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
For the fiscal year ended June 30, 2007
or
[ ]Transition Report Pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the Transition period from ______ to ______
Commission File Number 0-10004
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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: Common Stock, par
value $.01 per share
(Title of Each Class)
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the Registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act. Yes _ No _X_
Indicate by check mark if the Registrant is not required to file reports
pursuant to Section 13 or Section 15(d) of the Act. Yes _ No _X_
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 a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of "accelerated
filer" and "large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer _ Accelerated filer _X_ Non-accelerated filer _
Indicate by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Act). Yes _ No _X_
As of December 31, 2006, the aggregate market value of the common stock of
Registrant held by non-affiliates based upon the last sale price of the stock on
such date was $76,600,550.
As of September 25, 2007, 19,442,597 shares of common stock of Registrant 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
2007 Annual Meeting of Stockholders.
PART I
ITEM 1: BUSINESS.
NAPCO Security Systems, Inc. ("NAPCO" or the "Company") was incorporated in
December 1971 in the State of Delaware. Its executive offices are located at 333
Bayview Ave, Amityville NY 11701. Its telephone number is (631) 842-9400.
The Company is a diversified manufacturer of security products, encompassing
intrusion and fire alarms, building access control systems and electronic
locking devices. These products are used for commercial, residential,
institutional, industrial and governmental applications, and are sold worldwide
principally to independent distributors, dealers and installers of security
equipment.
Website Access to Company Reports
Copies of our filings under the Securities Exchange Act of 1934 (including
annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K and all amendments to these reports) are available free of charge on
our website (www.napcosecurity.com) on the same day they are electronically
filed with the Securities and Exchange Commission.
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, manufactures 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 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, 2007, 2006, and 2005, the Company
expended approximately $5,319,000, $5,109,000, and $4,865,000, 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, 2007, the Company had approximately 804 full-time employees.
Marketing
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 65% and 70% of the Company's total sales
for the fiscal years ended June 30, 2007 and 2006, 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.
In the ordinary course of the Company's business the Company grants extended
payment terms to certain customers. Those customers have materially complied
with the extended payment terms. For further discussion on Accounts Receivable
and Concentration of Credit Risk see disclosures included in Item 7.
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, 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 principal components in the Company's products are integrated circuits,
printed circuit boards, microprocessors, sheet metal, plastic resin, machined
and cast metal components. 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.
Seasonality
The Company's fiscal year begins on July 1 and ends on June 30. Historically,
the end users of Napco's products want to install its products prior to the
summer; therefore sales of its products peak in the period April 1 through June
30, the Company's fiscal fourth quarter, and are reduced in the period July 1
through September 30, the Company's fiscal first quarter. To a lesser degree,
sales in Europe are also adversely impacted in the Company's first fiscal
quarter because of European vacation patterns, i.e., many distributors and
installers are closed for the month of August. In addition, demand is affected
by the housing and construction markets.
Raw Materials
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.
Sales Backlog
In general, orders for the Products are processed by the Company from inventory.
A sales backlog of approximately $965,000 and $739,000 existed as of June 30,
2007 and 2006, 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
with these regulations 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.
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 table:
Financial Information Relating to Domestic and Foreign Operations
-----------------------------------------------------------------
2007 2006 2005
------------------- ------------------- ------------------
(in thousands)
Sales to external
customers(1):
Domestic $56,810 $58,549 $54,654
Foreign 9,392 10,999 10,575
------------------- ------------------- ------------------
Total Net Sales $66,202 $69,548 $65,229
=================== =================== ==================
Identifiable assets:
United States $47,636 $46,651 $41,753
Dominican Republic (2) 21,246 18,924 14,658
Other foreign countries 7,903 5,623 3,496
------------------- ------------------- ------------------
Total Identifiable Assets $76,785 $71,198 $59,907
=================== =================== ==================
(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) Consists primarily of inventories and fixed assets located at the Company's
principal manufacturing facility in the Dominican Republic.
ITEM 1A: RISK FACTORS.
The risks described below are among those that could materially and adversely
affect the Company's business, financial condition or results of operations.
These risks could cause actual results to differ materially from historical
experience and from results predicted by any forward-looking statements related
to conditions or events that may occur in the future.
Our Business Could Be Materially Adversely Affected as a Result of General
Economic and Market Conditions
------------------------------
We are subject to the effects of general economic and market conditions. If
these conditions deteriorate, our business, results of operations or financial
condition could be materially adversely affected.
Our Business Could Be Materially Adversely Affected as a Result of Housing
Market Conditions
-----------------
We are subject to the effects of housing market conditions. If these conditions
deteriorate, resulting in the decline in new housing starts, existing home sales
or existing home renovations, our business, results of operations or financial
condition could be materially adversely affected, particularly in our intrusion
product lines.
Our Business Could Be Materially Adversely Affected as a Result of Lessening
Demand in the Security Market
-----------------------------
Our revenue and profitability depend on the overall demand for our products.
Delays or reductions in spending, domestically or internationally, for
electronic security systems could materially adversely affect demand for our
products, which could result in decreased revenues or earnings.
The Markets We Serve Are Highly Competitive and We May Be Unable to Compete
Effectively
-----------
We compete with approximately 20 other companies that manufacture and market
security equipment to distributors, dealers, control stations and original
equipment manufacturers. Some of these companies may 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,
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.
Our Business Could be Materially Adversely Affected as a result of Offerring
Extended Payment Terms to Customers
-----------------------------------
We regularly grant credit terms beyond 30 days to our customers. These terms are
offered in an effort to keep a full line of our products in-stock at our
customers locations. The longer terms that are granted, the more risk is
inherent in collection of those receivables. We believe that our Bad Debt
reserves are adequate to account for this inherent risk.
Competitors May Develop New Technologies or Products in Advance of Us
---------------------------------------------------------------------
Our business may be materially adversely affected by the announcement or
introduction of new products and services by our competitors, and the
implementation of effective marketing or sales strategies by our competitors.
There can be no assurance that competitors will not develop products that are
superior to the Company's products. Further, there can be no assurance that the
Company will not experience additional price competition, and that such
competition may not adversely affect the Company's position and results of
operations.
The Company's Products are Subject to Technological Changes from Time to Time,
Which may Result in Increased Research and Developments Expenditures to Attract
or Retain Customers
-------------------
The industry in which the Company operates is characterized by constantly
improved products. Future success will depend, in part, on our ability to
continue to develop and market products and product enhancements
cost-effectively, which will require continued expenditures for product
engineering, sales and marketing. The Company's research and development
expenditures, which were $5,319,000 and $5,109,000 for 2007 and 2006,
respectively, are principally targeted at enhancing existing products, and to a
lesser extent at developing new ones. If the Company cannot modify its products
to meet its customers' changing needs, we may lose sales.
We Rely On Distributors To Sell Our Products And Any Adverse Change In Our
Relationship With Our Distributors Could Result In A Loss Of Revenue And Harm
Our Business.
-------------
We distribute our products primarily through independent distributors and
wholesalers of security alarm and security hardware equipment. Our distributors
and wholesalers also sell our competitors' products, and if they favor our
competitors' products for any reason, they may fail to market our products as
effectively or to devote resources necessary to provide effective sales, which
would cause our results to suffer. In addition, the financial health of these
distributors and wholesalers and our continuing relationships with them are
important to our success. Some of these distributors and wholesalers may be
unable to withstand adverse changes in business conditions. Our business could
be seriously harmed if the financial condition of some of these distributors and
wholesalers substantially weakens.
Members of Management and Certain Directors Beneficially Own a Substantial
Portion of the Company's Common Stock and May Be in a Position to Determine the
Outcome of Corporate Elections
------------------------------
Richard L. Soloway, our Chief Executive Officer, members of management and the
Board of Directors beneficially own 33% of the currently outstanding shares of
Common Stock. By virtue of such ownership and their positions with Napco, they
may have the practical ability to determine the election of all directors and
control the outcome of substantially all matters submitted to Napco's
stockholders.
In addition, Napco has a staggered Board of Directors. Such concentration of
ownership and the staggered Board could have the effect of making it more
difficult for a third party to acquire, or discourage a third party from seeking
to acquire, control of Napco.
We Are Dependent Upon the Efforts of Richard L. Soloway, Our Chief Executive
Officer
-------
The success of the Company is largely dependent on the efforts of Richard L.
Soloway, Chief Executive Officer. The loss of his services could have a material
adverse effect on the Company's business and prospects. There is currently no
succession plan.
Our Business Could Be Materially Adversely Affected by an Increase in the
Exchange Rate of the Dominican Peso
-----------------------------------
We are exposed to foreign currency risks due to our significant operations in
the Dominican Republic. We have significant operations in the Dominican Republic
which are denominated in Dominican pesos. We are subject to the risk that
currency exchange rates between the United States and the Dominican Republic
will fluctuate, potentially resulting in an increase in some of our expenses
when US dollars are transferred to Dominican pesos to pay these expenses.
ITEM 1B: UNRESOLVED STAFF COMMENTS.
Not applicable.
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'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, 2007, 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 space of approximately 800 square feet. This lease
expires in May 2008 and provides for an annual renewal at substantially the same
terms and conditions.
The Company's joint venture located in the United Arab Emirates leases office
and warehouse space of approximately 1,100 square feet. This lease expires in
February 2008 and provides for an annual renewal at substantially the same terms
and conditions..
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.
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.
Not Applicable
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, Global 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
Global Market System and as adjusted for the 3:2 stock split effective as of
June 2006 and the 3:2 stock split effective as of December 2005. In addition,
September 30, 2005 data is also adjusted to reflect the November 2004 20% stock
dividend.
Quarter Ended Fiscal 2007
-------------------------
Common Stock Sept. 30 Dec. 31 March 31 June 30
-------- ------- -------- -------
High $10.80 $6.67 $6.05 $6.35
Low $ 5.96 $5.38 $4.62 $5.33
Quarter Ended Fiscal 2006
-------------------------
Common Stock Sept. 30 Dec. 31 March 31 June 30
-------- ------- -------- -------
High $6.40 $7.604 $11.473 $11.767
Low $4.546 $5.147 $ 6.673 $ 8.32
Approximate Number of Security Holders
The number of holders of record of NAPCO's Common Stock as of September 19, 2007
was 128 (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 cash dividends must be approved by the Company's
primary lender.
