<PAGE>
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
-----------------------------------
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE
ACT OF 1934.
For the quarterly period ended December 31, 1998.
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number
001-14502
-----------------------------------
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 of organization)
LEVEL 7, 77 PACIFIC HIGHWAY
NORTH SYDNEY, NSW AUSTRALIA 2060
(Address of principal executive offices) (Zip Code)
(011) (612) 9936-2424
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. [X] Yes [_] No
Number of Shares of Common Stock Outstanding on February 12, 1999:
5,550,500
- --------------------------------------------------------------------------------
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HOME SECURITY INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
JUNE 30, DECEMBER 31,
--------------------------------
NOTE 1998 1998
$US $US
-----------------------------------------------------
<S> <C> <C> <C>
ASSETS
- ------
Current assets
Cash and cash equivalents 7,006,183 4,338,900
Accounts receivable - trade, net 874,745 3,160,262
Inventories 2 2,032,443 6,537,902
Prepaid expenses and other current assets 1,173,449 1,706,527
--------------------------------
Total current assets 11,086,820 15,743,591
--------------------------------
Non-current assets
Investment in partnership 303,424 300,793
Investments in affiliated companies 7,405,130 7,248,776
Capital assets, net 1,068,237 2,895,609
Intangibles, net 9,601,923 21,743,535
Deferred income taxes 1,016,652 1,325,763
Other non-current assets 3,115 3,075
--------------------------------
Total non-current assets 19,398,481 33,517,551
--------------------------------
Total assets 30,485,301 49,261,142
================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities
Bank overdraft - 194,295
Note payable - FAI Insurance Group 619,233 1,223,000
Note payable - Integral Investments Limited 5 - 385,483
Payables - trade 4,280,422 3,230,475
Accrued liabilities 777,516 1,442,451
Lease liability 28,704 275,611
Income tax payable 1,608,648 2,450,283
Deferred income 650,949 834,930
--------------------------------
Total current liabilities 7,965,472 10,036,528
--------------------------------
Non-current liabilities
Note payable - FAI Insurance group 5 4,117,902 3,454,975
Note payable - Integral Investments Limited - 8,382,294
Lease liability 33,342 363,738
Accrued liabilities 91,944 104,610
Deferred income 177,769 231,182
--------------------------------
Total non-current liabilities 4,420,957 12,536,799
--------------------------------
Total liabilities 12,386,429 22,573,327
--------------------------------
Minority interest - 1,825,704
Stockholders' 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 shares issued and outstanding as of June 30, 1998 and
5,550,500 shares issued and outstanding as of December 31, 1998. 5,150 5,550
Additional paid-in capital 16,111,311 19,710,911
Warrants 5 - 504,000
Secured Note (2,375,000) (2,375,000)
Accumulated other comprehensive loss 3 (976,565) (958,820)
Retained earnings 5,333,976 7,975,470
--------------------------------
Total stockholders' equity 18,098,872 24,862,111
--------------------------------
Total liabilities and stockholders' equity 30,485,301 49,261,142
================================
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
2
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED SIX MONTHS ENDED
DECEMBER 31, DECEMBER 31,
NOTE -------------------------------------------------------------------------------
1997 1998 1997 1998
$US $US $US $US
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Sales 10,769,464 12,185,335 21,818,161 22,411,573
Cost of goods sold
- other (6,659,864) (5,575,814) (12,985,600) (11,437,424)
- inventory revaluation - (271,727) - (271,727)
-------------------------------------------------------------------------------
Gross profit 4,109,600 6,337,794 8,832,561 10,702,422
General and administrative expenses (2,628,558) (4,038,963) (5,127,206) (5,946,076)
Research and development expenses - (190,221) - (190,221)
-------------------------------------------------------------------------------
Income from operations 1,481,042 2,108,610 3,705,355 4,566,125
Interest income 143,832 106,923 233,842 222,420
Interest expenses - related party - (100,763) - (199,546)
- other (3,232) (179,272) (3,232) (180,476)
-------------------------------------------------------------------------------
Income before taxes and equity in income
of affiliated companies and minority
