Napco Security Technologies, Inc (NSSC) Q4 2022 Earnings Call Transcript

Greetings and welcome to Napco Security Technologies Fiscal Fourth Quarter and Full-Year 2022 Earnings Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Patrick McKillop, Vice President of Investor Relations. Thank you. You may begin.

Thank you. Good morning. I'm Patrick McKillop, Vice President of Investor Relations for Napco Security. Thank you for joining us for today's conference call to discuss our financial results for our fiscal fourth quarter and fiscal 2022 year. By now, all of you should have had the opportunity to review the press release discussing the results. If you have not, a copy of the release is available in the Investor Relations section of our website, www.napcosecurity.com. On the call today is Richard Soloway, President and CEO of Napco Security Technologies; and Kevin Buchel, Executive Vice President and CFO. Before we begin, let me take a moment to read the forward-looking statements. This presentation contains forward-looking statements that are based on current expectations, estimates, forecasts, and projections of future performance based on management's judgment, beliefs, current trends, and anticipated product performance. These forward-looking statements include, without limitation, statements relating to growth drivers of the Company's business, such as school security products and recurring revenue services, potential market opportunities, the benefits of our recurring revenue products to customers and dealers, our ability to control expenses and costs and expected annual run rate for SaaS recurring monthly revenue. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those contained in the forward-looking statements. These factors include, but are not limited to, such risk factors described in our SEC filings, including our annual report on Form 10-K. Other unknown or unpredictable factors or underlying assumptions subsequently proving to be incorrect could cause actual results to differ materially from those in the forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance, or achievements. You should not place undue reliance on these forward-looking statements. All information provided in today's press release and this conference call is as of today's date unless otherwise stated, and we undertake no duty to update such information, except as required under applicable law. I will turn the call over to Dick in a moment, but before I do, I just wanted to mention we are actively working on our IR schedule for this fall and hope to see you all soon. Investor outreach is crucial, especially for small-cap companies such as Napco, and I would like to thank all of those folks that assist us in these conferences and marketing trips. With that out of the way, let me turn the call over to Richard Soloway, President and CEO of Napco Security Technologies. Dick, the floor is yours.

Thank you, Patrick. Good morning, everyone, and welcome to our conference call. Thank you for joining us today to discuss our results. We are very pleased to report our fiscal 2022 record sales of $143.6 million and record profits of $19.6 million. Recurring revenue continues to grow at a very strong rate, and the annual run rate is now approximately $54 million based on July 2022 recurring revenues. Our balance sheet remains strong with our cash balances in excess of $46 million and we have no debt. We continue to focus on capitalizing on key industry trends, which include wireless fire and intrusion alarms, school security solutions plus enterprise access control systems and architectural locking products. The management team here at Napco continues to focus on the key metrics of growth, profits, returns on equity, and controlling costs. These metrics are important to us, as well as our shareholders. We continue to execute our business strategy, and our interests are aligned with our shareholders as Senior Management at Napco owns approximately 21% of the equity. Before I go into greater detail, I will now turn the call over to our CFO, Kevin Buchel. He will provide an overview of our fiscal fourth quarter and fiscal year results, and then I'll be back with more on our strategies and outlook. Kevin?

