Greetings and welcome to the NAPCO Security Technologies Inc. Fiscal Second Quarter 2019 Results Conference Call. At this time, all participants are 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. It is now my pleasure to introduce your host, Mr. Patrick McKillop, Director of Investor Relations. Thank you. You may begin.

Thank you. Good morning. My name is Patrick McKillop and 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 results for our fiscal second quarter 2019. 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 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 with 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 measures 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 over to Dick in a moment, but before I do, I just wanted to mention a few things on the IR front. In terms of upcoming investor outreach, we will be marketing in Dallas on February 7 and on March 18, we will be attending the ROTH Conference in Dana Point, California. Also recently we received the new sell-side coverage from William Blair. Matt Pfau and his team did a great job on the report that was issued. Investor outreach is crucial especially for small cap companies such as NAPCO and I would like to thank all of 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 second fiscal 2019 marked another record revenue and profitability performance for NAPCO. We now have 18 consecutive quarters of year-over-year record sales. Our recurring revenue continues to grow at a rapid rate. The annual run rate is now $17.2 million as of December 2018. Our strategy of targeting professional installations and mostly commercial end markets is driving our continuous growth. Our balance sheet remained strong with zero debt as of this report and our cash balances continued to grow. We remained focused on capitalizing on key industry trends. These trends include smart connected home, recurring revenue growth in cellular alarm communication, and the creation of school security and safety products. The key metrics of growth, profits and returns on equity are equally important to both shareholders and the management team here at NAPCO. Our business strategy is executing well and our interests are aligned with our shareholders and senior management at NAPCO owns 38% of the equity. Before I go into greater detail, I'll now turn the call over to our CFO, Kevin Buchel, who will provide an overview of our fiscal second quarter financial results and then I'll be back with more on our strategies and outlook. Kevin?

Thank you, Dick and good morning everybody. For the second quarter net sales increased 18% to $24.8 million which was a record second quarter performance and the 18th consecutive quarter of year-over-year record sales as compared to $21.1 million last year. For the six months ended December 31, 2018 net sales increased 14% to $48.2 million as compared to $42.2 million last year. The increase in sales for the three and six months ended December 31, 2018 were primarily related to increased sales of our door locking products, alarm communications and intrusion products, and access products. Recurring monthly revenue increased 46% for the quarter to $4.1 million versus $2.8 million a year ago and for the six months increased 46% to $7.9 million from $5.4 million last year. Recurring revenue now has an annual run rate of $17.2 million based on December 2018 recurring revenue. Gross profit for the second quarter increased 26% to $10.7 million with a gross margin of 43% as compared to $8.5 million with a gross margin of 40% last year. For the six months gross profit increased 19% to $20.2 million with a gross margin of 42% as compared to $17 million with a gross margin of 40% last year. The increase in gross profit and gross margin for the three and six months was primarily due to the increase in sales. R&D expenses for the second quarter increased 8% to $1.8 million or 7% of sales compared to $1.6 million or 8% of sales last year. For the six months R&D expenses increased 8% to $3.5 million or 7% of sales as compared to $3.2 million or 8% of sales last year. The increase for the three and the six months is primarily due to increased salaries and some additional personnel. SG&A expenses to…

Kevin, thank you. We continue to be excited about the growth in our business which is being driven by the addition of recurring revenue and school security products. We expect that the growth trend in recurring revenue and school security as well as the other parts of our business to continue in the future. We continue to see demand for recurring revenue products coming from alarm communicators including fire, intrusion, and the growth of the smart home category. The topic of school security remains an important issue in the United States and we continue to believe there is a significant opportunity in this vertical. During 2018 there were 82 reported school shooting incidences at K-12 schools, the most since reporting of incidences restarted in 1970. As you all know, last year we witnessed many horrific school shooting tragedies. We remain dedicated to providing solutions and products that the schools so desperately need. We believe that this market is very large with over 100,000 K-12s and 10,000 colleges and universities in the U.S. In total, states have poured approximately $1 billion into school security since February 2018. As an example recently, Senator Clausen in Minnesota recently stated that he will be proposing legislation which will appropriate $500 million for violent protection and facility security. During 2018 Minnesota budgeted $25 million to school security and a grant request totaling 10 times that amount or roughly $250 million. The pipeline for school security projects looks robust and we will continue to announce new wins when we can as we need to receive approval from the schools prior to doing so. The professional alarm monitoring market will continue to grow over the next few years we believe as demand for connected systems over traditional systems continue. In the U.S. there are approximately 133 million…

Thank you. [Operator Instructions] Our first question comes from the line of Matt Pfau with William Blair. Please proceed with your question.

