10-K
1
tm2024728-1_10k.htm
FORM 10-K
UNITED STATES SECURITIES AND EXCHANGE
COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
x
Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for
the fiscal year ended June 30, 2020
or
̈
Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 for the Transition period from
___ to___
Commission File Number 0-10004
NAPCO SECURITY TECHNOLOGIES, INC.
(Exact name of Registrant as specified
in its charter)
333 Bayview Avenue, Amityville, New York 11701
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (631) 842-9400
Securities registered
pursuant to Section 12(b) of the Act:
Title of each class Trading Symbol(s) Name of each exchange on which registered
Common Stock, par value $0.01 per share NSSC Nasdaq Stock Market
Securities registered pursuant to Section
12(g) of the Act: None
Indicate
by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ̈
No x
Indicate
by check mark if the Registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ̈
No x
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 Exchange
Act of 1934 during the preceding 12 months (or for 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 ̈
Indicate
by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files). Yes x
No ̈
Indicate by
check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting
company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”,
“smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ̈ Accelerated filer x Non-accelerated filer ̈ Smaller reporting company x Emerging growth company ̈
Indicate by
check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ̈
No x
As of December 31, 2019, the aggregate market
value of the common stock of Registrant held by non-affiliates based upon the last sale price of the stock on such date was $339,054,796.
As of September 14, 2020, 18,347,351 shares
of common stock of Registrant were outstanding.
Documents
Incorporated by Reference
Part III incorporates
information by reference from the Registrant’s definitive proxy statement to be filed with the Securities and Exchange Commission
in connection with the solicitation of proxies for the Registrant’s 2020 Annual Meeting of Stockholders.
PART I
ITEM 1: BUSINESS.
Overview
Napco Security Technologies, Inc (“NAPCO”, “the
Company”, “we”) 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 change in our net sales was 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 and implementation of
cost-reduction measures.
Our Products and Services
The Company’s products and services
are comprised of the following:
· Alarm Lock standalone and networked digital door locks
· Marks USA standard and custom Locksets, Panic Devices and Door Closers
· NAPCO Gemini intrusion alarm equipment
· NAPCO StarLink and FireLink cellular communication devices and services
· NAPCO iSecure integrated cellular intrusion alarm systems
· Continental Access door controllers and hosted services for access control
Door Security Products.
The Company manufactures a variety of door locking devices
including microprocessor-based electronic door locks with push button, card reader and bio-metric operation, door alarms, mechanical
door locks and simple dead bolt locks. These devices may control a single door or, in the case of some of the Company’s
microprocessor-based door locks, may be networked with the Company’s access control systems and controlled remotely.
Intrusion and Fire Alarm Systems.
Alarm systems usually consist of various detectors, a control
panel, a digital keypad and signaling equipment. When a break-in occurs, an intrusion detector senses the intrusion and activates
a control panel via hard-wired or wireless transmission that sets off the signaling equipment and, in most cases, causes a bell
or siren to sound. Communication equipment such as a cellular or digital communicator may be used to transmit the alarm signal
to a central station or another person selected by a customer. Cellular communicators have become more popular and panels and
communicators are trending towards integration so that many alarm panels will contain an integrated cellular communication device.
The Company manufactures and markets the
following products for these alarm systems:
Cellular communication services.
The Company provides cellular access for the cellular communication
devices described above. These services are provided and invoiced on a month to month basis. Revenues from services have grown
significantly over the past several years, increasing 100% from fiscal 2018 to fiscal 2020. These revenues, which currently have
a gross margin of approximately 82% as of June 30, 2020, represent approximately 24% of our total revenue as of June 30, 2020.
The Company’s long-term goal is to have recurring revenues from services to represent at least 50% of total revenue.
Access Control Systems.
Access control systems consist of one or more of the following:
various types of identification readers (e.g. card readers, hand scanners), a control panel, a PC-based computer and electronically
activated door-locking devices. When an identification card or other identifying information is entered into the reader, the information
is transmitted to the control panel/PC which then validates the data and determines whether or not to grant access by electronically
deactivating the door locking device. An electronic log is kept which records various types of data regarding access activity.
Video Surveillance Systems.
Video surveillance systems typically consist of one or more
video cameras, a control panel and a video monitor or PC. More advanced systems can also include a recording device and some type
of remote communication device such as an internet connection to a PC or browser-enabled cell phone. The system allows the user
to monitor various locations at once while recorders save the video images for future use. Remote communication devices can allow
the user to view and control the system from a remote location. The Company designs, engineers, and markets the software and control
panels discussed above. It also buys and resells various video cameras, PC-based computers and peripheral equipment for video
surveillance systems.
