Napco Security Technologies, Inc. (NSSC) Q2 2015 Earnings Report, Transcript and Summary

Greetings and welcome to the NAPCO Security Technologies Second Quarter Fiscal 2015 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Mr. Todd Fromer, Managing Partner of KCSA, Strategic Communications. Thank you, Mr. Fromer. You may now begin.

Good morning and thank you all for joining us today for NAPCO’s financial results for the second quarter ended December 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 KCSA at 212-682-6300. We will immediately send it to you by either fax or e-mail. 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 now out of the way, let me turn the call over to Richard Soloway, President and Chairman of NAPCO Security Technologies. Dick, the floor is yours.

Good morning, everyone and thank you for joining us. This morning, NAPCO reported results for the second fiscal quarter of 2015. We are incredibly pleased with our results. Our business is clicking in all cylinders and our new products are gaining increased adoption, thanks in large part to a robust and energized dealer network. We are executing on growing our recurring revenue products and beginning to see significant gross margin expansion as our revenue mix shifts to higher margin products and we see the benefits of owning and managing our manufacturing facility in the Dominican Republic. In our door locking and access control division, we continue to see strong interest in our lock down products, which leverages industry leading technology to keep our school safe. During the quarter, we recognized a $410,000 order from a lock down equipment to a major Midwestern college a deal we signed and announced last quarter. Our 10,000 plus strong dealer network is telling us interest is strong for these types of hybrid, access control, door locking solutions to expect more orders like this one and the one we fulfilled for Pepperdine University last year. Educational institutions are waking up to the fact that while we can never fully prevent evil from harming this in children, a well-designed and implemented door locking and access control system can stop the soulless individuals in their track. This quarter, we launched our innovative new ArchiTech Networx Designer Wireless Access Control Platform. This product combines the capabilities of advanced large scale access control with high-end architecturally aesthetic wireless locking hardware. The product targets the multi-tenant building and the luxury office space market, where customers demand high security access control with high-tech upscale look. Our inaugural sale occurred in December at a 400-unit apartment building in New Jersey. And apartment construction – as apartment construction rebounds from the great recession and potential tenants demand safety and luxury, we think we are well-positioned to continue capitalizing on this trend. In our alarm division, our iBridge Connected Home Product was named by Security Sales and Integration the best connected home security product in the prevention and security industry, a much sought-after honor in our industry. Security Sales and Integration is one of the United States leading B2B systems integration publication and its annual top list of top 30 innovations is the premier accolade for the security industry. While we are pleased with the recognition by our peers we are not resting on our laurels. We have recently introduced an add-on service for the iBridge Connected Home Suite, which provides subscribers text message and video alert notification. From what we can see no one else in the market is offering this level of customization, we are providing for managing their home remotely, whether it’s related to a video issue, service pack issue or something in between. Further more our alarm division is also seeing strong results from other products. Alarm deal is currently in the favorish prices of replacing 2G GSM radios that communicate alarm signals to central stations as that network sunsets into the year 2017. As a result, our recurring revenue sales including our StarLink 3G, 4G communicators are up 53%. We expect to see interest continue with the introduction of the CDMA version of the StarLink radio that we will run on Verizon’s network and StarLink products to communicate commercial fire emergencies. The market opportunity for a product that can communicate commercial fire alarms over wireless network is huge. We already landed one major contract and expect to begin to recognize substantial revenues from new offering in the quarters ahead. The gathering momentum, I was just excited our ability to deliver a greater shareholder value. As we stated in previous disclosures, we have clear targets of what won NAPCO’s business to look like by fiscal year 2017. They are $100 million target revenue run rate, while reducing seasonality, $10 million annual revenue contribution from recurring total revenue stream, gross margin north of 40% and $1 a share in annual earnings. This quarter’s results combined with what we are seeing through our discussions with our dealer network gives us confidence we are well on the way to hitting our goals. To some extent we think the market is missing this trend and frankly that is why we continue to buyback our shares and what we believe is a very good price compared to the intrinsic value we have been creating. To that end, we bought back 196,630 shares of our outstanding common stock this quarter at a weighted average price of $4.45 per share. We continue to believe the best use of our excess cash is to buyback our stock, because we feel it is undervalued. At this point buying back our stock is more attractive than any other strategy we could potentially employ with our excess cash and we continue to make opportunistic purchases in the market where we see fit. When you consider that we continue to pay down our debt, we believe that we have created a compelling value proposition for our shareholders that should improve over time as the revenue mix continues to shift towards more recurring higher margin products and we head into fourth quarter which is historically NAPCO’s strongest of the year. This is a very exciting time for NAPCO. Last quarter we talked how we felt that we reached an inflection point in our business whereby we can unlock the value of our operational efficiencies and economies of scale. This quarter’s results demonstrate that we are more than just talk. We are delivering strong growth as new recurring revenue products introduced to our dealer network begin to sell-through faster and we are demonstrating our earnings power by releasing the operating leverage provided by our Dominican Republic facility. We fully expect these trends to continue and we remain optimistic that this will be our strongest fiscal year on record. I would now like to turn the call over to Kevin to review the quarterly results. Kevin?

