Napco Security Technologies, Inc. (NASDAQ:NSSC) Q1 2024 Earnings Call Transcript

Napco Security Technologies, Inc. (NASDAQ:NSSC) Q1 2024 Earnings Call Transcript November 6, 2023

Napco Security Technologies, Inc. beats earnings expectations. Reported EPS is $0.28, expectations were $0.22.

Operator: Welcome to the Napco Security Technologies Fiscal Q1 2024 Earnings Call. Our host for today’s call is Fran Okoniewski, Vice President of Investor Relations. [Operator Instructions] I would now like to turn the call over to your host. Fran, you may begin.

Fran Okoniewski: Thank you, Ross and good morning everyone. My name is Fran Okoniewski, Vice President of Investor Relations for Napco Security Technologies. Thank you all for joining us for today’s conference call to discuss our financial results for our fiscal first quarter 2024. By now, all of you should have had the opportunity to review our earnings press release discussing the results of our quarter. If you have not, a copy of the release is available in the Investor Relations section of our website, napcosecurity.com. On the call today are Richard Soloway, our President and Chief Executive Officer of Napco Security Technologies and Kevin Buchel, our Executive Vice President and Chief Financial Officer. Before we begin, let me take a moment to read the forward-looking statement as this presentation contains forward-looking statements that are based on current expectations, estimates, forecasts and projections of future performance based on management’s judgment, beliefs, current trends and anticipated product performance.

These forward-looking statements include, without limitation, statements relating to growth drivers of the company’s business, such as school security products, reoccurring revenue services, potential market opportunities, the benefits of our reoccurring revenue products to customers and dealers, our ability to control expenses and costs and expected annual run-rate for software-as-a-service recurring monthly revenue. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those contained in the forward-looking statements. These factors include, but are not limited to, such risk factors described in our SEC filings, including our annual report on Form 10-K. Other unknown or unpredictable factors or underlying assumptions subsequently proving to be incorrect could cause actual results to differ materially from those in the forward-looking statements.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. You should not place undue reliance on these forward-looking statements. All information provided in today’s press release and this conference call is as of today’s date, unless otherwise stated and we undertake no duty to update such information, except as required under applicable law. I will turn the call over to Dick in a moment, but before I do, I want to mention that we will be attending the ISC East Industry Trade Show on November 15 and 16 in New York City’s Javits Center. If anyone is interested in attending and meeting with us, please contact me and I will arrange to get you a pass.

In addition, we will be attending the 26th Annual Needham Growth Conference in January. We are also planning for some non-deal roadshow activity in the near future. With that out of the way, let me turn the call over to Richard Soloway, President and Chief Executive Officer of Napco Security Technologies. Dick, the floor is yours.

Richard Soloway: Thank you, Fran. Good morning, everyone and welcome to our conference call. Thank you for joining us today to discuss our results. We are pleased to report our fiscal Q1 2024 record sales of $41.7 million. This is the 12th consecutive quarter we achieved record sales for a quarterly reporting period. Recurring revenue service continues to grow at a very strong rate and the annual prospective run rate is now $72.5 million based on October 2023 recurring revenues. Our balance sheet remains strong with our cash balances at $74.6 million, up 68% over fiscal Q1 2023 and up 12% sequentially. We have no debt. We continue to focus on capitalizing on key industry trends, which include wireless fire and intrusion alarms and the related recurring revenue service school security solutions, plus enterprise access control systems and architectural locking products.

The management team here at Napco continues to focus on the key metrics of growth, profits and returns on equity and controlling our costs. These metrics are important to us as well as our shareholders. We continue to execute our business strategy, and our interests are aligned with our shareholders as senior management of Napco owns approximately 10% of the equity. Before I go into greater detail, I will now turn the call over to our CFO, Kevin Buchel. He will provide an overview of our fiscal first quarter results, and then I’ll be back with more on our strategies and view of our markets. Kevin?

