UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
--- EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: SEPTEMBER 30, 2008
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND
--- EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _________ TO_________.
Commission File number: 0-10004
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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 (IRS Employer Identification
incorporation of organization) Number)
333 Bayview Avenue
Amityville, New York 11701
---------------------------------------- -----------------------------
(Address of principal executive offices) (Zip Code)
(631) 842-9400
-------------------------------------------------------
(Registrant's telephone number including area code)
None
-------------------------------------------------------
(Former name, former address and former fiscal year if
changed from last report)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities and Exchange Act of 1934
during the preceding 12 months (or shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days:
Yes X No
------- -------
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting company. See
definition of "large accelerated filer", "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act:
Large Accelerated Filer Accelerated Filer X
------- -------
Non-Accelerated Filer Smaller reporting company
------- -------
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act):
Yes No X
------- -------
Number of shares outstanding of each of the issuer's classes of common stock, as
of: NOVEMBER 14, 2008
COMMON STOCK, $.01 PAR VALUE PER SHARE 19,095,713
1
Page
----
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
INDEX - SEPTEMBER 30, 2008
Condensed Consolidated Balance Sheets, September 30, 2008 and
June 30, 2008 3
Condensed Consolidated Statements of Income for the Three
Months ended September 30, 2008 and 2007 4
Condensed Consolidated Statements of Cash Flows for the Three
Months ended September 30, 2008 and 2007 5
Notes to Condensed Consolidated Financial Statements 6
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 13
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk 18
ITEM 4. Controls and Procedures 18
PART II: OTHER INFORMATION 19
SIGNATURE PAGE 20
2
PART I: FINANCIAL INFORMATION
ITEM 1. Financial Statements
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30, June 30,
ASSETS 2008 (unaudited) 2008
------ ---------------- ----------
(in thousands, except
share data)
Current Assets:
Cash and cash equivalents $ 4,276 $ 2,765
Accounts receivable, net of reserves 26,479 25,823
Inventories 26,890 19,548
Prepaid expenses and other current assets 1,576 1,121
Deferred income taxes 790 769
---------------- ----------
Total Current Assets 60,011 50,026
Inventories - non-current, net 8,440 7,724
Property, plant and equipment, net 9,601 8,989
Intangible assets, net 16,039 --
Goodwill, net 10,584 9,686
Other assets 793 298
---------------- ----------
Total Assets $ 105,468 $ 76,723
================ ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
------------------------------------
Current Liabilities:
Current portion of long-term debt $ 3,572 $ --
Accounts payable 5,917 4,857
Accrued expenses 1,980 1,333
Accrued salaries and wages 2,392 2,543
---------------- ----------
Total Current Liabilities 13,861 8,733
Long-term debt 35,528 12,400
Accrued income taxes 299 294
Deferred income taxes 1,646 1,607
Minority interest in subsidiary 147 147
---------------- ----------
Total Liabilities 51,481 23,181
---------------- ----------
Commitments and Contingencies
Stockholders' Equity:
Common stock, par value $.01 per share;
40,000,000 shares authorized, 20,095,713 and
20,092,473 shares issued and 19,095,713 and
19,092,473 shares outstanding, respectively 201 201
Additional paid-in capital 13,548 13,424
Retained earnings 45,853 45,532
---------------- ----------
59,602 59,157
Less: Treasury Stock, at cost (1,000,000 shares) (5,615) (5,615)
---------------- ----------
Total stockholders' equity 53,987 53,542
---------------- ----------
Total Liabilities and Stockholders' Equity $ 105,468 $ 76,723
================ ==========
See accompanying notes to condensed consolidated
financial statements.
3
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited)
Three Months Ended
September 30,
-----------------------------
2008 2007
------------- -------------
(in thousands, except share
and per share data)
Net sales $ 17,483 $ 13,876
Cost of sales 11,877 8,652
------------- -------------
Gross Profit 5,606 5,224
Selling, general and administrative expenses 4,776 4,421
------------- -------------
Operating Income 830 803
------------- -------------
Other expense:
Interest expense, net 315 195
Other expenses, net 79 7
------------- -------------
Total Other expenses 394 202
------------- -------------
Income Before Minority Interest and Provision
for Income Taxes 436 601
Minority interest in loss of subsidiary 42 38
------------- -------------
Income Before Provision for Income Taxes 478 639
Provision for income taxes 156 265
------------- -------------
Net Income $ 322 $ 374
============= =============
Earnings per share:
Basic $ 0.02 $ 0.02
============= =============
Diluted $ 0.02 $ 0.02
============= =============
Weighted average number of shares outstanding:
Basic 19,095,361 19,567,689
============= =============
Diluted 19,479,269 20,157,065
============= =============
See accompanying notes to condensed consolidated
financial statements.
4
NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Three Months Ended
September 30,
---------------------------
2008 2007
----------- -----------
(in thousands)
Cash Flows from Operating Activities:
Net income $ 322 $ 374
Adjustments to reconcile net income to net cash
and cash equivalents provided by (used in)
operating activities:
Depreciation and amortization 378 277
Provision for (Recovery of) doubtful accounts 42 (40)
Change to inventory obsolescence reserve --
Deferred income taxes 18 (254)
Non-cash stock based compensation expense 118 59
Changes in operating assets and liabilities, net of
acquisition effects:
Accounts receivable 1,138 3,513
Inventories (1,317) (2,491)
Prepaid expenses and other current assets (354) 16
Other assets -- (71)
Accounts payable, accrued expenses, accrued salaries
and wages, and accrued income taxes 291 500
----------- -----------
Net Cash Provided by Operating Activities 636 1,883
----------- -----------
Cash Flows Used in Investing Activities:
Cash used in business acquisition, net of cash acquired
of $520 (24,555) --
Purchases of property, plant and equipment (115) (344)
----------- -----------
Net Cash Used in Operating Activities (24,670) (344)
----------- -----------
Cash Flows from Financing Activities:
Proceeds from exercise of employee stock options 6 --
Proceeds from acquisition financing 25,000 --
Proceeds from long-term debt borrowings 2,200 --
Principal payments on long-term debt (1,500) --
Cash paid for deferred financing costs (161) --
Cash paid for purchase of treasury stock -- (1,371)
----------- -----------
Net Cash Provided by (Used in) Financing Activities 25,545 (1,371)
----------- -----------
Net increase in Cash and Cash Equivalents 1,511 168
Cash and Cash Equivalents, Beginning of Period 2,765 1,748
----------- -----------
Cash and Cash Equivalents, End of Period $ 4,276 $ 1,916
=========== ===========
Cash Paid During the Period for:
--------------------------------
Interest $ 159 $ 186
=========== ===========
Income taxes $ 125 $ --
=========== ===========
Non-cash Investing activities:
------------------------------
Adjustment to Retained earnings relating to
adoption of FIN 48 $ -- $ 485
=========== ===========
Accrued Business Acquisition costs $ 295 --
Debt assumed in the acquisition $ 1,000 --
=========== ===========
See accompanying notes to condensed consolidated financial statements.
