-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, URmuiSuBQngcwZxG/zTFItHIOmiNnxahht1pxAUSSpYwlJARuSyEZW9d/LJRoAbM DJ1wlGFE2mBLL43snH6hoA== 0000950147-03-000207.txt : 20030214 0000950147-03-000207.hdr.sgml : 20030214 20030214091423 ACCESSION NUMBER: 0000950147-03-000207 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20021230 FILED AS OF DATE: 20030214 FILER: COMPANY DATA: COMPANY CONFORMED NAME: RURAL METRO CORP /DE/ CENTRAL INDEX KEY: 0000906326 STANDARD INDUSTRIAL CLASSIFICATION: LOCAL & SUBURBAN TRANSIT & INTERURBAN HWY PASSENGER TRAINS [4100] IRS NUMBER: 860746929 STATE OF INCORPORATION: DE FISCAL YEAR END: 0630 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-22056 FILM NUMBER: 03562754 BUSINESS ADDRESS: STREET 1: 8401 EAST INDIAN SCHOOL RD CITY: SCOTTSDALE STATE: AZ ZIP: 85251 BUSINESS PHONE: 4809943886 10-Q 1 e-9587.txt QUARTERLY REPORT FOR THE QTR ENDED 12/31/2002 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended December 31, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to _______________ Commission file number 0-22056 RURAL/METRO CORPORATION (Exact name of Registrant as specified in its charter) DELAWARE 86-0746929 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 8401 EAST INDIAN SCHOOL ROAD SCOTTSDALE, ARIZONA 85251 (Address of principal executive offices) (Zip Code) (480) 606-3886 (Registrant's telephone number, including area code) 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 whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] At February 11, 2003, there were 16,270,399 shares of Common Stock outstanding, exclusive of treasury shares held by the Registrant. RURAL/METRO CORPORATION INDEX TO QUARTERLY REPORT ON FORM 10-Q FOR THE QUARTERLY PERIOD ENDED DECEMBER 31, 2002 Page ---- Part I. Financial Information Item 1. Financial Statements: Consolidated Balance Sheet 3 Consolidated Statement of Operations and Comprehensive Income (Loss) 4 Consolidated Statement of Cash Flows 6 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 32 Item 3. Quantitative and Qualitative Disclosures About Market Risk Conditions 52 Item 4. Controls and Procedures 52 Part II. Other Information Item 1. Legal Proceedings 52 Item 6. Exhibits and Reports on Form 8-K 54 Signatures 55 2 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS RURAL/METRO CORPORATION CONSOLIDATED BALANCE SHEET DECEMBER 31, 2002 AND JUNE 30, 2002 (IN THOUSANDS) DECEMBER 31, JUNE 30, 2002 2002 --------- --------- (UNAUDITED) ASSETS CURRENT ASSETS Cash ............................................... $ 8,963 $ 9,828 Accounts receivable, net ........................... 95,777 99,115 Inventories ........................................ 12,074 12,220 Prepaid expenses and other ......................... 8,708 9,015 --------- --------- Total current assets ..................... 125,522 130,178 PROPERTY AND EQUIPMENT, net ........................ 45,873 48,532 GOODWILL ........................................... 41,167 41,244 OTHER ASSETS ....................................... 23,359 17,484 --------- --------- $ 235,921 $ 237,438 ========= ========= LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES Accounts payable ................................... $ 8,830 $ 11,961 Accrued liabilities ................................ 57,870 73,719 Deferred subscription fees ......................... 15,234 15,409 Current portion of long-term debt .................. 1,406 1,633 --------- --------- Total current liabilities ................ 83,340 102,722 LONG-TERM DEBT, net of current portion ............. 306,040 298,529 OTHER LIABILITIES .................................. 339 477 DEFERRED INCOME TAXES .............................. 650 650 --------- --------- Total liabilities ........................ 390,369 402,378 --------- --------- COMMITMENTS AND CONTINGENCIES MINORITY INTEREST .................................. 379 379 --------- --------- REDEEMABLE PREFERRED STOCK ......................... 5,390 -- --------- --------- STOCKHOLDERS' EQUITY (DEFICIT) Common stock ....................................... 164 159 Additional paid-in capital ......................... 138,791 138,470 Accumulated deficit ................................ (297,933) (313,025) Accumulated other comprehensive income (loss) ...... -- 10,316 Treasury stock ..................................... (1,239) (1,239) --------- --------- Total stockholders' equity (deficit) ..... (160,217) (165,319) --------- --------- $ 235,921 $ 237,438 ========= ========= See accompanying notes 3 RURAL/METRO CORPORATION CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2002 AND 2001 (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED SIX MONTHS ENDED DECEMBER 31, DECEMBER 31, ---------------------- ---------------------- 2002 2001 2002 2001 --------- --------- --------- --------- NET REVENUE ................................................... $ 123,464 $ 114,333 $ 249,029 $ 230,807 --------- --------- --------- --------- OPERATING EXPENSES Payroll and employee benefits ............................... 70,233 65,905 141,345 134,226 Provision for doubtful accounts ............................. 19,017 16,633 37,742 33,371 Depreciation and amortization ............................... 3,309 3,911 6,749 7,942 Other operating expenses .................................... 23,211 22,358 45,745 43,888 --------- --------- --------- --------- Total operating expenses .............................. 115,770 108,807 231,581 219,427 --------- --------- --------- --------- OPERATING INCOME .............................................. 7,694 5,526 17,448 11,380 Interest expense, net ......................................... (7,491) (5,651) (13,377) (12,475) Other income (expense), net ................................... -- 9 -- 9 --------- --------- --------- --------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES, AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE ................................................... 203 (116) 4,071 (1,086) INCOME TAX (PROVISION) BENEFIT ................................ (55) 1,625 (110) 1,605 --------- --------- --------- --------- INCOME FROM CONTINUING OPERATIONS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE ........................... 148 1,509 3,961 519 INCOME FROM DISCONTINUED OPERATIONS (Including gain on the disposition of Latin American operations of $12,488 in the six months ended December 31, 2002) ..................... -- 1,661 12,332 1,461 --------- --------- --------- --------- INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE ................................................... 148 3,170 16,293 1,980 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE ........... -- -- -- (49,513) --------- --------- --------- --------- NET INCOME (LOSS) ............................................. 148 3,170 16,293 (47,533) Less: Accretion of redeemable preferred stock ................. (1,201) -- (1,201) -- --------- --------- --------- --------- NET INCOME (LOSS) APPLICABLE TO COMMON STOCK .................. (1,053) 3,170 15,092 (47,533) Cumulative translation adjustments ............................ -- 4,244 (242) 4,204 Recognition of cumulative translation adjustments in conjunction with the disposition of Latin American operations .................................................. -- -- (10,074) -- --------- --------- --------- --------- COMPREHENSIVE INCOME (LOSS) .................................. $ (1,053) $ 7,414 $ 4,776 $ (43,329) ========= ========= ========= =========
4 RURAL/METRO CORPORATION CONSOLIDATED STATEMENT OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) FOR THE THREE AND SIX MONTHS ENDED DECEMBER 31, 2002 AND 2001 (UNAUDITED) (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED SIX MONTHS ENDED DECEMBER 31, DECEMBER 31 ------------------------ ----------------------- 2002 2001 2002 2001 ---------- ---------- ---------- ---------- INCOME (LOSS) PER SHARE Basic -- Income (loss) from continuing operations before cumulative effect of change in accounting principle less accretion of redeemable preferred stock ........... $ (0.07) $ 0.10 $ 0.17 $ 0.03 Income (loss) from discontinued operations .............. -- 0.11 0.77 0.10 ---------- ---------- ---------- ---------- Income (loss) before cumulative effect of change in accounting principle less accretion of redeemable preferred stock ....................................... (0.07) 0.21 0.94 0.13 Cumulative effect of change in accounting principle ..... -- -- -- (3.29) ---------- ---------- ---------- ---------- Net income (loss) applicable to each common share ..... $ (0.07) $ 0.21 $ 0.94 $ (3.16) ========== ========== ========== ========== Diluted -- Income (loss) from continuing operations before cumulative effect of change in accounting principle less accretion of redeemable preferred stock ........... $ (0.07) $ 0.10 $ 0.15 $ 0.03 Income (loss) from discontinued operations .............. -- 0.11 0.69 0.10 ---------- ---------- ---------- ---------- Income (loss) before cumulative effect of change in accounting principle less accretion of redeemable preferred stock ....................................... (0.07) 0.21 0.84 0.13 Cumulative effect of change in accounting principle ..... -- -- -- (3.26) ---------- ---------- ---------- ---------- Net income (loss) applicable to each common share ..... $ (0.07) $ 0.21 $ 0.84 $ (3.13) ========== ========== ========== ========== AVERAGE NUMBER OF SHARES OUTSTANDING -- BASIC ............... 16,142 15,100 16,068 15,065 ========== ========== ========== ========== AVERAGE NUMBER OF SHARES OUTSTANDING -- DILUTED ............. 16,142 15,336 17,898 15,183 ========== ========== ========== ==========
See accompanying notes 5 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS RURAL/METRO CORPORATION CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE SIX MONTHS ENDED DECEMBER 31, 2002 AND 2001 (UNAUDITED) (IN THOUSANDS)
2002 2001 -------- -------- CASH FLOWS FROM OPERATING ACTIVITIES Net income (loss) .......................................... $ 16,293 $(47,533) Adjustments to reconcile net income (loss) to cash provided by operating activities -- Non-cash portion of gain on disposition of Latin American operations .................................... (13,732) -- Cumulative effect of change in accounting principle ...... -- 49,513 Depreciation and amortization ............................ 6,773 8,324 Gain on sale of property and equipment ................... (359) (311) Provision for doubtful accounts .......................... 37,742 33,515 Undistributed losses of minority shareholder ............. -- (9) Equity earnings net of distributions received ............ (1,121) (393) Amortization of deferred financing costs ................. 1,049 455 Amortization of debt discount ............................ 13 13 Change in assets and liabilities -- Increase in accounts receivable .......................... (34,983) (29,980) (Increase) decrease in inventories ....................... 85 (77) (Increase) decrease in prepaid expenses and other ........ 112 (16) (Increase) decrease in other assets ....................... 204 (2,055) Decrease in accounts payable ............................. (2,515) (1,331) Decrease in accrued liabilities and other liabilities .... (4,456) (3,609) Increase (decrease) in deferred subscription fees ........ (174) 135 -------- -------- Net cash provided by operating activities ............ 4,931 6,641 -------- -------- CASH FLOWS FROM INVESTING ACTIVITIES Capital expenditures ....................................... (4,716) (2,864) Proceeds from the sale of property and equipment ........... 474 965 -------- -------- Net cash used in investing activities ................ (4,242) (1,899) -------- -------- CASH FLOWS FROM FINANCING ACTIVITIES Repayments on revolving credit facility .................... -- (1,263) Repayment of debt and capital lease obligations ............ (748) (702) Cash paid for debt issuance costs .......................... (971) -- Issuance of common stock ................................... 186 153 -------- -------- Net cash used in financing activities ................ (1,533) (1,812) -------- -------- EFFECT OF CURRENCY EXCHANGE RATE CHANGES ON CASH ........... (21) (310) -------- -------- INCREASE (DECREASE) IN CASH ................................ (865) 2,620 CASH, beginning of period .................................. 9,828 8,699 -------- -------- CASH, end of period ........................................ $ 8,963 $ 11,319 ======== ========
See accompanying notes 6 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and the instructions to Form 10-Q. Accordingly, they do not include all information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. (1) INTERIM RESULTS In the opinion of management, the consolidated financial statements for the three and six month periods ended December 31, 2002 and 2001 include all adjustments, consisting only of normal recurring adjustments, necessary for a fair statement of the consolidated financial position and results of operations. The results of operations for the three and six-month periods ended December 31, 2002 and 2001 are not necessarily indicative of the results of operations for the full fiscal year. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K, as amended, for the fiscal year ended June 30, 2002. Certain financial information for prior periods has been reclassified to conform to the current presentation. The consolidated balance sheet as of June 30, 2002 has been derived from the audited consolidated balance sheet included in the Company's Annual Report on Form 10-K, as amended, for the year ended June 30, 2002 but does not include all of the disclosures required by generally accepted accounting principles. (2) LIQUIDITY During the six months ended December 31, 2002, the Company had net income before the accretion of redeemable preferred stock of $16.3 million compared with a net loss of $47.5 million in the six months ended December 31, 2001. Net income in the six months ended December 31, 2002 included a $12.5 million gain related to the disposition of the Company's Latin American operations while the six months ended December 31, 2001 included a charge of $49.5 million relating to the adoption effective July 1, 2001 of the new goodwill accounting standard as discussed in Note 7. During the three months ended December 31, 2002, the Company had net income before the accretion of redeemable preferred stock of $148,000 compared with net income of $3.2 million for the three months ended December 31, 2001. The Company's operating activities provided cash totaling $4.9 million in the six months ended December 31, 2002 and $6.6 million in the six months ended December 31, 2001. At December 31, 2002, the Company had cash of $9.0 million, debt of $307.4 million and a stockholders' deficit of $160.2 million. The Company's debt includes $149.9 million of 7 7/8% senior notes due 2008, $152.4 million outstanding under its credit facility, $4.2 million payable to a former joint venture partner and $900,000 of capital lease obligations. As discussed in Note 4, the Company was not in compliance with certain of the covenants contained in its revolving credit facility. On September 30, 2002, the Company entered into an amended credit facility with its lenders, which, among other things, extended the maturity date of the facility from March 16, 2003 to December 31, 2004, waived previous non-compliance, and required the issuance to the lenders of 211,549 shares of the Company's Series B redeemable preferred stock. The Company's ability to service its long-term debt, to remain in compliance with the various restrictions and covenants contained in its credit agreements and to fund working capital, capital expenditures and business development efforts will depend on its ability to generate cash from operating activities which is subject to, among other things, its future operating performance as well as to general economic, financial, 7 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS competitive, legislative, regulatory and other conditions, some of which may be beyond its control. If the Company fails to generate sufficient cash from operations, it may need to raise additional equity or borrow additional funds to achieve its longer-term business objectives. There can be no assurance that such equity or borrowings will be available or, if available, will be at rates or prices acceptable to the Company. Although there can be no assurances, management believes that cash flow from operating activities coupled with existing cash balances will be adequate to fund the Company's operating and capital needs as well as enable it to maintain compliance with its various debt agreements through December 31, 2003. To the extent that actual results or events differ from the Company's financial projections or business plans, its liquidity may be adversely impacted. (3) ACCOUNTING FOR STOCK BASED COMPENSATION At December 31, 2002, the Company had two stock compensation plans. The Company accounts for those plans under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. Stock-based compensation expense has not been reflected in the consolidated statement of operations and comprehensive income (loss), as all options granted under those plans had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share as if the Company had applied the fair value recognition provisions of FASB Statement No 123, Accounting for Stock-Based Compensation.
Three Months Ended Six Months Ended December 31, December 31, ------------------------ ----------------------- 2002 2001 2002 2001 ---------- ---------- ---------- ---------- Net income (loss) applicable to common stock $ (1,053) $ 3,170 $ 15,092 $ (47,533) Deduct: Stock based employee compensation determined under the fair value method for all awards, net of related tax effects (865) (154) (951) (329) ---------- ---------- ---------- ---------- Pro forma net income (loss) applicable to common stock $ (1,918) $ 3,016 $ 14,141 $ (47,862) ========== ========== ========== ========== Earnings per share: Basic - as reported $ (0.07) $ 0.21 $ 0.94 $ (3.16) ========== ========== ========== ========== Basic - pro forma $ (0.12) $ 0.20 $ 0.88 $ (3.18) ========== ========== ========== ========== Diluted - as reported $ (0.07) $ 0.21 $ 0.84 $ (3.13) ========== ========== ========== ========== Diluted - pro forma $ (0.12) $ 0.20 $ 0.79 $ (3.15) ========== ========== ========== ==========
8 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (4) LONG-TERM DEBT The Company's long-term debt consists of the following at December 31, 2002 and June 30, 2002 (in thousands): DECEMBER 31, JUNE 30, 2002 2002 --------- --------- 7 7/8% senior notes due 2008 .................... $ 149,865 $ 149,852 Credit facility due December 2004 ............... 152,420 144,369 Note payable to former joint venture partner, monthly payments through June 2006 ... 4,202 4,622 Capital lease and other obligations, at varying rates from 3.5% to 12.75%, due through 2013 ... 959 1,319 --------- --------- 307,446 300,162 Less: Current maturities ........................ (1,406) (1,633) --------- --------- $ 306,040 $ 298,529 ========= ========= In March 1998, the Company entered into a $200.0 million revolving credit facility originally scheduled to mature March 16, 2003. The revolving credit facility was unsecured and was unconditionally guaranteed on a joint and several basis by substantially all of the Company's domestic wholly-owned current and future subsidiaries. Interest rates and availability under the revolving credit facility depended on the Company meeting certain financial covenants, including a total debt leverage ratio, a total debt to capitalization ratio, and a fixed charge ratio. Revolving credit facility borrowings were initially priced at the greater of (i) prime rate or Federal Funds rate plus 0.5% plus an applicable margin, or (ii) a LIBOR-based rate. The LIBOR-based rates included a margin of 0.875% to 1.75%. In December 1999, primarily as a result of additional provisions for doubtful accounts, the Company was not in compliance with three financial covenants under the revolving credit facility: total debt leverage ratio, total debt to total capitalization ratio and fixed charge coverage ratio. The Company received a series of compliance waivers regarding these covenant violations covering the periods from December 31, 1999 through April 1, 2002. The waivers provided for, among other things, enhanced reporting and other requirements and that no additional borrowings would be available under the facility. Pursuant to the waivers, as LIBOR contracts expired in March 2000, all related borrowings were priced at prime plus 0.25 percentage points and interest became payable monthly. Pursuant to the waivers, the Company was required to accrue additional interest expense at a rate of 2.0% per annum on the outstanding balance. The Company recorded approximately $7.4 million of additional interest expense through September 30, 2002. In connection with the waivers, the Company also made unscheduled principal payments totaling $5.2 million. Effective September 30, 2002, the Company entered into an amended credit facility pursuant to which, among other things, the maturity date of the credit facility was extended to December 31, 2004 and any prior noncompliance was permanently waived. The principal terms of the amended credit facility are as follows: 9 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS * WAIVER. Prior noncompliance was permanently waived with respect to the covenant violations described above and with respect to certain other noncompliance items, including non-reimbursement of approximately $2.6 million drawn by beneficiaries under letters of credit issued under the original facility. * MATURITY DATE. The maturity date of the facility was extended to December 31, 2004. * PRINCIPAL BALANCE. Accrued interest (approximately $6.9 million), non-reimbursed letters of credit and various fees and expenses associated with the amended credit facility (approximately $1.2 million) were added to the principal amount of the loan, resulting in an outstanding principal balance as of the effective date of the amendment equal to $152.4 million. * NO REQUIRED AMORTIZATION. No principal payments are required until the maturity date of the facility. * INTEREST RATE. The interest rate was increased to LIBOR plus 7.0% (8.4% as of December 31, 2002), payable monthly. By comparison, the effective interest rate (including the 2.0% of additional accrued interest described above) applicable to the original facility immediately prior to the effective date of the amendment was 7.0%. * FINANCIAL COVENANTS. The amended facility includes financial covenants similar to the ones included in the original credit facility, with compliance levels under such covenants adjusted to levels consistent with the Company's current business levels and outlook. The covenants include (i) total debt leverage ratio (initially set at 7.48), (ii) minimum tangible net worth (initially set at a $230.1 million deficit), (iii) fixed charge coverage ratio (initially set at 0.99), (iv) limitation on capital expenditures of $11 million per fiscal year; and (v) limitation on operating leases during any period of four fiscal quarters to 3.10% of consolidated net revenues. The compliance levels for covenants (i) through (iii) above are set at varying levels on a quarterly basis. Compliance is tested quarterly based on annualized or year-to-date results as applicable. * OTHER COVENANTS. The amended credit facility includes various non-financial covenants equivalent in scope to those included in the original facility. The covenants include restrictions on additional indebtedness, liens, investments, mergers and acquisitions, asset sales, and other matters. The amended credit facility includes extensive financial reporting obligations and provides that an event of default occurs should we lose customer contracts in any fiscal quarter with an aggregate EBITDA contribution of $5 million or more (net of anticipated contributions from new contracts). * EXISTING LETTERS OF CREDIT. Pursuant to the amended facility, letters of credit issued pursuant to the original credit agreement were reissued or extended, to a maximum of $3.5 million, for letter of credit fees aggregating 1 7/8% per annum. A third letter of credit, in the amount of $2.6 million which was previously drawn by its beneficiary, will be reissued subject to application of the funds originally drawn in reduction of the principal balance of the facility and payment of a letter of credit fee equal to 7% per annum. * EQUITY INTEREST. In consideration of the amended facility, the Company issued shares of its Series B redeemable preferred stock to the participants in the credit facility. See discussion of the redeemable preferred stock in Note 5. 10 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The Company recorded approximately $7.0 million of deferred debt issuance costs related to the amended credit facility ($4.2 million related to the fair value of the redeemable preferred stock, $1.2 million of lender fees which were added to the balance of the amended facility and $1.6 million of related professional fees). The unamortized portion of these costs is included in other assets in the accompanying consolidated balance sheet as of December 31, 2002. These costs will be amortized to interest expense over the life of the agreement. The fair value of the redeemable preferred stock was estimated to be equivalent to the market value of the common stock to be issued upon conversion of the redeemable preferred stock, measured at the date of the amendment. The redeemable preferred stock balance will be accreted to the greater of $15.0 million or the value of the common shares into which the preferred shares would otherwise be converted, over the life of the agreement or until the preferred shares are converted to common shares. In March 1998, the Company issued $150.0 million of its 7 7/8% Senior Notes due 2008 (the Senior Notes) under Rule 144A under the Securities Act of 1933, as amended (Securities Act). Interest under the Senior Notes is payable semi-annually on September 15 and March 15, and the Senior Notes are not callable until March 2003 subject to the terms of the Indenture. The Company incurred expenses related to the offering of approximately $5.3 million and is amortizing these costs to interest expense over the life of the Senior Notes. In April 1998, we filed a registration statement under the Securities Act relating to an exchange offer for the Senior Notes. The registration statement became effective on May 14, 1998. The Senior Notes are general unsecured obligations of the Company and are fully and unconditionally guaranteed on a joint and several basis by substantially all of its domestic wholly-owned current and future subsidiaries (the Guarantors). The Senior Notes contain certain covenants that, among other things, limit our ability to incur certain indebtedness, sell assets, or enter into certain mergers or consolidations. The Company does not believe that the separate financial statements and related footnote disclosures concerning the Guarantors provide any additional information that would be material to investors in making an investment decision. Consolidating financial information for the Company (the Parent), the Guarantors and the Company's remaining subsidiaries (the Non-Guarantors) is as follows: 11 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING BALANCE SHEET AS OF DECEMBER 31, 2002 (IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL --------- ---------- -------------- ------------ --------- ASSETS CURRENT ASSETS Cash ....................................... $ -- $ 8,964 $ (1) $ -- $ 8,963 Accounts receivable, net ................... -- 90,920 4,857 -- 95,777 Inventories ................................ -- 12,074 -- -- 12,074 Prepaid expenses and other ................. -- 8,688 20 -- 8,708 --------- --------- --------- --------- --------- Total current assets .................... -- 120,646 4,876 -- 125,522 PROPERTY AND EQUIPMENT, net ................... -- 45,681 192 -- 45,873 GOODWILL ...................................... -- 41,167 -- -- 41,167 DUE FROM (TO) AFFILIATES ...................... 269,255 (240,518) (28,737) -- -- OTHER ASSETS .................................. 9,073 13,837 449 -- 23,359 INVESTMENT IN SUBSIDIARIES .................... (127,407) -- -- 127,407 -- --------- --------- --------- --------- --------- $ 150,921 $ (19,187) $ (23,220) $ 127,407 $ 235,921 ========= ========= ========= ========= ========= LIABILITIES, REDEEMABLE PREFERRED STOCK AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES Accounts payable ........................... $ -- $ 8,751 $ 79 $ -- $ 8,830 Accrued liabilities ........................ 3,463 56,821 (2,414) -- 57,870 Deferred subscription fees ................. -- 15,234 -- -- 15,234 Current portion of long-term debt .......... -- 1,403 3 -- 1,406 --------- --------- --------- --------- --------- Total current liabilities ............... 3,463 82,209 (2,332) -- 83,340 LONG-TERM DEBT, net of current portion ........ 302,285 3,755 -- -- 306,040 OTHER LIABILITIES ............................. -- 339 -- -- 339 DEFERRED INCOME TAXES ......................... -- 1,814 (1,164) -- 650 --------- --------- --------- --------- --------- Total liabilities ....................... 305,748 88,117 (3,496) -- 390,369 --------- --------- --------- --------- --------- MINORITY INTEREST ............................. -- -- -- 379 379 --------- --------- --------- --------- --------- REDEEMABLE PREFERRED STOCK .................... 5,390 -- -- -- 5,390 --------- --------- --------- --------- --------- STOCKHOLDERS' EQUITY (DEFICIT) Common stock ............................... 164 82 8 (90) 164 Additional paid-in capital ................. 138,791 54,622 20,148 (74,770) 138,791 Retained earnings (accumulated deficit) .... (297,933) (162,008) (39,880) 201,888 (297,933) Treasury stock ............................. (1,239) -- -- -- (1,239) --------- --------- --------- --------- --------- Total stockholders' equity (deficit) .... (160,217) (107,304) (19,724) 127,028 (160,217) --------- --------- --------- --------- --------- $ 150,921 $ (19,187) $ (23,220) $ 127,407 $ 235,921 ========= ========= ========= ========= =========
