ALARMFORCE INDUSTRIES INC. MANAGEMENT S DISCUSSION AND ANALYSIS June 14, 2016

Transcription

1 MANAGEMENT S DISCUSSION AND ANALYSIS June 14, 2016 For the three and six months ended April 30, 2016 and April 30, 2015 (Expressed in CDN dollars)

2 Table of Contents 1. INTRODUCTION FORWARD-LOOKING INFORMATION COMPANY OVERVIEW DISCUSSION OF OPERATIONS SUMMARY OF QUARTERLY RESULTS LIQUIDITY AND CAPITAL RESOURCES FINANCIAL POSITION OUTSTANDING SHARE CAPITAL OFF-BALANCE SHEET FINANCING RELATED PARTY TRANSACTIONS CRITICAL ACCOUNTING ESTIMATES DISCLOSURE CONTROLS AND PROCEDURES ACCOUNTING POLICY DEVELOPMENTS CAPITAL STRUCTURE RISKS AND UNCERTAINTIES OUTLOOK

3 1. INTRODUCTION The following Management s Discussion and Analysis ( MD&A ), of operating results and financial position for the three and six months ended April 30, 2016 and 2015 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, Copies of these documents can be found on the SEDAR website at 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. 2. FORWARD-LOOKING INFORMATION 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. 2

4 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 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. 3. COMPANY OVERVIEW 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 is focused on growing recurring monthly revenue ( RMR ) and average revenue per user ( ARPU ) through a strong subscriber base, enhanced 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. In February 2016, the Company launched new bundled pricing and services which provides the consumer with pre-packaged services with tiered pricing and service options. Three bundles are currently being offered, AlarmForce Secure, AlarmForce Control and AlarmForce Command. These bundles continue to provide great value at an affordable price. They provide the customer with simple and affordable options offered at different price points and service offerings to match those price points. The newly launched touchscreen keypad is incorporated as part of these bundled offerings. We expect the adoption of these bundled services to assist us in articulating patterns in consumer habits and their preferred product/service mix and in ensuring that the Company s offerings are meeting consumer preferences. Management is closely monitoring the sales trends of these bundled services to accurately forecast, manage and facilitate consumer needs. During the second quarter of 2016, the Company launched a touchscreen keypad as part of the new bundled service offerings, which equips the customer with increased functionalities at his/her fingertips such as visual status of the alarm, arming and disarming capabilities, home automation control features (managing door locks, power plugs, thermostats, video cameras) and other control capabilities, paired with an esthetically appealing design. The Company continues to expand its portfolio of home automation services, expanding on its Wi-Fi enabled door locks, power plugs and thermostats under the AlarmForce Connect umbrella. The AlarmForce Connect Smartphone App (the App ) which was refreshed in 2015 for enhanced user experience and functionality, allows the customer the flexibility of remotely controlling the heating and cooling system within their home through a Wi-Fi enabled thermostat. The App also provides the ability to monitor and control a user s home security system remotely and is available on IOS, Android and Blackberry devices. The take-rate of AlarmForce Connect among new subscribers was 48% for the second quarter of 2016, compared to 44% for the same quarter of Year to date adoption rates for AlarmForce Connect were 41% in 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. 3

5 The Company continues to install its camera offering, VideoRelay, which 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 containing three images of the person at the door. The subscriber, upon receiving the , 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 two-way 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. 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 16% of new alarm subscribers for the second quarter of 2016 compared to 15% in the comparative quarter of As at April 30, 2016, the Company had 9,500 subscribers using VideoRelay services, of which 6,200 were in Canada and 3,300 in the US. The Company s fall sensor which is an enhancement to our Personal Emergency Response ( PERS ) offering ( AlarmCare ) continues to gain traction 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 consistent positive reception that the fall sensor has received to date with 83% adoption rate with new AlarmCare subscribers in the second quarter of 2016, up from 78% in the second quarter of 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 9,001 AlarmCare subscribers as at April 30, 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 April 30, 2016, the Company had 134,000 alarm subscribers benefiting from these features, of which 100,600 are in Canada and 33,500 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 69% of new alarm subscribers for the second quarter of 2016 versus 66% in the comparative quarter of CellWave is available exclusively to AlarmForce subscribers. 4