interest 1,621,642 1,935,498 3,935,965 4,408,523
Income tax expense (523,097) (932,080) (1,401,979) (1,848,944)
-------------------------------------------------------------------------------
Income before equity in income of
affiliated companies and minority interest 1,098,545 1,003,418 2,533,986 2,559,579
Equity in income of affiliated companies 4 - 190,134 - 238,586
Minority interest - (156,671) (156,671)
Net income 1,098,545 1,036,881 2,533,986 2,641,494
===============================================================================
Net income per common share
Basic earnings per share $ 0.21 $ 0.19 $ 0.50 $ 0.49
Diluted earnings per share $ 0.21 $ 0.19 $ 0.49 $ 0.49
Weighted average number of shares
outstanding
Basic 5,150,500 5,550,500 5,083,750 5,350,500
Diluted 5,201,796 5,550,500 5,148,279 5,356,479
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
3
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASHFLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31,
--------------------------------
1997 1998
$US $US
--------------------------------
<S> <C> <C>
Net cash provided by operating activities 2,871,556 924,579
--------------------------------
Cashflow from investing activities
Receipt from related parties 1,470,159 -
Purchase of IIHSL, net of cash acquired - (3,087,082)
Additions to capital assets (215,317) (509,702)
Other cash inflows/(outflows) from investing activities (253,755) 166,558
--------------------------------
Net cash provided by/(used in) investing activities 1,001,087 (3,430,226)
--------------------------------
Cashflow from financing activities
Common stock issuance 3,934,678 -
Share issue costs (436,408) -
Other cash inflows/(outflows) from financing activities 98,033 (58,175)
--------------------------------
Net cash provided by financing activities 3,596,303 (58,175)
--------------------------------
Net increase/(decrease) in cash held 7,468,946 (2,563,822)
--------------------------------
Cash at the beginning of the financial period 118 7,006,183
Effect of exchange rate change on cash (17) (103,461)
--------------------------------
Cash at the end of the financial period 7,469,047 4,338,900
================================
Supplemental disclosure of cashflow information:
Interest paid 3,232 187,477
Income taxes paid 288,140 2,529,225
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements
4
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1: SIGNIFICANT ACCOUNTING POLICIES
a) Principles of Consolidation and Basis of Preparation -
The consolidated financial statements have been prepared by Home Security
International, Inc ("the Company"), without audit. The financial statements
include consolidated balance sheets, consolidated statements of income, and
consolidated statements of cash flows. In the opinion of management, all
adjustments, which consist of normal recurring adjustments, necessary to present
fairly the financial position, results of operations and cash flows for all
periods have been made.
The financial statements should be read in conjunction with the consolidated
financial statements as of and for the fiscal year ended June 30, 1998 and the
footnotes thereto included in the Company's Annual Report on Form 10-K.
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles in the United States of
America (" U.S. GAAP "). The investment in FAI Finance Corporation Pty Limited
("FFC") and Bayside Partnership ("the Partnership") are recorded using the
equity method.
All inter-company accounts and transactions have been eliminated upon
consolidation.
5
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
NOTE 2: INVENTORIES JUNE 30, DECEMBER 31,
--------------------------------------------
1998 1998
$US $US
--------------------------------------------
<S> <C> <C>
Finished goods 1,727,670 3,357,165
Work in progress - 277,277
Raw materials - 2,598,821
Sales aids 304,773 304,639
--------------------------------------------
2,032,443 6,537,902
============================================
</TABLE>
NOTE 3: COMPREHENSIVE INCOME
As of July 1, 1998 the Company adopted Statement of Financial Accounting
Standards No. 130, "Reporting Comprehensive Income", which requires companies to
report all changes in equity during a period, except those resulting from
investment by owners and distribution to owners, in a financial statement for
the period in which they are recognized. The Company has chosen to disclose
Comprehensive Income, which encompasses net income and foreign currency
translation adjustments, in the notes to the condensed consolidated financial
statements for interim reporting purposes.
