UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
--- EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 2008
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
--- EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO _______.
Commission File number: 0-10004
--------------------------------
NAPCO SECURITY SYSTEMS, INC.
------------------------------------------------------
(Exact name of Registrant as specified in its charter)
Delaware 11-2277818
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(State or other jurisdiction of (IRS Employer Identification
incorporation of organization) Number)
333 Bayview Avenue
Amityville, New York 11701
---------------------------------------- ----------------------------------
(Address of principal executive offices) (Zip Code)
(631) 842-9400
------------------------------------------------------
(Registrant's telephone number including area code)
None
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(Former name, former address and former fiscal year if
changed from last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days:
Yes X No
--------- ---------
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
definition of "large accelerated filer", "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act:
Large Accelerated Filer ___ Accelerated Filer _X_ Non-Accelerated Filer ___
Smaller reporting company ___
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act):
Yes No X
--------- ---------
Number of shares outstanding of each of the issuer's classes of common stock, as
of: MAY 6, 2008
COMMON STOCK, $.01 PAR VALUE PER SHARE 19,092,473
1
Page
------
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
INDEX - MARCH 31, 2008
Condensed Consolidated Balance Sheets, March 31, 2008
and June 30, 2007 3
Condensed Consolidated Statements of Income for the Three
Months ended March 31, 2008 and 2007 4
Condensed Consolidated Statements of Income for the Nine
Months ended March 31, 2008 and 2007 5
Condensed Consolidated Statements of Cash Flows for the
Nine Months ended March 31, 2008 and 2007 6
Notes to Condensed Consolidated Financial Statements 7
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 14
ITEM 3. Quantitative and Qualitative Disclosures About
Market Risk 19
ITEM 4. Controls and Procedures 19
PART II: OTHER INFORMATION 20
SIGNATURE PAGE 21
2
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
March 31, June 30,
ASSETS 2008 (unaudited) 2007
------ ---------------- ----------------
(in thousands, except share data)
Current Assets:
Cash and cash equivalents $ 2,060 $ 1,748
Accounts receivable, less reserve for doubtful accounts 21,808 25,579
Inventories, net 26,057 21,342
Prepaid expenses and other current assets 1,291 1,171
Income taxes receivable 443 -
Deferred income taxes 765 1,050
---------------- ----------------
Total Current Assets 52,424 50,890
Inventories - non-current, net 8,623 6,881
Property, plant and equipment, net 8,950 9,135
Goodwill, net 9,686 9,686
Other assets 306 193
---------------- ----------------
Total Assets $ 79,989 $ 76,785
================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Accounts payable $ 6,173 $ 5,045
Accrued expenses 1,062 1,638
Accrued salaries and wages 2,149 2,631
Accrued income taxes - 96
---------------- ----------------
Total Current Liabilities 9,384 9,410
Long-term debt 13,900 10,900
Accrued income taxes 288 1,836
Deferred income taxes 1,680 1,235
Minority interest in subsidiary 147 147
---------------- ----------------
Total Liabilities 25,399 23,528
---------------- ----------------
Stockholders' Equity:
Common stock, par value $.01 per share; 40,000,000 shares
authorized, 20,092,473 and 20,090,313 shares issued and 19,092,473
and 19,665,141 shares outstanding, respectively 201 201
Additional paid-in capital 13,366 13,147
Retained earnings 46,638 42,299
---------------- ----------------
60,205 55,647
Less: Treasury Stock, at cost (1,000,000 and 425,172 shares, respectively) (5,615) (2,390)
---------------- ----------------
Total stockholders' equity 54,590 53,257
---------------- ----------------
Total Liabilities and Stockholders' Equity $ 79,989 $ 76,785
================ ================
See accompanying notes to condensed consolidated financial statements.
3
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)
Three Months Ended
March 31,
---------------------------------------
2008 2007
---------------- ----------------
(in thousands, except share and
per share data)
Net sales $ 16,222 $ 15,566
Cost of sales 10,699 10,072
---------------- ----------------
Gross Profit 5,523 5,494
Selling, general and administrative expenses 3,955 4,226
---------------- ----------------
Operating Income 1,568 1,268
---------------- ----------------
Interest expense, net 216 168
Other expenses, net 12 4
---------------- ----------------
Other expenses 228 172
---------------- ----------------
Income Before Minority Interest and (Benefit) Provision for Income Taxes 1,340 1,096
Minority interest in loss of subsidiary 33 41
---------------- ----------------
Income Before (Benefit) Provision for Income Taxes 1,373 1,137
(Benefit) provision for income taxes (1,904) 5
---------------- ----------------
Net Income $ 3,277 $ 1,132
================ ================
Earnings per common share:
Basic $ 0.17 $ 0.06
================ ================
Diluted $ 0.17 $ 0.06
================ ================
Weighted average number of common shares outstanding:
Basic 19,092,487 20,078,996
================ ================
Diluted 19,626,043 20,576,505
================ ================
See accompanying notes to condensed consolidated financial statements.
4
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)
Nine Months Ended
March 31,
---------------------------------------
2008 2007
---------------- ----------------
(in thousands, except share and
per share data)
Net sales $ 46,264 $ 45,672
Cost of sales 30,356 28,794
---------------- ----------------
Gross Profit 15,908 16,878
Selling, general and administrative expenses 12,252 12,205
---------------- ----------------
Operating Income 3,656 4,673
---------------- ----------------
Interest expense, net 635 377
Other expenses, net 30 13
---------------- ----------------
Other expenses 665 390
---------------- ----------------
Income Before Minority Interest and (Benefit) Provision for Income Taxes 2,991 4,283
Minority interest in loss of subsidiary 92 95
---------------- ----------------
Income Before (Benefit) Provision for Income Taxes 3,083 4,378
(Benefit) Provision for income taxes (1,741) 1,150
---------------- ----------------
Net Income $ 4,824 $ 3,228
================ ================
Earnings per common share:
Basic $ 0.25 $ 0.16
================ ================
Diluted $ 0.24 $ 0.16
================ ================
Weighted average number of common shares outstanding:
Basic 19,319,967 20,021,196
================ ================
Diluted 19,873,655 20,673,139
================ ================
See accompanying notes to condensed consolidated financial statements.