6 The Company is in the process of finalizing its partnership with third party manufacturers and software providers that specialize in security and home automation products in an effort to bring forth a new product offering and enhanced experience to our customers. Drawing on specialty manufacturers for new alarm and video offerings with cutting-edge technology will enable AlarmForce to bring new features and product enhancements to the market at a faster pace and more efficient manner.. The Company s lower marketing spend relative to the same period in 2015 is reflective of its plan to launch third party product towards the end of fiscal 2016 and reduce marketing spend in the US markets. As a result, lower gross additions have been experienced in the first half of In the first half of 2016, the Company purchased 20,900 common shares through the Normal Course Issuer Bid ( NCIB ) at an average price of $11.49 and subsequently cancelled these shares during the first half of 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. Total consolidated revenues grew to a total of $28,959,127 in the first six months of 2016, an increase of 5% or 2% excluding the impact of foreign exchange, compared to the same period of The Company s primary source of revenue is recurring monthly services pursuant to the terms of subscriber agreements. In the first half of 2016, revenue from recurring monthly services accounted for 94% of total revenue. The Company s Recurring Monthly Revenue ( RMR ) as at April 30, 2016 grew to $4,505,291 from $4,457,296 as at April 30, 2015, reflecting an increase of 1% (flat excluding the effect of foreign exchange). Canadian revenue totaled $20,066,185 in the first six months of 2016 compared to $19,389,214 in the comparative period of 2015 reflecting an increase of 3%. Revenues in the US increased to $8,892,942 from $8,199,604 or an increase of 8% over the same period of Excluding the impact of foreign exchange, the US revenue decreased by 3% over the comparative period of This decrease directly reflects the Company shifting its focus towards more capital efficient markets in Canada and the US. Average revenue per subscriber continues to be driven by our ongoing 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. These enhanced services form a core foundation of a number of the Company s new bundled service offerings. The Company finished the first half of 2016 with a total of 143,600 subscribers. The Company added a total of 9,500 gross subscribers in Canada and the US with a net decrease of 600 total subscribers in the first six months of 2016 driven by lower gross additions resulting from reduced marketing and advertising expenditures. As at April 30, 2016, total subscribers amounted to 143,600. In Canada, subscribers remained flat with Canadian subscribers totaling 109,700 and in the US, net subscribers decreased to 33,900. US subscribers comprise 24% of the Company s total subscriber base. Cash, cash equivalents and short term investments totaled $12,502,962 as at April 30, 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 the first half of 2016 totaled $4,203,384 compared to $3,994,984 over the same period of 2015, an increase of $208,400 or 5%. Basic and diluted Earnings Per Share ( EPS ) increased to $0.36 compared to $0.34 in the comparative period of EBITDA increased marginally by 1% or $56,845 over the comparative period of 2015 to $ 8,569,140. For the second quarter, EBITDA totaled $4,261,424, up from $3,918,190 for the comparative period of EBITDA in the first half of 2016 was adversely impacted by a one-time settlement with a former executive of AlarmForce. 5

7 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 is currently exploring additional, supplementary distribution channels which could leverage 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 remains 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. Reconciliation of IFRS earnings to adjusted EBITDA 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 (adjusted for marketing expenditures) reported for the three and six months ended April 30, 2016 and 2015: Three months ended Six months ended April 30, 2016 April 30, 2015 April 30, 2016 April 30, 2015 $ $ $ $ Net income/(loss) 1,807,924 1,699,062 4,203,384 3,994,984 Add: income taxes 648, ,831 1,495,618 1,439,846 Income/(loss) before income taxes 2,456,022 2,326,893 5,699,002 5,434,830 Add: Amortization expense 1,805,402 1,591,297 2,870,138 3,077,465 EBITDA 4,261,424 3,918,190 8,569,140 8,512,295 Add: marketing expenses 2,079,390 3,519,448 4,439,713 6,834,663 Adjusted EBITDA 6,340,814 7,437,638 13,008,853 15,346,958 6

