1 SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND - ----- EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED: MARCH 31, 1999 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND - ----- EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______________ TO _______________ . Commission File Number: 0-10004 NAPCO SECURITY SYSTEMS, INC. (Exact name of Registrant as specified in its charter) DELAWARE 11-2277818 (State or other jurisdiction of (IRS Employer Identification Number) incorporation or organization) 333 Bayview Avenue Amityville, New York 11701 (Zip Code) (516) 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 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 ------- ------- Number of shares outstanding of each of the issuer's classes of common stock, as of: MARCH 31, 1999 COMMON STOCK, $.01 PAR VALUE PER SHARE 3,490,151
2 NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES INDEX MARCH 31, 1999 Page PART I: FINANCIAL INFORMATION (unaudited) Condensed Consolidated Balance Sheets, March 31, 1999 and June 30, 1998 3 Condensed Consolidated Statements of Income for the Nine Months Ended March 31, 1999 and 1998 4 Condensed Consolidated Statements of Income for the Three Months Ended March 31, 1999 and 1998 5 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended March 31, 1999 and 1998 6 Notes to Condensed Consolidated Financial Statements 7 Management's Discussion and Analysis of Financial Condition and Results of Operations 9 PART II: OTHER INFORMATION 12 SIGNATURE PAGE 13 INDEX TO EXHIBITS 14 -2-
3 NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS (unaudited) <TABLE> <CAPTION> March 31, June 30, ASSETS 1999 1998 -------- -------- (in thousands, except share data) <S> <C> <C> <C> Current Assets: Cash and cash equivalents $ 1,983 $ 1,989 Accounts receivable, less allowance for doubtful accounts: March 31, 1999 $ 1,092 June 30, 1998 $ 755 12,273 14,760 Inventories, net (Note 2) 24,693 25,438 Prepaid expenses and other current assets 847 674 Deferred income taxes, net 1,292 1,292 -------- -------- Total current assets 41,088 44,153 Property, Plant and Equipment, net of accumulated depreciation and amortization (Note 3): March 31, 1999 $ 11,953 June 30, 1998 $ 11,055 11,338 11,491 Goodwill, net 2,512 2,592 Other Assets 341 327 -------- -------- $ 55,279 $ 58,563 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Current portion of long-term debt $ 1,748 $ 1,667 Accounts payable 3,512 3,862 Accrued and other current liabilities 1,392 1,678 Accrued taxes 558 3,004 -------- -------- Total current liabilities 7,210 10,211 Long-Term Debt 17,512 18,644 Deferred Income Taxes 875 875 -------- -------- Total liabilities 25,597 29,730 Stockholders' Equity: Common stock, par value $.01 per share; 21,000,000 shares authorized, 5,908,602 shares issued; 3,490,151 and 3,489,651 shares outstanding, respectively 59 59 Additional paid-in capital 751 749 Retained earnings 33,321 32,474 Less: Treasury stock, at cost (2,418,451 shares) (4,449) (4,449) -------- -------- Total stockholders' equity 29,682 28,833 -------- -------- $ 55,279 $ 58,563 ======== ======== </TABLE> See accompanying notes to Condensed consolidated Financial Statements. -3-
4 NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited) <TABLE> <CAPTION> Nine Months Ended March 31, ---------------------------- 1999 1998 ----------- ----------- (in thousands, except share and per share data) <S> <C> <C> Net Sales $ 33,608 $ 35,687 Cost of Sales 25,591 26,895 ----------- ----------- Gross profit 8,017 8,792 Selling, General and Administrative Expenses 7,970 6,886 ----------- ----------- Operating income 47 1,906 ----------- ----------- Interest Expense, net 1,047 811 Other Expense, net 59 112 ----------- ----------- 1,106 923 ----------- ----------- Income (loss) before (benefit) provision for income taxes (1,059) 983 (Benefit) Provision for Income Taxes (1,906) 274 ----------- ----------- Net income $ 847 $ 709 =========== =========== Earnings Per Share (Note 5): Basic $ 0.24 $ 0.16 =========== =========== Diluted $ 0.24 $ 0.16 =========== =========== Weighted Average Number of Shares Outstanding (Note 5): Basic 3,480,401 4,374,477 =========== =========== Diluted 3,505,824 4,441,177 =========== =========== </TABLE> See accompanying notes to Condensed consolidated Financial Statements. -4-
5 NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF INCOME (unaudited) <TABLE> <CAPTION> Three Months Ended March 31, ---------------------------- 1999 1998 ----------- ----------- (in thousands, except share and per share data) <S> <C> <C> Net Sales $ 11,672 $ 12,023 Cost of Sales 8,950 9,201 ----------- ----------- Gross profit 2,722 2,822 Selling, General and Administrative Expenses 3,247 2,277 ----------- ----------- Operating income (525) 545 ----------- ----------- Interest Expense, net 327 282 Other Expense, net 150 100 ----------- ----------- 477 382 ----------- ----------- Income (loss) before (benefit) provision for income taxes (1,002) 163 (Benefit) Provision for Income Taxes (1,345) 42 ----------- ----------- Net income $ 343 $ 121 =========== =========== Earnings Per Share (Note 5): Basic $ 0.10 $ 0.03 =========== =========== Diluted $ 0.10 $ 0.03 =========== =========== Weighted Average Number of Shares Outstanding (Note 5): Basic 3,480,401 4,377,477 =========== =========== Diluted 3,491,250 4,396,477 =========== =========== </TABLE> See accompanying notes to Condensed consolidated Financial Statements. -5-