Thank you, Dick and good morning everybody. Revenues for the 3 months ended December 31, 2014 increased 7% to a Q2 record of $19.6 million compared to $18.4 million in the same period a year ago. For the six months, revenue increased 4% to $36.9 million, a record for the first six months of the fiscal year from $35.6 million for the same period one year ago. The increase in sales for the three months and six months was due primarily to increased sales of the company’s door locking, intrusion and access control products. Gross profit for the three months ended December 31, 2014 increased approximately 20% to $6.1 million or 31.2% of sales compared to $5.1 million or 27.7% of sales for the same period a year ago. Gross profit for the six months increased approximately 12% to $11.4 million or 30.8% of sales compared to $10.1 million or 28.4% of sales in the same period a year ago. The increase in gross profit for the three and six months was primarily due to the increased sales and a positive shift in product mix to higher margin products. This also demonstrates the impact of increased recurring revenue as well as our overall efficiency as our sales volume increases. Selling, general and administrative expenses for the quarter increased $430,000 or 9% to $5 million or 25.6% of sales compared to $4.6 million or 24.9% of sales for the same period last year. Selling, general and administrative expenses for the six months increased by $640,000 or approximately 7% to $10 million or 27.1% of sales compared to $9.4 million or 26.3% of sales a year ago. The increase in selling, general and administrative expenses for the three and six months was due primarily to the addition of selling personnel and increased media or advertising. Operating income for the quarter increased by $592,000 or 117% to $1.1 million as compared to $504,000 for the same period a year ago. Operating income for the six months increased $598,000 or 80% to $1.3 million from $744,000 in the same period a year ago. Interest expense for the quarter decreased by $26,000 or 33% to $54,000 as compared to $80,000 for the same period a year ago. Interest expense for the six months decreased by $70,000 or 39% to $109,000 as compared to $179,000 for the same period a year ago. The decrease in interest expense for the three and six months ended December 31, 2014 resulted from lower average outstanding debt and lower interest rates during the current period as compared to the same period a year ago. Net income increased by $583,000 or 158% to $951,000 or $0.05 per diluted share as compared to $368,000 or $0.02 per diluted share for the same period last year. Net income for the six months increased by $619,000 or 126% to $1.1 million or $0.06 per diluted share compared to net income of $491,000 or $0.03 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 $580,000 or 60% to $1.5 million or $0.08 per diluted share as compared to $962,000 or $0.05 per diluted share last year. Adjusted EBITDA for the six months increased $553,000 or 34% to $2.2 million or $0.11 per diluted share as compared to $1.6 million or $0.08 per diluted share for the same period a year ago. At December 31, 2014, the company had $1.7 million in cash and cash equivalents compared to $2.5 million at June 30, 2014. The company also had working capital of $32.7 million at December 31, 2014 compared with working capital of $33.4 million at June 30, 2014 paying down our debt and optimizing our collective capital remains the top priority for NAPCO. Debt net of cash was $9.3 million at December 31, 2014. Debt net of cash has now been reduced by $26.6 million from $35.9 million since we acquired Marks in August of 2008. That concludes my formal remarks. And I would now like to return the call back to Dick.

