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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, 2003
[ ] QUARTERLY 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) (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 [ ] No [X]
Number of shares outstanding of each of the issuer's classes of common stock, as
of: JANUARY 30, 2004
COMMON STOCK, $.01 PAR VALUE PER SHARE 3,220,016
1
Page
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PART I: FINANCIAL INFORMATION (unaudited)
ITEM I. Financial Statements
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
INDEX - DECEMBER 31, 2003
Condensed Consolidated Balance Sheets, December 31, 2003 and
June 30, 2003 3
Condensed Consolidated Statements of Operations for the Three
Months ended December 31, 2003 and 2002 4
Condensed Consolidated Statements of Operations for the Six
Months ended December 31, 2003 and 2002 5
Condensed Consolidated Statements of Cash Flows for the Six
Months ended December 31, 2003 and 2002 6
Notes to Condensed Consolidated Financial Statements 7
Management's Discussion and Analysis of Financial Condition and
Results of Operations 12
PART II: OTHER INFORMATION 18
SIGNATURE PAGE 19
CERTIFICATIONS PURSUANT TO SECTION 302 OF THE
SARBANES-OXLEY ACT OF 2002 20
2
PART I: FINANCIAL INFORMATION (unaudited)
ITEM 1. Financial Statements
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
December 31, June 30,
2003 2003
----------------- ----------------
(in thousands, except share data)
ASSETS
Current Assets:
Cash $ 1,794 $ 1,794
Accounts receivable, less reserve for doubtful accounts:
December 31, 2003 $ 276
June 30, 2003 $ 215 13,257 17,425
Inventories, net (Note 2) 17,479 16,922
Prepaid expenses and other current assets 1,025 525
Deferred income taxes 1,253 1,253
------------- -----------
Total current assets 34,808 37,919
Property, Plant and Equipment, net 9,152 9,466
Goodwill 9,686 9,686
Other assets 182 278
------------- -----------
$ 53,828 $ 57,349
============= ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt $ 1,900 $ 1,900
Accounts payable 2,771 3,374
Accrued expenses 1,050 1,812
Accrued salaries and wages 1,122 1,501
Accrued income taxes 634 489
------------- -----------
Total current liabilities 7,477 9,076
Long-term debt 11,650 14,100
Deferred income taxes 816 816
------------- -----------
Total liabilities 19,943 23,992
------------- -----------
Shareholders' Equity:
Common stock, par value $.01 per share; 21,000,000 shares authorized,
6,091,072 and 6,069,752 shares issued, respectively;
3,220,016 and 3,198,696 shares outstanding, respectively 61 61
Additional paid-in capital 1,424 1,342
Retained earnings 40,259 39,813
Less: Treasury stock, at cost (2,871,056 shares) (7,859) (7,859)
------------- -----------
Total stockholders' equity 33,885 33,357
------------- -----------
$ 53,828 $ 57,349
============= ===========
See accompanying notes to condensed consolidated financial statement
3
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Three Months Ended
December 31,
-------------------------------------------
2003 2002
------------------ ----------------------
(restated; see Note 1)
(in thousands, except share and per share data)
Net Sales $ 14,629 $ 13,859
Cost of Sales 10,077 10,290
--------------- -----------
Gross profit 4,552 3,569
Selling, General and Administrative Expenses 3,305 3,145
--------------- -----------
Operating income 1,247 424
--------------- -----------
Interest Expense, net 102 187
Other Expense, net 24 13
--------------- -----------
126 200
--------------- -----------
Income before provision for income taxes 1,121 224
Provision for income taxes 393 79
--------------- -----------
Net income $ 728 $ 145
=============== ===========
Net income per share (Note 4): Basic $ 0.23 $ 0.04
=============== ===========
Diluted $ 0.21 $ 0.04
=============== ===========
Weighted average number of shares outstanding (Note 4): Basic 3,215,776 3,423,346
=============== ===========
Diluted 3,488,567 3,654,569
=============== ===========
See accompanying notes to condensed consolidated financial statements
4
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Six Months Ended
December 31,
------------------------------------------
2003 2002
------------------ ----------------------
(restated; see Note 1)
(in thousands, except share and per share data)
Net Sales $ 24,464 $ 25,584
Cost of Sales 16,929 18,967
--------------- --------------
Gross profit 7,535 6,617
Selling, General and Administrative Expenses 6,582 6,426
--------------- --------------
Operating income 953 191
--------------- --------------
Interest Expense, net 230 436
Other (Income) expense, net 36 (187)
--------------- --------------
266 249
--------------- --------------
Income (loss) before provision (benefit) for income taxes 687 (58)
Provision (benefit) for income taxes 241 (20)
