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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, 1999
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File No. 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
(Zip Code)
North Sydney, NSW
(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 September 24, 1999, of Common Stock held by
non-affiliates of the registrant: $2,734,167.30 based on the last reported
sale price on the American Stock Exchange.
Number of shares of Common Stock outstanding on September 24, 1999:
5,828,278 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,
1999. 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 trade name 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"), which includes a SecurityGuard alarm, a smoke
alarm/detector, a rechargeable fire extinguisher, and a fire blanket, provides
home protection to a customer's premises through interior heat sensitive
motion detectors, flashing lights, a siren, window decals and a centralized
processing unit ("CPU") with the ability to communicate signals to a central
monitoring station. In order to capitalize on its base of customers with
installed SecurityGuard Systems (which the Company believes to be
approximately 237,000 which constitutes 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 over the last twelve months. The SecurityGuard alarm
and other major components are manufactured exclusively by Ness Security
Products Pty Limited, a recently acquired subsidiary.
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 eighty-one distribution offices in Australia
and New Zealand, with an additional twenty-one 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 to
Bradley Cooper. On March 31, 1997, FAI Insurances reacquired the business and
substantially all of the assets of the international operations from Mr.
Cooper. Thereafter, on June 30, 1997, the Company completed a reorganization,
and thereby began operations as a Delaware corporation. Following its
reorganization, in July 1997 the Company completed its initial public
offering.
Security Alarm Industry
The Australian, New Zealand and North American security alarm industry is
large, growing rapidly and characterized by a high degree of fragmentation,
low residential penetration and a continuing trend toward consolidation. The
Company believes that the European market is similarly fragmented and that the
residential segment in Europe is substantially less penetrated than in North
America. Industry statistics published by Security Distributing and Marketing
Magazine, an industry publication, indicate that revenues for the electronic
security alarm segment of the security industry grew from $9.7 billion in 1990
to $15.2 billion in 1998. Management and other industry sources estimate that
there will be a substantial amount of new residential customers created in
North America and Europe over the next several years as more and more
consumers elect to include home security in their places of living.
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The Company's management believes that growth in the residential security
alarm industry is and will continue to be 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. Fifth, the aging population and increase in
two career families worldwide have contributed to an increased focus on
residential security.
The Company believes that the residential security alarm industry is
characterized by the following attributes:
High Degree of Fragmentation. Although residential security alarm
services 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 and by
increasing the size of the Distributor Network in those countries in which it
now operates. In addition, the Company expects to expand its operations by
initiating the Distributor Network in new international markets and through
generating sources of recurring revenue by offering both its new and existing
alarm customers additional 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.
Online Monitoring and Other 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 237,000, which constitutes 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 offers
online security alarm monitoring services to its customers in Australia, New
Zealand and South Africa. The Company intends to expand its online monitoring
program, both as an upgrade and as part of a point of sale package, in the
Australian and New Zealand operation in fiscal 2000. Additionally, the Company
intends to offer on-line monitoring in other markets where the Company's base
of customers with installed SecurityGuard Systems in a region is sufficient to
support such an operation.
International Expansion. The Company is committed to actively expanding its
international operations in both Europe and North American and is placing
greater emphasis on those markets 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 in that market. Additionally, the Company
recognizes that each separate state in North America should be treated as an
individual market with it's own individual characteristics. This plan will be
implemented by the Company's existing senior management team and the newly
appointed World Development Directors, who will spend extended periods of time
in markets targeted for expansion in order to more effectively direct the
growth of the Company's 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 market, other than initial recruitment and
product approval expenses.
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 by increasing the number of independent sales agents and
distributors, 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
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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.
Vertical Integration. In order to enhance sales and improve operating
efficiencies and margins, the Company has made two strategic acquisitions, the
acquisition of Ness Security Products Pty Limited (the "Ness Transaction") in
October 1998 and April 1999 and the acquisition of FAI Finance Corporation Pty
Limited (the "FFC Transaction") in December 1997. In the two part Ness
Transaction, the Company acquired 100% of Ness, the manufacturer of the
SecurityGuard alarm. Ness is a leading designer and manufacturer of security
and safety related products within Australia. Prior to the Company's
acquisition of Ness, sales of the SecurityGuard alarm to the Company
represented approximately 67% of Ness's sales, which had resulted in attempts
by Ness to diversify its product line and thereby increase sales to other
companies. In order to ensure that the business operations of Ness would be
primarily focused on serving the interests of the Company, the Company
acquired 75.04% of Ness in October 1998 and the remaining 24.96% of Ness in
April 1999. During fiscal year ended June 30, 1999, Ness's sales of the
Security Guard alarm to the Company represented approximately 66% of Ness's
total sales. 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 100% of
the price mark-up previously 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.
In 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 to purchase the remaining 50% equity interest in FFC at
any time prior to December 31, 2001 (the "FFC Option"). FFC was 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. For the fiscal year
ended June 30, 1999, approximately 74% of the principal amount of all consumer
loans made by FFC were made to finance SecurityGuard System purchases in
Australia and New Zealand. 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 was critical
to the future growth of the Company because it would reduce 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, 1999, approximately 69% financed their purchase (and approximately
69% of those purchases were financed by FFC). FFC also markets personal loan
products in Australia and New Zealand to customers who have established a good
credit rating. FFC makes fixed term, fixed rate loans to customers who meet
specific policy guidelines. The Company expects the personal loans market to
generate significant revenues in the future.
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 largest residential security alarm businesses in the market. Currently
there are sixty-nine distributor offices in Australia and twelve distributor
offices in New Zealand. Despite current fiscal year results, the Company has
experienced significant increases in unit sales of alarm systems in Australia
and New Zealand over the past five fiscal years. In Australia and New Zealand
the Company sold 47,171 units in fiscal year 1999.
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The Company first expanded outside of Australia and New Zealand in 1994 and
is actively expanding its international operations. The Company continues to
place increasing importance on its international 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-one international distributor offices located in Germany (two), the
Netherlands (eleven), South Africa (one), the United Kingdom (four),
Switzerland (one) and the United States (two). Unit sales for the
international markets amounted to 7,630 units in fiscal year 1999.
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. 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 one of 37 products to achieve the Australian
Design Mark, and thereafter was 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 rechargeable 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 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. The Company's average fee for a SecurityGuard System, was approximately
AUD $2,390 per account customer for the fiscal year ended June 30, 1999,
including all installation service charges. Also included within the cost of
each SecurityGuard System is a one year limited warranty on system parts and
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
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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
On-line Monitoring and 24 Hour Emergency Response Services. The Company
began selling twenty-four hour on-line monitoring services as an upgrade to
its Australian and New Zealand customers during the second half of the fiscal
year ended June 30, 1999. As at June 30, 1999, the Company had installed
approximately 2,200 monitored lines as upgrades for its existing customers in
Australia and New Zealand. The Company intends to start selling on-line
monitoring services as part of its point of sale products and services to new
customers in Australia and New Zealand in the first half of fiscal 2000 when
the Company's sales force has been educated and trained about these new
services. The Company is currently outsourcing the monitoring services 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. Monitoring stations in each of the
Company's international markets will be established when 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. 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.
Extended Warranty. In September 1996, the Company commenced offering an
extended warranty program to its customers in Australia and New Zealand, which
offers customers the opportunity to extend the original manufacturers product
warranty of twelve months by an additional twelve or twenty-four months. The
average cost of the extended 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. The Company had
approximately 24,327 outstanding extended warranty contracts at June 30, 1999.
The percentage of contracts divided between twelve and twenty-four-month
contracts were 29% and 71% respectively. The income derived from the sale of
extended warranty contracts is recognized proportionately over the period of
each contract.
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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 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. 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. 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 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
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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.
Customer Service. In 1995, the Company implemented its "We Care" customer
satisfaction program. 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 a commission 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 and Dealers. 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 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, 1999, the Company had 708
Independent Agents (including 139 agents in training and 129 agents 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
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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, 1999 there were four persons who had been
designated as Dealers by the Company.
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 SecurityGuard System
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, 1999, the Company
had sixty-three Area Distributors, including sixteen 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 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
Security Guard 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, 1999, the Company had forty-one Distributors,
including six in markets outside of Australia and New Zealand.
During fiscal 1999 the Company developed four additional levels in the
Distributor Network: (i) Training Network Distributors; (ii) Regional Network
Distributors; (iii) Regional Vice Presidents; and (iv) Global Directors. The
introduction of these new levels is designed to increase sales by (a)
motivating competition between Distributors to achieve the limited number of
available vacancies for each new level and (b) utilizing the "in the field"
expertise and resources of Distributors. The Company expects the new levels to
be filled by existing Distributors meeting the qualification criteria over the
next fiscal year. Advancement through the new levels of the Distributor
Network is based exclusively on the participant's success in sales of the
Company's products. The following is a description of each new tier of the
Distributor Network.
Level 4--Training Network Distributors. The role of a Training Network
Distributor ("TND") is to work with a small group of under-achieving "off
program" Distributors and re-educate them in the Direct Sales Marketing
Program. The TND and under-achieving Distributors have a teacher-pupil
relationship. TNDs focus on turning each under-achieving Distributor into a
"center of excellence." To be promoted to this level, a Distributor needs to
meet certain specified criteria in relation to (i) office sales levels, (ii)
agent sales levels, (iii) recruitment, (iv) Area Distributor advancement, and
(v) motivation and team building skills. TNDs receive no additional override
commissions. For a TND to be promoted to Regional Network Distributor, it must
meet a predetermined level of performance in turning around under achieving
Distributors within a specified period.
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Level 5--Regional Network Distributors. Each Regional Network Distributor
("RND") is assigned a territory, currently generating approximately six
hundred unit sales per month, to develop. The territory will include a network
of Area Distributors, Distributors and Training Network Distributors. Each RND
is responsible for significantly lifting sales in its assigned territory by
achieving predetermined targets. Each RND is paid additional override
commissions on the unit sales of its territory. The override commissions
increase exponentially as the territory sales increase motivating RNDs to
reach the maximum override commissions level. A RND must achieve predetermined
sales levels in order to be promoted to Regional Vice President. A RND will be
demoted to TND if certain specified sales levels are not consistently
maintained.
Level 6--Regional Vice Presidents. Each Regional Vice President ("RVP") is
assigned a region encompassing the territories of several RNDs. The aim of
each RVP is to cause the RNDs in its region to achieve double their targets
and attempt to reach the Global Director level. RVPs are compensated in a
similar manner to RNDs although the RVP override commissions are set at two
levels relating to the level of unit sales of its region. A RVP will be
demoted to RND if certain specified sales levels are not consistently
maintained.
Level 7--Global Directors. Global Director is the highest level in the
Distributor Network. In order to reach Global Director level, RVPs must
compete with each other to be the most qualified RVP when a Global Director
position becomes available. Global Directors are responsible and accountable
for sales in four to eight regions in a number of different markets. Global
Directors receive override commissions equal to half the total override
commissions earned by the RVPs in their regions. Similar to all other levels,
the Global Director level is a target driven position. Failure to achieve
specified targets will result in the demotion of a Global Director and
promotion of the most qualified RVP at that time into the vacated Global
Director position.
Manufacturing
Ness manufactures 70 types of circuit boards and 160 different finished
goods including its (i) SecurityGuard alarm, (ii) 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; (iii) 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; (iv) Quantum Dual, a leading security
alarm detector which combines a passive infra-red sensor and a doppler
microwave to detect intruders far more reliably than conventional detectors.
Quantum Dual also utilizes a microprocessor and has a special anti-creep zone
lens that detects human movement directly below the lens where most detectors
are "blind"; and (v) 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. Ness employs the latest in advanced manufacturing
techniques and leading edge technology in order to maintain its production of
high quality security alarm products including the SecurityGuard. The
manufacturing process begins on either one of Ness' two Surface Mount lines,
where the components are placed by high speed placement machines on printed
circuit boards, are bonded, then conveyed into a Heller Reflow Oven. Any
components too large for machine placement are hand inserted, before the fully
loaded circuit board enters the Nitrogen Wave Soldering Machine for
completion. The board is then inspected and tested on a Flying Probe Tester,
where it is In-Circuit tested, for correct component placement, prior to
having a full functional test (average first time pass rate is approximately
97-98%), before it enters final assembly and packaging. The average monthly
printed circuit assembly production for Ness is currently 50,000 boards.
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
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central monitoring station. 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.
Strategic Acquisitions
Ness Transaction. On July 17, 1998, the Company entered into a Stock
Purchase Agreement with Integral Investments Limited ("Integral"), which was
amended as of October 1, 1998 (the "Stock Purchase Agreement"), whereby the
Company agreed to purchase all of the issued and outstanding common stock of
Integrated International Home Security Limited ("IIHSL"), a British Virgin
Islands company that owned 75.04% of the issued and outstanding common stock
of Ness, a leading designer and manufacturer of security alarm products in
Australia and the Company's sole supplier of its SecurityGuard alarm. Pursuant
to the Stock Purchase Agreement, Integral obtained the right to designate one
nominee for election to the board of directors of the Company. Integral
designated Paul Brown, its sole shareholder, as its nominee.
Pursuant to the Stock Purchase Agreement, the Company paid aggregate
consideration consisting of: (i) 400,000 shares of common stock; (ii) a five
year convertible warrant to purchase 360,000 of Common Stock at an exercise of
$13.00; (iii) cash in the amount of $2,426,000 ($126,000 paid concurrent with
the execution of the Purchase Agreement and $2,300,000 paid upon closing of
the Transaction); and (iv) a promissory note, secured by all of the issued and
outstanding shares of IIHSL, in the amount of $9,098,000 payable in
installments of $400,000 on each of June 30, 1999 (paid on July 7, 1999) and
December 31, 1999, respectively, with the balance of the note due on June 30,
2000 ("Ness Note"). Integral has assigned its rights to receive the Company's
securities under the Stock Purchase Agreement and the Ness Note to its
affiliate, International Home Security Investments Limited ("IHSIL"). If any
portion of the principal amount of the Ness Note is still outstanding on
October 1, 1999, the Company shall issue an additional five year warrant to
purchase 200,000 shares of the Company's Common Stock at an exercise price of
$13.00 per share to IHSIL. Additionally, if any portion of the principal
amount of the Ness Note is still outstanding on January 1, 2000, the Company
shall issue an additional five year warrant to purchase 200,000 shares of the
Company's Common Stock at an exercise price of $13.00 per share to IHSIL.
On April 9, 1999, the Company effectively purchased the remaining 24.96% of
the issued and outstanding common stock of Ness not held by the Company
through a series of transactions in which: (i) Nazareno Circosta the principal
management officer of Ness ("Circosta"), agreed to enter into a Non-
Competition Agreement with the Company in exchange for a cash payment of
$656,700; (ii) Circosta agreed to purchase 277,778 shares of HSI Common Stock
for $2,599,352; and (iii) Ness agreed to redeem the common stock of Ness held
by Circosta Pty Limited, a unit trust beneficially owned by Circosta as well
as certain employees, for $2,140,179. In addition, Ness agreed to pay
$3,066,776 to Circosta in exchange for the termination of his existing
employment contract and the execution of a new employment contract.
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 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 100% of the price mark-up charged for such systems by
Ness to the Company and by more cost effectively purchasing the major
component parts of Ness' primary products.
Ness's 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, 1999, Ness had 132 employees
in Australia and 6 employees in Hong Kong.
FFC Transaction. On December 31, 1997, the Company purchased 50% of the
issued and outstanding shares of FFC (the "FFC Shares") from FAI Insurances in
the FFC Transaction. The AUD $10,750,000
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($7,059,525) purchase price for the FFC Shares was paid through the delivery
of a five year promissory note which bears interest at a rate of 7.75% per
annum payable monthly in arrears (the "FFC Note"), which is secured by the FFC
Shares. The next installment of AUD $2,000,000 ($1,313,400) will be due under
the FFC Note on December 31, 1999. 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 ("FFC Note
Payment"). Pursuant to a Deed of Variation executed February 7, 1999, the
Company agreed to make an accelerated payment on the FFC Note in the amount of
AUD $500,000 ($328,350) in exchange for FAI Insurances' waiver of the FFC Note
Payment in connection with Ness Transaction, as well as other considerations.
In the FFC Transaction, the Company also received the FFC Option, at no
additional cost, exercisable at any time until December 31, 2001, to purchase
the remaining 50% interest in FFC from FAI Insurances, for the same
consideration plus 50% of FFC's retained earnings and 50% of the net change in
FFC's capital reserves from the date of the FFC Transaction until the date the
FFC Option is exercised. If the FFC Option is exercised FAI Insurances will
finance the purchase price 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 related to 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.
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. Currently the
maximum available to FFC under the Receivables Purchase Agreement is AUD $50
million ($32.8 million). The Company believes that the Receivables Purchase
Agreement provides FFC the necessary capital to support its financing
activities and future growth.
The Company believes it will be able to actively grow the receivables
balance of FFC. In addition to the funds that may be loaned to FFC by FAI
Insurances and the Company, FFC is actively seeking to expand its receivables
facility and is evaluating additional options to grow its receivable balance.
FFC's main office is located in Sydney, Australia. FFC also maintains an
office in Auckland, New Zealand. As of June 30, 1999, FFC had forty-five
employees in Australia and sixteen employees in New Zealand.
Competition
The security alarm industry in the markets in which the Company operates is
highly competitive and fragmented. The Company competes with numerous other
companies for new customers. The Company's major competitors for first-time
purchasers of alarm systems in Australia and New Zealand are Signature
Security and ADT Security Services, Inc. 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
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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 similar
marketing and sales strategy that it uses in Australia and New Zealand
modified to suit the nuances of such markets.
Trademarks and Intellectual Property
The Company operates under the registered Company name "FAI Home Security"
in Australia, New Zealand, North America, Europe and South Africa. The
Company's License Agreement with FAI Insurances permits it to use the "FAI"
name and logos on a royalty free, non-exclusive, non transferable basis. The
License Agreement has a perpetual term and will terminate only upon breach by
the Company.
Upon acquiring Ness Security Products Pty Limited the Company obtained over
ten trademarks relating to Ness Security Products Pty Limited's products.
While the Company obtains trademarks as appropriate and considers certain of
its trademarks valuable, it does not believe any one of them by itself is
crucial to the successful conduct of its business. The Company relies on a
combination of patent, trademark registrations, copyrights and confidentiality
agreements to protect its intellectual property.
Government Regulation
The Company's 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.
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.
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.
Our alarm monitoring business utilizes telephone lines and radio
frequencies to transmit alarm signals. The cost of telephone lines, and the
type of equipment, which may be used in telephone line transmission, are
currently regulated by federal governments, state governments or both in
Australia, New Zealand and the United States of America. The operation and
utilization of radio frequencies are also regulated by federal governments,
state governments or both. In addition, the laws of certain of the other
foreign jurisdictions in which the Company operate regulate the telephone
communications with the local authorities.
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".
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Employees
At August 11, 1999, the Company employed 243 individuals, including 205 on
a full-time basis, 2 on a part-time basis and 36 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 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,
currency fluctuation as identified more fully below 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 stockholders, 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 identified
above and the risks detailed under the caption "Risk Factors" below or
otherwise described herein or detailed from time to time in the Company's
other filings made with the Securities and Exchange Commission.
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.
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. Furthermore, there can be no assurance that the Direct
Sales Marketing Program and the Distributor Network will be successful in
other markets. 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
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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, 1999,
approximately 70% 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 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. 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 .6810 on June 30, 1998 to a
low of .5495 during the fiscal year ended June 30, 1999 and as of September
24, 1999 was valued at .6517 as compared to the U.S. dollar. The change in
valuation has resulted in lower reported revenues than budgeted when
translated into U.S. dollars for the fiscal year ended June 30, 1999. 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.
Risk Associated With Acquisitions. The Company's success will depend, in
part, on its ability to integrate its acquisition of FFC and the recent
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.
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
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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.
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 $4.1
million, $1.4 million, $2.1 million and $2.1 million respectively.
Recruitment of Independent Dealers and Agents. The Company is dependent on
the continued recruitment of new Dealers and 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 Dealers and Independent Agents that the Distributor
Network can recruit and the Company can train. There can be no assurance that
a sufficient number of Dealers and Independent Agents will be recruited or
retained by the Distributor Network.
Competition. The security alarm industry in each market 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.
16
<PAGE>
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, holidays
and reduced hours of daylight. 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.
