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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(Mark One)
[X]ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED JUNE 30, 1998
OR
[_]TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE
SECURITIES EXCHANGE ACT OF 1934
COMMISSION FILE NUMBER 1-14502
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HOME SECURITY INTERNATIONAL, INC.
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
DELAWARE 98-0169495
(STATE OR OTHER JURISDICTION OF (I.R.S. EMPLOYER IDENTIFICATION NO.)
INCORPORATION OR ORGANIZATION)
LEVEL 7, 77 PACIFIC HIGHWAY 2060
NORTH SYDNEY, NSW (ZIP CODE)
(ADDRESS OF PRINCIPAL EXECUTIVE
OFFICES)
(011) (612) 9936-2424
(REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE)
SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT: NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: COMMON STOCK,
$.001 PAR VALUE
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to
the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
AGGREGATE MARKET VALUE, AS OF OCTOBER 2, 1998, OF COMMON STOCK HELD BY NON-
AFFILIATES OF THE REGISTRANT: $25,181,281 BASED ON THE LAST REPORTED SALE
PRICE ON THE AMERICAN STOCK EXCHANGE.
NUMBER OF SHARES OF COMMON STOCK OUTSTANDING ON OCTOBER 2, 1998: 5,150,500
SHARES
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant intends to file a definitive Proxy Statement pursuant to
regulation 14A within 120 days after the end of the fiscal year ended June 30,
1998. Portions of such Proxy Statement are incorporated by reference in Part
III of this report.
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PART I
ITEM 1. BUSINESS
OVERVIEW
Home Security International, Inc., a Delaware corporation (the "Company") is
a direct sales company which, through an extensive distributor network (the
"Distributor Network"), sells, installs and services a residential security
alarm system marketed under the tradename SecurityGuard, principally in
Australia and New Zealand, with expanding international operations in Europe,
South Africa and North America. The Company's security system (the
"SecurityGuard System") includes a SecurityGuard alarm, which provides home
protection to a customer's premises through an interior heat sensitive motion
detector, flashing lights, a siren, window decals and a centralized processing
unit ("CPU") with the ability to communicate signals to a central monitoring
station, as well as a smoke alarm/detector, a rechargeable fire extinguisher,
and a fire blanket. In order to capitalize on its base of customers with
installed SecurityGuard Systems (which the Company believes to be
approximately 182,000, based on the number of units sold since the Company's
inception), the Company is continually seeking additional methods of
generating recurring revenue, including the sale of extended warranties to its
customers and the introduction of on-line alarm monitoring services in
Australia and New Zealand in the next twelve months.
The Company was founded by Bradley D. Cooper and commenced business in
Sydney, Australia in 1988. At its inception, the Company sold alarms through
part-time dealers who purchased franchises from the Company. In May 1991, the
Company adopted a more traditional sales structure by shifting to commission-
based compensation for its employees/agents, who were given extensive in-house
sales training. Although this approach allowed the Company to expand and
establish an office in Melbourne, Australia and to grow to five offices in
Australia within a year and a half, the growth and the income generation of
its sales force plateaued. In response to this development, in early 1993, the
Company implemented the Distributor Network strategy, which converted the
existing Company owned and operated branch offices to independently owned and
operated distribution offices, and converted the Company employed salespersons
to independent distributors responsible for their own costs. The Company
believes that this shift to the Distributor Network strategy is responsible
for the rapid growth in unit sales since that time. Since the first
independent distribution office launched its operations in September 1993, the
Company has grown to a total of sixty-seven distribution offices in Australia
and New Zealand, with an additional eighteen offices in Europe, South Africa
and North America.
In 1990 50% of the Company was sold to FAI Insurances Limited ("FAI
Insurances") and the remaining 50% was sold to FAI Insurances in a series of
transactions during 1994 and 1995. In November 1995, FAI Insurances sold the
home security operations of the Company outside Australia and New Zealand (the
"International Assets") to Bradley Cooper.
On March 31, 1997, FAI Insurances Limited ("FAI Insurances") acquired the
home security operations of the Company outside Australia and New Zealand (the
"International Assets") from Mr. Cooper. Thereafter, on June 30, 1997, the
Company acquired from FAI Insurances (i) the Australian and New Zealand
security alarm operations ("Australia and New Zealand Operations") of FAI
Insurances and (ii) the International Assets (collectively, the
"Reorganization"), and thereby began operations as a Delaware corporation.
Following the Reorganization, in July 1997 the Company completed an initial
public offering (the "IPO") of its common stock, $.001 par value per share
(the "Common Stock"). On July 20, 1998 the Company filed a registration
statement with the Securities and Exchange Commission (the "Commission") in
order to offer an additional 1,300,000 shares of Common Stock to the public
(the "Offering"). In light of recent conditions in the securities markets, the
Company is unsure of the timing or feasibility of such an Offering.
SECURITY ALARM INDUSTRY
According to the IBIS Information Service Report on the Security and
Investigative Services L7864, printed April 14, 1997 (the "IBIS Report") the
security alarm industry in Australia derives 90% of its revenue from
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businesses and 10% from households, and is concentrated among four companies,
including the Company, Brambles Industries Ltd., Chubb Security Holdings
Australia Ltd. and Tempo Services Ltd., who account for approximately 68% of
the market. The IBIS Report indicated that gross sales for the entire industry
for 1995-1996 were AUD $866 million and that the real rate of growth during
that year was estimated at 3.5%. The Company's management believes that growth
in the residential security alarm industry is attributable to a number of
factors. First, it appears that media coverage of crime, along with political
discussions concerning its causes and remedies, have increased public
consciousness of crime. Second, a number of insurance companies offer premium
discounts to customers with security and fire detection systems or require
their customers to maintain such systems as a condition of coverage. Third,
the worldwide residential market for security alarms remains relatively
unpenetrated. Fourth, there is an industry trend toward reducing installation
costs to increase affordability.
The Company believes that the security alarm services industry is
characterized by the following attributes:
High Degree of Fragmentation. Although residential security alarm
services in Australia, New Zealand and worldwide are consolidating, the
industry remains highly fragmented, consisting of major international
companies and a large number of local and regional companies within each
geographic market. The fragmented nature of the industry can be attributed
to the low capital requirements associated with performing basic
installation and maintenance of security alarm systems. However, the
business of a full service, integrated security services company providing
central station monitoring services is capital intensive, and the Company
believes that the high fixed costs of establishing both central monitoring
stations and full service operations contribute to the small number of
national competitors in each international market.
Continued Product Diversification and Integration of Services. The
products and services marketed in the residential security alarm industry
range from alarm systems that provide basic intrusion and fire detection to
sophisticated systems incorporating features such as closed circuit
television and access control. A recent trend in the residential security
alarm industry has been increased integration of different types of
products into single systems provided by single vendors. The Company
believes that this trend is a result of the need for enhanced security
services on a more cost-effective basis. Whereas basic alarm systems were
once adequate for many businesses and homes, it appears that many consumers
now demand remote control access and monitoring integrated into a single
system to provide for their overall security needs. A security alarm system
which provides burglar and fire alarm monitoring and remote control, all
integrated into one central system, not only provides enhanced security
services, but also is more cost-effective than separate systems installed
by separate vendors. Accordingly, the Company is aggressively positioning
itself to take advantage of this trend by expanding the services offered to
its customers to include 24-hour monitoring services. In this environment,
the Company believes that it can gain a competitive advantage over smaller
companies in the industry that do not have the infrastructure or the
expertise to support the larger and more sophisticated integrated systems.
Advances in Digital Communications Technology. Alarm systems use either
hardwired or wireless technology for systems installed on subscribers'
premises and may include digital, multiplex and wireless (radio)
technologies for the transmission of alarm signals to a central monitoring
center. Prior to the development of digital communications technology,
alarm monitoring required a dedicated telephone line, which made long-
distance monitoring uneconomic. Consequently, alarm monitoring companies
were required to maintain a large number of geographically dispersed
monitoring stations in order to achieve a national or regional presence.
The development of digital communications technology eliminated the need
for dedicated telephone lines, reducing the cost of monitoring services to
the subscriber and permitting the monitoring of subscriber accounts over a
wide geographic area from a central monitoring station. The elimination of
local monitoring stations has not only decreased the cost of providing
alarm monitoring services, it has also substantially increased the
economies of scale for larger alarm service companies. In addition, the
concurrent development of microprocessor-based control panels has
substantially reduced the cost of the subscriber equipment available to
consumers in the residential and commercial markets and has substantially
reduced service costs because many diagnostic and maintenance functions can
be performed from a vendor's office without sending a technician to the
customer's premises.
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STRATEGY
The Company expects to increase sales by continuing to focus its sales
efforts on markets underserved by the security alarm industry, by increasing
the size of the Distributor Network in those countries in which it now
operates and by initiating the Distributor Network in new international
markets. The Company also expects to generate sources of recurring revenue by
offering its existing base of customers with installed alarms security related
services, such as extended warranties and on-line monitoring services. The
Company is also seeking to become more efficient and cost-effective by taking
advantage of the increased economies of scale afforded by its growth and
through the integration of its strategic acquisitions, which should allow the
Company to realize increased profits. Each of the key elements of the
Company's growth strategy is discussed below.
Focus on Underserved Markets. The Company's sales and marketing efforts are
focused on demographic groups which have traditionally been underserved by the
security alarm industry. The Company aggressively markets its products to
middle income families and retired persons in contrast to a majority of its
competitors, which tend to focus their attention on the upper middle class
market. The Company believes that by focusing its marketing on the underserved
markets it currently serves, the Company will continue to reach a customer
base which has been historically ignored by the security alarm industry.
Increased Penetration of Existing Geographic Markets. The Company believes
that its success is directly related to its increased penetration of existing
geographic markets. By actively expanding the Distributor Network in existing
geographic markets via increasing the number of independent sales agents and
distributors in those areas, the Company believes that it will be able to
increase account density in those regions and thereby enhance the efficiency
of its operations and its distributors. By increasing sales in a given area,
the Company believes that it achieves increased operating efficiencies
associated with providing its 24 hour emergency response services and warranty
maintenance. Also by increasing the number of SecurityGuard System
installations in each distributor area in which it has already secured
customers, it will be able to provide monitoring to its customers at a lower
marginal cost. Additionally, as the Company penetrates a new market it
develops a reputation for providing quality products and superior customer
service, which enhances community awareness of the Company. The Company
believes this increased community awareness is important to its ability to
generate high quality sales leads.
International Expansion. The Company is committed to actively expanding its
international operations and is placing greater emphasis on those operations
as a significant source of future growth. The Company intends to expand its
international operations via the controlled growth model it employed to
successfully grow its Australian and New Zealand operations. The Company's
strategy is to develop a limited number of distribution offices in each new
market it enters while learning the intricacies and nuances of selling to such
market before aggressively expanding its distributor base within that market.
This plan will be implemented by the Company's existing senior management
team, who will spend extended periods of time in markets targeted for
expansion in order to more effectively direct the growth of the international
operations. After targeting a region for expansion, the Company generally
appoints a limited number of Distributors for that region. These Distributors
are responsible for establishing operations in the designated region and
report directly to the Company's head office in Australia. Prior to
appointment in a new market, each new Distributor must successfully complete
an intensive twelve week training program at the Company's offices in
Australia. The Distributors bear all costs of commencing operations in their
respective markets, other than initial recruitment and product approval
expenses.
Additional Services and Recurring Revenue. The Company continually seeks to
generate additional and recurring revenue from its existing base of customers
with previously installed SecurityGuard Systems (which the Company believes to
be approximately 182,000, based on the number of units sold since the
Company's inception). To this end, the Company currently sells extended
warranties to its customers (to supplement the one year limited warranty which
accompanies the sale of the SecurityGuard System) and intends to offer online
security alarm monitoring services to its customers in Australia and New
Zealand within the next twelve months. The Company currently offers, as part
of the SecurityGuard System, twenty-four hour emergency response services,
which is provided by local security patrol persons upon telephonic
notification that an alarm has
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sounded. In May 1998 the Company began offering on-line monitoring services on
a limited basis to its customers in South Africa and intends to offer on-line
monitoring in other markets when the Company's base of customers with
installed SecurityGuard Systems in any such region is sufficient to support
such an operation.
Vertical Integration. In order to enhance sales and improve operating
efficiencies and margins, the Company in December 1997 closed one strategic
acquisition, whereby it acquired a 50% interest in FAI Finance Corporation Pty
Ltd ("FFC"), a consumer finance company primarily in the business of financing
purchases of the SecurityGuard System in Australia and New Zealand (the "FFC
Transaction"), and in July 1998, the Company announced its intention to close
a second strategic acquisition, whereby it will acquire a 75% interest in Ness
Security Products Pty Ltd ("Ness"), which manufactures the SecurityGuard alarm
(the "Ness Transaction"). Pursuant to the FFC Transaction, the Company
acquired a 50% equity interest in FFC, a consumer business finance company
operating in Australia and New Zealand, along with an option (the "FCC
Option"), at no additional cost, exercisable within four years of the date of
the FFC Transaction, to purchase the remaining 50% equity interest in FFC from
FAI Insurances, for the same consideration plus 50% of the net change in FFC's
retained earnings from the date of the FFC Transaction until the date the FFC
Option is exercised. FFC was originally founded primarily to provide financing
for the Company's security alarm sales, particularly for those consumers not
normally serviced by traditional financing companies, such as retired persons
and renters. Although for the fiscal year ended June 30, 1998, approximately
80% of the principal amount of all consumer loans made by FFC were made to
finance SecurityGuard System purchases in Australia and New Zealand, in recent
years FFC has begun diversifying its products and services to become less
dependent on the Company as a source of business. The acquisition of FFC by
the Company helps ensure that the operations of FFC will continue to primarily
serve the Company's interests. In addition, the Company believes the FFC
Transaction is critical to the future growth of the Company because it reduces
an operational risk by ensuring the availability of credit to purchasers of
the SecurityGuard System in Australia and New Zealand, of whom, during the
fiscal year ended June 30, 1998, approximately 75% of purchases of the
SecurityGuard System in Australia and New Zealand were financed (and
approximately 74% of those purchases were financed by FFC). It is also
anticipated that FFC will market additional products and services to the
Company's customers as a way for FFC to generate additional revenue. See
"Business--Strategic Acquisitions."
The Company also intends to acquire a 75% interest in Ness, the manufacturer
of the SecurityGuard alarm. Ness is a leading designer and manufacturer of
security and safety related products within Australia. Sales of the
SecurityGuard alarm to the Company represented approximately 77% of Ness'
sales during the fiscal year ended June 30, 1998, which has resulted in
attempts by Ness to diversify its product line and thereby increase sales to
other companies. Consummating the Ness Transaction ensures that the business
operations of Ness will be primarily focused on serving the interests of the
Company. The acquisition of Ness will also reduce certain operational risks by
affording the Company better control over production times and schedules,
which have become more important in light of the greater lead times required
to ensure timely delivery of the Company's products in international markets.
The Company also believes it will be able to reduce the manufacturing cost of
the SecurityGuard alarm by more effectively negotiating with Ness' suppliers.
Furthermore, the Company will effectively achieve a higher profit margin on
the sale of the SecurityGuard System by recovering in income 75% of the price
mark-up currently charged by Ness to the Company. Ness also has an award
winning research and development staff which will facilitate the development
of enhancements to the SecurityGuard System, including a dialer to assist the
Company in providing future on-line monitoring services to its existing base
of customers. See "Business--Strategic Acquisitions."
GEOGRAPHIC OPERATIONS
The Company has been actively selling SecurityGuard Systems for
approximately eight years in Australia and New Zealand and believes it is one
of the fastest growing residential security alarm businesses in the market.
Currently there are fifty-five distributor offices in Australia and twelve
distributor offices in New Zealand. The Company has experienced significant
increases in unit sales of alarm systems in Australia and New Zealand over the
past five fiscal years. Unit sales in Australia and New Zealand have increased
from 12,235 units in fiscal year 1994 to 50,081 units in fiscal year 1998.
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Although the Company's principal operations are concentrated in Australia
and New Zealand, it conducts operations throughout the world. Accordingly, the
Company's financial performance could be adversely affected by fluctuations in
currency exchange rates as well as changes in duty rates. Furthermore, as the
Company reports its financial results in U.S. dollars, a significant movement
in the value of the U.S. dollar against certain international currencies,
particularly the Australian dollar ("AUD"), could have a material adverse
effect on the Company's reported financial position and results of operations.
The AUD has declined in value relative to the U.S. dollar from .7452 on July
1, 1997 to .6192 on June 30, 1998 and as of September 25, 1998 was valued at
.5911 as compared to the U.S. dollar.
The Company is actively expanding its international operations and is
placing increasing importance on those operations as a significant source of
future growth. The Company believes that the characteristics and growth of the
Australian and New Zealand markets are representative of the conditions that
exist in the other countries in which the Company operates or plans to
commence operations. The Company currently maintains a total of twenty-four
international distributor offices located in Belgium (one), Canada (two),
Germany (five), the Netherlands (five), South Africa (one), the United Kingdom
(seven) and the United States (three). Of the twenty-four international
offices, sixteen have been opened since July 1, 1997; one in South Africa, two
in the United States, five in the United Kingdom, four in Germany and four in
the Netherlands. Unit sales for the international markets have increased from
1,157 units in fiscal year 1995 to 7,508 units in fiscal year 1998. See "Home
Security International, Inc.--Notes to Consolidated Financial Statements, Note
13" for a more detailed discussion of the Company's operation split by
geographic location.
Over the next two years the Company intends to continue its international
expansion by adding distribution offices in established markets and entering
new markets. The planned international expansion efforts outside Australia and
New Zealand may cause an increase in expenses from time to time, without
necessarily generating a corresponding increase in revenue. Additionally, the
lack of availability of financing in new regions could significantly impact
the successful expansion of the Company's operations. See "Risk Factors--Risk
of International Expansion"; "Risk Factors--Dependence on Consumer Financing."
There can be no assurance that the success of the Distributor Network and
corresponding operating results in Australia and New Zealand can be replicated
throughout the world.
THE SECURITYGUARD SYSTEM
The Company's SecurityGuard alarm was designed and developed by Ness and is
a two time winner of the prestigious Australian Design Award (1992 and 1996)
and a winner of the Australian Design Mark (1996). The Australian Design Mark
and the Australian Design Award are awarded by Standards Australia, an
independent not-for-profit organization which utilizes industry and design
experts to evaluate products for excellence. To attain the Australian Design
Mark, a product must achieve excellence in four key areas: (i) the design
process; (ii) the product; (iii) the manufacture of the product; and (iv) the
product lifecycle. Generally, a product must first achieve the Australian
Design Mark to be eligible to receive the Australian Design Award. In special
circumstances products that are innovative and original in design can achieve
the Australian Design Award without first receiving the Australian Design
Mark. Due to its innovative design, in 1992 the SecurityGuard alarm received
the Australian Design Award prior to receiving the Australian Design Mark. In
1996, the SecurityGuard alarm was only one of 37 products to achieve the
Australian Design Mark, and thereafter was only one of eight products to
achieve Australian Design Award status in that year.
The basic SecurityGuard alarm provides protection for two openings to the
premises through interior heat sensitive motion detectors, a siren, flashing
lights, window decals and a CPU with the ability to communicate signals to the
Company's proposed central monitoring station. In addition to the
SecurityGuard alarm, as part of the SecurityGuard System, the Company provides
the customer with a smoke alarm/detector, a fire extinguisher and a fire
blanket. The Company's smoke alarm/detector features dual ionization chambers
to limit false alarms, incorporates low battery warning beeps and when
triggered, emits a loud persistent siren noise in the high frequency range of
the audible sound spectrum. Smoke alarm/detectors are recommended by all fire
and emergency services, and are now compulsory in new homes in certain areas.
Customers have the option of adding sirens and motion detectors and increasing
fire protection by means of additional smoke and heat detectors and
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alarms. The SecurityGuard System also features the ability to arm and disarm
the alarm via a wireless remote control device which also acts as a "panic
button". The remote control feature of the SecurityGuard System helps
differentiate the Company's alarm from those of its competitors whose alarm
systems generally require the input of a security code to arm and disarm the
alarm. Also included within the cost of each SecurityGuard System is a one
year limited warranty on system parts and a one year limited warranty on
labor.
The SecurityGuard alarm is molded in an extruded polycarbonate casing and
features double soldered circuitry, a sealed independent power source, battery
back up and automatic testing of battery power supply. It is radio controlled
with access through a radio transmitted, sixteen digit, binary code bit
stream. It has a security key override switch, and a 120 decibel (at 1 meter)
horn speaker installed within the alarm, plus an external siren and blue
flashing strobe light. The alarm features infra-red detection cells that
respond effectively to body temperature, remote controls and a tuner set to
optimum range, signal and strength. The alarm's volume is deliberately set at
a level that causes extreme discomfort to human beings and should result in
the invader leaving the premises. In addition, the volume of the alarm is
sufficient to alert not just the home's residents, but also their neighbors,
increasing the likelihood that the invader will be seen and apprehended. The
alarm reacts instantaneously on detecting an intruder, reducing the intruder's
ability to search for or remove valuables. Unlike silent alarms, which are
linked to police stations or other patrols, the SecurityGuard System's
immediate shrill alarm does not furnish the home invader with a pre-
established or known response time. The design of the SecurityGuard alarm is
not intended to assist in catching intruders, but to prevent protected homes
from being burglarized or invaded and to minimize losses if they are invaded.
The SecurityGuard System complies with the relevant Australian/NZ Standards
for alarm system manufacture, AS2201.1/5. The system carries guarantees of
quality and service on terms and conditions comparable to others in the
industry.
The SecurityGuard System installed by the Company is a wireless alarm
system, which uses radio signals from transmitters incorporated into the
protective devices to communicate activation signals from such devices to the
customer's CPU. By comparison, hard-wire devices, which are characterized by
substantially higher initial costs to the customer, use actual wires to
connect each of the protective devices to the customer's CPU. Wireless devices
can generally be installed more simply and quickly than those that require
alarm wiring, thus reducing labor costs. In addition, wireless devices are
also easy to remove and reinstall when a customer relocates to a new
residence.
