NAPCO Security Technologies, Inc. — Form 10-Q Summary
Reporting period: Quarter and nine months ended March 31, 2020, filed May 6, 2020. Although the request identifies “2019 Q3,” this filing covers fiscal third-quarter 2020. Amounts below are in U.S. dollars; financial statement figures are generally in millions.
Business context and results
NAPCO manufactures security, access-control, door-locking, alarm and video-surveillance products and provides recurring wireless communication services. Its fiscal year ends June 30; sales historically peak in the fiscal fourth quarter. Results through March 31 preceded the full impact of COVID-19, which management said remained uncertain.
| Metric | Three months ended March 31, 2020 | Year-over-year | Nine months ended March 31, 2020 | Year-over-year |
|---|---|---|---|---|
| Net sales | $26.24 million | +4.4% | $78.35 million | +6.8% |
| Gross profit / margin | $11.96 million / 45.6% | 42.7% prior-year margin | $35.60 million / 45.4% | 42.2% prior-year margin |
| Operating income | $4.05 million | +10.9% | $11.65 million | +33.9% |
| Net income | $3.62 million; diluted EPS $0.20 | +15.8%; EPS was $0.17 | $10.42 million; diluted EPS $0.56 | +39.0%; EPS was $0.40 |
| Operating cash flow | Not presented for the quarter | — | $6.61 million | $5.76 million prior year |
Recurring service revenue drove growth: it increased 37% in the quarter to $6.23 million and 39% for the nine months to $17.38 million. Equipment revenue was comparatively flat over nine months; door-locking sales declined, partly offset by intrusion and access-product growth. Management attributed improved gross margins primarily to the greater service-revenue mix. SG&A rose 16.5% in the quarter, including higher advertising, sales staffing and salaries, bad-debt reserves related to economic conditions, and stock-option expense.
Cash, liquidity and capital
- Cash was $11.04 million at March 31, 2020, versus $8.03 million at June 30, 2019. Current assets were $70.92 million and current liabilities $13.87 million; working capital was approximately $57.05 million.
- Nine-month operating cash flow of $6.61 million was offset by $1.33 million of reported property and equipment purchases and $2.35 million spent repurchasing shares. Cash increased $3.01 million.
- No revolving-credit borrowings were outstanding. The company had an $11 million asset-secured facility, expiring June 2021, with $11 million available, subject to borrowing-base limits and financial covenants. Interest expense was minimal; the filing reports no other outstanding debt.
- Inventory increased to $42.64 million from $34.84 million, including non-current inventory of $8.02 million versus $5.26 million. Management cited new devices supporting recurring services and production level-loading.
- Share repurchases totaled 137,303 shares for $2.35 million during the nine months; 297,422 shares remained authorized for repurchase at period-end.
Material developments, outlook and risks
- COVID-19: Management said the pandemic had not adversely affected operations or results through March 31, but expected economic effects to worsen and persist for an indeterminate period. Risks include weaker customer demand and collections, increased bad debts, supplier interruptions, employee availability and possible impairment charges. The overall impact could not be estimated.
- Subsequent event: In April 2020, the company received $1.054 million under the PPP, bearing 1% interest and maturing in April 2022. Some or all may be forgiven, subject to requirements; forgiveness was uncertain.
- Intangible asset: A decline in revenue associated with the Marks trade name triggered an impairment assessment. A preliminary analysis found no impairment at March 31, but management said conditions were difficult to assess and planned further evaluation with its fiscal fourth-quarter annual impairment test. A future impairment could be material.
- Tax contingency: The IRS proposed approximately $1.8 million of additional tax, excluding interest and penalties, related to fiscal 2016. NAPCO contested the proposed adjustment and recorded no additional reserve, while acknowledging there was no assurance it would prevail. The IRS also notified the company of an examination of its fiscal 2017 return.
- Other commitments: Adoption of lease accounting resulted in recognition of a $7.4 million operating-lease asset and liability, principally associated with a 99-year Dominican Republic land lease. Management considered ordinary-course litigation, in aggregate, not expected to materially affect financial position or results.
- Management said existing working capital, operating cash flows and the revolving facility should fund operations for at least the next 12 months. The filing provides no quantified revenue or earnings guidance. Results are seasonal and sensitive to housing and construction markets; management also identified customer concentration, fixed manufacturing costs, and Dominican peso exposure. A 10% U.S. dollar movement against the peso was estimated to change annual operating income by approximately $0.7 million.
Important facts for investors to verify
- Whether COVID-19 subsequently affected sales, customer collections, bad-debt reserves, suppliers or operating capacity, and whether the PPP loan was forgiven or repaid.
- Results of the fiscal fourth-quarter trade-name impairment assessment and any resulting charge.
- Outcome and potential exposure of the disputed $1.8 million IRS proposal and the fiscal 2017 examination.
- Inventory conversion and obsolescence, given the increase in total and non-current inventory, and the adequacy of liquidity if demand weakens.
- Customer concentration: one customer represented 24% of receivables at March 31, 2020; another represented 13%.