SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
--- EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2007
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
--- EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM ________ TO ________.
Commission File number: 0-10004
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NAPCO SECURITY SYSTEMS, INC.
----------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 11-2277818
------------------------------- -----------------------------
(State or other jurisdiction of (IRS Employer Identification
incorporation of organization) Number)
333 Bayview Avenue
Amityville, New York 11701
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(Address of principal executive offices) (Zip Code)
(631) 842-9400
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(Registrant's telephone number including area code)
None
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(Former name, former address and former fiscal year if
changed from last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days:
Yes X No
------------- -------------
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the
Exchange Act):
Large Accelerated Filer Accelerated Filer X Non-Accelerated Filer
----- ----- -----
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act):
Yes No X
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Number of shares outstanding of each of the issuer's classes of common stock,
as of: NOVEMBER 12, 2007
COMMON STOCK, $.01 PAR VALUE PER SHARE 19,349,964
1
Page
PART I: FINANCIAL INFORMATION ----
ITEM 1. Financial Statements
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
INDEX - SEPTEMBER 30, 2007
Condensed Consolidated Balance Sheets, September 30, 2007 and
June 30, 2007 3
Condensed Consolidated Statements of Income for the Three
Months ended September 30, 2007 and 2006 4
Condensed Consolidated Statements of Cash Flows for the Three
Months ended September 30, 2007 and 2006 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 11
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 15
ITEM 4. Controls and Procedures 16
PART II: OTHER INFORMATION 17
SIGNATURE PAGE 18
2
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, June 30,
ASSETS 2007 (unaudited) 2007
------ ----------- ----------
(in thousands, except share data)
Current Assets:
Cash and cash equivalents $ 1,916 $ 1,748
Accounts receivable, less reserve for doubtful accounts 22,106 25,579
Inventories, net 23,120 21,342
Prepaid expenses and other current assets 1,155 1,171
Deferred income taxes 1,079 1,050
----------- ----------
Total Current Assets 49,376 50,890
Inventories - non-current, net 7,594 6,881
Property, plant and equipment, net 9,201 9,135
Goodwill, net 9,686 9,686
Other assets 264 193
----------- ----------
Total Assets $76,121 $76,785
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 5,383 $ 5,045
Accrued expenses 1,726 1,638
Accrued salaries and wages 2,185 2,631
Accrued income taxes 332 96
----------- ----------
Total Current Liabilities 9,626 9,410
Long-term debt 10,900 10,900
Accrued income taxes 2,605 1,836
Deferred income taxes 1,010 1,235
Minority interest in subsidiary 147 147
----------- ----------
Total Liabilities 24,288 23,528
----------- ----------
Stockholders' Equity:
Common stock, par value $.01 per share; 40,000,000 shares authorized,
20,090,313 shares issued and 19,434,477 and 19,665,141 shares
outstanding, respectively 201 201
Additional paid-in capital 13,205 13,147
Retained earnings 42,188 42,299
----------- ----------
55,594 55,647
Less: Treasury Stock, at cost (655,836 and 425,172 shares, respectively) (3,761) (2,390)
----------- ----------
Total stockholders' equity 51,833 53,257
----------- ----------
Total Liabilities and Stockholders' Equity $76,121 $76,785
=========== ==========
See accompanying notes to condensed consolidated financial statements.
3
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)
Three Months Ended
September 30,
-----------------------------
2007 2006
------------ ---------------
(in thousands, except share
and per share data)
Net sales $ 13,876 $ 14,029
Cost of sales 8,747 8,470
------------ ---------------
Gross Profit 5,129 5,559
Selling, general and administrative expenses 4,326 3,998
------------ ---------------
Operating Income 803 1,561
------------ ---------------
Interest expense, net 195 90
Other expenses, net 7 4
------------ ---------------
Other expenses 202 94
------------ ---------------
Income Before Minority Interest and Provision for Income Taxes 601 1,467
Minority interest in loss of subsidiary 38 13
------------ ---------------
Income Before Provision for Income Taxes 639 1,480
Provision for income taxes 265 528
------------ ---------------
Net Income $ 374 $ 952
============ ===============
Earnings per share (Note 4):
Basic $ 0.02 $ 0.05
============ ===============
Diluted $ 0.02 $ 0.05
============ ===============
Weighted average number of shares outstanding (Note 4):
Basic 19,567,689 19,951,298
============ ===============
Diluted 20,157,065 20,807,264
============ ===============
See accompanying notes to condensed consolidated financial statements.
4
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Three Months Ended
September 30,
-------------------------
2007 2006
------------ ------------
(in thousands)
Cash Flows from Operating Activities:
Net income $ 374 $ 952
Adjustments to reconcile net income to net cash and cash equivalents
provided by (used in) operating activities:
Depreciation and amortization 277 278
Recovery of doubtful accounts (40) (40)
Deferred income taxes (254) 24
Non-cash stock based compensation expense 59 84
Changes in operating assets and liabilities:
Accounts receivable 3,513 1,375
Inventories (2,491) (4,147)
Prepaid expenses and other current assets 16 (119)
Other assets (71) (124)
Accounts payable, accrued expenses, accrued salaries and
wages, and accrued income taxes 500 250
------------ ------------
Net Cash Provided by (Used in) Operating Activities 1,883 (1,467)
------------ ------------
Cash Flows Used in Investing Activities:
Purchases of property, plant and equipment (344) (214)
------------ ------------
Cash Flows from Financing Activities:
Proceeds from exercise of employee stock options - 9
Cash paid for purchase of treasury stock (1,371) -
------------ ------------
Net Cash (Used in) Provided by Financing Activities (1,371) 9
------------ ------------
Net increase (decrease) in Cash and Cash Equivalents 168 (1,672)
Cash and Cash Equivalents, Beginning of Period 1,748 2,738
------------ ------------
Cash and Cash Equivalents, End of Period $ 1,916 $ 1,066
============ ============
Cash Paid During the Period for:
--------------------------------
Interest $ 186 $ 87
============ ============
Income taxes $ - $ -
============ ============
Non-cash Investing activities:
------------------------------
Adjustment to Retained earnings relating to adoption
of FIN 48 (see Note 8) $ 485 $ -
============ ============
See accompanying notes to condensed consolidated financial statements.
