Napco Security Technologies, Inc. (NSSC) Q1 2018 Earnings Report, Transcript and Summary

Greetings, and welcome to the NAPCO Security Technologies Inc. First Fiscal Quarter 2018 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, Patrick McKillop, Director of Investor Relations. Thank you, Mr. McKillop, you may begin.

Thank you, Doug. Hello, my name is Patrick McKillop and I'm the Director of Investor Relations here at NAPCO Security. Good morning and thank you all for joining us for today's conference call to discuss our financial results for our fiscal first quarter 2018. 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 in the Investor Relations section of our website at www.napcosecurity.com. On the call today is Richard Soloway, President and CEO of NAPCO Security Technologies and Kevin Buchel, Senior Vice President and CFO. 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 other financial tables issued earlier today, you'll find the 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. I will turn the call over to Dick in a moment but before I do I just wanted to mention a few things on the IR front. First of all, I invite you all to go and see our newly re-designed website which was recently launched and we are really excited about it. This new website has a [modern murkier] features which allow for investors, dealers and distributors to more easily find the information they are speaking. In terms of upcoming investor out reach we are attending the LD Micro Conference, as well as the Benchmark Conference which are both being held during the month of December. We expect to meet lots of new investors during these events and share the bright future we see ahead with them. Investor outreach is crucial especially for small cap companies such as NAPCO and I would like to thank all of those folks that assisted in these conferences and marketing trips. Lastly, I would like to mention that NAPCO will be exhibiting its products at the upcoming trade show ISC East in New York this month on the 15th and 16th at the Javits center. If you are interested in coming to the show and checking our booth, please contact me. With that out of the way, let me turn the call over to Richard Soloway, President and CEO of NAPCO Security Technologies. Dick, the floor is yours.

Thank you, Patrick. Good morning everyone and welcome to our conference call. Thank you for joining us today to discuss our results. The first quarter of fiscal 2018 marked another record revenue performance for NAPCO. This quarter marks the 13th consecutive quarter of increased sales growth for the company. Our SaaS revenue continues to grow at a rapid pace. The annual run rate is now 10.6 million as of September. StarLink connect our latest decision to the communicated series started its commercial launch this past April is performing well in the early months of the launch. Our investments in R&D, selling and marketing expenses did not increase significantly during the quarter versus the year ago period. We believe that the current levels of investment are now appropriate. Our growing sales momentum is evidenced by the $21.2 million record breaking revenue for the first quarter demonstrates our investments are having a positive impact on our sales. Our balance sheet remains very healthy and our cash position is growing. We continue to capitalize on key industry trends that are impacting our results favourably. Included in these trends are recurring revenue growth in cellular alarm communications, the creation of products for the Internet of Things, the connected home, and the development of products for improving school, security and safety. We continue to execute on our business strategy and take advantage of these trends. Driving growth, profits and returns on equity are important for us and our shareholders. Our senior management owns 30% of the equity thus our interest are aligned with shareholders. Before I go into greater detail, I'll now turn the call over to our CFO, Kevin Buchel. He will provide an overview of the financial results and then I'll be back with more of our strategies and outlook. Kevin?

Thank you Dick and good morning everybody. For the first quarter, net sales increased 5% to $21.2 million, which was a record first quarter performance. The increase in sales for the three months ended September 30, 2017 was due primarily to increased intrusion sales driven by the aforementioned 56% increase in SaaS recurring revenue as well as an increase in sales of products from the access control division. As Dick stated before, SaaS recurring revenue now has an annual run rate of $10.6 million based on September 2017 recurring revenue. Gross margin for the first quarter was 32.5% of sales, which was 50 basis points increase versus the first quarter last year. The increase in margin for the quarter versus a year ago was primarily due to the aforementioned increase of sales. As Dick mentioned our R&D and SG&A spend levels did not increase significantly versus a year ago and we now believe that we are at the appropriate levels. SG&A costs for Q1 increase $84,000 or 1% over year to $5.8 million and as a percentage of sales decreased to 27.5% from 28.4% last year. Operating income for the first quarter increased 48% to $1.1 million as compared to $716,000 last year. Income before taxes for the quarter increased 49% to $1,033,000 compared to $692,000 for the comparable period last year. And income tax expense for the quarter increased by $19,000 to $143,000. The company’s effective tax rate was 14% for the three months ended September 30, 2017 and that compares to 18% for the same period last year. During the quarter, net income increased 57% to $890,000 or $0.05 per diluted share as compared to $568,000 or $0.03 per diluted share last year. The increase in net income was primarily due to the items we previously mentioned. Adjusted EBITDA for the quarter was outlined in the schedule included in today's press release, increased 33% to $1.4 million or $0.08 per diluted share compared to $1.1 million or $0.06 per diluted share last year. Moving on to the balance sheet; the cash balance at September 30, 2017 was $4.5 million as compared to $3.5 million at June 30, 2017. Our working capital as of September 30, 2017 was $41.2 million as compared to $40.8 million at June 30. The current ratio was 5.9:1 at September 30, as compared to 4.9:1 at June 30. And debt, net of cash remains at zero as of September 30. CapEx was $514,000 during the quarter. For the quarter, CapEx levels were higher than our normal range and as we stated before the increase levels of CapEx or for the expansion of our NOC or network operating center and other projects that helps facilitate the increased levels of business we are now processing. That concludes my formal remarks and I would now like to return the call back to Dick.