Hey guys, thanks for taking my questions and nice job on the quarter. I wanted to start off with the recurring revenue business and a nice result there in the quarter, maybe just an update on how you feel about attaining your $40 million in recurring revenue goal? And then relative to non-StarLink recurring revenue products when do you think we could start seeing contribution from those products in the results?

Thanks so much. Our goal is to come out with many new products which have a recurring revenue component and it all piles on to our successful result. We keep added new StarLink communicators, now we're adding integrated control panels with communicators inside of them and then at the ISC show we're going to show some new products and it's all part of our goal. So if you take the growth rate we've been talking about 45% and 50%, you compounded out we should be into the $40 million number in a couple of years.

Got it. And then I wanted to hit on the school security opportunity, it seems like that was a significant driver of some of the hardware outperformance in the quarter. These school shooting incidents have been happening for quite some time. Obviously 2018 was a bad year, but I guess where do you think in terms of the results in the quarter and what you're seeing in the pipeline, where are we at in terms of a tipping point in schools getting more serious about their security?

Well Matt, we've been saying that we saw the tide turning so to speak after the shooting Parkland in Florida about a year ago, it's February 2018. As a result of that it seemed to be a tipping point change where schools were waking up and finally doing something about this horrible problem school security. And so for us, we've seen a lot of quoting activity. We've had more wins. We've had more press release announcement. Sometimes they don’t let us announce it, but lot of times now they are and this is just the beginning we fee. But there's been a lot of money that's come down from government to schools to make it easier, especially K-12 was always faced with budget issues and the universities who have big endowments are starting to spend that money. So what you see this quarter I think is just the beginning. We think that there is a lot more to go. We talk of this and termed it early stages or early innings of school security, much more to come, much more to be done and we are there for the schools and I think you could expect to see more of this in the quarter to come.

Got it, and then just one more on the school opportunity, one of the deals you press released this quarter was the Lewisville ISD in Texas, that seemed like based on the press release a more comprehensive deal at least for a school district than you've done in the past, so maybe can you just talk about is, is that the case, what drove them to you perhaps purchase a more comprehensive set of products in other school districts and then you know is this - can this potentially be the trend going forward?

We like to cross sell in a lot of division and we're the only company that has locking, access control and alarm. Our business cards have a whole lot of different divisions and a brief description of what they do and when a school closes in for school safety and security, we always like to present the full NAPCO complement of product. And in this case they needed more burglary products, so our sister divisions did that job. That's kind of the MO that we're going for. Typically the security department or the locking department, lock shop department of the schools call you in. We have dealers and we have access control specialists in all these territories around the country because we have thousands and thousands of dealers, more than 12,000. We have 2000 – we have 10,000 security dealers, 2000 system integrators and they are in every territory. So they get called in and then they call us and we try to figure out what is the best mix of the products that will protect the school. So we go beyond a normal just school locking product, we go into fire, burglary, and access. And because we have a – the only company with that, and because we have a fusion, backbone network which is our software network everything integrates well together and the good – it helps us a lot. We try to sell the schools because we are one integrated solutions rather than dealing with a bunch of different companies, so they try to cobble together a system. So that's an advantage. So that's a big marketing push that we have going on here.

Great, and just one last one from me in terms of the hardware revenue, I believe this is the first non-fourth quarter to have hardware revenue over $20 million which is obviously an important mark for you guys. How should we think about this going forward, is this something that you think you can reach on a more regular basis now or was there something sort of one off in the quarter that where still a bit away before you can hit the $20 million hardware revenue in a non-fourth quarter on a more regular basis?