5
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
1.) Summary of Significant Accounting Policies and Other Disclosures
----------------------------------------------------------------
The accompanying Condensed Consolidated Financial Statements are unaudited.
In management's opinion, all adjustments (consisting of only normal
recurring accruals) necessary for a fair presentation have been made. The
results of operations for the period ended September 30, 2007 are not
necessarily indicative of results that may be expected for any other
interim period or for the full year.
The unaudited Condensed Consolidated Financial Statements should be read in
conjunction with the Consolidated Financial Statements and related notes
contained in the Company's Annual Report on Form 10-K for the year ended
June 30, 2007. The accounting policies used in preparing these unaudited
Condensed Consolidated Financial Statements are consistent with those
described in the June 30, 2007 Consolidated Financial Statements. However,
for interim financial statements, inventories are calculated using a gross
profit percentage.
The consolidated financial statements include the accounts of Napco
Security Systems, Inc. and all of its wholly-owned subsidiaries. The
Company has also consolidated a 51%-owned joint venture. The 49% interest,
held by a third party, is reflected as minority interest. All inter-company
balances and transactions have been eliminated in consolidation.
The Company has made a number of estimates and assumptions relating to the
assets and liabilities, the disclosure of contingent assets and liabilities
and the reporting of revenues and expenses to prepare these financial
statements in conformity with accounting principles generally accepted in
the United States. Actual results could differ from those estimates.
Seasonality
The Company's fiscal year begins on July 1 and ends on June 30.
Historically, the end users of Napco's products want to install its
products prior to the summer; therefore sales of its products peak in the
period April 1 through June 30, the Company's fiscal fourth quarter, and
are reduced in the period July 1 through September 30, the Company's fiscal
first quarter. To a lesser degree, sales in Europe are also adversely
impacted in the Company's first fiscal quarter because of European vacation
patterns, i.e., many distributors and installers are closed for the month
of August. In addition, demand is affected by the housing and construction
markets.
Advertising and Promotional Costs
Advertising and promotional costs are included in "Selling, General and
Administrative" expenses in the condensed consolidated statements of income
and are expensed as incurred. Advertising expense for the three months
ended September 30, 2007 and 2006 was $522,000 and $358,000, respectively.
Research and Development Costs
Research and development costs incurred by the Company are charged to
expense in the year incurred. Company-sponsored research and development
costs of $1,332,000 and $1,293,000 were charged to expense for the three
months ended September 30, 2007 and 2006, respectively, and are included in
"Cost of Sales" in the condensed consolidated statements of income.
Business Concentration and Credit Risk
An entity is more vulnerable to concentrations of credit risk if it is
exposed to risk of loss greater than it would have had if it mitigated its
risk through diversification of customers. Such risks of loss manifest
themselves differently, depending on the nature of the concentration, and
vary in significance.
The Company had two customers with accounts receivable balances that
aggregated 46% and 38% of the Company's accounts receivable at September
30, 2007 and June 30, 2007, respectively. Sales to neither of these
customers exceeded 10% of net sales in any of the past three fiscal years.
6
In the ordinary course of business, the Company has established a reserve
for doubtful accounts and customer deductions in the amount of $325,000 and
$365,000 as of September 30, 2007 and June 30, 2007, respectively. Our
reserve for doubtful accounts is a subjective critical estimate that has a
direct impact on reported net earnings. This reserve is based upon the
evaluation of accounts receivable agings, specific exposures and historical
trends.
Stock Options
During the three months ended September 30, 2007 the Company granted no
stock options under its 2002 Employee Incentive Stock Option Plan or its
2000 Non-employee Incentive Stock Option Plan. No options were exercised
under these plans during the three months ended September 30, 2007.
Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board ("FASB") issued SFAS
Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income
Taxes - An Interpretation of FASB Statement No. 109". FIN 48 clarifies the
accounting for uncertainty in income taxes recognized in an enterprise's
financial statements in accordance with SFAS No. 109, "Accounting for
Income Taxes". This Interpretation prescribes a recognition threshold and
measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax
return. This Interpretation also provides guidance on de-recognition,
classification, interest and penalties, accounting in interim periods,
disclosure, and transition. FIN 48 is effective for financial statements
issued for fiscal years beginning after December 15, 2006 and is to be
applied to all open tax years as of the date of effectiveness. The Company
has adopted the provisions of FIN 48 effective July 1, 2007. For the
effects of this implementation see Note 8.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements".
SFAS No. 157 provides guidance for using fair value to measure assets and
liabilities. In addition, this statement defines fair value, establishes a
framework for measuring fair value, and expands disclosures about fair
value measurements. Where applicable, this statement simplifies and
codifies related guidance within generally accepted accounting principles.
This statement is effective for financial statements issued for fiscal
years beginning after November 15, 2007, and interim periods within those
fiscal years. The Company's adoption of SFAS No. 157 is not expected to
have a material effect on its consolidated financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin ("SAB") No.