Kevin, thank you. The two key themes for NAPCO’s business which continue to play out in a positive way are the addition of SaaS revenue recurring revenue and school security. SaaS recurring revenue for the company continues to grow at a very strong rate. Demand for alarm communications and the Internet of Things which includes the connected home category are driving the growth of our SaaS recurring revenues. In school security, an area which has a large addressable market and constantly receives significant attention, the market remains vibrant and we expect new spending by schools and universities to continue at a strong rate. U.S. alarm market is a multibillion dollar market and that goes a long history and a great reputation in the security business. The design of our new products by our engineers has the goal of being appealing and feature pack for a great end user experience. We are executing on our strategy to develop new innovative products and services which will help our channel partners grow and succeed. The connected home products and services market continues to grow and our StarLink Connect is participating in this exciting growth vertical. A recent report from Parks Associates stated that 42% of all new security systems in installed include a smart home device. Furthermore, 70% of new security installs included interactive services, which has the ability to control the alarm system, lighting, door locks, thermostat and see live video remotely. The StarLink Connect communicator replaces the need for traditional phone lines in order to send the alarm signals to the central station. In addition, StarLink Connect can be used in tandem with our iBridge smartphone tablet app which gives customers the interactive services I had previously mentioned. We have 10,000 plus dealers in our network and the unique features that StarLink Connect has makes it an attractive product for them to install. A few of the features that the dealers love include the ability of the Connect to be compactible with many of our competitors alarm systems and saves the entire money during install. They also attracted the ability of remote trouble shooting which saves them from potentially sending a truck to a customer’s home or small business. In the U.S. there are approximately 133 million homes of which 22 million have alarms installed. We believe the market opportunity that Connect can see large as it includes both the retrofit and new installed business. We also continue to be excited about our opportunities for installing Dual Path Fire, our CA4K and our ArchiTech Series Networx Lock. All of these products are relatively new in their launches and we see a great future ahead for all of them. The ArchiTech Networx series Locks are an ideal access control solution which blends advanced wireless access control convenience within any décor and a choice of trims and finishes. These locks have the capabilities to control access one door at a time or across a wireless network. The battery life is unsurpassed with multiple years of use, even in high traffic areas. ArchiTech locks are the perfect solutions for existing system upgrades or new installs. Across the U.S. we are seeing the construction of many luxury high rise buildings and these buildings of a type where the ArchiTech locks are being used. We are experiencing cross selling opportunities as well for every ArchiTech lock on the front door of condominium high rise resident it generates a need for matching mechanical interior hardware throughout the residence. The StarLink Dual Path fire communicator is also contributing to the growth of our SaaS revenue line which as you know is growing at a healthy rate for us. StarLink Dual Path is a second version of the original Single Path Fire Communicator and is able to be used in cities like New York and LA where the local codes require Dual Path, both cellular and IP form of alarm communication. According to our internal research there are millions of commercial buildings across the U.S. which will need to be upgraded from the plain existing old telephone lines they are currently using as many of the major carriers are no longer supporting these lines. A great opportunity exists with the StarLink Dual Path with these building and it gives our dealers an easy solution to the problem. The StarLink Series now offers the most extensive line of communicators in the industry. SaaS revenue, recurring revenue is something that has contributed to our success in the last few years, and we are focused on developing new products which can bring more of the type of revenue to us. Access control as a service is an area that we are expanding into with the recently launched CA4K product. CA4K product will enable the company and its integrators to offer cloud-based access control service. These services will enable customers to eliminate the need for a in-house staff to perform tasks such as security badge creation, compiling attendance reports, removing ex-employees in the system. These services will not be outsourced and the Integrators and NAPCO will share the recurring revenue generated from those services. Moving on to a discussion of other major paradigm shift that is driving our business, that is the growth of security and safety in schools. Here at NAPCO we are focused on providing solutions for schools, colleges and universities helps to stop the intruders. It's unfortunate to report, but in the month of September we had two more school shooting incidences; one at high school in Spokane Washington area and one at Central Illinois area. These are truly horrific events and here at NAPCO we’re doing our part, trying to help, prevent these tragedies. We remain focused on addressing the urgent need for better security solutions in our nation’s school. On our last financial results call, we discussed the recent letter that was sent to President, Trump regarding the need for funding this critical issue. While we can't predict what will happen with this initiative and others that are being worked on. We can't say that we continue to win the school security job. Our solutions that are currently being used in thousand schools across the USA, we may make announcements when we can and get approval from the school and continue to build our pipeline of projects. We will begin our Q&A session portion of this school in a few minutes, but I first would like to give a brief summary. NAPCO is in a strong position to continue its growth and sales and profits going forward. We believe that our investments in R&D, sales and marketing are beginning to show returns which will increase throughout the fiscal year 2018. NAPCO’s senior management maintains a high level of ownership in our equity approximately 38%, and I would like to thank everyone for their support and for joining us in the exciting future we have. Our formal remarks are now concluded. We would now like to open the call for a Q&A session. Operator, please proceed.

