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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended June 30, 2000
OR
[_] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission File No. 1-14502
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HOME SECURITY INTERNATIONAL, INC.
(Exact name of Registrant as specified in its charter)
Delaware 98-0169495
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
Level 7, 77 Pacific Highway 2060
North Sydney, NSW (Zip Code)
(Address of principal executive offices)
(011) (612) 9936-2424
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock,
$.001 Par Value
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [_]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [_]
Aggregate market value, as of September 29, 2000, of Common Stock held
by non-affiliates of the registrant: $303,401 based on the last reported sale
price on the American Stock Exchange.
Number of shares of Common Stock outstanding on September 29, 2000: 5,828,278
Shares
DOCUMENTS INCORPORATED BY REFERENCE
The Registrant intends to file a definitive Proxy Statement pursuant to
regulation 14A within 120 days after the end of the fiscal year ended June 30,
2000. Portions of such Proxy Statement are incorporated by reference in Part III
of this report.
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PART I
ITEM 1. BUSINESS
Overview
Home Security International, Inc., a Delaware corporation (the
"Company") is a direct sales company which, through a distributor network (the
"Distributor Network"), sells, installs, monitors and services a residential
security alarm system marketed under the trade name SecurityGuard, principally
in Australia and New Zealand, with international operations in Europe, South
Africa and North America. The Company's security system (the "SecurityGuard
System") provides home protection to a customer's premises through interior heat
sensitive motion detectors, and a centralized processing unit ("CPU") which
communicates signals to a central monitoring station. Initially, the Company
successfully generated revenues from the margins realized on sales of
unmonitored SecurityGuard Systems, resulting in a base of customers with
installed SecurityGuard Systems of approximately 264,000. Over the last twelve
months the Company has focused on generating recurring revenue, through the sale
of extended warranties to its customers and the introduction of on-line alarm
monitoring services in Australia, New Zealand, North America, and Europe. The
SecurityGuard alarm and other major components are manufactured exclusively for
the Company by Ness Security Products Pty Limited, a wholly owned subsidiary.
The Company was founded by Bradley D. Cooper and commenced business in
Sydney, Australia in 1988. At its inception, the Company sold alarms through
part-time dealers who purchased franchises from the Company. In May 1991, the
Company adopted a more traditional sales structure by shifting to commission-
based compensation for its employees/agents, who were given extensive in-house
sales training. Although this approach allowed the Company to expand and
establish an office in Melbourne, Australia and to grow to five offices in
Australia within a year and a half, the growth and the income generation of its
sales force plateaued. In response to this development, in early 1993, the
Company implemented the Distributor Network strategy, which converted the
existing Company owned and operated branch offices to independently owned and
operated distribution offices, and converted the Company employed salespersons
to independent distributors responsible for their own costs.
During the last fiscal year, the Company devoted substantial resources
and personnel to refine and introduce into its Distributor Network a new sales
strategy offering the customer the SecurityGuard System alarm for an affordable
monthly payment over a 60-month period (the "On-line Monitoring Program").
This new On-line Monitoring Program represents a dynamic change from
the Company's previous strategy of simply selling its alarm system at full price
with little opportunity for continued customer access or revenue generation
except for selling periodic upgrades. The On-line Monitoring Program is based on
a United States market model that has been adopted by many major security
companies whereby the equipment and the monitoring component are repaid through
a monthly payment plan.
The Company's strategy for growth is based on the successful roll-out
of the new On-line Monitoring Program through its Distributor Network into
existing and new markets and the sale of five-year on-line monitoring contracts
through its Upgrade Program to its existing 264,000 residential customers. As
The Company's current level of monthly unit sales is insufficient to generate
positive cashflow from operations . There is no guarantee that the Company will
achieve a breakeven level of unit sales or will be successful in obtaining
additional external funding to cover negative operational cash flow. The lack of
such capital could have a material adverse effect on the Company's operations,
Security Alarm Industry
The Australian, New Zealand and North American security alarm industry
is large, growing rapidly and characterized by a high degree of fragmentation,
low residential penetration with a continuing trend toward consolidation. The
Company believes that the European market is similarly fragmented and that the
residential segment in Europe is substantially less penetrated than in North
America. Industry statistics published by Security Distributing and Marketing
Magazine, an industry publication, indicate that revenues for the electronic
security alarm segment of the security industry grew from $9.7 billion in 1990
to $16.1 billion in 1999. Management and other industry sources estimate that
there will be a substantial amount of new residential customers created in North
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America and Europe over the next several years as more and more consumers elect
to include security systems in their places of living.
The Company's management believes that growth in the residential
security alarm industry is and will continue to be attributable to a number of
factors. First, it appears that media coverage of crime, along with political
discussions concerning its causes and remedies, have increased public
consciousness of crime. Second, a number of insurance companies offer premium
discounts to customers with security and fire detection systems or require their
customers to maintain such systems as a condition of coverage. Third, the
worldwide residential market for security alarms remains relatively
unpenetrated. Fourth, there is an industry trend toward reducing installation
costs to increase affordability. Fifth, the aging population and increase in two
career families worldwide have contributed to an increased focus on residential
security.
The Company believes that the residential security alarm industry is
characterized by the following attributes:
High Degree of Fragmentation. Although residential security alarm
services worldwide are consolidating, the industry remains highly fragmented,
consisting of major international companies and a large number of local and
regional companies within each geographic market. The fragmented nature of the
industry can be attributed to the low capital requirements associated with
performing basic installation and maintenance of security alarm systems.
However, the business of a full service, integrated security services company
providing central station monitoring services is capital intensive, and the
Company believes that the high fixed costs of establishing both central
monitoring stations and full service operations contribute to the small number
of national competitors in each international market.
Continued Product Diversification and Integration of Services. The
products and services marketed in the residential security alarm industry range
from alarm systems that provide basic intrusion and fire detection to
sophisticated systems incorporating features such as closed circuit television
and access control. A recent trend in the residential security alarm industry
has been increased integration of different types of products into single
systems provided by single vendors. The Company believes that this trend is a
result of the need for enhanced security services on a more cost-effective
basis. Whereas basic alarm systems were once adequate for many businesses and
homes, it appears that many consumers now demand remote control access and
monitoring integrated into a single system to provide for their overall security
needs. A security alarm system which provides burglar alarm monitoring and
remote control, all integrated into one central system, not only provides
enhanced security services, but also is more cost-effective than separate
systems installed by separate vendors. Accordingly, the Company is positioning
itself to take advantage of this trend by expanding the services offered to its
customers to include 24-hour monitoring services. In this environment, the
Company believes that it can gain a competitive advantage over smaller companies
in the industry that do not have the infrastructure or the expertise to support
the larger and more sophisticated integrated systems.
Advances in Digital Communications Technology. Alarm systems use
either hardwired or wireless technology for systems installed on subscribers'
premises and may include digital, multiplex and wireless (radio) technologies
for the transmission of alarm signals to a central monitoring center. Prior to
the development of digital communications technology, alarm monitoring required
a dedicated telephone line, which made long-distance monitoring uneconomic.
Consequently, alarm-monitoring companies were required to maintain a large
number of geographically dispersed monitoring stations in order to achieve a
national or regional presence. The development of digital communications
technology eliminated the need for dedicated telephone lines, reducing the cost
of monitoring services to the subscriber and permitting the monitoring of
subscriber accounts over a wide geographic area from a central monitoring
station. The elimination of local monitoring stations has not only decreased the
cost of providing alarm-monitoring services, it has also substantially increased
the economies of scale for larger alarm service companies. In addition, the
concurrent development of microprocessor-based control panels has substantially
reduced the cost of the subscriber equipment available to consumers in the
residential and commercial markets and has substantially reduced service costs
because many diagnostic and maintenance functions can be performed from a
vendor's office without sending a technician to the customer's premises.
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Strategy
The Company expects to generate revenues by continuing to focus its
sales efforts on markets underserved by the security alarm industry and by
increasing the size of the Distributor Network in those countries in which it
now operates. In addition, the Company expects to expand its operations by
establishing a Distributor Network in new international markets and through
generating sources of recurring revenue by offering both its new and existing
alarm customers additional security related services, such as extended
warranties and on-line monitoring services. Each of the key elements of the
Company's growth strategy is discussed below.
On Line Monitoring Program - New Customers. During the last fiscal
year, the Company devoted substantial resources and personnel to refine and
introduce into its Distributor Network a new sales strategy offering the
customer the SecurityGuard System alarm for an affordable monthly payment over a
60-month period (the "On-line Monitoring Program").
This new On-line Monitoring Program represents a dynamic change from
the Company's previous strategy of simply selling its alarm system at full price
with little opportunity for continued customer access or revenue generation
except for selling periodic upgrades. The On-line Monitoring Program is based on
a United States market model that has been adopted by many major security
companies whereby the equipment and the monitoring component are repaid through
a monthly repayment plan.
The Company completed the conversion of Australia, New Zealand and the
United States markets to the new program during the last quarter of fiscal 2000.
The Company also launched the On-line Monitoring Program in the United Kingdom
and Netherlands markets during the last quarter of fiscal 2000 and the first
quarter of fiscal 2001. It is the Company's intention to launch a program in
each market that provides a basic security package consisting of an alarm and
on-line monitoring services for five years. The Company plans to expand its
distributor network through a recruitment program.
Upgrade Program - Existing Customers. The Company has continued to
contact its existing customer-base to offer its 5-year on-line monitoring
services package (the "Upgrade Program"). During the fiscal year ended June 30,
2000, the Company upgraded 7,639 alarm systems with on-line monitoring services.
These new connections represented a 265% increase from the on-line monitoring
connections made during the fiscal year ended June 30, 1999. As of June 30,
2000, more than 9,700 of the Company's existing 264,000 customers have entered
into agreements to purchase the Company's on-line monitoring services.
Extended Warranty Program. The Company currently sells extended
warranties to its customers (to supplement the one year limited warranty, which
has historically accompanied the sale of the SecurityGuard System). Revenues
related to extended warranties will continue to be recognized over the life of
the warranty agreement with the customer, although payment is received in full
at the beginning of the agreement. The Company intends to continue this program
during the next fiscal year.
International Expansion. The Company is committed to actively
expanding its international operations in both Europe and North America and is
placing greater emphasis on those markets as a significant source of future
growth. The Company intends to expand its international operations via the
controlled growth model it employed in its Australian and New Zealand
operations. The Company's strategy is to develop a limited number of
distribution offices in each new market it enters while learning the intricacies
and nuances of selling to such markets before aggressively expanding its
distributor base in that market. Additionally, the Company recognizes that each
separate state in North America should be treated as an individual market with
it's own individual characteristics. After targeting a region for expansion, the
Company generally appoints a limited number of Distributors for that region.
These Distributors are responsible for establishing operations in the designated
region and report directly to the Company's head office in Australia. Prior to
appointment in a new market, each new Distributor must successfully complete an
intensive twelve-week training program at the Company's offices in Australia.
The Distributors bear all costs of commencing operations in their respective
market, other than initial recruitment and product approval expenses.
Increased Penetration of Existing Geographic Markets. By actively
expanding the Distributor Network in existing geographic markets through
increases in the number of independent sales agents and distributors, the
Company believes that it will be able to increase account density in those
regions and thereby enhance the efficiency of its
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operations and its distributors. By increasing sales in a given area, the
Company believes that it achieves increased operating efficiencies associated
with providing its 24 hour emergency response services and warranty maintenance.
Also by increasing the number of SecurityGuard System installations in each
distributor area in which it has already secured customers, it will be able to
provide monitoring to its customers at a lower marginal cost. Additionally, as
the Company penetrates a new market it develops a reputation for providing
quality products and superior customer service, which enhances community
awareness of the Company. The Company believes this increased community
awareness is important to its ability to generate high quality sales leads.
Geographic Operations
The Company has been actively selling SecurityGuard Systems for
approximately nine years in Australia and New Zealand and despite significant
declines in unit sales over the past fiscal year believes it is one of the
largest residential security alarm businesses in the market. As at June 30,
2000, there were thirty-nine distributor offices in Australia and five
distributor offices in New Zealand as compared to sixty-nine and twelve
respectively in Australia and New Zealand in fiscal 1999.
The Company first commenced operations outside of Australia and New
Zealand in 1994 and is seeking to grow its international operations. As at June
30, 2000 the Company had a total of eleven international distributor offices
located in the Netherlands (six), South Africa (one), the United Kingdom (two),
and the United States (two). Unit sales for the international markets amounted
to 5,664 units in fiscal year 2000 as compared to 7,630 units in fiscal year
1999.
The Company intends to expand internationally by adding distribution
offices in established markets and entering new markets. The planned
international expansion efforts outside Australia and New Zealand may cause an
increase in expenses from time to time, without necessarily generating a
corresponding increase in revenue. Additionally, the lack of availability of
finance in new regions could significantly impact the successful expansion of
the Company's operations. There can be no assurance that the Distributor Network
can be replicated successfully throughout the world.
The SecurityGuard System
The Company's SecurityGuard alarm was designed and developed by Ness
and is a two time winner of the prestigious Australian Design Award (1992 and
1996) and a winner of the Australian Design Mark (1996). The Australian Design
Mark and the Australian Design Award are awarded by Standards Australia, an
independent not-for-profit organization which utilizes industry and design
experts to evaluate products for excellence. To attain the Australian Design
Mark, a product must achieve excellence in four key areas: (i) the design
process; (ii) the product; (iii) the manufacture of the product; and (iv) the
product lifecycle. Generally, a product must first achieve the Australian Design
Mark to be eligible to receive the Australian Design Award. In special
circumstances products that are innovative and original in design can achieve
the Australian Design Award without first receiving the Australian Design Mark.
Due to its innovative design, in 1992 the SecurityGuard alarm received the
Australian Design Award prior to receiving the Australian Design Mark. In 1996,
the SecurityGuard alarm was one of 37 products to achieve the Australian Design
Mark, and thereafter was one of eight products to achieve Australian Design
Award status in that year.
The SecurityGuard System installed by the Company is a wireless alarm
system, which uses radio signals from transmitters incorporated into the
protective devices to communicate activation signals from such devices to the
customer's CPU. By comparison, hard-wire devices, which are characterized by
substantially higher initial costs to the customer, use actual wires to connect
each of the protective devices to the customer's CPU. Wireless devices can
generally be installed more simply and quickly than those that require alarm
wiring, thus reducing labor costs. In addition, wireless devices are also easy
to remove and reinstall when a customer relocates to a new residence.
The Company's monitored SecurityGuard alarm provides protection to the
premises through interior heat sensitive motion detectors, and a CPU, which
communicates signals to the Company's designated central monitoring station. The
SecurityGuard System also features the ability to arm and disarm the alarm via a
wireless remote control device which also acts as a panic button. The remote
control feature of the SecurityGuard System helps differentiate the Company's
alarm from those of its competitors whose alarm systems generally require the
input of a security code into a keypad to arm and disarm the alarm. The Company
has historically, included within
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the cost of each SecurityGuard System a one-year limited warranty on system
parts and labor. With the introduction of the On Line Monitoring Program the
Company has extended its limited warranty to two years.
The SecurityGuard alarm is molded in an extruded polycarbonate casing
and features double soldered circuitry, a sealed independent power source,
battery back up and automatic testing of battery power supply. It is radio
controlled by compact waterproof wireless keys, which incorporate a proprietary,
dedicated encryption algorithm in the transmission signal. This ensures that the
digital wireless code cannot be copied and replayed to compromise the system
through the use of "code-grabbers". In addition the wireless signals between the
main unit and remote detectors are fully supervised and the batteries are
checked under load automatically for maximum security. The SecurityGuard alarm
has a security key override switch and a 120 decibel (at 1 meter) horn speaker
installed within the alarm. The alarm features infrared detection cells that
respond effectively to body temperature, remote controls and a tuner set to
optimum range, signal and strength. The alarm's volume is deliberately set at a
level that causes extreme discomfort to human beings and should result in the
invader leaving the premises. In addition, the volume of the alarm is sufficient
to alert not just the home's residents, but also their neighbors, increasing the
likelihood that the invader will be seen and apprehended. The alarm reacts
instantaneously on detecting an intruder, reducing the intruder's ability to
search for or remove valuables. The SecurityGuard System complies with the
relevant Australian/NZ Standards for alarm system manufacture, AS2201.1/5. The
system carries guarantees of quality and service on terms and conditions
comparable to others in the industry. Peripheral products for SecurityGuard
alarm include wireless passive infra red detectors, wireless reed switches,
wireless vibration sensor and a wireless dialer which is used for communicating
two way alarm signals to a Central Monitoring Station via a telephone line.
Services
On-line Monitoring and 24 Hour Emergency Response Services. The
Company began selling twenty-four hour on-line monitoring services as an upgrade
to its Australian and New Zealand customers during the second half of the fiscal
year ended June 30, 1999. As at June 30, 2000, the Company had installed
approximately 9,700 monitored lines as upgrades for its existing customers in
Australia and New Zealand. The Company commenced selling on-line monitoring
services as part of its point of sale products and services to new customers in
Australia and New Zealand in September 1999. As of June 30, 2000, the Company
had installed approximately 6,400 monitored lines as part of its point of sale
for new customers in Australia and New Zealand. The Company is currently
outsourcing the monitoring services in Australia and New Zealand to a central
station in Sydney, Australia that utilizes advanced communications and computer
systems to route incoming alarm signals and telephone calls to operators.
Depending on the type of service chosen by the customer, central monitoring
personnel will respond to alarms by relaying information to local security
patrols or police departments, notifying the customer or taking other
appropriate action. Non-emergency administrative signals will include power
failures, low battery signals, deactivation and reactivation of the alarm
monitoring system, and test signals, and will be processed automatically by
central monitoring station computers. Historically, the Company offered twenty-
four hour emergency response service to its customers as part of its
SecurityGuard System for five years from the date of installation free of
charge. As part of this service the Company contracts with local security patrol
services to send personnel to a residence upon telephonic notification that an
alarm has sounded. With the introduction of the On-Line Monitoring Program the
Company has continued to offer this service to verified alarm notifications.
Extended Warranty. In September 1996, the Company commenced offering
an extended warranty program to its customers in Australia and New Zealand,
which offers customers the opportunity to extend the original manufacturers
product warranty of historically twelve months (currently twenty-four months) by
an additional twelve or twenty-four months. The average cost of the extended
warranty to the customer is AUD $99 for twelve months and AUD $169 for twenty-
four months. The extended warranty contract covers all costs of repairs and
labor during the contract period. The Company had approximately 30,181
outstanding extended warranty contracts at June 30, 2000. The percentage of
contracts divided between twelve and twenty-four-month contracts were 29% and
71% respectively. The income derived from the sale of extended warranty
contracts is recognized proportionately over the period of each contract.
Installation And Field Services. Each distribution office is required
by the Company to maintain its own installation and field service personnel.
Distributors subcontract services and installation to third parties who are
trained by the Company to install and maintain the SecurityGuard System.
Installations of new systems are performed promptly after the completion of the
sale. After completing an installation, the technician instructs the
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customer on the use of the system and furnishes a written manual and, in many
instances, an instructional video. In order to demonstrate its commitment to
customer service, the Company also requires each technician to clean up all
debris caused by the installation of the system before completing the
installation as well as offering to perform any other minor maintenance work for
the customer. Additional follow-up instruction is provided by Independent Agents
as needed.
Sales and Marketing
The Company's business success is dependent upon the continued
successful implementation of its Direct Sales Marketing Program by its
Distributor Network. The Direct Sales Marketing Program is a systematic approach
to selling the SecurityGuard System through low cost lead generation, door to
door selling, telemarketing and in home sales appointments. The program focus is
on middle income families and retirees, a market which the Company believes has
been historically underserved by the security alarm industry. Sales leads are
generated using various methods, including referrals from in home sales
appointments, shopping center "drop box" promotions and the collection of crime
awareness and fire safety surveys conducted in shopping malls and in targeted
neighborhoods. These leads are then utilized to set up in home sales
appointments, during which the sales representatives make a crime awareness and
fire safety presentation and then demonstrates the functionality of the
SecurityGuard System. In order to increase the effectiveness of its Direct Sales
Marketing Program, the Company requires participants in its Distributor Network
to regularly participate in comprehensive training seminars developed by the
Company relating to all aspects of its Direct Sales Marketing Program. The
Company believes that its Direct Sales Marketing Program represents a
competitive advantage over other security alarm companies.
The Distributor Network is responsible for all marketing of the
SecurityGuard System. The Company does not generally use media advertising to
promote the SecurityGuard System, instead it relies on the Independent Agents to
generate leads. The Independent Agents solicit sales leads from every in-home
appointment, as well as through shopping mall "drop box" promotions and the
collection of crime awareness and fire safety surveys. In exchange for
completing a survey or participating in a promotion, individuals are given a
chance to win a free SecurityGuard System. Telemarketers contact individuals who
respond to these efforts and make appointments for home visits by Independent
Agents. Each individual who hosts an in-home sales appointment, regardless of
whether the individual makes a purchase, receives a valuables register, a book
containing crime, fire and general home safety tips and a personal attack alarm.
The Company's sales and marketing approach stresses three aspects of the
SecurityGuard System: deterrence, detection and ejection. The Company believes
that the mere existence of a security alarm system in a home deters burglars and
home invaders from attempting entry. The features of the SecurityGuard System
are aimed at detecting any unauthorized access. Once activated, the alarm is
designed to provoke a quick flight response by the intruder, preventing a
burglary or, at a minimum, minimizing the loss. During the in home presentation,
the Independent Agent presents a mounted display of the alarm and related
equipment and describe its features. Furthermore, the Independent Agents use the
in-home presentation to educate the consumer with regard to the crime level of
the area and the utility of the SecurityGuard System in dealing with crime and
in reducing danger and losses to the property.
The Company believes the utilization of these selling methods is an
effective means of generating quality leads and a high frequency of in-home
sales appointments from such leads. By focusing on persons who participate in
its promotions and surveys, and confirming the individuals' continued interest
through follow-up telephone contact to arrange in-home appointments, the
Distributor Network identifies those persons most likely to respond favorably to
its sales efforts. The Company also believes that by making sales to multiple
homes in a neighborhood and increasing crime awareness in the neighborhood,
crime prevention synergies and additional sales opportunities are achieved as
neighbors begin to work together to minimize crime. While the Company's sales
approach relies on an emotional response from the potential customer, the
Company maintains an active training and compliance program to deter abusive
sales practices and to ensure that the Independent Agents do not use a high-
pressure approach to increase unit sales.
Customer Service. In 1995, the Company implemented its "We Care"
customer satisfaction program. The We Care program consists of a number of
measures intended to maximize customer satisfaction, including an annual survey
of customers, periodic awards to participants in the Distributor Network who
maintain superior customer satisfaction, and the installation of a toll-free
number which customers can call with any questions or complaints. The We Care
program also includes a total quality management program through which the
Company analyzes and
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documents all processes critical to customer satisfaction, including sales,
installations, monitoring, billing and customer service. The Company then
implements improvements and continually updates the analysis process.