Total Comprehensive Income for the three and six-month periods ended
December 31, 1997 and 1998 was as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
DECEMBER 31,
----------------------------------------------
1997 1998
$US $US
----------------------------------------------
<S> <C> <C>
1,098,545 1,036,881
Net Income
Other comprehensive (loss) income:
Foreign currency translation adjustment (177,576) 218,645
----------------------------------------------
Total comprehensive income 920,969 1,255,526
==============================================
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31,
----------------------------------------------
1997 1998
$US $US
----------------------------------------------
<S> <C> <C>
Net Income 2,533,986 2,641,494
Other comprehensive (loss) income:
Foreign currency translation adjustment (173,655) 17,745
----------------------------------------------
Total comprehensive income 2,360,331 2,659,239
==============================================
</TABLE>
6
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 4: EQUITY IN INCOME OF 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
Limited (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. Selected summarized financial information for FFC is presented
below.
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
DECEMBER 31, DECEMBER 31,
-------------------------------------------
1998 1998
$US $US
-------------------------------------------
<S> <C> <C>
Net interest income 2,011,735 3,441,383
Net income 523,624 759,858
</TABLE>
Reconciliation of equity in income of affiliated companies for the three
and six month periods ended December 31, 1998 is shown below.
<TABLE>
<CAPTION>
THREE MONTHS SIX MONTHS
DECEMBER 31, DECEMBER 31,
--------------------------------------------
1998 1998
$US $US
--------------------------------------------
<S> <C> <C>
50 percent of Net income of affiliated company - FFC 261,812 379,929
Amortization of goodwill - FFC (71,678) (141,343)
--------------------------------------------
Equity in income of affiliated companies 190,134 238,586
============================================
</TABLE>
7
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
(UNAUDITED)
NOTE 5: ACQUISITON OF INTEGRATED INTERNATIONAL HOME SECURITY LIMITED
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. 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
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 $8,602,666 for
financial reporting purposes), payable in installments of $400,000 on each of
June 30,1999 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).
The IIHSL acquisition has been accounted for under the purchase method of
accounting. The purchase price has been preliminary allocated based on estimated
fair values at date of acquisition, pending final determination of certain
balances. This preliminary allocation has resulted in acquired goodwill of
approximately $ 12,185,020, which is 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 date.
The Company has filed a Report on Form-8K in relation to this acquisition
including audited financial statements of IIHSL and Pro Forma financial
statements.
Pro Forma net income adjusted as though the 100% acquisition of IIHSL took
place at the beginning of the periods being reported on is shown below.
<TABLE>
<CAPTION>
SIX MONTHS ENDED
DECEMBER 31,
-------------------------------------------
1997 1998
$US $US
-------------------------------------------
(IN THOUSANDS EXCEPT PER SHARE DATA)
<S> <C> <C>
Pro forma net sales 25,800 24,963
Pro forma net income 2,807 2,737
Pro forma net income per common share
Basic earnings per share 0.51 0.49
Diluted earnings per share 0.50 0.49
Pro forma weighted average number of shares outstanding
Basic 5,550 5,550
Diluted 5,654 5,556
</TABLE>
8
<PAGE>
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
This discussion and analysis of the Company's financial condition and
results of operations 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 fluctuations
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" in the Company's Annual Report on Form 10-K for the
fiscal year ended June 30, 1998 and expanded upon herein, and as detailed from
time to time in the Company's other filings made with the Securities and
Exchange Commission.
COMPARISON OF THREE MONTHS ENDED DECEMBER 31, 1998 AND DECEMBER 31, 1997.
NET SALES: Net sales increased by $1.4 million or 13% from $10.8 million
for the three months ended December 31, 1997 to $12.2 million for the three
months ended December 31, 1998, despite a 15% decline in the value of the
Australian Dollar ("AUD") against the U.S. dollar from an average conversion
rate of 0.7074 for the three months ended December 31, 1997 to 0.6032 for the
three months ended December 31, 1998.
The increase in net sales was attributable to the inclusion of $1.8 million
in net sales from the IIHSL acquisition, relating to sales of manufactured goods
not sold through the distributor network. Total unit sales increased from 14,303
units for the three months ended December 31, 1997 to 15,053 units for the three
months ended December 31, 1998.