The Company designs, engineers, manufactures and markets the
software and control panels discussed above. It also buys and resells various identification readers, PC-based computers and various
peripheral equipment for access control systems.
Peripheral Equipment
The Company also markets peripheral and related equipment manufactured
by other companies. Revenues from peripheral equipment have not been significant.
Our Growth Drivers
Recurring Revenue
Business
In 2012, we began to
generate recurring revenue by developing our ground-breaking cellular radio technology. Since then, we have continued to introduce
additional products generating recurring revenues, primarily in the cellular communication devices such as our StarLink,
iBridge, and more recently the iSecure product lines. These products are installed at the premises of end customers and we generate
revenue by not only upfront purchase of our products, but also monthly subscription fees for services we perform at our cloud-based
operations center to monitor security breaches and fire alarms. The monthly recurring revenue allows us to generate a more consistent
and predictable stream of income and mitigates the risk of fluctuation in market demand. In addition, these products tend to generate
higher gross margin, which has the effect of improving our profitability. We believe there is a significant market opportunity
for these products and services, because many commercial and residential customers prefer to purchase real-time security monitoring
services to ensure continuous protection and swift responses to security breaches and fire alarms.
We also experienced accelerating
growth in our recurring revenue from sales of fire radio products. In the past few years, we introduced several Starlink fire
radio solutions, including a Starlink dual path radio that can utilize cellular or internet. Dual path radios are required in
certain areas such as New York City or L.A. County. A third fire radio was introduced approximately 18 months ago in the form
of a Firelink fire panel with a Starlink fire radio built into it. In general, the gross margin for fire radio products is higher
than the other Starlink solutions. The sales of fire radio products have contributed positively to our gross margin during the
fiscal year ended June 30, 2020. We expect that fire radio products will continue to be an increasing portion of the overall mix
of our recurring revenue and positively impact our gross margin.
We intend to continue
pursuing recurring revenue opportunities by developing new and innovative products and implementing aggressive and effective sales
and marketing effort. As of June 30, 2020, our recurring revenue constituted approximately 24% of our total revenue, and our strategy
is to increase the percentage of our recurring revenue versus total revenue in the foreseeable future.
School Security and Public Safety
The recent growth of our business is partly driven by the significant
need for increased security in schools and other public spaces. In the U.S., there are over 100,000 K-12 schools, over 10,000
colleges and universities and over 350,000 houses of worship. Less than 10% of these institutions have adequate protection from
an active shooter or intruder. As a result of increased “active shooter” incidents, a number of U.S. states and local
governments have substantially increased school security budgets. Many colleges and universities have large endowments which
are starting to be utilized to address this critical issue. Security equipment and services focused on education has reached over
$3 billion in revenues and this segment is still in the early stages as many K-12 schools, colleges and universities have still
not addressed this issue.
With a full suite of products and solutions, we believe we
are well positioned to meet the security needs of schools, houses of worship, and other places where people congregate.
Depending on the needs of the school and their budget, the Company offers (i) Standalone LocDown locks which can be operated by
a teacher, (ii) a series of Networx standalone wireless locks which communicate with central controls, or (iii) enterprise-class
access control with cellular connectivity, which allows the head of security to lock down all or part of the campus, including
dorm rooms, classrooms and administrative offices, from a centralized office.
The Company has had several significant wins in school security
contracts, including the Houston Independent School District, which is the largest school district in Texas and the seventh largest
in the U.S. On this project the Company implemented its Enterprise-wide security solution via its Continental Access control with
intrusion, video and alarm communicators. Another example is Pepperdine University in Malibu, California, where the Company provided
a lockdown system in place for its over 1,700 dorm rooms that required both locking and access control technologies. We were chosen
because we were the only security company that has both locking and access control technologies that work on the same platform
and met the needs of the university.
Competitive Strengths
The security products industry is highly competitive. The Company's
primary competitors are comprised of approximately 12 other companies that manufacture and market security equipment to distributors,
dealers, central stations and original equipment manufacturers. The Company believes that not one of these competitors is dominant
in the industry. Most of these companies have substantially greater financial and other resources than the Company. However, unlike
the Company, we believe that none of these competitors manufactures all key building security verticals: Intrusion Alarms and
Access Control, Connectivity, and Locking devices. As more and more security installations include multiple verticals, the various
systems need to communicate with each other. By having everything manufactured under one roof, we can offer customers one integrated
platform solution without the risk of incompatible equipment from multiple vendors to “talk” to each other. Furthermore,
many of our distributors, customers, and dealers prefer a single source of supply with more consistency in quality, pricing and
timely shipment of products. In addition, we believe our competitors will face substantial challenges and barriers to duplicate
or establish similar integrated offerings for all of these key markets.
