Edgar Filing: LIFELINE SYSTEMS INC

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

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FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934

For the quarter ended March 31, 2002 Commission File Number 0-13617

LIFELINE SYSTEMS, INC.
(Exact name of registrant as specified in its charter)

MASSACHUSETTS 04-2537528
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

111 Lawrence Street
Framingham, Massachusetts 01702-8156
(Address of principal executive offices) (Zip Code)

(508) 988-1000
(Registrant's telephone number, including area code)

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Securities registered pursuant to Section 12(b) of the Act: NONE

Securities registered pursuant to Section 12(g) of the Act:

Common stock $0.02 par value
----------------------------
(Title of Class)

Indicate by check mark whether the registrant (i) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (ii) has been subject to such filing
requirements for the past 90 days. Yes X No
--------- -----------

Number of shares outstanding of the issuer's class of common stock as of April
30, 2002: 6,429,631

LIFELINE SYSTEMS, INC.
INDEX

PAGE

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Consolidated Balance Sheets - March 31, 2002
and December 31, 2001 ...................................................... 3

Consolidated Statements of Income and Comprehensive Income -
Three months ended March 31, 2002 and 2001 ................................. 4

Consolidated Statements of Cash Flows - Three months

ended March 31, 2002 and 2001 .............................................. 5

Notes to Consolidated Financial Statements .......................................... 6-12

ITEM 2.

Management's Discussion and Analysis of Results of

Operations and Financial Condition ......................................... 13-19

ITEM 3.

Quantitative and Qualitative Disclosures about Market Risk .......................... 19-20

PART II. OTHER INFORMATION

ITEM 6.

Exhibits and Reports on Form 8-K .................................................... 20

SIGNATURES ................................................................................... 21

-2-

LIFELINE SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)

March 31, December 31,
2002 2001
---- ----

ASSETS (Unaudited)
Current assets:
Cash and cash equivalents ..................................................... $ 7,190 $ 5,742
Accounts receivable, net ...................................................... 11,565 12,118
Inventories ................................................................... 5,044 4,129
Net investment in sales-type leases ........................................... 2,672 2,874
Prepaid expenses and other current assets ..................................... 2,076 1,947
Deferred income taxes ......................................................... 1,444 1,436
-------------- --------------
Total current assets ...................................................... 29,991 28,246

Property and equipment, net ........................................................ 30,585 30,712
Goodwill, net ...................................................................... 7,226 7,226
Other intangible assets, net ....................................................... 5,954 6,414
Net investment in sales-type leases ................................................ 4,244 4,337
Other assets ....................................................................... 107 67
-------------- --------------
Total assets .............................................................. $ 78,107 $ 77,002
============== ==============

LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable .............................................................. $ 1,657 $ 1,972
Accrued expenses .............................................................. 3,206 2,197
Accrued payroll and payroll taxes ............................................. 1,951 4,282
Accrued income taxes .......................................................... 1,655 730
Deferred revenues ............................................................. 985 1,026
Current portion of capital lease obligation ................................... 1,023 1,080
Current portion of long term debt ............................................. 1,111 1,105
Product warranty and other current liabilities ................................ 356 329
Accrued restructuring and other non-recurring charges ......................... 434 506
-------------- --------------
Total current liabilities ................................................. 12,378 13,227

Deferred income taxes .............................................................. 5,823 5,799
Deferred compensation and other non-current liabilities ............................ 145 150
Long term portion of capital lease obligation ...................................... 1,429 1,657
Long term debt, net of current portion ............................................. 3,105 3,343
Accrued restructuring and other non-recurring charges, long term ................... 480 617
-------------- --------------
Total liabilities ......................................................... 23,360 24,793
Commitments and contingencies
Stockholders' equity:
Common stock, $0.02 par value, 20,000,000 shares authorized,
7,028,665 shares issued at March 31, 2002 and 6,934,461 shares issued
at December 31, 2001 ...................................................... 140 139
Additional paid-in capital .................................................... 23,015 22,000
Retained earnings ............................................................. 36,967 35,446
Less: Treasury stock at cost, 621,089 shares at March 31, 2002
and December 31, 2001 .................................................. (4,556) (4,556)
Notes receivable - officer ............................................. (550) (550)
Accumulated other comprehensive loss/cumulative translation adjustment . (269) (270)
-------------- --------------
Total stockholders' equity ................................................ 54,747 52,209
-------------- --------------
Total liabilities and stockholders' equity ................................ $ 78,107 $ 77,002
============== ==============

The accompanying notes are an integral part of these consolidated financial
statements.

