NAPCO Security Technologies Inc (NSSC) 2015 Q3 法說會逐字稿

Greetings, and welcome to the NAPCO Securities Technology third-quarter fiscal 2015 financial results conference call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Todd Fromer, managing partner of KCSA Strategic Communications. Thank you, sir. You may begin.

Thank you. Good morning, and thank you all for joining us for today's conference call to discuss NAPCO's financial results for the third quarter ended March 31, 2015. By now all of you should have had the opportunity to review the press release discussed in the results. If you have not, please call our office, KCSA, at 212-682-6300. We will immediately send it to you by either fax or email.

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

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

With that out of the way, let me turn the call over to Richard Soloway, President and Chairman of NAPCO Security Technologies. Dick, the floor is yours.

Thanks, Todd. Good morning, everyone, and thank you for joining us. This morning, NAPCO reported results for the third fiscal quarter of 2015. We are pleased with our performance in what was a challenging environment for the Company. As many of you experienced firsthand, the months of January, February, and March brought record cold temperatures, ferocious winds, and plenty of snow. This is especially true in the Northeast, where a large number of NAPCO's 10,000-plus dealers are located.

The unreasonably brutal winter made it difficult for our dealers to conduct sales calls, which are critical in an industry where business is done face to face. It also made it difficult for them to install the NAPCO products that provided recurring revenue stream. Despite the challenges, our financial results are solid, and we continue to grow our top line and sales of recurring revenue product.

More importantly, we emerged from the winter with continued excitement about the Company's trajectory. In April, NAPCO was a featured exhibitor at ISC West, the security industry's largest US trade show. Of course, all of our divisions or products were met with a warm reception, including our StarLink Fire communicators, architect network designer wireless access control locks, and Lifesaver healthcare locking solutions. Our strong showing at ISC West underscored NAPCO's position as one of the most dynamic companies in the security industry.

The positive reaction also demonstrated that the investments we have made in our business to develop our product lines are paying off. One of the things we focused on is keeping our capital expenditures and R&D spend constant on a quarterly basis. Since our business is seasonal, that, along with our fixed-cost structure, results in margins being lower in the beginning of the year. When you take into consideration that we are entering the fourth quarter, which is historically our strongest, coupled with the additions we have made to our product line, we expect to see a ramp-up in both revenues and profitability. One of NAPCO's major initiatives has been our focus on introducing and growing recurring revenue services. During the quarter, recurring revenue from our alarm division increased 46% year over year and 6% sequentially. Equally impressive, recurring revenue for the first nine months of the year was 58% versus the same period last year.

Looking closer at our recurring revenue products, during the third quarter, we successfully launched our CDMA version of the StarLink alarm communicator, which features Verizon wireless service. We expect this product to considerably expand our footprint in the alarm communication category and fuel substantial growth. Much of that growth is being driven by the sense of urgency alarm dealers and their customers feel to replace the 2G GSM radios that communicate alarm signals to central stations by the time that network sunsets into the year 2017.

In late June, towards the end of our fiscal year, we expect to take another large step in growing our service-based revenues with the launch of a full line of commercial fire alarm communicators also under the StarLink brand name. This edition will help us mark our -- price of our -- the burgeoning fire alarm communicator category. This category is undergoing tremendous growth as alarms that use traditional phone lines are being replaced with fire alarms that make use of more advanced and reliable CDMA signaling.

We also saw continued success with our entry into the connected home category. The number of dealers participating in our iBridge connected home dealer program rose 27% during the quarter. This increase demonstrates that NAPCO is meeting the needs of traditional residential alarm dealers looking to expand their offerings beyond installing security alarms by taking advantage of the connected home revolution. The program targets those dealers by providing technical and sales training, customized sales materials, broad-based content into that advertising, and consumer leads.

Outside of our recurring revenue products, we continue to see growth in our education vertical, which is being driven by our innovative suite of LocDown access control locking solution. From the cost-effective LocDown intruder lock by Marks, which enables a teacher to lock his or her classroom door safely from inside the classroom and out of harm's way, to Alarm Lock's network wireless locking system, which can lock down an entire school campus in seconds, we are playing a significant role in protecting our schools from potential predators, particularly shooters.

As part of our commitment to make schools safer, NAPCO has created a measurable index known as the School Access-Control Vulnerability Index, or SAVI. NAPCO's training security dealers on how to conduct a SAVI audit, which quantitatively measures a school's security capabilities in withstanding an attack by an intruder. Once the order is conducted, our dealers can correct any vulnerability at a given institution by installing the proper security measures.