108, "Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements" ("SAB No. 108") to
provide guidance on the consideration of the effects of prior year
misstatements in quantifying current year misstatements for the purpose of
a materiality assessment. Under SAB No. 108, companies should evaluate a
misstatement based on its impact on the current year income statement, as
well as the cumulative effect of correcting such misstatements that existed
in prior years existing in the current year's ending balance sheet. The
Company's adoption of SAB No. 108 did not have a material impact on its
consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities". SFAS No. 159 permits entities
to choose to measure many financial instruments and certain other items at
fair value. The objective is to improve financial reporting by providing
entities with the opportunity to mitigate volatility in reported earnings
caused by measuring related assets and liabilities differently without
having to apply complex hedge accounting provisions. Most of the provisions
of this Statement apply only to entities that elect the fair value option.
However, the amendment to SFAS No. 115, "Accounting for Certain Investments
in Debt and Equity Securities", applies to all entities with
available-for-sale and trading securities. Some requirements apply
differently to entities that do not report net income. SFAS No. 159 will
become effective for the Company in its fiscal year ending June 30, 2009.
The Company's adoption of SFAS No. 159 is not expected to have a material
effect on its consolidated financial statements.
The FASB ratified the consensuses reached in EITF Issue No. 06-3, "How
Taxes Collected from Customers and Remitted to Governmental Authorities
Should Be Presented in the Income Statement (That is, Gross versus Net
Presentation)" ("EITF 06-3"). The EITF reached a consensus that the scope
of the Issue includes any tax assessed by a governmental authority that is
both imposed on and concurrent with a specific revenue-producing
transaction between a seller and a customer, and may include, but is not
limited to, sales, use, value-added, and some excise taxes. The
presentation of taxes within the scope of this Issue on either a gross or a
net basis is an accounting policy decision that should be disclosed.
Furthermore, for taxes reported on a gross basis, a company should disclose
the aggregate amount of those taxes in interim and annual financial
7
statements for each period for which an income statement is presented if
that amount is significant. The disclosures required under this consensus
should be applied retrospectively to interim and annual financial
statements for all periods presented, if those amounts are significant. The
Company adopted EITF 06-3 on January 1, 2006. The adoption of EITF 06-3 did
not have a significant impact on the Company's consolidated financial
statements. The Company currently records its sales net of any value added
or sales tax.
2.) Stock-based Compensation
------------------------
The Company has established two share incentive programs as discussed in
more detail in the Consolidated Financial Statements and related notes
contained in the Company's annual report on Form 10-K for the year ended
June 30, 2007. Prior to fiscal 2006, the Company applied the intrinsic
value method as outlined in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees," ("APB No. 25") and related
interpretations in accounting for stock options and share units granted
under these programs. Under the intrinsic value method, no compensation
expense was recognized if the exercise price of the Company's stock options
equaled the market price of the underlying stock on the date of the grant.
Stock-based compensation costs of $59,000 and $84,000 were recognized in
three months ended September 30, 2007 and 2006, respectively. Unearned
stock-based compensation cost was $522,000 as of September 30, 2007.
3.) Inventories
-----------
For interim financial statements, inventories are calculated using a gross
profit percentage. The Company regularly reviews parts and finished goods
inventories on hand and, when necessary, records a provision for excess or
obsolete inventories. As of September 30, 2007 and June 30, 2007, balances
in these reserves amounted to $1,200,000. The Company also regularly
reviews the period over which its inventories will be converted to sales.
Any inventories expected to convert to sales beyond 12 months from the
balance sheet date are classified as non-current.
Inventories, net of reserves consist of the following (in thousands):
September 30, June 30,
2007 2007
Component parts $ 16,475 $ 15,139
Work-in-process 3,416 3,139
Finished product 10,823 9,945
---------- ----------
$ 30,714 $ 28,223
========== ==========
Classification of inventories, net of reserves:
Current $ 23,120 $ 21,342
Non-current 7,594 6,881
---------- ----------
$ 30,714 $ 28,223
========== ==========
4.) Earnings Per Common Share
-------------------------
The Company follows the provisions of SFAS No. 128, "Earnings Per Share".
In accordance with SFAS No. 128, earnings per common share amounts ("Basic
EPS") were computed by dividing earnings by the weighted average number of
common shares outstanding for the period. Earnings per common share
amounts, assuming dilution ("Diluted EPS"), were computed by reflecting the
potential dilution from the exercise of stock options. SFAS No. 128
requires the presentation of both Basic EPS and Diluted EPS on the face of
the condensed consolidated statements of income.
A reconciliation between the numerators and denominators of the Basic and
Diluted EPS computations for earnings is as follows (in thousands except
per share data):
8
Three months ended September 30, 2007
-------------------------------------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
------------------ ----------------- -----------------
Basic EPS
---------
Net income, as reported $ 374 19,568 $ 0.02
Effect of dilutive securities
-----------------------------
Employee Stock Options $ - 589 $ -
------------------ ----------------- -----------------
Diluted EPS
-----------
Net income, as reported and
assumed option exercises $ 374 20,157 $ 0.02
================== ================= =================
62,000 options to purchase shares of common stock in the three months ended
September 30, 2007 were excluded in the computation of Diluted EPS because
the exercise prices were in excess of the average market price for this
period and their inclusion would be anti-dilutive.
Three months ended September 30, 2006
-------------------------------------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
------------------ ----------------- -----------------
Basic EPS
---------
Net income, as reported $ 952 19,951 $ 0.05
Effect of dilutive securities
-----------------------------
Employee Stock Options $ - 856 $ -
------------------ ----------------- -----------------
Diluted EPS
-----------
Net income, as reported and
assumed option exercises $ 952 20,807 $ 0.05
================== ================= =================
37,000 options to purchase shares of common stock in the three months ended
September 30, 2006 were excluded in the computation of Diluted EPS because
the exercise prices were in excess of the average market price for this
period.
