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Item 2. Management’s Discussion and Analysis

2024-11-04 compared with 2024-05-06 · 72 added, 81 removed, 30 unchanged (84% of the section changed)

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Statement Regarding Forward Looking Statements

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.

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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.

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 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 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.

Our wireless communication services have led to the substantial growth in our monthly recurring revenues.

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 and Prima product lines.

Today, 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.

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.

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.

Our monthly recurring service revenue, which is less susceptible to these fluctuations, allows us to generate a more consistent and predictable income stream.

Napco is a leading manufacturer and designer of high-tech electronic security devices, wireless communication services for intrusion and fire alarm systems as well as a 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, used for commercial, residential, institutional, industrial and governmental applications.

We have experienced significant growth in recent years, primarily driven by our recurring service revenues from wireless communication services for intrusion and fire alarm systems.

NAPCO has established a heritage and proven record in the professional security community for reliably delivering both advanced technology and high-quality security solutions.

We are dedicated to developing innovative technology and producing the next generation of reliable security solutions that utilize remote communications and wireless networks.

Highlights from the quarter ended September 30, 2024 compared with the comparable quarter in fiscal 2023 included:

● Net sales for the quarter increased 6% to a record $44.0 million.

● Recurring service revenue (“RSR”) for the quarter increased 22% to $21.1 million.

● Gross margin for recurring service revenue increased to 91% as compared to 90%.

● Gross margin for equipment revenue was 24% as compared to 28%.

● Net income increased 7% to a first quarter record $11.2 million.

Industry Trends

Our industry is dynamic and highly competitive, with frequent changes in both technologies and business models.

Each industry shift is an opportunity to conceive new products, new technologies, or new ideas that can further transform the industry and our business.

Napco continually innovates through a broad range of research and development activities that seek to identify and address the changing demands of customers, industry trends, and competitive forces.

Economic Conditions and Other Factors

We are subject to the effects of general macroeconomic and market conditions.

The markets for security devices and services are dynamic and highly competitive.

Our competitors are continually developing new products and solutions for consumers and businesses.

We must continue to evolve and adapt to respond to customer and user preferences over an extended time in pace with this changing environment.

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 2024 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.

Our discussion and analysis of our financial condition and results of operations are based upon our Condensed Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States.

The preparation of these financial statements requires a high degree of judgment, either in the application and interpretation of existing accounting literature or in the development of estimates that affect the reported amounts of assets, liabilities, revenues, and expenses.

We continuously evaluate our estimates and judgments based on historical experience, as well as other factors that we believe to be reasonable under the circumstances.

The results of our evaluation form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources.

Critical estimates include management’s judgments associated with reserves for sales returns and allowances, allowance for credit losses, overhead expenses applied to inventory, inventory reserves, valuation of intangible assets, share based compensation and income taxes.

These estimates may change in the future if underlying assumptions or factors change, and actual results may differ from these estimates.

Results of Operations

Three months ended March 31,

Nine months ended March 31,

(dollars in thousands)

Three months ended September 30,

(dollars in thousands)

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Provision for income taxes

Net Sales for the three months ended March 31, 2024 increased by $5,735,000, or 13.2%, to $49,267,000 as compared to $43,532,000 for the same period a year ago.

The increase in sales for the three months ended March 31, 2024 was due primarily to revenue increases in recurring communication services ($4,390,000), Alarm Lock brand door-locking products ($407,000), and Marks brand door-locking products ($2,330,000) as partially offset by a decrease in Napco brand intrusion products ($1,376,000) and Continental brand access control products (16,000).

Net Sales for the nine months ended March 31, 2024 increased by $13,151,000, or 10.5%, to $138,490,000 as compared to $125,339,000 for the same period a year ago.

The increase in sales for the nine months ended March 31, 2024 was due primarily to revenue increases in recurring communication services ($11,530,000), Alarm Lock brand door-locking products ($2,684,000), and Marks brand door-locking products ($4,651,000) as partially offset by a decrease in Continental brand access control products ($122,000) and Napco brand intrusion products ($5,592,000).

The Company's gross profit increased by $5,205,000 to $26,484,000, or 53.8% of net sales, for the three months ended March 31, 2024 as compared to $21,279,000, or 48.9% of net sales, for the same period a year ago.

