Greetings and welcome to NAPCO Security Technologies Third Quarter 2018 Results Conference Call. At this time, all participants will be in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to, Patrick McKillop, Director of Investor Relations. Please go ahead.

Thank you. Good morning. My name is Patrick McKillop. I'm the Director of Investor Relations for NAPCO Security. Thank you all for joining us for today's conference call to discuss our financial result for our fiscal third quarter 2018. By now, all of you should have had an opportunity to review the press release discussing the results. If you have not, a copy of the release is available on the Investors Relations section of our website, www.napcosecurity.com. On the call today is Richard Soloway, President and CEO of NAPCO Security Technologies, and Kevin Buchel, Senior Vice President and CFO. Before we begin, let me take a moment to read the forward-looking statement. This conference call may contain forward-looking statements that involve numerous risks and uncertainties. Actual results, performance or achievements may differ materially from those anticipated in such forward-looking statements as a result of certain factors, including those set forth in the Company's filings with the SEC. During the call, we may also present certain non-GAAP financial measures such as adjusted EBITDA and certain ratios that are used within these measures. In the press release and on the financial tables issued earlier today, you'll find a definition of these non-GAAP financial measures, a reconciliation of these non-GAAP financial measures with the closest GAAP financial measure, as well as a discussion about why we think these non-GAAP financial matters are relevant to our results. These financial measures are included for the benefit of investors and should not be considered instead of GAAP measures. I will turn the call to Dick in a moment, but before I do, I just want to mention a few things on the IR front. In terms of our upcoming Investor outreach, we are marketing in Milwaukee this week. If you would like to meet, please contact me to arrange a meeting. Also, we will be presenting at the Robert Baird Conference on June 7, in New York City. Investor outreach is crucial especially for small cap companies such as NAPCO and I would like to thank all those folks that assist us in these conferences and marketing trips. With that out of the way, let me turn the call over to Richard Soloway, President and CEO of NAPCO Security Technologies. Dick, the floor is yours.

Thank you, Patrick. Good morning everyone and welcome to our conference call. Thank you for joining us today to discuss our results. The third quarter of fiscal 2018 marked another record revenue performance in NAPCO. This quarter marks the 15th consecutive quarter of increased sales growth for the Company. Our past recurring revenues continue to grow at a rapid rate. During the third quarter of 2018, our recurring revenues increased 49%. The driver of the growth for recurring revenue continues to be, all of our StarLink offering which includes Intrusion, Fire and Connect. The annual run rate is now $12.9 million. During the third quarter, our investments in R&D, selling and marketing expenses did not increase during the quarter versus the year ago period. The levels and investment for R&D and SG&A, items we believe are not at the appropriate levels and we are beginning to see the return on these investments as evidenced by a 92% increase in net income. Our balance sheet remains strong with net debt of zero and healthy cash balances. We remain focused on capitalizing on key industry trends. These trends include the creation of school security and safety product, the smart connected home and recurring revenue growth in cellular alarm communication. All these trends are having a positive impact on our result. Driving growth, profit and returns on equity are important to us and our shareholders. Our business strategy is executing well and our interests are aligned with our shareholders as senior management of NAPCO owns 38% of the equity. Before I go into greater detail, I'll now turn the call over to our CFO, Kevin Buchel to provide an overview of our fiscal third quarter financial results, and I'll be back with more on our strategies and outlook. Kevin?

Thank you Dick and good morning everybody. So, the third quarter net sales increased 7% to $22.2 million, which was a record third quarter performance. For the nine-months ended March 31, 2018, net sales increased 5% to $64.4 million. The increase in sales for the three-months ended March 31, 2018, we assume primarily to increase recurring service revenue, access control products and door locking products. For the nine months, the increase in sales was due primarily to increased recurring service revenue as well as increased sales from access control product. Gross profit for the third quarter increased 6% to $8.9 million and for the nine-months increased 5% to $25.9 million. I'd like to point out that research and development expenses are now shown separately as part of our operating expense and are no-longer included in cost of goods sold. We believe this is a clear presentation and we've made this reclassification for all prior periods as well. So, under this new presentation, the gross margin for both the third quarter and the nine-month ended March 31, 2018 was 40.1% as compared to 40.2% and 40% for the three and nine month last year, respectively. As Dick mentioned, our R&D and SG&A spend levels did not increase significantly versus the year ago period, and we know believe that we're at the appropriate level. R&D expenses for the quarter were relatively constant at $1.78 million, or 7.5% of sales as compared to $1.7 million or 8.2% of sales last year. For the nine months, R&D expenses were also relatively constant at $4.9 million or 7.6% of sales as compared to $4.9 million or 8% of sales last year. SG&A cost for Q3 decreased 3.9% to $5.3 million or 23.9% of sales as compared to $5.5 million of 26.6% of sales last year.…

