NAPCO SECURITY TECHNOLOGIES, INC files 10-K

NAPCO SECURITY TECHNOLOGIES, INC revealed 10-K form on Friday, September 13.

The Company’s staff of 58 sales and marketing support employees located at the Company’s Amityville offices sells and markets the Products primarily to independent distributors and wholesalers of security alarm and security hardware equipment. Management estimates that these channels of distribution represented approximately 57%, and 54% of the Company’s total sales for the fiscal years ended June 30, 2019 and 2018, respectively. The remaining revenues are primarily from installers and governmental institutions. The Company’s sales representatives periodically contact existing and potential customers to introduce new products and create demand for those as well as other Company products. These sales representatives, together with the Company’s technical personnel, provide training and other services to wholesalers and distributors so that they can better service the needs of their customers. In addition to direct sales efforts, the Company advertises in technical trade publications and participates in trade shows in major United States and European cities.

In the ordinary course of the Company’s business the Company grants extended payment terms to certain customers. The Company had one customer with an accounts receivable balance that comprised 19% and 22% of the Company’s accounts receivable at June 30, 2019 and 2018, respectively. Sales to this customer comprised 10% of net sales in each of the fiscal years ended June 30, 2019 and 2018. The Company had another customer with an accounts receivable balance that comprised 11% of the Company’s accounts receivable at both June 30, 2019 and 2018. Sales to this customer did not exceed 10% for fiscal years ended June 30, 2019 or 2018. For further discussion on Concentration of Credit Risk see disclosures included in Item 1A and Item 7.

(1) All of the Company’s sales originate in the United States and are shipped primarily from the Company’s facilities in the United States. There were no sales into any one foreign country in excess of 10% of total Net Sales.

Our business may be materially adversely affected by the announcement or introduction of new products and services by our competitors, and the implementation of effective marketing or sales strategies by our competitors. The industry in which the Company operates is characterized by constantly improved products. There can be no assurance that competitors will not develop products that are superior to the Company’s products. The Company has historically invested approximately 6% to 8% of annual revenues on Research and Development to mitigate this risk. Future success will depend, in part, on our ability to continue to develop and market products and product enhancements cost-effectively. The Company’s research and development expenditures are principally targeted at enhancing existing products, and to a lesser extent at developing new ones. Further, there can be no assurance that the Company will not experience additional price competition, and that such competition may not adversely affect the Company’s revenues and results of operations.

Richard L. Soloway, our Chief Executive Officer, members of management and the Board of Directors beneficially own approximately 38% of the currently outstanding shares of Common Stock. By virtue of such ownership and their positions with Napco, they may have the practical ability to determine the election of all directors and control the outcome of substantially all matters submitted to Napco’s stockholders.

The Company is a diversified manufacturer and service provider of security products, encompassing access control systems, door security products, intrusion and fire alarm systems, video surveillance products for commercial and residential use and wireless communication service for intrusion and fire alarm systems. 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 2% of our revenues for each of the fiscal years ended June 30, 2019 and 2018. During fiscal 2019, recurring revenue from service was $17,427,000, representing approximately 17% of Net sales.

The security products market is characterized by constant incremental innovation in product design and manufacturing technologies. Generally, the Company devotes 6-8% of revenues to research and development (R&D) on an annual basis. The Company does not expect products resulting from our R&D investments in a given fiscal year to contribute materially to revenue during that same 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.

The Company analyzes sales returns and is able to make reasonable and reliable estimates of product returns based on the Company’s past history. Estimates for sales returns are based on several factors including actual returns and based on expected return data communicated to it by its customers. Accordingly, the Company believes that its historical returns analysis is an accurate basis for its allowance for sales returns. Actual results could differ from those estimates. As a percentage of gross sales, sales returns, rebates and allowances were 8% and 7% for the fiscal years ended June 30, 2019 and 2018, respectively.

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 one customer with an accounts receivable balance that comprised 19% and 22% of the Company’s accounts receivable at June 30, 2019 and 2018, respectively. Sales to this customer comprised 10% of net sales in each of the fiscal years ended June 30, 2019 and 2018. The Company had another customer with an accounts receivable balance that comprised 11% of the Company’s accounts receivable at June 30, 2019 and June 30, 2018. Sales to this customer did not exceed 10% of net sales in either of the fiscal years ended June 30, 2019 and 2018.