Unit sales in the Australian and New Zealand market increased 3% from
12,582 units for the three months ended December 31, 1997 to 12,993 units for
the three months ended December 31, 1998. Unit sales in the Australian market
increased 16% from 9,882 units for the three months ended December 31, 1997 to
11,437 units for the three months ended December 31, 1998 due to an increase in
the number of distributors in this market. However, unit sales in New Zealand
decreased 42% from 2,700 units for the three months ended December 31, 1997 to
1,556 units for the three months ended December 31, 1998. The decline in unit
sales in New Zealand is attributable to two distributors relocating from New
Zealand to the US market and a decline in net unit sales per distributor. During
the three month period ended December 31, 1998, the Company implemented a
program whereby key executives of the Company conducted training of all
distributors in the New Zealand market to maximize unit sales per
distributorship and to increase the number of distributors.
Unit sales in Europe, South Africa and the United Kingdom increased 9% from
1,721 units for the three months ended December 31, 1997 to 1,868 for the three
months ended December 31, 1998. Unit sales in the European market increased
compared to the corresponding period in 1997 while unit sales in the South
African market decreased due to structural change in the distributor network. In
the United States market the Company continues to focus on establishing a
foundation from which the distribution network can grow.
9
<PAGE>
COST OF GOODS SOLD - OTHER: Cost of goods sold decreased 16.3% from $6.7
million for the three months ended December 31, 1997 to $5.6 million for the
three months ended December 31, 1998. As a percentage of net sales, cost of
goods sold decreased 16% from 62% for the three months ended December 31, 1997
to 46% for the three months ended December 31, 1998. The reduction in cost of
goods is attributable to the consolidation of IIHSL with the Company for the
three months ended December 31, 1998. As a result of the acquisition of IIHSL
the Company's gross margin as a percentage of sales increased 14% from 38% for
the three months ended December 31, 1997 to 52% for the three months ended
December 31, 1998.
COST OF GOODS SOLD - INVENTORY REVALUATION: Cost of goods sold - inventory
revaluation represents the elimination of inter-company profits recognized by
IIHSL on the inventory carried by the Company ("inventory revaluation") at
December 31, 1998. The effect of the inventory revaluation is largest when first
recognized as it is calculated on the entire inventory held by the Company.
GENERAL AND ADMINISTRATIVE EXPENSES: General and administrative expenses
were $4.0 million for the three months ended December 31, 1998, compared to $2.6
million for the three months ended December 31, 1997. Total general and
administrative expenses, as a percentage of net sales, increased 9% to 33% for
the three months ended December 31, 1998 compared to 24% for the three months
ended December 31, 1997. The increase in general and administrative expenses as
a percentage of net sales was primarily attributable to the following two
factors for the three months ended December 31, 1998: (a) inclusion of expenses
relating to IIHSL of $1.0 million; and (b) amortization of goodwill generated
from the acquisition of IIHSL of $0.2 million. The Company incurred additional
expenses in the period ended December 31, 1998 relating to the establishment of
the on-line monitoring, the establishment of the United States market and the
expansion of the European market.
RESEARCH AND DEVELOPMENT: Research and Development expenses for the three
months ended December 31, 1998 represents costs incurred by IIHSL in relation to
product approvals and the design and development of new products.
INCOME FROM OPERATIONS: Income from operations increased 40% from $1.5
million for the three months ended December 31, 1997 to $2.1 million for the
three months ended December 31, 1998. The increase in income from operations
reflects the acquisition of IIHSL that has enabled the Company to increase both
its sales revenue and margins.
INTEREST INCOME: Interest income remained stable at $0.1 million for the
three months ended December 31, 1997 and 1998, respectively.