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LIFELINE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME
(In thousands except for per share data)
(Unaudited)

Three months ended
March 31,
-----------------------------
2002 2001
---- ----

Revenues
Services ......................................................... $18,393 $15,806
Net product sales ................................................ 6,155 5,385
Finance and rental income ........................................ 311 373
----------- -----------

Total revenues .............................................. 24,859 21,564
----------- -----------

Costs and expenses
Cost of services ................................................. 10,617 9,510
Cost of sales .................................................... 1,905 1,858
Selling, general, and administrative ............................. 9,271 7,851
Research and development ......................................... 463 391
----------- -----------

Total costs and expenses .................................... 22,256 19,610
----------- -----------

Income from operations ................................................. 2,603 1,954
----------- -----------

Other income (expense)
Interest income .................................................. 24 57
Interest expense ................................................. (80) (71)
Other income (expense) ........................................... (12) (44)
----------- -----------

Total other income (expense), net ........................... (68) (58)
----------- -----------

Income before income taxes ............................................. 2,535 1,896
Provision for income taxes ............................................. 1,014 778
----------- -----------

Net income ............................................................. 1,521 1,118
Other comprehensive income (loss), net of tax
Foreign currency translation adjustments ......................... 1 (102)
----------- -----------

Comprehensive income ................................................... $ 1,522 $ 1,016
=========== ===========

Net income per weighted average share:
Basic ............................................................ $ 0.24 $ 0.18
====== ======
Diluted .......................................................... $ 0.23 $ 0.18
====== ======

Weighted average shares:
Basic ............................................................ 6,361 6,047
===== =====
Diluted .......................................................... 6,709 6,307
===== =====

The accompanying notes are an integral part of these consolidated financial
statements.

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LIFELINE SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Dollars in thousands)
(Unaudited)

Three months ended
March 31,
-----------------------------
2002 2001
---- ----

Cash flows from operating activities:
Net income .................................................................... $ 1,521 $ 1,118
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization ............................................ 2,367 2,163
Deferred income taxes .................................................... 16 3
Deferred compensation .................................................... - (35)
Changes in operating assets and liabilities:
Accounts receivable ...................................................... 551 (333)
Inventories .............................................................. (915) (134)
Net investment in sales-type leases ...................................... 295 250
Prepaid expenses, other current assets and other assets .................. (169) (274)
Accrued payroll and payroll taxes ........................................ (2,330) (1,857)
Accounts payable, accrued expenses and other liabilities ................. 681 (303)
Income taxes payable ..................................................... 923 (218)
Accrued restructuring charge ............................................. (209) (262)
----------- -----------

Net cash provided by operating activities ............................ 2,731 118
----------- -----------

Cash flows from investing activities:
Additions to property and equipment ........................................... (1,728) (2,273)
Business purchases and other .................................................. (58) (521)
----------- -----------

Net cash used in investing activities ................................ (1,786) (2,794)
----------- -----------

Cash flows from financing activities:
Principal payments under long term obligations ................................ (517) (259)
Net proceeds (payments) under short-term borrowings ........................... - 47
Proceeds from issuance of common stock ........................................ 1,011 242
----------- -----------

Net cash provided by financing activities ............................ 494 30
----------- -----------

Effect of foreign exchange on cash .................................................. 9 (52)
----------- -----------
Net increase (decrease) in cash and cash equivalents ................................ 1,448 (2,698)
Cash and cash equivalents at beginning of period .................................... 5,742 4,417
----------- -----------

Cash and cash equivalents at end of period .......................................... $ 7,190 $ 1,719
=========== ===========
Non-cash activity:
Capital leases ................................................................ $ - $ 192
Deferred compensation ......................................................... 5 71

The accompanying notes are an integral part of these consolidated financial
statements.

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LIFELINE SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. The information furnished has been prepared from the accounts without
audit. In the opinion of the Company, the accompanying consolidated
financial statements contain all adjustments necessary, consisting only of
those of a normal recurring nature, to present fairly its consolidated
financial position as of March 31, 2002 and the consolidated statements of
income and cash flows for the three months ended March 31, 2002 and 2001.

While the Company believes that the disclosures presented are adequate to
make the information not misleading, these statements should be read in
conjunction with the consolidated financial statements and the related
notes included in the Company's Annual Report on Form 10-K, as filed with
the Securities and Exchange Commission on March 29, 2002, for the year
ended December 31, 2001.

The results of operations for the three-month period ended March 31, 2002
are not necessarily indicative of the results expected for the full year.

2. Details of certain balance sheet captions are as follows (in thousands):

March 31, December 31,
2002 2001
--------- ------------

Inventories:
Purchased parts and assemblies ...................... $ 1,389 $ 759
Work-in-process ..................................... 76 42
Finished goods ...................................... 3,579 3,328
-------- --------
$ 5,044 $ 4,129
======== ========

Property and equipment:
Equipment ........................................... $ 27,184 $ 26,285
Furniture and fixtures .............................. 873 873
Equipment provided to customers ..................... 17,767 16,707
Equipment under capital leases ...................... 5,050 5,050
Leasehold improvements .............................. 5,362 5,314
Capital in progress ................................. 639 925
-------- --------
56,875 55,154
Less: accumulated depreciation and amortization .... (26,290) (24,442)
-------- --------
Total property and equipment, net ................... $ 30,585 $ 30,712
======== ========

