Greetings and welcome to NAPCO Security Technologies Fiscal Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions].Please note, this conference is being recorded. I would now like to turn the call over to your host, Mr. Patrick McKillop. Thank you, you may begin.

Thank you. Good morning, my name is Patrick McKillop. I am 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 third quarter 2020. 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, Senior Vice President and CFO.Before we begin, let me take a moment to read the forward-looking statements. 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 will 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. We remain steadfast in our investor outreach during the COVID-19 crisis and our still available for conference calls and/or video calls with the investor community. Many investor conferences have been switched to a virtual format and we look forward to this new experience.We will be in virtual attendance for the Needham Conference on May 20, the Stifel Cross Sector Insight Conference on June 8, the William Blair Conference on June 9, and the Canaccord Genuity Conference on August 11 through the 13th. There will be presentations and one-on-one meetings at these conferences. So please mark your calendar.Investor outreach is crucial especially for small cap companies such as NAPCO. Now we'd like to thank all of those folks that assist us in these investor outreach efforts.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 fiscal Q3 earnings results conference call. Thank you for joining us today.We're living in challenging times, to say the least. I'm very proud of our company's fiscal third quarter 2020 performance which marked another record revenue and profitability performance to NAPCO.Our SaaS recurring revenues continue to grow at a rapid rate. Our recurring revenues annual run rate is now $25.4 million as of the end of March. Our focus on targeting mostly commercial end markets and professional installation is driving this continuous growth.Our cash balances remain healthy, and our balance sheet is clean with no debt. We continue to be focused on capitalizing on the key industry trends. These trends include wireless, fire, and intrusion log communicators, school security solutions, enterprise access control systems, and architectural locking products.Our management team continues to focus on the key metrics of growth, profits, and returns on equity. These metrics are important to us as well as our shareholders. Our business strategy is executing well and our interest are aligned with our shareholders as senior management at NAPCO owns 38% 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 third 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 third quarter, net sales increased 4% to $26.2 million which was a record third quarter performance and the 23rd consecutive quarter of year-over-year record sales as compared to $25.1 million for the same period a year-ago. For the nine months ended March 31, 2020, net sales increased 7% to $78.4 million as compared to $73.3 million last year. The increase in sales for the quarter and the nine months were primarily related to increased sales of our alarm communication services and sales of intrusion and access products as partially offset by a decrease in sales of door locking products.Recurring monthly revenue for the Alarm division increased 37% for the quarter, and 39% for the nine months and now has an annual run rate of $25.4 million based on March 2020 recurring revenue.Net sales for the quarter would likely have been significantly higher, if not for encountered COVID-19 related supply chain disruptions which has since been rectified, and which was caused by the initial shock of this unprecedented crisis.Gross profit for the third quarter increased 11% to $12 million with a gross margin of 46% as compared to $10.7 million with a gross margin of 43% last year. For the nine months, gross profit increased 15% to $35.6 million with a gross margin of 45% as compared to $31 million with a gross margin of 42% last year. The 300 basis point increases in gross margins for the quarter and the nine months respectively was primarily driven by the previously mentioned strong increases in recurring revenue with a gross margin increase by 500 basis points to 84% for the quarter versus 79% last year and 300 basis points to 81% for the nine months versus 78% last year.Recurring revenue margins continue to expand…

Thanks, Kevin.We continue to believe that the growth we have witnessed in our business should continue in the future as our business is comprised of 80% commercial, many of our products are deemed essential, such as non-discretionary commercial fire alarm communicators.NAPCO also plays a vital role in the healthcare vertical with our locking and access control divisions, which for example provide entry exit devices and push-pull locks with anti-microbial finishes.Recently our Alarm Lock division, DL2700 locks being in hold at the U.S. Army Corps of Engineers at a temporary field hospital in the McCormick Place Convention Center in Chicago, which had a need for access control. We were very proud they chose our Alarm Lock products.The need for security is greater now with many businesses closed and employees are not there to watch the store, restaurant, or office. Recently, the New York Post published an article that stated NYPD data showed a 25% rise in commercial burglaries during this COVID-19 shutdown and similar increases have been reported across the country and other large cities.We continue to see growth coming from a long communicators of fire, intrusion, and the smart home category as evidenced by the growth of our recurring revenue products. The fire radios, in particular, are literally on fire, as evidenced by an 84% gross margin for recurring revenue in Q3.The school security market remains a contributor to our growth, and there remains a significant marketing opportunity. New funding initiatives continue to take place to help the schools pay for the upgrades they need. Recently, the Kentucky legislature approved its fiscal 2021 budget which includes $40 million for school security despite the expectation of lower tax revenues due to COVID-19. We also continue to monitor the progress of the School Violence Prevention and Mitigation Act of 2019 which was…

