NAPCO Security Technologies Inc (NSSC) 2014 Q4 法說會逐字稿

Greetings, and welcome to the NAPCO Security Technologies fiscal year and fourth-quarter 2014 financial results conference call.

(Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brett Maas, of Hayden IR. Thank you sir, you may begin.

Good morning, and thank you all for joining us on today's conference call to discuss NAPCO's financial results for the 3 and 12 months ended June 30, 2014. By now, all of you should have the opportunity to have reviewed the press release discussing the results. If you have not, please call our office, Hayden IR, at 646-419-4300, and we'll immediately send it to you either by fax or e-mail.

On the call today is Richard Soloway, President and Chairman of NAPCO Securities Technologies, and Kevin Buchel, Senior VP of Operations and Finance.

Before we begin, let me take a moment to read the forward-looking statement. This conference call may contain forward-looking statements that involve numerous risks and uncertainties. Actual results, performance or achievements may differ materially from those anticipated in such forward-looking statements as the result of certain factors. Including those set forth in the Company's filings with the SEC.

With that out of the way, let me turn call over to Richard Soloway, Chairman and President of NAPCO Security Technologies. Dick, please go ahead.

Thank you, Brett. Good morning everyone. Thank you for joining NAPCO's quarterly conference call to discuss the financial results for the 3 months and 12 months ending June 30, 2014.

This was a year of progress for NAPCO. Our focus this year was expanding our addressable market by entering new segments, specifically emerging segments that were ancillary to our historical areas of focus.

We also wanted to expand our base of recurring revenue, providing us greater visibility into our revenue stream, and more effectively leveraging our business model. We were successful in both of these key strategic goals, and I am confident that as we enter FY15 with the Company solidly positioned to move forward. While we are encouraged by our progress and increasingly confident in our long term opportunities, this progress is not fully reflected in our short-term financial results.

We did generate record revenue for the full year, a positive sign, considering how strong 2013 was for NAPCO. Our recurring revenue essentially doubled over the last year.

Our growth was broad based, with almost all of our divisions showing growth. We expect this growth to accelerate in FY15 and beyond.

We adjusted the beginning of the adoption curve for many of our solutions. Most notably, our connected home offerings and our solutions for school security.

Response from our dealers has been strong. We are changing the market, bringing high technology to a traditional lower tech industry, and it takes time to train our dealers. I'm encouraged by our progress here.

We have invested heavily to make our solutions easy to install, and this is helping us gain market share. We expected the growth to come more quickly than it has, but I share this color with you to demonstrate the progress we have made and continue to make.

We are in this for the long term. Every day, I am more confident that we will see accelerated growth, and we have developed a powerful business model to leverage this growth. With high gross margins and a scalable manufacturing infrastructure.

We also continued to invest in our sales and marketing efforts to position us for long-term growth across each of our divisions. Despite the impact to our net income from these investments, we still delivered 15% growth in net income over last fiscal year, and bolstered our competitive position. We believe these investments will help us drive incremental growth over the long term.

Our growth and future earnings potential are influenced by two main drivers. An increasing portion of recurring revenue, and further increasing orders, volumes of orders, to more effectively utilize existing manufacturing capacity and exploit our operating leverage. We expect both of these influences to drive increased margins, and higher operating cash flows as we move into FY15.

In FY14, with the increasing contribution from recurring revenues, we were able to drive expanded margins and income in the quarter by exploiting the operating leverage inherent in our existing infrastructure and business model. First, through careful cost controls and greater recurring revenues, we delivered the highest gross margins in eight years in the fourth-quarter of FY14. Second, the high proportion of fixed costs in our domestic and offshore manufacturing facilities helped to minimize the incremental costs associated with adding incremental sales.

The very nature of recurring revenue is that they typically lead to overall higher margins. We remain focused on building our recurring revenue streams, particularly from our iBridge connected home and StarLink wireless radio products to drive further margin expansion going forward.

I will now turn the call over to Kevin to discuss our financial details. Kevin?

Thank you, Dick and good morning, everybody.

