NAPCO Security Technologies Inc (NSSC) 2018 Q3 法說會逐字稿

Greetings, and welcome to the NAPCO Security Technologies Third Quarter Fiscal 2018 Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to Patrick McKillop, Director of Investor Relations. Please go ahead.

Thank you. Good morning. My name is Patrick McKillop. I'm the Director of Investor Relations for NAPCO Security. Thank you all for joining us for today's conference call to discuss our financial results for our fiscal third quarter 2018.

By now, all of you should have had an opportunity to review the press release discussing the results. If you have not, a copy of the release is available in the Investor Relations section of our website, www.napcosecurity.com.

On the call today is Richard Soloway, President and CEO of NAPCO Security Technologies; and Kevin Buchel, Senior Vice President and CFO.

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 a result of certain factors, including those set forth in the company's filings with the SEC.

During the call, we may also present certain non-GAAP financial measures, such as adjusted EBITDA and certain ratios that are used with these measures. In the press release and on the financial tables issued earlier today, you'll find the definition of these non-GAAP financial measures, a reconciliation of these non-GAAP financial measures with the closest GAAP financial measure as well as a discussion about why we think these non-GAAP financial measures are relevant to our results. These financial measures are included for the benefit of investors and should not be considered instead of GAAP measures.

I'll turn the call over the Dick in a moment. Before I do, I just wanted to mention a few things in the IR front.

In terms of our upcoming investor outreach, we are marketing in Milwaukee this week. If you would like to meet, please contact me to arrange a meeting. Also, we will be presenting at the Robert Baird conference on June 7 in New York City. Investor outreach is crucial, especially for a small-cap company, such as NAPCO, and I would like to thank all those folks that assist us in these conferences and marketing trips.

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

Thank you, Patrick. Good morning, everyone, and welcome to our conference call. Thank you for joining us today to discuss our results.

The third quarter of fiscal 2018 marked another record revenue performance for NAPCO. This quarter marks the 15th consecutive quarter of increased sales growth for the company. Our SaaS recurring revenues continued to grow at a rapid rate. During the third quarter of 2018, our recurring revenues increased 49%. The driver of the growth for recurring revenue continues to be all of our StarLink offerings, which include Intrusion, Fire and Connect. The annual run rate is now $12.9 million.

During the third quarter, our investments in R&D, selling and marketing expenses did not increase during the quarter versus the year-ago period. The levels of investments for R&D and SG&A, items we believe are now at the appropriate levels, and we are beginning to see the return on these investments as evidenced by a 92% increase in net income.

Our balance sheet remains strong with net debt of 0 and healthy cash balances.

We remain focused on capitalizing on key industry trends. These trends include the creation of school security and safety products, the smart connected home and recurring revenue growth in cellular alarm communications. All of these trends are having a positive impact on our results. Driving growth, profits and returns on equity are important to us and our shareholders.

Our business strategy is executing well, and our interests are aligned with our shareholders as senior management of NAPCO owns 38% of the equity.

Before I go into greater detail, I'll now turn the call over to our CFO, Kevin Buchel. He will provide an overview of our fiscal third quarter financial results, and then I'll be back with more on our strategies and outlook. Kevin?

Thank you, Dick, and good morning, everybody. For the third quarter, net sales increased 7% to $22.2 million, which was a record third quarter performance. For the 9 months ended March 31, 2018, net sales increased 5% to $64.4 million. The increase in sales for the 3 months ended March 31, 2018, was due primarily to increased recurring service revenue, access control products and door-locking products. For the 9 months, the increase in sales was due primarily to increased recurring service revenue as well as increased sales from access control products.

Gross profit for the third quarter increased 6% to $8.9 million, and for the 9 months increased 5% to $25.9 million.

I'd like to point out that research and development expenses are now shown separately as part of our operating expenses and are no longer included in cost of goods sold. We believe this is a clearer presentation, and we've made this reclassification for all prior periods as well. So under this new presentation, the gross margin for both the third quarter and the 9 months ended March 31, 2018, was 40.1% as compared to 40.2% and 40% for the 3 and 9 months last year, respectively.

