NAPCO Security Technologies Inc (NSSC) 2008 Q4 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the NAPCO Security Systems Inc. year-end conference call. (Operator Instructions). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Mr. Donald Weinberger, of Wolfe Axelrod Weinberger Associates. Thank you, sir, you may begin.

Good morning and thank you all for joining us for today's conference call to discuss NAPCO's financial results for the year ended June 30, 2008. By now all of you should have had the opportunity to review the press release discussing the results, but if you have not, please call my office, Wolfe Axelrod Weinberger Associates, at 212-370-4500, and we will immediately send it to you either by fax or email.

On the call with me today is Mr. Rich Soloway, Chairman and Chief Executive Officer of NAPCO Security Systems, and Mr. Kevin Buchel, Senior VP of Operations and Finance. Before I ask our host, Dick Soloway, CEO of NAPCO, to discuss the particulars of today's news, 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 could 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 Securities and Exchange Commission.

With that out of the way, let me turn the discussion over to Richard Soloway, President and Chief Executive Officer of NAPCO Security Systems.

Good morning everyone and thank you for joining NAPCO's quarterly conference call to discuss the financial results for the year ended June 30, 2008.

We are encouraged with the level of business during the fourth quarter and fiscal year, particularly in these economic times as we continue to make strides in growing each of our divisions, both domestically and internationally.

As many of you know, we closed on acquisition of Marks USA a few weeks ago. It is important to reiterate that it met all the internal acquisition criteria, including that the deal be done in cash and not for stock, something that could have had been dilutive for our shareholders, and that it be accretive turnings from day one.

In addition to these criteria, Marks USA adds to the foray of NAPCO commercial, industrial and institutional product offerings, and strengthens our holds within the door technology segment of the security -- of security products.

NAPCO should now realize approximately 80% of its revenues from the commercial, industrial, institutional segments of the security industry, which should bode well for our gross margins, as these sectors traditionally have higher gross margins than residential security.

Fiscal 2008 was a year of transition for our Company. We ended the year with sales growth of 8% for the fourth quarter, and 3.3% up for the year. We reduced our inventory levels from a year ago, and we delivered on our promise to make a significant accretive acquisition.

Fiscal 2008 saw a decline in our gross margins, and this was caused by several factors. First and foremost, our inventory declined this year, after dramatically increasing last year. The effect of this was that last year's gross margins had a benefit of increased overhead absorption. This year's margin did not have that benefit.

Secondly, a larger portion of our revenue were buy-sell transactions of certain security products that we do not manufacture in-house. That has a double impact. First, buy-sell sales have lower margin than products that we manufacture. Plus, by not using our low-cost manufacturing facility we are once again hurting our overhead absorption.

The last factor impacting our gross margin was the strong international sales, which grew by 30% this year. International sales have significantly lower margins than our domestic sales.

Obviously, we have to get our margins back to the higher levels we have been experiencing during the past several years. How do we do that? For the fiscal 2009 we have identified certain steps that we will be taking which will improve our gross margins.

First, we will be instituting certain cost-cutting measures, which will better align our expenses with present manufacturing levels. This improved alignment will improve our overhead absorption.

Second, we will aggressively shift as many SKUs as possible from buy-sells to in-house manufacturing. This program, which has already commenced, will lead to higher margins because our low-cost manufacturing facility will be on a plan to replace the more expensive outside manufacturing.

Also, by creating more work for our low-cost manufacturing facility, we will once again increase our overhead absorption.

There is one more important step we took which will help improve our gross margins, and that is the Marks acquisition, whose most recent sales was $25 million.

We believe that this acquisition presents many opportunities and synergies, which will enhance our gross margin in the near-term.

And now I would like to turn the call over to Kevin Buchel, our CFO, to briefly review the details of the financial results.

As for our financial performance, NAPCO recorded revenues for the year of $68,367,000, which is a 3% increase over revenues of $66,202,000 for fiscal 2007.

International sales for the fourth quarter were $4.2 million, or 19% of total revenues, and were up 44% from the $2.9 million level from the same period a year ago.

For the fiscal year international sales represented $12.2 million, or 18% of total revenue, and that was up 30% from the [$9.24] million level for the same period a year ago.

Gross profit was $20.4 million or 30% this fiscal year as compared to $24 million or 36% last year. This 6% differential was previously discussed by Dick.

One more thing about gross profit, gross profit for the fourth quarter of fiscal 2008 was affected by the recognition of certain material and factory expenses in the fourth quarter that should have been charged to cost of goods sold during the first nine months of fiscal 2008.