5
NAPCO SECURITY SYSTEMS, INC AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
1.) Summary of Significant Accounting Policies and Other Disclosures
----------------------------------------------------------------
The accompanying Condensed Consolidated Financial Statements are unaudited.
In management's opinion, all adjustments (consisting of only normal
recurring accruals) necessary for a fair presentation have been made. The
results of operations for the period ended September 30, 2008 are not
necessarily indicative of results that may be expected for any other
interim period or for the full year.
The unaudited Condensed Consolidated Financial Statements should be read in
conjunction with the Consolidated Financial Statements and related notes
contained in the Company's Annual Report on Form 10-K for the year ended
June 30, 2008. The accounting policies used in preparing these unaudited
Condensed Consolidated Financial Statements are consistent with those
described in the June 30, 2008 Consolidated Financial Statements. However,
for interim financial statements, inventories are calculated using a gross
profit percentage. In addition, the Condensed Consolidated Balance Sheet
was derived from the audited financial statements but does not include all
disclosures required by Generally Accepted Accounting Principles ("GAAP").
The consolidated financial statements include the accounts of Napco
Security Systems, Inc. and all of its wholly-owned subsidiaries, including
those of Marks USA, a newly formed subsidiary which acquired substantially
all of the assets and certain liabilities of G. Marks Hardware, Inc.
("Marks") acquired on August 18, 2008 . The Company has also consolidated a
51%-owned joint venture. The 49% interest, held by a third party, is
reflected as minority interest. All inter-company balances and transactions
have been eliminated in consolidation.
The Company has made a number of estimates and assumptions relating to the
assets and liabilities, the disclosure of contingent assets and liabilities
and the reporting of revenues and expenses to prepare these financial
statements in conformity with accounting principles generally accepted in
the United States. Actual results could differ from those estimates.
Seasonality
The Company's fiscal year begins on July 1 and ends on June 30.
Historically, the end users of Napco's products want to install its
products prior to the summer; therefore sales of its products peak in the
period April 1 through June 30, the Company's fiscal fourth quarter, and
are reduced in the period July 1 through September 30, the Company's fiscal
first quarter. To a lesser degree, sales in Europe are also adversely
impacted in the Company's first fiscal quarter because of European vacation
patterns, i.e., many distributors and installers are closed for the month
of August. In addition, demand is affected by the housing and construction
markets.
Advertising and Promotional Costs
Advertising and promotional costs are included in "Selling, General and
Administrative" expenses in the condensed consolidated statements of income
and are expensed as incurred. Advertising expense for the three months
ended September 30, 2008 and 2007 was $301,000 and $522,000, respectively.
Research and Development Costs
Research and development costs are included in "Cost of Sales" in the
condensed consolidated statements of income and are expensed as incurred.
Research and development expense for the three months ended September 30,
2008 and 2007 was $1,312,000 and $1,332,000, respectively.
Business Concentration and Credit Risk
An entity is more vulnerable to concentrations of credit risk if it is
exposed to risk of loss greater than it would have had if it mitigated its
risk through diversification of customers. Such risks of loss manifest
themselves differently, depending on the nature of the concentration, and
vary in significance.
The Company had two customers with accounts receivable balances that
aggregated 30% and 34% of the Company's accounts receivable at September
30, 2008 and June 30, 2008, respectively. Sales to neither of these
customers exceeded 10% of net sales in any of the past three fiscal years.
6
Allowance for Doubtful Accounts
In the ordinary course of business, the Company has established a reserve
for doubtful accounts and customer deductions in the amount of $408,000 and
$405,000 as of September 30, 2008 and June 30, 2008, respectively. The
Company's reserve for doubtful accounts is a subjective critical estimate
that has a direct impact on reported net earnings. This reserve is based
upon the evaluation of accounts receivable agings, specific exposures and
historical trends.
Stock Options
During the three months ended September 30, 2008 the Company granted
100,000 stock options under its 2002 Employee Incentive Stock Option Plan.
These grants have an exercise price of $4.25, a fair value of approximately
$198,000 and vest over a two-year period from the date of grant. There were
no options granted under its 2000 Non-employee Incentive Stock Option Plan.
There were 3,240 options exercised, with proceeds of approximately $6,000,
under the 2002 Employee Incentive Stock Option Plan and no exercises under
the 2000 Non-employee Incentive Stock Option Plan during the three months
ended September 30, 2008.
Intangible Assets
Under the Statement of Accounting Standards ("SFAS") No.142, "Goodwill and
Other Intangible Assets", all goodwill and certain intangible assets
determined to have indefinite lives will not be amortized but will be
tested for impairment at least annually. Intangible assets other than
goodwill will be amortized over their useful lives and reviewed for
impairment at least annually or more often whenever there is an indication
that the carrying amount may not be recovered.
The Company's acquisition of substantially all of the assets and certain
liabilities of Marks included intangible assets with a fair value of
$16,100,000 on the date of acquisition. In accordance with the requirements
of SFAS No. 141, "Business Combinations", the Company recorded the
estimated value of $9,800,000 related to the customer relationships,
$340,000 related to a non-compete agreement and $6,300,000 related to the
Marks trade name within intangible assets. The remaining excess of the
purchase price of $897,000 was assigned to Goodwill. In accordance with the
provisions of SFAS No. 142, "Goodwill and Other Intangible Assets", the
intangible assets will be amortized over their estimated useful lives of
twenty years (customer relationships) and seven years (non-compete
agreement). The Marks USA trade name was deemed to have an indefinite life.
The goodwill recorded as a result of the acquisition is deductible for
Federal and New York State income tax purposes over a period of 15 years.
Recent Accounting Pronouncements
In March 2008, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 161, "Disclosures about Derivative Instruments and Hedging
Activities - an amendment of FASB Statement No. 133. This statement changes
the disclosure requirements for derivative instruments and hedging
activities. Entities are required to provide enhanced disclosures about (a)
how and why an entity uses derivative instruments, (b) how derivative
instruments and related hedged items are accounted for under Statement 133
and its related interpretations, and (c) how derivative instruments and
related hedged items affect an entity's financial position, financial
performance, and cash flows. SFAS No. 161 is effective for fiscal years and
interim periods beginning after November 15, 2008. The Company's adoption
of SFAS No. 161 is not expected to have a material effect on its condensed
consolidated financial statements.
