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: DECEMBER 31, 2006
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
NAPCO SECURITY SYSTEMS, INC.
(Exact name of Registrant as specified in its charter)
Delaware 11-2277818
(State or other jurisdiction of (IRS Employer
incorporation of organization) Identification Number)
333 Bayview Avenue
Amityville, New York 11701
(Address of principal executive offices) (Zip Code)
(631) 842-9400
(Registrant's telephone number including area code)
None
(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
--- ---
Number of shares outstanding of each of the issuer's classes of common stock, as
of: FEBRUARY 6, 2007
COMMON STOCK, $.01 PAR VALUE PER SHARE 20,090,313
1
Page
----
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
INDEX - DECEMBER 31, 2006
Condensed Consolidated Balance Sheets, December 31, 2006 and
June 30, 2006 3
Condensed Consolidated Statements of Income for the Three
Months ended December 31, 2006 and 2005 4
Condensed Consolidated Statements of Income for the Six
Months ended December 31, 2006 and 2005 5
Condensed Consolidated Statements of Cash Flows for the Six
Months ended December 31, 2006 and 2005 6
Notes to Condensed Consolidated Financial Statements 7
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 12
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 17
ITEM 4. Controls and Procedures 17
PART II: OTHER INFORMATION 18
SIGNATURE PAGE 19
2
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
December 31,
2006 June 30,
(unaudited) 2006
------------ --------
(in thousands, except
share data)
ASSETS
Current Assets:
Cash and cash equivalents $ 731 $ 2,738
Accounts receivable, less allowance for doubtful
accounts 22,774 25,153
Inventories, net 30,766 22,666
Prepaid expenses and other current assets 1,168 755
Deferred income taxes 1,701 1,531
------- -------
Total current assets 57,140 52,843
Property, plant and equipment, net 9,065 9,038
Goodwill 9,686 9,686
Other assets 267 155
------- -------
Total Assets $76,158 $71,722
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 6,374 $ 6,060
Accrued expenses 1,325 1,372
Accrued salaries and wages 2,437 2,586
Accrued income taxes 558 1,877
------- -------
Total current liabilities 10,694 11,895
Long-term debt 7,700 4,700
Accrued income taxes 2,243 2,243
Deferred income taxes 2,032 1,887
Minority interest in subsidiary 147 147
------- -------
Total liabilities 22,816 20,872
------- -------
Stockholders' Equity :
Common stock, par value $.01 per share; 40,000,000
shares authorized, 20,090,313 and 19,950,453
shares issued and outstanding, respectively 201 200
Additional paid-in capital 12,963 12,568
Retained earnings 40,178 38,082
------- -------
Total stockholders' equity 53,342 50,850
------- -------
Total Liabilities and Stockholders' Equity $76,158 $71,722
======= =======
See accompanying notes to condensed consolidated financial statements.
3
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)
Three Months Ended
December 31,
-------------------------
2006 2005
----------- -----------
(in thousands, except
share and per share data)
Net sales $ 16,077 $ 17,223
Cost of sales 10,252 11,174
----------- -----------
Gross Profit 5,825 6,049
Selling, general and administrative expenses 3,981 3,785
----------- -----------
Operating Income 1,844 2,264
----------- -----------
Interest expense, net 119 60
Other expenses, net 5 2
----------- -----------
Other expenses 124 62
----------- -----------
Income Before Minority Interest and
Provision for Income Taxes 1,720 2,202
Minority interest in net loss of subsidiary, net 41 54
----------- -----------
Income Before Provision for Income Taxes 1,761 2,256
Provision for income taxes 617 773
----------- -----------
Net Income $ 1,144 $ 1,483
=========== ===========
Earnings per share (Note 1 and Note 4) *: Basic $ 0.06 $ 0.07
=========== ===========
Diluted $ 0.06 $ 0.07
=========== ===========
Weighted average number of shares
outstanding (Note 1 and Note 4) *: Basic 20,034,552 19,775,998
=========== ===========
Diluted 20,628,793 20,593,902
=========== ===========
* The 3:2 stock split declared in May 2006 (see Note 1) has been
retroactively reflected in all 2005 share and per share data.
See accompanying notes to condensed consolidated financial statements.
