UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
(Mark One)
[X] Annual Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934 [No Fee Required]
For the fiscal year ended June 30, 2006
or
Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934 [No Fee Required]
For the Transition period from ______ to ______
COMMISSION FILE NUMBER 0-10004
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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, 2005, 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 $89,243,371.
As of September 21, 2006, 19,955,313 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
2006 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.
PRODUCTS
Access Control Systems. Access control systems consist of one or more of the
following: various types of identification readers (e.g. card readers, hand
scanners, etc.), a control panel, a PC-based computer and electronically
activated door-locking devices. When an identification card or other identifying
information is entered into the reader, the information is transmitted to the
control panel/PC which then validates the data and determines whether to grant
access or not by electronically deactivating the door locking device. An
electronic log is kept which records various types of data regarding access
activity.
The Company designs, engineers and markets the software and control panels
discussed above. It also buys and resells various identification readers,
PC-based computers and various peripheral equipment for access control systems.
Alarm Systems. Alarm systems usually consist of various detectors, a control
panel, a digital keypad and signaling equipment. When a break-in occurs, an
intrusion detector senses the intrusion and activates a control panel via
hard-wired or wireless transmission that sets off the signaling equipment and,
in most cases, causes a bell or siren to sound. Communication equipment such as
a digital communicator may be used to transmit the alarm signal to a central
station or another person selected by a customer.
The Company manufactures and markets the following products for alarm
systems:
Automatic Communicators. When a control panel is activated by a signal from
an intrusion detector, it activates a communicator that can automatically
dial one or more pre-designated telephone numbers. If programmed to do so,
a digital communicator dials the telephone number of a central monitoring
station and communicates in computer language to a digital communicator
receiver, which prints out an alarm message.
Control Panels. A control panel is the "brain" of an alarm system. When
activated by any one of the various types of intrusion detectors, it can
activate an audible alarm and/or various types of communication devices.
For marketing purposes, the Company refers to its control panels by the
trade name, generally "Gemini(TM)" and "Magnum Alert(TM)" followed by a
numerical designation.
Combination Control Panels/Digital Communicators and Digital Keypad
Systems. A combination control panel, digital communicator and a digital
keypad (a plate with push button numbers as on a telephone, which
eliminates the need for mechanical keys) has continued to grow rapidly in
terms of dealer and consumer preference. Benefits of the combination format
include the cost efficiency resulting from a single microcomputer function,
as well as the reliability and ease of installation gained from the
simplicity and sophistication of micro-computer technology.
Door Security Devices. The Company manufactures a variety of exit alarm
locks including simple dead bolt locks, door alarms and
microprocessor-based electronic door locks with push button and card reader
operation.
Fire Alarm Control Panel. Multi-zone fire alarm control panels, which
accommodate an optional digital communicator for reporting to a central
station, are also manufactured by the Company.
Area Detectors. The Company's area detectors are both passive infrared heat
detectors and combination microwave/passive infrared detectors that are
linked to alarm control panels. Passive infrared heat detectors respond
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, 2006, 2005, and 2004, the Company
expended approximately $5,109,000, $4,865,000, and $4,254,000, 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, 2006, the Company had approximately 950 full-time employees.
MARKETING
The Company's staff of 54 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 70% and 73% of the Company's total sales
for the fiscal years ended June 30, 2006 and 2005, 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.
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.
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 $739,000 and $438,000 existed as of June 30,
2006 and 2005, 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
2006 2005 2004
------- ------- -------
(in thousands)
Sales to external customers(1):
Domestic $58,549 $54,654 $48,626
Foreign 10,999 10,575 9,467
------- ------- -------
Total Net Sales $69,548 $65,229 $58,093
======= ======= =======
Identifiable assets:
United States $47,175 $41,753 $40,153
Dominican Republic (2) 18,924 14,658 13,075
Other foreign countries 5,623 3,496 3,444
------- ------- -------
Total Identifiable Assets $71,722 $59,907 $56,672
======= ======= =======
(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 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.
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 $5,109,000 and $4,865,000 for 2006 and 2005,
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 29% 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, 2006, 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.
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 2007.
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 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
Quarter Ended Fiscal 2005
---------------------------------------
Common Stock Sept. 30 Dec. 31 March 31 June 30
-------- ------- -------- -------
High $3.352 $5.947 $5.884 $4.676
Low $2.481 $3.263 $4.471 $3.898
APPROXIMATE NUMBER OF SECURITY HOLDERS
The number of holders of record of NAPCO's Common Stock as of September 21, 2006
was 137 (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 authorized by the
Company's primary lender.
EQUITY COMPENSATION PLAN INFORMATION AS OF JUNE 30, 2006
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SECURITIES TO BE WEIGHTED AVERAGE FUTURE ISSUANCE (EXCLUDING
ISSUED UPON EXERCISE OF EXERCISE PRICE OF SECURITIES REFLECTED IN
OUTSTANDING OPTIONS OUTSTANDING OPTIONS COLUMN a)
PLAN CATEGORY (a) (b) (c)
------------- -------------------------- ------------------- --------------------------
Equity compensation plans approved by security
holders: 1,333,050 $2.41 613,800
Equity compensation plans not approved by
security holders: -- -- --
--------- ----- -------
Total 1,333,050 $2.41 613,800
========= ===== =======
ITEM 6. SELECTED FINANCIAL DATA.
The table below summarizes selected financial information. For further
information, refer to the audited consolidated financial statements and the
notes thereto beginning on page FS-1 of this report.
Fiscal Year Ended or at June 30
-------------------------------------------------------------------
(In thousands, except share data)
2006(1) 2005(5) 2004(1) 2003(1) 2002(1)
----------- ----------- ----------- ----------- -----------
Statement of earnings data:
Net Sales $ 69,548 $ 65,229 $ 58,093 $ 57,340 $ 55,836
Gross Profit 25,941 23,924 19,540 15,401 14,717
Income from Operations 9,523 8,910 6,065 2,225 2,817
Net Income 6,119 5,629 3,335 1,010 1,575(4)
Cash Flow Data:
Net cash flows (used in) provided
by operating activities (168) 7,205 6,275 6,482 7,091
Net cash flows used in investing
activities (1,679) (658) (681) (752) (709)
Net cash flows provided by (used
in)financing activities 3,407 (6,165) (6,592) (5,436) (5,919)
Per Share Data:
Net earnings per common share:
Basic $ .31 $ .29 $ .19 $ .06 $ .09
Diluted $ .30 $ .28 $ .17 $ .05 $ .08
Weighted average common shares
outstanding:
Basic 19,785,000 19,265,000 17,906,000 17,942,000 18,101,000
Diluted 20,605,000 20,284,000 19,119,000 19,208,000 19,112,000
Cash Dividends declared per common
share (2) $ .00 $ .00 $ .00 $ .00 $ .00
Balance sheet data (3):
Working capital $ 40,948 $ 31,017 $ 28,992 $ 28,843 $ 31,812
Total assets 71,722 59,907 56,672 57,349 60,752
Long-term debt 4,700 1,950 6,400 14,100 16,588
Stockholders' equity 50,850 43,678 37,904 33,357 34,528
(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 authorized by the Company's primary lender.
(3) Working capital is calculated by deducting Current Liabilities from Current
Assets.
(4) The Company eliminated a deferred tax asset and a related valuation
allowance in fiscal 2002. This had the effect of increasing net income by
$688,000 in fiscal 2002.
(5) Share and per share data have been restated to reflect the effect of the
3:2 stock split effective December 2005 and the 3:2 stock split effective
June 2006.
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 16% of our 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 2% of our
revenues for fiscal 2006.
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 2006 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
of electronic security products and services versus the rather sluggish
performance of most technology related sectors during the similar period.
Electronic security vendors, however, did not completely escape the fallout from
the broader downturn in capital spending in the economy. 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.
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.
