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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: DECEMBER 31, 2004
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO ________.
Commission File number: 0-10004
NAPCO SECURITY SYSTEMS, INC
----------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 11-2277818
- ---------------------------------------- ----------------------------
(State or other jurisdiction of (IRS Employer Identification
incorporation of organization) Number)
333 Bayview Avenue
Amityville, New York 11701
- ---------------------------------------- ---------------------------
(Address of principal executive offices) (Zip Code)
(631) 842-9400
---------------------------------------------------
(Registrant's telephone number including area code)
None
------------------------------------------------------
(Former name, former address and former fiscal year if
changed from last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days:
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act):
Yes [ ] No [X]
Number of shares outstanding of each of the issuer's classes of common stock, as
of: JANUARY 28, 2005
COMMON STOCK, $.01 PAR VALUE PER SHARE 8,556,710
1
Page
----
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES INDEX - DECEMBER 31, 2004
Condensed Consolidated Balance Sheets, December 31, 2004 and June 30, 2004 3
Condensed Consolidated Statements of Income for the Three Months ended December 31, 2004 and 2003 4
Condensed Consolidated Statements of Income for the Six Months ended December 31, 2004 and 2003 5
Condensed Consolidated Statements of Cash Flows for the Six Months ended December 31, 2004 and 2003 6
Notes to Condensed Consolidated Financial Statements 7
ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 13
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 17
ITEM 4. Controls and Procedures 18
PART II: OTHER INFORMATION 18
SIGNATURE PAGE 19
2
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
December 31, June 30,
2004 (unaudited) 2004
---------------- ------------
(in thousands, except share data)
ASSETS
Current Assets:
Cash $ 1,579 $ 796
Accounts receivable, less allowance for doubtful accounts 17,094 19,927
Inventories, net 14,992 14,594
Prepaid expenses and other current assets 610 760
Deferred income taxes 1,763 1,763
-------- --------
Total current assets 36,038 37,840
Property, Plant and Equipment, net 8,937 8,987
Goodwill 9,686 9,686
Other assets 186 159
-------- --------
$ 54,847 $ 56,672
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current portion of long-term debt $ - $ 1,900
Accounts payable 4,759 3,789
Accrued expenses 789 963
Accrued salaries and wages 1,792 1,911
Accrued income taxes 4 285
-------- --------
Total current liabilities 7,344 8,848
Long-term debt 4,363 6,400
Accrued income taxes 2,520 2,243
Deferred income taxes 1,277 1,277
-------- --------
Total liabilities 15,504 18,768
-------- --------
Stockholders' Equity (Note 1) *:
Common stock, par value $.01 per share; 21,000,000 shares
authorized, 8,544,710 and 8,503,670 shares issued and
outstanding, respectively 85 85
Additional paid-in capital 11,435 11,381
Retained earnings 27,823 26,438
-------- --------
Total stockholders' equity 39,343 37,904
-------- --------
$ 54,847 $ 56,672
======== ========
* The 20% stock dividend declared on November 8, 2004 (see Note 1), has been
retroactively reflected in Stockholders' Equity.
See accompanying notes to condensed consolidated financial statement
3
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)
Three Months Ended
December 31,
-----------------------------------------------
2004 2003
----------- -----------
(in thousands, except share and per share data)
Net Sales $ 16,019 $ 14,629
Cost of Sales 11,101 10,077
----------- -----------
Gross profit 4,918 4,552
Selling, General and Administrative Expenses 3,468 3,305
----------- -----------
Operating income 1,450 1,247
----------- -----------
Interest Expense, net 58 102
Other Expenses, net 55 24
----------- -----------
Other expenses 113 126
----------- -----------
Income before provision for income taxes 1,337 1,121
Provision for income taxes 465 393
----------- -----------
Net income $ 872 $ 728
=========== ===========
Net income per share (Note 1 and Note 4) *: Basic $ 0.10 $ 0.09
=========== ===========
Diluted $ 0.10 $ 0.09
=========== ===========
Weighted average number of shares
outstanding (Note 1 and Note 4) *: Basic 8,525,500 7,718,707
=========== ===========
Diluted 9,104,098 8,256,933
=========== ===========
* The 20% stock dividend declared on November 8, 2004 (see Note 1), has been
retroactively reflected in all 2003 share and per share data.