5.) Long Term Debt
--------------
Long-term debt consists of a revolving credit and term loan facility with a
balance of $10,900,000 at September 30, 2007 and at June 30, 2007. In
September 2007, the Company amended its secured revolving credit agreement
with its primary bank. The Company's borrowing capacity under the amended
agreement was increased to $25,000,000 from $18,000,000. The amended
revolving credit agreement is secured by all the accounts receivable,
inventory, the Company's headquarters in Amityville, New York and certain
other assets of Napco Security Systems, Inc. and the common stock of three
of the Company's subsidiaries. The revolving credit agreement bears
interest at either the Prime Rate less 1/4% or an alternate rate based on
LIBOR as described in the agreement. As of September 30, 2007 the interest
rate on the outstanding portion of this facility was 6.7%. The September
2007 amendment also extended the revolving credit agreement to September
2011. Any outstanding borrowings are to be repaid or refinanced on or
before that time. The agreement contains various restrictions and covenants
including, among others, restrictions on payment of dividends, restrictions
on borrowings, restrictions on capital expenditures, the maintenance of
minimum amounts of tangible net worth, and compliance with other certain
financial ratios, as defined in the agreement. As of September 30, 2007 the
Company was not in compliance with one of these covenants relating to
Tangible Net Worth for which it subsequently received the appropriate
waiver and covenant amendment from its primary bank.
6.) Geographical Data
-----------------
The Company is engaged in one major line of business: the development,
manufacture, and distribution of security alarm products and door security
devices for commercial and residential use. Sales to unaffiliated customers
are primarily shipped from the United States. The Company has customers
worldwide with major concentrations in North America, Europe, and South
America.
The Company observes the provisions of SFAS No. 131. The following
represents selected consolidated geographical data for the three months
ended September 30, 2007 and 2006 (in thousands):
9
Three Months ended September 30,
------------------------------------------
2007 2006
------------------- ------------------
Sales to external customers(1):
Domestic $ 11,573 $ 11,435
Foreign 2,303 2,594
------------------- ------------------
Total Net Sales $ 13,876 $ 14,029
=================== ==================
As of
------------------------------------------
September 30, 2007 June 30, 2007
------------------- -------------------
Identifiable assets:
United States $ 46,441 $ 47,636
Dominican Republic (2) 22,532 21,246
Other foreign countries 7,148 7,903
------------------- -------------------
Total Identifiable Assets $ 76,121 $ 76,785
=================== ===================
(1) All of the Company's sales occur in the United States and are shipped
primarily from the Company's facilities in the United States and United
Kingdom. There were no sales into any one foreign country in excess of 10%
of Net Sales. (2) Consists primarily of inventories ($17,534,000) and fixed
assets ($5,017,000) located at the Company's principal manufacturing
facility in the Dominican Republic.
7.) Commitments and Contingencies
-----------------------------
In the normal course of business, the Company is a party to claims and/or
litigation. Management believes that the settlement of such claims and/or
litigation, considered in the aggregate, will not have a material adverse
effect on the Company's financial position and results of operations.
8.) Income Taxes
------------
In March 2003, Napco Security Systems, Inc. timely filed its income tax
return for the fiscal year ended June 30, 2002. This return included an
election to treat one of the Company's foreign subsidiaries, Napco DR, as
if it were a domestic corporation beginning July 1, 2001. This election was
based on a then recently enacted Internal Revenue Code ("Code") provision.
As a result of this election, Napco DR is treated, for Federal income tax
purposes, as transferring all of its assets to a domestic corporation in
connection with an exchange. Although this type of transfer usually results
in the recognition of taxable income to the extent of any untaxed earnings
and profits, the Code provision provides an exemption for applicable
corporations. The Company qualifies as an applicable corporation pursuant
to this Code section, and based on this Code exemption, the Company treated
the transfer of approximately $27,000,000 of Napco DR's untaxed earnings
and profits as nontaxable.
The Internal Revenue Service has issued a Revenue Procedure which is
inconsistent with the Code exemption described above. The Code is the
actual law; a Revenue Procedure is the IRS's interpretation of the law. The
Code has a higher level of authority than a Revenue Procedure. Management
believes that it has appropriately relied on the guidance in the Code when
filing its income tax return. If challenged, the Company believes that the
potential liability would have ranged from $0 to $9,450,000. However, the
Company also believes there were other mitigating factors that would limit
the amount of the potential liability, and as a result, management accrued
a liability of $2,243,000 as of June 30, 2002. As a result of the lapse in
the applicable statute of limitations, the Company reversed $407,000 of
this accrued liability during fiscal 2007, resulting in a long-term accrued
income tax liability of $1,836,000 as of June 30, 2007.
As a result of the implementation of FIN48 as of July 1, 2007, the Company
increased its accrued income tax liability by $715,000, from $1,836,000 to
$2,551,000, to provide for additional reserves for uncertain income tax
positions, relating to the fiscal years 2004 through 2007, the only periods
subject to examination by the taxing authorities. The increase in the
accrued income tax liability of $715,000 was offset in part by a $230,000
increase in a related deferred income tax asset, resulting in a net
reduction to retained earnings of $485,000 (representing the cumulative
effect of adopting FIN 48).
10
During the quarter ended September 30, 2007, the Company increased its
reserve for uncertain income tax positions by $54,000, excluding the
related deferred tax benefit (representing interest on unrecognized income
tax positions), resulting in a long-term accrued income tax liability of
$2,605,000.
The Company's practice is to recognize interest and/or penalties related to
income tax matters in income tax expense and accrued income taxes. As of
September 30, 2007, the Company had accrued interest totaling $467,000,
excluding the related deferred tax asset.
As of September 30, 2007, the Company had, approximately $2,325,000 of
unrecognized net tax benefits (including the related accrued interest and
net of the related deferred income tax benefit of $280,000) that, if
recognized, would favorably affect the effective income tax rate in any
future periods.