Okay. Thanks Kevin. That concludes our formal remarks, Kevin and I would like to open the call for questions. Operator, please proceed.

Thank you. We would now be conducting a question-and-answer session. [Operator Instructions] Our first question is from Kara Anderson with B. Riley & Company. Please go ahead.

Hi, good morning. The 53% increase in the alarm division’s recurring revenue, is that inclusive of StarLink and iBridge?

Yes, it’s all of these together.

Okay. And then did any part of the Mid-Western College projects flow into Q3?

Q2 is where it all went in, but there is a chance for a second round of equipment that they are going to be needing, so right now the order that we had all shipped in Q2.

Okay.

A lot of the schools that we do usually do a first phase and then there is additional follow-up business. So, we have expected for most of the school jobs that we have been announcing.

And then the inaugural sale of the ArchiTech Networx product did that meaningfully add to revenues in the quarter and if so can you quantify it?

It did impact revenue in the quarter. We don’t disclose it though Kara, but it’s meaningful and it will be more meaningful as we go forward. It’s going to be we believe a big area of business for us.

Okay. And then previously you said that you expected to ramp-up selling expenses for the first half of fiscal 2015, now that we are into the second half should we expect to see the elevated selling expenses going forward?

I think you should expect to see at the rate that we have spent in the first two quarters that rate could continue. We don’t expect the rates to increase in the second half of the year. However, as sales ramp up and if they ramp up even beyond where they have been, you will see higher commission expense. So from that point of view you will see higher selling expenses, but that will be a good thing, we will be happy to have that.

And then lastly, do you think that you can grow revenues sequentially coming off this strong quarter and this larger win from the Mid-Western College?

Well, as we have said on our last half of our year is our strongest half of our year. So we expect to have nice growth in the next few quarters.

Great. Thank you.

Thank you. The next question is from Pete Enderlin of MAZ Partners. Please go ahead.

Good morning and congratulations on the gathering momentum.

Thank you.

How long can you keep showing RMR growth of more than 50% or high double-digits before you have to break it out as a percentage of revenues?

Well, we have said therefore it becomes 10% of our revenue we would stop breaking it out.

Right. Well, I mean I guess what I am trying to get out is how close are you to that at this point?

There is still a little distance there, but we love the expansion of it and we are going to be adding additional recurring revenue products that will get us to that finish point even quicker.

And how would you break down the sources of the recurring revenues that you have between commercial, residential, educational or whatever?

Right now, majority of the recurring revenue is coming from residential and more commercial. With the addition of the fire communicators, we expect to get heavily into the commercial closings. And with the addition of the CDMA Verizon network coming onboard that should be proposed [indiscernible]. The new iBridge where we are doing the video on the iBridge that we have discussed drive a lot of business also. So, it’s an exciting time for smartphone operating system that, that’s the big trend that will go on for years.

And Dick, how would you compare the growth potentials in the higher education vertical versus maybe secondary education or primary schools? I mean, obviously, there is a significant need for lock down and security in those markets as well, but it seems like most of your wins have been in big college and university area?

Well, the K-12 has budget issues.

Yes.

We don’t advertise and discuss the wins, but we are selling a lot of our Marks K-12 product there, 25, 50, 100 on certain key parts of the school, but the college was our big win, high margin products dollars. So, they kind of make the cut, but both markets are addressed by a product line, which is kind of unique, but there is no company like us as both the economical and the top line vertical.

Okay. Again, congratulations on the results and thanks for taking my questions.

Thank you again.

Thank you. [Operator Instructions] The next question is from Walter Ramsley of Walrus Partners. Please go ahead.

Thank you. Congratulations. Really nice quarter. I have got a question about the new ArchiTech platform, can you describe for the, let’s say, the people in that apartment building, I mean, what’s the difference between what they had before and what you are putting in? I mean, how does it look, look how does it work?