12 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING BALANCE SHEET AS OF JUNE 30, 2002 (IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL --------- ---------- -------------- ------------ --------- ASSETS CURRENT ASSETS Cash ............................................. $ -- $ 9,424 $ 404 $ -- $ 9,828 Accounts receivable, net ......................... -- 93,579 5,536 -- 99,115 Inventories ...................................... -- 12,178 42 -- 12,220 Prepaid expenses and other ....................... -- 8,864 151 -- 9,015 --------- --------- --------- --------- --------- Total current assets .......................... -- 124,045 6,133 -- 130,178 PROPERTY AND EQUIPMENT, net ......................... -- 47,972 560 -- 48,532 GOODWILL ............................................ -- 41,167 77 -- 41,244 DUE FROM (TO) AFFILIATES ............................ 267,612 (215,197) (52,415) -- -- OTHER ASSETS ........................................ 3,031 12,163 2,290 -- 17,484 INVESTMENT IN SUBSIDIARIES .......................... (131,570) -- -- 131,570 -- --------- --------- --------- --------- --------- $ 139,073 $ 10,150 $ (43,355) $ 131,570 $ 237,438 ========= ========= ========= ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT) CURRENT LIABILITIES Accounts payable ................................. $ -- $ 11,049 $ 912 $ -- $ 11,961 Accrued liabilities .............................. 10,171 61,280 2,268 -- 73,719 Deferred subscription fees ....................... -- 15,409 -- -- 15,409 Current portion of long-term debt ................ -- 1,620 13 -- 1,633 --------- --------- --------- --------- --------- Total current liabilities ..................... 10,171 89,358 3,193 -- 102,722 LONG-TERM DEBT, net of current portion .............. 294,221 4,275 33 -- 298,529 OTHER LIABILITIES ................................... -- 477 -- -- 477 DEFERRED INCOME TAXES ............................... -- 1,814 (1,164) -- 650 --------- --------- --------- --------- --------- Total liabilities ............................. 304,392 95,924 2,062 -- 402,378 --------- --------- --------- --------- --------- MINORITY INTEREST ................................... -- -- -- 379 379 --------- --------- --------- --------- --------- STOCKHOLDERS' EQUITY (DEFICIT) Common stock ..................................... 159 82 17 (99) 159 Additional paid-in capital ....................... 138,470 54,622 34,942 (89,564) 138,470 Retained earnings (accumulated deficit) .......... (313,025) (140,478) (90,692) 231,170 (313,025) Accumulated other comprehensive income (loss) .... 10,316 -- 10,316 (10,316) 10,316 Treasury stock ................................... (1,239) -- -- -- (1,239) --------- --------- --------- --------- --------- Total stockholders' equity (deficit) .......... (165,319) (85,774) (45,417) 131,191 (165,319) --------- --------- --------- --------- --------- $ 139,073 $ 10,150 $ (43,355) $ 131,570 $ 237,438 ========= ========= ========= ========= =========
13 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2002 (IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL --------- ---------- -------------- ------------ --------- NET REVENUE ................................... $ -- $ 120,884 $ 2,580 $ -- $ 123,464 --------- --------- --------- --------- --------- OPERATING EXPENSES Payroll and employee benefits ................. -- 68,700 1,533 -- 70,233 Provision for doubtful accounts ............... -- 18,810 207 -- 19,017 Depreciation and amortization ................. -- 3,266 43 -- 3,309 Other operating expenses ...................... -- 22,614 597 -- 23,211 --------- --------- --------- --------- --------- Total expenses .......................... -- 113,390 2,380 -- 115,770 --------- --------- --------- --------- --------- OPERATING INCOME .............................. -- 7,494 200 -- 7,694 Income from wholly-owned subsidiaries ......... 7,415 -- -- (7,415) -- Interest expense, net ......................... (7,267) (62) (162) -- (7,491) --------- --------- --------- --------- --------- INCOME FROM CONTINUING OPERATIONS BEFORE INCOME TAXES ............................... 148 7,432 38 (7,415) 203 INCOME TAX PROVISION .......................... -- (55) -- -- (55) --------- --------- --------- --------- --------- INCOME FROM CONTINUING OPERATIONS ............. 148 7,377 38 (7,415) 148 INCOME (LOSS) FROM DISCONTINUED OPERATIONS .... -- -- -- -- -- --------- --------- --------- --------- --------- NET INCOME .................................... $ 148 $ 7,377 $ 38 $ (7,415) $ 148 ========= ========= ========= ========= =========
14 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING STATEMENT OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2001 (IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL --------- ---------- -------------- ------------ --------- NET REVENUE ................................. $ -- $ 111,417 $ 2,916 $ -- $ 114,333 --------- --------- --------- --------- --------- OPERATING EXPENSES Payroll and employee benefits ............... -- 64,025 1,880 -- 65,905 Provision for doubtful accounts ............. -- 16,382 251 -- 16,633 Depreciation and amortization ............... -- 3,862 49 -- 3,911 Other operating expenses .................... -- 21,956 402 -- 22,358 --------- --------- --------- --------- --------- Total expenses ........................ -- 106,225 2,582 -- 108,807 --------- --------- --------- --------- --------- OPERATING INCOME ............................ -- 5,192 334 -- 5,526 Income from wholly-owned subsidiaries ....... 6,901 -- -- (6,901) -- Interest expense, net ....................... (5,392) (15) (244) -- (5,651) Other income (expense), net ................. -- -- -- 9 9 --------- --------- --------- --------- --------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES ....................... 1,509 5,177 90 (6,892) (116) INCOME TAX BENEFIT .......................... -- 1,625 -- -- 1,625 --------- --------- --------- --------- --------- INCOME FROM CONTINUING OPERATIONS ........... 1,509 6,802 90 (6,892) 1,509 INCOME FROM DISCONTINUED OPERATIONS ......... 1,661 -- 1,661 (1,661) 1,661 --------- --------- --------- --------- --------- NET INCOME .................................. $ 3,170 $ 6,802 $ 1,751 $ (8,553) $ 3,170 ========= ========= ========= ========= =========
15 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED DECEMBER 31, 2002 (IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL --------- ---------- -------------- ------------ --------- NET REVENUE ................................... $ -- $ 243,838 $ 5,191 $ -- $ 249,029 --------- --------- --------- --------- --------- OPERATING EXPENSES Payroll and employee benefits ................. -- 138,157 3,188 -- 141,345 Provision for doubtful accounts ............... -- 37,310 432 -- 37,742 Depreciation and amortization ................. -- 6,662 87 -- 6,749 Other operating expenses ...................... -- 44,580 1,165 -- 45,745 --------- --------- --------- --------- --------- Total expenses .......................... -- 226,709 4,872 -- 231,581 --------- --------- --------- --------- --------- OPERATING INCOME .............................. -- 17,129 319 -- 17,448 Income from wholly-owned subsidiaries ......... 16,949 -- -- (16,949) -- Interest expense, net ......................... (12,988) (48) (341) -- (13,377) --------- --------- --------- --------- --------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES ......................... 3,961 17,081 (22) (16,949) 4,071 INCOME TAX PROVISION .......................... -- (110) -- -- (110) --------- --------- --------- --------- --------- INCOME (LOSS) FROM CONTINUING OPERATIONS ...... 3,961 16,971 (22) (16,949) 3,961 INCOME (LOSS) FROM DISCONTINUED OPERATIONS .... 12,332 12,488 (156) (12,332) 12,332 --------- --------- --------- --------- --------- NET INCOME (LOSS) ............................. $ 16,293 $ 29,459 $ (178) $ (29,281) $ 16,293 ========= ========= ========= ========= =========
16 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING STATEMENT OF OPERATIONS FOR THE SIX MONTHS ENDED DECEMBER 31, 2001 (IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL ---------- ---------- -------------- ------------ ---------- NET REVENUE ................................................ $ -- $ 225,010 $ 5,797 $ -- $ 230,807 ---------- ---------- ---------- ---------- ---------- OPERATING EXPENSES Payroll and employee benefits .............................. -- 130,293 3,933 -- 134,226 Provision for doubtful accounts ............................ -- 32,843 528 -- 33,371 Depreciation and amortization .............................. -- 7,802 140 -- 7,942 Other operating expenses ................................... -- 43,049 839 -- 43,888 ---------- ---------- ---------- ---------- ---------- Total expenses ....................................... -- 213,987 5,440 -- 219,427 ---------- ---------- ---------- ---------- ---------- OPERATING INCOME ........................................... -- 11,023 357 -- 11,380 Income from wholly-owned subsidiaries ...................... 12,384 -- -- (12,384) -- Interest expense, net ...................................... (11,865) (78) (532) -- (12,475) Other income (expense), net ................................ -- -- -- 9 9 ---------- ---------- ---------- ---------- ---------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE INCOME TAXES, AND CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE .................................... 519 10,945 (175) (12,375) (1,086) INCOME TAX BENEFIT ......................................... -- 1,605 -- -- 1,605 ---------- ---------- ---------- ---------- ---------- INCOME (LOSS) FROM CONTINUING OPERATIONS BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE .................................. 519 12,550 (175) (12,375) 519 INCOME FROM DISCONTINUED OPERATIONS ........................ 1,461 -- 1,461 (1,461) 1,461 ---------- ---------- ---------- ---------- ---------- INCOME BEFORE CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE .................................. 1,980 12,550 1,286 (13,836) 1,980 CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE ........ (49,513) (49,513) -- 49,513 (49,513) ---------- ---------- ---------- ---------- ---------- NET INCOME (LOSS) .......................................... $ (47,533) $ (36,963) $ 1,286 $ 35,677 $ (47,533) ========== ========== ========== ========== ==========
17 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE SIX MONTHS ENDED DECEMBER 31, 2002 (IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL ---------- ---------- -------------- ------------ ---------- CASH FLOW FROM OPERATING ACTIVITIES Net income (loss) ................................... $ 16,293 $ 29,459 $ (178) $ (29,281) $ 16,293 Adjustments to reconcile net income (loss) to cash provided by (used in) operations-- Non-cash portion of gain on disposition of Latin American operations .............................. 139 -- (13,871) -- (13,732) Depreciation and amortization ..................... -- 6,658 115 -- 6,773 Gain on sale of property and equipment ............ -- (224) (135) -- (359) Provision for doubtful accounts ................... -- 37,310 432 -- 37,742 Equity earnings net of distributions received ..... -- (1,121) -- -- (1,121) Amortization of deferred financing costs .......... 1,049 -- -- -- 1,049 Amortization of discount on Senior Notes .......... 13 -- -- -- 13 Change in assets and liabilities-- Increase in accounts receivable ................... -- (34,650) (333) -- (34,983) (Increase) decrease in inventories ................ -- 103 (18) -- 85 (Increase) decrease in prepaid expenses and other . -- 176 (64) -- 112 (Increase) decrease in other assets ............... (263) (573) 1,040 -- 204 (Increase) decrease in due to/from affiliates ..... (16,575) (25,192) 12,507 29,260 -- Increase (decrease) in accounts payable ........... -- (2,772) 257 -- (2,515) Increase (decrease) in accrued liabilities and other liabilities ................................ 150 (4,597) (9) -- (4,456) Decrease in deferred subscription fees ............ -- (174) -- -- (174) ---------- ---------- ---------- ---------- ---------- Net cash provided by (used in) operating activities .................................. 806 4,403 (257) (21) 4,931 ---------- ---------- ---------- ---------- ---------- CASH FLOW FROM INVESTING ACTIVITIES Capital expenditures ................................ -- (4,562) (154) -- (4,716) Proceeds from the sale of property and equipment .... -- 436 38 -- 474 ---------- ---------- ---------- ---------- ---------- Net cash used in investing activities .................................. -- (4,126) (116) -- (4,242) ---------- ---------- ---------- ---------- ---------- CASH FLOW FROM FINANCING ACTIVITIES Repayment of debt and capital lease obligations ..... -- (737) (11) -- (748) Cash paid for debt issuance costs ................... (971) -- -- -- (971) Issuance of common stock ............................ 186 -- -- -- 186 ---------- ---------- ---------- ---------- ---------- Net cash used in financing activities ........ (785) (737) (11) -- (1,533) ---------- ---------- ---------- ---------- ---------- EFFECT OF CURRENCY EXCHANGE RATE CHANGE ............... (21) -- (21) 21 (21) ---------- ---------- ---------- ---------- ---------- DECREASE IN CASH ...................................... -- (460) (405) -- (865) CASH, beginning of period ............................. -- 9,424 404 -- 9,828 ---------- ---------- ---------- ---------- ---------- CASH, end of period ................................... $ -- $ 8,964 $ (1) $ -- $ 8,963 ========== ========== ========== ========== ==========
18 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS CONSOLIDATING STATEMENT OF CASH FLOWS FOR THE SIX MONTHS ENDED DECEMBER 31, 2001 (IN THOUSANDS)
PARENT GUARANTORS NON-GUARANTORS ELIMINATIONS TOTAL ---------- ---------- -------------- ------------ ---------- CASH FLOW FROM OPERATING ACTIVITIES Net loss ............................................ $ (47,533) $ (36,963) $ 1,286 $ 35,677 $ (47,533) Adjustments to reconcile net loss to cash provided by (used in) operations-- Cumulative effect of a change in accounting principle ....................................... -- 49,513 -- -- 49,513 Depreciation and amortization ..................... -- 7,802 522 -- 8,324 (Gain) loss on sale of property and equipment ..... -- 122 (433) -- (311) Provision for doubtful accounts ................... -- 32,843 672 -- 33,515 Undistributed losses of minority shareholders ..... -- -- -- (9) (9) Equity earnings net of distributions received ..... -- (393) -- -- (393) Amortization of deferred financing costs .......... 455 -- -- -- 455 Amortization of discount on Senior Notes .......... 13 -- -- -- 13 Change in assets and liabilities-- Increase in accounts receivable ................... -- (29,797) (183) -- (29,980) (Increase) decrease in inventories ................ -- (99) 22 -- (77) (Increase) decrease in prepaid expenses and other . (51) 244 (209) -- (16) (Increase) decrease in other assets ............... (910) 1,184 (2,329) -- (2,055) (Increase) decrease in due to/from affiliates ..... 48,224 (11,960) (286) (35,978) -- Increase (decrease) in accounts payable ........... -- (2,423) 1,092 -- (1,331) Increase (decrease) in accrued liabilities and other liabilities ................................ 1,222 (3,518) (1,313) -- (3,609) Increase in deferred subscription fees ............ -- 108 27 -- 135 ---------- ---------- ---------- ---------- ---------- Net cash provided by (used in) operating activities .................................. 1,420 6,663 (1,132) (310) 6,641 ---------- ---------- ---------- ---------- ---------- CASH FLOW FROM INVESTING ACTIVITIES Capital expenditures ................................ -- (2,498) (366) -- (2,864) Proceeds from the sale of property and equipment .... -- 365 600 -- 965 ---------- ---------- ---------- ---------- ---------- Net cash provided by (used in) investing activities .................................. -- (2,133) 234 -- (1,899) ---------- ---------- ---------- ---------- ---------- CASH FLOW FROM FINANCING ACTIVITIES Repayments on revolving credit facility, net ........ (1,263) -- -- -- (1,263) Repayment of debt and capital lease obligations ..... -- (684) (18) -- (702) Issuance of common stock ............................ 153 -- -- -- 153 ---------- ---------- ---------- ---------- ---------- Net cash used in financing activities ........ (1,110) (684) (18) -- (1,812) ---------- ---------- ---------- ---------- ---------- EFFECT OF CURRENCY EXCHANGE RATE CHANGE ............... (310) -- (310) 310 (310) ---------- ---------- ---------- ---------- ---------- INCREASE (DECREASE) IN CASH ........................... -- 3,846 (1,226) -- 2,620 CASH, beginning of period ............................. -- 6,763 1,936 -- 8,699 ---------- ---------- ---------- ---------- ---------- CASH, end of period ................................... $ -- $ 10,609 $ 710 $ -- $ 11,319 ========== ========== ========== ========== ==========
19 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS (5) REDEEMABLE PREFERRED STOCK In consideration of the amended facility, the Company issued shares of its Series B redeemable preferred stock to the participants in the credit facility. The redeemable preferred stock is convertible into 2,115,490 common shares (10% of the sum of the common shares outstanding on a diluted basis, as defined). The conversion ratio is subject to upward adjustment if the Company issues common stock or securities convertible into the Company's common stock for consideration less than the fair market value of such securities at the time of such transaction. Because a sufficient number of common shares are not currently available to permit conversion, the Company intends to seek stockholder approval to amend its certificate of incorporation to authorize additional common shares. Conversion of the preferred shares occurs automatically upon notice from the Company, assuming approval by the Company's stockholders of sufficient common shares to permit conversion. Should the Company's stockholders fail to approve such a proposal by December 31, 2004, the Company will be required to redeem the preferred stock for a price equal to the greater of $15 million or the value of the common shares into which the preferred shares would otherwise have been convertible. In addition, should the Company's stockholders fail to approve such a proposal, the redeemable preferred stock enjoys a preference upon a sale of the Company, a sale of its assets and in certain other circumstances; this preference equals the greater of (i) the value of the common shares into which the redeemable preferred stock would otherwise have been convertible or (ii) $12.5 million or $15 million depending on whether the triggering event occurs prior to December 31, 2003 or December 31, 2004, respectively. At the election of the holder, the preferred shares carry voting rights as if such shares were converted into common shares. The preferred shares do not bear a dividend. The preferred shares (and common shares issuable upon conversion of the preferred shares) are entitled to certain registration rights. The terms of the preferred shares limit the Company from issuing senior or pari passu preferred shares and from paying dividends on, or redeeming, shares of junior stock. The Company has recorded accretion of the redeemable preferred stock totaling $1.2 million during the three and six months ended December 31, 2002. (6) DISPOSITION OF LATIN AMERICAN OPERATIONS Due to the deteriorating economic conditions and continued devaluation of the local currency, the Company reviewed its strategic alternatives with respect to the continuation of operations in Latin America, including Argentina and Bolivia, and determined that the Company would benefit from focusing on its domestic operations. Effective September 27, 2002, the Company sold its Latin American operations to local management for the assumption of net liabilities. The gain resulting from the disposition of the Latin American operations totaled $12.5 million and is included in the income from discontinued operations for the six months ended December 31, 2002. The gain includes the assumption by the buyer of net liabilities of $3.3 million (including accounts receivable of $0.6 million and accrued liabilities of $4.8 million) as well as the recognition of related cumulative translation adjustments of $10.1 million. Revenue related to the Company's Latin American operations totaled $2.4 million and $18.6 million for the six months ended December 31, 2002 and 2001, respectively. Revenue related to Company's Latin American operations totaled $9.4 million for the three months ended December 31, 2001. The Company's Latin American operations generated losses of $156,000 for the six months ended December 31, 2002 and income of $1.5 million for the six months ended December 2001.The Company's Latin American operations generated income of $1.7 million for the three months ended December 31, 2001. The Argentine operations and Bolivian medical transportation operations were included in the Company's medical transportation and 20 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS related service segment. The Bolivian fire operations were included in the Company's Fire and Other segment. (7) RESTRUCTURING CHARGE AND OTHER During fiscal 2001, the Company decided to close or downsize nine service areas and in connection therewith, recorded restructuring charges in accordance with Emerging Issues Task Force 94-3 "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring)" (EITF 94-3) as well as other related charges totaling $9.1 million. These charges included $1.5 million to cover severance costs associated with the termination of approximately 250 employees, all of whom were expected to leave by the end of fiscal 2002, lease termination and other exit costs of $2.4 million, and asset impairment charges for goodwill and property and equipment of $4.1 million and $1.1 million, respectively, related to the impacted service areas. Approximately 109 of the impacted employees have been terminated, as of December 31, 2002. The previously mentioned charge included accrued severance, lease termination and other costs totaling $1.5 million relating to an under performing service area that the Company had planned to exit at the time of contract expiration in December 2001. During fiscal 2002, the contract was extended for a one-year period at the request of the municipality to enable it to transition medical transportation service to a new provider. The operating environment in this service area has improved and the Company was recently awarded a new multi-year contract. The contract related to this award was finalized during the quarter ended December 31, 2002 and as a result, the remaining reserve of $1.3 million was released to income. This reversal was reflected in the accompanying consolidated statement of operations in other operating expenses. A summary of activity in the Company's restructuring reserves is as follows (in thousands):
LEASE SEVERANCE TERMINATION OTHER EXIT COSTS COSTS COSTS TOTAL ------- ------- ------- ------- Balance at June 30, 2002 ........... $ 757 $ 1,514 $ 32 $ 2,303 Fiscal 2003 Usage ................ (24) (137) (76) (237) Adjustments ...................... (314) 145 169 -- Restructuring charge reversals ... (414) (873) (114) (1,401) ------- ------- ------- ------- Balance at December 31, 2002 ....... $ 5 $ 649 $ 11 $ 665 ======= ======= ======= =======
(8) GOODWILL The Company adopted SFAS No. 142, Goodwill and Other Intangible Assets (SFAS 142) effective July 1, 2001 and discontinued amortization of goodwill as of that date. During the first quarter of fiscal 2002, the Company identified its various reporting units which consist of the individual cost centers within its medical transportation and fire and other operating segments for which separately identifiable cash flow information is available. During the second quarter of fiscal 2002, the Company completed the first step impairment test as of July 1, 2001at which time potential impairments were identified in certain reporting units. During the fourth quarter of fiscal 2002, the Company completed the second step test and determined that all or a portion of the goodwill applicable to certain of its reporting units was impaired as of July 1, 2001 resulting in an aggregate charge of $49.5 million. The fair value of the reporting units was determined using the discounted cash flow method and a discount rate of 15.0%. This charge has been reflected in the accompanying consolidated statement of operations as the cumulative effect of change in accounting 21 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS principle. Additionally, the Company's results for the first quarter of fiscal 2002 have been restated to reflect this charge in that period as required by SFAS 142. The Company has selected June 30 as the date on which it will perform its annual goodwill impairment test. (9) NET INCOME (LOSS) PER SHARE A reconciliation of the numerators and denominators (weighted average number of shares outstanding) of the basic and diluted income (loss) per share computations for the three and six-month periods ended December 31, 2002 and 2001 is as follows (in thousands, except per share amounts):