--------------- --------------
Net income (loss) $ 446 $ (38)
=============== ==============
Net income (loss) per share (Note 4): Basic $ 0.14 $ (0.01)
=============== ==============
Diluted $ 0.13 $ (0.01)
=============== ==============
Weighted average number of shares outstanding (Note 4): Basic 3,210,083 3,393,796
=============== ==============
Diluted 3,486,129 3,393,796
=============== ==============
See accompanying notes to condensed consolidated financial statements
5
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended
December 31,
---------------------------------------
2003 2002
--------------- --------------
(in thousands)
Net Cash Provided by Operating Activities $ 2,592 $ 3,132
--------------- -------------
Cash Flows used in Investing Activities:
Net purchases of property, plant and equipment (224) (456)
--------------- -------------
Cash Flows from Financing Activities:
Proceeds from long-term debt - 500
Proceeds from exercise of employee stock options 82 237
Principal payments on long-term debt (2,450) (3,050)
--------------- -------------
Net cash used in financing activities (2,368) (2,313)
--------------- -------------
Net Increase in Cash - 363
Cash, Beginning of Period 1,794 1,500
--------------- -------------
Cash, End of Period $ 1,794 $ 1,863
=============== =============
Cash Paid During the Period for:
Interest $ 237 $ 438
=============== =============
Income taxes $ 95 $ -
=============== =============
See accompanying notes to condensed consolidated financial statement.
6
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED STATEMENTS
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 quarterly period ended December
31, 2003 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 the Company after elimination of all material inter-company
balances and transactions. 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,
2003. The accounting policies used in preparing these unaudited
Condensed Consolidated Financial Statements are consistent with those
described in the June 30, 2003 Consolidated Financial Statements,
except as disclosed.
Advertising and Promotional Costs
Advertising and promotional costs are included in "Selling, General and
Administrative" expenses in the Condensed Consolidated Statements of
Operations. Advertising expense for the three months ended December 31,
2003 and 2002 was $263,000 and $208,000, respectively. Advertising
expense for the six months ended December 31, 2003 and 2002 was
$645,000 and $651,000, 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 December 31, 2003 and 2002 was $1,269,000 and
$1,313,000, respectively. Research and Development expense for the six
months ended December 31, 2003 and 2002 was $2,553,000 and $2,577,000,
respectively. These expenses are included in "Cost of sales" in the
Condensed Consolidated Statements of Operations.
Concentration of Credit Risk
An entity is more vulnerable to concentrations of credit risk if it is
exposed to risk of loss greater than it would have had it mitigated its
risk through diversification of customers. Such risks of loss are
manifest differently, depending on the nature of the concentration, and
vary in significance. We have two major customers that accounted for
approximately $963,000, or 7%, and $3,035,000, or 22%, of our
consolidated net sales for the three months ended December 31, 2003 and
December 31, 2002, respectively. These two major customers accounted
for approximately $2,408,000, or 10%, and $5,686,000, or 22%, of our
consolidated net sales for the six months ended December 31, 2003 and
December 31, 2002, respectively. These two customers accounted for
$3,565,000, or 27%, and $7,665,000, or 44%,of our accounts receivable
as of December 31, 2003 and June 30, 2003, respectively. The largest of
these two customers accounted for $881,000, or 6%, and $2,032,000, or
15%, of sales for the three months ended December 31, 2003 and December
31, 2002, respectively. The largest of these two customers accounted
for $1,574,000, or 6%, and $3,805,000, or 15%, of sales for the six
months ended December 31, 2003 and December 31, 2002, respectively. The
largest customer accounted for $3,565,000, or 27%, and $3,787,000, or
22%, of accounts receivable at December 31, 2003 and June 30, 2003,
respectively. 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 our net sales,
cash flows, and/or financial condition. In the ordinary course of
business, we have established an allowance for doubtful accounts and
customer deductions in the amount of $247,000 and $215,000 as of
September 30, 2003 and June 30, 2003, respectively. Our allowance for
doubtful accounts is a subjective critical estimate that has a direct
impact on reported net earnings. This reserve is based upon the
evaluation of accounts receivable aging, specific exposures and
historical trends.