Thank you. At this time, we'll be conducting a question-and-answer session. [Operator Instructions].Our first question comes from Matt Pfau with William Blair. Please proceed with your question.

Hey, guys thanks for taking my questions and nice job operating in a difficult environment here. So first wanted to ask on the production facility in the Dominican Republic, maybe you can just give us an update on how that's been performing and if you've been able to maintain adequate levels of production?

Kevin, do you want to take that one?

Sure. So the DR is operating, Dominican Republic even though it's a warm climate has COVID-19 issues like the rest of the world. We've been lucky. We had a little disruption at the end of the quarter, the last week of the quarter, and the first week of the new quarter, two weeks. And it worked out for us because we were going to be closed for Easter week anyway the week of April 6. And like in baseball, you can make trades for the shutdown weeks. So we have three planned shutdown weeks in the DR, the Easter week, the week after the fiscal year is over, and Christmas.So because there was a lot of chaos right at the beginning of April, really the end of March, beginning of April. We closed for two weeks and made a trade, the first week that we closed, we traded it for the Easter week, and the next week we traded for the June, end of June, beginning of July shutdown. So it really doesn't cost us anything extra. It's like trading shutdown time. Since then they're back in operation, which is very -- we're very fortunate a lot of our competitors can't say that. We have a competitor who manufactures in Mexico their whole operation was shut. So we're very lucky. We're operating and we're operating in Amityville. And we're going to get through this. We have a lot of experience getting through crises. And of course, nobody's seen anything like this.But we were prepared from the 2008/2009 horrible situation; we had with the economy then. Then we had $40 million of debt. We have no debt now; we had no recurring revenue back then. Now we have a $25 million run rate. And of course we have cash. And we're prepared for this. So I don't know how long it's going to last, the states are starting to open up. But the DR is running, Amityville is running, and we're doing the best we can, feel like things will be back soon, we hope.

Great. And then I wanted to also ask for an update, one of your 10% customers a large distributor last quarter put a pause on its purchasing as it was going through an M&A process. Could you just give us an update on if you saw that distributor come back in the quarter and make additional purchases?

Yes. So this distributor who last quarter, they were in the midst of being acquired now it's determined who's acquiring them, the acquisition is going forward. It hasn't closed yet but it will, it's one $8 billion company acquiring another $8 billion company. We saw sequentially, our business with this customer go up 64%. Today, we're virtually back to where they always were and where we think they always will be. We also, of course look at the sell-through statistics. And the sell-through stats were up 9% in the third quarter versus the third quarter a year-ago. So these were all very positive signs.The way we look at this is, yes, this is a change the acquisition hasn't concluded yet. But this is more opportunity for us. This is another giant distributor taking over a fairly big one. The company that did the acquiring, we didn't do any business with them. So now we have the chance to do a lot more business. So we don't look at this negatively, we're very happy with the 64% sequential increase. And lots of opportunity ahead is the way we view it.

Got it. And last one from me. Really nice increase on the recurring gross margin, obviously due to the strong sales of your fire products, how should we think about that, that gross margin going forward? Should there be some variability there depending upon product mix, or should it sort of stay at this 84% level? Thanks.

Well, Matt, gross margins tend to jump around a little bit. We were at 78%, a couple of quarters ago. We got to 81% last quarter. Now we're at 84% in Q3. It can go higher. The more concentration there is of fire radios where we get more money for those than the other radios, the better that mix is going to be. I always like to be conservative. So I don't like to anticipate it's 84%, it's going to 86% to 88% to 90%. But who knows, it could. We're focused big time on getting the margins as high as they could get. And we're doing a lot of other things beyond the mix to try to get those margins high.So whether we'll be 84% in Q4 beyond, I can't really say, but suffice to say, gross margins are recurring a phenomenal and then as we add more recurring revenue to our other product lines, it's going to get even better, because we're not just satisfied that recurring revenue is -- it's not even 20% of the business. We want it to be 50% of the business. And as we go-forward and do more things and have our engineers develop more product, that's our goal, that's our five-year goal to have 50% in recurring. And could you imagine that with these kind of margins, it's unbelievable. So that's our goal.