Three Months Ended Six Months Ended December 31, December 31, -------------------- -------------------- 2002 2001 2002 2001 -------- -------- -------- -------- Income (loss) from continuing operations before cumulative effect of change in accounting principle $ 148 $ 1,500 $ 3,961 $ 519 Less: Accretion of redeemable preferred stock (1,201) -- (1,201) -- -------- -------- -------- -------- Income (loss) from continuing operations before cumulative effect of change in accounting principle less accretion of redeemable preferred stock $ (1,053) $ 1,500 $ 2,760 $ 519 ======== ======== ======== ======== Average number of shares outstanding - Basic 16,142 15,100 16,068 15,065 Add: Incremental shares for: Dilutive effect of stock options -- 236 1,830 118 -------- -------- -------- -------- Average number of shares outstanding - Diluted 16,142 15,336 17,898 15,183 ======== ======== ======== ======== Income (loss) per share - Basic Income (loss) from continuing operations before cumulative effect of change in accounting principle $ 0.00 $ 0.10 $ 0.24 $ 0.03 Less: Accretion of redeemable preferred stock (0.07) -- (0.07) -- -------- -------- -------- -------- Income (loss) from continuing operations before cumulative effect of change in accounting principle less accretion of redeemable preferred stock $ (0.07) $ 0.10 $ 0.17 $ 0.03 ======== ======== ======== ======== Income (loss) per share - Diluted Income (loss) from continuing operations before cumulative effect of change in accounting principle $ 0.00 $ 0.10 $ 0.22 $ 0.03 Less: Accretion of redeemable preferred stock (0.07) -- (0.07) -- -------- -------- -------- -------- Income (loss) from continuing operations before cumulative effect of change in accounting principle less accretion of redeemable preferred stock $ (0.07) $ 0.10 $ 0.15 $ 0.03 ======== ======== ======== ========
Stock options with exercise prices above the applicable market prices have been excluded from the calculation of diluted earnings per share. Such options totaled 4.5 million and 5.4 million at December 31, 2002 and 2001, 22 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS respectively. As a result of anti-dilutive effects, approximately 1.9 million option shares which had exercise prices below the applicable market prices, were not included in the computation of diluted loss per share for the three months ended December 31, 2002. Earnings per share is affected by the accretion of the redeemable preferred stock of approximately $1.2 million per quarter. Additionally, upon approval of the stockholders of additional common shares and notice from the Company to holders of the redeemable preferred stock, 2,115,490 common shares will be included in the denominator of the earnings per share calculation. (10) SEGMENT REPORTING For financial reporting purposes, the Company has classified its operations into two reporting segments that correspond with the manner in which such operations are managed: the Medical Transportation and Related Services Segment and the Fire and Other Segment. Each reporting segment consists of cost centers (operating segments) representing the Company's various service areas that have been aggregated on the basis of the type of services provided, customer type and methods of service delivery. The Medical Transportation and Related Services Segment includes emergency ambulance services provided to individuals pursuant to contracts with counties, fire districts, and municipalities, as well as non-emergency ambulance services provided to individuals requiring either advanced or basic levels of medical supervision during transport. The Segment also includes alternative transportation services, operational and administrative support services related to the Company's public/private alliance with the City of San Diego. The Fire and Other Segment includes a variety of fire protection services including fire prevention, suppression, training, alarm monitoring, dispatch, fleet and billing services. The accounting policies as described in the Company's Annual Report on Form 10-K, as amended, have also been followed in the preparation of the accompanying financial information for each reporting segment. For internal management purposes, the Company's measure of segment profitability is defined as income (loss) from continuing operations before interest, income taxes, depreciation and amortization. Additionally, segment assets are defined as consisting solely of accounts receivable. The following tables summarize the information required to be presented by SFAS 131, Disclosures about Segments of an Enterprise and Related Information, as of and for the three and six months ended December 31, 2002 and 2001. The Company has revised certain of the information presented below as of and for the three and six months ended December 31, 2001. Such revisions consist of: * The inclusion of alternative transportation services ($2.6 million in the three months ended December 31, 2001 and $5.4 million in the six months ended December 31, 2001) as well as operational and administrative support services related to the Company's public/private alliance with the City of San Diego ($3.7 million in the three months ended December 31, 2001 and $7.3 million in the six months ended December 31, 2001) within the Medical Transportation and Related Services Segment (such services were previously included in the Fire and Other Segment); 23 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS * The clarification of the measure of segment profitability as well as the definition of segment assets to correspond with the manner in which the Company has historically managed its operations; and * The addition of a reconciliation of the segment financial information to corresponding amounts contained in the Consolidated Financial Statements. These revisions had no impact on the Company's consolidated financial position, results of operations or cash flows. 24 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Information by reporting segment is set forth below:
MEDICAL TRANSPORTATION AND RELATED FIRE AND SERVICES OTHER CORPORATE TOTAL ---------- ---------- ---------- ---------- (IN THOUSANDS) THREE MONTHS ENDED DECEMBER 31, 2002 Net revenues from external customers .. $ 102,895 $ 20,569 $ -- $ 123,464 Segment profit (loss) ................. 11,818 2,740 (3,555) 11,003 Segment assets ........................ 94,691 1,086 -- 95,777 THREE MONTHS ENDED DECEMBER 31, 2001 Net revenues from external customers .. $ 96,059 $ 18,274 $ -- $ 114,333 Segment profit (loss) ................. 11,630 2,106 (4,299) 9,437 Segment assets ........................ 96,867 1,590 -- 98,457 SIX MONTHS ENDED DECEMBER 31, 2002 Net revenues from external customers .. $ 206,689 $ 42,340 $ -- $ 249,029 Segment profit (loss) ................. 24,515 6,751 (7,069) 24,197 Segment assets ........................ 94,691 1,086 -- 95,777 SIX MONTHS ENDED DECEMBER 31, 2001 Net revenues from external customers .. $ 193,874 $ 36,933 $ -- $ 230,807 Segment profit (loss) ................. 21,923 5,095 (7,696) 19,322 Segment assets ........................ 96,867 1,590 -- 98,457
A reconciliation of segment profit (loss) to income (loss) from continuing operations before income taxes and cumulative effect of change in accounting principle is as follows:
THREE MONTHS ENDED SIX MONTHS ENDED DECEMBER 31, DECEMBER 31, ------------------------ ------------------------ 2002 2001 2002 2001 ---------- ---------- ---------- ---------- Segment profit (loss) ............................. $ 11,003 $ 9,437 $ 24,197 $ 19,322 Depreciation and amortization ..................... (3,309) (3,911) (6,749) (7,942) Interest expense, net ............................. (7,491) (5,651) (13,377) (12,475) Other expense, net ................................ -- 9 -- 9 ---------- ---------- ---------- ---------- Income (loss) from continuing operations before income taxes, and cumulative effect of change in accounting principle ....................... $ 203 $ (116) $ 4,071 $ (1,086) ========== ========== ========== ==========
25 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS A reconciliation of segment assets to total assets is as follows: AS OF DECEMBER 31, ----------------------- 2002 2001 ---------- ---------- Segment assets ............................. $ 95,777 $ 98,457 Cash ....................................... 8,963 11,319 Inventories ................................ 12,074 13,241 Prepaid expenses and other ................. 8,708 5,027 Property and equipment, net ................ 45,905 51,989 Goodwill ................................... 41,167 92,345 Other assets ............................... 23,327 14,365 ---------- ---------- $ 235,921 $ 286,743 ========== ========== (11) RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based Compensation -- Transition and Disclosure, an amendment of SFAS No. 123." SFAS No. 148 amended SFAS No. 123, "Accounting for Stock-Based Compensation," to provide alternative methods of transition for an entity that voluntarily changes to the fair value based method of accounting for stock-based employee compensation. It also amends the disclosure provisions of SFAS No. 123 to require prominent disclosure about the effects on reported net income of an entity's accounting policy decisions with respect to stock-based employee compensation. In addition, SFAS No. 148 amends Accounting Principles Board Opinion No. 28, "Interim Financial Reporting", to require disclosure about those effects in interim financial information. SFAS 148 is effective for financial statements for fiscal years ending after December 15, 2002, including certain amendments to required disclosures related to stock-based compensation included in condensed financial statements for interim periods beginning after December 15, 2002. The Company has complied with the disclosure requirements of SFAS No. 148 and does not anticipate voluntarily changing to the fair value based method of accounting for stock-based employee compensation. In November 2002, the FASB issued FASB Interpretation No. 45 (FIN 45), "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others". FIN 45 clarifies the requirements of FASB Statement No. 5, "Accounting for Contingencies", relating to the guarantor's accounting for, and disclosure of, the issuance of certain types of guarantees. FIN 45 is to be applied on a prospective basis to guarantees issued or modified after December 31, 2002. The Company does not expect the application of FIN 45 to have a material impact on its financial condition or results of operations. (12) COMMITMENTS AND CONTINGENCIES MEDICARE FEE SCHEDULE On April 1, 2002, the Medicare Ambulance Fee Schedule Final Rule became effective. The final rule categorizes seven levels of ground ambulance services, ranging from basic life support to specialty care transport, and two categories of air ambulance services. The base rate conversion factor for services to Medicare patients was set at $170.54, plus separate mileage payments based on specified relative value units for each level of ambulance service. Adjustments also were included to recognize differences in relative practice costs among geographic areas, and higher transportation costs that may be incurred by ambulance providers in rural areas with low population density. The Final Rule requires ambulance providers to accept the assigned reimbursement rate as full payment, after patients have submitted their deductible and 20 percent of Medicare's fee for service. In addition, the Final Rule calls for a five-year phase-in period to allow time for providers to adjust to the new payment rates. The fee schedule will be phased in at 20-percent increments each year, with payments being made at 100 percent of the fee schedule in 2006 and thereafter. The Company currently believes that the Medicare Ambulance Fee Schedule will have a neutral net impact on its medical transportation revenue at incremental and full phase-in periods, primarily due to the geographic diversity of its operations. These rules could, however, result in contract renegotiations or other actions to offset any negative impact at the regional level that could have a material adverse effect on the Company's business, financial condition, cash flows, and results of operations. Changes in reimbursement policies or other governmental action, together with the financial challenges of some private, third-party payers and budget pressures on other payer sources could influence the timing and, potentially, the receipt of payments and reimbursements. A reduction in coverage or reimbursement rates by third-party payers, or an increase in the Company's cost structure relative to the rate increase in the Consumer Price Index (CPI), or costs incurred to implement the mandates of the fee schedule could have a material adverse effect on the Company's business, financial condition, cash flows, and results of operations. 26 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS LEGAL PROCEEDINGS From time to time, the Company is subject to litigation and regulatory investigations arising in the ordinary course of business. The Company believes that the resolution of currently pending claims or legal proceedings will not have a material adverse effect on its business, financial condition, cash flows or results of operations. However, the Company is unable to predict with certainty the outcome of pending litigation and regulatory investigations. In some cases, insurance coverage may not be adequate to cover all liabilities arising out of such claims. In addition, due to the nature of the Company's business, Center for Medicare and Medicaid Services (CMS) and other regulatory agencies are expected to continue their practice of performing periodic reviews and initiating investigations related to the Company's compliance with billing regulations. Unfavorable resolutions of pending or future litigation, regulatory reviews and/or investigations, either individually or in the aggregate, could have a material adverse effect on the Company's business, financial condition, cash flows and results of operations. The Company, Warren S. Rustand, the former Chairman of the Board and Chief Executive Officer of the Company, James H. Bolin, the former Vice Chairman of the Board, and Robert E. Ramsey, Jr., the former Executive Vice President and former Director, were named as defendants in two purported class action lawsuits: HASKELL V. RURAL/METRO CORPORATION, ET AL., Civil Action No. C-328448 filed on August 25, 1998 in Pima County, Arizona Superior Court and RUBLE V. RURAL/METRO CORPORATION, ET AL., CIV 98-413-TUC-JMR filed on September 2, 1998 in United States District Court for the District of Arizona. The two lawsuits, which contain virtually identical allegations, were brought on behalf of a class of persons who purchased the Company's publicly traded securities including its common stock between April 28, 1997 and June 11, 1998. Haskell v. Rural/Metro seeks unspecified damages under the Arizona Securities Act, the Arizona Consumer Fraud Act, and under Arizona common law fraud, and also seeks punitive damages, a constructive trust, and other injunctive relief. Ruble v. Rural/Metro seeks unspecified damages under Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended. The complaints in both actions allege that between April 28, 1997 and June 11, 1998 the defendants issued certain false and misleading statements regarding certain aspects of the Company's financial status and that these statements allegedly caused the Company's common stock to be traded at artificially inflated prices. The complaints also allege that Mr. Bolin and Mr. Ramsey sold stock during this period, allegedly taking advantage of inside information that the stock prices were artificially inflated. On May 25, 1999, the Arizona State Court granted a request for a stay of the Haskell action until the Ruble action is finally resolved. The Company and the individual defendants moved to dismiss the Ruble action. On January 25, 2001, the Court granted the motion to dismiss, but granted the plaintiffs leave to replead. On March 31, 2001, the plaintiffs filed a second amended complaint. The Company and the individual defendants moved to dismiss the second amended complaint. On March 8, 2002, the Court granted the motions to dismiss of Mr. Ramsey and Mr. Bolin with leave to replead and denied the motions to dismiss of the Company and Mr. Rustand. The result is that Mr. Ramsey and Mr. Bolin have been dismissed from the Ruble v. Rural/Metro case although the Court has permitted plaintiffs leave to file another complaint against those individuals. Mr. Rustand and the Company remain defendants. The parties have commenced discovery in the Ruble v. Rural/Metro case. During discovery, the parties conduct investigation through formal processes such as depositions, subpoenas and requests for production of documents. This phase is currently expected to run through November 2003. In addition, Plaintiffs have moved to certify the class in the Ruble v. Rural/Metro case. Defendants, without waiving the right to object in the future, at this juncture expect to stipulate to the certification of the class. 27 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS The Company and the individual defendants are insured by primary and excess insurance policies, which were in effect at the time the lawsuits were filed (the "D&O Policies"). The Company's primary carrier had been funding the costs of the litigation and attorney's fees over approximately the last four years. Recently, however, the Company's primary carrier notified all defendants that it is taking the position that there is no coverage. The primary carrier purports to base this decision on the actions of one of the Company's former officers, whom the primary carrier claims assisted the Plaintiffs in the Ruble v. Rural/Metro case in such a way as to trigger an exclusion under the policy. The Company and the carrier have agreed in principle to an interim funding agreement, subject to final documentation under which the carrier would advance defense costs in the underlying litigations pending a court determination of the coverage dispute. While the Company intends to vigorously pursue its rights under the D&O Policies, the Company is unable to predict with certainty the outcome of these matters. A final and binding adverse judgment on the coverage dispute could have a material adverse effect on the Company's business, financial condition, cash flows and results of operations. Based on the information currently available, the Company does not have the ability to estimate it's potential liability, if any, related to this matter. The Company, Arthur Andersen LLP, Cor Clement and Jane Doe Clement, Randall L. Harmsen and Jane Doe Harmsen, Warren S. Rustand and Jane Doe Rustand, James H. Bolin and Jane Doe Bolin, Jack E. Brucker and Jane Doe Brucker, Robert B. Hillier and Jane Doe Hillier, John S. Banas III and Jane Doe Banas, Louis G. Jekel and Karen Whitmer, Mary Anne Carpenter and John Doe Carpenter, William C. Turner and Jane Doe Turner, Henry G. Walker and Jane Doe Walker, Louis A. Witzeman and Jane Doe Witzeman, John Furman and Jane Doe Furman, and Mark Liebner and Jane Doe Liebner were named as defendants in a purported class action lawsuit: STEVEN A. SPRINGBORN V. RURAL/METRO CORPORATION, ET AL., Civil Action No. CV 2002-019020 filed on September 30, 2002 in Maricopa County, Arizona Superior Court. The lawsuit was brought on behalf of a class of persons who purchased our publicly traded securities including our common stock from July 1, 1996 through June 30, 2001. The primary allegations of the complaint include violations of various state and federal securities laws, breach of contract, common law fraud, and mismanagement of the Company's 401(k) plan, Employee Stock Purchase Plan and Employee Stock Ownership Plan. The Plaintiffs seek unspecified compensatory and punitive damages. The Plaintiffs amended the Complaint on October 17, 2002 adding Barry Landon and Jane Doe Landon as defendents and making certain additional allegations and claims. On October 30, 2002, Defendant Arthur Andersen LLP removed the action to the United States District Court, District of Arizona, CIV-02-2183-PHX-JWS. The Company and the individual defendants have consented to this removal. The Company and the individual defendants have been served with the summons and complaint and are in the process of responding to the Amended Complaint. Based on the information currently available, the Company does not have the ability to estimate it's potential liability, if any, related to this matter. As previously reported, LaSalle Ambulance, Inc., a New York corporation which is a subsidiary of Rural/Metro Corporation, was sued in the case of Ann Bogucki and Patrick Bogucki v. LaSalle Ambulance Service, et al., Index No. I 1995 2128, in the Supreme Court of the State of New York, Erie County. In January 2003, the parties reached an agreement in principle to settle the matter. The agreement in principle, which does not result in the Company recording any additional claims expense, provides for a full release of LaSalle Ambulance in April 2003 subject to completion of final settlement documentation and plaintiff's receipt of agreed consideration. 28 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS GENERAL LIABILITY AND WORKERS' COMPENSATION POLICIES With respect to the Company's liability insurance policies (including it's general liability, auto liability and professional liability policies) for the policy years commencing in June 2000, 2001 and 2002, the Company is required by each policy to set aside $100,000 per month into a designated "loss fund" account which cash is restricted to the payment of our retention obligations as required under such policies. The Company expects to fund these deposits on a monthly basis in subsequent years until such time as the total loss fund deposits equal the contractual ceiling on our aggregate retention obligation under these policies. The loss fund balances vary during the course of the year depending upon the frequency and severity of claims payments; however, the Company typically maintains a minimum balance in each loss fund of at least $250,000. If claims payments within the Company's retention layer exceed the applicable loss fund balance required for that policy year, the current monthly funding obligation will be accelerated to the extent of such excess. Such accelerated payments could have a material adverse effect on the Company's business, financial condition, results of operations and cash flows. The Company's liability insurance policies for the policy years commencing in June 2000 and June 2001 were issued by Legion Insurance Company (Legion) as fronting carrier and are 100% reinsured by an "A++" rated insurance carrier unrelated to Legion. At the time the coverage was purchased, Legion was an "A" rated insurance carrier. Under these policies, the obligation of the reinsurer to pay covered losses effectively commences once the Company satisfies it's self-insured retention obligations on a per occurrence or aggregate basis. As of December 31, 2002, all closed liability claims under these policies have been resolved within the retention layer. However, as remaining claims develop, the Company anticipates that the retention layer will be exhausted, at which point the reinsurer will be obligated to fund all losses and expenses related to such claims. On April 1, 2002, the Pennsylvania Insurance Department (the "Department") placed Legion under rehabilitation. The Department is conducting the rehabilitation process, subject to judicial review by the Commonwealth Court of Pennsylvania. Based upon the information currently available, the Company believes that it's reinsurance proceeds will be available to pay claims in excess of the retention as originally contracted notwithstanding the rehabilitation process. However, if the Court deems the Company's reinsurance to be a general asset of Legion, then reinsurance proceeds to fund covered liability losses in excess of the retention may be substantially reduced, delayed or unrecoverable. In such an event, the Company may be required to fund liability losses for these policy years in excess of the retention to the extent that such losses are not covered by state guaranty funds (whether due to liability coverage caps or other circumstances applicable to such guaranty funds). For the policy year commencing May 1, 2001 through May 1, 2002, the Company purchased a workers' compensation policy issued by Legion, which included a deductible to be paid by the Company for each occurrence (subject to an aggregate maximum limit). The Company also concurrently purchased a deductible reimbursement policy issued by Mutual Indemnity (Bermuda) Ltd. (Mutual Indemnity), an affiliate of Legion. The deductible reimbursement policy requires Mutual Indemnity to fully cover the Company's deductible obligations under the workers compensation policy. Under the deductible reimbursement policy, the Company pre-paid all of it's anticipated deductible obligations for the policy year by making contributions of approximately $6.5 million into a loss fund account held by Mutual Indemnity. As noted above, the Department placed Legion into rehabilitation in April 2002. In January 2003, the Commonwealth Court of Pennsylvania ordered the Legion rehabilitator and Mutual Indemnity to establish a trust account, to be funded by deposits held by Mutual Indemnity (including deposits in our loss fund account), for the benefit of the insureds which had placed the 29 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS deposits with Mutual Indemnity. It is the Company's understanding that the Legion rehabilitator intends to appeal the decision of the court to enforce this trust mechanism and that the rehabilitator has asserted, on behalf of Legion, that funds held by Mutual Indemnity (including deposits in our loss fund account) are assets of Legion that should be available to its general creditors. Pending resolution of this matter, Mutual Indemnity has suspended funding workers compensation claims from the amounts we previously deposited with it and some claims are being handled by state guaranty funds or paid directly by the Company. The Company believes the rehabilitator's appeal lacks merit based upon the facts and circumstances. The Company is actively participating in the court proceedings to cause such a trust account mechanism to be created and to operate so as to fully cover all it's deductible obligations as originally intended and to return to the Company any remaining deposit balance once all claims are closed. However, if the funds on deposit with Mutual Indemnity are determined to be general assets of Legion, then use of the Company's loss fund deposits to pay workers compensation claims within it's deductible may be substantially reduced, delayed or unrecoverable. In such an event, the Company may be required to fund the deductible portion of workers compensation claims arising in this policy year, without access to existing deposits in the loss fund account held by Mutual Indemnity. To the extent that workers' compensation claims exceed our deductible portion, the Company currently anticipates that the applicable state guaranty funds will provide coverage for such excess at no additional cost to the Company. During fiscal years 1992 through 2001, the Company purchased certain portions of it's workers' compensation coverage from Reliance Insurance Company ("Reliance"). At the time coverage was purchased, Reliance was an "A" rated insurance company. In connection with this coverage, the Company provided Reliance with various amounts and forms of collateral (e.g., letters of credit, surety bonds and cash deposits) to secure it's performance under the respective policies as was customary and required in the workers' compensation marketplace at the time. As of December 31, 2002, Reliance held $3.0 million of cash collateral under this coverage. On May 29, 2001, Reliance was placed under rehabilitation by the Department and on October 3, 2001 was placed into liquidation. It is the Company's understanding that the collateral held by the Reliance liquidator will be returned to it once all related claims have been satisfied so long as we have satisfied the claim payment obligations under the related policies. To the extent that certain of the Company's workers' compensation claims have exceeded the deductible under the Reliance policies, the applicable state guaranty funds have provided such excess coverage at no additional cost to the Company. We currently anticipate that the state guaranty funds will continue to provide such excess coverage. Based upon the information currently available, the Company believes that the amounts on deposit with Reliance and Mutual Indemnity are fully recoverable and will either be returned to the Company or used to pay claims on our behalf as originally intended, and that state guaranty funds will provide coverage for claims in excess of the deductible. The Company further believe that reinsurance proceeds for it's liability policies for policy years commencing in June 2000 and June 2001 will be available to cover claims in excess of the retention as originally intended or that state guaranty funds will provide coverage for such excess subject to applicable limitations. The Company's inability to access the funds on deposit with Reliance or Mutual Indemnity or to access our liability reinsurance proceeds, or claims in excess of the deductible or retention limitations that are not covered by state guaranty funds, could have a material adverse effect on the Company's business, financial condition, results of operations and cash flows. 