We also have a manufacturing facility located in the Dominican
Republic (“D.R.”) that manufactures over 90% of our products. It is located in a free zone which is a tax-advantaged
location. The Company also benefits from the lower tariffs available to it under The Dominican Republic-Central America FTA (CAFTA-DR).
The D.R. manufacturing operation is vertically integrated and operates in a low-cost location, where the typical labor cost is
approximately one-tenth (1/10) of the cost for similar services in the U.S. The D.R. facility allows us to maintain a lower manufacturing
overhead and improve our gross margin. This facility is currently running one shift, plus a second shift on select products with
the ability to run 3 full shifts. Additional staffing is readily available for future expansion. The approximate annual revenue
that can be generated per shift is approximately $100 million. The building is a self-contained “concrete bunker”
with ability to withstand Category 5 hurricanes. Both locations contain enough land to build additional space; 180,000 square
feet of additional manufacturing space in the D.R., and approximately 100,000 square feet of office and warehousing space in Amityville,
should the need arise. The Company has multiple transportation options between the D.R. and Amityville facilities. Shipping times
from the D.R. to the Amityville facility are typically 6-8 days.
We perform our managerial and administrative activities in
the U.S. in our facility located in Amityville, New York, which is 100,000 square feet and serves as Company’s headquarters,
containing its corporate offices, research and development, design, sales administration, technical services, finance, procurement,
manufacturing control, warehousing, and shipping operations. We believe that our ability to provide timely and effective technical
support and services to our U.S. customers from our U.S. facility in Amityville is an advantage over other companies in the security
industry that have moved customer service functions overseas to countries such as India and Philippines. Our dealers and customers
rely substantially on the ability to communicate real-time to experts who can provide clear and understandable advice and instruction,
because they are usually dealing with highly technical problems on a job site with little time to spare.
The Company competes primarily on the basis of the features,
quality, reliability and pricing of, and the incorporation of the latest innovative and technological advances into, its products.
The Company also competes by offering technical support services to its customers. In addition, the Company competes on the basis
of its expertise, its proven products, its reputation and its ability to provide products to customers on a timely basis. The
inability of the Company to compete with respect to any one or more of the aforementioned factors could have an adverse impact
on the Company's business.
Our Strategy
Due to paradigm changes
in the security marketplace, the Company’s focus has been on mandatory (non-elective) systems, such as fire systems with
central station monitoring in commercial buildings, and iOT-driven connectivity services in high growth and margin categories.
As copper land lines are phased out and more people switch to cellular phone service for their homes, our cellular communication
services become increasingly attractive in these installations, both new and existing. We have built a strong competitive position
by developing a wide range of software capabilities from embedded micro-coding to enterprise system software, database
design, mobile applications development, user portal design, mechanical and electronic mechanisms and telecommunications,
featuring our significant radio and cellular communications expertise. This has enabled us to create recurring revenue opportunities across
product lines, and we intend to expand such opportunities to generate recurring revenue that account for over 50% of our total
revenue and to sustain profitability from recurring accounts receivable margins of 80%. We are also focusing on security solutions
for the healthcare industry, including anti-ligature lockets designed for life safety and liability reduction in hospitals, behavior
health institutions and correctional facilities, and such products are highly profitable while complying with applicable regulatory
and health standards. We believe that these accomplishments are possible due to our advanced set of in-house engineering technology
capability from mechanical to electronic and electro-mechanical products, digital, microprocessor and analog circuit design,
networking products, and wireless and cellular communications electronics.
Research and Development
The success of the Company’s business depends substantially
on its ability to develop new and proprietary technology and products. The research and development (“R&D”) costs
incurred by the Company are charged to expense as incurred and are included in "Operating expenses" in the consolidated
statements of operations. During the fiscal years ended June 30, 2020 and 2019, the Company expended approximately $7,257,000
and $7,212,000, respectively, on research and development activities conducted primarily by its engineering department to develop
and improve the products. The Company intends to continue to conduct a significant portion of its future research and development
activities internally.
Employees
As of June 30, 2020, the Company had 1,161
full-time employees.
Marketing
The Company's staff of approximately 62 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 52%, and 57% of the Company's total sales for the fiscal years ended June 30, 2020 and 2019, respectively. The remaining
revenues are primarily from installers and governmental institutions. The Company
currently has approximately 12,000 customers made up of distributors, installing dealers and wholesalers who purchase our products
from distributors or directly from the Company. 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.
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.
