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: MARCH 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 Identification
incorporation of organization) 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 Non-Accelerated Filer X
--- --- ---
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: MAY 8, 2006
COMMON STOCK, $.01 PAR VALUE PER SHARE 13,300,185
Page
----
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
INDEX - MARCH 31, 2006
Condensed Consolidated Balance Sheets, March 31, 2006 and
June 30, 2005 3
Condensed Consolidated Statements of Income for the Three
Months ended March 31, 2006 and 2005 4
Condensed Consolidated Statements of Income for the Nine
Months ended March 31, 2006 and 2005 5
Condensed Consolidated Statements of Cash Flows for the Nine
Months ended March 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 13
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 17
ITEM 4. Controls and Procedures 18
PART II: OTHER INFORMATION 19
SIGNATURE PAGE 20
2
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, June 30,
2006 (unaudited) 2005
---------------- --------
(in thousands, except share
data)
ASSETS
Current Assets:
Cash and cash equivalents $ 988 $ 1,178
Accounts receivable, less allowance for doubtful accounts 20,729 21,899
Inventories, net 23,115 16,242
Prepaid expenses and other current assets 953 799
Deferred income taxes 1,567 1,356
------- -------
Total current assets 47,352 41,474
Property, Plant and Equipment, net 9,186 8,533
Goodwill 9,686 9,686
Other assets 145 214
------- -------
$66,369 $59,907
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 5,758 $ 5,249
Accrued expenses 1,150 1,156
Accrued salaries and wages 2,077 2,518
Accrued income taxes 1,315 1,534
------- -------
Total current liabilities 10,300 10,457
Long-term debt 3,700 1,950
Accrued income taxes 2,243 2,243
Deferred income taxes 1,707 1,579
------- -------
Total liabilities 17,950 16,229
------- -------
Stockholders' Equity (Note 1):
Common stock, par value $.01 per share; 40,000,000 and
21,000,000 shares authorized, 13,300,185 and
12,982,665 shares issued and outstanding, respectively 133 130
Additional paid-in capital 13,280 11,585
Unearned stock-based compensation (730) --
Retained earnings 35,736 31,963
------- -------
Total stockholders' equity 48,419 43,678
------- -------
$66,369 $59,907
======= =======
* The 3:2 stock split declared on November 29, 2005 (see Note 1) has been
retroactively reflected in Stockholders' Equity.
See accompanying notes to condensed consolidated financial statements.
3
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)
Three Months Ended
March 31,
-------------------------
2006 2005
----------- -----------
(in thousands, except
share and per share data)
Net Sales $ 17,085 $ 15,743
Cost of Sales 10,729 10,647
----------- -----------
Gross profit 6,356 5,096
Selling, General and Administrative Expenses 4,032 3,423
----------- -----------
Operating income 2,324 1,673
----------- -----------
Interest Expense, net 68 50
Other Expenses, net 4 72
----------- -----------
Other expenses 72 122
----------- -----------
Income before minority interest and provision for
income taxes 2,252 1,551
Minority interest in net income of subsidiary, net 2 --
----------- -----------
Income before provision for income taxes 2,250 1,551
Provision for income taxes 775 538
----------- -----------
Net income $ 1,475 $ 1,013
=========== ===========
Net income per share (Note 1 and Note 4) *: Basic $ 0.11 $ 0.08
=========== ===========
Diluted $ 0.11 $ 0.07
=========== ===========
Weighted average number of shares
outstanding (Note 1 and Note 4) *: Basic 13,245,385 12,865,689
=========== ===========
Diluted 13,807,626 13,583,310
=========== ===========
* The 3:2 stock split declared on November 29, 2005 (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 STATEMENT OF INCOME (UNAUDITED)
Nine Months Ended
March 31,
-------------------------
2006 2005
----------- -----------
(in thousands, except
share and per share data)
Net Sales $ 48,488 $ 45,202
Cost of Sales 30,958 30,915
----------- -----------
Gross profit 17,530 14,287
Selling, General and Administrative Expenses 11,690 10,263
----------- -----------
Operating income 5,840 4,024
----------- -----------
Interest Expense, net 166 176
Other Expenses, net 10 170
----------- -----------
Other expenses 176 346
----------- -----------
Income before minority interest and provision for income taxes 5,664 3,678
Minority interest in net loss of subsidiary, net 113 --