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

3. The calculation of per share earnings is as follows:

(In thousands except per share figures)

Three months ended
March 31,
---------------------------------
2002 2001
---- ----

Basic:
------
Net income ............................................................. $1,521 $1,118
Weighted average common shares outstanding ............................. 6,361 6,047

Net income per share, basic ............................................ $0.24 $0.18
======== ==========

Diluted:
--------
Net income for calculating diluted earnings per share .................. $1,521 $1,118

Weighted average common shares outstanding ............................. 6,361 6,047
Common stock equivalents ............................................... 348 260
-------- ----------
Total weighted average shares .......................................... 6,709 6,307

Net income per share, diluted .......................................... $0.23 $0.18
======== ==========

For the three months ended March 31, 2002, there were no options excluded from
the computation of diluted net income per share. For the three months ended
March 31, 2001, options to purchase 345,087 shares at an average exercise price
of $19.81 were not included in the computation of diluted net income per share
as their effect would have been anti-dilutive.

4. SEGMENT INFORMATION

The Company is active in one business segment: designing, marketing, monitoring
and supporting its personal response units. The Company maintains sales,
marketing and monitoring operations in both the United States and Canada.

-7-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

4. SEGMENT INFORMATION (continued)

Geographic Segment Data

Net revenues from customers are based on the location of the customer.
Geographic information related to the results of operations for the periods
ended March 31, 2002 and 2001 and the financial position as of March 31, 2002
and December 31, 2001 is presented as follows:

(In thousands)

March 31, March 31,
2002 2001
--------------------------
Net Sales:
United States ......... $ 22,951 $ 19,816
Canada ................ 1,908 1,748
--------------------------
$ 24,859 $ 21,564
==========================

Net Income:
United States ......... $ 1,355 $ 982
Canada ................ 166 136
--------------------------
$ 1,521 $ 1,118
==========================

March 31, December 31,
2002 2001
----------------------------
Total Assets:
United States ........ $ 70,467 $ 69,495
Canada ............... 7,640 7,507
----------------------------
$ 78,107 $ 77,002
============================

5. RESTRUCTURING AND NON RECURRING CHARGES

In September 2000, the Company recorded a pre-tax non-recurring charge of
approximately $2.7 million for costs it expected to incur to address erroneous
low-battery signals in some of its personal help buttons. Included in the
non-recurring charge are anticipated material and mailing costs for exchanging
buttons, providing hospital programs with higher inventory levels for the
planned swap, and the cost of installer visits to subscriber homes to replace
the buttons.

At March 31, 2002, accrued restructuring and other non-recurring charges of
nearly $914,000 represented the remaining unutilized costs associated with the
anticipated cost of addressing erroneous low-battery signals in personal help
buttons.

-8-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

5. RESTRUCTURING AND NON RECURRING CHARGES (continued)

The following is a roll-forward of accrued restructuring and non-recurring
charges for the three months ended March 31, 2002:

(In thousands)

Balance at December 31, 2001 ............ $1,123

Less: Amounts utilized ................. (209)
-----------

Balance at March 31, 2002 ............... $914
===========

6. LONG TERM DEBT

The Company has a $10.0 million line of credit agreement. The agreement contains
several covenants, including the Company maintaining certain levels of financial
performance and capital structure. These financial covenants include a
requirement for a current ratio of at least 1.5 to 1.0 and a leverage ratio of
no more than 1.0 to 1.0. In addition, there are certain negative covenants that
include limitations on the Company's capital and other expenditures,
restrictions on the Company's capacity to obtain additional debt financing,
restrictions on the disposition of the Company's assets, and restrictions on its
investment portfolio. The line of credit matures on June 30, 2002, and as of
March 31, 2002 the Company had $4.2 million outstanding under this line.
Management of the Company and its bank have mutually agreed to the terms of a
renegotiated line of credit. The final agreement is pending approval from the
Company's board of directors.

7. GOODWILL AND INTANGIBLES

During the first quarter of 2002, the Company recorded intangible assets related
to provider agreements entered into with community hospitals ("customer") for
conversion to services provided by the Company. The intangible assets related to
these agreements consist of the cost of purchasing the rights to service and/or
manage the personal response systems program located in various stand-alone
facilities. These agreements allow the Company to provide monitoring and/or
business support services to existing and future subscribers of the customer in
accordance with the terms of the agreements. The Company amortizes the
acquisition costs over the initial life of the agreements, which is typically
five years.

In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations."
SFAS 141 requires the purchase method of accounting for business combinations
initiated after June 30, 2001 and eliminates the pooling-of-interests method.
The Company adopted SFAS 141 in the first quarter of 2002 and it did not have an
impact on its financial statements.

