AlarmForce Industries Inc.
ALARMFORCE INDUSTRIES INC.
MANAGEMENT’S DISCUSSION AND ANALYSIS
January 21, 2016
675 Garyray Drive, Toronto Ontario Canada, M9L 1R2 Telephone: 416-445-2001 Facsimile: 416-445-8358 Email: [email protected]
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis Table of Contents 1.
FORWARD-LOOKING INFORMATION ..........................................................................................................2
COMPANY OVERVIEW ....................................................................................................................................3
SELECTED ANNUAL INFORMATION ............................................................................................................7
DISCUSSION OF OPERATIONS .......................................................................................................................8
SUMMARY OF QUARTERLY RESULTS ......................................................................................................13
DISCUSSION OF FOURTH QUARTER 2015 RESULTS ...............................................................................15
LIQUIDITY AND CAPITAL RESOURCES .....................................................................................................15
FINANCIAL POSITION ....................................................................................................................................17
OUTSTANDING SHARE CAPITAL ................................................................................................................18
OFF-BALANCE SHEET FINANCING .............................................................................................................20
RELATED PARTY TRANSACTIONS .............................................................................................................20
CRITICAL ACCOUNTING ESTIMATES ........................................................................................................20
DISCLOSURE CONTROLS AND PROCEDURES .........................................................................................21
ACCOUNTING POLICY DEVELOPMENTS ..................................................................................................22
CAPITAL STRUCTURE ...................................................................................................................................23
RISKS AND UNCERTAINTIES .......................................................................................................................23
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis 1.
The following Management’s Discussion and Analysis (“MD&A”), of operating results and financial position for the years ended October 31, 2015 and 2014 is supplementary to, and should be read in conjunction with the audited consolidated financial statements and related notes for the financial year ended October 31, 2015. Copies of these documents can be found on the SEDAR website at www.sedar.com. The MD&A is intended to help readers understand the dynamics of our business and the key factors underlying our financial results. The MD&A and the consolidated financial statements were reviewed by the Company’s Audit Committee and approved by the Board of Directors.
This document contains forward-looking statements which reflect management’s current expectations about future events and financial and operating performance of the Company. Words such as “may”, “will”, “should”, “could”, “anticipate”, “believe,” “expect, “intend”, “plan”, “potential”, “continue” and similar expressions have been used to identify these forward-looking statements. Forward-looking statements contained in this document may include estimates, plans, expectations, opinions, forecasts, projections, guidance or other statements that are not statements of fact. These statements reflect management’s current views with respect to future events or conditions, including prospective financial performance, financial position, and predictions of future actions, plans or strategies. Certain material factors and assumptions were applied in drawing our conclusions and making these forward looking statements. These statements reflect management’s current views, beliefs and assumptions and are subject to certain inherent risks and uncertainties. Factors that could cause actual performance to differ materially include, but are not limited to:
ability to develop or acquire new technology; competition in the market; development of new products; economic growth and fluctuations; proper performance of security equipment; the reliability of our payroll processing services; the protection and privacy of personal information which we hold; the risks associated with credit, including customer delinquencies and the collection of outstanding account balances; capital expenditures; the exchange rate of the US currency fluctuations; changes in accounting policies and estimates; changes in consumer preferences, customer demand for our security products and services and our ability to maintain customer relationships; disruption to manufacturing and distribution activities due to labour disruptions, bad weather, natural disasters and other unforeseen adverse events; human resource matters, including recruitment and retention of competent personnel; our inability to maintain or renew existing product sourcing arrangements; and the discontinuation by our suppliers of certain technologies or the exiting by one of our suppliers from the electronic securities systems market.
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis The above (and other) factors could cause our actual results, performance or achievements to be materially different from any future results, performance or achievements that may be expressed or implied by these forward-looking statements. See “Risks and Uncertainties” below and the section entitled “Risk Factors” in the Company’s most recent annual information form available under the Company’s profile on SEDAR at www.sedar.com. Should one or more of these risks or uncertainties materialize, or should the assumptions underlying our projections or forward-looking statements prove incorrect, our actual results may vary materially from those described in this MD&A as intended, planned, anticipated, believed, estimated or expected. We do not intend and do not assume any obligation to update these forward-looking statements whether as a result of new information, plans, events or otherwise, unless required by law. The Company’s forward-looking statements are expressly qualified in their entirety by this cautionary statement.
AlarmForce Industries Inc. (the “Company” or “AlarmForce”) is a Canadian company whose core business is the provision of home protection and personal monitoring services including security alarm monitoring, personal emergency response monitoring, video surveillance, home automation and related services to subscribers throughout Canada and selected centers across the United States of America (the “US”). AlarmForce is a public company whose shares are listed on the Toronto Stock Exchange under the ticker symbol “AF”. The Company was incorporated under the laws of Canada on November 16, 1988 and is a leading provider of its services, including its two-way voice security systems in Canada. With a history of over 27 years, the Company has developed one of the most prominent and well respected brands in the industry. The Company has historically manufactured its own proprietary wireless two-way voice controller panels which facilitate live two-way voice communication between the subscriber and the Company’s monitoring station thereby offering immediate response and/or assistance in the event of emergencies. AlarmForce is a leading provider of residential security monitoring. The Company has been focused on growing its subscriber base through its service offerings and integrated customer experience. We aim to provide our subscribers with a seamless experience across all channels and continue to improve the overall customer experience. The Company continues to expand its portfolio of home automation services, expanding on its Wi-Fi enabled door locks and power plugs under the AlarmForce Connect umbrella. During the fourth quarter, the Company refreshed its AlarmForce Connect Smartphone App (the “App”) to enhance user experience and functionality and launched a Wi-Fi enabled thermostat. The thermostat allows the user to remotely access and control the heating and cooling system within their home through the App. The thermostat expanded the Company’s home automation product portfolio which can be accessed remotely using the App. The App also provides the ability to monitor and control a user’s home security system remotely. The AlarmForce Connect Smartphone App is available on IOS, Android and Blackberry devices. In the fourth quarter of 2015, the take-rate of AlarmForce Connect among new subscribers was 40% compared to 42% in the third quarter of 2015. We continue to advertise the AlarmForce Connect services and benefits, including the convenience of the Company’s home automation offerings and expect the adoption rate to be strong among new customers. The Company continues to install its camera offering, “VideoRelay, with the take-rate among new subscribers of 10% during the quarter. VideoRelay allows the customer to see and communicate with the home when they cannot be there in person. When VideoRelay is triggered by the detection of motion or by pressing the doorbell, the control unit immediately sends an email containing three images of the person at the door. The subscriber, upon receiving the email, can log into the App on a smartphone or the portal on a computer to watch a real time video stream. In addition, the user can activate a twoway voice communication link. Actions are recorded and archived and can be easily accessed by the subscriber. The system can be configured as “event driven” to receive alerts or notifications, in the event a camera has been triggered or “on demand” allowing the user to view or listen-in live from any smart phone or personal computer with an internet connection. Management believes that adding enhanced video surveillance helps subscribers increase the effectiveness of their security systems. Although the VideoRelay system can operate independently of the alarm system, approximately 94% of VideoRelay subscribers opt to bundle their services with alarm services. 3
