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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: MARCH 31, 2004
[ ] 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) (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 an accelerated filer (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: APRIL 27, 2004
COMMON STOCK, $.01 PAR VALUE PER SHARE 6,960,636
1
Page
----
PART I: FINANCIAL INFORMATION
ITEM I. Financial Statements (unaudited)
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
INDEX - MARCH 31, 2004
Condensed Consolidated Balance Sheets, March 31, 2004 and
June 30, 2003 3
Condensed Consolidated Statements of Operations for the Three
Months ended March 31, 2004 and 2003 4
Condensed Consolidated Statements of Operations for the Nine
Months ended March 31, 2004 and 2003 5
Condensed Consolidated Statements of Cash Flows for the Nine
Months ended March 31, 2004 and 2003 6
Notes to Condensed Consolidated Financial Statements 7
ITEM II. Management's Discussion and Analysis of Financial Condition and
Results of Operations 14
ITEM III. Quantitative and Qualitative Disclosures About Market Risk 17
ITEM IV. Controls and Procedures 18
PART II: OTHER INFORMATION 19
SIGNATURE PAGE 21
2
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited)
March 31, June 30,
2004 2003
----------- ---------
(restated, see Note 1)
(in thousands, except share data)
ASSETS
Current Assets:
Cash $ 1,488 $ 1,794
Accounts receivable, less reserve for doubtful accounts:
March 31, 2004 $ 305
June 30, 2003 $ 215 15,905 17,425
Inventories, net (Note 3) 16,464 16,922
Prepaid expenses and other current assets 623 525
Deferred income taxes 1,253 1,253
----------- ---------
Total current assets 35,733 37,919
Property, Plant and Equipment, net 9,086 9,466
Goodwill 9,686 9,686
Other assets 169 278
----------- ---------
$ 54,674 $ 57,349
=========== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt $ 1,900 $ 1,900
Accounts payable 3,027 3,374
Accrued expenses 805 1,812
Accrued salaries and wages 1,496 1,501
Accrued income taxes 924 489
----------- ---------
Total current liabilities 8,152 9,076
Long-term debt 10,175 14,100
Deferred income taxes 816 816
----------- ---------
Total liabilities 19,143 23,992
----------- ---------
Shareholders' Equity (Note 1):
Common stock, par value $.01 per share; 21,000,000 shares authorized,
6,960,632 and 6,397,392 shares issued, respectively;
6,960,632 and 6,397,392 shares outstanding, respectively 70 64
Retained earnings 35,461 33,293
----------- ---------
Total stockholders' equity 35,531 33,357
----------- ---------
$ 54,674 $ 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
March 31,
-------------------------------
2004 2003
----------- ----------
(restated; see Note 1)
(in thousands, except share and per share data)
Net Sales $ 14,742 $ 13,406
Cost of Sales 10,120 9,910
----------- ----------
Gross profit 4,622 3,496
Selling, General and Administrative Expenses 3,363 3,487
----------- ----------
Operating income 1,259 9
----------- ----------
Interest Expense, net 101 141
Other Expense, net 30 69
----------- ----------
Other expense 131 210
----------- ----------
Income (loss) before provision (benefit) for income taxes 1,128 (201)
Provision (benefit) for income taxes 394 (65)
----------- ----------
Net income (loss) $ 734 $ (136)
=========== ==========
Net income (loss) per share (Note 1 and Note 4): Basic $ 0.11 $ (0.02)
=========== ==========
Diluted $ 0.11 $ (0.02)
=========== ==========
Weighted average number of shares outstanding
(Note 1 and Note 4): Basic 6,706,752 6,607,392
=========== ==========
Diluted 6,947,574 6,607,392
=========== ==========
See accompanying notes to condensed consolidated financial statements
4
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Nine Months Ended
March 31,
-------------------------------
2004 2003
----------- ----------
(restated; see Note 1)
(in thousands, except share and per share data)
Net Sales $ 39,206 $ 38,990
Cost of Sales 27,049 28,877
----------- ----------
Gross profit 12,157 10,113
