NAPCO Security Technologies Inc (NSSC) 2010 Q4 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Napco Security Technologies, Inc. year-end financial results conference call.

(Operator Instructions).

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, Claudia. Good morning, and thank you all for joining us for today's conference call to discuss Napco's financial result for the fourth quarter and year ended June 30, 2010. By now, all of you should have had the opportunity to review the press release discussing the results. But if you have not received it, 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 this mornings 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. Thank you for joining Napco's quarterly conference call to discuss the financial results for the three and 12 months ending June 30, 2010. Net sales for the fourth quarter were $20.636 million, a 9% increase from the net sales of the same quarter a year ago, and a 29% sequential increase over the net sales recorded for the third quarter of fiscal 2010. The quarterly sales report, which showed year-over-year improvement, came primarily from our intrusion and door-locking divisions. As we have previously reported in prior calls and today's press release, the global economic crisis continued to have an adverse impact on our business during fiscal 2010. But we are optimistic that these conditions have bottomed out, and our backlog levels continue to remain high at historic levels, which we think is an indication of improved demand from a year ago. The sales backlog of approximately $2.236 million and $1.554 million, existed as of June 30, 2010 and 2009 respectively.

While difficult economic conditions persist, we have implemented several cost containment measures during the past year, which puts us in a position for improved profitability, when economic conditions improve. We expect to complete the integration of Marks production from the US to our Dominican Republic facility during the next few months. Upon the completion of the integration of Marks, Napco's cost savings should approximate $2 million per year, and take full effect in fiscal 2011.

While we believe economic conditions have bottomed out, the uncertainty and lingering nature of the recession has prompted us to begin further measures at reducing expenses, while still delivering a comprehensive line of exciting, dealer-friendly, and reliable, new and existing security products. Despite this challenging economic environment, we have been extremely busy within our R&D department, and are very confident in the growth opportunities presented by our new products, and the recurring revenue -- revenues generated by many of them.

Specifically, our new Napco commercial platform will give our Company a powerful presence, in the high gross margin, billion dollar, commercial fire, life safety sector of the security industry. It opens up a whole new avenue of business for Napco into schools, factory, office buildings, hospitals, retail centers, and much more. The product, which incorporates several innovations to the segment provides eight to 255 point addressable or conventional wired, wireless commercial fire, intrusion, and it's a combination of fire and intrusion control panel.

Additionally, Napco's launched a wireless version of its popular iSee Video product line. iSee Video provides both Napco and it's alarm dealer partners with incremental service-driven income stream. Reoccurring revenue generating products are becoming a larger part of the strategic planning for the Company's product portfolio. The iSee video product line allows homeowners and businesses to remotely view live video, or stored video clips of activities in their homes or businesses from any computer or web-enabled cell phones anywhere in the world.

The new wireless video line will make installation easier and faster, enabling dealers to install more systems, and for Napco to add more reoccurring revenue subscribers to our already substantial customer base. These new products, these new product offerings, along with the completion of the Marks consolidation in 2010 will now enable us to further streamline the marketing, sales, and manufacturing costs of the combined operations. We believe this structure, along with our large network of security dealers, will instill our extensive and technologically advanced line of products, puts us in a strong position, as economic conditions improve and market demand increases. And now I'd like to turn the call over to Kevin to briefly review the financial details of the financial results. Kevin?

Thank you, Dick. Net sales for the fourth quarter ended June 30, 2010 were $20.636 million, an increase of 9% from $18.979 million one year ago. As Dick previously mentioned, this increase came primarily from our intrusion and door-locking divisions. Net sales for fiscal 2010 decreased by 2.6% to $67.757 million, from $69.565 million in fiscal 2009. The decrease in sales was primarily the result of a decrease in products, specific to the Company's Middle East operation, $1.867 million. The Company's sales continued to be adversely affected by the world-wide economic downturn.

Gross profit for fourth quarter was $3.040 million, compared to $3.472 million in the same quarter of fiscal 2009. The Company's gross profit decreased $574,000 to $14.522 million, or 21.4% of net sales in fiscal 2010, as compared to $15.096 million, or 21.7% of net sales in fiscal 2009. Gross profit in fiscal 2010 as compared to fiscal 2009, was affected by the lower sales levels in fiscal 2010, and the restructuring costs charged in fiscal 2009.

