NAPCO Security Technologies(NSSC) - 2019 Q4 - Annual Report

PART I Business NAPCO is a diversified security product manufacturer and service provider, selling globally through distributors, with R&D focus and seasonal sales peaks - NAPCO is a diversified manufacturer of security products (access control, door-locking, intrusion/fire alarm, video surveillance) and provides wireless communication services for these systems[8][144] - Products are sold worldwide to independent distributors, dealers, and installers for commercial, residential, institutional, industrial, and governmental applications[8][77][144] - The company expended approximately $7.212 million on R&D in fiscal year 2019, an 8.8% increase from $6.630 million in fiscal year 2018, primarily for product development and improvement[22][105][161] - Independent distributors and wholesalers represented approximately 57% of total sales for fiscal year 2019 (54% in fiscal year 2018)[24] - As of June 30, 2019, the Company had 1,076 full-time employees[23] - Sales historically peak in the fiscal fourth quarter (April 1 through June 30) and are reduced in the fiscal first quarter (July 1 through September 30) due to end-user installation preferences[29][75][145] - Sales backlog decreased from $2.151 million as of June 30, 2018, to $992,000 as of June 30, 2019, with the entire backlog expected to be filled during fiscal 2020[31] Sales to External Customers and Identifiable Assets by Geography (in thousands) | Category | Fiscal Year Ended June 30, 2019 | Fiscal Year Ended June 30, 2018 | | :-------------------------- | :------------------------------ | :------------------------------ | | Sales to external customers: | | | | Domestic | $100,716 | $89,490 | | Foreign | $2,216 | $2,256 | | Total Net Sales | $102,932 | $91,746 | | Identifiable assets (as of June 30): | | | | United States | $59,683 | $52,928 | | Dominican Republic | $26,225 | $20,341 | | Total Identifiable Assets | $85,908 | $73,269 | Risk Factors The company faces risks from economic conditions, CEO dependence, intense competition, operational inefficiencies, market demand fluctuations, and potential future internal control weaknesses - General economic and market conditions, including deterioration in the U.S. or international economy, could materially adversely affect revenue, profit, and cash flow levels[37][74] - The Company's success is largely dependent on the efforts of Richard L. Soloway, Chief Executive Officer, and there is currently no succession plan in place, posing a material adverse effect risk[38][109] - The security products industry is highly competitive, with approximately 12 other companies, many having substantially greater financial resources, competing on features, quality, reliability, pricing, innovation, and technical support[26][27][43] - The Company regularly grants extended payment terms (beyond 30 days) to certain customers, increasing the inherent risk in collecting receivables[44] - Reliance on independent distributors and wholesalers, who also sell competitors' products, could lead to a loss of revenue if they favor competitors or face financial weakening[45] - Members of management and the Board of Directors beneficially own approximately 38% of outstanding common stock, potentially influencing corporate elections and making acquisitions more difficult[46] - Offshore operations in the Dominican Republic expose the Company to adverse tax consequences if indefinitely reinvested foreign earnings are repatriated, subject to additional withholding taxes[48][49] - Exposure to foreign currency risks due to operations in the Dominican Republic; a 10% strengthening or weakening of the U.S. dollar against the Dominican Peso could result in an annual increase or decrease in income from operations of approximately $700,000[55][111] - A material weakness in internal control over financial reporting identified at June 30, 2018, was remediated during fiscal 2019, but there is no assurance that future material weaknesses will not arise[53][54][235] Unresolved Staff Comments This item states that there are no unresolved staff comments from the SEC Properties The Company owns executive offices and production/warehousing facilities in Amityville, New York, and a larger production/warehousing facility in the Dominican Republic, where a majority of products are manufactured - The Company owns a 95,000 square foot facility in Amityville, New York, for executive offices, production, and warehousing, with space for expansion[57] - A foreign subsidiary in the Dominican Republic owns a 167,000 square foot production and warehousing facility, with the land leased under a 99-year agreement expiring in 2092 at an annual cost of approximately $288,000[58][98][221] - A majority of the Company's products are manufactured at the Dominican Republic facility, utilizing U.S. quality control standards[58] - Management believes these facilities are more than adequate to meet the Company's needs in the foreseeable future[59] Legal Proceedings There are no pending or threatened material legal proceedings against NAPCO or its subsidiaries, though the Company is appealing a proposed IRS income adjustment for fiscal year 2016 - There are no pending or threatened