Napco Security Technologies, Inc. (NSSC) Q1 2016 Earnings Report, Transcript and Summary

Greetings, and welcome to the NAPCO Security Technologies, Inc. First Quarter Fiscal 2016 Financial Results. 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. I would now like to turn the conference over to your host, Mr. Todd Fromer, Managing Partner of KCSA Strategic Communications. Thank you. You may now begin.

Thank you. Good morning and thank you all for joining us today for conference call to discuss NAPCO’s financial results for the three months ended September 30, 2015. By now, all of you should have had the opportunity to review the press release discussing the results. If you have not, please contact KCSA Strategic Communications by phone at 212-682-6300 or by mail at napco@kcsa.com and we will send it to you. 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.

Thanks Todd. Good morning, everyone, and thank you for joining NAPCO’s quarterly conference call to discuss the financial results for the three months ending September 30, 2015. We are very pleased with the way we kicked off fiscal year 2016, delivering record first quarter revenues and almost doubling net income year-over-year. What's driving our strong financial performance? It’s simple. Our line-up of innovative products and services, which continue to wow the marketplace quarter-after-quarter, year-after-year. This particular quarter was highlighted by the strong growth of our locking solution and our continued expansion into the recurring revenue-driven by alarm communicator market. The latter has been a success story and really underscores the strength of our R&D process and a success in launching recurring revenue services. This quarter, we introduced the StarLink commercial intrusion and fire-alarm communicators to great fanfare. This is the latest addition to the full line of UL-approved StarLink commercial radios, which are in demand as users of commercial alarm systems look to replace disappearing traditional phone line signals with advanced wireless cellular communications technology. To give you a flavor of how popular these products have been, we have increased our second quarter production forecast by 35% of our original projections and have added an additional assembly line in our Dominican Republic manufacturing facility to fill orders more quickly. Overall, we recorded a 38% increase in subscription based recurring revenue over the last year's first quarter. As we experienced success with our StarLink products, we also continued to gain traction with our other recurring revenue of subscription-based services, including iBridge Connected Home. iBridge Connected Home products provide consumers with a lifestyle management suite of services, enabling them to remotely control various subsystems in the home, such as, lighting, security, climate control, garage doors, video cameras and small appliances and door locks. Our dealer network is embracing iBridge in increasing numbers and taking advantage of our iBridge Connected Home Dealer program. This program targets traditional residential alarm dealers looking to expand their offerings beyond installing security alarms. The program provides technical and sales training, customized sales materials, web page content, internet advertising and consumer leads. As more dealers join the program and recognize the benefits of offering iBridge to their customers, we anticipate that interest and ultimately sales of these products will grow. At the beginning of the call, I mentioned that we are seeing strong demand for our locking solutions. Our success in this category is primarily coming from sales of super premium architectural hardware that are used in high-rise apartment buildings. Construction of multi-family units is booming, particularly in the higher end of the market. The CoStar Group, a real estate analytics provider, estimates that 80% of the apartment construction in the major metropolitan areas today is for luxury buildings. NAPCO is ideally suited to provide developers with locks that are secure and esthetically pleasing. Our architect line is the first wireless locking product line to recognize the pent-up demand for providing architects and interior designers with a multitude of super premium door-locking hardware looks and options of all electrified with the most uncompromising advanced access, security, technology available today. The locks come in hundreds of trims and finishes that satisfy the broad spectrum of designer taste. Since the inaugural sale of this integrated access control and wireless locking hardware system took place in March at a 400-unit luxury apartment complex in New Jersey, interest has remained strong, and with some real estate forecast indicated multi-family construction will continue to remain at this pace into 2016, we are very excited about the opportunities ahead of us. Education continues to remain a hot vertical. As institutions of all shapes and sizes stick to improve campus safety, NAPCO continues to play a significant role in protecting our schools. Our innovative Alarm Lock, Marks, Continental Access control products, many of which are specifically designed by our company for school application increasingly fits in the needs of both K-through-12 and colleges and university educational institutions, and as active shooter events have become more commonplace, we have designed solutions to mitigate these threats. Our school vertical, specifically Project Lockdown, which incorporates our School Access-control Vulnerability Index or SAVI and audit systems takes a holistic and active approach in training security dealers and end-user school officials on how to significantly reduce or prevent mass shooting incidents. With all the positive momentum in our business, we believe that our stock is undervalued, particularly when you look at the intrinsic value we have been creating. During the quarter, we opportunistically bought back as part of our 1 million share repurchase program, which was enacted in September 2014. During these three months ending September 30, 2015 the company repurchased 16,093 shares with outstanding common stock for weighted average price of $5.87 per share. As part of our normal course of operation, the management team and Board of NAPCO routinely evaluate the company’s capital allocation strategy. Our share repurchase program remains in place, but we are also exploring other value accretive ways of deploying our cash. With our business continuing to move in a positive direction, our net debt position solid and our CapEx spend stable, we are in place to continue our trend of generating strong free cash flows. We have a sophisticated Board in place who is committed to putting this cash to use in a way that will provide the most value for the shareholders. And as we do, we will be sure to keep the financial community updated. Overall, we are excited about NAPCO’s trajectory, as we progress through fiscal 2016. We continue to see strong interest in our product lines and recurring revenue services. With that said, I'd 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 September 30, 2015 increased 5% to a first quarter record of $18.1 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 and intrusion products, as well as increases in recurring revenue. Gross profit for the three months ended September 30, 2015, increased approximately 7% to $5.6 million or 31.1% of sales, compared to $5.3 million, or 30.3% of sales, for the same period a year ago. The increase in gross profit for the three months was primarily due to increased sales, as well as continued positive shift in product mix for the company's door-locking products. This also demonstrates the impact of increased recurring revenue, as well is our overall efficiency as are sales volume increases. Selling, general and administrative expenses for the quarter increased approximately $300,000 or 6% to $5.3 million or 29.3% of sales, compared to $5 million or 28.9% of sales for the same period last year. The increase in selling, general and administrative expenses for the three months was due primarily to the addition of selling personnel and increased media advertising and trade show expenditures. Operating income for the quarter increased by approximately $78,000 or 32% to $324,000 as compared to $246,000 for the same period a year ago. Interest expense for the quarter decreased by $6000 or 11% to $49,000, as compared to $55,000 for the same period a year ago. The decrease in interest expense for the three months ended September 30, 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 increased by approximately $156,000 or 98% to $315,000 or $0.02 per diluted share, as compared to $159,000 or $0.01 per diluted share for the same period last year. At September 30, 2015, the company had $2.8 million in cash and cash equivalents, compared to $2.3 million at June 30, 2015. The company also had working capital of $34.2 million at September 30, 2015, compared with working capital of $35.6 million at June 30, 2015. Paying down our debt and optimizing our cost of capital remains the top priority for NAPCO. Debt, net of cash, was $6.5 million at September 30, 2015. Debt, net of cash, is now been reduced by $29.4 million from $35.9 million since we acquired Marks in August of 2008 with 1.9 million of the reduction occurring in the first fiscal quarter of 2016. That concludes my formal remarks, and I would now like to return the call back to Dick.

