<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 March 31, 1999.
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)
<TABLE>
<S> <C>
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)
</TABLE>
(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 May 14, 1999: 5,550,500
================================================================================
<PAGE>
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
HOME SECURITY INTERNATIONAL, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
<TABLE>
<CAPTION>
JUNE 30, MARCH 31,
-------------------------------
NOTE 1998 1999
$US $US
-----------------------------------------
<S> <C> <C> <C>
ASSETS
- ------
Current assets
Cash and cash equivalents 7,006,183 4,737,401
Accounts receivable - trade, net 874,745 3,265,937
Inventories 2 2,032,443 6,327,953
Prepaid expenses and other current assets 1,173,449 1,936,318
--------------------------------
Total current assets 11,086,820 16,267,609
--------------------------------
Non-current assets
Investment in partnership 303,424 308,909
Investments in affiliated companies 7,405,130 7,524,874
Capital assets, net 1,068,237 3,318,056
Intangibles, net 9,601,923 21,870,935
Deferred income taxes 1,016,652 1,555,077
Other non-current assets 3,115 3,159
--------------------------------
Total non-current assets 19,398,481 34,581,010
--------------------------------
Total assets 30,485,301 50,848,619
================================
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Current liabilities
Note payable - FAI Insurance Group 619,233 1,570,000
Note payable - Integral Investments Limited 5 - 785,486
Payables - trade 4,280,422 3,329,812
Accrued liabilities 777,516 1,320,886
Lease liability 28,704 285,991
Income tax payable 1,608,648 2,691,398
Deferred income 650,949 893,191
--------------------------------
Total current liabilities 7,965,472 10,876,764
--------------------------------
Non-current liabilities
Note payable - FAI Insurance group 5 4,117,902 2,983,000
Note payable - Integral Investments Limited - 8,147,407
Lease liability 33,342 306,299
Accrued liabilities 91,944 149,382
Deferred income 177,769 239,930
--------------------------------
Total non-current liabilities 4,420,957 11,826,018
--------------------------------
Total liabilities 12,386,429 22,702,782
--------------------------------
Minority interest - 2,003,597
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 March 31, 1999. 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) (701,940)
Retained earnings 5,333,976 8,998,719
--------------------------------
Total stockholders' equity 18,098,872 26,142,240
--------------------------------
Total liabilities and stockholders' equity 30,485,301 50,848,619
================================
</TABLE>
The accompanying notes are an integral part of these condensed
consolidated financial statements
2
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED NINE MONTHS ENDED
MARCH 31, MARCH 31,
---------------------------------------------------------------------------
NOTE 1998 1999 1998 1999
$US $US $US $US
--------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Net Sales 10,339,646 11,585,255 32,157,807 33,996,829
Cost of goods sold (5,879,396) (5,569,643) (18,864,996) (17,278,794)
---------------------------------------------------------------------------
Gross profit 4,460,250 6,015,612 13,292,811 16,718,035
General and administrative expenses (2,956,244) (3,652,787) (8,083,449) (9,628,902)
Research and development expenses - (211,086) - (401,307)
---------------------------------------------------------------------------
Income from operations 1,504,006 2,151,739 5,209,362 6,687,826
Interest income 99,998 90,631 333,840 313,051
Interest expenses - related party (111,425) (81,909) (111,425) (251,416)
- other (3,719) (174,642) (6,951) (355,118)
---------------------------------------------------------------------------
Income before taxes and equity in
income of affiliated companies and
minority interest 1,488,860 1,985,819 5,424,826 6,394,343
Income tax expense (546,800) (842,447) (1,948,780) (2,691,391)
---------------------------------------------------------------------------
Income before equity in income of `
affiliated companies and minority interest 942,060 1,143,372 3,476,046 3,702,952
Equity in income of affiliated companies 4 97,275 57,771 97,275 296,356
Minority interest - (177,894) - (334,565)
---------------------------------------------------------------------------
Net income 1,039,335 1,023,249 3,573,321 3,664,743
===========================================================================
Net income per common share
Basic earnings per share $ 0.20 $ 0.18 $ 0.70 $ 0.68
Diluted earnings per share $ 0.20 $ 0.18 $ 0.69 $ 0.68
Weighted average number of shares
outstanding
Basic 5,150,500 5,550,500 5,106,000 5,417,167
Diluted 5,175,692 5,553,548 5,157,417 5,422,169
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements
3
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASHFLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
NINE MONTHS ENDED
MARCH 31,
----------------------------------
1998 1999
$US $US
----------------------------------
----------------------------------
<S> <C> <C>
Net cash provided by operating activities 3,029,745 3,238,667
----------------------------------
Cashflow from investing activities
Receipt from/(payments to) related parties 1,802,920 (244,105)