Revenues for the three months ended June 30, 2014 were $21.5 million, compared to $21.8 million in the same period a year ago. For the 12 months, sales increased 4% to a record $74.4 million, from $71.4 million in the same period a year ago.

The small decrease in sales for the three months was due to a challenging comparison, which was the result of a large contract award from Pepperdine University during the fourth-quarter of FY13. The increase in revenue for the 12 months was due primarily to increased sales of access control and door locking products. As well as an increase in intrusion recurring revenue, which was partially offset by a decrease in sales to one of our intrusion customers.

Gross profit for the three months ended June 30, 2014 was $8.3 million or 38.5% of sales, compared to $8.3 million or 38.1% of sales for the same period a year ago. As Dick mentioned, this was our highest gross margin in eight years, demonstrating the strength of our business model and the increased contribution of recurring revenue.

Gross profit for the 12 months increased approximately 9% to $23.7 million or 31.9% of sales, compared to $21.7 million or 30.4% of sales for the same period a year ago. The increase in gross profit and gross profit as a percentage of sales for the 12 months was primarily due to the increased sales, and a favorable shift in product mix, and the impact of increased recurring revenue.

As Dick mentioned, we've been investing in our sales and marketing functions, and this is reflected in our SG&A expenses. Selling, general and administrative expenses for the quarter were $5.5 million or 25.3% of sales, compared to $4.7 million or 21.7% of sales for the same period last year.

SG&A expenses for the 12 months increased by $1.4 million or approximately 8% to $19.4 million or 26.1% of sales, compared to $18 million or 25.2% of sales a year ago. Specifically, the increase in selling, general and administrative expenses for the 3 and 12 months was due primarily to increased sales, salaries and commissions. As well as increased advertising and trade show expenditures, as we invest for future long term growth.

Operating income for the quarter decreased by $734,000 or 21% to $2.8 million, as compared to $3.6 million for the same period a year ago. Operating income for the 12 months was up approximately 16% to $4.3 million from $3.7 million in the same period a year ago.

Interest expense for the quarter decreased by $52,000 or 48% to $56,000, as compared to $108,000 for the same period a year ago. Interest expense for the 12 months decreased by $200,000 or 40.4% to $295,000, as compared to $495,000 for the same period a year ago. The decrease in interest expense for the 3 and 12 months of FY14 resulted from lower borrowings on our revolving line of credit and our term loan.

Inclusive of the increased investments in sales and marketing, our net income for the quarter decreased by $874,000 or 27.2% to $2.3 million or $0.12 per diluted share, as compared to $3.2 million or $0.17 per diluted share for the same period last year. Net income for the 12 months increased by $455,000 or 15.1% to $3.5 million or $0.18 per diluted share, compared to net income of $3 million or $0.16 per diluted share for the same period last year.

Adjusted EBITDA for the quarter, as per the schedule included in today's press release, decreased $719,000 or 17.7% to approximately $3.3 million or $0.17 per diluted share. As compared to $4.1 million or $0.21 per diluted share last year. Adjusted EBITDA for the 12 months increased $441,000 or 7.7% to $6.1 million or $0.32 per diluted share, as compared to $5.7 million or $0.29 per diluted share for the same period a year ago.

At June 30, 2014, the Company had $2.5 million in cash and cash equivalents compared to $3.2 million at June 30, 2013. NAPCO had working capital of $33.4 million, as compared with working capital of $33.2 million at June 30, 2013. The current ratio was 4.6 to 1, as compared to 4.9 to 1 at June 30, 2013.

Cash generated by operating activities for the 12 months decreased slightly by 3.2% to $4.7 million, compared to $4.9 million for the year-ago period. Paying down our debt remains a top priority for NAPCO.

Continuing to reduce our financial leverage strengthens our position for long term growth, either through increased investment in innovative technology or bolt-on acquisitions to expand our capabilities and/or geographic reach. Debt, net of cash, has now been reduced by $26.6 million from $35.9 million to $9.3 million since we acquired Marks in August of 2008, with $3.9 million of this reduction occurring in FY14.

That concludes my formal remarks, and I will now turn the call back over to Dick.

Thanks, Kevin. Let me speak for a few minutes about the industry, and our increasing strong position within this industry.