Selling, general and administrative expenses for the fourth quarter of fiscal 2010 decreased $284,000 to $4.737 million, or 23% of net sales from $5.021 million, or 26.5% of net sales in the fourth quarter of fiscal 2009. Selling, general & administrative expenses for fiscal 2010 decreased $1.353 million to $18.810 million, or 27.8% of net sales from the $20.163 million, or 29% of net sales level in fiscal 2009. These decreases resulted from the Company reducing it's general payroll, and certain selling and marketing expenses in the second half of fiscal 2009, in reaction to the decline in sales levels beginning in the third quarter of fiscal 2009. Fiscal 2010 reflects a full-year of these reduced expenses.

During fiscal 2010, the Company recorded a non-cash adjustment for goodwill impairment of $923,000, and that compared to a $9.686 million impairment charge during fiscal 2009. Interest expense for the three months ended June 30, 2010 increased by $140,000 to $607,000, as compared to $467,000 for the same period a year ago. Interest expense for fiscal 2010 increased by $729,000 to $2.366 million, from $1.637 million for the same period a year ago. The increase in interest expense is primarily the result of the increase in borrowing rates charged by the Company's primary banks, as partially offset by the Company's reduction of the outstanding borrowings under it's term loan.

The Company's benefit for income taxes for the three months ended June 30, 2010 decreased by $2.313 million to a benefit of $412,000, as compared to a benefit of $2.725 million for the same period a year ago. The Company's benefit for income taxes for fiscal 2010 decreased by $2.2 million to a benefit of $1.084 million, as compared to a benefit of $3.299 million for the same period a year ago. The decrease in the benefit for income taxes from fiscal 2009 to fiscal 2010, resulted primarily from the Company recognizing a net tax benefit to income tax expense of $3.293 million in fiscal 2009, for an impairment charge to goodwill in that year.

Net income improved by $7.332 million or 79%, to a net loss of $1.892 million, or negative $0.10 per diluted share for the three months ended June 30, 2010, as compared to a net loss of $9.224 million, or a loss of $0.47 per diluted share for the same period a year ago. Net income for fiscal 2010 increased by $6.882 million or 51%, to a net loss of $6.5 million, as compared to a net loss of $13.382 million in fiscal 2009. This resulted primarily from the aforementioned reduced SG&A expenses in fiscal 2010 of $1.353 million, the impairment charge to goodwill of $9.686 million, and restructuring costs of $1.274 million, both of which occurred in fiscal 2009, and partially offset by the higher interest expense in fiscal 2010 of $729,000, as well as the reduction of the benefit for income tax of $2.2 million.

With a lot of non-cash and one-time expenses, as well as our interest expense, it is important to point out, that our adjusted EBITDA, as per the schedule included in this morning's release, increased $100,000 to $127,000 for the three months ended June 30, 2010, versus the $27,000 reported in the same quarter last year. And for the 12 month period ended June 30, 2010, adjusted EBITDA increased $596,000 to $434,000, as compared to a loss of $162,000 for the same 12 month period a year ago.

Napco's balance sheet continues to be sound. We ended the year with $5.5 million in cash. And debt, net of cash, was reduced by $11.6 million, from $35.9 million to $24.3 million since acquiring Marks USA in August of 2008. $0.6 million of this reduction occurred in the fourth quarter ended June 30, 2010. Cash generated from operations was approximately $0.6 million for the quarter, and $5.3 million for the 12 months ended June 30, 2010.

Accounts receivable decreased by $2.2 million to $17.8 million at June 30, 2010, an 11% decrease from the June 30, 2009 level of $20 million. This decrease occurred, even though sales in the fourth quarter were 9% higher, as previously mentioned. Inventory reduction in the year ended June 30, 2010 was approximately $4.8 million, as a result of the aggressive utilization of existing inventory as previously reported. Inventory reduction in the fourth quarter of fiscal 2010 amounted to $2 million. That concludes my formal remarks. And I'd now like to turn the call back over to Dick.

