Napco Security Technologies, Inc. (NSSC) Q3 2013 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the NAPCO Security Technologies, Inc. Fiscal Third Quarter 2013 Earnings Conference Call. [Operator Instructions] I will now turn the presentation over to Peter Seltzberg, Vice President of Investor Relations. Please go ahead, sir.

Good morning, and thank you all for joining us for today's conference call to discuss NAPCO's financial results for the third quarter ended March 31, 2013. By now, all of you should have had the opportunity to review the press release discussing the results. If you have not, please call our office, Hayden IR at (646) 419-4300, and we'll immediately send it to you by either fax or e-mail. On the call today is Richard Soloway, Chairman and Chief Executive Officer of NAPCO Security Technologies; and Kevin Buchel, Senior VP of Operations and Finance. Before I ask our host, Dick Soloway, CEO of NAPCO, to discuss the particulars of today's news, let me take a moment to read the forward-looking statement. This conference call may contain forward-looking statements that involve numerous risks and uncertainties. Actual results, performance or achievements could differ materially from those anticipated in such forward-looking statements as a result of certain factors, including those set forth in the company's filings with the SEC. With that out of the way, let me turn the call over to Richard Soloway, President and Chief Executive Officer of NAPCO Security Technologies. Dick, please proceed.

Thanks, Peter. Good morning, everyone. Thank you for joining NAPCO's quarterly conference call to discuss the financial results for the 3 months ending March 31, 2013. The third quarter progressed with mixed results, with progress in certain key areas, both in terms of sales and contribution to our profitability, tempered by continued weakness in our intrusion business, primarily due to Superstorm Sandy and what we would consider a normal learning curve response to the new products that we've just recently introduced to the market. The strength was in the our locking products and in particular, our Marks division product line, which has shown consistent recovery over the last 3 quarters, and I'll get to that in a moment. Looking to our fourth quarter, which we are already just about halfway through, we are excited about our positioning as a technology leader with new products out in the market. We have seen new products start to ship, with both product and recurring revenue sales. We think as time passes and basic homes and furnishings are restored to those affected by Superstorm Sandy, people will again start to emphasize the security of their home and will choose our products. And historically, the fourth quarter has always been our strongest for bookings, orders and revenues. So we remain highly confident in our ability to grow and materially scale the business. Now speaking further to the progress we have made in our Marks division, we are encouraged to report that this segment grew 29% in the third quarter compared to last year's third quarter. Marks has turned the corner in our first fiscal year -- quarter of this year, has been growing substantially and year-over-year ever since, and is now exceeding our expectations. Our pipeline for this segment continues to expand, particularly with our LocDown product group. Since the unfortunate incident in Newtown, Connecticut, administrators of schools around the country, from elementary schools to university campuses are pursuing better locking devices on all of the doors to protect their students, teachers and employees from violent attacks and security breaches within their respective domains. Our Marks division has the most effective products on the market for this and after 3 improved quarters in a row, we are confident that this part of the business will continue to grow in our fourth quarter and beyond. In addition, we are also seeing strong improvement in the construction industry and this will also add to revenue expansion in this product line. Beyond the improvements in Marks, we also generated solid increases in NAPCO's high-margin commercial locking division revenue and increases in recurring revenue from installations of our StarLink2 radios. As a result, we continue to be encouraged by the growth in our recurring revenue streams. The StarLink2 radio delivered a 20% sequential increase in radio installations as compared to the second fiscal quarter. While we have made several recurring revenue products, StarLink2 is our marquee product and is leading the way for us. As I mentioned, the weakness in our intrusion segment, which is still feeling the impact, especially in the Northeast from the hurricane, was offset to our gains. This region is one of our largest overall in sales, so the negative impact of the storm is significant. While we are confident that the need for safer and more secure environments is a trend that is here to stay, we have found that homeowners still remain focused on purchasing the basic materials and