-9-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

7. GOODWILL AND INTANGIBLES (continued)

In July 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets", which was effective January 1, 2002. SFAS 142 requires, among other
things, the discontinuance of goodwill amortization. In addition, the standard
includes provisions for the reclassification of certain existing recognized
intangibles as goodwill, reassessment of the useful lives of existing recognized
intangibles, reclassification of certain intangibles out of previously reported
goodwill and the identification of reporting units for purposes of assessing
potential future impairments of goodwill. SFAS 142 also requires the Company to
complete a transitional goodwill impairment test within six months from the date
of adoption. The Company adopted SFAS 142 in the first quarter of 2002, and as a
result did not record approximately $200,000 of goodwill amortization expense as
compared to the first quarter of 2001. The Company believes that the adoption of
SFAS 142 will result in an additional 1% improvement to service margins in 2002
as a result of the exclusion of nearly $820,000 of goodwill amortization
expense.

In accordance with SFAS 142, the Company ceased amortizing goodwill with a net
carrying value totaling approximately $7.2 million as of the date of adoption.
The Company performed a transitional impairment test as required by SFAS 142 and
determined that there were no goodwill or intangible asset impairment losses
that should be recognized. The Company also determined that no reclassifications
between goodwill and intangible assets were required. Information pertaining to
intangible assets and goodwill and the effects of adopting SFAS 142 are
presented below.

Intangible Assets
At March 31, 2002 and December 31, 2001, acquired intangible assets were related
to provider agreements entered into with customers for conversion to services
provided by the Company:

(Dollars in thousands)

March 31, December 31,
2002 2001
-------------------------

Gross carrying amount .................... $10,624 $10,566
Less: accumulated amortization .......... (4,670) (4,152)
-------------------------
Net book value ........................... $5,954 $ 6,414
=========================

All of the Company's acquired intangible assets are subject to amortization.
Amortization expense for acquired intangible assets for the three months ended
March 31, 2002 and 2001 was approximately $516,000 and $482,000 respectively.

-10-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

7. GOODWILL AND INTANGIBLES (continued)

Estimated amortization expense for the current fiscal year and the succeeding
four years is as follows:

Fiscal Year Ended
December 31, Amount
------------- ------
2002 ................................ $1,990
2003 ................................ 1,939
2004 ................................ 1,376
2005 ................................ 480
2006 ................................ 121

Goodwill
The following information reflects pro forma adjustments to exclude goodwill
amortization expense and related tax effects:

For the three months
(Dollars in thousands, except per share data) ended March 31,
------------- -------------

2002 2001
---- ----
Net income:
Reported net income ...................................... $1,521 $1,118
Add back: goodwill amortization, net of taxes ........... -- 121
------------- --------------

Adjusted net income ...................................... $1,521 $1,239
============= ==============

Basic earnings per share:
Weighted average common shares outstanding ............... 6,361 6,047
Reported net income ...................................... $0.24 $0.18
Add back: goodwill amortization, net of taxes ........... -- 0.02
------------- --------------
Adjusted net income ...................................... $0.24 $0.20
============= ==============

Diluted earnings per share:
Total weighted average shares ............................ 6,709 6,307
Reported net income ...................................... $0.23 $0.18
Add back: goodwill amortization, net of taxes ........... -- 0.02
------------- --------------
Adjusted net income ...................................... $0.23 $0.20
============= ==============

8. NEWLY ISSUED ACCOUNTING STANDARDS

In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS 144 supercedes FASB Statement No. 121,
"Accounting for the

-11-

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (continued)

8. NEWLY ISSUED ACCOUNTING STANDARDS (continued)

Impairment of Long-Lived Assets and for Long Lived Assets to Be Disposed Of."
SFAS 144 applies to all long-lived assets (including discontinued operations)
and consequently amends Accounting Principles Board Opinion No. 30, "Reporting
Results of Operations - Reporting the Effects of Disposal of a Segment of a
Business." SFAS 144 is effective for financial statements issued for fiscal
years beginning after December 15, 2001. The Company adopted SFAS 144 in the
first quarter of 2002 and it did not have a significant impact on its financial
statements.

9. CONTINGENT LIABILITIES AND COMMITMENTS

The Company is currently being audited by Revenue Canada asserting deficiencies
in goods and services tax and sales tax for the Company's 1993 to 1999 tax
years. On March 26, 2002, the Company received a proposed tax assessment, (which
includes penalties and interest), of CAN$1,050,000 (approximately US$658,000
based on current exchange rates at March 31, 2002). The Company believes that it
should be able to reduce the amount of the proposed tax deficiency following
further discussions with and by providing additional documentation to Revenue
Canada. However, there is no assurance that the Company will be successful in
its discussions. The Company does not believe that the payment of any such
deficiency will have a material adverse impact on the Company's financial
position or results of operations or cash flows.