Gross profit on equipment sales was $8,556,000, or 28.8% of net equipment sales, for the three months ended March 31, 2024 as compared to $7,610,000, or 26.8% of net

equipment sales, for the same period a year ago.

Gross profit on service revenues was $17,928,000, or 91.8% of net service revenues, for the three months ended March 31, 2024 and $13,669,000, or 90.3% 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 revenues during the three months ended March 31, 2024 resulted primarily from increased equipment revenues as well as a favorable shift in product mix to the Company’s locking products, which typically have higher gross margins than the Company’s intrusion products.

The increase in gross profit in dollars and as a percentage of net sales on service revenues during the three months ended March 31, 2024 was primarily the result of the increase in revenues as described above as well as a greater proportion of those revenues being generated by the Company’s fire radios, which generate higher monthly service charges than those of the Company’s intrusion radios.

The increases in total Gross Profit and total Gross Profit as a Percentage of Net Sales resulted from the increases described above.

The Company's gross profit increased by $23,710,000 to $73,909,000, or 53.4% of net sales, for the nine months ended March 31, 2024 as compared to $50,199,000, or 40.1% of net sales, for the same period a year ago.

Gross profit on equipment sales was $23,801,000, or 28.6% of net equipment sales, for the nine months ended March 31, 2024 and $11,170,000, or 13.7% of net equipment sales, for the same period a year ago.

Gross profit on service revenues was $50,108,000, or 90.5% of net service revenues, for the three months ended March 31, 2024 and $39,029,000, or 89.1% 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 revenues during the nine months ended March 31, 2024 resulted primarily from increased equipment revenues as well as a favorable shift in product mix to the Company’s locking products, which typically have higher gross margins than the Company’s intrusion products.

Additionally, the increase in the gross profit percentage for the nine months ended March 31, 2024 was due to the lower margins realized during the first two quarters of fiscal 2023.

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 during the first two quarters of fiscal 2023.

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.

The increase in gross profit in dollars and as a percentage of net sales on service revenues during the nine months ended March 31, 2024 was primarily the result of the increase in revenues as described above as well as a greater proportion of those revenues being generated by the Company’s fire radios, which generate higher monthly service charges than those of the Company’s intrusion radios.

The increases in total Gross Profit and total Gross Profit as a Percentage of Net Sales resulted from the increases described above.

Research and development expenses for the three months ended March 31, 2024 increased by $443,000 to $2,757,000, or 5.6% of net sales, as compared to $2,314,000, or 5.3% of net sales, for the same period a year ago.

Research and development expenses for the nine months ended March 31, 2024 increased by $772,000 to $7,736,000, or 5.6% of net sales, as compared to $6,964,000, or 5.6% of net sales, for the same period a year ago.

The increase in research and development for the three and nine months primarily resulted from compensation increases and additional staff.

Selling, general and administrative (“SG&A”) expenses for the three months ended March 31, 2024 increased by $808,000 to $9,233,000 as compared to $8,425,000 for the same period a year ago.

SG&A expenses as a percentage of net sales decreased to 18.7% for the three months ended March 31, 2024 as compared to 19.4% for the same period a year ago.

The increase in SG&A expenses for the three months ended March 31, 2024 was primarily due to increases in legal expenses as well as additional expenses relating to the Company’s enhancing its internal control systems offset by a decrease in advertising expense.

The decrease as a percentage of net sales was due primarily to the increase in net sales being proportionally larger than the increase in SG&A expenses.

Selling, general and administrative expenses for the nine months ended March 31, 2024 increased by $1,600,000 to $26,319,000 as compared to $24,719,000 for the same period a year ago.

SG&A expenses as a percentage of net sales decreased to 19.0% for the nine months ended March 31, 2024 as compared to 19.7% for the same period a year ago The increase in SG&A expenses for the nine months ended March 31, 2024 was primarily due to increases in legal and accounting fees as well as additional expenses relating to the Company’s enhancing its internal control systems.

These increased expenses were partially offset by decreased incentive compensation for certain executive officers as well as a decrease in the stock based compensation.

The decrease as a percentage of net sales was due primarily to the increase in net sales being proportionally larger than the increase in SG&A expenses.

Interest and other income, net for the three months ended March 31, 2024 increased by $200,000 to income of $637,000 as compared to income of $437,000 for the same period a year ago.

