Napco Security Technologies, Inc. (NASDAQ:NSSC) Q4 2023 Earnings Call Transcript

Napco Security Technologies, Inc. (NASDAQ:NSSC) Q4 2023 Earnings Call Transcript August 30, 2023

Operator: Welcome to the NAPCO Security Technologies Fiscal Q4 and Fiscal 2023 Earnings Call. Our host for today’s call is Patrick McKillop, Vice President of Investor Relations. At this time, all participants will be in a listen-only mode. Later, we will conduct a question-and-answer session. I would now like to turn the call over to your host, Mr. McKillop, you may begin, sir.

Patrick McKillop: Thank you. Good morning. My name is Patrick Mckillop, Vice President 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 fourth quarter and fiscal year 2023. By now, all of you should have had the 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, Executive Vice President and CFO. Before we begin, let me take a moment to read the forward-looking statement. 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.

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These forward-looking statements include, without limitation, statements relating to growth drivers of the company’s business, such as school security products and 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 SaaS 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. We 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 just want to mention that we will be attending the Lake Street Capital Conference on September 17 in New York and are planning for some non-deal road shows in the near future. Dick, the floor is yours.

Richard Soloway: Thank you, Patrick. Good morning, everyone, and welcome to our conference call. Thank you for joining us today to discuss our results. We are very pleased to report our fiscal fourth quarter record sales of $44.7 million, which was the 11th consecutive quarter of sales growth. Our fiscal year 2023 sales of $170 million were also a record. Recurring revenue continued to grow at a strong rate and the annual run rate is now approximately $67 million based on July 2023 recurring revenues. Our balance sheet remains strong with our cash balances at approximately $67 million and we have no debt. Also, we are pleased to report the company announced its quarterly dividend of $0.08 per share to be paid on September 22, 2023 to shareholders of record on September 1, 2023.

This represents an increase of 28% from the previous quarterly dividend. We continue to focus on capitalizing on opportunities in our key end markets, which are mostly commercial, such as office and apartment buildings, retail stores and restaurants, schools, hospitals, airports and government buildings. Our product lines such as wireless fire and intrusion alarms, school security solutions, enterprise access control and architectural locking products are delivering growth to our sales, and we are working every day to continue this growth pattern. The key metrics that the management team here at NAPCO focuses on are growth, profits and returns on equity and controlling costs. These metrics are important for us as well as our shareholders. We look forward to continuing our growth streak in fiscal 2024 and beyond.

Before I go into further detail, I will now turn the call over to our CFO, Kevin Buchel. He will provide an overview of our fiscal fourth quarter and fiscal 2023 results, and then I’ll be back with more on our strategies and outlook. Kevin?

Kevin Buchel: Thank you, Dick, and good morning, everybody. Net sales for the three months ended June 30, 2023 increased by 3% to a quarterly record $44.7 million as compared to $43.2 million for the same period a year ago. Net sales for the 12 months ended June 30, 2023, increased by 18% to $170 million as compared to $143.6 million for the same period a year ago. Recurring revenue for the quarter increased 27% to $16.1 million as compared to $12.7 million for the same period last year. Recurring revenue for the 12 months ended June 30, 2023 increased 30% to $59.9 million compared to $46 million for the same period a year ago. Our recurring service revenues now have a prospective annual run rate of approximately $67 million based on July 2023 recurring service revenues, which compares to the $63 million run rate based on April 2023 recurring service revenues, which we reported back in May.

Equipment sales for the quarter decreased 6% and to $28.6 million as compared to $30.5 million for the same period last year. This decrease was primarily due to a decrease in radio sales as partially offset by increases in both our Alarm Lock and Marks door locking products. The slowdown in radio sales in Q4 was primarily the result of excess inventory in the distribution channel as several distributors loaded 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. We believe this 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.