Okay. Thanks Kevin. In conclusion, fiscal year 2016 is shaping up to be another exciting year in the company's history. During the first quarter, we continue to see strong interest across our product line, as well as see the benefits of our investments in higher margin recurring revenue products and services. As we move ahead, we are dedicated to doing what’s in the best interest of shareholders, while finding new ways to innovate and prosper. As part of our effort to build upon our considerable presence in the industry, on November 18 and 19, NAPCO will be exhibiting our commercial and residential security solutions and ISC East. For those of you who don't know, ISC East is one of the largest security trade shows in the U.S., bringing together manufacturers and dealers all under one roof at the Javits Center in New York City. At this year’s show, we will be launching several new state-of-the-art product initiatives. We encourage all of you to visit us at the show and learn more about the latest trends and developments in the industry, as well as see demonstrations of our products. That concludes our formal remarks. Kevin and I would like to open the call for questions. Operator, please proceed.

Thank you. [Operator Instructions] One moment please, while we poll for questions. Thank you. Our first question comes from the line of Kara Anderson with B. Riley & Company. Please proceed with your question.

Hi, good morning. I'm just wondering if you can go over your revenue threshold or trigger expectations, at which point, we can expect more meaningful gross margin expansion?

Kara, the first quarter for us is always our lowest one, and so we were encouraged to have a record-breaker of $18.1 million. You know that the quarters get better as the year progresses, and while we're not making - we’re not giving guidance or anything, we expect each quarter to get better. Now Q2, that will now end, was a $19.5 million quarter last year. So obviously if we could continue the trend of being at least 5% better, and we expect it to be even better than that, but if we did 5% better, we'd be in the 20s. Once we hit that 20s, that's when you get that tremendous hockey stick leverage that we like to talk about, where the gross margin really expands. So the expectation is as the year progresses, we'll see more of that.

Okay. Thank you.

You're welcome.

Thank you. Our next question comes from the line of Myran Khan [ph] with Stifel. Please proceed with your question

Good morning, gentlemen.

Good morning.

You can't turn on the television without seeing an ad from one of the cable companies telling you to have a wide house and alarms and everything, and I'm just wondering what effect - that could have a good effect on you people or a bad effect on your business. But it must have a bad effect on the alarm dealers which are your biggest clients. But tell me I'm wrong, so I could feel better?

