Overview





NAPCO is one of the leading manufacturers and designers of high-tech electronic
security devices, as well as a leading provider of school safety solutions. We
offer a diversified array of security products, encompassing access control
systems, door-locking products, intrusion and fire alarm systems and video
surveillance products. 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. We have experienced significant growth in recent years, primarily
driven by fast growing recurring service revenues generated from wireless
communication services for intrusion and fire alarm systems, as well as our
school security products that are designed to meet the increasing needs to
enhance school security as a result of on-campus shooting and violence in the
U.S.



Since 1969, NAPCO has established a heritage and proven record in the
professional security community for reliably delivering both advanced technology
and high quality security solutions, building many of the industry's best-known
brands, such as NAPCO Security Systems, Alarm Lock, Continental Access, Marks
USA, and other popular product lines: including Gemini and F64-Series
hardwire/wireless intrusion systems and iSee Video internet video solutions. We
are also dedicated to developing innovative technology and producing the next
generation of reliable security solutions that utilize remote communications and
wireless networks, including our StarLink, iBridge, and more recently the
iSecure product lines. Today, millions of businesses, institutions, homes, and
people around the globe are protected by products from the NAPCO Group of
Companies.



Our net sales were $101.4 million and $102.9 million for the fiscal years ended
June 30, 2020 and 2019, respectively.  The changes of our net sales during these
periods were driven primarily by increased sales of our products in the
recurring revenue business as offset by a 34% decrease in sales of hardware in
the fourth quarter of fiscal 2020 as compared to the same period a year ago.
This decrease was due primarily to the economic effects of the COVID-19 pandemic
and the related closures mandated by federal and state governments. Our net
income was $8.5 million and $12.2 million for the fiscal years ended June 30,
2020 and 2019, respectively. The decrease in net income during this period was
due primarily to the COVID-19 impact described above as partially offset by the
growth of our recurring revenue business, implementation of cost-reduction

measures.



Economic and Other Factors




We are subject to the effects of general economic and market conditions. In the
event that the U.S. or international economic conditions deteriorate, our
revenue, profit and cash-flow levels could be materially adversely affected in
future periods. In the event of such deterioration, 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. If such events do occur, they may result in our fixed and
semi-variable expenses becoming too high in relation to our revenues and cash
flows.









Seasonality



The Company's fiscal year begins on July 1 and ends on June 30. Historically,
the end users of the Company's products want to install its products prior to
the summer; therefore sales of its products historically 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. In
addition, demand for our products is affected by the housing and construction
markets. Deterioration of the current economic conditions may also affect this
trend.



Our fourth quarter of fiscal 2020 reflects the challenging business
environment resulting from the COVID-19 pandemic. The COVID-19 pandemic has
caused difficulties for security equipment professionals getting access to both
commercial and residential installation sites. The Company believes this access
issue is an industry-wide issue related to COVID-19 and not reflective of the
loss of any market share unique to the Company or any long-term negative
reflection of the post-pandemic vibrancy of the security industry as a whole.

Critical Accounting Policies and Estimates


The Company's significant accounting policies are fully described in Note 1 to
the Company's consolidated financial statements included in its 2020 Annual
Report on Form 10-K. Management believes the following critical accounting
policies, among others, affect its more significant judgments and estimates used
in the preparation of its consolidated financial statements.



Net Sales



The Company is engaged in one major line of business: the development,
manufacture, and distribution of security products, encompassing access control
systems, door security products, intrusion and fire alarm systems, alarm
communication services, and video surveillance products for commercial and
residential use. The Company also provides wireless communication service for
intrusion and fire alarm systems on a monthly basis. 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. Sales to unaffiliated customers
are primarily shipped from the United States. The Company has customers
worldwide with major concentrations in North America.



Revenue is recognized upon transfer of control of promised products or services
to customers in an amount that reflects the consideration the Company expects to
receive in exchange for those products or services.



For product sales the Company typically transfers control at a point in time
upon shipment or delivery of the product. For monthly communication services the
Company satisfies its performance obligation as the services are rendered and
therefore recognizes revenue over the monthly period.



Typically timing of revenue recognition coincides with the timing of invoicing
to the customers, at which time the Company has an unconditional right to
consideration. As such, the Company typically records a receivable when revenue
is recognized.



