NAPCO Security Technologies Inc (NSSC) 2009 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Napco Security Technologies Incorporated second-quarter and six months 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, Mr. Don Weinberger of Wolfe Axelrod Weinberger Associates. Thank you. Mr. Weinberger, you may begin.

Thank you, Rob. Good morning and thank you all for joining us for today's conference call to discuss Napco's financial results for the second quarter ended December 31, 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 e-mail.

On the call with me today is Mr. Richard Soloway, Chairman and Chief Executive Officer of Napco Security Technologies, 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 Technologies. Dick, please proceed.

Thank you, Don. Good morning, everyone, and thanks for joining Napco's quarterly conference call to discuss the financial results for the second quarter of fiscal 2009 which ended December 31, 2008.

In light of continued challenges related to the global economy, we are pleased with our second-quarter fiscal 2009 financial results. Despite these adverse conditions, we generated EBITDA of $1.4 million and cash flow from operations of approximately $2.7 million. Our debt position, net of cash, was reduced this quarter by approximately $2.3 million.

During the second quarter, the increase in net sales for the three and six months was largely the result of the revenues from our commercial products.

Going forward, we believe the emphasis will be on maintaining the momentum that exists in our commercially driven locking and access control businesses while driving growth back into the residential security and international sectors.

I was also encouraged with the improved gross margin level this quarter of 32.6% over the level that we achieved last quarter of 32% and for all of fiscal 2008 of 30%. The gross margin improvement is due to a better product mix, which included a smaller amount of low-margin buy/sell sales transactions and a lower percentage of international sales. The gross margin improvement was also impacted by the addition of Marks USA revenue and the strength of our overall businesses.

The integration of Marks into Napco is in full motion. While we believe additional synergies and cost savings are ahead of us, Napco is now able to furnish the diverse security industry through our group's divisions by creating a one-stop shop for dealers of all sizes and needs throughout the world. At Napco, we believe this is especially important during this current economic climate. By marketing our products through different sales teams, distributors and installers in our umbrella of divisions -- Alarm Lock, Continental and Marks -- we can take full advantages of security market conditions as well as many cross-selling opportunities.

In addition, we continue to maintain investing in research and development to create and provide our dealers with the highest quality products that can be used in various settings and situations. Specifically speaking, Alarm Lock's stand-alone Access Control locks provide a cost-effective security solution to retail outlets, hospitals, and schools and universities. The increased need to control retail theft and the continued counter-economic growth of the healthcare and education sectors continues to provide strong demand for Alarm Lock locking solutions.

Another great example, our Marks USA division, has targeted new product introductions towards the growing retrofit and refurbishment commercial markets. Marks new lines of life safety healthcare lock sets, HI-SECURITY locking cylinders, and the custom locking products line all focus on already-existing commercial institutions with a need to expand or revitalize their facilities with new and improved security equipment.

Public buildings and institutions are reflecting a renewed interest in enhancing their security and limiting workspace violence in this tough economic climate. Many local governments have already begun to procure such upgrades and improvements ahead of the massive stimulus package from the federal government that is likely to be passed in the next few days.

The need for our products doesn't stop there. Continental's enterprise-class access control solution with its innovative lockdown feature has met with strong market vitality.

The iSee Video product and service line will continue to exhibit vibrancy as small business needs for the product grows during these challenging economic times. The product enables retail outlet managers to keep track of multiple locations via video surveillance which can be viewed from any Web-enabled cell phone or computer. iSee Video will help retailers better control internal shrinkage and shoplifting by supplying store owners with video clips e-mailed at the time of the event, which shows security breaches in high-resolution video. The iSee Video product provides Napco and its network of dealers a consistent recurring revenue stream which carries little expense and can drop those revenues right to our bottom line.

On the international front, Napco recently introduced a voice-enabled security system that speaks in the consumer's native language to enable operation and announce status of the system. This unique product has met with positive market acceptance and promises to drive encouraging international sales growth.

Before I turn the call over to Kevin, I would like to briefly mention that after receiving approval from the Board of Directors and the Company's shareholders, the Company name has officially been changed to Napco Security Technologies Incorporated. We believe the name change was prudent as it more closely identifies with the ongoing research and development efforts as well as our recent acquisition of Marks USA, which engages in, among other things, the door lock technology business.

While our name has changed slightly, it actually denotes who we are -- a leader in manufacturing the most advanced technological security products. Now with one of the industry's most diverse technologically advanced portfolios of security solutions, Napco is well positioned to help our global network of thousands of security service providers and customers meet what will be a growing need for security. Our new products and strategic direction emphasizes the deliveries of enhanced and increased capabilities to meet the increased future security demands of our end users and consumers.