The security systems market continues to be a dynamic one. Driven by strong end-user demand for high-tech solutions to protect against intrusion and fire, as well as capabilities for protecting and managing access to homes and businesses remotely. And this is where we are uniquely positioned to deliver.

NAPCO is the only security and locking systems Company with end-to-end solutions for commercial and residential security systems, with a broadened expansive dealer network for distribution. Our portfolio of products is the only complete one stop shop for security dealers and their customers. Our dealers more and more are seeking an integrated approach, with both security systems and locking solutions for protection of businesses and homes.

NAPCO can provide both aspects, seamlessly, all-in one place. Our products stand up to market and customer demands, because we are intimately involved in not only the manufacturing and distribution of the products. But the initial design and development is all done in-house by our in house team of industry experts, who have first hand field experience.

I have no doubt each of these strengths will serve us well, and differentiate us from our competition in the future.

There are several facets to the security systems market, and we are in all the hot areas that consumers are interested in now. Primarily school security, with our LocDown products, and the connected home segment with our iBridge solution. Both of these areas are in the infancy stages of development, making for a fragmented market with ample opportunities for long term growth and expansion.

Let me speak in more detail about each of these high profile opportunities. First, is the concept of the connected home. This concept truly is the wave of the future for residential home management.

You can see strong evidence of this at all of the large home box improvement stores as they attempt to address the market for the do-it-yourselfer. And at the other end of the spectrum, several of the large companies, such as Apple and Google, are acquiring capabilities to capture this growing segment of the security market.

But what differentiates NAPCO are two things. First, our 8,000 dealer strong network of security professionals. Our dealers are already positioned in the communities to provide professional installation and support.

This, coupled with our internally developed and manufactured iBridge product puts NAPCO at the ready to meet customer and market demands. Unlike our competitors, it is extremely flexible and feature-rich home automation and security system built on our proprietary patented technologies. It is changing the way homeowners manage, control and secure their homes.

And for our shareholders, it generates a stream of recurring revenue with low incremental costs to drive higher gross margins. Higher than the average of all of our portfolio.

A key component to our iBridge offering is the ability to see live video, and control a variety of home elements. Such as the thermostat, garage door, lights, small appliances, and locks all through your smartphone.

Applications for this are the ability to watch school aged children who may be home alone after school for a period of time. Keep an eye on nannies and babysitters, or keeping contractors who have access to your home honest while you are away.

Other applications include using your smartphone to turn on lights as you come home, adjust the temperature from your couch, or as you leave the office so your house is the optimal temperature when you arrive home. You can lock and unlock your doors with your smartphone. You don't have to carry keys with you if you go out for a run, or if you need to allow access to a guest or delivery remotely when you're not home.

This is what homeowners are seeking, and the applications are numerous, providing homeowners with security and reassurance while they are home or away. Again, important for our shareholders and investors is the revenue and profits that is generated from our Connected Home Solutions. Because we manufacture our products, the revenue generation begins with the sale of the equipment, but continues with the recurring monthly revenue for monitoring and the potential for upgrades and add-ons.

This is great potential for increased volumes in this segment of the market. Today, there are approximately 25 million homes in the US currently monitored by alarm companies for burglary and fire that do not have connected home capabilities. As we continue to train and educate our network of dealers, we expect to continue our penetration in this area.

To tie our products together and maximize the capabilities of our offerings, we have constructed our secure all-in one network called Fusion, to serve as a backbone or electronic bus for all of our products. With Fusion, all of our synergistic technologies combined in one sophisticated simplified totally integrated security solution to provide seamless near inoperability of intrusion, fire, protection, and video access control and locking. This one security platform makes for a unique dealer installation, while operations and deployment are much easier and more cost effective than ever before.

As I've mentioned in the past, these products are relatively new and are still in the very early stages of deployment. We have introduced these products to our dealer network, and are continuing our efforts to train and educate them so they in turn can meet the needs of their customers. These networked fully integrated products are a step up from the technology curve, and require more advanced training than the hardwire solutions of the past, and will take some time to educate and train all of our 8,000 dealers across our network.