INTEREST EXPENSE: Interest expense for the three months ended December 31,
1998 was $0.3 million compared to $0.0 million for the three months ended
December 31, 1997. The interest charge for the three months ended December 31,
1998 was made up of two separate interest charges: (a) interest payments of
$101,000 to FAI Insurances Limited pursuant to the FFC Note; and (b) a non-cash
imputed interest charge $165,000 booked 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 promissory note, secured by the IIHSL shares, in the amount of
$9,098,000, bearing no interest. U.S. GAAP purchase accounting principles
require 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.
INCOME TAX EXPENSE: Due to (a) future tax benefits in relation to the
Canadian and USA operations of $0.1 million not being brought to account; and
(b) non-deductible amortization of goodwill generated from the acquisition of
IIHSL of $0.2 million, the effective rate of tax increased 16% from 32% for the
three months ended December 31, 1997 to 48% for the three months ended December
31,1998.
EQUITY IN INCOME OF AFFILIATED COMPANIES: Equity in income of affiliates
for the three months ended December 31, 1998 was $190,000. This was calculated
by taking the Company's 50% share of FFC's net income of $262,000 for the three
months ended December 31, 1998 and deducting amortization of goodwill for the
same period of $72,000. There was no equity in income of affiliates for the
three months ended December 31, 1997 as the FFC Transaction took place on
December 31,1997.
10
<PAGE>
MINORITY INTEREST: Minority interest represents an independent third
party's ownership of 24.96% of Ness, and the corresponding profit allocation for
the three months ended December 31, 1998.
NET INCOME: Net income decreased 6% from $1.1 million for the three months
ended December 31, 1997 to $1.0 million for the three months ended December 31,
1998.
COMPARISON OF SIX MONTHS ENDED DECEMBER 31, 1998 AND DECEMBER 31, 1997.
NET SALES: Net sales increased by $0.6 million or 3% from $21.8 million for
the six months ended December 31, 1997 to $22.4 million for the six months ended
December 31, 1998 despite a 15% decline in the value of the AUD against the U.S.
dollar from an average conversion rate of 0.7074 for the six months ended
December 31, 1997 to 0.6032 for the six months ended December 31, 1998.
The increase in net sales was primarily attributable to the inclusion of
$1.8 million in net sales from the IIHSL acquisition October 1, 1998, relating
to sales of manufactured goods not sold through the distribution network. Total
unit sales increased from 27,657 units for the six months ended December 31,
1997 to 29,730 units for the three months ended December 31, 1998.
Unit sales in the Australian and New Zealand market increased 5% from
24,419 units for the six months ended December 31, 1997 to 25,659 units for the
six months ended December 31, 1998. Unit sales in the Australian market
increased 17% from 19,230 units for the six months ended December 31, 1997 to
22,458 units for the six months ended December 31, 1998 due to an increase in
the number of distributors in this market. However, unit sales in New Zealand
decreased 39% from 5,189 units for the six months ended December 31, 1997 to
3,156 units for the six months ended December 31, 1998. The decline in unit
sales in New Zealand is attributable to two distributors relocating from New
Zealand to the United States market and a decline in net unit sales per
distributor. During the period ended December 31, 1998, the Company implemented
a program whereby key executives of the Company conducted training of all
distributors in the New Zealand market to maximize unit sales per
distributorship and to increase the number of distributors.
Unit sales in Europe, South Africa and the United Kingdom increased 27%
from 3,238 units for the three months ended December 31, 1997 to 4,124 for the
three months ended December 31, 1998. Unit sales in the European market
increased compared to the corresponding period in 1997 and the Company
anticipates appointing additional distributors in this market in the next two
quarters.
COST OF GOODS SOLD - OTHER: Cost of goods sold decreased 14% from $13
million for the six months ended December 31, 1997 to $11.4 million for the six
months ended December 31, 1998. As a percentage of net sales, cost of goods sold
decreased 9% from 60% for the six months ended December 31, 1997 to 51% for the
six months ended December 31, 1998. The reduction in cost of goods is
attributable to the consolidation of IIHSL with the Company for the six months
ended December 31, 1998. As a result of the acquisition of IIHSL the Company's
gross margin as a percentage of sales increased 8% from 40% for the six months
ended December 31, 1997 to 48% for the six months ended December 31, 1998.