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 7%, 6% and 7% in fiscal 2006, 2005
and 2004, 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
33% and 35% of the Company's accounts receivable at June 30, 2006 and 2005,
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 $420,000 and $380,000 as of
June 30, 2006 and 2005, 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.
INVENTORY
We state our inventory at the lower of cost or fair market value, with cost
being determined on the first-in, first-out (FIFO) method. We believe FIFO most
closely matches the flow of our products from manufacture through sale. The
reported net value of our inventory includes finished saleable products,
work-in-process and raw materials that will be sold or used in future periods.
Inventory cost includes raw materials, direct labor and overhead.
We also record an inventory obsolescence reserve, which represents the
difference between the cost of the inventory and its estimated market value,
based on various product sales projections. This reserve is calculated using an
estimated obsolescence percentage applied to the inventory based on age,
historical trends and requirements to support forecasted sales. In addition, and
as necessary, we may establish specific reserves for future known or anticipated
events.
GOODWILL
Effective July 1, 2001, the Company adopted Statement of Financial Accounting
Standards (SFAS) No. 141, Business Combinations and SFAS No. 142, Goodwill and
Other Intangible Assets. These statements established accounting and reporting
standards for acquired goodwill and other intangible assets. Specifically, the
standards address how acquired intangible assets should be accounted for both at
the time of acquisition and after they have been recognized in the financial
statements. In accordance with SFAS No. 142, intangible assets, including
purchased goodwill, must be evaluated for impairment. Those intangible assets
that are classified as goodwill or as other intangibles with indefinite lives
are not amortized.
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 is 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
range from $0 to $9,450,000. However, the Company also believes there are 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.
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 activities
during fiscal 2006 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. 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, 2006, the Company's unused
sources of funds consisted principally of $2,738,000 in cash and approximately
$13,300,000, 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 2008.
The Company is a party to an amended and restated secured revolving credit
agreement with its primary bank, pursuant to which borrowing capacity is
$18,000,000. 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 three of the Company's subsidiaries.
The revolving credit agreement bears interest at either the Prime Rate less 1/4%
or an alternate rate based on LIBOR as described in the agreement. The revolving
credit agreement has been extended to September 2008. 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 2006, 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:
2006 2005 2004
-------- -------- --------
Current Ratio 4.4 to 1 4.0 to 1 4.3 to 1
Sales to Receivables 2.8 to 1 3.0 to 1 2.9 to 1
-------- -------- --------
Total debt to equity .09 to 1 .04 to 1 .2 to 1
======== ======== ========
As of June 30, 2006, the Company had no material commitments for purchases or
capital expenditures, except as discussed below.
On April 26, 1993, the Company's foreign subsidiary entered into a 99-year land
lease of approximately 4 acres of land in the Dominican Republic, at an annual
cost of approximately $288,000.
Working Capital. Working capital increased by $9,931,000 to $40,948,000 at June
30, 2006 from $31,017,000 at June 30, 2005. The increase in working capital was
primarily the result of the Company's net income and an increase in accounts
receivable, inventory and long-term debt. Working capital is calculated by
deducting Current Liabilities from Current Assets.
Accounts Receivable. Accounts Receivable increased by $3,254,000 to $25,153,000
at June 30, 2006 from $21,899,000 at June 30, 2005. This increase resulted
primarily from the granting of additional payment terms to certain of the
Company's burglar alarm customers as well as the increased sales during the
fourth quarter of fiscal 2006 as compared to the fourth quarter of fiscal 2005.
Inventory. Inventory increased by $6,424,000 to $22,666,000 at June 30, 2006 as
compared to $16,242,000 at June 30, 2005. 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 newer products which did not occur
during fiscal 2006. The Company anticipates that this inventory will be sold
during fiscal 2007.
Accounts Payable, and Accrued Expenses. Accounts payable and accrued expenses
increased by $1,095,000 to $10,018,000 as of June 30, 2006 as compared to
$8,923,000 at June 30, 2005. This increase is primarily due to the increased
purchases of raw materials and the timing of payments to the Company's vendors.
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
---------------------------------------------------------------
Less than More than
Contractual obligations Total 1 year 1-3 years 3-5 years 5 years
----------------------- ----------- ---------- ---------- --------- -----------
Long-term debt obligations $ 4,700,000 $ -- $4,700,000 $ -- $ --
Land lease (86 years remaining) (1) 24,768,000 288,000 576,000 576,000 23,328,000
Operating lease obligations 101,000 87,000 14,000 -- --
Other long-term obligations (employment
agreements) (1) 2,457,000 969,000 1,488,000 -- --
----------- ---------- ---------- -------- -----------
Total $32,026,000 $1,344,000 $6,778,000 $576,000 $23,328,000
=========== ========== ========== ======== ===========
(1) see footnote 10 to the consolidated financial statements.
RESULTS OF OPERATIONS
FISCAL 2006 COMPARED TO FISCAL 2005
Fiscal year ended
June 30,
----------------- % Increase/
2006 2005 (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.
FISCAL 2005 COMPARED TO FISCAL 2004
Fiscal year ended
June 30,
----------------- % Increase/
2005 2004 (decrease)
------- ------- -----------
Net sales $65,229 $58,093 12.3%
Gross profit 23,924 19,540 22.4%
Gross profit as a % of net sales 36.7% 33.6% 3.1%
Selling, general and administrative 15,014 13,475 11.4%
Income from operations 8,910 6,065 46.9%
Interest expense, net 224 420 (46.7)%
Other expense, net 58 109 (46.8)%
Provision for income taxes 3,227 2,201 46.6%
Net income 5,629 3,335 68.8%
Net Sales. Net sales in fiscal 2005 increased by 12.3% to $65,229,000 from
$58,093,000 in fiscal 2004. The Company's sales growth was primarily due to
increased sales of the Company's burglar alarm and door locking products. During
the quarter ended December 31, 2003, the Company began the process of realigning
its burglar alarm products distribution network which culminated in the
termination of a major burglar alarm distributor. The Company reallocated its
burglar alarm products business across its extensive national network of
independent distributors. The Company has seen the positive effects of this
realignment reflected in the increase in net sales as well as the increase in
gross profit as discussed below.
Gross Profit. The Company's gross profit increased $4,384,000 to $23,924,000 or
36.7% of net sales in fiscal 2005 as compared to $19,540,000 or 33.6% of net
sales in fiscal 2004. 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, a decrease in the
Company's inventory obsolescence reserve resulting primarily from the increase
in net sales, increased margins resulting from the realignment of the Company's
burglar alarm products as well as cost reductions of certain of the Company's
raw material costs.
Expenses. Selling, general and administrative expenses as a percentage of net
sales remained relatively constant at 23% in both fiscal 2005 and fiscal 2004.
Interest expense for fiscal 2005 decreased by $196,000 to $224,000 from $420,000
for the same period a year ago. The decrease in interest expense is primarily
the result of the reduction of the Company's outstanding debt by $6,350,000
during fiscal 2005.
Other Expenses. Other expenses decreased $51,000 to $58,000 in fiscal 2005 as
compared to $109,000 in fiscal 2004.
Income Taxes. The Company's provision for income taxes increased by $1,026,000
to a provision of $3,227,000 in fiscal 2005 as compared to $2,201,000 in fiscal
2004. This increase in the provision for income taxes is primarily due to a
$3,092,000 increase in income before income taxes in fiscal 2005 as compared to
fiscal 2004. The increase in income before income taxes is due primarily to the
items discussed above.
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.
In March 2004, the Company's Board of Directors approved a two-for-one stock
split in the form of a 100% stock dividend of the Company's common stock payable
to stockholders of record on April 13, 2004. The additional shares were
distributed on April 27, 2004. The Company utilized all 2,871,056 of its shares
held as treasury stock as of April 27, 2004 plus an additional 609,260 shares in
paying this stock dividend. The cost of treasury stock was applied first to
additional paid-in capital (to the extent there was a positive balance), then
directly to retained earnings.
