Napco Security Technologies, Inc. (NSSC) Q3 2014 Earnings Report, Transcript and Summary

Greetings, and welcome to the NAPCO Security Technologies Third Quarter 2014 Financial Results Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now turn the conference over to Mr. Peter Seltzberg of Hayden IR. Thank you, Mr. Seltzberg, you may begin.

Good morning, and thank you for all joining us for today's conference call to discuss NAPCO's financial results for the third quarter ended March 31, 2014. 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. We'll immediately send it to you by either fax or email, your choice. On the call today is Richard Soloway, President and Chairman of NAPCO Security Technologies; and Kevin Buchel, Senior VP of Operations and Finance. Before we begin, 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 may 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 now turn the call over to Richard Soloway, Chairman and President of NAPCO Security Technologies. Dick, congratulations on the quarter. Please go ahead.

Thank you, Peter. Good morning, everyone. Thank you for joining NAPCO's quarterly conference call to discuss the financial results for the 3 months and 9 months ending March 31, 2014. The third fiscal quarter was one of solid progress on several fronts, and we believe we are well positioned for a strong finish to the year, which we are confident will be our first of many years of growth to come. As a reminder, our business tends to be highly seasonal, with the largest contribution at the top and bottom lines coming in the fiscal fourth quarter. As we move into what has been historically our strongest seasonal quarter, I believe we are well positioned strategically as we have been in the history of NAPCO. During the third quarter of fiscal 2014, we delivered significant improvement in profitability, with gross margins and net income both increasing for the 3 and 9 months. We saw rather large increases in our higher-margin recurring revenue, and our higher-margin Access Control and locking products to drive these improvements. At the top line, our revenue gains were modest for the 3 months as severe weather slowed demand in our residential intrusion line of products. As many of you probably know, most of the Northeast United States experienced abnormally severe winter weather this year, as our winter was unusually cold and snowy, and the cold weather lasted into April. And this had an impact on buying decisions by consumers and, working up the chain, delayed installations and equipment purchases from dealers and our distributors. We estimate the weather resulted in approximately $1.5 million of delayed revenues in the quarter, and absent this impact, we'd be reporting revenue growth of more than 9% in the quarter. This is simply a situation of timing, as we do not believe this business was lost, just delayed, and we are seeing early signs of pent-up demand contributing to our fourth quarter results. What we're really excited about is the progress we made increasing our profitability. We experienced a favorable shift in the mix, which contributed considerably to margin expansion and bottom line improvement. As we have been communicating for several quarters, we are focused on building our recurring revenue streams, which primarily comes from our iBridge Connected Home and StarLink wireless radio products. As reported in the press release today, recurring revenue was up 95% for the third quarter compared to the third quarter last year, and grew sequentially by 11%. Fiscal year-to-date, recurring revenue was up 94%, and this important revenue stream continues to grow nicely. In addition, a more favorable mix of higher margin Access Control and locking products helped our profitability. The number of new account initiations and installations again increased during the quarter, driven by increased consumer demand for high-tech, remote control, home automation solutions. Further, our profitability profile was also favorably impacted by the further reductions in interest expense driven by both a lower interest rate and overall lower debt level. As the high-tech security industry continues to evolve and new products are introduced, we continue to see market demand driven by 2 key catalysts: The first is the concept of the Connected Home; and the second is a need for more comprehensive, more robust school security systems across the nation. Each of these markets is still in the early growth phase of development. Anticipating these market trends, we have diversity [indiscernible] in our product line by investing in the development of technologically advanced products that are scalable, interoperable and deliver as an integrated solution to our customers. Let me first talk in a little more detail about the solutions to address the residential market and address the needs for a connected home. Our comprehensive iBridge solution enables users to remotely manage thermostats, locks, lighting, video cameras, security systems and small appliances from a smartphone, tablet or computer. Built on a proprietary patented technology, iBridge is the most flexible, feature-rich, home automation security system of Connected Home solutions on the market today. The open architecture of the iBridge system allows any component to communicate in real time with any other part of the system, making consumers' experience seamless while making homes safer and convenient to manage. As we have discussed in the past, this advanced patented technology has been developed internally and the capabilities are unmatched by any of our competitors. As the word continues to get out about the Connected Home and the market matures beyond early adoption, which is where we are right now, we think that it makes a lot of sense to embrace the products being offered by the marketing powerhouses of the world and build a platform that can be communicated with their products. We are especially excited about the video capabilities of the iBridge system, which