See accompanying notes to condensed consolidated financial statements
4
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)
Six Months Ended
December 31,
-----------------------------------------------
2004 2003
----------- -----------
(in thousands, except share and per share data)
Net Sales $ 29,459 $ 24,464
Cost of Sales 20,268 16,929
----------- -----------
Gross profit 9,191 7,535
Selling, General and Administrative Expenses 6,840 6,582
----------- -----------
Operating income 2,351 953
----------- -----------
Interest Expense, net 126 230
Other Expenses, net 98 36
----------- -----------
Other expenses 224 266
----------- -----------
Income before provision for income taxes 2,127 687
Provision for income taxes 742 241
----------- -----------
Net income $ 1,385 $ 446
=========== ===========
Net income per share (Note 1 and Note 4) *: Basic $ 0.16 $ 0.06
=========== ===========
Diluted $ 0.15 $ 0.05
=========== ===========
Weighted average number of shares
outstanding (Note 1 and Note 4) *: Basic 8,516,019 7,699,859
=========== ===========
Diluted 9,035,422 8,264,993
=========== ===========
* The 20% stock dividend declared on November 8, 2004 (see Note 1), has been
retroactively reflected in all 2003 share and per share data.
See accompanying notes to condensed consolidated financial statements
5
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Six Months Ended
December 31,
---------------------
2004 2003
--------- ---------
(in thousands)
Cash Flows from Operating Activities:
Net income $ 1,385 $ 446
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 563 558
Provision for doubtful accounts (35) 61
Changes in operating assets and liabilities:
Accounts receivable 2,870 4,106
Inventories (400) (557)
Prepaid expenses and other current assets 150 (500)
Other assets (57) 76
Accounts payable, accrued expenses, accrued salaries and
wages, and accrued income taxes 673 (1,598)
--------- ---------
Net Cash Provided by Operating Activities 5,149 2,592
--------- ---------
Cash Flows used in Investing Activities:
Net purchases of property, plant and equipment (483) (224)
--------- ---------
Cash Flows from Financing Activities:
Proceeds from exercise of employee stock options 54 82
Proceeds from long-term debt 2,350 -
Principal payments on long-term debt (6,287) (2,450)
--------- ---------
Net cash used in financing activities (3,883) (2,368)
--------- ---------
Net Increase in Cash 783 -
Cash, Beginning of Period 796 1,794
--------- ---------
Cash, End of Period $ 1,579 $ 1,794
========= =========
Cash Paid During the Period for:
Interest $ 134 $ 237
========= =========
Income taxes $ 738 $ 95
========= =========
See accompanying notes to condensed consolidated financial statement.
6
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED STATEMENTS (unaudited)
1.) Summary of Significant Accounting Policies and Other Disclosures
The accompanying Condensed Consolidated Financial Statements are
unaudited. In management's opinion, all adjustments (consisting of only
normal recurring accruals) necessary for a fair presentation have been
made. The results of operations for the periods ended December 31, 2004
are not necessarily indicative of results that may be expected for any
other interim period or for the full year.
The unaudited Condensed Consolidated Financial Statements include the
accounts of the Company after elimination of all material inter-company
balances and transactions. The Company has made a number of estimates and
assumptions relating to the assets and liabilities, the disclosure of
contingent assets and liabilities and the reporting of revenues and
expenses to prepare these financial statements in conformity with
accounting principles generally accepted in the United States. Actual
results could differ from those estimates. The unaudited Condensed
Consolidated Financial Statements should be read in conjunction with the
Consolidated Financial Statements and related notes contained in the
Company's Annual Report on Form 10-K for the year ended June 30, 2004. The
accounting policies used in preparing these unaudited Condensed
Consolidated Financial Statements are consistent with those described in
the June 30, 2004 Consolidated Financial Statements, except as disclosed.
Advertising and Promotional Costs
Advertising and promotional costs are included in "Selling, General and
Administrative" expenses in the Condensed Consolidated Statements of
Income and are expensed as incurred. Advertising expense for the three
months ended December 31, 2004 and 2003 was $310,000 and $263,000,
respectively. Advertising expense for the six months ended December 31,
2004 and 2003 was $695,000 and $645,000, respectively.
Research and Development Costs
Research and development costs incurred by the Company are charged to
expense in the period incurred. Research and Development expense for the
three months ended December 31, 2004 and 2003 was $1,532,000 and
$1,269,000, respectively. Research and Development expense for the six
months ended December 31, 2004 and 2003 was $2,977,000 and $2,553,000,
respectively. These expenses are included in "Cost of sales" in the
Condensed Consolidated Statements of Income.
Business Concentration and Credit Risk
An entity is more vulnerable to concentrations of credit risk if it is
exposed to risk of loss greater than it would have had it mitigated its
risk through diversification of customers. Such risks of loss are manifest
differently, depending on the nature of the concentration, and vary in
significance. The Company has two major customers with Sales and Accounts
Receivable as follows (in thousands):
Sales for the three months ended December 31,
---------------------------------------------
2004 2003
----- -----
$ % $ %
----- -- ----- --
Customer A 1,458 9% 1,160 8%
Customer B 1,120 7% 881 6%
----- -- ----- --
2,578 16% 2,041 14%
===== == ===== ==
Sales for the six months ended December 31,
---------------------------------------------
2004 2003
----- -----
$ % $ %
----- -- ----- --
Customer A 2,560 9% 1,211 5%
Customer B 2,099 7% 1,573 6%
----- -- ----- --
4,659 16% 2,784 11%
===== == ===== ==
7
Accounts Receivable as of:
-------------------------------------------
December 31,
2004 June 30, 2004
------------ -------------
$ % $ %
-------- -- --------- --
Customer A 2,448 14% 2,071 10%
Customer B 4,334 25% 4,197 21%
----- -- ----- --
6,782 39% 6,268 31%
===== == ===== ==
These customers sell primarily within North America. Although management
believes that these customers are sound and creditworthy, a severe adverse
impact on their business operations could have a corresponding material
adverse effect on our net sales, cash flows, and/or financial condition.