Thank you, Dick, and good morning, everybody. Net sales for the quarter increased 22% to a quarterly record of $40.2 million, as compared to $35.4 million for the same period one year ago. Net sales for the fiscal year ended June 30, 2022, increased 26% to a record $143.6 million, as compared to $114 million for the same period a year ago. Recurring monthly revenue continued its strong growth, increasing 33% for Q4 to $12.7 million, compared to $9.5 million for the same period last year, and increasing 36% for the fiscal year to $46 million, as compared to $33.9 million last year. Our recurring service revenues now have a prospective annual run rate of approximately $54 million based on July 2022 recurring service revenues. In addition, our equipment sales in Q4 increased 18% to $30.5 million, as compared to $25.9 million for Q4 last year. For fiscal 2022, equipment sales increased 22% to $97.6 million, as compared to $80.1 million last year. This strong growth of our recurring revenue is primarily attributable to the continued strength of our StarLink cellular radio products driven by increases in the commercial intrusion and fire alarm business. The increase in equipment sales for the quarter and the fiscal year was related to increases in all segments of our business: Napco intrusion products, alarm lock, and Marks brand to our locking products and Continental Access products. Gross profit for the three months ended June 30, 2022, increased 22% to $19.2 million with a gross margin of 44%, as compared to $15.7 million with a gross margin of 44% for the same period a year ago. Gross profit for the fiscal year ended June 30, 2022, increased 17% to $59.2 million with a gross margin of 41%, as compared to $50.7 million with a gross margin of 45% for the same period a year ago. Gross profit for recurring revenue for the fourth quarter increased 34% to $11.1 million with a very strong 87% gross margin, as compared to $8.3 million with the gross margin of 87% for the same period last year. Gross profit for recurring revenue for fiscal 2022 increased 38% to $40 million with a gross margin of 87%, as compared to $29 million with a gross margin of 86% last year, a 100 basis point improvement. Gross profit for equipment sales for Q4 increased 9% to $8.1 million with a gross margin of 27%, as compared to $7.5 million with a gross margin of 29% last year. The equipment gross margin of 27%, an 800 basis point improvement over the equipment margin last quarter Q3. For fiscal 2022, gross profit decreased 12% to $19.1 million with a gross margin of 20%, as compared to $21.7 million with a gross margin of 27% last year. The 800 basis point increase in equipment gross margins for the quarter, as compared to the prior quarter was primarily driven by higher sales, which leads to more overhead cost absorption in our Dominican Republic manufacturing facility, as well as improved product mix, more higher margin equipment sales, and by strategic price increases, which we have implemented on select products. The decrease in gross margins for equipment sales for the quarter and fiscal year, as compared to last year was primarily due to the continued inflation of freight and component parts costs relating to the current worldwide supply chain problems, as well as increased sales of our StarLink radios, which have lower margins, but result in the more profitable recurring revenues. Research and development costs for the quarter increased 8% to $2.1 million or 5% of sales, as compared to $1.9 million or 5% of sales for the same quarter a year ago. Research and development costs for fiscal year ended June 30, 2022, increased 5% to $8 million or 6% of sales, as compared to $7.6 million or 7% of sales for the same period last year. The increase for the quarter and the full fiscal year was primarily due to salary increases and additional staff. The decrease in R&D as a percentage of net sales was due to the record increases in net sales. Selling, general, and administrative expenses for the quarter increased 24% to $8.9 million or 21% of net sales, as compared to $7.2 million or 20% of sales for the same period last year. Selling, general and administrative expenses for the fiscal year ended June 30, 2022, increased 31% to $32.9 million or 23% of net sales, as compared to $25.2 million or 22% of net sales for the same period last year. The increase in selling, general and administrative expenses for both the fourth quarter and the full fiscal year was due primarily to increased sales incentive compensation relating to the aforementioned increase in net sales, as well as increases in tradeshow, stock-based compensation, which occurred in Q2, and legal expenses. Operating income for the quarter increased 25% to $8.2 million, as compared to $6.6 million for the same period last year. Operating income for the full fiscal year ended June 30, 2022, increased 2% to $18.2 million, as compared to $17.9 million for the same period last year. The Company's provision for income taxes for the three months ended June 30, 2022, decreased 56% to $476,000 with an effective tax rate of 6%, as compared to $1.1 million with an effective tax rate of 16% for the same period last year. For fiscal 2022, the provision for income taxes decreased 11% to $2.2 million with an effective tax rate of 10%, as compared to $2.5 million with an effective tax rate of 14% last year. The decrease in the effective tax rate for fiscal 2022 was primarily due to non-taxable income of $3.9 million, which occurred in Q2 from the extinguishment of debt. Net income for the quarter increased 36% to a fourth quarter record $7.5 million or $0.20 per diluted share, as compared to $5.5 million or $0.15 per diluted share for the same period last year. Net income for the fiscal year ended June 30, 2022, increased 27% to a record $19.6 million or $0.53 per diluted share, as compared to $15.4 million or $0.42 per diluted share in the same period last year. Adjusted EBITDA for the quarter increased 29% to a fourth quarter record $9.3 million or $0.25 per diluted share, as compared to $7.2 million or $0.20 per diluted share for the same period last year and adjusted EBITDA for the fiscal year ended June 30, 2022, increased 13% to a record $22.6 million or $0.61 per diluted share, as compared to $20.1 million or $0.55 per diluted share in the same period last year. The EBITDA margin for the fourth quarter of fiscal 2022 was 21% and for the full fiscal year was 16%. Moving on to the balance sheet. At June 30, 2022, the Company had $46.8 million in cash, cash equivalents, and marketable securities, as compared to $40.2 million as of June 30, 2021. The working capital defined as current assets less current liabilities was $93.1 million at June 30, 2022, as compared with working capital of $75.4 million at June 30, 2021. The current ratio defined as current assets divided by current liabilities was 4.5:1 at June 30, 2022, and 4.7:1 at June 30, 2021. Cash provided by operating activities for fiscal 2022 was $8.3 million, as compared to $23 million for the same period last year. This decrease was primarily due to inventories increasing in fiscal 2022 by $19.3 million, as compared to a decrease of $8.8 million in the same period a year ago. The increase in inventories is primarily the result of the continued increase in component unit costs and freight, as well as increased volume of purchases of certain components that have become difficult to source during the worldwide supply chain problems. While our inventory grew in fiscal 2022, this has also led to our strong sales growth as we continue to invest resources to maximize the production and sales of our StarLink cellular radios, which results in highly profitable and continuous recurring revenue. CapEx for the quarter was $293,000 versus $441,000 in the year-ago period, and CapEx for the fiscal year 2022 was $1,482,000, compared to $1,007,000 in the year-ago period. And we have no debt. That concludes my formal remarks. And I would now like to return the call back to Dick.