Equity Compensation Plan Information as of June 30, 2007
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SECURITIES TO WEIGHTED AVERAGE FUTURE ISSUANCE
BE ISSUED UPON EXERCISE EXERCISE PRICE OF (EXCLUDING SECURITIES
OF OUTSTANDING OPTIONS OUTSTANDING OPTIONS REFLECTED IN COLUMN (a)
PLAN CATEGORY (a) (b) (c)
Equity compensation plans approved by 1,285,640 $2.81 528,520
security holders:
Equity compensation plans not approved __ __ __
by security holders:
-------------------------- ---------------------- -------------------------
Total 1,285,640 $2.81 528,520
========================== ====================== =========================
ISSUER PURCHASES OF EQUITY SECURITIES
-------------------------------------------------------------------------------------------------------------------
Period Total Number of Average Price Total Number of Maximum Number of
Shares Purchased Paid per Share Shares Purchased as Shares that May Yet
Part of Publically Be Purchased Under
Announced Plans or Plans or Programs
Programs
-------------------------------------------------------------------------------------------------------------------
April 1, 2007 - April 30, 2007 85,400 $5.66 85,400 735,000
May 1, 2007 - May 31, 2007 78,653 $5.97 78,653 656,347
June 1, 2007 - June 30, 2007 81,519 $5.97 81,519 574,828
-------------------------------------------------------------------------------------------------------------------
Total for the quarter ended June 30, 2007 245,572 $5.86 245,572 574,828
======= =======
-------------------------------------------------------------------------------------------------------------------
On March 16, 2007, the Company announced that its Board of Directors authorized
the repurchase of up to one million (1,000,000) shares of its common stock.
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 and per share data)
2007 2006 2005(1) 2004(1) 2003(1)
---- ---- ---- ---- ----
Statement of earnings data:
Net Sales $66,202 $69,548 $65,229 $58,093 $57,340
Gross Profit 23,189 25,941 23,924 19,540 15,401
Income from Operations 6,501 9,523 8,910 6,065 2,225
Net Income 4,217 6,119 5,629 3,335 1,010
Cash Flow Data:
Net cash flows (used in) provided by (3,674) (168) 7,205 6,275 6,482
operating activities
Net cash flows used in investing (1,294) (1,679) (658) (681) (752)
activities
Net cash flows provided by (used in) 3,978 3,407 (6,165) (6,592) (5,436)
financing activities
Per Share Data:
---------------
Net earnings per common share:
Basic $.21 $.31 $.29 $.19 $.06
Diluted $.20 $.30 $.28 $.17 $.05
Weighted average common shares outstanding:
Basic 19,961,000 19,785,000 19,265,000 17,906,000 17,942,000
Diluted 20,599,000 20,605,000 20,284,000 19,119,000 19,208,000
Cash Dividends declared per common $.00 $.00 $.00 $.00 $.00
share (2)
Balance sheet data (3):
Working capital $41,480 $36,321 $31,017 $28,992 $28,843
Total assets 76,785 71,198 59,907 56,672 57,349
Long-term debt 10,900 4,700 1,950 6,400 14,100
Stockholders' equity 53,257 50,850 43,678 37,904 33,357
(1) Share and per share data have been restated to reflect the effect of a 2:1
stock split effective April 2004, a 20% stock dividend effective November
2004, a 3:2 stock split effective December 2005 and a 3:2 stock split
effective June 2006.
(2) 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 approved by the Company's
primary lender.
(3) 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.
Overview
The Company is a diversified manufacturer of security products, encompassing
intrusion and fire alarms, building access control systems and electronic
locking devices. These products are used for commercial, residential,
institutional, industrial and governmental applications, and are sold worldwide
principally to independent distributors, dealers and installers of security
equipment. International sales accounted for approximately 14% of our revenues
for fiscal year 2007 and 16% of revenues for fiscal year 2006.
The Company owns and operates manufacturing facilities in Amityville, New York
and the Dominican Republic. A significant portion of our operating costs are
fixed, and do not fluctuate with changes in customer demand or utilization of
our manufacturing capacity. As product demand rises and factory utilization
increases, the fixed costs are spread over increased output, which should
improve profit margins. Conversely, when sales decline our fixed costs are
spread over reduced levels, thereby decreasing margins.
In February 2004 the Company entered into a joint venture with an unrelated
company to sell security-related products, including those manufactured by the
Company, in the Middle East. The Company owns 51% of the newly formed company,
an LLC organized in New York, which has its main operations in the United Arab
Emirates. Revenues generated by this joint venture were approximately 3% of our
revenues for fiscal 2007.
The security products market is characterized by constant incremental innovation
in product design and manufacturing technologies. Generally, the Company devotes
7-8% of revenues to research and development (R&D) on an annual basis. Products
resulting from our R&D investments in fiscal 2007 did not contribute materially
to revenue during this fiscal year, but should benefit the Company over future
years. In general, the new products introduced by the Company are initially
shipped in limited quantities, and increase over time. Prices and manufacturing
costs tend to decline over time as products and technologies mature.
Economic and Other Factors
The post-September 11 era has generally been characterized by increased demand
for electronic security products and services. The Company believes the security
equipment market is likely to continue to exhibit healthy growth, particularly
in industrial sectors, due to ongoing concerns over the adequacy of security
safeguards. The Company's business is also affected by the housing markets.
During periods of increased construction of new homes and renovations, demand
for the Company's intrusion products is higher.
Seasonality
The Company's fiscal year begins on July 1 and ends on June 30. Historically,
the end users of Napco's products want to install its products prior to the
summer; therefore sales of its products peak in the period April 1 through June
30, the Company's fiscal fourth quarter, and are reduced in the period July 1
through September 30, the Company's fiscal first quarter. To a lesser degree,
sales in Europe are also adversely impacted in the Company's first fiscal
quarter because of European vacation patterns, i.e., many distributors and
installers are closed for the month of August. In addition, demand is affected
by the housing and construction markets.
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, rebates and allowances were 8%, 7% and 6% in fiscal 2007, 2006
and 2005, 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 if 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 with accounts receivable balances that aggregated
38% and 33% of the Company's accounts receivable at June 30, 2007 and 2006,
respectively. Sales to neither of these customers exceeded 10% of net sales in
any of the past three fiscal years.
In the ordinary course of business, we have established a reserve for doubtful
accounts and customer deductions in the amount of $365,000 and $420,000 as of
June 30, 2007 and 2006, respectively. Our reserve 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.
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 costs include
raw materials, direct labor and overhead. The Company's overhead expenses are
applied based, in part, upon estimates of the proportion of those expenses that
are related to procuring and storing raw materials as compared to the
manufacture and assembly of finished products. These proportions, the method of
their application, and the resulting overhead included in ending inventory, are
based in part on subjective estimates and approximations and actual results
could differ from those estimates.
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, requirements to support forecasted sales, and
the ability to find alternate applications of its raw materials and to convert
finished product into alternate versions of the same product to better match
customer demand. There is inherent professional judgment and subjectivity made
by both production and engineering members of management in determining the
estimated obsolescence percentage. In addition, and as necessary, the Company
may establish specific reserves for future known or anticipated events.
The Company also regularly reviews the period over which its inventories will be
converted to sales. Any inventories expected to convert to sales beyond 12
months from the balance sheet date are classified as non-current.
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.
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 its goodwill
is not impaired.
Income Taxes
Deferred income taxes are recognized for the expected future tax consequences of
temporary differences between the amounts reflected for financial reporting and
tax purposes. Net deferred tax assets are adjusted by a valuation allowance if,
based on the weight of available evidence, it is more likely than not that some
portion or all of the net deferred tax assets will not be realized. If the
Company determines that a deferred tax asset will not be realizable or that a
previously reserved deferred tax asset will become realizable, an adjustment to
the deferred tax asset will result in a reduction of, or increase to, earnings
at that time. The provision (benefit) for income taxes represents U.S. Federal,
state and foreign taxes. Through June 30, 2001, the Company's subsidiary in the
Dominican Republic, Napco/Alarm Lock Group International, S.A. ("Napco DR"), was
not subject to tax in the United States, as a result, no taxes were provided.
Effective July 1, 2001, the Company made a domestication election for Napco DR.
Accordingly, its income has been subject to taxation in the United States on a
going forward basis.
In March 2003, Napco Security Systems, Inc. timely filed its income tax return
for the fiscal year ended June 30, 2002. This return included an election to
treat one of the Company's foreign subsidiaries, Napco DR, as if it were a
domestic corporation beginning July 1, 2001. This election was based on a then
recently enacted Internal Revenue Code ("Code") provision. As a result of this
election, Napco DR is treated, for Federal income tax purposes, as transferring
all of its assets to a domestic corporation in connection with an exchange.
Although this type of transfer usually results in the recognition of taxable
income to the extent of any untaxed earnings and profits, the Code provision
provides an exemption for applicable corporations. The Company qualifies as an
applicable corporation pursuant to this Code section, and based on this Code
exemption, the Company treated the transfer of approximately $27,000,000 of
Napco DR's untaxed earnings and profits as nontaxable.
The Internal Revenue Service has issued a Revenue Procedure which is
inconsistent with the Code exemption described above. The Code is the actual
law; a Revenue Procedure is the IRS's interpretation of the law. The Code has a
higher level of authority than a Revenue Procedure. Management believes that it
has appropriately relied on the guidance in the Code when filing its income tax
return. If challenged, the Company believes that the potential liability would
have ranged from $0 to $9,450,000. However, the Company also believes there were
other mitigating factors that would limit the amount of the potential liability,
and as a result, management accrued a liability of $2,243,000 as of June 30,
2002. As of June 30, 2007, $407,000 of this accrued liability was no longer
required as a result of the lapse in the applicable statute of limitations. The
Company reduced this accrued liability accordingly during fiscal 2007 which
reduced the Company's effective tax rate from approximately 37.9% to 31.3% for
the fiscal year ended June 30, 2007. The statute of limitations on the remainder
of this accrued liability of $1,836,000 will lapse in fiscal 2008. The Company
has not accrued any related interest or penalties. The Company's tax provision
utilizes estimates made by management and as such, is subject to change as
described in Note 1 of the Consolidated financial statements.
Liquidity and Capital Resources
The Company's cash on hand combined with proceeds from operating and financing
activities during fiscal 2007 were adequate to meet the Company's capital
expenditure needs and short and long-term debt obligations. The Company's
primary internal source of liquidity is the cash flow generated from operations.
The primary source of financing related to borrowings under an $18,000,000
secured revolving credit facility, increased to $25,000,000 subsequent to June
30, 2007. 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. As of June 30, 2007, the Company's unused
sources of funds consisted principally of $1,748,000 in cash and approximately
$7,100,000, which represents the unused portion of its secured revolving credit
facility. 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 2009.
The Company is a party to an amended and restated secured revolving credit
agreement with its primary bank, pursuant to which borrowing capacity is
$25,000,000. Amounts under the amended revolving credit agreement are secured by
all the accounts receivable, inventory and certain other assets of the Company,
including a first and second mortgage on the Company's headquarters in
Amityville, New York and common stock of certain 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. In September
2007, the revolving credit agreement was increased from $18,000,000 to
$25,000,000 and extended from September 2008 to September 2011. Any outstanding
borrowings must be repaid or refinanced on or before that time. The agreement
contains various restrictions and covenants including, among others,
restrictions on payment of cash 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 2007, the Company exceeded the
restriction on capital expenditures for which it received the appropriate waiver
from its primary bank.