4
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)
Six Months Ended
December 31,
-------------------------
2006 2005
----------- -----------
(in thousands, except
share and per share data)
Net sales $ 30,106 $ 31,403
Cost of sales 18,722 20,229
----------- -----------
Gross Profit 11,384 11,174
Selling, general and administrative expenses 7,979 7,658
----------- -----------
Operating Income 3,405 3,516
----------- -----------
Interest expense, net 209 98
Other expenses, net 9 6
----------- -----------
Other expenses 218 104
----------- -----------
Income Before Minority Interest and
Provision for Income Taxes 3,187 3,412
Minority interest in net loss of subsidiary, net 54 115
----------- -----------
Income Before Provision for Income Taxes 3,241 3,527
Provision for income taxes 1,145 1,229
----------- -----------
Net Income $ 2,096 $ 2,298
=========== ===========
Earnings per share (Note 1 and Note 4) *: Basic $ 0.10 $ 0.12
=========== ===========
Diluted $ 0.10 $ 0.11
=========== ===========
Weighted average number of shares
outstanding (Note 1 and Note 4) *: Basic 19,992,925 19,662,681
=========== ===========
Diluted 20,715,830 20,580,189
=========== ===========
* The 3:2 stock split declared in May 2006 (see Note 1) has been
retroactively reflected in all 2005 share and per share data.
See accompanying notes to condensed consolidated financial statements.
5
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Six Months Ended
December 31,
-----------------
2006 2005
------- -------
(in thousands)
Cash Flows from Operating Activities:
Net income $ 2,096 $ 2,298
Adjustments to reconcile net income to net
cash and cash equivalents (used in)
operating activities:
Depreciation and amortization 564 520
(Recovery of) Provision for doubtful
accounts (70) 20
Deferred income taxes (25) (90)
Excess tax benefits from exercise of stock
options -- (210)
Non-cash stock based compensation expense 228 115
Changes in operating assets and liabilities:
Accounts receivable 2,449 595
Inventories (8,100) (4,806)
Prepaid expenses and other current assets (413) (16)
Other assets (116) 61
Accounts payable, accrued expenses, accrued
salaries and wages, and accrued income
taxes (1,201) (72)
------- -------
Net Cash Used in Operating Activities (4,588) (1,585)
------- -------
Cash Flows Used in Investing Activities:
Purchases of property, plant and equipment (587) (1,010)
------- -------
Cash Flows from Financing Activities:
Proceeds from exercise of employee stock
options 168 279
Proceeds from long-term debt 3,000 1,750
Excess tax benefits from exercise of stock
options -- 210
------- -------
Net Cash Provided by Financing Activities 3,168 2,239
------- -------
Net (decrease) in Cash and Cash Equivalents (2,007) (356)
Cash and Cash Equivalents, Beginning of Period 2,738 1,178
------- -------
Cash and Cash Equivalents, End of Period $ 731 $ 822
======= =======
Cash Paid During the Period for:
Interest $ 182 $ 87
======= =======
Income taxes $ 2,488 $ 1,604
======= =======
See accompanying notes to condensed consolidated financial statements.
6
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 December 31, 2006 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 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, owned 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.
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, 2006. The accounting policies used in preparing these unaudited
Consolidated Financial Statements are consistent with those described in
the June 30, 2006 Consolidated Financial Statements. However, for interim
financial statements, inventories are calculated using a gross profit
percentage.
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.
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 December 31, 2006 and 2005 was $340,000 and $185,000, respectively.
Advertising expense for the six months ended December 31, 2006 and 2005 was
$698,000 and $592,000, respectively.
Research and Development Costs
Research and development costs are included in Cost of Sales in the
Condensed Consolidated Statements of Income and are expensed as incurred.
Research and Development expense for the three months ended December 31,
2006 and 2005 was $1,320,000 and $1,258,000, respectively. Research and
Development expense for the six months ended December 31, 2006 and 2005 was
$2,613,000 and $2,403,000, respectively.
