Greetings, and welcome to the NAPCO Security Technologies, Inc. Fiscal First Quarter 2021 Earnings Release Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Patrick McKillop, Director of Investor Relations. Thank you. You may begin.

Thanks, Daryl. Good morning. My name is Patrick McKillop, I'm the Director of Investor Relations here at NAPCO Security. Thank you all for joining us for today's conference call to discuss our financial results for our fiscal first quarter 2021. 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 statement. This presentation contains forward-looking statements that are based on current expectations, estimates, forecasts and projections of future performance based on management's judgment, beliefs, current trends and anticipated product performance. These forward-looking statements include, without limitation, statements relating to growth drivers of the company's business, such as school security products and recurring revenue services, potential market opportunities, the benefits of our recurring revenue products to customers and dealers, our ability to control expenses and costs and expected annual run rate for SaaS recurring monthly revenue. Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those contained in the forward-looking statements. These factors include, but are not limited to, such risk factors as described in our SEC filings, including our annual report on Form 10-K, other unknown or unpredictable factors or underlying assumptions subsequently proving to be incorrect, could cause actual results to differ materially from those in forward-looking statements. Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, level of activity, performance or achievements. 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 take -- undertake no duty to update such information, except as required under applicable law. I will turn the call over to Dick in a moment. Before I do, I just wanted to mention a few things on the IR front. We will be attending the Needham Growth Conference, which is taking place January 11 through the 15th of 2021. Also, we are planning for more virtual road shows throughout the remainder of the year. 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.

Thanks, Patrick. Good morning, everyone, and welcome to our conference call. Thank you for joining us today to discuss our results. I am pleased to report that because of our efforts and strong business model, we have delivered significantly improved results compared to the fourth quarter of fiscal 2020. Despite the ongoing COVID-19 pandemic, first quarter reoccurring service revenue, gross margin, net income and adjusted EBITDA all exceeded analyst expectations. Our recurring revenues continue to grow at a rapid rate. Our recurring revenues increased 36% in Q1 and now have an annual run rate of $29.7 million as of September. Our focus on targeting the professional installations and mostly commercial end markets is driving this continuous growth. Our balance sheet remains strong, and our cash balances continue to grow. We remain focused on capitalizing on key industry trends, which include school security solutions, wireless fire and intrusion alarm, plus enterprise access control systems and architectural locking products. The NAPCO management team continues to focus on the key metrics of growth, profits and returns on equity and controlling costs, especially during these difficult times. 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 at NAPCO currently owns 36% of the equity. Before I go into further detail, I'll now turn the call over to our CFO, Kevin Buchel. He will provide an overview of our fiscal first quarter results, and then I'll be back with more on the strategies and outlook. Kevin?

Thank you, Dick, and good morning, everybody. For the first quarter, our financial performance was significantly better than last quarter as we generated major increases in each of these categories, recurring service revenue, gross margin for both equipment sales and recurring service revenue, net income and adjusted EBITDA, and we also exceeded analysts' expectations in each of these metrics. Net sales for the quarter was $23.2 million compared to $23 million in the fourth quarter of fiscal 2020 and $26.3 million for the same period a year ago. The 12% decrease in sales for the quarter versus a year ago were primarily related to decreased equipment sales, which were caused by the ongoing COVID-19 pandemic, which has caused difficulty -- difficulties for security equipment professionals getting access to both commercial and residential installation sites. We believe this is an industry-wide issue and not due to the loss of any market share unique to NAPCO or any longer-term negative view of the post-pandemic health of the security industry. On the positive side, StarLink radios and fire products continued to significantly increase in Q1 compared to both Q4 and Q1 in fiscal 2020. This is important as these are the products that generate recurring revenue. And to that end, recurring monthly revenue continued its strong growth, increasing 36% for the quarter. Recurring revenue now has an annual run rate of $29.7 million based on September 2020 recurring revenue. As I mentioned on our last earnings call, the majority of the company's factory costs are fixed costs. As you remember, when equipment sales for a quarter increased above $20 million, overhead absorption increases, gross margins expand. Conversely, when equipment sales are below $20 million, the opposite occurs. We're in the midst of a COVID-19 pandemic, which have temporarily affected the volume of our…