Our next question comes from Mike Walkley with Canaccord Genuity. Please proceed with your question.

Sorry, I was on mute. Hope this time everybody healthy and well on the call and congratulations, a great quarter in a tough environment.

Thanks Mike.

So just building on that last question. When you look at kind of the fire radios which you guys mentioned on fire in terms of demand, it's my understanding they have even higher ARPUs. So is there any reason to think that the services revenue gross margin should remain below 80 or above going forward? I know you think they can bounce around but certainly seems like the high-margin business is going to be even improving in the mix over the intermediate term?

You know, the more fire -- fire radios came after the other radio. So the black radio is the first one, the connect radio is the next one, and then the fire radios came. So the fire radio, they're like the baby of the group. And so we knew that the more they became a larger percentage of the mix that the overall margins would go up. And so, honestly I think this is going to continue. I always know that margins can jump around, but there's nothing that tells me that this -- this growth of going into the 80s can continue. It should. We're doing everything we can to sell more fire radios. We also have the fire panel, FireLink's panel that has the radio built into it. Buildings don't have a choice; they have to put this stuff in, regardless of what's going on. So yes, there's no reason to believe it shouldn't continue.

Great, thanks. I know it's a different world and probably last time you guys set longer-term targets. But yes, how are you feeling about just the recurring revenue ramp and mix of business over time? And say it hits 50% of your business longer-term. What do you think that does to the model in terms of adjusted EBITDA margins?

Well, five -- the five year goal, the 50:50 split is still our goal. We haven't changed that. And at those levels, EBITDA margins would be tremendous pushing 50%. Whether or not we get there exactly in five years, hard to say. But our other goal of getting to $40 million recurring revenue by June of 2021, we're still going after that, too. Now, will it maybe with everything going on, will it take a couple of more quarters? It could, it might but in the big picture that's a tremendous run rate to have in a very short order of time, basically, a year, a year-and-a-half from now. It's just what we're going after. We know that the COVID-19 is we think it's going to pass eventually, a lot of it's commercial. And we're going to still continue to get this recurring revenue. Timing is the hard part to predict. Big picture, it's very, very successful.

Okay, thanks. Just as you look into the June quarter obviously, a lot can change, the states open up and demand improves later in the quarter. Can you first maybe help us quantify what happened at the Dominican Republic in terms of the lot sales at the end of March? Have they already been sold into the channel here during the June quarter? If you could help us with that? And then, based on where you're seeing strength more on the enterprise side, how does that impact what you sell during the quarter in terms of gross margin? That's clearly leverage is important, but is there a product mix that's maybe more favorable in what you're able to sell right now? Thank you.

So more than a million dollars of sales was impacted in that last week of the quarter. And then once we started up again in the next quarter and the DR came back, those sales are being built. So it's going to help Q4. We don't know how Q4 is going to play out as a whole. It's possible that -- we had a very, very successful Q4 last year with $29 million.I don't know if we'll be able to do that again, we're going to do our best. One of the benefits we have is a lot of our sales come at the end of the quarter. So of the $29 million that we did last June quarter, probably three quarters of it came at the end, last few weeks.So that helps us because the more states that open up and the more business gets back to normal as we get closer and closer to June, that gives us an opportunity to recover or at least hit our goals because our goals remain the same. We still want to be above last year. We want to keep our streak of successful quarters in a row going, it's going to be hard this quarter, but we think we could do it.What we don't know is the mix of sales. School security is a big part of what we do the universities; we don't think are being impacted as much as K through 12. The universities have money. They have their endowments. Nobody has asked these schools the perfect time to put security in place. K through 12 is a little different. K through 12, those schools are closed too, they rely on money. Now a lot of money's been granted to these schools earmarked specifically for security. And I know K through 12, they got to have a lot of budget issues in a lot of state, they're going to eventually get back as well. But the margins are better on the University School jobs. But they're all going to need it. It's like, almost like a pause, but it'll continue.We know a bunch of our sales guys are now starting to travel, believe it or not in the states that are opening up. One of them, I know was visiting a school, a school job this week. So we're counting on the schools to continue that helps the margins that helps. The more product we put through that DR operation, the better the margins are. So our outlook is to get it as high as it could be this quarter, DR is up and running. And let's see what happens.