Distributor Network
The Distributor Network is a structured sales hierarchy of Independent
Agents, Trainee Distributors and Distributors who are compensated solely on the
basis of sales of the Company's SecurityGuard Systems. The Company believes that
it possesses an advantage over other direct sales companies since advancement
through the Distributor Network is based exclusively on the participant's
success in sales of the Company's products, rather than recruitment of other
sales representatives. The Independent Agents, who are the entry level
participants in the Distributor Network, are motivated by an attractive sales
commission structure, as well as the opportunity to become Trainee Distributors
who own and operate their own distribution business. Independent Agents are
promoted based on a proven ability to sell the Company's products over a defined
period of time. Each Trainee Distributor purchases products from their
Distributor for resale to end users through Independent Agents who operate out
of their offices. Successful Trainee Distributors, in turn, can become
Distributors who earn a commission override on sales by the Company made to
their attributed Trainee Distributors as well as continuing to earn profits on
the sales made by their distribution business. The Company believes that the
Distributor Network, in addition to offering a potential for substantial
individual compensation and profit, is an effective motivational tool which
emphasizes peer ranking and recognition in order to improve sales performance.
The Company also believes the Distributor Network gives it a significant
strategic advantage over its competitors by limiting the capital investment
needed to grow the Company, since its Trainee Distributors and Distributors are
responsible for most costs associated with running their distribution businesses
(including all recruitment, agent commissions, telemarketing and SecurityGuard
System installation costs). The following is a description of each tier of the
Distributor Network.
Level 1--Independent Agent and Field Service Managers. The majority of
the sales personnel within the Distribution Network are Independent Agents who
contract directly with Distributors and Area Distributors. Independent Agents
are compensated solely by commissions paid by the Area Distributors or
Distributors on SecurityGuard System sales made by the Independent Agent. The
Independent Agents primary responsibilities include the generation of leads and
the delivery of scripted in home sales presentations to potential customers.
Every prospective Independent Agent starts as an agent in training and goes
through the Company's training program, which includes accompanying existing
Independent Agents on in home sales presentations prior to becoming an
Independent Agent. For an Independent Agent to be promoted to a Trainee
Distributor he/she is required to achieve a predetermined level of sales over a
specified period and must successfully complete a course in trainee
distributorship operation. As of June 30, 2000, the Company had 270 Independent
Agents (including 60 agents in training). Historically, the Company has also
utilized "Dealers" to sell the SecurityGuard System to the public. As of
September 1, 2000 the Company has replaced dealers with Field Sales Managers.
Field Sales Managers operate out of a Distributor's or a Trainee Distributor's
office, under the supervision of the Distributor or Trainee Distributor, as the
case may be. Field Sales Managers primary role is to take one sales agent each
night to observe the Field Sales Managers presentations, in order to provide a
continual training platform for independent agents. Field Sales Managers like
Independent Agents, are compensated solely by commissions on SecurityGuard
Systems sold. In addition Field Sales Managers earn a bonus commission upon
reaching pre-determined sales target and are paid an override on sales made by
the agents who accompany the Field Sales Managers on presentations.
Level 2--Trainee Distributors. Trainee Distributors sell the
SecurityGuard System to the public utilizing the Independent Agents and Field
Sales Managers as their sales representatives. Trainee Distributors own and
operate their own offices and are responsible for most costs associated with the
implementation of the Direct Sales Marketing Program within their assigned area,
including telemarketing, lead generation and recruitment. Independent Agents and
Field Sales Managers operate from the Trainee Distributor's premises and are
paid commissions by the Trainee Distributor based on their sales of
SecurityGuard Systems. Effective September 1, 2000, the Trainee Distributors
purchase the SecurityGuard Systems from their Distributors, and their
compensation is the profit earned from the sales of the SecurityGuard Systems
less the payment of (i) commissions to Independent Agents, (ii) the cost of the
SecurityGuard System and (iii) operating expenses (including recruiting,
telemarketing and installation costs). There is no limit to the number of
Independent Agents and Field Sales Managers that can operate out of a Trainee
Distributor's office. For Trainee Distributors to be promoted to Distributors,
they are required to achieve a predetermined level of sales within a specified
period and then maintain these levels of sales in the future. Trainee
Distributors must also successfully complete a course in advanced
distributorship operation. As
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of June 30, 2000, the Company had thirty-eight Trainee Distributors, including
nine in markets outside of Australia and New Zealand.
Level 3--Distributors. Distributors, with support from the Company,
are responsible for ensuring that Independent Agents are motivated and
proficient in all aspects of direct sales by, among other items: (i) ensuring
all new Independent Agents go through a specified training program which
includes proficiency tests, video taping and "on the job" observation and
critical analysis; (ii) organizing major conferences annually, as well as
running weekly internal training seminars; (iii) professionally videotaping
major training conferences and seminars; (iv) professionally recording
teleconferences of meetings where Distributors discuss topics on business
enhancement, such as lead generation; (v) running reward programs for the
introduction or recruitment of new staff members; and (vi) recognizing and
rewarding other staff for securing new customers. Distributors purchase Security
Guard Systems directly from the Company and are compensated in a manner similar
to the Trainee Distributors although they also make an additional gross profit
when selling the Security Guard Systems to their Trainee Distributors.
Independent Agents and Field Sales Managers working under a Distributor are paid
the same commission structure as those working under a Trainee Distributor. As
of June 30, 2000, the Company had seventeen Distributors, including two in
markets outside of Australia and New Zealand.
Manufacturing
On April 9, 1999, the Company completed its purchase of Ness Security
Products Pty Limited ("Ness"), a leading designer and manufacturer of security
alarm products in Australia and the Company's sole supplier of its SecurityGuard
alarm. Ness was founded in 1972 and has been the Company's sole supplier of its
SecurityGuard alarm since 1989.
Ness manufactures approximately 70 types of circuit boards and 160
different finished goods including its (i) SecurityGuard alarm, (ii) Medi-Alarm,
a personal alarm that notifies an attendant when the user requires assistance,
specifically designed for aged and immobile residents of retirement communities
and nursing homes; (iii) D 8 Dialer Security Alarm Panel, a traditional
electricity-based security alarm system designed for commercial and residential
markets that utilizes a dialer to call a central monitoring station and features
eight fully programmable zones, programmable siren, radio interface and secure
remote arming/disarming capabilities; (iv) Quantum Dual, a leading security
alarm detector which combines a passive infra-red sensor and a doppler microwave
to detect intruders far more reliably than conventional detectors. Quantum Dual
also utilizes a microprocessor and has a special anti-creep zone lens that
detects human movement directly below the lens where most detectors are "blind";
and (v) other sensor detector products, including "Nessensor", an advanced high
frequency vibration sensor for traditional residential and commercial security
system installations. Ness has an accomplished research and development staff
and an ISO 9001 certified computer board manufacturing facility that utilizes
state-of-the-art surface mount technology. Ness employs the latest in advanced
manufacturing techniques and leading edge technology in order to maintain its
production of high quality security alarm products including the SecurityGuard.
The manufacturing process begins on either one of Ness' two Surface Mount lines,
where the components are placed by high speed placement machines on printed
circuit boards, are bonded, then conveyed into a Heller Reflow Oven. Any
components too large for machine placement are hand inserted, before the fully
loaded circuit board enters the Nitrogen Wave Soldering Machine for completion.
The board is then inspected and tested on a Flying Probe Tester, where it is In-
Circuit tested, for correct component placement, prior to having a full
functional test (average first time pass rate is approximately 97-98%), before
it enters final assembly and packaging. The average monthly printed circuit
assembly production for Ness is currently 30,000 boards.
The Company believes that Ness currently has excess manufacturing
capacity that may allow Ness to provide contract manufacturing services for
third parties until such time as the Company requires all of Ness' manufacturing
capacity.
Ness's main office is located in Sydney, Australia, and Ness has
distribution offices in each of Melbourne, Perth and Brisbane. Ness also
maintains an office in Hong Kong. As of June 30, 2000, Ness had 121 employees in
Australia and 5 employees in Hong Kong.
Subsequent to June 30, 2000 the Company agreed to sell 49% of Ness to
HIH Insurances for $AUD17.5 Million. The proceeds of the sale will be used to
retire short-term debt and long-term debt of $AUD13 Million and to provide
liquidity for operating activities.
<PAGE>
FAI Finance Corporation Pty Limited. ("FFC").
On December 31, 1997, the Company purchased 50% of the issued and
outstanding shares of FFC (the "FFC Shares") from FAI Insurances Limited
("FAI"). FFC is a consumer and business finance company which specializes in the
provision of consumer credit, primarily to purchasers of the SecurityGuard
System through sales finance arrangements with the Company and participants in
the Distributor Network, and also through personal loan and insurance products
which are not currently related to the Company's business.
Effective March 31, 2000, the Company, through its wholly-owned
subsidiary FAI Home Security Pty. Limited ("FHS"), sold its 50% interest in FFC
to FAI for approximately $8,117,567 (the "FFC Sale"). On April 7, 2000, FAI paid
FHS $2,400,000, the remainder of the FFC Sale price was paid on or about April
26, 2000. FAI, which owns approximately 47% of the common stock of the Company,
is a wholly owned subsidiary of HIH Insurance Limited ("HIH").
In connection with FHS's purchase of FFC in Fiscal 1997, FAI provided
FHS with vendor financing, approximately $4,439,175 of which remained
outstanding at the time of the FFC Sale (the "FAI Note"). Pursuant to the terms
of the FFC Sale, FAI agreed to extend the payment terms of the FAI Note,
guaranteed by a security interest in Ness Security Products Pty. Ltd. ("Ness").
Upon receipt of the proceeds of the FFC Sale, the Company paid to Integrated
Investments Limited ("IIL") $8,200,000 in full settlement of the $8,298,000 due
to IIL as of June 30, 2000 (the "IIL Payment"). The decrease in the amount paid
versus that owed as of March 31, 2000 reflects a discount for the time value of
money. To the extent that the proceeds from the FFC Sale were insufficient to
pay IIL in full, FAI lent the shortfall to FHS and added that amount to the FAI
Note which accrues annual interest at the rate of 7.75% per annum and requires
monthly payments of principal and interest over sixty months.
Competition
The security alarm industry in the markets in which the Company
operates is highly competitive and fragmented. The Company competes with
numerous other companies for new customers. The Company's major competitors for
first-time purchasers of alarm systems in Australia and New Zealand are
Signature Security and ADT Security Services, Inc. Competition for new accounts
is based primarily on purchase price, monthly monitoring fee, the range of
services offered, and reputation for quality. The Company believes it has a
superior marketing strategy because of its focus on underserved markets and the
implementation of the Direct Sales Marketing Program to the end user through the
Distributor Network. There is no assurance that the Company will continue to
have a competitive advantage in the Australian and New Zealand markets. The loss
of any competitive position by the Company in either Australia or New Zealand
could have a material adverse effect on the Company.
In marketing the SecurityGuard System outside of Australia and New
Zealand, the Company faces competition from large national and international
alarm installation and monitoring companies. Many of those companies are better
capitalized than the Company and often offer low-priced installations of
security systems, which may adversely affect the Company's ability to
successfully penetrate and compete in such markets using a similar marketing and
sales strategy that it uses in Australia and New Zealand.
Trademarks and Intellectual Property
The Company operates under the registered Company name "FAI Home
Security" in Australia, New Zealand, North America, Europe and South Africa. The
Company's License Agreement with FAI Insurances permits it to use the "FAI" name
and logos on a royalty free, non-exclusive, non-transferable basis. The License
Agreement has a perpetual term and will terminate only upon breach by the
Company.
Upon acquiring Ness Security Products Pty Limited the Company obtained
over ten trademarks relating to Ness Security Products Pty Limited's products.
While the Company obtains trademarks as appropriate and considers certain of its
trademarks valuable, it does not believe any one of them by itself is crucial to
the successful conduct of its business. The Company relies on a combination of
patent, trademark registrations, copyrights and confidentiality agreements to
protect its intellectual property.
<PAGE>
Government Regulation
The Company's operations in Australia and New Zealand, as well as its
other worldwide operations, are subject to a variety of laws, regulations and
licensing requirements of federal, state and local authorities. In certain
jurisdictions, the Company is required to obtain licenses or permits prior to
the commencement of operations, and the Company may also be required to comply
with standards governing employee selection and training, and to meet certain
standards in the conduct of its business. Many jurisdictions also require
certain of the Company's employees to obtain licenses or permits.
The alarm industry is also subject to requirements imposed by various
insurance, approval, licensing and standards organizations. Depending upon the
type of customer served, the type of security service provided and the
requirements of the applicable local governmental jurisdiction, adherence to the
requirements and standards of such organizations is mandatory in some instances
and voluntary in others. In most countries, the Company's advertising and sales
practices are regulated by various consumer protection laws. Such laws and
regulations include restrictions on the manner in which the Company promotes the
sale of its security alarm systems and require the Company to provide purchasers
of its alarm systems with certain rescission rights.
Our alarm monitoring business utilizes telephone lines and radio
frequencies to transmit alarm signals. The cost of telephone lines, and the type
of equipment, which may be used in telephone line transmission, are currently
regulated by federal governments, state governments or both in Australia, New
Zealand and the United States of America. The operation and utilization of radio
frequencies are also regulated by federal governments, state governments or
both. In addition, the laws of certain of the other foreign jurisdictions in
which the Company operates, regulate the telephone communications with the local
authorities.
Recently, a trend has emerged on the part of local governmental
authorities to adopt various measures aimed at reducing the number of false
alarms. Such measures include (i) subjecting alarm monitoring companies to fines
or penalties for transmitting false alarms, (ii) licensing individual alarm
systems and the revocation of such licenses following a specified number of
false alarms, (iii) imposing fines on alarm customers for false alarms, (iv)
imposing limitations on the number of times the police will respond to alarms at
a particular location and (v) requiring further verification of an alarm signal
before the police will respond. See "Risk Factors-- Government Regulation".
Employees
At August 21, 2000, the Company employed 246 individuals, including 6
on a consultancy basis, 216 on a full-time basis, 5 on a part-time basis and 19
on an hourly basis. Currently, 53 production employees of Ness Security Products
Pty Limited fall under the award of the Australian Industry Group. None of the
Company's other employees are represented by a labor union or covered by a
collective bargaining agreement. The Company believes it has an excellent
relationship with its employees.
During July and August 2000 the Company made 33 staff reductions as
part of cost control initiatives, reducing the total employees from 279 to 246.
Safe Harbor Statement Under The Private Securities Litigation Reform Act of 1995
This filing contains certain forward-looking statements and
information within the meaning of Section 27A of the Securities Act of 1933, as
amended (the "Securities Act") and Section 21E of the Securities Exchange Act of
1934, as amended (the "Exchange Act"), that are based on beliefs of, and
information currently available to, the Company's management as well as
estimates and assumptions made by the Company's management. When used in this
filing, words such as "anticipate," "believe," "estimate," "expect," "future,"
"intend," "plan" and similar expressions as they relate to the Company or the
Company's management, identify forward-looking statements. Such statements
reflect the current views of the Company with respect to future events and are
subject to certain risks, uncertainties and assumptions relating to the
Company's operations and results of operations, competitive factors and pricing
pressures, shifts in market demand, the performance and needs of the residential
security alarm industry, the costs of product development, currency fluctuation
as identified more fully below and other risks and uncertainties including, in
addition to any uncertainties specifically identified in the text surrounding
such
<PAGE>
statements, uncertainties with respect to changes or developments in social,
economic, business, industry, market, legal and regulatory circumstances and
conditions and actions taken or omitted to be taken by third parties, including
the Company's stockholders, customers, suppliers, business partners,
competitors, and legislative, regulatory, judicial and other governmental
authorities and officials. Should one or more of these risks or uncertainties
materialize, or should the underlying estimates or assumptions prove incorrect,
actual results or outcomes may vary significantly from those anticipated,
believed, estimated, expected, intended or planned. Such factors include, but
are not limited to, the risks identified above and the risks detailed under the
caption "Risk Factors" below or otherwise described herein or detailed from time
to time in the Company's other filings made with the Securities and Exchange
Commission.
Risk Factors
THE FOLLOWING RISK FACTORS SHOULD BE CONSIDERED CAREFULLY IN ADDITION
TO THE OTHER INFORMATION IN THIS REPORT ON FORM 10-K IN EVALUATING THE COMPANY
AND ITS BUSINESS.
Continuing Losses; Negative Cash Flows.
As reflected in the Company's financial statements, the Company has suffered a
significant reduction in revenues during the year ended June 30, 2000, resulting
in a net operating loss of $11,109,879. Such losses have been accompanied by a
reduction in the Company's cash position from $2,976,240 at the end of Fiscal
1999 to $1,394,133 at the end of Fiscal 2000. Both the continuing losses and the
present cash position have impaired the Company's ability to fund current
operations. This raises substantial uncertainty about the Company's ability to
continue as a going concern. Subsequent to June 30, 2000, management has entered
into a transaction to sell 49% of Ness - the Company's manufacturing operation.
The future success of the Company is dependent on it utilizing the proceeds
received from this sale to achieve increased sales volumes and a reduction in
expenses. While the Company believes the cash raised from the sale of Ness will
be sufficient to finance the changes needed to achieve the sales targets
forecasted and therefore continue as a going concern, there is no certainty as
to whether the proceeds of the Ness sale will be sufficient to fund current
operations or that the predicted level of sales activity will be achieved. See
Notes to Consolidated Financial Statement, Notes 9, 21 and 22.
History of Decrease in Security Alarm Sales. The Company has
experienced significant decreases in its security alarm sales for the past
fiscal year. While the Company has taken a number of measures to increase its
revenues from the sale of security alarms there can be no assurance that these
measures will succeed or that the Company will become profitable. Furthermore,
as it is difficult to predict the success of the Company's new sales strategy,
which focuses on monitoring services, historical results should not be relied
upon as an indication of future performance. As the Company's current level of
monthly unit sales is insufficient to generate positive cashflow from operations
the Company must obtain additional external funding. There is no guarantee that
the Company will obtain additional external funding. The lack of such external
funding could have a material adverse effect on the Company's operations,
liquidity and financial position.
Risk of International Expansion. Although the Company's sales
historically have been generated in the Australian and New Zealand markets, the
Company has initiated expansion programs in Europe, South Africa and North
America. There can be no assurance that the Company will be able to market, sell
and deliver its products and services successfully in these new markets. A key
component of the Company's strategy is deployment of its Direct Sales Marketing
Program in markets outside of Australia and New Zealand through its Distributor
Network. Although the Company believes that the implementation of the
Distributor Network in those markets limits the Company's costs related to
expansion, the Company is still required to bear certain start-up costs when
entering new markets, including costs related to obtaining regulatory approval
of the SecurityGuard System and other pre-operational start-up costs. The
expenses associated with establishing the Distributor Network in new markets
during any period may substantially affect the Company's operating results
during that period. Furthermore, there can be no assurance that the Direct Sales
Marketing Program and the Distributor Network will be successful in other
markets. In addition, for the Company to expand successfully into a new market,
the Company must obtain a sufficient number and density of customers in that
market to support the additional investment made by the Company, and establish a
relationship with a local financing company that will finance the purchase of
products by customers. There can be no assurance that the required customer
numbers and density in any new market will be achieved or that a relationship
with a local financing company in that market will be established. If the
revenues generated by the Company in new and existing markets are not sufficient
to offset the expense of establishing and maintaining the infrastructure to
facilitate expansion of international operations, the Company's business,
operating results and financial condition could be materially adversely
affected. The Company is also subject to certain risks inherent in operating
globally, including international monetary conditions, tariffs, import licenses,
trade policies, domestic and foreign tax policies and foreign manufacturing
regulations. Furthermore, varying climatic conditions in countries in which the
Company operates or intends to commence operations may affect the performance of
the alarm system, thereby requiring modification of its design.
Dependence on Consumer Financing. For the fiscal year ended June 30,
2000, approximately 80% of the sales of SecurityGuard Systems by participants of
the Distributor Network to consumers were financed on an installment basis.
Historically, the Company's distributors in Australia and New Zealand have the
option of offering potential consumers financing from FFC or other financing
organizations. In each of the other markets in which the Distributor Network
operates, the Company has arranged for a local financing company to make
financing available
<PAGE>
to purchasers in the market. With the introduction of the On Line Monitoring
Program almost all sales of the SecurityGuard System will involve the
utilization of financing to factor the monthly installment receivables. The
availability of finance in new international markets and the continued
availability of finance in existing markets will be a significant factor in
determining whether the Company will succeed in these markets. Any changes in
interest rates or credit quality requirements or lending practices of financing
organizations may adversely affect sales of the Company's products and therefore
have a material adverse effect on the Company. There can be no assurance that
financing will be available on terms which are attractive to consumers and
suitable for the Company's operations.
Currency Fluctuations and Duty Rates. Although the Company's principal
operations are concentrated in Australia and New Zealand, it conducts operations
throughout the world. Accordingly, the Company's financial performance could be
adversely affected by fluctuations in currency exchange rates as well as changes
in duty rates. Furthermore, as the Company reports its financial results in U.S.
dollars, a significant movement in the value of the U.S. dollar against certain
international currencies, particularly the Australian dollar ("AUD"), could have
a material adverse effect on the Company's reported financial position and
results of operations. The AUD has declined in value relative to the U.S. dollar
from .6567 on June 30, 1999 to a low of .56450 during the fiscal year ended June
30, 2000 and as of September 29, 2000 was valued at .5415 as compared to the
U.S. dollar. 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.
Management of Growth. An important element of the Company's business
strategy has been and continues to be the maintenance and growth of its
Distributor Network beyond its present base of operations. The development of
new growth strategies has placed and will continue to place substantial demands
on the Company's management, operational resources and system of financial
controls. The Company's future operating results will depend in part on the
Company's ability to continue to implement and maintain operating and financial
systems and to expand, train and manage its employees and members of its
Distributor Network. Additionally, management of growth may limit the time
available to the Company's management to devote to other operational, financial
and strategic issues. There can be no assurance that the Company will
successfully implement and maintain the necessary operational and financial
systems or successfully obtain, integrate and utilize the personnel, management,
operational and financial resources required to manage a developing and
expanding business in new markets. Failure to implement such systems
successfully and use such resources effectively could have a material adverse
effect on the Company's results of operations and financial condition.
Government Regulation. The Company must receive approval from the
various regulatory and licensing authorities for each country, state and local
area in which it operates. The Company may be required to obtain formal approval
to operate the Direct Sales Marketing Program and for the construction, design,
functionality, acceptability or merchantable quality of the SecurityGuard
System. The time that it takes to secure these approvals in any market will
affect the Company's growth and ability to establish a presence in such markets.
In certain jurisdictions, the Company has been required to obtain licenses or
permits prior to the commencement of operations. The loss of such licenses or
permits, or the establishment of conditions to the granting or retention of such
licenses or permits, could have a material adverse effect on the Company. In
certain jurisdictions the Company may also be required to comply with standards
governing employee selection and training, and to meet certain standards in the
conduct of its business. Although the Company believes that it is presently in
substantial compliance with all licensing and regulatory requirements in each
jurisdiction in which it operates, there can be no assurance the Company will be
able to secure the necessary regulatory approvals in all of the countries or
smaller geographic areas in which it seeks to operate or that it will continue
receiving regulatory approvals for its existing activities. Recently, a trend
has emerged on the part of local governmental authorities to adopt various laws
and regulations aimed at reducing the number of false alarms. Enactment of such
measures could have a material affect on the Company's future business and
results of operations.
