Napco Security Technologies, Inc. (NSSC) Q3 2016 Earnings Report, Transcript and Summary

Greetings, and welcome to the NAPCO Security Technologies Third Quarter Fiscal 2016 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]. I would now like to turn the conference over to your host, Garth Russell, KCSA's Strategic Communications. Thank you. You may now begin.

Good morning, and thank you all for joining us on today's conference call to discuss NAPCO's financial results for the three months ended March 31, 2016. 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 at napco@kcsa.com, and we will it to you. On the call today is Richard Soloway, Chairman and President of NAPCO Securities; and Kevin Buchel, Senior VP of Operations and Finance. Before we begin, let me take a moment to read the forward-looking statements. This conference call may contain certain 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, let me now turn the call over to Richard Soloway, President, Chief Executive Officer, and our Chairman of NAPCO. Rick, the floor is yours.

Thanks, Garth. Good morning, everyone. Thank you for joining NAPCO's quarterly conference call to discuss our financial result for the three months ending March 31, 2016. I'm excited to report third quarter sales of $19.8 million, making this the fourth consecutive period of record breaking quarterly sales. The success we are seeing in the market is being driven by several of our new innovative electronic product line for intrusion, security, school safety, connected home, fire system, as well as the continued success of our enterprise class access control and door locking products. In the third quarter, the standout products were in the alarm division which store product sales increased 31%. In addition we saw a 42% surge in the recovering revenue for the alarm division compared to this period last year, and a 10% sequential increase from the end of the December quarter. The increase in sales where our products provide reoccurring monthly revenue is exciting for a number of reason. For one, it strengthens our relationship with the dealers in our network by enabling them to increase their revenue from each customer. Secondly, it reflects our leadership position in developing advanced new products that offer the latest capability end-users desire as wireless and internet things enable devices are hot items today. And then there is the financial benefit of having high margin reoccurring revenue stream that offers NAPCO even greater financial stability as RMR grows into a material portion of our revenue. As a result we expect RMR to create significant value for our shareholders for years to come. The main product driving RMR for us is the line of StarLink 3G/4G and Verizon CDMA alarm radio. These devices continue to experience strong market demand as users of residential and commercial alarm systems are looking to replace hot phone lines with advanced wireless cellular communications technology. In addition aging 2G wireless backup radios need to be replaced with 3G/4G primary radios as the 2G networks are being phased out. Best of all, the addressable market for StarLink is tremendous. I have only started to scratch the surface. For example, the residential small business intrusion radio we launched two years ago and the commercial fire radio we launched months ago are generating greater demand this year as more and more dealers are seeing the benefits of a wireless solution both on upgrading their existing base of back up radios and as a primary communication system for new job. Additionally, the wireless StarLink offers the dealers and users a more cost effective solution than dedicated past line and is more reliable solution. Finally because every commercial building requires a fire alarm system, we believe our new fire radio will be a major revenue driver for many years to come. In an effort to support the growing demand for this product, we've recently appointed Dave Lyons to Vice President of sales for intrusion, connected home and the fire division. Dave came to us with a long tenure in the security business. He previously held positions at security and fire companies, including both Honeywell's System Center and United Technologies Interlogix. He is now responsible for generating sales revenue as well as bolstering the NAPCO sales team led by Jorge Hevia, Senior VP Sales and Marketing, in his ongoing effort to achieve higher sales and gross, and profit margins for the company. On the school safety side of the business, we continue to see growing market demand. Our diversified suite of lockdown access control system are uniquely designed to play a significant role in protecting students, faculty and administrators in both K through 12 and colleges and universities across the U.S. We recently announced that the lockdown platform has been installed in hundreds of schools, colleges and universities across the U.S.A. This access control system is part of a new wave of technology protecting students at all levels by enabling administrators to wirelessly control access to and within schools. We are constantly reminded of the need for schools to have various levels of safety protocols in place. Last week there was a deadly shooting of a teacher in a parking lot of a Maryland school as the assailant then proceeded to two other non-school locations. These events lead to the lockdown of approximately 200 schools in the area while police hunted down the suspect. With every present school safety concerns, we have seen state and federal governments makes a push to increase funding for school protection. At a number of state legislative bodies continue to convene on the topic this year. As a result, spending in this space is projected to increase from $2.7 billion to nearly $4.9 billion in 2017 which shows both the need and market for school security products. We're working with schools to identify solutions that provide a safe environment as well as address the ever changing federal and state regulation. Our project lockdown initiative which incorporates the School Access Control Vulnerability Index, or SAVI, and audit system takes the holistic and active approach to training security dealers and end-user school officials on how to significantly reduce or prevent a mass incident. Before turning the call over to Kevin, I want to cap my comments by saying how pleased we are with the company's direction. We're seeing strong interest for our recently released product. While I only pointed out two of our product line, we have a diverse line of products across our subsidiaries that cover a number of market. We believe that this diversity offers enhance stability in our sales while also offering multiple shot on goal for big hit like we are seeing with StarLink. To maintain our leading edge in the market, we are continuously making investments in R&D to succeed in the quarters and years ahead. With that said I would like now to turn the call over to Kevin to review the quarterly result.