6 NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) <TABLE> <CAPTION> Nine Months Ended March 31, -------------------- 1999 1998 ------- ------- (in thousands) <S> <C> <C> Net Cash Provided by (Used in) Operating Activities $ 1,790 $(1,679) ------- ------- Cash Flows from Investing Activities: Purchases of property, plant and equipment (745) (238) ------- ------- Net cash used in investing activities (745) (238) ------- ------- Cash Flows from Financing Activities: Proceeds from long-term debt borrowings -- 2,550 Principal payments on long-term debt (1,051) (450) ------- ------- Net cash (used in) provided by financing activities (1,051) 2,100 ------- ------- Net Increase (Decrease) in Cash and Cash Equivalents (6) 183 Cash and Cash Equivalents at Beginning of Period 1,989 1,006 ------- ------- Cash and Cash Equivalents at End of Period $ 1,983 $ 1,189 ======= ======= Cash Paid During the Period for: Interest $ 879 $ 663 ======= ======= Income taxes $ 250 $ 85 ======= ======= </TABLE> See accompanying notes to Condensed consolidated Financial Statements. -6-
7 NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 1.) Summary of Significant Accounting Policies and Other Disclosures The information for the nine months ended March 31, 1999 and 1998 is unaudited, but in the opinion of the Company, all adjustments (consisting only of normal recurring adjustments) considered necessary for a fair presentation of the results of operations for such periods have been included. The results of operations for the periods may not necessarily reflect the annual results of the Company. The Company has adopted all recently effective accounting standards which have an impact on its condensed financial statements. 2.) Inventories <TABLE> <CAPTION> Inventories consist of: March 31, June 30, 1999 1998 ------- ------- (in thousands) <S> <C> <C> Component parts $ 9,932 $10,200 Work-in-process 3,958 4,056 Finished products 10,903 11,182 ------- ------- $24,693 $25,438 ======= ======= </TABLE> 3.) Property, Plant and Equipment <TABLE> <CAPTION> Property, Plant and Equipment consists of: March 31, June 30, 1999 1998 ------- ------- (in thousands) <S> <C> <C> Land $ 904 $ 904 Building 8,911 8,911 Molds and dies 3,065 2,819 Furniture and fixtures 928 912 Machinery and equipment 9,427 8,944 Building improvements 56 56 ------- ------- 23,291 22,546 Less: Accumulated depreciation and amortization 11,953 11,055 ------- ------- $11,338 $11,491 ======= ======= </TABLE> 4.) In August 1995, the Internal Revenue Service ("IRS") informed the Company that it had completed the audit of the Company's Federal tax returns for fiscal years 1986 through 1993. The IRS had issued a report to the Company proposing adjustments that would result in taxes due of approximately $4.3 million excluding interest charges. The primary adjustments presented by the IRS related to intercompany pricing and royalty charges, DISC earnings and charitable contributions. The Company disagreed with the IRS and began the process of vigorously appealing this assessment using all remedies and procedural actions available under the law. The Company had provided a reserve to reflect its estimate of the ultimate resolution of this matter, so that the outcome of this matter would not have a material adverse effect on the Company's consolidated financial statements. During fiscal 1999, the Company both continued to discuss the assessment with the IRS Appeals Office and concluded an IRS examination of fiscal years 1994 through 1997. In July 1998 the Company received a revised audit report which eliminated the original assessment for the fiscal years 1986 through 1993. In April 1999 the Company favorably resolved the IRS examination of fiscal years 1994 through 1997. The Company has accepted both audit reports and the final government approvals have been received. Accordingly, the benefit for income taxes for the three and nine months ended March 31, 1999 reflects the favorable effect of the reversal of previously recorded reserves. -7-