Geographic Concentration. Sales in Australia and New Zealand for the fiscal
years ended June 30, 1997, June 30, 1998 and June 30, 1999 accounted for
approximately 94%, 87% and 86%, respectively, of the Company's total unit
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 in Australia and New Zealand or other
factors affecting these markets.
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.
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. See
Item 3. Legal Proceedings.
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
17
<PAGE>
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 counsel, Dibbs, Crowther & Osborne, 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.
Potential Adverse Effect of Warrants, and other Dilutive Transactions. The
Company issued warrants to purchase an aggregate of 240,000 shares of Common
Stock to the representatives of the underwriters of its initial public
offering at an exercise price of $16.50 per share (the "IPO Warrants"). As
part of the Ness Transaction, the Company and has issued warrants to purchase
an aggregate of 360,000 shares at an exercise price of $13.00 per share and
has agreed to issue on October 1, 1999, additional warrants to purchase an
aggregate of 200,000 shares at an exercise price of $13.00 per share and on
January 1, 2000, additional warrants to purchase an aggregate of 200,000
shares at an exercise price of $13.00 per share, in the event any portion of
the Ness Note remains outstanding on such dates (collectively, the "Ness
Warrants"). Additionally, the Company has reserved 1,150,000 shares of Common
Stock for issuance under its employee 1997 Stock Option Plan of which 710,000
shares are subject to outstanding options which are exercisable at a price of
$10.00 per share. The Company has reserved 50,000 shares of Common Stock for
issuance under its 1997 Non-Employee Director Stock Option Plan of which
options to purchase 20,000 shares have been granted at an exercise price of
$10.00 per share and options to purchase 7,500 shares have been granted at
$10.6875 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. Further, the
Company may choose to exercise the FFC Option and acquire the remaining 50%
interest in FFC. If the consideration for such a transaction consists of
Common Stock or other securities, stockholders of the Company could suffer
dilution of their interests in the Company.
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.
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
18
<PAGE>
Insurances, constitute approximately 824 square meters and are leased at a
rental rate of AUD $380 ($250) per square meter, per annum. The Company has
entered into a five-year lease expiring in 2002 for the executive offices,
with an option to extend the lease arrangement for an additional five years
with respect to certain portions of the space. The remainder of the space is
leased on a month by month basis. The Company has also entered into a three-
year lease expiring in 2001 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 ($144) per square meter per
annum and the Company has acquired an option on 140 square meters at the same
location.
Ness's administration, manufacturing and warehousing operations are located
at 167 Prospect Highway, Seven Hills, Sydney, Australia. Ness leases, at a
cost of AUD $102 ($67) per square meter per annum, a total of 2,674 square
meters at Seven Hills, consisting of 440 square meters of office space and
2,234 square meters of warehouse space. This lease expires in 2003.
Additionally, Ness has three distribution outlets located in (i) Blackburn,
Victoria, (ii) Mansfield, Queensland, and (iii) West Perth, Western Australia.
The total leased space for these distribution outlets is 1,010 square meters
at an average rate of AUD $74 ($49) per square meter per annum under leases
with expiration dates varying from 2001 to monthly tenancy.
The Company has entered into a three-and-a-half-year lease expiring in 2003
of space in a building adjoining Ness's offices at Seven Hills. The leased
space, totaling 3,117 square meters, consists of 467 square meters of office
space and 2,648 square meters of warehouse space. The Company intends to move
its administrative, customer care, extended warranty and twenty-four hour on-
line monitoring divisions to this location due to the AUD $103 ($68) per
square meter per annum rental rate. Ness will use this additional warehouse
space for its expanding manufacturing operations. Upon relocating to Seven
Hills the Company will either sub-lease or cancel the 80 Chandos Street lease.
The Company also leases an office in England at 2nd Floor Lodge House, Kay
Street, Burnley, Lancashire. The lease expires on September 24, 2004 and
provides for an annual rent of (Pounds)11,960 ($18,909). The office
constitutes approximately 130 square meters and is leased at a rate of
(Pounds)92 ($145) per square meter per annum. The Company also leases a
warehouse facility in Manchester, England.
The Company believes that its existing office, warehouse and manufacturing
space is adequate to meet its future needs.
ITEM 3. LEGAL PROCEEDINGS
A class action lawsuit has been filed against the Company in the Victorian
registry of the Federal Court of Australia alleging violations of the
Australian Trade Practice Act by authorized Distributors of the Company. The
class action alleges that misrepresentations were made by salespersons when
selling SecurityGuard alarm systems from July 9, 1993 to present to customers
who used FFC to finance their purchases. This litigation is in its very
preliminary stages and no discovery has been taken, and therefore, the Company
cannot quantify its ultimate liability, if any, for the payment of damages in
this lawsuit. Notwithstanding the foregoing, the Company believes that the
allegations in the lawsuit do not provide a basis for the recovery of damages
because the Company believes that the materials provided by the Company to its
Distributors and its sales force did not violate the Australian Trade Practice
Act. The Company intends to aggressively defend this lawsuit.
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.
19
<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 since the Company's initial public offering.
<TABLE>
<CAPTION>
Fiscal June 1998 High Low
---------------- ------- -------
<S> <C> <C>
First Quarter (July 15-September 30, 1997)............... $14.875 $10.000
Second Quarter (October 1-December 31, 1997)............. 13.250 9.000
Third Quarter (January 1-March 31, 1998)................. 11.375 9.062
Fourth Quarter (April 1-June 30, 1998)................... 13.875 10.000
<CAPTION>
Fiscal June 1999 High Low
---------------- ------- -------
<S> <C> <C>
First Quarter (July 1-September 30, 1998)................ $13.000 $ 8.375
Second Quarter (October 1-December 31, 1998)............. 11.250 7.500
Third Quarter (January 1-March 31, 1999)................. 11.500 8.625
Fourth Quarter (April 1-June 30, 1999)................... 9.000 5.375
</TABLE>
On September 24, 1999, the last reported sale price of the Common Stock as
reported by the American Stock Exchange was $3.1875. Based on information
obtained from the Company's transfer agent, there are seven 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
On April 9, 1999, as part of the Ness Acquisition, the Company sold 277,778
shares of the Company's common stock to Mr. Nazareno Circosta, The Fourf
Superannuation Trust, Mr. Terrence Gail, John Circosta, Mary Cartisano, The
Eagle Superannuation Trust, and Naztech Corporation Pty Limited, each an
accredited investor, in exchange for a $2,599,352 ninety-day promissory note
secured by such shares (paid in full by June 30, 1999). The sale of such
shares was exempt from registration pursuant to Section 4(2) of the Securities
Act of 1933, as amended.
On September 30, 1998, as part of the Ness Transaction, the Company issued
warrants to acquire 360,000 shares of the Company's common stock at an
exercise price of $13.00 per share to Integral's affiliate, International Home
Security Investments Limited. These warrants are fully exercisable and will
expire on October 1, 2003 as part of the consideration paid by the Company for
Integral's interest in IIHSL, the holder, at that time, of a 75.04% interest
in Ness. The sale of such warrants was exempt from registration pursuant to
Section 4(2) of the Securities Act of 1933, as amended.
Dividend Policy
During the two most recent fiscal years 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.
20
<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, 1995, 1996, 1997, 1998 and 1999 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 this filing.
<TABLE>
<CAPTION>
Years Ended June 30,
------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
(in thousands, except per share, unit sales,
and monitored lines)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net sales.................. $ 21,437 $ 26,701 $ 33,465 $ 44,119 $ 45,993
Cost of goods sold......... (14,219) (17,585) (24,274) (26,295) (23,274)
-------- -------- -------- -------- --------
Gross profit............... 7,218 9,116 9,191 17,824 22,719
General and administrative
expenses.................. (5,031) (6,368) (5,619) (10,088) (12,673)
Amortization and
depreciation.............. (60) (238) (434) (722) (1,832)
Research and development... -- -- -- -- (395)
-------- -------- -------- -------- --------
Income from operations..... 2,127 2,510 3,138 7,014 7,819
Interest income (expense),
net....................... 65 203 784 226 (506)
-------- -------- -------- -------- --------
Income before taxes, equity
in income of affiliated
companies and minority
interest.................. 2,192 2,713 3,922 7,240 7,313
Income tax expense......... (722) (1,054) (1,630) (2,111) (3,541)
-------- -------- -------- -------- --------
Income before equity in
income of affiliated
companies and minority
interest.................. 1,470 1,659 2,292 5,129 3,772
Equity in income of
affiliated companies...... -- -- -- 252 311
Minority interest.......... -- -- -- -- (335)
-------- -------- -------- -------- --------
Net income................. $ 1,470 $ 1,659 $ 2,292 $ 5,381 $ 3,748
======== ======== ======== ======== ========
Diluted net income per
share of Common Stock..... $ 0.51 $ 1.04 $ 0.68
Diluted weighted average
shares of Common Stock
Outstanding............... 4,500 5,182 5,517
Unit Sales and Monitored
Lines Data(1)
Unit Sales................. 25,280 31,669 38,071 57,589 54,801
Cumulative unit sales...... 54,462 86,131 124,202 181,791 236,592
Monitored lines............ -- -- -- -- 2,204
<CAPTION>
Years Ended June 30,
------------------------------------------------
1995 1996 1997 1998 1999
-------- -------- -------- -------- --------
(in thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents.. $ 1,230 $ 370 $ -- $ 7,006 $ 2,976
Working capital (deficit).. 1,684 3,451 (1,754) 3,121 (2,983)
Total assets............... 7,671 13,384 15,957 30,485 51,477
Total debt, including
current portion........... -- -- -- 4,737 13,155
Shareholders' equity....... 3,912 9,894 9,790 18,099 29,074
</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 Security Guard System since the Company began operations in 1988.
21
<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. During the fiscal year ended June 30, 1999 the Company
introduced the upgrade monitoring program, converting its existing database to
monitoring. The SecurityGuard alarm and other major components are
manufactured exclusively by Ness Security Products Pty Limited, a recently
acquired subsidiary.
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 monitoring contracts are collected and
recognized monthly over the life of the monitoring contracts. 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 July 17, 1998, the Company entered into a the Stock Purchase Agreement
with Integral Investments Limited, which was amended as of October 1, 1998,
whereby the Company agreed to purchase all of the issued and outstanding
common stock of IIHSL. Pursuant to the Stock Purchase Agreement, the Company
paid aggregate consideration consisting of: (i) 400,000 shares of common
stock; (ii) a five year convertible warrant to purchase 360,000 of Common
Stock at an exercise of $13.00; (iii) cash in the amount of $2,426,000
($126,000 paid concurrent with the execution of the Purchase Agreement and
$2,300,000 paid upon closing of the Transaction); and (iv) the Ness Note,
consisting of a promissory note, secured by all of the issued and outstanding
shares of IIHSL, in the amount of $9,098,000 payable in installments of
$400,000 on each of June 30, 1999 (paid on July 7, 1999) and December 31,
1999, respectively, with the balance of the note due on June 30, 2000.
Integral has assigned its rights to receive the Company's securities under the
Stock Purchase Agreement and the Ness note to its affiliate IHSIL. If any
portion of the principal amount of the Ness Note is still outstanding on
October 1, 1999, the Company shall issue an additional five year warrant to
purchase 200,000 shares of the Company's Common Stock at an exercise price of
$13.00 per share to IHSIL. Additionally, if any portion of the principal
amount of the Ness Note is still outstanding on January 1, 2000, the Company
shall issue an additional five year warrant to purchase 200,000 shares of the
Company's Common Stock at an exercise price of $13.00 per share to IHSIL.
On April 9, 1999, the Company effectively purchased the remaining 24.96% of
the issued and outstanding common stock of Ness not held by the Company
through a series of transactions in which: (i) Nazareno Circosta the principal
management officer of Ness ("Circosta"), agreed to enter into a Non-
Competition Agreement with the Company in exchange for a cash payment of
$656,700; (ii) Circosta agreed to purchase 277,778 shares of HSI Common Stock
for $2,599,352; and (iii) Ness agreed to redeem the common stock of Ness held
by Circosta Pty Limited, a unit trust beneficially owned by Circosta as well
as certain employees, for $2,140,179. In addition, Ness agreed to pay
$3,066,776 to Circosta in exchange for the termination of his existing
employment contract and the execution of a new employment contract.
On December 31, 1997, the Company acquired a 50% equity interest in FFC.
The purchase price of $7,059,525 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
22
<PAGE>
through personal loan and insurance products which are not currently part of
the Company's business. For the year ended June 30, 1999 approximately 74% 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.
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 periods compared.
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,
-------------------
1997 1998 1999
----- ----- -----
(Unaudited)
<S> <C> <C> <C>
Net sales................................................ 100.0% 100.0% 100.0 %
Cost of goods sold....................................... 72.5% 59.6% 50.6 %
----- ----- -----
Gross profit............................................. 27.5% 40.4% 49.4 %
General and administrative expenses...................... 16.8% 22.9% 27.6 %
Amortization and depreciation............................ 1.3% 1.6% 4.0 %
Research and development................................. -- -- 0.9 %
----- ----- -----
Income from operations................................... 9.4% 15.9% 17.0 %
Interest income (expense), net........................... 2.3% 0.5% (1.1)%
----- ----- -----
Income before taxes, equity in income of affiliated
companies and minority interest......................... 11.7% 16.4% 15.9 %
Income tax expense....................................... 4.9% 4.8% 7.7 %
----- ----- -----
Income before equity in income of affiliated companies
and minority interest................................... 6.8% 11.6% 8.2 %
Equity in income of affiliated companies................. -- 0.6% 0.7 %
Minority interest........................................ -- -- 0.7 %
----- ----- -----
Net income............................................... 6.8% 12.2% 8.1 %
</TABLE>
Comparison of fiscal years ended June 30, 1999 and June 30, 1998.
Net Sales: Net sales increased by $1.9 million or 4% from $44.1 million for
the fiscal year ended June 30, 1998 to $46.0 million for the fiscal year ended
June 30, 1999. Included in net sales for the fiscal year ended June 30, 1999
was $6.3 million in net sales from IIHSL relating to Direct Retail Sales of
manufactured goods to third party customers other than the Company ("Direct
Retail Sales") for the nine months since the acquisition of IIHSL (October 1,
1999 through June 30, 1999) and other sales which include extended warranties
and rebates. Because the Company acquired IIHSL in October 1998 there were no
Direct Retail Sales for the year ended June 30, 1998. Distributor sales
decreased by $4.9 million or 13% from $42.9 million for the fiscal year ended
June 30, 1998 to $38.0 million for the fiscal year ended June 30, 1999. The
reduction of Distributor sales was primarily a result of a 38% decline in unit
sales in New Zealand and a 52% decline in unit sales in South Africa.
Units sold in the Australian market increased 2% from 40,498 units for the
fiscal year ended June 30, 1998 to 41,194 units for the fiscal year ended June
30, 1999. Units sold in New Zealand decreased 38% from 9,583
23
<PAGE>
units for the fiscal year ended June 30, 1998 to 5,977 units for the fiscal
year ended June 30, 1999. The decline in number of units sold in New Zealand
is attributable to a reduction in the number of Distributor offices currently
selling in the New Zealand market. The number of units sold in the South
African market decreased 52% during the fiscal year ended June 30, 1999 to
1,087 as compared to 2,252 for the fiscal year ended June 30, 1998. The
decline in units sold in South Africa was attributable to test selling in
major city areas in an attempt to capture a share of the larger market.
Selling in the city areas proved unsuccessful and the focus in the South
African operation has been returned to rural areas.
Unit sales in Europe and the United Kingdom increased 29% from 4,581 units
for the fiscal year ended June 30, 1998 to 5,893 for the fiscal year ended
June 30, 1999. The Company has begun allocating resources no longer required
in Europe into the United States market to establish a foundation from which
to grow the U.S. distribution network.
The Company's online monitoring program is being rolled out in Australia
and New Zealand. The Company currently has in excess of 2,200 monitored lines,
the majority of these being installed during the six months ended June 30,
1999. The Company intends to expand its on-line monitoring program, including
both upgrade and point of sale, in the Australian and New Zealand operations
in the fourth quarter of Fiscal 1999. All setup and development expenses
relating to the on-line monitoring program have been expensed as incurred.
Cost of Goods Sold--other: Cost of goods sold decreased 11% from $26.3
million for the fiscal year ended June 30, 1998 to $23.3 million for the
fiscal year ended June 30, 1999. As a percentage of net sales, cost of goods
sold decreased 9% from 60% for the fiscal year ended June 30, 1998 to 51% for
the fiscal year ended June 30, 1999. 2% of the reduction in cost of goods is
attributable to the decline in sales, while the remaining 7% was directly
attributable to the acquisition of IIHSL. The acquisition of IIHSL enabled the
Company (on a consolidated basis) to capture the IIHSL gross margin reflected
in the reduction of the Company's cost of goods sold. As a result, the
Company's gross margin as a percentage of sales increased 9% from 40% for the
fiscal year ended June 30, 1998 to 49% for the fiscal year ended June 30,
1999.
General and Administrative Expenses: General and administrative expenses
were $12.7 million for the fiscal year ended June 30, 1999, compared to $10.1
million for the fiscal year ended June 30, 1998. Total general and
administrative expenses, as a percentage of net sales, increased 5% to 28% for
the fiscal year ended June 30, 1999 compared to 23% for the fiscal year ended
June 30, 1998. The increase in general and administrative expenses as a
percentage of net sales was primarily attributable to the inclusion of
expenses relating to IIHSL of $2.8 million. The Company also incurred
additional expenses during the fiscal year ended June 30, 1999 relating to the
establishment of the on-line monitoring and start-up expenses for the
establishment of the United States market.
Amortization and depreciation: Amortization and depreciation increased 157%
from $0.7 million for the fiscal year ended June 30, 1998 to $1.8 million for
the fiscal year ended June 30, 1999. Amortization of goodwill increased 100%
from $0.5 million for the fiscal year ended June 30, 1998 to $1.0 million for
the fiscal year ended June 30, 1999. The increase was directly attributable to
the inclusion, (for the nine months October 1, 1999--June 30, 1999), of
amortization relating to the goodwill recorded upon the acquisition of IIHSL.
The increase in depreciation and amortization of capital and leased assets of
$0.6 million from $0.2 million for the fiscal year ended June 30, 1998 to $0.8
million for the fiscal year ended June 30, 1999 was attributable to the
introduction of $2.4 million dollars of capital equipment from the IIHSL
acquisition.
Research and Development: Research and Development expenses for the fiscal
year ended June 30, 1999 represents costs incurred by IIHSL since its
acquisition on October 1, 1998, in relation to product approvals and the
design and development of new products.
Income From Operations: Income from operations increased 13% from $7.0
million for the fiscal year ended June 30, 1998 to $7.9 million for the fiscal
year ended June 30, 1999. The increase in income from operations reflects the
benefits from the acquisition of IIHSL which include (a) increased revenues
from IIHSL
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<PAGE>
Direct Retail Sales, (b) the capture of IIHSL's margin, for sales made to the
Company, reflected as a reduction in the Company's cost of goods.
Interest Income: Interest income remained stable at $0.4 million for the
fiscal year ended June 30, 1999 and 1998, respectively.
Interest Expense--related party: Interest expense--related party is derived
from the vendor financed loan initiated as part of the FFC Transaction on
December 31, 1997. For the fiscal year ended June 30, 1999 interest expense--
related party was $0.4 million compared to $0.2 million for the fiscal year
ended June 30, 1998. The $0.2 million increase occurs because interest
expense--related party for the fiscal year ended June 30, 1998 includes only
six months of interest paid by the Company to FAI Insurances Limited (December
31, 1997--June 30, 1998) while interest expense--related party for the fiscal
year ended June 30, 1999 includes twelve months of interest (July 1, 1998--
June 30, 1999).
Interest Expense--other: Interest expense--other for the fiscal year ended
June 30, 1999 was $0.6 million. The interest charge for the fiscal year ended
June 30, 1999 consisted of a non-cash imputed interest charge $0.6 million
recorded in order to comply with the United States Generally Accepted
Accounting Principles ("U.S. GAAP") purchase accounting principles. Pursuant
to the Stock Purchase Agreement through which the Company acquired 100% of the
issued and outstanding stock of IIHSL, the Company issued a non-interest
bearing promissory note, secured by the IIHSL shares, in the amount of
$9,098,000. U.S. GAAP requires a premium to be recorded for debt securities
issued with an interest rate fixed materially above or below the effective
rate or current yield of an otherwise comparable security. The interest charge
is only reflected in the June 30, 1999 year end since IIHSL was acquired in
October 1998.