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
differently, depending on the nature of the concentration, and vary in
significance. The Company has two major customers with Sales and Accounts
Receivable as follows (in thousands):
7
Sales for the three months Sales for the six months
ended December 31, ended December 31,
--------------------------- ---------------------------
2006 2005 2006 2005
------------ ------------ ------------ ------------
$ % $ % $ % $ %
------ --- ------ --- ------ --- ------ ---
Customer A $1,242 8% $1,245 7% $2,406 8% $2,562 8%
Customer B 1,893 12% 1,740 10% 2,520 8% 2,427 8%
------ --- ------ --- ------ --- ------ ---
$3,135 20% $2,985 17% $4,926 16% $4,989 16%
====== === ====== === ====== === ====== ===
Accounts Receivable as of:
December 31, June 30,
2006 2006
------------ ------------
$ % $ %
------ --- ------ ---
Customer A $5,090 22% $5,225 21%
Customer B 3,623 16% 3,083 12%
------ --- ------ ---
$8,713 38% $8,308 33%
====== === ====== ===
These customers sell primarily within North America. Although management
believes that these customers are sound and creditworthy, a severe adverse
impact on their business operations could have a corresponding material
adverse effect on the Company's net sales, cash flows, and/or financial
condition. In the ordinary course of business, the Company has established
an allowance for doubtful accounts and customer deductions in the amount of
$350,000 and $420,000 as of December 31, 2006 and June 30, 2006,
respectively. The decrease in this allowance related primarily to the
Company's recent history of lower bad debt write-offs. The allowance for
doubtful accounts is a subjective critical estimate that has a direct
impact on reported net earnings. This allowance is based upon the
evaluation of accounts receivable aging, specific exposures and historical
trends.
Stock Options
During the three and six months ended December 31, 2006 the Company granted
66,500 stock options under its 2002 Employee Incentive Stock Option Plan.
These grants have exercise prices between $6.02 and $6.62, a fair market
value of $259,000 and vest over a four year period from the date of grant.
135,000 and 139,860 ISO options were exercised under this plan with
proceeds of $160,000 and $169,000 during the three and six months ended
December 31, 2006, respectively.
Stock Dividend and Stock Splits
On May 10, 2006 the Company's Board of Directors approved a 3-for-2 stock
split of its common stock, to be paid in the form of a 50% stock dividend
to stockholders of record on May 24, 2006. The Company delivered the shares
on June 7, 2006. Upon completion of the split, the total number of shares
of common stock outstanding increased from approximately 13,300,000 to
approximately 19,950,000.
On November 29, 2005 the Company's Board of Directors approved a 3-for-2
split of its common stock, payable in the form of a 50% stock dividend to
stockholders of record on December 14, 2005. The additional shares were
distributed on December 28, 2005. Upon completion of the split, the total
number of shares of common stock outstanding increased from approximately
8,795,000 to approximately 13,192,000.
All share and per share amounts (except par value) have been retroactively
adjusted to reflect the stock splits and dividend. There was no net effect
on total stockholders' equity as a result of these transactions.
8
Recent Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("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. The Company is currently evaluating the
requirements of FIN 48 and has not yet determined if the adoption of FIN 48
will have a significant impact on the Company's consolidated financial
statements.
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. SAB No.
108 will become effective for the Company in its fiscal year ending June
30, 2007. The Company's adoption of SAB No. 108 did not have a material
impact on its condensed consolidated financial statements.
2.) Employee 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, 2006. 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 employee
stock options equaled the market price of the underlying stock on the date
of the grant. Stock-based compensation costs of $144,000 and $56,000 were
recognized in three months ended December 31, 2006 and 2005, respectively.
Stock-based compensation costs of $228,000 and $115,000 were recognized in
six months ended December 31, 2006 and 2005, respectively. The effect on
both Basic and Diluted Earnings per share was $0.007 and $0.003 for the
three months ended December 31, 2006 and 2005, respectively. The effect on
both Basic and Diluted Earnings per share was $0.011 and $0.006 for the six
months ended December 31, 2006 and 2005, respectively.
3.) Inventories
Inventories consist of (in thousands):
December 31, June 30,
2006 2006
------------ --------
Component parts $18,370 $13,533
Work-in-process 3,521 2,595
Finished products 8,875 6,538
------- -------
$30,766 $22,666
======= =======
For interim financial statements, inventories are calculated using a gross
profit percentage. 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 and requirements to support forecasted sales. As of December 31,
2006 and June 30,
9
2006, balances in these reserves amounted to $836,000 and $987,000,
respectively. In addition, and as necessary, the Company may establish
specific reserves for future known or anticipated events.