Kevin Buchel: Thank you, Dick and good morning everybody. Net sales for the 3 months ended September 30, 2023, increased by 6% to a fiscal first quarter record of $41.7 million as compared to $39.5 million for the same period last year. Recurring monthly service revenue continued its strong growth, increasing 25% in Q1 to $17.3 million compared to $13.8 million for the same period last year. Our recurring service revenues now have a prospective annual run rate of approximately $72.5 million based on October 2023 recurring service revenues, and that compares to $67 million based on July 2023 recurring service revenues which we reported back in August. Equipment sales for the quarter decreased 5% to $24.4 million as compared to $25.7 million last year.

This decrease was primarily due to the expected softness in radio sales as some distributors work off excess inventory, which was the result of distributors loading up with radios when the impending 3G Verizon sunset was approaching and they wanted to ensure that they had updated 5G radios in their inventory. And this was partially offset by increases in both our Alarm Lock and our Marks store locking products, which increased 24% in Q1 versus last year’s Q1. We believe the excess radio inventory in the channel is a temporary situation, and we expect radio sales to continue to be a key contributor to our hardware sales and lead to the continued growth of our highly profitable recurring revenue. Gross profit for the 3 months ended September 30, 2023, increased 54% to $22.4 million with a gross margin of 54%, and that compares to $14.6 million with a gross margin of 37% for the same period a year ago.

Gross profit for equipment sales for Q1 increased 188% to $6.9 million with a gross margin of 28% and that compares to $2.4 million with a gross margin of 9% last year. Gross profit for recurring revenues for the first quarter increased 28% to $15.6 million with a 90% gross margin, and that compares to $12.2 million with a gross margin of 88% and for the same period last year. The increase in gross profit dollars and gross margin for equipment sales was primarily the result of more normalized material and freight costs after the cessation of the global supply chain problems as well as the shift in product mix to higher-margin locking products. The 200 basis point increase in gross margin on service revenues now 90% was primarily due to the continued increase in service revenues relating to the company’s fire radios, which have higher monthly selling prices than the company’s intrusion radios.

Research and development costs for the quarter remained relatively constant at $2.4 million or 6% of sales for both Q1 this year as well as Q1 last year. Selling, general and administrative expenses for the quarter were also relatively constant at $8.4 million or 20% of net sales as compared to $8.5 million or 22% of net sales last year. Operating income for the quarter increased 222% to $11.6 million as compared to $3.6 million for the same period last year. The company’s provision for income taxes for the 3 months ended September 30, 2023, increased by approximately $1.1 million to $1.5 million with an effective tax rate of 13% as compared to $461,000 with an effective tax rate of 13% for the same period a year ago. The increase in the provision for income taxes for the 3 months was primarily due to higher taxable income.

Net income for the quarter increased 239% to a Q1 record $10.5 million or $0.28 per diluted share as compared to $3.1 million or $0.08 per diluted share for the same period last year, and it represents 25% of net sales. Adjusted EBITDA for the quarter increased 174% to a Q1 record $12.9 million or $0.35 per diluted share, and that compares to $4.7 million or $0.13 per diluted share for the same period last year and equates to an adjusted EBITDA margin of 31%. Moving on to the balance sheet. At September 30, 2023, the company had $74.6 million in cash, cash equivalents and marketable securities, and that compared to $66.7 million at June 30, 2023, and that represents a 12% increase. Working capital is defined as current assets less current liabilities, was $115.9 million at September 30, 2023, and that compares with working capital of $111.7 million at June 30, 2023.

And the current ratio, defined as current assets divided by current liabilities with 6.3:1 at September 30, 2023, and was 6.7:1 at June 30, 2023. Cash provided by operating activities for the 3 months ended September 30, 2023, was $11.2 million, and that compared to cash used in operating activities of $2 million for the same period last year. CapEx for the quarter was $256,000 and that compared to $372,000 in the prior period last year. This concludes my formal remarks, and I would now like to return the call back to Dick.

Richard Soloway: Kevin, thank you. As I mentioned, our fiscal 2024 is off to a great start with fiscal Q1 results, achieving record profits driven by hardware enabled recurring revenue growth of 25%, representing 41% of total company revenues. Total company revenues were up 6% year-over-year and we achieved gross profit growth of 54% to $22.4 million. While our equipment revenue declined by 5%, gross margins on such sales increased to 28%, and our recurring revenue grew by 25% to $17.3 million with an annual run rate of $72.5 million as of October 2023. And our locking sales from our Alarm Lock and Marks divisions, which represents 62% of our hardware sales, increased 24% in Q1 versus last year’s Q1. As we work through channel inventory, we expect equipment revenues to reaccelerate as thousands of 3G radios need to be replaced and we anticipate these will be replaced with Napco’s newer generation radios because alarm dealers must have new functioning and recurring revenue-producing radios to monitor alarm conditions.