All share and per share amounts (except par value) have been retroactively
adjusted to reflect the stock 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.
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, 2006, an aggregate principal amount of
approximately $4,700,000 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
$47,000 in interest that year.
A significant number of foreign sales transactions by the Company are
denominated in U.S. dollars. As such, the Company has shifted foreign currency
exposure onto many of its foreign customers. As a result, if exchange rates move
against foreign customers, the Company could experience difficulty collecting
unsecured accounts receivable, the cancellation of existing orders or the loss
of future orders. The foregoing could materially adversely affect the Company's
business, financial condition and results of operations. In addition, the
Company transacts certain sales in Europe in British Pounds Sterling, therefore
exposing itself to a certain amount of foreign currency risk. Management
believes that the amount of this exposure is immaterial. We are also exposed to
foreign currency risk relative to expenses incurred in Dominican Pesos ("RD$"),
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 $450,000.
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 Reporting FS-2
Report of Independent Registered Public Accounting Firm FS-3
Consolidated Financial Statements:
Consolidated Balance Sheets as of June 30, 2006 and 2005 FS-4
Consolidated Statements of Income for the Fiscal Years Ended June 30,
2006, 2005 and 2004 FS-6
Consolidated Statements of Stockholders' Equity for the Fiscal Years
Ended June 30, 2006, 2005 and 2004 FS-7
Consolidated Statements of Cash Flows for the Fiscal Years Ended
June 30, 2006, 2005 and 2004 FS-8
Notes to Consolidated Financial Statements, June 30, 2006 FS-10
Schedules:
II. Valuation and Qualifying Accounts FS-24
b. Supplemental Financial Data FS-25
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
FS-1
smaller public companies. Based on that evaluation, our management
concluded that our internal control over financial reporting was effective
as of June 30, 2006. 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.
There have not been any 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.
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 has full and free access to the Audit Committee, with and without
the presence of management.
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 management's assessment, included in the accompanying
Management's Report on Internal Controls over Financial Reporting, that
NAPCO Security Systems, Inc. and Subsidiaries (the "Company") maintained
effective internal controls over financial reporting as of June 30, 2006,
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. Our
responsibility is to express an opinion on management's assessment and an
opinion on the effectiveness of 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 included obtaining an understanding of
internal control over financial reporting, evaluating management's
assessment, testing and evaluating the design and effectiveness of internal
control, and performing 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 the 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 and
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 its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that the Company maintained
effective internal control over financial reporting as of June 30, 2006 is
fairly stated, in all material respects, based on the criteria established
in Internal Control-Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Also in our opinion,
the Company maintained, in all material respects, effective internal
controls over financial reporting as of June 30, 2006, based
FS-2
on the criteria established in Internal Control-Integrated Framework issued
by the Committee of Sponsoring Organizations of the Treadway Commission.
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, 2006 and 2005 and the related consolidated
statements of income, stockholders' equity, and cash flows and the related
financial statement schedule for the fiscal years ended June 30, 2006, 2005
and 2004 of the Company and our report dated September 8, 2006 expressed an
unqualified opinion on those financial statements and financial statement
schedule.
/s/ Marcum & Kliegman LLP
Marcum & Kliegman LLP
Melville, New York
September 8, 2006
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, 2006
and 2005, and the related consolidated statements of income, stockholders'
equity and cash flows for each of the three years in the period ended June
30, 2006. Our audits also included the financial statement schedule as of
and for the years ended June 30, 2006, 2005 and 2004 listed in the index at
Item 15. These consolidated financial statements and financial statement
schedule are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements and financial statement schedule based on our audits.
We conducted our audits in accordance with 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 consolidated 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. An
audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial
position of NAPCO Security Systems, Inc. and Subsidiaries, as of June 30,
2006 and 2005, and the consolidated results of its operations and its cash
flows for each of the three years in the period ended June 30, 2006 in
conformity with accounting principles generally accepted in the United
States of America. Also, in our opinion, the related financial statement
schedule, when considered in relation to the basic consolidated financial
statements taken as a whole presents fairly, in all material aspects, the
information set forth therein.
We have also audited, in accordance with the standards of the Public
Company Accounting Oversight Board (United States), the effectiveness of
the Company's internal control over financial reporting as of June 30,
2006, 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 8, 2006, expressed an
unqualified opinion on management's assessment of the effectiveness of the
Company's internal control over financial reporting and an unqualified
opinion on the effectiveness of the Company's internal control over
financial reporting.
/s/ Marcum & Kliegman LLP
Marcum & Kliegman LLP
Melville, New York
September 8, 2006
FS-3
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2006 and 2005
(In Thousands, Except Share Data)
ASSETS
2006 2005
------- -------
CURRENT ASSETS
Cash and cash equivalents $ 2,738 $ 1,178
Accounts receivable, less reserve for doubtful
accounts 25,153 21,899
Inventories, net 22,666 16,242
Prepaid expenses and other current assets 755 799
Deferred income taxes 1,531 1,356
------- -------
Total Current Assets 52,843 41,474
Property, plant and equipment, net 9,038 8,533
Goodwill, net 9,686 9,686
Other assets 155 214
------- -------
TOTAL ASSETS $71,722 $59,907
======= =======
See accompanying notes to consolidated financial statements.
FS-4
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
June 30, 2006 and 2005
(In Thousands, Except Share Data)
LIABILITIES AND STOCKHOLDERS' EQUITY
2006 2005
------- -------
CURRENT LIABILITIES
Accounts payable $ 6,060 $ 5,249
Accrued expenses 1,372 1,156
Accrued salaries and wages 2,586 2,518
Accrued income taxes 1,877 1,534
------- -------
Total Current Liabilities 11,895 10,457
Long-term debt 4,700 1,950
Accrued income taxes 2,243 2,243
Deferred income taxes 1,887 1,579
Minority interest in subsidiary 147 --
------- -------
Total Liabilities 20,872 16,229
------- -------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY (1)
Common stock, par value $0.01 per share; 40,000,000
and 21,000,000 shares authorized; 19,950,453
and 19,474,173 shares issued and outstanding,
respectively 200 195
Additional paid-in capital 13,213 11,520
Unearned stock-based compensation (645) --
Retained earnings 38,082 31,963
------- -------
TOTAL STOCKHOLDERS' EQUITY 50,850 43,678
------- -------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $71,722 $59,907
======= =======
(1) The 3:2 stock split declared on November 29, 2005 and the 3:2 stock split
declared on May 10, 2006 (see Note 1), have been retroactively reflected in
Stockholders' Equity.
See accompanying notes to consolidated financial statements.
FS-5
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
Years Ended June 30, 2006, 2005, and 2004
(In Thousands, Except Share and Per Share Data)
2006 2005 2004
----------- ----------- -----------
Net sales $ 69,548 $ 65,229 $ 58,093
Cost of sales 43,607 41,305 38,553
----------- ----------- -----------
Gross Profit 25,941 23,924 19,540
Selling, general, and administrative expenses 16,418 15,014 13,475
----------- ----------- -----------
Operating Income 9,523 8,910 6,065
----------- ----------- -----------
Other income (expense):
Interest expense, net (258) (224) (420)
Other, net (14) (58) (109)
----------- ----------- -----------
(272) (282) (529)
----------- ----------- -----------
Income Before Minority Interest and Income Taxes 9,251 8,628 5,536
Minority interest in loss of subsidiary 132 228 --
----------- ----------- -----------
Income Before Provision for Income Taxes 9,383 8,856 5,536
Provision for income taxes 3,264 3,227 2,201
----------- ----------- -----------
Net Income $ 6,119 $ 5,629 $ 3,335
=========== =========== ===========
Earnings per share: (1)
Basic $ 0.31 $ 0.29 $ 0.19
Diluted $ 0.30 $ 0.28 $ 0.17
Weighted average number of shares outstanding: (1)
Basic 19,785,000 19,265,000 17,906,000
Diluted 20,605,000 20,284,000 19,119,000
(1) The 3:2 stock split effective December 2005 and the 3:2 stock split
effective June 2006 (see Note 1), have been retroactively reflected in all
2005 and 2004 share and per share data. The 20% stock dividend reported in
the first quarter of 2005 (see Note 1), has been retroactively reflected in
all 2004 share and per share data.