8 4. DISCUSSION OF OPERATIONS Revenues Consolidated revenues increased by 5% or $1,370,309 in the first half of 2016 to a total of $28,959,127 compared to $27,588,818 in the comparative period of Revenues from the Canadian operations totaled $20,066,185 reflecting a growth of $676,971 or 3% and revenue from the US operations grew by $693,338 to $8,892,942 reflecting an increase of 8%. Excluding the effect of foreign exchange, revenues in the US declined by USD$208,786 or 3%, reflecting reduced growth resulting from significant reduction in marketing and advertising spend in the region. Revenue generated from recurring monthly services pursuant to the terms of subscriber agreements accounted for 94% of total revenue. In the second quarter of 2016, consolidated revenue grew by 3% or $449,811 to a total of $14,454,757 compared to $14,004,946 in the second quarter of Revenue from Canadian operations grew $349,341 or 4% in the second quarter of 2016 to $10,079,057 when compared to the same quarter of Total revenues from the US operations grew by 2% or $100,470 (a decrease of 9% excluding the effect of foreign exchange) to $4,375,700 in the second quarter of This is largely a reflection of the Company refocusing its advertising expenditures towards more capital efficient markets in both Canada and the US. Revenue growth is a 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. Average revenue per subscriber grew to $31.37 as at April 30, 2016, reflecting a 3% increase (2% excluding the effect of foreign exchange) when compared to $30.38 over the comparative period in US revenue made up 31% of the Company s total revenue in the first half of 2016 compared to 30% in the same period of With the continued emphasis on enhanced value added services, the average revenue per new subscriber in the first six months of 2016 totaled $35.68 compared to $35.21 in the comparative period of 2015, an increase of 1% (flat excluding the effect of foreign exchange). In Canada, average revenue per new user increased to $33.30 in the first half of 2016, up 2% from the comparative period of We expect a continued growth in new ARPU as the Company introduces new home automation and monitoring solutions along with its tiered bundled pricing that will attract new subscribers and achieve greater penetration of our existing subscriber base. RMR as at April 30, 2016 was $4,505,291 compared to $4,457,296 as at April 30, 2015, an increase of 1% (flat excluding the impact of foreign exchange). The Company achieved this marginal increase, despite completing the accounts receivable review and resulting cancellation of an incremental 4,300 subscribers in the fourth quarter of The Company expects to grow RMR by increasing the take-rates of its newly launched bundled pricing packages, which include value-added services such as CellWave, AlarmForce Connect, VideoRelay, the thermostat and the newly launched touchscreen keypad in variations as part of the pre-packaged price and service offerings. Management also expects to extend the average life of our subscriber base by providing customer service excellence and in-demand products and services. In the first half of 2016, new subscriber adoption rates were 13% for VideoRelay services, 67% for CellWave services, 41% for AlarmForce Connect services and 83% for fall sensors for AlarmCare. Similarly, the adoption rates for the second quarter of 2016 were 16% for VideoRelay services, 69% for CellWave services, 48% for AlarmForce Connect services and 83% for fall sensors for AlarmCare. This compares to the second quarter of 2015 where the adoption rates were 15% for VideoRelay services, 66% for CellWave services, 44% for AlarmForce Connect services and 78% for fall sensors for AlarmCare. With the launch of a number of home automation products in 2015 to complement existing products (Wi-Fi enabled door locks, power plugs, thermostat and the newly launched touchscreen keypad in February 2016) and the pending adoption of third-party manufactured products, we are optimistic such services will continue to be well received with our subscribers and allow us to further build our suite of home protection and automation products and services. 7

9 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 $8,820,726 in the first half of 2016, compared to $6,844,153 in the comparative period of 2015, an increase of $1,976,573 or 29%. Cost of sales in the second quarter of 2016 totaled $4,573,849 reflecting an increase of $828,564 or 22% when compared to the same quarter of The increase in cost of sales was partly driven by the increased costs incurred to improve customer service efficiencies. The Company s efforts to retain customers through focused loyalty and retention offerings also increased the overall cost of sales. Other factors resulting in increased cost of sales are higher labour costs and system and radio upgrades. In addition, lower rental equipment capitalization was experienced in the second quarter and the first half of 2016 in comparison to the same period of 2015 where significant development costs related to the development of the second generation VideoRelay camera were incurred. 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 We are confident that our conversion plan will optimize our resource availability and customer demand within the required timelines. In the first half of 2016 (when compared to the same period of 2015), costs related to the manufacturing and purchase of security products increased by $1,440,575 driven by the timing and amount of purchases. Costs related to servicing existing customers increased by $459,115 and costs related to central station, most of which are labour, increased by $76,883. The Company continuously evaluates the requirements of field support staff and monitoring station personnel to ensure labour efficiency and capacity utilization. Gross Profit In the first half of 2016, gross profit totaled $20,138,401 compared to $20,744,665 in the same period of 2015, a decrease of $606,264 or 3%. Gross profit margin as a percentage of total revenue decreased to 70% when compared to 75% in the same period of In the second quarter of 2016, gross profit decreased to 68% compared to 73% in the comparative quarter of 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. 8

