Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations
This Quarterly Report on Form 10-Q 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 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, 2022 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.
Overview
Napco Security Technologies, Inc (“NAPCO”, “the Company”, “we”) is one of the leading manufacturers and designers of high-tech electronic security devices, cellular communication services for intrusion and fire alarm systems 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 widely recognized 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.
Economic and Other Factors
We are subject to the effects of general economic and market conditions. If 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.
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Seasonality
The Company's fiscal year begins on July 1 and ends on June 30. 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. The monthly recurring service revenue, which is less susceptable to these fluctuations, allows us to generate a more consistent and predictable stream of income and mitigates the risk of fluctuation in market demand for our equipment products.
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 2022 Annual Report on Form 10-K. Management believes these critical accounting policies, among others, affect its more significant judgments and estimates used in the preparation of its consolidated financial statements.
Results of Operations
Three months ended December 31,
Six months ended December 31,
(dollars in thousands)
(dollars in thousands)
% Increase/
% Increase/
2022
2021
(decrease)
2022
2021
(decrease)
Net sales: equipment revenues
$
27,434
$
22,380
22.6
%
$
53,121
$
43,207
22.9
%
service revenues
14,880
11,028
34.9
%
28,686
21,252
35.0
%
Total net sales
42,314
33,408
26.7
%
81,807
64,459
26.9
%
Gross Profit: equipment
6,247
1,809
245.3
%
12,269
6,464
89.8
%
services
13,215
9,634
37.2
%
25,360
18,435
37.6
%
Total gross profit
19,462
11,443
70.1
%
37,629
24,899
51.1
%
Gross profit as a % of net sales:
46.0
%
34.3
%
34.1
%
46.0
%
38.6
%
19.1
%
equipment
22.8
%
8.1
%
181.7
%
23.1
%
15.0
%
54.4
%
services
88.8
%
87.4
%
1.7
%
88.4
%
86.7
%
1.9
%
Research and development
2,222
1,978
12.3
%
4,650
3,909
19.0
%
Selling, general and administrative
7,804
8,195
(4.8)
%
16,294
15,541
4.8
%
Selling, general and administrative as a percentage of net sales
18.4
%
24.5
%
(24.9)
%
19.9
%
24.1
%
(17.4)
%
Operating income
9,436
1,270
643.0
%
16,685
5,449
206.2
%
Interest and other income (expense), net
187
58
222.4
%
84
75
12.0
%
Gain on extinguishment of debt
—
—
—
—
3,904
(100.0)
%
Provision for income taxes
1,177
291
304.5
%
1,921
639
200.6
%
Net income
8,446
1,037
714.5
%
14,848
8,789
68.9
%
Net Sales for the three months ended December 31, 2022 increased by $8,906,000, or 26.7%, to $42,314,000 as compared to $33,408,000 for the same period a year ago. The increase in sales for the three months ended December 31, 2022 was due primarily to increased recurring communication service revenues ($3,852,000), Alarm Lock brand door-locking products ($3,191,000), Marks brand door-locking products ($1,288,000), and Continental brand access control products ($664,000) partialy offset by Napco brand intrusion products, which include the Company’s cellular radio products which declined ($89,000). Net Sales for the six months ended December 31, 2022 increased by $17,348,000, or 26.9%, to $81,807,000 as compared to $64,459,000 for the same period a year ago. The increase in sales for the six months ended December 31, 2022 was due primarily to increased recurring communication service revenues ($7,434,000), Napco brand intrusion products, which include the Company’s cellular radio products ($3,242,000), Alarm Lock brand door-locking products ($4,317,000), Marks brand door-locking products ($1,285,000), and Continental brand access control products ($1,069,000). 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.
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The Company's gross profit increased by $8,019,000 to $19,462,000, or 46.0% of net sales, for the three months ended December 31, 2022 as compared to $11,443,000, or 34.3% of net sales, for the same period a year ago. Gross profit on equipment sales was $6,247,000, or 22.8% of net equipment sales, for the three months ended December 31, 2022 and $1,809,000, or 8.1% of net equipment sales, for the same period a year ago. Gross profit on service revenues was $13,215,000, or 88.8% of net service revenues, for the three months ended December 31, 2022 and $9,634,000, or 87.4% of net service revenues, for the same period a year ago. The increase in gross profit in dollars and as a percentage of net sales on equipment sales and service revenues was was primarily the result of the increase in revenues of each as described above as well as increased availability and lower costs of components and transportation as compared to the same period last year which resulted from improvements within the Company’s supply chain. The increase in revenues resulted in improved overhead absorption rates. In addition, the increase in gross margin on service revenues was due, in part, to increased service revenues relating to the Company’s fire radios, which have higher monthly selling prices than the Company’s intrusion radios.
The Company's gross profit increased by $12,730,000 to $37,629,000, or 46.0% of net sales, for the six months ended December 31, 2022 as compared to $24,899,000, or 38.6% of net sales, for the same period a year ago. Gross profit on equipment sales was $12,269,000, or 23.1% of net equipment sales, for the six months ended December 31, 2022 and $6,464,000, or 15.0% of net equipment sales, for the same period a year ago. Gross profit on service revenues was $25,360,000, or 88.4% of net service revenues, for the six months ended December 31, 2022 and $18,435,000, or 86.7% of net service revenues, for the same period a year ago. The increase in gross profit in dollars and as a percentage of net sales on equipment sales and service revenues was was primarily the result of the increase in revenues of each as described above as well as increased availability and lower costs of components and transportation as compared to the same period last year which resulted from improvements within the Company’s supply chain. The increase in revenues resulted in improved overhead absorption rates. In addition, the increase in gross margin on service revenues was due, in part, to increased service revenues relating to the Company’s fire radios, which have higher monthly selling prices than the Company’s intrusion radios.