utilizes the modern IP connectivity delivered real time, high-resolution, and frame rate video to consumers anytime, anywhere through any internet-enabled device. The practical uses of this technology are endless, including monitoring of intruders, keeping an eye on home service providers such as nannies, babysitters, home cleaning services, children as they arrive home from school and, of course, the nefarious intruder should an incident occur. Once it is professionally installed, this state-of-the-art technology solution is extremely easy to use. The ubiquity of smartphones and tablets, coupled with the need for convenient, quicker tools to ease the burden of managing the hectic, nonstop pace of the everyday of everybody's life, will continue to drive demand for control of the home solutions. NAPCO is at the forefront of innovation with our iBridge solution, as meeting those needs seamlessly. Video is a very large market opportunity for us. There are approximately 25 million end-users in the U.S. currently monitored by alarm companies for burglary and fire without remote video access. This is an easy upsell for dealers due to high-quality, low cost, and ease of installation and adds to recurring revenue stream. In our efforts to drive top line growth with these products, we are taking a distributor neutral position, recognizing that end users can procure our products through multiple channels, including local, independent dealers, as well as other potential partners. Our dealer program is targeting 10,000 independent dealers, providing them with access to the entire suite of products along with marketing, sales and installation support in exchange for a contractual commitment to install NAPCO's security iBridge Connected Home product line. To support this important line of product at ISC North -- ISC West, North America's largest security industry trade show, we launched the iBridge Connected Home Dealer program. This program, which is the first of its kind, combines security and connected home automation programs, targeting the thousands of independent security dealers in the U.S. interested in marketing the iBridge Connected Home brand. We will be offering Connected Home automation-specific training, marketing and sales support to help them take advantage of this rapidly growing product category. Keep in mind, these products are much more advanced than traditional home security solutions, which use -- and they use IP technology, routers and other advanced technology rather than hardwired solutions of the years past. The need to train personnel to make them comfortable with this technology is an important step to drive future sales and iBridge Connected Home dealer program will provide exactly that support. Turning to the second evolving market trend, we have school campus security. Unfortunately, our country continues to see escalating threats of violence in our local schools and universities, creating a demand for increased protection of our children, teachers and administrators. This is increasing and continued pressure from citizens and legislators alike to provide safe, secure class rooms and campuses with full lockdown and isolation capabilities in the event of a threat. We currently have our school safety program -- products installed in over 100 schools and educational facilities, protecting our nation's students of all ages and the main -- and the business remains a good growth driver for us. In response, end-to-end products and solutions, which cover the spectrum from Access Control products for buildings to both mechanical and electronic locking products to intrusion and fire systems. During Q3, we continued the execution of Project LocDown, a cross-divisional initiative, which uniquely positions Marks USA LocDown, intruder locks, Alarm Lock's network wireless locks and Continental Access Controls card access systems in providing a totally integrated access control and lockdown solution that allows campus officials and law enforcement to perform a real-time, global lockdown in less than 10 seconds and deploy wireless, network accessed locks to immediately secure campus offices and facilities in the event of a threat. The program utilizes the training and certification of security integrators in being able to evaluate a given school's security quotient, utilizing a measurable index known as School Access-Control Vulnerability Index, called S.A.V.I., S-A-V-I. Dealers are educated in how to conduct a S.A.V.I. audit and then are able to address any security needs by installing school-specific security measures. Our entire team is focused on education as a top vertical market for future growth and expansion by identifying cross-selling opportunities within our existing installed base of educational institutions. Specifically, schools that are currently using our Continental Access Control system are a prime candidate for integrating our wireless locks. In support of our own marketing and sales efforts, we have also retained WordHampton Public Relations to support our 2 newest product launches, LocDown Solutions and iBridge Connected Home. We will work in partnership with WordHampton to bolster our communications and messaging around these 2 products, providing deeper penetration in each of their respective markets. Equipped with a suite of high-tech, fully-integrated marketing -- market-leading products, we are aggressively pursuing numerous growth strategies to both deepen our penetration with -- within existing markets, as well as broaden our reach into new verticals and other projects. Our financial objectives are simple. Get the revenues higher and increase our margins to achieve higher levels of earnings. To do this, we must continue to add manufacturing volume in our Dominican plant and continue to build our recurring revenue streams. We are committed to these goals and I am pleased that we continue to make progress each day in getting there. I'll now turn the call over to Kevin to discuss the financial results. Kevin?