Raw Materials
The Company prepares specifications for component parts used
in the products and purchases the components from outside sources or fabricates the components itself. These components, if standard,
are generally readily available; if specially designed for the Company, there is usually more than one alternative source of supply
available to the Company on a competitive basis. The Company generally maintains inventories of all critical components. A majority
of purchased components are sourced from U.S. and Asian suppliers and are typically shipped directly to the D.R. The Company for
the most part is not dependent on any one source for its raw materials. The Company believes that any vendor that is currently
the sole source of a component can be replaced without a material impact on the Company.
Corporate Information and History
The Company was founded
in 1969 and incorporated as NAPCO in December 1971 in the State of Delaware. NAPCO
went public on NASDAQ with the ticker symbol “NSSC”, in 1972.
In 1987, the Company
acquired a locking company, Alarm Lock Systems, the first of its three acquisitions. In 1990, the Company began the process of
moving most of its manufacturing operations offshore. After studying various options, the D.R. was chosen as it is relatively
close to our headquarters (three and half hours by plane), is in the same time zone, has a relatively stable political and economic
situation and is a low cost manufacturing environment. In 1995, the Company built a state-of-the-art 180,000 square foot facility
in the D.R., and we continued to improve and upgrade the facility’s manufacturing capability by utilizing and acquiring
the latest technology and equipment. In 2000, the Company made another acquisition, acquiring an access control company,
Continental Instruments. In 2008, the Company acquired another locking company, Marks USA.
Our executive offices are located at 333 Bayview Ave, Amityville
NY 11701. Our telephone number is (631) 842-9400.
Website Access to Company Reports
Copies of our filings under the Securities
Exchange Act of 1934 (including annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all
amendments to these reports) are available free of charge on our website (www.napcosecurity.com) on the same day they are
electronically filed with the Securities and Exchange Commission. The Company has one class of Common Stock which trades on the
NASDAQ Global Market under the symbol “NSSC”.
ITEM 1A: RISK FACTORS
The risks described below are among those
that could materially and adversely affect the Company’s business, financial condition or results of operations. These risks
could cause actual results to differ materially from historical results and from any results predicted by any forward-looking
statements related to conditions or events that may occur in the future.
Our business operation and financial performance are
adversely affected by the COVID-19 pandemic and related events.
We are subject to risks related to the global pandemic associated
with the COVID-19 disease, which has spread globally to the U.S. and other countries where we have operations, including the Dominican
Republic. Numerous federal and state governmental jurisdictions have imposed “stay-at-home” orders, quarantines, travel
bans and similar governmental orders and restrictions to control the spread of COVID-19. Such orders or restrictions have resulted
in business closures, work stoppages, slowdowns and delays in commercial activities, unprecedented and widespread unemployment,
disruptions to ports and other shipping infrastructure, border closures, and other travel or health-related restrictions, thereby
negatively impacting our customers, suppliers, distributors, employees, offices, and the industry in which we operate.
As a result of the COVID-19 pandemic and the related economic
downturn, we have experienced a decline in the demand for our products, as our distributors and customers reduced orders and adjusted
their inventory channel in response to slowdown in spending and demand for security products. A prolonged stay-at-home order,
or any other continued decrease in economic activity as a result of COVID-19 pandemic, would have a negative adverse impact on
our customers and their financial condition, which could impact their ability to meet their financial obligations and could result
in elevated levels of delinquencies and bad debt losses. In addition, we rely upon our third-party vendors to provide parts and
materials for us to produce our products. If any of these vendors are unable to continue to provide us with these parts and materials,
it could negatively impact our ability to serve our customers. We also could be adversely affected if key personnel or a significant
number of employees were to become unavailable due to the effects and restrictions of COVID-19 pandemic in areas where we operate.
We manufacture substantially all of products in our factory
in Dominican Republic, which are then shipped to us in the United States for further distribution. The government authorities
in Dominican Republic have imposed curfews and restrictions as a result of the pandemic that impacted activities at the factory,
which may reduce our productivity and output. Additional restrictions and limitation on international travel and transportation,
including air travel, may make it more difficult for us to ship and transport products from Dominican Republic to the U.S., which
may cause delays and disruptions in our supply chain.
Moreover, if we determine that intangible assets are not realizable
as a result of the COVID-19 pandemic, we may be required to write down these assets or incur impairment charge under current accounting
standards, which would have a negative effect on our consolidated financial statements. The continuing adverse economic conditions
in the U.S. due to the pandemic have and may continue to reduce revenues associated with our intangible assets, including assets
acquired in our prior acquisitions, and result in a reduction of future expected cash flows. Such a reduction could result in
significant impairment charges to adjust the carrying value of the intangible assets.