Dependence On Key Management Executives. The success of the Company's
business is largely dependent upon the active participation of Bradley D. Cooper
and other executive officers. The loss or interruption of the continued services
for any reason of one or more of the Company's key officers or the inability of
the Company to hire or retain qualified executives may have a material adverse
effect on the Company's business. Although Mr. Cooper's principal occupation is
as the Company's Chief Executive Officer, he has significant interests in other
<PAGE>
operating companies, and periodically gives speeches and writes articles on
sales motivation techniques. The Company has "key-man" life insurance policies
on Mr. Cooper of $3.3 million.
Recruitment of Independent Agents. The Company is dependent on the
continued recruitment of new Independent Agents to serve as sales agents for the
Distributor Network. The Distributor Network faces competition in the
recruitment of sales agents from other organizations, some of which are not in
the security alarm industry. The Company's ability to maintain or increase its
sales growth in the future will depend in part upon the number and quality of
Independent Agents that the Distributor Network can recruit and the Company can
train. There can be no assurance that a sufficient number of Independent Agents
will be recruited or retained by the Distributor Network.
Competition. The security alarm industry in each market where the
Company operates is highly competitive and there can be no assurance that the
Company will be able to compete successfully in the future. Although the Company
had previously achieved rapid growth in the sale of the SecurityGuard System in
Australia and New Zealand, it has in the last fiscal period suffered a
significant decline in unit sales. There is no assurance that the Company will
again achieve sales success in these countries. In marketing the SecurityGuard
System outside Australia and New Zealand, the Company competes with larger
national and international companies who may be better capitalized and who
conduct media advertising, which the Company does not currently utilize. In the
United States, the Company faces competition from alarm installation and
monitoring companies which are better capitalized than the Company and which
offer low-priced installations of security systems. Competitive pressure may
require the Company to reduce its prices to achieve the unit sales growth rate
it requires. Furthermore, new competitors are continuing to enter the industry
and the Company may encounter additional competition from such future industry
entrants.
Quarterly Variations In Operating Results. The Company has
historically experienced fluctuations in its quarterly operating results and
expects to experience fluctuations of its quarterly operating results in the
future. These fluctuations have been caused by many factors, including, among
others, the opening and closing of distributor offices, the volume and timing of
customer generation, competitive pricing pressures, local and national crime
rates in the markets in which the Distributor Network operates, general economic
conditions, foreign currency fluctuations and seasonality. The Company's sales
can be hampered by unfavorable weather conditions, holidays and reduced hours of
daylight. The Company's budgeted expenses are based, to some extent, on its
expectations of future sales and customer growth. The Company may be unable to
adjust spending in a timely manner to compensate for any unexpected revenue
shortfall due to levels of new sales that are lower than anticipated. Given the
possibility of quarterly fluctuations, the Company believes that comparisons of
the results of its operation for preceding quarters are not necessarily
meaningful and that the results for any one quarter should not be relied upon as
an indication of future performance. In the event that the Company's revenues or
operating results for any quarter are lower than expected by securities analysts
or the market in general, such shortfall could have an immediate and significant
adverse impact on the market price of the Company's Common Stock.
Geographic Concentration. Sales in Australia and New Zealand for the
fiscal years ended June 30, 1998, June 30, 1999 and June 30, 2000 accounted for
approximately 87%, 86% and 79%, respectively, of the Company's total unit sales.
The Company expects that sales in Australia and New Zealand will continue to
account for a significant portion of the Company's net sales in the future. The
performance of the Company may be adversely affected by any change in regional
economic conditions in Australia and New Zealand or other factors affecting
these markets.
Product Concentration. To date, sales of the SecurityGuard System and
related services accounted for substantially all of the Company's sales, and
will continue to account for substantially all sales in the foreseeable future.
Decline in the demand for this product, whether as a result of competition,
technological change or otherwise, would have a material adverse effect on the
Company's business, financial condition and results of operations.
Risks of Liability. Most of the alarm installation agreements and
other agreements pursuant to which the Company and the Distributor Network sell
the SecurityGuard System and related services contain provisions and disclaimers
limiting liability to customers. These provisions and disclaimers are intended
to reduce the risk of liability to the Company for the acts or omissions of
employees or Distributor Network representatives and for
<PAGE>
system failures. However, in the event of litigation with respect to such
matters, there can be no assurance that these liability limiting provisions and
disclaimers will be enforceable. While the Company currently carries insurance
of various types, including general liability and errors and omissions
insurance, the loss experience of the Company and other security service
companies may affect the availability and cost of such insurance in the future.
Certain of the Company's insurance policies and the laws of some jurisdictions
may limit or prohibit insurance coverage for punitive or certain other types of
damages, or liability arising from gross negligence or wanton behavior. The cost
and effect of litigation could have a material adverse effect on the Company.
Adverse Publicity. Direct sales companies are occasionally the subject
of print articles and broadcast programs which present a negative view of such
companies and that emphasize their use of high-pressure sales practices.
Although the Company maintains an active training and compliance program to
deter abusive sales practices by the participants in the Distributor Network,
the Company and the Distributor Network occasionally have received adverse
publicity. The Company has been the subject of isolated news articles accusing
its sales agents of high pressure sales practices including focusing on
customers' fears by using photographs of burglarized homes to encourage
purchases of the SecurityGuard System, and for charging above market financing
rates to consumers who cannot afford the product. Publicity of this nature could
have a material adverse affect on the Company's sales and earnings. See Item 3.
Legal Proceedings.
Limitations on Enforceability of Judgments. A substantial portion of
the assets of the Company are, and for the foreseeable future will be, located
outside the United States. In addition, all or a substantial portion of the
assets of directors, executive officers and experts residing outside the United
States are or may be located outside of the United States, primarily in
Australia. As a result, it may not be possible to effect service of process in
the United States on such directors and executive officers, such experts or on
the Company's subsidiaries or to enforce, collect or realize upon, judgments
against such persons obtained in United States courts which are predicated upon
civil liability under United States securities laws. The Company has been
advised by its special Australian counsel, Dibbs, Crowther & Osborne, that there
are doubts as to the enforceability of civil liabilities imposed by United
States courts and as to the ability of stockholders to pursue in Australian
courts claims based on the contents of this Prospectus or otherwise predicated
on United States federal securities laws against the Company or its directors,
executive officers and experts.
Foreign Taxation. Because the Company is a United States corporation
which generates substantially all of its income from non-U.S. operations, its
income will generally be subject to taxation in different jurisdictions. Certain
operations of the Company conducted outside the United States or by foreign
subsidiaries, in addition to being subject to taxation in foreign jurisdictions,
are also subject to various provisions of the Internal Revenue Code of 1986, as
amended (the "Code"), which impose special taxes in certain circumstances on
foreign subsidiaries of United States corporations. While the Company will
generally receive foreign tax credits for taxes paid in foreign jurisdictions
which can be offset against United States tax liabilities, there can be no
assurance that the Company will generate sufficient United States income to
fully utilize such foreign tax credits.
Potential Adverse Effect of Warrants, and other Dilutive Transactions.
The Company issued warrants to purchase an aggregate of 240,000 shares of Common
Stock to the representatives of the underwriters of its initial public offering
at an exercise price of $16.50 per share (the "IPO Warrants"). As part of the
Ness Transaction, the Company and has issued warrants to purchase an aggregate
of 760,000 shares at an exercise price of $13.00 per share. (collectively, the
"Ness Warrants"). Additionally, the Company has reserved 1,150,000 shares of
Common Stock for issuance under its employee 1997 Stock Option Plan of which
710,000 shares are subject to outstanding options which are exercisable at a
price of $10.00 per share, and 102,500 shares are subject to outstanding options
which are exercisable at a price of $5.00 per share. The Company has reserved
50,000 shares of Common Stock for issuance under its 1997 Non-Employee Director
Stock Option Plan of which options to purchase 20,000 shares have been granted
at an exercise price of $10.00 per share, options to purchase 7,500 shares have
been granted at $10.6875 per share and options to purchase 7,500 shares have
been granted at $2.1875 per share. The holders thereof will have the opportunity
to profit from a rise in the market price of the Common Stock without assuming
the risk of ownership, with a resulting dilution in the interest of the other
security holders. As long as the IPO Warrants, Ness Warrants and other Company
options remain unexercised, the Company's ability to obtain additional capital
might be adversely affected. Moreover, the holders of the IPO Warrants, the Ness
Warrants and other Company options may exercise such warrants or options at a
time when the Company would, in all likelihood, be able to obtain any needed
capital by a new offering of its securities on terms more favorable than those
under which the existing warrants or options are exercisable.
<PAGE>
Possible Illiquidity of Trading Market. The Common Stock is listed on
the American Stock Exchange. To continue to be listed on the American Stock
Exchange, the Company must continue to satisfy certain maintenance standards. If
the Company is unable to maintain the standards for continued quotation on the
American Stock Exchange, the Common Stock could be subject to delisting by the
American Stock Exchange. In such event, an investor would find it more difficult
to dispose of the Shares, or to obtain accurate quotations as to their price.
ITEM 2. PROPERTIES
The Company's executive office and administrative divisions are
located at 77 Pacific Highway, North Sydney, Australia. The offices, which are
leased from a subsidiary of FAI Insurances, constitute approximately 639 square
meters and are leased at a rental rate of AUD $380 ($229) per square meter, per
annum. The Company has entered into a five-year lease expiring in 2002 for the
executive offices, with an option to extend the lease arrangement for an
additional five years with respect to certain portions of the space. The
remainder of the space is leased on a month by month basis.
Ness's administration, manufacturing and warehousing operations are
located at 167 Prospect Highway, Seven Hills, Sydney, Australia. Ness leases, at
a cost of AUD $102 ($61) per square meter per annum, a total of 2,674 square
meters at Seven Hills, consisting of 440 square meters of office space and 2,234
square meters of warehouse space. This lease expires in 2003. Additionally, Ness
has three distribution outlets located in (i) Blackburn, Victoria, (ii)
Mansfield, Queensland, and (iii) West Perth, Western Australia. The total leased
space for these distribution outlets is 1,010 square meters at an average rate
of AUD $81 ($49) per square meter per annum under leases with expiration dates
varying from 2001 to monthly tenancy. The Company has entered into a three-and-
a-half-year lease expiring in 2003 of space in a building adjoining Ness's
offices at Seven Hills. The leased space, totaling 3,117 square meters, consists
of 467 square meters of office space and 2,648 square meters of warehouse space.
The Company's customer care, extended warranty and service divisions were
relocated during the year to this location due to the AUD $102 ($61) per square
meter per annum rental rate. Ness will use this additional warehouse space for
it's manufacturing operations.
The Company also leases an office in England at 2nd Floor Lodge House,
Kay Street, Burnley, Lancashire. The lease expires on September 24, 2004 and
provides for an annual rent of (pound)11,960 ($18,168). The office constitutes
approximately 130 square meters and is leased at a rate of (pound)92 ($140) per
square meter per annum. The Company also leases a warehouse facility in
Manchester, England. The Company believes that its existing office, warehouse
and manufacturing space is adequate to meet its future needs.
ITEM 3. LEGAL PROCEEDINGS
A class action lawsuit has been filed against the Company in the
Victorian registry of the Federal Court of Australia alleging violations of the
Australian Trade Practice Act by authorized Distributors of the Company. The
class action alleges that misrepresentations were made by salespersons when
selling SecurityGuard alarm systems from July 9, 1993 to present to customers
who used FFC to finance their purchases. This litigation is in its very
preliminary stages and no discovery has been undertaken, and therefore, the
Company cannot quantify its ultimate liability, if any, for the payment of
damages in this lawsuit. Notwithstanding the foregoing, the Company believes
that the allegations in the lawsuit do not provide a basis for the recovery of
damages because the Company believes that the materials provided by the Company
to its Distributors and its sales force did not violate the Australian Trade
Practice Act. The Company intends to aggressively defend this lawsuit. In the
event the Company is not successful in defending this lawsuit, the outcome could
have a material adverse effect on the financial condition and results of
operation of the Company.
On September 17, 2000, a former distributor in the Company's Belgium
market has initiated legal proceedings in the Belgium courts seeking
compensation in relation to representations made by the Company to the
distributor and the validity of product approvals. This action seeks to recover
approximately $200,000 from the Company. The Company intends to aggressively
defend this action.
The Company experiences routine litigation in the normal course of its
business. The Company does not believe that any currently pending or threatened
litigation will have a material adverse effect on the financial condition and
results of operations of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
<PAGE>
PART II.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER
MATTERS
Market information
On July 15, 1997, the Company commenced the initial public offering of
its Common Stock, which has been traded on the American Stock Exchange since
that date.
The following table sets forth the high and low closing sale prices of
the Common Stock as reported by the American Stock Exchange for the two most
recent fiscal years.
<TABLE>
<CAPTION>
Fiscal June 1999 High Low
---------------- ------------ ----------
<S> <C> <C>
First Quarter (July 1-September 30, 1998) .................. $13.000 $8.375
Second Quarter (October 1-December 31, 1998) ............... 11.250 7.500
Third Quarter (January 1-March 31, 1999).................... 11.500 8.625
Fourth Quarter (April 1-June 30, 1999)...................... 9.000 5.375
Fiscal June 2000 High Low
---------------- ------------ ----------
First Quarter (July 1-September 30, 1999) .................. $5.937 $2.875
Second Quarter (October 1-December 31, 1999) ............... 3.500 1.625
Third Quarter (January 1-March 31, 2000).................... 4.000 1.687
Fourth Quarter (April 1-June 30, 2000)...................... 1.875 0.687
</TABLE>
On September 29, 2000, the last reported sale price of the Common
Stock as reported by the American Stock Exchange was $0.3125. Based on
information obtained from the Company's transfer agent, there are seven holders
of record of the Common Stock and the Company believes that the number of
beneficial owners of its Common Stock is in excess of 250.
Recent Sale of Unregistered Securities
On April 9, 1999, as part of the Ness Acquisition, the Company sold
277,778 shares of the Company's common stock to Mr. Nazareno Circosta, The Fourf
Superannuation Trust, Mr. Terrence Gail, John Circosta, Mary Cartisano, The
Eagle Superannuation Trust, and Naztech Corporation Pty Limited, each an
accredited investor, in exchange for a $2,599,352 ninety-day promissory note
secured by such shares (paid in full by June 30, 1999). The sale of such shares
was exempt from registration pursuant to Section 4(2) of the Securities Act of
1933, as amended.
On September 30, 1998, as part of the Ness Transaction, the Company
issued warrants to acquire 360,000 shares of the Company's common stock at an
exercise price of $13.00 per share to Integral's affiliate, International Home
Security Investments Limited. These warrants are fully exercisable and will
expire on October 1, 2003 as part of the consideration paid by the Company for
Integral's interest in IIHSL, the holder, at that time, of a 75.04% interest in
Ness. The sale of such warrants was exempt from registration pursuant to Section
4(2) of the Securities Act of 1933, as amended.
On both October 1, 1999 and January 1, 2000, as part of the Ness
Transaction, the Company issued warrants to acquire 200,000 shares of the
Company's common stock at an exercise price of $13.00 per share to Integral's
affiliate, International Home Security Investments Limited. These warrants are
fully exercisable and will expire on October 1, 2004 and January 1, 2005,
respectively, as part of the consideration paid by the Company for Integral's
interest in IIHSL, the holder, at that time, of a 75.04% interest in Ness. The
sale of such warrants was exempt from registration pursuant to Section 4(2) of
the Securities Act of 1933, as amended.
<PAGE>
Dividend Policy
During the two most recent fiscal years the Company has paid no
dividends on the Common Stock and does not anticipate doing so for the
foreseeable future. Dividends will only be paid at such time as the cash flow of
the Company is sufficient to justify such payments. The Company anticipates that
all earnings, if any, for the foreseeable future will be retained to finance the
growth and development of the business.
<PAGE>
ITEM 6. SELECTED FINANCIAL DATA
The selected financial information set forth below has been derived
from the financial data of the Company, its subsidiaries and its predecessor
entities, including FAI Home Security Pty Limited, FAI Home Security (ENZED)
Limited, FAI Home Security (NZ) Trust and FAI Home Security (NZ) Limited. The
selected statement of operations and balance sheet data of the Company as of and
for the years ended June 30, 1996, 1997, 1998, 1999 and 2000 have been derived
from the audited consolidated financial statements of the Company. See
"Consolidated Financial Statements of Home Security International--Note 1". The
selected financial information set forth below should be read in conjunction
with "Management's Discussion and Analysis of Financial Condition and Results of
Operations" and the financial statements and notes thereto included elsewhere in
this filing.
<TABLE>
<CAPTION>
Years Ended June 30,
----------------------------------------------------------------
1996 1997 1998 1999 2000
----------- ---------- ---------- ---------- ----------
(in thousands, except per share, unit sales,
and monitored lines)
<S> <C> <C> <C> <C> <C>
Statement of Operations Data:
Net sales .................................................. $ 26,701 $ 33,465 $ 44,119 $ 45,993 $ 28,638
Cost of goods sold ......................................... (17, 585) (24,274) (26,295) (23,295) (15,545)
----------- ---------- ---------- ---------- ----------
Gross profit ............................................... 9,116 9,191 17,824 22,719 13,093
General and administrative expenses and provision for
bad and doubtful debts ................................... (6,368) (5,619) (10,088) (12,673) (19,547)
Amortization and depreciation .............................. (238) (434) (722) (1,832) (2,809)
Impairment of intangible assets ............................ -- -- -- -- (1,699)
Research and development ................................... -- -- -- (395) (654)
----------- ---------- ---------- ---------- ----------
Income (loss) from operations .............................. 2,510 3,138 7,014 7,819 (11,616)
Non operating income -- other .............................. -- -- -- -- 380
Interest income (expense), net ............................. 203 784 226 (506) (1,170)
----------- ---------- ---------- ---------- ----------
Income (loss) before taxes, equity in income of affiliated
Companies and minority interest .......................... 2,713 3,922 7,240 7,313 (12,406)
Income tax expense (benefit) ............................... (1,054) (1,630) (2,111) (3,541) 1,240
----------- ---------- ---------- ---------- ----------
Income (loss) before equity in income of affiliated
Companies and minority interest .......................... $ 1,659 $ 2,292 $ 5,129 $ 3,772 $(11,166)
Equity in income of affiliated companies ................... -- -- 252 311 56
Minority interest .......................................... -- -- -- (335) --
----------- ---------- ---------- ---------- ----------
Net income (loss) .......................................... 1,659 2,292 5,381 3,748 (11,110)
=========== ========== ========== ========== ==========
Diluted net income per share of Common Stock ............... $ 0.51 $ 1.04 $ 0.68 $ (1.91)
Diluted weighted average shares of Common
Stock Outstanding ........................................ 4,500 5,182 5,517 5,828
Unit Sales and Monitored Lines Data(1)
Unit Sales ................................................. 31,669 38,071 57,589 54,801 27,402
Cumulative unit sales ...................................... 86,131 124,202 181,791 236,592 263,994
Monitored lines ............................................ -- -- -- 2,204 16,091
</TABLE>
<TABLE>
<CAPTION>
Years Ended June 30,
----------------------------------------------------------------
1996 1997 1998 1999 2000
----------- ---------- ---------- ---------- ----------
(in thousands)
<S> <C> <C> <C> <C> <C>
Balance Sheet Data:
Cash and cash equivalents .................................. $ 370 $ -- $ 7,006 $ 2,976 $ 1,394
Working capital (deficit) .................................. 3,451 (1,754) 3,121 (3,628) (1,875)
Total assets ............................................... 13,384 15,957 30,485 51,477 42,134
Total debt, including current portion....................... -- -- 4,737 13,155 12,295
Shareholders' equity ....................................... 9,894 9,790 18,099 29,074 18,331
</TABLE>
-----------
(1) Unit sales represents the sales of the SecurityGuard System during the
applicable period and cumulative unit sales represents the aggregate sales of
the Security Guard System since the Company began operations in 1988.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
Overview
<PAGE>
The Company is a direct sales company which, through the Distributor
Network, sells, installs, monitors and services a residential security alarm
system marketed under the trade name SecurityGuard, principally in Australia,
with operations in Europe, New Zealand, North America and South Africa. The
SecurityGuard alarm and other major components are manufactured exclusively by
Ness Security Products Pty Limited ("Ness"), a wholly owned subsidiary.
Historically, the Company's revenues from SecurityGuard System sales
were recorded upon shipment by the Company to Area Distributors and Distributors
net of any discounts. Revenues related to upgrade monitoring contracts were
collected and recognized monthly over the life of the monitoring contracts.
Revenues related to extended warranties were, and will continue to be,
recognized over the life of the warranty agreement with the customer, although
payment is received in full at the beginning of the agreement. In the face of
increased competition in the industry, there can be no assurance that the
Company will not face increased pricing pressure, which in turn could lead to
changes in the selling price of the SecurityGuard System or services furnished
by the Company. The impact of any such price changes on the Company's revenue or
operating results cannot be accurately determined.
Due to the significant fall in revenues, and large operating loss experienced
by the Australian and New Zealand operations during the year ended June 30,
2000, management has made an assessment of the fair value of the long lived
assets in these regions. In accordance with SFAS 121, based on undiscounted
future cash flow projections, management concluded that there is no impairment
in the intangible assets in relation to Australia and New Zealand as of June 30,
2000 (written down value $6,963,558). The undiscounted cash flow projections
utilized to make this assessment forecast a substantial increase in the level of
sales over those currently being achieved. Uncertainty exists as to whether the
predicted level of sales activity will be achieved. Management believes that the
cash received as a result of the 49% sale of the Ness manufacturing operation,
subsequent to June 30, 2000 (see Note 21) will be sufficient to allow the
necessary investment to meet the sales targets forecast.
Recent Developments
On Line Monitoring Program - New Customers
During the last fiscal year, the Company devoted substantial resources
and personnel to refine and introduce into its Distributor Network a new sales
strategy offering the customer the SecurityGuard System alarm for an affordable
monthly payment over a 60-month period (the "On-line Monitoring Program").
This new On-line Monitoring Program represents a dynamic change from
the Company's previous strategy of simply selling its alarm system at full price
with little opportunity for continued customer access or revenue generation
except for selling periodic upgrades. The On-line Monitoring Program is based on
a United States market model that has been adopted by many major security
companies whereby the equipment and the monitoring component are repaid through
a monthly interest free contract.
Revenue derived from the On-Line Monitoring Program is split between
revenue relating to sale of the security system and revenue relating to the
supply of monitoring services. Revenue relating to the sale of equipment is
recognized upon receipt of funds from the Companies financier and is shown net
of returns and rebates. Revenue relating to the supply of monitoring services is
recognized over the period the services are supplied. The initial cash inflow
from the On-line Monitoring Program is approximately 40% greater than the
Company's former sales program. Over the life of the contract, the Company will
incur additional monthly cash outflows equal to the cost of monitoring the
lines. At the completion of the initial contract, the Company will receive, for
the remaining life of the connection, cash inflows equal to the monthly
recurring revenue paid by the customer less the cost of monitoring the line.
The Company completed the conversion of Australia and New Zealand
markets to the new strategy in April 2000. The Company completed its launch of
the new strategy in the United States in May 2000. The Company also launched the
On-line Monitoring Program in the United Kingdom and Netherlands markets during
the last quarter of Fiscal 2000. It is the Company's intention to launch a
program in each market that provides a basic security package consisting of an
alarm and on-line monitoring services for five years. The Company plans to
expand its distributor network through a recruitment program.
Upgrade Program - Existing Customers
The Company has continued to contact its existing customer-base to
offer its 5-year on-line monitoring services package (the "Upgrade Program").