Selling, General and Administrative Expenses 9,945 9,913
----------- ----------
Operating income 2,212 200
----------- ----------
Interest Expense, net 331 577
Other (Income) expense, net 66 (118)
----------- ----------
Other expense 397 459
----------- ----------
Income (loss) before provision (benefit) for income taxes 1,815 (259)
Provision (benefit) for income taxes 635 (85)
----------- ----------
Net income (loss) $ 1,180 $ (174)
=========== ==========
Net income (loss) per share (Note 1 and Note 4): Basic $ 0.18 $ (0.03)
=========== ==========
Diluted $ 0.17 $ (0.03)
=========== ==========
Weighted average number of shares outstanding
(Note 1 and Note 4): Basic 6,555,282 6,697,492
=========== ==========
Diluted 6,772,018 6,697,492
=========== ==========
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,
-------------------------------
2004 2003
----------- ----------
(in thousands)
Net Cash Provided by Operating Activities $ 3,173 $ 4,180
Cash Flows used in Investing Activities:
Net purchases of property, plant and equipment (444) (606)
----------- ----------
Cash Flows from Financing Activities:
Proceeds from long-term debt 1,000 4,250
Proceeds from exercise of employee stock options 890 259
Principal payments on long-term debt (4,925) (5,377)
Payments for purchase of treasury stock - (2,442)
----------- ----------
Net cash used in financing activities (3,035) (3,310)
----------- ----------
Net Increase (Decrease) in Cash (306) 264
Cash, Beginning of Period 1,794 1,500
----------- ----------
Cash, End of Period $ 1,488 $ 1,764
=========== ==========
Cash Paid During the Period for:
Interest $ 336 $ 586
=========== ==========
Income taxes $ 96 $ 14
=========== ==========
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 March 31,
2004 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 and are expensed as incurred. Advertising expense for the three
months ended March 31, 2004 and 2003 was $193,000 and $330,000,
respectively. Advertising expense for the nine months ended March 31, 2004
and 2003 was $838,000 and $981,000, 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, 2004 and 2003 was $1,332,000 and $1,568,000,
respectively. Research and Development expense for the nine months ended
March 31, 2004 and 2003 was $3,885,000 and $4,145,000, respectively. These
expenses are included in "Cost of sales" in the Condensed Consolidated
Statements of Operations.
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 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 three major customers as follows:
Sales for the three months ended March 31,
-------------------------------------------
2004 2003
------------------ -----------------------
$ % $ %
--------- ----- ---------- -----
Customer A 1,329,212 9.0% 794,757 5.9%
Customer B 1,123,274 7.6% (1) -
Customer C (1) - 3,556,226 26.5%
--------- ---- --------- ----
2,452,486 16.6% 4,350,983 32.4%
Sales for the nine months ended March 31,
-------------------------------------------
2004 2003
------------------ -----------------------
$ % $ %
--------- ----- ---------- -----
Customer A 2,902,857 7.4% 2,675,917 6.9%
Customer B 2,333,896 6.0% (1) -
Customer C (1) - 7,384,462 18.9%
--------- ---- --------- ----
5,236,753 13.4% 10,060,379 25.8%
7
Accounts Receivable as of:
-------------------------------------------
March 31, 2004 June 30, 2003
-------------------------------------------
$ % $ %
--------- ----- --------- -----
Customer A 4,028,310 25.3% 3,877,694 22.3%
Customer B 2,014,406 12.7% (1) -
Customer C (1) - 3,787,173 21.7%
--------- ---- --------- ----
6,042,716 38.0% 7,664,867 44.0%
(1) The customer did not qualify as a major customer in this period.
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 $305,000 and
$215,000 as of March 31, 2004 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.
Stock Options
During the three and nine months ended March 31, 2004 the Company granted
52,000 stock options to employees. In addition, 260,300 and 281,620
options were exercised during the three and nine months ended March 31,
2004, respectively.