The total accrued liability related to the election described above as of
September 30, 2007 (including related accrued interest) totaled $2,354,000.
The statute of limitations on the remainder of this accrued liability is
scheduled to lapse in fiscal 2008, which would result in a net benefit to
income tax expense of $2,198,000 ($2,354,000 less the related $156,000
deferred income tax benefit).
9.) Treasury Stock
--------------
On March 16, 2007, the Company announced that its Board of Directors
authorized the repurchase of up to one million (1,000,000) shares of its
common stock. As of September 30, 2007, the Company has repurchased 655,836
shares at a weighted average price of $5.73 per share. Subsequent to
September 30, 2007, the Company has repurchased an additional 85,593 shares
at a weighted average price of $5.48 per share.
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations
-------------
Napco Security Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
This Quarterly Report on Form 10-Q and the information incorporated by reference
may include "Forward-Looking Statements" within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Exchange Act of 1934. The
Company intends the Forward-Looking Statements to be covered by the Safe Harbor
Provisions for Forward-Looking Statements. All statements regarding the
Company's expected financial position and operating results, its business
strategy, its financing plans and the outcome of any contingencies are
Forward-Looking Statements. The Forward-Looking Statements are based on current
estimates and projections about our industry and our business. Words such as
"anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates,"
or variations of such words and similar expressions are intended to identify
such Forward-Looking Statements. The Forward-Looking Statements are subject to
risks and uncertainties that could cause actual results to differ materially
from those set forth or implied by any Forward-Looking Statements. For example,
the Company is highly dependent on its Chief Executive Officer for strategic
planning. If he is unable to perform his services for any significant period of
time, the Company's ability to continue growing could be adversely affected. In
addition, factors that could cause actual results to differ materially from the
Forward-Looking Statements include, but are not limited to, adverse tax
consequences of offshore operations, distribution problems, unforeseen
environmental liabilities and the uncertain military, political and economic
conditions in the world.
Overview
The Company is a diversified manufacturer of security products, encompassing
intrusion and fire alarms, building access control systems and electronic
locking devices. These products are used for commercial, residential,
institutional, industrial and governmental applications, and are sold worldwide
principally to independent distributors, dealers and installers of security
equipment. International sales accounted for approximately 17% and 18% of our
revenues for the three months ended September 30, 2007 and 2006, respectively.
The Company owns and operates manufacturing facilities in Amityville, New York
and the Dominican Republic. A significant portion of our operating costs are
fixed, and do not fluctuate with changes in customer demand or utilization of
our manufacturing capacity. As product demand rises and factory utilization
increases, the fixed costs are spread over increased output, which should
improve profit margins. Conversely, when sales decline our fixed costs are
spread over reduced levels, thereby decreasing margins.
In February 2004 the Company entered into a joint venture with an unrelated
company to sell security-related products, including those manufactured by the
Company, in the Middle East. The Company owns 51% of the newly formed company,
an LLC organized in New York, which has its main operations in the United Arab
Emirates. Revenues generated by this joint venture were approximately 3% of our
revenues for the three months ended September 30, 2007.
11
The security products market is characterized by constant incremental innovation
in product design and manufacturing technologies. Generally, the Company devotes
7-8% of revenues to research and development (R&D) on an annual basis. Products
resulting from our R&D investments in the three months ended September 30, 2007
did not contribute materially to revenue during this period, but should benefit
the Company over future periods. In general, the new products introduced by the
Company are initially shipped in limited quantities, and increase over time.
Prices and manufacturing costs tend to decline over time as products and
technologies mature.
Economic and Other Factors
The post-September 11 era has generally been characterized by increased demand
for electronic security products and services. The Company believes the security
equipment market is likely to continue to exhibit healthy growth, particularly
in industrial sectors, due to ongoing concerns over the adequacy of security
safeguards. The Company's business is also affected by the housing markets.
Demand for the Company's intrusion products, which accounted for approximately
50% of Net sales in Fiscal 2007, has a direct correlation to demand in the
housing market.
Seasonality
The Company's fiscal year begins on July 1 and ends on June 30. Historically,
the end users of Napco's products want to install its products prior to the
summer; therefore sales of its products peak in the period April 1 through June
30, the Company's fiscal fourth quarter, and are reduced in the period July 1
through September 30, the Company's fiscal first quarter. To a lesser degree,
sales in Europe are also adversely impacted in the Company's first fiscal
quarter because of European vacation patterns, i.e., many distributors and
installers are closed for the month of August. In addition, demand is affected
by the housing and construction markets.
Critical Accounting Policies
The discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in conformity with accounting principles generally accepted in the United
States. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses reported in those financial statements. These
judgments can be subjective and complex, and consequently actual results could
differ from those estimates. Our most critical accounting policies relate to
revenue recognition; concentration of credit risk; inventory; goodwill; and
income taxes.
Revenue Recognition
Revenues from merchandise sales are recorded at the time the product is shipped
or delivered to the customer pursuant to the terms of sale. We report our sales
levels on a net sales basis, which is computed by deducting from gross sales the
amount of actual sales returns and allowances and an amount established for
anticipated sales returns and allowances.
Our accrual for sales returns and allowances is a subjective critical estimate
that has a direct impact on reported net sales and income. This accrual is
calculated based on a history of gross sales and actual sales returns and
allowances, as well as management's estimate of anticipated sales returns and
allowances. As a percentage of gross sales, sales returns, rebates and other
allowances were 4% and 9% for the three months ended September 30, 2007 and
2006, respectively.
Concentration of Credit Risk
An entity is more vulnerable to concentrations of credit risk if it is exposed
to risk of loss greater than it would have had if it mitigated its risk through
diversification of customers. Such risks of loss manifest themselves
differently, depending on the nature of the concentration, and vary in
significance.