This would result in both additional hardware revenue and increasing recurring revenue for the company. We continue to focus on our previously stated goals of $150 million run rate in recurring revenue and $150 million of equipment revenue on or about the end of fiscal 2026. Achieving these goals as well as our gross margin goals of 80% for recurring revenue, and it was 90% here in Q1 and a 50% goal for equipment would generate EBITDA margins in excess of 45%. We are well on our way to achieving this goal as our EBITDA margin in Q1 was 31%. There are thousands of commercial buildings of all types such as offices, hospitals, schools, coffee shops, restaurants, and others that still require upgrades from legacy copper phone lines. Our StarLink line of radios have the widest coverage range of both AT&T and Verizon with rich feature sets, which our dealers love.

Margins for recurring revenue improved by 200 basis points to 90% this quarter versus 88% in the same period a year ago. As we have previously stated, the constraints of the supply chain are abating, and we believe in the coming months that combined with new distribution services we have developed, we will begin to reinvigorate our equipment sales to even higher levels than any time before. When that happens, we also expect to generate increased hardware gross margins as the higher the level of hardware sales, the more overhead absorption occurs in our Dominican Republic factory and this expands our gross margins. We also announced the hiring of Deloitte & Touche as our new accounting firm. Deloitte has one of the largest professional service networks in the world and is known for their renowned reputation expertise and having a strong track record of providing high-quality audit and advisory services to a wide range of clients.

At this stage, for Napco, it’s essential to choose a big four firm with industry-specific experience that aligns with our organization and who understands the unique challenges and regulations relevant to our sector. An additional highlight in this quarter was the partnering with one of the largest alarm product distributors in the U.S.A. with over 100 branches across the country to service alarm dealers, system integrators and locking professionals and with this new relationship, our distribution network expands to over 300 locations. Our R&D team remains hard at work, developing more products for the future, which will help us grow our recurring revenue business. In October 2023, we introduced a new high-volume small business residential burglar fire alarm called Prima, which could generate substantial growth in hardware sales and profits and most importantly, add substantial recurring revenue service to Napco.

Also in the quarter, we have made some strategic investments and personnel adding to the existing talent of our team. These additions in engineering and specialized sales will help us continue to develop more new and exciting products faster and take them to market in new ways so as to get our alarm locking and integrators excited. Lastly, as indicated in the earnings release, we will be issuing another $0.08 per share dividend and we are proud of this program as the Napco team has created such tremendous shareholder value over the years, and this is another way for us to distribute profitable growth to investors. We are off to a great start for fiscal 2024, and we have a pristine balance sheet, no debt and continue to generate strong sales and healthy profits.

We believe we can continue this growth well into the future as we work toward our fiscal 2026 goals and beyond. I’d like to thank everyone for their support and for joining us in this exciting future we have. Our formal remarks are now concluded and we would like to open the call for the Q&A session. Ross, please proceed.

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Q&A Session

Operator: [Operator Instructions] And our first question comes from Matt Pfau from William Blair. Please go ahead, Matt.

Matt Pfau: Hey, guys. Thanks for taking my questions and nice results. I wanted to just first ask on the accounting restatements that you had. It looked like you’ve changed the auditor to help address that. Anything else you’re doing internally to help address some of those past issues? And how should we think about those impacting your expenses? Thanks.

Kevin Buchel: Thanks, Matt. So we’ve done a few things. One, our procedures at the end of the quarter is different than it was in the past. We performed price testing on any large items that are in the raw materials. We compare it to what we had. If there is any changes, we adjust it. We do the same thing in October on a test basis and we continue to investigate any changes that might have occurred. We didn’t see hardly any changes in this past quarter. We didn’t expect to see any changes of the supply chain crisis, the chaos that it brought with it is over. And that’s really what caused these changes in pricing in the last year. But we still check it, and we are investing in a module that will do a lot of this quicker and in a more automated fashion, and we expect that to be live by Q3.