We remain committed to staying on the cutting edge of security technology, pioneering the way for innovation and creative applications for our products. Just last week, in conjunction with Control4 Corporation a recognized leader in home automation, we announced that NAPCO Security Systems software was recently Control4 certified. This new integration with Control4's platform enables Control4 dealers to quickly and easily integrate security within their projects, and offer state of the art protection for homes and businesses.

This partnership demonstrates yet another channel by which we have expanded the availability of our products, specifically within the custom integration market. Our software would allow Control4 supported devices to be managed based on the activities detected by any NAPCO Gemini Security System alarm panel. Control4users can monitor, manage and control alarm panel activities such as arming while away or home, disarm a burglar alarm or fire alarm, or create other alerts such as specific zone openings and/or closing, and execute actions such as lighting scenes.

The second catalyst I have been talking about is school security. We have made significant investments in our LocDown products in order to provide fully integrated solutions with schools and campuses, regardless of the price point, the simple migration pass as customers look to upgrade and invest further in their security systems.

At the lower end, our basic mechanical products are a great entry point when a customer is just getting started or there are budgetary constraints. From there, our customers can move up the chain to our electronic products, and further up the line to wireless and fully integrated enterprise solutions.

Our internally developed and manufactured LocDown solutions are cutting edge in today's market. No other competitor comes close to offering such a complete and comprehensive solution.

It is technologies such as these that have established our Company as a product innovator and leader in the security system market. Through our ongoing investments in R&D, we're able to stay on the cutting edge of our industry and step ahead of where user demand will take us. Traditionally, we have managed R&D investment to approximately 7% of revenue, and expect this to continue going forward.

We continue to believe that highly integrated end-to-end soup-to-nuts solutions are the key to long-term success in this business. Our deep industry knowledge, along with our complete understanding of the consumer demands are the differentiator for us, as we work from stem-to-stern to design, develop, test, manufacture, sell and support our suite of security offerings.

Our portfolio of high-tech diversified products across each of our divisions has NAPCO optimally positioned to meet the increasing and evolving demand for security products, both in the commercial and residential spaces. The investments we are making in our sales and marketing organizations are essential for the long-term growth of the Company. And as we look to FY15 and beyond, and strive to improve on year-over-year growth we delivered in FY14.

As we look at our sources of our revenue, we continue to expect the recurring revenue sources to expand and become an even larger portion of our total sales to generate not only top line growth, but even faster growth on the bottom line.

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

Thank you.

(Operator Instructions)

You're first question comes from the line of Kurt Caramanidis with Carl M Henning.

Hello, guys, good quarter. Question for you, do you think this upcoming fiscal year is a year where you could maybe do a $20 million quarter other than the fourth-quarter?

We're in the early stages of our business, and we have a solid business where we have a whole catalog of products which give us a nice baseline of products. And we believe that with our Connected Home and our school security products, and our fire products, and additional other products, we can grow our business nicely.

I can't really predict exactly how quickly the products are going to be accepted and how fast. But I know we're on the right track with these products. And I also know that every day, we're adding more and more recurring revenue products to our pile of business, so that's going to help generate a lot of top line also.

Our goal is to have four fourth-quarters, which is our strongest quarter, all year round. And our goal, also, is to get rid of some of the lumpiness which we typically see in the first-quarter by having recurring revenue being a strong base.

And some day in the future, we may even be able to predict exactly how things are going and where our numbers are going to be. But right now, it's a little early to say. The only thing I can say is, we have a great business and there's more demand for security systems than ever before.

So generally, though, would you be looking for top line growth in this fiscal year?

Of course. We want to see top line growth, and we're pushing very hard to get it. That's why we did the additional sales and spent more money for sales personnel, because our time is now. And as we know, the Connected Home and school security is a very important aspect of the way people are thinking, and we want make sure that we present it and have it out there so the adoption rate is as quick as possible.

Certainly, it seems like with all the crazy stuff going on out there this is a great time to be in the security business.

Any other questions?

(Operator Instructions)

Our next question comes from the line of Pete Enderlin with MAZ Partners.