SERVICES
24 Hour Emergency Response Services; On-line Monitoring. The Company
currently offers twenty-four hour emergency response service to its customers
as part of its SecurityGuard System for five years from the date of
installation. As part of this service the Company contracts with local
security patrol services to send personnel to a residence upon telephonic
notification that an alarm has sounded. In addition, the Company intends to
market twenty-four hour on-line monitoring services to all of its Australian
and New Zealand customers within the next twelve months and began providing
(on a limited basis) twenty-four hour on-line monitoring to its South African
customers in May 1998. Initially, the Company intends to outsource the
monitoring in Australia and New Zealand to a central station in Sydney,
Australia that utilizes advanced communications and computer systems to route
incoming alarm signals and telephone calls to operators. The Company intends
to begin construction of its own central monitoring station in Sydney,
Australia in March 1999. Monitoring stations in each of the Company's
international markets will be established as its installed base in such market
is sufficient to support such an operation. Depending on the type of service
chosen by the customer, central monitoring personnel will respond to alarms by
relaying information to local security patrols or police departments,
notifying the customer or taking other appropriate action. Non-emergency
administrative signals will include power failures, low battery signals,
deactivation and reactivation of the alarm monitoring system, and test
signals, and will be processed automatically by central monitoring station
computers.
Extended Warranty. In September 1996, the Company commenced offering an
extended warranty program to its customers in Australia and New Zealand, which
offers the opportunity to extend the original manufacturers product warranty
of twelve months by an additional twelve or twenty-four months. The cost of
the extended
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warranty to the customer is AUD $99 for twelve months and AUD $169 for twenty-
four months. The extended warranty contract covers all costs of repairs during
the contract period. From the time the Company commenced its extended warranty
program through June 30, 1998 it had entered into 17,252 extended warranty
contracts. The percentage of contracts divided between twelve and twenty-four-
month contracts were 38% and 62% respectively. The income derived from the
sale of extended warranty contracts is recognized proportionately over the
period of each contract.
Installation And Field Services. Each distribution office is required by the
Company to maintain its own installation and field service personnel.
Distributors subcontract services and installation to third parties who are
trained by the Company to install and maintain the SecurityGuard System.
Installations of new systems are performed promptly, without charge, after the
completion of the sale. After completing an installation, the technician
instructs the customer on the use of the system and furnishes a written manual
and, in many instances, an instructional video. In order to demonstrate its
commitment to customer service the Company also requires each technician to
clean up all debris caused by the installation of the system before completing
the installation, as well as offering to perform any other minor maintenance
work for the customer. Additional follow-up instruction is provided by
"Independent Agents" (See "Business--Distributor Network") as needed. As the
density of the Company's customer base increases, the Company will be able to
more efficiently schedule and route field service technicians. The increased
efficiency in scheduling and routing also allows the Company to provide faster
field service response and support, which leads to a higher level of customer
satisfaction.
SALES AND MARKETING
The Company's business success is dependent upon the continued successful
implementation of its "Direct Sales Marketing Program" by its Distributor
Network. The Direct Sales Marketing Program is a systematic approach to
selling the SecurityGuard System through low cost lead generation,
telemarketing and in home sales appointments. The program focus is on middle
income families and retirees, a market which the Company believes has been
historically underserved by the security alarm industry. Sales leads are
generated using various methods, including referrals from in home sales
appointments, shopping center "drop box" promotions and the collection of
crime awareness and fire safety surveys conducted in shopping malls and in
targeted neighborhoods. These leads are then utilized by telemarketers to set
up in home sales appointments, during which the sales representatives make a
crime awareness and fire safety presentation and then demonstrate the
functionality of the SecurityGuard System. In order to increase the
effectiveness of its Direct Sales Marketing Program, the Company requires
participants in its Distributor Network to regularly participate in
comprehensive training seminars developed by the Company relating to all
aspects of its Direct Sales Marketing Program. The Company believes that its
Direct Sales Marketing Program represents a competitive advantage over other
security alarm companies.
The Distributor Network is responsible for all marketing of the
SecurityGuard System. The Company does not generally use media advertising to
promote the SecurityGuard System; instead, it relies on the Independent Agents
to generate leads. The Independent Agents solicit sales leads from every in-
home appointment, as well as through shopping mall "drop box" promotions and
the collection of crime awareness and fire safety surveys. In exchange for
completing a survey or participating in a promotion, individuals are given a
chance to win a free SecurityGuard System. Telemarketers contact individuals
who respond to these efforts and make appointments for home visits by
Independent Agents. Each individual who hosts an in-home sales appointment,
regardless of whether the individual makes a purchase, receives a valuables
register, a book containing crime, fire and general home safety tips and a
personal attack alarm. During the in home presentation, the Independent Agents
present a mounted display of the alarm and related equipment and describe
their features. Furthermore, the Independent Agents use the in-home
presentation to educate the consumer with regard to the crime level of the
area and the utility of the SecurityGuard System in dealing with crime and in
reducing danger and losses to the property.
The Company believes the utilization of these selling methods is an
effective means of generating quality leads and a high frequency of in-home
sales appointments from such leads. By focusing on persons who
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participate in its promotions and surveys, and confirming the individuals'
continued interest through follow-up telephone contact to arrange in-home
appointments, the Distributor Network identifies those persons most likely to
respond favorably to its sales efforts. This has led to sales rates from home
visits which are much higher than for companies which rely on random door to
door sales. The Company also believes that by making sales to multiple homes
in a neighborhood and increasing crime awareness in the neighborhood, crime
prevention synergies and additional sales opportunities are achieved as
neighbors begin to work together to minimize crime. While the Company's sales
approach relies on an emotional response from the potential customer, the
Company maintains an active training and compliance program to deter abusive
sales practices and to ensure that the Independent Agents do not use a high-
pressure approach to increase unit sales.
The Company's sales and marketing approach stresses three aspects of the
SecurityGuard System: deterrence, detection and ejection. The Company believes
that the mere existence of a security alarm system in a home deters burglars
and home invaders from attempting entry. The features of the SecurityGuard
System are aimed at detecting any unauthorized access. Once activated, the
alarm is designed to provoke a quick flight response by the intruder,
preventing a burglary or, at a minimum, minimizing the loss.
Customer Service. In 1995, the Company implemented its "We Care" customer
satisfaction program by recruiting, as its Director of Customer Care and
Compliance, an individual who had previously been a Senior Investigation
Officer of an Australian state government consumer affairs organization. The
We Care program consists of a number of measures intended to maximize customer
satisfaction, including an annual survey of customers, periodic awards to
participants in the Distributor Network who maintain superior customer
satisfaction, and the installation of a toll-free number which customers can
call with any questions or complaints. The We Care program also includes a
total quality management program through which the Company analyzes and
documents all processes critical to customer satisfaction, including sales,
installations, monitoring, billing and customer service. The Company then
implements improvements and continually updates the analysis process.
DISTRIBUTOR NETWORK
The Distributor Network is a structured sales hierarchy of "Independent
Agents", "Area Distributors" and "Distributors" who are compensated solely on
the basis of sales of the Company's SecurityGuard Systems. The Company
believes that it possesses an advantage over other direct sales companies
since advancement through the Distributor Network is based exclusively on the
participant's success in sales of the Company's products, rather than
recruitment of other sales representatives. The Independent Agents, who are
the entry level participants in the Distributor Network, are motivated by an
attractive sales commission structure, as well as the opportunity to become
Area Distributors who own and operate their own distribution business.
Independent Agents are promoted based on a proven ability to sell the
Company's products over a defined period of time. Each Area Distributor
purchases products from the Company for resale to end users through
Independent Agents who operate out of their offices. Successful Area
Distributors, in turn, can become Distributors who earn an override on sales
by the Company made to their attributed Area Distributors as well as
continuing to earn profits on the sales made by their distribution business.
The Company believes that the Distributor Network, in addition to offering a
potential for substantial individual compensation and profit, is an effective
motivational tool which emphasizes peer ranking and recognition in order to
improve sales performance. The Company also believes the Distributor Network
gives it a significant strategic advantage over its competitors by limiting
the capital investment needed to grow the Company, since its Area Distributors
and Distributors are responsible for most costs associated with running their
distribution businesses (including all recruitment, telemarketing and
SecurityGuard System installation costs). The following is a description of
each tier of the Distributor Network.
Level 1--Independent Agent. The majority of the sales personnel within the
Distribution Network are Independent Agents who contract directly with
Distributors and Area Distributors. Independent Agents are compensated solely
by commissions paid by the Area Distributors or Distributors on SecurityGuard
System sales made by the Independent Agent. The Independent Agents primary
responsibilities include the generation of leads
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and the delivery of scripted in home sales presentations to potential
customers. Every prospective Independent Agent starts as an agent in training
and goes through the Company's training program, which includes accompanying
existing Independent Agents on in home sales presentations prior to becoming
an Independent Agent. For an Independent Agent to be promoted to an Area
Distributor he/she is required to achieve a predetermined level of sales over
a specified period and must successfully complete a course in area
distributorship operation. As of June 30, 1998, the Company had 758
Independent Agents (including 164 agents in training and 132 agents in markets
outside of Australia and New Zealand).
Level 2--Area Distributors. Area Distributors sell the SecurityGuard System
to the public utilizing the Independent Agents as their sales representatives.
Area Distributors own and operate their own offices and are responsible for
most costs associated with the implementation of the Direct Sales Marketing
Program within their assigned area, including telemarketing, lead generation
and recruitment. Independent Agents operate from the Area Distributor's
premises and are paid commissions by the Area Distributor based on their sales
of SecurityGuard Systems. The Area Distributors purchase the SecurityGuard
Systems directly from the Company, and their compensation is the profit earned
from the sales of the SecurityGuard Systems less the payment of (i)
commissions to Independent Agents, (ii) the cost of the purchases of the
SecurityGuard System by the Area Distributors and (iii) operating expenses
(including recruiting, telemarketing and installation costs). There is no
limit to the number of Independent Agents that can operate out of an Area
Distributor's office. For Area Distributors to be promoted to Distributors,
they are required to achieve a predetermined level of sales within a specified
period and must successfully complete a course in advanced distributorship
operation. As of June 30, 1998, the Company had fifty-one Area Distributors,
including fifteen in markets outside of Australia and New Zealand.
Level 3--Distributors. Distributors, with support from the Company, are
responsible for ensuring that Independent Agents are motivated and proficient
in all aspects of direct sales by, among other items: (i) ensuring that all
new Independent Agents go through a specified training program which includes
proficiency tests, video taping and "on the job" observation and critical
analysis; (ii) organizing major conferences annually, as well as running
weekly internal training seminars; (iii) professionally videotaping major
training conferences and seminars; (iv) professionally recording
teleconferences of meetings where Distributors discuss topics on business
enhancement, such as lead generation; (v) running reward programs for the
introduction or recruitment of new staff members; and (vi) recognizing and
rewarding other staff for securing new customers. Distributors are compensated
in a manner similar to the Area Distributors, although they may purchase
SecurityGuard Systems from the Company at a slightly lower price per unit than
Area Distributors. In addition to earning profits on sales made by their own
distribution business, Distributors receive a commission override for all
purchases by Area Distributors within the Distributor Network that are
attributed to them by the Company. Independent Agents working under a
Distributor are paid the same commission structure as those working under an
Area Distributor. As of June 30, 1998, the Company had thirty-seven
Distributors, including nine in markets outside of Australia and New Zealand.
Historically, the Company has also utilized "Dealers" to sell the
SecurityGuard System to the public. Dealers operate out of a Distributor's or
an Area Distributor's office, under the supervision of the Distributor or Area
Distributor, as the case may be. Dealers, like Independent Agents, are
compensated solely by commissions on SecurityGuard Systems sold, but earn a
greater proportion of the sales price as commission than that earned by an
Independent Agent. As of June 30, 1998 there were ten persons who had been
designated as Dealers by the Company.
STRATEGIC ACQUISITIONS
FFC Transaction. On December 31, 1997, the Company purchased 50% of the
shares of FFC (the "FFC Shares") from FAI Insurances in the FFC Transaction.
FFC, a consumer finance company with operations in Australia and New Zealand,
was the financing source for approximately 74% of the financed sales of the
SecurityGuard System to end users in Australia and New Zealand for the fiscal
year ended June 30, 1998, which
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constituted approximately 56% of all sales of the SecurityGuard System in
Australia and New Zealand during that period. The purchase price for the FFC
Shares of $7,016,525 was paid through the delivery of a five year promissory
note (the "FFC Note"), which bears interest at a rate of 7.75% per annum
payable monthly in arrears and is secured by the FFC Shares. The first
installment of $1,631,750 was paid on January 2, 1998. The next principal
installment of $619,233 is due on December 31, 1998. Pursuant to the terms of
the FFC Note, as amended, the Company is required to utilize any funds raised
in any equity offering subsequent to the FFC Transaction to pay down the FFC
Note if available after paying the cash portion of the Ness Transaction. The
Company also received the FFC Option, at no additional cost, exercisable
within four years of the date of the FFC Transaction, to purchase the
remaining 50% interest in FFC from FAI Insurances, for the same consideration
plus 50% of the net change in FFC's retained earnings from the date of the FFC
Transaction until the date the FFC Option is exercised. If the FFC Option is
exercised, the purchase price will be financed by FAI Insurances over a four-
year period from the date on which the FFC Option is exercised on terms
comparable to the FFC Note.
FFC is a consumer and business finance company which specializes in the
provision of consumer credit, primarily to purchasers of the SecurityGuard
System through sales finance arrangements with the Company and participants in
the Distributor Network, and also through personal loan and insurance products
which are not currently part of the Company's business. The FFC Transaction
ensures that the operations of FFC will be focused primarily on servicing the
Company's customers. The Company believes the FFC Transaction is critical to
the future growth of the Company because it will help ensure the availability
of credit to purchasers of the SecurityGuard System in Australia and New
Zealand. For the fiscal year ended June 30, 1998, approximately 75% of sales
by the Distributor Network to end-users were financed on an installment basis.
The FFC Transaction also benefits the Company by enabling the Company to
utilize the management of FFC to assist the Company in establishing financing
arrangements in new international markets. FFC may also be able to capitalize
on the Company's existing and future base of customers with installed alarms
by marketing additional products and services to them, such as personal loans,
as a way of generating additional revenue for FFC.
FFC was founded in 1991 by FAI Insurances, primarily to provide financing
for purchases of the SecurityGuard System in the Australia and New Zealand
markets, particularly for certain groups of individuals not normally serviced
by traditional financing companies, such as retired persons and renters. For
the fiscal year ended June 30, 1998 approximately 80% of all consumer loans
made by FFC were made to finance purchases of the SecurityGuard System in
Australia and New Zealand. FFC's loan receivables carry a blended interest
rate of approximately 23%.
FFC was initially funded by an interest free loan from FAI Insurances of AUD
$30 million, secured by a lien on all of its assets. Since the FFC
Transaction, FFC has paid interest, at the rate of 7.75% per annum, on its
outstanding loan balance from FAI Insurances (which was $20,272,824 as of June
30, 1998). In addition, pursuant to a shareholders agreement, FAI Insurances
has agreed with the Company that for every dollar the Company loans to FFC,
FAI Insurances is obligated to match the amount of the loan. The Company
believes FFC will be an attractive use of funds for its excess cash flows from
operations.
Currently, FFC's principal source of funds is a Receivables Purchase
Agreement with Westpac Banking Corporation ("Westpac"), pursuant to which FFC
sells eligible receivables to Westpac and undertakes to continue to service
the receivables in exchange for a management fee. The net effect of the
arrangement provides Westpac with approximately one-third of the interest
collected by FFC, in exchange for providing FFC with the funds. The net cost
of funds to FFC incorporates the historical effect of non-payment, as FFC
bears the risk of non-payment on each financing arrangement sold to Westpac.
The maximum currently available to FFC under the Receivables Purchase
Agreement is AUD $30 million. The Company believes that the Receivables
Puchase Agreement provides FFC the necessary capital to support its financing
activities and future growth. The Company also believes it will be able to
actively grow the receivables balance of FFC. In addition to the funds which
may be loaned to FFC by FAI Insurances and the Company, FFC is actively
seeking to expand its receivables facility with Westpac and is evaluating
additional options as a way of growing its receivable balance. See "Business--
Strategy".
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FFC's main office is located in Sydney, Australia. FFC also maintains an
office in Auckland, New Zealand. As of June 30, 1998, FFC had forty-two
employees in Australia and fourteen employees in New Zealand.
Ness Transaction. On July 17, 1998, the Company entered into a stock
purchase agreement (the "Stock Purchase Agreement"), amended as of September
30, 1998, whereby the Company agreed to purchase all of the issued and
outstanding common stock of International Integrated Home Security Limited
("IIHSL"), a British Virgin Islands holding company. IIHSL is the holder of
75.04% of the issued and outstanding common stock of Ness. Ness is a designer
and manufacturer of security alarm products in Australia and the Company's
sole supplier of the SecurityGuard alarm. For the fiscal year ended June 30,
1998, the Company's purchases of the SecurityGuard alarm from Ness represented
approximately 77% of Ness' total sales. The purchase price for all of the
issued and outstanding common stock of IIHSL will consist of the following:
(i) 400,000 shares of Common Stock, (ii) warrants convertible into 360,000
shares of Common Stock at an exercise price of $13.00 per share, which will be
exercisable through the year 2003 (the "Ness Warrants") and (iii) $11,398,000
in cash and a secured promissory note (the "Cash Portion"). Initially, the
Company intended to close the Ness Transaction immediately following the
closing of the Offering. In light of recent conditions in the securities
markets, the Company is unsure of the timing or feasibility of such an
Offering. Therefore, the Company has renegotiated the terms with the holder of
all of the issued and outstanding common stock of IIHSL, and has initiated
discussion and negotiations with the holder of the 24.96% minority interest in
Ness. The Company intends to close the Ness Transaction as soon as
practicable.
Ness was founded in 1972 and has been the Company's sole supplier of its
SecurityGuard alarm since 1989. The Company anticipates that one of the
principal benefits of the Ness Transaction for the Company is that it will
ensure that Ness' business operations will be focused primarily on producing
products for the Company. The Ness Transaction will also enable the Company to
better control production times and schedules. Furthermore, the Company will
be able to achieve a higher profit margin on the sale of its SecurityGuard
Systems by recovering in income 75% of the price mark-up charged for such
systems by Ness to the Company and by purchasing the major component parts of
Ness' primary products in a more cost effective manner.
Ness manufactures other products in addition to its SecurityGuard alarm,
including its (i) Medi Alarm, a personal alarm that notifies an attendant when
the user requires assistance, specifically designed for aged and immobile
residents of retirement communities and nursing homes; (ii) D 8 Dialer
Security Alarm Panel, a traditional electricity-based security alarm system
designed for commercial and residential markets that utilizes a dialer to call
a central monitoring station and features eight fully programmable zones,
programmable siren, radio interface and secure remote arming/disarming
capabilities; (iii) Quantum Dual, a leading security alarm detector which
combines a passive infra-red sensor, a doppler microwave and a special anti-
creep zone lens that detects human movement directly below the lens where most
detectors are "blind" to detect intruders far more reliably than conventional
detectors; and (iv) other sensor detector products, including "Nessensor", an
advanced high frequency vibration sensor for traditional residential and
commercial security system installations.
Ness has an accomplished research and development staff and an ISO 9001
certified computer board manufacturing facility that utilizes state-of-the-art
surface mount technology. The Company believes that Ness' research and
development expertise will be extremely important in supporting the Company's
ability to successfully provide on-line monitoring services, by assisting the
Company in the incorporation of a dialer into the existing SecurityGuard alarm
to permit communication with the proposed central monitoring station. For
fiscal year 1998, Ness spent approximately 44% of its research and development
costs on the Company's product. In fiscal year 1999 the Company anticipates
that Ness will focus approximately 70% of its research and development costs
on the Company's product. The Company also believes that Ness currently has
excess manufacturing capacity that may allow Ness to provide contract
manufacturing services for third parties until such time as the Company
requires all of Ness' manufacturing capacity. See "Business--Strategy".
Ness' main office is located in Sydney, Australia, and Ness has distribution
offices in each of Melbourne, Perth and Brisbane. Ness also maintains an
office in Hong Kong. As of June 30, 1998, Ness had 137 employees in Australia
and five employees in Hong Kong.
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Since the inception of Ness' relationship with the Company in 1989, senior
management of the two companies have met regularly. The Company is currently a
party to a manufacturing/supply agreement with Ness under which Ness
manufactures the SecurityGuard alarm for the Company. The agreement precludes
termination prior to the year 2007 under normal circumstances, and grants the
Company the exclusive right to sell the SecurityGuard alarm throughout the
world (except the United States) and a non-exclusive right to sell to the
United States market. The agreement also provides that Ness may market and
sell the SecurityGuard alarm within the Company's exclusive territory, but
only upon the Company's prior written consent, which shall not be unreasonably
withheld. The manufacturing agreement further provides that Ness will be
permitted to market and sell the SecurityGuard alarm in places where the
Company does not intend to carry on business. Ness' right to sell the
SecurityGuard alarm in any country terminates if it supplies or sells any
product to companies that sell products in that country using a marketing
method or strategy which is similar in nature to that used by the Company.
Upon consummation of the Ness Transaction the Company plans to renegotiate the
manufacturing agreement in order to improve the terms on which it buys the
SecurityGuard alarm and to gain the exclusive right to sell the SecurityGuard
alarm in the United States.
COMPETITION
The security alarm industry in Australia, New Zealand and the international
markets in which the Company operates is highly competitive and fragmented.
The Company competes with numerous other companies for new customers. The
Company's three major competitors for first-time purchasers of alarm systems
in Australia and New Zealand are Brambles Industries Ltd, Chubb Security
Holdings Australia Ltd, and Tempo Services Ltd. Competition for new accounts
is based primarily on purchase price, monthly monitoring fee, the range of
services offered, and reputation for quality. The Company believes it has a
superior marketing strategy because of its focus on underserved markets and
the implementation of the Direct Sales Marketing Program to the end user
through the Distributor Network. Although the Company believes that it is a
leading seller of residential alarm systems in Australia and New Zealand,
there is no assurance that the Company will continue to have a competitive
advantage in those countries. The loss of any competitive position by the
Company in either Australia or New Zealand could have a material adverse
effect on the Company.
In marketing the SecurityGuard System outside of Australia and New Zealand,
the Company faces competition from large national and international alarm
installation and monitoring companies. Many of those companies are better
capitalized than the Company and often offer low-priced installations of
security systems. However, the Company believes that it will be able to
successfully penetrate and compete in such markets using the same marketing
and sales strategy that it uses in Australia and New Zealand.
TRADEMARKS AND INTELLECTUAL PROPERTY
The Company operates under the tradename "FAI Home Security" in Australia,
New Zealand, North America, Europe and South Africa. Pursuant to the
Reorganization, the Company's previous royalty agreement with FAI Insurances,
which provided for the payment of commissions for each SecurityGuard System
sold, in exchange for the use of the "FAI" name and logo, was replaced by a no
cost license agreement (the "License Agreement") with FAI Insurances for the
continued use of the "FAI" name and logo. The License Agreement permits it to
use the "FAI" name and logos on a royalty free, non-exclusive, non
transferable basis. Additionally, the License Agreement has a perpetual term
and will terminate only upon breach by the Company.