Well, the line is very unique and it’s kind of a combination of the Marks architectural aesthetics and the alarm lock technologies where we make fobs which fits on to the door or within the door. And you have a beautiful looking locking device in the outside, not these large, ugly looking locks and the beautiful cosmetics and then you have complete control with a key fob or card or keypad to operate the door and also the doors can be networked throughout the whole building. So, it’s on a network to the security person that is on deck and has new radio transmitters inside of it. So, it’s got a lot of technology to it and the builders and architects like it. This looks pretty. They can network and give high security within the building and control all the doors as far as who can come in at what time, certain temporary codes and a lot of other attributes that the alarm lock trilogy line had. So, it’s a good hybrid.

Yes, okay.

So, we expect to do a lot of business with this both the high rises, office building, it’s a revolutionary changing product.

Sure. It sounds great. So, the immediate market, would you say it’s more new construction or a retrofit or a combination or where is the….

We designed it, so that it could be retrofit or for new or also that door manufacturers can insert it within the door itself during the door manufacturing process. So, it has all these attributes to it. So, we are going after all these markets. And it’s an evolutionary change in the locking business, which has been the same for thousands of years. This is the new electronic age of locking. And the officers like it and the builders, developers like it as they were adding something sexy to their offering to consumers.

Yes, I would think. So, from a financial standpoint, would you say that’s it kind of replacing some of your old sales or is it primarily added on to what you had before or how would you characterize those?

I think there is always a need for our traditional product line. This is the build upon that and traditional product line we are expanding that out as all kinds of new distribution and this is for more high end type of technology if the door is opening.

Yes. Man it sounds great. I got a couple of other questions, if you don’t mind, the tax rate during December quarter was a little on the low side, was that just kind of a slope curve, I mean what’s the expected tax rate say for full year?

The tax rate jumps around from quarter-to-quarter, but when you get to the end of the year it will be between 10% and 15%. Of other times when you have a strong quarter the rate will actually be lower the percentage. So we expect we haven’t changed, we expect 10% to 15% despite whatever the rate was this quarter being low.

Well, I am going to have to hire your accountant so that when I have a good quarter and my income goes up I get a lower tax rate, I would like to turn to that?

I hope, yes.

Okay. And just one other thing I guess on the 2-year forecast getting to $100 million is that organic, is that still the way you put that together or does that include some acquisitions or what’s your game plan for getting to that target?

We think that if we block and tackle and execute the way we have been doing we can reach that number in a couple of years. Of course the economy is taking hold and it’s got to be continued construction going on and things like that, but we think we can do it. We have a lot of these new products. There is a lot of excitement about all the different aspects of our business in all the divisions.

Okay. Well, anyway congratulations. It looks like things are really falling into play. Thank you.

Yes. And that was – that’s without acquisition.

Right. I got that. Thank you, Richard.

Thank you.

Thank you. The next question is from Rick Fetterman of Fetterman Investments. Please go ahead.

Thank you. Good morning. I have a couple of questions regarding the apartment projects which you did in New Jersey, did – you may have mentioned this earlier, if you did I am sorry I missed it, was the job completed and payment received in the Q2?

The job has been shipped and it’s being installed as we speak.

So if it was booked in Q2 revenue though?

Q2 revenues to receivable in Q2 and we will get it in this quarter we will get paid in this quarter.

Okay. And the – you said – the release said there was a 400 unit apartment that I mean does that suggest its rental units and if the answer is yes, are there other apartment projects that have the same ownership as this one you kind of see if there is more market with the same people?

Yes, we have a group of developers that we are pursing that put up these large units like this own this area. And then we are branching out as the product becomes mainstream and manufacturing to the other key cities around the country. So it’s good for any size building co-ops, apartments any size buildings where you want to have a beautiful looking device that networks up the entire building both garage doors and back doors and service doors and where the security guards can control lot of the comings and goings on what’s going on according to the wishes of the tenant.

Okay. Thank you very much. Good luck.

Thanks Rick. Thank you.

Thank you. [Operator Instructions] Okay, it appears we have no further questions in queue at this time. I would 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 if you have any further questions please feel free to call KCSA, Kevin or myself. We thank you for your interest and support and we look forward to speaking to all of you again in a few months to discuss NAPCO’s fiscal third quarter 2015 results. Goodbye and have a great day everyone.

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.