5
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Nine Months Ended
March 31,
---------------------------------------
2008 2007
---------------- ----------------
(in thousands)
Cash Flows from Operating Activities:
Net income $ 4,824 $ 3,228
Adjustments to reconcile net income to net cash and cash equivalents
provided by (used in) operating activities:
Depreciation and amortization 854 861
Provision for (Recovery of) doubtful accounts 40 (80)
Change to inventory obsolescence reserve 150 (151)
Deferred income taxes 730 (180)
Non-cash stock based compensation expense 216 336
Changes in operating assets and liabilities:
Accounts receivable 3,731 2,890
Inventories (6,607) (8,967)
Prepaid expenses and other current assets (120) (41)
Income tax receivable (443) -
Other assets (113) (152)
Accounts payable, accrued expenses, accrued salaries and
wages, and accrued income taxes (2,061) (2,218)
---------------- ----------------
Net Cash Provided by (Used in) Operating Activities 1,201 (4,474)
---------------- ----------------
Cash Flows Used in Investing Activities:
Purchases of property, plant and equipment (668) (786)
---------------- ----------------
Cash Flows from Financing Activities:
Proceeds from exercise of employee stock options 4 168
Proceeds from long-term debt borrowings 5,000 4,500
Principal payments on long-term debt (2,000) -
Cash paid for purchase of treasury stock (3,225) (944)
---------------- ----------------
Net Cash (Used in) Provided by Financing Activities (221) 3,724
---------------- ----------------
Net increase (decrease) in Cash and Cash Equivalents 312 (1,536)
Cash and Cash Equivalents, Beginning of Period 1,748 2,738
---------------- ----------------
Cash and Cash Equivalents, End of Period $ 2,060 $ 1,202
================ ================
Cash Paid During the Period for:
--------------------------------
Interest $ 589 $ 325
================ ================
Income taxes $ 102 $ 2,526
================ ================
Non-cash Investing activities:
------------------------------
Adjustment to Retained earnings relating to adoption
of FIN 48 $ 485 $ -
================ ================
See accompanying notes to condensed consolidated financial statements.
6
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
1.) Summary of Significant Accounting Policies and Other Disclosures
----------------------------------------------------------------
The accompanying Condensed Consolidated Financial Statements are unaudited.
In management's opinion, all adjustments (consisting of only normal
recurring accruals) necessary for a fair presentation have been made. The
results of operations for the period ended March 31, 2008 are not
necessarily indicative of results that may be expected for any other
interim period or for the full year.
The unaudited Condensed Consolidated Financial Statements should be read in
conjunction with the Consolidated Financial Statements and related notes
contained in the Company's Annual Report on Form 10-K for the year ended
June 30, 2007. The accounting policies used in preparing these unaudited
Condensed Consolidated Financial Statements are consistent with those
described in the June 30, 2007 Consolidated Financial Statements. However,
for interim financial statements, inventories are calculated using a gross
profit percentage.
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.
The Company has made a number of estimates and assumptions relating to the
assets and liabilities, the disclosure of contingent assets and liabilities
and the reporting of revenues and expenses to prepare these financial
statements in conformity with accounting principles generally accepted in
the United States. Actual results could differ from those estimates.
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.
Advertising and Promotional Costs
Advertising and promotional costs are included in "Selling, General and
Administrative" expenses in the condensed consolidated statements of income
and are expensed as incurred. Advertising expense for the three months
ended March 31, 2008 and 2007 was $100,000 and $402,000, respectively.
Advertising expense for the nine months ended March 31, 2008 and 2007 was
$817,000 and $1,100,000, respectively. The decrease in the three and nine
months in fiscal 2008 was due to the timing of a major tradeshow. In the
prior year this tradeshow occurred in March of 2007 but it did not occur
until April of 2008 in the current fiscal year.
Research and Development Costs
Research and development costs are included in "Cost of Sales" in the
condensed consolidated statements of income and are expensed as incurred.
Research and development expense for the three months ended March 31, 2008
and 2007 was $1,375,000 and $1,325,000, respectively. Research and
development expense for the nine months ended March 31, 2008 and 2007 was
$4,097,000 and $3,938,000, respectively.
Business Concentration and Credit Risk
An entity is more vulnerable to concentrations of credit risk if it is
exposed to risk of loss greater than it would have had 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 42% and 38% of the Company's accounts receivable at March 31,
2008 and June 30, 2007, respectively. Sales to neither of these customers
exceeded 10% of net sales in any of the past three fiscal years.
7
In the ordinary course of business, the Company has established a reserve
for doubtful accounts and customer deductions in the amount of $405,000 and
$365,000 as of March 31, 2008 and June 30, 2007, respectively. The
Company's 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.
Stock Options
During the three and nine months ended March 31, 2008 the Company granted 0
and 40,000 stock options under its 2002 Employee Incentive Stock Option
Plan, respectively. These grants have exercise prices between $5.35 and
$5.89, a fair value of approximately $145,000 and vest over a four-year
period from the date of grant. 1,080 options were exercised under the 2002
Plan with proceeds of approximately $2,000 during the three months ended
March 31, 2008 and 2,160 options were exercised with proceeds of
approximately $4,000 under the 2002 Plan during the nine months ended March
31, 2008. No options were granted or exercised under the Company's 2000
Non-employee Incentive Stock Option Plan.