In February 2008, the FASB issued FASB Staff Position ("FSP") No. FAS
157-1, "Application of FASB Statement No. 157 to FASB Statement No. 13 and
Other Accounting Pronouncements That Address Fair Value Measurements for
Purposes of Lease Classification or Measurement under Statement 13." This
FSP amends SFAS No. 157 to exclude certain leasing transactions accounted
for under previously existing accounting guidance. However, this scope
exception does not apply to assets acquired and liabilities assumed in a
business combination, regardless of whether those assets and liabilities
are related to leases.
In February 2008, the FASB issued FSP No. FAS 157-2, "Effective Date of
FASB Statement No. 157". This FSP delays the effective date of SFAS No.
157, "Fair Value Measurements", for non-financial assets and non-financial
liabilities, except for items that are recognized or disclosed at fair
value in the financial statements on a recurring basis (at least annually).
This FSP defers the effective date of SFAS No. 157 to fiscal years
beginning after November 15, 2008, and interim periods within those fiscal
years for items within the scope of this FSP.
In October 2008, the FASB issued FSP No. FAS 157-3, "Determining the Fair
Value of a Financial Asset When the Market for That Asset Is Not Active"
("FSP 157-3"). FSP 157-3 classified the application of SFAS No. 157 in an
inactive market. It demonstrated how the fair value of a financial asset is
determined when the market for that financial asset is inactive. FSP 157-3
was effective upon issuance, including prior periods for which financial
statements had not been issued. The implementation of FSP 157-3 did not
have a material effect on the Company's condensed consolidated financial
statements.
7
In April 2008, the FASB issued FASB Staff Position SFAS 142-3,
"Determination of the Useful Life of Intangible Assets" ("FSP SFAS 142-3").
FSP SFAS 142-3 amends the factors that should be considered in developing
renewal or extension assumptions used to determine the useful life of a
recognized intangible asset under FASB Statement No. 142, Goodwill and
Other Intangible Assets. The objective of this FSP is to improve the
consistency between the useful life of a recognized intangible asset under
Statement 142 and the period of expected cash flows used to measure the
fair value of the asset under SFAS 141R, Business Combinations, and other
U.S. GAAP principles. FSP SFAS 142-3 is effective for fiscal years
beginning after December 31, 2008. The adoption of FSP SFAS 142-3 is
effective July 1, 2009 and is not expected to have a material effect on the
Company's condensed consolidated financial statements.
In December 2007, the FASB issued SFAS No. 141 (revised 2007), "Business
Combinations" ("SFAS No. 141(R)"). SFAS No. 141(R) replaces SFAS No. 141,
"Business Combinations," however, it retains the fundamental requirements
of the former Statement that the acquisition method of accounting
(previously referred to as the purchase method) be used for all business
combinations and for an acquirer to be identified for each business. SFAS
No. 141(R) defines the acquirer as the entity that obtains control of one
or more businesses in the business combination and establishes the
acquisition date as the date that the acquirer achieves control. Among
other requirements, SFAS No. 141(R) requires the acquiring entity in a
business combination to recognize the identifiable assets acquired,
liabilities assumed and any non-controlling interest in the acquiree at
their acquisition-date fair values, with limited exceptions;
acquisition-related costs generally will be expensed as incurred. SFAS No.
141(R) requires certain financial statement disclosures to enable users to
evaluate and understand the nature and financial effects of the business
combination. SFAS No. 141(R) must be applied prospectively to business
combinations that are consummated beginning in the Company's fiscal 2010.
The Company's adoption of SFAS No. 141(R) is not expected to have a
material effect on its condensed consolidated financial statements.
In December 2007, the FASB issued SFAS No. 160, "Non-controlling Interests
in Consolidated Financial Statements, an Amendment of ARB No. 51" ("SFAS
No. 160") to establish accounting and reporting standards for the
non-controlling interest in a subsidiary and for the deconsolidation of a
subsidiary. Among other requirements, SFAS No. 160 clarifies that a
non-controlling interest in a subsidiary, which is sometimes referred to as
minority interest, is to be reported as a separate component of equity in
the consolidated financial statements. SFAS No. 160 also requires
consolidated net income to include the amounts attributable to both the
parent and the non-controlling interest and to disclose those amounts on
the face of the consolidated statement of income. SFAS No. 160 must be
applied prospectively for fiscal years, and interim periods within those
fiscal years, beginning in the Company's fiscal 2010, except for the
presentation and disclosure requirements, which will be applied
retrospectively for all periods. The Company's adoption of SFAS No. 160 is
not expected to have a material effect on its condensed consolidated
financial statements.
In February 2007, the FASB issued SFAS No. 159, "The Fair Value Option for
Financial Assets and Financial Liabilities". SFAS No. 159 permits entities
to choose to measure many financial instruments and certain other items at
fair value. The objective is to improve financial reporting by providing
entities with the opportunity to mitigate volatility in reported earnings
caused by measuring related assets and liabilities differently without
having to apply complex hedge accounting provisions. Most of the provisions
of this Statement apply only to entities that elect the fair value option.
However, the amendment to SFAS No. 115, "Accounting for Certain Investments
in Debt and Equity Securities", applies to all entities with
available-for-sale and trading securities. Some requirements apply
differently to entities that do not report net income. SFAS No. 159 became
effective for the Company in its fiscal year ending June 30, 2009. The
Company's adoption of SFAS No. 159 did not have a material effect on its
condensed consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements".
SFAS No. 157 provides guidance for using fair value to measure assets and
liabilities. In addition, this statement defines fair value, establishes a
framework for measuring fair value, and expands disclosures about fair
value measurements. Where applicable, this statement simplifies and
codifies related guidance within generally accepted accounting principles.
SFAS No. 157 became effective for the Company in its fiscal year ending
June 30, 2009. The Company's adoption of SFAS No. 159 did not have a
material effect on its condensed consolidated financial statements.
8
Reclassification.
Certain expenses in Cost of sales for fiscal 2008 have been reclassified to
Selling, general and administrative expenses to conform with the current
years presentation.
2.) Stock-based Compensation
------------------------
The Company has established two share incentive programs as discussed in
more detail in the Consolidated Financial Statements and related notes
contained in the Company's annual report on Form 10-K for the year ended
June 30, 2008. The Company accounts for its stock options and share units
granted in accordance with SFAS No. 123(R), "Share-Based Payment" ("SFAS
No. 123(R)") which requires that all stock-based compensation must be
recognized as an expense in the financial statements and that cost be
measured at the fair market value of the award. SFAS No. 123(R) also
requires that excess tax benefits related to stock option exercises be
reflected as financing cash inflows instead of operating cash inflows.
