unless cancellation notice is delivered in accordance with the terms of the contract. If the customer cancels prior to the end of the contract term, other than in accordance with the contract, we may charge the customer the charges that would have been paid over the remaining term of the contract, or charge an early cancellation fee.
Several states have adopted, or are considering the adoption of statutes, consumer protection policies or legal precedents which purport to void the automatic renewal provisions of our customer contracts, or otherwise restrict the charges we can impose upon contract cancellation. Such initiatives could compel us to increase the length of the initial term of our contracts, and increase our charges during the initial term, and consequently lead to less demand for our services and increase our attrition. Adverse judicial determinations regarding these matters could cause us to incur legal exposure to customers against whom such charges have been imposed, and the risk that certain of our customers may seek to recover such charges through litigation. In addition, the costs of defending such litigation and enforcement actions could have an adverse effect on us.
Cyclical industry and economic conditions have affected and may continue to adversely affect the financial condition and results of operations of our electronic security services.
The operating results of our electronic security services may be adversely affected by the general cyclical pattern of the electronic security services industry. Demand for electronic security services is significantly affected by levels of commercial construction and consumer and business discretionary spending. The market for new construction and the real estate market in general are cyclical and, in the event of a decline in the market for new developments, it is likely that demand for our electronic security monitoring services would also decline, which could negatively impact our results of operations.
Our electronic security services business is subject to attrition of subscriber accounts.
Our electronic security services operations experiences attrition of subscriber accounts as a result of, among other factors, relocation of subscribers, adverse financial and economic conditions, and competition from other electronic security system companies. In addition, our electronic security services operation experiences attrition of newly acquired accounts to the extent that we do not integrate these accounts or do not adequately service the accounts or because of dissatisfaction with prior service. Attrition and an increase in attrition rates could have a material adverse effect on our revenues and earnings, and our ability to maintain compliance with various covenants in our credit facilities.
Lower crime rates could have an adverse effect on our results of operations.
For the past several years crime rates have been dropping in the United States, particularly in the State of Florida. According to the Florida Department of Law Enforcement’s 2006 Annual Uniform Crime Report, Florida’s index crime rate has reached a 36-year low dropping by 1.0 percent in 2006 from 2005. Particularly relevant to our business is the decrease in the number of burglaries. While the number of homes and businesses with installed electronic security systems has continued to increase even as crime rates have decreased, this may not continue to be the case. Any significant decrease in the number of homes and businesses installing new electronic security systems could have a material adverse effect on our business.
We rely on technology that may become obsolete, which could require significant capital expenditures.
Our monitoring services depend upon the technology (hardware and software) of security alarm systems. In order to maintain our customer base that currently uses security alarm components that are or could become obsolete, we will likely be required to upgrade or implement new technologies that could require significant capital expenditures. We may not be able to successfully implement new technologies or adapt existing technologies to changing market demands. If we are unable to adapt in response to changing technologies, market conditions or customer requirements in a timely manner, such inability could adversely affect our business.
Shifts in our current and future customers’ selection of telecommunications services could increase customer attrition and could adversely impact our earnings and cash flow.
Certain elements of our operating model rely on our customers’ selection and continued use of traditional, land-line telecommunications services, which we use to communicate with our monitoring operations. In recent years, many customers have shown a preference for subscribing only to cellular technology and have discontinued use of land-line telephone services. In order to continue to service existing customers who cancel their land-line telecommunications services and service new customers who do not subscribe to land-line telecommunications services, customers must upgrade to alternative and typically more expensive wireless or internet based technologies. Continued shifts in customers’ preferences regarding telecommunications services could continue to adversely impact attrition and our earnings and cash flow.
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The loss of our Underwriter Laboratories listing could negatively impact our competitive position.
All of our alarm monitoring centers are UL listed. To obtain and maintain a UL listing, an alarm monitoring center must be located in a building meeting UL’s structural requirements, have back-up and uninterruptible power supplies, have secure telephone lines and maintain redundant computer systems. UL conducts periodic reviews of alarm monitoring centers to ensure compliance with their regulations. Non-compliance could result in a suspension of our UL listing. The loss of our UL listing could negatively impact our competitive position
We are exposed to greater risks of liability for employee acts or omissions, or system failure, than may be inherent in other businesses.