In the ordinary course of business, we have established an allowance for
doubtful accounts and customer deductions in the amount of $320,000 and
$355,000 as of December 31, 2004 and June 30, 2004, respectively. The
allowance for doubtful accounts is a subjective critical estimate that has
a direct impact on reported net earnings. This allowance is based upon the
evaluation of accounts receivable aging, specific exposures and historical
trends.
Stock Options
During the six months ended December 31, 2004 the Company granted no stock
options under its 2002 Employee Incentive Stock Option Plan. 36,960 and
41,040 options were exercised under this plan during the three and six
months ended December 31, 2004, respectively.
Stock Dividend and Stock Split
In November 2004, the Company's Board of Directors approved a twenty
percent (20%) stock dividend of the Company's common stock payable to
stockholders of record on November 22, 2004. The effect of the stock
dividend, which has been accounted for similar to a stock split, has been
retroactively reflected in all share and per share data. The additional
shares of 1,424,118 were distributed on December 6, 2004. There is no net
effect on total stockholders' equity as a result of the stock dividend.
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. There was no
net effect on total stockholders' equity as a result of the stock split.
Recent Accounting Pronouncements
In November 2004, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("FAS") No. 151, "Inventory
Costs, an amendment of ARB No. 43, Chapter 4" ("FAS 151"). FAS 151
clarifies that abnormal inventory costs such as costs of idle facilities,
excess freight and handling costs, and wasted materials (spoilage) are
required to be recognized as current period costs. The provisions of FAS
151 are effective for fiscal 2006. Management is currently evaluating the
provisions of FAS 151 and does not expect adoption will have a material
impact on the Company's financial position, results of operations, or cash
flows.
In December 2004, the FASB finalized FAS No. 123R "Share-Based Payment"
("FAS 123R"), amending FAS No. 123, effective beginning the Company's
first quarter of fiscal 2006. FAS 123R will require the Company to expense
stock options based on grant date fair value in its financial statements.
Further, the adoption of FAS 123R will require additional accounting
related to the income tax effects and additional disclosure regarding the
cash flow effects resulting from share-based payment arrangements. The
effect of expensing stock options on the Company's results of operations
using a Black-Scholes option-pricing model is presented in Note 2. The
adoption of FAS 123R will have no effect on the Company's cash flows or
financial position, but will have an adverse impact on results of
operations.
In December 2004, the FASB issued FASB Staff Position No. FAS 109-2,
"Accounting and Disclosure Guidance for the Foreign Earnings Repatriation
Provision within the American Jobs Creation Act of 2004", ("SP FAS
109-2"). The American Jobs Creation Act introduces a special one-time
dividends received deduction on the repatriation of certain foreign
earnings to a U.S. taxpayer
8
("repatriation provision"), provided certain criteria are met. SP FAS
109-2 provides accounting and disclosure guidance for the repatriation
provision. Although SP FAS 109-2 is effective immediately, until the
Treasury Department or Congress provides additional clarifying language on
key elements of the repatriation provision, the Company is unable to
determine the amount of foreign earnings, if any, that would be
repatriated. Accordingly, the Company will complete its evaluation after
the necessary guidance is provided.
In December 2004, the FASB issued FAS No. 153, "Exchanges of Nonmonetary
Assets - an amendment of APB Opinion No. 29". This statement amends APB
Opinion No. 29 to eliminate the exception for nonmonetary exchanges of
similar productive assets and replaces it with a general exception for
exchanges of nonmonetary assets that do not have commercial substance. A
nonmonetary exchange has commercial substance if the future cash flows of
the entity are expected to change significantly as a result of the
exchange. The provisions of FAS No. 153 are effective for the Company's
fiscal year ending June 2006. The adoption of FAS No. 153 is not expected
to have a material impact on the Company's consolidated financial
position, liquidity, or results of operations.
2.) Employee Stock-based Compensation
The Company has established a number of share incentive programs as
discussed in more detail in the Company's annual report on Form 10-K for
the year ended June 30, 2004. The Company applies the intrinsic value
method as outlined in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees", and related interpretations in
accounting for stock options and share units granted under these programs.
Under the intrinsic value method, no compensation expense is recognized if
the exercise price of the Company's employee stock options equals the
market price of the underlying stock on the date of grant. Accordingly, no
compensation cost has been recognized. The Company adopted the disclosure
portion of FAS No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure" requiring quarterly FAS No. 123 pro forma
disclosure.