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis During Q3 the Company announced that it was suspending development of a proprietary second generation VideoRelay camera in favour of adopting an outsourced partnership with third party manufacturers specializing in security and home automation. Drawing on specialty manufacturers with cutting-edge technology will enable AlarmForce to bring new features and product enhancements to the market more quickly and cost effectively. Subscribers with video services only are considered additional subscribers and subscribers with both alarm and video services are considered one subscriber with multiple services. The take-rate of VideoRelay services was 12% of new alarm subscribers for the twelve months ended October 31, 2015 compared to 13% in 2014. As at October 31, 2015, the Company had 9,300 subscribers using VideoRelay services, of which 5,900 were in Canada and 3,400 in the US. The Company’s fall sensor which was introduced this year as an enhancement to our Personal Emergency Response (“PERS”) offering (“AlarmCare”) continues to benefit from its positive reception by PERS customers. Providing an additional level of safety previously unavailable, the fall sensor is designed to detect the difference between normal activity and an actual fall. The fall sensor pendant is one of the smallest on the market, is waterproof, and has a battery life that is greater than 2 years. We are pleased with the positive reception that the fall sensor has received to date and is reflected in the 71% adoption rate with new AlarmCare subscribers through fiscal 2015, up from 68% through the third quarter. The AlarmCare System is designed to help people live independently and with confidence, affording those requiring a level of personal monitoring the peace of mind of knowing that in the event of emergency, help can be immediately dispatched. Although the AlarmCare System is geared towards people of all ages, seniors and persons with medical conditions or disabilities are particularly drawn to this service that allows for both comfort and security in one’s home. The user benefits from having both the base station including two-way voice communication, and a lightweight, water resistant pendant or wristband. If more than one person in the protected home is interested in using the AlarmCare system, additional pendants are available. Each pendant maintains its own distinct signal with each linked to the individual’s vital medical information which is maintained at the Central Monitoring Station (“Central Station”) and passed on to responding authorities in the event of a medical emergency. The Company’s highly trained operators at its Central Station can communicate directly with the AlarmCare user, assess the situation occurring inside the home, and then contact the appropriate level of help if necessary. The Company had 8,750 AlarmCare subscribers as at October 31, 2015. The Company’s monitored home and personal security offerings have historically included the manufacturing, installation and servicing of its own proprietary wireless two-way voice controller panels which facilitate live two-way voice communication between the subscriber and the Company’s Central Station. Upon activation, this offers audio verification and an immediate response and/or assistance in the event of emergencies. This two-way voice communication feature reduces false alarms and increases the police response time by providing verification of an actual event. As at October 31, 2015, the Company had 134,800 alarm subscribers benefiting from these features, of which 100,800 are in Canada and 34,000 in the US. The Company also manufactures “CellWave”, an innovative technology offered as an enhancement to the wireless alarm system. CellWave allows an AlarmForce system to be installed without the need for a traditional phone line or internet connectivity. Two-way voice technology is integrated with non-traditional phone services such as cellular phones and VoIP or other digital phone systems. The take-rate of CellWave services was 65% of new alarm subscribers through 2015 versus 58% for 2014). CellWave is available exclusively to AlarmForce subscribers. Pursuant to the Company’s Normal Course Issuer Bid (“NCIB”), the Company purchased 113,100 common shares at an average price of $10.98 and subsequently cancelled these shares during 2015. The Board believes share buybacks at the right price are in the best interest of the Company’s shareholders and such purchases constitute an attractive investment opportunity and a desirable use of cash that enhances shareholder value.
Consolidated revenues grew to a total of $56,137,182 in 2015 reflecting an increase of 7% or 3% excluding the impact of foreign exchange, compared to the same period of 2014. The fourth quarter revenues grew by 9% (3% excluding the impact 4
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis of foreign exchange). The Company’s revenue is primarily generated from recurring monthly services pursuant to the terms of subscriber agreements. In 2015, revenue from recurring monthly services accounted for 94% of total revenue. Recurring Monthly Revenue (“RMR”) grew to $4,479,603 in 2015, an increase of 7% (3% excluding the effect of foreign exchange) over the comparative period of 2014. Canadian revenue totaled $39,034,997 in 2015 compared to $38,411,130 in 2014. Revenues in the US increased to $17,102,185 from $14,170,974 or an increase of 25% over 2014. Excluding the impact of foreign exchange, the US revenue increased by 6% over 2014. Revenue growth is driven by higher average number of subscribers over the period and continued growth in average revenue per subscriber, derived from an increase in the takerates of enhanced service offerings such as CellWave, VideoRelay and AlarmForce Connect. We continue to focus our efforts on multiple service offerings, which is reflected in the increased average revenue per new subscriber totaling $35.69 as at October 31, 2015, compared to $32.48 at October 31, 2014, an increase of 10%. Excluding the impact of foreign exchange, average revenue per new subscriber increased by 5%. Increasing average revenue per subscriber is driven by our continued introduction of additional home automation and convenience features and services that increase the Company’s value proposition and service offering to our customers. Such value added services include VideoRelay, CellWave, AlarmForce Connect (which includes Wi-Fi door locks, power plugs and the thermostat) and the fall sensor for the AlarmCare system.
Total Revenue ($ millions)
RMR ($ millions)
In 2015, the Company added a total of 22,700 gross subscribers in Canada and the US with a marginal net decline in total subscribers (-0.3%) from Q3 2015 driven by an aged accounts receivable reassessment completed during the fourth quarter. The Company finished 2015 with total subscribers of 144,200. Net subscriber growth in the fourth quarter was impacted negatively by an aged accounts receivable reassessment which resulted in the cancellation of subscriber accounts in excess of normal course attrition. Total cancellations for the quarter were approximately 9,000 versus 5,000 for the same period in 2014. In Canada, net subscribers grew by 900 accounts bringing the total Canadian subscribers to 109,700 and in the US, net subscribers declined by 1,400 accounts bringing the total US subscribers to 34,500.
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis
Cash, cash equivalents and short term investments totaled $8,225,521 as at October 31, 2015. Short term investments consist of guaranteed investment certificates that are invested for a period ranging from 91 days up to one year from the date of purchase. AlarmForce generates strong cash flows from operations and currently funds all growth internally. Net income in 2015 totaled $4,976,372 compared to $7,811,680 for 2014, a decrease of $2,835,308 or 36%. Similarly, basic and diluted Earnings Per Share (“EPS”) decreased to $0.43 in 2015 from $0.65 in 2014. The decrease is driven by one-time costs associated with the change in management that occurred during the year including severance and recruitment expenses, higher than normal legal fees and settlements, and non-cash write-downs associated with ceasing in-house development of the second generation VideoRelay camera and an aged accounts receivable reassessment which impacted both accounts receivable and rental equipment. Excluding these non-recurring items, net income and EPS would have been $7,718,778 and $0.66 respectively. In addition, the Company’s transition to an external media agency resulted in higher costs than the comparable prior period. EBITDA decreased by 27% or $4,222,012 to $11,685,597 over the comparative period of 2014. Adjusting for one-time items, EBITDA would have been $15,416,762 . In May 2015, the Company announced the appointment of Graham Badun as the new President and CEO, replacing Anthony Pizzonia who decided to step down. Mr. Badun was group Chief Executive Officer of Brookfield Residential Property Services, a division of Brookfield Asset Management. During his tenure as CEO, he oversaw expansion from Canada into eight countries, grew multiple brands across three business lines and was recognized as of one of the 100 most influential leaders in real estate in the U.S. In July 2015, the Company announced the appointment of Chris Lynch as the new CFO, with Chetna Kapadia taking on a newly created VP Finance role with the Company. Mr. Lynch joined from Brookfield Global Relocation Services, a division of Brookfield Asset Management, where he was SVP Corporate Finance & Treasurer with responsibility for the Financial Planning & Analysis, Pricing, Treasury and Corporate Finance functions. In addition, subsequent to year end the Company added new executives for each of Sales and Marketing and Operations. Beth Robertson joined as Vice President, Sales and Marketing in November 2015 and Jennifer Anderson joined as Vice President, Operations in January 2016.
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis The Company has historically increased its subscriber account base solely through organic account creation. The Company expects to continue to drive organic growth by optimizing its marketing and advertising spend and creating awareness of its home and personal protection product and service offerings across Canada and in select markets in the US. In addition, AlarmForce will explore additional, supplementary distribution channels which could leverage and take advantage of the Company’s strong brand awareness and value proposition. Our broad and innovative set of products and services meet a range of customer needs for today’s active and increasingly mobile lifestyle. We believe we are well positioned to continue to grow and expand in the home and personal protection markets while taking advantage of the growing demand for home automation, medical monitoring and lifestyle services with an attractive suite of products and services. Subscriber retention is an area of critical focus as customer loyalty and increasing customer tenure creates incremental value. We continue to assess the subscriber life cycle from acquisition to fulfillment through cancellation, to better understand how we can service our customers and maintain them as loyal customers for longer periods. This involves qualifying customers to ensure we are pursuing clients with the right characteristics and evaluating the overall customer service experience to ensure we provide consistent quality of service and a strong value proposition at a fair price.