Kevin, thank you. Our fiscal 2022 was a sales record breaker and once again our fourth quarter was the highest sales for any quarter in the Company's history. We are pleased that we were able to beat street consensus on revenue, equipment gross margin, EPS, net income, and adjusted EBITDA metrics. The quarter also marked our seventh consecutive quarter of year-over-year sales growth and we look forward to surpassing the previous streak of 23 quarters that was disrupted in 2020 by COVID-19. One key area of our success continues to come from the commercial fire and intrusion alarm business. Today's news headlines are all about the continued interest rate hikes and when the U.S. might fall into a recession. I would like to remind you that our Company is recession-resistant as 80% of our business is commercial and one of our primary growth drivers, the commercial fire alarm business is a mandatory non-discretionary item. Commercial buildings must have and maintain a fire alarm system in order to receive a certificate of occupancy. Given the high profitability and essential nature of this business, we focus on this as a key area of our resources. The recurring revenue annual run rate is now approximately $54 million as of July 2022. Our StarLink radios continue to have strong sales and we are optimistic that we could reach our previously mentioned goal of $150 million in recurring revenue earlier than 2026. The 3G sunset at the end of calendar 2022 is fast approaching and dealers are racing to complete commercial fire alarm upgrades. We believe that we are in a strong position to benefit from this, as well as the continued need to upgrade legacy systems from old-fashioned copper phone lines. Our StarLink radios have the widest coverage with both AT&T and Verizon service and feature-rich functionalities that our dealers love. There are still millions of buildings that need to be either upgraded from copper or replaced an older 3G cellular radio. The constraints of the supply chain continue to be challenging, but clearly our strategy to temporarily sacrifice hardware gross margin by purchasing components at higher prices so that we can continue to manufacture radios, which lead to continued high-margin recurring revenues for each radio installed and operating, is working. We are pleased that the equipment margins improved by 800 basis points to 27% in this quarter versus Q3. We continue to aggressively manage supply chain issues by developing alternative supply sources and delivery methods, while also reengineering products when necessary. We believe that in the next six to nine months, new supplier sources we are developing will begin to reinvigorate our equipment margins and bring them to even higher levels than we have generated. The backlog for the Company remains at historic highs and could remain high for the remainder of 2022 due to the continued supply chain issues. We remain encouraged by the continued strength of the sell-through statistics we are seeing from several of our largest distributors. With activations for our StarLink radios remaining strong, we believe that we are taking market share from our competition, based on this and customers telling us that they can't get product from the competition. Our fully integrated technologies for the school security market continue to remain a top priority for Napco and school security projects continue to ramp up. School administrators have started to turn their attention back to the need for security solutions as more incidents happen. Our fully integrated solutions for the school security market generate healthy margins for our business. Now, more than ever, we are laser-focused on further penetration of the school security market, which is comprised of approximately 130,000 K-12 schools and 5,000 colleges and universities across the country. The availability of grants to schools to fund these security projects has never been better. As an example, we recently saw that Governor Mike DeWine of Ohio announced that 1,183 schools in 81 counties will receive nearly $47 million in grant funding as part of his Ohio K through 12 school safety grant program. Many other states continue to pass funding initiatives as well. Our strategy is to offer seamless security solutions, which allow our dealers and us to generate recurring revenue streams. We are now able to generate recurring revenue from all divisions of the company with the latest product addition Air Access, which will generate recurring revenue from the locking and access control divisions, which has never been done before. Air Access is the industry's first cellular-based access control system, which we believe is a $1 billion market opportunity. The benefits of Air Access include no need for upfront investment and expensive hardware, no need to interfere with the corporate IT networks, which can be a major problem for installers, and no onsite database backups or software updates.