Equipment sales for the year ended June 30, 2023, increased 13% to $110 million as compared to $97.6 million in the prior year. This increase in equipment sales was primarily due to increased sales of Alarm Lock and Marks door locking products as well as Continental Access Control products as partially offset by the aforementioned slowdown in radio sales. Gross profit for the three months ended June 30, 2023 increased 20% to $23 million with a gross margin of 52% as compared to $19.2 million with a gross margin of 44% for the same period a year ago. Gross profit for the 12 months ended June 30, 2023, increased by 24% to $73.2 million with a gross margin of 43% and as compared to $59.2 million with a gross margin of 41% for the same period a year ago.

Gross profit for equipment sales for the three months ended June 30, 2023, increased 7% to $8.7 million with a gross margin of 30% as compared to $8.1 million with a gross margin of 27% for the same period a year ago. Gross profit for equipment sales for the 12 months ended June 30, 2023, increased 4% to $19.9 million with a gross margin of 18% and as compared to $19.1 million with a gross margin of 20% for the same period a year ago. Gross profit for recurring revenues for the three months ended June 30, 2023 increased 29% to $14.3 million with a gross margin of 89% as compared to $11.1 million with a gross margin of 87% for the same period a year ago. Gross profit for recurring revenues for the 12 months ended June 30, 2023, increased 33% to $53.4 million with a gross margin of 89% as compared to $40 million with a gross margin of 87% for the same period a year ago.

The increase in gross profit dollars for equipment sales for both the 3 and the 12 months ended June 30 and 2023 as well as the gross margin for equipment sales for the three months ended June 30, 2023, is primarily the result of higher locking sales, which also increased overhead absorption as partially offset by lower radio sales as well as higher prices of certain component parts. The company purchased these higher-priced components at a significant premium during the supply chain interruptions during the latter part of fiscal 2022 in order to continue to supply the company’s radios that lead to the increased recurring revenue. The price of these components began decreasing during fiscal 2023, but was the primary reason for the 200 basis point reduction in equipment margins for fiscal 2023 as compared to the prior year.

The increase in gross profit dollars for recurring service revenues for both the 3 and the 12 months ended June 30, 2023 was due to the sales of the company’s line of StarLink radios, which represents approximately 20% of total hardware sales. The continued increase in the gross margin for recurring revenue for both the three and the 12 months was primarily due to increased 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 increased 14% to $2.4 million or 5% of sales as compared to $2.1 million or 5% of sales for the same period a year ago. Research and development costs for the 12 months increased 16% to $9.3 million or 5% of sales as compared to $8 million or 6% of sales for the same period a year ago.

The increase in dollars was due primarily to salary increases and some additional staff. Selling, general and administrative expenses for the quarter remained relatively constant at $8.9 million or 20% of net sales as compared to $8.9 million or 21% of net sales for the same period last year. Selling, general and administrative expenses for the 12 months increased 2% to $33.6 million or 20% of net sales as compared to $32.9 million or 23% of sales for the same period last year. Operating income for the quarter increased 44% to $11.8 million as compared to $8.2 million for the same period last year. And operating income for the 12 months ended June 30, 2023, increased 66% to $30.3 million as compared to $18.2 million for the same period last year.

The company’s provision for income taxes for the three months ended June 30, 2023, increased by $1.1 million to $1.6 million, with an effective tax rate of 13% as compared to $476,000 with an effective tax rate of 6% for the same period a year ago, and the company’s provision for income taxes for the 12 months ended June 30, 2023 increased by $1.9 million to $4.1 million, with an effective tax rate of 13% as compared to $2.2 million with an effective tax rate of 10% for the same period a year ago. The increase in the provision for income taxes for both the 3 and the 12 months was primarily due to higher taxable income. The increase in the effective tax rate from 10% to 13% was primarily due to $3.9 million in nontaxable income from a onetime extinguishment of debt incurred in fiscal 2022 income.