8 NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS 5.) Net Income Per Common Share Effective December 31, 1997, the Company adopted Statement of Financial Accounting standards ("SFAS") No. 128, "Earnings per share". In accordance with SFAS No. 128, net income per common share amounts ("basic EPS") were computed by dividing net income by the weighted average number of common shares outstanding for the period. Net income 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 income statement. Net income per share amounts for the same prior-year periods have been restated to conform to the provisions of SFAS No. 128. A reconciliation between the numerators and denominators of the basic and diluted EPS computations for net income is as follows: <TABLE> <CAPTION> Nine Months Ended March 31, 1999 (in thousands, except per share data) ---------------------------------------- Net Income Shares Per Share (numerator) (denominator) Amounts ----- ----- ----- <S> <C> <C> <C> Net income $ 847 -- -- ----- BASIC EPS Net income attributable to common stock $ 847 3,480 $0.24 ----- EFFECT OF DILUTIVE SECURITIES Options -- 26 0.00 ----- ----- ----- DILUTED EPS Net income attributable to common stock and assumed option exercises $ 847 3,506 $0.24 ----- ===== ===== </TABLE> <TABLE> <CAPTION> Three Months Ended March 31, 1999 (in thousands, except per share data) ---------------------------------------- Net Income Shares Per Share (numerator) (denominator) Amounts ----- ----- ----- <S> <C> <C> <C> Net income $ 343 -- -- ----- BASIC EPS Net income attributable to common stock $ 343 3,480 $0.10 ----- EFFECT OF DILUTIVE SECURITIES Options -- 11 -- ----- ----- ----- DILUTED EPS Net income attributable to common stock and assumed option exercises $ 343 3,491 $0.10 ----- ===== </TABLE> Options to purchase 11,220 shares of common stock in the nine months and 68,870 in the three months ended March 31, 1999 were not included in the computation of diluted EPS because the exercise prices exceeded the average market price of the common shares for this period. These options were still outstanding at the end of the period. -8-
9 NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Results of Operations Sales for the nine months ended March 31, 1999 decreased by 6% to $33,608,000 as compared to $35,687,000 for the same period a year ago. For the quarter ended March 31, 1999 net sales decreased by 3% to $11,672,000 from $12,023,000 for the same period in fiscal 1998. During the three and nine months ended March 31, 1999 net sales were affected by two of the Company's customers tightening their levels of the Company's product in their inventory. In January 1999 this major customer announced that it had acquired substantially all of the assets of one of the customers discussed above. In the Company's opinion, the reduction of inventory by these two customers was due in part to their anticipation of this acquisition. In addition, the Company's sales were affected by the recent economic problems in Latin America. The Company is assisting its customers closely in keeping its products readily available while maintaining an acceptable credit risk and cash flows. The Company's gross margin for the nine months ended March 31, 1999 decreased by $775,000 to $8,017,000 or 23.9% of sales as compared to $8,792,000 or 24.6% of sales for the same period a year ago. Gross margin for the three months ended March 31, 1999 was $2,722,000 or 23.3% of sales as compared to $2,822,000 or 23.5% of sales for the same period a year ago. This decrease was primarily due to the same issues resulting in the decreased sales volume as discussed above. Selling, general and administrative expenses for the nine months ended March 31, 1999 increased by $1,084,000 to $7,970,000 as compared to $6,886,000 a year ago. For the three months ended March 31, 1999 selling, general and administrative expenses increased by $970,000 to $3,247,000 from $2,246,000 for the same period a year ago. These increases were primarily related to the Company's increased selling and marketing focus in the international marketplace. In addition, the Company increased its allowance for doubtful accounts reserve in light of the economic uncertainty in Latin America. Interest and other expense for the nine months ended March 31, 1999 increased by $183,000 to $1,106,000 from $923,000 for the same period a year ago. For the three months ended March 31, 1999 interest and other expenses increased by $95,000 to $477,000 from $382,000 for the same period in fiscal 1998. These increases were primarily due to the additional debt incurred in the fourth quarter of fiscal 1998. Provision for income taxes for the nine months ended March 31, 1999 decreased by $2,180,000 to a benefit of $1,906,000 as compared to a provision of $274,000 for the same period a year ago. For the three months ended March 31, 1999 provision for income taxes decreased by $1,387,000 to a benefit of $1,345,000 as compared to a provision of $42,000 for the same period a year ago. These decreases were primarily due to the favorable effect of the reversal of previously recorded reserves no longer required with respect to IRS audits of fiscal years 1986 through 1997 as well as the decrease in income before provision for income taxes. Net income increased by $138,000 to $847,000 or $.24 per share for the