Thanks, Kevin. As we look ahead, we remain confident in our ability to building Napco into a Company that develops the most technologically advanced, intuitively designed, security solutions for the vast security marketplace. We believe that our exciting new product offerings, including several with recurring revenue opportunities, along with the final integration of Marks, will add value to our Company's position in the marketplace, and build Napco into the premier provider of unique, top-notch, cutting-edge security technology products. Our long-term growth prospects are strong, as the demand for security and protection is on the rise, due as a result of less police visibility due to federal, state, and city budget constraints. We maintain that the value proposition for Napco's products only increases during times like these, for property managers and homeowners alike. Terrorism and violence issues, both in the homeland and abroad, continue to remain at the forefront, enabling further interest in our technologies to protect people and property. That concludes our formal remarks. Kevin and I would like to open the call for any questions. Operator, please proceed.

Thank you.

(Operator Instructions).

Our first question is coming from the line of Del Warmington with Delwar Capital. Please state your question.

Yes. My question relates to your cost of goods sold. It is right around the [8%] range and so forth. Is it in plan, to more start bring down your cost of goods sold? And could you more to break out the various elements of your cost of goods sold?

We plan on reducing costs of goods sold. One of the things that Dick mentioned, is that we are going to further reduce our costs. We have done a whole bunch of reductions already, which is why we were able to at least generate positive adjusted EBITDA. Now we are going to go further, and further reduce our cost. Most of our cost of goods sold is made up of materials. That's the majority. And we work hard to keep our material costs down. The smallest part of our, of our cost of goods sold is the labor, because we do have the facility in the Dominican Republic. And the third part of our costs, is our overhead. And that's -- we will work hard on reducing that. That's made up of a lot of different categories.

What percentage of the cost of goods sold is labor?

I would say it is probably 10%.

Okay. Thanks a million.

You're welcome.

Our next question comes from the line of Roger Graf with Alar Max.

Hi, Kevin. You had indicated that the debt net of cash was a reduction of $11 million, how much of that was a reduction of the bank debt?

That's all a reduction of the bank debt. The entire amount is a reduction of the bank debt. That's what it is. That reduction that we mentioned is all bank debt. So the bank debt, being made up of the term loan and the revolver.

Thank you. The next question is coming from Ashok Kumar with Rodman & Renshaw.

Thank you. Just as a follow up to the earlier question, back to the gross margins, ex-ing out inventory reserves, just wondering what were the normalized gross margins for the quarter? And on the backlog, did you see any commercial, any of your commercial products, enter your backlog? And then on a forward basis, given that September is seasonally weak in North America and Europe, what is the revenue level that you are comfortable with? And the last question will be on the credit in the facilities, do you feel that you will be able to conclude the discussions in the current quarter?

With -- let's start with the last part, the credit facility. We're, as the release mentioned, we believe we're in the final stages of resolving it. We have worked very hard the last few months, towards getting that done. We are hopeful that in the next week or so we could announce that it's done. There is no guarantees until it's done, it is not done. But we are optimistic, that's where we are heading. Both sides would like to get it done. It is good for both sides, and then we could go on running our business. Regarding sales in this quarter, we don't make predictions about what the sales level is going to be. Our first quarter is our lowest quarter, our weakest quarter. And so it won't hit the level, that we just hit in the fourth. But we are in that last stage now. We do a lot of shipping in the last few days, so this week that we are in right now will determine how well we do. We are very busy right now.

Regarding the commercial aspect of our business, commercial is 80% of our business, and residential is 20%. We saw some very nice increases in our locking, and our intrusion business, and we expect this will continue. We can't really tell what's going to happen with housing recovery on the 20%. But people are needing more security systems, residentially also to protect their property. So we see a little bit of vibrancy in that area also.

Does your backlog reflect the 80/20 split, or is it different?

It reflects it. We introduced the brand-new combination control panel, which is a first for us, and a first for the industry. It is the most comprehensive control panel for the commercial fire, and it has a burglary component to it in the industry. It is a multi-billion dollar sector. And we have never been in this sector. And a lot of dealers, we have thousands and thousands of dealers. that want to do fire business. And we have this product for them. It's just coming off the assembly line right now. It has got great margins to it.