Long term goal in a couple years, couple or three years is to be $100 million worth of hardware revenue and $40 million with recurring monthly revenue. Put those together, you are talking about much greater profitability for the company. So this hardware growth this quarter is part of what you're going to be seeing going forward in the future. But our goal is, we don't look at it quarter-to-quarter, but it seems to be coming together pretty quick and we expect to hit our goals a couple of years out. And I think that Kevin has been modeling with you guys where we could be profitably wise and it's very, very positive for the company.

Great, that's it from me guys, I'll pass it on, thanks.

Thank you, Matt.

Thank you. Our next question comes from the line of Mike Walkley with Canaccord Genuity. Please proceed with your question.

Hi this is Anthony on for Mike. Thanks for taking my questions and congrats again on the strong quarter. Just in terms of your hardware gross margin expansion we saw was that attributed primarily to higher margin projects like – with the schools or are you starting to see some progress on the cost saving initiatives as far as like sourcing components from Asia?

It’s a combination Anthony. So we talked a lot about how we get leverage from our Dominican factory when it grows about a certain point. So when we're over the $20 million mark that's a key for us and so the leverage starts to kick in on getting margin expansion, overhead absorption, we saw that. We see a lot of that Q4, but when you go over $20 million you get to see it in other quarters. So you saw it in this quarter as well. The initiatives from Asia, that's begun as well. That takes time to get to true long term effect, but there is a little bit of that too. There's a lot more of that to come in the future. And also school jobs, they can be very profitable, depends on what the schools buy. We had some of that in this quarter also. So we had a little bit of everything, But if you get to the point where the $20 million level has exceeded then you get that margin expansion on the hardware side plus great margins on the recurring get both things working, you get numbers like you saw this quarter.

Got it, got it, great. And then on the R&D, it remained elevated I'd say relative to last year, somewhat of the Q1 levels and is this kind of uptick in investment. I think you had mentioned you know more focused on the recurring revenue side, any sense for the types of offerings we might expect? I know you had just mentioned in your prepared remarks, access control as a service, any other color you can provide on what's coming out of the R&D Investment there?

Oh, we talked about the integrated alarm, fire alarm systems with recurring revenue communicators inside. So there has been more of that type of things. And we'd like to get recurring revenue from all our divisions and we're very diligently to do that. We have 50 engineers now, we increased their engineering budget, so we could get more people and do these exciting thing. We have a lot of ideas and turn them into finished products. So it all bodes very well for our company for years and years to come. Everybody needs more security. We've got the creative concept and now we have more engineers, so we can turn more products out. I would say comes to the ISC show and see a couple of things which kind of be pretty, pretty revolutionary for our industry. And then you can talk to some of the dealers that are using our products see how they are going to be responding to the nil things we are going to be showing, so it could be a real eye opener.

Right, right and then just lastly from me, I'm just coming off the holiday quarter, any data points or callers from dealers on StarLink Connect, relative to some of the other…?

The StarLink Connect has a very, very large market. It’s a market that we are penetrating, it's a good contributor to our growth and it will continue for years and years. As you know, the StarLink Connect modernized 20 million, 30 million alarms that were sold previously by dealers before such a thing as connected home was invented. So if the StarLink Connect makes those symptoms which many of them were working fine, they just don’t have app control or thermostat blocks the lights and live video makes all of that available to those existing alarms and the dealers love it because they can be in and out of a premise in an hour, rather than days and days. We had to rip out the old alarms system and put a new modernized Connect home alarm. Now we're installing Connect which is all down in an hour and it's quite an innovation. It works on every brand of control panel that is out there that is going to install and includes like big would project here to get it done and it is reaping nice benefits for the company.

Thank you. Our next question comes from the line of Gary Mobley with The Benchmark Company. Please proceed with your question.

Hi guys, good morning. Congratulations to the strong quarter. Want to start asking about the accelerating RSR or previous known as RMR revenue. That quarter-to-quarter delta has been growing consecutively for the past three quarters and so I'm wondering if that is mostly a function of the two-way radios which I believe carries a fivefold increase over the normal or the average for the different radios?