Interest and other income, net for the nine months ended March 31, 2024 increased by $1,285,000 to income of $1,806,000 as compared to income of $521,000 for the same period a year ago.

The increase in income for the three and nine months was primarily due to an increase in interest income on certificates of deposits.

The Company’s provision for income taxes for the three months ended March 31, 2024 increased by $507,000 to $1,935,000 as compared to $1,428,000 for the same period a year ago.

Net Sales for the three months ended September 30, 2024 increased $2,327,000 to $44,003,000 as compared to $41,676,000 in the comparable period.

Net equipment revenues for the three months ended September 30, 2024, decreased $1,474,000 to $22,917,000 as compared to $24,391,000 in the comparable period.

The decrease in net equipment sales was primarily due to decreases in intrusion and access alarm products of $233,000 and door locking devices of $1,241,000.

Net service revenues for the three months ended September 30, 2024, increased $3,801,000 to $21,086,000 as compared to $17,285,000 in the Comparable period.

The increase in net service revenues was primarily due to an increase in our cellular (radio) communication device activations.

Overall gross profit for the three months ended September 30, 2024 increased $2,203,000 to $24,616,000, or 55.9% of net sales, as compared to $22,413,000, or 53.8% of net sales, for the comparable period.

Gross profit from equipment sales was $5,407,000, or 23.6% of equipment sales, as compared to $6,894,000, or 28.3% of net equipment sales, for the comparable period.

The decrease in gross profit percentage from equipment sales is primarily a result of product mix.

Door locking products historically result in higher margin percentages as compared to access alarm products and specifically cellular (radio) communicator devices, which also result in future increases in recurring alarm communication services revenue.

Gross profit on service revenues was $19,209,000, or 91.1% of net service revenues, as compared to $15,519,000, or 89.8% of net service revenues, for the comparable period a year ago.

The increase in gross profit percentage was a result of renegotiation of royalty arrangements and volume rebates received from carriers.

Research and Development

Research and development expenses for the three months ended September 30, 2024 increased by $620,000 to $3,057,000, or 6.9% of net sales, as compared to $2,437,000, or 5.8% of net sales, for the comparable period.

The increase in research and development expenses was primarily a result of annual compensation increases and hiring of additional resources.

Selling, General and Administrative

Selling, general and administrative (“SG&A”) expenses for the three months ended September 30, 2024 increased by $1,282,000 to $9,703,000 as compared to $8,421,000 for the comparable period.

The increase in SG&A expenses was primarily attributable to compensation increases and hiring of additional staff, increases in advertising and insurance costs, partially offset by decreases in professional fees.

Other Income (Expense)

Interest and other income, net for the three months ended September 30, 2024 increased by $704,000 to income of $1,144,000 as compared to income of $440,000 for the comparable period.

The increase in income was primarily due to an increase in interest income on short-term investments as a result of higher interest rates and larger deposit balances.

The Company’s provision for income taxes for the three months ended September 30, 2024 increased by $298,000 to $1,815,000 as compared to $1,517,000 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 12.8% and 13.0% for the three months ended March 31, 2024 and 2023 respectively.

The Company’s provision for income taxes for the nine months ended March 31, 2024 increased by $2,901,000 to $5,376,000 as compared to $2,475,000 for the same period a year ago.

The increase in the provision for income taxes for the nine months was primarily due to higher taxable income in the U.S.

The Company’s effective rate for income tax was 12.9% and 13.0% for the nine months ended March 31, 2024 and 2023, respectively.

Net income for the three months ended March 31, 2024 increased by $3,647,000 to $13,196,000 or $0.36 per diluted share as compared to $9,549,000 or $0.26 per diluted share for the same period a year ago.

Net income for the nine months ended March 31, 2024 increased by $19,722,000 to $36,284,000 or $0.98 per diluted share as compared to $16,562,000 or $0.45 per diluted share for the same period a year ago.

The increase in net income for the three and nine months ended March 31, 2024, was primarily due to the items described above.

The Company’s effective rate for income tax was 14.0% and 12.6% for the three months ended September 30, 2024 and 2023 respectively.

The Company’s effective tax rate for the three months ended September 30, 2024 increased as a result of higher non-deductible stock based compensation.

Liquidity and Capital Resources

The Company has cash, certificates of deposit (“CD”) which mature within 12 months, and marketable securities which aggregate to $87.5 million.