furnishings to rebuild their homes. We expect that our opportunity to provide intrusion devices and services to resume, but when is hard to say with any degree of certainty. Some consolidation among intrusion distributors and a downturn in orders from one of our large intrusion dealers also contributed to a negative variance in our quarterly sales. But there is a range of encouraging events related to our intrusion segment. We began shipping our iBridge product in April, and we expect top line contribution from these shipments in this quarter. The feedback we are getting is the product is the best application in the market. In addition to remote-controlling your security system and video cameras, there are 3 additional verticals to this product. First, locking; second, heating and cooling; and third, lighting. Depending on the features selected by the end user, we expect to generate recurring revenue from these products. iBridge and iRemote are being well received by the dealer network, as it also guarantees that the dealers will share in the recurring revenues. While this technology is simple to install, the technology itself does require additional training for dealers and the adoption issues associated with new products. Our leading indicators, which include increased contact with all our call centers and presales activities, are showing trends towards long-term sales. I will discuss this more later in the call. I would note that the number of calls we received in the last few months about iBridge and iRemote products is the highest we've experienced in any new product in our company's history. Turning to our access control segment, we received a very large order for our Continental Access Control division, subsequent to the end of the quarter. This is the biggest single order ever for Continental Access Control and one of the largest in the history of our company. This order had supervised sophisticated and customized access control solutions to a large private university, and we won this contract based on superior technology, our ability to deliver it and the ability to customize the product. This win significantly bolsters our confidence that we will experience meaningful growth in this important segment. Our Continental Access Control division is working quickly to incorporate and integrate as many of the 1,500 network wireless locks into the university environment during our fourth quarter as possible. The Networx product is being installed on a beautiful campus and has an exacting architectural specification, and we are able to meet all of these requirements in a very tight timeframe. Due to the tragic events that dominated the news, campus security is becoming a more prominent concern for colleges and universities, as well as private schools and high schools. We expect additional orders from other universities who are looking to improve on-campus security using state-of-the-art technology. As a recognized leader, we are well-positioned to meet this demand. The Networx line has 2 products for schools, it is based on radio control locking, so you can install new locking in a building without tearing up the walls and laying new cables. This product is incorporated into our Fusion 2.9 software and is offered by our sales forces directly to schools. Networx for the school allows the superintendent, principal, teachers, or the security officer, to lock down an entire school, a wing or a building with the push of a button. We see Fusion 2.9 as a solid driver to revenue growth, and we expect it to expand our access control, radio control, locking and commercial intrusion divisions. Fusion fuses together our product lines, and thus allows core selling of all of the different parts of our business. That said, this is a new approach to our industry and it takes time to train, and we've been doing this now since January. We are the market leader for this approach. Nobody else has this technology. It makes NAPCO a one-stop shop for security. With Fusion, all our products can talk to each other. This aligns perfectly with our customers who believe in fully integrated systems rather than standalone lines. We have no competitors who can offer dealers access control, locking and intrusion on an integrated network. As I mentioned previously on a conference call, we've hired a product manager to help with our GEM-C, our commercial fire product line. This individual is helping us refine the sophisticated product, and we expect that GEM-C can be a big contributor to revenue and earnings growth going forward. We are delivering more and more sophisticated products than ever in the history of our company. We continue to focus on products that will generate recurring revenues. These new products are gaining traction as we move into the last quarter of fiscal 2013, and we continue to expect positive momentum even as we were less than satisfied with our top and bottom line growth in the quarter we are now reporting. I now like to turn the call over to Kevin, to give a brief overview of the financial details. Kevin?