The Company had two customers with accounts receivable balances that aggregated
46% and 38% of the Company's accounts receivable at September 30, 2007 and June
30, 2007, respectively. Sales to neither of these customers exceeded 10% of net
sales in any of the past three fiscal years.
In the ordinary course of business, we have established a reserve for doubtful
accounts and customer deductions in the amount of $325,000 and $365,000 as of
September 30, 2007 and June 30, 2007, respectively. Our reserve for doubtful
accounts is a subjective critical estimate that has a direct impact on reported
net earnings. This reserve is based upon the evaluation of accounts receivable
agings, specific exposures and historical trends.
12
Inventories
For interim financial statements, inventories are calculated using a gross
profit percentage. This valuation method is based, in part, on subjective
estimates and approximations and actual results could differ from those
estimates.
In addition, the Company records an inventory obsolescence reserve, which
represents the difference between the cost of the inventory and its estimated
market value, based on various product sales projections. This reserve is
calculated using an estimated obsolescence percentage applied to the inventory
based on age, historical trends, requirements to support forecasted sales, and
the ability to find alternate applications of its raw materials and to convert
finished product into alternate versions of the same product to better match
customer demand. There is inherent professional judgment and subjectivity made
by both production and engineering members of management in determining the
estimated obsolescence percentage. In addition, and as necessary, the Company
may establish specific reserves for future known or anticipated events.
The Company also regularly reviews the period over which its inventories will be
converted to sales. Any inventories expected to convert to sales beyond 12
months from the balance sheet date are classified as non-current.
Goodwill
Effective July 1, 2001, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 141, Business Combinations and SFAS No. 142, Goodwill and
Other Intangible Assets. These statements established accounting and reporting
standards for acquired goodwill and other intangible assets. Specifically, the
standards address how acquired intangible assets should be accounted for both at
the time of acquisition and after they have been recognized in the financial
statements. In accordance with SFAS No. 142, intangible assets, including
purchased goodwill, must be evaluated for impairment. Those intangible assets
that are classified as goodwill or as other intangibles with indefinite lives
are not amortized.
Impairment testing is performed in two steps: (i) the Company determines
impairment by comparing the fair value of a reporting unit with its carrying
value, and (ii) if there is an impairment, the Company measures the amount of
impairment loss by comparing the implied fair value of goodwill with the
carrying amount of that goodwill. At the close of Fiscal 2007, the Company
performed its annual impairment evaluation required by this standard and
determined that its goodwill is not impaired.
Income Taxes
In March 2003, Napco Security Systems, Inc. timely filed its income tax return
for the fiscal year ended June 30, 2002. This return included an election to
treat one of the Company's foreign subsidiaries, Napco DR, as if it were a
domestic corporation beginning July 1, 2001. This election was based on a then
recently enacted Internal Revenue Code ("Code") provision. As a result of this
election, Napco DR is treated, for Federal income tax purposes, as transferring
all of its assets to a domestic corporation in connection with an exchange.
Although this type of transfer usually results in the recognition of taxable
income to the extent of any untaxed earnings and profits, the Code provision
provides an exemption for applicable corporations. The Company qualifies as an
applicable corporation pursuant to this Code section, and based on this Code
exemption, the Company treated the transfer of approximately $27,000,000 of
Napco DR's untaxed earnings and profits as nontaxable.
The Internal Revenue Service has issued a Revenue Procedure which is
inconsistent with the Code exemption described above. The Code is the actual
law; a Revenue Procedure is the IRS's interpretation of the law. The Code has a
higher level of authority than a Revenue Procedure. Management believes that it
has appropriately relied on the guidance in the Code when filing its income tax
return. If challenged, the Company believes that the potential liability would
have ranged from $0 to $9,450,000. However, the Company also believes there were
other mitigating factors that would limit the amount of the potential liability,
and as a result, management accrued a liability of $2,243,000 as of June 30,
2002. As a result of the lapse in the applicable statute of limitations, the
Company reversed $407,000 of this accrued liability during fiscal 2007,
resulting in a long-term accrued income tax liability of $1,836,000 as of June
30, 2007.
As a result of the implementation of FIN48 as of July 1, 2007, the Company
increased its accrued income tax liability by $715,000, from $1,836,000 to
$2,551,000, to provide for additional reserves for uncertain income tax
positions, relating to the fiscal years 2004 through 2007, the only periods
subject to examination by the taxing authorities. The increase in the accrued
income tax liability of $715,000 was offset in part by a $230,000 increase in a
related deferred income tax asset, resulting in a net reduction to retained
earnings of $485,000 (representing the cumulative effect of adopting FIN 48).
13
During the quarter ended September 30, 2007, the Company increased its reserve
for uncertain income tax positions by $54,000, excluding the related deferred
tax benefit (representing interest on unrecognized income tax positions),
resulting in a long-term accrued income tax liability of $2,605,000.
The Company's practice is to recognize interest and/or penalties related to
income tax matters in income tax expense and accrued income taxes. As of
September 30, 2007, the Company had accrued interest totaling $467,000,
excluding the related deferred tax asset.
As of September 30, 2007, the Company had, approximately $2,325,000 of
unrecognized net tax benefits (including the related accrued interest and net of
the related deferred income tax benefit of $280,000) that, if recognized, would
favorably affect the effective income tax rate in any future periods.
The total accrued liability related to the election described above as of
September 30, 2007 (including related accrued interest) totaled $2,354,000. The
statute of limitations on the remainder of this accrued liability is scheduled
to lapse in fiscal 2008, which would result in a net benefit to income tax
expense of $2,198,000 ($2,354,000 less the related $156,000 deferred income tax
benefit).