I think he cut out.

I think our speaker disconnected. Please, we'll have them back on the line momentarily.

And we're almost complete, so.

Let me -- one second.

Patrick, can you ping him? Because I do not have the number for him; his number came up restricted?

Yes, I'll shoot him real quick.

Thank you. And to the audience, we thank you for your patience and understanding. Okay, we do have our speaker back with us. We thank you for your patience and understanding.

Thank you. The recurring revenue annual run rate is now approximately $54 million as of July 2022. Our StarLink radios continue to have strong sales and we are optimistic that we could reach our previously mentioned goal of $150 million in recurring revenue earlier than 2026. The 3G sunset at the end of calendar 2022 is fast approaching and dealers are racing to complete commercial fire alarm upgrades. We believe that we are in a strong position to benefit from this, as well as the continued need to upgrade legacy systems from old-fashioned copper phone lines. Our StarLink radios have the widest coverage with both AT&T and Verizon service and rich feature sets that our dealers love. There are still millions of buildings that need to be either upgraded from copper or replaced an older 3G cellular radio. The constraints of the supply chain continue to be challenging, but clearly our strategy to temporarily sacrifice hardware gross margin by purchasing components at higher prices so that we can continue to manufacture radios, which lead to continued high-margin recurring revenues for each radio installed and operating is working well. We are pleased that the equipment margins improved by 800 basis points to 27% in this quarter versus Q3 and we continue to aggressively manage supply chain issues by developing alternative supply sources and delivery methods, while also reengineering products where necessary. We believe that in the next six to nine months, new supplier sources we are developing will begin to reinvigorate our equipment margins and bring them to even higher levels than what we had previously generated. The backlog for the company remains at historic highs and could remain high for the remainder of 2022 due to the continued supply chain issues. We remain encouraged by the continued strength of the sell-through statistics we are seeing from several of our largest distributors. With activations for our StarLink radios remaining strong, we believe that we are taking market share from our competition, based on this and customers telling us that they can't get product from the competition. Our fully integrated technologies for the school security market continue to remain a top priority for Napco, and school security projects continue to ramp up. School administrators have started to turn their attention back to the need for security solutions as more incidents happen. Our fully integrated solutions for the school security generate healthy margins for our business. And now more than ever, we are laser-focused on further penetration of the school security market, which is comprised of approximately 130,000 K-12 schools and 5,000 colleges and universities across the country. The availability of grants to schools to fund these security projects has never been better. As an example, we recently saw that Governor Mike DeWine of Ohio announced that 1,183 schools in 81 counties will receive nearly $47 million in grant funding as part of his Ohio K through 12 school safety grant program. Many other states continue to pass funding initiatives as well. Our strategy is to offer seamless security solutions, which allow our dealers and us to generate recurring revenue streams. We are now able to generate recurring revenue from all divisions of the company with the latest product addition Air Access, which will generate recurring revenue from the locking and access control divisions, which has never been done before. Air Access is the industry's first cellular-based access control system, which we believe is a $1 billion market opportunity. The benefits of Air Access include no need for upfront investment and expensive hardware, no need to interfere with the corporate IT networks, which can be a major problem for installers, and no onsite database backups or software updates.

I think he cut out.

I think our speaker disconnected. Please, we'll have them back on the line momentarily.

And we're almost complete, so.

Let me -- one second.

Patrick, can you ping him? Because I do not have the number for him; his number came up restricted?

Yes, I'll shoot him real quick.

Thank you. And to the audience, we thank you for your patience and understanding. Okay, we do have our speaker back with us. We thank you for your patience and understanding.