GOVERNMENT REGULATION
The Company's domestic operations in Australia and New Zealand, as well as
its other worldwide operations, are subject to a variety of laws, regulations
and licensing requirements of federal, state and local authorities. In certain
jurisdictions, the Company is required to obtain licenses or permits prior to
the commencement of operations, and the Company may also be required to comply
with standards governing employee selection and training, and to meet certain
standards in the conduct of its business. Many jurisdictions also require
certain of the Company's employees to obtain licenses or permits.
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The alarm industry is also subject to requirements imposed by various
insurance, approval, licensing and standards organizations. Depending upon the
type of customer served, the type of security service provided and the
requirements of the applicable local governmental jurisdiction, adherence to
the requirements and standards of such organizations is mandatory in some
instances and voluntary in others. The Company has experienced delays in
achieving product approval from local authorities in Belgium, which has
resulted in larger than anticipated start-up expenses and delays in the
commencement of sales in that country.
In most countries, the Company's advertising and sales practices are
regulated by various consumer protection laws. Such laws and regulations
include restrictions on the manner in which the Company promotes the sale of
its security alarm systems and require the Company to provide purchasers of
its alarm systems with certain rescission rights. From time to time,
government regulators have initiated investigations into the Company or
members of the Distributor Network.
Recently, a trend has emerged on the part of local governmental authorities
to adopt various measures aimed at reducing the number of false alarms. Such
measures include (i) subjecting alarm monitoring companies to fines or
penalties for transmitting false alarms, (ii) licensing individual alarm
systems and the revocation of such licenses following a specified number of
false alarms, (iii) imposing fines on alarm customers for false alarms, (iv)
imposing limitations on the number of times the police will respond to alarms
at a particular location and (v) requiring further verification of an alarm
signal before the police will respond. See "Risk Factors--Government
Regulation".
EMPLOYEES
At June 30, 1998, the Company employed eighty-two individuals, including
sixty-eight on a full-time basis, one on a part-time basis and thirteen
employees on an hourly basis. Currently, none of the Company's employees are
represented by a labor union or covered by a collective bargaining agreement.
The Company believes it has an excellent relationship with its employees.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF
1995
This filing contains certain forward-looking statements and information
within the meaning of Section 27A of the Securities Act of 1933, as amended
(the "Securities Act") and Section 21E of the Securities and Exchange Act of
1934, as amended (the "Exchange Act"), that are based on beliefs of, and
information currently available to, the Company's management as well as
estimates and assumptions made by the Company's management. When used in this
filing, words such as "anticipate," "believe," "estimate," "expect," "future,"
"intend," "plan" and similar expressions as they relate to the Company or the
Company's management, identify forward-looking statements. Such statements
reflect the current views of the Company with respect to future events and are
subject to certain risks, uncertainties and assumptions relating to the
Company's operations and results of operations, competitive factors and
pricing pressures, shifts in market demand, the performance and needs of the
residential security alarm industry, the costs of product development and
other risks and uncertainties including, in addition to any uncertainties
specifically identified in the text surrounding such statements, uncertainties
with respect to changes or developments in social, economic, business,
industry, market, legal and regulatory circumstances and conditions and
actions taken or omitted to be taken by third parties, including the Company's
shareholders, customers, suppliers, business partners, competitors, and
legislative, regulatory, judicial and other governmental authorities and
officials. Should one or more of these risks or uncertainties materialize, or
should the underlying estimates or assumptions prove incorrect, actual results
or outcomes may vary significantly from those anticipated, believed,
estimated, expected, intended or planned. Such factors include, but are not
limited to, the risks detailed under the caption "Risk Factors" below or
otherwise described herein or detailed from time to time in the Company's
Securities and Exchange Commission filings.
RISK FACTORS
THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY IN ADDITION TO THE
OTHER INFORMATION IN THIS REPORT ON FORM 10-K IN EVALUATING THE COMPANY AND
ITS BUSINESS.
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Risk of International Expansion. Although the Company's sales historically
have been generated in the Australian and New Zealand markets, the Company has
initiated expansion programs in Europe, South Africa and North America. There
can be no assurance that the Company will be able to market, sell and deliver
its products and services successfully in these new markets. A key component
of the Company's strategy is deployment of its Direct Sales Marketing Program
in markets outside of Australia and New Zealand through its Distributor
Network. Although the Company believes that the implementation of the
Distributor Network in those markets limits the Company's costs related to
expansion, the Company is still required to bear certain start-up costs when
entering new markets, including costs related to obtaining regulatory approval
of the SecurityGuard System and other pre-operational start-up costs. The
expenses associated with establishing the Distributor Network in new markets
during any period may substantially affect the Company's operating results
during that period. In addition, for the Company to expand successfully into a
new market, the Company must obtain a sufficient number and density of
customers in that market to support the additional investment made by the
Company, and establish a relationship with a local financing company that will
finance the purchase of products by customers. There can be no assurance that
the required customer numbers and density in any new market will be achieved
or that a relationship with a local financing company in that market will be
established. If the revenues generated by the Company in new and existing
markets are not sufficient to offset the expense of establishing and
maintaining the infrastructure to facilitate expansion of international
operations, the Company's business, operating results and financial condition
could be materially adversely affected. The Company is also subject to certain
risks inherent in operating globally, including international monetary
conditions, tariffs, import licenses, trade policies, domestic and foreign tax
policies and foreign manufacturing regulations. Furthermore, varying climatic
conditions in countries in which the Company operates or intends to commence
operations may affect the performance of the alarm system, thereby requiring
modification of its design.
Dependence on Consumer Financing. For the fiscal year ended June 30, 1998,
approximately 75% of the sales of SecurityGuard Systems by participants of the
Distributor Network to consumers were financed on an installment basis. The
Company's distributors in Australia and New Zealand have the option of
offering potential consumers financing from FFC (see "Business--Strategic
Acquisitions") or other financing organizations. In each of the other markets
in which the Distributor Network operates, the Company has arranged for a
local financing company to make financing available to purchasers in the
market. The availability of consumer financing in new international markets
and the continued availability of consumer finance in existing markets will be
a significant factor in determining whether the Company will succeed in these
markets. Any changes in interest rates or credit quality requirements of
financing organizations may adversely affect sales of the Company's products
and therefore have a material adverse effect on the Company. There can be no
assurance that financing will be available on terms which are attractive to
consumers and suitable for the Company's operations.
Currency Fluctuations and Duty Rates. Although the Company's principal
operations are concentrated in Australia and New Zealand, it conducts
operations throughout the world. (See "Risk Factors--Geographic
Concentration".) Accordingly, the Company's financial performance could be
adversely affected by fluctuations in currency exchange rates as well as
changes in duty rates. Furthermore, as the Company reports its financial
results in U.S. dollars, a significant movement in the value of the U.S.
dollar against certain international currencies, particularly the Australian
dollar ("AUD"), could have a material adverse effect on the Company's reported
financial position and results of operations. The AUD has declined in value
relative to the U.S. dollar from .7452 on July 1, 1997 to .6192 on June 30,
1998 and as of September 25, 1998 was valued at .5911 as compared to the U.S.
dollar. The change in valuation resulted in lower reported revenues than
budgeted when translated into U.S. dollars for the fiscal year ended June 30,
1998. The Company has experienced gains and losses in recent periods due to
transactions in foreign currencies. The Company hedged a portion of its
foreign exchange risk against the U.S. dollar through an AUD $2.5 million
dollar collar hedge and an AUD $1.0 million dollar forward contract, both of
which were settled on June 26, 1998. Although the Company is not in the
business of currency hedging, it may from time to time engage in hedge
arrangements. Nevertheless, there can be no assurance that the Company will be
successful in limiting risks related to currency fluctuations and that changes
in exchange rates will not have a material adverse effect on the Company or
its results of operations. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations--Liquidity and Capital
Resources".
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Risk Associated With Acquisitions. The Company's success will depend, in
part, on its ability to integrate its recent acquisition of FFC and the
proposed acquisition of Ness, into the Company's core sales business. There
can be no assurance that the Company will be able to successfully integrate
such businesses into its operations without substantial costs, delays or other
problems, that either FFC or Ness will have a positive effect on the Company's
profitability in an amount sufficient to justify the investment therein or
that the Company will be able to realize expected operating and economic
efficiencies in the operation of either Ness or FFC following such
acquisitions. In addition, integration of such acquisitions may require a
substantial amount of time from key management personnel. If the Company does
not manage these acquisitions effectively, its business, financial condition
and results of operations could be materially adversely affected. See
"Business--Strategic Acquisitions".
Management of Growth. An important element of the Company's business
strategy has been and continues to be expansion of its Distributor Network
beyond its present base of operations. This expansion has placed and will
continue to place substantial demands on the Company's management, operational
resources and system of financial controls. The Company's future operating
results will depend in part on the Company's ability to continue to implement
and maintain operating and financial systems and to expand, train and manage
its employees and members of its Distributor Network. Additionally, management
of growth may limit the time available to the Company's management to devote
to other operational, financial and strategic issues. There can be no
assurance that the Company will successfully implement and maintain the
necessary operational and financial systems or successfully obtain, integrate
and utilize the personnel, management, operational and financial resources
required to manage a developing and expanding business in new markets. Failure
to implement such systems successfully and use such resources effectively
could have a material adverse effect on the Company's results of operations
and financial condition.
Government Regulation. The Company must receive approval from the various
regulatory and licensing authorities for each country, state and local area in
which it operates. The Company may be required to obtain formal approval to
operate the Direct Sales Marketing Program and for the construction, design,
functionality, acceptability or merchantable quality of the SecurityGuard
System. The time that it takes to secure these approvals in any market will
affect the Company's growth and ability to establish a presence in such
markets. In certain jurisdictions, the Company has been required to obtain
licenses or permits prior to the commencement of operations. The loss of such
licenses or permits, or the establishment of conditions to the granting or
retention of such licenses or permits, could have a material adverse effect on
the Company. In certain jurisdictions the Company may also be required to
comply with standards governing employee selection and training, and to meet
certain standards in the conduct of its business. Although the Company
believes that it is presently in substantial compliance with all licensing and
regulatory requirements in each jurisdiction in which it operates, there can
be no assurance the Company will be able to secure the necessary regulatory
approvals in all of the countries or smaller geographic areas in which it
seeks to operate or that it will continue receiving regulatory approvals for
its existing activities. Recently, a trend has emerged on the part of local
governmental authorities to adopt various laws and regulations aimed at
reducing the number of false alarms. Enactment of such measures could have a
material affect on the Company's future business and results of operations.
See "Business--Government Regulation".
Dependence On Key Management Executives. The success of the Company's
business is largely dependent upon the active participation of Bradley D.
Cooper and other executive officers. The loss or interruption of the continued
services for any reason of one or more of the Company's key officers or the
inability of the Company to hire or retain qualified executives may have a
material adverse effect on the Company's business. Although Mr. Cooper's
principal occupation is as the Company's Chief Executive Officer and Chairman,
he has significant interests in other operating companies, and periodically
gives speeches and writes articles on sales motivation techniques. The Company
has "key-man" life insurance policies on Mr. Cooper, Terrence J. Youngman
(President), David Appleby (Vice President of International Business
Development) and Geoffrey D. Knowles (Vice President of Marketing) for $5
million, $1 million, $2 million and $2 million respectively.
16
<PAGE>
Recruitment of Independent Agents. The Company is dependent on the continued
recruitment of new Independent Agents to serve as sales agents for the
Distributor Network. The Distributor Network faces competition in the
recruitment of sales agents from other organizations, some of which are not in
the security alarm industry. The Company's ability to maintain or increase its
sales growth in the future will depend in part upon the number and quality of
Independent Agents that the Distributor Network can recruit and the Company
can train. There can be no assurance that a sufficient number of Independent
Agents will be recruited or retained by the Distributor Network.
Competition. The security alarm industry in each country where the Company
operates is highly competitive and there can be no assurance that the Company
will be able to compete successfully in the future. Although the Company has
achieved rapid growth in the sale of the SecurityGuard System in Australia and
New Zealand, there is no assurance that the Company will have continued
success in these countries. Although the Company believes that the Distributor
Network provides it with a competitive advantage over other security alarm
companies in Australia and New Zealand, the loss of any such competitive
position could have a material adverse effect on the Company. In marketing the
SecurityGuard System outside Australia and New Zealand, the Company competes
with larger national and international companies who may be better capitalized
and who conduct media advertising, which the Company does not currently
utilize. In the United States, the Company faces competition from alarm
installation and monitoring companies which are better capitalized than the
Company and which offer low-priced installations of security systems.
Competitive pressure may require the Company to reduce its prices to achieve
in other countries the growth rate it has experienced in Australia and New
Zealand. Furthermore, new competitors are continuing to enter the industry and
the Company may encounter additional competition from such future industry
entrants. See "Business--Competition".
Quarterly Variations In Operating Results. The Company has historically
experienced fluctuations in its quarterly operating results and expects to
experience fluctuations of its quarterly operating results in the future.
These fluctuations have been caused by many factors, including, among others,
the opening and closing of distributor offices, the volume and timing of
customer generation, competitive pricing pressures, local and national crime
rates in the markets in which the Distributor Network operates, general
economic conditions, foreign currency fluctuations and seasonality. The
Company's sales can be hampered by unfavorable weather conditions and
holidays. The Company's budgeted expenses are based, to some extent, on its
expectations of future sales and customer growth. The Company may be unable to
adjust spending in a timely manner to compensate for any unexpected revenue
shortfall due to levels of new sales that are lower than anticipated. Given
the possibility of quarterly fluctuations, the Company believes that
comparisons of the results of its operation for preceding quarters are not
necessarily meaningful and that the results for any one quarter should not be
relied upon as an indication of future performance. In the event that the
Company's revenues or operating results for any quarter are lower than
expected by securities analysts or the market in general, such shortfall could
have an immediate and significant adverse impact on the market price of the
Company's Common Stock. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations".
Geographic Concentration. Sales in Australia and New Zealand for the fiscal
years ended June 30, 1996, 1997 and 1998 accounted for approximately 94%, 94%
and 88%, respectively, of the Company's total net sales. The Company expects
that sales in Australia and New Zealand will continue to account for a
significant portion of the Company's net sales in the future. The performance
of the Company may be adversely affected by any change in regional economic
conditions or other factors affecting these markets. See "Business--Geographic
Operations".
Product Concentration. To date, sales of the SecurityGuard System and
related services accounted for substantially all of the Company's sales, and
will continue to account for substantially all sales in the foreseeable
future. Decline in the demand for this product, whether as a result of
competition, technological change or otherwise, would have a material adverse
effect on the Company's business, financial condition and results of
operations. See "Business--SecurityGuard System" and "Business--Services".
17
<PAGE>
Risks of Liability. Most of the alarm installation agreements and other
agreements pursuant to which the Company and the Distributor Network sell the
SecurityGuard System and related services contain provisions and disclaimers
limiting liability to customers. These provisions and disclaimers are intended
to reduce the risk of liability to the Company for the acts or omissions of
employees or Distributor Network representatives and for system failures.
However, in the event of litigation with respect to such matters, there can be
no assurance that these liability limiting provisions and disclaimers will be
enforceable. While the Company currently carries insurance of various types,
including general liability and errors and omissions insurance, the loss
experience of the Company and other security service companies may affect the
availability and cost of such insurance in the future. Certain of the
Company's insurance policies and the laws of some jurisdictions may limit or
prohibit insurance coverage for punitive or certain other types of damages, or
liability arising from gross negligence or wanton behavior. The cost and
effect of litigation could have a material adverse effect on the Company.
Adverse Publicity. Direct sales companies are occasionally the subject of
print articles and broadcast programs which present a negative view of such
companies and that emphasize their use of high pressure sales practices.
Although the Company maintains an active training and compliance program to
deter abusive sales practices by the participants in the Distributor Network,
the Company and the Distributor Network occasionally have received adverse
publicity. The Company has been the subject of isolated news articles accusing
its sales agents of high pressure sales practices including focusing on
customers' fears by using photographs of burglarized homes to encourage
purchases of the SecurityGuard System, and for charging above market financing
rates to consumers who cannot afford the product. Publicity of this nature
could have a material adverse affect on the Company's sales and earnings.
Additionally, from time to time, government regulators have initiated
investigations into the Company or members of the Distributor Network. See
"Business--Government Regulation".
Limitations on Enforceability of Judgments. A substantial portion of the
assets of the Company are, and for the foreseeable future will be, located
outside the United States. In addition, all or a substantial portion of the
assets of directors, executive officers and experts residing outside the
United States are or may be located outside of the United States, primarily in
Australia. As a result, it may not be possible to effect service of process in
the United States on such directors and executive officers, such experts or on
the Company's subsidiaries or to enforce, collect or realize upon, judgments
against such persons obtained in United States courts which are predicated
upon civil liability under United States securities laws. The Company has been
advised by its special Australian legal counsel that there are doubts as to
the enforceability of civil liabilities imposed by United States courts and as
to the ability of stockholders to pursue in Australian courts claims based on
the contents of this Prospectus or otherwise predicated on United States
federal securities laws against the Company or its directors, executive
officers and experts.
Foreign Taxation. Because the Company is a United States corporation which
generates substantially all of its income from non-U.S. operations, its income
will generally be subject to taxation in different jurisdictions. Certain
operations of the Company conducted outside the United States or by foreign
subsidiaries, in addition to being subject to taxation in foreign
jurisdictions, are also subject to various provisions of the Internal Revenue
Code of 1986, as amended (the "Code"), which impose special taxes in certain
circumstances on foreign subsidiaries of United States corporations. While the
Company will generally receive foreign tax credits for taxes paid in foreign
jurisdictions which can be offset against United States tax liabilities, there
can be no assurance that the Company will generate sufficient United States
income to fully utilize such foreign tax credits.
Anti-takeover Considerations. Certain provisions of the Company's By-Laws
and Delaware law could discourage potential acquisition proposals, delay or
prevent a change in control of the Company, and limit the price that certain
investors might be willing to pay in the future for shares of the Company's
Common Stock. For example, these provisions allow a staggered board of
directors and the issuance, without stockholder approval, of preferred stock
with rights and privileges senior to the Common Stock. The issuance of
preferred stock could result in the dilution of the voting power of the shares
of Common Stock and could have a dilutive
18
<PAGE>
effect on earnings per share. The Company is also subject to Section 203 of
the Delaware General Corporation Law which, subject to certain exceptions,
prohibits a Delaware corporation from engaging in any of a broad range of
business ventures with any "interested stockholder" for a period of three
years following the date that such stockholder became an interested
stockholder.
Potential Adverse Effect of Warrants and Company Options. The Company issued
warrants to purchase an aggregate of 240,000 shares of Common Stock to the
managing underwriter's of the IPO (the "IPO Representatives") which are
exercisable at a price of $16.50 per share (the "IPO Warrants") and will issue
warrants to purchase an aggregate of 360,000 shares pursuant to the Ness
Transaction, exercisable at a price of $13.00 per share (the "Ness Warrants").
Additionally, the Company has reserved 50,000 shares of Common Stock for
issuance under its 1997 Non-Employee Director Stock Option Plan and 750,000
shares of Common Stock for issuance under its employee 1997 Stock Option Plan
of which 20,000 and 750,000 options, respectively, have been issued, all at an
exercise price of $10.00 per share. The holders thereof will have the
opportunity to profit from a rise in the market price of the Common Stock
without assuming the risk of ownership, with a resulting dilution in the
interest of the other security holders. As long as the IPO Warrants, Ness
Warrants and other Company options remain unexercised, the Company's ability
to obtain additional capital might be adversely affected. Moreover, the
holders of the IPO Warrants, the Ness Warrants and other Company options may
exercise such warrants or options at a time when the Company would, in all
likelihood, be able to obtain any needed capital by a new offering of its
securities on terms more favorable than those under which the existing
warrants or options are exercisable.
Risk Associated With the Potential Acquisition of the Remaining Interest of
FFC and/or Ness. The Company may choose to proceed with the acquisition of the
remaining 50% interest in FFC that it does not currently own by exercising the
FFC Option, and is currently negotiating with the management of Ness to
acquire the 24.96% interest it will not acquire pursuant to the Ness
Transaction. If the consideration for either such transaction consists of
cash, a substantial portion of the Company's available cash may have to be
used to consummate the transaction. If the consideration for either
transaction consists of Common Stock or other securities, stockholders of the
Company could suffer dilution of their interests in the Company. In addition,
the consummation of either transaction could involve acquisition related
charges. See "Business--Strategic Acquisitions".
Shares Eligible For Future Sale. Sales of shares of Common Stock by existing
shareholders or by existing holders of outstanding options and warrants, under
Rule 144 of the Act, pursuant to the exercise of registration rights or
otherwise, could have an adverse effect on the price of the Common Stock. The
holders of the IPO Warrants will be able to sell publicly the Common Stock
issuable upon exercise thereof, either through the exercise of certain
registration rights, or for shares issued pursuant to the "cashless exercise"
provisions thereof, pursuant to Rule 144.
No Dividends. The Company does not anticipate paying dividends on its Common
Stock for the foreseeable future. Dividends will only be paid at such time as
the cash flow of the Company is sufficient to justify such payments, provided
that there are no restrictions on payment of dividends under credit or other
agreements. See "Dividend Policy".
Possible Illiquidity of Trading Market. The Common Stock is listed on the
American Stock Exchange. To continue to be listed on the American Stock
Exchange, the Company must continue to satisfy certain maintenance standards.
If the Company is unable to maintain the standards for continued quotation on
the American Stock Exchange, the Common Stock could be subject to delisting by
the American Stock Exchange. In such event, an investor would find it more
difficult to dispose of the Shares, or to obtain accurate quotations as to
their price.
Potential Volatility of Stock Price. The stock market has, from time to
time, experienced significant price and volume fluctuations that may be
unrelated to the operating performance of particular companies. Such broad
market fluctuations may adversely affect the market price of the Common Stock.
In addition, the market price of
19
<PAGE>
the Common Stock may prove to be highly volatile. Announcements of innovations
or new commercial products by the Company or its competitors, developments or
disputes concerning proprietary rights, regulatory developments and currency
fluctuations in countries in which the Company operates, as well as period to
period fluctuations in financial results, among other factors, may have a
significant impact on the market price of the Common Stock.
ITEM 2. PROPERTIES
The Company's executive office, administrative, customer care and extended
warranty divisions are located at 77 Pacific Highway, North Sydney, Australia.