The nature of the services we provide potentially exposes us to greater risks of liability for employee acts or omissions or system failures than may be inherent in other businesses. In an attempt to reduce this risk, substantially all of our alarm monitoring agreements and other agreements pursuant to which we sell our products and services contain provisions limiting our liability to customers and third parties. However, in the event of litigation with respect to such matters, these limitations may not be enforced. In addition, the costs of such litigation could have an adverse effect on us.
The Company carries insurance of various types, including general liability and professional liability insurance in amounts management considers adequate and customary for the industry. Some of the Company’s insurance policies, and the laws of some states, may limit or prohibit insurance coverage for punitive or certain other types of damages, or liability arising from gross negligence. If the Company incurs increased losses related to employee acts or omissions, or system failure, or if the Company is unable to obtain adequate insurance coverage at reasonable rates, or if the Company is unable to receive reimbursements from insurance carriers, the Company’s financial condition and results of operations could be materially and adversely affected.
Risk Factors Relating to our Materials Operation
We have entered into transactions with our affiliates which result in conflicts of interests.
We have entered into a number of transactions with our affiliates, including but not limited to an investment in the Caribbean involving companies in which certain of our current and former officers and directors have an interest. Material transactions are disclosed in our audited consolidated financial statements and the periodic reports we file with the Securities and Exchange Commission. See “Item 13—Certain Relationships and Related Transactions”. These transactions result in conflicts of interests. Our Audit Committee reviews and approves transactions between us and our affiliates, including our officers and directors. Our policy is that all of these transactions be reviewed and approved by the audit committee prior to completion. In addition, our Articles of Incorporation provide that no contract or other transaction between us and any other corporation shall in any way be invalidated by the fact that any of our directors are interested in or are directors or officers of the other party to the transaction.
We are subject to some risks due to the nature of our foreign operations.
The majority of our discontinued operations in 2007 were conducted in foreign countries located in the Caribbean, primarily Antigua and Barbuda, Sint Maarten, St. Martin and the Bahamas. The risks of doing business in foreign areas include potential adverse changes in U.S. diplomatic relations with foreign countries, changes in the relative purchasing power of the U.S. dollar, hostility from local populations, adverse effects of exchange controls, changes in either import or export tariffs, nationalization, interest rate fluctuations, restrictions on the withdrawal of foreign investment and earnings, government policies against businesses owned by non-nationals, expropriations of property, the instability of foreign governments, any civil unrest or insurrection that could result in uninsured losses and other political, economic and regulatory conditions, risks or difficulties. Adverse changes in currency exchange rates or raw material commodity prices, both in absolute terms and relative to competitors’ risk profiles, could adversely impact our operations. We are not subject to these risks in the U.S. Virgin Islands, since the Virgin Islands is a United States territory. We believe our only significant foreign currency exposure is the Euro. We are also subject to U.S. federal income tax upon the distribution of certain offshore earnings. Although we have not encountered significant difficulties in our foreign operations, we could encounter difficulties in the future.
Our materials business operates in a highly competitive environment and we may not be able to compete effectively for customers, causing us to lose all or a portion of our market share.
We have competitors in the materials business in the locations where we conduct business. The competition includes local ready-mix concrete, and importers of aggregates and concrete blocks. We also encounter competition from the producers of asphalt, which is an alternative material to concrete for road construction.
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We are highly dependent on the availability of barging and towing services in the Caribbean.
Our materials business is highly dependent upon the availability of barging services to import sand, aggregate, cement and block. We have experienced in the past, and could experience in the future, a short-term shortage of barging capacity which would have an adverse affect on our operations.
| Item 1B. | Unresolved Staff Comments |
Not applicable.
| Item 2. | Property |
General
The following table shows information on the properties and facilities that we owned or leased for our operations at February 29, 2008:
| Description |
Location |
Lease Expiration with all Options (M/Yr) | ||
| Shared Facilities |
||||
| Principal executive offices |
Boca Raton, Florida | 9/2020(1) | ||
| Administrative Offices |
Deerfield Beach, Florida | 5/2013(2) | ||