-12-

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND
FINANCIAL CONDITION

This and other reports, proxy statements, and other communications to
stockholders, as well as oral statements by the Company's officers or its
agents, may contain forward-looking statements within the meaning of Section 21E
of the Securities Exchange Act of 1934, as amended, with respect to, among other
things, the Company's future revenues, operating income, or earnings per share.
Without limiting the foregoing, the words "believes," "anticipates," "plans,"
"expects," and similar expressions are intended to identify forward-looking
statements. There are a number of factors of which the Company is aware that may
cause the Company's actual results to vary materially from those forecast or
projected in any such forward-looking statement. These factors include, without
limitation, those set forth below under the caption "Certain Factors That May
Affect Future Results." The Company's failure to successfully address any of
these factors could have a material adverse effect on the Company's future
results of operations.

RESULTS OF OPERATIONS

Total revenues for the quarter ended March 31, 2002 increased nearly 15% to
$24.9 million as compared to total revenues of $21.6 million for the quarter
ended March 31, 2001.

Service revenues, at $18.4 million for the first quarter of 2002, represented
approximately 74% of the Company's first quarter total revenues. This increase,
up from $15.8 million or 73% of total revenues for the first quarter of 2001, is
a result of the Company's continued service offering strategy and includes
revenue generated by the acquisition of certain assets of SOS Industries, Inc.,
which the Company acquired in April 2001. Overall, the Company achieved a 9%
increase in its monitored subscriber base to 349,000 subscribers as of March 31,
2002 of which approximately 9,500 subscribers were the initial result of the SOS
acquisition. The Company believes that the growth in the number of subscribers
was negatively impacted by the previously disclosed battery-related issue in
some of its personal help buttons, however it also believes that it has overcome
the worst of this negative impact. The Company's ability to sustain the current
level of service revenue growth depends on its ability to continue to make
improvements in service delivery, expand the market for its personal response
services, convert community hospital programs to services provided by the
Company and increase its focus on referral development and innovative partner
relationships in new channels of distribution. The Company believes that the
high quality of its services and its commitment to providing caring and rapid
response to the at-risk elderly and the physically challenged will be factors in
meeting this challenge.

Net product revenues for the first quarter of 2002 increased 14% to $6.2 million
from $5.4 million for the same period in 2001. The majority of the increase in
the first quarter was the result of sales of the Company's newly developed
site-monitoring platform for those customers who perform their own monitoring at
their local facilities. However, with a finite number of these types of
customers, the Company believes that equipment sales for the year ended December
31, 2002 may be consistent with or lower than 2001. It also continues to believe
that equipment sales may remain flat or decline in periods subsequent to 2002 as
it has experienced little or no growth in sales of its home communicators since
it began providing its customers' subscribers with the Lifeline service under
its Business Management Services ("BMS") program, which includes monitoring and
the use of Company-owned home communicators for a single fee. However, the
Company believes that the launch of its new Senior Living initiative, under
which the Company will seek to develop alliances

-13-

with senior living facilities to provide them with a cost-effective and
distinctive safety feature to appeal to residents and their families, may
mitigate the decline in product revenue in 2002 and in periods subsequent to
2002.

Finance and rental income, representing income earned from the Company's
portfolio of sales-type leases, decreased by 17% to $311,000 for the three
months ended March 31, 2002 from $373,000 recorded for the same period in the
previous year. With the Company's focus on its service offerings it expects
finance income to decline in future periods because such income is directly
related to product sales.

Total recurring revenues, consisting of service revenues and finance and rental
income, rose to $18.7 million for the three months ended March 31, 2002 from
$16.2 million for the same period in 2001. Recurring revenues represented 75% of
total revenue in both periods. With the Company's continued focus on its service
offerings, it expects its recurring revenues to continue to increase in future
periods.

Cost of services, as a percentage of service revenues, improved 2% to 58% for
the quarter ended March 31, 2002 as compared to 60% for the three months ended
March 31, 2001. The improvement is equally attributable to the Company's goal of
making its service offerings more profitable with productivity improvements,
leveraging the capabilities of the CareSystem monitoring platform and effective
pricing and to the adoption of SFAS 142 which resulted in the Company not
recording approximately $200,000 of goodwill amortization expense in the first
quarter of 2002 as compared to the same period in the prior year. On a dollar
basis, cost of services increased $1.1 million to $10.6 million from $9.5
million from the comparable prior period as a result of the following factors.
The growth in the number of subscribers serviced under the Company's BMS program
resulted in an increase in depreciation of the cost of home communicators
provided to those subscribers served under this model. The Company incurred
operational costs associated with the acquisition of SOS Industries, Inc. during
the first quarter of 2002 that it did not have for the same period in 2001.
Depreciation of the Company's new billing system, which was placed in service in
August 2001, also contributed to the dollar increase.

The Company adopted SFAS 142 in the first quarter of 2002, which requires, among
other things, the discontinuance of goodwill amortization. As noted above the
Company did not record approximately $200,000 of goodwill amortization expense
as compared to the first quarter of 2001. The Company believes that the adoption
of SFAS 142 will result in an additional 1% improvement to service margins in
2002 as a result of the exclusion of nearly $820,000 of goodwill amortization
expense. The Company expects continued positive service margin improvements for
the remainder of 2002.

