Greetings and welcome to the Napco Security Technologies Fiscal First Quarter 2023 Results 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 turn the conference over to your host, Patrick McKillop, Vice President of Investor Relations. Thank you. You may begin.

Thank you. Good morning. My name is Patrick McKillop, Vice President of Investor Relations for Napco Security. Thank you for joining us for today's conference call to discuss our financial results for our fiscal first quarter 2023. 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 on 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, Executive Vice President and CFO. Before we begin, let me take a moment to read the forward-looking statements. 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 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 the 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…

Thank you, Patrick. Good morning, everyone, and welcome to our conference call. Thank you for joining us today to discuss our results. We are very pleased to report our fiscal Q1 2023 record sales of $39.5 million. Recurring revenue continue to grow at a very strong rate and the annual run rate is now approximately $58 million based on October 2022 recurring revenues. Our balance sheet remains strong with our cash balances at $44.4 million and we have no debt. We continue to focus on capitalizing on key industry trends, which include wireless fire and intrusion alarms, school security solutions, plus enterprise access control systems and architectural locking products. The management team, here at Napco continues to focus on the key metrics of growth, profits, returns on equity and controlling costs. These metrics are important for us, as well as our shareholders. We continue to execute our business strategy and our interests are aligned with our shareholders as senior management of Napco owns approximately 21% of the equity. Before I go into greater detail, I will now turn the call over to our CFO, Kevin Buchel, who will provide an overview of our fiscal first quarter results, and then I'll be back with more on our strategies and outlook. Kevin?

Thank you, Dick, and good morning, everybody. Net sales for the quarter increased 27% to a quarterly record of $39.5 million as compared to $31.1 million for the same period one-year ago. Our equipment sales in Q1 increased 23% to $25.7 million as compared $20.8 million for the same year ago period. Recurring monthly revenue continued its strong growth increasing 35% in Q1 to $13.8 million, compared to $10.2 million for the same period last year. Our recurring service revenues now have a prospective annual run rate of approximately $58 million, based on October 2022 recurring service revenues. The increase in equipment sales for the quarter were related to increases in all segments of our business, intrusion products, locking products, and access control products, they all increased. The strong growth of our recurring revenue is primarily attributable to the continued strength of our Starlink cellular radio products, driven by increases in the commercial intrusion and fire alarm business. Gross profit for the three months ended September 30, 2022, increased 35% to $18.2 million with a gross margin of 46%, as compared to $13.5 million with a gross margin of 43% for the same period a year ago. Gross profit for equipment sales for Q1 increased 29% to $6 million with a gross margin of 23% as compared to $4.7 million with a gross margin of 22% last year. Gross profit for recurring revenue for the first quarter increased 38% to $12.1 million with an 88% gross margin as compared to $8.8 million with a gross margin of 86% for the same period last year. The increase in gross profit dollars, as well as the 300 basis point increase in gross margin was primarily the result of the aforementioned increase in revenues, which leads to greater overhead of cost absorption in…

Kevin, thank you. Our first quarter was a sales record breaker continuing our sales growth streak, which is now our eighth consecutive quarter of year-over-year sales growth. Prior to the COVID pandemic, we had 23 consecutive quarters of growth and we look forward to surpassing that streak in the future. We are pleased that we were able to beat published street consensus estimates for revenue, EPS, net income, adjusted EBITDA metrics. One key area of our success continues to come from our commercial fire and intrusion alarm business. Today's news headlines are all about the continued interest rates hikes and when the U.S. might fall into a recession. I would like to remind you that our company is highly recession resistant as 80% of our business is commercial and one of our primary growth drivers, the commercial fire alarm business is a mandatory non-discretionary item. Commercial buildings must have and maintain a fire alarm system in order to receive a certificate of occupancy. Given the high profitability and essential nature of this business, we focus on this as a key area of our resources. Our equipment and recurring revenue, both generated exceptional growth this quarter increasing 23% and 35% respectively. The annual run rate for recurring revenue is now approximately 58 million as of October 2022. Our Starlink radios continue to have strong sales and we are optimistic that we can reach our previous mentioned goals of 150 million in recurring revenue and 150 million of equipment revenue by the end of fiscal 2026 or possibly sooner. Achievement of those goals, as well as our gross margin goals of 80% for recurring revenue and 50% for equipment revenue could generate EBITDA margins in excess of 45%. As the 3G sunset at the end of calendar 2022 is fast approaching and…

Thank you. [Operator Instructions] Our first question comes from Mike Walkley with Canaccord Genuity. Please state your question.