material legal proceedings to which NAPCO or its subsidiaries are subject[60] - The Company is party to an IRS proceeding concerning a proposed $1.8 million income adjustment for fiscal 2016 related to deemed dividends; the Company has filed a formal protest and believes it will prevail[60][90][192] Mine Safety Disclosure This item states that mine safety disclosure is not applicable to the Company's operations PART II Market for Common Equity, Stockholder Matters and Issuer Purchases NAPCO's common stock is traded on NASDAQ under NSSC, with 18.48 million shares outstanding as of September 10, 2019, and no cash dividends declared in the past two fiscal years - NAPCO's Common Stock is traded on the NASDAQ Stock Market, Global Market System, under the symbol NSSC[64] - As of September 10, 2019, there were 82 holders of record of NAPCO's Common Stock and 18,477,784 shares outstanding[4][65] - NAPCO has not declared any cash dividends on its Common Stock during the past two fiscal years[66][69] Equity Compensation Plan Information as of June 30, 2019 (in thousands) | Category | Number of Securities to be Issued Upon Exercise of Outstanding Options (a) | Weighted Average Exercise Price of Outstanding Options (b) | Number of Securities Remaining Available for Future Issuance (Excluding Securities Reflected in Column (a)) (c) | | :------------------------------------ | :--------------------------------------------------------------------- | :------------------------------------------------------- | :---------------------------------------------------------------------------------------------------------------- | | Equity compensation plans approved by security holders | 97,900 | $11.50 | 822,900 | | Equity compensation plans not approved by security holders | — | — | — | | Total | 97,900 | $11.50 | 822,900 | Selected Financial Data The selected financial data highlights a positive trend in net sales, gross profit, and net income from fiscal year 2015 to 2019, with strong liquidity and no long-term debt as of 2019 Selected Financial Data (in thousands, except share and per share data) | Metric | 2019 | 2018 | 2017 | 2016 | 2015 | | :-------------------------------------- | :----- | :----- | :----- | :----- | :----- | | Statement of earnings data: | | | | | | | Net Sales | $102,932 | $91,746 | $87,374 | $82,513 | $77,762 | | Gross Profit | $43,890 | $37,995 | $36,301 | $33,753 | $31,429 | | Income from Operations | $13,466 | $8,414 | $6,378 | $6,323 | $5,281 | | Net Income | $12,223 | $7,649 | $5,599 | $5,773 | $4,845 | | Cash Flow Data: | | | | | | | Net cash flows provided by operating activities | $8,653 | $7,864 | $2,448 | $9,160 | $3,887 | | Net cash flows used in investing activities | $(1,988) | $(1,280) | $(1,414) | $(693) | $(730) | | Net cash flows used in financing activities | $(3,945) | $(4,730) | $(1,385) | $(7,008) | $(3,294) | | Per Share Data: | | | | | | | Basic Net earnings per common share | $0.66 | $0.41 | $0.30 | $0.31 | $0.25 | | Diluted Net earnings per common share | $0.66 | $0.41 | $0.30 | $0.31 | $0.25 | | Balance sheet data: | | | | | | | Working capital | $51,083 | $44,301 | $40,798 | $36,888 | $35,590 | | Total assets | $85,908 | $73,269 | $70,862 | $64,769 | $65,037 | | Long-term debt | $0 | $0 | $3,500 | $4,500 | $9,100 | | Stockholders' equity | $71,172 | $63,453 | $56,889 | $51,273 | $46,504 | Management's Discussion and Analysis of Financial Condition and Results of Operations This section provides an overview of NAPCO's business, financial performance, and key factors influencing its operations, highlighting significant increases in net sales and net income for fiscal 2019, supported by strong liquidity Overview This section provides an overview of NAPCO's diversified security product business, its revenue streams, cost structure, and R&D investment strategy - NAPCO is a diversified manufacturer and service provider of security products, with international sales accounting for approximately 2% of revenues for both fiscal years ended June 30, 2019 and 2018[71] - Recurring revenue from service was $17.427 million in fiscal 2019, representing approximately 17% of Net sales[71] - A significant portion of operating costs are fixed, meaning increased production levels and factory utilization can contribute to increasing profit margins[72] - The Company generally devotes 6-8% of revenues to research and development (R&D) annually, primarily for enhancing existing products, with benefits expected over future years[73] Economic and Other Factors General economic and market conditions, both domestic and international, can significantly impact the company's revenue, profit, and cash flow levels - General economic and market conditions, both U.S. and international, can materially adversely affect revenue, profit, and cash flow levels, potentially leading to delayed payments or cancelled purchases[74] Seasonality Sales historically peak in the fiscal fourth quarter and are reduced in the first quarter, influenced by installation timing and housing market trends - Sales historically peak in the fiscal fourth quarter (April 1 through June 30) and are reduced in the fiscal first quarter (July 1 through September 30), influenced by end-user installation