Thank you, Rick, and good morning everybody. Revenues for the three months ended March 31, 2016 increased 11% to a quarterly record of $19.8 million compared to $17.9 million in the same period a year ago. So the nine month revenue increased 7% to $58.4 million, a record for the first nine months of the fiscal year from $54.8 million for the same period one year ago. The increase in sales is primarily attributable to a 31% increase in long products sales for the third quarter, increase sales of the company's door locking products and the continuing dramatic increase in recurring monthly revenue which grew 42% in the third quarter. Gross profit for the three months ended March 31, 2016 increased approximately 14% to $6.1 million or 30.8% of sales compared to $5.3 million or 29.9% of sales for the same period a year ago. Gross profit for the nine months increased approximately 7% to $17.9 million or 30.7% of sales compared to $16.7 million or 30.5% of sales in the same period a year ago. The increase in gross profit for the three months and nine months was primarily due to higher sales including increased recurring revenue as partially offset by increased R&D expenses. Selling, general and administrative expenses for the quarter were flat at $4.9 million or 24.7% of sales compared to $4.9 million or 27.2% of sales for the same period last year. Selling general and administrative expenses for the nine months increased by $494,000 or approximately 3% to $15.4 million or 26.3% of sales compared to $14.9 million or 27.2% of sales a year ago. Operating income for the quarter increased by approximately $740,000 or 155% to $1.2 million as compared to $477,000 for the same period a year ago. Operating income for the nine months increased $748,000 or 41% to approximately $2.6 million from $1.8 million in the same period a year ago. Interest expense for the quarter decreased by $7,000 or 13% to $45,000 as compared to $52,000 for the same period a year ago. Interest expense for the nine months decreased by $22,000 or 14% to $139,000 as compared to $161,000 for the same period a year ago. The decrease in interest expense for the three and nine months ended March 31, 2016 resulted from lower average outstanding debt during the current period as compared to the same period a year ago. Net income increased by approximately $649,000 or 164% to $1 million or $0.06 per diluted share as compared to $395,000 or $0.03 per diluted share for the same period last year. Net income for the nine months increased by $830,000 or 55% to $2.3 million or $0.12 per diluted share compared to net income of $1.5 million or $0.08 per diluted share for the same period last year. Adjusted EBITDA for the quarter as per the schedule included in today's press released increased approximately $697,000 or 80% to $1.6 million or $0.08 per diluted share as compared to $870,000 or $0.05 per diluted share last year. Adjusted EBITDA for the nine months increased $634,000 or 21% to $3.7 million or $0.20 per diluted share as compared to $3.1 million or $0.16 per diluted share for the same period a year ago. At March 31, 2016, the company had $3.3 million in cash and cash equivalents compared to $2.3 million at June 30, 2015. The company also had working capital of $34.1 million at March 31, 2016, compared with working capital of $35.6 million at June 30, 2015. Paying down debt and optimizing our cost of capital remains a top priority for NAPCO. During the quarter, we repaid $400,000 of debt, reducing our outstanding balance excluding cash by 5%, $4.2 million. For the nine months, we repaid $3.2 million of debt, reducing our outstanding balance by 30%. The debt net of cash $4.2 million at March 31, 2016, at this pace the cash keeps coming in and the debt should be close to zero by the end of the calendar year. That concludes my formal remarks and I would now like to return the call back to Rick.

