NAPCO Security Technologies, Inc. — Form 10-Q
Business context and reporting period. This unaudited filing covers the fiscal second quarter and six months ended December 31, 2022; comparisons are with the corresponding 2021 periods. NAPCO designs and manufactures electronic security products, school safety solutions, and provides recurring wireless communication services for alarm systems. It sells primarily through independent distributors, dealers, and installers. Hardware sales are seasonal, typically peaking in the fiscal fourth quarter.
Financial performance
| Metric | Three months ended Dec. 31, 2022 | Three months ended Dec. 31, 2021 | Six months ended Dec. 31, 2022 | Six months ended Dec. 31, 2021 |
|---|---|---|---|---|
| Net sales | $42.3 million | $33.4 million | $81.8 million | $64.5 million |
| Gross profit / margin | $19.5 million / 46.0% | $11.4 million / 34.3% | $37.6 million / 46.0% | $24.9 million / 38.6% |
| Operating income | $9.4 million | $1.3 million | $16.7 million | $5.4 million |
| Net income | $8.4 million | $1.0 million | $14.8 million | $8.8 million |
| Diluted EPS | $0.23 | $0.03 | $0.40 | $0.24 |
- Revenue mix and growth: Quarterly equipment revenue rose 22.6% to $27.4 million and service revenue rose 34.9% to $14.9 million. For the six months, equipment revenue increased 22.9% and service revenue increased 35.0%. Service revenue represented about 35% of quarterly and six-month sales.
- Profitability: Quarterly operating income increased to $9.4 million from $1.3 million; six-month operating income rose to $16.7 million from $5.4 million. The filing attributes stronger gross profit and margins to sales growth, improved component availability and lower component and transportation costs, improved overhead absorption, and higher-margin fire-radio service revenue.
- Cash flow: Six-month operating cash flow was $1.1 million, down from $7.8 million. Inventory growth used $14.8 million of cash, partly offset by an $8.3 million reduction in receivables. Investing activities used $10.9 million, including $10.1 million for marketable securities and other investments and $0.8 million for capital expenditures.
- Liquidity and debt: At December 31, cash and cash equivalents were $32.0 million, investments-other were $10.1 million, and marketable securities were $5.0 million. Current assets were $119.6 million and current liabilities $18.0 million. No borrowings were outstanding under the $11.0 million revolving facility, which expires in June 2024. Total liabilities were $24.9 million.
- Working capital: Total inventory increased $14.4 million from June 30 to $64.2 million, including $15.5 million classified as non-current. Management cited precautionary radio inventory and purchases of hard-to-source components. Receivables declined $8.2 million to $21.0 million, partly reflecting seasonal sales and unusually high June 2022 shipments.
Changes, outlook, and risks
- Quarterly net sales grew 26.7% and six-month net sales grew 26.9%. Management linked equipment growth to customer demand recovering after pandemic-related declines, alongside growth in recurring services and door-locking products.
- Six-month net income rose 68.9%, but the comparison is affected by a $3.9 million PPP loan-forgiveness gain recorded in the prior-year period. Excluding that gain, prior-year six-month net income and diluted EPS would have been approximately $4.9 million and $0.13, respectively. There was no corresponding gain in the current period.
- No quantified revenue or earnings guidance is provided. Management believes working capital, operating cash flows, and the revolving credit agreement will fund operations for at least the next 12 months, and expects inventory to decrease as supply-chain challenges subside.
- Risks include economic deterioration affecting demand and customer collections; supply interruptions and inventory obsolescence; hardware seasonality and exposure to housing and construction markets; customer concentration in receivables; and foreign-currency exposure to Dominican-peso expenses. Management estimates a 10% U.S. dollar move against the Dominican peso would change annual operating income by approximately $944,000.
- Two previously identified material weaknesses in internal control over financial reporting remained unresolved at December 31, 2022: IT general controls (user access and program change management) and controls over excess and slow-moving inventory reserves. Management said remediation was in progress and expected completion during fiscal 2023. The filing states the weaknesses had not caused identified financial-statement misstatements.
- Other items: the Dominican Republic facility lease was modified in September 2022, reducing the lease asset and liability by $1.3 million. The company reported routine litigation and believes aggregate settlement will not materially affect its financial position or results. It reported no material change to previously disclosed risk factors.
Key facts for investors to verify
- Whether recurring service growth and the reported margin improvement continue, and how much depends on component availability, freight costs, and product mix.
- Whether inventory levels and cash conversion improve, given the substantial inventory build and low operating cash flow relative to net income.
- Progress and completion of remediation for the two material weaknesses, especially inventory-reserve review controls.
- Availability and covenant compliance under the $11.0 million revolving facility, including the transition from LIBOR after June 30, 2023.
- How current-period earnings compare with prior periods after accounting for the prior-year PPP forgiveness gain and differing effective tax rates.