NAPCO SECURITY TECHNOLOGIES, INC. 
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 actually 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 endedJune 30, 2020 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 theSEC 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. OverviewNapco Security Technologies, Inc ("NAPCO", "the Company", "we") is one of the leading manufacturers and designers of high-tech electronic security devices, wireless 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 theU.S. While recurring service revenues have continued to increase during the COVID-19 pandemic, equipment sales were negatively impacted by the economic slowdown associated with this pandemic. 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 best-known brands, such asNAPCO 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 theNAPCO Group of Companies .
Economic and Other Factors
We are subject to the effects of general economic and market conditions. In the event that theU.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. 25 Table of Contents Seasonality The Company's fiscal year begins onJuly 1 and ends onJune 30 . Historically, the end users of the Company's products want to install its products prior to the summer; therefore sales of its products historically peak in the periodApril 1 through June 30 , the Company's fiscal fourth quarter, and are reduced in the periodJuly 1 through September 30 , the Company's fiscal first quarter. In addition, demand for our products is affected by the housing and construction markets. Deterioration of the current economic conditions may also affect this trend. Our fourth quarter of fiscal 2020 and the first and second quarters of fiscal 2021 reflected the challenging business environment resulting from the COVID-19 pandemic. The COVID-19 pandemic has caused difficulties for security equipment professionals getting access to both commercial and residential installation sites. We sell our products primarily through distribution to dealers and we are now seeing strong sell-through statistics from several of our largest distributors. Increased sell-through of our products from our distributors to the alarm and locking dealers during the quarter as compared to the same quarter last year, which was pre COVID-19, indicates that security equipment professionals are getting increased access to both commercial and residential installation sites and using more and more of our 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 2020 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/
2020 2019 (decrease) 2020 2019 (decrease)Net sales: equipment revenues$ 19,016 $ 20,045 (5.13) %$ 34,914 $ 40,966 (14.77) % service revenues 8,189 5,784 41.58 % 15,464 11,148 38.72 % 27,205 25,829 5.33 % 50,378 52,114 (3.33) % Gross profit: equipment 4,417 7,443 (40.66) % 9,008 14,726 (38.83) % services 6,986 4,684 49.15 % 13,087 8,919 46.73 % 11,403 12,127 (5.97) % 22,095 23,645 (6.56) %
Gross profit as a % of net sales: 41.92 % 46.95 % (10.73)
% 43.86 % 45.37 % (3.34) % equipment 23.23 % 37.13 % (37.44) % 25.80 % 35.95 % (28.23) % services 85.31 % 80.98 % 5.34 % 84.63 % 80.01 % 5.78 % Research and development 1,884 1,823 3.35 % 3,773 3,572 5.63 % Selling, general and administrative 5,850 6,310 (7.29) % 11,999 12,470 (3.78) % Selling, general and administrative as a percentage of net sales 21.50 % 24.43 % (11.98) % 23.82 % 23.93 % (0.46) % Operating income 3,669 3,994 (8.14) % 6,323 7,603 (16.84) % Interest expense (income), net 3 (9) (133.33)
% 9 (2) (550.00) %
Provision for income taxes 469 431 8.82 % 798 800 (0.25) %
Net income 3,197 3,572 (10.50) % 5,516 6,805 (18.94) %
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Results of Operations
Sales for the three months endedDecember 31, 2020 increased by$1,376,000 to$27,207,000 as compared to$25,829,000 for the same period a year ago. Sales for the six months endedDecember 31, 2020 decreased by$1,736,000 to$50,378,000 as compared to$52,114,000 for the same period a year ago. The increase in sales for the three months endedDecember 31, 2020 was due primarily to increased recurring communication service revenues ($2,405,000 ) and sales of intrusion and access products ($463,000 ) as partially offset by a decrease in sales of door-locking products ($1,492,000 ). Sales of the Company's door-locking products continue to be negatively impacted by the COVID-19 pandemic. The decrease in sales for the six months endedDecember 31, 2020 was due primarily to decreased sales of door-locking products ($5,826,000 ) and intrusion and access products ($226,000 ) as partially offset by an increase in recurring communication service revenues ($4,316,000 ) Gross profit for the three months endedDecember 31, 2020 decreased to$11,403,000 or 41.9% of sales as compared to$12,127,000 or 47.0% of sales for the same period a year ago. Gross profit on equipment sales for the three months endedDecember 31, 2020 decreased to$4,417,000 or 23.2% of equipment sales as compared to$7,443,000 or 37.1% of equipment sales for the same period a year ago. Gross profit on sales of services for the three months endedDecember 31, 2020 increased to$6,986,000 or 85.3% of service sales as compared to$4,684,000 or 81.0% of service sales for the same period a year ago. Gross profit for the six months endedDecember 31, 2020 decreased to$22,095,000 or 43.9% of sales as compared to$23,645,000 or 45.4% of sales for the same period a year ago. Gross profit on equipment sales for the six months endedDecember 31, 2020 decreased to$9,008,000 or 25.8% of equipment sales as compared to$14,726,000 or 36.0% of equipment sales for the same period a year ago. Gross profit on sales of services for the six months endedDecember 31, 2020 increased to$13,087,000 or 84.6% of service sales as compared to$8,919,000 or 80.0% of service sales for the same period a year ago. The decrease in gross profit and