Another rapidly growing vertical that is generating considerable increase in door locking volumes is the healthcare market. Our Marks LifeSaver locking line provides unique, effective, anti-ligature protection for behavioral institutions, veterans' hospitals, interrogation rooms, and holding cells. This innovative design of products helps the institutions to prevent people from harming themselves.

With all the positive momentum in our business, we believe our stock is undervalued. We continue to buy back our shares at what we believe is a very good price compared to the intrinsic value we have been creating. To this end, we have bought back 398,717 shares of our outstanding common stock since the buyback was announced in September at a weighted average of $4.74 per share. We continue to believe the best use of our excess cash is to buy back our stock. At this point, buying back our stock at these levels is more attractive than any of the strategies we could potentially employ with our excess cash, and we will continue to make opportunistic purchases in the market where we see fit. When you consider that we continue to pay down our debt, we believe that we have created a compelling value proposition for our shareholders.

Overall, all the pieces are in place for NAPCO to finish what has already been a strong year on a high note. As we progress through the fiscal fourth quarter, which is prime selling season in many of our end markets, our dealer network is excited about our suite of innovative products as well as the programs we offer like SAVI and iBridge connected home to help them close more sales.

Simultaneously, we are executing on growing our recurring revenue stream. We will enable -- this will enable us to see significant gross margin expansion as our revenue mix shifts to higher-margin products, and we see the benefit from owning and managing our manufacturing facility in the Dominican Republic.

I would like to turn the call over to Kevin to review the quarterly results. Kevin?

Thank you, Dick, and good morning, everybody. Revenues for the three months ended March 31, 2015 increased 4% to $17.9 million, compared to $17.3 million in the same period a year ago. The increase in sales for the three months was due primarily to increased sales of the Company's door-locking products, increased recurring revenue as partially offset by decreased sales of intrusion and access-control products.

For the nine months, revenues increased 4% to $54.8 million from $52.9 million for the same period one year ago. The increase in sales for the nine months was due primarily to an increase in door-locking, intrusion, add access-control products, as well as increased recurring revenue. Gross profit for the three months ended March 31, 2015 is roughly flat at $5.3 million, or 29.9% of sales, compared to $5.3 million, or 30.8% of sales, for the same period a year ago. Gross profit for the nine months increased approximately 8% to $16.7 million, or 30.5% of sales, compared to $15.4 million, or 29.2% of sales, in the same period a year ago. The increase in gross profit for the nine months was primarily due to increased sales and a positive shift in product mix to higher-margin products. This also demonstrates the impact of increased recurring revenue as well as our overall efficiency as our sales volume increases.

Selling, general, and administrative expenses for the quarter increased $301,000, or 7%, to $4.9 million, or 27.2% of sales, compared to $4.6 million, or 26.4% of sales, for the same period last year. Selling, general, and administrative expenses for the nine months increased by $941,000, or approximately 7%, to $14.9 million, or 27.2% of sales, compared to $13.9 million or 26.4% of sales year ago. The increase in selling, general, and administrative expenses for the three and nine months is due primarily to the addition of selling personnel and increased media advertising.

Operating income for the quarter decreased by $272,000, or 36%, to $477,000 as compared to $749,000 for the same period a year ago. Operating income for the nine months increased $326,000, or 22%, to $1.8 million from $1.5 million in the same period a year ago.

Interest expense for the quarter decreased by $7,000, or 12%, to $52,000 as compared to $59,000 for the same period a year ago. Interest expense for the nine months decreased by $78,000, or 33%, and $161,000 as compared to $239,000 for the same period a year ago. The decrease in interest expense for the three and nine months ended March 31, 2015 resulted from lower average outstanding debt and lower interest rates during the current period as compared to the same period a year ago.

Net income decreased by $255,000, or 39%, to $395,000, or $0.02 per diluted share, as compared to $650,000, or $0.03 per diluted share, for the same period last year. Net income for the nine months increased by $364,000, or 32%, to $1.5 million, or $0.08 per diluted share, compared to net income of $1.1 million, or $0.06 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 $330,000, or 28%, to $870,000, or $0.05 per diluted share, as compared to $1.2 million, or $0.06 per diluted share, last year. Adjusted EBITDA for the nine months increased $276,000, or 10%, to $3.1 million, or $0.16 per diluted share, as compared to $2.8 million, or $0.14 per diluted share, for the same period a year ago.