This was the result of not fully adjusting the gross profit method that we used for the first nine months of the year for the negative impact of product mix, in particular, the aforementioned usually large amount of buy-sell sales, as well as the impact that the change in inventory levels. Last year it rose by over $5.6 million, and this year it declined by over $1 million, had on the required expensing of overhead costs that were capitalized into inventory as of the end of the prior fiscal year.

Selling, general and administrative expenses for the year as a percentage of sales decreased to 25.3% from 26.4% a year ago. SG&A expenses were $17.3 million, down 1% from the $17.5 million level in the prior year.

Interest expense for the year increased by $182,000 as compared to the same period in the prior year. This increase was due to the increase in the average outstanding borrowings under our line of credit. We anticipate higher interest expense going forward due to the additional debt incurred to purchase Marks USA a few weeks ago. However, we anticipate that we will be able to reduce debt under our separate $25 million revolving line of credit, which amounted to $12.4 million as of June 30 as compared to $10.9 million last year. And that will happen as a result of our reduced inventory levels and our continuing efforts of our inventory reduction program.

As previously reported in the third fiscal quarter, our provision for taxes benefited by $2.1 million from the reversal of a prior tax liability no longer required. The benefit from income taxes for fiscal 2008 amounted to $1.4 million as compared to its provision of $1.9 million last year.

Net income for fiscal 2008 was $3.7 million or $0.19 per fully diluted share, a decrease of 12% from the $4.2 million or $0.20 per fully diluted weighted average share for fiscal 2007.

Per-share results are based on 19,802,000 and 20,599,000 fully diluted weighted average shares outstanding in fiscal 2008 and 2007, respectively.

NAPCO's balance sheet continues to remain financially strong. At fiscal year-end the current ratio was 5.7 to 1, as compared to 5.4 to 1 last year.

We believe NAPCO is adequately capitalized with approximately $12.6 million of our $25 million credit facility currently unused as of the fiscal year end.

As I previously pointed out, we believe the turnaround in inventory levels, which has already occurred, and which we believe will continue, will leave NAPCO with additional resources and flexibility to support future growth.

That concludes my formal remarks. I would now like to turn the call over to Dick.

To conclude my formal remarks, I would like to reiterate that we believe strongly in our business, and believe the acquisition of Marks USA was a great opportunity to expand our reach even further by catapulting NAPCO to new high levels of sales, nearing the $100 million mark.

We believe Marks can add value to our Company after complete integration and position NAPCO as the premier provider of top-notch cutting-edge security door technology products.

While it is the Company's policy not to issue formal revenue and guidance, I would like to offer some insight to some industry trends we are seeing in the marketplace.

Despite the current issues affecting global economies, the Company remains positive, but cautious, that fiscal 2009 will experience growth. We believe there will be many synergies between NAPCO and Marks USA and that will be generated as we go forward. Which will help enhance our consolidated bottom line, as well as the anticipated positive impact from many new products.

We will comment on such synergies as they occur throughout the year. While we anticipate to complete the integration of Marks USA over the next 12 months, we are enthused that it will be immediately accretive to NAPCO's per-share results. We anticipate some accretion in this quarter, which will have about 45 days of Marks' results included. Shareholders can expect to see a full first quarter accretion in NAPCO's second fiscal quarter ending December 31, 2008.

That concludes our formal remarks. Kevin and I would like to open the call for any questions. Operator, please proceed.

(Operator Instructions). Josh Jabs, Wells Capital Roth Capital.

Good morning. Thanks for doing the call -- nice to see. First off, I guess, Kevin, going back into the gross margins, given what you have in inventory right now, and the way you expect to [lay] off for the next couple of quarters, how quickly do you think margins get back towards that 30% mark?

Then as a follow on to that, can you guys give us a little more color and what products [were in] that buy-sell situation?

We expect the inventory is going to keep declining the next several quarters. We are at $27 million roughly as of June 30, '08. It came down significantly, especially in last quarter -- in the fourth quarter, which you know the high sales volume will drive inventory decline. Plus we have been working really hard on reducing the inventory beyond what the sales does through our inventory reduction program.

We expect inventory is going to keep going down. And it won't -- it will have an effect on margins. It won't have the dramatic effect that it had in this period, because last year we had a big increase of inventory, it was up $6 million. This year it has come down. That swing, that turnaround, that is what really hurts the margins.