Thank you. The recurring revenue annual run rate is now approximately $54 million as of July 2022. Our StarLink radios continue to have strong sales and we are optimistic that we could reach our previously mentioned goal of $150 million in recurring revenue earlier than 2026. The 3G sunset at the end of calendar 2022 is fast approaching, and dealers are racing to complete commercial fire alarm upgrades. We believe that we are in a strong position to benefit from this, as well as the continued need to upgrade legacy systems from old-fashioned copper phone lines. Our StarLink radios have the widest coverage with both AT&T and Verizon service and rich feature sets that our dealers love. There are still millions of buildings that need to be either upgraded from copper or replaced an older 3G cellular radio. The constraints of the supply chain continue to be challenging, but clearly our strategy to temporarily sacrifice hardware gross margin by purchasing components at higher prices so that we can continue to manufacture radios, which lead to continued high-margin recurring revenues for each radio installed and operating is working. We are pleased that the equipment margins improved by 800 basis points to 27% in this quarter versus Q3, and we continue to aggressively manage supply chain issues by developing alternative supply sources and delivery methods while also reengineering products where necessary. We believe that in the next six to nine months, new supplier sources we are developing will begin to reinvigorate our equipment margins and bring them to even higher levels than we have previously generated. The backlog for the Company remains at historic highs and could remain high for the remainder of 2022 due to the continued supply chain issues. We remain encouraged by the continued strength of the sell-through statistics we are seeing from several of our largest distributors. With activations for our StarLink radios remaining strong, we believe that we are taking market share from our competition based on this and customers telling us that they can't get product from the competition. Our fully integrated technologies for the school security market continue to remain a top priority for Napco, and school security projects continue to ramp up. School administrators have started to turn their attention back to the need for security solutions as more incidents happen. Our fully integrated solutions for the school security market generate healthy margins for our business. And now more than ever, we are laser-focused on further penetration of the school security market, which is comprised of approximately 130,000 K-12 schools and 5,000 colleges and universities across the country. The availability of grants to schools to fund these security projects has never been better. As an example, we recently saw that Governor Mike DeWine of Ohio announced that 1,183 schools in 81 counties will receive nearly $47 million in grant funding as part of his Ohio K through 12 school safety grant program. Many other states continue to pass funding initiatives as well. Our strategy is to offer seamless security solutions, which allow our dealers and us to generate recurring revenue streams. We are now able to generate recurring revenue from all divisions of the company with the latest product addition Air Access, which will generate recurring revenue from the locking and access control divisions, which has never been done before. Air Access is the industry's first cellular-based access control system, which we believe is a $1 billion market opportunity. The benefits of Air Access include no need for upfront investment and expensive hardware, no need to interfere with corporate IT networks, which can be a major problem for installers, and no onsite database backups or software updates.

The R&D team remains hard at work developing even more products for the future, which will help grow our recurring revenue business. We have experienced tremendous success over the last five years growing our recurring revenue and believe the best is yet to come. We will now begin our Q&A session portion of this call in a moment. Our fiscal 2022, despite the continued supply chain challenges, was a record-breaking successful one with sales and profitability. We have a strong balance sheet, no debt, and have made the business decision to use the cash we have to spend more on raw materials and logistics as necessary to ensure that we maintain our sales and profitability growth trends. Our seasoned management team has experience from previous supply chain disruptions, which is helping us navigate the current environment. We are now in our fiscal 2023 and believe the best is yet to come. Napco’s senior management maintains a high level of ownership in our equity, approximately 21%. I would like to thank everyone for their support and for joining us during the exciting future we have. Our formal remarks are now concluded. We would now like to open the call for the Q&A session. Operator, please proceed.

Thank you. At this time we’ll be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Jim Ricchiuti with Needham and Company. Please proceed with your question.

Hi, thank you. Question just with respect to the growth, the 18% growth that you saw on the equipment business. How much of that would you say, Kevin, maybe you can answer this is -- has it was price-driven, because you did benefit from clearly from some price increases that you implemented?

Right, so we added a price increase of somewhere -- I really don't want to disclose the amount, but it was on selective products. If I was going to say how much of the 18% it contributed, I would say it's 3 or 4 points maybe at best.

Got it. And follow-up question, just with respect to the equipment business. The strength you saw in gross margins, obviously, there are puts and takes here, a high volume quarter. But I'm wondering what are you seeing in terms of potentially a leveling off of component and expediting costs? And is there any concern on your part or should we be mindful of any impact from you being out in the market procuring components at higher prices that are obviously in your inventories, as we think about gross margins on a go-forward basis?

The supply chain prices are not going away yet. It's going to probably last through the end of the calendar year, maybe into 2023. I'm not counting on it ending anytime soon, I hope it does. We've seen some improvement in logistics. Some of the freight costs have come down slightly. I haven't seen the improvements in component costs on those hard-to-get parts. So that's why we continue to do everything we can to get them. I'm not counting on the Texas Instruments of the world to help us unless I can sit around and wait until 2024, which I won't. So we're making our own alternative supply arrangements with we have alternatives. Another six to nine months and we'll start seeing the benefit of that, and that will help the margins a lot. It will also help us be even stronger than we were before the supply chain, because now we have much higher volumes that we put through our Dominican facility, so you wind up getting that overhead absorption and gross margin expansion. There are the higher inventory costs and that will affect the margins going forward. That goes the other way but all in all given the volume that we expect to see, given the dramatic improvement in costs that we expect to see when we have these alternative sources in place, and given that we did another price increase this past July and we might do another one after that, I think the margins will be much healthier in 2023 -- calendar 2023.