Now, I'd like to turn the call over to Kevin to review the details of the financial results. Kevin?

Thank you, Dick, and good morning, everybody.

As for the financial performance of our fiscal second quarter, sales for the three months ended December 31, 2008 increased by approximately 18% to $19.079 million as compared to $16.166 million for the same period a year ago.

Sales for the six months ended December 31, 2008 increased by approximately 22% to $36.562 million as compared to $30.042 million for the same period a year ago. The increase in net sales for the three and six months was largely the result of the revenues contributed from the Marks USA acquisition, as well as increased sales in the Company's door locking and access control products, as partially offset by a decrease in the Company's intrusion products.

Gross profit for the three months ended December 31, 2008 increased by 14% to $6.214 million or 32.6% of sales, as compared to $5.447 million or 33.7% of sales for the same period a year ago. Gross profit for the six months ended December 31, 2008 increased 11% to $11.820 million or 32.3% of sales, as compared to $10.671 million or 35.5% of sales for the same period a year ago. The increase in gross profit in dollars for the three and six months was primarily due to the increase in net sales, as previously discussed, the strength of our commercially driven locking and access control products, as partially offset by an increase in certain overhead expenses in cost of sales.

Gross margin decreased year-over-year by 1.1%, primarily from the increase in certain overhead expenses as well as a decrease in production of the Company's Intrusion product lines, resulting in lower overhead absorption but it did show sequential improvement from the first-quarter level of 32% and all of fiscal 2008's level of 30%. As mentioned in today's press release, we are cautiously optimistic that gross margins will continue to improve as a result of continued integration of Marks USA as well as a major across-the-board cost savings program that was recently instituted which will better align our cost structure as well as improve efficiency.

Selling, general and administrative expenses for the three months ended December 31, 2008 increased by $1.286 million to $5.448 million, or 28.6% of sales, as compared to $4.162 million or 25.7% of sales a year ago. Selling, general and administrative expenses for the six months ended December 31, 2008 increased by $1.641 million to $10.224 million or 28% of sales, as compared to $8.583 million or 28.6% of sales a year ago.

The increase in dollars for the three and six months ended December 31, 2008 was due primarily to the additional expenses related to Marks. The three months ended December 31, 2008 also included an increase in an expense due to a major trade show that took place in October 2008. This tradeshow occurred in September 2007 and was therefore included in selling, general and administrative expense for the first quarter of fiscal 2008. As we further consolidated Marks into Napco, we believe that more cost savings and synergies lie ahead, including cross-selling and improved efficiencies which, in the long run, will lower SG&A costs.

Interest expense for the three months ended December 31, 2008 increased by $205,000 to $429,000 as compared to $224,000 for the same period a year ago. Interest expense for the six months ended December 31, 2008 increased by $325,000 to $744,000 as compared to $419,000 for the same period a year ago. The increase in interest expense for the three and six months resulted primarily from the increase in the Company's average outstanding debt which was due to the $25 million term loan utilized for the Marks acquisition in August 2008.

The Company's provision for income taxes for the three months ended December 31, 2008 increased by $231,000 to a provision of $129,000 as compared to a benefit of $102,000 for the same period a year ago. The Company's provision for income taxes for the six months ended December 31, 2008 increased by $122,000 to $285,000 as compared to $163,000 for the same period a year ago.

The increase in the provision for income taxes for the three and six months resulted primarily from two factors. First, the Company's corporate restructuring occurred during the quarter ended December 31, 2007. As a result, the Company's effectively for income tax in that period was lower, and it also included a certain one-time -- coupled with certain one-time benefits.

In addition, Marks USA does not yet benefit from the corporate restructuring. This will occur in future quarters as we continue to integrate Marks into our overall company.

EBITDA was $1.4 million for the three months ended December 31, 2008 as compared to $1.578 million for the same quarter a year earlier, an 11% decrease. EBITDA for the six months ended December 31, 2008 was $2.571 million as compared to $2.69 million for the same six-month period a year ago, a 4% decrease.

Net income was $332,000 or $0.02 per diluted share for the three months ended December 31, 2008, as compared to $1.172 million or $0.06 per diluted share for the same period a year ago. Net income was $654,000 or $0.03 per diluted share for the six months ended December 31, 2008 as compared to $1.547 million or $0.08 per diluted share for the same period a year ago. The decrease for the three and six months ended December 31, 2008 was primarily due to the decrease in net sales and gross profit in the Company's Intrusion product lines, higher tax rates versus a year ago, and the expense from a major trade show during the quarter.

