What changed in this filing

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Item 7. Management’s Discussion and Analysis

2022-08-29 compared with 2021-09-13 · 70 added, 73 removed, 162 unchanged (47% of the section changed)

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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..

While recurring service

revenues have continued to increase during the COVID-19 pandemic, equipment sales were negatively impacted by the economic slowdown associated with this pandemic.

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 widely recognized brands, such as NAPCO Security Systems, Alarm Lock, Continental Access, Marks USA, and other popular product lines:

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Our net sales were $143.6 million, $114.0 million and $101.4 million for the fiscal years ended June 30, 2022, 2021 and 2020, respectively.

The change in our net sales from fiscal 2020 to 2021 was driven primarily by increased sales of our products in the recurring revenue business ($9.9 million) and sales of equipment ($2.7 million) as compared to the same period a year ago.

This increase was due primarily to the recovery from the economic effects of the COVID-19 pandemic and the related closures mandated by federal and state governments.

The change in our net sales from fiscal 2019 to 2020 was driven primarily by increased sales of our products in the recurring revenue business as offset by a 34% decrease in sales of equipment 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.

The change in our net sales was driven primarily by increased sales of our recurring services ($12.1 million) and sales of equipment ($17.5 million) as compared to the same period a year ago.

The increase in equipment sales was due primarily to the recovery from the economic effects of the COVID-19 pandemic and the elimination of most of the closures mandated by federal and state governments during the early and peak stages of the pandemic.

As these closures abated and economic conditions improved, our equipment sales increased.

In addition, fiscal 2022 net sales increased due, in part, to an increase in sales of the Company’s cellular radio products as the major cellular providers sunset their 3G networks.

Our net income was $19.6 million, $15.4 million and $7.8 million for the fiscal years ended June 30, 2022, 2021 and 2020, respectively.

The changes in net income during this period was due primarily to the COVID-19 impact and subsequent recovery described above, as well as by the growth of our recurring revenue business.

The increases in net income during this period were due primarily to the recovery from the COVID-19 impact described above, as well as by the growth of our cellular products and the associated recurring revenue business.

Economic and Other Factors

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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.

Historically, the end users of the Company’s hardware products want to install these products prior to the summer;

therefore, sales of these 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 all of our products may be affected by the housing and construction markets.

Deterioration of the current economic conditions may also affect this trend.

Our fourth quarter of fiscal 2020 and fiscal 2021 reflected the challenging business environment resulting from the COVID-19 pandemic.

The COVID-19 pandemic had caused difficulties for security equipment professionals getting access to both commercial and residential installation sites.

We sell our products primarily through distribution to dealers and we are now seeing strong sell-through statistics from several of our largest distributors.

Increased sell-through of our products from our distributors to the alarm and locking dealers during the third and fourth quarters of fiscal 2021, as compared to the three quarters preceding them, indicates that security equipment professionals are getting increased access to both commercial and residential installation sites and using more and more of our products.

Critical Accounting Policies and Estimates

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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.

For monthly communication services, the Company satisfies its performance obligation as the services are rendered overt the course of the month 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.

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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.

Payment for monthly communication services is billed on a monthly basis and is typically due at the beginning of the month of service or in 30 days for customers with an open account.

The Company provides limited standard warranty for defective products, usually for a period of 24 to 36 months.

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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.

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.The Company analyzes sales returns and is able to make reasonable and reliable estimates of product returns based on the Company’s past history.

The Company analyzes product 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.

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The Company had one customer with an accounts receivable balance that comprised 22%, 19% and 24% of the Company’s accounts receivable at June 30, 2022, 2021 and 2020, respectively.

Sales to this customer did not exceed 10% of net sales in either of the fiscal years ended June 30, 2021 or 2020.

Sales to this customer comprised 10% of net sales during fiscal year ended June 30, 2019.

Sales to this customer did not exceed 10% of net sales during fiscal years ended June 30, 2022, 2021 and 2020.

The Company had another customer with an accounts receivable balance that comprised 11% of the Company’s accounts receivable at June 30, 2021.

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Sales to this customer did not exceed 10% of net sales in any of the fiscal years ended June 30, 2022, 2021 and 2020, respectively.

The Company had another customer with an accounts receivable balance that comprised 10% of the Company’s accounts receivable at June 30, 2021 and 2019.

The Company had another customer with an accounts receivable balance that comprised 16% and 12% of the Company’s accounts receivable at June 30, 2022 and 2021.