30 RURAL/METRO CORPORATION NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS FIRE CONTRACT The Company was recently notified that an initiative to form a municipal fire department in one of the municipalities to which it provides fire protection services, would be voted on in May 2003. Should the initiative pass, the Company's contract will be terminated. This contract represented $4.2 million and $8.4 million of net revenue for the three and six months ended December 31, 2002, respectively. 31 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. FORWARD-LOOKING STATEMENTS AND FACTORS THAT MAY AFFECT RESULTS Statements in this Report that are not historical facts are hereby identified as "forward-looking statements" as that term is used under the securities laws. We caution readers that such "forward-looking statements," including those relating to our future business prospects, working capital, accounts receivable collection, liquidity, cash flow, capital needs, operating results and compliance with debt facilities, wherever they appear in this Report or in other statements attributable to us, are necessarily estimates reflecting our best judgment and involve a number of risks and uncertainties that could cause actual results to differ materially from those suggested by the "forward-looking statements." You should consider such "forward looking-statements" in light of various important factors, including those set forth below and others set forth from time to time in our reports and registration statements filed with the Securities and Exchange Commission. All references to "we," "our," "us," or "Rural/Metro" refer to Rural/Metro Corporation, and its predecessors, operating divisions, direct and indirect subsidiaries, and affiliates. Rural/Metro Corporation, a Delaware corporation, is strictly a holding company. All services, operations, and management functions are provided through its subsidiaries and affiliated entities. This Report should be read in conjunction with our Annual Report on Form 10-K, as amended, for the fiscal year ended June 30, 2002. INTRODUCTION We derive our revenue primarily from fees charged for ambulance and fire protection services. We provide ambulance services in response to emergency medical calls (911 emergency ambulance services) and non-emergency transport services (general transport services) to patients on both a fee-for-service and nonrefundable subscription fee basis. Per transport revenue depends on various factors, including the mix of rates between existing markets and new markets and the mix of activity between 911 emergency ambulance services and non-emergency transport services as well as other competitive factors. Fire protection services are provided either under contracts with municipalities, fire districts or other agencies or on a nonrefundable subscription fee basis to individual homeowners or commercial property owners. Medical transportation and related services revenue includes 911 emergency and non-emergency ambulance and alternative transportation service fees as well as municipal subsidies and subscription fees. Ambulance and alternative transportation service fees are recognized as the services are provided and are recorded net of estimated Medicare, Medicaid and other contractual discounts. Ambulance subscription fees, which are generally received in advance, are deferred and recognized on a pro rata basis over the term of the subscription agreement, which is generally one year. Payments received from third-party payers represent a substantial portion of our ambulance service fee receipts. We maintain an allowance for Medicare, Medicaid and contractual discounts and doubtful accounts based on credit risks applicable to certain types of payers, historical collection trends and other relevant information. This allowance is examined on a quarterly basis and is revised for changes in circumstances surrounding the collectibility of receivables. Provisions for Medicare, Medicaid and contractual reimbursement limitations are included in the calculation of medical transportation services revenue. Because of the nature of our ambulance services, it is necessary to respond to a number of calls, primarily 911 emergency ambulance service calls, which may not result in transports. Results of operations are discussed below on the basis of actual transports because transports are more directly related to revenue. Expenses associated with calls that do not result in transports are included in operating expenses. The percentage of calls not resulting in transports varies substantially depending upon the mix of non-emergency ambulance and 911 emergency ambulance service calls in individual markets and is generally higher in service areas in which the calls are primarily 911 emergency ambulance service calls. Rates in our markets take into account the anticipated number of 32 calls that may not result in transports. We do not separately account for expenses associated with calls that do not result in transports. Revenue generated under fire protection service contracts is recognized over the life of the contract. Subscription fees received in advance are deferred and recognized over the term of the subscription agreement, which is generally one year. Other revenue primarily consists of revenue generated from dispatch, fleet, billing, training and home health care services and is recognized when the services are provided. CRITICAL ACCOUNTING ESTIMATES AND JUDGMENTS The discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. In connection with the preparation of these financial statements, we are required to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue, and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates, including those related to revenue recognition, allowance for Medicare, Medicaid and other contractual discounts and doubtful accounts, and general liability and workers' compensation claim reserves. We base our estimates on historical experience and on various other assumptions that we believe are reasonable under the circumstances. Such historical experience and assumptions form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. We have identified the accounting policies below as critical to our business operations and the understanding of our results of operations. The impact of these policies on our business operations is discussed throughout Management's Discussion and Analysis of Financial Condition and Results of Operations where such policies affect our reported and expected financial results. The discussion below is not intended to be a comprehensive list of our accounting policies. For a detailed discussion on the application of these and other accounting policies, see Note 1 in the Notes to the Consolidated Financial Statements included in our Annual Report on Form 10-K, as amended, for the year ended June 30, 2002, which contains accounting policies and other disclosures required by accounting principles generally accepted in the United States of America. MEDICAL TRANSPORTATION AND RELATED FEE REVENUE RECOGNITION -- Ambulance and alternative transportation service fees are recognized when services are provided and are recorded net of a provision for Medicare, Medicaid, and other contractual reimbursement limitations. Because of the length of the collection cycle with respect to ambulance and alternative transportation service fees, it is necessary to estimate the amount of these reimbursement limitations at the time revenue is recognized. Estimates of amounts uncollectible due to such reimbursement limitations are based on historical collection data, historical write-off activity and current relationships with payers, and are computed separately for each service area. The estimated uncollectibility is translated into a percentage of total revenue which is applied to calculate the provision. If the historical data used to calculate these estimates does not properly reflect the collectibility of the current revenue stream, revenue could be overstated or understated. Provisions made for reimbursement limitations on ambulance and alternative transportation service fees are included in the calculation of medical transportation and related service revenue and totaled $32.9 million and $32.3 million for the three months ended December 31, 2002 and 2001, respectively and $66.5 and $66.3 for the six months ended December 31, 2002 and 2001, respectively. PROVISION FOR DOUBTFUL ACCOUNTS FOR MEDICAL TRANSPORTATION AND RELATED FEES -- Ambulance and alternative transportation service fees are billed to various payer sources. As discussed above, provisions for uncollectibility due to Medicare, Medicaid and contractual reimbursement limitations are recorded as provisions against revenue. We estimate additional provisions related to the potential uncollectibility of other payers based on historical collection data and historical write-off activity. The provision for doubtful accounts percentage that is applied to ambulance and alternative transportation service 33 fee revenue is calculated as the difference between the total expected collection percentage less provision percentages applied for Medicare, Medicaid and contractual reimbursement limitations. If historical data used to calculate these estimates does not properly reflect the collectibility of the current net revenue stream, the provision for doubtful accounts may be overstated or understated. The provision for doubtful accounts on ambulance and alternative transportation service revenue totaled $19.0 million and $16.5 million for the three months ended December 31, 2002 and 2001, respectively and $37.7 million and $33.2 million for the six months ended December 31, 2002 and 2001, respectively. WORKERS' COMPENSATION RESERVES -- Beginning May 1, 2002, we purchased a corporate-wide "first-dollar" workers' compensation insurance policy, under which we have no obligation to pay any deductible amounts on claims occurring during the policy period. This policy covers all workers' compensation claims made by our employees. Accordingly, provisions for workers' compensation expense for claims arising on and after May 1, 2002 are reflective of premium costs only. Prior to May 1, 2002, our workers' compensation policies included a deductible obligation of $250,000 per claim, which was increased in recent years to $500,000 per claim, with no aggregate limit. Claims relating to these prior policy years remain outstanding. Claim reserves were estimated based on historical claims data and the ultimate projected value of those claims. For claims occurring prior to May 1, 2002, our third-party administrator established initial estimates at the time a claim was reported and periodically reviews the development of the claim to confirm that the estimates are adequate. In fiscal 2002, we engaged an outside insurance expert to review the estimates set by our third-party administrator on certain claims and to participate in our periodic internal claim reviews. We also periodically engage actuaries to assist us in the determination of the adequacy of our workers' compensation claim reserves. If the ultimate development of these claims is significantly different than those that have been estimated, the reserves for workers' compensation claims could be overstated or understated. Reserves related to workers' compensation claims totaled $13.0 million and $15.9 million at December 31, 2002 and June 30, 2002, respectively. GENERAL LIABILITY RESERVES -- We are subject to litigation arising in the ordinary course of our business. In order to minimize the risk of our exposure, we maintain certain levels of coverage for comprehensive general liability, automobile liability, and professional liability claims. Internally and throughout this report, we refer to these three types of policies collectively as "general liability" policies. The coverage provided by these policies currently is, and historically has been, subject to a retention or deductible. Provisions are made to record the cost of premiums as well as that portion of the claims that is our responsibility. In general, our retention obligation for policies issued in fiscal years prior to 2001 ranges from $100,000 to $250,000 per claim (with no aggregate limit), depending on the policy year and line of coverage. Beginning in fiscal 2001, our deductible amount increased to $1,000,000 per claim; however, we also purchased a liability ceiling for each of those policy years, which permanently caps our maximum aggregate retention obligation. Our third-party administrator establishes initial estimates at the time a claim is reported and periodically reviews the development of the claim to confirm that the estimates are adequate. In fiscal 2002, we engaged an outside insurance expert to review the estimates set by our third-party administrator on certain claims and to participate in our periodic internal reviews. We also periodically engage actuaries to assist us in the determination of our general liability claim reserves. If the ultimate development of these claims is significantly different than those that have been estimated, the reserves for general liability claims could be overstated or understated. Reserves related to general liability claims totaled $14.8 million and $15.4 million at December 31, 2002 and June 30, 2002, respectively. Two of the Company's insurers under its general liability and workers compensation programs for various policy years have entered rehabilitation or liquidation proceedings in Pennsylvania. See "Liquidity and Capital Resources." CONTRACTUAL OBLIGATIONS AND OTHER COMMITMENTS We have certain cash contractual obligations related to our debt instruments that come due at various times. In addition, we have other commitments in the form of standby letters of credit and surety bonds. As reported in our 2002 Annual Report on Form 10-K, as amended, we have contractual obligations related 34 to our credit facility of $152.4 million and Senior Notes of $150.0 million, as well as other commitments related to standby letters of credit of $3.5 million and preferred stock redemption amounts totaling $15.0 million. Other contractual obligations for capital leases and notes payable and operating leases as well as commitments related to surety bonds have not changed substantially since year-end. THREE MONTHS ENDED DECEMBER 31, 2002 COMPARED TO THREE MONTHS ENDED DECEMBER 31, 2001 REVENUE Net revenue increased approximately $9.2 million, or 8.0%, from $114.3 million for the three months ended December 31, 2001 to $123.5 million for the three months ended December 31, 2002. MEDICAL TRANSPORTATION AND RELATED SERVICES -- Medical transportation and related service revenue increased $6.8 million, or 7.1%, from $96.1 million for the three months ended December 31, 2001 to $102.9 million for the three months ended December 31, 2002. This increase is comprised of a $7.7 million increase in same service area revenue attributable to rate increases, call screening and other factors. Additionally, there was a $700,000 increase in revenue related to a new 911 contract that went into effect during the first quarter of fiscal 2003 offset by a $1.5 million decrease related to service areas identified for closure in fiscal 2001. Total transports, including alternative transportation, decreased 14,000, or 4.8%, from approximately 294,000 (approximately 256,000 ambulance and approximately 38,000 alternative transportation) for the three months ended December 31, 2001 to approximately 280,000 (approximately 257,000 ambulance and approximately 23,000 alternative transportation) for the three months ended December 31, 2002. Service areas identified for closure in fiscal 2001 accounted for a decrease of approximately 4,000 transports. Transports in areas that we served in both the three months ended December 31, 2002 and 2001 decreased by approximately 11,000 transports. These decreases were offset by an increase of approximately 1,000 transports related to a new 911 contract that went into effect during the first quarter of fiscal 2003. FIRE AND OTHER -- Fire protection services revenue increased by $1.8 million, or 11.8%, from $15.3 million for the three months ended December 31, 2001 to $17.1 million for the three months ended December 31, 2002. Fire protection services revenue increased primarily due to rate and utilization increases in our subscription fire programs of $759,000 and rate increases on existing contracts and additional fire contracts of $718,000. We were notified that an initiative to form a municipal fire department in one of the municipalities to which we provide fire protection services would be voted on in May 2003. Should the initiative pass, our contract with the municipality would be terminated. This contract represented $4.2 million of fire protection services revenue for the three months ended December 31, 2002. Other revenue increased by $600,000, or 20.7%, from $2.9 million for the three months ended December 31, 2001 to $3.5 million for the three months ended December 31, 2002. Other revenue increases are primarily related to increased revenue related to the public/private alliance with the City of San Diego of $311,000. OPERATING EXPENSES PAYROLL AND EMPLOYEE BENEFITS -- Payroll and employee benefit expenses increased approximately $4.3 million, or 6.5%, from approximately $65.9 million for the three months ended December 31, 2001 to $70.2 million for the three months ended December 31, 2002. The increase is primarily related to increased workers compensation expense of $1.1 million due to increased insurance rates as well as general wage increases. Payroll and employee benefits as a percentage of net revenue was 56.8% for the three months ended December 31, 2002 compared to 57.7% for the three months ended December 31, 2001 with the decrease attributable to increased rates on medical transportation revenue. 35 PROVISION FOR DOUBTFUL ACCOUNTS -- The provision for doubtful accounts increased $2.4 million, or 14.5%, from $16.6 million, or 14.5% of total revenue, for the three months ended December 31, 2001 to $19.0 million, or 15.4% of total revenue, for the three months ended December 31, 2002. The provision for doubtful accounts on ambulance and alternative transportation service revenue was 19.2% for the three months ended December 31, 2002 and 17.9% for the three months ended December 31, 2001. The increase primarily reflects the mix between ambulance and alternative transportation services as well as slightly increased bad debt rates on ambulance services. The bad debt rate on alternative transportation services is significantly lower than that on ambulance services. Due to the Company's restructuring efforts, revenue relating to alternative transportation services is becoming a smaller percentage of our overall medical transportation revenue. Ambulance services bad debt as a percentage of ambulance service revenue was 19.4% for the three months ended December 31, 2002 and 18.2% for the three months ended December 31, 2001. DEPRECIATION - Depreciation decreased $0.6 million, or 15.4%, from $3.9 million for the three months ended December 31, 2001 to $3.3 million for the three months ended December 31, 2002. The decrease is primarily due to decreased capital expenditures in recent years. Depreciation was 3.4% and 2.9% of net revenue for the three months ended December 31, 2001 and 2002, respectively. OTHER OPERATING EXPENSES -- Other operating expenses consist primarily of rent and related occupancy expenses, vehicle and equipment maintenance and repairs, insurance, fuel and supplies, travel, and professional fees. Other operating expenses increased approximately $800,000, or 3.6%, from $22.4 million for the three months ended December 31, 2001 to $23.2 million for the three months ended December 31, 2002. The increase in other operating expenses is primarily due to increases in general liability expenses of $1.0 million due to increased premium rates in the new policy year as well as general increases in other operating expense categories. These increases were offset by the reversal of a portion of the fiscal 2001 restructuring charge. A charge was recorded in fiscal 2001 relating to an underperforming service area that we had planned to exit at the time of contract expiration in December 2001. During fiscal 2002, the contract was extended for a one-year period at the request of the municipality to enable it to transition medical transportation service to a new provider. The operating environment in this service area has improved and we were awarded a new multi-year contract. The contract related to this award was finalized during the three months ended December 31, 2002 and as a result, the remaining reserve of $1.3 million was released to income. Other operating expenses decreased from 19.6% of net revenue for the three months ended December 31, 2001 to 18.8% of net revenue for the three months ended December 31, 2002 (19.9% excluding the reversal of the fiscal 2001 restructuring charge described above). INTEREST EXPENSE -- Interest expense increased by $1.8 million, or 31.6%, from $5.7 million for the three months ended December 31, 2001 to $7.5 million for the three months ended December 31, 2002. This increase was primarily caused by increased effective rates due to the renegotiation of the credit facility. Amortization of deferred financing costs totaled $913,000 in the three months ended December 31, 2002. In addition, the average rate charged on the credit facility increased from 7.75% for the three months ended December 31, 2001 to 8.71% for the three months ended December 31, 2002. The principal balance on the credit facility was $141.8 million at December 31, 2001 compared to $152.4 million at December 31, 2002. See further discussion on the amended credit facility, which became effective September 30, 2002, in "Liquidity and Capital Resources." INCOME TAXES -- We recorded an income tax provision of $55,000 for the three months ended December 31, 2002 as compared to an income tax benefit of $1.6 million for the three months ended December 31, 2001. The provision for the three months ended December 31, 2002 is primarily related to provisions for state income taxes. The benefit recorded in the three months ended December 31, 2001 is primarily related to a $1.6 million income tax refund received during the period. INCOME (LOSS) FROM DISCONTINUED OPERATIONS - Due to the deteriorating economic conditions and continued devaluation of the local currency, we reviewed our strategic alternatives with respect to the continuation of operations in Latin 36 America, including Argentina and Bolivia, and determined that we would benefit from focusing on our domestic operations. Effective September 27, 2002, we sold our Latin American operations to local management in exchange for the assumption of net liabilities. Our Latin American operations generated $1.7 million of income for the three months ended December 31, 2001. SIX MONTHS ENDED DECEMBER 31, 2002 COMPARED TO SIX MONTHS ENDED DECEMBER 31, 2001 REVENUE Net revenue increased approximately $18.2 million, or 7.9%, from $230.8 million for the six months ended December 31, 2001 to $249.0 million for the six months ended December 31, 2002. MEDICAL TRANSPORTATION AND RELATED SERVICES -- Medical transportation and related service revenue increased $12.8 million, or 6.6%, from $193.9 million for the six months ended December 31, 2001 to $206.7 million for the six months ended December 31, 2002. This increase is comprised of a $15.7 million increase in same service area revenue attributable to rate increases, call screening and other factors. Additionally, there was a $1.3 million increase in revenue related to a new 911 contract that went into effect during the first quarter of fiscal 2003 offset by a $2.0 million decrease related to the loss of the 911 contract in Arlington, Texas and a $2.2 million decrease related to service areas identified for closure in fiscal 2001. Total transports, including alternative transportation, decreased 30,000, or 5.0%, from approximately 598,000 (approximately 521,000 ambulance and approximately 77,000 alternative transportation) for the six months ended December 31, 2001 to approximately 568,000 (approximately 520,000 ambulance and approximately 48,000 alternative transportation) for the six months ended December 31, 2002. The loss of the 911 contract in Arlington, Texas accounted for a decrease of approximately 4,000 transports. Service areas identified for closure in fiscal 2001 accounted for a decrease of approximately 8,000 transports. Transports in areas that we served in both the six months ended December 31, 2002 and 2001 decreased by approximately 20,000 transports. These decreases were offset by an increase of approximately 2,000 transports related to a new 911 contract that went into effect during the first quarter of fiscal 2003. FIRE AND OTHER -- Fire protection services revenue increased by approximately $4.1 million, or 13.3%, from approximately $30.9 million for the six months ended December 31, 2001 to approximately $35.0 million for the six months ended December 31, 2002. Fire protection services revenue increased primarily due to increases in forestry revenue of $1.0 million due to a particularly active wildfire season and to rate and utilization increases in our subscription fire programs of $1.5 million and rate increases on existing contracts and additional fire contracts of $1.3 million. We were notified that an initiative to form a