Income Tax Expense: The effective rate of tax increased from 29% for the
fiscal year ended June 30, 1998 to 48% for fiscal year ended June 30, 1999.
This increase is primarily attributable to the following factors: (i) 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 $0.6 million after tax) for the fiscal year ended June
30, 1998, which was subsequently reversed for the fiscal year ended June 30,
1999 as a result of a change in the tax laws; (ii) non-deductible amortization
of goodwill generated from the acquisition of IIHSL during the fiscal year
ended June 30, 1999 of $0.5 million ($0.2 million tax effect); and (iii) a
prior year tax adjustment of $0.1 million recorded in fiscal 1999.
Equity in Income of Affiliated Companies: Equity in income of affiliates
for the fiscal year ended June 30, 1999 was $310,000. This was calculated by
taking the Company's 50% share of FFC's net income of $608,000 for the fiscal
year ended June 30, 1999 and deducting amortization of goodwill for the same
period of $298,000. There was only six months of equity in income of
affiliates for the fiscal year ended June 30, 1998, being $252,000, as the FFC
Transaction took place on December 31, 1997.
Minority Interest: Minority interest represents an independent third
party's ownership of 24.96% of Ness, and the corresponding profit allocation
for the period from October 1, 1998 to April 9, 1999.
Net Income: Net income decreased 31% from $5.4 million for the fiscal year
ended June 30, 1998 to $3.7 million for the fiscal year ended June 30, 1999.
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
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<PAGE>
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 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.
26
<PAGE>
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.
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.
Liquidity and Capital Resources
The principal source of the Company's liquidity historically has been
cashflow from operations. The Company currently has a $0.6 million credit
facility with Westpac Banking Corporation. The Company is currently
negotiating an increase in its credit facility to up to $1.8 million.
Furthermore, the Company is investigating a securitization program for its on-
line monitoring program.
Effective October 1, 1998, the Company executed the Stock Purchase
Agreement with Integral Investments Limited ("Integral"), a entity controlled
by Paul Brown, through which the Company acquired the IIHSL Shares. Pursuant
to the Stock Purchase Agreement, the Company paid aggregate consideration
consisting of: (i) 400,000 shares Common Stock; (ii) five year convertible
warrants to purchase 360,000 shares of Common Stock at an exercise price of
$13.00 per share; (iii) cash in the amount of $2,426,000; (iv) a promissory
note, secured by the IIHSL Shares, in the amount of $9,098,000, payable in
installments of $400,000 on each of June 30,1999 (paid on July 7, 1999) and
December 31, 1999, with the balance of the note due on June 30, 2000 (the
"Ness Note"); and, (v) a non-refundable re-negotiation fee of $200,000. 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 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.
The Company has entered into negotiations with Paul Brown, to restructure
the Ness Note. The Company is exploring the possibility of restructuring the
Ness Note with a mixture of new debt and equity.
On April 9, 1999, the Company effectively purchased the remaining 24.96
percent of the issued and outstanding common stock of Ness through a series of
transactions in which: (i) Nazareno Circosta the principal management officer
of Ness ("Circosta") agreed to enter into a Non-Competition Agreement with the
Company in exchange for a cash payment of $656,700; (ii) Circosta agreed to
purchase 277,778 shares of HSI Common Stock for $2,599,352; (iii) Ness agreed
to redeem 260,000 shares of Ness ("Ness Shares") from Circosta Pty
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<PAGE>
Limited, a unit trust beneficially owned by Circosta as well as certain
relevant employees, for $2,140,179 (collectively, the "Redemption
Transaction"). In addition, Ness agreed to pay $3,066,776 to Circosta in
exchange for Circosta terminating his existing employment contract and
entering into a new employment contract with Ness.
Cashflow from operations declined $1.6 million from $6.0 million for the
fiscal year ended June 30, 1998 to $4.3 million for the fiscal year ended June
30, 1999.
In April, 1998 the Company entered into an agreement with AMA Finance
Corporation Pty Limited ("AMA") whereby AMA agreed to provide second line
consumer finance for the sale of the Company's SecurityGuard to customers
failing to meet the lending criteria of FFC. Although the Company's
Distributors receive no income from AMA financed sales ("AMA sales"), each AMA
sale is registered as a unit sale for commission and bonus calculations. Upon
completion of an AMA sale the Company records a receivable of A$700 ($460) due
from AMA which is repayable in twelve equal installments commencing eight
months from installation (the "Repayment Cycle"). The total receivable due
from AMA (the "AMA Receivable") increased from $56,000 as at June 30, 1998 to
$1.1 million as at June 30, 1999. The AMA Receivable balance of $1.1 million
as at June 30, 1999 is not expected to increase materially in the next fiscal
year as the Repayment Cycle has reached maturity and AMA sales are expected to
remain constant. The AMA Receivable is secured by a fixed and floating charge
over AMA's finance receivables generated from the Company's AMA sales. Use of
cash related to accounts receivable during the fiscal year ended June 30, 1999
of $1.1 million was wholly attributable to the increase in the AMA Receivable.
Use of cash related to the $1.6 million in deferred income tax during
fiscal year ended June 30, 1999 was a result of the following; (i) deferred
tax assets of $0.6 million were booked during the fiscal year ended June 30,
1999 predominately relating to future income tax benefits derived from the
parent; (ii) provisional income tax installments paid during the year relating
to the fiscal year ended June 30, 1998; and (iii) $1.1 million in timing
difference attributable to the Ness transaction resulting in overpayment of
provisional income tax by Ness Security Products Pty Limited during the year
ended June 30, 1999. Ness Security Products Pty Limited expects to recoup the
overpayment upon remittance of its next provisional tax payment.
Net cash used in investing activities increased from a deficit of $1.8
million during the fiscal year ended June 30, 1998 to a deficit of $11.3
million during the fiscal year ended June 30, 1999. The deficit in net cash
used in investing activities was primarily due to the $9.1 million associated
with the acquisition of Ness made up of (i) cash payments of $126,000,
$2,300,000 and $200,000 paid in relation to the IIHSL acquisition; (ii) cash
payments of $2,140,179, and $3,066,776 in relation to the final 24.96%
acquisition of Ness; and (iii) $1,282,427 paid in acquisition cost for both
(i) and (ii) above. During the year ended June 30, 1999 the Company purchased
capital assets of $1.4 million, including manufacturing equipment for Ness of
$1.0 million.
Net cash generated from financing activities decreased from a surplus of
$3.5 million during the fiscal year ended June 30, 1998 to a surplus of $2.7
million for the fiscal year ended June 30, 1999. The surplus of $2.7 million
for the fiscal year ended June 30, 1999 consisted of (i) capital subscribed of
$2.6 million from the purchase of 277,778 shares of HSI Common Stock by
Circosta as part of the Ness Transaction; (ii) $0.6 million from the leaseback
of manufacturing equipment by Ness including a surface mount technology line
for $450,000 and a flying probe tester for $150,000; and (iii) 0.5 million in
repayments of borrowing by Ness to Westpac Banking Corporation ("Wesptac"). As
of June 30, 1999, Ness had fully repaid it's borrowing from Westpac.
Assuming a restructuring of the Ness Note on terms favorable to the
Company, 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 and the introduction of point of
sale on-line monitoring. It is expected that excess cashflows generated by the
Company will be used to fund its upgrade on-line monitoring program and
international expansion. The Company may be required to obtain additional
capital to fund growth from other financing sources if the cashflow generated
by the Australian
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and New Zealand and European 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.
Year 2000 disclosure
The Company has been completed a Year 2000 compliance evaluation of its
information technology infrastructure. The Company has identifies three areas
of exposure, each which can be further subdivided into two areas of implicit
risk classification.
(i) Software--"Mission Critical" & "Non-Mission Critical"
(ii) Hardware--"Mission Critical" & "Non-Mission Critical"
(iii) Remaining Infrastructure--"Mission Critical" & "Non-Mission
Critical"
Mission critical software includes the Company's accounting package,
customer database, and operating systems, including Windows 95 and Windows NT.
The services of an external information technology firm were utilized to
conduct this review and provide an analysis of the Company's potential risks.
The results of this review indicate that 100% of the mission critical software
have been identified as being fully year 2000 compliant currently or following
the loading of software patches. The structured rollout of the required
software patches is presently underway, and will be finalized by the end of
September 1999. The Company would need to invest approximately $40,000 to make
its current customer database year 2000 compliant. In order to benefit from
advances in technology rather than making its current customer database
compliant the Company is purchasing a replacement customer database to be
installed and fully operational prior to December 31, 1999 at an estimated
cost of $145,000. The Company has currently spent $15,000 on achieving year
2000 compliance and estimates that, excluding the purchase of the new customer
database, the total remaining cost to achieve year 2000 compliance will be
approximately $35,000. In addition, 100% of the Company's non-mission critical
software has been found to be year 2000 compliant following, in certain cases,
the loading of software patches.
Mission critical hardware encompasses the data communication infrastructure
and all server end hardware. The services of an external information
technology firm were utilized to conduct a review of these systems and provide
an analysis of the Company's potential risks. Such review has been completed
and the findings were conclusive. 100% of the mission critical hardware has
been tested and determined to be year 2000 compliant. Furthermore, only one
non-mission critical hardware product, a modem, has been found to be non-
compliant. It has been replaced.
The remaining infrastructure has been reviewed, and the rectification of
any exposures will be achieved by the end of October 1999. The Company has
also adopted a policy requiring written confirmation of Year 2000 compliance
from any prospective vendor. Furthermore, the Company has ensured all
subsidiaries, including each of FFC and Ness, implement the above strategies
to address Year 2000 issues. FFC is currently involved in a joint project with
FAI General Insurance Company Limited ("FAI General"), a subsidiary of FAI
Insurances Limited, to identify, categorize and if necessary, update, all
software and hardware components to address Year 2000 issues.
FFC has obtained confirmation from the vendor of its financial database
package that such software is Year 2000 compliant. Ness has confirmed that by
year end there will be no Year 2000 exposures. Ness has addressed Year 2000
issues in all of its products, including the SecurityGuard System. Ness has
also received confirmation that its mission critical network, hardware and
software are Year 2000 compliant.
The Company does not expect that the cost, if any, to modify its
infrastructures, in order to achieve Year 2000 compliance, will have a
material impact on its financial condition or results of operations. This
statement is a Year 2000 Readiness Disclosure entitled to protection as
provided in the Year 2000 Information and Readiness Disclosure Act.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's major market risk exposure is foreign currency fluctuations.
Geographically, the majority of the Company's operating subsidiaries are
located outside the United States, with operations conducted in their
respective local currencies. Accordingly, the Company's financial performance
could be adversely affected by fluctuations in currency exchange 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. A hypothetical 10% change in foreign exchange rates
would have impacted reported earnings by approximately $0.8 million for the
fiscal year ended June 30, 1999.
In addition, fluctuations in currency exchange rates could adversely affect
the Company's cash reserve balances. The Company's subsidiaries hold cash and
cash equivalents in local currency in order to provide liquidity for day-to-
day operations. A hypothetical 10% change in foreign exchange rates would have
impacted the Company's cash reserves balances by approximately $0.2 million at
June 30, 1999.
The Company is also exposed to foreign currency risk as a result of the FFC
Note. The FFC Note bears interest at a rate of 7.75% per annum payable monthly
in arrears, is denominated in Australian dollars, is payable in installments
and matures December 31, 2002. At June 30, 1999, AUD $7,250,000 was
outstanding under the FFC Note. The present value of the future cash outlays
(assuming a 5% discount factor) was equivalent to AUD $7,575,000 million at
June 30, 1999. A hypothetical 10% fluctuation in the AUD would have impacted
the future cash outlays committed under the FFC Note at June 30, 1999 by
approximately $0.5 million.
Although the Company is not in the business of currency hedging, it may
from time to time engage in currency hedging arrangements. Nevertheless, there
can be no assurance that the Company will be successful in limiting risks
related to currency fluctuations or that changes in exchange rates will not
have a material adverse effect on the Company or its results of operations.
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.
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, 1999.
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, 1999.
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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, 1999.
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, 1999.
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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, 1997,
1998 and 1999
Consolidated Balance Sheets as of June 30, 1998 and 1999
Consolidated Statements of Cashflows for the Years Ended June 30,
1997, 1998 and 1999
Consolidated Statements of Changes in Shareholders' Equity for the
Years Ended June 30, 1997, 1998 and 1999
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>
<C> <S>
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 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 Registrant (1)
3.2 Bylaws of the Registrant (1)
4.1 IPO Representatives Warrant Agreement (1)
4.2 Warrant dated as of September 30, 1998, issued by the Registrant
to International Home Security Investments Limited (9)
10.1* Amended and Restated 1997 Employee Stock Option Plan
10.2* Amended and Restated 1997 Non-Employee Directors' Stock Option
Plan
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)
10.7* Executive Service Agreement dated July 15, 1997 between the
Registrant and Terrence J. Youngman (4)
</TABLE>
32
<PAGE>
<TABLE>
<C> <S>
10.8* Executive Service Agreement dated July 15, 1997 between the
Registrant and Robert D. Appleby (4)
10.9* Executive Service Agreement dated July 15, 1997 between the
Registrant and Mark Whitaker (4)
10.10* Executive Service Agreement dated July 15, 1997 between the
Registrant and Geoffrey D. Knowles (4)
10.11 Option Agreement dated September 5, 1994 between Bradley D.
Cooper and FAI Insurances Limited (2)
10.12 Sale Agreement dated November 11, 1995, among Bradley D. Cooper,
FAI Insurances Ltd, FAI Home Security Holding Pty Ltd. and
Kamarasi Pty Ltd. (2)
10.13* Management Services Agreement with Speakeasy Ltd. (2)
10.14 Promissory Note Payable to Bradley D. Cooper (4)
10.15 Promissory Note Payable to FAI Home Security Holdings Pty
Limited (4)
10.16 Promissory Note Payable to FAI Home Security (ENZED) Limited (4)
10.17 Share Sale Agreement dated December 31, 1997 by and between FAI
Insurances Limited and FAI Home Security Pty. Limited (6)
10.18 Shareholders Agreement dated December 31, 1997 by and between
FAI Insurances Limited and FAI Home Security Pty. Limited (6)
10.19 Consultancy Engagement Agreement effective October 1, 1997,
among the Registrant, Speakeasy Pty. Ltd. and Bradley D. Cooper
(7)
10.20 Stock Purchase Agreement dated July 17, 1998 between the
Registrant and International Home Security Investments Limited
(8)
10.21 Stock Purchase Agreement dated as of July 17, 1998, and amended
as of September 30, 1998, by and between the Registrant and
Integral Investments Limited (9)
10.22 Secured Promissory Note dated as of September 30, 1998, executed
by the Registrant in favor of Integral Investments Limited (9)
10.23 Share Buy Back Agreement between Ness Security Products Pty Ltd.
and Integrated International Home Security Limited (10)
10.24 Employment Agreement between Ness Security Products Pty Limited;
Nazareno Circosta and Home Security International, Inc. (10)
10.25 Termination Agreement between Nazareno Circosta and Ness
Security Products Pty Limited (10)
10.26 Non-Competition Agreement between Nazareno Circosta and Home
Security International, Inc. (10)
10.27 Share Buy Back Agreement between Circosta Pty Limited and Ness
Security Products Pty Limited (10)
21.1 List of Subsidiaries
23.1 Consent of Arthur Andersen
23.2 Consent of Deloitte & Touche
27.1 Financial Data Schedule (EDGAR version only)
</TABLE>
- --------
* Compensation Plan or Agreement
(1) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (Registration No. 333-26399), as amended, filed with the
Securities and Exchange Commission on May 2, 1997
(2) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (Registration No. 333-26399), as amended, filed with the
Securities and Exchange Commission on June 10, 1997
33
<PAGE>
(3) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (Registration No. 333-26399), as amended, filed with the
Securities and Exchange Commission on June 25, 1997
(4) Incorporated by reference to the Registrant's Annual Report on Form 10-K
filed with the Securities and Exchange Commission on September 29, 1997
(5) Incorporated by reference to the Registrant's Quarterly Report on Form 10-
Q filed with the Securities and Exchange Commission on November 14, 1997
(6) Incorporated by reference to the Registrant's Report on Form 8-K filed
with the Securities and Exchange Commission on January 15, 1998
(7) Incorporated by reference to the Registrant's Quarterly Report on Form 10-
Q filed with the Securities and Exchange Commission on February 17, 1998
(8) Incorporated by reference to the Registrant's Registration Statement on
Form S-1 (Registration No. 333-54921), filed with the Securities and
Exchange Commission on July 20, 1998
(9) Incorporated by reference to the Registrant's Quarterly Report on Form 10-
Q filed with the Securities and Exchange Commission on November 16, 1998
(10) Incorporated by reference to the Registrant's Current Report on Form 8-K
filed with the Securities and Exchange Commission on June 17, 1999
(b) Reports on Form 8-K:
On October 7, 1998, the Registrant filed a current report on Form 8-K
describing the purchase of 100% of the shares of International Integrated
Home Security Limited by the Registrant.
On December 15, 1998, the Registrant filed an amended current report on
Form 8-K/A to file the requisite financials associated with the purchase of
100% of the shares of International Integrated Home Security Limited by the
Registrant.
On June 17, 1999, the Registrant filed a current report on Form 8-K
describing the acquisition of the remaining 24.96% interest in Ness
Security Products Pty Limited.
34
<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 28, 1999
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,
1999 ("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 28, 1999
____________________________________ Officer (Principal
Bradley D. Cooper Executive Officer)
/s/ Mark Whitaker Executive Vice President of September 28, 1999
____________________________________ Finance and Treasurer
Mark Whitaker (Principal Financial and
Accounting Officer)
/s/ Paul Brown Director September 28, 1999
____________________________________
Paul Brown
Director September , 1999
____________________________________
Steve Rabinovici
</TABLE>
35
<PAGE>
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page
----
<S> <C>
Home Security International, Inc.:
Report of Independent Public Accountants................................ 37
Independent Auditors' Report............................................ 38
Consolidated Statements of Income for the Years Ended June 30, 1997,
1998 and 1999.......................................................... 39
Consolidated Balance Sheets as of June 30, 1998 and 1999................ 40
Consolidated Statements of Cashflows for the Years Ended June 30, 1997,
1998 and 1999.......................................................... 41
Consolidated Statements of Changes in Shareholders' Equity for the Years
Ended June 30, 1997, 1998 and 1999..................................... 42
Notes to Consolidated Financial Statements.............................. 43
FAI Finance Corporation Pty Limited:
Report of Independent Public Accountants................................ 59
Consolidated Statements of Income for the Years Ended June 30, 1997,
1998 and 1999.......................................................... 60
Consolidated Balance Sheets as of June 30, 1998 and 1999................ 61
Consolidated Statements of Cashflows for the Years Ended June 30, 1997,
1998 and 1999.......................................................... 62
Consolidated Statements of Changes in Shareholders' Equity for the Years
Ended June 30, 1997, 1998 and 1999..................................... 63
Notes to Consolidated Financial Statements.............................. 64
</TABLE>
36
<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, 1999 and 1998, and related
consolidated statements of income, changes in shareholders' equity and cash
flows for each of the three years ended June 30, 1999. 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 did not audit the financial statements of
Integrated International Home Security Limited and its subsidiaries, which
statements reflect total assets and total revenues of 23 and 14 percent in
1999 of the related consolidated totals. These statements were audited by
other auditors whose report has been furnished to us, and our opinion, insofar
as it relates to the amounts included for those entities, is based solely in
the report of the other auditors.
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 and the report of other auditors provide a reasonable basis
for our opinion.
In our opinion, based on our audit and the report of other auditors, the
financial statements referred to above present fairly, in all material
respects, the financial position of Home Security International, Inc. as of
June 30, 1999 and 1998, and the results of its operations and its cash flows
for each of the three years ended June 30, 1999 in conformity with generally
accepted accounting principles in the United States of America.