Recent Accounting Pronouncements
In March 2008, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 161, "Disclosures about Derivative Instruments and Hedging
Activities - an amendment of FASB Statement No. 133. This statement changes
the disclosure requirements for derivative instruments and hedging
activities. Entities are required to provide enhanced disclosures about (a)
how and why an entity uses derivative instruments, (b) how derivative
instruments and related hedged items are accounted for under Statement 133
and its related interpretations, and (c) how derivative instruments and
related hedged items affect an entity's financial position, financial
performance, and cash flows. SFAS No. 161 is effective for fiscal years and
interim periods beginning after November 15, 2008. The Company's adoption
of SFAS No. 161 is not expected to have a material effect on its condensed
consolidated financial statements.
In February 2008, the FASB issued FASB Staff Position ("FSP") No. FAS
157-1, "Application of FASB Statement No. 157 to FASB Statement No. 13 and
Other Accounting Pronouncements That Address Fair Value Measurements for
Purposes of Lease Classification or Measurement under Statement 13." This
FSP amends SFAS No. 157 to exclude certain leasing transactions accounted
for under previously existing accounting guidance. However, this scope
exception does not apply to assets acquired and liabilities assumed in a
business combination, regardless of whether those assets and liabilities
are related to leases.
In February 2008, the FASB issued FSP No. FAS 157-2, "Effective Date of
FASB Statement No. 157". This FSP delays the effective date of SFAS No.
157, "Fair Value Measurements", for non-financial assets and non-financial
liabilities, except for items that are recognized or disclosed at fair
value in the financial statements on a recurring basis (at least annually).
This FSP defers the effective date of SFAS No. 157 to fiscal years
beginning after November 15, 2008, and interim periods within those fiscal
years for items within the scope of this FSP.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business
Combinations" ("SFAS No. 141(R)"). SFAS No. 141(R) replaces SFAS No. 141,
"Business Combinations," however, it retains the fundamental requirements
of the former Statement that the acquisition method of accounting
(previously referred to as the purchase method) be used for all business
combinations and for an acquirer to be identified for each business. SFAS
No. 141(R) defines the acquirer as the entity that obtains control of one
or more businesses in the business combination and establishes the
acquisition date as the date that the acquirer achieves control. Among
other requirements, SFAS No. 141(R) requires the acquiring entity in a
business combination to recognize the identifiable assets acquired,
liabilities assumed and any non-controlling interest in the acquiree at
their acquisition-date fair values, with limited exceptions;
acquisition-related costs generally will be expensed as incurred. SFAS No.
141(R) requires certain financial statement disclosures to enable users to
evaluate and understand the nature and financial effects of the business
combination. SFAS No. 141(R) must be applied prospectively to business
combinations that are consummated beginning in the Company's fiscal 2010.
The Company's adoption of SFAS No. 141(R) is not expected to have a
material effect on its condensed consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, "Non-controlling Interests
in Consolidated Financial Statements, an Amendment of ARB No. 51" ("SFAS
No. 160") to establish accounting and reporting standards for the
non-controlling interest in a subsidiary and for the deconsolidation of a
subsidiary. Among other requirements, SFAS No. 160 clarifies that a
non-controlling interest in a subsidiary, which is sometimes referred to as
minority interest, is to be reported as a separate component of equity in
the consolidated financial statements. SFAS No. 160 also requires
consolidated net income to include the amounts attributable to both the
parent and the non-controlling interest and to disclose those amounts on
the face of the consolidated statement of income. SFAS No. 160 must be
8
applied prospectively for fiscal years, and interim periods within those
fiscal years, beginning in the Company's fiscal 2010, except for the
presentation and disclosure requirements, which will be applied
retrospectively for all periods. The Company's adoption of SFAS No. 160 is
not expected to have a material effect on its condensed consolidated
financial statements.
In December 2007, the U.S. Securities and Exchange Commission issued Staff
Accounting Bulletin No. 110 ("SAB 110"). This staff accounting bulletin
("SAB") expresses the views of the staff regarding the use of a
"simplified" method, as discussed in SAB No. 107 ("SAB 107"), in developing
an estimate of expected term of "plain vanilla" share options in accordance
with SFAS No. 123 (revised 2004), Share-Based Payment. In particular, the
staff indicated in SAB 107 that it will accept a company's election to use
the simplified method, regardless of whether the company has sufficient
information to make more refined estimates of expected term. At the time
SAB 107 was issued, the staff believed that more detailed external
information about employee exercise behavior (e.g., employee exercise
patterns by industry and/or other categories of companies) would, over
time, become readily available to companies. Therefore, the staff stated in
SAB 107 that it would not expect a company to use the simplified method for
share option grants after December 31, 2007. The staff understands that
such detailed information about employee exercise behavior may not be
widely available by December 31, 2007. Accordingly, the staff will continue
to accept, under certain circumstances, the use of the simplified method
beyond December 31, 2007. The Company's adoption of SAB 111 is not expected
to have a material effect on its condensed 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 condensed consolidated financial statements.
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 condensed consolidated financial statements.
2.) Stock-based Compensation
------------------------
The Company has established two share incentive programs as discussed in
more detail in the Consolidated Financial Statements and related notes
contained in the Company's annual report on Form 10-K for the year ended
June 30, 2007. The Company accounts for its stock options and share units
granted in accordance with SFAS No. 123(R), "Share-Based Payment" ("SFAS
No. 123(R)") which requires that all stock-based compensation must be
recognized as an expense in the financial statements and that cost be
measured at the fair market value of the award. 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.
Stock-based compensation costs of $64,000 and $107,000 were recognized in
three months ended March 31, 2008 and 2007, respectively. Stock-based
compensation costs of $216,000 and $336,000 were recognized in nine months
ended March 31, 2008 and 2007, respectively. Unearned stock-based
compensation cost was $509,000 as of March 31, 2008.