Okay. Well, hi. We sell more products than the alarm dealers, because we sell locking people and integrators. So we are multi-pronged. We have a lot of irons in the fire. But in the alarm business what's happening is the alarm dealers do most of the business with our alarms all around the country, and they have a preponderance of the business. So what happens is they don't have a lot of money to advertise, so that the - these large cable companies are doing lot of the advertising and sensitizing the consumer that such a technology exists. And then the alarm companies do a lot of mailings to their customers who have alarms in this tens of millions of alarms out there that need to be upgraded to the lifestyle connected home, which is what we are talking about, we call it iBridge. So from a point of view of advertising, it sensitizes everybody and lets the alarm companies get a lot of ride, all bolsterizing with the cable companies advertising. So we look at that as a good thing because we want to expand that market.

Good. Thank you. Keep up the good work.

Thanks a lot.

Thank you.

Thank you. Our next question comes from the line of Pete Enderlin with MAZ Partners. Please proceed with your question.

Thank you. Good morning.

Good morning.

Your top line has been pretty steady mid-single-digits revenue growth. Sort of big question is, what can you do to accelerate that top line growth rate? When you hear about all the things that are going on in the market for security products, it's sort of surprising that your growth isn't already faster. So what can you do - I know you’re bringing out lots of new products, you’re adding some marketing and sales people. Are there other specific things you can do to generate faster top line growth?

Well, we go to all the trade shows. We have sales people in each of our division, and if the process fail, so what happens is both the consumers and school administration, the cities have to all get there ducks lined up so that they pick out the best solution, and we have excellent solutions and our guys are out there working in the field, working in trade shows and that's what we're doing. So it takes a little bit of time, but we are looking for our growth to be stronger than 5% and we made - we believe that in the 17-year, we can be close to a $100 million by the end of ‘17, roughly. It depends on the adoption rate. In the meantime, we are making lots of money with our recurring revenue and that continues to be an important factor for us. And we'll figure out what we are going to do to deploy that cash. We throw off a lot of cash. We’re also going out and we are meeting new investors. KCSA is introducing us to a lot of new investors. We are going to conferences. We have two coming up, so we want everybody to know about it. So we're working on all these facets of our business.

And in terms of total dollar top line growth, obviously the recurring revenues in the wireless alarm business are growing very rapidly from a small base, but which business segment has the best potential to grow dollar revenues over the next several years?

It all is - in order to amortize that Dominican operations and get that hockey stick leverage, we need all the different divisions to contribute. So it depends on the adoption rate, the school, active shooters, schools are now arming themselves against all these predators. The iBridge and the recurring revenue, our recurring revenue services that are replacing copper phone lines that lots of places don't have any more, the new architect locking devices that we are doing for high-rise luxury apartment houses. The builders want to have something more sexy than the key lock, so we invested a beautiful series of locks which operates off the smartphones to open up your door and they are specially encrypted. They also can network all the way down to security people within the building. So there is a lot of things going on and the world is a little bit upside down and people need these solution. So we are developing a lot of new things and driving the business best way we can.

Yes, well, that sort of circles around back to the point I made at the beginning, it seems like your top line growth should be growing faster, given all these exciting products and the fundamental underlying demand. So maybe another question is, would there be some sort of strategic relationship that you could enter into that would give you more market presence, more visibility and allow you to accelerate with the overall top line growth?

Well, we work with the dealers and the installers and the integrators and the locksmiths and their adoption rate of new technology is maybe not as fast as some point of purchase thing at a big box store, but it’s a stall and steady growing business and we think we can accelerate $100 million in the 17 year. That's how do look at.

Okay. And then one last question, Dick, and that is, in the institutional security lockdown access market et cetera, what potential is there for recurring revenues which would include services, software, communications, upgrades whatever? Was that going to be mainly a hardware contract installation kind of business?

We are looking for ways of doing recurring revenue in that field. It's a little bit different, but there are other things - we’ve acquired three companies up to this point, and it could be a potential acquisition if it fits our criteria which could move us up a little bit more in volume and advertise the Dominican factory. So we have the three legs of the security stool. We are the only company that has that, locking, access control and alarms. But there are some add-on bolt-on things that we could add to the mix here. So as long as it’s accretive from day one and it goes down the pipeline to our different dealers and the price is right, it could happen with us also, another acquisition.

Okay. Thank you for taking the questions.

Thank you.

Thank you. [Operator Instructions] Our next question comes from the line of Scott Billeadeau with Walrus Partners. Please proceed with your question.