Net income for the quarter was a quarterly record $10.6 million or $0.28 per diluted share as compared to $7.5 million or $0.20 per diluted share for the same period last year, a 40% increase, and it represents 24% of sales. Net income for the 12 months was $27.1 million was $0.73 per diluted share as compared to $19.6 million or $0.53 per diluted share for the same period last year. That’s a 38% increase, and it represents 16% of net sales. Adjusted EBITDA for the quarter was a quarterly record $13 million or $0.35 per diluted share as compared to $9.3 million or $0.25 and per diluted share for the same period last year. That’s a 41% increase, and it equates to an adjusted EBITDA margin of 29%. Adjusted EBITDA for the 12 months was $34.3 million or $0.93 per diluted share as compared to $22.6 million per diluted share for the same period last year.

That’s a 52% increase and equates to an adjusted EBITDA margin of 20%. Net income and earnings per share for last year’s 12-month period reflect other income of $3.9 million, which resulted from the aforementioned extinguishment of debt during the quarter ended September 30, 2021. Without such benefit, net income and earnings per share for the 12 months ended June 30, 2022, would have been $15.7 million and $0.43, respectively. Moving on to the balance sheet. At June 30, 2023, the company had $66.7 million in cash and cash equivalents, other investments and marketable securities, and that compares to $46.8 million at June 30, 2022. Working capital, defined as current assets less current liabilities, the $111.7 million at June 30, 2023, and that compared with working capital of $93.1 million at June 30, 2022.

The Current ratio, defined as current assets divided by current liabilities, was 6.7:1 at June 30, 2023, and it was 4.5:1 at June 30, 2022. The Cash provided by operating activities for the 12 months ended June 30, 2023, was $24.7 million, and that compared to $8.3 million for the same period last year. and that’s a 198% increase. CapEx for the quarter was $1.2 million versus $293,000 and in the year ago period. And for the 12 months ended June 30, 2023, was $2.96 million compared to $1.5 million in the prior year period, and we have no debt. Finally, due to the previously announced need to restate the first, second and third fiscal quarters of fiscal 2023, the company will delay filing its Form 10-K for up to 15 calendar days. We will file the amended 10-Qs as soon as the restatement process is completed with our current expectation being sometime this week.

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

Richard Soloway: Kevin, thank you. For fiscal year 2023 showed continued growth with record sales and profits, and we look forward to breaking our previous record of 23 consecutive quarters of growth, which we had prior to the COVID pandemic. We are not satisfied with the equipment margins of 18% during our fiscal 2023. However, we are pleased to have generated $27 million in net income which is 16% of net sales. Also $34 million in adjusted EBITDA, equaling 20% EBITDA. Margins is another positive takeaway from the fiscal year results. As we enter into fiscal 2024, we believe that most of the additional material and freight costs due to the supply chain crisis are behind us. This should bode well for improved equipment margins.

The commercial fire log business is a mandatory nondiscretionary items. Commercial buildings must have and maintain a fire alarm system in order to receive the certificate of occupancy. Given the high profitability and essential nature of this business, we focus on this as a key area of our resources. Recurring revenue generated growth, increasing 27% for the quarter and 30% for the fiscal year. The annual run rate for recurring revenue is now approximately $67 million as of July 2023. We estimate that there are millions of commercial buildings of all types such as offices, hospitals, schools, coffee shops, gas speed restaurants and others that still require upgrades from old-fashioned copper phone lines. Our StarLink radios have the widest coverage for both AT&T and Verizon service and which feature sets, which our dealers love.

We continue to focus on our previously mentioned goals of $150 million run rate in recurring revenue and $150 million of equipment revenue by the end of fiscal 2026. While the exact time frame for hitting these goals is uncertain, achievement of those goals as well as our gross margin goals of 80% to recurring revenue and it was 89% for fiscal 2023 and 50% of equipment revenues could generate EBITDA margins in excess of 45%. Full administration are focused on the needs of security solutions as more school shootings continue to happen. We were pleased to learn that recently University of Arizona recently installed over 700 Trilogy electronic locks on the campus. Our fully integrated solutions to the school security sector generate healthy margins for our business.