----------- -----------
Income before provision for income taxes 5,777 3,678
Provision for income taxes 2,004 1,280
----------- -----------
Net income $ 3,773 $ 2,398
=========== ===========
Net income per share (Note 1 and Note 4) *: Basic $ 0.29 $ 0.19
=========== ===========
Diluted $ 0.27 $ 0.18
=========== ===========
Weighted average number of shares
outstanding (Note 1 and Note 4) *: Basic 13,153,431 12,804,585
=========== ===========
Diluted 13,720,926 13,463,438
=========== ===========
* The 3:2 stock split declared on November 29, 2005 (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)
Nine Months Ended
March 31,
-----------------
2006 2005
------- -------
(in thousands)
Cash Flows from Operating Activities:
Net income $ 3,773 $ 2,398
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation and amortization 811 844
Provision for doubtful accounts 105 (35)
Deferred income taxes (83) --
Excess tax benefits from exercise of stock options (210) --
Non-cash stock based compensation expense 312 --
Changes in operating assets and liabilities:
Accounts receivable 1,065 2,375
Inventories (6,873) (638)
Prepaid expenses and other current assets (154) (81)
Other assets 65 (42)
Accounts payable, accrued expenses, accrued salaries and
wages, and accrued income taxes 53 1,255
------- -------
Net Cash (Used in) Provided by Operating Activities (1,136) 6,076
------- -------
Cash Flows used in Investing Activities:
Purchases of property, plant and equipment (1,461) (548)
------- -------
Cash Flows from Financing Activities:
Proceeds from exercise of employee stock options 447 216
Proceeds from long-term debt 1,750 2,350
Principal payments on long-term debt -- (7,737)
Excess tax benefits from exercise of stock options 210 --
------- -------
Net cash provided by (used in) financing activities 2,407 (5,171)
------- -------
Net (decrease) increase in Cash (190) 357
Cash, Beginning of Period 1,178 796
------- -------
Cash, End of Period $ 988 $ 1,153
======= =======
Cash Paid During the Period for:
Interest $ 146 $ 177
======= =======
Income taxes $ 2,096 $ 784
======= =======
See accompanying notes to condensed consolidated financial statements.
6
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED 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 March 31, 2006 are not
necessarily indicative of results that may be expected for any other
interim period or for the full year. Certain prior year amounts have been
reclassified to conform with the current years' presentation.
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, 2005. The accounting policies used in preparing these unaudited
Condensed Consolidated Financial Statements are consistent with those
described in the June 30, 2005 Consolidated Financial Statements, except as
described herein (see Note 2). However, for interim financial statements,
inventories are calculated using a gross profit percentage.
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 March 31, 2006 and 2005 was $180,000 and $163,000, respectively.
Advertising expense for the nine months ended March 31, 2006 and 2005 was
$772,000 and $786,000, respectively.
Research and Development Costs
Research and development costs incurred by the Company are charged to
expense in the period incurred. Research and Development expense for the
three months ended March 31, 2006 and 2005 was $1,286,000 and $1,222,000,
respectively. Research and Development expense for the nine months ended
March 31, 2006 and 2005 was $3,690,000 and $3,692,000, respectively. These
expenses 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
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 months
ended March 31,
---------------------------
2006 2005
------------ ------------
$ % $ %
----- ---- ----- ----
Customer A 1,402 8% 1,353 8%
Customer B 1,190 7% 1,374 9%
----- --- ----- ---
2,592 15% 2,727 17%
===== === ===== ===
7
Sales for the nine months
ended March 31,
---------------------------
2006 2005
------------ ------------
$ % $ %
----- ---- ----- ----
Customer A 3,964 8% 3,452 7%
Customer B 3,617 8% 3,945 9%
----- --- ----- ---
7,581 16% 7,397 16%
===== === ===== ===
Accounts Receivable as of:
March 31, June 30,
2006 2005
------------ ------------
$ % $ %
----- ---- ----- ----
Customer A 4,820 23% 4,400 20%
Customer B 2,657 13% 3,306 15%
----- --- ----- ---
7,477 36% 7,706 35%
===== === ===== ===
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
$485,000 and $380,000 as of March 31, 2006 and June 30, 2005, respectively.