3.) Inventories
-----------
For interim financial statements, inventories are calculated using a gross
profit percentage. The Company regularly reviews parts and finished goods
inventories on hand and, when necessary, records a reserve for excess or
obsolete inventories. As of March 31, 2008 and June 30, 2007, balances in
these reserves amounted to $1,350,000 and $1,200,000, respectively. 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.
9
Inventories, net of reserves consist of the following (in thousands): March 31, June 30,
2008 2007
--------- ---------
Component parts $ 18,603 $ 15,139
Work-in-process 3,857 3,139
Finished product 12,220 9,945
--------- ---------
$ 34,680 $ 28,223
========= =========
Classification of inventories, net of reserves: Current $ 26,057 $ 21,342
Non-current 8,623 6,881
--------- ---------
$ 34,680 $ 28,223
========= =========
4.) Earnings Per Common Share
-------------------------
The Company follows the provisions of SFAS No. 128, "Earnings Per Share".
In accordance with SFAS No. 128, earnings per common share amounts ("Basic
EPS") were computed by dividing earnings by the weighted average number of
common shares outstanding for the period. Earnings per common share
amounts, assuming dilution ("Diluted EPS"), were computed by reflecting the
potential dilution from the exercise of stock options. SFAS No. 128
requires the presentation of both Basic EPS and Diluted EPS on the face of
the condensed consolidated statements of income.
A reconciliation between the numerators and denominators of the Basic and
Diluted EPS computations for earnings is as follows (in thousands except
per share data):
Three months ended March 31, 2008
----------------------------------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
---------------- ---------------- -----------------
Basic EPS
---------
Net income, as reported $ 3,277 19,092 $ 0.17
Effect of dilutive securities
-----------------------------
Employee Stock Options $ - 534 $ -
---------------- ---------------- -----------------
Diluted EPS
-----------
Net income, as reported and
assumed option exercises $ 3,277 19,626 $ 0.17
================ ================ =================
196,000 options to purchase shares of common stock in the three months ended March 31, 2008 were excluded in the
computation of Diluted EPS because the exercise prices were in excess of the average market price for this period
and their inclusion would be anti-dilutive.
Three months ended March 31, 2007
----------------------------------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
---------------- ---------------- -----------------
Basic EPS
---------
Net income, as reported $ 1,132 20,079 $ 0.06
Effect of dilutive securities
-----------------------------
Employee Stock Options $ - 498 $ -
---------------- ---------------- -----------------
Diluted EPS
-----------
Net income, as reported and
assumed option exercises $ 1,132 20,577 $ 0.06
================ ================ =================
10
154,000 options to purchase shares of common stock in the three months ended March 31, 2007 were excluded in the
computation of Diluted EPS because the exercise prices were in excess of the average market price for this period
and their inclusion would be anti-dilutive.
Nine months ended March 31, 2008
----------------------------------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
---------------- ---------------- -----------------
Basic EPS
---------
Net income, as reported $ 4,824 19,320 $ 0.25
Effect of dilutive securities
-----------------------------
Employee Stock Options $ - 554 $ (0.01)
---------------- ---------------- -----------------
Diluted EPS
-----------
Net income, as reported and
assumed option exercises $ 4,824 19,874 $ 0.24
================ ================ =================
187,000 options to purchase shares of common stock in the nine months ended March 31, 2008 were excluded in the
computation of Diluted EPS because the exercise prices were in excess of the average market price for this period.
Nine months ended March 31, 2007
----------------------------------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
---------------- ---------------- -----------------
Basic EPS
---------
Net income, as reported $ 3,228 20,021 $ 0.16
Effect of dilutive securities
-----------------------------
Employee Stock Options $ - 652 $ -
---------------- ---------------- -----------------
Diluted EPS
-----------
Net income, as reported and
assumed option exercises $ 3,228 20,673 $ 0.16
================ ================ =================
82,000 options to purchase shares of common stock in the nine months ended March 31, 2007 were excluded in the
computation of Diluted EPS because the exercise prices were in excess of the average market price for this period
and their inclusion would be anti-dilutive.
5.) Long Term Debt
--------------
Long-term debt consists of a revolving credit and term loan facility with
outstanding borrowings of $13,900,000 at March 31, 2008 and $10,900,000 at
June 30, 2007. 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. As of March 31, 2008 the
interest rate on the outstanding portion of this facility was 5.3%. 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.
6.) 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 three and nine
months ended March 31, 2008 and 2007 (in thousands):
11
Three Months ended March 31, Nine Months ended March 31,
-------------------------------------------------------------------------------
2008 2007 2008 2007
------------------------------------- -------------------------------------
Sales to external customers(1):
-------------------------------
Domestic $ 13,288 $ 13,407 $ 38,255 $ 39,215
Foreign 2,934 2,159 8,009 6,457
---------------- ---------------- ---------------- ----------------
Total Net Sales $ 16,222 $ 15,566 $ 46,264 $ 45,672
================ ================ ================ ================
As of
-------------------------------------
March 31, 2008 June 30, 2007
---------------- ----------------
Identifiable assets:
--------------------
United States $ 47,236 $ 47,636
Dominican Republic (2) 25,156 21,246
Other foreign countries 7,597 7,903
---------------- ----------------
Total Identifiable Assets $ 79,989 $ 76,785
================ ================
(1) All of the Company's sales occur in the United States and are shipped primarily from the Company's facilities in the
United States and United Kingdom. There were no sales into any one foreign country in excess of 10% of Net Sales.
(2) Consists primarily of inventories ($20,060,000 and $16,088,000) and fixed assets ($4,949,000 and $5,007,000) located
at the Company's principal manufacturing facility in the Dominican Republic as of March 31, 2008 and June 30, 2007,
respectively.
7.) Commitments and Contingencies
-----------------------------
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.
