Item 2. Management’s Discussion and Analysis
Item 2. 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. 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, 2024 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 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 three and nine months ended March 31, 2025 compared with the comparable periods in fiscal 2024 included:
● Net sales decreased 10.8% to $44.0 million and 5.5% to $130.9 million, for the three and nine months.
● Recurring service revenue (“RSR”) increased 10.6% and 15.4% to $21.6 and $63.9 million for the three and nine months.
● Total gross profit margin increased from 53.8% to 57.2% and 53.4% to 56.7% for the three and nine months.
● Gross margin for RSR decreased to 90.8% as compared to 91.8% for the three months and increased to 91.1% as compared to 90.5% for the nine months.
● Generated $38.9 million in cash flows from operations for the nine months ended March 31, 2025 as compared to $31.0 in fiscal 2024.
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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.
On April 2, 2025, the U.S. announced a new universal baseline tariff of 10%, (which includes imports from the Dominican Republic where we manufacture most of our products) plus significant additional country-specific tariffs for select trading partners, on all U.S. imports. The reciprocal country-specific tariffs were subsequently paused for 90 days on most countries. The uncertainty around the long-term tariff rates that could be applied to our importation of products into the U.S. presents significant challenges to our operations and supply chain and could impact future result. We cannot predict what additional actions might be considered or implemented by the U.S. or its trade partners, particularly in the current geopolitical environment. We anticipate that the imposition of the baseline 10% tariff will increase the cost of our products and could impact product margins. The uncertainty could also cause disturbances in ocean shipping capacity that could affect our ability to secure ocean freight containers for our products, and create inflationary effects on our costs, in addition to the direct impact of tariffs. We are closely monitoring the evolving tariff landscape and attempting to mitigate these impacts, including using pricing adjustments, sourcing strategies and other cost-mitigation measures. However, there can be no assurance that we will be able to fully mitigate the impacts of such tariffs or that the imposition of tariffs, and the resulting economic impact on the U.S. market and consumer, will not be material to our financial results.
We primarily source our manufacturing materials from Asia, including Taiwan, India and China, with additional sourcing from other producers throughout the world. There have been significant proposed reciprocal tariffs on certain of these countries. At this time, the overall impact on our business related to tariffs remains uncertain and depends on multiple factors, including the duration and potential expansion of current tariffs, future changes to tariff rates, scope, or enforcement, reciprocal measures by impacted trade partners, inflationary effects, changes to consumer purchasing behavior, and the effectiveness of our responses in managing these challenges.
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.
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.
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Results of Operations
Three months ended March 31,
Nine months ended March 31,
(dollars in thousands)
(dollars in thousands)
% Increase/
% Increase/
2025
2024
(decrease)
2025
2024
(decrease)
Net sales: equipment revenues
$
22,351
$
29,735
(24.8)
%
$
66,993
$
83,133
(19.4)
%
service revenues
21,610
19,532
10.6
%
63,904
55,357
15.4
%
Total net sales
43,961
49,267
(10.8)
%
130,897
138,490
(5.5)
%
Gross Profit: equipment
5,499
8,556
(35.7)
%
16,025
23,801
(32.7)
%
services
19,628
17,928
9.5
%
58,207
50,108
16.2
%
Total gross profit
25,127
26,484
(5.1)
%
74,232
73,909
0.4
%
Gross profit as a % of net sales:
57.2
%
53.8
%
6.3
%
56.7
%
53.4
%
6.2
%
equipment
24.6
%
28.8
%
(14.6)
%
23.9
%
28.6
%
(16.4)
%
services
90.8
%
91.8
%
(1.1)
%
91.1
%
90.5
%
0.7
%
Research and development
3,185
2,757
15.5
%
9,349
7,736
20.9
%
Selling, general and administrative
10,796
9,233
16.9
%
30,710
26,319
16.7
%
Selling, general and administrative as a percentage of net sales
24.6
%
18.7
%
31.6
%
23.5
%
19.0
%
23.7
%
Operating income
11,146
14,494
(23.1)
%
34,173
39,854
(14.3)
%
Interest and other income, net
862
637
35.3
%
2,927
1,806
62.1
%
Provision for income taxes
1,886
1,935
(2.5)
%
5,326
5,376
(0.9)
%
Net income
10,122
13,196
(23.3)
%
31,774
36,284
(12.4)
%
Net Sales
Three Months Ended March 31, 2025:
Net sales for the three months ended March 31, 2025 decreased $5,306,000 to $43,961,000 as compared to $49,267,000 in the comparable period.