During the fiscal year ended June 30, 2000, the Company upgraded 7,639 alarm
systems with on-line monitoring services. These new connections represented a
265% increase from
<PAGE>
the on-line monitoring connections made during the fiscal year ended June 30,
1999. As of June 30, 2000, more than 9,700 of the Company's existing 264,000
customers have entered into agreements to purchase the Company's on-line
monitoring services.
During the fiscal year ended June 30, 2000, the Company recognized on
an installment basis the revenue from the Upgrade Program over the period of
each contract. All selling and installation cost for the Upgrade Program have
been capitalized and will be expensed over the period of each contract. All
setup and development expenses relating to the Upgrade Program have been
expensed as incurred. During the fiscal year ended June 30, 2000, the Upgrade
Program generated an initial cash outflow consisting of product, installation
and sales commission costs. The Company completed an initial funding facility to
finance the initial cash deficiency to ensure the Upgrade Program could be
expanded during the fiscal year. See Item 7. Management's Discussions and
Analysis of Financial Condition and Results of Operation - Liquidity and Capital
Resources.
During the first quarter of fiscal 2001, the Company obtained finance
for the upgrade program similar to the financing provided for its On-Line
Monitoring Program. See Item 7. Management's Discussions and Analysis of
Financial Condition and Results of Operation - Liquidity and Capital Resources.
Under the new financing arrangement revenue derived from the Upgrade Program
will be split between revenue relating to upgrade of the existing security
system and revenue relating to the supply of monitoring services. Revenue
relating to upgrade of the existing security system will be recognized upon
receipt of funds from the Companies financier and is shown net of returns and
rebates. Revenue relating to the supply of monitoring services will be
recognized over the period the services are supplied. The initial cash inflow
resulting from the new financing arrangement for the Upgrade Program will be
similar to the On-Line Monitoring Program, eliminating the previous negative
cashflow experienced previously. Over the life of the contract, the Company will
incur additional monthly cash outflows equal to the cost of monitoring the
lines. At the completion of the initial contract, the Company will receive, for
the remaining life of the connection, cash inflows equal to the monthly
recurring revenue paid by the customer less the cost of monitoring the line.
Due to continued losses since the inception of the United Kingdom and
North American operations, management made an assessment of the fair values of
the long-lived assets of these entities. Based on fair value assessments using
undiscounted future cash flow projections in accordance with SFAS 121 or offers
from interested third parties, as appropriate, management concluded that the
intangible assets related to the operations in the United Kingdom and North
America were fully impaired as of June 30, 2000.
Total impairment of goodwill recorded during the fiscal year ended
June 30, 2000 can be broken down as follows:
United Kingdom $ 738,142
North America 960,496
-----------
$ 1,698,638
===========
The consolidated financial statements are translated into U.S. dollars
to reflect the Company's reporting currency. The assets and liabilities are
translated at the balance sheet date exchange rate. The statements of operations
data for each period have been translated at the average exchange rate
throughout such period. The resulting translation effects are reflected in
shareholders' equity. Because of fluctuations in the values of currencies in
which the Company receives revenues against the U.S. dollar, the Company
believes that period to period comparisons of reported financial results, may
not fully reflect sales and other operating trends for the periods compared.
<PAGE>
Results of Operations
The following table summarizes the Company's operating results as a
percentage of net sales for the periods indicated.
<TABLE>
<CAPTION>
Year Ended June 30,
1998 1999 2000
--------- --------- ---------
<S> <C> <C> <C>
Statement of Operations Data:
Net sales ............................................................ 100.0% 100.0% 100.0%
Cost of goods sold ................................................... 59.6% 50.6% 54.3%
--------- --------- ---------
Gross profit ......................................................... 40.4% 49.4% 45.7%
General and administrative expenses .................................. 22.9% 27.6% 68.3%
Amortization and depreciation ........................................ 1.6% 4.0% 9.8%
Impairment of intangible assets ...................................... -- -- 5.9%
Research and development ............................................. -- 0.9% 2.3%
--------- --------- ---------
Income (loss) from operations ........................................ 15.9% 17.0% (40.6)%
Non operating income -- other ........................................ -- -- 1.3%
Interest income (expense), net ....................................... 0.5% (1.1)% (4.0)%
--------- --------- ---------
Income (loss) before taxes, equity in income of affiliated
companies and minority interest .................................... 16.4% 15.9% (43.3)%
Income tax expense (benefit) ......................................... 4.8% 7.7% (4.3)%
--------- --------- ---------
Income (loss) before equity in income of affiliated
companies and minority interest .................................... 11.6% 8.2% (39.0)%
Equity in income of affiliated companies ............................. 0.6% 0.7% 0.2%
Minority interest .................................................... -- 0.7% --
--------- --------- ---------
Net income (loss) .................................................... 12.2% 8.1% (38.8)%
========= ========= =========
</TABLE>
Comparison of fiscal years ended June 30, 2000 and June 30, 1999.
Net Sales: Net sales decreased by $17.4 million or 38% from $46.0
million for the fiscal year ended June 30, 1999 to $28.6 million for the fiscal
year ended June 30, 2000. Distributor sales decreased by $21.3 million or 56%
from $38.0 million for fiscal year ended June 30, 1999 to $16.7 million for the
fiscal year ended June 30, 2000. The reduction in Distributor sales was
primarily a result of a 50% decline in total sales from 54,801 units for the
fiscal year ended June 30, 1999 to 27,402 for the fiscal year ended June 30,
2000. Additionally, since the introduction of the On-Line Monitoring Program
revenues of $1.9 million relating to the supply of monitoring services have been
deferred for the fiscal year ended June 30, 2000 and will be recognized over the
period the services are supplied, being predominately sixty months.
Sales of manufactured goods not sold through the distributor network
("Direct Retail Sales") increased by $2.3 million or 37% from $6.3 million for
fiscal year ended June 30, 1999 to $8.6 million for the fiscal year ended June
30, 2000. The increase in Direct Retail Sales was primarily attributable to the
inclusion of an additional $2.6 million in Direct Retail Sales for the three
months ended September 30, 1999. The IIHSL acquisition was effective October 1,
1998 and therefore the additional Direct Retail Sales did not apply for the
three months ended September 30, 1998.
Units sold in the Australian market decreased 51% from 41,194 units
for the fiscal year ended June 30, 1999 to 20,059 units for the fiscal year
ended June 30, 2000. Units sold in New Zealand decreased 72% from 5,977 units
for the fiscal year ended June 30, 1999 to 1,679 units for the fiscal year ended
June 30, 2000.
The decline in number of units sold in Australia and New Zealand is
attributable to:
(i) A reduction in the number of Distributor offices currently selling
in the Australian and New Zealand market.
(ii) A reduction in the number of independent sales agents due to (i).
(iii) The delay in the introduction of the Online Monitoring Program into
the Distribution network.
(iv) Increased competition.
<PAGE>
Unit sales in Europe and the United Kingdom decreased 13% from 5,893
units for the fiscal year ended June 30, 1999 to 5,099 for the fiscal year ended
June 30, 2000. Unit sales in the Netherlands increased 15% from 3,864 for the
fiscal year ended June 30, 1999 to 4,457 for the fiscal year ended June 30,
2000.
The Company has intentionally directed all management resources away
from the South African market to concentrate the resources of the Company on the
Australian, New Zealand, USA and European markets. The South African market
recorded 230 unit sales during the fiscal year ended June 30, 2000 compared to
1,087 for the fiscal year ended June 30, 1999.
Cost of Goods Sold: Cost of goods sold decreased 33% from $23.3
million for the fiscal year ended June 30, 1999 to $15.5 million for the fiscal
year ended June 30, 2000. As a percentage of net sales, cost of goods sold
increased 3% from 51% for the fiscal year ended June 30, 1999 to 54% for the
fiscal year ended June 30, 2000. The increase in cost of goods sold as a
percentage of net sales is primarily attributable to the $1.9 million deferral
of revenues relating to the supply of monitoring services. With the $1.9 million
deferral of revenues added back to net sales, cost of goods sold as a percentage
of net sales remained stable at 51%.
General and Administrative Expenses: General and administrative
expenses increased $3.8 million to $16.6 million for the fiscal year ended June
30, 2000, compared to $12.8 million for the fiscal year ended June 30, 1999. The
increase in general and administrative expenses was primarily attributable to:
(i) An increase in the warranty provision of $0.3 million to cover the
extension of the warranty period offered by the Company from one to
two years with the introduction of the On Line Monitoring Program.
(ii) Foreign exchange loss of $0.8 million realized on the full repayment
of the $8.3 million note owing to Integrated Investments Limited
("IIL Note").
(iii) The fixed nature of the expenses relating to the administration and
provision of service to the Distribution Network.
(iv) Market research, consulting and travel expenses incurred by the
Company in Australia and New Zealand relating to the Task Force
program formed by the Company in June 1999. This program involved a
comprehensive survey of 8,000 customers as well as focus groups
throughout the Australia and New Zealand market, creation of new
marketing techniques and ultimately the creation of the new Online
Monitoring Program. All expenses have been recognized as incurred.
(v) Implementation costs associated with the launch of the new
SecurityGuard 3 product in both Australia and New Zealand.
(vi) Marketing and development costs relating to the Upgrade Program
resulting in the 7,639 connections to on-line monitoring from the
Company's existing 264,000 home customer base during the fiscal year
ended June 30, 2000.
(vii) Program development costs relating to the United States market and
the On-line Monitoring Program.
(viii) The inclusion of $1.2 million of additional expenses relating to
IIHSL. The IIHSL acquisition was effective October 1, 1998 and
therefore the additional expenses did not apply for the three months
ended September 30, 1998.
Provision for doubtful debts and bad debts written off: Provision for
doubtful debts and bad debts written off increased to $2.7 million for the
fiscal year ended June 30, 2000 from a recovery of $0.1 million for the fiscal
year ended June 30, 1999, an increase of $2.8 million.
The increase in provision for doubtful debts and bad debts written off
was primarily attributable to:
<PAGE>
(i) The write-off of $1.3 million in bad debts relating to
receivables owing by Distributor offices that have ceased
operations.
(ii) The provision of $1.4 million for doubtful debts consisting
of:
(a) Provision of $0.5 million for receivables owing by
Distributor offices for which the collection has been
deemed by management to be doubtful.
(b) Provision of $0.9 million against the outstanding loan
to FAI Home Distributors Pty Limited.
The Company is seeking to recover the bad debts owing by Distributors offices
that have closed in the following manner: (i) the Company is seeking recovery
directly from distributors utilizing all possible legal measures; (ii) the
company is seeking legal advice in the event that a Distributor is unable to
meet its obligations regarding the companies ability to recover these amounts
through the enforcement of the guarantee provided by FAI Home Distributors Pty
Limited ("FHD"), whereby FHD is required to repay Distributor bad debts after a
365 day notice period; and (iii) the Company is seeking legal advice, in the
event FHD is unable to meet its obligations regarding the Company's ability to
recover these amounts from Brad Cooper under the guarantee supplied to FHD. The
extent to which, if any, the guarantees provided by FHD and Brad Cooper are
enforceable to repay Distributor bad debts is uncertain and subject to legal
advice.
Amortization and depreciation: Amortization and depreciation increased
by 55% from $1.8 million for the fiscal year ended June 30, 1999 to $2.8 million
for the fiscal year ended June 30, 2000. This was directly attributable to: (i)
the inclusion of $0.1 million of additional depreciation relating to the
capitalization of monitoring dialers which commenced July 1, 1999; (ii) the
write down of $0.1 million of fixed assets which were determined to be of
negligible value; (iii) the inclusion of $0.3 million of additional depreciation
relating to the capitalization of cost associated with the Upgrade Program; (iv)
the inclusion of $0.8 million of additional depreciation and amortization of
capital assets relating to Ness; and, (v) the inclusion of $0.2 million of
additional amortization relating to goodwill recorded upon the acquisition of
IIHSL. The IIHSL acquisition was effective October 1, 1998 and therefore the
additional depreciation and amortization described in clause (iv) and (v) above
did not apply for the three months ended September 30, 1998.
Impairment of intangible assets: Impairment of intangible assets for
the fiscal year ended June 30, 2000 was $1.7 million. Due to continued losses
since the inception of the United Kingdom and North American operations,
management made an assessment of the fair values of the long-lived assets of
these entities. Based on fair value assessments using undiscounted future cash
flow projections in accordance with SFAS 121 or offers from interested third
parties, as appropriate, management concluded that the intangible assets related
to the operations in the United Kingdom and North America were fully impaired as
of June 30, 2000.
Total impairment of goodwill recorded during the fiscal year ended
June 30, 2000 was split as follows:
United Kingdom $ 738,142
North America 960,496
-----------
$ 1,698,638
Research and Development: Research and Development expense was $0.7
million for the fiscal year ended June 30, 2000 compared to $0.4 million for the
fiscal year ended June 30, 1999. The $0.3 million increase is attributable to:
(i) the exclusion of $0.2 million of Research and Development expenses relating
to Ness for the three months ended September 30, 1998; and (ii) costs incurred
by Ness in relation to product approvals and the design and development of new
products.
Income From Operations: Income from operations decreased from $7.8
million for the fiscal year ended June 30, 1999 to a loss of $11.6 million for
the fiscal year ended June 30, 2000. The decrease in income from operations
reflects: (i) the reduction in unit sales in the fiscal year ended June 30,
2000; (ii) the increased in general and administrative expenses as discussed
above; and, (iii) the impairment of intangible assets as discussed above.
Non Operating Income - Other: Non Operating Income - Other represents;
(i) The $0.3 million write-off of the Company's 49% interest in
the Bayside Partnership purchased June 30, 1998, which had
entered into an agreement with Prime Life Corporation to
acquire a retirement village in Melbourne, Australia. The
Company had been unable to reach an agreement as to the
appropriate management fee to be charged for the
administration of this passive investment. The Company has
terminated this relationship to focus its resources on its
core business.
<PAGE>
The investment in the partnership provided the Company with a
permanent difference for tax purposes of $1.5 million
(approximately $0.5 million after tax) for the fiscal year
ended June 30, 1998. Due to changes in tax laws this benefit
was reversed for fiscal year ended June 30, 1999 and has
subsequently been reinstated as a result of the write-off of
the interest in the partnership.
(ii) The $0.6 million profit on the sale of the Company's 50%
interest in FFC to FAI Insurances Limited, effective March 31,
2000.
(iii) A $0.1 million discount for the time value of money received
on the early settlement of the IIL Note.
Interest Income: Interest income decreased 25% from $0.4 million for
the fiscal year ended June 30, 1999 to $0.3 million for the fiscal year ended
June 30, 2000. The decrease in interest income is directly attributable to the
reduction in the Company's excess Cash and Cash Equivalents over the fiscal year
ended June 30, 2000.
Interest Expense-related party: Interest expense--related party
increased from $0.4 million for the fiscal year ended June 30, 1999 to $0.7
million for fiscal year ended June 30, 2000. Interest expense-related party
consists of interest payments on: (a) the vendor-financed loan initiated as part
of the FFC Transaction on December 31, 1997, and amended as at March 31, 2000;
and (b) the funding facility initiated on December 22, 1999 to finance the
initial cash deficiency of the Upgrade Program. The increase of $0.3 million was
directly attributable to the Upgrade Program funding facility for the six months
ended June 30, 2000.
Interest Expense--other: Interest expense--other increased from $0.6
million for the fiscal year ended June 30, 1999 to $0.8 million for the fiscal
year ended June 30, 2000. The interest charge for both fiscal years ended June
30, 2000 and 1999 consisted of a non-cash imputed interest charge recorded in
order to comply with the U.S. GAAP purchase accounting principles. Pursuant to
the Stock Purchase Agreement through which the Company acquired 100% of the
issued and outstanding stock of IIHSL, the Company issued a non-interest bearing
promissory note, secured by the IIHSL shares, in the amount of $9,098,000. U.S.
GAAP requires a discount to be recorded for debt securities issued in connection
with an acquisition with an interest rate fixed materially below the effective
rate or current yield of an otherwise comparable security. The interest charge
was not reflected in the three months ended September 30, 1998 since IIHSL was
acquired in October 1998.
Income Tax (Expense) Benefit: As the Company incurred a loss for the
fiscal year ended June 30, 2000, it derived a tax benefit and an effective tax
rate before valuation allowance, goodwill amortization and impairment of 38%.
This contrasted to the prior corresponding period when a profit was derived and
the effective tax rate before valuation allowance, goodwill amortization and
impairment was 43%. The effective rate of tax rate before valuation allowance,
goodwill amortization and impairment for the fiscal year ended June 30, 2000 was
affected by (i) the difference between accounting and taxable profit on the
sale of the Company's 50% interest in FFC due to the effect of capital gains
indexation and equity accounting adjustments and (ii) the re-instatement of the
permanent difference for tax purposes of $1.5 million (approximately $0.5
million after tax) derived from the investment in the Bayside Partnership which
was written off as at December 31, 1999.
Realization of deferred tax benefits associated with net operating
losses ("NOL") and credit carryforwards is dependent upon generating sufficient
taxable income prior to their expiration. Management believes that there is a
risk that certain of these NOL and credit carryforwards may expire unused and,
accordingly, has established a valuation allowance against them of $2.4 million
as of June 30, 2000. Although realization is not assured for the remaining
deferred tax assets, management believes it is more likely than not that they
will be realize through future taxable earnings or alternative tax strategies.
However, the net deferred tax assets could be reduced in the near term if
management's estimates of taxable income during the carryforward period are
significantly reduced or alternative tax strategies are no longer viable.
Equity in Income of Affiliated Companies: Equity in income of
affiliates decreased from $311,000 for the fiscal year ended June 30, 1999 to
$56,000 for the fiscal year ended June 30, 2000. This was calculated by taking
the Company's 50% share of FFC's net income of $278,000 for the fiscal year
ended June 30, 2000 and deducting amortization of goodwill for the same period
of $222,000. The decrease in FFC's net income during the fiscal year ended June
30, 2000 as compared to the fiscal year ended June 30, 1999 was primarily
attributable to the Company's reduction in unit sales.
<PAGE>
Minority Interest: Minority interest for the nine months ended March
31,1999 represents an independent third party's ownership of 24.96% of Ness, and
the corresponding profit allocation for the fiscal year ended June 30, 1999.
Effective April 9, 1999 the Company acquired the remaining 24.96% interest in
Ness, eliminating the minority interest.
Net Income (loss): Net income (loss) decreased from a profit of $3.7
million for the fiscal year ended June 30, 1999 to a loss of $11.1 million for
the fiscal year ended June 30, 2000.
Comparison of fiscal years ended June 30, 1999 and June 30, 1998.
Net Sales: Net sales increased by $1.9 million or 4% from $44.1
million for the fiscal year ended June 30, 1998 to $46.0 million for the fiscal
year ended June 30, 1999. Included in net sales for the fiscal year ended June
30, 1999 was $6.3 million in net sales from IIHSL relating to Direct Retail
Sales of manufactured goods to third party customers other than the Company
("Direct Retail Sales") for the nine months since the acquisition of IIHSL
(October 1, 1999 through June 30, 1999) and other sales which include extended
warranties and rebates. Because the Company acquired IIHSL in October 1998 there
were no Direct Retail Sales for the year ended June 30, 1998. Distributor sales
decreased by $4.9 million or 13% from $42.9 million for the fiscal year ended
June 30, 1998 to $38.0 million for the fiscal year ended June 30, 1999. The
reduction of Distributor sales was primarily a result of a 38% decline in unit
sales in New Zealand and a 52% decline in unit sales in South Africa.
Units sold in the Australian market increased 2% from 40,498 units for
the fiscal year ended June 30, 1998 to 41,194 units for the fiscal year ended
June 30, 1999. Units sold in New Zealand decreased 38% from 9,583 units for the
fiscal year ended June 30, 1998 to 5,977 units for the fiscal year ended June
30, 1999. The decline in number of units sold in New Zealand is attributable to
a reduction in the number of Distributor offices currently selling in the New
Zealand market. The number of units sold in the South African market decreased
52% during the fiscal year ended June 30, 1999 to 1,087 as compared to 2,252 for
the fiscal year ended June 30, 1998. The decline in units sold in South Africa
was attributable to test selling in major city areas in an attempt to capture a
share of the larger market. Selling in the city areas proved unsuccessful and
the focus in the South African operation has been returned to rural areas.
Unit sales in Europe and the United Kingdom increased 29% from 4,581
units for the fiscal year ended June 30, 1998 to 5,893 for the fiscal year ended
June 30, 1999. The Company has begun allocating resources no longer required in
Europe into the United States market to establish a foundation from which to
grow the U.S. distribution network.
The Company's online monitoring program is being rolled out in
Australia and New Zealand. The Company currently has in excess of 2,200
monitored lines, the majority of these being installed during the six months
ended June 30, 1999. The Company intends to expand its on-line monitoring
program, including both upgrade and point of sale, in the Australian and New
Zealand operations in the fourth quarter of Fiscal 1999. All setup and
development expenses relating to the on-line monitoring program have been
expensed as incurred.
Cost of Goods Sold--other: Cost of goods sold decreased 11% from $26.3
million for the fiscal year ended June 30, 1998 to $23.3 million for the fiscal
year ended June 30, 1999. As a percentage of net sales, cost of goods sold
decreased 9% from 60% for the fiscal year ended June 30, 1998 to 51% for the
fiscal year ended June 30, 1999. 2% of the reduction in cost of goods is
attributable to the decline in sales, while the remaining 7% was directly
attributable to the acquisition of IIHSL. The acquisition of IIHSL enabled the
Company (on a consolidated basis) to capture the IIHSL gross margin reflected in
the reduction of the Company's cost of goods sold. As a result, the Company's
gross margin as a percentage of sales increased 9% from 40% for the fiscal year
ended June 30, 1998 to 49% for the fiscal year ended June 30, 1999.
General and Administrative Expenses: General and administrative
expenses were $12.7 million for the fiscal year ended June 30, 1999, compared to
$10.1 million for the fiscal year ended June 30, 1998. Total general and
administrative expenses, as a percentage of net sales, increased 5% to 28% for
the fiscal year ended June 30, 1999 compared to 23% for the fiscal year ended
June 30, 1998. The increase in general and administrative expenses as a
percentage of net sales was primarily attributable to the inclusion of expenses
relating to IIHSL of $2.8 million.
<PAGE>
The Company also incurred additional expenses during the fiscal year ended June
30, 1999 relating to the establishment of the on-line monitoring and start-up
expenses for the establishment of the United States market.
Provision for doubtful debts and bad debts written off: Provision for
doubtful debts and bad debts written off decreased $1.0 million from $0.9
million for the fiscal year ended June 30, 1998 to a recovery of $0.1 million
for the fiscal year ended June 30, 1999. The recovery $0.1 million consisted of
the reversal of provisions made in the fiscal year ended June 30, 1998 relating
to doubtful debts that were collected during the fiscal year ended June 30,
1999.
Amortization and depreciation: Amortization and depreciation increased
157% from $0.7 million for the fiscal year ended June 30, 1998 to $1.8 million
for the fiscal year ended June 30, 1999. Amortization of goodwill increased 100%
from $0.5 million for the fiscal year ended June 30, 1998 to $1.0 million for
the fiscal year ended June 30, 1999. The increase was directly attributable to
the inclusion, (for the nine months October 1, 1999--June 30, 1999), of
amortization relating to the goodwill recorded upon the acquisition of IIHSL.