COST OF GOODS SOLD - INVENTORY REVALUATION: Cost of goods sold - inventory
revaluation represents the inventory revaluation at December 31, 1998. The
effect of the inventory revaluation is largest when first recognized as it is
calculated on the entire inventory held by the Company.
GENERAL AND ADMINISTRATIVE EXPENSES: General and administrative expenses
were $5.9 million for the six months ended December 31, 1998, compared to $5.1
million for the six months ended December 31, 1997. Total general and
administrative expenses, as a percentage of net sales, increased 3% to 26.5% for
the six months ended December 31, 1998 compared to 23.5% for the six months
ended December 31, 1997. The increase in general and administrative expenses as
a percentage of net sales was primarily attributable to the following two
factors for the three months ended December 31, 1998: (a) inclusion of expenses
relating to IIHSL of $1.0 million; and (b) amortization of goodwill generated
from the acquisition of IIHSL of $0.2 million. The Company incurred additional
expenses in the period ended December 31, 1998 relating to the establishment of
the on-line monitoring, the establishment of the United States market and the
expansion of the European market.
11
<PAGE>
RESEARCH AND DEVELOPMENT: Research and Development expenses for the six
months ended December 31, 1998 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 24% from $3.7
million for the six months ended December 31, 1997 to $4.6 million for the six
months ended December 31, 1998. The increase in income from operations reflects
the acquisition of IIHSL that has enabled the Company to increase both its sales
revenue and margins.
INTEREST INCOME: Interest income remained stable at $0.2 million for the
six months ended December 31, 1997 and 1998, respectively.
INTEREST EXPENSE: Interest expense for the six months ended December 31,
1998 was $0.4 million compared to $0.0 million for the three months ended
December 31, 1997. The interest charge for the six months ended December 31,
1998 was made up of two separate interest charges: (a) interest payments of
$200,000 to FAI Insurances Limited pursuant to the FFC Note; and (b) a non-cash
imputed interest charge of $165,000 booked in order to comply with U.S. GAAP
purchase accounting principles. Pursuant to the Stock Purchase Agreement
through which the Company acquired 100% of the issued and outstanding stock
IIHSL, the Company issued a promissory note, secured by the IIHSL shares, in the
amount of $9,098,000, bearing no interest. U.S. GAAP purchase accounting
principles require 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.
INCOME TAX EXPENSE: Due to: (a) future tax benefits in relation to the
Canadian and USA operations of $0.1 million not being booked; and (b) non-
deductible amortization of goodwill generated from the Ness acquisition of $0.2
million, the effective rate of tax increased 6% from 36% for the six months
ended December 31, 1997 to 42% for the six months ended December 31,1998.
EQUITY IN INCOME OF AFFILIATED COMPANIES: Equity in income of affiliates
for the six months ended December 31, 1998 was $239,000. This was calculated by
taking the Company's 50% share of FFC's net income of $380,000 for the six
months ended December 31, 1998 and deducting amortization of goodwill for the
same period of $141,000. There was no equity in income of affiliates for the six
months ended December 31, 1997 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 three months ended December 31, 1998.
NET INCOME: Net income increased 4% from $2.5 million for the six months
ended December 31, 1997 to $2.6 million for the six months ended December 31,
1998.
LIQUIDITY AND CAPITAL RESOURCES
The principal source of the Company's liquidity historically has been, and
in the future is expected to be, cashflow from operations. The Company currently
has no credit facility with a bank or other financial institution, although it
believes appropriate facilities would be available on reasonable terms if
needed.
Effective October 1, 1998, the Company executed the Stock Purchase
Agreement 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 ($126,000 paid concurrent with the
execution of the Stock Purchase Agreement and $2,300,000 to be paid upon the
closing of the transaction); (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 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. 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
12
<PAGE>
$13.00 per share. Likewise, if any portion of the principal amount of the Note
is still outstanding on January 1, 2000, the Company shall issue an additional
five year warrant to purchase 200,000 shares of HSI common stock at an exercise
price of $13.00 per share.