Great. Thanks for taking my questions and congratulations on the strong results.

Thank you, Mike.

I guess for both Kevin and Dick, it appears your focus on the commercial market is paying dividends, is some of your more consumer focused security competitors are struggling with poor results, especially compared to your strong results. Could you guys update us on the competitive environment? And with your record backlog levels, how is the commercial market holding up for your products?

We focus on the commercial and 80% of our business is commercial and we have a lot of new products coming out for the commercial market and we're doing a lot of marketing. In fact, the show that's coming up in the Javit Center, we are going to be holding a seminar on the trade show floor we're going to do a party for the dealers. A lot of dealers want to know about commercial. They are tired of the residential [doggy dog] [ph]. They want to go into the commercial business, which is much more stable. So, we're going to be showing our Air Access, which is our product, which will get us recurring revenue from the Access division of our company, as well as the locking division, and we expect to have – the show is going to have thousands of dealers coming from all over the Northeast to the show and we've gotten the most requests to come to the seminar ever in our history of our company. So, obviously commercial is a great success and it's very stable as we know, because they have a certificate of occupancy for a building. Even if half the employees come to work, they still have to keep the alarm systems working, and they got to do it either through upgrading the copper, which is being taken out of service or putting in new systems and we make both. We make the [rip] [ph] and replace type of equipment, as well as brand new equipment for new jobs. So, our dealers are very busy doing that work. So, it's a very strong growth area for the company.

Great. Thanks. And that's great to hear the excitement for Air Access at ISC next week. I just want to clarify Air Access that recurring revenue piece since it takes a while to train the channel that is excluded from your fiscal 2026 forecast, if it starts to pick up, would that be up side or is it included in those longer-term forecasts?

Right, Mike. So, you're right. So Air Access is not included in our 2026 goals. That's going to be [gravely] [ph] on top of what's a very exciting 2026 goal. and Air Access’ new product takes about 18 months to really start seeing results. So, we came out with it beginning of this calendar year. We think by next year, going to start to see some good action from Air Access, but it's not part of the 150, 150.

Great. That's helpful. Last question from me and I'll pass the line. Kevin, you're using the strong balance sheet as a competitive advantage in inventory levels are elevated. What would net cash be if you're at more normal inventory levels and two part to that question. Just with the excess cash you guys are building on your balance sheet, what are thoughts of what you might do with that cash as it continues to accumulate as you start to hit these longer-term goals? Thank you.

So Mike, if we didn't have to increase the inventory to keep things moving along, our cash balance probably would have been 70 million instead of 44 million. but we do what we have to do because we want those sales and those profits to keep going. This is going to start to change. The inventory we believe is going to start to come down in the second half of fiscal 2023. That will help cash grow. Cash grows every month because of recurring revenue. The first of the month cash comes pouring in. We've had to use it for inventory. When that changes and it's going to change soon, the cash number itself will start to grow. What are we going to do with it? The high class problem. Again, we've studied different things. Acquisitions, we don't need one. If somebody comes to us with a perfect company to be acquired, we'd consider it, but it's got to be just right. It's got to be something we can manufacture in the Dominican Republic. Got to be something that's accretive from day one. We got to be able to sell it in our channel. We want to pay a fair multiple, things like that. Somebody comes to us with that, we're interested. If not, we've got plenty to do and plenty of ammunition to hit our goals. Somebody said, why don't you do it with dividend? We'll consider that. Somebody says, buyback stock. We've done that in the past. They're all good ideas, high-class problems, and we will figure out what to do.

Okay. Well, congrats again on the strong results and I'll pass the line.

Thanks, Mike.

Thank you.

Our next question comes from Jim Ricchiuti with Needham & Company. Please go ahead.

Hi. Thank you. Good morning. Just wanted to again, go back to the hardware margins because there are some moving parts here, obviously. To what extent have you had to step-up even further the procurement of some of these hard to get parts? And how do we think about that relative to the benefit, the tailwind you're getting from price increases?

