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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------------
FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934 [No Fee Required]
For the fiscal year ended June 30, 2004
or
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934 [No Fee Required]
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 (I.R.S. Employer I.D. Number)
incorporation or organization)
333 BAYVIEW AVENUE,
AMITYVILLE, NEW YORK 11701
(Address of principal executive offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(631) 842-9400
--------------
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $.01 PER SHARE
(Title of Each Class)
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 Exchange Act of
1934 during the preceding 12 months (or for such 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 if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [ X]
As of December 31, 2003, the aggregate market value of the common stock
held by non-affiliates based upon the last sale price of the stock on such date
was $19,636,725.
As of September 14, 2004 7,088,992 shares of common stock were
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III incorporates information by reference from the Registrant's
definitive proxy statement to be filed with the Securities and Exchange
Commission in connection with the solicitation of proxies for the Registrant's
2004 Annual Meeting of Stockholders to be held on December 13, 2004.
1
PART I
ITEM 1. BUSINESS.
NAPCO Security Systems, Inc. ("NAPCO" or the "Company") was incorporated in
December 1971 in the State of Delaware.
NAPCO and its subsidiaries (collectively, the "Company") are engaged in the
development, manufacture, distribution and sale of security alarm products and
door security devices (the "Products") for commercial and residential
installations.
PRODUCTS
Access Control Systems. Access control systems consist of one or more of the
following: various types of identification readers (e.g. card readers, hand
scanners, etc.), a control panel, a PC-based computer and electronically
activated door-locking devices. When an identification card or other identifying
information is entered into the reader, the information is transmitted to the
control panel/PC which then validates the data and determines whether to grant
access or not by electronically deactivating the door locking device. An
electronic log is kept which records various types of data regarding access
activity.
The Company designs, engineers and markets the software and control panels
discussed above. It also buys and resells various identification readers,
PC-based computers and various peripheral equipment for access control systems.
Alarm Systems. Alarm systems usually consist of various detectors, a control
panel, a digital keypad and signaling equipment. When a break-in occurs, an
intrusion detector senses the intrusion and activates a control panel via
hard-wired or wireless transmission that sets off the signaling equipment and,
in most cases, causes a bell or siren to sound. Communication equipment such as
a digital communicator may be used to transmit the alarm signal to a central
station or another person selected by a customer.
The Company manufactures and markets the following products for alarm systems:
Automatic Communicators. When a control panel is activated by a signal from an
intrusion detector, it activates a communicator that can automatically dial one
or more pre-designated telephone numbers. If programmed to do so, a digital
communicator dials the telephone number of a central monitoring station and
communicates in computer language to a digital communicator receiver, which
prints out an alarm message.
Control Panels. A control panel is the "brain" of an alarm system. When
activated by any one of the various types of intrusion detectors, it can
activate an audible alarm and/or various types of communication devices. For
marketing purposes, the Company refers to its control panels by the trade name,
generally "Gemini(TM)" and "Magnum Alert(TM)" followed by a numerical
designation.
Combination Control Panels/Digital Communicators and Digital Keypad Systems. A
combination control panel, digital communicator and a digital keypad (a plate
with push button numbers as on a telephone, which eliminates the need for
mechanical keys) has continued to grow rapidly in terms of dealer and consumer
preference. Benefits of the combination format include the cost efficiency
resulting from a single microcomputer function, as well as the reliability and
ease of installation gained from the simplicity and sophistication of
micro-computer technology.
Door Security Devices. The Company manufactures a variety of exit alarm locks
including simple dead bolt locks, door alarms and microprocessor-based
electronic door locks with push button and card reader operation.
Fire Alarm Control Panel. Multi-zone fire alarm control panels, which
accommodate an optional digital communicator for reporting to a central station,
are also manufactured by the Company.
Area Detectors. The Company's area detectors are both passive infrared heat
detectors and combination microwave/passive infrared detectors that are linked
to alarm control panels. Passive infrared heat detectors respond
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to the change in heat patterns caused by an intruder moving within a protected
area. Combination units respond to both changes in heat patterns and changes in
microwave patterns occurring at the same time.
PERIPHERAL EQUIPMENT
The Company also markets peripheral and related equipment manufactured by other
companies. Revenues from peripheral equipment have not been significant.
RESEARCH AND DEVELOPMENT
The Company's business involves a high technology element. A substantial amount
of the Company's efforts are expended to develop and improve the Products.
During the fiscal years ended June 30, 2004, 2003, and 2002, the Company
expended approximately $4,254,000, $4,516,000, and $4,239,000, respectively, on
Company-sponsored research and development activities conducted by its
engineering department. The Company intends to continue to conduct a significant
portion of its future research and development activities internally.
EMPLOYEES
As of June 30, 2004, the Company had approximately 765 full-time employees.
MARKETING AND MAJOR CUSTOMERS
The Company's staff of 44 sales and marketing support employees located at the
Company's Amityville and United Kingdom offices sells and markets the Products
primarily to independent distributors and wholesalers of security alarm and
security hardware equipment. Management estimates that these channels of
distribution represented approximately 72% and 76% of the Company's total sales
for the fiscal year ended June 30, 2004 and 2003, respectively. The remaining
revenues are primarily from alarm installers and governmental institutions. The
Company's sales representatives periodically contact existing and potential
customers to introduce new products and create demand for those as well as other
Company Products. These sales representatives, together with the Company's
technical personnel, provide training and other services to wholesalers and
distributors so that they can better service the needs of their customers. In
addition to direct sales efforts, the Company advertises in technical trade
publications and participates in trade shows in major United States and European
cities. Some of the Company's products are marketed under the "private label" of
certain customers.
The Company had two customers (Customer A and B) with accounts receivable
balances that aggregated 31% and 29% of the Company's accounts receivable at
June 30, 2004 and 2003, respectively. Sales to neither of these customers
exceeded 10% of net sales in any of the past three years.
The Company had a third customer (Customer C) whose accounts receivable balance
was 22% of the Company's accounts receivable at June 30, 2003. The Company had
no accounts receivable due from this customer as of June 30, 2004. This customer
accounted for 1%, 19% and 17% of the Company's net sales in fiscal 2004, 2003
and 2002. During the past three fiscal years no other customer represented more
than 10% of the Company's net sales. The Company terminated its relationship
with Customer C in fiscal 2004. The termination of this customer did not have a
materially adverse effect on the Company's operations.
COMPETITION
The security alarm products industry is highly competitive. The Company's
primary competitors are comprised of approximately 20 other companies that
manufacture and market security equipment to distributors, dealers, central
stations and original equipment manufacturers. The Company believes that no one
of these competitors is dominant in the industry. Certain of these companies
have substantially greater financial and other resources than the Company.
The Company competes primarily on the basis of the features, quality,
reliability and pricing of, and the incorporation of the latest innovative and
technological advances into, its Products. The Company also competes by offering
technical support services to its customers. In addition, the Company competes
on the basis of its expertise,
3
its proven products, its reputation and its ability to provide Products to
customers on a timely basis. The inability of the Company to compete with
respect to any one or more of the aforementioned factors could have an adverse
impact on the Company's business. Relatively low-priced "do-it-yourself" alarm
system products have become available in recent years and are available to the
public at retail stores. The Company believes that these products compete with
the Company only to a limited extent because they appeal primarily to the
"do-it-yourself" segment of the market. Purchasers of such systems do not
receive professional consultation, installation, service or the sophistication
that the Company's Products provide.
RAW MATERIALS AND SALES BACKLOG
The Company prepares specifications for component parts used in the Products and
purchases the components from outside sources or fabricates the components
itself. These components, if standard, are generally readily available; if
specially designed for the Company, there is usually more than one alternative
source of supply available to the Company on a competitive basis. The Company
generally maintains inventories of all critical components. The Company for the
most part is not dependent on any one source for its raw materials.
In general, orders for the Products are processed by the Company from inventory.
A sales backlog of approximately $469,000 and $226,000 existed as of June 30,
2004 and 2003, respectively. The Company does not generally have a material
backlog.
GOVERNMENT REGULATION
The Company's telephone dialers, microwave transmitting devices utilized in its
motion detectors and any new communication equipment that may be introduced from
time to time by the Company must comply with standards promulgated by the
Federal Communications Commission ("FCC") in the United States and similar
agencies in other countries where the Company offers such products, specifying
permitted frequency bands of operation, permitted power output and periods of
operation, as well as compatibility with telephone lines. Each new Product that
is subject to such regulation must be tested for compliance with FCC standards
or the standards of such similar governmental agencies. Test reports are
submitted to the FCC or such similar agencies for approval. Cost of compliance
has not been material.
PATENTS AND TRADEMARKS
The Company has been granted several patents and trademarks relating to the
Products. While the Company obtains patents and trademarks as it deems
appropriate, the Company does not believe that its current or future success is
dependent on its patents or trademarks.
4
FOREIGN SALES
The revenues and identifiable assets attributable to the Company's domestic and
foreign operations for its last three fiscal years, are summarized in the
following tabulation:
Financial Information Relating to Domestic and Foreign Operations
2004 2003 2002
------- ------- -------
(in thousands)
Sales to external customers(1):
Domestic $48,626 $47,965 $46,652
Foreign 9,467 9,375 9,184
------- ------- -------
Total Net Sales $58,093 $57,340 $55,836
======= ======= =======
Identifiable assets:
United States $40,153 $39,005 $40,955
Dominican Republic (2) 13,075 15,691 17,035
Other foreign countries 3,444 2,653 2,762
(1) All of the Company's sales occur in the United States and are shipped
primarily from the Company's facilities in the United States and United Kingdom.
There were no sales into any one foreign country in excess of 10% of total Net
Sales.
(2) Identifiable assets consist primarily of inventories and fixed assets
located at the Company's principal manufacturing facility in the Dominican
Republic.
ITEM 2. PROPERTIES.
The Company owns executive offices and production and warehousing facilities at
333 Bayview Avenue, Amityville, New York. This facility consists of a
fully-utilized 90,000 square foot building on a six acre plot. This six-acre
plot provides the Company with space for expansion of office, manufacturing and
storage capacities. The Company completed construction on this facility in 1988
with the proceeds from industrial revenue bonds that have since been retired.