The increase in depreciation and amortization of capital and leased assets of
$0.6 million from $0.2 million for the fiscal year ended June 30, 1998 to $0.8
million for the fiscal year ended June 30, 1999 was attributable to the
introduction of $2.4 million dollars of capital equipment from the IIHSL
acquisition.
Impairment of intangible assets: There was no impairment of intangible
assets for the fiscal years ended June 30, 1998 and 1999.
Research and Development: Research and Development expenses for the
fiscal year ended June 30, 1999 represents costs incurred by IIHSL since its
acquisition on October 1, 1998, in relation to product approvals and the design
and development of new products.
Income From Operations: Income from operations increased 13% from $7.0
million for the fiscal year ended June 30, 1998 to $7.9 million for the fiscal
year ended June 30, 1999. The increase in income from operations reflects the
benefits from the acquisition of IIHSL which include (a) increased revenues from
IIHSL Direct Retail Sales, (b) the capture of IIHSL's margin, for sales made to
the Company, reflected as a reduction in the Company's cost of goods.
Interest Income: Interest income remained stable at $0.4 million for
the fiscal year ended June 30, 1999 and 1998, respectively.
Interest Expense--related party: Interest expense--related party is
derived from the vendor-financed loan initiated as part of the FFC Transaction
on December 31, 1997. For the fiscal year ended June 30, 1999 interest expense--
related party was $0.4 million compared to $0.2 million for the fiscal year
ended June 30, 1998. The $0.2 million increase occurs because interest expense--
related party for the fiscal year ended June 30, 1998 includes only six months
of interest paid by the Company to FAI Insurances Limited (December 31, 1997--
June 30, 1998) while interest expense--related party for the fiscal year ended
June 30, 1999 includes twelve months of interest (July 1, 1998--June 30, 1999).
Interest Expense--other: Interest expense--other for the fiscal year
ended June 30, 1999 was $0.6 million. The interest charge for the fiscal year
ended June 30, 1999 consisted of a non-cash imputed interest charge $0.6 million
recorded in order to comply with the United States Generally Accepted Accounting
Principles ("U.S. GAAP") purchase accounting principles. Pursuant to the Stock
Purchase Agreement through which the Company acquired 100% of the issued and
outstanding stock of IIHSL, the Company issued a non-interest bearing promissory
note, secured by the IIHSL shares, in the amount of $9,098,000. U.S. GAAP
requires a premium to be recorded for debt securities issued with an interest
rate fixed materially above or below the effective rate or current yield of an
otherwise comparable security. The interest charge is only reflected in the June
30, 1999 year end since IIHSL was acquired in October 1998.
Income Tax Expense: The effective rate of tax increased from 29% for
the fiscal year ended June 30, 1998 to 48% for fiscal year ended June 30, 1999.
This increase is primarily attributable to the following factors: (i) the
purchase by the Company, on June 30, 1998, of a 49% interest in a partnership
that has entered into an agreement with Prime Life Corporation to acquire a
retirement village in Melbourne, Australia. The investment in the partnership
provided the Company with a permanent difference for tax purposes of $1.7
million (approximately $0.6
<PAGE>
million after tax) for the fiscal year ended June 30, 1998, which was
subsequently reversed for the fiscal year ended June 30, 1999 as a result of a
change in the tax laws; (ii) non-deductible amortization of goodwill generated
from the acquisition of IIHSL during the fiscal year ended June 30, 1999 of $0.5
million ($0.2 million tax effect); and (iii) a prior year tax adjustment of $0.1
million recorded in fiscal 1999.
Equity in Income of Affiliated Companies: Equity in income of
affiliates for the fiscal year ended June 30, 1999 was $310,000. This was
calculated by taking the Company's 50% share of FFC's net income of $608,000 for
the fiscal year ended June 30, 1999 and deducting amortization of goodwill for
the same period of $298,000. There was only six months of equity in income of
affiliates for the fiscal year ended June 30, 1998, being $252,000, as the FFC
Transaction took place on December 31, 1997.
Minority Interest: Minority interest represents an independent third
party's ownership of 24.96% of Ness, and the corresponding profit allocation for
the period from October 1, 1998 to April 9, 1999.
Net Income: Net income decreased 31% from $5.4 million for the fiscal
year ended June 30, 1998 to $3.7 million for the fiscal year ended June 30,
1999.
Liquidity and Capital Resources
Cashflow from operations declined $8.9 million from a cash-inflow of
$4.3 million for the fiscal year ended June 30, 1999 to a cash-outflow of $4.6
million for the fiscal year ended June 30, 2000. The decline in cashflow from
operations was primarily due to; (i) the decline in the Company's net income
after non cash items; (ii) provisional income tax payments of $1.8 million
relating to the fiscal year ended June 30, 1999; and (iii) an increase in
inventory of $1.9 million due to stockpiling of certain components predicted to
be in limited supply over the first half of Fiscal 2001.
Net cash generated by investing activities increased from a deficit of
$11.0 million for the fiscal year ended June 30, 1999 to a surplus of $4.2
million for the fiscal year ended June 30, 2000. The deficit in net cash used in
investing activities for the fiscal year ended June 30, 1999 was primarily due
to: (i) the $9.1 million associated with the acquisition of Ness made up of: (a)
cash payments of $126,000, $2,300,000 and $200,000 paid in relation to the IIHSL
acquisition; (b) cash payments of $2,140,179, and $3,066,776 in relation to the
final 24.96% acquisition of Ness; and (c) $1,282,427 paid in acquisition cost
for both (a) and (b) above; and (ii) the purchase of capital assets of $1.4
million, including manufacturing equipment for Ness of $1.0 million. Net cash
generated by investing activities for the fiscal year ended June 30, 2000
primarily consisted of (i) proceeds from the sale of the Company's 50% interest
in FAI Finance Corporation Pty Limited of $8.1 million; (ii) capitalized
monitoring dialers of $1.4 million; (iii) capitalized Upgrade Program costs of
$1.5 million; (iv) $0.6 million for the purchase of capital assets; and (v) a
short term loan of $0.7 million granted to FAI Home Distributors Pty Limited.
Net cash generated from financing activities decreased from a surplus
of $2.4 million for the fiscal year ended June 30, 1999 to a deficit of $1.4
million for the fiscal year ended June 30, 2000. The deficit consisted of: (i)
installment payments made on the Note outstanding to Integrated Investments
Limited ("IIL Note") of $0.4 million paid on July 7, 1999, $0.1 million paid on
February 15, 2000 and $0.3 million paid on February 21, 2000; (ii) final payment
of $8.2 million to Integrated Investments Limited as full settlement of the IIL
Note on or about April 26, 2000; (iii) cash received of $4.7 million for the
sale of upgrade monitoring receivables to FFC pursuant to the Receivables
Purchase Agreement ("RPA") less collections remitted to FFC of $0.4 million; and
(vi) loans from FAI Insurances Limited consisting of: (a) $3.0 million in short
term debt financing, at a rate of 7.75% per annum, with principal and interest
payable in a bullet on February 28, 2001(the "HIH Note"); and (b) a $0.3 million
extension of the FAI Note pursuant to the FFC Sale and monthly repayments of
$0.2 million.
FFC-Receivables Purchase Agreement. On December 22, 1999, the Company
entered into the Receivables Purchase Agreement ("RPA") with FAI Finance
Corporation Pty Limited ("FFC"). Under this agreement, the Company has the right
to sell eligible upgrade monitoring receivables to FFC and undertakes to
continue to service the receivables in exchange for an upfront cash payment
equal to the sum of the total receivable less 15% retained as sub-ordinated
debt. This facility specifically relates to the Company's Upgrade Program
offering five-year monitoring contracts to its existing 264,000 residential
customers. Previously, the Company has funded this program from cash flow from
operations.
<PAGE>
Under the RPA, the Company must maintain a sub-ordinated loan with FFC
equal to 15% of the outstanding receivable sold. The sub-ordinated loan as at
June 30, 2000 was $0.6 million.
The Company has not recognized the sales of receivables under the
agreement as a sale for financial reporting purposes. The sales proceeds
received from FFC have been recognized as secured borrowing, and interest and
line fees under the FFC facility have been recognized as interest expense. Under
the agreement the Company pays interest to FFC at 12.5% per annum on the used
portion of the facility plus a line fee of 2.0%. As at June 30, 2000 the limit
of the facility provided by FFC, being $4.7 million, was drawn to $4.7 million.
Sale of FFC. Effective March 31, 2000, the Company, through its
wholly-owned subsidiary FAI Home Security Pty. Limited ("FHS"), sold its 50%
interest in FFC to FAI Insurances Limited ("FAI") for approximately $8,117,567.
On April 7, 2000, FAI paid FHS $2,400,000, the remainder of the sale
price was paid on or around April 26, 2000. FAI, which owns approximately 47% of
the common stock of the Company, is a wholly owned subsidiary of HIH Insurance
Limited ("HIH").
In connection with FHS's purchase of FFC in Fiscal 1997, FAI provided
FHS with vendor financing, approximately $4,439,175 of which remains outstanding
at the time of the sale (the "FAI Note"). Pursuant to the terms of the sale, FAI
agreed to extend the payment terms of the FAI Note, which will be guaranteed by
a security interest in Ness Security Products Pty. Ltd. ("Ness"). Upon receipt
of the proceeds of the sale, the Company paid to Integrated Investments Limited
("IIL") $8,200,000 in full settlement of the $8,298,000 due to IIL as of June
30, 2000 (the "IIL Payment"). The decrease in the amount paid versus that owed
as of June 30, 2000 reflects a discount for the time value of money. To the
extent that the proceeds from the Sale were insufficient to pay IIL in full, FAI
lent the shortfall to FHS and added that amount to the FAI Note which will
accrue annual interest at the rate of 7.75% and requires monthly payments of
principal and interest over sixty months.
In addition to the above described transactions, pursuant to the terms
of the sale, FFC agreed to increase the limit on its existing factoring facility
with FHS from approximately $3.0 million to approximately $4.6 million.
Sutter Securities, Inc. issued a fairness opinion stating that the
Sale was in the best interest of the public shareholders of HSI and a reasonable
third-party transaction.
As of October 1, 1999, and January 1, 2000 the Company has issued five
year convertible warrants to purchase 400,000 shares of Common Stock at an
exercise price of $13.00 per share to Integral Investments Limited ("IIL")
pursuant to the terms originating from the acquisition of IIHSL.
The Company's strategy for growth is based on the successful roll-out
of the new On-line Monitoring Program through its Distributor Network into
existing and new markets and the sale of five-year on-line monitoring contracts
through its Upgrade Program to its existing 264,000 residential customers. As
the Company's current level of monthly unit sales is insufficient to generate
positive cashflow from operations the Company must obtain additional external
funding until a breakeven level of sales is achieved. There is no guarantee that
the Company will achieve a breakeven level of unit sales or will be successful
in obtaining additional external funding. The lack of such capital could have a
material adverse effect on the Company's operations, liquidity and financial
position.
Subsequent external funding. On August 3, 2000 and August 17, 2000 HIH
Insurances provided the Company with approximately $0.5 million and $1.5
million, respectively, in short term debt financing, at a rate of 7.75% per
annum, with principal and interest payable at call (on demand). The short term
financing is unsecured.
The $2.0 million infusion of capital by HIH increases cash reserves of
the Company to approximately $2.6 million. The Company has further access to an
overdraft facility of approximately $570,000. It is the intention of the Company
to utilize the proceeds of this short term financing to: (i) fund the current
deficiency in cash flow from operations; (ii) repay outstanding creditors; and
(iii) fund a major recruitment campaign in the Company's Australian market.
On August 4, 2000 the Company received $0.5 million of additional
unsecured external funding from International Home Security Investments Limited,
at a rate of 10% per annum, with interest payable weekly in arrears, and the
balance payable upon successful completion of any capital or equity raising or
from proceeds from
<PAGE>
the sale of assets. Paul Brown, a director of the Company, is also a director
and sole shareholder of International Home Security Investments Limited.
The Company has entered into an agreement to sell 49% of its shareholding in
Ness Security Products ("Ness") for cash consideration of $AUD17.5m to HIH
Insurances (the "Ness Sale"). From the sale proceeds the Company has agreed to
repay $AUD13 million to HIH Insurances in relation to the FAI Note and short
term finance provided by HIH. Furthermore, HIH has agreed to provide additional
funds of $AUD2.5 million by June 30, 2001.
The Company believes the $AUD4.5 million cash raised in the Ness sale and the
additional availability of funds of $AUD2.5 million will provide the Company
with sufficient liquidity to fund the cash flow deficit from operating
activities that the Company expects in the first three quarters of Fiscal 2001.
The Company expects its business plan to produce positive cash flow from
operations in the last quarter of Fiscal 2001 provided sales targets are
achieved.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's major market risk exposure is foreign currency
fluctuations. Geographically, the majority of the Company's operating
subsidiaries are located outside the United States, with operations conducted in
their respective local currencies. Accordingly, the Company's financial
performance could be adversely affected by fluctuations in currency exchange
rates. Furthermore, as the Company reports its financial results in U.S.
dollars, a significant movement in the value of the U.S. dollar against certain
international currencies, particularly the Australian dollar ("AUD"), could have
a material adverse effect on the Company's reported financial position and
results of operations. A hypothetical 10% change in foreign exchange rates would
have impacted reported earnings by approximately $1.4 million for the fiscal
year ended June 30, 2000.
In addition, fluctuations in currency exchange rates could adversely
affect the Company's cash reserve balances. The Company's subsidiaries hold cash
and cash equivalents in local currency in order to provide liquidity for day-to-
day operations. A hypothetical 10% change in foreign exchange rates would have
impacted the Company's cash reserves balances by approximately $0.1 million at
June 30, 2000.
The Company is also exposed to foreign currency risk as a result of:
(i) The FFC Note. The FFC Note bears interest at a rate of 7.75% per
annum, is denominated in Australian dollars, and requires monthly payments of
principal and interest over sixty months . At June 30, 2000, AUD $7,418,000 was
outstanding under the FFC Note. The present value of the future cash outlays
(assuming a 5% discount factor) was equivalent to AUD $8,854,000 at June 30,
2000. A hypothetical 10% fluctuation in the AUD would have impacted the future
cash outlays committed under the FFC Note at June 30, 2000 by approximately $0.5
million.
(ii) The HIH Note. The HIH Note bears interest at 7.75% per annum,
with interest and principal repayable in a bullet at the end of the notes nine-
month term, being February 28, 2001. The note is denominated in Australian
dollars. At June 30, 2000, AUD $5,065,000 was outstanding under the HIH Note.
The present value of the future cash outlays (assuming a 5% discount factor) was
equivalent to AUD $5,087,000 at June 30, 2000. A hypothetical 10% fluctuation in
the AUD would have impacted the future cash outlays committed under the HIH Note
at June 30, 2000 by approximately $0.3 million.
(iii) The Receivables Purchase Agreement ("RPA"). The RPA bears
interest at 14.5% per annum (including line fees), is denominated in Australian
dollars, and requires monthly payments of principal and interest over the sixty
month term of the receivables ("RPA Note"). At June 30, 2000, AUD $6,904,000 was
outstanding under the RPA Note. The present value of the future cash outlays
(assuming a 5% discount factor) was equivalent to AUD $9,366,000 at June 30,
2000. A hypothetical 10% fluctuation in the AUD would have impacted the future
cash outlays committed under the FFC Note at June 30, 2000 by approximately $0.6
million.
Although the Company is not in the business of currency hedging, it
may from time to time engage in currency hedging arrangements. Nevertheless,
there can be no assurance that the Company will be successful in limiting risks
related to currency fluctuations or that changes in exchange rates will not have
a material adverse effect on the Company or its results of operations.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The information required by this item is contained in the financial
statements set forth in Item 14(a) under the caption "Consolidated Financial
Statements" as part of this report.
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There have been no changes in or disagreements with accountants on
accounting or financial disclosure matters during the Company's fiscal years
ended June 30, 2000, 1999 and 1998.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information concerning directors and executive officers of the
Company required under this Item is incorporated herein by reference to the
Company's definitive proxy statement pursuant to Regulation 14A, to be filed
with the Commission not later than 120 days after the close of the Company's
fiscal year ended June 30, 2000.
ITEM 11. EXECUTIVE COMPENSATION
The information concerning directors and executive officers of the
Company required under this Item is incorporated herein by reference to the
Company's definitive proxy statement pursuant to Regulation 14A, to be filed
with the Commission not later than 120 days after the close of the Company's
fiscal year ended June 30, 2000.
ITEM 12: SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information concerning directors and executive officers of the
Company required under this Item is incorporated herein by reference to the
Company's definitive proxy statement pursuant to Regulation 14A, to be filed
with the Commission not later than 120 days after the close of the Company's
fiscal year ended June 30, 2000.
ITEM 13: CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information concerning directors and executive officers of the
Company required under this Item is incorporated herein by reference to the
Company's definitive proxy statement pursuant to Regulation 14A, to be filed
with the Commission not later than 120 days after the close of the Company's
fiscal year ended June 30, 2000.
<PAGE>
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) Documents Filed With This Report:
1. Financial Statements. The following are included herein under Item 8:
Home Security International, Inc.
Report of Independent Public Accountants
Consolidated Statements of Income for the Years Ended June
30, 1998, 1999 and 2000.
Consolidated Balance Sheets as of June 30, 1999 and 2000
Consolidated Statements of Cashflows for the Years
Ended June 30, 1998, 1999 and 2000
Consolidated Statements of Changes in Shareholders' Equity
for the Years Ended June 30, 1998, 1999 and 2000.
Notes to Consolidated Financial Statements
2. Financial Statement Schedules. There are no financial statement
schedules filed as part of this report, since the required information is
included in the financial statements, including notes thereto, or the
circumstances requiring inclusion of such schedules are not present.
3. Exhibits. The following exhibits are filed herewith or incorporated by
reference as indicated. Exhibit numbers refer to Item 601 of Regulation S-K. As
used in the list of Exhibits below, "Registrant" refers to Home Security
International, Inc.
2.1 Share Purchase Agreement relating to the purchase of
shares in FAI Home Security Pty Limited and FAI Home
Security (ENZED) Limited (4)
2.2 NZ Asset Purchase Agreement between FAI Home Security
Holdings New Zealand Limited and FAI Home Security
(ENZED) Limited (4)
2.3 NZ Share Sale Agreement between FAI Home Security
Holdings New Zealand and FAI Home Security
Holdings Pty Limited (4)
2.4 2.4 Trade Mark License Agreement between FAI Insurances
and FAI Home Security Pty Limited (4)
3.1 Certificate of Incorporation of the Registrant (1)
3.2 Bylaws of the Registrant (1)
4.1 IPO Representatives Warrant Agreement (1)
4.2 Warrant dated as of September 30, 1998, issued by the
Registrant to International Home Security
Investments Limited (9)
10.1* Amended and Restated 1997 Employee Stock Option
Plan (2)
10.2* Amended and Restated 1997 Non-Employee Directors' Stock
Option Plan (2)
10.3 International Asset Purchase Agreement between FAI
Insurances and Cooper International Group (2)
10.4 Manufacturing Agreement among Ness Security Products
Pty Limited, FAI Home Security Pty Limited and FAI
Home Security Holdings Pty Limited (4)
10.5* Executive Service Agreement with Bradley D. Cooper (4)
10.6* Amendment to Executive Service Agreement with Bradley
D. Cooper (4)
<PAGE>
10.7* Executive Service Agreement dated July 15, 1997 between
the Registrant and Terrence J. Youngman (4)
10.8* Executive Service Agreement dated July 15, 1997 between
the Registrant and Robert D. Appleby (4)
10.9* Executive Service Agreement dated July 15, 1997 between
the Registrant and Mark Whitaker (4)
10.10* Executive Service Agreement dated July 15, 1997 between
the Registrant and Geoffrey D. Knowles (4)
10.11 Option Agreement dated September 5, 1994 between
Bradley D. Cooper and FAI Insurances Limited (2)
10.12 Sale Agreement dated November 11, 1995, among Bradley
D. Cooper, FAI Insurances Ltd, FAI Home Security
Holding Pty Ltd. and Kamarasi Pty Ltd. (2)
10.13 10.13* Management Services Agreement with Speakeasy
Ltd. (2)
10.14 Promissory Note Payable to Bradley D. Cooper (4)
10.15 Promissory Note Payable to FAI Home Security Holdings
Pty Limited (4)
10.16 Promissory Note Payable to FAI Home Security (ENZED)
Limited (4)
10.17 Share Sale Agreement dated December 31, 1997 by and
between FAI Insurances Limited and FAI Home
Security Pty. Limited (6)
10.18 Shareholders Agreement dated December 31, 1997 by and
between FAI Insurances Limited and FAI Home
Security Pty. Limited (6)
10.19 Consultancy Engagement Agreement effective October 1,
1997, among the Registrant, Speakeasy Pty. Ltd.
and Bradley D. Cooper (7)
10.20 Stock Purchase Agreement dated July 17, 1998 between
the Registrant and International Home Security
Investments Limited (8)
10.21 Stock Purchase Agreement dated as of July 17, 1998, and
amended as of September 30, 1998, by and between
the Registrant and Integral Investments Limited
(9)
10.22 Secured Promissory Note dated as of September 30, 1998,
executed by the Registrant in favor of Integral
Investments Limited (9)
10.23 Share Buy Back Agreement between Ness Security Products
Pty Ltd. and Integrated International Home
Security Limited (10)
10.24 Employment Agreement between Ness Security Products Pty
Limited; Nazareno Circosta and Home Security
International, Inc. (10)
10.25 Termination Agreement between Nazareno Circosta and
Ness Security Products Pty Limited (10)
10.26 Non-Competition Agreement between Nazareno Circosta and
Home Security International, Inc. (10)
10.27 Share Buy Back Agreement between Circosta Pty Limited
and Ness Security Products Pty Limited (10)
10.28 Warrant Certificate (11)
10.29 Form of Warrant Certificate (11)
10.30 Share Sale Agreement between FAI Home Security Pty Ltd.
and FAI Insurances Limited (12)
10.31 Guarantee and Indemnity between Ness Security Products
Pty Limited and FAI Insurances Limited (12)
21.1 List of Subsidiaries
23.1 Consent of Arthur Andersen
23.2 Consent of Deloitte & Touche
27.1 Financial Data Schedule (EDGAR version only)
--------------
*Compensation Plan or Agreement
(1) Incorporated by reference to the Registrant's Registration Statement
on Form S-1 (Registration No. 333- 26399), as amended, filed with the
Securities and Exchange Commission on May 2, 1997
(2) Incorporated by reference to the Registrant's Registration Statement
on Form S-1 (Registration No. 333- 26399), as amended, filed with the
Securities and Exchange Commission on June 10, 1997
(3) Incorporated by reference to the Registrant's Registration Statement
Form S-1 (Registration No. 333- 26399), as amended, filed with the
Securities and Exchange Commission on June 25, 1997
(4) Incorporated by reference to the Registrant's Annual Report on Form
10-K filed with the Securities and Exchange Commission on September
29, 1997
(5) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q filed with the Securities and Exchange Commission on November 14,
1997
(6) Incorporated by reference to the Registrant's Report on Form 8-K filed
with the Securities and Exchange Commission on January 15, 1998
<PAGE>
(7) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q filed with the Securities and Exchange Commission on February 17,
1998
(8) Incorporated by reference to the Registrant's Registration Statement
on Form S-1 (Registration No. 333- 54921), filed with the Securities
and Exchange Commission on July 20, 1998
(9) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q filed with the Securities and Exchange Commission on November 16,
1998
(10) Incorporated by reference to the Registrant's Current Report on
Form 8-K filed with the Securities and Exchange Commission on June 17,
1999
(11) Incorporated by reference to the Registrant's Quarterly Report on Form
10-Q filed with the Securities and Exchange Commission on February 14,
2000.