The increase in this allowance related primarily to a bankruptcy of one of
the Company's customers. 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 nine months ended March 31, 2006 the Company granted
25,000 and 70,000 stock options, respectively, under its 2002 Employee
Incentive Stock Option Plan. The aggregate fair value of these options,
calculated using the Black-Scholes option pricing model, was $262,000 and
$546,000, respectively, which will be expensed over the four year vesting
schedule. 108,000 and 317,520 options were exercised under this plan during
the three and nine months ended March 31, 2006, respectively. These figures
reflect the effect of the 3:2 stock split described below.
Stock Dividend and Stock Splits
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. There was no net effect on total
stockholders' equity as a result of the stock split. All share and per
share amounts have been retroactively adjusted to reflect the stock
dividend and stock splits.
Recent Accounting Pronouncements
In September 2005, the Financial Accounting Standards Board ("FASB") issued
FASB Staff Position ("FSP") No. FAS 123(R)-1, "Classification and
Measurement of Freestanding Financial Instruments Originally Issued in
Exchange for Employee Services under FASB Statement No. 123(R)," to defer
the requirement of SFAS No. 123(R) that a freestanding financial instrument
originally subject to SFAS No. 123(R) becomes subject to the recognition
and measurement requirements of other applicable GAAP when the rights
conveyed by the instrument to the holder are no longer dependent on the
holder being an employee of the entity. The rights under stock-based
payment awards issued to employees by the Company are all dependent on the
recipient being an employee of the Company. Therefore, this FSP currently
does not have an impact on the Company's consolidated financial statements
and its measurement of stock-based compensation in accordance with SFAS No.
123(R).
8
In October 2005, the FASB issued FSP No. FAS 123(R)-2, "Practical
Accommodation to the Application of Grant Date as Defined in FASB Statement
No. 123(R)," to provide guidance on determining the grant date for an award
as defined in SFAS No. 123(R). This FSP stipulates that assuming all other
criteria in the grant date definition are met, a mutual understanding of
the key terms and conditions of an award to an individual employee is
presumed to exist upon the award's approval in accordance with the relevant
corporate governance requirements, provided that the key terms and
conditions of an award (a) cannot be negotiated by the recipient with the
employer because the award is a unilateral grant, and (b) are expected to
be communicated to an individual recipient within a relatively short time
period from the date of approval. The Company has applied the principles
set forth in this FSP upon its adoption of SFAS No. 123(R).
In November 2005, the FASB issued FSP No. FAS 123(R)-3, "Transition
Election Related to Accounting for the Tax Effects of Share-Based Payment
Awards", to provide an alternate transition method for the implementation
of SFAS No. 123(R). Because some entities do not have, and may not be able
to re-create, information about the net excess tax benefits that would have
qualified as such had those entities adopted SFAS No. 123(R) for
recognition purposes, this FSP provides an elective alternative transition
method. That method comprises (a) a computational component that
establishes a beginning balance of the APIC pool related to employee
compensation and (b) a simplified method to determine the subsequent impact
on the APIC pool of employee awards that are fully vested and outstanding
upon the adoption of SFAS No. 123(R). The Company has applied the
alternative transition method set forth in this FSP upon its adoption of
SFAS No. 123(R).
In February 2006, the FASB issued FSP No. FAS 123(R)-4, "Classification of
Options and Similar Instruments Issued as Employee Compensation That Allow
for Cash Settlement upon the Occurrence of a Contingent Event", to address
the classification of options and similar instruments issued as employee
compensation that allow for cash settlement upon the occurrence of a
contingent event. The guidance in this FSP amends paragraphs 32 and A229 of
FASB Statement No. 123 (revised 2004), "Share-Based Payment". The Company
has applied the principles set forth in this FSP upon its adoption of SFAS
No. 123(R).
2.) Employee Stock-based Compensation
The Company has established two share incentive programs as discussed in
more detail in the Company's annual report on Form 10-K for the year ended
June 30, 2005. 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. Accordingly, no compensation cost was recognized in the
accompanying condensed consolidated statements of income prior to fiscal
year 2006 on stock options granted to employees, since all options granted
under the Company's share incentive programs had an exercise price equal to
the market value of the underlying common stock on the date of grant.
Stock-based compensation costs of $197,000 and $312,000 were recognized in
three and nine months ended March 31, 2006, respectively. The effect on
Basic Earnings per share was $0.015 and $0.024 for the three and nine
months ended March 31, 2006, respectively. The effect on both Diluted
Earnings per share was $0.014 and $0.023 for the three and nine months
ended March 31, 2006, respectively.