The impact of the COVID-19 pandemic remains highly uncertain
and subject to change. We cannot predict when the pandemic will end and when related governmental orders and restrictions will
be eased or lifted, and any extension or prolonged implementation of these restrictions will further adversely affect our business,
customers and financial results. Even after such orders and restrictions are eased or lifted, the severe economic harm and recession
inflicted upon the jurisdictions and areas in which we operate may last for an extended period of time and continue to adversely
affect our business and financial performance, and there is no guarantee that we will be able to act quickly and effectively to
return to our normal operations.
Our business could be materially adversely affected as
a result of general economic and market conditions.
We are subject to the effects of general economic and market
conditions. In the event that the any of these 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 expenses being too high in relation to our revenues and cash flows.
During weak economic times, the available pool of independent
distributors, dealers and installers of security equipment may decline as the prospects for home building and home renovation
projects diminish, which may have a corresponding impact on our growth prospects. In addition, there is an increased risk during
these periods that an increased percentage of independent distributors, dealers and installers of security equipment will file
for bankruptcy protection, which may harm our reputation, revenue, profitability and results of operations.
The markets we serve are highly competitive and we may
be unable to compete effectively.
We compete with approximately 12 other companies that manufacture
and market security equipment to distributors, dealers, control stations and original equipment manufacturers in the U.S. Most
of these companies may have substantially greater financial and other resources than the Company. The Company competes primarily
on the basis of the features, quality, reliability and pricing of, and the incorporation of the latest innovative and technological
advances into its products, as well as technical support services to its customers. The Company competes on the basis of its expertise,
its proven products, its reputation and its ability to provide products to customers on a timely basis. The inability of the Company
to compete with respect to any one or more of the aforementioned factors could have an adverse impact on the Company's business.
Our business may also 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. Our industry 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. We have historically invested approximately
6% to 8% of annual revenues on R&D to mitigate this risk. However, many of our competitors have dedicated more resources and
capabilities to R&D, including committing more engineers and capital expenditures, to develop and design new product that
may enter the markets sooner or with more penetration. 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
We may not be able to maintain or control our expenses
proportionate to our sales volumes to generate profit for our business.
Certain of our expenses are fixed or semi-variable, including
our costs for operating our manufacturing facilities. While expense levels relative to current sales levels result in positive
net income and cash flows, if sales levels decrease significantly and we are unable to reduce expenses proportionately, our business
may be adversely affected. The amount of our operating expenses are subject to variables and factors that may not be within our
control, including but are not limited to, unexpected expenses relating to the manufacturing of products; increased compensation
requirement for our employees and cost of raw materials. A significant portion of our expense is labor cost, including costs for
workers who are operating our facility in the Dominican Republic. While we have been able to control our expenses due to the lower
labor costs in the Dominican Republic, there is no guarantee that such costs will not increase in the future, or that sufficient
number of workers in Dominican Republic will be available to operate the facility efficiently, and our failure to maintain effective
labor costs may adversely affect our results of operations.
Our business could be adversely affected as a result
of housing and commercial building market conditions.
We are subject to the effects of housing and commercial building
market conditions. The sales of our security products tend to increase during period in which new housing and commercial real
estate constructions are increasing. If these conditions deteriorate, resulting in declines in new housing or commercial building
constructions, existing home or commercial building sales or renovations, our business, results of operations or financial condition
could be materially adversely affected, particularly in our intrusion and door locking product lines. The condition of the residential
and commercial building markets in which we operate is cyclical and depends on the condition of the economy in the United States,
and on the perceptions of investors of the overall economic outlook. Rising interest rates, declining employment levels, declining
demand for real estate, declining real estate values or periods of general economic slowdown or recession or the perception that
any of these events may occur have negatively impacted the real estate market in the past and may in the future negatively impact
our ability to sell products and generate new revenue sources.
We may not be able to grow our recurring revenue business
to generate consistent revenue and profitability.
A significant driver of our growth is our recurring revenue
business in which customers who purchased our products and equipment are required to pay monthly fees for communications services
to maintain the operation of such products. Our recurring revenue products, such as StarLink, iSecure and iBridge, tend to generate
higher gross margin and are less susceptible to volatility of market demand and economic conditions. However, our revenue recurring
business is relatively new and we have limited experience in developing, marketing and selling such products. We also face intense
competition where other companies with greater resources and experience have established a wider and more entrenched customer
base for similar products and services, making it more difficult for us to penetrate into such market. In addition, we are required
to incur costs to maintain a network operations center to provide customer support and services, and to comply with federal and
state regulations governing the operation and communications of these products. Such costs may reduce our profitability if we
are not able to grow and expand the recurring revenue business. As we are increasingly dependent on recurring revenue products
as a driver for growth, our failure to execute our strategy for this business line will materially adversely affect our financial
conditions and prospects.