The Company's foreign subsidiary located in the Dominican Republic, NAPCO/Alarm
Lock Grupo International, S.A. (formerly known as NSS Caribe, S.A.), owns a
building of approximately 167,000 square feet of production and warehousing
space in the Dominican Republic. That subsidiary also leases the land associated
with this building under a 99-year lease expiring in the year 2092. As of June
30, 2004, a majority of the Company's products were manufactured at this
facility, utilizing U.S. quality control standards.
The Company's foreign subsidiary located in the United Kingdom, Napco Group
Europe Ltd, leases office and warehouse space of approximately 10,000 square
feet. This lease expires in June 2010.
Management believes that these facilities are more than adequate to meet the
needs of the Company in the foreseeable future.
ITEM 3. 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
5
($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 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
At the Company's Annual Meeting of Stockholders held on April 26, 2004, three
nominees were elected as directors to serve until the Annual Meeting of
Stockholders following fiscal year 2006:
Nominee "For" "Withheld"
- ------------------- --------- ---------
Paul Stephen Beeber 3,002,194 17,700
Randy Blaustein 2,986,318 33,576
Donna Soloway 2,986,118 33,776
The following directors' terms of office continued after the meeting:
Directors to serve until the Annual Meeting of Stockholders following fiscal
year 2004:
Richard Soloway
Kevin Buchel
Directors to serve until the Annual Meeting of Stockholders following fiscal
year 2005:
Andrew J. Wilder
Arnold Blumenthal
6
PART II
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES.
PRINCIPAL MARKET
NAPCO's Common Stock is traded on the NASDAQ Stock Market, National Market
System, under the symbol NSSC.
The tables set forth below reflect the range of high and low sales of the Common
Stock in each quarter of the past two fiscal years as reported by the NASDAQ
National Market System and as adjusted for the 2:1 stock split effective as of
April 2004.
Quarter Ended
Fiscal 2004
-------------
Common Stock Sept. 30 Dec. 31 March 31 June 30
-------- ------- -------- -------
High $ 4.875 $ 4.475 $ 8.875 $ 11.60
Low $ 4.275 $ 3.625 $ 3.30 $ 6.50
Quarter Ended
Fiscal 2003
-------------
Common Stock Sept. 30 Dec. 31 March 31 June 30
-------- ------- -------- -------
High $ 4.62 $ 5.095 $ 5.10 $ 4.735
Low $ 2.79 $ 4.30 $ 3.805 $ 3.75
APPROXIMATE NUMBER OF SECURITY HOLDERS
The number of holders of record of NAPCO's Common Stock as of September 7, 2004
was 161 (such number does not include beneficial owners of stock held in nominee
name).
DIVIDEND INFORMATION
NAPCO has declared no cash dividends during the past two years with respect to
its Common Stock, and the Company does not anticipate paying any cash dividends
in the foreseeable future. Any dividends must be authorized by the Company's
primary lender.
EQUITY COMPENSATION PLAN INFORMATION
AS OF JUNE 30, 2004
NUMBER OF SECURITIES
NUMBER OF SECURITIES WEIGHTED AVERAGE REMAINING AVAILABLE
TO BE ISSUED UPON EXERCISE PRICE OF FOR FUTURE ISSUANCE
EXERCISE OF OUTSTANDING (EXCLUDING SECURITIES
OUTSTANDING OPTIONS OPTIONS REFLECTED IN COLUMN a)
PLAN CATEGORY (a) (b) (c)
Equity compensation plans approved
by security holders: 746,400 $ 3.82 294,000
Equity compensation plans not approved
by security holders: __ __ __
-------------------- ----------------- -----------------------
Total 746,400 $ 3.82 294,000
==================== ================= =======================
7
ITEM 6. SELECTED FINANCIAL DATA.
The table below summarizes selected financial information. For further
information, refer to the audited consolidated financial statements and the
notes thereto beginning on page FS-1 of this report.
Fiscal Year Ended or at June 30
-----------------------------------------------------------
(In thousands, except share data)
2004* 2003*(1) 2002*(1) 2001*(1) 2000 (1)
--------- ---------- ---------- --------- ---------
Statement of earnings data:
Net Sales $ 58,093 $ 57,340 $ 55,836 $ 54,771 $ 53,946
Gross Profit 19,540 15,401 14,717 14,317 13,198
Income from Operations 6,065 2,225 2,817 1,859 3,122
Net Income (2) 3,335 1,010 1,575 251 2,010
Cash Flow Data:
Net cash flows provided by operating activities $ 6,275 $ 6,482 $ 7,091 $ 1,326 $ 2,822
Net cash flows used in investing activities (681) (752) (709) (8,283) (1,221)
Net cash flows (used in) provided by financing activities (6,592) 5,436 (5,919) 5,610 (1,447)
Per Share Data:
Net earnings per common share:
Basic $ .50 $ .15 $ .23 $ .04 $ .29
Diluted $ .47 $ .14 $ .22 $ .04 $ .29
Weighted average common shares outstanding:
Basic 6,632,000 6,645,000 6,704,000 6,938,000 6,990,000
Diluted 7,081,000 7,114,000 7,078,000 7,054,000 7,026,000
Cash Dividends declared per common share (3) $ .00 $ .00 $ .00 $ .00 $ .00
Balance sheet data (4):
Working capital $ 28,992 $ 28,843 $ 31,812 $ 33,232 $ 35,280
Total assets 56,672 57,349 60,752 63,677 55,529
Long-term debt 6,400 14,100 16,588 21,567 16,183
Stockholders' equity 37,904 33,357 34,528 32,944 33,359
* includes results of Continental Instruments, LLC which was acquired in July,
2000.
(1) Restated to reflect the effect of a 2:1 stock split effective April 2004.
(2) Net income results through 2001 included Amortization Expense related to
goodwill.
8
(3) The Company has never paid a dividend on its common stock. It is the
policy of the Board of Directors to retain earnings for use in the
Company's business. Any dividends must be authorized by the Company's
primary lender.
(4) Working capital is calculated by deducting Current Liabilities from
Current Assets.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in conformity with accounting principles generally accepted in the United
States. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses reported in those financial statements. These
judgments can be subjective and complex, and consequently actual results could
differ from those estimates. Our most critical accounting policies relate to
revenue recognition; concentration of credit risk; inventory; goodwill; and
income taxes.
REVENUE RECOGNITION
Revenues from merchandise sales are recorded at the time the product is shipped
or delivered to the customer pursuant to the terms of purchase. We report our
sales levels on a net sales basis, which is computed by deducting from gross
sales the amount of actual returns received and an amount established for
anticipated returns and allowances.
Our sales return accrual is a subjective critical estimate that has a direct
impact on reported net sales and income. This accrual is calculated based on a
history of gross sales and actual sales returns, as well as management's
estimate of anticipated returns and allowances. As a percentage of gross sales,
sales returns and allowances were 7%, 10% and 7% in fiscal 2004, 2003 and 2002,
respectively.
CONCENTRATION OF CREDIT RISK
An entity is more vulnerable to concentrations of credit risk if it is exposed
to risk of loss greater than it would have had it mitigated its risk through
diversification of customers. Such risks of loss manifest themselves
differently, depending on the nature of the concentration, and vary in
significance.
The Company had two customers (Customer A and B) with accounts receivable
balances that aggregated 31% and 29% of the Company's accounts receivable at
June 30, 2004 and 2003, respectively. Sales to neither of these customers
exceeded 10% of net sales in any of the past three years.
The Company had a third customer (Customer C) whose accounts receivable balance
was 22% of the Company's accounts receivable at June 30, 2003. The Company had
no accounts receivable due from this customer as of June 30, 2004. This customer
accounted for 1%, 19% and 17% of the Company's net sales in fiscal 2004, 2003
and 2002. During the past three fiscal years no other customer represented more
than 10% of the Company's net sales. The Company terminated its relationship
with Customer C in fiscal 2004. The termination of this customer did not have a
materially adverse effect on the Company's operations.
In the ordinary course of business, we have established an allowance for
doubtful accounts and customer deductions in the amount of $355,000 and $215,000
as of June 30, 2004 and 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
agings, specific exposures and historical trends.
9
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 market value,
based on various product sales projections. This reserve is calculated using an
estimated obsolescence percentage applied to the inventory based on age,
historical trends and requirements to support forecasted sales. In addition, and
as necessary, we may establish specific reserves for future known or anticipated
events.
GOODWILL
Effective July 1, 2001, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 141, Business Combinations and SFAS No. 142, Goodwill and
Other Intangible Assets. These statements established accounting and reporting
standards for acquired goodwill and other intangible assets. Specifically, the
standards address how acquired intangible assets should be accounted for both at
the time of acquisition and after they have been recognized in the financial
statements. In accordance with SFAS No. 142, intangible assets, including
purchased goodwill, must be evaluated for impairment. Those intangible assets
that are classified as goodwill or as other intangibles with indefinite lives
are not amortized.
In accordance with SFAS No. 142, the Company completed its transitional
impairment testing of intangible assets during the first quarter of fiscal 2002.
That effort, and preliminary assessments of the Company's identifiable
intangible assets, indicated that no adjustment would be required upon adoption
of this pronouncement. The impairment testing is performed in two steps: (i) the
Company determines impairment by comparing the fair value of a reporting unit
with its carrying value, and (ii) if there is an impairment, the Company
measures the amount of impairment loss by comparing the implied fair value of
goodwill with the carrying amount of that goodwill. The Company has performed
its annual impairment evaluation required by this standard and determined that
the goodwill is not impaired.
INCOME TAXES
Deferred income taxes are recognized for the expected future tax consequences of
temporary differences between the amounts reflected for financial reporting and
tax purposes. The provision (benefit) for income taxes represents U.S. Federal,
State and foreign taxes. Through June 30, 2001, the Company's subsidiary in the
Dominican Republic, Napco/Alarm Lock Group International, S.A. ("Napco DR"), was
not subject to tax in the United States, and as a result, no taxes were
provided. Effective July 1, 2001, the Company made a domestication election for
Napco DR. Accordingly, its income will be subject to taxation in the United
States on a going forward basis.