As discussed in Note 1, FAS No. 123R will require the Company to expense
stock options based on grant date fair value in its financial statements.
The effect of expensing stock options on the Company's results of
operations using a Black-Scholes option-pricing model is presented in the
following pro forma table:
Three Months Six Months
Ended December 31, Ended December 31,
------------------ ------------------
2004 2003 2004 2003
------ ------ -------- -------
(in thousands, except per share data)
Net income, as reported $ 872 $ 728 $ 1,385 $ 446
Deduct: Total stock-based employee compensation
expense determined under fair value method
for all awards, net of related tax effects (41) (39) (63) (92)
------ ------ -------- -------
Pro forma net income $ 831 $ 689 $ 1,322 $ 354
====== ====== ======== =======
Earnings per common share (1):
Basic - as reported $ 0.10 $ 0.09 $ 0.16 $ 0.06
====== ====== ======== =======
Basic - pro forma $ 0.10 $ 0.09 $ 0.16 $ 0.05
====== ====== ======== =======
Diluted - as reported $ 0.10 $ 0.09 $ 0.15 $ 0.05
====== ====== ======== =======
Diluted - pro forma $ 0.09 $ 0.08 $ 0.15 $ 0.04
====== ====== ======== =======
(1) Information reflects stock dividend and stock split. See Note 1.
3.) Inventories
Inventories consist of:
December 31, June 30,
2004 2004
------------ --------
(in thousands)
Component parts $ 9,681 $ 9,423
Work-in-process 1,389 1,352
Finished products 3,924 3,819
------------ --------
$ 14,994 $ 14,594
============ ========
For interim financial statements, inventories are calculated using a gross
profit percentage.
9
4.) Earnings Per Common Share
The Company follows the provisions of FAS No. 128, "Earnings Per Share".
In accordance with FAS No. 128, earnings per common share amounts ("Basic
EPS") were computed by dividing earnings by the weighted average number of
common shares outstanding for the period. Earnings per common share
amounts, assuming dilution ("Diluted EPS"), were computed by reflecting
the potential dilution from the exercise of stock options. FAS No. 128
requires the presentation of both Basic EPS and Diluted EPS on the face of
the consolidated statements of income.
A reconciliation between the numerators and denominators of the Basic and
Diluted EPS computations for earnings is as follows (in thousands except
per share data) (Information reflects the stock dividend and stock split
as described in Note 1):
Three months ended December 31, 2004
----------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
BASIC EPS
Net income attributable to common stock $ 872 8,549 $ 0.10
EFFECT OF DILUTIVE SECURITIES
Options $ - 579 -
----------- ------------- ---------
DILUTED EPS
Net income attributable to common stock
and assumed option exercises $ 872 9,128 $ 0.10
=========== ============= =========
No options to purchase shares of common stock in the three months ended
December 31, 2004 were excluded in the computation of Diluted EPS because
no option prices were in excess of the average market price for the three
months ended December 31, 2004.
Three months ended December 31, 2003
----------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
BASIC EPS
Net income attributable to common stock $ 728 7,723 $ 0.09
EFFECT OF DILUTIVE SECURITIES
Options $ - 538 -
----------- ------------- ---------
DILUTED EPS
Net income attributable to common stock
and assumed option exercises $ 728 8,261 $ 0.09
=========== ============= =========
Options to purchase 74,400 shares of common stock in the three months
ended December 31, 2003 were not included in the computation of Diluted
EPS because the option price was in excess of the average market price for
the three months ended December 31, 2003. These options were still
outstanding at the end of the period.
Six months ended December 31, 2004
----------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
BASIC EPS
Net income attributable to common stock $ 1,385 8,539 $ 0.16
EFFECT OF DILUTIVE SECURITIES
Options $ - 520 0.01
----------- ------------- ---------
DILUTED EPS
Net income attributable to common stock
and assumed option exercises $ 1,385 9,059 $ 0.15
=========== ============= =========
No options to purchase shares of common stock in the six months ended
December 31, 2004 were excluded in the computation of Diluted EPS because
no option prices were in excess of the average market price for the six
months ended December 31, 2004.
10
Six months ended December 31, 2003
----------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------- ---------
BASIC EPS
Net income attributable to common stock $ 446 7,700 $ 0.06
EFFECT OF DILUTIVE SECURITIES
Options $ - 565 $ 0.01
----------- ------------- ---------
DILUTED EPS
Net income attributable to common stock
and assumed option exercises $ 446 8,265 $ 0.05
=========== ============= =========
Options to purchase 79,680 shares of common stock in the six months ended
December 31, 2003 were not included in the computation of Diluted EPS
because the option price was in excess of the average market price for the
six months ended December 31, 2003. These options were still outstanding
at the end of the period.