8.) Income Taxes
------------
In March 2003, Napco Security Systems, Inc. timely filed its income tax
return for the fiscal year ended June 30, 2002. This return included an
election to treat one of the Company's foreign subsidiaries as if it were a
domestic corporation beginning July 1, 2001. This election was based on a
then recently enacted Internal Revenue Code ("Code") provision. As a result
of this election, this subsidiary is treated, for Federal income tax
purposes, as transferring all of its assets to a domestic corporation in
connection with an exchange. Although this type of transfer usually results
in the recognition of taxable income to the extent of any untaxed earnings
and profits, the 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 this subsidiary's untaxed
earnings and profits as nontaxable.
The Internal Revenue Service has issued a Revenue Procedure that is
inconsistent with the Code exemption described above. 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 a result of the lapse in
the applicable statute of limitations, the Company reversed $407,000 of
this accrued liability during fiscal 2007, resulting in a long-term accrued
income tax liability of $1,836,000 as of June 30, 2007.
As a result of the implementation of FIN48 as of July 1, 2007, the Company
increased its accrued income tax liability by $715,000, from $1,836,000 to
$2,551,000, to provide for additional reserves for uncertain income tax
positions, relating to the fiscal years 2004 through 2007, the only periods
12
subject to examination by the taxing authorities. The increase in the
accrued income tax liability of $715,000 was offset in part by a $230,000
increase in a related deferred income tax asset, resulting in a net
reduction to retained earnings of $485,000 (representing the cumulative
effect of adopting FIN 48).
During the nine months ended March 31, 2008, the Company decreased its
reserve for uncertain income tax positions by $1,888,000, excluding the
related deferred tax benefit (representing interest on unrecognized income
tax positions), resulting in a long-term accrued income tax liability of
$249,000. The Company's practice is to recognize interest and/or penalties
related to income tax matters in income tax expense and accrued income
taxes. As of March 31, 2008, the Company had accrued interest totaling
$39,000, excluding the related deferred tax asset. As of March 31, 2008,
the Company had, approximately $190,000 of unrecognized net tax benefits
(including the related accrued interest and net of the related deferred
income tax benefit of $98,000) that, if recognized, would favorably affect
the effective income tax rate in any future periods.
During the quarter ended March 31, 2008, the Company recognized a net tax
benefit to income tax expense of $2,131,000 (a $2,263,000 liability
reversal, including interest, less a reversal of $132,000 of the related
deferred tax asset). This benefit resulted primarily from the Company's
domestication election, which has expired as the result of the expiration
of the related statute of limitations. For the three months ended March 31,
2008, the total accrued liability related to the Company's domestication
election has been reversed into income as a result of this expiration.
Additionally, a state tax exposure for the 2004 fiscal year has been
reversed due to the expiration of the statute of limitations. These
reversals resulted in a net benefit to income tax expense of $2,197,000
(consisting of a reversal of the accrued liability, including interest, at
December 31, 2007 of $2,365,000 less the related $168,000 reversal of the
deferred tax asset) during the three months ended March 31, 2008.
During the quarter ended December 31, 2007 the Company completed a
corporate restructuring for which new offshore companies were formed (Napco
DR, S.A. and Napco Americas). These newly formed wholly-owned subsidiaries
are included in the Company's condensed consolidated financial statements.
The existing US-based companies ("Napco US") and these newly formed
offshore companies entered into technology licenses and research and
development cost sharing agreements. Also, Napco DR, S.A. purchased the
majority of the operating assets previously held by the existing Dominican
subsidiary. Napco DR, S.A. is doing business in a Free Zone Park in the
Dominican Republic and as such is not subject to Dominican corporate income
taxes. Napco US plans to permanently reinvest a substantial portion of its
foreign earnings and as such has not provided US corporate taxes on the
permanently reinvested earnings. Due to the restructuring, the Company's
effective tax rate is lower in the second and third quarters and is
projected to be lower than the US statutory rates in the fourth quarter as
well.
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 for the nine months ended March 31, 2008 is as follows (dollars in
thousands):
% of
Pre-tax
Amount Income
-------- --------
Tax at Federal statutory rate $ 1,048 34.0%
Increases (decreases) in
taxes resulting from:
Reserve for uncertain tax positions (2,131) (69.1)
Stock based compensation expense 73 2.4
Adjustment for adoption of FIN48 66 2.1
U.S. benefit on foreign source income (721) (23.4)
Other, net (76) (2.5)
-------- --------
(Benefit) for income taxes $(1,741) (56.5)%
======== ========
9.) 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 March 31, 2008, the Company has repurchased all
1,000,000 of these shares at a weighted average price of $5.62 per share.
13
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations
-------------
Napco Security Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
This Quarterly Report on Form 10-Q and the information incorporated by reference
may include "Forward-Looking Statements" within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Exchange Act of 1934. The
Company intends the Forward-Looking Statements to be covered by the Safe Harbor
Provisions for Forward-Looking Statements. All statements regarding the
Company's expected financial position and operating results, its business
strategy, its financing plans and the outcome of any contingencies are
Forward-Looking Statements. The Forward-Looking Statements are based on current
estimates and projections about our industry and our business. Words such as
"anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates,"
or variations of such words and similar expressions are intended to identify
such Forward-Looking Statements. The Forward-Looking Statements are subject to
risks and uncertainties that could cause actual results to differ materially
from those set forth or implied by any Forward-Looking Statements. 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, significant fluctuations in the exchange
rate between the Dominican Peso and the U.S. Dollar, distribution problems,
unforeseen environmental liabilities and the uncertain military, political and
economic conditions in the world.
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 17% and 14% of our
revenues for the nine months ended March 31, 2008 and 2007, respectively.
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 6% of our
revenues for the nine months ended March 31, 2008.
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 the three months ended March 31, 2008 did
not contribute materially to revenue during this period, but should benefit the
Company over future periods. 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 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.