Sales to this customer did not exceed 10% of net sales in any of the fiscal years ended June 30, 2022, 2021 and 2020.

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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.

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.

This reserve is calculated using an estimated obsolescence percentage applied to the inventory based on age, historical trends, product life cycle, 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.

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For the year ended June 30, 2022, the Company recognized a net income tax expense of $2,247,000.

During the year ending June 30, 2021, the Company decreased its reserve for uncertain income tax positions by $208,000.

During the year ending June 30, 2022, the Company increased its reserve for uncertain income tax positions by $25,000.

The Company’s practice is to recognize interest and penalties related to income tax matters in income tax expense and accrued income taxes.

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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.

contracts are or contain leases, (2) lease classification for any expired or existing leases, and (3) initial direct costs for any existing leases.

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.

1 unchanged sentence

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.

Financial positions for reporting periods beginning on or after July 1, 2019 are presented under new guidance.

Liquidity and Capital Resources

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The Company believes its current working capital, cash flows from operations and its revolving credit agreement will be sufficient to fund the Company’s operations through the next twelve months.

As of June 30, 2021, the Company maintained a revolving credit facility of $11,000,000 which expires in June 2024 and term loans from the U.S.

As of June 30, 2022 and 2021, long-term debt consisted of a revolving line of credit of $11,000,000 (“Revolver Agreement”), with no amounts outstanding, which expires in June 2024.

As of June 30, 2021, the Company had term loans from the U.S.

Small Business Administration totaling $3,904,000 through its Payroll Protection Program (“PPP”).

As of June 30, 2021, the Company had no outstanding borrowings and $11,000,000 in availability under the revolving credit facility and $3,904,000 outstanding under the PPP term loans.

Pursuant to the CARES Act, the loans may be forgiven by the SBA.

The Company has applied to have the balance of the Loan forgiven.

Following year-end, $2,850,000 of the PPP Loan was forgiven in accordance with guidelines set for in the PPP.

The Company will recognize debt forgiveness in the first quarter of 2022 in the amount of $2,850,000 and will recognize further forgiveness income in the quarter that the remaing forgiveness application may be granted.

While the Company believes that it meets to requirements for forgiveness, there can be no assurance that its remaining application will be granted.

The PPP Loans were entirely forgiven during first quarter of the fiscal year ending June 30, 2022.

The revolving credit facility contains various restrictions and covenants including, among others, restrictions on borrowings and compliance with certain financial ratios, as defined in the agreement.

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Working capital increased by $17,751,000 to $93,142,000 at June 30, 2022 from $75,391,000 at June 30, 2021.

Working capital is calculated by deducting Current Liabilities from Current Assets.

Working Capital increased by $14,939,000 to $75,391,000 at June 30, 2021 from $60,452,000 at June 30, 2020.Working capital is calculated by deducting Current Liabilities from Current Assets.

Accounts Receivable.

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The increase in Accounts Receivable was due primarily to an increase in net sales for the quarter ended June 30, 2022 as compared to the same quarter a year ago.

Accounts Receivable increased by $5,149,000 to $28,081,000 at June 30, 2021 as compared to $22,932,000 at June 30, 2020.

The increase in Accounts Receivable was due primarily to an increase in net sales for the quarter ended June 30, 2022 as compared to the same quarter a year ago.

Inventories, which include both current and non-current portions, increased by $18,086,000 to $49,786,000 at June 30, 2022 as compared to $31,700,000 at June 30, 2021.

The increase was due primarily to higher costs of component parts and freight-in.

The increase was also due to the ongoing shortages of certain component parts and the Company purchasing large quantities of these hard to source component parts when they become available.

Inventories, which include both current and non-current portions, decreased by $8,715,000 to $31,700,000 at June 30, 2021 as compared to $40,415,000 at June 30, 2020.

The decrease was due, in part, to the Company completing the rollout of several new products that were introduced during fiscal 2020.

Inventories of these items were built up during fiscal 2020 in anticipation of initial stocking orders from the Company’s customers.

The decrease was due, in part, to the Company completing the rollout of several new productes that were introduced during fiscal 2020.

Inventories of these items were built up during fiscal 2020 in anticipation of initial sotcking orders from the Company’s customers.

The decrease in inventory was also due to the Company’s efforts to move closer to “just in time” procurement and production cycles where component parts and finished goods are scheduled for delivery closer to the expected requirement date.

