Napco Security Technologies, Inc. (NSSC) Q3 2015 Earnings Report, Transcript and Summary

Greetings, and welcome to the NAPCO Security Technologies Third Quarter Fiscal 2015 Financial Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Todd Fromer, Managing Partner of KCSA, Strategic Communications. Thank you, sir. You may begin.

Thank you. 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, 2015. 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 following 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 turn the call over to Richard Soloway, President and Chairman of NAPCO Security Technologies. Dick, the floor is yours.

Thanks, Todd. Good morning, everyone and thank you for joining us. This morning, NAPCO reported results for the third fiscal quarter of 2015. We are pleased with our performance in what was a challenging environment for the company. As many of you experienced firsthand, the months of January, February and March put record cold temperatures, ferocious winds and plenty of snow. This is especially true in the Northeast, where a large number of NAPCO’s 10,000 plus dealers are located. The unreasonably brutal winter made it difficult for our dealers to conduct sales calls, which are critical in an industry, where business is done face-to-face. It also made it difficult for them to install the NAPCO products that provided recurring revenue streams. Despite the challenges, our financial results were solid and we continue to grow our top line and sales of recurring revenue products. More importantly, we emerge from the winter with continued excitement about the company’s trajectory. In April, NAPCO was a featured exhibitor at ISC West, the security industry’s largest U.S. tradeshow. Across all of our divisions, our products were met with a warm reception, including our StarLink fire communicators, architect network designer wireless access control locks, and LifeSaver healthcare locking solutions. Our strong showing at ISC West underscored NAPCO’s position as one of the most dynamic companies in the security industry. The positive reaction also demonstrated that the investments we have made in our business to develop our product line are paying off. One of the things we focused on is keeping our capital expenditures and R&D spend constant on a quarterly basis. Since our business is seasonal that along with our fixed cost structure results in margins being lower in the beginning of the year. When you take into consideration that we are entering the fourth quarter, which is historically our strongest, coupled with the additions we have made to our product line, we expect to see a ramp up in both revenues and profitability. One of NAPCO’s major initiatives has been our focus on introducing and growing recurring revenue services. During the quarter, recurring revenue from our alarm division increased 46% year-over-year and 6% sequentially. Equally impressive, recurring revenue for the first nine months of the year was 58% versus the same period last year. Looking closer at our recurring revenue products, during the third quarter, we successfully launched our CDMA version of the StarLink alarm communicator, which features Verizon wireless service. We expect this product to considerably expand our footprint in the alarm communication category and fuel substantial growth. Much of that growth is being driven by the sense of urgency alarm dealers and their customers feel to replace the 2G GSM radios that communicate alarm signals to the central stations by the time that network sunsets into the year 2017. In late June towards the end of our fiscal year, we expect to take another large step in growing our service-based revenues with the launch of a full line of commercial fire alarm communicators, also under the StarLink brand name. This addition will help us mark our place of mark on the burgeoning fire alarm communicator category. This category is undergoing tremendous growth as alarms that use traditional phone lines are being replaced with fire alarms that make use of more advanced and reliable CDMA signaling. We also saw continued success with our entry into the connected home category. The number of dealers participating in our iBridge Connected Home dealer program rose 27% during the quarter. This increase demonstrates that NAPCO is meeting needs of traditional residential alarm dealers looking to expand their offerings beyond installing security alarms by taking advantage of the connected home revolution. The program targets those dealers by providing technical and sales training, customized sales materials, web-based content, Internet advertising and consumer leads. Outside of our recurring revenue products, we continue to see growth in our education vertical, which is being driven by our innovative suite of LocDown access control locking solutions. From the cost effective LocDown intruder lock locked by Marks, which enables a teacher to lock his or her classroom door safely from inside the classroom and out of harm’s way to alarm locks network wireless locking system which can LockDown an entire school campus in seconds. We are playing a significant role in protecting our schools from potential predators, particularly shootings. As part of our commitment to make schools safer, NAPCO has created a measurable index known as the School Access-Control Vulnerability Index, or SAVI. NAPCO is training security dealers on how to conduct a SAVI audit, which quantitatively measures a school’s security capabilities in withstanding an attack by an intruder. Once the audit is conducted, our dealers can correct any vulnerability at a given institution by installing the proper security measures. Another rapidly growing vertical that is generating considerable increase in door locking volumes is the healthcare market. Our Marks LifeSaver locking line provides unique, effective anti-ligature protection for behavioral institutions, veterans’ hospitals, interrogation rooms and holding cells. This innovative design of products helps these institutions to prevent people from harming themselves. With all the positive momentum in our business, we believe our stock is undervalued. We continue to buyback our shares at what we believe is a very good price compared to the intrinsic value we have been creating. To this end, we have bought back 398,717 shares of our outstanding common stock since the buyback was announced in September at a weighted average of $4.74 per share. We continue to believe the best use of our excess cash is to buyback our stock. At this point, buying back our stock at these levels is more attractive than any of the strategies we could potentially employ with our excess cash and we will 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. Overall, all the pieces are in place for NAPCO to finish what has already been a strong year on a high note. As we progress through the fiscal fourth quarter, which is prime selling season in many of our end markets, our dealer network is excited about our suite of innovative products, as well as the programs we offer like SAVI and iBridge Connected Home to help them close more sales. Simultaneously, we are executing on growing our recurring revenue streams. We will enable – this will enable us to see significant gross margin expansion as our revenue mix shifts to higher margin products and we see the benefits from owning and managing our manufacturing facility in the Dominican Republic. I would like to turn the call over to Kevin to review the quarterly results. Kevin?