Thanks Kevin. The two paradigm shifts in our business that we have been continuing to highlight are school security and the growth of our SaaS recurring revenue, remain as positive forces in our business. Early in the call, while discussing our financial results for the quarter, we highlighted the strong growth of our SaaS recurring revenue. We continue to see demand coming from alarm communications, the connected home category and the overall expansion of the Internet of Things theme. The school security opportunity continues to remain significant for us. As a reminder, the total addressable market is very large with over 100,000 K-12 schools and over 10,000 houses and universities in the USA. Many of these schools have little or no security in place to protect them from the constant threat of violence incidences. We believe that going forward the amount of new spending on security and safety products from school will continue at a strong rate for the foreseeable future. Last month, we attended ISC West trade show in Las Vegas, which had another record year for attendance. During this show, we met with many of our channel partners and targeted new channel partners. These relationships are important to us. Our R&D staff is always hard at work developing new products that will help our channel partners grow and succeed. Dealer training by us continues to be hosted throughout the country and attendance remains high which is significant as we want to have as many dealers selling our product as possible. As a reminder, we mentioned last quarter that we were voted one of the best intrusion brands alongside industry titans such as Honeywell and Bosch, during a survey that was completed by Security Sales & Integration magazine which is the top industry publication. We are very proud of…

Thank you. [Operator Instructions] Thank you. The first question today is coming from the line of Mike Walkley with Canaccord Genuity. Please state your question.

Great. Thanks for taking my question. Thanks for breaking out the R&D. How do you guys think about the current levels of operating expenses in terms of supporting a business growth going forward? And you hinted some new product introduction. So do you think is the R&D levels to support your new product portfolio?

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

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

Great. Congratulations on a strong quarter in leveraging the model. Just in terms of, you talked also about sourcing new components and leverage that could create on the gross margin line. Can you talk about how easy or how quickly it would take to switch components and maybe that time horizon where you could see that seven figure savings coming through the cost of goods sold line?

The savings will be contributing over the next 24 months. It will accelerate, I would guess after about nine months because we have to get the components check and make sure there are exactly the quality we need and then filter them into the assembly line, so that you can get the savings. So I would say the seven figures are very reasonable, and I think we can do that. It was a very exciting trip. We found all the components that we use directly with Asian sources and could make a big difference to our gross profit.

And these saving are recurring, another form of recurring. You know, you save it, you save it over and over and over again, which is a great thing.

Now it makes sense. And then you highlighted on the call just to the school safety, pipeline growing. Can you help us think about the pipeline maybe now versus a year ago? And how you see that business opportunity improving over time?

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

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

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

Thank you.

Thank you, Mike.

The next question comes from the line of Gary Mobley with Benchmark Company. Please go ahead with your questions.

Good morning gentlemen. Dick, you mentioned Verizon based LTE StarLink product just launched. And can you help us understand significance of this products in terms of addressable market, in other words, did you not have the Verizon based cellular connectivity in these products in the past, does it give you a new avenue to sort of distributors, value at retailers, et cetera?

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

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

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

Okay. Thank you guys.

You are welcome Gary.

Thank you.

The next question is from the line of [indiscernible] with [indiscernible]. Please proceed with your question.

Yeah, quick question. Could you quantify the size of the school security market, how big is it from a developed point of view?

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

Thank you.

Thank you.

[Operator Instructions]. Thank you. At this time, we have no additional question. I'd like to turn the call over to management for further remarks. Thank you everyone for participating in today's conference call. As always, if you have any further questions, please feel free to call Patrick, Kevin or myself for further information. We thank you for your interest and support and we look forward to speaking to all of you again in a few months to discuss NAPCO's fiscal Q4 2018 results. Bye-bye have a great day.

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