Research and development expenses for the three months ended December 31, 2022 increased $244,000 to $2,222,000, or 5.3% of net sales, as compared to $1,978,000, or 5.9% of net sales, for the same period a year ago. Research and development expenses for the six months ended December 31, 2022 increased $741,000 to $4,650,000, or 5.7% of net sales, as compared to $3,909,000, or 6.1% of net sales, for the same period a year ago. The increase in dollars was due primarily to salary increases and additional staff.
Selling, general and administrative expenses for the three months ended December 31, 2022 decreased by $391,000 or 4.8% to $7,804,000 from $8,195,000 for the same period a year ago. Selling, general and administrative expenses as a percentage of net sales decreased to 18.4% for the three months ended December 31 2022 as compared to 24.5% for the same period a year ago. The decrease in dollars resulted primarily from higher stock option expense and legal expenses incurred in the three months ended December 31, 2021. The decrease as a percentage of net sales was due primarily to the increase in net sales as partially offset by the aforementioned increase in expense dollars. Selling, general and administrative expenses for the six months ended December 31, 2022 increased by 753,000 or 4.8% to $16,294,000 from $15,541,000 for the same period a year ago. Selling, general and administrative expenses as a percentage of net sales decreased to 19.9% for the six months ended December 31 2022 as compared to 24.1% for the same period a year ago. The increase in dollars resulted primarily from increases in credit card processing fees, insurance expense and commission expenses. The decrease as a percentage of net sales was due primarily to the increase in net sales as partially offset by the aforementioned increase in expense dollars.
Interest and other income (expense), net for the three months ended December 31, 2022 increased by $129,000 to income of $187,000 as compared to income of $58,000 for the same period a year ago. Interest and other income (expense), net for the six months ended December 31, 2022 increased by $9,000 to income of $84,000 as compared to income of $75,000 for the same period a year ago.
Gain on extinguishment of debt resulted from a one-time gain in the three months ended September 30, 2021 which resulted from the forgiveness of the Company’s PPP loans as described in Note 8 to the condensed consolidated financial statements.
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The Company’s provision for income taxes for the three months ended December 31, 2022 increased by $886,000 to $1,177,000 as compared to $291,000 for the same period a year ago. The increase in the provision for income taxes for the three months was primarily due to higher taxable income in the U.S. The Company’s effective rate for income tax was 12.2% and 21.9% for the three months ended December 31, 2022 and 2021, respectively. The Company’s provision for income taxes for the six months ended December 31, 2022 increased by $1,282,000 to $1,921,000 as compared to $639,000 for the same period a year ago. The increase in the provision for income taxes for the six months was primarily due to higher taxable income in the U.S. The Company’s effective rate for income tax was 11.5% and 6.8% for the six months ended December 31, 2022 and 2021, respectively. The effective rate for the six months ended December 31, 2021 was reduced due to the other income of $3.9 million being non-taxable.
Net income for the three months ended December 31, 2022 increased by $7,409,000 to $8,446,000 or $0.23 per diluted share as compared to $1,037,000 or $0.03 per diluted share for the same period a year ago. Net income for the six months ended December 31, 2022 increased by $6,059,000 to $14,848,000 or $0.40 per diluted share as compared to $8,789,000 or $0.24 per diluted share for the same period a year ago. The increase in net income for the three and six months ended December 31, 2022 was primarily due to the items described above. Without the inclusion of $3.9 million of income from the forgiveness of debt net income and diluted earnings per share for the six months ended December 31, 2021 would have been $4.9 million and $0.13, respectively
Liquidity and Capital Resources
During the six months ended December 31, 2022, the Company utilized a portion of its cash balance at June 30, 2022 ($10,856,000 of $41,730,000) to purchase marketable securities and other investments ($10,078,000) and property, plant and equipment ($816,000). During the six months ended December 31, 2022, the Company generated a cash flow from operations of $1,088,000. 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.
Accounts receivable at December 31, 2022 decreased by $8,233,000 to $20,985,000 as compared to $29,218,000 at June 30, 2022. This decrease is primarily the result of the higher sales volume of equipment during the quarter ended June 30, 2022, which is typically the Company’s highest, as compared to the quarter ended December 31, 2022. In addition, sales of the Company’s radio communication products were unusually high in the month of June 2022 due to the Company fulfilling backorders of these products which had built up during the world-wide supply chain difficulties. Sales of these products were at more normal levels in the month of December 2022.
Inventories, which include both current and non-current portions, increased by $14,406,000 to $64,192,000 at December 31, 2022 as compared to $49,786,000 at June 30, 2022. The increase was due primarily to a build-up of inventory of the Company’s radio products in order to mitigate potential supply chain interuptions of these products. 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. As these challenges begin to subside, the Company believes it’s inventory levels will decrease.
Accounts payable and accrued expenses, not including income taxes payable, decreased by $6,917,000 to $17,708,000 as of December 31, 2022 as compared to $24,625,000 as of June 30, 2022. This decrease is primarily due to a decrease in the Company’s accrued refund liability, which is explained in Note 2 to the Notes to the Company’s Consolidated Financial Statements, and a decrease in accrued salaries, a decrease in accrued annual bonuses and a decrease in accounts payable which relates to the Company reducing purchases of component parts in the latter part of the quarter ended December 31, 2022 after building up it’s inventory in fiscal 2022.
As of December 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. 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. The Company’s long-term debt is described more fully in Note 8 to the condensed consolidated financial statements.
As of December 31, 2022, the Company had no material commitments for capital expenditures or inventory purchases other than purchase orders issued in the normal course of business. In addition, the Company has a refund liability of $4,096,000 as of December 31, 2022 for customer returns and promotional credits as more fully discussed in Note 2 to the Condensed Consolidated Financial Statements.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.