Prior Period Adjustment
The Company's financial statements for the three and six months
ended December 31, 2002 have been restated to reflect an adjustment of
its income tax provision related to the taxation of one of the
Company's foreign subsidiaries, Napco/Alarm Lock Grupo
7
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED STATEMENTS
International S.A. As further described in Note 6 of the Company's 10-K
for June 30, 2003, in March 2003, the Company made an election with the
filing of its income tax return for the fiscal year ended June 30,
2002. As a result, the tax provision and related deferred tax balance
sheet accounts have been restated.
The effect of this restatment on the Company's operations for the
three and six months ended December 31, 2002 is as follows (in
thousands except per share data):
As Previously Reported As Restated
---------------------- -----------
(in thousands except per share data)
Three months ended December 31, 2002:
Provision for income taxes $ 5 $ 79
Net income 219 145
Earnings per share: Basic $0.06 0.04
Earnings per share: Diluted $0.06 0.04
Six months ended December 31, 2002:
Provision/(benefit) for income taxes $ 10 ($ 20)
Net loss (68) (38)
Loss per share: Basic ($0.02) (0.01)
Loss per share: Diluted ($0.02) (0.01)
2.) Employee Stock-based Compensation
As of December 31, 2003, the Company had established a number of share
incentive programs as discussed in more detail in our annual report on
Form 10-K for the year ended June 30, 2003. The Company applies the
intrinsic value method as outlined in Accounting Principles Board
Opinion No. 25, "Accounting for Stock Issued to Employees", and related
interpretations in accounting for stock options and share units granted
under these programs. Under the intrinsic value method, no compensation
expense is recognized if the exercise price of the Company's employee
stock options equals the market price of the underlying stock on the
date of grant. Accordingly, no compensation cost has been recognized.
The Company adopted the disclosure portion of Statement of Financial
Accounting Standard ("SFAS") No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure" requiring quarterly SFAS No.
123 pro forma disclosure. The following table illustrates the effect on
net earnings and earnings per share as if the fair value method had
been applied to all outstanding and unvested awards in each period
presented.
Three Months Six Months
Ended December 31, Ended December 31,
------------------------- ------------------------
2003 2002 (1) 2003 2002(1)
------- -------- ------- -------
(unaudited)
(in thousands, except per share data)
Net income (loss), as reported $ 728 $ 145 $ 446 $ (38)
Deduct: Total stock-based employee compensation
expense determined under fair value method
for all awards, net of related tax effects (1) (50) (54) (108)
------- ------- ------- -------
Pro forma net income (loss) $ 727 $ 95 $ 392 $ (146)
======= ======= ======= =======
Net income (loss) per common share:
Basic - as reported $ 0.23 $ 0.04 $ 0.14 $ (0.01)
======= ======= ======= =======
Basic - pro forma $ 0.23 $ 0.03 $ 0.12 $ (0.04)
======= ======= ======= =======
Diluted - as reported $ 0.21 $ 0.04 $ 0.13 $ (0.01)
======= ======= ======= =======
Diluted - pro forma $ 0.21 $ 0.03 $ 0.11 $ (0.04)
======= ======= ======= =======
(1) Fiscal 2002 information is presented as restated. See Note 1.
8
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED STATEMENTS
3.) Inventories
Inventories consist of:
December 31, June 30,
2003 2003
-------- -------
(in thousands)
Component parts $ 9,943 $ 9,626
Work-in-process 2,523 2,443
Finished products 5,013 4,853
-------- -------
$ 17,479 $16,922
======== =======
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 consolidated statements of
operations.