Net equipment revenues for the three months ended March 31, 2025, decreased $7,384,000 to $22,351,000 as compared to $29,735,000 in the comparable period. The decrease in net equipment sales was attributable to decreases in intrusion and access alarm products of $2,090,000 and door locking devices of $5,294,000. The overall decrease in net equipment revenue was primarily due to reduced sales of approximately $5.1 million at three of our larger distributors as follows; (i) a distributor who purchases both our intrusion and locking products, and decided to reduce corporate-wide purchases to stabilize their existing inventory levels; (ii) a locking distributor whose reduced purchases was primarily driven by the timing of project work with their customer; and (iii) a second locking distributor who was looking to reduce their inventory levels.
Net service revenues for the three months ended March 31, 2025, increased $2,078,000 to $21,610,000 as compared to $19,532,000 in the comparable period. The increase in net service revenues was due to an increase in the number of our cellular (radio) communication devices put into service and activated.
Nine Months Ended March 31, 2025 :
Net sales for the nine months ended March 31, 2025 decreased $7,593,000 to $130,897,000 as compared to $138,490,000 in the comparable period.
Net equipment revenues for the nine months ended March 31, 2025, decreased $16,140,000 to $66,993,000 as compared to $83,133,000 in the comparable period. The decrease in net equipment sales was attributable to decreases in intrusion and access alarm products of $6,025,000 and door locking devices of $10,115,000. Of the overall decrease in net equipment sales approximately $5.8 million was attributable to one of the Company’s larger distributors, which purchases both our intrusion and locking products, and made a decision to reduce corporate-wide purchases to stabilize their existing inventory levels. In addition, the reduction in door
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locking device sales was primarily attributable to reduced purchases by four of the Company’s locking customers of approximately $8.3 million, which was partially driven by the timing of project work with one of the customers.
Net service revenues for the nine months ended March 31, 2025, increased $8,547,000 to $63,904,000 as compared to $55,357,000 in the comparable period. The increase in net service revenues was due to an increase in the number of our cellular (radio) communication devices put into service and activated.
Gross Profit
Three Months Ended March 31, 2054
Overall gross profit for the three months ended March 31, 2025 decreased $1,357,000 to $25,127,000, or 57.2% of net sales, as compared to $26,484,000, or 53.8% of net sales, for the comparable period.
Gross profit from equipment sales was $5,499,000, or 24.6% of equipment sales, as compared to $8,556,000, or 28.8% of net equipment sales, for the comparable period. The decrease in gross profit percentage from equipment sales is primarily a result of product mix and lower absorption of fixed overhead costs as a result of the decrease in equipment revenue.
Gross profit on service revenues was $19,628,000, or 90.8% of net service revenues, as compared to $17,928,000, or 91.8% of net service revenues, for the comparable period a year ago. The decrease in gross profit percentage was a result of a negotiation of a one-time lower royalty payment in the comparable quarter.
Nine Months Ended March 31, 2025 :
Overall gross profit for the nine months ended March 31, 2025 increased $323,000 to $74,232,000, or 56.7% of net sales, as compared to $73,909,000, or 53.4% of net sales, for the comparable period.
Gross profit from equipment sales was $16,025,000, or 23.9% of equipment sales, as compared to $23,801,000, or 28.6% of equipment sales, for the comparable period. The decrease in gross profit percentage from equipment sales is primarily a result of product mix and lower absorption of fixed overhead costs as a result of the decrease in equipment revenue.
Gross profit on service revenues was $58,207,000, or 91.1% of net service revenues, as compared to $50,108,000, or 90.5% 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 March 31, 2025 increased by $428,000 to $3,185,000, or 7.2% of net sales, as compared to $2,757,000, or 5.6% 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.