The offices, which are leased from a subsidiary of FAI Insurances, constitute
approximately 824 square meters and are leased at a rental rate of AUD $380
per square meter, per annum. The Company has entered into a five-year lease
expiring in 2002, with an option to extend the lease arrangement for an
additional five years with respect to certain portions of the space. The
Company has also taken a three year lease for its twenty-four hour on-line
monitoring division at level 2, 80 Chandos Street, Leonards, Australia. The
division will occupy 280 square meters at a cost of AUD $220 per square meter
per annum and has acquired an option on 140 square meters at the same
location. The Company intends to construct a central monitoring station at
this address beginning in March, 1999. The Company believes that its existing
office space is adequate to meet its future needs.
The Company has an office in England at 2nd Floor Lodge House, Kay Street,
Burnley, Lancashire. The lease expires on April 12, 2000 and has an annual
rent of STG (pounds) 6640. The Company also leases a warehouse facility in
Manchester, England. The Company believes that its existing office and
warehouse space in Europe is adequate to meet its future needs.
ITEM 3. LEGAL PROCEEDINGS
The Company experiences routine litigation in the normal course of its
business. The Company does not believe that any currently pending or
threatened litigation will have a material adverse effect on the financial
condition and results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
20
<PAGE>
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
On July 15, 1997, the Company commenced the initial public offering of its
Common Stock, which has been traded on the American Stock Exchange since that
date.
The following table sets forth the high and low closing sale prices of the
Common Stock as reported by the American Stock Exchange for the periods
indicated.
<TABLE>
<CAPTION>
FISCAL 1998 HIGH LOW
----------- ------ ------
<S> <C> <C>
First Quarter (July 15-September 30, 1997)................. $14.88 $10.00
Second Quarter (October 1-December 31, 1997)............... 13.25 9.00
Third Quarter (January 1-March 31, 1998)................... 11.38 9.06
Fourth Quarter (April 1-June 30, 1998)..................... 13.88 10.00
</TABLE>
On October 2, 1998, the last reported sale price of the Common Stock as
reported by the American Stock Exchange was $8.81. Based on information
obtained from the Company's transfer agent, there are ten holders of record of
the Common Stock and the Company believes that the number of beneficial owners
of its Common Stock is in excess of 250.
RECENT SALE OF UNREGISTERED SECURITIES
None
DIVIDEND POLICY
Except for a final dividend distribution to FAI Insurances made prior to the
IPO of approximately $5.9 million (including a partial return of capital of
approximately $0.6 million), the Company has paid no dividends on the Common
Stock and does not anticipate doing so for the foreseeable future. Dividends
will only be paid at such time as the cash flow of the Company is sufficient
to justify such payments. The Company anticipates that all earnings, if any,
for the foreseeable future will be retained to finance the growth and
development of the business, including the operations of FFC.
21
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The selected financial information set forth below has been derived from the
financial data of the Company, its subsidiaries and its predecessor entities,
including FAI Home Security Pty Limited, FAI Home Security (ENZED) Limited,
FAI Home Security (NZ) Trust and FAI Home Security (NZ) Limited. The selected
statement of operations and balance sheet data of the Company as of and for
the years ended June 30, 1994, 1995, 1996, 1997 and 1998 have been derived
from the audited consolidated financial statements of the Company. See
"Consolidated Financial Statements of Home Security International--Note 1".
The selected financial information set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations" and the financial statements and notes thereto
included elsewhere in the Prospectus.
STATEMENT OF OPERATIONS DATA:
<TABLE>
<CAPTION>
YEARS ENDED JUNE 30,
--------------------------------------------
1994 1995 1996 1997 1998
------- ------- ------- ------- --------
(IN THOUSANDS, EXCEPT PER SHARE AND UNIT
SALES DATA)
<S> <C> <C> <C> <C> <C>
Net sales....................... $10,629 $21,437 $26,701 $33,465 $ 44,119
Cost of goods sold.............. (6,728) (14,219) (17,585) (24,274) (26,295)
------- ------- ------- ------- --------
Gross profit.................... 3,901 7,218 9,116 9,191 17,824
General and administrative
expenses....................... (3,955) (5,091) (6,606) (6,053) (10,810)
Research and development........ -- -- -- -- --
------- ------- ------- ------- --------
Income (loss) from operations... (54) 2,127 2,510 3,138 7,014
Interest income, net............ 5 65 203 784 226
------- ------- ------- ------- --------
Income before taxes, equity in
income of affiliated companies
and minority interest (49) 2,192 2,713 3,922 7,240
Income tax expense.............. (25) (722) (1,054) (1,630) (2,111)
------- ------- ------- ------- --------
Income (loss) before equity in
income of affiliated companies
and minority interest (74) 1,470 1,659 2,292 5,129
Equity in income of affiliated
companies...................... -- -- -- -- 252
Minority interest............... -- -- -- -- --
------- ------- ------- ------- --------
Net income (loss)............... $ (74) $ 1,470 $ 1,659 $ 2,292 $ 5,381
======= ======= ======= ======= ========
Diluted net income per share of
Common Stock................... $ 0.51 $ 1.04
Diluted weighted average shares
of Common Stock outstanding.... 4,500 5,182
UNIT SALES DATA:(1)
Unit sales...................... 12,235 25,280 31,669 38,071 57,589
Cumulative unit sales........... 29,182 54,462 86,131 124,202 181,791
</TABLE>
BALANCE SHEET DATA:
<TABLE>
<CAPTION>
JUNE 30,
---------------------------------------
1994 1995 1996 1997 1998
------ ------ ------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Cash and cash equivalents............... $ 247 $1,230 $ 370 $ -- $ 7,006
Working capital (deficit)............... (1) 1,684 3,451 (1,754) 3,121
Total assets............................ 2,281 7,671 13,384 15,957 30,485
Total debt, including current portion... 557 -- -- -- 4,737
Shareholders' equity.................... 369 3,912 9,894 9,790 18,099
</TABLE>
- --------
(1) Unit sales represents the sales of the SecurityGuard System during the
applicable period and cumulative unit sales represents the aggregate sales
of the SecurityGuard System since the Company began operations in 1988.
22
<PAGE>
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
OVERVIEW
The Company is a direct sales company which, through the Distributor
Network, sells, installs and services a residential security alarm system
marketed under the trade name SecurityGuard, principally in Australia and New
Zealand, with expanding international operations in Europe, South Africa and
North America.
The Company's revenues from SecurityGuard System sales are recorded upon
shipment by the Company to Area Distributors and Distributors and are net of
any discounts. Revenues related to extended warranties are recognized over the
life of the warranty agreement with the customer, although payment is received
in full at the beginning of the agreement. In the face of increased
competition in the industry, there can be no assurance that the Company will
not face increased pricing pressure, which in turn could lead to changes in
the selling price of the SecurityGuard System or services furnished by the
Company. The impact of any such price changes on the Company's revenue or
operating results cannot be accurately determined.
On June 30, 1997, the Company acquired from FAI Insurances Limited and
certain of its subsidiaries ("FAI Insurances") (i) the Australian and New
Zealand security alarm operations ("Australia and New Zealand Operations") of
FAI Insurances and (ii) the assets of FAI Insurances' security alarm
operations outside Australia and New Zealand (which were previously purchased
by FAI Insurances from Bradley D. Cooper on March 31, 1997) ("International
Assets") (collectively, the "Reorganization"). Pursuant to the Reorganization,
the Company's previous existing royalty agreement with FAI Insurances, which
provided for the payment of commissions for each SecurityGuard System sold in
exchange for the use of the "FAI" name and logo was replaced by a no cost
license agreement (the "License Agreement") with FAI Insurances for the
continued use of the "FAI" name and logo. As a result of the Reorganization,
the Company's financial statements have been prepared using the U.S. GAAP
"common control" concept. Under this concept, the financial statements of the
Company include the results of operations of the Company's predecessor
entities operated by FAI Insurances (i.e., FAI Home Security Pty Limited, FAI
Home Security (ENZED) Limited, FAI Home Security (NZ) Trust and FAI Home
Security (NZ) Limited) as if the Company had owned such entities before the
Reorganization. Additionally, the Company has included in its financial
statements for the year ended June 30, 1997 the results for three months of
operations (April 1, 1997-June 30, 1997) of the International Assets purchased
by FAI Insurances on March 31, 1997 from Bradley D. Cooper and subsequently
transferred to the Company as part of the Reorganization. The inclusion of the
operating results of that business for the three month period had no material
impact on the Company's results for the year ended June 30, 1997.
On December 31, 1997, the Company acquired a 50% equity interest in FFC. The
purchase price of $7,016,525 for the FFC Shares was paid by the Company
through delivery of the FFC Note which provides for periodic principal
payments over a five year period, and bears interest at a per annum rate of
7.75% payable monthly in arrears. FFC is a consumer and business finance
company operating in Australia and New Zealand. FFC specializes in the
provision of consumer credit, primarily to purchasers of the SecurityGuard
System through sales finance arrangements with the Company and participants in
the Distributor Network, and also through personal loan and insurance products
which are not currently part of the Company's business. For the fiscal year
ended June 30, 1998 approximately 80% of the principal amount of loans made by
FFC were derived from consumer loans to finance purchases of the SecurityGuard
System by end users in Australia and New Zealand. FFC is also experiencing
growth in its business from sources other than the Company, particularly in
the personal loan market. See "Business--Strategic Acquisitions".
The consolidated financial statements are translated into U.S. dollars to
reflect the Company's reporting currency. The assets and liabilities are
translated at the balance sheet date exchange rate. The statements of
operations data for each period have been translated at the average exchange
rate throughout such period. The resulting translation effects are reflected
in shareholders' equity. Because of fluctuations in the values of currencies
in which the Company receives revenues against the U.S. dollar, the Company
believes that period to period comparisons of reported financial results, may
not fully reflect sales and other operating trends for the
23
<PAGE>
periods compared. Despite the decline in value of the AUD against the U.S.
dollar from an average conversion rate of .7452 in fiscal 1997 to .6810 in
fiscal 1998, the Company's revenue and income increased. There are no
indications as to what the future currency fluctuations will mean to the
Company. As of September 25, 1998 the AUD was valued at .5911 as compared to
the U.S. dollar.
On October 1, 1997, the Company entered into an AUD $2.5 million collar
hedge which expired on June 30, 1998. The contract was taken out to secure a
foreign currency translation rate within a band of 0.7200 and 0.7461 for AUD
conversion to U.S. dollars. Additionally, on December 4, 1997 the Company
entered into a forward contract selling AUD $1.0 million for U.S. dollars at
0.6800 which also expired on June 30, 1998. These contracts were settled on
June 26, 1998. For the fiscal year ended June 30, 1998 the Company recorded a
gain of $355,000 on those contracts (which were accounted for as a reduction
to general and administrative expenses). As of June 30, 1998 the Company had
no outstanding derivative contracts.
The Company is currently in the process of evaluating its information
technology infrastructure ("ITI") for Year 2000 compliance. In this regard,
the Company has identified three (3) areas of exposure:
1. THE COMPANY'S OPERATING ENVIRONMENT: This category has been further sub-
categorised into the following: Software, Hardware, and Remaining
Infrastructure. The Software and Hardware exposures have been identified as
either "mission critical" or "non-mission critical".
i)SOFTWARE
Mission critical software includes the Company's accounting package,
customer databases, and operating systems, including Windows 95 and
Windows NT. Non-mission critical software encompasses all other
software.
The Company is presently undergoing a review process with regard to
mission critical software. The Company expects to achieve Year 2000
compliance for all mission critical software by early 1999. Conformity
issues with non-mission critical software will be evaluated in early
1999.
ii)
HARDWARE
Mission critical hardware encompasses the data communication
infrastructure and all server end hardware. Non-mission critical
hardware comprises all other hardware, such as desktops, printers,
photocopiers and laptops.
The Company has employed an external information technology firm to
review its mission critical hardware and provide an analysis of the
Company's potential risks, and alternatives to ensure Year 2000
compliance. The Company expects to achieve Year 2000 compliance for its
mission critical hardware by the end of 1998. Non mission critical
hardware will be evaluated in early 1999.
iii)
REMAINING INFRASTRUCTURE
Included in this category are telephones, air conditioning, lighting,
electricity and building access. The remaining infrastructure is
expected to be evaluated on an ongoing basis over the next fiscal year.
2. THE COMPANY'S RELIANCE ON EXTERNAL PARTIES: This category includes all
vendors, financial institutions and service providers. The Company is in the
process of identifying and evaluating the impact of all mission critical
vendors on Year 2000 compliance. All major vendors will be contacted with a
request to supply a response in writing, which confirms the services or
products they supply are Year 2000 compliant. The Company has also adopted a
policy requiring written confirmation of Year 2000 compliance from any
prospective vendor.
3. YEAR 2000 COMPLIANCE OF SUBSIDIARY COMPANIES: The Company will ensure all
subsidiaries, including FFC, and Ness, after it has been acquired, implement
the above strategies to ensure Year 2000 compliance.
FFC is currently involved in a joint project with FAI General Insurance
Company Limited ("FAI General"), a subsidiary of FAI Insurances, to identify,
categorize and update, where required, all software and hardware components to
ensure Year 2000 compliance. FFC's has obtained confirmation from the vendor
of its financial database package, that such software is Year 2000 compliant.
24
<PAGE>
The Company has obtained confirmation from Ness that the SecurityGuard
System is Year 2000 compliant. The Company will also utilize both internal and
external resources to test the manufacturing infrastructure of Ness for Year
2000 compliance and if necessary, to reprogram or replace any non-compliant
manufacturing equipment.
The Company does not expect that the cost to modify its ITI and/or other
infrastructures, if necessary, to become Year 2000 compliant will have a
material impact on its financial condition or results of operations.
RESULTS OF OPERATIONS
The following table summarizes the Company's operating results as a
percentage of net sales for the periods indicated.
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
--------------------
1996 1997 1998
------ ------ ------
(UNAUDITED)
<S> <C> <C> <C>
Net sales.............................................. 100.0% 100.0% 100.0%
Cost of goods sold..................................... 65.9% 72.5% 59.6%
------ ------ ------
Gross profit........................................... 34.1% 27.5% 40.4%
Management fees received--related party................ -- 1.7% --
General and administrative expenses.................... 24.7% 19.8% 24.5%
------ ------ ------
Income from operations................................. 9.4% 9.4% 15.9%
Interest income net.................................... 0.8% 2.3% 0.5%
------ ------ ------
Income before income taxes, equity in income of
affiliated companies.................................. 10.2% 11.7% 16.4%
Income tax expense..................................... 4.0% 4.9% 4.8%
------ ------ ------
Income before equity in income of affiliated companies. 6.2% 6.8% 11.6%
Equity in income of affiliated companies............... -- -- 0.6%
------ ------ ------
Net income............................................. 6.2% 6.8% 12.2%
</TABLE>
Comparison of fiscal years ended June 30, 1998 and June 30, 1997.
Net Sales: Net sales increased by $10.7 million or 32% from $33.5 million
for the fiscal year ended June 30, 1997 to $44.1 million for the fiscal year
ended June 30, 1998. The increase in net sales was primarily due to the
following factors: (i) a 19% increase in net sales in the Australia and New
Zealand markets, from $32.8 million for the fiscal year ended June 30, 1997 to
$39.0 million for the fiscal year ended June 30, 1998, which was primarily
attributable to a 36% increase in unit sales in Australia and New Zealand from
36,892 units for the fiscal year ended June 30, 1997 to 50,081 units for the
fiscal year ended June 30, 1998; and (ii) the inclusion in the fiscal year
ended June 30, 1998 of $5.1 million of net sales from the European, South
African and North American markets, (reflecting a full year of operations in
such markets) compared to $0.7 million of net sales in the international
markets included in the financial results for the fiscal year ended June 30,
1997 (which reflected sales in such markets only during the period from March
31, 1997, the date on which the International Assets were acquired by the
Company, until June 30, 1997). Unit sales in these markets for the fiscal year
ended June 30, 1998 were 7,508 units compared to 2,649 units for the fiscal
year ended June 30, 1997, an increase of 183%. Unit sales during fiscal year
1997 included 1,618 units which were sold during the nine month period prior
to the acquisition of the International Assets by the Company.
Cost of Goods Sold: Cost of goods sold increased by $2.0 million from $24.3
million to $26.3 million. This represented a decrease, as a percentage of net
sales, from 73% to 60% for the fiscal years ended June 30, 1997 and 1998,
respectively. This decrease, however, was partly due to the elimination during
the 1998 fiscal year of the royalty fee charged for the use of the FAI name by
FAI Insurances during the fiscal year ended June 30, 1997. As adjusted to
exclude this related party royalty charge of $3.6 million, cost of goods for
the fiscal year ended June 30, 1997 would have been $20.6 million, which was
62% of revenues. This reduction from 62% to
25
<PAGE>
60% was due primarily to a change in the Chief Executive Officer's
compensation package, from a commission basis (recorded in cost of goods sold)
for the fiscal year ended June 30, 1997, to a base salary plus 10% of net
profit after tax (recorded in general and administrative expenses) for the
fiscal year ended June 30, 1998.
Management Fees Received--Related Party: Management fees received from a
related party of $0.6 million for the fiscal year ended June 30, 1997, were
eliminated as an intercompany transaction for the fiscal year ended June 30,
1998.
General and Administrative Expenses: General and administrative expenses
were $10.8 million for the fiscal year ended June 30, 1998, compared to $6.6
million for the fiscal year ended June 30, 1997. General and administrative
expenses for the fiscal year ended June 30, 1998, however, included a full
year of expenses relating to the European, North American and South African
operations (i.e. $2.3 million), compare to only three months of such expenses
during fiscal year 1997 (i.e. $0.3 million). Included in the international
market expenses is a provision of $0.4 million due to delays in the product
approval process in Belgium and a $0.3 million charge was expensed in relation
to the establishment of the U.S. market. General and administrative expense
also included an offsetting gain of $0.4 million resulting from the settlement
of its derivative contracts. Total general and administrative expenses, as a
percentage of net sales (as adjusted to exclude the management fees of $0.6
million received from a related party in the 1997 period) increased to 24.5%
for the fiscal year ended June 30, 1998 compared to 19.8% for the fiscal year
ended June 30, 1997. The re-classification of the Chief Executive Officer's
compensation package during fiscal year 1998 resulted in an increase of $1.3
million or 2.9% as a percentage of net sales for the fiscal year ended June
30, 1998 as compared to the fiscal year ended June 30, 1997.
Income From Operations: Income from operations increased from $3.1 million
for the fiscal year ended June 30, 1997 to $7.0 million for the fiscal year
ended June 30, 1998. As adjusted to exclude the related party royalty payments
(which were eliminated pursuant to the License Agreement) and the management
fee income received from a related party, income from operations increased
$0.9 million from $6.2 million for the fiscal year ended June 30, 1997
compared to $7.0 million for the fiscal year ended June 30, 1998.
Interest Income: Interest income decreased from $837,000 for the fiscal year
ended June 30, 1997 to $450,000 for the fiscal year ended June 30, 1998.
However, the fiscal year ended June 30, 1997 included related party interest
income of $756,000. Excluding interest income received from related parties
for the fiscal year ended June 30, 1997, interest income increased from
$82,000 to $424,000 for the fiscal years ended June 30, 1997 and 1998
respectively. The increase during the 1998 period was attributable to higher
cash balances and interest received from Bradley D. Cooper.
Interest Expense: Interest expense for the fiscal year ended June 30, 1998
was $225,000. This included interest payments of $217,000 to FAI Insurances
pursuant to the FFC Note. For the fiscal year ended June 30, 1997 interest
expense was $60,000.
Income Tax Expense: The effective rate of tax decreased from 42% for the
fiscal year ended June 30, 1997 to 29% for the fiscal year ended June 30,
1998. This reduction is primarily attributable to the following factors: (i)
the introduction of income earned in the United Kingdom, South Africa and
Canada all of which have lower tax rates than Australia; and (ii) the purchase
by the Company, on June 30, 1998, of a 49% interest in a partnership that has
entered into an agreement with Prime Life Corporation to acquire a retirement
village in Melbourne, Australia. The investment in the partnership provided
the Company with a permanent difference for tax purposes of $1.7 million
(approximately $601,000 after tax) for the fiscal year ended June 30, 1998.
Equity in Income of Affiliated Companies: Equity in income of affiliates for
the fiscal year ended June 30, 1998 was $252,000. This was calculated by
taking the Company's 50% share of FFC's net income of $414,000 for the six
months ended June 30, 1998 and deducting amortization of goodwill for the same
period of $162,000. There was no equity in income of affiliates for the fiscal
year ended June 30, 1997 as the FFC Transaction took place on December 31,
1997.
26
<PAGE>
Net Income: Net income increased from $2.3 million for the fiscal year ended
June 30, 1997 to $5.4 million for the fiscal year ended June 30, 1998.
However, as described above, the fiscal year ended June 30, 1997 included
related party charges of $3.6 million in royalty payments, interest income of
$0.8 million and management fee income of $0.6 million. As adjusted to exclude
these related party charges and interest income, net income increased 42% from
$3.8 million for the fiscal year ended June 30, 1997 to $5.4 million for the
fiscal year ended June 30, 1998.
Comparison of fiscal years ended June 30, 1997 and June 30, 1996
Net Sales. Net sales increased by $6.8 million or 25% from $26.7 million for
the fiscal year ended June 30, 1996 to $33.5 million for the fiscal year ended
June 30, 1997. This increase was primarily due to continued growth of unit
sales in the New Zealand market. Net sales in the Australian market increased
by approximately $0.6 million (2.5%) from $21.9 million for the fiscal year
ended June 30, 1996 to $22.5 million for the fiscal year ended June 30, 1997.
Cost of Goods Sold. Cost of goods sold increased by $6.7 million from fiscal
year 1996 to fiscal year 1997. As a percentage of net sales, cost of goods
sold increased from 66% for the fiscal year ended June 30, 1996 to 73% for the
fiscal year ended June 30, 1997. This increase was due, in part, to the
increased cost of goods from the manufacturer for an updated version of the
SecurityGuard alarm with enhanced features, increases in commission and bonus
payments to senior executives related to sales volumes and increases in
royalty fees paid to related parties for use of the FAI brand name. This
royalty, which was eliminated for all periods after June 30, 1997, increased
as a percentage of revenues from 10% for the fiscal year ended June 30, 1996
to 11% for the fiscal year ended June 30, 1997. Excluding related party
expenses such as royalty charges for both periods, cost of goods sold, as a
percentage of revenues, increased from 56% of total revenue for the fiscal
year ended June 30, 1996 to 62% for the fiscal year ended June 30, 1997.