Stock Split
In March 2004, the Company's Board of Directors approved a two-for-one
stock split in the form of a 100% stock dividend of the Companys common
stock payable to stockholders of record on April 13, 2004. The additional
shares were distributed on April 27, 2004. The Company utilized all
2,871,056 of its shares held as Treasury stock as of April 27, 2004 plus
an additional 609,260 shares in paying this stock dividend. All share and
per share amounts (except par value) have been retroactively adjusted to
reflect the stock split. There was no net effect on total stockholders'
equity as a result of the stock split. The retroactive effect of the
two-for-one stock split within Stockholders' Equity at June 30, 2003 is as
follows (in thousands):
As reported Effect of Stock Split As adjusted
----------- --------------------- -----------
Common stock $ 61 $ 3 $ 64
Additional paid-in capital 1,342 (1,342) -
Retained earnings 39,813 (6,520) 33,293
Less: Treasury stock, at cost (7,859) 7,859 -
----------- ----------- ---------
Total Stockholders' equity $ 33,357 $ - $ 33,357
=========== =========== =========
Prior Period Adjustment
The Company's financial statements for the three and nine months ended
March 31, 2003 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 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.
8
The effect of this restatement on the Company's operations for the three
and nine months ended March 31, 2003 is as follows (in thousands, except
per share data) (restated to reflect two-for-one stock split as previously
discussed):
As Previously Reported As Restated
---------------------- -----------
(in thousands except per share data)
Three months ended March 31, 2003:
Provision (Benefit) for income taxes $ 5 $ (65)
Net loss (206) (136)
Earnings per share: Basic (0.03) (0.02)
Earnings per share: Diluted (0.03) (0.02)
Nine months ended March 31, 2003:
Provision (Benefit) for income taxes $ 15 $ (85)
Net loss (274) (174)
Earnings per share: Basic (0.04) (0.03)
Earnings per share: Diluted (0.04) (0.03)
2.) Employee Stock-based Compensation
As of March 31, 2004, 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
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 Nine Months
Ended March 31, Ended March 31,
------------------------ ------------------------
2004 2003(1) 2004 2003(1)
------- ------- -------- -------
(unaudited)
(in thousands, except per share data)
Net income (loss), as reported $ 734 $ (136) $ 1,180 $ (174)
Deduct: Total stock-based employee compensation
expense determined under fair value method
for all awards, net of related tax effects (63) (263) (118) (370)
------- ------- -------- -------
Pro forma net earnings, attributable to common stock $ 671 $ (399) $ 1,062 $ (544)
======= ======= ======== =======
Earnings per common share (1):
Basic - as reported $ 0.11 $ (0.02) $ 0.18 $ (0.03)
======= ======= ======== =======
Basic - pro forma $ 0.10 $ (0.06) $ 0.16 $ (0.08)
======= ======= ======== =======
Diluted - as reported $ 0.11 $ (0.02) $ 0.17 $ (0.03)
======= ======= ======== =======
Diluted - pro forma $ 0.10 $ (0.06) $ 0.16 $ (0.08)
======= ======= ======== =======
(1) Information is presented as restated. See Note 1.
9
3.) Inventories
Inventories consist of:
March 31, June 30,
2004 2003
---------- -----------
(in thousands)
Component parts $ 9,366 $ 9,626
Work-in-process 2,377 2,443
Finished products 4,721 4,853
---------- -----------
$ 16,464 $ 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 (Information restated
as described in Note 1):
Three months ended March 31, 2004
(in thousands, except per share data)
-----------------------------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
Net income $ 734 - -
-------- ----- -----
BASIC EPS
Net income attributable to common stock $ 734 6,707 $0.11
EFFECT OF DILUTIVE SECURITIES
Options $ - 241 -
-------- ----- -----
DILUTED EPS
Net income attributable to common stock
and assumed option exercises $ 734 6,948 $0.11
======== ===== =====
Options to purchase 10,000 shares of common stock in the three months
ended March 31, 2004 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 March 31, 2004. These options were still outstanding at
the end of the period.
10
Three months ended March 31, 2003 (as restated)
(in thousands, except per share data)
-------------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ----------
Net loss $ (136) - -
---------- ----- ------
BASIC EPS
Net income attributable to common stock $ (136) 6,607 $(0.02)
EFFECT OF DILUTIVE SECURITIES
Options $ - - -
---------- ----- ------
DILUTED EPS
Net loss attributable to common stock
and assumed option exercises $ (136) 6,607 $(0.02)
========== ===== ======
Options to purchase 843,720 shares of common stock in the three months
ended March 31, 2003 were not included in the computation of Diluted EPS
because the Company incurred a loss for the nine months, therefore the
impact would have been anti-dilutive. These options were still outstanding
at the end of the period.