Thank you, good morning. Can you give us some sense of how big that contribution from the Pepperdine business was in the fourth-quarter of last year?

Pete, last year in the fourth quarter, the Pepperdine order was, in total, was $1.5 million. In the fourth-quarter it was a good portion of it, let's say three-quarters of it at least.

And most of the rest fell in the first-quarter of this fiscal year?

In Q1 of FY14.

Right, okay. You've mentioned 8,000 dealers. Could you give us an idea of the geographical spread of those dealers?

Obviously, not in great detail, but are they mostly concentrated on the East Coast? Are there pockets on the West Coast?

It looks like there are, but how is that spread across the country? And are there areas where you could add more dealers that you don't have the penetration right now to get?

We're talking about dealers in the intrusion space.

Right.

Intrusion and fire space. And we have dealers spread out in most of the major cities and towns throughout the country. There is a large portion of our dealers in the East Coast, but we are spread out all over the country.

The dealer base of 8,000 is a rough approximation. There are thousands of dealers that are out there that may not be using NAPCO products right now. They may be using another brand, and we believe that with our technology solutions and our end-to-end components that we're going to win more and more dealers over to our side as the industry continues to evolve.

Especially, in the Connected Home, because we have a great solution that can upgrade our panels and can be used for new jobs. And also our radio communicator, which has become a universally used product. So that it can send alarm signals from any type of premise to a dealer's central station without having the dealer add any additional expensive fancy equipment, or having to recertify, so it's become very, very popular.

In fact, we're now packaging them in mass quantities so dealers can carry them and use them on jobs for intrusion and fire. So there's a lot of good things here, and we try to develop as many products as we can with recurring revenue. So we're not just selling the product once, which was historically the way the Company operated up until a couple years ago and now we're building the recurring revenue base with our StarLink radios, our iBridge and our video systems.

Okay, thanks. And with regard to that, when might we see the recurring revenue stream grow to the point where you need to break it out from a financial reporting standpoint?

Well, Pete, we said at 10%. So right now, the recurring revenue is several million for us. So my hope is within the next few years.

I don't believe it's going to happen this year. I wish it would, it would be great. I don't think it's a FY15 story yet, but maybe by 2016 or certainly 2017.

Okay, thanks a lot.

You're welcome.

(Operator Instructions)

Our next question comes from the line of John Kurdy with Singular Research.

Good morning. A question regarding further increases in the SG&A line. You had a big increase in the fourth-quarter as you put a lot of money into hiring people and training, et cetera. Do you anticipate those kinds of increases, at least maybe in the first couple of quarters of the upcoming fiscal year relative to last year?

I do. I do anticipate that for the next couple of quarters. Q4 was particularly heavy also, because we had a couple of big trade shows that fell into that period, and spent more on the marketing and the advertising within that show. But I'd say from a spending point of view, the next couple of quarters I would expect it to continue.

Are the trade shows annual trade shows or do they come every couple of three years?

No, these are annual shows. For example, we had the ISC West Show that occurred in the fourth-quarter. That's the biggest show of the year for our industry.

So when you get an opportunity to showcase your products, you get one shot at a big show like that, you want to do it right. And as Dick mentioned earlier, we have a lot of products that the time is now. So we felt it was smart to spend the money, and that was just one avenue of how we spent the money.

And your gross margins were up a little bit in the fourth-quarter. And obviously, the Pepperdine contract probably skewed things in the fourth-quarter of the prior year. I'm trying to get a little better sense.

I know you're not breaking out the numbers in recurring revenue. But you did mention the improvement in margin was due to product mix and recurring revenue. And I'm wondering if you could maybe at least talk a little bit more about that, and maybe give us maybe some clue as to how much of the margin improvement is being driven by the recurring revenues which you had indicated are now several million dollars.

So recurring revenues gross margin is very high. It's 80%, 90% let's say. It's a very high percentage. So as that grows, that's going to have a big effect on gross margin as a whole.

Last year, in Q4, the Pepperdine order, that was a very high gross margin order as well. This year we didn't have it. We had smaller ones.