municipal fire department in one of the municipalities to which we provide fire protection services would be voted on in May 2003. Should the initiative pass, our contract with the municipality would be terminated. This contract represented $8.4 million of fire protection services revenue for the six months ended December 31, 2002. Other revenue increased by $1.4 million, or 23.3%, from $6.0 million for the six months ended December 31, 2001 to $7.4 million for the six months ended December 31, 2002. Other revenue increases are primarily related to increased revenue related to the public/private alliance with the City of San Diego of $834,000. OPERATING EXPENSES PAYROLL AND EMPLOYEE BENEFITS -- Payroll and employee benefit expenses increased approximately $7.1 million, or 5.3%, from approximately $134.2 million for the six months ended December 31, 2001 to $141.3 million for the six months ended December 31, 2002. The increase is primarily related to increased workers compensation expense of $588,000 due to increased insurance rates as well as general wage increases. Additionally, there was an increase of $814,000 in management incentives which is primarily reflective of a $500,000 reversal made in the six months ended December 31, 2001 for unused accrued amounts. Payroll and employee benefits as a percentage of net revenue was 56.7% for the six 37 months ended December 31, 2002 compared to 58.1% for the six months ended December 31, 2001 with the decrease attributable to increased rates on medical transportation revenue. PROVISION FOR DOUBTFUL ACCOUNTS -- The provision for doubtful accounts increased $4.3 million, or 12.9%, from $33.4 million, or 14.5% of total revenue, for the six months ended December 31, 2001 to $37.7 million, or 15.1% of total revenue, for the six months ended December 31, 2002. The provision for doubtful accounts on ambulance and alternative transportation service revenue was 18.9% for the six months ended December 31, 2002 and 17.8% for the six months ended December 31, 2001. The increase primarily reflects the mix between ambulance and alternative transportation services as well as slightly increased bad debt rates on ambulance services. The bad debt rate on alternative transportation services is significantly lower than that on ambulance services. Due to the Company's restructuring efforts, revenue relating to alternative transportation services is becoming a smaller percentage of our overall medical transportation revenue. Ambulance services bad debt as a percentage of ambulance service revenue was 19.2% for the six months ended December 31, 2002 and 18.0% for the six months ended December 31, 2001. DEPRECIATION - Depreciation decreased $1.2 million, or 15.2%, from $7.9 million for the six months ended December 31, 2001 to $6.7 million for the six months ended December 31, 2002. The decrease is primarily due to decreased capital expenditures in recent years. Depreciation was 3.4% and 2.7% of net revenue for the six months ended December 31, 2001 and 2002, respectively. OTHER OPERATING EXPENSES -- Other operating expenses consist primarily of rent and related occupancy expenses, vehicle and equipment maintenance and repairs, insurance, fuel and supplies, travel, and professional fees. Other operating expenses increased approximately $1.8 million, or 4.1%, from $43.9 million for the six months ended December 31, 2001 to $45.7 million for the six months ended December 31, 2002. The increase in other operating expenses is primarily due to increases in general liability expenses of $1.8 million due to increased premium rates in the new policy year as well as general increases in other operating expense categories. This increase was offset by the reversal of a portion of the fiscal 2001 restructuring charge. A charge was recorded in fiscal 2001 relating to an underperforming service area that we had planned to exit at the time of contract expiration in December 2001. During fiscal 2002, the contract was extended for a one-year period at the request of the municipality to enable it to transition medical transportation service to a new provider. The operating environment in this service area has improved and we were awarded a new multi-year contract. The contract related to this award was finalized during the six months ended December 31, 2002 and as a result, the remaining reserve of $1.3 million was released to income. Other operating expenses decreased from 19.0% of net revenue for the six months ended December 31, 2001 to 18.4% of net revenue for the six months ended December 31, 2002 (18.9% excluding the reversal of the fiscal 2001 restructuring charge described above). INTEREST EXPENSE -- Interest expense increased by approximately $900,000, or 7.2%, from $12.5 million for the six months ended December 31, 2001 to $13.4 million for the six months ended December 31, 2002. This increase was primarily due to increased effective interest rates related to the renegotiation of the credit facility. Amortization of deferred financing costs totaled $1.0 million in the six months ended December 31, 2002 See further discussion on the amended credit facility, which became effective September 30, 2002, in "Liquidity and Capital Resources." INCOME TAXES -- We recorded an income tax provision of $110,000 for the six months ended December 31, 2002 as compared to an income tax benefit of $1.6 million for the six months ended December 31, 2001. The provision for the six months ended December 31, 2002 is primarily related to provisions for state income taxes. The benefit recorded in the six months ended December 31, 2001 is primarily related to a $1.6 million income tax refund received during that period. INCOME (LOSS) FROM DISCONTINUED OPERATIONS - Due to the deteriorating economic conditions and continued devaluation of the local currency, we reviewed our strategic alternatives with respect to the continuation of operations in Latin America, including Argentina and Bolivia, and determined that we would benefit from focusing on our domestic operations. Effective September 27, 2002, we sold our Latin American operations to local management in exchange for the assumption 38 of net liabilities. The gain on the disposition of our Latin American operations totaled $12.5 million and is included in income from discontinued operations for the six months ended December 31, 2002. Our Latin American operations generated a loss of $156,000 and income of $1.5 million for the six months ended December 31, 2002 and 2001, respectively. CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE -- We adopted the new rules on accounting for goodwill and other intangible assets effective July 1, 2001. Under the transitional provisions of Statement of Financial Accounting Standards (SFAS) No. 142, "Goodwill and Other Intangible Assets," we performed impairment tests on the net goodwill and other intangible assets associated with each of our reporting units with the assistance of independent valuation experts, using a valuation date of July 1, 2001, and determined that a transitional goodwill impairment charge of $49.5 million, net of $0 income taxes, was required. This impairment primarily relates to our medical transportation and related services segment. The impairment charge is non-cash and non-operational in nature and is reflected as a cumulative effect of change in accounting principle in the accompanying consolidated statement of operations, retroactively applied to the quarter ended September 30, 2001, in accordance with the provisions of SFAS No. 142. LIQUIDITY AND CAPITAL RESOURCES During the six months ended December 31, 2002, we recorded net income before the accretion of redeemable preferred stock of $16.3 million compared with a net loss of $47.5 million for the six months ended December 31, 2001. Net income for the six months ended December 31, 2002 includes a gain on the disposal of our Latin American operations of $12.5 million while the net loss for the six months ended December 31, 2001 includes a charge of $49.5 million relating to the adoption effective July 1, 2001 of the new goodwill standard. Cash provided by operating activities totaled $4.9 million for the six months ended December 31, 2002 and $6.6 million for the six months ended December 31, 2001. At December 31, 2002, we had cash of $9.0 million, total debt of $307.4 million and a stockholders' deficit of $160.2 million. Our total debt at December 31, 2002 included $149.9 million of our 7 7/8% senior notes due 2008, $152.4 million outstanding under our revolving credit facility, $4.2 million payable to a former joint venture partner and $900,000 of capital lease obligations. On September 30, 2002, we entered into an amended credit facility with our lenders which, among other things, extended the maturity date of the facility from March 16, 2003 through December 31, 2004, waived previous non-compliance, and required the issuance to the lenders of 211,549 shares of our Series B redeemable preferred stock. Our ability to service our long-term debt, to remain in compliance with the various restrictions and covenants contained in our credit agreements and to fund working capital, capital expenditures and business development efforts will depend on our ability to generate cash from operating activities which is subject to, among other things, our future operating performance as well as to general economic, financial, competitive, legislative, regulatory and other conditions, some of which may be beyond our control. If we fail to generate sufficient cash from operations, we may need to raise additional equity or borrow additional funds to achieve our longer-term business objectives. There can be no assurance that such equity or borrowings will be available or, if available, will be at rates or prices acceptable to us. Although there can be no assurances, management believes that cash flow from operating activities coupled with existing cash balances will be adequate to fund our operating and capital needs as well as enable us to maintain compliance with our various debt agreements through December 31, 2003. To the extent that actual results or events differ from our financial projections or business plans, our liquidity may be adversely impacted. 39 During the six months ended December 31, 2002, cash flow provided by operations was $5.0 million resulting primarily from net income of $16.3 million, offset by the non-cash effect of the disposal of our Latin American operations of $13.7 million, non-cash depreciation and amortization expense of $6.8 million and provision for doubtful accounts of $37.7 million. Additionally, cash flow from operating activities was negatively impacted by a decrease in accrued liabilities of $4.5 million and an increase in accounts receivable of $35.0 million. Cash flow provided by operations was $6.6 million for the six months ended December 31, 2001. Cash used in investing activities was $4.2 million for the six months ended December 31, 2002 due primarily to capital expenditures of approximately $4.8 million offset by proceeds from the sale of property and equipment of $500,000. Cash used in investing activities was $1.9 million for the six months ended December 31, 2001, due to capital expenditures of $2.9 million net of proceeds from the sale of property and equipment of $1.0 million. Cash used in financing activities was approximately $1.5 million for the six months ended December 31, 2002, primarily due to repayments on capital lease obligations and other debt and cash paid for debt issuance costs. Cash used in financing activities was approximately $1.8 million for the six months ended December 31, 2001. Our accounts receivable, net of the allowance for Medicare, Medicaid and contractual discounts and doubtful accounts, were $95.8 million and $99.1 million as of December 31, 2002 and June 30, 2002, respectively. The decrease in net accounts receivable is due to many factors, including the disposal of the Latin American operations, collection of outstanding receivables related to closed service areas and overall improvement in collections on existing operations. The allowance for Medicare, Medicaid, contractual discounts and doubtful accounts was $32.7 million at June 30, 2002 compared to $30.6 million at December 31, 2002. The change in the allowance for Medicare, Medicaid, contractual discounts and doubtful accounts is due to the write-off of uncollectible receivables offset by the current period provision for doubtful accounts. We have instituted several initiatives to improve our collection procedures. While management believes that we have a predictable method of determining the realizable value of our accounts receivable, based on continuing difficulties in the healthcare reimbursement environment, there can be no assurance that there will not be additional future write-offs. See Risk Factors - -- "We depend on reimbursements by third-party payers and individuals." With respect to our liability insurance policies (including our general liability, auto liability and professional liability policies) for the policy years commencing in June 2000, 2001 and 2002, we are required by each policy to set aside $100,000 per month into a designated "loss fund" account which cash is restricted to the payment of our retention obligations as required under such policies. We expect to fund these deposits on a monthly basis in subsequent years until such time as our total loss fund deposits equal the contractual ceiling on our aggregate retention obligation under these policies. The loss fund balances vary during the course of the year depending upon the frequency and severity of claims payments; however, we typically maintain a minimum balance in each loss fund of at least $250,000. If claims payments within our retention layer exceed the applicable loss fund balance required for that policy year, our current monthly funding obligation will be accelerated to the extent of such excess. Such accelerated payments could have a material adverse effect on our business, financial condition, results of operations and cash flows. Our liability insurance policies for the policy years commencing in June 2000 and June 2001 were issued by Legion Insurance Company (Legion) as fronting carrier and are 100% reinsured by an "A++" rated insurance carrier unrelated to Legion. At the time we purchased coverage, Legion was an "A" rated insurance carrier. Under these policies, the obligation of our reinsurer to pay covered losses effectively commences once we satisfy our self-insured retention obligations on a per occurrence or aggregate basis. As of December 31, 2002, all closed liability claims under these policies have been resolved within our retention layer. However, as remaining claims develop, we anticipate that our retention layer will be exhausted, at which point our reinsurer will be 40 obligated to fund all losses and expenses related to such claims. On April 1, 2002, the Pennsylvania Insurance Department (the "Department") placed Legion under rehabilitation. The Department is conducting the rehabilitation process, subject to judicial review by the Commonwealth Court of Pennsylvania. Based upon the information currently available, we believe that our reinsurance proceeds will be available to pay claims in excess of our retention as originally contracted notwithstanding the rehabilitation process. However, if the Court deems our reinsurance to be a general asset of Legion, then reinsurance proceeds to fund covered liability losses in excess of our retention may be substantially reduced, delayed or unrecoverable. In such an event, we may be required to fund liability losses for these policy years in excess of our retention to the extent that such losses are not covered by state guaranty funds (whether due to liability coverage caps or other circumstances applicable to such guaranty funds). For the policy year commencing May 1, 2001 through May 1, 2002, we purchased a workers' compensation policy issued by Legion, which included a deductible to be paid by us for each occurrence (subject to an aggregate maximum limit). We also concurrently purchased a deductible reimbursement policy issued by Mutual Indemnity (Bermuda) Ltd. (Mutual Indemnity), an affiliate of Legion. The deductible reimbursement policy requires Mutual Indemnity to fully cover our deductible obligations under the workers compensation policy. Under the deductible reimbursement policy, we pre-paid all of our anticipated deductible obligations for the policy year by making contributions of approximately $6.5 million into a loss fund account held by Mutual Indemnity. As noted above, the Department placed Legion into rehabilitation in April 2002. In January 2003, the Commonwealth Court of Pennsylvania ordered the Legion rehabilitator and Mutual Indemnity to establish a trust account, to be funded by deposits held by Mutual Indemnity (including deposits in our loss fund account), for the benefit of the insureds which had placed the deposits with Mutual Indemnity. It is our understanding that the Legion rehabilitator intends to appeal the decision of the court to enforce this trust mechanism and that the rehabilitator has asserted, on behalf of Legion, that funds held by Mutual Indemnity (including deposits in our loss fund account) are assets of Legion that should be available to its general creditors. Pending resolution of this matter, Mutual Indemnity has suspended funding workers compensation claims from the amounts we previously deposited with it and some claims are being handled by state guaranty funds or paid directly by us. We believe the rehabilitator's appeal lacks merit based upon the facts and circumstances. We are actively participating in the court proceedings to cause such a trust account mechanism to be created and to operate so as to fully cover all our deductible obligations as originally intended and to return to us any remaining deposit balance once all claims are closed. However, if our funds on deposit with Mutual Indemnity are determined to be general assets of Legion, then use of our loss fund deposits to pay workers compensation claims within our deductible may be substantially reduced, delayed or unrecoverable. In such an event, we may be required to fund the deductible portion of workers compensation claims arising in this policy year, without access to existing deposits in the loss fund account held by Mutual Indemnity. To the extent that workers' compensation claims exceed our deductible portion, we currently anticipate that the applicable state guaranty funds will provide coverage for such excess at no additional cost to us. During fiscal years 1992 through 2001, we purchased certain portions of our workers' compensation coverage from Reliance Insurance Company ("Reliance"). At the time we purchased the coverage, Reliance was an "A" rated insurance company. In connection with this coverage, we provided Reliance with various amounts and forms of collateral (e.g., letters of credit, surety bonds and cash deposits) to secure our performance under the respective policies as was customary and required in the workers' compensation marketplace at the time. As of December 31, 2002, Reliance held $3.0 million of cash collateral under this coverage. On May 29, 2001, Reliance was placed under rehabilitation by the Department and on October 3, 2001 was placed into liquidation. It is our understanding that the collateral held by the Reliance liquidator will be returned to us once all related claims have been satisfied so long as we have satisfied our claim payment obligations under the related policies. To the extent that certain of our workers' compensation claims have exceeded our deductible under the Reliance policies, the applicable state guaranty funds have provided such excess coverage 41 at no additional cost to us. We currently anticipate that the state guaranty funds will continue to provide such excess coverage. Based upon the information currently available, we believe that the amounts on deposit with Reliance and Mutual Indemnity are fully recoverable and will either be returned to us or used to pay claims on our behalf as originally intended, and that state guaranty funds will provide coverage for claims in excess of our deductible. We further believe that reinsurance proceeds for our liability policies for policy years commencing in June 2000 and June 2001 will be available to cover claims in excess of our retention as originally intended or that state guaranty funds will provide coverage for such excess subject to applicable limitations. Our inability to access the funds on deposit with Reliance or Mutual Indemnity or to access our liability reinsurance proceeds, or claims in excess of our deductible or retention limitations that are not covered by state guaranty funds, could have a material adverse effect on our business, financial condition, results of operations and cash flows. We had working capital of $42.2 million at December 31, 2002, including cash of $9.0 million compared with working capital of $27.5 million, including cash of $9.8 million at June 30, 2002. The increase in working capital is primarily due to the $15.8 million decrease in accrued liabilities which is related to a decrease in accrued interest due to the conversion of accrued interest to principal in the amended credit facility as well as the assumption of the Argentine liabilities by the buyer in the disposition of our Latin American operations. In March 1998, we entered into a $200.0 million revolving credit facility originally scheduled to mature March 16, 2003. The credit facility is unsecured and was unconditionally guaranteed on a joint and several basis by substantially all of our domestic wholly owned current and future subsidiaries. Interest rates and availability under the revolving credit facility depended on our meeting certain financial covenants, including total debt leverage ratios, total debt to capitalization ratios, and fixed charge ratios. The revolving credit facility initially was priced at the greater of (i) prime rate or Federal Funds rate plus 0.5% plus the applicable margin, or (ii) a LIBOR-based rate. The LIBOR-based rates ranged from LIBOR plus 0.875% to LIBOR plus 1.75%. In December 1999, primarily as a result of additional provisions for doubtful accounts, we were not in compliance with three financial covenants under the revolving credit facility: total debt leverage ratio, total debt to total capitalization ratio and fixed charge coverage ratio. We received a series of compliance waivers regarding the financial covenants covering the periods from December 31, 1999 through April 1, 2002. The waivers provided among other things, for enhanced reporting and other requirements and that no additional borrowings would be available to us. Pursuant to the waivers, as LIBOR contracts expired in March 2000, all borrowings were priced at prime rate plus 0.25 percentage points and interest became payable monthly. Pursuant to the waivers, we also were required to accrue additional interest expense at a rate of 2.0% per annum on the outstanding balance on the revolving credit facility. We recorded approximately $7.4 million of additional interest expense through September 30, 2002. In connection with the waivers, we also made principal payments in an aggregate amount of $5.2 million. Effective September 30, 2002, we entered into an amended credit facility pursuant to which, among other things, the maturity date of the credit facility was extended to December 31, 2004 and our prior noncompliance was permanently waived. The principal terms of the amended and restated credit agreement are as follows: * WAIVER. Prior noncompliance was permanently waived with respect to the covenant violations described above and with respect to certain other noncompliance items, including non-reimbursement of approximately $2.6 42 million drawn by beneficiaries under letters of credit issued under the original facility. * MATURITY DATE. The maturity date of the facility was extended to December 31, 2004. * PRINCIPAL BALANCE. Accrued interest (approximately $6.9 million), non-reimbursed letters of credit and various fees and expenses associated with the amended credit facility (approximately $1.2 million) were added to the principal amount of the loan, resulting in an outstanding principal balance as of the effective date of the amendment equal to $152.4 million. * NO REQUIRED AMORTIZATION. No principal payments are required until the maturity date of the facility. * INTEREST RATE. The interest rate was increased to LIBOR plus 7.0% (8.4% as of December 31, 2002), payable monthly. By comparison, the effective interest rate (including the 2.0% of additional accrued interest described above) applicable to the original facility immediately prior to the effective date of the amendment was 7.0%. * FINANCIAL COVENANTS. The amended facility includes financial covenants similar to the ones included in the original credit facility, with compliance levels under such covenants adjusted to levels consistent with current business levels and outlook. The covenants include (i) total debt leverage ratio (initially set at 7.48), (ii) minimum tangible net worth (initially set at a $230.1 million deficit), (iii) fixed charge coverage ratio (initially set at 0.99), (iv) limitation on capital expenditures of $11 million per fiscal year; and (v) limitation on operating leases during any period of four fiscal quarters to 3.10% of consolidated net revenues. The compliance levels for covenants (i) through (iii) above are set at varying levels on a quarterly basis. Compliance is tested quarterly based on annualized or year-to-date results as applicable. * OTHER COVENANTS. The amended credit facility includes various non-financial covenants equivalent in scope to those included in the original facility. The covenants include restrictions on additional indebtedness, liens, investments, mergers and acquisitions, asset sales, and other matters. The amended credit facility includes extensive financial reporting obligations and provides that an event of default occurs should we lose customer contracts in any fiscal quarter with EBITDA contribution of $5 million or more (net of anticipated contributions from new contracts). * EXISTING LETTERS OF CREDIT. Pursuant to the amended facility, letters of credit issued pursuant to the original credit agreement were reissued or extended, to a maximum of $3.5 million, for letter of credit fees aggregating 1 7/8% per annum. A third letter of credit, in the amount of $2.6 million which was previously drawn by its beneficiary, will be reissued subject to application of the funds originally drawn in reduction of the principal balance of the facility and payment of a letter of credit fee equal to 7% per annum. * EQUITY INTEREST. As additional consideration for entering into the amended credit facility, we issued shares of our Series B redeemable preferred stock to the participants in the amended credit facility. The redeemable preferred stock is convertible into 2,115,490 common shares (10% of the post-conversion common shares outstanding on a diluted basis, as defined). The conversion ratio is subject to upward adjustment if we issue common stock or securities convertible into our common stock for consideration less than the fair market value of such securities at the time of such transaction. Because a sufficient number of common shares are not currently available to permit conversion, we intend to seek stockholder approval to amend our certificate of incorporation to authorize additional common shares. Conversion of the preferred shares occurs automatically upon notice from the Company, assuming approval by our stockholders of sufficient common shares to permit conversion. Should