Thank you. [Operator Instructions] Our first question comes from the line of Gary Mobley from Benchmark. Please proceed with your question.

Good morning, gentlemen. Thanks for taking my question. Congratulations on another your positive year-over-year growth comp for revenue and whatnot. Want start by asking about product revenue. And looking at the product revenue category you sort of backing out your commentary from the RMR contribution; looks like we've been trending flattish on a year-to-year basis in product revenue for now for majority of this, maybe the last six quarters? And I'm just curious to know what the puts and takes there are on the product revenue, can it grow. You mentioned access control continues to grow. So therefore what is failing to grow? Where would like to bolster market share and what particular products and whatnot?

Gary, we have a lot of products which we sell which generate the recurring revenue, and that, as we’ve said we're kind of in the early stages of introduction of lot of these. So they take a while for them to become embedded in the dealer's repertoire of his offering. The signs are that we are getting good signs of positive interest in this. We are very well known in the different deals that we’re in, access control, locking and alarm and we expect to get nice growth for years and years in the future at of all of these types of things. So, all I can say is just to hang in and stay tight because this is our 13th consecutive quarter of growth and we expect many, many more to come.

Okay. Was there any impact from the hurricanes in third quarter in productivity done in the Dominican Republic?

Not really. The only thing, it was little bit more closely because we -- the seas were rough so we flew product in. As you know the factory there is built for – and it was custom-built for us, and it's really a concrete bunker, a very large one, but we kept rolling along, the storms actually went to the north of the island, the island is the size of Connecticut Rhode Island together, so that went to the north side just a little wind and rain on the south side where we are.

Got you. Okay. And focusing again on the product revenue and gross margin contribution, if I do the math, and correct me doing math wrong? Our product gross margin did they trend down about 200 basis point year-over-year and what can you attribute that to?

I guess if you’re carving out recurring, you’re right. And the mix, but we win some big school job. They have a very high margin. So this quarter didn't have a very big school job. We had a lot of K-12 type job, University tend to be higher margin in the K-12. So that's all it takes. You haven’t shipped ever so slightly on the good side of the gross margin. Our R&D which is included in cost sales was at the same level. You guys haven't seen it yet and you’ll see – when you see the Q, but it’s virtually the same dollar amount as it was last year at this time, and that’s what we’ve said what’s going to happen. So we’re pleased with that because while the spend level is same we’re going to be coming out with a lot more stuff as this fiscal year progressed. Some of which you’ll see at the ISC Show next week. So, for us quarter-to-quarter sometimes one division is up, but other one is not so up. The big picture, we see great things ahead, more RMR, more hardware sales to help us get the leverage that we talk to many of you about.

Okay. Last question from me. On the StarLink control panels in the communicator product, what is your roadmap to evolve with some of the emerging LT IoT standards such as CAT-M1 and the Bi2. I know you’re not in the business of creating cellular modems, but is that a key focal point in terms of product roadmap for the panel? And that is well positioned in the marketplace?

Yes. I mean, the communications format changing and we made our products such that you can change it, for instance, LTE is a CAT-1, formerly CDMA, all these format that the carriers changing to we’re going along with because ours equip that way. We designs our products such that each of these formats are on a circuit board that plugs into the main board of the unit, so that as the carriers notify the industry machine-to-machine industry, security industry is going to be a change in the format of communication. We can plug in a board and not change the product, product which they had produced. It’s the great thing for the dealers and he doesn’t rip out the products, and we are the only company that does that. So, just plug in the new board and its ready to go. So we’re staying up with all the trends and every two, three years things change. The next trend probably will last five years which is Cat, the cat trend like. So that’s our positioning in the market.