Thank you, Dick and good morning everybody. Revenues for the three months ended March 31, 2015 increased 4% to $17.9 million compared to $17.3 million in the same period a year ago. The increase in sales for the three months was due primarily to increased sales of the company’s door locking products, increased recurring revenue and partially offset by decreased sales of intrusion and access control products. For the nine months, revenues increased 4% to $54.8 million from $52.9 million for the same period 1 year ago. The increase in sales for the nine months was due primarily to an increase in door locking, intrusion and access control products as well as increased recurring revenue. Gross profit for the three months ended March 31, 2015 is roughly flat at $5.3 million or 29.9% of sales compared to $5.3 million or 30.8% of sales for the same period a year ago. Gross profit for the nine months increased approximately 8% to $16.7 million, or 30.5% of sales compared to $15.4 million, or 29.2% of sales in the same period a year ago. The increase in gross profit for the nine months was primarily due to increased sales and a positive shift in product mix to higher margin products. This also demonstrates the impact of increased recurring revenues as well as our overall efficiency as our sales volume increases. Selling, general and administrative expenses for the quarter increased $301,000, or 7% to $4.9 million, or 27.2% of sales compared to $4.6 million, or 26.4% of sales for the same period last year. Selling, general and administrative expenses for the nine months increased by $941,000 or approximately 7% to $14.9 million, or 27.2% of sales compared to $13.9 million, or 26.4% of sales a year ago. The increase in selling, general, and administrative expenses for the three and nine months was due primarily to the addition of selling personnel and increased media advertising. Operating income for the quarter decreased by $272,000, or 36% to $477,000 as compared to $749,000 for the same period a year ago. Operating income for the nine months increased $326,000, or 22% to $1.8 million from $1.5 million in the same period a year ago. Interest expense for the quarter decreased by $7,000, or 12% to $52,000 as compared to $59,000 for the same period a year ago. Interest expense for the nine months decreased by $78,000, or 33% to $161,000 as compared to $239,000 for the same period a year ago. The decrease in interest expense for the three and nine months ended March 31, 2015 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 decreased by $255,000, or 39% to $395,000, or $0.02 per diluted share as compared to $650,000, or $0.03 per diluted share for the same period last year. Net income for the nine months increased by $364,000 or 32% to $1.5 million, or $0.08 per diluted share compared to net income of $1.1 million, or $0.06 per diluted share for the same period last year. Adjusted EBITDA for the quarter as per the schedule included in today’s press release decreased $330,000 or 28% to $870,000 or $0.05 per diluted share as compared to $1.2 million or $0.06 per diluted share last year. Adjusted EBITDA for the nine months increased $276,000 or 10% to $3.1 million or $0.16 per diluted share as compared to $2.8 million or $0.14 per diluted share for the same period a year ago. At March 31, 2015, 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 $32.3 million at March 31, 2015 compared with working capital of $33.4 million at June 30, 2014. Paying down our debt and optimizing our cost of capital remains the top priority for NAPCO. Debt net of cash was $8.9 million at March 31, 2015. Debt net of cash has now been reduced by $27 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. In conclusion, our commitment to enhancing shareholder value remains steadfast. As part of that commitment, we continues to roll out new recurring revenue products while growing revenues from existing ones, as well as making the opportunistic repurchase of shares in the open market. We are excited about the positive developments in our business and believe we are well-positioned to deliver strong results to round out the year and demonstrate the leverage in our business model. That concludes our formal remarks. Kevin and I would like to open the call for questions. Operator, please proceed.