The Company’s gross profit increased by $5,895,000 to $43,890,000 or 42.6% of net sales in fiscal 2019 as compared to $37,995,000 or 41.4% of net sales in fiscal 2018. Gross profit was primarily affected by the increase in net sales as discussed above as partially offset by increased salary and freight expenses.

Selling, general and administrative expenses for fiscal 2019 increased by $261,000 to $23,212,000 as compared to $22,951,000 in fiscal 2018. Selling, general and administrative expenses as a percentage of net sales decreased to 22.6% in fiscal 2019 from 25.0% in fiscal 2018. The increase in dollars resulted primarily from increases in employee compensation. The decrease as a percentage of sales was primarily the result of the percentage increase in sales exceeding that of the increase in Selling, general and administrative expenses.

The Company’s provision for income taxes for fiscal 2019 increased by $538,000 to $1,222,000 as compared to $684,000 for the same period a year ago. The Company’s effective tax rate remained relatively constant at 9% for fiscal 2019 as compared to 8% for fiscal 2018.

All foreign sales transactions by the Company are denominated in U.S. dollars. As such, the Company has shifted foreign currency exposure onto 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. We are also exposed to foreign currency risk relative to expenses incurred in Dominican Pesos (“RD$”), the local currency of the Company’s production facility in the Dominican Republic. The result of a 10% strengthening or weakening in the U.S. dollar to the RD$ would result in an annual increase or decrease in income from operations of approximately $700,000.

The Company analyzes sales returns and is able to make reasonable and reliable estimates of product returns based on the Company’s past history. Estimates for sales returns are based on several factors including actual returns and based on expected return data communicated to it by its customers. Accordingly, the Company believes that its historical returns analysis is an accurate basis for its allowance for sales returns. Actual results could differ from those estimates. As a percentage of gross sales, sales returns, rebates and allowances were 8% and 7% for the fiscal years ended June 30, 2019 and 2018, respectively.

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 one customer with an accounts receivable balance that comprised 19% and 22% of the Company’s accounts receivable at June 30, 2019 and 2018, respectively. Sales to this customer comprised 10% of net sales in each of the fiscal years ended June 30, 2019 and 2018. The Company had another customer with an accounts receivable balance that comprised 11% of the Company’s accounts receivable at June 30, 2019 and June 30, 2018. Sales to this customer did not exceed 10% of net sales in either of the fiscal years ended June 30, 2019 and 2018.

On December 22, 2017, the U.S. government passed the Tax Cuts and Jobs Act (the ‘Tax Act’). The Tax Act is comprehensive tax legislation effective January 1, 2018 that implements complex changes to the U.S. tax code including, but not limited to, the reduction of the corporate tax rate from 35% to 21% and includes provisions to tax GILTI. We are subject to the GILTI provisions effective for fiscal year ended June 30, 2019. The Tax Act also imposed a one-time transition tax on its unremitted foreign earnings. ASC 740 requires filers to record the effects of tax law changes in the period enacted. However, the SEC issued Staff Accounting Bulletin No. 118 (‘SAB 118’), that permits filers to record provisional amounts during a measurement period ending no later than one year from the date of the Act’s enactment. As of March 31, 2019, the Company finalized its accounting for the income tax effects of the Tax Act and no additional expense was recorded since the final transition tax expense was equal to the $381,000 provisional expense reported in the fiscal year ended June 30, 2018. The net section 965 tax liability was $442,000, which is payable over 8 years.