At March 31, 2015, the Company had $1.7 million in cash and cash equivalents compared to $2.5 million at June 30, 2014. The Company overhead working capital was $32.3 million at March 31, 2015, compared with working capital of $33.4 million at June 30, 2014. Paying down our debt and optimizing our cost of capital remains a top priority for NAPCO. Debt, net of cash, was $8.9 million at March 31, 2015. Debt net of cash has now been reduced by $27 million from $35.9 million since we acquired Marks in August 2008. That concludes my formal remarks, and I would now like to return the call back to date.

Okay. Thanks, Kevin. In conclusion, our commitment to enhancing shareholder value remains steadfast. As part of that commitment, we continue to roll out new recurring revenue products or growing revenues from existing ones as well as making the opportunistic repurchase of shares in open market. We are excited about the positive developments in our business in believe we are well positioned to deliver strong results to round out the year and demonstrate the leverage in our business model. They concludes our formal remarks. Kevin and I would like to open the call for questions. Operator, please proceed.

(Operator Instructions) Joshua Reilly, Northland Securities.

So I guess my first question is could you give us an update on the pipeline here for the spring or school lockdown product? And what are you seeing overall in the spending environment on the school side? Is there a budget out there for new products?

Hi, Josh. The school business has been picking up nicely, both K through 12 and colleges and university. We have a full line of products that do that. We have -- we are in the midst of producing some customized versions of our locking to match the architectural requirement by the schools. We are very versatile in being able to do that because Marks makes architectural hardware and Alarm Lock makes the customized electronics.

We don't really break down the amount of school business, but it is a little lumpy. It comes typically at a time when the schools are out. That's when the orders come through so that the locks can be replaced while there are no students in the schools.

But we have high hopes. Our rep organization, our sales organization, is out visiting all kinds of schools, and there's of whole list of schools that we've closed on our website. So you might want to refer to that. And we believe that the lumpiness will smooth out, as legislation tends to be being discussed around the country about having a school lockdown. And with our SAVI report and our product line, we feel very positive about it.

Okay. I think you mentioned intrusion and access control wasn't as strong as you might've hoped. Was the main driver of that weather in the quarter, would you say, or was there something else there?

I think that the weather was a dampening factor because the deal is (inaudible) that nobody was going out. They weren't making calls. People weren't really installing alarms. So it kind of put a quenching effect on things. Historically, we always had a very strong fourth, and we have -- we expect that that history will continue. We have kept our expenses level throughout the quarters, so when the volume comes in in the fourth, that should throw off a lot of revenue and profitability.

Okay. And then my last question is the gross margin was down slightly year over year, when the growing percentage of recurring revenue business should be bringing that up. My takeaway is what is driving that in the quarter. Is it that the locking business was stronger than you expected, in that has a lower than Company-average gross margin? Just wanted to confirm that.

The locking GP is very good, and that helped the GP. The thing that hurt the GP for the quarter is if you are spending more money than you were last year, and we are, the GP is going down. So we are spending more on R&D. We're not stopping the R&D just because the weather is bad. We continue to spend -- we're trying to get products to market as fast as we can. We are also spending more money on the SG&A line to get it to market as fast as we can because we want to hit our goals that we have talked about. 2017, we expect to be at a much higher level than we are now. And in order to do that, we have to spend money.

And so when you spend the money, and then you have a quarter where the sales get hurt by weather or whatever, it looks worse than it was in the prior year. But to us it is just a small measure of time; it doesn't mean much in the big picture. And in the fourth quarter, which is where we are now, it's going to come roaring back.

All right. Thanks, guys.

(Operator Instructions) Kara Anderson, B. Riley.

Just to piggyback off of Josh's comments, can you quantify the impact from weather on the quarter's revenues?

It's hard for us to do that, Kara, because remember how we sell. We are selling through distribution. But what we see and what we hear is that the distributors' inventory levels weren't so low because nobody was out selling. Dealers weren't out selling. So it's hard for us to exactly quantify. But what we felt was it was worse than even it was last year. Last year, the weather wasn't great either. This year, it was even worse. Records were being set in many cities for snowfall and such.

So it's hard for us not only to quantify it, it's also hard for us to tell you for sure it's going to come back in this quarter. We think we're going to get a bunch of it back in Q4, but that's also hard to quantify.

Okay. And then also you mentioned 2017 goals. Can you update us on your longer-term revenue and gross margin expectations and sort of the time frame for achieving those?

Well, we -- nothing has really changed as far as our expectations. For 2017, we expect the recurring revenue to be at a $10 million clip. So that -- we're doing a lot of things, a lot of promotion, spending money to get that number up as fast as we can because that's a high-GP business. Recurring revenue, as many of you know, it's 80%-plus GP. So it's important that we get that, and recurring revenue is the gift that keeps on giving.