gross profit as a percentage of equipment sales for the three and six months was primarily due to the decrease in net sales of equipment, an unfavorable shift in product mix from door-locking products to intrusion products as well as lower overhead absorption which resulted from the Company's lower purchasing and production levels. The lower levels of component part purchases and production were due to the Company's efforts to reduce its inventory levels as well as the reduced hardware revenues discussed above. The increase in gross profit and gross profit as a percentage of service sales for the three and six months endedDecember 31, 2020 was due primarily to the increase in service revenues as well as a favorable shift in service product mix to higher margin service plans. Research and development expenses for the three months endedDecember 31, 2020 increased$61,000 to$1,884,000 as compared to$1,823,000 for the same period a year ago. Research and development expenses for the six months endedDecember 31, 2020 increased$201,000 to$3,773,000 as compared to$3,572,000 for the same period a year ago. These increases were due primarily to increased payroll. Selling, general and administrative expenses for the three months endedDecember 31, 2020 decreased 7.3% to$5,850,000 from$6,310,000 for the same period a year ago. Selling, general and administrative expenses as a percentage of net sales decreased to 21.5% for the three months endedDecember 31, 2020 as compared to 24.4% for the same period a year ago. Selling, general and administrative expenses for the six months endedDecember 31, 2020 decreased 3.8% to$11,999,000 from$12,470,000 for the same period a year ago. Selling, general and administrative expenses as a percentage of net sales remained relatively constant at 23.8% for the six months endedDecember 31, 2020 as compared to 23.9% for the same period a year ago. The decreases in Selling, general and administrative expenses and as a percentage of sales for the three and six months was primarily due to decreased travel, tradeshow and stock option expense. Interest expense, net for the three months endedDecember 31, 2020 remained relatively constant at$3,000 as compared to$(9,000) for the same period a year ago. Interest expense, net for the six months endedDecember 31, 2020 remained relatively constant at$9,000 as compared to$(2,000) for the same period a year ago. The Company's provision for income taxes for the three months endedDecember 31, 2020 increased by$38,000 to$469,000 as compared to$431,000 for the same period a year ago. The Company's provision for income taxes for the six months endedDecember 31, 2020 remained relatively constant at$798,000 as compared to$800,000 for the same period a year ago. The increase in the provision for income taxes for the three months was primarily due to accrued interest and state tax resulting from the Company's settlement of theIRS audit for the fiscal year endedJune 30, 2016 as well as higher taxable income in theU.S , as compared to income in the DR. The Company's effective rate for income tax was 13% and 11% for the three months and the six months endedDecember 31, 2020
and
2019, respectively.
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Net income for the three months ended December 31, 2020 decreased by $375,000 to
$3,197,000 or $0.17 per diluted share as compared to $3,572,000 or $0.19 per
diluted share for the same period a year ago. Net income for the six months
ended December 31, 2020 decreased by $1,289,000 to $5,516,000 or $0.30 per
diluted share as compared to $6,805,000 or $0.37 per diluted share for the same
period a year ago. The decrease in net income for the three and six months ended
December 31, 2020 was primarily due to the items described above.
Liquidity and Capital Resources
During the three months endedDecember 31, 2020 the Company utilized a portion of its cash generated from operations ($390,000 of$8,938,000 ) to purchase property, plant and equipment. 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 atDecember 31, 2020 decreased by$1,709,000 as compared toJune 30, 2020 . This decrease is primarily the result of the higher sales volume of equipment during the quarter endedJune 30, 2020 , which is typically the Company's highest, as compared to the quarter endedDecember 31, 2020 as well as extending longer payment terms for certain customers during the quarter endedJune 30, 2020 to assist them during the economic slowdown resulting from the COVID-19 pandemic. Inventories atDecember 31, 2020 decreased by$3,719,000 fromJune 30, 2020 . This decrease is primarily the result of the Company utilizing some of the additional inventory it had built up during the COVID-19 pandemic as partially offset by level-loading its production output throughout the year, whereas the Company's sales are typically highest in the fourth quarter. The non-current portion of inventory increased$2,391,000 primarily due to the Company reducing its production planning in response to decreased demand during the COVID pandemic.
Accounts payable and accrued expenses other than accrued income taxes decreased
by
As ofDecember 31, 2020 , the Company maintained a revolving credit facility of$11,000,000 which expires inJune 2024 and term loans from theU.S. Small Business Administration totaling$3,904,000 through its Payroll Protection Program ("PPP"). As ofDecember 31, 2020 , the Company had no outstanding borrowings and$11,000,000 in availability under the revolving credit facility and$3,904,000 outstanding under the PPP term loans. The Company's long-term debt is described more fully in Note 7 to the condensed consolidated financial statements. The facility contains various restrictions and covenants including, among others, restrictions on borrowings and compliance with certain financial ratios, as defined in the agreement.
As of
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