/s/ Arthur Andersen
Sydney
September 28, 1999
37
<PAGE>
INDEPENDENT AUDITORS' REPORT
To the Shareholders of
Integrated International Home Security Limited
We have audited the consolidated balance sheets of Integrated International
Home Security Limited (the "Company") as of June 30, 1999 and 1998 and the
related consolidated statements of income, cashflows and changes in
shareholders' equity for the years then ended (all expressed in United States
dollars) (not presented herein). These financial statements are the
responsibility of the Company's management. Our responsibility is to express
an opinion on the consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform an 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 statements presentation. We believe our
audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements (not presented
herein) present fairly, in all material respects, the financial position of
the Company at June 30, 1999 and 1998 and the results of its operations, its
cashflows and its changes in shareholders' equity for the years then ended in
accordance with generally accepted accounting principles in the United States
of America.
/s/ Deloitte & Touche
August 9, 1999
British Virgin Islands
38
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
For the Years Ended June 30,
-------------------------------------
1997 1998 1999
Note $US $US $US
---- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net Sales......................... 2 33,464,595 44,118,502 45,993,049
Cost of goods sold--related party. 16 (3,647,376) -- --
--other.................... (20,626,411) (26,294,641) (23,274,202)
----------- ----------- -----------
Gross Profit...................... 9,190,808 17,823,861 22,718,847
Management fees received--related
parties.......................... 16 559,002 -- --
General and administrative
expenses......................... (6,177,958) (10,088,327) (12,673,379)
Amortization and depreciation..... (434,360) (721,989) (1,831,479)
Research and development.......... -- -- (394,957)
----------- ----------- -----------
Income from operations............ 3,137,492 7,013,545 7,819,032
Non operating income--other....... 6,740 -- --
Interest income--related party.... 16 755,613 26,679 --
--other..................... 81,790 423,526 429,795
Interest expenses--related party.. 16 (60,046) (216,629) (377,071)
--other.................... -- (7,904) (559,133)
----------- ----------- -----------
Income before taxes, equity in
income of affiliated companies... 3,921,589 7,239,217 7,312,623
Income tax expense................ 15 (1,629,973) (2,111,084) (3,540,806)
----------- ----------- -----------
Income before equity in income of
affiliated companies............. 2,291,616 5,128,133 3,771,817
Equity in income of affiliated
companies........................ 11 -- 252,417 310,421
Minority interest................. -- -- (334,565)
----------- ----------- -----------
Net income........................ 2,291,616 5,380,550 3,747,673
=========== =========== ===========
Net income per common share
Basic earnings per share........ $ 0.51 $ 1.05 $ 0.68
Diluted earnings per share...... $ 0.51 $ 1.04 $ 0.68
Weighted average number of shares
outstanding
Basic........................... 4,500,000 5,117,125 5,513,000
Diluted......................... 4,500,000 5,181,612 5,516,751
</TABLE>
The accompanying notes are an integral part of these financial statements
39
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
As of June 30,
----------------------
Note 1998 $US 1999 $US
----- ---------- ----------
ASSETS
------
<S> <C> <C> <C>
Current assets
Cash and cash equivalents....................... 7,006,183 2,976,240
Accounts receivable--related party.............. 16 -- 217,516
Accounts receivable--trade, net................. 3 874,745 3,190,633
Inventories, net................................ 4 2,032,443 6,974,109
Prepaid expenses and other current assets....... 5 1,173,449 1,508,016
---------- ----------
Total current assets.......................... 11,086,820 14,866,514
---------- ----------
Non-current assets
Investment in partnership....................... 10 303,424 323,398
Investment in affiliated companies.............. 11 7,405,130 7,874,928
Property, plant and equipment, net.............. 8 1,068,237 3,460,791
Intangibles, net................................ 9 9,601,923 23,014,184
Restrictive Covenant............................ 18 -- 638,458
Accounts receivable--trade, net................. 3 -- 241,588
Deferred income taxes........................... 15 1,016,652 1,057,559
Other non-current assets........................ 3,115 --
---------- ----------
Total non-current assets...................... 19,398,481 36,610,906
---------- ----------
Total assets.................................. 30,485,301 51,477,420
========== ==========
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
<S> <C> <C> <C>
Current liabilities
Bank overdraft.................................. -- 150,938
Note payable--FAI Insurances Group.............. 11,16 619,233 1,313,400
Note payable--Integral Investments Limited...... 16,18 -- 8,394,024
Payables--trade................................. 4,280,422 3,714,810
Accrued warranty................................ 247,126 384,534
Accrued security callout........................ 382,222 314,056
Other accrued liabilities....................... 148,168 752,417
Lease liability................................. 28,704 438,023
Income tax payable.............................. 1,608,648 1,355,696
Deferred income................................. 650,949 1,032,099
---------- ----------
Total current liabilities..................... 7,965,472 17,849,997
---------- ----------
Non-current liabilities
Note payable--FAI Insurances Group.............. 11,16 4,117,902 3,447,675
Lease liability................................. 33,342 720,512
Accrued security callout........................ 91,944 147,564
Deferred income................................. 177,769 238,019
---------- ----------
Total non-current liabilities................. 4,420,957 4,553,770
---------- ----------
Total liabilities............................. 12,386,429 22,403,767
---------- ----------
Shareholders' equity
Preferred stock $.001 value; 1,000,000 shares
authorized, none outstanding................... -- --
Common stock $.001 value; 20,000,000 shares
authorized and 5,150,500 and 5,828,278 shares
issued and outstanding as of June 30, 1998 and
1999 respectively.............................. 18 5,150 5,828
Additional paid-in capital...................... 16,111,311 22,309,708
Warrants........................................ 7 -- 504,000
Secured note.................................... 6 (2,375,000) (2,375,000)
Accumulated other comprehensive loss............ (976,565) (452,532)
Retained earnings............................... 5,333,976 9,081,649
---------- ----------
Total shareholders' equity.................... 18,098,872 29,073,653
---------- ----------
Total liabilities and shareholders' equity.... 30,485,301 51,477,420
========== ==========
</TABLE>
The accompanying notes are an integral part of these financial statements
40
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASHFLOW
<TABLE>
<CAPTION>
For the Years Ended June 30,
-----------------------------------
1997 1998 1999
$US $US $US
---------- ---------- -----------
<S> <C> <C> <C>
Cashflow from operating activities
Net income.............................. 2,291,616 5,380,550 3,747,673
Adjustments to reconcile net income to
net cash from operating activities:
Depreciation.......................... 42,100 181,835 540,282
Minority interest..................... -- -- 334,565
Imputed interest...................... -- -- 527,982
Amortisation of goodwill.............. 391,924 540,154 1,040,391
Amortisation of leased assets......... -- -- 243,487
Profit on sale of capital assets...... -- -- (36,869)
Finance lease costs................... -- -- 50,697
Equity in income of affiliated
companies............................ -- (252,417) (310,421)
Deferred income taxes................. (138,947) (585,314) (1,574,764)
Provisions for losses on accounts
receivable........................... 100,715 670,988 (651,544)
Provisions for stock obsolescence..... -- -- (1,047)
Increase (decrease) in operating
assets:
Accounts receivable--trade.......... (203,120) (1,025,880) (1,109,771)
Inventories......................... (965,610) (930,349) 1,045,771
Prepaid expenses and other assets... (33,054) (830,074) 125,586
(Increase) decrease in operating
liabilities:
Accounts payable.................... 2,159,629 1,051,807 365,190
Accrued liabilities................. 1,193,531 1,774,149 (49,607)
---------- ---------- -----------
Net cash provided by operating
activities........................... 4,838,784 5,975,449 4,287,601
---------- ---------- -----------
Cashflow from investing activities
Proceeds from sale of capital assets.... -- -- 105,022
Additions to capital assets............. (871,894) (553,404) (1,424,405)
Investment in affiliated companies...... -- (2,000,578) 289,650
Investment in partnership............... -- (303,424) (1,542)
Purchase of controlled entity, net of
cash acquired.......................... -- -- (9,115,382)
Restrictive covenant.................... -- -- (627,110)
Short term loans (granted)/repayments
received............................... 295,353 23,488 (234,833)
Receipt from (payments) to related
parties................................ 2,137,679 1,020,054 (250,844)
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................. 880,924 (1,813,864) (11,259,444)
---------- ---------- -----------
Cashflow from financing activities
Dividend and trust distribution paid.... (5,294,296) -- --
Return of capital....................... (581,928) -- --
Capital subscribed...................... -- 3,934,678 2,599,352
Share issue costs....................... -- (436,408) --
Funds from sale and leaseback of fixed
assets................................. -- -- 627,027
Finance lease payments.................. -- -- (188,125)
Net repayments of borrowings............ -- -- (509,090)
Increase (decrease) in bank overdraft... 31,795 (29,055) 125,844
---------- ---------- -----------
Net cash provided by (used in)
financing activities................. (5,844,429) 3,469,215 2,655,008
---------- ---------- -----------
Net increase (decrease) in cash held...... (124,721) 7,630,800 (4,316,835)
Cash at the beginning of the financial
period................................... 369,837 118 7,006,183
Effect of exchange rate changes on cash... (244,998) (624,735) 286,892
---------- ---------- -----------
Cash at the end of the financial period... 118 7,006,183 2,976,240
========== ========== ===========
Supplemental disclosure of cash
information
Interest paid........................... 515,763 224,533 411,985
Income taxes paid....................... 946,230 1,249,831 3,995,368
</TABLE>
The accompanying notes are an integral part of these financial statements
41
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
<TABLE>
<CAPTION>
Additional Accumulated Cumulative Total
Paid-in Retained Translation Secured Shareholders'
Amount Capital Earnings Adjustment Warrants Note Equity
------ ----------- ----------- ----------- -------- ----------- -------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JUNE 30, 1996.. $ 2 $ 6,016,944 $ 3,490,188 $ 386,693 $ -- $ -- $ 9,893,827
Comprehensive income.... 2,291,616 (553,335) 1,738,281
Additional paid-in
capital................ 1 4,803,675 4,803,676
Dividends and trust
distributions and
return of capital...... (581,928) (5,294,296) (5,876,224)
Reorganization
adjustment............. 4,497 (534,082) (239,892) (769,477)
------ ----------- ----------- --------- -------- ----------- -----------
BALANCE, JUNE 30, 1997.. 4,500 10,238,691 (46,574) (406,534) -- -- 9,790,083
Comprehensive income.... 5,380,550 (570,031) 4,810,519
Additional paid-in
capital................ 400 4,004,600 4,005,000
Issue of shares to
Bradley D. Cooper...... 250 2,499,750 (2,375,000) 125,000
Less share issue costs.. (631,730) (631,730)
------ ----------- ----------- --------- -------- ----------- -----------
BALANCE, JUNE 30, 1998.. 5,150 16,111,311 5,333,976 (976,565) -- (2,375,000) 18,098,872
Comprehensive income.... 3,747,673 524,033 4,271,706
Additional paid-in
capital................
Issue of 677,778 shares. 678 6,198,397 6,199,075
Issue of warrants to
purchase Common stock.. 504,000 504,000
------ ----------- ----------- --------- -------- ----------- -----------
BALANCE, JUNE 30, 1999.. $5,828 $22,309,708 $ 9,081,649 $(452,532) $504,000 $(2,375,000) $29,073,653
====== =========== =========== ========= ======== =========== ===========
</TABLE>
The accompanying notes are an integral part of these financial statements
42
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(All amounts in US$ 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 $208,894 for the NZ
Note.
The main business activities of the Company are the design, manufacture,
sale, service and monitoring of security alarm systems, which are sold via a
distributor network to residential and small business premises in the
countries of operations.
On December 31, 1997 the Company acquired 50 percent of the equity interest
in FAI Finance Corporation Pty Limited (together with its subsidiary FAI
Finance Corporation (NZ) Limited, herein call "FFC") from FAI Insurances Ltd.
FFC is a consumer finance company in both Australia and New Zealand and
finances a significant portion of customer accounts of the Company's
distributorship network in Australia and New Zealand.
Effective October 1, 1998, the Company purchased all of the issued and
outstanding common stock of Integrated International Home Security Limited
("IIHSL"), a British Virgin Islands holding company ("the Ness transaction").
IIHSL held 75.04 percent of the issued and outstanding common stock of Ness
Security Products Pty Limited ("Ness") up until April 9, 1999. On April 9,
1999 IIHSL acquired the remaining 24.96% of the issued and outstanding common
stock of Ness. Ness is a leading manufacturer of security alarm products in
Australia and the Company's sole supplier of the SecurityGuard alarm.
43
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(All amounts in US$ unless stated otherwise)
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 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, the
acquisition of the interest in FFC and the Partnership were accounted for
using the equity method. Additionally, the IIHSL acquisition and the
acquisition of the remainder of Ness have also been accounted for under the
equity method of accounting. The consolidated statements of income for the
year ended June 30, 1997 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, highly liquid, investments with
maturities of three months or less and are stated at cost, which approximates
fair value.
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 weighted average exchange rates for the fiscal
year. The resulting translation effects are reflected in shareholders' equity.
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.
44
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(All amounts in US$ unless stated otherwise)
g) Revenue Recognition--
Revenue from the sale of security systems 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
monitoring contracts for periods of up to five years. Extended product
warranty revenues are recognized on a straight-line basis over the respective
lives of the warranties. All unearned portions of the product warranty
revenues are treated in the balance sheet as "Deferred Income". Monitoring
revenue is recognized on receipt of monthly payments for each contract.
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 work in progress, finished goods and raw materials.
Inventories are stated at the lower of cost (first-in, first-out method), or
market. The elements of cost include direct labour, raw materials and
manufacturing overhead.
j) Property, plant and equipment--
Property, plant and equipment are recorded at cost. Maintenance and repairs
are expensed in the period to which they relate. Property under capital leases
(see Note 13) is amortized over the lease terms. Depreciation on property,
plant and equipment 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
Plant and machinery................ 5.0
Office equipment................... 8.0
Motor vehicles..................... 6.5
Computer equipment................. 3.5
Leasehold improvements............. 3.0
</TABLE>
k) Leased Assets--
Leased assets, classified as finance leases, are recorded at the present
value of minimum lease payments. A financed lease is one which effectively
transfers from the lessor to the lessee substantially all the risks and
benefits incidental to ownership of the leased property. Capitalized leased
assets are amortized on a straight-line basis over the estimated useful life
of the asset. Finance lease payments are allocated between interest expense
and the reduction of lease liability over the term of the lease. The interest
expense is determined by applying the interest rate implicit in the lease to
the outstanding lease liability at the beginning of each lease payment period.
Operating lease payments are charged as an expense in the period in which
they are incurred.
45
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(All amounts in US$ unless stated otherwise)
l) Research and Development--
Research and development costs consist of expenditures incurred during the
course of planned search and investigation aimed at discovery of new knowledge
which will be useful in developing new products or processes, or significantly
enhancing existing products or production processes, and the implementation of
such through design, testing of product alternatives or construction of
prototypes. The Company expenses all research and development costs as they
are incurred.
m) Pension and Other Benefit Plans--
The Company contributes to pension plans on behalf of its employees. The
pension plans are accumulation funds and the Company has no liability to
members under the plans. The Company charges all contributions as expenses
when incurred. The Company contributed a total of $361,740 to pension plans
during fiscal year ended June 30, 1999 compared to $172,104 in fiscal year
ended June 30, 1998. The Company has no other pension or other employment
benefit plans.
n) 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, 1999.
o) 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 at the time of the sale 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.
p) Security call-out--
The Company provides a security call-out service for emergency response for
five years from the date each alarm system is installed. 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.
q) 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 and the Company
presently purchases certain raw materials offshore. 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.
46
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(All amounts in US$ unless stated otherwise)
r) 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 dilutive stock options and warrants have been exercised.
s) 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. SFAS No. 123 "Accounting for
Stock Based Compensation", which the Company adopted 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.
t) New Accounting Pronouncements--
Organizations that set accounting standards in the United States have
issued several accounting pronouncements that the Company will be required to
adopt in future reporting periods.
SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities"
was issued in June 1999 and establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, (collectively referred to as derivatives) and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measures
those instruments at fair value. As issued, this Statement is effective for
all fiscal quarters, beginning after June 15, 1999, with earlier application
encouraged. Subsequently, in June 1999, SFAS No. 137 "Accounting for
Derivative Instruments and Hedging Activities--Deferral of Effective Date of
FASB Statement No. 133" was issued. This pronouncement changed the effective
date of SFAS No. 133 to all fiscal years beginning after June 15, 2000, with
earlier application encouraged. Management of the Company is evaluating this
new pronouncement to determine its impact upon future reporting.
AICPA Statement of Position 98-1 ("Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use") provides guidance on
accounting for the costs of computer software developed or obtained for
internal use, generally requiring direct development costs to be capitalized
while training and data conversion costs should be expensed as incurred. The
SOP is effective for fiscal years beginning after December 15, 1998.
Management anticipates the adoption of this pronouncement in fiscal year 1999
will not have a material impact on its financial statements. Home Security
International, Inc is currently in the process of installing and implementing
a new manufacturing and accounting software package, for which the accounting
treatment has been substantially consistent with the new accounting rule.
SFAS No. 132 "Employers, Disclosure about Pensions and Other Post
Retirement Benefits" was issued in February 1998 and has been 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.
47
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(All amounts in US$ unless stated otherwise)
NOTE 2: NET SALES
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------
1997 1998 1999
---------- ---------- ----------
<S> <C> <C> <C>
Direct retail sales................... -- -- 6,332,955
Distributor sales..................... 33,183,267 42,858,457 38,036,152
Other................................. 516,601 1,553,592 1,848,149
---------- ---------- ----------
Gross sales........................... 33,699,868 44,412,049 46,217,256
Less: Returns and rebates............. (235,273) (293,547) (224,207)
---------- ---------- ----------
Net sales............................. 33,464,595 44,118,502 45,993,049
========== ========== ==========
</TABLE>
NOTE 3: ACCOUNTS RECEIVABLE--TRADE
<TABLE>
<CAPTION>
June 30,
--------------------
1998 1999
--------- ---------
<S> <C> <C>
Accounts receivable................................. 1,643,980 3,661,215
Less: Allowance for doubtful accounts............... (769,235) (228,994)
--------- ---------
Accounts receivable--trade, net..................... 874,745 3,432,221
Less: non-current portion........................... -- (241,588)
--------- ---------
Current portion..................................... 874,745 3,190,633
========= =========
</TABLE>
NOTE 4: INVENTORIES
<TABLE>
<CAPTION>
June 30,
-------------------
1998 1999
--------- ---------
<S> <C> <C>
Finished goods....................................... 2,032,443 4,025,348
Work in progress..................................... -- 288,382
Raw materials........................................ -- 3,158,131
--------- ---------
2,032,443 7,471,861
Less: provision for obsolescence..................... -- (497,752)
--------- ---------
2,032,443 6,974,109
========= =========
</TABLE>
NOTE 5: PREPAID EXPENSES AND OTHER CURRENT ASSETS
<TABLE>
<CAPTION>
June 30,
-------------------
1998 1999
--------- ---------
<S> <C> <C>
Prepayments........................................... 557,355 829,791
Other loans........................................... -- 229,880
Sundry debtors........................................ 616,094 448,345
--------- ---------
1,173,449 1,508,016
========= =========
</TABLE>
Other loans consist of $131,375 owing by Bradley D. Cooper and $98,505 owing
by Nazareno Circosta. Both amounts represent unsecured personal loan advances,
repayable on demand and bear interest at commercial rates. Mr. Cooper's loan
includes interest on the secured note (See Note 6), net of amounts due to Mr.
Cooper.
48
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(All amounts in US$ unless stated otherwise)
NOTE 6: SECURED NOTE
On July 15, 1997 Bradley D. Cooper purchased 250,000 shares of the
Company's Common Stock at $10.00 per share. Five percent (5%) of the purchase
price for the shares, being $125,000, was paid by Mr. Cooper in cash and the
remainder, $2,375,000, was paid through a five-year note to the Company
bearing interest at 7.0% per annum, payable semi-annually, and secured by the
shares purchased. The note is repayable on the fifth anniversary of its
issuance. The interest payable on the note is due on a full recourse basis.
During the fiscal year ended June 30, 1999, interest totaling $166,250 under
this loan was charged to Mr. Cooper's personal loan advance (see Note 5).
NOTE 7: WARRANTS
In connection with the Ness acquisition (see Note 18), the Company has
issued a five year convertible warrant to purchase 360,000 shares of Common
Stock in the Company to International Home Security Investments Limited
("Holder") with a market value of $504,000 at the date of issuance. Each
warrant entitles the holder, upon exercise, to receive from the Company one
share of fully paid, non-assessable Common Stock of the Company for U.S.