Thank you, Kevin. Our first quarter equipment sales were impacted by the ongoing COVID-19 pandemic However, as Kevin mentioned, sales of StarLink radios and fire products were not impacted. And as a result, we continue our strong recurring revenue growth, along with 84% gross margin. Our seasoned executive team here at NAPCO performed well by managing costs, delivering improved margins and beating Street consensus earnings per share estimate. We have recently seen positive signs from some of our largest distributors that sell-through rates have increased. We continue to believe that we are well positioned to rebound for the economic recovery. Our business is comprised of 80% commercial, and many of our products are deemed essential such as nondiscretionary commercial fire alarm communicators. NAPCO also plays a vital role in the health care vertical with our locking and access control divisions, which, for example, provide entry/exit devices and push/pull locks with antimicrobial finishes. The trend of violence in cities across America continues to happen every day, and these events are driving the need for more security. Many businesses, such as stores, restaurants and officers, are preparing for more volatile times ahead. The growth of recurring revenue, which in part is being driven by the commercial StarLink fire radios, continues to be a bright spot in our business. The fire radios in particular are also helping recurring revenue gross margin expansion as evidenced by the 500 basis point improvement versus the year ago period. As the communication paradigm continues to sunset away from legacy copper and the 3G infrastructure, it creates a significant opportunity for our proprietary StarLink radios and alarm systems for fire and burglary to generate additional steady streams of recurring service revenue growth. The school security market remains a significant market opportunity. While we have seen some delays in…

[Operator Instructions] Our first questions come from the line of Matt Pfau with William Blair.

I wanted to start off with the sell-through that you're seeing from your distributors and wondering if you can provide any more details on what you're seeing there. And then when you think we could potentially see some of these distributors ramp up their purchasing activity again?

Kevin, do you want to take that?

Yes, sure. So Matt, we talked about sell-through on the last call, and we had, at that time, sell-through stats from -- we talked about a couple of distributors. We had it through July and August. So now I have July, August and September, I have the whole quarter. And I looked at a couple of the 2 biggest ones on the alarm side, and I looked at a few on the locking side. And here's what I thought was very interesting. So on the alarm side, our biggest customer, who we've talked about at length here, had a 25% increase in sell-through stats compared to the prior quarter. So sequential, a sequential increase of 25%. Year-over-year, it was up 28%. It's pretty strong. Another big alarm distributor had a 35% sequential increase and a 39% increase year-over-year. This again is for the July, August, September quarter. On the locking side, I look there as well, we have -- I looked at the 3 biggest ones we have. The first guy is part of that big customer that we have. Sequentially, they were up 32%. They were down only 4% year-over-year. The next big customer I looked at was up 55% sequentially and was up 16% year-over-year. And the third one I looked at was up 30% sequentially and up 15% year-over-year. So that bodes well for the future. And I said on the last call, you just don't know when the distributors are going to actually place orders. They're probably playing it very conservative, trying to be just-in-time distributors. But with stats like these, they're going to have no choice soon. I expect this to translate into factory sales soon. Will it be in this quarter, the quarter we're in now, Q2? One would think so. With stats like that, how low could their inventory levels get? Certainly, for the balance of '21 Q3 and Q4 for us, I think that's the expectation we have unless something changes. I know the pandemic hasn't gone away yet, but more and more dealers are getting access. These are pretty powerful stats. So we continue to monitor it. And as we learn more, we'll share it with everybody. But right now, we're very encouraged by the sell-through stats.

Great. And then the other thing I wanted to ask about was the fire business. So all of your recurring businesses seem to be doing well, but in particular, the fire business seems to be doing -- or at least seems to be a standout there. What are you seeing that's driving that business right now? And maybe just sort of an update on how you think about that opportunity longer term.

We love the fire business because it's a mandated business to keep a sophisticated occupancy in a building. So there are a lot of fire logs, millions and millions of them that use comfort as the communications link to the central offices. Copper is going away, not being supported by the carriers anymore. And therefore, the dealers are looking to replace the copper with a radio solution, and StarLink seems to be a very important radio of choice to the dealers. So we have many, many years of the retooling of commercial buildings of all types from copper to radios. And as far as I can see in the future, it's -- we're talking about huge quantities of jobs that are going to be converted using StarLink. And we also have fire panel for new work. So when a new job goes into a building, they can use a StarLink Fire panel. So automatically, besides having zones for smoke and carbon oxide, it also has a built-in radio, which communicates to the central office and reports these fire conditions. So it holds very, very well for us. It's mandated, it's not elected, and we're going to keep building upon this sector of our communications business.

Our next questions come from the line of Mike Walkley with Canaccord Unity.

Great. I hope everybody is safe and well on the call. Kevin or Dick, I just wanted to follow up on the strong gross margins in the quarter. Can you help us think about the cost savings? Is there now a new level below $20 million where you start to see kind of cost improve from on the hardware front? Or maybe just think about just maybe a product mix versus some permanent cost reductions that are going to help the gross margin trends.