We may not be able to sustain and continue the growth
of school security products.
We recently experienced significant growth of demand for our
security products from schools, universities and other educational institutions as a result of the national focus on prevention
of school violence. Federal and state governmental authorities have proposed and enacted numerous legislation and laws, including
the School Violence Prevention and Mitigation Act of 2019 that provide increased funding to public schools to implement and enhance
security systems. While our business has benefited from such additional federal and state funding and increased demand, there
is no guarantee that such funding and trend will continue. For example, if school shutdown continues as a result of the COVID-19
pandemic and various stay-at-home orders imposed by state governments, there could be a reduced need for schools to acquire and
implement security systems, and state and federal government may also decide to reduce funding or impose additional criteria for
funding. These factors may result in a decline of demand for our school security products which in turn may adversely affect our
financial performance.
We rely on distributors to sell our products and an adverse
change in our relationship with such distributors may adversely affect our financial performance.
We distribute our products primarily through independent distributors
and wholesalers of security alarm and security hardware equipment. Our distributors and wholesalers also sell our competitors'
products, and if they favor our competitors' products for any reason, they may fail or reduce their effort to market and sell
our products as effectively or to devote resources necessary to provide effective sales, which would adversely affect our financial
performance. In addition, our distributors order our products and maintain their inventory based on forecasts of potential demands
from dealers and end customers, and our distributors may not be able to forecast such demand accurately, which may adversely affect
our ability to generate sales and revenue in a timely manner. In some cases, distributors may delay ordering our products until
they receive confirmation of orders from dealers and end customers, and this delay may cause disruption and make it more difficult
for us to fill their order timely and effectively, which may adversely affect our revenue and sales.
The financial health of our distributors and wholesalers and
our continuing relationships with them are important to our success. Some of these distributors and wholesalers, particularly
smaller firms with limited working capital and resources, may not be able to withstand adverse changes in business conditions
or mitigate the negative impact of a prolonged economic downturn or recession, including the impact of the COVID-19 pandemic.
The failure of our distributors to maintain financial heath and success will impact our ability to generate revenues. Furthermore,
our relationship with distributors may change or terminate due to other factors beyond our control, including but are not limited
to, acquisition of distributors by third parties may not be willing to continue the relationship with us; internal restructuring
or refocus of business strategies; and changes in management, all of which may negatively impact our ability to continue to sell
to such distributors. Finally, we generally do not have long-term agreements with distributors who purchase our products primarily
through purchase orders. Without an agreement, we are not able to guarantee that such distributors will not discontinue or terminate
relationship with us at any time, and any loss of distributor will negatively impact our financial conditions and results of operations.
We may not able to gain widespread or timely market acceptance
of our new products and continue to build and enhance our brand to achieve growth.
We rely on introduction of new products and services to penetrate
new markets and identify additional sources of revenues order to grow our business. However, many of our distributors and customers
may not be willing to change or switch to new products and equipment, or may require an extended period time to assess, test and
evaluate functionalities and performance of our new products. Any delays in establishing widespread acceptance of our new products
may adversely affect our financial performance and growth. In order to ensure market acceptance of new products, we have incurred
and expect to incur significant expenses in sales and marketing campaign, and we may not be able to justify such costs if the
effort does not produce sufficient sales and customer accounts.
We believe that building
and maintaining market awareness, brand recognition and goodwill of our business and products in a cost-effective manner is important
to our overall success in achieving widespread acceptance of our existing and future products and is an important element in attracting
new customers. An important part of our business strategy is to increase awareness of our brand and to provide marketing leadership,
services and support to our distributor and customer network. While we may choose to engage in a broader marketing campaign to
further promote our brand, this effort may not be successful. Our efforts in developing our brand may be hindered by the marketing
efforts of our competitors and our reliance on our third parties to promote our brand. If we are unable to cost-effectively maintain
and increase awareness of our brand, our business, financial condition, cash flows and results of operations could be harmed.
Our financial results could be materially adversely affected
as a result of offering extended payment terms to customers or if we are not able to collect our accounts receivables on a timely
basis from major customers.
We regularly grant credit terms beyond 30 days to certain distributors
and customers primarily in an effort to keep a full line of our products in-stock at our customers’ locations. The longer
the terms that are granted, the more risk is inherent in the collection of those receivables. We cannot guarantee that distributors
and customers will be able to make payments on a timely basis even after a thorough review of their credit and financial history.
