NAPCO Security Technologies, Inc. — Form 10-Q
Reporting period: Fiscal second quarter and six months ended December 31, 2020. Unless noted otherwise, amounts are in millions; quarterly and six-month results are compared with the periods ended December 31, 2019.
Business context
NAPCO designs and sells electronic security equipment, including intrusion and access systems, door-locking products, and school-safety solutions, and provides recurring wireless alarm-communication services. Equipment sales remained affected by COVID-19-related installation-site access and economic disruption, while recurring service revenue continued to grow. Management reported strong distributor sell-through. Sales are seasonal, typically peaking in the fiscal fourth quarter.
Financial results
| Metric | Three months | Six months |
|---|---|---|
| Net sales | $27.205 million, up 5.3% | $50.378 million, down 3.3% |
| Equipment revenue | $19.016 million, down 5.1% | $34.914 million, down 14.8% |
| Service revenue | $8.189 million, up 41.6% | $15.464 million, up 38.7% |
| Gross profit / margin | $11.403 million / 41.9% | $22.095 million / 43.9% |
| Operating income | $3.669 million, down 8.1% | $6.323 million, down 16.8% |
| Net income | $3.197 million, down 10.5% | $5.516 million, down 18.9% |
| Diluted EPS | $0.17, versus $0.19 | $0.30, versus $0.37 |
Service gross margin increased to 85.3% for the quarter and 84.6% for the six months, while equipment gross margin fell to 23.2% and 25.8%, respectively. Management attributed weaker equipment profitability to lower sales, product mix, reduced production and purchasing levels, and lower overhead absorption. Higher-margin service growth and lower SG&A partially offset that pressure.
Cash flow and liquidity: Six-month operating cash flow was $8.937 million, compared with $4.813 million a year earlier. Capital spending was $0.389 million; cash increased $8.548 million to $26.796 million. At December 31, current assets were $79.262 million and current liabilities $13.479 million. The company had $3.904 million of PPP loans outstanding, no borrowings on its $11 million revolving facility, and $11 million of revolver availability. The revolver expires in June 2024. Total reported debt was $3.904 million; the PPP loans bear 1% interest.
Changes, outlook, risks and unusual items
- Quarterly sales growth came from a $2.405 million increase in recurring services and higher intrusion/access sales, offset by a $1.492 million decline in door-locking products. For the six-month period, service growth was more than offset by lower door-locking and intrusion/access sales.
- Inventory declined $3.719 million from June 30, 2020, while the non-current inventory balance increased $2.129 million to $8.653 million. Management linked the non-current increase to reduced production planning amid pandemic-related demand changes.
- Management said cash, operating cash flow and the revolving facility should fund operations for at least the next 12 months. The filing provides no specific revenue or earnings guidance. Management noted improving distributor sell-through, but warned that economic deterioration could affect sales, collections and cash flow.
- The company expected to apply for forgiveness of its $3.904 million PPP loans during fiscal 2021. Forgiveness is subject to SBA approval and documentation; the company cautioned that full or partial forgiveness is not assured and could be challenged in an audit.
- The IRS’s fiscal 2017 audit includes a disputed Section 956 issue. The company stated it believes the IRS position is inconsistent with the law and is willing to litigate if necessary. It reported $0.918 million of unrecognized net tax benefits and $0.100 million of accrued tax interest at December 31, 2020.
- A secondary offering by the chairman and president involved 2,668,032 shares, including the underwriters’ additional purchase. NAPCO received no proceeds and recorded $0.289 million of offering expenses in SG&A.
- Customer concentration is notable: one customer represented 14% of quarterly sales and 18% of receivables at December 31; two additional customers each represented 12% and 11% of receivables. A 10% U.S. dollar move against the Dominican peso would, according to the filing, change annual operating income by approximately $0.7 million.
- The filing reported no material change in previously disclosed risk factors. It also stated disclosure controls were effective and no material change in internal control over financial reporting occurred during the quarter.
Important facts for investors to verify
- PPP loan forgiveness status, timing, and any SBA review or repayment obligation.
- Whether equipment margins and door-locking demand recover, and whether the increase in non-current inventory creates obsolescence or realization risk.
- Progress and potential financial exposure from the fiscal 2017 IRS audit and related tax positions.
- Exposure to major customers and Dominican-peso operating costs, as well as the effect of COVID-19 on installation access and demand.
- The filing contains small MD&A-versus-financial-statement differences: quarterly sales are stated as $27.207 million in one MD&A passage versus $27.205 million in the income statement, and operating cash flow is cited as $8.938 million versus $8.937 million. Verify against the filed financial statements and XBRL data.