5) Long Term Debt
In May 2001, the Company amended its secured revolving credit agreement
with its primary bank. The Company's borrowing capacity under the amended
agreement was increased to $18,000,000. The amended revolving credit
agreement is secured by all the accounts receivable, inventory, the
Company's headquarters in Amityville, New York, common stock of three of
the Company's subsidiaries and certain other assets of Napco Security
Systems, Inc. The revolving credit agreement bears interest at either the
Prime Rate less 1/4% or an alternate rate based on LIBOR as described in
the agreement. The agreement contains various restrictions and covenants
including, among others, restrictions on payment of dividends,
restrictions on borrowings, restrictions on capital expenditures, the
maintenance of minimum amounts of tangible net worth, and compliance with
other certain financial ratios, as defined in the agreement. In October
2004 the Company renegotiated this secured revolving credit agreement at
essentially the same terms and conditions with a new expiration date of
September 2008. In December 2004, the Company utilized a portion of this
revolving credit agreement to accelerate full repayment of its two term
loans, aggregating $1,658,000, which were outstanding at the beginning of
the quarter ended December 31, 2004.
6.) Geographical Data
The revenues attributable to the Company's domestic and foreign operations
for the periods presented are summarized in the following tabulation (in
thousands):
Three Months Six Months
Ended December 31, Ended December 31,
------------------- ------------------
2004 2003 2004 2003
-------- -------- -------- --------
Sales to external customers (1):
Domestic $ 13,576 $ 12,174 $ 25,038 $ 20,148
Foreign 2,443 2,455 4,421 4,316
-------- -------- -------- --------
Total Net Sales $ 16,019 $ 14,629 $ 29,459 $ 24,464
======== ======== ======== ========
(1) All of the Company's sales occur in the United States and are shipped
primarily from the Company's facilities in the United States and United
Kingdom. There were no sales into any one foreign country in excess of 10%
of Net Sales.
11
7) Commitments and Contingencies
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.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Napco Security Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
This Quarterly Report on Form 10-Q and the information incorporated by reference
may include "Forward-Looking Statements" within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Exchange Act of 1934. The
Company intends the Forward-Looking Statements to be covered by the Safe Harbor
Provisions for Forward-Looking Statements. All statements regarding the
Company's expected financial position and operating results, its business
strategy, its financing plans and the outcome of any contingencies are
Forward-Looking Statements. The Forward-Looking Statements are based on current
estimates and projections about our industry and our business. Words such as
"anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates,"
or variations of such words and similar expressions are intended to identify
such Forward-Looking Statements. The Forward-Looking Statements are subject to
risks and uncertainties that could cause actual results to differ materially
from those set forth or implied by any Forward-Looking Statements. Factors that
could cause actual results to differ materially from the Forward-Looking
Statements include, but are not limited to, adverse tax consequences of offshore
operations, distribution problems, unforeseen environmental liabilities and the
uncertain military, political and economic conditions in the world. The Company
assumes no obligation to update publicly the Forward-Looking Statements
contained herein, whether as a result of new information, future events or
otherwise, except as may be required by law.
Critical Accounting Policies
The Company's consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States of America
which require, in some cases, that certain estimates and assumptions be made
that affect the amounts and disclosures reported in the those financial
statements and the related accompanying notes. Estimates are based on current
facts and circumstances, prior experience and other assumptions believed to be
reasonable. Management uses its best judgment in valuing these estimates and
may, as warranted, solicit external advice. Actual results could differ from
these estimates, assumptions and judgments and these differences could be
material. The following critical accounting policies, some of which are impacted
significantly by estimates, assumptions and judgments, affect the Company's
consolidated financial statements. Our most critical accounting policies relate
to revenue recognition; concentration of credit risk; inventory; goodwill and
other intangible assets; and income taxes.
Revenue Recognition
Revenues from merchandise sales are recorded at the time the product is shipped
or delivered to the customer pursuant to the terms of purchase. We report our
sales levels on a net sales basis, which is computed by deducting from gross
sales the amount of actual returns received and an amount established for
anticipated returns and allowances.
Our sales return accrual is a subjective critical estimate that has a direct
impact on reported net sales. This accrual is calculated based on a history of
gross sales and actual sales returns, as well as management's estimate of
anticipated returns and allowances.