See accompanying notes to consolidated financial statements.
FS-6
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (1)
Years Ended June 30, 2006, 2005 and 2004
(In Thousands, Except Share Data)
Common stock
------------------- Additional Unearned
Number Paid-in Stock-based Retained
of Shares Amount Capital Compensation Earnings Total
---------- ------ ---------- ------------ -------- -------
BALANCE - June 30, 2003 7,676,870 $ 77 $11,236 $ -- $22,043 $33,356
Retroactive effect of 3:2 stock split
effective December 2005 3,838,435 38 (38) -- -- --
Retroactive effect of 3:2 stock split
effective June 2006 5,757,828 58 (58) -- -- --
Exercise of employee stock options,
July 1, 2003 to April 27, 2004 1,638,468 16 (9) -- 956 963
Tax benefit in connection
with exercise of stock options -- -- -- -- 104 104
Exercise of employee stock options,
April 28, 2004 to June 30, 2004 221,832 2 144 -- -- 146
Net income -- -- -- -- 3,335 3,335
---------- ---- ------- ------- ------- -------
BALANCE - June 30, 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
Adjustment to record unearned stock-
Based compensation -- -- 1,041 (1,041) -- --
Amortization of unearned stock-
Based compensation -- -- -- 396 -- 396
Net income -- -- -- -- 6,119 6,119
---------- ---- ------- ------- ------- -------
BALANCE - June 30, 2006 19,950,453 $200 $13,213 $ (645) $38,082 $50,850
========== ==== ======= ======= ======= =======
(1) Restated to reflect the effect of a 3:2 stock split effective June 2006, a
3:2 stock split effective December 2005 and a 20% stock dividend effective
November 2004.
See accompanying notes to consolidated financial statements.
FS-7
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30, 2006, 2005, and 2004 (In Thousands)
2006 2005 2004
------- ------- -------
CASH FLOWS FROM OPERATING ACTIVITIES
Net income $ 6,119 $ 5,629 $ 3,335
Adjustments to reconcile net income to net cash
(used in) provided by operating activities:
Depreciation and amortization 1,192 1,156 1,189
Provision for doubtful accounts 40 43 140
Deferred income taxes 131 709 (49)
Excess tax (benefit) expense from exercise
of stock options (210) (104) 104
Non-cash stock based compensation expense 396 -- --
Changes in operating assets and liabilities:
Accounts receivable (3,294) (2,014) (2,642)
Inventories (6,424) (1,648) 2,328
Prepaid expenses and other current assets 44 (39) (235)
Other assets 43 (35) 90
Accounts payable, accrued expenses, accrued salaries and
wages, accrued income taxes and minority interest 1,795 3,508 2,015
Net Cash (Used in) Provided By Operating Activities (168) 7,205 6,275
------- ------- -------
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of property, plant, and equipment (1,679) (658) (681)
------- ------- -------
CASH FLOWS FROM FINANCING ACTIVITIES
Principal payments on long-term debt -- (9,700) (8,700)
Proceeds from long-term debt 2,750 3,350 1,000
Proceeds from exercise of employee stock options 447 249 1,108
Excess tax benefit from exercise
of stock options 210 -- --
Loan costs paid -- (64) --
------- ------- -------
Net Cash Provided By (Used In) Financing Activities 3,407 (6,165) (6,592)
------- ------- -------
Net Increase (Decrease) In Cash and
Cash Equivalents 1,560 382 (998)
CASH AND CASH EQUIVALENTS - Beginning 1,178 796 1,794
------- ------- -------
CASH AND CASH EQUIVALENTS - Ending $ 2,738 $ 1,178 $ 796
======= ======= =======
See accompanying notes to consolidated financial statements.
FS-8
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended June 30, 2006, 2005, and 2004
(In Thousands)
2006 2005 2004
------ ------ ----
SUPPLEMENTAL CASH FLOW INFORMATION
Interest paid, net $ 228 $ 217 $427
Income taxes paid $2,573 $1,366 $106
See accompanying notes to consolidated financial statements.
FS-9
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.
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 $1,564,000 and $419,000 of
short-term time deposits at June 30, 2006 and 2005, respectively. The Company
considers all highly liquid investments with original maturities of three months
or less to be cash equivalents. The Company has cash balances in banks in excess
of the maximum amount insured by the FDIC as of June 30, 2006 and 2005.
Accounts Receivable
Accounts receivable is stated net of the reserve for doubtful accounts of
$420,000 and $380,000 as of June 30, 2006 and June 30, 2005, 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.
In addition, the Company records an inventory obsolescence reserve, which
represents the difference between the cost of the inventory and its estimated
market value, based on various product sales projections. This reserve is
calculated using an estimated obsolescence percentage applied to the inventory
based on age, historical trends and requirements to support forecasted sales.
For the fiscal years 2006, 2005 and 2004, charges/(recoveries) and balances in
these reserves amounted to $(531,000) and $987,000; $(517,000) and $1,518,000;
$1,035,000 and $2,035,000, respectively. In addition, and as necessary, the
Company may establish specific reserves for future known or anticipated events.
FS-10
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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.
Revenue Recognition
In accordance with SEC Staff Accounting Bulletin Topic 13, Revenue Recognition,
the Company recognizes revenue when the following criteria are met: (i)
persuasive evidence of an agreement exists, (ii) there is a fixed and
determinable price for the Company's product, (iii) shipment and passage of
title occurs, and (iv) collectibility is reasonably assured. Revenues from
merchandise sales are recorded at the time the product is shipped or delivered
to the customer pursuant to the terms of the sale. The Company reports its sales
levels on a net sales basis, with net sales being computed by deducting from
gross sales the amount of actual sales returns and the amount of reserves
established for anticipated sales returns.
Advertising and Promotional Costs
Advertising and promotional costs are included in "Selling, General and
Administrative" expenses in the consolidated statements of income and are
expensed as incurred. Advertising expense for the fiscal years ended June 30,
2006, 2005 and 2004 was $1,318,000, $1,274,000 and $1,030,000, respectively.
Research and Development Costs
Research and development costs incurred by the Company are charged to expense in
the year incurred. Company-sponsored research and development costs of
$5,109,000, $4,865,000 and $4,254,000 were charged to expense for the fiscal
years ended June 30, 2006, 2005 and 2004, respectively, and are included in
"Cost of Sales" in the consolidated statements of income.
FS-11
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.
In March 2004, the Company's Board of Directors approved a two-for-one stock
split in the form of a 100% stock dividend of the Company's common stock payable
to stockholders of record on April 13, 2004. The additional shares were
distributed on April 27, 2004. The Company utilized all 2,871,056 (on a
pre-split basis) of its shares held as treasury stock as of April 27, 2004 plus
an additional 609,260 (on a pre-split basis) shares in paying this stock
dividend. The cost of treasury stock was applied first to additional paid-in
capital (to the extent there was a positive balance), then directly to retained
earnings.