Cost of sales was 31% of net product sales for the three months ended March 31,
2002 as compared to 35% for the three months ended March 31, 2001. The
improvement can be attributable to efficiencies created by higher than normal
inventory production in anticipation of the Company supporting a manufacturing
site at its corporate location as well achievements in improving its marketing
accessories margins. The Company expects cost of sales for 2002 to be relatively
consistent as a percentage of net product sales with results achieved in 2001.

Selling, general and administrative ("SG&A") expenses as a percentage of total
revenues were 37% for the first quarter of 2002 as compared to 36% for the first
quarter of 2001. First quarter SG&A

-14-

expenditures increased $1.4 million to $9.3 million for the first quarter of
2002 from $7.9 million for the same period in 2001. The Company's increased
expenditures are primarily attributable to a higher level of marketing
initiatives incurred in the first quarter of 2002 as compared to the first
quarter of 2001. The Company also incurred expenditures in the first quarter of
2002 which it did not have in the first quarter of 2001, related to its
commitment to install its new site-monitoring platform for those customers who
perform their own monitoring at their local facilities. As a result of overall
insurance industry increases, the Company is also incurring higher insurance
premiums and deductibles. The Company believes that SG&A expenses could increase
as a percentage of revenue in 2002 as it continues with its business initiatives
and incurs higher insurance premiums and deductibles.

Research and development expenses were nearly 2% of total revenues for the
quarters ended March 31, 2002 and 2001. Research and development efforts are
focused on ongoing product improvements and developments. The Company expects to
maintain these expenses, as a percentage of total revenues, at a relatively
consistent level for the remainder of 2002.

The Company's effective tax rate was 40% for the quarter ended March 31, 2002
as compared to 41% for the three months ended March 31, 2001. The reduction in
the effective tax rate is due to the benefit of a previously disclosed tax
credit earned under a Tax Incrementing Finance agreement with the town of
Framingham, Massachusetts.

LIQUIDITY AND CAPITAL RESOURCES

During the three months ended March 31, 2002, the Company's portfolio of cash
and cash equivalents increased nearly $1.5 million to $7.2 million at March 31,
2002 from $5.7 million at December 31, 2001. The increase was mainly
attributable to profitable operations of $3.9 million, net improvements in its
accounts receivable portfolio of $0.6 million, proceeds from stock option
exercises of $1.0 million and an increase in the Company's income tax liability
of approximately $0.9 million resulting from the timing of its tax payment which
occurred in April 2002. Items that offset the increase in the Company's cash
position were purchases of property and equipment of $1.7 million, payments of
nearly $3.0 million in employee bonuses and the net inventory increase of $0.9
million in the first quarter of 2002 in anticipation of supporting a
manufacturing site at its corporate location and to minimize the risk of supply
interruption during the transition. As a result of its notice of termination of
its contract with its outside electronics product manufacturer, and in
accordance with the terms of the contract, the Company may be obligated to
purchase certain amounts of inventory from the manufacturer. The Company does
not believe that this obligation will have a material adverse effect on its
liquidity, financial condition or results of operations.

The Company is party to Master Lease Agreements for up to $5.6 million for
furniture, computers, security systems and other related equipment purchases.
For financial reporting purposes, these leases are recorded as capital leases
and accordingly the associated assets are being depreciated over their estimated
useful life. As of March 31, 2002 the Company had made purchases of
approximately $5.0 million under these agreements.

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include limitations on the Company's capital and other expenditures,
restrictions on the Company's capacity to obtain additional debt financing,
restrictions on the disposition of the Company's assets, and restrictions on its
investment portfolio. The line of credit matures on June 30, 2002, and as of
March 31, 2002 the Company had $4.2 million outstanding under this line.
Management of the Company and its bank have mutually agreed to the terms of a
renegotiated line of credit. The final agreement is pending approval from the
Company's board of directors.

The following summarizes the Company's contractual obligations at March 31, 2002
and the effect such obligations are expected to have on its liquidity and cash
flows in future periods:

(Dollars in thousands)

2002 2003 2004 2005 2006 Thereafter (1)
---- ---- ---- ---- ---- --------------

Contractual
Obligations:

Long term debt $933 $1,207 $1,113 $723 $530 $-

Capital leases 890 885 458 302 118 11

Operating leases 963 1,222 1,303 1,229 1,126 7,570
--------- -------------- ------------ --------------- ------------ -------------------

Total Obligations $2,786 $3,314 $2,874 $2,254 $1,774 $7,581
========= ============== ============ =============== ============ ===================

(1) The Company has contractual obligations on its corporate facility lease
through the year 2013.

The Company expects that funding requirements for operations and in support of
future growth are expected to be met primarily from operating cash flow,
existing cash and marketable securities and the availability from time to time
under its line of credit. The Company expects these sources will be sufficient
to finance the cash needs of the Company through the next twelve months. This
includes the continued investment in its response center platform, the
requirements of its internally funded lease financing program, any future
potential acquisitions and other investments in support of its current business.

