Business context and reporting period
NAPCO Security Technologies, Inc. designs and sells electronic security equipment, including access-control, door-locking, intrusion and fire-alarm, and video-surveillance products; it also provides recurring wireless alarm-communication services. This unaudited Form 10-Q covers the three months ended September 30, 2020, the company’s fiscal first quarter of 2021, compared with the same quarter of 2019. Results are affected by normal seasonality: equipment sales historically peak in the fiscal fourth quarter and are lower in the July–September quarter.
Financial performance and position
| Metric | Q1 FY2021 | Q1 FY2020 | Change |
|---|---|---|---|
| Net sales | $23.173 million | $26.285 million | Down 11.8% |
| Equipment revenue | $15.898 million | $20.921 million | Down 24.0% |
| Service revenue | $7.275 million | $5.364 million | Up 35.6% |
| Gross profit / gross margin | $10.692 million / 46.1% | $11.518 million / 43.8% | Profit down 7.2% |
| Operating income | $2.654 million | $3.609 million | Down 26.5% |
| Net income | $2.319 million | $3.233 million | Down 28.3% |
| Diluted earnings per share | $0.13 | $0.17 | Down $0.04 |
| Operating cash flow | $3.765 million | $2.927 million | Up $0.838 million |
Service gross profit was $6.101 million, or 83.9% of service sales, versus $4.235 million, or 79.0%, a year earlier. Equipment gross profit was $4.591 million, or 28.9% of equipment sales, versus $7.283 million, or 34.8%. Research and development expense rose 8.0% to $1.889 million; selling, general and administrative expense was nearly unchanged at $6.149 million.
Cash and cash equivalents were $21.870 million at September 30, 2020, up from $18.248 million at June 30, 2020. Operating cash flow less $143,000 of capital spending resulted in a $3.622 million increase in cash. Total assets were $106.028 million and stockholders’ equity was $80.324 million. Debt totaled $3.904 million in PPP loans at 1% interest; there were no revolver borrowings and $11 million of revolving-credit availability. The company reported current assets of $76.549 million and current liabilities of $13.855 million. It stated working capital, operating cash flow and the credit facility should fund operations for the next 12 months.
Material changes, outlook and risks
Management attributed weaker equipment sales primarily to COVID-19-related difficulty accessing commercial and residential installation sites, particularly affecting door-locking products. It characterized the access issue as industry-wide and said it did not believe it reflected company-specific market-share losses or lasting weakness in the industry. Recurring service revenue continued to grow; management cited higher service volume and a favorable shift toward higher-margin service plans. No specific revenue or earnings guidance was provided.
Inventory increased to $42.443 million from $41.755 million at June 30, including a rise in non-current inventory to $8.915 million from $6.524 million. Management linked this to lower-than-planned demand, production planning and overseas supply-chain lead times of 30–90 days. The company said it deferred open purchases, though substantial deliveries had already arrived.
The $3.904 million PPP loan remained recorded as debt. NAPCO anticipated applying for forgiveness during fiscal 2021, but forgiveness is subject to SBA approval and is not assured. The revolving credit agreement was amended in September 2020 to extend maturity to June 2024, remove certain restrictions and release the mortgage on the Amityville facility; financial covenants and other restrictions remain.
Tax matters include an ongoing IRS audit of fiscal 2017 concerning the IRC Section 956 issue, which the company disputes and says it may litigate. The filing reports $918,000 of unrecognized net tax benefits and accrued tax-related interest of $92,000. The company also disclosed ordinary-course claims and litigation, which management does not expect in aggregate to materially adversely affect financial position or results. Foreign-exchange exposure includes Dominican-peso expenses: a 10% strengthening or weakening of the U.S. dollar was estimated to change annual operating income by approximately $700,000. Management reported disclosure controls were effective and no material change in internal controls during the quarter.
Important facts for investors to verify
- Whether COVID-related installation-site access constraints and reduced equipment demand persist, and whether recurring service growth continues to offset hardware weakness.
- Inventory conversion, especially the increase in inventory classified as non-current, and any resulting obsolescence or cash-flow effects.
- Whether the company obtains full or partial forgiveness of the $3.904 million PPP loan, and the timing and conditions of any SBA decision.
- Developments in the IRS fiscal 2017 audit and potential tax, interest or litigation outcomes.
- Compliance with credit-facility covenants and the adequacy of liquidity if sales or customer collections weaken.
- Customer concentration and collections: certain customers represented 11%–12% each of receivables at quarter-end.