Thank you, Dick, and good morning, everybody. Revenues for the 3 months ended March 31, 2014, increased 1% to $17.3 million compared to $17.2 million in the same period a year ago. As Dick mentioned, revenue growth was impacted by the severe weather, which affected residential intrusion sales. We estimate this had an approximate $1.5 million impact on third quarter revenues. For the 9 months, sales increased 7% to $52.9 million from $49.6 million in the same period a year ago. The increase in sales for the 3 and 9 months was due to increased sales of Access Control products and door-locking products, which was partially offset by decreases in intrusion products. Gross profit for the 3 months ended March 31, 2014, increased 14.3% to $5.3 million or 30.8% of sales compared to $4.7 million or 27.1% of sales for the same period a year ago. Gross profit for the 9 months increased approximately 15% to $15.4 million or 29.2% of sales compared to $13.4 million or 27.1% of sales for the same period a year ago. The increase in gross profit for the 3 and 9 months was primarily due to the increased sales and a favorable shift in product mix to higher margin door-locking and Access Control products. This also demonstrates the impact of increased recurring revenue, as well as our overall efficiency as the sales volume increases. Selling, general and administrative expenses for the quarter increased $155,000 or approximately 3.5% to $4.6 million or 26.4% of sales compared to $4.4 million or 25.7% of sales for the same period last year. Selling, general and administrative expenses for the 9 months increased by $675,000 or approximately 5.1% to $13.9 million or 26.4% of sales compared to $13.3 million or 26.8% of sales a year ago. The increase in selling, general and administrative expenses for the 3 and 9 months was due primarily to additional sales personnel. Operating income for the quarter increased by $510,000 or 213% to $749,000 as compared to $239,000 for the same period a year ago. Operating income for the 9 months increased $1.3 million or approximately 833% to $1.5 million from $160,000 in the same period a year ago. Interest expense for the quarter decreased by $44,000 or 43% to $59,000 as compared to $103,000 for the same period a year ago. Interest expense for the 9 months decreased by $148,000 or 38% to $239,000 as compared to $387,000 for the same period a year ago. The decrease in interest expense for the 3 and 9 months of fiscal 2014 resulted from lower average outstanding debt and lower interest rates. Net income increased by $539,000 or 486% to $650,000 or $0.03 per diluted share as compared to $111,000 or $0.01 per diluted share for the same period last year. Net income for the 9 months increased by $1.3 million to $1.1 million or $0.06 per share compared to a net loss of $188,000 or negative $0.01 per diluted share for the same period last year. Adjusted EBITDA for the quarter, as per the schedule included in today's press release, increased $592,000 or 81% to approximately $1.3 million or $0.07 per diluted share as compared to $733,000 or $0.04 per diluted share last year. Adjusted EBITDA for the 9 months increased $1.4 million or 87% to $3 million or $0.15 per diluted share as compared to $1.6 million or $0.08 per diluted share for the same period a year ago. At March 31, 2014, the company had $2.4 million in cash and cash equivalents compared to $3.2 million at June 30, 2013. NAPCO had working capital of $31.2 million as compared with working capital of $33.2 million at June 30, 2013. Current ratio is 4.5:1 as compared to 4.9:1 at June 30, 2013. The cash generated by operating activities for the 9 months increased $1.3 million or 44% to $4.3 million compared to $3 million for the same period a year ago. Paying down debt -- paying down our debt remains a key priority for NAPCO as we have [indiscernible] previous acquisitions. Debt, net of cash, has now been reduced by $26.1 million from $35.9 million to $9.8 million since we acquired Marks in August of '08. $3.4 million of this reduction occurred during the first 9 months of this fiscal year. That concludes my formal remarks. I will now turn the call back over to Dick.

Thanks, Kevin. I am pleased with the progress we are making in expanding and balancing our portfolio of high-tech, diversified products to deliver sustainable growth and profitability. Our suite of products and services positions us to meet the changing and heightened demand for security products, both by consumers who increasingly recognize the benefits of monitoring and controlling their home systems from almost anywhere via their smart devices, which generates multiple recurring revenue for these services, and to our long-standing presence in high gross margin commercial security solutions, addressing rapidly-growing sectors such as education. We are confident, we are positioned for our first year of growth in recent years, and we head into the final quarter of our fiscal year. The fourth quarter has historically been our strongest due to the seasonality of our business, with many property owners waiting to secure their homes and buildings before their summer vacations. This concludes our formal remarks. Kevin and I would like to open the call for questions. Operator, please proceed.