The ability of distributors and customers to make such payments may be subject to factors beyond our control, including their
financial conditions and business operation. We may also incur additional costs and effort to collect past due receivables without
assurance that a sufficient or any amount of bad debt can be collected.
We sell security products and systems and if our solutions
fail for any reason, we could be subject to liability and our business could suffer.
We sell security products and services, which are designed
to secure the safety of our customer and their commercial, residential, institutional, industrial or governmental properties.
Our products and services may contain undetected defects in the software, infrastructure, third-party components or processes.
If these solutions fail for any reason, including due to defects in our hardware, software, a carrier outage or user error, we
could be subject to liability for such failures and our business could suffer. In addition, our products and systems are not installed
by us, and if third parties do not install or maintain our products correctly, our products and systems may not function properly.
If the improper installation or maintenance of our products and systems leads to service or equipment failures after introduction
of, or an upgrade to, our products and systems, we could experience harm to our branded reputation, claims by our customers or
installers or lost revenue during the period required to address the cause of the problem. Any defect in, or disruption to, our
products and systems could cause consumers not to purchase additional products or systems from us, prevent potential consumers
from purchasing our products and systems or harm our reputation.
We are subject to risks relating to the operation of
a manufacturing facility in Dominican Republic.
We operate a manufacturing facility in Dominican Republic where
the majority of our products is made and shipped to our U.S. distributors. The facility requires us to incur certain fixed operating
costs that do not fluctuate with changes in production levels or utilization of our manufacturing capacity. If production levels
decline due to lower demand or reduced customer orders, our fixed costs are spread over reduced levels, which may contribute to
decreasing margins and reduced profitability. Operation of a manufacturing facility also subjects us to certain additional risks,
including but not limited to the following:
·
Unavailability of workers or insufficient workforce to operate the factory;
·
Compliance with local regulatory requirements, including labor laws and tax requirements;
·
Difficulties in communication and coordination with U.S. headquarters;
·
Natural disasters such as hurricanes which may damage our factory; and
·
Effect of general political and economic conditions of the Dominican Republic.
The occurrence of any of these factors may adversely affect
the production output and operation of our factory, which will disrupt our supply chain and negatively impact our financial performance.
Furthermore, we have not identified any alternative third-party factory that can manufacture our products; therefore it would
be difficult for us to replace any loss of output of capacity if our factory in Dominican Republic is not functioning properly
or at all.
Our business could be materially adversely affected by
a weakening of the U.S. dollar against the Dominican peso.
We are exposed to foreign currency risks due to our operations
in the Dominican Republic. We have significant operations in the Dominican Republic, which conducts certain transactions in Dominican
pesos. We are subject to the risk that currency exchange rates between the United States and the Dominican Republic will fluctuate
significantly, potentially resulting in an increase in some of our expenses when US dollars are transferred to Dominican pesos
to pay these expenses. For example, if the U.S. dollars weakens and the currency exchange rate is less favorable, it may be more
costly for us to pay expenses for our factory in the Dominican Republic, which may adversely affect our financial conditions and
results of operations.
Our business could be materially adversely affected by
adverse tax consequences of offshore operations.
We operate on a global basis, with a portion of our operating
income generated outside the United States. We intend to reinvest these earnings in our foreign operations indefinitely, except
where we are able to repatriate these earnings to the United States without material incremental tax expense. A significant portion
of our assets that result from these earnings remain outside the United States. If these indefinitely reinvested earnings were
repatriated into the United States as dividends, we would be subject to additional withholding taxes.
Our failure to
maintain the security of our information and technology networks could adversely affect us.
We are dependent on information
technology networks and systems, including the Internet, to process, transmit and store electronic information and, in the normal
course of our business, we collect and retain certain information pertaining to our distributors, customers, partners and employees,
including personal information. If security breaches in connection with the delivery of our solutions allow unauthorized third
parties to access any of this data or obtain control of our systems, our reputation, business, financial condition, cash flows
and results of operations could be harmed.
The legal, regulatory
and contractual environment surrounding information security, privacy and credit card fraud is constantly evolving and
companies that collect and retain such information are under increasing attack by cyber-criminals around the world. Further, as
the regulatory focus on privacy issues continues to increase and worldwide laws and regulations concerning the protection of data
and personal information expand and become more complex, these potential risks to our business will intensify. A significant actual
or potential theft, loss, fraudulent use or misuse of distributors, customers, employee or other personally identifiable data,
whether by third parties or as a result of employee malfeasance or otherwise, non-compliance with our contractual or other legal
obligations regarding such data or a violation of our privacy and security policies with respect to such data could result in
loss of confidential information, damage to our reputation, early termination of our business relationships, litigation, regulatory
investigations or actions and other liabilities or actions against us, including significant fines by U.S. federal and state authorities,
and other countries and private claims by companies and individuals for violation of data privacy and security regulations.