Stock-based compensation costs of $118,000 and $59,000 were recognized in
three months ended September 30, 2008 and 2007, respectively. Unearned
stock-based compensation cost was $532,000 as of September 30, 2008.
The fair values of stock options granted during the three months ended
September 30, 2008 were estimated on the date of grant using the
Black-Scholes option pricing model that used the following weighted average
assumptions:
Expected life in years 5
Risk-free interest rates 3.07%
Volatility 49.86%
Dividend yield 0%
3.) Inventories
-----------
For interim financial statements, inventories are calculated using a gross
profit percentage. The Company regularly reviews parts and finished goods
inventories on hand and, when necessary, records a reserve for excess or
obsolete inventories. As of September 30, 2008 and June 30, 2008, the
balance in this reserve amounted to $1,432,000 and $1,200,000,
respectively. The Company also regularly reviews the period over which its
inventories will be converted to sales. Any inventories expected to convert
to sales beyond 12 months from the balance sheet date are classified as
non-current.
Inventories, net of reserves consist of the following (in thousands):
September 30, June 30,
2008 2008
Component parts $ 19,230 $ 12,924
Work-in-process 4,804 4,114
Finished product 11,296 10,234
-------- --------
$ 35,330 $ 27,272
======== ========
Classification of inventories,
net of reserves:
Current $ 26,890 $ 19,548
Non-current 8,440 7,724
-------- --------
$ 35,330 $ 27,272
======== ========
4.) Earnings Per Common Share
-------------------------
The Company follows the provisions of SFAS No. 128, "Earnings Per Share".
In accordance with SFAS No. 128, earnings per common share amounts ("Basic
EPS") were computed by dividing earnings by the weighted average number of
common shares outstanding for the period. Earnings per common share
amounts, assuming dilution ("Diluted EPS"), were computed by reflecting the
potential dilution from the exercise of stock options. SFAS No. 128
requires the presentation of both Basic EPS and Diluted EPS on the face of
the condensed consolidated statements of income.
A reconciliation between the numerators and denominators of the Basic and
Diluted EPS computations for earnings is as follows (in thousands except
per share data):
Three months ended September 30, 2008
-------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------ ---------
Basic EPS
Net income, as reported $ 322 19,095 $ 0.02
Effect of dilutive securities
Employee Stock Options $ - 384 $ -
----------- ------------ ---------
Diluted EPS
Net income, as reported and
assumed option exercises $ 322 19,479 $ 0.02
=========== ============ =========
9
397,000 options to purchase shares of common stock in the three months
ended September 30, 2008 were excluded in the computation of Diluted EPS
because the exercise prices were in excess of the average market price for
this period and their inclusion would be anti-dilutive.
Three months ended September 30, 2007
-------------------------------------
Net Income Shares Per Share
(numerator) (denominator) Amounts
----------- ------------ ---------
Basic EPS
---------
Net income, as reported $ 374 19,568 $ 0.02
Effect of dilutive securities
-----------------------------
Employee Stock Options $ - 589 $ -
----------- ------------ ---------
Diluted EPS
-----------
Net income, as reported and
assumed option exercises $ 374 20,157 $ 0.02
=========== ============ =========
62,000 options to purchase shares of common stock in the three months ended
September 30, 2007 were excluded in the computation of Diluted EPS because
the exercise prices were in excess of the average market price for this
period and their inclusion would be anti-dilutive.
Option activity during the three months ended September 30, 2008 is
summarized as follows:
Weighted Average
Options Exercise Price
--------- ----------------
Outstanding at July 1, 2008 1,323,480 $ 2.89
Granted 100,000 4.25
Cancelled -- --
Exercised (3,240) (1.90)
---------
Outstanding at September 30, 2008 1,420,240 2.99
=========
Exercisable at September 30, 2008 1,199,281
=========
5.) Acquisition of Business
-----------------------
On August 18, 2008, the Company acquired substantially all of the assets
and business of G. Marks Hardware, Inc. ("Marks") for $25.2 million, the
repayment of $1 million of bank debt and the assumption of current
liabilities as described more fully in the Asset Purchase Agreement. As
such, the operations of Marks have been included in the Company's Statement
of Income for the period August 18, 2008 to September 30, 2008. The Marks
business involves the manufacturing and distribution of door-locking
devices. The Company completed this acquisition at a price in excess of the
value of the net identifiable assets because it believes that the
combination of the two companies offers the potential for manufacturing and
operational synergies as the Company combines the Marks operations and
production into its own door-locking operations and production structure.
The Company funded the acquisition with a term loan from its lenders as
described in Note 6.
The acquisition described above was accounted for as a purchase and was
valued based on management's estimate of the fair value of the assets
acquired and liabilities assumed. The estimates of fair value are
preliminary and subject to adjustment for a period of up to one year from
the date of acquisition. Based on the Company's evaluation, the allocation
of the purchase price for the acquisition was as follows (in thousands):
Assets Acquired:
Cash $ 520
Accounts receivable 1,836
Inventory 6,740
Prepaid expenses and other current assets 112
Property and equipment 801
Other assets 340
Goodwill 897
Intangible assets 16,100
----------
27,346
----------
Less: Liabilities Assumed:
Line of credit borrowings outstanding 1,000
Accounts payable 637
Accrued expenses 339
----------
1,976
----------
Total consideration (including acquisition
Costs of $197) $ 25,370
==========
10
In accordance with the requirements of SFAS No. 141, "Business
Combinations", the Company recorded the estimated value of $9,800,000
related to the customer relationships, $340,000 related to a non-compete
agreement and $6,300,000 related to the Marks trade name within intangible
assets and the excess of the purchase price over the fair value of the
acquired assets of $897,000 was assigned to Goodwill. In accordance with
the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets", the
intangible assets will be amortized over their estimated useful lives of
twenty years (customer relationships) and seven years (non-compete
agreement). The weighted average amortization period of these assets is
19.6 years. The Marks trade name was deemed to have an indefinite life. The
goodwill recorded as a result of the acquisition is deductible for Federal
and New York State income tax purposes over a period of 15 years.
Unaudited pro-forma consolidated financial information is presented below
as if the acquisition had occurred as of the first day of the earliest
period presented. Results have been adjusted to account for: (1) the
initial $25,000,000 cash borrowing and related interest expense under the
term loan, (2) cash used to repay $1,000,000 in assumed bank debt at
closing of the purchase transaction, (3) deferred financing costs and
related amortization associated with the term loan, (4) additional salary
and employee stock option expense for employees not previously included in
salary expense, and (5) amortization expense of acquired intangible assets.