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 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) (Information reflects the stock splits as described in Note
1):
Three months ended December 31, 2006
---------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
BASIC EPS
Net income, as reported $1,144 20,035 $0.06
EFFECT OF DILUTIVE SECURITIES
Employee Stock Options $ -- 594 $ --
------ ------ -----
DILUTED EPS
Net income, as reported and
assumed option exercises $1,144 20,629 $0.06
====== ====== =====
55,434 options to purchase shares of common stock in the three months ended
December 31, 2006 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 December 31, 2005
---------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
BASIC EPS
Net income, as reported $1,483 19,776 $0.07
EFFECT OF DILUTIVE SECURITIES
Employee Stock Options $ -- 818 $ --
------ ------ -----
DILUTED EPS
Net income, as reported and
assumed option exercises $1,483 20,594 $0.07
====== ====== =====
No options to purchase shares of common stock in the three months ended
December 31, 2005 were excluded in the computation of Diluted EPS because
no exercise prices were in excess of the average market price for this
period.
Six months ended December 31, 2006
---------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
BASIC EPS
Net income, as reported $2,096 19,993 $0.10
EFFECT OF DILUTIVE SECURITIES
Employee Stock Options $ - 723 $ --
------ ------ -----
DILUTED EPS
Net income, as reported and
assumed option exercises $2,096 20,716 $0.10
====== ====== =====
10
46,466 options to purchase shares of common stock in the six months ended
December 31, 2006 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.
Six months ended December 31, 2005
---------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
BASIC EPS
Net income attributable,
as reported $2,298 19,662 $ 0.12
EFFECT OF DILUTIVE SECURITIES
Employee Stock Options $ -- 918 $(0.01)
------ ------ ------
DILUTED EPS
Net income, as reported and
assumed option exercises $2,298 20,580 $ 0.11
====== ====== ======
No options to purchase shares of common stock in the six months ended
December 31, 2005 were excluded in the computation of Diluted EPS because
no exercise prices were in excess of the average market price for this
period.
5.) Long Term Debt
The Company's primary source of financing is an $18,000,000 revolving
credit agreement, secured by all the accounts receivable, inventory, the
Company's headquarters in Amityville, New York, common stock of three of
the Company's subsidiaries and certain other assets of Napco Security
Systems, Inc. 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. 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. The agreement has an
expiration date of September 2008 and any outstanding borrowings are to be
repaid or refinanced on or before that time.
6.) Geographical Data
The Company's domestic and foreign sales for the periods presented are
summarized in the following tabulation (in thousands):
Three Months Six Months
Ended December 31, Ended December 31,
------------------ ------------------
2006 2005 2006 2005
------- ------- ------- -------
Sales to external customers (1):
Domestic $14,374 $14,688 $25,809 $26,682
Foreign 1,703 2,535 4,297 4,721
------- ------- ------- -------
Total Net Sales $16,077 $17,223 $30,106 $31,403
======= ======= ======= =======
(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.
7.) Commitments and Contingencies
In December 2004, the Company became a defendant in a product related
lawsuit, in which the plaintiff seeks damages of approximately $1,500,000.
This action is being defended by the Company's insurance company on behalf
of the Company. Management believes that the action is without merit and
plans to have this action vigorously defended.
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.
11
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 16% of our revenues
for fiscal year 2006 and 14% for the first six months of fiscal 2007.
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 production rises and factory utilization
increases, the fixed costs are spread over increased output, which has a
positive impact on profit margins. Conversely, when production and factory
utilization decline our fixed costs are spread over reduced levels, thereby
having a negative impact on profit 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 2% of our
revenues for fiscal 2006 and 2% for the first six months of fiscal 2007.
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 fiscal 2006 did not contribute materially
to revenue during fiscal 2006, but should benefit the Company in future years.
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.
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.
12
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 purchase. We report our
sales levels on a net sales basis, which is computed by deducting from gross
sales the amount of actual returns received and an amount established for
anticipated returns and allowances.
Our sales return accrual 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, as well as management's
estimate of anticipated returns and allowances.
