Item 2. Management’s Discussion and Analysis
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Restatement of Previously Issued Financial Statements
This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” has been amended and restated to give effect to the restatement of our financial statements, as more fully described in Note 1A to our financial statements entitled “Restatement of Previously Issued Financial Statements”. For further detail regarding the restatement, see “Explanatory Note” and “Item 4. Controls and Procedures.”
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.
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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.
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 susceptible 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 (as Restated)
2021
(decrease)
2022 (as Restated)
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
1,139
1,809
(37.0)
%
3,560
6,464
(44.9)
%
services
13,215
9,634
37.2
%
25,360
18,435
37.6
%
Total gross profit
14,354
11,443
25.4
%
28,920
24,899
16.1
%
Gross profit as a % of net sales:
33.9
%
34.3
%
(1.2)
%
35.4
%
38.6
%
(7.5)
%
equipment
4.2
%
8.1
%
(48.1)
%
6.7
%
15.0
%
(55.3)
%
services
88.8
%
87.4
%
1.6
%
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
4,328
1,270
240.8
%
7,976
5,449
46.4
%
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
586
291
101.4
%
1,047
639
63.8
%
Net income
3,929
1,037
278.9
%
7,013
8,789
(20.2)
%
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) partially 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
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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.
The Company's gross profit increased by $2,911,000 to $14,354,000, or 33.9% 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 $1,139,000, or 4.2% 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 on equipment sales and service revenues was primarily the result of the increase in revenues of each as described above. The decrease in gross profit as a percentage of equipment sales was primarily the result of the sale of the remaining portion of finished goods that were in opening inventory that contained certain higher priced components as disclosed in the Form 10-Q/A for the period ending September 30, 2022. The Company purchased these components at a significant premium during the supply chain interruptions during the latter part of fiscal 2022 in order to continue to supply the Company’s communication devices that led to the creation of recurring service revenues for the Company. These higher expenses were partially offset by the higher sales volume in the three months ended December 31, 2022 as compared to the same period a year ago. The increase in gross margin on service revenues was due primarily to continued increases in overall recurring service revenues as well as 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 $4,021,000 to $28,920,000, or 35.4% 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 $3,560,000, or 6.7% 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 on equipment sales and service revenues was primarily the result of the increase in revenues of each as described above. The decrease in gross profit as a percentage of equipment sales was primarily the result of the sale of the remaining portion of finished goods that were in opening inventory that contained certain higher priced components as disclosed in the Form 10-Q/A for the period ending September 30, 2022. The Company purchased these components at a significant premium during the supply chain interruptions during the latter part of fiscal 2023 in order to continue to supply the Company’s communication devices that relate to the Company’s recurring service revenues. These higher expenses were partially offset by the higher sales volume in the three months ended December 31, 2022 as compared to the same period a year ago. The increase in gross margin on service revenues was due primarily to continued increases in overall recurring service revenues as well as 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.
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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.
The Company’s provision for income taxes for the three months ended December 31, 2022 increased by $295,000 to $586,000 as compared to $291,000 for the same period a year ago. The increase in the provision for income taxes for the three months ended December 31, 2022 was primarily due to higher taxable income in the U.S. The Company’s effective rate for income tax was 13.0% 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 $408,000 to $1,047,000 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 13.0% 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 a one-time gain on extinguishment of debt of $3.9 million being non-taxable.
Net income for the three months ended December 31, 2022 increased by $2,892,000 to $3,929,000 or $0.11 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 decreased by $1,776,000 to $7,013,000 or $0.19 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 ended December 31, 2022 was primarily due to the items described above. The decrease in net income for the three months ended September 30, 2022 was primarily due to the inclusion of one-time income from the forgiveness of debt ($3.9 million related to the Company’s PPP loan) in other income in the three months ended September 30, 2021 as well as the other items described above, including the decline in gross profit on hardware sales in the current year’s quarter.
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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 was 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 $5,697,000 to $55,483,000 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 interruptions of these products. The increase was also due to shortages of certain component parts and the Company purchasing large quantities of these hard-to-source component parts when they became available. As these challenges begin to subside, the Company believes its inventory levels of these items 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 was 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 its 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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