Research and development expenses for the nine months ended March 31, 2025 increased by $1,613,000 to $9,349,000, or 7.1% of net sales, as compared to $7,736,000, or 5.6% 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 March 31, 2025 increased by $1,563,000 to $10,796,000 as compared to $9,233,000 for the comparable period. The increase in SG&A expenses was primarily attributable to increased legal fees related to the litigation discussed in Note 13 of $704,000, compensation and benefit increases and hiring of additional staff of $586,000, increases in insurance costs of $162,000 and increases in advertising of $138,000, offset by reductions in investor relations expenses.
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Selling, general and administrative (“SG&A”) expenses for the nine months ended March 31, 2025 increased by $4,391,000 to $30,710,000 as compared to $26,319,000 for the comparable period. The increase in SG&A expenses was primarily attributable to compensation and benefit increases and hiring of additional staff of $2,900,000, increases in professional and consulting fees of $665,000, increases in insurance costs of $456,000, and increases in advertising of $442,000, offset by an insurance recovery of legal fees.
Other Income (Expense)
Interest and other income, net for the three months ended March 31, 2025 increased by $225,000 to income of $862,000 as compared to income of $637,000 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.
Interest and other income, net for the nine months ended March 31, 2025 increased by $1,121,000 to income of $2,927,000 as compared to income of $1,806,000 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.
Income Taxes
The Company’s provision for income taxes for the three months ended March 31, 2025 of $1,886,000 remained consistent as compared to $1,935,000 for the same period a year ago. The Company’s effective rate for income tax was 15.7% and 12.8% for the three months ended March 31, 2025 and 2024 respectively. The Company’s effective tax rate for the three months ended March 31, 2025 increased as a result of lower estimated R&D tax credits for the period.
The Company’s provision for income taxes for the nine months ended March 31, 2025 of $5,326,000 remained consistent as compared to $5,376,000 for the same period a year ago. The Company’s effective rate for income tax was 14.4% and 12.9% for the nine months ended March 31, 2025 and 2024 respectively. The Company’s effective tax rate for the nine months ended March 31, 2025 increased as a result of lower estimated R&D tax credits for the period and higher non-deductible stock based compensation.
Liquidity and Capital Resources
Our cash and cash equivalents increased by $8,072,000 during the nine months ended March 31, 2025, and our cash and cash equivalents and short-term investments as of March 31, 2025 was $89,297,000. 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 March 31, 2025, 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 nine months ended March 31, 2025 and 2024 is as follows:
Cash Flows from Operating Activities
Net cash provided by operating activities was $38.9 million for the nine months ended March 31, 2025 and was due to net income of $31.8 million and increase in cash flow from changes in operating assets and liabilities of $6.9 million offset by adjustments for non-cash items of $0.3 million. The changes in operating assets and liabilities were largely attributable to decreases in accounts receivables, inventories and prepaid expenses partially offset by increases in income tax receivable and decreases in accounts payable and accrued expenses.
Net cash provided by operating activities was $31.0 million for the nine months ended March 31, 2024 and was due to net income of $36.3 million and adjustments for non-cash items of $.8 million, partially offset by a decrease in cash flow from operating activities due to changes in operating assets and liabilities of $6.1 million. The changes in operating assets and liabilities was largely attributable to an increase in accounts receivable and inventories partially offset by an increase in and accounts payable and accrued expenses.
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Cash Flows from Investing Activities
The net cash provided by investing activities of $15.1 million during the nine months ended March 31, 2025 was primarily attributable to the redemption of other investments of $27.3 million partially offset by expenditures used for capital expenditures of $1.8 million and purchase of investments of $10.2 million. The cash used in investing activities of $2.3 million during the nine months ended March 31, 2024, was primarily attributable to expenditures used for capital expenditures and purchase of investments. The change in use of cash for investing activities from 2024 to 2025 was a increase in the redemption of investments in term deposits (other investments).
Cash Flows from Financing Activities
The cash used in financing activities of $45.9 million for the nine months ended March 31, 2025 was primarily related to the purchase of treasury shares and the payment of stockholder dividends. The cash used in financing activities of $9.1 million for the nine months ended March 31, 2024 was primarily related to the payment of stockholder dividends.
Contractual Obligations and Commitments
As of March 31, 2025, 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.
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