We have very large assortment of radios now, because we make the original burglar radio which was small business in residential, stores, shopping centers and things like that and that was $5 to $9 a month. And then we have fire radios which get us up to $25 a month both single path and dual path fire radios and they've been just approved in the most strict jurisdiction, be it a replacement or leased phone lines that commercial buildings have to have. This is a comparative substitute. We get up to $25 a month for those. And then we have the connect radios which are the ones with a home automation hub built in, we get up to $13 for those. And now we came out with the StarLink with the integrated radio built into it, fire, commercial fire, big business for us, big new growth for us. And as we like to say, fire is on fire. So we expect more and more business from the integrated solutions that we offer the dealer. They go in very quick and a very modern don't have to rely on the telecommunications carrier. Now the dealer can make a profit by installing it that the money is going to the telecommunications company, it goes to the dealer and also the property owner. They split the difference that the telecom companies will normally be getting. So there are a lot of exciting things and at the ISC show we will show more exciting things with recurring revenues, so it's a good scenario for us and for our dealers and for people to be protected.

Okay, I know in the past you haven’t broken out the continental axis business attributes to the overall revenue, but I wanted to ask about the diversity of the Continental Access business or in general the building access security business? How much diversity was there in the quarter which contributed to the overall product revenue strength and any level of detail with respect to overall revenue contribution Continental Access will be helpful as well?

We break out the revenues somewhat and you'll see it when the Q is published. We combine our locking companies together, locking piece was up about 11% for the quarter and 7% for six months, recurring was up 46% for the quarter and it’s up 46% for the six months. The intrusion and access we combined that because they're kind of related if anyway and so the best I could give you in terms of a breakout is that piece was up 16% for the quarter and 13% for the six months comp. I think that everything was going also in this working.

So is the diversity of that growth was it driven by one or two specific installations?

I would say it was across the board. We always say we're not a one trick pony, we've got a lot of things going and was a lot of things clicking this quarter on all divisions, on all fronts, and that's what we work hard to do. We want everything clicking. We don't just want the recurring working; we want the hardware working, we want to each of the divisions within the hardware to do well. So there's more that can be done, we could do better even yet, like we've said earlier, the goal of $25 million quarters, $100 million hardware, that's our goal. We're going to work hard to hit that as fast as we can get there.

Okay, that’s helpful. That's it from me. Thanks guys.

Thanks Gary.

Thank you. Our next question comes from the line of Joseph Osha with JMP Securities. Please proceed with your question.

Hi there, my compliments on the quarter.

Thank you.

I'm wondering if we could return to this issue of integration with third party hardware. Obviously you're doing very well with your own products, but you've got some companies out there [indiscernible] for example really pushing on price points for third parties and I'm just wondering when you interact with your dealers, what type of feedback you're getting in terms of in-house versus third party? It interests me that you still see this 60:40 hardware versus recurring revenue mix even a couple years out. I wonder if can comment on that? Thank you

Well, some of our products, the access products work with competitors products, the key competitors products, so we integrated with those. There are some jobs that we run into where they want to use our locking systems and our access systems and they want to network up with the existing systems on large building or campus, so we integrate with those other systems. But we're very diversified in the fact that we have our totally integrated solutions that we like to sell we make, but we try to make our stuff attach to the key software platform that are in the industry, so we're getting, you are seeing a lot of that.

And do you think that - obviously you've got this very nice operating leverage out of the DR which is which is great, do you, I mean there will come a point at which you have to decide whether to add to that scale or perhaps more to the third parties, do you see the mix shifting over time or is the idea even over the longer term to be the - to borrow your phrase, sales so what you make?

We're going to constantly drive forward to increase our sales both with the integration into others and also with our total vertically integrated product line. We have a lot of capacity in integrated bubbling. We can do a $100 million per shift. We can get all the people we need to make all these products. So we’re going to keep building up the factory. As we hit these magic numbers of $100 million, $40 million profitability really starts jumping tremendously and that’s our goal, that’s where we want to be in a couple of years from now.

Okay, thank you very much.

Thanks, Joe.

Thank you. Our next question comes from the line of P. Enderlin with Mars Partners [ph]. Please proceed with your question.

Thank you. Good morning.

Good morning.

I have a few longer term questions. First, is there any realistic way, practical way that you can address the international potential of some of your products and thereby of course help fill up that plant as well?