Per-share results are based on 19,095,713 and 19,820,906 fully diluted weighted average shares outstanding for the three months ended December 31, 2008 and 2007 respectively, and 19,206,453 and 19,985,412 fully diluted weighted average shares outstanding for the six months ended December 31, 2008 and 2007, respectively.

Napco's balance sheet continues to remain financially strong. We ended the quarter with $5.6 million in cash and our total debt position, net of cash, was reduced this quarter by approximately $2.3 million. In addition, we have generated approximately $3.2 million in cash flow from operations thus far this year and $2.7 million of it came during this last quarter.

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

Thanks, Kevin. As we look ahead to the remainder of fiscal 2009 and these uncertain times, we remain confident in our ability to increase sales by developing the most technologically advanced design security systems for the vast security marketplace. With our latest security acquisition, Marks USA, our business mix is now 80% -- approximately 80% commercial, industrial, governmental, institutional, and 20% residential security.

I'd like to reiterate that we believe strongly in our business and believe the acquisition of Marks was and is a great opportunity to expand our reach. We believe that our exciting new product offerings, along with the integration of Marks, can add value to our company's position in the marketplace and build Napco into a premier provider of unique, top-notch, cutting-edge security technology products.

We're going to continue to work aggressively to gain market penetration and increase market share throughout all of our segments of our businesses. Despite the economic climate of today, the global security market remains healthy, and I continue to believe that we are well-positioned to greatly improve shareholder value.

While we don't know what the troubled economy brings in the short term, we do know, given our 30-plus years of history, that our formula works in the long term. Our footprint for success has led us to profitability each and every year in our company's existence. Our high-quality products keep dealers coming back for more. This stems directly from our consistent expenditures in good times or bad in our research and development department. In addition, we continue to remain a shareholder-focused company, growing our business over the years both internally and externally with accretive-only acquisitions which have had no extra dilution to the shareholder stake in Napco.

As we head into our seasonally stronger quarters, we continue to anticipate continued profitability and strong cash flow that will help us continue our R&D efforts as well as reduce debt levels.

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

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. (Operator Instructions). Ben Lichtenberg, Noble.

Good morning, everyone, and congratulations on a very respectable quarter in a very tough environment. It's good to see management so aligned with shareholders, something we don't see in this environment either. We see management so often just grasping onto their jobs and looking the other way.

Just a quick question as to inventory -- it's grown as a percentage of sales to a more than noticeable number. Any color there, please?

Yes, Ben. The inventory for this past quarter actually grew by about $1.3 million from the September level. We have been working hard to reduce our inventory. We did do that at the end of June. The overall inventory compared to year ago obviously is going to be a lot higher because we now have Marks in the picture.

Understood.

We level-lowered our factory, meaning the better quarters, the higher-sales quarters come in these upcoming two periods, Q3 and Q4, especially Q4. So rather than just built at the very end, we build evenly throughout the year.

The inventory grew by $1.3 million. In the past, it grows a lot more during the course of the year in anticipation of these higher quarters, so you can't really feel the fact that we've done better than we have in the past.

The fact that intrusion sales were weaker did hurt that effort. A lot of the inventory that we have to move in these upcoming quarters relates to intrusion. Intrusion will come back. When it comes back, we will move that inventory.

And a related question -- please define "noncurrent inventories".

The way that noncurrent inventory is defined is inventory that statistically you will not be using over the next 12 months. So if statistically you have 10,000 units but statistically, based on your present run rate, you are showing sales of 8000 units, you take those 2000 units and you put it into long-term inventory. It changes every moment, because the statistics change all the time. It has nothing to do with anything other than a calculation of that.

I got it, okay. While I have you, one last question, also on the balance sheet. Probably it's buried in the notes but I don't have them in front of me -- the debt. What type of terms do you have? You seem to have some fairly liberal repayment periods.

Right. Well, we have two pieces of the debt. One is a term loan, which is on the acquisition, and the other is a revolver.

The term loan is the $25 million term loan that we signed to do the Marks acquisition. It's paid back over five years with seven-year amortization, so it means we pay it back as if it is seven years with a lump sum at the end. It's got an interest option of LIBOR plus 2.25, and LIBOR is way down, so the interest rate is pretty favorable.

The other part is the revolver, which is a $20 million revolver, that has interest at a similar or a little over rate than what I just described for the term loan.

Okay, very good. Thank you.

(Operator Instructions). Rick Fetterman, Fetterman Investments.

Good morning, everyone. By the way, thank you for including the summary balance sheet in the release which I had mentioned on the last call; I appreciate it.

Can you break out the Marks revenue in this quarter?

We don't break out the revenue. The Marks revenue in general was slightly below the level that we -- at the level that we bought the company for. So we were at a $25 million level when we bought the company. It was slightly below that, not a lot.