nine months ended March 31, 1999 as compared to $709,000 or $.16 per share for the same period a year ago. For the three months ended March 31, 1999 net income increased by $222,000 to $343,000 or $.10 per share from $121,000 or $.03 per share for the same period in fiscal 1998. These increases were primarily due to the items discussed above as well as the reduction in the number of common shares outstanding by the Company's purchase of 889,576 shares of Treasury stock in the fourth quarter of fiscal 1998. Liquidity and Capital Resources During the nine months ended March 31, 1999 the Company utilized virtually all of its cash generated from operations to reduce its outstanding borrowings and to purchase property and equipment. This resulted in a decrease in outstanding debt to $19,260,000 at March 31, 1999 from $20,311,000 at June 30, 1998 while cash and cash equivalents remained relatively constant at $1,983,000 as of March 31, 1999 as compared to $1,989,000 at June 30, 1998. Accounts Receivable at March 31, 1999 decreased $2,487,000 to $12,273,000 as compared to $14,760,000 at June 30, 1998. This decrease is primarily the result of the higher sales volume during the quarter ended June 30, 1998 as compared to the quarter ended March 31, 1999. In addition, the Company provided for additional reserves for doubtful accounts in response to the recent economic problems in Latin America. -9-
10 NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Inventory at March 31, 1999 decreased by $745,000 to $24,793,000 as compared to $25,438,000 at June 30, 1998. This decrease was primarily the result of the Company's operational efforts at streamlining its planning and procurement processes to reduce its onhand inventory requirements while improving delivery response to its customers. In May of 1998 the Company repurchased 889,576 shares of Napco common stock for $5.00 per share from one of its co-founders. $2.5 million was paid at closing with the balance of the purchase price to be paid over a four (4) year period. The portion of the purchase price paid at closing was financed by the Company's primary bank and is to be repaid over a five (5) year period. On May 13, 1997, the Company refinanced the majority of its bank debt with a new primary bank and entered into a $16,000,000 secured revolving credit agreement, a $3,000,000 line of credit to be used in connection with commercial and standby letters of credit and replaced the $2,500,000 standby letter of credit securing an earlier loan from another bank in connection with the Company's international operations. These agreements replaced the existing $11,000,000 and $2,000,000 credit agreements with another bank. The Company restructured its debt to allow for future growth and expansion as well as to obtain terms more favorable to the Company. As part of the debt restructuring, the Company retired the outstanding Industrial Revenue Bonds relating to the financing of the Company's Amityville facility. The revolving credit agreement will expire in May, 2000 and any outstanding borrowings are to be repaid on or before that time. On April 26, 1993 the Company's foreign subsidiary entered into a 99 year lease of approximately four acres of land in the Dominican Republic, at an annual cost of approximately $272,000. The foreign subsidiary relocated its operations to this site at the end of fiscal 1995. The Company has entered into employment agreements with Richard Soloway, Chairman of the Board and President, and Jorge Hevia, Vice President of Corporate Sales and Marketing (see Exhibit 10(Q) and 10(R) respectively). As of March 31, 1999 the Company had no material commitments for capital expenditures. Year 2000 Date Conversion As the century turns from 1900 to 2000, date-sensitive systems may recognize the year 2000 as 1900 or not at all. This results primarily because of the conventional use of a two digit date field in most software applications. The inability to properly recognize the year 2000 may cause systems to process financial and operational information incorrectly. The Company believes that virtually all of the Company's systems are now fully compliant. Due to the fact that the Company's software manufacturer includes the year 2000 upgrade as part of its ongoing maintenance, the Company expects to expend a minimal amount of its resources in this area. Although the Company expects its critical systems to be compliant, there is no guarantee that these results will be achieved. Specific factors that give rise to this uncertainty include a possible failure to identify all susceptible systems, noncompliance by third parties whose systems and operations impact the Company, and other similar uncertainties. In addition to internal Year 2000 remediation activities, the Company is in contact with key suppliers and customers to reduce the likelihood of any significant interruption in the business between the Company and these important third