All share and per share amounts (except par value) have been retroactively
adjusted to reflect the stock 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
------------------------ ------------------------ --------------------------
2006 2005 2004 2006 2005 2004 2006 2005 2004
------ ------ ------ ------ ------ ------ ------ ------ ------
Basic EPS: $6,119 $5,629 $3,335 19,785 19,265 17,906 $ 0.31 $ 0.29 $ 0.19
Effect of Dilutive
FS-12
Securities: Employee
Stock options -- -- -- 820 1,019 1,213 (0.01) (0.01) (0.02)
------ ------ ------ ------ ------ ------ ------ ------ ------
Diluted EPS: $6,119 $5,629 $3,335 20,605 20,284 19,119 $ 0.30 $ 0.28 $ 0.17
====== ====== ====== ====== ====== ====== ====== ====== ======
Options to purchase 37,500, 0 and 27,000 shares of common stock for the three
fiscal years ended June 30, 2006, 2005 and 2004, 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 $396,000 were recognized for the fiscal year. The effect
on both Basic and Diluted Earnings per share was $0.02 for the fiscal year.
Effective July 1, 2005, the Company adopted Statement of Financial Accounting
Standards ("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 requires
us 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.).
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
years ended June 30,:
2005 2004
------ ------
(In thousands,
except per share
data)
Net income, as reported $5,629 $3,335
Deduct: Total stock-based employee compensation expense determined
under fair value method for all awards, net of related tax effects 227 210
------ ------
Pro forma net income $5,402 $3,125
====== ======
Earnings per common share (1):
Net earnings per common share - Basic, as reported $ 0.29 $ 0.19
====== ======
Net earnings per common share - Basic, pro forma $ 0.28 $ 0.17
====== ======
FS-13
Net earnings per common share - Diluted, as reported $0.28 $0.17
===== =====
Net earnings per common share - Diluted, pro forma $0.27 $0.16
===== =====
The fair value of each option grant for the periods presented above was
estimated on the date of grant using the Black-Scholes option-pricing model with
the following weighted average assumptions:
2004
-------
Risk-free interest rates 4.70%
Expected lives 5 years
Expected volatility 48%
Expected dividend yields 0%
(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, 2006.
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, 2006, 2005 and 2004, the
Company's operations did not give rise to material items includable in
comprehensive income, which were not already included in net income.
Accordingly, the Company's comprehensive income is the same as its net income
for all periods presented.
Segment Reporting
The Company follows the provisions of SFAS No. 131, Disclosures about Segments
of an Enterprise and Related Information. Pursuant to this pronouncement, the
reportable operating segments are determined based on the Company's management
approach. The management approach, as defined by SFAS No. 131, is based on the
way that the chief operating decision maker organizes the segments within an
enterprise for making operating decisions and assessing performance. The
Company's results of operations are reviewed by the chief operating decision
maker on a consolidated basis and the Company operates in only one segment. The
Company has presented required geographical data in Note 11, and no additional
segment data has been presented.
Fair Value of Financial Instruments
The Company calculates the fair value of financial instruments and includes this
additional information in the notes to the financial statements where the fair
value is different than the book value of those financial instruments. When the
fair value approximates book value, no additional disclosure is made. The
Company uses quoted market prices whenever available to calculate these fair
values. When quoted market prices are not available, the Company uses standard
pricing models for various types of financial instruments which take into
account the present value of estimated future cash flows. At June 30, 2006 and
2005, management of the Company believes the carrying value of all financial
instruments approximated fair value.
Shipping and Handling Revenues and Costs
Emerging Issues Task Force (EITF) Issue No. 00-10, Accounting for Shipping and
Handling Revenues and Costs requires that all shipping and handling billed to
customers should be reported as revenue and the costs associated with these
revenues may be classified as either cost of sales, or selling, general, and
administrative costs, with footnote disclosure as to
FS-14
classification of these costs. The Company records the amount billed to
customers in net sales and classifies the costs associated with these revenues
in cost of sales.
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 November 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 151, "Inventory Costs" ("FAS 151"). This statement amends Accounting
Research Bulletin No. 43, Chapter 4, "Inventory Pricing" and removes the "so
abnormal" criterion that under certain circumstances could have led to the
capitalization of these items. FAS 151 requires that idle facility expense,
excess spoilage, double freight and re-handling costs be recognized as
current-period charges regardless of whether they meet the criterion of "so
abnormal". FAS 151 also requires that the allocation of fixed production
overhead expenses to the costs of conversion be based on the normal capacity of
the production facilities. The provisions of this statement are effective for
the Company in fiscal year 2007. The adoption of FAS 151 does not currently have
an impact on the Company's consolidated financial statements.
In December 2004, the FASB issued SFAS No. 153, "Exchanges of Nonmonetary
Assets, - an Amendment of APB Opinion No. 29" ("SFAS 153"), which was effective
for the Company for asset-exchange transactions beginning July 1, 2005. Under
APB 29, asstes received in certain types of nonmonetary exchanges were permitted
to be recorded at the carrying value of the assets that were exchanged (i.e.
recorded on a carryover basis). As amended by SFAS 153, assets received in some
circumstances will have to be recorded instead at their fair values. SFAS 153
does not currently have an impact on the Company's consolidated financial
statements.
In May 2005, FASB issued SFAS No. 154, "Accounting Changes and Error Corrections
- a Replacement of APB Opinion No. 20 and FASB No. 3". This statement requires
retrospective application of prior periods' financial statements of changes in
accounting principles, unless it is impracticable to determine the period
specific effects, or the cumulative effect of the change. The provisions of this
statement are effective for the Company in fiscal year 2007. Currently, the
Company does not have changes in accounting principle so the adoption of SFAS
No. 154 is not expected to have an impact on the Company's consolidated
financial statements.
In September 2005, FASB issued FASB Staff Position ("FSP") No. FAS 123(R)-1,
"Classification and Measurement of Freestanding Financial Instruments Originally
Issued in Exchange for Employee Services under FASB Statement No. 123(R)," to
defer the requirement of SFAS No. 123(R) that a freestanding financial
instrument originally subject to SFAS No. 123(R) becomes subject to the
recognition and measurement requirements of other applicable GAAP when the
rights conveyed by the instrument to the holder are no longer dependent on the
holder being an employee of the entity. The rights under stock-based payment
awards issued to employees by the Company are all dependent on the recipient
being an employee of the Company. Therefore, this FSP currently does not have an
impact on the Company's consolidated financial statements and its measurement of
stock-based compensation in accordance with SFAS No. 123(R).
In October 2005, the FASB issued FSP No. FAS 123(R)-2, "Practical Accommodation
to the Application of Grant Date as Defined in FASB Statement No. 123(R)," to
provide guidance on determining the grant date for an award as defined in SFAS
No. 123(R). This FSP stipulates that assuming all other criteria in the grant
date definition are met, a mutual understanding of the key terms and conditions
of an award to an individual employee is presumed to exist upon the award's
approval in accordance with the relevant corporate governance requirements,
provided that the key terms and conditions of an award (a) cannot be negotiated
by the recipient with the employer because the award is a unilateral grant, and
(b) are expected to be communicated to an individual recipient within a
relatively short time period from the date of approval. The Company has applied
the principles set forth in this FSP upon its adoption of SFAS No. 123(R).
FS-15
In November 2005, the FASB issued FSP No. FAS 123(R)-3, "Transition Election
Related to Accounting for the Tax Effects of Share-Based Payment Awards", to
provide an alternate transition method for the implementation of SFAS No.
123(R). Because some entities do not have, and may not be able to re-create,
information about the net excess tax benefits that would have qualified as such
had those entities adopted SFAS No. 123(R) for recognition purposes, this FSP
provides an elective alternative transition method. That method comprises (a) a
computational component that establishes a beginning balance of the APIC pool
related to employee compensation and (b) a simplified method to determine the
subsequent impact on the APIC pool of employee awards that are fully vested and
outstanding upon the adoption of SFAS No. 123(R). The Company has applied the
alternative transition method set forth in this FSP upon its adoption of SFAS
No. 123(R).