As Dick mentioned, our R&D and SG&A spend levels did not increase significantly versus the year-ago period, and we now believe that we're at the appropriate levels.

R&D expenses for the quarter were relatively constant at $1.7 million or at 7.5% of sales as compared to $1.7 million or 8.2% of sales last year. For the 9 months, R&D expenses were also relatively constant at $4.9 million or 7.6% of sales as compared to $4.9 million or 8% of sales last year.

SG&A costs for Q3 decreased 3.9% to $5.3 million or 23.9% of sales as compared to $5.5 million or 26.6% of sales last year. This decrease was due primarily to decreases in various advertising and marketing expenses. For the 9 months, SG&A costs remained relatively constant at $16.8 million or 26.1% of sales as compared to $16.8 million or 27.3% of sales last year.

Operating income for the third quarter increased 68% to $1.9 million as compared to $1.1 million last year. And for the 9 months, operating income increased 42% to $4.1 million as compared to $2.9 million last year.

Income before income taxes for the quarter increased 69% to $1.9 million compared to $1.1 million for the comparable period last year. And for the 9 months, income before income taxes increased 42% to $4.1 million as compared to $2.9 million last year.

Income tax expense for the quarter decreased by $103,000 to $64,000 compared to $167,000 last year. Income tax expense for the 9 months decreased by $362,000 to $118,000 as compared to $480,000 for the same period a year ago. The decrease in income tax expense for the 3 and 9 months was primarily due to recent changes in the federal tax code. As a result, the company's effective tax rate was 3% and 15% for the 3 months ended March 31, 2018, and 2017, respectively, and 3% and 17% for the 9 months ended March 31, 2018, and 2017, respectively.

Net income for the third quarter increased 92% to $1.8 million or $0.10 per diluted share as compared to $952,000 or $0.05 per diluted share last year. And for the 9 months, net income increased 66% to $4 million or $0.21 per diluted share as compared to $2.4 million or $0.13 per diluted share last year. The increases in net income for the 3 and 9 months were primarily due to the items previously mentioned.

Adjusted EBITDA for the quarter, as outlined in the schedule included in today's press release, increased 54% to $2.3 million or $0.12 per diluted share compared to $1.5 million or $0.08 per diluted share last year. And for the 9 months, adjusted EBITDA increased 32% to $5.3 million or $0.28 per diluted share as compared to $4 million or $0.21 per diluted share last year.

Moving on to the balance sheet. The cash balance at March 31, 2018, was $4.3 million as compared to $3.5 million at June 30, 2017. Our working capital as of March 31, 2018, was $40.5 million as compared to $40.8 million at June 30, 2017. Current ratio is 5.8:1 at March 31, 2018, as compared to 4.9:1 at June 30, 2017. And as we've previously mentioned, debt net of cash was 0 at March 31, 2018. CapEx was $367,000 during the quarter and for the 9 months, was $1 million.

Finally, as we have mentioned previously, we opportunistically buy back our stock, and we reactivated the company's stock buyback program at the end of December 2017. And for the quarter ended March 31, 2018, we repurchased 122,795 shares at a weighted average purchase price of $9.29 per share.

That concludes my formal remarks, and I would now like to return the call back to Dick.

Thanks, Kevin. The 2 paradigm shifts in our business that we have been continued to headlight are school security and the growth of our SaaS recurring revenue remain as positive forces in our business. Early in the call while discussing our financial results for the quarter, we highlighted the strong growth of our SaaS recurring revenue. We continue to see demand coming from alarm communications, the connected home category and the overall expansion of the Internet of Things theme.

The school security opportunity continues to remain significant for us. As a reminder, the total addressable market is very large with over 100,000 K-12 schools and over 10,000 colleges and universities in the U.S.A. Many of these schools have little or no security in place to protect them from the constant threat of violent incidences. We believe that going forward, the amount of new spending on security and safety products from schools will continue at a strong rate for the foreseeable future.

Last month, we attended the ISC West trade show in Las Vegas, which had another record year for attendants. During the show, we met with many of our channel partners and targeted new channel partners. These relationships are important to us. Our R&D staff is always hard at work, developing new products that will help our channel partners grow and succeed. Dealer training by us continues to be hosted throughout the country, and attendance remains high, which is significant as we want to have as many dealers selling our products as possible.