$13.00.
NOTE 8: PROPERTY, PLANT AND EQUIPMENT
<TABLE>
<CAPTION>
June 30,
---------------------
1998 1999
--------- ----------
<S> <C> <C>
Furniture and fixtures............................. 204,373 382,839
Office equipment................................... 236,610 665,245
Motor vehicles..................................... 273,373 633,972
Computer equipment................................. 402,906 612,727
Plant.............................................. -- 2,713,455
Leasehold improvements............................. 180,895 305,279
Less: Accumulated depreciation..................... (229,920) (1,852,726)
--------- ----------
1,068,237 3,460,791
========= ==========
</TABLE>
NOTE 9: INTANGIBLES
<TABLE>
<CAPTION>
June 30,
----------------------
1998 1999
---------- ----------
<S> <C> <C>
Goodwill on investment............................ 10,803,072 25,514,670
Less: Accumulated amortization.................... (1,201,149) (2,500,486)
---------- ----------
9,601,923 23,014,184
========== ==========
</TABLE>
Goodwill represents (1) the excess of the purchase price paid by the then
ultimate parent entity, FAI Insurances Limited over the fair value of assets
acquired as part of the reorganization, (2) the excess of the purchase price
paid by the Company over the fair value of assets acquired when the Company
purchased all of the issued and outstanding common stock of IIHSL, (3) the
excess of the purchase price paid by IIHSL over the fair value of assets
acquired when IIHSL acquired the remaining 24.96% of the issued and
outstanding common stock of Ness and (4) the excess of the purchase price paid
by Ness over the fair value of assets acquired when Ness purchased Ness
Security Products (Asia) Limited and Ness Security USA Inc.
49
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(All amounts in US$ unless stated otherwise)
NOTE 10: INVESTMENT IN PARTNERSHIP
Effective June 30, 1998, the Company purchased a 49 percent interest in a
partnership (the "Partnership") that has entered into an agreement with Prime
Life Corporation Limited to acquire a retirement village in Melbourne,
Australia. On June 30, 1999, the partnership was converted into a limited
partnership. The $303,424 investment in the Partnership was accounted for
using the purchase method. Accordingly, the Company has not recognized any
Partnership earnings in either the 1998 or 1999 fiscal years. In addition, two
members of the Company's senior management also purchased a combined interest
in the Partnership of 30 percent.
NOTE 11: 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 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 $7,059,525, 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, $6,226,382 of the purchase
price was allocated to goodwill.
During the fiscal year ended June 30, 1998, FFC declared a dividend of
$1,970,100. The Company has classified its 50 percent share of the dividend as
"Investment in affiliated companies", as the dividend was reinvested in FFC
during the quarter ended September 30, 1998.
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. As at June 30, 1999 $1,313,400 was due
currently and $3,447,675 was due long term.
NOTE 12: FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts reflected in the consolidated balance sheets for cash
equivalents, accounts receivable and payable approximate their respective fair
values due to the short maturities of those instruments. The carrying value of
the long-term payable to FAI Insurances Limited approximates its fair value as
the loan was granted on December 31, 1997 at market rates which have not
changed significantly. The carrying value of the current payable to Integral
Investments Limited approximates its fair value as the loan was granted on
October 1, 1998 and is discounted for financial reporting purposes.
NOTE 13: LEASE COMMITMENTS
The Company leases several production facilities and motor vehicles under
long--term leases and has the option to purchase the facilities for a normal
cost at the termination of the lease. Included in property, plant and
equipment are the following assets held under capital leases.
50
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(All amounts in US$ unless stated otherwise)
Capital leases
<TABLE>
<CAPTION>
June 30,
------------------
1998 1999
------- ---------
<S> <C> <C>
Motor vehicles.............................................. 75,472 340,776
Plant and machinery......................................... -- 1,392,496
------- ---------
75,472 1,733,272
Less: accumulated amortization.............................. (15,796) (686,402)
------- ---------
59,676 1,046,870
======= =========
</TABLE>
The following is a schedule by year of future gross minimum rental payments
for all capital leases reconciled to the present value of net minimum finance
lease payments as of June 30, 1999.
Minimum rental payments for all capital leases
<TABLE>
<CAPTION>
June 30,
----------------
1998 1999
------ ---------
<S> <C> <C>
Payable no later than one year................................. 30,196 520,784
Payable later than one year but not later than two years....... 14,899 307,936
Payable later than two years but not later than three years.... 14,899 190,861
Payable later than three years but not later than four years... 10,724 310,012
Payable later than four years but not later than five years.... -- --
------ ---------
Minimum lease payments......................................... 70,718 1,329,593
Less: amount representing interest............................. 8,672 171,058
------ ---------
Present value of net minimum lease payments.................... 62,046 1,158,535
Less: current portion.......................................... 28,704 438,023
------ ---------
Long-term obligations under capital leases..................... 33,342 720,512
====== =========
</TABLE>
The operating lease commitments of the Company consist of property rentals
used as offices in Sydney, Melbourne, Brisbane and Perth and computer
equipment leases.
Operating lease commitments
<TABLE>
<CAPTION>
June 30,
-----------------
1998 1999
------- ---------
<S> <C> <C>
Payable no later than
one year............... 175,094 425,076
Payable later than one
year but not later than
two years.............. 175,094 376,219
Payable later than two
years but not later
than three years....... 159,536 297,909
Payable later than three
years but not later
than four years........ 100,204 120,117
Payable later than four
years but not later
than five years........ -- --
Payable later than five
years.................. -- --
------- ---------
Total minimum operating
lease payments......... 609,928 1,219,321
======= =========
</TABLE>
<TABLE>
<CAPTION>
Year Ended June 30,
-----------------------
1997 1998 1999
------- ------- -------
<S> <C> <C> <C>
Rent expenses........................................... 214,229 316,220 560,196
======= ======= =======
</TABLE>
51
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(All amounts in US$ unless stated otherwise)
NOTE 14: SEGMENT INFORMATION
The Company operates principally in one industry segment including the
design, manufacture, sale, service and monitoring of security alarm systems.
The Company's identifies its segments based on management responsibility
within Australasia, Europe, North America and other segments. No single
customer accounts for more than 10% of the Company's revenues.
Effective July 1, 1998, the Company adopted SFAS No. 131, "Disclosure about
Segments of an Enterprise and Related Information" 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, or decision making group, organize segments within the company for
making operating decisions and assessing performance. The Company's operating
decision making group consists of various members of management. The operating
segments are managed separately because each operating segment represents a
strategic business unit that serves different geographic markets.
52
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(All amounts in US$ unless stated otherwise)
The Company's reportable segments include Australasia, Europe, North
America and other segments. Information about the Company's reportable
segments split by geographic location is shown below.
<TABLE>
<CAPTION>
Year Ended June 30,
----------------------------------
1997 1998 1999
---------- ---------- ----------
<S> <C> <C> <C>
Net sales:
Australasia........................ 32,815,262 38,984,766 40,649,874
Europe............................. 547,083 3,469,824 4,500,221
North America...................... 102,250 742,142 332,968
Other.............................. -- 921,770 509,986
---------- ---------- ----------
33,464,595 44,118,502 45,993,049
========== ========== ==========
Income (loss) from operations:
Australasia........................ 3,148,318 8,349,647 10,687,595
Europe............................. 90,175 (124,231) (112,191)
North America...................... (92,520) (1,317,008) (2,544,841)
Other.............................. (8,481) 105,137 (211,531)
---------- ---------- ----------
3,137,492 7,013,545 7,819,032
========== ========== ==========
Depreciation:
Australasia........................ 40,210 164,642 515,469
Europe............................. -- 11,434 18,368
North America...................... 2,225 5,759 27,696
Other.............................. -- -- --
---------- ---------- ----------
42,435 181,835 561,533
========== ========== ==========
Amortization:
Australasia........................ 368,668 447,135 1,149,789
Europe............................. 11,023 43,854 43,854
North America...................... 11,490 46,180 46,180
Other.............................. 743 2,985 30,123
---------- ---------- ----------
391,924 540,154 1,269,946
========== ========== ==========
Capital expenditure:
Australasia........................ 865,901 572,116 1,392,121
Europe............................. -- 42,305 28,961
North America...................... 43,648 26,897 --
Other.............................. -- -- 3,323
---------- ---------- ----------
909,549 641,318 1,424,405
========== ========== ==========
</TABLE>
<TABLE>
<CAPTION>
June 30,
---------------------
1998 1999
---------- ----------
<S> <C> <C>
Identifiable assets:
Australasia....................................... 18,682,610 43,799,762
Europe............................................ 1,765,934 1,473,681
North America..................................... 2,842,347 797,064
Other............................................. 188,227 2,430,673
---------- ----------
23,479,118 48,501,180
Corporate assets.................................. 7,006,183 2,976,240
---------- ----------
30,485,301 51,477,420
========== ==========
</TABLE>
53
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(All amounts in US$ unless stated otherwise)
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 15: 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,
-------------------------------
1997 1998 1999
--------- --------- ---------
<S> <C> <C> <C>
Expected income tax expense at statutory
rates.................................. 1,351,883 2,657,809 2,448,691
Tax effect of permanent and other
differences:
Over (under) provision for income tax
in prior years....................... (8,538) (5,622) 16,195
Writeback (deduction) allocated from
investment in Partnership............ -- (600,609) 553,111
Non-deductible expenses and other
items................................ 145,535 69,264 246,729
Non-assessable income and other items. -- (198,812) (107,694)
Amortization of goodwill.............. 141,093 189,054 383,774
--------- --------- ---------
1,629,973 2,111,084 3,540,806
========= ========= =========
The tax expense is split between:
Current............................... 1,711,286 2,578,343 3,581,713
Deferred.............................. (81,313) (467,259) (40,907)
--------- --------- ---------
1,629,973 2,111,084 3,540,806
========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
June 30,
--------------------
1998 1999
--------- ---------
<S> <C> <C>
Deferred tax assets are comprised of timing
differences on:
Provisions not currently deductible for tax
purposes for:
Doubtful accounts............................ 216,023 18,576
Warranty..................................... 87,373 122,248
Employee entitlements........................ -- 283,397
Security call--out........................... 146,003 136,601
Extended warranty............................ 295,046 --
Stock obsolescence........................... -- 106,528
Other........................................ 29,130 59,962
Sundry accruals................................ 11,146 28,203
Investment in partnership...................... -- (579,209)
Capitalized monitoring costs................... -- (241,430)
Tax losses carried forward..................... 352,898 1,192,295
Prepayments.................................... (120,967) (69,612)
--------- ---------
Net deferred tax assets.......................... 1,016,652 1,057,559
========= =========
</TABLE>
As of June 30, 1999 and 1998, no valuation allowances are deemed necessary
as management expects to realize all tax losses carried forward as future tax
deductions.
54
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(All amounts in US$ unless stated otherwise)
As of June 30, 1999, the tax assets derived from Net Operating Loss carry
forwards (NOLs) consist of NOL tax assets with expiration dates as follows:
<TABLE>
<S> <C>
2005............................ $210,827
2013............................ 36,451
2019............................ 750,008
No Expiration................... 195,009
</TABLE>
NOTE 16: RELATED PARTY TRANSACTIONS
At June 30, 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.
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 year ended June 30, 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,
-------------------
1998 1999
--------- ---------
<S> <C> <C>
Amounts due to related party:
Current liabilities:
FAI Insurances Limited............................ 619,233 1,313,400
Integral Investments Limited...................... -- 8,394,024
Non-current liabilities:
FAI Insurances Limited............................ 4,117,902 3,447,675
</TABLE>
The above loans from FAI Insurances Limited relate to the acquisition of
FFC. Refer to Note 11 for further details on the terms and conditions of the
loans.
The above loan from Integral Investments Limited relate to the Ness
Transaction. Refer to Note 18 for further details on the term and conditions
of the loans.
On June 23, 1999, due to a continued working capital deficit, Mr. Whitaker,
the Company's Chief Financial Officer, took ownership and became, the sole
director of FAI Home Distributors Pty Limited ("FHD"), previously owned and
operated by the Company's distributor network. Mr. Whitaker receives no
remuneration from FHD. FHD pays for all the Distributor Network's marketing
and promotional expenses in Australia and New Zealand in return for a payment
of approximately $45 for each SecurityGuard system sold in these regions. From
time to time the Company supplies FHD with a short-term loan facility allowing
FHD to cover short-term
55
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(All amounts in US$ unless stated otherwise)
cash flow deficiencies caused by semi annual and annual conference costs. The
short-term loan facilities are repayable on demand and bear interest at
commercial rates. The net liabilities of FHD at June 30, 1999 were $795,000
based on unaudited financial statements. On July 20, 1999 FHD entered into an
agreement with the Company whereby FHD agreed to pay the Company, in full 365
days from receipt of a notice requiring payment, all irrecoverable bad debts,
incurred by the Company as a result supplying stock on credit to it's
distributors. On July 20, 1999 Bradley D. Cooper entered into a deed
guaranteeing the amounts owing to the Company by FHD.
<TABLE>
<CAPTION>
June 30,
------------
1998 1999
---- -------
<S> <C> <C>
Amounts due from related party:
Current assets:
FAI Home Distributors Pty Limited........................ -- 217,516
</TABLE>
<TABLE>
<CAPTION>
Year Ended June 30,
-------------------------
1997 1998 1999
--------- ------- -------
<S> <C> <C> <C>
Net income is stated after
the following items:
Interest on direct
advances to:
FAI Insurances Limited.. 60,046 -- --
Non exclusive database
license fee paid by
FAI Insurances Limited
to:
FAI Home Security Pty
Limited................ -- 338,362 --
FAI Home Security
(ENZED) Limited........ -- 72,207 --
Royalty fees paid to:
FAI Insurances Limited.. 3,647,376 -- --
Interest on loans paid to:
FAI Insurances Limited.. -- 216,629 377,071
Interest on loans received
from:
FAI Home Security
Holdings Pty Limited... -- 26,679 --
FAI Finance Corporation
(NZ) Limited........... 755,613 -- --
Management fees paid to:
FAI Finance Corporation
(NZ) Limited........... 58,394 -- --
Management fees received
from:
FAI Home Security
Holdings Pty Limited... 559,002 -- --
Office rentals paid to:
FAI General Insurance
Company Limited........ 213,240 207,870 204,110
Computer rentals paid to:
FAI Home Security
Holdings Pty Limited... 92,937 -- --
</TABLE>
56
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(All amounts in US$ unless stated otherwise)
NOTE 17: 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 1,150,000 shares of Common Stock to management,
employees and advisers of the Company. The 1997 Plan provides for the grant 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 710,000 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, 80,000 to Mr. Whitaker and 40,000 to 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 the 40,000 Options
granted to Ms. Hilbert have vested and the 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 October 31, 2003.
The Company has reserved 50,000 shares of Common Stock for issuance under
its 1997 Non-Employee Director Stock Option Plan of which options to purchase
20,000 shares have been granted at an exercise price of $10.00 per share and
options to purchase 7,500 shares have been granted at $10.6875 per share.
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 at
the time received options to purchase 5,000 shares of Common Stock at $10.00
per share under the 1997 Non-Employee Director Stock Option Plan. An
additional 7,500 shares of Common Stock at $10.6875 per share were granted to
the Company's non-employee directors on the day following the February 17,
1999 annual meeting. 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 and expire on the tenth anniversary of such date.
NOTE 18: NESS TRANSACTION
a) Ness transaction--
Effective October 1, 1998, the Company purchased pursuant to an amended
stock purchase agreement (the "Stock Purchase Agreement") all of the issued
and outstanding common stock (the "IIHSL Shares") of Integrated International
Home Security Limited ("IIHSL"), a British Virgin Islands holding company (the
"IIHSL acquisition"). 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
IIHSL Shares consisted of the following: (i) 400,000 shares of the Company's
common stock, $0.001 par value per share (the "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; (iii) cash in the
amount of $2,426,000 ($126,000 paid
57
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
(All amounts in US$ unless stated otherwise)
concurrent with the execution of the Stock Purchase Agreement and $2,300,000
paid upon closing of the transaction); (iv) a promissory note, secured by the
IIHSL Shares, in the amount of $9,098,000 (discounted to $8,394,024 as at June
30, 1999 for financial reporting purposes), payable in installments of
$400,000 on each of June 30,1999 (paid on July 7, 1999) and December 31, 1999,
with the balance of the note due on June 30, 2000 ("Note"); and, (v) a non-
refundable re-negotiation fee of $200,000 resulting from the conversion of the
proposed cash payment of $9,098,000 to the promissory note referred to in
(iv).
On April 9, 1999, the Company effectively purchased the remaining 24.96
percent of the issued and outstanding common stock of Ness (the "Ness
acquisition") through a series of transactions in which: (i) Nazareno Circosta
the principal management officer of Ness ("Circosta") agreed to enter into a
Non-Competition Agreement with the Company in exchange for a cash payment of
$656,700; (ii) Circosta agreed to purchase 277,778 shares of HSI Common Stock
for $2,599,352; (iii) Ness agreed to redeem 260,000 shares of Ness ("Ness
Shares") from Circosta Pty Limited, a company owned by Circosta as well as
certain relevant employees, for $2,140,179 (collectively, the "Redemption
Transaction"). In addition, Ness agreed to pay $3,066,776 to Circosta in
exchange for Circosta terminating his existing employment contract and
entering into a new employment contract with Ness.
As a result of the Redemption Transaction, the Company's wholly-owned
subsidiary, IIHSL, became the sole owner of Ness.
The IIHSL and Ness acquisitions have been accounted for under the purchase
method of accounting. The purchase price has been allocated based on estimated
fair values at date of acquisition. This allocation has resulted in acquired
goodwill of $12,039,658 relating to the IIHSL acquisition, and $2,171,096
relating to the Ness acquisition. Both goodwill amounts are being amortized on
a straight-line basis over 20 years. The results of operations have been
included in the consolidated financial statements since the acquisition dates.
Pro Forma net income adjusted as though the 100% acquisition of IIHSL and
Ness took place at the beginning of the periods being reported on is shown
below.
<TABLE>
<CAPTION>
Year Ended June 30,
--------------------
1997 1998 1999
------ ------ ------
(in thousands
except per share
data)
<S> <C> <C> <C>
Pro forma net sales................................ 34,956 49,540 48,545
Pro forma income from operations................... 4,770 10,151 8,576
Pro forma net income............................... 2,710 6,692 4,314
Pro forma net income per common share
Basic earnings per share......................... 0.52 1.15 0.74
Diluted earnings per share....................... 0.52 1.13 0.74
Pro forma weighted average number of shares
outstanding
Basic............................................ 5,178 5,828 5,828
Diluted.......................................... 5,178 5,916 5,832
</TABLE>
58
<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 the 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 two years in the period
ended 30 June 1998 in conformity with generally accepted accounting principles
in the United States of America.
The consolidated financial statements of FAI Finance Corporation Pty
Limited as of and for the year ended June 30, 1999 which are presented solely
for comparative purposes, were not audited by Independent Public Accountants.