Business Concentration and Credit Risk
An entity is more vulnerable to concentrations of credit risk if it is exposed
to risk of loss greater than it would have had it mitigated its risk through
diversification of customers. Such risks of loss are manifest differently,
depending on the nature of the concentration, and vary in significance. The
Company has two major customers with Sales and Accounts receivable as follows
(in thousands):
Sales for the three months ended December 31,
---------------------------------------------
2004 2003
----- -----
$ % $ %
----- -- ----- --
Customer A 1,458 9% 1,160 8%
Customer B 1,120 7% 881 6%
----- -- ----- --
2,578 16% 2,041 14%
===== == ===== ==
13
Sales for the six months ended December 31,
-------------------------------------------
2004 2003
----- -----
$ % $ %
----- -- ----- --
Customer A 2,560 9% 1,211 5%
Customer B 2,099 7% 1,573 6%
----- -- ----- --
4,659 16% 2,784 11%
===== == ===== ==
Accounts Receivable as of:
-------------------------------------------
December 31,
2004 June 30, 2004
----- -------------
$ % $ %
----- -- ----- --
Customer A 2,448 14% 2,071 10%
Customer B 4,334 25% 4,197 21%
----- -- ----- --
6,782 39% 6,268 31%
===== == ===== ==
These customers sell primarily within North America. Although management
believes that these customers are sound and creditworthy, a severe adverse
impact on their business operations could have a corresponding material adverse
effect on our net sales, cash flows, and/or financial condition. In the ordinary
course of business, we have established an allowance for doubtful accounts and
customer deductions in the amount of $320,000 and $355,000 as of December 31,
2004 and June 30, 2004, respectively. Our allowance for doubtful accounts is a
subjective critical estimate that has a direct impact on reported net earnings.
This reserve is based upon the evaluation of accounts receivable aging, specific
exposures and historical trends.
Inventories
We state our inventory at the lower of cost or fair market value, with cost
being determined on the first-in, first-out (FIFO) method. We believe FIFO most
closely matches the flow of our products from manufacture through sale. The
reported net value of our inventory includes finished saleable products,
work-in-process and raw materials that will be sold or used in future periods.
Inventory cost includes raw materials, direct labor and overhead.
We also record an inventory obsolescence reserve, which represents the
difference between the cost of the inventory and its estimated fair market
value, based on various product sales projections. This reserve is calculated
using an estimated obsolescence percentage based on age, historical trends and
requirements to support forecasted sales. In addition, and as necessary, we may
establish specific inventory obsolescence reserves for known or anticipated
events. For interim financial statements, inventories are calculated using a
gross profit percentage.
Goodwill and Other Intangible Assets
Goodwill is calculated as the excess of the cost of purchased businesses over
the value of their underlying net assets. Goodwill is not amortized. Other
intangible assets are not material.
On an annual basis, we test goodwill for impairment. To determine the fair value
of these intangible assets, there are many assumptions and estimates we choose.
To mitigate undue influence, we use industry accepted valuation models and set
criteria that are reviewed and approved by various levels of management. We
evaluate our recorded goodwill with the assistance of a third-party valuation
firm.
Income taxes
We have accounted for, and currently account for, income taxes in accordance
with SFAS No. 109, "Accounting for Income Taxes". This statement establishes
financial accounting and reporting standards for the effects of income taxes
that result from an enterprise's activities during the current and preceding
years. It requires an asset and liability approach for financial accounting and
reporting of income taxes.
14
Stock Dividend
In November 2004, the Company's Board of Directors approved a twenty percent
(20%) stock dividend of the Company's common stock payable to stockholders of
record on November 22, 2004. The additional shares were distributed on December
6, 2004. The effect of the stock dividend has been retroactively reflected in
all share and per share data. As a result, all references to numbers of shares
have been increased by 20%, and there has been a corresponding decrease to all
per share amounts, throughout this entire document for all periods presented.
This resulted in a reduction in earnings per share due to the increase in the
weighted average number of shares outstanding as a result of the 20% stock
dividend. Retroactive adjustment to all share and per share data is necessary to
assure such information is comparable for all periods presented. There is no net
effect on total stockholders' equity as a result of the stock dividend.