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 differently, depending
on the nature of the concentration, and vary in significance. The Company has
two major customers with Sales and Accounts Receivable as follows (in
thousands):
Sales for the three Sales for the six
months ended December 31, months ended December 31,
--------------------------- ---------------------------
2006 2005 2006 2005
------------ ------------ ------------ ------------
$ % $ % $ % $ %
------ --- ------ --- ------ --- ------ ---
Customer A $1,242 8% $1,245 7% $2,406 8% $2,562 8%
Customer B 1,893 12% 1,740 10% 2,520 8% 2,427 8%
------ --- ------ --- ------ --- ------ ---
$3,135 20% $2,985 17% $4,926 16% $4,989 16%
====== === ====== === ====== === ====== ===
Accounts Receivable as of:
December 31,
2006 June 30, 2006
------------ -------------
$ % $ %
------ --- ------ ----
Customer A $5,090 22% $5,225 21%
Customer B 3,623 16% 3,083 12%
------ --- ------ ---
$8,713 38% $8,308 33%
====== === ====== ===
These customers sell primarily within North America. Although management
believes that these customers are sound and creditworthy, a severe adverse
impact on their business operations could have a corresponding material adverse
effect on the Company's net sales, cash flows, and/or financial condition. In
the ordinary course of business, the Company has established an allowance for
doubtful accounts and customer deductions in the amount of $350,000 and $420,000
as of December 31, 2006 and June 30, 2006, respectively. The decrease in this
allowance related primarily to the Company's recent history of lower bad debt
write-offs.
13
The allowance for doubtful accounts is a subjective critical estimate that has a
direct impact on reported net earnings. This allowance is based upon the
evaluation of accounts receivable aging, specific exposures and historical
trends.
Inventories
We state our inventory at the lower of cost or fair market value, with cost
being determined on the first-in, first-out (FIFO) method. We believe FIFO most
closely matches the flow of our products from manufacture through sale. The
reported net value of our inventory includes finished saleable products,
work-in-process and raw materials that will be sold or used in future periods.
Inventory cost includes raw materials, direct labor and overhead.
We also record 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 and requirements to support forecasted sales. In addition, and
as necessary, we may establish specific reserves for future known or anticipated
events. For interim financial statements, inventories are calculated using a
gross profit percentage.
Goodwill and Other Intangible Assets
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. The Company has performed its annual
impairment evaluation required by this standard and determined that its goodwill
is not impaired.
Income taxes
Deferred income taxes are recognized for the expected future tax consequences of
temporary differences between the amounts reflected for financial reporting and
tax purposes. Net deferred tax assets are adjusted by a valuation allowance if,
based on the weight of available evidence, it is more likely than not that some
portion or all of the net deferred tax assets will not be realized. If the
Company determines that a deferred tax asset will not be realizable or that a
previously reserved deferred tax asset will become realizable, an adjustment to
the deferred tax asset will result in a reduction of, or increase to, earnings
at that time. The provision for income taxes represents U.S. Federal, state and
foreign taxes. Through June 30, 2001, the Company's subsidiary in the Dominican
Republic, Napco/Alarm Lock Group International, S.A. ("Napco DR"), was not
subject to tax in the United States, as a result, no taxes were provided.
Effective July 1, 2001, the Company made a domestication election for Napco DR.
Accordingly, its income is subject to taxation in the United States on a going
forward basis.
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 originally determined that the potential
liability would range from $0 to $9,450,000. However, the Company also believes
there are other mitigating factors that would limit the amount of the potential
liability, and as a result, management accrued
14
a liability of $2,243,000 as of June 30, 2002. Currently, the Company is
expecting to reduce this accrued liability by $400,000 in March 2007 and the
balance in fiscal 2008. The Company's tax provision utilizes estimates made by
management and as such, is subject to change as described in Note 1 of the
Consolidated financial statements included in the Company's Form 10-K for the
year ended June 30, 2006.