SELECTED ANNUAL INFORMATION
The following summary of selected audited financial information is derived from, and should be read in conjunction with, the Company’s audited consolidated financial statements, including the notes thereto, for the financial years ended October 31, 2015, 2014, and 2013:
Subscriber base OPERATIONS: Total revenue Gross profit EBITDA* Income before income taxes Net income Cash flow from operating activities Diluted weighted average common shares Diluted earnings per share Cash dividends declared per share Monthly recurring revenue (RMR) Average revenue per subscriber FINANCIAL POSITION: Cash and cash equivalents
October 31, 2015 October 31, 2014 October 31, 2013 144,200 144,700 141,200 $ $ $ 56,137,182 39,191,147 11,685,597 6,318,860 4,976,372 8,992,947 11,644,203 0.43 0.17 4,479,603 31.07
52,582,104 37,941,320 15,907,609 10,493,122 7,811,680 11,826,831 11,857,087 0.65 0.71 4,196,481 29.01
49,108,256 37,565,308 12,799,334 7,418,370 5,447,314 10,814,485 12,041,409 0.45 0.10 4,145,102 27.90
* Earnings Before Interest T ax Depreciation and Amortization is a key performance indicator in the security industry and should not be interpreted as IFRS earnings.
Management expects that the strong cash position and cash generated from operations will be sufficient to satisfy all capital requirements, advertising expenditures, research and development costs, and other costs related to product integration. If additional capital is required to support incremental growth initiatives, the Company maintains adequate access to liquidity and would look to use a responsible amount of leverage to supplement these growth needs.
Reconciliation of IFRS earnings and previously Canadian GAAP to adjusted EBITDA 7
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis EBITDA is defined as earnings before interest expense, taxes, depreciation and amortization. EBITDA does not have any standardized meaning defined by IFRS, and is therefore unlikely to be comparable to similar measures presented by other companies. It should not be considered in isolation of IFRS measures such as net income or cash flows, as a measure of liquidity. Management views EBITDA as a measure to assess the operating performance of the Company. Management believes that it allows the Company to assess its ongoing business without the impact of depreciation or amortization expenses. Also, EBITDA is a commonly reported measure and is widely used by investors as an indicator of a company’s operating performance and a valuation metric. Most companies in the residential security industry purchase subscriber accounts and capitalize those acquisition costs and amortize them over the estimated life of the subscriber. AlarmForce is one of the few companies whose growth has been organically created. The Company’s marketing expenses are treated as period costs and therefore the accounting treatment is not directly comparable with other alarm companies in the industry who grow through the acquisition of monitoring accounts. AlarmForce’s annual budget for marketing expenditures fluctuates based on the Company’s plans for expansion into new markets, increased focus in certain existing markets and the introduction of new products and services. Due to the discretionary nature of these marketing expenditures, the Company provides the following reconciliation of adjusted EBITDA to net income reported for the years ended October 31, 2015 and 2014:
Net income/(loss) Add: income taxes Income/(loss) before income taxes Add: Amortization expense EBITDA Add: marketing expenses Adjusted EBITDA Non-recurring expenses EBITDA excluding non-recurring expenses Adjusted EBITDA excluding non-recurring expenses
October 31, 2015 October 31, 2014 $ $ 4,976,372 7,811,680 1,342,488 2,729,663 6,318,860 10,541,343 5,366,737 11,685,597 14,022,874 25,708,471 3,731,165 15,416,762
5,366,266 15,907,609 12,438,134 28,345,743 15,907,609
In the third and fourth quarters of 2015, the Company incurred large one-time costs associated with the change in management including severance and recruitment expenses, higher than normal legal fees and settlements, and non-cash write-downs associated with ceasing in-house development of the second generation VideoRelay camera and an aged accounts receivable reassessment which impacted accounts receivable and rental equipment. Due to the non-recurring nature of these expenses, the above table outlines EBITDA and adjusted EBITDA excluding those one-time costs to reflect the Company’s adjusted EBITDA from normal course.
DISCUSSION OF OPERATIONS 8
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis Revenues Consolidated revenues increased by 7% or $3,555,078 in 2015, to a total of $56,137,182 compared to $52,582,104 in 2014. Revenues from the Canadian operations totaled $39,034,997 reflecting a growth of $623,867 or 2% and revenue from the US operations grew by $923,554 to $17,102,185 reflecting an increase of 25%. Excluding the effect of foreign exchange, revenues in the US grew by USD$746,002 or 6%. Revenue generated from recurring monthly services pursuant to the terms of subscriber agreements accounted for 94% of total revenue. Consolidated gross revenues in the fourth quarter of 2015 grew by 9% or $1,152,817 to a total of $14,443,992 compared to $13,291,175 in the comparable quarter of 2014. Revenues from the Canadian operations grew by $229,264 or 2% for the fourth quarter of 2015 compared to the same quarter of 2014. Total revenues from the US operations grew by 25% (5% excluding the impact of foreign exchange) to $4,587,590 in the fourth quarter of 2015. Revenue growth is the direct result of increased recurring monthly service revenue generated from higher take-rates on enhanced service offerings, which results in higher average revenue per subscriber from monthly subscription fees. Due to the accounts receivable reassessment, total subscribers declined by 0.3% since the end of fiscal 2014. US subscribers comprise 24% of the Company’s total subscriber base. Average revenue per subscriber grew to $31.07 as at October 31, 2015, a 7% increase (3% excluding the effect for foreign exchange) when compared to $29.01 over the comparative period in 2014. US revenue made up 30% of the Company’s total revenue in 2015 compared to 27% in 2014. With an increased emphasis on enhanced value added services, the average revenue per new subscriber in 2015 totaled $35.69 compared to $32.48 in 2014, an increase of 10% (5% excluding the effect for foreign exchange). We expect this to continue as the Company introduces new home automation and monitoring solutions that will attract new subscribers and achieve greater penetration of our existing subscriber base. RMR as at October 31, 2015 was $4,479,603 compared to $4,196,481 as at October 31, 2014, an increase of 7% (3% excluding the impact of foreign exchange). The Company expects to grow RMR by increasing the take-rates on value-added services such as CellWave, AlarmForce Connect, VideoRelay the fall sensor for AlarmCare, and the newly launched thermostat. Management also expects to extend the average life of our subscriber base by providing customer service excellence and in-demand products and services. In 2015, new subscriber adoption rates were 12% for VideoRelay services, 65% for CellWave services, 40% for AlarmForce Connect services and 71% for fall sensors for AlarmCare. The fall sensor, which is an add-on service for the AlarmCare system, was launched in January 2015. With the launch of a number of home automation products in 2015 to complement existing products (Wi-Fi enabled door locks, power plugs and thermostat) we are optimistic such services will be well received with our subscribers and allow us to further build our suite of home protection and automation products and services.
Revenue by Region
Revenue by Region
Revenue by Region 24%
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis Cost of sales Cost of sales consists of costs to purchase and/or manufacture products and costs related to the servicing of existing subscribers which include salaries and telecommunication costs. Total cost of sales were $16,946,035 in 2015, compared to $14,640,784 in 2014, an increase of $2,305,251 or 16%. The increase in cost of sales in 2015 was partly driven by the Company’s decision to discontinue development of its proprietary second generation camera in favour of partnering with third-party manufacturers and the associated write-down of development costs incurred. Other factors resulting in increased cost of sales are higher labour costs and higher rental equipment write-offs resulting from accelerated attrition in the fourth quarter of 2015. Cost of sales in the fourth quarter totaled $5,007,994 an increase of $1,214,278 over the same quarter of 2014. Management makes every attempt to maintain tight controls over production related costs and staffing levels through constant negotiations with vendors and contractors, and exercises prudent judgment in maintaining cost efficiencies. The Company continues to invest in its subscribers by incurring costs related to the conversion program to replace 2G radios with 3G radios in Canada and the US. We have implemented a conversion program to replace 2G radios at no additional cost to our customers that will continue throughout 2016. We are confident that our conversion plan will optimize our resource availability and customer demand within the required timelines. In 2015 (when compared to 2014), costs related to the manufacturing and purchase of security products increased by $1,156,664 , costs related to servicing existing customers increased by $1,241,609 and costs related to central station, most of which are labour, decreased by $93,022. The Company continuously evaluates the requirements of field support staff and monitoring station personnel to ensure labour efficiency and capacity utilization.