Effective July 1, 2005, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 123(R), "Share-Based Payment" ("SFAS No.
123(R)"). This statement replaces SFAS No. 123, "Accounting for Stock-Based
Compensation" ("SFAS No. 123") and supersedes APB No. 25. SFAS No. 123(R)
requires that all stock-based compensation be recognized as an expense in
the financial statements and that such cost be measured at the fair value
of the award. This statement was adopted using the modified prospective
method of application, which requires us to recognize compensation expense
on a prospective basis. Therefore, prior period financial statements have
not been restated. Under this method, in addition to reflecting
compensation expense for new share-based awards, expense is also recognized
to reflect the remaining service period of awards that had been included in
pro-forma disclosures in prior periods. SFAS No. 123(R) also requires that
excess tax benefits related to stock option exercises be reflected as
financing cash inflows instead of operating cash inflows.
Prior to the Company's adoption of SFAS No. 123(R), SFAS No. 123 required
that the Company provide pro forma information regarding net earnings and
net earnings per common share as if compensation cost for the Company's
stock-based awards had been determined in accordance with the fair value
method prescribed therein. The Company had previously adopted the
disclosure portion of SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure," requiring quarterly SFAS No. 123
pro forma disclosure. The pro forma charge for compensation cost related to
stock-based awards granted was recognized over the service period. For
stock options, the service period represents the period of time between the
date of grant and the date each option becomes exercisable without
consideration of acceleration provisions (e.g., retirement, change of
control, etc.).
The following table illustrates the effect on net earnings per common share
as if the fair value method had been applied to all outstanding awards for
the three and nine months ended March 31, 2005:
9
Three Months ended Nine Months ended
March 31, 2005 March 31, 2005
---------------------- ----------------------
(in thousands, (in thousands,
except per share data) except per share data)
Net income, as reported $1,013 $2,398
Deduct: Total stock-based employee compensation
expense determined under fair value method
for all awards, net of related tax effects (55) (171)
------ ------
Pro forma net income $ 958 $2,227
====== ======
Earnings per common share (1):
Basic - as reported $ 0.08 $ 0.19
====== ======
Basic - pro forma $ 0.07 $ 0.17
====== ======
Diluted - as reported $ 0.07 $ 0.18
====== ======
Diluted - pro forma $ 0.07 $ 0.17
====== ======
(1) Information reflects stock dividend and stock splits. See Note 1.
3.) Inventories
March 31, June 30,
2006 2005
--------- --------
Inventories consist of (in thousands):
Component parts $15,366 $10,740
Work-in-process 2,388 1,697
Finished products 5,361 3,805
------- -------
$23,115 $16,242
======= =======
For interim financial statements, inventories are calculated using a gross
profit percentage.
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) (Information reflects the stock dividend and stock splits
as described in Note 1):
Three months ended March 31, 2006
---------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
BASIC EPS
Net income attributable to common stock $1,475 13,245 $0.11
EFFECT OF DILUTIVE SECURITIES
Options $ -- 562 $ --
------ ------ -----
DILUTED EPS
Net income attributable to common stock
and assumed option exercises $1,475 13,807 $0.11
====== ====== =====
25,000 options to purchase shares of common stock in the three months ended
March 31, 2006 were excluded in the computation of Diluted EPS because the
option prices were in excess of the average market price for this period.
10
Three months ended March 31, 2005
---------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
BASIC EPS
Net income attributable to common stock $1,013 12,866 $ 0.08
EFFECT OF DILUTIVE SECURITIES
Options $ -- 717 $(0.01)
------ ------ ------
DILUTED EPS
Net income attributable to common stock
and assumed option exercises $1,013 13,583 $ 0.07
====== ====== ======
No options to purchase shares of common stock in the three months ended
March 31, 2005 were excluded in the computation of Diluted EPS because no
option prices were in excess of the average market price for this period.
Nine months ended March 31, 2006
---------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
BASIC EPS
Net income attributable to common stock $3,773 13,153 $ 0.29
EFFECT OF DILUTIVE SECURITIES
Options $ -- 568 $(0.02)
------ ------ ------
DILUTED EPS
Net income attributable to common stock
and assumed option exercises $3,773 13,721 $ 0.27
====== ====== ======
25,000 options to purchase shares of common stock in the nine months ended
March 31, 2006 were excluded in the computation of Diluted EPS because the
option prices were in excess of the average market price for this period.