/s/ Arthur Andersen
Sydney
August 20, 1998
59
<PAGE>
FAI FINANCE CORPORATION
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
For the Years Ended June 30,
-----------------------------------
1997 1998 1999
Note $US $US $US
---- ---------- ---------- -----------
(Unaudited)
<S> <C> <C> <C> <C>
Interest income--other................ 6,399,516 8,589,957 8,986,893
--related party................ 11 -- -- 11,569
Interest expenses--related party...... 11 (755,741) (1,297,681) (1,560,867)
--other........................ (1,170,662) (1,154,521) (1,399,259)
---------- ---------- ----------
Net interest income................... 4,473,113 6,137,755 6,038,336
Management fee income--related party.. 11 61,675 69,075 26,285
---------- ---------- ----------
Operating revenues.................... 4,534,788 6,206,830 6,064,621
General and administrative expenses--
other................................ 4 (2,042,788) (3,001,603) (3,279,853)
Bad debts and allowance for losses.... 2 (807,800) (766,270) (1,223,732)
---------- ---------- ----------
Income before taxes................... 1,684,200 2,438,957 1,561,036
Income tax expense.................... 10 (580,205) (919,232) (373,434)
---------- ---------- ----------
Net income............................ 1,103,995 1,519,725 1,187,602
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
60
<PAGE>
FAI FINANCE CORPORATION
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
As of June 30,
-----------------------
1998 1999
ASSETS Note $US $US
------ ----- ---------- -----------
(Unaudited)
<S> <C> <C> <C>
Cash and cash equivalents........................ 5 241,889 263,100
Receivables--related party....................... 11 -- 9,223
Receivables 2
Consumer loans................................. 38,138,274 42,851,279
Business finance loans......................... 592,076 1,250,262
---------- ----------
Total receivables............................ 38,730,350 44,101,541
Less: Allowance for losses of receivables...... 2 592,709 1,005,080
---------- ----------
Net receivables.............................. 38,137,641 43,096,461
Prepaid expenses and other current assets........ 6 873,729 399,928
Restricted Deposits.............................. 7, 14 913,553 1,109,904
Property, plant and equipment, net............... 8 410,415 475,356
Deferred income taxes............................ 10 209,319 494,554
Intangibles...................................... 9 232,387 231,661
---------- ----------
Total assets................................. 41,018,933 46,080,187
========== ==========
<CAPTION>
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
<S> <C> <C> <C>
Bank overdraft................................... 441,916 --
Borrowing--Westpac Banking Corporation........... 14 16,260,681 19,897,335
Payables--trade.................................. 637,975 558,471
Accrued liabilities.............................. 55,532 69,421
Provision for interim dividend................... 1,857,700 --
Income tax payable............................... 375,645 209,084
Payables--related party.......................... 11 20,582,441 21,703,833
---------- ----------
Total liabilities............................ 40,211,890 42,438,144
---------- ----------
Shareholders' equity
Common stock ($A1.00 value; 100,000 shares
authorized;
50,002 shares outstanding).................... 36,976 36,976
Additional paid in capital..................... 335,592 2,193,292
Foreign currency translation reserve........... (1,049,553) (1,259,855)
Retained earnings.............................. 1,484,028 2,671,630
---------- ----------
Total shareholders' equity................... 807,043 3,642,043
---------- ----------
Total liabilities and shareholders' equity... 41,018,933 46,080,187
========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
61
<PAGE>
FAI FINANCE CORPORATION
CONSOLIDATED STATEMENTS OF CASHFLOWS
<TABLE>
<CAPTION>
For the Years Ended June 30,
-------------------------------------
1997 1998 1999
$US $US $US
----------- ----------- -----------
(Unaudited)
-----------
<S> <C> <C> <C>
Cashflow from operating activities
Net income............................ 1,103,995 1,519,725 1,187,602
Adjustments to reconcile net income to
net cash
from Operating activities:
Depreciation........................ 55,318 127,353 163,514
Amortization of goodwill............ 35,020 15,333 14,120
Deferred taxes and income tax
payable............................ (613,974) 364,378 (452,074)
Provision for losses on term loans
receivable......................... 279,192 150,871 376,509
(Increase) decrease in operating
assets:
Prepaid expenses and other assets. (450,320) (332,444) 140,971
Increase (decrease) in operating
liabilities:
Accounts payable.................. 7,443 639,357 (138,073)
Accrued liabilities............... 12,306 21,888 10,044
----------- ----------- -----------
Net cash provided by operating
activities..................... 428,980 2,506,461 1,302,613
----------- ----------- -----------
Cashflow from investing activities
Additions to plant and equipment...... (258,225) (273,951) (209,736)
Term loans funded..................... (33,411,428) (53,485,579) (51,319,507)
Collection of principal............... 23,706,843 38,112,514 48,291,690
----------- ----------- -----------
Net cash used in investing
activities..................... (9,962,810) (15,647,016) (3,237,553)
----------- ----------- -----------
Cashflow from financing activities
Net proceeds from/(payments on)
borrowings........................... (420,924) 7,244,019 2,652,804
Decrease in restricted deposits....... (104,988) (188,062) (141,077)
Receipts/(payments) from/(to) related
parties.............................. 8,679,306 7,094,301 (195,872)
Increase (decrease) in bank overdraft. 1,530,134 (923,065) (447,530)
----------- ----------- -----------
Net cash provided by financing
activities..................... 9,683,528 13,227,193 1,868,325
----------- ----------- -----------
Net increase (decrease) in cash held.... 149,698 86,638 (66,615)
----------- ----------- -----------
Cash at the beginning of the financial
period................................. 17,576 211,096 241,889
Effect of exchange rate change on cash
held................................... 43,822 (55,845) 87,826
----------- ----------- -----------
Cash at the end of the financial period. 211,096 241,889 263,100
=========== =========== ===========
Supplement disclosure of cashflow
information
Interest paid......................... 755,742 2,452,201 2,960,126
Income taxes paid..................... 1,200,788 286,592 1,013,291
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
62
<PAGE>
FAI FINANCE CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
<TABLE>
<CAPTION>
Additional Accumulated Cumulative Total
Paid-in Retained Translation Shareholders'
Amount Capital Earnings Adjustment Equity
$US $US $US $US $US
------- ---------- ----------- ----------- -------------
<S> <C> <C> <C> <C> <C>
BALANCE, JUNE 30, 1996.. $36,976 $ 335,592 $ 718,008 $ 36,578 $ 1,127,154
Comprehensive income.... 1,103,995 (100,679) 1,003,316
------- --------- ----------- ----------- -----------
BALANCE, JUNE 30, 1997.. 36,976 335,592 1,822,003 (64,101) 2,130,470
Comprehensive income.... 1,519,725 (985,452) 534,273
Cash dividend declared
($36.15 per share)..... (1,857,700) (1,857,700)
------- --------- ----------- ----------- -----------
BALANCE, JUNE 30, 1998.. 36,976 335,592 1,484,028 (1,049,553) 807,043
Comprehensive income.... 1,187,602 (210,302) 977,300
Additional paid-in
capital................ 1,857,700 1,857,700
------- --------- ----------- ----------- -----------
BALANCE, JUNE 30, 1999*. 36,976 2,193,292 2,671,630 (1,259,855) 3,642,043
======= ========= =========== =========== ===========
</TABLE>
- --------
*The movements from July 1, 1998 to June 30, 1999 are unaudited.
The accompanying notes are an integral part of these consolidated financial
statements
63
<PAGE>
FAI FINANCE CORPORATION
NOTES TO THE 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 are 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 74 percent of all consumer
loans rise from Home Security International, Inc's ("the Company") distributor
network in Australia and New Zealand.
b) Principles of Consolidation and Basis of Preparation--
The accompanying 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.
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.
64
<PAGE>
FAI FINANCE CORPORATION
NOTES TO THE 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) Property Plant and Equipment--
Property plant and equipment are recorded at cost. Maintenance and repairs
are expensed in the period to which they relate. Depreciation on property
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 pension plans on behalf of its employees. The pension
plans are accumulation funds and FFC has no liability to members under the
plans. FFC charges all contributions as expenses when incurred. FFC
contributed a total of $78,909 to pension plans during fiscal year ended June
30, 1999 compared to $53,495 in fiscal year ended June 30, 1998. 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--
Organizations that set accounting standards in the United States have
issued several accounting pronouncements that the Company will be required to
adopt in future reporting periods.
SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities"
was issued in June 1999 and establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, (collectively referred to as derivatives) and for hedging
activities. It
65
<PAGE>
FAI FINANCE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measures those
instruments at fair value. As issued, this Statement is effective for all
fiscal quarters, beginning after June 15, 1999, with earlier application
encouraged. Subsequently, in June 1999, SFAS No 137 "Accounting for Derivative
Instruments and Hedging Activities--Deferral of Effective Date of FASB
Statement No. 133" was issued. This pronouncement changed the effective date
of SFAS No. 133 to all fiscal years beginning after June 15, 2000, with
earlier application encouraged. Management of the Company is evaluating this
new pronouncement to determine its impact upon future reporting.
AICPA Statement of Position 98-1 ("Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use") provides guidance on
accounting for the costs of computer software developed or obtained for
internal use, generally requiring direct development costs to be capitalized
while training and data conversion costs should be expensed as incurred. The
SOP is effective for fiscal years beginning after December 15, 1998.
Management anticipates the adoption of this pronouncement in fiscal year 1999
will not have a material impact on its financial statements. Home Security
International, Inc. is currently in the process of installing and implementing
a new manufacturing and accounting software package, for which the accounting
treatment has been substantially consistent with the new accounting rule.
SFAS No. 132 "Employers, Disclosure about Pensions and Other Post
Retirement Benefits" was issued in February 1998 and has been 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: 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, 1998 and June 30, 1999.
b) Contractual Maturity of Loan Receivables (unaudited)--
The contractual maturities of FFC's receivables at June 30, 1999 are due as
follows:
<TABLE>
<CAPTION>
After 2001
1999 $US 2000 $US $US Total $US
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
Consumer loans................ 21,343,443 17,206,270 4,301,566 42,851,279
Business finance loans........ 875,183 375,079 -- 1,250,262
---------- ---------- --------- ----------
Total loans............... 22,218,626 17,581,349 4,301,566 44,101,541
========== ========== ========= ==========
</TABLE>
The average yield on FFC's receivables at June 30, 1999 was 22.53% per
annum.
c) Allowance for Losses--
<TABLE>
<CAPTION>
June 30,
-------------------
1998
$US 1999 $US
------- -----------
(Unaudited)
<S> <C> <C>
Balance at the beginning of the year.................. 550,974 592,709
Provision for losses.................................. 41,735 412,371
------- ---------
Balance at the end of the year........................ 592,709 1,005,080
======= =========
</TABLE>
66
<PAGE>
FAI FINANCE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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>
Years Ended June 30,
---------------------------
1997 1998 1999
$US $US $US
------- ------- -----------
(Unaudited)
<S> <C> <C> <C>
Increase in allowance for losses.............. 279,193 41,735 412,371
Bad debts charged off......................... 528,607 724,535 811,361
------- ------- ---------
Total..................................... 807,800 766,270 1,223,732
======= ======= =========
</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.
NOTE 4: GENERAL AND ADMINISTRATIVE EXPENSES
The following table sets forth a summary of the major components of general
and administrative expenses:
<TABLE>
<CAPTION>
Years Ended June 30,
-------------------------------
1997 1998 1999
$US $US $US
--------- --------- -----------
(Unaudited)
<S> <C> <C> <C>
Employee salaries......................... 836,372 1,255,840 1,619,349
Communications............................ 315,020 303,533 426,305
Space costs............................... 104,812 190,607 211,917
Legal fees................................ 81,337 92,107 109,333
Depreciation.............................. 55,318 127,355 161,050
Research information...................... 99,591 133,126 158,706
Office expenses........................... 175,695 379,379 243,740
Travel.................................... 6,319 59,200 77,650
Bank charges.............................. 72,081 140,893 114,920
Other..................................... 296,243 319,563 156,883
--------- --------- ---------
Total................................. 2,042,788 3,001,603 3,279,853
========= ========= =========
</TABLE>
NOTE 5: CASH
<TABLE>
<CAPTION>
June 30,
-------------------
1998 1999
$US $US
------- -----------
(Unaudited)
<S> <C> <C>
Cash on hand.......................................... 594 651
Cash at bank.......................................... 241,295 262,449
------- -------
241,889 263,100
======= =======
</TABLE>
67
<PAGE>
FAI FINANCE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
NOTE 6: PREPAID EXPENSES AND OTHER CURRENT ASSETS
<TABLE>
<CAPTION>
June 30,
-------------------
1998 1999
$US $US
------- -----------
(Unaudited)
<S> <C> <C>
Prepayments........................................... 25,208 14,599
Sundry debtors........................................ 848,521 385,329
------- -------
873,729 399,928
======= =======
</TABLE>
NOTE 7: RESTRICTED DEPOSITS
<TABLE>
<CAPTION>
June 30,
-------------------
1998 1999
$US $US
------- -----------
(Unaudited)
<S> <C> <C>
Deposits--Westpac Banking Corporation................. 913,553 1,109,904
------- ---------
913,553 1,109,904
======= =========
</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.
NOTE 8: PROPERTY, PLANT AND EQUIPMENT
<TABLE>
<CAPTION>
June 30,
---------------------
1998 1999
$US $US
-------- -----------
(Unaudited)
<S> <C> <C>
Office equipment.................................... 165,836 173,332
Plant............................................... 32,587 67,515
Motor vehicles...................................... 73,121 151,948
Computer equipment.................................. 246,211 366,866
Leasehold improvements.............................. 77,200 80,995
Less: Accumulated depreciation...................... (184,540) (365,300)
-------- --------
410,415 475,356
======== ========
</TABLE>
NOTE 9: INTANGIBLES
<TABLE>
<CAPTION>
June 30,
--------------------
1998 1999
$US $US
------- -----------
(Unaudited)
<S> <C> <C>
Goodwill on investment............................... 278,864 295,737
Less: Accumulated amortization....................... (46,477) (64,076)
------- -------
232,387 231,661
======= =======
</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
68
<PAGE>
FAI FINANCE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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>
Years Ended June 30,
-----------------------------
1997 1998 1999
$US $US $US
-------- ------- -----------
(Unaudited)
<S> <C> <C> <C>
Expected income tax expense at statutory
rates.................................... 591,684 852,599 325,164
Tax effect of permanent and other
differences:
Over provision for income tax in prior
years.................................. (42,152) -- --
Non-deductible expenses and other items. 24,336 61,113 43,187
Amortization of goodwill................ 6,337 5,520 5,083
-------- ------- --------
580,205 919,232 373,434
======== ======= ========
The tax expense is split between:
Current................................. 710,273 880,302 658,669
Deferred................................ (130,068) 38,930 (285,235)
-------- ------- --------
580,205 919,232 373,434
======== ======= ========
</TABLE>
<TABLE>
<CAPTION>
June 30,
--------------------
1998 $US
$US 1999
------- -----------
(Unaudited)
<S> <C> <C>
Deferred tax assets are comprised of timing
differences on:
Provisions not currently deductible for tax
purposes for:
Doubtful debts................................ 192,179 313,702
Leave......................................... 17,948 22,914
Other......................................... 3,648 --
Sundry accruals................................. 4,205 186,345
Deferred costs.................................. (5,374) (23,982)
Prepayments..................................... 4,972 (4,425)
Tax losses carried forward...................... (8,259) --
------- -------
Net deferred tax asset............................ 209,319 494,554
======= =======
</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, 1999.
69
<PAGE>
FAI FINANCE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
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,
1999.
Cervale Pty Limited ("Cervale") is related by the 100% holding of Bradley
D. Cooper, the Company's Chief Executive Officer, in Cervale.
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,
----------------------
1998 1999
$US $US
---------- -----------
(Unaudited)
<S> <C> <C>
Amounts due from related party:
Non Current Liabilities..........................
FAI Home Security Holdings (New Zealand)......... -- 9,223
Limited............................................
<CAPTION>
June 30,
----------------------
1998 1999
$US $US
---------- -----------
(Unaudited)
<S> <C> <C>
Amounts due to related party:
Non Current Liabilities..........................
FAI Insurances Limited......................... 9,563,073 11,323,505
FAI General Insurance Company Ltd.............. 10,424,200 10,380,328
FAI Home Security Pty Limited.................. 309,617 --
FAI Home Security Holdings (New Zealand) ...... 285,551 --
Limited............................................
---------- ----------
20,582,441 21,703,833
========== ==========
</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 was 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 loans were
non-interest bearing and repayable on demand. As at June 30, 1999 these non-
interest bearing loans had been paid in full.
70
<PAGE>
FAI FINANCE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Continued)
<TABLE>
<CAPTION>
Years Ended June 30,
---------------------------
1997 1998 1999
$US $US $US
------- ------- -----------
(Unaudited)
<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............ 754,176 314,582 --
FAI Home Security Holdings (New Zealand)
Limited................................ 1,565 28,957 --
Interest on loans paid by FAI Finance
Corporation Pty Limited to:
FAI General Insurance Company Ltd....... -- 414,619 838,029
FAI Insurances Ltd...................... -- 539,523 722,838
Interest on loans received by FAI Finance
Corporation Pty Limited From:
Cervale Pty Limited..................... -- -- 11,569
Management fees received by FAI Finance
Corporation (NZ) Limited from:
FAI Home Security Holdings (New Zealand)
Limited................................ 61,675 40,701 26,285
Vision Publishing Pty Limited........... -- 28,374 --
Office rentals paid by FAI Finance
Corporation Pty Limited to:
FAI General Insurance Company Limited... 51,535 98,503 118,322
</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.
71
<PAGE>
FAI FINANCE CORPORATION
NOTES TO FINANCIAL STATEMENTS--(Continued)
NOTE 13: SEGMENT INFORMATION
FFC operates principally in one industry segment being consumer finance.
The Company's identifies its segments based on management responsibility
within Australia and New Zealand. No single customer accounts for more than
10% of the Company's revenues.
Effective July 1, 1998, the Company adopted SFAS No. 131, "Disclosure about
Segments of an Enterprise and Related Information" 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, or decision making group, organize segments within the company for
making operating decisions and assessing performance. FFC's operating decision
making group consists of various members of management. The operating segments
are managed separately because each operating segment represents a strategic
business unit that serves different geographic markets.
The Company's reportable segments are Australia and New Zealand.
Information about the Company's reportable segments split by geographic
location is shown below.
<TABLE>
<CAPTION>
Years Ended June 30,
-------------------------------
1997 1998 1999
$US $US $US
--------- --------- -----------
(Unaudited)
<S> <C> <C> <C>
Net interest income:
Australia............................... 3,496,927 4,452,019 4,582,786
New Zealand............................. 976,186 1,685,736 1,455,550
--------- --------- ---------
4,473,113 6,137,755 6,038,336
========= ========= =========
Operating revenues:
Australia............................... 3,496,927 4,480,393 4,754,652
New Zealand............................. 1,037,861 1,726,437 1,309,970
--------- --------- ---------
4,534,788 6,206,830 6,064,622
========= ========= =========
Bad debts and allowance for losses:
Australia............................... 754,141 579,972 799,053
New Zealand............................. 53,659 186,298 424,679
--------- --------- ---------
807,800 766,270 1,223,732
========= ========= =========
Net income:
Australia............................... 750,864 1,021,385 800,645
New Zealand............................. 353,131 498,340 386,956
--------- --------- ---------
1,103,995 1,519,725 1,187,601
========= ========= =========
</TABLE>
<TABLE>
<CAPTION>
June 30,
----------------------
1998 1999
$US $US
---------- -----------
(Unaudited)
<S> <C> <C>
Identifiable assets
Australia........................................ 30,225,503 36,324,849
New Zealand...................................... 10,793,430 9,755,338
---------- ----------
41,018,933 46,080,187
========== ==========
</TABLE>
72
<PAGE>
FAI FINANCE CORPORATION
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS--(Concluded)
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 subordinated loan with Westpac equal to the greater of
$2,627,000 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 $6,567,000.
FFC is required to maintain a cash reserve account (restricted deposit)
with Westpac, the balance of which is not less than the greater of $657,000
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 sub-
ordinated 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 $32,835,000
(utilized at June 30, 1999--$19,897,000). 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 $32,385,000 at
13.5% per annum, until August 14, 2001. FFC has also set a floor on the same
notional principal and maturity, at 5.75% per annum.
73
<PAGE>
Exhibit 10.1
AMENDED AND RESTATED
HOME SECURITY INTERNATIONAL, INC.
1997 EMPLOYEES' STOCK OPTION PLAN
1. Purpose of the 1997 Employees' Stock Option Plan
------------------------------------------------
The purpose of the Plan is to enable the Company to attract, retain and
motivate its employees by providing for or increasing the proprietary interests
of such employees in the Company through increased stock ownership.
The Plan provides for Options which either (i) qualify as incentive stock
Options ("Incentive Options") within the meaning of that term in Section 422 of
the Internal Revenue Code of 1986, as amended, or (ii) do not so qualify under
Section 422 of the Code ("Nonstatutory Options") (collectively "Options"). Any
Option granted under this Plan will be clearly identified at the time of grant
as to whether it is intended to be either an Incentive Option or a Nonstatutory
Option.
2. Definitions.
-----------
The following terms, when appearing in the text of this Plan in capitalized
form, will have the meanings set out below:
(a) "Board" means the Board of Directors of the Company.
(b) "Code" means the Internal Revenue Code of 1986, as heretofore or
hereafter amended.
(c) "Committee" means the committee appointed by the Board pursuant to
Section 3 below.