Results of Operations
---------------------
--------------------------------------------
Three months ended September 30, (in
thousands)
--------------------------------------------
2007 2006 % Increase/
(decrease)
--------------------------------------------
Net sales $ 13,876 $ 14,029 (1.1)%
Gross profit 5,129 5,559 (7.7)%
Gross profit as a % of net sales 37.0% 39.6% (2.6)%
Selling, general and administrative 4,326 3,998 8.2%
Selling, general and administrative
as a percentage of net sales 31.2% 28.5% 2.7%
Operating income 803 1,561 (48.6)%
Interest expense 195 90 116.7%
Other expense
7 4 75.0%
Minority interest in net loss
(income) of subsidiary, net 38 13 192.3%
Provision for income taxes 265 528 (49.8)%
Net income 374 952 (60.7)%
--------------------------------------------
Sales for the three months ended September 30, 2007 decreased by approximately
1% to $13,876,000 as compared to $14,029,000 for the same period a year ago. The
decrease in sales for the three months was due to lower sales in the Company's
Access Control products as partially offset by increases in the Company's
intrusion-related sales..
The Company's gross profit for the three months ended September 30, 2007
decreased by $430,000 to $5,129,000 or 37.0% of sales as compared to $5,559,000
or 39.6% of sales for the same period a year ago. The decrease in gross profit
was due primarily to lower production levels, and an associated decrease in
overhead absorption rates, in the first three months of fiscal 2008 as compared
to the same period in fiscal 2007 as well as a reduction in the first quarter of
fiscal 2006 in the Company's inventory reserves of approximately $150,000.
Selling, general and administrative expenses for the three months ended
September 30, 2007 increased by $328,000 to $4,326,000, or 31.2% of sales, as
compared to $3,998,000, or 28.5% of sales a year ago. The increase in dollars
and as a percentage of sales for the three months ended September 30, 2007 was
due primarily to the timing of tradeshow expenses relating to a major tradeshow
which occurred in September 2007. The same tradeshow occurred in October of 2006
in the prior fiscal year.
14
Interest expense, net for the three months ended September 30, 2007 increased by
$105,000 to $195,000 as compared to $90,000 for the same period a year ago. This
increase resulted primarily from the increase in the Company's average
outstanding debt, the result of the Company's increase in inventory as discussed
below.
The Company's provision for income taxes for the three months ended September
30, 2007 decreased by $263,000 to $265,000 as compared to $528,000 for the same
period a year ago. The tax provision for the three months ended September 30,
2007 is calculated using an estimated annual effective tax rate of 36%. The
Company's effective rate for the three months ended September 30, 2007 was 41%,
which included an additional provision of $36,000 resulting from the Company's
adoption of FIN48 as described in Note 8. The decrease in provision for income
taxes for the three months resulted primarily from the decrease in Income before
income tax.
Net income decreased by $578,000 to $374,000 or $0.02 per diluted share for the
three months ended September 30, 2007 as compared to $952,000 or $0.05 per
diluted share for the same period a year ago. This decrease was primarily due to
the aforementioned decreases in gross profit and increases in selling, general
and administrative and interest expenses, net of the related decrease in
provision for income taxes.
Liquidity and Capital Resources
-------------------------------
During the three months ended September 30, 2007 the Company utilized all of its
cash from operations to purchase property, plant and equipment ($344,000) and
treasury stock ($1,371,000). One of the key factors in the use of operating cash
was our investment in additional inventory ($2,491,000) as discussed below. The
Company's management believes that current working capital, cash flows from
operations and its revolving credit agreement will be sufficient to fund the
Company's operations through at least the next twelve months.
Accounts Receivable at September 30, 2007 decreased $3,473,000 to $22,106,000 as
compared to $25,579,000 at June 30, 2007. This decrease is primarily the result
of the higher sales volume during the quarter ended June 30, 2007 as compared to
the quarter ended September 30, 2007 as partially offset by extended terms
granted to certain of the Company's customers during the quarter ended June 30,
2007. Certain of these terms extended beyond September 30, 2007.
Inventories at September 30, 2007 increased by $2,491,000 to $30,714,000 as
compared to $28,223,000 at June 30, 2007. This increase was primarily the result
of the Company level-loading its production schedule in anticipation of its
historical sales cycle where a larger portion of the Company's sales occur in
the latter fiscal quarters as compared to the earlier quarters as well as to
support a projection of higher sales in fiscal 2007.
In September 2007, the Company amended its secured revolving credit agreement
with its primary bank. The Company's borrowing capacity under the amended
agreement was increased to $25,000,000 from $18,000,000. As of September 30,
2007 there was approximately $14,100,000 available under the secured revolving
credit facility. The amended revolving credit agreement is secured by all the
accounts receivable, inventory, the Company's headquarters in Amityville, New
York and certain other assets of Napco Security Systems, Inc. and the common
stock of three of the Company's subsidiaries. The revolving credit agreement
bears interest at either the Prime Rate less 1/4% or an alternate rate based on
LIBOR as described in the agreement. As of September 30, 2007 the interest rate
on the outstanding portion of this facility was 6.7%. The September 2007
amendment also extended the revolving credit agreement to September 2011. Any
outstanding borrowings are to be repaid or refinanced on or before that time.
The agreement contains various restrictions and covenants including, among
others, restrictions on payment of dividends, restrictions on borrowings,
restrictions on capital expenditures, the maintenance of minimum amounts of
tangible net worth, and compliance with other certain financial ratios, as
defined in the agreement. As of September 30, 2007 the Company was not in
compliance with one of these covenants relating to Tangible Net Worth for which
it subsequently received the appropriate waiver and covenant amendment from its
primary bank.
As of September 30, 2007 the Company had no material commitments for capital
expenditures or inventory purchases other than purchase orders issued in the
normal course of business.