The pro-forma information presented below does not purport to present what
actual results would have been if the acquisition had occurred at the
beginning of such periods, nor does the information project results for any
future period. The unaudited pro-forma consolidated financial information
should be read in conjunction with the historical financial information
included in other reports and documents filed with the United Stated
Securities and Exchange Commission.
The unaudited pro-forma consolidated financial information for the three
months ended September 30, 2008 and 2007 is as follows:
Three months ended September 30,
2008 2007
--------- ----------
(in thousands, except per share data)
Pro-forma:
Net sales $ 20,002 $ 20,277
Net income $ 416 $ 566
Net income (loss) per share:
Basic $ 0.02 $ 0.03
Diluted $ 0.02 $ 0.03
Weighted average number of shares:
Basic 19,095,361 19,567,689
Diluted 19,479,269 20,157,055
6.) Long Term Debt
--------------
On August 18, 2008, the Company and its banks amended and restated the
existing $25,000,000 revolving credit agreement. The amended facility is
$50,000,000 and provides for a $25,000,000 revolving credit line as well as
a $25,000,000 term portion of which the entire $25,000,000 was utilized to
finance the asset purchase agreement as described in Note 5. The amended
revolving credit agreement and term loan 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 agreements bear interest
at either the Prime Rate or an alternate rate based on LIBOR as described
in the agreement. The August amendment extended the revolving credit
agreement to August 2012. Any outstanding borrowings are to be repaid or
refinanced on or before that time. As of September 30, 2008 there was
$14,100,000 outstanding under the revolving credit facility with an
interest rate of 4.6% and $25,000,000 outstanding under the term loan with
an interest rate of 5.0%. The term loan is to be repaid in 19 quarterly
installments of $893,000 each commencing in December 2008 and a final
payment of $8,033,000 due in August 2013. The agreements contain various
restrictions and covenants including, among others, restrictions on payment
of dividends, restrictions on borrowings and compliance with certain
financial ratios, as defined in the agreement. As of September 30, 2008 the
Company was in violation of the certain financial covenants for which it
has received the appropriate waiver from its banks. In addition, the
Company's revolving credit line was amended to $20,000,000 from
$25,000,000.
11
7.) Geographical Data
-----------------
The Company is engaged in one major line of business: the development,
manufacture, and distribution of security alarm products and door security
devices for commercial and residential use. Sales to unaffiliated customers
are primarily shipped from the United States. The Company has customers
worldwide with major concentrations in North America, Europe, and South
America.
The Company observes the provisions of SFAS No. 131. The following
represents selected consolidated geographical data for the three months
ended September 30, 2008 and 2007 (in thousands):
Three Months ended September 30,
--------------------------------
2008 2007
--------------------------------
Sales to external customers(1):
-------------------------------
Domestic $ 15,427 $ 11,573
Foreign 2,056 2,303
------------- -------------
Total Net Sales $ 17,483 $ 13,876
============= =============
As of
--------------------------------
September 30,
2008 June 30, 2008
------------- -------------
Identifiable assets:
--------------------
United States $ 77,792 $ 50,056
Dominican Republic (2) 21,237 19,841
Other foreign countries 6,439 6,826
------------- -------------
Total Identifiable Assets $ 105,468 $ 76,723
============= =============
(1) All of the Company's sales occur in the United States and are shipped
primarily from the Company's facilities in the United States and United
Kingdom. There were no sales into any one foreign country in excess of 10%
of Net Sales.
(2) Consists primarily of inventories ($16,291,000 and $14,754,000) and
fixed assets ($4,873,000 and $4,970,000) located at the Company's principal
manufacturing facility in the Dominican Republic as of September 30, 2008
and June 30, 2008, respectively.
8.) Commitments and Contingencies
-----------------------------
In the normal course of business, the Company is a party to claims and/or
litigation. Management believes that the settlement of such claims and/or
litigation, considered in the aggregate, will not have a material adverse
effect on the Company's financial position and results of operations. In
August 2008, the Company entered into a lease for the building where Marks
has maintained its operations. The lease provides for an annual base rent
of $288,750 plus maintenance and real estate taxes, expires in August 2009
and provides for two annual extensions thereafter at similar terms and
conditions. The Company intends to move the Marks operations into its
facilities after constructing extensions of approximately 35,000 square
feet. To date, the Company does not have estimates for the cost of this
move or the related construction. The Marks business involves the
manufacturing and distribution of door-locking devices.
9.) Income Taxes
------------
The provision for income taxes represents Federal, foreign, and state and
local income taxes. The effective rate differs from statutory rates due to
the effect of state and local income taxes, tax rates in foreign
jurisdictions and certain nondeductible expenses. Our effective tax rate
will change from quarter to quarter based on recurring and non-recurring
factors including, but not limited to, the geographical mix of earnings,
enacted tax legislation, and state and local income taxes. In addition,
changes in judgment from the evaluation of new information resulting in the
recognition, de-recognition or re-measurement of a tax position taken in a
prior annual period are recognized separately in the quarter of the change.
The Company does not expect that our unrecognized tax benefits will
significantly change within the next twelve months. We file a consolidated
U.S. income tax return and tax returns in certain state and local and
foreign jurisdictions. There are no current tax examinations in progress.
Accordingly, as of September 30, 2008, we remain subject to examination in
all tax jurisdictions for all relevant jurisdictional statutes.
The Company adopted the provisions of FIN 48 as of July 1, 2007. The
Company has identified its U.S. Federal income tax return and its State
return in New York as its major tax jurisdictions. During the three months
ending September 30, 2008 the Company increased its reserve for uncertain
income tax positions by $5,000. As a result, as of September 30, 2008 the
Company has a long-term accrued income tax liability of $ 299,000.
12
Item 2. Management's Discussion and Analysis of Financial Condition and Results
------------------------------------------------------------------------
of Operations
-------------
Napco Security Systems, Inc.