General and Administrative Expenses. General and administrative expenses
were $6.6 million for both the fiscal years ended June 30, 1996 and 1997. As a
percentage of net sales, total general and administrative expenses decreased
to 20% in the fiscal year ended June 30, 1997 from 25% for the fiscal year
ended June 30, 1996. The decrease as a percentage of net sales for the fiscal
year ended June 30, 1997 compared to the fiscal year ended June 30, 1996,
reflects the economies of scale of operating the Distributor Network, since
increases in net sales did not entail a proportionate increase in overhead.
Furthermore, the decrease in general and administrative expenses reflects
changes to the Chief Executive Officer's employment agreement made during
fiscal 1997, which made him responsible for all costs of support staff,
travel, accommodation and other expenses related to the performance of his
duties as Chief Executive Officer of the Company. For fiscal 1997, these
expenses were encompassed by the commission structure used to compensate the
Chief Executive Officer and for such period were therefore included in cost of
goods sold rather than general and administrative expense. Additionally, the
Company received a management fee of $0.5 million (net of management fees paid
to FFC) from FAI Insurances in connection with the management of the
international operations. General and administrative expenses also include a
charge of $0.4 million for the amortization of goodwill which was expensed in
the fiscal year ended June 30, 1997 compared to $0.2 million for the fiscal
year ended June 30, 1996.
Income from Operations. Income from operations increased from $2.5 million
for the fiscal year ended June 30, 1996 to $3.1 million for the fiscal year
ended June 30, 1997. If royalty payments to FAI Insurances for the use of the
FAI name and other related party charges and income were excluded for both
periods, income from operations would have increased from $5.3 million for the
fiscal year ended June 30, 1996 to $6.8 million for the fiscal year ended June
30, 1997.
Interest Income. Interest income was approximately $0.8 million for the
fiscal year ended June 30, 1997 compared to $0.2 million for the fiscal year
ended June 30, 1996. This was due to the higher loan balances with a related
party, FFC, during the year ended June 30, 1996.
27
<PAGE>
Income Tax Expense. The effective rate of tax increased from 39% for the
fiscal year ended June 30, 1996 to 42% for the fiscal year ended June 30,
1997. This was due to the non-deductibility of goodwill amortization of $0.4
million during fiscal year ended June 30, 1997.
Net Income. Net income increased from $1.7 million for the fiscal year ended
June 30, 1996 to $2.3 million for the fiscal year ended June 30, 1997.
LIQUIDITY AND CAPITAL RESOURCES
The principal source of the Company's liquidity historically has been, and
in the future is expected to be, cashflow from operations. The Company
currently has no credit facility with a bank or other financial institution,
although it believes appropriate facilities would be available on reasonable
terms if needed.
In July 1997 the Company sold a total of 450,500 shares of Common Stock
pursuant to the IPO (including 150,500 shares pursuant to an over-allotment
option) at an issue price of $10.00, and obtained net proceeds of $3,497,670.
In addition, prior to the IPO, 250,000 shares of Common Stock of the Company
were sold to Bradley D. Cooper at the IPO price for cash of $125,000 and a
secured note of $2,375,000.
On October 1, 1997, the Company entered into an AUD $2.5 million collar
hedge which expired on June 30, 1998. The contract was taken out to secure a
foreign currency translation rate within a band of 0.7200 and 0.7461 for AUD
conversion to U.S. dollars. Additionally, on December 4, 1997 the Company
entered into a forward contract selling AUD $1.0 million for U.S. dollars at
0.6800 which also expired on June 30, 1998. These contracts were settled on
June 26, 1998. For the year ended June 30, 1998 the Company recorded a gain of
$355,000 on its derivatives. As at June 30, 1998 the Company has no
outstanding derivative contracts.
On December 31, 1997 the Company entered into the FFC Transaction. The
purchase price of $7,016,525 was paid by delivery of the FFC Note, which is
payable over a period of five years, with interest at a rate of 7.75% per
annum payable monthly in arrears. The first installment of $1,631,750 was paid
on January 2, 1998 and the next principal installment of $619,000 is due on
December 31, 1998. For the six months ended June 30, 1998 interest in the
amount of $217,000 was paid under the FFC Note. The Company was also granted
the FFC Option to purchase the remaining 50% equity interest in FFC from FAI
Insurances, for the same consideration paid by the Company for the FFC Shares
plus 50% of the net change in FFC's retained earnings from the date of the FFC
Transaction until the date the FFC Option is exercised.
On June 30, 1998, the Company purchased, for $303,000, a 49% interest in a
partnership that has entered into an agreement with Prime Life Corporation
Limited to acquire a retirement village in Melbourne, Australia. The Company
believes this passive investment will provide the Company with greater returns
than interest earned on excess cash. The Company has given the operators of
the partnership significant incentives and has limited the operators ability
to take commercial risks, in order to maximize the Company's return on its
investment.
On July 17, 1998, the Company entered into a stock purchase agreement (the
"Stock Purchase Agreement"), amended as of September 30, 1998, whereby the
Company agreed to purchase all of the issued and outstanding common stock of
International Integrated Home Security Limited ("IIHSL"), a British Virgin
Islands holding company. IIHSL is the holder of 75.04% of the issued and
outstanding common stock of Ness Security Products Pty Ltd. ("Ness"). Ness is
a designer and manufacturer of security alarm products in Australia and the
Company's sole supplier of the SecurityGuard alarm. For the fiscal year ended
June 30, 1998, the Company's purchases of the SecurityGuard alarm from Ness
represented approximately 77% of Ness' total sales. The purchase price for all
of the issued and outstanding common stock of IIHSL will consist of the
following: (i) 400,000 shares of Common Stock, (ii) warrants convertible into
360,000 shares of Common Stock at an exercise price of $13.00 per share, which
will be exercisable through the year 2003 (the "Ness Warrants") and (iii)
$11,398,000 in cash and a secured promissory note (the "Cash Portion"). The
promissory note in the amount of $9,098,000 is secured by all of the issued
and outstanding stock of IIHSL and is payable in
28
<PAGE>
installments of $400,000 on each of June 30, 1999 and December 31, 1999,
respectively, with the balance of the note due on June 30, 2000 ("Note").
During the term of the Note, the Company is required to make prepayment on the
Note to the extent of any debt or equity financing. Additionally, if any
portion of the principal amount of the Note is still outstanding on October 1,
1999, the Company shall issue an additional five year warrant to purchase
200,000 shares of HSI Common Stock at an exercise price of $13.00 per share.
Likewise, if any portion of the principal amount of the Note is still
outstanding on January 1, 2000, the Company shall issue an additional five
year warrant to purchase 200,000 shares of HSI common stock at an exercise
price of $13.00 per share.
Cashflow from operations increased from $4.8 million for the fiscal year
ended June 30, 1997 to $6.0 million for the fiscal year ended June 30, 1998.
The increase in cash flow provided by operations directly reflects the
increase in profitability of the Company for the fiscal year ended June 30,
1998.
Accounts receivable increased during the fiscal year ended June 30, 1998 as
a result of the continued expansion of the Distributor Network in the fiscal
year ended June 30, 1998.
Net cash used in investing activities decreased from a surplus of $0.9
million during the fiscal year ended June 30, 1997 to a deficit of $1.8
million during the fiscal year ended June 30, 1998. The decrease in net cash
used in investing activities was primarily due to the following factors: (i)
payment of the first installment of $1.6 million on the FFC Note and an
advance of $0.3 million to FFC; (ii) purchase of additional plant and
equipment of $0.6 million; (iii) settlement of related party balances; and
(iv) purchase, for $0.3 million, of a 49% interest in the partnership that has
entered into an agreement to acquire a retirement village in Melbourne,
Australia, as described above.
Net cash generated from financing activities increased from a deficit of
$5.8 million during the fiscal year ended June 30, 1997 to a surplus of $3.5
million. This increase primarily resulted from the sale of shares in the IPO
in July 1997.
The Company believes that internally generated cashflows will be adequate to
support currently planned business operations over the next twelve months. The
Company's strategy for growth is based on the expansion of its Distributor
Network into existing and new markets, with the costs of such expansion
largely borne by the distributor. It is expected excess cashflows generated by
the Company will be used in part to fund the expansion of FFC's operations and
if the Company acquires the remaining 24.96% interest of Ness it will not own
following the closing of the Ness Transaction, for such acquisition.
Additionally, the Company may from time to time, use excess cash flows to make
strategic acquisitions or other investments. Notwithstanding that the
Company's costs in expanding its Distributor Network are expected to be
limited, the Company may be required to obtain additional capital to fund
growth from other financing sources if the cashflow generated by the
Australian and New Zealand operations is insufficient to meet the cash
requirements of developing the international operations. Potential sources of
such capital may include proceeds from bank financing or additional offerings
of the equity or debt securities of the Company. There can be no assurance
that such capital will be available on acceptable terms from these or other
potential sources. The lack of such capital could have a material adverse
effect on the Company's operations.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's operations are concentrated outside of the United States.
Accordingly, the Company's financial performance could be adversely affected
by fluctuations in currency exchange rates. As the Company reports its
financial results in U.S. dollars, a significant movement in the value of the
U.S. dollar against certain international currencies, particularly the AUD,
could have a material adverse effect on the Company's reported financial
position and results of operations. The AUD has declined in value relative to
the U.S. dollar from .7452 on July 1, 1997 to .6192 on June 30, 1998 and as of
September 25, 1998 was valued at .5911 as compared to the U.S. dollar. The
change in valuation resulted in lower reported revenues than budgeted when
translated into U.S. dollars for the fiscal year ended June 30, 1998.
29
<PAGE>
The Company periodically enters into forward currency exchange contracts and
options to manage the risk of foreign currency fluctuations, since a
significant portion of its sales are in foreign currencies. The change in fair
value of the contracts is recognized immediately and included in the
determination of net income. The Company is not a trader in derivative
securities, and it has not used speculative derivative products for the purpose
of generating revenues earnings from changes in market conditions. While the
Company is not in the business of currency hedging, it may from time to time
engage in such arrangements.
ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is contained in the financial
statements set forth in Item 14(a) under the caption "Consolidated Financial
Statements" as part of this report.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with accountants on accounting
or financial disclosure matters during the Company's fiscal years ended June
30, 1998, 1997 and 1996.
30
<PAGE>
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning directors and executive officers of the Company
required under this Item is incorporated herein by reference to the Company's
definitive proxy statement pursuant to Regulation 14A, to be filed with the
Commission not later than 120 days after the close of the Company's fiscal year
ended June 30, 1998.
ITEM 11. EXECUTIVE COMPENSATION
The information concerning directors and executive officers of the Company
required under this Item is incorporated herein by reference to the Company's
definitive proxy statement pursuant to Regulation 14A, to be filed with the
Commission not later than 120 days after the close of the Company's fiscal year
ended June 30, 1998.
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information concerning directors and executive officers of the Company
required under this Item is incorporated herein by reference to the Company's
definitive proxy statement pursuant to Regulation 14A, to be filed with the
Commission not later than 120 days after the close of the Company's fiscal year
ended June 30, 1998.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information concerning directors and executive officers of the Company
required under this Item is incorporated herein by reference to the Company's
definitive proxy statement pursuant to Regulation 14A, to be filed with the
Commission not later than 120 days after the close of the Company's fiscal year
ended June 30, 1998.
31
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents Filed With This Report:
1. Financial Statements. The following are included herein under Item
8:
Home Security International, Inc.
Report of Independent Public Accountants
Consolidated Statements of Income for the Years Ended June 30, 1996, 1997
and 1998
Consolidated Balance Sheets as of June 30, 1997 and 1998
Consolidated Statements of Cashflows for the Years Ended June 30, 1996,
1997 and 1998
Consolidated Statements of Changes in Shareholders' Equity for the Years
Ended June 30, 1996, 1997 and 1998
Notes to Consolidated Financial Statements
FAI Finance Corporation Pty Limited:
Report of Independent Public Accountants
Consolidated Statements of Income for the Years Ended June 30, 1996, 1997
and 1998
Consolidated Balance Sheets as of June 30, 1997 and 1998
Consolidated Statements of Cashflows for the Year Ended June 30, 1996, 1997
and 1998
Consolidated Statements of Changes in Shareholders' Equity for the Years
Ended June 30, 1996, 1997 and 1998
Notes to Consolidated Financial Statements
2. Financial Statement Schedules. There are no financial statement schedules
filed as part of this report, since the required information is included in the
financial statements, including notes thereto, or the circumstances requiring
inclusion of such schedules are not present.
3. Exhibits. The following exhibits are filed herewith or incorporated by
reference as indicated. Exhibit numbers refer to Item 601 of Regulation S-K. As
used in the list of Exhibits below, "Registrant" refers to Home Security
International, Inc.
<TABLE>
<S> <C>
2.1 Share Purchase Agreement relating to the purchase of shares in FAI Home
Security Pty Limited and FAI Home Security (ENZED) Limited (4)
2.2 NZ Asset Purchase Agreement between FAI Home Security Holdings New Zealand
Limited and FAI Home Security (ENZED) Limited (4)
2.3 NZ Share Sale Agreement between FAI Home Security Holdings New Zealand
Limited and FAI Home Security Holdings Pty Limited (4)
2.4 Trade Mark License Agreement between FAI Insurances and FAI Home Security
Pty Limited (4)
3.1 Certificate of Incorporation of the Company (1)
3.2 Bylaws of the Company (1)
4.1 IPO Representatives Warrant Agreement (1)
*10.1 1997 Employee Stock Option Plan (5)
*10.2 1997 Non-Employee Directors' Stock Option Plan (5)
10.3 International Asset Purchase Agreement between FAI Insurances and Cooper
International Group (2)
10.4 Manufacturing Agreement among Ness Security Products Pty Limited, FAI Home
Security Pty Limited and FAI Home Security Holdings Pty Limited (4)
*10.5 Executive Service Agreement with Bradley D. Cooper (4)
*10.6 Amendment to Executive Service Agreement with Bradley D. Cooper (4)
</TABLE>
32
<PAGE>
<TABLE>
<S> <C>
*10.7 Executive Service Agreement dated July 15, 1997 between the Company and
Terrence J. Youngman (4)
*10.8 Executive Service Agreement dated July 15, 1997 between the Company and
Robert D. Appleby (4)
*10.9 Executive Service Agreement dated July 15, 1997 between the Company and
Mark Whitaker (4)
*10.10 Executive Service Agreement dated July 15, 1997 between the Company and
Geoffrey D. Knowles (4)
*10.11 Executive Service Agreement dated July 15, 1997 between the Company and
Felicity A. Hilbert (4)
10.12 Option Agreement dated September 5, 1994 between Bradley D. Cooper and FAI
Insurances Limited (2)
10.13 Sale Agreement dated November 11, 1995, among Bradley D. Cooper, FAI
Insurances Ltd, FAI Home Security Holding Pty Ltd. and Kamarasi Pty Ltd.
(2)
*10.14 Management Services Agreement with Speakeasy Ltd. (2)
10.15 Promissory Note Payable to Bradley D. Cooper (4)
10.16 Promissory Note Payable to FAI Home Security Holdings Pty Limited (4)
10.17 Promissory Note Payable to FAI Home Security (ENZED) Limited (4)
10.18 Share Sale Agreement dated December 31, 1997 by and between FAI Insurances
Limited and FAI Home Security Pty. Limited (6)
10.19 Shareholders Agreement dated December 31, 1997 by and between FAI
Insurances Limited and FAI Home Security Pty. Limited (6)
10.20 Consultancy Engagement Agreement effective October 1, 1997, among the
Company, Speakeasy Pty. Ltd. and Bradley D. Cooper (7)
10.21 Stock Purchase Agreement dated July 17, 1998 between the Company and
International Home Security Investments Limited (8)
10.22 Form of Underwriting Agreement with IPO Representative (1)
21.1 List of Subsidiaries (8)
27.1 Financial Data Schedule (EDGAR version only)
</TABLE>
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*Compensation Plan or Agreement
(1) Incorporated by reference to the Company's Registration Statement on Form
S-1 (Registration No. 333-26399), as amended, filed with the Securities
Exchange Commission on May 2, 1997
(2) Incorporated by reference to the Company's Registration Statement on Form
S-1 (Registration No. 333-26399), as amended, filed with the Securities
Exchange Commission on June 10, 1997
(3) Incorporated by reference to the Company's Registration Statement on Form
S-1 (Registration No. 333-26399), as amended, filed with the Securities
Exchange Commission on June 25, 1997
(4) Incorporated by reference to the Company's Annual Report on Form 10-K filed
with the Securities Exchange Commission on September 29, 1997
(5) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
filed with the Securities Exchange Commission on November 14, 1997
(6) Incorporated by reference to the Company's Report on Form 8-K filed with
the Securities Exchange Commission on January 15, 1998
(7) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
filed with the Securities Exchange Commission on February 17, 1998
(8) Incorporated by reference to the Company's Registration Statement on Form
S-1 (Registration No. 333-54921), filed with the Securities Exchange
Commission on July 20, 1998
(b) Reports on Form 8-K:
No Reports on Form 8-K have been filed during the last fiscal quarter
covered by this Report.
33
<PAGE>
SIGNATURES
PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED
ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED.
Home Security International, Inc.
(Registrant)
/s/ Bradley D. Cooper
By: _________________________________
Bradley D. Cooper
Chairman and Chief Executive
Officer
(Principal Executive Officer)
Date: September , 1998
KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned directors and
officers of Home Security International, Inc., a Delaware corporation, which
is filing an Annual Report on Form 10-K for the fiscal year ended June 30,
1998 ("Form 10-K Report") with the Securities and Exchange Commission, under
the provisions of the Securities and Exchange Act of 1934, as amended, hereby
constitute and appoint Bradley D. Cooper and Mark Whitaker, and each of them,
each of their true and lawful attorneys-in-fact and agents; with full power of
substitution and resubstitution, for him or her in his or her name, place and
stead, in any and all capacities, to sign such Form 10-K Report and any or all
amendments to the Form 10-K Report, and all other documents in connection
therewith to be filed with the Securities and Exchange Commission, granting
unto said attorneys-in-fact and agents, and each of them, full power and
authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises, as fully to all interests and
purposes as each of them might or could do in person, hereby ratifying and
confirming all that said attorneys-in-fact and agents or any of them, or their
substitute or substitutes, may lawfully do or cause to be done by virtue
hereof.
PURSUANT TO THE REQUIREMENTS OF THE SECURITIES ACT OF 1934, THIS REPORT HAS
BEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN
THE CAPACITIES AND ON THE DATES INDICATED.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
--------- ----- ----
<S> <C> <C>
/s/ Bradley D. Cooper Chairman and Chief Executive September 30, 1998
____________________________________ Officer (Principal
Bradley D. Cooper Executive Officer)
/s/ Mark Whitaker Chief Financial Officer, September 30, 1998
____________________________________ Executive Vice President of
Mark Whitaker Finance and Treasurer
(Principal Financial and
Accounting Officer)
/s/ Timothy M. Mainprize Director September 30, 1998
____________________________________
Timothy M. Mainprize
/s/ Steven A. Rothstein Director September 30, 1998
____________________________________
Steven A. Rothstein
/s/ Steven Rabinovici Director September 30, 1998
____________________________________
Steve Rabinovici
/s/ Dennis J. Puleo Director September 30, 1998
____________________________________
Dennis J. Puleo
</TABLE>
34
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
Home Security International, Inc.:
Report of Independent Public Accountants................................ 36
Consolidated Statements of Income for the Years Ended June 30, 1996,
1997 and 1998.......................................................... 37
Consolidated Balance Sheets as of June 30, 1997 and 1998................ 38
Consolidated Statements of Cashflows for the Years Ended June 30, 1996,
1997 and 1998.......................................................... 39
Consolidated Statements of Changes in Shareholders' Equity for the Years
Ended June 30, 1996, 1997 and 1998..................................... 40
Notes to Consolidated Financial Statements.............................. 41
FAI Finance Corporation Pty Limited:
Report of Independent Public Accountants................................ 54
Consolidated Statements of Income for the Years Ended June 30, 1996,
1997 and 1998.......................................................... 55
Consolidated Balance Sheets as of June 30, 1997 and 1998................ 56
Consolidated Statements of Cashflows for the Year Ended June 30, 1996,
1997 and 1998.......................................................... 57
Consolidated Statements of Changes in Shareholders' Equity for the Years
Ended June 30, 1996, 1997 and 1998..................................... 58
Notes to Consolidated Financial Statements.............................. 59
</TABLE>
35
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of
Home Security International, Inc.:
We have audited the accompanying consolidated balance sheets of the Home
Security International, Inc. as of June 30, 1998 and 1997, and related
consolidated statements of income, changes in shareholders' equity and cash
flows for each of the three years ended June 30, 1998. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards in Australia, which are substantially similar to generally accepted
auditing standards in the United States of America. Those standards require
that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Home
Security International, Inc. as of June 30, 1998 and 1997, and the results of
its operations and its cash flows for each of the three years ended June 30,
1998 in conformity with generally accepted accounting principles in the United
States of America.