The Agreement also provides for a LIBOR-based interest rate option of LIBOR plus 1.15% to 2.00%, depending on the ratio of outstanding debt to EBITDA, which is to be measured and adjusted quarterly, a prime rate-based option of the prime rate plus 0.25% and other terms and conditions as more fully described in the Agreement. In addition, the Agreement provides for availability to be limited to the lesser of $11,000,000 or the result of a borrowing base formula based upon the Company’s Accounts Receivables and Inventory values net of certain deductions. The Company’s obligations under the Agreement continue to be secured by all of its assets, including but not limited to, deposit accounts, accounts receivable, inventory, and the Company’s corporate headquarters in Amityville, NY, equipment and fixtures and intangible assets. In addition, the Company’s wholly-owned subsidiaries, with the exception of the Company’s foreign subsidiaries, have issued guarantees and pledges of all of their assets to secure the Company’s obligations under the Agreement. All of the outstanding common stock of the Company’s domestic subsidiaries and 65% of the common stock of the Company’s foreign subsidiaries has been pledged to secure the Company’s obligations under the Agreement.

In December 2012, the stockholders approved the 2012 Employee Stock Option Plan (the 2012 Employee Plan). The 2012 Employee Plan authorizes the granting of awards, the exercise of which would allow up to an aggregate of 950,000 shares of the Company’s common stock to be acquired by the holders of such awards. Under this plan, the Company may grant stock options, which are intended to qualify as incentive stock options (ISOs), to valued employees. Any plan participant who is granted ISOs and possesses more than 10% of the voting rights of the Company’s outstanding common stock must be granted an option with a price of at least 110% of the fair market value on the date of grant.

Under the 2012 Employee Plan, stock options may be granted to valued employees with a term of up to 10 years at an exercise price equal to or greater than the fair market value on the date of grant and are exercisable, in whole or in part, at 20% per year beginning on the date of grant. An option granted under this plan shall vest in full upon a ‘change in control’ as defined in the plan. At June 30, 2019, 72,500 stock options were outstanding, 33,800 stock options were exercisable and 792,900 stock options were available for grant under this plan.

Under the 2012 Non-Employee Plan, stock options may be granted with a term of up to 10 years at an exercise price equal to or greater than the fair market value on the date of grant and are exercisable in whole or in part at 20% per year beginning on the date of grant. An option granted under this plan shall vest in full upon a ‘change in control’ as defined in the plan. At June 30, 2019, 10,200 stock options were outstanding, 3,000 stock options were exercisable and no further stock options were available for grant under this plan.

Under the 2018 Non-Employee Plan, stock options may be granted with a term of up to 10 years at an exercise price equal to or greater than the fair market value on the date of grant and are exercisable in whole or in part at 20% per year beginning on the date of grant. An option granted under this plan shall vest in full upon a ‘change in control’ as defined in the plan. At June 30, 2019, 15,200 stock options were outstanding, 2,400 stock options were exercisable and 30,000 stock options were available for grant under this plan.

As of June 30, 2019, the Company was obligated under three employment agreements and one severance agreement. The employment agreements are with the Company’s CEO, Senior Vice President of Sales and Marketing (‘the SVP of Sales’) and the Senior Vice President of Engineering (‘the SVP of Engineering’). The employment agreement with the CEO provides for an annual salary of $752,000, as adjusted for inflation; incentive compensation as may be approved by the Board of Directors from time to time and a termination payment in an amount up to 299% of the average of the prior five calendar year’s compensation, subject to certain limitations, as defined in the agreement. The employment agreement renews annually in August unless either party gives the other notice of non-renewal at least six months prior to the end of the applicable term. The employment agreement with the SVP of Sales expires in October 2020 and provides for an annual salary of $334,000, a bonus arrangement for fiscal 2019 and, if terminated by the Company without cause, severance of nine months’ salary and continued company-sponsored health insurance for six months from the date of termination. The employment agreement with the SVP of Engineering expires in August 2020 and provides for an annual salary of $302,000, a bonus arrangement for fiscal 2019 and, if terminated by the Company without cause, severance of nine month’s salary and continued company-sponsored health insurance for six months from the date of termination. The severance agreement is with the Senior Vice President of Operations and Finance and provides for, if terminated by the Company without cause or within three months of a change in corporate control of the Registrant, severance of nine month’s salary, continued company-sponsored health insurance for six months from the date of termination and certain non-compete and other restrictive provisions.

(1) All of the Company’s sales originate in the United States and are shipped primarily from the Company’s facilities in the United States. There were no sales into any one foreign country in excess of 10% of total Net Sales.

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