10 Selling, General and Administrative Expenses ( SG & A ) In the first half of 2016, selling and marketing expenses totaled $5,582,346 compared to $7,995,719 in the same quarter of 2015, a decrease of $2,413,373 or 30%. In the second quarter of 2016, selling and marketing expenses decreased by $1,372,825 or 34% to $2,698,149 from $4,070,974 in the same quarter of The Company incurred lower marketing spend in the first half of 2016 in advance of an expected launch of new third party equipment in the second half of the year. This has also resulted in lower gross additions for the same period. The decrease period over period is also partially driven by the Company refocusing its advertising efforts towards more capital efficient markets in Canada and the US and the timing of media and advertising spend. Advertising expenditures, consisting of radio, television, print, internet and other media make up 80% of selling expenses. The Company maintains a marketing spend in the markets in which it continues to focus on growing subscribers to ensure an ongoing level of frequency and reach. 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. The Company continues to refocus its advertising expenditures to those markets in Canada and the US which generate better returns with more attractive customer creation attributes. 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 environmental sensors and 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, the touchscreen keypad and other home automation offerings. Selling expenses unrelated to advertising comprised 20% of the total selling costs and consisted primarily of marketing salaries and benefits. These other selling expenses remained flat with a marginal decrease of $18,423 to $1,142,633 compared to $1,161,056 in the comparative period of 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 the first six months of 2016, general and administrative expenses totaled $5,791,078 compared to $4,237,687 in the comparative period of 2015, an increase of $1,553,391, or 37%. In the second quarter of 2016, general and administrative expenses totaled $2,814,642 reflecting an increase of $586,840 or 26% when compared to the same quarter of The change is primarily reflective of the change in the Company s management and leadership team which occurred in the third quarter of In the first half of 2016, administrative salaries increased by 63% or $897,591 The increase reflects additions to the Company s operational and executive team when compared to the same period of Consulting fees increased by 38% or $265,570 We expect to maintain this higher level of ongoing G&A costs as a result of the new executive leadership team and the multiyear process of renewal and change that is positioning the Company well for the future. Telecommunication costs increased by 37% or $33,853. 9

11 Management continues to focus on collection efforts of receivables and has allocated required resources for a more timely cancellation of non-recoverable accounts. 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 totaled $2,870,138 for the first half of 2016 compared to $3,077,465 in the comparative period of In the second quarter of 2016, amortization expenses totaled $1,805,402 when compared to $1,591,297 in the comparative quarter of Fluctuations in amortization of plant and equipment reflect net additions made to rental equipment from the net new subscribers added in the period. 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. 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 the first half of 2016, the Company experienced a foreign exchange loss of $ 195,837 from the fluctuating US dollar, compared to a gain of $1,036 in the same period of The Company has not deemed it necessary to utilize any financial instruments 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 the first six months of 2016, income tax expense increased by $55,772 to $1,495,618 from $1,439,846 in the comparative period of Income tax expense for the second quarter of 2016 increased by $20,267 to $ 648,098 compared to $627,831 in the same quarter of This is a direct result of an increase in pre-tax income compared to the first half of Income taxes based on combined Federal and Provincial statutory income tax rates remained at 26.50% in the first six months of 2016 and 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. Net Income Operating income before income taxes for the first half of 2016 totaled $5,699,002 Net income totaled $4,203,384 and basic and diluted earnings per share amounted to $0.36 Similarly, operating income before income taxes for the second quarter of 2016 was $2,456,022, net income was $1,807,924 and basic and diluted earnings per share totaled $0.16. The increase in net income is primarily due to decreased selling and marketing expenses partially offset by increased general and administrative expenses. 10

