Napco Security Technologies, Inc. (NASDAQ:NSSC) Q2 2024 Earnings Call Transcript

Napco Security Technologies, Inc. (NASDAQ:NSSC) Q2 2024 Earnings Call Transcript February 5, 2024

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Operator: Good morning, ladies and gentlemen, and welcome to the NAPCO Security Technologies Fiscal Second Quarter of 2024 Earnings Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded on Monday, February 5, 2024. I would now like to turn the conference over to Francis Okoniewski, Vice President, Investor Relations. Please go ahead.

Francis Okoniewski: Thank you, Jillie, and good morning, everyone. My name is Fran Okoniewski, Vice President, Investor Relations for NAPCO Security Technologies. I just want to thank you all for joining us today on our conference call to discuss our financial results for our fiscal second 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 not, a copy of the release is available in the Investor Relations section of our website, www.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 CFO. Before we begin, let me take a moment to read the forward-looking statements 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, recurring revenue services, potential market opportunities, the benefits of our recurring 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 for 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 we are actively planning our Investor Relations Calendar for more non-deal road shows and conferences in the near future as investor outreach is very important to NAPCO, and I would like to thank all those folks that assist us in these conferences and non-deal road shows.

Also, we invite you to come and visit our booth at the upcoming ISC West Trade Show, April 9th through the 11th in Las Vegas. ISC West is the industry’s largest trade show with over 30,000 attendees. So, if anyone is interested in attending, please contact me and I will arrange to get you a pass. 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.

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 Q2 2024 record sales of $47.5 million. This is the 13th consecutive quarter we’ve achieved record sales for the quarterly period. Recurring revenue subscription service continues to grow at a very strong rate and the annual prospective run rate is now $76.5 million based on January 2024 recurring revenues. Our balance sheet remains strong with our cash balances at $79 million, an 18% increase over the June 30, 2023 level. 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 service revenues, 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, as well as 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 second quarter results, and then, I will be back with more on our strategies and view of our markets. Kevin, the floor is yours.

Kevin Buchel: Thank you, Dick. Good morning, everyone. Net sales for the quarter increased 12% to $47.5 million, and that’s the highest quarterly sales in the company’s history. And that compares to $42.3 million for the same period one year ago. Net sales for the six months ended December 31, 2023 increased 9% to a six-month record of $89.2 million, and that compares to $81.8 million for the same period one year ago. Recurring monthly service revenue continued its strong growth, increasing 25% in Q2 to $18.5 million as compared to $14.9 million for the same period last year. Recurring monthly service revenue for the six months ended December 31, 2023 increased 25% to $35.8 million as compared to $28.7 million last year. Recurring service revenues now have a prospective annual run rate of approximately $76.5 million based on January 2024 recurring revenues, and that compares to $72.5 million based on October 2023 recurring service revenues, which we reported back in November.

Equipment sales for the quarter increased 6% to $29 million as compared to $27.4 million last year. This increase was due primarily to revenue increases in both Alarm Lock and Marks brand door-locking products, as well as increased sales of NAPCO brand intrusion products. Of note is that the StarLink radios sales in Q2 sequentially increased over those sales in Q1 by 63%. Equipment sales for the six months increased 1% to $53.4 million as compared to $53.1 million for the same period last year. This increase was primarily due to increases in both Alarm Lock and Marks locking sales as — offset by a decrease in NAPCO intrusion sales due to the previously discussed decline in StarLink radios. Gross profit for the three months ended December 31, 2023 increased 74% to $25 million with a gross margin of 53% as compared to $14.4 million with a gross margin of 34% for the same period last year.

And the gross profit for the six months increased 64% to $47.4 million with a gross margin of 53% as compared to $28.9 million with a gross margin of 35% a year ago. Gross profit for recurring service revenue for the quarter increased 21% to $16.7 million with a gross margin of 90%, and that compares to $13.2 million with a gross margin of 89% last year. And gross profit for recurring service revenue for the six months increased 21% to $32.2 million with a gross margin of 90%, as compared to $25.4 million with a gross margin of 88% last year. Gross profit for equipment revenues in Q2 increased 633% to $8.4 million with a gross margin of 29%, as compared to $1.1 million with a gross margin of 4% last year. And gross profit for equipment revenues for the six months increased 328% to $15.2 million with a gross margin of 29%, as compared to $3.6 million with a gross margin of 7% for the same period last year.