timing and housing/construction markets[75] Critical Accounting Policies and Estimates The company's critical accounting policies involve significant judgments and estimates for sales returns, doubtful accounts, inventory reserves, intangible assets, and income taxes - The Company's critical accounting policies involve significant judgments and estimates for sales returns and allowances, allowance for doubtful accounts, inventory reserves, intangible assets, and income taxes[76][147] - Revenue is recognized upon transfer of control of products or services; product sales are recognized at shipment or delivery, and monthly communication services are recognized over the monthly period as services are rendered[78][179] - Sales returns, rebates, and allowances were 8% of gross sales in fiscal 2019, up from 7% in fiscal 2018, with reserves established based on historical data and expected returns[82][183] - One customer comprised 19% of accounts receivable and 10% of net sales at June 30, 2019 (22% and 10% at June 30, 2018); another customer comprised 11% of accounts receivable in both years but did not exceed 10% of net sales[83][185] - The reserve for doubtful accounts was $88,000 at June 30, 2019, down from $195,000 at June 30, 2018, based on evaluation of aging, specific exposures, and historical/anticipated events[84][150] - Inventories are valued at the lower of cost (FIFO) or net realizable value, and an obsolescence reserve is recorded based on product sales projections, age, and historical trends[85][86][151][152] - No impairment of long-lived assets or indefinite intangible assets was determined for the years ended June 30, 2019 and 2018[87][88] - The Company recognized a net income tax expense of $1.222 million for fiscal 2019, with an effective tax rate of 9.1% (compared to 8.2% in fiscal 2018)[91][108][190] - The Company is appealing an IRS proposed adjustment of approximately $1.8 million to income for fiscal 2016, believing it will prevail[90][192] - The reserve for uncertain income tax positions decreased by $96,000 during fiscal 2019, with $125,000 of unrecognized net tax benefits as of June 30, 2019[91][195][197] Liquidity and Capital Resources The company's liquidity is primarily driven by operating cash flow and an $11 million revolving credit facility, with no outstanding long-term debt - The Company's primary internal source of liquidity is cash flow from operations, supplemented by an $11 million revolving credit facility expiring in June 2021, with $0 outstanding as of June 30, 2019 and 2018[93][96][198] - Cash and cash equivalents increased to $8.028 million at June 30, 2019, from $5.308 million at June 30, 2018[93][133] - Working capital increased by $6.782 million to $51.083 million at June 30, 2019, from $44.301 million at June 30, 2018[99] - Accounts Receivable increased by $3.232 million to $25.970 million at June 30, 2019, primarily due to increased sales[99] - Inventories increased by $5.904 million to $34.838 million at June 30, 2019, primarily due to building levels of recently introduced and soon-to-be-introduced new products[100] - Accounts payable and accrued expenses increased by $4.715 million to $13.824 million at June 30, 2019, primarily due to the increase in inventory[101] - The Company repurchased 274,065 shares of its common stock for $3.998 million during fiscal 2019[95][215] Liquidity Ratios (as of June 30) | Ratio | 2019 | 2018 | | :---------------- | :------- | :------- | | Current Ratio | 4.6 to 1 | 5.7 to 1 | | Sales to Receivables | 4.0 to 1 | 4.0 to 1 | | Total debt to equity | 0.0 to 1 | 0.0 to 1 | Off-Balance Sheet Arrangements The company does not maintain any off-balance sheet arrangements - The Company does not maintain any off-balance sheet arrangements[102] Results of Operations Net sales and gross profit significantly increased in fiscal 2019 compared to 2018, driven by growth in alarm communication services and various product lines Fiscal Year Ended June 30 (dollars in thousands) | Metric | 2019 | 2018 | % Increase/(decrease) | | :-------------------------------------- | :----- | :----- | :-------------------- | | Net sales | $102,932 | $91,746 | 12.2% | | Gross profit | $43,890 | $37,995 | 15.5% | | Gross profit as a % of net sales | 42.6% | 41.4% | 2.9% | | Research and development | $7,212 | $6,630 | 8.8% | | Selling, general and administrative | $23,212 | $22,951 | 1.1% | | Selling, general and administrative as a % of net sales | 22.6% | 25.0% | (9.6)% | | Income from operations | $13,466 | $8,414 | 60.0% | | Interest expense, net | $21 | $81 | (74.1)% | | Provision for income taxes | $1,222 | $684 | 78.7% | | Net income | $12,223 | $7,649 | 59.8% | - The $11.186 million increase in net sales was primarily driven by increased sales of alarm communication services ($5.425 million), Napco brand intrusion products ($2.809 million), Alarm Lock brand door-locking products ($2.246 million), Marks brand door-locking products ($568,000), and Continental brand access control products ($138,000)[104] - Gross profit increased by $5.895 million, and gross profit margin improved from 41.4% to 42.6%, primarily due to increased net sales, partially offset by higher salary and freight expenses[105] - Selling, general