The Company takes into consideration a number of factors in measuring its
liquidity, including the ratios set forth below:
2007 2006 2005
---- ---- ----
Current Ratio 5.4 to 1 4.1 to 1 4.0 to 1
Sales to Receivables 2.6 to 1 2.8 to 1 3.0 to 1
Total debt to equity .20 to 1 .09 to 1 .04 to 1
As of June 30, 2007, the Company had no material commitments for capital
expenditures or inventory purchases other than purchase orders issued in the
normal course of business. 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.
Working Capital. Working capital increased by $5,159,000 to $41,480,000 at June
30, 2007 from $36,321,000 at June 30, 2006. The increase in working capital was
primarily the result of the Company's net income and an increase in inventories
and long-term debt. Working capital is calculated by deducting Current
Liabilities from Current Assets.
Accounts Receivable. Accounts Receivable increased by $426,000 to $25,579,000 at
June 30, 2007 from $25,153,000 at June 30, 2006. This increase resulted
primarily from the granting of additional payment terms to certain of the
Company's burglar alarm customers during the fourth quarter of fiscal 2007 as
compared to the fourth quarter of fiscal 2006.
Inventories. Inventories increased by $5,557,000 to $28,223,000 at June 30, 2007
as compared to $22,666,000 at June 30, 2006. The increase in inventory levels
was primarily the result of the Company's increased production in anticipation
of increased sales of some of the Company's core and newer products which did
not occur during fiscal 2007. In the second half of fiscal 2007 the Company
reduced its production rates and delayed delivery of some of its raw material
purchases in order to reduce its inventory levels. During fiscal 2007 the
Company also in-sourced the manufacturing of the majority of its access control
products which had been manufactured by a subcontractor. These changes resulted
in additional overhead expenses in the form of procurement and production
support from the Company's engineering department in NY as well as from a shift
in certain previously production-related overhead expenses to raw-materials. The
Company anticipates that the inventory levels of its core products will return
to more normal levels in fiscal 2008.
Accounts Payable and Accrued Expenses. Accounts payable and accrued expenses
decreased by $704,000 to $9,314,000 as of June 30, 2007 as compared to
$10,018,000 at June 30, 2006. This decrease is primarily due to decreased
purchases of raw materials during the fourth quarter, which was part of the
Company's program to reduce its inventory levels from the increased levels at
mid-year as previously discussed.
Off-Balance Sheet Arrangements
The Company does not maintain any off-balance sheet arrangements.
Contractual Obligations
The following table summarizes the Company's contractual obligations by fiscal
year:
Payments due by period
----------------------------------------------------------------------------------
Contractual obligations Total Less than 1 year 1-3 years 3-5 years More than 5 years
----------------------- ----------- ---------------- ----------- ----------- -----------------
Long-term debt obligations $10,900,000 $ -- $ -- $10,900,000 $ --
Land lease (86 years remaining) (1) 24,480,000 288,000 576,000 576,000 23,040,000
Operating lease obligations 198,000 114,000 84,000 -- --
Other long-term obligations
(employment agreements) (1) 1,134,000 1,039,000 95,000 -- --
-------------------------------------------------------------------------------------
Total $36,712,000 $1,441,000 $755,000 $11,476,000 $23,040,000
=====================================================================================
(1) see footnote 11 to the consolidated financial statements.
Results of Operations
Fiscal 2007 Compared to Fiscal 2006
Fiscal year ended June 30,
--------------------------
% Increase/
2007 2006 (decrease)
---- ---- -----------
Net sales $ 66,202 $ 69,548 (4.8)%
Gross profit 23,189 25,941 (10.6)%
Gross profit as a % of net sales 35.0% 37.3% (2.3)%
Selling, general and administrative 16,688 16,418 1.6%
Income from operations 6,501 9,523 (31.7)%
Interest expense, net 637 258 146.9%
Other expense, net 17 14 21.4%
Provision for income taxes 1,922 3,264 (41.1)%
Net income 4,217 6,119 (31.1)%
Net Sales. Net sales in fiscal 2007 decreased by 4.8% to $66,202,000 from
$69,548,000 in fiscal 2006. The decrease in sales was primarily due to decreased
sales of the Company's burglar alarm products ($6,407,000), which management
believes was impacted by the slowdown in the U.S. housing market and reduced
demand in the Company's European market, as partially offset by increased sales
of door-locking and access control products ($2,290,000).
Gross Profit. The Company's gross profit decreased $2,752,000 to $23,189,000 or
35.0% of net sales in fiscal 2007 as compared to $25,941,000 or 37.3% of net
sales in fiscal 2005. The decrease in gross profit in both absolute dollars and
as a percentage of net sales was due primarily to the decreased overhead
absorption resulting in the Company's reduction in its production levels in the
second half of fiscal 2007 which was due to the decrease in net sales during the
year.
Selling, general and administrative expenses as a percentage of net sales
increased to 25.2% in fiscal 2007 from 23.6% in fiscal 2006. Selling, general
and administrative expenses for fiscal 2007 increased by $270,000 to $16,688,000
from $16,418,000 in fiscal 2006. These increases are due primarily to increases
in certain salesman compensation expenses ($497,000) as partially offset by
decreases in the Company's Sarbanes-Oxley compliance costs ($107,000) and bad
debt expense ($125,000).
Interest expense for fiscal 2007 increased by $379,000 to $637,000 from $258,000
for the same period a year ago. The increase in interest expense is primarily
the result of the increase in outstanding debt and an increase in interest rates
available to the Company during fiscal 2007.
Other Expenses. Other expenses remained relatively constant at $17,000 in fiscal
2007 as compared to $14,000 in fiscal 2006.
Fiscal 2006 Compared to Fiscal 2005
Fiscal year ended June 30,
2006 2005 % Increase/
(decrease)
---- ---- -----------
Net sales $ 69,548 $ 65,229 6.6%
Gross profit 25,941 23,924 8.4%
Gross profit as a % of net sales 37.3% 36.7% 0.6%
Selling, general and administrative 16,418 15,014 9.4%
Income from operations 9,523 8,910 6.9%
Interest expense, net 258 224 15.2%
Other expense, net 14 58 (75.9)%
Provision for income taxes 3,264 3,227 1.1%
Net income 6,119 5,629 8.7%
Net Sales. Net sales in fiscal 2006 increased by 6.6% to $69,548,000 from
$65,229,000 in fiscal 2005. The Company's sales growth was primarily due to
increased sales of the Company's burglar alarm products within the United
States. In fiscal 2004, the Company terminated a major burglar alarm distributor
and reallocated its burglar alarm products business across its extensive
national network of independent distributors. During fiscal 2006, the Company
continues to see the positive effects of this realignment reflected in the
increase in net sales described above as well as the increase in gross profit
resulting from the increased sales as discussed below.
Gross Profit. The Company's gross profit increased $2,017,000 to $25,941,000 or
37.3% of net sales in fiscal 2006 as compared to $23,924,000 or 36.7% of net
sales in fiscal 2005. The increase in gross profit in both absolute dollars and
as a percentage of net sales was due primarily to the increased overhead
absorption associated with the increase in net sales and a decrease in the
Company's inventory obsolescence reserve of $531,000, resulting primarily from
the increase in net sales.
Selling, general and administrative expenses as a percentage of net sales
increased slightly to 23.6% in fiscal 2006 from 23.0% in fiscal 2005. Selling,
general and administrative expenses for fiscal 2006 increased by $1,404,000 to
$16,418,000 from $15,014,000 in fiscal 2005. These increases are due primarily
to variable expenses relating to the increased sales described above ($766,000),
the recording of non-cash compensation expenses beginning in fiscal 2006 in
accordance with FAS123R ($396,000) and expenses relating to the Company's
operations in Dubai ($169,000).
Interest expense for fiscal 2006 increased by $34,000 to $258,000 from $224,000
for the same period a year ago. The increase in interest expense is primarily
the result of the increase in interest rates available to the Company during
fiscal 2006.
Other Expenses. Other expenses decreased by $44,000 to $14,000 in fiscal 2006 as
compared to $58,000 in fiscal 2005, primarily as the result of the completion of
amortization of capitalized loan costs during fiscal 2006.
Stock Dividend and Stock Split
On May 10, 2006 the Company's Board of Directors approved a 3-for-2 stock split
of its common stock, to be paid in the form of a 50% stock dividend to
stockholders of record on May 24, 2006. The Company delivered the shares on June
7, 2006. Upon completion of the split, the total number of shares of common
stock outstanding increased from approximately 13,300,000 to approximately
19,950,000.
In November 2005 the Company's Board of Directors approved a 3-for-2 split of
its common stock, payable in the form of a 50% stock dividend to stockholders of
record on December 14, 2005. The additional shares were distributed on December
28, 2005. Upon completion of the split, the total number of shares of common
stock outstanding increased from approximately 8,795,000 to approximately
13,192,000.
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.
All share and per share amounts (except par value) have been retroactively
adjusted to reflect the stock splits and dividend. There was no net effect on
total stockholders' equity as a result of these transactions.
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. For example,
the Company is highly dependent on its Chief Executive Officer for strategic
planning. If he is unable to perform his services for any significant period of
time, the Company's ability to continue growing could be adversely affected. In
addition, factors that could cause actual results to differ materially from the
Forward-Looking Statements include, but are not limited to, adverse tax
consequences of offshore operations, distribution problems, unforeseen
environmental liabilities and the uncertain military, political and economic
conditions in the world. The Company's Risk Factors are discussed in more detail
in Item 1A.
ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company's principal financial instrument is long-term debt (consisting of a
revolving credit 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. At June 30, 2007, an aggregate principal amount of
approximately $10,900,000 was outstanding under the Company's credit facility
with a weighted average interest rate of approximately 6.6%. 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
$109,000 in interest that year.
A significant number of foreign sales transactions by the Company are
denominated in U.S. dollars. As such, the Company has shifted foreign currency
exposure onto many of its foreign customers. As a result, if exchange rates move
against foreign customers, the Company could experience difficulty collecting
unsecured accounts receivable, the cancellation of existing orders or the loss
of future orders. The foregoing could materially adversely affect the Company's
business, financial condition and results of operations. In addition, the
Company transacts certain sales in Europe in British Pounds Sterling, therefore
exposing itself to a certain amount of foreign currency risk. Management
believes that the amount of this exposure is immaterial. We are also exposed to
foreign currency risk relative to expenses incurred in Dominican Pesos ("RD$"),
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 $415,000.
