NATIONAL PRESTO INDUSTRIES INC annual report, FY2017

National Presto Industries, Inc. 2017 Form 10-K Summary

Business context and reporting period

National Presto Industries, Inc. reported results for the fiscal year ended December 31, 2017. The company operates two continuing segments: Housewares/Small Appliance, which designs and distributes consumer appliances and housewares, and Defense, which manufactures ammunition, ordnance-related products, energetic devices, and less-lethal products primarily for the U.S. Department of Defense and prime contractors.

The former Absorbent Products segment was sold to Drylock Technologies on January 3, 2017 and is presented as a discontinued operation for all periods. The filing also provides unaudited quarterly data; fourth-quarter sales were $115.6 million and fourth-quarter net earnings were $16.8 million.

Financial performance and key metrics

Metric	2017	2016	Change
Net sales	$333.6 million	$341.9 million	Down 2%
Gross profit	$87.2 million	$85.7 million	Up 2%
Gross margin	26.1%	25.1%	Up approximately 100 basis points
Operating profit	$61.7 million	$62.5 million	Down 1%
Earnings from continuing operations	$43.3 million	$41.9 million	Up 3%
Net earnings	$53.0 million	$44.6 million	Up 19%
Basic and diluted EPS	$7.58	$6.39	Up 19%
Cash flow from operating activities	$24.3 million	$66.4 million	Down $42.1 million

Continuing-operations earnings benefited from higher other income, including interest income and lease and transition-services income. Effective income tax rates were approximately 34% in both years. The 2017 tax provision included a $534,000 increase from revaluing deferred tax balances after the U.S. corporate tax rate was reduced from 35% to 21% beginning in 2018.

Housewares/Small Appliance sales declined 10% to $97.3 million, gross profit declined to $16.9 million, and operating profit declined to $6.3 million. Defense sales increased 1% to $236.3 million, gross profit increased to $70.4 million, and operating profit increased to $55.4 million. Defense gross margin improved to approximately 30% from 28%, reflecting product mix and efficiency improvements.

Cash, liquidity, capital structure, and dividends

Cash and cash equivalents were $11.2 million at December 31, 2017, compared with $27.0 million at year-end 2016.
Marketable securities increased to $144.3 million from $84.5 million. This included $114.3 million of variable-rate demand notes that management considers highly liquid and redeemable at par plus interest within seven days.
Total current assets were $338.5 million and current liabilities were $45.5 million. Working capital was $293.0 million, and the current ratio was 7.4 to 1.0.
The company had no borrowings under its $5.0 million unsecured line of credit at year-end. The filing does not report material long-term debt.
Capital expenditures were $7.4 million, including investments in the Eau Claire facility and Defense production facilities.
Cash used in financing activities was $38.0 million, primarily reflecting dividends. Dividends paid during 2017 totaled $5.50 per share, consisting of a $1.00 regular dividend and a $4.50 extra dividend.
On February 9, 2018, the board declared a $1.00 regular dividend and a $5.00 extra dividend per share; $42.0 million was paid on March 15, 2018.

Material changes versus the prior comparable period

Net sales declined by $8.3 million, primarily because Housewares/Small Appliance shipments decreased; Defense sales increased modestly on higher unit shipments.
Gross profit increased by $1.6 million despite lower sales, as Defense gross profit increased by $5.7 million and offset the $4.1 million decline in Housewares/Small Appliance gross profit.
Intangibles amortization increased by $1.9 million, primarily because more units were shipped under an acquired government sales contract.
Operating cash flow declined substantially because of increased inventories, reduced payables, and other working-capital changes. The 2017 cash flow also included significant noncash gains related to the divestiture and involuntary conversion of equipment.
The sale of Absorbent Products generated $64.0 million of net cash proceeds and an $11.4 million pretax gain. Discontinued operations contributed $9.6 million of after-tax earnings in 2017 versus $2.6 million in 2016.
Defense backlog declined to approximately $308.2 million at December 31, 2017 from $358.9 million, with anticipated production and shipment over approximately 18 to 24 months.
Total employees decreased to 982 from 1,138, primarily reflecting the divestiture of Absorbent Products.

Guidance, outlook, management commentary, risks, and unusual items

The filing does not provide formal revenue or earnings guidance. Management expects to continue evaluating acquisitions and making capital investments where appropriate returns are projected. Management states that the company has substantial liquidity to fund operations, dividends, acquisitions, and growth.

Defense outlook is supported by a new five-year Army 40mm systems contract covering fiscal years 2017 through 2021, with approximately $79.0 million of value for fiscal 2017 and deliveries scheduled to begin in late 2018. A subsequent $58.2 million option award was received in February 2018, with deliveries scheduled to begin in early 2020. Actual contract volumes remain dependent on military requirements, appropriations, procurement regulations, and Department of Defense funding.

Housewares/Small Appliance sales are seasonal, highly price-sensitive, and dependent on consumer spending. Walmart represented 10% of consolidated sales in 2017, and the loss or reduction of this customer could materially affect results.
Most housewares products are sourced from third-party suppliers in Asia, particularly China, creating exposure to supply interruptions, freight costs, tariffs, labor issues, political conditions, and U.S. dollar/Renminbi fluctuations.
Defense contracts are concentrated with the U.S. Government and prime contractors and are primarily fixed-price. Cost increases, quality failures, subcontractor performance issues, or production delays could reduce margins or cause losses.
Government contracts may be terminated for convenience or default, and future performance depends on Congressional appropriations and defense-budget priorities.
The company is partly self-insured for product liability and does not maintain product recall insurance. Product recalls, liability claims, or warranty issues could materially affect results.
The company maintains an environmental reserve of $1.15 million. Management believes it is adequate, but additional studies, monitoring, or remediation could require higher costs.
The company had $191.3 million of disclosed contractual obligations at year-end, including $190.7 million of purchase obligations, principally outstanding purchase orders. Many purchase orders may be cancellable, but cancellation costs are uncertain.
The company adopted a tax-rate reduction remeasurement in 2017 and expected the lower 21% corporate tax rate to benefit future liquidity and cash flow.

Important facts an investor should verify

Whether the Defense segment can replace or exceed the 2017 shipment levels as existing 40mm contracts wind down and the FY2017-2021 contract ramps up.
The composition, liquidity, credit quality, and interest-rate exposure of the $144.3 million marketable-securities portfolio, including the $114.3 million of variable-rate demand notes.
The sustainability of Housewares/Small Appliance demand, gross margins, and customer relationships, particularly with Walmart and Asian suppliers.
The effect of inventory growth and reduced operating cash flow on future cash generation.
The remaining proceeds and timing associated with the additional $4.0 million of delayed Absorbent Products assets.
The potential impact of fixed-price defense contracts, government funding changes, contract termination, subcontractor performance, and material-cost inflation.
The adequacy of environmental, product-liability, warranty, tax, and other contingency reserves.
The company’s ability to maintain its regular and extra dividend policy while funding capital expenditures and potential acquisitions.

The independent auditor issued an unqualified opinion on the consolidated financial statements and internal control over financial reporting as of December 31, 2017.