Napco Security Technologies, Inc: Form 10-Q for the period ended Dec 31, 2024

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 six months ended December 31, 2024 compared with the comparable periods in fiscal 2024 included:

• Net sales decreased 9.7% to $42.9 million and 2.6% to $86.9 million, for the three and six months.
• Recurring service revenue (“RSR”) increased 14.4% and 18.1% to $21.2 and $42.3 million for the three and six months.
• Total gross profit margin increased from 52.6% to 57.0% and 53.2% to 56.5% for the three and six months.
• Gross margin for RSR increased to 91.3% and 91.2% as compared to 89.9% and 89.8% for the three and six months.
• Generated $25.5 million in cash flows from operations for the six months ended December 31, 2024 as compared to $18.7 in fiscal 2024.

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.

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

(dollars in thousands)

(dollars in thousands)

31

Net Sales

Three Months Ended December 31, 2024:

Net sales for the three months ended December 31, 2024 decreased $4,614,000 to $42,933,000 as compared to $47,547,000 in the comparable period. Net equipment revenues for the three months ended December 31, 2024, decreased $7,282,000 to $21,725,000 as compared to $29,007,000 in the comparable period. The decrease in net equipment sales was primarily due to decreases in intrusion and access alarm products of $3,702,000 and door locking devices of $3,580,000. The reduction is attributable to reduced sales by two of the Company’s larger distributors, one of which reduced all purchases to reduce existing inventory levels, and a second distributor who was completing a management restructuring which resulted in reduced purchases. In addition, the timing of project work has impacted sales of custom door locking devices.

Net service revenues for the three months ended December 31, 2024, increased $2,668,000 to $21,208,000 as compared to $18,540,000 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.

Six Months Ended December 31, 2024:

Net sales for the six months ended December 31, 2024 decreased $2,287,000 to $86,936,000 as compared to $89,223,000 in the comparable period. Net equipment revenues for the six months ended December 31, 2024, decreased $8,756,000 to $44,642,000 as compared to $53,398,000 in the comparable period. The decrease in net equipment sales was primarily due to decreases in intrusion and access alarm products of $3,936,000 and door locking devices of $4,821,000. The reduction is attributable to reduced sales by two of the Company’s larger distributors, one of which reduced all purchases to reduce existing inventory levels, and a second distributor who was completing a management restructuring which resulted in reduced purchases. In addition, the timing of project work has impacted sales of custom door locking devices.

Net service revenues for the six months ended December 31, 2024, increased $6,469,000 to $42,294,000 as compared to $35,825,000 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 December 31, 2024

Overall gross profit for the three months ended December 31, 2024 decreased $523,000 to $24,489,000, or 57.0% of net sales, as compared to $25,012,000, or 52.6% of net sales, for the comparable period.

Gross profit from equipment sales was $5,119,000, or 23.6% of equipment sales, as compared to $8,351,000, 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. In addition, 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 communication services revenue.

Gross profit on service revenues was $19,370,000, or 91.3% of net service revenues, as compared to $16,661,000, or 89.9% 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.

Six Months Ended December 31, 2024:

Overall gross profit for the six months ended December 31, 2024 increased $1,680,000 to $49,105,000, or 56.5% of net sales, as compared to $47,425,000, or 53.2% of net sales, for the comparable period.

Gross profit from equipment sales was $10,526,000, or 23.6% of equipment sales, as compared to $15,245,000, or 28.5% 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. In addition, 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 $38,579,000, or 91.2% of net service revenues, as compared to $32,180,000, 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 December 31, 2024 increased by $565,000 to $3,107,000, or 7.2% of net sales, as compared to $2,542,000, or 5.3% 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 six months ended December 31, 2024 increased by $1,185,000 to $6,164,000, or 7.1% of net sales, as compared to $4,979,000, 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 December 31, 2024 increased by $1,546,000 to $10,211,000 as compared to $8,665,000 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.

Selling, general and administrative (“SG&A”) expenses for the six months ended December 31, 2024 increased by $2,828,000 to $19,914,000 as compared to $17,086,000 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 December 31, 2024 increased by $192,000 to income of $921,000 as compared to income of $729,000 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 six months ended December 31, 2024 increased by $896,000 to income of $2,065,000 as compared to income of $1,169,000 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 December 31, 2024 decreased by $299,000 to $1,625,000 as compared to $1,924,000 for the same period a year ago. The decrease in the provision for income taxes for the three months was primarily due to lower taxable income in the U.S. The Company’s effective rate for income tax was 13.4% and 13.2% for the three months ended December 31, 2024 and 2023 respectively. The Company’s effective tax rate for the three months ended December 31, 2024 increased as a result of higher non-deductible stock based compensation.

The Company’s provision for income taxes for the six months ended December 31, 2024 of $3,440,000 remained consistent as compared to $3,441,000 for the same period a year ago. The Company’s effective rate for income tax was 13.7% and 13.0% for the six months ended December 31, 2024 and 2023 respectively. The Company’s effective tax rate for the six months ended December 31, 2024 increased as a result of higher non-deductible stock based compensation.