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-25 of this report as follows:
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
Page
----
Management Report on Internal Controls Over Financial Reporting FS-1
Report of Independent Registererd Public Accounting Firm on Internal Control Over Financial FS-2
Reporting
Report of Independent Registered Public Accounting Firm FS-3
Consolidated Financial Statements:
Consolidated Balance Sheets as of June 30, 2007 and 2006 FS-4
Consolidated Statements of Income for the Fiscal Years Ended June 30, 2007, 2006 and 2005 FS-6
Consolidated Statements of Stockholders' Equity for the Fiscal Years Ended June 30, 2007, FS-7
2006 and 2005
Consolidated Statements of Cash Flows for the Fiscal Years Ended June 30, 2007, 2006 and FS-8
2005
Notes to Consolidated Financial Statements, June 30, 2007 FS-9
Schedules:
II. Valuation and Qualifying Accounts FS-21
b. Supplementary Financial Data FS-22
MANAGEMENT REPORT ON INTERNAL CONTROLS OVER FINANCIAL REPORTING
Management is responsible for the preparation of Napco Security Systems, Inc.
(Napco Security Systems) consolidated financial statements and related
information. Management uses its best judgment to ensure that the consolidated
financial statements present fairly, in all material respects, Napco Security
Systems consolidated financial position and results of operations in conformity
with generally accepted accounting principles.
The financial statements have been audited by an independent registered public
accounting firm in accordance with the standards of the Public Company
Accounting Oversight Board. Their report expresses the independent accountant's
judgment as to the fairness of management's reported operating results, cash
flows and financial position. This judgment is based on the procedures described
in the second paragraph of their report.
Napco Security Systems management is responsible for establishing and
maintaining adequate internal control over financial reporting. Under the
supervision of management, we conducted an evaluation of the effectiveness of
our internal control over financial reporting based on the framework in Internal
Control -- Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission published in 1992 and subsequent
guidance prepared specifically for smaller public companies.
As a result of our evaluation, management concluded that our internal control
over financial reporting was ineffective as of June 30, 2007 due to the
identification of material weaknesses in our internal controls over financial
reporting. A material weakness is a control deficiency or combination of control
deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented
or detected.
To address the weaknesses described below, we performed additional analysis and
performed other procedures to ensure the consolidated financial statements were
prepared in accordance with generally accepted accounting principles.
Accordingly, management believes that the consolidated financial statements
included in this Annual Report on Form 10-K, fairly present, in all material
respects, our financial condition, results of operations and cash flows for the
periods presented in accordance with generally accepted accounting principles.
These weaknesses, identified by our independent registered accounting firm,
Marcum & Kliegman LLP, related to:
The valuation of inventories: Management uses certain estimation methods for the
capitalization of overhead costs and for quantifying reserves for obsolete and
slow-moving inventories. These estimation methods being utilized by management
were not effective.
Management does not have adequate controls in place to properly classify its
inventories in accordance with Accounting Research Bulletin 43.
To address these weaknesses, we have initiated a review of the ways in which we
can accumulate information to provide better substantiation of our overhead
estimates, will be implementing a time tracking system and have established an
additional review of our obsolescence estimates. We will also conduct a review
of our inventory turnover and utilize this review to support classification on
the balance sheet.
We believe that the measures we have taken have addressed each matter identified
as a material weakness by management and our independent registered public
accounting firm. We will continue to monitor the effectiveness of our internal
controls and procedures on an ongoing basis and will take further actions, as
appropriate.
There have not been any other changes in our internal control over financial
reporting that occurred during our first fiscal quarter that have materially
affected or are reasonably likely to affect our internal control over financial
reporting.
Marcum & Kliegman LLP, an independent registered public accounting firm, that
audited our consolidated financial statements included in this Annual Report on
Form 10-K, has issued an attestation report on management's assessment of Napco
Security System's internal control over financial reporting.
The Board of Directors of Napco Security Systems has an Audit Committee
comprised of three non-management directors. The Committee meets periodically
with financial management and the independent auditors to review accounting,
control, audit and financial reporting matters. Marcum & Kliegman have full and
free access to the Audit Committee, with and without the presence of management.
FS-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON INTERNAL CONTROL OVER
FINANCIAL REPORTING
To the Audit Committee of the
Board of Directors and Stockholders
of NAPCO Security Systems, Inc.
We have audited NAPCO Security Systems, Inc. and Subsidiaries' (the "Company")
internal control over financial reporting as of June 30, 2007, based on criteria
established in Internal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. The Company's management is
responsible for maintaining effective internal control over financial reporting,
and for its assessment of the effectiveness of internal control over financial
reporting, included in the accompanying "Management Report on Internal Control
over Financial Reporting". Our responsibility is to express an opinion on the
Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the 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 effective
internal control over financial reporting was maintained in all material
respects. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing and evaluating
the design and operating effectiveness of internal control based on the assessed
risk. Our audit also included performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
A company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company's
assets that could have a material effect on the financial statements.
Because of the inherent limitations, internal control over financial reporting
may not prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that degree of compliance with
the policies or procedures may deteriorate.
A material weakness is a control deficiency, or combination of deficiencies, in
internal control over financial reporting, such that there is a reasonable
possibility that a material misstatement of the Company's annual or interim
financial statements will not be prevented or detected on a timely basis. The
following material weaknesses have been identified and included in management's
annual report on internal control over financial reporting:
(1) With respect to the valuation of inventories, management uses certain
estimation methods for the capitalization of overhead costs and for quantifying
reserves for obsolete and slow-moving inventories. These estimation methods
being utilized by management were not effective; and
(2) Management does not have adequate controls in place to properly classify its
inventories in accordance with Accounting Research Bulletin 43.
These material weaknesses were considered in determining the nature, timing and
extent of audit tests applied in our audit of the fiscal 2007 consolidated
financial statements and financial statement schedule, and this report does not
affect our report dated September 12, 2007.
In our opinion, because of the effect of the material weaknesses described above
on the achievement of the objectives of the control criteria, NAPCO Security
Systems, Inc. and Subsidiaries has not maintained effective internal control
over financial reporting as of June 30, 2007, based on criteria established in
Internal Control-Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission.
FS-2
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated balance sheets as
of June 30, 2007 and 2006, and the related consolidated statements of income,
stockholders' equity and cash flows of NAPCO Security Systems, Inc. and
Subsidiaries for each of the three years in the period ended June 30, 2007, and
our report dated September 12, 2007 expressed an unqualified opinion.
/s/ Marcum & Kliegman LLP
Marcum & Kliegman LLP
Melville, NY
September 12, 2007
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Audit Committee of the
Board of Directors and Stockholders
of NAPCO Security Systems, Inc.
We have audited the accompanying consolidated balance sheets of NAPCO Security
Systems, Inc. and Subsidiaries (the "Company") as of June 30, 2007 and 2006, and
the related consolidated statements of income, changes in stockholders' equity
and cash flows for each of the three years in the period ended June 30, 2007.
Our audits also included the financial statement schedule as of and for the
years ended June 30, 2007, 2006 and 2005 listed in the index at Item 15. These
consolidated financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audits.
We conducted our audits in accordance with the 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 also includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements, 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 financial position of NAPCO Security
Systems, Inc. and Subsidiaries, as of June 30, 2007 and 2006, and the results of
its operations and its cash flows for each of the three years in the period
ended June 30, 2007 in conformity with Generally Accepted Accounting Principles
(United States). 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 aspects, the information set forth
therein.
We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), NAPCO Security Systems, Inc. and
Subsidiaries internal control over financial reporting as of June 30, 2007,
based on the criteria established in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission
and our report dated September 12, 2007 expressed an adverse opinion on the
effectiveness of the Company's internal control over financial reporting because
of the existence of material weaknesses.
/s/ Marcum & Kliegman LLP
Marcum & Kliegman LLP
Melville, NY
September 12, 2007
FS-3
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2007 and 2006
(In Thousands)
ASSETS
2007 2006
--------- --------
CURRENT ASSETS
Cash and cash equivalents $ 1,748 $ 2,738
Accounts receivable, less reserve for doubtful
accounts 25,579 25,153
Inventories, net 21,342 18,563
Prepaid expenses and other current assets 1,171 755
Deferred income taxes 1,050 1,007
--------- --------
Total Current Assets 50,890 48,216
Inventories - non-current, net 6,881 4,103
Property, plant and equipment, net 9,135 9,038
Goodwill, net 9,686 9,686
Other assets 193 155
--------- --------
TOTAL ASSETS $76,785 $71,198
========= ========
See accompanying notes to consolidated financial statements.
FS-4
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2007 and 2006
(In Thousands, Except Share Data)
LIABILITIES AND STOCKHOLDERS' EQUITY
2007 2006
--------- ---------
CURRENT LIABILITIES
Accounts payable $ 5,045 $ 6,060
Accrued expenses 1,638 1,372
Accrued salaries and wages 2,631 2,586
Accrued income taxes 96 1,877
--------- ---------
Total Current Liabilities 9,410 11,895
Long-term debt 10,900 4,700
Accrued income taxes 1,836 2,243
Deferred income taxes 1,235 1,363
Minority interest in subsidiary 147 147
---------- ---------
Total Liabilities 23,528 20,348
---------- ---------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock, par value $0.01 per share;
40,000,000 shares authorized; 20,090,313 and
19,950,453 shares issued; 19,665,141 and
19,950,453 shares outstanding, respectively 201 200
Additional paid-in capital 13,147 12,568
Retained earnings 42,299 38,082
---------- ---------
55,647 50,850
Less: Treasury Stock, at cost (425,172 shares) (2,390) -
---------- ---------
TOTAL STOCKHOLDERS' EQUITY 53,257 50,850
---------- ---------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 76,785 $ 71,198
========== =========
See accompanying notes to consolidated financial statements.
FS-5
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30, 2007, 2006, and 2005
(In Thousands, Except Share and Per Share Data)
2007 2006 2005
---------- ----------- ----------
Net sales $ 66,202 $ 69,54 $ 65,229
Cost of sales 43,013 43,607 41,305
---------- ----------- ----------
Gross Profit 23,189 25,941 23,924
Selling, general, and administrative expenses 16,688 16,418 15,014
-------- ----------- ----------
Operating Income 6,501 9,523 8,910
-------- ----------- ----------
Other expense:
Interest expense, net (637) (258) (224)
Other, net (17) (14) (58)
-------- ----------- ----------
(654) (272) (282)
-------- ----------- ----------
Income Before Minority Interest and Income Taxes 5,847 9,251 8,628
Minority interest in loss of subsidiary 292 132 228
-------- ----------- ----------
Income Before Provision for Income Taxes 6,139 9,383 8,856
Provision for income taxes 1,922 3,264 3,227
-------- ----------- ----------
Net Income $ 4,217 $ 6,119 $ 5,629
======== =========== ==========
Earnings per share:
Basic $ 0.21 $ 0.31 $ 0.29
Diluted $ 0.20 $ 0.30 $ 0.28
Weighted average number of shares outstanding:
Basic 19,961,000 19,785,000 19,265,000
Diluted 20,599,000 20,605,000 20,284,000
See accompanying notes to consolidated financial statements.