CRITICAL ACCOUNTING POLICIES

The discussion and analysis of financial condition and results of operations are
based upon the Company's consolidated financial statements. The preparation of
these consolidated financial statements requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those estimates. The Company
has identified the following accounting policies as critical to understanding
the preparation of its consolidated financial statements and results of
operations.

Revenue recognition
Service revenues, associated primarily with providing monitoring services under
the Company's Lifeline Monitoring Services ("LMS") and Business Management
Services ("BMS") programs, are recognized in the period the service is provided.
Deferred revenue represents billings to customers

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for annual service contracts for which revenue has not been recognized because
the service has not yet been provided. Service revenues are then recognized
ratably over the contractual period. Product revenues from the sale of personal
response products are recognized upon shipment. While the Company does not have
a specific right of return policy, it does record a provision for an estimated
amount of future returns based on historical experience and any notification
received of an error in type of product shipped. Such returns have historically
been immaterial to the Company's total product revenue, and the Company does not
foresee any change that could have a material adverse effect on the Company's
operating results for the period or periods in which such returns materialize.
Finance income attributable to sales-type lease contracts is initially recorded
as unearned income and subsequently recognized under the interest method over
the term of the leases.

Allowance for doubtful accounts
The Company maintains allowances for doubtful accounts for estimated losses
resulting from the inability of its customers to make required payments. It
estimates the allowance based upon historical collection experience, analysis of
accounts receivable by aging categories and customer credit quality. If the
financial condition of the Company's customers were to deteriorate, resulting in
an impairment of their ability to make payments, additional allowances may be
required.

Impairment of long-lived assets, goodwill and other intangibles
The Company assesses the impairment of goodwill and other intangibles on an
annual basis or, along with long-lived assets, whenever events or changes in
circumstances indicate that the carrying value may not be recoverable. It uses
an estimate of the future undiscounted net cash flows of the related asset or
asset grouping over the remaining life in measuring whether assets are
recoverable. Based on the Company's expectation of future undiscounted net cash
flows, an impairment loss would be recorded by writing down the assets to their
estimated realizable values. Any resulting impairment loss could have a material
adverse effect on the Company's results of operations.

Inventories
The Company values its inventories at the lower of cost or market, as determined
by the first-in, first-out method. It regularly reviews inventory quantities on
hand and records a provision for excess or obsolete inventory based upon its
estimated forecast of product demand. If actual future demand is less than the
projections made by management, then additional provisions may be required.

Warranty
The Company's products are generally under warranty against defects in material
and workmanship. The Company provides an accrual for estimated warranty costs at
the time of sale of the related products based upon historical return rates and
repair costs at the time of the sale. A significant increase in product return
rates could have a material adverse effect on the Company's results of
operations.

NEWLY ISSUED ACCOUNTING STANDARDS

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In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets." SFAS 144 supercedes FASB Statement No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long Lived Assets to
Be Disposed Of." SFAS 144 applies to all long-lived assets (including
discontinued operations) and consequently amends Accounting Principles Board
Opinion No. 30, "Reporting Results of Operations - Reporting the Effects of
Disposal of a Segment of a Business." SFAS 144 is effective for financial
statements issued for fiscal years beginning after December 15, 2001. The
Company adopted SFAS 144 in the first quarter of 2002 and it did not have a
significant impact on its financial statements.

CERTAIN FACTORS THAT MAY AFFECT FUTURE RESULTS

The following important factors, among others, could cause actual results to
differ materially from those indicated by forward-looking statements made in
this Quarterly Report on Form 10-Q and presented elsewhere by management from
time to time.

The Company completed the transition of its United States subscribers to its
CareSystem call center platform during 1999. There can be no assurance that the
Company will realize the productivity improvements and other intended benefits
from CareSystem to justify the Company's investment.

The Company recorded a non-recurring charge of approximately $2.7 million in the
third quarter of 2000 for costs it expected to incur to address a previously
disclosed battery-related issue, including anticipated material and mailing
costs for exchanging buttons, providing hospital programs with higher inventory
levels for the planned swap, and support for the cost of installer visits to
subscriber homes to replace the button. The Company cannot be certain that the
charge it recorded to address this issue will be sufficient to cover all of its
associated expenses. In addition, the Company has changed its battery vendor.
The Company cannot be certain that it will not experience disruption related to
such change.

Beginning in the second quarter of 2002 the Company has once again developed a
manufacturing site at its corporate location to assemble its personal response
equipment. In connection with the implementation of this site, the Company ended
its outsourcing arrangement with an outside electronics product manufacturer.
The Company has not supported a manufacturing site for the past two years and as
a result there can be no assurance that the transition from outsourced
manufacturing to internal manufacturing for its personal response equipment will
not have a negative adverse effect on its results of operations or that the
Company will not experience difficulties in successfully transitioning the
assembly process of its personal response equipment to its corporate location.