In March 2003, Napco Security Systems, Inc. timely filed its income tax return
for the fiscal year ended June 30, 2002. This return included an election to
treat one of the Company's foreign subsidiaries as if it were a domestic
corporation beginning July 1, 2001. This election is based on a recently enacted
Internal Revenue Code ("Code") provision. As a result of this election, this
subsidiary is treated, for Federal income tax purposes, as transferring all of
its assets to a domestic corporation in connection with an exchange. Although
this type of transfer usually results in the recognition of taxable income to
the extent of any untaxed earnings and profits, the recently enacted Code
provision provides an exemption for applicable corporations. The Company
qualifies as an applicable corporation per this Code section, and based on this
Code exemption, the Company's tax return treated the transfer of approximately
$27,000,000 of this subsidiary's untaxed earnings and profits as nontaxable.
The Internal Revenue Service has issued a Revenue Procedure that is inconsistent
with the Code exemption described above. Management believes that it has
appropriately relied on the guidance in the Code when filing its income tax
return. Nevertheless, as of June 30, 2002, the Company has removed the
$2,225,000 deferred tax asset related to its net operating loss carryforward
("NOL") of $6,545,000. The NOL would have expired through 2017. As a result of
the utilization of the NOL for book purposes, the Company has also eliminated
the valuation reserve
10
of $2,913,000 during the year ended June 30, 2002. The Company's tax provision
utilizes estimates made by management and as such is subject to change as
described in note 1 to the Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
The Company's cash on hand combined with proceeds from operating activities
during fiscal 2004 were adequate to meet the Company's capital expenditure needs
and short and long-term debt obligations. The primary source of financing
related to borrowings under a $18,000,000 secured revolving credit facility. The
Company expects that cash generated from operations and cash available under the
Company's bank line of credit will be adequate to meet its short-term liquidity
requirements. The Company's primary internal source of liquidity is the cash
flow generated from operations. As of June 30, 2004, the Company's unused
sources of funds consisted principally of $796,000 in cash and approximately
$12,287,000 which represents the unused portion of its secured revolving credit
facility. 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 first quarter of fiscal 2006.
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 and certain other assets of Napco
Security Systems, Inc., a first and second mortgage on the Company's
headquarters in Amityville, New York and common stock of three of the Company's
subsidiaries. The revolving credit agreement bears interest at either the Prime
Rate less 1/4% or an alternate rate based on LIBOR as described in the
agreement. The revolving credit agreement, which previously had an expiration
date of April 2005, has been extended to July 2005. Any outstanding borrowings
are to be repaid or refinanced on or before that time. The Company plans to
refinance this agreement prior to its expiration. 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. During fiscal 2004, at
certain dates the Company was not in compliance with certain covenants, but
received waivers and amendments from its bank. As of June 30, 2004, the Company
was in compliance with these covenants.
In November 2000 the Company adopted a stock repurchase program. As amended,
this program authorizes the Company to repurchase up to 410,000 shares of its
common stock. As of June 30, 2004 the Company had repurchased 405,210 shares
under this program.
In January 2003, the Company repurchased 500,000 shares of its common stock from
two shareholders, unaffiliated with the Company, at $4.88 per share, a discount
from its then current trading price of $5.01. The transaction was approved by
the board of directors and the purchase price of $2,442,000 (including fees of
$5,000) was financed through the Company's revolving line of credit and a new
five (5) year term loan from its primary lender for $1,250,000. This term loan
is being repaid in 60 equal monthly installments commencing on April 30, 2003.
The Company takes into consideration a number of factors in measuring its
liquidity, including the ratios set forth below:
2004 2003 2002
-------- -------- --------
Current Ratio 4.3 to 1 4.2 to 1 4.5 to 1
Sales to Receivables 2.9 to 1 3.3 to 1 3.0 to 1
Total debt to equity .2 to 1 .5 to 1 .6 to 1
As of June 30, 2004, the Company had no material commitments for purchases or
capital expenditures, except as discussed below.
On April 26, 1993, the Company's foreign subsidiary entered into a 99-year land
lease of approximately 4 acres of land in the Dominican Republic, at an annual
cost of approximately $288,000.
On July 27, 2000, the Company signed an Asset Purchase Agreement to acquire the
net assets of Continental Instruments, LLC ("Continental") for an purchase price
of $7,522,500 in cash, less subsequent purchase price
11
adjustments of approximately $460,000, plus future deferred payments of
$1,700,000 in cash to be paid over 24 months. The Company financed the
transaction with borrowings under a 60 Month Installment loan of $8,250,000.
Continental designs and sells access control and other security control systems
to dealers and distributors worldwide.
Working Capital. Working capital increased by $149,000 to $28,992,000 at June
30, 2004 from $28,843,000 at June 30, 2003. The increase in working capital was
primarily the result of the increase in net income and decrease in inventory as
partially offset by debt reduction and an increase in accounts receivable.
Working capital is calculated by deducting Current Liabilities from Current
Assets.
Accounts Receivable. Accounts Receivable increased by $2,502,000 to $19,927,000
at June 30, 2004 from $17,425,000 at June 30, 2003. This increase resulted
primarily from the granting of additional payment terms to certain of the
Company's burglar alarm customers.
Inventory. Inventory decreased by $2,328,000 to $14,594,000 at June 30, 2004 as
compared to $16,922,000 at June 30, 2003. The decrease in inventory levels was
primarily the result of reductions in the Company's manufacturing overhead costs
due, in part, to a favorable change in the exchange rate relating to the
Company's Dominican Republic manufacturing facility as well as cost reductions
of certain of the Company's raw material costs.
Accounts Payable and Accrued Expenses. Accounts payable and accrued expenses
remained relatively constant at $6,663,000 as of June 30, 2004 as compared to
$6,687,000 at June 30, 2003.
CONTRACTUAL OBLIGATIONS
The following table summarizes the Company's contractual obligations by fiscal
year:
Payments due by period
---------------------------------------------------------------------
Less than More than 5
Contractual obligations Total 1 year 1-3 years 3-5 years years
- ----------------------------------- ----------- ----------------- ----------- ---------- -----------
Long-term debt obligations $ 8,300,000 $ 1,900,000 $ 6,213,000 $ 187,000 $ -
Land lease (88 years remaining) (1) 25,344,000 288,000 576,000 576,000 23,904,000
Operating lease obligations 338,000 142,000 156,000 40,000 -
Other long-term obligations 2,950,618 1,085,070 1,394,183 471,365 -
----------- ----------------- ----------- ---------- -----------
Total $36,932,618 $ 3,415,070 $ 2,126,183 $7,487,365 $23,904,000
=========== ================= =========== ========== ===========
(1) see footnote 10 to the consolidated financial statements.
RESULTS OF OPERATIONS
FISCAL 2004 COMPARED TO FISCAL 2003
Net Sales. Net sales in fiscal 2004 increased by 1% to $58,093,000 from
$57,340,000 in fiscal 2004. The Company's sales growth was primarily due to
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
12
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.
Gross Profit. The Company's gross profit increased $4,139,000 to $19,540,000 or
33.6% of net sales in fiscal 2004 as compared to $15,401,000 or 26.9% of net
sales in fiscal 2003. The increase in gross profit in both absolute dollars and
as a percentage of net sales was due primarily to the shift in product mix
towards higher margin products such as door locking devices and access control
products. Gross profit was also positively impacted by lower manufacturing
overhead costs due, in part, to a favorable change in the exchange rate relating
to the Company's Dominican Republic manufacturing facility as well as cost
reductions of certain of the Company's raw material costs.
Expenses. Selling, general and administrative expenses increased by 2% to
$13,475,000, or 23% of net sales in fiscal 2004 from $13,176,000, or 23% of net
sales in fiscal 2003. This increase was due primarily to the increase in certain
variable selling expenses associated with the increase in net sales from fiscal
2003 to 2004.
Interest expense for fiscal 2004 decreased by $307,000 to $420,000 from $727,000
for the same period a year ago. The decrease in interest expense is primarily
the result of the Company reducing its outstanding debt by $7,700,000 during
fiscal 2004.
Other Expenses. Other expenses increased $236,000 to an expense of $109,000 in
fiscal 2004 as compared to income of $127,000 in fiscal 2003. This increase
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.
Income Taxes. The Company's provision for income taxes increased by $1,586,000
to a provision of $2,201,000 in fiscal 2004 as compared to $615,000 in fiscal
2003. This increase in the provision for income taxes is primarily due to a
$3,911,000 increase in income before income taxes in fiscal 2004 as compared to
fiscal 2003. The increase in income before income taxes is due primarily to the
items discussed above.
FISCAL 2003 COMPARED TO FISCAL 2002
Net Sales. Net sales in fiscal 2003 increased by 3% to $57,340,000 from
$55,836,000 in fiscal 2002. The Company's sales growth was due primarily to
increased domestic sales volume in the Company's burglar alarm product line.
Gross Profit. The Company's gross profit increased $684,000 to $15,401,000 or
26.9% of net sales in fiscal 2003 as compared to $14,717,000 or 26.4% of net
sales in fiscal 2002. The increase in gross profit in both absolute dollars and
as a percentage of net sales was due primarily to the increase in sales as
discussed above. Gross profit was also positively impacted by cost reductions of
certain of the Company's raw material costs.
Expenses. Selling, general and administrative expenses increased by 11% to
$13,176,000, or 23% of net sales in fiscal 2003 from $11,900,000, or 21% of net
sales in fiscal 2002. This increase was due primarily to additional investment
in the Company's sales force, primarily in the international and access control
areas.
Other Expenses. Other expenses decreased $858,000 to $600,000 in fiscal 2003 as
compared to $1,458,000 in fiscal 2002. This decrease was due primarily to the
decrease in interest expense resulting from the Company's continued reduction of
the outstanding principal on its outstanding debt as well as a decline in
interest rates available to the Company. In addition, during the quarter ended
September 30, 2002, the Company settled litigation 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.
Income Taxes. Benefit for income taxes changed by $831,000 to a provision of
$615,000 in fiscal 2003 as compared to a benefit of $216,000 in fiscal 2002. The
current year income tax provision relates primarily to the Company electing to
treat its main foreign subsidiary as a U.S. Company for book and tax purposes.
13
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 Company's 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. The cost of treasury stock was applied first to
additional paid-in capital (to the extent there was a positive balance), then
directly to retained earnings. 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.
FORWARD-LOOKING INFORMATION
This Annual Report on Form 10-K 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-K. 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.