(12) Incorporated by reference to the Registrant's Current Report on Form
8-K filed with the Securities and Exchange Commission on April 14,
2000.
(b) Reports on Form 8-K:
On October 7, 1998, the Registrant filed a current report on
Form 8-K describing the purchase of 100% of the shares of International
Integrated Home Security Limited by the Registrant.
On December 15, 1998, the Registrant filed an amended
current report on Form 8-K/A to file the requisite financials
associated with the purchase of 100% of the shares of International
Integrated Home Security Limited by the Registrant.
On June 17, 1999, the Registrant filed a current report on
Form 8-K describing the acquisition of the remaining 24.96% interest in
Ness Security Products Pty Limited.
On April 14, 2000, the Registrant filed a current report on
Form 8-K describing the disposition of a 50% interest in FAI Finance
Corporation Pty. Ltd.
<PAGE>
Home Security International, Inc.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
Report of Independent Public Accountant........................... F-2
Independent Auditor's Report...................................... F-3
Consolidated Statement of Income for the years ended
June 30, 1998, 1999 and 2000...................................... F-4
Consolidated Balance Sheets as of June 30, 1999 and 2000.......... F-5
Consolidated Statements of Cashflows for the years Ended
June 30, 1998, 1999 and 2000...................................... F-6
Consolidated Statements of Changes in Shareholders' Equity
for the Years Ended June 30, 1998, 1999 and 2000.................. F-7
Notes to Consolidated Financial Statements........................ F-8
</TABLE>
F-1
<PAGE>
Report of Independent Public Accountants
To the Board of Directors and Shareholders of Home Security International, Inc.;
We have audited the accompanying consolidated balance sheets of Home Security
International, Inc. and subsidiaries (the "Company") as of June 30, 2000 and
1999, and the related consolidated statements of income, shareholders' equity
and cash flows for each of the years in the three-year period ended June 30,
2000. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits. We did not audit the financial statements of
Ness Security Products Pty Limited, which statements reflect total assets and
total revenues of 28 and 29 percent in 2000 of the related consolidated totals.
Those statements were audited by other auditors whose report has been furnished
to us, and our opinion, insofar as it relates to the amounts included for those
entities, is based solely on the report of the other auditors.
We conducted our audits in accordance with auditing standards generally accepted
in Australia, which are substantially consistent with auditing standards
generally accepted in the United States. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits and the report of
other auditors provide a reasonable basis for our opinion.
In our opinion, based on our audit and the report of other auditors the
financial statements referred to above present fairly, in all material respects,
the financial position of Home Security International, Inc. and subsidiaries as
of June 30, 2000 and 1999, and the results of their operations and their cash
flows for each of the three years in the three-year period ended June 30, 2000
in conformity with accounting principles generally accepted in the United
States.
/s/ Arthur Andersen
Sydney
September 29, 2000
F-2
<PAGE>
INDEPENDENT AUDIT REPORT TO THE MEMBERS
---------------------------------------
OF NESS SECURITY PRODUCTS PTY LIMITED
-------------------------------------
Scope
-----
We have audited the financial report of Ness Security Products Pty Limited for
the financial year ended 30 June 2000 as set out on pages 4 to 27. The financial
report includes the consolidated financial statements of the consolidated entity
comprising the company and the entities it controlled at the year's end or from
time to time during the financial year. The company's directors are responsible
for the financial report. We have conducted an independent audit of the
financial report in order to express an opinion on it to the members of the
company.
Our audit has been conducted in accordance with Australian Auditing Standards to
provide reasonable assurance whether the financial report is free of material
mistatement. Our procedures included examination, on a test basis, of evidence
supporting the amounts and other disclosures in the financial report, and the
evaluation of accounting policies and significant accounting estimates. These
procedures have been undertaken to form an opinion whether, in all material
respects, the financial report is presented fairly in accordance with Accounting
Standards issued in Australia and other mandatory professional reporting
requirements and statutory requirements so as to present a view which is
consistent with our understanding of the company's and the consolidated entity's
financial position, and performance as represented by the results of their
operations and their cash flows.
The audit opinion expressed in this report has been formed on the above basis.
Audit Opinion
-------------
In our opinion, the financial report of Ness Security Products Pty Limited is
in accordance with:
(a) the Corporations Law, including:
(i) giving a true and fair view of the company's and consolidated entity's
financial position as at 30 June 2000 and of their performance for the
year ended on that date; and
(ii) complying with According Standards and the Corporations Regulations;
and
(b) other mandatory professional reporting requirements.
/s/ Deloitte Touche Tohmatsu
DELOITTE TOUCHE TOHMATSU
/s/ M. Dreyer
M. Dreyer
Partner
Chartered Accountants
Parramatts, 29 September 2000
_________________________________________
The liability of Deloitte Touche Tohmatsu
is limited by, and to the extent of, the
Accountants' Scheme under the
Professional Standards Act 1994 (NSW).
F-3
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
For the Years Ended June 30,
------------------------------------------------------
1998 1999 2000
Note $US $US $US
---------- ---------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Net Sales 2 44,118,502 45,993,049 28,637,514
Cost of goods sold (26,294,641) (23,274,202) (15,545,007)
---------------- ----------------- -----------------
Gross Profit 17,823,861 22,718,847 13,092,507
General and administrative expenses (9,211,254) (12,754,698) (16,814,046)
Bad and doubtful debts expense (877,073) 81,319 (2,732,975)
Amortization and depreciation (721,989) (1,831,479) (2,809,161)
Impairment of long-lived assets - - (1,698,638)
Research and development - (394,957) (653,908)
---------------- ----------------- -----------------
Income/(Loss) from operations 7,013,545 7,819,032 (11,616,221)
Non operating income - other - - 379,881
Interest income - related party 26,679 - -
- other 423,526 429,795 254,606
Interest expenses - related party (216,629) (377,071) (669,860)
- other (7,904) (559,133) (754,842)
---------------- ----------------- -----------------
Income/(Loss) before taxes, equity in income of
affiliated companies 7,239,217 7,312,623 (12,406,436)
Income tax (expense)/benefit (2,111,084) (3,540,806) 1,240,424
---------------- ----------------- -----------------
Income/(Loss) before equity in income of
affiliated companies 5,128,133 3,771,817 (11,166,012)
252,417 310,421 56,133
- (334,565) -
---------------- ----------------- -----------------
5,380,550 3,747,673 (11,109,879)
================ ================= =================
Net income/(loss) per common share
Basic earnings/(loss) per share $1.05 $0.68 $(1.91)
Diluted earnings/(loss) per share $1.04 $0.68 $(1.91)
Weighted average number of shares outstanding
Basic 5,117,125 5,513,000 5,828,278
Diluted 5,181,612 5,516,751 5,828,795
</TABLE>
F-4
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONSOLIDATED BALANCE SHEET
<TABLE>
<CAPTION>
As of June 30,
------------------------------------------------------
1999 2000
Note $US $US
---------------- ----------------- -----------------
<S> <C> <C> <C>
ASSETS
------
Current assets
Cash and cash equivalents 2,976,240 1,394,133
Accounts receivable - related party 16 217,516 -
Accounts receivable - trade, net 3 3,190,633 2,317,748
Inventories, net 4 6,974,109 8,036,329
Prepaid expenses and other current assets 5 807,016 398,742
----------------- -----------------
Total current assets 14,165,514 12,146,952
================= =================
Non-current assets
Investment in partnership 10 323,398 -
Investment in affiliated companies 11 7,874,928 -
Capital assets, net 8 4,161,791 5,646,876
Restrictive covenant 19 638,458 485,347
Intangibles, net 9 23,014,184 20,499,355
Accounts receivable - trade, net 3 241,588 150,735
Deferred income taxes 15 1,057,559 2,589,771
Receivable - FAI Finance Corporation Pty Limited 16,17 614,581
----------------- -----------------
Total non-current assets 37,311,906 29,986,665
----------------- -----------------
Total assets 51,477,420 42,133,617
================= =================
LIABILITIES AND SHAREHOLDERS' EQUITY
------------------------------------
Current liabilities
Bank overdraft 20 150,938 510,023
Notes payable - FAI Insurances Group 11,16 1,313,400 3,861,290
Note payable - Integral Investments Limited 16,19 8,394,024 -
Borrowing - FAI Finance Corporation
Pty Limited 16,17 - 1,154,022
Payables - trade 3,714,810 4,554,290
Accrued warranty 384,534 418,371
Accrued security callout 314,056 198,057
Other accrued liabilities 696,404 1,563,268
Lease liability 13 438,023 314,328
Income tax payable 1,355,696 -
Deferred income 1,032,099 1,447,994
----------------- -----------------
Total current liabilities 17,793,984 14,021,643
----------------- -----------------
Non-current liabilities
Note payable - FAI Insurances Group 11,16 3,447,675 3,659,703
Borrowing - FAI Finance Corporation Pty Limited 16,17 - 3,619,976
Lease liability 13 720,512 574,608
Other accrued liabilities 56,013 56,490
Accrued security callout 147,564 113,506
Accrued warranty - 116,048
Deferred income 238,019 1,640,151
----------------- -----------------
Total non-current liabilities 4,609,783 9,780,482
----------------- -----------------
Total liabilities 22,403,767 23,802,125
================= =================
Shareholders' equity
Preferred stock $.001 value; 1,000,000 shares
authorized, none outstanding - -
Common stock $.001 value; 20,000,000 shares authorized
and 5,828,278 shares issued and outstanding
18 5,828 5,828
Additional paid - in capital 22,309,708 22,309,708
Warrants 7 504,000 1,064,000
Secured note 6 (2,375,000) (2,375,000)
Accumulated other comprehensive loss (452,532) (644,814)
Retained earnings/(accumulated losses) 9,081,649 (2,028,230)
----------------- -----------------
Total shareholders' equity 29,073,653 18,331,492
----------------- -----------------
Total liabilities and shareholders' equity 51,477,420 42,133,617
================= =================
</TABLE>
F-5
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF CASHFLOW
<TABLE>
<CAPTION>
For the Years Ended June 30,
------------------------------------------------------
1998 1999 2000
Note $US $US $US
--------- ---------------- ----------------- -----------------
<S> <C> <C> <C> <C>
Cashflow from operating activities
Net income/(loss) 5,380,550 3,747,673 (11,109,879)
Adjustments to reconcile net income to net
cash from operating activities:
Depreciation 181,835 540,282 990,052
Minority interest - 334,565 -
Imputed interest - 527,982 733,857
Amortisation of goodwill 540,154 1,040,391 1,335,315
Impairment of long-lived assets - - 1,698,638
Amortisation of leased assets - 243,487 483,794
Profit on sale of capital assets - (36,869) (37,885)
Profit on sale of investments, net - - (281,881)
Debt discount - - (98,000)
Equity in income of affiliated companies (252,417) (310,421) (56,133)
Deferred income taxes (585,314) (1,574,764) (2,746,522)
Bad and doubtful debts expense 877,073 (81,319) 2,732,975
Provisions for stock obsolescence - (1,047) 238,095
Decrease/(Increase) in operating assets:
Accounts receivable - trade (1,231,965) (1,679,996) (1,589,037)
Inventories (930,349) 1,045,771 (1,861,691)
Prepaid expenses and other assets (830,074) 125,586 408,274
Increase in operating liabilities:
Accounts payable 1,051,807 365,190 1,536,073
Accrued liabilities 1,774,149 1,090 3,007,366
---------------- ----------------- -----------------
Net cash provided by/(used in) operating activities
5,975,449 4,287,601 (4,616,589)
---------------- ----------------- -----------------
Cashflow from investing activities
Proceeds from sale of capital assets - 105,022 53,693
Additions to capital assets (553,404) (1,424,405) (3,287,421)
Investment in affiliated companies (2,000,578) 289,650 -
Investment in partnership (303,424) (1,542) -
Purchase of controlled entity, net of cash acquired - (9,115,382) -
Restrictive covenant - (627,110) -
Short term repayments received / (loans granted) 23,488 (234,833) (652,284)
Proceeds from sale of investment - - 8,117,567
---------------- ----------------- -----------------
Net cash (used in)/ provided by investing
activities (2,833,918) (11,008,600) 4,231,555
---------------- ----------------- -----------------
Cashflow from financing activities
Capital subscribed 3,934,678 2,599,352 -
Share issue costs (436,408) - -
Funds from sale and leaseback of fixed assets - 627,027 -
Finance lease payments - (188,125) (346,391)
Receipt from/ (payment to) related parties 1,020,054 (250,844) (1,427,688)
Net repayments of borrowings - (509,090) -
(Decrease)/ Increase in bank overdraft (29,055) 125,844 359,085
---------------- ----------------- -----------------
Net cash provided by (used in) financing
activities 4,489,269 2,404,164 (1,414,994)
---------------- ----------------- -----------------
Net increase (decrease) in cash held 7,630,800 (4,316,835) (1,800,028)
Cash at the beginning of the financial period 118 7,006,183 2,976,240
Effect of exchange rate changes on cash (624,735) 286,892 217,921
---------------- ----------------- -----------------
Cash at the end of the financial period 7,006,183 2,976,240 1,394,133
================ ================= =================
Supplemental disclosure of cash information
Interest paid 224,533 411,985 685,208
Income taxes paid 1,249,831 3,995,368 1,769,572
</TABLE>
F-6
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY
<TABLE>
<CAPTION>
Additional Accumulated Cumulative Total
Paid-in Retained Translation Secured Shareholders'
Amount Capital Earnings Adjustment Warrants Note Equity
$US $US $US $US $US $US $US
----------- ------------- --------------- --------------- ------------- ------------- --------------
<S> <C> <C> <C> <C> <C> <C> <C>
BALANCE, JUNE 30, 1997 4,500 10,238,691 (46,574) (406,534) - - 9,790,083
Comprehensive income 5,380,550 (570,031) 4,810,519
Additional paid-in capital 400 4,004,600 4,005,000
Issue of shares to
Bradley D. Cooper 250 2,499,750 (2,375,000) 125,000
Less share issue costs 0 (631,730) (631,730)
---------- ------------ -------------- -------------- ------------ ------------ --------------
BALANCE, JUNE 30, 1998 5,150 16,111,311 5,333,976 (976,565) - (2,375,000) 18,098,872
Comprehensive income 3,747,673 524,033 4,271,706
Issue of 677,778 shares 678 6,198,397 6,199,075
Issue of warrants to
purchase Common Stock 504,000 504,000
---------- ------------ -------------- -------------- ------------ ------------ --------------
BALANCE, JUNE 30, 1999 5,828 22,309,708 9,081,649 (452,532) 504,000 (2,375,000) 29,073,653
Comprehensive income (11,109,879) (192,282) (11,302,161)
Issue of warrants to
purchase Common Stock 560,000 560,000
---------- ------------ -------------- -------------- ------------ ------------ --------------
BALANCE, JUNE 30, 2000 5,828 22,309,708 (2,028,230) (644,814) 1,064,000 (2,375,000) 18,331,492
========== ============ ============== ============== ============ ============ ==============
</TABLE>
F-7
<PAGE>
HOME SECURITY INTERNATIONAL, INC.
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
(All amounts in US$ unless stated otherwise)
NOTE 1 : NATURE OF BUSINESS AND SIGNIFICANT ACCOUNTING POLICIES
a) Nature of Business -
Home Security International, Inc. ("HSI") was incorporated in the state of
Delaware, United States of America, on April 11, 1997. On June 30, 1997 HSI
acquired from a subsidiary of FAI Insurances Limited and from various companies
controlled by Bradley D. Cooper, the home security operations in Australia, New
Zealand, the United Kingdom (including certain European countries), South
Africa, Canada and the United States of America.
The main business activities of the Company are the design, manufacture, sale,
service and monitoring of security alarm systems, which are sold via a
distributor network to residential and small business premises in the countries
of operations.
On December 31, 1997 the Company acquired 50 percent of the equity interest in
FAI Finance Corporation Pty Limited (together with its subsidiary FAI Finance
Corporation (NZ) Limited, herein call "FFC") from FAI Insurances Ltd. FFC is a
consumer finance company in both Australia and New Zealand and finances a
significant portion of customer accounts of the Company's distributorship
network in Australia and New Zealand. On March 31, 2000 the Company sold it's 50
percent equity interest in FFC back to FAI Insurances Ltd (see Note 11).
Effective October 1, 1998, the Company purchased all of the issued and
outstanding common stock of Integrated International Home Security Limited
("IIHSL"), a British Virgin Islands holding company ("the Ness transaction").
IIHSL held 75.04 percent of the issued and outstanding common stock of Ness
Security Products Pty Limited ("Ness") up until April 9, 1999. On April 9, 1999
IIHSL acquired the remaining 24.96% of the issued and outstanding common stock
of Ness. Ness is a leading manufacturer of security alarm products in Australia
and the Company's sole supplier of the SecurityGuard alarm.
Effective December 31, 1999, as part of an internal restructure IIHSL's holding
of the issued and outstanding common stock of Ness was transferred to FAI Home
Security Pty Limited. On June 29, 2000, the Company dissolved IIHSL as a result
of its inactivity.
b) Principles of Consolidation and Basis of Preparation -
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles in the United States of
America ("US GAAP").
All significant intercompany accounts and transactions have been eliminated upon
consolidation.
c) Cash and Cash Equivalents -
Cash equivalents consist of short-term, highly liquid, investments with
maturities of three months or less and are stated at cost, which approximates
fair value.
d) Foreign Currencies -
The consolidated financial statements are translated into US dollars to reflect
the Company's reporting currency. The assets and liabilities are translated at
the balance sheet date exchange rate. The profit and loss items have been
translated at the weighted average exchange rates for the fiscal year. The
resulting translation effects are reflected in other comprehensive income, a
component of shareholders' equity.
e) Use of Estimates -
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the amounts reported in the financial statements and accompanying notes.
Actual results could differ from those estimates, and such differences may be
material to the financial statements.
F-8
<PAGE>
f) Income Taxes -
The Company accounts for income taxes under Statement of Financial Accounting
Standards ("SFAS") No. 109 "Accounting for Income Taxes" which requires an asset
and liability method of accounting for income taxes. Under SFAS No. 109,
deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amount of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the year in which those temporary
differences are expected to be recovered or settled. Under SFAS No. 109, the
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. A valuation
allowance reduces deferred tax assets when it is "more likely than not" that
some portion or all of the deferred tax assets will not be realised.
g) Revenue Recognition -
Revenue from the sale of security systems is recognized at the time of shipment
of products and is shown net of returns and rebates (see Note 2). Recognition of
revenue from the sale of monitored security systems is split between revenue
relating to sale of the security system and revenue relating to monitoring
services. Revenue relating to monitoring services is recognised over the period
the services are provided. All unearned portions of the monitoring revenues are
recorded in the balance sheet as "Deferred Income". Management estimates the
total amount of revenue to be allocated between the sale of the equipment and
monitoring services based on the respective margins realised when sold
separately.
The Company sells extended product warranties for periods of one to two years.
Extended product warranty revenues are recognized on a straight-line basis over
the respective lives of the warranties. As customers pay upfront for the product
warranties, all unearned portions of the product warranty revenues are recorded
in the balance sheet as "Deferred Income".
The Company also sells monitoring contracts to its existing customers for
periods of up to five years. Monitoring revenue derived from existing customers
is recognized each month as monitoring services are provided.
h) Allowance for Doubtful Accounts -
Management reviews the collectability of accounts receivable on a regular basis.
Amounts, if any, which are determined to be uncollectable, are provided for in
the financial statements in the period such determination is made.
i) Inventories -
Inventories consist of work in progress, finished goods and raw materials.
Inventories are stated at the lower of cost (first-in, first-out method) or
market. The elements of cost include direct labor, raw materials and
manufacturing overhead.
j) Capital assets -
Capital assets are recorded at cost. Maintenance and repairs are expensed in the
period to which they are incurred. Capital assets under capital leases (see Note
13) are amortized over the lease terms.
Capitalized upgrade costs consist of product, selling and installation costs
associated with the upgrade of the Company's existing customers to its monitored
alarm systems. These costs have been capitalized and will be expensed over the
same period revenues are earned and recognised on each contract, being
predominantly five years.
Depreciation and amortization on capital assets is calculated using the
straight-line method over the following estimated useful lives of the assets:
Years
Furniture and fixtures 8.0
Plant and machinery 5.0
Office equipment 8.0
Motor vehicles 6.5
Computer equipment 3.5
Leasehold improvements 3.0
<PAGE>
Capitalized diallers 5.0
Capitalized upgrade costs 5.0
k) Leased Assets -
Leased assets, classified as finance leases, are recorded at the present value
of minimum lease payments. A financed lease is one which effectively transfers
from the lessor to the lessee substantially all the risks and benefits
incidental to ownership of the leased property. Capitalized leased assets are
amortized on a straight-line basis over the estimated useful life of the asset.
Finance lease payments are allocated between interest expense and the reduction
of lease liability over the term of the lease. The interest expense is
determined by applying the interest rate implicit in the lease to the
outstanding lease liability at the beginning of each lease payment period.
Operating lease payments are charged as an expense in the period in which they
are incurred.
l) Research and Development -
Research and development costs consist of expenditures incurred during the
course of planned search and investigation aimed at discovery of new knowledge
which will be useful in developing new products or processes, or significantly
enhancing existing products or production processes, and the implementation of
such through design, testing of product alternatives or construction of
prototypes. The Company expenses all research and development costs as they are
incurred.
m) Employee Benefit Plans -
The Company contributes to pension plans on behalf of its employees. The pension
plans are accumulation funds and the Company has no liability to members under
the plans. The Company charges all contributions as expenses when incurred. The
Company contributed a total of $471,610 to pension plans during fiscal year
ended June 30, 2000 compared to $361,740 in fiscal year ended June 30, 1999 and
$172,104 in fiscal year ended June 30, 1998. The Company has no other pension or
other employment benefit plans.
n) Intangible Assets -
Intangible assets represent the excess of cost over fair value of assets
acquired and are amortized using the straight-line method over twenty years.
o) Long-Lived Assets -
Long-lived assets consist primarily of capital assets and intangible assets. In
accordance with Statement of Financial Accounting Standards No.121 "Accounting
for Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed Of"
("SFAS 121"), the recoverability of long-lived assets is evaluated at the
operating segment level by an analysis of operating results and consideration of
other significant events or changes in the business environment. If an operating
segment has indications of possible impairment such as current operating losses
and projections that there is a likelihood that such operating losses will
continue, the Company will evaluate whether impairment exists on the basis of
undiscounted expected future cash flows from operations before interest for the
remaining life of the asset. If an impairment exists, the carrying amount of the
related long-lived asset is reduced to its estimated fair value (See Note 9).
p) Warranty -
The Company warrants its products against defects in design, materials and
workmanship for up to two years from the date of installation. A provision for
estimated warranty costs is recorded at the time of the sale based on
management's best estimate of future warranty costs. Management's estimate is
based upon historical warranty costs and is periodically adjusted to reflect
actual experience.
q) Security call-out -
<PAGE>
Historically, the Company provided a free of charge security call-out service
for emergency response for five years from the date each non-monitored alarm
system was installed. A provision for estimated security call-outs is recorded
based on management's best estimate of future security call-out costs.