And now more than ever, we are laser-focused on further penetration of the school security market. which is comprised of approximately 130,000 K-12 schools and 5,000 colleges and universities across the country. Offering seamless security solutions, which allow for our dealers and us to generate recurring revenue streams is central to our strategy. The recently launched Air Access product will enable us to generate recurring revenue from all divisions of the company. Air Access will generate recurring revenue from locking and access control, which has never been done before. Air Access is the industry’s first cellular-based access control system which we believe is a large market opportunity. The product continues to make strides in the market, and we expect more momentum in the future as our sales teams are actively educating unlocking and access control dealers, about this new exciting opportunity for them with air access.

At the recent ISC West trade show back in March, we unveiled a new product with a built-in recurring revenue radio. It is called PRIMA, which we and our thousands of dealers are very excited about. PRIMA is a revolutionary super-long panel with a full color, 7-inch LCV touch screen for security, fire, video and automation, featuring intuitive use and set up smart with self-healing WiFi and video and door bells that prevent dealer service goals and at a very powerful back end. PRIMA also was named on security sales and Integration magazine as the most valuable product in 2023. We expect to have this available to dealers in early fiscal 2024. Our R&D team remains hard at work developing even more products for the future, which will help grow our recurring revenue business.

We’ve experienced tremendous success over the last several years, growing our recurring revenue and believe the growth we have witnessed will continue at a healthy rate. Lastly, I mentioned earlier, we are excited to announce the increase in our quarterly dividend by 28% to $0.08 per share to shareholders of record on September 1, 2023. We believe that it is important to balance our capital allocations priorities, including investing in growth opportunities, maintaining a strong balance sheet and returning capital to our shareholders. We will begin our question-and-answer portion of this call in a moment. Our fiscal year 2023 generated strong sales and profitability. There is a pristine balance sheet and no debt. We believe we can continue this growth in fiscal 2024 and beyond.

I would like to thank everyone for their support and for joining us in the exciting future we have. Our formal remarks are now concluded. We’d now like to open the call for a Q&A session. Operator, please proceed.

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Q&A Session

Operator: [Operator Instructions] And our first question comes from Jim Ricchiuti from Needham & Company. Your line is open.

James Ricchiuti: Hi, thank you. Good morning. So I wanted to talk a little bit about the puts and takes in the radio business. I mean it sounds like you continue to see strong demand for fire radios and where the overhang is in the channel is on the intrusion StarLink radios. So two questions. Number one is, can you talk a little bit about how you see the channel inventories being worked down on the – for the intrusion StarLink radios, what kind of sell-through are you hearing from your channel partners? And then I have a follow-up question as it relates to the fire radio business.

Kevin Buchel: Okay, Jim. So we get statistics from our key distributors that we watch very closely. And what we see with a couple of these distributors, not all of them, is a glut of inventory on the smaller radio and it seems to have come about because they loaded up on radios during the height of the preparedness for the 3G sunset. 3G sunset for Verizon was January 2 or 3 of 2023. Nobody wanted to really get caught short, and not everybody could deliver radios. We’ve talked about this on prior calls. We were able to deliver when others couldn’t and that ability to deliver has helped us. We’ve picked up more business, some large accounts, which we’ve talked about. But these distributors, they didn’t want to get caught short, they bought up a lot and they bought it for – because of the 3G sunset because of lack of delivery from others.

And now they have too much because now the things have settled down, the 3G sunset is finished. They have to work that inventory down and we’ll help them. This happens periodically all the time. The demand for radios as a whole is very good. That’s why you saw it grew by 27% for the quarter versus a year ago. That’s why the run rate went from $63 million to $67 million, and we can’t judge the strength of recurring revenue based on a couple of distributors having too much of one type of radio. So we’ll work with them to move it, we believe it will move, and we still feel very good and confident about our recurring revenue and its growth for the future.