The increase in both gross profit dollars and gross margin for recurring revenue for the three and six months ended December 31, 2023 was primarily the result of the previously mentioned increase in recurring revenues, as well as a greater proportion of those revenues being generated by our StarLink Fire radios, which generate higher monthly service charges than the other StarLink radios. The increase in both gross profit dollars and gross margin for equipment revenues for both the three and the six months ended December 31, 2023, primarily resulted from lower costs of certain components as compared to the same period last year when we were still feeling the effects of the global supply chain shortage. In addition, the aforementioned increase in equipment sales was also a factor in the increase in gross profit and gross margin.

Research and development costs for the quarter increased 14% to $2.5 million, or 5% of sales, and that compares to $2.2 million, or 5% of sales, for the same period a year ago. And research and development costs for the six months ended December 31, 2023 increased 7% to $5 million, or 6% of sales, and that compares to $4.7 million, or 6% of sales, for the same period a year ago. The increase for the three and the six months primarily resulted from compensation increases and additional staff. Selling, general and administrative expenses for the quarter increased 11% to $8.7 million or 18% of net sales. And that compares to $7.8 million, or 18% of net sales, for the same period last year. Selling, general and administrative expenses for the six months ended December 31, 2023 increased 5% to $17.1 million, or 19% of net sales, and that compares to $16.3 million, or 20% of sales, for the same period last year.

The increase in SG&A for the three months was primarily due to increases in legal and advertising expenses, as well as additional expenses relating to the enhancing of our internal control systems. The increase for the six months was primarily due to legal and accounting fees, as well as the aforementioned enhancing of our internal control systems. The decrease in SG&A as a percentage of net sales for both the three and the six months was due to the increase in net sales being proportionately larger than the increase in SG&A expenses. Operating income for the quarter increased 219% to $13.8 million as compared to $4.3 million for the same period last year. Operating income for the six months ended December 31, 2023 increased 218% to $25.4 million as compared to $8 million for the same period last year.

Interest and other income for the three months increased 290% to $729,000 as compared to $187,000 last year. And for the six months, interest and other income increased by $1.1 million to $1.2 million compared to $84,000 last year. The increase for both the three and the six months ended December 31, 2023 was due to increased interest income from certificates of deposits. The provision for income taxes for the three months increased by $1.3 million to $1.9 million with an effective tax rate of 13%, as compared to $586,000 with an effective tax rate of 13% last year. And for the six months, the provision for income tax has increased by $2.4 million to $3.4 million with an effective tax rate of 13%, as compared to $1.047 million with an effective tax rate of 13%.

The increase in the provision for both the three and the six months ended December 31, 2023 was due to increases in taxable income. Net income for the quarter increased 221% to a quarterly record $12.6 million, or $0.34 per diluted share. And that compares to $3.9 million, or $0.11 per diluted share, for the same period last year. And that represents 27% of net sales. Net income for the six months ended December 31, 2023 increased 229% to a six-month record of $23.1 million, or $0.62 per diluted share. And that compares to $7 million, or $0.19 per diluted share for the same period last year. And that represents 26% of net sales. Adjusted EBITDA for the quarter increased 191% to a quarterly record $15.1 million or $0.41 per diluted share. And that compares to $5.2 million or $0.14 per diluted share for the same period a year ago.

And that equates to an adjusted EBITDA margin of 32%. Adjusted EBITDA for the six months ended December 31, 2023 increased 182% to a six-month record $28 million, or $0.76 per diluted share. And that compares to $9.9 million, or $0.27 per diluted share, for the same period last year, and equates to an adjusted EBITDA margin of 31%. Moving on to the balance sheet. As of December 31, 2023, the company had $79 million in cash and cash equivalents, other investments and marketable securities, and that compares to $66.7 million at June 30, 2023. That’s an 18% increase. Company had no debt as of December 31, 2023. Cash provided by operating activities for the six months ended December 31, 2023 was $18.7 million. And that compares to $1.1 million for the same period last year.

Working capital is defined as current assets less current liabilities. It was $128.5 million on December 31, 2023, and that compares with working capital of $111.7 million at June 30, 2023. The current ratio, defined as current assets divided by current liabilities, was 7.1 to 1 at December 31, 2023, and 6.7 to 1 at June 30, 2023. CapEx for the quarter was $426,000, and that compares to $444,000 in the prior-year period. That concludes my formal remarks, and I would now like to return the call back to Dick.

Richard Soloway: Thank you, Kevin. The first half of fiscal 2024 is off to a great start with fiscal Q1 and fiscal Q2 results, achieving record sales and profits, driven by hardware-enabled recurring revenue growth of 25% and which represents approximately 40% of total company revenues. Our net income of $12.6 million and adjusted EBITDA of $15.1 million were quarterly record breakers. Equipment revenue improved, growing 6% for the quarter, with gross margins on such sales sequentially increasing to 29% from 28% last quarter. Radio sales in Q2 improved over Q1, increasing by approximately 63%. While such sales were still 13% below the radio sales of Q2 last year, when the impending 3G Verizon sunset was rapidly approaching, the increase over last quarter was significant.