Okay, last question for me and I'll pass it on. More big picture strategic with your mix pretty good for this tough environment. Some of your competitors might not be as so, how do you see NAPCO's position in the market on the other side and especially since like you highlighted earlier, you have a much stronger balance sheet than 2008/2009, do you see your market share gain opportunities or even the ability maybe to consolidate the market, on the other side. Just strategically, how are you guys thinking about things? Thank you.

The way we're thinking about it is we're going to be adding recurring revenue to all our product lines. And come the fall this year, we'll have it for a cloud-based radio system, which will allow access control of locking dealers to be able to get recurring revenue, a different type of recurring revenue for them, utilizing our hardware and paying a fee for the services that we're going to provide them. And we think that's going to be very exciting for them. It's a system where it doesn't require the IT departments of companies to give it a blessing, the dealer and the management of the company get it done without affecting the network of the company. It's going to be an exciting time for the dealers. And we're gearing up for that. And that's going to add now recurring revenue to the -- all three legs of our business.And we still feel very confident that as Kevin was talking about that we can come out with additional technology products. There's a lot of products we have in the pipeline that are going to be coming out or going to be enhancing our recurring revenue with equipment and hardware products which are new and unique to the industry. And we believe that five years out, we will get to that 50:50 split of recurring revenue and equipment sales. So we're optimistic that way.More and more security is needed, more and more security is going to be needed. It's a very important aspect of life today. So we're in a good field and we know how to capitalize on it. And we also know how to control our costs. As you can see, we've controlled our costs very well, so that we can get more efficiency out of our operation. So keep an eye on that, because we don't want that to get out of hand.

Our next question comes from Jeff Kessler with Imperial Capital. Please proceed with your question.

Thank you. And thank you for taking my questions. Can you give me some idea of which verticals are that you're working with right now are seeing like site restrictions in which, you're getting depending on the integrator, kind of tough to get on the site or not at all at this point, and which -- and then which markets are freely allowing both your install and service people to get on, it sounds like to me, like university is being closed down or that second group, what's -- what about the first group that's a little bit harder? And also maybe are there some instances in which particularly small business where you've had orders and those orders just have not come through because the business itself does not come through?

Well, Jeff, we're very diversified. Because we sell more than 15,000 security dealers and integrators and we sell more than 10,000 locking people. And the products that we sell are in all areas of all types of commerce, as well as residential. Of course 80% of what we do is commercial and a lot of that is legislated into a get a certificate of occupancy for buildings.We have great demographics happening now where buildings are changing over from landlines, plain old pots lines, and they need a communications network that works for them. And that's what our StarLink Radio Communicators do. So in a lot of cases, the word continues in all kinds of buildings, and they're converting those buildings over to radios and utilizing our network. So it's scattered all over.I can't give you a specific of one type of business or another. But you read about in the newspapers, that there's a lot of -- crime is picked up a lot in the commercial line because lots of buildings are closed. And there's burglaries and break-ins, plus you have the phone lines that are not functioning in places that have to be engaged with new StarLink Radios due to the fact that the phone company doesn't want to support those lines. So we need continuity of communication between a building and a central station. And when the lines go down, because of service issues, the alarm company is dispatched and the communications link is made using our StarLink. So there's a lot of driving forces in cross-currents, but all of it bodes for good business going forward.

Okay. So my follow-up question is, the fire business has been around for quite a while, it's a low- growth business. It is -- it's a highly regulated business, it has to be done. And so it's a great business if you can meet that bar. The question is, there are large companies in that business that have kind of put up their lines in the sand with regard to being the provider of product everything from enunciators to basic online communicators? How are you able to -- how you're able to get share away from some of these very large let's call it incumbents who've been there for years and assume the smaller company all of a sudden being able to take on -- being able to take on and add to their products with new products that that the customers are moving toward. There must be some pushback; you must be getting some pushback from some of these folks that while you are getting so much success out of your new fire product?