A reconciliation between the numerators and denominators of the Basic
and Diluted EPS computations for earnings is as follows:
Three months ended December 31, 2003
(in thousands, except per share data)
----------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
Net income $ 728 - -
----------- ------------- --------
BASIC EPS
Net income attributable to common stock $ 728 3,216 $ 0.23
EFFECT OF DILUTIVE SECURITIES
Options $ - 273 ($ 0.02)
----------- ------------- --------
DILUTED EPS
Net income attributable to common stock
and assumed option exercises $ 728 3,489 $ 0.21
=========== ============= ========
Options to purchase 31,000 shares of common stock in the three months
ended December 31, 2003 were not included in the computation of Diluted
EPS because the option price was in excess of the average market price
for the three months ended December 31, 2003. These options were still
outstanding at the end of the period.
9
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED STATEMENTS
Three months ended December 31, 2002 (as restated)
(in thousands, except per share data)
--------------------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
Net income $ 145 - -
----------- ------------- ---------
BASIC EPS
Net income attributable to common stock $ 145 3,423 $ 0.04
EFFECT OF DILUTIVE SECURITIES
Options $ - 232 -
----------- ------------- ---------
DILUTED EPS
Net income attributable to common stock
and assumed option exercises $ 145 3,655 $ 0.04
=========== ============= =========
Six months ended December 31, 2003
(in thousands, except per share data)
--------------------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
Net income $ 446 - -
----------- ------------- ---------
BASIC EPS
Net income attributable to common stock $ 446 3,210 $ 0.14
EFFECT OF DILUTIVE SECURITIES
Options $ - 276 ($ 0.01)
----------- ------------- ---------
DILUTED EPS
Net income attributable to common stock
and assumed option exercises $ 446 3,486 $ 0.13
=========== ============= =========
Options to purchase 33,200 shares of common stock in the six months
ended December 31, 2003 were not included in the computation of Diluted
EPS because the option price was in excess of the average market price
for the six months ended December 31, 2003. These options were still
outstanding at the end of the period.
10
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED STATEMENTS
Six months ended December 31, 2002 (as restated)
(in thousands, except per share data)
--------------------------------------------------
Net Loss Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
Net loss $ (38) - -
----------- ------------- ---------
BASIC EPS
Net loss attributable to common stock $ (38) 3,394 ($ 0.01)
EFFECT OF DILUTIVE SECURITIES
Options $ - - -
----------- ------------- ---------
DILUTED EPS
Net loss attributable to common stock
and assumed option exercises $ (38) 3,394 ($ 0.01)
=========== ============= =========
Options to purchase 372,660 shares of common stock in the six months
ended December 31, 2002 were not included in the computation of Diluted
EPS because the Company incurred a loss for the six months, therefore
the impact would have been anti-dilutive. These options were still
outstanding at the end of the 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 revolving credit agreement will expire
in January, 2005 and any outstanding borrowings are to be repaid or
refinanced on or before that time. The agreement contains various
restrictions and covenants including, among others, restrictions on
payment of dividends, restrictions on borrowings, restrictions on
capital expenditures, the maintenance of minimum amounts of tangible
net worth, and compliance with other certain financial ratios, as
defined in the agreement. As of December 31, 2003 the Company was not
in compliance with one of the non-financial covenants in this agreement
which related directly to the Company's delay in filing is Form 10-K
for fiscal 2003 and its Form 10-Q for the three months ended September
30, 2003. The Company has since received the appropriate waivers from
its bank and filed the aforementioned Form 10-K and Form 10-Q.
6.) Geographical Data
The revenues attributable to the Company's domestic and foreign
operations for the periods presented are summarized in the following
tabulation (in thousands):
Three Months Six Months
Ended December 31, Ended December 31,
-------------------- --------------------
2003 2002 2003 2002
------- ------- ------- -------
Sales to external customers(1):
Domestic $12,174 $11,284 $20,148 $20,856
Foreign 2,455 2,575 4,316 4,728
------- ------- ------- -------
Total Net Sales $14,629 $13,859 $24,464 $25,584
======= ======= ======= =======
(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 country in excess of 10% of Net
Sales.
11
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED STATEMENTS
7) Commitments and Contingencies
As previously reported, on or about August 27, 2001, a five-count
Verified 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 Verified Complaint
seemingly seeks fifteen million dollars ($15,000,000) in damages on
behalf of Mr. Ramirez based on theories including strict liability in
tort, negligence, breach of warranty, failure to warn, etc. The
Verified Complaint also seeks damages in the amount of two million
dollars ($2,000,000) on behalf of Ms. Ramirez based on an allegation
that she has been, and forever will be, "deprived of the society,
services, companionship consortium and support of" Mr. Ramirez based on
the personal injuries he suffered in a fire which purportedly occurred
on November 5, 1999. This case was consolidated with the related case
concerning the same incident, captioned Jose Ramirez and Glenda Ramirez
v. Mark T. Miller, Chelsea Gardens Owners Corp., Eichner Rudd
Management Associates, Ltd., Napco Security Group and Alarm Lock
Systems, Inc., asserting the same claims against the Company. The
action is being defended by NAPCO's insurance company on behalf of
NAPCO. The Alarm Lock product in question has been tested and still
functions correctly, and the Company believes that action is without
merit. NAPCO 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.
12
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
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
The discussions set forth in this Form 10-Q should be read in conjunction with
the financial information included herein and in the Company's Annual Report on
Form 10-K for the year ended June 30, 2003. Management's discussion and analysis
of financial condition and results of operations and other sections of this
Quarterly Report contain forward-looking statements. Such forward-looking
statements are identified by use of forward-looking words such as "anticipates",
"believes", "plans", "estimates", "expects", and "intends" or words or phrases
of similar expression. These forward-looking statements are subject to various
assumptions, risk and uncertainties, including but not limited to: changes in
political and economic conditions; changes in demand for the Company's products;
acceptance of new products; changes in conditions in the various geographical
markets where the Company does business; technology developments affecting the
Company's products; changes in laws and regulations; and to those matters
discussed in the Company's filings with the Securities and Exchange Commission.
Accordingly, actual circumstances and results could differ materially from those
contemplated by the forward-looking statements.
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, 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.
Concentration of Credit Risk
An entity is more vulnerable to concentrations of credit risk if it is exposed
to risk of loss greater than it would have had it mitigated its risk through
diversification of customers. Such risks of loss are manifest differently,
depending on the nature of the concentration, and vary in significance. We have
two major customers that accounted for approximately $963,000, or 7%, and
$3,035,000, or 22%, of our consolidated net sales for the three months ended
December 31, 2003 and December 31, 2002, respectively. These two major customers
accounted for approximately $2,408,000, or 10%, and $5,686,000, or 22%, of our
consolidated net sales for the six months ended December 31, 2003 and December
31, 2002, respectively. These two customers accounted for $3,565,000, or 27%,
and $7,665,000, or 44%,of our accounts receivable as of December 31, 2003 and
June 30, 2003, respectively. The largest of these two customers accounted for
$881,000, or 6%, and $2,032,000, or 15%, of sales for the three months ended
December 31, 2003 and December 31, 2002, respectively. The largest of these two
customers accounted for $1,574,000, or 6%, and $3,805,000, or 15%, of sales for
the six months ended December 31, 2003 and December 31, 2002, respectively. The
largest customer accounted for $3,565,000, or 27%, and $3,787,000, or 22%, of
accounts receivable at December 31, 2003 and June 30, 2003, respectively. 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 our
net sales, cash flows, and/or financial condition. In the ordinary course of
business, we have established an allowance for doubtful accounts and customer
deductions in the amount of $247,000 and $215,000 as of September 30, 2003 and
June 30, 2003, respectively. Our allowance for doubtful accounts is a subjective
critical estimate that has a direct impact on reported net earnings. This
reserve is based upon the evaluation of accounts receivable aging, specific
exposures and historical trends.
13
Inventory
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
Goodwill is calculated as the excess of the cost of purchased businesses over
the value of their underlying net assets. Goodwill is not amortized. Other
intangible assets are not material.
On an annual basis, we test goodwill and other intangible assets for impairment.
To determine the fair value of these intangible assets, there are many
assumptions and estimates we choose. To mitigate undue influence, we use
industry accepted valuation models and set criteria that are reviewed and
approved by various levels of management. Additionally, we evaluated our
recorded goodwill with the assistance of a third-party valuation firm.
Income taxes
We have accounted for, and currently account for, income taxes in accordance
with SFAS No. 109, "Accounting for Income Taxes". This statement establishes
financial accounting and reporting standards for the effects of income taxes
that result from an enterprise's activities during the current and preceding
years. It requires an asset and liability approach for financial accounting and
reporting of income taxes.
Controls and Procedures
Our disclosure controls and procedures are designed to ensure that information
required to be disclosed in reports that we file or submit under the Securities
and Exchange Act of 1934 is recorded, processed, summarized and reported within
the time periods specified in the rules and forms of the Securities and Exchange
Commission. The Chief Executive Officer and the Chief Financial Officer have
reviewed the effectiveness of our disclosure controls and procedures within the
last ninety days and have concluded that the disclosure controls and procedures
(as defined in Rules 13(a)-14(c) and 15(d)-14(e) promulgated under the
Securities Exchange Act of 1934) are effective. There were no significant
changes in our internal controls or in other factors that could significantly
affect these controls subsequent to the last day they were evaluated by our
Chief Executive Officer and Chief Financial Officer nor were any corrective
actions required with regard to significant accounting deficiencies or material
weaknesses.
Results of Operations
Sales for the three months ended December 31, 2003 increased by 6% to
$14,629,000 as compared to $13,859,000 for the same period a year ago. Sales for
the six months ended December 31, 2003 decreased by 4% to $24,464,000 as
compared to $25,584,000 for the same period a year ago. The increase in net
sales for the three months ended December 31, 2003 was primarily due to
increased sales of the Company's door locking and access control products. The
decrease in net sales for the six months ended December 31, 2003 was primarily
due to the aforementioned increased sales in the Company's door locking and
access control products, as partially offset by lower burglar alarm sales
principally as a result of a major distributor's introduction of its
company-wide inventory reduction program, which reduced its purchasing levels.
During the quarter ended December 31, 2003, the Company began the process of
realigning its burglar alarm products distribution network which culminated in
the termination of the aforementioned major burglar alarm distributor. The
Company reallocated its burglar alarm products business across its extensive
national network of independent distributors.
The Company expects that this new burglar alarm products distribution structure
will generate increased sales and provide more meaningful distribution, because
the Company's burglar alarm dealer brand loyalty and appreciation for its
quality products is stronger than ever.
14
The Company's gross profit for the three months ended December 31, 2003
increased by $983,000 to $4,552,000 or 31.1% of sales as compared to $3,569,000
or 25.8% of sales for the same period a year ago. Gross profit for the six
months ended December 31, 2003 increased by $918,000 to $7,535,000 or 30.8% of
sales as compared to $6,617,000 or 25.9% of sales for the same period a year
ago. The changes in dollars for the three and six months ended December 31, 2003
are due primarily to the increase in sales in second quarter as discussed above
as well as the increase in gross margin as a percentage of sales. The increase
in gross margin as a percentage of sales was primarily due to lower
manufacturing overhead costs due, in part, to a favorable change in the exchange
rate relating to the Company's Dominican Republic manufacturing facility.
Selling, general and administrative expenses for the three months ended December
31, 2003 remained relatively constant at $3,305,000, or 22.6 % of sales, as
compared to $3,145,000, or 22.7% of sales a year ago. For the six months ended
December 31, 2003 selling, general and administrative expenses remained
relatively constant at $6,582,000, or 26.9% of sales, as compared to $6,426,000,
or 25.1% of sales a year ago.
Interest expense for the three months ended December 31, 2003 decreased by
$85,000 to $102,000 from $187,000 for the same period a year ago. Interest
expense for the six months ended December 31, 2003 decreased by $206,000 to
$230,000 from $436,000 for the same period a year ago. These changes for the
three and six months resulted primarily from two factors; a reduction in the
Company's average outstanding debt and a decrease in interest rates available to
the Company.
Other income/expense for the three months ended December 31, 2003 increased by
$11,000 to $24,000 from $13,000 for the same period a year ago. Other
Income/expense for the six months ended December 31, 2003 increased by $223,000
to an expense of $36,000 from income of $187,000 for the same period a year
ago. The change for the six months resulted primarily from the Company settling
litigation during the quarter ended September 30, 2002 which it had initiated
as the plaintiff and realized a gain of approximately $210,000. This gain was
recorded as Other Income during the quarter ended September 30, 2002.
The Company had a provision for income taxes for the three months ended December
31, 2003 of $393,000 as compared to a provision of $79,000, as restated, for the
same period a year ago. The Company had a provision for income taxes for the six
months ended December 31, 2003 of $241,000 as compared to a benefit of
($20,000), as restated, for the same period a year ago. The tax provisions and
benefit are calculated using an effective tax rate of 35%.
Net income increased by $583,000 to $728,000 or $0.23 per share for the three
months ended December 31, 2003 as compared to $145,000 or $0.04 per share, as
restated, for the same period a year ago. Net income increased by $484,000 to
$446,000 or $0.14 per share for the six months ended December 31, 2003 as
compared to a loss of ($38,000) or ($0.01) per share, as restated, for the same
period a year ago. These changes were primarily due to the items discussed
above.
Liquidity and Capital Resources
During the six months ended December 31, 2003 the Company utilized a portion of
its cash generated from operations to reduce certain of its outstanding
borrowings, purchase property, plant and equipment and invest in additional
inventory as discussed below. During the first quarter of fiscal 2001, the
Company entered into an $8,250,000 term loan agreement, payable over 60 equal
monthly installments, in order to purchase the assets of Continental
Instruments, LLC. 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 second quarter
of fiscal 2005.
Accounts Receivable at December 31, 2003 decreased $4,168,000 to $13,257,000 as
compared to $17,425,000 at June 30, 2003. This decrease is primarily the result
of the higher sales volume during the quarter ended June 30, 2003 as compared to
the quarter ended December 31, 2003.
Inventory at December 31, 2003 increased by $557,000 to $17,479,000 as compared
to $16,922,000 at June 30, 2003. This slight 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 partially
offset by the increase in net sales during the second quarter.
In January 2003, the Company repurchased 250,000 shares of its common stock from
two stockholders, unaffiliated with the Company, at $9.75 per share, a discount
from its then current trading price of $10.01. The transaction was approved by
the board of directors and the purchase price of $2,437,500 was financed through
the Company's revolving line of credit and a new five (5) year term loan from
its primary bank for approximately 50% of the purchase price. This term loan is
for $1,250,000 and is being repaid in 60 equal monthly installments commencing
on April 30, 2003.
15
Other than the $8,250,000 and $1,250,000 loans described above, the Company's
bank debt consisted of an $18,000,000 secured revolving credit agreement and a
$3,000,000 line of credit to be used in connection with commercial and standby
letters of credit. In February 2004 the Company's bank approved an extension of
the expiration date of the secured revolving credit agreement from July 2004 to
January 2005. As of December 31, 2003 the Company was not in compliance with one
of the non-financial covenants in this agreement which related directly to the
Company's delay in filing its Form 10-K for fiscal 2003 and its Form 10-Q for
the three months ended September 30, 2003. The Company has since received the
appropriate waivers from its bank and filed the aforementioned Form 10-K and
Form 10-Q.
As of December 31, 2003 the Company had no material commitments for capital
expenditures or inventory purchases other than purchase orders used in the
normal course of business.
Business Outlook
We believe the business outlook for our industry has shown signs of improvement
in recent months. Strengthening consumer confidence, slightly lower unemployment
rates, and recently-enacted changes in U.S. tax legislation appear to have
benefited the American economy, resulting in continued advances in the gross
domestic product. Housing starts remain strong with interest rates at their
lowest levels in over 40 years, and recent comments by the Federal Reserve Board
suggest a "patient" approach toward future interest rate increases. These
factors seem to have had a positive impact on business and consumer spending
habits which could have a positive impact on the Company's incoming order
trends. If these apparent signs of economic recovery can be sustained, we
believe the longer-term outlook is promising as well. As the economy
strengthens, however, it is also possible that costs associated with production
(including raw materials, freight, salaries, utilities and marketing expenses
such as advertising) may increase. We cannot reasonably predict when, or to what
extent, events may occur which could impact the availability of such resources
and/or their related cost to the Company.
We continue to believe that there is considerable interest on the part of
businesses and consumers to invest in security. We also believe that this
interest has, until recently, been restrained by such factors as high
unemployment and sluggish consumer confidence levels. As the economy improves
and this interest in business and home security continues to emerge, as we
anticipate it will, we believe we will be well positioned to take advantage of
the long-awaited increase in demand as a result of our established products and
our vertically-integrated business model.
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 facilities) 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. A significant rise in the prime rate
could materially adversely affect the Company's business, financial condition
and results of operations. At December 31, 2003 an aggregate amount of
approximately $13,500,000 was outstanding under these facilities. 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 $135,000 in interest that year.
Where appropriate, 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. 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.
Forward-looking Information
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
16
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.
Factors that could cause actual results to differ materially from the
Forward-Looking Statements include, but are not limited to, inability to
refinance, adverse tax consequences of offshore of operations, distribution
problems, unforeseen environmental liabilities and the uncertain military,
political and economic conditions in the world. These and other risks are
detailed in Part I, Item 1 and elsewhere in this Form 10-Q. The Company assumes
no obligation to update publicly the Forward-Looking Statements contained
herein, whether as a result of new information, future events or otherwise,
except as may be required by law.
We assume no responsibility to update forward-looking statements made herein or
otherwise.
ITEM 4: Controls and Procedures
At the end of the period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer, of the Company's disclosure controls and procedures pursuant to
Exchange Act Rule 13 a - 15(e). Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures are effective. During the second quarter of fiscal year
2004, there were no changes in the Company's internal control over financial
reporting that have materially affected, or are reasonable likely to materially
affect, the Company's internal control over financial reporting.
17
PART II: OTHER INFORMATION
Item 1. Legal Proceedings.
There are no pending or threatened material legal proceedings to which
NAPCO or its subsidiaries or any of their property is subject, except:
As previously reported, on or about August 27, 2001, a five-count
Verified 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 Verified Complaint
seemingly seeks fifteen million dollars ($15,000,000) in damages on
behalf of Mr. Ramirez based on theories including strict liability in
tort, negligence, breach of warranty, failure to warn, etc. The
Verified Complaint also seeks damages in the amount of two million
dollars ($2,000,000) on behalf of Ms. Ramirez based on an allegation
that she has been, and forever will be, "deprived of the society,
services, companionship consortium and support of" Mr. Ramirez based on
the personal injuries he suffered in a fire which purportedly occurred
on November 5, 1999. This case was consolidated with the related case
concerning the same incident, captioned Jose Ramirez and Glenda Ramirez
v. Mark T. Miller, Chelsea Gardens Owners Corp., Eichner Rudd
Management Associates, Ltd., Napco Security Group and Alarm Lock
Systems, Inc., asserting the same claims against the Company. The
action is being defended by NAPCO's insurance company on behalf of
NAPCO. The Alarm Lock product in question has been tested and still
functions correctly, and the Company believes that action is without
merit. NAPCO 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.
Item 2. Changes in Securities
None
Item 3. Defaults Upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits None
(b) Form 8-K Filings
(i) On December 29, 2003 the Company announced that it had
resolved its previously disclosed international tax matter and
also released its unaudited results for fiscal 2003.
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(ii) On December 15, 2003 the Company announced that it had
replaced its accountants, KPMG LLP, with Marcum & Kliegman LLP
prior to the completion of KPMG's audit of the Company's financial
statements for fiscal 2003 along with KPMG's response.
(iii) On October 16, 2003 the Company announced that it had been
notified by NASDAQ that it was not in compliance with its filing
requirements due to the as yet unfiled form 10-K for fiscal 2003
and that its ticker symbol would become NSSCE throughout this
delinquency period.
(iv) On October 14, 2003 the Company announced that its 10-K
filing for fiscal 2003 would be delayed by an unresolved
international tax matter.
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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 13, 2004
NAPCO SECURITY SYSTEMS, INC
(Registrant)
By: /s/ Richard Soloway
-------------------------------------------------
Richard 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