Management's Discussion and Analysis of Financial Condition and Results of
Operations
This Quarterly Report on Form 10-Q and the information incorporated by reference
may include "Forward-Looking Statements" within the meaning of Section 27A of
the Securities Act of 1933 and Section 21E of the Exchange Act of 1934. The
Company intends the Forward-Looking Statements to be covered by the Safe Harbor
Provisions for Forward-Looking Statements. All statements regarding the
Company's expected financial position and operating results, its business
strategy, its financing plans and the outcome of any contingencies are
Forward-Looking Statements. The Forward-Looking Statements are based on current
estimates and projections about our industry and our business. Words such as
"anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates,"
or variations of such words and similar expressions are intended to identify
such Forward-Looking Statements. The Forward-Looking Statements are subject to
risks and uncertainties that could cause actual results to differ materially
from those set forth or implied by any Forward-Looking Statements. For example,
the Company is highly dependent on its Chief Executive Officer for strategic
planning. If he is unable to perform his services for any significant period of
time, the Company's ability to continue growing could be adversely affected. In
addition, factors that could cause actual results to differ materially from the
Forward-Looking Statements include, but are not limited to, adverse tax
consequences of offshore operations, significant fluctuations in the exchange
rate between the Dominican Peso and the U.S. Dollar, distribution problems,
unforeseen environmental liabilities and the uncertain military, political and
economic conditions in the world.
Overview
The Company is a diversified manufacturer of security products, encompassing
intrusion and fire alarms, building access control systems and electronic
locking devices. These products are used for commercial, residential,
institutional, industrial and governmental applications, and are sold worldwide
principally to independent distributors, dealers and installers of security
equipment. International sales accounted for approximately 12% and 17% of our
revenues for the three months ended September 30, 2008 and 2007, respectively.
The Company owns and operates manufacturing facilities in Amityville, New York
and the Dominican Republic. A significant portion of our operating costs are
fixed, and do not fluctuate with changes in production levels or utilization of
our manufacturing capacity. As production levels rise and factory utilization
increases, the fixed costs are spread over increased output, which should
improve profit margins. Conversely, when production levels decline our fixed
costs are spread over reduced levels, thereby decreasing margins.
On August 18, 2008, the Company acquired substantially all of the assets and
business of G. Marks Hardware, Inc. ("Marks") for $25.2 million, the repayment
of $1 million of bank debt and the assumption of certain current liabilities.
The Company also entered into a lease for the building where Marks has
maintained its operations. The lease provides for an annual base rent of
$288,750 plus maintenance and real estate taxes, expires in August 2009 and
provides for two annual extensions thereafter. The Company intends to move the
Marks operations into its facilities after constructing extensions of
approximately 35,000 square feet. To date, the Company does not have estimates
for the cost of this move or the related construction. The Marks business
involves the manufacturing and distribution of door-locking devices.
13
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 2008 did not contribute materially
to revenue during this fiscal year, but should benefit the Company over future
years. In general, the new products introduced by the Company are initially
shipped in limited quantities, and increase over time. Prices and manufacturing
costs tend to decline over time as products and technologies mature.
Economic and Other Factors
The post-September 11 era has generally been characterized by increased demand
for electronic security products and services. The Company believes the security
equipment market is likely to continue to exhibit growth, particularly in
industrial sectors, due to ongoing concerns over the adequacy of security
safeguards. The Company's business is also affected by the housing markets.
Seasonality
The Company's fiscal year begins on July 1 and ends on June 30. Historically,
the end users of Napco's products want to install its products prior to the
summer; therefore sales of its products peak in the period April 1 through June
30, the Company's fiscal fourth quarter, and are reduced in the period July 1
through September 30, the Company's fiscal first quarter. To a lesser degree,
sales in Europe are also adversely impacted in the Company's first fiscal
quarter because of European vacation patterns, i.e., many distributors and
installers are closed for the month of August. In addition, demand is affected
by the housing and construction markets. Critical Accounting Policies and
Estimates
The discussion and analysis of our financial condition and results of operations
are based upon our consolidated financial statements, which have been prepared
in conformity with accounting principles generally accepted in the United
States. The preparation of these financial statements requires us to make
estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses reported in those financial statements. These
judgments can be subjective and complex, and consequently actual results could
differ from those estimates. Our most critical accounting policies relate to
revenue recognition; concentration of credit risk; inventories; intangible
assets; goodwill; and income taxes.
Revenue Recognition
Revenues from merchandise sales are recorded at the time the product is shipped
or delivered to the customer pursuant to the terms of sale. We report our sales
levels on a net sales basis, which is computed by deducting from gross sales the
amount of actual returns received and an amount established for anticipated
returns and other 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% and 4% for the three months ended
September 30, 2008 and 2007, respectively.
Concentration of Credit Risk
An entity is more vulnerable to concentrations of credit risk if it is exposed
to risk of loss greater than it would have had if it mitigated its risk through
diversification of customers. Such risks of loss manifest themselves
differently, depending on the nature of the concentration, and vary in
significance.
14
The Company had two customers with accounts receivable balances that aggregated
30% and 34% of the Company's accounts receivable at September 30, 2008 and June
30, 2008, 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 $408,000 and $405,000 as of
September 30, 2008 and June 30, 2008, respectively. Our reserve for doubtful
accounts is a subjective critical estimate that has a direct impact on reported
net earnings. This reserve is based upon the evaluation of accounts receivable
agings, specific exposures and historical trends.
Inventories
Inventories are valued at the lower of cost or fair market value, with cost
being determined on the first-in, first-out (FIFO) method. The reported net
value of inventory includes finished saleable products, work-in-process and raw
materials that will be sold or used in future periods. Inventory costs include
raw materials, direct labor and overhead. The Company's overhead expenses are
applied based, in part, upon estimates of the proportion of those expenses that
are related to procuring and storing raw materials as compared to the
manufacture and assembly of finished products. These proportions, the method of
their application, and the resulting overhead included in ending inventory, are
based in part on subjective estimates and approximations and actual results
could differ from those estimates.
In addition, the Company records an inventory obsolescence reserve, which
represents the difference between the cost of the inventory and its estimated
market value, based on various product sales projections. The balance in this
reserve was $1,432,000 and $1,200,000 as of September 30, 2008 and June 30,
2008, respectively. This reserve is calculated using an estimated obsolescence
percentage applied to the inventory based on age, historical trends,
requirements to support forecasted sales, and the ability to find alternate
applications of its raw materials and to convert finished product into alternate
versions of the same product to better match customer demand. There is inherent
professional judgment and subjectivity made by both production and engineering
members of management in determining the estimated obsolescence percentage. In
addition, and as necessary, the Company may establish specific reserves for
future known or anticipated events.
The Company also regularly reviews the period over which its inventories will be
converted to sales. Any inventories expected to convert to sales beyond 12
months from the balance sheet date are classified as non-current.
Goodwill and Other Intangible Assets
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,
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.