Investment in affiliated companies (2,130,285) 281,870
Purchase of IIHSL, net of cash acquired - (3,356,615)
Short term loans (granted), repayments received 23,107 (622,504)
Additions to capital assets (391,245) (1,109,145)
Other cash inflows from investing activities - 31,907
----------------------------------
Net cash used in investing activities (695,503) (5,018,592)
----------------------------------
Cashflow from financing activities
Common stock issuance 3,934,678 -
Share issue costs (436,409) -
Other cash outflows from financing activities (29,615) (496,310)
----------------------------------
Net cash provided by/(used in) financing activities 3,468,654 (496,310)
----------------------------------
Net increase/(decrease) in cash held 5,802,896 (2,276,235)
----------------------------------
Cash at the beginning of the financial period 118 7,006,183
Effect of exchange rate change on cash 9 7,453
----------------------------------
Cash at the end of the financial period 5,803,023 4,737,401
==================================
Supplemental disclosure of cashflow information:
Interest paid 118,376 309,267
Income taxes paid 796,153 3,067,917
</TABLE>
The accompanying notes are an integral part of these condensed consolidated
financial statements
4
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE 1: SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation and Basis of Preparation -
The condensed consolidated financial statements presented herein and these
notes have been prepared by Home Security International, Inc. ("the Company"),
without audit. In the opinion of the registrants' management, the unaudited
condensed consolidated financial statements included in this filing on Form 10-Q
reflect all adjustments which consist of normal recurring adjustments necessary
to present fairly the financial information.
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 CONDENSED CONSOLIDATED FINANCIAL STATEMENTS -(CONTINUED)
(UNAUDITED)
<TABLE>
<CAPTION>
NOTE 2: INVENTORIES JUNE 30, MARCH 31,
-----------------------------------------
1998 1999
$US $US
-----------------------------------------
<S> <C> <C>
Finished goods 1,727,670 2,844,883
Work in progress - 410,527
Raw materials - 2,925,370
Sales aids 304,773 147,173
-----------------------------------------
2,032,443 6,327,953
=========================================
</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 nine-month periods ended March
31, 1998 and 1999 was as follows:
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
1998 1999
$US $US
-----------------------------------------
<S> <C> <C>
Net income 1,039,335 1,023,249
Other comprehensive income:
Foreign currency translation adjustment 109,747 256,880
-----------------------------------------
Total comprehensive income 1,149,082 1,280,129
=========================================
<CAPTION>
NINE MONTHS ENDED
MARCH 31,
-----------------------------------------
1998 1999
$US $US
-----------------------------------------
<S> <C> <C>
Net Income 3,573,321 3,664,743
Other comprehensive (loss) income:
Foreign currency translation adjustment (63,908) 274,625
-----------------------------------------
Total comprehensive income 3,509,413 3,939,368
=========================================
</TABLE>
6
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONDENSED 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 ENDED
MARCH 31,
--------------------------------------
1998 1999
$US $US
--------------------------------------
<S> <C> <C>
Net interest income 1,423,111 1,188,371
Net income 360,194 262,934
<CAPTION>
NINE MONTHS ENDED
MARCH 31,
--------------------------------------
1998 1999
$US $US
--------------------------------------
<S> <C> <C>
Net interest income 4,298,010 4,629,754
Net income 932,964 1,022,794
</TABLE>
Reconciliation of equity in income of affiliated companies for the three and
nine month periods ended March 31, 1998 and 1999 is shown below.
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
--------------------------------------
1998 1999
$US $US
--------------------------------------
<S> <C> <C>
50 percent of Net income of affiliated company - FFC 180,097 131,467
Amortization of goodwill - FFC (82,822) (73,696)
Equity in income of affiliated companies 97,275 57,771
<CAPTION>
NINE MONTHS ENDED
MARCH 31,
--------------------------------------
1998 1999
$US $US
--------------------------------------
<S> <C> <C>
50 percent of Net income of affiliated company - FFC 180,097 131,467
Amortization of goodwill - FFC (82,822) (73,696)
Equity in income of affiliated companies 97,275 57,771
</TABLE>
7
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO CONDENSED 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 $12,776,282, 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>
NINE MONTHS ENDED
MARCH 31,
------------------------------------------
1998 1999
$US $US
------------------------------------------
(in thousands except per share data)
<S> <C> <C>
Pro forma net sales 36,369 36,548
Pro forma income from operations 8,582 7,465
Pro forma net income 4,478 3,766
Pro forma net income per common share
Basic earnings per share 0.81 0.68
Diluted earnings per share 0.78 0.68
Pro forma weighted average number of shares outstanding
Basic 5,550 5,550
Diluted 5,711 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 MARCH 31, 1999 AND MARCH 31, 1998.
NET SALES: Net sales increased by $1.3 million or 13% from $10.3 million
for the three months ended March 31, 1998 to $11.6 million for the three months
ended March 31, 1999, despite a 12% decline in the value of the Australian
Dollar ("AUD") against the U.S. dollar from an average conversion rate of 0.6971
for the three months ended March 31, 1998 to 0.6103 for the three months ended
March 31, 1999.
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 decreased from 13,262
units for the three months ended March 31, 1998 to 12,950 units for the three
months ended March 31, 1999. The decline in unit sales is primarily attributable
to the poor performance of the South African operation. Unit sales in South
Africa for the three months ended March 31, 1999 fell to 88 in comparison to 571
in the three months ended March 31, 1998. Unit sales are not expected to improve
in the next two quarters due to structural changes required to address the poor
market conditions.
The Company's online monitoring program is currently being rolled out in
Australia and New Zealand. The Company has in excess of 1,000 monitored lines,
the majority of these being installed during the three months ended March 31,
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.
Unit sales in the Australian and New Zealand market decreased 3% from
11,472 units for the three months ended March 31, 1998 to 11,116 units for the
three months ended March 31, 1999. Unit sales in the Australian market increased
2% from 9,326 units for the three months ended March 31, 1998 to 9,550 units for
the three months ended March 31, 1999. However, unit sales in New Zealand
decreased 27% from 2,146 units for the three months ended March 31, 1998 to
1,566 units for the three months ended March 31, 1999. The
9
<PAGE>
decline in unit sales in New Zealand is attributable to a decline in net unit
sales per distributor and a material decrease in consumer finance approvals.
Unit sales in New Zealand are expected to improve based upon a number of new
initiatives to be introduced to this market during the next quarter.
Unit sales in Europe and the United Kingdom increased 66% from 1,000 units
for the three months ended March 31, 1998 to 1,659 for the three months ended
March 31, 1999. The Company believes the European market has reached a critical
mass, which will facilitate acceleration in the expansion of the market through
increased recruitment and rollout of the distribution network. The Company
intends to focus on creating a similar base for expansion in its U.S. operations
over the next twelve months. The Company expects to commit key resources from
its worldwide operations to the U.S. market.
COST OF GOODS SOLD: Cost of goods sold decreased 5.1% from $5.9 million for
the three months ended March 31, 1998 to $5.6 million for the three months ended
March 31, 1999. As a percentage of net sales, cost of goods sold decreased 9%
from 57% for the three months ended March 31, 1998 to 48% for the three months
ended March 31, 1999. The reduction in cost of goods is attributable to the
consolidation of IIHSL with the Company for the three months ended March 31,
1999. The acquisition of IIHSL enabled the Company 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
43% for the three months ended March 31, 1998 to 52% for the three months ended
March 31, 1999.
GENERAL AND ADMINISTRATIVE EXPENSES: General and administrative expenses
were $3.7 million for the three months ended March 31, 1999, compared to $3.0
million for the three months ended March 31, 1998. Total general and
administrative expenses, as a percentage of net sales, increased 3% to 32% for
the three months ended March 31, 1999 compared to 29% for the three months ended
March 31, 1998. 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 March 31, 1999: (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 March 31, 1999 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 March 31, 1999 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 47% from $1.5
million for the three months ended March 31, 1998 to $2.2 million for the three
months ended March 31, 1999. The increase in income from operations reflects
the benefits from the acquisition of IIHSL which include (a) increased revenues
from IIHSL sales from sources outside the Distributor Network, and (b) the
capture of IIHSL's gross 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 $0.1 million for the
three months ended March 31, 1998 and 1999, respectively.
INTEREST EXPENSE - RELATED PARTY: Interest expense - related party remained
stable at $0.1 million for the three months ended March 31, 1998 and 1999,
respectively.
INTEREST EXPENSE - OTHER: Interest expense - other for the three months
ended March 31, 1999 was $175,000 compared to $4,000 for the three months ended
March 31, 1998. The interest charge for the three months ended March 31, 1999
consisted of a non-cash imputed interest charge $175,000 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 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.
10
<PAGE>
INCOME TAX EXPENSE: Due to (a) non-deductible amortization of goodwill
generated from the acquisition of IIHSL of $0.2 million, and (b) a prior year
tax adjustment of $0.1 million, the effective rate of tax increased 4% from 37%
for the three months ended March 31, 1998 to 42% for the three months ended
March 31,1999.
EQUITY IN INCOME OF AFFILIATED COMPANIES: Equity in income of affiliates
decreased by $39,000 from $97,000 for the three months ended March 31, 1998 to
$58,000 for the three months ended March 31, 1999. This was calculated by taking
the Company's 50% share of FFC's net income of $131,000 for the three months
ended March 31, 1999 and deducting amortization of goodwill for the same period
of $74,000.
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 March 31, 1999.
NET INCOME: Net income remained constant at $1.0 million for both the three
months ended March 31, 1998 and 1999.
COMPARISON OF NINE MONTHS ENDED MARCH 31, 1999 AND MARCH 31, 1998.
NET SALES: Net sales increased by $1.8 million or 6% from $32.2 million for
the nine months ended March 31, 1998 to $34.0 million for the nine months ended
March 31, 1999 despite a 12% decline in the value of the Australian Dollar
("AUD") against the U.S. dollar from an average conversion rate of 0.6971 for
the nine months ended March 31, 1998 to 0.6103 for the nine months ended March
31, 1999.
The increase in net sales was primarily attributable to the inclusion of
$3.6 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 5% from 40,899 units for the nine months ended March 31,
1998 to 42,826 units for the nine months ended March 31, 1999.
The Company's online monitoring program is currently being rolled out in
Australia and New Zealand. The Company has in excess of 1,000 monitored lines,
the majority of these being installed during the three months ended March 31,
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.
Unit sales in the Australian and New Zealand market increased 3% from
35,891 units for the nine months ended March 31, 1998 to 36,847 units for the
nine months ended March 31, 1999. Unit sales in the Australian market increased
12% from 28,556 units for the nine months ended March 31, 1998 to 32,117 units
for the nine months ended March 31, 1999 due to an increase in the number of
distributors in this market. However, unit sales in New Zealand decreased 36%
from 7,335 units for the nine months ended March 31, 1998 to 4,730 units for the
nine months ended March 31, 1999. The decline in unit sales in New Zealand is
attributable to a decline in net unit sales per distributor and a material
decrease in consumer finance approvals. Unit sales in New Zealand are expected
to improve based upon a number of new initiatives to be introduced to this
market during the next quarter.
Unit sales in Europe and the United Kingdom increased 40% from 3,175 units
for the nine months ended March 31, 1998 to 4,432 for the nine months ended
March 31, 1999. The European market is now experiencing consistent quarterly
growth in unit sales. The Company intends to allocate additional resource no
longer required in Europe into the United States market to focus on the
establishment of a foundation from which the distribution network can grow in
the U.S. Unit sales in the South African market decreased 31% during the nine
months ended March 31, 1999 to 957 as compared to 1,395 for the nine months
ended March 31, 1998.
COST OF GOODS SOLD - OTHER: Cost of goods sold decreased 8% from $18.9
million for the nine months ended March 31, 1998 to $17.3 million for the nine
months ended March 31, 1999. As a percentage of net sales,
11
<PAGE>
cost of goods sold decreased 8% from 59% for the nine months ended March 31,
1998 to 51% for the nine months ended March 31, 1999. The reduction in cost of
goods is attributable to the consolidation of IIHSL with the Company for the
nine months ended March 31, 1999. The acquisition of IIHSL enabled the Company
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 8% from 41% for the nine months ended March 31, 1998 to 49% for
the nine months ended March 31, 1999.
GENERAL AND ADMINISTRATIVE EXPENSES: General and administrative expenses
were $9.6 million for the nine months ended March 31, 1999, compared to $8.1
million for the nine months ended March 31, 1998. Total general and
administrative expenses, as a percentage of net sales, increased 3% to 28% for
the nine months ended March 31, 1999 compared to 25% for the nine months ended
March 31, 1998. 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 March 31, 1999: (a) inclusion of expenses relating to
IIHSL of $1.9 million; and (b) amortization of goodwill generated from the
acquisition of IIHSL of $0.3 million. The Company incurred additional expenses
in the period ended March 31, 1999 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 nine
months ended March 31, 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 29% from $5.2
million for the nine months ended March 31, 1998 to $6.7 million for the nine
months ended March 31, 1999. The increase in income from operations reflects the
benefits from the acquisition of IIHSL which include (a) increased revenues from
IIHSL sales made from sources outside the Distributor Network, (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 $0.3 million for the
nine months ended March 31, 1998 and 1998, respectively.
INTEREST EXPENSE - RELATED PARTY: Interest expense - related party is
derived from the FFC Transaction with regard to the vendor financed loan
initiated as part of the FAI Finance Corporation acquisition on December 31,
1997. For the nine months ended March 31, 1999 interest expense - related party
was $0.3 million compared to $0.1 million for the nine months ended March 31,
1998. The $0.2 million increase occurs because interest expense - related party
for the nine months ended March 31, 1998 includes only three months of interest
paid by the Company to FAI Insurances Limited (December 31, 1997 - March 31,
1998) while interest expense - related party for the nine months ended March 31,
1999 includes nine months of interest (July 1, 1998 - March 31, 1999).
INTEREST EXPENSE - OTHER: Interest expense - other for the nine months
ended March 31, 1999 was $355,000 compared to $7,000 for the nine months ended
March 31, 1998. The interest charge for the nine months ended March 31, 1999
consisted of a non-cash imputed interest charge $330,000 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 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 operation of $55,000 not being recorded; (b) non-deductible
amortization of goodwill generated from the acquisition of IIHSL of $0.3
million; and (c) a prior year tax adjustment of $0.1 million, the effective rate
of tax increased 6% from 36% for the nine months ended March 31, 1998 to 42% for
the nine months ended March 31,1999.
EQUITY IN INCOME OF AFFILIATED COMPANIES: Equity in income of affiliates
for the nine months ended
12
<PAGE>
March 31, 1999 was $296,000. This was calculated by taking the Company's 50%
share of FFC's net income of $511,000 for the nine months ended March 31, 1999
and deducting amortization of goodwill for the same period of $215,000. There
was only three months of equity in income of affiliates for the nine months
ended March 31, 1998, being $97,000, 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 six months ended March 31, 1999.
NET INCOME: Net income increased 3% from $3.6 million for the nine months
ended March 31, 1998 to $3.7 million for the nine months ended March 31, 1999.
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 $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 remained stable, being $3.0 million for the nine
months ended March 31, 1998 compared to $3.2 million for the nine months ended
March 31, 1999.
Net cash used in investing activities decreased from a deficit of $0.7
million during the nine months ended March 31, 1998 to a deficit of $5.0 million
during the nine months ended March 31, 1999. The deficit in net cash used in
investing activities was primarily due to: (a) $3.4 million for consideration
paid and costs associated with the acquisition of Ness: (b) $0.6 million for the
purchase of capital assets by Ness; and, (c) a short term loan granted of $0.6
million.
Net cash generated from financing activities decreased from a surplus of
$3.5 million during the nine months ended March 31, 1998 to a deficit of $0.5
million for the nine months ended March 31, 1999.
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 may be used in part to acquire the remaining 24.96% interest of Ness, if
the Company can reach agreement with the owners of such interest. 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
13
<PAGE>
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 three (3) areas of exposure, each which can be further subdivided
into two (2) 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 Company has employed an external information technology firm to review its
mission critical software and provide an analysis of the Company's potential
risks. The results of this review indicate that of the total core applications
100% have been identified as being year 2000 Compliant. The Company is in the
process of implementing all recommendations and expects to have addressed all
matters raised in the review by the end of the first quarter of Fiscal 2000. The
Company 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 completed and the external firm concluded that in general
the position of the hardware has, except for one product (a non-core modem),
been identified as year 2000 compliant.
The remaining infrastructure is presently being reviewed, and the
identification and rectification of any exposures will be achieved 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 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.
CURRENCY FLUCTUATIONS
14
<PAGE>
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 .6941 on March 31, 1998 to .6280 on March 31,
1999. The change in valuation resulted in lower reported revenues than budgeted
when translated into U.S. dollars for three and nine months ended March 31,
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.
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
Not Applicable
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) Exhibit 27 Financial Data Schedule
(b) Not Applicable
15
<PAGE>
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: May 14, 1999
16
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<PERIOD-START> JAN-01-1999
<PERIOD-END> JUN-30-1999
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