Gross Profit In 2015, gross profit totaled $39,191,147 compared to $37,941,320 in 2014, an increase of $1,249,827 or 3%. Gross profit margin as a percentage of total revenue decreased to 70% when compared to 72% in 2014. Management expects gross profit margins to remain consistent with current levels. Margins in 2015 were adversely impacted by the one-time write-down of capitalized development costs associated with ceasing development of its proprietary second generation camera during the third quarter. As the Company progresses on its strategic plan and multi-year process of renewal and change that will position it for the future, it will continue to deploy resources towards new product implementation and development, product and service enhancements and fostering customer loyalty and retention.
Selling, General and Administrative Expenses (“SG & A”) Selling and marketing expenses in 2015 increased to $16,200,379 from $14,659,259 in 2014, an increase of 11% or $1,541,120. This increase over the year is partially due to one-time implementation costs to transition the media buying to an external media agency and ongoing agency fees related to the media planning and buying. Advertising expenditures, consisting of radio, television, print, internet and other media make up 87% of selling expenses. The Company maintains a marketing spend in US markets to ensure an ongoing level of frequency and reach. While the marketing spend in the US dollar has remained relatively consistent, a reduction in the Canadian dollar will increase the total marketing spend attributed to the US. To drive strong and economically attractive gross subscriber additions, the Company continues to partner with its external media agency to optimize its advertising spend both on a market-by-market and media channel basis. This has enabled the Company to test the efficiency and effectiveness of its various media strategies in order to drive favourable outcomes. Although the Company does not expect to increase its spend on advertising, it does intend to continuously evaluate, optimize and redirect its spending across markets and channels in order to maximize opportunities. To that end, during the fourth 10
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis quarter, the Company began to refocus its advertising expenditures to those markets in Canada and the US which generate better returns with more attractive customer creation attributes. Those US markets include North Carolina and Ohio. In addition, the Company anticipates that US spending and fees related to the media agency engagement will continue to be impacted by a strong US dollar. The Company does expect to realize benefits derived from efficient advertising spend associated with more effective media buying and its ability to measure and understand the impact of spend levels in its markets. We will continue exploring new and creative approaches to our direct-to-consumer marketing and customer acquisition strategies. Advertising campaigns will continue to be geared towards educating the market on the benefits of home protection including the core service of two-way voice, professional installation and monitored security. In addition, our marketing message will also promote the benefits of other ancillary home protection products such as monitored smoke and carbon monoxide detectors and enhanced service offerings such as VideoRelay, CellWave, AlarmForce Connect, the fall sensor, thermostat and other home automation offerings. Selling expenses unrelated to advertising comprised 13% of the total selling costs and consisted primarily of marketing salaries and benefits. These other selling expenses decreased marginally by $43,620 to $2,177,505 compared to $2,221,125 in 2014. Management remains focused on optimizing customer acquisition costs and continuously evaluates staffing needs and marketing and selling expenses against the effectiveness of marketing campaigns and initiatives. General and administrative (“G&A”) expenses consist of administrative salaries and benefits, telecommunication costs, consulting fees, legal expenses, bad debts and other administrative related expenses. In 2015, general and administrative expenses totaled $11,337,353 compared to $7,422,673 in 2014, an increase of $3,914,680, or 53%. In 2015, administrative salaries increased by 43% or $1,239,823 . The increase reflects termination benefits resulting from a change in the President and CEO as well as incremental costs associated with additions to the leadership team. Consulting fees increased by 94% or $911,369 primarily due to higher than normal legal costs and recruitment costs associated with the change in leadership. While we expect to have a modestly higher level of ongoing G&A costs related to the change in executive leadership and multi-year process of renewal and change that will position the Company well for the future, we do not expect the one-time severance, legal and recruitment costs to re-occur in future periods. Telecommunication costs decreased by 29% or $66,000. Other administrative costs increased by 41%, or $1,439,000 driven by higher bad debts arising from the accelerated attrition due to the detailed review of the Company’s aged receivables. The outcome of this review and reassessment should drive improved collection efforts of receivables, and more timely cancellation of nonrecoverable accounts going forward. As we aim to provide an excellent customer experience, we are focused on continuous improvement and enhancing the value we bring to our customers in order to drive customer loyalty and retention.
Other expenses Amortization expenses, consisting of property, plant and equipment and intangible assets remained flat at $5,366,737 in 2015 compared to $5,366,266 in 2014. Fluctuations in amortization of plant and equipment reflect net additions made to rental equipment from the net new subscribers added in the year. The Company’s policy is to amortize rental equipment and video equipment on a straight line basis over 10 years. Rental equipment refers to security equipment installed at a subscriber’s location that remains the property of the Company.
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis Foreign exchange gain The Company is exposed to currency risk due to the US operations and consolidations resulting in translation differences. Also, a certain portion of the Company’s purchases are in US currency, resulting in US dollar-denominated liabilities. These activities result in exposure to fluctuations in foreign currency rates as the Company adjusts its foreign exchange translation rate periodically. In 2015, the Company experienced a foreign exchange gain of $32,182 from the fluctuating US dollar, compared to a gain of $48,221 in 2014. The Company has not deemed it necessary to utilize any financial instruments or cash management policies to mitigate foreign currency risk.
Income taxes There are temporary and timing differences that give rise to deferred income taxes, such as differences between capital cost allowance and amortization, translation differences from foreign operations, and amortization of sales revenue that are immediately recognized in taxable income at the time the sale is completed. These differences are expected to reverse in the future. In 2015, income tax expense decreased by $1,387,175 to $1,342,488 from $2,729,663 in 2014. This is a direct result of a decrease in net income compared to 2014. Income taxes based on combined Federal and Provincial statutory income tax rates remained at 26.50% in 2015 and 2014. The Company conducts research and development activities, which may be eligible for investment tax credits and accounts for them when there is reasonable assurance that they will be received. Any investment tax credit refund will be applied against the account in which the original expenditure was incurred. The tax effects of the significant components of temporary differences giving rise to the deferred tax assets are as follows for the years 2013-2015: October 31, 2015 October 31, 2014 October 31, 2013
Deferred tax liabilities for intangible assets and other depreciable assets Deferred tax assets arising from deferred revenue and other miscellaneous items Net deferred tax liabilities/(assets)
1,000 (3,308,000) ($3,307,000)
Net Income Operating income before taxes for the year totaled $6,318,860 . Net income totaled $4,976,372 and basic and diluted earnings per share amounted to $0.43 for 2015. Net income and earnings per share were unfavourably impacted by $3,731,165 of one-time items. Excluding these one-time items, net income and earnings per share would have been $7,718,778 and $0.66 respectively.
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis Operating results by reportable segment The Company operates primarily in one industry segment, which is security monitoring, and related home and personal protection services. The Company has operations in North America, specifically in Canada and the US. By geographical areas of the Company, the following table outlines revenues for years ended October 31, 2015 and 2014:
Revenue by region
October 31, 2015 October 31, 2014 $ $
Canada US Total Revenue
39,034,997 17,102,185 56,137,182
38,411,130 14,170,974 52,582,104
SUMMARY OF QUARTERLY RESULTS
The following table contains selected consolidated financial information for the Company, prepared in accordance with IFRS, for the eight most recently completed quarters of 2015 and 2014:
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis 2015 Q4
Net US subscriber growth
Total net growth in subscribers
Income/(loss) before taxes
Basic earnings/(loss) per share
Diluted earnings/(loss) per share
Net CDN subscriber growth
FINANCIAL POSITION: Total assets
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis Trends The consolidated revenue growth trend reflects year-over-year growth in recurring monthly revenues from having a higher average subscriber base during the year and higher average revenue per subscriber driven by customers subscribing to multiple enhanced service offerings and the impact of a stronger US dollar affecting our revenues from the US operations. Historically, the Company’s financial and operating results have not been subject to significant seasonal fluctuations. However, subscriber activations may fluctuate from one quarter to another resulting from periodic promotions and new product launches. Operating profits and subscriber additions may be influenced by the timing of our advertising and promotional expenditures. Subscriber additions and attrition are somewhat attributable to seasonal relocations during the summer months, re-opening of the school year during the fourth quarter, as well as our concentrated marketing efforts generally conducted during new product launches and competitive entrances into the market. The Company’s operations are not dependent upon any single customer or a group of customers. Other fluctuations in net income from quarter-to-quarter can also be attributed to foreign exchange gains and losses, the timing of equipment purchases and changes in corporate tax rates and income tax expenses.