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There also can be no assurance that the decision to assemble its equipment will
result in the anticipated cost containment or that the Company will maintain
cost of sales at a relatively consistent percentage of product sales in 2002.
This could have a material adverse effect on the Company's business, financial
condition, or results of operations.

The Company's results are partially dependent on its ability to develop services
and products that keep pace with continuing technological changes, evolving
industry standards, changing subscriber preferences and new service and product
introductions by the Company's competitors. There can be no assurance that
services, products or technologies developed by others will not render
Lifeline's services or products noncompetitive or obsolete.

The Company's revenue growth is partially dependent on its ability to increase
the number of subscribers served by its monitoring centers by an amount which
exceeds the number of subscribers lost. The Company's ability to continue to
increase service revenue is a key factor in its long-term growth, and there can
be no assurance that the Company will be able to do so. The Company's failure to
increase service revenue could have a material adverse effect on the Company's
business, financial condition, or results of operations.

The Company's monitoring operations are concentrated principally in its
corporate headquarters facility. Although the Company believes that it has
constructed safeguards to protect against system failures, the disruption of
service at its monitoring facility, whether due to telephone or electrical
failures, earthquakes, fire, weather or other similar events or for any other
reason, could have a material adverse effect on the Company's business,
financial condition, or results of operations.

The Company believes that its future success will depend in large part upon its
ability to attract and retain key personnel. Although the Company believes it is
making progress in retaining and recruiting well-trained, highly capable people,
there can be no assurance that the Company will continue to be successful in
attracting and retaining such personnel.

The Company may expand its operations through the acquisition of additional
businesses. There can be no assurance that the Company will be able to identify,
acquire or profitably manage additional businesses or successfully integrate any
acquired businesses into the Company without substantial expenses, delays or
other operational or financial problems. In addition, acquisitions may involve a
number of special risks, including diversion of management's attention, failure
to retain key acquired personnel, unanticipated events, contingent liabilities
and amortization of acquired intangible assets. There can be no assurance that
the acquired businesses, if any, will achieve anticipated revenues or earnings.

ITEM 3 - QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Company has considered the provisions of Financial Reporting Release No. 48
"Disclosure of Accounting Policies for Derivative Financial Instruments and
Derivative Commodity Instruments, and Disclosure of Quantitative and Qualitative
Information about Market Risk Inherent in Derivative Financial Instruments,
Other Financial Instruments and Derivative Commodity Instruments." The Company
had no holdings of derivative financial or commodity-based instruments or other
market risk sensitive instruments entered into for trading purposes at March 31,
2002. As described in the following paragraphs, the Company believes that it
currently has no material exposure to interest rate and foreign currency
exchange rate risks in its instruments entered into for other than trading
purposes.

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Interest rates

The Company's balance sheet includes a revolving credit facility and a term loan
that are subject to interest rate risk. Both loans are priced at floating rates
of interest, with the working capital line of credit being based on LIBOR and
the fixed loan being based on the bank's prime interest rate at the Company's
option. As a result of these factors, at any given time, a change in interest
rates could result in either an increase or decrease in the Company's interest
expense. The Company performed a sensitivity analysis as of March 31, 2002 to
assess the potential effect of a 100 basis point increase or decrease in
interest rates and concluded that near-term changes in interest rates in such
magnitude should not materially affect the Company's consolidated financial
position, results of operations or cash flows.

Foreign currency exchange rates

The Company's earnings are affected by fluctuations in the value of the U.S.
Dollar as compared to the Canadian Dollar, as a result of the sale of its
products and services in Canada and translation adjustments associated with the
conversion of the Company's Canadian subsidiary into the reporting currency
(U.S. Dollar). As such, the Company's exposure to changes in Canadian exchange
rates could impact the Company's consolidated financial position, results of
operations or cash flows. The Company performed a sensitivity analysis as of
March 31, 2002 to assess the potential effect of a 10% increase or decrease in
Canadian foreign exchange rates and concluded that near-term changes in Canadian
exchange rates should not materially affect the Company's consolidated financial
position, results of operations or cash flows. The Company's sensitivity
analysis of the effects of changes in foreign currency exchange rates in such
magnitude did not factor in a potential change in sales levels or local prices
for its services/products.

PART II. OTHER INFORMATION

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

(a) Reports on Form 8-K - No reports on Form 8-K were filed for the three
months ended March 31, 2002.

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LIFELINE SYSTEMS, INC.

SIGNATURES

Pursuant to the requirements of the Securities and Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.

May 10, 2002 LIFELINE SYSTEMS, INC.
------------ ----------------------
Date Registrant

/s/ Ronald Feinstein
------------------------------------
Ronald Feinstein
Chief Executive Officer

/s/ Dennis M. Hurley
------------------------------------
Dennis M. Hurley
Senior Vice President of Finance and
Administration, Principal Financial
and Accounting Officer

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