The Company's acquisition of substantially all of the assets and certain
liabilities of Marks included intangible assets with a fair value of $16,100,000
on the date of acquisition. In accordance with the requirements of SFAS No. 141,
"Business Combinations", the Company recorded the estimated value of $9,800,000
related to the customer relationships, $340,000 related to a non-compete
agreement and $6,300,000 related to the Marks trade name within intangible
assets and Goodwill of $897,000 subject to further adjustment. In accordance
with the provisions of SFAS No. 142, "Goodwill and Other Intangible Assets", the
intangible assets will be amortized over their estimated useful lives of twenty
years (customer relationships) and seven years (non-compete agreement). The
Marks USA trade name was deemed to have an indefinite life. The goodwill
recorded as a result of the acquisition is deductible for Federal and New York
State income tax purposes over a period of 15 years.
15
Income Taxes
The provision for income taxes represents Federal, foreign, and state and local
income taxes. The effective rate differs from statutory rates due to the effect
of state and local income taxes, tax rates in foreign jurisdictions and certain
nondeductible expenses. Our effective tax rate will change from quarter to
quarter based on recurring and non-recurring factors including, but not limited
to, the geographical mix of earnings, enacted tax legislation, and state and
local income taxes. In addition, changes in judgment from the evaluation of new
information resulting in the recognition, de-recognition or re-measurement of a
tax position taken in a prior annual period are recognized separately in the
quarter of the change.
We do not expect that our unrecognized tax benefits will significantly change
within the next twelve months. We file a consolidated U.S. income tax return and
tax returns in certain state and local and foreign jurisdictions. There are no
current tax examinations in progress. Accordingly, as of September 30, 2008, we
remain subject to examination in all tax jurisdictions for all relevant
jurisdictional statutes.
Results of Operations
---------------------
-------------------------------------------
Three months ended September 30,
(dollars in thousands)
-------------------------------------------
2008 2007 % Increase/
(decrease)
-------------------------------------------
Net sales $ 17,483 $ 13,876 26.0%
Gross profit 5,606 5,224 7.3%
Gross profit as a % of net sales 32.1% 37.6% (5.5)%
Selling, general and administrative 4,776 4,421 8.0%
Selling, general and administrative
as a percentage of net sales 27.3% 31.9% (4.6)%
Operating income 830 803 3.4%
Interest expense, net 315 195 61.5%
Other expense
79 7 1,028.6%
Minority interest in net loss of
subsidiary, net 42 38 10.5%
Provision for income taxes 156 265 (41.1)%
Net income 322 374 (13.9)%
-------------------------------------------
Sales for the three months ended September 30, 2008 increased by approximately
26% to $17,483,000 as compared to $13,876,000 for the same period a year ago.
The increase in sales for the three months ended September 30, 2008 was
primarily the result of the six weeks of net sales added from the Marks
acquisition as well as a 2% increase in the Company's other product lines. This
2% increase was primarily due to increases in the Company's door locking and
access control products as partially offset by decreased sales of intrusion
products.
The Company's gross profit for the three months ended September 30, 2008
increased to $5,606,000 or 32.1% of sales as compared to $5,224,000 or 37.6% of
sales for the same period a year ago. The increase in Gross profit in dollars
for the three months was primarily due to the addition of the Gross profit of
Marks ($1,057,000) resulting from the acquisition on August 18, 2008 as
partially offset by a decrease in Gross profit in the Company's other products.
Selling, general and administrative expenses for the three months ended
September 30, 2008 increased by $355,000 to $4,776,000, or 27.3% of sales, as
compared to $4,421,000, or 31.9% of sales a year ago. The increase in dollars
for the three months ended September 30, 2008 was due primarily to the
additional expenses relating to Marks ($454,000) as partially offset by a
decrease in tradeshow expenses due to a major tradeshow occurring in October
2008 ($199,000). This tradeshow occurred in September 2007 and was therefore
included in Selling, general and administrative expense for the first quarter of
fiscal 2008. The decrease in Selling, general and administrative expenses as a
percentage of net sales was due to the timing of this tradeshow as well as Marks
having lower Selling, general and administrative expenses as a percentage of
sales as compared to rest of the Company.
16
Interest expense, net for the three months ended September 30, 2008 increased by
$120,000 to $315,000 as compared to $195,000 for the same period a year ago. The
increase in interest expense for the three months resulted primarily from the
increase in the Company's average outstanding debt, which was due to the
$25,000,000 of bank financing utilized for the Marks acquisition.
The Company's provision for income taxes for the three months ended September
30, 2008 decreased by $109,000 to $156,000 as compared to $265,000 for the same
period a year ago. The decrease in provision for income taxes for the three
months resulted primarily from the Company's corporate restructuring during the
quarter ended December 31, 2007. As a result, the Company's effective rate for
for income tax was 32.6% for the three months ended September 30, 2008, which
reflected the effect of this restructuring and 41.5% for the three months ended
September 30, 2007, which did not.
Net income decreased by $52,000 to $322,000 or $0.02 per diluted share for the
three months ended September 30, 2008 as compared to $374,000 or $0.02 per
diluted share for the same period a year ago. The decrease for the three months
ended September 30, 2008 was primarily due to the decrease in gross profit as a
percentage of sales as discussed above as partially offset by the additional net
income generated from the Marks acquisition ($240) as well as the lower
effective tax rate relating to the Company's corporate restructuring described
above.
Liquidity and Capital Resources
-------------------------------
During the three months ended September 30, 2008 the Company utilized all of its
cash from operations and additional borrowings to complete the Marks acquisition
($26,173,000, which includes payment of the $1,000,000 of assumed debt),
purchase inventory ($1,317,000) and property, plant and equipment ($115,000).
The Company's management believes that current working capital, cash flows from
operations and its revolving credit agreement will be sufficient to fund the
Company's operations through at least the next twelve months.
Accounts Receivable at September 30, 2008 increased $656,000 to $26,479,000 as
compared to $25,823,000 at June 30, 2008. This increase is primarily the result
of Marks acquisition ($2,540,000) as partially offset by the lower sales volume
during the quarter ended September 30, 2008 as compared to the quarter ended
June 30, 2008, which is typically the Company's highest.
Inventories at September 30, 2008 increased by $8,058,000 to $35,330,000 as
compared to $27,272,000 at June 30, 2008. This increase was primarily the result
of the Marks acquisition ($5,774,000) as well as the Company level-loading its
production schedule in anticipation of its historical sales cycle where a larger
portion of the Company's sales occur in the latter fiscal quarters as compared
to the earlier quarters. The Company initiated several steps in order to reduce
inventory levels in fiscal 2008 and expects to continue them in fiscal 2009.