There is a backlog of this product. And we expect it to be very, very successful to the Company, because the fire component of the business is all commercial. And it is mandated by all states that you have to have fire in -- to get a Certificate of Occupancy, and also where people congregate. So this is an area for us which is new. In the past, we've done residential fire systems. But this is commercial fire, and it's done with the newest technology. It actually took more than a year to get it through UL, and it was in development for three years. And it's going to have tremendous legs for us, going forward. So we are very excited about that. And that's in the backlog somewhat. But it does take time for these products to infiltrate the industry. People have to use it. We have to seed it through, but we know it is in the sweet spot of the commercial fire business, and that's a very lucrative area for us, for the industry.

And Kevin on your -- P&L model, looking out on a normalized basis, what should we be looking at, in terms of gross margin and EBITDA margin?

Well, the -- the gross margin for us is dictated by our top line. And the better our top line, the better that gross margin is going to be. We've had a lot of -- changes going on with the marks, merging them into our Dominican facility, merging them into this facility here. With a lot of that settled, and with a lot of cuts that we've done, with a lot more cuts that we are going to do, we want to start approaching the 30% level. That's -- if you go back to our history, we were used to being in the 30s.

We do need the strong sales volume to get there, and we ended the year in the 20s. But I think we could work our way up towards that level. And when we start hitting the 30% level, then the money starts to drop to the bottom line faster, because we are basically amortizing our overhead more rapidly. So that's what we are pushing towards. On an EBITDA basis -- we do --- it will -- one will trail the other one. When we do well on the gross margin level, it will all drop. We will control ur SG&A, and we will be very successful in doing that. That part is the easy part. You got to get the top line. We need the economy to cooperate a little bit, and the Company will do well.

Thank you.

(Operator Instructions).

Our next question is coming from the line of Harvey Stober with Axiom Capital Group. Please state your question.

Good morning. A question, if I am looking at the numbers, I guess the -- the biggest concern I have is gross margins. And there was a previous caller who made some comments related to that. Can you give us a little bit more color on that, talk about potentials of pricing, what you are seeing in terms of flexibility for pricing, number one? Also, in terms of your new product, are there costs related to the launches of some of these new products that are holding back your margins? And also, are there inventory issues related to the buildup for the launch of these products, that are also somehow impacting your gross margins? So maybe you can go over some of these issues, and give us more color on the trends in gross margins, and when you expect them to reverse, and what will be the gating factors?

One thing that effects gross margins, is the costs of amortizing that overhead, if our sales level is not high enough, then the margins are going to suffer. So we had some of that, in this year, this fiscal year. Obviously the Company is built to do more than $69 million, $67 million. So we hope to be in a higher level of sales, so we could amortize faster. But we are going to cut more costs to get that margin up. But one of the other things that happened in this year is our sales and our backlog increased a lot. Our backlog level was much higher than we've ever had in our life here. In order for us to attack that backlog, we had to work very hard on procuring materials. We had to work very hard on getting those materials into our factory. That means air freight, that means overtime to meet the sales demand. Those are costs that hurt the GP. It helped generate the sales level, and now we are more normalized. But we cut back our inventory levels very much -- way down -- to meet what we saw was the new economic mode that we were in. When sales started to come back, we had to react to that. We don't want to live with a very, very high backlog. We want to plan better. So now, we believe we've cut a lot of that air fare, a lot of that overtime out. That will help margins, as we move into 2011. I don't think there are any issues really relating to costs, with the introduction of the new products, none that I am aware of.

Well, one of the issues, regarding the new fire commercial panel, is that there are a lot of components that go into that product line, strobe lights, sirens and panels, and smoke detectors, and carbon monoxide detectors, and transmitters. It's a system. And all of the components have to be in stock. So what we have done now is we have gotten indications from a number of our customers and pre-sold a lot of the production that's coming out from the factory going forward. So what we do is, we schedule on a quarterly basis, and we are pre-selling the systems, so that we don't take an inventory position, because there are so many SKUs, but we sell pre-sold components to our customers. That way we can turn the cash very quickly, and that's one of the things that we are doing to minimize our inventory expense and to do better scheduling.

We know that the -- you have been reading, everybody has been reading about the Chinese, what's going on in China. A lot of the components we have, they are designed by us in here in Amityville. And then we have the components assembled, or we buy the components from a lot of the Chinese manufacturers, capacitors, resistors, printed circuit boards, and a lot of things. So what we're trying to do is plan better, with using our MAPEX system, and we bought some additional modules from MAPEX so that we can bring things in -- more accurately. The Chinese manufacturers have cut back a lot on their production.