Nine months ended March 31, 2005
---------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
BASIC EPS
Net income attributable to common stock $2,398 12,805 $ 0.19
EFFECT OF DILUTIVE SECURITIES
Options $ -- 658 $(0.01)
------ ------ ------
DILUTED EPS
Net income attributable to common stock
and assumed option exercises $2,398 13,463 $ 0.18
====== ====== ======
No options to purchase shares of common stock in the nine months ended
March 31, 2005 were excluded in the computation of Diluted EPS because no
option prices were in excess of the average market price for this period.
5.) Long Term Debt
In May 2001, the Company amended its secured revolving credit agreement
with its primary bank. The Company's borrowing capacity under the amended
agreement was increased to $18,000,000. The amended revolving credit
agreement is 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. As of March 31, 2006, the
Company was not in compliance with one of these covenants for which it has
subsequently received the appropriate waiver from its primary bank. In
October 2004 the Company renegotiated this secured revolving credit
agreement at essentially the same terms and conditions with a new
expiration date of September 2008.
11
6.) Geographical Data
The Company's domestic and foreign sales for the periods presented are
summarized in the following tabulation (in thousands):
Three Months Nine Months
Ended March 31, Ended March 31,
----------------- -----------------
2006 2005 2006 2005
------- ------- ------- -------
Sales to external customers (1):
Domestic $14,375 $13,045 $41,057 $37,614
Foreign 2,710 2,698 7,431 7,588
------- ------- ------- -------
Total Net Sales $17,085 $15,743 $48,488 $45,202
======= ======= ======= =======
(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
As previously reported, on or about August 27, 2001, a Complaint was filed
against NAPCO Security Group and Alarm Lock Systems, Inc. by Jose Ramirez
and Glenda Ramirez in the Supreme Court of State of New York, County of the
Bronx. The Complaint sought fifteen million dollars ($15,000,000) in
damages on behalf of Mr. Ramirez and two million dollars ($2,000,000) on
behalf of Ms. Ramirez. On May 2, 2006, the Company's motion for summary
judgment was granted. As a result, the case against the Company was
dismissed.
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.
12
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% and 15% of our
revenues for fiscal year 2005 and the first nine months of fiscal 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.
The security 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 that fiscal year, but should benefit the Company over 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 11th era has generally been characterized by a favorable
business climate for suppliers of 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.
Critical Accounting Policies
The Company's consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States of America
which require, in some cases, that certain estimates and assumptions be made
that affect the amounts and disclosures reported in the those financial
statements and the related accompanying notes. Estimates are based on current
facts and circumstances, prior experience and other assumptions believed to be
reasonable. Management uses its best judgment in valuing these estimates and
may, as warranted, solicit external advice. Actual results could differ from
these estimates, assumptions and judgments and these differences could be
material. The following critical accounting policies, some of which are impacted
significantly by estimates,
13
assumptions and judgments, affect the Company's consolidated financial
statements. Our most critical accounting policies relate to revenue recognition;
concentration of credit risk; inventory; goodwill and other intangible assets;
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. 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
months ended March 31,
-------------------------
2006 2005
----------- -----------
$ % $ %
----- --- ----- ---
Customer A 1,402 8% 1,353 8%
Customer B 1,190 7% 1,374 9%
----- --- ----- ---
2,592 15% 2,727 17%
===== === ===== ===
Sales for the nine
months ended March 31,
-------------------------
2006 2005
----------- -----------
$ % $ %
----- --- ----- ---
Customer A 3,964 8% 3,452 7%
Customer B 3,617 8% 3,945 9%
----- --- ----- ---
7,581 16% 7,397 16%
===== === ===== ===
Accounts Receivable as of:
--------------------------
March 31, June 30,
2006 2005
----------- -----------
$ % $ %
----- --- ----- ---
Customer A 4,820 23% 4,400 20%
Customer B 2,657 13% 3,306 15%
----- --- ----- ---
7,477 36% 7,706 35%
===== === ===== ===
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 $485,000 and $380,000
as of March 31, 2006 and June 30, 2005, respectively. 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.