Got it. And just Dick alluded to sell-through among your larger channel partners. I wonder if you could just provide a little bit more color on that and I'll jump back in the queue. Thank you.

So we've seen -- we keep we have very good stats on all our key distributors and we watch what the sell-through stats are. These are -- they are sales to their customers. And they remain very strong through the end of the fiscal year through June. They remain very strong year-over-year for all the divisions. That's just the Napco division, but for alarm lock and for Marks, that's to us a sign of the strength of the business. We could sell all we want to the distributors, but if they don't sell it, that doesn't do us any good. The fact that their sell-through stats are strong leads us to believe strength going forward. We do have, as Dick mentioned in his remarks, a big backlog as of June 30 in the $10 million range. That backlog is something, the demand is huge. We can keep up with it. Our Dominican factory can keep up with it because we have the ability to run $300 million at about that facility on three shifts. So we can't keep up with it, because we just can't get enough components, keep up with the demand. Although we're doing everything we can hence the larger inventory, hence the dramatic hardware growth of 18% for the quarter and 22% for the year.

Got it. Thank you.

Our next question is from Jaeson Schmidt with Lake Street. Please proceed with your question.

Hi, guys. Thanks for taking my questions. Just regarding the backlog number you noted that it remains at record levels. So I assume it's kind of grown from that $10 million level, you talked about last quarter?

I would say, Jaeson, it's similar, similar amount to the $10 million level that we mentioned last quarter, and then obviously this is as of June 30. So even though we were able to ship hardware sales of $30 million and we started the quarter with about $10 million in backlog, we still have that amount. That gives you an idea of the kind of demand. If we were able to ship every nickel out of here, it would have been a $40 million hardware quarter, which would have been amazing. Demand is still strong for our products. We are putting very good numbers on the board. We’re doing everything we can to lower that backlog in the coming months.

All the products that we make for each of the division are all in big demand by the dealers. There is a lot of need for security in commercial buildings and schools and fire alarm systems. So all the products have big demand, and we should have been the products out as quickly as we get them from our factory, and the orders just keep coming in, which is a very, very good thing. We spend a lot of time in engineering with redoing some of our circuitry, so we can use components that we can buy. It's a wonderful thing to have an integrated engineering department in the company and an integrated manufacturing division in the company, because it makes you much faster on your key projects. If we can't get a particular part, we will find another part, redo our circuitry, and get those parts in the factory then produce with it. So we're doing a lot of that now. As we talked about, the hardest parts to get are microprocessors, which we are redeveloping all new sources of microprocessors. In six to nine months from now, those processors will be new brands, and those new brands will help us reduce our backlog. We're shipping even more because as we ship more orders, we get more orders, and it's the position we'd like to be in.

Okay. That's helpful. And I know you guys don't provide guidance, but could you just talk about how order patterns have been for these first two months of the September quarter?

I don't like to talk too much about the current quarter that we're in, but I will say that our first quarter, which used to be very, very low in the summer months, we don't have that pattern anymore. For example, school security jobs, you wouldn't see any when the kids were in school. Those patterns have changed. You could see school security orders anytime of year; nobody is waiting around for even for the kids to be out of school, because they can't wait. It really goes the same with other parts of the business. People are doing what they can to get their hands on product just like we are to get our hands on the hard-to-get components. So no matter what time of year it is, the business remains strong.

Okay, perfect. And then just last one from me, and I'll jump back into the queue. On the SG&A line, you mentioned kind of variable comp trade shows. Just given the strength in June, would we expect SG&A to moderate a bit here in the September quarter?

We would, Jaeson. A large part of the increase in SG&A was commission driven, so with hardware sales being up 18% for the quarter and recurring revenue being up 33% for the quarter and hardware sales being up 22% for the full year, and recurring up 36% for the full year, there was a lot of rewards that went through our sales team and rightfully so. You saw that in the Q4 numbers, and so that will moderate somewhat in Q1. That would be probably the biggest thing that will change.

Okay, thanks a lot, guys.

