NAPCO Security Technologies, Inc. — Form 10-Q Summary
Period: Quarter and nine months ended March 31, 2019; unaudited. Although the request labels this “2018 Q3,” the filing covers fiscal 2019 third quarter.
Business context
NAPCO manufactures security and access-control products and provides recurring alarm communication services. It sells primarily through independent distributors, dealers and installers. The company reports one operating segment. Sales are seasonal, historically peaking in the fiscal fourth quarter (April–June).
Key financial results
| Metric | Three months ended March 31 | Nine months ended March 31 |
|---|---|---|
| Net sales | $25.143 million, up 13.3% from $22.200 million | $73.348 million, up 13.7% from $64.486 million |
| Gross profit / margin | $10.729 million / 42.7%, versus $8.892 million / 40.1% | $30.959 million / 42.2%, versus $25.857 million / 40.1% |
| Operating income | $3.647 million, up 90.7% | $8.700 million, up 110.3% |
| Net income | $3.122 million, or $0.17 diluted EPS; prior year $1.829 million, or $0.10 | $7.495 million, or $0.40 diluted EPS; prior year $3.952 million, or $0.21 |
| Operating cash flow | Not separately presented for the quarter | $5.763 million, versus $4.687 million |
- Quarterly revenue growth reflected higher communication service revenue (+$1.388 million), intrusion/access products (+$1.254 million) and door-locking products (+$0.301 million). For nine months, services contributed $3.916 million of the sales increase.
- Quarterly and nine-month R&D expense was $1.851 million and $5.358 million, respectively. SG&A was $5.231 million and $16.901 million. SG&A as a share of sales declined to 20.8% and 23.0%, respectively.
- Effective tax rates were 14% for both 2019 periods, versus 3% in the comparable 2018 periods. The filing cites the first-time application of GILTI and higher pretax income.
- Cash and cash equivalents were $5.499 million at March 31, 2019, compared with $5.308 million at June 30, 2018. Total liabilities were $13.188 million; no debt was drawn on the $11 million revolving facility, which expires June 2021.
- Working-capital items included inventories of $34.574 million, up $5.640 million since June 30, 2018, including $5.875 million classified as non-current. The company attributed the inventory build to new devices supporting service revenue and production level-loading.
- Nine-month investing cash use was $1.598 million, principally capital expenditures; financing cash use was $3.974 million, including $3.998 million of share repurchases. The company repurchased 274,065 shares during the nine months at a weighted-average $14.59 per share.
Changes, outlook and risks
- Growth in revenue, gross margin and operating income was accompanied by higher R&D costs and a substantially higher tax provision. Management attributed gross-margin improvement primarily to increased sales and operating leverage.
- Management stated that working capital, operating cash flow and the revolving facility should fund operations for the next 12 months. No specific revenue or earnings guidance was provided. Management said fiscal 2019 R&D investments were not expected to contribute materially to revenue that year, though they may benefit future years.
- Adoption of ASC 606 on July 1, 2018 reduced opening retained earnings by approximately $720,000, net of tax. It also changed the presentation of certain reserves; the impact on current-period product sales was described as immaterial.
- The IRS proposed a fiscal 2016 tax adjustment relating to deemed dividends under IRC Section 956. The potential incremental liability is approximately $1.8 million, excluding interest and penalties. NAPCO disputes the position and recorded no additional reserve; management said it believes it will prevail but acknowledged no assurance of a favorable outcome.
- Disclosure controls and procedures were not effective as of March 31, 2019. Management identified a material weakness involving insufficient supervision and review over financial reporting and said remediation was being designed, with completion expected during fiscal 2019.
- Other risks include customer concentration (one customer represented 14% of quarterly sales and 12% of nine-month sales), economic and housing-market sensitivity, dependence on the CEO, and foreign-exchange exposure to Dominican-peso expenses. Management estimated a 10% U.S. dollar move against the Dominican peso would change annual operating income by approximately $630,000.
- Management said ordinary-course litigation was not expected to have a material adverse effect. The filing also notes that deterioration in economic conditions could affect demand, collections and cash flow.
Important facts for investors to verify
- Whether the company remediated the disclosed material weakness and established effective controls.
- Developments in the IRS Section 956 dispute and potential exposure beyond the stated $1.8 million.
- Inventory levels, conversion of non-current inventory to sales, and operating cash flow given the inventory-related cash use.
- Sustainability of service-revenue growth and the reported margin improvement, particularly through the seasonally important fourth quarter.
- Customer concentration, availability under the borrowing-base facility, and Dominican-peso sensitivity.