On August 18, 2008, the Company and its banks amended and restated the existing
$25,000,000 revolving credit agreement. The amended facility is $50,000,000 and
provides for a $25,000,000 revolving credit line as well as a $25,000,000 term
portion of which the entire $25,000,000 was utilized to finance the asset
purchase agreement as described in Note 12. The amended revolving credit
agreement and term loan 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 agreements bear interest at either the Prime Rate or an
alternate rate based on LIBOR as described in the agreement. The August
amendment extended the revolving credit agreement to August 2012. Any
outstanding borrowings are to be repaid or refinanced on or before that time. As
of September 30, 2008 there was $14,100,000 outstanding under the revolving
credit facility with an interest rate of 4.6% and $25,000,000 outstanding under
the term loan with an interest rate of 5.0%. The term loan is to be repaid in 19
quarterly installments of $893,000 each commencing in December 2008 and a final
payment of $8,033,000 due in August 2013. The agreements contain various
restrictions and covenants including, among others, restrictions on payment of
dividends, restrictions on borrowings and compliance with certain financial
ratios, as defined in the agreement. As of September 30, 2008 the Company was in
violation of the covenant relating to the ratio of Funded Debt to EBITDA for
which it has received the appropriate waiver from its banks. In addition, the
Company's revolving credit line was amended to $20,000,000 from $25,000,000 in
November 2008.
As of September 30, 2008 the Company had no material commitments for capital
expenditures or inventory purchases other than purchase orders issued in the
normal course of business.
17
ITEM 3: Quantitative and Qualitative Disclosures About Market Risk
------------------------------------------------------------------
The Company's principal financial instrument is long-term debt (consisting of a
revolving credit facility and term loan) that provides for interest at the prime
rate or an alternate rate based on LIBOR as described in the agreement. 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 September 30, 2008, an aggregate principal amount of approximately
$39,100,000 was outstanding under the Company's credit facility with a weighted
average interest rate of approximately 4.9%. If principal amounts outstanding
under the Company's credit facility remained at this level for an entire year
and the prime rate increased or decreased, respectively, by 1% the Company would
pay or save, respectively, an additional $391,000 in interest that year.
A significant number of foreign sales transactions by the Company are
denominated in U.S. dollars. As such, the Company has shifted foreign currency
exposure onto many of its foreign customers. As a result, if exchange rates move
against foreign customers, the Company could experience difficulty collecting
unsecured accounts receivable, the cancellation of existing orders or the loss
of future orders. The foregoing could materially adversely affect the Company's
business, financial condition and results of operations. In addition, the
Company transacts certain sales in Europe in British Pounds Sterling, therefore
exposing itself to a certain amount of foreign currency risk. Management
believes that the amount of this exposure is immaterial. We are also exposed to
foreign currency risk relative to expenses incurred in Dominican Pesos ("RD$"),
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 $314,000.
ITEM 4: Controls and Procedures
-------------------------------
We maintain disclosure controls and procedures that are designed to ensure that
information required to be disclosed in our Exchange Act reports is recorded,
processed, summarized and reported within the time periods specified in the
SEC's rules and forms, and that such information is accumulated and communicated
to our management to allow timely decisions regarding required disclosure.
Management necessarily applied its judgment in assessing the costs and benefits
of such controls and procedures, which, by their nature, can provide only
reasonable assurance regarding management's control objectives.
At the conclusion of the period ended September 30, 2008, we carried out an
evaluation, under the supervision and with the participation of our management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures. Based upon that evaluation, the Chief Executive Officer and Chief
Financial Officer concluded that our disclosure controls and procedures were
effective in alerting them in a timely manner to information relating to the
Company required to be disclosed in this report except as follows:
Management's review over it's internal controls at the conclusion of fiscal 2008
identified conditions which they deemed to be material weaknesses, (as defined
by standards established by the SEC and the Public Company Accounting Oversight
Board) with respect to certain of our inventory valuation methods both at
year-end and relating to the Gross profit method used to calculate Gross profit
and Inventories for interim reporting purposes. Management has informed it's
independent auditors and the Audit Committee that it has corrected its method of
calculating its gross profit and inventory for interim reporting by including a
more comprehensive review of changes within the business and accounting for
those changes where appropriate. The Company has also initiated a review of the
ways in which we can more accurately cost its inventory for year-end reporting
and will continue to monitor the effectiveness of these actions and will make
any other changes or take such additional actions as management determines to be
appropriate. Management expects to complete the actions relating to the year-end
inventory valuation during fiscal 2009.
During the first quarter of fiscal 2009, there were no changes in the Company's
internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect, the Company's internal control over
financial reporting except for the procedure described above which has corrected
the weakness relating to interim Gross profit and inventory calculations.
18
PART II: OTHER INFORMATION
Item 1A. Risk Factors
------------
Information regarding the Company's Risk Factors are set forth in the
Company's Annual Report on Form 10-K for the year ended June 30, 2008.
There have been no material changes in the risk factors previously
disclosed in the Company's Form 10-K for the year ended June 30, 2008
during the three months ended September 30, 2008 except as follows:
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. In addition, since October 2008, the U.S. and international
financial markets have taken a significant loss and continue to be very
volatile. In the event that the downturn in the U.S. or international
financial markets is prolonged, our revenue levels could be materially
adversely affected. If the current worldwide economic downturn
continues, many of our current or potential future customers may
experience serious cash flow problems and as a result may, modify,
delay or cancel purchases of our products. Additionally, customers may
not be able to pay, or may delay payment of, accounts receivable that
are owed to us. Furthermore, the current downturn and market
instability makes it difficult for us to forecast our revenues.
Our Business Could Be Materially Adversely Affected by the Integration
-----------------------------------------------------------------------
of Marks into Our Existing Operations
-------------------------------------
Our business is dependent on the orderly, effective integration of the
acquired Marks business, technologies, product lines and employees into
our organization. If this integration is unsuccessful, our business may
be materially adversely affected.
Item 6. Exhibits
--------
31.1 Certification Pursuant to Rule 13a-14(a)/15d-14(a) of Richard
L. Soloway, Chairman of the Board and President
31.2 Certification Pursuant to Rule 13a-14(a)/15d-14(a) of Kevin S.
Buchel, Senior Vice President of Operations and Finance
32.1 Section 1350 Certifications
19
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
November 17, 2008
NAPCO SECURITY SYSTEMS, INC
(Registrant)
By: /S/ RICHARD L. SOLOWAY
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Richard L. Soloway
Chairman of the Board of Directors, President and Secretary
(Chief Executive Officer)
By: /S/ KEVIN S. BUCHEL
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Kevin S. Buchel
Senior Vice President of Operations and Finance and Treasurer
(Principal Financial and Accounting Officer)
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