The contract with the customer states the final terms of the sale, including the
description, quantity, and price of each product purchased. Payment for product
sales is typically due within 30 and 180 days of the delivery date. Payment for
monthly communication services is billed on a monthly basis and is typically due
at the beginning of the month of service.



The Company provides limited standard warranty for defective products, usually
for a period of 24 to 36 months. The Company accepts returns for such defective
products as well as for other limited circumstances. The Company also provides
rebates to customers for meeting specified purchasing targets and other coupons
or credits in limited circumstances. The Company establishes reserves for the
estimated returns, rebates and credits and measures such variable consideration
based on the expected value method using an analysis of historical data. Changes
to the estimated variable consideration in subsequent periods are not material.



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 9% and 8% for the fiscal years ended June 30, 2020 and 2019, respectively.

Concentration of Credit Risk





An entity is more vulnerable to concentrations of credit risk if it is exposed
to risk of loss greater than it would have had if it mitigated its risk through
diversification of customers. Such risks of loss manifest themselves
differently, depending on the nature of the concentration, and vary in
significance. The Company had one customer with an accounts receivable balance
that comprised 24% and 19% of the Company's accounts receivable at June 30, 2020
and 2019, respectively. Sales to this customer did not exceed 10% of net sales
during fiscal year ended June 30, 2020. Sales to this customer comprised 10% of
net sales during fiscal year ended June 30, 2019. The Company had another
customer with an accounts receivable balance that comprised 10% of the Company's
accounts receivable at June 30, 2020. Sales to this customer did not exceed 10%
of net sales in either of the fiscal years ended June 30, 2020 and 2019. The
Company had another customer with an accounts receivable balance that comprised
10% of the Company's accounts receivable at June 30, 2019. Sales to this
customer did not exceed 10% of net sales in either of the fiscal years ended
June 30, 2020 and 2019.



In the ordinary course of business, we have established a reserve for doubtful
accounts and customer deductions in the amount of $326,000 and $88,000 as of
June 30, 2020 and 2019, 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 or anticipated events.



Inventories



Inventories are valued at the lower of cost or net realizable 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 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
realizable value, based on various product sales projections. This reserve is
calculated using an estimated obsolescence percentage applied to the inventory
based on age, historical trends, 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.



Intangible Assets




Impairment of Long-lived Assets - The Company reviews its long-lived assets and
certain identifiable intangibles for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. Recoverability of assets to be held and used is measured by a
comparison of the carrying amount of an asset group to future net undiscounted
cash flows expected to be generated by the asset group. If such assets are
considered to be impaired, the impairment to be recognized is measured by the
amount by which the carrying amount of the assets exceeds the fair value of the
assets. Assets to be disposed of are reported at the lower of the carrying
amount or fair value less costs to sell. As of June 30, 2020 and 2019, the
Company has determined that no impairment of long-lived assets exists.



The Company evaluates its indefinite-lived intangible assets for impairment at
least on an annual basis and will evaluate them earlier if there are indicators
of a potential impairment. Those intangible assets that are classified as other
intangibles with indefinite lives are not amortized. Impairment testing is
performed in two steps: (i) the Company determines if there is impairment by
comparing the fair value of a reporting unit with its carrying value, and (ii)
if there is impairment, the Company measures the amount of impairment loss by
comparing the implied fair value of intangible assets with the carrying amount
of the intangible assets.The Company has concluded that no impairment of
intangible assets occurred during the year ended June 30, 2019. During the 4th
quarter of fiscal 2020, the Company determined that its indefinite-lived
intangible asset relating to its Marks USA I subsidiary trade-name was impaired.
Accordingly, the Company recorded an impairment charge of $1,852,000 and as a
result concluded that the asset no longer was considered to have an
indefinite-life and reclassified the remaining balance of the underlying asset
from indefinite-lived to a long-lived asset with a remaining useful life of

20
years as of June 30, 2020.



Income Taxes



The Company has identified the United States and New York State as its major tax
jurisdictions. Fiscal year 2017 is currently under audit by the Internal Revenue
Service ("IRS"). Fiscal year 2018 and forward years are still open for
examination. In addition, the Company has a wholly-owned subsidiary which
operates in a Free Zone in the Dominican Republic ("DR") and is exempt from

DR
income tax.