Cashflow from operations decreased from $2.9 million for the six months
ended December 31, 1997 to $0.9 million for the six months ended December 31,
1998. The decrease in cash flow provided by operations was attributable to (i)
early repayment of creditors within the European, South African and North
American operations which enabled these operations to reduce the cost of
inventories by taking advantage of favorable exchange rates, and (ii)
capitalization in prepayments and other assets costs associated with the filling
of a Form S-1 with the Securities and Exchange Commission on July 20, 1998.
Accounts receivable increased $2.3 million during the six months ended
December 31, 1998. The increase in accounts receivable resulted from:
1. The consolidation of IIHSL, increasing accounts receivable by $1.3
million.
2. The advance of alarm system units to selected Distributors in the
Australian and New Zealand markets. The cost of the alarm system unit
advancement has been secured against sales rebates achieved by the
Distributors for the six months ended December 31, 1998. The rebates
were accrued against trade payables while the stock advancements were
charged to accounts receivable.
Net cash used in investing activities decreased from a surplus of $1.0
million during the six months ended December 31, 1997 to a deficit of $3.4
million during the six months ended December 31, 1998. The deficit in net cash
used in investing activities was primarily due to the consideration paid and
costs associated with the acquisition of Ness.
Net cash generated from financing activities decreased from a surplus of
$3.6 million during the six months ended December 31, 1997 to a deficit of $0.05
million for the six months ended December 31, 1998.
The Company believes that internally generated cashflows will be adequate
to support currently planned business operations over the next twelve months.
The Company's strategy for growth is based on the expansion of its Distributor
Network into existing and new markets, with the costs of such expansion largely
borne by the distributor. It is expected excess cashflows generated by the
Company will be used in part, if the Company acquires the remaining 24.96%
interest of Ness, for such acquisition. Additionally, the Company may from time
to time, use excess cash flows to make strategic acquisitions or other
investments. Notwithstanding that the Company's costs in expanding its
Distributor Network are expected to be limited, the Company may be required to
obtain additional capital to fund growth from other financing sources if the
cashflow generated by the Australian and New Zealand operations is insufficient
to meet the cash requirements of developing the international operations.
Potential sources of such capital may include proceeds from bank financing or
additional offerings of the equity or debt securities of the Company. There can
be no assurance that such capital will be available on acceptable terms from
these or other potential sources. The lack of such capital could have a material
adverse effect on the Company's operations.
YEAR 2000 DISCLOSURE
The Company is currently in the process of evaluating its information
technology infrastructure ("ITI") for Year 2000 compliance. In this regard, the
Company has identified three (3) areas of exposure. First, the Company's
operating environment, which includes the following: software, hardware, and the
remaining infrastructure. The software and hardware exposures have been
identified as either "mission critical" or "non-mission critical". Mission
critical software includes the Company's accounting package, customer databases,
and operating systems, including Windows 95 and Windows NT. The Company is
presently undergoing a review process with regard to mission critical software.
The Company expects to have addressed all Year 2000 issues for all mission
critical software by early 1999, and anticipates that the costs to achieve
compliance will not have a material impact on the financial condition or results
of operations of the Company. Mission critical hardware encompasses the data
communication infrastructure and all server end hardware. The Company has
employed an external information technology firm to review its mission critical
hardware and provide an analysis of the Company's potential risks, and
alternatives to address Year 2000 issues. Such review has been
13
<PAGE>
completed and the Company is awaiting the results of the review. The Company
will implement all recommendations and expects to have addressed all Year 2000
issues impacting its mission critical hardware by the end of the third quarter
of fiscal 1999.
Additionally, the Company has formed a Year 2000 Compliance Committee ("the
Committee") with representatives from all departments of the Company including
Ness and FFC. The Committee is charged with the evaluation of all non-mission
critical software and hardware and the remaining infrastructure of the Company
to address the remaining Year 2000 issues. The Committee is also responsible for
contacting all major vendors with a request to supply a response in writing,
which confirms the services or products they supply are Year 2000 compliant. The
Company has also adopted a policy requiring written confirmation of Year 2000
compliance from any prospective vendor. 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. In regards to Ness, the Company has begun to
utilize the same internal and external resources identified above, to test the
manufacturing infrastructure of Ness for Year 2000 compliance. If necessary, the
Company will reprogram or replace any non-compliant manufacturing equipment.