The following table shows the effect of retroactively reflecting this 20% stock
dividend on earnings per share for the three and six months ended December 31,
2004 and December 31, 2003 (in thousands except share and per share data):
Three months ended Six months ended
December 31, 2003 December 31, 2003
------------------ -----------------
Net income $ 728 $ 446
Earnings per share before retroactive effect of 20%
stock dividend:
Basic $ 0.11 $ 0.07
Diluted $ 0.11 $ 0.06
Weighted average number of shares outstanding before
retroactive effect of 20% stock dividend:
Basic 6,435,701 6,416,547
Diluted 6,884,223 6,887,494
Earnings per share as reported (after giving
effect of 20% stock dividend):
Basic $ 0.09 $ 0.06
Diluted $ 0.09 $ 0.05
Weighted average number of shares outstanding as reported (after
giving effect of 20% stock dividend):
Basic 7,718,707 7,699,856
Diluted 8,256,933 8,264,993
15
Results of Operations
Three months ended December 31, Six months ended December 31,
------------------------------------ ------------------------------------
Increase/ Increase/
2004 2003 (decrease) 2004 2003 (decrease)
---------- ---------- ---------- ---------- ---------- ----------
Net sales $ 16,019 $ 14,629 $ 1,390 $ 29,459 $ 24,464 $ 4,995
Gross profit 4,918 4,552 366 9,191 7,535 1,656
Gross profit as a % of net sales 30.7% 31.1% (0.4%) 31.2% 30.8% 0.4%
Selling, general and administrative 3,468 3,305 163 6,840 6,582 258
Income from operations 1,450 1,247 203 2,351 953 1,398
Interest expense 58 102 (44) 126 230 (104)
Other expense 55 24 31 98 36 62
Provision for income taxes 465 393 72 742 241 501
Net income 872 728 144 1,385 446 939
Sales for the three months ended December 31, 2004 increased by 10% to
$16,019,000 as compared to $14,629,000 for the same period a year ago. Sales for
the six months ended December 31, 2004 increased by 20% to $29,459,000 as
compared to $24,464,000 for the same period a year ago. The increase in net
sales for the three and six months ended December 31, 2004 was primarily due to
increased sales of the Company's burglar alarm products. Sales in the first two
fiscal quarters of last year were adversely affected by a major distributor's
introduction of its company-wide inventory reduction program. During the quarter
ended December 31, 2003, the Company began the process of realigning its burglar
alarm products distribution network, which culminated in the termination of the
aforementioned major burglar alarm distributor. The Company reallocated its
burglar alarm products business across its extensive national network of
independent distributors. Management believes that this realignment of its
distribution network resulted in increased sales during the first two quarters
of fiscal 2005.
The Company's gross profit for the three months ended December 31, 2004
increased by $366,000 to $4,918,000 or 30.7% of sales as compared to $4,552,000
or 31.1% of sales for the same period a year ago. Gross profit for the six
months ended December 31, 2004 increased by $1,656,000 to $9,191,000 or 31.2% of
sales as compared to $7,535,000 or 30.8% of sales for the same period a year
ago. The increase in dollars was due primarily to the increase in sales as
discussed above. During the three and six months ended December 31, 2004, gross
profit as a percentage of sales was affected by an unfavorable change in the
foreign currency exchange rate relating to the Company's Dominican Republic
manufacturing facility which was substantially offset by more efficient overhead
absorption due to the increase in sales described above.
Selling, general and administrative expenses for the three months ended December
31, 2004 increased by $163,000 to $3,468,000, or 21.6% of sales, as compared to
$3,305,000, or 22.6% of sales a year ago. Selling, general and administrative
expenses for the six months ended December 31, 2004 increased by $258,000 to
$6,840,000, or 23.2% of sales, as compared to $6,582,000, or 26.9% of sales a
year ago. The increase in dollars and the decline in Selling, general and
administrative expenses as a percentage of sales for the three and six months
ended December 31, 2004 were due primarily to net sales increasing as described
above while non-variable expenses remained relatively constant.
Interest expense for the three months ended December 31, 2004 decreased by
$44,000 to $58,000 from $102,000 for the same period a year ago. Interest
expense for the six months ended December 31, 2004 decreased by $104,000 to
$126,000 from $230,000 for the same period a year ago. The change for the three
and six months resulted primarily from the reduction in the Company's average
outstanding debt.
Other Income/expense for the three months ended December 31, 2004 increased by
$31,000 to $55,000 from $24,000 for the same period a year ago. Other
Income/expense for the six months ended December 31, 2004 increased by $62,000
to $98,000 from $36,000 for the same period a year ago. This increase resulted
primarily from expenses related to the Company's joint venture in the Middle
East, which was formed in April of 2004.
The Company had a provision for income taxes for the three months ended December
31, 2004 of $465,000 as compared to $393,000 for the same period a year ago.
Provision for income taxes for the six months ended December 31, 2004 increased
by $501,000 to $742,000 as compared to $241,000 for the same period a year ago.
The tax provisions are calculated using an estimated effective tax rate of 35%.
Net income increased by $144,000 to $872,000 or $0.10 per share for the three
months ended December 31, 2004 as compared to $728,000 or $0.09 per share for
the same period a year ago. For the six months ended December 31, 2004 net
income increased by
16
$939,000 to $1,385,000 or $0.16 per share as compared to $446,000 or $0.06 per
share for the same period a year ago. The effect of the 20% stock dividend
discussed above has been retroactively reflected in all per share data. These
changes were primarily due to the items discussed above.
Liquidity and Capital Resources
During the six months ended December 31, 2004 the Company utilized a portion of
its cash generated from operations to reduce certain of its outstanding
borrowings (by $3,937,000), purchase property, plant and equipment ($483,000)
and invest in additional inventory ($400,000) as discussed below. The Company's
management believes that current working capital, cash flows from operations and
its revolving credit agreement will be sufficient to fund the Company's
operations through at least the second quarter of fiscal 2006.
Accounts Receivable at December 31, 2004 decreased $2,833,000 to $17,094,000 as
compared to $19,927,000 at June 30, 2004. This decrease is primarily the result
of the higher sales volume during the quarter ended June 30, 2004 as compared to
the quarter ended December 31, 2004.