DISCUSSION OF FOURTH QUARTER 2015 RESULTS
Gross revenues in the fourth quarter of 2015 grew at a rate of 9% to a total of $14,443,992 from the corresponding quarter of 2014. Revenues from the Canadian operations grew by 2% to $9,856,402 and revenues from the US operations grew by 25% to a total of $4,587,590 in the fourth quarter of 2015. Excluding the effect of foreign exchange, revenues in the US grew by $172,585 or 5%. Growth in revenues quarter over quarter is a reflection of an increase in average subscriber base, growth in RMR and increase in average revenue per subscriber resulting from the addition of enhanced value added services. Operating income before taxes in the fourth quarter amounted to $1,478,174 . Net income totaled $1,343,295 and basic and diluted earnings per shares amounted to $ 0.12 per share in the fourth quarter. A number of one-time items were incurred during the year which adversely affected operating results. During the fourth quarter, one-time costs totaled $1,237,165 . Excluding these items, net income and earnings per share would have totaled $2,252,611 and $0.19 respectively. While the Company experienced a net decline in subscribers during the fourth quarter and overall for 2015, this was driven by the Accounts Receivable reassessment which resulted in a number of incremental cancellations in excess of prior periods. Gross subscriber additions for the quarter and full year were higher than levels achieved in 2014 with 22,700 gross additions in 2015, up from 22,600 in 2014. During the fourth quarter, the Company began to reassess the allocation of advertising spend across its markets served in order to better optimize spending to those markets with more attractive return characteristics. This practice will continue going forward, and as a result, may impact gross additions if the level of spend redirected from one market is not fully absorbed into another existing or new market. However, the advertising dollars that are spent will continue to be towards those markets with strong return and customer demographic profiles thereby improving the quality of the Company’s subscriber base.
LIQUIDITY AND CAPITAL RESOURCES
As at October 31, 2015, the Company had cash and cash equivalents of $6,133,042 and short-term investments totaling $2,092,479 which consist of GICs maturing beyond 90 days up to a maximum period of one year. Unused credit facilities
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis of $5,800,000 are also available for future operating and capital requirements. The Company expects its primary use of cash will be on operating activities and capital expenditures. We believe that our cash position and operating cash flows will be sufficient to meet our operational, capital and business needs over the next twelve months. The cash flows from operating activities, and cash flows used in financing and investing activities for years ending October 31, 2015 and 2014 are summarized below: October 31, 2015 October 31, 2014 Operating activities: Cash flow from operations Changes in non-cash operating items Investing activities Financing activities Net change in cash and cash equivalents Cash and cash equivalents, beginning of period Cash and cash equivalents, end of period
10,676,568 (1,683,621) 8,992,947 (4,601,475) (2,999,634) 1,391,838 4,741,204 6,133,042
13,232,174 (1,405,343) 11,826,831 2,099,154 (11,480,992) 2,444,993 2,296,211 4,741,204
In 2015, cash flow after working capital adjustments was $8,992,947 compared to $11,826,831 in of 2014, a decrease of $2,833,884 or 24%. Cash flow from operating activities excluding working capital adjustments, which are temporary in nature, was $10,843,734 compared to $13,232,174 in 2014, a decrease of $2,388,440 or 18%. The Company reinvests cash generated from operations into the business to maintain and grow the subscriber base and to improve and expand the infrastructure. The cash outflow through investing activities is required in order to maintain and grow our subscriber base and expand our infrastructure. These investments are intended to support subscriber growth while improving the productivity of our workplace, improving systems and enhancing the overall customer experience. For 2015, our investing activities consisted of capital expenditures totaling $4,363,160 compared to $5,140,241 in 2014. The timing and maturity of the short-term investments also impacts our cash flows from investing activities. We expect our capital spending to reflect the additions of new subscribers, systems maintenance and improvement requirements, and investment into revenue generating capital assets in support of the Company’s strategic plan. Cash used for financing activities decreased by $8,481,358 to $2,999,634 in 2015 compared to $11,480,992 in 2014. The annual cash dividend payout in 2015 was $1,748,940 compared to $8,473,921 in 2014. The payment of the special dividend of $0.60 per share is reflected in 2014. An increase in the quarterly dividend was declared in March 2015. In addition, the Company purchased for cancellation a total of 113,100 common shares for a total price of $1,250,694 under the NCIB in 2015, compared to 314,600 shares purchased for a total price of $3,315,821 in 2014.
The Company expects to continue investing in growing its subscriber base through capital expenditures to support the installation of new home and personal protection offerings. Management will continue its emphasis on add-on services such as VideoRelay, CellWave, AlarmForce Connect, the fall sensor for AlarmCare, the recently launched thermostat and other home automation products and services. Alarm and video surveillance security systems are initially installed under three16
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2015 Management’s discussion and analysis year agreements. AlarmCare subscribers do not sign a fixed period agreement. The Company has historically manufactured the equipment for its home and personal protection systems which includes CellWave, VideoRelay and AlarmCare. The manufacturing process involves purchasing various key components from foreign and domestic manufacturers, and utilizing local subcontractors in certain phases of the manufacturing process. The Company’s assembly operations are housed in Toronto, Ontario. The Company is exploring the introduction of third-party equipment, for which it will benefit from market developments and technological advances made by these market leading manufacturing organizations.
Long-term debt The Company currently operates with zero long-term debt on its balance sheet. The Company has total available credit facilities in the amount of $5,800,000 (October 31, 2014 - $5,800,000) and is in compliance with all bank loan covenants as at October 31, 2015.
Commitments and contractual obligations The Company is committed to operating leases for premises, vehicles, and office equipment, contractual obligations for office equipment expiring at various dates up to April 2021. Future minimum payments are as follows: Contractual obligations Operating leases ($) 2016 69,725 2017 21,302 2018 18,902 2019 14,113 2020 14,113 Thereafter 7,057 Total Contractual obligations 145,212
The Company has been named as a defendant in a lawsuit filed by a former member of management, subsequent to termination of his employment. The total potential claim is approximately $11.3 million; $1.3 million for damages relating to wrongful dismissal, and $10 million for punitive and aggravated damages and/or damages for breach of the Ontario Human Rights Code. Management believes that the Company has fulfilled its obligations pursuant to the termination provision of the executive’s employment contract, and believe the claim for punitive and aggravated damages and/or damages for breach of the Ontario Human Rights Code are excessive and without merit. The Company is subject to various claims and litigation matters arising out of the ordinary course of business including contractual disputes, employment matters, product and general liability claims and intellectual property issues. Although such matters cannot be predicted with certainty, the Company does not consider its exposure to such litigation to be material to the Company’s consolidated financial statements. Since the Company cannot predict the final outcome of these legal matters, as at October 31, 2015, no amount has been accrued in the consolidated financial statements.