The Company was audited by the IRS for the fiscal year 2016. In July 2019, the
Company received Form 4549-A, Income Tax Examination Changes from the IRS
proposing an adjustment to income for the fiscal 2016 tax year regarding deemed
dividends based on its interpretation of Internal Revenue Code ("IRC") Section
956 arising from the intercompany balances on the books of the Company. In
August 2019, the Company filed a formal protest with the IRS requesting an
opportunity to appeal the examination findings to the Appeals Office. During
fiscal year 2020, the Company settled the issue at Appeals. There is a provision
booked for the federal and state impact of $762,000 and $70,000, respectively.



The Company is currently under audit for the fiscal year 2017. The IRS has
raised the IRC Section 956 issue that was settled during the fiscal year 2016
audit. The Company strongly believes that the position of the IRS with regard to
this matter is inconsistent with the provisions of IRC Section 956 and that the
Company is willing to go to court, if necessary to argue its position. During
fiscal 2020, a provision for the incremental tax liability of $657,000 and
interest of 66,000 was recorded for the 2017 and 2018 fiscal years.



For the year ended June 30, 2020, the Company recognized a net income tax
expense of $2,284,000. During the year ending June 30, 2020 the Company
increased its reserve for uncertain income tax positions by $824,000. The
Company's practice is to recognize interest and penalties related to income tax
matters in income tax expense and accrued income taxes. As of June 30, 2020, the
Company had accrued interest totaling $83,000 and $866,000 of unrecognized net
tax benefits that, if recognized, would favorably affect the Company's effective
income tax rate in any future period. The Company claims research and
development ("R&D") tax credits on eligible research and development
expenditures. The R&D tax credits are recognized as a reduction to income tax
expense.



Deferred tax assets and liabilities are recognized for the future tax
consequences attributable to temporary differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
income in the period that includes the enactment date. Deferred income tax
expense represents the change during the period in the deferred tax assets and
deferred tax liabilities. Deferred tax assets are reduced by a valuation
allowance when, in the opinion of management, it is more likely than not that
some portion or all of the deferred tax assets will not be realized. The Company
measures and recognizes the tax implications of positions taken or expected to
be taken in its tax returns on an ongoing basis.









Leases



Effective July 1, 2019, the Company adopted the new lease accounting standard
using the modified retrospective transition option of applying the new standard
at the adoption date. In addition, we elected the package of practical
expedients permitted under the transition guidance within the new standard,
which among other things, allowed us to not reassess (1) whether any expired or
existing contracts are or contain leases, (2) lease classification for any
expired or existing leases, and (3) initial direct costs for any existing
leases. Adoption of the new standard resulted in the recording of an operating
ROU asset and lease liabilities of approximately $7.7 million. Given the length
of the lease term, the right-of-use asset and corresponding liability assume a
weighted discount rate as disclosed below. A change in the rate utilized could
have a material effect on the amounts reported. Financial positions for
reporting periods beginning on or after July 1, 2019 are presented under new
guidance, while prior period amounts are not adjusted and continue to be
reported in accordance with previous guidance.

Liquidity and Capital Resources


The Company's cash on hand as of June 30, 2020 combined with proceeds from
operating activities during fiscal 2020 were adequate to meet the Company's
capital expenditure and financing needs during fiscal 2020. The Company's
primary internal source of liquidity is the cash flow generated from operations.
The primary source of external financing is a revolving credit facility of
$11,000,000 (the "Revolving Credit Facility") which expires in June 2021. As of
June 30, 2020, $0 was outstanding under this revolving line of credit. The
Company has not drawn on this line of credit since June of 2018. In the fourth
quarter of fiscal 2020 the Company applied for and received a loan of $3,904,000
under the Federal government's Payroll Protection Program ("PPP") administered
by the U.S. Small Business Administration ("SBA"). Pursuant to the CARES Act,
the loan may be forgiven by the SBA. The Company anticipates applying for
forgiveness of these loans during fiscal 2021. The amount of loan forgiveness is
determined by and is subject to the sole approval of the SBA. As of June 30,
2020, the Company's unused sources of funds consisted principally of $18,248,000
in cash and cash equivalents and $11,000,000 unused balance available under

its
revolving line of credit.

The Revolving Credit Facility contains 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 restated agreement.