In February 2006, the FASB issued FSP No. FAS 123(R)-4, "Classification of
Options and Similar Instruments Issued as Employee Compensation That Allow for
Cash Settlement upon the Occurrence of a Contingent Event", to address the
classification of options and similar instruments issued as employee
compensation that allow for cash settlement upon the occurrence of a contingent
event. The guidance in this FSP amends paragraphs 32 and A229 of FASB Statement
No. 123 (revised 2004), "Share-Based Payment". The Company's Option Plans have
no cash settlement provisions. Therefore, this FSP currently does not have an
impact on the Company's consolidated financial statements or its measurement of
stock-based compensation in accordance with SFAS No. 123(R).
In June 2006, the FASB issued Interpretation No. 48, "Accounting for Uncertainty
in Income Taxes" ("FIN 48"). This interpretation clarified the accounting for
uncertainty in income taxes recognized in accordance with SFAS No. 109,
"Accounting for Income Taxes" ("SFAS No. 109"). Specifically, FIN 48 clarifies
the application of SFAS No. 109 by defining a criterion that an individual tax
position must meet for any part of the benefit of that position to be recognized
in an enterprise's financial statements. Additionally, FIN 48 provides guidance
on measurement, derecognition, classification, interest and penalties,
accounting in interim periods of income taxes, as well as the required
disclosure and transition. This interpretation is effective for fiscal years
beginning after December 15, 2006. The Company is currently evaluating the
requirements of FIN 48 and has not yet determined if the adoption of FIN 48 will
have a significant impact on the Company's consolidated financial statements.
NOTE 2 - Business and Credit Concentrations
The Company had two customers with accounts receivable balances that aggregated
33% and 35% of the Company's accounts receivable at June 30, 2006 and 2005,
respectively. Sales to neither of these customers exceeded 10% of net sales in
any of the past three years.
NOTE 3 - Inventories
Inventories consist of the following:
June 30,
-----------------
2006 2005
------- -------
(In thousands)
Component parts $13,533 $10,740
Work-in-process 2,595 1,697
Finished product 6,538 3,805
------- -------
$22,666 $16,242
======= =======
NOTE 4 - Property, Plant, and Equipment
Property, plant and equipment consist of the following:
FS-16
June 30,
-----------------
2006 2005 Useful Life In years
------- ------- ------------------------------------------
(In thousands)
Land $ 904 $ 904 --
Buildings 8,911 8,911 30 to 40
Molds and dies 4,786 4,563 3 to 5
Furniture and fixtures 1,583 1,401 5 to 10
Machinery and equipment 14,054 12,780 7 to 10
Leasehold improvements 191 191 Shorter of the lease term or life of asset
------- -------
30,429 28,750
Less: accumulated depreciation
and amortization 21,391 20,217
------- -------
$ 9,038 $ 8,533
======= =======
Depreciation and amortization expense on property, plant, and equipment was
approximately $1,174,000, $1,112,000 and $1,159,000 in fiscal 2006, 2005 and
2004, respectively.
NOTE 5 - Income Taxes
Provision (benefit) for income taxes consists of the following:
For the Years Ended June 30,
----------------------------
2006 2005 2004
------ ------ ------
(In thousands)
Current income taxes:
Federal $3,107 $2,496 $2,250
State 15 5 --
Foreign 11 17 --
------ ------ ------
$3,133 $2,518 $2,250
Deferred income tax expense (benefit) 131 709 (49)
------ ------ ------
Provision for income taxes $3,264 $3,227 $2,201
====== ====== ======
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,
--------------------------------------------------------
2006 2005 2004
---------------- ----------------- -----------------
% of % of % of
Pre-tax Pre-tax Pre-tax
Amount Income Amount Income Amount Income
------ ------- ------- ------- ------- -------
Tax at Federal statutory rate $3,190 34.0% $3,011 34.0% $1,882 34.0%
Increases (decreases) in taxes
resulting from:
Meals and entertainment 62 .7 60 .7 54 1.0
State income taxes, net of
FS-17
Federal income tax benefit 10 .1 3 -- 97 1.7
Foreign source income and taxes (7) (.1) (2) -- -- --
Stock based compensation expense 96 1.0 -- -- -- --
Alternative Minimum Tax
Credit utilization 43 .5 -- -- -- --
Valuation allowance -- -- -- -- (97) (1.7)
Other, net (130) (1.4) 155 1.7 265 4.8
------ ---- ------ ---- ------ ----
Provision for income taxes $3,264 34.8% $3,227 36.4% $2,201 39.8%
====== ==== ====== ==== ====== ====
Deferred tax assets and deferred tax liabilities at June 30, 2006 and 2005 are
as follows (in thousands):
Current Long-Term
Deferred Tax Assets Deferred Tax Assets
(Liabilities) (Liabilities)
------------------- -------------------
2006 2005 2006 2005
------ ------ ------- -------
Accounts receivable $ 39 $ 67 $ -- $ --
Inventories 1,218 1,020 -- --
Accrued liabilities 235 269 -- --
State net operating loss carryforward 388 354 -- --
Stock based compensation expense 39 -- -- --
Goodwill -- -- (969) (798)
Property, plant and equipment -- -- (918) (824)
Alternative minimum tax credit -- -- -- 43
------ ------ ------- -------
1,919 1,710 (1,887) (1,579)
Valuation allowance (388) (354) -- --
Net deferred taxes $1,531 $1,356 $(1,887) $(1,579)
====== ====== ======= =======
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
range from $0 to $9,450,000. However, the Company also believes there are 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.
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 the following:
FS-18
June 30,
---------------
2006 2005
------ ------
(In thousands)
Revolving credit and term loan facility (a) $4,700 $1,950
Term loan (b) -- --
Term loan (c) -- --
------ ------
$4,700 $1,950
====== ======
(a) In May 2001, the Company amended its secured revolving credit agreement with
its primary bank. The Company's borrowing capacity under the amended agreement
was increased to $18,000,000. The amended revolving credit agreement is secured
by all the accounts receivable, inventory, the Company's headquarters in
Amityville, New York and certain other assets of Napco Security Systems, Inc.
and the common stock of three of the Company's subsidiaries. The revolving
credit agreement bears interest at either the Prime Rate less 1/4% or an
alternate rate based on LIBOR as described in the agreement. At June 30, 2006,
the interest rate on this debt was 6.6%. The revolving credit agreement which
was to expire in July 2005 was subsequently extended to September 2008 and any
outstanding borrowings are to be repaid or refinanced on or before that time.
The agreement contains various restrictions and covenants including, among
others, restrictions on payment of dividends, restrictions on borrowings,
restrictions on capital expenditures, the maintenance of minimum amounts of
tangible net worth, and compliance with other certain financial ratios, as
defined in the agreement. During fiscal 2006, the Company exceeded the
restriction on capital expenditures for which it received the appropriate waiver
from its primary bank.
(b) On July 27, 2000, the Company entered into a five year $8,250,000 secured
term loan with its primary bank in connection with the acquisition of
Continental Instruments Systems, LLC. Under the agreement, the loan was to be
repaid in 60 equal monthly installments of $137,500, plus interest. The
agreement contained various restrictions and covenants including, among others,
restrictions on payment of dividends, restrictions on borrowings, restrictions
on capital expenditures, the maintenance of minimum amounts of tangible net
worth, and compliance with other certain financial ratios, as defined in the
agreement. In December 2004, the Company accelerated full repayment of this
secured term loan and the treasury stock repurchase term loan described in
paragraph (c) below.
(c) In connection with the treasury stock repurchase described in Note 8, the
Company entered into a five year $1,250,000 term loan from its primary bank.
Under this agreement, the loan was to be repaid in 60 equal monthly installments
of $20,833, plus interest at a variable rate as defined. In December 2004, the
Company repaid this loan in full.
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. Under this plan, there were 135,000 stock option grants outstanding and
exercisable as of June 30, 2006.
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, 2006, 1,198,050 stock options were granted, 559,800 stock
options were available for grant, and 805,098 stock options were exercisable
under this plan.