The following is a discussion of significant changes in the consolidated statement of financial position since November 1, 2014. Total assets at October 31, 2015 were $41,139,670 compared to $40,801,693 at October 31, 2014. Current assets increased 17
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis by $1,343,526. Cash and cash equivalents and short-term investments increased by $1,421,724, prepaid expenses decreased by $82,115, inventory decreased by $750,517 and trade and other receivables decreased by $199,928. As a result of the reassessment of the accounts receivable initiated in the third and fourth quarters, trade and other receivables decreased to reflect increased write-offs and reserves taken against doubtful accounts. Efforts are being made to improve collection processes in order to drive reductions in trade and other receivables and to better manage account delinquencies. Prepaid expenses consist of insurance payments and payments made in advance to suppliers for the procurement of alarm/video components. The decrease in prepaid expenses is a direct result of the timing of advance payments made to suppliers. Deferred income tax assets increased by $507,000 to $3,307,000 because of timing differences resulting from revenue generating equipment and changes in deferred revenue. Total liabilities decreased by $1,642,340 to $8,834,552 as at October 31, 2015. Trade payables and accrued liabilities decreased by $754,382 to $4,538,793 as at October 31, 2015, primarily due to the timing of equipment purchases and media buying. Deferred revenue decreased by 20% or $658,638 due to periodic promotional offers for the installation of add-on equipment. During 2015, the Company purchased for cancellation a total of 113,100 shares under the NCIB, which decreased the book value of the share capital by $120,975. The effect of these transactions brought the share capital to $12,391,023 as at October 31, 2015.
OUTSTANDING SHARE CAPITAL
Financing activities The Company is authorized to issue an unlimited number of common shares. The changes in the issued common shares of the Company during fiscal years ended October 31, 2015 and 2014 were as follows:
Balance, October 31, 2013 For cash pursuant to stock option plan Purchased for cancellation Balance, October 31, 2014 Cancelled through normal course issuer bid: Purchased for cancellation Balance, October 31, 2015
Number of Shares 11,953,858 65,000 (314,600) 11,704,258
Amount $ 12,538,644 308,750 (335,396) 12,511,998
The Company is committed to issuing 218,683 common shares, if exercised, under options that were outstanding as at October 31, 2015 (205,000 as at October 31, 2014). Exercise prices under the options and the remaining life of options as at October 31, 2015 are summarized below:
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis
Number of options 150,000 25,000 13,683 30,000
Remaining contractual life (Years) 3.5 0.5 4.5 4.5
Exercise Price $11.41 $10.25 $10.16 $10.61
Number of options exercisable 60,000 25,000 13,683 6,000
Stock Option Plan The Company has an incentive stock option plan in place for its directors, officers and employees. Options may be granted for a period not exceeding five years at an option price not less than the market price of the shares at the time the option is granted. The maximum number of common shares which may be set aside for issuance under the plan is 2,250,000, provided that, from time to time, such number may be increased subject to approval of the shareholders of the Company. The maximum number of common shares that may be reserved for issuance to any one person under the plan is 5% of the common shares outstanding at the time of the grant, less the number of shares reserved for issuance to such person. On March 18, 2015, the Company granted stock options to purchase up to 13,683 common shares at an exercise price of $10.16 per common share. The options are fully vested. These stock options will expire on March 18, 2020. On April 15, 2015, the Company granted stock options to purchase up to 30,000 common shares at an exercise price of 10.61 per common share to an external director. These options are subject to vesting. These stock options will expire on April 15, 2020. The fair value of the stock options granted on March 18, 2015 and April 15, 2015 were calculated using the Black Scholes option pricing model on the date of grant with the following assumptions:
Options granted Exercise price Risk-free interest rate Expected option life Expected volatility Fair value of stock option Expected dividend yield
30,000 $10.61 0.77% 5 years 22% $1.71 1.70%
13,683 $10.16 0.74% 5 years 22% $1.62 1.77%
Dividend policy During 2015, the Company paid quarterly cash dividends to shareholders totaling $1,748,940 compared to $8,473,921 ($1,306,766 excluding the special dividend paid) in 2014. Quarterly dividends initially increased from $0.025 per share to $0.03 per share in April 2014 with a subsequent increase to $0.045 per share in March 2015. The Board of Directors declared a cash dividend of $0.045 payable for all issued and outstanding shares of the Company on record as at October 31, 2015, payable on November 20, 2015. The Board's decision to continue the cash dividend policy reflects the Company’s confidence in its ability to continue generating cash flows necessary to support operational needs while sustaining a regular dividend to shareholders. Following a period of consistent growth in recurring cash flows, the Board wishes to provide shareholders the opportunity to benefit from the Company’s operational strength. 19
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis Deferred Share Units The Company has a Deferred Share Unit (“DSU”) plan as part of the total compensation for directors and executive personnel. The fair value of the amount payable to members of the executive team and directors under the DSU plan, which are settled in cash, is recognized as a compensation expense with a corresponding increase in deferred share units payable based on the vesting periods. The number of DSUs granted is determined by the DSU plan for directors and executive personnel. The fair value of the DSUs is calculated using the average closing price on the Toronto Stock Exchange of the common shares of the Company on the last five trading days preceding the DSU grant date. The number of DSUs granted are redeemable when a participant is no longer a director, officer or employee of the Company or any of its subsidiaries. The accrued liability is revalued at the end of each reporting period until settlement. As at October 31, 2015 the fair value of the DSUs outstanding was $116,171 (2014 – Nil). Any change in fair value of the DSUs is recognized in the period in which the change occurs.
OFF-BALANCE SHEET FINANCING
The Company did not have any off-balance sheet arrangements or obligations other than the operating leases disclosed above.
RELATED PARTY TRANSACTIONS
Transactions between the Company and its subsidiaries, which are related parties of the Company, have been eliminated on consolidation and are not disclosed in this note. Our key management personnel have authority and responsibility for overseeing, planning, directing and controlling our activities and include the Board of Directors and certain senior executive members. The remuneration of Directors and key management of the Company for the years ended October 31, 2015 and 2014 is as follows:
Short-term employee benefits Post employment benefits Termination benefits Total
October 31, 2015 October 31, 2014 $ $ 780,979 671,979 5,186 10,042 713,443 1,499,608 682,021
CRITICAL ACCOUNTING ESTIMATES
The Company’s significant accounting policies are described in note 2 of the consolidated financial statements dated October 31, 2015. The preparation of these financial statements in conformity with IFRS requires management to make 20
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting periods. Actual outcomes could differ from these estimates. Estimates are based on a number of factors, including historical experience, current events and actions that the Company may undertake in the future, and other assumptions that are believed to be reasonable under the circumstances. By their nature, these estimates are subject to measurement uncertainty. Key areas of estimation, where management has made difficult, complex or subjective judgments, often as a result of matters that are inherently uncertain, are the allowance for doubtful accounts, deferred income taxes, capitalization of labour and overhead rates, useful lives of depreciable assets, impairment assessments of intangible assets, legal and tax contingencies, measurement of share-based compensation plans, indefinite life identifiable intangibles and goodwill using estimated future cash flows. Significant changes in assumptions could result in a material adjustment to the carrying amounts of assets and liabilities, and revenues and expenses.
Property, plant and equipment and intangible assets Certain costs incurred are capitalized and amortized over the estimated useful lives of the respective assets, which principally include rental equipment and intangible assets, consisting primarily of franchise rights. The carrying value of the assets depends on their estimated useful life, which is the period over which the assets are written off. Rental equipment, which the Company continues to own during and after the term of the subscriber agreement, is written off over the estimated tenyear useful life of the security systems. The use of wireless technology makes retrieval and relocation of systems easy and very cost-effective allowing the Company to relocate or re-deploy the equipment if necessary. Franchise rights are written off over the remaining terms of the respective franchise agreements. If the estimated useful lives of these assets were materially incorrect, the Company would experience increases or decreases in amortization charges in the future, which in turn would result in material changes to the net income.
Allowance for doubtful accounts The estimate of the Company’s allowance for doubtful accounts could change from period to period, since this allowance is a function of the balance and composition of the Company’s trade and other receivables, which may fluctuate on a monthto-month basis. The variations in trade and other receivables balance can arise from changes in accounts receivable collection performance.
Income tax assets and liabilities Current income tax assets and liabilities are estimated based on the amount of tax that is calculated as being owed to the tax authorities, net of periodic installment payments. Deferred income tax assets and liabilities are comprised of the tax effects of temporary differences between the carrying amount and tax basis of assets and liabilities. The timing of these temporary differences is estimated. The carrying amounts of the assets and liabilities are based on the amounts recorded in the financial statements and are therefore subject to accounting estimates that are inherent in those balances. These assessments are based upon the applicable tax legislation, regulations and interpretations, all of which are subject to interpretation. The composition of deferred income tax assets and liabilities may change from period to period because of changes in the estimates of these significant uncertainties.