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 any of its or its subsidiaries
ITI and/or other infrastructures, in order to address Year 2000 issues 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.
CURRENCY FLUCTUATIONS
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. 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 .6516 on December 31, 1997 to .6115 on December
31, 1998. The change in valuation resulted in lower reported revenues than
budgeted when translated into U.S. dollars for three and six months ended
December 31, 1998. Although the Company is not in the business of currency
hedging, it may from time to time engage in hedge arrangements. Nevertheless,
there can be no assurance that the Company will be successful in limiting risks
related to currency fluctuations and that changes in exchange rates will not
have a material adverse effect on the Company or its results of operations.
ITEM 3: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable
PART II - OTHER INFORMATION
ITEM 1: LEGAL PROCEEDINGS
Not Applicable
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Effective October 1, 1998, the Company purchased, pursuant to the Stock
Purchase Agreement, the IIHSL Shares. IIHSL is the holder of 75.04 percent of
the issued and outstanding common stock of Ness. The purchase price for the
IIHSL Shares consisted of the following: (i) 400,000 shares of the Common Stock
(issued pursuant to Section 4(2) of the Securities Act), (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
14
<PAGE>
amount of $2,426,000 ($126,000 paid concurrent with the execution of the Stock
Purchase Agreement and $2,300,000 paid upon the closing of the transaction);
(iv) a promissory note, secured by the IIHSL Shares, in the amount of $9,098,000
(discounted to $8,602,666 for financial reporting purposes), payable in
installments of $400,000 on each of June 30,1999 and December 31, 1999, with the
balance of the note due on June 30, 2000 (the "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).
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.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
Not Applicable
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable
ITEM 5. OTHER INFORMATION
Not Applicable
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
27 Financial Data Schedule
(b) Reports on Form 8-K
On December 15, 1998, the Registrant filed an amended report on Form
8-K to file the requisite financials associated with the purchase of 100%
of the shares of International Integrated Home Security Limited.
HOME SECURITY INTERNATIONAL, INC.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
HOME SECURITIES INTERNATIONAL, INC.
(Registrant)
By: /s/ Bradley D. Cooper
______________________________________________
Bradley D. Cooper
Chairman and Chief Executive Officer
(Principal Executive Officer)
By: /s/ Mark Whitaker
______________________________________________
Mark Whitaker
Vice President of Finance and Treasurer
(Principal Financial and Accounting Officer)
Dated: February 12, 1998
15
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND> This schedule contains summary financial information extracted from
Home Security International, Inc. and subsidiaries consolidated financial
statements as of June 30, and December 31, 1998 and is qualified in its entirety
by reference to such financial statements.
</LEGEND>
<MULTIPLIER> 1
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> JUN-30-1998
<PERIOD-START> OCT-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 4,338,900
<SECURITIES> 0
<RECEIVABLES> 3,160,262
<ALLOWANCES> 0
<INVENTORY> 6,537,902
<CURRENT-ASSETS> 15,743,591
<PP&E> 2,895,609
<DEPRECIATION> 0
<TOTAL-ASSETS> 49,261,142
<CURRENT-LIABILITIES> 10,036,528
<BONDS> 0
0
0
<COMMON> 5,550
<OTHER-SE> 17,839,911
<TOTAL-LIABILITY-AND-EQUITY> 49,261,142
<SALES> 12,185,335
<TOTAL-REVENUES> 12,292,258
<CGS> 5,847,541
<TOTAL-COSTS> 5,847,541
<OTHER-EXPENSES> 4,229,184
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 280,035
<INCOME-PRETAX> 1,935,498
<INCOME-TAX> 932,080
<INCOME-CONTINUING> 1,003,418
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 1,036,881
<EPS-PRIMARY> 0.19
<EPS-DILUTED> 0.19
</TABLE>