14
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 fair market
value, based on various product sales projections. This reserve is calculated
using an estimated obsolescence percentage based on age, historical trends and
requirements to support forecasted sales. In addition, and as necessary, we may
establish specific inventory obsolescence reserves for 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 for Goodwill 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 the 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 (benefit) 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 believes 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 a liability of $2,243,000 as of June 30, 2002.
The Company's tax provision utilizes estimates made by management and as such,
is subject to change.
15
Results of Operations
Three months ended March 31, Nine months ended March 31,
------------------------------- -------------------------------
% Increase/ % Increase/
2006 2005 (decrease) 2006 2005 (decrease)
------- ------- ----------- ------- ------- -----------
Net sales $17,085 $15,743 8.5% $48,488 $45,202 7.3%
Gross profit 6,356 5,096 24.7% 17,530 14,287 22.7%
Gross profit as a % of net sales 37.2% 32.4% 4.8% 36.2% 31.6% 4.6%
Selling, general and administrative 4,032 3,423 17.8% 11,690 10,263 13.9%
Selling, general and administrative
as a percentage of net sales 23.6% 21.7% 1.9% 24.1% 22.7% 1.4%
Operating income 2,324 1,673 38.9% 5,840 4,024 45.1%
Interest expense 68 50 36.0% 166 176 (5.7)%
Other expense 4 72 (94.4)% 10 170 (94.1)%
Minority interest in net income of
subsidiary, net 2 -- n/a 113 -- n/a
Provision for income taxes 775 538 44.1% 2,004 1,280 56.6%
Net income 1,475 1,013 45.6% 3,773 2,398 57.3%
Sales for the three months ended March 31, 2006 increased by approximately 9% to
$17,085,000 as compared to $15,743,000 for the same period a year ago. Sales for
the nine months ended March 31, 2006 increased by approximately 7% to
$48,488,000 as compared to $45,202,000 for the same period a year ago. The
increase in sales for the three and nine months was mainly in the Company's
intrusion alarm and access control product lines.
The Company's gross profit for the three months ended March 31, 2006 increased
by $1,260,000 to $6,356,000 or 37.2% of sales as compared to $5,096,000 or 32.4%
of sales for the same period a year ago. The Company's gross profit for the nine
months ended March 31, 2006 increased by $3,243,000 to $17,530,000 or 36.2% of
sales as compared to $14,287,000 or 31.6% of sales for the same period a year
ago. The increase in gross profit was due primarily to the increase in sales
which allowed for more fixed overhead absorption. Increased margins also
resulted from a reduction in the Company's inventory reserves of approximately
$200,000, the Company's previously reported realignment of its burglar alarm
product distribution network as well as cost reductions of certain of the
Company's raw material costs.
Selling, general and administrative expenses for the three months ended March
31, 2006 increased by $609,000 to $4,032,000, or 23.6% of sales, as compared to
$3,423,000, or 21.7% of sales a year ago. Selling, general and administrative
expenses for the nine months ended March 31, 2006 increased by $1,427,000 to
$11,690,000, or 24.1% of sales, as compared to $10,263,000, or 22.7% of sales a
year ago. The increase in dollars and as a percentage of sales for the three and
nine months ended March 31, 2006 was due primarily to increased selling
activity, an increase in bad debt expense relating to a bankruptcy of one of the
Company's customers as well as the recording of non-cash compensation expenses
beginning in fiscal 2006 in accordance with FAS123R.
Interest expense, net for the three months ended March 31, 2006 increased by
$18,000 to $68,000 as compared to $50,000 for the same period a year ago.
Interest expense, net for the nine months ended March 31, 2006 decreased $10,000
to $166,000 as compared to $176,000 for the same period a year ago. The increase
in the third quarter of fiscal 2006 resulted primarily from the increase in
interest rates as compared to those from the same period a year ago. The slight
decrease in first nine months of fiscal 2006 resulted primarily from lower
average outstanding borrowings as partially offset by the increase in interest
rates during the nine months ended March 31, 2006 as compared to the same period
a year ago.
The Company's provision for income taxes for the three months ended March 31,
2006 increased by $237,000 to $775,000 as compared to $538,000 for the same
period a year ago. The Company's provision for income taxes for the nine months
ended March 31, 2006 increased by $724,000 to $2,004,000 as compared to
$1,280,000 for the same period a year ago. The tax provisions are calculated
using an estimated effective tax rate of 35%. The increase in provision for
income taxes resulted from the increase in Income before income tax, which
resulted primarily from the aforementioned increase in net sales and gross
profit.