DISCLOSURE CONTROLS AND PROCEDURES
The President and Chief Executive Officer (the “CEO”) and Chief Financial Officer (the “CFO”) of the Company, together with management are responsible for establishing and maintaining adequate disclosure controls and procedures to provide reasonable assurance that material information relating to the Company is made known to them and have designed internal 21
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2015 Management’s discussion and analysis controls over financial reporting (“ICFR”) to provide reasonable assurance regarding the reliability of the Company’s financial reporting in accordance with IFRS in its consolidated financial statements. The CEO and CFO of the Company, together with management, have evaluated, or caused to be evaluated under their supervision, the effectiveness of the Company’s disclosure controls and procedures and ICFR. Based on that evaluation, they have concluded that the design of disclosure controls and procedures and the design of ICFR to be effective, as at October 31, 2015. The CEO and CFO, together with management, have also evaluated whether there were changes in the Company’s ICFR as at October 31, 2015, that have been materially affected, or are reasonably likely to materially affect the Company’s ICFR. No such changes were identified through their evaluation.
ACCOUNTING POLICY DEVELOPMENTS
Initial application of Standards and Interpretations The following standards have been applied for periods beginning on or after January 1, 2014, and have no effect on the Company’s financial statements or performance: Effective for periods starting on or after IAS 36 Impairment of Assets
January 1, 2014
IAS 32 Financial Instruments: Presentation
January 1, 2014
Future Accounting Pronouncements Certain new standards, amendments to existing standards, and interpretations were issued by the International Accounting Standard Board (“IASB”) that are mandatory but not yet effective for the current reporting period, and therefore have not been applied in preparing these consolidated financial statements. The following standards may have a material impact on future consolidated financial statements of the Company: IFRS 9 Financial Instruments
January 1, 2018
IFRS 15 Revenue
January 1, 2018
IFRS 9 replaces IAS 39 Financial Instruments: Recognition and Measurement, and applies to classification and measurement of financial assets and financial liabilities. This is a three-phase project with the objective of improving and simplifying the reporting for financial instruments. In subsequent phases, the IASB will address hedge accounting and impairment of financial assets. The adoption of the first phase of IFRS 9 will have an impact on the classification and measurement of financial assets, but will potentially have no impact on classification and measurement of financial liabilities. The Company will quantify the impact in conjunction with the other phases when issued. IFRS 15 establishes principles for reporting the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. It provides a single model for an entity to recognize revenue in order to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. IFRS 15 supersedes the following standards: IAS 11 Construction Contracts, IAS 18 Revenue, IFRIC 13 Customer Loyalty Programmes, IFRIC 15 Agreements for the Construction of Real Estate, IFRIC 18 Transfers of Assets from Customers and SIC-31 Revenue-Barter Transactions involving Advertising Services. The Company will quantify the impact in conjunction with the other phases when issued. 22
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis The Company is in the process of determining the extent of the impact of these standards on its consolidated financial statements.
The capital structure of the Company consists principally of shareholders’ equity comprised of retained earnings and share capital. The Company’s strategy has been to minimize the use of debt financing to fund growth and manage its capital structure based on operational needs and the risk characteristics of the underlying assets. The Company’s primary uses of capital are to finance working capital requirements and capital expenditures, which are currently funded from its internally generated cash flows. The Company’s objectives when managing capital are: (i)
to ensure sufficient liquidity to pursue its growth strategy;
(ii) to deploy a strong and efficient capital base to provide an appropriate return on investment to shareholders and maintain investor, creditor and market confidence. The components of the Company’s capital structure are as follows: October 31, 2015 October 31, 2014 $ $ Cash and cash equivalents, and short-term investments
Share capital Other capital reserves
The Company manages its capital structure to provide operational flexibility and makes adjustments based on economic conditions and market opportunities. In order to maintain or adjust the capital structure, the Company may consider the purchase of shares for cancellation, the issuance of new shares, or new debt. Debt: The Company’s banking facilities are subject to covenants which require the Company to maintain a debt to net worth ratio to be no greater than 1.25:1 and a debt servicing coverage ratio of no less than 1.25:1. As at October 31, 2015, the Company was in compliance with these covenants and based on the current business plans and economic conditions, the Company is not aware of any condition or event that would give rise to non-compliance with these covenants. The Company has $5,800,000 in credit facilities available as at October 31, 2015 and 2014, which can be drawn at an interest of prime plus a rate that will be mutually agreed upon at the time of the drawdown and are due on demand. These credit facilities are secured by a general assignment of book debts and a general security agreement. The Company did not require the use of these credit facilities in 2015 or 2014.
RISKS AND UNCERTAINTIES
Due to general uncertainties inherent in the global economic climate, we expect that possible weakness in consumer spending and tightening of the credit markets can lead to an overall deterioration of economic conditions and potentially slow the rate of growth in the subscriber account base. We, however, remain optimistic that the Company will be able to 23
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis continue the momentum in new customer installations through continued investment in creative advertising campaigns and its product and monitored home and personal protection offerings. In addition to general economic factors, the Company’s business is subject to a number of risk factors, some of which although not an exhaustive list, have been described below. The principal risks include consumer behaviors, attrition of accounts, technological changes, and competition as further described below. The Company has certain business risks linked to the collection of receivables and subscriber attrition risk, which management believes is manageable. For additional discussion of risk factors pertaining to the Company, please see the Company’s annual information form, which is available under the Company’s profit on SEDAR at www.sedar.com.
Attrition of accounts Customer attrition results from a variety of different factors, including relocation of subscribers, financial difficulties experienced by the customer, competition, an economic downturn and other socio-economic factors. Any significant increase in the Company’s attrition rates could have a materially adverse effect on the Company’s business, financial performance, liquidity and operating results.
Collectability of Receivables Certain consumer attributes, behaviour and circumstances have the potential to result in payment delinquencies and nonpayment of monthly subscription fees. Any significant increase in non-payment across the subscriber base and/or deterioration in the anticipated recovery of outstanding receivables could have a materially adverse effect on the Company’s business, financial performance, liquidity and operating results.
Technological changes As technology evolves in the security and telecommunication industries, the Company will attempt to keep abreast of the changes, yet there are no assurances that the Company’s products or services will continue to be competitive as a result of such technological advancements. There are also no guarantees that the telecommunications companies or other companies will not enter the residential home security business with improvements in technology. Some of our recurring monthly services depend on wireless technology of security related systems and should the need arise we may be required to implement new technology, which could require significant expenditures. The Company makes every attempt to fully embrace and implement the new wireless technology. However, we may not be able to successfully implement these new technologies or adapt to changing market demands within competitive time frames. If we are unable to adapt to changing technologies, market conditions or customer requirements in a timely manner, such inability could adversely affect our business.
Competition The Company competes with larger companies, as well as smaller regional and local companies, in all of its operations. Furthermore, new competitors are continuing to enter the home and personal protection segments of the residential home security industry and the Company may encounter additional competition from these new entrants. Some of the Company’s current competitors have, and new competitors may have, greater financial resources than the Company. The effect of such competition may be to reduce the volume of potential subscribers available to the Company, which could adversely affect the Company’s financial performance.
Risks of litigation The nature of the security services provided by the Company potentially exposes it to risks of liability for employee acts or omissions or system failures. The Company’s subscriber agreements pursuant to which it distributes its products and services contain provisions limiting liability to subscribers in an attempt to reduce this risk. However, in the event of litigation with respect to such matters, there can be no assurance that these limitations will be enforced, and the costs of 24
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2015 Management’s discussion and analysis such litigation could have a material adverse effect on the Company.