Results of Operations
Three months ended December 31, Six months ended December 31,
(in thousands) (in thousands)
------------------------------- -------------------------------
% Increase/ % Increase/
2006 2005 (decrease) 2006 2005 (decrease)
------- ------- ----------- ------- ------- -----------
Net sales $16,077 $17,223 (6.7)% $30,106 $31,403 (4.1)%
Gross profit 5,825 6,049 (3.7)% 11,384 11,174 1.9%
Gross profit as a % of net sales 36.2% 35.1% 1.1% 37.8% 35.6% 2.2%
Selling, general and administrative 3,981 3,785 5.2% 7,979 7,658 4.2%
Selling, general and administrative
as a percentage of net sales 24.8% 22.0% 2.8% 26.5% 24.4% 2.1%
Operating income 1,844 2,264 (18.6)% 3,405 3,516 (3.2)%
Interest expense 119 60 98.3% 209 98 113.3%
Other expense 5 2 150% 9 6 50.0%
Minority interest in net loss of
subsidiary, net 41 54 (24.1)% 54 115 (53.0)%
Provision for income taxes 617 773 (20.2)% 1,145 1,229 (6.8)%
Net income 1,144 1,483 (22.9)% 2,096 2,298 (8.8)%
Sales for the three months ended December 31, 2006 decreased by approximately 7%
to $16,077,000 as compared to $17,223,000 for the same period a year ago. Sales
for the six months ended December 31, 2006 decreased by approximately 4% to
$30,106,000 as compared to $31,403,000 for the same period a year ago. The
decrease in sales for the six months occurred primarily within the three months
ended December 31, 2006 and was due to lower sales in the Company's European
market.
The Company's gross profit for the three months ended December 31, 2006
decreased by $224,000 to $5,825,000 or 36.2% of sales as compared to $6,049,000
or 35.1% of sales for the same period a year ago. The Company's gross profit for
the six months ended December 31, 2006 increased by $210,000 to $11,384,000 or
37.8% of sales as compared to $11,174,000 or 35.6% of sales for the same period
a year ago. The decrease in gross profit for the three months was due primarily
to the lower sales for the period as partially offset by increased overhead
absorption resulting from the increased production rate described below, a more
favorable product mix resulting from the increased sales of the Company's door
locking and access control products as well as a positive raw material pricing
variance. The increase in gross profit for the six months was due primarily to
the same factors affecting the three months as well as a reduction in the first
fiscal quarter in the Company's inventory reserves of approximately $150,000.
Selling, general and administrative expenses for the three months ended December
31, 2006 increased by $196,000 to $3,981,000, or 24.8% of sales, as compared to
$3,785,000, or 22.0% of sales a year ago. Selling, general and administrative
expenses for the six months ended December 31, 2006 increased by $321,000 to
$7,979,000, or 26.5% of sales, as compared to $7,658,000, or 24.4% of sales a
year ago. The increase in dollars and as a percentage of sales for the three and
six months ended December 31, 2006 was due primarily to additional corporate
sales staffing, increased advertising of the Company's access control products,
and commission expense related to increases in sales of the Company's
door-locking products as partially offset by a decrease in bad debt expense
resulting from the Company's recent history of lower bad debt write-offs. In
addition, the increase for the six months also resulted from additional expenses
relating to the Company's initial audit of its internal controls required by the
Sarbanes-Oxley Act of 2002. As fiscal 2006 was the initial period requiring an
audit by the Company's Independent Registered Public Accounting Firm and that
the opinion expressed by them for that period was that our assessment that we
maintained effective internal controls over financial reporting was fairly
stated, Management believes that these audit expenses will be reduced for fiscal
2007 as much of the documentation performed for the initial assessment and audit
will be utilized in subsequent periods.
15
Interest expense, net for the three months ended December 31, 2006 increased by
$59,000 to $119,000 as compared to $60,000 for the same period a year ago.
Interest expense, net for the six months ended December 31, 2006 increased by
$111,000 to $209,000 as compared to $98,000 for the same period a year ago. The
increase in each of the first two quarters of fiscal 2006 resulted primarily
from the increase in the Company's average outstanding debt, the result of the
Company's increase in inventory as discussed below, as well as in interest rates
as compared to those from the same period a year ago.
The Company's provision for income taxes for the three months ended December 31,
2006 decreased by $156,000 to $617,000 as compared to $773,000 for the same
period a year ago. The Company's provision for income taxes for the six months
ended December 31, 2006 decreased by $84,000 to $1,145,000 as compared to
$1,229,000 for the same period a year ago. The tax provision for the three and
six months ended December 31, 2006 is calculated using an estimated annual
effective tax rate of 36% and 35%, respectively. The decrease in provision for
income taxes resulted from the decrease in Income before income tax.