We are also – we hired a consulting firm to work with us to get our procedures and policies and internal controls to be perfect, so that we don’t have any weaknesses or no deficiencies. They will be working hand in hand with Deloitte. Deloitte will start right after we file our Q1 which will be in the next day or 2. Once that Q is filed, Deloitte becomes our new accountants. They will work hand-in-hand with the consultant. We plan on hiring an internal control auditor on our staff. We plan on hiring to industrial engineers to focus on the material and the labor costings. Each of these things is in motion. We haven’t felt the impact of any of them yet because this is all happening now. So over the next 12 months, we will start to see the expense impact of this – my guess is it will cost up to $1 million over the course of the year.

So if you measure us from October through the following September, it will probably be $1 million more than what we’ve seen – up to $1 million. All well worth it, and we’re looking forward to working closely with both Deloitte and our consulting firm.

Matt Pfau: Got it. That’s helpful. And wanted to follow-up on the equipment revenue results. So it sounds like there was some continued weakness in radio sales, but strength in other areas to help offset that. Can you give us an idea of the revenue and performance by segment there so we can better understand what’s going on in the equipment business. Thanks.

Kevin Buchel: Right. You’ll see this in the Q when it gets filed either later today or in the next couple of days. I’m not sure exactly when it’s going to be, but it will be soon. There is a table that’s in footnote two, and it shows the breakout between intrusion and access alarm products, door locking devices and recurring revenue. So in this quarter that we just completed, the intrusion and access alarm was $9.3 million. Door locking products was $15.1 million and the recurring which you can also see on the income statement was $17.3 million. The intrusion part was down. We expected it to be down. Last year, a year ago at this time, we were in what I call radio mania, where everybody was loading up trying to get their hands on as many radios as they could, given the impending 3G sunset, which was occurring January of 2023, which did happen.

A lot of dealers are last-minute guys, but they were scrambling around to load up, and there wasn’t a lot of choices either. A lot of our competitors were having trouble delivering. You remember going back a year ago, there was – we were in the midst of supply chain issues. Nobody could get their hands on the micros that are required in these radios. We were able to get our hands on it and we spent the money to get our hands on it. We spent extra money buying these chips from brokers, we did whatever we could to keep things moving. Because we knew how, a, how important it was to get radios in the hands of all the dealers. But also, we know that it leads to recurring revenue. And we – as we’ve talked about before, picked up some new large accounts because we were able to deliver and others couldn’t.

And some distributors just bought up whatever they can get their hands on. So not a surprise – now that inventory has to be worked off now that the sunset has come and gone. And we were encouraged. We saw that the sell-through stats for Q1 were better than they were in Q4. We knew they were going to be less than they were a year ago, not a surprise, but we worked very closely with our distributors to help them move this equipment through opening up also a brand new large distributor with over 100 locations is going to help move overall radio inventory that we expect to happen. We’ve seen signs of that already. So that’s encouraging. And from a locking point of view, locking we have two companies Alarm Lock and Marks. They have both been doing great for several quarters in a row.

It’s attributable to infrastructure upgrades at airports, it’s attributable to school security, a bunch of school jobs that we’re getting can’t announce it. A lot of times the schools don’t let us, but we see it, we hear about it. We know about it. Hospitals buildings that want to go to a more upgradable locking setup where you don’t have to use a key big projects with hotels. It’s happening all over. We’re very encouraged by the strength of the locking business and of course, the locking margins are better than, say, the radio margins. But radio margins might be 20%. Of course, it leads to the recurring. Locking margins mid-30s to over 40. So that helped the overall gross margin for the quarter.

Matt Pfau: Great. Appreciate the additional detail, and you taking my questions. Thanks.

Kevin Buchel: Thanks, Matt.

Operator: Our next question comes from Jim Ricchiuti from Needham & Company. Please go ahead, Jim.

Jim Ricchiuti: Hi, thank you. I wanted to get a little bit more color, if we could, on the new distribution source that you’re talking about. It sounds like this has the potential to be another important channel for you guys. I wonder if you could elaborate on how quickly that might scale?