Hi, guys, thanks for taking my question. Can you just talk about, I guess, that quick more of a housekeeping, the tax rate, and I think you got a tax benefit this quarter as opposed to [indiscernible]. Could you just roughly give me an update there?

Yes, Scott. So our tax rate tends to be about 15% - 10% to 15% by the time the year is over, the fiscal year is over. And it goes - it jumps around - when we make more money as the year progresses, you'll see more tax rate. In this particular quarter, we had a small benefit for a very specific factor that has to do with our offshore facility, but typically if you’re modeling, I would use 10% to 15%. That's the fair rate.

Okay. And then as you mentioned getting some of the architectural locking and so forth, can you give me or give us an idea of what the AS - shouldn’t the ASPs be going up on your locking systems from that perspective? Maybe you could talk a little bit about that.

Yes, the industry has traditionally made mechanical locks and we have mechanical locks made by a market division which are architectural locks of every color and style. And now we are electrifying all those locks. So you’re going to get a value for additional electronics, which is going to be average selling price of those systems is much higher than mechanical locks.

And are you selling those now? I’m just trying to get a figure compared to the year ago quarter, whether those higher ASPs be installed in this quarter? I'm trying to figure out how much was volume and how much was the ASP on year-over-year basis.

We introduced our new architect series couple of quarters ago. We got our first job. It’s just the beginning stages of the adoption rate of the new electronic high premium locks. So we are in the early stages, but we've gotten some jobs. And typically what happens is people want to see in the action and working and then more builders, developers will adopt it. But this is very strong interest in these smartphone operated door-locks which network throughout a building. In the school area, we have - for the K-through-12s, mechanical locking as a base starter, and then we go up to networked wireless locks, like as an example Pepperdine University put in a big access control and network system, so they can change the key codes, lockdown the school or portions of the school. So all of this is building momentum.

I mean, is it 2% of the business, 5% of the business. Can you maybe help us get a sense of how much of this…

Early stages. And we don't really give our percentages for competitive reasons, but early stages. And if you fast-forward another year or so, it's going to be get stronger and stronger. As I said, the adoption rate and doing your test installations take time, but this is the future and we're right in it. We have the best technology in the area of networked smartphone operated locks.

And then on recurring revenues, how much of the quarter was recurring revenue?

We don't break that out either, but what we’ve said is we're running at about a $4 million pace on an annual basis and that’s roughly 5% of the total revenue on an annual basis. With the kind of growth that we are seeing, Scott, 38% in this quarter and 10% sequential, we feel pretty good about getting to $10 million of recurring revenue by ‘17 and we are doing lot of things to get to that $10 million, including the new Fire Radio that we introduced last month or two months ago, having more reps on the ground to sell radios, which is all kind of move that we are making to push that recurring, which is very profitable 80% to 85% profit to get to $10 million in two years.

Scott, if you really - if you want to get a great bird’s eye view of us and the industry, if you could come to the Javits on the 18th and 19th, you will see the full line of products, you will be able to feel what the dealers are interested in and you'll get a tremendous perspective on the industry.

Okay. And on those types of products, who is the primary competitor? Is there a big guy in that space?

There is different competitors. We are the only one in three different spaces. You have the alarm space, you have the access control space and you have the locking space. And there is different competitors in each of these - one of the competitors like Honeywell is in two of the areas, but you have Stanley in the locking and different companies. But we are the only ones that is integrated all these three areas, because the dealers today are looking to grow and do more business in the commercial area and when you integrate all these products together, they play well together, unlike if it's an Apple and a Microsoft product, they sometimes don't work well together. But when you use the NAPCO Fusion network, it all works together, the locking, access control and alarms.

Okay. And just final question. I think you had locking growing 8% for the quarter, overall business 5%. So was - I don't know if you break down alarm, access control, locking or it one or the - was there one that was lagging to bring the growth rate down to 5%?

Well, we talked about how locking was up, we talked about the intrusion up. International was not up. That’s a very small part of our business now, smaller and smaller, which we talked about over the last few years how international regulations, UL-like regulations internationally have pushed American companies out because they have very specific requirements for products to sell internationally and we're not looking to spend our R&D money to develop a product that very specific to a given country. So international was down.

Okay. All right. That’s it. I'll get in. Thanks.

Thank you, Scott.

Thank you.

Thank you. Our next question is a follow-up from the line of Myran Khan [ph] with Stifel. Proceed with your question.

I didn't ask for a follow-up.

Okay.

I'm sorry sir. You were in queue. One moment. Mr. Soloway, it seems there are no further questions at this time. I'll turn the floor back to you for any final concluding remarks.

Okay. Thank you everyone for participating in today's conference call. As always, should 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 you all again in a few months to discuss NAPCO’s fiscal 2016 second quarter results. Have a great day everyone. Bye-bye.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.