/s/ Arthur Andersen
Sydney
July 24, 1998
36
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE YEARS ENDED JUNE 30,
-------------------------------------
1996 1997 1998
----------- ----------- -----------
NOTE $US $US $US
---- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net sales......................... 2 26,700,922 33,464,595 44,118,502
Cost of goods sold--related party. 15 (2,750,468) (3,647,376) --
--other.................... (14,834,094) (20,626,411) (26,294,641)
----------- ----------- -----------
Gross profit...................... 9,116,360 9,190,808 17,823,861
Management fees received--related
parties.......................... 15 -- 559,002 --
General and administrative
expenses......................... (6,606,377) (6,612,318) (10,810,316)
----------- ----------- -----------
Income from operations............ 2,509,983 3,137,492 7,013,545
Non operating income--other....... -- 6,740 --
Interest income--related party.... 15 75,087 755,613 26,679
--other..................... 175,719 81,790 423,526
Interest expenses--related party.. 15 (47,625) (60,046) (216,629)
--other.................... -- -- (7,904)
----------- ----------- -----------
Income before taxes and equity in
income of affiliated companies... 2,713,164 3,921,589 7,239,217
Income tax expense................ 14 (1,054,170) (1,629,973) (2,111,084)
----------- ----------- -----------
Income before equity in income of
affiliated companies............. 1,658,994 2,291,616 5,128,133
Equity in income of affiliated
companies........................ 10 -- -- 252,417
----------- ----------- -----------
Net income........................ 1,658,994 2,291,616 5,380,550
=========== =========== ===========
Net income per common share
Basic earnings per share........ $ 0.37 $ 0.51 $ 1.05
Diluted earnings per share...... $ 0.37 $ 0.51 $ 1.04
Weighted average number of shares
outstanding
Basic........................... 4,500,000 4,500,000 5,117,125
Diluted......................... 4,500,000 4,500,000 5,181,612
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
37
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
AS OF JUNE 30,
----------------------
1997 1998
---------- ----------
NOTE $US $US
----- ---------- ----------
ASSETS
- ------
<S> <C> <C> <C>
Current assets
Cash and cash equivalents...................... 118 7,006,183
Accounts receivable--related party............. 15 2,025,455 --
Accounts receivable--trade, net................ 3 615,560 874,745
Inventories.................................... 4 1,277,104 2,032,443
Prepaid expenses and other current assets...... 5 449,458 1,173,449
---------- ----------
Total current assets......................... 4,367,695 11,086,820
---------- ----------
Non-current assets
Investment in partnership...................... 9 -- 303,424
Investment in affiliated companies............. 10 -- 7,405,130
Capital assets, net............................ 7 869,571 1,068,237
Intangibles, net............................... 8 10,142,077 9,601,923
Deferred income taxes.......................... 14 549,393 1,016,652
Receivables--related party..................... 15 24,366 --
Other non-current assets....................... 3,748 3,115
---------- ----------
Total non-current assets..................... 11,589,155 19,398,481
---------- ----------
Total assets................................. 15,956,850 30,485,301
========== ==========
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
<S> <C> <C> <C>
Current liabilities
Bank overdraft................................. 31,795 --
Note payable--FAI Insurances Group............. 10,15 -- 619,233
Payables--trade................................ 4,018,147 4,280,422
Accrued warranty............................... 411,778 247,126
Accrued security callout....................... 486,864 382,222
Other accrued liabilities...................... 206,970 148,168
Lease liability................................ 19,068 28,704
Income tax payable............................. 467,961 1,608,648
Deferred income................................ 479,307 650,949
---------- ----------
Total current liabilities.................... 6,121,890 7,965,472
---------- ----------
Non-current liabilities
Note payable--FAI Insurances Group............. 10,15 -- 4,117,902
Lease liability................................ 44,877 33,342
Accrued security callout....................... -- 91,944
Deferred income................................ -- 177,769
---------- ----------
Total non-current liabilities................ 44,877 4,420,957
---------- ----------
Total liabilities............................ 6,166,767 12,386,429
---------- ----------
Shareholders' equity
Preferred stock $.001 value; 1,000,000 shares
authorized, none outstanding.................. -- --
Common stock $.001 value; 20,000,000 shares
authorized and 4,500,000 and 5,150,500 shares
issued and outstanding as of June 30, 1997 and
1998 respectively............................. 18 4,500 5,150
Additional paid-in capital..................... 10,238,691 16,111,311
Secured note................................... 6 -- (2,375,000)
Foreign currency translation reserve........... (406,534) (976,565)
Retained earnings (accumulated losses)......... (46,574) 5,333,976
---------- ----------
Total shareholders' equity................... 9,790,083 18,098,872
---------- ----------
Total liabilities and shareholders' equity... 15,956,850 30,485,301
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
38
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASHFLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED JUNE 30,
----------------------------------
1996 $US 1997 $US 1998 $US
---------- ---------- ----------
<S> <C> <C> <C>
Cashflow from operating activities
Net income............................... 1,658,994 2,291,616 5,380,550
Adjustments to reconcile net income to
net cash from operating activities:
Depreciation........................... 11,192 42,100 181,835
Amortisation of goodwill............... 226,498 391,924 540,154
Equity in income of affiliated
companies............................. -- -- (252,417)
Deferred income taxes.................. (1,143,650) (138,947) (585,314)
Provision for losses on accounts
receivable............................ 58,213 100,715 670,988
Increase in operating assets:
Accounts receivable--trade........... (21,925) (203,120) (1,025,880)
Inventories.......................... (239,731) (965,610) (930,349)
Prepaid expenses and other assets.... (305,224) (33,054) (830,074)
Increase (decrease) in operating
liabilities:
Accounts payable..................... (489,880) 2,159,629 1,051,807
Accrued liabilities.................. 734,742 1,193,531 1,774,149
---------- ---------- ----------
Net cash provided by operating
activities........................ 489,229 4,838,784 5,975,449
---------- ---------- ----------
Cashflow from investing activities
Proceeds from sale of capital assets..... 112,062 -- --
Additions to capital assets.............. (70,701) (871,894) (553,404)
Investment in affiliated companies....... -- -- (2,000,578)
Investment in partnership................ -- -- (303,424)
Short term loans (granted)/repayments
received................................ (3,129) 295,353 23,488
Receipt from/(payments to) related
parties................................. (1,429,568) 2,137,679 1,020,054
Purchase of goodwill..................... -- (271,826) --
Proceeds from sale of investment......... -- 1,914 --
Cash in predecessor entities not
acquired................................ -- (410,302) --
---------- ---------- ----------
Net cash provided by/(used in)
investing activities.............. (1,391,336) 880,925 (1,813,864)
---------- ---------- ----------
Cashflow from financing activities
Dividend and trust distribution paid..... -- (5,294,296) --
Return of capital........................ -- (581,928) --
Capital subscribed....................... -- -- 3,934,678
Share issue costs........................ -- -- (436,408)
Increase (decrease) in bank overdraft.... -- 31,795 (29,055)
---------- ---------- ----------
Net cash provided by (used in)
financing activities.............. -- (5,844,429) 3,469,215
---------- ---------- ----------
Net increase (decrease) in cash held....... (902,107) (124,721) 7,630,800
---------- ---------- ----------
Cash at the beginning of the financial
period.................................... 1,229,501 369,837 118
Effect of exchange rate changes on cash.... 42,443 (244,998) (624,735)
---------- ---------- ----------
Cash at the end of the financial period.... 369,837 118 7,006,183
========== ========== ==========
Supplemental disclosure of cashflow
information:
Interest paid............................ 59,945 515,763 224,533
Income taxes paid........................ 1,279,393 946,230 1,249,831
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
39
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
CAPITAL STOCK FOREIGN
ISSUED ADDITIONAL CURRENCY RETAINED TOTAL
---------------- PAID-IN SECURED TRANSLATION EARNINGS SHAREHOLDERS'
SHARES AMOUNT CAPITAL NOTE RESERVE UNAPPROPRIATED EQUITY
--------- ------ ----------- ----------- ----------- -------------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JUNE 30, 1995.. 2 $ 2 $ 2,085,090 $ -- $ (4,240) $1,831,194 $ 3,912,046
Foreign currency
translation Adjustment. 390,933 390,933
Additional paid-in
capital................ 3,931,854 3,931,854
Net Income 1996......... 1,658,994 1,658,994
--------- ------ ----------- ----------- --------- ---------- -----------
BALANCE, JUNE 30, 1996.. 2 2 6,016,944 -- 386,693 3,490,188 9,893,827
Foreign currency
translation Adjustment. (553,335) (553,335)
Additional paid-in
capital................ 1 1 4,803,675 4,803,676
Net Income 1997......... 2,291,616 2,291,616
Dividends and Trust
Distributions and
return of capital...... (581,928) (5,294,296) (5,876,224)
Reorganisation
Adjustments............ 4,499,997 4,497 (239,892) (534,082) (769,477)
--------- ------ ----------- ----------- --------- ---------- -----------
BALANCE, JUNE 30, 1997.. 4,500,000 4,500 10,238,691 -- (406,534) (46,574) 9,790,083
Foreign currency
translation Adjustment. (570,031) (570,031)
Additional paid-in
capital................ 400,500 400 4,004,600 4,005,000
Issue of shares to
Bradley D. Cooper...... 250,000 250 2,499,750 (2,375,000) 125,000
Less share issue costs.. (631,730) (631,730)
Net Income 1998......... 5,380,550 5,380,550
----------- ----------- --------- ---------- -----------
BALANCE, JUNE 30, 1998
(Note 18).............. 5,150,500 $5,150 $16,111,311 $(2,375,000) $(976,565) $5,333,976 $18,098,872
========= ====== =========== =========== ========= ========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
40
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(ALL AMOUNTS IN US$ UNLESS STATED OTHERWISE)
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(a) Nature of Business--
Home Security International, Inc. ("HSI") was incorporated in the state of
Delaware, United States of America, on April 11, 1997. On June 30, 1997 HSI
acquired from a subsidiary of FAI Insurances Limited the capital stock of FAI
Home Security Pty Limited (incorporated in New South Wales, Australia on
August 13, 1990) and FAI Home Security (ENZED) Limited (incorporated in
Auckland, New Zealand on April 24, 1997) as well as certain tangible and
intangible assets of the United Kingdom (including certain European
countries), South Africa, Canada and the United States of America home
security operations ("International Operations"). Home Security International
(Canada), Inc. (incorporated in Ontario, Canada on July 24, 1997), Home
Security International (UK) Limited (incorporated in Cardiff, United Kingdom
on July 30, 1997) and Home Security International (SA) (Proprietary) Limited
(incorporated in Midrand, South Africa on August 7, 1997) were incorporated
with HSI being sole shareholder to each. HSI and its wholly owned subsidiaries
are all collectively called "the Company". The background to the acquisition
(which was accounted for as a reorganization) is as follows:
FAI Home Security (ENZED) Limited acquired all of the intangible assets,
fixed assets and inventory, net of warranty provision, from FAI Home Security
(NZ) Trust on April 30, 1997. The consideration for the acquisition was the
issue of fully paid ordinary shares for the value of the intangibles, and a
note payable ("NZ Note") of $208,894 for the net intangible assets acquired.
FAI Home Security (NZ) Trust then sold these shares and the NZ Note to FAI
Home Security Holdings Pty Limited on June 30, 1997.
The International Operations were acquired by FAI Home Security Holdings Pty
Limited on March 31, 1997 from various companies controlled by Bradley D.
Cooper (the "Cooper International Group").
As part of the reorganization on June 30, 1997 HSI acquired from FAI Home
Security Holdings Pty Ltd all of the shares of FAI Home Security Pty Limited
and FAI Home Security (ENZED) Limited, plus the NZ Note and the inventory,
fixed assets and intangible assets of the International Operations
("International Assets") in exchange for the issue of 4,499,999 shares, the
issue of a $911,892 note payable to FAI Home Security Holdings Pty Limited
("FAI Note") equivalent to the book value of assets acquired, being $641,138,
plus $270,754, and a further note payable in the amount of $208,894 for the NZ
Note.
The main business activities of the Company are the sale, service and
monitoring of security alarm systems, which are sold via a distributor network
to residential and small business premises in the countries of operations.
The security alarm system, "SecurityGuard", and other major components are
supplied exclusively by Ness Security Products Pty Limited, an unrelated
company based in Sydney, Australia (See Note 18).
On December 31, 1997 the Company acquired 50 percent of the equity interest
in FAI Finance Corporation Pty Limited (together with its subsidiary FAI
Finance Corporation (NZ) Limited, herein called "FFC") from FAI Insurances
Ltd. FFC is a consumer finance company in both Australia and New Zealand and
finances a significant portion of customer accounts financed by the Company's
distributorship network in Australia and New Zealand.
(b) Principles of Consolidation and Basis of Preparation--
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles in the United States
of America ("US GAAP"). The investment in FFC and the Partnership (See Note 9)
are recorded using the equity method.
41
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(ALL AMOUNTS IN US$ UNLESS STATED OTHERWISE)
The acquisition of FAI Home Security Pty Limited and FAI Home Security
(ENZED) Limited was accounted for as a reorganization of entities under common
control on an historic cost basis in a manner similar to a pooling of
interests. The acquisition of the International Operations by HSI's
predecessor and the acquisition of the interest in FFC and the Partnership
were accounted for using the purchase method.
The consolidated statements of income for the years ended June 30, 1997 and
1996 include the financial statements of the Company and FAI Home Security
(NZ) Limited and FAI Home Security (NZ) Trust as those entities were under
common control during those years. Results of the International Operation for
the three months ended June 30, 1997 have been included in the 1997
consolidated financial statements as those operations were acquired by HSI's
predecessor on March 31, 1997.
All intercompany accounts and transactions have been eliminated upon
consolidation.
(c) Cash and Cash Equivalents--
Cash equivalents consist of short-term investments with maturities of three
months or less and are stated at cost, which approximates market.
(d) Foreign Currencies--
The consolidated financial statements are translated into US dollars to
reflect the Company's reporting currency. The assets and liabilities are
translated at the balance sheet date exchange rate. The profit and loss items
have been translated at the average exchange rates for the fiscal year. The
resulting translation effects are reflected in shareholders' equity.
The functional currency of FAI Home Security (ENZED) Limited is New Zealand
dollars, for FAI Home Security Pty Limited is Australian dollars, for Home
Security International (UK) Limited is British Pound Sterling, for Home
Security International (Canada), Inc. is Canadian dollars, and for Home
Security International (SA)(Proprietary) Limited is the South African Rand.
(e) Use of Estimates--
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates, and such
differences may be material to the financial statements.
(f) Income Taxes--
The Company accounts for income taxes under Statement of Financial
Accounting Standards ("SFAS") No. 109 ("Accounting for Income Taxes") which
requires an asset and liability method of accounting for income taxes. Under
SFAS No. 109, deferred tax assets and liabilities are recognized for the
future tax consequences attributable to differences between the financial
statement carrying amount of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the year in which
those temporary differences are expected to be recovered or settled. Under
SFAS No. 109, the effect on deferred tax assets and liabilities of a change in
tax rates is recognized in income in the period that includes the enactment
date.
42
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(ALL AMOUNTS IN US$ UNLESS STATED OTHERWISE)
(g) Revenue Recognition--
Revenue is recognized at the time of shipment of products and is shown net
of returns and rebates. The Company also sells extended product warranties for
periods of one to two years and the revenue derived is recognized on a
straight-line basis over the life of the warranties. All unearned portions of
the warranties are treated in the balance sheet as "Deferred Income".
(h) Allowance for Doubtful Accounts--
Management reviews the collectability of accounts receivable on a regular
basis. Amounts, if any, which are determined to be uncollectable, are provided
for in the financial statements in the period such determination is made.
(i) Inventories--
Inventories consist of wholesale stock and sales aids and are stated at the
lower of cost (first-in, first-out method) or market.
(j) Capital assets--
Capital assets are recorded at cost. Maintenance and repairs are expensed in
the period to which they relate. Depreciation on capital assets is calculated
using the straight-line method over the following estimated useful lives of
the assets:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Furniture and fixtures........................................... 8.0
Office equipment................................................. 8.0
Motor vehicles................................................... 6.5
Computer equipment............................................... 3.5
Leasehold improvements........................................... 3.0
</TABLE>
(k) Research and Development--
The Company has no significant research and development activities.
(l) Pension and Other Benefit Plans--
The Company contributes to a pension plan on behalf of its employees. The
pension plan is an accumulation fund and the Company has no liability to
members under the plan. The Company has no other pension or other employment
benefit plans.
(m) Intangible Assets--
Intangible assets represent the excess of cost over fair value of assets
acquired and are amortized using the straight-line method over twenty years.
The carrying value of intangible assets is periodically reviewed by management
based on the expected future undiscounted operating cash flows of the related
business unit. Based upon its most recent analysis, management believes that
no material impairment of intangible assets exists at June 30, 1998.
The excess of cost over fair value of the assets of FFC acquired will be
amortized using the straight-line method over twenty years and will be
recognized as part of the Company's equity in net income of FFC.
43
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(ALL AMOUNTS IN US$ UNLESS STATED OTHERWISE)
(n) Warranty--
The Company warrants its products against defects in design, materials and
workmanship for one year from the date of installation. A provision for
estimated warranty costs is recorded based on management's best estimate of
future warranty costs. Management's estimate is based upon historical warranty
costs and is periodically adjusted to reflect actual experience. Changes in
these estimates could result in an adjustment to the provision maintained.
(o) Security call-out--
The Company provides a security call-out service for emergency response for
five years from the date of installation. A provision for estimated security
call-outs is recorded based on management's best estimate of future security
call-out costs. Management's estimate is based upon historical security call-
out costs and is periodically adjusted to reflect actual experience. Changes
in these estimates could result in an adjustment to the provision maintained.
(p) Derivative Financial Instruments--
The Company periodically enters into forward currency exchange contracts and
options to manage the risk of foreign currency fluctuations, since a
significant portion of its sales are in foreign currencies. The change in fair
value of the contracts is recognized immediately and included in the
determination of net income. The Company is not a trader in derivative
securities, and it has not used speculative derivative products for the
purpose of generating earnings from changes in market conditions.
(q) Earnings per Share--
Earnings per share have been computed according to the provisions of SFAS
No. 128, ("Earnings Per Share") using the weighted average number of shares
outstanding and assuming the 1997 reorganization occurred as of January 1,
1996. Diluted earnings per share have been computed based on the assumption
that all stock options have been exercised.
(r) Stock Option Plan--
The Company accounts for its stock option plans (the "Option Plans") in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, ("Accounting for Stock Issued to Employees"). As such, compensation
expense is recorded on the date of grant only if the current market price of
the underlying stock exceeds the exercise price. FASB Statement No. 123, which
became effective in 1996, allows entities to continue to apply the provisions
of APB Opinion No. 25 but requires pro forma net earnings and pro forma
earnings per share disclosures for employee stock option grants made in 1995
and thereafter as if the fair-value-based method defined in SFAS No. 123 had
been applied. The Company has determined that the net income and net income
per common share would not be materially affected by the provision of SFAS No.
123.
(s) New Accounting Pronouncements--
SFAS No. 130, ("Reporting Comprehensive Income") was issued in June 1997 and
will be adopted by the Company effective July 1, 1998. This new pronouncement
establishes standards for reporting and display of comprehensive income and
its components. Adoption of this standard will not impact the Company's
financial position or results of operations.
44
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(ALL AMOUNTS IN US$ UNLESS STATED OTHERWISE)
SFAS No. 131, ("Disclosure about Segments of an Enterprise and Related
Information") was issued in June 1997 and will be adopted by the Company
effective July 1, 1998. SFAS No. 131 introduces a new model for segment
reporting called the "management approach". The management approach is based
on the way that the chief operating decision maker organizes segments within
the company for making operating decisions and assessing performance.
Management of the Company is evaluating this new pronouncement to determine
its impact upon current reporting.
SFAS No. 132, ("Employers, Disclosure about Pensions and Other Post
Retirement Benefits") was issued in February 1998 and will be adopted by the
Company effective July 1, 1998. This new pronouncement standardizes employers'
disclosures about pension and other post retirement benefit plans. It does not
change the measurement or recognition of these plans. Adoption of this
standard will not have a material impact on the Company's financial position
or results of operations.
NOTE 2: NET SALES
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
----------------------------------
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
Direct retail sales................... 1,366,926 -- --
Distributor sales..................... 25,053,110 33,183,267 42,858,457
Other................................. 497,637 516,601 1,553,592
---------- ---------- ----------
Gross sales........................... 26,917,673 33,699,868 44,412,049
Less: Returns and rebates............. (216,751) (235,273) (293,547)
---------- ---------- ----------
Net sales............................. 26,700,922 33,464,595 44,118,502
========== ========== ==========
</TABLE>
NOTE 3: ACCOUNTS RECEIVABLE-TRADE
<TABLE>
<CAPTION>
JUNE 30,
-------------------
1997 1998
-------- ---------
<S> <C> <C>
Accounts receivable.................................. 745,280 1,643,980
Less: Allowances for doubtful accounts............... (129,720) (769,235)
-------- ---------
615,560 874,745
======== =========
</TABLE>
NOTE 4: INVENTORIES
<TABLE>
<CAPTION>
JUNE 30,
-------------------
1997 1998
--------- ---------
<S> <C> <C>
Wholesale stock....................................... 879,476 1,727,670
Sales aids............................................ 397,628 304,773
--------- ---------
1,277,104 2,032,443
========= =========
</TABLE>
NOTE 5: PREPAID EXPENSES AND OTHER CURRENT ASSETS
<TABLE>
<CAPTION>
JUNE 30,
-----------------
1997 1998
------- ---------
<S> <C> <C>
Prepayments............................................. 210,556 557,355
Sundry debtors.......................................... 238,902 616,094
------- ---------
449,458 1,173,449
======= =========
</TABLE>
45
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(ALL AMOUNTS IN US$ UNLESS STATED OTHERWISE)
NOTE 6: SECURED NOTE
The Company has issued 250,000 shares at par value $0.001 to Bradley D.
Cooper in exchange for cash of $125,000 and the issuance of a five year, 7.0%
semi-annual interest bearing note secured by the shares issued to the value of
$2,375,000.
NOTE 7: CAPITAL ASSETS
<TABLE>
<CAPTION>
JUNE 30,
------------------
1997 1998
------- ---------
<S> <C> <C>
Furniture and fixtures................................ 216,064 204,373
Office equipment...................................... 157,051 236,610
Motor vehicles........................................ 164,884 273,373
Computer equipment.................................... 255,764 402,906
Leasehold improvements................................ 114,140 180,895
Less: Accumulated depreciation........................ (38,332) (229,920)
------- ---------
869,571 1,068,237
======= =========
</TABLE>
NOTE 8: INTANGIBLES
<TABLE>
<CAPTION>
JUNE 30,
----------------------
1997 1998
---------- ----------
<S> <C> <C>
Goodwill on investment............................ 10,803,072 10,803,072
Less: Accumulated amortization.................... (660,995) (1,201,149)
---------- ----------
10,142,077 9,601,923
========== ==========
</TABLE>
Goodwill represents the excess of the purchase price paid by the then
ultimate parent entity, FAI Insurances Limited over the fair value of assets
acquired as part of the reorganization.
NOTE 9: INVESTMENT IN PARTNERSHIP
Effective June 30, 1998, the Company purchased a 49 percent interest in
Bayside Partnership (the "Partnership") that subsequently entered into an
agreement with Prime Life Corporation Limited to acquire a retirement village
in Melbourne, Australia. The $303,424 investment in the Partnership was
accounted for using the equity method.
In addition to the Company's interest in the Partnership two senior
management personnel also purchased a combined interest in the Partnership of
30 percent.
NOTE 10: INVESTMENT IN AFFILIATED COMPANIES
On December 31, 1997 the Company purchased 50 percent of the issued and
outstanding shares (the "FFC Shares") of FAI Finance Corporation Pty Limited
and its subsidiary FAI Finance Corporation (NZ) Limited (FFC) from FAI
Insurances Ltd (the "FFC Transaction"). FFC, a consumer finance company with
operations in Australia and New Zealand, finances a significant portion of the
Company's financed sales.