Okay, thanks Kevin. In conclusion, we are excited by the momentum of our business. We have identified specific market opportunities with our StarLink radios and LockDown school safety offering, as well as others that should provide strong growth for many quarters and years to come. This is especially true for the current fourth quarter as it is traditionally our strongest quarter of the year due to the seasonality of the alarm installation and construction industries. Lastly, while we continue to deliver ever strong of financial results, we do not believe the growing shareholder value is being reflected in our share price. While investor interest is solid, we are dedicated to garnering greater awareness from the broader investment community as well as to better support the influx of investor inquiries already being received. To support this effort, we recently appointed Patrick McKillop as our in-house director of IR. Patrick will support our ability to participate in more investor conferences and one-on-one meetings with investors and analysts. This concludes our formal remarks. Kevin, I would now like to open the call for questions. Operator, please proceed.

Thank you. At this time we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Kara Anderson, B. Riley & Company.

Hi, good morning. Just wondering if you could comment on whether there was a particular win that contributed to the 31% increase in the alarm product division?

It's general across the board, rising of the tide. No particular win.

And then could you comment on the performance of locking and access controlled products on a year-over-year basis?

Locking continues to do well. There are a lot of schools that need locking security. You heard Dick mention the shooting in Washington. 200 schools locked down. We get school security jobs every day. Some of them are big, some of them are small, but there are many schools that needs security. That's a strong area, it's a big growth area. We expect it to be a big growth area for years to come because most schools don't have security in place in its schools.

We're going to put up our new presentation in the next day or so and a lot of that goes into the school's safety and security products that we have. We have a very, very wide range of products and we're getting a lot of wins all over the country, so we expect that to continue with all the new budgeting that the school administrations are getting and the push from both state and federal to install security to protect the students.

Okay. And then can you comment generally on sort of the recurring run rate we're seeing?

Well, the numbers are out and the percentages. What specifically are you talking about?

I mean what run rate are we looking at? What percentage of total revenues are we seeing today?

Kara, why we don't disclose the pure number, we have been saying what the run rate is. I guess that's what you're asking. And it keeps going up and today the run rate is about $5.2 million on an annual basis.

Okay.

It's a mix, Kara, of the StarLink radios as well as our iBridge connected home. But the StarLink is becoming a primary contributor to that because dealers are standardizing on it because of its functionality and its pricing as effective range of features.

We don't want to make a prediction, obviously, but we've only been doing this a couple of years basically and to be at that level in a short period of time and with this kind of growth that we're seeing, we're going to get pretty far pretty quick. If this keeps up, then we expect this to keep up.

We have a bunch of new products which are coming out that we've shown at the international security conference a month ago where the dealers were really lined up behind these products looking at them because for our industry, very sensational, their functionality, the ability to control other equipment out there in the field and it gives the -- things as well as communications functionality to other brands of equipment.

I mean on that front, how much of the growth can you describe to the sunset of 2G that's sort of one time in nature that you're seeing. Do we see that go away at one point?

Well, at the end of 2017, the 2G network is supposed to be down. That network was made up of hundreds and hundreds of backup radios that the insurance companies wanted the alarm companies to install. If you had big collections of art and other expensive things around the business and home. Now, with the fact that the world has changed, the paradigm is that people don't have dialup phones anymore. The alarm companies are finding that let's make the radios our primary communicator, and that's what's going on right now. So I see that the future is full of radio and connected home products, and I see that it's going to go on forever. It's the new standard of the industry. And we have the greatest range of products that are out there and we have a lot of new exciting ones that are coming out that we've shown at the show and others that are in R&D right now. So it's a big driving force for us.