A lot of the international, we use to sell more overseas, but it became complicated because different countries have different specs. And we didn't want to have all these different product lines and there's all the engineering into all these different product lines because it just confuses our growth areas which is South America which has plenty of needs and plenty of business. So we decided that we will make a couple of universal items like our access control for overseas, but a lot of the other items we don't spend a lot of time developing versus we just be a sap sucker into our engineering efforts. We try to keep our expenses in line. We did spend more money on engineering, hence you are seeing more new products coming for the North and South American market which is a big market. Schools are a big market. Modernizing alarm systems for commercial building is a big market and we can go into really high, high volume and profitability with just focusing on these things, so that’s kind of direction.

Okay, fair enough and well so, now with your debt free and generating increasing cash flow would you consider a dividend?

It’s one of our considerations. Yes, that’s on the list, so we'll keep that in mind.

Okay and then lastly, Dick, you’ve done a great job and a lot of this is coming to fruition, what can you tell us about potential succession planning to the company?

Well, we have a very good group here with Kevin, George, Michael, this is our executive team. And we’re going to get to a point where these guys can take over and run the place, but we all run it together now and we all know what we're all doing. We have many management discussion and meeting as far as where we're going. Kevin is involved in not just in the finance but he is in the operations of the business, the directions, product where we're going with product and marketing. Jorge Hevia is involved in all aspects of the business, also and so is Michael Carrieri, our engineering Vice President. So that's how we operate the business and we’ve been doing it for a lot of years together and now that the business has hit these paradigm shifts we're really making a lot of hay out of it. With the recurring revenue products and the technology that we've developed over the years and it's great that the industry is going more tech because it kind of suit us just right. And all of our guys here that I mentioned are all in these meetings and having discussions and we come up with great direction and ideas, this quarter was very nice representation to that.

That's very helpful. Thanks very much.

Thank you. Our next question comes from the line of Abba Horwitz with OS Capital. Please proceed with your question.

Hi, guys congratulations on a wonderful quarter.

Thank you.

You guys are in a unique position today because you have no debt to pay down and your cash is building and I assume over the next two years through the excess cash flow you'll generate, you'll have quite a bit of money on the balance sheet. And from what I understands also is that you're really not interested in acquisitions because there's enough to do in the company itself today that actually would say don't do an acquisition. So you're going to have a real serious cash build and I'm wondering, what do you propose to do with that cash build that you have?

That's a high class problem that where we started the phase. We've been generating a lot of cash for a number of years and it’s accelerating. We paid off the debt originally with this cash how it is building. So, there's a lot of people that are asking what you are you going to do with it? The previous caller to you said once you start giving dividends, so we have a list of how to solve this high class cash problem and that's where we're facing now, so that’s it, is our goal.

Okay, is there a limit in the stock purchase price, do you have a limit where you'll buy it and what level is there a number here on - based on free cash flow or free cash flow yield or something like that?

When we buy back stock Abba?

Yes, is there, do you have a certain price, would you buy back stock at $20 or is it more closer to you know 14?

Very strict guidelines and so - we do and we always say we do it opportunistically and we keep our eye on it and it's worked out well for us. If you look at our average price over the time that we’ve been doing this versus the stock price today, we've done a really, really good job at that. One of the ways we've spent the cash, I wouldn’t rule out an acquisition either, but it has to be perfect. We're always saying if we hit the buyer's criteria that we want, that’s a possible [indiscernible] use of cash, the five criteria being going to be pay for multiple, it's got to be accretive to day one, it has got to utilize our dealer network, got to be able to manufacturing at the Dominican Republic and we'd like to have a earn out associated with it. So if we could hit on those five points, and acquisitions could be on the table too, but we don't need to, have plenty to here.

Okay, wonderful. When can we get some more color on the products that will be coming out to understand better what they do and how the - I guess the model works?

Are you talking about the new product?

Yes.

Well, there will be showing at the ISC show and unveiled there and there will be press releases about there, so that’s in April.

Okay, wonderful guys. Thank you very much.

Any time.

Thank you. We have reached the end of our question-and-answer session. I would like to turn the call back over to Mr. Soloway for any closing remarks.

Thank you everyone for participating in today’s conference call. As always should you have any further questions please feel free to call Patrick, Kevin or myself. We thank you for your interest and support. We look forward to speaking to you all again in a few months to discuss NAPCO’s fiscal Q3, ‘19 results. Bye-bye.

Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.