As part of the FFC Transaction, the Company received an option (the "FFC
Option"), at no additional cost, exercisable within four years of the date of
the FFC Transaction, to purchase the remaining 50 percent interest in FFC for
the same consideration plus 50 percent of the net change in FFC's retained
earnings from the date of the FFC Transaction until the date the FFC Option is
exercised. If the FFC Option is exercised, the
46
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(ALL AMOUNTS IN US$ UNLESS STATED OTHERWISE)
purchase price will be financed by FAI Insurances over a four year period from
the date the FFC Option is exercised on terms comparable to the FFC Note (as
defined below).
The purchase price of $6,866,000, including direct costs incurred during the
acquisition, was allocated to the net assets of FFC based on the estimated
fair market values. As a result of the allocation, $5,890,000 of the purchase
price was allocated to goodwill.
Included in the consolidated statements of income is the Company's
proportionate share of FFC earnings, less amortization of goodwill, for the
period from January 1, 1998 to June 30, 1998.
During the year, FFC declared a dividend of $1,857,600. The Company has
classified its 50 percent share as "Investment in affiliated companies", as
the receivable is to be reinvested in FFC within the next fiscal year.
Also included in "Investment in affiliated companies" is an unsecured, non-
interest bearing loan to FFC, repayable on demand, of $309,600.
The purchase price for the FFC Shares was paid through the issuance of a
five year promissory note (the "FFC Note"), bearing interest at 7.75% per
annum, secured by the FFC Shares. Principal payments, which are payable in
Australian dollars, are due on the following dates;
<TABLE>
<S> <C>
December 31--
1998........................................................ 619,233
1999........................................................ 1,238,400
2000........................................................ 1,238,400
2001........................................................ 1,238,400
2002........................................................ 402,702
---------
4,737,135
=========
</TABLE>
NOTE 11: FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts reflected in the consolidated balance sheets for cash
equivalents, accounts receivable and payable approximate their respective fair
values due to the short maturities of those instruments. The carrying value of
the long-term payable to FAI Insurances Limited approximates its fair value as
the loan was granted on December 31, 1997 at market rates which have not
changed significantly.
NOTE 12: LEASE COMMITMENTS
The operating lease commitments of the Company consist of property rentals
and computer equipment leases.
<TABLE>
<CAPTION>
JUNE 30,
---------------
1997 1998
------- -------
<S> <C> <C>
Payable not later than one year.......................... 181,166 175,094
Payable later than one year but not later than two years. 181,166 175,094
Payable later than two years but not later than three
years................................................... 179,243 159,536
Payable later than three years but not later than four
years................................................... 173,717 100,204
Payable later than four years but not later than five
years................................................... 126,143 --
------- -------
841,435 609,928
======= =======
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-----------------------
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Rental expense.................................... 218,610 214,229 316,220
======= ======= =======
</TABLE>
47
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(ALL AMOUNTS IN US$ UNLESS STATED OTHERWISE)
NOTE 13: SEGMENT INFORMATION
The Company operates principally in one industry segment including the sale,
service and monitoring of security alarm systems. The Company's area of
current operations is principally in Australia and New Zealand with start-up
operations in the United Kingdom, Europe, Canada, USA and South Africa. No
single customer accounts for more than 10% of the Company's revenues.
Information about the Company's operations split by geographic location is
shown below.
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
----------------------------------
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
Net sales:
Australia......................... 21,937,533 22,488,078 31,361,814
New Zealand....................... 4,763,389 10,327,184 7,622,952
United Kingdom.................... -- 547,083 3,469,824
South Africa...................... -- -- 921,770
Canada............................ -- 102,250 742,142
United States..................... -- -- --
---------- ---------- ----------
26,700,922 33,464,595 44,118,502
========== ========== ==========
Income (loss) from operations before
related party royalty payment:
Australia......................... 3,707,419 3,956,520 7,238,129
New Zealand....................... 1,553,032 2,839,174 1,111,518
United Kingdom.................... -- 90,175 (124,231)
South Africa...................... -- (8,481) 105,137
Canada............................ -- (40,400) (854,025)
United States..................... -- (52,120) (462,983)
---------- ---------- ----------
5,260,451 6,784,868 7,013,545
Less: Related party royalty
payments........................... (2,750,468) (3,647,376) --
---------- ---------- ----------
2,509,983 3,137,492 7,013,545
========== ========== ==========
Income (loss) from operations:
Australia......................... 1,448,608 1,457,489 7,238,129
New Zealand....................... 1,061,375 1,690,829 1,111,518
United Kingdom.................... -- 90,175 (124,231)
South Africa...................... -- (8,481) 105,137
Canada............................ -- (40,400) (854,025)
United States..................... -- (52,120) (462,983)
---------- ---------- ----------
2,509,983 3,137,492 7,013,545
========== ========== ==========
Depreciation:
Australia......................... 11,192 36,453 161,421
New Zealand....................... -- 3,757 3,221
United Kingdom.................... -- -- 11,434
South Africa...................... -- -- --
Canada............................ -- 2,225 5,759
United States..................... -- -- --
---------- ---------- ----------
11,192 42,435 181,835
========== ========== ==========
</TABLE>
48
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(ALL AMOUNTS IN US$ UNLESS STATED OTHERWISE)
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-----------------------
1996 1997 1998
------- ------- -------
<S> <C> <C> <C>
Amortization...................................... 226,498 391,924 540,154
======= ======= =======
Capital expenditure:
Australia....................................... 70,701 856,205 551,668
New Zealand..................................... -- 9,696 20,448
United Kingdom.................................. -- -- 42,305
South Africa.................................... -- -- --
Canada.......................................... -- 43,648 26,897
United States................................... -- -- --
------- ------- -------
70,701 909,549 641,318
======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
JUNE 30,
---------------------
1997 1998
---------- ----------
<S> <C> <C>
Identifiable assets:
Australia......................................... 13,055,853 18,164,341
New Zealand....................................... 430,468 518,269
United Kingdom.................................... 418,863 1,765,934
South Africa...................................... 24,368 188,227
Canada............................................ 183,631 882,889
United States..................................... 1,843,549 1,959,458
---------- ----------
15,956,732 23,479,118
Corporate assets.................................. 118 7,006,183
---------- ----------
15,956,850 30,485,301
========== ==========
</TABLE>
Identifiable assets are those assets that are identified with the operation
in each geographic area. Corporate assets are principally cash and short-term
deposits.
NOTE 14: INCOME TAX
The actual income tax expense attributable to net income differed from the
amounts computed by applying local federal tax rates to income before taxes as
a result of the following:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-------------------------------
1996 1997 1998
--------- --------- ---------
<S> <C> <C> <C>
Expected income tax expense at statutory
rates.................................. 940,639 1,351,883 2,657,809
Tax effect of permanent and other
differences:
Over provision for income tax in prior
years................................ (862) (8,538) (5,622)
Deduction allocated from Investment in
Partnership.......................... -- -- (600,609)
Non-deductible expenses and other
items................................ 32,854 145,535 (129,548)
Amortization of goodwill.............. 81,539 141,093 189,054
--------- --------- ---------
1,054,170 1,629,973 2,111,084
========= ========= =========
The tax expense is split between:
Current............................... 699,653 1,711,286 2,578,343
Deferred.............................. 354,517 (81,313) (467,259)
--------- --------- ---------
1,054,170 1,629,973 2,111,084
========= ========= =========
</TABLE>
49
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(ALL AMOUNTS IN US$ UNLESS STATED OTHERWISE)
FAI Home Security Pty Limited purchased tax losses on June 30, 1996 from FAI
Home Security Holdings Pty Limited and FAI Insurances Limited for $110,202 and
$766,344, respectively. These tax losses were utilized during the 1996
financial year by offsetting them against taxable income.
The Australian government is contemplating certain revisions to its tax laws
which may be applied retroactively and have an adverse effect on the Company's
tax position. In accordance with SFAS No. 109, Accounting For Income Taxes,
such effects of tax law changes are not reflected on the financial statements
until enacted.
<TABLE>
<CAPTION>
JUNE 30,
------------------
1997 1998
------- ---------
<S> <C> <C>
Deferred tax assets are comprised of timing
differences on:
Provisions not currently deductible for tax
purposes for:
Doubtful accounts.............................. 46,982 216,023
Warranty....................................... 118,293 87,373
Security call-out.............................. 126,563 146,003
Extended warranty.............................. 172,550 295,046
Other.......................................... 60,851 29,130
Sundry accruals.................................. 29,638 11,146
Tax losses carried forward....................... -- 352,898
Prepayments...................................... (5,484) (120,967)
------- ---------
Net deferred tax assets............................ 549,393 1,016,652
======= =========
</TABLE>
NOTE 15: RELATED PARTY TRANSACTIONS
At June 20, 1997, FAI Finance Corporation (NZ) Limited was related by the
majority holding of the then ultimate parent entity of FFC and the Company,
FAI Insurances Limited.
Interest has been charged on all amounts due to or payable from all related
parties, with the exception of the amount payable to FAI Home Security Pty
Limited, a subsidiary of the Company, by its previous parent, FAI Home
Security Holdings Pty Limited, which was non-interest bearing. Interest has
been charged in arrears at an annualized commercial rate on a monthly basis.
Management fees charged to or received from related parties are an
apportionment of overhead costs incurred by the relevant related entity.
During fiscal 1997, FAI Home Security Pty Limited incurred staff and
administration costs on behalf of FAI Home Security Holdings Pty Limited,
whereas FAI Finance Corporation (NZ) Limited incurred costs to administer the
New Zealand customer loan book.
During the years ended June 30, 1996 and 1997 royalties were paid to the
Company's then ultimate parent entity, FAI Insurances Limited, for naming
rights in relation to all business conducted by the Company. The basis of
royalty payments was 6% of the final retail value of sales made by the Company
entities and its distributors. No further royalties were charged for the use
of the FAI trade name after July 1, 1997.
FAI General Insurance Company Limited, a subsidiary of FAI Insurances Ltd,
leases office space to FAI Home Security Pty Limited at a commercial rate.
<TABLE>
<CAPTION>
JUNE 30,
--------------
1997 1998
--------- ----
<S> <C> <C>
Amounts due from related parties:
Current assets:
FAI Home Security Holdings Pty Limited................. 2,025,455 --
Non-current assets:
FAI Secure Home Finance Pty Limited.................... 24,366 --
</TABLE>
50
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(ALL AMOUNTS IN US$ UNLESS STATED OTHERWISE)
The FAI Secure Home Finance Pty Limited loan was unsecured and non-interest
bearing. The FAI Home Security Holdings Pty Limited loan was unsecured and
non-interest bearing until June 30, 1997. As of July 1, 1997 interest was
charged on the loan at the Westpac Bank indicator rate.
<TABLE>
<CAPTION>
JUNE 30,
--------------
1997 1998
---- ---------
<S> <C> <C>
Amounts due to related party:
Current liabilities:
FAI Insurances Limited................................. -- 619,233
Non-current liabilities:
FAI Insurances Limited................................. -- 4,117,902
</TABLE>
The above loans relate to the acquisition of FFC. Refer to Note 10 for
further details on the terms and conditions of the loans.
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
---------------------------
1996 1997 1998
--------- --------- -------
<S> <C> <C> <C>
Net income is stated after the following
items:
Interest on direct advances to:
FAI Insurances Limited.................. 47,625 60,046 --
Non exclusive database license fee paid by
FAI Insurances Limited to:
FAI Home Security Pty Limited........... -- -- 338,362
FAI Home Security (ENZED) Limited....... -- -- 72,207
Royalty fees paid to:
FAI Insurances Limited.................. 2,750,468 3,647,376 --
Interest on loans paid to:
FAI Insurances Limited.................. -- -- 216,629
Interest on loans received from:
FAI Home Security Holdings Pty Limited.. -- -- 26,679
FAI Finance Corporation (NZ) Ltd........ 75,087 755,613 --
Management fees paid to:
FAI Finance Corporation (NZ) Ltd........ 43,628 58,394 --
Management fees received from:
FAI Home Security Holdings Pty Limited.. -- 559,002 --
Office rentals paid to:
FAI General Insurance Company Limited... 218,613 213,240 207,870
Computer rentals paid to:
FAI Home Security Holdings Pty Limited.. 96,925 92,937 --
</TABLE>
NOTE 16: STOCK OPTION PLANS
The Company has two stock option plans.
1997 Stock Option Plan. The Company has adopted the 1997 Stock Option Plan
(the "1997 Plan"), under which the Compensation Committee may grant options to
purchase up to an aggregate of 750,000 shares of Common Stock to management,
employees and advisers of the Company. The 1997 Plan provides for the grant
51
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(ALL AMOUNTS IN US$ UNLESS STATED OTHERWISE)
of stock options ("Options"), including incentive stock options within the
meaning of Section 422 of the United States Internal Revenue Code of 1986, as
amended (the "Code"), and non-statutory stock options that do not qualify as
stock options under Section 422 of the Code ("Non-Statutory Options"). The
Company has issued a total of 750,000 options under the 1997 Stock Option
Plan, all at an exercise price of $10.00 per share, including 250,000 to Mr.
Cooper, 90,000 to Mr. Youngman and 80,000 to each of Mr. Whitaker and Ms.
Hilbert, granted on July 15, 1997 and 165,000 to Mr. Appleby and 85,000 to Mr.
Knowles, granted on April 8, 1998. Each of these Options vests in annual 20%
increments over a five year period, with the first 20% vested and exercisable
on the first anniversary of the grant date, except that 85,000 Options granted
to Mr. Appleby and 55,000 Options granted to Mr. Knowles will vest in
increments upon the Company achieving certain unit sales numbers outside of
Australia and New Zealand prior to June 30, 1999 or if the Company fails to
achieve the targeted unit sales number on October 31, 2003.
1997 Non-Employee Director Stock Option Plan. The Company has adopted the
1997 Non-Employee Director Stock Option Plan, under which 50,000 shares of
Common Stock have been authorized for issuance. Upon the closing of the
Company's initial stock offering ("IPO"), all four non-employee directors
received options to purchase 5,000 shares of Common Stock at $10.00 per share
under the 1997 Non-Employee Director Stock Option Plan. Commencing with the
first annual meeting of the shareholders following the IPO, all non-employee
directors continuing to serve as such will receive, on the day following each
annual meeting, options to purchase an additional 2,500 shares of Common Stock
at an exercise price equivalent to the market price of the stock on the date
of such grant. All such grants will be Non-Statutory Options. The Options
granted under the 1997 Non-Employee Director Stock Option Plan are exercisable
beginning six months from the date of grant.
NOTE 17: DERIVATIVES
During the year ended June 30, 1998 the Company had entered into a forward
currency exchange contract with a maturity date of June 30, 1998. Under the
contract the Company agreed to sell AUD$1,000,000 and to receive $680,000 on
maturity.
The Company also entered into two foreign currency options, which matured on
June 30, 1998. The Company has purchased an Australian dollar put / United
States dollar call for AUD$2,500,000 with an exercise price of AUD$1 = $0.72
and has sold an Australian dollar call / United States dollar put for
AUD$2,500,000 with an exercise price of AUD$1 = $0.7461.
The above derivatives were closed out on June 26, 1998. For the year ended
June 30, 1998 the Company recorded a gain of $355,000 on its derivatives. As
at June 30, 1998 the Company has no outstanding derivative contracts.
NOTE 18: SUBSEQUENT EVENTS
(a) Proposed share offering--
On July 20, 1998 a Form S-1 was filed with the Securities and Exchange
Commission for the issuance of up to a maximum of 1,495,000 shares of common
stock of the Company.
52
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)
(ALL AMOUNTS IN US$ UNLESS STATED OTHERWISE)
(b) Ness transaction (unaudited)--
On July 17, 1998, the Company entered into an agreement, amended as of
September 30, 1998 whereby the Company will purchase all of the issued and
outstanding common stock of International Integrated Home Security Limited
("IIHSL"), a British Virgin Islands holding company (the "Ness Transaction").
IIHSL is the holder of 75.04 percent of the issued and outstanding common
stock of Ness Security Products Pty Limited ("Ness"). Ness is a leading
manufacturer of security alarm products in Australia and the Company's sole
supplier of the SecurityGuard alarm. The purchase price for the issued and
outstanding common stock of IIHSL will consist of the following: (i) 400,000
shares of the Company's Common Stock, (ii) warrants immediately exercisable
into 360,000 shares of Common Stock at an exercise price of $13.00, until the
year 2003 and (iii) $11,398,000 in cash and a secured promissory note.
53
<PAGE>
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Shareholders of FAI Finance Corporation Pty
Limited:
We have audited the accompanying consolidated balance sheet of FAI Finance
Corporation Pty Limited as of June 30, 1998 and 1997 and the related
consolidated statements of income, changes in shareholders' equity and cash
flows for each of the three years in the period ended June 30, 1998. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards in Australia, which are substantially similar to generally accepted
auditing standards in the United States of America. Those standards require
that we plan and perform the audits to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the
accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe
that our audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of FAI
Finance Corporation Pty Limited as of June 30, 1998 and 1997 and the results
of its operations and its cash flows for each of the three years in the period
ended 30 June 1998 in conformity with generally accepted accounting principles
in the United States of America.
/s/ Arthur Andersen
Sydney
August 20, 1998
54
<PAGE>
FAI FINANCE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
---------------------------------
1996 1997 1998
NOTE $US $US $US
---- --------- ---------- ----------
<S> <C> <C> <C> <C>
Interest income........................ 2,814,877 6,399,516 8,589,957
Interest expenses--related party....... 11 (75,087) (755,741) (1,297,681)
--other......................... (145,479) (1,170,662) (1,154,521)
--------- ---------- ----------
Net interest income.................... 2,594,311 4,473,113 6,137,755
Management fee income related party.... 11 43,628 61,675 69,075
--------- ---------- ----------
Operating revenues..................... 2,637,939 4,534,788 6,206,830
General and administrative expenses--
other................................. 4 (888,377) (2,042,788) (3,001,603)
Bad debts and allowance for losses..... 2 (402,017) (807,800) (766,270)
--------- ---------- ----------
Income before taxes.................... 1,347,545 1,684,200 2,438,957
Income tax expense..................... 10 (491,898) (580,205) (919,232)
--------- ---------- ----------
Net income ............................ 855,647 1,103,995 1,519,725
========= ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
55
<PAGE>
FAI FINANCE CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
JUNE 30,
----------------------
1997 1998
---------- ----------
ASSETS NOTE $US $US
- ------ ---- ---------- ----------
<S> <C> <C> <C>
Cash and cash equivalents......................... 5 211,096 241,889
Receivables 2
Consumer loans.................................. 29,780,843 38,138,274
Business finance loans.......................... 1,020,528 592,076
---------- ----------
Total receivables............................. 30,801,372 38,730,350
Less: Allowance for losses of receivables....... 2 550,974 592,709
---------- ----------
Net receivables............................... 30,250,398 38,137,641
Prepaid expenses and other current assets......... 6 684,198 873,729
Restricted Deposits............................... 7,14 893,588 913,553
Plant and equipment, net.......................... 8 343,050 410,415
Deferred income taxes............................. 10 208,814 209,319
Intangibles....................................... 9 296,440 232,387
---------- ----------
Total assets.................................. 32,887,583 41,018,933
========== ==========
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
- ------------------------------------
<S> <C> <C> <C>
Bank overdraft.................................... 1,541,954 441,916
Borrowing Westpac Banking Corporation............. 14 11,641,113 16,260,681
Payables trade.................................... 84,793 637,975
Accrued liabilities............................... 43,141 55,532
Provision for interim dividend.................... -- 1,857,700
Income tax payable................................ 1,063 375,645
Payables related party............................ 11 17,445,050 20,582,441
---------- ----------
Total liabilities............................. 30,757,113 40,211,890
---------- ----------
Shareholders' equity
Common stock ($A1.00 value; 100,000 shares
authorized; 50,002 shares outstanding)......... 36,976 36,976
Additional paid in capital...................... 335,592 335,592
Foreign currency translation reserve............ (64,101) (1,049,553)
Retained earnings............................... 1,822,003 1,484,028
---------- ----------
Total shareholders' equity.................... 2,130,470 807,043
---------- ----------
Total liabilities and shareholders' equity.... 32,887,583 41,018,933
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
56
<PAGE>
FAI FINANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASHFLOWS
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-------------------------------------
1996 1997 1998
$US $US $US
----------- ----------- -----------
<S> <C> <C> <C>
Cashflow from operating activities
Net income............................ 855,647 1,103,995 1,519,725
Adjustments to reconcile net income to
net cash from Operating activities:
Depreciation........................ 24,860 55,318 127,353
Amortization of goodwill............ 17,185 35,020 15,333
Deferred taxes and income tax
payable............................ 43,308 (613,974) 364,378
Provision for losses on term loans
receivable......................... 257,633 279,192 150,871
(Increase) decrease in operating
assets:
Prepaid expenses and other assets. (244,198) (450,320) (332,444)
Increase (decrease) in operating
liabilities:
Accounts payable.................. 201,529 7,443 639,357
Accrued liabilities............... (15,679) 12,306 21,888
----------- ----------- -----------
Net cash provided by operating
activities..................... 1,140,285 428,980 2,506,461
----------- ----------- -----------
Cashflow from investing activities
Additions to plant and equipment...... (107,277) (258,225) (273,951)
Term loans funded..................... (22,930,642) (33,411,428) (53,485,579)
Collection of principal............... 9,950,145 23,706,843 38,112,514
----------- ----------- -----------
Net cash used in investing
activities..................... (13,087,774) (9,962,810) (15,647,106)
----------- ----------- -----------
Cashflow from financing activities
Net proceeds from borrowings.......... 8,444,131 (420,924) 7,244,019
Decrease in restricted deposits....... (788,600) (104,988) (188,062)
Receipts from related parties......... 3,890,195 8,679,306 7,094,301
Increase (decrease) in bank overdraft. 11,819 1,530,134 (923,065)
----------- ----------- -----------
Net cash provided by financing
activities..................... 11,557,545 9,683,528 13,227,193
----------- ----------- -----------
Net increase (decrease) in cash held.... (389,944) 149,699 86,638
----------- ----------- -----------
Cash at the beginning of the financial
period................................. 379,406 17,576 211,096
Effect of exchange rate change on cash.. 28,114 43,821 (55,845)
----------- ----------- -----------
Cash at the end of the financial period. 17,576 211,096 241,889
=========== =========== ===========
Supplemental disclosure of cashflow
information
Interest paid......................... 220,566 755,742 2,452,201
Income taxes paid..................... 497,783 1,200,788 286,592
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
57
<PAGE>
FAI FINANCE CORPORATION
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
CAPITAL STOCK
ISSUED
($1 AUSTRALIAN ADDITIONAL FOREIGN RETAINED TOTAL
DOLLAR PAID-IN CURRENCY EARNINGS CASH SHAREHOLDERS'
PAR VALUE) AMOUNT CAPITAL TRANSLATION UNAPPROPRIATED DIVIDEND EQUITY
SHARES $US $US RESERVE $US $US $US $US
-------------- ------- ---------- ----------- -------------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JUNE 30, 1995.. 50,002 36,976 335,592 (14,151) (137,639) -- 220,778
Foreign currency
translation adjustment 50,729 50,729
Net income 1996......... 855,647 855,647
------ ------- -------- ----------- ---------- ----------- ----------
BALANCE, JUNE 30, 1996.. 50,002 36,976 335,592 36,578 718,008 -- 1,127,154
Foreign currency
translation adjustment. (100,679) (100,679)
Net income 1997......... 1,103,995 1,103,995
------ ------- -------- ----------- ---------- ----------- ----------
BALANCE, JUNE 30, 1997.. 50,002 36,976 335,592 (64,101) 1,822,003 -- 2,130,470
Foreign currency
translation Adjustment. (985,452) (985,452)
Net income 1998......... 1,519,725 1,519,725
Cash dividend declared
($36.15 per share)..... (1,857,700) (1,857,700)
------ ------- -------- ----------- ---------- ----------- ----------
BALANCE, JUNE 30, 1998.. 50,002 $36,976 $335,592 $(1,049,553) $3,341,728 $(1,857,700) $ 807,043
====== ======= ======== =========== ========== =========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
58
<PAGE>
FAI FINANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1: NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
(a) Nature of Business--
FAI Finance Corporation Pty Ltd was incorporated in New South Wales,
Australia on October 15, 1991 and FAI Finance Corporation (NZ) Ltd was
incorporated in Auckland, New Zealand on May 23, 1996. The capital stock of
FAI Finance Corporation (NZ) Ltd is owned by FAI Finance Corporation Pty Ltd.