Commercially, commercial business seems to have held up pretty good, so where the intrusion side on our existing businesses was weaker and our commercial side on our existing business was strong, the Marks piece held up pretty good. I'm not going to say it was exactly where we were when we thought the company, but the decline was not all that much.

The commercial piece of the business is broken into a few components. There's the build-outs and retrofit market, which Marks does a lot and we are going to be expanding that. Then there's the new commercial buildings which are being completed. So you have both of those components.

We are spending a lot of time on marketing to the retrofit and build-out market because we see a lot of that. That's kind of a perky part of the commercial business. Marks has been a well-suited to do that type of work because we are a manufacturer here in the USA and we can get quick supplies to people that are doing the retrofit work.

Okay. When you announced the Marks acquisition, you had said you expected it would take 12 to 15 months to integrate the two companies and move the manufacturing down to the Dominican. Is that still a realistic goal? Do you have any comments on the progress here in the last I guess five months or so?

What we're doing now is a lot of the products that use subcontractors to manufacture the parts -- we are moving those items from the subcontractor to the Dominican operation. We expect to have a lot of that stuff moved out to the Dominican over the next 12 months because the Dominican operation has the machinery to make the sub-chassis and all of the other parts. So that's our plan on the manufacturing.

On the purchasing side of the business, we are taking groups of the top suppliers of Marks and the top suppliers of Napco. We are cross-checking prices so that we get the best of both worlds and bring our overall costs down.

We are also meeting on a regular basis with the sales forces in both so that we can cross-sell to the distributors on the Napco side, Alarm Lock side and Continental side, and to the Marks USA side, because there are different distributors, different dealers, and different installers. We will be marketing, cross-marketing to both of those groups.

So I would say things are moving along very nicely. We expect that a lot of this work will be done by the end of this calendar year, and we expect to see a lot of synergistic help to both companies by the end of the fiscal year this year.

Okay. Based on the original -- the revenue of around $25 million for Marks when you purchased it and the revenue that Napco generated pre-Marks, we would all hope that the revenues would be $90 million-plus for this year. Is there any visibility or any comment on whether you think that's still a reasonable number, given the economic environment we are in?

I would say that we have to be cautiously optimistic that things will continue to perk along. We are in all these diverse markets being commercial locking, commercial access control, commercial intrusion and some residential. So it's hard to predict, but we have a very broad base, the broadest base of all the security manufacturing companies because in security manufacturing, most companies are either in a locking area -- that's all they stay in -- or they are in the access control and intrusion. Us being in both is allowing us to do some very, very interesting products and those products are going to be unveiled at the International Security Conference coming up in Las Vegas in the next couple of months. So it allows us to have many more products to the marketplace, broaden it out with a very wide palette of dealers rather than just staying with one segment of security dealers. We are selling to commercial dealers of locking, commercial dealers of intrusion, access control integrators to the tune of thousands of these people, so we are very diversified.

What is a reasonable expectation for us for gross part profit margin after integration, say starting next year? I mean, I realize this is a process, not an event, and you certainly are making some progress as you go. But if you hit a certain percentage, what would that be where we would say, "They got it!"?

Well, we've gotten it with Alarm Lock and we've gotten it with Continental, and we're going to get it with Marks USA. I don't know if Kevin wants to help out in that.

We're not going to obviously be able to predict it, but you guys who have been with us for a while have seen the trend of our margins approaching 40% in the past when our volumes are strong and we are clicking on all cylinders. We were 37%, 38% in the past.

When you start seeing it get close to that, approaching 40%, you're going to say "They got it!" That's what were trying to do. What will help that is, A, getting the volume up on all pieces. So I think we are doing really well on the commercial side. When intrusion comes back, that will help. Number two, when we get the Marks integration going fully, that will help because, remember, they were 33% when we acquired them. It's obviously going to get better than that. When the sales are high, in the $90 million-plus range, that's going to allow us to absorb a lot of overhead. You guys have seen it in the past. That's when we are clicking on all cylinders.

Okay, one last item -- Dick, have you had any feedback? I mean, I know residential is slow for the reasons that everybody is aware of, but any comments back from ADT or Brinks or anyone else regarding the iSee Video? I'm curious if -- how many systems you have on your server now where you are actually doing the saving of the data.

Let me give you a little bit of color on intrusion residential. When we check to see the vitality of that business, we find that the sellout of the products from our distribution is holding up. What that means is that people are very concerned. The consumer is very concerned about intrusion problems. You know that there's always a spike in crime as you get deeper into recessionary times. We know that what's going to happen in the future, the budgets for police are going to be cut and there's going to be more need for security and intrusion products. So we know that is happening.