Yes. So, we've had to – we do whatever we have to do to get those hard to get points. And that means paying much higher pricing. You try to get it from the supplier. Supplier tells you nothing available until 2024. We can't wait around. So, we go to brokers. The broker market, you pay more, but what it does is, it allows us to keep manufacturing radios and it allows us to get that 88% gross margin recurring revenue. So, it's well worth doing, but we don't want to live its way forever. So, we have started to develop alternative sources. From the traditional sources that are telling us to wait until 2024. We believe those alternatives are going to become available to us in the next – within six months. So, we might start to see that in Q3, our fiscal Q3, which is the January, February, March quarter, certainly by the April, May, June quarter. That's going to help margins get back to and probably exceed the levels they were before this whole supply chain mess started. So, we do what we have to do. The engineers also, if we ask them to, they develop alternatives, substitution of parts. But whatever has to be done, we do to keep that strong revenue going and strong recurring revenue. You see the results this quarter paid off.

Well Kevin, in the near term potentially still some choppiness in hardware margins until you start seeing some of the benefit of this?

Right. Supply chain is not over. There has been some easing of freight costs, freight costs have come down a bit. It's gotten a little easier on some of the difficult components, but it's still out there. It's still out there Jim and we're going to keep doing what we have to do until it's over.

And my follow-up question just relates to the channel. I mean, you sound like you're hearing pretty good things in the channel. You suggested you're seeing some share gains. Just in terms of sell-through. Any color you could provide on that? Thank you.

Our key distributors sell-through stats when compared to a year ago, very impressive. Top three of four guys all about last year. So, that's very encouraging. We watch that like a hawk. We watch it every month and we summarize it quarterly. All moving in the right direction. Very powerful stats and we expect it to continue going forward.

Jim, if you come to the show, as you are based in New York City, you come to the Javit Show, you'll see our booth. You'll see our products. They are head and shoulders better than the competition. They look different. They have different antenna systems because the dealers want to get long range out of their products. They have different functionality. They have just a different look to them, compared to everything else that's out there, plus we deliver. We keep those assembly lines working with, as Kevin said, with the different ways of getting parts, redesigning parts to fit into the circuit boards. We keep picking up more and more share. We're hearing that all over the place. That's why there's a big turnout for people to come and see the Air Access. We're going to do a 45-minute seminar, Day 1 November 16 of the show. And we expect that that's going to be a big contributor and it's going to round out our product lines that every one of our segments of security is going to have a recurring revenue return to it. So, you'll be able to see that and we welcome you and any of the other investors and analysts to come to the show.

Thanks for the invitation. Congrats on the quarter by the way.

Thanks, Jim.

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

Hey, guys. Thanks for taking my questions. I just want to follow-up on the equipment gross margin. It sounds like you expect some return to normalization sort of in that March and June quarter, is that confidence really just driven by the expectation for some of the supply constraints and pricing challenges to start to ease or really more driven by the price increases you guys are starting to flow through?

There's multiple factors that make us feel confident that it's going to be better, certainly by the second half of fiscal 2023. Yes, we took price increase in April. We took another one in July. That has to help. We didn't do on October 1. We're looking, we may do another one, January, but we haven't made that decision yet. So, that's one factor. The mix is a factor. We're seeing the locking sales really pick up. Locking sales have a stronger gross margin than radios, radios we love because of the recurring, but the actual hardware sales, the locking is much higher margins. We're seeing that pick up. And by January or sometime in Q3, maybe Q4 we're going to start buying these crazy priced parts, these difficult chips that we're paying in some cases 10x more than we have to. We're going to see that go back to more normalized pricing. That's why we're so encouraged. We hang in for a little longer, you see the kind of numbers we put on the board even with paying these prices. Picture what it's going to look like when we could pay more normalized pricing. A $5 chip, not a $30 chip. That's why we're very optimistic.