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's principal financial instrument is long-term debt (consisting of a
revolving credit and term loan facility) that provides for interest at a spread
below the prime rate. The Company is affected by market risk exposure primarily
through the effect of changes in interest rates on amounts payable by the
Company under this credit facility. A significant rise in the prime rate could
materially adversely affect the Company's business, financial condition and
results of operations. At June 30, 2004, an aggregate principal amount of
approximately $8,300,000 was outstanding under the Company's credit facility and
term loans with a weighted average interest rate of approximately 3%. If
principal amounts outstanding under the Company's credit facility remained at
this year-end level for an entire year and the prime rate increased or
decreased, respectively, by 1% the Company would pay or save, respectively, an
additional $83,000 in interest that year. In October 2000, the Company entered
into an interest rate swap to maintain the value-at-risk inherent in its
interest rate exposures. This instrument expired on October 30, 2002.
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 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 have a material adverse affect on
the Company's business, financial condition and results of operations.
14
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
a. Financial Statements: Financial statements required pursuant to this Item are
presented on pages FS - 1 through FS - 24 of this report as follows:
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
JUNE 30, 2004 AND 2003
Page
----
Report of Independent Registered Public Accounting Firm FS-1
Consolidated Financial Statements:
Consolidated Balance Sheets as of June 30, 2004 and 2003 FS-2
Consolidated Statements of Income for the Fiscal Years Ended June 30, 2004, 2003 and 2002 FS-4
Consolidated Statements of Stockholders' Equity for the Fiscal Years Ended June 30, 2004,
2003 and 2002 FS-5
Consolidated Statements of Cash Flows for the Fiscal Years Ended June 30, 2004, 2003 and
2002 FS-6
Notes to Consolidated Financial Statements, June 30, 2004 FS-8
Schedules:
II. Valuation and Qualifying Accounts FS-24
b. Supplementary Financial Data FS-25
15
NAPCO SECURITY SYSTEMS, INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULES
June 30, 2004 and 2003
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
The Audit Committee of the
Board of Directors and Stockholders
Napco Security Systems, Inc. and Subsidiaries
We have audited the accompanying consolidated balance sheets of Napco Security
Systems, Inc. (a Delaware corporation) and subsidiaries (the "Company") as of
June 30, 2004 and 2003, and the related consolidated statements of income,
stockholders' equity, and cash flows for each of the three years in the period
ended June 30, 2004. Our audits also included the financial statement schedule
as of and for the years ended June 30, 2004, 2003 and 2002 listed in the Index
at Item 15. These consolidated financial statements and financial statement
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these consolidated financial statements and
financial statement schedule based on our audits.
We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of Napco
Security Systems, Inc. and subsidiaries as of June 30, 2004 and 2003, and the
consolidated results of its operations and its cash flows for each of the three
years in the period ended June 30, 2004, in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion, the related financial statement schedule, when considered in relation
to the basic consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information set forth therein.
/s/ MARCUM & KLIEGMAN LLP
Woodbury, New York
September 14, 2004
FS-1
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2004 and 2003
(In Thousands, Except Share Data)
ASSETS
2004 2003
---- ----
CURRENT ASSETS
Cash and cash equivalents $ 796 $ 1,794
Accounts receivable, less reserve for doubtful accounts
of $355 and $215, respectively 19,927 17,425
Inventories 14,594 16,922
Prepaid expenses and other current assets 760 525
Deferred income taxes 1,763 1,253
------- -------
Total Current Assets 37,840 37,919
Property, plant and equipment, net 8,987 9,466
Goodwill, net 9,686 9,686
Other assets 159 278
------- -------
TOTAL ASSETS $56,672 $57,349
======= =======
See accompanying notes to consolidated financial statements.
FS-2
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2004 and 2003
(In Thousands, Except Share Data)
LIABILITIES AND STOCKHOLDERS' EQUITY
2004 2003
------- -------
CURRENT LIABILITIES
Current portion of long-term debt $ 1,900 $ 1,900
Accounts payable 3,789 3,374
Accrued expenses 963 1,812
Accrued salaries and wages 1,911 1,501
Accrued income taxes 285 489
------- -------
Total Current Liabilities 8,848 9,076
Long-term debt, net of current portion 6,400 14,100
Accrued income taxes 2,243 --
Deferred income taxes 1,277 816
------- -------
Total Liabilities 18,768 23,992
------- -------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (1)
Common stock, par value $0.01 per share; Authorized
21,000,000 shares; issued and outstanding 7,086,392
and 6,397,392 shares, respectively 71 64
Additional paid-in capital 145 --
Retained earnings 37,688 33,293
------- -------
TOTAL STOCKHOLDERS' EQUITY 37,904 33,357
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS'
EQUITY $56,672 $57,349
======= =======
(1) Fiscal 2003 data restated to reflect the effect of a 2:1 stock split
effective April 2004.
See accompanying notes to consolidated financial statements.
FS-3
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30, 2004, 2003, and 2002
(In Thousands, Except Share and Per Share Data)
2004 2003 2002
----------- ----------- -----------
Net sales $ 58,093 $ 57,340 $ 55,836
Cost of sales 38,553 41,939 41,119
----------- ----------- -----------
Gross Profit 19,540 15,401 14,717
Selling, general, and administrative expenses 13,475 13,176 11,900
----------- ----------- -----------
Operating Income 6,065 2,225 2,817
----------- ----------- -----------
Other income (expense):
Interest expense, net (420) (727) (1,409)
Other, net (109) 127 (49)
----------- ----------- -----------
(529) (600) (1,458)
----------- ----------- -----------
Income Before Income Taxes 5,536 1,625 1,359
Provision (benefit) for income taxes 2,201 615 (216)
----------- ----------- -----------
Net Income $ 3,335 $ 1,010 $ 1,575
=========== =========== ===========
Earnings per share: (1)
Basic $ 0.50 $ 0.15 $ 0.23
Diluted $ 0.47 $ 0.14 $ 0.22
Weighted average number of shares outstanding: (1)
Basic 6,632,000 6,863,000 6,752,000
Diluted 7,081,000 7,358,000 7,126,000
(1) Fiscal 2003 and 2002 restated to reflect the effect of a 2:1 stock split
effective April 2004.
See accompanying notes to consolidated financial statements.
FS-4
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (1)
Years Ended June 30, 2004, 2003 and 2002
(In Thousands, Except Share Data)
Common stock Treasury Stock
------------------- Additional ----------------------
Number of Paid-in Retained Number of
Shares Amount Capital Earnings Shares Amount Total
------ ------ --------- -------- ------ ------ -----
BALANCE - July 1, 2001 5,938,852 $ 59 $ 831 $ 37,228 2,572,256 $(5,174) $ 32,944
Retroactive effect of 2:1 stock
split effective April 27, 2004 794,340 8 (831) (4,351) (2,572,256) 5,174 --
---------- ----- ------- -------- ---------- ------- --------
BALANCE - as adjusted 6,733,192 67 -- 32,877 -- -- 32,944
Purchase of treasury shares (97,600) (1) -- (242) -- -- (243)
Exercise of employee stock
options 130,800 2 -- 250 -- -- 252
Net income -- -- -- 1,575 -- -- 1,575
---------- ----- ------- -------- ---------- ------- --------
BALANCE - June 30, 2002 6,766,392 68 -- 34,460 -- -- 34,528
Purchase of treasury shares (500,000) (5) -- (2,437) -- -- (2,442)
Exercise of employee stock
options 131,000 1 -- 260 -- -- 261
Net income -- -- -- 1,010 -- -- 1,010
---------- ----- ------- -------- ---------- ------- --------
BALANCE - June 30, 2003 6,397,392 64 -- 33,293 -- -- 33,357
Exercise of employee stock
options, July 1, 2003 to April 27, 2004 606,840 6 -- 956 -- -- 962
Tax benefit in connection
with exercise of stock options -- -- -- 104 -- -- 104
Exercise of employee stock
options, April 28, 2004 to June 30, 2004 82,160 1 145 -- -- -- 146
Net income -- -- -- 3,335 -- -- 3,335
---------- ----- ------- -------- ---------- ------- --------
BALANCE - June 30, 2004 7,086,392 $ 71 $ 145 $ 37,688 -- $ -- $ 37,904
========== ===== ======= ======== ========== ======= ========
(1) Restated to reflect the effect of a 2:1 stock split effective April 27, 2004
(Note 1).
See accompanying notes to consolidated financial statements.
FS-5
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30, 2004, 2003, and 2002
(In Thousands)
2004 2003 2002
------- ------- -------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 3,335 $ 1,010 $ 1,575
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 1,189 1,294 1,529
Provision for doubtful accounts 140 16 45
Deferred income taxes (49) 173 (117)
Tax benefit in connection with exercise
of stock options 104 -- --
Changes in operating assets and liabilities:
Accounts receivable (2,642) 872 (1,418)
Inventories 2,328 2,041 4,271
Prepaid expenses and other current assets (235) 366 4
Other assets 90 (90) 167
Accounts payable, accrued expenses, accrued
salaries and wages, and accrued income taxes 2,015 800 1,035
------- ------- -------
Net Cash Provided By Operating Activities 6,275 6,482 7,091
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, plant, and equipment (681) (752) (709)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on long-term debt (8,700) (7,505) (6,128)
Proceeds from long-term debt 1,000 4,250 200
Purchase of treasury shares -- (2,442) (243)
Proceeds from exercise of employee stock options 1,108 261 252
------- ------- -------
Net Cash Used In Financing Activities (6,592) (5,436) (5,919)
------- ------- -------
Net Increase (Decrease) In Cash and
Cash Equivalents (998) 294 463
CASH AND CASH EQUIVALENTS - Beginning 1,794 1,500 1,037
------- ------- -------
CASH AND CASH EQUIVALENTS - Ending $ 796 $ 1,794 $ 1,500
------- ------- -------
See accompanying notes to consolidated financial statements.
- FS-6
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30, 2004, 2003, and 2002
(In Thousands)
2004 2003 2002
---- ---- ------
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid, net $427 $733 $1,403
Income taxes paid $106 $ 15 $ 10
See accompanying notes to consolidated financial statements.
FS-7
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - Nature of Business and Summary of Significant Accounting Policies
Nature of Business
Napco Security Systems, Inc. and subsidiaries (the "Company") is engaged
principally in the development, manufacture, and distribution of security
alarm products and door security devices for commercial and residential
use.
Principles of Consolidation
The consolidated financial statements include the accounts of Napco
Security Systems, Inc. and all of its wholly-owned subsidiaries. All
intercompany balances and transactions have been eliminated in
consolidation.