Going forward I don't want to predict and project on this call right now where our margins are going to go. But I believe that the hit sort of that we took this year as a result of this inventory turnaround should not be as dramatic. We didn't have big, huge inventory growth this year. We had a decline. The decline should continue.

As far as what products are buy-sell products, they are across the spectrum. We don't want to mention specifically which products that they are, but it is across the spectrum of what we do. It is international products within NAPCO products. It is within all the divisions. And it was an unusually higher amount that occurred, especially again in the fourth quarter. And it is hard to predict whether that is going to keep occurring, but that change definitely affects our margins.

We would rather have the business, obviously, with building markets, especially overseas. I think the steps we're taking to compensate for that, such as cost-cutting measures that we going to take to align us with our manufacturing levels, those are the kind of things that we going to do to return margins.

I guess the big question here is, without giving specific guidance on the gross margin, the productlines are thought to have gross margin between 30% and 50%. And you just dipped down to 18% gross margin in the last quarter. How much do we view that as one time in nature?

And are we north of 30% again regularly into this first part of the year, or is that something that is going to take time to build back towards the former levels?

I think 18% is not necessarily an indication of where we are now. It is an indication of what happened to us in the fourth quarter. But as we go forward, our margins should be more similar to a 30% low, where we're trying to build it from that to more of the 35% level, where we have been the last few years.

Then just switching gears here, quickly on the new productlines, specifically iSeeVideo, do you have any (technical difficulty) for us around how adoption is coming within your current (technical difficulty)? And then we saw an EDT commercial for VideoView, any metrics on sales? For EDT?

We can just tell you that the introduction of the product -- since the introduction of the product, there is a nice ramp up on the product.

Today video surveillance, the way we do it, is very, very unique. We are the guys that are leading in this area. And we believe this area is a very, very hot area in security. It is an area where you could use your cell phone or laptop from anywhere in the world and be able to see what is going on in your home or your business for a subscription rate.

In other words, it is installed by the professional alarm companies. They get a reoccurring revenue component, as well as we get it on this for using our server farm. And it is ramping up very, very nicely. It is very a exciting product. It is probably one of the most exciting products that the industry has seen in many, many years.

And as you know, we won Consumer Product of the Year at the International Security Conference about four or five months ago. We have a lot of hope that this is going to be a major and important product for our Company.

Kevin, would you expect to report like a deferred revenue line at some point for the monitoring side of that business?

I think it's the deferred revenue becomes a material thing, which we hope it will, we will have to do that. Absolutely.

At least for now I guess we can look at it -- I know you're not providing any metrics, but maybe we wait for that deferred revenue line, and at that point we will have something to track?

Yes. We are accounting for that that way now, we are just, again, not disclosing it as a separate line within because it is not material enough. But as this thing gets bigger, it will have to be broken out. I hope we get to that point, and that is what our expectation is.

We think that this year could be a very strong year for the iSee Video, so we will have to look at that as a possibility going forward.

(Operator Instructions). Rick Fetterman, Fetterman Investments.

Kevin, do you expect the acquisition to be accretive to free cash flow after the accounting for the debt payments that will be made on a quarterly basis?

I do. Not so much in Q1, because we're not getting -- we're only getting a half a quarter's worth from the acquisition, but going forward I do expect it.

There's a few good things about this Marks acquisition. Before we even touched it, it generated approximately $4 million of EBITDA, obviously before the debt we're taking on. That is before we touch it. We're doing certain things immediately to increase that $4 million.

In addition, they get paid very quickly compared to our average receivables. That is going to help our cash flow very nicely also. So I do you expect that our cash that they will generate will be more than covering our debt payment that we have to make.

I remembered -- hope I am correct, please tell me if I'm not -- a statement made a while back that sort of a magic revenue number for significantly better margins was about $20 million a quarter. On a regular basis, not one here and then two that were below $20 million and then another one that was over $20 million, but on an ongoing basis $20 million a quarter in the Dominican facility. And that could get the margins up as high as the low 40s.

After the manufacturing is integrated over the next 12 months or so, is that still a reasonable expectation?

I think the components of the $20 million, if that is a number, is very important to us. The $20 million, it is made up of buy-sell transactions -- a lot of buy-sell sales, that is different than if the $20 million is made from products that are manufactured in the Dominican Republic. We need products -- that $20 million that gets us those good volumes, those good margins, we want to be making manufacturing those.

The more we manufacture, the more we're going to absorb overhead, the better our margins are going to be. The more commercial business that is -- makes up the $20 million or better, the better our margins are going to be. And, of course, if we do have crazy swings in our inventory that will help the margins be better. So there is a lot of pieces to the pie.