Thank you, Dick, and good morning, everybody. Revenues for the 3 months ended March 31, 2013, was $17.2 million, unchanged from the same period a year ago. For the 9 months, sales decreased 3% to $49.6 million from $51.1 million, as compared to the same period a year ago. The decrease in sales for the 3 and 9 months was due to several factors. These include: Several intrusion customers reduced their inventory levels; we experienced a decrease in demand from one of our large intrusion dealers; and this was offset, partially offset by an increase in our door locking products. Gross profit for the 3 months ended March 31, 2013, decreased 8.1% to $4.7 million or 27.1% of sales, compared to $5.1 million or 29.4% of sales for the same period a year ago. Gross profit for the 9 months decreased 4.9% to $13.4 million or 27.1% of sales, compared to $14.1 million or 27.6% of sales for the same period a year ago. The decrease in gross profit for the 3 and the 9 months was primarily due to increased expenditures on research and development, primarily relating to our iBridge tablet-style keypad and related applications, as well as a onetime payment of $175,000 as settlement of a product licensing dispute. A key point I would like to mention, is that for the 9 months, gross profit margin was relatively flat, and that's despite $1.5 million in lower revenue and $700,000 more in incremental R&D spending for the period, demonstrating the impact of increased recurring revenue as well as our overall efficiency, both of which should benefit us as revenues recover and scale. Selling, general and administrative expenses for the quarter were $4.4 million or 25.6% of sales, essentially unchanged compared to last year. Selling, general and administrative expenses for the 9 months increased by $543,000 or 4.3% to $13.2 million or 26.6% of sales, compared to $12.7 million or 24.8% of sales a year ago. The increase in selling, general and administrative expenses for the 9 months was due primarily to additional sales personnel and increased advertising and trade show expenditures. Operating income for the quarter decreased by $431,000 or 62.6% to $258,000, as compared to $689,000 for the same period a year ago. Operating income for the 9 months decreased by $1.2 million or 85.2% to $213,000, as compared to $1.4 million for the same period a year ago. Interest expense for the quarter decreased by $165,000 or 57.5% to $122,000, as compared to $287,000 for the same period a year ago. Interest expense for the 9 months decreased by $449,000 or 50.5% to $440,000, as compared to $889,000 for the same period a year ago. The decrease in interest expense for the 3 and 9 months of 2013 resulted from lower interest rates charged by the company's bank, as well as lower outstanding debt in the current period. Net income decreased by $192,000 or 63.4% to $111,000 or $0.01 per share, as compared to $303,000 or $0.02 per share for the same period last year. Net income for the 9 months decreased by $633,000 to a loss of $188,000 or negative $0.01 per share, as compared to net income of $445,000 or $0.02 per share for the same period last year. Adjusted EBITDA for the quarter, as per the schedule included in today's press release, decreased $493,000 or 39.6% to $752,000, as compared to $1.2 million last year. Adjusted EBITDA for the 9 months decreased $1.4 million or 45.6% to $1.7 million, as compared to $3.1 million for the same period a year ago. Cash generated by operating activities for the 9 months was $3 million, unchanged from the same period last year. And debt, net of cash, has now been reduced by $21 million from $35.9 million to $14.9 million, since we acquired Marks in August of 2008. $2.4 million of this reduction occurred in the past 9 months. That concludes my formal remarks, and I'd now like to return the call back to Dick.