Demand for the Company's intrusion products, which accounted for approximately
50% of Net sales in the first nine months of Fiscal 2008, has a direct
correlation to demand in the housing market.
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
14
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
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 sale. We report our sales
levels on a net sales basis, which is computed by deducting from gross sales the
amount of actual sales returns and allowances and an amount established for
anticipated sales returns and allowances.
Our accrual for sales returns and allowances 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 and
allowances, as well as management's estimate of anticipated sales returns and
allowances. As a percentage of gross sales, sales returns, rebates and other
allowances were 7% and 8% for the three months ended March 31, 2008 and 2007,
respectively and 6% and 8% for the nine months ended March 31, 2008 and 2007,
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
42% and 38% of the Company's accounts receivable at March 31, 2008 and June 30,
2007, 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 $405,000 and $365,000 as of
March 31, 2008 and June 30, 2007, 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
For interim financial statements, inventories are calculated using a gross
profit percentage. This valuation method is 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. As of
March 31, 2008 and June 30, 2007, balances in these reserves amounted to
$1,350,000 and $1,200,000, respectively.
The Company also regularly reviews the period over which its inventories will be
converted to sales. Any inventories which are expected to convert to sales
beyond 12 months from the balance sheet date are classified as non-current.
15
Goodwill
In accordance with SFAS No. 142, intangible assets, including purchased
goodwill, are evaluated by the Company 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. At the close of Fiscal 2007, the Company
performed its annual impairment evaluation required by this standard and
determined that its goodwill is not impaired.
Income Taxes
In March 2003, Napco Security Systems, Inc. timely filed its income tax return
for the fiscal year ended June 30, 2002. This return included an election to
treat one of the Company's foreign subsidiaries as if it were a domestic
corporation beginning July 1, 2001. This election was based on a then recently
enacted Internal Revenue Code ("Code") provision. As a result of this election,
this subsidiary is treated, for Federal income tax purposes, as transferring all
of its assets to a domestic corporation in connection with an exchange. Although
this type of transfer usually results in the recognition of taxable income to
the extent of any untaxed earnings and profits, the 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 this subsidiary'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 a result of the lapse in the applicable statute of limitations, the
Company reversed $407,000 of this accrued liability during fiscal 2007,
resulting in a long-term accrued income tax liability of $1,836,000 as of June
30, 2007.
As a result of the implementation of FIN48 as of July 1, 2007, the Company
increased its accrued income tax liability by $715,000, from $1,836,000 to
$2,551,000, to provide for additional reserves for uncertain income tax
positions, relating to the fiscal years 2004 through 2007, the only periods
subject to examination by the taxing authorities. The increase in the accrued
income tax liability of $715,000 was offset in part by a $230,000 increase in a
related deferred income tax asset, resulting in a net reduction to retained
earnings of $485,000 (representing the cumulative effect of adopting FIN 48).
During the nine months ended March 31, 2008, the Company decreased its reserve
for uncertain income tax positions by $1,888,000, excluding the related deferred
tax benefit (representing interest on unrecognized income tax positions),
resulting in a long-term accrued income tax liability of $249,000. The Company's
practice is to recognize interest and/or penalties related to income tax matters
in income tax expense and accrued income taxes. As of March 31, 2008, the
Company had accrued interest totaling $39,000, excluding the related deferred
tax asset. As of March 31, 2008, the Company had, approximately $190,000 of
unrecognized net tax benefits (including the related accrued interest and net of
the related deferred income tax benefit of $98,000) that, if recognized, would
favorably affect the effective income tax rate in any future periods.
During the quarter ended March 31, 2008, the Company recognized a net tax
benefit to income tax expense of $2,131,000 (a $2,263,000 liability reversal,
including interest, less a reversal of $132,000 of the related deferred tax
asset). This benefit resulted primarily from the Company's domestication
election, which has expired as the result of the expiration of the related
statute of limitations. For the three months ended March 31, 2008, the total
accrued liability related to the Company's domestication election has been
reversed into income as a result of this expiration. Additionally, a state tax
exposure for the 2004 fiscal year has been reversed due to the expiration of the
statute of limitations. These reversals resulted in a net benefit to income tax
expense of $2,197,000 (consisting of a reversal of the accrued liability,
including interest, at December 31, 2007 of $2,365,000 less the related $168,000
reversal of the deferred tax asset) during the three months ended March 31,
2008.
During the quarter ended December 31, 2007 the Company completed a corporate
restructuring for which new offshore companies were formed (Napco DR, S.A. and
Napco Americas). These newly formed wholly-owned subsidiaries are included in
the Company's condensed consolidated financial statements. The existing US-based
companies ("Napco US") and these newly formed offshore companies entered into
16
technology licenses and research and development cost sharing agreements. Also,
Napco DR, S.A. purchased the majority of the operating assets previously held by
the existing Dominican subsidiary. Napco DR, S.A. is doing business in a Free
Zone Park in the Dominican Republic and as such is not subject to Dominican
corporate income taxes. Napco US plans to permanently reinvest a substantial
portion of its foreign earnings and as such has not provided US corporate taxes
on the permanently reinvested earnings. Due to the restructuring, the Company's
effective tax rate is lower in the second and third quarters and is projected to
be lower than the US statutory rates in the fourth quarter as well.