our stockholders fail to approve such a proposal by December 31, 2004, we will be required to redeem the preferred stock for a price equal to the greater of $15 million or the value of the common shares into which the preferred shares would otherwise have been convertible. In addition, should our stockholders fail to approve such a proposal, the redeemable preferred stock enjoys a preference upon a sale of our company, a sale of our assets and in certain other circumstances; this preference equals the greater of (i) the value of the 43 common shares into which the redeemable preferred stock would otherwise have been convertible or (ii) $12.5 million or $15 million depending on whether the triggering event occurs prior to December 31, 2003 or December 31, 2004, respectively. At the election of the holder, the preferred shares carry voting rights as if such shares were converted into common shares. The preferred shares do not bear a dividend. The preferred shares (and common shares issuable upon conversion of the preferred shares) are entitled to certain registration rights. The terms of the preferred shares limit us from issuing senior or pari passu preferred shares and from paying dividends on, or redeeming, shares of junior stock. We recorded approximately $7.0 million of deferred debt issuance costs related to the amended credit facility ($4.2 million related to the fair value of the redeemable preferred stock, $1.2 million of lender fees which were added to the principal balance of the facility and $1.6 million of related professional fees). These costs are included in other assets in the accompanying consolidated balance sheet as of December 31, 2002. These costs will be amortized to interest expense over the life of the agreement. The fair value of the redeemable preferred stock was estimated to be the market value of the common stock to be acquired upon conversion of the redeemable preferred stock, measured at the date of the amendment. The redeemable preferred stock balance will be accreted to the greater of $15.0 million or the value of the common shares into which the preferred shares would otherwise be converted over the life of the agreement or until the preferred shares are converted to common shares. Due to the higher interest rate associated with the amended credit facility, we anticipate that our cash interest expense will increase approximately $5.6 million annually. In March 1998, we issued $150.0 million of 7 7/8% Senior Notes due 2008 (the Notes) under Rule 144A under the Securities Act of 1933, as amended (Securities Act). Interest under the Notes is payable semi-annually on September 15 and March 15, and the Notes are not callable until March 2003 subject to the terms of the Indenture. We incurred expenses related to the offering of approximately $5.3 million and are amortizing these costs to interest expense over the life of the Notes. In April 1998, we filed a registration statement under the Securities Act relating to an exchange offer for the Notes. The registration became effective on May 14, 1998. The Notes are general unsecured obligations of our company and are unconditionally guaranteed on a joint and several basis by substantially all of our domestic wholly owned current and future subsidiaries. The Notes contain certain covenants that, among other things, limit our ability to incur certain indebtedness, sell assets, or enter into certain mergers or consolidations. Since March 2000, we have satisfied all of our cash needs through cash flow from operations and our cash reserves. Similarly, we expect that cash flow from operations and our existing cash reserves will be sufficient to meet our regularly scheduled debt service and our planned operating and capital needs for the 12 months subsequent to December 31, 2002. Through our restructuring program we have closed or downsized several locations that were negatively impacting our cash flow. In addition, we have significantly reduced our corporate overhead. We have improved the quality of our revenue and have experienced an upward trend in daily cash collections. There can be no assurance that we will meet our targeted levels of operating cash flow or that we will not incur significant unanticipated liabilities. Similarly, there can be no assurance that we will be able to obtain additional debt or equity financing on terms satisfactory to us, or at all, should cash flow from operations and our existing cash resources prove to be inadequate. As discussed above, though we have successfully negotiated an amendment and extension of our credit facility, we will not have access to additional borrowings under such facility. If we are required to seek additional financing, any such arrangement may involve material and substantial dilution to existing stockholders resulting from, among other things, issuance of equity securities or the conversion of all or a portion of our existing debt to equity. In such event, the percentage ownership of our current stockholders will be materially reduced, and such equity securities may have rights, preferences or privileges senior to our current common stockholders. If we require additional financing but are unable to obtain it, our business, financial condition, cash flows and results of operations may be materially adversely affected. 44 EFFECTS OF FOREIGN CURRENCY EXCHANGE FLUCTUATIONS As a result of the sale of our Latin American operations in September 2002, it is not anticipated that future fluctuations in the currency exchange rates will have an adverse effect on us. RISK FACTORS The following risk factors, in addition to those discussed elsewhere in this report, should be carefully considered in evaluating us and our business. WE HAVE SIGNIFICANT INDEBTEDNESS. We have significant indebtedness. As of December 31, 2002, we have approximately $307.4 million of consolidated indebtedness, consisting primarily of $150.0 million of 7 7/8% senior notes due in 2008 and approximately $152.4 million outstanding under our credit facility. Our ability to service our debt depends on our future operating performance, which is affected by governmental regulations, the state of the economy, financial factors, and other factors, certain of which are beyond our control. We may not generate sufficient funds to enable us to make our periodic debt payments. Failure to make our periodic debt payments could have a material adverse effect on our business, financial condition, results of operations and cash flows. OUR LOAN AGREEMENTS REQUIRE US TO COMPLY WITH NUMEROUS COVENANTS AND RESTRICTIONS. The agreement governing the terms of the senior notes contains certain covenants limiting our ability to: * incur certain additional debt * create certain liens * pay dividends * issue guarantees * redeem capital stock * enter into transactions with * make certain investments affiliates * issue capital stock of * sell assets subsidiaries * complete certain mergers and consolidations The amended credit facility contains other more restrictive covenants and requires us to satisfy certain financial tests, including a total debt leverage ratio, a minimum tangible net worth amount, and a fixed charge ratio. Our ability to satisfy those covenants can be affected by events both within and beyond our control, and we may be unable to meet these covenants. A breach of any of the covenants or other terms of our debt could result in an event of default under the amended credit facility or the senior notes or both, which could have a material adverse effect on our business, financial condition, results of operations and cash flows. WE MAY NOT BE ABLE TO GENERATE SUFFICIENT OPERATING CASH FLOW. Despite significant net losses in fiscal 2001 and 2000, our restructuring efforts have enabled us to self-fund our operations since March 2000 from existing cash reserves and operating cash flow. However, we may be unable to sustain our targeted levels of operating cash flow. Our ability to generate operating cash flow will depend upon various factors, including industry conditions, economic conditions, competitive conditions, and other factors, many of which are beyond our control. Because of our significant indebtedness, a substantial portion of our cash flow from operations is dedicated to debt service and is not available for other purposes. The terms of our amended credit facility do not permit additional borrowings thereunder. In addition, the amended credit facility and the senior notes also restrict our ability to provide collateral to any prospective lender. If we are unable to meet our targeted levels of operating cash flow, or in the event of an unanticipated cash requirement (such as an adverse litigation outcome, reimbursement delays, significantly increased costs of insurance or other matters) we will need to pursue additional debt or equity financing. Any 45 such financing may not be available on terms acceptable to us, or at all. If we issue equity securities in connection with any such arrangement, the percentage ownership of our current stockholders will be materially reduced, and such equity securities may have rights, preferences or privileges senior to our current common stockholders. Failure to maintain adequate operating cash flow will have a material adverse effect on our business, financial condition, results of operations and cash flows. WE FACE SIGNIFICANT DILUTION OF OUR COMMON STOCK In conjunction with the amended credit facility we issued shares of our Series B redeemable preferred stock to the participants in the amended credit facility. The redeemable preferred stock is convertible into 2,115,490 common shares. Because sufficient common shares are not currently available to permit conversion, we intend to seek stockholder approval to authorize additional common shares. Conversion of the redeemable preferred stock to common shares will result in dilution of approximately 12%. Until such time as the additional common shares are authorized, the fair value of the redeemable preferred stock will be accreted to the greater of $15.0 million or the value of which the redeemable preferred stock would have otherwise been converted. This accretion will be a reduction in income available to common stockholders. WE DEPEND ON REIMBURSEMENTS BY THIRD-PARTY PAYERS AND INDIVIDUALS. We receive a substantial portion of our payments for ambulance services from third-party payers, including Medicare, Medicaid, and private insurers. We received approximately 90.0% of our ambulance fee collections from such third party payers during the three months ended December 31, 2002, including approximately 27.3% from Medicare. In the three months ended December 31, 2001 we received 87.8% of ambulance fee collections from these third parties, including 25.1% from Medicare. We received approximately 90.0% of our ambulance fee collections from such third-party payers during the six months ended December 31, 2002, including approximately 26.5% from Medicare. In the six months ended December 31, 2001, we also received approximately 87.2% of ambulance fee collections from these third parties, including approximately 25.0% from Medicare. The reimbursement process is complex and can involve lengthy delays. From time to time, we experience these delays. Third-party payers are continuing their efforts to control expenditures for health care, including proposals to revise reimbursement policies. We recognize revenue when we provide ambulance services; however, there can be lengthy delays before we receive payment. In addition, third-party payers may disallow, in whole or in part, requests for reimbursement based on assertions that certain amounts are not reimbursable or additional supporting documentation is necessary. Retroactive adjustments may change amounts realized from third-party payers. Due to the nature of our business and our participation in the Medicare and Medicaid reimbursement programs, we are involved from time to time in regulatory reviews or investigations by governmental agencies of matters such as compliance with billing regulations. We may be required to repay these agencies if a finding is made that we were incorrectly reimbursed, or we may lose eligibility for certain programs in the event of certain types of noncompliance. Delays and uncertainties in the reimbursement process adversely affect the level of accounts receivable, increase the overall costs of collection, and may adversely affect our working capital and cause us to incur additional borrowing costs. Unfavorable resolutions of pending or future regulatory reviews or investigations, either individually or in the aggregate, could have a material adverse effect on our business, financial condition, cash flows and results of operations. We also face the continuing risk of non-reimbursement to the extent that uninsured individuals require emergency ambulance service in service areas where an adequate subsidy is not provided. Amounts not covered by third-party payers are the obligations of individual patients. We may not receive whole or partial reimbursement from these uninsured individuals. We continually review the mix of activity between emergency and general medical transport in view of the reimbursement environment and evaluate methods of recovering these amounts through the collection process. 46 We establish an allowance for Medicare, Medicaid and contractual discounts and doubtful accounts based on credit risk applicable to certain types of payers, historical trends, and other relevant information. We review our allowance for doubtful accounts on an ongoing basis and may increase or decrease such allowances from time to time, including in those instances when we determine that the level of effort and cost of collection of certain accounts receivable is unacceptable. The risks associated with third-party payers and uninsured individuals and the inability to monitor and manage accounts receivable successfully could have a material adverse effect on our business, financial condition, cash flows, and results of operations. Our collection policies or our allowance for Medicare, Medicaid and contractual discounts and doubtful accounts receivable may not be adequate. WE HAVE EXPERIENCED MATERIAL INCREASES IN THE COST OF OUR INSURANCE AND SURETY PROGRAMS AND IN RELATED COLLATERALIZATION REQUIREMENTS. We have experienced a substantial rise in the costs associated with both our insurance and surety bonding programs in comparison to prior years. We have experienced significant increases both in the premiums we have had to pay, and in the collateral or other advance funding required. We also have increased our deductible and self-insurance retentions under several coverages. Many counties, municipalities, and fire districts also require us to provide a surety bond or other assurance of financial and performance responsibility, and the cost and collateral requirements associated with obtaining such bonds have increased. A significant factor is the overall hardening of the insurance, surety and re-insurance markets, which has resulted in demands for larger premiums, collateralization of payment obligations and increasingly rigorous underwriting requirements. Our higher costs also result from our claims history and from vendors' past perception of our financial position due to our current debt structure and cash position, as well as the qualified opinion formerly issued with respect to our audited financial statements. Sustained and substantial annual increases in premiums and requirements for collateral or pre-funded deductible obligations may have a material adverse effect on our business, financial condition, cash flow and results of operations. CLAIMS AGAINST US COULD EXCEED OUR INSURANCE COVERAGE. We are subject to a significant number of accident, injury and professional liability claims as a result of the nature of our business and the day-to-day operation of our vehicle fleet. The coverage limits of our policies may not be adequate. Liabilities in excess of our insurance coverage could have a material adverse effect on our business, financial condition, cash flows, and results of operations. Claims against us, regardless of their merit or outcome, also may have an adverse effect on our reputation and business. OUR RESERVES MAY PROVE INADEQUATE. Under our general liability and employee medical insurance programs, and under our workers' compensation programs prior to May 1, 2002, we are responsible for deductibles in varying amounts. Our insurance coverages in prior years generally did not include an aggregate limitation on our liability. We have established reserves for losses and loss adjustment expenses under these policies. Our reserves are estimates based on industry data and historical experience, and include judgments of the effects that future economic and social forces are likely to have on our experience with the type of risk involved, circumstances surrounding individual claims and trends that may affect the probable number and nature of claims arising from losses not yet reported. Consequently, loss reserves are inherently uncertain and are subject to a number of highly variable and difficult to predict circumstances. For these reasons, there can be no assurance that our ultimate liability will not materially exceed our reserves. If our reserves prove to be inadequate, we will be required to increase our reserves with a corresponding reduction, which may be material, to our operating results in the period in which the deficiency is identified. We periodically engage actuaries in order to verify the reasonableness of our reserve estimates. However, our reserves may prove inadequate and may have a material adverse effect on our business, financial condition, cash flows and results of operations. 47 TWO INSURANCE COMPANIES WITH WHICH WE HAVE PREVIOUSLY DONE BUSINESS ARE IN FINANCIAL DISTRESS. Two previous insurers (Reliance Insurance Company and Legion Insurance Company) under our workers' compensation and general liability programs are currently in liquidation and rehabilitation proceedings, respectively, in Pennsylvania. With respect to the affected policy years, these proceedings may result in the loss of all or part of the collateral and/or funds deposited by us for payment of claims within our deductible or self-insured retention relating to our workers' compensation programs, and may result in restricted access to reinsurance proceeds relating to our general liability program. Based upon the information currently available, we believe that the amounts on deposit are fully recoverable and will either be returned to us or used to pay claims on our behalf as originally intended. We further believe that reinsurance proceeds for our liability policies will be available to cover claims in excess of our retention as originally intended. Our inability to access the funds on deposit or to access our liability reinsurance proceeds could have a material adverse effect on our business, financial condition, results of operations and cash flows. To the extent that claims exceed our deductible limits and our insurers do no satisfy their coverage obligations, we may be forced to satisfy a portion of those claims directly, which could have a material adverse effect on our business, financial condition, result of operations and cash flows. RECENTLY ENACTED RULES MAY ADVERSELY AFFECT OUR REIMBURSEMENT RATES OF COVERAGE. On April 1, 2002, the Medicare Ambulance Fee Schedule Final Rule became effective. The Final Rule categorizes seven levels of ground ambulance services, ranging from basic life support to specialty care transport, and two categories of air ambulance services. The base rate conversion factor for services to Medicare patients was set at $170.54, plus separate mileage payment based on specified relative value units for each level of ambulance service. Adjustments also were included to recognize differences in relative practice costs among geographic areas, and higher transportation costs that may be incurred by ambulance providers in rural areas with low population density. The Final Rule requires ambulance providers to accept the assigned reimbursement rate as full payment, after patients have submitted their deductible and 20 percent of Medicare's fee for service. In addition, the Final Rule calls for a five-year phase-in period to allow time for providers to adjust to the new payment rates. The fee schedule will be phased in at 20-percent increments each year, with payments being made at 100 percent of the fee schedule in 2006 and thereafter. We believe the Medicare Ambulance Fee Schedule will cause a neutral net impact on our medical transportation revenue at incremental and full phase-in periods, primarily due to the geographic diversity of our U.S. operations. These rules could, however, result in contract renegotiations or other actions by us to offset any negative impact at the regional level that could have a material adverse effect on our business, financial condition, cash flows, and results of operations. Changes in reimbursement policies, or other governmental action, together with the financial challenges of some private, third-party payers and budget pressures on other payer sources could influence the timing and, potentially, the receipt of payments and reimbursements. A reduction in coverage or reimbursement rates by third-party payers, or an increase in our cost structure relative to the rate increase in the Consumer Price Index (CPI), or costs incurred to implement the mandates of the fee schedule could have a material adverse effect on our business, financial condition, cash flows, and results of operations. CERTAIN STATE AND LOCAL GOVERNMENTS REGULATE RATE STRUCTURES AND LIMIT RATES OF RETURN. State or local government regulations or administrative policies regulate rate structures in most states in which we conduct ambulance operations. In certain service areas in which we are the exclusive provider of services, the municipality or fire district sets the rates for emergency ambulance services pursuant to a master contract and establishes the rates for general ambulance services that we are permitted to charge. Rates in most service areas are set at the same amounts for emergency and general ambulance services. For example, the State of Arizona establishes a rate of return on sales we are permitted to earn in determining the ambulance service rates we may charge in that state. Ambulance services revenue generated in Arizona accounted for approximately 19.7% and 15.4% of net revenue for the three months ended December 31, 2002 and 48 2001, respectively. Ambulance services revenue generated in Arizona accounted for approximately 19.3% and approximately 15.8% of net revenue for the six months ended December 31, 2002 and 2001, respectively. We may be unable to receive ambulance service rate increases on a timely basis where rates are regulated or to establish or maintain satisfactory rate structures where rates are not regulated. Municipalities and fire districts negotiate the payments to be made to us for fire protection services pursuant to master contracts. These master contracts are based on a budget and on level of effort or performance criteria desired by the municipalities and fire districts. We could be unsuccessful in negotiating or maintaining profitable contracts with municipalities and fire districts. NUMEROUS GOVERNMENTAL ENTITIES REGULATE OUR BUSINESS. Numerous federal, state, local, and foreign laws, rules and regulations govern various aspects of the business of ambulance service and fire fighting service providers, covering matters such as licensing, rates, employee certification, environmental matters, radio communications and other factors. Certificates of necessity may be required from state or local governments to operate ambulance services in a designated service area. Master contracts from governmental authorities are subject to risks of cancellation or unenforceability as a result of budgetary and other factors and may subject us to certain liabilities or restrictions that traditionally have applied only to governmental bodies. Federal, state, local, or foreign governments could: * change existing laws, rules or regulations, * adopt new laws, rules or regulations that increase our cost of doing business, * lower reimbursement levels, * choose to provide services for themselves, or * otherwise adversely affect our business, financial condition, cash flows, and results of operations. We could encounter difficulty in complying with all applicable laws, rules and regulations. HEALTH CARE REFORMS AND COST CONTAINMENT MAY AFFECT OUR BUSINESS. Numerous legislative proposals have been considered that would result in major reforms in the U.S. health care system. We cannot predict which, if any, health care reforms may be proposed or enacted or the effect that any such legislation would have on our business. The Health Insurance Portability and Accountability Act of 1996 (HIPAA), which protects the privacy of patients' health information handled by health care providers and establishes standards for its electronic transmission, was enacted on August 21, 1996. The final rule, which took effect on April 14, 2001, requires covered entities to comply with the final rule's provisions by April 14, 2003, and covers all individually identifiable health information used or disclosed by a covered entity. Our HIPAA Subcommittee of the Corporate Compliance Committee is addressing the impact of HIPAA and considering changes to or enactment of policies, training and/or procedures which may need to be implemented to comply under the final rule. Because the impact of HIPAA on the health care industry is not known at this time, we may incur significant costs associated with implementation and continued compliance with HIPAA or further legislation which may have a material adverse effect on our business, financial condition, cash flows, or results of operations. In addition, managed care providers are focusing on cost containment measures while seeking to provide the most appropriate level of service at the most appropriate treatment facility. Changing industry practices could have an adverse effect on our business, financial condition, cash flows, and results of operations. 