Thanks, Kevin. The last 18 months had been a period of tremendous change for NAPCO, perhaps the most exciting time in our history. For years, NAPCO has been a recognized leader in all sorts of security products, from alarm systems to state-of-the-art door locking, but technology is rapidly changing, our industry, and as it has in most industries, and NAPCO has responded aggressively to meet these changes. Today, more than ever, NAPCO is a technology company. For the first time in our history, we have hired Internet and mobile application developers. Development of apps for tablets and smartphones has become a key component of our R&D efforts. Our training and support team, previously focused on walking installers through wiring or the programming of keypads is increasingly tasked with more complex explanations of wireless networking and setups. I don't think anyone listening is surprised when I say that in the near future, we will all use our smartphones to not only arm or disarm our alarm systems, but also to lock our doors, control lights and temperature settings, and view security cameras. Early adopters are doing this today. And in the near future, this will be as common as a traditional push-button keypad. And the power of smartphones, coupled with the power of network devices, will enable even more convenience in the future. NAPCO is hard at work investing in R&D to remain the leader in this space, helping to drive the advancement in technology. In addition, we believe that the era of landline home phones is coming into an end. Younger people increasingly opt not to have a traditional landline home phone, but relying on their mobile devices. Also savvy criminals are used to cutting home phone lines as a way of testing if a house is alarmed, or as a way to bypass the alarm so they can break in. These trends have led to rapid move to alarms that are connected to monitoring stations via cellular M2M radios. We support this, and our installation network is increasingly looking for these options. In the short term, this has created challenges for traditional installers, many of whom are not computer experts. We are increasing our efforts to support these installers with training programs, additional collateral materials and telephone support, so they can meet their customers' demands. In addition, these Internet and wireless products are ideally suited for younger generations, many of whom are buying their first homes or opening their first businesses today. Older generations are not as comfortable with these advances, though increasingly, they are inquiring about smart-connected systems like we now provide. As the market shifts to generations who grew up with these sorts of technologies, adoption will accelerate. We are seeing this already. One of our typical leading indicators of revenue growth, particularly from new products, is the amount of presale interest we get from our base of installers. Installers often reach out to our call centers to inquire about new products, in an effort to familiarize themselves with the installations, understanding potential issues and to ask questions about the features. Their goal is to become as familiar with these advancements as possible, so they can effectively upsell these products to their customers. As I've said, customer inquirers have been high, and we've had to devote extra resources to handle the incoming call volume. We still cannot predict with precision as to when this will translate to sales, but we are extremely encouraged with the interest these products have received. I'll remind you that the iBridge line of products began shipping in April. We can see initial revenue from these exciting products in the fourth fiscal quarter, the quarter ending June 30, and we expect solid sequential growth from these products going forward. iBridge is the most flexible, product-rich, home automation and security system in the marketplace. iBridge works with WiFi, as well as 4-wire tablets. It is a centralized control for alarm systems, video, electronic locking, lighting and temperature, all remote-controlled by a smartphone or tablet. In addition, the products I just mentioned range from cellular radios to our smart-connected devices like the iBridge products, drive recurring revenue for NAPCO. As I've mentioned repeatedly, the last 4 quarters, this is a key area of focus for us. We are counting on iBridge and iRemote to help us return our intrusion products to a growth trajectory, and everything we have seen has reinforced our confidence that this will occur and occur relatively soon. Overall, our business remains mixed. Locking products, especially from our Marks division, are strong. Intrusion and access control products are not as strong, but we are seeing clear indications of a rebound in the quarters to come. We continue to feel the impact of Superstorm Sandy, particularly on our intrusion product line. We expect it to take another quarter or 2 for demand to shift from rebuilding homes, to protecting these homes with intrusion devices. But our fundamentals remain strong, and we expect to have all 4 parts of our business producing at a higher level as we move into fiscal 2014. As we've consistently noted publicly, and as we've proven in the past, as our revenue grows past $20 million per quarter, our ability to leverage our low-cost high-quality manufacturing in the Dominican Republic, coupled with our ability to amortize this facility, allows us to drive incrementally higher profits. Our fourth quarter historically has been our seasonally strongest quarter. We fully believe that this will be the case this year as well. That concludes our formal remarks. Kevin and I would like to open the call for questions. Operator, please proceed.

[Operator Instructions] Your first question today comes from Walter Ramsley with Walrus Partners.

I had a question about the college business, the LocDown product. Can you give us an idea of what the potential might be for that, as far as getting some additional schools? Is this going to be a long sales cycle? Or are there customers already sort of lining up for that product?

Hi, Walter, it's Dick. We received this very large order from a very high profile school, and we believe that this is going to be a great place for our products to be because it's highly visible, and many, many universities, colleges, need this type of product line, and we're the most advanced in this product line. It's very easy to operate, it's very easy to install, and it's really, really high-quality. It allows total flexibility of securing the premise, 1 door or multi-doors or entire wings, and we believe that it's going to be a great leader for us. And that's in this system, which is a wireless system. So it can be installed in a premise without ripping up all the architectural walls. We also make less expensive LocDown products. We have the most LocDown products in the industry. We make basic mechanical LocDown products for lower budgets, which are through the Marks group. We make standalone access control products for high schools with a little larger budget, through our Alarm Lock group, and then this ultimate LocDown wireless system through our Continental group. So we're very well-positioned to supply any application to protect any type of school at any type of budget. And we have lots of our salespeople talking to schools now, and we believe it's going to be a very big part of our business.

Yes. So the education application, do you foresee kind of adding some of these other features as well where you've got the remote control, not just for the locking but for the heat, and the lights and the cameras?

Well, we have the Fusion 2.9, which integrates every one of our product lines. And we have our intrusion product line, we have our access product line, and we have our locking product line. And we're the only manufacturer that has integrated these systems together, so it's easy to install, easy-to-use and we've become a one-stop shop for the dealers. There's no manufacturer on the marketplace that has these 3 segments of security. There are some manufacturers that have intrusion and access, or some manufacturers have locking, but we tie it all together with our acquisitions, and now we're able to put all of this on one network, and it should be a very exciting thing because integrators can offer all kinds of variations to their customers.