The school security gross margins are very good. When you sell these sophisticated LocDown systems, they have great margin. And instead of having one large one, we had smaller ones in the Fourth-quarter. But each one of them has great margin.

So as locking product grows, or the recurring revenue grows, or access control grows, those are the margin products. Those are the gross margin areas, and they all did well in this fiscal year, particularly Q4. 38.5%, it's the highest we've had since a quarter since 2006.

And I knew that was going to be a tough comp, because last year it was 38.1%. So I was pleasantly surprised, and happy to see that we could continue that. And that just proves our model, that when we get to $20 million plus quarters or $80 million, $90 million levels, that's going to be what the margin is.

We've been saying that. We say at $80 million, gross margin is 35%. $90 million, gross margin is between 37%, 38%, and now maybe even 39%. And over $100 million of gross margin to go over 40%.

We get big bottom line numbers for that. So the challenge for us, we got to have as the general minority has said, $20 million quarters every quarter, and then the moneys going to drop to the bottom line. We're investing in the SG&A to get to that point, as well as the R&D to develop those products.

In terms of getting to $100 million in revenue and getting a 40% margin, I'm assuming that $100 million includes a sizeable amount of recurring revenue in that number to get to a 40% overall margin for the year?

When we did our modeling at $100 million, 40% GP, we weren't really assuming huge growth in the recurring revenue to get to that gross margin. You get to that gross margin because of overhead absorption. That's the part that really makes that GP grow, and the recurring revenue is the icing on the cake. Believe me, it helps a lot.

But just expansion of GP through our offshore facility, it happens very naturally when you get the volume. Overhead gets absorbed rapidly when you kind of get to $20 million or better, that's when you see that margin expansion.

We saw it again this quarter, that helped. School security orders helped, and of course the recurring. It is all part of this.

One last question. The Pepperdine order was a big order, and you've had some big orders in the past. This quarter, you've mentioned that you had a lot of smaller orders.

Are you changing your marketing approach at all, or changing your target market to go after more smaller orders that are maybe easier to and quicker to complete?

What we're doing is we have our sales organizations. We have three that are specifically in this. The access control sales organization, the two locking companies, and even our intrusion people, as they see opportunities, they cross-selling and getting other of our groups involved, we try to go after as many projects as we can.

A lot of the school projects, and that includes large universities and colleges as well as K-12s, which are a little bit shorter cycle on acceptance and delivery. But what happens is, we have many, many bids out there working with our integrators that are doing the installation. And we would expect that as the schools get more into protecting their campuses, they're going to want more and more of the product and the bids will be moved up and awarded.

So we always have a lot of bids out there, and we try to do it with every sales person we have. And but there's no specific time that we can guarantee when a bid is going to be approved, except that we have great solutions. And as Pepperdine said, we have glowing reports on our system.

It takes a little bit of time, but it works through the school administrations. When the schools meet with each other and they have their conferences, there's a lot of discussion about security and what we're going to do is we're going to improve security. And our savvy report is becoming very, very well known that we're kind of a leader in the industry of talking about all aspects of school security.

Even things we don't manufacture, like unbreakable glass and certain types of door closures and things like that. But we have the technology, solutions and we're getting more well known.

So I would expect to get traction. I just can't tell you exactly when it is that these bids are going to be awarded. But we're always piling more and more into the hopper as far as bids, and showing the advances, and the progress, and the safety that a NAPCO system can give a school, either K through 12 or college and university.

And the very last question. Regarding your tax rate, it continues to remain very low. Do you expect that to continue for the foreseeable future?

I do. It jumps around a little, but it's still an advantageous rate. It will go anywhere between 5% and 15% depending upon the specific conditions that exist in that period we're reporting. But it's an advantageous rate, and we expect it to continue.

Thank you very much for your time today.

Thank you.

It appears we have no further questions at this time. I would now like to turn the floor back over to management for closing comments.

Okay. Thank you, everyone, for participating in today's conference call. If you have any further questions, please feel free to call Hayden IR, Brett, Kevin, or myself. We thank you for your interest and support, and look forward to speaking to you in the coming months as we head into our FY15 year.

Thank you very much. Have a great day, everybody.

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