As a reminder, we mentioned last quarter that we were voted one of the best intrusion brands alongside industry titans, such as Honeywell and Bosch, during a survey that was completed by Security Sales & Integration magazine, which is a top industry publication. We are very proud of this as it shows we were able to compete amongst the industry giants.

In our current quarter, fiscal Q4, we plan to introduce a complete line of StarLink Verizon LTE wireless communicators, which will keep us at the forefront of cellular technology. Last year at this time, we introduced the StarLink Connect, which is a perfect solution for the residential and small business market.

In 2017, it was voted the winner of 2 prestigious awards during the ISC West trade show. The Connect communicator allows the transmission of alarm signals over the cellular networks in lieu of the traditional phone lines that have been used for many years. The Connect communicator is feature packed and gives the end user the ability to receive and upgrade to their alarm system without the need to remove existing hardware that's already installed in their home.

Our iBridge smartphone tablet app, which works in tandem with the Connect communicator, gives the end user customer interactive services, such as control of the alarm system, lighting, door locks, thermostats and seeing live video. The Connect is compatible with many of the major competitors' brands, which our dealers love as well. Dealers can save time and money using the Connect during the installation process, which enables them to schedule more jobs during the workday. Remote troubleshooting is also a great feature, which can help dealers avoid having to send a truck to a residence or small business, all the while still collecting a service call fee.

The market opportunity for the StarLink Connect, we believe, is very large, and it is applicable for new installs and retrofits. Currently, there are approximately 133 million households in the U.S., and only 22 million have alarm systems installed. The Connect smart home vertical continues to grow, and we often hear about the DIY service-monitored solution that you may find at big-box stores or on the Internet. However, a recent survey report by first analyst securities show that a large percentage of homeowners that install DIY products ultimately end up removing them and later replacing them with professionally installed and monitored systems. We believe that we are still in the early innings of the connected home market, and the best is yet to come.

Switching gears to some of the other products in our portfolio. We really believe that the outlook for these products is very positive as well. These products include: StarLink Dual Path-Fire Communicator, CA4K Access Control software, ArchiTech and Networx wireless locks. The pace of new construction high-rise buildings in the U.S. remains robust, and we believe this bodes well for our business in the future.

Many of the new buildings are multi-use residential and commercial space, which will require access control via communicators and modern wireless locks. The aforementioned products in our portfolio are perfect solution for many of these new high-rise multi-use buildings. Many of these products have the opportunity to be used in retrofit applications as well. For example, we discussed on our last call the University of California, Berkeley project in which they're installing these StarLink Dual Path-Fire communicators around the campus. The StarLink Dual Path is going to replace the use of old copper phone lines, which will save them money as well as improve fire and safety communications.

According to our internal research, there are millions of commercial buildings across the U.S., which need to be upgraded from existing plain old telephone lines, which they are currently using as many of the carriers no longer are supporting these lines.

StarLink Dual Path is a contributor to the growth of recurring revenues we received, and the dealers love this great solution for their commercial clients.

We are focused on bringing more SaaS revenue, recurring revenue products, and it has been a great contributor to our success in the last few years. Our R&D staff is working on new products, which will bring more recurring revenue to our sales. We continue to work on the development of Access Control as a service, which will be used in our CA4K software.

NAPCO and its integrators will be able to offer cloud-based services to end users. These cloud-based services, such as employee or visitor badge creation, attendance report and adding or deleting employees from a database, can be outsourced by the building owners. By outsourcing the above-mentioned services, building owners can save money, and we as well as our integrators will be able to share in the recurring revenue that is being generated by providing these outsourced services.

Moving on to a very important topic that many of you know we have been talking about for some time, school security. We all share deep sorrow with the event that took place back in February at Marjory Stoneman Douglas High School in Florida. As a result of this tragedy, many would have expected more to be done by now. And frankly, the majority of schools in the U.S. are still vulnerable targets.