Ability to maintain profitability and manage growth There can be no assurances that the Company’s business and growth strategy will enable the Company to remain profitable in the future. The Company’s future operating results will depend on a number of factors, including (i) the efficiency and effectiveness of the Company’s marketing and advertising programs, (ii) the Company’s ability to develop and drive growth through additional channels, (iii) the Company’s ability to identify and develop markets for both organic and acquisition based growth opportunities, (iv) the Company’s ability to continuously improve its service to achieve new and enhanced customer benefits, better quality service and reduced costs, (v) the Company’s ability to successfully identify and respond to emerging trends in the home and personal protection and security industry, (vi) the level of competition in the home and personal protection industry, (vii) the Company’s ability to continue to attract new subscribers, and (viii) the ability to manage attrition levels and subscriber replacement costs. There can be no assurance that the Company will be able to effectively manage its growth, and any failure to do so could have a material adverse effect on the Company’s business, financial position, liquidity and financial performance.
Human Resources The Company’s success is highly dependent on the abilities, experience and personal efforts of the leadership team to manage its operations and growth. The future success of the Company is dependent on the management of the Company. The departure of any of the operations or management personnel or their inability to continue executing against their key competencies could have an adverse impact on the Company’s growth, business, financial position, liquidity and operating results.
Effectiveness and efficiency of advertising expenditures The Company’s future growth and profitability will be dependent in part on the effectiveness and efficiency of the Company’s advertising expenditures, including the ability of the Company to (i) create greater awareness of the Company’s products and services, (ii) determine the appropriate creative message and media mix for future advertising expenditures, (iii) effectively manage advertising costs in order to maintain acceptable operating margins and customer acquisition costs, and (iv) influence consumer purchase decisions based on its value proposition and core product and service offerings. There can be no assurance that the Company will experience benefits from advertising expenditures in the future. In addition, no assurance can be given that the Company’s planned advertising expenditures will result in increased sales, will generate sufficient levels of product and service awareness or that the Company will be able to manage such advertising expenditures on a cost-effective basis.
Development of Dealer Channel The Company’s future growth and profitability could be dependent in part on its ability to develop and implement an effective dealer strategy, including the ability of the Company to (i) attract a pool of exclusive independent dealers capable of marketing and installing the Company’s home protection systems, (ii) effectively manage the costs paid to dealers to purchase the accounts underwritten and created on behalf of the Company, (iii) provide ongoing training, development and support to dealers working on behalf of the Company, and (iv) manage channel conflict which might arise between the Company’s traditional direct-to-consumer strategy and any dealer channel that is created.
Supply chain The Company currently relies on major components to be manufactured on an Original Equipment Manufacturer (“OEM”) basis, and with the introduction of third-party products will be reliant upon those manufacturers with which it chooses to source its controller panel. Reliance upon OEMs and third-party product manufacturers as well as industry supply conditions generally involves several risks, including the possibility of defective products (which can adversely affect the Company’s reputation for reliability), a shortage of components and delays in delivery schedules (which can adversely affect the Company’s distribution schedules), and increases in component costs (which can adversely affect the Company’s 25
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2015 Management’s discussion and analysis profitability). The Company has some single-sourced manufacturer relationships, either because alternative sources are not readily or economically available or because the relationship is advantageous due to performance, quality, support, delivery, capacity, or price considerations. If these sources are unable or unwilling to manufacture our products in a timely and reliable manner, the Company could experience temporary distribution interruptions, delays, or inefficiencies, adversely affecting our financial performance. Even where alternative OEMs or third-party product manufacturers are available, qualification of the alternative manufacturers and establishment of reliable suppliers could result in delays adversely affecting operating results.
Possible adverse effect of “false alarm” ordinances According to American industry sources, approximately 98% of alarm activations that result in the dispatch of police or fire department personnel are not emergencies, and thus are “false alarms”. Significant concern has arisen in certain municipalities about the high incidence of “false alarms”. Although AlarmForce believes it maintains a relatively low number of false alarms by providing live two-way voice communication with the residence and thereby minimizing the number of dispatches, this concern could cause a decrease in the likelihood or timeliness of police response to alarm activations and thereby decrease the propensity of consumers to purchase or maintain home protection monitoring services. A number of municipalities have implemented or are considering adopting various measures aimed at reducing the number of false alarms. Such measures include (i) subjecting monitoring companies to fines for transmitting false alarms, (ii) licensing individual security systems and the revocation of such licenses following a specified number of false alarms, (iii) imposing fines on security subscribers for false alarms, (iv) imposing limitations on the number of times police will respond to alarms at a particular location after a specified number of false alarms, and (v) requiring further verification of an emergency signal before the police will respond. As a result, the Company has determined that the most appropriate and cost effective method to address these police service policies is to retain a private dispatch security response team to respond to the alarm signals.
Expansion The success of the Company’s continued expansion will depend upon many factors, including the ability of the Company to maintain acceptable attrition rates, efficient customer acquisition costs and control of operating costs while pursuing gross subscriber additions. There can be no assurance that the Company will be able to grow or achieve continued expansion. Such risks, if they materialize, could have a material adverse effect on the Company’s business, financial position, liquidity and financial performance.
Possible adverse effect of future government regulations The Company’s operations are subject to a variety of laws, regulations and licensing requirements of federal, provincial, municipal and regulatory authorities and United Laboratories of Canada. The loss of such licenses, or the imposition of conditions to the granting or retention of such licenses, could have a material adverse effect on the Company. The Company believes that it is in material compliance with applicable laws and regulatory requirements.
The North American residential security market is estimated to be worth greater than US$12 billion annually and it is growing at approximately 5% per year. Personal health monitoring, a relatively new sector being served by our industry is estimated to be about US$1.5 billion in size growing at 10% annually. Both the home and personal protection segments are benefiting from the emergence of home automation and enhanced offerings which are drawing new customers, products, services and companies into the market. 26
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis Over the past few years, increased complexity and pace of technological change have been a driving force in home and personal protection segments. New products and services are emerging at a very rapid rate and they are broadening the market opportunity for traditional security companies and expanding the addressable market by increasing the penetration of available households. The emergence of the smart, connected home presents a renewed opportunity for growth and requires preparing our organization to adapt and thrive in this new environment. A number of steps have and continue to be taken to position the Company to take advantage of these exciting changes in the industry. This multi-year process of renewal and change forms the foundation of a refreshed strategic direction for AlarmForce. The Company has prospered by marketing and delivering professional home security services directly to consumers at fair prices. Our past strategy has been rooted in a vertically integrated approach that has included proprietary products and services. Going forward, we will need to be able to adapt our business quickly to respond to market demands for innovative new products and services. This includes partnering with leading, open platform manufacturers to offer in-demand products to our customers. Our strong brand awareness will be a critical component of our strategy and will support growth as well as differentiate us from competitors. We will be investing in our brand, technology, services and infrastructure to solidify our position with our current customers and to ensure that we can compete effectively and attract new customers. Our investment decisions will be driven by a solid understanding of the changing industry landscape that will be based on a foundation of data, research and analysis. Our capital will be allocated to those opportunities that will help add new customers and deliver more value added services to each customer while generating appropriate returns for each dollar invested. This focus on efficient and profitable customer acquisition and retention is a key foundation to the Company’s strategic plan. Opportunities will be evaluated and assessed based on the Company’s return parameters and ability to drive incremental growth at attractive returns. The Company’s focus on operational and process improvements will enable AlarmForce to continue to demonstrate strong performance while taking advantage of opportunities in the industry. In line with this focus, the Company has identified a clear approach to growth including: 1. Increasing Inquiries Increased investment in core markets Refreshed and expanded messaging New partners 2. Improving Cross-Sell Home protection bundles New features Refreshed and re-energized sales group 3. Generating Higher Average Revenue Per User: Improved products Transparent bundled pricing 4. Entering new markets and channels Exploring the establishment of a dealer network Increasing marketing in targeted areas Opportunistic acquisitions 5. Reducing attrition Customer service excellence through recruiting and additional training Dedicated loyalty and retention initiatives
In summary, the home and personal protection segments of the residential home security industry are large and growing markets in North America. Demographic shifts and an increased interest in home automation and technology driven offerings will continue to expand the market opportunity and draw new entrants to the industry. AlarmForce’s revised strategy continues to be underpinned by its founding promise of high quality home protection and security at a reasonable 27
ALARMFORCE INDUSTRIES INC.
2015 Management’s discussion and analysis price. The Company believes that executing on its plan will position it well to continue to compete effectively in this exciting and evolving marketplace.