Accounting Estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America requires
management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent gains and
losses at the date of the financial statements and the reported amounts of
revenues and expenses during the reporting period. Critical estimates
include management's judgments associated with revenue recognition,
concentration of credit risk, inventories, goodwill and income taxes.
Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents include approximately $308,000 and $223,000 of
short-term time deposits at June 30, 2004 and 2003, respectively. The
Company considers all highly liquid investments with original maturities
of three months or less to be cash equivalents.
The Company has cash balances in banks in excess of the maximum amount
insured by the FDIC as of June 30, 2004 and 2003.
Inventories
Inventories are valued at the lower of cost or fair market value, with
cost being determined on the first-in, first-out (FIFO) method. The
reported net value of 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.
In addition, the Company records an inventory obsolescence reserve, which
represents the difference between the cost of the inventory and its
estimated market value, based on various product sales projections. This
reserve is calculated using an estimated obsolescence percentage applied
to the inventory based on age, historical trends and requirements to
support forecasted sales. For the fiscal years 2004, 2003 and 2002,
charges/(recoveries) and balances in these reserves amounted to $1,035,000
and $2,035,000; $300,000 and $1,000,000; ($500,000) and $700,000;
respectively. In addition, and as necessary, the Company may establish
specific reserves for future known or anticipated events.
FS-8
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - Nature of Business and Summary of Significant Accounting Policies,
continued
Property, Plant, and Equipment
Property, plant, and equipment are carried at cost less accumulated
depreciation. Expenditures for maintenance and repairs are charged to
expense as incurred; costs of major renewals and improvements are
capitalized. At the time property and equipment are retired or otherwise
disposed of, the cost and accumulated depreciation are eliminated from the
asset and accumulated depreciation accounts and the profit or loss on such
disposition is reflected in income.
Depreciation is recorded over the estimated service lives of the related
assets using primarily the straight-line method. Amortization of leasehold
improvements is calculated by using the straight-line method over the
estimated useful life of the asset or lease term, whichever is shorter.
Goodwill
Effective July 1, 2001, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 141, Business Combinations and SFAS No.
142, Goodwill and Other Intangible Assets. These statements established
accounting and reporting standards for acquired goodwill and other
intangible assets. Specifically, the standards address how acquired
intangible assets should be accounted for both at the time of acquisition
and after they have been recognized in the financial statements. In
accordance with SFAS No. 142, intangible assets, including purchased
goodwill, must be evaluated for impairment. Those intangible assets that
are classified as goodwill or as other intangibles with indefinite lives
are not amortized.
In accordance with SFAS No. 142, the Company completed its transitional
impairment testing of intangible assets during the first quarter of fiscal
2002. That effort, and preliminary assessments of the Company's
identifiable intangible assets, indicated that no adjustment would be
required upon adoption of this pronouncement. The impairment testing is
performed in two steps: (i) the Company determines impairment by comparing
the fair value of a reporting unit with its carrying value, and (ii) if
there is an impairment, the Company measures the amount of impairment loss
by comparing the implied fair value of goodwill with the carrying amount
of that goodwill. The Company has performed its annual impairment
evaluation required by this standard and determined that the goodwill is
not impaired.
FS-9
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - Nature of Business and Summary of Significant Accounting Policies,
continued
Long-Lived Assets
In accordance with SFAS No. 144, Accounting for the Impairment or Disposal
of Long-Lived Assets, long-lived assets are reviewed for impairment
whenever events or changes in circumstances indicate that the carrying
amount of the assets in question may not be recoverable. An impairment
would be recorded in circumstances where undiscounted cash flows expected
to be generated by an asset are less than the carrying value of that
asset.
Revenue Recognition
In accordance with SEC Staff Accounting Bulletin Topic 13, Revenue
Recognition, the Company recognizes revenue when the following criteria
are met: (i) persuasive evidence of an agreement exists, (ii) there is a
fixed and determinable price for the Company's product, (iii) shipment and
passage of title occurs, and (iv) collectibility is reasonably assured.
Revenues from merchandise sales are recorded at the time the product is
shipped or delivered to the customer pursuant to the terms of the sale.
The Company reports its sales levels on a net sales basis, with net sales
being computed by deducting from gross sales the amount of actual sales
returns and the amount of reserves established for anticipated sales
returns.
Advertising and Promotional Costs
Advertising and promotional costs are included in "Selling, General and
Administrative" expenses in the consolidated statements of income and are
expensed as incurred. Advertising expense for the fiscal years ended June
30, 2004, 2003 and 2002 was $1,030,000, $1,128,000 and $1,084,000,
respectively.
Research and Development Costs
Research and development costs incurred by the Company are charged to
expense in the year incurred. Company-sponsored research and development
costs of $4,254,000, $4,516,000 and $4,239,000 were charged to expense for
the fiscal years ended June 30, 2004, 2003 and 2002, respectively and are
included in "Cost of Sales" in the consolidated statements of income.
Income Taxes
Deferred income taxes are recognized for the expected future tax
consequences of temporary differences between the amounts reflected for
financial reporting and tax purposes. Net deferred tax assets are adjusted
by a valuation allowance if, based on the weight of available evidence, it
is more likely than not that some portion or all of the net deferred tax
assets will not be realized. If the Company determines that a deferred tax
asset will not be realizable or that a previously reserved deferred tax
asset will become realizable, an adjustment to the deferred tax asset will
result in a reduction of, or increase to, earnings at that time. The
provision (benefit) for income taxes represents U.S. Federal, state and
foreign taxes. Through June 30, 2001, the Company's subsidiary in the
Dominican Republic, Napco/Alarm Lock Group International, S.A. ("Napco
DR"), was not subject to tax in the United States, as a result, no taxes
were provided. Effective July 1, 2001, the Company made a domestication
election for Napco DR. Accordingly, its income will be subject to taxation
in the United States on a going forward basis.
FS-10
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - Nature of Business and Summary of Significant Accounting Policies,
continued
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 Company's 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. The cost of
treasury stock was applied first to additional paid-in capital (to the
extent there was a positive balance), then directly to retained earnings.
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.
Earnings Per Share
The Company follows the provisions of SFAS No. 128, Earnings Per Share.
Basic net income per common share (Basic EPS) is computed by dividing net
income by the weighted average number of common shares outstanding.
Diluted net income per common share (Diluted EPS) is computed by dividing
net income by the weighted average number of common shares and dilutive
common share equivalents and convertible securities then outstanding. SFAS
No. 128 requires the presentation of both Basic EPS and Diluted EPS on the
face of the consolidated statements of income.
The following provides a reconciliation of information used in calculating
the per share amounts for the fiscal years ended June 30 (in thousands,
except per share data):
Net income Weighted Average Shares Net income per share
------------------------ ----------------------- ----------------------------
2004 2003 2002 2004 2003 2002 2004 2003 2002
---- ---- ---- ---- ---- ---- ---- ---- ----
Basic EPS: $3,335 $1,010 $1,575 6,632 6,645 6,704 $ 0.50 $ 0.15 $ 0.23
Effect of Dilutive
Securities:
Employee stock
options -- -- -- 449 495 374 (0.03) (0.01) (0.01)
------ ------ ------ ----- ----- ----- ------ ------ ------
Diluted EPS: $3,335 $1,010 $1,575 7,081 7,140 7,078 $ 0.47 $ 0.14 $ 0.22
====== ====== ====== ===== ===== ===== ====== ====== ======
Options to purchase 10,000, 56,000 and 50,000 shares of common stock for
the three fiscal years ended June 30, 2004, 2003 and 2002, respectively,
were not included in the computation of Diluted EPS because the exercise
prices exceeded the average market price of the common shares for the
respective periods and, accordingly, their inclusion would be
anti-dilutive. These options were still outstanding at the end of the
respective periods.
Stock-Based Compensation
The Company accounts for stock-based compensation under the provisions of
SFAS No. 123, Accounting for Stock-Based Compensation. Accordingly, the
Company has elected to continue to apply the intrinsic value method of
accounting set forth in Accounting Principles Board (APB) Opinion No. 25,
Accounting for Stock Issued to Employees, while providing the required pro
forma disclosures as if the fair value method of SFAS No. 123 had been
applied.
FS-11
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - Nature of Business and Summary of Significant Accounting Policies,
continued
Under the intrinsic value method, no compensation expense is recognized if
the exercise price of the Company's employee stock options equals or
exceeds the market price of the underlying stock on the date of grant.
Accordingly, no compensation cost has been recognized on options granted
to employees. SFAS No. 123, requires that the Company provide pro forma
information regarding net earnings and net earnings per common share as if
compensation cost for the Company's stock option programs had been
determined in accordance with the fair value method prescribed therein.
The Company adopted the disclosure portion of SFAS No. 148, Accounting for
Stock-Based Compensation - Transition and Disclosure requiring quarterly
SFAS No. 123 pro forma disclosure. The following table illustrates the
effect on net earnings and earnings per common share as if the fair value
method had been applied to all outstanding awards in each period
presented:
Year Ended June 30,
2004 2003 2002
-------- -------- ---------
(In thousands, except per share data)
Net income, as reported $ 3,335 $ 1,010 $ 1,575
Deduct: Total stock-based employee compensation
expense determined under fair value method for
all awards, net of related tax effects 210 329 376
-------- -------- ---------
Pro forma net income $ 3,125 $ 681 $ 1,199
======== ======== =========
Earnings per common share:
Net earnings per common share - Basic, as reported $ .50 $ 0.15 $ 0.23
======== ======== =========
Net earnings per common share - Basic, pro forma $ .47 $ 0.10 $ 0.18
======== ======== =========
Net earnings per common share - Diluted, as reported $ .47 $ 0.14 $ 0.22
======== ======== =========
Net earnings per common share - Diluted, pro forma $ .44 $ 0.10 $ 0.17
======== ======== =========
The fair value of each option grant was estimated on the date of grant
using the Black-Scholes option-pricing model with the following
assumptions:
2004 2003 2002
---- ---- ----
Risk-free interest rates 4.70% 2.71% 3.50%
Expected lives 5 years 5 years 5 years
Expected volatility 48% 42% 43%
Expected dividend yields 0% 0% 0%
FS-12
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - Nature of Business and Summary of Significant Accounting Policies,
continued
Foreign Currency
All assets and liabilities of foreign subsidiaries are translated into
U.S. Dollars at fiscal year-end exchange rates. Income and expense items
are translated at average exchange rates prevailing during the fiscal
year. The realized and unrealized gains and losses associated with foreign
currency translation, as well as related other comprehensive income, were
not material for the three years ended June 30, 2004.
