NAPCO Security Technologies, Inc. — Form 10-Q Summary
Reporting period: The quarter ended September 30, 2018, the first quarter of NAPCO’s fiscal 2019 (not calendar-year 2018 Q1). The filing’s interim financial statements are unaudited. Unless noted otherwise, dollar amounts below are in millions.
Business context and financial results
NAPCO manufactures and sells security products, including access control, door-locking, intrusion and fire alarm, and video-surveillance products, and provides alarm communication services. Sales are primarily through independent distributors, dealers, and installers. The company operates as one reportable segment. Sales are typically seasonally lower in the July–September fiscal first quarter and peak in the April–June fourth quarter.
| Metric | Q1 FY2019 | Q1 FY2018 | Change |
|---|---|---|---|
| Net sales | $23.376 | $21.174 | +10.4% |
| Gross profit / margin | $9.559 / 40.9% | $8.486 / 40.1% | +12.6%; +0.8 percentage points |
| Operating income / margin | $1.759 / 7.5% | $1.059 / 5.0% | +66.1% |
| Net income | $1.504 | $0.890 | +69.0% |
| Diluted EPS | $0.08 | $0.05 | Up $0.03 |
| Operating cash flow | $3.119 | $1.501 | +$1.618 |
Revenue growth reflected higher communication-service revenue (up $1.219 million), intrusion and access product sales (up $0.581 million), and door-locking product sales (up $0.402 million). Equipment revenue was $19.590 million versus $18.586 million; service revenue was $3.786 million versus $2.588 million. The revenue note reports prior-period services of $2.567 million, which does not match the income statement; investors may wish to verify the presentation.
Research and development expense rose to $1.745 million from $1.607 million, primarily due to salaries and added personnel. Selling, general and administrative expense rose to $6.055 million from $5.820 million, mainly reflecting higher executive incentive compensation, but declined as a share of sales to 25.9% from 27.5%. Net interest expense was $7,000 versus $26,000. The income-tax provision was $248,000 versus $143,000; the reported effective tax rate was 14% in both periods.
Cash flow, liquidity, and debt
- Cash and cash equivalents were $7.469 million at September 30, up from $5.308 million at June 30, 2018. Cash increased $2.161 million during the quarter.
- Operating cash flow of $3.119 million was partly used for capital expenditures of $424,000 and share repurchases of $549,000. Investing cash flow was negative $424,000; financing cash flow was negative $534,000.
- Current assets were $56.861 million and current liabilities were $13.125 million, for working capital of $43.736 million. Current liabilities increased from $9.402 million at June 30, mainly due to accrued expenses.
- No revolving-credit borrowings were outstanding. The $11 million facility, expiring in June 2021, was fully available, subject to borrowing-base terms and financial covenants. The company said working capital, operating cash flow, and the facility should fund operations for at least the next 12 months.
- Inventories totaled $30.240 million, including $5.082 million classified as non-current; total inventory increased from $28.934 million at June 30. Management attributed the increase to inventory for new service-related devices and production level-loading.
Material changes, outlook, and risks
- Revenue-recognition adoption: NAPCO adopted ASC 606 on July 1, 2018 using the modified retrospective method. Adoption reduced opening retained earnings by approximately $720,000, net of a $191,000 tax benefit, primarily from revised variable-consideration accounting. It increased sales-allowance reserves by a net $1.627 million and recorded approximately $716,000 of return-related assets. Certain reserves were presented as current refund liabilities rather than reductions to receivables. The company said the standard’s effect on Q1 product sales was immaterial.
- Outlook: No specific financial guidance was provided. Management said products resulting from fiscal 2019 R&D investment are not expected to contribute materially to revenue in fiscal 2019, though they may benefit later years. The company generally devotes 6–8% of annual revenue to R&D.
- Risks and sensitivities: Management cited economic conditions, housing and construction demand, product competitiveness, tax consequences of offshore operations, financing availability, and dependence on the CEO for strategic planning. A 10% strengthening or weakening of the U.S. dollar against the Dominican peso was estimated to change annual operating income by approximately $630,000. Foreign sales are denominated in U.S. dollars, which may affect foreign customers’ ability to pay or maintain orders.
- Controls: The company reported that disclosure controls and procedures were ineffective at September 30, 2018. Management identified a material weakness involving insufficient supervision and review to ensure proper internal control over financial reporting, and expected remediation during fiscal 2019. No material change in internal controls during the quarter was reported.
- Other items: NAPCO repurchased 39,163 shares at an average $14.02 per share, leaving 169,627 shares available under the repurchase plan. Management said ordinary-course litigation, in aggregate, was not expected to have a material adverse effect. Cash balances exceeded applicable deposit-insurance limits, although the company reported no historical losses on such balances.
Important facts for investors to verify
- Track service-revenue growth, product-line performance, and the noted difference in comparative service-revenue figures.
- Assess inventory growth, non-current inventory, and the adequacy of reserves for returns, rebates, and obsolete inventory.
- Review the ASC 606 opening-equity adjustment and the ongoing effect of refund liabilities and return-related assets.
- Monitor remediation of the material weakness and confirm whether disclosure controls become effective.
- Check liquidity and compliance with credit-facility covenants, as well as the impact of seasonality and Dominican-peso movements.