During the nine months ended March 31, 2024, the Company utilized a portion of its cash balance at June 30, 2023 ($160,000) to purchase marketable securities and other investments ($1,123,000) and property, plant and equipment ($1,043,000).

The securities and investments consist of money market accounts, CD’s and time deposits.

During the nine months ended March 31, 2024, the Company generated cash flows from operations of $31,032,000.

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 March 31, 2024 increased by $4,204,000 to $30,273,000 as compared to $26,069,000 at June 30, 2023.

This increase was due primarily to sales of intrusion products to a large, new customer during the nine months ended March 31, 2024 as well as sales of door locking products to one of the Company’s customers in March 2024 to supply several of their contracting jobs.

Inventories, which include both current and non-current portions, increased by $1,754,000 to $50,103,000 as of March 31, 2024, as compared to $48,349,000 at June 30, 2023.

The increase was due primarily to the Company level-loading its production facility where production is smoothed out over the year in order to avoid large fluctuations in manpower requirements throughout the fiscal year.

Accounts payable and accrued expenses, not including income taxes payable, remained consistent at $19,745,000 as of March 31, 2024 as compared to $19,686,000 as of June 30, 2023.

As of March 31, 2024 long-term debt consisted of a revolving line of credit of $20,000,000 (“Amended Agreement”), with no amounts outstanding, which expires in February 2029.

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 March 31, 2024, 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’s balance sheet reflects a refund liability of $5,224,000 as of March 31, 2024 for customer returns and promotional credits which is more fully discussed in Note 2 to the condensed consolidated financial statements.

Our cash and cash equivalents increased by $20,255,000 during the quarter ended September 30, 2024, and our cash and cash equivalents and short-term investments as of September 30, 2024 was $96,522,000.

We believe that our projected cash flow from operations, combined with our cash and short-term investments, will be sufficient to meet our projected working capital requirements, contractual obligations, and other cash flow needs for the next twelve months.

As of September 30, 2024, the Company’s available revolving credit line was $20,000,000, which expires in February 2029, none of which has been drawn.

The Company has no outstanding debt.

A summary of the cash flow activity for the periods ended September 30, 2024 and 2023 is as follows:

Cash Flows from Operating Activities

Net cash provided by operating activities was $12.0 million for the period ended September 30, 2024 and was due to net income of $11.2 million and increase in cash flow from changes in operating assets and liabilities of $1.3 million, partially offset by adjustments for non-cash items of $.4 million.

The changes in operating assets and liabilities were largely attributable to increases in accounts receivables and decreases in inventories and accounts payable and accrued expenses.

Net cash provided by operating activities was $11.2 million for the period ended September 30, 2023 and was due to net income of $10.5 million and adjustments for non-cash items of $1.7 million, partially offset by a decrease in cash flow from operating activities due to changes in operating assets and liabilities of $1.0 million.

The changes in operating assets and liabilities was largely attributable to a decrease in accounts receivable and an increase in and accounts payable and accrued expenses offset by an increase in inventories.

Cash Flows from Investing Activities

The net cash provided by investing activities of $15.5 million during the period ended September 30, 2024 was primarily attributable to the redemption of other investments ($16.3 million) partially offset by expenditures used for capital expenditures ($.7 million) and purchase of investments ($.1 million).

The cash used in investing activities of $0.6 million during the period ended September 30, 2023, was primarily attributable to expenditures used for capital expenditures and purchase of investments.

The change in use of cash for investing activities from 2023 to 2024 was a reduction in investments in term deposits (other investments).

Cash Flows from Financing Activities

The cash used in financing activities of $7.2 million for the period ended September 30, 2024 was primarily related to the purchase of treasury shares.

The cash used in financing activities of $2.9 million for the period ended September 30, 2023 was primarily related to the payment of stockholder dividends.

Contractual Obligations and Commitments

As of September 30, 2024, the Company had no material commitments for capital expenditures or inventory purchases other than purchase orders issued in the normal course of business.

On April 26, 1993, the Company's foreign subsidiary entered into a 99-year land lease of approximately 4 acres of land in the Dominican Republic, on which the Company’s principle manufacturing facility is located, at an annual base rent of approximately $235,000 and $105,000 in annual service charges.

The service charges increase 2% annually over the remaining life of the lease.

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-Q

Item 2. Management’s Discussion and Analysis