Comprehensive Income
The Company follows the provisions of SFAS No. 130, Reporting
Comprehensive Income, which established rules for the reporting of
comprehensive income and its components. For the fiscal years ended June
30, 2004, 2003 and 2002, the Company's operations did not give rise to
material items includable in comprehensive income, which were not already
included in net income. Accordingly, the Company's comprehensive income is
the same as its net income for all periods presented.
Segment Reporting
The Company follows the provisions of SFAS No. 131, Disclosures about
Segments of an Enterprise and Related Information. Pursuant to this
pronouncement, the reportable operating segments are determined based on
the Company's management approach. The management approach, as defined by
SFAS No. 131, is based on the way that the chief operating decision maker
organizes the segments within an enterprise for making operating decisions
and assessing performance. The Company's results of operations are
reviewed by the chief operating decision maker on a consolidated basis and
the Company operates in only one segment. The Company has presented
required geographical data in Note 11, and no additional segment data has
been presented.
Fair Value of Financial Instruments
The Company calculates the fair value of financial instruments and
includes this additional information in the notes to the financial
statements where the fair value is different than the book value of those
financial instruments. When the fair value approximates book value, no
additional disclosure is made. The Company uses quoted market prices
whenever available to calculate these fair values. When quoted market
prices are not available, the Company uses standard pricing models for
various types of financial instruments which take into account the present
value of estimated future cash flows. At June 30, 2004 and 2003,
management of the Company believes the carrying value of all financial
instruments approximated fair value.
Shipping and Handling Revenues and Costs
Emerging Issues Task Force (EITF) Issue No. 00-10, Accounting for Shipping
and Handling Revenues and Costs requires that all shipping and handling
billed to customers should be reported as revenue and the costs associated
with these revenues may be classified as either cost of sales, or selling,
general, and administrative costs, with footnote disclosure as to
classification of these costs. The Company records the amount billed to
customers in net sales and classifies the costs associated with these
revenues in cost of sales.
FS-13
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - Nature of Business and Summary of Significant Accounting Policies,
continued
Derivative Instruments and Hedging Activities
SFAS No. 133, Accounting for Derivative Instruments and Hedging
Activities, as amended by SFAS No. 138, Accounting for Certain Derivative
Instruments and Certain Hedging Activities provides accounting and
reporting standards for derivative instruments, including certain
derivative instruments embedded in other contracts, and for hedging
activities. SFAS No. 133, as amended, requires the recognition of all
derivative instruments as either assets or liabilities in the balance
sheet measured at fair value.
In October 2000, the Company entered into an interest rate swap to
maintain the value-at-risk inherent in its interest rate exposures. This
financial instrument expired in October 2002. This transaction met the
requirements for cash flow hedge accounting, as the instrument was
designated to a specific debt balance. Accordingly, any gain or loss
associated with the difference between interest rates was included as a
component of interest expense. The Company does not hold or enter into
derivative financial instruments for trading or speculative purposes.
New Accounting Pronouncement
In January 2003, as revised December 2003, the FASB issued Interpretation
No. 46R ("FIN 46"), Consolidation of Variable Interest Entities, an
Interpretation of ARB No. 51. FIN 46 requires certain variable interest
entities to be consolidated by the primary beneficiary of the entity if
the equity investors in the entity do not have the characteristics of a
controlling financial interest or do not have sufficient equity at risk
for the entity to finance its activities without additional financial
support from other parties. FIN 46 is effective for all new variable
interest entities created or acquired after January 31, 2003. For variable
interest entities created or acquired prior to February 1, 2003, the
provisions of FIN 46 must be applied for the first interim or annual
period beginning after March 15, 2004. The effect of the adoption of this
new accounting pronouncement did not have a significant impact on the
Company's consolidated financial statements for the year ended June 30,
2004.
NOTE 2 - Business and Credit Concentrations
The Company had two customers (Customer A and B) with accounts receivable
balances that aggregated 31% and 29% of the Company's accounts receivable
at June 30, 2004 and 2003, respectively. Sales to neither of these
customers exceeded 10% of net sales in any of the past three years.
The Company had a third customer (Customer C) whose accounts receivable
balance was 22% of the Company's accounts receivable at June 30, 2003. The
Company had no accounts receivable due from this customer as of June 30,
2004. This customer accounted for 1%, 19% and 17% of the Company's net
sales in fiscal 2004, 2003 and 2002. During the past three fiscal years no
other customer represented more than 10% of the Company's net sales. The
Company terminated its relationship with customer C in fiscal 2004.
FS-14
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 3 - Inventories
Inventories consist of the following:
June 30
-------
2004 2003
------- -------
(In thousands)
Component parts $ 9,423 $ 9,626
Work-in-process 1,352 2,443
Finished products 3,819 4,853
------- -------
$14,594 $16,922
======= =======
NOTE 4 - Property, Plant, and Equipment
Property, plant and equipment consist of the following:
June 30
---------------------- Useful Life
2004 2003 In years
--------- --------- -------------------------
(In thousands)
Land $ 904 $ 904 --
Buildings 8,911 8,911 30 to 40
Molds and dies 4,438 4,360 3 to 5
Furniture and fixtures 1,334 1,223 5 to 10
Machinery and equipment 12,314 11,823 7 to 10
Shorter of the lease term
Leasehold improvements 191 191 or life of asset
--------- ---------
28,092 27,412
Less: accumulated depreciation
and amortization 19,105 17,946
--------- ---------
$ 8,987 $ 9,466
========= =========
Depreciation and amortization expense on property, plant, and equipment
was approximately $1,159,000, $1,254,000 and $1,408,000 in fiscal 2004,
2003 and 2002, respectively.
FS-15
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - Income Taxes
Provision (benefit) for income taxes consists of the following:
For the Years Ended June 30
----------------------------
2004 2003 2002
------- ------ ------
(In thousands)
Current income taxes:
Federal $ 2,250 $ 428 $ --
Foreign -- 15 51
------- ------ ------
2,250 443 51
Deferred income tax (benefit) expense (49) 172 (267)
------- ------ ------
Provision (benefit) for income taxes $ 2,201 $ 615 $ (216)
======= ====== ======
The difference between the statutory U.S. Federal income tax rate and the
Company's effective tax rate as reflected in the consolidated statements
of income is as follows (dollars in thousands):
For the Years Ended June 30
----------------------------------------------------------------
2004 2003 2002
------------------- ------------------- --------------------
% of % of % of
Pre-Tax Pre-Tax Pre-Tax
Amount Income Amount Income Amount Income
------- ------- ------- ------- -------- -------
Tax at Federal statutory rate $ 1,882 34.0% $ 553 34.0% $ 462 34.0%
Increases (decreases) in
taxes resulting from:
Meals and entertainment 54 1.0 55 3.4 46 3.3
State income taxes, net of
Federal income tax benefit 97 1.7 -- -- -- --
Foreign source income
and taxes 19 1.1 2,234 164.3
Valuation allowance (97) (1.7) -- -- (2,913) (214.2)
Other, net 265 4.8 (12) (.7) (45) (3.3)
------- ------ ------- ------ ------- ------
Provision (benefit) for
income taxes $ 2,201 39.8% $ 615 37.8% $ (216) (15.9)%
======= ====== ======= ====== ======== ======
FS-16
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - Income Taxes, continued
Deferred tax assets and deferred tax liabilities at June 30, 2004 and 2003
are as follows (in thousands):
Current Long-Term
Deferred Tax Assets Deferred Tax Assets
(Liabilities) (Liabilities)
2004 2003 2004 2003
------- ------- -------- -------
Accounts receivable $ 105 $ 108 $ -- $ --
Inventories 1,229 847 -- --
Accrued liabilities 249 249 -- --
State net operating loss carryforward 97 -- -- --
Goodwill -- -- (509) (338)
Property, plant and equipment -- -- (768) (478)
Alternative minimum tax credit 167 49 -- --
Other 13 -- -- --
------- ------- ------- ------
1,860 1,253 (1,277) (816)
Valuation allowance (97) -- -- --
------- ------- ------- ------
Net deferred taxes $ 1,763 $ 1,253 $(1,277) $ (816)
======= ======= ======= ======
In March 2003, Napco Security Systems, Inc. timely filed its income tax
return for the fiscal year ended June 30, 2002. This return included an
election to treat one of the Company's foreign subsidiaries, Napco DR, as
if it were a domestic corporation beginning July 1, 2001. This election is
based on a recently enacted Internal Revenue Code ("Code") provision. As a
result of this election, Napco DR is treated, for Federal income tax
purposes, as transferring all of its assets to a domestic corporation in
connection with an exchange. Although this type of transfer usually
results in the recognition of taxable income to the extent of any untaxed
earnings and profits, the recently enacted Code provision provides an
exemption for applicable corporations. The Company qualifies as an
applicable corporation per this Code section, and based on this Code
exemption, the Company's tax return treated the transfer of approximately
$27,000,000 of Napco DR's untaxed earnings and profits as nontaxable.
The Internal Revenue service has issued a Revenue Procedure which is
inconsistent with the Code exemption described above. Management believes
that it has appropriately relied on the guidance in the Code when filing
its income tax return. Nevertheless, as of June 30, 2002, the Company has
removed the $2,225,000 deferred tax asset related to its net operating
loss carryforward ("NOL") of $6,545,000. The NOL would have expired
through 2017. As a result of the utilization of the NOL for book purposes,
the Company has also eliminated the valuation allowance of $2,913,000
during the year ended June 30, 2002. The Company's tax provision utilizes
estimates made by management and as such, is subject to change as
described in Note 1.
FS-17
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 5 - Income Taxes, continued
The 1998 through 2002 income tax returns of the United Kingdom subsidiary
were examined by the United Kingdom Inland Revenue. The resultant tax
liability of $33,000 most of which relates to 1999, is reflected in the
June 30, 2002 consolidated financial statements.