and administrative expenses increased by $261,000 but decreased as a percentage of net sales from 25.0% to 22.6%, indicating improved operating leverage[106] - Interest expense decreased significantly by $60,000 due to the elimination of outstanding debt during fiscal 2018[107] Forward-looking Information The report contains forward-looking statements subject to risks and uncertainties, including economic conditions, CEO dependence, and foreign currency fluctuations - The report includes "Forward-Looking Statements" covered by Safe Harbor Provisions, which are subject to risks and uncertainties that could cause actual results to differ materially[109] - Key factors that could cause actual results to differ include uncertain economic, military, and political conditions, dependence on the CEO, ability to maintain competitive products, adverse tax consequences of offshore operations, ability to maintain adequate financing, and significant fluctuations in the exchange rate between the Dominican Peso and the U.S. Dollar[109] Quantitative and Qualitative Disclosures About Market Risk The company is exposed to market risk primarily through interest rate changes on its revolving credit facility and foreign currency fluctuations, particularly between the U.S. dollar and the Dominican Peso - The Company is affected by market risk exposure primarily through the effect of changes in interest rates on amounts payable under its revolving credit facility, which provides for LIBOR-based or prime rate-based interest[110][198] - All foreign sales transactions are denominated in U.S. dollars, shifting foreign currency exposure to customers, but the Company is exposed to foreign currency risk for expenses incurred in Dominican Pesos[111] - A 10% strengthening or weakening in the U.S. dollar to the Dominican Peso would result in an annual increase or decrease in income from operations of approximately $700,000[111] Financial Statements and Supplementary Data This item presents the audited consolidated financial statements for NAPCO Security Technologies, Inc. and its subsidiaries, along with management's report and the independent auditor's report on internal control - The item includes the Management Report on Internal Control, Report of Independent Registered Public Accounting Firm, and Consolidated Financial Statements (Balance Sheets, Statements of Income, Stockholders' Equity, Cash Flows, and Notes)[113][245] - Management assessed and determined that the Company maintained effective internal control over financial reporting as of June 30, 2019[117] - Baker Tilly Virchow Krause, LLP, the independent registered public accounting firm, issued an unqualified opinion on the consolidated financial statements and the effectiveness of internal control over financial reporting as of June 30, 2019[122] - The Company adopted FASB Accounting Standards Update No. 2014-09 (Topic 606), Revenue from Contracts with Customers, effective July 1, 2018[123][175] Management Report on Internal Control Management is responsible for and assessed the effectiveness of internal control over financial reporting, concluding it was effective as of June 30, 2019 - Management is responsible for establishing and maintaining adequate internal control over financial reporting and assessed its effectiveness based on the COSO framework[114][117] - Management determined that as of June 30, 2019, the Company maintained effective internal control over financial reporting[117] Report of Independent Registered Public Accounting Firm Baker Tilly Virchow Krause, LLP issued an unqualified opinion on the consolidated financial statements and the effectiveness of internal control over financial reporting - Baker Tilly Virchow Krause, LLP audited the consolidated financial statements and the Company's internal control over financial reporting[121] - The auditors issued an unqualified opinion, stating that the financial statements present fairly, in all material respects, the financial position and results of operations, and that the Company maintained effective internal control over financial reporting as of June 30, 2019[122] - The Company changed its method of accounting for revenue for the year ended June 30, 2019, due to the adoption of FASB Accounting Standards Update No. 2014-09 (Topic 606)[123] Consolidated Financial Statements This section includes the Consolidated Balance Sheets, Statements of Income, Stockholders' Equity, and Cash Flows for fiscal years 2019 and 2018 - The report includes Consolidated Balance Sheets, Consolidated Statements of Income, Consolidated Statements of Stockholders' Equity, and Consolidated Statements of Cash Flows for the fiscal years ended June 30, 2019 and 2018[113][132][135][138][140][245] Notes to Consolidated Financial Statements These notes provide detailed information on the company's accounting policies, revenue recognition, inventory, property, debt, stock-based compensation, and other financial disclosures - The Company adopted ASC 606, Revenue from Contracts with Customers, effective July 1, 2018, resulting in a net decrease to opening retained earnings of approximately $719,000[175][176] Disaggregation of Revenues by Major Product Lines (in thousands) | Major Product Lines | Fiscal