What's happening is I've been through this before, where we invented new products in the past and picked up a lot of share. It's actually how the company started. We invented a tape dialer communicator in the very beginning of our company and all the large competitors that we had that were in the business since the 1920s, these guys, didn't have a technology to make the type of products we made, or came on late with their version while we got established.While we see the same thing happening today, there's a lot of technology and a lot of special source in what we do with our communicator business. The value that we give to our products is recognized by the trade and they're flocking to it. And the competitors have their thing, they're very large ships. And it takes a lot of time for those ships to turn and make different moves. But we're there and you can see from our success that our strategy is working. We're going to be introducing more and more things and only staying one step ahead.Now that we've got the wind behind us, where communication is going with radio, rather than leased copper, which is kind of where a lot of our competitors are and the functionalities they get with their products doesn't really cut it the way our functionality works.So the dealers say, I want to use the best for my clients. And we're getting more and more pedigree, higher pedigree dealers and it seems to be working. And that's -- that's our strategy. It worked since the beginning of NAPCO; it's worked over the years. It's grown NAPCO and it’s going to continue to grow NAPCO. And as Kevin enumerated to you, our five-year plan is to be 50% in equipment and 50% recurring revenue and that's going to make for very strong margins.

Our next question comes from Abba Horwitz with Old School Partners. Please proceed with your question.

Good morning. I just wanted -- I have three small questions. One, what was the average price you purchased -- repurchased shares during the quarter?

$16.99.

Okay, that’s pretty good. I also wanted to understand you -- you put on your website these new locks called Germline and it looks like this is a new opportunity that I know you mentioned in the beginning of the call. Could you talk a little bit about what the opportunity is for you guys in this form Germline kind of locks that you now are starting to sell?

Are you talking about the ones with the coatings on them?

And anti-microbial finishes?

Right. We do a lot of hospital work with our dealers and we have coatings, anti-microbial coatings which are put on to the lock handles such that it kills the germs that get onto the locks. So that's -- that's becoming more and more popular. We introduced that maybe a couple years ago, and it's becoming very, very popular. And I expect it's going to become even more popular going forward. It's a special type of coating to it which kills -- kills the germs that get on to it.

Have you gotten interest since the whole corona breakout?

We’re selling lots of different types of locks. As you can see, we got chosen by the McCormick for their hospital because they recognized that our locks are special and more and more dealers are recognizing that. So I expect more and more business from that going forward.We have business from a lot of different areas, Abba. We do hospitals and we do schools and I would expect that more and more people are going to want the anti-microbial on their locks because it just makes for a safer type of environment within a facility.

Okay. But you're not seeing anything special because of the Coronavirus in terms of huge spectrum demand for this kind of product?

It's very early now, but I would expect it to be very popular.

Okay. And just final question here. In terms of -- because you're mainly your supply chain is covered, it looks like and you do most of your production, if not all your production in the confines of America, including obviously the DR. Are you getting any interest from distributors that you didn't do business with before because of the supply chain issue where they cannot get product, that's generally made in China?

Yes. We're recognizing that a lot of our competitors now make their entire product in China. And besides the fact that there's lot of disruption and because of the news reports about buying American and everything else, I would expect that there's going to be a lot of disruption with our competitors to make their products in China. So a lot of dealers are wanting to buy American. So that's going to help us also, it's another thing that helps us.Then we have our competitors make products in Mexico, a lot of Mexican factories of our competitors are closed down. They're not allowed to operate. So we're going to get business from that also.So we're ready with ready-to-build as much as needed to satisfy the dealers. And what's great about NAPCO is we're Amityville Long Island, out in JFK airport, where they can get answers right away, they can get inventory. They can call and they speak to people that speak English and a technical. We have a very good technical department. So the dealers can get instant answers. And it's a very good thing and that's why we like to make our products and keep our business in the United States because it's a big market that we can do well in.

[Operator Instructions].There are no further questions at this time. At this point, I'd like to turn the call back to Dick Soloway for closing comments.

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 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 Q4 2020 and fiscal year 2020 results. Please stay safe, healthy and strong. Bye-bye.

This concludes today's conference. You may disconnect your lines at this time and we thank you for your participation.