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Accounts payable and accrued expenses, not including income taxes payable, increased by $8,470,000 to $24,625,000 as of June 30, 2022 as compared to $16,155,000 at June 30, 2021.

This increase is primarily due to an increase in the Company’s accrued refund liability, which is explained in Note 2 to the Notes to the Company’s Consolidated Financial Statements, as well as higher accrued incentive compensation as of June 30, 2021 as compared to June 30, 2020.

This increase is primarily due to increased purchases of component parts during the quarter ended June 30, 2022 as compared to the same period a year ago as well as an increase in the Company’s accrued refund liability, which is explained in Note 2 to the Notes to the Company’s Consolidated Financial Statements.

Accounts payable and accrued expenses, not including income taxes payable, increased by $1,684,000 to $16,155,000 as of June 30, 2021 as compared to $14,471,000 at June 30, 2020.

This increase is primarily due to an increase in the Company’s accrued refund liability, which is explained in Note 2 to the Company’s Consolidated Financial Statements, as well as higher accrued incentive compensation as of June 30, 2021 as compared to June 30, 2020.

Off-Balance Sheet Arrangements

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Fiscal year ended June 30, (dollars in thousands)

equipment revenues

service revenues

Gross Profit:

Gross profit as a % of net sales

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Selling, general and administrative as a % of net sales

Impairment of intangible asset

Income from operations

Operating Income

Interest expense, net

Gain on extinguishment of debt

Provision for income taxes

Net sales in fiscal 2022 increased by $29,558,000 to $143,593,000 as compared to $114,035,000 in fiscal 2021.

The increase in net sales was primarily due to increased sales of the Company’s recurring alarm communication services ($9,859,000), Napco brand intrusion products ($5,972,000) and Marks brand door-locking products ($2,051,000), as partially offset by decreased sales of the Company’s Alarm Lock brand door-locking products ($4,720,000) and Continental brand access control products ($191,000).

The increase in net sales was primarily due to increased sales of the Company’s recurring alarm communication services ($12,077,000), Napco brand intrusion products ($11,699,000), Alarm Lock brand door-locking products ($3,136,000), Marks brand door-locking products ($1,533,000) and Continental brand access control products ($1,113,000).

The Company’s increase in equipment sales was primarily due to customer demand returning after the decline during the COVID-19 pandemic and the related closures throughout the United States.

This was partially offset by a decrease in the Company’s Alarm Lock products, which was due primarily to school districts and other institutions postponing their capital projects in the latter portion of the Company’s 2020 fiscal year and throughout fiscal 2021.

In addition, fiscal 2022 net sales increased due, in part, to an increase in sales of the Company’s cellular radio products as the major cellular providers sunset their 3G networks.

The Company's gross profit increased by $8,408,000 to $59,156,000 or 41.2% of net sales in fiscal 2022 as compared to $50,748,000 or 44.5% of net sales in fiscal 2021.

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Gross profit on service revenues was $40,015,000 or 87.0% of net service revenues in fiscal 2022 and $29,018,000 or 85.6% of net service revenues, in fiscal 2021.

Gross profit on equipment sales was primarily affected by the shift in sales to the Company’s Starlink radio products, which typically have lower margins but result in recurring service revenues, and from the Company’s Alarm Lock products as discussed above.

The Alarm Lock products are among the Company’s highest margin equipment products.

Gross profit on equipment sales was also affected by the Company’s reduction in it’s production and inventories which impacted it’s overhead absorption rate.

Gross profit on equipment sales was primarily affected by increased costs of component parts and freight as well as the shift in sales to the Company’s Starlink radio products, which typically have lower margins but result in recurring service revenues.

Research and Development expenses increased by $404,000 to $8,024,000 in fiscal 2022 as compared to $7,620,000 in fiscal 2021.

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Selling, general and administrative expenses for fiscal 2022 increased by $7,711,000 to $32,907,000 as compared to $25,196,000 in fiscal 2021.

Selling, general and administrative expenses as a percentage of net sales decreased to 22.1% in fiscal 2021 from 23.4% in fiscal 2020.

The increase in dollars resulted primarily from increases in employee compensation.

The decrease as a percentage of sales was primarily the result of the increase in net sales as described above, as partially offset by the aforementioned increase in employee compensation expenses.

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 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, 2021.

Selling, general and administrative expenses as a percentage of net sales increased to 22.9% in fiscal 2022 from 22.1% in fiscal 2021.