During the year ended June 30, 2020, the Company utilized a portion of its cash
on hand at June 30, 2019 ($4,069,000 of $8,028,000) to repurchase outstanding
shares of its stock ($2,454,000) and purchase property, plant and equipment
($1,615,000).



As of June 30, 2020, the Company's primary outside source of financing consisted
of the Revolving Credit Facility of $11,000,000 which expires in June 2021 and
the PPP loans which expire in April and May of 2022. As of June 30, 2020 and
2019, there were no outstanding balances under the Revolving Credit Facility and
$3,904,000 was outstanding under the PPP loans. These facilities are described
more fully in Note 7 to the consolidated financial statements.



The Company believes its current working capital, anticipated 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.

The Company takes into consideration several factors in measuring its liquidity, including the ratios set forth below:





                             As of June 30,
                           2020           2019
Current Ratio            4.5 to 1       4.6 to 1
Sales to Receivables     4.4 to 1       4.0 to 1
Total debt to equity     0.1 to 1       0.0 to 1




As of June 30, 2020, the Company had no material commitments for capital
expenditures or inventory purchases other than purchase orders issued in the
normal course of business. On April 26, 1993, the Company's foreign subsidiary
entered into a 99-year land lease of approximately 4 acres of land in the
Dominican Republic, on which the Company's principle manufacturing facility is
located, at an annual rent of approximately $288,000.



Working Capital. Working capital increased by $19,963,000 to $61,046,000 at June
30, 2020 from $51,083,000 at June 30, 2019. Working capital is calculated by
deducting Current Liabilities from Current Assets.



Accounts Receivable. Accounts Receivable decreased by $3,038,000 to $22,932,000
at June 30, 2020 as compared to $25,970,000 at June 30, 2019. The decrease in
Accounts Receivable was due primarily to a decrease in hardware sales for the
quarter ended June 30, 2020 as compared to the same quarter a year ago.

Inventories. Inventories, which include both current and non-current portions, increased by $6,917,000 to $41,755,000 at June 30, 2020 as compared to $34,838,000 at June 30, 2019. The increase was due primarily to the Company building up levels of its recently introduced and soon to be introduced new products.





Accounts Payable and Accrued Expenses. Accounts payable and accrued expenses,
not including income taxes payable, increased by $648,000 to $14,472,000 as of
June 30, 2020 as compared to $13,824,000 at June 30, 2019. This increase is
primarily due to the increase in inventory as described above.

Off-Balance Sheet Arrangements

The Company does not maintain any off-balance sheet arrangements.

Results of Operations

Fiscal 2020 Compared to Fiscal 2019





                                                       Fiscal year ended

June 30, (dollars in thousands)


                                                                                                   % Increase/
                                                        2020                    2019               (decrease)
Net sales                                         $         101,359       $         102,932                (1.5 )%
Gross profit                                                 43,592                  43,890                (0.7 )%
Gross profit as a % of net sales                               43.0 %                  42.6 %               0.9 %
Research and development                                      7,257                   7,212                 0.6 %
Selling, general and administrative                          23,670                  23,212                 2.0 %
Selling, general and administrative as a % of
net sales                                                      23.4 %                  22.6 %               3.5 %
Impairment of intangible asset                                1,852        

              -                   -
Income from operations                                       10,813                  13,466               (19.7 )%
Interest expense, net                                             9                      21               (57.1 )%
Provision for income taxes                                    2,284                   1,222                86.9 %
Net income                                                    8,520                  12,223               (30.3 )%










Net sales in fiscal 2020 decreased by $1,573,000 to $101,359,000 as compared to
$102,932,000 in fiscal 2019. The decrease in net sales was primarily due to
decreased sales of the Company's Alarm Lock brand door-locking products
($2,565,000), Marks brand door-locking products ($5,258,000), and Continental
brand access control products ($542,000) as partially offset by increased sales
of the Company's recurring alarm communication services ($6,608,000) and Napco
brand intrusion products ($200,000). The Company's hardware sales were
negatively impacted by the COVID-19 pandemic, which has caused difficulties for
security equipment professionals getting access to both commercial and
residential installation sites. The Company believes this access issue is an
industry-wide issue related to COVID-19 and not reflective of the loss of any
market share unique to the Company or any long-term negative reflection of the
post-pandemic vibrancy of the security industry as a whole.