We expect radio sales to continue to be a key contributor to our hardware sales and continue to lead to the continued growth of our highly profitable recurring revenues. Gross margin for recurring service revenues was once again strong at 90%. And when combined with gross margin on equipment revenues of 29%, the total gross margin for Q2 amounted to 53%, which compares to 34% for last year’s Q2. We are particularly pleased to see the growth in equipment revenues, which was primarily attributable to the continued strength of locking revenue in addition to the improvement in intrusion sales. We also saw — we also are pleased with the increase in the recurring revenue’s annual run rate, which increased to $76.5 million based on January 2024 recurring revenues, compared to an annual run rate of $72.5 million based on October 2023 recurring revenues.

Our Alarm Lock and Marks locking hardware lines continue to see growth in school and classroom security, healthcare, and retail loss prevention, as well as multi-dwelling commercial and residential applications, growing approximately 10% compared to last year and approximately 18% compared to Q1. Locking sales, once again, represented 61% of hardware sales in Q2. We continue to remain focused on further penetrating each of these markets. Net income of $12.6 million, besides being a Q2 record breaker, represents 27% of net sales. Adjusted EBITDA of $15.1 million, also a Q2 record, represents an adjusted EBITDA margin of 32%. We believe we are well on our way to achieving our adjusted EBITDA margin target of approximately 45% on or about the end of fiscal 2026 as our targeted equipment sales reach $150 million and our recurring revenue service level reaches $150 million.

Our balance sheet continues to get stronger, with cash and cash equivalents, other investments and marketable securities increasing 18% to $79 million as compared to $66.7 million at June 30, 2023. We have no debt. And the net cash provided by operating activities for the six months ending December 31, 2023 was also strong, amounting to $18.7 million. We recently announced the introduction of Prima by NAPCO, a new all-in-one alarm for security, fire, video and connected home. We anticipate that Prima will address an important mass segment of the security market, including residential and small business systems. With built-in Wi-Fi and cellular radio communications, customer alert notifications, and video and smart home subscription options for each installed system, the security dealer as well as NAPCO can add more recurring revenue generating accounts.

There are millions of commercial buildings of all types, such as offices, hospitals, schools, coffee shops, restaurants, as well as residences 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 really love. As we have previously stated, the constraints of the supply chain have abated, and we believe in the coming months that combined with new distributive sources we have developed, we will begin to invigorate our equipment sales and associated margins to even higher levels than any time before. As we’ve stated previously, the higher the hardware sales, the more overhead absorption occurs in our Dominican Republic factory, and this expands our gross margins.

And finally, as indicated in this morning’s earnings release, the company will be issuing a quarterly dividend of $0.10 per share to be paid on March 22, 2024 to shareholders of record on March 1, 2024. This represents a 25% increase over the previous dividend of $0.08 paid on December 22, 2023. 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 our investors. The first six months of fiscal 2024 have generated strong sales and profitability. We believe we can continue this growth well into the future as we work toward our fiscal 2026 goals and targets 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. We would like to open the call for the Q&A session. Operator, please proceed.

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Q&A Session

Operator: Thank you. [Operator Instructions] Your first question comes from Chad Bennett from Craig-Hallum. Please go ahead.

Chad Bennett: Great, thanks. Great job guys on the quarter. Great to see the rebound in the equipment business. So, I guess maybe first question is, I know you touched on it in the formal remarks, just on the radio inventory issue. It seems like it’s largely behind us and probably even faster than maybe we thought. Just trying to get an idea, do we still expect some headwind in the March quarter or potentially even in the June quarter from that inventory issue, or how should we think about that?

Kevin Buchel: I think, Chad, that we thought it was going to take a couple of quarters to get it behind us. We thought that this quarter would be affected similarly as it was in Q1. We saw a lot of progress in Q2, and hence you saw the big increase in radio sales in this quarter versus last. We’re not done yet. We’re not 100% there. We still have some work to do. I think at the end of Q3, it’ll be all behind us, but the fact of what’s occurred in Q2, there’s a lot to getting this issue behind us. And we’re going to continue to work hard to make sure there’s no issue left by the end of Q3.

Chad Bennett: Right, got it. And then, just shift into the locking side of the business, I think you talked about locking growth of roughly 10% year-over-year. Just in terms of kind of sell-through there and demand there, were there any changes in demand in that business? And then, I think you highlighted the verticals that you’re seeing strength in. Should we think about that business differently from a growth rate relative to what you did this quarter, or was this quarter kind of an anomaly there?