[Operator Instructions] Our first question is from Walter Ramsley of Walrus Partners.

Could you spend a minute and just kind of describe how the weather affected the residential business? I'm not sure I completely understand why a little snow would deter the dealers from installing those things?

Walter, it's Dick. What we found with our dealers is they were kind of staying home. They weren't out working that hard. They weren't getting a lot of calls. Consumers were basically locked within their houses. It was -- and it kept on going, on and on and on all winter. And we're doing so much in the way of investing time with the dealers and there's such an interest that the weather just pushes back a little bit. But I can see from the reports that I get from the salesmen, and I look at all the reports that come in, that there's lots of trial that's going on with all the products and that there are systems going in and I would expect a rebound and growth from this sector because it kind of just dropped off at this period of time. And considering all of the products that we have and all of the time we've spent training, it's a condition that was not normal and it was a weather-related condition as we checked and we polled with our dealers and distributors. So we expect a rebound on this.

Okay. And the show that the company went out recently to do, with the 10,000 dealers, or I don't know how many showed up to the actual show. But do you have any information as to how that -- how those contracts are being signed? Is it still -- are they signing or are they still kind of checking it out or what's the response so far?

Well the show was in Las Vegas a couple of weeks ago and we showed our Connected Home products and we also, off the show floor, we also had a big room where we had a presentation to the dealers. These are not consumers but these are actual alarm dealers that want to know about the Connected Home, this new technology, want to know how they can get more recurring revenue and build up on their customer -- existing customer base, plus new customers. This new technology, which seems to be very popular now that smartphones have become everywhere, ubiquitous. So what happened was, we had put 200 chairs in this room and we had done marketing, we had taken an ad out in the daily newspaper that goes around the show and it wound up that we had standing room only at the show. It was just an overwhelming response. At that show, we showed the technology and put it through its paces. We also had a couple of magazine people, Connected Home related, telling us stories about Connected Home in the future, the Internet of Things. And it was very, very interesting. It went on for about an hour, maybe 1.5 hours, if I remember correctly. And everybody was very interested in what we were doing. Plus we announced that we're going to have a dealer association that we're putting together, which will be special decals, literature, training and a program if they want to join this association that we're putting together. And we've signed up many, many dealers to this and we expect to continue to do this. So there's a lot of interest and demand. And we're in the first inning of the Connected Home introduction to dealers. It's a new concept but it's their lifeblood. It's recurring revenue and we get recurring revenue from it. So we'll be selling a lot of product and we'll get recurring revenue. [indiscernible] part of the show.

Good. As far as those 10,000 independent dealers are concerned, can you describe how much competition there is that you're encountering to get into that market? I mean, obviously, ADT and Comcast, I mean, they've got their own thing going. But just in the independent segment, who are you competing against? And how do you compare against that?

Well, the -- it's a very fragmented business. The dealers have -- some dealers have 1 truck and some dealers have 50 trucks. The national account is ADT. We supply some products to ADT. And we have a solution that no other competitors have. It's got the widest ranging, most features, longest transmission range within a premise and the nicest graphics. For the consumer, it's easy to use. So we don't see it as a major competition but they are in that field. We also have the greatest live video on smartphones and we have many national superregional accounts that are using that and now we're bringing them into the Connected Home area. As we make recurring revenue as they subscribe to all these functions. So that was very exciting. And the other exciting thing at the show was also that we showed our school solutions, LocDown solutions for K through 12, universities. And as we talked about in this quarter, the industrial business was very, very strong. It had great margins and we expect it to continue that way and just keep getting stronger and stronger. So we're firing on both chambers, both the Connected Home to expand out the dealers and get recurring revenue for them and us, and also the high-margin products of Continental, Marks and Alarm Lock. So we have eggs in a couple of baskets.

Good. So just last of all, I guess, you brought up the school market. Can you just kind of give us an update on how the big university contracts are shaping up? If you have a backlog there and what sort of time horizon you're looking at as far as generating revenues from that?

Well, we're getting -- we have over 100 schools and universities. We have a whole list that we've published and more and more of these facilities are jumping on board. So we would expect it to continue because we think it's only a drop in the bucket to the amount of security that the schools should have versus what they've got now. And as the administration and the security departments learn about our products, both at the International Security Conference and the American Society of Industrial Security, which is a show coming up, more and more of this will get embedded into them. They'll see our solutions and our solutions are from value to the most deluxe. And we have every facet in between. And we're excited about the margin expansion that we get on these products and it should be a strong growth driver going forward.