Thanks, Jaeson.

Take care.

Our next question comes from Mike Walkley with Canaccord Genuity. Please proceed with your question.

Hi, guys. Good morning. It's Daniel on for Mike. Thanks for taking my questions and congrats on the strong results. Can you just talk about how your vendors are dealing with some of the price pressures? And maybe how we should think about this impacting gross margins moving forward?

Our vendors are doing all they can to keep up with the demand that we're giving them, but it depends on who the vendor is. In some cases, and I mentioned Texas Instruments earlier, they are doing things to help and help will be on the way by 2024, which is not good enough for us. Other vendors, what they're doing is they're trying to shift the product to companies like us, who have tremendous demand and who are essential businesses. We are dealing with fire, and in many cases, we’re deemed an essential business. If they could shift the demand to us over other companies who may not be considered essential, then they'll shift it. We work with these vendors day in and day out. I do specifically, calling them letting them know what our needs are. You have to be the squeaky wheel. We're still in a crisis, and we believe it's helped because we believe that we've been able to deliver products and get our hands on these hard-to-get components better than our competition. The reason for that is one; we've been through these types of crises before, maybe not exactly like this, but we've been through this before. We have the experience, and we're relentless in trying to get what we need. This will go on for a few several more months, but we're not sitting back. We are developing alternatives that we can get our hands on that is better priced, and once that happens, then six months from now, you'll see a big change in the margins; pricing will be more normalized.

Right. And as a quick follow-up. Could you provide us with some details on how your higher margin projects such as schools and locking are trending?

Once the kids came back to school last September, we started to see the horrific events that we were used to when the kids were in school before that. The shootings I think like there was one every other week. When that started the activity for school security started to increase. We announced a few wins recently. We announced a win with Pepperdine University, who we've done five other jobs for. We announced a couple of wins, two very large school districts. Both districts have over 700 schools, big districts, big projects. Over time, they don't buy all the equipment they need for every school all at once. But over time they state the equipment they need. There is a tremendous demand that I believe is going to happen soon, because the schools don't want to wait anymore. The event in Texas where several elementary school kids were killed, the schools don't want to be the next one. This perhaps will be the last straw for many of these schools. There’s certainly money available. Dick mentioned in his remarks the State of Ohio money available for the K-12s. There are other states, the same thing has happened. The colleges and the universities have big endowments. Money is not an issue. Getting it done is the issue, getting to the point where these classrooms are locked from the inside and you don't have to run into the hallway and get somebody to lock it from the outside. That's the change that's coming, and so we've seen a lot of activity, and we think this is a big area that we bode very well for our business in the upcoming months.

Great. Thanks so much for the details.

You're welcome.

Our next question comes from Brian Ruttenbur with Imperial Capital. Please proceed with your question.

Great. Thank you very much. First of all, on cash generation. In fiscal '23, can you talk a little bit about what you anticipate? I assume that inventory levels won't be increasing at the level that they have historically?

So, Brian, we expect that inventory levels will come down. They're at very high levels now. Besides the fact that we're buying a lot of those hard-to-get components, we’re happy that we're doing that because that leads to the recurring revenue. Besides that, we're buying a lot of that, there are two other factors that are driving the inventory up. One is we are on the road to taking an alternate path to get those changed components of these alternative sources where we're buying basically two sets of parts and two sets of boards. We are transitioning into a new way of operating with the radios. It’s almost like we’re doubling our inventory level. That will do two things. It will help us in our cost structure going forward, but it will help us meet the demand of the products. We don't expect that backlog to be $10 million for too much longer. If that backlog dropped to just a couple of million, that's a big change in inventory. Also remember the inventory has higher overhead costs in it as well. And when we sell those products, that inventory is going to drop. Luckily, we have the cash to do this. Our cash at the end of June was about $46 million. If the inventory didn't grow the way it did, it would have been $66 million. We have the strong balance sheet to do whatever it takes to keep the lines moving, to keep the radios out there moving, to keep the recurring moving. We’ll do whatever it takes. I expect the inventory to drop. If it doesn't happen right away, but the sales remain strong and the recurring keeps going, which is what we expect to happen, and so be it. Our CapEx usually is about $1 million to $2 million a year. The only thing that would dramatically change that is if we get to the point where our building in the Dominican Republic which could handle $300 million annual revenue on three shifts. When we outgrow that we're going to need a second building. We have the land and the space, and that would be a very high-class problem to invest another $5 million or so to put up a second building to do another $300 million.