FAI Finance Corporation Pty Ltd and FAI Finance Corporation (NZ) Ltd,
collectively ("FFC") or ("FAI Finance Corporation") is a consumer and business
finance company operating in Australia and New Zealand. The main business
activity of FFC is the sale and management of consumer, commercial and
business finance products. Currently more than 80 percent of all consumer
loans arise from financing of sales made by Home Security International, Inc's
("the Company") distributor network in Australia and New Zealand.
(b) Principles of Consolidation and Basis of Preparation--
The consolidated financial statements comprise the accounts of FAI Finance
Corporation Pty Limited and its controlled entity FAI Finance Corporation (NZ)
Ltd and have been prepared in accordance with generally accepted accounting
principles in the United States of America ("US GAAP").
All intercompany accounts and transactions have been eliminated.
(c) Cash and Cash Equivalents--
Cash equivalents consist of short-term investments with maturities of three
months or less and are stated at cost, which approximates market.
(d) Foreign Currencies--
The consolidated financial statements of FFC are translated into US dollars
to reflect the reporting currency of the Company. The assets and liabilities
of FFC are translated at the balance sheet date exchange rate. The profit and
loss items of FFC have been translated at the average exchange rates for each
period. The resulting translation effects are reflected in shareholders'
equity.
The functional currency of FAI Finance Corporation Pty Limited is Australian
dollars and the functional currency of FAI Finance Corporation (NZ) Ltd is New
Zealand dollars.
(e) Use of Estimates--
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ from those estimates, and such
differences may be material to the financial statements.
(f) Income Taxes--
FFC accounts for income taxes under Statement of Financial Accounting
Standards ("SFAS") No. 109 ("Accounting for Income Taxes") which requires an
asset and liability method of accounting for income taxes. Under SFAS No. 109,
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amount of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the year in which those temporary
differences are expected to be recovered or settled. Under SFAS No. 109, the
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date.
59
<PAGE>
FAI FINANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(g) Receivables--
Receivables are presented net of unearned interest. Unearned interest is
amortized to interest income using the effective interest method over the life
of the related loan or commitment period.
(h) Allowance for Losses--
The allowance for losses of receivables is established through direct
charges to income. The allowance for losses is determined by management after
analysis of the current trend in the loan portfolio including charge offs,
loan arrears and recoveries. FFC has adopted the policy of charging off
receivables for which no loan installment has been received in the last six
months.
(i) Plant and Equipment--
Plant and equipment are recorded at cost. Maintenance and repairs are
expensed in the period to which they relate. Depreciation on plant and
equipment is calculated using the straight-line method over the following
estimated useful lives of the assets:
<TABLE>
<CAPTION>
YEARS
-----
<S> <C>
Office equipment.................................................. 7.7
Plant............................................................. 6.0
Motor vehicles.................................................... 6.5
Computer equipment................................................ 4.0
Leasehold improvements............................................ 6.0
</TABLE>
(j) Research and Development--
FFC has no significant research and development activities.
(k) Pension and Other Benefit Plans--
FFC contributes to a pension plan on behalf of its employees. The pension
plan is an accumulation fund and FFC has no liability to members under the
plan. FFC has no other pension or other employment benefit plans.
(l) Derivative Financial Instruments--
FFC uses derivatives as part of its asset/liability management to reduce its
overall level of financial risk arising from normal business operations. FFC
currently uses interest rate options to cap its interest expense on part of
its external borrowings. FFC is not a trader in derivatives, and it has not
used speculative derivative products for the purpose of generating earnings
from changes in market conditions.
(m) New Accounting Pronouncements--
Certain reclassifications have been made to the prior year statements to
make them consistent with the current year presentation.
NOTE 2: LENDING ASSETS
Lending assets include loan receivables.
(a) Diversification of Credit Risk--
FFC predominantly lends to consumers. There are no individual loans which
exceed 5% of the lending assets at June 30, 1996, June 30, 1997 and June 30,
1998.
60
<PAGE>
FAI FINANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
(b) Contractual Maturity of Loan Receivables (unaudited)--
The contractual maturities of FFC's receivables at June 30, 1998 are due as
follows:
<TABLE>
<CAPTION>
1998 1999 AFTER 2000 TOTAL
$US $US $US $US
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Consumer loans................ 18,995,981 15,313,835 3,828,458 38,138,274
Business finance loans........ 414,453 177,623 -- 592,076
---------- ---------- --------- ----------
Total loans............... 19,410,434 15,491,458 3,828,458 38,730,350
========== ========== ========= ==========
</TABLE>
The average yield on FFC's receivables at June 30, 1998 was 23.10% per
annum.
(c) Allowance for Losses--
<TABLE>
<CAPTION>
JUNE 30,
---------------
1997 1998
$US $US
------- -------
<S> <C> <C>
Balance at the beginning of the year...................... 271,781 550,974
Provision for losses...................................... 279,193 41,735
------- -------
Balance at the end of the year............................ 550,974 592,709
======= =======
</TABLE>
FFC maintains an allowance for losses of receivables based upon management's
best estimate of future possible losses in the portfolio of receivables.
Management's estimate is based upon current economic conditions, previous loss
history, and knowledge of clients' financial position. Changes in these
estimates could result in an increase in the reserves maintained.
(d) Bad Debts and Allowance for losses--
Bad debts and allowance for losses comprise:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-----------------------
1996 1997 1998
$US $US $US
------- ------- -------
<S> <C> <C> <C>
Increase in allowance for losses.................. 257,633 279,193 41,735
Bad debts charged off............................. 144,384 528,607 724,535
------- ------- -------
Total......................................... 402,017 807,800 766,270
======= ======= =======
</TABLE>
NOTE 3: LEGAL PROCEEDINGS
FFC is party to a number of legal proceedings as plaintiff and defendant,
all arising in the ordinary course of its business. Although the ultimate
amount for which FFC may be held liable, if any, is not ascertainable, FFC
believes that the amounts, if any, which may ultimately be funded or paid with
respect to these matters will not have a material adverse effect on the
financial condition or results of operations of FFC.
61
<PAGE>
FAI FINANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 4: GENERAL AND ADMINISTRATIVE EXPENSES
The following table sets forth a summary of the major components of general
and administrative expenses:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
---------------------------
1996 1997 1998
$US $US $US
------- --------- ---------
<S> <C> <C> <C>
Employee salaries............................. 370,786 836,372 1,255,840
Communications................................ 68,925 315,020 303,533
Space costs................................... 39,138 104,812 190,607
Legal fees.................................... 16,642 81,337 92,107
Depreciation.................................. 24,860 55,318 127,355
Research information.......................... 43,699 99,591 133,126
Office expenses............................... 130,280 175,695 379,379
Travel........................................ 3,256 6,319 59,200
Bank charges.................................. 108,151 72,081 140,893
Other......................................... 82,640 296,243 319,563
------- --------- ---------
Total..................................... 888,377 2,042,788 3,001,603
======= ========= =========
</TABLE>
NOTE 5: CASH
<TABLE>
<CAPTION>
JUNE 30,
---------------
1997 1998
$US $US
------- -------
<S> <C> <C>
Cash on hand.............................................. 373 594
Cash at bank.............................................. 210,723 241,295
------- -------
211,096 241,889
======= =======
</TABLE>
NOTE 6: PREPAID EXPENSES AND OTHER CURRENT ASSETS
<TABLE>
<CAPTION>
JUNE 30,
---------------
1997 1998
$US $US
------- -------
<S> <C> <C>
Prepayments............................................... 46,628 25,208
Sundry debtors............................................ 637,570 848,521
------- -------
684,198 873,729
======= =======
</TABLE>
NOTE 7: RESTRICTED DEPOSITS
<TABLE>
<CAPTION>
JUNE 30,
---------------
1997 1998
$US $US
------- -------
<S> <C> <C>
Deposits--Westpac Banking Corporation..................... 893,588 913,553
------- -------
893,588 913,553
======= =======
</TABLE>
Access to the funds in this account is restricted in accordance with the
Receivables Purchase Agreement entered into with Westpac Banking Corporation.
Refer to Note 14.
62
<PAGE>
FAI FINANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 8: PLANT AND EQUIPMENT
<TABLE>
<CAPTION>
JUNE 30,
-----------------
1997 1998
$US $US
------- --------
<S> <C> <C>
Office equipment....................................... 104,574 165,836
Plant.................................................. 29,318 32,587
Motor vehicles......................................... 47,210 73,121
Computer equipment..................................... 177,738 246,211
Leasehold improvements................................. 68,582 77,200
Less: Accumulated depreciation......................... (84,372) (184,540)
------- --------
343,050 410,415
======= ========
</TABLE>
NOTE 9: INTANGIBLES
<TABLE>
<CAPTION>
JUNE 30,
----------------
1997 1998
$US $US
------- -------
<S> <C> <C>
Initial goodwill on investment.......................... 335,592 278,864
Amortization of goodwill................................ (39,152) (46,477)
------- -------
296,440 232,387
======= =======
</TABLE>
Goodwill represents the excess of the purchase price paid by FAI Insurances
Limited, over the fair value of assets acquired when FAI General Insurance
Company Limited acquired the shares in Secure Home Finance Pty Limited (later
FAI Finance Corporation Pty Limited) from FAI Home Security Holdings Pty
Limited on March 1, 1995. The goodwill associated with this acquisition has
been pushed down to FFC and is being amortized over 20 years.
NOTE 10: INCOME TAX
The actual income tax expense attributable to net income differed from the
amounts computed by applying local federal tax rate to net income before taxes
as a result of the following:
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-------------------------
1996 1997 1998
$US $US $US
------- -------- -------
<S> <C> <C> <C>
Expected income tax expense at statutory rates........ 474,017 591,684 852,599
Tax effect of permanent and other differences:
Over provision for income tax in prior years........ 696 (42,152) --
Non-deductible expenses and other items............. -- 24,336 61,113
Amortization of goodwill............................ 17,185 6,337 5,520
Change in tax rates in deferred tax benefits........ -- -- --
------- -------- -------
491,898 580,205 919,232
======= ======== =======
The tax expense is split between:
Current............................................. 482,101 710,273 880,302
Deferred............................................ 9,797 (130,068) 38,930
</TABLE>
63
<PAGE>
FAI FINANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Tax losses have been purchased by FFC at June 30, 1996 for $497,783 and June
30, 1997 for $671,751 from FAI Insurances Group. These were utilized during
the financial year.
<TABLE>
<CAPTION>
JUNE 30,
----------------
1997 1998
$US $US
------- -------
<S> <C> <C>
Deferred tax assets are comprised of timing differences on:
Provisions not currently deductible for tax purposes for:
Doubtful debts........................................... 198,351 192,179
Leave.................................................... 15,530 17,948
Other.................................................... 4,389 3,648
Sundry accruals............................................ -- 4,205
Deferred costs............................................. -- (5,374)
Prepayments................................................ (9,456) 4,972
Tax losses carried forward................................. -- (8,259)
------- -------
Net deferred tax asset....................................... 208,814 209,319
======= =======
</TABLE>
NOTE 11: RELATED PARTY TRANSACTIONS
FAI Home Security (NZ) Trust, FAI Home Security Holdings (New Zealand)
Limited and FAI General Insurance Company Ltd, each of which is owned by FAI
Insurances Limited, are related by the 50 percent holding of FAI Insurances
Limited, in FAI Finance Corporation Pty Limited as at June 30, 1998.
FAI Home Security Pty Limited, which is owned by the Company, is related by
its 50 percent holding in FAI Finance Corporation Pty Limited as at June 30,
1998.
Management fees charged to related parties are an allocation of overhead
costs incurred by the relevant related entity. FAI Finance Corporation (NZ)
Limited incurred costs to administer the FAI Home Security Holdings (New
Zealand) Limited's New Zealand customer loans book.
<TABLE>
<CAPTION>
JUNE 30,
---------------------
1997 1998
$US $US
---------- ----------
<S> <C> <C>
Amounts due to related party:
Non Current Liabilities
FAI Insurances Limited......................... -- 9,563,073
FAI General Insurance Company Ltd.............. 7,511,515 10,424,200
FAI Home Security Pty Limited.................. -- 309,617
FAI Home Security (NZ) Trust................... 9,546,227 --
FAI Home Security Holdings (New Zealand)
Limited....................................... 387,308 285,551
---------- ----------
17,445,050 20,582,441
========== ==========
</TABLE>
The above loans are unsecured, bear interest at the Westpac Bank indicator
rate and are repayable on demand, with the exception of the FAI Insurances
Limited, FAI General Insurance Company Ltd and FAI Home Security Pty Limited
loans. The FAI Insurances Limited and FAI General Insurance Company Ltd loans
were non-interest bearing and repayable on demand as at December 31, 1997. As
from January 1, 1998 these two loans bear interest at the Westpac Bank
indicator rate. The FAI Home Security Pty Limited loan is non-interest bearing
and repayable on demand. As from January 1, 1998, FAI Insurances Limited and
FAI General Insurances Company Ltd, together, agreed to match funding provided
by FAI Home Security Pty Limited to FFC. These
64
<PAGE>
FAI FINANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
loans are non-interest bearing and repayable on demand. As at June 30, 1998
$309,617 of the FAI General Insurances Company Ltd loan balance and all of the
FAI Home Security Pty Limited loan balance fell under this category.
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
----------------------
1996 1997 1998
$US $US $US
------ ------- -------
<S> <C> <C> <C>
Net income is stated after the following items:
Interest on loans paid by FAI Finance Corporation (NZ)
Limited to:
FAI Home Security (NZ) Trust........................ 67,174 754,176 314,582
FAI Home Security Holdings (New Zealand) Limited.... 7,913 1,565 28,957
Interest on loans paid by FAI Finance Corporation Pty
Limited to:
FAI General Insurance Company Ltd................... -- -- 414,619
FAI Insurances Ltd.................................. -- -- 539,523
Management fees received by FAI Finance Corporation
(NZ) Limited from:
FAI Home Security Holdings (New Zealand) Limited.... 43,628 61,675 40,701
Vision Publishing Pty Limited....................... -- -- 28,374
Office rentals paid by FAI Finance Corporation Pty
Limited to:
FAI General Insurance Company Limited............... 65,611 51,535 98,503
</TABLE>
NOTE 12: FAIR VALUE DISCLOSURES
SFAS No. 107 "Disclosures about Fair Value of Financial Instruments",
requires disclosure of fair value information for certain financial
instruments, for which it is practicable to estimate that value. Since there
is no well-established market for many of FFC's assets, fair values are
estimated using present value and other valuation techniques. These techniques
are significantly affected by the assumptions used, including the discount
rate and estimates of future cash flows. These assumptions are inherently
judgmental and changes in such assumptions could significantly affect fair
value calculations. The derived fair value estimates may not be substantiated
by comparison to independent markets and may not be realized in immediate
liquidation of the instrument.
For variable rate borrowings that reprice frequently, fair values were
assumed to equal carrying values. The loans from FAI Insurances Limited and
FAI General Insurance Company Limited were renegotiated as part of the
Company's acquisition of a 50% interest in FFC. These loans bear interest from
January 1, 1998, and as a consequence their carrying values approximate fair
values.
For fixed rate consumer and business loans, the fair values were assumed to
equal carrying values as the market interest rates charged on the loans have
not changed significantly since the loans were granted.
Carrying values approximate fair values for all other financial instruments.
65
<PAGE>
FAI FINANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
NOTE 13: SEGMENT INFORMATION
The following table shows certain financial information by geographical
region.
<TABLE>
<CAPTION>
YEAR ENDED JUNE 30,
-----------------------------
1996 1997 1998
$US $US $US
--------- --------- ---------
<S> <C> <C> <C>
Net interest income:
--Australia............................... 2,480,922 3,496,927 4,452,019
--New Zealand............................. 113,389 976,186 1,685,736
--------- --------- ---------
2,594,311 4,473,113 6,137,755
========= ========= =========
Operating revenues:
--Australia............................... 2,481,860 3,496,927 4,480,393
--New Zealand............................. 156,079 1,037,861 1,726,437
--------- --------- ---------
2,637,939 4,534,788 6,206,830
========= ========= =========
Bad debts and allowance for losses:
--Australia............................... 401,610 754,141 579,972
--New Zealand............................. 407 53,659 186,298
--------- --------- ---------
402,017 807,800 766,270
========= ========= =========
Net income:
--Australia............................... 781,853 750,864 1,021,385
--New Zealand............................. 73,794 353,131 498,340
--------- --------- ---------
855,647 1,103,995 1,519,725
========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
JUNE 30,
---------------------
1997 1998
$US $US
---------- ----------
<S> <C> <C>
Identifiable assets
--Australia....................................... 22,543,219 30,225,503
--New Zealand..................................... 10,344,364 10,793,430
---------- ----------
32,887,583 41,018,933
========== ==========
</TABLE>
NOTE 14: FINANCE FACILITIES
On June 28, 1996, FFC entered into the Receivables Purchase Agreement with
Westpac Banking Corporation ("Westpac"). Under this agreement, FFC has the
right to sell eligible receivables to Westpac and undertakes to continue to
service the receivables in exchange for a management fee.
FFC also has the option to re-purchase the receivables at an amount
determined by Westpac which is to take into account the outstanding principal
on purchased loans and any outstanding obligations to Westpac under the
agreement, including unpaid interest and facility fees.
Under the Receivables Purchase Agreement, FAI General Insurance Company
Limited must maintain a sub-ordinated loan with Westpac equal to the greater
of $2,477,000 and 25% of the outstanding sold receivable in the first year or
not less than 20% in subsequent years. The right of FAI General Insurance
Company Limited to receive interest and principal repayments in respect of the
loan are subject to Westpac's prior ranking as agreed between the parties. FAI
General Insurance Company Limited has agreed to provide a subordinated loan to
Westpac to a maximum of $12,384,000.
66
<PAGE>
FAI FINANCE CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONCLUDED)
FFC is required to maintain a cash reserve account (restricted deposit) with
Westpac, the balance of which is not less than the greater of $619,000 and 5%
of the outstanding principal on sold receivables. Interest on the cash reserve
account is only paid after the interest obligations under the Westpac loan and
subordinated loan have been met. The balance of the account is only available
to FFC after all outstanding obligations to Westpac and the subordinated loans
have been met.
FFC has not recognized the sales of receivables under the agreement as a
sale for financial reporting purposes. The sales proceeds received from
Westpac have been recognized as secured borrowing, and interest, program and
line fees under the Westpac facility have been recognized as interest expense.
Under the agreement FFC pays interest to Westpac at the Australian Bank Bill
rate plus 2.0% per annum. In addition, FFC pays program and line fees as
agreed between the parties.
The current limit of the facility provided by Westpac is $18,576,000
(utilized at June 30, 1998--$16,261,000). The scheduled commitment termination
date for the Receivables Purchase Agreement is the third anniversary of the
date the agreement was entered into. This date may be extended at the sole
discretion of Westpac on the second or any subsequent anniversary of the
Agreement for a further period of one year. If FFC wants an extension of the
scheduled commitment termination date it must give a written request to
Westpac at least 60 days before the relevant anniversary. If Westpac agrees,
it must give written notice to FFC not later than the day of the relevant
anniversary.
NOTE 15: DERIVATIVES
FFC has entered an interest rate collar with Westpac. Under the collar FFC
has capped its interest payable on a notional borrowing of $18,576,000 at
13.5% per annum, until August 14, 2000. FFC has also set a floor on the same
notional principal and maturity, at 6.15% per annum.
67
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from
Home Security International, Inc. Consolidated Financial Statements and is
qualified in its entirety by reference to such financial statements.
</LEGEND>
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> JUL-01-1997
<PERIOD-END> JUN-30-1998
<CASH> 7,006,183
<SECURITIES> 0
<RECEIVABLES> 1,643,980
<ALLOWANCES> 769,235
<INVENTORY> 2,032,443
<CURRENT-ASSETS> 11,086,820
<PP&E> 1,298,157
<DEPRECIATION> 229,920
<TOTAL-ASSETS> 30,485,301
<CURRENT-LIABILITIES> 7,593,932
<BONDS> 0
0
0
<COMMON> 0
<OTHER-SE> 0
<TOTAL-LIABILITY-AND-EQUITY> 30,485,301
<SALES> 44,118,502
<TOTAL-REVENUES> 44,568,707
<CGS> (26,294,641)
<TOTAL-COSTS> 0
<OTHER-EXPENSES> (10,810,316)
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> (224,533)
<INCOME-PRETAX> 7,239,217
<INCOME-TAX> (2,111,084)
<INCOME-CONTINUING> 252,417
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,380,550
<EPS-PRIMARY> 1.05
<EPS-DILUTED> 1.04
</TABLE>