Thank you. We will now be conducting the question-and-answer session. [Operator Instructions] Our first question comes from the line of Joshua Reilly with Northland Securities. Please proceed with your question.

Thank you, guys. So I guess my first question is, could you give us an update on the pipeline here for the spring or the school LockDown product. And what are you seeing overall in the spending environment on the school side, is there a budget out there for new products?

Hi, Josh. The school business has been picking up nicely both K-12 and colleges and universities. We have a full line of products that do that. We have in the – we are in the midst of producing some customized versions of our locking to match the architectural requirements by the schools. We are very versatile in being able to do that because Marks makes architectural hardware and alarm lock makes the customized electronics. We don’t really break down the amount of school business, but it is a little lumpy. It comes typically at a time when the schools are out. That’s when the orders come through so that the locks can be replaced when there are no students in the schools. But we have high hopes our rep organization, our sales organization is out visiting all kinds of schools and there is a whole list of schools that we have closed on our website. So you might want to refer to that. And we believe that the lumpiness will kind of smooth out as legislation seems to be being discussed around the country about having the school LockDown and with our SAVI report in our product line, we feel very, very positive about it.

Okay. I think you mentioned the intrusion and access control wasn’t as strong as you might have hoped, was the main driver of that weather in the quarter would you say or was there something else there?

I think that the weather was a dampening factor because the dealers all told us that nobody was going out, they weren’t making any calls, people weren’t really installing alarms. So it kind of put a quenching effect on things. Historically, we always had a very strong fourth and we have – we expect that, that history will continue. We have kept our expenses level throughout the quarters, so when the volume comes in, in the fourth that should trough a lot of revenue and profitability.

Okay. And then my last question is the gross margin was down slightly year-over-year when the growing percentage of recurring revenue business should be bringing that up, it might take away – what’s driving that in the quarter that locking business was stronger than you expected and kind of have the lower than company average gross margin just wanted to confirm that?

Roughly, the locking GP is very good and that helped the GP. The thing that hurt the GP for the quarter is if you are spending more money than you were last year than we are – the GP is going to go down. So, we are spending more R&D. We are not stopping the R&D just because the weather is bad. We continue to spend – we are trying to get products to market as fast as we can. We are also spending more money on the SG&A line to get it to market as fast as we can, because we want to hit our goals that we talked about in 2017. We expect to be at a much higher level than we are now. And in order to do that, we have to spend money. And so when you spend the money, then you have a quarter where their sales get hurt by weather or whatever, it looks worse than it was say in the prior year. But to us, it’s just a small measure of time, it doesn’t mean much in the big picture and in the fourth quarter, which is where we are now, it’s going to come roaring back.

Alright. Thanks guys.

Okay, Josh.

[Operator Instructions] Our next question comes from the line of Kara Anderson with B. Riley. Please proceed with your question.

Hi, guys. Good morning. Just to sort of piggyback off of Joshua’s comments, can you quantify the impact from weather on the quarter’s revenues?

It’s hard for us to do that, Kara, because remember how we sell. We are selling through distribution, but what we see and what we hear is that the distributors, inventory levels weren’t so low, because nobody was out selling, dealers weren’t out-selling. So, it’s hard for us to exactly quantify, but what we felt was it was worse than even as it was last year. Last year, the weather wasn’t great either. This year, it was even worse. Records would be set in many cities for snowfall and such. So, it’s hard for us not only to quantify it, it’s also hard for us to tell you for sure it’s going to come back in this quarter. We think we are going to get a bunch of it back in Q4, but that’s also hard to quantify.

Okay. And then also, you mentioned 2017 goals, can you update us on your longer term revenue and gross margin expectations and sort of the timeframe for achieving those?

Well, nothing has really changed as far as our expectations. For 2017, we expect the recurring revenue to be at a $10 million clip. So that we are doing a lot of things, a lot of promotions, spending money to get that number up as fast as we can, because that’s high GP business. Recurring revenue, as many of you know, is 80% plus GP. So, it’s important that we get that and recurring revenue is the gift that keeps on giving. So, we are spending a lot of money and promotions to get recurring up. So, that goal is still the same. And we also with all of our products and promotions, etcetera, our goal is also to be at a much higher clip by ‘17. We have set at $100 million run-rate. Nothing has changed just because of a quarter that had some bad weather. So, our goals are the same.