Well, in this quarter -- in last quarter, we saw -- we took a big hit on the gross margin on equipment sales. And we didn't want to go through that again because we -- while we're seeing improvement and people are getting more access to buildings and the sell-through stats are strong, we can't live our life waiting for the distributors to necessarily place the kind of orders that they should. So we reacted to it. We have a lot of experience in reacting in difficult times. The recession of '09 taught us well, and so we made cross cuts that affected the margin on equipment sales. It's probably a combination of that and mix, but a lot of it was cost cutting. We saw this trend of declining hardware sales at the tail end of Q3 of last year, the March quarter. We obviously saw it continue in the June quarter. We wanted to react to it. We're not going to sit back and just watch it happen, and so that's why you saw the margin increase on equipment sales go up so dramatically to about 29%. We think things are going to be coming back. So these cost cuts are not permanent because once things are back, a lot of these costs will go up again. But we want to be -- our margins should be at a $20 million level in the mid-30s. And again, as we get the hardware sales to go to $25 million like they've been in, say, the Q4 period, then it starts to hit 40%. Those are still our goals. We want to grow hardware sales, just like we want to grow the recurring revenue sales. They're both important. Recurring revenue has been dramatically high margins, the 80% plus. The hardware sales will get dramatic margins as it grows. We believe it will grow. We'll cut costs as necessary. But when we don't have to, we'll restore them. And at $25 million, it will be a close to 40% gross margin on hardware sales. And as it goes above that, we want to get it to the 50% range. So it's very important, just like recurring, both. And the mix will help us, too, depends on the mix. The mix helped us this quarter versus last year, but it's a combination.

Great. And just a follow-up question just on the hardware business. Historically, there's been a lot of end-of-quarter buying, and thanks for sharing some of those encouraging trends on your large customer sell-through trends. Is there any early sign here in October that maybe they're going to more linear buying so you're starting to see signs of recovery? Or I guess another way to ask it is, how much lower can some of these customers go in inventory until they really need to start buying products again to start seeing a little better growth trends with things opening and recovering?

We have encouraged the distributors to not sit back and wait. And we've seen on -- with some of them that they've been doing more buying on a week-to-week basis than we've seen before. So as I look at the October stats, it's just 1 month of factory sales, but on some of these guys, very encouraging. I think they want to buy as they go. They don't want to wait until the end because they're not even sure what's going to happen to wait until the end of December and put in a big buy. They can't afford to wait. They're running low as the sell-through stats remain strong. So some of them have done what we've told them to do. Buy weekly, don't just wait until the end. It's crazy that it all comes down to the last 2 weeks of a given quarter. So I think in these cautious times and them not wanting to run out, we're seeing that, and that's encouraging also.

Great. And last question for me, and I'll pass it on. Just on the school market, it certainly makes sense with education, just struggling to operate during the pandemics. That makes sense. Some opportunities have been pushed out a little bit. Can you just talk about what you're seeing in terms of the pipeline and feedback on when timing of these projects might happen if they're not lost but more delayed just given such a challenging environment for the education system?

We're not seeing cancellations, we're seeing delays in some cases. Schools are wrestling with, am I open for students? Am I hybrid 100%? Am I somewhere in the middle? They want to get the jobs done. That's what we're hearing. And in some parts of the country, we're seeing that happen, and we're getting jobs in parts of the country. In other parts, it's like an on-hold type of situation. We're encouraged that we haven't seen any cancellations. We're encouraged that quoting still remains strong. When these integrators are going to be able to get into certain schools, it's hard to say. Schools are wrestling with overall problem of trying to keep the school safe from COVID. But we were encouraged by seeing Department of Justice issuing $50 million in grants to schools across the U.S. We were encouraged what we saw in the State of Indiana improving $19.4 million in state matching grants. School security is not going away. It's slowed up somewhat understandably. But for us, it remains a big part of this business. There are some jobs that we've gotten, and we're in the midst of trying to get approval on them so we could announce it. We have to get approval in order to announce it. And as we get that, we will announce it. But believe me, it's -- school security is here to stay, and it's just a question of when it really starts to ramp up again, we feel the sales come through.

Our next questions come from the line of Jaeson Schmidt with Lake Street.

Just curious if you could comment on what customer reception has been on Air Access and just if the current macro backdrop has changed your thinking on when that potentially could be a meaningful revenue contributor.

Air Access is a very unique product in the industry. It will be the only one that uses the cellular network such that you don't have to go through the IT departments network because the IT deployment doesn't like to have product on their network, which could create an entrance for hackers to come in. So it will also allow the dealers to connect to the building that we're projecting with all the equipment up in the cloud. You want to have to have equipment on site. The equipment is servers and things like that, that will all be in the cloud. And it will make it easier for upgrades for -- and changes to the software, and it will also allow the end users to be able to use app, to be able to interrogate and find out what's going on with their systems and allow the dealers to do time and attendance, roster list, do remote management through the cloud. So the end user will be able to access data, and the deal will be able to introduce -- be able to get data from the cloud. And it allow the dealers to penetrate the market quicker and not having to have equipment, which is expensive on site. A lot of that equipment, we don't make. It's other equipment that is communications on the network type of equipment. But -- so we're not going to see any loss. We're going to pick up a lot more business. We're going to pick up recurring revenue in a whole vertical where we don't have recurring revenue. Our recurring revenue comes from buyer systems, burglar alarm systems, and we want recurring revenue from our locking and access system. And Air Access will allow us to introduce it to that part of…

Okay. That's very helpful. Appreciate that color. And then just as a follow-up. Previously, you guys were targeting exiting June '21 with that annualized recurring revenue target of $40 million. Just curious if you think that's still on the table.