Net income increased by $462,000 to $1,475,000 or $0.11 per share for the three
months ended March 31, 2006 as compared to $1,013,000 or $0.08 per share for the
same period a year ago. Net income increased by $1,375,000 to $3,773,000 or
$0.29 per share
16
for the nine months ended March 31, 2006 as compared to $2,398,000 or $0.19 per
share for the same period a year ago. These increases were primarily due to the
aforementioned increases in net sales and gross profit as partially offset by
the increases in selling, general and administrative expenses, net of the
related increase in provision for income taxes. The effect of the 3-for-2 stock
split discussed above has been retroactively reflected in all fiscal 2005 per
share data.
Liquidity and Capital Resources
During the nine months ended March 31, 2006 the Company utilized all of its cash
generated from operations plus proceeds from its revolving line of credit
($1,750,000) to purchase property, plant and equipment ($1,461,000) and invest
in additional inventory ($6,873,000) 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 March 31, 2006 decreased $1,170,000 to $20,729,000 as
compared to $21,899,000 at June 30, 2005. This decrease is primarily the result
of the higher sales volume during the quarter ended June 30, 2005 as compared to
the quarter ended March 31, 2006 as well as extended terms granted to certain of
the Company's customers during the quarter ended June 30, 2005. Certain of these
terms extended beyond March 31, 2006.
Inventory at March 31, 2006 increased by $6,873,000 to $23,115,000 as compared
to $16,242,000 at June 30, 2005. This increase was primarily the result of the
Company's 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 adding
additional models to the Company's existing product lines.
As of March 31, 2006, the Company's credit facility consisted of an $18,000,000
secured revolving credit agreement. In December 2004, the Company utilized a
portion of this revolving credit agreement to accelerate repayment of two term
loans aggregating $1,658,000 As of March 31, 2006 there was approximately
$14,300,000 available under the secured revolving credit facility. This credit
facility expires in September 2008.
As of March 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.
ITEM 3: Quantitative and Qualitative Disclosures About Market Risk
The Company's principal financial instrument is long-term debt consisting of a
revolving credit and term loan facility that provides for interest at a spread
above 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 March 31, 2006 an aggregate amount of
approximately $3,700,000 was outstanding under this facility. If these
borrowings 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 $37,000 in interest that year.
From time to time, the Company requires that letters of credit be provided on
foreign sales. In addition, a significant number of transactions by the Company
are denominated in U.S. dollars. As such, the Company has shifted foreign
currency exposure onto many of its foreign customers. As a result, if exchange
rates move against foreign customers, the Company could experience difficulty
collecting unsecured accounts receivable, the cancellation of existing orders or
the loss of future orders. The foregoing could materially adversely affect the
Company's business, financial condition and results of operations because
approximately 15% of the Company's net sales are derived from foreign customers.
In addition, the Company transacts approximately 50% of these foreign sales in
British Pounds Sterling, therefore exposing itself to a certain amount of
foreign currency risk. Management believes that the amount of this exposure is
immaterial. We are also exposed to foreign currency risk relative to the
Dominican Peso ("RD$"), 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 $365,000.
17
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 March 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.
Our independent registered accounting firm Marcum & Kliegman, LLP ("MK"),
informed us and our Audit Committee of the Board of Directors that in connection
with their audit of our financial results for the fiscal year ended June 30,
2005, MK had discovered conditions which they deemed to be significant
deficiencies, (as defined by standards established by the Public Company
Accounting Oversight Board) in our financial statement closing process. A
significant deficiency is a control deficiency where there is more than a remote
likelihood that a misstatement of the company's annual or interim financial
statements that is more than inconsequential will not be prevented or detected.
The significant deficiencies related to the timely performance of processes and
procedures for the period end closing process and its review by internal
accounting personnel. Management has informed MK and the Audit Committee that it
will increase its staffing relating to the financial statement closing process
to more a adequate level to prevent reoccurrences of this deficiency 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 this action be be completed before the end of
fiscal 2006.
During the third quarter of 2006, 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 as described above. Management does not believe that
the above significant deficiencies affected the results of the quarter ended
March 31, 2006 or any prior period.
18
PART II: OTHER INFORMATION
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
19
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.
May 9, 2006
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)
20