One of the other things that advantages we have as we get more normalized is, we're spending a lot of line with our engineers, redesigning software and hardware such that we can get a flow of these components utilizing other components that we've never utilized before, but we'll work in our products if we redesign the software and change the board's around. So, we have a great engineering team here and we have a lot of very exciting products on tap to create more volume for us and more recurring revenue, but they're taking a little bit of a back seat right now because of the fact that we're having the engineering departments keeping the lines going with the rejiggering of the circuit boards and the housings and things like that, so we can keep a steady flow of finished goods. But as Kevin is talking about, as soon as we get normalized, which is going to happen in the couple of quarters, then those engineers can go back to come up with the exciting things that the dealers are wanting. We do lots of focus groups. We have a great industry reputation. Top in the business, we are like the top dog of manufacturing the radios. Our hardware is very, very special, and we have a lot of new ideas that we want to introduce to the marketplace and it's going to be a very exciting future. And as we get back to full new development instead of spending time on rejiggering components and circuit boards, it'll just drive our business to the highest heights. So, very excited about that.

Okay. That's helpful. And then just as a follow-up, looking at the school security market, in your prepared remarks, you called out some funding obviously still a big focus on school security. Curious if you've seen any change in the deal size in that market? And I guess, relatedly, historically pre-COVID, you did see some sort of seasonality throughout your fiscal year in that market. Do you expect that to continue here in this fiscal year?

I don't think seasonality is an issue anymore. K-12 after the shooting in Uvalde, Texas, they want to do whatever they could do right away. And really what the main thing they have to do is, they have to give the teachers the ability to lock the classrooms from the inside. That's the biggest problem in K-12. It's a simple solution. So, we're seeing a lot of activity. Hopefully, it's going to lead to a lot more sales, but we're seeing a lot. And they don't have to wait. They could do these jobs, while the kids are still in school. In the old days, years ago, they used to want to do it during the December break or during the summer. Those days are over. These schools can afford to wait. They have to act now. We're seeing a lot of activity in the K-12 markets. Universities also, but the big change I've seen in K-12 since Uvalde. In the marketplace K-12, we make two different types of locks that the schools like. One is with the remote control clicker, so that it could be locked across the classroom by the teacher or authorized person. And they don't have to get near the door because there's been a lot of shootings through the doors. So, we make that and we're very good at making wireless and unique products and we're doing very well with the remote control locks. Then we also make a conventional lock, which is more economical, which is, what they call the Grade 1 lock, it's the highest security type of lock, fits on the door, replaces the existing lock, and it has a mechanical flipper on the back of it, which allows the door to be locked because the doors in schools swing outward and there's no locks on the inside. They're all key operated on the outside, which is the way they built schools. So, with our replacement lock and we're selling a lot of hardware as Kevin was alluding to, it's going into all kinds of commercial buildings, schools, and we make it two ways: wirelessly and we make it with flipper. So, we have a very, very good line of products, which are Grade 1 for the schools. and hospitals. We see them all over in the hospitals, all over. Everywhere you want to keep the bad guys out.

Okay. Appreciate the color. Thanks guys.

Thanks Jaeson.

Our next question comes from Brain Ruttenbur with Imperial Capital. Please state your question.

Yes, thank you very much. Quick question. In terms of a price increase, how much was from volume versus price increases? In terms of – sorry, your revenue from equipment revenue grew 23%. So, how much of that growth was from pricing versus volume?

I would say, the majority was from volume. The pricing took effect. The second one was July 1 and it wasn't a huge price increase. Most of the 23% came from selling more radio, selling more locks. If I had to break it out, I would say 18% growth, the rest price increase.

Okay. And then just one question on, in terms of competitive environment, can you talk about the way you're gaining market share is because the competitors, A, don't have the product or B, that your product is less expensive or is it superior? Can you talk a little bit more about that? You're talking about your product being better, but is it because the competitor just doesn't have a product out there that's available?

When we design our products, we design them with features that are very, very important to the dealers. And we design our products as a universal, so they work on all kinds of applications. A lot of our competitors, most of them make it for their own ecosystem and they're not universal. So, the dealers have a product, which has a lot of functionality and works in every system. We put a lot of extra features on it. If you take a look at our radios as two big rabbit ears stuck up on the top of it, which kind of parrots what the cellular towers look like because it amplifies the signals. If you look at the competitors, they have a little pencil sticking up on the top of the thing and it doesn't have the same punch through as our radios. As an example, as a visible example. When you take a look at our software, it works in a way which is very easy for the consumer, the end user to utilize and the product installs very quickly. Then you take a look at the hardware for schools, the complete product line, where we have the mechanical ones, we have the electro mechanical, and we have the wireless versions. So, a deal that can get every single functionality. And the functionality is very rich, compared to the competition. We've prepared checklists and we know what we have to add to it. And we've been doing this a long time. So, we've added a lot of function reality that the competition doesn't have, that's very wide ranging. If you come to the show, you'll be able to see it. You can walk over to another competitor's booth, look at what they got, and just look at what we've…

And what you're going to hear is, also they can't get delivery. On top of everything they just said, the competition is quoted 26-weeks, 32-weeks, guys can't wait. These are commercial jobs. They can't wait. It allows us to get in there, deliver and pick-up market share.