For now I think that to think about 40% is too aggressive, obviously, but I think to get back to the mid-30% is certainly a realistic possibility, especially with adding Marks to the equation and taking the steps that we're planning on taking.

Did you comment, and if you didn't, could you comment on what percentage, or even a dollar amount, of your revenues or cost of goods -- well, I guess revenues -- what the component part was of buy-sell versus items that you actually manufactured in-house?

We don't break that out. The best I could tell you is that it significantly changed in the last quarter and really in the last six months for us.

A lot of it built -- a lot of it due to international sales, but again from other areas as well. There are certain products that are buy-sell products and had taken off. Which is a good thing. It raises the sales. It doesn't help us again on the overhead -- leveraging of the overhead, but helps the top line. We're trying --.

I've got just one or two more questions and I will get out of the way. Did international break even this fiscal year, or is it -- my recollection is that somewhere in the $12 million revenue range was key. Or is it something that you expect, if not, you expect to occur say by year-end the next six -- well, at this point, the next three months, but the end of this calendar year?

Again, we don't break out the profits by international. But certainly, going up 30% for the year bodes well towards our profit level on international sales. It has grown dramatically. And if this kind of growth continues, it is going to be very profitable area for us, even at the lower margins.

Our goal is to keep trying to grow those sales. It is a key segment for us. It is a segment that, along with all the other areas we're trying to grow, could be very important for us going forward, again, even with the lower margins.

One last thing regarding the iSeeVideo. Can you comment on -- you said sales are improving there or ramping up. What kind of, I guess, unit sales are being made on a quarterly basis? And also have many units or systems are being monitored and the information stored via your server facility?

Dick here. We don't make -- we don't give numbers out on the iSeeVideo, but the ramp up is very exciting for us, so we do expect to get a lot of additional subscribers on to our system throughout this year.

It is interesting because this is a -- we're creating a new area in security, which really hasn't been done with a server and subscription service to it in our industry.

Up to this point the type of solution is really for higher end businesses, because it is very expensive. We figured out a way to do it for the consumers that is -- you could do your office or your home very inexpensively.

We have a lot of large companies that are looking at this to take it on as a reoccurring revenue, new stream of business for them. And the security industry hasn't seen anything as a new stream of business since the monitoring of burglar alarms and fire alarms. A lot of people feel that this video component of security is going to be one of the fastest-growing areas in security. And we are seeing it in our numbers.

As we talked about with Josh before, it will be recorded as it becomes a stronger and stronger part of our business. We have high hopes for this fiscal 2009 for this product and beyond.

One last thing, Kevin, in addition to the mandatory debt reduction for the Marks acquisition, did you say that you expected by the end of this year to have some reduction in the debt, that $12.4 million, that without previous to the acquisition?

Yes, I did. Because one of the benefits of reducing the inventory in the -- by the end of the year, we reduced it by about $1 million. And a lot of it -- we were up for the year, as I am sure a lot of you remember. We reduced it dramatically to get to a point where we went from being way up to down $1 million.

That will lead to cash, obviously. We will convert that to cash, and we'll use that to pay down debt. We'll use it to pay off the $12 million that we have now. We're going to continue to try to reduce inventory even further so that continues.

Richard Molinsky, Max Communications.

Just a quick question. With the stock as low as it is right now, and you guys have bought stock at higher prices, is there any plans at all to add to that position, or just keep -- conserve the capital, just use it for inventory or just growth at this point time?

The acquisition of Marks, we opened up a separate line of credit for $25 million at LIBOR plus 2.25 money. And we believe that as far as making investments, we want to make investments into that business, and that is why we did this. That is our near-term, mid-term view right now.

Sorry about that guys. Sorry, the other phone was ringing here, but I missed the last thing you said there for a second. I'm sorry.

Our near-term, mid-term view is to build up the Marks and to build our business up internally, and to move some of the buy-sells into the factory. Now that their critical mass has been reached, it is now a time to move them back in to get that synergy of moving them in, and our overhead amortized over more manufactured products. That is our goal.

Has the expectations of the acquisition, dealing with the people and working with them now that you have acquired them, has it moved as smoothly as you thought or were there has been some roadblocks along the way trying to get things done, where you had different management team in?

No, Marks USA is being run by the same President that has run the Company for 25 years. They are three miles away from here. And we're going to bring them into our facility in the next year, because they're running out of space and they have a very nice growth rate.