12 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 the three and six months ended April 30, 2016 and 2015: Three months ended Six months ended Revenue by region April 30, 2016 April 30, 2015 April 30, 2016 April 30, 2015 $ $ $ $ Canada 10,079,057 9,729,716 20,066,185 19,389,214 US 4,375,700 4,275,230 8,892,942 8,199,604 Total Revenue 14,454,757 14,004,946 28,959,127 27,588, 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 with US dollar denominated RMR converted at the period ended spot rate, which is consistent with industry standards. In prior years, US dollar denominated RMR was reported at the average rate for the period Q2 Q1 Q4 Q3 Q2 Q1 Q4 Q3 Net CDN subscriber growth (300) 300 (700) Net US subscriber growth (600) - (2,400) Total net growth in subscribers (900) 300 (3,100) 600 1, OPERATIONS: $ $ $ $ $ $ $ $ RMR 4,505,291 4,670,694 4,545,848 4,584,896 4,457,296 4,441,054 4,234,758 4,150,187 Total revenue 14,454,757 14,504,370 14,443,992 14,104,372 14,004,946 13,583,872 13,291,175 13,152,940 Income/(loss) before taxes 2,456,022 3,242,980 1,478,174 (594,144) 2,326,893 3,107,937 2,745,531 2,108,233 Net income/(loss) 1,807,924 2,395,460 1,343,295 (361,907) 1,699,062 2,295,922 2,082,102 1,552,458 Basic earnings/(loss) per share (0.03) Diluted earnings/(loss) per share (0.03) FINANCIAL POSITION: Total assets 43,314,129 42,277,103 41,139,670 40,208,535 41,283,167 41,483,470 40,801,693 38,904,879 Shareholders equity 35,277,426 33,965,774 32,305,118 31,964,951 32,814,049 32,149,495 30,324,801 28,549,413 11

13 Trends The consolidated revenue growth trend reflects period-over-period growth in recurring monthly revenues from a higher average revenue per subscriber driven by customers subscribing to multiple enhanced service offerings and the impact of a strong 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, advertising campaigns 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 and pricing 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. 6. LIQUIDITY AND CAPITAL RESOURCES As at April 30, 2016, the Company had cash and cash equivalents of $12,502,962. Unused credit facilities 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. Historically, our cash position and operating cash flows have been sufficient to meet our operational, capital and business needs. We expect to continue generating sufficient cash flows to sustain operational growth over the next twelve months. The cash flows from operating activities, and cash flows used in financing and investing activities for three and six months ending April 30, 2016 and 2015 are summarized below: For three months ended For six months ended April 30, 2016 April 30, 2015 April 30, 2016 April 30, 2016 $ $ $ $ Operating activities: Cash flow from operations 3,611,954 3,488,725 7,072,015 7,391,374 Changes in working capital adjustments 1,079,857 (803,379) 642,579 (1,462,044) Cash flow from operating activities 4,691,811 2,685,346 7,714,594 5,929,330 Investing activities 1,065,486 (1,336,378) (62,060) (3,790,879) Financing activities (520,662) (932,534) (1,282,614) (1,437,238) Net change in cash and cash equivalents 5,236, ,434 6,369, ,213 Cash and cash equivalents, beginning of period 7,266,327 5,025,983 6,133,042 4,741,204 Cash and cash equivalents, end of period 12,502,962 5,442,417 12,502,962 5,442,417 In the first half of 2016, cash flow after working capital adjustments was $7,714,594 compared to $5,929,330 in the same period of 2015, an increase of $1,785,264 or 30%. Cash flow from operating activities excluding working capital adjustments, which are temporary in nature, was $7,072,015 compared to $7,391,374 in the same period of 2015, a decrease of $319,359 or 4%. The Company reinvests cash generated from operations into the business to maintain and grow the subscriber base and to improve and expand the infrastructure.