49 WE DEPEND ON CERTAIN BUSINESS RELATIONSHIPS. We depend to a great extent on certain contracts with municipalities or fire districts to provide 911 emergency ambulance services and fire protection services. Our six largest contracts accounted for approximately 18.4% and 16.3% of net revenue for the three months ended December 31, 2002 and 2001, respectively. Our six largest contracts accounted for approximately 18.4% and approximately 17.2% of net revenue for the six months ended December 31, 2002 and 2001, respectively. One of these contracts accounted for approximately 4.3% and 3.7% of net revenue for the three months ended December 31, 2002 and 2001, respectively. One of these contracts accounted for approximately 4.3% and approximately 3.8% of net revenue for the six months ended December 31, 2002 and 2001, respectively. Contracts with municipalities or fire districts may have certain budgetary approval constraints. Failure to allocate funds for a contract may adversely affect our ability to continue to perform services without suffering significant losses. The loss or cancellation of several of these contracts could have a material adverse effect on our business, financial condition, cash flow, and results of operations. We may not be successful in retaining our existing contracts or in obtaining new contracts for emergency ambulance services or for fire protection services. Our contracts with municipalities and fire districts and with managed care organizations and health care providers are short term or open-ended or for periods ranging from two years to five years. During such periods, we may determine that a contract is no longer favorable and may seek to modify or terminate the contract. When making such a determination, we may consider factors, such as weaker than expected transport volume, geographical issues adversely affecting response times, and delays in implementing technology upgrades. We face certain risks in attempting to terminate unfavorable contracts prior to their expiration because of the possibility of forfeiting performance bonds and the potential adverse political and public relations consequences. Our inability to terminate or amend unfavorable contracts could have a material adverse effect on our business, financial condition, cash flows, and results of operations. We also face the risk that areas in which we provide fire protection services through subscription arrangements with residents and businesses will be converted to tax-supported fire districts or annexed by municipalities. WE FACE RISKS ASSOCIATED WITH OUR PRIOR RAPID GROWTH, INTEGRATION, AND ACQUISITIONS. We must integrate and successfully operate the ambulance service providers that we have acquired. The process of integrating management, operations, facilities, and accounting and billing and collection systems and other information systems requires continued investment of time and resources and can involve difficulties, which could have a material adverse effect on our business, financial condition, cash flows, and results of operations. Unforeseen liabilities and other issues also could arise in connection with the operation of businesses that we have previously acquired or may acquire in the future. For example, we recently became aware of, and have taken corrective action with respect to, various issues arising primarily from the transition to us from various acquired operations of Federal Communications Commission (FCC) licenses for public safety and private wireless radio frequencies used in the ordinary course of our business. While we do not currently anticipate that action with respect to these issues by the FCC's enforcement bureau will result in material monetary fines or license forfeitures, there can be no assurance that this will be the case. Our acquisition agreements contain purchase price adjustments, rights of set-off, indemnification, and other remedies in the event that certain unforeseen liabilities or issues arise in connection with an acquisition. However, these purchase price adjustments, rights of set-off, indemnification, and other remedies expire and may not be sufficient to compensate us in the event that any liabilities or other issues arise. WE FACE ADDITIONAL RISKS ASSOCIATED WITH OUR INTERNATIONAL OPERATIONS. Due to the deteriorating economic conditions and continued devaluation of the local currency, we have reviewed our strategic alternatives with respect to the continuation of operations in Latin America, including Argentina and Bolivia. We have determined that we would benefit from focusing on our domestic operations. Effective September 27, 2002, we sold our Latin American operations to local management. We believe that both the structure of our pre-sale operations and of the sale transaction itself shield us from liabilities associated with past or future activities of our former Latin American operations. However, due to the 50 nature of local laws and regulatory requirements and the uncertain economic and political environment, particularly in Argentina, there can be no assurance that we will not be required to defend against future claims. Unanticipated claims successfully asserted against us could have an adverse effect on our business, financial condition, cash flows, and results of operations. WE ARE IN A HIGHLY COMPETITIVE INDUSTRY. The ambulance service industry is highly competitive. Ambulance and general transport service providers compete primarily on the basis of quality of service, performance, and cost. In order to compete successfully, we must make continuing investments in our fleet, facilities, and operating systems. We believe that counties, fire districts, and municipalities consider the following factors in awarding a contract: * quality of medical care, * historical response time performance, * customer service, * financial stability, and * personnel policies and practices. We currently compete with the following entities to provide ambulance services: * governmental entities (including fire districts), * hospitals, * other national ambulance service providers, * large regional ambulance service providers, and * local and volunteer private providers. Municipalities, fire districts, and health care organizations that currently contract for ambulance services could choose to provide ambulance services directly in the future. We are experiencing increased competition from fire departments in providing emergency ambulance service. Some of our current competitors and certain potential competitors have or have access to greater capital and other resources than us. Tax-supported fire districts, municipal fire departments, and volunteer fire departments represent the principal providers of fire protection services for residential and commercial properties. Private providers represent only a small portion of the total fire protection market and generally provide services where a tax-supported municipality or fire district has decided to contract for these services or has not assumed the financial responsibility for fire protection. In these situations, we provide services for a municipality or fire district on a contract basis or provide fire protection services directly to residences and businesses who subscribe for this service. We cannot provide assurance that: * we will be able continue to maintain current contracts or subscription or to obtain additional fire protection business on a contractual or subscription basis; * fire districts or municipalities will not choose to provide fire protection services directly in the future; or * areas in which we provide services through subscriptions will not be converted to tax-supported fire districts or annexed by municipalities. WE DEPEND ON OUR MANAGEMENT AND OTHER KEY PERSONNEL. Our success depends upon our ability to recruit and retain key personnel. We could experience difficulty in retaining our current key personnel or in attracting and retaining necessary additional key personnel. Low unemployment in certain market areas currently makes the recruiting, training, and retention of full-time and part-time personnel more difficult and costly, including the cost of overtime wages. Our internal growth will further increase the demand on our 51 resources and require the addition of new personnel. We have entered into employment agreements with certain of our executive officers and certain other key personnel. Failure to retain or replace our key personnel may have an adverse effect on our business. IT MAY BE DIFFICULT FOR A THIRD PARTY TO ACQUIRE US. Certain provisions of our certificate of incorporation, shareholders' rights plan and Delaware law could make it more difficult for a third party to acquire control of our company, even if a change in control might be beneficial to stockholders. This could discourage potential takeover attempts and could adversely affect the market price of our common stock. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK CONDITIONS. Our primary exposure to market risk consists of changes in interest rates on our borrowing activities. We face the possibility of increased interest expense in connection with our amended credit facility which bears interest at LIBOR plus 7.0%. A 1% increase in the LIBOR rate would increase our interest expense on an annual basis by approximately $1.5 million. The remainder of our debt is primarily at fixed interest rates. We continually monitor this risk and review the potential benefits of entering into hedging transactions, such as interest rate swap agreements, to mitigate the exposure to interest rate fluctuations. ITEM 4. CONTROLS AND PROCEDURES We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our reports under the Securities Exchange Act of 1934, as amended (the "Exchange Act") is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms, and that such information is accumulated and communicated to the management, including the Chief Executive Officer and Vice President of Finance, as appropriate, to allow timely decisions regarding required disclosure. Management necessarily applies its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can provide only reasonable assurance regarding management's control objectives. Within 90 days prior to the date of filing of this report, we carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer along with the Vice President of Finance, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon the foregoing, the Chief Executive Officer along with the Vice President of Finance concluded that our disclosure controls and procedures are designed to ensure that the information required to be disclosed by us in the reports filed or submitted by us under the Exchange Act is recorded, processed, summarized and reported within the applicable time periods. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to the date we carried out the evaluation. RURAL/METRO CORPORATION AND SUBSIDIARIES PART II. OTHER INFORMATION. ITEM 1 -- LEGAL PROCEEDINGS. From time to time, we are subject to litigation and regulatory investigations arising in the ordinary course of business. We believe that the resolutions of currently pending claims or legal proceedings will not have a material adverse effect on our business, financial condition, cash flows and results of operations. However, we are unable to predict with certainty the outcome of pending litigation and regulatory investigations. In some pending cases, our insurance coverage may not be adequate to cover all liabilities arising out of such claims. In addition, due to the nature of our business, Center for Medicare 52 and Medicaid Services (CMS) and other regulatory agencies are expected to continue their practice of performing periodic reviews and initiating investigations related to the Company's compliance with billing regulations. Unfavorable resolutions of pending or future litigation, regulatory reviews and/or investigations, either individually or in the aggregate, could have a material adverse effect on our business, financial condition, cash flows and results of operations. As previously reported, the Company, Arthur Andersen LLP and certain of the Company's current and former officers and directors and their spouses were named as defendants in a purported class action lawsuit: Steven A. Springborn v. Rural/Metro Corporation, et al., filed on September 30, 2002 in Maricopa County, Arizona Superior Court. The Plaintiffs amended the Complaint on October 17, 2002 adding Barry Landon and Jane Doe Landon as defendents and making certain additional allegations and claims. On October 30, 2002, Defendant Arthur Andersen LLP removed the action to the United States District Court, District of Arizona. The Company and the individual defendants have consented to this removal. The Company and the individual defendants have been served with the summons and complaint and are in the process of responding to the Amended Complaint. As previously reported, LaSalle Ambulance, Inc., a New York corporation which is a subsidiary of Rural/Metro Corporation, was sued in the case of Ann Bogucki and Patrick Bogucki v. LaSalle Ambulance Service, et al., Index No. I 1995 2128, in the Supreme Court of the State of New York, Erie County. In January 2003, the parties reached an agreement in principle, which does not result in any additional claims expense, to settle the matter. The agreement in principle provides for a full release of LaSalle Ambulance in April 2003 subject to completion of final settlement documentation and plaintiff's receipt of agreed consideration. 53 ITEM 6 -- EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits 3.1 (c) Amendment No. 1 to the Rights Agreement dated as of August 23, 1995 between the Registrant and American Securities Transfer, Inc., the Rights Agent. * 10.16 (o) Form of Change of Control Agreement by and between the Registrant and the following executive officers: (i) Jack E. Brucker, dated April 25, 2002; and (ii) John S. Banas III, dated September 27, 2002. * (b) Reports on Form 8-K Form 8-K filed October 15, 2002 relating to the sale of Latin American operations (via the sale of the stock of applicable subsidiaries) to local management for assumption of net liabilities. An amendment to this Form 8-K filed December 10, 2002 included a pro forma condensed balance sheet as of June 30, 2002 and pro forma condensed statements of operations for each of the years in the three year period ended June 30, 2002 reflecting such sale. Form 8-K filed October 16, 2002 relating to the amended credit facility with our bank lenders which among other provisions, extended the maturity date of the facility from March 16, 2003 through December 31, 2004, waived previous non-compliance, and required the issuance to the lenders of 211,549 shares of our Series B redeemable preferred stock. Form 8-K filed October 22, 2002 relating to the notice from the Nasdaq Listing Qualifications Panel indicating we evidenced compliance with the requirements necessary for continued listing on the Nasdaq SmallCap Market. - ---------- * Filed herewith 54 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. RURAL/METRO CORPORATION Dated: February 14, 2003 By: /s/ Jack E. Brucker ------------------------------------ Jack E. Brucker, President & Chief Executive Officer (Principal Executive Officer) By: /s/ Randall L. Harmsen ------------------------------------ Randall L. Harmsen, Vice President of Finance (Principal Financial Officer and Principal Accounting Officer) 55 CERTIFICATION I, Jack E. Brucker, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Rural/Metro Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 14, 2003 /s/ Jack E. Brucker ---------------------------------------- President and Chief Executive Officer Rural/Metro Corporation 56 CERTIFICATION I, Randall L. Harmsen, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Rural/Metro Corporation; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: February 14, 2003 /s/ Randall L. Harmsen ---------------------------------------- Vice President of Finance (Principal Financial Officer and Principal Accounting Officer) Rural/Metro Corporation 57 EX-3.1C 3 ex3-1c.txt AMENDMENT NO. 1 TO THE RIGHTS AGREEMENT Exhibit 3.1(c) AMENDMENT NO. 1 TO RIGHTS AGREEMENT This Amendment No. 1 to Rights Agreement (this "Amendment"), dated as of October 30, 2002, is made between Rural/Metro Corporation, a Delaware corporation (the "Company"), and Computershare Trust Company, Inc., a Colorado corporation (f/k/a American Securities Transfer, Inc.) (the "Rights Agent"). WHEREAS, the Company and the Rights Agent are parties to that certain Rights Agreement, dated as of August 23, 1995 (the "Rights Agreement"); WHEREAS, pursuant to Section 26 of the Rights Agreement, the Company has the right to amend the Rights Agreement, and the Rights Agent is required to approve such amendment upon the direction of the Company; and WHEREAS, the Company hereby directs an amendment to the Rights Agreement, and the Rights Agent consents to such amendment of the Rights Agreement as set forth in this Amendment. NOW THEREFORE, the parties hereto mutually agree as follows: 1. AMENDMENT TO SECTION 1(A). Section 1(a) of the Rights Agreement is hereby amended and restated, in its entirety, to read as follows: "(a) "Acquiring Person" shall mean any Person who or which, together with all Affiliates and Associates of such Person, shall be the Beneficial Owner of 15% or more of the shares of Common Stock then outstanding except the term "Acquiring Person" shall not include the Company, any Subsidiary of the Company, any employee benefit plan of the Company or of any Subsidiary of the Company, or any person or entity organized, appointed or established by the Company for or pursuant to the terms of any such plan; provided, however, if the Board of Directors of the Company determines in good faith that a Person that would otherwise qualify as an "Acquiring Person" has become such inadvertently, and such Person divests as promptly as practicable a sufficient number of shares of Common Stock so that such Person would no longer be an "Acquiring Person," then such Person shall not be deemed to be or have been an "Acquiring Person" for any purposes of this Agreement." 2. SURVIVAL OF TERMS AND PROVISIONS OF RIGHTS AGREEMENT. Except as expressly modified and superseded by this Amendment, all terms and provisions of the Rights Agreement shall continue in full force and effect. The Company and the Rights Agent agree that the Rights Agreement, as amended hereby, shall continue to be legal, valid, binding and enforceable against each party hereto, in accordance with the terms of the Rights Agreement, as amended hereby. 3. FINAL AGREEMENT. The Rights Agreement, as amended hereby, represents the entire expression of the parties with respect to the subject matter therein and herein, on the date this Amendment is executed. 5. COUNTERPARTS. This Amendment may be executed in any number of counterparts or via facsimile, all of which taken together, shall constitute an original and one and the same instrument. IN WITNESS WHEREOF, the parties hereto have executed this Amendment on date set forth above. RURAL/METRO CORPORATION By: John S. Banas III ------------------------------------ Name: John S. Banas III ---------------------------------- Title: Senior Vice President & General Counsel --------------------------------- COMPUTERSHARE TRUST COMPANY, INC. By: /s/ Kellie Gwinn ------------------------------------ Name: Kellie Gwinn ---------------------------------- Title: Vice President --------------------------------- COMPUTERSHARE TRUST COMPANY, INC. By: /s/ Deborah Sorheim ------------------------------------ Name: Deborah Sorheim ---------------------------------- Title: Secretary/Treasurer --------------------------------- EX-10.16O 4 ex10-16o.txt FORM OF CHANGE OF CONTROL AGREEMENT Exhibit 10.16(o) --------------------- - ---------------------- c/o Rural/Metro Corporation 8401 East Indian School Road Scottsdale, Arizona 85251 Re: CHANGE OF CONTROL AGREEMENT Dear _________: In the past, our Board of Directors (the "Board") concluded that it was in the best interests of Rural/Metro Corporation ("Rural/Metro") and its shareholders to take appropriate steps to allay any concerns you may have had about your future employment opportunities with Rural/Metro and its subsidiaries (Rural/Metro and its subsidiaries are collectively referred to as the "Company"). As a result, the Board offered you a special package of benefits described in your current Change of Control Agreement. As we have discussed, the Board has decided to offer certain enhancements to your current Change of Control Agreement. This revised Change of Control Agreement ("Agreement") reflects those enhancements. Please bear in mind that the benefits described below are being offered to you alone and we accordingly ask that you refrain from discussing this special program with others. Also, please note that the special benefits package described below will only be effective if you sign the extra copy of this Agreement which is enclosed, and return it to me on or before ___________. If you timely sign and return the Agreement, it will replace your current Change of Control Agreement. 1. TERM OF AGREEMENT. This Agreement is effective as of ______________, and will continue in effect as long as you are actively employed by Rural/Metro, unless you and Rural/Metro agree in writing to its termination. 2. ELIGIBILITY FOR COC PAYMENT. You will receive the "COC Payment," as defined in Section 3, if: (a) Your employment with the Company is terminated without "Cause" (as defined in Section 9) within two years following a Change of Control; or (b) You terminate your employment with the Company for "Good Reason" (as defined in Section 8) within two years following a Change of Control. Notwithstanding the foregoing, no COC Payment will be payable if your employment is terminated for Cause, if you terminate your employment without Good Reason, or if your employment is terminated by reason of your "Disability" (as defined in Section 11(d)) or your death. In addition, the COC Payment will not be payable if your employment is terminated by you or the Company for any or no reason before a Change of Control occurs or if your employment is terminated by you or the Company for any or no reason more than two years after a Change of Control has occurred. In order to receive the COC Payment, you must execute any release reasonably requested by Rural/Metro of claims that you may have pursuant to this Agreement (but not any other claims). The COC Payment will be payable without regard to whether you look for or obtain alternative employment following your termination of employment with the Company. 3. COMPUTATION OF COC PAYMENT. The "COC Payment" is a lump sum payment equal to the sum of: (a) 200% of your annualized base salary as of the day on which the Change of Control occurs; plus (b) 200% of an amount equal to (i) the incentive compensation paid or payable to you pursuant to our Management Incentive Program on account of performance during the calendar year immediately preceding the calendar year in which the Change of Control occurs and (ii) any other bonuses or incentive compensation paid or payable to you for such year. The COC Payment is in addition to and distinct from any payments to which you may be entitled due to your termination pursuant to the terms of your "Employment Agreement" (as defined in Section 21), any applicable law, or otherwise. The COC Payment will be paid in one lump sum within five days following your termination of employment. In the event of your death, any unpaid portion of the COC Payment will be paid to your surviving spouse, or if there is no surviving spouse, to your family trust or, if these is no family trust, to your estate. 4. ACCELERATION OF OR PAYMENT FOR OPTIONS. If an agreement is entered into that will result in a Change of Control, before the Change of Control occurs the Board will accelerate the vesting and exercisability of any options you hold to acquire Company stock that, pursuant to their terms, are not yet vested and exercisable (the "Existing Options"). As a general rule, the Existing Options and any other options that you hold will remain exercisable following the Change of Control until the options lapse in accordance with their terms. However, if your employment with the Company is terminated without "Cause" within two years following a Change of Control or you terminate your employment with the Company for "Good Reason" within two years following a Change of Control, the Existing Options and any other options that 2 you hold will remain exercisable until the later of ninety days after the last day of the Severance Period (as defined below), or ten years after the Grant Date (five years after the Grant Date if the Options are incentive stock options and you are a shareholder who at the Grant Date owned stock possessing more than 10% of the combined voting power of all classes of stock of Rural/Metro or any parent or subsidiary of Rural/Metro). If the exercise period relating to incentive stock options granted in compliance with Section 422 of the Internal Revenue Code would be exceeded by application of the foregoing, then the incentive stock option shall be considered to be a non-qualified stock option. The "Severance Period" shall be as defined in Section 9 of your Employment Agreement, but not less than two years for purposes of this Agreement. 5. BENEFITS CONTINUATION. If your employment is terminated by the Company without Cause, or if you terminate your employment for Good Reason, within two years following a Change of Control, you will continue to receive life, disability, accident and group health Insurance benefits substantially similar to those which you were receiving immediately prior to your termination of employment for a period of twenty-four (24) months following your termination of employment. Such benefits shall be provided on substantially the same terms and conditions as they were provided prior to the Change of Control. If a particular insurance benefit may not be continued for any reason, the Company shall pay a "Benefit Allowance" to the Executive. The Benefit Allowance will equal 145% of the cost to Rural/Metro of providing the unavailable insurance benefit to a similarly situated employee. The Benefit Allowance shall be paid on a monthly basis or in a single lump sum. The cost of providing the unavailable benefit to a similarly situated employee and whether the Benefit Allowance will be paid in monthly installments or in a lump sum will be determined by Rural/Metro in the exercise of its discretion. The Company does not intend to provide duplicative benefits. As a result, benefits otherwise receivable pursuant to this Section shall be reduced or eliminated if and to the extent that you receive such benefits pursuant to your Employment Agreement. Benefits otherwise receivable pursuant to this Section also shall be reduced or eliminated if and to the extent that you receive comparable benefits from any other source (for example, another employer). 3 6. INCENTIVE COMPENSATION. If you are employed by the Company on the day on which a Change of Control occurs, the incentive compensation to which you will be entitled under the Management Incentive Program for the calendar year in which the Change of Control occurs will equal at least the "Minimum Incentive Compensation Amount". The "Minimum Incentive Compensation Amount" will equal the incentive compensation to which you would have been entitled if the year were to end on the day on which the Change of Control occurs, based upon performance up to that date. In measuring financial performance, financial results through the date of the Change of Control will be annualized. 