Liquidity and Capital Resources

Our cash and cash equivalents increased by $20,678,000 during the six months ended December 31, 2024, and our cash and cash equivalents and short-term investments as of December 31, 2024 was $99,195,000. 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 December 31, 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 six months ended December 31, 2024 and 2023 is as follows:

Cash Flows from Operating Activities

Net cash provided by operating activities was $25.5 million for the six months ended December 31, 2024 and was due to net income of $21.7 million and increase in cash flow from changes in operating assets and liabilities of $4.0 million offset by adjustments for non-cash items of $.2 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 $18.7 million for the six months ended December 31, 2023 and was due to net income of $23.1 million and adjustments for non-cash items of $.9 million, partially offset by a decrease in cash flow from operating activities due to changes in operating assets and liabilities of $5.3 million. The changes in operating assets and liabilities was largely attributable to a decrease in accounts receivable and inventories partially offset by an increase in and accounts payable and accrued expenses.

Cash Flows from Investing Activities

The net cash provided by investing activities of $17.7 million during the six months ended December 31, 2024 was primarily attributable to the redemption of other investments ($27.3 million) partially offset by expenditures used for capital expenditures ($1.8 million) and purchase of investments ($7.6 million). The cash used in investing activities of $1.4 million during the six months ended December 31, 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 increase in the redemption of investments in term deposits (other investments).

Cash Flows from Financing Activities

The cash used in financing activities of $22.6 million for the six months ended December 31, 2024 was primarily related to the purchase of treasury shares. The cash used in financing activities of $5.9 million for the six months ended December 31, 2023 was primarily related to the payment of stockholder dividends.

Contractual Obligations and Commitments

As of December 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. 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.

Interest Rate Risk

Our exposure to market rate risk for changes in interest rates primarily relates to our investment portfolio. We internally manage our investment portfolios considering investment opportunities and risks, tax consequences, and overall financing strategies. Our investment portfolio includes equity securities and U.S. treasury securities with a total fair value of approximately $15.7 million at December 31, 2024. These securities are subject to interest rate risk and, based on our investment portfolio at December 31, 2024, a 100 basis point increase in interest rates would result in a decrease in the fair value of the portfolio of approximately $314,000. While an increase in interest rates may reduce the fair value of the investment portfolio, we will not realize the losses in the Consolidated Statements of Income unless the individual fixed-income securities are sold prior to recovery or the loss is determined to be other-than-temporary.

Currency Exchange Risk

We conduct business with non-U.S. customers, however all foreign sales transactions by the Company are denominated in U.S. dollars. As such, the Company has shifted foreign currency exposure onto its foreign customers.

If changes in exchange rates were to negatively effect these customers, the Company could have trouble collecting unsecured receivables, and or experience the cancellation of existing orders or the loss of future orders. The foregoing could materially adversely affect the Company's business, financial condition and results of operations.

We are also exposed to foreign currency risk relative to expenses incurred in Dominican Pesos ("RD$"), the local currency of the Company's production facility in the Dominican Republic. The result of a 10% strengthening or weakening in the U.S. dollar to the RD$ would result in an annual increase or decrease in income from operations of approximately $889,000.

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management to allow timely decisions regarding required disclosure as of December 31, 2024. Management applies its judgment in assessing the costs and benefits of such controls and procedures, which, by their nature, can provide only reasonable assurance regarding management’s control objectives. Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of December 31, 2024. Based on that evaluation, management concluded that such disclosure controls and procedures were not effective, at the reasonable assurance level, as of December 31, 2024, as a result of the material weaknesses in internal control over financial reporting discussed below.

Previously Identified Material Weaknesses in Internal Control over Financial Reporting

As disclosed in our Annual Report on Form 10-K for the year ended June 30, 2024, management identified a material weakness in internal control related to inventory costing. The material weakness was a result of ineffective review of information used in the inventory costing process.

Plans for Remediation of Material Weakness

Management, with the oversight of the audit committee of our Board of Directors, has designed and implemented reconciliation procedures to determine that the information used in the costing of inventory is complete and accurate. We expect the steps taken to date will remediate the underlying cause of this material weakness and will improve the effectiveness of our internal control over financial reporting.

The material weakness cannot be considered remediated until applicable controls have operated for a sufficient period of time that would allow management to test and conclude that these controls are operating effectively. Accordingly, we will continue to monitor and evaluate the effectiveness of our internal control over financial reporting in the areas affected by the material weakness, and the Company will continue to devote time, attention and financial resources to this effort.

Changes in Internal Control over Financial Reporting

During the quarter ended December 31, 2024, there were no changes in the Company’s internal controls over financial reporting, except for the remediation efforts described above, that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting except as described above.

Information regarding the Company’s Risk Factors are set forth in the Company’s Annual Report on Form 10-K for the year ended June 30, 2024 as well as the Form 424(b)(7) Prospectus, filed on March 7, 2024. There has been no material change in the risk factors previously disclosed in the Company’s Form 10-K and Form 424(b)(7) for the three and six months ended December 31, 2024.