Our efforts remain focused on providing the products and solutions that the schools need. We have solutions for all schools, whether they have a small budget or large. So what has changed since the incident in February? We are seeing significant activity upon legislators being reported on the news on a regular basis now. A few examples include the President hosting a meeting with students and parents to discuss school security solutions, Florida passing legislation to spend $500 million in school security, Wisconsin passing a bill to spend $100 million and Maryland adding $125 million to school security, plus an additional $50 million to be included annually going forward. These are just a few examples, and we expect that more will happen in the future.

Our SAVI audit for school safety is a great tool for assessing the potential threats to schools and can be used by our integrators as well as the administrators at schools who are trying to address the needs at their respective schools. The funding for school security is starting to plot a new course, and we believe this will be beneficial to our business going forward.

We have announced projects this quarter from Pepperdine, which is the third time they have used our products on their campus as well as projects in Albany County Schools in Wyoming.

Our pipeline continues to build, and we will announce new wins when we can.

Finally, I'd like to discuss a new initiative that we are currently undertaking, which we believe will be beneficial to our business model. Recently, we have been reviewing our component sourcing model, and we have discovered additional ways to save costs. Just a month ago, myself and the team of NAPCO employees made the journey to Asia. We attended trade shows and met with many manufacturers of components that we're using in our products. It is our plan to start utilizing these new sources and thus, create savings, which will be beneficial to our financial model. The amount of savings we could amass by undertaking this initiative could be in the 7 figures, thus creating significantly more profitability. We are focused on delivering profits to our shareholders, an addition to driving our sales -- growth in sales. This is another important initiative.

We will begin our Q&A session portion of this call in a few moments. But first, I'd like to give a brief summary. We now are in the final quarter of the fiscal year, our fiscal fourth quarter traditionally our strongest quarter. NAPCO is in a strong position to continue its growth in sales and profits going forward. We believe that our investments in R&D, sales and marketing are beginning to show returns, and we are excited about the balance of fiscal 2018 and beyond.

NAPCO senior management retains -- maintains a high level of ownership in our equity, approximately 38%. And I'd like to thank everyone for their support and for joining us in the exciting future we have.

Our formal remarks are now concluded. We would like to open the call for the Q&A session. Operator, please proceed.

(Operator Instructions) The first question today is coming from the line of Mike Walkley with Canaccord Genuity.

Thanks for breaking out the R&D. How do we -- how do you guys think about the current levels of operating expenses in terms of supporting business growth going forward? And you hinted at some new product introduction. So do we -- do you think you have the right R&D levels to support your new product portfolio?

Mike, it's Dick. Yes, we think we have the right levels at this point now, and we expect to get a lot of additional output with this level of spending. We're on the cusp of delivering a lot of new and exciting products in the industry, and it should be great for our future.

And Mike, you also now are starting to see the leverage. You could see that R&D as a percentage of sales, the percentage is now lower because the sales are rising, so we're starting to see leverage there. And the same thing on the selling and marketing, the SG&A, again, a lower percentage of sales. We keep those levels steady. The sales grow. The model gets stronger.

Great. And just in terms of you talked also about sourcing new components and leverage that could create on the gross margin line. Can you talk about how easy or how quickly it would take to switch components and maybe that time horizon where you could see that 7-figure savings coming through the cost of goods sold line?

Yes. The savings will be contributing over the next 24 months. It'll accelerate, I would guess, after about 9 months because we have to get the components checked to make sure they're exactly the quality we need and then filter them into the assembly lines, so there -- that they -- we can get the savings. So I would say the 7 figure is very reasonable, and I think we can be able to do that. It was a very exciting trip. We found all of the components that we use directly with Asian sources and going to make a big difference to our gross profit.

And these savings are recurring, another form of recurring. You save it. You'd save it over and over and over again, which is a great thing.

No, it makes sense. And then you highlighted on the call just the school safety pipeline growing. Can you help us think about the pipeline maybe now versus a year ago and how you see that business opportunity improving over time?

Well, we talked about with school shootings in February and the state legislature is waking up and the President talking about it making it a national issue, we're seeing more business. Not all the business can be published because some of the schools don't want this. But the ones that can be, we do publish, so that the shareholders can get a feeling for what's going on. But it's a very important vertical for us, and we see that we've really only scratched the surface of these 100,000 K-12 and 10,000 colleges and universities. We've done hundreds and hundreds of them, but the room for growth is there and schools definitely need all this protection with all the craziness that's going on.