The increases in dollars and as a percentage of net sales resulted primarily from increases in sales commissions, tradeshow, stock option and legal expenses.

Interest and other expense, net for fiscal 2022 remained relatively constant at $16,000 as compared to $5,000 for the same period a year ago.

The Company’s provision for income taxes for fiscal 2021 increased by $145,000 to $2,429,000 as compared to $2,284,000 for the same period a year ago.

Gain on extinguishment of debt resulted from a one-time gain in fiscal 2022 which resulted from the forgiveness of the Company’s PPP loans as described in the Liquidity and Capital Resources section and Note 8 to the condensed consolidated financial statements.

The Company’s provision for income taxes for fiscal 2022 decreased by $267,000 to $2,247,000 as compared to $2,514,000 for the same period a year ago.

The Company’s effective tax rate decreased to 10% for fiscal 2022 as compared to 14% for fiscal 2021.

The decrease in the Company’s fiscal 2021 effective tax rate is a direct result of additional tax expense recorded in fiscal 2020 for the IRS audit of the Company’s 2016 fiscal year.

decrease in the Company’s fiscal 2022 effective tax rate is primarily due to the $3,904,000 in non-taxable income from extinguishment of debt.

Net income for fiscal 2022 increased by $4,186,000 to $19,599,000 as compared to $15,413,000 in fiscal 2021.

3 unchanged sentences

Fiscal year ended June 30, (dollars in thousands)

equipment revenues

service revenues

Gross Profit:

Gross profit as a % of net sales

3 unchanged sentences

Impairment of intangible asset

Income from operations

Operating Income

Interest expense, net

Gain on extinguishment of debt

Provision for income taxes

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 equipment 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.

Net sales in fiscal 2021 increased by $12,676,000 to $114,035,000 as compared to $101,359,000 in fiscal 2020.

The Company’s increase in equipment sales was primarily due to customer demand returning after the decline during the COVID-19 pandemic and the related closures throughout the United States.

The Company’s gross profit increased by $7,904,000 to $50,748,000 or 44.5% of net sales in fiscal 2021 as compared to $42,844,000 or 42.3% of net sales in fiscal 2020.

Gross profit on equipment sales was $21,730,000 or 27.1% of net equipment sales in fiscal 2021 and $23,132,000 or 29.9% of net equipment sales, in fiscal 2020.

Gross profit on service revenues was $29,018,000 or 85.6% of net service revenues in fiscal 2021 and $19,712,000 or 82.0% of net service revenues, in fiscal 2020.

Gross profit was primarily affected by the decrease in equipment 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.

The Alarm Lock products are among the Company’s highest margin equipment products.

Gross profit on equipment sales was also affected by the Company’s reduction in its production and inventories which impacted it’s overhead absorption rate as well as a decrease in the Company’s reserve for obsolete inventory.

Research and Development expenses increased by $363,000 to $7,620,000 in fiscal 2021 as compared to $7,257,000 in fiscal 2020.

This increase was due primarily to salary increases and additional staff.

Selling, general and administrative expenses for fiscal 2021 increased by $1,526,000 to $25,196,000 as compared to $23,670,000 in fiscal 2020.

Selling, general and administrative expenses as a percentage of net sales increased to 23.4% in fiscal 2020 from 22.6% in fiscal 2019.

Selling, general and administrative expenses as a percentage of net sales decreased to 22.1% in fiscal 2021 from 23.4% in fiscal 2020.

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.

The decrease as a percentage of sales

was primarily the result of the increase in net sales as described above, as partially offset by the aforementioned increase in employee compensation expenses.

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.

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There was no impairment charge for the year ended June 30, 2021.

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

Interest and other expense, net for fiscal 2021 remained relatively constant at $5,000 as compared to $9,000 for the same period a year ago.

The Company’s provision for income taxes for fiscal 2021 increased by $253,000 to $2,514,000 as compared to $2,261,000 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.

The Company’s effective tax rate decreased to 14% for fiscal 2021 as compared to 21% for fiscal 2020.

The decrease in the Company’s fiscal 2021 effective tax rate is a direct result of additional tax expense recorded in fiscal 2020 for the Internal Revenue Service (“IRS”) audit of the Company’s 2016 fiscal year.

Net income for fiscal 2021 increased by $7,618,000 to $15,413,000 as compared to $7,795,000 in fiscal 2020.

This resulted primarily from the items discussed above.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-K

Item 7. Management’s Discussion and Analysis