NOTE 6 - Long-Term Debt
Long-term debt consists of the following:
June 30
------------------
2004 2003
------- -------
(In thousands)
Revolving credit and term loan facility (a) $ 5,713 $11,513
Term loan (b) 1,650 3,300
Term loan (c) 937 1,187
------- -------
8,300 16,000
Less: current portion of long-term debt 1,900 1,900
------- -------
$ 6,400 $14,100
======= =======
(a) 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 and certain other assets of Napco Security Systems, Inc. and
the common stock of three of the Company's subsidiaries. The
revolving credit agreement bears interest at either the Prime Rate
less 1/4% or an alternate rate based on LIBOR as described in the
agreement. At June 30, 2004, the interest rate on this debt was
2.99%. The revolving credit agreement which was to expire in April
2005 was subsequently extended to July, 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 June
30, 2004, the Company was in compliance with these covenants.
(b) On July 27, 2000, the Company entered into a five year $8,250,000
secured term loan with its primary bank in connection with the
acquisition of Continental Instruments Systems, LLC. Under the
agreement, the loan is to be repaid in 60 equal monthly installments
of $137,500, plus interest. 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 June 30, 2004, the Company was in
compliance with these covenants.
FS-18
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 6 - Long-Term Debt, continued
The Company entered into an interest rate swap agreement to exchange
floating rate for fixed rate interest payments periodically over the
life of this agreement. The interest rate swap was designated as a
cash flow hedge and the difference between interest paid and
received was included as a component of interest expense. The swap
contract had a fixed interest rate of 8.68% and terminated on
October 30, 2002. The debt instrument bears interest at either the
Prime Rate or an alternate rate based on LIBOR as described in the
agreement. At June 30, 2004 the interest rate on the debt was 3.34%
(c) In connection with the treasury stock repurchase described in Note
8, the Company entered into a five year $1,250,000 term loan from
its primary bank. Under this agreement, the loan is to be repaid in
60 equal monthly installments of $20,833, plus interest at a
variable rate as defined. At June 30, 2004, the interest rate on
this debt was 3.19%.
Maturities of long-term debt are as follows:
Year Ending
June 30, Amount
- ----------- --------------
(In thousands)
2005 $1,900
2006 5,963
2007 250
2008 187
------
Total $8,300
======
NOTE 7 - Stock Options
In November 1992, the stockholders approved a 10-year extension of the
already-existing 1982 Incentive Stock Option Plan (the 1992 Plan). The
1992 Plan authorized the granting of awards, the exercise of which would
allow up to an aggregate of approximately 1,632,000 shares of the
Company's common stock to be acquired by the holders of such awards. The
1992 Plan terminated in October 2002. As of June 30, 2004, there were
292,400 stock options granted to employees and directors of which 226,000
were exercisable.
In December 2002, the stockholders approved the 2002 Employee Stock Option
Plan (the 2002 Plan). The 2002 Plan authorizes the granting of awards, the
exercise of which would allow up to an aggregate of 680,000 shares of the
Company's common stock to be acquired by the holders of such awards. Under
the 2002 Plan, the Company may grant stock options, which are intended to
qualify as incentive stock options (ISOs), to key employees. Any plan
participant who is granted ISOs and possesses more than 10% of the voting
rights of the Company's outstanding common stock must be granted an option
with a price of at least 110% of the fair market value on the date of
grant.
FS-19
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - Stock Options, continued
Under the 2002 Plan, stock options have been granted to key employees with
a term of 10 years at an exercise price equal to the fair market value on
the date of grant and are exercisable in whole or in part at 20% per year
from the date of grant. At June 30, 2004, 406,000 stock options were
granted, 274,000 stock options were available for grant, and 141,600 stock
options were exercisable under this plan.
The following table reflects activity under the 1992 and 2002 Plans for
the fiscal years ended:
June 30
-------------------------------------------------------------------------------------
2004 2003 2002
-------------------------- ------------------------ -----------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Shares price Shares price Shares price
------------ ---------- ------------ -------- ----------- --------
Outstanding at beginning of year 1,284,400 $ 2.61 1,117,400 $ 1.89 1,153,700 $ 1.76
Granted 104,000 5.38 322,000 4.90 112,000 2.98
Exercised (657,000) 1.61 (131,000) 1.99 (130,800) 1.93
Forfeited (33,000) 3.25 (6,000) 1.94 (4,000) 1.94
Canceled/lapsed -- -- (18,000) 1.94 (13,500) 1.94
----------- ---------- ----------- -------- ---------- --------
Outstanding at end of year 698,400 $ 3.94 1,284,400 $ 2.61 1,117,400 $ 1.86
=========== ========== =========== ======== ========== ========
Exercisable at end of year 367,600 $ 3.34 850,400 $ 1.96 731,960 $ 1.75
=========== ========== =========== ======== ========== ========
Weighted average fair value of
options granted $ 3.05 $ 1.95 $ 1.23
The following table summarizes information about stock options outstanding
at June 30, 2004:
Options outstanding Options exercisable
-------------------------------------- -----------------------
Weighted
Number average Weighted Number Weighted
outstanding remaining average exercisable average
Range of exercise at June 30, contractual exercise at June 30, exercise
prices 2004 life price 2004 price
- ----------------- ----------- ----------- -------- ----------- --------
$1.50 to $1.93 40,000 0.7 $ 1.53 40,000 $ 1.53
$1.94 to $1.99 41,600 1.0 1.94 29,360 1.94
$2.00 to $3.19 210,800 1.9 2.64 156,640 2.55
$3.20 to $5.65 406,000 4.1 5.06 141,600 5.02
------- ---- ------- --------- ------
698,400 3.02 $ 3.94 367,600 $ 3.34
======= ==== ======= ========= ======
FS-20
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 7 - Stock Options
In September 2000, the stockholders approved a 10 year extension of the
already existing 1990 nonemployee stock option plan (the 2000 Plan) to
encourage nonemployee directors and consultants of the Company to invest
in the Company's stock. The 2000 Plan provides for the granting of
nonqualified stock options, the exercise of which would allow up to an
aggregate of 100,000 shares of the Company's common stock to be acquired
by the holders of the stock options. The 2000 Plan provides that the
option price will not be less than 100% of the fair market value of the
stock at the date of grant. Options are exercisable at 20% per year and
expire five years after the date of grant. The Company has adopted SFAS
No. 123 to account for stock-based compensation awards granted to
nonemployee consultants, under which a compensation cost is recognized for
the fair value of the options granted as of the date of grant. Under this
plan, as of June 30, 2004, 2003 and 2002, 80,000 options were granted to
directors with a weighted average exercise price of $2.07 and a weighted
average remaining contractual life at June 30, 2004 of 1.2 years. There
were 32,000 options exercised under the 2000 Plan during the year ended
June 30, 2004. There were no other options exercised, cancelled, or
forfeited under this plan during the years ended June 30, 2004, 2003 and
2002. As of June 30, 2004, 2003 and 2002, respectively, 32,000, 48,000 and
32,000 stock options were exercisable under this plan. No compensation
expense was recorded for stock options granted to directors.
NOTE 8 - Stock Purchase
In January 2003, the Company repurchased 500,000 shares of its common
stock from two stockholders, unaffiliated with the Company, at $4.88 per
share, a discount from its then current trading price of $5.01. The
transaction was approved by the Board of Directors and the purchase price
of $2,442,000 (including fees of $5,000), was financed through the
Company's revolving line of credit and a new five year term loan from its
primary bank for $1,250,000. The term loan is being repaid in 60 equal
monthly installments commencing on April 30, 2003.
NOTE 9 - 401(k) Plan
The Company maintains a 401(k) plan covering all U.S. employees with one
or more years of service. The plan is qualified under Sections 401(a) and
401(k) of the Internal Revenue Code. The Company provides for matching
contributions of 50% of the first 2% of employee contributions. Company
contributions to the plan totaled approximately $73,000, $73,000, and
$70,000 for the fiscal years ended 2004, 2003 and 2002, respectively.
FS-21
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 - Commitments and Contingencies
Leases
The Company is committed under various operating leases, which do not
extend beyond fiscal 2010. Minimum lease payments through the expiration
dates of these leases, with the exception of the land lease referred to
below, are as follows:
Year Ending
June 30, Amount
- ----------- --------
2005 $142,000
2006 89,000
2007 67,000
2008 39,000
2009 1,000
--------
Total $338,000
========
Rent expense, with the exception of the land lease referred to below,
totaled approximately $192,000, $321,000 and $319,000 for the fiscal years
ended June 30, 2004, 2003 and 2002, respectively.
Land Lease
On April 26, 1993, one of the Company's foreign subsidiaries entered into
a 99 year lease for approximately four acres of land in the Dominican
Republic, at an annual cost of approximately $288,000, on which the
Company's principal production facility is located.
Letters of Credit
At June 30, 2004, the Company was committed for approximately $299,000
under open commercial letters of credit.
Litigation
In August 2001, the Company became a defendant in a product related
lawsuit, in which the plaintiff seeks damages of approximately
$17,000,000. This action is being defended by the Company's insurance
company on behalf of the Company. Management believes that the action is
without merit and plans to have this action vigorously defended.
In the normal course of business, the Company is a party to claims and/or
litigation. Management believes that the settlement of such claims and/or
litigation, considered in the aggregate, will not have a material adverse
effect on the Company's financial position and results of operations.
FS-22
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 10 Commitments and Contingencies, continued
Employment Agreements
As of June 30, 2004, the Company was obligated under four employment
agreements and one severance agreement. Compensation under the agreements
includes annual salaries approximating $1,085,000. The employment
agreements provide for annual bonuses based upon sales and profits, or a
formula to be determined by the Board of Directors, and various severance
payments as defined in each agreement. One agreement, with current annual
compensation of $471,000, includes additional compensation of 100,000
stock options that vest 20% per year or upon a change in control, as
defined, and a termination payment in an amount equal to 299% of the
average of the prior five calendar year's compensation, subject to certain
limitations, as defined. The employment agreements expire at various times
through June 2008.
NOTE 11 - Geographical Data
The Company is engaged in one major line of business: the development,
manufacture, and distribution of security alarm products and door security
devices for commercial and residential use. Sales to unaffiliated
customers are primarily shipped from the United States. The Company has
customers worldwide with major concentrations in North America, Europe,
and South America.