All right. Congrats again on the terrific growth. Thanks guys.

Thank you.

[Operator Instructions] Our next question comes from the line of Michael Walkley from Canaccord Genuity. Please proceed with your question.

Hey, guys. Congrats on the strong quarter. This is Josh [ph] for Mike. Just starting off on the $10.6 million run rate for recurring revenue, just one quick clarification on that, when you say September, that means that the month of September had that 10.6 run rate and you shouldn't infer that you can just take 10.6 divided by four and that's what the total recurring revenue was for the quarter. Is that correct?

Right. It takes September basically multiple by it by 12. That’s how we’ve been referring to it as we’ve gone along on this journey, it’s gotten to be very exciting journey. Yes. September…

Okay, great. That’s what I though. And then we already touched on this little bit, but I was hoping to get some more color on the seasonality of the hardware business. I know -- everybody knows that the June quarter in the strongest quarter, but how should we think about the other quarters in terms of product hardware revenue?

Each of the quarters grow as the year progress, obviously the September quarter, historically it’s always been the weakest. We’re so much encouraged that those of you that have been with us for years that now September is the weakest quarter is now at 21.1 quarter. A lot of the heavy lifting is done by the recurring, but the hardware sales have been doing well. They probably would've done even better, you know part of the country was battered by hurricane, we talked about the [DR] Hurricane, part of the country was battered, really didn’t affects us that much, but it may affected our hardware sales a little bit. It’s hard to say exactly. You got a lot of SKUs. You got a lot of dealers. You got a lot of distributors. So the way we look at it is the quarters are going to get stronger as the year progresses ending like it typically does with that big fourth quarter.

Okay, great. And then, you mentioned this a little bit already, the StarLink Connect product. How many of your 10,000 dealers which estimators telling at this point?

Competitive purposes we don’t talk about how many dealers, but we’re shipping -- increases in large numbers to our various distributors that the dealers are pulling it through. And the signs are at the trade shows that dealers coming up to us and its very exciting, they are putting it in and its now modernizes the alarm systems that are out there that they pulled over the years including our competitors alarm system because in order to get connected home. We have to traditionally rip out the old alarm, put this is and put in a new modern alarm with connected home. With this you don’t have to that. The half hour, one hour install and now you have at control of your existing alarm, so as I said it’s a very, very, early on aspect of our business. It takes a while but all the signs are its going to be very, very positive to generate more and more recurring revenue and hardware growth for us.

Okay, great. And then, you mentioned the R&D spend was flat year-over-year. With all these new products that you’ve invested in recently that seem to be off the strong start, how should we think about R&D spend going forward? If it can grow throughout the year or you expected to be flat now for a few quarters or… ?

We think that the spend level that we had for fiscal 2017 is going to be at the similar level in 2018, and the guys are working really hard to produce a lot more products. As I said, you’re going to see more coming out, you’ll see some of that at the show next week. So we believe the spend level is right where we want it to be and this quarter was an indication of that because it was flat. We do spend a little more in the other quarters, but when you add it all up at the end of June, it should be at similar levels as it was in 2017.

Okay, great. And then last question from me, you mentioned just briefly already that you are working on some legislative matters regarding school security. Is there – are there any developments that we should be looking for or monitoring going forward that might hint at success demand?

Well you know there’s a big problem all over the country that just with school any public places we have problems with active shooters coming in, it’s not a world that we had known in the past to new world. So there are a number of associations which sent letters to the President and asking him to incorporate monies than in it’s infrastructure built. So with all of this increased problems that we are seeing around the country, shootings major shootings every couple of weeks, I wouldn’t be surprised if we got to see some things that are happening in the news, so just keep your eyes peeled, right nobody is focused on getting the tax aspect of America straightened out, changing the tax laws, but I know there’s infrastructure bill that’s going to be traveling through and that will be up next, so just watch the newspapers, we’ll drive along with the success of that but we are not 100% counting on that, we are out there marketing all the time to school and we are also marketing to other public forums and having locking and access control and alarms where you call for panic and help right away it’s a very important thought protecting society and we are doing our part.

There are no other questions in the queue. I’d like to hand the call back over to management for closing comments.

Thank you. Thank you everyone for participating in today’s conference call. As always, should you have any further questions, please feel free to call Patrick, Kevin or myself for further information. We thank you for your interest and support, and we would look forward to speaking to you all again in a few months to discuss NAPCO’s fiscal Q2, 2018 results. Bye, bye.

Thanks, bye, bye.

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