Nine months ended March 31, 2004
(in thousands, except per share data)
-------------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ----------
Net income $ 1,180 - -
---------- ----- ------
BASIC EPS
Net income attributable to common stock $ 1,180 6,555 $ 0.18
EFFECT OF DILUTIVE SECURITIES
Options $ - 217 $(0.01)
---------- ----- ------
DILUTED EPS
Net income attributable to common stock
and assumed option exercises $ 1,180 6,772 $ 0.17
========== ===== ======
Options to purchase 60,800 shares of common stock in the nine months ended
March 31, 2004 were not included in the computation of Diluted EPS because
the option price was in excess of the average market price for the nine
months ended March 31, 2004. These options were still outstanding at the
end of the period.
11
Nine months ended March 31, 2003 (as restated)
(in thousands, except per share data)
-------------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ----------
Net loss $ (174) - -
---------- ----- ------
BASIC EPS
Net loss attributable to common stock $ (174) 6,697 $(0.03)
EFFECT OF DILUTIVE SECURITIES
Options $ - - -
---------- ----- ------
DILUTED EPS
Net loss attributable to common stock
and assumed option exercises $ (174) 6,697 $(0.03)
========== ===== ======
Options to purchase 843,720 shares of common stock in the nine months
ended March 31, 2003 were not included in the computation of Diluted EPS
because the Company incurred a loss for the nine 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. In April 2004 the Company's bank approved an extension of
the expiration date of the secured revolving credit agreement from January
2005 to April 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.
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 Nine Months
Ended March 31, Ended March 31,
-------------------------- --------------------------
2004 2003 2004 2003
--------- --------- --------- ----------
Sales to external customers(1):
Domestic $12,467 $11,508 $32,615 $32,368
Foreign 2,275 1,898 6,591 6,622
------- ------- ------- -------
Total Net Sales $14,742 $13,406 $39,206 $38,990
======= ======= ======= =======
(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.
12
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.
13
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. 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.
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.
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 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
three major customers as follows:
Sales for the three months ended March 31,
--------------------------------------------
2004 2003
--------------------------------------------
$ % $ %
--------- ----- --------- -----
Customer A 1,329,212 9.0% 794,757 5.9%
Customer B 1,123,274 7.6% (1) -
Customer C (1) - 3,556,226 26.5%
--------- ---------
2,452,486 16.6% 4,350,983 32.4%
14
Sales for the nine months ended March 31,
--------------------------------------------
2004 2003
-------------------- ---------------------
$ % $ %
--------- ----- --------- -----
Customer A 2,902,857 7.4% 2,675,917 6.9%
Customer B 2,333,896 6.0% (1) -
Customer C (1) - 7,384,462 18.9%
--------- ----------
5,236,753 13.4% 10,060,379 25.8%
Accounts Receivable as of:
--------------------------------------------
March 31, 2004 June 30, 2003
-------------------- ---------------------
$ % $ %
--------- ----- --------- -----
Customer A 4,028,310 25.3% 3,877,694 22.3%
Customer B 2,014,406 12.7% (1) -
Customer C (1) - 3,787,173 21.7%
--------- ---------
6,042,716 38.0% 7,664,867 44.0%
(2) The customer did not qualify as a major customer in this period.
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 $305,000 and $215,000 as of March 31, 2004
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.
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.
15
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.