(d) "Company" means Home Security International, Inc. or any "parent" as
that term is defined by Section 424(e) of the Code or "subsidiary
corporation", as that term is defined by Section 424(f) of the Code,
thereof, unless the context requires it to be limited to Home Security
International, Inc.
(e) "Disabled Grantee" means a Grantee who is disabled within the meaning
of Section 422(c)(6) of the Code.
(f) "Employees" means the class of employees consisting of individuals
regularly employed by the Company on a full-time salaried basis who
are primarily management or highly compensated employees, or such
other employees as the Committee shall so determine.
(g) "Executive Officer" means those individuals who, on the last day of
the taxable year at issue: (i) served as the Company's chief executive
officer or was acting in a similar capacity, regardless of
compensation level; and (ii) the four most highly
<PAGE>
compensated executive officers (other than the chief executive
officer) all as determined pursuant to 26 C.F.R (S) 1.162-27(c)(2).
(h) "Fair Market Value" means, with respect to the common stock of the
Company, the price at which the stock would change hands between an
informed, able and willing buyer and seller, neither of which is under
a compulsion to enter into the transaction. Fair Market Value will be
determined in good faith by the committee in accordance with a
valuation method which is consistent with the guidelines set forth in
Treasury Regulation 1.421-7(e)(2) or any applicable regulations issued
pursuant to Section 422(a) of the Code. Fair Market Value will be
determined without regard to any restriction other than a restriction
which, by its terms, will never lapse.
(i) "Grantee" means an eligible Employee under this Plan who has been
granted an Option.
(j) "Incentive Option" means an Option that qualifies for the benefit
described in Section 421 of the Code, by virtue of compliance with the
provisions of Section 422 of the Code.
(k) "Nonstatutory Option" means an Option that is not an Incentive Option.
(1) "Option" means either an Incentive Option or a Nonstatutory Option
granted under this Plan.
(m) "Option Agreement" means the agreement entered into between the
Company and an individual Grantee and specifying the terms and
conditions of the Option granted to the Grantee, which terms and
conditions will recite or incorporate by reference: (i) the provisions
of this Plan which are not subject to variation; and (ii) the variable
terms and conditions of each Option granted hereunder which will apply
to that Grantee.
(n) "Optionee" means a Grantee, and, under the appropriate circumstances,
his guardian, representative, heir, distributes, legatee or successor
in interest, including any transferee.
(o) "Plan" means this 1997 Employees' Stock Option Plan, as the same may
from time to time be amended.
(p) "Stock" means the Company's common stock.
3. Administration of the Plan.
--------------------------
The Plan shall be administered by a Committee of the Board.
a. Committee Membership. The Plan shall be administered by a committee
appointed by the Board, to be known as the Compensation Committee (the
"Committee"). The Committee shall be not less than two members and
2
<PAGE>
comprised solely of Non-employee Directors, as defined by Rule 16b-
3(b)(3)(i) of the Securities and Exchange Act of 1934 ("1934 Act"), or
any successor definition adopted by the Securities and Exchange
Commission, and who shall each also qualify as an outside Director for
purposes of Section 162(m) of the Code. Any vacancy occurring on the
Committee may be filled by appointment by the Board. The Board at its
discretion may from time to time appoint members to the Committee in
substitution of members previously appointed, may remove members of
the Committee and may fill vacancies, however caused, in the
Committee. If no Committee is constituted, all members of the Board
who would otherwise qualify as Committee members shall constitute the
Committee.
b. Committee Procedures. The Committee shall select one of its members
as chairman and shall hold meetings at such times and places as it may
determine. A quorum of the Committee shall consist of a majority of
its members, and the Committee may act by vote of a majority of its
members present at a meeting at which there is a quorum, or without a
meeting by written consent signed by all members of the Committee. If
any powers of the Committee hereunder are limited or denied by the
Board, the same powers may be exercised by the Board.
c. Committee Responsibilities. The Committee will interpret the Plan,
prescribe, amend and rescind any rules or regulations necessary or
appropriate for the administration of the Plan, and make such other
determinations and take such other actions it deems necessary or
advisable, except as otherwise expressly reserved for the Board.
Subject to the limitations imposed by the Board, and the terms of the Plan,
the Committee may periodically determine which Employees should receive Options
under the Plan, whether the Options shall be Incentive Options or Nonstatutory
Options, the number of shares covered by such Options, the per share purchase
price for such shares, and the terms thereof, including but not limited to
transferability of such Options, and shall have full power to grant such
Options. In making its determinations, the Committee shall consider, among
other relevant factors, the importance of the duties of the Grantee to the
Company, his or her experience with the Company, and his or her future value to
the Company.
All decisions, interpretations and other actions of the Committee shall be
final and binding on all Grantees, Optionees and all persons deriving their
rights from a Grantee or Optionee. No member of the Board or the Committee
shall be liable for any action or failed to be taken in good faith or
determination made pursuant to the Plan.
4. Stock Subject to Plan.
---------------------
This Plan authorizes the Committee to grant Options to Employees up to the
aggregate amount of 1,150,000 shares of Stock, subject to eligibility and any
limitations specified herein. Adjustment in the shares subject to the Plan
shall be made provided in Section 9. Any shares covered by an Option which, for
any reason expires, terminates or is canceled may be re-Optioned under the Plan.
3
<PAGE>
5. Eligibility
-----------
a. General Rule. All employees defined in section 2(f) shall be eligible
to be granted Options.
b. Ten Percent Stockholders. An employee who owns more than ten percent
(10%) of the total combined voting power of all classes of outstanding
Stock of the Company, its parent or subsidiaries shall not be eligible
for designation as a Grantee of an Incentive Option unless (i) the
exercise price for each share of Stock subject to such Incentive
Option is at least one hundred ten percent (110%) of the Fair Market
Value of a share of Stock on the date of grant, and (ii) such
Incentive Option, by its terms, is not exercisable after the
expiration of five (5) years from the date of grant.
c. Attribution Rules. For purposes of Subsection (b) above, in
determining stock ownership, an Employee shall be deemed to own the
stock owned, directly or indirectly, by or for his brothers, sisters
(whether by the whole or half blood), spouse, ancestors and lineal
descendants. Stock owned, directly or indirectly, by or for a
corporation, partnership, estate or trust shall be deemed to be owned
proportionately by or for its shareholders, partners or beneficiaries.
d. Outstanding Stock. For purpose of Subsection (b) above, "outstanding
stock" shall include all stock actually issued and outstanding
immediately after the grant. "Outstanding stock" shall include shares
authorized for issuance under outstanding Options held by the Employee
or by any other person.
e. Term of Plan. The Committee may make such grants at any time and in
any amounts that it, in its discretion, may designate, subject to the
other relevant limitations set out in this Plan. No Options will be
granted under this Plan after the day prior to the tenth (10th)
anniversary of the date this Plan is adopted or the date this Plan is
approved by the stockholders of the Company whichever date occurs
first.
f. Individual limits of Executive officers. Subject to the provisions of
Section 9 hereof the number of Option shares granted in a fiscal year
of the Company to each Executive officer, shall not exceed 250,000
shares for any fiscal year for which such person is classified as an
Executive Officer.
g. Incentive Option Limitation. The aggregate Fair Market Value of the
Stock for which Incentive Options granted to any one Employee under
this Plan and under all incentive stock Option plans of the Company,
its parents(s) and subsidiaries, may by their terms first become
exercisable during any calendar year shall not exceed $100,000,
determining Fair Market Value of the Stock subject to any Option as of
the time that Option is granted. If the date on which one or more
Incentive Options could be first exercised would be accelerated
pursuant to any other provision of the Plan or any Stock Option
Agreement referred to in Section 6(a), or an amendment thereto, and
the acceleration of such exercise date would
4
<PAGE>
result in a violation of the restriction set forth in the preceding
sentence, then notwithstanding any such other provision; the exercise
date of such incentive Options shall be accelerated only to the
extent, if any, that is permitted under Section 422 of the Code and
the exercise date of the Incentive Options with the lowest Option
prices shall be accelerated first. Any exercise date which cannot be
accelerated without violating the $100,000 restriction of this section
shall nevertheless be accelerated, and the portion of the Option
becoming exercisable thereby shall be treated as a Nonstatutory
Option.
6. Terms and Conditions of All Options Under the Plan.
--------------------------------------------------
Each Option granted shall be subject to all applicable terms and conditions
of the Plan and may be subject to any other terms and conditions which are not
inconsistent with the Plan and which the Committee deems appropriate for
inclusion in the Option grant. The Committee will designate from among the
Employees, those who will be granted Options.
a. Option Agreements. All Options granted under the Plan shall be
evidenced by a written Option Agreement.
b. Number of Shares. Each Option Agreement shall specify the number of
shares of the Stock each such Employee will be entitled to purchase
pursuant to the Option and shall provide for the adjustment of such
number in accordance with Section 9. Each Option Agreement shall state
the minimum number of shares which must be exercised at any time, if
any.
c. Nature of Option. Each Option Agreement shall specify the intended
nature of the Option as an Incentive Stock Option, a Nonstatutory
Option or partly of each type.
d. Exercise Price. Each Option Agreement shall specify the exercise
price. The exercise price of either the Incentive Stock Option or the
Nonstatutory Option shall not be less than on hundred percent (100%)
of the Fair Market Value of a share of Stock on the date of grant.
Subject to the foregoing, the exercise price under any Option shall be
determined by the Committee in its sole discretion. The exercise price
shall be payable in the form described in section 7.
e. Term of Option. The Option Agreement shall specify the term of the
Option. The term of any Option granted under this Plan is subject to
expiration, termination, and cancellation as set forth within this
Plan.
f. Exercisability. Subject to the provisions of the Plan, the Committee
may grant Options which are vested, or which become vested upon the
happening of an event or events as specified by the Committee. Each
Option Agreement shall specify the date when all or any installment of
the Option is to become exercisable. Exercisable Options may be
exercised in whole or in part. Such Option shall not be exercisable
after the expiration of such term which shall be fixed by the
Committee ending not later than ten years from the date such Option is
granted.
5
<PAGE>
g. Withholding Taxes: If, upon exercise of any Nonstatutory Option (or
any Incentive Option which is treated as a Nonstatutory Option because
it fails to meet the requirements set forth herein and in the Code for
Incentive Stock Options), the Optionee fails to tender full payment to
the Company for any federal income tax withholding required in
connection with such exercise, the Committee shall withhold from the
Optionee sufficient shares having a Fair market Value (determined
under Section 2(h)) equal to any amount which the Company is required
to withhold under the Code.
h. Requirement of Certificate. An Optionee shall not be deemed to be the
holder of, or to have any of the rights of a holder with respect to,
any shares subject to such Option unless and until he has received a
certificate or certificates therefor.
i. Termination and Acceleration of Option. For Incentive Options:
If the employment of a Grantee who is not a Disabled Grantee
is terminated without cause, or such Grantee voluntarily quits or
retires under any retirement plan of the Company, any then
outstanding and exercisable stock Option held by such Grantee
shall be exercisable, in accordance with the provisions of the
Option Agreement, by such Grantee at any time prior to the
expiration date of such Option or within three months after the
date of termination of employment or service, whichever is the
shorter period;
ii. If the employment of a Grantee who is a Disabled Optionee is
terminated without cause, any then outstanding and exercisable
Option held by such an Optionee shall be exercisable, in
accordance with the provisions of the Option Agreement, by such a
Grantee at any time prior to the expiration date of such Option
or within one year after the date of such termination of
employment or service, whichever is the shorter period;
iii. Following the death of a Grantee during employment, any
outstanding and exercisable Options held by such an Grantee at
the time of death shall be exercisable, in accordance with the
provisions of the Option Agreement referred to in Section 6(a),
by the person or persons entitled to do so under the will of the
Grantee, or, if the Optionee shall fail to make testamentary
disposition of the stock Option or shall die intestate, by the
legal representative of the Grantee at any time prior to the
expiration date of such Option or within one year after the date
of death, whichever is the shorter period.
For all Options issued hereunder:
i. If the Company terminates the employment of a Grantee for cause,
all outstanding Options held by the Grantee at the time of such
termination shall automatically terminate unless the Committee
notifies the Grantee that his or her Options will not terminate.
A termination "for cause" shall
6
<PAGE>
be defined under each written Option Agreement issued pursuant to
Section 6(a). The Company assumes no responsibility and is under
no obligation to notify a Transferee of early termination of an
Option on account of a Grantee's termination of employment.
ii. Whether termination of employment or other service is a
termination "for cause" and whether a Grantee is a Disabled
Grantee shall be determined in each case, in its discretion, by
the Committee and any such determination by the Committee shall
be final and binding.
7. Payment for Shares
------------------
a. Cash. Payment in full for shares purchased under an Option may be
made in cash (including check, bank draft or money order) at the time
that the Option is exercised.
b. Stock. In lieu of cash an Optionee may, with the consent of the
Committee, make payment for Stock purchased under an Option, with
Stock, in whole or in part, by either of the following methods:
i. By tendering to the Company in good form for transfer, shares of
Stock valued at Fair Market Value on the date the Option is
exercised. Such shares will have been owned by the Optionee or
the Optionee's representative for the time specified by the
Committee but in no case shall the Optionee, or his
representative have held a beneficial interest in such tendered
shares for a period of less than six months prior to the exercise
of the Option.
ii. By requesting the Company to withhold from the number of shares
of Stock otherwise issuable upon exercise of the Option that
number of shares having an aggregate Fair Market Value on the
date of exercise equal to the exercise price for all of the
shares of Stock subject to such exercise.
c. Promissory Notes. The Board has authority and reserves the right to
make an independent determination as to whether the Company shall
assist any Grantee to whom an Option is granted hereunder in the
payment of the purchase price payable on exercise of an Option. Upon
application by a Grantee and to the extent that the Board
independently determines that the Company shall provide assistance,
payment may be made all or in part with a full recourse promissory
note executed by the Grantee. The interest rate, security and other
terms and conditions of such note shall be determined by the Board. In
no event shall the stock certificate(s) representing such shares be
released to the Grantee until such note is paid in full.
8. Use of Proceeds from Stock.
--------------------------
7
<PAGE>
Cash proceeds from the sale of Stock pursuant to Options granted under the
Plan shall constitute general funds of the Company.
9. Adjustments.
-----------
Changes or adjustments in the Option price, number of shares subject to an
Option or other specifics as the Committee should decide will be considered or
made pursuant to the following rules:
a. Upon Changes in Stock. If the outstanding Stock is increased or
decreased, or is changed into or exchanged for a different number or
kinds of shares or securities, as a result of one or more
reorganizations, recapitalization, stock splits, reverse stock splits,
split-up, combination of shares, exchange of shares, change in
corporate structure, or otherwise, appropriate adjustments will be
made in the exercise price or the number and/or kind of shares or
securities for which Options may thereafter be granted under this Plan
and for which Options then outstanding under this Plan may thereafter
be exercised. The Committee will make such adjustments as it may deem
fair, just and equitable to prevent substantial dilution or
enlargement of the rights granted to or available for Optionees. No
adjustment provided for in this Section 9 will require the Company to
issue or sell a fraction of a share or other security. Nothing in this
Section will be construed to require the Company to make any specific
or formula adjustment.
b. Prohibited Adjustment. If any such adjustment provided for in this
Section 9 requires the approval of stockholders in order to enable the
Company to grant or amend Options, then no such adjustment will be
made without the required stockholder approval. Notwithstanding the
foregoing, if the effect of any such adjustment would be to cause an
Incentive Option to fail to continue to qualify under Section 422 of
the Code or to cause a modification, extension or renewal of such
Option within the meaning described in Section 424 of the Code, the
Committee may elect that such adjustment not be made but rather shall
use reasonable efforts to effect such other adjustment of each then
outstanding Option as the Committee, in its sole discretion, shall
deem equitable and which will not result in any disqualification,
modification, extension or renewal (within the meaning of Section 424
of the Code) of such Incentive Option.
c. Further Limitations. Nothing in this Section will entitle the
Optionee to adjustment of his Option in the following circumstances:
i. The issuance or sale of additional shares of the Stock, through
public offering or otherwise;
ii. The issuance or authorization of an additional class of capital
stock of the Company;
iii. The conversion of convertible preferred stock or debt of the
Company into Stock; and
8
<PAGE>
iv. The payment of dividends except as provided in section 9 (a).
The grant of an Option shall not effect in any way the right or power of
the Company to make adjustments, reclassifications, reorganizations or changes
of its capital or business structure, to merge or consolidate or to dissolve,
liquidate, sell or transfer all or any part of its business or assets.
10. Legal Requirements:
------------------
a. Compliance with all laws. The Company will not be required to issue
or deliver any certificates for shares of Stock prior to (a) the
listing of any such Stock to be acquired pursuant to the exercise of
any Option on any stock exchange on which the Stock may then be
listed, and (b) the compliance with any registration requirements or
qualification of such shares under any federal securities laws,
including without limitation the Securities Act of 1933, as amended,
the rules and regulations promulgated thereunder, or state securities
laws and regulations, the regulations of any stock exchange or
interdealer quotation system on which the Company's securities may
then be listed, or obtaining any ruling or waiver from any government
body which the Company will, in its sole discretion, determine to be
necessary or advisable, or which, in the opinion of counsel to the
Company, is otherwise required.
b. Compliance with Specific Code Provisions. It is the intent of the
Company that the Plan and its administration conform strictly to the
requirements of Section 422 of the Code with respect to Incentive
Options. Therefore, notwithstanding any other provisions of this Plan,
nothing herein will contravene any requirement set forth in Section
422 of the Code with respect to Incentive Options and if inconsistent
provisions are otherwise found herein, they will be deemed void and
unenforceable or automatically amended to conform, as the case may be.
c. Plan Subject to Delaware Law. All questions arising with respect to
the provisions of the Plan will be determined by application for the
Code and the laws of the state of Delaware except to the extent that
Delaware laws are preempted by any federal law.
11. Rights as a Shareholder.
-----------------------
An Optionee, or anyone claiming rights derived from an Optionee, shall have
no rights as a shareholder with respect to any Stock covered by his Option until
the date of issuance of the stock certificate to him after receipt of the
consideration in full set forth in the Option Agreement. Except as provided in
Section 9 hereof or as may be required by Section 7(c) or 10(a), no adjustments
will be made for dividends, whether ordinary or extraordinary, whether in cash
securities, or other property, for distributions for which the record date is
prior to the date on which the Option is exercised.
9
<PAGE>
12. Restrictions on Shares.
-----------------------
Prior to the issuance or delivery of any shares of the Stock under the
Plan, the person exercising the Option may be required to:
a. represent and warrant that the shares of the Stock to be acquired upon
exercise of the Option are being acquired for investment for the
account of such person and not with a view to resale or other
distribution thereof;
b. represent and warrant that such person will not, directly or
indirectly, sell, transfer, assign, pledge (except for a pledge of
shares issued or delivered upon payment in whole or in part of the
Option price with a promissory note as contemplated by Section 7),
hypothecate or otherwise dispose of any such shares unless the sale,
transfer, assignment, pledge, hypothecation or other disposition of
the shares is pursuant to the provisions of this Plan and effective
registrations under the 1933 Act and any applicable state or foreign
securities laws or pursuant to appropriate exemptions from any such
registrations; and
c. execute such further documents as may be reasonably required by the
Committee upon exercise of the Option or any part thereof, including
but not limited to any stock restriction agreement that the Committee
may choose to require.
Nothing in this Plan shall assure any Optionee that shares issuable under
this Option are registered on a Form S-8 under the Securities Act of 1933 ("1933
Act") or on any other form. The certificate or certificates representing the
shares of the stock to be issued or delivered upon exercise of an Option may
bear a legend evidencing the foregoing and other legends required by any
applicable securities laws. Furthermore, nothing herein or any Option granted
hereunder will require the Company to issue any Stock upon exercise of any
Option if the issuance would, in the opinion of counsel for the Company,
constitute a violation of the 1933 Act, as amended, applicable state securities
laws, or any other applicable rule or regulation then in effect. The Company
shall have no liability for failure to issue shares upon any exercise of Options
because of a delay pending the meeting of any such requirements.