Management's estimate is based upon historical security call-out costs and is
periodically adjusted to reflect actual experience. The Company does not provide
free of charge security call-out services for emergency response with monitored
alarm systems except where a police report is issued.
r) Derivative Financial Instruments -
The Company periodically enters into forward currency exchange contracts and
options to manage the risk of foreign currency fluctuations, since a significant
portion of its sales are in foreign currencies and the Company presently
purchases certain raw materials offshore. The change in fair value of the
contracts is recognized immediately and included in the determination of net
income. The Company is not a trader in derivative securities, and it has not
used speculative derivative products for the purpose of generating earnings from
changes in market conditions.
s) Earnings per Share -
Earnings per share have been computed according to the provisions of SFAS No.
128 "Earnings Per Share" using the weighted average number of shares
outstanding. Diluted earnings per share have been computed based on the
assumption that dilutive stock options and warrants have been exercised.
t) Stock Option Plan -
The Company accounts for its stock option plans (the "Option Plans") in
accordance with the provisions of Accounting Principles Board ("APB") Opinion
No. 25, ("Accounting for Stock Issued to Employees"). As such, compensation
expense is recorded on the date of grant only if the current market price of the
underlying stock exceeds the exercise price. SFAS No. 123 "Accounting for Stock
Based Compensation", which the Company adopted in 1996, allows entities to
continue to apply the provisions of APB Opinion No. 25 but requires pro forma
net earnings and pro forma earnings per share disclosures for employee stock
option grants made in 1995 and thereafter as if the fair-value-based method
defined in SFAS No. 123 had been applied. The Company has determined that the
net income and net income per common share would not be materially affected by
the provision of SFAS No. 123.
u) New Accounting Pronouncements -
Organizations that set accounting standards in the United States have issued
several accounting pronouncements that the Company will be required to adopt in
future reporting periods.
SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities" was
issued in June 1998 and establishes accounting and reporting standards for
derivative instruments, including certain derivative instruments embedded in
other contracts, (collectively referred to as derivatives) and for hedging
activities. It requires that an entity recognize all derivatives as either
assets or liabilities in the statement of financial position and measures those
instruments at fair value. As issued, this Statement is effective for all fiscal
quarters, beginning after June 15, 1999, with earlier application encouraged.
Subsequently, in June 1999, SFAS No 137 "Accounting for Derivative Instruments
and Hedging Activities - Deferral of Effective Date of FASB Statement No.133"
was issued. This pronouncement changed the effective date of SFAS No.133 to all
fiscal years beginning after June 15, 2000, with earlier application encouraged.
Management of the Company is evaluating this new pronouncement to determine its
impact upon future reporting.
Emerging Issues Task Force ("EITF") 2000-14 "Accounting for Certain Sales
Incentives" was issued in May of 2000 and provides guidance on the recognition,
measurement and income statement classification for sales incentives offered
voluntarily by a vendor to its customers. This EITF is effective for all
reporting periods beginning after May 18, 2000. Management of the Company is
evaluating this pronouncement to determine its impact upon future reporting.
FASB Interpretation No. 44 "Accounting for Certain Transactions Involving Stock
Compensation" (an interpretation of APB Opinion No. 25) was issued in March of
2000 and clarifies certain items in the application of APB Opinion No. 25. This
interpretation is effective July 1, 2000. Management of the Company is
evaluating this pronouncement to determine its impact upon future reporting.
w) Prior Year Reclassifications
Certain reclassifications have been made to prior year information to conform
with current year presentation.
<PAGE>
NOTE 2: NET SALES
<TABLE>
<CAPTION>
-------------------------------------------------------------
Year Ended June 30,
-------------------------------------------------------------
1998 1999 2000
--------------------- ------------------- ------------------
<S> <C> <C> <C>
Direct retail sales 6,332,955 8,615,256
-
Distributor sales 42,858,457 38,036,152 16,668,046
Monitoring sales 91,657 1,017,516
-
Other 1,553,592 1,756,492 2,588,366
--------------------- ------------------- ------------------
Gross sales 44,412,049 46,217,256 28,889,184
Less: Returns and rebates (293,547) (224,207) (251,670)
--------------------- ------------------- ------------------
Net sales 44,118,502 45,993,049 28,637,514
===================== =================== ==================
</TABLE>
NOTE 3: ACCOUNTS RECEIVABLE-TRADE
<TABLE>
<CAPTION>
June 30,
1999 2000
------------------ -----------------
<S> <C> <C>
Accounts receivable - trade 3,661,215 2,987,660
Less: Allowance for doubtful accounts (228,994) (519,177)
------------------ -----------------
Accounts receivable - trade, net 3,432,221 2,468,483
Less: non-current portion (241,588) (150,735)
------------------ -----------------
Current portion 3,190,633 2,317,748
================== =================
</TABLE>
NOTE 4: INVENTORIES
<TABLE>
<CAPTION>
June 30,
1999 2000
------------------- -----------------
<S> <C> <C>
Finished goods 4,025,348 3,946,765
Work in progress 288,382 372,676
Raw materials 3,158,131 4,403,478
------------------ -----------------
7,471,861 8,722,919
Less: provision for obsolescence (497,752) (686,590)
------------------ -----------------
6,974,109 8,036,329
================== =================
</TABLE>
NOTE 5: PREPAID EXPENSES AND OTHER CURRENT ASSETS
<TABLE>
<CAPTION>
June 30,
1999 2000
------------------ -----------------
<S> <C> <C>
Prepayments 128,791 90,613
Other loans/(borrowings) - Bradley D. Cooper 131,375 (101,200)
Other loans - Nazareno Circosta 98,505 90,375
Sundry debtors 448,345 318,954
------------------ -----------------
807,016 398,742
================== =================
</TABLE>
Other loans/(borrowings) to/(from) Bradley D. Cooper, the Company's Chief
Executive Officer, and Nazareno Circosta, Ness Security Products Pty Limited's
Managing Director, represent unsecured loan advances, repayable on demand and
bear interest at commercial rates. Mr Cooper's loan as at June 30, 1999 includes
interest on the secured note (see Note 6), net of amounts due to Mr Cooper.
NOTE 6: SECURED NOTE
On July 15, 1997 Bradley D. Cooper purchased 250,000 shares of the Company's
Common Stock at $10.00 per share. Five percent (5%) of the purchase price for
the shares, being $125,000, was paid by Mr. Cooper in cash and the remainder,
$2,375,000, was paid through a five-year note to the Company bearing interest at
7.0% per annum, payable semi-annually, and secured by the shares purchased. The
note is repayable on the fifth anniversary of its issuance. The interest payable
on the note is due on a full recourse basis. During the fiscal year ended June
30, 2000, interest totaling $166,705 under this loan was charged as a reduction
to amounts owed to Mr Cooper (see Note 5).
<PAGE>
NOTE 7: WARRANTS
As of October 1, 1998, 1999 and January 1, 2000, the Company issued five year
convertible warrants to purchase 360,000, 200,000 and 200,000 shares of Common
Stock respectively, to International Home Security Investments Limited
("Holder") pursuant to the terms originating from the Ness transaction (see Note
19). Each warrant has a market value of U.S. $1.40 as at the date of issuance.
Each warrant entitles the holder, upon exercise, to receive from the Company one
share of fully paid, non-assessable Common Stock of the Company for U.S. $13.00.
NOTE 8: CAPITAL ASSETS
<TABLE>
<CAPTION>
June 30,
1999 2000
------------------ ------------------
<S> <C> <C>
Furniture and fixtures 382,839 381,620
Office equipment 665,245 701,524
Motor vehicles 633,972 820,108
Computer equipment 612,727 454,821
Plant 2,713,455 2,629,129
Leasehold improvements 305,279 177,308
Capitalized diallers - 1,063,159
Capitalized upgrade costs 701,000 2,165,488
Less: Accumulated depreciation and amortization (1,852,726) (2,746,281)
------------------ ------------------
4,161,791 5,646,876
================== ==================
</TABLE>
Depreciation and amortization expense for capital assets was $1,473,846,
$783,769 and $181,835 for the fiscal years ended June 30, 2000, 1999, and 1998
respectively.
NOTE 9: INTANGIBLES
<TABLE>
<CAPTION>
June 30,
1999 2000
------------------ ------------------
<S> <C> <C>
Goodwill on investment 25,514,670 25,805,951
Less: Impairment (1,698,638)
-
Less: Accumulated amortization (2,500,486) (3,607,958)
------------------ -----------------
23,014,184 20,499,355
================== =================
</TABLE>
Goodwill represents (1) the excess of the purchase price paid by the then
ultimate parent entity, FAI Insurances Limited over the fair value of assets
acquired as part of the reorganization, (2) the excess of the purchase price
paid by the Company over the fair value of assets acquired when the Company
purchased all of the issued and outstanding common stock of IIHSL, and (3) the
excess of the purchase price paid by IIHSL over the fair value of assets
acquired when IIHSL acquired the remaining 24.96% of the issued and outstanding
common stock of Ness.
Due to the continued losses since the inception of the United Kingdom and North
American operations, management made an assessment of the fair values of the
long-lived assets of these entities. Based on fair value assessments using
undiscounted future cash flow projections in accordance with SFAS 121,
management concluded that the intangible assets related to the operations in the
United Kingdom and North America were fully impaired as of June 30, 2000.
Due to the significant fall in revenues, and large operating loss, experienced
by the Australian and New Zealand operations during the year ended June 30,
2000, management has made an assessment of the fair value of the long lived
assets in these regions. In accordance with SFAS 121, based on undiscounted
future cash flow projections, management concluded that there is no impairment
in the intangible assets in relation to Australia and New Zealand as of June 30,
2000 (written down value $6,963,558). The undiscounted cash flow projections
utilized to make this assessment forecast a substantial increase in the level of
sales over those currently being achieved. Uncertainty exists as to whether the
predicted level of sales activity will be achieved. Management believes that the
cash received as a result of the 49% sale of the Ness manufacturing operation,
subsequent to June 30, 2000 (see Note 21) will be sufficient to allow the
necessary investment to meet the sales targets forecast.
Total impairment of goodwill recorded during the fiscal year ended June 30, 2000
can be analyzed as follows:
United Kingdom 738,142
North America 960,496
-----------------------
1,698,638
=======================
<PAGE>
NOTE 10: INVESTMENT IN PARTNERSHIP
Effective June 30, 1998, the Company purchased a 49 percent interest in a
partnership (the "Partnership") that has entered into an agreement with Prime
Life Corporation Limited to acquire a retirement village in Melbourne,
Australia. On June 30, 1999 the Partnership was converted to a limited
partnership. The investment balance of $323,398 in the Partnership was accounted
for using the purchase method. Accordingly, the Company has not recognized any
Partnership earnings in either the 1998, 1999 or 2000 fiscal years. The Company
was unable to reach an agreement with Prime Life Corporation Limited as to the
appropriate management fee to be charged for the administration of this passive
investment. As a result, in December of 1999, the Company wrote off its
investment in the Partnership.
NOTE 11: INVESTMENT IN AFFILIATED COMPANIES
On December 31, 1997 the Company purchased 50 percent of the issued and
outstanding shares (the "FFC Shares") of FAI Finance Corporation Pty Limited and
its subsidiary FAI Finance Corporation (NZ) Limited ("FFC") from FAI Insurances
Ltd (the "FFC Transaction"). FFC, a consumer finance company with operations in
Australia and New Zealand, finances a significant portion of the Company's
financed sales.
The purchase price of $7,059,525, related to the FFC transaction, included
direct costs incurred during the acquisition and was allocated to the net assets
of FFC based on the estimated fair market values. As a result of the allocation,
$6,226,382 of the purchase price was allocated to goodwill.
The purchase price for the FFC Shares was paid through the issuance of a five
year promissory note (the "FAI Note"), bearing interest at 7.75% per annum,
secured by the FFC Shares.
During the fiscal year ended June 30, 1998, FFC declared a dividend of
$1,970,100. The Company has classified its 50 percent share of the dividend as
"Investment in affiliated companies", as the dividend was reinvested in FFC
during the quarter ended September 30, 1998.
Effective March 31, 2000, the Company, through its wholly-owned subsidiary FAI
Home Security Pty Limited ("FHS"), sold its 50% interest in FFC to FAI
Insurances Limited ("FAI") for approximately $8,117,567 (the "Sale"). The
Company recognized a gain on the Sale of $598,864 which forms part of "Non-
operating income" in the consolidated statement of income. On April 7, 2000, FAI
paid FHS $2,400,000. The remainder of the sale price was paid on April 26, 2000.
FAI, which owns approximately 47% of the common stock of the Company, is a
wholly owned subsidiary of HIH Insurance Limited ("HIH").
At the time of the sale, approximately $4,439,175 of the FAI Note remained
outstanding. Pursuant to the terms of the Sale, FAI extended the payment terms
of the FAI Note, which is guaranteed by a security interest in Ness Security
Products Pty. Ltd. ("Ness"). Upon receipt of the proceeds of the Sale, the
Company paid to Integrated Investments Limited ("IIL") $8,200,000 in full
settlement of the $8,298,000 due to IIL as of June 30, 2000 (the "IIL Payment").
The decrease in the amount paid versus that owed as of June 30, 2000 reflects a
discount for the time value of money. As the proceeds from the Sale were
insufficient to pay IIL in full, FAI lent the shortfall, being $316,088, to FHS
and added that amount to the FAI Note which accrues annual interest at the rate
of 7.75% and requires monthly payments of principal and interest over sixty
months, with a maturity date of March 26, 2005. As of June 30, 2000, total
principal payments payable per fiscal year are due as follows:
2000/2001 809,701
2001/2002 874,731
2002/2003 944,983
2003/2004 1,020,877
2004/2005 819,113
-----------------------
4,469,405
=======================
<PAGE>
NOTE 12: FAIR VALUE OF FINANCIAL INSTRUMENTS
The carrying amounts reflected in the consolidated balance sheets for cash
equivalents, accounts receivable and payable approximate their respective fair
values due to the short maturities of those instruments. The carrying value of
the long-term payables to FAI Insurances Limited and FAI Finance Corporation Pty
Limited approximates their fair values as the related interest rates for each
loan were renegotiated and granted, respectively, at rates which approximate
market.
NOTE 13: LEASE COMMITMENTS
The Company leases several production facilities and motor vehicles under long -
term leases and has the option to purchase the facilities for a normal cost at
the termination of the lease. Included in property, plant and equipment are the
following assets held under capital leases.
Capital leases
<TABLE>
<CAPTION>
June 30,
1999 2000
------------------ -----------------
<S> <C> <C>
Motor vehicles 340,776 354,765
Plant and machinery 1,392,496 1,269,434
------------------ -----------------
1,733,272 1,624,199
Less: accumulated amortization (686,402) (767,412)
------------------ -----------------
1,046,870 856,787
================== =================
</TABLE>
The following is a schedule by year of future gross minimum rental payments for
all capital leases reconciled to the present value of net minimum finance lease
payments as of June 30, 2000.
Minimum rental payments for all capital leases
<TABLE>
<CAPTION>
June 30,
1999 2000
------------------ -----------------
<S> <C> <C>
Payable no later than one year 520,784 371,645
Payable later than one year but not later than two years 307,936 240,535
Payable later than two years but not later than three years 190,861 338,679
Payable later than three years but not later than four years 310,012 56,632
------------------ -----------------
Minimum lease payments 1,329,593 1,007,491
Less: amount representing interest 171,058 118,555
------------------ -----------------
Present value of net minimum lease payments 1,158,535 888,936
Less: current portion 438,023 314,328
------------------ -----------------
Long-term obligations under capital leases 720,512 574,608
================== =================
</TABLE>
Operating lease commitments
<TABLE>
<CAPTION>
June 30,
1999 2000
------------------ -----------------
<S> <C> <C>
Payable no later than one year 425,076 783,728
Payable later than one year but not later than two years 376,219 725,750
Payable later than two years but not later than three years 297,909 396,656
Payable later than three years but not later than four years 120,117 4,606
------------------ -----------------
Total minimum operating lease payments 1,219,321 1,910,740
================== =================
</TABLE>
The operating lease commitments of the Company consist of property rentals used
as offices in Sydney, Melbourne, Brisbane and Perth and computer equipment
leases.
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------------------------------
1998 1999 2000
-------------------- ------------------ -----------------
<S> <C> <C> <C>
Rent expenses 316,220 560,196 606,513
</TABLE>
<PAGE>
NOTE 14: SEGMENT INFORMATION
The Company operates principally in one industry segment including the design,
manufacture, sale, service and monitoring of security alarm systems. The
Company's identifies its segments based on management responsibility within
Australasia, Europe, North America and other segments. No single customer
accounts for more than 10% of the Company's revenues.
Effective July 1, 1998, the Company adopted SFAS No. 131, "Disclosure about
Segments of an Enterprise and Related Information" SFAS No. 131 introduces a new
model for segment reporting called the " management approach". The management
approach is based on the way that the chief operating decision maker, or
decision making group, organize segments within the company for making operating
decisions and assessing performance. The Company's operating decision making
group consists of various members of management. The operating segments are
managed separately because each operating segment represents a strategic
business unit that serves different geographic markets.
The Company's reportable segments include Australasia, Europe, North America and
other segments. Information about the Company's reportable segments split by
geographic location is shown below.
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------------------------------
1998 1999 2000
-------------------- ------------------ -----------------
<S> <C> <C> <C>
Net sales:
Australasia 38,984,766 40,649,874 25,029,170
Europe 3,469,824 4,500,221 3,281,435
North America 742,142 332,968 214,272
Other 921,770 509,986 112,637
-------------------- ------------------ -----------------
44,118,502 45,993,049 28,637,514
==================== ================== =================
Income (loss) from operations:
Australasia 8,349,647 10,687,595 (6,308,043)
Europe (124,231) (112,191) 3,894
North America (1,317,008) (2,544,841) (5,239,484)
Other 105,137 (211,531) (72,588)
-------------------- ------------------ -----------------
7,013,545 7,819,032 (11,616,221)
==================== ================== =================
Impairment of long-lived assets:
Australasia - - 183,086
Europe - - 738,142
North America - - 777,410
Other - - -
-------------------- ------------------ -----------------
- - 1,698,638
==================== ================== =================
Depreciation and amortization of capital assets:
Australasia 164,642 737,705 1,453,883
Europe 11,434 18,368 19,963
North America 5,759 27,696 -
Other - - -
-------------------- ------------------ -----------------
181,835 783,769 1,473,846
==================== ================== =================
Amortization of intangible assets:
Australasia 447,135 920,234 1,199,789
Europe 43,854 43,854 40,199
North America 46,180 46,180 42,331
Other 2,985 30,123 52,996
-------------------- ------------------ -----------------
540,154 1,040,391 1,335,315
==================== ================== =================
</TABLE>
<PAGE>
<TABLE>
<S> <C> <C> <C>
Capital expenditure:
Australasia 572,116 1,392,121 3,267,442
Europe 42,305 28,961 5,408
North America 26,897 - 14,571
Other - 3,323 0
-------------------- ------------------ -----------------
641,318 1,424,405 3,287,421
==================== ================== =================
</TABLE>
<TABLE>
<CAPTION>
June 30,
1999 2000
------------------ -----------------
<S> <C> <C>
Identifiable assets: 43,799,762 39,425,198
Australasia 1,473,681 897,331
Europe 797,064 333,063
North America 2,430,673 83,891
------------------ -----------------
Other 48,501,180 40,739,483
2,976,240 1,394,134
------------------ -----------------
Corporate assets 51,477,420 42,133,617
================== =================
</TABLE>
Identifiable assets are those assets that are identified with the operation in
each geographic area. Corporate assets are principally cash and short-term
deposits.
NOTE 15: INCOME TAX
The actual income tax expense/(benefit) attributable to net income differed from
the amounts computed by applying local federal tax rates to income before taxes
as a result of the following:
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------------------------------
1998 1999 2000
-------------------- ------------------ -----------------
<S> <C> <C> <C>
Expected income tax expense / (benefit) at
statutory rates 2,657,809 2,448,691 (4,058,016)
Tax effect of permanent and other differences:
(Over)/under provision for income tax
in prior years (5,622) 16,195 (43,180)
Writeback/(deduction) allocated from
investment in Partnership (600,609) 553,111 (550,302)
Non-deductible expenses and other items
69,264 246,729 459,276
Non-assessable income and other items
(198,812) (107,694) (677,195)
Amortization of goodwill 189,054 383,774 591,069
Impairment of goodwill 530,443
- -
Impact of change in future tax rates
- - 120,829
Valuation allowance 2,386,651
- -
-------------------- ------------------ -----------------
2,111,084 3,540,806 (1,240,425)
==================== ================== =================
The tax expense/(benefit) is split between:
Current 2,578,343 3,581,713 291,788
Deferred (467,259) (40,907) (1,532,213)
--------------------- ------------------- ------------------
2,111,084 3,540,806 (1,240,425)
===================== =================== ==================
</TABLE>
<TABLE>
<CAPTION>
June 30,
1999 2000
------------------ ------------------
<S> <C> <C>
Deferred tax assets are comprised of timing
differences on:
Provisions not currently deductible
for tax purposes for:
Doubtful accounts 18,576 176,552
Warranty 122,248 166,012
Employee entitlements 283,397 300,588
</TABLE>
<PAGE>
<TABLE>
<S> <C> <C>
Security call - out 136,601 90,520
Stock obsolescence 106,528 227,973
Other 59,962 316,317
Sundry accruals 28,203 (50,439)
Investment in partnership (579,209) -
Capitalized monitoring costs (241,430) (627,113)
Tax losses carried forward 1,192,295 4,379,409
Prepayments (69,612) (18,501)
Valuation allowance - (2,371,547)
------------------ -----------------
Net deferred tax assets 1,057,559 2,589,771
================== =================
</TABLE>
As of June 30, 2000, the tax assets derived from net operating loss carry
forwards (NOLs) consist of NOL tax assets with expiration dates as follows:
2005 210,827
2007 5,937
2013 54,092
2019 698,281
2020 1,117,125
No Expiration 2,293,147
------------------------
4,379,409
========================
Realisation of deferred tax assets associated with NOL and credit carry forwards
is dependent upon generating sufficient taxable income prior to their
expiration. Management believes that there is a risk that certain of these NOL
and credit carryforwards may expire unused and, accordingly, has established a
valuation allowance against them of $2,371,547 as of June 30, 2000. Although
realization is not assured for the remaining deferred tax assets, management
believes it is more likely than not that they will be realized through future
taxable earnings or alternative tax strategies. However, the net deferred tax
assets could be reduced in the near term if management's estimates of taxable
income during the carryforward period are significantly reduced or alternative
tax strategies are no longer viable.
NOTE 16: RELATED PARTY TRANSACTIONS
Interest has been charged on all amounts due to or payable from all related
parties.
FAI General Insurance Company Limited, a subsidiary of FAI Insurances Ltd,
leases office space to FAI Home Security Pty Limited at a commercial rate.
In addition to the loans due to/from a Director and an employee as explained in
Note 5 and the secured note with a Director as disclosed in Note 6, the
following amounts were due to/from related parties as of June 30, 1999 and 2000.