Okay, last question for me. Did you repurchase any shares in the quarter?

We did. It wasn't a lot but we bought back 76,543 shares in the March quarter.

Okay, that's it for me. Thank you.

Thank you. Our next question comes from Pete Enderlin [ph].

Thank you, good morning. Maybe I missed it, do you have some rough indicator or statistic on the industry wide percentage of 2G home systems that are still out there still relying that disappearing technology?

There are no published stats on it. NAPCO and others were making 2G radios in small quantities as the backup radio for years and years and years. I don't know the total amount but they're still hundreds of thousands of them out there. And a lot of it is going to continue and it ends in 2017 when the network is completely down. What's going to happen is I expect that in January, February people are going to find out that, hey my backup system is not working and then it's also going to be a big rush for the first three to six months of '17 to get more radios. So it should continue for a while.

Well the end of that system is going to be at the end of 2017 right?

2016.

Okay.

2016 the 2G network is down entirely.

Okay, got it.

2017, a lot of people are going to wake up and say, hey what I'm going to do, and then our StarLink radios are the alternative that is the best.

Okay, you mentioned higher R&D. What was the actual number?

Let's see. I have to look for that, I don't have at my fingertips here. Give me a second. So we spent $1.5 million in the quarter, and last year in the same quarter $1.350 million.

So about our increase, do you expect that trend to continue for a while?

I just want to point out before we answer that, we're up about 600,000 for the nine months. I do expect it to continue like that as we try to get many new products out to market faster. The faster we get these products out, the faster we get to our goal to be $100 million Company. We showed about 12 new products out at the ISC show and the dealers loved them, and now they are being launched so that should bode well for the many quarters. But there is more and more things in communications and internet and cellular that are going to be brought out. So want to keep staying on the leading edge.

And one of those new products is the CA4K software. Can you provide some more color on what that does and how it works?

The CA4K is a tremendous step over the three thousand software. It has lots of new features. It also has a feature that's going to allow us to get more recurring revenue as of the access control business. We invented a way to do that, and that's going to be in the 4K. So besides being better graphics, more functionality, it will also allow the integrators to get recurring revenue from their end user consumers.

And what's the format or shape of that recurring revenue for that system, and what recurring revenue was it?

What happens is it will be managed, for instance a dealer integrator will be able to manage his customer's access control system remotely and charge for it. It will be able to change codes and do a lot of additional things that typically the customer would have to do himself and sometimes it gets a little complicated. So he'll be able to offer enhanced remote services and charge for it.

Okay, great. So as far as the service offering basically.

Exactly.

Yes, all right, thank you very much.

Thank you. [Operator Instructions] Our next question comes from Louis Mizar [ph] from Asset Investors.

Good morning. I was just wondering if there's any interest in any M&A activity.

Well we're always interested in taking look at companies that use our network of distributors and dealers, and that our customers which are our dealers can install. And if it fits that profile and we're interested in those type of companies. We've acquired three companies up to this point and it has to be the right type of product line. We do have the very broadest product line of products in the business because we're the only company that has fire alarms, burglar alarms, access control and locking system. So it would be end on type of product lines that we would do to those basic legs that we call the security stool. We're the only company with three legs on the stool, but we're looking.

Oh, good. The in house person who's going to do the investor relations. Does that include trying to get other analyst to follow the company because according to what I see I have one of us that has estimated the earnings?

That's a big part of it. We're going to outreach to analysts, to investors and work through the agency to do this. In fact, Kevin and I, are going out on a road trip right after this across the Midwest to talk to a lot of new people. Patrick will be with us, and we'll just broaden out our shoulders and get more.

Okay, sounds good. Thanks very much.