Net income decreased by $339,000 to $1,144,000 or $0.06 per diluted share for
the three months ended December 31, 2006 as compared to $1,483,000 or $0.07 per
diluted share for the same period a year ago. Net income decreased by $202,000
to $2,096,000 or $0.10 per diluted share for the six months ended December 31,
2006 as compared to $2,298,000 or $0.11 per diluted share for the same period a
year ago. These decreases were primarily due to the aforementioned decreases in
net sales and gross profit and increases in selling, general and administrative
expenses, net of the related decrease in provision for income taxes. In
addition, the decrease for the three months also resulted from the
aforementioned decrease in Gross profit. The effect of the 3-for-2 stock splits
discussed above has been retroactively reflected in all fiscal 2005 per share
data.
Liquidity and Capital Resources
During the six months ended December 31, 2006 the Company utilized $4.6 million
of cash in operations as well as $3,000,000 in additional borrowings to purchase
property, plant and equipment ($587,000). One of the key factors in the use of
operating cash was our investment in additional inventory ($8,100,000) 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 December 31, 2006 decreased $2,379,000 to $22,774,000 as
compared to $25,153,000 at June 30, 2006. This decrease is primarily the result
of the higher sales volume during the quarter ended June 30, 2006 as compared to
the quarter ended December 31, 2006 as partially offset by extended terms
granted to certain of the Company's customers during the quarter ended June 30,
2006. Certain of these terms extended beyond December 31, 2006.
Inventory at December 31, 2006 increased by $8,100,000 to $30,766,000 as
compared to $22,666,000 at June 30, 2006. 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
producing additional inventory to support the introduction of the Company's new
Freedom 64 code-less intrusion alarm system and several other key new products
as well as to support a projection of higher sales in the first two quarters of
fiscal 2007. Because these levels have not yet been realized, subsequent to
December 2006, the Company has reduced its purchasing levels, manufacturing
labor and production output accordingly with the intention of reducing these
inventory levels.
As of December 31, 2006, the Company's credit facility consisted of an
$18,000,000 secured revolving credit agreement. As of December 31, 2006 there
was approximately $10,300,000 available under the secured revolving credit
facility. This credit facility expires in September 2008.
As of December 31, 2006 the Company had no material commitments for capital
expenditures or inventory purchases other than purchase orders issued in the
normal course of business.
16
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
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 December 31, 2006, an aggregate principal amount of
approximately $7,700,000 was outstanding under the Company's credit facility. If
principal amounts outstanding under the Company's credit facility remained at
this quarter-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 $77,000 in interest that year.
A significant number of foreign sales transactions by the Company are
denominated in U.S. dollars. As such, the Company has shifted foreign currency
exposure onto many of its foreign customers. As a result, if exchange rates move
against foreign customers, the Company could experience difficulty collecting
unsecured accounts receivable, the cancellation of existing orders or the loss
of future orders. The foregoing could materially adversely affect the Company's
business, financial condition and results of operations. In addition, the
Company transacts certain sales in Europe in British Pounds Sterling, therefore
exposing itself to a certain amount of foreign currency risk. Management
believes that the amount of this exposure is immaterial. We are also exposed to
foreign currency risk relative to expenses incurred in Dominican Pesos ("RD$"),
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 $450,000.
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 December 31, 2006, 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.
During the second quarter of fiscal 2007, 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.
17
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, 2006.
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, 2006
during the three months ended December 31, 2006.
Item 4. Submission of Matters to a Vote of Security Holders
(a) The annual meeting of stockholders ("the Annual Meeting") was held on
December 6, 2006.
(c) At the Annual Meeting, three directors were re-elected as directors
through 2009:
Paul Stephen Beeber - 18,774,133 votes "for", 351,363 votes
"withheld",
Randy B. Blaustein - 17,670,179 votes "for", 1,455,317 votes
"withheld", and
Donna A. Soloway - 17,633,163 votes "for", 1,492,333 votes
"withheld",
Item 6. Exhibits
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
18
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.
February 9, 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)
19