As we get into these dealers and because they're getting delivery and they find the products are really superior then they say, well, what else have you got? And we show them other things, which are helpful to them. So, it allows us really expand our market, our product placement in these dealers in a wider area. So, from the point of view of COVID helped us get pickup share because we know how to reengineer, we know how to deal with a lot of the vendors because over the years we've had shortages of components and we just put our techniques into play. So, it’s working out very well.

Great. Thank you very much.

Thanks, Brian.

Our next question comes from Raj Sharma with B. Riley. Please state your question.

Yes, thanks for taking my questions again. Congratulations on the solid results. It's fantastic, amazing. Especially given where a lot of competitors focused on the residential are showing some struggles and your pickup also in recurring revenues is showing strength as you had indicated earlier, are you – as far as sell-through at dealers, are you – so, what I'm hearing is, that you're not seeing any indications of delays or pullbacks at all given, kind of where the flavor of the economy is currently?

No, not yet and hopefully not ever. Again, we look at these stats every month and through September, very strong sell-through versus a year ago. And that's what we look at and looking really good. Hopefully, it keeps up.

Perfect. Perfect. And then on the school security side, any sort of indications that the actual school security sales are picking up, how do we – I mean, obviously, locks and access, how do we tell what and sort of what percentage of the business this quarter could – would you say was – would be attributed to security projects?

We can't tell you that Raj. I wish I could. A lot of these sales go directly to distribution, we don't even know who it's for. But I am seeing locking sales are picking up and that’s usually an indication that schools is a nice big part of that. And locking has become stronger like it was pre-COVID. During COVID, it got weaker. Now, it's picking up again. I'm sure that has something to do with schools, but I can't tell you specifically.

Got it. And then any traction in – on Air Access, and, you know, are you doing sales on that product?

Yes. We're selling Air Access. And as we said, there's always a delay when you introduce a product because our products are highly technical, so we have to train a lot of dealers. But as I said earlier on the conversation, the number of inquiries to come to our seminar and talk about our product of Air Access is the greatest in the history of the company, compared to other introductions. So that bodes well for the dealers wanting this type of product. We spent a lot of time developing it. We had a lot of focus groups on it, and it hits the spot just right for access control dealers where they can get recurring revenue utilizing cell service instead of hardwires and traditional IT type of installations. So, this is very exciting for us and that's why at the show we have the seminar, we're going to be training dealers, and this is a very big show. Thousands of dealers are coming to this show. And the buzz is starting now. But as Kevin said before, the 2026 goal of [150 million [ph] recurring, and 150 million in hardware does not even include the Air Access recurring revenues and hardware sales that we expect.

Great. Great. And then on the sales backlog and you reported that number in the past. What was the amount currently and sort of how many quarters do you think you could you could satisfy that backlog in?

So, the backlog, it's still at historic levels. At the end of March, it was about 10 million; at the end of June, it was about 10 million; at the end of September, it was between 6 million and 7 million. And it's not the same 6 million to 7 million within that 10 million. It's new. The more we [ship] [ph], the more we get rid of the backlog, more orders come in.

It's [turning] [ph]. So, orders are rushing in very, very quickly.

So it's still a pretty big number. We're not used to those kind of numbers, but it's good as we head into this new quarter.

Great. Great. Thank you again. Great. Great. Fantastic quarter. Thank you for taking my questions. I'll take this offline. Thank you.

Thanks Raj.

Thank you.

Thank you. There are no further questions at this time. I'll turn the floor back over to management for 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 2023 results. Thank you for listening and bye-bye.

Thank you. This concludes today's conference. All parties may disconnect. Have a great day.