Results of Operations
---------------------
------------------------------------------ ------------------------------------------
Three months ended March 31, (dollars in Nine months ended March 31, (dollars in
thousands) thousands)
------------------------------------------ ------------------------------------------
% Increase/ % Increase/
2008 2007 (decrease) 2008 2007 (decrease)
------------------------------------------ ------------------------------------------
Net sales $ 16,222 $ 15,566 4.2% $ 46,264 $ 45,672 1.3%
Gross profit 5,523 5,494 0.5% 15,908 16,878 (5.7)%
Gross profit as a % of net sales 34.0% 35.3% (1.3)% 34.4% 37.0% (2.6)%
Selling, general and administrative 3,955 4,226 (6.4)% 12,252 12,205 0.4%
Selling, general and administrative
as a percentage of net sales 24.4% 27.1% (2.7)% 26.5% 26.7% (0.2)%
Operating income 1,568 1,268 (23.7)% 3,656 4,673 (21.8)%
Interest expense, net 216 168 28.6% 635 377 68.4%
Other expense
12 4 200.0% 30 13 130.8%
Minority interest in net loss of
subsidiary, net 33 41 (19.5)% 92 95 (3.2)%
(Benefit) Provision for income taxes (1,904) 5 (38,180.0)% (1,741) 1,150 (251.4)%
Net income 3,277 1,132 189.5% 4,824 3,228 49.4%
------------------------------------------ ------------------------------------------
Sales for the three months ended March 31, 2008 increased by approximately 4% to
$16,222,000 as compared to $15,566,000 for the same period a year ago. Sales for
the nine months ended March 31, 2008 increased approximately 1% to $46,264,000
as compared to $45,672,000 for the same period a year ago. The increase in sales
for the three months was due primarily to increases in the Company's
international sales and its door-locking products as partially offset by a
decrease in intrusion detection products. The increase in sales for the nine
months was due primarily to increases in the Company's international sales as
partially offset by a decrease in intrusion detection products.
The Company's gross profit for the three months ended March 31, 2008 remained
relatively constant at $5,523,000 or 34.0% of sales as compared to $5,494,000 or
35.3% of sales for the same period a year ago. The Company's gross profit for
the nine months ended March 31, 2008 decreased by $970,000 to $15,908,000 or
34.4% of sales as compared to $16,878,000 or 37.0% of sales for the same period
a year ago. The decrease in gross profit for the nine months resulted primarily
from a lower overhead absorption rate and an increase in the inventory reserve
of $150,000 in the nine months ended March 31, 2008 as well as a decrease in the
Company's inventory reserve in the nine months ended March 31, 2007. The
absorption rate in the first nine months of fiscal 2008 decreased as a result of
the Company's high forecast and production rates in the first nine months of
fiscal 2007 as compared to those in the first nine months of fiscal 2008.
Selling, general and administrative expenses for the three months ended March
31, 2008 decreased by $271,000 to $3,955,000, or 24.4% of sales, as compared to
$4,226,000, or 27.1% of sales a year ago. Selling, general and administrative
expenses for the nine months ended March 31, 2008 remained relatively constant
at $12,252,000, or 26.5% of sales, as compared to $12,205,000, or 26.7% of sales
a year ago. The decrease in dollars and as a percentage of sales for the three
months ended March 31, 2008 was due primarily to the timing of a major tradeshow
($264,000). In the prior year this tradeshow occurred in March of 2007 but it
did not occur until April of 2008 in the current fiscal year.
Interest expense, net for the three months ended March 31, 2008 increased by
$48,000 to $216,000 as compared to $168,000 for the same period a year ago.
Interest expense, net for the nine months ended March 31, 2008 increased by
$258,000 to $635,000 as compared to $377,000 for the same period a year ago. The
17
increase in interest expense for the three and nine months resulted primarily
from the increase in the Company's average outstanding debt which was due
primarily to the Company's increase in inventory and its Treasury stock
repurchases as discussed below.
The Company's provision for income taxes for the three months ended March 31,
2008 decreased by $1,909,000 to a benefit of $1,904,000 as compared to a
provision of $5,000 for the same period a year ago. The Company's provision for
income taxes for the nine months ended March 31, 2008 decreased by $2,891,000 to
a benefit of $1,741,000 as compared to a provision of $1,150,000 for the same
period a year ago. The decrease in provision for income taxes for the three and
nine months resulted primarily from the Company recognizing a net tax benefit to
income tax expense of $2,131,000 as described on page 16. In addition, during
the quarter ended December 31, 2007 Napco completed a corporate restructuring
for which new offshore companies were formed. As a result, the Company's
effective rate for the three and nine months ended December 31, 2007, prior to
the effect of the $2,131,000 benefit described above, was 17% and 13%,
respectively, which reflected this restructuring as well as an additional
provision of $66,000 resulting from the Company's adoption of FIN48, both as
described in Note 8 of the accompanying condensed consolidated financial
statements.
Net income increased by $2,145,000 to $3,277,000 or $0.17 per diluted share for
the three months ended March 31, 2008 as compared to $1,132,000 or $0.06 per
diluted share for the same period a year ago. Net income increased by $1,596,000
to $4,824,000 or $0.24 per diluted share for the nine months ended March 31,
2008 as compared to $3,228,000 or $0.16 per diluted share for the same period a
year ago. The increase for the three and nine months ended March 31, 2008 was
primarily due to the tax benefit relating to the Company's Dominican Republic
operation described above.
Liquidity and Capital Resources
-------------------------------
During the nine months ended March 31, 2008 the Company utilized all of its cash
from operations and additional borrowings to purchase inventory ($6,457,000),
property, plant and equipment ($668,000) and treasury stock ($3,225,000). The
Company's management believes that current working capital, cash flows from
operations and its revolving credit agreement will be sufficient to fund the
Company's operations through at least the next twelve months.
Accounts Receivable at March 31, 2008 decreased $3,771,000 to $21,808,000 as
compared to $25,579,000 at June 30, 2007. This decrease is primarily the result
of the higher sales volume during the quarter ended June 30, 2007 as compared to
the quarter ended March 31, 2008.
Inventories at March 31, 2008 increased by $6,457,000 to $34,680,000 as compared
to $28,223,000 at June 30, 2007. This increase was primarily the result of the
Company level-loading its production schedule in anticipation of its historical
sales cycle where a larger portion of the Company's sales occur in the latter
fiscal quarters as compared to the earlier quarters as well as to support a
projection of higher sales in fiscal 2008. The Company has initiated several
steps in order to reduce inventory levels and it is our expectation that we will
begin seeing noticeable reductions during the fourth quarter of fiscal 2008 and
continuing in fiscal 2009.