We're at $30 million now, Jaeson, basically at $29.7 million as of September. So 3 more quarters to get to $40 million. I don't see any big delay. We could get there a little early. We could get there a little after. But basically, our target is unchanged. The strength of the recurring revenue products hasn't diminished. If we saw that the hardware sales on radios had diminished in this quarter or even in last quarter, then maybe we would feel differently and revise the $40 million target. But we didn't see that. We see the continual strength, so that target remains intact.

Our next questions come from the line of Jeffrey Kessler with Imperial Capital.

Congratulations on continuing the recurring revenue sales throughout a tough period. And my question does relate to when you to see some on-premises installation from the installers and the integrators begin to happen again and you begin to start having -- are you in a position now where you are ramped up internally to take on that type of business? What type of flex between the actual installation -- equipment installation business and your recurring sales, if you want to call it, force? Will you have to go through when we begin to see pent-up demand come back as the pandemic wanes whenever it does?

I guess, Jeff, what you're asking is can we handle a large volume of more recurring revenue.

Right. And can you flex your expenses and your sales force and your installation for sufficiently in a short amount of time to maintain efficiency and margin?

Let me answer you. As far as recurring revenue, we built out a very scalable network operating center or cloud, so it can handle all kinds of volume. We expect it will be in the $40 million run rate in by end of this fiscal year, which is June 30, on or about. And we can go beyond that, much beyond that because it's a matter of just adding memory onto our expandable NOC. And we have a couple of NOCs now in different locations. So we're ready for all of that. As far as getting employees in our Dominican factory, we have no problem. There's a high unemployment rate down there. We can scale up. We have the -- we have -- we're running on one shift. We can scale up to a second shift. We can go to a third shift. We can handle all the volume we can get. We can get our parts in from around the world. Some are made in America, some are made in Asia and some are -- including China. There's no duty -- there's no tariffs of components in Dominican. It's all converted there as a finished product comes up. So we can scale up pretty quickly. We get the labor to do anything we have to do, we can get the parts. The vendors are collaborating for us to start buying more and more. So I think it's going to be a very smooth transition to handle the highest highs. With all the recurring revenue starting and on the Air Access, we expect very exciting recurring revenue, and we scaled up our business both from the manufacturing point of view, and the NOC point of view to handle it all.

All right. Great. The second thing is on the product, particularly specific to Air Access, but in terms of remote and, as you might call it, cloud-based access in general, are you -- you're saying at the moment you're about the only folks out there doing it. I have to believe that companies like -- I don't know. I'll just throw out a name. It's just like a Rio…

We're the only company that is going to be doing it with cellular.

Okay, okay.

There are companies that are doing it the old fashion way through the IT department and not cellular, but that causes all kinds of grief for the IT management people in the company, and it causes a harder penetration for the dealers to get business. So we're going to do it as one aspect of it cellularly. The deal has a choice. You can go the traditional way or you can go into using our cellular radios and some unique technology that we've developed to do all that. So you can go either way. We expect that this is going to be a tremendous boost for the business.

Yes. I was -- that was my question, is basically, are you going to give your folks a choice with regard to if they want to go the -- if they want to do the traditional way or they want to -- or just simply because there may be some specifiers that demand or integrators that demand it that way because that's what they can do. They don't know how to do the cellular yet. You have a -- and given the ease of use, I'm assuming that goes -- that using cellular is not a big education process, and you have that capability of getting your people up to -- getting your clients up to speed quickly, or at least, the distributors do in being able to get them to understand how to use these cellular radios quickly.

Exactly. We're going to do a lot of lunch and learns seminars, but it's not -- we made it very simple so you didn't have to be a rocket scientist to utilize it. It'll just cut out the interference you get from the IT department in the companies. And there'll be no equipment required on site. That'll be up in the cloud. There'll be no rolling of trucks by the dealers once it's installed and programmed. All changes will be done at the cloud. The dealer can interrogate the cloud and give valuable management services to businesses and even issue visitor's badges, all remotely. And the consumer that working in the companies can get data out of it also with an app. So it's going to be a thing that works very well in the alarm business. Our full recurring revenue was the alarm business. The integrators and the locksmiths will now be able to join that party and be able to get recurring revenue from their jobs, not just sell one-off jobs.

There are no further questions at this time. I'd like to hand the call back over to management 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 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 Q2 '21 results. Bye-bye.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.