parties relating to the Year 2000 issue. A comprehensive survey of all vendors and customers has not been made and is not presently planned. The Company's efforts thus far have been focused on key vendors and customers. If these third parties do not convert their systems in a timely manner and in a way that is compatible with the Company's systems, the Year 2000 issue could have a material adverse effect on the Company's operations. The Company believes that its actions with key suppliers and customers will minimize these risks. The vast majority of the Company's products are not date-sensitive. The Company has collected information on current and discontinued date-sensitive products. At this time, the Company does not have in place a comprehensive, global contingency plan relative to potential Year 2000 disruptions. Rather, each significant system with a potential problem either has been repaired and tested or is being updated. Contingency plans for certain types of unforseen problems are being developed. -10-
11 NAPCO SECURITY SYSTEMS, INC. AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (continued) Forward-looking Statements This quarterly report, other than historical financial information, contains forward-looking statements, as defined in the Private Securities Litigation Reform Act of 1995, that involve a number of risks and uncertainties. Important factors that could cause actual results to differ materially from those indicated by such forward-looking statements are set forth in Item 1 of the Company's annual report on Form 10-K for the year ended June 30, 1998. These include risks and uncertainties relating to competition and technological change, intellectual property rights, capital spending, international operations, and the Company's acquisition strategies. -11-
12 PART II: OTHER INFORMATION Item 1. Legal Proceedings In August 1995, the Internal Revenue Service ("IRS") informed the Company that it had completed the audit of the Company's Federal tax returns for fiscal years 1986 through 1993. The IRS had issued a report to the Company proposing adjustments that would result in taxes due of approximately $4.3 million excluding interest charges. The primary adjustments presented by the IRS related to intercompany pricing and royalty charges, DISC earnings and charitable contributions. The Company disagreed with the IRS and began the process of vigorously appealing this assessment using all remedies and procedural actions available under the law. The Company had provided a reserve to reflect its estimate of the ultimate resolution of this matter, so that the outcome of this matter would not have a material adverse effect on the Company's consolidated financial statements. During fiscal 1999, the Company both continued to discuss the assessment with the IRS Appeals Office and concluded an IRS examination of fiscal years 1994 through 1997. In July 1998 the Company received a revised audit report which eliminated the original assessment for the fiscal years 1986 through 1993. In April 1999 the Company favorably resolved the IRS examination of fiscal years 1994 through 1997. The Company has accepted both audit reports and the final government approvals have been received. Accordingly, the benefit for income taxes for the three and nine months ended March 31, 1999 reflects the favorable effect of the reversal of previously recorded reserves. Item 2. Changes in Securities None Item 3. Defaults Upon Senior Securities None Item 4. Submission of Matters to a Vote of Security Holders None Item 5. Other Information On April 21, 1999, the Company's board of directors adopted amendments to by-laws relating to: (1) Section 11, Article 1 replacing the provision on written consent of shareholders in lieu of meeting with a notice provision relating to shareholder proposals; and (2) the amendment of Article 11 to provide that shareholders may amend the by-laws by an eighty percent (80%) vote, all as described in Exhibit 3(ii)(A). Item 6. Exhibits and Reports on Form 8-K (a) Exhibits 3(ii)(A) Amendments to by-laws 10(Q) Employment agreement; Richard Soloway 10(R) Employment agreement; Jorge Hevia 22 Financial Data Schedule (b) No reports on Form 8-K have been filed during the Company's fiscal quarter ended March 31, 1999. -12-
13 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. May 14, 1999 NAPCO SECURITY SYSTEMS, INC. (Registrant) By: /s/ Richard Soloway ----------------------------------------- Richard Soloway Chairman of the Board of Directors, President and Secretary (Principal Executive Officer) By: /s/ Kevin S. Buchel ----------------------------------------- Kevin S. Buchel Senior Vice President of Operations and Finance and Treasurer (Principal Financial and Accounting Officer) -13-
14 INDEX TO EXHIBITS Exhibits - -------- 3(ii)(A) Amendments to by-laws 10(Q) Employment agreement: Richard Soloway 10(R) Employment agreement: Jorge Hevia 22 Financial Data Schedule -14-