Treasury stock at March 31, 2008 increased by $3,225,000 to $5,615,000 from
$2,390,000 at June 30, 2007. The treasury stock was repurchased pursuant to the
repurchase plan authorized by the Company's Board of Directors on March 16,
2007, which authorized the repurchase of up to one million (1,000,000) shares of
its common stock. In January of 2008, the Company completed the repurchase of
these 1,000,000 shares.
Accrued income taxes decreased by $2,057,000 from $1,932,000 at June 30, 2007 to
a net receivable of $125,000 at March 31, 2008. This decrease resulted primarily
from the Company recognizing a net tax benefit to income tax expense of
$2,131,000 as described on page 16.
Long-term debt consists of a revolving credit and term loan facility with
outstanding borrowings of $13,900,000 at March 31, 2008 and $10,900,000 at June
30, 2007. 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. As of March 31, 2008 the interest rate on the outstanding portion of
this facility was 5.3%. 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.
18
As of March 31, 2008 the Company had no material commitments for capital
expenditures or inventory purchases other than purchase orders issued in the
normal course of business.
ITEM 3: Quantitative and Qualitative Disclosures About Market Risk
-------------------------------------------------------------------
The Company's principal financial instrument is long-term debt (consisting of a
revolving credit 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 March 31, 2008, an aggregate principal amount of
approximately $13,900,000 was outstanding under the Company's credit facility
with a weighted average interest rate of approximately 5.3%. If principal
amounts outstanding under the Company's credit facility remained at this
year-end level for an entire year and the prime rate increased or decreased,
respectively, by 1% the Company would pay or save, respectively, an additional
$139,000 in interest that year.
A significant number of foreign sales transactions by the Company are
denominated in U.S. dollars. As such, the Company has shifted foreign currency
exposure onto many of its foreign customers. As a result, if exchange rates move
against foreign customers, the Company could experience difficulty collecting
unsecured accounts receivable, the cancellation of existing orders or the loss
of future orders. The foregoing could materially adversely affect the Company's
business, financial condition and results of operations. In addition, the
Company transacts certain sales in Europe in British Pounds Sterling, therefore
exposing itself to a certain amount of foreign currency risk. Management
believes that the amount of this exposure is immaterial. We are also exposed to
foreign currency risk relative to expenses incurred in Dominican Pesos ("RD$"),
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 4: Controls and Procedures
--------------------------------
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms, and that such information is accumulated and communicated
to our management to allow timely decisions regarding required disclosure.
Management necessarily applied its judgment in assessing the costs and benefits
of such controls and procedures, which, by their nature, can provide only
reasonable assurance regarding management's control objectives.
At the conclusion of the period ended March 31, 2008, 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
effective in alerting them in a timely manner to information relating to the
Company required to be disclosed in this report except as follows:
Management's review over it's internal controls at the conclusion of fiscal 2007
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 ("ARB No. 43"). Management has informed it's independent auditors and the
Audit Committee that it has corrected its method of classifying its inventory so
as to be in compliance with ARB No. 43, has initiated a review of the ways in
which we can accumulate information to provide better substantiation of our
overhead estimates, including implementation of an additional 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 these
actions during fiscal 2008.
During the third quarter of fiscal 2008, 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 procedure described above which has corrected
the weakness relating to inventory classification on the balance sheet.
19
PART II: OTHER INFORMATION
Item 1A. Risk Factors
------------
Information regarding the Company's Risk Factors are set forth in the
Company's Annual Report on Form 10-K for the year ended June 30,
2007. There have been no material changes in the risk factors
previously disclosed in the Company's Form 10-K for the year ended
June 30, 2007 during the three months ended March 31, 2008.
Item 2. Unregistered Sales of Equity Securities and Uses of Proceeds
------------------------------------------------------------
Issuer Purchases of Equity Securities:
-------------------------------------------------------------------------------------------------------------------
Total Number of Maximum Number
Shares Purchased as of Shares that May
Total Number of Average Part of Publically Yet Be Purchased
Shares Price Paid Announced Plans or Under Plans or
Period Purchased per Share Programs Programs
-------------------------------------------------------------------------------------------------------------------
January 1, 2008 - January 31, 2008 17,671 $5.98 17,671 -
February 1, 2008 - February 29, 2008 - - - -
March 1, 2008 - March 31, 2008 - - - -
-------------------------------------------------------------------------------------------------------------------
Total for the quarter ended March 31, 2008 17,671 $5.98 17,671 -
====== ======
-------------------------------------------------------------------------------------------------------------------
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. In January of 2008, the Company completed the
repurchase of these 1,000,000 shares.
Item 4. Submission of Matters to a Vote of Security Holders
---------------------------------------------------
None
Item 6. Exhibits
--------
31.1 Certification Pursuant to Rule 13a-14(a)/15d-14(a) of Richard
L. Soloway, Chairman of the Board and President
31.2 Certification Pursuant to Rule 13a-14(a)/15d-14(a) of Kevin
S. Buchel, Senior Vice President of Operations and Finance
32.1 Section 1350 Certifications
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
May 9, 2008
NAPCO SECURITY SYSTEMS, INC
(Registrant)
By: /S/ RICHARD L. SOLOWAY
-------------------------------------------------------------------
Richard L. Soloway
Chairman of the Board of Directors, President and Secretary
(Chief Executive Officer)
By: /S/ KEVIN S. BUCHEL
-------------------------------------------------------------------
Kevin S. Buchel
Senior Vice President of Operations and Finance and Treasurer
(Principal Financial and Accounting Officer)
21