Year Ended June 30, 2019 | Fiscal Year Ended June 30, 2018 | | :-------------------------- | :------------------------------ | :------------------------------ | | Intrusion and access alarm products | $31,557 | $28,610 | | Door locking devices | $53,948 | $51,134 | | Services | $17,427 | $12,002 | | Total Revenues | $102,932 | $91,746 | Inventories, Net of Reserves (in thousands) | Category | June 30, 2019 | June 30, 2018 | | :-------------------------- | :------------ | :------------ | | Component parts | $21,543 | $16,495 | | Work-in-process | $5,377 | $4,491 | | Finished product | $7,918 | $7,948 | | Total Inventories | $34,838 | $28,934 | | Classification of inventories: | | | | Current | $29,576 | $24,533 | | Non-current | $5,262 | $4,401 | - Property, plant, and equipment, net, totaled $7.694 million at June 30, 2019, with depreciation and amortization expense of approximately $1.085 million in fiscal 2019[188] - The Company has an $11 million revolving line of credit expiring in June 2021, with no outstanding balances as of June 30, 2019 and 2018[198] - Total stock-based compensation expense recognized was $160,000 in fiscal 2019 and $146,000 in fiscal 2018, across three stock option plans (2012 Employee, 2012 Non-Employee, 2018 Non-Employee)[167][200] - The Company repurchased 274,065 shares of its common stock for $3.998 million during fiscal 2019[215] - Company contributions to its 401(k) plan totaled $133,000 in fiscal 2019[218] - Operating lease payments total $85,000 through fiscal 2023, and the annual land lease cost in the Dominican Republic is $288,000 until 2092[219][221] - The Company has employment agreements with its CEO, Senior Vice President of Sales and Marketing, and Senior Vice President of Engineering, and a severance agreement with the Senior Vice President of Operations and Finance[223] PART III Changes in and Disagreements with Accountants on Accounting and Financial Disclosure This item confirms that there have been no changes in or disagreements with the Company's accountants on accounting and financial disclosure matters Control and Procedures Management concluded that disclosure controls were effective as of June 30, 2019, and a prior material weakness in internal control was remediated - The Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of June 30, 2019[231] - Management's Report on Internal Control over Financial Reporting states that management determined effective internal control over financial reporting as of June 30, 2019[117][232] - The effectiveness of the Company's internal control over financial reporting as of June 30, 2019, was audited by Baker Tilly Virchow Krause, LLP, who issued an unqualified opinion[118][122][232] - A material weakness in internal control over financial reporting identified during the quarter ended June 30, 2018, was remediated during the fiscal year ended June 30, 2019[235] Other Information This item states that there is no other information required to be reported Directors, Executive Officers and Corporate Governance Information regarding the Company's directors, executive officers, and corporate governance practices is incorporated by reference from the 2019 Proxy Statement - The Company has adopted a Code of Ethics applicable to senior executive and financial officers, which is posted on its website[237] Executive Compensation Information concerning executive and director compensation is incorporated by reference from the Company's 2019 Proxy Statement Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Information regarding security ownership and equity compensation plan details is incorporated by reference from the 2019 Proxy Statement and Item 5 Certain Relationships and Related Transactions, and Director Independence Information on certain relationships, related transactions, and director independence is incorporated by reference from the Company's 2019 Proxy Statement Principal Accounting Fees and Services Information regarding principal accountant fees and the Audit Committee's pre-approval policy is incorporated by reference from the Company's 2019 Proxy Statement PART IV Exhibits and Financial Statement Schedules This item lists the financial statements, schedules, and exhibits filed as part of the 10-K report, including corporate documents and certifications - The item includes the consolidated financial statements of NAPCO Security Technologies, Inc. and its subsidiaries, as presented in Part II, Item 8[245] - Exhibits include corporate organizational documents, credit agreements, various stock option plans (2002, 2012, 2018), employment agreements, the Code of Ethics, a list of subsidiaries, consent of independent auditors, and Section 302 and 906 certifications[247][249][250] Signatures The report is signed by authorized representatives of NAPCO Security Technologies, Inc., including the Principal Executive and Financial Officers, dated September 13, 2019 - The report was signed on September 13, 2019, by Richard Soloway (Chairman of the Board of Directors, President and Secretary, Principal Executive Officer) and Kevin S. Buchel (Senior Vice President of Operations and Finance and Treasurer, Principal Financial and Accounting Officer), along with other directors[252][253]