Results of Operations
Sales for the three months ended March 31, 2004 increased by 10% to $14,742,000
as compared to $13,406,000 for the same period a year ago. Sales for the nine
months ended March 31, 2004 increased by 1% to $39,206,000 as compared to
$38,990,000 for the same period a year ago. The increase in net sales for the
three months ended March 31, 2004 was primarily due to increased sales of the
Company's door locking and access control products. The increase in net sales
for the nine months ended March 31, 2004 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's gross profit for the three months ended March 31, 2004 increased
by $1,126,000 to $4,622,000 or 31.4% of sales as compared to $3,496,000 or 26.1%
of sales for the same period a year ago. Gross profit for the nine months ended
March 31, 2004 increased by $2,044,000 to $12,157,000 or 31.0% of sales as
compared to $10,113,000 or 25.9% of sales for the same period a year ago. The
changes in dollars for the three and nine months ended March 31, 2004 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 March
31, 2004 declined slightly to $3,363,000, or 22.8 % of sales, as compared to
$3,487,000, or 26.0% of sales a year ago. For the nine months ended March 31,
2004 selling, general and administrative expenses remained relatively constant
at $9,945,000, or 25.4% of sales, as compared to $9,913,000, or 25.4% of sales a
year ago. The decline in Selling, general and administrative expenses as a
percentage of sales for the three months ended March 31, 2004 was due primarily
to net sales increasing as described above while expenses remained relatively
constant.
Interest expense for the three months ended March 31, 2004 decreased by $40,000
to $101,000 from $141,000 for the same period a year ago. Interest expense for
the nine months ended March 31, 2004 decreased by $246,000 to $331,000 from
$577,000 for the same period a year ago. These changes for the three and nine
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 March 31, 2004 decreased by
$39,000 to $30,000 from $69,000 for the same period a year ago. Other
income/expense for the nine months ended March 31, 2004 increased by $184,000 to
an expense of $66,000 from income of $118,000 for the same period a year ago.
The change for the nine 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 March
31, 2004 of $394,000 as compared to a benefit of ($65,000), as restated, for the
same period a year ago. The Company had a provision for income taxes for the
nine months ended March 31, 2004 of 635,000 as compared to a benefit of
($85,000), as restated, for the same period a year ago. The tax provisions and
benefit are calculated using an estimated effective tax rate of 35%.
Net income increased by $870,000 to $734,000 or $0.11 per share for the three
months ended March 31, 2004 as compared to a loss of ($136,000) or ($0.02) per
share, as restated, for the same period a year ago. Net income increased by
$1,354,000 to $1,180,000 or $0.18 per share for the nine months ended March 31,
2004 as compared to a loss of ($174,000) or ($0.03) per share, as restated, for
the same period a year ago. These changes were primarily due to the items
discussed above.
16
Liquidity and Capital Resources
During the nine months ended March 31, 2004 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 third quarter
of fiscal 2005.
Accounts Receivable at March 31, 2004 decreased $1,520,000 to $15,905,000 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 March 31, 2004.
Inventory at March 31, 2004 decreased by $458,000 to $16,464,000 as compared to
$16,922,000 at June 30, 2003. This slight decrease was primarily the result of
the increase in net sales during the third quarter as partially offset by 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.
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.
Other than the $8,250,000 and $1,250,000 loans described above, the Company's
credit facilities 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 April 2004 the Company's bank approved an
extension of the expiration date of the secured revolving credit agreement from
January 2005 to April 2005.
As of March 31, 2004 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
17
adversely affect the Company's business, financial condition and results of
operations. At March 31, 2004 an aggregate amount of approximately $10,000,000
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
$100,000 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.
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 third 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.
18
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
31.1 Certification Pursuant to Rule 13a-14(a)/15d-14(a) of Richard
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
(b) Form 8-K Filings
(i) On March 30, 2004 the Company filed an 8-K reporting under item
5, Other Events, and Item 7, Financial Statements and Exhibits.
19
(ii) On February 23, 2004 the Company filed an 8-K reporting under
Item 5, Other Events, and Item 7, Financial Statements and Exhibits.
(iii) On February 17, 2004 the Company filed an 8-K reporting under
Item 5, Other Events, and Item 7, Financial Statements and Exhibits.
(iv) On February 917, 2004 the Company filed an 8-K reporting under
Item 5, Other Events, and Item 7, Financial Statements and Exhibits.
(v) On January 9, 2004 the Company Company filed an 8-K reporting
under Item 5, Other Events, Item 7, Financial Statements and
Exhibits, and Item 12, Results of Operations and Financial
Condition..
20
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 6, 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)
21