In addition, cyber-attacks from computer hackers and cyber
criminals and other malicious Internet-based activity continue to increase generally, and perpetrators of cyber-attacks may be
able to develop and deploy viruses, worms, ransomware, malware, DNS attacks, wireless network attacks, attacks on our cloud networks,
phishing attempts, social engineering attempts, distributed denial of service attacks and other advanced persistent threats or
malicious software programs that attack our products and services, our networks and network endpoints or otherwise exploit any
security vulnerabilities of our products, services and networks. Techniques used to obtain unauthorized access or to sabotage
systems change frequently and generally are not recognized until launched against a target. As a result, we may be unable to anticipate
these techniques or to implement adequate preventative measures. We cannot be certain that advances in cyber-capabilities or other
developments will not compromise or breach the technology protecting the networks that access our platforms and solutions, and
we can make no assurance that we will be able to detect, prevent, timely and adequately address or mitigate the negative effects
of cyber-attacks or other security breaches. If any one of these risks materializes, our business, financial condition, cash flows
or results of operations could be materially and adversely affected.
We rely on the effort and service of Richard L. Soloway,
our founder, Chief Executive Officer and major stockholder.
The success of the Company is largely dependent on the effort
and service of Richard L. Soloway, who is our founder, President, Chief Executive Officer, Chairman of the Board and a major stockholder.
We depend on Mr. Soloway on various aspects of our business operation, including his experience and knowledge in the industry,
extensive relationships with distributors and customers, and his leadership to develop and implement business strategies. The
loss or reduction of services by Mr. Soloway could have a material adverse effect on the Company's business and prospects.
Our business could be materially adversely affected as
a result of the inability to maintain adequate financing.
While our business is currently solely dependent on cash-flows
from operations to fund operations and capital expenditures we have an unused credit facility in the event that we need to supplement
current cash-flows with outside financing. The credit facility provides for certain financial covenants relating to ratios affected
by profit, asset and debt levels. If the Company’s profits, asset or cash-flow levels decline below the minimums required
to meet these covenants and we require outside financing, the Company may be materially adversely affected. Effects on the Company
could include higher interest costs, reduction in borrowing availability or revocation of these credit facilities.
We are obligated to develop and maintain a system of
effective internal controls over financial reporting. These internal controls may be determined to be not effective, which may
adversely affect investor confidence in our company and, as a result, the value of our common stock.
We have been and are required, pursuant to Section 404 of the
Sarbanes-Oxley Act, to furnish a report by management on, among other things, the effectiveness of our internal control over financial
reporting on an annual basis. This assessment includes disclosure of any material weaknesses identified by our management in our
internal control over financial reporting. During the evaluation and testing process, if we identify one or more material weaknesses
in our internal control over financial reporting, we will be unable to assert that our internal controls are effective and would
be required to disclose any material weaknesses identified in Management’s Report on Internal Control over Financial Reporting.
While we have established certain procedures and control over our financial reporting processes, we cannot assure you that these
efforts will prevent restatements of our financial statements in the future.
Our independent registered public accounting firm is also required,
pursuant to Section 404 of the Sarbanes-Oxley Act, to report on the effectiveness of our internal control over financial reporting.
For future reporting periods, our independent registered public accounting firm may issue a report that is adverse in the event
it is not satisfied with the level at which our controls are documented, designed or operating. We may not be able to remediate
any future material weaknesses, or to complete our evaluation, testing and any required remediation in a timely fashion.
If we are unable to conclude that our internal control over
financial reporting is effective, or if our independent registered public accounting firm is unable to express an opinion that
our internal controls over financial reporting are effective, investors could lose confidence in the accuracy and completeness
of our financial reports, which could cause the price of our common stock to decline, and we could be subject to sanctions or
investigations by regulatory authorities, including the SEC and Nasdaq. Failure to remediate any material weakness in our internal
control over financial reporting, or to maintain other effective control systems required of public companies, could also restrict
our future access to the capital markets.
Risks Related to Ownership of Our Common Stock
Sales of a substantial number of shares of our common
stock in the public market could cause our market price to decline.
Sales of a substantial number of shares of our common stock
in the public market, or the perception that these sales might occur, could depress the market price of our common stock and could
impair our ability to raise capital through the sale of additional equity securities. We are unable to predict the effect that
sales, particularly sales by our directors, executive officers, and significant stockholders, may have on the prevailing market
price of our common stock. Additionally, the shares of common stock subject to outstanding options under our equity incentive