Our next question is from Raj Sharma with B. Riley. Please proceed with your question.

Hi. Thank you, guys. Excellent results. I congratulate you. I just have a question -- a couple of questions. Is it correct to assume that your revenues would have been higher by $10 million over a few quarters if you didn't have supply chain issues? And is this rise in the inventory costs the key cause of the operating cash flow impact? And if you -- these higher inventory costs will they impact your equipment margins in fiscal '23? Or do you expect the gross margins to hang in, if not improve because of the higher equipment revenues?

Okay. So Raj, on the first part. With a $10 million -- if we didn't have that $10 million backlog, yes, our sales would have been higher by $10 million. We did start the quarter with a $10 million backlog. So anyway, you want to look at it, our sales would have been higher. Typically historically, we don't have a backlog. Our backlog is usually a few hundred thousand dollars, up to a $1 million at most in the norm. This was 10 times that. Yes, the sales would have been higher. Will this keep up? Hard to say. I think it will. A lot of this is driven by us taking market share from the competition. We didn't really talk about it on this call, but as an example, with our radio business, we do business now with a lot of big players, the ADTs of the world, Johnson Controls, Siemens; these are big names and they were just getting started with them. Once they really start to roll, why wouldn't that demand keep up and then some? We have a very, very powerful offering. So we expect demand to continue and as far as the inventory and the cash flow, the inventory once that inventory that’s higher cost, because of overhead and higher pricing, once that sells, those are higher costs in our -- that will affect our gross margin. On the other side, we took a price increase in April, we took another one in July, we're going to go to alternative sources that are going to be much, much lower cost than what we've been spending now. We think in the end when it all shakes out, the higher inventory costs, but these other changes and improvements and a better mix also more school projects, which help the mix, all the divisions being up, which had better margins than the radios. We think when you push it all together, the overall margins will be better. Better than what they were pre-COVID days. That's our expectation. Cash flows will improve, the inventories will come down. Again we have the strength, we have the balance sheet to handle whatever is going to come our way. The last time we were in a big recession back in '08, we had no cash and lots of debt. It's a much different picture now to handle whatever comes our way having almost $50 million in cash and no debt.

Perfect. And then on the school wins. Were these existing customers or new customers? And also, could you comment on traction for Air Access and how do you see that playing out in the next few quarters?

The school wins, Pepperdine was one of them; that was probably the fifth or sixth time we've had a job through them with them. They are a customer for life. When we started with them, it started with they wanted to do the dorms, then they wanted to come back second time for classrooms, then they came back a third time they wanted to do the admin offices, they came back a fourth time they wanted to do off-site campuses because they have campuses all over the place. Now they've come back; they put up additional dorms and athletic buildings, so we just keep supplying them as their needs keep coming about. The other two were somewhat new. There were big school districts in the country; we can't really talk about who they were, it’s confidential, but they're big and they have over 700 schools in the district. Each one of them, our expectation is going to see more of this and the demand is going to pick up. It's hard for us to get asked this all the time how much is your school business, and we can't tell because many times the schools would buy directly from the integrator, who will buy directly from the distributor. We're not even involved. If it's large, we typically are involved, but many times we aren't. So we really don't know, but when we see the locking and the access business go up, because it affects both of those, we know that there is a lot of activity in schools, so that's happening. As far as Air Access, that's in the early stages. It was introduced recently. We believe it takes 18 months before it’s a real contributor. Right now we're not getting any recurring revenue from the schools. That would be one area where I would expect it eventually to contribute. We’re very encouraged. Everybody seems to be very excited about it. The locking guys and the access guys have never gotten recurring revenue before. This is going to give it to them, and we're going to get it as well. Just that one is going to take a little time; we don't even include whatever contribution Air Access is going to have when we project out to 2026, I'd say that our recurring revenue will be $150 million or sooner than 2026. We're not even counting that, but we do still have high expectations for that product line.

Great. Thank you. Thank you, that was splendid. Thank you for the excellent color. I'll take my questions offline. Thanks.

Thanks.

We have reached the end of the question-and-answer session. I'd now like to turn the call back over to Richard Soloway for closing comments.

Thank you, everyone, for participating in today's conference call. As always, should you have any further questions, please feel free to call Patrick, Kevin, or myself for further information. We thank you for your interest and support and we look forward to speaking to you all again in a few months to discuss Napco's fiscal Q1 ‘23 results. Have a wonderful day, everybody.

This concludes today's conference. You may disconnect your lines at this time. And we thank you for your participation.