The Company's gross profit decreased by $298,000 to $43,592,000 or 43.0% of net
sales in fiscal 2020 as compared to $43,890,000 or 42.6% of net sales in fiscal
2019. Gross profit on hardware sales was $23,380,000 or 30.1% of net hardware
sales in fiscal 2020 and $30,265,000 or 35.4% of net hardware sales, in fiscal
2019. Gross profit on service revenues was $19,712,000 or 82.0% of net service
revenues in fiscal 2020 and $13,625,000 or 78.2% of net service revenues, in
fiscal 2019. Gross profit was primarily affected by the decrease in hardware
sales as discussed above as partially offset by increased service revenues.

Research and Development expenses remained relatively constant at $7,257,000 in fiscal 2020 as compared to $7,212,000 in fiscal 2019.





Selling, general and administrative expenses for fiscal 2020 increased by
$458,000 to $23,670,000 as compared to $23,212,000 in fiscal 2019. Selling,
general and administrative expenses as a percentage of net sales increased to
23.4% in fiscal 2020 from 22.6% in fiscal 2019. The increase in dollars resulted
primarily from increases in employee compensation. The increase as a percentage
of sales was primarily the result of the decrease in net sales as described
above and the increased employee compensation expenses.



At the conclusion of fiscal 2020, the Company determined that its
indefinite-lived intangible asset relating to its Marks USA I subsidiary
trade-name was impaired. Accordingly, the Company recorded an impairment charge
of $1,852,000 and reclassified the remaining balance of the underlying asset
from indefinite-lived to a long-lived asset with a remaining useful life of 20
years as of June 30, 2020. There was no impairment charge for the year ended
June 30, 2019.

Interest expense for fiscal 2020 remained relatively constant at $9,000 as compared to $21,000 for the same period a year ago.





The Company's provision for income taxes for fiscal 2020 increased by $1,062,000
to $2,284,000 as compared to $1,222,000 for the same period a year ago. The
Company's effective tax rate increased to 21% for fiscal 2020 as compared to 9%
for fiscal 2019. The increase in the Company's effective tax rate resulted from
the resolution of an IRS audit of the Company's 2016 fiscal year, resulting in
an additional provision of $1,555,000.



Net income for fiscal 2020 decreased by $3,703,000 to $8,520,000 as compared to
$12,223,000 in fiscal 2019. This resulted primarily from the items discussed
above.

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS





This Annual Report on Form 10-K and the documents we incorporate by reference
contain forward-looking statements within the meaning of Section 27A of the
Securities Act of 1933, as amended, or the Securities Act, and Section 21E of
the Securities Exchange Act of 1934, as amended, or the Exchange Act. All
statements, other than statements of historical fact, included or incorporated
in this prospectus regarding our strategy, future operations, clinical trials,
collaborations, intellectual property, cash resources, financial position,
future revenues, projected costs, prospects, plans, and objectives of management
are forward-looking statements. The words "believes," "anticipates,"
"estimates," "plans," "expects," "intends," "may," "could," "should,"
"potential," "likely," "projects," "continue," "will," "schedule," "would," and
similar expressions are intended to identify forward-looking statements,
although not all forward-looking statements contain these identifying words. We
cannot guarantee that we actually will achieve the plans, intentions or
expectations disclosed in our forward-looking statements and you should not
place undue reliance on our forward-looking statements. These forward-looking
statements involve known and unknown risks, uncertainties, and other factors,
which may be beyond our control, and which may cause our actual results,
performance, or achievements to be materially different from future results,
performance, or achievements expressed or implied by such forward-looking
statements. There are a number of important factors that could cause our actual
results to differ materially from those indicated or implied by forward-looking
statements. See "Risk Factors" in our Annual Report on Form 10-K for the year
ended June 30, 2020 for more information. These factors and the other cautionary
statements made in this prospectus and the documents we incorporate by reference
should be read as being applicable to all related forward-looking statements
whenever they appear in this prospectus and the documents we incorporate by
reference. In addition, any forward-looking statements represent our estimates
only as of the date that this prospectus is filed with the SEC and should not be
relied upon as representing our estimates as of any subsequent date. We do not
assume any obligation to update any forward-looking statements. We disclaim any
intention or obligation to update or revise any forward-looking statement,
whether as a result of new information, future events or otherwise, except as
may be required by law.

© Edgar Online, source Glimpses