Inventory at December 31, 2004 increased by $398,000 to $14,992,000 as compared
to $14,594,000 at June 30, 2004. This increase was primarily the result of the
Company's level-loading its production schedule in anticipation of its
historical sales cycle where a larger portion of the Company's sales occur in
the latter fiscal quarters as compared to the earlier quarters as well as a
reduction in the Company's inventory reserve of $205,000.
In January 2003, the Company repurchased 500,000 shares of its common stock from
two stockholders, unaffiliated with the Company, at $4.07 per share, a discount
from its then current trading price of $4.17. 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 was
being repaid in 60 equal monthly installments commencing on April 30, 2003. In
December 2004, the Company accelerated the remaining installments and repaid the
term loan in full.
During the first quarter of fiscal 2001, the Company entered into an $8,250,000
term loan agreement, payable over 60 equal monthly installments, in order to
purchase the assets of Continental Instruments, LLC. In December 2004, the
Company accelerated the remaining installments and repaid the term loan in full.
As of December 31, 2004, the Company's credit facilities consist of an
$18,000,000 secured revolving credit agreement. In April 2004 the Company's bank
approved an extension of the expiration date of the secured revolving credit
agreement from January 2005 to April 2005. In October 2004 the Company
renegotiated this secured revolving credit agreement at essentially the same
terms and conditions with a new expiration date of September 2008. In December
2004, the Company utilized a portion of this revolving credit agreement to
accelerate repayment of the term loans described above. As of December 31, 2004
there was $13,637,000 available under this secured revolving credit facility.
As of December 31, 2004 the Company had no material commitments for capital
expenditures or inventory purchases other than purchase orders used in the
normal course of business.
ITEM 3: Quantitative and Qualitative Disclosures About Market Risk
The Company's principal financial instrument is long-term debt consisting of a
revolving credit and term loan facility that provides for interest at a spread
above the prime rate. The Company is affected by market risk exposure primarily
through the effect of changes in interest rates on amounts payable by the
Company under this credit facility. A significant rise in the prime rate could
materially adversely affect the Company's business, financial condition and
results of operations. At December 31, 2004 an aggregate amount of approximately
$4,400,000 was outstanding under this facility. If these borrowings remained at
this quarter-end level for an entire year and the prime rate increased or
decreased, respectively, by 1% the Company would pay or save, respectively, an
additional $44,000 in interest that year.
Where appropriate, the Company requires that letters of credit be provided on
foreign sales. In addition, a significant number of transactions by the Company
are denominated in U.S. dollars. As such, the Company has shifted foreign
currency exposure onto many of its foreign customers. As a result, if exchange
rates move against foreign customers, the Company could experience difficulty
collecting unsecured accounts receivable, the cancellation of existing orders or
the loss of future orders. The foregoing could materially adversely affect the
Company's business, financial condition and results of operations. In addition,
the Company transacts certain sales in Europe in British Pounds Sterling,
therefore exposing itself to a certain amount of foreign currency risk.
17
Management believes that the amount of this exposure is immaterial. We are also
exposed to foreign currency risk relative to the Dominican Peso ("RD$"), the
local currency of the Company's production facility in the Dominican Republic.
The result of a 10% strengthening in the U.S. dollar to our RD$ expenses would
result in an annual decrease in income from operations of approximately
$260,000.
ITEM 4: Controls and Procedures
At the end of the period covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company's
management, including the Company's Chief Executive Officer and Chief Financial
Officer, of the Company's disclosure controls and procedures pursuant to
Exchange Act Rule 13 a - 15(e). Based upon that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures are effective. During the second quarter of fiscal year
2005, 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.
PART II: OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders
(a) The annual meeting of stockholders ("the Annual Meeting") was held
on December 13, 2004.
(b) At the Annual Meeting, two directors were re-elected as Directors
through 2007:
Richard L. Soloway - 5,798,681 votes "for", 127,027 votes
"withheld", and
Kevin S. Buchel - 5,798,681 votes "for", 127,027 votes
"withheld"
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certification Pursuant to Rule 13a-14(a)/15d-14(a) of Richard
L. Soloway, Chairman of the Board and President
31.2 Certification Pursuant to Rule 13a-14(a)/15d-14(a) of Kevin S.
Buchel, Senior Vice President of Operations and Finance
32.1 Section 1350 Certifications
(b) Form 8-K Filings
None
18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
February 10, 2005
NAPCO SECURITY SYSTEMS, INC
(Registrant)
By: /s/ Richard L. Soloway
----------------------------------------------------------------------
Richard L. Soloway
Chairman of the Board of Directors, President and Secretary
(Chief Executive Officer)
By: /s/ Kevin S. Buchel
----------------------------------------------------------------------
Kevin S. Buchel
Senior Vice President of Operations and Finance and Treasurer
(Principal Financial and Accounting Officer)
19