FS-6
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
Years Ended June 30, 2007, 2006 and 2005
(In Thousands, Except Share Data)
Common stock Treasury Stock
--------------------- Additional -------------------
Number of Paid-in Number Retained
Shares Issued Amount Capital of Shares Amount Earnings Total
---------- -------- --------- ---------- ------- ---------- ----------------
BALANCE - July 1, 2004 19,133,433 $ 191 $ 11,275 -- $ -- $ 26,438 $ 37,904
Exercise of employee stock options 340,740 4 245 -- -- -- 249
Adjustment to tax benefit on exercise
of stock options -- -- -- -- -- (104) (104)
Net income -- -- -- -- -- 5,629 5,629
---------- --------- --------- ---------- ------- ----------- ---------------
BALANCE - June 30, 2005 19,474,173 $ 195 $ 11,520 -- $ -- $ 31,963 $ 43,678
Exercise of employee stock options 476,280 5 442 -- -- -- 447
Tax benefit in connection with
exercise of stock options -- -- 210 -- -- -- 210
Non-cash stock-based
compensation expense -- -- 396 -- -- -- 396
Net income -- -- -- -- -- 6,119 6,119
---------- --------- --------- ---------- ------- ----------- ---------------
BALANCE - June 30, 2006 19,950,453 $ 200 $ 12,568 -- $ -- $ 38,082 $ 50,850
Exercise of employee stock options 139,860 1 167 -- -- -- 168
Non-cash stock-based
compensation expense -- -- 412 -- -- -- 412
Repurchase of Treasury shares -- -- -- (425,172) (2,390) -- (2,390)
Net income -- -- -- -- -- 4,217 4,217
---------- --------- --------- ---------- ------- ----------- ---------------
BALANCE - June 30, 2007 20,090,313 $ 201 $ 13,147 (425,172) $(2,390) $ 42,299 $ 53,257
========== ========= ========= ========== ======= ===========$ ===============
See accompanying notes to consolidated financial statements.
FS-7
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30, 2007, 2006, and 2005 (In Thousands)
2007 2006 2005
---------- ---------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 4,217 $ 6,119 $ 5,629
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation and amortization 1,201 1,192 1,156
Charge (Recovery) to obsolescence reserve 213 (531) (517)
(Recovery) Provision for doubtful accounts (55) 40 43
Deferred income taxes (170) 131 709
Excess tax benefit from exercise of stock options -- (210) (104)
Non-cash stock based compensation expense 412 396 --
Changes in operating assets and liabilities:
Accounts receivable (371) (3,294) (2,014)
Inventories (5,770) (5,893) (1,131)
Prepaid expenses and other current assets (416) 44 (39)
Other assets (42) 43 (35)
Accounts payable, accrued expenses, accrued salaries and
wages, accrued income taxes and minority interest (2,893) 1,795 3,508
---------- ---------- ----------
Net Cash (Used in) Provided By Operating Activities (3,674) (168) 7,205
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, plant, and equipment (1,294) (1,679) (658)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES
Cash paid for purchase of Treasury Stock (2,390) -- --
Principal payments on long-term debt (1,100) -- (9,700)
Proceeds from long-term debt 7,300 2,750 3,350
Proceeds from exercise of employee stock options 168 447 249
Excess tax benefit from exercise
of stock options -- 210 --
Loan costs paid -- -- 64)
---------- ---------- ----------
Net Cash Provided By (Used In) Financing Activities 3,978 3,407 (6,165)
---------- ---------- ----------
Net (Decrease) Increase In Cash and
Cash Equivalents (990) 1,560 382
CASH AND CASH EQUIVALENTS - Beginning 2,738 1,178 796
---------- ---------- ----------
CASH AND CASH EQUIVALENTS - Ending $ 1,748 $ 2,738 $ 1,178
========== ========== ==========
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid, net $ 520 $ 228 $ 217
Income taxes paid $ 4,280 $ 2,573 $ 1,366
See accompanying notes to consolidated financial statements.
FS-8
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 a diversified
manufacturer of security products, encompassing intrusion and fire alarms,
building access control systems and electronic locking devices. These products
are used for commercial, residential, institutional, industrial and governmental
applications, and are sold worldwide principally to independent distributors,
dealers and installers of security equipment.
Principles of Consolidation
The consolidated financial statements include the accounts of Napco Security
Systems, Inc. and all of its wholly-owned subsidiaries. The Company has also
consolidated a 51%-owned joint venture. The 49% interest, held by a third party,
is reflected as minority interest. All inter-company balances and transactions
have been eliminated in consolidation.
Reclassifications
Certain prior year amounts have been reclassified to conform with the current
year's presentation including the reclassification of $4,103,000 of inventories
to inventories, non-current. The reclassifications have no effect on previously
reported income.
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 $195,000 and $1,564,000 of
short-term time deposits at June 30, 2007 and 2006, 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 and other international agencies as of
June 30, 2007 and 2006.
Accounts Receivable
Accounts receivable is stated net of the reserves for doubtful accounts and for
returns and other allowances of $365,000 and $420,000 and $1,385,000 and
$1,839,000 as of June 30, 2007 and June 30, 2006, respectively. Our reserves for
doubtful accounts and for returns and other allowances are subjective critical
estimates that have a direct impact on reported net earnings. These reserves are
based upon the evaluation of accounts receivable agings, specific exposures,
sales levels and historical trends.
FS-9
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 costs include
raw materials, direct labor and overhead. The Company's overhead expenses are
applied based, in part, upon estimates of the proportion of those expenses that
are related to procuring and storing raw materials as compared to the
manufacture and assembly of finished products. These proportions, the method of
their application, and the resulting overhead included in ending inventory, are
based in part on subjective estimates and approximations and actual results
could differ from those estimates.
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, requirements to support forecasted sales, and
the ability to find alternate applications of its raw materials and to convert
finished product into alternate versions of the same product to better match
customer demand. There is inherent professional judgment and subjectivity made
by both production and engineering members of management in determining the
estimated obsolescence percentage. For the fiscal years 2007, 2006 and 2005,
charges/(recoveries) and balances in these reserves amounted to $213,000 and
$1,200,000; $(531,000) and $987,000; $(517,000) and $1,518,000, respectively. In
addition, and as necessary, the Company may establish specific reserves for
future known or anticipated events.
The Company also regularly reviews the period over which its inventories will be
converted to sales. Any inventories expected to convert to sales beyond 12
months from the balance sheet date are classified as non-current.
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
The Company accounts for goodwill in accordance with 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,
purchased goodwill must be evaluated for impairment on an annual basis. Those
intangible assets that are classified as goodwill or as other intangibles with
indefinite lives are not amortized.
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.
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.
FS-10
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 other allowances and the
amount of reserves established for anticipated sales returns and other
allowances.
Sales Returns and Other Allowances
The Company analyzes sales returns in accordance with SFAS No. 48 "Revenue
Recognition When Right of Return Exists". The Company is able to make reasonable
and reliable estimates of product returns based on the Company's past history.
Estimates for sales returns are based on several factors including actual
returns and based on expected return data communicated to it by its customers.
Accordingly, the Company believes that its historical returns analysis is an
accurate basis for its allowance for sales returns. Actual results could differ
from those estimates.
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,
2007, 2006 and 2005 was $1,374,000, $1,318,000 and $1,274,000, respectively.
Research and Development Costs
Research and development costs incurred by the Company are charged to expense in
the year incurred. Company-sponsored rearch and development costs of $5,319,000,
$5,109,000 and $4,865,000 were charged to expense for the fiscal years ended
June 30, 2007, 2006 and 2005, 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 is subject to taxation in the United States on a going
forward basis.
Stock Dividend and Stock Split
On May 10, 2006 the Company's Board of Directors approved a 3-for-2 stock split
of its common stock, to be paid in the form of a 50% stock dividend to
stockholders of record on May 24, 2006. The Company delivered the shares on June
7, 2006. Upon completion of the split, the total number of shares of common
stock outstanding increased from approximately 13,300,000 to approximately
19,950,000.
On November 29, 2005 the Company's Board of Directors approved a 3-for-2 split
of its common stock, payable in the form of a 50% stock dividend to stockholders
of record on December 14, 2005. The additional shares were distributed on
December 28, 2005. Upon completion of the split, the total number of shares of
common stock outstanding increased from approximately 8,795,000 to approximately
13,192,000.
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 (on a pre-dividend
basis) were distributed on December 6, 2004.
FS-11
All share and per share amounts (except par value) have been retroactively
adjusted to reflect the stock splits and dividend. There was no net effect on
total stockholders' equity as a result of these transactions.
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
--------------------------------- ----------------------------- ------------------------
2007 2006 2005 2007 2006 2005 2007 2006 2005
--------- ---------- ---------- --------- -------- --------- ------- ------- -------
Basic EPS: $ 4,217 $ 6,119 $ 5,629 19,961 19,785 19,265 $ 0.21 $ 0.31 $ 0.29
Effect of Dilutive
Securities: Employee
Stock options -- -- -- 638 820 1,019 (0.01) (0.01) (0.01)
--------- ---------- ---------- --------- -------- --------- ------- ------- ------
Diluted EPS: $ 4,217 $ 6,119 $ 5,629 20,599 20,605 20,284 $ 0.20 $ 0.30 $ 0.28
========= ========== ========== ========= ======== ========= ======= ======= ======
Options to purchase 87,674, 37,500 and 0 shares of common stock for the three
fiscal years ended June 30, 2007, 2006 and 2005, 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 has established two share incentive programs as discussed in Note 7.
Prior to fiscal 2006, the Company applied the intrinsic value method as outlined
in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to
Employees," ("APB No. 25") and related interpretations in accounting for stock
options and share units granted under these programs. Under the intrinsic value
method, no compensation expense was recognized if the exercise price of the
Company's employee stock options equaled the market price of the underlying
stock on the date of the grant. Accordingly, no compensation cost was recognized
in the accompanying condensed consolidated statements of income prior to fiscal
year 2006 on stock options granted to employees, since all options granted under
the Company's share incentive programs had an exercise price equal to the market
value of the underlying common stock on the date of grant. Stock-based
compensation costs of $412,000 and $396,000 were recognized for fiscal years
2007 and 2006, respectively. The effect on both Basic and Diluted Earnings per
share was $0.02 for fiscal years 2007 and 2006, respectively.
Effective July 1, 2005, the Company adopted SFAS No. 123(R), "Share-Based
Payment" ("SFAS No. 123(R)"). This statement replaces SFAS No. 123, "Accounting
for Stock-Based Compensation" ("SFAS No. 123") and supersedes APB No. 25. SFAS
No. 123(R) requires that all stock-based compensation be recognized as an
expense in the financial statements and that such cost be measured at the fair
value of the award. This statement was adopted using the modified prospective
method of application, which required the Company to recognize compensation
expense on a prospective basis. Therefore, prior period financial statements
have not been restated. Under this method, in addition to reflecting
compensation expense for new share-based awards, expense is also recognized to
reflect the remaining service period of awards that had been included in
pro-forma disclosures in prior periods. SFAS No. 123(R) also requires that
excess tax benefits related to stock option exercises be reflected as financing
cash inflows instead of operating cash inflows.
