Napco Security Technologies, Inc Q2 FY2024 Earnings Call

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. 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.

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. 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, and our ability to control expenses and costs. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those contained in the forward-looking statements. We believe that the expectations reflected in the forward-looking statements are reasonable, but 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 by law. I will now turn the call over to Richard Soloway, President and CEO of NAPCO Security Technologies. Dick, the floor is yours.

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, 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.

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. Net sales for the six months ended December 31, 2023 increased 9% to a six-month record of $89.2 million. 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 service revenues now have a prospective annual run rate of approximately $76.5 million based on January 2024 recurring revenues. Equipment sales for the quarter increased 6% to $29 million as compared to $27.4 million last year 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. Gross profit for the three months ended December 31, 2023 increased 74% to $25 million with a gross margin of 53%. Research and development costs for the quarter increased 14% to $2.5 million. Selling, general and administrative expenses for the quarter increased 11% to $8.7 million. Operating income for the quarter increased 219% to $13.8 million. Net income for the quarter increased 221% to a quarterly record $12.6 million, or $0.34 per diluted share. Adjusted EBITDA for the quarter increased 191% to a quarterly record $15.1 million. Cash provided by operating activities for the six months ended December 31, 2023 was $18.7 million. The company had $79 million in cash and cash equivalents as of December 31, 2023, and we have no debt. That concludes my formal remarks, and I would now like to return the call back to Dick.

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% that represents approximately 40% of total company revenues. 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. 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 an increase in the annual run rate for recurring revenue, which increased to $76.5 million. We believe we are well on our way to achieving our adjusted EBITDA margin target of approximately 45% by the end of fiscal 2026. 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. 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. 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. Thank you for your support and for joining us.

Your first question comes from Chad Bennett from Craig-Hallum. Please go ahead.

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?

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. 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.

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?

Locking has done well for several quarters in a row, maybe the last 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.

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?

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% 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. We think the margins will get better on the hardware as we progress through the rest of the fiscal year.

Got it. Thanks. Nice job on the quarter.

Thanks, Chad.

Thank you.

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

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

We saw, on the intrusion side, a big improvement from the two distributors who we've been referring to as being the ones that had the excess radio inventory. 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, 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.

We want you to understand that our radios, which generate recurring subscription revenue, have tremendous opportunities because you have millions of commercial buildings that are still operating on the old legacy copper. 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.

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.

Yes. The higher cost should be behind us. We're working on getting the inventory that we possess, getting through that as well. If it's not gone by Q3, most of it will be. 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.

Got you. That's it for me. Thanks a lot, guys.

Thanks, Jaeson.

Thank you.

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

Hi. Thank you. Question, I wanted to go back again to the sequential growth in radios, 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?

It's both, Jim. Adding the new distributor certainly helped. But it's not like we loaded up this new distributor to give us a one-time hit improvement to radio sales. We sold this new distributor normal amounts. It's a contributor. But besides that, the contribution we saw was helping the other distributors move through their inventory.

There's going to be 30,000 security installation dealers visiting us in Las Vegas, which is the biggest show. Our new products will be right there. So, we're going to get a lot of leads. And as I said, there are millions of jobs that have to be upgraded from legacy copper. There are huge numbers of jobs of new work that have to be installed. So, we expect to get even more pull-through between our existing distributor base and our new distributor.

Hey, Dick, what kind of traction are you seeing from Prima? I know it's early days yet, but what's the initial read on how the product is doing?

I think that the product has tremendous legs to it. The product is beyond anything else in the security industry with its functionality, ease of installation. The Prima was designed so that the actual salesman that sells the job to the end user customer can install it in less than 15 minutes. We expect that considering that alarms are being put in, this will become a standard of the security industry. Every alarm that goes in that's Prima has a recurring revenue tail to it, so it's going to generate a lot more recurring revenue.

Got it. Final question for me. Kevin, just looking at the expense side, how much of the higher costs for the stepped-up financial controls were in the quarter, or is this going to be more fully reflected in the March quarter? And lastly, just on tax rate, should we assume a similar tax rate?

Some of the additional costs went into the SG&A in this quarter. We've only done one quarter with our auditors. We have our consulting firm, so that's filtered into the numbers. What you haven't seen yet are the additional employees. I expect that will start in Q3. Our tax rate has been around 13%. I continue to use 15% for modeling.

Okay. Thank you.

Thanks, Jim.

Your next question comes from Matt Pfau from William Blair. Please go ahead.

Hey, great. Thanks for taking my questions, and nice quarter, guys. I wanted to first ask on the new distributor that you added. How should we think about that going forward? Is there going to be an inflection or is this more of a slow ramp?

Yeah. Our distributor has been around a long time, with the 115 branches. We didn't load them up. This is a more normalized ramp up. Whatever impact they had in Qs one and two, we expect it to improve dramatically. They're the biggest security distributor out there. And we've only been dealing with them for a little bit of Q1 and all of Q2.

Got it. I know it's early, but are you seeing new installers start to use NAPCO products? And are you getting inbounds or developing relationships with new installers as a result of the new distributor agreement?

We're seeing new larger customers due to this arrangement. With introductions and the fact that our products are superior to what's on the marketplace, these new customers have said, 'Wow, I didn't realize the functionality we get and the ease of installation we get.' So, it's a great relationship because there are certain dealers that want to use this particular distributor.

Great. Thanks for taking my questions, guys. Appreciate it.

Thanks, Matt.

Your next question comes from Raj Sharma from B. Riley. Please go ahead.

Yeah, thank you. Congratulations on the nice quarter, guys. My question is on the growth rate for the next few quarters. Alarm and intrusion this quarter is about flat and locking was up 10%. Should we expect what kind of growth rate for the next few quarters? In-line or ramping up?

Alarm was actually up this quarter by about 5%. We want to aim for 10% or greater. This 6% that we were up for this quarter was encouraging, and we expect more due to Prima and the new distributor.

Great. And the locking is the similar sort of a growth rate or higher?

Locking has been higher, modestly at 10%.

Right. And next question is recurring revenues. The retention rates must be pretty high. Is there any sort of number on the retention rate or the number of devices that are live?

The retention rate is very high. Churn is insignificant. We're mostly commercial, and churn is inconsequential. There are roughly 750,000 radios generating the run rate of $76.5 million.

Got it. And the growth in recurring revenues, which products are contributing the most?

The Fire radios are the biggest contributor. Fire radios get the most on a monthly basis compared to the others. The others are great, too, but Fire is number one.

Got it. Regarding the sell-through at dealers, you mentioned it is improving. Overall, do you think the sell-through at dealers is up 5% or 10% now?

I think it's fair to say that it's up compared to what we expected. It's happening faster.

Got it. That's it for me. Thank you for answering my questions again.

Thank you, Raj.

Congratulations on a good quarter. Thanks.

And there are no further questions at this time. I will turn the call back over to the CEO, Richard Soloway, for closing remarks.

Thank you, everyone, for participating in today's conference call. Should you have any further questions, please feel free to call Fran, Kevin, or myself for further information. We thank you for your interest and support, and we look forward to speaking to you all again in a few months to discuss NAPCO's fiscal Q3 results. Have a great day, everybody. Bye-bye.

Ladies and gentlemen, this concludes your conference call for today. We thank you for joining, and you may now disconnect your lines. Thank you.