NAPCO Security Technologies, Inc. — FY2018 Form 10-K
Reporting period: Fiscal year ended June 30, 2018. This annual report also presents unaudited fourth-quarter results. Financial amounts below are in millions of dollars unless otherwise stated.
Business context
NAPCO manufactures security and access-control equipment, door-locking products, intrusion and fire alarm systems, and video surveillance products; it also provides wireless alarm communication services. It sells mainly through independent distributors, dealers and installers. Most manufacturing takes place in the Dominican Republic. Sales are seasonal, historically strongest in the fiscal fourth quarter.
Financial performance and liquidity
| Metric | FY2018 | FY2017 | Change |
|---|---|---|---|
| Net sales | $91.746 | $87.374 | +5.0% |
| Gross profit | $37.995 | $36.301 | +4.7% |
| Gross margin | 41.4% | 41.5% | -0.1 percentage point |
| Operating income | $8.414 | $6.378 | +31.9% |
| Net income | $7.649 | $5.599 | +36.6% |
| Diluted EPS | $0.41 | $0.30 | +$0.11 |
| Cash from operations | $7.865 | $2.448 | +$5.417 |
| Capital expenditures | $1.280 | $1.414 | -$0.134 |
Service revenue rose to $12.002 million from $7.938 million, while equipment revenue was nearly flat at $79.744 million versus $79.436 million. Management attributed sales growth chiefly to alarm communication services (+$4.064 million) and Continental access-control products (+$1.247 million), partly offset by declines in several intrusion and door-locking product lines. Operating profit benefited from higher sales and lower SG&A, including reduced advertising and trade-show costs; higher salary and freight costs partly offset gross-profit gains. R&D expense was $6.630 million, about 7% of sales.
Fourth-quarter sales were $27.260 million, operating income $4.277 million and net income $3.697 million, compared with $25.684 million, $3.462 million and $3.222 million, respectively, in FY2017 Q4.
At year-end, cash and equivalents were $5.308 million, working capital was $44.301 million and the current ratio was 5.7:1. The company had no debt outstanding and had an $11.0 million revolving facility available through June 2021, subject to borrowing-base limits and covenants. It repaid $3.5 million of debt, repurchased $1.337 million of stock and spent $1.280 million on property and equipment during FY2018. Management said available working capital, expected operating cash flow and the revolver should fund operations for at least 12 months. No cash dividends were paid.
Changes, outlook and notable items
- Net sales increased 5.0%, while net income rose 36.6%; gross margin was essentially stable. The effective tax rate declined to 8.2% from 11.1%.
- The 2017 U.S. Tax Act led to a provisional $381,000 transition-tax expense and a $136,000 deferred-tax benefit. The company planned to pay transition tax in installments over eight years; final tax accounting was not complete, and the impact could change.
- Revenue standard Topic 606 became effective for the company July 1, 2018. NAPCO expected changes in accounting for certain variable consideration and a cumulative retained-earnings adjustment; the filing does not provide a clear amount.
- Backlog was approximately $2.151 million at June 30, 2018, versus $0.922 million a year earlier; management expected to fill the FY2018 backlog during FY2019. No specific revenue or earnings guidance was provided.
- Management cited the housing and commercial construction markets, economic conditions, competition, distributor relationships, customer collections, CEO dependence without a succession plan, and Dominican peso exposure as risks. A 10% U.S. dollar strengthening or weakening against the Dominican peso was estimated to change annual operating income by about $0.7 million.
- One customer represented 10% of FY2018 sales and 22% of year-end receivables; another represented 11% of receivables. The company reported no material pending litigation and no off-balance-sheet arrangements.
Controls and audit matters
Management concluded disclosure controls were ineffective and identified a material weakness in internal control over financial reporting involving insufficient supervision and review. The auditor issued an adverse opinion on internal controls, but an unqualified opinion on the financial statements. Management said it began remediation in the quarter ending September 30, 2018, including stronger, documented approval and review procedures. Earlier revenue-control weaknesses were described as remediated during FY2018.
Important facts for investors to verify
- Progress and independent validation of remediation of the material weakness, including whether additional control deficiencies emerge.
- The final Topic 606 adoption adjustment and its effects on revenue timing, retained earnings and disclosures.
- Subsequent adjustments to the provisional Tax Act transition-tax estimate and the treatment of foreign earnings.
- Sustainability of service-revenue growth, quarterly seasonality, margins and operating cash generation.
- Receivable concentration and collection exposure, Dominican peso sensitivity, revolver availability and compliance with credit covenants.