And last question for me, and I'll pass the line, is it's great to see the recurring revenue with another year -- another quarter of strong year-over-year growth. Can you talk about the drivers there? And also, now you're breaking out the margins, just as you continue to add more scale to that platform, how we could see margin leverage on that piece of business also.

The margin leverage is very exciting because, as you see, the gross margin on recurring is in the 70s, pushes 80% sometimes. As we add more 75% to 80% gross margin items, which is the recurring revenue, the model is going to get even stronger. And so we've been seeing tremendous growth quarter after quarter. This quarter was 49%. As we add that much recurring revenue to our picture and it's high gross margin business, it's only -- the model is only going to get stronger. The GP is just going to keep climbing. That's what we expect because we think we're in the early stages of the recurring revenue. There's a lot that's happening on that front. A lot of these products are only out a year, 1.5 years. The oldest recurring revenue product is only out 3 years. So there's a lot to grow, and the R&D guys are working on more stuff. Believe me, we love recurring revenue. We want more of it, and it's going to come in new ways as we go forward.

The next question comes from the line of Gary Mobley with Benchmark Company.

Dick, you mentioned the Verizon-based LTE StarLink products just launched. And can you help us understand the significance of this product in terms of addressable market? In other words, did you not have the Verizon-based cellular connectivity in these products in the past? Does it give you new -- a new avenue to a set of distributors and value at resellers, et cetera?

Right. LTE is something that is new with the carriers for the purpose of data. And we found that in the past, the network wasn't as built out and as robust as the previous technologies that are out there. So we waited now to a point where we can give 100% reliable communications for burglary and fire and medical emergencies. So we've come out with a whole line of LTE because the market is mature enough to accept it. And LTE has long legs, so it'll go on for at least 10 years using that technology. So we've developed some pretty amazing equipment using LTE and more to come, which makes it ultra reliable because our goal is to be a competitive substitute for old-fashioned copper, which has been a traditional way signals are going. And now with our LTE, we can now offer LTE in that reliability.

Okay. Correct me if I'm wrong, but in the past, weren't you suggesting that RMR can be in an annualized pace at the end of the fiscal year, the month of June, at about $15 million annually? And is that a level you still feel comfortable with? And then, Kevin, last on the tax rate. What would you suspect your non-GAAP tax rate trends to looking over the next 12 months or even longer?

The run rate of recurring we said should approach $15 million by June 30. And we're at $12.9 million now, so it'll be close. We might beat it. We'll be close to it if we don't beat it. And we also said by the following June that we expect to be over $20 million. So our expectations haven't changed. The recurring remains a strong part of the business. And as we go forward, it could get even better as we introduce more products to the mix. As far as the tax rate going forward, we expect an effective tax rate somewhere between 15% and 17%. That's what I would use if I was modeling. It was very low this year because we had -- as a result of the new legislation, we had certain things on the books that we didn't need anymore, and we were able to take back some of the accruals. But going forward, 15% to 17%, I think, is a fair guesstimate.

The next question is from the line of Del Warmington with Delwar.

Quick question. I'm not sure if I missed it. Could you quantify the size of the school security market? How big is it from a dollar point of view?

It's hundreds of millions to $1 billion of the segments that we're looking to protect. That's classroom doors of K-12s as well as colleges and universities. And that's -- and we think that, that's going to grow because it's integrated also to communications for changing key codes around large campuses. So it's a very, very nice market for us, and we have the best offerings in school security for lockdown of schools and protection because our equipment is totally wireless for the big campuses, and then we make the mechanical devices for K-12s where they don't have a big budget.

(Operator Instructions) At this time, we have no additional questions. I would like to turn the floor back to management for further remarks.

Thank you, everyone, for participating in today's conference call. As always, should you have any further questions, please feel free to call Patrick, Kevin or myself for further information. We thank you for your interest and support, and we look forward to speaking to all of you again in a few months to discuss NAPCO's fiscal Q4 '18 results. Bye-bye. Have a great day.

Thank you. Today's conference has concluded. You may disconnect your lines at this time. Thank you for your participation.