Richard Soloway: Let me add one more thing. So the radios that Kevin is talking about are the low-cost residential, small business pizzeria-type radios, and that business is moving along but we had to supply into the distributors because they ask them, and we produce a a lot of them. They’re a little backed up. But what we – and that is a radio that’s added to an existing alarm system to replace the copper. So we expect that to continue. The sell-through has been – is good on that. But the glut will be eroded down and will get more normalized. At the ISC show out West a few months ago, we showed the entire alarm system with a built in StarLink radio and with technology beyond everything in the marketplace, it was a tremendous hit.

So that radio, that black radio is now being built into a complete control panel for automation, residential, small business, and that will be out in the next 60 days. So what’s going to be contributing to the recurring monthly revenue is not only the sell-through of the black radios, which upgrade the existing alarm systems from copper, but it’s also this brand new, unique, alarm panel radio, which will be the new work. And these are the type of things we do in our engineering department with [eight] (ph) additional products, which are going to add a lot of recurring revenue to the company going forward. And it’s a very exciting future we have with this. And I want everybody to understand that. The black radios are for retrofit. And that will continue because you’ve got millions of jobs that still need to be upgraded.

And the new PRIMA radio is a complete alarm system for new jobs and you know that people need more security than ever before, we need security for homes, we need security for businesses, and that’s what PRIMA will do with a built-in recurring radio, where we get recurring revenue as well as a dealer. So that’s how the picture looks.

James Ricchiuti: Got it. Just with respect to PRIMA, let me just ask the question. What kind of expectations do you have for this product? And maybe Kevin, how would you characterize the margin profile of this product. And then lastly, just on the fire business, fire radio business. Do you anticipate – you’ve had several strong quarters. Does this begin to plateau for you?

Kevin Buchel: Fire radios – you’re going to answer Dick?

Richard Soloway: You do the fire radios please, and then I’ll talk about the PRIMA and what its potential is.

Kevin Buchel: Fire radios, talked about this, is mandated. It has to be – you have to have a working fire radio in a building. They got to get away from copper. This is what we keep talking about that there’s a lot of buildings and buildings are not just high rises when you think of a building, think of buildings coming in all sizes and shapes. They all have to get away from copper. Copper is not being supported. So we believe, A, it’s mandated, B, they have to get away from it. And C, there’s millions more to come, more changes to come. So as a result of that, yes, fire radios, we believe is going to continue to be strong for years to come. It’s our number one radio, has the best margins, more than 50% of our total radios.

You see what our margins are in recurring revenue. The 89%, it was 89% for the whole year. That’s because fire radios because we get more money for fire radio than the other types. So we believe this strength is here, and it’s not going anywhere. And don’t read into anything because of a lot of inventory on the black radios, fire has moved very nicely – continues to move. Now when we – Dick will talk about PRIMA, when we sell PRIMA, the recurring revenue on that is not like it is for fire radios. It’s less but it’s incremental recurring revenue. When we did our 150 goals of recurring and hardware sales, we weren’t counting on PRIMA, we didn’t even know about PRIMA. PRIMA is new, it’s incremental recurring revenue. It will help us get to our goals that much sooner.

We do get less per month than we would for a fire radio. So my goal for recurring revenue when I first did the goals was 80%. We’re at 89%. We’ve got plenty of room between the goal and the actual. So we’ll watch it. We’ll see how it goes with the recurring from PRIMA.

Richard Soloway: Right. So PRIMA is the new work. The black radio is the retrofitting the copper. I figure we got 5 to 8 years of retrofitting copper with black radios because there’s millions and millions of jobs that have to be done and the dealers are doing in as necessary. A lot of dealers don’t go out and speak to their customers about upgrading away from copper. They wait until there’s an event, maybe the phone company turns off the copper on these issues with the cracking old copper lines and then they go in. Some dealers go in and start promoting right away. But we have a great radio in the black radio, and it’s moving out nicely. But the deal is putting a lot of new jobs. And our new PRIMA is for new work. And what’s going to happen is there are millions of jobs that have to be done with new radios – new radio panels.