Kevin Buchel: Locking has done well for several quarters in a row, maybe last, even, couple of years in a row. So, nothing unusual that gave us the strength. What’s great is we have two locking companies. We have Alarm Lock and we have Marks, and both of them are firing on all cylinders. And that’s why we’re seeing the success in locking. So, we expect that to continue for many quarters to come.

Chad Bennett: Got it. And then, maybe last one for me. EBITDA margins look phenomenal, continue to improve in the low-30%s, I think, again, at least ahead of what I was thinking. I know we had some finance and accounting costs that rolled in this quarter, potentially maybe incrementally more rolling in in the next quarter, but it seems to me like EBITDA margins are likely going from the low-30%s to the mid-30%s in a short period of time. Is that a fair assessment, Kevin?

Kevin Buchel: Yeah, well, we’re at 32%. We’re well on our way to the 45%. It’s going to take more time. We won’t get to the 45% obviously by the end of this fiscal year. But when you have 40% of your revenue generating 90% gross margins, which is what we have, the recurring now being roughly 40% of total revenues, that takes you a long way to getting to where we want to go. And we’re going to keep adding, obviously, to that recurring. And we think the margins will get better on the hardware as we progress through the rest of the fiscal year. Between those two events, there’s no reason why we shouldn’t see the EBITDA margin go even higher in this fiscal year.

Chad Bennett: Got it. Thanks. Nice job on the quarter.

Kevin Buchel: Thanks, Chad.

Richard Soloway: Thank you.

Operator: Your next question comes from Jaeson Schmidt from Lake Street. Please go ahead.

Jaeson Schmidt: Hey, guys. Thanks for taking my questions. Kevin, just curious if you could share with us some of the sell-through metrics you saw your distributors in the December quarter.

Kevin Buchel: We saw, on the intrusion size, a big improvement from the two distributors who we’ve been referring to as being the ones that had the excess radio inventory. So that was — we expected that to occur. It occurred faster than we thought. One in particular, they just did a phenomenal job working their way through. So, their sell-through stats were great. And the sell-through stats for most of the intrusion is much better than it’s been. Not back to where it was. No, we’re not 100% to where we were, say, a year ago, but we are much better than where we were a quarter ago. And we expect that to continue as we continue to help our distributors promote products, help them move radios. We’re coming out with additional radios that are going to give us recurring.

So, we’re doing a lot of things that are going to help the sell-through. And the sell-through stats with locking continue to do well. We watch all these stats every week, every month. We watch the inventory levels for all of our distributors. We’re pretty pleased the way things have been going right now.

Richard Soloway: We want you to understand that our radios, which generates the recurring subscription revenue, has tremendous opportunities because you have millions of commercial buildings that are still operating on the old legacy copper. And our radios are the best choice for the dealers. They have a lot of features that the dealers like. So, it’s really supercharging the Fire radios. Additionally, there’s many, many small business residential jobs that need our radios also. So, we make a line of those radios. Millions and millions of jobs are out there that are operating on copper that have to be converted over over the next few years. And then, you have all of our products with the radios built in. The Fire panels, it’s built in.

The new Prima, it’s built in. And those jobs are for new work. So, there’s a lot of opportunities for us. And it’s a very, very exciting future. And you can feel what’s going on by taking a look at our numbers. And we expect this to continue to our 2026 goal of $150 million recurring. So that’s the future for us.

Jaeson Schmidt: Okay, that’s really helpful. And I know you mentioned that you think the radio inventory issue will be behind you after Q3, but just curious if your own higher cost inventory should largely be chewed through by then as well.

Kevin Buchel: Yes. The higher cost should be behind us. Besides working on inventory at distributors, we’re working on getting the inventory that we possess, getting through that as well. And so, if it’s not gone by Q3, I think most of it will be, maybe there’ll be some in Q4. But most of our inventory now is more normally costed. Days of the crazy high costs caused by the supply chain are mostly behind us.

Jaeson Schmidt: Got you. That’s it for me. Thanks a lot, guys.

Kevin Buchel: Thanks, Jaeson.

Richard Soloway: Thank you.

Operator: Your next question comes from Jim Ricchiuti from Needham & Co. Please go ahead.

Jim Ricchiuti: Hi. Thank you. Question, I wanted to go back again to the sequential growth in radios, and admittedly, this is somewhat of an easy comparison, but to what extent are you seeing any benefit on the radio side from the addition of the new distributor, or is it also just in combination with the improved sell-through in general?