13. Transferability.
---------------
The Committee shall retain the authority and discretion to permit a Non
statutory Option, but in no case an Incentive Option, to be transferable as long
as such transfers are made to one or more of the following: family members,
including children of Grantee, spouse of Grantee, or grandchildren of Grantee or
trusts for such family members ("Transferee"), provided that such transfer is a
bona fide gift (as defined in Rule 16 b-3) and accordingly, the Grantee receives
no consideration for the transfer, and that the Options transferred continue to
be subject to the same terms and conditions that were applicable to the Options
immediately prior to the transfer. Options are also subject to transfer by will
or the laws of descent and distribution. Options granted pursuant to this Plan
shall not be otherwise transferred, assigned, pledged, hypothecated or disposed
of in any way, whether by operation of law or otherwise. The designation of a
beneficiary shall not constitute a transfer.
14. No Right to Continued Employment.
--------------------------------
10
<PAGE>
This Plan, and any Option granted under this Plan, will not confer upon any
Optionee any right with respect to continued employment by the Company nor shall
they alter, modify, limit or interfere with any right or privilege of the
Company under any employment agreement heretofore or hereinafter executed with
any Optionee, including the right to terminate any Optionee's employment at any
time for or without cause to change his level of compensation or to change his
responsibilities or position.
15. Corporate Reorganizations.
-------------------------
Upon the dissolution or liquidation of the Company, or upon a
reorganization, merger or consolidation of the Company as a result of which the
outstanding securities-of the class then subject to Options hereunder are
changed into or exchanged for cash or property or securities not of the
Company's issue, or upon a sale of substantially all the property of the Company
to, or the acquisition of stock representing more than eighty percent (80%) of
the voting power of the stock of the Company then outstanding, by another
corporation or person, the Plan will terminate and all Options will lapse. The
result described above will not occur if provision is made in writing in
connection with such transaction for the continuance of the Plan and/or for the
assumption of Options earlier granted, or the substitution for such Options of
Options covering the stock of a successor employer corporation, or a parent or a
subsidiary thereof, with appropriate adjustments as to the number and kind of
shares and prices, in which event the Plan and Options theretofore granted will
continue in the manner and under the terms so provided. If the Plan and
unexercised Options shall terminate pursuant to the foregoing, all persons
entitled to exercise any unexercised portions of Options then outstanding shall
have the right, at such time prior to the consummation of the transaction
causing the termination as the Company shall designate, to exercise the
unexercised portions of their Options, including the portions thereof which
would but for this Section 15, not yet be exercisable.
16. Modification, Extension and Renewal.
-----------------------------------
a. Options. Subject to the conditions of, and within the limitations
prescribed in the Plan herein, the Committee may modify, extend,
cancel or renew outstanding Options. Notwithstanding the foregoing, no
modification will, without the prior written consent of the Optionee,
alter, impair or waive any rights or obligations associated with any
Option earlier granted under the Plan.
b. Plan. The Board at any time, and from time to time, may interpret,
amend or discontinue the Plan, subject to the limitation, however,
that, except as provided in Section 9 (relating to adjustments upon
changes in Stock), no amendment shall be made, except upon approval by
vote of a majority of the outstanding shares of the company, which
will:
1. Increase the number of shares reserved for Options under the
Plan; or
2. Reduce the minimum permissible exercise Price or
3. Change the requirements for eligibility for Participation under
the Plan;
4. Extend the ten year duration of this Plan.
11
<PAGE>
17. Plan Date and Duration.
----------------------
The Plan shall take effect on the date it is adopted by the Board and was
adopted by the stockholders of the Company prior to June 30, 1997. Options may
not be granted under this Plan more than ten years after the date of the
adoption of this Plan, or of shareholder approval thereof, whichever is earlier.
HOME SECURITY INTERNATIONAL, INC., A Delaware
Corporation
12
<PAGE>
Exhibit 10.2
AMENDED AND RESTATED
HOME SECURITY INTERNATIONAL, INC.
1997 DIRECTORS' STOCK OPTION PLAN
1. Purpose of the 1997 Directors' Stock Option Plan:
------------------------------------------------
This Stock Option Plan ("the Plan") is designed to enable Home Security
International, Inc., a Delaware corporation (the "Company") and it subsidiaries
to attract, retain, and motivate the members of its Board of Directors who are
non-employee directors ("Directors") by providing for or increasing the
proprietary interest of such individuals in the Company, and by more closely
aligning their interests with those of the Company's shareholders.
2. Eligibility:
-----------
The persons who shall be eligible to receive Options shall be Directors of
the Company (the "Eligible Directors") who are not full-time employees of or
consultants to the Company.
3. Stock:
-----
Subject to the provisions of Section 9 (relating to the adjustment upon
changes in stock), there will be reserved for issuance upon the exercise of
Options to be granted from time to time under the Plan an aggregate of 50,000
shares of Common Stock, no par value, of the Company ("Stock"). In the event
that any outstanding Options under the Plan for any reason expires or is
canceled or terminated, the shares of stock allocable to the unexercised portion
of such Option may again be subject to an Option under the Plan.
4. Administration:
--------------
This Plan shall be administered by the Compensation Committee (the
"Committee"), comprised solely of Non-Employee Directors as defined by Rule 16b-
3(b)(3)(i) of the Securities Exchange Act of 1934 ("1934 Act"), or any successor
definition adopted by the Securities and Exchange Commission, and who shall each
also qualify as an Outside Director for purposes of Section 162(m) of the
Internal Revenue Code ("Code"). Any vacancy occurring on the Committee may be
filled by appointment by the Board. The Board at its discretion may from time
to time appoint members to the Committee in substitution of members previously
appointed, may remove members of the Committee and may fill vacancies, however
caused, in the Committee. If no Committee is constituted, all members of the
Board who would otherwise qualify as Committee members shall constitute the
Committee. The interpretation and construction by the Committee of any
provisions of the Plan or of any Option granted under it shall be final unless
otherwise determined by the Board of Directors. No member of the Board of
Directors or the Committee shall be liable for any action or determination made
in good faith with respect to the Plan or any Option granted under it.
5. Terms and Conditions of Options:
-------------------------------
<PAGE>
Stock Options granted pursuant to the Plan shall be evidenced by agreements
("Agreements") in such form as the Committee shall from time to time recommend
and the Board of Directors shall from time to time approve, which Agreements
shall comply with and be subject to the following terms and conditions:
a. On the next business day following the close of each of the regular
annual shareholders meetings for each of the fiscal years 1998, 1999
and 2000 (each such date is hereafter the "Date of Grant"), each
Eligible Director ("Grantee") shall receive an Option for 2,500 shares
of Stock, provided such Eligible Director continues to serve in the
capacity of director.
b. Each Option shall state the Option price which shall be 100% of the
fair market value of the shares of Stock of the Company on the
applicable Date of Grant. The fair market value is defined for the
purposes of this Plan as the last sales price on the day preceding the
Date of Grant.
c. Payment for Options may be made as follows:
i. Cash. Payment in full for shares purchased under an Option may
be made in cash (including check, bank draft or money order) at
the time that the Option is exercised.
ii. Stock. In lieu of cash an Optionee may, with the consent of the
Committee, make payment for Stock purchased under an Option, in
whole or in part, by:
(1) tendering to the Company in good form for transfer, shares
of Stock valued at fair market value on the date the Option
is exercised (any Stock so tendered must be held by the
Option holder for a period of at least six months prior to
the tender), or
(2) by requesting the Company to withhold from the number of
shares of Stock otherwise issuable upon exercise of the
Option that number of shares having an aggregate fair market
value on the date of exercise equal to the exercise price
for all of the shares of Stock subject to such exercise (for
purposes of this subsection, fair market value is defined as
the last sales price on the day preceding the exercise of
the Option).
2
<PAGE>
iii. Promissory Notes. The Board has authority and reserves the
right to make an independent determination as to whether the
Company shall assist any Grantee in the payment of the purchase
price payable on exercise of an Option. Upon application by a
Grantee and to the extent that the Board independently
determines that the Company shall provide assistance, payment
may be made all or in part with a full recourse promissory note
executed by the Grantee. The interest rate, security and other
terms and conditions of such note shall be determined by the
Board. In no event shall the stock certificates) representing
such shares be released to the Grantee until such note is paid
in full.
d. No stock acquired under this Plan may be disposed of within six months
from the Date of Grant.
e. The term of any Option shall be ten (10) years from the date it was
granted.
f. In no event shall any Option be exercisable prior to the approval of
this Plan by the holders of a majority of the shares of the Company's
Stock present, or represented and entitled to vote, at the annual
shareholders' meeting following the granted Option, duly held in
accordance with the applicable laws of the State of Delaware.
g. Subject to the approval of the Board of Directors, the Committee shall
have and retain the authority and discretion to permit an Option to be
transferable as long as such transfers are made to one or more of the
following: family members, including children of the Grantee, the
spouse of the Grantee, or grandchildren of the Grantee or trusts for
such family members ("Transferees"), provided that such transfer is a
bona fide gift and accordingly, the Grantee receives no consideration
for the transfer, and that the Options transferred continue to be
subject to the same terms and conditions that were applicable to the
Options immediately prior to the transfer. Options are also subject
to transfer by will or the laws of descent and distribution. Options
shall not be otherwise transferred, assigned, pledged, hypothecated or
disposed of in any way, whether by operation of law or otherwise. A
Transferee may not subsequently transfer an Option. The designation
of a beneficiary shall not constitute a transfer.
h. An Option shall terminate and shall not be exercisable if the person
to whom it is granted ceases to be a Director of the Company, except
that, subject to the limitation hereafter stated in this paragraph
5(h):
i. if his directorship is terminated by any reason other than his
death or on account of any act of fraud, intentional
misrepresentation, embezzlement, misappropriation or conversion
of assets or opportunities of the Company or any direct or
indirect majority-owned subsidiary of the Company, he, or his
successors or assigns, may after termination of his directorship,
at any time within ten (10) years from the date the Option was
granted, exercise
3
<PAGE>
his Option, but only to the extent that it was exercisable by him
on the date of termination of his office, and
ii. if he dies while a Director of the Company, or within three
months after termination of his office, his Option may be
exercised by his successors or assigns at any time within 18
months following his death, but only to the extent that such
Option was exercisable by him on the date of termination of his
office.
An Option may not be exercised to any extent by anyone after the
expiration of its term. Anything in this paragraph 5(h) to the
contrary notwithstanding, an Option shall not terminate solely by
reason of the fact that the person to whom it is granted ceases to be
a Director of the Company if such person shall become or remain an
officer of the Company as provided in the By-laws simultaneously with
his ceasing to be a Director; and in such event the subsequent ceasing
of such person to be an officer of the Company at a time when such
person is not a Director of the Company shall have the same effect as
if such person were then to have ceased to be a Director of the
Company. The Company assumes no responsibility and is under no
obligation to notify a Transferee of early termination of an Option on
account of a Director's termination of office.
i. Neither a person to whom an Option is granted, nor his Transferee,
legal representative, heir, legatee, or distributee shall be deemed to
be the holder of, or to have any of the rights of a holder with
respect to, any shares subject to such Option unless and until he has
received a certificate or certificates therefor. Under no
circumstances shall any certificate be issued within six months of the
Date of Grant. Except as provided in Section 9 hereof, no adjustments
will be made for dividends, whether ordinary or extraordinary, whether
in cash, securities, or other property, for distributions for which
the record date is prior to the date on which the Option is exercised.
j. If, upon exercise of any Option, the Grantee fails to tender payment
to the Company for any federal or state income tax or withholding, the
Committee shall withhold from the Grantee sufficient shares or
fractional shares having a fair market value equal to any amount that
the Company is required to withhold under the Code or State law.
k. The minimum number of shares with respect to which an Option may be
exercised in part at any time is 100.
4
<PAGE>
6. Restrictions on Shares:
----------------------
Prior to the issuance or delivery of any shares of Stock under the Plan,
the person exercising the Option may be required to:
a. represent and warrant that the shares of Stock to be acquired upon
exercise of the Option are being acquired for investment for the
account of such person and not with a view to resale or other
distribution thereof;
b. represent and warrant that such person will not, directly or
indirectly, transfer, sell, assign, pledge, hypothecate or otherwise
dispose of any such shares unless the transfer, sale, assignment,
pledge (except for a pledge of shares issued or delivered upon payment
in whole or in part of the Option price with a promissory note as
contemplated by Section 5(c)(iii)), hypothecation or other disposition
of the shares is pursuant to the provisions of this Plan, effective
registrations under the 1933 Act and any applicable state or foreign
securities laws, or pursuant to appropriate exemptions from any such
registrations; and
c. execute such further documents as may be reasonably required by the
Committee upon exercise of the Option or any part thereof, including
but not limited any stock restriction agreement that the Committee may
choose to require.
The certificate or certificates representing the shares of Stock to be
issued or delivered upon exercise of an Option may bear a legend evidencing the
foregoing and other legends required by any applicable securities laws.
Furthermore, nothing herein or any Option granted hereunder will require the
Company to issue any Stock upon exercise of any Option if the issuance would, in
the opinion of counsel for the Company, constitute a violation of the Securities
Act of 1933, as amended, the Delaware securities laws, or any other applicable
rule or regulation then in effect and the Company shall have no liability for
failure to issue shares upon any exercise of Options because of a delay pending
the meeting of any such requirements.
7. Use of Proceeds from Stock:
--------------------------
Cash proceeds from the sale of stock pursuant to Options granted under the
Plan shall constitute general funds of the Company.
8. No Implied Covenants:
--------------------
Neither this Plan nor any action taken hereunder shall be construed as
giving any Director any right to be retained in office.
5
<PAGE>
9. Adjustment Upon Changes in Stock:
--------------------------------
If any change is made in the Stock subject to the Plan, or subject to any
Option granted under the Plan (through merger, consolidation, reorganization,
recapitalization, stock dividend, split-up, combination of shares, exchange of
shares, change in corporate structure, or otherwise) appropriate adjustments
shall be made by the Board of Directors as to the kind and maximum number of
shares subject to the Plan, and the kind and number of shares and price per
share of Stock subject to outstanding Options.
10. Modification, Extension and Renewal:
-----------------------------------
Subject to the conditions of, and within the limitations prescribed in,
Section 15, hereof, the Committee may cancel, modify, extend or renew
outstanding Options. Notwithstanding the foregoing, no modification will,
without the prior written consent of the Grantee, alter, impair or waive any
rights or obligations associated with any Option earlier granted under the Plan.
Further, but subject to Section 9, the Committee may not change the number of
shares of the Company's Stock issuable under the Plan or the class of persons
who are eligible to participate in the Plan.
11. Compliance with Other Laws and Regulations:
------------------------------------------
The Plan, the Options granted hereunder, and the obligation of the Company
to sell and deliver Stock under such Options, shall be subject to all applicable
federal and state laws, rules and regulations, and to such approvals by any
government or regulatory authority or investigative agency as may be required.
The Company shall not be required to issue or deliver any certificates for
shares of Stock prior to (a) the listing of any such Stock to be acquired
pursuant to the exercise of any Option on any stock exchange on which the Stock
may then be listed; and (b) the compliance with any registration requirements or
qualification of such shares under any federal or state securities laws, or the
obtaining of any ruling or waiver from any government body that the Company or
its subsidiaries shall, in their sole discretion, determine to be necessary or
advisable, or that, in the opinion of counsel to the Company or its
subsidiaries, is otherwise required.
12. Corporate Reorganizations:
-------------------------
Upon the dissolution or liquidation of the Company, or upon a
reorganization, merger or consolidation of the Company as a result of which the
outstanding securities of the class then subject to Options hereunder are
changed into or exchanged for cash or property or securities not of the
Company's issue, or upon a sale of substantially all the property of the Company
to, or the acquisition of stock representing more than eighty percent (80%) of
the voting power of the stock of the Company then outstanding, by another
corporation or person, the Plan will terminate and all Options will lapse. The
result described above will not occur if provision is made in writing in
connection with such transaction for the continuance of the Plan and/or for the
assumption of Options earlier granted, or the substitution for such Options of
Options covering the stock of a successor corporation, or a parent or a
subsidiary thereof, with appropriate
6
<PAGE>
adjustments as to the number and kind of shares and prices, in which event the
Plan and Options theretofore granted will continue in the manner and under the
terms so provided.
13. Financial Assistance:
--------------------
Upon an independent determination of the Board consistent with Section
5(c)(iii) herein, the Company may assist a Grantee in purchasing an Option
granted hereunder by lending the amount of such purchase price to such Grantee
on such terms and at such rates of interest and upon such security (or
unsecured) as is authorized by the Board.
14. Governing Law:
-------------
All questions arising with respect to the provisions of the Plan will be
determined by application of the Code and the laws of the state of Delaware
except to the extent that Delaware laws are preempted by any federal law.
15. Amendment of the Plan:
---------------------
The Board of Directors at any time, and from time to time, may amend the
Plan, subject to the limitation, however, that, except as provided in Section 9
(relating to adjustments upon changes in Stock), no amendment shall be made,
except upon approval by vote of a majority of the outstanding shares of the
Company, which will:
a. Increase the number of shares reserved for Options under the Plan; or
b. Reduce the Option price below 100% of fair market value at the time an
Option is granted;
c. Change the requirements for eligibility for participation under the
Plan; or
d. Extend the ten year duration of this Plan.
16. Termination or Suspension of the Plan:
-------------------------------------
The Board of Directors at any time may suspend or terminate the Plan.
Unless previously terminated by the Board, this Plan shall terminate on and no
further Options will be granted after the tenth (10th) anniversary of the
Effective Date of the Plan, as described in Section 17 hereof.
Rights and obligations under any Option granted while the Plan is in effect
shall not be altered or impaired by suspension or termination of the Plan,
except by consent of the person to whom the Option was granted.
17. Effective Date:
--------------
This Plan shall become effective on the date it is adopted by the Company's
Board of Directors, provided that the shareholders approve the Plan within
twelve months thereafter.
The Plan shall take effect on the date it is adopted by the Board subject
to approval by the stockholders of the Company prior to June 30, 1997. Options
may not be granted under this Plan
7
<PAGE>
more than ten years after the date of the adoption of this Plan, or of
shareholder approval thereof, whichever is earlier.
HOME SECURITY INTERNATIONAL, INC.,
A Delaware Corporation
8
<PAGE>
Exhibit 21.1
List of Subsidiaries of Home Security International, Inc.
100% owned:
1. FAI Home Security Pty Ltd., incorporated in Australia, which does business
under the name "FAI Home Security."
2. FAI Home Security (ENZED) Ltd., incorporated in Auckland, New Zealand,
which does business under the name "FAI Home Security."
3. Home Security International (UK) Limited, incorporated in the United
Kingdom, which does business under the name "FAI Home Security."
4. Home Security International (Canada), Inc, incorporated in Canada, which
does business under the name "FAI Home Security."
5. Home Security International (SA) (Proprietary) Limited, incorporated in
South Africa, which does business under the name "FAI Home Security."
6. Home Security International (USA), Inc, incorporated in Delaware, United
States, which does business under the name "FAI Home Security."
7. Integrated International Home Security Limited, incorporated in the British
Virgin Islands.
8. Ness Security Products Pty Ltd., incorporated in Australia, which does do
business under the name "Ness Security Products."
9. Ness Security Products (Asia) Limited, incorporated in Hong Kong, which
does business under the name "Ness Security Products (Asia)."
10. Ness U.S.A Incorporated, incorporated in California, United States of
America.
11. International Acceptances, Inc., incorporated in Delaware, United States of
America.
50% owned:
12. FAI Finance Corporation Pty Ltd., incorporated in Australia, which does
business under the name "FAI Finance Corporation."
13. FAI Finance Corporation (NZ) Ltd., incorporated in Australia, which does
business under the name "FAI Finance Corporation."
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
As Independent Public Accountants, we hereby consent to the incorporation by
reference of our reports dated September 28, 1999 for Home Security
International, Inc. and dated August 20, 1998 for FAI Finance Corporation Pty
Limited, both appearing in this Form 10-K, into Home Security International,
Inc's previously filed registration statements on Form S-1 (No. 333-59421) and
Form S-8 (No. 333-68445).
Arthur Andersen
Sydney
September 28, 1999
<PAGE>
Exhibit 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the prospectuses
constituting part of the registration statements on Form S-1 (No. 333-59421) and
Form S-8 (No. 333-68445) of Home Security International, Inc. of our report
relating to our audit of the consolidated balance sheets of Integrated
International Home Security Limited as of June 30, 1999 and 1998 and the related
consolidated statements of income, cashflows and changes in shareholders' equity
for the year then ended, which report is dated August 9, 1999 and appears in
this Form 10-K.
/s/ Deloitte & Touche
September 28, 1999
British Virgin Islands
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