The people are totally cooperative. We let them run as an independent company. And we want to use our strengths to help them grow their business by sharing our sales reps with them, by sharing our higher volume of purchasing with them, so they can reduce their costs. And all the other things that we can bring to help them keep their business growing. But we're going to keep going in the direction that they have been very successful in doing, and we don't want to tinker around with that.

Terrific. So as long as you and them get along, and there were no problems, that is a good sign.

The relationship is great. They are great people.

Terrific. I appreciate guys. Good luck. I am looking forward to seeing better numbers and continued improvement.

(Operator Instructions). Seeing as there are no further questions -- there is another question. Josh Jabs, Roth Capital.

Just a couple of quick follow-ups here. First, international has been growing pretty well this year. Can you give us a little bit of information on where that growth is coming from? I know you have pretty substantial operations in Europe and in the Middle East. How is that breaking out between those two geographies?

We don't break it down that way. But overall the marketplace is being the UK and Europe are the second biggest market after the USA. We have a good team of guys over there and a good following of distributors. And they're doing quite a job.

We expect to supplement them with some additional European products, with different European frequencies, probably in the next 90 days, so that we do help to increase their business even more.

So we have high hopes for them. We also have our warehouses operations over in Europe where we ship to them our products, so they get good service. And we have a nice following. So we expect it to continue.

The weak dollar helped us also because of the fact that they can buy our products inexpensively. And because we are a Dominican operation, there is no duty into Europe and the UK, because of the Lome Convention, where the Caribbean Basin Initiative Convention, where you can export into the European Community with no duty.

So our locks and our alarms and our access control and other products, which are not inexpensive items, they are inexpensive items, they are systems and expensive items, they come in no duty. So it gives us a nice advantage. Plus we only sell in dollars at the present time. Those are some of the reasons why the European and international business are kicking up a lot.

Dick, specifically here, are your European sales four times bigger than your Middle East sales? Give us some rough estimate of the ratio. I guess one of the things that we're looking at is Europe has been, and especially with the dollar the way it has been -- sales to Europe have probably been pretty solid over the last year. It looks like Europe is going to slow a little bit. What are the implications of that on your business?

The crime rate in those countries is pretty, pretty high, and we expect that they will continue along. People can buy our products very reasonably -- the installing people and put them into a lot of the different trouble areas around the European Community as well as the UK. And we see that as a very strong growth area for us.

I don't really break down what is European, what is UK and what is Middle Eastern. But our products are in demand, and I expect them to continue that way, and even a stronger way going forward.

Last question on the segment is segment revenues -- I know you don't break it all the way out here but, is it fair to say that intrusion is still more than 50% of the business? And how do you expect that to change over the next couple of quarters?

We're more -- now we are into -- the Alarm Lock division manufactures strictly door technology products with an electronic component, a large electronic component.

Marks USA is mechanical grade one door locking products for high-end contact hardware business, as well as locksmith distribution business. We have got the door technology area pretty well covered. Marks has many, many blue-chip accounts -- hotels, national brand names.

And they are in the contact hardware area, which means as the buildings are being built and completed they're adding the door hardware and safety equipment in these buildings. That we expect to continue. And it looks like that is feeling very good for the future.

There are lots of buildings that are under construction that they have to finish up and add all the hardware equipment, so we would expect that that will continue. They sell a lot domestically, but they also export a lot. That is how we see it. What was the second part of the question?

That's all right. I guess I'm just looking at -- has there been any significant change in the segment mix between your divisions? Is intrusion still -- I know Marks USA will change it, but as of today has the mix between the segments changed significantly in the last 12 months?

All of the Continental business, all of Marks, and 50% of the intrusion business is commercial. And all of Alarm Lock is the commercial door business. So I would say intrusion is becoming a smaller portion of our business.

We estimated by adding Marks into the equation, that the residential piece is like 20% now and the commercial piece is 80%. There has been a big shift. A lot of it has to do with Marks. A lot of it has to do with the growth of the commercial areas of the business. So the best way to look at it is that our best guesstimates by adding Marks is that it is 80% versus 20%.

Seeing as there are no further questions, I would like to call turn back to management for any concluding remarks.

That concludes our formal remarks. Kevin and I would like to thank everybody for participating in today's conference call.

As always, should you have any additional questions, please feel free to call Don Weinberger, Kevin Buchel or myself. We thank you for your interest and support, and look forward to speaking to all of you again in November to discuss NAPCO's first quarter results. Thank you.

Ladies and gentlemen, this concludes today's teleconference. Thank you for your participation.