But the dealers are -- the distributors are very, very hesitant right now to stick their neck out and buy a lot of inventory. So they're running things much, much tighter. But the installations are going in fairly evenly, from all the feedback we're getting, by the dealers because they are busy. So it's really the distributors that are holding back with bank lines of credit and other issues that they have. So that's a little bit of color to tell you that intrusion is steady but we are seeing the distributors cutting back.

In addition to that, some of the dealers are also holding back because there are numbers of dealers out there that put in no money down alarm systems -- which means that they have to have more credit on the street. They are hesitant. Even though the demand is for more information, they are not wanting to sell to people where they think they are a credit risk. So it slows things down a little bit, but they are electing not to take jobs. So we have a pent-up demand but the dealers are holding back and the distributors are holding back.

So I think we've got to watch this next quarter, see how things are because we said we're going to drive more volume back into intrusion. Intrusion has some nice vitality from what I'm telling you.

When it comes to iSee Video, it's a new recurring revenue source for the dealers. They want to sell that to their existing accounts where they have decent credit experience with them.

So we are seeing a steady, steady growth of installations with the recurring revenue-generating service component, and we are creating a new category in the security market. This has never been done before. It takes a little bit of time to create the category, but all of the feedback is that the dealers like very much the iSee Video, they like the fact that they give additional services to their end-user consumers, that it's a product of today's times, and it's not very expensive for them to get into this business and get a new stream of recurring revenue. So we have great hopes that this is going to be very successful going forward.

Thank you very much. Congratulations and best of luck going forward.

(Operator Instructions). David Ratliff, Doucet Asset Management.

Good morning, gentlemen. A follow-up with -- the last caller had a question about your iSee Video product and the recurring revenue stream. Is there any flavor or any kind of additional information you can give us about the progress of that product? Like, you are seeing 100% growth in sales or -- I know it's starting from a small number -- but like the ramp for iSee Video?

Well, the iSee Video is aimed for consumers that are being monitored by the alarm companies already, and there are millions and millions of those consumers, and there are thousands of the alarm dealers. So alarm companies are traditionally slow on the adoption because of the fact they want to make sure that the products, what's installed, they don't have any trouble and don't get any callbacks which could make the consumer that's there -- burglar and fire alarm consumer customer -- upset. So there's just a certain gestation period. But we have a very nice ramp on installations, and it's building this new category in the security business, and it's working well.

So we expect the momentum to continue to keep growing, and we expect to get many, many thousands of consumers added to this system on a quarterly basis. That's what we would hope, and we expect this snowball to continue. So there's no alternative to it. Any alternative that's on the market is very, very expensive, it's in the multi-thousands of dollars, whereas this product, the consumer between $10 and $20 can now watch video in his business or his home and not have to be there -- on his cell phone or his computer. That's a very, very hot area in the intrusion and burglar alarm business. So we have great hopes that this thing is going to continue its rise in installations.

Okay. I got on the call about 10 minutes late, so I missed if you gave a backlog number that included possibly the Marks piece. Was that provided?

No, we didn't disclose the backlog number.

Okay. The last question, then, I have is in reference to your stock price. Obviously, with your cash, you have a lot going on with the integration and probably the new products that are good uses of your cash or your working capital. But at this level of stock price, has the idea been floated that the Company would buy back some of its stock?

From the point of view of where we are at right now, we have debt and the way we usually do it is, as we get cash flow -- and you can see we are throwing off cash from operations --

Right.

-- we pay back the debt. That's what we're doing. It's one of the things we could do; we've done it over the years; we've bought back stock. But right now, we are focused on paying back debt as quickly as we can during these economic times. We are conservative that way.

This is Don Weinberger; I just want to add. The negative on that also is of course you decrease the amount of shares out there and that drives up the liquidity, and this company actually needs liquidity. We are very conscious of getting the story out and telling it. As a matter of fact next week we will be presenting at the Roth conference, their micro cap session and we look forward to that. We do other proactive things in terms of getting the story out to the financial community, and we will continue to do so.

Okay, excellent. I see that the insiders still hold a significant amount of the stock, so I just wanted to throw that question out. But congratulations on another good quarter, and good luck with the integration.

Thank you. There are no further questions at this time. I would like to turn the floor back over to management for closing comments.

Thank you, everybody, for participating in today's conference call. As always, should you have any additional questions, please feel free to call Don Weinberger, Kevin or myself. We thank you for your interest and support and look forward to speaking to all of you again in a few months to discuss Napco's third-quarter results.

Take care. Thank you.

Ladies and gentlemen, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.