Great, thank you.

You are welcome, Kara.

[Operator Instructions] Our next question comes from the line of Leon Semonian, a Private Investor. Please proceed with your question.

I am distracted you are buying back. Is that being retired out on the treasury?

Out in the treasury, Leon.

Thank you. Bye-bye.

Mr. Soloway, it appears we have no further questions at this time – I am sorry, we did get another question. Our question is from [indiscernible] Partners. Please proceed with your question.

Hi, good morning. I was wondering if you could give me a sense – give us a sense of how the quarter is progressing that we are in right now? You have been able to see I guess about a month and a half of the quarter, could you give us some insight?

We really can’t give any predictions on how the quarter will be and how it’s progressing. We can just tell you historically for more than 10 years, the fourth is by far the strongest quarter and we would expect the same type of thing this year. A lot of the business comes through in the very, very end of the quarter. So we expect there would be expenses that we have been spending for sales, marketing and engineering that our profitability will bounce back to higher level once the volume is completed by the end of June.

Okay. Can you give us a sense of what kind of gross margin you are expecting for this quarter?

Well, what we could say up is if we have the kind of quarter that we had last year and the year before, in each case it was a $21.5 million, $21.8 million a quarter, $21.5 million last year, $21.8 million the year before. In each of those years, the gross margin was 38% plus. We know when we get over 20, that’s when the action starts. You get over 21, you are going to be over 35, to be close to 38. So while we can’t predict that the sales for the quarter is going to be exactly $21 million, $22 million, $23 million, we do believe it’s going to be over $20 million, and once it’s over $20 million, you get what we call the hockey stick leverage. So we feel very confident about that leverage. Just hard for us to tell you right here and now how high over the $20 million is it going to be.

Okay. And just the balance sheet, are you slowing down the debt pay down, is this a level you are going to hold this debt or do you want to get it to zero?

Well, right now what we have been doing with the buyback is just paying as required as opposed to paying extra. So depending upon how we handle the buyback, we will slow the buyback. We will pay more towards the debt. Once it got below $10 million, we got very comfortable. And at that point, we feel like we did what we have to do as long as we make our payments that are due will do. So we don’t have to get to zero. The debt level is comfortable for us and the interest cost is very low. We pay LIBOR plus 1.5%. So it’s almost like free money in a sense.

Okay. And just finally, you made some new hires in terms of sales I was wondering if you could comment on how those new hires have been going?

We have hired people in the sales area of most of our divisions. We have also put on sales reps in greater quantity than ever before and it takes a little bit of time for them to bring in the business. But we can feel and see from the feedback that we get from these people that there is going to be a lot of business generated. You back that up with the new products that we have got going on that are coming out, fire and LockDown and lots of recurring revenue products, more feet on the street is what the name of the game is for us with the reps and with the salespeople and it makes for a very bright scenario.

Okay. Do you guys – in order to get that number in 2017, will this require you to do any sort of acquisitions?

No, that’s organic growth.

Okay. Because when we look at the estimates out there, we are looking at around $80 million this year, $84 million next year. So to get to that number, I believe you have to do about $100 million if I am correct?

At a run rate of.

Okay. And so that would require some serious growth from 2016 to 2017?

Yes, but a run rate of means $25 million type quarters. So yes, we have a lot of work to do and I think we have the products to get there.

Okay. Do you think that at this point you flat lined in terms of costs or are you going to be adding more costs in order to build up the SG&A?

I don’t think we are going to have to increase it beyond the new spend rate that we are. Right now we are spending at say $1 million more than we have spent in the past. The only thing that we think is variable is the sales commission part. So as those sales grow, there is going to be additional commission costs. And as those sales grow, there will be additional freight costs. So, other than those two costs, we don’t see any major additions to the selling costs. It might be promotions also. We pick our spots in order to get those sales to grow fast like we have to have it happen. There might be some selling promotions here and there. So, I don’t think it’s going to be millions of dollars more, but it might be a little bit more here and there.

Okay, perfect. Thanks guys. Thank you.

Thank you.

Mr. Soloway, we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Okay, 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 me. 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 2015 fourth quarter and full year results. Bye-bye.

Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.