The Company observes the provisions of SFAS No. 131. The following
represents selected consolidated geographical data for the fiscal years
ended June 30, 2004, 2003, and 2002:
2004 2003 2002
------- ------- -------
(In thousands)
Sales to external customers(1):
Domestic $48,626 $47,965 $46,652
Export 9,467 9,375 9,184
------- ------- -------
$58,093 $57,340 $55,836
======= ======= =======
Identifiable assets:
United States $40,153 $39,005 $40,955
Foreign(2) 16,519 18,344 19,797
------- ------- -------
$56,672 $57,349 $60,752
======= ======= =======
(1) All of the Company's sales occur in the United States and are shipped
primarily from the Company's facilities in the United States and United
Kingdom. There were no sales into any one foreign country in excess of 10%
of total net sales.
(2) Foreign identifiable assets consist primarily of inventories and fixed
assets, which are located at the Company's principal manufacturing
facility in the Dominican Republic.
FS-23
SCHEDULE II
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Years Ended June 30, 2004, 2003, and 2002
(In Thousands)
Column A Column B Column C Column D Column E
- -------------------------------------------- ------------ ---------- ------------ ----------
Balance at Charged to Deductions/ Balance at
beginning of costs and (recoveries) end of
Description period expenses (1) period
- -------------------------------------------- ------------ ---------- ------------ ----------
For the year ended June 30, 2002:
Allowance for doubtful accounts
(deducted from accounts receivable) $ 700 $ 45 $ 352 $ 393
For the year ended June 30, 2003:
Allowance for doubtful accounts
(deducted from accounts receivable) $ 393 $ 16 $ 194 $ 215
For the year ended June 30, 2004:
Allowance for doubtful accounts
(deducted from accounts receivable) $ 215 $ 140 $ -- $ 355
(1) Deductions relate to uncollectible accounts charged off to valuation
accounts, net of recoveries.
FS-24
b. Supplementary Financial Data
QUARTERLY RESULTS
The following table sets forth unaudited financial data for each of the
Company's last eight fiscal quarters (in thousands except for per share data).
Fiscal Year Ended June 30, 2004
------------------------------------------------------------------
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- -------------- ------------- --------------
Net Sales $ 9,835 $ 14,629 $ 14,742 $ 18,887
Gross Profit 2,983 4,552 4,622 7,383
Income (Loss) from Operations (294) 1,247 1,259 3,853
Net Income (Loss) (282) 728 734 2,155
Net Income (Loss) Per Share
Basic EPS (.04)* .11* .11 .32
Diluted EPS (.04)* .10* .11 .30
Fiscal Year Ended June 30, 2003
------------------------------------------------------------------
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- -------------- ------------- --------------
Net Sales $ 11,725 $ 13,859 $ 13,406 $ 18,350
Gross Profit 3,048 3,569 3,496 5,288
Income (Loss) from Operations (233) 424 9 2,025
Net Income (Loss) (183) 145 (136) 1,184
Net Income (Loss) Per Share:
Basic EPS (.03)* .02* (.03)* .19*
Diluted EPS (.03)* .02* (.03)* .18*
* Restated to reflect 2:1 stock split reported in the third fiscal quarter of
2004.
FS-25
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND 304(B)
FINANCIAL DISCLOSURE.
None
ITEM 9A. CONTROL 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 and sufficient to timely alert them to
material information required to be included in the Company's periodic SEC
filings and to ensure that the information required to be disclosed in the
reports that the Company files under the Securities Exchange Act of 1934 is
recorded, processed, summarized, and reported within the time periods specified
in the SEC's rules and forms. During the fourth quarter of 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
ITEM 9B. OTHER INFORMATION
None
PART III
The information called for by Part III is hereby incorporated by reference from
the information set forth and under the headings "Beneficial Ownership of Common
Stock", "Election of Directors", "Executive Compensation", "Corporate Governance
and Board Matters", "Information Concerning Executive Officers", "Section 16(a)
Beneficial Ownership Reporting Compliance" and "Principal Accountant Fees and
Services" in the Company's definitive proxy statement for the 2004 Annual
Meeting of Stockholders, to be filed with the Securities and Exchange Commission
pursuant to Regulation 14A within 120 days after the end of the fiscal year
covered by this Annual Report on Form 10-K.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a)1. Financial Statements
The following consolidated financial statements of NAPCO Security Systems, Inc.
and its subsidiaries are included in Part II, Item 8:
Page
----
Report of Independent Registered Public Accounting Firm FS-1
Consolidated Balance Sheets as of June 30, 2004 and 2003 FS-2
Consolidated Statements of Income for the Years Ended June 30, 2004, 2003 and 2002 FS-4
Consolidated Statements of Stockholders' Equity for the Years Ended June 30, 2004, 2003 and 2002 FS-5
Consolidated Statements of Cash Flows for the Years Ended June 30, 2004, 2003 and 2002 FS-6
Notes to Consolidated Financial Statements, June 30, 2004, 2003 and 2002 FS-8
(a)2. Financial Statement Schedules
The following consolidated financial statement schedules of NAPCO Security
Systems, Inc. and its subsidiaries are included in Part II, Item 8:
Page
----
II: Valuation and Qualifying Accounts FS-24
Schedules other than those listed above are omitted because of the absence of
the conditions under which they are required or because the required information
is shown in the consolidated financial statements and/or notes thereto.
18
(a)3 and (b). Exhibits
Management Contracts designated by asterisk.
Exhibit No. Title
- ----------- -----
Ex-3.(i) Articles of Incorporation, as amended Exhibit 3(I) to Report on Form 10-Q for
the fiscal year ended December 31, 2001
Ex-3.(ii) Amended and Restated By-Laws E-1
Ex-10.A (i) Amended and Restated 1992 Incentive Stock Exhibit 10.A to Report on Form 10-K for
Option Plan fiscal year ended June 30, 2001
*Ex-10.A (ii) 2002 Employee Stock Option Plan Exhibit 10.Y to Report on Form 10-Q for
the fiscal quarter ended December 31,
2003
*Ex-10.B 2000 Non-Employee Stock Option Plan Exhibit 10.B to Report on Form 10-K for
fiscal year ended June 30, 2001
Ex-10.C Loan and Security Agreement with Marine E-17
Midland Bank dated as of May 12 1997
Ex-10.D Revolving Credit Note #1 to Marine Midland E-65
Bank dated as of May 12 1997
Ex-10.E Revolving Credit Note #2 to Marine Midland E-72
Bank dated as of May 12 1997
Ex-10.F Promissory Note to Marine Midland Bank dated E-79
as of May 12 1997
Ex-10.G Amendment No.1 to the Loan and Security E-83
Agreement with Marine Midland Bank dated as of
May 28 1998
Ex-10.H Term Loan Note to Marine Midland Bank dated as E-87
of May 28 1998
*Ex-10.I Amended and Restated Employment Agreement with Exhibit 10.I to Report on Form 10-K for
Richard Soloway fiscal year ended June 30, 2003
*Ex.10.J Employment Agreement with Jorge Hevia Exhibit 10.R to Report on Form 10-Q for
period ended March 31, 2001
Ex-10.K Amendment No. 2 to the Loan and Security Exhibit 10.S to Report on Form 10-K for
Agreement with HSBC Bank dated as of June fiscal year ended June 30, 2001
30,2001
*Ex-10.L Employment Agreement with Michael Carrieri Exhibit 10.U to Report on Form 10-Q For
fiscal quarter ended September 30, 2001
19
*Ex-10.M Indemnification Agreement dated August 9, 2001 Exhibit 10.T to Report on Form 10-K For
fiscal year ended June 30, 2001
Ex-10.O Amendment No. 4 to Loan and Security Agreement Exhibit 10.V to Report on Form 8-K
Filed July 27, 2002
Ex-10.P Amendment No. 8 to Loan and Security Agreement Exhibit 10.W to Report on Form 10-K for
fiscal year ended June 30, 2001
Ex-10.Q Note Modification Agreement Exhibit 10.W to Report on Form 10-K for
fiscal year ended June 30, 2001
Ex-10.R Amendment No. 10 to the Loan and Security Exhibit 10.R to Report on Form 10-K for
Agreement fiscal year ended June 30, 2003
Ex-10.S Amendment No. 3 to the Loan and Security E-91
Agreement
Ex-10.T Amendment No. 9 to the Loan and Security E-97
Agreement
Ex-10.U Amendment No. 11 to the Loan and Security E-106
Agreement
Ex-10.V Amendment No. 12 to the Loan and Security E-111
Agreement
Ex-10.W Amendment No. 13 to the Loan and Security E-116
Agreement
Ex-14.0 Code of Ethics Exhibit 14.0 to Report on Form 10-K for
the fiscal year ended June 30, 2003
Ex-21.0 Subsidiaries of the Registrant E-121
Ex-23.1 Consent of Independent Auditors E-122
Ex-31.1 Section 302 Certification of Chief Executive E-123
Officer
Ex-31.2 Section 302 Certification of Chief Financial E-124
Officer
Ex-32.1 Certification of Chief Executive Officer E-125
Pursuant to 18 USC Section 1350 and Section
906 of Sarbanes - Oxley Act of 2002
Ex-32.2 Certification of Chief Financial Officer E-126
Pursuant to 18 USC Section 1350 and Section
906 of Sarbanes - Oxley Act of 2002
20
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, as amended, the Registrant has duly caused this Report to be signed
on its behalf by the undersigned, thereunto duly authorized.
September 27, 2004
NAPCO SECURITY SYSTEMS, INC.
(Registrant)
By: /s/ RICHARD SOLOWAY
--------------------------------
Richard Soloway
Chairman of the Board of
Directors, President and Secretary
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and the dates indicated.
Signature Title Date
--------- ----- ----
/s/RICHARD SOLOWAY Chairman of the Board of Directors, September 27, 2004
- --------------------------- President and Secretary
Richard Soloway (Principal Executive Officer)
and Director
/s/KEVIN S. BUCHEL Senior Vice President September 27, 2004
- --------------------------- of Operations and Finance
Kevin S. Buchel and Treasurer
(Principal Financial and
Accounting Officer) and Director
/s/PAUL STEPHEN BEEBER Director September 27, 2004
- ---------------------------
Paul Stephen Beeber
/s/RANDY B. BLAUSTEIN Director September 27, 2004
- ---------------------------
Randy B. Blaustein
/s/ARNOLD BLUMENTHAL Director September 27, 2004
- ---------------------
Arnold Blumenthal
/s/DONNA SOLOWAY Director September 27, 2004
- ---------------------------
Donna Soloway
/s/ANDREW J WILDER Director September 27, 2004
- ---------------------------
Andrew J. Wilder
21