NAPCO Security Technologies, Inc. — Q2 FY2019 Form 10-Q
Reporting period: Quarter and six months ended December 31, 2018; fiscal year ends June 30. The company manufactures and sells security equipment and provides alarm communication services. Figures below are in millions of dollars unless otherwise noted.
Financial results
| Metric | Three months ended Dec. 31, 2018 | Year-over-year change | Six months ended Dec. 31, 2018 | Year-over-year change |
|---|---|---|---|---|
| Net sales | $24.829 | +17.6% | $48.205 | +14.0% |
| Gross profit / margin | $10.671 / 43.0% | +25.9% / +2.8 percentage points | $20.230 / 42.0% | +19.2% / +1.9 percentage points |
| Operating income | $3.294 | +182.5% | $5.053 | +127.1% |
| Net income | $2.869 | +132.7% | $4.373 | +106.0% |
| Diluted EPS | $0.15 | vs. $0.07 | $0.23 | vs. $0.11 |
- Quarterly sales gains came from door-locking products (+$1.325 million), communication services (+$1.309 million), and intrusion/access products (+$1.083 million). For the six-month period, services contributed the largest increase (+$2.528 million).
- SG&A was 22.6% of quarterly sales and 24.2% of six-month sales, down from 26.9% and 27.2%, respectively. R&D expense increased 7.5% for the quarter and 8.0% for the half year.
- Six-month operating cash flow was $6.346 million, compared with $2.824 million a year earlier. Capital spending was $1.119 million; treasury-stock purchases used $2.638 million. Cash increased to $7.921 million from $5.308 million at June 30, 2018.
- At December 31, cash was $7.921 million, current assets $56.516 million, and current liabilities $13.242 million. Total liabilities were $13.656 million. The company had no borrowings on its $11 million revolving credit facility, which expires in June 2021.
- Inventory totaled $33.183 million, including $6.067 million classified as non-current, up from $28.934 million at June 30. Management attributed the increase to inventory for new service-related devices and level-loaded production.
Changes, outlook, and risks
- Management attributed higher gross profit primarily to sales growth. The filing also notes that higher production and factory utilization can spread fixed costs over more output; results are subject to seasonal demand, which historically peaks in the fiscal fourth quarter.
- Napco adopted ASC 606 on July 1, 2018 using the modified retrospective method. Adoption reduced opening retained earnings by approximately $720,000 after tax. It also changed the presentation of certain refund liabilities and return-related assets; the reported impact on current-period product sales was immaterial.
- Management said working capital, operating cash flows, and the credit facility should fund operations for at least the next 12 months. It did not provide numerical revenue or earnings guidance. R&D products are not expected to contribute materially to fiscal 2019 revenue, though they may benefit later years.
- The IRS proposed an approximately $1.8 million additional tax liability, excluding interest and penalties, concerning fiscal 2016 deemed dividends under IRC Section 956. Management disputes the adjustment and recorded no additional reserve, but acknowledged the matter may not be resolved in its favor.
- The company reported ineffective disclosure controls as of December 31, 2018, citing a previously identified material weakness involving insufficient supervision and review over financial reporting. Management was designing remediation and expected to complete it during fiscal 2019.
- Other disclosed risks include reliance on the CEO, economic and construction-market conditions, customer credit and collections, and Dominican peso exposure. Management estimated that a 10% U.S. dollar move against the Dominican peso would change annual operating income by approximately $630,000. One customer represented 12% of quarterly and 11% of six-month sales.
- Sales returns, rebates, and allowances were 5% of gross sales for the quarter and 7% for the half year, versus 8% in both prior-year periods. Management stated ordinary-course litigation was not expected to have a material adverse effect.
Key facts investors should verify
- Whether revenue and margin growth continue, and how much is attributable to recurring service revenue versus equipment sales.
- Inventory growth, non-current inventory, and the conversion of inventory into sales and cash.
- The resolution and potential financial impact of the IRS proposed adjustment, including any interest or penalties.
- Progress and effectiveness of remediation for the disclosed material weakness in internal controls.
- Customer concentration, collections, and the impact of currency changes on Dominican Republic operating costs.
- Effects of the ASC 606 presentation and opening-retained-earnings adjustment when comparing periods.