Yes. It sounds like it's got great potential. Switching gears to the intrusion business. Was that decline almost exclusively related to the Sandy hurricane? Or were there other issues involved there as well?

Right. It's a combination, Walter. Superstorm Sandy-related, consolidation in the intrusion area, a couple of distributors consolidated, and until they figure out what their needs are, they cut back on their orders. Generally, that's what it is. One of our customers cut back. I think it's also Superstorm Sandy-related. They're busy doing other things. They're not installing as many units as they used to install. They're busy because they're in other segments of other business, related to repairing homes. So I think Superstorm is the main thing, consolidation is probably the second thing. And we think it will come back and especially, if it's buoyed by the new products that were coming out, the iBridge, it's buoyed by the radio business, which again was up 20%. That's 3x in a row, it's up 22%, 20%, another 20%. That creates tremendous gross profit for us. And you could see, as you compare the 9-month gross margins, they were pretty close even with the sales lower and even with $700,000 more in R&D. The reason why it was so close, is the impact -- a lot of the reason why it's so close is the impact of the radio business, the recurring revenue.

Yes. With the iBridge product line, we're aligned with the dealers in a very, very unique way because the iBridge product line allows the dealers to make more recurring revenue than just recurring revenue from burglar alarm monitoring or fire alarm monitoring. Now they can give interactive services to the consumers, and consumers are using these interactive services so they can adjust the heat from being outside of a premise, they can turn their lights on, they can look at video. All these interactive services are very much near and dear to dealers because they want to increase their recurring revenue monthly bill. And the dealers are using our service to be able to get to the end-user consumer, so that's how we get our fee. So they get their fee, we get our fee, that means we're aligned together, and it's a motivation for them to want to sell this and install this. And we're seeing that early indications are very, very good about this -- on this.

Okay. Just one last thing, I guess, just generally speaking, fiscal 2014, do you guys see that as being a really big year? Or do you see it more as another kind of investment year of getting ready for the payoff farther down the road?

We see the momentum building. We can't really predict, but there's a lot of excitement in what we've been offering to the dealer and integrated community. We can see these big orders from locking coming in. We see 2.9 is fusing together all of our product lines. So we're very optimistic that this next fiscal year should be a very good year for us. And we believe that the future bodes well for us with all of this because there's going to be a lot of dealers that are going to be getting into our products more and more, and we have a very big push-on to train the dealers, both in-house and on their site, and there's a lot of training going on. So that bodes well for additional sales. We're seeing lots of reports from the field that the dealers are trying 1 of these, 3 of these, 5 of these. They're repeating, and that's building momentum. So it should be very exciting going forward.

Your next question comes from Leo Cirunian [ph], private investor.

In this -- we're in a merger and acquisition mode with the stock market recovering. Is it reasonable to believe that a company like this should be very high-priority for acquisition? And have you experienced any approaches?

We are very, very unique in our product line. We're in a great field. I rather be doing this, rather than building big ships and things like that, luxury yachts. It's a business that's turning from a basic business to a technology business, and it has a recurring revenue component, and that's very exciting. We want to build our recurring revenue component, as well as build our top line revenue, so we can amortize the cost of our factory. And that is going to make us very, very profitable. So we always keep our eyes open, looking for additional acquisitions of companies that can add to our product line, as -- for instance, carbon monoxide detectors, other types of detectors, which can be used for access control. So we're looking to acquire companies in the future because of the fact that we want to pay down our debt right now, and we know that we're going to be, we believe, very, very profitable, and when we get to that point, another acquisition could be in our future. As far as the company being part of an acquisition of another company, anything is possible because of the fact that we're always open to these subjects. But we believe that we want to get another year or 2 under our belt of profitability because the company will be much more valuable at that time.

[Operator Instructions] And we seem to have no further questions at this time. I'll hand the call back over to Dick Soloway for closing comments.

Okay, thank you, everybody, for participating in today's conference call. As always, should you have any further questions, please feel free to call Hayden IR, Kevin or myself. We thank you for your interest and support, and we look forward to speaking with all of you again in a few months to discuss NAPCO's fourth quarter results of fiscal 2013. Bye-bye, and have a great day.

Ladies and gentlemen, that does conclude our conference call for today. We thank you for your participation. You may now disconnect your lines.