7. CHANGE OF CONTROL DEFINED. For purposes of this Agreement, the term Change of Control shall mean any one or more of the following transactions or situations: (a) A sale, transfer, or other disposition by Rural/Metro through a single transaction or a series of transactions of securities of Rural/Metro representing 30% or more of the combined voting power of Rural/Metro's then outstanding securities to any "Unrelated Person" or "Unrelated Persons" acting in concert with one another. For purposes of this Section, the term "Person" shall mean and include any individual, partnership, joint venture, association, trust, corporation, or other entity (including a "group" as referred to in Section 13(d)(3) of the Securities Exchange Act of 1934 (the "Act")). For purposes of this Section, the term "Unrelated Person" shall mean and include any Person other than: Rural/Metro, a wholly-owned subsidiary of Rural/Metro, or an employee benefit plan of Rural/Metro. (b) A sale, transfer, or other disposition through a single transaction or a series of transactions of all or substantially all of the assets of Rural/Metro to an Unrelated Person or Unrelated Persons acting in concert with one another. (c) A change in the ownership of Rural/Metro through a single transaction or a series of transactions such that any Unrelated Person or Unrelated Persons acting in concert with one another become the "Beneficial Owner", directly or indirectly, of securities of Rural/Metro representing at least 30% of the combined voting power of Rural/Metro's then outstanding securities. For purposes of this Section, the term "Beneficial Owner" shall have the same meaning as given to that term in Rule l3d-3 promulgated under the Act, provided that any pledgee of voting securities shall not be deemed to be the Beneficial Owner thereof prior to its acquisition of voting rights with respect to such securities. (d) Any consolidation or merger of Rural/Metro with or into an Unrelated Person, unless immediately after the consolidation or merger the holders of the common stock of Rural/Metro immediately prior to the 4 consolidation or merger are the Beneficial Owners of securities of the surviving corporation representing at least 50% of the combined voting power of the surviving corporation's then outstanding securities. (e) During any period of two (2) years, individuals who, at the beginning of such period, constituted the Board of Directors of Rural/Metro cease, for any reason, to constitute at least a majority thereof, unless the election or nomination for election of each new director was approved by the vote of at least two-thirds (2/3rds) of the directors then still in office who were directors at the beginning of such period. (f) A change in control of Rural/Metro of a nature that would be required to be reported in response to Item 6(e) of Schedule 14A of Regulation 14A promulgated under the Act, or any successor regulation of similar import, regardless of whether Rural/Metro is subject to such reporting requirement. Notwithstanding any provision herein to the contrary, the filing of a proceeding for the reorganization of Rural/Metro under Chapter 11 of the Federal Bankruptcy Code or any successor or other statute of similar import shall not be deemed to be a Change of Control for purpose of this Agreement. If more than one of the transactions or situations referred to above occurs during the term of this Agreement, each shall be treated as a separate Change of Control. 8. GOOD REASON DEFINED. For purposes of this Agreement, "Good Reason" shall mean any one or more of the following: (a) The assignment to you of any duties which are inconsistent with, or the reduction of powers or functions associated with, your current positions, duties, responsibilities and status with Rural/Metro, or a change in your reporting responsibilities, or in the conditions of your employment; provided that a single reduction by Rural/Metro of less than 10% (or aggregate reductions totaling less than 10%) in your base salary as in effect on the date hereof or as the same may be increased as provided in your Employment Agreement is permissible and shall not constitute "Good Reason". (b) The failure of Rural/Metro to cause any successor to expressly assume and agree to perform this Agreement pursuant to Section 12 hereof. 5 (c) Any purported termination by Rural/Metro of your employment that is not effected by a Notice of Termination pursuant to Section 11 below or for grounds not constituting Cause. (d) Rural/Metro relieving you of your duties. (e) Rural/Metro requiring you to relocate, without your express written consent, to an employment location which is more than 50 miles from your employment location on the date of the Change of Control. (f) Any other event which constitutes "Good Reason" under paragraph 7A of your Employment Agreement with Rural/Metro. If there is no such agreement in effect at the time of your termination, this paragraph (f) shall be inapplicable. 9. CAUSE DEFINED. For purposes of this Agreement, the term "Cause" shall be given the meaning ascribed to such term in your Employment Agreement, and shall be determined in the same manner as provided in your Employment Agreement, as it may be amended from time to time. If no written Employment Agreement is in effect at the time of your termination of employment, "Cause" shall be given the meaning ascribed to it in the last written Employment Agreement that was in effect between you and the Company that included a definition of "Cause". 10. CEILING ON BENEFITS. The Internal Revenue Code (the "Code") places significant tax burdens on you and the Company if the total payments made to you due to a Change of Control exceed prescribed limits. For example, if your limit is $300,000 and the total payments equal or exceed the limit, you are subject to an excise tax under Section 4999 of the Code of 20% of all amounts paid to you in excess of $100,000. If your limit is $300,000, you will not be subject to an excise tax if you receive $299,999. If you receive $300,000, you will be subject to an excise tax of $40,000 (20% of $200,000). In order to avoid this excise tax and the related adverse tax consequences for the Company, by signing this Agreement, you will be agreeing that the present value of your "Total Payments" (as defined below) will not exceed an amount equal to two and ninety-nine hundredths (2.99) times your "Base Period Income" (as defined below). This is the maximum amount which you may receive without becoming subject to the excise tax imposed by Section 4999 of the Code or which the Company may pay without loss of deduction under Section 280G of the Code. 6 "Base Period Income" is an amount equal to your "annualized includable compensation" for the "base period" as defined in Sections 280G(d)(1) and (2) of the Code and the regulations adopted thereunder. Generally, your "annualized includable compensation" is the average of your annual taxable income from the Company for the "base period", which is the five calendar years prior to the year in which the Change of Control occurs. These concepts are complicated and technical and all of the rules set forth in the applicable regulations apply for purposes of this Agreement. Your "Total Payments" include the sum of the COC Payment and any other "payments in the nature of compensation" (as defined in Section 280G of the Code and the regulations adopted thereunder) to or for your benefit, the receipt of which is contingent on a Change of Control and to which Section 280G of the Code applies. If Rural/Metro believes that these rules will result in a reduction of the payments to which you are entitled under this Agreement, it will so advise you within 60 days following delivery of the "Notice of Termination" described in Section 11. You and Rural/Metro will then, at Rural/Metro's expense, retain legal counsel, certified public accountants, and/or a firm of recognized executive compensation consultants to provide an opinion or opinions concerning whether your Total Payments exceed the limit discussed above. Rural/Metro will select the legal counsel, certified public accountants and executive compensation consultants. If you do not accept one or more of the parties selected by Rural/Metro, you may provide Rural/Metro with the names of legal counsel, certified public accountants and/or executive compensation consultants acceptable to you. If Rural/Metro does not accept the party or parties selected by you, the legal counsel, certified public accountants and/or executive compensation consultants selected by you and Rural/Metro, respectively, will select the legal counsel, certified public accountants and/or executive compensation consultants to provide the opinions required. At a minimum, the opinions required by this Section must set forth (a) the amount of your Base Period Income, (b) the present value of the Total Payments and (c) the amount and present value of any payments in excess of 3 times your Base Period Income. If the opinions state that there would be such an excess, your payments under this Agreement will be reduced to the extent necessary to eliminate the excess. If the legal counsel or certified public accountants selected to provide the opinions referred to above so requests in connection with the opinion required by this Section, a firm of recognized executive compensation consultants, selected by you and Rural/Metro pursuant to the procedures set forth above, shall provide an opinion, upon which such legal counsel or 7 certified public accountants may rely, as to the reasonableness of any item of compensation as reasonable compensation for services rendered before or after the Change of Control. If Rural/Metro believes that your Total Payments will exceed the limitations of this Section, it will nonetheless make payments to you, at the times stated above, in the maximum amount that it believes may be paid without exceeding such limitations. The balance, if any, will then be paid after the opinions called for above have been received.If the amount paid to you by Rural/Metro is ultimately determined, pursuant to the opinion referred to above or by the Internal Revenue Service, to have exceeded the limitation of this Section, Rural/Metro will promptly pay you an additional amount in cash (the "Gross-up Payment") equal to the sum of any excise tax imposed pursuant to Section 4999 of the Code or any comparable provision of state or local law (an "Excise Tax") and all taxes, interest and penalties including, without limitation, any federal, state and local income taxes payable by you as a result of the receipt of the Gross-up Payment, or as a result of any liability for or the withholding or the assessment of any Excise Tax or the receipt of the Gross-up Payment. For such purposes, federal income taxes shall be determined net of the maximum reduction in such federal income taxes that could be obtained from the deduction of such state and local taxes as calculated by (i) taking into account the effects of all limitations on the deductibility for federal income tax purposes of such state and local taxes (including without limitation the nondeductibility of state and local taxes for federal alternative minimum tax purposes, limitations on deductibility of itemized deductions or miscellaneous itemized deductions, and the phase-out of personal exemptions, (ii) assuming that your only income consists of compensation paid to you by Rural/Metro, and (iii) utilizing your actual itemized deductions other than for state and local income taxes for your taxable year immediately preceding the taxable year the Gross-Up Payment is to be made. It is intended that under this provision Rural/Metro will indemnify you in such a manner that you shall not suffer any loss or expense by reason of the assessment of any Excise Tax or your receipt of or entitlement to the Gross-Up Payment. For purposes of this Agreement, "federal income taxes" include, without limitation, federal alternative minimum taxes. In the event that the provisions of Sections 280G and 4999 of the Code are repealed without succession, this Section shall be of no further force or effect. 11. TERMINATION NOTICE AND PROCEDURE. Any termination by the Company or you of your employment shall be communicated by written Notice of Termination to you if such Notice of Termination is delivered by the Company and to the Company if such Notice of Termination is delivered by you, all in accordance with the following procedures: 8 (a) The Notice of Termination shall indicate the specific termination provision in this Agreement relied upon and shall set forth in reasonable detail the facts and circumstances alleged to provide a basis for termination. (b) Any Notice of Termination by the Company shall be in writing signed by the Chairman of the Board of Rural/Metro, specifying in detail the basis for such termination. (c) If the Company shall furnish a Notice of Termination for Cause and you in good faith notify the Company that a dispute exists concerning such termination within the 15 day period following your receipt of such notice, you may elect to continue your employment during such dispute. If it is thereafter determined that (i) Cause did exist, your "Termination Date" shall be the earlier of (A) the date on which the dispute is finally determined, either by mutual written agreement of the parties or pursuant to the alternative dispute resolution provisions of Section 18 or (B) the date of your death, or (ii) Cause did not exist, your employment shall continue as if the Company had not delivered its Notice of Termination and there shall be no Termination Date arising out of such notice. (d) If the Company shall furnish a Notice of Termination by reason of Disability and you in good faith notify the Company that a dispute exists concerning such termination within the 15-day period following your receipt of such notice, you may elect to continue your employment during such dispute. The dispute relating to the existence of a Disability shall be resolved by the opinion of the licensed physician selected by Rural/Metro; provided, however, that if you do not accept the opinion of the licensed physician selected by Rural/Metro, the dispute shall be resolved by the opinion of a licensed physician who shall be selected by you; provided further, however, that if Rural/Metro does not accept the opinion of the licensed physician selected by you, the dispute shall be finally resolved by the opinion of a licensed physician selected by the licensed physicians selected by Rural/Metro and you, respectively. If it is thereafter determined that (i) a Disability did exist, your Termination Date shall be the earlier of (A) the date on which the dispute is resolved or (B) the date of your death, or (ii) a Disability did not exist, your employment shall continue as if the Company had not delivered its Notice of Termination and there shall be no Termination Date arising out of such notice. For purposes of this Agreement, "Disability" shall be given the meaning ascribed to such term in your Employment Agreement at the time the Disability determination is being made. If there is no Employment Agreement that defines "Disability", "Disability" shall mean your inability to perform your customary duties for the Company due to a physical or mental condition that is considered to be of long-lasting or indefinite duration. (e) If you in good faith furnish a Notice of Termination for Good Reason and the Company notifies you that a dispute exists concerning the termination within the 15 day period following the Company's receipt of such 9 notice, you may elect to continue your employment during such dispute. If it is thereafter determined that Good Reason did exist, your Termination Date shall be the earlier of (A) the date on which the dispute is finally determined, either by mutual written agreement of the parties or pursuant to the alternative dispute resolution provisions of Section 18, (B) the date of your death or (C) one day prior to the second anniversary of a Change of Control, and your payments hereunder shall reflect events occurring after you delivered the Notice of Termination. If it is determined that Good Reason did not exist, you will be deemed to have terminated your employment without Good Reason, and your Termination Date shall be either (A) the date on which you furnished the Notice of Termination for Good Reason, if you did not elect to continue your employment during the dispute concerning whether Good Reason existed, or (B) the date on which it is determined that Good Reason did not exist, if you elected to continue your employment during the dispute concerning whether Good Reason existed. You may withdraw any Notice of Termination at any time and the employment relationship shall continue. (f) If you do not elect to continue employment pending resolution of a dispute regarding a Notice of Termination, and it is finally determined that the reason for termination set forth in such Notice of Termination did not exist, if such notice was delivered by you, you shall be deemed to have voluntarily terminated your employment other than for Good Reason and, if delivered by the Company, the Company will be deemed to have terminated you other than by reason of Disability or Cause. (g) For purposes of this Agreement, a transfer from Rural/Metro to one of its subsidiaries or a transfer from a subsidiary to Rural/Metro or another subsidiary shall not be treated as a termination of employment although it may, in certain circumstances, provide you with Good Reason to terminate employment pursuant to Section 8. 12. SUCCESSORS. Rural/Metro will require any successor (whether direct or indirect, by purchase, merger, consolidation or otherwise) to all or substantially all of the business and/or assets of Rural/Metro or any of its subsidiaries to expressly assume and agree to perform this Agreement in the same manner and to the same extent that Rural/Metro or any subsidiary would be required to perform it if no such succession had taken place. Failure of Rural/Metro to obtain such assumption and agreement prior to the effectiveness of any such succession shall be a breach of this Agreement and shall entitle you to compensation in the same amount and on the same terms to which you would be entitled hereunder if you terminate your employment for Good Reason following a Change of Control, except that for purposes of implementing the foregoing, the date on which any such 10 succession becomes effective shall be deemed the Termination Date. As used in this Agreement, "Rural/Metro" shall mean Rural/Metro as hereinbefore defined and any successor to its business and/or assets as aforesaid which assumes and agrees to perform this Agreement by operation of law or otherwise. 13. BINDING AGREEMENT. This Agreement shall inure to the benefit of and be enforceable by you and your personal or legal representatives, executors, administrators, successors, heirs, distributees, devisees and legatees. If you should die while any amount would still be payable to you hereunder had you continued to live, all such amounts shall be paid in accordance with the second paragraph of Section 3. 14. NOTICE. For purposes of this Agreement, notices and all other communications provided for in this Agreement shall be in writing and shall be deemed to have been duly given when delivered or mailed by United States certified or registered mail, return receipt requested, postage prepaid, addressed to the respective addresses set forth on the first page of this Agreement, provided that all notices to Rural/Metro shall be directed to the attention of the Chairman of the Board of Rural/Metro with a copy to the Secretary of Rural/Metro, or to such other address as either party may have furnished to the other in writing in accordance herewith, except that notice of change of address shall be effective only upon receipt. 15. MISCELLANEOUS. No provision of this Agreement may be modified, waived or discharged unless such waiver, modification or discharge is agreed to in writing and signed by you and the Chairman of the Board of Rural/Metro. No waiver by either party hereto at any time of any breach by the other party hereto of, or compliance with, any condition or provision of this Agreement to be performed by such other party shall be deemed a waiver of similar or dissimilar provisions or conditions at the same or at any prior or subsequent time. No agreements or representations, oral or otherwise, express or implied, with respect to the subject matter hereof have been made by either party which are not expressly set forth in this Agreement. The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of Arizona without regard to its conflicts of law principles. All references to sections of the Securities Exchange Act of 1934 or the Code shall be deemed also to refer to any successor provisions to such sections. Any payments provided for hereunder shall be paid net of any applicable withholding required under federal, state or local law. The obligations of the Company that arise prior to the expiration of this Agreement shall survive the expiration of the term of this Agreement. 11 16. VALIDITY. The invalidity or unenforceability of any provision of this Agreement shall not affect the validity or enforceability of any other provision of this Agreement, which shall remain in full force and effect. 17. COUNTERPARTS. This Agreement may be executed in several counterparts, each of which shall be deemed to be an original but all of which together will constitute one and the same instrument. 18. ALTERNATIVE DISPUTE RESOLUTION. All claims, disputes and other matters in question between the parties arising under this Agreement shall, unless otherwise provided herein (such as in Sections 10 and 11(d)), be resolved in accordance with the arbitration or alternative dispute resolution provisions included in your Employment Agreement. If no written Employment Agreement is in effect at the time of your termination of employment, or, if the Employment Agreement in effect at the time of your termination of employment does not include arbitration or alternative dispute resolution provisions, all claims, disputes and other matters in question between the parties arising under this Agreement shall be decided by arbitration in Phoenix, Arizona, in accordance with the National Rules for the Resolution of Employment Disputes of the American Arbitration Association (including such procedures governing selection of the specific arbitrator or arbitrators), unless the parties mutually agree otherwise. The Company shall pay the costs of any such arbitration. The award by the arbitrator or arbitrators shall be final, and judgment may be entered upon it in accordance with applicable law in any state or Federal court having jurisdiction thereof. 19. EXPENSES AND INTEREST. If a good faith dispute shall arise with respect to the enforcement of your rights under this Agreement or if any arbitration or legal proceeding shall be brought in good faith to enforce or interpret any provision contained herein, or to recover damages for breach hereof, and you are the prevailing party, you shall recover from the Company any reasonable attorneys' fees and necessary costs and disbursements incurred as a result of such dispute or legal proceeding, and prejudgment interest on any money judgment obtained by you calculated at the rate of interest announced by Bank One, Arizona, NA from time to time as its prime rate from the date that payments to you should have been made under this Agreement. It is expressly provided that the Company shall in no event recover from you any attorneys' fees, costs, disbursements or interest as a result of any dispute or legal proceeding involving the Company and you. 12 20. PAYMENT OBLIGATIONS ABSOLUTE. Rural/Metro's obligation to pay you the compensation and to make the arrangements in accordance with the provisions herein shall be absolute and unconditional and shall not be affected by any circumstances; provided, however, that Rural/Metro may apply amounts payable under this Agreement to any debts owed to Rural/Metro by you on your Termination Date. All amounts payable by Rural/Metro in accordance with this Agreement shall be paid without notice or demand. If Rural/Metro has paid you more than the amount to which you are entitled under this Agreement, Rural/Metro shall have the right to recover all or any part of such overpayment from you or from whomsoever has received such amount. 21. EFFECT ON EMPLOYMENT AGREEMENT. This Agreement supplements, and does not replace, your Employment Agreement, as it may be amended or replaced from time to time (the "Employment Agreement"). You will be entitled to receive all amounts due to you pursuant to your Employment Agreement, but some benefits due pursuant to your Employment Agreement may reduce the benefits due pursuant to Section 5. If there is any conflict between the provisions of this Agreement and your Employment Agreement, the provisions of this Agreement shall control. 22. ENTIRE AGREEMENT. This Agreement, your Employment Agreement, and any Stock Option Agreements set forth the entire agreement between you and the Company concerning the subject matter discussed in this Agreement and supersede all prior agreements, promises, covenants, arrangements, communications, representations or warranties, whether written or oral, by any officer, employee or representative of the Company. Any prior agreements or understandings with respect to the subject matter set forth in this Agreement are hereby terminated and canceled. 23. DEFERRAL OF PAYMENTS. To the extent that any payment under this Agreement, when combined with all other payments received during the same calendar year that are subject to the limitations on deductibility under Section 162(m) of the Code, would exceed the limitations on deductibility under Section 162(m) of the Code for such year, such excess shall, in the discretion of Rural/Metro, be deferred to the next succeeding calendar year. Such deferred amounts, together with interest at the rate of eight percent (8%) per annum, shall be paid no later than the 60th day after the beginning of such next succeeding calendar year, provided that such payment, when combined with any other payments subject to the Section 162(m) limitations received during the first forty-five (45) days of such next succeeding calendar year, does not exceed the limitations on deductibility under Section 162(m) of the Code for such next succeeding calendar year. 13 24. PARTIES. This Agreement is an agreement between you and Rural/Metro. In certain cases, though, obligations imposed upon Rural/Metro may be satisfied by a Rural/Metro subsidiary. Any payment made or action taken by a Rural/Metro subsidiary shall be considered to be a payment made or action taken by Rural/Metro for purposes of determining whether Rural/Metro has satisfied its obligations under this Agreement. If you would like to participate in this special benefits program, please sign and return the extra copy of this letter which is enclosed. Sincerely, ---------------------------------------- Cor Clement Chairman, Board of Directors 14 ACCEPTANCE I hereby accept the offer to participate in this special benefit program and I agree to be bound by all of the provisions noted above. ---------------------------------------- 15 EX-99.1 5 ex99-1.txt CERTIFICATION PURSUANT TO SARBANES-OXLEY ACT EXHIBIT 99.1 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (SUBSECTIONS (a) AND (b) OF SECTION 1350, CHAPTER 63 OF TITLE 18, UNITED STATES CODE) Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of Title 18, United States Code), the undersigned officer of Rural/Metro Corporation, a Delaware corporation (the "Company"), does hereby certify with respect to the Quarterly Report of the Company on Form 10-Q for the quarter ended December 31, 2002 as filed with the Securities and Exchange Commission (the "10-Q Report") that: (1) the 10-Q Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the 10-Q Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: February 14, 2003 /s/ Jack E. Brucker - --------------------------------------- Jack E. Brucker President and Chief Executive Officer EX-99.2 6 ex99-2.txt CERTIFICATION PURSUANT TO SARBANES-OXLEY ACT EXHIBIT 99.2 CERTIFICATION PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 (SUBSECTIONS (a) AND (b) OF SECTION 1350, CHAPTER 63 OF TITLE 18, UNITED STATES CODE) Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of Title 18, United States Code), the undersigned officer of Rural/Metro Corporation, a Delaware corporation (the "Company"), does hereby certify with respect to the Quarterly Report of the Company on Form 10-Q for the quarter ended December 31, 2002 as filed with the Securities and Exchange Commission (the "10-Q Report") that: (1) the 10-Q Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) the information contained in the 10-Q Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Dated: February 14, 2003 /s/ Randall L. Harmsen - --------------------------------------- Randall L. Harmsen Vice President of Finance (Principal Financial Officer and Principal Accounting Officer) -----END PRIVACY-ENHANCED MESSAGE-----