They can't get the labor in their factories, they have a lot of holidays. So it makes it much more strategic for us, to have better MAPEX software, and to have more people. We brought some material management people on board, so we can do a better job. As Kevin said, we spent a lot of money on air fare to satisfy our customers. Now we are going to be cutting back on air fare, with better technology, and people more vigilant watching the parts, and longer term commitments to our Chinese subcontractor suppliers. And I think this is going to help a lot. We should see some big improvements in this fiscal year with all of this. It seems to be falling into place very nicely.

Okay. So are you suggesting that -- that -- when does that begin? Is that this quarter or next quarter, or is it the beginning of 2011, when do you expect that to start showing up in the bottom line results?

It's in process right now. It seems to be working out well for us. I think it will probably become, in the next couple of quarters, more apparent.

Okay. Thank you.

Our next question is coming from the line of David Ratliff with Doucet Capital. Please state your question.

Hi. Good morning, gentlemen. Most of my questions have been answered, but have you guys broken out what percentage of revenue is currently made up of recurring revenues? Or is that a material number yet?

Well, as we have said, in the past that when it becomes more than 10% of our business, we'll break it out. The recurring revenue from a few different products, not only the wireless video product that I was referring to in my previous comments, but also from our radio -- back up radios is becoming a bigger and bigger factor. So when it gets to be the 10% level, we will report it. We have additional reoccurring revenue products which are going to add to this stream of cash, which are coming on board this year, additional radios which we believe are going to be very, very exciting to the industry, and kind of change the communications in the business a lot.

So, as I said, our strategic plan is to have reoccurring revenue products, as a bigger part of our business. It is hard to figure out how to do that, because traditionally reoccurring revenue belongs in the area of the dealers, and the monitoring companies. But because the technology today is so much more advanced, and is so much more software, both in the cloud computing aspect of things and service storage, it is beyond the scope of a lot of our customers, to spend the amount of money required to do recurring revenue products with this new technology. So we are doing it for them, and making it easy for them. But then there's a fee to utilize our servers and our other technology that we have. So, it seems to be the new trend for us, and we look more and more at doing this. So we would expect that we will get to this 10% level in the future. I can't give you exactly how it is going to be. But every customer that adds radios and video is adding to our reoccurring revenue.

Right. Okay. Kind of on the same line of questioning, the -- so the iSee video product isn't obviously a big part of your revenues at the moment. But are you seeing like a growth rate starts out as a small number, so that maybe the growth rate is an impressive number off that small number? I mean is -- can you give any color as to what you are seeing from that product line?

It is a steadily growing product line, that we sell directly to the dealers, and we sell it also to some of the large installation companies under other brand names. It seems like we have created a new market, where it is very, very easy for the dealers to install it, and the consumers like to use it. I use it myself all the time when I am traveling. I am able to see everything that's going on with real time video. It's a whole new category in the business, and we are the leader in it. And I believe that it is going to be a very large percentage of the actual commercial and residential accounts that are going to be put on by the dealers. In the future, we will have this as a component. It will be burglar protection, fire protection, and video protection. And as far as this type of video, where you use remote servers, we are the leader in this. And it is going to be tremendous going forward. That's my belief. And we see a steady stream of people, everyday coming on to our servers. So it is growing.

Okay. And last question, you gave the SG&A number in the press release, but do you have handy, what selling was versus what G&A was in the quarter?

Yes. I don't have that at my fingertips here, but we talk later. I--.

It will be probably be in the Q.

Yes.

That's all my questions. Thanks, and good luck next quarter.

Thanks very much.

(Operator Instructions).

Gentlemen, it appears we have no further questions. I will turn the floor back over to management for any closing comments.

Okay. This is Dick Soloway. I want to thank everyone for participating in today's conference call. As always, should you have any additional questions, please feel free to call Don, Kevin, or myself. We thank you all for your interest and support, and look forward to speaking with all of you again in several weeks to discuss Napco's first quarter of fiscal 2011. Take care. Bye-bye.

This does conclude today's teleconference. You may disconnect your lines at this time, and we thank you for your participation.