FS-19
The fair value of each option granted during fiscal 2006 was estimated on the
date of grant using the Black-Scholes option-pricing model with the following
weighted average assumptions:
Risk-free interest rates 4.58%
Expected lives 9 years
Expected volatility 63%
Expected dividend yields 0%
The following table reflects activity under the 1992 and 2002 Plans for the
fiscal years ended June 30,:
2006 2005 2004
-------------------- -------------------- -----------------------
Weighted Weighted Weighted
average average average
exercise exercise exercise
Options price Options price Options price
--------- -------- --------- -------- ---------- ----------
Outstanding at beginning of year 1,544,940 $ 1.62 1,885,680 $ 1.46 3,467,880 $ 0.97
Granted 161,250 7.67 -- -- 280,800 1.99
Exercised (346,680) 1.00 (340,740) .73 (1,860,300) .60
Forfeited (24,300) 1.62 -- -- (2,700) 1.20
Cancelled/lapsed (2,160) .72 -- -- -- --
--------- -------- --------- -------- ---------- ----------
Outstanding at end of year 1,333,050 $ 2.41 1,544,940 $ 1.62 1,885,680 $ 1.46
========= ======== ========= ======== ========== ==========
Exercisable at end of year 940,098 $ 1.95 989,820 $ 1.24 992,520 $ 1.24
========= ======== ========= ======== ========== ==========
Weighted average fair value of
options granted $ 6.69 n/a $ 1.13
Total intrinsic value of
options exercised $191,000 $109,000 $1,170,000
Cash received from option exercises for fiscal years 2006, 2005 and 2004 was
$447,000, $249,000 and $1,108,000, respectively. The actual tax benefit
(provision) realized for the tax deductions from option exercises totaled
$210,000, $104,000 and $(104,000) for fiscal years 2006, 2005 and 2004,
respectively.
The following table summarizes information about stock options outstanding at
June 30, 2006:
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 2006 life price 2006 price
----------------- ----------- ----------- -------- ----------- --------
$0.72 to $4.00 1,171,800 6.31 $ 1.81 907,848 $ 1.78
$4.01 to $7.50 123,750 9.63 5.50 24,750 5.50
$7.51 to $11.16 37,500 9.73 11.16 7,500 11.16
--------- ---- ------ ------- ------
1,333,050 6.72 $ 2.41 940,098 $ 1.95
========= ==== ====== ======= ======
The following table is the summary of the Company's non-vested shares as of June
30, 2006 and changes during the fiscal year then-ended:
Weighted
Average
Options Exercise
Outstanding Price
----------- --------
Non-vested as of July 1, 2005 447,120 $0.77
Granted 161,250 $6.22
Vested 215,418 $2.02
------- -----
Non-vested as of June 30, 2006 392,952 $3.34
======= =====
FS-20
As of June 30, 2006, there was $645,000 of total unearned stock-based
compensation cost related to non-vested share-based compensation arrangements
granted under the 1992 and 2002 plans. That cost is expected to be recognized
over a weighted average period of 4 years. The total fair value of the options
vested during fiscal 2006 was $396,000.
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 expired 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. Under this plan, no options were
outstanding as of June 30, 2006. Prior to fiscal 2004, an aggregate of 216,000
options had been granted to directors with a weighted average exercise price of
$0.76. There were 129,600, 0 and 86,400 options exercised under this plan during
the fiscal years 2006, 2005 and 2004, respectively. There were no other options
exercised, cancelled, or forfeited under this plan during the fiscal years 2006,
2005 and 2004. As of June 30, 2006, 2005 and 2004, respectively, 0, 129,600 and
86,400 were exercisable under this plan. No compensation expense was recorded
for stock options granted to directors. There are 54,000 options available for
future grants under the 2000 Plan.
NOTE 8 - Stock Purchase
In January 2003, the Company repurchased 1,350,000 shares of its common stock
from two stockholders, unaffiliated with the Company, at $1.80 per share, a
discount from its then current trading price of $1.85. The transaction was
approved by the Board of Directors and the purchase price of $2,442,000
(including fees of $5,000), was financed through the Company's revolving line of
credit and a new five year term loan from its primary bank for $1,250,000. The
term loan was being repaid in 60 equal monthly installments commencing on April
30, 2003. In December 2004, the Company repaid this term loan in full.
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 $89,000, $80,000, and $73,000 for the fiscal years ended
2006, 2005 and 2004, 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
----------- --------
2007 $ 87,000
2008 14,000
2009 --
2010 --
2011 --
--------
Total $101,000
========
FS-21
Rent expense, with the exception of the land lease referred to below, totaled
approximately $136,000, $138,000 and $192,000 for the fiscal years ended June
30, 2006, 2005 and 2004, respectively.
Land Lease
On April 26, 1993, one of the Company's foreign subsidiaries entered into a 99
year lease for approximately four acres of land in the Dominican Republic, at an
annual cost of approximately $288,000, on which the Company's principal
production facility is located.
Letters of Credit
At June 30, 2006, the Company was committed for approximately $710,000 under
open commercial letters of credit.
Litigation
In August 2001, a Complaint was filed against the Company by Jose Ramirez and
Glenda Ramirez in the Supreme Court of State of New York, County of the Bronx.
The Complaint sought $15,000,000 in damages on behalf of Mr. Ramirez and
$2,000,000 on behalf of Ms. Ramirez. On May 2, 2006, the Company's motion for
summary judgment was granted. As a result, the case against the Company was
dismissed.
In December 2004, the Company became a defendant in a product related lawsuit,
in which the plaintiff seeks damages of approximately $1,500,000. This action is
being defended by the Company's insurance company on behalf of the Company.
Management believes that the action is without merit and plans to have this
action vigorously defended.
In the normal course of business, the Company is a party to claims and/or
litigation. Management believes that the settlement of such claims and/or
litigation, considered in the aggregate, will not have a material adverse effect
on the Company's financial position and results of operations.
Employment Agreements
As of June 30, 2006, the Company was obligated under three employment agreements
and one severance agreement. Compensation under the agreements includes annual
salaries approximating $969,000. 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
$495,000, includes additional compensation of 100,000 stock options that vest
20% per year or upon a change in control, as defined, and a termination payment
in an amount equal to 299% of the average of the prior five calendar year's
compensation, subject to certain limitations, as defined. The employment
agreements expire at various times through June 2008.
NOTE 11 - Geographical Data
The Company is engaged in one major line of business: the development,
manufacture, and distribution of security alarm products and door security
devices for commercial and residential use. Sales to unaffiliated customers are
primarily shipped from the United States. The Company has customers worldwide
with major concentrations in North America, Europe, and South America.
The Company observes the provisions of SFAS No. 131. The following represents
selected consolidated geographical data for the fiscal years ended June 30,
2006, 2005, and 2004:
2006 2005 2004
------- ------- -------
(in thousands)
Sales to external customers(1):
Domestic $58,549 $54,654 $48,626
Foreign 10,999 10,575 9,467
------- ------- -------
Total Net Sales $69,548 $65,229 $58,093
======= ======= =======
FS-22
Identifiable assets:
United States $47,175 $41,753 $40,153
Dominican Republic (2) 18,924 14,658 13,075
Other foreign countries 5,623 3,496 3,444
------- ------- -------
Total Identifiable Assets $71,722 $59,907 $56,672
======= ======= =======
(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-23
SCHEDULE II
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
VALUATION AND QUALIFYING ACCOUNTS
Years Ended June 30, 2006, 2005, and 2004 (In Thousands)
Column B Column C Column D Column E
Balance at Charged to Deductions/ Balance at
Column A Beginning costs and (recoveries) end of
Description of period expenses (1) period
----------- ---------- ---------- ------------ ----------
For the year ended June 30, 2004:
Allowance for doubtful accounts
(deducted from accounts receivable) $215 $140 $-- $355
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
(1) Deductions relate to uncollectible accounts charged off to valuation
accounts, net of recoveries.