So we're spending a lot of money and promotions to get recurring up. So that goal is still the same. And we also, with all of our products and promotions, et cetera, our goal is also to be at a much higher clip by 2017. We have sat at a $100 million run rate. Nothing has changed just because of a quarter that had some bad weather. So our goal is the same.

Great. Thank you.

(Operator Instructions) Leon Sirinian.

The fact that you are buying back, is that being retired or held by the treasury?

Held in the treasury, Leon.

Thank you. Bye.

Abba Horwitz, Old School Partners.

I was wondering if you could give me a sense -- give us a sense of how the quarter is progressing that we're in right now. You've been able to see, I guess, what, a month and a half of the quarter? Could you give us some insight?

We really can't give any predictions on how the quarter will be and how it's progressing. We can just tell you historically, for more than 10 years, the fourth is by far the strongest quarter, and we would expect the same type of thing this year. A lot of the business comes due in the very, very end of the quarter. So we expect with the expenses that we've been spending for sales, marketing, and engineering, that profitability will bounce back to higher levels once the volume is completed by the end of June.

Okay. Can you give us a sense of what kind of gross margin you are expecting for this quarter?

Well, what we can say, Abba, is is if we have the kind of quarter that we had last year and the year before, in each case it was a $21.5 million, $21.8 million quarter -- $21.5 million last year, $21.8 million the year before. In each of those years, the gross margin was 38% plus. We know when we get over $20 million, that's when action starts. You get over $21 million, you're going to be over $35 million, should be close to $38 million. So while we can't predict that the sales for the quarter is going to be exactly $21 million, $22 million, $23 million, we do believe it's going to be over $20 million. And once it's over $20 million, you get the what we call hockey-stick leverage. So we feel very confident about that leverage. It's just hard for us to tell you right here and now how high over the $20 million it is going to be.

Okay. And just the balance sheet, are you slowing down the debt paydown? Is this a level you are going to hold this debt, or do you want to get it to zero?

Well, right now, what we've been doing with the buyback is just paying as required as opposed to paying extra. So depending upon how we handle the buyback, we slow -- the buyback will pay more towards the debt. Once it got below $10 million, we got very comfortable. And at that point, we feel like we can do what we have to do as long as we make our payments that are due. So we don't have to get to zero. The debt level is comfortable for us, and the interest cost is very low. We pay LIBOR plus 1 1/2. So it's almost like free money in this case.

Okay. And just finally, you made some new hires in terms of sales. I was wondering if you could comment on how those new hires have been going.

Yes, we've hired people in the sales area of most of our divisions. We've also put on sales reps in greater quantity than ever before. And it takes a little bit of time for them to bring in the business. But we can feel and see from the feedback that we get from the people that there is going to be a lot of business generated. You back that up with the new products that we've got going on that are coming out, Fire and LocDown and lots of recurring revenue products, more feet on the street is what the name of the game is for us with the reps and with the salespeople, and it makes for a very bright scenario.

Okay. Do you guys -- in order to get to that number in 2017, will this require you to do any sort of acquisition?

That's organic growth.

Okay, because when we look at the estimates out there, we're looking at around $80 million this year, $84 million next year. So to get to that number, I believe you have to do about $100 million, if I'm correct.

At a run rate of.

So that would require some serious growth from 2015 to 2017.

Yes. A run rate of means $25 million-type quarters. So, yes, we have a lot of work to do, and we think we have the products to get there.

Okay. Do you think that at this point you flatlined in terms of costs, or are you going to be adding more costs in order to build up the SG&A?

I don't think we're going to have to increase it beyond the new spend rate that we are. Right now, we're spending at, say, a $1 million more than we have spent the past. The only thing that we think is variable is the sales commission part. So as those sales grow, there's going to be additional commission costs. And as those sales grow, there will be additional freight costs.

So other than those costs, we don't see any major additions to the selling costs. It might be promotions also. We pick our spots in order to get those sales to grow fast, like we have to have it happen. There might be some selling promotions here and there. So I don't think it's going to be millions of dollars more, but it might be a little more here and there.

Okay, perfect. Thanks, guys.

Mr. Soloway, we have no further questions at this time. I would now like to turn the floor back over to you for closing comments.

Okay. Thank you, everyone, for participating in today's conference call. As always, if you have any further questions, please feel free to call KCSA, Kevin, or me. We thank you for your interest in support, and we look for to speaking to all of you again in a few months to discuss NAPCO's fiscal 2015 fourth-quarter and full-year results. Bye bye.

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.