Thank you. Our next question comes from David Kanen from Aegis Capital.

Good morning guys. Thanks for taking my questions. The first one is in the latest quarter of your recurring revenue. Can you share with us what happened with ARPU? Is it increasing or is it more or less the same as it was in the immediately preceding quarter?

ARPU is a term that we're not familiar with. Could you explain that?

The average revenue per user. If you take the total revenue divided by the number of users you have in your recurring revenue. What was the cost per user that you're charging?

Let me describe it differently. We have a fixed menu of services, so all customers pay the same.

But don't you have a mix of some fire/commercial versus consumer alarm? I'm assuming a consumer alarm customer or residential alarm customers paying less than a fire or commercial customer? What I'm driving at is when you blend it out, what does it work out to be per user? It's got to be different. No?

Well, we have a menu for residential small commercial and that is one type of radio, and then we have a fire radio which is another type, and the menu of prices in the fire radio is higher than the burglar alarm radio – small business radio. But the volume is less because of the nature of commercial versus residential, but we have never really broken it down. We're just watching how many were selling of each and they're all growing. The fire radio is a new phenomenon for us and we've only been selling it for a few months and it's doing fabulously because of the fact that we had to increase the production schedule beyond our expectations. That radio, it gets us roughly $15 to $30 a month depending on how often it checks into the central station. Those are the stats of it right now.

Okay. And then Kevin, I know you're very good at modeling. Can you share with me the contribution margin on the next dollar of recurring revenue? Let's say you have another million dollars of recurring revenue, what does that contribute to the bottom line?

The gross margin on recurring is about 90%. On a gross margin basis, that million dollars would contribute $900,000. There's very little expense beyond that on that million dollars.

Do you know what I think should happen here? I think maybe you should have a private call with Kevin because you have very specific needs.

Okay. I appreciate that, Dick. Before I jump off, I just have one final question. You guys alluded to continuing to invest in the R&D, which of course is necessary to continue to grow. Do you expect R&D year-over-year to increase? And if so, can you give me a rough idea of how much?

Well, it's about $500,000 or $600,000 greater through nine months. When the whistle blows on June 30, it will probably be $750,000 to $800,000 more than it was a year ago. We're spending more to get the products out faster, we're very busy now, we're in our fourth quarter. As many of you know, our fourth quarter is our big quarter. Last year in our fourth quarter we earned about $0.20 on an adjusted EBITDA basis. If we just stay flat this year and do the same thing, we'll finish at about $0.40. Obviously we hope to do more in the fourth quarter. But it's our big quarter, we're very busy, the R&D guys are really busy, biggest, $750,000 more.

Okay and then you expect to continue to invest in your next fiscal year?

Oh, yes. We do.

Okay.

We're going to push to get to that $100 million. When we get to the $100 million, as many of you know, big things happen, we get the hockey stick leverage, the GP goes way up, the money drops to the bottom. Faster we get there, the better it is for everybody.

Okay. Well, thank you, guys. Congratulations and good luck.

Thanks, David.

Thank you.

[Operator Instructions] We do have a follow up coming from Louis Mizar [ph].

I'm sorry. I just missed that number. I heard you say $0.40. What was that in reference to?

That's in reference to the fact that we've done on an adjusted EBITDA basis. We've done $0.20 so far this year and if we just match what we did last year's fourth quarter, that's our big quarter. Last year in the fourth quarter we did $0.20 for adjusted EBITDA. We'll just match it and do it again, we'll finish at $0.40. Obviously we hope to do better.

Okay. Thanks very much.

Thank you. At this time we have no further question. I will turn the call back over to our speakers for closing comments.

Thank you everyone for participating in today's conference call. As always, should you have any further questions, please feel free to call KCSA, Patrick, Kevin or me. We thank you for your interest and support and look forward to speaking to you all again in a few months to discuss NAPCO's fiscal 2016 fourth quarter results. Bye, bye. Have a wonderful day.

Thank you. That does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation.