Napco Security Technologies, Inc. (NSSC) Q4 2016 Earnings Report, Transcript and Summary

Greetings and welcome to the NAPCO Security Technologies Fourth Quarter and Full Year 2016 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to Mr. Patrick McKillop, Director of Investor Relations. Thank you. You may begin.

Hello. My name is Patrick McKillop, Director of Investor Relations for NAPCO Security. Good morning and thank you all for joining us for today’s conference call to discuss our financial results for the fiscal fourth quarter and fiscal 2016. By now, all of you should have had the opportunity to review the press release discussing the results. If you have not, a copy of the release is available on the Investor Relations section of our website, napcosecurity.com. On the call today is Richard Soloway, Chairman and President 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. During the call, we may also present certain non-GAAP financial measures such as adjusted EBITDA and certain ratios that are used with these measures. In the press release and on the financial tables issued earlier today, you will find a definition of these non-GAAP financial measures, a reconciliation of these non-GAAP financial measures with the closest GAAP financial measure, as well as a discussion about why we think these non-GAAP financial measures are relevant to our results. These financial measures are included for the benefit of investors and should not be considered instead of GAAP measures. With that out of the way, let me turn the call over to Richard Soloway, Chairman and President of NAPCO Security technologies. Dick, the floor is yours.

Thank you, Patrick. Good morning, everyone. Welcome to the call and thank you for your interest in NAPCO. It’s a pleasure to be here with you today to discuss the outstanding results that the company produced in fiscal 2016. We achieved record results in the fourth quarter and for the year despite being up against difficult comparisons with a strong performance last year. The fourth quarter was our fifth in a row to have record quarterly revenue performance and produced the highest quarterly net income in our history. Recurring revenue grew 63% last year and while still a relatively small piece of our overall revenue as it grows it will provide greater margin contribution as well as greater consistency and predictability in our financial results. We also demonstrated the operating leverage in our business as the 6% increase in revenue drove a 19% increase in net income. Growth in the internet of things as well improving school security and safety are key industry trends in our business and continues to impact our results favorably. And we expect our business strategies will continue to take advantage of these trends and drive greater growth, profitability and shareholder returns going forward. Before I go into greater detail, I will now turn the call over to our Senior Vice President and CFO, Kevin Buchel. He will provide an overview of our financial results. And then I will be back with more in our strategies and outlook. Kevin?

Thank you, Dick and good morning everybody. We had record results for the fourth quarter and the year both in terms of top and bottom line. For the fourth quarter, net sales increased 5% to $24.1 million, which was a quarterly record. And for fiscal 2016, net sales increased 6% to $82.5 million, which was also a record. The increase in sales was primarily related to the strength in our alarm products and electronic door locking systems as well as our growth in our recurring revenue. Recurring monthly revenue from the alarm division increased 68% for the quarter, 63% for the fiscal year and sequentially the increase was 14%. Gross margin for the fourth quarter was 40% of sales, which was slightly below the 40.6% posted last year. For fiscal ‘16, gross profit was 33.4% of sales, which was consistent with the 33.5% posted during the prior year. During fiscal 2016, we continued to reinvest a portion of the incremental margin contribution from the increase in sales in R&D to support the launch of new products and services, which resulted in relatively flat year-over-year margin comparison. The operating leverage in our business was more evident in our operating income line as we were able to produce a 6% increase in sales with minimal incremental investment in the operating expense line. For the quarter, selling, general and administrative expenses were flat at $5.9 million and for fiscal ‘16, SG&A expenses increased by 2% to $21.3 million. As a result, operating margin improved to 15.6% for the quarter and 7.7% for fiscal 2016, which was a 50 basis point improvement for the quarter and a 90 basis point improvement for the year. Demonstrating the operating leverage in our business, the 6% increase in fiscal 2016 sales resulted in a 19% increase in net income as incremental sales were leveraged over our fixed costs. During the fourth quarter, net income increased by approximately 3% to $3.4 million or $0.18 per diluted share as compared to the same period last year and the highest fourth quarter level in our history. Net income for fiscal 2016 increased by 19% to $5.8 million and earnings per share increased 24% to $0.31 per diluted share. Adjusted EBITDA for the quarter, as outlined in the schedule included in today’s press release, increased approximately 7% year-over-year to $4.1 million or $0.22 per diluted share. Adjusted EBITDA for the fiscal year increased 13% year-over-year to $7.8 million or $0.42 per diluted share. Moving on to cash flows in the balance sheet, we generated more than $9 million in operating cash flow during fiscal ‘16, which was due primarily to the increase in net income as well as improvements in working capital and that $9 million was a record. We used the bulk of the cash to repay our long-term debt, which decreased 55% to $4.5 million at the end of the year. The remaining uses of cash went to repurchase $1 million in common stock for our 193,000 shares, along with $700,000 in CapEx and the CapEx was consistent with the spending last year. The remaining balance of cash flow was added to our cash balance, which increased by $1.5 million to $3.8 million at the end of the year. That concludes my formal remarks. And I would now like to return the call back to Dick.

Okay. Thanks, Kevin. The record financial results of this past year are a direct result of our strategies to position NAPCO to benefit from the two key paradigm shifts that are positively affecting the players in our industry. First is the significant growth of the internet of things and second is the significant amount of attention and new spending related to improving school security and safety. I will cover the internet of things paradigm shift first. Alarms, locking and access control are one of the first and fastest growing sets of devices and systems to benefit from and connect to the internet. As a result, there are opportunities for NAPCO to take market share while upgrading installed base of existing technologies as well as benefits from accelerating end market growth as customers realize the benefits of connecting these devices and systems to the internet. To take advantage of this paradigm shift, our strategies are focused on introducing new and innovative products and services that are compelling to the end user customer as well as products and services that help our dealers grow and succeed. This year, we successfully introduced our StarLink fire and commercial communicator. StarLink continues to experience strong market demand as customers look to use 3G and 4G wireless connection to replace traditional dial-up phone line as well as 2G wireless connection. Speaking of which, the phase out or sunset of 2G wireless networks will be taking place at the end of 2016, which we think will continue to drive demand for StarLink through the balance of this calendar year and well into the next. This fall, we will launch the StarLink Connect Controller, which expands our StarLink offering as the universal cellular solution capable of interfacing with the existing installed base. This opens up the market for our StarLink radios to replace the wireline and 2G wireless connections of not just our own alarm systems, but also the tens of millions of installed alarm systems from other providers. In addition, StarLink Connect can be used in tandem with our iBridge Connected Home Services, which gives customers, control of lighting, HVAC, door locks and remote video viewing and recording from any smart device. It is important to understand that in addition to being a compelling value proposition to the end user customer expanding the addressable market for StarLink and iBridge will also have a positive impact on our recurring revenue streams, which is an important driver for growth and profitably for us as well as our channel partners. We have a network of more than 10,000 dealers and 2,000 system integrators. In order to retain and attract new channel partners, it is important that we continue to develop advanced new products that offer the latest capabilities that end-user customers desire such as the IoT. Our expanded line of StarLink and iBridge products also allows dealers to remotely and more cost effectively program, monitor and maintain systems as well as participate in the recurring revenue stream. Clearly, this strategy is working for us. Our channel partner relationships are strong and as Kevin mentioned earlier, recurring revenue increased by 63% this past year. Moving on to a discussion of the other major paradigm shift that is driving our business, which is the growth of security and safety in school. We continue to see growing market demand for our diverse suite of LockDown access control systems, which are uniquely designed to play a significant role protecting students, faculty, administrators in both K-12 and colleges and universities across the USA. This paradigm shift in school security will be a major growth driver for 2017 and beyond. To address this opportunity, we have formed a school safety sales division and created our project LockDown initiative, which incorporates our School Access-Control Vulnerability Index, or SAVI. This is our proprietary audit system which takes a holistic and active approach in training security dealers and end user school officials on how to significantly reduce or prevent a mass incident. In addition to our dedicated go-to market initiatives, we believe our end-to-end scalable and modular solutions will allow us to take market share from our competitors. We are winning business, because system integrators and their customers prefer our solutions that seamlessly integrate access control, fire, intrusion and locking technologies over the competitors’ point solutions, which are more difficult to integrate and maintain. This past year, we made two key hires that will provide us dedicated sales leadership, focused on taking advantage of each of the paradigm shifts in our business and allow us to accelerate top line growth. In March, we appointed Dave Lyons to Vice President of Sales-Intrusion, Internet of Things, Connected Home and the Fire Division. Dave comes to us from Honeywell and has done an outstanding job thus far as evidenced by the results we have reported today. In August, we hired Byron Thurmond to lead the newly created school and safety, campus safety division. We are very excited to have Byron on board and driving what we feel is a large and growing market opportunity. With 30 years of experience, Byron oversaw security systems for the Houston Independent School District, which is the seventh largest school district in the USA. Byron’s extensive experience in this vertical will help drive us to new business levels. Before I open up the call to questions, I want to cap off my comments by saying how pleased we are with the company’s direction. We are seeing strong interest for our recently released products and have an active pipeline of new products and services that we will be introducing this year. With the right strategies in place to take advantage of the paradigm shifts that are positively affecting our industry, we are well-positioned to continue to drive top line growth in the high single-digit range. Based on the market acceptance of our newly introduced products, we believe we have the opportunity to accelerate growth into the double-digit range. While we plan to continue to invest a portion of incremental sales contribution into R&D and sales talent, we expect to continue to demonstrate the operating leverage in our business. As incremental sales contributions leveraged overall fixed cost, we expect our bottom line will continue to grow at twice the rate of our top line and in turn continue to enhance returns and create shareholder value. That concludes our formal remarks. Kevin and I would like to open the call for questions. Operator, please proceed.

[Operator Instructions] Our first question comes from Beth Lilly from GAMCO Investors.

Good morning.

Good morning, Beth.

I wanted to just spend a minute. I mean, you showed good top line growth and you talked about reinvesting the portion of that top line growth back into R&D so that as a result your bottom line was flat. Can you talk about kind of what types of projects you are investing in on the R&D side?

Well, we have four divisions. And the integration of locking related to schools, high-rise buildings is a real strong growth area and we are putting additional engineers into that area of design, because the time is now for that. So, we brought in some new software and hardware engineers to develop that product line. So, they are a group, I would say, more than six new products coming out, which we think is going to be major contributors to the top and bottom line with these new engineers. When it comes to the alarm division, internet of things and connectivity which generate lots of recurring revenue, the wind is on our back in that area. Also we have experienced lots of success and we want to leverage that. So, we are going to be introducing a bunch of additional products that we have shown at the last international security show, which have lots of recurring revenue, but also will drive the top line to new heights. Each of the new products in that division we are incorporating recurring revenue type of technology into it. So, now that things are doing very well, we brought additional software and hardware engineers to that group also. So, we think we are at about the right point now, the right balance to capture lots of additional sales and profits with the group we have now.

Okay. And do you anticipate spending – as we move into 2016, do you anticipate that type of spending as well or are we going to start to see more leverage on the bottom line?

I think that the – as far as the hiring is concerned, I think we have the right balance now. So, as the top line grows, we are going to see that leverage really start to kick in.

Okay.

Beth, I just want to say that we spent $6.2 million on R&D and that was about $800,000 more than last year and a lot of it is going to go to generate more recurring revenue products. And you know how we feel about recurring revenue. We love it and we want more of it and we want to get to our goals faster. It’s important. The time is now. We want to get to our goals faster. So, we try to balance out how to spend that money to get to our goals and not impact the bottom line. The bottom line did grow by 19% for the year.

Yes, yes. But my question more pertains to the fourth quarter.

Right. Fourth quarter also I will add was a very strong quarter last year. It was a difficult comp. And I was happy to see that we, on the GP line, we are in the same range and on the top line was able to beat it by 5%.

Okay, great. Alright. That’s all my questions. Thank you.

Thank you.

[Operator Instructions] And if there are no further questions, I would like to turn the floor back over to management for any 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 Patrick, Three Part Advisors, 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 Q1 ‘17 results. Bye-bye.

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