<TABLE>
<CAPTION>
June 30,
1999 2000
------------------ -----------------
<S> <C> <C>
Amounts due from related parties:
Current assets:
FAI Home Distributors Pty Limited (1) 217,516
869,800
Less: Allowance for doubtful accounts - (869,800)
------------------ -----------------
217,516 -
================== =================
FAI Finance Corporation Pty Limited (2) - 614,581
</TABLE>
(1) In December 1998, the FAI Home Security Distributors Association, an
association formed by the Company's distributors in Australia, reorganized into
FAI Home Distributors Pty Ltd. (collectively, the "Association"). The purpose of
the Association is to collect and utilize funds received from the Company's
Distributors to develop the business of the Company in Australia and New
Zealand, i.e. to identify target sales areas, train the sales force, organize
conventions of distributors and the sales force, etc. Although the Association's
prime source of funds is
<PAGE>
from the distributors, the Company, through its Australian subsidiary, also
advances funds to the Association to pay for certain promotional activities
which funds are then repaid to the Company over time.
On June 23, 1999, due to the continued working capital deficit, Mr. Whitaker,
the Company's Chief Financial Officer, took ownership and became, the sole
director of the Association, previously owned and operated by the Company's
distributor network. Mr. Whitaker receives no remuneration from the Association.
At June 30, 2000, the Association owed the Company $869,800 as a result of
working capital advances. Due to the uncertainty of the recoverability of the
advanced funds the Company fully provided for these amounts as at June 30, 2000.
In December 1998, prior to the appointment of Mr. Whitaker as sole director and
shareholder of the Association, the Association, with the unanimous consent of
the Company's distributors in Australia, agreed to pay the Company for the
distributors' bad debts accumulated by the Company for inventory advances made
to individual distributors from time to time (the "Company Receivable"). At the
same time, in consideration for Mr. Cooper guaranteeing the repayment of the
Company Receivable and any future bad debts, the Association, with the unanimous
consent of the Company's distributors in Australia, agreed to pay Mr. Cooper
either $21,464 per month or $41.57 per unit sold per month towards repayment of
$1,208,401 in debt accumulated by Mr. Cooper in developing the business prior to
the Company's initial public offering (the "Cooper Receivable"), which debt was
not acquired by FAI Insurances with the International Assets in 1997.
The Company Receivable is repayable by the Association at the rate of $4,896
until paid in full. The Association has also agreed to repay the Company for any
future bad debts of the distributors within one year of demand by the Company.
In addition, Mr. Cooper has agreed to guarantee all payments due by the
Association to the Company.
The enforceability of the obligation of the Association to repay these debts and
the enforceability of the guarantee provided by Mr. Cooper is currently subject
to a detailed review by the Company's legal advisers. No amounts are recoverable
under the guarantee provided by Mr. Cooper until 21 July 2001.
During the year the Company has provided additional working capital to FAI Home
Distributors Pty Limited to finance the provision of training and motivational
activities for its Distribution Network. Furthermore, FAI Home Distributors Pty
Limited has required funds in relation to legal actions initiated on behalf of
the Distribution Network to protect the copyright of marketing materials and to
enforce restraint obligations against Distributors offices that have closed or
sought to compete contrary to there contractual obligations. The additional
working capital is an unsecured loan to be repaid from future contributions
provided by members of approximately $40 per unit sold.
As a result of the reduction in units sales, the working capital needs of FAI
Home Distributors Pty Limited has been fully funded by the Company. The Company
has given notice under the guarantee provided by FAI Home Distributors Pty
Limited to recover $1.3 million in bad debts relating to receivables owing by
Distributor's offices that have closed. The Company is seeking to recover these
bad debts after the 365 day notice period which is due to occur July 21, 2000.
The Company is seeking legal advice as to its ability to recover these debts in
the event, in the event FAI Home Distributors and Brad Cooper is unable to meet
its obligations.
In February 1999, Mr. Cooper and FAI Finance Corporation Pty Limited ("FFC"),
the Company's 50%-owned subsidiary, entered into a transaction whereby FFC
purchased $515,137 of the Cooper Receivable (the "Factoring Transaction") from
Mr. Cooper for $334,474. As part of the Factoring Transaction, the Association
entered into an agreement to pay FFC $515,137, bearing interest at a rate of
14.5% per annum, in twenty-four monthly installments of $21,464. The balance
remaining due to FFC from the Association June 30, 2000 was $193,177. In
addition, as part of the Factoring Transaction, (i) the Association gave FFC the
right to first priority on all contributions and payments received by the
Association, including moneys advanced from the Company for promotional
activities to the Association, (ii) Mr. Cooper secured the Association's
payments to FFC with personal assets, and (iii) Mr. Cooper agreed to indemnify
FFC for any losses which might arise as a result of any non-payment or
insolvency of Home Distributors or any dispute between the parties.
On April 12, 2000 FFC agreed to extend the Factoring Transaction of February
1999 to the remaining $693,264 debt owed by the Association to Mr. Cooper. The
payments are to commence at the completion of the initial Factoring Transaction
being March 2001.
(2) The loan to FAI Finance Corporation Pty Limited represents the sub-ordinated
loan relating to the Receivables Purchase Agreement. Refer to Note 17 for
further details on the terms and conditions of the sub-ordinated loan.
<TABLE>
<CAPTION>
June 30,
1999 2000
--------- ---------
<S> <C> <C>
Amounts due to related party:
Current liabilities:
FAI Insurances Limited (1) 1,313,400 3,861,290
Integral Investments Limited (2) 8,394,024 -
FAI Finance Corporation Pty Limited (3) - 1,154,022
Non-current liabilities:
FAI Insurances Limited (1) 3,447,675 3,659,703
FAI Finance Corporation Pty Limited (3) - 3,619,976
</TABLE>
FAI Insurances Limited and FAI Finance Corporation Pty Limited are both wholly
owned subsidiaries of HIH Insurances Limited.
(1) The loans from FAI Insurances Limited relate to the acquisition and sale of
FFC (refer to Note 11 for further details on the terms and conditions of this
loan) and a $3,012,500 million short term loan, granted on May 29, 2000, bearing
interest at 7.75% per annum, with principal and accrued interest payable in a
bullet on February 28, 2001. The $3,012,500 short term loan is guaranteed by a
security interest in Ness.
<PAGE>
(2) The above loan from Integral Investments Limited relate to the Ness
Transaction. Refer to Note 19 for further details on the term and conditions of
the loan. The loan was fully paid on April 26, 2000.
(3) The above loans from FAI Finance Corporation Pty Limited relate to the
Receivables Purchase Agreement. Refer to Note 17 for further details on the
terms and conditions of the Receivables Purchase Agreement.
<TABLE>
<CAPTION>
Year Ended June 30,
------------------------------------------------------------
1998 1999 2000
-------------------- ------------------ -----------------
<S> <C> <C> <C>
Net income is stated after the following expenses
arising from transactions with related parties:
Non exclusive database license fee paid by
FAI Insurances Limited to:
FAI Home Security Pty Limited 338,362 - -
FAI Home Security (ENZED) Limited 72,207 - -
Interest on loans paid to:
FAI Insurances Limited 216,629 377,071 421,176
FAI Finance Corporation Pty Limited - - 248,684
Interest on loans received from:
FAI Home Security Holdings Pty Limited 26,679 - -
Office rentals paid to:
FAI General Insurance Company Limited 207,870 204,110 153,740
</TABLE>
NOTE 17: RECEIVABLES PURCHASE AGREEMENT
On December 22, 1999, the Company entered into the Receivables Purchase
Agreement ("RPA") with FAI Finance Corporation Pty Limited ("FFC"). Under this
agreement, the Company has the right to sell eligible upgrade monitoring
receivables to FFC and undertakes to continue to service the receivables in
exchange for an upfront cash payment equal to the sum of the total receivable
less 15% retained as sub-ordinated debt. This facility specifically relates to
the Company's Upgrade Program offering five-year monitoring contracts to its
existing 250,000 residential customers. Previously, the Company has funded this
program from cash flow from operations.
Under the RPA, the Company must maintain a sub-ordinated loan with FFC equal to
15% of the outstanding receivable sold. The sub-ordinated loan as at June 30,
2000 was $614,581. This is classified as a non-current receivable on the balance
sheet as the majority of the underlying debt is non-current.
The Company has not recognized the receivables sold under the agreement as a
sale for financial reporting purposes. The sales proceeds received from FFC have
been recognized as secured borrowings, and interest and line fees under the FFC
facility have been recognized as interest expense. Under the agreement the
Company pays interest to FFC at 12.5% per annum on the used portion of the
facility plus a line fee of 2.0%. As at June 30, 2000 the limit of the facility
provided by FFC was $4,518,750 of which $4,159,418 was drawn.
NOTE 18: STOCK OPTION PLANS
The Company has two stock option plans.
1997 Stock Option Plan. The Company has adopted the 1997 Stock Option Plan (the
"1997 Plan"), under which the Compensation Committee may grant options to
purchase up to an aggregate of 1,150,000 shares of Common Stock to management,
employees and advisers of the Company. The 1997 Plan provides for the grant of
stock options ("Options"), including incentive stock options within the meaning
of Section 422 of the United States Internal Revenue Code of 1986, as amended
(the "Code"), and non-statutory stock options that do not qualify as stock
options under Section 422 of the Code ("Non-Statutory Options").
The Company has issued a total of 812,500 options under the 1997 Stock Option
Plan, 710,000 at an exercise price of $10.00 per share and 102,500 at an
exercise price of $5.00 per share. Options with an exercise price of $10.00 were
issued as follows; 250,000 to Mr. Cooper, 90,000 to Mr. Youngman, 80,000 to Mr.
Whitaker and 40,000 to Ms.
<PAGE>
Hilbert, granted on July 15, 1997 and 165,000 to Mr. Appleby and 85,000 to Mr.
Knowles, granted on April 8, 1998. Each of these Options with an exercise price
of $10.00 per share vests in annual 20% increments over a five year period, with
the first 20% vested and exercisable on the first anniversary of the grant date,
except that the 40,000 Options granted to Ms. Hilbert have vested and the 85,000
Options granted to Mr. Appleby, and 55,000 Options granted to Mr. Knowles, will
vest in increments upon the Company achieving certain unit sales numbers outside
of Australia and New Zealand prior to October 31, 2003.
The 102,500 options issued with an exercise price of $5.00 were issued on
December 6, 1999 to non-executive employees. Each of these options vested 25% on
December 6, 1999 and then in 25% increments over a three year period, except
that 20,000 will vest upon the Company achieving certain set performance goals
prior to December 9, 2009.
1997 Non-Employee Director Stock Option Plan. The Company has adopted the 1997
Non-Employee Director Stock Option Plan, under which 50,000 shares of Common
Stock have been authorized for issuance. Upon the closing of the Company's
initial stock offering ("IPO"), all four non-employee directors at the time
received options to purchase 5,000 shares of Common Stock at $10.00 per share
under the 1997 Non-Employee Director Stock Option Plan.
Commencing with the first annual meeting of the shareholders following the IPO,
all non-employee directors continuing to serve as such will receive, on the day
following each annual meeting, options to purchase an additional 2,500 shares of
Common Stock at an exercise price equivalent to the market price of the stock on
the date of such grant. All such grants will be Non-Statutory Options. To date,
an additional 15,000 shares of Common Stock, 7,500 at $10.6875 per share and
7,500 at $2.1875 per share, were granted to the Company's non-employee directors
on the day following the February 17, 1999 and the December 6, 1999 annual
meeting, respectively.
The Options granted under the 1997 Non-Employee Director Stock Option Plan are
exercisable beginning six months from the date of grant and expire on the tenth
anniversary of such date.
NOTE 19: NESS TRANSACTION
Effective October 1, 1998, the Company purchased pursuant to an amended stock
purchase agreement (the "Stock Purchase Agreement") all of the issued and
outstanding common stock (the "IIHSL Shares") of Integrated International Home
Security Limited ("IIHSL"), a British Virgin Islands holding company (the "IIHSL
acquisition"). IIHSL is the holder of 75.04 percent of the issued and
outstanding common stock of Ness Security Products Pty Limited ("Ness"). Ness is
a leading manufacturer of security alarm products in Australia and the Company's
sole supplier of the SecurityGuard alarm.
The purchase price for the IIHSL Shares consisted of the following: (i) 400,000
shares of the Company's common stock, $0.001 par value per share (the "Common
Stock"), (ii) warrants convertible into 360,000 shares of Common Stock at an
exercise price of $13.00 per share, which will be exercisable through the year
2003; (iii) cash in the amount of $2,426,000 ($126,000 paid concurrent with the
execution of the Stock Purchase Agreement and $2,300,000 paid upon closing of
the transaction); (iv) a promissory note, secured by the IIHSL Shares, in the
amount of $9,098,000 (discounted to $8,394,024 as at June 30, 1999 for financial
reporting purposes), payable in installments of $400,000 on each of June 30,1999
(paid on July 7, 1999) and December 31, 1999, with the balance of the note due
on June 30, 2000 ("Note"); and, (v) a non-refundable re-negotiation fee of
$200,000 resulting from the conversion of the proposed cash payment of
$9,098,000 to the promissory note referred to in (iv).
On April 9, 1999, the Company effectively purchased the remaining 24.96 percent
of the issued and outstanding common stock of Ness (the "Ness acquisition")
through a series of transactions in which: (i) Nazareno Circosta the principal
management officer of Ness ("Circosta") agreed to enter into a Non-Competition
Agreement with the Company in exchange for a cash payment of $656,700; (ii)
Circosta agreed to purchase 277,778 shares of HSI Common Stock for $2,599,352;
(iii) Ness agreed to redeem 260,000 shares of Ness ("Ness Shares") from Circosta
Pty Limited, a company owned by Circosta as well as certain relevant employees,
for $2,140,179 (collectively, the "Redemption Transaction"). In addition, Ness
agreed to pay $3,066,776 to Circosta in exchange for Circosta terminating his
existing employment contract and entering into a new employment contract with
Ness.
As a result of the Redemption Transaction, the Company's wholly-owned
subsidiary, IIHSL, became the sole owner of Ness.
The IIHSL and Ness acquisitions have been accounted for under the purchase
method of accounting. The purchase price has been allocated based on estimated
fair values at date of acquisition. This allocation has resulted in acquired
<PAGE>
goodwill of $12,039,658 relating to the IIHSL acquisition, and $2,171,096
relating to the Ness acquisition. Both goodwill amounts are being amortized on a
straight-line basis over 20 years. The results of operations have been included
in the consolidated financial statements since the acquisition dates.
Pro Forma net income adjusted as though the 100% acquisition of IIHSL and Ness
took place at the beginning of the periods being reported on is shown below.
<TABLE>
<CAPTION>
June 30,
1999 2000
------------------ -----------------
<S> <C> <C>
Pro forma net sales 49,540 48,545
Pro forma income from operations 10,151 8,576
Pro forma net income 6,692 4,314
Pro forma net income per common share
Basic earnings per share 1.15 0.74
Diluted earnings per share 1.13 0.74
Pro forma weighted average number of shares outstanding
Basic 5,828 5,828
Diluted 5,916 5,832
</TABLE>
Subsequent to June 30, 2000 the Company agreed to sell 49% of Ness to HIH
Insurances for $AUD17.5 million. The proceeds of the sale will be used to retire
short-term debt and long term debt of $AUD13 million and to provide liquidity
for operating activities.
NOTE 20: BANK OVERDRAFT
As of June 30, 2000 and June 30, 1999, the Company had $92,477 and $451,562,
respectively, undrawn on its $602,500 credit facility with Westpac Banking
Corporation. The credit facility bears interest at 9.75 percent per annum.
NOTE 21: NESS SALE--SUBSEQUENT EVENT
The Company has entered into an agreement to sell 49% of its shareholding in
Ness Security Products for cash consideration of $AUD17.5m to HIH Insurances.
From the sale proceeds the Company has agreed to repay $AUD13 million to HIH
Insurances in relation to the FAI Note and short term finance provided by HIH
with the balance of $AUD4.5 million to be paid in cash. Furthermore, HIH has
agreed to provide additional loan funds of $AUD2.5 million by June 30, 2001.
The Company believes the $AUD4.5 million cash raised in the Ness Sale and the
additional availability of loan funds of $AUD2.5 million will provide the
Company with sufficient liquidity to fund the cash flow deficit from operating
activities that the Company expects in the first three quarters of Fiscal 2001.
The Company expects its business plan to produce positive cash flow from
operations in the last quarter of Fiscal 2001, provided sales targets are
achieved.
NOTE 22: NEW BUSINESS MODEL--SUBSEQUENT EVENT
The Company has prepared a business plan which the Company believes will
produce positive cash flows from its operating activities. The business model
takes the following approach:
1. Reduction in General and Administrative Expenses
The Company during July and August 2000 made 33 staff reductions as part of
cost control initiatives, reducing the total employees from 279 to 246. The
Company intends to further reduce the total employees of the Company in the six
months to December 2000 through both natural attrition and redundancies. The
expenses associated with both marketing and service have been reviewed and
through the use of technology these expenses are expected to be reduce.
The management structure of the group will be revised and appropriate cost
reductions made in relation to the number of officers and executives required
for the Company's operating activities.
2. Closure of unprofitable operations or markets within the Company
The Company is currently undertaking a review of each segment of its
operating activities and identifying markets or products that remain
unprofitable and/or are unlikely to produce positive cash flow from operations
in the next 12 months. These markets or products will be either closed, put on
hold until the group can sustain the development costs of the market or product
or restructured to produce immediate positive cash flow contributions to the
Company.
3. Increase Unit Sales
a) Recruitment
The Company intends in the three months from October 2000 to January 2001 to
launch a major campaign in all its remaining markets to recruit an increased
number of independent sales agents to significantly increase its sales force.
b) Centers of Excellence
The Company further intends to establish a number of centers of excellence or
training facilities operated by the Distributor Network or by the Company
itself, whereby each individual distributor office and independent sales agents
can be retrained on an ongoing and regular basis. The Company intends to focus
its resources on establishing these centers of excellence as hubs for motivation
and training which will reduce the Company's costs associated with sales staff
attending individual offices on a regular basis.
c) Revised Distributor Program
On September 1, 2000 the Company launched, a revised Distributor Program whereby
individuals within the sales hierarchy can be redefined within the hierarchy
upon the failure to achieve pre-determined sales levels. This reduction in
status within the network has been implemented to provide all levels of the
sales hierarchy the opportunity of re-training upon the non-achievement of pre-
determined Company benchmarks.
The Company expects the requirement to reach pre-determined sales levels on a
monthly basis to remain, to ensure that each Distributor office has sufficient
motivation and training to continue to produce unit sales levels required by the
Company and more importantly result in a more financially viable Distribution
Network.
4. Increased Margins
The Company intends to revise the gross margin in all its products and markets.
Increased margins can be achieved in three areas.
a) Reduction in Product Costs,
b) Reduction in Costs associated with providing monitoring services to its
customers, and
c) Reduction in Distributor commissions associated with the installation and
connection of monitoring.
The Company intends to pursue all outcomes to produce improved margins to the
group.
5. Reduction in Finance Costs
The Ness Sale will result in a reduction in the finance cost associated with the
FFC Note and the Company's other short term debt funding. The Company will seek
to reduce all finance costs associated with rollout of its monitoring plan.
6. Going Concern
There is substantial uncertainty about the Company's ability to continue as a
going concern. To continue as a going concern it must achieve the improvements
in operating performance outlined in points 1-5 above. The achievement of this
improvement in operating performance is uncertain. Management believes that the
cash received from the 49% sale of the Ness manufacturing operation, subsequent
to June 30, 2000 (see note 21), along with the implementation of the new
business model, will be sufficient to achieve the improvement in operating
performance required for the Company to continue as a going concern.
NOTE 23: LEGAL PROCEEDINGS
A class action lawsuit has been filed against the Company in the Victorian
registry of the Federal Court of Australia alleging violations of the Australian
Trade Practice Act by authorized Distributors of the Company. The class action
alleges that misrepresentations were made by salespersons when selling
SecurityGuard alarm systems from July 9, 1993 to present to customers who used
FFC to finance their purchases. This litigation is in its very preliminary
stages and no discovery has been undertaken, and therefore, the Company cannot
quantify its ultimate liability, if any, for the payment of damages in this
lawsuit. Notwithstanding the foregoing, the Company believes that the
allegations in the lawsuit do not provide a basis for the recovery of damages
because the Company believes that the materials provided by the Company to its
Distributors and its sales force did not violate the Australian Trade Practice
Act. The Company intends to aggressively defend this lawsuit. In the event the
Company is not successful in defending this lawsuit, the outcome could have a
material adverse effect on the financial condition and results of operation of
the Company.
On September 17, 2000, a former distributor in the Company's Belgium market
initiated legal proceedings in the Belgium courts seeking compensation in
relation to representations made by the Company to the distributor and the
validity of product approvals. This action seeks to recover approximately
$200,000 from the Company. The Company intends to aggressively defend this
action.
The Company experiences routine litigation in the normal course of its
business. The Company does not believe that any currently pending or threatened
litigation will have a material adverse effect on the financial condition and
results of operations of the Company.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Home Security International, Inc.
(Registrant)
By: /s/ Bradley D. Cooper
------------------------
Bradley D. Cooper
Chief Executive Officer
(Principal Executive Officer)
Date: September 29, 2000
KNOW ALL PERSONS BY THESE PRESENTS, that the undersigned directors and
officers of Home Security International, Inc., a Delaware corporation, which is
filing an Annual Report on Form 10-K for the fiscal year ended June 30, 1999
("Form 10-K Report") with the Securities and Exchange Commission, under the
provisions of the Securities and Exchange Act of 1934, as amended, hereby
constitute and appoint Bradley D. Cooper and Mark Whitaker, and each of them,
each of their true and lawful attorneys-in-fact and agents; with full power of
substitution and resubstitution, for him or her in his or her name, place and
stead, in any and all capacities, to sign such Form 10-K Report and any or all
amendments to the Form 10-K Report, and all other documents in connection
therewith to be filed with the Securities and Exchange Commission, granting unto
said attorneys-in-fact and agents, and each of them, full power and authority to
do and perform each and every act and thing requisite and necessary to be done
in and about the premises, as fully to all interests and purposes as each of
them might or could do in person, hereby ratifying and confirming all that said
attorneys-in-fact and agents or any of them, or their substitute or substitutes,
may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1934, this report
has been signed below by the following persons on behalf of the registrant and
in the capacities and on the dates indicated.
<TABLE>
<CAPTION>
Signature Title Date
<S> <C> <C>
/s/ Bradley D. Cooper Chief Executive September 29, 2000
-----------------------------------------------
Bradley D. Cooper Officer (Principal Executive
Officer)
/s/ Mark Whitaker Executive Vice President of September 29, 2000
-----------------------------------------------
Mark Whitaker Finance and Treasurer (Principal
Financial and Accounting
Officer)
/s/ Rodney Adler Chairman September 29, 2000
-----------------------------------------------
Rodney Adler
/s/ Paul Brown Director September 29, 2000
-----------------------------------------------
Paul Brown
</TABLE>
<PAGE>
<TABLE>
<S> <C> <C>
/s/ Steve Rabinovici Director September 29, 2000
-----------------------------------------------
Steve Rabinovici
/s/ Harry Singer Director September 29, 2000
-----------------------------------------------
Harry Singer
</TABLE>