ITEM 3: Quantitative and Qualitative Disclosures About Market Risk
-------------------------------------------------------------------
The Company's principal financial instrument is long-term debt (consisting of a
revolving credit facility) that provides for interest at a spread below the
15
prime rate. The Company is affected by market risk exposure primarily through
the effect of changes in interest rates on amounts payable by the Company under
this credit facility. At September 30, 2007, an aggregate principal amount of
approximately $10,900,000 was outstanding under the Company's credit facility
with a weighted average interest rate of approximately 6.7%. If principal
amounts outstanding under the Company's credit facility remained at this
year-end level for an entire year and the prime rate increased or decreased,
respectively, by 1% the Company would pay or save, respectively, an additional
$109,000 in interest that year.
A significant number of foreign sales transactions by the Company are
denominated in U.S. dollars. As such, the Company has shifted foreign currency
exposure onto many of its foreign customers. As a result, if exchange rates move
against foreign customers, the Company could experience difficulty collecting
unsecured accounts receivable, the cancellation of existing orders or the loss
of future orders. The foregoing could materially adversely affect the Company's
business, financial condition and results of operations. In addition, the
Company transacts certain sales in Europe in British Pounds Sterling, therefore
exposing itself to a certain amount of foreign currency risk. Management
believes that the amount of this exposure is immaterial. We are also exposed to
foreign currency risk relative to expenses incurred in Dominican Pesos ("RD$"),
the local currency of the Company's production facility in the Dominican
Republic. The result of a 10% strengthening in the U.S. dollar to our RD$
expenses would result in an annual decrease in income from operations of
approximately $415,000.
ITEM 4: Controls and Procedures
--------------------------------
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms, and that such information is accumulated and communicated
to our management to allow timely decisions regarding required disclosure.
Management necessarily applied its judgment in assessing the costs and benefits
of such controls and procedures, which, by their nature, can provide only
reasonable assurance regarding management's control objectives.
At the conclusion of the period ended September 30, 2007, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures were
effective in alerting them in a timely manner to information relating to the
Company required to be disclosed in this report except as follows:
Management's review over it's internal controls at the conclusion of fiscal 2007
identified conditions which they deemed to be material weaknesses, (as defined
by standards established by the SEC and the Public Company Accounting Oversight
Board) with respect to certain of our inventory valuation estimation methods and
the classification of inventory in accordance with Accounting Research Bulletin
43 ("ARB No. 43"). Management has informed it's independent auditors and the
Audit Committee that it has corrected its method of classifying its inventory so
as to be in compliance with ARB No. 43, has initiated a review of the ways in
which we can accumulate information to provide better substantiation of our
overhead estimates, including implementation of an additional time-tracking
system, and established an additional review of our obsolescence estimates. We
will also conduct a review of our inventory turnover and utilize this review to
support classification on the balance sheet to prevent reoccurrences of these
material weaknesses and will continue to monitor the effectiveness of these
actions and will make any other changes or take such additional actions as
management determines to be appropriate. Management expects to complete these
actions during fiscal 2008.
During the first quarter of fiscal 2008, there were no changes in the Company's
internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting except for the procedure described above which has corrected
the weakness relating to inventory classification on the balance sheet.
16
PART II: OTHER INFORMATION
Item 1A. Risk Factors
------------
Information regarding the Company's Risk Factors are set forth in the
Company's Annual Report on Form 10-K for the year ended June 30,
2007. There have been no material changes in the risk factors
previously disclosed in the Company's Form 10-K for the year ended
June 30, 2007 during the three months ended September 30, 2007.
Item 2. Unregistered Sales of Equity Securities and Uses of Proceeds
------------------------------------------------------------
--------------------------------------------------------------------------------------------------------------------
Total Number of
Shares Purchased as Maximum Number of
Total Number of Average Part of Publically Shares that May Yet
Shares Price Paid Announced Plans or Be Purchased Under
Period Purchased per Share Programs Plans or Programs
--------------------------------------------------------------------------------------------------------------------
July 1, 2007 - July 30, 2007 30,100 $6.55 30,100 544,728
August 1, 2007 - August 31, 2007 121,800 $5.90 121,800 422,928
September 1, 2007 - September 30, 2007 78,764 $5.69 78,764 344,164
--------------------------------------------------------------------------------------------------------------------
Total for the quarter ended September 30, 230,664 $5.91 230,664 344,164
2007 ======= =======
--------------------------------------------------------------------------------------------------------------------
On March 16, 2007, the Company announced that its Board of Directors
authorized the repurchase of up to one million (1,000,000) shares of
its common stock.
Item 6. Exhibits
--------
10.A Amended and Restated Loan and Security Agreement with HSBC
Bank USA dated September 7, 2007
10.B Waiver and Amendment dated November 8, 2007 to Amended and
Restated Loan and Security Agreement with HSBC Bank USA dated
September 7, 2007
31.1 Certification Pursuant to Rule 13a-14(a)/15d-14(a) of Richard
L. Soloway, Chairman of the Board and President
31.2 Certification Pursuant to Rule 13a-14(a)/15d-14(a) of Kevin
S. Buchel, Senior Vice President of Operations and Finance
32.1 Section 1350 Certifications
17
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
November 14, 2007
NAPCO SECURITY SYSTEMS, INC
(Registrant)
By: /S/ RICHARD L. SOLOWAY
-------------------------------------------------------------------
Richard L. Soloway
Chairman of the Board of Directors, President and Secretary
(Chief Executive Officer)
By: /S/ KEVIN S. BUCHEL
-------------------------------------------------------------------
Kevin S. Buchel
Senior Vice President of Operations and Finance and Treasurer
(Principal Financial and Accounting Officer)
18