Prior to the Company's adoption of SFAS No. 123(R), SFAS No. 123 required that
the Company provide pro-forma information regarding net earnings and net
earnings per common share as if compensation cost for the Company's stock-based
awards had been determined in accordance with the fair value method prescribed
therein. The Company had previously adopted the disclosure portion of SFAS No.
148, "Accounting for Stock-Based Compensation - Transition and Disclosure,"
requiring quarterly SFAS No. 123 pro-forma disclosure. The pro-forma charge for
compensation cost related to stock-based awards granted was recognized over the
service period. For stock options, the service period represents the period of
time between the date of grant and the date each option becomes exercisable
without consideration of acceleration provisions (e.g., retirement, change of
control, etc.).
FS-12
The following table illustrates the effect on net earnings per common share as
if the fair value method had been applied to all outstanding awards for the year
ended June 30, 2005 (in thousands, except per share data):
2005
---------
Net income, as reported $ 5,629
Deduct: Total stock-based employee compensation expense determined
under fair value method for all awards, net of related tax effects 227
---------
Pro-forma net income $ 5,402
=========
Earnings per common share (1):
Net earnings per common share - Basic, as reported $ 0.29
=========
Net earnings per common share - Basic, pro forma $ 0.28
=========
Net earnings per common share - Diluted, as reported $ 0.28
=========
Net earnings per common share - Diluted, pro forma $ 0.27
=========
(1) Information reflects stock dividend and stock split discussed above.
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, 2007.
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, 2007, 2006 and 2005, 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 approximates 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, 2007 and
2006, management of the Company believes the carrying value of all financial
instruments approximated fair value.
FS-13
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 ($490,000
and $513,000 in fiscal years 2007 and 2006, respectively) and classifies the
costs associated with these revenues in cost of sales ($912,000 and $930,000 in
fiscal years 2007 and 2006, respectively).
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.
New Accounting Pronouncements
In June 2006, the Financial Accounting Standards Board ("FASB") issued SFAS
Interpretation No. 48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes -
An Interpretation of FASB Statement No. 109". FIN 48 clarifies the accounting
for uncertainty in income taxes recognized in an enterprise's financial
statements in accordance with SFAS No. 109, "Accounting for Income Taxes". This
Interpretation prescribes a recognition threshold and measurement attribute for
the financial statement recognition and measurement of a tax position taken or
expected to be taken in a tax return. This Interpretation also provides guidance
on de-recognition, classification, interest and penalties, accounting in interim
periods, disclosure, and transition. FIN 48 is effective for financial
statements issued for fiscal years beginning after December 15, 2006. The
Company is currently evaluating the impact of the application of FIN 48.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements". SFAS
No. 157 provides guidance for using fair value to measure assets and
liabilities. In addition, this statement defines fair value, establishes a
framework for measuring fair value, and expands disclosures about fair value
measurements. Where applicable, this statement simplifies and codifies related
guidance within generally accepted accounting principles. This statement is
effective for financial statements issued for fiscal years beginning after
November 15, 2007, and interim periods within those fiscal years. The Company's
adoption of SFAS No. 157 is not expected to have a material effect on its
consolidated financial statements.
In September 2006, the SEC issued Staff Accounting Bulletin ("SAB") No. 108,
"Considering the Effects of Prior Year Misstatements when Quantifying
Misstatements in Current Year Financial Statements" ("SAB No. 108") to provide
guidance on the consideration of the effects of prior year misstatements in
quantifying current year misstatements for the purpose of a materiality
assessment. Under SAB No. 108, companies should evaluate a misstatement based on
its impact on the current year income statement, as well as the cumulative
effect of correcting such misstatements that existed in prior years existing in
the current year's ending balance sheet. The Company's adoption of SAB No. 108
did not have a material impact on its consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities". SFAS No. 159 permits entities to
choose to measure many financial instruments and certain other items at fair
value. The objective is to improve financial reporting by providing entities
with the opportunity to mitigate volatility in reported earnings caused by
measuring related assets and liabilities differently without having to apply
complex hedge accounting provisions. Most of the provisions of this Statement
apply only to entities that elect the fair value option. However, the amendment
to SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities", applies to all entities with available-for-sale and trading
securities. Some requirements apply differently to entities that do not report
net income. SFAS No. 159 will become effective for the Company in its fiscal
year ending June 30, 2009. The Company's adoption of SFAS No. 159 is not
expected to have a material effect on its consolidated financial statements.
FS-14
The FASB ratified the consensuses reached in EITF Issue No. 06-3, "How Taxes
Collected from Customers and Remitted to Governmental Authorities Should Be
Presented in the Income Statement (That is, Gross versus Net Presentation)"
("EITF 06-3"). The EITF reached a consensus that the scope of the Issue includes
any tax assessed by a governmental authority that is both imposed on and
concurrent with a specific revenue-producing transaction between a seller and a
customer, and may include, but is not limited to, sales, use, value-added, and
some excise taxes. The presentation of taxes within the scope of this Issue on
either a gross or a net basis is an accounting policy decision that should be
disclosed. Furthermore, for taxes reported on a gross basis, a company should
disclose the aggregate amount of those taxes in interim and annual financial
statements for each period for which an income statement is presented if that
amount is significant. The disclosures required under this consensus should be
applied retrospectively to interim and annual financial statements for all
periods presented, if those amounts are significant. The Company adopted EITF
06-3 on January 1, 2006. The adoption of EITF 06-3 did not have a significant
impact on the Company's consolidated financial statements. The Company currently
records its sales net of any value added or sales tax.
NOTE 2 - Business and Credit Concentrations
-------------------------------------------
The Company had two customers with accounts receivable balances that aggregated
38% and 33% of the Company's accounts receivable at June 30, 2007 and 2006,
respectively. Sales to neither of these customers exceeded 10% of net sales in
any of the past three years.
NOTE 3 - Inventories
--------------------
Inventories, net of reserves are valued at lower of cost (first-in, first-out
method) or market. The Company regularly reviews parts and finished goods
inventories on hand and, when necessary, records a provision for excess or
obsolete inventories. The Company also regularly reviews the period over which
its inventories will be converted to sales. Any inventories expected to convert
to sales beyond 12 months from the balance sheet date are classified as
non-current.
Inventories, net of reserves consist of the following:
June 30,
---------------------
2007 2006
-------- ---------
(In thousands)
Component parts $ 15,139 $ 13,533
Work-in-process 3,139 2,595
Finished product 9,945 6,538
-------- ---------
$ 28,223 $ 22,666
======== =========
Classification of inventories, net of reserves:
Current $ 21,342 $18,563
Non-current 6,881 4,103
-------- ---------
$ 28,223 $ 22,666
======== =========
FS-15
NOTE 4 - Property, Plant, and Equipment
---------------------------------------
Property, plant and equipment consist of the following:
June 30,
----------------------------
2007 2006 Useful Life In years
------------ ---------- ------------------------------------------
(In thousands)
Land $ 904 $ 904 --
Buildings 8,911 8,911 30 to 40
Molds and dies 4,925 4,786 3 to 5
Furniture and fixtures 1,630 1,583 5 to 10
Machinery and equipment 15,163 14,054 7 to 10
Leasehold improvements 190 191 Shorter of the lease term or life of asset
------------ ----------
31,723 30,429
Less: accumulated depreciation
and amortization 22,588 21,391
------------ ----------
$ 9,135 $9,038
============ ==========
Depreciation and amortization expense on property, plant, and equipment was
approximately $1,201,000, $1,174,000 and $1,112,000 in fiscal 2007, 2006 and
2005, respectively.
NOTE 5 - Income Taxes
----------------------
Provision (benefit) for income taxes consists of the following:
For the Years Ended June 30,
-----------------------------------------
2007 2006 2005
--------- --------- ----------
(In thousands)
Current income taxes:
Federal $ 2,069 $ 3,107 $ 2,496
State 15 15 5
Foreign 8 11 17
--------- --------- -----------
$ 2,092 $ 3,133 $ 2,518
Deferred income tax (benefit) expense 170) 131 709
--------- --------- -----------
Provision for income taxes $ 1,922 $ 3,264 $ 3,227
========= ========= ===========
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,
--------------------------------------------------------------
2007 2006 2005
------------------- ---------------------- ---------------
% of % of % of
Pre-tax Pre-tax Pre-tax
Amount Income Amount Income Amount Income
Tax at Federal statutory rate $ 2,087 34.0% $ 3,190 34.0% $ 3,011 34.0%
Increases (decreases) in
taxes resulting from:
Meals and entertainment 60 1.0 62 .7 .7
State income taxes, net of
Federal income tax benefit 10 .2 10 .1 3 --
Foreign source income and taxes (5) (.1) (7) (.1) (2) --
Stock based compensation expense 99 1.6 96 1.0 -- --
Alternative Minimum Tax
Credit utilization -- -- 43 .5 -- --
Tax reserve reversal (407) (6.6) -- -- -- --
Other, net 78 1.2 (130) (1.4) 155 1.7
---------- -------- ----------- --------- ------- ------
Provision for income taxes $ 1,922 31.3% $ 3,264 34.8% $ 3,227 36.4%
========== ======== =========== ========= ======= ======
Deferred tax assets and deferred tax liabilities at June 30, 2007 and 2006 are
as follows (in thousands):
Current Long-Term
Deferred Tax Assets Deferred Tax Assets
(Liabilities) (Liabilities)
--------------------------- ---------------------------
2007 2006 2007 2006
---------- ---------- ----------- ----------
Accounts receivable $ 26 $ 39 $ -- $ --
Inventories 770 733 646 485
Accrued liabilities 254 235 -- --
State net operating loss carryforward 480 388 -- --
Stock based compensation expense -- -- 80 39
Goodwill -- -- (1,140) (969)
Property, plant and equipment -- -- (821) (918)
--------- ---------- ----------- ----------
1,530 1,395 (1,235) (1,363)
Valuation allowance (480) (388) -- --
--------- ---------- ----------- ----------
Net deferred taxes $ 1,050 $ 1,007 $ (1,235) $(1,363)
========= ========== =========== ==========
In March 2003, Napco Security Systems, Inc. timely filed its income tax return
for the fiscal year ended June 30, 2002. This return included an election to
treat one of the Company's foreign subsidiaries, Napco DR, as if it were a
domestic corporation beginning July 1, 2001. This election was based on a then
recently enacted Internal Revenue Code ("Code") provision. As a result of this
election, Napco DR is treated, for Federal income tax purposes, as transferring
all of its assets to a domestic corporation in connection with an exchange.
Although this type of transfer usually results in the recognition of taxable
income to the extent of any untaxed earnings and profits, the Code provision
provides an exemption for applicable corporations. The Company qualifies as an
applicable corporation pursuant to this Code section, and based on this Code
exemption, the Company treated the transfer of approximately $27,000,000 of
Napco DR's untaxed earnings and profits as nontaxable.
FS-16
The Internal Revenue Service has issued a Revenue Procedure which is
inconsistent with the Code exemption described above. The Code is the actual
law; a Revenue Procedure is the IRS's interpretation of the law. The Code has a
higher level of authority than a Revenue Procedure. Management believes that it
has appropriately relied on the guidance in the Code when filing its income tax
return. If challenged, the Company believes that the potential liability would
have ranged from $0 to $9,450,000. However, the Company also believes there were
other mitigating factors that would limit the amount of the potential liability,
and as a result, management accrued a liability of $2,243,000 as of June 30,
2002. As of June 30, 2007, $407,000 of this accrued liability was no longer
required as a result of the lapse in the applicable statute of limitations. The
Company reduced this accrued liability accordingly during fiscal 2007 which
reduced the Company's effective tax rate from approximately 37.9% to 31.3% for
the fiscal year ended June 30, 2007. The statute of limitations on the remainder
of this accrued liability of $1,836,000 will lapse in fiscal 2008. The Company
has not accrued any related interest or penalties. The Company's tax provision
utilizes estimates made by management and as such, is subject to change as
described in Note 1 of the Consolidated financial statements.
NOTE 6 - Long-Term Debt
-----------------------
Long-term debt consists of a revolving credit and term loan facility with a
balance of $10,900,000 and $4,700,000 at June 30, 2007 and 2006, respectively.
In September 2007, the Company amended its secured revolving credit agreement
with its primary bank. The Company's borrowing capacity under the amended
agreement was increased to $25,000,000 from $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, 2007, the interest rate on this debt was 6.6%. The
September 2007 amendment also extended the revolving credit agreement to
September 2011. 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. During fiscal 2007, the Company exceeded
the restriction on capital expenditures for which it received the appropriate
waiver from its primary bank.
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 4,406,400 shares of the Company's common stock to be
acquired by the holders of such awards. The 1992 Plan terminated in October 2002
and there were no stock option grants outstanding under this plan as of June 30,
2007.
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 1,836,000 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.
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, 2007, 1,331,480 stock options were granted, 504,520 stock
options were available for grant, and 1,048,288 stock options were exercisable
under this plan.
The fair value of each option granted during fiscal 2007 and fiscal 2006 was
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted average assumptions:
2007 2006
----------- -----------
Risk-free interest rates 4.7% 4.6%
Expected lives 7.15 years 9 years
Expected volatility 59% 63%
Expected dividend yields 0% 0%
The following table reflects activity under the 1992 and 2002 Plans for the
fiscal years ended June 30,:
2007 2006 2005
------------------- -------------------- --------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Options price Options price Options price
-------- --------- ----------- -------- --------- ----------
Outstanding at beginning of year 1,333,050 $ 2.41 1,544,940 $ 1.62 1,885,680 $ 1.46
Granted 66,500 6.25 161,250 7.67 -- --
Exercised (139,860) 1.21 (346,680) 1.00 (340,740) .73
Forfeited (4,050) 1.90 (24,300) 1.62 -- --
Cancelled/lapsed -- -- (2,160) .72 -- --
-------- --------- ----------- -------- ---------- ---------
Outstanding at end of year 1,255,640 $ 2.75 1,333,050 $ 2.41 1,544,940 $ 1.62
======== ========= =========== ======== ========== =========
Exercisable at end of year 1,048,288 $ 2.24 940,098 $ 1.95 989,820 $ 1.24
======== ========= =========== ======== ========== =========
Weighted average fair value at
grant date of options granted $ 3.88 $ 6.69 n/a
Total intrinsic value of
options exercised $73,000 $191,000 $109,000
FS-17
Cash received from option exercises for fiscal years 2007, 2006 and 2005 was
$168,000, $447,000 and $249,000, respectively. The actual tax benefit realized
for the tax deductions from option exercises totaled $0, $210,000 and $104,000
for fiscal years 2007, 2006 and 2005, respectively.
The following table summarizes information about stock options outstanding at
June 30, 2007:
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 2007 life price 2007 price
--------------------------- ----------- ----------- ----------- ----------- ------------
$0.72 to $ 4.00 1,027,890 6.08 $ 1.89 970,488 $ 1.88
$4.01 to $ 7.50 190,250 8.51 5.76 62,800 5.66
$7.51 to $11.16 37,500 8.73 11.16 15,000 11.16
----------- ----------- ----------- ----------- ------------
1,255,640 6.52 $ 2.75 1,048,288 $ 2.24
=========== =========== =========== =========== ============
As of June 30, 2007, there was $581,000 of total unearned stock-based
compensation cost related to non-vested share-based compensation arrangements
granted under the 2002 Plan. That cost is expected to be recognized over a
weighted average period of 7 years. The total fair value of the options vested
during fiscal 2007 was $412,000.
In September 2000, the stockholders approved a 10 year extension of the already
existing 1990 non-employee stock option plan (the 2000 Plan) to encourage
non-employee directors and consultants of the Company to invest in the Company's
stock. The 2000 Plan provided for the granting of non-qualified stock options,
the exercise of which would allow up to an aggregate of 270,000 shares of the
Company's common stock to be acquired by the holders of the stock options. The
2000 Plan provided that the option price will not be less than 100% of the fair
market value of the stock at the date of grant. Options were exercisable at 20%
per year and expire five years after the date of grant. Compensation cost is
recognized for the fair value of the options granted to non-employee directors
and consultants as of the date of grant. $24,000 of compensation expense was
recorded for stock options granted to directors. There are 24,000 options
available for future grants under the 2000 Plan.
The following table reflects activity under the 2000 Plan for the fiscal years
ended June 30,:
2007 2006 2005
----------------------- --------------------- -------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Options price Options price Options price
---------- ----------- ---------- --------- ---------- -------
Outstanding at beginning of year -- $ -- 129,600 $ 1.15 129,600 $ .76
Granted 30,000 5.03 -- -- -- --
Exercised -- -- (129,600) 1.15 -- --
Forfeited -- -- -- -- -- --
Cancelled/lapsed -- -- -- -- -- --
---------- ----------- ---------- --------- ---------- --------
Outstanding at end of year 30,000 $ 5.03 -- $ -- 129,600 $ .76
========== =========== ========== ========= =====-==== ========
Exercisable at end of year 6,000 $ 5.03 -- -- 129,600 $ .76
========== =========== ========== ========= ========== ========
Weighted average fair value at
grant date of options granted $ 3.16 n/a n/a
Total intrinsic value of
options exercised n/a $ 42,000 n/a
As of June 30, 2007, there was $70,000 of total unearned stock-based
compensation cost related to non-vested share-based compensation arrangements
granted under the 2000 Plan. That cost is expected to be recognized over a
weighted average period of 4 years.
NOTE 8 - Treasury Stock
-----------------------
On March 16, 2007, the Company announced that its Board of Directors authorized
the repurchase of up to one million (1,000,000) shares of its common stock. As
of June 30, 2007, the Company has repurchased 425,172 shares at a weighted
average price of $5.62 per share. Subsequent to June 30, 2007, the Company has
repurchased an additional 222,544 shares at a weighted average price of $5.96
per share.
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 $91,000, $89,000, and $80,000 for the fiscal years ended
2007, 2006 and 2005, respectively.
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
----------- ---------
2008 $ 114,000
2009 56,000
2010 25,000
2011 3,000
----------
Total $ 198,000
FS-18
Rent expense, with the exception of the land lease referred to below, totaled
approximately $178,000, $136,000 and $138,000 for the fiscal years ended June
30, 2007, 2006 and 2005, respectively.
Land Lease
On April 26, 1993, one of the Company's foreign subsidiaries entered into a 99
year lease, expiring in 2092, 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, 2007, the Company was committed for approximately $270,000 under
open commercial letters of credit.
Litigation
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-19
Employment Agreements
As of June 30, 2007, the Company was obligated under three employment agreements
and one severance agreement. Compensation under the agreements includes annual
salaries approximating $1,039,000. 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. The
agreement with the Company's Chief Executive Officer provides for a salary of
$546,000, includes additional compensation of 25,000 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,
2007, 2006, and 2005:
2007 2006 2005
---- ---- ----
(in thousands)
Sales to external customers(1):
Domestic $ 56,810 $ 58,549 $ 54,654
Foreign 9,392 10,999 10,575
------ ------ ---------
Total Net Sales $ 66,202 $ 69,548 $ 65,229
======== ======== ========
Identifiable assets:
United States $ 47,636 $ 46,651 $ 41,753
Dominican Republic (2) 21,246 18,924 14,658
Other foreign countries 7,903 5,623 3,496
----- ----- -----
Total Identifiable Assets $ 76,785 $ 71,198 $ 59,907
======== ======== ========
(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) Consists primarily of inventories and fixed assets, which are located at the
Company's principal manufacturing facility in the Dominican Republic.
FS-20
SCHEDULE II
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Years Ended June 30, 2007, 2006, and 2005 (In Thousands)
Column A Column B Column C Column D Column E
---------------------------------------------- ---------- ---------- ----------- -----------
Balance at Charged to Deductions/ Balance at
Beginning costs and (recoveries) end of
Description of period expenses (1) period
---------------------------------------------- ---------- ---------- ----------- -----------
For the year ended June 30, 2005:
Allowance for doubtful accounts
(deducted from accounts receivable) $ 355 $ 43 $ 18 $ 380
For the year ended June 30, 2006:
Allowance for doubtful accounts
(deducted from accounts receivable) $ 380 $ 70 $ 30 $ 420
For the year ended June 30, 2007:
Allowance for doubtful accounts
(deducted from accounts receivable) $ 420 $ (55) $ -- $ 365
(1) Deductions relate to uncollectible accounts charged off to valuation
accounts, net of recoveries.
FS-21
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, 2007,
-----------------------------------------------------------------------------------
First Quarter Second Quarter Third Quarter Fourth Quarter
------------- -------------- ------------- --------------
Net Sales $ 14,029 $ 16,077 $ 15,566 $ 20,530
Gross Profit 5,559 5,825 5,494 6,311
Income from Operations 1,561 1,844 1,268 1,828
Net Income 952 1,144 1,132 989
Net Income Per Share
Basic EPS .05 .06 .06 .05
Diluted EPS .05 .06 .06 .05
Fiscal Year Ended June 30, 2006,
-----------------------------------------------------------------------------------
First Quarter(1) Second Quarter(2) Third Quarter(2) Fourth Quarter
------------- -------------- ------------- --------------
Net Sales $ 14,180 $ 17,223 $ 17,085 $ 21,060
Gross Profit 5,125 6,049 6,356 8,411
Income from Operations 1,252 2,264 2,324 3,683
Net Income 815 1,483 1,475 2,346
Net Income Per Share(1):
Basic EPS .04 .08 .07 .12
Diluted EPS .04 .07 .07 .12
(1) Restated to reflect the 3:2 stock split effective June 2006 and the 3:2 stock split effective December 2005.
(2) Restated to reflect the 3:2 stock split effective June 2006.
Seasonality
The Company's fiscal year begins on July 1 and ends on June 30. Historically,
the end users of Napco's products want to install its products prior to the
summer; therefore sales of its products peak in the period April 1 through June
30, the Company's fiscal fourth quarter, and are reduced in the period July 1
through September 30, the Company's fiscal first quarter. To a lesser degree,
sales in Europe are also adversely impacted in the Company's first fiscal
quarter because of European vacation patterns, i.e., many distributors and
installers are closed for the month of August.
ITEM 9: CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
FS-22
ITEM 9A: CONTROL AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. At the conclusion of the
period ended June 30, 2007, we carried out an evaluation, under the supervision
and with the participation of our management, including our Chief Executive
Officer and Chief Financial Officer, of the effectiveness of the design and
operation of our disclosure controls and procedures. Based upon that evaluation,
the Chief Executive Officer and Chief Financial Officer concluded that our
disclosure controls and procedures were not effective in alerting them in a
timely manner to information relating to the company required to be disclosed in
this report.
Management's Annual Report on Internal Control Over Financial Reporting.
Management's Report on Internal Control Over Financial Reporting on page FS-1 is
incorporated herein by reference.
Attestation Report of the Registered Public Accounting Firm. Report of
Independent Registered Public Accounting Firm on page FS-2 is incorporated
herein by reference.
Changes in Internal Control Over Financial Reporting. During the fourth quarter
of 2007, there were no changes in the Company's internal control over financial
reporting that have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting except for the
following: Management's review over it's internal controls identified conditions
which they deemed to be material weaknesses, (as defined by standards
established by the SEC and the Public Company Accounting Oversight Board) with
respect to certain of our inventory valuation estimation methods and the
classification of inventory in accordance with Accounting Research Bulletin 43.
Management has informed it's independent auditors and the Audit Committee that
it has initiated a review of the ways in which we can accumulate information to
provide better substantiation of our overhead estimates, will be implementing a
time tracking system and established an additional review of our obsolescence
estimates. We will also conduct a review of our inventory turnover and utilize
this review to support classification on the balance sheet.to prevent
reoccurrences of these material weaknesses and will continue to monitor the
effectiveness of these actions and will make any other changes or take such
additional actions as management determines to be appropriate. Management
expects to complete this action during fiscal 2008.
ITEM 9B: OTHER INFORMATION
None
PART III
--------
The information called for by Part III is hereby incorporated by reference from
the information set forth under the headings "Election of Directors", "Corporate
Governance and Board Matters", "Executive Compensation", "Beneficial Ownership
of Common Stock" and "Principal Accountant Fees" in the Company's definitive
proxy statement for the 2007 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.
We have adopted a Code of Ethics which applies to our senior executive and
financial officers, among others. The Code is posted on our website,
www.napcosecurity.com under the "Investors - Other" captions. We intend to make
all required disclosures regarding any amendment to, or waiver of, a provision
of the Code of Ethics for senior executive and financial officers by posting
such information on our website.
PART IV
-------
ITEM 15: EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(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
----
Management Report on Internal Controls Over Financial Reporting FS-1
Report of Independent Registererd Public Accounting Firm on Internal Control Over FS-2
Financial Reporting
Report of Independent Registered Public Accounting Firm FS-3
Consolidated Financial Statements:
Consolidated Balance Sheets as of June 30, 2007 and 2006 FS-4
Consolidated Statements of Income for the Fiscal Years Ended June 30, 2007, 2006 and 2005 FS-6
Consolidated Statements of Stockholders' Equity for the Fiscal Years Ended June 30, 2007, FS-7
2006 and 2005
Consolidated Statements of Cash Flows for the Fiscal Years Ended June 30, 2007, 2006 and FS-8
2005
Notes to Consolidated Financial Statements, June 30, 2007 FS-9
(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-21
b. Supplementary Financial Data FS-22
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.
(a)3 and (b). Exhibits
Management Contracts designated by asterisk.
Exhibit No. Title
----------------------------------------------------------------------------------------------
Ex-3.(i) Certificate of Amendment of Certificate Exhibit-3.(i) to Report on Form 10-
of Incorporation K for the fiscal year ended June
30, 2006
----------------------------------------------------------------------------------------------
Ex-3.(ii) Certificate of Incorporation as amended Exhibit-3.(ii) to Report on Form
10-K for the fiscal year ended
June, 30 2006
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Ex-3.(iii) Amended and Restated By-Laws Exhibit 3.(ii) to Report on Form
10-K for the fiscal year ended
June 30, 2004
----------------------------------------------------------------------------------------------
Ex-10.A (i) Amended and Restated 1992 Incentive Stock Exhibit 10.A(i) to Report on Form
Option Plan 10-K for the fiscal year ended
June 30, 2005
----------------------------------------------------------------------------------------------
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, 2002
----------------------------------------------------------------------------------------------
Ex-10.B 2000 Non-Employee Stock Option Plan Exhibit-10.B to Report on Form 10-K
for the fiscal year ended June 30,
2006
----------------------------------------------------------------------------------------------
Ex-10.C Loan and Security Agreement with Marine Exhibit 10-C to Report on Form 10-K
Midland Bank dated as of May 12, 1997 for the fiscal year ended June 30,
2004
----------------------------------------------------------------------------------------------
Ex-10.D Revolving Credit Note #1 to Marine Exhibit 10-D to Report on Form 10-K
Midland Bank dated as of May 12, 1997 for the fiscal year ended June 30,
2004
----------------------------------------------------------------------------------------------
Ex-10.E Revolving Credit Note #2 to Marine Exhibit 10-E to Report on Form 10-K
Midland Bank dated as of May 12, 1997 for the fiscal year ended June 30,
2004
----------------------------------------------------------------------------------------------
Ex-10.F Promissory Note to Marine Midland Bank Exhibit 10-F to Report on Form 10-K
dated as of May 12, 1997 for the fiscal year ended June 30,
2004
----------------------------------------------------------------------------------------------
Ex-10.G Amendment No.1 to the Loan and Security Exhibit 10-G to Report on Form 10-K
Agreement with Marine Midland Bank dated for the fiscal year ended June 30,
as of May 28, 1998 2004
----------------------------------------------------------------------------------------------
Ex-10.H Term Loan Note to Marine Midland Bank Exhibit 10-H to Report on Form 10-K
dated as of May 28, 1998 for the fiscal year ended June 30,
2004
----------------------------------------------------------------------------------------------
*Ex-10.I Amended and Restated Employment Agreement Exhibit 10.I to Report on Form 10-K
with Richard Soloway for fiscal year ended June 30,
2003
----------------------------------------------------------------------------------------------
*Ex-10.J Employment Agreement with Jorge Hevia Exhibit 10-J to Report on Form 10-K
for the fiscal year ended June 30,
2005
----------------------------------------------------------------------------------------------
Ex-10.K Amendment No. 2 to the Loan and Security Exhibit 10-K to Report on Form 10-K
Agreement with HSBC Bank dated as of for the fiscal year ended June 30,
June 30, 1999 2005
----------------------------------------------------------------------------------------------
*Ex-10.L Employment Agreement with Michael Exhibit 10-L to Report on Form 10-K
Carrieri for the fiscal year ended June 30,
2005
----------------------------------------------------------------------------------------------
*Ex-10.M Indemnification Agreement dated August 9, Exhibit 10-M to Report on Form 10-K
1999 for the fiscal year ended June 30,
2005
----------------------------------------------------------------------------------------------
Ex-10.O Amendment No. 4 to Loan and Security Exhibit 10-O to Report on Form 10-K
Agreement for the fiscal year ended June 30,
2005
---------------------------------------------------------------------------------------------
Ex-10.P Amendment No. 8 to Loan and Security Exhibit-10.P to Report on Form 10-K
Agreement for the fiscal year ended June 30,
2006
---------------------------------------------------------------------------------------------
Ex-10.Q Note Modification Agreement Exhibit 10.X 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
Agreement for fiscal year ended June 30,
2003
---------------------------------------------------------------------------------------------
Ex-10.S Amendment No. 3 to the Loan and Security Exhibit 10-S to Report on Form 10-K
Agreement for the fiscal year ended June 30,
2004
---------------------------------------------------------------------------------------------
Ex-10.T Amendment No. 9 to the Loan and Security Exhibit 10-T to Report on Form 10-K
Agreement for the fiscal year ended June 30,
2004
---------------------------------------------------------------------------------------------
Ex-10.U Amendment No. 11 to the Loan and Security Exhibit 10-U to Report on Form 10-K
Agreement for the fiscal year ended June 30,
2004
---------------------------------------------------------------------------------------------
Ex-10.V Amendment No. 12 to the Loan and Security Exhibit 10-V to Report on Form 10-K
Agreement for the fiscal year ended June 30,
2004
---------------------------------------------------------------------------------------------
Ex-10.W Amendment No. 13 to the Loan and Security Exhibit 10-W to Report on Form 10-K
Agreement for the fiscal year ended June 30,
2004
---------------------------------------------------------------------------------------------
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-18
---------------------------------------------------------------------------------------------
Ex-23.1 Consent of Independent Auditors E-19
---------------------------------------------------------------------------------------------
Ex-31.1 Section 302 Certification of Chief E-20
Executive Officer
---------------------------------------------------------------------------------------------
Ex-31.2 Section 302 Certification of Chief E-21
Financial Officer
---------------------------------------------------------------------------------------------
Ex-32.1 Certification of Chief Executive Officer E-22
Pursuant to 18 USC Section 1350 and
Section 906 of Sarbanes - Oxley Act of
2002
---------------------------------------------------------------------------------------------
Ex-32.2 Certification of Chief Financial Officer E-23
Pursuant to 18 USC Section 1350 and
Section 906 of Sarbanes - Oxley Act of
2002
---------------------------------------------------------------------------------------------
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, 2007
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, 2007
-------------------------- President and Secretary and Director
Richard Soloway (Principal Executive Officer)
/s/KEVIN S. BUCHEL Senior Vice President of Operations September 27, 2007
-------------------------- and Finance and Treasurer and Director
Kevin S. Buchel (Principal Financial and Accounting Officer)
/s/PAUL STEPHEN BEEBER Director September 27, 2007
--------------------------
Paul Stephen Beeber
/s/RANDY B. BLAUSTEIN Director September 27, 2007
--------------------------
Randy B. Blaustein
/s/ARNOLD BLUMENTHAL Director September 27, 2007
--------------------------
Arnold Blumenthal
/s/DONNA SOLOWAY Director September 27, 2007
--------------------------
Donna Soloway
/s/ANDREW J. WILDER Director September 27, 2007
--------------------------
Andrew J. Wilder