14 The cash outflow through investing activities is required in order to maintain and grow our RMR and ARPU through a strong subscriber base and expand our infrastructure. These investments are intended to support growth in average revenue per subscriber while improving the productivity of our workplace, improving systems and enhancing the overall customer experience. For the first half of 2016, our investing activities consisted of capital expenditures totaling $2,049,627 compared to $3,621,573 in the comparative period of 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 $154,624 to $1,282,614 in the first six months of 2016 compared to $1,437,238 in the comparative period of The cash dividend payout in first two quarters of 2016 was $1,042,264 compared to $701,838 in the same period of An increase in the quarterly dividend was declared in March In addition, the Company purchased for cancellation a total of 20,900 common shares for a total price of $240,350 under the NCIB in the first six months of 2016, compared to 69,800 shares purchased for a total price of $735,400 in the comparative period of The Company expects to continue investing in its subscriber base through capital expenditures to support the installation of new home and personal protection offerings. Management will continue its emphasis on value-added services such as VideoRelay, CellWave, AlarmForce Connect, the fall sensor for AlarmCare, the thermostat and the recently launched touchscreen keypad and other home automation products and services. Alarm and video surveillance security systems are initially installed under three-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 has been exploring third-party equipment and software over the past several months and after detailed analysis, is close to finalizing and engaging in partnerships with vendors that specialize in security and home automation products. Management believes the Company will benefit from market developments and technological advances made by these market leading manufacturing and software 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 (April 30, $5,800,000) and is in compliance with all bank loan covenants as at April 30, Commitments and contractual obligations The Company s commitments have not changed from the last fiscal year end. Please refer to the consolidated financial statements dated October 31, 2015 for details. The Company was named a defendant in a lawsuit filed by a former member of management, subsequent to termination of his employment. The Company has now resolved this litigation matter. The Company has been named a defendant in a lawsuit filed by a former franchisee, seeking total damages of $18 million for breach of contractual and statutory obligations. The Company believes the claim is without merit and intends to make a rigorous defence to the claim. Since the Company cannot predict the final outcome of this legal proceedings, no amount has been accrued in the consolidated financial statements. 16

15 7. FINANCIAL POSITION The following is a discussion of significant changes in the consolidated statement of financial position since November 1, Total assets at April 30, 2016 were $43,314,129 compared to $41,139,670 at October 31, Current assets increased by $2,786,057. Cash and cash equivalents increased by $6,369,920, short-term investments decreased by $2,092,479, prepaid expenses increased by $121,946, inventory decreased by $501,135 and trade and other receivables decreased by $157,833. Efforts are continually 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 increase in prepaid expenses is a direct result of the timing of advance payments made to suppliers. Deferred income tax assets increased by $104,000 to $3,411,000 due to of timing differences resulting from revenue generating equipment and changes in deferred revenue. Total liabilities decreased by $797,849 to $8,036,703 as at April 30, Trade payables and accrued liabilities decreased by $800,012 to $3,738,781 as at April 30, 2016, primarily due to the timing of equipment purchases and media buying. Deferred revenue decreased by 11% or $301,096 due to periodic promotional offers for the installation of add-on equipment. During the first six months of 2016, the Company purchased for cancellation a total of 20,900 shares under the NCIB, which decreased the book value of the share capital by $240,350. The effect of these transactions brought the share capital to $12,368,660 as at April 30, 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 the six months ended April 30, 2016 and 2015 were as follows: Number of Amount Shares $ Balance, October 31, ,704,258 12,511,998 Cancelled through normal course issuer bid: Purchased for cancellation under NCIB (113,100) (120,975) Balance, October 31, ,591,158 12,391,023 Cancelled through normal course issuer bid: Purchased for cancellation (20,900) (22,363) Balance, Apr 30 and Jun 14, ,570,258 12,368,660 17

16 The Company is committed to issuing 193,683 common shares, if exercised, under options that were outstanding as at April 30, 2016 (248,683 as at April 30, 2015). Exercise prices under the options and the remaining life of options as at April 30, 2016 are summarized below: Expiry Date Number of options Remaining contractual life (Years) Exercise Price April 17, ,000 3 $11.41 March 18, , $10.16 April 15, ,000 4 $10.61 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. The Company did not issue any stock options in the first six months of Dividend policy During the first six months of 2016, the Company paid quarterly cash dividends to shareholders totaling $1,042,264 compared to $701,838 in the comparative period of 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 April 29, 2016, payable on May 20, 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. 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 April 30, 2016 the fair value of the DSUs outstanding was $168,067 (April 30, 2015 Nil). Any change in fair value of the DSUs is recognized in the period in which the change occurs. 18