NAPCO Security Technologies, Inc. — Form 10-Q Summary
Reporting period: First quarter of fiscal 2020, the three months ended September 30, 2019; comparisons are with the three months ended September 30, 2018 unless stated otherwise. The filing was signed November 8, 2019. NAPCO manufactures security products and provides wireless alarm communication services. Its fiscal first quarter is seasonally softer; sales historically peak in the April–June quarter.
Financial performance
| Metric | Q1 FY2020 | Q1 FY2019 | Change |
|---|---|---|---|
| Net sales | $26.285 million | $23.376 million | +12.4% |
| Gross profit / margin | $11.518 million / 43.8% | $9.559 million / 40.9% | Margin +2.9 percentage points |
| Operating income / margin | $3.609 million / 13.7% | $1.759 million / 7.5% | Operating income +105.2% |
| Net income | $3.233 million | $1.504 million | +115.0% |
| Diluted EPS | $0.17 | $0.08 | Up $0.09 |
| Operating cash flow | $2.927 million | $3.119 million | Down $0.192 million |
| Cash and cash equivalents | $10.774 million | $8.028 million at June 30, 2019 | Up $2.746 million |
Equipment revenue was $20.921 million, up 6.8%; service revenue was $5.364 million, up 41.7%. Management attributed the sales increase primarily to communication services (+$1.578 million), intrusion and access products (+$0.922 million), and door-locking products (+$0.409 million). SG&A was $6.160 million, or 23.4% of sales versus 25.9%; R&D was $1.749 million, broadly unchanged. The effective income tax rate was 10%, compared with 14%.
Capital expenditures were $0.181 million, leaving operating cash flow less capital expenditures of approximately $2.746 million. Inventory increased $2.402 million from June 30 to $37.240 million, including $6.100 million classified as non-current. Accounts receivable was $24.730 million. Current assets were $68.668 million and current liabilities $15.090 million.
There were no borrowings under the $11 million revolving facility, which expires in June 2021; the filing reported $11 million of availability. Total liabilities were $23.026 million, including $7.384 million of operating lease liabilities. The Company reported no material debt borrowings.
Changes, outlook and risks
- Revenue growth and improved gross margin drove higher operating income and net income. Operating expenses rose only modestly. Despite higher net income, operating cash flow declined year over year, with inventory investment a significant use of cash.
- Management said working capital, operating cash flows, and the credit facility should fund operations for the next 12 months. No specific revenue or earnings guidance was provided. Management noted that results are seasonal and affected by housing and construction activity, production levels, and factory utilization.
- Effective July 1, 2019, adoption of lease accounting Topic 842 resulted in recognition of approximately $7.7 million of operating lease right-of-use assets and lease liabilities. The principal disclosed lease is a Dominican Republic land lease running to 2092; the filing reports a 72-year weighted-average remaining lease term.
- The IRS proposed a fiscal 2016 tax adjustment related to IRC Section 956 that could create approximately $1.8 million of additional tax, excluding interest and penalties. NAPCO protested the proposed adjustment, believes its tax position is correct, and recorded no additional reserve; there is no assurance it will prevail. The Company also reported $171,000 of unrecognized net tax benefits.
- One customer represented 13% of quarterly sales and 24% of receivables at September 30, 2019. Management identified economic and market conditions, product competitiveness, offshore tax consequences, Dominican peso movements, and dependence on the CEO for strategic planning among relevant risks. A 10% strengthening or weakening of the U.S. dollar against the Dominican peso was estimated to change annual operating income by approximately $0.7 million.
- Management said ordinary-course claims and litigation, in aggregate, were not expected to materially adversely affect financial position or results. It reported no material change to risk factors in the fiscal 2019 Form 10-K. Disclosure controls were assessed as effective, with no materially affecting change in internal control over financial reporting during the quarter.
Most important facts for investors to verify
- Whether service revenue growth and the improved gross margin persist, particularly given seasonality and customer demand conditions.
- Inventory levels, non-current inventory, and cash conversion; operating cash flow was below the prior-year quarter despite substantially higher net income.
- Resolution and potential financial impact of the IRS Section 956 dispute, for which no additional reserve was recorded.
- Customer concentration and collection exposure, including the leading customer’s 24% share of receivables.
- Availability and covenant terms of the secured revolving credit facility, and the effects of the long-term Dominican Republic lease and currency exposure.