FS-24
b. Supplementary Financial Data
QUARTERLY RESULTS
The following table sets forth unaudited financial data for each of the
Company's last eight fiscal quarters (in thousands except for per share data):
Fiscal Year Ended June 30, 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
Basic EPS .04 .08 .07 .12
Diluted EPS .04 .07 .07 .12
Fiscal Year Ended June 30, 2005
---------------------------------------------------------------------------
First Quarter(3) Second Quarter(1) Third Quarter(1) Fourth Quarter(1)
---------------- ----------------- ---------------- -----------------
Net Sales $13,440 $16,019 $15,743 $20,027
Gross Profit 4,273 4,918 5,096 9,637
Income from Operations 901 1,450 1,673 4,886
Net Income 513 872 1,013 3,231
Net Income Per Share(1):
Basic EPS .03 .04 .05 .17
Diluted EPS .03 .04 .05 .16
(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.
(3) Restated to reflect the 3:2 stock split effective June 2006, the 3:2 stock
split effective December 2005 and the 20% stock dividend effective November
2004.
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.
FS-25
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
ITEM 9A. CONTROL AND PROCEDURES
Evaluation of Disclosure Controls and Procedures. At the conclusion of the
period ended June 30, 2006, 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.
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 2006, 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: Our independent registered accounting firm Marcum & Kliegman, LLP
("MK"), informed us and our Audit Committee of the Board of Directors that in
connection with their audit of our financial results for the fiscal year ended
June 30, 2005, MK had discovered conditions which they deemed to be significant
deficiencies, (as defined by standards established by the Public Company
Accounting Oversight Board) in our financial statement closing process. A
significant deficiency is a control deficiency where there is more than a remote
likelihood that a misstatement of the company's annual or interim financial
statements that is more than inconsequential will not be prevented or detected.
The significant deficiencies related to the timely performance of processes and
procedures for the period end closing process and its review by internal
accounting personnel. Management has informed MK and the Audit Committee that it
will increase its staffing relating to the financial statement closing process
to more a adequate level to prevent reoccurrences of this deficiency 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 completed this action during the fourth quarter of
fiscal 2006.
ITEM 9B. OTHER INFORMATION
None
PART III
The information called for by Part III is hereby incorporated by reference from
the information set forth and under the headings "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 2006 Annual Meeting of Stockholders, to be
filed with the Securities and Exchange Commission pursuant to Regulation 14A
within 120 days after the end of the fiscal year covered by this Annual Report
on Form 10-K.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(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 Financial Reporting FS-2
Report of Independent Registered Public Accounting Firm FS-3
Consolidated Financial Statements:
Consolidated Balance Sheets as of June 30, 2006 and 2005 FS-4
Consolidated Statements of Income for the Fiscal Years Ended June 30, 2006, 2005 and 2004 FS-6
Consolidated Statements of Stockholders' Equity for the Fiscal Years Ended June 30, 2006, 2005 and 2004 FS-7
Consolidated Statements of Cash Flows for the Fiscal Years Ended June 30, 2006, 2005 and 2004 FS-8
Notes to Consolidated Financial Statements, June 30, 2006 FS-10
(a)2. Financial Statement Schedules
The following consolidated financial statement schedules of NAPCO Security
Systems, Inc. and its subsidiaries are included in Part II, Item 8:
Page
----
II: Valuation and Qualifying Accounts FS-24
Schedules other than those listed above are omitted because of the absence of
the conditions under which they are required or because the required information
is shown in the consolidated financial statements and/or notes thereto.
(a)3 and (b). Exhibits
Management Contracts designated by asterisk.
Exhibit No. Title
----------- -----
Ex-3.(i) Certificate of Amendment of Certificate of Incorporation E-1
Ex-3.(ii) Certificate of Incorporation as amended E-2
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 Option Plan Exhibit 10.A(i) to Report on Form 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 E-5
Ex-10.C Loan and Security Agreement with Marine Midland Bank dated Exhibit 10-C to Report on Form 10-K for the
as of May 12, 1997 fiscal year ended June 30, 2004
Ex-10.D Revolving Credit Note #1 to Marine Midland Bank dated as of Exhibit 10-D to Report on Form 10-K for the
May 12, 1997 fiscal year ended June 30, 2004
Ex-10.E Revolving Credit Note #2 to Marine Midland Bank dated as of Exhibit 10-E to Report on Form 10-K for the
May 12, 1997 fiscal year ended June 30, 2004
Ex-10.F Promissory Note to Marine Midland Bank dated as of May 12, Exhibit 10-F to Report on Form 10-K for the
1997 fiscal year ended June 30, 2004
Ex-10.G Amendment No. 1 to the Loan and Security Agreement with Exhibit 10-G to Report on Form 10-K for the
Marine Midland Bank dated as of May 28, 1998 fiscal year ended June 30, 2004
Ex-10.H Term Loan Note to Marine Midland Bank dated as of May 28, Exhibit 10-H to Report on Form 10-K for the
1998 fiscal year ended June 30, 2004
*Ex-10.I Amended and Restated Employment Agreement with Richard Exhibit 10.I to Report on Form 10-K for fiscal
Soloway 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 Agreement with HSBC Exhibit 10-K to Report on Form 10-K for the
Bank dated as of June 30, 1999 fiscal year ended June 30, 2005
*Ex-10.L Employment Agreement with Michael Carrieri Exhibit 10-L to Report on Form 10-K for the
fiscal year ended June 30, 2005
*Ex-10.M Indemnification Agreement dated August 9, 1999 Exhibit 10-M to Report on Form 10-K for the
fiscal year ended June 30, 2005
Ex-10.O Amendment No. 4 to Loan and Security Agreement Exhibit 10-O to Report on Form 10-K for the
fiscal year ended June 30, 2005
Ex-10.P Amendment No. 8 to Loan and Security Agreement E-10
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 Agreement Exhibit 10.R to Report on Form 10-K for fiscal
year ended June 30, 2003
Ex-10.S Amendment No. 3 to the Loan and Security Agreement Exhibit 10-S to Report on Form 10-K for the
fiscal year ended June 30, 2004
Ex-10.T Amendment No. 9 to the Loan and Security Agreement Exhibit 10-T to Report on Form 10-K for the
fiscal year ended June 30, 2004
Ex-10.U Amendment No. 11 to the Loan and Security Agreement Exhibit 10-U to Report on Form 10-K for the
fiscal year ended June 30, 2004
Ex-10.V Amendment No. 12 to the Loan and Security Agreement Exhibit 10-V to Report on Form 10-K for the
fiscal year ended June 30, 2004
Ex-10.W Amendment No. 13 to the Loan and Security Agreement Exhibit 10-W to Report on Form 10-K 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 Executive Officer E-20
Ex-31.2 Section 302 Certification of Chief Financial Officer E-21
Ex-32.1 Certification of Chief Executive Officer Pursuant to 18 USC E-22
Section 1350 and Section 906 of Sarbanes - Oxley Act of 2002
Ex-32.2 Certification of Chief Financial Officer Pursuant to 18 USC E-23
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 22, 2006
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 22, 2006
------------------------------------- President and Secretary
Richard Soloway (Principal Executive Officer)
and Director
/s/ KEVIN S. BUCHEL Senior Vice President September 22, 2006
------------------------------------- of Operations and Finance
Kevin S. Buchel and Treasurer
(Principal Financial and
Accounting Officer) and Director
/s/ PAUL STEPHEN BEEBER Director September 22, 2006
-------------------------------------
Paul Stephen Beeber
/s/ RANDY B. BLAUSTEIN Director September 22, 2006
-------------------------------------
Randy B. Blaustein
/s/ ARNOLD BLUMENTHAL Director September 22, 2006
-------------------------------------
Arnold Blumenthal
/s/ DONNA SOLOWAY Director September 22, 2006
-------------------------------------
Donna Soloway
/s/ ANDREW J WILDER Director September 22, 2006
-------------------------------------
Andrew J. Wilder