[Operator Instructions] The next question is from Leon Suronean [ph], a private investor.

I am going to ask a question. Without giving specific names and numbers. I cannot imagine a company this size, small compared to other people, that larger companies aren't looking at you with merger or acquisition in mind. And here, again, without specific names and numbers, my guess would be that you're inundated with proposals? That's my question.

Well, it's a very fragmented business and we thank you for being a shareholder over these many years. And we believe that we're sized correctly for our dealer base, because it's a very fragmented dealer base. The average dealer probably has 2 or 3 trucks running around and we really service them well. And now we're into the training mode of showing them how can they make more recurring revenue than just the intrusion and fire business with the Connected Home, which really is a valuable service for the consumers, to be able to watch what's going on in your home and control your lighting and heating as you get nearby. So we believe that the value of the company will continue to grow and become much more valuable in the years -- in the next few years because of the fact that we're generating all this new technology, which generates new recurring revenue for us. So whatever our value is today, the maturity is going to be over the next couple of years. And then we're going to really expect to see some very nice results from all the engineering and marketing that we've been doing in the last couple of years. So I'm glad you're with us and, I would say, just keep an eye on us. It should be very exciting going forward.

[Operator Instructions] We do have a question from the line of Gary Surodoneam [ph], a private investor.

I do have a question on retrofit programs. With a large installed base of existing hardwired systems and technology that's changed very rapidly over the years, what kind of retrofit programs are available? And how actively are you pursuing those?

Okay. We have a very exciting retrofit program, which is based on the fact that the copper dial-up lines on premises is going away. Lots of people today are moving into a premise that don't have a dial-up phone anymore. So -- or a dial-up phone is very expensive and they want to take it out and just use your cell phones. So we have a product called StarLink, which is basically a little black box, half the size of a cigar box, and in that is a little radio transceiver, which is connected and retrofits to existing alarms or can be used as a primary communicator of alarm signals. And it goes to our network operating center to the alarm company's central station. So we get a recurring revenue stream from that. There are millions and millions of homes that are starting to pull the plug on hardwire. Why should they pay the phone companies when they don't even use it anymore? I know myself, I don't get very many phone calls over the hardwire anymore. Everything comes through my cell phone. So where -- we put together a package of StarLinks, which is a StarLink 6 pack, which seems to be very exciting for the industry and it came out from the trade show, in discussions with the dealers. They said, "We love this thing. We want to make it a retrofit package." And we're doing that. And I think it's going to be a really a great shot in the arm for us because our radio is considered the best in the business. It upgrades to any of the Gs that come out. Right now, we're in 3G/4G, but you can do 5G, 6G as they come out in technology and our radios upgrade without throwing them away like the competitors. They also are uploadable and downloadable and the dealers like that. So with our new 6 pack, with the millions of jobs that are going in with the radios becoming a primary or the jobs with the radio has to retrofit to get rid of the copper, because there is no copper, or if you put in a VoIP line on a residence, it interferes with the normal dial up, so they use radios, the dealers do, as the solution for communications. So that's one thing we're doing to retrofit. We also make our iBridge retrofit with our existing control panels. So you can add the automated home and lighting control and temperature control and video to any job that's out there. So there's a lot of exciting things that are going on. This business is not a business where its like an impact at the checkout counter. This is a business where its -- we're working in the streets with the dealers and training them and showing them how to upgrade and do different technologies with the existing alarms and new alarms. And it's an exciting paradigm shift within our industry and we expect to get a lot of sales and profitability out of it.

My follow-up question was going to be about upgrading and also adding video and you covered that. So it's good to hear you've got those kinds of products. I know as a -- I'm a private investor but I'm also a custom luxury homebuilder in the Northeast and I've built several very significant homes that have elaborate alarm systems but they are outdated. So I'm sure there's a lot of clients out there that would look to upgrade to that latest technology without having to reinvent the entire wheel. So thanks for your input.

Send me an e-mail and we'd love to come and show you a demonstration face-to-face, and I think you'd be very impressed.

Thank you. We have no further questions in the queue at this time. I'd like to turn the floor back over to management for any closing remarks.

Thank you, everyone, for participating in today's conference call. As always, should you have any further questions, please feel free to call Hayden IR, Kevin Buchel or myself, and we thank you for your interest and support. And we look forward to speaking to you all again in a few months to discuss NAPCO's fiscal 2014 fourth quarter and full year results. Bye for now.

Thank you. Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time, and thank you for your participation.